Quarterly Report

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)

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

($ in thousands)

		(Unaudited) June 30, 2012				December 31, 2011
ASSETS
Current assets:
Cash and cash equivalents		$	410,014			$	326,094
Accounts receivable, less allowances of $112,768 and $107,048, respectively			545,818				585,157
Prepaid expenses			63,474				63,422
Income taxes and other current assets			279,473				264,357
Total current assets			1,298,779				1,239,030
Restricted cash			105,591				144,680
Property, plant and equipment, net			7,481,896				7,547,523
Goodwill			6,337,719				6,337,719
Other intangibles, net			1,719,434				1,964,505
Other assets			202,176				196,311
Total assets		$	17,145,595			$	17,429,768
LIABILITIES AND EQUITY
Current liabilities:
Long-term debt due within one year		$	616,575			$	94,016
Accounts payable			314,706				519,548
Advanced billings			147,641				152,784
Accrued other taxes			71,388				64,392
Accrued interest			166,272				169,340
Other current liabilities			222,970				152,136
Total current liabilities			1,539,552				1,152,216
Deferred income taxes			2,491,867				2,458,018
Pension and other postretirement benefits			908,976				918,701
Other liabilities			203,059				225,858
Long-term debt			7,670,517				8,205,841
Equity:
Shareholders' equity of Frontier:
Common stock, $0.25 par value (1,750,000,000 authorized shares,
998,501,000 and 995,128,000 outstanding, respectively, and
1,027,986,000 issued, at June 30, 2012 and December 31, 2011)			256,997				256,997
Additional paid-in capital			4,732,393				4,773,383
Retained earnings			71,776				226,721
Accumulated other comprehensive loss, net of tax			(377,129	)			(386,963	)
Treasury stock			(369,142	)			(415,001	)
Total shareholders' equity of Frontier			4,314,895				4,455,137
Noncontrolling interest in a partnership			16,729				13,997
Total equity			4,331,624				4,469,134
Total liabilities and equity		$	17,145,595			$	17,429,768

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

 

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PART I.  FINANCIAL INFORMATION (Continued)

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

($ in thousands, except for per-share amounts)

(Unaudited)

		For the three months ended								For the six months ended
		June 30,								June 30,
		2012				2011				2012				2011
Revenue		$	1,258,777			$	1,322,255			$	2,526,831			$	2,668,952
Operating expenses:
Network access expenses			115,433				126,629				231,002				277,913
Other operating expenses			539,911				578,096				1,091,494				1,158,436
Depreciation and amortization			307,047				358,986				664,347				710,243
Integration costs			28,602				20,264				63,746				33,487
Total operating expenses			990,993				1,083,975				2,050,589				2,180,079
Operating income			267,784				238,280				476,242				488,873
Investment income			9,991				175				12,094				3,290
Losses on early extinguishment of debt			(70,818	)			-				(70,818	)			-
Other income (loss), net			(1,187	)			(557	)			2,298				5,913
Interest expense			172,054				166,864				336,916				334,279
Income before income taxes			33,716				71,034				82,900				163,797
Income tax expense			11,717				37,190				30,411				73,757
Net income			21,999				33,844				52,489				90,040
Less: Income attributable to the noncontrolling interest in a partnership			4,010				1,583				7,732				3,068
Net income attributable to common shareholders of Frontier		$	17,989			$	32,261			$	44,757			$	86,972
Basic and diluted net income per share attributable to common
shareholders of Frontier		$	0.02			$	0.03			$	0.04			$	0.09

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

($ in thousands)

(Unaudited)

 

		For the three months ended June 30,								For the six months ended June 30,
		2012				2011				2012				2011
Net income		$	21,999			$	33,844			$	52,489			$	90,040
Other comprehensive income, net
of tax (see Note 15)			5,567				3,335				9,834				4,990
Comprehensive income			27,566				37,179				62,323				95,030
Less:  Comprehensive income
attributable to the noncontrolling
interest in a partnership			(4,010	)			(1,583	)			(7,732	)			(3,068	)
Comprehensive income attributable to
the common shareholders of Frontier		$	23,556			$	35,596			$	54,591			$	91,962

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

 

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 PART I.  FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2011, THE SIX MONTHS ENDED DECEMBER 31, 2011 AND

