10-Q 1 form10q3q2010.htm 3RD QUARTER 2010 FORM 10-Q form10q3q2010.htm





FRONTIER COMMUNICATIONS CORPORATION


FORM 10-Q


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934


FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010







 
 

 


UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q
(Mark One)
x  
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

or

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

For the transition period from _________to__________

Commission file number:  001-11001

FRONTIER COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
06-0619596
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
   
     
3 High Ridge Park
   
Stamford, Connecticut   
 
06905
(Address of principal executive offices)
 
(Zip Code)
     
(203) 614-5600
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   X        No ___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
  
Yes   X         No ___
                                                                              
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

  Large accelerated filer    x                            Accelerated filer    o                                  Non-accelerated filer    o                                Smaller reporting company     o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes             No  X    

The number of shares outstanding of the registrant’s Common Stock as of October 29, 2010 was 993,874,000.

 
 

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Index


 
Page No.
Part I.  Financial Information (Unaudited)
 
   
Item 1.  Financial Statements
 
   
     Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009
2
   
     Consolidated Statements of Operations for the three and nine  months ended September 30, 2010 and 2009
3
   
     Consolidated Statements of Equity for the nine months ended September 30, 2009, the three months ended
     December 31, 2009 and the nine months ended September 30, 2010
 
4
   
     Consolidated Statements of Comprehensive Income for the three and nine months ended
September 30,  2010 and 2009
 
4
   
     Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009
5
   
     Notes to Consolidated Financial Statements
6
   
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
22
   
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
40
   
Item 4.  Controls and Procedures
41
   
Part II.  Other Information
 
   
Item 1.  Legal Proceedings
42
   
Item 1A.  Risk Factors
42
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
42
   
Item 6.  Exhibits
44
   
Signature
45
   

 
 
1

 
 
Explanatory Note
Effective July 1, 2010, Frontier’s scope of operations and balance sheet capitalization changed materially as a result of the completion of the Transaction, as described in Note 3 of the Notes to Consolidated Financial Statements.  Historical financial and operating data presented for Frontier is not indicative of the future financial position or operating results for Frontier, and  includes the results of operations of the Acquired Business, as defined in Note 3 of the Notes to Consolidated Financial Statements, from the date of acquisition on July 1, 2010.  The financial discussion represents an analysis of our results of operations on a historical basis for our Frontier operations as of and for the three and nine months ended September 30, 2010 and 2009, which includes the results of operations of the Acquired Business for just the three months ended September 30, 2010.

PART I.  FINANCIAL INFORMATION
Item 1.Financial Statements

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
 
   
 
       
   
(Unaudited)
September 30, 2010
   
December 31, 2009
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 351,065     $ 358,693  
Accounts receivable, less allowances of $51,054 and $30,171, respectively
    568,914       190,745  
Prepaid expenses
    159,200       28,081  
Income taxes and other current assets
    57,070       102,561  
Total current assets
    1,136,249       680,080  
                 
Restricted cash
    187,400       -  
Property, plant and equipment, net
    7,575,800       3,133,521  
Goodwill
    6,256,282       2,642,323  
Other intangibles, net
    2,645,083       247,527  
Other assets
    194,124       174,804  
Total assets
  $ 17,994,938     $ 6,878,255  
                 
LIABILITIES AND EQUITY
               
Current liabilities:
               
Long-term debt due within one year
  $ 79,987     $ 7,236  
Accounts payable
    346,390       139,556  
Other current liabilities
    901,522       245,885  
Total current liabilities
    1,327,899       392,677  
                 
Deferred income taxes
    2,043,575       722,192  
Other liabilities
    1,107,882       630,187  
Long-term debt
    8,181,603       4,794,129  
                 
Equity:
               
Shareholders' equity of Frontier:
               
                 
 
               
                 
Common stock, $0.25 par value (1,750,000,000 and 600,000,000 authorized shares, respectively, 993,883,000 and 312,328,000 outstanding, respectively, and 1,027,986,000 and 349,456,000 issued, respectively, at September 30, 2010 and December 31, 2009)
    256,997       87,364  
Additional paid-in capital
    5,708,020       956,401  
Retained earnings
    31,115       2,756  
Accumulated other comprehensive loss, net of tax
    (241,347 )     (245,519 )
Treasury stock
    (433,179 )     (473,391 )
Total shareholders' equity of Frontier
    5,321,606       327,611  
Noncontrolling interest in a partnership
    12,373       11,459  
Total equity
    5,333,979       339,070  
Total liabilities and equity
  $ 17,994,938     $ 6,878,255  
                 
The accompanying Notes are an integral part of these Consolidated Financial Statements.
 
2

 

PART I.  FINANCIAL INFORMATION (Continued)


FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
($ in thousands, except for per-share amounts)
(Unaudited)


   
For the three months ended
   
For the nine months ended
 
      September 30,       September 30,  
   
2010
   
2009
   
2010
   
2009
 
                         
Revenue
  $ 1,402,968     $ 526,816     $ 2,438,954     $ 1,596,914  
                                 
Operating expenses:
                               
Network access expenses
    134,132       54,549       240,814       174,436  
Other operating expenses
    616,364       192,948       999,038       585,906  
Depreciation and amortization
    339,894       103,123       540,917       373,499  
Acquisition and integration costs
    78,533       3,706       125,867       14,457  
Total operating expenses
    1,168,923       354,326       1,906,636       1,148,298  
                                 
Operating income
    234,045       172,490       532,318       448,616  
                                 
Investment income
    397       655       6,394       5,480  
Other income, net
    2,207       5,200       13,497       13,240  
Interest expense
    166,607       96,578       354,362       283,997  
                                 
Income before income taxes
    70,042       81,767       197,847       183,339  
Income tax expense
    40,358       29,021       88,752       65,328  
                                 
Net income
    29,684       52,746       109,095       118,011  
Less: Income attributable to the noncontrolling interest in a partnership
    689       587       2,414       1,631  
                                 
Net income attributable to common shareholders of Frontier
  $ 28,995     $ 52,159     $ 106,681     $ 116,380  
                                 
 
                               
Basic and diluted net income per common share attributable to common
   shareholders of Frontier
  $ 0.03     $ 0.17     $ 0.18     $ 0.37  
                                 



The accompanying Notes are an integral part of these Consolidated Financial Statements.

 
3

 

 PART I.  FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009, THE THREE MONTHS ENDED DECEMBER 31, 2009 AND THE NINE MONTHS ENDED SEPTEMBER 30, 2010
($ and shares in thousands, except for per-share amounts)
(Unaudited)

   
Frontier Shareholders
             
                           
          Accumulated
                   
               
Additional
         
Other
                         
   
Common Stock
   
Paid-In
   
Retained
   
Comprehensive
   
Treasury Stock
   
Noncontrolling
   
Total
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Loss
   
Shares
   
Amount
   
Interest
   
Equity
 
                                                       
Balance January 1, 2009
    349,456     $ 87,364     $ 1,117,936     $ 38,163     $ (237,152 )     (38,142 )   $ (487,266 )   $ 10,561     $ 529,606  
Stock plans
    -       -       (8,248 )     -       -       1,013       13,792       -       5,544  
Dividends on common stock
    -       -       (156,176 )     (78,099 )     -       -       -       -       (234,275 )
Net income
    -       -       -       116,380       -       -       -       1,631       118,011  
Other comprehensive income, netof tax
    -       -       -       -       11,375       -       -       -       11,375  
Distributions
    -       -       -       -       -       -       -       (1,500 )     (1,500 )
Balance September 30, 2009
    349,456       87,364       953,512       76,444       (225,777 )     (37,129 )     (473,474 )     10,692       428,761  
Stock plans
    -       -       2,889       -       -       1       83       -       2,972  
Dividends on common stock
    -       -       -       (78,091 )     -       -       -       -       (78,091 )
Net income
    -       -       -       4,403       -       -       -       767       5,170  
Other comprehensive loss, net
   of tax
    -       -       -       -       (19,742 )     -       -       -       (19,742 )
Balance December 31, 2009
    349,456       87,364       956,401       2,756       (245,519 )     (37,128 )     (473,391 )     11,459       339,070  
Acquisition of Spinco
    678,530       169,633       5,048,266       -       -       -       -       -       5,217,899  
Stock plans
    -       -       (31,927 )     -       -       3,025       40,212       -       8,285  
Dividends on common stock
    -       -       (264,720 )     (78,322 )     -       -       -       -       (343,042 )
Net income
    -       -       -       106,681       -       -       -       2,414       109,095  
Other comprehensive income, net
   of tax
    -       -       -       -       4,172       -       -       -       4,172  
Distributions
    -       -       -       -       -       -       -       (1,500 )     (1,500 )
Balance September 30, 2010
    1,027,986     $ 256,997     $ 5,708,020     $ 31,115     $ (241,347 )     (34,103 )   $ (433,179 )   $ 12,373     $ 5,333,979  
                                                                         
