FRONTIER COMMUNICATIONS CORPORATION
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
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OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE YEAR ENDED DECEMBER 31, 2008
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2008
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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
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FRONTIER COMMUNICATIONS CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 06-0619596
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
3 High Ridge Park
Stamford, Connecticut 06905
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 614-5600
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class
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Name of each exchange on which registered
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Common Stock, par value $.25 per share New York Stock Exchange
Series A Participating Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes X No
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Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. Yes No X
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of "accelerated filer", "large accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
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The aggregate market value of common stock held by non-affiliates of the
registrant on June 30, 2008 was approximately $3,610,891,000 based on the
closing price of $11.34 per share on such date.
The number of shares outstanding of the registrant's Common Stock as of January
30, 2009 was 311,311,000.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Company's 2009 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K.
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
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PART I
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Item 1. Business 2
Item 1A. Risk Factors 8
Item 1B. Unresolved Staff Comments 13
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Executive Officers 14
PART II
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Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 16
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 39
Item 9A. Controls and Procedures 39
Item 9B. Other Information 39
PART III
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Item 10. Directors, Executive Officers and Corporate Governance 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 39
Item 13. Certain Relationships and Related Transactions, and Director
Independence 40
Item 14. Principal Accountant Fees and Services 40
PART IV
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Item 15. Exhibits and Financial Statement Schedules 40
Index to Consolidated Financial Statements F-1
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
PART I
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Item 1. Business
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Frontier Communications Corporation (Frontier) (formerly known as Citizens
Communications Company through July 30, 2008) and its subsidiaries are referred
to as the "Company," "we," "us" or "our" throughout this report. Frontier was
incorporated in the State of Delaware in 1935 as Citizens Utilities Company.
We are a communications company providing services to rural areas and small and
medium-sized towns and cities. Revenue was $2.2 billion in 2008. Among the
highlights for 2008:
* Cash Generation
We continued to generate significant free cash flow through
further growth of broadband and value added services,
productivity improvements and a disciplined capital expenditure
program that emphasizes return on investment.
* Stockholder Value
During 2008, we repurchased $200.0 million of our common stock
and we continued to pay an annual dividend of $1.00 per common
share.
* Growth
During 2008, we added approximately 57,100 new High-Speed
Internet customers (net) and 116,000 customers began buying a
bundle or package of our services. At December 31, 2008, we had
approximately 579,900 high-speed data customers and 749,800
customers buying a bundle or package of services. We also offer a
television product in partnership with DISH Network (DISH), and
at the end of 2008 we had approximately 119,900 DISH customers.
Our mission is to be the leader in providing communications services to
residential and business customers in our markets. We are committed to
delivering innovative and reliable products and solutions with an emphasis on
convenience, service and customer satisfaction. We offer a variety of voice,
data and internet, and television services that are available as bundled or
packaged solutions and for some products, a la carte. We believe that superior
customer service and innovative product positioning will continue to
differentiate us from our competitors in the markets in which we compete.
Telecommunications Services
As of December 31, 2008, we operated as an incumbent local exchange carrier
(ILEC) in 24 states.
The telecommunications industry is undergoing significant changes and
difficulties and our financial results reflect the impact of this challenging
environment. As discussed in more detail in Management's Discussion and Analysis
of Financial Condition and Results of Operations (MD&A), we operate in an
increasingly challenging environment and, accordingly, our revenues have
decreased slightly in 2008.
Our business is primarily with residential customers and, to a lesser extent,
business customers. Our services include:
* access services;
* local services;
* long distance services;
* data and internet services;
* directory services;
* television services; and
* wireless services.
2
Frontier is typically the leading incumbent carrier in the markets we serve and
provides the "last mile" of telecommunications services to residential and
business customers in these markets.
Access services. Switched access services allow other carriers to use our
facilities to originate and terminate their long distance voice and data
traffic. These services are generally offered on a month-to-month basis and the
service is billed on a minutes-of-use basis. Access charges are based on access
rates filed with the Federal Communications Commission (FCC) for interstate
services and with the respective state regulatory agency for intrastate
services. In addition, subsidies received from state and federal universal
service funds based on the high cost of providing telephone service to certain
rural areas are a part of our access services revenue.
Revenue is recognized when services are provided to customers or when products
are delivered to customers. Monthly recurring access service fees are billed in
advance. The unearned portion of this revenue is initially deferred as a
component of other liabilities on our balance sheet and recognized as revenue
over the period that the services are provided.
Local services. We provide basic telephone wireline services to residential and
business customers in our service areas. Our service areas are largely
residential and are generally less densely populated than the primary service
areas of the largest incumbent local exchange carriers. We also provide enhanced
services to our customers by offering a number of calling features, including
call forwarding, conference calling, caller identification, voicemail and call
waiting. All of these local services are billed monthly in advance. The unearned
portion of this revenue is initially deferred as a component of other
liabilities on our balance sheet and recognized as revenue over the period that
the services are provided. We also offer packages of communications services.
These packages permit customers to bundle their basic telephone line service
with their choice of enhanced, long distance, television and internet services
for a monthly fee and/or usage fee depending on the plan.
We intend to continue our efforts to increase the penetration of our enhanced
services. We believe that increased sales of such services will produce revenue
with higher operating margins due to the relatively low marginal operating costs
necessary to offer such services. We believe that our ability to integrate these
services with other services will provide us with the opportunity to capture an
increased percentage of our customers' communications expenditures (wallet
share).
Long distance services. We offer long distance services in our territories to
our customers. We believe that many customers prefer the convenience of
obtaining their long distance service through their local telephone company and
receiving a single bill. Long distance network service to and from points
outside of our operating territories is provided by interconnection with the
facilities of interexchange carriers (IXCs). Our long distance services are
billed either as unlimited/fixed number of minutes in advance or on a per
minute-of-use basis, in which case it is billed in arrears. The earned but
unbilled portion of these fees are recognized as revenue and accrued in accounts
receivable in the period that the services are provided.
Data and internet services. We offer data services including internet access
(via high-speed or dial up internet access), frame relay, Metro ethernet and
asynchronous transfer mode (ATM) switching services. We offer other data
transmission services to other carriers and high-volume commercial customers
with dedicated high-capacity circuits ranging from DS-1's to Gig E. Such
services are generally offered on a contract basis and the service is billed on
a fixed monthly recurring charge basis. Data and internet services are typically
billed monthly in advance. The unearned portion of these fees are initially
deferred as a component of other liabilities on our balance sheet and recognized
as revenue over the period that the services are provided.
Directory services. Directory services involves the provision of white and
yellow page directories for residential and business listings. We provide this
service through two third-party contractors. In a majority of our markets, the
contractor is paid a percentage of revenues from the sale of advertising in
these directories and in the remaining markets, we receive a flat fee. Our
directory service also includes "Frontier Pages," an internet-based directory
service which generates advertising revenue. We recognize the revenue from these
services over the life of the related white or yellow pages book, which is
typically one calendar year.
Television services. We offer a television product in partnership with DISH
Network. We provide access to all-digital television channels featuring movies,
sports, news, music and high-definition TV programming. We offer packages of
100, 200 or 250 channels and include high-definition channels, premium channels,
family channels and ethnic channels. We also provide access to local channels.
We are in an "agency" relationship with DISH. We bill the customer for the
monthly services and remit those billings to DISH without recognizing any
revenue. We in turn receive from DISH and recognize as revenue activation fees,
other residual fees and nominal management, billing and collection fees.
3
Wireless services. During 2006, we began offering wireless data services in
certain markets. Our wireless data services utilize technologies that are
relatively new, and we depend to some degree on the representations of equipment
vendors, lab testing and the experiences of others who have been successful at
deploying these new technologies. As of December 31, 2008, we provided wireless
data WIFI networks in 18 municipalities, four colleges and universities and over
120 business establishments. Revenue is recognized when services are provided to
customers. Long-term contracts are billed in advance on an annual or semi-annual
basis. End-user subscribers are billed in advance on a monthly recurring basis
and colleges, universities and businesses are billed on a monthly recurring
basis for a fixed number of users. The unearned portion of this revenue is
initially deferred as a component of other liabilities on our balance sheet and
recognized as revenue over the period that the services are provided. Hourly,
daily and weekly casual end-users are billed by credit card at the time of use.
The following table sets forth the number of our access lines and High-Speed
Internet subscribers as of December 31, 2008 and 2007.
Access Lines and High-Speed
Internet Subscribers at December 31,
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State 2008 2007
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New York................ 825,700 897,300
Pennsylvania............ 506,100 522,500
Minnesota............... 280,500 287,400
California.............. 193,200 202,900
Arizona................. 192,800 199,600
West Virginia........... 188,200 183,700
Illinois................ 127,900 129,000
Tennessee............... 105,300 108,600
Wisconsin............... 79,100 78,800
Iowa.................... 56,900 57,100
Nebraska................ 51,400 53,300
All other states (13)... 227,200 231,800
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Total 2,834,300 2,952,000
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Change in the number of our access lines is one factor that is important to our
revenue and profitability. We have lost access lines primarily because of
competition, changing consumer behavior (including wireless substitution),
economic conditions, changing technology and by some customers disconnecting
second lines when they add High-Speed Internet or cable modem service. We lost
approximately 174,800 access lines (net) during the year ended December 31,
2008, but added approximately 57,100 High-Speed Internet subscribers (net)
during this same period. With respect to the access lines we lost in 2008,
133,700 were residential customer lines and 41,100 were business customer lines.
The business line losses were principally in our eastern region and Rochester,
New York, while the residential losses were throughout our markets. We expect to
continue to lose access lines but to increase High-Speed Internet subscribers
during 2009 (although not enough to offset access line losses). A substantial
further loss of access lines, combined with increased competition and the other
factors discussed in MD&A, may cause our revenues, profitability and cash flows
to decrease during 2009.
Regulatory Environment
General
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The majority of our operations are regulated by the FCC and various state
regulatory agencies, often called public service or utility commissions.
Certain of our revenue is subject to regulation by the FCC and various state
regulatory agencies. We expect federal and state lawmakers to continue to review
the statutes governing the level and type of regulation for telecommunications
services.
The Telecommunications Act of 1996, or the 1996 Act, dramatically changed the
telecommunications industry. The main purpose of the 1996 Act was to open local
telecommunications marketplaces to competition. The 1996 Act preempts state and
local laws to the extent that they prevent competition with respect to
communications services. Under the 1996 Act, however, states retain authority to
impose requirements on carriers necessary to preserve universal service, protect
public safety and welfare, ensure quality of service and protect consumers.
States are also responsible for mediating and arbitrating interconnection
agreements between competitive local exchange carriers (CLECs) and ILECs if
voluntary negotiations fail. In order to create an environment in which local
competition is a practical possibility, the 1996 Act imposes a number of
requirements for access to network facilities and interconnection on all local
communications providers. Incumbent local carriers must interconnect with other
carriers, unbundle some of their services at wholesale rates, permit resale of
some of their services, enable collocation of equipment, provide local telephone
number portability and dialing parity, provide access to poles, ducts, conduits
and rights-of-way, and complete calls originated by competing carriers under
termination arrangements.
4
At the federal level and in a number of the states in which we operate, we are
subject to price cap or incentive regulation plans under which prices for
regulated services are capped in return for the elimination or relaxation of
earnings oversight. The goal of these plans is to provide incentives to improve
efficiencies and increased pricing flexibility for competitive services while
ensuring that customers receive reasonable rates for basic services. Some of
these plans have limited terms and, as they expire, we may need to renegotiate
with various states. These negotiations could impact rates, service quality
and/or infrastructure requirements which could impact our earnings and capital
expenditures. In other states in which we operate, we are subject to rate of
return regulation that limits levels of earnings and returns on investments. We
continue to advocate our position for less regulation with various regulatory
agencies. In some of our states, we have been successful in reducing or
eliminating price regulation on end-user services under state commission
jurisdiction.
For interstate services regulated by the FCC, we have elected a form of
incentive regulation known as "price caps" for most of our operations. In May
2000, the FCC adopted a methodology for regulating the interstate access rates
of price cap companies through May 2005. The program, known as the Coalition for
Affordable Local and Long Distance Services, or CALLS plan, reduced prices for
interstate-switched access services and phased out many of the implicit
subsidies in interstate access rates. The CALLS program expired in 2005 but
continues in effect until the FCC takes further action. The FCC may address
future changes in access charges during 2009 and such changes may adversely
affect our revenues and profitability.
Another goal of the 1996 Act was to remove implicit subsidies from the rates
charged by local telecommunications companies. The CALLS plan addressed this
requirement for interstate services. Some state legislatures and regulatory
agencies are looking to reduce the implicit subsidies in intrastate rates. The
most common subsidies are in access rates that historically have been priced
above their costs to allow basic local rates to be priced below cost.
Legislation has been considered in several states to require regulators to
eliminate these subsidies and implement state universal service programs where
necessary to maintain reasonable basic local rates. However, not all the
reductions in access charges would be fully offset. We anticipate additional
state legislative and regulatory pressure to lower intrastate access rates.
Some state legislatures and regulators are also examining the provision of
telecommunications services to previously unserved areas. Since many unserved
areas are located in rural markets, we could be required to expend the necessary
capital to expand our service territory into some of these areas.
Recent and Potential Regulatory Developments
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Wireline and wireless carriers are required to provide local number portability
(LNP). LNP is the ability of customers to switch from a wireline or wireless
carrier to another wireline or wireless carrier without changing telephone
numbers. We are 100% LNP capable in our largest markets and over 99% of our
exchanges are LNP capable. We will upgrade the remaining exchanges in response
to bona fide requests as required by FCC regulations.
The FCC and state regulators are currently considering a number of proposals for
changing the manner in which eligibility for federal subsidies is determined as
well as the amounts of such subsidies. In May 2008, the FCC issued an order to
cap Competitive Eligible Telecommunications Companies (CETC) receipts from the
high cost Federal Universal Service Fund. While this order will have no impact
on our current receipt levels, we believe this is a positive first step to limit
the rapid growth of the fund. The CETC cap will remain in place until the FCC
takes additional steps towards needed reform.
The FCC is considering proposals that may significantly change interstate,
intrastate and local intercarrier compensation and would revise the Federal
Universal Service funding and disbursement mechanisms. When and how these
proposed changes will be addressed are unknown and, accordingly, we are unable
to predict the impact of future changes on our results of operations. However,
future reductions in our subsidy and access revenues will directly affect our
profitability and cash flows as those regulatory revenues do not have associated
variable expenses. As discussed in MD&A, our access and subsidy revenues
declined in 2008 compared to 2007. Our access and subsidy revenues are both
likely to decline further in 2009.
Certain states have open proceedings to address reform to intrastate access
charges and other intercarrier compensation. We cannot predict when or how these
matters will be decided or the effect on our subsidy or access revenues. In
addition, we have been approached by, and/or are involved in formal state
proceedings with, various carriers seeking reductions in intrastate access rates
in certain states.
5
Regulators at both the federal and state levels continue to address whether VOIP
services are subject to the same or different regulatory and financial models as
traditional telephony. The FCC has concluded that certain VOIP services are
jurisdictionally interstate in nature and are thereby exempt from state
telecommunications regulations. The FCC has not addressed other related issues,
such as: whether or under what terms VOIP originated traffic may be subject to
intercarrier compensation; and whether VOIP services are subject to general
state requirements relating to taxation and general commercial business
requirements. The FCC has stated its intent to address these open questions in
subsequent orders in its ongoing "IP-Enabled Services Proceeding," which opened
in February 2004. Internet telephony may have an advantage over our traditional
services if it remains less regulated.
In January 2008, the FCC released public notices requesting comments on two
petitions that have been filed regarding net neutrality and the application of
the FCC's Internet Policy Statement. It is uncertain whether these petitions
will result in any formal FCC action.
