Annual Reports

 
Quarterly Reports

  • 10-Q (Nov 9, 2017)
  • 10-Q (Aug 3, 2017)
  • 10-Q (May 8, 2017)
  • 10-Q (Nov 7, 2016)
  • 10-Q (Aug 4, 2016)
  • 10-Q (May 5, 2016)

 
8-K

 
Other

Windstream 10-Q 2007
Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

 

þ               

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

 

¨               

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-32422

WINDSTREAM CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   20-0792300

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4001 Rodney Parham Road,

Little Rock, Arkansas

  72212
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (501) 748-7000

 


(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ YES ¨ NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨            Accelerated filer þ            Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). ¨ YES þ NO

Number of common shares outstanding as of July 31, 2007: 477,395,581

The Exhibit Index is located on page 52.

 



Table of Contents

WINDSTREAM CORPORATION

FORM 10-Q

TABLE OF CONTENTS

 

          Page No.
PART I – FINANCIAL INFORMATION
Item 1.    Financial Statements   
  

Consolidated Balance Sheets – June 30, 2007 (unaudited) and December 31, 2006

   2
  

Consolidated Statements of Income (unaudited)

   3
  

Consolidated Statements of Cash Flows (unaudited)

   4
  

Consolidated Statements of Shareholders’ Equity (unaudited)

   5
  

Notes to Consolidated Financial Statements (unaudited)

   6
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    28
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    47
Item 4.   

Controls and Procedures

   48
PART II – OTHER INFORMATION
Item 1.    Legal Proceedings    49
Item 1A.    Risk Factors    49
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    *
Item 3.    Defaults Upon Senior Securities    *
Item 4.    Submission of Matters to a Vote of Security Holders    50
Item 5.    Other Information    *
Item 6.   

Exhibits

   50

* No reportable information under this item.

 

1


Table of Contents

WINDSTREAM CORPORATION

FORM 10-Q

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

(Millions)   

(Unaudited)

June 30,

    December 31,  
Assets    2007     2006  

Current Assets:

    

Cash and short-term investments

   $ 483.8     $ 386.8  

Accounts receivable (less allowance for doubtful accounts of $11.5 and $10.4, respectively)

     311.1       337.2  

Inventories

     44.3       43.5  

Prepaid expenses and other

     34.3       29.2  

Assets held for sale

     75.5       80.0  
                

Total current assets

     949.0       876.7  
                

Goodwill

     1,965.0       1,965.0  

Other intangibles

     1,076.4       1,100.4  

Net property, plant and equipment

     3,893.7       3,939.8  

Other assets

     122.3       148.8  

Total Assets

   $ 8,006.4     $ 8,030.7  
    

Liabilities and Shareholders’ Equity

                

Current Liabilities:

    

Current maturities of long-term debt

   $ 49.3     $ 32.2  

Accounts payable

     156.1       169.5  

Advance payments and customer deposits

     90.8       82.8  

Accrued dividends

     119.3       119.2  

Accrued taxes

     52.7       31.9  

Accrued interest

     143.2       148.2  

Other current liabilities

     41.3       68.4  

Liabilities related to assets held for sale

     29.2       32.4  
                

Total current liabilities

     681.9       684.6  

Long-term debt

     5,439.5       5,456.2  

Deferred income taxes

     1,002.2       990.8  

Other liabilities

     409.3       429.3  

Total liabilities

     7,532.9       7,560.9  

Commitments and Contingencies (See Note 8)

    

Shareholders’ Equity:

    

Common stock, $0.0001 par value, 1,000.0 shares authorized, 477.4 shares issued and outstanding at June 30, 2007

            

Additional paid-in capital

     562.7       550.5  

Accumulated other comprehensive income (loss)

     (136.5 )     (150.8 )

Retained earnings

     47.3       70.1  
                

Total shareholders’ equity

     473.5       469.8  

Total Liabilities and Shareholders’ Equity

   $   8,006.4     $ 8,030.7  

See the accompanying notes to the unaudited interim consolidated financial statements.

 

2


Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

     

Three Months

Ended June 30,

   

Six Months

Ended June 30,

 
(Millions, except per share amounts)    2007     2006     2007     2006  

Revenues and sales:

        

Service revenues

   $ 732.2     $ 603.5     $ 1,450.1     $ 1,208.2  

Product sales

     94.5       127.8       160.3       226.1  
                                

Total revenues and sales

     826.7       731.3       1,610.4       1,434.3  

Costs and expenses:

        

Cost of services (excluding depreciation of $101.7, $84.1, $201.6 and $172.1, respectively, included below)

     253.0       193.3       488.6       385.7  

Cost of products sold

     51.1       102.1       96.6       186.4  

Selling, general, administrative and other

     101.3       84.4       204.4       164.5  

Depreciation and amortization

     126.9       98.9       252.0       201.5  

Royalty expense to Alltel

           62.4             129.6  

Restructuring and other charges

     1.6       5.0       6.4       7.5  

Total costs and expenses

     533.9       546.1       1,048.0       1,075.2  

Operating income

     292.8       185.2       562.4       359.1  

Other income, net

     6.3             11.5       1.2  

Intercompany interest income from Alltel

           18.0             31.9  

Interest expense

     (108.1 )     (4.5 )     (222.8 )     (8.4 )
                                

Income before income taxes

     191.0       198.7       351.1       383.8  

Income taxes

     75.1       80.0       135.3       152.3  
                                

Net income

   $   115.9     $   118.7     $ 215.8     $ 231.5  

Earnings per share:

        

Basic

     $.24       $.29       $.46       $.57  

Diluted

     $.24       $.29       $.45       $.57  

See the accompanying notes to the unaudited interim consolidated financial statements.

 

3


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

     

Six Months

Ended June 30,

 
(Millions)    2007     2006  

Cash Provided from Operations:

    

Net income

   $ 215.8     $ 231.5  

Adjustments to reconcile net income to net cash provided from operations:

    

Depreciation and amortization

     252.0       201.5  

Provision for doubtful accounts

     11.2       10.3  

Stock-based compensation expense

     8.3       2.1  

Pension and postretirement benefits expense

     19.1       19.5  

Other, net

     7.3       6.4  

Changes in operating assets and liabilities:

    

Accrued taxes

     18.5       46.2  

Other current liabilities

     (27.3 )     (5.2 )

Other, net

     8.6       12.2  
                

Net cash provided from operations

     513.5       524.5  

Cash Flows from Investing Activities:

    

Additions to property, plant and equipment

     (178.0 )     (155.4 )

Other, net

     1.2       19.9  
                

Net cash used in investing activities

     (176.8 )     (135.5 )

Cash Flows from Financing Activities:

    

Dividends paid on common shares

     (238.5 )      

Dividends paid to Alltel prior to spin-off

           (98.8 )

Repayments of borrowings

     (500.1 )     (0.1 )

Debt issued, net of issuance costs

     498.9        

Changes in advances to Alltel prior to spin-off

           (292.0 )
                

Net cash used in financing activities

     (239.7 )     (390.9 )
    

Increase (decrease) in cash and short-term investments

     97.0       (1.9 )

Cash and Short-term Investments:

    

Beginning of the period

     386.8       11.9  

End of the period

   $ 483.8     $ 10.0  

See the accompanying notes to the unaudited interim consolidated financial statements.

 

4


Table of Contents

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(Millions, except per share amounts)    Additional
Paid-In
Capital
   Accumulated
Other
Comprehensive
Income (Loss)
    Retained
Earnings
    Total  

Balance at December 31, 2006

   $ 550.5    $ (150.8 )   $ 70.1     $ 469.8  

Net income

                215.8       215.8  

Other comprehensive income, net of tax: (See Note 10)

         

Change in projected benefit obligation of pension plan

          (10.1 )           (10.1 )

Amortization of actuarial gains/losses

          10.0             10.0  

Unrealized holding gains on interest rate swaps

          14.4             14.4  

Comprehensive income

          14.3       215.8       230.1  

Additional transfers from Alltel (See Note 3)

     3.9                  3.9  

Stock-based compensation expense

     8.3                  8.3  

Dividends of $0.50 per share declared to stockholders

                (238.6 )     (238.6 )

Balance at June 30, 2007

   $ 562.7    $ (136.5 )   $ 47.3     $ 473.5  

See the accompanying notes to the unaudited interim consolidated financial statements.

 

5


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

_____

 

1. Preparation of Interim Financial Statements:

In this report, Windstream Corporation and its subsidiaries are referred to as “Windstream”, “we”, or “the Company”. For all periods prior to the effective time of the merger with Valor Communications Group, Inc. (“Valor”) described herein, references to the Company include Alltel Holding Corp. or the wireline telecommunications division and related businesses of Alltel Corporation (“Alltel”).

The accompanying unaudited consolidated financial statements have been prepared based upon Securities and Exchange Commission (“SEC”) rules that permit reduced disclosure for interim periods. Certain information and footnote disclosures have been condensed or omitted in accordance with those rules and regulations. The accompanying consolidated balance sheet at December 31, 2006 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. In our opinion, these financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial condition for the interim periods shown including normal recurring accruals and other items. The results for the interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, this report should be read in conjunction with the consolidated financial statements and accompanying notes included in Windstream’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC on March 1, 2007.

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of probable losses and expenses. Actual results could differ from those estimates, and such differences could be material. Certain amounts previously reported have been reclassified to conform to the current year presentation of the consolidated financial statements. These reclassifications did not impact net or comprehensive income.

 

2. Accounting Changes:

Discontinuance of the Application of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation” – Historically, the Company’s regulated operations, except for certain operations acquired in Kentucky in 2002 and in Nebraska in 1999, followed the accounting for regulated enterprises prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 71. This accounting recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, certain intercompany revenues and expenses earned and incurred by the Company’s regulated subsidiaries were not eliminated because they were priced in accordance with Federal Communications Commission (“FCC”) guidelines and recovered through the regulatory process.

Due to continued access line loss resulting from increased levels of competition from alternative voice providers, as well as due to a shift of the customer base from rate-of-return markets to markets under an alternative form of regulation, Windstream determined in the third quarter 2006 that it was no longer appropriate to continue the application of SFAS No. 71 for reporting its financial results. Accordingly, the Company discontinued the application of SFAS No. 71 according to the provisions of SFAS No. 101, “Regulated Enterprises – Accounting for the Discontinuance of the Application of FASB Statement No. 71”, and began eliminating all intercompany revenues and related expenses.

