10-K 1 form10k2012.htm 2012 FORM 10-K form10k2012.htm











FRONTIER COMMUNICATIONS CORPORATION



FORM 10-K




ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934


FOR THE YEAR ENDED DECEMBER 31, 2012


 
 

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012   
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)
     
 Registrant's telephone number, including area code: (203) 614-5600

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $.25 per share
 
The NASDAQ Stock Market LLC
Series A Participating Preferred Stock Purchase Rights
 
The NASDAQ Stock Market LLC
                                                                        
Securities registered pursuant to Section 12(g) of the Act:  NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   X      No __

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes __  No X

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 Website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

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

     Large Accelerated Filer  [X]                        Accelerated Filer  [  ]                         Non-Accelerated Filer  [  ]                    Smaller Reporting Company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes __  No

The aggregate market value of common stock held by non-affiliates of the registrant on June 29, 2012 was $3,799,677,000 based on the closing price of $3.83 per share on such date.

The number of shares outstanding of the registrant's Common Stock as of February 15, 2013 was 998,275,000.
 

 
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Company's 2013 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

 
 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
   
 
PART I
    Page
     
Item 1.
Business
2
     
Item 1A.
Risk Factors
15
     
Item 1B.
Unresolved Staff Comments
21
     
Item 2.
Properties
22
     
Item 3.
Legal Proceedings
22
     
Item 4.
Mine Safety Disclosures
22
     
Executive Officers
 
23
     
PART II
   
     
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
25
     
Item 6.
Selected Financial Data
28
     
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
     
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
50
     
Item 8.
Financial Statements and Supplementary Data
51
     
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
51
     
Item 9A.
Controls and Procedures
51
     
Item 9B.
Other Information
51
     
PART III
   
     
Item 10.
Directors, Executive Officers and Corporate Governance
51
     
Item 11.
Executive Compensation
52
     
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
52
     
Item 13.
Certain Relationships and Related Transactions, and Director Independence
52
     
Item 14.
Principal Accountant Fees and Services
52
     
PART IV
   
     
Item 15.
Exhibits and Financial Statement Schedules
52
     
Signatures
 
57
     
Index to Consolidated Financial Statements
 
F-1
 

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

PART I

Item 1.   Business

Frontier Communications Corporation (Frontier) is the largest communications company providing services predominantly to rural areas and small and medium-sized towns and cities in the U.S. Frontier and its subsidiaries are referred to as the “Company,” “we,” “us” or “our” throughout this report.  Frontier was incorporated in the state of Delaware in 1935, originally under the name of Citizens Utilities Company, and was known as Citizens Communications Company from 2000 until July 31, 2008.

Our mission is to be the leader in providing communications services to residential and business customers in our markets.  We are committed to delivering innovative and reliable products and solutions with an emphasis on convenience, service and customer satisfaction.  We offer a variety of voice, data, and television services and products, some that are available á la carte, and others that are available as bundled or packaged solutions.  We believe that our local engagement structure, 100% U.S.–based workforce and innovative product positioning will continue to differentiate us from our competitors in the markets in which we compete.

In 2012, we completed the integration of our July 2010 acquisition of properties from Verizon Communications Inc. (Verizon), an acquisition that tripled the size of the Company and is described in more detail below.  Additionally, we undertook the following significant steps in 2012 to position the Company for the future:

·  
Broadband Expansion
During 2012, we expanded our broadband availability to 318,000 new households, bringing our total of new available households to 973,000 since the July 2010 acquisition.  As of December 31, 2012, we are able to offer broadband to over 6.2 million households.  During 2012 and early 2013, Frontier received $66.0 million and $5.9 million, respectively, or a total of $71.9 million, from the Connect America Fund (CAF) to support broadband deployment in unserved high-cost areas.  As of December 31, 2012, we had broadband in excess of 1 Mbps available to 88% of the households in our territory, in excess of 3 Mbps available to 83% of the households in our territory, in excess of 6 Mbps available to 74% of the households in our territory, and in excess of 20 Mbps available to 40% of the households in our territory.
 
·  
Systems Conversion
In March 2012, the Company successfully completed the conversion of all of its network and systems from the July 2010 acquisition onto one platform, ten months ahead of schedule.  The completion of the conversions enhanced the Company’s ability to manage the business and further reduce costs.  Following the completion of the conversions, the Company is focused on simplifying its processes, eliminating redundancies and further reducing its cost structure while continuing to improve its customer service capabilities.
 
·  
Improved Residential Customer Metrics
During 2012, our rate of residential customer loss improved to 7.0% for the full year of 2012 as compared to 9.9% for 2011.  We believe that these improvements in customer retention are principally due to our investments in our network, our local engagement strategy, improved customer service and the introduction of our stand alone Simply Broadband product, as well as customer recognition of the value of our products, services and bundled options, fewer residential moves out of territory, fewer moves by businesses to competitors and our ability to compete with cable telephony in a maturing market place.
 
·  
Cost Reductions
We have fully achieved our acquisition cost savings synergy target of $650 million as of the end of 2012.  The cost savings in 2012 from our targeted initiatives list (which includes, but is not limited to, cancellation or reduction of vendor services, network cost savings, contractor reductions, benefit changes and real estate savings) was approximately $25 million on a quarterly basis, or $101 million on an annualized basis, and combined with the savings achieved in 2011 and 2010, equates to an annualized cost savings run rate of $653 million as of the end of 2012.
 

 
2

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES


 
·  
Strengthened Balance Sheet and Financial Profile
Effective February 16, 2012, our Board of Directors set the annual cash dividend at $0.40 per share.  The Board reduced the dividend from $0.75 per share to $0.40 per share in order to strengthen our balance sheet and improve operational and financial flexibility.
 
During 2012, we raised $1.4 billion in three registered debt offerings.  We used part of the proceeds to retire and repurchase an aggregate principal amount of $757.0 million of debt during the year.  As a result, we have excess proceeds from those offerings that are included in cash and cash equivalents as of the end of the year, which will be used to repurchase or retire existing indebtedness or for general corporate purposes.  Additionally, on January 15, 2013, we retired $502.7 million of our 6.25% Senior Notes due 2013 with cash on hand.
 
For the year ended December 31, 2012, we generated revenue of $5.0 billion, including customer revenue of $4.4 billion and regulatory revenue of $0.6 billion, and net cash provided from operating activities of $1.6 billion.  We have a well-balanced debt maturity schedule and we have available liquidity of over $2.1 billion as of December 31, 2012, comprised of cash and available credit on our $750 million revolving credit facility.
 
Our average monthly total revenue per customer in 2012 improved by $5.44, or 4%, to $127.32, as compared to the prior year.  Residential customer monthly churn was further reduced in 2012 to 1.62% from 1.69% in 2011.  We added 60,900 direct broadcast satellite (DBS) video subscribers during 2012 with our video product offered through DISH Network (DISH).  We lost 203,100 DirecTV video subscribers in the third quarter of 2012 when Frontier chose to not offer DirecTV as part of its bundled packages.
 
We believe that our local engagement strategy enhances customer loyalty.  On January 10, 2013, we strategically realigned our regional reporting structure from six regions to four regions. In addition, we decentralized certain functions, such as sales and marketing, enabling us to further strengthen our local engagement strategy, which we believe will deepen our relationships with customers and ultimately improve customer retention and average revenue per customer.  We also realigned certain corporate support functions in order to achieve improved customer service. This realignment will enable our local leaders to specifically target sales and marketing efforts to the communities they serve.

Communications Services

We tripled the size of the Company in July 2010 when we acquired 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 Acquired Territories), including Internet access and long distance services and broadband video provided to designated customers in the Acquired Territories (which we refer to as the Acquired Business).  We financed the purchase of the Acquired Business (the Transaction) with a distribution of $5.2 billion of common stock to Verizon shareholders (678.5 million shares) and the assumption of $3.5 billion of debt.

As of December 31, 2012, we are the nation’s fourth largest Incumbent Local Exchange Carrier (ILEC), with 3.2 million customers, 1.8 million broadband connections and 14,700 employees. We operate as an ILEC in 27 states.

We conduct business with both business and residential customers, and we provide the “last mile” of telecommunications services to customers in these markets.  During 2012, our customer revenue was $4,435.4 million, including business revenue of $2,317.2 million and residential revenue of $2,118.2 million.  At December 31, 2012, we had 1,787,600 broadband subscribers and 346,600 video customers.  Our services and products include:

·  
data and Internet services
-­  
wireline broadband services
­-  
data transmission services (e.g., DS1, DS3, Ethernet, dedicated Internet Protocol)
­-  
wireless broadband services
­-  
computer security (i.e., Frontier Secure)
­-  
commercial VoIP service
 
·  
local and long distance voice services
-­  
local voice services
­-  
enhanced services (e.g., voicemail, call waiting)
­-  
long distance network services

 
3

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
 
·  
access services
 
·  
video services
­ -  
direct broadcast satellite utilizing DISH
­ -  
terrestrial utilizing fiber to the home
 
·  
sales of customer premise equipment
 

Company Strategies
 
The key elements of our strategy are as follows:
 
Enhance customer loyalty through local engagement.  Our strategy includes engaging our markets at the local level to ensure that we have a locally customer-driven sales and service focus that differentiates us from our competitors.  Our markets are operated by local managers responsible for the customer experience, as well as the financial results, in those markets.  We invest in infrastructure improvements and enhancements each year, recognizing that the economic livelihood of the communities we serve will affect opportunities to grow the business. We therefore have a vested interest in the economic development of the communities we serve. We are involved in these communities to create a competitive advantage through long-term customer loyalty.  We are committed to providing best-in-class service throughout our markets and, by doing so, we expect to maximize retention of current customers and gain new customers.
 
Increase revenue per customer.  We continue to apply the sales and marketing practices that we have historically employed throughout our markets, including the sale of voice, data and video services as bundled packages and the use of promotions and incentives to drive market share.  We believe these marketing strategies yield increased revenue per customer, strong customer relationships and improved customer retention.  We tailor our services to the needs of our business and residential customers in the markets we serve and continually evaluate the introduction of new and complimentary products and services.  We are increasing broadband availability to our customer base through innovative packages and promotions, and we plan to improve subscription rates for broadband services.  We provide direct broadcast satellite services from DISH in all of our markets and fiber optic video services in parts of three states.  We have implemented several growth initiatives, including launching new products and services, such as wireless broadband, satellite video and broadband products, Internet advertising and “Frontier Secure” computer  security and technical support. We will continue to focus on growing those products and services and plan to offer new ones in the future.
 
Expand broadband footprint.  We are concentrating on broadband as the core component of our service offering and growth.  Consequently, we have earmarked capital expenditures for the expansion and improvement of broadband availability and speeds in our markets and view this expansion as an opportunity to retain a greater number of customers and increase average revenue per customer.  These capital expenditures include enhancing the existing outside plant by pushing fiber deeper into the network, enhancing transport and expanding the capability of our data backbone.

As of December 31, 2012, approximately 88% of the households throughout the Company’s territories had access to our wireline broadband products with speeds of at least 1 Mbps.  See “Network Architecture and Technology” for a table that summarizes our broadband availability to the households throughout the Company’s territories at speeds in excess of 1 Mbps, 3 Mbps, 4 Mbps, 6 Mbps, 12 Mbps and 20 Mbps for the total Company.  In addition, we have committed to federal and state regulatory authorities to expand broadband availability in certain areas of the Acquired Territories.  See “—Regulatory Environment—Regulation of our business.”  During the fourth quarter of 2012, we began selling a satellite broadband product with speed between 256 Kbps and 40 Mbps in selected markets.
 
Realize Cost Savings. The Company accelerated its final conversion of the Acquired Business systems onto one company platform in March 2012,  ten months ahead of the original target.  We have achieved cost savings of approximately $653 million as a result of the Transaction, principally by: (1) leveraging the scalability of our existing corporate administrative functions, information technology and network systems to cover certain former Acquired Business functions and systems; (2) in-sourcing certain functions formerly provided by third-party service providers to the Acquired Business; and (3) achieving improved efficiencies and more favorable rates with third-party vendors and the consolidation of certain facilities. The cost savings in 2012 from our targeted initiatives list (which includes, but is not limited to, cancellation or reduction of vendor services, network cost savings, contractor reductions, benefit changes and real estate savings) was approximately $101 million on an annualized basis, and when combined with the savings achieved in 2011 and 2010, equates to an annualized cost savings run rate of approximately $653 million, which exceeds our original estimate of $500 million of cost savings. 

 
4

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Growth through selective acquisitions.  We continue to evaluate and may pursue select strategic acquisitions that would enhance revenues and cash flows.  We will continue to adhere to our selective criteria in any acquisition analysis.
 
Services
 
We offer a broad portfolio of high-quality communications services for business and residential customers in each of our markets.  These include services traditionally associated with local telephone companies, as well as other services such as long distance, Internet access, broadband-enabled services and video services. We offer these services both á la carte and, increasingly, as bundled packages which are purposely designed to simplify customer purchasing decisions and to provide the customer with pricing discounts.  We also offer incentives and promotions to influence customers to purchase or retain certain services.  We also enhance customer retention by offering one-, two- and three-year price protection plans under which customers commit to a term in exchange for predictable pricing or other incentives and promotions.  We are staffed locally with skilled technicians and supervisory personnel, which enables us to provide efficiently and reliably an array of communications services to meet our customers’ needs.  Our call center operations and field technicians are staffed with 100% U.S.-based personnel.
 
Generation of Revenue
 
We generate revenue primarily by providing: (1) data and Internet services and wireless data services; (2) basic local and long distance voice wireline services to business and residential customers in our service areas; (3) network access to interexchange carriers for origination and termination of long distance voice and data traffic; (4) sales of third party and owned video services; and (5) sales of customer premise equipment.
 
Data and Internet services. We offer a wide range of wireline broadband services to our residential, commercial and carrier customers.  Residential services include broadband, dial up Internet, portal and e-mail products.  Commercial services include Ethernet, Dedicated Internet, Multiprotocol Label Switching (MPLS), and TDM data transport services. These services are all supported by a 24-7 help desk and an advanced Network Operations Center.  Such services are generally offered on a contract basis and the service is billed on a fixed monthly recurring charge basis.  Data and Internet services are typically billed monthly in advance.

We also offer our Frontier Secure suite of products aimed at managing the personal computing experience for our customers and designed to provide value and simplicity to meet customers’ ever-changing needs.  The Frontier Secure products and services suite includes an in-home, full installation of the Company’s broadband 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).

We offer wireless broadband services (using unlicensed WiFi spectrum) in select markets utilizing networks that we own or operate.  Long-term contracts are billed in advance on an annual or semi-annual basis.  End-user subscribers are billed in advance on a monthly recurring basis and businesses, colleges and universities are billed on a monthly recurring basis for a fixed number of users.  Hourly, daily and weekly casual end-users are billed by credit card at the time of use.

Local and long distance voice services.  We provide basic telephone wireline services to business and residential customers in our service areas.  Our service areas are largely residential and generally less densely populated than the primary service areas of the largest ILECs.  We also provide enhanced services to our customers by offering a number of calling features, including call forwarding, conference calling, caller identification, voicemail and call waiting.  All of these local services are billed monthly in advance.  Long distance network service to and from points outside our operating territories are provided by interconnection with the facilities of interexchange carriers.  Our long distance services are billed either as unlimited/fixed number of minutes in advance or on a per minute-of-use basis.

 
5

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
We also offer packages of communications services.  These packages permit customers to bundle their basic telephone line service with their choice of enhanced, long distance, video and Internet services for a monthly fee or usage fee depending on the plan.
 
We are continuing our efforts to increase the penetration of our enhanced services which produce revenue with higher operating margins due to the relatively low marginal operating costs necessary to offer such services.  Integrating these services with other services may provide the opportunity to capture an increased percentage of our customers’ communications expenditures.
 
Access services.  Our switched access services allow other carriers to use our facilities to originate and terminate their local and long distance voice traffic. These services are generally offered on a month-to-month basis and the service billed primarily on a minutes-of-use basis. Switched access charges have been based on access rates filed with the FCC for interstate services and with the respective state regulatory agency for intrastate services. On November 18, 2011, the FCC released the USF/ICC Report & Order (the Order) that, beginning in July 2012, requested us to transition terminating switched access rates over time to near zero by July 2017. The Order enables companies to recover part of the decline through increases in subscriber line fees charged to some residential and business wireline voice customers.  While the FCC has asserted jurisdiction over these terminating access rates, during the transition the charges will continue to be based on tariffs filed with both the FCC and state regulatory agencies. Monthly recurring access service fees are billed in advance.   In addition, subsidies that are received from state and federal authorities based on the higher cost of providing telephone service to certain rural areas are a part of our access services revenue. Beginning in July 2012, the Company began receiving federal subsidies for the deployment of broadband in unserved and high cost areas.
 
Video services.  We offer video services under an agency relationship with DISH, which we selected as the only satellite provider for Frontier in August 2011.  During the third quarter of 2012, we unbundled over 203,100 DirecTV customers from our bills and no longer sell, manage or earn revenues from DirecTV.  We receive from the applicable satellite provider and recognize as revenue activation fees, other residual fees and nominal management, billing and collection fees. Additionally, we offer fiber optic video services on a limited basis in the states of Indiana, Oregon and Washington pursuant to franchises, permits and similar authorizations issued by local franchising authorities utilizing fiber optic delivery transport to the home.

Customer Premise Equipment.  We offer our small, medium and enterprise business customers a wide range of third-party telecommunications equipment tailored to their specific business needs.  Equipment sales are most often sold in conjunction with a variety of voice, data and Internet services; however, equipment may also be sold on a stand-alone basis.  We recognize revenue for these equipment sales as specified in the contracts, typically at time of installation and acceptance by our customers.

Our Company, like others in the industry, utilizes reporting metrics focused on units. Consistent with our strategy to focus on the customer, we also utilize total, business and residential customer metrics that, when combined with unit counts, provides additional insight into the results of our strategic initiatives described above.