Some state regulators (including New York and Illinois) have in the past
considered imposing on regulated companies (including us) cash management
practices that could limit the ability of a company to transfer cash between its
subsidiaries or to its parent company. None of the existing state requirements
materially affect our cash management but future changes by state regulators
could affect our ability to freely transfer cash within our consolidated
companies. Frontier reached an agreement with the New York Public Service
Commission removing many legacy Open Market Plan restrictions, including many
cash management restrictions, and reduced the triggers that would force the
Company to carry out specific remaining restrictions.
President Obama has signed into law an economic stimulus package that includes
funding, through grants, for new broadband investment to unserved and
underserved communities. Depending on the final amount made available and the
conditions included in the package with respect to acceptance and use of the
money, the Company may be eligible to receive funds from this package. These
funds, if received, would be used by us to expand broadband to customers in our
markets to whom it is not available due to the high cost of providing the
service to those areas.
Competition
Competition in the telecommunications industry is intense and increasing. We
experience competition from many telecommunications service providers, including
cable operators offering VOIP products, wireless carriers, long distance
providers, competitive local exchange carriers, internet providers and other
wireline carriers. We believe that as of December 31, 2008, approximately 65% of
the households in our territories had VOIP as an available service option from
cable operators. We also believe that competition will continue to intensify in
2009 and may result in reduced revenues. Our business experienced erosion in
access lines and switched access minutes in 2008 primarily as a result of
competition and business downsizing. We also experienced a reduction in revenue
in 2008 as compared to 2007.
The recent severe contraction in the global financial markets and ongoing
recession may be impacting consumer behavior to reduce household expenditures by
not purchasing our services and/or by discontinuing our services. These trends
are likely to continue and may result in a challenging revenue environment.
These factors could also result in increased delinquencies and bankruptcies and,
therefore, affect our ability to collect money owed to us by residential and
business customers.
We employ a number of strategies to combat the competitive pressures and changes
to consumer behavior noted above. Our strategies are focused in the following
areas: customer retention, upgrading and up-selling services to our existing
customer base, new customer growth, win backs, new product deployment, and
operating expense and capital expenditure reductions.
We hope to achieve our customer retention goals by bundling services around the
local access line and providing exemplary customer service. Bundled services
include High-Speed Internet, unlimited long distance calling, enhanced telephone
features and video offerings. We tailor these services to the needs of our
residential and business customers in the markets we serve and continually
evaluate the introduction of new and complementary products and services, which
can also be purchased separately. Customer retention is also enhanced by
offering one, two and three year price protection plans where customers commit
to a term in exchange for predictable pricing and/or promotional offers.
Additionally, we are focused on enhancing the customer experience as we believe
exceptional customer service will differentiate us from our competition. Our
commitment to providing exemplary customer service is demonstrated by the
expansion of our customer services hours, shorter scheduling windows for in-home
appointments and the implementation of call reminders and follow-up calls for
service appointments. In addition, due to a recent realignment and restructuring
of approximately 70 local area markets, those markets are now operated by local
managers with responsibility for the customer experience, as well as the
financial results, in those markets.
6
We utilize targeted and innovative promotions to sell new customers, including
those moving into our territory, win back previously lost customers, upgrade and
up-sell existing customers on a variety of service offerings including
High-Speed Internet, video, and enhanced long distance and feature packages in
order to maximize the average revenue per access line (wallet share) paid to
Frontier. Depending upon market and economic conditions, we may continue to
offer such promotions to drive sales and may offer additional promotions in the
future.
Lastly, we are focused on introducing a number of new products that our
customers desire, including unlimited long distance minutes, bundles of long
distance minutes, wireless data, internet portal advertising and the "Frontier
Peace of Mind" product suite. This last category is a suite of products aimed at
managing the total communications and personal computing experience for our
customers. The Peace of Mind product and services are designed to provide value
and simplicity to meet our customers' ever-changing needs. The Peace of Mind
product and services suite includes services such as an in-home, full
installation of our high-speed product, two hour appointment windows for the
installation, hard drive back-up services, enhanced help desk PC support and
inside wire maintenance. We offer a portion of our Peace of Mind services,
including hard drive back-up services and enhanced help desk PC support, both to
our customers and to other users inside and outside of our service territories.
Although we are optimistic about the opportunities provided by each of these
initiatives, we can provide no assurance about their long term profitability or
impact on revenue.
We believe that the combination of offering multiple products and services to
our customers pursuant to price protection programs, billing them on a single
bill, providing superior customer service, and being active in our local
communities will make our customers more loyal to us, and will help us generate
new, and retain existing, customer revenue.
Divestiture of Electric Lightwave, LLC
In 2006, we sold our CLEC business, Electric Lightwave, LLC (ELI) for $255.3
million (including the sale of associated real estate) in cash plus the
assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale was approximately $5.0 million due to the utilization of
existing tax net operating losses on both the federal and state level.
Segment Information
With the 2006 sale of our CLEC (ELI), we currently operate in only one
reportable segment.
Financial Information about Foreign and Domestic Operations and Export Sales
We have no foreign operations.
General
Order backlog is not a significant consideration in our business. We have no
material contracts or subcontracts that may be subject to renegotiation of
profits or termination at the election of the Federal government. We hold no
patents, licenses or concessions that are material.
Employees
As of December 31, 2008, we had 5,671 employees. Approximately 2,900 of our
employees are affiliated with a union. The number of union employees covered by
agreements set to expire during 2009 is 1,400. We consider our relations with
our employees to be good.
7
Available Information
We are subject to the informational requirements of the Securities Exchange Act
of 1934. Accordingly, we file periodic reports, proxy statements and other
information with the Securities and Exchange Commission (SEC). Such reports,
proxy statements and other information may be obtained by visiting the Public
Reference Room of the SEC at 100 F Street, NE, Washington, D.C. 20549 or by
calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet
site (www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically. Material filed by us can also be inspected at the offices of the
New York Stock Exchange, Inc. (NYSE), 20 Broad Street, New York, NY 10005, on
which our common stock is listed. On June 9, 2008, our Chief Executive Officer
submitted the annual certification required by Section 303A.12(a) of the NYSE
Listed Company Manual. In addition, the certifications of our Chief Executive
Officer and Chief Financial Officer required under Section 302 of the
Sarbanes-Oxley Act of 2002 are included as exhibits to this Form 10-K.
We make available, free of charge on our website, our Annual Report on Form
10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments
to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act, as soon as practicable after we electronically file these
documents with, or furnish them to, the SEC. These documents may be accessed
through our website at www.frontier.com under "Investor Relations." The
information posted or linked on our website is not part of this report.
We also make available on our website, or in printed form upon request, free of
charge, our Corporate Governance Guidelines, Code of Business Conduct and
Ethics, and the charters for the Audit, Compensation, and Nominating and
Corporate Governance committees of the Board of Directors. Stockholders may
request printed copies of these materials by writing to: 3 High Ridge Park,
Stamford, Connecticut 06905 Attention: Corporate Secretary. Our website address
is www.frontier.com.
Item 1A. Risk Factors
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Before you make an investment decision with respect to our securities, you
should carefully consider all the information we have included or incorporated
by reference in this Form 10-K and our subsequent periodic filings with the SEC.
In particular, you should carefully consider the risk factors described below
and read the risks and uncertainties related to "forward-looking statements" as
set forth in the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section of this Form 10-K. The risks and
uncertainties described below are not the only ones facing our company.
Additional risks and uncertainties that are not presently known to us or that we
currently deem immaterial or that are not specific to us, such as general
economic conditions, may also adversely affect our business and operations. The
following risk factors should be read in conjunction with MD&A and the
consolidated financial statements and related notes included in this report.
Risks Related to Competition and Our Industry
---------------------------------------------
We face intense competition, which could adversely affect us.
The telecommunications industry is extremely competitive and
competition is increasing. The traditional dividing lines between long distance,
local, wireless, cable and internet service providers are becoming increasingly
blurred. Through mergers and various service expansion strategies, services
providers are striving to provide integrated solutions both within and across
geographic markets. Our competitors include CLECs and other providers (or
potential providers) of services, such as internet service providers, or ISPs,
wireless companies, neighboring incumbents, VOIP providers and cable companies
that may provide services competitive with the services that we offer or intend
to introduce. Competition is intense and increasing and we cannot assure you
that we will be able to compete effectively. For example, at December 31, 2008,
we had 174,800 fewer access lines than we had at December 31, 2007, and we
believe wireless and cable telephony providers have increased their market share
in our markets. We expect to continue to lose access lines and that competition
with respect to all our products and services will increase.
We expect competition to intensify as a result of the entrance of new
competitors, penetration of existing competitors into new markets, changing
consumer behavior and the development of new technologies, products and services
that can be used in substitution for ours. We cannot predict which of the many
possible future technologies, products or services will be important to maintain
our competitive position or what expenditures will be required to develop and
provide these technologies, products or services. Our ability to compete
successfully will depend on the success and cost of marketing efforts and on our
ability to anticipate and respond to various competitive factors affecting the
industry, including a changing regulatory environment that may affect our
competitors and us differently, new services that may be introduced, changes in
consumer preferences, demographic trends, economic conditions and pricing
strategies by competitors. Increasing competition may reduce our revenues and
increase our marketing and other costs as well as require us to increase our
capital expenditures and thereby decrease our cash flow.
8
Some of our competitors have superior resources, which may place us at a
cost and price disadvantage.
Some of our current and potential competitors have market presence,
engineering, technical and marketing capabilities, and financial, personnel and
other resources substantially greater than ours. In addition, some of our
competitors can raise capital at a lower cost than we can. Consequently, some
competitors may be able to develop and expand their communications and network
infrastructures more quickly, adapt more swiftly to new or emerging technologies
and changes in customer requirements, take advantage of acquisition and other
opportunities more readily and devote greater resources to the marketing and
sale of their products and services than we can. Additionally, the greater brand
name recognition of some competitors may require us to price our services at
lower levels in order to retain or obtain customers. Finally, the cost
advantages of some competitors may give them the ability to reduce their prices
for an extended period of time if they so choose.
Risks Related to Our Business
-----------------------------
Decreases in certain types of our revenues will impact our profitability.
Our business has experienced declining access lines, switched access
minutes of use, long distance prices, Federal and state subsidies and related
revenues because of economic conditions, increasing competition, changing
consumer behavior (such as wireless displacement of wireline use, email use,
instant messaging and increasing use of VOIP), technology changes and regulatory
constraints. Our access lines declined 7% in 2008, and 6% in 2007 (excluding the
access lines added through our acquisitions of Commonwealth Telephone
Enterprises, Inc. (Commonwealth or CTE) and Global Valley Networks, Inc. and GVN
Services (together GVN)). These factors are likely to cause our local network
service, switched network access, long distance and subsidy revenues to continue
to decline, and these factors, together with increased cash taxes may cause our
cash generated by operations to decrease.
A significant portion of our revenues ($285.0 million, or 13% in 2008)
is derived from access charges paid by IXCs for services we provide in
originating and terminating intrastate and interstate traffic. The amount of
access charge revenues we receive for these services is regulated by the FCC and
state regulatory agencies.
We may be unable to grow our revenue and cash flow despite the initiatives
we have implemented.
We must produce adequate cash flow that, when combined with funds
available under our revolving credit facility, will be sufficient to service our
debt, fund our capital expenditures, pay our taxes and maintain our current
dividend policy. We expect that our cash taxes, which increased significantly in
2008, will continue to increase in 2009 due to our expectations of continued
profitability and the effects of fully utilizing our federal net operating loss
carryforwards and Alternative Minimum Tax (AMT) tax credit carryforwards that
were generated in prior years. We have implemented several growth initiatives,
including increasing our marketing promotion/expenditures and launching new
products and services with a focus on areas that are growing or demonstrate
meaningful demand such as wireline and wireless High-Speed Internet, the DISH
satellite television product and our Peace of Mind computer technical support.
We cannot assure you that these initiatives will improve our financial position
or our results of operations.
We may complete a significant strategic transaction that may not achieve
intended results and/or increase our outstanding shares and/or debt or result in
a change of control.
We continuously evaluate and may in the future enter into strategic
transactions. Any such transaction could happen at any time, could be
material to our business and could take any number of forms, including, for
example, an acquisition, merger or a sale of all or substantially all of our
assets.
Evaluating potential transactions and integrating completed ones may divert
management's attention from ordinary operating matters. The success of these
and other potential transactions will depend, in part, on our ability to
realize the anticipated synergies, cost savings and growth opportunities
through the successful integration of the businesses we acquire with our
existing business. Even if we are successful integrating acquired businesses,
we cannot assure you that these integrations will result in the realization
of the full benefit of the anticipated synergies, cost savings or growth
opportunities or that these benefits will be realized within the expected
time frames. In addition, acquired businesses may have unanticipated
liabilities or contingencies.
If we complete an acquisition, investment or other strategic transaction
we may require additional financing that could result in an increase in the
number of our outstanding shares and/or the aggregate amount of our debt. The
number of shares of our common stock and/or the aggregate principal amount of
our debt that we may issue may be significant. A strategic transaction may
result in a change in control of our company or otherwise materially and
adversely impact our business.
9
Weak economic conditions may decrease demand for our services.
We could be sensitive to the ongoing recession. Downturns in the
economy and competition in our markets could cause some of our existing
customers to reduce or eliminate their purchases of our basic and enhanced
services, High-Speed Internet and video services and make it difficult for us to
obtain new customers. In addition, current economic conditions could cause our
customers to delay or discontinue payment for our services.
Disruption in our networks and infrastructure may cause us to lose
customers and incur additional expenses.
To attract and retain customers, we will need to continue to provide
them with reliable service over our networks. Some of the risks to our networks
and infrastructure include physical damage to access lines, security breaches,
capacity limitations, power surges or outages, software defects and disruptions
beyond our control, such as natural disasters and acts of terrorism. From time
to time in the ordinary course of business, we experience short disruptions in
our service due to factors such as cable damage, inclement weather and service
failures of our third party service providers. We could experience more
significant disruptions in the future. We could also face disruptions due to
capacity limitations if changes in our customers' usage patterns for our
High-Speed Internet services result in a significant increase in capacity
utilization, such as through increased usage of video or peer-to-peer file
sharing applications. Disruptions may cause interruptions in service or reduced
capacity for customers, either of which could cause us to lose customers and
incur additional expenses, and thereby adversely affect our business, revenue
and cash flows.
Our business is sensitive to the creditworthiness of our wholesale
customers.
We have substantial business relationships with other
telecommunications carriers for whom we provide service. While bankruptcies of
these carriers have not had a material adverse effect on our business in recent
years, future bankruptcies in our industry could result in our loss of
significant customers, more price competition and uncollectible accounts
receivable. Such bankruptcies may be more likely in the future, given the
ongoing recession. As a result, our revenues and results of operations could be
materially and adversely affected.
A significant portion of our workforce is unionized, and if we are unable
to reach new agreements before our current labor contracts expire, our unionized
workers could engage in strikes or other labor actions that could materially
disrupt our ability to provide services to our customers.
As of December 31, 2008, we had approximately 5,700 active employees.
Approximately 2,900, or 51%, of these employees were represented by unions
subject to collective bargaining agreements. Of the union-represented employees,
approximately 1,400, or 49%, have collective bargaining agreements that expire
in 2009. We cannot predict the outcome of negotiations for these agreements. If
we are unable to reach new agreements, union employees may engage in strikes,
work slowdowns or other labor actions, which could materially disrupt our
ability to provide services. New labor agreements may impose significant new
costs on us, which could adversely affect our financial condition and results
of operations in the future.
Risks Related to Liquidity, Financial Resources and Capitalization
------------------------------------------------------------------
The recent severe contraction in the global financial markets and ongoing
recession may have an impact on our business and financial condition.