Transactions with affiliates that were not eliminated under the provisions of SFAS No. 71 during the six months ended June 30, 2006 primarily included product sales, directory publishing royalties and sales, and sales of other telecommunications services. Sales of telecommunications equipment from the Company’s product distribution operations to the Company’s regulated subsidiaries resulted in $33.3 million and $61.9 million in product sales and cost of products sold for the three and six months ended June 30, 2006, respectively. These regulated subsidiaries also recognized $9.5 million and $19.1 million in service revenues for the three and six months ended June 30, 2006, respectively, related to royalties received from the directory publishing subsidiary (“Windstream Yellow Pages”), with Windstream Yellow Pages recognizing the offsetting royalty expense in cost of products sold. Miscellaneous billings by Windstream Yellow Pages to the regulated subsidiaries resulted in $2.1 million and $3.8 million in product sales and cost of products sold for the three and six months ended June 30, 2006, respectively. Amounts billed to other affiliates of the Company for interconnection and toll services resulted in $11.1 million and $21.7 million of service revenues and cost of services for the three and six months ended June 30, 2006, respectively.

 

6


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

2. Accounting Changes, Continued:

 

Change in Accounting Estimate – During April 2007, the Company completed studies of the depreciable lives of assets held and used in its Missouri operations and an operating subsidiary in Texas. The related depreciation rates were changed effective April 1, 2007. The depreciable lives were lengthened to reflect the estimated remaining useful lives of the wireline plant based on the Company’s expected future network utilization and capital expenditure levels required to provide service to its customers. The effect of the change on depreciation rates in the Missouri and Texas operations resulted in a decrease in depreciation expense of $1.8 million and an increase in net income of $1.1 million for the three months ended June 30, 2007.

Change in Accounting Principle – Windstream adopted Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes” on January 1, 2007. The adoption of FIN 48 resulted in no impact to either the Company’s reserves for uncertain tax positions or to retained earnings. At the adoption date, and as of June 30, 2007, the Company had approximately $1.3 million of gross unrecognized tax benefits, all of which relate to periods preceding the spin-off from Alltel, and all of which would impact its effective tax rate if recognized.

The Company is indemnified for these reserves for uncertain tax positions in accordance with the Tax Sharing Agreement with Alltel dated July 17, 2006; consequently, a corresponding receivable from Alltel equaling the gross unrecognized tax benefits plus accrued interest expense has been recognized.

Interest and penalties related to uncertain tax positions are recognized in income tax expense. As of June 30, 2007, the Company had accrued approximately $0.2 million of interest expense and penalties related to uncertain tax positions. For the six months ended June 30, 2007, interest expense recognized related to these uncertain positions was not significant.

The tax years 2003 – 2006 remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company has identified its federal tax return and state tax returns in Arkansas, Florida, Georgia, Kentucky, Nebraska, North Carolina, and Texas as “major” taxing jurisdictions.

The Company does not reasonably estimate that the unrecognized tax benefits will change significantly within the next twelve months.

Recently Issued Accounting Pronouncements – In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures related to fair value measurements that are included in a company’s financial statements. SFAS No. 157 does not expand the use of fair value measurements in financial statements, but emphasizes that fair value is a market-based measurement and not an entity-specific measurement that should be based on an exchange transaction in which a company sells an asset or transfers a liability (exit price). SFAS No. 157 also establishes a fair value hierarchy in which observable market data would be considered the highest level, while fair value measurements based on an entity’s own assumptions would be considered the lowest level. For calendar year companies like Windstream, SFAS No. 157 is effective beginning January 1, 2008. The Company is currently evaluating the effects, if any, that SFAS No. 157 will have on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115”. SFAS No. 159 allows measurement at fair value of eligible financial assets and liabilities that are not otherwise measured at fair value. If the fair value option for an eligible item is elected, unrealized gains and losses for that item shall be reported in current earnings at each subsequent reporting date. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparison between the different measurement attributes the company elects for similar types of assets and liabilities. This statement is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the application of the fair value option and its effect on its consolidated financial statements.

 

3. Spin-off of Company from Alltel Corporation and Merger with Valor Communications Group, Inc.:

On November 2, 2005, Alltel Holding Corp. was incorporated as a wholly-owned subsidiary of Alltel to hold Alltel’s wireline telecommunications business in connection with a contemplated spin-off of these assets. This wireline business was operated by certain other Alltel subsidiaries, which provided customers with local, long distance, network access, and

 

7


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

3. Spin-off of Company from Alltel Corporation and Merger with Valor Communications Group, Inc., Continued:

 

Internet services. These subsidiaries also sold and warehoused telecommunications products, published telephone directories for affiliates and other independent telephone companies, and provided billing and other information technology services to other carriers.

On July 17, 2006, Alltel completed the spin-off of Alltel Holding Corp. to its stockholders. Pursuant to the spin-off, Alltel transferred certain wireline assets and liabilities to Alltel Holding Corp. at their historical cost basis. During the first quarter of 2007, $4.7 million of additional net plant assets, $1.2 million of related deferred tax liabilities, and $0.4 million of additional pension assets were identified by Alltel as being attributable to Alltel Holding Corp. The Company recorded these balances in March 2007 as an adjustment to additional paid-in capital in the consolidated balance sheet.

Immediately after the consummation of the spin-off, Alltel Holding Corp. merged with and into Valor, with Valor continuing as the surviving corporation. The resulting company was renamed Windstream Corporation. The merger was accounted for using the purchase method of accounting for business combinations in accordance with SFAS No. 141, “Business Combinations”, with Alltel Holding Corp. serving as the accounting acquirer. The accompanying unaudited interim consolidated financial statements reflect the combined operations of Alltel Holding Corp. and Valor following the spin-off and merger transactions on July 17, 2006. Results of operations prior to the merger and for all historical periods presented are for Alltel Holding Corp.

In connection with the merger, the Company recorded $13.7 million of severance and severance-related costs and $4.1 million of contract termination costs in goodwill in accordance with Emerging Issues Task Force (“EITF”) Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination”. Of this liability, $4.8 million in severance and severance-related costs and $1.0 million of contract termination costs were paid during the six months ended June 30, 2007. The remaining liability of $2.8 million consists of a lease obligation assumed from Valor for a facility vacated following the merger. This amount will be paid over the remaining term of the lease through 2010 with cash from operations.

The following unaudited pro forma condensed consolidated statements of income of Windstream for the three and six months ended June 30, 2006, respectively, assume that the spin-off from Alltel and merger with Valor occurred as of January 1, 2006:

 

(Millions, except per share amounts)

   Three Months Ended    Six Months Ended
   2006    2006

Revenues and sales

   $852.7    $1,677.3

Net income

   $106.4    $   210.9

Earnings per share:

     

Basic

       $.22          $.45

Diluted

       $.22          $.45

The unaudited pro forma information presents the combined operating results of Alltel Holding Corp. and Valor, with the results prior to the acquisition date adjusted to include the pro forma impact of the following: the elimination of transactions between Alltel Holding Corp. and Valor; additional amortization of intangible assets resulting from the merger; the elimination of merger expenses; additional interest expense incurred on notes issued pursuant to the spin-off and merger; and the impact of income taxes on these pro forma adjustments utilizing Windstream’s statutory tax rate of 38.9 percent for the six months ended June 30, 2006.

The unaudited pro forma results are presented for illustrative purposes only and do not reflect the realization of potential cost savings, or any related restructuring costs. These pro forma results do not purport to be indicative of the results that would have actually been obtained if the merger occurred as of January 1, 2006, nor does the pro forma data intend to be a projection of results that may be obtained in the future.

 

8


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

4. Related Party Transactions:

 

For the six months ended June 30, 2006, certain services such as information technology, accounting, legal, tax, marketing, engineering, and risk and treasury management were provided to the Company by Alltel. Expenses were allocated based on actual direct costs incurred. Where specific identification of expenses was not practicable, the cost of such services was allocated based on the most relevant allocation method to the service provided: either net sales of the Company as a percentage of net sales of Alltel, total assets of the Company as a percentage of total assets of Alltel, or headcount of the Company as a percentage of headcount of Alltel. Total expenses allocated to the Company were $83.0 million and $149.3 million in the three and six months ended June 30, 2006, respectively. The costs of these services charged to the Company and the allocated liabilities assigned to the Company are not necessarily indicative of the costs and liabilities that would have been incurred if the Company had performed these functions as a stand-alone entity. However, management believes that methods used to make such allocations were reasonable.

For the periods through June 30, 2006, the Company maintained a licensing agreement with The ALLTEL Kansas Limited Partnership, an Alltel affiliate, under which the Company’s regulated subsidiaries were charged a royalty fee for the use of

the Alltel brand name in marketing and distributing telecommunications products and services. The amount of the royalty fee charged was computed by multiplying the regulated subsidiaries’ annual revenues and sales by 12.5 percent. In anticipation of the spin-off, Alltel and the Company terminated this licensing agreement on June 30, 2006 as the Company no longer uses the Alltel brand name.

For the six months ended June 30, 2006, the Company participated in the centralized cash management practices of Alltel. Under those practices, cash balances were transferred daily to Alltel bank accounts. The Company obtained interim financing from Alltel to fund its daily cash requirements and invested short-term excess funds with Alltel. The Company earned interest income on receivables due from Alltel and was charged interest expense for payables due to Alltel. Subsequent to the spin-off, Windstream no longer participates in this program as the Company has its own established cash management program. The interest rates charged on payables to Alltel were 5.95 percent in the six months ended June 30, 2006. Interest rates earned on receivables from Alltel were 4.99 percent in the six months ended June 30, 2006.

Subsequent to the spin-off, Windstream and Alltel continue to provide each other certain of the services discussed above, at negotiated rates pursuant to a transition services agreement. In addition to the transition services agreement, Windstream and Alltel entered into certain other agreements extending for periods of up to three years. Under those agreements, Alltel will continue to provide Windstream with network transport for its long distance operations and other services, while Windstream will continue to provide local phone service, long distance and broadband Internet service as well as certain network management services to Alltel, all at negotiated rates. In addition, Windstream and Alltel entered into a tax-sharing agreement that generally requires Alltel to indemnify Windstream for any taxes attributable to Windstream’s operations for periods prior to the spin-off, while Windstream must indemnify Alltel for any taxes resulting from the spin-off in certain circumstances.

 

5. Goodwill and Other Intangible Assets:

Goodwill represents the excess of cost over the fair value of net identifiable tangible and intangible assets acquired through various business combinations. The Company has acquired identifiable intangible assets through its acquisitions of interests in various wireline properties. The cost of acquired entities at the date of the acquisition is allocated to identifiable assets, and the excess of the total purchase price over the amounts assigned to identifiable assets is recorded as goodwill.

As of January 1, 2007, the Company completed the annual impairment reviews of its goodwill and indefinite-lived franchise rights and determined that no write-down in the carrying value of these assets was required. As of June 30, 2007 and December 31, 2006, the carrying value of the indefinite-lived wireline franchise rights in the state of Kentucky acquired in 2002 was $265.0 million. As of June 30, 2007 and December 31, 2006, the carrying value of the indefinite-lived wireline franchise rights in the Valor properties acquired during 2006 was $600.0 million.