 
6

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES



   
As of or for the year ended
December 31,
 
   
2012
   
2011
 
Total Customer Metrics:
           
    Total Customers
    3,173,169       3,413,666  
    Total Customer Revenue (in 000’s)
  $ 4,435,436     $ 4,623,902  
    Average monthly total revenue per Customer
  $ 127.32     $ 121.88  
    Average monthly total Customer revenue per Customer
  $ 112.68     $ 107.50  
Business Customer Metrics:
               
   Customers
    286,106       309,900  
   Revenue (in 000’s)
  $ 2,317,212     $ 2,353,375  
   Average monthly business revenue per Customer
  $ 650.63     $ 601.14  
                 
Residential Customer Metrics:
               
   Customers
    2,887,063       3,103,766  
   Revenue (in 000’s)
  $ 2,118,224     $ 2,270,527  
   Average monthly residential revenue per Customer (1)
  $ 58.03     $ 57.40  
   Customer monthly churn
    1.62 %     1.69 %


 (1)  Calculation excludes the Mohave Cellular Limited Partnership.
 
During 2012, we lost 240,500 customers, as compared to a loss of 375,400 customers in 2011.  Also, during 2012, the average monthly total customer revenue per customer increased $5.18, or 5%, over 2011.  We lost 216,700 residential customers and 23,800 business customers during the year ended December 31, 2012, or 7% on an annual basis, as compared to 341,400 residential customers and 33,900 business customers lost during the year ended December 31, 2011, or 10% on an annual basis. Average monthly residential revenue per customer increased $0.63 to $58.03 during 2012 as compared to 2011.  This increase is due to the additional monthly subscriber line charges to our residential customers which were implemented in the third quarter of 2012, as permitted by the Order as well as increased product penetration and rationalized pricing. Economic conditions and/or increasing competition could make it more difficult to sell our bundled service offerings, and cause us to increase our promotions and/or lower our prices for our products and services, which would adversely affect our revenue, profitability and cash flows.

During 2012, we added 23,400 new broadband subscribers, net, as compared to 45,200 during 2011. We believe that the lower customer activations were due to the final systems conversion during 2012 and the delayed roll-out of marketing promotions in the second half of 2012. At December 31, 2012, we had 1,787,600 broadband subscribers.  Throughout our properties, we offer a video product through DISH and, in addition, we offer fiber optic video services in three states.  We gained 43,600 video subscribers, net during 2012, excluding the impact of unbundling DirecTV customers from our bills.  At December 31, 2012, we had 346,600 video customers.


 
7

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

The following table sets forth total residential customers in the states in which we operated as of December 31, 2012.

       
Percentage of
   
Residential
 
residential
State
 
customers
 
customers
         
West Virginia………………………………
 
                350,070
 
12.1%
New York…………………………………..
 
                292,754
 
10.1%
Indiana……………………………………..
 
                285,571
 
9.9%
Illinois………………………………………
 
                273,409
 
9.5%
Ohio………………………………………..
 
                258,730
 
9.0%
Michigan………………………………….
 
                208,414
 
7.2%
Washington……………………………….
 
                199,034
 
6.9%
Wisconsin…………………..…………….
 
                141,472
 
4.9%
Pennsylvania…………….…..……………
 
                136,370
 
4.7%
Oregon…………………….……………….
 
                134,796
 
4.7%
Minnesota………………………...……….
 
                107,456
 
3.7%
North Carolina…………………………….
 
                103,950
 
3.6%
California……………………………..……
 
                  78,121
 
2.7%
Arizona……………………………………..
 
                  73,870
 
2.6%
Idaho……………………………………….
 
                  54,960
 
1.9%
South Carolina…………………………….
 
                  44,781
 
1.5%
Other States (1)……………...…….……….
 
                143,305
 
5.0%
     Total …………………………………….
 
             2,887,063
 
100%
Total commercial customers
 
                286,106
   
Total customers
 
             3,173,169
   
         
 
_______________________
 (1) Includes Tennessee, Nevada, Iowa, Nebraska, Alabama, Utah, Georgia, New Mexico, Montana, Mississippi and Florida.
 
The number of our access lines is one metric that has been used to understand our revenue and profitability.  Access lines, however, have become less relevant given our strategic focus on customer retention and broadband penetration.  Traditionally, we lose access lines because of competition, economic conditions, and by the loss of second lines upon the addition of broadband service.  An additional factor was introduced at the end of the second quarter of 2012 when, Frontier began selling Simply Broadband, which is our broadband service without any wireline circuit switched voice capabilities.  We are attracting and retaining customers with this product, and it has had a positive impact on our residential customer counts and revenues.  As a result, when selling this service to acquire or retain customers, no access lines are sold nor are they counted.  Similarly, during the fourth quarter of 2012, Frontier began selling a satellite broadband product and we are trialing an AT&T Mobility product bundled with broadband service in selected markets.  In both of these cases, a wireline voice capability may not be included and accordingly, in that situation, an access line will not be counted.  In addition, in our normal course of business, we proactively remove access lines when we upgrade business customers from multiple circuit switched lines and replace them with data facilities that can be used for voice services via VoIP.  As a result of all of the above, changes in access lines are not necessarily an indication of a loss of revenue or customers.

Network Architecture and Technology
 
Our local exchange carrier networks consist of central office hosts and remote sites, primarily equipped with digital and Internet Protocol switches.  The outside plant consists of transport and distribution delivery networks connecting our host central office with remote central offices and ultimately with our customers.  We own fiber optic and copper cable, which have been deployed in our networks and are the primary transport technologies between our host and remote central offices and interconnection points with other incumbent carriers.
 
 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Our fiber optic and copper transport system is capable of supporting increasing customer demand for high bandwidth transport services.  We are currently upgrading our network with the latest Internet Protocol Transport and routing equipment, Reconfigurable Optical ADM Add/Drop Multiplexers (ROADM) transport systems, Very High Bit-Rate DSL (VDSL) broadband equipment, and Voice over Internet Protocol (VoIP) switches.  These systems will support advanced services such as Ethernet, Dedicated Internet, Multiprotocol Label Switching (MPLS) transport, and VoIP.  The network is designed with redundancy and auto-failover capability on our major circuits.

As of December 31, 2012 and 2011, we had expanded our broadband availability to the households throughout the Company’s territories as follows:

                     
 
2012
       
2011
 
Frontier
 
Acquired
 
Total
       
Total
(In excess of)
Legacy
 
Territories
 
Company
       
Company
                     
1 Mbps
92%
 
86%
 
88%
       
83%
3 Mbps
80%
 
84%
 
83%
       
76%
4 Mbps
76%
 
78%
 
77%
       
66%
6 Mbps
66%
 
77%
 
74%
       
56%
12 Mbps
42%
 
54%
 
51%
       
NA
20 Mbps
38%
 
41%
 
40%
       
28%

Rapid and significant changes in technology are expected to continue to occur in the communications industry.  Our success will depend, in part, on our ability to anticipate and adapt to technological changes.  We believe that our existing network architecture will enable us to respond to these technological changes efficiently. In addition, we anticipate reducing costs through the sharing of best practices across operations, centralization or standardization of functions and processes, and deployment of technologies and systems that provide for greater efficiencies and profitability.
 
Competition
 
Competition in the communications industry is intense. 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, satellite video, satellite broadband and other wireline carriers.  We believe that as of December 31, 2012, approximately 95% of the households in our territories could receive voice, data and video services from a competitive provider.

Business and residential customer behavior is affected by the ongoing economic uncertainty, including uncertain policy matters at the federal government level. The weak economic environment may produce increased delinquencies and bankruptcies and, therefore, affect our ability to collect money owed to us by business and residential customers.

As a result of competition and the stagnant economy, some of our customers may discontinue our services.  These trends may continue and may result in a continued challenging revenue environment.

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.

On the commercial side of our business, we are focused on many of the same strategies and enhancements described above as well as providing transport services to wireless cell towers in our territories and expanding the number of people selling and servicing our medium, enterprise and government customers with sophisticated products and services (e.g., IP PBX, E911 equipment, Ethernet, SIP trunking).

We are focused on enhancing the customer experience to differentiate us from our competition.  Our commitment to customer service is demonstrated by our 100% U.S.-based workforce, our expanded customer service hours, shorter scheduling windows for in-home appointments, 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 voice customers. Our bundled services include broadband, unlimited long distance calling, enhanced telephone features and video offerings.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
We are also focused on increasing sales of existing products, including unlimited long distance minutes, bundles of long distance minutes, wireless data, Internet portal advertising, and the Frontier Secure product suite.  In 2012, the Frontier Secure products generated $27.3 million in revenue.  Hard drive back-up services, 24-7 help desk PC support and our www.TumTiki.com website, that provides over-the-top Internet video, are also available to consumers and small businesses throughout the United States.  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.

We believe that offering multiple products and services to our customers pursuant to price protection programs, billing on a single bill, on-line bill pay, providing superior customer service, and being active in our local communities will develop customer loyalty which should help us generate new, and retain existing, customer revenue.

For additional discussion of our competitive strategies, see “Company Strategies” above.

Regulatory Environment

The majority of our operations are regulated by the FCC and various state regulatory agencies, often called public service or utility commissions.
 
Some of our revenue is subject to regulation by the FCC and various state regulatory agencies.  We expect federal and state lawmakers to continue to review and revise the statutes governing the level and type of regulation for telecommunications services.
 
Regulation of our business
 
We are subject to federal, state and local regulation.  We have various regulatory authorizations for our regulated service offerings.  At the federal level, the FCC generally exercises jurisdiction over facilities and services of common carriers, such as our company, to the extent those facilities are used to provide, originate or terminate interstate or international telecommunications services.  State regulatory commissions generally exercise jurisdiction over common carriers’ facilities and services to the extent those facilities are used to provide, originate or terminate intrastate telecommunications services. In particular, state regulatory agencies have substantial oversight over the provision by incumbent telephone companies of interconnection and non-discriminatory network access to competitive providers.  In addition, local governments often regulate the public rights-of-way necessary to install and operate networks, and may require service providers to obtain licenses or franchises regulating their use of public rights-of-way.  Municipalities and other local government agencies also may regulate other limited aspects of our business, by requiring us to obtain cable franchises, construction permits and to abide by building codes.
 
We believe that competition in our service areas will continue to increase in the future as a result of the Telecommunications Act of 1996 (the “1996 Act” or the “Telecommunications Act”) and actions taken by the FCC and state regulatory authorities, and through increased deployment of various types of technology, although the ultimate form and degree of competition cannot be predicted at this time.  Competition may lead to loss of revenues and profitability as a result of loss of customers; reduced usage of our network by our customers who may use alternative providers for voice and data services; and reductions in prices for our services which may be necessary to meet competition.
 
Under the 1996 Act, state regulatory commissions have jurisdiction to arbitrate and review interconnection disputes and agreements between ILECs and competitive local exchange carriers, in accordance with rules set by the FCC.  State regulatory commissions also may impose fees on providers of telecommunications services within their respective states to support state universal service programs.  Many of the states in which we operate require prior approvals or notifications for certain acquisitions and transfers of assets, customers, or ownership of regulated entities.
 
The FCC and certain state regulatory commissions, in connection with granting their approvals of the Transaction, specified certain capital expenditure and operating requirements for the Acquired Territories for specified periods of time post-closing.  These requirements focus primarily on certain capital investment commitments to expand broadband availability to at least 85% of the households throughout the Acquired Territories with minimum download speeds of 3 megabits per second (Mbps) by the end of 2013 and 4 Mbps by the end of 2015.  As of December 31, 2012 we had expanded broadband availability in excess of 1 Mbps to 86% of the households throughout the Acquired Territories, in excess of 3 Mbps to 84% of the households throughout the Acquired Territories, and in excess of 4 Mbps to 78% of the households throughout the Acquired Territories.  We are on track to satisfy our 85% requirement for 3 Mbps by the end of 2013.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
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 a letter of credit for $190.0 million in 2010. Another $72.4 million of cash in an escrow account (with a cash balance of $23.9 million and an associated liability of $0.2 million as of December 31, 2012) was acquired in connection with the Transaction to be used for service quality initiatives in the state of West Virginia.  As of December 31, 2012, $145.0 million had been released from escrow and the Company had a restricted cash balance in these escrow accounts in the aggregate amount of $42.7 million, including interest earned. In addition, as of December 31, 2012, the letter of credit had been reduced to $40.0 million.  The aggregate amount of these escrow accounts and the letter of credit will continue to decrease over time as Frontier makes the required capital expenditures in the respective states.

In addition, in certain states, we are subject to operating restrictions such as rate caps (including maintenance of existing rates on business and residential products and wholesale prices and terms of interconnection agreements with competitive local exchange carriers and arrangements with carriers that, in each case, existed as of the time of the Transaction), continuation of product bundle offerings that we offered before the Transaction, and restrictions on how early termination fees are calculated, restrictions on caps on usage of broadband capacity, and certain minimum service quality standards for a defined period of time (the failure of which to meet may result in penalties, including, in one state, cash management limitations on certain of our subsidiaries in that one state). In one other state, our subsidiaries are subject to restrictions on the amount of dividends that can be paid to the parent company for a period ending on June 30, 2014.  We are also required to report certain financial information and adhere for a period of time to certain conditions regulating competition and consumer protection. Although most of these requirements are generally consistent with our business plans, they may restrict our flexibility in operating our business during the specified periods, including our ability to raise rates in a declining revenue environment and to manage cash transfers from our subsidiaries in two states if we do not meet certain operating service criteria.

Some legislation and regulations are, or could in the future be, the subject of judicial proceedings, legislative hearings and administrative proposals or challenges which could change the manner in which the entire industry operates.  Neither the outcome of any of these developments, nor their potential impact on us, can be predicted at this time.  Regulation can change rapidly in the communications industry, and such changes may have an adverse effect on us.  See “Risk Factors—Risks Related to Regulation—Changes in federal or state regulations may reduce the switched access charge revenues we receive.”
 
Regulation of the telecommunications industry at the federal and state level
 
At the federal level and in a number of the states in which we operate, we are subject to price cap or incentive regulation plans under which prices for regulated services are capped in return for the elimination or relaxation of earnings oversight.  The goal of these plans is to provide incentives to improve efficiencies and increased pricing flexibility for competitive services while ensuring that customers receive reasonable rates for basic services.  Some of these plans have limited terms and, as they expire, we may need to renegotiate with various states.  These negotiations could impact rates, service quality and/or infrastructure requirements which could impact our earnings and capital expenditures.  In other states in which we operate, we are subject to rate of return regulation that limits levels of earnings and returns on investments. Approximately 26% of our total access lines at December 31, 2012 are in state jurisdictions under the rate of return regulatory model.  The FCC’s National Broadband Plan, a non-binding set of recommendations released in March 2010 and described further below, recommends requiring all incumbent local exchange carriers to be regulated for interstate services, if at all, under incentive regulation.  On November 18, 2011, the FCC released a Report and Order and Further Notice of Proposed Rulemaking on the subject of the Order.  We will continue to advocate our position for no or reduced regulation with various regulatory agencies.  In some of our states, we have already been successful in reducing or eliminating price regulation on end-user services subject to state commission jurisdiction.
 
The FCC’s Order changed how federal subsidies are calculated and disbursed, with these changes being phased-in beginning in 2012. These changes transition the Federal Universal Service High-Cost Fund, which supports voice services in high-cost areas, to the CAF, which supports broadband deployment in high-cost areas. CAF Phase I, implemented in 2012, provides for ongoing USF support for price cap carriers to be capped at the 2011 amount. In addition, the FCC in CAF Phase I made available for price cap ILECs an additional $300 million in incremental high cost broadband support to be used for broadband deployment to unserved areas. Frontier was eligible to receive $71.9 million of the total $300 million CAF Phase I interim support. On July 24, 2012, Frontier formally notified the FCC and appropriate state commissions of its intent to accept those funds and identified the unserved locations to be served using the funds. The $71.9 million in incremental CAF Phase I support is expected to enable an incremental 92,877 households and will be accounted for as Contributions in Aid of Construction.  Frontier is required to implement, spend and enable these 92,877 households no later than July 24, 2015.  As of December 31, 2012, Frontier has received $66.0 million of the CAF Phase I support funds and has initially recorded these funds as increases to Cash and Other liabilities in the balance sheet.  The FCC is currently considering the rules for distribution of incremental CAF funding in 2013.
 
 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Telephone companies are subject to FCC rules governing privacy of certain customer information.  Among other things, these rules obligate carriers to implement procedures to: protect certain customer information from inappropriate disclosure; obtain customer permission to use certain information in marketing; authenticate customers before disclosing account information; and annually certify compliance with the FCC’s rules.
 
Most states have certification requirements that require providers of telecommunications services to obtain authority from the state regulatory commission prior to offering common carrier services.  Most of the local exchange companies that are operated by us operate as incumbent carriers in the states in which they operate and are certified in those states to provide local telecommunications services.  State regulatory commissions regulate some of the rates ILECs charge for intrastate services, including rates for intrastate access services paid by providers of intrastate long distance services.  The Order, however, removes much of the states’ authority to set terminating intrastate switched access rates.  This aspect of the Order has been challenged by certain parties in court.
 
Recent and potential regulatory developments
 
The FCC, state regulators, and federal and state legislators are currently considering a number of proposals for changing the manner in which eligibility for federal and state subsidies is determined as well as the amounts of such subsidies. Future reductions in our subsidy or switched access revenues may directly affect our profitability and cash flows as those regulatory revenues do not have an equal level of associated variable expenses.  Switched access and subsidy revenues continued to decline in 2012, as compared to 2011, and are expected to decline further in 2013.
 
On November 18, 2011, the FCC adopted the Order to reform the Federal Universal Service High-Cost Fund and Intercarrier Compensation.  Intercarrier Compensation, which is the payment framework that governs how carriers compensate each other for the exchange of interstate traffic, will transition over a number of years, with the first step implemented in July 2012, to a near zero rate for terminating traffic by 2017.  Frontier will be able to recover a significant portion of those revenues through end user rates and other replacement support mechanisms.  Additionally, the Order requires VoIP providers to pay interstate terminating interconnection charges and requires all carriers terminating traffic to provide appropriate call information, thus prohibiting so-called “phantom traffic.”  The Order preempts the states with regard to the regulation of intrastate terminating access rates.  The reform of the Universal Service Fund shifts the existing High-Cost portion of the fund from supporting voice services to supporting broadband deployment in high-cost areas.  The Order has been challenged by certain parties in court and certain parties have also petitioned the FCC to reconsider various aspects of the Order.  Accordingly, Frontier cannot predict the long-term impact at this time but believes that the Order will provide a stable regulatory framework to facilitate Frontier’s ongoing focus on the deployment of broadband into its rural markets.

