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EX-31.2 - SHASSIAN CERTIFICATION - FRONTIER COMMUNICATIONS CORPshassiancert.htm
EX-10.1 - SUE D'EMIC AGREEMENT - FRONTIER COMMUNICATIONS CORPdemicagreement.htm
EX-31.1 - WILDEROTTER CERTIFICATION - FRONTIER COMMUNICATIONS CORPwilderottercert.htm
EX-32.2 - SHASSIAN 906 CERTIFICATION - FRONTIER COMMUNICATIONS CORPshassian906cert.htm
EXCEL - IDEA: XBRL DOCUMENT - FRONTIER COMMUNICATIONS CORPFinancial_Report.xls
EX-32.1 - WILDEROTTER 906 CERTIFICATION - FRONTIER COMMUNICATIONS CORPwilderotter906cert.htm




FRONTIER COMMUNICATIONS CORPORATION


FORM 10-Q


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934


FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011







 
 

 


UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

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

For the quarterly period ended March 31, 2011

or

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

For the transition period from _________to__________

Commission file number:  001-11001

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

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

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

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

Yes   X        No ___

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

         Large accelerated filer [ X ]                          Accelerated filer [    ]                           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 number of shares outstanding of the registrant’s Common Stock as of May 2, 2011 was 995,219,000.

 
 

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

Index


 
Page No.
Part I.  Financial Information (Unaudited)
 
   
Item 1.  Financial Statements
 
   
     Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010
2
   
     Consolidated Statements of Operations for the three months ended March 31, 2011 and 2010
3
   
     Consolidated Statements of Equity for the three months ended March 31, 2010, the nine months ended
     December 31, 2010 and the three months ended March 31, 2011
 
4
   
     Consolidated Statements of Comprehensive Income for the three months ended
March 31,  2011 and 2010
 
4
   
     Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010
5
   
     Notes to Consolidated Financial Statements
6
   
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
19
   
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
35
   
Item 4.  Controls and Procedures
36
   
Part II.  Other Information
 
   
Item 1.  Legal Proceedings
37
   
Item 1A.  Risk Factors
37
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
37
   
Item 6.  Exhibits
39
   
Signature
40
   





 
1

 
Explanatory Note
Effective July 1, 2010, Frontier’s scope of operations and balance sheet capitalization changed materially as a result of the completion of the Transaction, as described in Note 2 of the Notes to Consolidated Financial Statements.  Historical financial and operating data presented for Frontier is not indicative of the future financial position or operating results for Frontier, and  includes the results of operations of the Acquired Business, as defined in Note 2 of the Notes to Consolidated Financial Statements, from the date of acquisition on July 1, 2010.  The financial discussion represents an analysis of our results of operations on a historical basis for our Frontier operations as of and for the three months ended March 31, 2011and 2010, which includes the results of operations of the Acquired Business for just the three months ended March 31, 2011.

PART I.  FINANCIAL INFORMATION
Item 1.Financial Statements
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)
             
   
(Unaudited)
March 31, 2011
   
December 31, 2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 359,382     $ 251,263  
Accounts receivable, less allowances of $80,195 and $73,571, respectively
    519,239       568,308  
Prepaid expenses
    93,284       100,603  
Income taxes and other current assets
    204,983       208,245  
Total current assets
    1,176,888       1,128,419  
                 
Restricted cash
    184,207       187,489  
Property, plant and equipment, net
    7,572,985       7,590,614  
Goodwill
    6,277,637       6,292,194  
Other intangibles, net
    2,354,023       2,491,195  
Other assets
    212,783       200,319  
Total assets
  $ 17,778,523     $ 17,890,230  
                 
LIABILITIES AND EQUITY
               
Current liabilities:
               
Long-term debt due within one year
  $ 279,873     $ 280,002  
Accounts payable
    385,480       436,886  
Advanced billings
    168,065       171,602  
Accrued other taxes
    148,981       167,857  
Accrued interest
    214,768       170,228  
Other current liabilities
    213,089       212,782  
Total current liabilities
    1,410,256       1,439,357  
                 
Deferred income taxes
    2,264,679       2,220,677  
Pension and other postretirement benefits
    827,735       816,588  
Other liabilities
    208,595       220,172  
Long-term debt
    7,986,248       7,983,693  
                 
Equity:
               
Shareholders' equity of Frontier:
               
Common stock, $0.25 par value (1,750,000,000 authorized shares,
               
995,225,000 and 993,855,000 outstanding, respectively, and
               
1,027,986,000  issued at March 31, 2011
               
and December 31, 2010)
    256,997       256,997  
Additional paid-in capital
    5,321,796       5,525,471  
Retained earnings
    131,818       77,107  
Accumulated other comprehensive loss, net of tax
    (227,894 )     (229,549 )
Treasury stock
    (414,695 )     (433,286 )
Total shareholders' equity of Frontier
    5,068,022       5,196,740  
Noncontrolling interest in a partnership
    12,988       13,003  
Total equity
    5,081,010       5,209,743  
Total liabilities and equity
  $ 17,778,523     $ 17,890,230  
                 
The accompanying Notes are an integral part of these Consolidated Financial Statements.
 
2
 

PART I.  FINANCIAL INFORMATION (Continued)


FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
($ in thousands, except for per-share amounts)
(Unaudited)

 
   
2011
   
2010
 
             
Revenue
  $ 1,346,697     $ 519,849  
                 
Operating expenses:
               
Network access expenses
    151,284       53,543  
Other operating expenses
    580,340       193,025  
Depreciation and amortization
    351,257       101,049  
Acquisition and integration costs
    13,223       10,370  
Total operating expenses
    1,096,104       357,987  
                 
Operating income
    250,593       161,862  
                 
Investment income
    3,115       2,497  
Other income, net
    6,470       4,956  
Interest expense
    167,415       93,787  
                 
Income before income taxes
    92,763       75,528  
                 
Income tax expense
    36,567       32,056  
                 
Net income
    56,196       43,472  
Less: Income attributable to the noncontrolling interest in a partnership
    1,485       907  
Net income attributable to common shareholders of Frontier
  $ 54,711     $ 42,565  
                 
Basic and diluted net income per common share attributable to common
               
shareholders of Frontier
  $ 0.05     $ 0.14  
                 

 

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

 
3

 

 PART I.  FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2010, THE NINE MONTHS ENDED DECEMBER 31, 2010 AND THE THREE MONTHS ENDED MARCH 31, 2011
($ and shares in thousands)
(Unaudited)