 

9


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

5. Goodwill and Other Intangible Assets, Continued:

 

Intangible assets subject to amortization were as follows:

 

(Millions)

   June 30, 2007
   Gross
Cost
   Accumulated
Amortization
    Net Carrying
Value

Valor customer list

   $   210.0    $ (39.1 )   $ 170.9

Other customer lists

     67.6      (31.0 )     36.6

Cable franchise rights

     22.5      (18.6 )     3.9
                     
     $ 300.1    $ (88.7 )   $ 211.4
       

(Millions)

   December 31, 2006
   Gross
Cost
   Accumulated
Amortization
    Net Carrying
Value

Valor customer list

   $ 210.0    $ (19.2 )   $ 190.8

Other customer lists

     67.6      (27.6 )     40.0

Cable franchise rights

     22.5      (17.9 )     4.6
                     
     $ 300.1    $ (64.7 )   $ 235.4

The Valor customer list is amortized on an accelerated sum-of-the-years digits methodology over its estimated useful life of 9 years. Other customer lists are amortized on a straight-line basis over their estimated useful lives of 10 years. Cable franchise rights subject to amortization are amortized on a straight-line basis over their estimated useful lives of 15 years. Amortization expense for intangible assets subject to amortization was $12.4 million and $24.0 million for the three and six month periods ended June 30, 2007, respectively, as compared to $2.0 million and $4.0 million for the same periods in 2006. Amortization expense for intangible assets subject to amortization is estimated to be $48.0 million in 2007, $43.4 million in 2008, $38.7 million in 2009, $32.6 million in 2010 and $27.9 million in 2011.

 

6. Debt and Derivative Instruments:

Long-term debt was as follows:

 

(Millions)

   June 30,     December 31,  
   2007     2006  

Issued by Windstream Corporation:

    

Senior secured credit facility, Tranche A – variable rates, due July 17, 2011

   $ 500.0     $ 500.0  

Senior secured credit facility, Tranche B – variable rates, due July 17, 2013 (a)

     1,400.0       1,900.0  

Debentures and notes, without collateral:

    

2016 Notes – 8.625%, due August 1, 2016

     1,746.0       1,746.0  

2013 Notes – 8.125%, due August 1, 2013

     800.0       800.0  

2019 Notes – 7.00%, due March 15, 2019 (a)

     500.0        

Issued by subsidiaries of the Company:

    

Valor Telecommunications Enterprises LLC and Valor Telecommunications Finance Corp. – 7.75%, due February 15, 2015 (b)

     400.0       400.0  

Windstream Holdings of the Midwest, Inc. – 6.75%, due April 1, 2028 (b)

     100.0       100.0  

Debentures and notes, without collateral:

    

Windstream Georgia Communications Corp. – 6.50%, due November 15, 2013

     70.0       70.0  

Teleview, Inc. – 7.00%, due January 2, 2010 and May 2, 2010

     0.7       0.8  

Discount on long-term debt, net of premiums

     (27.9 )     (28.4 )
                
     5,488.8       5,488.4  

Less current maturities

     (49.3 )     (32.2 )
                

Total long-term debt

   $   5,439.5     $ 5,456.2  

 

 

(a)

On February 27, 2007, Windstream issued $500.0 million aggregate principal amount of senior notes due 2019, with an interest rate of 7.0 percent (“the February 27th refinancing transaction”). Windstream used the net proceeds of the offering to repay $500.0 million of amounts outstanding under the term loan portion of its senior secured credit facilities.

 

10


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

6. Debt and Derivative Instruments, Continued:

 

Additionally, Windstream received the consent of lenders to an amendment and restatement of its $2.9 billion secured credit facilities. Windstream amended and restated its senior secured credit facilities to, among other things, reduce the interest payable under tranche B of the term loan portion of the facilities; modify the pre-payment provision; and modify certain covenants to permit the consummation of the previously announced split off of its directory publishing business.

 

  (b) The Company’s collateralized subsidiary debt is equally and ratably secured with debt under the senior secured credit facilities.

The terms of the credit facility and indentures include customary covenants that, among other things, require Windstream to maintain certain financial ratios and restrict its ability to incur additional indebtedness. These financial ratios include a maximum leverage ratio of 4.5 to 1.0 and a minimum interest coverage ratio of 2.75 to 1.0. The leverage ratio is the ratio of indebtedness to adjusted EBITDA, and the interest coverage ratio is the ratio of adjusted EBITDA to cash interest expense. Adjusted EBITDA means (1) net income, adjusted to exclude the cumulative effect of accounting changes and certain other exceptions; plus (2) the following items, to the extent deducted from consolidated adjusted net income: (a) provision for taxes based on income or profits; (b) interest expense, to the extent deducted in computing net income; (c) depreciation, amortization, goodwill impairment charges and other non-cash expenses, subject to certain exceptions; plus (d) the amount of any minority interest expense deducted in computing net income; plus (e) any non-cash compensation charge arising from any grant of stock, stock options or other equity-based awards, to the extent deducted in computing net income; plus (f) certain non-cash income (or loss) related to hedging activities, to the extent deducted in computing net income; minus (g) non-cash items increasing such net income, subject to certain exceptions. In addition, the covenants include restrictions on capital expenditures, which must not exceed a specified amount for any fiscal year (for 2007 this amount is $530.0 million, which includes $80.0 million of unused capacity from 2006). The Company was in compliance with these covenants as of June 30, 2007.

Maturities and sinking fund requirements for debt outstanding as of June 30, 2007 for each of the twelve month periods ended June 30, 2008, 2009, 2010, 2011 and 2012 are $49.3 million, $74.3 million, $99.2 million, $99.0 million, and $299.0, respectively.

Interest expense was as follows for the three and six months ended June 30:

 

(Millions)

   Three Months Ended     Six Months Ended  
   2007     2006     2007     2006  

Interest expense related to long-term debt

   $ 107.8     $ 5.1     $  222.6 (a)   $ 9.5  

Impacts of interest rate swaps

     1.1             2.0        

Other interest expense

           0.1       0.1       0.1  

Less capitalized interest expense

     (0.8 )     (0.7 )     (1.9 )     (1.2 )
                                
     $ 108.1     $ 4.5     $ 222.8     $ 8.4  

 

  (a) In connection with the February 27, 2007 refinancing transaction, the Company recorded additional non-cash interest expense of $5.3 million due to a write-off of the unamortized debt issuance costs associated with $500.0 million of the term loan that was paid down.

Due to the interest rate risk inherent in the variable rate senior secured credit facilities, the Company entered into four pay fixed, receive variable interest rate swap agreements on notional amounts totaling $1,600.0 million to convert variable interest rate payments to fixed. The four interest rate swap agreements amortize quarterly to a notional value of $906.3 million at maturity on July 17, 2013, and have an unamortized notional value of $1,487.5 million as of June 30, 2007. The variable rate received by Windstream on these swaps is the three-month LIBOR (London-Interbank Offered Rate), which was 5.36 percent at June 30, 2007. The weighted-average fixed rate paid by Windstream is 5.60 percent. The interest rate swap agreements are designated as cash flow hedges of the interest rate risk created by the variable interest rate paid on the senior secured credit facilities pursuant to the guidance in SFAS No. 133, “Derivative Financial Instruments”, as amended.

 

11


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

6. Debt and Derivative Instruments, Continued:

 

After the completion of the February 27th refinancing transaction, a portion of one of the four interest rate swap agreements with a notional value of $125.0 million was no longer considered an effective hedge as the portion of the Company’s senior secured credit facility that it was designated to hedge against was repaid. Changes in the market value of this portion of the swap, which has an unamortized notional value of $115.6 million as of June 30, 2007, are recognized in net income, including $2.5 million and $2.9 million recognized as other income in the unaudited consolidated statement of income for the three and six months ended June 30, 2007, respectively.

 

7. Employee Benefit Plans and Postretirement Benefits Other Than Pensions:

Prior to the spin-off from Alltel, substantially all of the Company’s employees participated in a non-contributory, qualified defined benefit pension plan maintained by Alltel. In December 2005, the qualified defined benefit pension plan was amended such that future benefit accruals for all eligible nonbargaining employees ceased as of December 31, 2005 (December 31, 2010 for employees who had attained age 40 with two years of service as of December 31, 2005). Following the spin-off, Windstream established a qualified defined benefit pension plan whose provisions are substantially equivalent to the provisions of the plan maintained by Alltel. The Company also assumed certain obligations from a qualified pension plan formerly sponsored by Valor, which is also non-contributory.

The components of pension expense were as follows for the three and six months ended June 30, 2007:

 

(Millions)

   Three Months Ended    Six Months Ended
               2007               2007

Service cost

   $      3.7    $      7.8

Interest cost

         13.2          26.0

Expected return on plan assets

         (19.4)          (38.8)

Prior service cost

          —            (0.1)

Net actuarial loss

          6.6          12.1
         

Net periodic benefit expense

   $     4.1    $      7.0

Pension expenses allocated to the Company by Alltel amounted to $5.3 million and $8.2 million for the three and six months ended June 30, 2006, respectively. Pension expenses in both years are included in cost of services and selling, general, administrative and other expenses in the unaudited consolidated statements of income.

Windstream also maintains supplemental executive retirement plans that provide unfunded, non-qualified supplemental retirement benefits to a select group of former management employees. There are no assets held in these supplemental retirement pension plans, as the Company funds the accrued costs of the plans as benefits are paid. For the six months ended June 30, 2007, Windstream contributed $0.4 million to fund the supplemental executive retirement plans.

The Company provides postretirement healthcare and life insurance benefits for eligible employees. Employees share in the cost of these benefits. The Company funds the costs of these plans as benefits are paid. The Company also assumed certain obligations from a postretirement healthcare plan formerly sponsored by Valor, which was merged into the Company’s existing plan on December 31, 2006. Windstream contributed $9.8 million to the postretirement plan during the six months ended June 30, 2007. The components of postretirement benefits expense were as follows for the three and six months ended June 30:

 

(Millions)

   Three Months Ended    Six Months Ended
   2007    2006    2007    2006

Service cost

   $ 0.1    $    $ 0.2    $

Interest cost

     3.8      4.8      7.5      7.2

Transition obligation

     0.2           0.4     

Prior service cost

     0.6      0.7      1.0      1.2

Net actuarial loss

     1.4      1.6      3.0      2.9
                           

Net periodic benefit expense

   $ 6.1    $ 7.1    $ 12.1    $ 11.3

 

12


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

7. Employee Benefit Plans and Postretirement Benefits Other Than Pensions, Continued:

 

The Company has historically sponsored a non-contributory defined contribution plan in the form of profit-sharing arrangements for eligible non-bargaining employees. On December 31, 2006, this profit-sharing plan was terminated, and as of the period ended March 31, 2007, the profit-sharing plan assets were merged into the employee savings plan under section 401(k) of the Internal Revenue Code. Pursuant to the merger of these plans, the Company no longer contributes to employee profit sharing accounts, and has increased its matching contribution to employee savings accounts from a maximum of 4% to a maximum of 6% of employee pretax contributions. The Company’s final cash contribution to the profit sharing plan for the 2006 plan year, totaling $5.2 million, was made in the second quarter of 2007 into each participant’s 401(k) account. This amount was included in other current liabilities in the accompanying consolidated balance sheet at December 31, 2006.

