Attached files
file | filename |
---|---|
EX-23.1 - KPMG CONSENT - Frontier Communications Parent, Inc. | kpmgconsent.htm |
EX-21.1 - LIST OF SUBS - Frontier Communications Parent, Inc. | listofsubs.htm |
EX-12.1 - RATIO OF EARNINGS - Frontier Communications Parent, Inc. | ratioofearn.htm |
EX-10.32 - RESTRICTED STOCK AGREEMENT FOR CEO - Frontier Communications Parent, Inc. | exhibit10-32.htm |
EX-31.2 - SHASSIAN CERTIFICATION - Frontier Communications Parent, Inc. | shassiancert.htm |
EX-10.22 - LARSON EMPLOYMENT AGREEMENT LETTER - Frontier Communications Parent, Inc. | exhibit10-22.htm |
EX-10.33 - RESTRICTED STOCK AGREEMENT FOR SLT - Frontier Communications Parent, Inc. | exhibit10-33.htm |
EX-31.1 - WILDEROTTER CERTIFICATION - Frontier Communications Parent, Inc. | wilderottercert.htm |
EX-32.2 - SHASSIAN 906 CERTIFICATION - Frontier Communications Parent, Inc. | shassian906cert.htm |
EX-32.1 - WILDEROTTER 906 CERTIFICATION - Frontier Communications Parent, Inc. | wilderotter906cert.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, 2009
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,
2009
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
|
New
York Stock Exchange
|
|
Series
A Participating Preferred Stock Purchase Rights
|
New
York Stock Exchange
|
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 Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). Yes
__ 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. [ ]
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 X
The
aggregate market value of common stock held by non-affiliates of the registrant
on June 30, 2009 was approximately $2,211,628,000 based on the closing price of
$7.14 per share on such date.
The
number of shares outstanding of the registrant's Common Stock as of February 16,
2010 was 312,284,000.
DOCUMENT
INCORPORATED BY REFERENCE
Portions
of the Proxy Statement for the Company's 2010 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 1
|
Page | |||
Item
1.
|
Business
|
2
|
||
Item
1A.
|
Risk
Factors
|
10
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||
Item
1B.
|
Unresolved
Staff Comments
|
20
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||
Item
2.
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Properties
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20
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||
Item
3.
|
Legal
Proceedings
|
21
|
||
Item
4.
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Submission
of Matters to a Vote of Security Holders
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21
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||
Executive
Officers
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22
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|||
PART II
|
||||
Item
5.
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
24
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||
Item
6.
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Selected
Financial Data
|
27
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||
Item
7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
28
|
||
Item
7A.
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Quantitative
and Qualitative Disclosures About Market Risk
|
49
|
||
Item
8.
|
Financial
Statements and Supplementary Data
|
50
|
||
Item
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
50
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||
Item
9A.
|
Controls
and Procedures
|
50
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||
Item
9B.
|
Other
Information
|
50
|
||
PART III
|
||||
Item
10.
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Directors,
Executive Officers and Corporate Governance
|
50
|
||
Item
11.
|
Executive
Compensation
|
50
|
||
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
50
|
||
Item
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
51
|
||
Item
14.
|
Principal
Accountant Fees and Services
|
51
|
||
PART IV
|
||||
Item
15.
|
Exhibits
and Financial Statement Schedules
|
51
|
||
Index
to Consolidated Financial Statements
|
F-1
|
PART I
Item
1. Business
Frontier
Communications Corporation (Frontier) (formerly known as Citizens Communications
Company through July 30, 2008) and its subsidiaries are referred to as the
“Company,” “we,” “us” or “our” throughout this report and references to the
“combined company” refer to the Company following the completion of the Verizon
Transaction (as defined below). Frontier was incorporated in the
State of Delaware in 1935 as Citizens Utilities Company.
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,
internet, and television services that are available as bundled or packaged
solutions and for some products, á la carte. We believe that our local
management structure, superior customer service and innovative product
positioning will continue to differentiate us from our competitors in the
markets in which we compete.
We are a
communications company providing services to rural areas and small and
medium-sized towns and cities. Revenue was $2.1 billion in
2009. Among the highlights for 2009:
·
|
Verizon
Transaction
As
previously announced, on May 13, 2009, we entered into an Agreement and
Plan of Merger (the merger agreement), which provides for a merger (the
merger) in which New Communications Holdings, Inc. (Spinco), a newly
formed subsidiary of Verizon Communications, Inc. (Verizon) will be merged
into Frontier (the Verizon Transaction). We expect the merger
to close during the second quarter of 2010.
|
The
combined company is expected to be the nation’s largest communications
services provider focused on rural areas and small and medium-sized towns
and cities, and the nation’s fifth largest incumbent local exchange
carrier, with more than 6.3 million access lines, 8 million voice and
broadband connections and 15,000 employees in 27 states on a pro forma
basis as of December 31, 2009. The combined company will offer
voice, data and video services to customers in its expanded geographic
footprint.
|
|
Assuming
the Verizon Transaction closes, based on the lower level of Spinco debt we
will be assuming from Spinco relative to Spinco’s projected operating cash
flows, the combined company’s overall debt will increase but its capacity
to service the debt will be significantly enhanced as compared to
Frontier’s capacity today. At December 31, 2009, Frontier’s net
debt to 2009 operating cash flow (“leverage ratio”) was 3.9
times. It is expected that the combined company’s leverage
ratio will be significantly lower at closing.
|
|
·
|
Debt
Refinancing
During
2009, we completed two registered offerings of senior unsecured notes for
an aggregate $1.2 billion principal amount. The proceeds were
used to repurchase approximately $1.1 billion of our long-term debt,
primarily with maturities in 2011 and 2013. As a result of
these debt transactions, as of December 31, 2009, we had reduced our debt
maturities through 2013 to approximately $7.2 million maturing in 2010,
$280.0 million maturing in 2011, $180.4 million maturing in 2012, and
$709.9 million maturing in 2013. We do not expect the Verizon
Transaction to change the amount of these near-term debt
maturities.
|
·
|
Stockholder
Value
During
2009, we continued to pay an annual dividend of $1.00 per common
share. In connection with the Verizon Transaction, we announced
that the annual dividend would be reduced to $0.75 per share upon
completion of the Verizon Transaction. Payment of dividends is at the
discretion of our Board of Directors.
|
2
·
|
Product
Growth
During
2009, we added approximately 56,000 new High-Speed Internet (HSI)
subscribers. At December 31, 2009, we had approximately 636,000 HSI
customers. We offer a television product with the DISH Network (DISH), and
we added approximately 53,000 DISH subscribers during 2009. At
December 31, 2009, we had approximately 173,000 DISH
customers.
|
·
|
Customer
Revenue
During
2009, our customer revenue from both residential and business customers
declined by $74.0 million, or 4%, although our average monthly customer
revenue per access line improved by $1.81, or 3%.
|
·
|
Access
Lines
During
2009, our rate of access line loss for both residential and business
access lines improved from the prior year. We believe this is primarily
attributable to the customer recognition of the value of our product
bundles, 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.
|
Communications Services
As of
December 31, 2009, we operated as an incumbent local exchange carrier
(ILEC) in 24 states.
The
communications industry is undergoing significant changes and difficulties and
our financial results reflect the impact of this challenging
environment. Accordingly, as discussed in more detail in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” (MD&A), our revenues have decreased in 2009.
Our
business is with both residential and business customers. Our
services include:
|
•
|
access
services;
|
|
•
|
local
services;
|
|
•
|
long
distance services;
|
|
•
|
data
and internet services;
|
|
•
|
directory
services;
|
|
•
|
television
services; and
|
|
•
|
wireless
services.
|
Frontier is typically the leading incumbent carrier in the markets we serve and provides the "last mile" of telecommunications services to residential and business customers in these markets.
Access
services. Switched access services allow other carriers to use
our facilities to originate and terminate their long distance voice and data
traffic. These services are generally offered on a month-to-month basis and the
service is billed on a minutes-of-use basis. Access charges are based
on access rates filed with the Federal Communications Commission (FCC) for
interstate services and with the respective state regulatory agency for
intrastate services. In addition, subsidies received from state and
federal universal service funds based on the higher cost of providing telephone
service to certain rural areas are a part of our access services
revenue.
3
Revenue
is recognized when services are provided to customers or when products are
delivered to customers. Monthly recurring access service fees are
billed in advance. The unearned portion of this revenue is initially deferred as
a component of other liabilities on our balance sheet and recognized as revenue
over the period that the services are
provided.
Local services. We
provide basic telephone wireline services to residential and business customers
in our service areas. 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. 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, television
and internet services for a monthly fee and/or usage fee depending on the
plan.
We intend to continue our efforts to increase the penetration of our enhanced services. We believe that increased sales of such services will produce revenue with higher operating margins due to the relatively low marginal operating costs necessary to offer such services. We believe that our ability to integrate these services with other services will provide us with the opportunity to capture an increased percentage of our customers' communications expenditures (wallet share).
Long distance
services. We offer long distance services in our territories
to our customers. We believe that many customers prefer the convenience of
obtaining their long distance service through their local telephone company and
receiving a single bill. Long distance network service to and from
points outside of our operating territories is provided by interconnection with
the facilities of interexchange carriers (IXCs). Our long distance
services are billed either as unlimited/fixed number of minutes in advance or on
a per minute-of-use basis.
Data and internet
services. We offer data services including internet access
(via high-speed or dial up internet access), portal and e-mail products frame
relay, Metro Ethernet, asynchronous transfer mode (ATM), switching services,
hard drive back-up services and 24-7 help desk PC support. We offer
other data transmission services to other carriers and high-volume commercial
customers with dedicated high-capacity circuits ranging from DS-1’s to Gig
E. 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.
Directory
services. Directory services involves the provision of white
and yellow page directories for residential and business listings. We
provide this service through two third-party contractors. In the
majority of our markets, the contractor is paid a percentage of revenues from
the sale of advertising in these directories. In the remaining markets, we
receive a flat fee from the contractor. Our directory service also
includes “Frontier Pages,” an internet-based directory service which generates
digital advertising revenue.
Television
services. We offer a television product in an agency
relationship with DISH. We
provide access to all-digital television channels featuring movies, sports,
news, music and high-definition TV programming. We offer packages of
100, 200 or 250 channels and include high-definition channels, premium channels,
family channels and foreign language channels. We also provide access
to local channels. We bill the customer for the monthly services and
remit those billings to DISH without recognizing any revenue. We in
turn receive from DISH and recognize as revenue activation fees, other residual
fees and nominal management, billing and collection fees.
Wireless
services. During 2006, we began offering wireless data
services in certain markets. As of December 31, 2009, we provided
wireless data WiFi networks in 19 municipalities and to five colleges and
universities and over 360 business establishments. Certain contracts
are billed in advance on an annual or semi-annual basis. Colleges,
universities and businesses 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.
4
The
following table sets forth the aggregate number of our access lines and HSI
subscribers by state as of December 31, 2009 and 2008.
Access
Lines and High-Speed
|
||||||||
Internet
Subscribers at December 31,
|
||||||||
State
|
2009
|
2008
|
||||||
New
York…………………………………..
|
782,700 | 825,700 | ||||||
Pennsylvania…………….…..……………
|
487,900 | 506,100 | ||||||
Minnesota………………………...……….
|
276,500 | 280,500 | ||||||
Arizona……………………………………..
|
189,600 | 192,800 | ||||||
West
Virginia………………………………
|
189,100 | 188,200 | ||||||
California……………………………..……
|
188,100 | 193,200 | ||||||
Illinois………………………………………
|
129,000 | 127,900 | ||||||
Tennessee………………………………….
|
102,100 | 105,300 | ||||||
Wisconsin………………………………….
|
77,600 | 79,100 | ||||||
Iowa……………………………………...…
|
56,000 | 56,900 | ||||||
Nebraska……………….…………….……..
|
50,000 | 51,400 | ||||||
All
other states (13)……………….……….
|
224,900 | 227,200 | ||||||
Total
|
2,753,500 | 2,834,300 | ||||||
Change in
the number of our access lines is one factor that is important to our revenue
and profitability. We have lost access lines primarily as a result of
competition and business downsizing, and because of changing consumer behavior
(including wireless substitution), economic conditions, changing technology and
by some customers disconnecting second lines when they add HSI. We
lost approximately 136,800 access lines (net) during the year ended December 31,
2009, but added approximately 56,000 HSI subscribers (net) during this same
period. With respect to the access lines we lost in 2009, 104,700
were residential customer lines and 32,100 were business customer
lines. Without taking into account the Verizon Transaction, we expect
to continue to lose access lines but to partially offset those losses with an
increase in HSI subscribers during 2010. A substantial further loss
of access lines, combined with increased competition and the other factors
discussed in MD&A, may cause our revenues, profitability and cash flows to
decrease during 2010.
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
residential customer metrics that, when combined with unit counts provides
additional insight into the results of our strategic initiatives outlined
above.
As of or for the year ended
December 31,
|
||||||||
2009
|
2008
|
|||||||
Residential:
|
||||||||
Customers
|
1,254,500 | 1,347,400 | ||||||
Revenue
(in ‘000’s)
|
$ | 899,800 | $ | 949,284 | ||||
Average
monthly residential customer
revenue
per customer
|
$ | 57.62 | $ | 56.42 | ||||
Percent
of customers
on
price protection plans
|
53.2 | % | 44.6 | % | ||||
Customer
monthly churn
|
1.47 | % | 1.57 | % | ||||
Products
per residential customer*
|
2.54 | 2.37 | ||||||
*
Products per Residential Customer: Primary Residential Voice line, HSI, Video
products have a value of 1. FTR long distance, POM, second lines,
Feature Packages and Dial-up have a value of 0.5.
5
Regulatory
Environment
General
The
majority of our operations are regulated by the FCC and various state regulatory
agencies, often called public service or utility commissions.
Certain
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 the
statutes governing the level and type of regulation for telecommunications
services.
The
Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main purpose of the 1996 Act was to open local
telecommunications marketplaces to competition. The 1996 Act preempts
state and local laws to the extent that they prevent competition with respect to
communications services. Under the 1996 Act, however, states retain authority to
impose requirements on carriers necessary to preserve universal service, protect
public safety and welfare, ensure quality of service and protect consumers.
States are also responsible for mediating and arbitrating interconnection
agreements between competitive local exchange carriers (CLECs) and ILECs if
voluntary negotiations fail. In order to create an environment in
which local competition is a practical possibility, the 1996 Act imposes a
number of requirements for access to network facilities and interconnection on
all local communications providers. Incumbent local carriers must
interconnect with other carriers, unbundle some of their services at wholesale
rates, permit resale of some of their services, enable collocation of equipment,
provide local telephone number portability and dialing parity, provide access to
poles, ducts, conduits and rights-of-way, and complete calls originated by
competing carriers under termination arrangements.
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. We continue to advocate our
position for no regulation with various regulatory agencies. In some
of our states, we have been successful in reducing or eliminating price
regulation on end-user services under state commission
jurisdiction.
For
interstate services regulated by the FCC, we have elected to comply with price
caps for most of our operations. In May 2000, the FCC adopted a methodology
for regulating the interstate access rates of price cap providers through May
2005. The program, known as the Coalition for Affordable Local and Long Distance
Services, or CALLS plan, reduced prices for interstate-switched access services
and phased out many of the implicit subsidies in interstate access rates. The
CALLS program expired in 2005 but continues in effect until the FCC takes
further action.
Another
goal of the 1996 Act was to remove implicit subsidies from the rates charged by
local telecommunications companies. The CALLS plan addressed this requirement
for interstate services. Some state legislatures and regulatory agencies are
looking to reduce the implicit subsidies in intrastate rates. The most common
subsidies are in intrastate access rates that historically have been priced
above their costs to allow basic local rates to be priced below cost.
Legislation has been considered in several states to require regulators to
eliminate these subsidies and implement state universal service programs where
necessary to maintain reasonable basic local rates. However, not all the
reductions in access charges would be fully offset. We anticipate additional
state legislative and regulatory pressure to lower intrastate access
rates.
Recent and Potential
Regulatory Developments
Federal
legislators, the FCC and state regulators are currently considering a number of
proposals for changing the manner in which eligibility for federal subsidies is
determined as well as the amounts of such subsidies. In May 2008, the FCC issued
an order to cap Competitive Eligible Telecommunications Companies (CETC)
receipts from the high cost Federal Universal Service Fund. In 2009,
the federal court upheld the FCC’s order and the cap remains in place pending
any future reform.
6
The FCC
is considering proposals that may significantly change interstate, intrastate
and local intercarrier compensation and would revise the Federal Universal
Service funding and disbursement mechanisms to incent expanded broadband
availability. When and how these proposed changes will be addressed
are unknown and, accordingly, we are unable to predict the impact of future
changes on our results of operations. However, future reductions in
our subsidy and access revenues will directly affect our profitability and cash
flows as those regulatory revenues do not have associated variable
expenses. As discussed in MD&A, our access and subsidy revenues
declined in 2009 compared to 2008. Our access and subsidy revenues
are both likely to decline further in 2010.
Certain
states have opened proceedings to address reform to intrastate access charges
and other intercarrier compensation. We cannot predict when or how
these matters will be decided or the effect on our subsidy or access
revenues. 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.
Regulators
at both the federal and state levels continue to address whether voice over
internet protocol (VOIP) services are subject to the same or different
regulatory and financial models as traditional telephony. The FCC has
concluded that certain VOIP services are jurisdictionally interstate in nature
and are thereby exempt from state telecommunications regulations. The
FCC has not addressed other related issues, such as: whether or under what terms
VOIP originated traffic may be subject to intercarrier compensation; and whether
VOIP services are subject to general state requirements relating to
taxation and general commercial business requirements. The FCC
has stated its intent to address these open questions in subsequent orders in
its ongoing “IP-Enabled Services Proceeding.” Internet telephony may have an
advantage over our traditional services if it remains less
regulated.
In
January 2008, the FCC released public notices requesting comments on two
petitions that have been filed regarding net neutrality and the application of
the FCC’s Internet Policy Statement. In addition, in October 2009 the
FCC issued a proposed rulemaking looking at rules to “Preserve a Free and Open
Internet.” The timing and the impact of any decision by the FCC are
unknown.
Some
state regulators have in the past considered imposing on regulated companies
(including us) cash management practices that could limit the ability of a
company to transfer cash between its subsidiaries or to its parent
company. None of the existing state requirements (New York)
materially affect our cash management but future changes by state regulators
could affect our ability to freely transfer cash within our consolidated
companies.
In
February 2009, the President signed into law an economic stimulus package, the
American Recovery and Reinvestment Act (ARRA), that includes $7.2 billion in
funding, through grants and loans, for new broadband investment and adoption in
unserved and underserved communities. We filed applications for the first round
of stimulus funding in West Virginia, but were notified in February 2010 that we
were not selected. The federal agencies responsible for administering
the programs released rules and evaluation criteria for the second round of
funding, with applications due by March 15, 2010. The Company will
evaluate opportunities but has not made a decision on whether it will apply for
any funding in this round.
Under the
ARRA, the FCC is required to create a National Broadband Plan by February 17,
2010. This date has been extended to March 17, 2010. The
Commission has requested comments from the public on a variety of topics,
including but not limited to availability, adoption, public safety and the roles
of Universal Service and Intercarrier Compensation in the Plan. The
outcome of the Plan is likely to lead to a series of proposed rulemakings from
the Commission, and the timing and impact of the outcome on Frontier are
unknown.
Competition
Competition
in the communications industry is intense and increasing. We experience
competition from many communications service providers. These
providers include cable operators offering video, data and VOIP products,
wireless carriers, long distance providers, competitive local exchange carriers,
Internet providers and other wireline carriers. We believe that as of
December 31, 2009, approximately 73% of the households in our territories had
VOIP as an available service option. We also believe that competition
will continue in 2010 and may result in reduced revenues.
7
The
lingering impact of the severe contraction in the global financial markets that
occurred in 2008 and 2009 and the subsequent recession has impacted residential
and business customer behavior to reduce expenditures by not purchasing our
services, reducing usage of our services or by discontinuing some or all of our
services. These trends may continue and may result in a continued
challenging revenue environment. These factors could also result in
increased delinquencies and bankruptcies and, therefore, affect our ability to
collect money owed to us by residential and business customers.
We employ
a number of strategies to combat the competitive pressures and changes in
consumer behavior noted above. Our strategies are focused on
preserving and generating new revenue through customer retention, upgrading and
up-selling services to our existing customer base, new customer growth, win
backs of former customers, new product deployment, and upon managing our
profitability and cash flow through targeted reductions in operating expenses
and capital expenditures.
We seek
to achieve our customer retention goals by offering attractive packages of
value-added services to our access line customers and providing exemplary
customer service. Bundled services include HSI, unlimited long distance calling,
enhanced telephone features and video offerings. We tailor these
services to the needs of our residential and business customers and continually
evaluate the introduction of new and complementary products and services, many
of which can also be purchased separately. Customer retention is also
enhanced by offering one-, two- and three-year price protection plans where
customers commit to a term in exchange for predictable pricing and/or
promotional offers. Additionally, we are focused on enhancing the
customer experience as we believe exceptional customer service will continue to
differentiate us from our competition. Our commitment to providing
exemplary customer service is demonstrated by the expansion of our customer
services hours, shorter scheduling windows for in-home appointments and the
implementation of call reminders and follow up calls for service
appointments. In addition, our 70 local area markets are operated by
local managers with responsibility for the customer experience, as well as the
financial results, in those markets. Customers in our markets have
direct access to those local managers to help them manage their communications
needs.
We
utilize targeted and innovative promotions like “aspirational gifts” (e.g.,
personal computers) or promotional credits to attract new customers, including
those moving into our territory, to win back former customers and to upgrade and
up-sell existing customers a variety of service offerings, including HSI, video,
and enhanced long distance and feature packages in order to maximize the average
revenue per customer (wallet share) paid to Frontier. Depending upon market and
economic conditions, we may offer such promotions to drive sales in the
future.
We have
restructured and augmented our sales distribution channels to improve coverage
of all segments of our business customer base. This includes adding
new sales teams dedicated to small business customers and enhancing the business
selling and support skills in our customer sales and service centers. We have
also increased our focus on customer premise equipment (CPE) sales for customers
requiring an equipment solution, and have extended our CPE sales reach beyond a
handful of markets. In addition, we are introducing new products utilizing
wireless and Internet technologies. We believe the combination of new
products and distribution channel improvements will help us improve business
customer acquisition and retention.
We are
also focused on increasing sales of newer products, including unlimited long
distance minutes, bundles of long distance minutes, wireless data, internet
portal advertising, and the “Frontier Peace of Mind” product
suite. This last category is a suite of products that is aimed at
managing the total communications and personal computing experience for our
customers and designed to provide value and simplicity to meet our customers’
ever-changing needs. The Frontier Peace of Mind products and services
suite includes services such as an in-home, full installation of our HSI
product, two hour appointment windows for the installation, hard drive back-up
services, 24-7 help desk PC support and inside wire maintenance (when
bundled). In 2009, the Frontier Peace of Mind products generated
approximately $3.2 million in revenue. Most recently, we introduced
our myfitv.com website which provides easy online access to video content,
entertainment and news available on the worldwide web. Although we are
optimistic about the opportunities provided by each of these initiatives to
increase revenue and reduce churn, we can provide no assurance about their long
term profitability or impact on revenue. Our hard drive back-up
services, 24-7 help desk PC support and myfitv.com services are also available
outside of our service territories.
We
believe that the combination of offering multiple products and services to our
customers pursuant to price protection programs, billing customers in a single
bill, providing superior customer service, and being active in our local
communities will make our customers more loyal, and will help us generate
additional, and retain existing, customer revenue.
8
Additional
Information on Verizon Transaction
Pursuant
to the Verizon Transaction, Spinco will merge with and into Frontier, and
Frontier will survive as the combined company conducting the combined business
operations of Frontier and Spinco. Spinco will hold 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
Spinco territory), including Internet access and long distance services and
broadband video provided to designated customers in the Spinco territory
(collectively, the Spinco business). Immediately prior to the merger,
Spinco will be spun off to Verizon stockholders. The merger will
result in Frontier acquiring approximately 4.2 million access lines, based on
access lines of the Spinco business as of December 31, 2009, and certain related
business assets from Verizon. The Spinco business generated revenues
of approximately $4.4 billion for the year ended December 31, 2008,
the last full year of available revenue for Spinco, and $3.1 billion for the
nine months ended September 30, 2009. Following the merger, the
separate existence of Spinco will cease and the combined company will continue
to operate under the Frontier name. The forgoing transactions are collectively
referred to as the “Verizon Transaction.” The completion of the
Verizon Transaction is subject to a number of conditions.
Our
stockholders have approved proposals related to the Verizon Transaction at a
special meeting of stockholders on October 27, 2009. No vote by
Verizon stockholders is required in connection with the Verizon Transaction;
Verizon, as the sole stockholder of Spinco, has already approved the Verizon
Transaction. The completion of the Verizon Transaction is subject to
a number of conditions, including availability of financing on terms that
satisfy certain requirements, receipt of regulatory approvals and other
customary closing conditions. As of February 26, 2010, we have
received approval for the Verizon Transaction from state regulatory commissions
in Arizona, California, Nevada, Ohio and South Carolina. Commission
hearings have been completed in all of the four remaining states where we expect
regulatory approval to be required (Illinois, Oregon, Washington and West
Virginia) and we have reached settlement or an agreement with most of the
intervening parties in all of those remaining states. We have also
received, as of such date, all of the required video local franchise approvals
for the Verizon Transaction subject to the satisfaction of certain conditions.
Verizon has received a favorable ruling from the IRS regarding the tax
consequences of the Verizon Transaction which was a condition to the Merger
Agreement. As of February 26, 2010, none of the conditions imposed in
the approval orders or settlements (which have generally focused on local rate
stability; service quality metrics and reporting, capital investment (including
commitments to expand broadband availability), pre-funding certain broadband
expansion into restricted cash accounts at closing, and periodic reporting of
certain operational and financial information) are expected to have a material
impact on our plans to operate the Spinco properties.
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. We
hold no patents, licenses or concessions that are material.
Employees
As of
December 31, 2009, we had approximately 5,400
employees. Approximately 2,800 of our employees are affiliated with a
union. The number of union employees covered by agreements expiring
during 2010 is approximately 750. We consider our relations with our
employees to be good.
9
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). Such 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. Material filed
by us can also be inspected at the offices of the New York Stock Exchange, Inc.
(NYSE), 20 Broad Street, New York, NY 10005, on which our common stock is
listed.
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 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.
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” as set forth in the “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” section of this Form
10-K. 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 the Verizon
Transaction
References to "the Company" in this section refer to
Frontier as the combined company following the closing of the Verizon
Transaction, assuming the Verizon Transaction closes.
The Verizon Transaction may not be
consummated on the terms or timeline currently contemplated or at
all.
The
consummation of the Verizon Transaction is subject to certain conditions,
including (i) the availability of financing on terms that satisfy certain
requirements (including with respect to pricing and maturity) and the receipt of
the proceeds thereof that, taken together with any Spinco debt securities and
the aggregate amount of Spinco indebtedness at the distribution date, equal
$3.333 billion, (ii) the absence of a governmental order that would
constitute a materially adverse regulatory condition, (iii) the receipt of
applicable regulatory consents, (iv) the receipt of certain favorable tax
rulings from the Internal Revenue Service (which have been obtained) and certain
tax opinions, (v) the absence of a material adverse effect on Frontier or
on Spinco or the Spinco business and (vi) other customary closing
conditions. We can make no assurances that the Verizon Transaction will be
consummated on the terms or timeline currently contemplated, or at all. We have
and will continue to expend a significant amount of capital and management’s
time and resources on the Verizon Transaction, and a failure to consummate the
transaction as currently contemplated, or at all, could have a material adverse
effect on our business and results of operations. In addition, Spinco may (with
Frontier’s consent and participation) choose to raise all or a portion of the
financing required to complete the Verizon Transaction described above prior to
the closing of the Verizon Transaction. If Spinco does so, and if the
Verizon transaction is ultimately not consummated or is delayed for a
significant period of time, we could be obligated to pay significant interest
expense and other costs in connection with the financing without ever achieving
the expected benefits of the Verizon Transaction. The trading price
of our securities could be adversely affected if the Verizon Transaction is not
consummated as currently contemplated, or at all.
10
Frontier’s effort to
combine Frontier’s business and the Spinco business may not be
successful.
The
acquisition of the Spinco business is the largest and most significant
acquisition Frontier has undertaken. Our management will be required to devote a
significant amount of time and attention to the process of integrating the
operations of Frontier’s business and the Spinco business, which may decrease
the time it will have to serve existing customers, attract new customers and
develop new services or strategies. We expect that the Spinco business will
operate on an independent basis, separate from Verizon’s other businesses and
operations, immediately prior to the closing of the merger (other than with
respect to the portion operated in West Virginia, which is expected to be ready
for integration into Frontier’s existing business at the closing of the merger)
and will not require significant post-closing integration for Frontier to
continue the operations of the Spinco business immediately after the merger.
However, the size and complexity of the Spinco business and the process of using
Frontier’s existing common support functions and systems to manage the Spinco
business after the merger, if not managed successfully by management, may result
in interruptions of the business activities of the Company that could have a
material adverse effect on the Company’s business, financial condition and
results of operations. In addition, management will be required to devote a
significant amount of time and attention before completion of the merger to the
process of migrating the systems and processes supporting the operations of the
Spinco business in West Virginia from systems owned and operated by Verizon to
those owned and operated by Frontier. The size, complexity and timing of this
migration, if not managed successfully by management, may result in
interruptions of Frontier’s business activities.
The Company
may not realize the growth opportunities and cost synergies that are anticipated
from the merger.
The
success of the merger will depend, in part, on the ability of the Company to
realize anticipated growth opportunities and cost synergies. The Company’s
success in realizing these growth opportunities and cost synergies, and the
timing of this realization, depends on the successful integration of Frontier’s
business and operations and the Spinco business and operations. Even if the
Company is able to integrate the Frontier and Spinco businesses and operations
successfully, this integration may not result in the realization of the full
benefits of the growth opportunities and cost synergies that Frontier currently
expects from this integration within the anticipated time frame or at all. For
example, the Company may be unable to eliminate duplicative costs, or the
benefits from the merger may be offset by costs incurred or delays in
integrating the companies.
After
the close of the Verizon Transaction, sales of our common stock may negatively
affect its market price.
The
market price of Frontier common stock could decline as a result of sales of
Frontier common stock in the market after the completion of the Verizon
Transaction or the perception that these sales could occur.
Depending
on the trading prices of Frontier common stock prior to the closing of the
Verizon Transaction and before accounting for (1) the elimination of fractional
shares and (2) any additional shares that may be issued as a result of amounts
paid, payable or forgone by Verizon pursuant to orders or settlements that are
issued or entered into in order to obtain governmental approvals in the Spinco
territory that are required to complete the transaction (with the number of
additional shares that may be issued under clause (2) above being restricted by
certain regulatory and other covenants and conditions to the transaction as
agreed to by the parties), Verizon stockholders will collectively own between
approximately 66% and 71% of our outstanding equity immediately following the
closing of the transaction.
If
the assets contributed to Spinco by Verizon are insufficient to operate the
Spinco business, it could adversely affect the Company’s business, financial
condition and results of operations.
Pursuant
to the distribution agreement executed in connection with the Verizon
Transaction, Verizon will contribute to Spinco defined assets and liabilities of
its local exchange business and related landline activities in the Spinco
territory, including Internet access and long distance services and broadband
video provided to designated customers in the Spinco territory. The merger
agreement provides that all the contributions will be made so that the Spinco
business (other than the portion conducted in West Virginia) is segregated from
Verizon’s other businesses at least 60 days prior to the closing of the spin-off
and merger. However, the contributed assets may not be sufficient to operate all
aspects of the Spinco business and the Company may have to use assets or
resources from Frontier’s existing business or acquire additional assets in
order to operate the Spinco business, which could adversely affect the Company’s
business, financial condition and results of operations.
11
Pursuant to
the distribution agreement, Frontier has certain rights to cause Verizon to
transfer to it any assets required to be contributed to Spinco under that
agreement that were not contributed as required. If Verizon were unable or
unwilling to transfer those assets to the Company, or if Verizon and Frontier
were to disagree about whether those assets were required to be contributed to
Spinco under the distribution agreement, the Company might not be able to obtain
those assets or similar assets from others without significant costs or at
all.
The
Company’s business, financial condition and results of operations may be
adversely affected following the merger if it is not able to obtain consents to
assign certain Verizon contracts to Spinco.
Certain
wholesale, large business, Internet service provider and other customer
contracts that are required to be assigned to Spinco by Verizon require the
consent of the customer party to the contract to effect this assignment. Verizon
and Frontier may be unable to obtain these consents on terms favorable to the
Company or at all, which could have a material adverse impact on the Company’s
business, financial condition and results of operations following the
merger.
Regulatory agencies may delay approval
of the Verizon Transaction, fail to approve it, or approve it in a manner that
may diminish the anticipated benefits of the merger.
Completion
of the Verizon Transaction is conditioned upon the receipt of certain government
consents, approvals, orders and authorizations. While Frontier and Verizon have
obtained certain, and intend to pursue vigorously all other, required
governmental approvals and do not know of any reason why they would not be able
to obtain the necessary approvals in a timely manner, the requirement to receive
these approvals before completion of the Verizon Transaction could delay the
completion of the Verizon Transaction. Any delay in the completion of the
Verizon Transaction could diminish the anticipated benefits of the Verizon
Transaction or result in additional transaction costs, loss of revenues or other
effects associated with uncertainty about the transaction. Any uncertainty over
the ability of the companies to complete the Verizon Transaction could make it
more difficult for Frontier to maintain or to pursue particular business
strategies. In addition, until the Verizon Transaction is completed, the
attention of Frontier management may be diverted from ongoing business concerns
and regular business responsibilities to the extent management is focused on
obtaining regulatory approvals.
Further,
governmental agencies may decline to grant required approvals, or they may
impose conditions on their approval of the Verizon Transaction that could have
an adverse effect on the Company’s business, financial condition and results of
operations. Any amounts paid, payable or forgone by Verizon pursuant to orders
or settlements that are issued or entered into in order to obtain governmental
approvals in the Spinco territory that are required to complete the Verizon
Transaction will increase the aggregate number of shares of Frontier common
stock to be issued pursuant to the merger agreement, and any such increase could
be significant. If any governmental agency declines to grant any
required approval for the Verizon Transaction, then the Verizon Transaction may
not be consummated. In addition, conditions imposed by governmental
agencies in connection with their approval of the Verizon Transaction (such as
service quality or capital expenditure requirements) may restrict the Company’s
ability to modify the operations of its business in response to changing
circumstances for a period of time after the closing of the merger and/or its
ability to expend cash for other uses, including for payment of
dividends.
The
merger agreement contains provisions that may discourage other companies from
trying to acquire Frontier.
The
merger agreement contains provisions that may discourage a third party from
submitting a business combination proposal to Frontier prior to the closing of
the merger that might result in greater value to Frontier stockholders than the
merger. The merger agreement generally prohibits Frontier from soliciting any
acquisition proposal, and Frontier may not terminate the merger agreement in
order to accept an alternative business combination proposal that might result
in greater value to Frontier stockholders than the merger. If the
merger agreement is terminated by Frontier or Verizon in certain circumstances,
Frontier may be obligated to pay a termination fee of $80.0 million to Verizon,
which would represent an additional cost for a potential third party seeking a
business combination with Frontier.