 
Frontier Shareholders
             
                 
          Accumulated
                 
         
Additional
     
Other
                     
 
Common Stock
 
Paid-In
 
Retained
 
Comprehensive
 
Treasury Stock
   
Noncontrolling
   
Total
 
 
Shares
 
Amount
 
Capital
 
Earnings
 
Loss
 
Shares
 
Amount
   
Interest
   
Equity
 
                                         
Balance January 1, 2010
  349,456   $ 87,364   $ 956,401   $ 2,756   $ (245,519 )   (37,128 ) $ (473,391 )   $ 11,459     $ 339,070  
  Stock plans
  -     -     (14,058 )   -     -     1,082     15,023       -       965  
  Dividends on common stock
  -     -     (78,355 )   -     -     -     -       -       (78,355 )
  Net income
  -     -     -     42,565     -     -     -       907       43,472  
  Other comprehensive income, net
                                                         
    of tax
  -     -     -     -     3,977     -     -       -       3,977  
  Distributions
  -     -     -     -     -     -     -       (1,500 )     (1,500 )
Balance March 31, 2010
  349,456     87,364     863,988     45,321     (241,542 )   (36,046 )   (458,368 )     10,866       307,629  
  Acquisition of the Acquired   
    Business
  678,530     169,633     5,048,266     -     -     -     -       -       5,217,899  
  Stock plans
  -     -     (14,071 )   -     -     1,915     25,082       -       11,011  
  Dividends on common stock
  -     -     (372,712 )   (78,322 )   -     -     -       -       (451,034 )
  Net income
  -     -     -     110,108     -     -     -       2,137       112,245  
  Other comprehensive income, net
                                                         
    of tax
  -     -     -     -     11,993     -     -       -       11,993  
Balance December 31, 2010
  1,027,986     256,997     5,525,471     77,107     (229,549 )   (34,131 )   (433,286 )     13,003       5,209,743  
  Stock plans
  -     -     (17,070 )   -     -     1,370     18,591       -       1,521  
  Dividends on common stock
  -     -     (186,605 )   -     -     -     -       -       (186,605
  Net income
  -     -     -     54,711     -     -     -       1,485       56,196  
  Other comprehensive income, net
                                                         
    of tax
  -     -     -     -     1,655     -     -       -       1,655  
  Distributions
  -     -     -     -     -     -     -       (1,500 )     (1,500 )
Balance March 31, 2011
  1,027,986   $ 256,997   $ 5,321,796   $ 131,818   $ (227,894 )   (32,761 ) $ (414,695 )   $ 12,988     $ 5,081,010  
                                                           
                                                           

 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
($ in thousands)
(Unaudited)
 
   
2011
   
2010
 
             
Net income
  $ 56,196     $ 43,472  
Other comprehensive income, net
               
   of tax
    1,655       3,977  
Comprehensive income
    57,851       47,449  
                 
Less:  Comprehensive income
               
   attributable to the noncontrolling
               
   interest in a partnership
    (1,485 )     (907 )
                 
Comprehensive income attributable to
               
   the common shareholders of Frontier
  $ 56,366     $ 46,542  
                 

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

 
4

 



PART I.  FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010
($ in thousands)
(Unaudited)

   
2011
   
2010
 
             
Cash flows provided by (used in) operating activities:
           
Net income
  $ 56,196     $ 43,472  
Adjustments to reconcile net income to net cash provided by
               
   operating activities:
               
Depreciation and amortization expense
    351,257       101,049  
Stock based compensation expense
    3,584       2,743  
Pension/OPEB costs
    11,279       7,323  
Other non-cash adjustments
    (2,999 )     (2,159 )
Deferred income taxes
    27,744       8,084  
Change in accounts receivable
    30,996       1,242  
Change in accounts payable and other liabilities
    29,469       (62,914 )
Change in prepaid expenses, income taxes and other current assets
    6,588       24,312  
Net cash provided by operating activities
    514,114       123,152  
                 
Cash flows provided from (used by) investing activities:
               
Capital expenditures - Business operations
    (203,534 )     (39,927 )
Capital expenditures - Integration activities
    (5,578 )     (29,679 )
Other assets purchased and distributions received, net
    (3,207 )     142  
Net cash used by investing activities
    (212,319 )     (69,464 )
                 
Cash flows provided from (used by) financing activities:
               
Long-term debt payments
    (969 )     (977 )
Dividends paid
    (186,605 )     (78,355 )
Repayment of customer advances for construction,
               
   distributions to noncontrolling interests and other
    (6,102 )     (1,954 )
Net cash used by financing activities
    (193,676 )     (81,286 )
                 
                 
Increase (decrease) in cash and cash equivalents
    108,119       (27,598 )
Cash and cash equivalents at January 1,
    251,263       358,693  
                 
Cash and cash equivalents at March 31,
  $ 359,382     $ 331,095  
                 
Supplemental cash flow information:
               
Cash paid during the period for:
               
Interest
  $ 119,067     $ 109,528  
Income taxes
  $ 8,946     $ -  
                 
                 
 

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

 
5

 

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)  
Summary of Significant Accounting Policies:
(a)  
Basis of Presentation and Use of Estimates:
Frontier Communications Corporation and its subsidiaries are referred to as “we,” “us,” “our,” “Frontier,” or the “Company” in this report. On July 1, 2010, Frontier completed the Transaction for the acquisition of the Acquired Business, as described further in Note 2.  Our interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2010. Certain reclassifications of balances previously reported have been made to conform to the current presentation.  All significant intercompany balances and transactions have been eliminated in consolidation. These interim unaudited consolidated financial statements include all adjustments (consisting of normal recurring accruals) considered necessary, in the opinion of Frontier’s management, to present fairly the results for the interim periods shown.  Revenues, net income and cash flows for any interim periods are not necessarily indicative of results that may be expected for the full year.  For our interim financial statements as of and for the period ended March 31, 2011, we evaluated subsequent events and transactions for potential recognition or disclosure through the date that we filed this quarterly report on Form 10-Q with the Securities and Exchange Commission (SEC).

The preparation of our interim financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities at the date of the financial statements, (ii) the disclosure of contingent assets and liabilities, and (iii) the reported amounts of revenue and expenses during the reporting period.  Actual results may differ from those estimates.  Estimates and judgments are used when accounting for allowance for doubtful accounts, impairment of long-lived assets, intangible assets, depreciation and amortization, income taxes, purchase price allocations, contingencies, and pension and other postretirement benefits, among others. Certain information and footnote disclosures have been excluded and/or condensed pursuant to SEC rules and regulations.

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

As required by law, the Company collects various taxes from its customers and subsequently remits these taxes to governmental authorities. Substantially all of these taxes are recorded through the consolidated balance sheet and presented on a net basis in our consolidated statements of operations.  We also collect Universal Service Fund (USF) surcharges from customers (primarily federal USF) which we have recorded on a gross basis in our consolidated statements of operations and included in revenue and other operating expenses at $28.1 million and $10.4 million for the three months ended March 31, 2011 and 2010, respectively.

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

 
6

 
The Company amortizes intangible assets with estimated useful lives over those lives and reviews such intangible assets to assess any impairment and whether factors exist that would necessitate a change in useful life and a different amortization period.

(2)   The Transaction:
On July 1, 2010, Frontier acquired the defined assets and liabilities of the local exchange business and related landline activities of Verizon Communications Inc. (Verizon) in Arizona, Idaho, Illinois, Indiana, Michigan, Nevada, North Carolina, Ohio, Oregon, South Carolina, Washington, West Virginia and Wisconsin and in portions of California bordering Arizona, Nevada and Oregon (collectively, the Territories), including Internet access and long distance services and broadband video provided to designated customers in the Territories (the Acquired Business).  Frontier is considered the accounting acquirer of the Acquired Business.

We are accounting for our acquisition of approximately 4.0 million access lines from Verizon (the Transaction) using the guidance included in Accounting Standards Codification (ASC) Topic 805. We incurred approximately $13.2 million of acquisition and integration related costs in connection with the Transaction during the three months ended March 31, 2011 and $10.4 million of acquisition related costs during the three months ended March 31, 2010, respectively.  Such costs are required to be expensed as incurred and are reflected in “Acquisition and integration costs” in our consolidated statements of operations.

Our consolidated statements of operations for the three months ended March 31, 2011 include $841.8 million of revenue and $97.5 million of operating income related to the results of operations of the Acquired Business.