 

8. Commitments and Contingencies:

On October 16, 2006, the Company received a negative ruling in a binding arbitration proceeding previously brought against Valor Communications Southwest LLC and Valor Communications Group, Inc., by former employees regarding stock option award agreements. On January 8, 2007, the arbitrator entered a final award for the former employees of $7.2 million for the value of options that the Company asserts were without value immediately prior to Valor’s initial public offering in February 2005. The Company had established a liability for this amount accounting for the merger with Valor in 2006. The basis for the award was the arbitrator’s finding that these particular claimants’ options were extended past the initial public offering date. The claimants have filed separate complaints to confirm the award in Oklahoma federal district court. The Company has filed motions in Oklahoma to dismiss, or alternatively to transfer, the complaints to Texas federal district court and also filed a separate motion to vacate the arbitrator’s award in Texas federal district court. The Company intends to vigorously assert and defend its position in the matter.

The Company is party to various other legal proceedings. Although the ultimate resolution of these various proceedings cannot be determined at this time, management of the Company does not believe that such proceedings, individually or in the aggregate, will have a material adverse effect on the future consolidated results of income, cash flows or financial condition of the Company.

In addition, management of the Company is currently not aware of any environmental matters that, individually or in the aggregate, would have a material adverse effect on the consolidated financial condition or results of operations of the Company.

 

9. Restructuring and Other Charges:

The following is a summary of the restructuring and other charges recorded in the three and six month periods ended June 30:

 

(Millions)

   Three Months Ended    Six Months Ended
   2007    2006    2007    2006

Fees associated with spin-off from Alltel

   $    $ 5.0    $    $ 7.5

Severance and employee benefit costs

               3.2     

Costs associated with split off of directory publishing business

     1.6           3.2     
                           

Total restructuring and other charges

   $ 1.6    $ 5.0    $ 6.4    $ 7.5

During the six months ended June 30, 2007, the Company incurred $3.2 million in accounting and legal fees and other expenses related to the anticipated sale of its directory publishing business (see Note 16). Of the total expenses incurred relating to the spin-off transaction, $1.6 million were recorded in the second quarter of 2007. The company also incurred $3.2 million in severance and employee related costs during the first quarter of 2007, primarily related to the continuation of a workforce reduction plan initiated during the fourth quarter of 2006 and concluded in the first quarter of 2007.

During the six months ended June 30, 2006, and in connection with the spin-off from Alltel and merger with Valor, the Company incurred $7.5 million of incremental costs, primarily consisting of consulting and legal fees. Of the total expenses incurred relating to the spin-off transaction, $5.0 million in fees were recorded in the second quarter of 2006.

 

13


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

9. Restructuring and Other Charges, Continued:

 

The following is a summary of the activity related to the liabilities associated with the Company’s restructuring and other charges for the six months ended June 30, 2007:

 

(Millions)        

Balance, beginning of period

   $ 28.9  

Restructuring expenses and other charges

     6.4  

Cash outlays during the period

     (19.7 )
        

Balance, end of period

   $ 15.6  

In the Company’s unaudited interim consolidated balance sheet at June 30, 2007, other current liabilities include a portion of this unpaid restructuring liability totaling $5.8 million, which consists of $2.9 million in severance and employee-related expenses related to the realignment of its operational functions, $2.8 million related to lease obligations on a vacated Valor facility, and $0.1 million of costs related to the spin-off from Alltel. The remaining unpaid restructuring liability of $9.8 million, which relates to fees resulting from the split off of the publishing business, is included in liabilities related to assets held for sale in the unaudited interim consolidated balance sheet at June 30, 2007.

 

10. Comprehensive Income:

Comprehensive income was as follows for the three and six month periods ended June 30:

 

(Millions)

   Three Months Ended    Six Months Ended
   2007     2006    2007     2006

Net Income

   $ 115.9     $ 118.7    $   215.8     $   231.5

Other comprehensive income (loss):

         

Change in projected benefit obligation of pension plan

     (16.7 )          (16.7 )    

Income tax benefit

     6.6            6.6      
                             
     (10.1 )          (10.1 )    
                             

Amortization of actuarial gains/losses

     8.7            16.4      

Income tax expense

     (3.4 )          (6.4 )    
                             
     5.3            10.0      
                             

Unrealized holding gains on interest rate swaps

     28.3            23.7      

Income tax expense

     (11.1 )          (9.3 )    
                             
     17.2            14.4      
                             

Other comprehensive income before income taxes

     20.3            23.4      

Income tax expense

     (7.9 )          (9.1 )    
                             

Other comprehensive income

   $ 12.4     $    $ 14.3     $

Comprehensive Income

   $ 128.3     $ 118.7    $ 230.1     $ 231.5

 

11. Earnings per Share:

Basic earnings per share of common stock was computed by dividing net income applicable to common shares by the weighted average number of common shares outstanding during each period. Diluted earnings per share reflects the potential dilution that could occur assuming conversion or exercise of all dilutive outstanding stock instruments.

Common shares in historical periods totaled 402.9 million and represented the shares issued to Alltel shareholders pursuant to the spin-off of the Alltel wireline division. Common shares in current periods include 70.9 million shares assumed through the merger with Valor.

 

14


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

11. Earnings per Share, Continued:

 

A reconciliation of the net income and numbers of shares used in computing basic and diluted earnings per share was as follows for the three and six month periods ended June 30:

 

(Millions, except per share amounts)

   Three Months Ended    Six Months Ended
   2007    2006    2007    2006

Basic earnings per share:

           

Net income applicable to common shares

   $ 115.9    $ 118.7    $   215.8    $   231.5

Weighted average common shares outstanding for the period

     473.5      402.9      473.5      402.9
                           

Basic earnings per share

     $.24      $.29      $.46      $.57

Diluted earnings per share:

           

Net income applicable to common shares

   $ 115.9    $ 118.7    $ 215.8    $ 231.5
                           

Weighted average common shares outstanding for the period

     473.5      402.9      473.5      402.9

Increase in shares resulting from:

           

Non-vested restricted stock awards

     1.3           1.2     
                           

Weighted average common shares assuming conversion

     474.8      402.9      474.7      402.9
                           

Diluted earnings per share

     $.24      $.29      $.45      $.57

 

12. Stock-Based Compensation:

Under the Company's stock-based compensation plans, Windstream may issue restricted stock and other equity securities to directors, officers and other key employees. The maximum number of shares available for issuance under the Windstream 2006 Equity Incentive Plan is 10.0 million shares. As of June 30, 2007, the balance available for grant under this Plan is approximately 6.1 million shares.

In May 2007, the Windstream Board of Directors approved an annual grant of restricted stock to certain management employees totaling approximately 215,000 common shares with a fair value on the date of the grant of approximately $3.0 million. This represents a standard annual grant to this employee group as a key component of their annual incentive compensation plan. These shares vest ratably over a three-year service period.

In February 2007, the Windstream Board of Directors approved grants of restricted stock to officers, executives, and non-employee directors totaling approximately 575,000 common shares with a fair value on the date of the grant of $8.5 million. This represents a standard annual grant to this employee and director group as a key component of their annual incentive compensation plan. Of the shares granted, approximately 325,000 shares contingently vest over a three-year period if performance-based operating targets are met each period. The operating target for the first vesting period was approved by the Board of Directors on February 6, 2007. Management has determined that it is probable that the target will be met for fiscal year 2007. The remaining shares vest ratably over a three-year service period, with the exception of approximately 35,000 shares granted to non-employee directors that vest over a one-year service period.

Non-vested Windstream restricted stock activity for the six months ended June 30, 2007 was as follows:

 

      (Thousands)    

Weighted Average
Fair Value Per Share

   Number of
Shares
   

Non-vested at December 31, 2006

   3,243.2     $12.55

Granted

   790.7     $14.87

Vested

   (0.3 )   $12.60

Forfeited

   (135.8 )   $12.84
          

Non-vested at June 30, 2007

   3,897.8     $13.01

 

15


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

12. Stock-Based Compensation, Continued:

 

At June 30, 2007, unrecognized compensation expense for non-vested Windstream restricted shares was $29.6 million. The unrecognized compensation expense for these non-vested restricted shares has a remaining weighted average vesting period of 2.0 years. Stock-based compensation expense was $4.5 million and $8.3 million for the three and six month periods ended June 30, 2007, respectively, as compared to $1.1 million and $2.1 million for the same periods of 2006. Expense recorded prior to the spin-off from Alltel was related to shares of Alltel common stock issued to the Company’s employees under Alltel’s stock compensation plans.

 

13. Supplemental Cash Flow Information:

During the six months ended June 30, 2007, the Company declared and accrued $119.3 million in dividends payable to shareholders of record on June 29, 2007. These dividends were subsequently paid on July 16, 2007. The Company also recorded an increase in the fair value of its interest rate swap agreements during the period, resulting in a non-cash decrease in other liabilities of $26.6 million.

During the six months ended June 30, 2006, Alltel transferred to the Company various assets and liabilities pursuant to the spin off, including $113.0 million in net plant assets, $200.4 million in pension assets and $93.7 million in net deferred income tax assets, which were included in net property, plant and equipment, other assets and deferred income taxes, respectively, in the Company’s unaudited consolidated balance sheet at June 30, 2006.

 

14. Business Segment Information:

The Company disaggregates its business operations based upon differences in products and services. The Company’s wireline segment consists of Windstream’s retail and wholesale telecommunications services, including voice service, long distance, data and special access, switched access and Universal Service Funds and miscellaneous and other services in 16 states. The Company does not have separate segment managers overseeing its retail and wholesale telecommunications services. Therefore, in assessing operating performance and allocating resources, the chief operating decision maker’s focus is at a level that consolidates the results of all services. In addition, incentive-based compensation for the wireline segment manager is directly tied to the combined operating results of the Company’s total wireline operations. Accordingly, the Company manages its wireline-based services as a single operating segment.

The product distribution segment consists of warehouse and logistics operations, and it procures and sells telecommunications infrastructure and equipment to both affiliated and non-affiliated businesses. It operates four warehouses across the United States.

Other operations consist of the Company’s directory publishing and telecommunications information services. The Company’s publishing subsidiary coordinates advertising, sales, printing, and distribution for 364 telephone directory contracts in 34 states. On December 12, 2006, Windstream announced that it would split off its directory publishing business (see Note 16). Immediately after the consummation of the spin-off and merger with Valor, the telecommunications information services operations no longer incurred revenues and expenses for providing data processing and outsourcing services as Valor was its sole external customer.