12
Failure to complete the merger could
adversely affect the trading price of Frontier’s securities as well as
Frontier’s business, financial condition and results of operations.
If the
merger is not completed for any reason, the trading price of Frontier’s common
stock may decline to the extent that the market price of the common stock
reflects positive market assumptions that the merger will be completed and the
related benefits will be realized. Frontier may also be subject to additional
risks if the merger is not completed, including:
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the
requirement in the merger agreement that, under certain circumstances,
Frontier pay Verizon a termination fee of
$80.0 million;
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substantial
costs related to the merger, such as legal, accounting, filing, financial
advisory, financial printing fees, and integration costs that have already
been incurred or will continue up to closing. While the Company
continues to evaluate certain other expenses, we currently expect to incur
approximately $100.0 million of integration expenses and approximately
$75.0 million of capital expenditures in
2010;
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substantial
interest expense will be incurred if Spinco initiates the financing of the
approximately $3.0 billion prior to closing;
and
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potential
disruption to the business of Frontier and distraction of its workforce
and management team.
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If the
spin-off does not qualify as a tax-free spin-off under Section 355 of the
Internal Revenue Code (the Code), including as a result of subsequent
acquisitions of stock of Verizon or Frontier, then Verizon or Verizon
stockholders may be required to pay substantial U.S. federal income taxes, and
Frontier may be obligated to indemnify Verizon for such taxes imposed on
Verizon.
The
spin-off and merger are conditioned upon Verizon’s receipt of a private letter
ruling from the IRS to the effect that the spin-off and certain related
transactions will qualify as tax-free to Verizon, Spinco and the Verizon
stockholders for U.S. federal income tax purposes (the IRS ruling). A private
letter ruling from the IRS generally is binding on the IRS. The favorable IRS
private letter ruling has been received by Verizon. As expected, the
IRS ruling does not rule that the spin-off satisfies every requirement for a
tax-free spin-off, and the parties will rely solely on the opinion of counsel
described below for comfort that such additional requirements are
satisfied.
The IRS ruling is based on, among other
things, certain representations and assumptions as to factual matters made by
Verizon, Spinco and Frontier. The failure of any factual representation or
assumption to be true, correct and complete in all material respects could
adversely affect the validity of the IRS ruling. In addition, the IRS ruling is
based on current law, and cannot be relied upon if current law changes with
retroactive effect.
The
spin-off will be taxable to Verizon pursuant to Section 355(e) of the Code
if there is a 50% or more change in ownership of either Verizon or Spinco,
directly or indirectly, as part of a plan or series of related transactions that
include the spin-off. Because Verizon stockholders will collectively own more
than 50% of the Frontier common stock following the merger, the merger alone
will not cause the spin-off to be taxable to Verizon under Section 355(e).
However, Section 355(e) might apply if other acquisitions of stock of
Verizon before or after the merger, or of Frontier after the merger, are
considered to be part of a plan or series of related transactions that include
the spin-off. If Section 355(e) applied, Verizon might recognize a very
substantial amount of taxable gain.
Under a
tax sharing agreement, in certain circumstances, and subject to certain
limitations, Frontier is required to indemnify Verizon against taxes on the
spin-off that arise as a result of actions or failures to act by Frontier, or as
a result of changes in ownership of the stock of Frontier after the merger. In
some cases, however, Verizon might recognize gain on the spin-off without being
entitled to an indemnification payment under the tax sharing
agreement.
13
If the merger does not qualify as a
tax-free reorganization under Section 368 of the Code, Frontier may be
required to pay substantial U.S. federal income taxes.
Frontier
expects that the merger will qualify as a tax-free reorganization under Section
368(a) of the Code, and the obligation of Frontier to consummate the merger is
conditioned upon receiving an opinion of counsel to that effect. Such opinion
will be based upon, among other things, certain representations and assumptions
as to factual matters made by Verizon, Spinco and Frontier. The failure of any
factual representation or assumption to be true, correct and complete in all
material respects could adversely affect the validity of the opinion. An opinion
of counsel represents counsel’s best legal judgment, is not binding on the IRS
or the courts, and the IRS or the courts may not agree with the opinion. In
addition, the opinion will be based on current law, and cannot be relied upon if
current law changes with retroactive effect. If the merger were taxable, Spinco
stockholders would recognize taxable gain or loss on their receipt of Frontier
stock in the merger, and Spinco would be considered to have made a taxable sale
of its assets to Frontier.
Frontier will
be unable to take certain actions after the merger because such actions could
jeopardize the tax-free status of the spin-off or the merger, and such
restrictions could be significant.
Frontier
is prohibited pursuant to a tax sharing agreement from taking actions that could
reasonably be expected to cause the spin-off to be taxable or to jeopardize the
conclusions of the IRS ruling or opinions of counsel received by Verizon or
Frontier. In particular, for two years after the spin-off, Frontier may
not:
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enter
into any agreement, understanding or arrangement or engage in any
substantial negotiations with respect to any transaction involving the
acquisition, issuance, repurchase or change of ownership of Frontier
capital stock, or options or other rights in respect of Frontier capital
stock, subject to certain exceptions relating to employee compensation
arrangements, stock splits, open market stock repurchases and stockholder
rights plans;
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permit
certain wholly owned subsidiaries owned by Spinco at the time of the
spin-off to cease the active conduct of the Spinco business to the extent
it was conducted immediately prior to the spin-off;
or
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voluntarily
dissolve, liquidate, merge or consolidate with any other person, unless
Frontier survives and the transaction otherwise complies with the
restrictions in the tax sharing
agreement.
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The tax
sharing agreement further restricts Frontier from prepaying, or modifying the
terms of, the Spinco debt securities, if any.
Nevertheless,
Frontier is permitted to take any of the actions described above if it obtains
Verizon’s consent, or if it obtains a supplemental IRS private letter ruling (or
an opinion of counsel that is reasonably acceptable to Verizon) to the effect
that the action will not affect the tax-free status of the spin-off or the
merger. However, the receipt by Frontier of any such consent, opinion or ruling
does not relieve Frontier of any obligation it has to indemnify Verizon for an
action it takes that causes the spin-off to be taxable to
Verizon.
Because
of these restrictions, for two years after the merger, Frontier may be limited
in the amount of capital stock that it can issue to make acquisitions or to
raise additional capital. Also, Frontier’s indemnity obligation to Verizon may
discourage, delay or prevent a third party from acquiring control of Frontier
during this two-year period in a transaction that stockholders of Frontier might
consider favorable.
14
Investors holding shares of Frontier
common stock immediately prior to the merger will, in the aggregate, have a
significantly reduced ownership and voting interest after the
merger.
After the
merger’s completion, Frontier stockholders will, in the aggregate, own a
significantly smaller percentage of the Company than they will collectively own
of Frontier immediately prior to the merger. Depending on the trading
prices of Frontier common stock prior to the closing of the merger and before
accounting for the elimination of fractional shares and adjustments for any
amounts paid, payable or forgone by Verizon pursuant to orders or settlements
that are issued or entered into in order to obtain governmental approvals in the
Spinco territory that are required to complete the merger and the spin-off,
Frontier stockholders will collectively own between approximately 29% and 34% of
the Company’s outstanding equity immediately following the closing of the
merger. Consequently, Frontier stockholder votes, collectively, will
have significantly less influence over the policies of the Company than they
would be able to exercise over the policies of Frontier immediately prior to the
merger. Moreover, the number of shares of Frontier common stock to be
issued to Verizon stockholders pursuant to the merger agreement is subject to
increase by any amounts paid, payable or forgone by Verizon pursuant to orders
or settlements that are issued or entered into in order to obtain government
approvals in the Spinco territory that are required to complete the merger or
the spin-off, and any such increase may be significant. In addition,
Verizon intends to exercise its right to designate three of the twelve members
of the board of directors of the Company.
The pendency of the merger could
adversely affect the business and operations of Frontier and the Spinco
business.
In
connection with the pending merger, some customers of each of Frontier and the
Spinco business may delay or defer decisions or may end their relationships with
the relevant company, which could negatively affect the revenues, earnings and
cash flows of Frontier and the Spinco business, regardless of whether the merger
is completed. Similarly, current and prospective employees of Frontier and the
Spinco business may experience uncertainty about their future roles with the
Company following the merger, which may materially adversely affect the ability
of each of Frontier and the Spinco business to attract and retain key personnel
during the pendency of the merger.
Risks Related to Frontier
and the Company’s Business Following the Merger
The
risks discussed below in this section refer to the “Company” for ease of
reference. The risks apply to Frontier as a stand-alone entity before
the Verizon Transaction is completed, will continue to apply to Frontier if the
Verizon Transaction is not completed for any reason and will also apply to the
combined company assuming the Verizon Transaction closes.
The Company will likely face further
reductions in access lines, switched access minutes of use, long distance
revenues and federal and state subsidy revenues, which could adversely affect
it.
The
businesses that will make up the Company have experienced declining access
lines, 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 constraint. For example, Frontier’s access
lines declined 6% in 2009 and 7% in 2008. In addition, Frontier’s
switched access minutes of use declined 12% in 2009 and 9% in 2008 (after
excluding the switched access minutes added through acquisitons in
2007). The Spinco business’s access lines declined 11.6% in 2009 and
10% in 2008. In addition, the Spinco business’s switched access
minutes of use declined 10% in 2009 and 11% in 2008. These factors,
among others, are likely to cause the Company’s local network service, switched
network access, long distance and subsidy revenues to continue to decline, and
these factors may cause the Company’s cash generated by operations to
decrease.
15
The Company
will face intense competition, which could adversely affect
it.
The
communications industry is extremely competitive and competition is increasing.
The traditional dividing lines between local, long distance, wireless, cable and
Internet service providers are becoming increasingly blurred. Through mergers
and various service expansion strategies, service providers are striving to
provide integrated solutions both within and across geographic markets. The
Company’s competitors will include competitive local exchange carriers and other
providers of services, such as Internet service providers, wireless companies,
VOIP providers and cable companies that may provide services competitive with
the services that the Company will offer or will intend to introduce.
Competition will continue to be intense following the merger, and Frontier
cannot assure you that the Company will be able to compete effectively. Frontier
also believes that wireless and cable telephony providers have increased their
penetration of various services in Frontier’s and Spinco’s markets. Frontier
expects the Company to continue to lose access lines and that competition with
respect to all the products and services of the Company will
increase.
Frontier
expects competition to intensify as a result of the entrance of new competitors,
penetration of existing competitors into new markets, changing consumer behavior
and the development of new technologies, products and services that can be used
in substitution for the Company’s products and services. Frontier cannot predict
which of the many possible future technologies, products or services will be
important in order to maintain the Company’s competitive position or what
expenditures will be required to develop and provide these technologies,
products or services. The Company’s ability to compete successfully will depend
on the success and cost of capital expenditure investments in the Frontier and
Spinco territories as well as the cost of marketing efforts and on the Company’s
ability to anticipate and respond to various competitive factors affecting the
industry, including a changing regulatory environment that may affect the
Company and its competitors differently, new services that may be introduced
(including wireless broadband offerings), changes in consumer preferences,
demographic trends, economic conditions and pricing strategies by competitors.
Increasing competition may reduce the Company’s revenues and increase the
Company’s marketing and other costs as well as require the Company to increase
its capital expenditures and thereby decrease its cash flow.
Some of the Company’s future
competitors will have superior resources, which may place the Company at a cost
and price disadvantage.
Some of
the companies that will be competitors of the Company will have market presence,
engineering, technical and marketing capabilities and financial, personnel and
other resources substantially greater than those of the Company. In addition,
some of these future competitors will be able to raise capital at a lower cost
than the Company. 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 the Company. Additionally, the greater brand name recognition of
some future competitors may require the Company to price its 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.
The Company may be unable to grow
its revenues and cash flows despite the initiatives Frontier has implemented and
intends to continue after the merger.
The
Company must produce adequate revenues and cash flows that, when combined with
funds available under Frontier’s revolving credit facility, will be sufficient
to service the Company’s debt, fund its capital expenditures, pay its taxes,
fund its pension and other employee benefit obligations and pay dividends
pursuant to its dividend policy. Frontier has identified some potential areas of
opportunity and has implemented and will continue to implement several growth
initiatives, including increasing marketing promotions and related expenditures
and launching new products and services with a focus on areas that are growing
or demonstrate meaningful demand such as wireline and wireless HSI, satellite
video products and the “Frontier Peace of Mind” suite of products, including
computer technical support. Frontier cannot assure you that management will
choose the best initiatives to pursue, that their approaches to these
opportunities will be successful or that these initiatives will improve the
Company’s financial position or its results of operations.
16
Weak economic
conditions may decrease demand for the Company’s
services.
The
Company could be sensitive to the ongoing recession if current economic
conditions or their effects continue. Downturns in the economy and competition
in the Company’s markets could cause some of the Company’s customers to reduce
or eliminate their purchases of the Company’s basic and enhanced services, HSI
and video services and make it difficult for the Company to obtain new
customers. In addition, if current economic conditions continue, they could
cause the Company’s customers to delay or discontinue payment for its
services.
Disruption in the
Company’s networks, infrastructure and information technology may cause the
Company to lose customers and incur additional
expenses.
To
attract and retain customers, the Company will need to provide customers with
reliable service. Some of the risks to the Company’s networks, infrastructure
and information technology include physical damage, security breaches, capacity
limitations, power surges or outages, software defects and disruptions beyond
its control, such as natural disasters and acts of terrorism. From time to time
in the ordinary course of business, the Company could experience short
disruptions in its service due to factors such as cable damage, inclement
weather and service failures of the Company’s third-party service providers. The
Company could experience more significant disruptions in the future. The Company
could also face disruptions due to capacity limitations if changes in the
Company’s customers’ usage patterns for its HSI 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 the
Company to lose customers and incur additional expenses, and thereby adversely
affect its business, revenues and cash flows.
The Company’s business will be
sensitive to the creditworthiness of its wholesale
customers.
The
Company will have substantial business relationships with other
telecommunications carriers for whom it will provide service. While bankruptcies
of these carriers have not had a material adverse effect on Frontier or the
Spinco business in recent years, future bankruptcies in their industry could
result in the loss of significant customers by the Company, as well as more
price competition and uncollectible accounts receivable. Such bankruptcies may
be more likely in the future if current economic conditions continue through
2010 or beyond. As a result, the Company’s revenues and results of operations
could be materially and adversely affected.
A significant portion of the Company’s
workforce will be represented by labor unions and will therefore be subject to
collective bargaining agreements, and if the Company is unable to enter into new
agreements or renew existing agreements before they expire, the Company workers
subject to collective bargaining agreements could engage in strikes or other
labor actions that could materially disrupt the Company’s ability to provide
services to its customers.
As of
December 31, 2009, Frontier had approximately 5,400 active employees.
Approximately 2,800, or 52%, of these employees were represented by unions and
were therefore subject to collective bargaining agreements. Of the
union-represented employees, approximately 750, or 27%, are subject to
collective bargaining agreements that expire in 2010 and approximately 1,200, or
43%, are subject to collective bargaining agreements that expire in
2011.
As of
December 31, 2009, assuming the Verizon Transaction had taken place as of that
date, Spinco would have had approximately 9,500 active employees. Approximately
6,800, or 72%, of these employees were represented by unions and were therefore
subject to collective bargaining agreements. Of the union-represented employees,
approximately 3,300, or 49%, are subject to collective bargaining agreements
that expire in 2010.
Frontier
cannot predict the outcome of negotiations for the collective bargaining
agreements of the Company. If the Company is 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 the Company’s ability to provide services. New labor
agreements or the renewal of existing agreements may impose significant new
costs on the Company, which could adversely affect its financial condition and
results of operations in the future.
17
The Company may complete a
significant strategic transaction that may not achieve intended results or could
increase the number of its outstanding shares or amount of outstanding debt or
result in a change of control.
The
management of the Company will evaluate and may in the future enter into
additional strategic transactions. Any such transaction could happen at any time
following the closing of the merger, could be material to the Company’s business
and could take any number of forms, including, for example, an acquisition,
merger or a sale of all or substantially all of the Company’s
assets.
Evaluating
potential transactions and integrating completed ones may divert the attention
of the Company’s management from ordinary operating matters. The success of
these potential transactions will depend, in part, on the Company’s ability to
realize the anticipated growth opportunities and cost synergies through the
successful integration of the businesses the Company acquires with its existing
business. Even if the Company is successful in integrating the acquired
businesses, Frontier 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 the
Company completes an acquisition, investment or other strategic transaction, the
Company may require additional financing that could result in an increase in the
number of its outstanding shares or the aggregate amount of its debt, although
there are restrictions on the ability of the Company to issue additional shares
of stock for these purposes for two years after the merger. See Risks Relating
to the Verizon Transaction—“Frontier will be unable to take certain actions
after the merger because such actions could jeopardize the tax-free status of
the spin-off or the merger, and such restrictions could be significant.” The
number of shares of the Company’s common stock or the aggregate principal amount
of its debt that it may issue may be significant. A strategic transaction may
result in a change in control of the Company or otherwise materially and
adversely affect its business.
A
significant portion of the Company’s work force is retirement
eligible.
As of December 31, 2009, approximately
1,200, or 22%, of Frontier's approximately 5,400 active employees are retirement
eligible. It is expected that a significant number of the Spinco
employees are or will be retirement eligible at or prior to the time of closing
of the Verizon Transaction. If these employees were to retire and
could not be promptly replaced, customer service could be negatively impacted,
which could have a material impact on the Company’s operations and financial
results.
If
the Company is unable to hire or retain key personnel, it may be unable to
successfully operate its business.
The
Company’s success will depend in part upon the continued services of its
management. The Company cannot guarantee that these key personnel and
others will not leave or compete with it. The loss, incapacity or
unavailability for any reason of key members of the management team could have a
material impact on the Company’s business. In addition, the Company’s
financial results and its ability to compete will suffer should it become unable
to attract, integrate or retain other qualified personnel in the
future.
18
Risks Related to Liquidity,
Financial Resources and Capitalization
The
risks discussed below in this section refer to the “Company” for ease of
reference. The risks apply to Frontier as a stand-alone entity before the
Verizon Transaction is completed and will continue to apply to Frontier if the
Verizon Transaction is not completed for any reason and will also apply to the
combined company assuming the Verizon Transaction closes.
If the lingering
impact of the severe contraction in the global financial markets and current
economic conditions continue through 2010, this economic scenario may have an
impact on the Company’s business and financial
condition.
The
diminished availability of credit and liquidity due to the lingering impact of
the severe contraction in the global financial markets and current economic
conditions may continue through 2010. This economic scenario may
affect the financial health of the Company’s customers, vendors and partners,
which in turn may negatively affect the Company’s revenues, operating expenses
and cash flows. In addition, although Frontier believes, based on currently
available information, that the financial institutions that have outstanding
commitments under Frontier’s revolving credit facility will be able to fulfill
their commitments to the Company, if the current economic environment and the
recent severe contraction in the global financial markets continue through 2010
or beyond, this could change in the future. It is Frontier’s
intention to replace its existing $250.0 million revolving credit facility with
a significantly larger facility by the closing date of the Verizon
Transaction.
Volatility
in asset values related to Frontier’s pension plan and our assumption of
Spinco’s pension plan obligations may require us to make cash contributions to
fund pension plan liabilities.
As a result of the ongoing payment of
benefits and negative investment returns arising from a contraction in the
global financial markets, Frontier’s pension plan assets have declined from
$822.2 million at December 31, 2007, to $608.6 million at December 31,
2009, a decrease of $213.6 million, or 26%. This decrease consisted of a decline
in asset value of $72.8 million, or 9%, and benefits paid of $140.8 million, or
17%. As a result of the continued accrual of pension benefits under the
applicable pension plan and the cumulative negative investment returns arising
from the contraction of the global financial markets since 2007, Frontier’s
pension expenses increased in 2009. While the pension asset values have
increased in 2009, Frontier expects to make a cash contribution to its pension
plan of $10.0 million in 2010. Once the merger is consummated, the Company will
maintain Frontier’s pension plan and will be responsible for contributions to
fund the plan’s liabilities, and may be required to continue making these cash
contributions in respect of liabilities under Frontier’s pension plan. The
Company will also, upon consummation of the merger, maintain pension plans that
assume the Spinco business’s pension plan liabilities for active employees. The
applicable Verizon tax-qualified pension plans will transfer assets to the
Spinco pension plans pursuant to applicable law and the terms of the employee
matters agreement entered into among Verizon, Spinco and
Frontier. The aggregate transfer related to the tax-qualified
pension plans for active union employees will be sufficient for full funding of
projected benefit obligations in the aggregate. Following the merger,
the Company will be responsible for making any required contributions to the new
pension plans to fund liabilities of the plans, and the ongoing pension expenses
of the Spinco business may require the Company to make cash contributions in
respect of the Spinco business’s pension plan liabilities.
19
Substantial
debt and debt service obligations may adversely affect us.
We have a
significant amount of indebtedness, which amounted to approximately
$4.8 billion at December 31, 2009. We 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, which
would increase our total debt. If the Verizon Transaction is
completed, the Company will have additional indebtedness in the amount of
approximately $3.4 billion at the closing of the Verizon Transaction. Despite
the substantial additional indebtedness that the Company would then have, the
Company would not be prohibited from incurring even more
indebtedness. If the Verizon Transaction is completed and the Company
was to incur additional indebtedness, the risks that result from our substantial
indebtedness could be magnified.
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, particularly
in light of the current credit
environment;
|
|
•
|
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 could 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 us, and competitors who may be
in a more favorable position to access additional capital
resources.
|
The Company will
require substantial capital to upgrade and enhance its
operations.
Verizon’s
historical capital expenditures in connection with the Spinco business,
excluding FiOS, have been significantly lower than Frontier’s level of capital
expenditures. Replacing or upgrading the Company’s infrastructure will require
significant capital expenditures, including any expected or unexpected
expenditures necessary to make replacements or upgrades to the existing
infrastructure of the Spinco business. If this capital is not available when
needed, the Company’s business will be adversely affected. Responding to
increases in competition, offering new services, and improving the capabilities
of, or reducing the maintenance costs associated with, the Company’s plant may
cause the Company’s capital expenditures to increase in the future. In addition,
the Company’s anticipated annual dividend will utilize a significant
portion of the Company’s cash generated by operations and therefore could limit
the Company’s ability to increase capital expenditures significantly. While
Frontier believes that the Company’s anticipated cash flows will be adequate to
maintain this dividend policy while allowing for appropriate capital spending
and other purposes, any material reduction in cash generated by operations and
any increases in planned capital expenditures, interest expense or cash taxes
would reduce the amount of cash available for further capital expenditures and
payment of dividends. Accelerated losses of access lines, the effects of
increased competition, lower subsidy and access revenues and the other factors
described above may reduce the Company’s cash generated by operations and may
require the Company to increase capital expenditures.
20
Risks Related to
Regulation
The
risks discussed below in this section refer to the “Company” for ease of
reference. The risks apply to Frontier as a stand-alone entity before
the Verizon Transaction is completed and will continue to apply to Frontier if
the Verizon Transaction is not completed for any reason and will also apply to
the combined company assuming the Verizon Transaction closes.
Changes in federal or state
regulations may reduce the access charge revenues the Company will
receive.
A
significant portion of Frontier’s revenues (approximately $246.3 million, or
12%, in 2009) are derived from access charges paid by other carriers for
services Frontier provides in originating and terminating intrastate and
interstate long distance traffic. As a result, Frontier expects a significant
portion (approximately 7%) of the Company’s revenues to continue to be derived
from access charges paid by these carriers for services that the Company will
provide in originating and terminating this traffic. The amount of access charge
revenues that Frontier and the Spinco business receive (and, after the closing,
the Company will receive) for these services is regulated by the FCC and state
regulatory agencies.
The FCC
is considering proposals that may significantly change interstate, intrastate
and local intercarrier compensation. When and how these proposed changes will be
addressed are unknown and, accordingly, Frontier cannot predict the impact of
future changes on the Company’s results of operations. However, future
reductions in the Company’s access revenues will directly affect the Company’s
profitability and cash flows as those regulatory revenues do not have associated
variable expenses.
Certain
states also have open proceedings to address reform to access charges and other
intercarrier compensation. Frontier cannot predict when or how these matters
will be decided or the effect on the Company’s subsidy or access revenues. In
addition, Frontier has been approached by, and is currently involved in formal
state proceedings with, various carriers seeking reductions in intrastate access
rates in certain states. Certain of those claims have led to formal complaints
to the applicable state regulatory agencies. A material reduction in the access
revenues the Company will receive would adversely affect its financial
results.
The Company
will be reliant on support funds provided under federal and state
laws.
A portion
of Frontier’s revenues (approximately $113.3 million in the aggregate, or 5%, in
2009) are derived from federal and state subsidies for rural and high cost
support, commonly referred to as universal service fund subsidies, including the
Federal High Cost Loop Fund, federal interstate access support, federal
interstate common line support, federal local switching support fund, various
state funds and surcharges billed to customers. The FCC and state regulatory
agencies 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. The FCC issued an order on May 1, 2008 to
cap the amounts that CETCs may receive from the high cost Federal Universal
Service Fund (USF). In 2009, a Federal court upheld the FCC’s
order and the cap remains in place pending any future reform. In
November 2008, the FCC issued a Further Notice of Proposed Rulemaking seeking
comment on several different alternatives, some of which could significantly
reduce the amount of federal high cost universal service support that the
Company would receive. Frontier cannot predict if or when the FCC will take
additional actions or the effect of any such actions on the Company’s subsidy
revenues.
Federal
subsidies representing interstate access support, rural high cost loop support
and local switching support represented approximately $69.1 million, or 3%, of
Frontier’s revenues in 2009. Frontier currently expects that as a
result of both an increase in the national average cost per loop and a decrease
in Frontier’s and the Spinco business’s cost structure, there will be a decrease
in the subsidy revenues Frontier and the Spinco business will earn in 2010
through the Federal High Cost Loop Fund. The amount of federal interstate access
support funds received may also decline as that fund is also subject to a
national cap and the amounts allocated among carriers within that cap can vary
from year to year. State subsidies represented approximately $8.7 million, or
less than 1%, of Frontier’s revenues in 2009. Approximately $35.5 million, or
2%, of Frontier’s 2009 revenues, represents a surcharge 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.” Frontier expects that approximately 5% of the
Company’s revenue will continue to be derived from federal and state subsidies,
and from surcharges to customers.
21
The Company and its
industry will likely remain highly regulated, and the Company will likely incur
substantial compliance costs that could constrain its ability to compete in its
target markets.
As an
incumbent local exchange carrier, the Company will be subject to significant
regulation from federal, state and local authorities. This regulation will
restrict the Company’s ability to change its rates, especially on its basic
services and its access rates, and will impose substantial compliance costs on
the Company. Regulation will constrain the Company’s ability to compete and, in
some jurisdictions, it may restrict how the Company is able to expand its
service offerings. In addition, changes to the regulations that govern the
Company may have an adverse effect upon its business by reducing the allowable
fees that it may charge, imposing additional compliance costs or otherwise
changing the nature of its operations and the competition in its
industry.
Pending
FCC rulemakings and state regulatory proceedings, including those relating to
intercarrier compensation and universal service, could have a substantial
adverse impact on the Company’s operations.
Risks Related to
Technology
The risks discussed below in
this section refer to the “Company” for ease of reference. The risks
apply to Frontier as a stand-alone entity before the Verizon Transaction is
completed and will continue to apply to Frontier if the Verizon Transaction is
not completed for any reason and will also apply to the combined company
assuming the Verizon Transaction closes.
In the future, as competition
intensifies within the Company’s markets, the Company may be unable to meet the
technological needs or expectations of its customers, and may lose customers as
a result.
The
communications industry is subject to significant changes in technology. If the
Company does not replace or upgrade technology and equipment, it may be unable
to compete effectively because it will not be able to meet the needs or
expectations of its customers. Replacing or upgrading the combined
infrastructure could result in significant capital expenditures.
In
addition, rapidly changing technology in the communications industry may
influence the Company’s customers to consider other service providers. For
example, the Company may be unable to retain customers who decide to replace
their wireline telephone service with wireless telephone service. In addition,
VoIP technology, which operates on broadband technology, now provides the
Company’s competitors with a competitive alternative to provide voice services
to the Company’s customers, and wireless broadband technologies may permit the
Company’s competitors to offer broadband data services to the Company’s
customers throughout most or all of its service areas.
22
Item
1B. Unresolved Staff
Comments
None.
Item
2. Properties
Our
principal corporate offices are located in leased premises at 3 High Ridge Park,
Stamford, Connecticut 06905.
Operations
support offices are currently located in leased premises at 180 South Clinton
Avenue, Rochester, New York 14646 and at 100 CTE Drive, Dallas, Pennsylvania
18612. Call center support offices are currently located in leased premises at
14450 Burnhaven Drive, Burnsville, Minnesota 55306 and 1398 South Woodland
Blvd., DeLand, Florida 32720. In addition, we lease and own space in
our operating markets throughout the United States.
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.
Item
3. Legal
Proceedings
We are
party to various legal proceedings arising in the normal course of our
business. The outcome of individual matters is not
predictable. However, we believe that the ultimate resolution of all
such matters, after considering insurance coverage, will not have a material
adverse effect on our financial position, results of operations, or our cash
flows.
Item
4. Submission of Matters to a
Vote of Security Holders
(a) The
registrant held a Special Meeting of Stockholders on October 27, 2009 (the
“Meeting”).
(b) Matters
submitted to stockholders at the Meeting:
(1) Adoption
of the Agreement and Plan of Merger, dated as of May 13, 2009, as amended by
Amendment No. 1 thereto, dated as of July 24, 2009, by and among Verizon
Communications Inc., New Communications Holdings Inc. and the Company (the
“Merger Agreement”). The matter passed with the following
vote:
Number
of votes FOR
|
182,102,556
|
Number
of votes AGAINST
|
5,295,793
|
Number
of votes ABSTAINING
|
1,227,112
|
(2) Amendment
to the Company’s Restated Certificate of Incorporation, as amended, to increase
the number of authorized shares of the Company’s common stock from 600,000,000
to 1,750,000,000. The matter passed with the following
vote:
Number
of votes FOR
|
177,956,211
|
Number
of votes AGAINST
|
9,245,127
|
Number
of votes ABSTAINING
|
1,424,123
|
(3) Approval
of the issuance of the Company’s common stock pursuant to the Merger
Agreement. The matter passed with the following vote:
Number
of votes FOR
|
181,328,959
|
Number
of votes AGAINST
|
6,012,151
|
Number
of votes ABSTAINING
|
1,284,351
|
23
Executive
Officers of the Registrant
Our
Executive Officers as of February 1, 2010 were:
Name
|
Age
|
Current Position and
Officer
|
Mary
Agnes Wilderotter
|
55
|
Chairman
of the Board, President and Chief Executive Officer
|
Donald
R. Shassian
|
54
|
Executive
Vice President and Chief Financial Officer
|
Hilary
E. Glassman
|
47
|
Senior
Vice President, General Counsel and Secretary
|
Peter
B. Hayes
|
52
|
Executive
Vice President, Commercial Sales
|
Robert
J. Larson
|
50
|
Senior
Vice President and Chief Accounting Officer
|
Daniel
J. McCarthy
|
45
|
Executive
Vice President and Chief Operating Officer
|
Cecilia
K. McKenney
|
47
|
Executive
Vice President, Human Resources and Call Center Sales &
Services
|
Melinda
White
|
50
|
Executive
Vice President and General Manager, Marketing and New Business
Operations
|
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.
MARY
AGNES WILDEROTTER has been with Frontier since November 2004. She was
elected President and Chief Executive Officer in November 2004 and Chairman of
the Board in December 2005. Prior to joining Frontier, she was Senior
Vice President - Worldwide Public Sector of Microsoft Corp. from February 2004
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.
DONALD R.
SHASSIAN has been with Frontier since April 2006. He is currently
Executive Vice President and Chief Financial Officer. 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.
HILARY E.
GLASSMAN has been with Frontier since July 2005 as Senior Vice President,
General Counsel and Secretary. Prior to joining Frontier, from
February 2003, she was associated with Sandler O'Neill & Partners, L.P., an
investment bank with a specialized financial institutions practice,
first as Managing Director, Associate General Counsel and then as Managing
Director, Deputy General Counsel. From February 2000 through February
2003, Ms. Glassman was Vice President and General Counsel of Newview
Technologies, Inc. (formerly e-Steel Corporation), a privately-held software
company.
PETER B.
HAYES has been with Frontier since February 2005. He is currently
Executive Vice President, Commercial Sales. Previously, Mr. Hayes was
Executive Vice President, Sales, Marketing and Business Development from
December 2005 to August 2009 and prior to that, Senior Vice President, Sales,
Marketing and Business Development from February 2005 to December
2005. Prior to joining Frontier, he was associated with Microsoft
Corp. and served as Vice President, Public Sector, Europe, Middle East, Africa
from 2003 to 2005 and Vice President and General Manager, Microsoft U.S.
Government from 1997 to 2003.
24
ROBERT J.
LARSON has been with Frontier since July 2000. He was elected Senior
Vice President and Chief Accounting Officer of Frontier in December
2002. Previously, he was Vice President and Chief Accounting Officer
from July 2000 to December 2002. Prior to joining Frontier, he was
Vice President and Controller of Century Communications Corp.
DANIEL J.
McCARTHY has been with Frontier since December 1990. He is currently
Executive Vice President and Chief Operating Officer. Previously, he
was Senior Vice President, Field Operations from December 2004 to December
2005. 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 Call Center Sales &
Service. Previously, she was 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.
MELINDA
WHITE has been with Frontier since January 2005. She is currently
Executive Vice President and General Manager, Marketing and New Business
Operations. Previously, she was Senior Vice President and General
Manager, Marketing and New Business Operations from July 2009 to November
2009. Prior to that, 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. From 2002 to
2005, Ms. White pursued a career in music.
25
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 traded on the New York Stock Exchange under the symbol
FTR. The following table indicates the high and low intra-day sales
prices, as reported by the New York Stock Exchange, per share during the periods
indicated.
2009
|
2008
|
|||||||||||||||
High
|
Low
|
High
|
Low
|
|||||||||||||
First
Quarter
|
$ | 8.87 | $ | 5.32 | $ | 12.84 | $ | 9.75 | ||||||||
Second
Quarter
|
$ | 8.16 | $ | 6.62 | $ | 11.96 | $ | 10.01 | ||||||||
Third
Quarter
|
$ | 7.60 | $ | 6.43 | $ | 12.94 | $ | 11.14 | ||||||||
Fourth
Quarter
|
$ | 8.57 | $ | 7.12 | $ | 11.80 | $ | 6.35 |
As of
February 16, 2010, the approximate number of security holders of record of our
common stock was 23,341. 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. Since the third quarter
of 2004, we have paid a regular annual cash dividend of $1.00 per share of
common stock to be paid quarterly. On May 13, 2009, we announced that concurrent
with the closing of the Verizon Transaction we intend to reduce our annual cash
dividend from $1.00 per share to $0.75 per share, to be paid quarterly, subject
to applicable law and within the discretion of our Board of
Directors. Cash dividends paid to shareholders were approximately
$312.4 million, $318.4 million and $336.0 million in 2009, 2008 and 2007,
respectively. There are no material restrictions on our ability to
pay dividends, except for the period leading up to the merger, during which time
pursuant to the merger agreement we may not pay dividends other than quarterly
dividends in an amount not to exceed $0.25 per share. The table below sets forth
dividends paid per share during the periods indicated.