The FCC also has an ongoing proceeding considering whether to make changes in its regulatory regime governing special access services, including whether to mandate lower rates, change standards for deregulation and pricing flexibility, or to require changes to other terms and conditions.  When and how these proposed changes will be addressed is unknown and, accordingly, we are unable to predict the impact of future changes on our results of operations.

Certain states also have their own open proceedings to address reform to intrastate access charges and other intercarrier compensation and state universal service funds.  In addition, we have been approached by, and/or are involved in formal state proceedings with, various carriers seeking reductions in intrastate access rates in certain states.  Although the FCC has pre-empted state jurisdiction on certain access charges, many states are still considering moving forward with their proceedings. We cannot predict when or how these matters will be decided or the effect on our subsidy or switched access revenues.
 
 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Regulators at both the federal and state levels continue to address whether VoIP services are subject to the same or different regulatory and intercarrier compensation regimes as traditional voice telephony.  The FCC, through the Order, has determined that VoIP-originated traffic terminating on the Public Switched Telephone Network is subject to interstate access rates.  The FCC declined to address other VoIP-related issues.  The FCC has stated its intent to address open questions regarding the treatment of VoIP services in its ongoing “IP-Enabled Services Proceeding.” Internet telephony may have an advantage in the marketplace over our traditional services if it remains less regulated.
 
Current and potential Internet regulatory obligations

In connection with our Internet access offerings, we could become subject to laws and regulations as they are adopted or applied to the Internet.  There is currently only limited regulation applicable to these services.  As the significance of the Internet expands, federal, state and local governments may pass laws and adopt rules and regulations, or apply existing laws and regulations to the Internet (including Internet access services), and related matters are under consideration in both federal and state legislative and regulatory bodies.  We cannot predict whether the outcome of pending or future proceedings will prove beneficial or detrimental to our competitive position.

The FCC adopted orders which put wireline broadband Internet access service, commonly delivered by DSL or fiber technology, as well as mobile wireless based broadband Internet access service and other forms of broadband Internet access services on an equal regulatory footing with cable modem service.  This approach is consistent with a United States Supreme Court decision upholding the FCC’s classification of cable modem services as “information services” not subject to mandatory common carriage regulation.  Specifically, the FCC has determined that these information services are functionally integrated with any underlying telecommunications component, and that there is no obligation to separate out and offer that transmission component subject to common carriage regulation.  The FCC has imposed particular regulatory obligations on broadband services.  For example, it has concluded that VoIP and facilities-based broadband Internet access providers must comply with the Communications Assistance for Law Enforcement Act, a decision that the United States Court of Appeals for the District of Columbia Circuit has upheld.  The FCC has also required VoIP providers to provide enhanced 911 emergency calling capabilities.
 
In October 2009, the FCC issued a proposed rulemaking looking at rules to “Preserve a Free and Open Internet,” including a reconsideration of the legal classification of broadband and proposed restrictions on broadband network management practices. On December 21, 2010, the FCC adopted an order imposing some regulations on Internet service providers.  These regulations affect fixed and mobile broadband providers differently.  These regulations became effective November 20, 2011, and Frontier is in compliance with these regulations.  These regulations are currently subject to court challenge by multiple parties, and the outcome and its effect on Frontier is unknown.
 
Video programming.  Federal, state and local governments extensively regulate the video services industry.  Our fiber optic video service is subject to, among other things, subscriber privacy regulations; requirements that we carry a local broadcast station or obtain consent to carry a local or distant broadcast station; rules for franchise renewals and transfers; the manner in which program packages are marketed to subscribers; and program access requirements.
 
We provide video programming, on a limited basis, in Oregon, Washington and Indiana pursuant to franchises, permits and similar authorizations issued by local franchising authorities utilizing fiber optic delivery transport to the home.  Most franchises are subject to termination proceedings in the event of a material breach.  In addition, most franchises require payment of a franchise fee as a requirement to the granting of authority.
 
Many franchises establish comprehensive facilities and service requirements, as well as specific customer service standards and monetary penalties for non-compliance.  In many cases, franchises are terminable if the franchisee fails to comply with significant provisions set forth in the franchise agreement governing system operations. We believe that we are in compliance and meeting all standards and requirements. Franchises are generally granted for fixed terms of at least ten years and must be periodically renewed.  Local franchising authorities may resist granting a renewal if either past performance or the prospective operating proposal is considered inadequate.
 
For information regarding approvals by local franchising authorities in connection with the transactions, see “— Regulatory Environment — Regulation of our business.”
 

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Environmental regulation
 
Like all other local telephone companies, the local exchange carrier subsidiaries we operate are subject to federal, state and local laws and regulations governing the use, storage, disposal of, and exposure to hazardous materials, the release of pollutants into the environment and the remediation of contamination.  As an owner and former owner of property, we are subject to environmental laws that could impose liability for the entire cost of cleanup at contaminated sites, including sites formerly owned by us, regardless of fault or the lawfulness of the activity that resulted in contamination.  We believe that our operations are in substantial compliance with applicable environmental laws and regulations.
 
Segment Information

We currently operate in only one reportable segment.

Financial Information about Foreign and Domestic Operations and Export Sales

We have no foreign operations.

General

Order backlog is not a significant consideration in our business.  We have no material contracts or subcontracts that may be subject to renegotiation of profits or termination at the election of the federal government.

Intellectual Property
 
We believe that we have the trademarks, trade names and intellectual property licenses that are necessary for the operation of our business.
 
Employees

As of December 31, 2012, we had approximately 14,700 employees.   Approximately 9,200 of our employees are represented by unions.   The number of employees covered by collective bargaining agreements that expired in 2012, but have been extended and are still open in 2013, is approximately 2,400.   The number of employees covered by collective bargaining agreements that expire in 2013 is approximately 4,150.   We consider our relations with our employees to be good.

Available Information

We are subject to the informational requirements of the Securities Exchange Act of 1934.  Accordingly, we file periodic reports, proxy statements and other information with the Securities and Exchange Commission (SEC).  These reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, D.C. 20549 or by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements and other information regarding the Company and other issuers that file electronically.

We make available, free of charge on our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as practicable after we electronically file these documents with, or furnish them to, the SEC.  These documents may be accessed through our website at www.frontier.com under “Investor Relations.”  The information posted or linked on our website is not part of this report.  We also make our Annual Report available in printed form upon request at no charge.

We also make available on our website, or in printed form upon request, free of charge, our Corporate Governance Guidelines, Code of Business Conduct and Ethics, and the charters for the Audit, Compensation, and Nominating and Corporate Governance committees of the Board of Directors.  Stockholders may request printed copies of these materials by writing to: 3 High Ridge Park, Stamford, Connecticut 06905 Attention: Corporate Secretary.  Our website address is www.frontier.com.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Item 1A.  Risk Factors
 
Before you make an investment decision with respect to any of our securities, you should carefully consider all the information we have included or incorporated by reference in this Form 10-K and our subsequent periodic filings with the SEC.  In particular, you should carefully consider the risk factors described below and read the risks and uncertainties related to “forward-looking statements” (which we do not undertake to update) as set forth in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Form 10-K, any of which could materially adversely affect our business, operating results, financial condition and the actual outcome of matters as to which forward-looking statements are made in this report.   The risks and uncertainties described below are not the only ones facing our company.  Additional risks and uncertainties that are not presently known to us or that we currently deem immaterial or that are not specific to us, such as general economic conditions, may also adversely affect our business and operations.  The following risk factors should be read in conjunction with MD&A and the consolidated financial statements and related notes included in this report.

Risks Related to Our Business

 We will likely face further reductions in voice customers, switched access minutes of use, long distance revenues and federal and state subsidy revenues, which could adversely affect us.
 
We have experienced declining voice customers, switched access minutes of use, long distance revenues, federal and state subsidies and related revenues because of economic conditions, increasing competition, changing consumer behavior (such as wireless displacement of wireline use, e-mail use, instant messaging and increasing use of VoIP), technology changes and regulatory constraints.  We will likely continue to experience reductions in the future.  The factors referred to above, among others, are likely to cause our local network service, switched network access, long distance and subsidy revenues to continue to decline, and these factors may cause our cash generated by operations to decrease.
 
We face intense competition, which could adversely affect us.
 
The communications industry is extremely competitive. Through mergers and various service expansion strategies, service providers are striving to provide integrated solutions both within and across geographic markets.  Our competitors include competitive local exchange carriers, Internet service providers, wireless companies, VoIP providers and cable companies that may provide services competitive with the services that we offer or intend to introduce.  We also believe that wireless and cable telephony providers have increased their penetration of various services in our markets.  We expect that we will continue to lose customers and that competition will remain robust.
 
We cannot predict which of the many possible future technologies, products or services will be important in order to maintain our competitive position or what expenditures will be required to develop and provide these technologies, products or services.  Our ability to compete successfully will depend on the success of capital expenditure investments in our territories, in addition to our new marketing efforts, our ability to anticipate and respond to various competitive factors affecting the industry, including a changing regulatory environment that may affect our business and that of our competitors differently, new services that may be introduced, changes in consumer preferences, demographic trends, economic conditions and pricing strategies by competitors.  Increasing competition may reduce our revenues and increase our marketing and other costs as well as require us to increase our capital expenditures and thereby decrease our cash flows.
 
Some of our competitors have superior resources, which may place us at a cost and price disadvantage.
 
Some of our competitors have market presence, engineering, technical, marketing and financial capabilities, substantially greater than ours.  In addition, some of these competitors are able to raise capital at a lower cost than we are able to.  Consequently, some of these competitors may be able to develop and expand their communications and network infrastructures more quickly, adapt more swiftly to new or emerging technologies and changes in customer requirements, take advantage of acquisition and other opportunities more readily and devote greater resources to the marketing and sale of their products and services than we will be able to.  Additionally, the greater brand name recognition of some competitors may require us to price our services at lower levels in order to retain or obtain customers. Finally, the cost advantages of some of these competitors may give them the ability to reduce their prices for an extended period of time if they so choose.
 

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
 
We may be unable to grow our revenues and cash flows despite the initiatives we have implemented.
 
We must produce adequate revenues and cash flows that, when combined with cash on hand and funds available under our revolving credit facility, will be sufficient to service our debt, fund our capital expenditures, pay our taxes, fund our pension and other employee benefit obligations and pay dividends pursuant to our dividend policy.  We have identified some potential areas of opportunity and implemented several growth initiatives, including increasing marketing promotions and related expenditures and launching new products and services with a focus on areas that are growing such as commercial, wireless and satellite broadband, satellite video products, and the Frontier Secure suite of products, which includes computer technical support.  We cannot assure you that these opportunities will be successful or that these initiatives will improve our financial position or our results of operations.

Weak economic conditions may decrease demand for our services or necessitate increased discounts.
 
We could be adversely impacted if current economic conditions or their effects continue.  Downturns in the economy and competition in our markets could cause some of our customers to reduce or eliminate their purchases of our basic and enhanced services, broadband and video services and make it difficult for us to obtain new customers.  In addition, if current economic conditions continue, our customers may delay or discontinue payment for our services or seek more competitive pricing from other service providers, or we may be required to offer increased discounts in order to retain our customers.
 
Disruption in our networks, infrastructure and information technology may cause us to lose customers and incur additional expenses.
 
To attract and retain customers, we must provide reliable service.  Some of the risks to our networks, infrastructure and information technology include physical damage, security breaches, capacity limitations, power surges or outages, software defects and other disruptions beyond our control, such as natural disasters and acts of terrorism.  From time to time in the ordinary course of business, we experience short disruptions in our service due to factors such as cable damage, theft of our equipment, inclement weather and service failures of our third-party service providers.  We could experience more significant disruptions in the future.  We could also face disruptions due to capacity limitations if changes in our customers’ usage patterns for our broadband services result in a significant increase in capacity utilization, such as through increased usage of video or peer-to-peer file sharing applications.  Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and/or incur additional expenses, and thereby adversely affect our business, revenues and cash flows.
 
    Our business is sensitive to the creditworthiness of our wholesale customers.
 
We have substantial business relationships with other telecommunications carriers for whom we provide service.  While bankruptcies of these carriers have not had a material adverse effect on our business in recent years, future bankruptcies in the industry could result in the loss of significant customers by us, as well as cause more price competition and increased uncollectible accounts receivable.  Such bankruptcies may be more likely in the future if economic conditions stagnate.  As a result, our revenues and results of operations could be materially and adversely affected.
 
A significant portion of our workforce is represented by labor unions.
 
As of December 31, 2012, we had approximately 14,700 employees.   Approximately 9,200 of these employees, or 63% of the total workforce, were represented by unions and were therefore subject to collective bargaining agreements.   Of the union-represented employees as of December 31, 2012, approximately 6,600, or 72% of the unionized workforce, are covered by collective agreements that expire in 2013 and approximately 1,200, or 13% of the unionized workforce, are covered by collective bargaining agreements that expire in 2014.

We cannot predict the outcome of negotiations of the collective bargaining agreements covering our employees.  If we are unable to reach new agreements or renew existing agreements, employees subject to collective bargaining agreements may engage in strikes, work slowdowns or other labor actions, which could materially disrupt our ability to provide services.  New labor agreements or the renewal of existing agreements may impose significant new costs on us, which could adversely affect our financial condition and results of operations in the future.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
If we are unable to hire or retain key personnel, we may be unable to operate our business successfully.
 
Our success will depend in part upon the continued services of our management.  We cannot guarantee that our key personnel will not leave or compete with us.  The loss, incapacity or unavailability for any reason of key members of our management team could have a material impact on our business.  In addition, our financial results and our ability to compete will suffer should we become unable to attract, integrate or retain other qualified personnel in the future.
 
Regulatory authorities, in connection with their approval of the acquisition, imposed on us certain conditions relating to our capital expenditures and business operations which may adversely affect our financial performance.
 
The FCC and certain state regulatory commissions, in connection with granting their approvals of the Transaction, specified certain capital expenditure and operating requirements for the Acquired Territories for specified periods of time post-closing.  These requirements focus primarily on certain capital investment commitments to expand broadband availability to at least 85% of the households throughout the acquired Territories with minimum download speeds of 3 megabits per second (Mbps) by the end of 2013 and 4 Mbps by the end of 2015.  As of December 31, 2012 we had expanded broadband availability in excess of 1 Mbps to 86% of the households throughout the Acquired Territories, in excess of 3 Mbps to 84% of the households throughout the Acquired Territories, and in excess of 4 Mbps to 78% of the households throughout the Acquired Territories.

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 a letter of credit for $190.0 million in 2010. Another $72.4 million of cash in an escrow account (with a cash balance of $23.9 million and an associated liability of $0.2 million as of December 31, 2012) was acquired in connection with the Transaction to be used for service quality initiatives in the state of West Virginia.  As of December 31, 2012, $145.0 million had been released from escrow and the Company had a restricted cash balance in these escrow accounts in the aggregate amount of $42.7 million, including interest earned. In addition, as of December 31, 2012, the letter of credit had been reduced to $40.0 million.  The aggregate amount of these escrow accounts and the letter of credit will continue to decrease over time as Frontier makes the required capital expenditures in the respective states.  The amounts held in these escrow accounts will not be released until Frontier makes the required capital expenditures, and we may have to spend more than the amounts currently held in these escrow accounts to achieve the capital expenditure and operating requirements.
 
     In addition, in certain states, we are subject to operating restrictions such as rate caps (including maintenance of existing rates on business and residential products and wholesale prices and terms of interconnection agreements with competitive local exchange carriers and arrangements with carriers that, in each case, existed as of the time of the Transaction), continuation of product bundle offerings that we offered before the Transaction, and restrictions on how early termination fees are calculated, restrictions on caps on usage of broadband capacity, and certain minimum service quality standards for a defined period of time (the failure of which to meet, may result in penalties, including in one state, cash management limitations on certain of our subsidiaries in that one state).  In one other state, our subsidiaries are subject to restrictions on the amount of dividends that can be paid to the parent company for a period ending on June 30, 2014.  We are also required to report certain financial information and adhere for a period of time to certain conditions regulating competition and consumer protection.

We may complete a future significant strategic transaction that may not achieve intended results or could increase the number of our outstanding shares or amount of outstanding debt or result in a change of control.
 
We continuously evaluate and may in the future enter into additional strategic transactions.  Any such transaction could happen at any time, could be material to our business and could take any number of forms, including, for example, an acquisition, merger or a sale of all or substantially all of our assets.
 
Evaluating potential transactions and integrating completed ones may divert the attention of our management from ordinary operating matters.  The success of these potential transactions will depend, in part, on our ability to realize the anticipated growth opportunities and cost synergies through the successful integration of the businesses we acquire with our existing business.  Even if we are successful in integrating acquired businesses, we cannot assure you that these integrations will result in the realization of the full benefit of any anticipated growth opportunities or cost synergies or that these benefits will be realized within the expected time frames.  In addition, acquired businesses may have unanticipated liabilities or contingencies.
 
If we complete an acquisition, investment or other strategic transaction, we may require additional financing that could result in an increase in the number of our outstanding shares or the aggregate amount of our debt.  The number of shares of our common stock or the aggregate principal amount of our debt that we may issue may be significant.  A strategic transaction may result in a change in control of our company or otherwise materially and adversely affect our business.
 
 
17

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Risks Related to Liquidity, Financial Resources and Capitalization
 
If the lingering impact of the ongoing economic uncertainty continues through 2013, it may have an impact on our business and financial condition.
 
Disruption and uncertainty in the capital markets, and tightening of credit availability may affect the financial health of our customers, vendors and partners, which in turn may negatively affect our revenues, operating expenses and cash flows.  In addition, we have a $750.0 million revolving credit facility that is scheduled to terminate on January 1, 2014.  Although we believe, based on information available to us, that the financial institutions syndicated under the revolving credit facility would be able to fulfill their commitments to us, this could change in the future.
 
Volatility in asset values related to Frontier’s pension plan and/or changes in pension plan assumptions may require us to make contributions to fund pension plan liabilities.
 