Diminished availability of credit and liquidity due to the recent
severe contraction in the global financial markets and ongoing recession may
impact the financial health of the Company's customers, vendors and partners,
which in turn may negatively impact the Company's revenues, operating expenses
and cash flows. In addition, although we believe, based on information available
to us, that the financial institutions syndicated under our revolving credit
facility would be able to fulfill their commitments to us, given the current
economic environment and the recent severe contraction in the global financial
markets, this could change in the future.
10
As a result of negative investment returns and ongoing benefit
payments, the Company's pension plan assets have declined from $822.2 million at
December 31, 2007 to $589.8 million at December 31, 2008, a decrease of $232.4
million, or 28%. This decrease represents a decline in asset value of $162.9
million, or 20%, and benefits paid of $69.5 million, or 8%. The decline in
pension plan assets did not impact our results of operations, liquidity or cash
flows in 2008. However, we expect that our pension expense will increase in 2009
and that we may be required to make a cash contribution to our pension plan
beginning in 2010.
The Company has significant debt maturities in 2011 when approximately
$1.1 billion of our debt matures. Historically, the Company has refinanced its
debt obligations well in advance of scheduled maturities. Given the current
credit environment, our ability to access the capital markets may be restricted,
our cost of borrowing may be materially higher than previous debt issuances
and/or we may not be able to borrow on terms as favorable as those in our
current debt instruments.
Substantial debt and debt service obligations may adversely affect us.
We have a significant amount of indebtedness, which amounted to $4.7
billion at December 31, 2008. We may also obtain additional long-term debt and
working capital lines of credit to meet future financing needs, subject to
certain restrictions under the terms of our existing indebtedness, which would
increase our total debt.
The significant negative consequences on our financial condition and
results of operations that could result from our substantial debt include:
* limitations on our ability to obtain additional debt or equity
financing, particularly in light of the current credit
environment;
* instances in which we are unable to meet the financial covenants
contained in our debt agreements or to generate cash sufficient
to make required debt payments, which circumstances have the
potential of accelerating the maturity of some or all of our
outstanding indebtedness;
* the allocation of a substantial portion of our cash flow from
operations to service our debt, thus reducing the amount of our
cash flow available for other purposes, including operating
costs, capital expenditures and dividends that could improve our
competitive position, results of operations or stock price;
* requiring us to sell debt or equity securities or to sell some of
our core assets, possibly on unfavorable terms, to meet payment
obligations;
* compromising our flexibility to plan for, or react to,
competitive challenges in our business and the communications
industry; and
* the possibility of our being put at a competitive disadvantage
with competitors who do not have as much debt as us, and
competitors who may be in a more favorable position to access
additional capital resources.
We will require substantial capital to upgrade and enhance our operations.
Replacing or upgrading our infrastructure will result in significant
capital expenditures. If this capital is not available when needed, our business
will be adversely affected. Increasing competition, offering new services,
improving the capabilities or reducing the maintenance costs of our plant may
cause our capital expenditures to increase in the future. In addition, our
ongoing annual dividend of $1.00 per share under our current policy utilizes a
significant portion of our cash generated by operations and therefore limits our
operating and financial flexibility and our ability to significantly increase
capital expenditures. While we believe that the amount of our dividend will
allow for adequate amounts of cash flow for capital spending and other purposes,
any material reduction in cash generated by operations and any increases in
capital expenditures, interest expense or cash taxes would reduce the amount of
cash generated by operations and available for payment of dividends. Losses of
access lines, the effects of increased competition, lower subsidy and access
revenues and the other factors described above may reduce our cash generated by
operations and may require us to increase capital expenditures. In addition, we
expect our cash paid for taxes, which increased significantly in 2008, will
continue to increase in 2009.
11
Risks Related to Regulation
---------------------------
The access charge revenues we receive may be reduced at any time.
A significant portion of our revenues ($285.0 million, or 13% in 2008)
is derived from access charges paid by IXCs for services we provide in
originating and terminating intrastate and interstate traffic. The amount of
access charge revenues we receive for these services is regulated by the FCC and
state regulatory agencies.
The FCC is considering proposals that may significantly change
interstate, intrastate and local intercarrier compensation. When and how these
proposed changes will be addressed are unknown and, accordingly, we are unable
to predict the impact of future changes on our results of operations. However,
future reductions in our access revenues will directly affect our profitability
and cash flows as those regulatory revenues do not have associated variable
expenses.
Certain states have open proceedings to address reform to access
charges and other intercarrier compensation. We cannot predict when or how these
matters will be decided or the effect on our subsidy or access revenues. In
addition, we have been approached by, and/or are involved in formal state
proceedings with, various carriers seeking reductions in intrastate access rates
in certain states. Certain of those claims have led to formal complaints to the
state PUCs. A material reduction in the access revenues we receive would
adversely affect our financial results.
We are reliant on support funds provided under federal and state laws.
We receive a portion of our revenue ($119.8 million, or 5%, in 2008 and
$130.0 million, or 6%, in 2007) from federal and state subsidies, including the
federal high cost fund, federal local switching support fund, federal universal
service fund surcharge and various state funds. The FCC and state regulators are
currently considering a number of proposals for changing the manner in which
eligibility for federal and state subsidies is determined as well as the amounts
of such subsidies. Although the FCC issued an order on May 1, 2008 to cap CETC
receipts from the high cost Federal Universal Service Fund, which we believe is
a positive first step to limit the rapid growth of the fund, the CETC Cap will
only remain in place until the FCC takes additional steps. We cannot predict
when the FCC will take additional actions or the effect of any such actions on
our subsidy revenue.
The federal high cost fund is our largest source of subsidy revenue
(approximately $20.8 million in 2008). We currently expect that as a result of
both an increase in the national average cost per loop and a decrease in our
cost structure, there will be a decrease in the subsidy revenue we earn in 2009
through the federal high cost support fund.
In addition, approximately $37.1 million, or 2% of our revenue
represents a surcharge to customers (local, long distance and IXC) which is
remitted to the FCC and recorded as an expense in "other operating expenses."
Our company and industry are highly regulated, imposing substantial
compliance costs and constraining our ability to compete in our target markets.
As an incumbent, we are subject to significant regulation from Federal,
state and local authorities. This regulation restricts our ability to change our
rates, especially on our basic services, and imposes substantial compliance
costs on us. Regulation constrains our ability to compete and, in some
jurisdictions, it may restrict how we are able to expand our service offerings.
In addition, changes to the regulations that govern us may have an adverse
effect upon our business by reducing the allowable fees that we may charge,
imposing additional compliance costs, or otherwise changing the nature of our
operations and the competition in our industry.
Customers are permitted to retain their wireline number when switching
to another service provider. This is likely to increase the number of our
customers who decide to disconnect their service from us. Other pending
rulemakings, including those relating to intercarrier compensation, universal
service and VOIP regulations, could have a substantial adverse impact on our
operations.
12
Risks Related to Technology
---------------------------
In the future as competition intensifies within our markets, we may be
unable to meet the technological needs or expectations of our customers, and may
lose customers as a result.
The telecommunications industry is subject to significant changes in
technology. If we do not replace or upgrade technology and equipment, we will be
unable to compete effectively because we will not be able to meet the needs or
expectations of our customers. Replacing or upgrading our infrastructure could
result in significant capital expenditures.
In addition, rapidly changing technology in the telecommunications
industry may influence our customers to consider other service providers. For
example, we may be unable to retain customers who decide to replace their
wireline telephone service with wireless telephone service. In addition, VOIP
technology, which operates on broadband technology, now provides our competitors
with a low-cost alternative to provide voice services to our customers.
Item 1B. Unresolved Staff Comments
-------------------------
None.
Item 2. Properties
----------
Our principal corporate offices are located in leased premises at 3 High Ridge
Park, Stamford, Connecticut 06905.
Operations support offices are currently located in leased premises at 180 South
Clinton Avenue, Rochester, New York 14646 and at 100 CTE Drive, Dallas,
Pennsylvania 18612. Call center support offices are currently located in leased
premises at 14450 Burnhaven Drive, Burnsville, Minnesota 55306 and 1398 South
Woodland Blvd., DeLand, Florida 32720. In addition, we lease and own space in
our operating markets throughout the United States.
Our telephone properties include: connecting lines between customers' premises
and the central offices; central office switching equipment; fiber-optic and
microwave radio facilities; buildings and land; and customer premise equipment.
The connecting lines, including aerial and underground cable, conduit, poles,
wires and microwave equipment, are located on public streets and highways or on
privately owned land. We have permission to use these lands pursuant to local
governmental consent or lease, permit, franchise, easement or other agreement.
Item 3. Legal Proceedings
-----------------
Ronald A. Katz Technology Licensing LP, filed suit against us for patent
infringement on June 8, 2007 in the U.S. District Court for the District of
Delaware. Katz Technology alleged that, by operating automated telephone
systems, including customer service systems, that allow our customers to utilize
telephone calling cards, order internet, DSL and dial-up services, and perform a
variety of account related tasks such as billing and payments, we had infringed
13 of Katz Technology's patents and continued to infringe three of Katz
Technology's patents. Katz Technology sought unspecified damages resulting from
our alleged infringement, as well as a permanent injunction enjoining us from
continuing the alleged infringement. Katz Technology subsequently filed a
tag-along notice with the Judicial Panel on Multi-District Litigation, notifying
them of this action and its relatedness to In re Katz Interactive Dial
Processing Patent Litigation (MDL No. 1816), pending in the Central District of
California before Judge R. Gary Klausner. The Judicial Panel on Multi-District
Litigation transferred the case to the Central District of California. This case
was settled on November 20, 2008 for an amount that was not material to the
Company. As part of the settlement, the Company agreed to pay for a nonexclusive
license under a comprehensive portfolio of patents that Katz Technology owns
relating to interactive voice applications. The case was dismissed, with
prejudice, in December 2008.
We are party to various legal proceedings arising in the normal course of our
business. The outcome of individual matters is not predictable. However, we
believe that the ultimate resolution of all such matters, after considering
insurance coverage, will not have a material adverse effect on our financial
position, results of operations, or our cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None in fourth quarter of 2008.
13
Executive Officers of the Registrant
Our Executive Officers as of February 1, 2009 were:
Name Age Current Position and Officer
---- --- ----------------------------
Mary Agnes Wilderotter 54 Chairman of the Board, President and Chief Executive Officer
Donald R. Shassian 53 Executive Vice President and Chief Financial Officer
Hilary E. Glassman 46 Senior Vice President, General Counsel and Secretary
Peter B. Hayes 51 Executive Vice President Sales, Marketing and Business Development
Robert J. Larson 49 Senior Vice President and Chief Accounting Officer
Daniel J. McCarthy 44 Executive Vice President and Chief Operating Officer
Cecilia K. McKenney 46 Executive Vice President, Human Resources and Call Center Sales & Services
Melinda White 49 Senior Vice President and General Manager, New Business Operations
There is no family relationship between directors or executive officers. The
term of office of each of the foregoing officers of Frontier will continue until
the next annual meeting of the Board of Directors and until a successor has been
elected and qualified.
MARY AGNES WILDEROTTER has been with Frontier since November 2004. She was
elected President and Chief Executive Officer in November 2004 and Chairman of
the Board in December 2005. Prior to joining Frontier, she was Senior Vice
President - Worldwide Public Sector of Microsoft Corp. from February 2004 to
November 2004 and Senior Vice President - Worldwide Business Strategy of
Microsoft Corp. from 2002 to 2004. Before that she was President and Chief
Executive Officer of Wink Communications from 1997 to 2002.
DONALD R. SHASSIAN has been with Frontier since April 2006. He is currently
Executive Vice President and Chief Financial Officer. Previously, he was Chief
Financial Officer from April 2006 to February 2008. Prior to joining Frontier,
Mr. Shassian had been an independent consultant since 2001 primarily providing
M&A advisory services to several organizations in the communications industry.
In his role as independent consultant, Mr. Shassian also served as Interim Chief
Financial Officer of the Northeast region of Health Net, Inc. for a short period
of time, and assisted in the evaluation of acquisition, disposition and capital
raising opportunities for several companies in the communications industry,
including AT&T, Consolidated Communications and smaller companies in the rural
local exchange business. Mr. Shassian is a certified public accountant, and
served for 5 years as the Senior Vice President and Chief Financial Officer of
Southern New England Telecommunications Corporation and for more than 16 years
at Arthur Andersen.
HILARY E. GLASSMAN has been with Frontier since July 2005. Prior to joining
Frontier, from February 2003, she was associated with Sandler O'Neill &
Partners, L.P., an investment bank with a specialized financial institutions
practice, first as Managing Director, Associate General Counsel and then as
Managing Director, Deputy General Counsel. From February 2000 through February
2003, Ms. Glassman was Vice President and General Counsel of Newview
Technologies, Inc. (formerly e-Steel Corporation), a privately-held software
company.
PETER B. HAYES has been with Frontier since February 2005. He is currently
Executive Vice President, Sales, Marketing and Business Development. Previously,
he was Senior Vice President, Sales, Marketing and Business Development from
February 2005 to December 2005. Prior to joining Frontier, he was associated
with Microsoft Corp. and served as Vice President, Public Sector, Europe, Middle
East, Africa from 2003 to 2005 and Vice President and General Manager, Microsoft
U.S. Government from 1997 to 2003.
ROBERT J. LARSON has been with Frontier since July 2000. He was elected Senior
Vice President and Chief Accounting Officer of Frontier in December 2002.
Previously, he was Vice President and Chief Accounting Officer from July 2000 to
December 2002. Prior to joining Frontier, he was Vice President and Controller
of Century Communications Corp.
DANIEL J. McCARTHY has been with Frontier since December 1990. He is currently
Executive Vice President and Chief Operating Officer. Previously, he was Senior
Vice President, Field Operations from December 2004 to December 2005. He was
Senior Vice President Broadband Operations from January 2004 to December 2004,
President and Chief Operating Officer of Electric Lightwave from January 2002 to
December 2004, President and Chief Operating Officer, Public Services Sector
from November 2001 to January 2002, Vice President and Chief Operating Officer,
Public Services Sector from March 2001 to November 2001 and Vice President,
Citizens Arizona Energy from April 1998 to March 2001.
14
CECILIA K. McKENNEY has been with Frontier since February 2006. She is currently
Executive Vice President, Human Resources and Call Center Sales & Service.
Previously, she was Senior Vice President, Human Resources from February 2006 to
February 2008. Prior to joining Frontier, she was the Group Vice President of
Headquarters of Human Resources of The Pepsi Bottling Group (PBG) from 2004 to
2005. Previously at PBG Ms. McKenney was the Vice President, Headquarters Human
Resources from 2000 to 2004.
MELINDA WHITE has been with Frontier since January 2005. She is currently Senior
Vice President and General Manager of New Business Operations. Previously, she
was Senior Vice President, Commercial Sales and Marketing from January 2006 to
October 2007. Ms. White was Vice President and General Manager of Electric
Lightwave from January 2005 to July 2006. Prior to joining Frontier, she was
Executive Vice President, National Accounts/Business Development for Wink
Communications from 1996 to 2002. From 2002 to 2005, Ms. White pursued a career
in music.
15
PART II
-------
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the New York Stock Exchange under the symbol FTR.
The following table indicates the high and low prices per share during the
periods indicated.
2008 2007
------------------------- -------------------------
High Low High Low
------------- ----------- ----------- -----------
First Quarter $ 12.84 $ 9.75 $ 15.58 $ 13.92
Second Quarter $ 11.96 $ 10.01 $ 16.05 $ 14.80
Third Quarter $ 12.94 $ 11.14 $ 15.62 $ 12.50
Fourth Quarter $ 11.80 $ 6.35 $ 14.54 $ 12.03
As of January 30, 2009, the approximate number of security holders of record of
our common stock was 24,517. This information was obtained from our transfer
agent, Illinois Stock Transfer Company.