The allocation of the purchase price of the Acquired Business is based on the fair value of assets acquired and liabilities assumed as of July 1, 2010, the effective date of the Transaction.  Our assessment of fair value is preliminary, and will be adjusted for information that is currently not available to us, primarily related to: other accrued liabilities, pending receipt of supporting documentation; deferred income tax assets and liabilities, pending Verizon providing us with tax values for the assets and liabilities of the Acquired Business; and pension and other postretirement liabilities, pending completion of actuarial studies and the related transfer of pension assets.

The preliminary allocation of the purchase price presented below represents the effect of recording the preliminary estimates of the fair value of assets acquired, liabilities assumed and related deferred income taxes as of the date of the Transaction, based on the total transaction consideration of $5.4 billion.  The following allocation of purchase price includes minor revisions to the preliminary allocation that was reported as of December 31, 2010 for goodwill and current liabilities primarily due to the sales and utility tax matter in the state of Washington.  These preliminary estimates will be revised in future periods and the revisions may materially affect the presentation of our consolidated financial results.  Any changes to the initial estimates of the fair value of the assets and liabilities will be recorded as adjustments to those assets and liabilities and residual amounts will be allocated to goodwill.

 
7

 


($ in thousands)
           
Total transaction consideration:
        $ 5,411,705  
Current assets
  $ 461,920          
Property, plant & equipment
    4,421,682          
Goodwill
    3,635,314          
Other intangibles – primarily customer list
    2,532,200          
Other noncurrent assets
    75,092          
Current liabilities
    (470,178 )        
Deferred income taxes
    (1,318,746 )        
Long-term debt
    (3,456,782 )        
Other noncurrent liabilities
    (468,797 )        
Total net assets acquired
  $ 5,411,705          

The Transaction provides for a post-closing adjustment for working capital, pension liabilities transferred and pension assets.  Frontier and Verizon have not finalized the results of these calculations.

The fair value of the total consideration issued to acquire the Acquired Business amounted to $5.4 billion and included $5.2 billion for the issuance of Frontier common shares and cash payments of $105.0 million.  As a result of the Transaction, Verizon stockholders received 678,530,386 shares of Frontier common stock.  Immediately after the closing of the Transaction, Verizon stockholders owned approximately 68.4% of the combined company’s outstanding equity, and existing Frontier stockholders owned approximately 31.6% of the combined company’s outstanding equity.

The following unaudited pro forma financial information presents the combined results of operations of Frontier and the Acquired Business as if the Transaction had occurred as of January 1, 2010.  The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the Transaction been completed as of January 1, 2010.  In addition, the unaudited pro forma financial information is not indicative of, nor does it purport to project, the future financial position or operating results of Frontier.  The unaudited pro forma financial information excludes acquisition and integration costs and does not give effect to any estimated and potential cost savings or other operating efficiencies that could result from the Transaction.

UNAUDITED PRO FORMA CONDENSED COMBINED
STATEMENTS OF OPERATIONS INFORMATION


   
For the three months ended March 31, 2010
($ in millions, except
       per share amounts)
     
       
Revenue
  $ 1,456  
Operating income
    335  
Net income attributable to common
     shareholders of Frontier
    92  
         
Basic and diluted net income per common
    share attributable to common
    shareholders of  Frontier
  $ 0.09  


 
8

 


(3)  
Accounts Receivable:
The components of accounts receivable, net are as follows:

   ($ in thousands)
 
March 31, 2011
   
December 31, 2010
 
    
               
    End user
 
583,224
   
$
627,573
 
    Other
   
16,210
     
14,306
 
    Less: Allowance for doubtful accounts
   
(80,195
)
   
(73,571
)
         Accounts receivable, net
 
$
519,239
   
$
568,308
 
                 

We maintain an allowance for estimated bad debts based on our estimate of our ability to collect accounts receivable. Bad debt expense, which is recorded as a reduction to revenue, was $28.3 million and $6.1 million for the three months ended March 31, 2011 and 2010, respectively.

(4)  
Property, Plant and Equipment:
Property, plant and equipment is as follows:

   ($ in thousands)
 
March 31, 2011
   
December 31, 2010
 
    
               
    Property, plant and equipment
 
12,973,725
   
$
12,795,280
 
    Less:  Accumulated depreciation
   
(5,400,740
)
   
(5,204,666
)
         Property, plant and equipment, net
 
$
7,572,985
   
$
7,590,614
 
                 

Depreciation expense is principally based on the composite group method.  Depreciation expense was $219.1 million and $87.0 million for the three months ended March 31, 2011 and 2010, respectively.  As a result of an independent study of the estimated remaining useful lives of our Frontier legacy plant assets, we adopted new lives for certain plant assets as of October 1, 2010.  In addition, we commissioned an independent study to determine the estimated remaining useful lives for our Acquired Business.  These new lives were adopted effective July 1, 2010.

(5)  
Goodwill and Other Intangibles:
The components of goodwill and other intangibles are as follows:

   ($ in thousands)
 
March 31, 2011
   
December 31, 2010
 
    
               
Goodwill:
 
$
6,277,637
   
$
6,292,194
 
                 
Other Intangibles:
               
    Customer base
 
2,697,509
   
$
2,702,409
 
    Software licenses
   
104,923
     
105,019
 
    Trade name and license
   
135,285
     
135,285
 
          Other intangibles
   
2,937,717
     
2,942,713
 
    Less: Accumulated amortization
   
(583,694
)
   
(451,518
)
         Total other intangibles, net
 
$
2,354,023
   
$
2,491,195
 
                 

 
9

 
Amortization expense was $132.2 million and $14.1 million for the three months ended March 31, 2011 and 2010, respectively. Amortization expense for the three months ended March 31, 2011 included $118.1 million for intangible assets (primarily customer base) that were acquired in the Transaction based on an estimated fair value of $2.5 billion and an estimated useful life of nine years for the residential customer list and 12 years for the business customer list, amortized on an accelerated method.  Amortization expense for the three months ended March 31, 2011 and 2010 included $14.1 million in each period for intangible assets (customer base and trade name) that were acquired in the acquisitions of Commonwealth Telephone Enterprises, Inc., Global Valley Networks, Inc. and GVN Services.

(6)  
Fair Value of Financial Instruments:
The following table summarizes the carrying amounts and estimated fair values for certain of our financial instruments at March 31, 2011 and December 31, 2010.  For the other financial instruments, representing cash, accounts receivable, long-term debt due within one year, accounts payable and other current liabilities, the carrying amounts approximate fair value due to the relatively short maturities of those instruments.  Other equity method investments, for which market values are not readily available, are carried at cost, which approximates fair value.

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

($ in thousands)
March 31, 2011
 
December 31, 2010
 
Carrying
     
Carrying
   
 
Amount
 
Fair Value
 
Amount
 
Fair Value
               
Long-term debt
$ 7,986,248
 
$  8,304,188
 
$  7,983,693
 
$    8,376,515
               

(7)  
Long-Term Debt:
The activity in our long-term debt from December 31, 2010 to March 31, 2011 is summarized as follows:

                       
     
Three months ended March 31, 2011
       
Interest
 
                   
Rate* at
 
 
December 31,
     
New
 
March 31,
   
March 31,
 
($ in thousands)
2010
 
Payments
 
Borrowings
 
2011
   
2011
 
                       
  Rural Utilities Service
                     
    Loan Contracts
$ 11,214   $ (256 )  $ -   $ 10,958       6.15 %
                                 
  Senior Unsecured Debt
  8,302,230     (713 )   -     8,301,517       8.01 %
 
                               
  Industrial Development
                               
     Revenue Bonds
  13,550     -     -     13,550       6.33 %
                                 
TOTAL LONG-TERM DEBT
$ 8,326,994   $ (969 )  $ -   $ 8,326,025       8.01 %
                                 
  Less: Debt Discount
  (63,299 )               (59,904 )        
  Less: Current Portion
  (280,002 )               (279,873 )        
                                 
  $ 7,983,693               $ 7,986,248          
                                 
 
* Interest rate includes amortization of debt issuance costs, debt premiums or discounts, and deferred gain on interest rate swap terminations.  The interest rates at March 31, 2011 represent a weighted average of multiple issuances.