Frontier’s pension plan assets have decreased from $1,258.0 million at December 31, 2011, to $1,253.6 million at December 31, 2012, a decrease of $4.4 million.  This decrease is a result of benefit payments of $172.6 million, primarily offset by $139.6 million of positive investment returns (including additional asset transfers from Verizon of $13.0 million) and net contributions of cash of $28.6 million.  The Company expects to make contributions of approximately $60 million in 2013.  Volatility in our asset values or returns may require us to make additional contributions in future years.
 
Substantial debt and debt service obligations may adversely affect us.
 
We have a significant amount of indebtedness, which amounted to $8.9 billion at December 31, 2012.  On January 15, 2013, $502.7 million of this indebtedness matured and was retired with cash on hand.  We have access to a $750.0 million revolving credit facility and may also obtain additional long-term debt and working capital lines of credit to meet future financing needs, subject to certain restrictions under the terms of our existing indebtedness.  Despite the substantial indebtedness that we have, we are not prohibited from incurring additional indebtedness.
 
The potential significant negative consequences on our financial condition and results of operations that could result from our substantial debt include:

·  
limitations on our ability to obtain additional debt or equity financing;

·  
instances in which we are unable to meet the financial covenants contained in our debt agreements or to generate cash sufficient to make required debt payments, which circumstances have the potential of accelerating the maturity of some or all of our outstanding indebtedness;

·  
the allocation of a substantial portion of our cash flow from operations to service our debt, thus reducing the amount of our cash flow available for other purposes, including operating costs, capital expenditures and dividends that would otherwise improve our competitive position, results of operations or stock price;

·  
requiring us to sell debt or equity securities or to sell some of our core assets, possibly on unfavorable terms, to meet payment obligations;

·  
compromising our flexibility to plan for, or react to, competitive challenges in our business and the communications industry; and

·  
the possibility of our being put at a competitive disadvantage with competitors who do not have as much debt as we do, and competitors who may be in a more favorable position to access additional capital resources.

In addition, our senior notes are rated below “investment grade” by independent ratings agencies.  This can result in higher borrowing costs for us.  We cannot assure you that these rating agencies will not lower our current debt ratings, if in the rating agencies’ judgment, such an action is appropriate.  A lowering of a rating may further increase our future borrowing costs and reduce our access to capital.
 
 
18

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
We cannot assure that we will be able to continue paying dividends.

Effective February 16, 2012, our Board of Directors set the annual cash dividend at $0.40 per share, a reduction from our prior dividend level of $0.75 per share.  However, the amount and timing of future dividend payments is subject to applicable law and will be made at the discretion of our Board of Directors based on factors such as cash flow and cash requirements, capital expenditure requirements, financial condition and other factors.
 
We have a significant amount of goodwill and other intangible assets on our balance sheet.  If our goodwill or other intangible assets become impaired, we may be required to record a non-cash charge to earnings and reduce our stockholders’ equity.

Under generally accepted accounting principles, intangible assets are reviewed for impairment on an annual basis or more frequently whenever events or circumstances indicate that its carrying value may not be recoverable.  The Company monitors relevant circumstances, including general economic conditions, enterprise value EBITDA multiples for rural ILEC properties, the Company’s overall financial performance, and the market prices for the Company’s common stock, and the potential that changes in such circumstances might have on the valuation of the Company’s intangible assets, including goodwill.  If our intangible assets are determined to be impaired in the future, we may be required to record a non-cash charge to earnings during the period in which the impairment is determined.

Risks Related to Regulation

Changes in federal or state regulations may reduce the switched access charge revenues we receive.
 
A significant portion of Frontier’s total revenues ($257.8 million, or 5%, in 2012) are derived from switched access charges paid by other carriers for services we provide in originating and terminating intrastate and interstate long distance traffic.  As a result, Frontier expects a significant portion of the Company’s revenues will continue to be derived from switched access charges paid by these carriers for services that the Company will provide in originating and terminating this traffic.  The amount of switched access charge revenues that the Company will receive for these services is regulated by the FCC and state regulatory agencies and is expected to decline in 2013.
 
On November 18, 2011, the FCC adopted the Order.  Intercarrier Compensation, which is the payment framework that governs how carriers compensate each other for the exchange of interstate traffic, will transition over a number of years, with the first step implemented in July 2012, to a near zero rate for terminating traffic by 2017.  Frontier will be able to recover a significant portion of those revenues through end user rates and other replacement support mechanisms.  Additionally, the Order requires VoIP providers to pay interstate terminating interconnection charges and requires all carriers terminating traffic to provide appropriate call information, thus prohibiting so-called “phantom traffic”.  The Order preempts the states with regard to the regulation of intrastate terminating access rates.  The reform of the Universal Service Fund shifts the existing High-Cost portion of the fund from supporting voice services to supporting broadband deployment in high-cost areas.  The Order has been challenged by certain parties in court and certain parties have also petitioned the FCC to reconsider various aspects of the Order. Accordingly, although we believe that the Order will provide a stable regulatory framework to facilitate Frontier’s ongoing focus on the deployment of broadband into its rural markets, Frontier cannot predict the long-term impact at this time.
 
The FCC also has an ongoing proceeding considering whether to make changes to its regulatory regime governing special access services. When and how these proposed changes will be addressed is unknown and, accordingly, Frontier cannot predict the impact of future changes on the Company’s results of operations.
 
Certain states also have their own open proceedings to address reform to intrastate access charges and other intercarrier compensation and state universal service funds.  In addition, Frontier has been approached by, and/or is involved in formal state proceedings with, various carriers seeking reductions in intrastate access rates in certain states.  Although the FCC has pre-empted state jurisdiction on certain access charges, many states are still considering moving forward with their proceedings. Frontier cannot predict when or how these matters will be decided or the effect on the Company’s subsidy or switched access revenues.  However, future reductions in the Company’s subsidy or switched access revenues may directly affect the Company’s profitability and cash flows as those regulatory revenues do not have an equal level of associated variable expenses.

 
19

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
We are reliant on support funds provided under federal and state laws.
 
A significant portion of Frontier’s total revenues ($318.6 million in the aggregate, or 6%, in 2012 and $300.1 million in the aggregate, or 6%, in 2011) are derived from federal and state subsidies for rural and high cost support, commonly referred to as universal service fund subsidies. The FCC’s Order changed how federal subsidies will be calculated and disbursed, with these changes being phased-in beginning in 2012.  These changes transition the Federal Universal Service High-Cost Fund, which supports voice services in high-cost areas, to the CAF, which supports broadband deployment in unserved and underserved high-cost areas. CAF Phase I, implemented in 2012, provides for ongoing USF support for price cap carriers to be capped at the 2011 amount. In addition, the FCC in CAF Phase I made available for price cap ILECs an additional $300 million in incremental high cost broadband support to be used for broadband deployment to unserved areas. Frontier was eligible to receive $71.9 million of the total $300 million CAF Phase I interim support. On July 9, 2012, Frontier announced that it would accept all of the funding for which it is eligible. On July 24, 2012, Frontier formally notified the FCC and appropriate state commissions of its intent to accept those funds and identified the unserved locations to be served using the funds. The $71.9 million in incremental CAF Phase I support is expected to enable an incremental 92,877 households and will be accounted for as Contributions in Aid of Construction.  Frontier is required to implement, spend and enable these 92,877 households no later than July 24, 2015.  As of December 31, 2012, Frontier has received $66.0 million of the CAF Phase I support funds and has recorded increases to Cash and Other liabilities in the balance sheet.  The FCC is currently considering the rules for distribution of incremental CAF funding in 2013.

Federal subsidies representing interstate access support, high cost loop support and local switching support represented $160.7 million, or 3%, of Frontier’s total revenues in 2012 and $154.0 million, or 3%, of Frontier’s total revenues in 2011.  State subsidies represented $38.2 million, or 1%, of Frontier’s total revenues in 2012 and $41.6 million, or 1%, in 2011.  Surcharges to customers (local, long distance and interconnection) to recover universal service fund contribution fees which are remitted to the FCC and recorded as an expense in “Other operating expenses”, represented $119.7 million, or 2%, of Frontier’s total revenues in 2012 and $104.5 million, or 2%, in 2011.
 
Our Company and our industry will likely remain highly regulated, and we could incur substantial compliance costs that could constrain our ability to compete in our target markets.
 
As an incumbent local exchange carrier, some of the services we offer are subject to significant regulation from federal, state and local authorities.  This regulation could impact our ability to change our rates, especially on our basic voice services and our access rates, and could impose substantial compliance costs on us.  Regulation could constrain our ability to compete and, in some jurisdictions, may restrict our ability to expand our service offerings.  In addition, changes to the regulations that govern our business (including any implementation of the Order) may have an adverse effect on our business by reducing the allowable fees that we may charge, imposing additional compliance costs, reducing the amount of subsidies or otherwise changing the nature of our operations and the competition in our industry. At this time it is unknown how these regulations will affect Frontier’s operations or ability to compete in the future.  This and other FCC rulemakings and state regulatory proceedings, including those relating to intercarrier compensation, universal service and broadband services, could have a substantial adverse impact on our operations.
 
In addition, in connection with our Internet access offerings, we could become subject to laws and regulations as they are adopted or applied to the Internet.  There is currently only limited regulation applicable to these services.  As the significance of the Internet expands, federal, state and local governments may pass laws and adopt rules and regulations, or apply existing laws and regulations to the Internet (including Internet access services), and related matters are under consideration in both federal and state legislative and regulatory bodies.  We cannot predict whether the outcome of pending or future proceedings will prove beneficial or detrimental to our competitive position.
 
We may not be able to deploy the unserved locations with the CAF funds received.
 
During 2012 and early 2013, we received $71.9 million from the CAF, which supports broadband deployment in high-cost areas.  If Frontier is unable to deploy to the 92,877 unserved locations with the CAF funds received to date in accordance with the FCC rules by July 2015, then the Company would need to incur additional capital expenditures or refund a portion of the CAF received in 2012 to the FCC.
 
 
20

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Risks Related to Technology

In the future, as competition intensifies within our markets, we may be unable to meet the technological needs or expectations of our customers, and may lose customers as a result.
 
The communications industry is subject to significant changes in technology.  If we do not replace or upgrade technology and equipment, we may be unable to compete effectively because we will not be able to meet the needs or expectations of our customers.  Replacing or upgrading our infrastructure could result in significant capital expenditures.
 
In addition, rapidly changing technology, enhancements to product offerings and the management of broadband speed and capacity issues may influence our customers to consider other service providers, like cable operators or wireless providers.  We may be unable to attract or retain new customers from cable companies due to their deployment of enhanced broadband and VoIP technology.  In addition, new capacity services for wireless broadband technologies may permit our competitors to offer broadband data services to our customers throughout most or all of our service areas.
 
Our Internet services could be adversely affected and we may be subject to increased costs and claims in connection with Internet and systems security and malicious Internet practices.
 
We use encryption and authentication technology licensed from third parties to provide secure transmission of confidential information, including our business data and customer information.  We also rely on employees in our network operations centers, data centers, call centers and retail stores to follow our procedures when handling such information.  Any unauthorized access, computer viruses, accidental or intentional release of confidential information or other disruptions could result in increased costs, customer dissatisfaction leading to loss of customers and revenues, and fines and other liabilities.
 
In addition, our Company or our customers using our network to access the Internet may become victim to malicious and abusive Internet activities, including unsolicited mass advertising (“spam”), peer-to-peer file sharing, distribution of viruses, worms and other destructive or disruptive software.  These activities could adversely affect our network, result in excessive call volume at our call centers and damage our or our customers’ equipment and data.
 
Despite security measures and business continuity plans, the Company’s information technology networks and infrastructure may be vulnerable to damage, disruptions or shutdowns due to attack by hackers or breaches, employee error or malfeasance, power outages, computer viruses, telecommunication or utility failures, systems failures, natural disasters or other catastrophic events. Any such events could result in legal claims or proceedings, liability or penalties under privacy laws, disruption in operations, misappropriation of sensitive data, damage to the Company’s reputation and costly response measures, which could adversely affect the Company’s business. There can be no assurance that such disruptions or misappropriations and the resulting repercussions will not be material to our results of operations, financial condition or cash flows.

Item 1B.  Unresolved Staff Comments

None.


 
21

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Item 2.     Properties

Our principal corporate offices are located in leased premises at 3 High Ridge Park, Stamford, Connecticut 06905.

Our principal operations support offices and call center support offices are currently located in leased or owned premises at 180 South Clinton Avenue, Rochester, New York 14646, at 100 CTE Drive, Dallas, Pennsylvania 18612, at 805 South Central Expressway, Allen, Texas 75013, at 14450 Burnhaven Drive, Burnsville, Minnesota 55306, at 1398 South Woodland Blvd., DeLand, Florida 32720, at 1800 41st Street, Everett, Washington 98203, at 1500 MacCorkle Avenue, Charleston, West Virginia 25303, at 8001 W. Jefferson Blvd., Fort Wayne, Indiana 46804, and at 1300 Columbus-Sandusky Road North, Marion, Ohio 43302.  In addition, we lease and own additional space in our operating markets throughout the United States for operations support and call center support.

Our telephone properties include: connecting lines between customers' premises and the central offices; central office switching equipment; fiber-optic and microwave radio facilities; buildings and land; and customer premise equipment. The connecting lines, including aerial and underground cable, conduit, poles, wires and microwave equipment, are located on public streets and highways or on privately owned land. We have permission to use these lands pursuant to local governmental consent or lease, permit, franchise, easement or other agreement.

The plants and properties (owned or leased) operated by Frontier and its subsidiaries are maintained in good condition and are believed to be suitable and adequate for our present needs.

Item 3.   Legal Proceedings

See Note 19 of the Notes to Consolidated Financial Statements included in Part IV of this report.

We are party to various legal proceedings (including individual, class and putative class actions) arising in the normal course of our business covering a wide range of matters and types of claims including, but not limited to,  general contracts, billing disputes, rights of access, taxes and surcharges, consumer protection, trademark and patent infringement, employment, regulatory, tort, claims of competitors and disputes with other carriers.  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 we are entitled, will not have a material adverse effect on our financial position, results of operations, or our cash flows.

Item 4.    Mine Safety Disclosures

Not applicable.


 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Executive Officers of the Registrant

Our Executive Officers as of February 15, 2013 were:

Name
Age
Current Position and Officer
Kathleen Q. Abernathy
56
Executive Vice President, External Affairs
Andrew Crain
51
Senior Vice President and General Counsel
Susana D’Emic
49
Senior Vice President and Controller
Lois Hedg-peth
56
Executive Vice President, Strategy
John M. Jureller
53
Executive Vice President and Chief Financial Officer-Elect
Daniel J. McCarthy
48
President and Chief Operating Officer
Cecilia K. McKenney
50
Executive Vice President, Human Resources and Administrative Services
Donald R. Shassian 57 Executive Vice President and Chief Financial Officer
Melinda White 53 Executive Vice President, Revenue Development
Mary Agnes Wilderotter
58
Chairman of the Board and Chief Executive Officer

There is no family relationship between directors or executive officers.  The term of office of each of the foregoing officers of Frontier will continue until the next annual meeting of the Board of Directors and until a successor has been elected and qualified.

KATHLEEN Q. ABERNATHY joined Frontier’s management team in March 2010, after serving as a member of Frontier’s Board of Directors from April 2006 to March 2010.  She is currently Executive Vice President, External Affairs.  Previously, she was Chief Legal Officer and Executive Vice President, Regulatory and Government Affairs from March 2010 to June 2012.  From October 2008 to March 2010, Ms. Abernathy was a partner at the law firm of Wilkinson Barker Knauer, LLP.  Prior to that time, she was a partner at the law firm of Akin Gump Strauss Hauer & Feld LLP from March 2006 to October 2008.  From June 2001 to December 2005, she served as a Commissioner at the Federal Communications Commission.

ANDREW CRAIN joined Frontier in June 2012 as Senior Vice President and General Counsel.  Prior to this, he was Scholar in Residence in the Interdisciplinary Telecommunications Program at the University of Colorado Boulder from August 2011 to June 2012, teaching communications law, research methods and telecommunications industry, and a Senior Fellow at the Silicon Flatirons Center for Law, Technology and Entrepreneurship.  From June 2000 to April 2011, Mr. Crain held various Deputy General Counsel and Associate General Counsel positions at Qwest Communications International, Inc. in the Regulatory, Commercial, FCC and Wholesale Groups.  From March 1997 to June 2000, he held legal positions at US West Communications (predecessor to Qwest), in the Regulatory and Litigation Groups.  Prior to joining Qwest, he was a Partner in the law firm of Ross & Hardies. 

SUSANA D’EMIC joined Frontier in April 2011 as Senior Vice President and Controller.  Previously, she was with Reader’s Digest Association from January 1998 until joining Frontier, most recently as Vice President, Corporate Controller from December 2007 until April 2011 and prior to that as Vice President, North American Controller from May 2003 until December 2007.  Before joining Reader’s Digest, she held various positions with Kraft Foods Corp., Colgate Palmolive Company and was an audit manager with KPMG (then KPMG Peat Marwick).  Ms. D’Emic is a certified public accountant.

LOIS HEDG-PETH joined Frontier in July 2012 as Executive Vice President, Strategy.  From September 2009 to September 2010 and September 2011 to April 2012, she was a contractor with Frontier with the position of Executive Vice President, Integration.  From 2002 to 2008, Ms. Hedg-peth held various positions with Centrica, a competitive energy retailer, including President, U.S. Operations; Executive Vice President of Marketing, Director of Energy for British Gas and Chief Operating Officer of North America for its Direct Energy division.  Prior to Centrica Ms. Hedg-peth was President, Fixed Wireless Operations, for AT&T Wireless.

JOHN M. JURELLER joined Frontier in January 2013 as Executive Vice President and Chief Financial Officer-Elect.  Mr. Jureller will become Chief Financial Officer on February 27, 2013 upon Mr. Shassian’s resignation from that position.  Mr. Jureller was Senior Vice President, Finance & Operations for the Resources Group of General Atlantic LLC from April 2008 to October 2012.  Previously, he was Chief Financial Officer of WestPoint International, Inc. from March 2006 to March 2008.  Prior to that, Mr. Jureller was a member of the Corporate Turnaround & Restructuring practice of AlixPartners, LLC from April 2003 to February 2006.  Before joining AlixPartners, LLC, Mr. Jureller was Chief Financial Officer of Trans-Resources, Inc., Senior Vice President, Corporate Development of Gartner, Inc. and Senior Vice President, Finance and Corporate Development at Caribiner International Inc. 