DIVIDENDS
The amount and timing of dividends payable on our common stock are within the
sole discretion of our Board of Directors. Commencing with the third quarter of
2004, we instituted a regular annual cash dividend of $1.00 per share of common
stock to be paid quarterly. Cash dividends paid to shareholders were
approximately $318.4 million, $336.0 million and $323.7 million in 2008, 2007
and 2006, respectively. There are no material restrictions on our ability to pay
dividends. The table below sets forth dividends paid per share during the
periods indicated.
2008 2007 2006
-------------- ------------- -------------
First Quarter $ 0.25 $ 0.25 $ 0.25
Second Quarter $ 0.25 $ 0.25 $ 0.25
Third Quarter $ 0.25 $ 0.25 $ 0.25
Fourth Quarter $ 0.25 $ 0.25 $ 0.25
16
STOCKHOLDER RETURN PERFORMANCE GRAPH
The following performance graph compares the cumulative total return of our
common stock to the S&P 500 Stock Index and to the S&P Telecommunications
Services Index for the five-year period commencing December 31, 2003.
[GRAPH]
The graph assumes that $100 was invested on December 31, 2003 in each of our
common stock, the S&P 500 Stock Index and the S&P Telecommunications Services
Index and that all dividends were reinvested.
INDEXED RETURNS
Base Years Ending
Period
Company / Index 12/03 12/04 12/05 12/06 12/07 12/08
-------------------------------------------------------------------------------------------------------------------------
Frontier Communications Corporation 100 133.18 127.45 161.02 152.92 115.46
S&P 500 Index 100 110.88 116.33 134.70 142.10 89.53
S&P Telecommunications Services 100 119.85 113.11 154.73 173.21 120.40
The foregoing performance graph and related information shall not be deemed
"soliciting material" or to be "filed" with the SEC, nor shall such information
be incorporated by reference into any future filings under the Securities Act of
1933 or the Securities Exchange Act of 1934, each as amended, except to the
extent we specifically incorporate it by reference into such filing.
RECENT SALES OF UNREGISTERED SECURITIES, USE OF PROCEEDS FROM REGISTERED
SECURITIES
None in fourth quarter of 2008.
17
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------------------------------------------------------------------------------
Maximum
Approximate
Total Number of Dollar Value of
Shares Purchased Shares that
as Part of May Yet Be
Total Number Average Publicly Purchased
of Shares Price Paid per Announced Plans Under the Plans
Period Purchased Share or Programs or Programs
-------------------------------------------------------------------------------------------------------------
October 1, 2008 to October 31, 2008
Share Repurchase Program (1) 327,700 $ 11.60 327,700 $ -
Employee Transactions (2) - $ - N/A N/A
November 1, 2008 to November 30, 2008
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) - $ - N/A N/A
December 1, 2008 to December 31, 2008
Share Repurchase Program (1) - $ - - $ -
Employee Transactions (2) 223 $ 8.63 N/A N/A
Totals October 1, 2008 to December 31, 2008
Share Repurchase Program (1) 327,700 $ 11.60 327,700 $ -
Employee Transactions (2) 223 $ 8.63 N/A N/A
(1) In February 2008, our Board of Directors authorized us to repurchase up to
$200.0 million of our common stock in public or private transactions over
the following twelve month period. This share repurchase program commenced
on March 4, 2008, and was completed on October 3, 2008.
(2) Includes restricted shares withheld (under the terms of grants under
employee stock compensation plans) to offset minimum tax withholding
obligations that occur upon the vesting of restricted shares. The Company's
stock compensation plans provide that the value of shares withheld shall be
the average of the high and low price of the Company's common stock on the
date the relevant transaction occurs.
18
Item 6. Selected Financial Data
-----------------------
The following tables present selected historical consolidated financial
information of Frontier for the periods indicated. The selected historical
consolidated financial information of Frontier as of and for each of the five
fiscal years in the period ended December 31, 2008 has been derived from
Frontier's historical consolidated financial statements. The selected historical
consolidated financial information as of December 31, 2008 and 2007 and for the
three years ended December 31, 2008 is derived from the audited historical
consolidated financial statements of Frontier included elsewhere in this Form
10-K. The selected historical consolidated financial information as of December
31, 2006, 2005 and 2004 and for the years ended December 31, 2005 and 2004 is
derived from the audited historical consolidated financial statements of
Frontier not included in this Form 10-K.
($ in thousands, except per share amounts) Year Ended December 31,
------------------------------------------ -------------------------------------------------------------------
2008 2007 2006 2005 2004
------------ ----------- ------------ ------------ -----------
Revenue (1) $ 2,237,018 $ 2,288,015 $ 2,025,367 $ 2,017,041 $ 2,022,378
Income from continuing operations $ 182,660 $ 214,654 $ 254,008 $ 187,942 $ 57,064
Net income $ 182,660 $ 214,654 $ 344,555 $ 202,375 $ 72,150
Basic income per share of common stock
from continuing operations $ 0.58 $ 0.65 $ 0.79 $ 0.56 $ 0.19
Earnings available for common shareholders per
basic share $ 0.58 $ 0.65 $ 1.07 $ 0.60 $ 0.24
Earnings available for common shareholders per
diluted share $ 0.57 $ 0.65 $ 1.06 $ 0.60 $ 0.23
Cash dividends declared (and paid) per common
share $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 2.50
As of December 31,
-------------------------------------------------------------------
2008 2007 2006 2005 2004
------------ ----------- ------------ ------------ ------------
Total assets $ 6,888,676 $ 7,256,069 $ 6,797,536 $ 6,427,567 $ 6,679,899
Long-term debt $ 4,721,685 $ 4,736,897 $ 4,467,086 $ 3,995,130 $ 4,262,658
Shareholders' equity $ 519,045 $ 997,899 $ 1,058,032 $ 1,041,809 $ 1,362,240
(1) Operating results include activities from our Vermont Electric segment for
three months of 2004, and for Commonwealth from the date of its acquisition
on March 8, 2007 and for GVN from the date of its acquisition on October
31, 2007.
19
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
Forward-Looking Statements
--------------------------
This annual report on Form 10-K contains forward-looking statements that are
subject to risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the statements. Statements that
are not historical facts are forward-looking statements made pursuant to the
safe harbor provisions of The Private Securities Litigation Reform Act of 1995.
Words such as "believe," "anticipate," "expect" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements
(including oral representations) are only predictions or statements of current
plans, which we review continuously. Forward-looking statements may differ from
actual future results due to, but not limited to, and our future results may be
materially affected by, any of the following possibilities:
* Reductions in the number of our access lines and High-Speed Internet
subscribers;
* The effects of competition from cable, wireless and other wireline
carriers (through voice over internet protocol (VOIP) or otherwise);
* Reductions in switched access revenues as a result of regulation,
competition and/or technology substitutions;
* The effects of greater than anticipated competition requiring new
pricing, marketing strategies or new product offerings and the risk
that we will not respond on a timely or profitable basis;
* The effects of changes in both general and local economic conditions
on the markets we serve, which can impact demand for our products and
services, customer purchasing decisions, collectability of revenue and
required levels of capital expenditures related to new construction of
residences and businesses;
* Our ability to effectively manage service quality;
* Our ability to successfully introduce new product offerings, including
our ability to offer bundled service packages on terms that are both
profitable to us and attractive to our customers;
* Our ability to sell enhanced and data services in order to offset
ongoing declines in revenue from local services, switched access
services and subsidies;
* Changes in accounting policies or practices adopted voluntarily or as
required by generally accepted accounting principles or regulators;
* The effects of ongoing changes in the regulation of the communications
industry as a result of federal and state legislation and regulation,
including potential changes in state rate of return limitations on our
earnings, access charges and subsidy payments, and regulatory network
upgrade and reliability requirements;
* Our ability to effectively manage our operations, operating expenses
and capital expenditures, to pay dividends and to reduce or refinance
our debt;
* Adverse changes in the credit markets and/or in the ratings given to
our debt securities by nationally accredited ratings organizations,
which could limit or restrict the availability of, and/or increase the
cost of financing;
* The effects of bankruptcies and home foreclosures, which could result
in increased bad debts;
* The effects of technological changes and competition on our capital
expenditures and product and service offerings, including the lack of
assurance that our ongoing network improvements will be sufficient to
meet or exceed the capabilities and quality of competing networks;
* The effects of increased medical, retiree and pension expenses and
related funding requirements;
20
* Changes in income tax rates, tax laws, regulations or rulings, and/or
federal or state tax assessments;
* Further declines in the value of our pension plan assets, which could
require us to make contributions to the pension plan beginning in
2010;
* The effects of state regulatory cash management policies on our
ability to transfer cash among our subsidiaries and to the parent
company;
* Our ability to successfully renegotiate union contracts expiring in
2009 and thereafter;
* Our ability to pay a $1.00 per common share dividend annually, which
may be affected by our cash flow from operations, amount of capital
expenditures, debt service requirements, cash paid for income taxes
(which will increase in 2009) and our liquidity;
* The effects of significantly increased cash taxes in 2009 and
thereafter;
* The effects of any unfavorable outcome with respect to any of our
current or future legal, governmental or regulatory proceedings,
audits or disputes;
* The possible impact of adverse changes in political or other external
factors over which we have no control; and
* The effects of hurricanes, ice storms and other severe weather.
Any of the foregoing events, or other events, could cause financial information
to vary from management's forward-looking statements included in this report.
You should consider these important factors, as well as the risks set forth
under Item 1A. "Risk Factors" above, in evaluating any statement in this report
on Form 10-K or otherwise made by us or on our behalf. The following information
is unaudited and should be read in conjunction with the consolidated financial
statements and related notes included in this report. We have no obligation to
update or revise these forward-looking statements.
Overview
--------
We are a full-service communications provider and one of the largest exchange
telephone carriers in the country. On July 31, 2006, we sold our competitive
local exchange carrier (CLEC), Electric Lightwave, LLC (ELI). We accounted for
ELI as a discontinued operation in our consolidated statements of operations. On
March 8, 2007, we completed the acquisition of Commonwealth Telephone
Enterprises, Inc. (Commonwealth or CTE), which included a small CLEC component.
This acquisition expanded our presence in Pennsylvania and strengthened our
position as a leading full-service communications provider to rural markets. On
October 31, 2007, we completed the acquisition of Global Valley Networks, Inc.
and GVN Services (together GVN), which expanded our presence in California and
also strengthened our rural position. As of December 31, 2008, we operated in 24
states with approximately 5,700 employees.
Competition in the telecommunications industry is intense and increasing. We
experience competition from many telecommunications service providers, including
cable operators offering VOIP products, wireless carriers, long distance
providers, competitive local exchange carriers, internet providers and other
wireline carriers. We believe that as of December 31, 2008, approximately 65% of
the households in our territories had VOIP as an available service option from
cable operators. We also believe that competition will continue to intensify in
2009 and may result in reduced revenues. Our business experienced a decline in
access lines and switched access minutes in 2007 and 2008, primarily as a result
of competition and business downsizing. We also experienced a reduction in
revenue in 2008 as compared to 2007.
The recent severe contraction in the global financial markets and ongoing
recession may be impacting consumer behavior to reduce household expenditures by
not purchasing our services and/or by discontinuing some or all of our services.
These trends are likely to continue and may result in a challenging revenue
environment. These factors could also result in increased delinquencies and
bankruptcies and, therefore, affect our ability to collect money owed to us by
residential and business customers.
We employ a number of strategies to combat the competitive pressures and changes
to consumer behavior noted above. Our strategies are focused in the following
areas: customer retention, upgrading and up-selling services to our existing
customer base, new customer growth, win backs, new product deployment, and
operating expense and capital expenditure reductions.
21
We hope to achieve our customer retention goals by bundling services around the
local access line and providing exemplary customer service. Bundled services
include High-Speed Internet, unlimited long distance calling, enhanced telephone
features and video offerings. We tailor these services to the needs of our
residential and business customers in the markets we serve and continually
evaluate the introduction of new and complementary products and services, which
can also be purchased separately. Customer retention is also enhanced by
offering one, two and three year price protection plans where customers commit
to a term in exchange for predictable pricing and/or promotional offers.
Additionally, we are focused on enhancing the customer experience as we believe
exceptional customer service will differentiate us from our competition. Our
commitment to providing exemplary customer service is demonstrated by the
expansion of our customer services hours, shorter scheduling windows for in-home
appointments and the implementation of call reminders and follow-up calls for
service appointments. In addition, due to a recent realignment and restructuring
of approximately 70 local area markets, those markets are now operated by local
managers with responsibility for the customer experience, as well as the
financial results, in those markets.
We utilize targeted and innovative promotions to sell new customers, including
those moving into our territory, win back previously lost customers, upgrade and
up-sell existing customers a variety of service offerings including High-Speed
Internet, video, and enhanced long distance and feature packages in order to
maximize the average revenue per access line (wallet share) paid to Frontier.
Depending upon market and economic conditions, we may offer such promotions to
drive sales in the future.
Lastly, we are focused on introducing a number of new products that our
customers desire, including unlimited long distance minutes, bundles of long
distance minutes, wireless data, internet portal advertising and the "Frontier
Peace of Mind" product suite. This last category is a suite of products aimed at
managing the total communications and personal computing experience for our
customers. The Peace of Mind product and services are designed to provide value
and simplicity to meet our customers' ever-changing needs. The Peace of Mind
product and services suite includes services such as an in-home, full
installation of our high-speed product, two hour appointment windows for the
installation, hard drive back-up services, enhanced help desk PC support and
inside wire maintenance. We offer a portion of our Peace of Mind services,
including hard drive back-up services and enhanced help desk PC support, both to
our customers and to other users inside and outside of our service territories.
Although we are optimistic about the opportunities provided by each of these
initiatives, we can provide no assurance about their long-term profitability or
impact on revenue.
We believe that the combination of offering multiple products and services to
our customers pursuant to price protection programs, billing them on a single
bill, providing superior customer service, and being active in our local
communities will make our customers more loyal to us, and will help us generate
new, and retain existing, customer revenue.
Revenues from data and internet services such as High-Speed Internet continue to
increase as a percentage of our total revenues and revenues from services such
as local line and access charges (including federal and state subsidies) are
decreasing as a percentage of our total revenues. Federal and state subsidy
revenue was $119.8 million in 2008, or 5% of our revenues, down from $130.0
million in 2007, or 6% of our revenues. We expect this trend to continue in
2009. The decreasing revenue from traditional sources, along with the potential
for increasing operating costs, could cause our profitability and our cash
generated by operations to decrease.
22
(a) Liquidity and Capital Resources
-------------------------------
As of December 31, 2008, we had cash and cash equivalents aggregating $163.6
million. Our primary source of funds continued to be cash generated from
operations. For the year ended December 31, 2008, we used cash flow from
operations, incremental borrowings and cash on hand to fund all of our investing
and financing activities, including debt repayments and stock repurchases.
We believe our operating cash flows, existing cash balances, and revolving
credit facility will be adequate to finance our working capital requirements,
fund capital expenditures, make required debt payments through 2009, pay taxes,
pay dividends to our stockholders in accordance with our dividend policy and
support our short-term and long-term operating strategies. However, a number of
factors, including but not limited to, increased cash taxes, losses of access
lines, increases in competition, lower subsidy and access revenues and the
impact of the current economic environment are expected to reduce our cash
generated by operations. In addition, although we believe, based on information
available to us, that the financial institutions syndicated under our revolving
credit facility would be able to fulfill their commitments to us, given the
current economic environment and the recent severe contraction in the global
financial markets, this could change in the future. Further, the current credit
market turmoil and our below investment grade credit ratings may make it more
difficult and expensive to refinance our maturing debt, although we do not have
any significant maturities until 2011. We have approximately $3.9 million and
$7.2 million of debt maturing in 2009 and 2010, respectively.