The Company accounts for intercompany sales at current market prices. The evaluation of segment performance is based on segment income, which is computed as revenues and sales less operating expenses, excluding the effects of the restructuring and other charges discussed in Note 9. In addition, non-operating items such as other income, net, intercompany interest income from Alltel, interest expense and income taxes have not been allocated to the segments.

 

16


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

14. Business Segment Information, Continued:

 

Segment operating results were as follows for the three and six month periods ended June 30:

 

(Millions)

   Three Months Ended     Six Months Ended  
   2007     2006     2007     2006  

Revenues and Sales from External Customers:

        

Wireline

   $ 752.4     $   589.2     $ 1,485.0     $ 1,179.3  

Product distribution

     33.0       36.6       63.8       70.4  

Other operations

     41.3       49.5       61.6       78.1  
                                

Total

   $ 826.7     $ 675.3     $ 1,610.4     $ 1,327.8  
                                

Intersegment Revenues and Sales:

        

Wireline

   $ 28.5     $ 37.7     $ 46.3     $ 70.5  

Product distribution

     52.5       46.4       104.9       81.7  

Other operations

     4.6       3.2       6.4       5.1  
                                

Total

   $ 85.6     $ 87.3     $ 157.6     $ 157.3  
                                

Total Revenues and Sales:

        

Wireline

   $ 780.9     $ 626.9     $ 1,531.3     $ 1,249.8  

Product distribution

     85.5       83.0       168.7       152.1  

Other operations

     45.9       52.7       68.0       83.2  
                                

Total business segments

     912.3       762.6       1,768.0       1,485.1  

Less intercompany eliminations

     (85.6 )     (31.3 )     (157.6 )     (50.8 )
                                

Total revenues and sales

   $ 826.7     $ 731.3     $ 1,610.4     $ 1,434.3  
                                

Segment Income:

        

Wireline

   $ 289.4     $ 181.6     $ 566.6     $ 356.9  

Product distribution

     0.3       2.9       (0.5 )     4.1  

Other operations

     4.7       5.7       2.7       5.6  
                                

Total segment income

     294.4       190.2       568.8       366.6  
                                

Restructuring and other charges

     (1.6 )     (5.0 )     (6.4 )     (7.5 )

Other income, net

     6.3             11.5       1.2  

Intercompany interest income from Alltel

           18.0             31.9  

Interest expense

     (108.1 )     (4.5 )     (222.8 )     (8.4 )
                                

Income before income taxes

   $ 191.0     $ 198.7     $ 351.1     $ 383.8  
                                

Segment assets were as follows:

(Millions)

               June 30,
2007
    December 31,
2006
 

Wireline

       $   7,882.1     $ 7,897.1  

Product distribution

         49.2       53.8  

Other operations (a)

         75.1       79.8  
                    

Total consolidated assets

                   $ 8,006.4     $ 8,030.7  
  (a) Other segment assets consist of directory publishing assets held for sale.

 

17


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

14. Business Segment Information, Continued:

 

Supplemental information pertaining to other operations was as follows for the three and six month periods ended June 30:

 

(Millions)

   Three Months Ended    Six Months Ended
   2007    2006    2007    2006

Revenues and Sales from External Customers:

           

Directory publishing

   $ 41.3    $ 45.4    $ 61.6    $ 70.0

Telecommunications information services

          4.1           8.1
                           

Total

   $ 41.3    $ 49.5    $ 61.6    $ 78.1
                           

Intersegment Revenues and Sales:

           

Directory publishing

   $ 4.6    $ 3.2    $ 6.4    $ 5.1
                           

Total

   $ 4.6    $ 3.2    $ 6.4    $ 5.1
                           

Total Revenues and Sales:

           

Directory publishing

   $ 45.9    $ 48.6    $ 68.0    $ 75.1

Telecommunications information services

          4.1           8.1
                           

Total revenues and sales

   $ 45.9    $ 52.7    $ 68.0    $ 83.2

 

18


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information:

 

In connection with the issuance of the 2013 Notes, the 2016 Notes and the 2019 Notes (“the guaranteed notes”), certain of our wholly-owned subsidiaries (the “Guarantors”), including all former subsidiaries of Valor, provided guarantees of those debentures. These guarantees are full and unconditional as well as joint and several. Certain Guarantors may be subject to restrictions on their ability to distribute earnings to the Company. The remaining subsidiaries (the “Non-Guarantors”) of Windstream are not guarantors of the guaranteed notes. In conjunction with the merger with Valor, Windstream assumed $400.0 million principal value of unsecured notes (the “Valor Notes”) guaranteed by all of Valor’s operating subsidiaries. The terms of those notes were amended to reflect the non-Valor Guarantors as guarantors of the Valor Notes.

The following information presents condensed consolidated statements of income for the three and six months ended June 30, 2007 and 2006, condensed consolidated balance sheets as of June 30, 2007 and December 31, 2006, and condensed consolidated statements of cash flows for the six months ended June 30, 2007 and 2006 of the parent company, the Guarantors, and the Non-Guarantors. Investments include investments in a non-consolidated affiliate as well as investments in net assets of subsidiaries held by the parent company and have been presented using the equity method of accounting.

 

    

Condensed Consolidated Statement of Income (Unaudited)

Three Months Ended June 30, 2007

 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

          

Service revenues

   $     $ 193.8     $ 558.8     $ (20.4 )   $ 732.2  

Product sales

           121.8       13.6       (40.9 )     94.5  
                                        

Total revenues and sales

           315.6       572.4       (61.3 )     826.7  

Costs and expenses:

          

Cost of services

           59.0       195.2       (1.2 )     253.0  

Cost of products sold

           101.4       9.8       (60.1 )     51.1  

Selling, general, administrative and other

     (0.4 )     31.8       69.9             101.3  

Depreciation and amortization

           41.8       85.1             126.9  

Restructuring and other charges

           1.6                   1.6  
                                        

Total costs and expenses

     (0.4 )     235.6       360.0       (61.3 )     533.9  

Operating income

     0.4       80.0       212.4             292.8  

Earnings from consolidated subsidiaries

     186.2       16.7       2.0       (204.9 )      

Other income (expense), net

     6.8       (0.5 )                 6.3  

Intercompany interest income (expense)

     (11.5 )     (8.4 )     19.9              

Interest expense

     (106.1 )     (1.6 )     (0.4 )           (108.1 )
                                        

Income before income taxes

     75.8       86.2       233.9       (204.9 )     191.0  

Income taxes (benefit)

     (40.1 )     23.9       91.3             75.1  
                                        

Net income

   $ 115.9     $ 62.3     $ 142.6     $ (204.9 )   $ 115.9  

 

19


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

    

Condensed Consolidated Statement of Income (Unaudited)

Six Months Ended June 30, 2007

 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

          

Service revenues

   $     $ 386.7     $ 1,091.7     $ (28.3 )   $ 1,450.1  

Product sales

           218.5       24.9       (83.1 )     160.3  
                                        

Total revenues and sales

           605.2       1,116.6       (111.4 )     1,610.4  

Costs and expenses:

          

Cost of services

           110.8       379.9       (2.1 )     488.6  

Cost of products sold

           185.7       20.2       (109.3 )     96.6  

Selling, general, administrative and other

           63.6       140.8             204.4  

Depreciation and amortization

           84.5       167.5             252.0  

Restructuring and other charges

           4.3       2.1             6.4  
                                        

Total costs and expenses

           448.9       710.5       (111.4 )     1,048.0  

Operating income

           156.3       406.1             562.4  

Earnings from consolidated subsidiaries

     363.8       26.3       (1.6 )     (388.5 )      

Other income (expense), net

     11.9       (0.3 )     (0.1 )           11.5  

Intercompany interest income (expense)

     (23.0 )     (18.4 )     41.4              

Interest expense

     (218.9 )     (3.0 )     (0.9 )           (222.8 )
                                        

Income before income taxes

     133.8       160.9       444.9       (388.5 )     351.1  

Income taxes (benefit)

     (82.0 )     46.7       170.6             135.3  
                                        

Net income

   $ 215.8     $ 114.2     $ 274.3     $ (388.5 )   $ 215.8  

 

20


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Income (Unaudited)  
     Three Months Ended June 30, 2006  
(Millions)    Parent    Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

           

Service revenues

   $    $ 77.9     $ 520.2     $ 5.4     $ 603.5  

Product sales

          138.0       9.8       (20.0 )     127.8  
                                       

Total revenues and sales

          215.9       530.0       (14.6 )     731.3  

Costs and expenses:

           

Cost of services

          25.2       157.9       10.2       193.3  

Cost of products sold

          118.7       8.0       (24.6 )     102.1  

Selling, general, administrative and other

          17.1       67.3             84.4  

Depreciation and amortization

          16.2       82.7             98.9  

Royalty expense to Alltel

          9.0       53.4             62.4  

Restructuring and other charges

          6.9       (1.9 )           5.0  
                                       

Total costs and expense

          193.1       367.4       (14.4 )     546.1  

Operating income

          22.8       162.6       (0.2 )     185.2  

Earnings from consolidated subsidiaries

                             

Other income (expense), net

          (0.2 )     0.2              

Intercompany interest income from Alltel

          1.3       16.7             18.0  

Interest expense

          (1.9 )     (2.6 )           (4.5 )
                                       

Income before income taxes

          22.0       176.9       (0.2 )     198.7  

Income taxes

          10.5       69.5             80.0  
                                       

Net income

   $    $ 11.5     $ 107.4     $ (0.2 )   $ 118.7  

 

21


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

    

Condensed Consolidated Statement of Income (Unaudited)

Six Months Ended June 30, 2006

 
(Millions)    Parent    Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

           

Service revenues

   $    $ 156.7     $ 1,058.7     $ (7.2 )   $ 1,208.2  

Product sales

          227.4       18.9       (20.2 )     226.1  
                                       

Total revenues and sales

          384.1       1,077.6       (27.4 )     1,434.3  

Costs and expenses:

           

Cost of services

          48.6       338.8       (1.7 )     385.7  

Cost of products sold

          197.1       14.8       (25.5 )     186.4  

Selling, general, administrative and other

          35.8       128.7             164.5  

Depreciation and amortization

          32.7       168.8             201.5  

Royalty expense to Alltel

          18.3       111.3             129.6  

Restructuring and other charges

          6.9       0.6             7.5  
                                       

Total costs and expense

          339.4       763.0       (27.2 )     1,075.2  

Operating income

          44.7       314.6       (0.2 )     359.1  

Earnings from consolidated subsidiaries

                             

Other income, net

          0.4       0.8             1.2  

Intercompany interest income from Alltel

          2.2       29.7             31.9  

Interest expense

          (3.8 )     (4.6 )           (8.4 )
                                       