THE SIX MONTHS ENDED JUNE 30, 2012

($ 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, 2011			1,027,986			$	256,997			$	5,525,471			$	77,107			$	(229,549	)			(34,131	)		$	(433,286	)		$	13,003			$	5,209,743
Stock plans			-				-				(13,338	)			-				-				1,379				19,025				-				5,687
Dividends on common stock			-				-				(373,215	)			-				-				-				-				-				(373,215	)
Net income			-				-				-				86,972				-				-				-				3,068				90,040
Other comprehensive income, net
of tax			-				-				-				-				4,990				-				-				-				4,990
Distributions			-				-				-				-				-				-				-				(3,000	)			(3,000	)
Balance June 30, 2011			1,027,986				256,997				5,138,918				164,079				(224,559	)			(32,752	)			(414,261	)			13,071				4,934,245
Stock plans			-				-				7,637				-				-				(106	)			(740	)			-				6,897
Dividends on common stock			-				-				(373,172	)			-				-				-				-				-				(373,172	)
Net income			-				-				-				62,642				-				-				-				4,926				67,568
Other comprehensive income, net
of tax			-				-				-				-				(162,404	)			-				-				-				(162,404	)
Distributions			-				-				-				-				-				-				-				(4,000	)			(4,000	)
Balance December 31, 2011			1,027,986				256,997				4,773,383				226,721				(386,963	)			(32,858	)			(415,001	)			13,997				4,469,134
Stock plans			-				-				(40,990	)			-				-				3,373				45,859				-				4,869
Dividends on common stock			-				-				-				(199,702	)			-				-				-				-				(199,702	)
Net income			-				-				-				44,757				-				-				-				7,732				52,489
Other comprehensive income, net
of tax			-				-				-				-				9,834				-				-				-				9,834
Distributions			-				-				-				-				-				-				-				(5,000	)			(5,000	)
Balance June 30, 2012			1,027,986			$	256,997			$	4,732,393			$	71,776			$	(377,129	)			(29,485	)		$	(369,142	)		$	16,729			$	4,331,624

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

 

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PART I.  FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND 2011

($ in thousands)

(Unaudited)

 

		2012				2011
Cash flows provided by (used in) operating activities:
Net income		$	52,489			$	90,040
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization expense			664,347				710,243
Stock based compensation expense			7,775				7,677
Pension/OPEB costs			27,853				16,560
Losses on early extinguishment of debt			70,818				-
Other non-cash adjustments			8,386				(6,735	)
Deferred income taxes			27,158				51,133
Change in accounts receivable			31,696				29,705
Change in accounts payable and other liabilities			(136,003	)			(49,414	)
Change in prepaid expenses, income taxes and other current assets			3,274				15,022
Net cash provided by operating activities			757,793				864,231
Cash flows provided from (used by) investing activities:
Capital expenditures - Business operations			(376,073	)			(414,039	)
Capital expenditures - Integration activities			(27,940	)			(18,986	)
Cash transferred from escrow			39,089				12,364
Other assets purchased and distributions received, net			(12,085	)			(7,289	)
Net cash used by investing activities			(377,009	)			(427,950	)
Cash flows provided from (used by) financing activities:
Long-term debt borrowings			500,000				-
Financing costs paid			(10,288	)			-
Long-term debt payments			(536,968	)			(78,024	)
Premium paid to retire debt			(52,078	)			-
Dividends paid			(199,702	)			(373,215	)
Repayment of customer advances for construction,
distributions to noncontrolling interests and other			2,172				(3,633	)
Net cash used by financing activities			(296,864	)			(454,872	)
Increase/(Decrease) in cash and cash equivalents			83,920				(18,591	)
Cash and cash equivalents at January 1,			326,094				251,263
Cash and cash equivalents at June 30,		$	410,014			$	232,672
Supplemental cash flow information:
Cash paid (received) during the period for:
Interest		$	328,771			$	328,728
Income taxes (refunds)		$	(208	)		$	27,203

 

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

 

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)	Summary of Significant Accounting Policies:

(a)	Basis of Presentation and Use of Estimates:

Frontier Communications Corporation and its subsidiaries are referred to as “we,” “us,” “our,” “Frontier,” or the “Company” in this report. Our interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2011. 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 June 30, 2012, 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) that we have recorded on a gross basis in our consolidated statements of operations and included in revenue and other operating expenses at $28.8 million and $26.1 million, and $58.5 million and $54.2 million, for the three and six months ended June 30, 2012 and 2011, 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.  Our operating segments consist of the following regions: Central, Midwest, National, Northeast, Southeast and West.  Our operating segments are aggregated into one reportable segment .