Cash Flow provided by and used in Operating Activities
------------------------------------------------------
Cash provided by operating activities declined $82.4 million, or 10%, for 2008
as compared to 2007. The decline resulted from a drop in operating income, as
adjusted for non-cash items, lower investment income, a decrease in accounts
payable and an increase in current income tax expenditures. These declines were
partially offset by a decrease in accounts receivable that positively impacted
our cash position as compared to the prior year.
We have in recent years paid relatively low amounts of cash taxes. We expect
that in 2009 and beyond our cash taxes will increase substantially, as our
federal net operating loss carryforwards and AMT tax credit carryforwards are
expected to be fully utilized. We paid $78.9 million in cash taxes during 2008,
and expect to pay approximately $90.0 million to $110.0 million in 2009. Our
2009 cash tax estimate reflects the anticipated favorable impact of bonus
depreciation that is part of the economic stimulus package signed into law by
President Obama.
Cash Flow used by and provided from Investing Activities
--------------------------------------------------------
Acquisitions
------------
On March 8, 2007, we acquired Commonwealth in a cash-and-stock taxable
transaction, for a total consideration of approximately $1.1 billion. We paid
$804.1 million in cash ($663.7 million net, after cash acquired) and issued
common stock with a value of approximately $249.8 million.
In connection with the acquisition of Commonwealth, we assumed $35.0 million of
debt under a revolving credit facility and $191.8 million face amount of
Commonwealth convertible notes (fair value of $209.6 million). During March
2007, we paid down the $35.0 million credit facility. We retired all of the
Commonwealth notes as of December 31, 2008.
On October 31, 2007, we acquired GVN for a total cash consideration of $62.0
million.
Rural Telephone Bank
--------------------
We received approximately $64.6 million in cash from the dissolution of the
Rural Telephone Bank (RTB) in April 2006, which resulted in the recognition of a
pre-tax gain of approximately $61.4 million during the second quarter of 2006,
as reflected in investment income in the consolidated statements of operations
for the year ended December 31, 2006. Our tax net operating losses were used to
absorb the cash liability for taxes.
Sale of ELI
-----------
During 2006, we sold ELI, our CLEC business (including its associated real
estate), for $255.3 million in cash plus the assumption of approximately $4.0
million in capital lease obligations.
23
Capital Expenditures
--------------------
In 2008, our capital expenditures were $288.3 million. We continue to closely
scrutinize all of our capital projects, emphasize return on investment and focus
our capital expenditures on areas and services that have the greatest
opportunities with respect to revenue growth and cost reduction. We anticipate
capital expenditures of approximately $250.0 million to $270.0 million for 2009.
Cash Flow used by and provided from Financing Activities
--------------------------------------------------------
Debt Reduction and Debt Exchanges
---------------------------------
In 2008, we retired an aggregate principal amount of $144.7 million of debt,
consisting of $128.7 million principal amount of our 9.25% Senior Notes due
2011, $12.0 million of other senior unsecured debt and rural utilities service
loan contracts, and $4.0 million of 5% Company Obligated Mandatorily Redeemable
Convertible Preferred Securities (EPPICS).
In 2007, we retired an aggregate principal amount of $967.2 million of debt,
including $3.3 million of EPPICS, and $17.8 million of 3.25% Commonwealth
convertible notes that were converted into our common stock. On April 26, 2007,
we redeemed $495.2 million principal amount of our 7.625% Senior Notes due 2008
at a price of 103.041% plus accrued and unpaid interest. During the first
quarter of 2007, we borrowed and repaid $200.0 million utilized to temporarily
fund the acquisition of Commonwealth, and we paid down the $35.0 million
Commonwealth credit facility. Through December 31, 2007, we retired $183.3
million face amount of Commonwealth convertible notes for which we paid $165.4
million in cash and $36.7 million in common stock. We also paid down $44.6
million of industrial development revenue bonds and $4.3 million of rural
utilities service loan contracts.
In 2006, we retired an aggregate principal amount of $251.0 million of debt,
including $15.9 million of EPPICS that were converted into our common stock.
During the first quarter of 2006, we entered into two debt-for-debt exchanges of
our debt securities. As a result, $47.5 million of our 7.625% notes due 2008
were exchanged for approximately $47.4 million of our 9.00% notes due 2031.
During the fourth quarter of 2006, we entered into four debt-for-debt exchanges
and exchanged $157.3 million of our 7.625% notes due 2008 for $149.9 million of
our 9.00% notes due 2031. The 9.00% notes are callable on the same general terms
and conditions as the 7.625% notes exchanged. No cash was exchanged in these
transactions. However, with respect to the first quarter debt exchanges, a
non-cash pre-tax loss of approximately $2.4 million was recognized in accordance
with EITF No. 96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," which is included in other income (loss), net.
On June 1, 2006, we retired at par our entire $175.0 million principal amount of
7.60% Debentures due June 1, 2006. On June 14, 2006, we repurchased $22.7
million of our 6.75% Senior Notes due August 17, 2006 at a price of 100.181% of
par. On August 17, 2006, we retired at par the $29.1 million remaining balance
of the 6.75% Senior Notes.
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.
Issuance of Debt Securities
---------------------------
On March 28, 2008, we borrowed $135.0 million under a senior unsecured term loan
facility that was established on March 10, 2008. The loan matures in 2013 and
bears interest based on the prime rate or London Interbank Offered Rate (LIBOR),
at our election, plus a margin which varies depending on our debt leverage
ratio. We used the proceeds to repurchase, during the first quarter of 2008,
$128.7 million principal amount of our 9.25% Senior Notes due 2011 and to pay
for the $6.3 million of premium on early retirement of those notes.
On March 23, 2007, we issued in a private placement an aggregate $300.0 million
principal amount of 6.625% Senior Notes due 2015 and $450.0 million principal
amount of 7.125% Senior Notes due 2019. Proceeds from the sale were used to pay
down $200.0 million principal amount of indebtedness incurred on March 8, 2007
under a bridge loan facility in connection with the acquisition of Commonwealth
and redeem, on April 26, 2007, $495.2 million principal amount of our 7.625%
Senior Notes due 2008. In the second quarter of 2007, we completed an exchange
offer (to publicly register the debt) for the $750.0 million in total of private
placement notes described above, in addition to the $400.0 million principal
amount of 7.875% Senior Notes due 2027 issued in a private placement on December
22, 2006, for registered notes.
24
On December 22, 2006, we issued in a private placement, $400.0 million principal
amount of 7.875% Senior Notes due January 15, 2027. Proceeds from the sale were
used to partially finance our acquisition of Commonwealth. These notes were
exchanged for registered securities, as described above.
In December 2006, we borrowed $150.0 million under a senior unsecured term loan
agreement. The loan matures in 2012 and bears interest based on an average prime
rate or LIBOR, at our election, plus a margin which varies depending on our debt
leverage ratio. We used the proceeds to partially finance our acquisition of
Commonwealth.
EPPICS
------
As of December 31, 2008, there was no EPPICS related debt outstanding to third
parties. The following disclosure provides the history regarding this issuance.
In 1996, our consolidated wholly owned subsidiary, Citizens Utilities Trust (the
Trust), issued, in an underwritten public offering, 4,025,000 shares of 5%
Company Obligated Mandatorily Redeemable Convertible Preferred Securities due
2036 (Trust Convertible Preferred Securities or EPPICS), representing preferred
undivided interests in the assets of the Trust, with a liquidation preference of
$50 per security (for a total liquidation amount of $201.3 million). These
securities had an adjusted conversion price of $11.46 per share of our common
stock. The conversion price was reduced from $13.30 to $11.46 during the third
quarter of 2004 as a result of the $2.00 per share of common stock special,
non-recurring dividend. The proceeds from the issuance of the Trust Convertible
Preferred Securities and a Company capital contribution were used to purchase
$207.5 million aggregate liquidation amount of 5% Partnership Convertible
Preferred Securities due 2036 from another wholly owned consolidated subsidiary,
Citizens Utilities Capital L.P. (the Partnership). The proceeds from the
issuance of the Partnership Convertible Preferred Securities and a Company
capital contribution were used to purchase from us $211.8 million aggregate
principal amount of 5% Convertible Subordinated Debentures due 2036. The sole
assets of the Trust were the Partnership Convertible Preferred Securities, and
our Convertible Subordinated Debentures were substantially all the assets of the
Partnership. Our obligations under the agreements relating to the issuances of
such securities, taken together, constituted a full and unconditional guarantee
by us of the Trust's obligations relating to the Trust Convertible Preferred
Securities and the Partnership's obligations relating to the Partnership
Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the annual 5% interest in
quarterly installments on the Convertible Subordinated Debentures in 2008, 2007
and 2006. Cash was paid (net of investment returns) to the Partnership in
payment of the interest on the Convertible Subordinated Debentures. The cash was
then distributed by the Partnership to the Trust and then by the Trust to the
holders of the EPPICS.
As of December 31, 2008, EPPICS representing a total principal amount of $197.8
million have been converted into 15,969,645 shares of our common stock. There
were no outstanding EPPICS as of December 31, 2008. As a result of the
redemption of all outstanding EPPICS as of December 31, 2008, the $10.5 million
in debt with related parties was reclassified by the Company against an
offsetting investment.
Interest Rate Management
------------------------
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. Cash proceeds on the swap terminations of
approximately $15.5 million were received in January 2008. The related gain has
been deferred on the consolidated balance sheet, and is being amortized into
interest expense over the term of the associated debt. For 2008, we recognized
$5.0 million of deferred gain and anticipate recognizing an additional $3.4
million of deferred gain during 2009.
The notional amounts of fixed-rate indebtedness hedged as of December 31, 2007
were $400.0 million. Such contracts required us to pay variable rates of
interest (estimated average pay rates of approximately 8.54% as of December 31,
2007) and receive fixed rates of interest (average receive rate of 8.50% as of
December 31, 2007). All swaps were accounted for under SFAS No. 133 (as amended)
as fair value hedges. For 2007 and 2006, the interest expense resulting from
these interest rate swaps totaled approximately $2.4 million and $4.2 million,
respectively.
Credit Facility
---------------
As of December 31, 2008, we had available lines of credit with seven financial
institutions in the aggregate amount of $250.0 million and there were no
outstanding standby letters of credit issued under the facility. Associated
facility fees vary, depending on our debt leverage ratio, and were 0.225% per
annum as of December 31, 2008. The expiration date for this $250.0 million five
year revolving credit agreement is May 18, 2012. During the term of the credit
facility we may borrow, repay and reborrow funds subject to customary
conditions. The credit facility is available for general corporate purposes but
25
may not be used to fund dividend payments. Although we believe, based on
information available to us, that the financial institutions syndicated under
our credit facility would be able to fulfill their commitments, given the
current economic environment and the recent severe contraction in the global
financial markets, this could change in the future.
Covenants
---------
The terms and conditions contained in our indentures and credit facility
agreements include the timely payment of principal and interest when due, the
maintenance of our corporate existence, keeping proper books and records in
accordance with U.S. GAAP, restrictions on the allowance of liens on our assets,
and restrictions on asset sales and transfers, mergers and other changes in
corporate control. We currently have no restrictions on the payment of dividends
either by contract, rule or regulation, other than those imposed by the Delaware
General Corporation Law. However, we would be restricted under our credit
facilities from declaring dividends if an event of default has occurred and is
continuing at the time or will result from the dividend declaration.
Our $200.0 million term loan facility with the Rural Telephone Finance
Cooperative (RTFC), which matures in 2011, contains a maximum leverage ratio
covenant. Under the leverage ratio covenant, we are required to maintain a ratio
of (i) total indebtedness minus cash and cash equivalents in excess of $50.0
million to (ii) consolidated adjusted EBITDA (as defined in the agreement) over
the last four quarters no greater than 4.00 to 1.
Our $250.0 million credit facility, and our $150.0 million and $135.0 million
senior unsecured term loans, each contain a maximum leverage ratio covenant.
Under the leverage ratio covenant, we are required to maintain a ratio of (i)
total indebtedness minus cash and cash equivalents in excess of $50.0 million to
(ii) consolidated adjusted EBITDA (as defined in the agreements) over the last
four quarters no greater than 4.50 to 1. Although all of these facilities are
unsecured, they will be equally and ratably secured by certain liens and equally
and ratably guaranteed by certain of our subsidiaries if we issue debt that is
secured or guaranteed.
Our credit facilities and certain indentures for our senior unsecured debt
obligations limit our ability to create liens or merge or consolidate with other
companies and our subsidiaries' ability to borrow funds, subject to important
exceptions and qualifications.
As of December 31, 2008, we were in compliance with all of our debt and credit
facility covenants.
Proceeds from the Sale of Equity Securities
-------------------------------------------
We receive proceeds from the issuance of common stock upon the exercise of
options pursuant to our stock-based compensation plans. For the years ended
December 31, 2008, 2007 and 2006, we received approximately $1.4 million, $13.8
million and $27.2 million, respectively, upon the exercise of outstanding stock
options.
Share Repurchase Programs
-------------------------
In February 2008, our Board of Directors authorized us to repurchase up to
$200.0 million of our common stock in public or private transactions over the
following twelve month period. This share repurchase program commenced on March
4, 2008 and was completed on October 3, 2008. During 2008, we repurchased
17,778,300 shares of our common stock at an aggregate cost of $200.0 million.
In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock in public or private transactions over the
following twelve month period. This share repurchase program commenced on March
19, 2007 and was completed on October 15, 2007. During 2007, we repurchased
17,279,600 shares of our common stock at an aggregate cost of $250.0 million.
In February 2006, our Board of Directors authorized us to repurchase up to
$300.0 million of our common stock in public or private transactions over the
following twelve-month period. This share repurchase program commenced on March
6, 2006. During 2006, we repurchased 10,199,900 shares of our common stock at an
aggregate cost of approximately $135.2 million. No further purchases were made
prior to expiration of this authorization.
Dividends
---------
We expect to pay regular quarterly dividends. Our ability to fund a regular
quarterly dividend will be impacted by our ability to generate cash from
operations. The declarations and payment of future dividends will be at the
discretion of our Board of Directors, and will depend upon many factors,
including our financial condition, results of operations, growth prospects,
funding requirements, applicable law, restrictions in our credit facilities and
other factors our Board of Directors deems relevant.
26
Off-Balance Sheet Arrangements
------------------------------
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial statements.
Future Commitments
------------------
A summary of our future contractual obligations and commercial commitments as of
December 31, 2008 is as follows:
Contractual Obligations:
------------------------
($ in thousands) Payment due by period
---------------- ---------------------------------------------------------------------
Total 2009 2010-2011 2012-2013 Thereafter
----------------- --------------- ---------------- ----------------- -----------------
Long-term debt obligations,
excluding interest $ 4,732,488 $ 3,857 $ 1,132,379 $ 1,009,497 $ 2,586,755
Interest on long-term debt 4,507,391 357,600 676,162 494,675 2,978,954
Operating lease obligations 66,500 22,654 21,499 12,781 9,566
Purchase obligations 34,142 23,286 10,196 330 330
FIN No. 48 liability 48,711 1,493 34,433 12,780 5
----------------- --------------- ---------------- ----------------- -----------------
Total $ 9,389,232 $ 408,890 $ 1,874,669 $ 1,530,063 $ 5,575,610
================= =============== ================ ================= =================
At December 31, 2008, we have outstanding performance letters of credit totaling
$21.9 million.
Divestitures
------------
On August 24, 1999, our Board of Directors approved a plan to divest our public
utilities services businesses, which included gas, electric and water and
wastewater businesses. We have sold all of these properties. All of the
agreements relating to the sales provide that we will indemnify the buyer
against certain liabilities (typically liabilities relating to events that
occurred prior to sale), including environmental liabilities, for claims made by
specified dates and that exceed threshold amounts specified in each agreement
(see Note 24).