Income before income taxes

          43.5       340.5       (0.2 )     383.8  

Income taxes

          16.0       136.3             152.3  
                                       

Net income

   $    $ 27.5     $ 204.2     $ (0.2 )   $ 231.5  

 

22


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

    

Condensed Consolidated Balance Sheet (Unaudited)

As of June 30, 2007

 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Assets

          

Current Assets:

          

Cash and short-term investments

   $ 466.2     $ 1.5     $ 16.1     $     $ 483.8  

Accounts receivable (less allowance for doubtful accounts of $11.5)

     0.6       99.6       210.9             311.1  

Inventories

           29.8       14.5             44.3  

Prepaid expenses and other

     1.4       4.1       28.8             34.3  

Assets held for sale

           75.5                   75.5  
                                        

Total current assets

     468.2       210.5       270.3             949.0  

Investments

     5,975.5       195.1       4.0       (6,174.6 )      

Goodwill and other intangibles

           1,539.9       1,501.5             3,041.4  

Net property, plant and equipment

     7.6       1,169.4       2,716.7             3,893.7  

Other assets

     37.2       9.2       75.9             122.3  

Total Assets

   $ 6,488.5     $ 3,124.1     $ 4,568.4     $ (6,174.6 )   $ 8,006.4  

Liabilities and Shareholders’ Equity

                                        

Current Liabilities:

          

Current maturities of long-term debt

   $ 39.0     $ 0.3     $ 10.0     $     $ 49.3  

Accounts payable

     10.9       32.6       112.6             156.1  

Affiliates payable

     443.7       976.0       (1,419.7 )            

Advance payments and customer deposits

           17.7       73.1             90.8  

Accrued dividends

     119.3                         119.3  

Accrued taxes

     (45.1 )     38.3       59.5             52.7  

Accrued interest

     140.9       1.7       0.6             143.2  

Other current liabilities

     14.1       10.8       16.4             41.3  

Liabilities related to assets held for sale

           29.2                   29.2  
                                        

Total current liabilities

     722.8       1,106.6       (1,147.5 )           681.9  

Long-term debt

     5,279.9       100.0       59.6             5,439.5  

Deferred income taxes

     (28.9 )     397.9       633.2             1,002.2  

Other liabilities

     41.2       35.2       332.9             409.3  

Total liabilities

     6,015.0       1,639.7       (121.8 )           7,532.9  

Commitments and Contingencies (See Note 8)

          

Shareholders’ Equity:

          

Common stock

           (0.4 )     25.9       (25.5 )      

Additional paid-in capital

     562.7       1,152.8       2,626.8       (3,779.6 )     562.7  

Accumulated other comprehensive income (loss)

     (136.5 )           (127.4 )     127.4       (136.5 )

Retained earnings

     47.3       332.0       2,164.9       (2,496.9 )     47.3  
                                        

Total shareholders’ equity

     473.5       1,484.4       4,690.2       (6,174.6 )     473.5  

Total Liabilities and Shareholders’ Equity

   $   6,488.5     $ 3,124.1     $ 4,568.4     $ (6,174.6 )   $ 8,006.4  

 

23


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

    

Condensed Consolidated Balance Sheet (Unaudited)

As of December 31, 2006

 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Assets

          

Current Assets:

          

Cash and short-term investments

   $ 362.4     $ 0.6     $ 23.8     $     $ 386.8  

Accounts receivable (less allowance for doubtful accounts of $10.4)

     0.9       110.0       226.3             337.2  

Inventories

           28.7       14.8             43.5  

Prepaid expenses and other

     10.0       3.1       16.1             29.2  

Assets held for sale

           80.0                   80.0  
                                        

Total current assets

     373.3       222.4       281.0             876.7  

Investments

     5,779.4       57.9       5.6       (5,842.9 )      

Goodwill and other intangibles

           1,560.6       1,504.8             3,065.4  

Net property, plant and equipment

     7.6       1,201.3       2,730.9             3,939.8  

Other assets

     43.8       11.3       93.7             148.8  

Total Assets

   $ 6,204.1     $ 3,053.5     $ 4,616.0     $ (5,842.9 )   $ 8,030.7  

Liabilities and Shareholders’ Equity

                                        

Current Liabilities:

          

Current maturities of long-term debt

   $ 22.0     $ 0.2     $ 10.0     $     $ 32.2  

Accounts payable

     10.6       35.9       123.0             169.5  

Affiliates payable

     167.9       1,025.6       (1,193.5 )            

Advance payments and customer deposits

           14.5       68.3             82.8  

Accrued dividends

     119.2                         119.2  

Accrued taxes

     (84.3 )     56.6       59.6             31.9  

Accrued interest

     145.8       1.7       0.7             148.2  

Other current liabilities

     13.6       16.3       38.5             68.4  

Liabilities related to assets held for sale

           32.4                   32.4  
                                        

Total current liabilities

     394.8       1,183.2       (893.4 )           684.6  

Long-term debt

     5,296.5       100.1       59.6             5,456.2  

Deferred income taxes

     (20.2 )     388.8       622.2             990.8  

Other liabilities

     63.2       37.3       328.8             429.3  

Total liabilities

     5,734.3       1,709.4       117.2             7,560.9  

Commitments and Contingencies (See Note 8)

          

Shareholders’ Equity:

          

Common stock

           (0.4 )     25.9       (25.5 )      

Additional paid-in capital

     550.5       1,153.0       2,626.6       (3,779.6 )     550.5  

Accumulated other comprehensive income (loss)

     (150.8 )           (127.2 )     127.2       (150.8 )

Retained earnings

     70.1       191.5       1,973.5       (2,165.0 )     70.1  
                                        

Total shareholders’ equity

     469.8       1,344.1       4,498.8       (5,842.9 )     469.8  

Total Liabilities and Shareholders’ Equity

   $   6,204.1     $ 3,053.5     $ 4,616.0     $ (5,842.9 )   $ 8,030.7  

 

24


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

    

Condensed Consolidated Statement of Cash Flows (Unaudited)

Six Months Ended June 30, 2007

 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Cash Provided from Operations:

          

Net income

   $ 215.8     $ 114.2     $ 274.3     $ (388.5 )   $ 215.8  

Adjustments to reconcile net income to net cash provided from operations:

          

Depreciation and amortization

           84.5       167.5             252.0  

Provision for doubtful accounts

           3.2       8.0             11.2  

Stock-based compensation expense

           0.7       7.6             8.3  

Pension and postretirement benefits expense

     0.1       3.1       15.9             19.1  

Equity in earnings (losses) from subsidiaries

     (363.8 )     (26.3 )     1.6       388.5        

Other, net

     (13.2 )     10.5       10.0             7.3  

Changes in operating assets and liabilities, net:

     405.1       (131.0 )     (274.3 )           (0.2 )
                                        

Net cash provided from operations

     244.0       58.9       210.6             513.5  

Cash Flows from Investing Activities:

          

Additions to property, plant and equipment

           (41.4 )     (136.6 )           (178.0 )

Other, net

                 1.2             1.2  
                                        

Net cash used in investing activities

           (41.4 )     (135.4 )           (176.8 )

Cash Flows from Financing Activities:

          

Dividends paid on common shares

     (238.5 )                       (238.5 )

Dividends from subsidiaries

     99.0       (16.1 )     (82.9 )            

Repayments of borrowings

     (500.0 )     (0.1 )                 (500.1 )

Debt issued, net of issuance costs

     499.3       (0.4 )                 498.9  
                                        

Net cash used in financing activities

     (140.2 )     (16.6 )     (82.9 )           (239.7 )

Increase (decrease) in cash and short-term investments

     103.8       0.9       (7.7 )           97.0  

Cash and Short-term Investments:

          

Beginning of the period

     362.4       0.6       23.8             386.8  
                                        

End of the period

   $ 466.2     $ 1.5     $ 16.1     $     $ 483.8  

 

25


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

15. Supplemental Guarantor Information, Continued:

 

    

Condensed Consolidated Statement of Cash Flows (Unaudited)

Six Months Ended June 30, 2006

 
(Millions)    Parent    Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Cash Provided from Operations:

           

Net income

   $    $ 27.5     $ 204.2     $ (0.2 )   $ 231.5  

Adjustments to reconcile net income to net cash provided from operations:

           

Depreciation and amortization

          32.7       168.8             201.5  

Provision for doubtful accounts

          10.2       0.1             10.3  

Stock-based compensation expense

                2.1             2.1  

Pension and postretirement benefits expense

          2.9       16.6             19.5  

Other, net

          (10.3 )     16.7             6.4  

Changes in operating assets and liabilities, net:

          (6.4 )     59.6             53.2  
                                       

Net cash provided from operations

          56.6       468.1       (0.2 )     524.5  

Cash Flows from Investing Activities:

           

Additions to property, plant and equipment

          (19.5 )     (135.9 )           (155.4 )

Other, net

          3.5       16.4             19.9  
                                       

Net cash used in investing activities

          (16.0 )     (119.5 )           (135.5 )

Cash Flows from Financing Activities:

           

Dividends paid to Alltel prior to spin-off

          (276.3 )     (379.5 )     557.0       (98.8 )

Repayments of borrowings

          (0.1 )                 (0.1 )

Changes in advances to Alltel prior to spin-off

          234.4       30.4       (556.8 )     (292.0 )
                                       

Net cash used in financing activities

          (42.0 )     (349.1 )     0.2       (390.9 )

Decrease in cash and short-term investments

          (1.4 )     (0.5 )           (1.9 )

Cash and Short-term Investments:

           

Beginning of the period

          7.1       4.8             11.9  
                                       

End of the period

   $    $ 5.7     $ 4.3     $     $ 10.0  

 

16. Pending Transactions:

On May 29, 2007 the Company announced that it entered into a definitive agreement to acquire all of the outstanding shares of CT Communications, Inc. (“CTC”) for $31.50 per share in cash. Including the assumption of cash and debt, the transaction is valued at approximately $585.0 million. The acquisition is expected to close in the third quarter of 2007, subject to certain conditions, including necessary approvals from federal and state regulators and CTC shareholders. On July 10, 2007 the Federal Trade Commission granted early termination of the required waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“Hart-Scott-Rodino Act”). Additionally, Windstream has confirmed with the public service commissions in each state in which CTC operates that further state approvals will not be required. The closing of the transaction is still contingent upon the approvals of the Federal Communications Commission and the vote of CTC shareholders, which is scheduled for August 23, 2007.

On December 12, 2006, Windstream announced that it would split off its directory publishing business (the “Publishing Business”) in what Windstream expects to be a tax-free transaction with entities affiliated with Welsh, Carson, Anderson & Stowe (“WCAS”), a private equity investment firm and Windstream shareholder.