2009
|
2008
|
2007
|
||||||||||
First
Quarter
|
$ | 0.25 | $ | 0.25 | $ | 0.25 | ||||||
Second
Quarter
|
$ | 0.25 | $ | 0.25 | $ | 0.25 | ||||||
Third
Quarter
|
$ | 0.25 | $ | 0.25 | $ | 0.25 | ||||||
Fourth
Quarter
|
$ | 0.25 | $ | 0.25 | $ | 0.25 |
26
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 Telecommunications
Services Index for the five-year period commencing December 31,
2004.
The graph assumes that $100 was invested on December 31, 2004 in each of our common stock, the S&P 500 Stock Index and the S&P Telecommunications Services Index and that all dividends were reinvested.
Base
|
INDEXED
RETURNS
Years
Ending
|
|||||||||||||||||||||||
Period
|
||||||||||||||||||||||||
Company
/ Index
|
12/04 | 12/05 | 12/06 | 12/07 | 12/08 | 12/09 | ||||||||||||||||||
Frontier
Communications Corporation
|
100 | 95.70 | 120.90 | 114.82 | 86.70 | 88.47 | ||||||||||||||||||
S&P
500 Index
|
100 | 104.91 | 121.48 | 128.16 | 80.74 | 102.11 | ||||||||||||||||||
S&P
Telecommunications Services
|
100 | 94.37 | 129.10 | 144.52 | 100.45 | 109.42 | ||||||||||||||||||
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 quarter ended December 31, 2009.
27
ISSUER
PURCHASES OF EQUITY SECURITIES
|
||||||||
Period
|
Total
Number of Shares Purchased
|
Average
Price Paid per Share
|
||||||
October
1, 2009 to October 31, 2009
|
||||||||
Employee
Transactions (1)
|
- | $ | - | |||||
November
1, 2009 to November 30, 2009
|
||||||||
Employee
Transactions (1)
|
12,756 | $ | 7.22 | |||||
December
1, 2009 to December 31, 2009
|
||||||||
Employee
Transactions (1)
|
230 | $ | 7.65 | |||||
Totals
October 1, 2009 to December 31, 2009
|
||||||||
Employee
Transactions (1)
|
12,986 | $ | 7.22 | |||||
|
|
(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.
|
28
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, 2009 has been derived from
Frontier’s historical consolidated financial statements. The selected
historical consolidated financial information as of December 31, 2009 and 2008
and for the three years ended December 31, 2009 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, 2007, 2006 and 2005 and for the years ended
December 31, 2006 and 2005 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,
|
||||||||
2009
|
2008
|
2007
|
2006
|
2005
|
|||||
Revenue (1)
|
$ 2,117,894
|
$ 2,237,018
|
$ 2,288,015
|
(4)
|
$ 2,025,367
|
$ 2,017,041
|
|||
Income from
continuing operations (2)
|
$ 123,181
|
$ 184,274
|
$ 216,514
|
(5)
|
$ 258,321
|
(6)
|
$ 189,923
|
||
Net
income attributable to common shareholders of Frontier
|
$ 120,783
|
$ 182,660
|
$ 214,654
|
$ 344,555
|
$ 202,375
|
||||
Basic
income per share of common stock
|
|||||||||
from
continuing operations (3)
|
$ 0.38
|
$ 0.57
|
$ 0.64
|
(4)(5)
|
$ 0.78
|
(6)
|
$ 0.55
|
||
Earnings
attributable to common shareholders of Frontier
|
|||||||||
per basic
share (3)
|
$ 0.38
|
$ 0.57
|
$ 0.64
|
(4)(5)
|
$ 1.06
|
(6)
|
$ 0.60
|
||
Earnings
attributable to common shareholders of Frontier
|
|||||||||
per
diluted share (3)
|
$ 0.38
|
$ 0.57
|
$ 0.64
|
(4)(5)
|
$ 1.06
|
(6)
|
$ 0.59
|
||
Cash
dividends declared (and paid) per common share
|
$ 1.00
|
$ 1.00
|
$ 1.00
|
$ 1.00
|
$ 1.00
|
||||
As
of December 31,
|
|||||||||
2009
|
2008
|
2007
|
2006
|
2005
|
|||||
Total
assets
|
$ 6,878,255
|
$ 6,888,676
|
$ 7,256,069
|
$ 6,797,536
|
$ 6,427,567
|
||||
Long-term
debt
|
$ 4,794,129
|
$ 4,721,685
|
$ 4,736,897
|
$ 4,467,086
|
$ 3,995,130
|
||||
Total
shareholders' equity of Frontier
|
$ 327,611
|
$ 519,045
|
$ 997,899
|
$ 1,058,032
|
$ 1,041,809
|
||||
(1)
|
Operating
results include activities for Commonwealth Telephone Enterprises, Inc.
(Commonwealth or CTE) from the date of its acquisition on March 8, 2007
and for Global Valley Networks, Inc. and GVN Services (together GVN) from
the date of their acquisition on October 31, 2007.
|
(2)
|
Operating
results exclude activities for Electric Lightwave, LLC (ELI) for 2006 and
2005. In 2006, we sold our CLEC business, ELI for $255.3
million (including the sale of associated real estate) in cash plus the
assumption of approximately $4.0 million in capital lease
obligations. We recognized a pre-tax gain on the sale of ELI of
approximately $116.7 million. Our pre-tax gain on the sale was
$71.6 million.
|
(3)
|
Operating
results include the pre-tax impacts of losses on retirement of debt or
exchanges of debt of $45.9 million ($28.9 million after tax or $0.09 per
share), $6.3 million ($4.0 million after tax or $0.01 per share), $18.2
million ($11.5 million after tax or $0.03 per share), $2.4 million ($1.5
million after tax or $0.01 per share) and $3.2 million ($2.0 million after
tax or $0.01 per share) for 2009, 2008, 2007, 2006 and 2005,
respectively.
|
(4)
|
Revenue
for 2007 includes the favorable one-time impact of $38.7 million ($24.4
million after tax or $0.07 per share) for a significant favorable
settlement of a carrier dispute.
|
(5)
|
Operating
results for 2007 reflect the positive pre-tax impact of a pension
curtailment gain of $14.4 million ($9.1 million after tax or $0.03 per
share), resulting from the freeze placed on certain pension benefits of
the former CTE non-union employees.
|
(6)
|
Operating
results for 2006 reflect the favorable pre-tax impact of a $61.4 million
($38.7 million after tax or $0.12 per share) gain recognized on the
liquidation and dissolution of Rural Telephone
Bank.
|
29
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 adversely affected by, any of the following
possibilities:
|
·
|
Our
ability to complete the Verizon
Transaction;
|
|
·
|
The
failure to obtain, delays in obtaining or adverse conditions contained in
any required regulatory approvals for the Verizon
Transaction;
|
|
·
|
For
two years after the merger, Frontier may be limited in the amount of
capital stock that it can issue to make acquisitions or to raise
additional capital. Also, Frontier’s indemnity obligation to Verizon may
discourage, delay or prevent a third party from acquiring control of
Frontier during this two-year period in a transaction that stockholders of
Frontier might consider favorable;
|
|
·
|
The
ability to successfully integrate the Verizon operations into our existing
operations;
|
|
·
|
The
effects of increased expenses incurred due to activities related to the
Verizon Transaction;
|
|
·
|
The
ability to migrate Verizon’s West Virginia operations from Verizon owned
and operated systems and processes to our owned and operated systems and
processes successfully;
|
|
·
|
The
risk that the growth opportunities and cost synergies from the Verizon
Transaction may not be fully realized or may take longer to realize than
expected;
|
|
·
|
The
sufficiency of the assets contributed by Verizon to enable the combined
company to operate the acquired
business;
|
|
·
|
Disruption
from the Verizon Transaction making it more difficult to maintain
relationships with customers, employees or
suppliers;
|
|
·
|
The
effects of greater than anticipated competition requiring new pricing,
marketing strategies or new product or service offerings and the risk that
we or, if the Verizon Transaction is completed, the combined company will
not respond on a timely or profitable
basis;
|
|
·
|
Reductions
in the number of our access lines or, if the Verizon Transaction is
completed, the combined company’s access lines that cannot be offset by
increases in HSI subscribers and sales of other
products;
|
|
·
|
Our
ability to sell enhanced and data services in order to offset ongoing
declines in revenues from local services, switched access services and
subsidies;
|
|
·
|
The
effects of ongoing changes in the regulation of the communications
industry as a result of federal and state legislation and
regulation;
|
|
·
|
The
effects of competition from cable, wireless and other wireline carriers
(through VOIP or otherwise);
|
30
|
·
|
Our
ability to adjust successfully to changes in the communications industry
and to implement strategies for
growth;
|
|
·
|
Adverse
changes in the credit markets or in the ratings given to our debt
securities or, if the Verizon Transaction is completed, the combined
company’s debt securities, by nationally accredited ratings organizations,
which could limit or restrict the availability, or increase the cost, of
financing;
|
|
·
|
Continued
reductions in switched access revenues as a result of regulation,
competition or technology
substitutions;
|
|
·
|
The
effects of changes in both general and local economic conditions on the
markets that we serve or that, if the Verizon Transaction is completed,
the combined company will serve, which can affect demand for our or its
products and services, customer purchasing decisions, collectability of
revenues and required levels of capital expenditures related to new
construction of residences and
businesses;
|
|
·
|
Our
ability to effectively manage service quality in our existing territories,
and if the Verizon Transaction is completed, in our new
territories;
|
|
·
|
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 our
customers;
|
|
·
|
Changes
in accounting policies or practices adopted voluntarily or as required by
generally accepted accounting principles or
regulations;
|
|
·
|
Our
ability to effectively manage our or, if the Verizon Transaction is
completed, the combined company’s operations, operating expenses and
capital expenditures, and to repay, reduce or refinance our or the
combined company’s debt;
|
|
·
|
The
effects of bankruptcies and home foreclosures, which could result in
difficulty in collection of revenues and loss of
customers;
|
|
·
|
The
effects of technological changes and competition on our capital
expenditures and product and service offerings or, if the Verizon
Transaction is completed, the capital expenditures and product and service
offerings of the combined company, including the lack of assurance that
the ongoing network improvements will be sufficient to meet or exceed the
capabilities and quality of competing
networks;
|
|
·
|
The
effects of increased medical, retiree and pension expenses and related
funding requirements;
|
|
·
|
Changes
in income tax rates, tax laws, regulations or rulings, and/or federal or
state tax assessments;
|
|
·
|
The
effects of state regulatory cash management policies on our ability or, if
the Verizon transaction is completed, the combined company’s ability to
transfer cash among our or the combined company’s subsidiaries and to the
parent company;
|
|
·
|
Our
ability to successfully renegotiate union contracts expiring in 2010 and
thereafter;
|
|
·
|
Declines
in the value of our pension plan assets or, if the Verizon Transaction is
completed, the combined company’s pension plan assets, which could require
us or the combined company to make contributions to the pension plan in
2011 and beyond;
|
|
·
|
Our
ability to pay dividends in respect of our common shares or, if the
Verizon Transaction is completed, the combined company’s common shares,
which may be affected by our or the combined company’s cash flow from
operations, amount of capital expenditures, debt service requirements,
cash paid for income taxes and our or the combined company’s
liquidity;
|
31
|
·
|
The
effects of any unfavorable outcome with respect to any current or future
legal, governmental or regulatory proceedings, audits or disputes with
respect to us or, if the Verizon Transaction is completed, the combined
company;
|
|
·
|
The
possible impact of adverse changes in political or other external factors
over which we or, if the Verizon Transaction is completed, the combined
company, would have no control; and
|
|
·
|
The
effects of hurricanes, ice storms or other natural
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” above, 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.
Overview
We are a
full–service communications provider and one of the largest exchange telephone
carriers in the country. As of December 31, 2009, we operated in 24
states with approximately 5,400 employees.
On May
13, 2009, we entered into a definitive agreement with Verizon under which
Frontier will acquire defined assets and liabilities of the local exchange
business and related landline activities of Verizon in the Spinco territory,
including Internet access and long distance services and broadband video
provided to designated customers in the Spinco territory. Assuming
that the merger occurred on December 31, 2009, the merger would have resulted in
Frontier acquiring approximately 4.2 million access lines and certain business
related assets from Verizon. The Verizon Transaction will be financed with
approximately $5.3 billion of common stock plus the assumption of approximately
$3.33 billion in debt. Certain of the conditions to the closing of
the Verizon Transaction have already been met: (1) Frontier’s shareholders
approved the Verizon Transaction at a special meeting of shareholders held on
October 27, 2009; (2) the Federal Trade Commission has granted early termination
of the waiting period under the Hart-Scott-Rodino Act; (3) approvals of all
necessary local video franchise authorities (subject to the satisfaction of
certain conditions); (4) receipt by Verizon of a favorable ruling from the IRS
regarding the tax consequences of the Verizon Transaction; and (5) five of the
nine required state regulatory approvals. Completion of the Verizon
Transaction remains subject to a number of other conditions, including the
receipt of the remaining four state regulatory approvals, approval from the FCC,
the completion of financing on terms that satisfy certain conditions as well as
other customary closing conditions. Subject to satisfaction of these
conditions, we anticipate closing this transaction during the second quarter of
2010.
During
2007, we completed the acquisitions of Commonwealth Telephone Enterprises, Inc.
(Commonwealth or CTE), and Global Valley Networks, Inc. and GVN
Services (together GVN) which expanded our presence in Pennsylvania and
California, and strengthened our position as a leading full-service
communications provider to rural markets.
Our
revenues declined in 2009. Revenues from data and internet services
such as HSI grew and increased as a percentage of our total revenues and
revenues from local access lines and access charges (including federal and state
subsidies) declined and decreased as a percentage of our total
revenues.
Regulatory
revenue includes switched access and subsidy revenue and represents 17% of our
revenues in 2009. Switched access revenue was $246.3 million in 2009,
or 12% of our revenues, down from $284.9 million in 2008, or 13% of our
revenues. Federal and state subsidy revenue, including surcharges
billed to customers that are remitted to the FCC, was $113.3 million in 2009, or
5% of our revenues, down from $119.8 million in 2008, or 5% of our
revenues. We expect these revenue trends in switched access and
subsidy revenue to continue in 2010.
Competition
in the communications industry is intense and increasing. We experience
competition from many communications service providers. These
providers include cable operators offering video, data, and VOIP products,
wireless carriers, long distance providers, competitive local exchange carriers,
Internet providers and other wireline carriers. We believe that as of
December 31, 2009, approximately 73% of the households in our territories had
VOIP as an available service option. We also believe that competition
will continue in 2010 and may result in reduced revenues.
32
The
lingering impact of the severe contraction in the global financial markets that
occurred in 2008 and 2009 and the subsequent recession has impacted residential
and business customer behavior to reduce expenditures by not purchasing our
services or by discontinuing some or all of our services. These
trends may continue and may result in a continued challenging revenue
environment. These factors could also result in increased
delinquencies and bankruptcies and, therefore, affect our ability to collect
money owed to us by residential and business customers.
We employ
a number of strategies to combat the competitive pressures and changes in
consumer behavior noted above. Our strategies are focused on
preserving and generating new revenues through customer retention, upgrading and
up-selling services to our existing customer base, new customer growth, win
backs of former customers, new product deployment, and upon managing our
profitability and cash flow through targeted reductions in operating expenses
and capital expenditures.
We seek
to achieve our customer retention goals by offering attractive packages of
value-added services to our access line customers and providing exemplary
customer service. Bundled services include HSI, unlimited long
distance calling, enhanced telephone features and video offerings. We
tailor these services to the needs of our residential and business customers and
continually evaluate the introduction of new and complementary products and
services, many of which can also be purchased separately. Customer
retention is also enhanced by offering one-, two-and three-year price protection
plans where customers commit to a term in exchange for predictable pricing
and/or promotional offers. Additionally, we are focused on enhancing
the customer experience as we believe exceptional customer service will
differentiate us from our competition. Our commitment to providing exemplary
customer service is demonstrated by our expanded customer service hours, shorter
scheduling windows for in-home appointments and the previously implemented call
reminders and follow-up calls for service appointments. In addition,
our 70 local area markets are operated by local managers with responsibility for
the customer experience, as well as the financial results, in those
markets. Customers in our markets have direct access to those local
managers to help them manage their communications needs.
We
utilize targeted and innovative promotions like “aspirational gifts” (e.g.,
personal computers) or promotional credits to attract new customers, including
those moving into our territory, to win back former customers and to upgrade and
up-sell existing customers a variety of service offerings including HSI, video,
and enhanced long distance and feature packages in order to maximize the average
revenue per customer (wallet share) paid to us. Depending upon market
and economic conditions, we may offer such promotions to drive sales in the
future.
We have
restructured and augmented our sales distribution channels to improve coverage
of all segments of the business customer base. This includes adding
new sales teams dedicated to small business customers and enhancing the business
selling and support skills in our customer sales and service
centers. We have also increased our focus on customer premise
equipment (CPE) sales for customers requiring an equipment solution, and have
extended our CPE sales reach beyond a handful of markets. In addition, we are
introducing new products utilizing wireless and Internet
technologies. We believe the combination of new products and
distribution channel improvements will help us improve business customer
acquisition and retention.
We are
also focused on increasing sales of newer products, including unlimited long
distance minutes, bundles of long distance minutes, wireless data, Internet
portal advertising, and the Frontier Peace of Mind product
suite. This last category is a suite of products that is aimed at
managing the total communications and personal computing experience for our
customers and designed to provide value and simplicity to meet our
customers’ ever-changing needs. The Frontier Peace of Mind products and services
suite includes services such as an in-home, full installation of our HSI
product, two hour appointment windows for the installation, hard drive back-up
services, 24-7 help desk PC support and inside wire maintenance (when
bundled). In 2009, the Frontier Peace of Mind products generated
approximately $3.2 million in revenue. Most recently, we introduced
our myfitv.com website which provides easy online access to video content,
entertainment and news available on the worldwide web. Our hard drive
back-up services, 24-7 help desk PC support and myfitv.com services are also
available outside of our service territories. Although we are
optimistic about the opportunities provided by each of these initiatives to
increase revenue and reduce churn, we can provide no assurance about their
long-term profitability or impact on revenue.
We
believe that the combination of offering multiple products and services to our
customers pursuant to price protection programs, billing them on a single bill,
providing superior customer service, and being active in our local communities
will make our customers more loyal, and will help us generate new, and retain
existing, customer revenue.
33
(a)
Liquidity and Capital Resources
As of December 31, 2009, we had cash and cash equivalents aggregating $358.7 million. Our primary source of funds continued to be cash generated from operations. For the year ended December 31, 2009, we used cash flow from operations, new borrowings and cash on hand to fund all of our investing and financing activities, including debt repayments.
We
believe our operating cash flows, existing cash balances, and 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 in accordance with our dividend policy, pay our acquisition and
integration costs and capital expenditures, and support our short-term and
long-term operating strategies through 2010. However, a number of
factors, including but not limited to, losses of access lines, pricing pressure
from increased competition, lower subsidy and access revenues and the impact of
the current economic environment are expected to reduce our cash generated by
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, given the
current economic environment and the recent severe contraction in the global
financial markets, this could change in the future. Further, the
current credit market turmoil and our below-investment grade credit ratings may
also make it more difficult and expensive to refinance our maturing
debt. As of December 31, 2009, we have approximately $7.2 million and
$280.0 million of debt maturing in 2010 and 2011, respectively.
The
consummation of the Verizon Transaction would result in a combined company with
significantly larger business operations and, consequently, greater working
capital, capital expenditure and other liquidity needs. Upon
consummation of the Verizon Transaction, we will be assuming approximately $3.4
billion of Spinco debt. As a result of the greater liquidity
requirements of the combined company, it is anticipated that we will seek to
expand our revolving credit facility in order to ensure that the combined
company has sufficient flexibility to meet its liquidity needs. In
addition, the Company may need or elect to raise capital in order to finance or
pre-fund commitments which may be made to governmental agencies in connection
with their approval of the Verizon Transaction, including commitments with
regard to capital expenditures.
In
addition, if Spinco (with Frontier’s consent and participation) chooses to raise
all or a portion of the financing required to complete the Verizon Transaction
prior to the closing of the Verizon Transaction, and the Verizon Transaction is
ultimately not consummated or is delayed for a significant period of time, we
could be obligated to pay significant interest expense and other costs in
connection with the financing without ever achieving the expected benefits of
the Verizon Transaction, which may impact our liquidity.
Assuming
the Verizon Transaction closes, based on the lower level of Spinco debt we will
be assuming from Spinco relative to Spinco’s projected operating cash flows, the
combined company’s overall debt will increase but its capacity to service the
debt will be significantly enhanced as compared to Frontier’s capacity
today. At December 31, 2009, the ratio of Frontier’s net debt to 2009
operating cash flow (“leverage ratio”) was 3.9 times. It is expected
that the combined company’s leverage ratio will be significantly lower at
closing.
Cash Flow provided by
Operating Activities
Cash flow
provided by operating activities improved $3.5 million for 2009 as compared to
2008.
Cash flow
provided by operating activities declined $82.4 million, or 10%, for 2008 as
compared to 2007. The decline resulted from a drop in operating
income, as adjusted for non-cash items, lower investment income, a decrease in
accounts payable and an increase in current income tax
expenditures. These declines were partially offset by a decrease in
accounts receivable that positively impacted our cash position as compared to
the prior year. We paid $78.9 million in cash taxes during
2008.
34
Cash paid
for taxes was $59.7 million, $78.9 million and $54.4 million in 2009, 2008 and
2007, respectively. Our 2009 cash taxes were lower than 2008
and reflect the benefits from accelerated tax depreciation arising from the 2009
American Recovery and Reinvestment Act (ARRA), utilization of AMT credits and
higher interest expense arising from our debt offerings not fully offset by debt
repurchases. We expect that in 2010 our cash taxes will be less than $10.0
million. We expect that our 2010 cash taxes will be reduced by the
receipt of tax refunds arising from the retroactive application of a change in
tax accounting for repairs and maintenance costs. In addition, our
2010 cash taxes will be impacted by approximately $60.0 million of tax benefits
arising from our integration activities and secondarily, our 2009 debt
refinancing activities. Absent the tax benefits generated by these integration
and refinancing activities, we estimate that cash taxes would be approximately
$60.0 million to $70.0 million in 2010.
In
connection with the pending Verizon Transaction, the Company commenced
activities during 2009 to obtain the necessary regulatory approvals, plan and
implement systems conversions and begin other initiatives necessary to
effectuate the closing, which is expected to occur during the second quarter of
2010, and enable the combined company to implement its “go to market” strategy
at closing. As a result, the Company incurred $28.3 million of
acquisition and integration costs and $25.0 million in capital expenditures
related to Verizon integration activities in 2009. While the Company
continues to evaluate certain other expenses, we currently expect to incur
operating expenses and capital expenditures of approximately $100.0 million and
$75.0 million, respectively, in 2010 related to these integration
activities.
Cash Flow used by Investing
Activities
Acquisitions
On March
8, 2007, we acquired Commonwealth in a cash-and-stock taxable transaction, for a
total consideration of approximately $1.1 billion. We paid $804.1
million in cash ($663.7 million net, after cash acquired) and issued our common
stock with a value of approximately $249.8 million.
In
connection with the acquisition of Commonwealth, we assumed $35.0 million of
debt under a revolving credit facility and $191.8 million face amount of
Commonwealth convertible notes (fair value of $209.6 million). During
March 2007, we paid down in full the $35.0 million credit
facility. We retired all of the Commonwealth notes as of December 31,
2008.
On
October 31, 2007, we acquired GVN for a total cash consideration of $62.0
million.
Capital
Expenditures
In 2009,
2008 and 2007, our capital expenditures were $256.0 million (including $25.0
million of Verizon integration-related capital expenditures), $288.3 million and
$315.8 million, 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 of approximately $220.0 million to $240.0 million for 2010 related
to our currently owned properties, and an additional $75.0 million of capital
expenditures related to the integration activities of the pending Verizon
Transaction.
Cash Flow used by and
provided from Financing Activities
Issuance of Debt
Securities
On
October 1, 2009, we completed a registered debt offering of $600.0 million
aggregate principal amount of 8.125% senior unsecured notes due
2018. The issue price was 98.441% of the principal amount of the
notes, and we received net proceeds of approximately $578.7 million from the
offering after deducting underwriting discounts and offering
expenses. We used the net proceeds from the offering, together with
cash on hand (including cash proceeds from our April 2009 debt offering
described below), to finance a cash tender offer for our outstanding 9.250%
Senior Notes due 2011 (the 2011 Notes) and our outstanding 6.250% Senior Notes
due 2013 (the 2013 Notes), as described below.
On April
9, 2009, we completed a registered offering of $600.0 million aggregate
principal amount of 8.25% senior unsecured notes due 2014. The issue price was
91.805% of the principal amount of the notes. We received net proceeds of
approximately $538.8 million from the offering after deducting underwriting
discounts and offering expenses. We used the net proceeds from the
offering to repurchase outstanding debt, as described below.
35
On March
28, 2008, we borrowed $135.0 million under a senior unsecured term loan facility
that was established on March 10, 2008. The loan matures in 2013 and
bears interest based on the prime rate or London Interbank Offered Rate (LIBOR),
at our election, plus a margin which varies depending on our debt leverage
ratio. We used the proceeds to repurchase, during the first quarter
of 2008, $128.7 million principal amount of the 2011 Notes and to pay for the
$6.3 million of premium on early retirement of those notes.
On March
23, 2007, we issued in a private placement an aggregate $300.0 million principal
amount of 6.625% Senior Notes due 2015 and $450.0 million principal amount of
7.125% Senior Notes due 2019. Proceeds from the sale were used to pay
down in full $200.0 million principal amount of indebtedness borrowed on March
8, 2007 under a bridge loan facility in connection with the acquisition of
Commonwealth, and to redeem, on April 26, 2007, $495.2 million principal amount
of our 7.625% Senior Notes due 2008. In the second quarter of 2007,
we completed an exchange offer (to publicly register the debt) for the $750.0
million in total of private placement notes described above, in addition to the
$400.0 million principal amount of 7.875% Senior Notes due 2027 issued in a
private placement on December 22, 2006, for registered notes.
Debt
Reduction
In 2009,
we retired an aggregate principal amount of $1,048.3 million of debt, consisting
of $1,047.3 million of senior unsecured debt, as described in more detail below,
and $1.0 million of rural utilities service loan contracts.
During
the fourth quarter of 2009, the Company purchased and retired, in accordance
with the terms of the tender offer referred to above, approximately $564.4
million aggregate principal amount of the 2011 Notes and approximately $83.4
million aggregate principal amount of the 2013 Notes. The aggregate
consideration for these debt repurchases was $701.6 million, which was financed
with the proceeds of the October 2009 debt offering and a portion of the
proceeds of the April 2009 debt offering, each as described above. The
repurchases in the tender offer resulted in a loss on the early retirement of
debt of approximately $53.7 million, which we recognized in the fourth quarter
of 2009.
In
addition to the debt tender offer, we used $388.9 million of the April 2009 debt
offering proceeds to repurchase in 2009 $396.7 million principal amount of debt,
consisting of $280.8 million of the 2011 Notes, $54.1 million of our 7.875%
Senior Notes due January 15, 2027, $35.9 million of the 2013 Notes, $16.0
million of our 7.125% Senior Notes due March 15, 2019 and $9.9 million of our
6.80% Debentures due August 15, 2026. An additional $7.8 million net
gain was recognized and included in Other income (loss), net in our consolidated
statements of operations for the year ended December 31, 2009 as a result of
these other debt repurchases.
As a
result of these 2009 debt transactions described above, as of December 31, 2009,
we had reduced our debt maturities through 2013 to approximately $7.2 million
maturing in 2010, $280.0 million maturing in 2011, $180.4 million maturing in
2012 and $709.9 million maturing in 2013. We do not expect the
Verizon Transaction to change the amount of these near-term debt
maturities.
In 2008,
we retired an aggregate principal amount of $144.7 million of debt, consisting
of $128.7 million principal amount of the 2011 Notes, $12.0 million of other
senior unsecured debt and rural utilities service loan contracts, and $4.0
million of 5% Company Obligated Mandatorily Redeemable Convertible Preferred
Securities (EPPICS).
In 2007,
we retired an aggregate principal amount of $967.2 million of debt, including
$3.3 million of EPPICS, and $17.8 million of 3.25% Commonwealth convertible
notes that were converted into our common stock. On April 26, 2007, we redeemed
$495.2 million principal amount of our 7.625% Senior Notes due 2008 at a price
of 103.041% plus accrued and unpaid interest. During the first
quarter of 2007, we borrowed and repaid $200.0 million utilized to temporarily
fund the acquisition of Commonwealth, and we paid down in full the $35.0 million
Commonwealth credit facility. Through December 31, 2007, we retired
$183.3 million face amount of Commonwealth convertible notes for which we paid
$165.4 million in cash and $36.7 million in common stock. We also paid down
$44.6 million of industrial development revenue bonds and $4.3 million of rural
utilities service loan contracts.
We may
from time to time repurchase 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.
36
EPPICS
As of
December 31, 2008 and 2009, there was no EPPICS related debt outstanding to
third parties. The following disclosure provides the history
regarding this issuance.
In 1996,
our consolidated wholly owned subsidiary, Citizens Utilities Trust (the Trust),
issued, in an underwritten public offering, 4,025,000 shares of 5% Company
Obligated Mandatorily Redeemable Convertible Preferred Securities due 2036
(Trust Convertible Preferred Securities or EPPICS), representing preferred
undivided interests in the assets of the Trust, with a liquidation preference of
$50 per security (for a total liquidation amount of $201.3
million). These securities had an adjusted conversion price of $11.46
per share of our common stock. The conversion price was reduced from
$13.30 to $11.46 during the third quarter of 2004 as a result of the $2.00 per
share of common stock special, non-recurring dividend. The proceeds
from the issuance of the Trust Convertible Preferred Securities and a Company
capital contribution were used to purchase $207.5 million aggregate liquidation
amount of 5% Partnership Convertible Preferred Securities due 2036 from another
wholly owned consolidated subsidiary, Citizens Utilities Capital L.P. (the
Partnership). The proceeds from the issuance of the Partnership Convertible
Preferred Securities and a Company capital contribution were used to purchase
from us $211.8 million aggregate principal amount of 5% Convertible Subordinated
Debentures due 2036. The sole assets of the Trust were the
Partnership Convertible Preferred Securities, and our Convertible Subordinated
Debentures were substantially all the assets of the Partnership. Our
obligations under the agreements relating to the issuances of such securities,
taken together, constituted a full and unconditional guarantee by us of the
Trust’s obligations relating to the Trust Convertible Preferred Securities and
the Partnership’s obligations relating to the Partnership Convertible Preferred
Securities.
In
accordance with the terms of the issuances, we paid the annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in 2008 and
2007. Cash was paid (net of investment returns) to the Partnership in
payment of the interest on the Convertible Subordinated
Debentures. The cash was then distributed by the Partnership to the
Trust and then by the Trust to the holders of the EPPICS.
As of
December 31, 2008, EPPICS representing the total aggregate liquidation
preference of $197.8 million have been converted into 15,969,645 shares of our
common stock. There were no outstanding EPPICS as of December 31,
2008 and 2009. As a result of the redemption of all outstanding
EPPICS as of December 31, 2008, the $10.5 million in debt with related parties
was reclassified by the Company against an offsetting investment.
Interest Rate
Management
On
January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
2011 Notes and 2013 Notes. Cash proceeds from the swap terminations of
approximately $15.5 million were received in January 2008. The
related gain has been deferred on the consolidated balance sheet, and is being
amortized into interest expense over the term of the associated
debt. We recognized $7.6 million and $5.0 million of deferred gain
during 2009 and 2008, respectively, and anticipate recognizing an additional
$1.0 million of deferred gain during 2010. For 2007, the interest expense
resulting from these interest rate swaps totaled approximately $2.4
million. At December 31, 2009 and 2008, we did not have any
derivative instruments.
Credit
Facility
As of
December 31, 2009, we had an available line of credit under our revolving credit
facility with seven financial institutions in the aggregate amount of $250.0
million and there were no outstanding standby letters of credit issued under the
facility. Associated facility fees vary, depending on our debt leverage ratio,
and were 0.225% per annum as of December 31, 2009. The expiration
date for this $250.0 million five year revolving credit agreement is May 18,
2012. During the term of the credit facility we may borrow, repay and
reborrow funds subject to customary borrowing conditions. The credit
facility is available for general corporate purposes but may not be used to fund
dividend payments.
37
Covenants
The terms
and conditions contained in our indentures and credit facility agreements
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 liens on our assets, and restrictions on asset sales
and transfers, mergers and other changes in corporate control. We
currently have no restrictions on the payment of dividends either by contract,
rule or regulation, other than those imposed by the General Corporation Law of
the State of Delaware. However, we would be restricted under our
credit facilities from declaring dividends if an event of default has occurred
and is continuing at the time or will result from the dividend
declaration.
Our
$200.0 million term loan facility with the Rural Telephone Finance Cooperative
(RTFC), which matures in 2011, our $250.0 million credit facility, and our
$150.0 million and $135.0 million senior unsecured term loans, 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 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.
Our
credit facilities 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, 2009, we were in compliance with all of our debt and credit
facility covenants.
Proceeds from the Sale of
Equity Securities
We
receive proceeds from the issuance of our common stock upon the exercise of
options pursuant to our stock-based compensation plans. For the years
ended December 31, 2009, 2008 and 2007, we received approximately $0.8 million,
$1.4 million and $13.8 million, respectively, upon the exercise of outstanding
stock options.
Share Repurchase
Programs
There
were no shares repurchased during 2009 under a share repurchase
program.
During
2008, we repurchased 17,778,300 shares of our common stock at an aggregate cost
of $200.0 million. During 2007, we repurchased 17,279,600 shares of
our common stock at an aggregate cost of $250.0 million.
Dividends
We intend
to pay regular quarterly dividends. Our ability to fund a regular
quarterly dividend will 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 deems
relevant. We have announced that after the closing of the Verizon
Transaction we intend to reduce our annual cash dividend from $1.00 per share to
$0.75 per share, subject to applicable law and within the discretion of our
Board of Directors, as discussed above. Until consummation of the
Verizon Transaction or termination of the merger agreement, we are also
restricted from increasing the amount of our dividends by the terms of our
merger agreement with Verizon.
Off-Balance Sheet
Arrangements
We do not
maintain any off-balance sheet arrangements, transactions, obligations or other
relationships with unconsolidated entities that would be expected to have a
material current or future effect upon our financial statements.