                                                                         

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
($ in thousands)
(Unaudited)

                     
 
   
 
For the three months ended September 30,
       
For the nine months ended September 30,
     
2010
     
2009
     
2010
     
2009
                               
Net income
 
$
29,684
   
$
52,746
   
$
109,095
   
$
118,011
Other comprehensive income (loss), net of tax
   
                 (3,782)
     
3,326
     
4,172
     
11,375
Comprehensive income
   
25,902
     
56,072
     
113,267
     
129,386
                               
 Less:  Comprehensive income attributable to the noncontrolling interest in a
    partnership
   
               
     (689)
     
              
       (587)
     
          
        (2,414)
     
                 
  (1,631)
                               
Comprehensive income attributable to the common shareholders of Frontier
 
$
25,213
   
$
55,485
   
$
110,853
   
$
127,755
                               
 
 
The accompanying Notes are an integral part of these Consolidated Financial Statements.

 
4

 



PART I.  FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
($ in thousands)
(Unaudited)


   
2010
   
2009
 
             
Cash flows provided by (used in) operating activities:
           
Net income
  $ 109,095     $ 118,011  
Adjustments to reconcile net income to net cash provided by
               
   operating activities:
               
Depreciation and amortization expense
    540,917       373,499  
Stock based compensation expense
    9,930       6,974  
Pension/OPEB costs
    24,224       24,802  
Gain on extinguishment of debt
    -       (7,755 )
Other non-cash adjustments
    5,866       1,293  
Deferred income taxes
    10,092       11,097  
Change in accounts receivable
    (13,356 )     17,409  
Change in accounts payable and other liabilities
    166,398       (53,481 )
Change in prepaid expenses, income taxes and other current assets
    33,004       (1,228 )
Net cash provided by operating activities
    886,170       490,621  
                 
Cash flows provided from (used by) investing activities:
               
Cash transferred to escrow
    (115,000 )     -  
Capital expenditures - Business operations
    (252,360 )     (161,893 )
Capital expenditures - Integration activities
    (77,936 )     (2,607 )
Cash paid for Spinco acquisition, net
    (82,560 )     -  
Other assets purchased and distributions received, net
    (1,728 )     951  
Net cash used by investing activities
    (529,584 )     (163,549 )
                 
Cash flows provided from (used by) financing activities:
               
Long-term debt borrowings
    -       538,830  
Long-term debt payments
    (6,286 )     (355,915 )
Financing costs paid
    (12,431 )     (1,021 )
Issuance of common stock
    -       680  
Dividends paid
    (343,042 )     (234,275 )
Repayment of customer advances for construction and distributions to noncontrolling interests
    (2,455 )     (2,843 )
Net cash used by financing activities
    (364,214 )     (54,544 )
                 
Increase (decrease) in cash and cash equivalents
    (7,628 )     272,528  
Cash and cash equivalents at January 1,
    358,693       163,627  
                 
Cash and cash equivalents at September 30,
  $ 351,065     $ 436,155  
                 
Supplemental cash flow information:
               
Cash paid during the period for:
               
Interest
  $ 299,158     $ 295,577  
Income taxes
  $ 4,042     $ 59,953  
                 
Non-cash investing and financing activities:
               
Shares issued for Spinco acquisition
  $ 5,217,899     $ -  
Assumed debt
  $ 3,456,782     $ -  
                 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 
5

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(1)  
Summary of Significant Accounting Policies:
(a)  
Basis of Presentation and Use of Estimates:
Frontier Communications Corporation and its subsidiaries are referred to as “we,” “us,” “our,” “Frontier,” or the “Company” in this report. Our interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2009. Certain reclassifications of balances previously reported have been made to conform to the current presentation.  All significant intercompany balances and transactions have been eliminated in consolidation. These interim unaudited consolidated financial statements include all adjustments (consisting of normal recurring accruals) considered necessary, in the opinion of Frontier’s management, to present fairly the results for the interim periods shown.  Revenues, net income and cash flows for any interim periods are not necessarily indicative of results that may be expected for the full year.  For our interim financial statements as of and for the periods ended September 30, 2010, we evaluated subsequent events and transactions for potential recognition or disclosure through the date that we filed this quarterly report on Form 10-Q with the Securities and Exchange Commission (SEC).

The preparation of our interim financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities at the date of the financial statements, (ii) the disclosure of contingent assets and liabilities, and (iii) the reported amounts of revenue and expenses during the reporting period.  Actual results may differ from those estimates.  Estimates and judgments are used when accounting for allowance for doubtful accounts, impairment of long-lived assets, intangible assets, depreciation and amortization, income taxes, purchase price allocations, contingencies, and pension and other postretirement benefits, among others. Certain information and footnote disclosures have been excluded and/or condensed pursuant to SEC rules and regulations.  The results of the interim periods are not necessarily indicative of the results for the full year.

(b)  
Revenue Recognition:
Revenue is recognized when services are provided or when products are delivered to customers.  Revenue that is billed in advance includes: monthly recurring network access services, special access services and monthly recurring local line and unlimited fixed long distance bundle charges.  The unearned portion of these fees is initially deferred as a component of other liabilities on our consolidated balance sheet and recognized as revenue over the period that the services are provided.  Revenue that is billed in arrears includes: non-recurring network access services, switched access services, non-recurring local services and long-distance services.  The earned but unbilled portion of these fees is recognized as revenue in our consolidated statements of operations and accrued in accounts receivable in the period that the services are provided.  Excise taxes are recognized as a liability when billed.  Installation fees and their related direct and incremental costs are initially deferred and recognized as revenue and expense over the average term of a customer relationship.  We recognize as current period expense the portion of installation costs that exceeds installation fee revenue.

As required by law, the Company collects various taxes from its customers and subsequently remits these taxes to governmental authorities. Substantially all of these taxes are recorded through the consolidated balance sheet and presented on a net basis in our consolidated statements of operations.  We also collect Universal Service Fund (USF) surcharges from customers (primarily federal USF) which we have recorded on a gross basis in our consolidated statements of operations and included in revenue and other operating expenses at $26.9 million and $9.9 million for the three months ended September 30, 2010 and 2009, respectively, and $48.7 million and $26.1 million for the nine months ended September 30, 2010 and 2009, respectively.

(c)  
Goodwill and Other Intangibles:
Intangibles represent the excess of purchase price over the fair value of identifiable tangible net assets acquired.  We undertake studies to determine the fair values of assets and liabilities acquired and allocate purchase prices to assets and liabilities, including property, plant and equipment, goodwill and other identifiable intangibles.  We annually (during the fourth quarter) or more frequently, if appropriate, examine the carrying value of our goodwill and trade name to determine whether there are any impairment losses.  We test for goodwill impairment at the “operating segment” level, as that term is defined in U.S. GAAP.  As of July 1, 2010 and as a result of the completion of the Transaction, the Company has five operating segments.  Our operating segments are aggregated into one reportable segment.

In accordance with U.S. GAAP, the Company amortizes intangible assets with estimated useful lives over those lives and reviews such intangible assets to assess any impairment which would necessitate a change in useful life and a different amortization period.  In addition, we periodically reassess the useful lives of our intangible assets to determine whether any changes are required.

 
6

 
(2)   Recent Accounting Literature and Changes in Accounting Principles:

Business Combinations
Business combinations are accounted for utilizing the guidance of Accounting Standards Codification (ASC) Topic 805, formerly Statement of Financial Accounting Standards (SFAS)  No. 141R, as amended by FSP SFAS No. 141(R)-1 which became effective on January 1, 2009. ASC Topic 805 requires an acquiring entity in a transaction to recognize all of the assets acquired and liabilities assumed at fair value at the acquisition date, to recognize and measure preacquisition contingencies, including contingent consideration, at fair value (if possible), to remeasure liabilities related to contingent consideration at fair value in each subsequent reporting period and to expense all acquisition related costs.  We are accounting for our July 1, 2010 acquisition of approximately 4.0 million access lines from Verizon Communications Inc. (Verizon) (the Transaction) using the guidance included in ASC Topic 805. We incurred approximately $78.5 million and $3.7 million of acquisition and integration related costs in connection with the Transaction during the three months ended September 30, 2010 and 2009, respectively, and approximately $125.9 million and $14.5 million for the nine months ended September 30, 2010 and 2009, respectively.  Such costs are required to be expensed as incurred and are reflected in “Acquisition and integration costs” in our consolidated statements of operations.