Prior to completing the transaction, Windstream will contribute the Publishing Business to a newly formed subsidiary (“Holdings”). Holdings will then pay a special dividend to Windstream in an amount equal to Windstream's tax basis in the Publishing Business (currently estimated to be approximately $45.0 million), issue additional shares of Holdings common stock to Windstream, and distribute to Windstream certain debt securities of Holdings having an aggregate principal amount of approximately $250.0 million less the amount of the special dividend. Windstream expects to exchange the Holdings debt securities for outstanding Windstream debt with an equivalent fair market value and then retire that Windstream debt. Windstream also intends to use the proceeds of the special dividend to retire Windstream debt or repurchase Windstream

 

26


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

16. Pending Transactions, Continued:

 

equity. Following the completion of these transactions, Windstream will exchange all of the outstanding equity of Holdings (the “Holdings Shares”) for an aggregate of 19,574,422 shares of Windstream common stock (the “Exchanged WIN Shares”), which will then be retired. Based on the trailing average of Windstream common stock at July 31, 2007 of $13.94, the Exchanged WIN Shares have a value of approximately $275.0 million, and the expected total value of the transaction will be approximately $525.0 million.

The transaction is subject to customary conditions, including (i) expiration of the required waiting period under the Hart-Scott-Rodino Act, (ii) the parties having received certain private letter rulings from the Internal Revenue Service (“IRS”) with respect to the tax treatment of the transactions, (iii) the receipt of customary solvency and surplus opinions by the Boards of Directors of Windstream and Holdings, and (iv) the contribution of the Publishing Business to Holdings and the exchange of Holdings debt for outstanding Windstream debt. The Company has since satisfied the requirements of the Hart-Scott-Rodino Act. The final closing of the transaction is conditioned on the absence of any injunction and certain terms of the Company’s debt instruments, but the terms of the transaction require it to be completed by December 31, 2008. This transaction is expected to be completed in the third or fourth quarter of 2007.

The Share Exchange Agreement provides for a customary working capital adjustment pursuant to which the parties will make cash payments to each other to the extent that the working capital of the Publishing Business is less than or greater than a specified target working capital amount at the time of closing. The Share Exchange Agreement contains customary representations, warranties and covenants and may be terminated if, among other things, the closing of the transaction has not been completed within twelve months or the IRS private letter rulings are not received. The parties have also agreed to customary indemnification for breaches of representations, warranties, covenants and other matters.

In connection with the consummation of the transaction, the parties and their affiliates will enter into certain related ancillary agreements, including a Publishing Agreement, a Billing and Collection Agreement and a Tax Sharing Agreement. Pursuant to the Publishing Agreement, Windstream will grant Windstream Yellow Pages, Inc. (“Windstream Yellow Pages”), the Windstream subsidiary that currently operates the Publishing Business, an exclusive license to publish Windstream directories. Windstream Yellow Pages will, at no charge to Windstream or its affiliates or subscribers, publish directories with respect to each Windstream service area in which Windstream or its affiliates are required to publish such directories by applicable law, tariff or contract. Subject to the termination provisions in the agreement, the Publishing Agreement will remain in effect for a term of fifty years. As part of this agreement, Windstream agreed to forego future royalty payments from Windstream Yellow Pages on advertising revenues generated from its directories for the duration of the Publishing Agreement. In conjunction with the Publishing Agreement, the Company has entered into an at-market executory contract to purchase minimum advertising in its directories for a period of three years, with a renewal option for two additional years available to WCAS. Due to the significant continuing involvement that Windstream will retain in the publishing business, as evidenced by these agreements and its obligation to provide telephone listings, publishing results are reflected in income from continuing operations in the accompanying unaudited consolidated statements on income.

The following table summarizes the net assets of the directory publishing operations that are classified as held for sale in the accompanying consolidated balance sheets:

 

(Millions)    June 30,
2007
   December 31,
2006

Current assets

   $ 67.0    $ 71.5

Net property, plant and equipment

     8.5      8.5
             

Assets held for sale

   $ 75.5    $ 80.0

Current liabilities

   $ 25.1    $ 26.5

Deferred income taxes

     3.8      5.5

Other liabilities

     0.3      0.4
             

Liabilities related to assets held for sale

   $ 29.2    $ 32.4

 

27


Table of Contents

WINDSTREAM CORPORATION

FORM 10-Q

PART I—FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Basis of Presentation

The following is a discussion and analysis of the historical results of operations and financial condition of Windstream Corporation (“Windstream”, “we”, or the “Company”). This discussion should be read in conjunction with the unaudited consolidated financial statements, including the notes thereto, for the interim periods ended June 30, 2007 and 2006 and Windstream’s Annual report on Form 10-K for the year ended December 31, 2006 filed with the SEC on March 1, 2007.

The Company is organized based on the products and services that it offers. Under this organizational structure, its operations consist of its wireline and product distribution segments, and other operations. The Company’s wireline segment consists of its retail and wholesale telecommunications services, including local, long distance, network access, video services, broadband and high-speed data services. The product distribution segment consists of warehouse and logistics operations, and it procures and sells telecommunications infrastructure and equipment to both affiliated and non-affiliated businesses. The Company’s other operations include the Company’s directory publishing and telecommunications information services operations. After the merger with Valor Communications Group, Inc. (“Valor”), telecommunications information services are no longer offered as Valor was the only external customer. As discussed in detail below, the Company has announced that it will split off the directory publishing business in the third quarter of 2007.

The management of the Company believes that the assumptions underlying its financial statements are reasonable. However, the Company’s financial statements included herein may not necessarily reflect its results of operations, financial position and cash flows in the future or what its results of operations, financial position and cash flows would have been had it been a separate, stand-alone company during the periods prior to the spin-off from Alltel Corporation (“Alltel”).

EXECUTIVE SUMMARY

Windstream is a customer-focused telecommunications company that provides local telephone, long distance, network access, video services, broadband and high-speed data services to approximately 3.2 million residential and business customers primarily located in rural areas in 16 states. Among the highlights in the second quarter of 2007:

 

 

The Company added approximately 37,000 net broadband customers, increasing its broadband customer base to over 752,000. During the quarter, the Company lost approximately 35,000 access lines or approximately 1 percent of its total access lines at the beginning of the quarter.

 

 

Revenues and sales increased $95.4 million as compared to the second quarter of 2006, due primarily to the acquisition of Valor. The acquisition of Valor accounted for an increase in revenues and sales of $123.7 million. An offsetting decrease in revenues and sales of $28.3 million was primarily due to the increase in intercompany eliminations from the discontinuance of the application of Statement of Financial Accounting Standards (“SFAS”) No. 71, “Accounting for the Effects of Certain Types of Regulation”.

 

 

Operating income increased $107.6 million from a year ago, primarily reflecting the acquisition of Valor, and the termination of a licensing agreement with Alltel as of June 30, 2006.

 

 

The Company paid $119.3 million in dividends to shareholders, and finished the quarter with $483.8 million in cash and short-term investments.

 

 

The Company incurred $108.1 million in interest expense in the second quarter of 2007 primarily due to the debt issued and assumed in conjunction with the spin-off from Alltel and merger with Valor.

During the remainder of 2007, the Company will continue to face significant challenges resulting from competition in the telecommunications industry and changes in the regulatory environment, including the effects of potential changes to the rules governing universal service and inter-carrier compensation. In addressing competition, the Company will continue to focus its efforts on improving customer service, increasing broadband penetration and expanding its service offerings.

 

28


Table of Contents

Pending Transactions

On May 29, 2007 the Company announced that it has entered into a definitive agreement to acquire all of the outstanding shares of CT Communications, Inc. (“CTC”) for $31.50 per share in cash. Including the assumption of cash and debt, the transaction is valued at approximately $585.0 million. The acquisition is expected to close in the third quarter of 2007, subject to certain conditions, including necessary approvals from federal and state regulators and CTC shareholders. On July 10, 2007 the Federal Trade Commission granted early termination of the required waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. Additionally, Windstream has confirmed with the public service commissions in each state in which CTC operates that further state approvals will not be required. The closing of the transaction is still contingent upon the approvals of the Federal Communications Commission (“FCC”) and the vote of CTC shareholders, which is scheduled for August 23, 2007.

Windstream intends to finance the acquisition primarily with existing cash and additional borrowings available under its $500.0 million revolving line of credit. Net of approximately $4.0 million in letters of credit, the Company has approximately $496.0 million in remaining capacity under this credit facility. Upon completion of the transaction, Windstream will add approximately 155,000 access lines, 30,000 broadband customers and 50,000 wireless customers in North Carolina, which are adjacent to existing operations, increasing the number of access lines to approximately 3.4 million and the number of broadband customers to approximately 785,000. Once complete, the transaction will increase Windstream’s position in these rural markets where it can leverage the Company’s brand and marketing experience and bring significant value to customers by offering competitive bundled services. CTC has broadband availability to 95 percent of its incumbent local exchange carrier (“ILEC”) lines, 75 percent of which can offer up to 10Mb speeds.

As discussed in Note 16 in the accompanying notes to the unaudited interim financial statements, the Company has entered into an agreement to split off its directory publishing business to Welsh, Carson, Anderson & Stowe (“WCAS”) in a transaction currently valued at approximately $525.0 million. As a result of the transaction, the Company will retire approximately 19.6 million shares of its common stock currently held by WCAS, and will retire up to $250.0 million of debt obligations. In return for this consideration, the Company will forego its royalty fee on directories published by WCAS in its service territories for a period of 50 years (“the Publishing Agreement”). The portion of the gain recognized on the sale of the publishing business attributable to the Company’s ongoing obligation stipulated by the Publishing Agreement will be deferred over the term of the agreement. This transaction is expected to be completed in the third quarter of 2007.

Adoption of Accounting Standards

Windstream adopted Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes” on January 1, 2007. The adoption of FIN 48 resulted in no impact to either the Company’s reserves for uncertain tax positions or to retained earnings. At the adoption date, and as of June 30, 2007, the Company had approximately $1.3 million of gross unrecognized tax benefits, all of which relate to periods preceding the spin-off from Alltel, and all of which would impact its effective tax rate if recognized.

The Company is indemnified for these reserves for uncertain tax positions in accordance with the Tax Sharing Agreement with Alltel dated July 17, 2006; consequently, a corresponding receivable from Alltel equaling the gross unrecognized tax benefits plus accrued interest expense has been recognized.

Interest and penalties related to uncertain tax positions are recognized in income tax expense. As of June 30, 2007, the Company had accrued approximately $0.2 million of interest expense and penalties related to uncertain tax positions. For the six months ended June 30, 2007, interest expense recognized related to these uncertain positions was not significant.

The tax years 2003 – 2006 remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company has identified its federal tax return and state tax returns in Arkansas, Florida, Georgia, Kentucky, Nebraska, North Carolina, and Texas as “major” taxing jurisdictions.