 

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

The Company amortizes finite lived intangible assets over their estimated useful lives and reviews such intangible assets at least annually to assess whether any potential impairment exists and whether factors exist that would necessitate a change in useful life and a different amortization period.

(2)     Recent Accounting Literature:

Fair Value Measurements

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

Presentation of Comprehensive Income

In June 2011, the FASB issued Accounting Standards Update No. 2011-05 (ASU 2011-05), “Comprehensive Income: Presentation of Comprehensive Income,” (ASC Topic 220).  ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance was to be applied retrospectively, and was effective for interim and annual periods beginning after December 15, 2011.  In December 2011, the FASB issued ASU No. 2011-12 that defers the effective date for amendments to the presentation of reclassifications of items out of accumulated other comprehensive income in ASU 2011-05.  The Company adopted ASU 2011-05 in the first quarter of 2012 with no impact on our financial position, results of operations or cash flows.

(3)     The Transaction:

On July 1, 2010, we 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 was considered the acquirer of the Acquired Business for accounting purposes.

We have accounted 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 $28.6 million and $20.3 million, and $63.7 million and $33.5 million of integration related costs in connection with the Transaction during the three and six months ended June 30, 2012 and 2011, respectively.  Such costs are required to be expensed as incurred and are reflected in “Integration costs” in our consolidated statements of operations.

 

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(4)     Accounts Receivable:

The components of accounts receivable, net are as follows:

($ in thousands)		June 30, 2012				December 31, 2011
Retail and Wholesale		$	606,209			$	639,842
Other			52,377				52,363
Less: Allowance for doubtful accounts			(112,768	)			(107,048	)
Accounts receivable, net		$	545,818			$	585,157

 

Retail and wholesale accounts receivable and the allowance for doubtful accounts are presented net of a fair value adjustment of $9.8 million at December 31, 2011.  No further fair value adjustment was required as of the quarter ended March 31, 2012. 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 $24.1 million and $18.1 million, and $40.7 million and $46.4 million for the three and six months ended June 30, 2012 and 2011, respectively.

Amounts for retail and wholesale accounts receivable as of December 31, 2011 have been revised to conform to the current presentation, reflecting a reduction of $31.0 million for customer volume discounts with a right of offset to the customer’s accounts receivable.  There was a similar reduction to other current liabilities in the balance sheet.

(5) Property, Plant and Equipment:

Property, plant and equipment, net is as follows:

($ in thousands)		June 30, 2012				December 31, 2011
Property, plant and equipment		$	13,962,614			$	13,638,136
Less:  Accumulated depreciation			(6,480,718	)			(6,090,613	)
Property, plant and equipment, net		$	7,481,896			$	7,547,523

Depreciation expense is principally based on the composite group method.  Depreciation expense was $208.5 million and $225.4 million, and $418.9 million and $444.5 million for the three and six months ended June 30, 2012 and 2011, respectively.  As a result of an independent study of the estimated remaining useful lives of our plant assets, we adopted new estimated remaining useful lives for certain plant assets as of October 1, 2011.

 

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(6)     Goodwill and Other Intangibles:

The components of goodwill and other intangibles, net are as follows:

($ in thousands)		June 30, 2012				December 31, 2011
Goodwill:		$	6,337,719			$	6,337,719
Other Intangibles:
Customer base		$	2,697,763			$	2,697,413
Software licenses			105,019				105,019
Trade name and license			135,285				135,285
Other intangibles			2,938,067				2,937,717
Less: Accumulated amortization			(1,218,633	)			(973,212	)
Total other intangibles, net		$	1,719,434			$	1,964,505

Amortization expense was $98.5 million and $133.6 million, and $245.5 million and $265.8 million for the three and six months ended June 30, 2012 and 2011, respectively. Amortization expense primarily represents the amortization of intangible assets (primarily customer base) that were acquired in the Transaction based on a fair value of $2.5 billion and a useful life of nine years for the residential customer base and 12 years for the business customer base, amortized on an accelerated method.  Amortization expense included $10.2 million and $27.4 million for the six months ended June 30, 2012 and 2011, respectively, for amortization associated with certain Frontier legacy properties, which were fully amortized in March 2012.