(3)   The Transaction:
On July 1, 2010, pursuant to the Agreement and Plan of Merger, dated as of May 13, 2009, as amended, by and among Verizon, New Communications Holdings Inc. (Spinco) and Frontier (the Merger Agreement), Spinco merged with and into Frontier, with Frontier considered the accounting acquirer of the Acquired Business (as defined below) and surviving as the combined company, conducting the combined business operations of Frontier and the Acquired Business (the Merger).  Immediately prior to the Merger, Spinco had been a wholly-owned subsidiary of Verizon and held the defined assets and liabilities of the local exchange business and related landline activities of Verizon in Arizona, Idaho, Illinois, Indiana, Michigan, Nevada, North Carolina, Ohio, Oregon, South Carolina, Washington, West Virginia and Wisconsin and in portions of California bordering Arizona, Nevada and Oregon (collectively, the Territories), including Internet access and long distance services and broadband video provided to designated customers in the Territories (the Acquired Business), was spun off to Verizon shareholders.
 
 
7

 
Our consolidated statements of operations for the three and nine months ended September 30, 2010 include $890.2 million of revenue and $134.3 million of operating income related to the results of operations of the Acquired Business from the date of its acquisition on July 1, 2010.

The allocation of the purchase price of the Acquired Business is based on the fair value of assets acquired and liabilities assumed as of July 1, 2010, the effective date of the Merger.  Our assessment of fair value is preliminary, and will be adjusted for information that is currently not available to us.

The preliminary allocation of the purchase price presented below represents the effect of recording the preliminary estimates of the fair value of assets acquired, liabilities assumed and related deferred income taxes as of the date of the Merger, based on the total transaction consideration of $5.4 billion.  These preliminary estimates will be revised in future periods and the revisions may materially affect the presentation of our consolidated financial results.  Any changes to the initial estimates of the fair value of the assets and liabilities will be recorded as adjustments to those assets and liabilities and residual amounts will be allocated to goodwill.

($ in thousands)
         
Total transaction consideration:
     
$
5,411,705
Current assets
$
489,034
     
Property, plant & equipment
 
4,499,958
     
Goodwill
 
3,613,959
     
Other intangibles – primarily customer list
 
2,554,147
     
Other assets
 
72,400
     
Current liabilities
 
(564,734
   
Deferred income taxes
 
(1,302,055
   
Long-term debt
 
(3,456,782
   
Other liabilities
 
(494,222
   
Total net assets acquired
$
5,411,705
     

The Transaction provides for a post-closing adjustment for working capital, pension liabilities transferred and pension assets.  Frontier and Verizon have not finalized the results of these calculations.  If an adjustment is made for the working capital “true-up”, the purchase price allocation will be revised.

The fair value of the total consideration issued to acquire the Acquired Business amounted to $5.4 billion and included $5.22 billion for the issuance of Frontier common shares and cash payments of $105.0 million.  As a result of the Merger, Verizon stockholders received 678,530,386 shares of Frontier common stock.  Immediately after the closing of the Merger, Verizon stockholders owned approximately 68.4% of the combined company’s outstanding equity, and existing Frontier stockholders owned approximately 31.6% of the combined company’s outstanding equity.

The following unaudited pro forma financial information presents the combined results of operations of Frontier and the Acquired Business as if the acquisition had occurred at the beginning of each period presented below.  The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the acquisition been completed at the beginning of each period presented below.  In addition, the unaudited pro forma financial information is not indicative of, nor does it purport to project, the future financial position or operating results of Frontier.  The unaudited pro forma financial information excludes acquisition and integration costs and does not give effect to any potential cost savings or other operating efficiencies that could result from the Merger.

 
8

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




UNAUDITED PRO FORMA CONDENSED COMBINED
STATEMENTS OF OPERATIONS INFORMATION


 
For the three months ended
September 30, 2009
 
For the nine months ended
September 30,
     
2010
   
2009
($ in millions, except
       per share amounts)
               
                 
Revenue
$
   1,514
 
$
4,293
 
$
4,617
Operating income
 
 366
   
941
   
1,063
Net income attributable to common
     shareholders of Frontier
 
 
     129
   
 
273
   
380
                 
Basic and diluted net income per common share attributable to common  shareholders of  Frontier
 
$
 
   0.13
 
 
$
 
0.28
 
$
0.38
                 

(4)  
Accounts Receivable:
   The components of accounts receivable, net at September 30, 2010 and December 31, 2009 are as follows:

   ($ in thousands)
 
September 30, 2010
   
December 31, 2009
   
    
                 
    End user
 
606,279
   
$
205,384
   
    Other
   
13,689
     
15,532
   
    Less: Allowance for doubtful accounts
   
(51,054
)
   
(30,171
)
 
         Accounts receivable, net
 
$
568,914
   
$
190,745
   
                   

We maintain an allowance for estimated bad debts based on our estimate of our ability to collect accounts receivable. Bad debt expense, which is recorded as a reduction to revenue, was $20.3 million and $10.5 million for the three months ended September 30, 2010 and 2009, respectively, and $31.6 million and $24.8 million for the nine months ended September 30, 2010 and 2009, respectively.

(5)  
Property, Plant and Equipment:
Property, plant and equipment at September 30, 2010 and December 31, 2009 is as follows:

   ($ in thousands)
 
September 30, 2010
   
December 31, 2009
   
    
                 
    Property, plant and equipment
 
12,714,009
   
$
7,803,062
   
    Less:  Accumulated depreciation
   
(5,138,209
)
   
(4,669,541
)
 
         Property, plant and equipment, net
 
$
7,575,800
   
$
3,133,521
   
                   

 
9

 
Depreciation expense is principally based on the composite group method.  Depreciation expense was $211.2 million and $89.1 million for the three months ended September 30, 2010 and 2009, respectively, and $384.1 million and $273.4 million for the nine months ended September 30, 2010 and 2009, respectively.  Effective upon the completion of an independent study of the estimated remaining useful lives of our Frontier legacy plant assets, we will adopt new lives for certain plant assets as of October 1, 2010.  In addition, we commissioned an independent study to determine the estimated remaining useful lives for our recently Acquired Business.  These new lives were adopted effective July 1, 2010.

(6)  
Goodwill and Other Intangibles:
The components of goodwill and other intangibles at September 30, 2010 and December 31, 2009 are as follows:

   ($ in thousands)
 
September 30, 2010
   
December 31, 2009
   
    
                 
Goodwill:
 
$
6,256,282
   
$
2,642,323
   
                   
Other Intangibles:
                 
    Customer base
 
2,716,608
   
$
270,309
   
     Software licenses
   
105,060
     
-
   
    Trade name and license
   
137,726
     
134,680
   
          Other intangibles
   
2,959,394
     
404,989
   
    Less: Accumulated amortization
   
(314,311
   
(157,462
)
 
         Total other intangibles, net
 
$
2,645,083
   
$
247,527
   
                   

Amortization expense was $128.7 million and $14.1 million for the three months ended September 30, 2010 and 2009, respectively, and $156.8 million and $100.1 million for the nine months ended September 30, 2010 and 2009, respectively. Amortization expense for both the three and nine months ended September 30, 2010 included $114.7 million for intangible assets (primarily customer base) that were acquired in the Transaction based on a preliminarily estimated fair value of $2.6 billion and a preliminarily estimated useful life of nine years for the residential customer list and 12 years for the business customer list, amortized on an accelerated method.  Amortization expense for the three and nine months ended September 30, 2010 and 2009 included $14.1 million and $42.2 million, respectively, for intangible assets (customer base and trade name) that were acquired in the acquisitions of Commonwealth Telephone Enterprises, Inc., Global Valley Networks, Inc. and GVN Services.  Amortization expense for the three and nine months ended September 30, 2009 included $0 million and $57.9 million, respectively, for amortization associated with certain Frontier legacy properties, which were fully amortized in June 2009.