38
Future
Commitments
A summary
of our future contractual obligations and commercial commitments as of December
31, 2009 is as follows:
Contractual
Obligations:
($
in thousands)
|
Payment
due by period
|
|||||||||||||||||||
Total
|
2010
|
2011-2012 | 2013-2014 |
Thereafter
|
||||||||||||||||
Long-term
debt obligations,
|
||||||||||||||||||||
excluding
interest
|
$ | 4,884,151 | $ | 7,236 | $ | 460,322 | $ | 1,310,372 | $ | 3,106,221 | ||||||||||
Interest
on long-term debt
|
4,593,546 | 362,308 | 703,055 | 592,803 | 2,935,380 | |||||||||||||||
Operating
lease obligations
|
64,288 | 24,417 | 20,034 | 12,903 | 6,934 | |||||||||||||||
Purchase
obligations
|
30,269 | 11,026 | 10,828 | 8,250 | 165 | |||||||||||||||
Liability
for uncertain tax positions
|
56,860 | 3,454 | 45,538 | 7,587 | 281 | |||||||||||||||
Total
|
$ | 9,629,114 | $ | 408,441 | $ | 1,239,777 | $ | 1,931,915 | $ | 6,048,981 | ||||||||||
At
December 31, 2009, we have outstanding performance letters of credit totaling
$27.7 million.
Divestitures
On August
24, 1999, our Board of Directors approved a plan to divest our public utilities
services businesses, which included gas, electric and water and wastewater
businesses. We have sold all of these properties. In 2006,
we disposed of ELI, our former CLEC business. All of the agreements
relating to the sales provide that we will indemnify the buyer against certain
liabilities (typically liabilities relating to events that occurred prior to
sale), including environmental liabilities, for claims made by specified dates
and that exceed threshold amounts specified in each agreement (see Note
21).
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 allowance for doubtful accounts, impairment of
long-lived assets, 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.
Allowance
for Doubtful Accounts
We
maintain an allowance for estimated bad debts based on our estimate of
collectability of our accounts receivable through a review of aging categories
and specific customer accounts. In 2009 and 2008, we had no “critical
estimates” related to telecommunications bankruptcies.
Asset
Impairment
In 2009
and 2008, we had no “critical estimates” related to asset
impairments.
39
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
reorganized our management and operating structure during the first quarter of
2009 to include our Rochester market with our existing New York State properties
and the rest of the East Region. This structure is consistent with how our Chief
Operating Decision Makers (CEO, CFO, COO) review our results on a daily, weekly
and monthly basis. As a result of the change, our operating segments (reporting
units) decreased from 4 (at December 31, 2008) to 3 (effective as of March 31,
2009). 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. Further, we determined that no impairment was indicated at
December 31, 2008 and March 31, 2009 for either the East or Rochester reporting
units and combining them did not alter the conclusion at either
date. No potential impairment was indicated and no further analysis
was deemed necessary.
All of
our ILEC properties share similar economic characteristics and as a result, we
aggregate our three operating segments into one reportable
segment. In determining fair value of goodwill during 2009 we
compared the net book value of the reporting units to current trading multiples
of ILEC properties as well as trading values of our publicly traded common
stock. Additionally, we utilized a range of prices to gauge
sensitivity. Our test determined that fair value exceeded book value
of goodwill for each of our reporting units as of December 31,
2009.
Goodwill
by reporting unit (operating segment) at December 31, 2009 is as
follows:
Reporting
Units
|
||||||||||||
($ in thousands)
|
East
|
West
|
Central
|
|||||||||
Goodwill
|
$ | 1,201,387 | $ | 34,736 | $ | 1,406,200 |
We did
not have any changes to our operating segments, reporting units, or changes in
the allocation of goodwill by reporting unit during the years ended December 31,
2007 and 2008. During the first quarter of 2007 we acquired
Commonwealth and included their operations and any related goodwill in our
Central region.
40
Each of
the above noted reporting units is an operating segment. 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 by a wide margin. As a result, the
second step of the goodwill impairment test was not required.
We
estimate fair value in two ways: (1) market or transaction based and (2) equity
based utilizing our share price. Market values for rural ILEC
properties are typically quoted as a multiple of cash flow or
EBITDA. Marketplace transactions and analyst reports support a range
of values around a multiple of 6 to 6.5 times annualized EBITDA. For
the purpose of the goodwill impairment test we define EBITDA as operating income
plus depreciation and amortization. We determined the fair value
estimates using 6 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. Additionally, a
second test was performed using our public market equity value or market
capitalization. Market capitalization (current market stock price
times total shares outstanding) is a public market indicator of equity value and
is useful in corroborating the 6 times EBITDA valuation because we are
singularly engaged in rural ILEC operating activities. Our stock
price on December 31, 2009 was $7.81 and when compared to the fair value using
the EBITDA multiple obtained above, exceeded such value before consideration of
any applicable control premium. We also used lower per share stock
prices to gauge the sensitivity of the estimate and its effect on the margin of
excess fair value over the carrying value. Total market
capitalization 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, 2009.
Depreciation
and Amortization
The
calculation of depreciation and amortization expense is based on the estimated
economic useful lives of the underlying property, plant and equipment and
identifiable intangible assets. An independent study updating the
estimated remaining useful lives of our property, plant and equipment assets is
performed annually. We adopted the lives proposed in the study
effective October 1, 2009. Our “composite depreciation rate”
decreased from 5.6% to 5.2% as a result of the study. We anticipate
depreciation expense of approximately $335.0 million to $355.0 million for 2010
related to our currently owned properties. We periodically reassess
the useful life of our intangible assets to determine whether any changes to
those lives are required.
Pension
and Other Postretirement Benefits
Our
estimates of pension expense, other postretirement benefits including retiree
medical benefits and related liabilities are “critical accounting
estimates.” We sponsor a noncontributory defined benefit pension plan
covering a significant number of our current and former 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. The pension plans for the majority of our current
employees are frozen. All of the employees who are still accruing
pension benefits are represented employees. 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 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. In making this
determination we consider, among other things, the yields on the Citigroup
Pension Discount Curve, the Citigroup Above-Median Pension Curve, the general
movement of interest rates and the changes in those rates from one period to the
next. This rate can change from year-to-year based on market
conditions that affect corporate bond yields. Our discount rate was
5.75% at year-end 2009, and 6.50% at year-end 2008.
41
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 2009, we changed our expected long-term rate of
return on plan assets to 8.0% from the 8.25% used in 2008. For 2010,
we will assume a rate of return of 8.00%. 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 2010 will be
$45.0 million to $55.0 million (they were $48.6 million in 2009), and that we
will make a $10.0 million cash contribution to our pension plan in
2010. No contributions were made to our pension plan during 2007,
2008 or 2009.
Income
Taxes
Our
effective tax rates in 2007, 2008 and 2009 were approximately at the statutory
rates.
Contingencies
At
December 31, 2006, we had a reserve of $8.0 million in connection with a
potential environmental claim in Bangor, Maine. This claim was settled with a
payment of $7.625 million plus additional expenses during the third quarter of
2007.
We
currently do not have any contingencies in excess of $5.0 million recorded on
our books.
Purchase
Price Allocation – Commonwealth and GVN
The
allocation of the approximate $1.1 billion paid to the “fair market value” of
the assets and liabilities of Commonwealth is a critical estimate. We
finalized our estimate of the fair values assigned to plant, customer list and
goodwill, as more fully described in Notes 3 and 6 to the consolidated financial
statements. Additionally, the estimated expected life of a customer
(used to amortize the customer list) is a critical estimate.
New Accounting
Pronouncements
The
following new accounting standards were adopted by the Company in 2009 without
any material financial statement impact. All of these standards are
more fully described in Note 2 to the consolidated financial
statements.
|
·
|
Fair Value Measurements (SFAS
No. 157, ASC Topic 820), as
amended
|
|
·
|
Business Combinations (SFAS
No. 141R, ASC Topic 805), as
amended
|
|
·
|
Noncontrolling Interests in
Consolidated Financial Statements (SFAS No. 160, ASC Topic
810)
|
|
·
|
Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities (FSP EITF No. 03-6-1, ASC Topic
260)
|
|
·
|
Subsequent Events (SFAS No.
165, ASC Topic 855)
|
|
·
|
The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles
(SFAS No. 168, ASC Topic
105)
|
|
·
|
Employers’ Disclosures about
Postretirement Benefit Plan Assets (FSP SFAS No. 132(R)-1, ASC Topic
715)
|
42
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Our
historical results include the results of operations of CTE from the date of its
acquisition on March 8, 2007 and of GVN from the date of its acquisition on
October 31, 2007. Accordingly, results of operations for 2009, 2008
and 2007 are not directly comparable as 2009 and 2008 results reflect the
inclusion of a full year of operations of CTE and GVN, whereas 2007 results
reflect the inclusion of approximately ten months of operations of CTE and of
two months of operations of GVN.
REVENUE
Revenue
is generated primarily through the provision of local, network access, long
distance, and data and internet services. Such revenues are generated
through either a monthly recurring fee or a fee based on usage at a tariffed
rate and revenue recognition is not dependent upon significant judgments by
management, with the exception of a determination of a provision for
uncollectible amounts.
Consolidated
revenue for 2009 decreased $119.1 million, or 5%, to $2,117.9 million as
compared to 2008. This decline is a result of lower local services revenue,
switched access revenue, long distance services revenue and subsidy revenue,
partially offset by a $31.3 million, or 5%, increase in data and internet
services revenue, each as described in more detail below.
Consolidated
revenue for 2008 decreased $51.0 million, or 2%, to $2,237.0 million as compared
to 2007. Excluding additional revenue attributable to the CTE
and GVN acquisitions for a full year in 2008 and for a partial period in 2007,
our revenue decreased $107.3 million during 2008, or 5%, as compared to
2007. During the first quarter of 2007, we had a significant
favorable settlement of a carrier dispute that resulted in a favorable one-time
impact to our revenue of $38.7 million. Excluding the additional
revenue due to the one-time favorable settlement in the first quarter of 2007
and the additional revenue attributable to the CTE and GVN acquisitions in 2008
and 2007, our revenue for the year ended December 31, 2008 declined $68.6
million, or 3%, as compared to the prior year. This decline is a
result of lower local services revenue, switched access revenue and subsidy
revenue, partially offset by a $37.3 million, or 8%, increase in data and
internet services revenue, each as described in more detail below.
Change in
the number of our access lines is one factor that is important to our revenue
and profitability. We have lost access lines primarily because of
changing consumer behavior (including wireless substitution), economic
conditions, changing technology, competition, and by some customers
disconnecting second lines when they add HSI or cable modem
service. In 2009, we lost approximately 136,800 access lines (net),
or 6% on an annual basis. This represents an improvement in our rate
of access line loss over 2008, during which we lost approximately 174,800 access
lines (net) or 7% on an annual basis. We believe this improvement is
attributable to the customer recognition of the value of our product bundles,
fewer residential moves out of territory, fewer moves by businesses to
competitors and our ability to compete with cable telephony in a maturing
marketplace. Economic conditions and/or increasing competition could make it
more difficult to sell our bundles, 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 flow.
During
2009, we added approximately 56,000 HSI subscribers. We expect to
continue to increase HSI subscribers in 2010 (although not enough to offset the
expected continued loss in access lines).
While the
number of access lines is an important 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 a
breakdown that presents residential customer counts, average monthly revenue,
percentage of customers on price protection plans and churn. It also
categorizes revenue into customer revenue (residential and business) and
regulatory revenue (switched access and subsidy revenue). Despite the
7% decline in residential customers and the 6% decline in total access lines,
our customer revenue, which is all revenue except switched access and subsidy
revenue, declined in 2009 by 4 percent as compared to the prior year
period. The average monthly residential and total customer revenue
per customer has improved, and resulted in an increased wallet share. A
substantial further loss of customers and access lines, combined with increased
competition and the other factors discussed herein may cause our revenue,
profitability and cash flows to decrease in 2010.
43
OTHER
FINANCIAL AND OPERATING DATA
|
||||||||||||||||||||||||||||
As
of
|
%
Increase
|
As
of
|
%
Increase
|
As
of
|
||||||||||||||||||||||||
December
31, 2009
|
(Decrease)
|
December
31, 2008
|
(Decrease)
|
December
31, 2007
|
||||||||||||||||||||||||
Access
lines:
|
||||||||||||||||||||||||||||
Residential
|
1,349,510 | (7 | %) | 1,454,268 | (8 | %) | 1,587,930 | |||||||||||||||||||||
Business
|
768,002 | (4 | %) | 800,065 | (5 | %) | 841,212 | |||||||||||||||||||||
Total
access lines
|
2,117,512 | (6 | %) | 2,254,333 | (7 | %) | 2,429,142 | |||||||||||||||||||||
High-Speed
Internet subscribers
|
635,947 | 10 | % | 579,943 | 11 | % | 522,845 | |||||||||||||||||||||
Video
subscribers
|
172,961 | 44 | % | 119,919 | 28 | % | 93,596 | |||||||||||||||||||||
For
the year ended December 31,
|
||||||||||||||||||||||||||||
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||||||||||||||||||||
2009 |
(Decrease)
|
(Decrease)
|
2008 |
(Decrease)
|
(Decrease)
|
2007 | ||||||||||||||||||||||
Revenue
(in 000's):
|
||||||||||||||||||||||||||||
Residential
|
$ | 899,800 | $ | (49,484 | ) | (5 | %) | $ | 949,284 | $ | (9,169 | ) | (1 | %) | $ | 958,453 | ||||||||||||
Business
|
858,460 | (24,561 | ) | (3 | %) | 883,021 | 32,921 | 4 | % | 850,100 | ||||||||||||||||||
Total
customer revenue
|
1,758,260 | (74,045 | ) | (4 | %) | 1,832,305 | 23,752 | 1 | % | 1,808,553 | ||||||||||||||||||
Regulatory
(Access Services)
|
359,634 | (45,079 | ) | (11 | %) | 404,713 | (74,749 | ) | (16 | %) | 479,462 | |||||||||||||||||
Total
revenue
|
$ | 2,117,894 | $ | (119,124 | ) | (5 | %) | $ | 2,237,018 | $ | (50,997 | ) | (2 | %) | $ | 2,288,015 | ||||||||||||
Switched
access minutes of use
|
||||||||||||||||||||||||||||
(in
millions)
|
8,854 | (12 | %) | 10,027 | (5 | %) | 10,592 | |||||||||||||||||||||
Average
monthly total revenue per
|
||||||||||||||||||||||||||||
access
line
|
$ | 80.74 | 1 | % | $ | 79.62 | 2 | % | $ | 77.72 | (1) | |||||||||||||||||
Average
monthly customer revenue
|
||||||||||||||||||||||||||||
per
access line
|
$ | 67.03 | 3 | % | $ | 65.22 | 4 | % | $ | 62.49 | ||||||||||||||||||
As
of
|
As
of
|
|||||||||||||||||||||||||||
December
31, 2009
|
December
31, 2008
|
|||||||||||||||||||||||||||
Residential
Customer Metrics:
|
||||||||||||||||||||||||||||
Customers
|
1,254,508 | (7 | %) | 1,347,423 | ||||||||||||||||||||||||
Revenue
(in 000's)
|
$ | 899,800 | (5 | %) | $ | 949,284 | ||||||||||||||||||||||
Average
Monthly Residential Customer
|
||||||||||||||||||||||||||||
Revenue
per Customer
|
$ | 57.62 | 2 | % | $ | 56.42 | ||||||||||||||||||||||
Percent
of Customers on Price Protection
|
||||||||||||||||||||||||||||
Plans
|
53.2 | % | 19 | % | 44.6 | % | ||||||||||||||||||||||
Customer
Monthly Churn
|
1.47 | % | (6 | %) | 1.57 | % | ||||||||||||||||||||||
Products per
Residential Customer (2)
|
2.54 | 7 | % | 2.37 | ||||||||||||||||||||||||
|
(1)
For the year ended December 31, 2007, the calculation includes CTE and GVN
data and excludes the $38.7 million favorable one-time impact from the
first quarter 2007 settlement of a switched access dispute. The
amount is $79.06 with the $38.7 million favorable one-time impact from the
settlement.
|
|
(2)
Products per Residential Customer: Primary Residential Voice line,
HSI, Video products have a value of 1. FTR long distance, POM,
second lines, Feature Packages and Dial-up have a value of
0.5.
|
44
REVENUE
|
|||||||||||||||||||||||||
2009
|
2008
|
2007
|
|||||||||||||||||||||||
($ in thousands)
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||||||||||||||||
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
|||||||||||||||||||
Local
services
|
$ | 781,388 | $ | (67,005 | ) | (8 | %) | $ | 848,393 | $ | (27,369 | ) | (3 | %) | $ | 875,762 | |||||||||
Data
and internet services
|
636,943 | 31,328 | 5 | % | 605,615 | 61,851 | 11 | % | 543,764 | ||||||||||||||||
Access
services
|
359,634 | (45,079 | ) | (11 | %) | 404,713 | (74,749 | ) | (16 | %) | 479,462 | ||||||||||||||
Long
distance services
|
165,774 | (16,785 | ) | (9 | %) | 182,559 | 2,034 | 1 | % | 180,525 | |||||||||||||||
Directory
services
|
107,096 | (6,251 | ) | (6 | %) | 113,347 | (1,239 | ) | (1 | %) | 114,586 | ||||||||||||||
Other
|
67,059 | (15,332 | ) | (19 | %) | 82,391 | (11,525 | ) | (12 | %) | 93,916 | ||||||||||||||
$ | 2,117,894 | $ | (119,124 | ) | (5 | %) | $ | 2,237,018 | $ | (50,997 | ) | (2 | %) | $ | 2,288,015 | ||||||||||
Local
services revenue for 2009 decreased $67.0 million, or 8%, to $781.4 million as
compared with 2008, primarily due to the continued loss of access lines that
accounted for $41.9 million of the decline and a reduction in all other related
services revenue of $25.1 million. Enhanced services revenue in 2009
decreased $14.7 million, as compared with 2008, primarily due to a decline in
access lines and a shift in customers purchasing our unlimited voice
communications packages with features included in the bundle instead of
purchasing individual features.
Local
services revenue for 2008 decreased $27.4 million, or 3%, to $848.4 million as
compared to 2007. Local services revenue for 2008 increased $20.4
million as a result of the CTE and GVN acquisitions, and legacy Frontier
operations decreased $47.8 million, or 6%, as compared to 2007, primarily due to
the continued loss of access lines which accounted for $40.4 million of the
decline and a reduction in all other related services of $7.4 million. Enhanced
services revenue for 2008, excluding the impact of the CTE and GVN acquisitions
for 2008 and 2007, decreased $5.6 million, or 3%, as compared to 2007, primarily
due to a decline in access lines and a shift in customers purchasing our
unlimited voice communications packages instead of individual
features. Rate increases that were effective August 2007 resulted in
a favorable 2008 impact of $3.0 million.
Data
and Internet Services
Data and
internet services revenue for 2009 increased $31.3 million, or 5%, to $636.9
million as compared with 2008, primarily due to the overall growth in the number
of HSI subscribers and high-capacity internet and ethernet circuits purchased by
customers. As of December 31, 2009, the number of the Company’s HSI
subscribers had increased by approximately 56,000, or 10%, since December 31,
2008. We have used “aspirational gifts” or promotional credits to
drive growth in HSI subscribers. Data and internet services also
includes revenue from data transmission services to other carriers and
high-volume commercial customers with dedicated high-capacity Internet and
ethernet circuits. Revenue from these dedicated high-capacity
circuits increased $7.3 million in 2009, as compared with 2008, primarily due to
growth in the number of those circuits.
Data and
internet services revenue for 2008 increased $61.9 million, or 11%, to $605.6
million as compared to 2007. Data and internet services revenue for
2008 increased $24.6 million as a result of the CTE and GVN acquisitions, and
legacy Frontier operations increased $37.3 million, or 8%, as compared to 2007,
primarily due to the overall growth in the number of HSI
subscribers. As of December 31, 2008, the number of the Company’s HSI
subscribers increased by approximately 57,100, or 11%, since December 31,
2007. Revenue from dedicated high-capacity circuits, including the
impact of $10.5 million attributable to the CTE and GVN acquisitions, increased
$26.9 million in 2008, as compared to 2007, primarily due to growth in the
number of those circuits.
In
February 2009, the President signed into law an economic stimulus package, ARRA,
that includes $7.2 billion in funding, through grants and loans, for new
broadband investment and adoption in unserved and underserved
communities. We filed applications for the first round of
stimulus funding in West Virginia, but were notified in February 2010 that we
were not selected. The federal agencies responsible for administering
the programs released rules and evaluation criteria for the second round of
funding, with applications due by March 15, 2010. The Company will
evaluate opportunities but has not made a decision on whether it will apply for
any funding in this round.
45
Access
Services
Access
services revenue for 2009 decreased $45.1 million, or 11%, to $359.6 million as
compared with 2008. Switched access revenue in 2009 of $246.3 million
decreased $38.6 million, or 14%, as compared with 2008, 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. Access services revenue includes subsidy payments we receive from
federal and state agencies, including surcharges billed to customers that are
remitted to the FCC. Subsidy revenue, including surcharges billed to
customers, for 2009 of $113.3 million decreased $6.5 million, or 5%, as compared
with 2008, primarily due to lower receipts under the Federal High Cost Fund
(FHCF) program resulting from our reduced cost structure and an increase in the
program’s National Average Cost per Local Loop (NACPL) used by the FCC to
allocate funds among all recipients.
Access
services revenue for 2008 decreased $74.7 million, or 16%, to $404.7 million as
compared to 2007. Access services revenue for 2008 increased $2.6
million as a result of the CTE and GVN acquisitions, and legacy Frontier
operations decreased $77.3 million, or 19%, as compared to 2007.
Switched access revenue for 2008, excluding the unfavorable impact of the CTE
and GVN acquisitions, decreased $56.8 million, or 20%, as compared to 2007,
primarily due to the settlement of a carrier dispute resulting in a favorable
impact on our 2007 revenue of $38.7 million (a one-time event), and 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. Excluding the impact of that one-time favorable settlement
in 2007, our switched access revenue for 2008 declined by $18.1 million, or 7%
from 2007. Subsidy revenue for 2008, excluding the additional subsidy
revenue attributable to the CTE and GVN acquisitions in 2008 and 2007, decreased
$20.5 million, or 16%, in 2008 to $104.1 million, as compared to 2007, primarily
due to lower receipts under the FHCF program resulting from our reduced cost
structure and an increase in the program’s NACPL used by the FCC to allocate
funds among all recipients. Subsidy revenue in 2008 was also
negatively impacted by $2.5 million in unfavorable adjustments resulting from
audits of the FHCF program.
Many
factors may lead to further increases in the NACPL, thereby resulting in
decreases in our federal subsidy revenue in the future. The FCC and
state regulatory agencies are currently considering a number of proposals for
changing the manner in which eligibility for federal subsidies is determined as
well as the amounts of such subsidies. On May 1, 2008, the FCC issued
an order to cap Competitive Eligible Telecommunications Companies (CETC)
receipts from the high cost Federal Universal Service Fund. In 2009, the
federal court upheld the FCC’s order and the cap remains in place pending any
future reform.
The FCC
is considering proposals that may significantly change interstate, intrastate
and local intercarrier compensation and would revise the Federal Universal
Service funding and disbursement mechanisms. When and how these
proposed changes will be addressed are unknown and, accordingly, we are unable
to predict the impact of future changes on our results of operations. However,
future reductions in our subsidy and access revenues will directly affect our
profitability and cash flows as those regulatory revenues do not have associated
variable expenses.
Certain
states have open proceedings to address reform to intrastate access charges and
other intercarrier compensation. We cannot predict when or how these
matters will be decided or the effect on our subsidy or access
revenues. 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.
Long
Distance Services
Long
distance services revenue for 2009 decreased $16.8 million, or 9%, to $165.8
million as compared with 2008, primarily due to a 3% reduction in the overall
minutes of use and a reduction in the average revenue per minute of
use. We expect our long distance services revenue to continue to
trend downward. We have actively marketed a package of unlimited long
distance minutes with our digital phone and state unlimited bundled service
offerings. These offerings have resulted in an increase in long distance
customers, and an increase in the minutes used by these
customers. This has lowered our overall average rate per minute
billed. While these package offerings have grown our long distance customer
base, those customers who still pay on a per minute of use basis have reduced
their calling volumes.
Long
distance services revenue for 2008 increased $2.0 million, or 1%, to $182.6
million as compared to 2007. Long distance services revenue for 2008
increased $5.8 million as a result of the CTE and GVN acquisitions, and legacy
Frontier operations decreased $3.8 million, or 2%, as compared to
2007. During 2008, we actively marketed a package of unlimited long
distance minutes with our digital phone and state unlimited bundled service
offerings.
46
Our long
distance services revenue may decrease in the future due to further declines in
minutes of use or increased penetration of our unlimited calling
packages. Competing services such as wireless, VOIP and cable
telephony are resulting in a loss of customers, minutes of use and further
declines in the rates we charge our customers. We expect these
factors will continue to adversely affect our long distance revenue in the
future.
Directory
Services
Directory
services revenue for 2009 decreased $6.3 million, or 6%, to $107.1 million as
compared with 2008, primarily due to lower revenues from yellow pages local
advertising.
Directory
services revenue for 2008 decreased $1.2 million, or 1%, to $113.3 million as
compared to 2007. Directory services revenue for 2008 increased $2.8
million as a result of the CTE and GVN acquisitions, and our legacy Frontier
operations decreased $4.0 million, or 4%, as compared to 2007 due to lower
revenues from yellow pages advertising, mainly in Rochester, New
York.
Other
Other
revenue for 2009 decreased $15.3 million, or 19%, to $67.1 million as compared
with 2008, primarily due to video promotional discounts of approximately $13.6
million.
Other
revenue for 2008 decreased $11.5 million, or 12%, to $82.4 million as compared
to 2007. Other revenue was impacted by a decrease in equipment sales
of $7.0 million, a decrease in service activation fee revenue of $3.3 million
and decreased “bill and collect” fee revenue of $3.2 million, partially offset
by higher DISH video revenue of $3.3 million.
OPERATING EXPENSES
NETWORK
ACCESS EXPENSES
|
|||||||||||||||
2009
|
2008
|
2007
|
|||||||||||||
($
in thousands)
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||||||
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
|||||||||
Network
access
|
$ 225,907
|
$ 3,894
|
2%
|
$ 222,013
|
$ (6,229)
|
(3%)
|
$ 228,242
|
Network access
Network
access expenses for 2009 increased $3.9 million, or 2%, to $225.9 million as
compared to 2008 due to higher “aspirational gift” costs (e.g., personal
computers), higher long distance carriage costs and additional data backbone
costs.
Network
access expenses for 2008 decreased $6.2 million, or 3%, to $222.0 million as
compared to 2007 primarily due to decreasing rates resulting from more efficient
circuit routing for our long distance and data products. Network
access expenses for 2008 increased $8.9 million as a result of the CTE and GVN
acquisitions, and legacy Frontier operations decreased $15.1 million, or 8%, as
compared to 2007.
During
2008, we expensed $4.2 million of promotional costs for Master Card gift cards
issued to new HSI customers entering into a two-year price protection plan and
to existing customers who purchased additional services under a two-year price
protection plan and $3.0 million for a flat screen television
promotion. In the fourth quarter of 2007, we expensed $11.4 million
of promotional costs associated with fourth quarter HSI promotions that
subsidized the cost of a new personal computer or a new digital camera provided
to customers entering into a multi-year commitment for certain bundled
services.
As we
continue to offer “aspirational gifts” as part of our promotions, increase our
sales of data products such as HSI and increase the penetration of our unlimited
long distance calling plans, our network access expense may increase in the
future. A decline in expenses associated with access line losses may
offset some of the increase.
47
OTHER
OPERATING EXPENSES
|
||||||||||||||||||||||
2009
|
2008
|
2007
|
||||||||||||||||||||
($ in thousands)
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
||||||||||||||||||
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
||||||||||||||||
Wage
and benefit expenses
|
$ | 360,551 | $ | (23,173 | ) | (6%) | $ | 383,724 | $ | (12,210 | ) | (3%) | $ | 395,934 | ||||||||
Pension
costs
|
34,196 | 34,033 |
NM
|
163 | 14,771 | 101% | (14,608 | ) | ||||||||||||||
Severance
and early retirement costs
|
3,788 | (3,810 | ) | (50%) | 7,598 | (6,276 | ) | (45%) | 13,874 | |||||||||||||
Stock
based compensation
|
9,368 | 1,580 | 20% | 7,788 | (1,234 | ) | (14%) | 9,022 | ||||||||||||||
All
other operating expenses
|
373,194 | (38,281 | ) | (9%) | 411,475 | 7,196 | 2% | 404,279 | ||||||||||||||
$ | 781,097 | $ | (29,651 | ) | (4%) | $ | 810,748 | $ | 2,247 | 0% | $ | 808,501 | ||||||||||
Wage
and benefit expenses
Wage and
benefit expenses for 2009 decreased $23.2 million, or 6%, to $360.6 million as
compared to 2008, primarily due to headcount reductions, decreases in
compensation, reduced overtime costs and lower benefit expenses.
Wage and
benefit expenses for 2008 decreased $12.2 million, or 3%, to $383.7 million as
compared to 2007. Wage and benefit expenses related to the CTE and
GVN acquisitions decreased $4.2 million and legacy Frontier operations decreased
$8.0 million primarily due to headcount reductions and associated decreases in
compensation and benefit costs attributable to the integration of the back
office, customer service and administrative support functions of the CTE and GVN
operations acquired in 2007.
Pension
Costs
The
decline in the value of our pension plan assets during 2008 resulted in an
increase in our pension expense in 2009. Pension costs for 2009 and 2008 were
approximately $34.2 million and $0.2 million,
respectively. Pension costs for 2009 include pension expense of
$41.7 million, less amounts capitalized into the cost of capital expenditures of
$7.5 million.
Pension
costs for 2008 and 2007 were approximately $0.2 million and $(14.6) million,
respectively. The amount for 2007 includes the costs for our CTE
plans acquired in 2007 and reflects the positive impact of a pension curtailment
gain of $14.4 million, resulting from the freeze placed on certain pension
benefits of the former CTE non-union employees. Also, effective
December 31, 2007, the CTE Employees’ Pension Plan was merged into the Frontier
Pension Plan.
The
Company’s pension plan assets have increased from $589.8 million at December 31,
2008 to $608.6 million at December 31, 2009, an increase of $18.8 million, or
3%. This increase is a result of positive investment returns of $90.2
million, or 15%, partially offset by ongoing benefit payments of $71.4 million,
or 12%, during 2009.
Based on
current assumptions and plan asset values, we estimate that our 2010 pension and
other postretirement benefit expenses (which were $48.6 million in 2009) will be
approximately $45.0 million to $55.0 million. No contributions were
made to Frontier’s pension plan during 2007, 2008 and 2009. We expect
that we will make a $10.0 million cash contribution to our pension plan in
2010.
48
Severance
and early retirement costs
Severance
and early retirement costs for 2009 decreased $3.8 million, or 50%, to $3.8
million as compared with 2008.
Severance
and early retirement costs for 2008 decreased $6.3 million, or 45%, as compared
to 2007. Severance and early retirement costs of $7.6 million in 2008
include charges recorded in the first half of 2008 of $3.4 million related to
employee early retirements and terminations for 42 Rochester, New York
employees. Additional severance costs of $4.0 million were recorded
in the fourth quarter of 2008, including $1.7 million of enhanced early
retirement pension benefits related to 55 employees.
Severance
and early retirement costs of $13.9 million in 2007 include a third quarter
charge of approximately $12.1 million related to initiatives to enhance customer
service, streamline operations and reduce costs. Approximately 120
positions were eliminated as part of this 2007 initiative, most of which were
filled by new employees at our remaining call centers. In addition,
approximately 50 field operations employees agreed to participate in an early
retirement program and another 30 employees from a variety of functions left the
Company in 2007.
Stock
based compensation
Stock
based compensation for 2009 increased $1.6 million, or 20%, to $9.4 million as
compared with 2008, due to increased costs for restricted stock
awards.
Stock
based compensation for 2008 decreased $1.2 million, or 14%, as compared to 2007
due to reduced costs associated with stock units and stock options.
All
other operating expenses
All other
operating expenses for 2009 decreased $38.3 million, or 9%, to $373.2 million as
compared to 2008, due to reduced costs for outside contractors and other
vendors, as well as lower fuel, travel and USF surcharges, partially offset by
slightly higher marketing expenses.
All other
operating expenses for 2008 increased $7.2 million, or 2%, to $411.5 million as
compared to 2007, primarily due to the additional expenses attributable to the
CTE and GVN acquisitions of $10.0 million in 2008 versus 2007, as 2008 includes
a full year of expenses for CTE and GVN while 2007 included approximately ten
months of costs for CTE and two months of costs for GVN. Our purchase of CTE has
enabled us to realize cost savings by leveraging our centralized back office,
customer service and administrative support functions over a larger customer
base.
DEPRECIATION
AND AMORTIZATION EXPENSE
|
|||||||||||||||||||||||||||
2009
|
2008
|
2007
|
|||||||||||||||||||||||||
($ in thousands)
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||||||||||||||||||
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
|||||||||||||||||||||
Depreciation
expense
|
$ | 362,228 | $ | (17,262 | ) | (5%) | $ | 379,490 | $ | 5,055 | 1% | $ | 374,435 | ||||||||||||||
Amortization
expense
|
114,163 | (68,148 | ) | (37%) | 182,311 | 10,890 | 6% | 171,421 | |||||||||||||||||||
$ | 476,391 | $ | (85,410 | ) | (15%) | $ | 561,801 | $ | 15,945 | 3% | $ | 545,856 | |||||||||||||||
Depreciation and amortization expense for 2009 decreased $85.4 million, or 15%, to $476.4 million as compared to 2008. The decrease is primarily due to reduced amortization expense, as discussed below, and a declining net asset base, partially offset by changes in the remaining useful lives of certain assets. An independent study updating the estimated remaining useful lives of our plant assets is performed annually. We revised our useful lives based on the study effective October 1, 2009. Our “composite depreciation rate” decreased from 5.6% to 5.2% as a result of the study. We anticipate depreciation expense of approximately $335.0 million to $355.0 million and amortization expense of approximately $56.2 million for 2010 related to our currently owned properties.
49
Amortization
expense for 2009 is comprised of $57.9 million for amortization associated with
our legacy Frontier properties, which were fully amortized in June 2009, and
$56.3 million for intangible assets (customer base and trade name) that were
acquired in the Commonwealth and Global Valley
acquisitions. Amortization expense for our legacy Frontier properties
was $126.4 million for 2008 and 2007.
Depreciation
and amortization expense for 2008 increased $15.9 million, or 3%, to $561.8
million as compared to 2007. Depreciation and amortization expense
increased $26.6 million as a result of the CTE and GVN acquisitions, and
decreased $10.7 million, or 2%, as compared to 2007, primarily due to a
declining net asset base for our legacy Frontier properties, partially offset by
changes in the remaining useful lives of certain assets.
ACQUISITION
AND INTEGRATION COSTS
|
|||||||||||
2009
|
2008
|
2007
|
|||||||||
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||
($ in thousands) |
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
||||
Acquisition
and
|
|||||||||||
integration
costs
|
$ 28,334
|
$ 28,334
|
100%
|
$ -
|
$ -
|
-
|
$ -
|
Acquisition
and integration costs represent expenses incurred to close the transaction
(legal, financial advisory, accounting, regulatory and other related costs) and
integrate the network and information technology platforms. While the
Company continues to evaluate certain other expenses, we currently expect to
incur acquisition and integration costs of approximately $100.0 million in
2010. We anticipate closing the Verizon Transaction during the second
quarter of 2010.