 
23

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
DANIEL J. McCARTHY has been with Frontier since December 1990.  He is currently President and Chief Operating Officer.  Previously, he was Executive Vice President and Chief Operating Officer from January 2006 to April 2012 and Senior Vice President, Field Operations from December 2004 to December 2005.  Prior to that, he was Senior Vice President Broadband Operations from January 2004 to December 2004, President and Chief Operating Officer of Electric Lightwave from January 2002 to December 2004, President and Chief Operating Officer, Public Services Sector from November 2001 to January 2002, Vice President and Chief Operating Officer, Public Services Sector from March 2001 to November 2001 and Vice President, Citizens Arizona Energy from April 1998 to March 2001.

CECILIA K. McKENNEY has been with Frontier since February 2006.  She is currently Executive Vice President, Human Resources and Administrative Services.  Previously, she was Executive Vice President, Human Resources and Sales Operations from May 2012 to January 2013, Executive Vice President, Human Resources and Call Center Sales & Service from February 2008 to May 2012 and Senior Vice President, Human Resources from February 2006 to February 2008.  Prior to joining Frontier, she was Group Vice President, Headquarters Human Resources, of The Pepsi Bottling Group (PBG) from 2004 to 2005.  Previously at PBG Ms. McKenney was Vice President, Headquarters Human Resources from 2000 to 2004.

DONALD R. SHASSIAN has been with Frontier since April 2006.  He is currently Executive Vice President and Chief Financial Officer.  Mr. Shassian has announced his intention to resign his position effective February 27, 2013.  Previously, he was Chief Financial Officer from April 2006 to February 2008.  Prior to joining Frontier, Mr. Shassian had been an independent consultant since 2001 primarily providing M&A advisory services to several organizations in the communications industry.  In his role as independent consultant, Mr. Shassian also served as Interim Chief Financial Officer of the Northeast region of Health Net, Inc. for a short period of time, and assisted in the evaluation of acquisition, disposition and capital raising opportunities for several companies in the communications industry, including AT&T, Consolidated Communications and smaller companies in the rural local exchange business.  Mr. Shassian is a certified public accountant, and served for 5 years as the Senior Vice President and Chief Financial Officer of Southern New England Telecommunications Corporation and for more than 16 years at Arthur Andersen, where his last position was as Partner in Charge of the North American Telecom Industry.

MELINDA WHITE has been with Frontier since January 2005.  She is currently Executive Vice President, Revenue Development.  Previously, she was Executive Vice President and General Manager, Marketing and New Business Operations from November 2009 to December 2010.  Prior to that, she was Senior Vice President and General Manager, Marketing and New Business Operations from July 2009 to November 2009.  Ms. White was Senior Vice President and General Manager of New Business Operations from October 2007 to July 2009 and prior to that, Senior Vice President, Commercial Sales and Marketing from January 2006 to October 2007.  Ms. White was Vice President and General Manager of Electric Lightwave from January 2005 to July 2006.  Prior to joining Frontier, she was Executive Vice President, National Accounts/Business Development for Wink Communications from 1996 to 2002.

MARY AGNES WILDEROTTER has been with Frontier since November 2004.  She is currently Chairman of the Board and Chief Executive Officer.  She was elected President and Chief Executive Officer in November 2004 and Chairman of the Board in December 2005.  She was President of Frontier until April 2012.  Prior to joining Frontier, she was Senior Vice President - Worldwide Public Sector of Microsoft Corp. from February 2003 to November 2004 and Senior Vice President - Worldwide Business Strategy of Microsoft Corp. from 2002 to 2004.  Before that she was President and Chief Executive Officer of Wink Communications from 1997 to 2002.




 
24

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

PART II

 
Item 5.          Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

PRICE RANGE OF COMMON STOCK

Our common stock is currently traded on the NASDAQ Global Select Market under the symbol FTR.  The following table indicates the high and low intra-day sales prices per share during the periods indicated, as reported by the New York Stock Exchange through December 15, 2011, and the NASDAQ Global Select Market commencing on December 16, 2011.

     2012      2011  
   
High
 
Low
   
High
 
Low
 
                     
First Quarter
  $ 5.37   $ 3.81     $ 9.84   $ 7.68  
Second Quarter
  $ 4.44   $ 3.06     $ 8.97   $ 7.71  
Third Quarter
  $ 5.15   $ 3.59     $ 8.23   $ 6.09  
Fourth Quarter
  $ 4.98   $ 4.09     $ 6.40   $ 4.79  
                             
 
As of February 15, 2013, the approximate number of security holders of record of our common stock was 529,020. This information was obtained from our transfer agent, Computershare Inc.

DIVIDENDS
 
The amount and timing of dividends payable on our common stock are within the sole discretion of our Board of Directors.  From the third quarter of 2004 through the second quarter of 2010, we paid an annualized cash dividend of $1.00 per share of common stock, paid quarterly.  From the third quarter of 2010 through the fourth quarter of 2011, we paid an annualized cash dividend of $0.75 per share of common stock, paid quarterly.  Effective February 16, 2012, our Board of Directors set the annual cash dividend at $0.40 per share. Cash dividends paid to shareholders were $399.4 million, $746.4 million and $529.4 million in 2012, 2011 and 2010, respectively.  There are no material restrictions on our ability to pay dividends.  The decrease in aggregate dividends paid in 2012, as compared to 2011, reflects the reduction in the amount of the dividend per share, as described above. The increase in aggregate dividends paid in 2011, as compared to 2010, reflects the increase in the number of shares outstanding as a result of the Transaction, offset in part by the reduction in the amount of the dividend per share, as described above.  The table below sets forth dividends paid per share during the periods indicated.
 
A portion of the dividends is classified as total ordinary dividends and represents qualified dividends, and a portion of the dividends is classified as non-dividend distributions and represents a return of capital.
 
 
     2012    2011    2010  
               
First Quarter
  $ 0.10   $ 0.1875   $ 0.25  
Second Quarter
  $ 0.10   $ 0.1875   $ 0.25  
Third Quarter
  $ 0.10   $ 0.1875   $ 0.1875  
Fourth Quarter
  $ 0.10   $ 0.1875   $ 0.1875  


 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

STOCKHOLDER RETURN PERFORMANCE GRAPH


The following performance graph compares the cumulative total return of our common stock to the S&P 500 Stock Index and to the S&P Telecommunication Services Index for the five-year period commencing December 31, 2007.
 
 
 
 
The graph assumes that $100 was invested on December 31, 2007 in each of our common stock, the S&P 500 Stock Index and the S&P Telecommunication Services Index and that all dividends were reinvested.
 
   
INDEXED RETURNS
 
Base
Years Ending
 
Period
         
Company / Index
12/07
12/08
12/09
12/10
12/11
12/12
Frontier Communications Corporation
100
75.50
77.05
107.09
63.37
57.78
S&P 500 Index
100
63.00
79.67
91.68
93.61
108.59
S&P Telecommunication Services
100
69.51
75.72
90.07
95.72
113.24

The foregoing performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, each as amended, except to the extent we specifically incorporate it by reference into such filing.


RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED SECURITIES

None in the fourth quarter of 2012.

 
26

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

 
 
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
 
             
Period
 
Total Number of Shares Purchased
   
Average Price Paid per Share
 
             
October 1, 2012 to October 31, 2012
           
Employee Transactions (1)
    4,463     $ 4.67  
                 
November 1, 2012 to November 30, 2012
               
Employee Transactions (1)
    2,386     $ 4.77  
                 
December 1, 2012 to December 31, 2012
               
Employee Transactions (1)
    12,060     $ 4.59  
                 
                 
Totals October 1, 2012 to December 31, 2012
               
Employee Transactions (1)
    18,909     $ 4.63  
                 

(1)
Includes restricted shares withheld (under the terms of grants under employee stock compensation plans) to offset minimum tax withholding obligations that occur upon the vesting of restricted shares.  The Company’s stock compensation plans provide that the value of shares withheld shall be the average of the high and low price of the Company’s common stock on the date the relevant transaction occurs.

 
27

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Item 6.  Selected Financial Data

The following tables present selected historical consolidated financial information of Frontier for the periods indicated.  The selected historical consolidated financial information of Frontier as of and for each of the five fiscal years in the period ended December 31, 2012 has been derived from Frontier’s historical consolidated financial statements.  The selected historical consolidated financial information as of December 31, 2012 and 2011 and for each of the three years ended December 31, 2012 is derived from the audited historical consolidated financial statements of Frontier included elsewhere in this Form 10-K.  The selected historical consolidated financial information as of December 31, 2010, 2009 and 2008 and for each of the years ended December 31, 2009 and 2008 is derived from the audited historical consolidated financial statements of Frontier not included in this Form 10-K.

($ in thousands, except per share amounts)
 
Year Ended December 31, (1)
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
Revenue
  $ 5,011,853     $ 5,243,043     $ 3,797,675     $ 2,117,894     $ 2,237,018  
Income from continuing operations (2) (3) (4)
  $ 153,314     $ 157,608     $ 155,717     $ 123,181     $ 184,274  
Net income attributable to common shareholders of Frontier (2) (3) (4)
  $ 136,636     $ 149,614     $ 152,673     $ 120,783     $ 182,660  
Net income attributable to common shareholders of Frontier
                                       
  per basic share (2) (3) (4)
  $ 0.14     $ 0.15     $ 0.23     $ 0.38     $ 0.57  
Net income attributable to common shareholders of Frontier
                                       
  per diluted share (2) (3) (4)
  $ 0.13     $ 0.15     $ 0.23     $ 0.38     $ 0.57  
Cash dividends declared (and paid) per common share
  $ 0.40     $ 0.75     $ 0.875     $ 1.00     $ 1.00  
                                         
   
As of December 31,
 
      2012       2011       2010       2009       2008  
Total assets
  $ 17,733,631     $ 17,448,319     $ 17,888,101     $ 6,903,528     $ 6,891,678  
Long-term debt
  $ 8,381,947     $ 8,224,392     $ 8,005,685     $ 4,819,402     $ 4,724,687  
Total shareholders' equity of Frontier
  $ 4,107,596     $ 4,455,137     $ 5,196,740     $ 327,611     $ 519,045  
                                         
 
 
(1)
Operating results include activities for the Acquired Business from the date of its acquisition from Verizon on July 1, 2010.
(2)
Operating results include the pre-tax impacts of losses on retirement of debt or exchanges of debt of $90.4 million ($56.7 million after tax or $0.06 per share), $45.9 million ($28.9 million after tax or $0.09 per share) and $6.3 million ($4.0 million after tax or $0.01 per share) for 2012, 2009 and 2008, respectively.
(3)
Operating results include pre-tax acquisition and integration costs of $81.7 million ($51.8 million after tax or $0.05 per share), $143.1 million ($88.4 million after tax or $0.09 per share), $137.1 million ($85.7 million after tax or $0.13 per share) and $28.3 million ($17.8 million after tax or $0.06 per share) for 2012, 2011, 2010 and 2009, respectively.
(4)
Operating results include pre-tax severance costs of $32.0 million ($21.0 million after tax or $0.02 per share), $15.7 million ($9.7 million after tax or $0.01 per share), $10.4 million ($6.4  million after tax or $0.01 per share), $3.8 million ($2.4  million after tax or $0.01  per share), and $7.6 million ($4.7  million after tax or $0.01  per share) for 2012, 2011, 2010, 2009 and 2008, respectively.

 

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements

This annual report on Form 10-K 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:

The effects of greater than anticipated competition which could require us to develop 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 voice customers that we cannot offset with increases in broadband subscribers and sales of other products and services;
 
The effects of competition from cable, wireless and other wireline carriers;
 
Our ability to maintain relationships with customers, employees or suppliers;
 
The effects of ongoing changes in the regulation of the communications industry as a result of federal and state legislation and regulation, or changes in the enforcement or interpretation of such legislation and regulation;
 
The effects of any unfavorable outcome with respect to any current or future legal, governmental or regulatory proceedings, audits or disputes;
 
The effects of changes in the availability of federal and state universal funding to us and our competitors;
 
Our ability to adjust successfully to changes in the communications industry and to implement strategies for growth;
 
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;
 
The effects of changes in accounting policies or practices adopted voluntarily or as required by generally accepted accounting principles or regulations;

 
 
 
29

 
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 technological changes and competition on our capital expenditures, product and service offerings and measurement of speeds and capacity, 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, pension and postemployment expenses and related funding requirements;
 
The effects of changes in income tax rates, tax laws, regulations or rulings, or federal or state tax assessments;
 
Our ability to successfully renegotiate union contracts in 2013 and thereafter;
 
Changes in pension plan assumptions and/or the value of our pension plan assets, which could require us to make increased contributions to the pension plan in 2013 and beyond;
 
The effects of customer bankruptcies and home foreclosures, which could result in difficulty in collection of revenues and loss of customers;
 
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;
 
Our cash flow from operations, amount of capital expenditures, debt service requirements, cash paid for income taxes and liquidity may affect our payment of dividends on our common shares;
 
The effects of state regulatory cash management practices that could limit our ability to transfer cash among our subsidiaries or dividend funds up to the parent company; and
   
The effects of severe weather events such as hurricanes, tornadoes, 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 evaluating any statement in this report on Form 10-K 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 and do not undertake to do so.

Investors should also be aware that while we do, at various times, communicate with securities analysts, it is against our policy to disclose to them selectively any material non-public information or other confidential information. Accordingly, investors should not assume that we agree with any statement or report issued by an analyst irrespective of the content of the statement or report. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
 

 
30

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

(a) Liquidity and Capital Resources

As of December 31, 2012, we had cash and cash equivalents aggregating $1,326.5 million (excluding total restricted cash of $42.7 million, representing funds escrowed for future broadband expansion and service quality initiatives). Our primary source of funds continued to be cash generated from operations.  For the year ended December 31, 2012, we used cash flow from operations, cash on hand and debt proceeds to fund principally all of our cash investing and financing activities, primarily capital expenditures, dividends and debt repayments.

In 2012, the Company completed three registered debt offerings totaling $1.4 billion in senior unsecured debt.  In addition, we retired an aggregate principal amount of $757.0 million of debt.  See “Cash Flows used by and provided from Financing Activities – Debt Financings and Debt Reductions” below for further discussion.

We have a revolving credit facility with a line of credit of $750.0 million.  We have not made any borrowings from this facility.

At December 31, 2012, we had a working capital surplus of $533.7 million, which includes the classification of $502.7 million of our 6.25% Senior Notes due 2013, maturing in the first quarter of 2013, as a current liability and which was retired on January 15, 2013 with cash on hand. We believe our operating cash flows, existing cash balances, and existing revolving credit facility will be adequate to finance our working capital requirements, fund capital expenditures, make required debt payments, pay taxes, pay dividends to our stockholders and support our short-term and long-term operating strategies through 2013.  However, a number of factors, including but not limited to, losses of voice customers, pricing pressure from increased competition, lower subsidy and switched access revenues and the impact of the current economic environment are expected to reduce our cash generated from operations.  In addition, although we believe, based on information available to us, that the financial institutions syndicated under our revolving credit facility would be able to fulfill their commitments to us, this could change in the future.  As of December 31, 2012, we had $560.5 million and $257.9 million of debt maturing in 2013 and 2014, respectively, although $502.7 million of the 2013 maturing debt was retired on January 15, 2013 with cash on hand.

In addition, the FCC and certain state regulatory commissions, in connection with granting their approvals of the Transaction, specified certain capital expenditure and operating requirements for the Acquired Territories for specified periods of time post-closing. These requirements focus primarily on certain capital investment commitments to expand broadband availability to at least 85% of the households throughout the Acquired Territories with minimum download speeds of 3 Mbps by the end of 2013 and 4 Mbps by the end of 2015.

As of December 31, 2012 and 2011, we had expanded our broadband availability to the households throughout the Company’s territories as follows:

                     
 
2012
       
2011
 
Frontier
 
Acquired
 
Total
       
Total
(In excess of)
Legacy
 
Territories
 
Company
       
Company
                     
1 Mbps
92%
 
86%
 
88%
       
83%
3 Mbps
80%
 
84%
 
83%
       
76%
4 Mbps
76%
 
78%
 
77%
       
66%
6 Mbps
66%
 
77%
 
74%
       
56%
12 Mbps
42%
 
54%
 
51%
       
NA
20 Mbps
38%
 
41%
 
40%
       
28%


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 a letter of credit for $190.0 million in 2010. Another $72.4 million of cash in an escrow account (with a cash balance of $23.9 million and an associated liability of $0.2 million as of December 31, 2012) was acquired in connection with the Transaction to be used for service quality initiatives in the state of West Virginia.   As of December 31, 2012, $145.0 million had been released from escrow.  As of December 31, 2012, the letter of credit had been reduced to $40.0 million.  The aggregate amount of these escrow accounts and the letter of credit will continue to decrease over time as Frontier makes the required capital expenditures in the respective states.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
In the third quarter of 2011, the Company contributed four administrative properties appraised at $58.1 million to its qualified defined benefit pension plan.  The Company is leasing back the properties from its pension plan for 15 years at a combined aggregate annual rent of $5.8 million.  The properties are managed on behalf of the pension plan by an independent fiduciary, and the terms of the leases were negotiated with the fiduciary on an arm’s-length basis.

Cash Flows provided by Operating Activities

Cash flows provided by operating activities declined $20.2 million, or 1%, in 2012 as compared to 2011.  The decrease was primarily the result of large cash settlements of accounts payable due to the timing of vendor payments during the first quarter of 2012.  Our accounts payable balances at December 31, 2011 were unusually high due to our systems conversion and broadband build activities in the second half of 2011.

We paid $4.7 million in net cash taxes during 2012, while cash refunds (net of cash taxes paid) for taxes of $33.1 million were received in 2011, and cash paid for taxes was $19.9 million in 2010.  Our 2012 cash taxes reflect the continued impact of bonus depreciation under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  We expect that in 2013 our cash taxes will be approximately $125 million to $150 million.