Discontinued Operations
-----------------------
On July 31, 2006, we sold our CLEC business, Electric Lightwave, LLC (ELI) for
$255.3 million (including a later sale of associated real estate) in cash plus
the assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale was approximately $5.0 million due to the utilization of
existing tax net operating losses on both the Federal and state level.
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 requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements, the disclosure of contingent assets and
liabilities, and the reported amounts of revenue and expenses during the
reporting period. Estimates and judgments are used when accounting for allowance
for doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, pension and other postretirement benefits, income
taxes, contingencies and purchase price allocations among others.
Management has discussed the development and selection of these critical
accounting estimates with the Audit Committee of our Board of Directors and our
Audit Committee has reviewed our disclosures relating to such estimates.
27
Allowance for Doubtful Accounts
We maintain an allowance for estimated bad debts based on our estimate of
collectability of our accounts receivable through a review of aging categories
and specific customer accounts. In 2008 and 2007, we had no "critical estimates"
related to telecommunications bankruptcies.
Asset Impairment
In 2008 and 2007, we had no "critical estimates" related to asset impairments.
Intangibles
Our indefinite lived intangibles consist of goodwill and trade name, which
resulted from the purchase of ILEC properties. We test for impairment of these
assets annually, or more frequently, as circumstances warrant. All of our ILEC
properties share similar economic characteristics and as a result, we aggregate
our four operating segments into one reportable segment. In determining fair
value of goodwill during 2008 we compared the net book value of the reporting
units to current trading multiples of ILEC properties as well as trading values
of our publicly traded common stock. Additionally, we utilized a range of prices
to gauge sensitivity. Our test determined that fair value exceeded book value of
goodwill for each of our reporting units.
Depreciation and Amortization
The calculation of depreciation and amortization expense is based on the
estimated economic useful lives of the underlying property, plant and equipment
and identifiable intangible assets. An independent study updating the estimated
remaining useful lives of our plant assets is performed annually. We adopted the
lives proposed in the study effective October 1, 2008. Our "composite
depreciation rate" increased from 5.5% to 5.6% as a result of the study. We
anticipate depreciation expense of approximately $350.0 million to $370.0
million for 2009. We periodically reassess the useful life of our intangible
assets to determine whether any changes to those lives are required.
Pension and Other Postretirement Benefits
Our estimates of pension expense, other postretirement benefits including
retiree medical benefits and related liabilities are "critical accounting
estimates." We sponsor noncontributory defined benefit pension plans covering a
significant number of current and former employees and other postretirement
benefit plans that provide medical, dental, life insurance and other benefits
for covered retired employees and their beneficiaries and covered dependents.
The pension plans for the majority of our current employees are frozen. The
accounting results for pension and post retirement benefit costs and obligations
are dependent upon various actuarial assumptions applied in the determination of
such amounts. These actuarial assumptions include the following: discount rates,
expected long-term rate of return on plan assets, future compensation increases,
employee turnover, healthcare cost trend rates, expected retirement age,
optional form of benefit and mortality. We review these assumptions for changes
annually with our independent actuaries. We consider our discount rate and
expected long-term rate of return on plan assets to be our most critical
assumptions.
The discount rate is used to value, on a present basis, our pension and
postretirement benefit obligation as of the balance sheet date. The same rate is
also used in the interest cost component of the pension and postretirement
benefit cost determination for the following year. The measurement date used in
the selection of our discount rate is the balance sheet date. Our discount rate
assumption is determined annually with assistance from our actuaries based on
the pattern of expected future benefit payments and the prevailing rates
available on long-term, high quality corporate bonds that approximate the
benefit obligation. In making this determination we consider, among other
things, the yields on the Citigroup Pension Discount Curve, the Citigroup
Above-Median Pension Curve, the general movement of interest rates and the
changes in those rates from one period to the next. This rate can change from
year-to-year based on market conditions that impact corporate bond yields. Our
discount rate was 6.50% at year-end 2008 and 2007.
The expected long-term rate of return on plan assets is applied in determining
the periodic pension and postretirement benefit cost as a reduction in the
computation of the expense. In developing the expected long-term rate of return
assumption, we considered published surveys of expected market returns, 10 and
20 year actual returns of various major indices, and our own historical 5 year,
10 year and 20 year investment returns. The expected long-term rate of return on
plan assets is based on an asset allocation assumption of 35% to 55% in fixed
income securities, 35% to 55% in equity securities and 5% to 15% in alternative
investments. We review our asset allocation at least annually and make changes
when considered appropriate. Our asset return assumption is made at the
beginning of our fiscal year. In 2008, we did not change our expected long-term
rate of return from the 8.25% used in 2007. Our pension plan assets are valued
at actual market value as of the measurement date.
28
We expect that our pension and other postretirement benefit expenses for 2009
will be $50.0 million to $55.0 million (they were $11.2 million in 2008), and
that we may be required to make a cash contribution to our pension plan
beginning in 2010. No contribution was made to our pension plan during 2008.
Income Taxes
Our effective tax rates in 2006, 2007 and 2008 were approximately at the
statutory rates.
Contingencies
At December 31, 2006, we had a reserve of $8.0 million in connection with a
potential environmental claim in Bangor, Maine. This claim was settled with a
payment of $7.625 million plus additional expenses during the third quarter of
2007.
We currently do not have any contingencies in excess of $5.0 million recorded on
our books.
Purchase Price Allocation - Commonwealth and GVN
The allocation of the approximate $1.1 billion paid to the "fair market value"
of the assets and liabilities of Commonwealth is a critical estimate. We
finalized our estimate of the fair values assigned to plant, customer list and
goodwill, as more fully described in Notes 3 and 7 to the consolidated financial
statements. Additionally, the estimated expected life of a customer (used to
amortize the customer list) is a critical estimate.
New Accounting Pronouncements
-----------------------------
The following new accounting standards were adopted by the Company in 2008
without any material financial statement impact. All of these standards are more
fully described in Note 2 to the consolidated financial statements.
* Accounting for Endorsement Split-Dollar Life Insurance Arrangements
----------------------------------------------------------------------
(EITF No. 06-4)
---------------
* Fair Value Measurements (SFAS No. 157)
--------------------------------------
* The Fair Value Option for Financial Assets and Financial Liabilities -
----------------------------------------------------------------------
Including an Amendment of FASB Statement No. 115 (SFAS No. 159)
---------------------------------------------------------------
* Accounting for Collateral Assignment Split-Dollar Life Insurance
----------------------------------------------------------------------
Arrangements (EITF No. 06-10)
-----------------------------
* Accounting for the Income Tax Benefits of Dividends on Share-Based
----------------------------------------------------------------------
Payment Awards (EITF No. 06-11)
-------------------------------
* The Hierarchy of Generally Accepted Accounting Principles (SFAS No.
----------------------------------------------------------------------
162)
----
The following new accounting standards that will be adopted by the Company in
2009 are currently being evaluated by the Company, but we do not expect their
adoption to have a material impact on our financial position, results of
operations or cash flows.
* Fair Value Measurements (SFAS No. 157), as amended
--------------------------------------------------
* Business Combinations (SFAS No. 141R)
-------------------------------------
* Noncontrolling Interests in Consolidated Financial Statements (SFAS
----------------------------------------------------------------------
No. 160)
--------
* Determining Whether Instruments Granted in Share-Based Payment
----------------------------------------------------------------------
Transactions are Participating Securities (FSP EITF 03-6-1)
-----------------------------------------------------------
* Employers' Disclosures about Postretirement Benefit Plan Assets (FSP
----------------------------------------------------------------------
SFAS 132 (R)-1)
---------------
29
(b) Results of Operations
---------------------
Our historical results include the results of operations of CTE from the date of
its acquisition on March 8, 2007 and of GVN from the date of its acquisition on
October 31, 2007. Accordingly, results of operations for 2008, 2007 and 2006 are
not directly comparable as 2008 results reflect the inclusion of a full year of
operations of CTE and GVN, whereas 2007 results reflect the inclusion of
approximately ten months of operations of CTE and of two months of operations of
GVN and 2006 results do not reflect the results of operations of CTE or GVN.
REVENUE
Revenue is generated primarily through the provision of local, network access,
long distance and data and internet services. Such revenues are generated
through either a monthly recurring fee or a fee based on usage at a tariffed
rate and revenue recognition is not dependent upon significant judgments by
management, with the exception of a determination of a provision for
uncollectible amounts.
Consolidated revenue for 2008 decreased $51.0 million, or 2%, to $2,237.0
million as compared to 2007. Excluding additional revenue attributable to the
CTE and GVN acquisitions for a full year in 2008 and for a partial period in
2007, our revenue decreased $107.3 million during 2008, or 5%, as compared to
2007. During the first quarter of 2007, we had a significant favorable
settlement of a carrier dispute that resulted in a favorable one-time impact to
our revenue of $38.7 million. Excluding the additional revenue due to the
one-time favorable settlement in the first quarter of 2007 and the additional
revenue attributable to the CTE and GVN acquisitions in 2008 and 2007, our
revenue for the year ended December 31, 2008 declined $68.6 million, or 3%, as
compared to the prior year. This decline is a result of lower local services
revenue, subsidy revenue and switched access revenue, partially offset by a
$37.3 million, or 8%, increase in data and internet services revenue, each as
described in more detail below.
Consolidated revenue for 2007 increased $262.6 million, or 13%, to $2,288.0
million as compared to 2006. Excluding the additional revenue attributable to
the CTE and GVN acquisitions in 2007, and the one-time favorable settlement as
referenced above in 2007, our revenue for 2007 was $1,982.7 million, a decrease
of $42.7 million, or 2%, as compared to 2006, primarily resulting from a
reduction of $39.9 million in subsidies received from federal and state funds.
Change in the number of our access lines is one factor that is important to our
revenue and profitability. We have lost access lines primarily because of
competition, changing consumer behavior (including wireless substitution),
economic conditions, changing technology and by some customers disconnecting
second lines when they add High-Speed Internet or cable modem service. We lost
approximately 174,800 access lines (net), including 22,200 second lines, during
2008, but added approximately 57,100 High-Speed Internet subscribers (net)
during this same period. We expect to continue to lose access lines but to
increase High-Speed Internet subscribers during 2009 (although not enough to
offset access line losses).
While the number of access lines are an important metric to gauge certain
revenue trends, it is not necessarily the best or only measure to evaluate the
business. Management believes that understanding different components of revenue
is most important. For this reason, presented on page 33 is a breakdown that
categorizes revenue into customer revenue and regulatory revenue (switched and
subsidy revenue). Despite the decline in access lines, our customer revenue,
which is all revenue except switched access and subsidy revenue, also improved
by more than 1.3 percent in 2008 versus 2007. The average monthly customer
revenue per access line has improved and resulted in an increased wallet share,
primarily from residential customers. A substantial further loss of access
lines, combined with increased competition and the other factors discussed
herein may cause our revenue, profitability and cash flows to decrease in 2009.
Our historical results include the results of operations of Commonwealth from
the date of its acquisition on March 8, 2007 and of GVN from the date of its
acquisition on October 31, 2007. The financial tables below include a
comparative analysis of our results of operations on a historical basis for
2008, 2007 and 2006. We have also presented an analysis of each category for
2007 for the results of Frontier (excluding CTE and GVN) and the results of our
acquisitions: CTE from March 8, 2007 through December 31, 2007, and the results
of GVN for the last two months of 2007, as included in the consolidated results
of operations. The figures in each of the charts in this section for 2007 relate
to Frontier legacy properties (excluding CTE and GVN).
30
REVENUE
2008 2007 2006
-------------------------------- -------------------------------------------------------------- ----------
($ in thousands) Frontier
--------------- (excluding
Amount $ Change % Change Amount Acquisitions CTE and GVN) $ Change % Change Amount
---------- ----------- -------- ----------- ------------- -------------- ---------- --------- ----------
Local services $ 848,393 $ ( 27,369) -3% $ 875,762 $ 95,197 $ 780,565 $(29,019) -4% $ 809,584
Data and internet
services 605,615 61,851 11% 543,764 58,934 484,830 60,621 14% 424,209
Access services 404,713 (74,749) -16% 479,462 70,235 409,227 (18,732) -4% 427,959
Long distance services 182,559 2,034 1% 180,525 27,070 153,455 183 0% 153,272
Directory services 113,347 (1,239) -1% 114,586 1,264 113,322 (816) -1% 114,138
Other 82,391 (11,525) -12% 93,916 13,908 80,008 (16,197) -17% 96,205
---------- ----------- ----------- ------------- -------------- ---------- ----------
$2,237,018 $ (50,997) -2% $2,288,015 $ 266,608 $ 2,021,407 $ (3,960) 0% $2,025,367
========== =========== =========== ============= ============== ========== ==========
Local Services
Local services revenue for 2008 decreased $27.4 million, or 3%, to $848.4
million as compared to 2007. Excluding the additional local services revenue
attributable to the CTE and GVN acquisitions for 2008 and 2007, local services
revenue for 2008 decreased $47.8 million, or 6%, as compared to 2007, primarily
due to the continued loss of access lines which accounted for $40.4 million of
the decline and a reduction in all other related services of $7.4 million.
Enhanced services revenue for 2008, excluding the impact of the CTE and GVN
acquisitions for 2008 and 2007, decreased $5.6 million, or 3%, as compared to
2007, primarily due to a decline in access lines and a shift in customers
purchasing our unlimited voice communications packages instead of individual
features. Rate increases that were effective August 2007 resulted in a favorable
2008 impact of $3.0 million.
Local services revenue for 2007 increased $66.2 million, or 8%, to $875.8
million as compared to 2006. Excluding the additional local services revenue
attributable to the CTE and GVN acquisitions of $95.2 million in 2007, local
services revenue for 2007 decreased $29.0 million, or 4%, to $780.6 million as
compared to 2006. The loss of access lines accounted for $28.7 million of this
decline in local services revenue, partially offset by rate increases in
Rochester, New York on residential lines that became effective August 2006 and
2007.
Economic conditions and/or increasing competition could make it more difficult
to sell our packages and 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.
Data and Internet Services
Data and internet services revenue for 2008 increased $61.9 million, or 11%, to
$605.6 million as compared to 2007. Data and internet services revenue for 2008,
excluding the additional data and internet services revenue attributable to the
CTE and GVN acquisitions for 2008 and 2007 increased $37.3 million, or 8%, as
compared to 2007, primarily due to the overall growth in the number of data and
High-Speed Internet customers. As of December 31, 2008, the number of the
Company's High-Speed Internet subscribers increased by approximately 57,100, or
11%, since December 31, 2007. Data and internet services also includes revenue
from data transmission services to other carriers and high-volume commercial
customers with dedicated high-capacity internet and ethernet circuits. Revenue
from these dedicated high-capacity circuits, including the impact of $10.5
million attributable to the CTE and GVN acquisitions, increased $26.9 million in
2008, as compared to 2007, primarily due to growth in the number of those
circuits.
Data and internet services revenue for 2007 increased $119.6 million, or 28%, to
$543.8 million as compared to 2006. Excluding the additional data and internet
services revenue attributable to the CTE and GVN acquisitions for 2007, data and
internet services revenue for 2007 increased $60.6 million, or 14%, as compared
to 2006, primarily due to growth in the number of data and High-Speed Internet
customers. As of December 31, 2007, the number of the Company's High-Speed
Internet subscribers increased by approximately 66,700, or 17%, since December
31, 2006. Revenue from dedicated high-capacity circuits increased $19.8 million
in 2007, primarily due to growth in the number of those circuits.