 
10

 

Additional information regarding our Senior Unsecured Debt is as follows:

 
March 31, 2011
 
December 31, 2010
   
Principal
   
Interest
     
Principal
   
Interest
 
($ in thousands)
 
Outstanding
   
Rate
     
Outstanding
   
Rate
 
                           
Senior Notes:
                         
  Due 5/15/2011
$
76,089
   
9.250%
   
$
76,089
   
9.250%
 
  Due 10/24/2011
 
200,000
   
6.270%
     
             200,000
   
6.270%
 
  Due 12/31/2012
 
143,625
   
1.625% (Variable)
     
144,000
   
1.688% (Variable)
 
  Due 1/15/2013
 
580,724
   
6.250%
     
             580,724
   
6.250%
 
  Due 12/31/2013
 
130,950
   
2.000% (Variable)
     
131,288
   
2.063% (Variable)
 
  Due 5/1/2014
 
600,000
   
8.250%
     
             600,000
   
8.250%
 
  Due 3/15/2015
 
300,000
   
6.625%
     
             300,000
   
6.625%
 
  Due 4/15/2015
 
500,000
   
7.875%
     
500,000
   
7.875%
 
  Due 4/15/2017
 
1,100,000
   
8.250%
     
1,100,000
   
8.250%
 
  Due 10/1/2018
 
600,000
   
8.125%
     
             600,000
   
8.125%
 
  Due 3/15/2019
 
434,000
   
7.125%
     
             434,000
   
7.125%
 
  Due 4/15/2020
 
1,100,000
   
8.500%
     
1,100,000
   
8.500%
 
  Due 4/15/2022
 
500,000
   
8.750%
     
500,000
   
8.750%
 
  Due 1/15/2027
 
345,858
   
7.875%
     
             345,858
   
7.875%
 
  Due 2/15/2028
 
200,000
   
6.730%
     
200,000
   
6.730%
 
  Due 10/15/2029
 
50,000
   
8.400%
     
50,000
   
8.400%
 
  Due 8/15/2031
 
945,325
   
9.000%
     
             945,325
   
9.000%
 
   
7,806,571
           
          7,807,284
       
                           
                           
Debentures:
                         
  Due 11/1/2025
 
138,000
   
7.000%
     
             138,000
   
7.000%
 
  Due 8/15/2026
 
1,739
   
6.800%
     
                 1,739
   
6.800%
 
  Due 10/1/2034
 
628
   
7.680%
     
                    628
   
7.680%
 
  Due 7/1/2035
 
125,000
   
7.450%
     
             125,000
   
7.450%
 
  Due 10/1/2046
 
193,500
   
7.050%
     
             193,500
   
7.050%
 
   
458,867
           
             458,867
       
Subsidiary Senior
                         
   Notes due 12/1/2012
 
36,000
   
8.050%
     
               36,000
   
8.050%
 
                           
Capital Lease Obligation
 
79
   
-
     
79
   
-
 
Total
$
8,301,517
   
8.01%
   
$
          8,302,230
   
8.04%
 
                           


 
11

 

We have a $750.0 million revolving credit facility (the Credit Facility).  As of March 31, 2011, we have not made any borrowings utilizing this facility.  The terms of the Credit Facility are set forth in the Credit Agreement, dated as of March 23, 2010, among the Company, the Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent (the Credit Agreement). Associated facility fees under the Credit Facility will vary from time to time depending on the Company’s credit rating (as defined in the Credit Agreement) and were 0.625% per annum as of March 31, 2011. The Credit Facility is scheduled to terminate on January 1, 2014. During the term of the Credit Facility, the Company may borrow, repay and reborrow funds, and may obtain letters of credit, subject to customary borrowing conditions. Loans under the Credit Facility will bear interest based on the alternate base rate or the adjusted LIBOR rate (each as determined in the Credit Agreement), at the Company’s election, plus a margin specified in the Credit Agreement based on the Company’s credit rating. Letters of credit issued under the Credit Facility will also be subject to fees that vary depending on the Company’s credit rating. The Credit Facility will be available for general corporate purposes but may not be used to fund dividend payments.

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

As of March 31, 2011, we were in compliance with all of our debt and credit facility financial covenants.

Our principal payments for the next five years are as follows as of March 31, 2011:
 
($ in thousands)
 
Principal Payments
 
    
     
2011 (remaining nine months)
  $ 279,033  
2012
  $ 180,366  
2013
  $ 709,855  
2014
  $ 600,517  
2015
  $ 800,549  
         
 
 

 
12

 

(8)  
Income Taxes:
The following is a reconciliation of the provision for income taxes computed at Federal statutory rates to the effective rates:
 
 
For the three months ended March 31,
 
   
2011
 
2010
 
                 
Consolidated tax provision at federal statutory rate
 
35.0
   
35.0
 
State income tax provisions, net of federal income
    tax benefit
 
3.8
     
2.4
   
All other, net
 
0.6
     
5.0
   
Effective tax rate
 
39.4
   
42.4
 
                 

Income taxes for the three months ended March 31, 2011 includes the impact of a $1.1 million charge resulting from increases in certain state income tax rates.  Income taxes for the three months ended March 31, 2010 includes the impact of a $4.1 million charge resulting from health care reform legislation associated with the passage of the Patient Protection and Affordable Care Act and of the Health Care and Education Reconciliation Act of 2010 (the Acts).  The health care reform legislation enacted in March 2010 under the Acts eliminated the tax deduction for the subsidy that the Company receives under Medicare Part D for prescription drug costs.

The amount of our uncertain tax positions whose statute of limitations are expected to expire during the next twelve months and which would affect our effective tax rate is $16.0 million as of March 31, 2011.

(9)  
Net Income Per Common Share:
The reconciliation of the net income per common share calculation is as follows:

($ and shares in thousands, except per share amounts)
 
For the three months ended March 31,
 
   
2011
   
2010
 
Net income used for basic and diluted earnings
           
   per common share:
           
Net income attributable to common shareholders of Frontier
  $ 54,711     $ 42,565  
                 
Less:  Dividends paid on unvested restricted stock awards
    (966 )     (641 )
Total basic and diluted net income attributable to common
               
   shareholders of Frontier
  $ 53,745     $ 41,924  
                 
Basic earnings per common share:
               
Total weighted average shares and unvested restricted stock awards
               
   outstanding - basic
    994,547       312,868  
Less:  Weighted average unvested restricted stock awards
    (4,798 )     (2,472 )
Total weighted average shares outstanding - basic
    989,749       310,396  
                 
Net income per share attributable to common shareholders of Frontier
  $ 0.05     $ 0.14  
 
               
Diluted earnings per common share:
               
Total weighted average shares outstanding - basic
    989,749       310,396  
Effect of dilutive shares
    1,213       -  
Effect of dilutive stock units
    474       -  
Total weighted average shares outstanding - diluted
    991,436       310,396  
                 
Net income per share attributable to common shareholders of Frontier
  $ 0.05     $ 0.14  
                 

 
13

 
Stock Options
For the three months ended March 31, 2011 and 2010, options to purchase 1,115,000 shares (at exercise prices ranging from $10.44 to $13.95) and 3,551,000 shares (at exercise prices ranging from $8.19 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 three months ended March 31, 2011 and 2010, we have deducted the impact of dividends paid on unvested restricted stock awards from net income attributable to common shareholders of Frontier.