(7)  
Fair Value of Financial Instruments:
The following table summarizes the carrying amounts and estimated fair values for certain of our financial instruments at September 30, 2010 and December 31, 2009.  For the other financial instruments, representing cash, accounts receivable, long-term debt due within one year, accounts payable and other current liabilities, the carrying amounts approximate fair value due to the relatively short maturities of those instruments.  Other equity method investments, for which market values are not readily available, are carried at cost, which approximates fair value.

 
10

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




The fair value of our long-term debt is estimated based on quoted market prices at the reporting date for those financial instruments.

($ in thousands)
September 30, 2010
 
December 31, 2009
 
Carrying
     
Carrying
   
 
Amount
 
Fair Value
 
Amount
 
Fair Value
               
Long-term debt
$  8,181,603
 
$  8,559,155
 
$  4,794,129
 
$    4,628,132
               


(8)  
Long-Term Debt:
The activity in our long-term debt from December 31, 2009 to September 30, 2010 is summarized as follows:


         
Nine months ended September 30, 2010
             
                                 
Interest
 
               
Debt
               
Rate* at
 
   
December 31,
         
Assumed
   
New
   
September 30,
   
Setember 30,
 
($ in thousands)
 
2009
   
Payments
   
from Spinco
   
Borrowings
   
2010
   
2010
 
                                     
   Rural Utilities Service Loan Contracts
  $ 15,600     $ (4,148 )   $ -     $ -     $ 11,452       6.14 %
                                                 
   Senior Unsecured Debt
    4,855,001       (2,138 )     3,450,078       -       8,302,941       8.04 %
 
                                               
   Industrial Development Revenue Bonds
    13,550       -       -       -       13,550       6.33 %
                                                 
TOTAL LONG-TERM DEBT
  $ 4,884,151     $ (6,286 )   $ 3,450,078     $ -     $ 8,327,943       8.04 %
                                                 
  Less: Debt Discount
    (82,786 )                             (66,353 )        
  Less: Current Portion
    (7,236 )                             (79,987 )        
                                                 
    $ 4,794,129                             $ 8,181,603          
                                                 

* Interest rate includes amortization of debt issuance costs, debt premiums or discounts, and deferred gain on interest rate swap terminations.  The interest rates at September 30, 2010 represent a weighted average of multiple issuances.

 
11

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Additional information regarding our Senior Unsecured Debt as of September 30, 2010 and December 31, 2009 is as follows:

 
September 30, 2010
 
December 31, 2009
   
Principal
   
Interest
     
Principal
   
Interest
 
($ in thousands)
 
Outstanding
   
Rate
     
Outstanding
   
Rate
 
                           
Senior Notes:
                         
  Due 5/15/2011
$
76,089
   
9.250%
   
$
               76,089
   
9.250%
 
  Due 10/24/2011
 
200,000
   
6.270%
     
             200,000
   
6.270%
 
  Due 12/31/2012
 
144,375
   
1.938% (Variable)
     
             145,500
   
1.625% (Variable)
 
  Due 1/15/2013
 
580,724
   
6.250%
     
             580,724
   
6.250%
 
  Due 12/31/2013
 
131,625
   
2.313% (Variable)
     
             132,638
   
2.000% (Variable)
 
  Due 5/1/2014
 
600,000
   
8.250%
     
             600,000
   
8.250%
 
  Due 3/15/2015
 
300,000
   
6.625%
     
             300,000
   
6.625%
 
  Due 4/15/2015
 
500,000
   
7.875%
     
-
   
-
 
  Due 4/15/2017
 
1,100,000
   
8.250%
     
-
   
-
 
  Due 10/1/2018
 
600,000
   
8.125%
     
             600,000
   
8.125%
 
  Due 3/15/2019
 
434,000
   
7.125%
     
             434,000
   
7.125%
 
  Due 4/15/2020
 
1,100,000
   
8.500%
     
-
   
-
 
  Due 4/15/2022
 
500,000
   
8.750%
     
-
   
-
 
  Due 1/15/2027
 
345,858
   
7.875%
     
             345,858
   
7.875%
 
  Due 2/15/2028
 
200,000
   
6.730%
     
-
   
-
 
  Due 10/15/2029
 
50,000
   
8.400%
     
-
   
-
 
  Due 8/15/2031
 
945,325
   
9.000%
     
             945,325
   
9.000%
 
   
7,807,996
           
          4,360,134
       
                           
                           
Debentures:
                         
  Due 11/1/2025
 
138,000
   
7.000%
     
             138,000
   
7.000%
 
  Due 8/15/2026
 
1,739
   
6.800%
     
                 1,739
   
6.800%
 
  Due 10/1/2034
 
628
   
7.680%
     
                    628
   
7.680%
 
  Due 7/1/2035
 
125,000
   
7.450%
     
             125,000
   
7.450%
 
  Due 10/1/2046
 
193,500
   
7.050%
     
             193,500
   
7.050%
 
   
458,867
           
             458,867
       
 
                         
Subsidiary Senior  Notes due 12/1/2012
 
36,000
   
8.050%
     
               36,000
   
8.050%
 
                           
Capital Lease Obligation
 
78
           
-
   
-
 
Total
$
8,302,941
   
8.04%
   
$
          4,855,001
   
7.86%
 
                           

We obtained a letter of credit for $190.0 million to guarantee certain of our capital investment commitments in West Virginia in connection with the Transaction.  On September 8, 2010, we entered into a $190.0 million unsecured letter of credit facility.  The terms of the letter of credit facility are set forth in a Credit Agreement, dated as of September 8, 2010, among the Company, the Lenders party thereto, and Deutsche Bank AG, New York Branch (the Bank), as Administrative Agent and Issuing Bank (the Letter of Credit Agreement).  The letter of credit was issued in its entirety as of the end of the third quarter of 2010.  The commitments under the Letter of Credit Agreement expire on September 20, 2011, with a Bank option to extend up to $100.0 million of the commitments to September 20, 2012. The Company is required to pay an annual facility fee on the available commitment, regardless of usage.  The covenants binding on the Company under the terms of the Letter of Credit Agreement are substantially similar to those in the Company’s other credit facilities, including limitations on liens, substantial asset sales and mergers, subject to customary exceptions and thresholds.

 
12

 
On March 23, 2010, we entered into a new $750.0 million revolving credit facility (the Credit Facility) that became effective on July 1, 2010, concurrent with the closing of the Merger and the termination of the Company’s previously existing revolving credit facility. As of September 30, 2010, we have not made any borrowings utilizing this facility.  The terms of the Credit Facility are set forth in the Credit Agreement, dated as of March 23, 2010, among the Company, the Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent (the Credit Agreement). Associated facility fees under the Credit Facility will vary from time to time depending on the Company’s credit rating (as defined in the Credit Agreement) and were 0.625% per annum as of September 30, 2010. The Credit Facility is scheduled to terminate on January 1, 2014. During the term of the Credit Facility, the Company may borrow, repay and reborrow funds, and may obtain letters of credit, subject to customary borrowing conditions. Loans under the Credit Facility will bear interest based on the alternate base rate or the adjusted LIBOR rate (each as determined in the Credit Agreement), at the Company’s election, plus a margin specified in the Credit Agreement based on the Company’s credit rating. Letters of credit issued under the Credit Facility will also be subject to fees that vary depending on the Company’s credit rating. The Credit Facility will be available for general corporate purposes but may not be used to fund dividend payments.

On April 12, 2010, Spinco completed a private offering for $3.2 billion aggregate principal amount of Senior Notes (the Senior Notes). The gross proceeds of the offering, plus $125.5 million (the Transaction Escrow) contributed by Frontier, were deposited into an escrow account.  Immediately prior to the completion of the Merger, the proceeds of the notes offering (less the initial purchasers’ discount) were released from the escrow account and used to make a special cash payment by Spinco to Verizon, as contemplated by the Transaction, with amounts in excess of the special cash payment and the initial purchasers' discount received by the Company (approximately $53.0 million). In addition, the $125.5 million Transaction Escrow was returned to the Company.

Upon completion of the Merger on July 1, 2010, we entered into a supplemental indenture with The Bank of New York Mellon, as Trustee, pursuant to which we assumed the obligations under the Senior Notes.   The Senior Notes were recorded at their fair value on the date of acquisition, which was approximately $3.2 billion.

The Senior Notes consist of $500.0 million aggregate principal amount of Senior Notes due 2015 (the 2015 Notes), $1.1 billion aggregate principal amount of Senior Notes due 2017 (the 2017 Notes), $1.1 billion aggregate principal amount of Senior Notes due 2020 (the 2020 Notes) and $500.0 million aggregate principal amount of Senior Notes due 2022 (the 2022 Notes).