The Company does not reasonably estimate that the unrecognized tax benefits will change significantly within the next twelve months.

 

29


Table of Contents

CONSOLIDATED RESULTS OF OPERATIONS

      Three Months Ended
June 30,
    Six Months Ended
June 30,
 
(Millions, except per share amounts)    2007     2006     2007     2006  

Revenues and sales:

        

Service revenues

   $ 732.2     $   603.5     $ 1,450.1     $ 1,208.2  

Product sales

     94.5       127.8       160.3       226.1  
                                

Total revenues and sales

     826.7       731.3       1,610.4       1,434.3  
                                

Costs and expenses:

        

Cost of services

     253.0       193.3       488.6       385.7  

Cost of products sold

     51.1       102.1       96.6       186.4  

Selling, general, administrative and other

     101.3       84.4       204.4       164.5  

Depreciation and amortization

     126.9       98.9       252.0       201.5  

Royalty expense to Alltel

           62.4             129.6  

Restructuring and other charges

     1.6       5.0       6.4       7.5  
                                

Total costs and expenses

     533.9       546.1       1,048.0       1,075.2  
                                

Operating income

     292.8       185.2       562.4       359.1  

Other income, net

     6.3             11.5       1.2  

Intercompany interest income from Alltel

           18.0             31.9  

Interest expense

     (108.1 )     (4.5 )     (222.8 )     (8.4 )
                                

Income before income taxes

     191.0       198.7       351.1       383.8  

Income taxes

     75.1       80.0       135.3       152.3  
                                

Net income

   $ 115.9     $ 118.7     $ 215.8     $ 231.5  

Earnings per share:

        

Basic

     $.24       $.29       $.46       $.57  

Diluted

     $.24       $.29       $.45       $.57  

Total revenues and sales increased $95.4 million, or 13 percent, and $176.1 million, or 12 percent, in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. Service revenues, which include voice service, long distance, data and special access, switched access and Universal Service Funds (“USF”) and miscellaneous and other revenues, increased year-over-year by $128.7 million, or 21 percent, and $241.9 million, or 20 percent, during these periods, respectively. The acquisition of Valor accounted for $123.7 million and $247.3 million of the year-over-year increases in total revenues and sales for the three and six months ended June 30, 2007, respectively. Additionally, revenues attributable to long distance and data and special access increased $24.0 million and $46.5 million during these periods, respectively, as compared to the same periods in 2006. These increases reflect increases in long distance customer billing rates during the fourth quarter of 2006 and the significant net increase in broadband customers during the twelve months ended June 30, 2007. Partially offsetting these year-over-year increases in service revenues are declines of $15.8 million and $22.8 million in the three and six months ended June 30, 2007, respectively, due to increases in eliminations of intercompany service revenues. This is due primarily to the discontinued application of SFAS No. 71 as previously discussed. In addition, compared to the same periods a year ago, voice revenues and switched access and USF revenues decreased $7.2 million and $34.2 million, in the three and six month periods ended June 30, 2007, respectively, primarily as a result of the loss of wireline access lines due to fixed-line competition and wireless substitution. Partially offsetting this year over year decrease for the three months ended June 30, 2007, the Company entered into a settlement agreement during the period with another carrier to resolve historical traffic disputes resulting in an increase in switched access revenues of $13.3 million.

Product sales decreased $33.3 million, or 26 percent, and $65.8 million, or 29 percent, for the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. Prior to the discontinuance of SFAS No. 71, the Company did not eliminate product sales to affiliates of $32.2 million and $60.7 million during the three and six month periods ended June 30, 2006, respectively. Partially offsetting these decreases, year-over-year increases in product sales of $3.3 million and $4.8 million, respectively, were due to increases in sales of customer premise equipment and broadband modems to retail customers.

Cost of services, which represents the cost of providing service, as well as business taxes and bad debt expense, increased $59.7 million, or 31 percent, and $102.9 million, or 27 percent, for the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. The acquisition of Valor accounted for $36.8 million and $69.0 million of the year-over-year increases in cost of services in the three and six month periods ended June 30, 2007,

 

30


Table of Contents

respectively. Additional increases of $12.5 million and $26.8 million, respectively, were due to an increase in interconnection expenses driven by an increase in the volume of long distance and Internet traffic. The remaining increases were due primarily to year-over-year increases in business taxes and USF fees of $7.5 million and $5.4 million during the three and six month periods ended June 30, 2007, respectively, primarily due to increases in the contribution factors used to determine the Company’s USF obligations, and increases in USF contributions related to increases in long distance revenues.

Cost of products sold decreased $51.0 million, or 50 percent, and $89.8 million, or 48 percent, in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. The decrease was consistent with the decline in product sales as discussed above, and was due primarily to an increase in intercompany eliminations of $48.5 million and $86.0 million during the three and six month periods ended June 30, 2006, respectively, caused by the discontinuance of the application of SFAS No. 71.

Selling, general, administrative and other expenses increased $16.9 million, or 20 percent, and $39.9 million, or 24 percent, in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. The acquisition of Valor accounted for $9.9 million and $18.7 million of these increases, respectively. A portion of the remaining increases were due to increases in advertising of $3.2 million and $8.2 million in the three and six month periods ended June 30, 2007, respectively, related to aggressive marketing around Windstream’s new brand. The remaining increases were caused by a shift from allocated corporate costs from Alltel in 2006 prior to the spin-off to the Company’s stand-alone corporate cost structure in 2007.

Depreciation and amortization expense increased $28.0 million, or 28 percent, and $50.5 million, or 25 percent, in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. The acquisition of Valor accounted for $30.6 million and $60.9 million of these increases, respectively. Partially offsetting these increases were declines primarily resulting from a reduction in depreciation rates for certain of the Company’s wireline operations, reflecting the results of studies of depreciable lives completed during 2007 and 2006 as further discussed below in “Results of Operations by Business Segment”.

Royalty expense to Alltel decreased $62.4 million, or 100 percent, and $129.6 million, or 100 percent, in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. Historically, certain of the Company’s wireline subsidiaries incurred a royalty charge from Alltel for the use of the Alltel brand name in marketing and distributing telecommunications products and services pursuant to a licensing agreement with an Alltel affiliate. The Company terminated this licensing agreement with Alltel on June 30, 2006 as the Alltel brand name is no longer used.

Operating income increased $107.6 million, or 58 percent, and $203.3 million, or 57 percent, in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006. The acquisition of Valor accounted for $45.5 million and $97.6 million of these increases, respectively. The remaining increases in operating income primarily reflect the decrease in royalty expense due to the termination of the licensing agreement with Alltel and the decrease in depreciation expense resulting from depreciation studies completed during 2007 and 2006, partially offset by the decline in wireline service operating margins resulting from the loss of access lines.

Restructuring and Other Charges

The following is a summary of the restructuring and other charges recorded during the six month period ended June 30, 2007:

 

(Millions)    Wireline    Product
Distribution
   Other
Operations
   Total

Severance and employee benefit costs

   $ 3.1    $ 0.1    $    $   3.2

Costs associated with split off of directory publishing

               3.2      3.2
                           

Total restructuring and other charges

   $ 3.1    $ 0.1    $ 3.2    $ 6.4

During the six months ended June 30, 2007, the Company incurred $3.2 million in accounting and legal fees and other expenses related to the anticipated sale of its directory publishing business (see Note 16). Of the total expenses incurred relating to the spin-off transaction, $1.6 million were recorded in the second quarter of 2007. The company also incurred $3.2 million in severance and employee related costs during the first quarter of 2007, primarily related to the continuation of a workforce reduction plan initiated during the fourth quarter of 2006 and concluded in the first quarter of 2007.

 

31


Table of Contents

During the six months ended June 30, 2006, in connection with the spin-off from Alltel and merger with Valor, the Company incurred $7.5 million of incremental costs, primarily consisting of consulting and legal fees associated with the wireline segment. Of the total expenses incurred relating to the spin-off transaction, $5.0 million were recorded in the second quarter of 2006.

In the Company’s accompanying unaudited interim consolidated balance sheet at June 30, 2007, other current liabilities include a portion of this unpaid restructuring liability totaling $5.8 million, which consists of $2.9 million in severance and employee-related expenses related to the realignment of its operational functions, $2.8 million related to lease obligations on a vacated Valor facility, and $0.1 million of costs related to the spin-off from Alltel. The remaining unpaid restructuring liability of $9.8 million, which relates to fees resulting from the split off of the publishing business, is included in liabilities related to assets held for sale in the unaudited interim consolidated balance sheet at June 30, 2007. Cash outlays for the Valor lease obligations will be disbursed from operating cash flows over the remaining term of the lease through 2010. The remaining unpaid liability will be disbursed over the remainder of 2007 and will be funded from operating cash flows. (See Note 9 to the unaudited consolidated financial statements for additional information regarding the restructuring and other charges.)

Other Income, Net

      Three Months Ended
June 30,
   Six Months Ended
June 30,
(Millions)    2007     2006    2007    2006

Interest income on cash and short-term investments

   $ 4.0     $    $ 8.3    $

Mark-to-market of interest rate swap agreement

     2.5            2.9     

Other income (expense), net

     (0.2 )          0.3      1.2
                            

Other income, net

   $ 6.3     $    $ 11.5    $ 1.2

Other income, net increased $6.3 million and $10.3 million in the three and six months ended June 30, 2007, respectively, as compared to the same periods of 2006, primarily due to interest income earned on cash and short-term investments. Cash and short-term investments totaled $483.8 million in the Company’s accompanying unaudited interim consolidated balance sheet at June 30, 2007. Prior to the spin-off in 2006, excess cash was invested with Alltel pursuant to an intercompany cash management agreement through which interest was earned on invested funds at rates averaging 4.99 percent during the six months ended June 30, 2006. This interest income was included in intercompany interest income from Alltel in the accompanying unaudited consolidated statement of income for the six months ended June 30, 2006. The increases in other income, net were also due in part to increases in market value of a portion of an interest rate swap agreement that the Company deemed ineffective during the first quarter of 2007, as discussed further in Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk. Pursuant to the guidance in SFAS No. 133, “Derivative Financial Instruments”, as amended, changes in the market value of the ineffective portion of this interest rate swap are included in net income. The market value calculation of this interest rate swap is based on estimates of forward variable interest rates, and changes in estimated forward rates could result in significant non-cash increases or decreases in other income, net in future periods.

Intercompany Interest Income from Alltel

Prior to the spin-off from Alltel, the Company participated in a centralized cash management program with Alltel. As discussed above, the Company earned interest on amounts remitted to Alltel at a rate based on current market rates for short-term investments. Intercompany interest income from Alltel decreased $18.0 million and $31.9 million in the three and six month periods ended June 30, 2007, respectively, as compared to the same periods of 2006 due to the cancellation of participation in the cash management program following the spin-o