Stock Units
At March 31, 2011 and 2010, we had 473,940 and 449,284 stock units, respectively, issued under our Non-Employee Directors’ Deferred Fee Equity Plan (Deferred Fee Plan) and the Non-Employee Directors’ Equity Incentive Plan (Directors’ Equity Plan).  These securities have not been included in the diluted income per share of common stock calculation for the three months ended March 31, 2010, because their inclusion would have an antidilutive effect.

(10)  
 Stock Plans:
At March 31, 2011, we had five stock-based compensation plans under which grants have been made and awards remained outstanding.  No further awards may be granted under three of the plans: the 1996 Equity Incentive Plan, the Amended and Restated 2000 Equity Incentive Plan (collectively, together with the 2009 Equity Incentive Plan, the EIP) and the Deferred Fee Plan.  At March 31, 2011, there were 12,540,761 shares authorized for grant under these plans and 7,057,774 shares available for grant under two of the plans.  

The following summary presents information regarding outstanding stock options as of March 31, 2011 and changes during the three months then ended with regard to options under the EIP:

         
Weighted
 
Weighted
     
   
Shares
   
Average
 
Average
   
Aggregate
   
 Subject to
   
 Option Price
 
 Remaining
   
Intrinsic
   
 Option
   
 Per Share
 
 Life in Years
   
 Value
Balance at January 1, 2011
1,507,000 0
  
$
10.50
 
1.7
 
$
603,000
 
Options granted
-   -
 
$
-
         
 
Options exercised
(10,000)0
 
$
  8.19
     
$
 12,000
 
Options canceled, forfeited or lapsed
(2,000)0
 
$
  8.19
         
Balance at March 31, 2011
1,495,000 0
 
$
10.52
 
1.4
 
$
 11,000
                     
Exercisable at March 31, 2011
1,495,000   
 
$
10.52
 
1.4
 
$
 11,000
                     
There were no options granted or exercised during the first three months of  2010.  There was no intrinsic value to the stock options outstanding and exercisable at March 31, 2010.  

 
14

 

The following summary presents information regarding unvested restricted stock as of March 31, 2011 and changes during the three months then ended with regard to restricted stock under the EIP:

         
Weighted
     
         
Average
     
   
 Number of
   
 Grant Date
   
Aggregate
   
 Shares
   
 Fair Value
   
Fair Value
Balance at January 1, 2011
4,440,000
 
$
8.29
 
$
43,199,000
 
Restricted stock granted
1,679,000
 
$
9.40
 
$
13,802,000
 
Restricted stock vested
(914,000)
 
$
9.91
 
$
7,509,000
 
Restricted stock forfeited
(51,000)
 
$
7.70
     
Balance at March 31, 2011
5,154,000
 
$
8.37
 
$
42,368,000

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 March 31, 2011 was $37.6 million and the weighted average period over which this cost is expected to be recognized is approximately two years.

The total fair value of shares granted and vested during the three months ended March 31, 2010 was approximately $9.7 million and $5.4 million, respectively.  The total fair value of unvested restricted stock at March 31, 2010 was $20.5 million. The weighted average grant date fair value of restricted shares granted during the three months ended March 31, 2010 was $7.69.   Shares granted during the first three months of 2010 totaled 1,300,000.

(11)  
Segment Information:
We operate in one reportable segment, Frontier.  Frontier provides both regulated and unregulated voice, data and video services to residential, business and wholesale customers and is typically the incumbent provider in its service areas.

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

(12)  
Investment Income:
The components of investment income are as follows:
 
   
For the three months ended
March 31,
 
   ($ in thousands)
 
2011
   
2010
 
             
    Interest and dividend income
  $ 2,731     $ 2,416  
    Investment gain
    552       -  
    Equity (loss) earnings
    (168 )     81  
    Total investment income
  $ 3,115     $ 2,497  
                 


 
15

 
(13)  
Other Income, Net:
 The components of other income, net are as follows:
  
   
For the three months ended
March 31,
 
   ($ in thousands)
 
2011
   
2010
 
             
Gain on expiration/settlement of
    customer advances
  $ 6,337     $ 4,743  
Litigation settlement proceeds
    100       262  
Other, net
    33       (49 )
    Total other income, net
  $ 6,470     $ 4,956  
                 

(14) Retirement Plans:
The following tables provide the components of net periodic benefit cost:
 
           
 
Pension Benefits
 
 
For the three months ended
 
 
March 31,
 
 
2011
   
2010
 
($ in thousands)
         
Components of net periodic pension benefit cost
         
Service cost
$ 9,615     $ 1,609  
Interest cost on projected benefit obligation
  21,172       12,381  
Expected return on plan assets
  (25,589 )     (11,649 )
Amortization of prior service cost /(credit)
  (50 )     (50 )
Amortization of unrecognized loss
  4,435       6,748  
Net periodic pension benefit cost
$ 9,583     $ 9,039  
               
               
               
 
Postretirement Benefits
 
 
Other Than Pensions (OPEB)
 
 
For the three months ended
 
 
March 31,
 
    2011       2010  
($ in thousands)
             
Components of net periodic postretirement benefit cost
             
Service cost
$ 4,228     $ 99  
Interest cost on projected benefit obligation
  6,328       2,629  
Expected return on plan assets
  (82 )     (108 )
Amortization of prior service cost/(credit)
  (2,550 )     (1,929 )
Amortization of unrecognized loss
  1,499       1,581  
Net periodic postretirement benefit cost
$ 9,423     $ 2,272  
               
               
 
During the first three months of 2011 and 2010, we capitalized $3.1 million and $1.7 million, respectively, of pension and OPEB expense into the cost of our capital expenditures, as the costs relate to our engineering and plant construction activities.  Based on current assumptions and plan asset values, we estimate that our 2011 pension and other postretirement benefit expenses will be between $70 million and $80 million before amounts capitalized into the cost of capital expenditures (they were $68.4 million in 2010 before amounts capitalized into the cost of capital expenditures, including the plan expenses of the Acquired Business for the second half of 2010).   We expect that we will make cash contributions to our pension plan of approximately $50 million in 2011, including payments of $2.6 million made through March 2011.

 
16

 
In connection with the completion of the Transaction on July 1, 2010, certain employees were transferred from various Verizon pension plans into 12 pension plans that were then merged with the Frontier Communications Pension Plan (the Plan) effective August 31, 2010.  Assets of $581.3 million, including approximately $142.5 million that represents a receivable of the Plan as of December 31, 2010, were transferred into the Plan during the second half of 2010, with the receivable to be settled by the transfer of assets by the end of the third quarter of 2011.  

The Company’s pension plan assets have increased from $1,290.3 million at December 31, 2010 to $1,304.6 million at March 31, 2011, an increase of $14.3 million, or 1%.  This increase is a result of  $42.8 million of positive investment returns and cash contributions of $2.6 million, less ongoing benefit payments of $31.1 million, during the first three months of 2011.  

(15) Commitments and Contingencies:
We anticipate total capital expenditures of approximately $750 million to $780 million for 2011 related to our Frontier legacy properties and the Acquired Business.  Although we from time to time make short-term purchasing commitments to vendors with respect to these expenditures, we generally do not enter into firm, written contracts for such activities.  