The 2015 Notes have an interest rate of 7.875% per annum, the 2017 Notes have an interest rate of 8.25% per annum, the 2020 Notes have an interest rate of 8.50% per annum and the 2022 Notes have an interest rate of 8.75% per annum. The Senior Notes were issued at a price equal to 100% of their face value. In the third quarter of 2010, we completed an exchange offer for the privately placed Senior Notes for registered notes.

Upon completion of the Merger on July 1, 2010, we also assumed additional debt of $250.0 million, including $200.0 million aggregate principal amount of 6.73% Senior Notes due February 15, 2028 and $50.0 million aggregate principal amount of 8.40% Senior Notes due October 15, 2029.

On April 9, 2009, we completed a registered offering of $600.0 million aggregate principal amount of 8.25% senior unsecured notes due 2014.  The issue price was 91.805% of the principal amount of the notes.  We received net proceeds of approximately $538.8 million from the offering after deducting underwriting discounts and offering expenses.  During the first nine months of 2009, we used $353.0 million of the proceeds to repurchase $360.8 million principal amount of debt, consisting of $280.8 million of our 9.25% Senior Notes due May 15, 2011 (the 2011 Notes), $54.1 million of our 7.875% Senior Notes due January 15, 2027, $16.0 million of our 7.125% Senior Notes due March 15, 2019 and $9.9 million of our 6.80% Debentures due August 15, 2026.  As a result of these repurchases, a $7.8 million gain was recognized and included in other income, net in our consolidated statements of operations for the nine months ended September 30, 2009.  We used the remaining proceeds from the offering to finance a cash tender offer for the 2011 Notes and our 6.250% Senior Notes due January 15, 2013 (the 2013 Notes) in the fourth quarter of 2009.

 
13

 
As of September 30, 2010, we were in compliance with all of our debt and credit facility financial covenants.

Our principal payments for the next five years are as follows as of September 30, 2010:


 
($ in thousands)
 
Principal Payments
    
   
2010 (remaining three months)
$
950
2011
$
279,956
2012
$
180,366
2013
$
709,855
2014
$
600,517
2015
$
800,549


(9)  
Income Taxes:
The following is a reconciliation of the provision for income taxes computed at Federal statutory rates to the effective rates for the three and nine months ended September 30, 2010 and 2009:

   
For the three months ended
September 30,
   
For the nine months ended
September 30,
 
   
 
2010
2009
   
2010
2009  
 
 
                   
Consolidated tax provision at federal statutory rate
    35.0 %     35.0 %     35.0 %     35.0 %
State income tax provisions, net of federal income tax benefit
    7.1       1.1       3.3       1.5  
Non-deductible transaction costs     17.4             6.1        
All other, net
    (1.9     (0.6 )     0.5       (0.9 )
      57.6 %     35.5 %     44.9 %     35.6 %
                             

In the third quarter of 2010, Frontier reduced certain deferred tax assets of approximately $12.0 million related to transaction costs which were not tax deductible.  Prior to the closing of the Merger, these costs were deemed to be tax deductible as the Transaction had not yet been successfully completed. These costs were incurred to facilitate the Merger and as such must be capitalized for tax purposes.

The first nine months of 2010 also includes the impact of $4.1 million resulting from health care reform legislation associated with the passage of the Patient Protection and Affordable Care Act and of the Health Care and Education Reconciliation Act of 2010 (the Acts), partially offset by a release of $0.9 million in the reserve related to uncertain tax positions and the permanent difference on a split-dollar life insurance policy settlement for $1.6 million.  The health care reform legislation enacted in March 2010 under the Acts has eliminated the tax deduction for the subsidy that the Company receives under Medicare Part D for prescription drug costs.
 
The amount of our uncertain tax positions expected to reverse during the next twelve months and which would affect our effective tax rate is $14.5 million as of September 30, 2010.

 
14

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 
(10)  
Net Income Per Common Share:
The reconciliation of the net income per common share calculation for the three and nine months ended September 30, 2010 and 2009, respectively, is as follows:

($ in thousands, shares in thousands, except per share amounts)
 
For  the three months ended September  30,
   
For the nine months ended September 30,
   
2010
   
2009
   
2010
   
2009
Net income used for basic and diluted earnings
                     
   per common share:
                     
Net income attributable to common shareholders of Frontier
$
28,9955
 
$
52,1599
 
$
106,6811
 
$
116,380
                       
Less:  Dividends allocated to unvested restricted stock awards
 
(8655
)
 
(5566
)
 
(2,2400
)
 
 (1,698)
 
                     
Total basic and diluted net income attributable to common
    shareholders of Frontier
$
28,1300
 
$
51,6033
 
$
104,4411
 
$
 114,682
                       
Basic earnings per common share:
                     
Total weighted-average shares and unvested restricted stock
    awards outstanding - basic
 
993,0566
   
312,3511
   
585,0499
   
312,140
Less:  Weighted-average unvested restricted stock awards
 
(4,1111
)
 
 (2,2500
)
 
(3,1800
)
 
 (2,150)
Total weighted-average shares outstanding – basic
 
988,9455
   
 310,1011
   
581,8699
   
 309,990
                       
Net income per share attributable to common shareholders of
    Frontier
$
0.033
 
$
 0.177
 
$
0.188
 
$
 0.37
 
                     
Diluted earnings per common share:
                     
Total weighted-average shares outstanding - basic
 
988,9455
   
310,1011
   
581,8699
   
309,990
Effect of dilutive restricted stock awards
 
8555
   
-  -
   
2500
   
-
Total weighted-average shares outstanding - diluted
 
989,8000
   
 310,1011
   
582,1199
   
 309,990
                       
Net income per share attributable to common shareholders of
    Frontier
$
0.033
 
$
 0.177
 
$
0.188
 
$
 0.37
                       

Stock Options
For the three and nine months ended September 30, 2010 and 2009, options to purchase 3,429,000 shares and 3,562,000 shares, respectively (at exercise prices ranging from $8.19 to $18.46), issuable under employee compensation plans were excluded from the computation of diluted earnings per share (EPS) for those periods because the exercise prices were greater than the average market price of our common stock and, therefore, the effect would be antidilutive.  In calculating diluted EPS we apply the treasury stock method and include future unearned compensation as part of the assumed proceeds.

In addition, for the three and nine months ended September 30, 2010 and 2009, we have deducted the impact of dividends paid on unvested restricted stock awards from net income attributable to common shareholders of Frontier.

Stock Units
At September 30, 2010 and 2009, we had 388,722 and 433,291 stock units, respectively, issued under our Non-Employee Directors’ Deferred Fee Equity Plan (Deferred Fee Plan) and the Non-Employee Directors’ Equity Incentive Plan (Directors’ Equity Plan).  These securities have not been included in the diluted income per share of common stock calculation because their inclusion would have an antidilutive effect.

 
15

 
(11)  
Stock Plans:
At September 30, 2010, we had five stock-based compensation plans under which grants have been made and awards remained outstanding.  No further awards may be granted under three of the plans: the 1996 Equity Incentive Plan, the Amended and Restated 2000 Equity Incentive Plan (collectively, together with the 2009 Equity Incentive Plan that was adopted on May 14, 2009, the EIP) and the Deferred Fee Plan.  At September 30, 2010, there were 12,540,761 shares authorized for grant under these plans and 10,114,342 shares available for grant under two of the plans.  

The following summary presents information regarding outstanding stock options as of September 30, 2010 and changes during the nine months then ended with regard to options under the EIP:

         
Weighted
 
Weighted
     
   
Shares
   
Average
 
Average
   
Aggregate
   
 Subject to
   
 Option Price
 
 Remaining
   
Intrinsic
   
 Option
   
 Per Share
 
 Life in Years
   
 Value
Balance at January 1, 2010
3,551,0000
 
$
13.74
 
1.5
 
$
-
 
Options granted
-  -
 
$
     -
         
 
Options exercised
-  -
 
$
     -
     
$
-
 
Options canceled, forfeited or lapsed
(122,0000
)
$
14.90
         
Balance at September 30, 2010
3,429,0000
 
$
13.70
 
0.8
 
$
-
                     
Exercisable at September 30, 2010
3,429,0000
 
$
13.70
 
0.8
 
$
-
                     

There were no options granted during the first nine months of 2010.  No cash was received upon the exercise of options during the first nine months of 2010.