INVESTMENT
INCOME/OTHER INCOME (LOSS), NET / INTEREST EXPENSE /
|
|||||||||||||||||||||||||||
INCOME
TAX EXPENSE
|
|||||||||||||||||||||||||||
2009
|
2008
|
2007
|
|||||||||||||||||||||||||
($ in thousands)
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||||||||||||||||||
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
|||||||||||||||||||||
Investment
income
|
$ | 6,285 | $ | (9,833 | ) | (61%) | $ | 16,118 | $ | (21,523 | ) | (57%) | $ | 37,641 | |||||||||||||
Other
income (loss), net
|
$ | (41,127 | ) | $ | (35,957 | ) |
NM
|
$ | (5,170 | ) | $ | 12,663 | 71% | $ | (17,833 | ) | |||||||||||
Interest
expense
|
$ | 378,214 | $ | 15,580 | 4% | $ | 362,634 | $ | (18,062 | ) | (5%) | $ | 380,696 | ||||||||||||||
Income
tax expense
|
$ | 69,928 | $ | (36,568 | ) | (34%) | $ | 106,496 | $ | (21,518 | ) | (17%) | $ | 128,014 | |||||||||||||
Investment
Income
Investment
income for 2009 declined $9.8 million, or 61%, to $6.3 million as compared with
2008 primarily due to reduced equity earnings of $4.2 million and a decrease of
$5.6 million in income from short-term investments of cash and cash equivalents,
as higher cash balances were more than offset by significantly lower short-term
investment rates.
Investment
income for 2008 decreased $21.5 million, or 57%, to $16.1 million as compared to
2007, primarily due to a decrease of $22.1 million in income from short-term
investments of cash and cash equivalents due to a lower investable cash
balance.
Our
average cash balances were $318.0 million, $177.5 million and $594.2 million for
2009, 2008 and 2007, respectively. The 2007 amount reflects the
impact of borrowing $550.0 million in December 2006 in anticipation of the
Commonwealth acquisition in 2007.
50
Other
Income (Loss), net
Other
income (loss), net for 2009 declined $36.0 million to $(41.1) million as
compared with 2008, primarily due to premiums paid on the early retirement of
debt of $45.9 million in 2009, partially offset by increased litigation
settlement proceeds of $3.8 million.
Other
income (loss), net for 2008 improved $12.7 million, or 71%, to $(5.2) million as
compared to 2007. Other income (loss), net improved in 2008 primarily
due to a reduction in the loss on retirement of debt of $11.9 million and the
$4.1 million expense of a bridge loan fee recorded during the first quarter of
2007.
Interest
Expense
Interest
expense for 2009 increased $15.6 million, or 4%, to $378.2 million as compared
with 2008, primarily due to higher average debt levels and interest rates in
2009. Our composite average borrowing rate as of December 31, 2009 as compared
with the prior year was 31 basis points higher, increasing from 7.54% to
7.85%.
Interest
expense for 2008 decreased $18.1 million, or 5%, to $362.6 million as compared
to 2007, primarily due to the amortization of the deferred gain associated with
the termination of our interest rate swap agreements and retirement of related
debt during the first quarter of 2008, along with slightly lower average debt
levels and average interest rates. Our composite average borrowing rate as of
December 31, 2008, as compared to 2007, was 40 basis points lower, decreasing
from 7.94% to 7.54%.
Our
average debt outstanding was $4,867.2 million, $4,753.0 million and $4,834.5
million for 2009, 2008 and 2007, respectively. The higher average
debt levels for 2009 result primarily from our April 2009 debt offering of
$600.0 million, as the net proceeds were not fully utilized to retire existing
debt until the fourth quarter of 2009.
Income
Tax Expense
Income
tax expense for 2009 decreased $36.6 million, or 34%, to $69.9 million as
compared with 2008, primarily due to lower taxable income arising from lower
operating income, lower investment income and loss on debt
repurchases. The second quarter of 2008 included a reduction in
income tax expense of $7.5 million that resulted from the expiration of certain
statute of limitations on April 15, 2008, as discussed below.
The
effective tax rate for 2009 was 36.2% as compared with 36.6% for 2008 and 37.2%
for 2007.
Cash paid
for taxes was $59.7 million, $78.9 million and $54.4 million in 2009, 2008 and
2007, respectively. Our 2009 cash taxes were lower than 2008
and reflect the benefits from accelerated tax depreciation arising from the
ARRA, utilization of AMT credits and higher interest expense arising from our
debt offerings not fully offset by debt repurchases. We expect that in 2010 our
cash taxes will be less than $10.0 million. We expect that our 2010
cash taxes will be reduced by the receipt of tax refunds arising from the
retroactive application of a change in tax accounting for repairs and
maintenance costs. In addition, our 2010 cash taxes will be impacted
by approximately $60.0 million of tax benefits arising from our integration
activities and secondarily, our 2009 debt refinancing activities. Absent the tax
benefits generated by these integration and refinancing activities, we estimate
that cash taxes would be approximately $60.0 million to $70.0 million in
2010.
Refunds
of approximately $56.2 million have been applied for in the Company’s 2008 tax
returns. The refunds result from a tax methods change applied for
during the third quarter of 2009. Refunds are recorded on our balance
sheet at December 31, 2009 in current assets within income taxes. We
recorded approximately $8.2 million (net) related to uncertain tax positions
under FASB Interpretation No. (FIN) 48 (ASC Topic 740) in 2009.
Income
tax expense for 2008 decreased $21.5 million, or 17%, as compared to 2007,
primarily due to lower taxable income and the reduction in income tax expense of
$7.5 million recorded in the second quarter of 2008 that resulted from the
expiration of certain statute of limitations on April 15, 2008, as discussed
below.
51
As a
result of the expiration of certain statute of limitations on April 15, 2008,
the liabilities on our books as of December 31, 2007 related to uncertain tax
positions recorded under FASB Interpretation No. (FIN) 48 (ASC Topic 740) were
reduced by $16.2 million in the second quarter of 2008. This
reduction lowered income tax expense by $7.5 million, goodwill by $3.0 million
and deferred income tax assets by $5.7 million during the second quarter of
2008.
INCOME
ATTRIBUTABLE TO THE NONCONTROLLING INTEREST
|
|||||||||||||||||||||||
IN
A PARTNERSHIP
|
|||||||||||||||||||||||
2009
|
2008
|
2007
|
|||||||||||||||||||||
($
in thousands)
|
$
Increase
|
%
Increase
|
$
Increase
|
%
Increase
|
|||||||||||||||||||
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
(Decrease)
|
(Decrease)
|
Amount
|
|||||||||||||||||
Income
attributable to
|
|||||||||||||||||||||||
the
noncontrolling interest
|
|||||||||||||||||||||||
in
a partnership
|
$ | 2,398 | $ | 784 | 49% | $ | 1,614 | $ | (246 | ) | (13%) | $ | 1,860 | ||||||||||
Income
attributable to the noncontrolling interest relates to our joint venture, Mohave
Cellular LP.
52
Item
7A. Quantitative and Qualitative
Disclosures about Market Risk
Disclosure
of primary market risks and how they are managed
We are
exposed to market risk in the normal course of our business operations due to
ongoing investing and funding activities, including those associated with our
pension assets. Market risk refers to the potential change in fair value of a
financial instrument as a result of fluctuations in interest rates and equity
prices. We do not hold or issue derivative instruments, derivative commodity
instruments or other financial instruments for trading purposes. As a
result, we do not undertake any specific actions to cover our exposure to market
risks, and we are not party to any market risk management agreements other than
in the normal course of business. Our primary market risk exposures
are interest rate risk and equity price risk as follows:
Interest
Rate Exposure
Our
exposure to market risk for changes in interest rates relates primarily to the
interest-bearing portion of our investment portfolio. Our long-term
debt as of December 31, 2009 was approximately 94% fixed rate debt with minimal
exposure to interest rate changes. We had no interest rate swap
agreements related to our fixed rate debt in effect at December 31,
2009.
Our
objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, all but $278.1 million
of our outstanding borrowings at December 31, 2009 have fixed interest rates. In
addition, our undrawn $250.0 million revolving credit facility has interest
rates that float with LIBOR, as defined. Consequently, we have
limited material future earnings or cash flow exposures from changes in interest
rates on our long-term debt. An adverse change in interest rates
would increase the amount that we pay on our variable obligations and could
result in fluctuations in the fair value of our fixed rate
obligations. Based upon our overall interest rate exposure at
December 31, 2009, a near-term change in interest rates would not materially
affect our consolidated financial position, results of operations or cash
flows.
On
January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. Cash proceeds on the swap
terminations of approximately $15.5 million were received in January
2008. The related gain has been deferred on the consolidated balance
sheet, and is being amortized into interest expense over the term of the
associated debt.
Sensitivity
analysis of interest rate exposure
At
December 31, 2009, the fair value of our long-term debt was estimated to be
approximately $4.6 billion, based on our overall weighted average borrowing rate
of 7.85% and our overall weighted average maturity of approximately 11.5
years. As of December 31, 2009, the weighted average maturity
applicable to our obligations had been extended over the weighted average
maturity as of December 31, 2008 by approximately 1.5 years due to the debt
offerings and refinancing activities that occurred during 2009.
Equity
Price Exposure
Our
exposure to market risks for changes in security prices as of December 31, 2009
is limited to our pension assets. We have no other security
investments of any material amount.
During
2008 and 2009, the diminished availability of credit and liquidity in the United
States and throughout the global financial system has resulted in substantial
volatility in financial markets and the banking system. These and
other economic events have had an adverse impact on investment
portfolios.
The
decline in the value of our pension plan assets during 2008 resulted in an
increase in our pension expense in 2009. The Company’s pension plan
assets have increased from $589.8 million at December 31, 2008 to $608.6 million
at December 31, 2009, an increase of $18.8 million, or 3%. This
increase is a result of positive investment returns of $90.2 million, or 15%,
partially offset by ongoing benefit payments of $71.4 million, or 12%, during
2009. We expect that we will make a $10.0 million cash contribution
to our pension plan in 2010.
53
Item
8. Financial Statements and
Supplementary Data
The
following documents are filed as part of this Report:
1.
Financial Statements, See Index on page F-1.
2.
Supplementary Data, Quarterly Financial Data is included in the Financial
Statements (see 1. above).
Item
9. Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure
None.
Item
9A. Controls and
Procedures
(i)
|
Evaluation
of Disclosure Controls and
Procedures
|
We carried out an evaluation,
under the supervision and with the
participation of our management, including our principal executive
officer and principal financial officer, regarding the effectiveness
of the design and operation of our disclosure controls
and procedures (as defined in Rules 13a–15(e) and 15d–15(e) under the
Securities Exchange Act of 1934) . Based upon this evaluation, our
principal executive officer and principal financial officer concluded, as of the
end of the period covered by this report, December 31, 2009, that our disclosure
controls and procedures were effective.
|
(ii)
|
Internal
Control Over Financial Reporting
|
|
(a)
|
Management’s
annual report on internal control over financial
reporting
|
Our management report on internal
control over financial reporting appears on page F-2.
(b) Report
of registered public accounting firm
The
report of KPMG LLP, our independent registered public accounting firm, on
internal control over financial reporting appears on page F-4.
(c) Changes
in internal control over financial reporting
We
reviewed our internal control over financial reporting at December 31,
2009. There has been no change in our internal control over financial
reporting identified in an evaluation thereof that occurred during the last
fiscal quarter of 2009 that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Item
9B. Other
Information
None.
PART III
Item
10. Directors, Executive
Officers and Corporate Governance
The
information required by this Item is incorporated by reference from our
definitive proxy statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2009. See “Executive Officers of the Registrant” in Part I of this
Report following Item 4 for information relating to executive
officers.
Item
11. Executive
Compensation
The
information required by this Item is incorporated by reference from our
definitive proxy statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2009.
54
Item
12. Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder
Matters
The
information required by this Item is incorporated by reference from our
definitive proxy statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2009.
Item
13. Certain Relationships and
Related Transactions, and Director Independence
The
information required by this Item is incorporated by reference from our
definitive proxy statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2009.
Item
14. Principal Accountant Fees
and Services
The
information required by this Item is incorporated by reference from our
definitive proxy statement for the 2010 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2009.
PART IV
Item
15. Exhibits and Financial
Statement Schedules
List of
Documents Filed as a Part of This Report:
|
(1)
|
Index
to Consolidated Financial
Statements:
|
Reports
of Independent Registered Public Accounting Firm
Consolidated
Balance Sheets as of December 31, 2009 and 2008
Consolidated
Statements of Operations for the years ended
December
31, 2009, 2008 and
2007
Consolidated
Statements of Equity for the years ended
December
31, 2009, 2008 and
2007
Consolidated
Statements of Comprehensive Income for the years ended
December
31, 2009, 2008 and 2007
Consolidated
Statements of Cash Flows for the years ended
December
31, 2009, 2008 and
2007
Notes to
Consolidated Financial Statements
All other
schedules have been omitted because the required information is included in the
consolidated financial statements or the notes thereto, or is not applicable or
not required.
55
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
(2) Index
to Exhibits:
All
documents referenced below were filed pursuant to the Securities Exchange Act of
1934 by the Company, file number 001-11001, unless otherwise
indicated.
|
Exhibit
|
No.
|
Description
|
2.1
|
Agreement
and Plan of Merger, dated as of May 13, 2009, by and among Verizon
Communications Inc. (“Verizon”), New Communications Holdings Inc.
(“Spinco”) and the Company (“Agreement and Plan of Merger”) (filed as
Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on May 15,
2009 (the “May 15, 2009 8-K)).
*
|
2.2
|
Amendment
No. 1 to Agreement and Plan of Merger, dated as of July 24, 2009, by and
among Verizon, Spinco and the Company (filed as Exhibit 2.2 to the
Company’s Registration Statement on Form S-4 (No. 333-160789) filed on
July 24, 2009).*
|
3.1
|
Restated
Certificate of Incorporation (filed as Exhibit 3.200.1 to the Company’s
Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2000).
*
|
3.2
|
Certificate
of Amendment of Restated Certificate of Incorporation, effective July 31,
2008 (filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q
for the fiscal quarter ended June 30, 2008). *
|
3.3
|
By-laws,
as amended February 6, 2009 (filed as Exhibit 99.1 to the Company’s
Current Report on Form 8-K filed on February 6, 2009).
*
|
4.1
|
Rights
Agreement, dated as of March 6, 2002, between the Company and Mellon
Investor Services, LLC, as Rights Agent (filed as Exhibit 1 to the
Company’s Registration Statement on Form 8-A filed on March 22,
2002).*
|
4.2
|
Amendment
No. 1 to Rights Agreement, dated as of January 16, 2003, between the
Company and Mellon Investor Services LLC, as Rights Agent (filed as
Exhibit 1.1 to the Company's Registration Statement on Form 8-A/A, dated
January 16, 2003).*
|
4.3
|
Amendment
No. 2 to Rights Agreement, dated as of May 12, 2009, between the Company
and Mellon Investor Services LLC, as Rights Agent (filed as Exhibit 4.1 to
the May 15, 2009 8-K).*
|
4.4
|
Indenture
of Securities, dated as of August 15, 1991, between the Company and
JPMorgan Chase Bank, N.A. (as successor to Chemical Bank), as Trustee (the
“August 1991 Indenture”) (filed as Exhibit 4.100.1 to the Company’s
Quarterly Report on Form 10-Q for the fiscal quarter ended September 30,
1991).*
|
4.5
|
Fourth
Supplemental Indenture to the August 1991 Indenture, dated October 1,
1994, between the Company and JPMorgan Chase Bank, N.A. (as successor to
Chemical Bank), as Trustee (filed as Exhibit 4.100.7 to the Company’s
Current Report on Form 8-K filed on January 3, 1995).*
|
4.6
|
Fifth
Supplemental Indenture to the August 1991 Indenture, dated as of June 15,
1995, between the Company and JPMorgan Chase Bank, N.A. (as successor to
Chemical Bank), as Trustee (filed as Exhibit 4.100.8 to the Company’s
Current Report on Form 8-K filed on March 29, 1996 (the “March 29, 1996
8-K”)).*
|
4.7
|
Sixth
Supplemental Indenture to the August 1991 Indenture, dated as of October
15, 1995, between the Company and JPMorgan Chase Bank, N.A. (as successor
to Chemical Bank), as Trustee (filed as Exhibit 4.100.9 to the March 29,
1996 8-K).*
|
4.8
|
Seventh
Supplemental Indenture to the August 1991 Indenture, dated as of June 1,
1996, between the Company and JPMorgan Chase Bank, N.A. (as successor to
Chemical Bank), as Trustee (filed as Exhibit 4.100.11 to the Company’s
Annual Report on Form 10-K for the year ended December 31, 1996 (the “1996
10-K”)).*
|
4.9
|
Eighth
Supplemental Indenture to the August 1991 Indenture, dated as of December
1, 1996, between the Company and JPMorgan Chase Bank, N.A. (as successor
to Chemical Bank), as Trustee (filed as Exhibit 4.100.12 to the 1996
10-K).*
|
4.10
|
Senior
Indenture, dated as of May 23, 2001, between the Company and JPMorgan
Chase Bank, N.A. (as successor to The Chase Manhattan Bank), as trustee
(the “May 2001 Indenture”) (filed as Exhibit 4.1 to the Company’s Current
Report on Form 8-K filed on May 24, 2001 (the “May 24, 2001
8-K”)).*
|
4.11
|
First
Supplemental Indenture to the May 2001 Indenture, dated as of May 23,
2001, between the Company and JPMorgan Chase Bank, N.A. (filed as Exhibit
4.2 to the May 24, 2001 8-K).*
|
4.12
|
Form
of Senior Note due 2011 (filed as Exhibit 4.4 to the May 24, 2001
8-K).*
|
56
4.13
|
Third
Supplemental Indenture to the May 2001 Indenture, dated as of November 12,
2004, between the Company and JPMorgan Chase Bank, N.A. (filed as Exhibit
4.1 to the Company’s Current Report on Form 8-K filed on November 12, 2004
(the “November 12, 2004 8-K”)).*
|
4.14
|
Form
of Senior Note due 2013 (filed as Exhibit A to Exhibit 4.1 to the November
12, 2004 8-K).*
|
4.15
|
Indenture,
dated as of August 16, 2001, between the Company and JPMorgan Chase Bank,
N.A. (as successor to The Chase Manhattan Bank), as Trustee (including the
form of note attached thereto) (filed as Exhibit 4.1 of the Company’s
Current Report on Form 8-K filed on August 22, 2001).*
|
4.16
|
Indenture,
dated as of December 22, 2006, between the Company and The Bank of New
York, as Trustee (filed as Exhibit 4.1 to the Company’s Current Report on
Form 8-K filed on December 29, 2006).*
|
4.17
|
Indenture dated
as of March 23, 2007 by and between the Company and The Bank of New York
with respect to the 6.625% Senior Notes due 2015 (including the form of
such note attached thereto) (filed as Exhibit 4.1 to the Company’s Current
Report on Form 8-K filed on March 27, 2007 (the “March 27, 2007
8-K”)).*
|
4.18
|
Indenture dated
as of March 23, 2007 by and between the Company and The Bank of New York
with respect to the 7.125% Senior Notes due 2019 (including the form of
such note attached thereto) (filed as Exhibit 4.2 to the March 27, 2007
8-K).*
|
4.19
|
Indenture
dated as of April 9, 2009, between the Company and The Bank of New
York Mellon, as Trustee (the “April 2009 Indenture”) (filed as Exhibit 4.1
to the Company’s Current Report on Form 8-K filed on April 9, 2009 (the
“April 9, 2009 8-K”)).*
|
4.20
|
First
Supplemental Indenture to the April 2009 Indenture, dated as of April 9,
2009, between the Company and The Bank of New York Mellon, as Trustee
(filed as Exhibit 4.2 to the April 9, 2009 8-K).*
|
4.21
|
Second
Supplemental Indenture to the April 2009 Indenture, dated as of October 1,
2009, between the Company and The Bank of New York Mellon, as Trustee
(filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on
October 1, 2009).*
|
10.1
|
Loan
Agreement between the Company and Rural Telephone Finance Cooperative for
$200,000,000 dated October 24, 2001 (filed as Exhibit 10.39 to the
Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 2001).*
|
10.2
|
Amendment
No. 1, dated as of March 31, 2003, to Loan Agreement between the Company
and Rural Telephone Finance Cooperative (filed as Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March
31, 2003).*
|
10.3
|
Amendment
No. 2, dated as of May 6, 2009, to Loan Agreement between the Company and
Rural Telephone Finance Cooperative (filed as Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March
31, 2009).*
|
10.4
|
Credit
Agreement, dated as of December 6, 2006, among the Company, as the
Borrower, and CoBank, ACB, as the Administrative Agent, the Lead Arranger
and a Lender, and the other Lenders referred to therein (filed as Exhibit
10.1 to the Company’s Current Report on Form 8-K filed on December 7,
2006).*
|
10.5
|
Loan
Agreement, dated as of March 8, 2007, among the Company, as borrower, the
Lenders listed therein, Citicorp North America, Inc., as Administrative
Agent, and Citigroup Global Markets Inc., Credit Suisse Securities (USA)
LLC and J.P. Morgan Securities Inc. as Joint-Lead Arrangers and
Joint Book-Running Managers (filed as Exhibit 10.3 to the March 9, 2007
8-K).*
|
10.6
|
Credit
Agreement, dated as of May 18, 2007, among the Company, the lenders party
thereto and Deutsche Bank AG New York Branch, as Administrative Agent, and
Deutsche Bank Securities Inc., as Sole Lead Arranger and Bookrunner (filed
as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year
ended December 31, 2007 (the “2007 10-K”)).
*
|
10.7
|
Credit
Agreement, dated as of March 10, 2008, among the Company, as the Borrower,
and CoBank, ACB, as the Administrative Agent, the Lead Arranger and a
Lender, and the other Lenders referred to therein (filed as Exhibit 10.1
to the Company’s Current Report on Form 8-K filed on March 10, 2008).*
|
10.8
|
Distribution
Agreement, dated as of May 13, 2009, by and among Verizon and Spinco
(“Distribution Agreement”) (filed as Exhibit 10.1 to the May 15, 2009
8-K).*
|
10.9
|
Amendment
No. 1 to Distribution Agreement, dated as of July 24, 2009, by and between
Verizon and Spinco (filed as Exhibit 10.2 to the Company’s Registration
Statement on Form S-4 (No. 333-160789) filed on July 24, 2009). *
|
10.10
|
Employee
Matters Agreement, dated as of May 13, 2009, by and among Verizon, Spinco
and the Company (filed as Exhibit 10.2 to the May 15, 2009 8-K).*
|
57
10.11
|
Tax
Sharing Agreement, dated as of May 13, 2009, by and among Verizon, Spinco
and the Company (filed as Exhibit 10.3 to the May 15, 2009 8-K).*
|
10.12
|
Non-Employee
Directors' Deferred Fee Equity Plan, as amended and restated December 29,
2008 (filed as Exhibit 10.7 to the Company’s Annual Report on Form 10-K
for the year ended December 31, 2008 (the “2008 10-K”).*
|
10.13
|
Non-Employee
Directors’ Equity Incentive Plan, as amended and restated December 29,
2008 (filed as Exhibit 10.8 to the 2008 10-K).*
|
10.14
|
Separation
Agreement between the Company and Leonard Tow effective July 10, 2004
(filed as Exhibit 10.2.4 of the Company’s Quarterly Report on Form 10-Q
for the fiscal quarter ended June 30, 2004).*
|
10.15
|
Citizens
Executive Deferred Savings Plan dated January 1, 1996 (filed as Exhibit
10.19 to the Company’s Annual Report on Form 10-K for the year ended
December 31, 1999 (the “1999 10-K”)).*
|
10.16
|
1996
Equity Incentive Plan, as amended and restated December 29, 2008 (filed as
Exhibit 10.11 to the 2008 10-K).*
|
10.17
|
Frontier
Bonus Plan (formerly Citizens Incentive Plan) (filed as Appendix A to the
Company's Proxy Statement dated April 10, 2007).*
|
10.18
|
Amended
and Restated 2000 Equity Incentive Plan, as amended and restated December
29, 2008 (filed as Exhibit 10.13 to the 2008 10-K).*
|
10.19
|
2009
Equity Incentive Plan (filed as Appendix A to the Company’s Proxy
Statement dated April 6, 2009).*
|
10.20
|
Amended
Employment Agreement, dated as of December 29, 2008, between the Company
and Mary Agnes Wilderotter (filed as Exhibit 10.14 to the 2008 10-K).*
|
10.21
|
Amended
Employment Agreement, dated as of December 24, 2008, between the Company
and Robert Larson (filed as Exhibit 10.15 to the 2008 10-K).
*
|
10.22
|
Employment
Letter, dated May 27, 2009, between the Company and Robert
Larson.
|
10.23
|
Offer
of Employment Letter, dated December 31, 2004, between the Company and
Peter B. Hayes (“Hayes Offer Letter”) (filed as Exhibit 10.23 to the
Company’s Annual Report on Form 10-K for the year ended December 31,
2004).*
|
10.24
|
Amendment
to Hayes Offer Letter, dated December 24, 2008 (filed as Exhibit 10.17 to
the 2008 10-K).*
|
10.25
|
Offer
of Employment Letter, dated March 7, 2006, between the Company and Donald
R. Shassian (“Shassian Offer Letter”) (filed as Exhibit 10.1 to the
Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March
31, 2006).*
|
10.26
|
Amendment
to Shassian Offer Letter, dated December 30, 2008 (filed as Exhibit 10.19
to the 2008 10-K).*
|
10.27
|
Form
of Arrangement with Daniel J. McCarthy and Melinda M. White with respect
to vesting of restricted stock upon a change-in-control (filed as Exhibit
10.22 to the 2007 10-K).
*
|
10.28
|
Offer
of Employment Letter, dated January 13, 2006, between the Company and
Cecilia K. McKenney (“McKenney Offer Letter”) (filed as Exhibit 10.1 to
the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended
March 31, 2008).
*
|
10.29
|
Amendment
to McKenney Offer Letter, dated December 24, 2008 (filed as Exhibit 10.23
to the 2008 10-K).*
|
10.30
|
Offer
of Employment Letter, dated July 8, 2005, between the Company and Hilary
E. Glassman (the “Glassman Offer Letter”) (filed as Exhibit 10.24 to the
2008 10-K).*
|
10.31
|
Amendment
to Glassman Offer Letter, dated December 29, 2008 (filed as Exhibit 10.25
to the 2008 10-K).*
|
10.32
|
Form
of Restricted Stock Agreement for
CEO.
|
10.33
|
Form
of Restricted Stock Agreement for named executive officers other than
CEO.
|
10.34
|
Summary
of Non-Employee Directors’ Compensation Arrangements Outside of Formal
Plans (filed as Exhibit 10.28 to the 2008 10-K).*
|
10.35
|
Membership
Interest Purchase Agreement between the Company and Integra Telecom
Holdings, Inc. dated February 6, 2006 (filed as Exhibit 10.1 to the
Company’s Current Report on Form 8-K filed on February 9, 2006).*
|
10.36
|
Stock
Purchase Agreement, dated as of July 3, 2007, between the Company and
Country Road Communications LLC (filed as Exhibit 2.1 to the Company’s
Current Report on Form 8-K filed on July 9, 2007).*
|
12.1
|
Computation
of ratio of earnings to fixed charges (this item is included herein for
the sole purpose of incorporation by
reference).
|
21.1
|
Subsidiaries
of the Registrant.
|
23.1
|
Auditors'
Consent.
|
31.1
|
Certification
of Principal Executive Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934 (the “1934
Act”).
|
58
31.2
|
Certification
of Principal Financial Officer pursuant to Rule 13a-14(a) under the 1934
Act.
|
32.1
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(“SOXA”).
|
32.2
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of
SOXA.
|
Exhibits
10.12 through 10.34 are management contracts or compensatory plans or
arrangements.
59
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
FRONTIER COMMUNICATIONS
CORPORATION
|
|
(Registrant)
|
|
By:
/s/ Mary Agnes
Wilderotter
|
|
Mary
Agnes Wilderotter
|
|
Chairman
of the Board, President and Chief Executive Officer
|
|
February
26, 2010
|
60
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
the 26th day of February 2010.
Signature
|
Title
|
|
/s/
Leroy T. Barnes, Jr.
|
Director
|
|
(Leroy
T. Barnes, Jr.)
|
||
/s/
Peter C. B. Bynoe
|
Director
|
|
(Peter
C. B. Bynoe)
|
||
/s/
Jeri B. Finard
|
Director
|
|
(Jeri
B. Finard)
|
||
/s/
Lawton W. Fitt
|
Director
|
|
(Lawton
W. Fitt)
|
||
/s/
William M. Kraus
|
Director
|
|
(William
M. Kraus)
|
||
/s/
Robert J. Larson
|
Senior
Vice President and Chief Accounting Officer
|
|
(Robert
J. Larson)
|
||
/s/
Howard L. Schrott
|
Director
|
|
(Howard
L. Schrott)
|
||
/s/
Larraine D. Segil
|
Director
|
|
(Larraine
D. Segil)
|
||
/s/
Donald R. Shassian
|
Executive
Vice President and Chief Financial Officer
|
|
(Donald
R. Shassian)
|
||
/s/
David H. Ward
|
Director
|
|
(David
H. Ward)
|
||
/s/
Myron A. Wick III
|
Director
|
|
(Myron
A. Wick III)
|
||
/s/
Mary Agnes Wilderotter
|
Chairman
of the Board, President and Chief Executive Officer
|
|
(Mary
Agnes Wilderotter)
|
||
61
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Index to
Consolidated Financial Statements
Item
|
Page
|
Management’s
Report on Internal Control Over Financial Reporting
|
F-2
|
Reports
of Independent Registered Public Accounting Firm
|
F-3
and F-4
|
Consolidated
Balance Sheets as of December 31, 2009 and 2008
|
F-5
|
Consolidated
Statements of Operations for the years ended
December
31, 2009, 2008 and 2007
|
F-6
|
Consolidated
Statements of Equity for the years ended
December
31, 2009, 2008 and 2007
|
F-7
|
Consolidated
Statements of Comprehensive Income for the years ended
December
31, 2009, 2008 and 2007
|
F-8
|
Consolidated
Statements of Cash Flows for the years ended
December
31, 2009, 2008 and 2007
|
F-9
|
Notes
to Consolidated Financial Statements
|
F-10
|
F-1
Management’s Report On
Internal Control Over Financial Reporting
The Board
of Directors and Shareholders
Frontier
Communications Corporation:
The
management of Frontier Communications Corporation and subsidiaries is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and
15d-15(f).
Under the
supervision and with the participation of our management, we conducted an
evaluation of the effectiveness of our internal control over financial reporting
based on the framework in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
evaluation our management concluded that our internal control over financial
reporting was effective as of December 31, 2009 and for the period then
ended.
Our
independent registered public accounting firm, KPMG LLP, has audited the
consolidated financial statements included in this report and, as part of their
audit, has issued their report, included herein, on the effectiveness of our
internal control over financial reporting.
Stamford,
Connecticut
February
26, 2010
F-2
Report Of Independent
Registered Public Accounting Firm
The Board
of Directors and Shareholders
Frontier
Communications Corporation:
We have
audited the accompanying consolidated balance sheets of Frontier Communications
Corporation and subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of operations, equity, comprehensive income and
cash flows for each of the years in the three-year period ended
December 31, 2009. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Frontier Communications
Corporation and subsidiaries as of December 31, 2009 and 2008 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2009, in conformity with U.S.
generally accepted accounting principles.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Frontier Communications Corporation’s internal
control over financial reporting as of December 31, 2009, based on criteria
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO), and our report dated
February 26, 2010 expressed an unqualified opinion on the effectiveness of
the Company’s internal control over financial reporting.
/s/
KPMG LLP
|
|
Stamford,
Connecticut
|
|
February 26,
2010
|
F-3
Report Of Independent
Registered Public Accounting Firm
The Board
of Directors and Shareholders
Frontier
Communications Corporation:
We have
audited Frontier Communications Corporation’s internal control over financial
reporting as of December 31, 2009, based on criteria established in
Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Frontier Communications
Corporation’s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, included in the accompanying
Management’s Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, Frontier Communications Corporation maintained, in all material
respects, effective internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Frontier
Communications Corporation and subsidiaries as of December 31, 2009 and
2008, and the related consolidated statements of operations, equity,
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 2009, and our report dated February 26, 2010
expressed an unqualified opinion on those consolidated financial
statements.