In connection with the Transaction, the Company undertook activities to plan and implement systems conversions and other initiatives necessary to effectuate the closing (Phase 1).   The Company continues to engage in activities to enable the Company to implement its “go to market” strategy in its new markets and to complete the conversions of all the remaining systems into one platform (Phase 2).   For the full year of 2011, the Company currently expects to incur operating expenses of approximately $90.0 million, including $13.2 million of integration costs incurred during the first three months of 2011, and capital expenditures of approximately $60.0 million, including $5.6 million related to integration activities incurred during the first three months of 2011, related to these Phase 2 initiatives.

In addition, the Federal Communications Commission (FCC) and certain state regulatory commissions, in connection with granting their approvals of the Transaction, specified certain capital expenditure and operating requirements for the acquired Territories for specified periods of time post-closing.  These requirements focus primarily on certain capital investment commitments to expand broadband availability and speeds to at least 85% of the households throughout the acquired Territories with minimum speeds of 3 megabits per second (Mbps) by the end of 2013 and 4 Mbps by the end of 2015. To satisfy all or part of certain capital investment commitments to three state regulatory commissions, we placed an aggregate amount of $115 million in cash into escrow accounts and obtained a letter of credit for $190 million in 2010. Another $72.4 million of cash in an escrow account, with an associated liability (reflected in Other liabilities), was acquired in connection with the Merger to be used for service quality initiatives in the state of West Virginia.  As of March 31, 2011, the Company had a restricted cash balance in these escrow accounts in the aggregate amount of $184.2 million.  The aggregate amount of these escrow accounts and the letter of credit will decrease over time as Frontier makes the required capital expenditures in the respective states.

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

 
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We sold all of our utility businesses as of April 1, 2004.  However, we have retained a potential payment obligation associated with our previous electric utility activities in the State of Vermont.  The Vermont Joint Owners (VJO), a consortium of 14 Vermont utilities, including us, entered into a purchase power agreement with Hydro-Quebec in 1987.  The agreement contains “step-up” provisions that state that if any VJO member defaults on its purchase obligation under the contract to purchase power from Hydro-Quebec, then the other VJO participants will assume responsibility for the defaulting party’s share on a pro-rata basis.  Our pro-rata share of the purchase power obligation is 10%.  If any member of the VJO defaults on its obligations under the Hydro-Quebec agreement, then the remaining members of the VJO, including us, may be required to pay for a substantially larger share of the VJO’s total purchase power obligation for the remainder of the agreement (which runs through 2015).  U.S. GAAP rules require that we disclose “the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee.”  U.S. GAAP rules also state that we must make such disclosure “… even if the likelihood of the guarantor’s having to make any payments under the guarantee is remote…”  As noted above, our obligation only arises as a result of default by another VJO member, such as upon bankruptcy.  Therefore, to satisfy the “maximum potential amount” disclosure requirement we must assume that all members of the VJO simultaneously default, an unlikely scenario given 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, 2011 and remained in default for the duration of the contract (another 5 years), we estimate that our undiscounted purchase obligation for 2011 through 2015 would be approximately $474.2 million.  In such a scenario, the Company would then own the power and could seek to recover its costs.  We would do this by seeking to recover our costs from the defaulting members and/or reselling the power to other utility providers or the northeast power grid.  There is an active market for the sale of power.  We could potentially lose money if we were unable to sell the power at cost.  We caution that we cannot predict with any degree of certainty any potential outcome.

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

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

Forward-Looking Statements

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

Our ability to successfully integrate the operations of the Acquired Business into Frontier’s existing operations;

The risk that the growth opportunities and cost synergies from the Transaction may not be fully realized or may take longer to realize than expected;

Our indemnity obligation to Verizon for taxes which may be imposed upon them as a result of changes in ownership of our stock may discourage, delay or prevent a third party from acquiring control of us during the two-year period ending July 2012 in a transaction that stockholders might consider favorable;

The effects of increased expenses incurred due to activities related to the Transaction and the integration of the Acquired Business;

Our ability to maintain relationships with customers, employees or suppliers;

The effects of greater than anticipated competition requiring new pricing, marketing strategies or new product or service offerings and the risk that we will not respond on a timely or profitable basis;

Reductions in the number of our access lines that cannot be offset by increases in High-Speed Internet (HSI) subscribers and sales of other products and services;

The effects of ongoing changes in the regulation of the communications industry as a result of federal and state legislation and regulation, or changes in the enforcement or interpretation of such legislation and regulation;

The effects of any unfavorable outcome with respect to any current or future legal, governmental or regulatory proceedings, audits or disputes;

The effects of changes in the availability of federal and state universal funding to us and our competitors;

The effects of competition from cable, wireless and other wireline carriers;

Our ability to adjust successfully to changes in the communications industry and to implement strategies for growth;

Continued reductions in switched access revenues as a result of regulation, competition or technology substitutions;

Our ability to effectively manage service quality in our territories and meet mandated service quality metrics;

Our ability to successfully introduce new product offerings, including our ability to offer bundled service packages on terms that are both profitable to us and attractive to customers;

Changes in accounting policies or practices adopted voluntarily or as required by generally accepted accounting principles or regulations;

 
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Our ability to effectively manage our operations, operating expenses and capital expenditures, and to repay, reduce or refinance our debt;

The effects of changes in both general and local economic conditions on the markets that we serve, which can affect demand for our products and services, customer purchasing decisions, collectability of revenues and required levels of capital expenditures related to new construction of residences and businesses;

The effects of customer bankruptcies and home foreclosures, which could result in difficulty in collection of revenues and loss of customers;

The effects of technological changes and competition on our capital expenditures and product and service offerings, including the lack of assurance that our network improvements will be sufficient to meet or exceed the capabilities and quality of competing networks;

The effects of increased medical, retiree and pension expenses and related funding requirements;

Changes in income tax rates, tax laws, regulations or rulings, or federal or state tax assessments;

The effects of state regulatory cash management practices that could limit our ability to transfer cash among our subsidiaries or dividend funds up to the parent company;

Our ability to successfully renegotiate union contracts expiring in 2011 and thereafter;

Declines in the value of our pension plan assets, which would require us to make increased contributions to the pension plan in 2011 and beyond;

Adverse changes in the credit markets or in the ratings given to our debt securities by nationally accredited ratings organizations, which could limit or restrict the availability, or increase the cost, of financing;

Limitations on the amount of capital stock that we can issue to make acquisitions or to raise additional capital until July 2012;

Our ability to pay dividends on our common shares, which may be affected by our cash flow from operations, amount of capital expenditures, debt service requirements, cash paid for income taxes and liquidity; and

The effects of severe weather events such as hurricanes, tornados, ice storms or other natural or man-made disasters.

Any of the foregoing events, or other events, could cause financial information to vary from management’s forward-looking statements included in this report.  You should consider these important factors, in evaluating any statement in this report on Form 10-Q or otherwise made by us or on our behalf.  The following information is unaudited and should be read in conjunction with the consolidated financial statements and related notes included in this report.  We have no obligation to update or revise these forward-looking statements, and do not undertake to do so.

Overview

See Note 2 of the Notes to Consolidated Financial Statements included in Part I, Item 1 of this report for a discussion of the Transaction.

As a result of the Transaction, the Company is the nation’s largest communications services provider focused on rural areas and small and medium-sized towns and cities in 27 states, and the nation’s fifth largest Incumbent Local Exchange Carrier (ILEC), with approximately 5.6 million access lines, 1.7 million broadband connections and 14,900 employees as of March 31, 2011.