The total intrinsic value of stock options exercised during the first nine months of 2009 was $0.1 million.  The total intrinsic value of stock options outstanding and exercisable at September 30, 2009 was zero.  There were no options granted during the first nine months of 2009.  Cash received upon the exercise of options during the first nine months of 2009 totaled $0.7 million.  

The following summary presents information regarding unvested restricted stock as of September 30, 2010 and changes during the nine months then ended with regard to restricted stock under the EIP:

         
Weighted
     
         
Average
     
   
 Number of
   
 Grant Date
   
Aggregate
   
 Shares
   
 Fair Value
   
Fair Value
Balance at January 1, 2010
2,193,000
 
$
10.41
 
$
17,126,000
 
Restricted stock granted
3,244,000
 
$
7.53
 
$
26,505,000
 
Restricted stock vested
(865,000)
 
$
10.89
 
$
7,072,000
 
Restricted stock forfeited
(97,000)
 
$
8.20
     
Balance at September 30, 2010
4,475,000
 
$
8.28
 
$
36,559,000

In connection with the completion of the Merger on July 1, 2010, the Company granted an aggregate of 1,911,000 shares of restricted stock with a total fair value of $14.2 million to its senior management, as a retention and transaction bonus based on contributions that senior management made to achieve key milestones of the Transaction, and to all employees (including senior management) as a Founder’s Stock Grant during the third quarter of 2010.  The restricted shares granted to senior management vest in three equal annual installments commencing one year after the grant date.  The Founder’s Stock granted to all employees vest 100% on the third anniversary of the grant date.
 
 
 
16

 
For purposes of determining compensation expense, the fair value of each restricted stock grant is estimated based on the average of the high and low market price of a share of our common stock on the date of grant.  Total remaining unrecognized compensation cost associated with unvested restricted stock awards at September 30, 2010 was $29.9 million and the weighted average period over which this cost is expected to be recognized is approximately two years.

The total fair value of shares granted and vested during the nine months ended September 30, 2009 was approximately $8.4 million and $3.9 million, respectively.  The total fair value of unvested restricted stock at September 30, 2009 was $16.8 million. The weighted average grant date fair value of restricted shares granted during the nine months ended September 30, 2009 was $8.42.   Shares granted during the first nine months of 2009 totaled 1,115,000.

(12)  
Segment Information:
We operate in one reportable segment, Frontier.  Frontier provides both regulated and unregulated voice, data and video services to residential, business and wholesale customers and is typically the incumbent provider in its service areas.

As permitted by U.S. GAAP, we have utilized the aggregation criteria to combine our operating segments because all of our Frontier properties share similar economic characteristics, in that they provide the same products and services to similar customers using comparable technologies in all of the states in which we operate.  The regulatory structure is generally similar.  Differences in the regulatory regime of a particular state do not materially impact the economic characteristics or operating results of a particular property.  In conjunction with the reorganization of our operating segments effective July 1, 2010, we reassigned goodwill to our reporting units using a relative fair value allocation approach.

(13)  
Investment Income:
The components of investment income for the three and nine months ended September 30, 2010 and 2009 are as follows:
 
 
For the three months ended September 30,
 
For the nine months ended September 30,
   ($ in thousands)
2010
 
2009
 
2010
   
2009
                       
    Interest and dividend income
$
289
   
$
482
 
$
2,822
   
$
4,682
    Investment gain
 
-
     
-
   
2,905
     
-
    Equity earnings
 
108
     
173
   
667
     
798
    Total investment income
$
397
   
$
655
 
$
6,394
   
$
5,480
                           


 
17

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




(14)  
Other Income, Net:
The components of other income, net for the three and nine months ended September 30, 2010 and 2009 are as follows:
 
 
 
For the three months ended
September 30,
 
For the nine months ended
September 30,
   ($ in thousands)
2010
 
2009
 
2010
   
2009
                       
Gain on debt repurchases
$
-
   
$
4,091
 
$
-
   
$
7,755
Gain on expiration/settlement of customer advances
 
1,175
     
228
   
6,023
     
2,741
Split-dollar life insurance policy settlement
 
75
     
-
   
4,454
     
-
Litigation settlement proceeds
 
1,035
     
909
   
3,135
     
3,095
Other, net
 
(78
)
   
(28
)
 
(115
)
   
(351)
    Total other income, net
$
2,207
   
$
5,200
 
$
13,497
   
$
13,240
                           


 
18

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(15)  
Retirement Plans:
The following tables provide the components of net periodic benefit cost:


   
Pension Benefits
   
Pension Benefits
 
   
For the three months ended
   
For the nine months ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
($ in thousands)
                       
Components of net periodic pension benefit cost
                       
Service cost
  $ 8,994     $ 1,704     $ 12,212     $ 4,574  
Interest cost on projected benefit obligation
    21,601       13,167       46,364       39,095  
Expected return on plan assets
    (23,262 )     (11,342 )     (46,561 )     (33,534 )
Amortization of prior service cost /(credit)
    (49 )     (63 )     (149 )     (191 )
Amortization of unrecognized loss
    7,048       6,518       20,545       20,358  
Net periodic pension benefit cost
  $ 14,332     $ 9,984     $ 32,411     $ 30,302  
                                 
                                 
   
Postretirement Benefits
   
Postretirement Benefits
 
   
Other Than Pensions
   
Other Than Pensions
 
   
For the three months ended
   
For the nine months ended
 
   
September 30,
   
September 30,
 
      2010       2009       2010       2009  
($ in thousands)
                               
Components of net periodic postretirement benefit cost
                               
Service cost
  $ 3,842     $ 44     $ 4,041     $ 270  
Interest cost on projected benefit obligation
    6,241       2,551       11,499       8,265  
Expected return on plan assets
    (113 )     (112 )     (330 )     (330 )
Amortization of prior service cost/(credit)
    (1,932 )     (1,936 )     (5,790 )     (5,812 )
Amortization of unrecognized loss
    528       818       3,690       3,780  
Net periodic postretirement benefit cost
  $ 8,566     $ 1,365     $ 13,110     $ 6,173  
                                 
 
During the first nine months of 2010 and 2009, we capitalized $5.4 million and $5.5 million, respectively, of pension expense into the cost of our capital expenditures, as the costs relate to our engineering and plant construction activities.  We expect that our 2010 pension and other postretirement benefit expenses will be between $65.0 million and $75.0 million for Frontier, including the plan expenses of the Acquired Business for the second half of 2010, as compared to $48.6 million in 2009.  We expect that we will make a $2.4 million cash contribution to our pension plan in the fourth quarter of 2010.

In connection with the completion of the Merger on July 1, 2010, certain employees were transferred from various Verizon pension plans into 12 pension plans that were then merged with the Frontier Communications Pension Plan (the Plan) effective August 31, 2010.  Assets of $453.2 million, representing approximately 80% of the total amount expected to be received, were transferred into the Plan during the third quarter of 2010, with the remainder to be transferred by the end of the first half of 2011.  

The Company’s pension plan assets have increased from $608.6 million at December 31, 2009 to $1,088.7 million at September 30, 2010, an increase of $480.1 million, or 79%.  This increase is a result of asset transfers from the Verizon pension plan trusts of $453.2 million, less ongoing benefit payments of $50.7 million, partially offset by $66.9 million of positive investment returns and cash contributions of $10.7 million during the first nine months of 2010.  
 
(16)  Commitments and Contingencies:
We anticipate total capital expenditures of approximately $500.0 million to $525.0 million for 2010 related to our Frontier legacy properties and the Acquired Business.  Although we from time to time make short-term purchasing commitments to vendors with respect to these expenditures, we generally do not enter into firm, written contracts for such activities.  

 
19

 
In connection with the Transaction, the Company undertook activities to plan and implement systems conversions and other initiatives necessary to effectuate the closing (Phase 1).  The Company currently expects to incur operating expenses, including deal costs, of approximately $135.0 million and capital expenditures of approximately $95.0 million in 2010 related to these integration initiatives in Phase 1.  The Company incurred $125.9 million of acquisition and integration costs and $77.9 million in capital expenditures related to integration activities during the first nine months of 2010. The Company continues to engage in activities to enable the Company to implement its “go to market” strategy in its new markets and to complete the conversions of all the remaining systems into one platform (Phase 2).  The Company currently expects to incur operating expenses and capital expenditures of $10.0 million and $10.0 million, respectively, in 2010 related to the commencement of these Phase 2 initiatives.