In connection with the Transaction, the Company undertook a variety of activities to integrate systems and implement other initiatives. As a result of the Transaction, the Company incurred $81.7 million of costs related to integration activities during 2012, as compared to $143.1 million and $137.1 million of acquisition and integration costs in 2011 and 2010, respectively.  All integration activities were completed as of the end of 2012.

Cash Flows used by Investing Activities

Capital Expenditures
In 2012, 2011 and 2010, our capital expenditures were $802.5 million (including $54.1 million of integration-related capital expenditures), $824.8 million (including $76.5 million of integration–related capital expenditures) and $577.9 million (including $97.0 million of integration-related capital expenditures), respectively.  We continue to closely scrutinize all of our capital projects, emphasize return on investment and focus our capital expenditures on areas and services that have the greatest opportunities with respect to revenue growth and cost reduction. We anticipate capital expenditures for business operations to decrease in 2013 to approximately $625 million to $675 million due to the completion of all integration activities and the planned completion of geographic broadband expansion requirements established in connection with regulatory approval of the Transaction.

Acquisitions
On July 1, 2010, Frontier issued common shares with a value of $5.2 billion and made payments of $105.0 million in cash as consideration for the Acquired Business.  In addition, as part of the Transaction, Frontier assumed $3.5 billion in debt.

Cash Flows used by and provided from Financing Activities

Debt Financings
On May 17, 2012, we completed a registered offering of $500 million aggregate principal amount of 9.250% senior unsecured notes due 2021, issued at a price of 100% of their principal amount.   We received net proceeds of $489.6 million from the offering after deducting underwriting fees and offering expenses.  The Company also commenced a tender offer to purchase the maximum aggregate principal amount of its 8.250% Senior Notes due 2014 (the 2014 Notes) and its 7.875% Senior Notes due 2015 (the April 2015 Notes and, together with the 2014 Notes, the Notes) that it could purchase for up to $500 million in cash (the Debt Tender Offer).  The 2014 Notes had an effective interest cost of 10.855%, reflecting the fact that such notes were issued at a discount in April 2009.
 
On August 15, 2012, the Company completed a registered offering of $600 million aggregate principal amount of 7.125% senior unsecured notes due 2023 (the 2023 Notes), issued at a price of 100% of their principal amount.  We received net proceeds of $588.1 million from the offering after deducting underwriting fees and offering expenses. The Company intends to use the net proceeds from the sale of the notes to repurchase or retire existing indebtedness or for general corporate purposes. 
 

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
On October 1, 2012, the Company completed a registered debt offering of $250 million aggregate principal amount of the 2023 Notes, issued at a price of 104.250% of their principal amount, equating to an effective yield of 6.551%.   We received net proceeds of $255.9 million from the offering after deducting underwriting fees and offering expenses.  The notes are an additional issuance of, are fully fungible with and form a single series voting together as one class with the $600 million aggregate principal amount of the 2023 Notes issued by the Company on August 15, 2012.   The Company intends to use the net proceeds from the sale of the notes to repurchase or retire existing indebtedness or for general corporate purposes.

Debt Reduction
In 2012, we retired an aggregate principal amount of $757.0 million of debt, consisting of $756.1 million of senior unsecured debt and $0.9 million of rural utilities service loan contracts.  Additionally, on January 15, 2013, we retired $502.7 million of our 6.25% Senior Notes due 2013 with cash on hand.

Pursuant to the Debt Tender Offer, the Company accepted for purchase $400 million aggregate principal amount of 2014 Notes, tendered for total consideration of $446.0 million, and $49.5 million aggregate principal amount of April 2015 Notes, tendered for total consideration of $54.0 million.  Frontier used proceeds from the sale of its May 2012 offering of $500.0 million of 9.250% Senior Notes due 2021, plus cash on hand, to purchase the Notes.

The repurchases in the Debt Tender Offer for the Notes resulted in a loss on the early extinguishment of debt of $69.0 million, which we recognized in the second quarter of 2012.  We also recognized losses of $2.1 million during the second quarter of 2012 for $78.1 million in total open market repurchases of our 6.25% Senior Notes due 2013. 

On October 1, 2012, the Company accepted for purchase $75.7 million and $59.3 million aggregate principal amount of the April 2015 Notes and its 8.250% Senior Notes due 2017 (the 2017 Notes), respectively, in open market repurchases for total consideration of $154.7 million.  The repurchases resulted in a loss on the early retirement of debt of $19.3 million that was recognized in the fourth quarter of 2012.   

In 2011, we retired an aggregate principal amount of $552.4 million of debt, consisting of $551.4 million of senior unsecured debt and $1.0 million of rural utilities service loan contracts.  In 2010, we retired an aggregate principal amount of $7.2 million of debt, consisting of $2.8 million of senior unsecured debt and $4.4 million of rural utilities service loan contracts.

We may from time to time make additional repurchases of our debt in the open market, through tender offers, exchanges of debt securities, by exercising rights to call or in privately negotiated transactions.  We may also refinance existing debt or exchange existing debt for newly issued debt obligations.

Bank Financing
The Company has a credit agreement (the Credit Agreement) with CoBank, ACB, as administrative agent, lead arranger and a lender, and the other lenders party thereto for a $575.0 million senior unsecured term loan facility with a final maturity of October 14, 2016.  The entire facility was drawn upon execution of the Credit Agreement in October 2011.  Repayment of the outstanding principal balance is made in quarterly installments in the amount of $14,375,000, which commenced on March 31, 2012, with the remaining outstanding principal balance to be repaid on the final maturity date.  Borrowings under the Credit Agreement bear interest based on the margins over the Base Rate (as defined in the Credit Agreement) or LIBOR, at the election of the Company.  Interest rate margins under the facility (ranging from 0.875% to 2.875% for Base Rate borrowings and 1.875% to 3.875% for LIBOR borrowings) are subject to adjustments based on the Total Leverage Ratio of the Company, as such term is defined in the Credit Agreement.  The current pricing on this facility is LIBOR plus 2.875%.  The maximum permitted leverage ratio, as defined in the Credit Agreement, is 4.5 times.  The proceeds of the facility were used to repay in full the remaining outstanding principal on three debt facilities (Frontier’s $200 million Rural Telephone Financing Cooperative term loan maturing October 24, 2011, its $143 million CoBank term loan maturing December 31, 2012, and its $130 million CoBank term loan maturing December 31, 2013) and the remaining proceeds were used for general corporate purposes.

The Credit Agreement contains customary representations and warranties, affirmative and negative covenants, including a restriction on the Company’s ability to declare dividends if an event of default has occurred or will result therefrom, a financial covenant that requires compliance with a leverage ratio, and customary events of default.  Upon proper notice, the Company may, in whole or in part, repay the facility without premium or penalty, but subject to breakage fees on LIBOR loans, if applicable.  Amounts pre-paid may not be re-borrowed.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES


Transaction Financing
On April 12, 2010, in anticipation of the Transaction, the Verizon subsidiary then holding the assets of the Acquired Business completed a private offering of $3.2 billion aggregate principal amount of 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 Transaction, 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 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 ($53.0 million). In addition, the $125.5 million Transaction Escrow was returned to the Company.

Upon completion of the Transaction 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 $3.2 billion.

The senior notes consisted 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 Transaction, 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.

Credit Facility
We have a $750.0 million revolving credit facility. As of December 31, 2012, we had not made any borrowings under this facility. The terms of the credit facility are set forth in the credit agreement (the Revolving Credit Agreement), dated as of March 23, 2010, among the Company, the Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent. Associated facility fees under the credit facility will vary from time to time depending on the Company’s credit rating (as defined in the Revolving Credit Agreement) and were 0.625% per annum as of December 31, 2012. 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 Revolving Credit Agreement), at the Company’s election, plus a margin specified in the Revolving 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 is available for general corporate purposes but may not be used to fund dividend payments.

Letter of Credit Facility
We also have a $40.0 million unsecured letter of credit facility, as amended. 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). An initial letter of credit for $190 million was issued to the West Virginia Public Service Commission to guarantee certain of our capital investment commitments in West Virginia in connection with the Transaction.  The initial commitments under the Letter of Credit Agreement expired on September 20, 2011, with the Bank exercising its option to extend $100.0 million of the commitments to September 20, 2012.   On September 11, 2012, the Company entered into an amendment to the Letter of Credit Agreement to extend $40 million of the commitments to September 20, 2013.  Two letters of credit, one for $20 million expiring March 2013 and the other for $20 million expiring September 2013, were issued on September 13, 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 amended 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.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Covenants
The terms and conditions contained in our indentures, the Credit Agreement, the Revolving Credit Agreement and the Letter of Credit Agreement include the timely payment of principal and interest when due, the maintenance of our corporate existence, keeping proper books and records in accordance with U.S. GAAP, restrictions on the incurrence of liens on our assets, and restrictions on asset sales and transfers, mergers and other changes in corporate control. We are not subject to restrictions on the payment of dividends either by contract, rule or regulation, other than that imposed by the General Corporation Law of the State of Delaware. However, we would be restricted under the Credit Agreement, the Revolving Credit Agreement and the Letter of Credit Agreement from declaring dividends if an event of default occurred and was continuing at the time or would result from the dividend declaration.

The Credit Agreement and the Revolving Credit Agreement each contain a maximum leverage ratio covenant. Under those covenants, we are required to maintain a ratio of (i) total indebtedness minus cash and cash equivalents (including restricted cash) in excess of $50.0 million to (ii) consolidated adjusted EBITDA (as defined in the agreements) over the last four quarters no greater than 4.50 to 1.  At December 31, 2012, the ratio of our net debt to adjusted operating cash flow (leverage ratio) was 3.17 times.

The Credit Agreement, the Revolving Credit Agreement, the Letter of Credit Agreement and certain indentures for our senior unsecured debt obligations limit our ability to create liens or merge or consolidate with other companies and our subsidiaries’ ability to borrow funds, subject to important exceptions and qualifications.

As of December 31, 2012, we were in compliance with all of our debt and credit facility covenants.

Dividends
We intend to pay regular quarterly dividends.  Our ability to fund a regular quarterly dividend could be impacted by our ability to generate cash from operations. The declarations and payment of future dividends will be at the discretion of our Board of Directors, and will depend upon many factors, including our financial condition, results of operations, growth prospects, funding requirements, applicable law, restrictions in agreements governing our indebtedness and other factors our Board of Directors deem relevant.

Off-Balance Sheet Arrangements
We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon our financial statements.

Future Commitments
A summary of our future contractual obligations and commercial commitments as of December 31, 2012 is as follows:

Contractual Obligations:
                               
($ in thousands)
       
Payment due by period
 
   
Total
   
2013
      2014-2015       2016-2017    
Thereafter
 
Long-term debt obligations,
                                 
   excluding interest
  $ 8,942,568     $ 560,550     $ 990,662     $ 1,386,652     $ 6,004,704  
                                         
Interest on long-term debt
    6,786,739       678,872       1,274,919       1,130,201       3,702,747  
                                         
Operating lease obligations
    182,174       95,323       30,415       14,685       41,751  
                                         
Capital lease obligations
    38,199       3,055       6,268       6,489       22,387  
                                         
Financing lease obligations
    81,016       5,339       10,446       10,957       54,274  
                                         
Purchase obligations
    95,205       48,338       36,799       8,868       1,200  
                                         
"Take or pay" contract obligations
    414,600       132,000       282,600       -       -  
                                         
Liability for uncertain tax positions
    13,625       6,973       6,177       475       -  
                 Total
  $ 16,554,126     $ 1,530,450     $ 2,638,286     $ 2,558,327     $ 9,827,063  
                                         
At December 31, 2012, we had outstanding performance letters of credit totaling $86.8 million.
 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
In our normal course of business we have obligations under certain non-cancelable arrangements for services.  During 2012, we entered into a “take or pay” arrangement for the purchase of future long distance and carrier services, whereby the Company committed to a minimum number of minutes of use and circuits.   Our total commitments under the arrangement are $132.0 million, $141.8 million and $140.8 million for the years ended December 31, 2013, 2014 and 2015, respectively.  As of December 31, 2012, we expect to utilize the services included within the arrangement and no liability for the take or pay provision has been recorded.
 
The Company has entered into an agreement to upgrade a significant portion of its existing vehicle fleet.  As of December 31, 2012, the Company has accepted delivery of  2,150 new vehicles and expects to accept delivery of 1,614 additional new vehicles by March 31, 2013.  The new vehicles expected to be leased under this program will represent approximately 50% of our vehicle fleet.   The minimum lease commitment for each vehicle is 1 year and the leases are renewable at the Company’s option.  The total annual lease expense for all of the new vehicles is expected to be approximately $30.0 million on an annualized basis upon the acceptance of the remaining vehicles.

Critical Accounting Policies and Estimates
We review all significant estimates affecting our consolidated financial statements on a recurring basis and record the effect of any necessary adjustment prior to their publication.  Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, it is possible that actual results could differ from those estimates and changes to estimates could occur in the near term.  The preparation of our financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses during the reporting period.  Estimates and judgments are used when accounting for revenue recognition, impairment of long-lived assets, impairment of intangible assets, depreciation and amortization, pension and other postretirement benefits, income taxes, contingencies and purchase price allocations, among others.

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and our Audit Committee has reviewed our disclosures relating to such estimates.

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 voice, features, long distance and inside wire 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.

We maintain an allowance for estimated bad debts based on our estimate of our ability to collect accounts receivable through a review of aging categories and specific customer accounts.  In 2012 and 2011, we had no “critical estimates” related to bankruptcies of telecommunications companies or any other customers.

Asset Impairment
We review long-lived assets to be held and used, including customer lists, and long-lived assets to be disposed of for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of the asset to the future undiscounted net cash flows expected to be generated by the asset. Recoverability of assets held for sale is measured by comparing the carrying amount of the assets to their estimated fair market value. If any assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value.  Also, we periodically reassess the useful lives of our tangible and intangible assets to determine whether any changes are required.  In 2012 and 2011, we had no “critical estimates” related to asset impairments.


 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Intangibles
Our indefinite lived intangibles consist of goodwill and trade name, which resulted from the purchase of ILEC properties.  We test for impairment of these assets annually, or more frequently, as circumstances warrant.  We test for goodwill impairment at the “operating segment” level, as that term is defined in U.S. GAAP.  Effective with the third quarter of 2011, the Company reorganized into six operating segments in order to leverage the full benefits of its local engagement model. The six operating segments consist of the following regions: Central, Midwest, National, Northeast, Southeast and West.  Our operating segments are aggregated into one reportable segment since they have similar economic characteristics.  In conjunction with the reorganization of our operating segments during the third quarter of 2011, we reassigned goodwill to our reporting units using a relative fair value allocation approach. This structure is consistent with how our Chief Operating Decision Makers (CEO, CFO, President and COO) review our results on a daily, weekly and monthly basis. After making the change in our operating segments, we reviewed our goodwill impairment test by comparing the EBITDA multiples for each reporting unit to their carrying values noting that no impairment indicator was present.  No potential impairment was indicated and no further analysis was deemed necessary.

Our annual goodwill impairment testing date is December 31.  Each of the operating segments is also a reporting unit.  The first step in the goodwill impairment test compares the carrying value of net assets of the reporting unit to its fair value.   The result of this first step indicated that fair value of each reporting unit exceeded the carrying value of such reporting units.  As a result, the second step of the goodwill impairment test was not required.

Goodwill by reporting unit (operating segment) at December 31, 2012 and 2011 is as follows:

   
Reporting Units
 
($ in thousands)
 
Northeast
   
National
   
Southeast
   
West
   
Central
   
Midwest
 
                                     
Goodwill
  $ 1,245,414     $ 1,176,139     $ 1,113,931     $ 1,072,499     $ 1,006,132     $ 723,604  
 
Enterprise values for rural ILEC properties are typically quoted as a multiple of cash flow or EBITDA.  Marketplace company comparisons and analyst reports support a range of values around a multiple of 5.5 to 7.5 times annualized EBITDA.  For the purpose of the goodwill impairment test we define EBITDA as operating income, net of acquisition and integration costs, non-cash pension/OPEB costs and severance costs, plus depreciation and amortization.  We determined the fair value estimates using 6.25 times EBITDA but also used lower EBITDA multiples to gauge the sensitivity of the estimate and its effect on the margin of excess of fair value over the carrying values of the reporting units.  Total fair value determined in this manner is then allocated to the reporting units based upon each unit’s relative share of consolidated EBITDA.  Our method of determining fair value has been consistently applied for the three years ending December 31, 2012.

The Company monitors relevant circumstances, including general economic conditions, enterprise value EBITDA multiples for rural ILEC properties, the Company’s overall financial performance and the market prices for the Company’s common stock, and the potential impact that changes in such circumstances might have on the valuation of the Company’s goodwill or other intangible assets.  If our goodwill or other intangible assets are determined to be impaired in the future, we may be required to record a non-cash charge to earnings during the period in which the impairment is determined.

Effective with the first quarter of 2013, the Company reorganized into four operating segments consisting of the following regions: East, Central, National and West.  Our operating segments are aggregated into one reportable segment.

Depreciation and Amortization
The calculation of depreciation and amortization expense is based upon the estimated useful lives of the underlying property, plant and equipment and identifiable intangible assets.  Depreciation expense is principally based on the composite group method for substantially all of our property, plant and equipment assets. Given the varying estimated useful lives of our property, plant and equipment assets, the Company utilizes multiple asset categories with separately determined composite lives and individual depreciation rates for each asset category.

Within the composite group method, we group individual assets, including cable and wire, into asset categories utilizing homogeneous characteristics, where such assets (i) are principally used in the same manner throughout the company, (ii) are subject to similar operating conditions and (iii) have similar estimated useful lives.  Examples of the asset categories we utilize include aerial cable-copper, aerial cable-fiber, aerial cable-station connections, underground cable-copper and underground cable-fiber.  As a result of continuing changes in technology, an independent study is conducted annually to update the estimated remaining useful lives of all individual asset categories.  The annual study includes models that consider actual usage, replacement history and certain assumptions about technology evolution to estimate the remaining useful lives of our asset base by asset category. The latest study was completed in the fourth quarter of 2012 and after review and analysis of the results, we adopted new estimated remaining useful lives for certain plant assets as of October 1, 2012, with an immaterial impact to depreciation expense.  Our composite depreciation rate for plant assets was 6.65% as a result of this study.  There have been no significant changes to the ranges of estimated useful lives for the individual asset categories, including the cable and wire asset groups, during the three years ended December 31, 2012.
 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Our finite lived intangibles include intangible assets related to the customer base acquired in the Transaction that were recorded at an estimated fair value of $2.5 billion with an estimated useful life of nine years for the residential customer list, as distinguished from the 12 years used for the business customer list. For both classes of assets, the “sum of the years digits” method is used to amortize the intangible assets, which tracks more closely with the projected revenue stream of each asset class.  Our Frontier legacy customer list intangible assets did not distinguish between business and residential classes and the amortization period was five years on the straight-line method.  We periodically reassess the useful life of our intangible assets to determine whether any changes to those lives are required.