31
Access Services
Access services revenue for 2008 decreased $74.7 million, or 16%, to $404.7
million as compared to 2007. Excluding the additional access services revenue
attributable to the CTE and GVN acquisitions for 2008 and 2007, access services
revenue for 2008 decreased $77.3 million, or 19%, as compared to 2007, for our
legacy Frontier operations. Switched access revenue for 2008, excluding the
unfavorable impact of the CTE and GVN acquisitions, decreased $56.8 million, or
20%, as compared to 2007, primarily due to the settlement of a carrier dispute
resulting in a favorable impact on our 2007 revenue of $38.7 million (a one-time
event), and the impact of a decline in minutes of use related to access line
losses and the displacement of minutes of use by wireless, email and other
communications services. Excluding the impact of that one-time favorable
settlement in 2007, our switched access revenue for 2008 declined by $18.1
million, or 7% from 2007. Access services revenue includes subsidy payments we
receive from federal and state agencies. Subsidy revenue for 2008, excluding the
additional subsidy revenue attributable to the CTE and GVN acquisitions in 2008
and 2007, decreased $20.6 million, or 16%, in 2008 to $104.1 million, as
compared to 2007, primarily due to lower receipts under the Federal High Cost
Fund program resulting from our reduced cost structure and an increase in the
program's National Average Cost Per Local Loop (NACPL) used by the Federal
Communications Commission (FCC) to allocate funds among all recipients. Subsidy
revenue in 2008 was also negatively impacted by $2.5 million in unfavorable
adjustments resulting from audits of the Federal High Cost Fund program.
Access services revenue for 2007 increased $51.5 million, or 12%, to $479.5
million as compared to 2006. Excluding the additional access services revenue
attributable to the CTE and GVN acquisitions of $70.2 million in 2007, access
services revenue for 2007 decreased $18.7 million, or 4%, as compared to 2006.
Switched access revenue of $284.6 million increased $21.2 million, or 8%, as
compared to 2006, primarily due to the settlement in the first quarter of 2007
of a dispute with a carrier resulting in a favorable impact on our revenue in
2007 of $38.7 million (a one-time event), partially offset by the impact of a
decline in minutes of use related to access line losses. Subsidy revenue for
2007 of $124.7 million decreased $39.9 million, or 24%, as compared to 2006,
primarily due to lower receipts under the Federal High Cost Fund program
resulting from our reduced cost structure and an increase in the program's
NACPL, along with reductions in Universal Service Fund (USF) surcharges due to
the elimination of high-speed internet units from the USF calculation.
Many factors may lead to further increases in the NACPL, thereby resulting in
decreases in our federal subsidy revenue in the future. The FCC and state
regulators are currently considering a number of proposals for changing the
manner in which eligibility for federal subsidies is determined as well as the
amounts of such subsidies. On May 1, 2008 the FCC issued an order to cap
Competitive Eligible Telecommunications Companies (CETC) receipts from the high
cost Federal Universal Service Fund. While this order will have no impact on our
current receipt levels, we believe this is a positive first step to limit the
rapid growth of the fund. The CETC cap will remain in place until the FCC takes
additional steps towards needed reform.
The FCC is considering proposals that may significantly change interstate,
intrastate and local intercarrier compensation and would revise the Federal
Universal Service funding and disbursement mechanisms. When and how these
proposed changes will be addressed are unknown and, accordingly, we are unable
to predict the impact of future changes on our results of operations. However,
future reductions in our subsidy and access revenues will directly affect our
profitability and cash flows as those regulatory revenues do not have associated
variable expenses.
Certain states have open proceedings to address reform to intrastate access
charges and other intercarrier compensation. We cannot predict when or how these
matters will be decided or the effect on our subsidy or access revenues. In
addition, we have been approached by, and/or are involved in formal state
proceedings with, various carriers seeking reductions in intrastate access rates
in certain states.
Long Distance Services
Long distance services revenue for 2008 increased $2.0 million, or 1%, to $182.6
million as compared to 2007. Excluding the additional long distance services
revenue attributable to CTE and GVN acquisitions, long distance services revenue
in 2008 decreased $3.8 million, or 2%, as compared to 2007. Generally, our long
distance services revenue is trending slightly downward due to a reduction in
the overall average revenue per minute of use. During 2008, we actively marketed
a package of unlimited long distance minutes with our digital phone and state
unlimited bundled service offerings. The sale of our digital phone and state
unlimited products, and their associated unlimited minutes, has resulted in an
increase in long distance customers, and an increase of 10% in the minutes used
by these customers. This has lowered our overall average rate per minute billed.
Long distance services revenue for 2007 increased $27.3 million, or 18%, to
$180.5 million as compared to 2006. Excluding the additional long distance
services revenue attributable to the CTE and GVN acquisitions of $27.1 million
in 2007, long distance services revenue for 2007 was relatively unchanged as
compared to 2006, despite an increase of 13% in our long distance minutes of use
due to more customers selecting our unlimited minutes of use package.
Our long distance minutes of use increased during 2008 and 2007, as compared
with the prior years and, as noted below in network access expenses, has
increased our cost of services provided. At the same time, average revenue per
minute of use has declined.
32
Our long distance services revenue has remained relatively unchanged, but may
decrease in the future due to lower rates and/or minutes of use. Competing
services such as wireless, VOIP and cable telephony are resulting in a loss of
customers, minutes of use and further declines in the rates we charge our
customers. We expect these factors will continue to adversely affect our long
distance revenue in the future.
Directory Services
Directory services revenue for 2008 decreased $1.2 million, or 1%, to $113.3
million as compared to 2007. Excluding the additional directory services revenue
attributable to the CTE and GVN acquisitions in 2008 and 2007, directory
services revenue for 2008 decreased $4.0 million, or 4%, as compared to 2007.
Directory services revenue in 2008 reflected lower revenues from yellow pages
advertising, mainly in Rochester, New York.
Directory services revenue for 2007 increased $0.4 million to $114.6 million as
compared to 2006. Excluding the additional directory services revenue
attributable to the CTE and GVN acquisitions of $1.3 million in 2007, directory
services revenue for 2007 decreased $0.8 million, or 1%, as compared to 2006,
reflecting slightly lower revenues from yellow pages advertising, mainly in
Rochester, New York.
Other
Other revenue for 2008 decreased $11.5 million, or 12%, to $82.4 million as
compared to 2007. Other revenue was impacted by a decrease in equipment sales of
$7.0 million, a decrease in service activation fee revenue of $3.3 million and
decreased "bill and collect" fee revenue of $3.2 million, partially offset by
higher DISH video revenue of $3.3 million.
Other revenue for 2007 decreased $2.3 million, or 2%, to $93.9 million as
compared to 2006. Excluding the additional other revenue attributable to the CTE
and GVN acquisitions of $13.9 million in 2007, other revenue for 2007 decreased
$16.2 million, or 17%, as compared to 2006, primarily due to a $9.9 million
increase in bad debt expense, the impact of a $3.4 million reduction in revenue
for our free video promotions with a multi-year customer commitment in some of
our markets, a decrease in service activation billing of $2.5 million and a
decrease of $1.8 million in wireless revenue from the Mohave Cellular Limited
Partnership.
OTHER FINANCIAL AND OPERATING DATA
As of % As of % As of
December 31, 2008 Change December 31, 2007 Change December 31, 2006
------------------- ------------ ------------------- -------------- ------------------
Access lines:
Residential 1,454,268 -8% 1,587,930 8% 1,476,802
Business 800,065 -5% 841,212 29% 649,772
------------------- ------------------- ------------------
Total access lines 2,254,333 -7% 2,429,142 14% 2,126,574
------------------- ------------------- ------------------
High-Speed Internet (HSI)
subscribers 579,943 11% 522,845 33% 393,184
Video subscribers 119,919 28% 93,596 49% 62,851
For the year ended December 31,
-----------------------------------------------------------------------------------------------
2008 $ Change % Change 2007 % Change 2006
------------------------------------------------ ------------------------------- ------------
Revenue:
Residential $ 944,786 $ (13,667) -1% $ 958,453
Business 887,519 37,419 4% 850,100
------------------- ------------ --------------
Total customer revenue 1,832,305 23,752 1% 1,808,553
------------------- ------------ --------------
Regulatory (Access Services) 404,713 (74,749) -16% 479,462
------------------- ------------ --------------
Total revenue $ 2,237,018 $ (50,997) -2% $ 2,288,015
------------------- ------------ --------------
Switched access minutes of use
(in millions) 10,027 -5% 10,592 4% 10,227
Average monthly total revenue
per access line $ 83.05 (1) 4% $ 79.94 (2) 3% $ 77.25
Average monthly customer revenue
per access line $ 68.65 (1) 6% $ 65.00 (1)
(1) For the years ended December 31, 2008 and 2007, the calculations exclude
CTE and GVN data.
(2) For the year ended December 31, 2007, the calculation excludes CTE and GVN
data and excludes the $38.7 million favorable one-time impact from the
first quarter 2007 settlement of a switched access dispute. The amount is
$81.50 with the $38.7 million favorable one-time impact from the
settlement.
33
OPERATING EXPENSES
NETWORK ACCESS EXPENSES
2008 2007 2006
------------------------------ ---------------------------------------------------------------- ---------
($ in thousands) Frontier
---------------- (excluding
Amount $ Change % Change Amount Acquisitions CTE and GVN) $ Change % Change Amount
--------- --------- ---------- ----------- ------------- ------------- -------- ---------- ---------
Network access $ 222,013 $ (6,229) -3% $ 228,242 $ 35,781 $ 192,461 $ 21,214 12% $ 171,247
Network access
Consolidated network access expenses for 2008 decreased $6.2 million, or 3%, to
$222.0 million as compared to 2007 primarily due to decreasing rates resulting
from more efficient circuit routing for our long distance and data products.
Excluding the additional network access expenses attributable to the CTE and GVN
acquisitions for 2008 and 2007, network access expenses decreased $15.1 million,
or 8%, in 2008 as compared to 2007. Excluding the additional network access
expenses attributable to the CTE and GVN acquisitions of $35.8 million in 2007,
network access expenses for 2007 increased $21.2 million, or 12%, as compared to
2006, primarily due to increasing rates and usage related to our long distance
product and our data backbone.
In the fourth quarter of 2008, we expensed $4.2 million of promotional costs for
Master Card gift cards issued to new High-Speed Internet customers entering into
a two-year price protection plan and to existing customers who purchased
additional services under a two-year price protection plan. In the first quarter
of 2008, we expensed $2.6 million for a flat screen television promotion.
Additionally, in the fourth quarters of 2007 and 2006, we expensed $11.4 million
and $9.7 million, respectively, of promotional costs associated with fourth
quarter High-Speed Internet promotions that subsidized the cost of a new
personal computer or a new digital camera in 2007, and a new personal computer
in 2006, provided to customers entering into a multi-year commitment for certain
bundled services.
As we continue to increase our sales of data products such as High-Speed
Internet and expand the availability of our unlimited long distance calling
plans, our network access expense may increase in the future. A decline in
expenses associated with access line losses, has offset some of the increase.
OTHER OPERATING EXPENSES
2008 2007 2006
------------------------------ -------------------------------------------------------------- ---------
($ in thousands) Frontier
---------------- (excluding
Amount $ Change % Change Amount Acquisitions CTE and GVN) $ Change % Change Amount
--------- ---------- -------- ----------- ------------- ------------ ----------- --------- ---------
Wage and benefit expenses $ 383,887 $ 2,561 1% $ 381,326 $ 28,907 $ 352,419 $ (6,408) -2% $ 358,827
Severance and early
retirement cost 7,598 (6,276) -45% 13,874 - 13,874 6,681 93% 7,193
Stock based compensation 7,788 (1,234) -14% 9,022 - 9,022 (1,318) -13% 10,340
All other operating
expenses 411,475 7,196 2% 404,279 72,086 (1) 332,193 (24,590) -7% 356,783
--------- ---------- ----------- ------------- ------------ ----------- ---------
$ 810,748 $ 2,247 0% $ 808,501 $ 100,993 $ 707,508 $ (25,635) -3% $ 733,143
========= ========== =========== ============= ============ =========== =========
(1) Includes $33.0 million of common corporate costs allocated to CTE
operations during 2007.
Consolidated other operating expenses for 2008 increased $2.2 million, to $810.7
million as compared to 2007, primarily the result of our CTE and GVN
acquisitions which was largely offset by synergies and cost reductions relating
to the legacy Frontier operations.
Wage and benefit expenses
Wage and benefit expenses for 2008 increased $2.6 million, or 1%, to $383.9
million as compared to 2007. Wage and benefit expenses attributable to the CTE
and GVN acquisitions increased $10.2 million, or 35%, in 2008 versus 2007,
primarily due to the pension curtailment gain of $14.4 million recognized in
2007, as discussed below. These additional costs were offset by a decrease of
$7.6 million primarily due to headcount reductions and associated decreases in
compensation and benefit costs attributable to the integration of the back
office, customer service and administrative support functions of the CTE and GVN
operations acquired in 2007.
Wage and benefit expenses for 2007 increased $22.5 million, or 6%, to $381.3
million as compared to 2006. Excluding the additional wage and benefit expenses
attributable to the CTE and GVN acquisitions of $28.9 million in 2007, wage and
benefit expenses for 2007 decreased $6.4 million, or 2%, as compared to 2006,
primarily due to headcount reductions and associated decreases in compensation
and benefit costs.
34
Included in our wage and benefit expenses are pension and other postretirement
benefit expenses. The amounts for 2007 include the costs for our CTE plans
acquired in 2007 and reflect the positive impact of a pension curtailment gain
of $14.4 million, resulting from the freeze placed on certain pension benefits
of the former CTE non-union employees. Based on current assumptions and plan
asset values, we estimate that our pension and other postretirement benefit
expenses (which were $11.2 million in 2008), will be approximately $50.0 million
to $55.0 million in 2009. No contribution was made to our pension plan during
2008 and none is expected to be made in 2009. Also, effective December 31, 2007,
the CTE Employees' Pension Plan was merged into the Frontier Pension Plan.
As a result of negative investment returns and ongoing benefit payments, the
Company's pension plan assets have declined from $822.2 million at December 31,
2007 to $589.8 million at December 31, 2008, a decrease of $232.4 million, or
28%. This decrease represents a decline in asset value of $162.9 million, or
20%, and benefits paid of $69.5 million, or 8%. The decline in pension plan
assets did not impact our results of operations, liquidity or cash flows in
2008. However, we expect that our pension expense will increase in 2009 and that
we will be required to make a cash contribution to our pension plan beginning in
2010.
Severance and early retirement costs
Severance and early retirement costs for 2008 decreased $6.3 million, or 45%, as
compared to 2007. Severance and early retirement costs of $7.6 million in 2008
include charges recorded in the first half of 2008 of $3.4 million related to
employee early retirements and terminations for 42 Rochester, New York
employees. Additional severance costs of $4.0 million were recorded in the
fourth quarter of 2008, including $1.7 million of enhanced early retirement
pension benefits related to 55 employees.
Severance and early retirement costs of $13.9 million in 2007 include a third
quarter charge of approximately $12.1 million related to initiatives to enhance
customer service, streamline operations and reduce costs. Approximately 120
positions were eliminated as part of this 2007 initiative, most of which were
filled by new employees at our remaining call centers. In addition,
approximately 50 field operations employees agreed to participate in an early
retirement program and another 30 employees from a variety of functions left the
Company in 2007.
Severance and early retirement costs for 2007 increased $6.7 million, or 93%, as
compared to 2006, primarily due to the 2007 charge of approximately $12.1
million related to initiatives to enhance customer service, streamline
operations and reduce costs, as discussed above.
Stock based compensation
Stock based compensation for 2008 decreased $1.2 million, or 14%, as compared to
2007 due to reduced costs associated with stock units and stock options.
Stock based compensation for 2007 decreased $1.3 million, or 13%, as compared to
2006 due to reduced costs associated with stock options, since fewer stock
option grants remained unvested as compared to 2006.