In addition, the Federal Communications Commission (FCC) and certain state regulatory commissions, in connection with granting their approvals of the Transaction, specified certain capital expenditure and operating requirements for our business for specified periods of time post-closing.  These requirements focus primarily on a variety of capital investment commitments, including the expansion of broadband availability and speeds to at least 85% of the households throughout the Company with minimum speeds of 3 megabits per second (Mbps) by the end of 2013 and 4 Mbps by the end of 2015.  To satisfy all or part of certain capital investment commitments to three state regulatory commissions, we placed an aggregate amount of $115.0 million in cash into escrow accounts and obtained the letter of credit for $190.0 million in the third quarter of 2010.  Another $72.4 million of cash in an escrow account, with an associated liability (reflected in other liabilities), was acquired in connection with the Merger to be used for service quality initiatives in the state of West Virginia.  As of September 30, 2010, the Company had a restricted cash balance in these escrow accounts in the aggregate amount of $187.4 million.  The aggregate amount of these escrow accounts and the letter of credit will decrease over time as Frontier makes the required capital expenditures in the respective states.

We are party to various legal proceedings arising in the normal course of our business covering a wide range of matters or types of claims including general contract, rights of access, tax, consumer protection, trademark and patent infringement, employment, regulatory and tort.  Litigation is subject to uncertainty and the outcome of individual matters is not predictable.  However, we believe that the ultimate resolution of all such matters, after considering insurance coverage, or other indemnities to which Frontier is entitled, will not have a material adverse effect on our financial position, results of operations, or our cash flows.

We sold all of our utility businesses as of April 1, 2004.  However, we have retained a potential payment obligation associated with our previous electric utility activities in the State of Vermont.  The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including us, entered into a purchase power agreement with Hydro-Quebec in 1987.  The agreement contains “step-up” provisions that state that if any VJO member defaults on its purchase obligation under the contract to purchase power from Hydro-Quebec, then the other VJO participants will assume responsibility for the defaulting party’s share on a pro-rata basis.  Our pro-rata share of the purchase power obligation is 10%.  If any member of the VJO defaults on its obligations under the Hydro-Quebec agreement, then the remaining members of the VJO, including us, may be required to pay for a substantially larger share of the VJO’s total purchase power obligation for the remainder of the agreement (which runs through 2015).  U.S. GAAP rules require that we disclose “the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee.”  U.S. GAAP rules also state that we must make such disclosure “… even if the likelihood of the guarantor’s having to make any payments under the guarantee is remote…”  As noted above, our obligation only arises as a result of default by another VJO member, such as upon bankruptcy.  Therefore, to satisfy the “maximum potential amount” disclosure requirement we must assume that all members of the VJO simultaneously default, a highly unlikely scenario given that the two members of the VJO that have the largest potential payment obligations are publicly traded with credit ratings equal to or superior to ours, and that all VJO members are regulated utility providers with regulated cost recovery.   Despite the remote chance that such an event could occur, or that the State of Vermont could or would allow such an event, assuming that all the members of the VJO defaulted on January 1, 2010 and remained in default for the duration of the contract (another 6 years), we estimate that our undiscounted purchase obligation for 2010 through 2015 would be approximately $600 million.  In such a scenario, the Company would then own the power and could seek to recover its costs.  We would do this by seeking to recover our costs from the defaulting members and/or reselling the power to other utility providers or the northeast power grid.  There is an active market for the sale of power.  We could potentially lose money if we were unable to sell the power at cost.  We caution that we cannot predict with any degree of certainty any potential outcome.

 
20

 

PART I. FINANCIAL INFORMATION (Continued)
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES



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

Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements.  Statements that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Words such as “believe,” “anticipate,” “expect” and similar expressions are intended to identify forward-looking statements. Forward-looking statements (including oral representations) are only predictions or statements of current plans, which we review continuously.  Forward-looking statements may differ from actual future results due to, but not limited to, and our future results may be materially affected by, potential risks or uncertainties.  You should understand that it is not possible to predict or identify all potential risks or uncertainties.  We note the following as a partial list:

·  
Limitations on the amount of capital stock that we can issue to make acquisitions or to raise additional capital during the two years after the Merger;
 
·  
Our indemnity obligation to Verizon for taxes which may be imposed upon them as a result of changes in ownership of our stock may discourage, delay or prevent a third party from acquiring control of us during the two-year period following the Merger in a transaction that stockholders might consider favorable;
 
·  
Our ability to successfully integrate the operations of the Acquired Business into Frontier’s existing operations;
 
·  
The effects of increased expenses incurred due to activities related to the Transaction and the integration of the Acquired Business;
 
·  
The risk that the growth opportunities and cost synergies from the Transaction may not be fully realized or may take longer to realize than expected;
 
·  
Our ability to maintain relationships with customers, employees or suppliers;
 
·  
The effects of greater than anticipated competition requiring new pricing, marketing strategies or new product or service offerings and the risk that we will not respond on a timely or profitable basis;
 
·  
Reductions in the number of our access lines that cannot be offset by increases in High-Speed Internet (HSI) subscribers and sales of other products and services;
 
·  
The effects of ongoing changes in the regulation of the communications industry as a result of federal and state legislation and regulation;
 
·  
The effects of changes in the availability of federal and state universal funding to us and our competitors;
 
·  
The effects of competition from cable, wireless and other wireline carriers (through Voice over Internet Protocol (VOIP), DOCSIS 3.0, 4G or otherwise);
 
·  
Our ability to adjust successfully to changes in the communications industry and to implement strategies for growth;
 
·  
Adverse changes in the credit markets or in the ratings given to our debt securities by nationally accredited ratings organizations, which could limit or restrict the availability, or increase the cost, of financing;
 
·  
Continued reductions in switched access revenues as a result of regulation, competition or technology substitutions;
 
·  
Our ability to effectively manage service quality in our territories and meet mandated service quality metrics;
 
·  
Our ability to successfully introduce new product offerings, including our ability to offer bundled service packages on terms that are both profitable to us and attractive to customers;
 
·  
Changes in accounting policies or practices adopted voluntarily or as required by generally accepted accounting principles or regulations;
 
 
21

 
·  
Our ability to effectively manage our operations, operating expenses and capital expenditures, and to repay, reduce or refinance our debt;
 
·  
The effects of changes in both general and local economic conditions on the markets that we serve, which can affect demand for our products and services, customer purchasing decisions, collectability of revenues and required levels of capital expenditures related to new construction of residences and businesses;
 
·  
The effects of customer bankruptcies and home foreclosures, which could result in difficulty in collection of revenues and loss of customers;
 
·  
The effects of technological changes and competition on our capital expenditures and product and service offerings, including the lack of assurance that our network improvements will be sufficient to meet or exceed the capabilities and quality of competing networks;
 
·  
The effects of increased medical, retiree and pension expenses and related funding requirements;
 
·  
Changes in income tax rates, tax laws, regulations or rulings, or federal or state tax assessments;
 
·  
The effects of state regulatory cash management policies on our ability to transfer cash among our subsidiaries and to the parent company;
 
·  
Our ability to successfully renegotiate union contracts expiring in 2010 and thereafter;
 
·  
Declines in the value of our pension plan assets, which would require us to make increased contributions to the pension plan in 2011 and beyond;
 
·  
Our ability to pay dividends on our common shares, which may be affected by our cash flow from operations, amount of capital expenditures, debt service requirements, cash paid for income taxes and liquidity;
 
·  
The effects of any unfavorable outcome with respect to any current or future legal, governmental or regulatory proceedings, audits or disputes;
 
·  
The possible impact of adverse changes to regulatory requirements imposed by various political bodies or other external factors over which we have no control; and
 
·  
The effects of severe weather events such as hurricanes, tornados, ice storms or other natural or man-made disasters.
 

Any of the foregoing events, or other events, could cause financial information to vary from management’s forward-looking statements included in this report.  You should consider these important factors, as well as the risks set forth under Item 1A. “Risk Factors” in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2010 and June 30, 2010, in evaluating any statement in this report on Form 10-Q or otherwise made by us or on our behalf.  The following information is unaudited and should be read in conjunction with the consolidated financial statements and related notes included in this report.  We have no obligation to update or revise these forward-looking statements.