/s/
KPMG LLP
|
|
Stamford,
Connecticut
|
|
February 26,
2010
|
F-4
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
AS
OF DECEMBER 31, 2009 AND 2008
($
in thousands)
2009
|
2008
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 358,693 | $ | 163,627 | ||||
Accounts
receivable, less allowances of $30,171 and $40,125,
respectively
|
190,745 | 222,247 | ||||||
Prepaid
expenses
|
28,081 | 33,265 | ||||||
Income
taxes
|
102,561 | 48,820 | ||||||
Total
current assets
|
680,080 | 467,959 | ||||||
Property,
plant and equipment, net
|
3,133,521 | 3,239,973 | ||||||
Goodwill,
net
|
2,642,323 | 2,642,323 | ||||||
Other
intangibles, net
|
247,527 | 359,674 | ||||||
Other
assets
|
174,804 | 178,747 | ||||||
Total
assets
|
$ | 6,878,255 | $ | 6,888,676 | ||||
LIABILITIES AND EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Long-term
debt due within one year
|
$ | 7,236 | $ | 3,857 | ||||
Accounts
payable
|
139,556 | 141,940 | ||||||
Advanced
billings
|
49,589 | 51,225 | ||||||
Other
taxes accrued
|
28,750 | 25,585 | ||||||
Interest
accrued
|
107,119 | 102,370 | ||||||
Other
current liabilities
|
60,427 | 57,798 | ||||||
Total
current liabilities
|
392,677 | 382,775 | ||||||
Deferred
income taxes
|
722,192 | 670,489 | ||||||
Other
liabilities
|
630,187 | 584,121 | ||||||
Long-term
debt
|
4,794,129 | 4,721,685 | ||||||
Equity:
|
||||||||
Shareholders'
equity of Frontier:
|
||||||||
Common stock, $0.25 par value (600,000,000 authorized shares; 312,328,000
and 311,314,000
|
||||||||
outstanding,
respectively, and 349,456,000 issued at December 31, 2009 and
2008)
|
87,364 | 87,364 | ||||||
Additional
paid-in capital
|
956,401 | 1,117,936 | ||||||
Retained
earnings
|
2,756 | 38,163 | ||||||
Accumulated
other comprehensive loss, net of tax
|
(245,519 | ) | (237,152 | ) | ||||
Treasury
stock
|
(473,391 | ) | (487,266 | ) | ||||
Total
shareholders' equity of Frontier
|
327,611 | 519,045 | ||||||
Noncontrolling
interest in a partnership
|
11,459 | 10,561 | ||||||
Total
equity
|
339,070 | 529,606 | ||||||
Total
liabilities and equity
|
$ | 6,878,255 | $ | 6,888,676 | ||||
The
accompanying Notes are an integral part of these Consolidated Financial
Statements
F-5
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
($
in thousands, except for per-share amounts)
2009
|
2008
|
2007
|
||||||||||
Revenue
|
$ | 2,117,894 | $ | 2,237,018 | $ | 2,288,015 | ||||||
Operating
expenses:
|
||||||||||||
Network
access expenses
|
225,907 | 222,013 | 228,242 | |||||||||
Other
operating expenses
|
781,097 | 810,748 | 808,501 | |||||||||
Depreciation
and amortization
|
476,391 | 561,801 | 545,856 | |||||||||
Acquisition
and integration costs
|
28,334 | - | - | |||||||||
Total
operating expenses
|
1,511,729 | 1,594,562 | 1,582,599 | |||||||||
Operating
income
|
606,165 | 642,456 | 705,416 | |||||||||
Investment
income
|
6,285 | 16,118 | 37,641 | |||||||||
Other
income (loss), net
|
(41,127 | ) | (5,170 | ) | (17,833 | ) | ||||||
Interest
expense
|
378,214 | 362,634 | 380,696 | |||||||||
Income
before income taxes
|
193,109 | 290,770 | 344,528 | |||||||||
Income
tax expense
|
69,928 | 106,496 | 128,014 | |||||||||
Net
income
|
123,181 | 184,274 | 216,514 | |||||||||
Less:
Income attributable to the noncontrolling
|
||||||||||||
interest
in a partnership
|
2,398 | 1,614 | 1,860 | |||||||||
Net
income attributable to common shareholders
|
||||||||||||
of
Frontier
|
$ | 120,783 | $ | 182,660 | $ | 214,654 | ||||||
Basic
and diluted income per common share
|
||||||||||||
attributable
to common shareholders of Frontier
|
$ | 0.38 | $ | 0.57 | $ | 0.64 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
F-6
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF EQUITY
FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
($
and shares in thousands, except for per-share amounts)
Frontier
Shareholders
|
||||||||||||||||||||||||||||||||||
Accumulated
|
||||||||||||||||||||||||||||||||||
Additional
|
Other
|
|||||||||||||||||||||||||||||||||
Common
Stock
|
Paid-In
|
Retained
|
Comprehensive
|
Treasury
Stock
|
Noncontrolling
|
Total
|
||||||||||||||||||||||||||||
Shares
|
Amount
|
Capital
|
Earnings
|
Loss
|
Shares
|
Amount
|
Interest
|
Equity
|
||||||||||||||||||||||||||
Balance
December 31, 2006
|
343,956 | $ | 85,989 | $ | 1,207,399 | $ | 134,705 | $ | (81,899 | ) | (21,691 | ) | $ | (288,162 | ) | $ | 10,587 | $ | 1,068,619 | |||||||||||||||
Stock
plans
|
- | - | (6,237 | ) | 667 | - | 1,824 | 25,399 | - | 19,829 | ||||||||||||||||||||||||
Acquisition
of Commonwealth
|
5,500 | 1,375 | 77,939 | - | - | 12,640 | 168,121 | - | 247,435 | |||||||||||||||||||||||||
Conversion
of EPPICS
|
- | - | (549 | ) | - | - | 291 | 3,888 | - | 3,339 | ||||||||||||||||||||||||
Conversion
of Commonwealth notes
|
- | - | 1,956 | - | - | 2,508 | 34,775 | - | 36,731 | |||||||||||||||||||||||||
Dividends
on common stock of
|
||||||||||||||||||||||||||||||||||
$1.00
per share
|
- | - | - | (336,025 | ) | - | - | - | - | (336,025 | ) | |||||||||||||||||||||||
Shares
repurchased
|
- | - | - | - | - | (17,279 | ) | (250,000 | ) | - | (250,000 | ) | ||||||||||||||||||||||
Net
income
|
- | - | - | 214,654 | - | - | - | 1,860 | 216,514 | |||||||||||||||||||||||||
Other
comprehensive income, net of tax
|
||||||||||||||||||||||||||||||||||
and
reclassification adjustments
|
- | - | - | - | 3,904 | - | - | - | 3,904 | |||||||||||||||||||||||||
Balance
December 31, 2007
|
349,456 | 87,364 | 1,280,508 | 14,001 | (77,995 | ) | (21,707 | ) | (305,979 | ) | 12,447 | 1,010,346 | ||||||||||||||||||||||
Stock
plans
|
- | - | (1,759 | ) | - | - | 1,096 | 15,544 | - | 13,785 | ||||||||||||||||||||||||
Acquisition
of Commonwealth
|
- | - | 1 | - | - | 3 | 38 | - | 39 | |||||||||||||||||||||||||
Conversion
of EPPICS
|
- | - | (74 | ) | - | - | 51 | 664 | - | 590 | ||||||||||||||||||||||||
Conversion
of Commonwealth notes
|
- | - | (801 | ) | - | - | 193 | 2,467 | - | 1,666 | ||||||||||||||||||||||||
Dividends
on common stock of
|
||||||||||||||||||||||||||||||||||
$1.00
per share
|
- | - | (159,939 | ) | (158,498 | ) | - | - | - | - | (318,437 | ) | ||||||||||||||||||||||
Shares
repurchased
|
- | - | - | - | - | (17,778 | ) | (200,000 | ) | - | (200,000 | ) | ||||||||||||||||||||||
Net
income
|
- | - | - | 182,660 | - | - | - | 1,614 | 184,274 | |||||||||||||||||||||||||
Other
comprehensive loss, net of tax
|
||||||||||||||||||||||||||||||||||
and
reclassification adjustments
|
- | - | - | - | (159,157 | ) | - | - | - | (159,157 | ) | |||||||||||||||||||||||
Distributions
|
- | - | - | - | - | - | - | (3,500 | ) | (3,500 | ) | |||||||||||||||||||||||
Balance
December 31, 2008
|
349,456 | 87,364 | 1,117,936 | 38,163 | (237,152 | ) | (38,142 | ) | (487,266 | ) | 10,561 | 529,606 | ||||||||||||||||||||||
Stock
plans
|
- | - | (5,359 | ) | - | - | 1,014 | 13,875 | - | 8,516 | ||||||||||||||||||||||||
Dividends
on common stock of
|
||||||||||||||||||||||||||||||||||
$1.00
per share
|
- | - | (156,176 | ) | (156,190 | ) | - | - | - | - | (312,366 | ) | ||||||||||||||||||||||
Net
income
|
- | - | - | 120,783 | - | - | - | 2,398 | 123,181 | |||||||||||||||||||||||||
Other
comprehensive income, net of tax
|
||||||||||||||||||||||||||||||||||
and
reclassification adjustments
|
- | - | - | - | (8,367 | ) | - | - | - | (8,367 | ) | |||||||||||||||||||||||
Distributions
|
- | - | - | - | - | - | - | (1,500 | ) | (1,500 | ) | |||||||||||||||||||||||
Balance
December 31, 2009
|
349,456 | $ | 87,364 | $ | 956,401 | $ | 2,756 | $ | (245,519 | ) | (37,128 | ) | $ | (473,391 | ) | $ | 11,459 | $ | 339,070 | |||||||||||||||
F-7
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
($
in thousands)
2009
|
2008
|
2007
|
||||||||||
Net
income
|
$ | 123,181 | $ | 184,274 | $ | 216,514 | ||||||
Other
comprehensive income (loss), net of tax
|
||||||||||||
and
reclassification adjustments (see Note 16)
|
(8,367 | ) | (159,157 | ) | 3,904 | |||||||
Comprehensive
income
|
114,814 | 25,117 | 220,418 | |||||||||
Less:
Comprehensive income attributable to
|
||||||||||||
the
noncontrolling interest in a partnership
|
2,398 | 1,614 | 1,860 | |||||||||
Comprehensive
income attributable to the common
|
||||||||||||
shareholders
of Frontier
|
$ | 112,416 | $ | 23,503 | $ | 218,558 | ||||||
The
accompanying Notes are an integral part of these Consolidated Financial
Statements.
F-8
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
($
in thousands)
2009
|
2008
|
2007
|
||||||||||
Cash
flows provided by (used in) operating activities:
|
||||||||||||
Net
income
|
$ | 123,181 | $ | 184,274 | $ | 216,514 | ||||||
Adjustments
to reconcile net income to net cash provided by
|
||||||||||||
operating
activities:
|
||||||||||||
Depreciation
and amortization expense
|
476,391 | 561,801 | 545,856 | |||||||||
Stock
based compensation expense
|
9,368 | 7,788 | 9,022 | |||||||||
Pension
expense
|
34,196 | 163 | (14,608 | ) | ||||||||
Loss
on extinguishment of debt, net
|
45,939 | 6,290 | 20,186 | |||||||||
Other
non-cash adjustments
|
2,080 | (8,658 | ) | (9,458 | ) | |||||||
Deferred
income taxes
|
61,217 | 33,967 | 81,011 | |||||||||
Legal
settlement
|
- | - | (7,905 | ) | ||||||||
Change
in accounts receivable
|
21,906 | 9,746 | (4,714 | ) | ||||||||
Change
in accounts payable and other liabilities
|
13,297 | (52,210 | ) | (21,649 | ) | |||||||
Change
in prepaid expenses and income taxes
|
(44,855 | ) | (3,895 | ) | 7,428 | |||||||
Net
cash provided by operating activities
|
742,720 | 739,266 | 821,683 | |||||||||
Cash
flows provided from (used by) investing activities:
|
||||||||||||
Capital
expenditures - Business operations
|
(230,966 | ) | (288,264 | ) | (306,203 | ) | ||||||
Capital
expenditures - Integration activities
|
(24,999 | ) | - | (9,590 | ) | |||||||
Cash
paid for acquisitions (net of cash acquired)
|
- | - | (725,548 | ) | ||||||||
Other
assets purchased and distributions received, net
|
673 | 5,489 | 6,629 | |||||||||
Net
cash used by investing activities
|
(255,292 | ) | (282,775 | ) | (1,034,712 | ) | ||||||
Cash
flows provided from (used by) financing activities:
|
||||||||||||
Long-term
debt borrowings
|
1,117,476 | 135,000 | 950,000 | |||||||||
Financing
costs paid
|
(2,204 | ) | (857 | ) | (12,196 | ) | ||||||
Long-term
debt payments
|
(1,027,408 | ) | (142,480 | ) | (946,070 | ) | ||||||
Premium
paid to retire debt
|
(66,868 | ) | (6,290 | ) | (20,186 | ) | ||||||
Settlement
of interest rate swaps
|
- | 15,521 | - | |||||||||
Issuance
of common stock
|
751 | 1,398 | 13,808 | |||||||||
Common
stock repurchased
|
- | (200,000 | ) | (250,000 | ) | |||||||
Dividends
paid
|
(312,366 | ) | (318,437 | ) | (336,025 | ) | ||||||
Repayment
of customer advances for construction
|
||||||||||||
and
distributions to noncontrolling interests
|
(1,743 | ) | (3,185 | ) | (942 | ) | ||||||
Net
cash used by financing activities
|
(292,362 | ) | (519,330 | ) | (601,611 | ) | ||||||
Increase
(decrease) in cash and cash equivalents
|
195,066 | (62,839 | ) | (814,640 | ) | |||||||
Cash
and cash equivalents at January 1,
|
163,627 | 226,466 | 1,041,106 | |||||||||
Cash
and cash equivalents at December 31,
|
$ | 358,693 | $ | 163,627 | $ | 226,466 | ||||||
Cash
paid during the period for:
|
||||||||||||
Interest
|
$ | 364,167 | $ | 365,858 | $ | 364,381 | ||||||
Income
taxes
|
$ | 59,735 | $ | 78,878 | $ | 54,407 | ||||||
Non-cash
investing and financing activities:
|
||||||||||||
Change
in fair value of interest rate swaps
|
$ | - | $ | 7,909 | $ | 18,198 | ||||||
Conversion
of EPPICS
|
$ | - | $ | 590 | $ | 3,339 | ||||||
Conversion
of Commonwealth notes
|
$ | - | $ | 1,666 | $ | 36,731 | ||||||
Shares
issued for Commonwealth acquisition
|
$ | - | $ | 39 | $ | 247,435 | ||||||
Acquired
debt
|
$ | - | $ | - | $ | 244,570 | ||||||
Other
acquired liabilities
|
$ | - | $ | - | $ | 112,194 | ||||||
The
accompanying Notes are an integral part of these Consolidated Financial
Statements.
F-9
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
(1)
|
Description of
Business and Summary of Significant Accounting
Policies:
|
(a) Description of Business:
Frontier
Communications Corporation (formerly known as Citizens Communications Company
through July 30, 2008) and its subsidiaries are referred to as “we,” “us,”
“our,” or the “Company” in this report. We are a communications company
providing services to rural areas and small and medium-sized towns and cities as
an incumbent local exchange carrier, or ILEC.
(b) Basis of Presentation and Use of
Estimates:
Our
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America (U.S.
GAAP). Certain reclassifications of balances previously reported have been made
to conform to the current presentation. All significant intercompany balances
and transactions have been eliminated in consolidation.
Our
consolidated financial statements have been adjusted on a retrospective basis to
reflect the adoption of two new accounting standards: Accounting Standards
Codification (ASC) Topic 810, (formerly Statement of Financial Accounting
Standards (SFAS) No. 160, “Noncontrolling Interests in Consolidated Financial
Statements”) and ASC Topic 260 (formerly FASB Staff Position (FSP) EITF No.
03-6-1, “Determining Whether Instruments Granted in Share-Based Payment
Transactions are Participating Securities.”) The prior period data for 2008 and
2007 presented in these consolidated financial statements and notes herein have
been adjusted retrospectively in accordance with ASC Topic 810 and ASC Topic
260. See Note 2 for further discussion.
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. Actual results may differ from
those estimates. Estimates and judgments are used when accounting for
allowance for doubtful accounts, impairment of long-lived assets, intangible
assets, depreciation and amortization, income taxes, purchase price allocations,
contingencies, and pension and other postretirement benefits, among
others.
(c) Cash
Equivalents:
We consider all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
(d) Revenue
Recognition:
Revenue
is recognized when services are provided or when products are delivered to
customers. Revenue that is billed in advance includes: monthly recurring network
access services, special access services and monthly recurring local line and
unlimited fixed long-distance bundle charges. The unearned portion of these fees
are 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 are
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.
F-10
The
Company collects various taxes from its customers and subsequently remits such
funds to governmental authorities. Substantially all of these taxes are recorded
through the consolidated balance sheet and presented on a net basis in our
consolidated statements of operations. We also collect Universal Service Fund
(USF) surcharges from customers (primarily federal USF) which we have recorded
on a gross basis in our consolidated statements of operations and included in
revenue and other operating expenses at $35.5 million, $37.1 million and $35.9
million for the years ended December 31, 2009, 2008 and 2007,
respectively.
(e) Property, Plant and
Equipment:
Property,
plant and equipment are stated at original cost or fair market value for our
acquired properties, including capitalized interest. Maintenance and repairs are
charged to operating expenses as incurred. The gross book value of routine
property, plant and equipment retired is charged against accumulated
depreciation.
(f) Goodwill and Other
Intangibles:
Intangibles
represent the excess of purchase price over the fair value of identifiable
tangible net assets acquired. We undertake studies to determine the
fair values of assets and liabilities acquired and allocate purchase prices to
assets and liabilities, including property, plant and equipment, goodwill and
other identifiable intangibles. We annually (during the fourth
quarter) or more frequently, if appropriate, examine the carrying value of our
goodwill and trade name to determine whether there are any impairment
losses. We test for goodwill impairment at the “operating segment”
level, as that term is defined in ASC Topic 350 (formerly Statement of Financial
Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible
Assets”). The Company revised its management and operating structure
during the first quarter of 2009 and now has three “operating
segments.” Our “operating segments” are aggregated into one
reportable segment.
(g) Impairment of Long-Lived
Assets and Long-Lived Assets to Be Disposed Of:
We review
long-lived assets to be held and used and long-lived assets to be disposed of,
including customer lists, 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.
(h) Derivative Instruments and
Hedging Activities:
We
account for derivative instruments and hedging activities in accordance with ASC
815 (formerly SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities”) ASC 815 requires that all derivative instruments, such as
interest rate swaps, be recognized in the financial statements and measured at
fair value regardless of the purpose or intent of holding them.
(i) Investments:
Investments
in entities that we do not control, but where we have the ability to exercise
significant influence over operating and financial policies, are accounted for
using the equity method of accounting.
(j) Income Taxes and Deferred
Income Taxes:
We file a
consolidated federal income tax return. We utilize the asset and liability
method of accounting for income taxes. Under the asset and liability method,
deferred income taxes are recorded for the tax effect of temporary differences
between the financial statement basis and the tax basis of assets and
liabilities using tax rates expected to be in effect when the temporary
differences are expected to reverse.
F-11
(k) Stock
Plans:
We have
various stock-based compensation plans. Awards under these plans are granted to
eligible officers, management employees, non-management employees and
non-employee directors. Awards may be made in the form of incentive stock
options, non-qualified stock options, stock appreciation rights, restricted
stock, restricted stock units or other stock-based awards. We have no awards
with market or performance conditions. Our general policy is to issue shares
upon the grant of restricted shares and exercise of options from
treasury.
The
compensation cost recognized is based on awards ultimately expected to vest. ASC
Topic 718 requires forfeitures to be estimated and revised, if necessary, in
subsequent periods if actual forfeitures differ from those
estimates.
(l) Net Income Per Common Share
Attributable to Common Shareholders:
Basic net
income per common share is computed using the weighted average number of common
shares outstanding during the period being reported on, excluding unvested
restricted stock awards. The impact of dividends paid on unvested restricted
stock awards have been deducted in the determination of basic and diluted net
income attributable to common shareholders of Frontier. Except when the effect
would be antidilutive, diluted net income per common share reflects the dilutive
effect of the assumed exercise of stock options using the treasury stock method
at the beginning of the period being reported on as well as common shares that
would result from the conversion of convertible preferred stock (EPPICS) and
convertible notes. In addition, the related interest on convertible debt (net of
tax) is added back to income since it would not be paid if the debt was
converted to common stock.
(2) Recent Accounting Literature
and Changes in Accounting Principles:
Fair Value
Measurements
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(currently ASC Topic 820), which defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value measurements. In
February 2008, the FASB amended SFAS No. 157 (ASC Topic 820) to defer the
application of this standard to nonfinancial assets and liabilities until 2009.
The provisions of SFAS No. 157 (ASC Topic 820) related to financial assets and
liabilities were effective as of the beginning of 2008. Our partial adoption of
SFAS No. 157 (ASC Topic 820) in the first quarter of 2008 had no impact on our
financial position, results of operations or cash flows. The adoption of SFAS
No. 157 (ASC Topic 820), as amended, in the first quarter of 2009 with respect
to its effect on nonfinancial assets and liabilities had no impact on our
financial position, results of operations or cash flows.
Business
Combinations
In
December 2007, the FASB revised SFAS No. 141, “Business Combinations”
(currently ASC Topic 805). The revised statement, SFAS No. 141R (ASC
Topic 805), as amended by FSP SFAS No. 141(R)-1 (ASC Topic 805), requires an
acquiring entity to recognize all the assets acquired and liabilities assumed in
a transaction at the acquisition date at fair value, to recognize and measure
preacquisition contingencies, including contingent consideration, at fair value
(if possible), to remeasure liabilities related to contingent consideration at
fair value in each subsequent reporting period and to expense all acquisition
related costs. The effective date of SFAS No. 141R (ASC Topic 805) was for
business combinations for which the acquisition date was on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008. We will account for our pending acquisition
of approximately 4.2 million access lines (as of December 31, 2009) from Verizon
Communications Inc. (Verizon) using the guidance included in SFAS No. 141R (ASC
Topic 805). For the year ended December 31, 2009, we incurred
approximately $28.3 million of acquisition and integration costs in connection
with our pending acquisition from Verizon. In accordance with SFAS
No. 141R (ASC Topic 805), such costs are required to be expensed as incurred and
are reflected in “Acquisition and integration costs” in our consolidated
statements of operations.
F-12
Noncontrolling Interests in
Consolidated Financial Statements
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (currently ASC Topic 810). SFAS
No. 160 (ASC Topic 810) establishes requirements for ownership interest in
subsidiaries held by parties other than the Company (sometimes called “minority
interest”) be clearly identified, presented and disclosed in the consolidated
statement of financial position within equity, but separate from the parent’s
equity. All changes in the parent’s ownership interest are required to be
accounted for consistently as equity transactions and any noncontrolling equity
investments in unconsolidated subsidiaries must be measured initially at fair
value. SFAS No. 160 (ASC Topic 810) was effective, on a prospective basis, for
fiscal years beginning after December 15, 2008. However, presentation and
disclosure requirements must be retrospectively applied to comparative financial
statements. The adoption of SFAS No. 160 (ASC Topic 810) in the first quarter of
2009 did not have a material impact on our financial position, results of
operations or cash flows.
Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities
In June
2008, the FASB ratified FSP EITF No. 03-6-1, “Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities” (currently ASC Topic 260). FSP EITF No. 03-6-1 (ASC Topic
260) addresses whether instruments granted in share-based payment transactions
are participating securities prior to vesting and, therefore, should be included
in the earnings allocation in computing earnings per share under the two-class
method. FSP EITF No. 03-6-1 (ASC Topic 260) was effective, on a
retrospective basis, for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those years. Our
outstanding non-vested restricted stock is a participating security in
accordance with FSP EITF No. 03-6-1 (ASC Topic 260) and we have adjusted our
previously reported basic and diluted income per common share. The adoption of
FSP EITF No. 03-6-1 (ASC Topic 260) in the first quarter of 2009 did not have a
material impact on our basic and diluted income per common share.
Employers’ Disclosures about Postretirement
Benefit Plan Assets
In
December 2008, the FASB issued FSP SFAS No. 132 (R)-1, “Employers’ Disclosures
about Postretirement Benefit Plan Assets” (currently ASC Topic 715). FSP SFAS
No. 132(R)-1 (ASC Topic 715) amends SFAS No. 132, “Employers’ Disclosures
about Pensions and Other Postretirement Benefits,” (ASC Topic 230) to provide
guidance on an employers’ disclosures about plan assets of a defined benefit
pension or other postretirement plan. FSP SFAS No. 132(R)-1 (ASC Topic 715)
requires additional disclosures about investment policies and strategies,
categories of plan assets, fair value measurements of plan assets and
significant concentrations of risk. The disclosures about plan assets required
by FSP SFAS No. 132(R)-1 (ASC Topic 715) are effective for fiscal years ending
after December 15, 2009. The adoption of the disclosure requirements of FSP
SFAS No. 132(R)-1 (ASC Topic 715) in 2009 did not have a material impact on our
financial position, results of operations or cash flows.
Subsequent
Events
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (currently ASC
Topic 855), which establishes general standards of accounting for and disclosure
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. In particular, SFAS No. 165
(ASC Topic 855) sets forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. SFAS No. 165 (ASC Topic 855)
was effective for interim or annual reporting periods ending after June 15,
2009. The adoption of SFAS No. 165 (ASC Topic 855) in the second
quarter of 2009 had no impact on our financial position, results of operations
or cash flows.
F-13
Accounting Standards
Codification
In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principals” (currently ASC
Topic 105). SFAS No. 168 (ASC Topic 105) replaces the guidance that previously
existed in SFAS No. 162, entitled “The Hierarchy of Generally Accepted
Accounting Principals” and designates the FASB Accounting Standards Codification
as the sole source of authoritative accounting technical literature for
nongovernmental entities. All accounting guidance that is not included in the
Accounting Standards Codification is now considered to be non-authoritative.
SFAS No. 168 (ASC Topic 105) was effective for financial statements issued for
interim and annual periods ending after September 15, 2009. The adoption of SFAS
No. 168 (ASC Topic 105) in the third quarter of 2009 had no impact on our
financial position, results of operations or cash flows.
(3) Acquisitions:
Pending
Acquisition:
On May
13, 2009, we entered into a definitive agreement with Verizon under which
Frontier will acquire defined assets and liabilities of the local exchange
business and related landline activities of Verizon, including Internet access
and long distance services and broadband video provided to designated customers.
Assuming that the merger occurred on December 31, 2009, the merger would have
resulted in Frontier acquiring approximately 4.2 million access lines and
certain business related assets from Verizon. The Verizon Transaction will be
financed with approximately $5.3 billion of common stock plus the assumption of
approximately $3.33 billion in debt. Certain of the conditions to the
closing of the Verizon Transaction have already been met: (1) Frontier’s
shareholders approved the Verizon Transaction at a special meeting of
shareholders held on October 27, 2009; (2) the Federal Trade Commission has
granted early termination of the waiting period under the Hart-Scott-Rodino Act;
(3) approvals of all necessary local video franchise authorities (subject to the
satisfaction of certain conditions); (4) receipt by Verizon of a favorable
ruling from the IRS regarding the tax consequences of the Verizon Transaction;
and (5) five of the nine required state regulatory
approvals. Completion of the Verizon Transaction remains subject to a
number of other conditions, including the receipt of the remaining four state
regulatory approvals, approval from the FCC, the completion of financing, on
terms that satisfy certain conditions as well as other customary closing
conditions. Subject to satisfaction of these conditions, we anticipate
closing this transaction during the second quarter of 2010.
Acquisitions of Commonwealth Telephone and
Global Valley Networks
On
March 8, 2007, we acquired Commonwealth Telephone Enterprises, Inc.
(“Commonwealth” or “CTE”) in a cash-and-stock taxable transaction, for a total
consideration of approximately $1.1 billion. We paid $804.1 million in cash
($663.7 million net, after cash acquired) and issued common stock with a value
of $249.8 million.
On
October 31, 2007, we acquired Global Valley Networks, Inc. and GVN Services
(together GVN) through the purchase from Country Road Communications, LLC of
100% of the outstanding common stock of Evans Telephone Holdings, Inc., the
parent Company of GVN. The purchase price of $62.0 million was paid with cash on
hand.
We have
accounted for the acquisitions of Commonwealth and GVN as purchases under U.S.
GAAP. Under the purchase method of accounting, the assets and liabilities of
Commonwealth and GVN were recorded as of their respective acquisition dates, at
their respective fair values, and consolidated with those of
Frontier.
F-14
The
following schedule provides a summary of the final purchase price paid by
Frontier in the acquisitions of Commonwealth and GVN:
($ in
thousands)
|
||||||||
Commonwealth
|
GVN
|
|||||||
Cash
paid
|
$ | 804,554 | $ | 62,001 | ||||
Value of
Frontier common stock issued
|
249,804 | - | ||||||
Total Purchase
Price
|
$ | 1,054,358 | $ | 62,001 | ||||
With
respect to our acquisitions of Commonwealth and GVN, the purchase price has been
allocated based on fair values to the net tangible and intangible assets
acquired and liabilities assumed. The final allocations were as
follows:
($ in thousands)
|
||||||||
Commonwealth
|
GVN
|
|||||||
Allocation
of purchase price:
|
||||||||
Current
assets (1)
|
$ | 187,986 | $ | 1,581 | ||||
Property,
plant and equipment
|
387,343 | 23,578 | ||||||
Goodwill
|
690,262 | 34,311 | ||||||
Other
intangibles
|
273,800 | 7,250 | ||||||
Other
assets
|
11,285 | 812 | ||||||
Current
portion of debt
|
(35,000 | ) | (17 | ) | ||||
Accounts
payable and other current liabilities
|
(80,375 | ) | (626 | ) | ||||
Deferred
income taxes
|
(143,539 | ) | (3,740 | ) | ||||
Convertible
notes
|
(209,553 | ) | - | |||||
Other
liabilities
|
(27,851 | ) | (1,148 | ) | ||||
Total
Purchase Price
|
$ | 1,054,358 | $ | 62,001 | ||||
(1) Includes
$140.6 million of total acquired cash.
The
following unaudited pro forma financial information presents the combined
results of operations of Frontier, Commonwealth and GVN as if the acquisitions
had occurred at the beginning of 2007. The historical results of the Company
include the results of Commonwealth from the date of its acquisition on
March 8, 2007, and GVN from the date of its acquisition on October 31,
2007. The pro forma information is not necessarily indicative of what the
financial position or results of operations actually would have been had the
acquisitions been completed at the beginning of 2007. In addition, the unaudited
pro forma financial information does not purport to project the future financial
position or operating results of Frontier after completion of the
acquisitions.
F-15
2007
|
||||
($ in
thousands, except per share amounts)
|
||||
Revenue
|
$ | 2,362,695 | ||
Operating
income
|
$ | 720,476 | ||
Net
income attributable to common shareholders
|
||||
of
Frontier
|
$ | 218,428 | ||
Basic
and diluted income per common share
|
$ | 0.65 |
(4)
|
Property, Plant and
Equipment:
|
The
components of property, plant and equipment at December 31, 2009 and 2008
are as follows:
Estimated
|
||||||||||||
($
in thousands)
|
Useful
Lives
|
2009
|
2008
|
|||||||||
Land
|
N/A | $ | 22,416 | $ | 22,631 | |||||||
Buildings and
leasehold improvements
|
41
years
|
348,002 | 344,839 | |||||||||
General
support
|
5
to 17 years
|
517,958 | 508,825 | |||||||||
Central
office/electronic circuit equipment
|
5
to 11 years
|
3,042,665 | 2,959,440 | |||||||||
Cable
and wire
|
15
to 60 years
|
3,730,998 | 3,623,193 | |||||||||
Other
|
20
to 30 years
|
24,368 | 24,703 | |||||||||
Construction
work in progress
|
116,655 | 97,429 | ||||||||||
7,803,062 | 7,581,060 | |||||||||||
Less:
Accumulated depreciation
|
(4,669,541 | ) | (4,341,087 | ) | ||||||||
Property, plant
and equipment, net
|
$ | 3,133,521 | $ | 3,239,973 | ||||||||
|
Depreciation
expense is principally based on the composite group method. Depreciation
expense was $362.2 million, $379.5 million and $374.4 million for the
years ended December 31, 2009, 2008 and 2007, respectively. Effective
with the completion of an independent study of the estimated useful lives
of our plant assets we adopted new lives beginning October 1,
2009.
|
(5)
|
Accounts
Receivable:
|
The
components of accounts receivable, net at December 31, 2009 and 2008 are as
follows:
($ in
thousands)
|
2009
|
2008
|
||||||
End
user
|
$ | 205,384 | $ | 244,395 | ||||
Other
|
15,532 | 17,977 | ||||||
Less: Allowance
for doubtful accounts
|
(30,171 | ) | (40,125 | ) | ||||
Accounts
receivable, net
|
$ | 190,745 | $ | 222,247 | ||||
F-16
An
analysis of the activity in the allowance for doubtful accounts for the years
ended December 31, 2009, 2008 and 2007 is as follows:
Additions
|
||||||||||||||||||||||||
Balance
at
|
Balance
of
|
Charged
to
|
Charged
to other
|
Balance
at
|
||||||||||||||||||||
beginning
of
|
acquired
|
bad
debt
|
accounts
-
|
end
of
|
||||||||||||||||||||
Allowance for
doubtful accounts
|
Period
|
properties
|
expense*
|
Revenue
|
Deductions
|
Period
|
||||||||||||||||||
2007
|
$ | 108,537 | $ | 1,499 | $ | 31,131 | $ | (77,898 | ) | $ | 30,521 | $ | 32,748 | |||||||||||
2008
|
$ | 32,748 | $ | 1,150 | $ | 31,700 | $ | 2,352 | $ | 27,825 | $ | 40,125 | ||||||||||||
2009
|
$ | 40,125 | $ | - | $ | 33,682 | $ | (6,181 | ) | $ | 37,455 | $ | 30,171 |
*
|
Such amounts are included in bad debt expense and for financial reporting
purposes are classified as
contra-revenue.
|
We
maintain an allowance for estimated bad debts based on our estimate of our
ability to collect our accounts receivable. Bad debt expense is recorded as a
reduction to revenue.
Our
allowance for doubtful accounts (and “end user” receivables) declined in 2007,
primarily as a result of the resolution of a principal carrier dispute. On
March 12, 2007, we entered into a settlement agreement with a carrier
pursuant to which we were paid $37.5 million, resulting in a favorable impact on
our revenue in the first quarter of 2007 of $38.7 million.
(6)
|
Other
Intangibles:
|
The
components of other intangibles at December 31, 2009 and 2008 are as
follows:
($ in thousands)
|
2009
|
2008
|
||||||
Customer
base
|
$ | 270,309 | $ | 1,265,052 | ||||
Trade
name and license
|
134,680 | 132,664 | ||||||
Other
intangibles
|
404,989 | 1,397,716 | ||||||
Less:
Accumulated amortization
|
(157,462 | ) | (1,038,042 | ) | ||||
Total
other intangibles, net
|
$ | 247,527 | $ | 359,674 | ||||
Amortization
expense was $114.2 million, $182.3 million and $171.4 million for the years
ended December 31, 2009, 2008 and 2007, respectively. Amortization expense
for 2009 is comprised of $57.9 million for amortization associated with our
“legacy” Frontier properties, which were fully amortized in June 2009, and $56.3
million for intangible assets (customer base and trade name) that were acquired
in the Commonwealth and Global Valley acquisitions. As of December 31,
2008, $263.5 million has been allocated to the customer base (five year life)
and $10.3 million to the trade name (five year life) acquired in the
Commonwealth acquisition, and $7.0 million to the customer base (five year life)
and $0.3 million to the trade name (five year life) acquired in the Global
Valley acquisition. Amortization expense, based on our estimate of useful lives,
is estimated to be $56.2 million in 2010 and 2011 and $11.3 million in
2012.