(7)     Fair Value of Financial Instruments:

The following table summarizes the carrying amounts and estimated fair values for long-term debt at June 30, 2012 and December 31, 2011.  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 upon quoted market prices at the reporting date for those financial instruments.

	June 30, 2012				December 31, 2011
	Carrying				Carrying
($ in thousands)	Amount		Fair Value		Amount		Fair Value
Long-term debt	$  7,670,517		$  7,768,998		$  8,205,841		$   7,958,873

 

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(8) Long-Term Debt:

The activity in our long-term debt from December 31, 2011 to June 30, 2012 is summarized as follows:

 

				Six months ended
				June 30, 2012									Interest
													Rate* at
		December 31,						New			June 30,		June 30,
($ in thousands)		2011			Payments			Borrowings			2012		2012
Rural Utilities Service
Loan Contracts	$	10,197		$	(687)		$	-		$	9,510		6.15%
Senior Unsecured Debt		8,325,774			(536,281)			500,000			8,289,493		7.90%
Industrial Development
Revenue Bonds		13,550			-			-			13,550		6.33%
TOTAL LONG-TERM DEBT	$	8,349,521		$	(536,968)		$	500,000		$	8,312,553		7.90%
Less: Debt Discount		(49,664)									(25,461)
Less: Current Portion		(94,016)									(616,575)
	$	8,205,841								$	7,670,517

* Interest rate includes amortization of debt issuance costs and debt premiums or discounts.  The interest rates at June 30, 2012 represent a weighted average of multiple issuances.

 

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Additional information regarding our Senior Unsecured Debt is as follows:

	June 30, 2012							December 31, 2011
		Principal			Interest				Principal			Interest
($ in thousands)		Outstanding			Rate				Outstanding			Rate
Senior Notes:
Due 1/15/2013	$	522,693			6.250%			$	580,724			6.250%
Due 5/1/2014		200,000			8.250%				600,000			8.250%
Due 3/15/2015		300,000			6.625%				300,000			6.625%
Due 4/15/2015		450,500			7.875%				500,000			7.875%
Due 10/14/2016 *		546,250			3.115% (Variable)				575,000			3.175% (Variable)
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 7/1/2021		500,000			9.250%				-			-
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%
		7,794,626							7,830,907
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%
Total	$	8,289,493			7.90%			$	8,325,774			7.93%

* Represents borrowings under the Credit Agreement with CoBank.

 

 

11

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

On May 17, 2012, the Company completed a registered offering of $500 million aggregate principal amount of 9.250% senior unsecured notes due 2021, issued at a price of 100% of their principal amount, and commenced a tender offer to purchase the maximum aggregate principal amount of its 8.250% Senior Notes due 2014 (the "2014 Notes") and its 7.875% Senior Notes due 2015 (the "April 2015 Notes" and, together with the 2014 Notes, the "Notes") that it could purchase for up to $500 million in cash.  The 2014 Notes had an effective interest cost of 10.855%, reflecting the fact that such notes were issued at a discount in April 2009.

On June 1, 2012, the Company accepted for purchase $400 million aggregate principal amount of 2014 Notes tendered for total consideration of $446.0 million.  On June 18, 2012, Frontier accepted for purchase $49.5 million aggregate principal amount of April 2015 Notes tendered for total consideration of $54.0 million.  Frontier used proceeds from the sale of its previously announced offering of $500.0 million of 9.250% Senior Notes due 2021, plus cash on hand, to purchase the Notes. As a result of the successful tender offer, the amount of 2014 Notes and April 2015 Notes outstanding as of June 30, 2012 were $200.0 million and $450.5 million, respectively.  

In connection with our tender offer and repurchase of the Notes, the Company recognized a loss of $69.2 million on the early extinguishment of debt during the second quarter of 2012.  We also recognized a loss of $1.6 million during the second quarter of 2012 for $58.0 million in open market repurchases of our 6.25% Senior Notes due 2013.