Overview
On July 1, 2010, pursuant to the Agreement and Plan of Merger, dated as of May 13, 2009, as amended, by and among Verizon, Spinco and Frontier, Spinco merged with and into Frontier, with Frontier surviving as the combined company and conducting the combined business operations of Frontier and the Acquired Business.  Immediately prior to the Merger, Spinco had been a wholly-owned subsidiary of Verizon and held the defined assets and liabilities of the local exchange business and related landline activities of Verizon in Arizona, Idaho, Illinois, Indiana, Michigan, Nevada, North Carolina, Ohio, Oregon, South Carolina, Washington, West Virginia and Wisconsin and in portions of California bordering Arizona, Nevada and Oregon, including Internet access and long distance services and broadband video provided to designated customers in the Territories, was spun off to Verizon shareholders.  The Transaction was financed with approximately $5.2 billion of common stock (Verizon shareholders received 678,530,386 shares of Frontier common stock) plus the assumption of approximately $3.5 billion principal amount of Spinco debt.

The Company is the nation’s largest communications services provider focused on rural areas and small and medium-sized towns and cities, and the nation’s fifth largest Incumbent Local Exchange Carrier (ILEC), with approximately 5.9 million access lines, 1.7 million broadband connections and 14,800 employees in 27 states as of September 30, 2010. On a pro forma basis, the Company’s revenues would have been approximately $6.1 billion for the year ended December 31, 2009 and approximately $4.3 billion for the nine months ended September 30, 2010.

 
22

 
Based on the level of debt and projected cash flows that we assumed from Spinco on July 1, 2010, our overall debt increased but our capacity to service the debt has been significantly enhanced as compared to our capacity immediately prior to the Merger.

Competition in the communications industry is intense and increasing. We experience competition from many communications service providers, including cable operators offering video, data and VOIP products, wireless carriers, long distance providers, competitive local exchange carriers, Internet providers and other wireline carriers.  We believe that competition will continue to intensify and may result in reduced revenues for the combined company.

The lingering impact of the severe contraction in the global financial markets that occurred in 2008 and 2009 and the subsequent recession has affected residential and business customer behavior.  Customers are reducing their spending by not purchasing our services or by discontinuing some or all of our services. These trends may continue and may result in a continued challenging revenue environment. The weak economic environment may produce increased delinquencies and bankruptcies and, therefore, affect our ability to collect money owed to us by residential and business customers.

We employ a number of strategies to combat the competitive pressures and changes in customer behavior noted above.  Our strategies are focused on preserving and generating new revenues through customer retention, upgrading and up-selling services to existing customers, new customer growth, win backs of former customers, new product deployment, and by managing our profitability and cash flow through targeted reductions in operating expenses and capital expenditures.

We are focused on enhancing the customer experience, as we believe exceptional customer service will differentiate us from our competition.  Our commitment to providing exemplary customer service is demonstrated by continuing our expanded customer service hours, in-home, full installation of the Company’s HSI product, shorter scheduling windows for in-home appointments and call reminders and follow-up calls for service appointments.   Additionally, we seek to achieve our customer retention goals by offering attractive packages of value-added services to our local access line customers and providing exemplary customer service. Our bundled services include HSI, unlimited long distance calling, enhanced telephone features, and video offerings (direct broadcast satellite services from DIRECTV and the Dish Network (DISH), FiOS services in certain states and over-the-top video on myfitv.com). We tailor these services to the needs of our residential and business customers and continually evaluate the introduction of new and complementary products and services, many of which can also be purchased separately. Customer retention is also enhanced by offering one-, two-and three-year price protection plans where customers commit to a term in exchange for predictable pricing and/or promotional offers.  In addition, the Company’s local area markets are operated by local managers with responsibility for the customer experience, as well as the financial results, in those markets. Customers in our markets have direct access to those local managers to help them manage their communications needs.
 
We are also focused on increasing sales of newer products, including unlimited long distance minutes, bundles of long distance minutes, wireless data, Internet portal advertising, and the Frontier Peace of Mind product suite. This last category is a suite of products that is aimed at managing the personal computing experience for our customers and is designed to provide value and simplicity to meet customers’ ever-changing needs. The Frontier Peace of Mind products and services suite includes services such as an in-home, full installation of the Company’s HSI product, two-hour appointment windows for the installation, hard drive back-up services, 24-7 help desk PC support and inside wire maintenance (when bundled). In 2009 and in the nine months ended September 30, 2010, the Frontier Peace of Mind products generated approximately $3.2 million and $3.8 million, respectively, in revenue for Frontier legacy operations. We also continue to offer the myfitv.com website, which provides easy online access to free television programs, video on demand movies and other entertainment. Hard drive back-up services, 24-7 help desk PC support and myfitv.com are also available outside of our service territories.  Although we are optimistic about the opportunities to increase revenue and reduce customer churn (i.e., customer attrition) that are provided by each of these initiatives, we cannot provide assurance about their long-term profitability or impact on revenue.
 
On the commercial side of our business, we are focused on many of the same strategies and enhancements described above as well as providing state-of-the-art transport services to wireless cell towers in our geographies and expanding the number and quality of people selling and servicing our medium and enterprise customers with sophisticated products (e.g. customer premises equipment) and services (e.g. SIP trunking).

We believe that the combination of offering multiple products and services to our customers pursuant to price protection programs, billing them on a single bill, providing superior customer service, and being active in our local communities will make our customers more loyal, and, as a result, will help us generate new, and retain existing, customer revenue.

 
23

 
Total revenues for Frontier improved $876.2 million during the third quarter of 2010 as compared to 2009 due to the $890.2 million of additional revenues in 2010 attributable to the Acquired Business.

Revenues for the Frontier legacy operations declined $14.0 million in the third quarter of 2010 as compared to 2009.  Revenues from data and internet services such as HSI grew and increased for our Frontier legacy properties as a percentage of total revenues and revenues from local and long distance services and from switched access and subsidy (including federal and state subsidies) declined and decreased as a percentage of our total revenues.

Switched access and subsidy revenue for Frontier of $162.0 million represented 12% of our revenues for the three months ended September 30, 2010.  Switched access revenue was $82.2 million for the three months ended September 30, 2010, or 6% of our revenues, up from $60.2 million for the three months ended September 30, 2009, or 11% of our revenues.  Federal and state subsidy revenue, including surcharges of $26.9 million billed to customers which are remitted to the FCC, was $79.9 million for the three months ended September 30, 2010, or 6% of our revenues, up from $31.1 million for the three months ended September 30, 2009, or 6% of our revenues.  We expect declining revenue trends in switched access and subsidy revenue during the remainder of 2010.

Expected Cost Savings Resulting from the Merger
Based on current estimates and assumptions, we expect to achieve significant cost savings and other synergies as a result of the Merger, principally (1) by leveraging the scalability of our existing corporate administrative functions and information technology and network systems to cover certain former Acquired Business functions and (2) by internalizing certain functions formerly provided by Verizon or by third-party service providers to the Acquired Business.

Effective with the closing of the Merger, the Acquired Business (other than with respect to West Virginia) has been operating on its existing single platform on an independent basis, and the Acquired Business with respect to West Virginia has been integrated into Frontier’s existing systems.  The main integration effort required for us to operate the Acquired Business immediately following the Merger was completed prior to the closing of the Merger, freeing up resources to implement post-merger strategies designed to achieve additional cost savings and drive revenue enhancements.

We estimate that, by 2013, our annualized cost savings will reach approximately $550 million.  During the third quarter of 2010, we realized cost savings of approximately $63 million, primarily by the elimination of previous costs related to Verizon centralized services.  This equates to an annualized run rate of approximately $250 million.  We expect to achieve annualized cost savings of approximately $300 million by the end of 2010, $400 million by the end of 2011 and $550 million by the end of 2012. The realization of the additional annual cost savings is expected to be fully achieved by 2013, when the Acquired Business’s network and information technology systems and processes are fully integrated with those of Frontier.

The foregoing future cost savings are based on our estimates and assumptions that, although we consider them reasonable, are inherently uncertain. These expected cost savings are subject to significant business, economic, competitive and regulatory uncertainties and contingencies, all of which are difficult to predict and many of which are beyond our control.  See “Forward Looking Statements” above. As a result, there can be no assurance that these or any other cost savings or synergies will actually be realized.

Strategies
The key elements of our strategy are as follows:

Expand broadband footprint. We are concentrating on broadband as a core component of our service offering and growth. As of September 30, 2010, approximately 92% of the households in Frontier’s legacy territories had access to Frontier’s broadband products.  At September 30, 2010, 68% of the households which were part of the Acquired Business had access to broadband products and services. We have earmarked capital expenditures for the expansion of broadband availability in the Acquired Business and view this expansion as an opportunity to satisfy customer needs and expectations, retain a greater number of customers and increase average revenue per customer.  These capital expenditures include enhancing the existing outside pla