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

We estimate that our annualized cost savings will reach approximately $550 million by the end of 2012 as we implement a targeted list of initiatives.  During 2010, we realized cost savings of approximately $140 million from this target list, primarily by the elimination of costs related to the previous owner’s centralized services applicable to the Acquired Business, in addition to a number of other cost reduction initiatives including reduction in employees and contractors and migration of long distance services to a different carrier.  Our first quarter 2011 savings from the targeted initiatives list (which includes, but is not limited to, network cost savings, contractor reductions, cancellation of vendor services, completion of the long distance migration to another carrier, benefit changes and real estate savings) was approximately $16 million and combined with the savings achieved in 2010 equates to an annualized cost savings run rate of approximately $368 million.  We expect to achieve annualized cost savings of approximately $400 million by the end of 2011 and $550 million by the end of 2012. The realization of the additional annual cost savings is expected to be fully achieved by the end of 2012, when the Acquired Business’ network and information technology systems and processes will be fully integrated with those of Frontier.

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

Regulatory Developments
On March 16, 2010, the FCC released, as required under the 2009 American Recovery and Reinvestment Act (ARRA), its National Broadband Plan. The National Broadband Plan proposes a series of actions that could result in additional regulatory requirements for broadband services as well as a series of other regulatory reforms. As a follow-up to the National Broadband plan, on February 8, 2011, the FCC adopted a Notice of Proposed Rulemaking seeking comment from the industry on both short- and long-term reforms to Intercarrier Compensation and the Federal Universal Service High Cost Fund.  The Notice asked for comment on a broad range of possible outcomes.  Frontier, along with many other parties in the industry, filed comments in April 2011.  Frontier cannot predict whether or when the FCC will take additional actions or the effect of any such actions on the Company’s subsidy revenues.

 
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The following should be read in conjunction with Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2010.

(a)  Liquidity and Capital Resources

As of March 31, 2011, we had cash and cash equivalents aggregating $359.4 million (excluding restricted cash of $184.2 million, representing funds set aside for future broadband expansion and service quality initiatives).  Our primary source of funds continued to be cash generated from operations.  For the three months ended March 31, 2011, we used cash flow from operations and cash on hand to fund all of our cash investing and financing activities.

At March 31, 2011, we had a working capital deficiency of $233.4 million. We believe our operating cash flows, existing cash balances, and existing revolving credit facility will be adequate to finance our working capital requirements, fund capital expenditures, make required debt payments, pay taxes, pay dividends to our stockholders 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 2011.  However, a number of factors, including but not limited to, losses of access lines, pricing pressure from increased competition, lower subsidy and switched access revenues and the impact of the current economic environment are expected to reduce our cash generated from operations.  In addition, although we believe, based on information available to us, that the financial institutions syndicated under our revolving credit facility would be able to fulfill their commitments to us, given the current economic environment, this could change in the future.  Further, our below-investment grade credit ratings may also make it more difficult and expensive to refinance our maturing debt.  As of March 31, 2011, we have approximately $279.0 million of debt maturing during the last nine months of 2011 and approximately $180.4 million of debt maturing in 2012.

The consummation of the Transaction resulted in a combined company with significantly larger business operations and, consequently, greater working capital, capital expenditure and other liquidity needs.  Upon consummation of the Transaction, we assumed approximately $3.5 billion principal amount of debt.  As a result of our greater liquidity requirements, we entered into a new revolving credit facility which increased our line of credit to $750.0 million to provide sufficient flexibility to meet our liquidity needs.  As of March 31, 2011, we have not made any borrowings utilizing this facility.

Based on the level of debt incurred and the additional cash flows resulting from the Transaction, our capacity to service our debt has been significantly enhanced as compared to our capacity immediately prior to the Transaction, although our overall debt increased.  At March 31, 2011, the ratio of our net debt to adjusted operating cash flow (“leverage ratio”) was 3.03 times.

In addition, the FCC and certain state regulatory commissions, in connection with granting their approvals of the Transaction, specified certain capital expenditure and operating requirements for the acquired Territories for specified periods of time post-closing.  These requirements focus primarily on certain capital investment commitments to expand broadband availability and speeds to at least 85% of the households throughout the acquired Territories with minimum speeds of 3 Mbps by the end of 2013 and 4 Mbps by the end of 2015.  To satisfy all or part of certain capital investment commitments to three state regulatory commissions, we placed an aggregate amount of $115.0 million in cash into escrow accounts and obtained a letter of credit for $190.0 million in 2010.  Another $72.4 million of cash in an escrow account, with an associated liability, was acquired in connection with the Transaction to be used for service quality initiatives in the state of West Virginia.  The aggregate amount of these escrow accounts and the letter of credit will decrease over time as Frontier makes the required capital expenditures in the respective states.

The Transaction provides for a post-closing calculation of working capital.  Frontier and Verizon have not finalized the results of this calculation nor the post-closing adjustment, if any.  The final resolution of this process will not negatively impact Frontier’s balance sheet or working capital.

Cash Flows provided by Operating Activities

Cash flows provided by operating activities improved $391.0 million, or 317%, for the three months ended March 31, 2011 as compared with the prior year period.  The improvement was primarily the result of incremental cash flow from the Acquired Business.
 
 
 
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We expect that in 2011 our cash taxes will be approximately $50 million to $75 million.  Our 2011 cash tax estimate reflects the continued impact of bonus depreciation under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  We paid cash taxes of $8.9 million during the first three months of 2011.

In connection with the Transaction, the Company continues to undertake a variety of activities to plan and implement systems conversions and other initiatives.   As a result of the Transaction, the Company incurred $13.2 million of costs related to integration activities during the first three months of 2011, as compared to $10.4 million of acquisition and integration costs during the first three months of 2010.         

Cash Flows used by Investing Activities

Capital Expenditures
For the three months ended March 31, 2011 and 2010, our capital expenditures were $209.1 million (including $5.6 million of integration–related capital expenditures) and $69.6 million (including $29.7 million of integration-related capital expenditures), respectively.  Capital expenditures in 2011 included $149.1 million associated with the Acquired Business.  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 total capital expenditures of approximately $750 million to $780 million for 2011 related to our Frontier legacy properties and the Acquired Business.
  
In connection with the Transaction, the Company continues to undertake a variety of activities to plan and implement systems conversions and other initiatives.  As a result of the Transaction, the Company incurred $5.6 million and $29.7 million of capital expenditures related to these integration activities during the first three months of 2011 and 2010, respectively.
  
Cash Flows used by Financing Activities

Debt Reduction
During the first three months of 2011 and 2010, we retired an aggregate principal amount of $1.0 million of debt in each period, consisting of $0.7 million of senior unsecured debt and $0.3 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.

Credit Facility
We have a $750.0 million revolving credit facility (the Credit Facility).  As of March 31, 2011, we have not made any borrowings utilizing this facility.  The terms of the Credit Facility are set forth in the Credit Agreement, dated as of March 23, 2010, among the Company, the Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent (the Credit Agreement). Associated facility fees under the Credit Facility will vary from time to time depending on the Company’s credit rating (as defined in the Credit Agreement) and were 0.625% per annum as of March 31, 2011. The Credit Facility is scheduled to terminate on January 1, 2014. During the term of the Credit Facility, the Company may borrow, repay and reborrow funds, and may obtain letters of credit, subject to customary borrowing conditions. Loans under the Credit Facility will bear interest based on the alternate base rate or the adjusted LIBOR rate (each as determined in the Credit Agreement), at the Company’s election, plus a margin specified in the Credit Agreement based on the Company’s credit rating. Letters of credit issued under the Credit Facility will also be subject to fees that vary depending on the Company’s credit rating. The Credit Facility will be available for general corporate purposes but may not be used to fund dividend payments.