We anticipate depreciation expense of approximately $850 million to $870 million and amortization expense of approximately $330 million for 2013.
  
Pension and Other Postretirement Benefits
Our estimates of pension expense, other postretirement benefits including retiree medical benefits and related liabilities are “critical accounting estimates.”  In connection with the completion of the Transaction 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. The asset transfers from Verizon to the Plan have been completed.  We sponsor a noncontributory defined benefit pension plan covering a significant number of our current and former Frontier legacy employees and other postretirement benefit plans that provide medical, dental, life insurance and other benefits for covered retired employees and their beneficiaries and covered dependents. All of the employees who are still accruing pension benefits are employees represented by unions.  The accounting results for pension and other postretirement benefit costs and obligations are dependent upon various actuarial assumptions applied in the determination of such amounts.  These actuarial assumptions include the following: discount rates, expected long-term rate of return on plan assets, future compensation increases, employee turnover, healthcare cost trend rates, expected retirement age, optional form of benefit and mortality.  We review these assumptions for changes annually with our independent actuaries.  We consider our discount rate and expected long-term rate of return on plan assets to be our most critical assumptions.

The discount rate is used to value, on a present value basis, our pension and other postretirement benefit obligations (OPEB) as of the balance sheet date.  The same rate is also used in the interest cost component of the pension and postretirement benefit cost determination for the following year.  The measurement date used in the selection of our discount rate is the balance sheet date.  Our discount rate assumption is determined annually with assistance from our actuaries based on the pattern of expected future benefit payments and the prevailing rates available on long-term, high quality corporate bonds that approximate the benefit obligation.

Since the completion of the Transaction on July 1, 2010, we have focused on integrating the operations and converging the processes of the Acquired Business to effectively operate as one business.  During the past two years, we have worked with Verizon and our third party actuaries to merge the plans, finalize the transfer of plan assets and ensure we have all the information necessary to make well informed decisions.  Based on the underlying changes in demographics and cash flows, we amended the estimation techniques regarding its actuarial assumptions, where appropriate, across all of our pension and postretirement plans. The most significant of such changes was in the estimation technique utilized to develop the discount rate for its pension and postretirement benefit plans. The revised estimation technique is based upon a settlement model (Bond:Link) of such liabilities as of December 31, 2012 that permits us to more closely match cash flows to the expected payments to participants than would be possible with the previously used yield curve model. We believe such a change results in an estimate of the discount rate that more accurately reflects the settlement value for plan obligations than the different yield curve methodologies used in prior years, as it provides the ability to review the quality and diversification of the portfolio to select the bond issues that would settle the obligation in an optimal manner.  This rate can change from year-to-year based on market conditions that affect corporate bond yields.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
In determining the discount rate as of December 31, 2011 and 2010, we considered, among other things, the yields on the Citigroup Above Median Pension Curve, the Towers Watson Index, the general movement of interest rates and the changes in those rates from one period to the next.

As a result of the change described above, Frontier is utilizing a discount rate of 4.00% as of December 31, 2012 for its qualified pension plan, compared to rates of 4.50% and 5.25% in 2011 and 2010, respectively.  The discount rate using the previous estimation technique would have been 3.75%, resulting in an immaterial impact to the projected benefit obligation at December 31, 2012 in comparison to the 4.00% discount rate. The discount rate for postretirement plans as of December 31, 2012 was a range of 4.00% to 4.20% compared to a range of 4.50% to 4.75% in 2011 and 5.25% in 2010.

The expected long-term rate of return on plan assets is applied in the determination of periodic pension and postretirement benefit cost as a reduction in the computation of the expense.  In developing the expected long-term rate of return assumption, we considered published surveys of expected market returns, 10 and 20 year actual returns of various major indices, and our own historical 5 year, 10 year and 20 year investment returns.  The expected long-term rate of return on plan assets is based on an asset allocation assumption of 35% to 55% in fixed income securities, 35% to 55% in equity securities and 5% to 15% in alternative investments.  We review our asset allocation at least annually and make changes when considered appropriate.  Our asset return assumption is made at the beginning of our fiscal year.  In 2010, 2011 and 2012, our expected long-term rate of return on plan assets was 8.0%, 8.0% and 7.75%, respectively.  Our actual return on plan assets in 2012 was 11.1%.  For 2013, we will assume a rate of return of 8.0%.  Our pension plan assets are valued at fair value as of the measurement date.

We expect that our pension and other postretirement benefit expenses for 2013 will be approximately $100 million to $110 million before amounts capitalized into the cost of capital expenditures.  In 2012, they were $81.6 million before amounts capitalized into the cost of capital expenditures. We expect to make contributions to our pension plan of approximately $60 million in 2013.  We made net contributions to our pension plan of $28.6 million in 2012, consisting of cash payments of $18.3 million and $10.3 million during the third and fourth quarter of 2012, respectively.  We made contributions to our pension plan of $76.7 million in 2011, consisting of cash payments of $18.6 million and the contribution of real property with a fair value of $58.1 million.  We made cash contributions of $13.1 million in 2010.

Income Taxes
Our effective tax rate was 33.0% in 2012 as compared to 35.9% in 2011 and 42.5% in 2010.  Income taxes for 2012 include the net reversal of reserves for uncertain tax positions for $12.3 million, partially offset by increases in deferred tax balances to reflect changes in estimates and changes in state effective rates and filing methods.

Income taxes for 2011 include the reduction of deferred tax balances based on the application of enacted state tax statutes for $6.8 million and the net reversal of a reserve for uncertain tax positions for $9.9 million, partially offset by the impact of a $10.8 million charge resulting from the enactment on May 25, 2011 of the Michigan Corporate Income Tax that eliminated certain future tax deductions.

The higher rate in 2010 was primarily related to the write-off of certain deferred tax assets in 2010 of $11.3 million related to Transaction costs which were not tax deductible.  Prior to the closing of the Transaction, these costs were deemed to be tax deductible as the Transaction had not yet been successfully completed. These costs were incurred to facilitate the Transaction and once the Transaction closed, these costs had to be capitalized for tax purposes.

Contingencies
See Note 19 of the Notes to Consolidated Financial Statements included in Part IV of this report for a discussion of commitments and contingencies.  Our contingencies include the potential obligation associated with our previous electric utility activities in the state of Vermont, along with ongoing regulatory issues and legal cases in the normal course of our business, including billing disputes.

Purchase Price Allocation - The Transaction
The allocation of the approximate $5.4 billion in total consideration to the “fair market value” of the assets and liabilities of the Acquired Business is a critical estimate.  The estimates of the fair values assigned to plant, customer base and goodwill, are more fully described in Notes 3 and 6 of the Notes to Consolidated Financial Statements.  Additionally, the estimated expected life of a customer (used to amortize the customer base) is a critical estimate.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
New Accounting Pronouncements
There were no new accounting standards issued and adopted by the Company in 2012, or that have been issued but are not required to be adopted until future periods, with any material financial statement impact.

Fair Value Measurements
In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-04 (ASU 2011-04), “Fair Value Measurements: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (Accounting Standards Codification (ASC) Topic 820).  ASU 2011-04 changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and IFRS. ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance was to be applied prospectively, and was effective for interim and annual periods beginning after December 15, 2011.  The Company adopted ASU 2011-04 in the first quarter of 2012 with no impact on our financial position, results of operations or cash flows.

Presentation of Comprehensive Income
In June 2011, the FASB issued ASU No. 2011-05 (ASU 2011-05), “Comprehensive Income: Presentation of Comprehensive Income,” (ASC Topic 220).  ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance was to be applied retrospectively, and was effective for interim and annual periods beginning after December 15, 2011.  The Company adopted ASU 2011-05 in the first quarter of 2012 with no impact on our financial position, results of operations or cash flows.

In February 2013, the FASB issued ASU No. 2013-02 (ASU 2013-02), “Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” (ASC Topic 220). ASU 2013-02 requires disclosing the effect of reclassifications out of accumulated other comprehensive income on the respective line items in net income in circumstances when U.S. GAAP requires the item being reclassified in its entirety to net income. This new guidance is to be applied prospectively. The Company adopted ASU 2013-02 during the fourth quarter of 2012 with no impact on our financial position, results of operations or cash flows.

Indefinite-Lived Intangible Assets
In July 2012, the FASB issued ASU No. 2012-02 (ASU 2012-02), “Intangibles—Goodwill and Other – Testing Indefinite-Lived Intangible Assets for Impairment,” (ASC Topic 350). ASU 2012-02 permits an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform a quantitative impairment test.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  This amendment also gives an entity the option not to calculate annually the fair value of an indefinite-lived intangible asset if the entity can determine that it is not more likely than not that the asset is impaired.  If an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action.  While ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, early adoption is permitted.  The Company adopted ASU 2012-02 during the fourth quarter of 2012 with no material impact on our financial position, results of operations or cash flows.


 
40

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

(b) Results of Operations

Effective July 1, 2010, the Company’s scope of operations and balance sheet capitalization changed materially as a result of the completion of the Transaction.  Historical financial and operating data presented for Frontier is not indicative of future results and includes the results of operations of the Acquired Business from the date of acquisition on July 1, 2010.  The financial discussion and tables below include a comparative analysis of our results of operations on a historical basis for our Frontier operations as of and for the years ended December 31, 2012, 2011 and 2010, which includes the results of operations of the Acquired Business for the years ended December 31, 2012 and 2011, and the six months ended December 31, 2010.  The variance explanations discussed below for the years ended December 31, 2011 and 2010 include a separate amount for the additional six months of revenue and operating expenses related to the operating results of the Acquired Business in 2011.  Certain analyses of revenue and operating expenses may refer to the results of the Frontier legacy operations, which excludes the Acquired Business.

REVENUE

Revenue is generated primarily through the provision of local, network access, long distance, data, video and Internet services.  Such revenues are generated through either a monthly recurring fee or a fee based on usage and revenue recognition is not dependent upon significant judgments by management, with the exception of a determination of a provision for uncollectible amounts.

Revenue for 2012 decreased $231.2 million, or 4%, to $5,011.9 million as compared to 2011.  This decline in 2012 is primarily the result of decreases in the number of business and residential customers and switched access revenue, partially offset by an increase in subsidies revenue, each as described in more detail below.

Switched access and subsidy revenue of  $576.4 million represented 12% of our revenues for 2012.  Switched access revenue was $257.8 million for 2012, or 5% of our revenues, as compared to $319.0 million for 2011, or 6% of our revenues.  Subsidy revenue was $318.6 million in 2012, or 6% of our revenues, as compared to $300.1 million in 2011, or 6% of our revenues.  We expect switched access and subsidy revenue to decline in 2013.

Revenue for 2011 increased $1,445.4 million, or 38%, to $5,243.0 million as compared to 2010.  Excluding the additional six months of revenue of $1,667.1 million attributable to the Acquired Business, our revenue for 2011 decreased $221.7 million, or 6%, as compared to 2010.  This decline in 2011 was a result of decreases in the number of business and residential customers, switched access, video and other revenue, partially offset by a $32.7 million, or 3%, increase in data and Internet services revenue, each as described in more detail below.

The number of our access lines is one metric that has been used to understand our revenue and profitability.  Access lines, however, have become less relevant given our strategic focus on customer retention and broadband penetration. Traditionally, we lose access lines because of competition, economic conditions, and by the loss of second lines upon the addition of broadband service.  An additional factor was introduced at the end of the second quarter of 2012 when Frontier began selling Simply Broadband, which is our broadband service without any wireline circuit switched voice capabilities.  We are attracting and retaining customers with this product, and it has had a positive impact on our residential customer counts and revenues.  As a result, when selling this service to acquire or retain customers, no access lines are sold nor are they counted.  Similarly, during the fourth quarter of 2012, Frontier began selling a satellite broadband product and we are trialing an AT&T Mobility product bundled with broadband service in selected markets.  In both of these cases, a wireline voice capability may not be included and accordingly, in that situation, an access line will not be counted.  In addition, in our normal course of business, we proactively remove access lines when we upgrade business customers from multiple circuit switched lines and replace them with data facilities that can be used for voice services via VoIP.  As a result of all of the above, changes in access lines are not necessarily an indication of a loss of revenue or customers.

During 2012, we lost 240,500 customers, as compared to a loss of 375,400 customers in 2011. We believe the improved customer retention in 2012 as compared to 2011 is principally due to our investments in our network, our local engagement strategy, improved customer service and the introduction of our Simply Broadband product.  Also, during 2012, the average monthly total customer revenue per customer increased $5.18, or 5%, over 2011.  We lost 216,700 residential customers and 23,800 business customers during the year ended December 31, 2012, or 7% on an annual basis, as compared to 341,400 residential customers and 33,900 business customers lost during the year ended December 31, 2011, or 10% on an annual basis. Average monthly residential revenue per customer increased $0.63 to $58.03 during 2012 as compared to 2011.  This increase is due to the additional monthly subscriber line charges to our residential customers which were implemented in the third quarter of 2012, as permitted by the Order, increased penetration of products and rationalized product pricing. Economic conditions and/or increasing competition could make it more difficult to sell our bundled service offerings, and cause us to increase our promotions and/or lower our prices for our products and services, which would adversely affect our revenue, profitability and cash flows.

 
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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
During the year ended December 31, 2012, the Company added 23,400 net broadband subscribers. During 2011, the Company added 45,200 net broadband subscribers.  We believe that the lower customer activations were due to the final systems conversion during 2012 and the delayed roll-out of marketing promotions in the second half of 2012.  The Company plans to significantly expand broadband availability and speed over the next several years.  We expect to continue to increase broadband subscribers in 2013.
 
As stated above, while the number of access lines is one metric to gauge certain revenue trends, it is not necessarily the best or only measure to evaluate our business.  Management believes that customer counts and understanding different components of revenue is most important.  For this reason, presented in the table titled “Other Financial and Operating Data” below is an analysis that presents customer counts, average monthly revenue, products per customer and churn.  It also categorizes revenue into customer revenue (business and residential) and regulatory revenue (switched access and subsidy revenue).  Despite the 7% decline in residential customers and the 8% decline in business customers during 2012, customer revenue (all revenue except switched access and subsidy revenue) declined in 2012 by only 4 percent as compared to the prior year.  The decline in customers was partially offset by increased penetration of additional products sold to both business and residential customers, which has increased our average monthly revenue per customer.  A substantial further loss of customers, combined with increased competition and the other factors discussed herein, may cause our revenue, profitability and cash flows to decrease in 2013.
 
OTHER FINANCIAL AND OPERATING DATA
 
                                           
   
As of
   
% Increase
   
As of
   
% Increase
   
    As of
             
   
December 31, 2012
   
(Decrease)
   
December 31, 2011
   
(Decrease)
              December 31, 2010
     
   
Customers
    3,173,169       (7%)       3,413,666       (10%)       3,789,016              
                                                     
Broadband subscribers
    1,787,561       1%       1,764,160       3%       1,718,959              
                                                     
Video subscribers
                                                   
   DISH and FiOS
    346,627       14%       303,046       (2%)       310,365              
   DirecTV (1)
    -       (100%)       224,519       7%       210,526              
Total video subscribers
    346,627       (34%)       527,565       1%       520,891              
                                                     
   
For the year ended December 31,
 
           
$ Increase
   
% Increase
           
$ Increase
   
% Increase
       
      2012    
(Decrease)
   
(Decrease)
      2011    
(Decrease)
   
(Decrease)
      2010  
Revenue (in 000's):
                                                     
   Business
  $ 2,317,212     $ (36,163 )     (2%)     $ 2,353,375     $ 746,829       46%     $ 1,606,546  
   Residential
    2,118,224       (152,303 )     (7%)       2,270,527       577,173       34%       1,693,354  
Customer revenue
  $ 4,435,436     $ (188,466 )     (4%)     $ 4,623,902     $ 1,324,002       40%     $ 3,299,900  
                                                         
   Switched access and subsidy
    576,417       (42,724 )     (7%)       619,141       121,366       24%       497,775  
Total revenue
  $ 5,011,853     $ (231,190 )     (4%)     $ 5,243,043     $ 1,445,368       38%     $ 3,797,675  
                                                         
Switched access minutes of use
                                                       
   (in millions)
    18,292               (3%)       18,894               30%       14,542  
Average monthly total revenue
                                                       
   per customer
  $ 127.32     $ 5.44       4%     $ 121.88                          
Average monthly total customer
                                                       
   revenue per customer
  $ 112.68     $ 5.18       5%     $ 107.50                          
                                                         
   
As of or for the
                   
As of or for the
                   
As of or for the
 
   
year ended
   
% Increase
           
year ended
   
% Increase
           
year ended
 
   
December 31, 2012
   
(Decrease)
           
December 31, 2011
   
(Decrease)
           
December 31, 2010
 
Business Customer Metrics:
                                                       
Customers
    286,106       (8%)               309,900       (10%)               343,823  
Revenue (in 000's)
  $ 2,317,212       (2%)             $ 2,353,375       46%             $ 1,606,546  
Average monthly business
                                                       
    revenue per customer
  $ 650.63       8%             $ 601.14                          
                                                         
Residential Customer Metrics:
                                                       
Customers
    2,887,063       (7%)               3,103,766       (10%)               3,445,193  
Revenue (in 000's)
  $ 2,118,224       (7%)             $ 2,270,527       34%             $ 1,693,354  
Average monthly residential
                                                       
   revenue per customer (2)
  $ 58.03       1%             $ 57.40                          
Customer Monthly Churn
    1.62 %     (4%)               1.69 %                        
                                                         
(1) Decline in video subscribers is due to the loss of 203,100 DirecTV subscribers in the third quarter of 2012 as Frontier no longer provides DirecTV as part of its bundled packages.
 