The Company has a credit agreement (the Credit Agreement) with CoBank, ACB, as administrative agent, lead arranger and a lender, and the other lenders party thereto for a $575.0 million senior unsecured term loan facility with a final maturity of October 14, 2016.  The entire facility was drawn upon execution of the Credit Agreement in October 2011.  Repayment of the outstanding principal balance is made in quarterly installments in the amount of $14,375,000, which commenced on March 31, 2012, with the remaining outstanding principal balance to be repaid on the final maturity date. Borrowings under the Credit Agreement bear interest based on the margins over the Base Rate (as defined in the Credit Agreement) or LIBOR, at the election of the Company.  Interest rate margins under the facility (ranging from 0.875% to 2.875% for Base Rate borrowings and 1.875% to 3.875% for LIBOR borrowings) are subject to adjustments based on the Total Leverage Ratio of the Company, as such term is defined in the Credit Agreement.  The initial pricing on this facility is LIBOR plus 2.875% through September 30, 2012.  The maximum permitted leverage ratio is 4.5 times.

 

We have a $750.0 million revolving credit facility.  As of June 30, 2012, we had not made any borrowings utilizing this facility.  The terms of the credit facility are set forth in the Revolving Credit Agreement, dated as of March 23, 2010, among the Company, the Lenders party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent (the Revolving 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 Revolving Credit Agreement) and were 0.625% per annum as of June 30, 2012. The credit facility is scheduled to terminate on January 1, 2014. During the term of the credit facility, the Company may borrow, repay and reborrow funds, and may obtain letters of credit, subject to customary borrowing conditions. Loans under the credit facility will bear interest based on the alternate base rate or the adjusted LIBOR rate (each as determined in the Revolving Credit Agreement), at the Company’s election, plus a margin specified in the Revolving Credit Agreement based on the Company’s credit rating. Letters of credit issued under the credit facility will also be subject to fees that vary depending on the Company’s credit rating. The credit facility will be available for general corporate purposes but may not be used to fund dividend payments.

We also have a $100.0 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). An initial 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 initial commitments under the Letter of Credit Agreement expired on September 20, 2011, with the Bank exercising its option to extend $100.0 million of the commitments to September 20, 2012.  The Company is required to pay an annual facility fee on the available commitment, regardless of usage.  The covenants binding on the Company under the terms of the Letter of Credit Agreement are substantially similar to those in the Company’s other credit facilities, including limitations on liens, substantial asset sales and mergers, subject to customary exceptions and thresholds.

 

12

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

As of June 30, 2012, 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 June 30, 2012:

 

		Principal
($ in thousands)		Payments
2012 (remaining six months)		$	64,939
2013		$	580,585
2014		$	257,916
2015		$	808,442
2016		$	345,466
2017		$	1,100,501

(9)    Income Taxes:

The following is a reconciliation of the provision for income taxes computed at federal statutory rates to the effective rates:

 

		For the three months ended							For the six months ended
		June 30,								June 30,
			2012				2011				2012		2011
Consolidated tax provision at federal statutory rate			35.0%				35.0%				35.0%		35.0%
Reversal of tax credits			-				14.8				-		6.4
State income tax provisions, net of federal income
tax benefit			1.5				3.5				2.7		3.8
All other, net			(1.7)				(0.9)				(1.0)		(0.2)
Effective tax rate			34.8%				52.4%				36.7%		45.0%

 

Income taxes for the three and six months ended June 30, 2011 includes the impact of a $10.5 million charge resulting from the enactment on May 25, 2011 of the Michigan Corporate Income Tax which eliminated certain future tax deductions.

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 $14 million as of June 30, 2012.

 

13

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(10) Net Income Per Common Share:

  The reconciliation of the net income per common share calculation is as follows:

		For the three months ended								For the six months ended
( $ and shares in thousands, except per share amounts )		June 30,								June 30,
		2012				2011				2012				2011
Net income used for basic and diluted earnings
per common share:
Net income attributable to common shareholders of Frontier		$	17,989			$	32,261			$	44,757			$	86,972
Less:  Dividends paid on unvested restricted stock awards			(735	)			(955	)			(1,472	)			(1,921	)
Total basic and diluted net income attributable to common
shareholders of Frontier		$	17,254			$	31,306			$	43,285			$	85,051
Basic earnings per common share:
Total weighted average shares and unvested restricted stock awards
outstanding - basic			998,462				994,482				996,989				994,413
Less:  Weighted average unvested restricted stock awards			(7,279	)			(5,125	)			(7,120	)			(4,933	)
Total weighted average shares outstanding - basic			991,183				989,357				989,869				989,480
Net income per share attributable to common shareholders of Frontier		$	0.02			$	0.03			$	0.04			$	0.09
Diluted earnings per common share:
Total weighted average shares outstanding - basic			991,183				989,357				989,869				989,480
Effect of dilutive shares			-				805				10				1,446
Effect of dilutive stock units			-				-				704				442
Total weighted average shares outstanding - diluted			991,183				990,162				990,583				991,368
Net income per share attributable to common shareholders of Frontier		$	0.02			$	0.03			$	0.04			$	0.09