F-17
(7)
|
Long-Term
Debt:
|
The
activity in our long-term debt from December 31, 2008 to December 31,
2009 is summarized as follows:
Year
Ended
|
Interest
|
||||||||||||||||||
December
31, 2009
|
Rate*
at
|
||||||||||||||||||
December
31,
|
New
|
December
31,
|
December
31,
|
||||||||||||||||
($ in thousands)
|
2008
|
Retirements
|
Borrowings
|
2009
|
2009
|
||||||||||||||
Rural
Utilities Service
|
|||||||||||||||||||
Loan
Contracts
|
$ | 16,607 | $ | (1,007 | ) | $ | - | $ | 15,600 | 6.07% | |||||||||
Senior
Unsecured Debt
|
4,702,331 | (1,047,330 | ) | 1,200,000 | 4,855,001 | 7.86% | |||||||||||||
Industrial
Development
|
|||||||||||||||||||
Revenue
Bonds
|
13,550 | - | - | 13,550 | 6.33% | ||||||||||||||
TOTAL
LONG-TERM
|
|||||||||||||||||||
DEBT
|
$ | 4,732,488 | $ | (1,048,337 | ) | $ | 1,200,000 | $ | 4,884,151 | 7.85% | |||||||||
Less:
Debt Discount
|
(6,946 | ) | (82,786 | ) | |||||||||||||||
Less:
Current Portion
|
(3,857 | ) | (7,236 | ) | |||||||||||||||
$ | 4,721,685 | $ | 4,794,129 | ||||||||||||||||
*
|
Interest
rate includes amortization of debt issuance costs, debt premiums or
discounts, and deferred gain on interest rate swap terminations. The
interest rates at December 31, 2009 represent a weighted average of
multiple issuances.
|
F-18
Additional
information regarding our Senior Unsecured Debt at
December 31:
2009
|
2008
|
||||||||||||
Principal
|
Interest
|
Principal
|
Interest
|
||||||||||
($ in
thousands)
|
Outstanding
|
Rate
|
Outstanding
|
Rate
|
|||||||||
Senior
Notes:
|
|||||||||||||
Due
5/15/2011
|
$ | 76,089 | 9.250% | $ | 921,276 | 9.250% | |||||||
Due
10/24/2011
|
200,000 | 6.270% | 200,000 | 6.270% | |||||||||
Due
12/31/2012
|
145,500 |
1.625%
(Variable)
|
147,000 |
2.448%
(Variable)
|
|||||||||
Due
1/15/2013
|
580,724 | 6.250% | 700,000 | 6.250% | |||||||||
Due
12/31/2013
|
132,638 |
2.000%
(Variable)
|
133,988 |
2.250%
(Variable)
|
|||||||||
Due
5/1/2014
|
600,000 | 8.250% | - | ||||||||||
Due
3/15/2015
|
300,000 | 6.625% | 300,000 | 6.625% | |||||||||
Due
10/1/2018
|
600,000 | 8.125% | - | ||||||||||
Due
3/15/2019
|
434,000 | 7.125% | 450,000 | 7.125% | |||||||||
Due
1/15/2027
|
345,858 | 7.875% | 400,000 | 7.875% | |||||||||
Due
8/15/2031
|
945,325 | 9.000% | 945,325 | 9.000% | |||||||||
4,360,134 | 4,197,589 | ||||||||||||
Debentures:
|
|||||||||||||
Due
11/1/2025
|
138,000 | 7.000% | 138,000 | 7.000% | |||||||||
Due
8/15/2026
|
1,739 | 6.800% | 11,614 | 6.800% | |||||||||
Due
10/1/2034
|
628 | 7.680% | 628 | 7.680% | |||||||||
Due
7/1/2035
|
125,000 | 7.450% | 125,000 | 7.450% | |||||||||
Due
10/1/2046
|
193,500 | 7.050% | 193,500 | 7.050% | |||||||||
458,867 | 468,742 | ||||||||||||
Subsidiary
Senior
|
|||||||||||||
Notes
due 12/1/2012
|
36,000 | 8.050% | 36,000 | 8.050% | |||||||||
Total
|
$ | 4,855,001 | 7.86% | $ | 4,702,331 | 7.54% | |||||||
During
2009, we retired an aggregate principal amount of $1,048.3 million of debt,
consisting of $1,047.3 million of senior unsecured debt, as described in more
detail below, and $1.0 million of rural utilities service loan
contracts.
On
October 1, 2009, we completed a registered debt offering of $600.0 million
aggregate principal amount of 8.125% senior unsecured notes due
2018. The issue price was 98.441% of the principal amount of the
notes, and we received net proceeds of approximately $578.7 million from the
offering after deducting underwriting discounts and offering
expenses. We used the net proceeds from the offering, together with
cash on hand, to finance a cash tender offer for up to $700.0 million to
purchase our outstanding 9.250% Senior Notes due 2011 (the 2011 Notes) and our
outstanding 6.250% Senior Notes due 2013 (the 2013 Notes), as described
below.
On April
9, 2009, we completed a registered offering of $600.0 million aggregate
principal amount of 8.25% senior unsecured notes due 2014. The issue
price was 91.805% of the principal amount of the notes. We received
net proceeds of approximately $538.8 million from the offering after deducting
underwriting discounts and offering expenses.
F-19
The
Company accepted for purchase, in accordance with the terms of the tender offer
referred to above, approximately $564.4 million aggregate principal amount of
the 2011 Notes and approximately $83.4 million of the 2013 Notes tendered during
the tender period, which expired on October 16, 2009. The aggregate
consideration for these debt repurchases was $701.6 million, which was financed
with the proceeds of the debt offering described above and cash on
hand. The repurchases resulted in a loss on the early retirement of
debt of $53.7 million, which we recognized in the fourth quarter of
2009.
In
addition to the debt tender offer, we used $388.9 million of the debt offering
proceeds in 2009 to repurchase $396.7 million principal amount of debt,
consisting of $280.8 million of the 2011 Notes, $54.1 million of our 7.875%
Senior Notes due January 15, 2027, $35.9 million of the 2013 Notes, $16.0
million of our 7.125% Senior Notes due March 15, 2019 and $9.9 million of our
6.80% Debentures due August 15, 2026. As a result of these
repurchases, a $7.8 million net gain was recognized and included in Other income
(loss), net in our consolidated statements of operations for the year ended
December 31, 2009.
As a
result of these 2009 debt financing, tender activities and other debt
repurchases described above, as of December 31, 2009, we reduced our 2011 debt
maturity to $280.0 million.
As of December 31, 2009, we had an
available line of credit with seven financial institutions in the aggregate
amount of $250.0 million. Associated facility fees vary, depending on
our debt leverage ratio, and were 0.225% per annum as of December 31, 2009. The
expiration date for this $250.0 million five year revolving credit agreement is
May 18, 2012. During the term of the credit facility we may borrow,
repay and reborrow funds, subject to customary borrowing
conditions. The credit facility is available for general corporate
purposes but may not be used to fund dividend payments.
During
2008, we retired an aggregate principal amount of $144.7 million of debt,
consisting of $128.7 million principal amount of the 2011 Notes, $12.0 million
of other senior unsecured debt and rural utilities service loan contracts, and
$4.0 million of 5% Company Obligated Mandatorily Redeemable Convertible
Preferred Securities (EPPICS).
On
March 28, 2008, we borrowed $135.0 million under a senior unsecured term
loan facility that was established on March 10, 2008. The loan matures in
2013 and bears interest of 2.00% as of December 31, 2009. The
interest rate is based on the prime rate or LIBOR, at our election, plus a
margin which varies depending on our debt leverage ratio. We used the proceeds
to repurchase, during the first quarter of 2008, $128.7 million principal amount
of the 2011 Notes and to pay for the $6.3 million of premium on early retirement
of these notes.
As of
December 31, 2008, EPPICS representing a total principal amount of $197.8
million have been converted into 15,969,645 shares of our common stock. There
were no outstanding EPPICS as of December 31, 2008. As a result of the
redemption of all outstanding EPPICS as of December 31, 2008, the $10.5
million in debt with related parties was reclassified by the Company against an
offsetting investment.
On
January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. Cash proceeds on the swap terminations of
approximately $15.5 million were received in January 2008. The related gain has
been deferred on the consolidated balance sheet, and is being amortized into
interest expense over the term of the associated debt.
During
2007, we retired an aggregate principal amount of $967.2 million of debt,
including $3.3 million of EPPICS and $17.8 million of 3.25% Commonwealth
convertible notes that were converted into our common stock. As further
described below, we temporarily borrowed and repaid $200.0 million during the
month of March 2007, utilized to temporarily fund our acquisition of
Commonwealth.
In
connection with the acquisition of Commonwealth, we assumed $35.0 million of
debt under a revolving credit facility and approximately $191.8 million face
amount of Commonwealth convertible notes (fair value of approximately $209.6
million). During March 2007, we paid down the $35.0 million credit facility, and
through December 31, 2007, we retired approximately $183.3 million face
amount (for which we paid $165.4 million in cash and $36.7 million in common
stock) of the convertible notes (premium paid of $18.9 million was recorded as
$17.8 million to goodwill and $1.1 million to other income (loss), net). The
remaining outstanding balance of $8.5 million was fully redeemed in the fourth
quarter of 2008.
F-20
On
March 23, 2007, we issued in a private placement an aggregate $300.0
million principal amount of 6.625% Senior Notes due 2015 and $450.0 million
principal amount of 7.125% Senior Notes due 2019. Proceeds from the sale were
used to pay down $200.0 million principal amount of indebtedness borrowed on
March 8, 2007 under a bridge loan facility in connection with the
acquisition of Commonwealth, and redeem, on April 26, 2007, $495.2 million
principal amount of our 7.625% Senior Notes due 2008.
During
the first quarter of 2007, we incurred and expensed approximately $4.1 million
of fees associated with the bridge loan facility established to temporarily fund
our acquisition of Commonwealth. In the second quarter of 2007, we completed an
exchange offer (to publicly register the debt) for the $750.0 million in total
of private placement notes described above, in addition to the $400.0 million
principal amount of 7.875% Senior Notes issued in a private placement on
December 22, 2006, for registered Senior Notes due 2027. On April 26,
2007, we redeemed $495.2 million principal amount of our 7.625% Senior Notes due
2008 at a price of 103.041% plus accrued and unpaid interest. The debt
retirement generated a pre-tax loss on the early extinguishment of debt at a
premium of approximately $16.3 million in the second quarter of 2007 and is
included in other income (loss), net. As a result of this debt redemption, we
also terminated three interest rate swap agreements hedging an aggregate $150.0
million notional amount of indebtedness. Payments on the swap terminations of
approximately $1.0 million were made in the second quarter of 2007.
As of
December 31, 2009, we were in compliance with all of our debt and credit
facility financial covenants.
Our
principal payments for the next five years are as follows:
Principal
|
||||
($ in thousands)
|
Payments
|
|||
2010
|
$ | 7,236 | ||
2011
|
$ | 279,956 | ||
2012
|
$ | 180,366 | ||
2013
|
$ | 709,855 | ||
2014
|
$ | 600,517 | ||
(8)
|
Derivative Instruments
and Hedging Activities:
|
Interest
rate swap agreements were used to hedge a portion of our debt that is subject to
fixed interest rates. Under our interest rate swap agreements, we agreed to pay
an amount equal to a specified variable rate of interest times a notional
principal amount, and to receive in return an amount equal to a specified fixed
rate of interest times the same notional principal amount. The notional amounts
of the contracts were not exchanged. No other cash payments are made unless the
agreement is terminated prior to maturity, in which case the amount paid or
received in settlement is established by agreement at the time of termination
and represents the market value, at the then current rate of interest, of the
remaining obligations to exchange payments under the terms of the
contracts.
On
January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. Cash proceeds on the swap terminations of
approximately $15.5 million were received in January 2008. The related gain has
been deferred on the consolidated balance sheet, and is being amortized into
interest expense over the term of the associated debt. For the years ended
December 31, 2009 and 2008, we recognized $7.6 million and $5.0 million,
respectively, of deferred gain and anticipate recognizing $1.0 million during
2010. For the year ended December 31, 2007, the interest expense
resulting from these interest rate swaps totaled approximately $2.4
million. At December 31, 2009 and 2008, we did not have any
derivative instruments.
F-21
(9)
|
Investment
Income:
|
The
components of investment income for the years ended December 31, 2009, 2008
and 2007 are as follows:
($ in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Interest and
dividend income
|
$ | 5,291 | $ | 10,928 | $ | 32,986 | ||||||
Equity
earnings
|
994 | 5,190 | 4,655 | |||||||||
Total
investment income
|
$ | 6,285 | $ | 16,118 | $ | 37,641 | ||||||
(10)
|
Other Income (Loss),
net:
|
The
components of other income (loss), net for the years ended December 31,
2009, 2008 and 2007 are as follows:
2009
|
2008
|
2007
|
||||||||||
Loss on
retirement of debt, net
|
$ | (45,939 | ) | $ | (6,290 | ) | $ | (18,217 | ) | |||
Bridge
loan fee
|
- | - | (4,069 | ) | ||||||||
Litigation
settlement proceeds/(costs)
|
2,749 | (1,037 | ) | - | ||||||||
Gain on
expiration/settlement of customer advances, net
|
2,741 | 4,520 | 2,031 | |||||||||
Other,
net
|
(678 | ) | (2,363 | ) | 2,422 | |||||||
Total
other income (loss), net
|
$ | (41,127 | ) | $ | (5,170 | ) | $ | (17,833 | ) | |||
During
the fourth quarter of 2009, we recognized a loss of $53.7 million on the early
retirement of debt in connection with a $700.0 million debt tender
offer. During 2009, we also recognized a $7.8 million gain as a
result of repurchasing $396.7 million principal amount of
debt. During 2009, we recorded litigation settlement proceeds of $2.7
million in connection with the Bangor, Maine legal matter.
During
2008, we retired certain debt and recognized a loss of $6.3 million on the early
extinguishment of debt at a premium, mainly for the 9.25% Senior Notes due 2011.
During 2008, we recorded legal fees and settlement costs in connection with the
Bangor, Maine legal matter of $1.0 million. During 2007, we incurred $4.1
million of fees associated with a bridge loan facility. In 2007, we retired
certain debt and recognized a loss of $18.2 million on the early extinguishment
of debt at a premium, mainly for the 7.625% Senior Notes due 2008. During 2009,
2008 and 2007, we recognized income of $2.7 million, $4.5 million and $2.0
million, respectively, in connection with certain retained liabilities that have
terminated, associated with customer advances for construction from our disposed
water properties.
F-22
(11)
|
Company Obligated
Mandatorily Redeemable Convertible Preferred
Securities:
|
As of
December 31, 2008, we fully redeemed the EPPICS related debt outstanding to
third parties. The following disclosure provides the history regarding this
issue.
In 1996,
our consolidated wholly-owned subsidiary, Citizens Utilities Trust (the Trust),
issued, in an underwritten public offering, 4,025,000 shares of EPPICS,
representing preferred undivided interests in the assets of the Trust, with a
liquidation preference of $50 per security (for a total liquidation amount of
$201.3 million). These securities had an adjusted conversion price of $11.46 per
share of our common stock. The conversion price was reduced from $13.30 to
$11.46 during the third quarter of 2004 as a result of the $2.00 per share of
common stock special, non-recurring dividend. The proceeds from the issuance of
the Trust Convertible Preferred Securities and a Company capital contribution
were used to purchase $207.5 million aggregate liquidation amount of 5%
Partnership Convertible Preferred Securities due 2036 from another wholly-owned
subsidiary, Citizens Utilities Capital L.P. (the Partnership). The proceeds from
the issuance of the Partnership Convertible Preferred Securities and a Company
capital contribution were used to purchase from us $211.8 million aggregate
principal amount of 5% Convertible Subordinated Debentures due 2036. The sole
assets of the Trust were the Partnership Convertible Preferred Securities, and
our Convertible Subordinated Debentures were substantially all the assets of the
Partnership. Our obligations under the agreements related to the issuances of
such securities, taken together, constituted a full and unconditional guarantee
by us of the Trust’s obligations relating to the Trust Convertible Preferred
Securities and the Partnership’s obligations relating to the Partnership
Convertible Preferred Securities.
In
accordance with the terms of the issuances, we paid the annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in 2008 and
2007. Cash was paid (net of investment returns) to the Partnership in payment of
the interest on the Convertible Subordinated Debentures. The cash was then
distributed by the Partnership to the Trust and then by the Trust to the holders
of the EPPICS.
As of
December 31, 2008, EPPICS representing a total principal amount of $197.8
million have been converted into 15,969,645 shares of our common stock. There
were no outstanding EPPICS as of December 31, 2008. As a result of the
redemption of all outstanding EPPICS as of December 31, 2008, the $10.5
million in debt with related parties was reclassified by the Company against an
offsetting investment.
(12) Capital
Stock:
On
October 27, 2009, in conjunction with the shareholder vote to approve the
Verizon Transaction, our stockholders approved an increase in the number of
authorized shares of Frontier common stock from 600,000 to
1,750,000. The Certificate of Amendment to our Restated Certificate
of Incorporation effectuating the increase will be filed and become effective
immediately prior to the effective time of the merger. The amount and timing of
dividends payable on common stock are, subject to applicable law, within the
sole discretion of our Board of Directors.
F-23
(13)
|
Stock
Plans:
|
At
December 31, 2009, we had five stock-based compensation plans under which
grants have been made and awards remained outstanding. These plans, which are
described below, are the 1996 Equity Incentive Plan (1996 EIP), the Amended and
Restated 2000 Equity Incentive Plan (2000 EIP), the Non-Employee Directors’
Deferred Fee Equity Plan (Deferred Fee Plan), the Non-Employee Directors’ Equity
Incentive Plan (Directors’ Equity Plan, and together with the Deferred Fee Plan,
the Director Plans) and the 2009 Equity Incentive Plan that was adopted on May
14, 2009 (2009 EIP).
Our
general policy is to issue shares upon the grant of restricted shares and
exercise of options from treasury. At December 31, 2009, there were
12,540,761 shares authorized for grant under these plans and 12,057,989 shares
available for grant under two of the plans. No further awards may be granted
under three of the plans: the 1996 EIP, the 2000 EIP or the Deferred Fee
Plan.
In
connection with the Director Plans, compensation costs associated with the
issuance of stock units was $0.7 million, $0.8 million and $1.6 million in 2009,
2008 and 2007, respectively. Cash compensation associated with the Director
Plans was $0.6 million in 2009 and $0.5 million in each of 2008 and 2007. These
costs are recognized in Other operating expenses.
We have
granted restricted stock awards to key employees in the form of our common
stock. The number of shares issued as restricted stock awards during 2009, 2008
and 2007 were 1,119,000, 887,000 and 722,000, respectively. None of the
restricted stock awards may be sold, assigned, pledged or otherwise transferred,
voluntarily or involuntarily, by the employees until the restrictions lapse,
subject to limited exceptions. The restrictions are time based. At
December 31, 2009, 2,193,000 shares of restricted stock were outstanding.
Compensation expense, recognized in Other operating expenses, of $8.7 million,
$6.9 million and $6.6 million, for the years ended December 31, 2009, 2008
and 2007, respectively, has been recorded in connection with these
grants.
1996, 2000 and 2009 Equity
Incentive Plans
Since the
expiration dates of the 1996 EIP and the 2000 EIP on May 22, 2006 and May
14, 2009, respectively, no awards have been or may be granted under the 1996 EIP
and the 2000 EIP. Under the 2009 EIP, awards of our common stock may be granted
to eligible officers, management employees and non-management employees in the
form of incentive stock options, non-qualified stock options, SARs, restricted
stock or other stock-based awards. As discussed under the Non-Employee
Directors’ Compensation Plans below, prior to May 25, 2006 non-employee
directors received an award of stock options under the 2000 EIP upon
commencement of service.
At
December 31, 2009, there were 10,000,000 shares authorized for grant under
the 2009 EIP and 9,979,000 shares available for grant. No awards were
granted more than 10 years after the effective date (May 14, 2009) of the 2009
EIP plan. The exercise price of stock options and SARs under the 2009, 2000 and
1996 EIPs generally are equal to or greater than the fair market value of the
underlying common stock on the date of grant. Stock options are not ordinarily
exercisable on the date of grant but vest over a period of time (generally four
years). Under the terms of the EIPs, subsequent stock dividends and stock splits
have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding
options.
F-24
The
following summary presents information regarding outstanding stock options and
changes with regard to options under the EIP:
Weighted
|
Weighted
|
||||||||||||||
Shares
|
Average
|
Average
|
Aggregate
|
||||||||||||
Subject
to
|
Option
Price
|
Remaining
|
Intrinsic
|
||||||||||||
Option
|
Per
Share
|
Life
in Years
|
Value
|
||||||||||||
Balance
at January 1, 2007
|
5,242,000 | $ | 12.41 | 4.4 | $ | 14,490,000 | |||||||||
Options
granted
|
- | $ | - | ||||||||||||
Options
exercised
|
(1,254,000 | ) | $ | 10.19 | $ | 6,033,000 | |||||||||
Options
canceled, forfeited or lapsed
|
(33,000 | ) | $ | 10.79 | |||||||||||
Balance
at December 31, 2007
|
3,955,000 | $ | 13.13 | 3.4 | $ | 5,727,000 | |||||||||
Options
granted
|
- | $ | - | ||||||||||||
Options
exercised
|
(187,000 | ) | $ | 7.38 | $ | 743,000 | |||||||||
Options
canceled, forfeited or lapsed
|
(55,000 | ) | $ | 10.40 | |||||||||||
Balance
at December 31, 2008
|
3,713,000 | $ | 13.46 | 2.5 | $ | 495,000 | |||||||||
Options
granted
|
- | $ | - | ||||||||||||
Options
exercised
|
(114,000 | ) | $ | 6.58 | $ | 65,000 | |||||||||
Options
canceled, forfeited or lapsed
|
(48,000 | ) | $ | 9.24 | |||||||||||
Balance
at December 31, 2009
|
3,551,000 | $ | 13.74 | 1.5 | $ | - | |||||||||
The following
table summarizes information about shares subject to options under the EIP at
December 31, 2009:
Options
Outstanding
|
Options
Exercisable
|
|||||||||||||||||
Weighted
Average
|
Weighted
|
|||||||||||||||||
Number
|
Range
of
|
Weighted
Average
|
Remaining
|
Number
|
Average
|
|||||||||||||
Outstanding
|
Exercise
Prices
|
Exercise
Price
|
Life
in Years
|
Exercisable
|
Exercise
Price
|
|||||||||||||
394,000 | $ | 8.19 - 8.19 | $ | 8.19 | 2.37 | 394,000 | $ | 8.19 | ||||||||||
511,000 | 10.44 - 10.44 | 10.44 | 3.4 | 511,000 | 10.44 | |||||||||||||
199,000 | 11.15 - 11.15 | 11.15 | 0.8 | 199,000 | 11.15 | |||||||||||||
476,000 | 11.79 - 11.79 | 11.79 | 1.38 | 476,000 | 11.79 | |||||||||||||
167,000 | 11.90 - 14.27 | 13.44 | 3.77 | 166,000 | 13.44 | |||||||||||||
582,000 | 15.02 - 15.02 | 15.02 | 0.75 | 582,000 | 15.02 | |||||||||||||
640,000 | 15.94 - 16.74 | 16.67 | 0.73 | 640,000 | 16.67 | |||||||||||||
582,000 | 18.46 - 18.46 | 18.46 | 0.75 | 582,000 | 18.46 | |||||||||||||
3,551,000 | $ | 8.19 - 18.46 | $ | 13.74 | 1.54 | 3,550,000 | $ | 13.74 | ||||||||||
The
number of options exercisable at December 31, 2008 and 2007 were 3,706,000
and 3,938,000, with a weighted average exercise price of $13.46 and $13.13,
respectively.
Cash
received upon the exercise of options during 2009, 2008 and 2007 was $0.8
million, $1.4 million and $13.8 million, respectively. There is no remaining
unrecognized compensation cost associated with unvested stock options at
December 31, 2009.
F-25
For
purposes of determining compensation expense, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model which requires the use of various assumptions including expected life of
the option, expected dividend rate, expected volatility, and risk-free interest
rate. The expected life (estimated period of time outstanding) of stock options
granted was estimated using the historical exercise behavior of employees. The
risk free interest rate is based on the U.S. Treasury yield curve in effect at
the time of the grant. Expected volatility is based on historical volatility for
a period equal to the stock option’s expected life, calculated on a monthly
basis. No stock option grants were issued in 2007, 2008 and 2009
under the EIP.
The
following summary presents information regarding unvested restricted stock and
changes with regard to restricted stock under the EIP:
Weighted
|
||||||||||||
Average
|
||||||||||||
Number
of
|
Grant
Date
|
Aggregate
|
||||||||||
Shares
|
Fair
Value
|
Fair
Value
|
||||||||||
Balance
at January 1, 2007
|
1,174,000 | $ | 12.89 | $ | 16,864,000 | |||||||
Restricted
stock granted
|
722,000 | $ | 15.04 | $ | 9,187,000 | |||||||
Restricted
stock vested
|
(587,000 | ) | $ | 12.94 | $ | 7,465,000 | ||||||
Restricted
stock forfeited
|
(100,000 | ) | $ | 13.95 | ||||||||
Balance
at December 31, 2007
|
1,209,000 | $ | 14.06 | $ | 15,390,000 | |||||||
Restricted
stock granted
|
887,000 | $ | 11.02 | $ | 7,757,000 | |||||||
Restricted
stock vested
|
(367,000 | ) | $ | 13.90 | $ | 3,209,000 | ||||||
Restricted
stock forfeited
|
(27,000 | ) | $ | 13.39 | ||||||||
Balance
at December 31, 2008
|
1,702,000 | $ | 12.52 | $ | 14,876,000 | |||||||
Restricted
stock granted
|
1,119,000 | $ | 8.42 | $ | 8,738,000 | |||||||
Restricted
stock vested
|
(557,000 | ) | $ | 12.77 | $ | 4,347,000 | ||||||
Restricted
stock forfeited
|
(71,000 | ) | $ | 11.02 | ||||||||
Balance
at December 31, 2009
|
2,193,000 | $ | 10.41 | $ | 17,126,000 | |||||||
For
purposes of determining compensation expense, the fair value of each restricted
stock grant is estimated based on the average of the high and low market price
of a share of our common stock on the date of grant. Total remaining
unrecognized compensation cost associated with unvested restricted stock awards
at December 31, 2009 was $15.2 million and the weighted average period over
which this cost is expected to be recognized is approximately two
years.
Non-Employee Directors’
Compensation Plans
Upon
commencement of his or her service on the Board of Directors, each non-employee
director receives a grant of 10,000 stock options. These options are currently
awarded under the Directors’ Equity Plan. Prior to effectiveness of the
Directors’ Equity Plan on May 25, 2006, these options were awarded under
the 2000 EIP. The exercise price of these options, which become exercisable six
months after the grant date, is the fair market value (as defined in the
relevant plan) of our common stock on the date of grant. Options granted under
the Directors’ Equity Plan expire on the earlier of the tenth anniversary of the
grant date or the first anniversary of termination of service as a director.
Options granted to non-employee directors under the 2000 EIP expire on the tenth
anniversary of the grant date.
Each
non-employee director also receives an annual grant of 3,500 stock units. These
units are currently awarded under the Directors’ Equity Plan and prior to
effectiveness of that plan, were awarded under the Deferred Fee Plan. Since the
effectiveness of the Directors’ Equity Plan, no further grants have been made
under the Deferred Fee Plan. Prior to April 20, 2004, each non-employee
director received an award of 5,000 stock options. The exercise price of such
options was set at 100% of the fair market value on the date the options were
granted. The options were exercisable six months after the grant date and remain
exercisable for ten years after the grant date.
F-26
In
addition, each year, each non-employee director is also entitled to receive a
retainer, meeting fees, and, when applicable, fees for serving as a committee
chair or as Lead Director. For 2009, each non-employee director had to elect, by
December 31 of the preceding year, to receive $40,000 cash or 5,760 stock
units as an annual retainer and to receive meeting fees and Lead Director and
committee chair stipends in the form of cash or stock units. Stock units are
awarded under the Directors’ Equity Plan. Directors making a stock unit election
must also elect to convert the units to either common stock (convertible on a
one-to-one basis) or cash upon retirement or death.
The
number of shares of common stock authorized for issuance under the Directors’
Equity Plan is 2,540,761, which includes 540,761 shares that were available for
grant under the Deferred Fee Plan on the effective date of the Directors’ Equity
Plan. In addition, if and to the extent that any “plan units” outstanding on
May 25, 2006 under the Deferred Fee Plan are forfeited or if any option
granted under the Deferred Fee Plan terminates, expires, or is cancelled or
forfeited, without having been fully exercised, shares of common stock subject
to such “plan units” or options cancelled shall become available under the
Directors’ Equity Plan. At December 31, 2009, there were 2,078,989 shares
available for grant. There were 11 directors participating in the Directors’
Plans during all or part of 2009. In 2009, the total options, plan
units, and stock earned were 0, 76,326, and 0, respectively. In 2008,
the total options, plan units, and stock earned were 0, 102,673, and 0,
respectively. In 2007, the total options, plan units, and stock
earned were 10,000, 98,070 and 0, respectively. Options granted prior
to the adoption of the Directors’ Equity Plan were granted under the 2000 EIP.
At December 31, 2009, 182,951 options were outstanding and exercisable
under the Director Plans at a weighted average exercise price of
$12.68.
For 2009,
each non-employee director received fees of $2,000 for each in-person Board of
Directors and committee meeting attended and $1,000 for each telephone Board and
committee meeting attended. The chairs of the Audit, Compensation, Nominating
and Corporate Governance and Retirement Plan Committees were paid an additional
annual fee of $25,000, $20,000, $7,500 and $7,500, respectively. In addition,
the Lead Director, who heads the ad hoc committee of non-employee directors,
received an additional annual fee of $15,000. A director must elect, by
December 31 of the preceding year, to receive meeting and other fees in
cash, stock units, or a combination of both. All fees paid to the non-employee
directors in 2009 were paid quarterly. If the director elects stock units, the
number of units credited to the director’s account is determined as follows: the
total cash value of the fees payable to the director are divided by 85% of the
closing prices of our common stock on the last business day of the calendar
quarter in which the fees or stipends were earned. Units are credited to the
director’s account quarterly.
We
account for the Deferred Fee Plan and Directors’ Equity Plan in accordance with
ASC Topic 718 (formerly SFAS No. 123R). To the extent directors elect to receive
the distribution of their stock unit account in cash, they are considered
liability-based awards. To the extent directors elect to receive the
distribution of their stock unit accounts in common stock, they are considered
equity-based awards. Compensation expense for stock units that are considered
equity-based awards is based on the market value of our common stock at the date
of grant. Compensation expense for stock units that are considered
liability-based awards is based on the market value of our common stock at the
end of each period.
(14) Income
Taxes:
The
following is a reconciliation of the provision for income taxes computed at
Federal statutory rates to the effective rates for the years ended
December 31, 2009, 2008 and 2007:
2009
|
2008
|
2007
|
|||||||
Consolidated
tax provision at federal statutory rate
|
35.0%
|
35.0%
|
35.0%
|
||||||
State
income tax provisions, net of federal income tax benefit
|
2.8
|
2.8
|
1.8
|
||||||
Tax
reserve adjustment
|
-
|
(1.4)
|
1.0
|
||||||
All
other, net
|
(1.6)
|
0.2
|
(0.6)
|
||||||
36.2%
|
36.6%
|
37.2%
|
|||||||
F-27
The
components of the net deferred income tax liability (asset) at December 31
are as follows:
($ in thousands)
|
2009
|
2008
|
||||||
Deferred income tax
liabilities:
|
||||||||
Property,
plant and equipment basis differences
|
$ | 666,393 | $ | 642,598 | ||||
Intangibles
|
292,736 | 248,520 | ||||||
Other,
net
|
3,924 | 15,946 | ||||||
963,053 | 907,064 | |||||||
Deferred income tax assets:
|
||||||||
Additional
pension/OPEB liability
|
154,856 | 146,997 | ||||||
Tax
operating loss carryforward
|
94,284 | 72,434 | ||||||
Employee
benefits
|
74,226 | 62,482 | ||||||
State
tax liability
|
2,531 | 7,483 | ||||||
Accrued
expenses
|
15,712 | 19,726 | ||||||
Bad
debts
|
9,435 | 12,026 | ||||||
Other,
net
|
13,121 | 14,550 | ||||||
364,165 | 335,698 | |||||||
Less:
Valuation allowance
|
(91,537 | ) | (67,331 | ) | ||||
Net
deferred income tax asset
|
272,628 | 268,367 | ||||||
Net
deferred income tax liability
|
$ | 690,425 | $ | 638,697 | ||||
Deferred tax assets and liabilities are reflected
in the following
|
||||||||
captions on the consolidated balance
sheet:
|
||||||||
Deferred
income taxes
|
$ | 722,192 | $ | 670,489 | ||||
Income
taxes
|
(31,767 | ) | (31,792 | ) | ||||
Net
deferred income tax liability
|
$ | 690,425 | $ | 638,697 | ||||
Our state
tax operating loss carryforward as of December 31, 2009 is estimated at
$1.2 billion. A portion of our state loss carryforward begins to expire in
2010.
F-28
The
provision (benefit) for Federal and state income taxes, as well as the taxes
charged or credited to shareholders’ equity of Frontier, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Income
taxes charged to the consolidated statement of
|
||||||||||||
operations:
|
||||||||||||
Current:
|
||||||||||||
Federal
|
$ | 11,618 | $ | 68,114 | $ | 37,815 | ||||||
State
|
(2,630 | ) | 4,415 | 9,188 | ||||||||
Total
current
|
8,988 | 72,529 | 47,003 | |||||||||
Deferred:
|
||||||||||||
Federal
|
49,916 | 32,984 | 75,495 | |||||||||
State
|
11,024 | 983 | 5,516 | |||||||||
Total
deferred
|
60,940 | 33,967 | 81,011 | |||||||||
Total
income taxes charged to the consolidated statement of
|
69,928 | 106,496 | 128,014 | |||||||||
operations (a)
|
||||||||||||
Income
taxes charged (credited) to shareholders' equity of
Frontier:
|
||||||||||||
Deferred income tax benefits on unrealized/realized gains
or
|
||||||||||||
losses on securities classified as available-for-sale
|
- | - | (11 | ) | ||||||||
Current benefit arising from stock options exercised and restricted
stock
|
881 | (4,877 | ) | (552 | ) | |||||||
Deferred income taxes (benefits) arising from the recognition
of
|
||||||||||||
additional pension/OPEB liability
|
(4,353 | ) | (88,410 | ) | (6,880 | ) | ||||||
Total
income taxes charged (credited) to shareholders' equity of Frontier
(b)
|
(3,472 | ) | (93,287 | ) | (7,443 | ) | ||||||
Total
income taxes: (a) plus (b)
|
$ | 66,456 | $ | 13,209 | $ | 120,571 | ||||||
During
2009, we retrospectively changed our method of accounting for repairs and
maintenance costs for tax return purposes. The effect of this change
was a decrease of our current tax expense and an offsetting increase of our
deferred tax expense of approximately $35.8 million in our 2009 income tax
provision. Additionally, in part due to the above noted accounting
change, refunds of approximately $56.2 million have been applied for in the
Company’s 2008 tax returns. Refunds are recorded on our balance sheet
at December 31, 2009 in current assets within income taxes. We
recorded approximately $8.2 million (net) related to uncertain tax positions
under FASB Interpretation No. (FIN) 48 (ASC Topic 740) in
2009.
ASC Topic
740 (formerly FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in
Income Taxes”) requires applying a “more likely than not” threshold to the
recognition and derecognition of uncertain tax positions either taken or
expected to be taken in the Company’s income tax returns. The total amount of
our gross tax liability for tax positions that may not be sustained under a
“more likely than not” threshold amounts to $61.9 million as of
December 31, 2009 including interest of $5.0 million. The amount
of our total tax liabilities reflected above that would positively impact the
calculation of our effective income tax rate, if our tax positions are
sustained, is $29.3 million as of December 31, 2009.
The
Company’s policy regarding the classification of interest and penalties is to
include these amounts as a component of income tax expense. This treatment of
interest and penalties is consistent with prior periods. We have recognized in
our consolidated statement of operations for the year ended December 31,
2009, additional interest in the amount of $1.4 million. We are subject to
income tax examinations generally for the years 2006 forward for Federal and
2005 for state filing jurisdictions. We also maintain uncertain tax positions in
various state jurisdictions. Amounts related to uncertain tax positions that may
change within the next twelve months are not material.