(2) Calculation excludes the Mohave Cellular Limited Partnership.
                                                 
42

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

REVENUE
 
                                           
   
2012
   
2011
   
2010
 
($ in thousands)
       
$ Increase
   
% Increase
         
$ Increase
   
% Increase
       
   
Amount
   
(Decrease)
   
(Decrease)
   
Amount
   
(Decrease)
   
(Decrease)
   
Amount
 
Local and long distance services
  $ 2,230,890     $ (220,421 )     (9%)     $ 2,451,311     $ 653,929       36%     $ 1,797,382  
Data and internet services
    1,823,010       (19,923 )     (1%)       1,842,933       607,337       49%       1,235,596  
Other
    381,536       51,878       16%       329,658       62,736       24%       266,922  
    Customer revenue
    4,435,436       (188,466 )     (4%)       4,623,902       1,324,002       40%       3,299,900  
Switched access and subsidy
    576,417       (42,724 )     (7%)       619,141       121,366       24%       497,775  
    Total Revenue
  $ 5,011,853     $ (231,190 )     (4%)     $ 5,243,043     $ 1,445,368       38%     $ 3,797,675  
                                                         

Local and Long Distance Services
Local and long distance services revenue for 2012 decreased $220.4 million, or 9%, to $2,230.9 million, as compared with 2011 primarily due to the continued loss of voice customers and, to a lesser extent, decreases in private line services and feature packages, partially offset by increased local charges, effective with the third quarter of 2012, to business and residential end users to the extent permitted by the Order.  Local and enhanced services revenue for 2012 decreased $157.0 million, or 8%, to $1,813.8 million, primarily due to the continued loss of voice customers and, to a lesser extent, decreases in private line services and feature packages, partially offset by increased local charges, effective with the third quarter of 2012, to business and residential end users to the extent permitted by the Order.    Long distance services revenue for 2012 decreased $63.4 million, or 13%, to $417.1 million, primarily due to a decrease in the number of long distance customers using our bundled service offerings, lower minutes of use and a lower average revenue per minute of use.

Local and long distance services revenue for 2011 increased $653.9 million, or 36%, to $2,451.3 million, as compared with 2010. Local and long distance services revenue for 2011 increased $836.1 million as a result of the additional six months of revenue in 2011 attributable to the Acquired Business. Excluding the additional six months of revenue related to the Acquired Business, local and long distance services revenue decreased $182.2 million, or 10%, as compared with 2010, primarily due to the continued loss of voice customers and, to a lesser extent, decreases in private line services and feature packages.  Local and enhanced services revenue for 2011 increased $527.6 million, or 37%, to $1,970.8 million, as compared with 2010. Local and enhanced services revenue for 2011 increased $670.6 million as a result of the additional six months of revenue in 2011 attributable to the Acquired Business. Excluding the additional revenue related to the Acquired Business, local and enhanced services revenue decreased $143.0 million, primarily due to the continued loss of voice customers and, to a lesser extent, decreases in private line services and feature packages. Long distance services revenue for 2011 increased $126.3 million, or 36%, to $480.5 million, as compared with 2010. Long distance services revenue for 2011 increased $165.5 million as a result of the additional six months of revenue in 2011 attributable to the Acquired Business. Excluding the additional revenue related to the Acquired Business, long distance services revenue decreased $39.2 million as compared with 2010, primarily due to a decrease in the number of long distance customers using our bundled service offerings, lower minutes of use and a lower average revenue per minute of use.

Data and Internet Services
Data and Internet services revenue for 2012 decreased $19.9 million, or 1%, to $1,823.0 million, as compared with 2011.  Data services revenue decreased $7.2 million to $838.4 million in 2012, as compared with 2011, primarily due to higher promotional discounts and customer credits.   As of December 31, 2012, the number of the Company’s broadband subscribers increased by 23,400, or 1%, since December 31, 2011.  Data and Internet services also includes nonswitched access revenue from data transmission services to other carriers and high-volume commercial customers with dedicated high-capacity Internet and ethernet circuits.  Nonswitched access revenue decreased $12.7 million to $984.6 million in 2012, as compared with 2011, due to lower monthly recurring charges and settlements of disputes with carriers.

Data and Internet services revenue for 2011 increased $607.3 million, or 49%, to $1,842.9 million, as compared with 2010.  Data and Internet services revenue for 2011 increased $574.7 million as a result of the additional six months of revenue in 2011 attributable to the Acquired Business.  Excluding the additional six months of revenue related to the Acquired Business, data and Internet services revenue increased $32.7 million, or 3%, as compared with 2010, primarily due to the overall growth in the number of broadband subscribers and high-capacity Internet and ethernet circuits purchased by customers.  Data services revenue for 2011, excluding the additional six months of revenue related to the Acquired Business, decreased $12.8 million to $608.2 million, as compared with 2010, primarily due to higher promotional discounts and customer credits.  As of December 31, 2011, the number of the Company’s broadband subscribers increased by 45,200, or 3%, since December 31, 2010.  Nonswitched access revenue for 2011, excluding the additional six months of revenue related to the Acquired Business, increased $45.5 million to $660.0 million, as compared with 2010, primarily due to growth in the number of those circuits.

 
43

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Other
Other revenue for 2012 increased $51.9 million, or 16%, to $381.5 million, as compared with 2011.  Other revenue for 2012 increased, as compared to 2011, primarily due to higher service activation fees from new customers, lower bad debt expenses that are charged against revenue and higher wireless revenue, partially offset by the reduction in customers for FiOS video service and lower directory services revenue.

Other revenue for 2011 increased $62.7 million, or 24%, to $329.7 million, as compared with 2010.  Other revenue for 2011 increased $87.1 million as a result of the additional six months of revenue in 2011 attributable to the Acquired Business.  Excluding the additional six months of revenue related to the Acquired Business, other revenue decreased $24.4 million, or 9%, as compared with 2010.  Directory services revenue for 2011, excluding the additional six months of revenue related to the Acquired Business, decreased $16.8 million, or 16%, as compared with 2010, primarily due to a decline in yellow pages advertising.   All other revenue for 2011, excluding the additional six months of revenue related to the Acquired Business, decreased $7.6 million, or 5%, primarily due to the reduction in customers for FiOS video service.          

Switched Access and Subsidy
Switched access and subsidy revenue for 2012 decreased $42.7 million, or 7%, to $576.4 million, as compared with 2011.  Switched access revenue for 2012 of $257.8 million, decreased $61.2 million, or 19%, as compared to 2011, primarily due to the impact of a decline in minutes of use related to access line losses and the displacement of minutes of use by wireless, email and other communications services combined with a reduction due to the second half impact of the lower rates enacted by the first phase of the FCC’s intercarrier compensation reform.  Switched access and subsidy revenue includes subsidy payments we receive from federal and state agencies, including surcharges billed to customers that are remitted to universal service administrators.  Subsidy revenue, including surcharges billed to customers of $119.7 million for 2012, of $318.6 million, increased $18.5 million, or 6%, as compared with 2011, primarily due to an increase in the customer surcharge revenue to support the Federal Universal Service Fund and increased recovery from the Federal Fund due to the implementation of the Order during the second half of 2012.  We expect a further decline in switched access and subsidy revenue in 2013.

Switched access and subsidy revenue for 2011 increased $121.4 million, or 24%, to $619.1 million, as compared with 2010.  Switched access and subsidy revenue increased $169.3 million as a result of the additional six months of revenue in 2011 attributable to the Acquired Business. Excluding the additional six months of revenue related to the Acquired Business, switched access and subsidy revenue decreased $47.9 million, or 10%, as compared with 2010.

Switched access revenue, excluding the additional six months of revenue related to the Acquired Business, for 2011 of $245.0 million, or 7% of our revenues, decreased $40.5 million, or 14%, as compared with $285.5 million, or 8% of our revenues in 2010.  These decreases were primarily due to the impact of a decline in minutes of use related to access line losses and the displacement of minutes of use by wireless, email and other communications services.  Subsidy revenue, excluding the additional six months of revenue related to the Acquired Business, for 2011 of $204.8 million, decreased $7.4 million, or 3%, as compared with 2010, primarily due to decreased support for local switching, the Federal Universal Service Fund and the Federal High Cost Fund. 

Federal and state subsidies and surcharges (which are billed to customers and remitted to universal service administrators) for the Company were $160.7 million, $38.2 million and $119.7 million, respectively, and $318.6 million in total, or 6% of our revenues, for 2012.  The federal and state subsidy revenue for 2012 represents 4% of our consolidated revenues.   Total federal and state subsidies and surcharges were $300.1 million, or 6% of our consolidated revenues, for 2011 and $212.3 million, or 6% of our consolidated revenues for 2010.

On November 18, 2011, the FCC released a Report and Order and Further Notice of Proposed Rulemaking on the subject of Universal Service Fund and intercarrier compensation reform. The Order changed how federal subsidies will be calculated and disbursed, with these changes being phased-in beginning in 2012. These changes transition the Federal Universal Service High-Cost Fund, which supports voice services in high-cost areas, to the CAF, which supports broadband deployment in high-cost areas. CAF Phase I, implemented in 2012, provides for ongoing USF support for price cap carriers to be capped at the 2011 amount. In addition, the FCC in CAF Phase I made available for price cap ILECs an additional $300 million in incremental high cost broadband support to be used for broadband deployment to unserved areas. Frontier was eligible to receive $71.9 million of the total $300 million CAF Phase I interim support. On July 9, 2012, Frontier announced that it would accept all of the funding for which it is eligible. On July 24, 2012, Frontier formally notified the FCC and appropriate state commissions of its intent to accept those funds and identified the unserved locations to be served using the funds. The $71.9 million in incremental CAF Phase I support is expected to enable an incremental 92,877 households for broadband service and will be accounted for as Contributions in Aid of Construction.  Frontier is required to implement, spend and enable these 92,877 households no later than July 24, 2015.  As of December 31, 2012, Frontier has received $66.0 million of the CAF Phase I support funds and has initially recorded as increases to Cash and Other liabilities in the balance sheet.  The FCC is currently considering the rules for distribution of incremental CAF funding in 2013.
 
 
44

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
The Order also makes changes to Intercarrier Compensation.  Intercarrier Compensation, which is the payment framework that governs how carriers compensate each other for the exchange of interstate traffic, will transition over a number of years, with the first step being implemented in July 2012, to a near zero rate for terminating traffic by 2017. Frontier will be able to recover a significant portion of those revenues through end user rates and other replacement support mechanisms.

Effective December 29, 2011, the Order required providers to pay interstate access rates for the termination of VoIP toll traffic. On April 25, 2012, the FCC, in an Order on Reconsideration, specified that changes to originating access rates for VoIP traffic will not be implemented until July 2014. The Order has been challenged by certain parties in court and certain parties have also petitioned the FCC to reconsider various aspects of the Order. With the initial implementation commencing in July 2012, the second half of 2012’s impact was immaterial.

Certain states also have their own open proceedings to address reform to intrastate access charges and other intercarrier compensation and state universal service funds.  In addition, we have been approached by, and/or are involved in formal state proceedings with, various carriers seeking reductions in intrastate access rates in certain states. Although the FCC has pre-empted state jurisdiction on certain access charges, many states are still considering moving forward with their proceedings. We cannot predict when or how these matters will be decided or the effect on our subsidy or switched access revenues. However, future reductions in our subsidy or switched access revenues may directly affect our profitability and cash flows as those regulatory revenues do not have an equal level of associated variable expenses.

 
 
 
OPERATING EXPENSES

NETWORK ACCESS EXPENSES
                     
   
2012
 
2011
 
2010
($ in thousands)
 
$ Increase
% Increase
   
$ Increase
% Increase
   
   
Amount
(Decrease)
(Decrease)
 
Amount
(Decrease)
(Decrease)
 
Amount
Network access
 $       441,588
 $      (77,094)
(15%)
 
 $        518,682
 $    135,003
35%
 
 $       383,679

Network access expenses for 2012 decreased $77.1 million, or 15%, to $441.6 million, as compared with 2011, primarily due to reduced data network and backbone costs, reflecting cost synergies realized in moving traffic onto the Frontier legacy backbone, decreased long distance carriage costs in 2012, including a reduction in costs for our originating traffic associated with the third quarter implementation of the Order and reduced content costs related to fewer customers for FiOS video service.  Network access expenses also included promotional costs of $6.6 million and $13.9 million in 2012 and 2011, respectively, for various broadband and video subscriber promotions.

Network access expenses for 2011 increased $135.0 million, or 35%, to $518.7 million, as compared with 2010.  Network access expenses for 2011 increased $171.3 million as a result of the additional six months of expenses in 2011 attributable to the Acquired Business.  Network access expenses, excluding the additional six months of expenses related to the Acquired Business, decreased $36.3 million, or 9%, to $347.4 million, as compared with 2010, primarily due to reduced data network and backbone costs, reflecting synergies realized in moving traffic onto the Frontier legacy backbone, and decreased long distance carriage costs in 2011. 

 
45

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
 
OTHER OPERATING EXPENSES
 
                                           
   
2012
   
2011
   
2010
 
($ in thousands)
       
$ Increase
   
% Increase
         
$ Increase
   
% Increase
       
   
Amount
   
(Decrease)
   
(Decrease)
   
Amount
   
(Decrease)
   
(Decrease)
   
Amount
 
Wage and benefit expenses
  $ 1,207,797     $ 78,780       7%     $ 1,129,017     $ 325,294       40%     $ 803,723  
All other operating expenses
    1,026,756       (122,646 )     (11%)       1,149,402       341,988       42%       807,414  
    $ 2,234,553     $ (43,866 )     (2%)     $ 2,278,419     $ 667,282       41%     $ 1,611,137  
                                                         

Wage and benefit expenses
Wage and benefit expenses for 2012 increased $78.8 million, or 7%, to $1,207.8 million, (including $32.0 million and $15.7 million of severance costs for 2012 and 2011, respectively, related to 1,099 and 318 employees), as compared to 2011, primarily due to higher costs for compensation and certain other benefits resulting from higher average employee headcount and incremental overtime costs in the third quarter of 2012 to repair the network for seasonally higher storm damage costs than in the prior year.  Incremental overtime and other costs incurred in 2012, resulting from seasonal storms, were approximately $10 million greater than 2011.  Since closing the Transaction, the Company has been reducing its reliance on outside contractors and vendors by bringing work in-house to employees. While wages have increased, they have been more than offset by reduced outside services. With the systems and network conversions completed, the Company is focusing on simplifying its processes to reduce wage and non-wage costs. In the fourth quarter of 2012, the Company recorded severance costs of $17.2 million related to the termination of 537 employees in connection with the re-engineering initiative. We expect headcount to decline further in 2013.

Wage and benefit expenses for 2011 increased $325.3 million, or 40%, to $1,129.0 million as compared to 2010. Wage and benefit expenses for 2011 increased $364.2 million as a result of the additional six months of expenses in 2011 attributable to the Acquired Business.  Wage and benefit expenses, excluding the additional six months of expenses related to the Acquired Business, decreased $38.9 million, or 5%, to $764.8 million, as compared with 2010, primarily due to lower costs for compensation and certain other benefits, including pension costs, as discussed below.

Pension and OPEB costs for the Company are included in our wage and benefit expenses. Pension and OPEB costs for 2012, 2011 and 2010 were approximately $65.8 million, $48.1 million and $60.2 million, respectively. Pension and OPEB costs include pension and OPEB expense of $81.6 million, $58.3 million and $68.5 million, less amounts capitalized into the cost of capital expenditures of $15.8 million, $10.2 million and $8.3 million for 2012, 2011 and 2010, respectively.

Based on current assumptions and plan asset values, we estimate that our 2013 pension and other postretirement benefit expenses (which were $81.6 million in 2012 before amounts capitalized into the cost of capital expenditures) will be approximately $100 million to $110 million before amounts capitalized into the cost of capital expenditures.

All other operating expenses
All other operating expenses for 2012 decreased $122.6 million, or 11%, to $1,026.8 million, as compared with 2011, primarily due to the elimination of redundant information technology costs with the completion of the systems conversions, and lower outside service costs, as described above.    

All other operating expenses for 2011 increased $342.0 million, or 42%, to $1,149.4 million, as compared with 2010. All other operating expenses for 2011 increased $439.5 million as a result of the additional six months of expenses in 2011 attributable to the Acquired Business.  All other operating expenses, excluding the additional six months of expenses related to the Acquired Business, decreased $97.5 million, or 12%, to $709.9 million, as compared with 2010, primarily due to $36.5 million in corporate costs allocated to the Acquired Business during the first six months of 2011, combined with lower outside service fees, other taxes and marketing costs.

Cost Savings Resulting from the Transaction
We have achieved cost savings as a result of the Transaction, principally (1) by leveraging the scalability of our existing corporate administrative functions, information technology and network systems to cover certain former Acquired Business functions and systems, (2) by in-sourcing certain functions formerly provided by third-party service providers to the Acquired Business and (3) by achieving improved efficiencies and more favorable rates with third-party vendors.
 
 
46

 
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
 
Our annualized cost savings reached approximately $653 million as of the end of 2012.  The cost savings in 2012 from our targeted initiatives list (which includes, but is not limited to, cancellation or reduction of vendor services, network cost savings, contractor reductions, benefit changes and real estate savings) was approximately $101 million on an annualized basis, and when combined with the savings achieved in 2011 and 2010, equates to an annualized cost savings run rate of approximately $653 million, which exceeds our original estimate of $500 million of cost savings.    

DEPRECIATION AND AMORTIZATION EXPENSE
 
                                           
   
2012
   
2011
   
2010
 
($ in thousands)
       
$ Increase
   
% Increase
         
$ Increase
   
% Increase
       
   
Amount
   
(Decrease)
   
(Decrease)
   
Amount
   
(Decrease)
   
(Decrease)
   
Amount
 
Depreciation expense
  $ 844,641     $ (36,840 )     (4%)     $ 881,481     $ 281,819       47%     $ 599,662  
Amortization expense
    422,166       (99,528 )     (19%)       521,694       227,637       77%       294,057  
    $ 1,266,807     $ (136,368 )     (10%)     $ 1,403,175     $ 509,456       57%     $ 893,719