Stock Options

For the three and six months ended June 30, 2012 and 2011, options to purchase 557,000 shares (at exercise prices ranging from $8.19 to $14.15) and 577,000 shares (at exercise prices ranging from $9.52 to $14.15), 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.

Stock Units

At June 30, 2012 and 2011, we had 704,527 and 442,212 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).

(11) Stock Plans:

At June 30, 2012, we had five stock-based compensation plans under which grants were 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 (the 2000 EIP) and the Deferred Fee Plan. At June 30, 2012, there were 12,540,761 shares authorized for grant and 3,281,422 shares available for grant under the 2009 Equity Incentive Plan (the 2009 EIP) and the Directors’ Equity Plan.  

 

14

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Performance Shares

On February 15, 2012, the Company’s Compensation Committee, in consultation with the other non-management directors of the Company’s Board of Directors and the Committee’s independent executive compensation consultant, adopted the new Frontier Long-Term Incentive Plan (the “LTIP”). LTIP awards will be granted in the form of performance shares.  The LTIP is offered under the Company’s 2009 Equity Incentive Plan and participants consist of senior vice presidents and above. The LTIP awards have performance, market and time-vesting conditions.

 

Beginning in 2012, during the first 90 days of a three-year performance period (a “Measurement Period”), a target number of performance shares are awarded to each LTIP participant with respect to the Measurement Period.  The performance metrics under the LTIP are (1) annual targets for operating cash flow based on a goal set during the first 90 days of each year in the three-year Measurement Period and (2) an overall performance “modifier” set during the first 90 days of the Measurement Period, based on the Company’s total return to stockholders (i.e., Total Shareholder Return or “TSR”) relative to the Diversified Telecommunications Services Group (GICS Code 501010) for the three-year Measurement Period.  LTIP awards will be paid out in the form of common stock shortly following the end of the three-year Measurement Period.  Operating cash flow performance will be determined at the end of each year and the annual results will be averaged at the end of the three-year Measurement Period to determine the preliminary number of shares earned under the LTIP award.

 

On February 15, 2012, the Compensation Committee granted 930,020 performance shares under the LTIP for the 2012-2014 Measurement Period and set the operating cash flow performance goal for the first year in that Measurement Period and the TSR modifier for the three-year Measurement Period.  Actual amounts earned will be subject to increase or decrease (including forfeiture of the entire award).  An executive must maintain a satisfactory performance rating during the Measurement Period and must be employed by the Company at the end of the three-year Measurement Period in order for the award to vest.  The Compensation Committee will determine the number of shares earned for the 2012-2014 Measurement Period in February 2015.

For the six months ended June 30, 2012, the Company recognized an expense of $0.2 million for the LTIP.

Restricted Stock

The following summary presents information regarding unvested restricted stock as of June 30, 2012 and changes during the six months then ended with regard to restricted stock under the 2009 EIP:

						Weighted
						Average
		Number of				Grant Date						Aggregate
		Shares				Fair Value						Fair Value
Balance at January 1, 2012		4,847,000		$			8.40		$		$                                 24,962,000
	Restricted stock granted	3,816,000		$		4.19				$		14,615,000
	Restricted stock vested	(1,173,000)		$		8.99				$		4,493,000
	Restricted stock forfeited	(250,000)		$		6.15
Balance at June 30, 2012		7,240,000		$		6.17				$		27,730,000

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 June 30, 2012 was $33.0 million and the weighted average period over which this cost is expected to be recognized is approximately two years.

Shares granted during the first six months of 2011 totaled 1,712,000.  The total fair value of shares granted and vested during the six months ended June 30, 2011 was approximately $13.8 million and $7.9 million, respectively.  The total fair value of unvested restricted stock at June 30, 2011 was $41.0 million. The weighted average grant date fair value of restricted shares granted during the six months ended June 30, 2011 was $9.40.