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

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

Our $200.0 million term loan facility with the Rural Telephone Finance Cooperative (RTFC), which matures in October 2011, the 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 (including restricted cash) in excess of $50.0 million to (ii) consolidated adjusted EBITDA (as defined in the agreements) over the last four quarters no greater than 4.50 to 1.

The Credit Facility, the Letter of Credit Facility 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 March 31, 2011, we were in compliance with all of our debt and credit facility covenants.

Dividends
We intend to pay regular quarterly dividends.  Effective July 1, 2010, our Board of Directors set the annual cash dividend rate at $0.75 per share, subject to applicable law and within the discretion of our Board of Directors.   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.

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.

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, impairment of intangible assets, depreciation and amortization, pension and other postretirement benefits, income taxes, contingencies and purchase price allocations, among others.

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

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 
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New Accounting Pronouncements
There were no new accounting standards that were adopted by the Company during the first three months of 2011.

 
 

 
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(b)  Results of Operations

Effective July 1, 2010, the Company’s scope of operations and balance sheet capitalization changed materially as a result of the completion of the Transaction.  Historical financial and operating data presented for Frontier is not indicative of future results and includes the results of operations of the Acquired Business from the date of acquisition on July 1, 2010.  The financial discussion and tables below include a comparative analysis of our results of operations on a historical basis for our Frontier operations as of and for the three months ended March 31, 2011 and 2010.  We have also presented an analysis of each category of revenue and operating expenses for the three months ended March 31, 2011 for the results of Frontier legacy operations (excluding the Acquired Business) and the results of the Acquired Business for the first quarter of 2011, as included in the consolidated results of operations.  All variance explanations discussed below are based upon an analysis of the first quarter of 2011 financial data for Frontier legacy operations (excluding the Acquired Business) in comparison to the first quarter of 2010, except that the first two sentences in each category of revenue or operating expenses below shows the revenue, operating expenses and/or variances based upon an analysis of Frontier including the Acquired Business.  Frontier has shown these adjustments to its financial presentations to exclude the effects of the Acquired Business because of the magnitude of the Transaction and its impact to our financial results in the three months ended March 31, 2011, as compared to the three months ended March 31, 2010.

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.

Revenue for the three months ended March 31, 2011 increased $826.9 million, or 159%, to $1,346.7 million as compared with the three months ended March 31, 2010.  Excluding additional revenue of $841.8 million attributable to the Acquired Business for the three months ended March 31, 2011, our revenue decreased $14.9 million, or 3%, as compared to the prior year period. The decline for our Frontier legacy operations during the first three months of 2011 is a result of decreases in the number of residential and business customers, switched access revenue and directory revenue, partially offset by a $8.6 million, or 5%, increase in data and internet services revenue, each as described in more detail below.

Revenues from data and internet services such as HSI grew and increased for our Frontier legacy properties as a percentage of total revenues and revenues from voice services like local and long distance services and from switched access and subsidy (including federal and state subsidies) declined and decreased as a percentage of our total revenues.

Switched access and subsidy revenue for Frontier of $166.2 million represented 12% of our revenues for the three months ended March 31, 2011.  Switched access revenue was $86.9 million for the three months ended March 31, 2011, or 6% of our revenues, up from $58.8 million, primarily due to $37.6 million in the Acquired Business, for the three months ended March 31, 2010, or 11% of our revenues.   We expect declining revenue trends in switched access and subsidy revenue during the remainder of 2011.

Change in the number of our access lines is one metric that is important to our revenue and profitability.  Our Frontier legacy operations lost access lines primarily because of changing consumer behavior (including wireless substitution), economic conditions, changing technology, competition, and by the loss of second lines upon the addition of HSI or cable modem service.  Our Frontier legacy operations lost approximately 31,100 access lines (net) during the three months ended March 31, 2011, or 6% on an annual basis, comparable to the 34,700 access lines (net) lost during the three months ended March 31, 2010, or 6% on an annual basis.  The Acquired Business lost approximately 105,700 access lines (net) during the three months ended March 31, 2011.  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 the three months ended March 31, 2011, the Company added approximately 10,500 HSI subscribers.  During the first quarter of 2011, the Company announced a price increase to be implemented in April 2011 for FiOS video customers in the state of Indiana who are on month-to-month plans.  While the Company implemented a number of retention promotions, losses of FiOS video customers increased during the quarter as did the loss of FiOS data customers.  During the first quarter, the Acquired Business lost approximately 4,900 FiOS data customers and added approximately 12,200 other HSI subscribers.  In connection with the Transaction, the Company agreed to requirements that focus primarily on certain capital investment commitments to expand broadband availability and speeds.  The Company plans to significantly expand broadband availability and speed over the next several years.  We expect to continue to increase HSI subscribers during the remainder of 2011.

 
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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 an analysis that  presents customer counts, average monthly revenue, products per customer, 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, customer revenue (all revenue except switched access and subsidy revenue) for our Frontier legacy operations declined in the first three months of 2011 by only 1 percent as compared to the prior year period.   The decline in customers and access lines for our Frontier legacy operations was partially offset by increased penetration of additional products sold to both residential and business customers, which has increased our average monthly revenue per customer.  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 the remainder of 2011.

 
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OTHER FINANCIAL AND OPERATING DATA
 
               
As of
             
   
As of
March 31, 2011
   
% Increase
(Decrease)
   
December 31, 2010
         
As of
March 31, 2010
 
Access lines:
                             
   Residential
    3,521,710       (3 %)     3,635,670             1,322,665  
   Business
    2,087,254       (1 %)     2,110,048             760,147  
Total access lines
    5,608,964       (2 %)     5,745,718             2,082,812  
                                       
HSI subscribers
    1,707,678       1 %     1,697,167             644,060  
Video subscribers
    546,404       3 %     531,446             175,775  
                                       
        For the three months ended March 31,          
                   
$ Increase
   
% Increase
         
      2011       2010    
(Decrease)
   
(Decrease)
         
Revenue (in 000's):
                                     
   Residential
  $ 576,679     $ 220,396     $ 356,283       162 %        
   Business
    603,797       210,669       393,128       187 %        
Total customer revenue
    1,180,476       431,065       749,411       174 %        
                                         
   Regulatory (switched
                                       
      access and subsidy)
    166,221       88,784       77,437       87 %        
Total revenue
  $ 1,346,697     $ 519,849     $ 826,848       159 %        
                                         
Switched access minutes of use
                                       
   (in millions)
    5,000       2,077               141 %        
Average monthly total revenue per
                                       
   access line
                                       
                    - Frontier Legacy
  $ 85.26     $ 82.51               3 %        
                    - Total Company
  $ 79.07                                  
Average monthly customer revenue
                                       
   per access line
                                       
                    -  Frontier Legacy
  $ 71.84     $ 68.42               5 %        
                    -  Total Company
  $ 69.31                                  
                                         
   
As of or for the three months ended March 31,
                 
                   
% Increase
                 
      2011       2010    
(Decrease)
                 
Residential customer metrics:
                                       
   Customers
    3,338,306       1,230,426       171 %                
   Revenue (in 000's)
  $ 576,679     $ 220,396       162 %                
   Products per residential customer (1)
                                       
        - Frontier Legacy
    2.64       2.54       4 %                
        - Total Company
    2.35