F-29
The
following table sets forth the changes in the Company’s balance of unrecognized
tax benefits for the years ended December 31, 2009 and 2008 in accordance
with ASC Topic 740:
($ in
thousands)
|
||||||||
2009
|
2008
|
|||||||
Unrecognized
tax benefits - beginning of year
|
$ | 48,711 | $ | 59,717 | ||||
Gross
decreases - prior year tax positions
|
(3,133 | ) | (2,070 | ) | ||||
Gross
increases - current year tax positions
|
12,412 | 2,379 | ||||||
Gross
decreases - expired statute of limitations
|
(1,130 | ) | (11,315 | ) | ||||
Unrecognized
tax benefits - end of year
|
$ | 56,860 | $ | 48,711 | ||||
The
amounts above exclude $5.0 million of accrued interest that we have recorded and
would be payable should the Company’s tax positions not be
sustained.
F-30
(15)
|
Net Income Per Common
Share:
|
The
reconciliation of the net income per common share calculation for the years
ended December 31, 2009, 2008 and 2007 is as follows:
($ in thousands,
except per-share amounts)
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Net
income used for basic and diluted
|
||||||||||||
earnings
per common share:
|
||||||||||||
Net
income attributable to common shareholders of Frontier
|
$ | 120,783 | $ | 182,660 | $ | 214,654 | ||||||
Less:
Dividends allocated to unvested restricted stock awards
|
(2,248 | ) | (1,744 | ) | (1,408 | ) | ||||||
Total
basic net income attributable to common shareholders
|
||||||||||||
of
Frontier
|
118,535 | 180,916 | 213,246 | |||||||||
Effect
of conversion of preferred securities - EPPICS
|
- | 130 | 152 | |||||||||
Total
diluted net income attributable to common shareholders
|
||||||||||||
of
Frontier
|
$ | 118,535 | $ | 181,046 | $ | 213,398 | ||||||
Basic
earnings per common share:
|
||||||||||||
Total
weighted-average shares and unvested restricted stock
awards
|
||||||||||||
outstanding
- basic
|
312,183 | 319,161 | 332,377 | |||||||||
Less:
Weighted-average unvested restricted stock awards
|
(2,162 | ) | (1,660 | ) | (1,340 | ) | ||||||
Total
weighted-average shares outstanding - basic
|
310,021 | 317,501 | 331,037 | |||||||||
Net
income per share attributable to common shareholders
|
||||||||||||
of
Frontier
|
$ | 0.38 | $ | 0.57 | $ | 0.64 | ||||||
Diluted
earnings per common share:
|
||||||||||||
Total
weighted-average shares outstanding - basic
|
310,021 | 317,501 | 331,037 | |||||||||
Effect
of dilutive shares
|
92 | 435 | 940 | |||||||||
Effect
of conversion of preferred securities - EPPICS
|
- | 306 | 401 | |||||||||
Total
weighted-average shares outstanding - diluted
|
310,113 | 318,242 | 332,378 | |||||||||
Net
income per share attributable to common shareholders
|
||||||||||||
of
Frontier
|
$ | 0.38 | $ | 0.57 | $ | 0.64 | ||||||
F-31
Stock
Options
For the
years ended December 31, 2009, 2008 and 2007, options to purchase 3,551,000
shares (at exercise prices ranging from $8.19 to $18.46), 2,647,000 shares (at
exercise prices ranging from $11.15 to $18.46) and 1,804,000 shares (at exercise
prices ranging from $15.02 to $18.46), respectively, issuable under employee
compensation plans were excluded from the computation of diluted earnings per
share (EPS) for those periods because the exercise prices were greater than the
average market price of our common stock and, therefore, the effect would be
antidilutive. In calculating diluted EPS we apply the treasury stock method and
include future unearned compensation as part of the assumed
proceeds.
In
addition, for the years ended December 31, 2009, 2008 and 2007, the impact
of dividends paid on unvested restricted stock awards have been deducted from
net income attributable to common shareholders of Frontier in accordance with
FSP EITF No. 03-6-1 (ASC Topic 260), which we adopted in the first quarter
of 2009 on a retrospective basis.
EPPICS
There
were no outstanding EPPICS at December 31, 2008 and 2009. At
December 31, 2007, we had 80,307 shares of potentially dilutive EPPICS,
which were convertible into our common stock at a 4.3615 to 1 ratio at an
exercise price of $11.46 per share. If all EPPICS that remained outstanding as
of December 31, 2007 were converted, we would have issued approximately
350,259 shares of our common stock. These securities have been included in the
diluted earnings per common share calculation for the period ended
December 31, 2007.
Stock
Units
At
December 31, 2009, 2008 and 2007, we had 440,463, 324,806 and 225,427 stock
units, respectively, issued under the Director Plans. These securities have not
been included in the diluted income per share of common stock calculation
because their inclusion would have had an antidilutive effect.
Share Repurchase
Programs
There
were no shares repurchased during 2009 under a share repurchase
program.
During
2008, we repurchased approximately 17.8 million shares of our common stock
at an aggregate cost of $200.0 million. During 2007, we repurchased
approximately 17.3 million shares of our common stock at an aggregate cost
of $250.0 million.
(16)
|
Comprehensive
Income:
|
Comprehensive
income consists of net income and other gains and losses affecting shareholders’
investment and pension/OPEB liabilities that, under GAAP, are
excluded from net income.
The
components of accumulated other comprehensive loss, net of tax at
December 31, 2009 and 2008 are as follows:
($ in thousands)
|
2009
|
2008
|
||||||
Pension
costs
|
$ | 374,157 | $ | 376,086 | ||||
Postretirement
costs
|
21,554 | 8,045 | ||||||
Deferred taxes
on pension and OPEB costs
|
(150,284 | ) | (146,997 | ) | ||||
All
other
|
92 | 18 | ||||||
$ | 245,519 | $ | 237,152 | |||||
F-32
Our other
comprehensive income (loss) for the years ended December 31, 2009, 2008 and
2007 is as follows:
2009
|
||||||
Before-Tax
|
Tax
Expense/
|
Net-of-Tax
|
||||
($ in thousands)
|
Amount
|
(Benefit)
|
Amount
|
|||
Net
actuarial loss
|
$ (35,759)
|
$ (10,149)
|
$ (25,610)
|
|||
Amortization
of pension and postretirement costs
|
24,179
|
6,862
|
17,317
|
|||
All
other
|
(74)
|
-
|
(74)
|
|||
Other
comprehensive (loss)
|
$ (11,654)
|
$ (3,287)
|
$ (8,367)
|
|||
2008
|
||||||
Before-Tax
|
Tax
Expense/
|
Net-of-Tax
|
||||
Amount
|
(Benefit)
|
Amount
|
||||
Net
actuarial loss
|
$ (252,358)
|
$ (90,122)
|
$ (162,236)
|
|||
Amortization
of pension and postretirement costs
|
4,795
|
1,712
|
3,083
|
|||
All
other
|
(4)
|
-
|
(4)
|
|||
Other
comprehensive (loss)
|
$ (247,567)
|
$ (88,410)
|
$ (159,157)
|
|||
2007
|
||||||
Before-Tax
|
Tax
Expense/
|
Net-of-Tax
|
||||
Amount
|
(Benefit)
|
Amount
|
||||
Amortization
of pension and postretirement costs
|
$ (3,023)
|
$ (6,880)
|
$ 3,857
|
|||
All
other
|
35
|
(12)
|
47
|
|||
Other
comprehensive income
|
$ (2,988)
|
$ (6,892)
|
$ 3,904
|
|||
(17)
|
Segment
Information:
|
We
operate in one reportable segment, Frontier. Frontier provides both regulated
and unregulated voice, data and video services to residential, business and
wholesale customers and is typically the incumbent provider in its service
areas.
As
permitted by ASC Topic 280 (formerly SFAS No. 131), we have utilized the
aggregation criteria in combining our operating segments because all of our
Frontier properties share similar economic characteristics, in that they provide
the same products and services to similar customers using comparable
technologies in all of the states in which we operate. The regulatory structure
is generally similar. Differences in the regulatory regime of a particular state
do not materially impact the economic characteristics or operating results of a
particular property.
F-33
(18)
|
Quarterly Financial
Data (Unaudited):
|
($ in thousands,
except per share amounts)
|
||||||||||||||||||||
2009
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
Total
Year
|
|||||||||||||||
Revenue
|
$ | 537,956 | $ | 532,142 | $ | 526,816 | $ | 520,980 | $ | 2,117,894 | ||||||||||
Operating
income
|
139,510 | 136,616 | 172,490 | 157,549 | 606,165 | |||||||||||||||
Net
income attributable to common shareholders of Frontier
|
36,303 | 27,918 | 52,159 | 4,403 | 120,783 | |||||||||||||||
Net
income available for common shareholders per basic
|
||||||||||||||||||||
and
diluted share
|
$ | 0.12 | $ | 0.09 | $ | 0.17 | $ | 0.01 | $ | 0.38 | ||||||||||
2008
|
||||||||||||||||||||
Revenue
|
$ | 569,205 | $ | 562,550 | $ | 557,871 | $ | 547,392 | $ | 2,237,018 | ||||||||||
Operating
income
|
164,312 | 161,969 | 164,241 | 151,934 | 642,456 | |||||||||||||||
Net
income attributable to common shareholders of Frontier
|
45,589 | 55,778 | 46,995 | 34,298 | 182,660 | |||||||||||||||
Net
income available for common shareholders per basic
|
||||||||||||||||||||
and
diluted share
|
$ | 0.14 | $ | 0.17 | $ | 0.15 | $ | 0.11 | $ | 0.57 | ||||||||||
The
quarterly net income per common share amounts are rounded to the nearest cent.
Annual net income per common share may vary depending on the effect of such
rounding. We recognized $10.8 million ($6.8 million or $0.02 per share after
tax), $3.7 million ($2.3 million or $0.01 per share after tax) and $13.9 million
($8.8 million or $0.03 per share after tax) of acquisition and integration costs
during the second, third and fourth quarters of 2009,
respectively. During the fourth quarter of 2009, we recognized a loss
of $53.7 million ($33.8 million or $0.11 per share after tax) on the early
retirement of debt in connection with a $700.0 million debt tender
offer.
(19)
|
Retirement
Plans:
|
We
sponsor a noncontributory defined benefit pension plan covering a significant
number of our former and current 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. The
benefits are based on years of service and final average pay or career average
pay. Contributions are made in amounts sufficient to meet ERISA funding
requirements while considering tax deductibility. Plan assets are invested in a
diversified portfolio of equity and fixed-income securities and alternative
investments.
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.
F-34
The
discount rate is used to value, on a present value basis, our pension and other
postretirement benefit obligations 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. In making this determination we consider, among other
things, the yields on the Citigroup Pension Discount Curve, the Citigroup
Above-Median Pension Curve, the general movement of interest rates and the
changes in those rates from one period to the next. This rate can change from
year-to-year based on market conditions that affect corporate bond yields. Our
discount rate was 5.75% at year-end 2009, and 6.50% at year-end 2008 and
2007.
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 pension asset investment allocation
decisions are made by the Retirement Investment & Administration Committee
(RIAC), a committee comprised of members of management, pursuant to a delegation
of authority by the Retirement Plan Committee of the Board of
Directors. The RIAC is responsible for reporting its actions to the
Retirement Plan Committee. Asset allocation decisions take into account
expected market return assumptions of various asset classes as well as expected
pension benefit payment streams. When analyzing anticipated benefit payments,
management considers both the absolute amount of the payments as well as the
timing of such payments. In 2009, we changed our expected long-term
rate of return on plan assets to 8.00% from the 8.25% used in
2008. For 2010, we will assume a rate of return of
8.00%. Our pension plan assets are valued at fair value as of the
measurement date. The measurement date used to determine pension and other
postretirement benefit measures for the pension plan and the postretirement
benefit plan is December 31.
F-35
Pension
Benefits
The
following tables set forth the pension plan’s projected benefit obligations and
fair values of plan assets as of December 31, 2009 and 2008 and the
components of net periodic benefit cost for the years ended December 31,
2009, 2008 and 2007:
($ in
thousands)
|
2009
|
2008
|
||||||
Change in projected benefit
obligation
|
||||||||
Projected
benefit obligation at beginning of year
|
$ | 831,687 | $ | 820,404 | ||||
Service
cost
|
6,098 | 6,005 | ||||||
Interest
cost
|
52,127 | 52,851 | ||||||
Actuarial
loss/(gain)
|
69,861 | 20,230 | ||||||
Benefits
paid
|
(71,373 | ) | (69,465 | ) | ||||
Plan
change
|
609 | - | ||||||
Special
termination benefits
|
1,567 | 1,662 | ||||||
Projected
benefit obligation at end of year
|
$ | 890,576 | $ | 831,687 | ||||
Change in plan assets
|
||||||||
Fair
value of plan assets at beginning of year
|
$ | 589,776 | $ | 822,165 | ||||
Actual
return on plan assets
|
90,222 | (162,924 | ) | |||||
Benefits
paid
|
(71,373 | ) | (69,465 | ) | ||||
Fair
value of plan assets at end of year
|
$ | 608,625 | $ | 589,776 | ||||
Funded
status
|
$ | (281,951 | ) | $ | (241,911 | ) | ||
Amounts recognized in the consolidated balance
sheet
|
||||||||
Other
long-term liabilities
|
$ | (281,951 | ) | $ | (241,911 | ) | ||
Accumulated
other comprehensive income
|
$ | 374,157 | $ | 376,086 | ||||
Expected
|
||||||||||||||||
($ in thousands)
|
2010
|
2009
|
2008
|
2007
|
||||||||||||
Components of net periodic benefit
cost
|
||||||||||||||||
Service
cost
|
$ | 6,098 | $ | 6,005 | $ | 9,175 | ||||||||||
Interest
cost on projected benefit obligation
|
52,127 | 52,851 | 50,948 | |||||||||||||
Expected
return on plan assets
|
(44,712 | ) | (65,256 | ) | (67,467 | ) | ||||||||||
Amortization
of prior service cost/(credit)
|
(199 | ) | (255 | ) | (255 | ) | (255 | ) | ||||||||
Amortization
of unrecognized loss
|
26,984 | 27,144 | 6,855 | 7,313 | ||||||||||||
Net
periodic benefit cost/(income)
|
40,402 | 200 | (286 | ) | ||||||||||||
Plan
curtailment gain
|
- | - | (14,379 | ) | ||||||||||||
Special
termination charge
|
1,567 | 1,662 | 467 | |||||||||||||
Total
periodic benefit cost/(income)
|
$ | 41,969 | $ | 1,862 | $ | (14,198 | ) | |||||||||
F-36
We
capitalized $7.5 million, $0.0 million and $0.1 million of pension expense into
the cost of our capital expenditures during the years ended December 31, 2009,
2008 and 2007, respectively, as the costs that relate to our engineering and
plant construction activities.
Effective
December 30, 2007, the CTE Employees’ Pension Plan was frozen for all
non-union Commonwealth employees. No additional benefit accruals for service
rendered subsequent to December 30, 2007 will occur for those participants.
As a result of this plan change and in accordance with ASC Topic 715 (formerly
SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits,”) a gain on pension
curtailment of $14.4 million was recorded in 2007 and included in Other
operating expenses in the consolidated statement of operations. Also, effective
December 31, 2007, the CTE Employees’ Pension Plan was merged into the
Frontier Pension Plan.
The
plan’s weighted average asset allocations at December 31, 2009 and 2008 by
asset category are as follows:
2009
|
2008
|
|||||||
Asset
category:
|
||||||||
Equity
securities
|
38% | 42% | ||||||
Debt
securities
|
51% | 48% | ||||||
Alternative
investments
|
10% | 9% | ||||||
Cash
and other
|
1% | 1% | ||||||
Total
|
100% | 100% |
The
plan’s expected benefit payments over the next 10 years are as
follows:
($ in
thousands)
|
||||||
Year
|
Amount
|
|||||
2010
|
$ | 60,820 | ||||
2011
|
62,558 | |||||
2012
|
64,929 | |||||
2013
|
66,619 | |||||
2014
|
67,179 | |||||
2015 - 2019 | 344,565 | |||||
Total
|
$ | 666,670 | ||||
No
contributions were made to the plan during 2007, 2008 and 2009. We
expect that we will make a $10.0 million cash contribution to our pension plan
in 2010.
The
accumulated benefit obligation for the plan was $876.5 million and $818.9
million at December 31, 2009 and 2008, respectively.
Assumptions
used in the computation of annual pension costs and valuation of the year-end
obligations were as follows:
2009
|
2008
|
2007
|
||||||||||
Discount
rate - used at year end to value obligation
|
5.75% | 6.50% | 6.50% | |||||||||
Discount
rate - used to compute annual cost
|
6.50% | 6.50% | 6.00% | |||||||||
Expected
long-term rate of return on plan assets
|
8.00% | 8.25% | 8.25% | |||||||||
Rate
of increase in compensation levels
|
3.00% | 3.00% | 3.50% |
F-37
Postretirement Benefits
Other Than Pensions—“OPEB”
The
following tables set forth the OPEB plan’s benefit obligations, fair values of
plan assets and the postretirement benefit liability recognized on our
consolidated balance sheets at December 31, 2009 and 2008 and the
components of net periodic postretirement benefit costs for the years ended
December 31, 2009, 2008 and 2007.
($ in thousands)
|
2009
|
2008
|
||||||
Change in benefit
obligation
|
||||||||
Benefit
obligation at beginning of year
|
$ | 178,615 | $ | 174,602 | ||||
Service
cost
|
361 | 444 | ||||||
Interest
cost
|
11,017 | 11,255 | ||||||
Plan
participants' contributions
|
4,086 | 3,753 | ||||||
Actuarial
loss
|
11,378 | 3,917 | ||||||
Benefits
paid
|
(16,167 | ) | (15,261 | ) | ||||
Plan
change
|
- | (95 | ) | |||||
Benefit
obligation at end of year
|
$ | 189,290 | $ | 178,615 | ||||
Change in plan assets
|
||||||||
Fair
value of plan assets at beginning of year
|
$ | 8,137 | $ | 9,369 | ||||
Actual
return on plan assets
|
1,018 | 388 | ||||||
Plan
participants' contributions
|
4,086 | 3,753 | ||||||
Employer
contribution
|
10,954 | 9,888 | ||||||
Benefits
paid
|
(16,167 | ) | (15,261 | ) | ||||
Fair
value of plan assets at end of year
|
$ | 8,028 | $ | 8,137 | ||||
Funded
status
|
$ | (181,262 | ) | $ | (170,478 | ) | ||
Amounts recognized in the consolidated balance
sheet
|
||||||||
Current
liabilities
|
$ | (9,052 | ) | $ | (8,916 | ) | ||
Other
long-term liabilities
|
$ | (172,210 | ) | $ | (161,562 | ) | ||
Accumulated
other comprehensive income
|
$ | 21,554 | $ | 8,045 | ||||
($ in thousands)
|
Expected
|
|||||||||||||||
2010
|
2009
|
2008
|
2007
|
|||||||||||||
Components of net periodic postretirement benefit
cost
|
||||||||||||||||
Service
cost
|
$ | 361 | $ | 444 | $ | 533 | ||||||||||
Interest
cost on projected benefit obligation
|
11,017 | 11,255 | 10,241 | |||||||||||||
Expected
return on plan assets
|
(439 | ) | (514 | ) | (578 | ) | ||||||||||
Amortization
of prior service cost/(credit)
|
(7,716 | ) | (7,751 | ) | (7,751 | ) | (7,735 | ) | ||||||||
Amortization
of unrecognized loss
|
6,324 | 5,041 | 5,946 | 6,099 | ||||||||||||
Net
periodic postretirement benefit cost
|
$ | 8,229 | $ | 9,380 | $ | 8,560 | ||||||||||
F-38
Assumptions
used in the computation of annual OPEB costs and valuation of the year-end OPEB
obligations were as follows:
2009
|
2008
|
2007
|
||||||||||
Discount
rate - used at year end to value obligation
|
5.75% | 6.50% | 6.50% | |||||||||
Discount
rate - used to compute annual cost
|
6.50% | 6.50% | 6.00% | |||||||||
Expected
long-term rate of return on plan assets
|
6.00% | 6.00% | 6.00% |
The plan’s weighted average asset allocations at December 31, 2009 and 2008 by asset category are as follows:
2009
|
2008
|
||
Asset category:
|
|||
Equity
securities
|
0%
|
0%
|
|
Debt
securities
|
100%
|
100%
|
|
Cash
and other
|
0%
|
0%
|
|
Total
|
100%
|
100%
|
|
The plan’s expected benefit payments over the next 10 years are as follows:
($ in thousands)
|
||||||||||||||
Gross
|
Medicare
Part D
|
|||||||||||||
Year
|
Benefits
|
Subsidy
|
Total
|
|||||||||||
2010
|
$ | 13,266 | $ | 461 | $ | 12,805 | ||||||||
2011
|
13,798 | 529 | 13,269 | |||||||||||
2012
|
13,961 | 642 | 13,319 | |||||||||||
2013
|
14,300 | 742 | 13,558 | |||||||||||
2014
|
14,510 | 850 | 13,660 | |||||||||||
2015 - 2019 | 75,185 | 5,786 | 69,399 | |||||||||||
Total
|
$ | 145,020 | $ | 9,010 | $ | 136,010 | ||||||||
Our expected contribution to the plan in 2010 is $12.8 million.
For
purposes of measuring year-end benefit obligations, we used, depending on
medical plan coverage for different retiree groups, a 8.5% annual rate of
increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2017 and remaining at that level thereafter. The
effect of a 1% increase in the assumed medical cost trend rates for each future
year on the aggregate of the service and interest cost components of the total
postretirement benefit cost would be $0.7 million and the effect on the
accumulated postretirement benefit obligation for health benefits would be $12.3
million. The effect of a 1% decrease in the assumed medical cost trend rates for
each future year on the aggregate of the service and interest cost components of
the total postretirement benefit cost would be $(0.6) million and the effect on
the accumulated postretirement benefit obligation for health benefits would be
$(10.7) million.
In
December 2003, the Medicare Prescription Drug Improvement and Modernization Act
of 2003 (the Act) became law. The Act introduced a prescription drug benefit
under Medicare. It includes a federal subsidy to sponsors of retiree health care
benefit plans that provide a benefit that is at least actuarially equivalent to
the Medicare Part D benefit. The amount of the federal subsidy is based on 28%
of an individual beneficiary’s annual eligible prescription drug costs ranging
between $250 and $5,000. We have determined that the Company-sponsored
postretirement healthcare plans that provide prescription drug benefits are
actuarially equivalent to the Medicare Prescription Drug benefit. The impact of
the federal subsidy has been incorporated into the calculation.
F-39
The
amounts in accumulated other comprehensive income that have not yet been
recognized as components of net periodic benefit cost at December 31, 2009
and 2008 are as follows:
($ in thousands)
|
Pension
Plan
|
OPEB
|
||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Net
actuarial loss
|
$ | 374,390 | $ | 377,183 | $ | 53,010 | $ | 47,252 | ||||||||
Prior
service cost/(credit)
|
(233 | ) | (1,097 | ) | (31,456 | ) | (39,207 | ) | ||||||||
Total
|
$ | 374,157 | $ | 376,086 | $ | 21,554 | $ | 8,045 | ||||||||
The amounts recognized as a component of accumulated comprehensive income for the years ended December 31, 2009 and 2008 are as follows:
Pension
Plan
|
OPEB
|
|||||||||||||||
($ in thousands)
|
2009
|
2008
|
2009
|
2008
|
||||||||||||
Accumulated
other comprehensive income at
|
||||||||||||||||
beginning
of year
|
$ | 376,086 | $ | 134,276 | $ | 8,045 | $ | 2,292 | ||||||||
Net
actuarial gain (loss) recognized during year
|
(27,144 | ) | (6,855 | ) | (5,041 | ) | (5,946 | ) | ||||||||
Prior
service (cost)/credit recognized during year
|
255 | 255 | 7,751 | 7,751 | ||||||||||||
Net
actuarial loss (gain) occurring during year
|
24,351 | 248,410 | 10,799 | 4,043 | ||||||||||||
Prior
service cost (credit) occurring during year
|
609 | - | - | (95 | ) | |||||||||||
Net
amount recognized in comprehensive income
|
||||||||||||||||
for
the year
|
(1,929 | ) | 241,810 | 13,509 | 5,753 | |||||||||||
Accumulated
other comprehensive income at end
|
||||||||||||||||
of
year
|
$ | 374,157 | $ | 376,086 | $ | 21,554 | $ | 8,045 | ||||||||
401(k) Savings Plans
We
sponsor employee retirement savings plans under section 401(k) of the Internal
Revenue Code. The plans cover substantially all full-time employees. Under the
plans, we provide matching contributions and also provide certain profit-sharing
contributions to certain employees upon the attainment of pre-established
financial criteria. Employer contributions were $4.4 million, $5.0 million and
$4.9 million for 2009, 2008 and 2007, respectively. The amount for 2007 includes
employer contributions of $0.4 million for CTE employees under a separate
Commonwealth plan. Also, effective December 31, 2007, the Commonwealth
Builder 401(k) Plan was merged into the Frontier 401(k) Savings
Plan.
(20)
|
Fair Value of
Financial Instruments:
|
In
September 2006, the FASB issued ASC Topic 820 (formerly SFAS No. 157, “Fair
Value Measurements”), which establishes a framework for measuring fair value in
accordance with generally accepted accounting principles in the United States
and expands disclosure requirements about fair value
measurements. ASC Topic 820 was effective for financial statements
issued for fiscal years beginning after November 15, 2007. We adopted
ASC Topic 820 effective January 1, 2008, for all financial assets and financial
liabilities, as required.
Fair
value is defined under ASC Topic 820 as the exit price associated with the sale
of an asset or transfer of a liability in an orderly transaction between market
participants at the measurement date. Valuation techniques used to measure fair
value under ASC Topic 820 must maximize the use of observable inputs and
minimize the use of unobservable inputs. In addition, ASC Topic 820 establishes
a three-tier fair value hierarchy, which prioritizes the inputs used in
measuring fair value.
F-40
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
The
following table represents the Company’s pension plan assets measured at fair
value on a recurring basis:
Fair
Value Measurements at December 31, 2009
|
||||||||||||||||
Quoted
|
Significant
|
|||||||||||||||
Prices
in Active
|
Other
|
Significant
|
||||||||||||||
Markets
for
|
Observable
|
Unobservable
|
||||||||||||||
Identical
Assets
|
Inputs
|
Inputs
|
||||||||||||||
Total
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||||||
Cash
and Cash Equivalents
|
$ | 23,202 | $ | - | $ | 23,202 | $ | - | ||||||||
U.S.
Government Obligations
|
85,255 | - | 85,255 | - | ||||||||||||
Corporate and
Other Obligations
|
200,671 | - | 200,671 | - | ||||||||||||
Common
Stock
|
67,571 | 67,571 | - | - | ||||||||||||
Commingled
Funds
|
36,120 | - | 22,198 | 13,922 | ||||||||||||
Common/Collective
Trust Funds
|
29,799 | - | 29,799 | - | ||||||||||||
Interest in
Registered Investment Companies
|
139,929 | 59,564 | 80,365 | - | ||||||||||||
Interest in
Limited Partnerships
|
29,727 | - | - | 29,727 | ||||||||||||
Insurance
Contracts
|
900 | - | 900 | - | ||||||||||||
Other
|
(75 | ) | - | (75 | ) | - | ||||||||||
Total
investments, at fair value
|
$ | 613,099 | $ | 127,135 | $ | 442,315 | $ | 43,649 | ||||||||
Interest and
Dividends Receivable
|
1,872 | |||||||||||||||
Due
from Broker for Securities Sold
|
36,715 | |||||||||||||||
Receivable
Associated with Insurance Contract
|
6,284 | |||||||||||||||
Due to
Broker for Securities Purchased
|
(49,345 | ) | ||||||||||||||
Total
Plan Assets, at Fair Value
|
$ | 608,625 |
The table
below sets forth a summary of changes in the fair value of the Plan’s Level 3
assets:
For the
year ended
December
31, 2009
|
||||||||
Interest
in
|
||||||||
Limited
|
Commingled
|
|||||||
Partnerships
|
Funds
|
|||||||
Balance,
beginning of year
|
$ | 28,924 | $ | 12,515 | ||||
Realized
gains/(losses)
|
(2,475 | ) | - | |||||
Unrealized
gains
|
3,786 | 1,407 | ||||||
Purchases and
(sales), net
|
(508 | ) | - | |||||
Balance, end of
year
|
$ | 29,727 | $ | 13,922 | ||||
The fair
value of our OPEB plan assets, which are measured using Level 1 inputs, was $8.0
million as of December 31, 2009.
F-41
FRONTIER
COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Notes to
Consolidated Financial Statements
The
following table summarizes the carrying amounts and estimated fair values for
certain of our financial instruments at December 31, 2009 and 2008. For the
other financial instruments, representing cash, accounts receivables, long-term
debt due within one year, accounts payable and other accrued liabilities, the
carrying amounts approximate fair value due to the relatively short maturities
of those instruments. Other equity method investments for which market values
are not readily available are carried at cost, which approximates fair
value.
($ in thousands)
|
2009
|
2008
|
||||||||||||||
Carrying
|
Carrying
|
|||||||||||||||
Amount
|
Fair
Value
|
Amount
|
Fair
Value
|
|||||||||||||
Long-term
debt
|
$ | 4,794,129 | $ | 4,628,132 | $ | 4,721,685 | $ | 3,651,924 | ||||||||
(21)
|
Commitments and
Contingencies:
|
On
June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco, Inc.,
received a “Notice of Indemnity Claim” from Citibank, N.A., that was related to
a case pending against Citibank and others in the U.S. Bankruptcy Court for the
Southern District of New York as part of the Global Crossing bankruptcy
proceeding. The case against Citibank and others has been settled with no
contribution from the Company and no further indemnification claims are
expected.
We are
party to various other legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our financial
position, results of operations, or our cash flows.
We
anticipate capital expenditures related to our currently owned properties of
approximately $220.0 million to $240.0 million for 2010. Although we from time
to time make short-term purchasing commitments to vendors with respect to these
expenditures, we generally do not enter into firm, written contracts for such
activities.
F-42
In
connection with the Verizon Transaction, the Company has commenced activities to
obtain the necessary regulatory approvals, plan and implement systems
conversions and other initiatives necessary to effectuate the closing, which is
expected to occur during the second quarter of 2010, and enable the Company to
implement its “go to market” strategy at closing. While the Company
continues to evaluate certain other expenses, the Company currently expects
to incur operating expenses and capital expenditures of approximately $100.0
million and $75.0 million, respectively, in 2010 related to these integration
initiatives. The Company incurred $28.3 million of acquisition and
integration costs and $25.0 million in capital expenditures related to the
integration of Verizon activities during 2009.
We
conduct certain of our operations in leased premises and also lease certain
equipment and other assets pursuant to operating leases. The lease arrangements
have terms ranging from 1 to 99 years and several contain rent escalation
clauses providing for increases in monthly rent at specific intervals. When rent
escalation clauses exist, we record annual rental expense based on the total
expected rent payments on a straight-line basis over the lease term. Certain
leases also have renewal options. Renewal options that are reasonably assured
are included in determining the lease term. Future minimum rental commitments
for all long-term noncancelable operating leases as of December 31, 2009
are as follows:
($ in thousands)
|
Operating
|
|||
Leases
|
||||
Year
ending December 31:
|
||||
2010
|
$ | 24,417 | ||
2011
|
11,627 | |||
2012
|
8,407 | |||
2013
|
7,107 | |||
2014
|
5,796 | |||
Thereafter
|
6,934 | |||
Total
minimum lease payments
|
$ | 64,288 | ||
Total
rental expense included in our consolidated statements of operations for the
years ended December 31, 2009, 2008 and 2007 was $25.9 million, $24.3
million and $23.6 million, respectively.
We are a
party to contracts with several unrelated long distance carriers. The contracts
provide fees based on traffic they carry for us subject to minimum monthly
fees.
At
December 31, 2009, the estimated future payments for obligations under our
noncancelable long distance contracts and service agreements are as
follows:
($ in
thousands)
|
||||
Year
|
Amount
|
|||
2010
|
$ | 11,026 | ||
2011
|
6,407 | |||
2012
|
4,421 | |||
2013
|
4,125 | |||
2014
|
4,125 | |||
Thereafter
|
165 | |||
Total
|
$ | 30,269 | ||
F-43
We sold
all of our utility businesses as of April 1, 2004. However, we have
retained a potential payment obligation associated with our previous electric
utility activities in the State of Vermont. The Vermont Joint Owners (VJO), a
consortium of 14 Vermont utilities, including us, entered into a purchase power
agreement with Hydro-Quebec in 1987. The agreement contains “step-up” provisions
that state that if any VJO member defaults on its purchase obligation under the
contract to purchase power from Hydro-Quebec, then the other VJO participants
will assume responsibility for the defaulting party’s share on a pro-rata basis.
Our pro-rata share of the purchase power obligation is 10%. If any member of the
VJO defaults on its obligations under the Hydro-Quebec agreement, then the
remaining members of the VJO, including us, may be required to pay for a
substantially larger share of the VJO’s total power purchase obligation for the
remainder of the agreement (which runs through 2015). U.S. GAAP rules require
that we disclose “the maximum potential amount of future payments (undiscounted)
the guarantor could be required to make under the guarantee.” U.S. GAAP rules
also state that we must make such disclosure “… even if the likelihood of the
guarantor’s having to make any payments under the guarantee is remote…” As noted
above, our obligation only arises as a result of default by another VJO member,
such as upon bankruptcy. Therefore, to satisfy the “maximum potential amount”
disclosure requirement we must assume that all members of the VJO simultaneously
default, a highly unlikely scenario given that the two members of the VJO that
have the largest potential payment obligations are publicly traded with credit
ratings equal to or superior to ours, and that all VJO members are regulated
utility providers with regulated cost recovery. Despite the remote chance that
such an event could occur, or that the State of Vermont could or would allow
such an event, assuming that all the members of the VJO defaulted on
January 1, 2010 and remained in default for the duration of the contract
(another 6 years), we estimate that our undiscounted purchase obligation for
2010 through 2015 would be approximately $0.6 billion. In such a scenario the
Company would then own the power and could seek to recover its costs. We would
do this by seeking to recover our costs from the defaulting members and/or
reselling the power to other utility providers or the northeast power grid.
There is an active market for the sale of power. We could potentially lose money
if we were unable to sell the power at cost. We caution that we cannot predict
with any degree of certainty any potential outcome.
At
December 31, 2009, we have outstanding performance letters of credit as
follows:
($ in
thousands)
|
||||
CNA
|
$ | 26,618 | ||
State
of New York
|
1,042 | |||
Total
|
$ | 27,660 | ||
CNA
serves as our agent with respect to general liability claims (auto, workers
compensation and other insured perils of the Company). As our agent, they
administer all claims and make payments for claims on our behalf. We reimburse
CNA for such services upon presentation of their invoice. To serve as our agent
and make payments on our behalf, CNA requires that we establish a letter of
credit in their favor. CNA could potentially draw against this letter of credit
if we failed to reimburse CNA in accordance with the terms of our agreement. The
value of the letter of credit is reviewed annually and adjusted based on claims
history.
None of
the above letters of credit restrict our cash balances.
F-44