 

15

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Stock Options

The following summary presents information regarding outstanding stock options as of June 30, 2012 and changes during the six months then ended with regard to options under the 2000 EIP and the 2009 EIP:

					Weighted		Weighted
		Shares			Average		Average			Aggregate
		Subject to			Option Price		Remaining			Intrinsic
		Option			Per Share		Life in Years			Value
Balance at January 1, 2012		895,000		$	9.94		1.3		$	-
	Options granted	-		$	-
	Options exercised	-		$	-
	Options canceled, forfeited or lapsed	(338,000)		$	8.19
Balance at June 30, 2012		557,000		$	11.01		1.4		$	-
Exercisable at June 30, 2012		557,000		$	11.01		1.4		$	-

 

There were no options granted during the first six months of 2011.  There were 10,000 options exercised during that period with cash received of $0.1 million.  There was no intrinsic value of the stock options outstanding and exercisable at June 30, 2011.  

(12)   Segment Information:

We operate in one reportable segment.  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.  

(13)   Investment Income:

The components of investment income are as follows:

 

		For the three months ended June 30,								For the six months ended June 30,
( $ in thousands )		2012				2011				2012				2011
Interest and dividend income		$	213			$	153			$	2,836			$	2,884
Investment gain			9,780				519				9,780				1,071
Equity earnings (loss)			(2	)			(497	)			(522	)			(665	)
Total investment income		$	9,991			$	175			$	12,094			$	3,290

During the second quarter of 2012, we recognized a gain of $9.8 million associated with cash received in connection with our previously written-off investment in Adelphia.

 

16

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PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(14)   Other Income (Loss), Net:

The components of other income (loss), net are as follows:

		For the three months ended June 30,								For the six months ended June 30,
( $ in thousands )		2012				2011				2012				2011
Gain on expiration/settlement of customer advances		$	-			$	-			$	3,463			$	6,337
All other, net			(1,187	)			(557	)			(1,165	)			(424	)
Total other income (loss), net		$	(1,187	)		$	(557	)		$	2,298			$	5,913

 

(15)   Comprehensive Income :

Comprehensive income consists of net income and other gains and losses affecting shareholders’ investment and pension/OPEB liabilities that, under U.S. GAAP, are excluded from net income.

The components of accumulated other comprehensive loss, net of tax are as follows:

		June 30,				December 31,
($ in thousands)		2012				2011
Pension costs		$	559,690			$	575,163
Postretirement costs			42,995				41,811
Deferred taxes on pension and OPEB costs			(225,704	)			(230,161	)
All other			148				150
		$	377,129			$	386,963

Our other comprehensive income for the three and six months ended June 30, 2012 and 2011 is as follows:

 

		For the three months ended June 30,
		2012												2011
		Before-Tax				Tax Expense/				Net-of-Tax				Before-Tax				Tax Expense/				Net-of-Tax
( $ in thousands)		Amount				(Benefit)				Amount				Amount				(Benefit)				Amount
Amortization of pension and postretirement costs		$	7,145			$	1,578			$	5,567			$	3,335			$	-			$	3,335
All other			-				-				-				270				270				-
Other comprehensive income		$	7,145			$	1,578			$	5,567			$	3,605			$	270			$	3,335
		For the six months ended June 30,
		2012													2011
		Before-Tax				Tax Expense/				Net-of-Tax				Before-Tax				Tax Expense/				Net-of-Tax
		Amount				(Benefit)				Amount				Amount				(Benefit)				Amount
Amortization of pension and postretirement costs		$	14,290			$	4,456			$	9,834			$	6,669			$	1,199			$	5,470
All other			-				-				-				(480	)			-				(480	)
Other comprehensive income		$	14,290			$	4,456			$	9,834			$	6,189			$	1,199			$	4,990

 

17

 

PART I. FINANCIAL INFORMATION (Continued)

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(16) Retirement Plans:

The following tables provide the components of net periodic benefit cost:

 

Pension Benefits

Pension Benefits

For the three months ended

For the six months ended

June 30,

June 30,

2012

2011

2012

2011

( $ in thousands )

Components of net periodic pension benefit cost