All other operating expenses
All other operating expenses for 2008 increased $7.2 million, or 2%, to $411.5
million as compared to 2007, primarily due to the additional expenses
attributable to the CTE and GVN acquisitions of $10.0 million in 2008 versus
2007, as 2008 includes a full year of expenses for CTE and GVN while 2007
included approximately ten months of costs for CTE and two months of costs for
GVN. Our purchase of CTE has enabled us to realize cost savings by leveraging
our centralized back office, customer service and administrative support
functions over a larger customer base.
All other operating expenses for 2007 increased $47.5 million, or 13%, to $404.3
million as compared to 2006. Excluding the additional expenses attributable to
the CTE and GVN acquisitions of $72.1 million in 2007, all other operating
expenses for 2007 decreased $24.6 million, or 7%, as compared to 2006, primarily
due to the allocation of common corporate costs over a larger base of
operations, which now includes CTE. Additionally, our USF contribution rate and
PUC fees decreased from 2006, resulting in a reduction in costs of $13.1 million
in 2007. An increase in consulting and other outside services of $11.7 million
for 2007 offset some of the decrease in expenses noted above.
35
DEPRECIATION AND AMORTIZATION EXPENSE
2008 2007 2006
------------------------------ ---------------------------------------------------------------- ---------
($ in thousands) Frontier
--------------- (excluding
Amount $ Change % Change Amount Acquisitions CTE and GVN) $ Change % Change Amount
--------- ---------- --------- ---------- ------------- ------------- ---------- --------- ---------
Depreciation expense $ 379,490 $ 5,055 1% $ 374,435 $ 45,289 $ 329,146 $(20,961) -6% $ 350,107
Amortization expense 182,311 10,890 6% 171,421 45,042 (1) 126,379 (1) 0% 126,380
--------- ---------- ---------- ------------- ------------- ---------- ---------
$ 561,801 $ 15,945 3% $ 545,856 $ 90,331 $ 455,525 $(20,962) -4% $ 476,487
========= ========== ========== ============= ============= ========== =========
(1) Represents amortization expense related to the customer base acquired in the
CTE and GVN acquisitions, and the Commonwealth trade name. Our assessment of the
value of the customer base and trade name, and associated expected useful life,
are based upon management estimate and independent appraisal.
Depreciation and amortization expense for 2008 increased $15.9 million, or 3%,
to $561.8 million as compared to 2007. Excluding the depreciation and
amortization expense for 2008 and 2007 attributable to the CTE and GVN
acquisitions, depreciation and amortization expense for 2008 decreased $10.7
million, or 2%, as compared to 2007, primarily due to a declining net asset base
for our legacy Frontier properties, partially offset by changes in the remaining
useful lives of certain assets. An independent study updating the estimated
remaining useful lives of our plant assets is performed annually. We adopted the
remaining useful lives proposed in the study effective October 1, 2008. Our
"composite depreciation rate" increased from 5.5% to 5.6% as a result of the
study. We anticipate depreciation expense of approximately $350.0 million to
$370.0 million and amortization expense of $113.9 million for 2009.
Consolidated depreciation and amortization expense for 2007 increased $69.4
million, or 15%, to $545.9 million as compared to 2006 as a result of our 2007
acquisitions of CTE and GVN. Excluding the impact of the CTE and GVN
acquisitions, depreciation expense for 2007 decreased $21.0 million, or 6%, as
compared to 2006 due to a declining net asset base partially offset by changes
in the remaining useful lives of certain assets.
INVESTMENT INCOME/OTHER INCOME (LOSS), NET / INTEREST EXPENSE /
INCOME TAX EXPENSE
2008 2007 2006
------------------------------- -------------------------------------------------------------- ----------
($ in thousands) Frontier
---------------- (excluding
Amount $ Change % Change Amount Acquisitions CTE and GVN) $ Change % Change Amount
--------- ---------- --------- ----------- ------------ -------------- ---------- --------- ----------
Investment income $ 14,504 $ (21,277) -59% $ 35,781 $ 402 $ 35,379 $ (44,057) -55% $ 79,436
Other income (loss),
net $ (5,170) $ 12,663 71% $ (17,833) $ 4,978 $ (22,811) $ (25,818) -859% $ 3,007
Interest expense $ 362,634 $ (18,062) -5% $ 380,696 $ (260) $ 380,956 $ 44,510 13% $ 336,446
Income tax expense $ 106,496 $ (21,518) -17% $ 128,014 $ 27,013 $ 101,001 $ (35,478) -26% $ 136,479
Investment Income
Investment income for 2008 decreased $21.3 million, or 59%, to $14.5 million as
compared to 2007, primarily due to a decrease of $22.1 million in income from
short-term investments of cash and cash equivalents due to a lower investable
cash balance.
Investment income for 2007 decreased $43.7 million, or 55%, to $35.8 million as
compared to 2006. Excluding the investment income attributable to the CTE and
GVN acquisitions of $0.4 million, investment income for 2007 decreased $44.1
million, or 55%, as compared to 2006, primarily due to the $64.6 million in
proceeds received in 2006 from the RTB liquidation and dissolution, partially
offset by an increase of $10.8 million in income from short-term investments of
cash and lower minority interest in joint ventures of $2.3 million.
We borrowed $550.0 million in December 2006 in anticipation of the Commonwealth
acquisition in 2007. Our average cash balances were $177.5 million, $594.2
million and $429.5 million for 2008, 2007 and 2006, respectively.
Other Income (Loss), net
Other income (loss), net for 2008 improved $12.7 million, or 71%, to $(5.2)
million as compared to 2007. Other income (loss), net improved in 2008 primarily
due to a reduction in the loss on retirement of debt of $11.9 million and the
$4.1 million expense of a bridge loan fee recorded during the first quarter of
2007.
Other income (loss), net for 2007 decreased $20.8 million to ($17.8) million as
compared to 2006. Excluding the other income attributable to the CTE and GVN
acquisitions of $5.0 million, other income (loss), net for 2007 decreased $25.8
million to ($22.8) million as compared to 2006, primarily due to the premium
paid of $18.2 million on the early retirement of debt during 2007 and a bridge
loan fee of $4.1 million.
36
Interest Expense
Interest expense for 2008 decreased $18.1 million, or 5%, to $362.6 million as
compared to 2007, primarily due to the amortization of the deferred gain
associated with the termination of our interest rate swap agreements and
retirement of related debt during the first quarter of 2008, along with slightly
lower average debt levels and average interest rates. Our composite average
borrowing rate as of December 31, 2008, as compared to 2007 was 40 basis points
lower, decreasing from 7.94% to 7.54%.
Interest expense for 2007 increased $44.5 million, or 13%, to $381.0 million as
compared to 2006, primarily due to $637.6 million of higher average debt in 2007
resulting from financing the CTE acquisition. Our composite average borrowing
rate as of December 31, 2007, as compared with our composite average borrowing
rate as of December 31, 2006 was 18 basis points lower, decreasing from 8.12% to
7.94%.
Our average debt outstanding was $4,753.0 million, $4,834.5 million and $4,196.9
million for 2008, 2007 and 2006, respectively.
Income Tax Expense
Income tax expense for 2008 decreased $21.5 million, or 17%, as compared to
2007, primarily due to lower taxable income and the reduction in income tax
expense of $7.5 million recorded in the second quarter of 2008 that resulted
from the expiration of certain statute of limitations on April 15, 2008, as
discussed below.
The effective tax rate for 2008 was 36.8% as compared with 37.4% for 2007. The
Company's effective tax rate decreased in 2008 mainly due to the impact of the
favorable tax reserve adjustment recorded in the second quarter of 2008.
We paid $78.9 million in cash taxes during 2008, an increase of $24.5 million
over 2007, reflecting the utilization of our tax loss carryforwards in prior
years. We expect to pay approximately $90.0 million to $110.0 million in 2009.
Our 2009 cash tax estimate reflects the anticipated favorable impact of bonus
depreciation that is part of the economic stimulus package signed into law by
President Obama.
As a result of the expiration of certain statute of limitations on April 15,
2008, the liabilities on our books as of December 31, 2007 related to uncertain
tax positions recorded under FASB Interpretation No. (FIN) 48 were reduced by
$16.2 million in the second quarter of 2008. This reduction lowered income tax
expense by $7.5 million, goodwill by $3.0 million and deferred income tax assets
by $5.7 million during the second quarter of 2008.
Excluding the income tax expense attributable to the CTE and GVN acquisitions of
$27.0 million, income tax expense for 2007 decreased $35.5 million, or 26%, as
compared to 2006, primarily due to changes in taxable income. Our effective tax
rate for 2007 was 37.4% as compared with an effective tax rate of 34.9% for
2006. The Company's effective tax rate increased in 2007 mainly due to changes
in permanent difference items and tax contingencies.
DISCONTINUED OPERATIONS
($ in thousands) 2006
---------------- ----------
Amount
----------
Revenue $ 100,612
Operating income $ 27,882
Income taxes $ 11,583
Net income $ 18,912
Gain on disposal of ELI, net of tax $ 71,635
On July 31, 2006, we sold our CLEC business, Electric Lightwave, LLC (ELI) for
$255.3 million (including a later sale of associated real estate) in cash plus
the assumption of approximately $4.0 million in capital lease obligations. We
recognized a pre-tax gain on the sale of ELI of approximately $116.7 million.
Our after-tax gain on the sale was $71.6 million. Our cash liability for taxes
as a result of the sale was approximately $5.0 million due to the utilization of
existing tax net operating losses on both the Federal and state level.
37
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Disclosure of primary market risks and how they are managed
We are exposed to market risk in the normal course of our business operations
due to ongoing investing and funding activities, including those associated with
our pension assets. Market risk refers to the potential change in fair value of
a financial instrument as a result of fluctuations in interest rates and equity
prices. We do not hold or issue derivative instruments, derivative commodity
instruments or other financial instruments for trading purposes. As a result, we
do not undertake any specific actions to cover our exposure to market risks, and
we are not party to any market risk management agreements other than in the
normal course of business. Our primary market risk exposures are interest rate
risk and equity price risk as follows:
Interest Rate Exposure
Our exposure to market risk for changes in interest rates relates primarily to
the interest-bearing portion of our investment portfolio. Our long-term debt as
of December 31, 2008 was approximately 94% fixed rate debt with minimal exposure
to interest rate changes after the termination of our remaining interest rate
swap agreements on January 15, 2008.
Our objectives in managing our interest rate risk are to limit the impact of
interest rate changes on earnings and cash flows and to lower our overall
borrowing costs. To achieve these objectives, all but $281.0 million of our
borrowings at December 31, 2008 have fixed interest rates. Consequently, we have
limited material future earnings or cash flow exposures from changes in interest
rates on our long-term debt. An adverse change in interest rates would increase
the amount that we pay on our variable obligations and could result in
fluctuations in the fair value of our fixed rate obligations. Based upon our
overall interest rate exposure at December 31, 2008, a near-term change in
interest rates would not materially affect our consolidated financial position,
results of operations or cash flows.
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with our
Senior Notes due in 2011 and 2013. Cash proceeds on the swap terminations of
approximately $15.5 million were received in January 2008. The related gain has
been deferred on the consolidated balance sheet, and is being amortized into
interest expense over the term of the associated debt.
Sensitivity analysis of interest rate exposure
At December 31, 2008, the fair value of our long-term debt was estimated to be
approximately $3.7 billion, based on our overall weighted average borrowing rate
of 7.54% and our overall weighted average maturity of approximately 12 years.
There has been no material change in the weighted average maturity applicable to
our obligations since December 31, 2007.
Equity Price Exposure
Our exposure to market risks for changes in security prices as of December 31,
2008 is limited to our pension assets. We have no other security investments of
any material amount.
During 2008, the diminished availability of credit and liquidity in the United
States and throughout the global financial system has resulted in substantial
volatility in financial markets and the banking system. These and other economic
events have had an adverse impact on investment portfolios.
As a result of negative investment returns and ongoing benefit payments, the
Company's pension plan assets have declined from $822.2 million at December 31,
2007 to $589.8 million at December 31, 2008, a decrease of $232.4 million, or
28%. This decrease represents a decline in asset value of $162.9 million, or
20%, and benefits paid of $69.5 million, or 8%. The decline in pension plan
assets did not impact our results of operations, liquidity or cash flows in
2008. However, we expect that our pension expense will increase in 2009 and that
we may be required to make a cash contribution to our pension plan beginning in
2010.
38
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements, See Index on page F-1.
2. Supplementary Data, Quarterly Financial Data is included in the
Financial Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None.
Item 9A. Controls and Procedures
-----------------------
(i) Evaluation of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our principal executive officer
and principal financial officer, regarding the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) .
Based upon this evaluation, our principal executive officer and principal
financial officer concluded, as of the end of the period covered by this
report, December 31, 2008, that our disclosure controls and procedures were
effective.
(ii) Internal Control Over Financial Reporting
(a) Management's annual report on internal control over financial reporting
Our management report on internal control over financial reporting appears
on page F-2.
(b) Report of registered public accounting firm
The report of KPMG LLP, our independent registered public accounting
firm, on internal control over financial reporting appears on page F-4.
(c) Changes in internal control over financial reporting
We reviewed our internal control over financial reporting at December 31,
2008. There has been no change in our internal control over financial
reporting identified in an evaluation thereof that occurred during the last
fiscal quarter of 2008 that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Item 9B. Other Information
-----------------
None.
PART III
--------
Item 10. Directors, Executive Officers and Corporate Governance
------------------------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2009 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2008. See "Executive Officers of the Registrant" in Part I of this Report
following Item 4 for information relating to executive officers.
Item 11. Executive Compensation
----------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2009 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2008.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
------------------------------------------------------------------
Related Stockholder Matters
---------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2009 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2008.
39
Item 13. Certain Relationships and Related Transactions, and Director
------------------------------------------------------------
Independence
------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2009 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2008.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information required by this Item is incorporated by reference from our
definitive proxy statement for the 2009 Annual Meeting of Stockholders to be
filed with the SEC pursuant to Regulation 14A within 120 days after December 31,
2008.
PART IV
-------
Item 15. Exhibits and Financial Statement Schedules
------------------------------------------
List of Documents Filed as a Part of This Report:
(1) Index to Consolidated Financial Statements:
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Operations for the years ended
December 31, 2008, 2007 and 2006
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2008, 2007 and 2006
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2008, 2007 and 2006
Consolidated Statements of Cash Flows for the years ended
December 31, 2008, 2007 and 2006
Notes to Consolidated Financial Statements
All other schedules have been omitted because the required information is
included in the consolidated financial statements or the notes thereto, or is
not applicable or not required.
40
(2) Index to Exhibits:
All documents referenced below were filed pursuant to the Securities Exchange
Act of 1934 by the Company, file number 001-11001, unless otherwise indicated.
Exhibit
No. Description
------- -----------
3.1 Restated Certificate of Incorporation (filed as Exhibit 3.200.1
to the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2000).*
3.2 Certificate of Amendment of Restated Certificate of
Incorporation, effective July 31, 2008 (filed as Exhibit 3.1 to
the Company's Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2008). *
3.3 By-laws, as amended February 6, 2009 (filed as Exhibit 99.1 to
the Company's current Report on Form 8-K filed on February 6,
2009). *
4.1 Rights Agreement, dated as of March 6, 2002, between the Company
and Mellon Investor Services, LLC, as Rights Agent (filed as
Exhibit 1 to the Company's Registration Statement on Form 8-A
filed on March 22, 2002).*
4.2 Amendment No. 1 to Rights Agreement, dated as of January 16,
2003, between the Company and Mellon Investor Services LLC, as
Rights Agent (filed as Exhibit 1.1 to the Company's Registration
Statement on Form 8-A/A, dated January 16, 2003).*
4.3 Indenture of Securities, dated as of August 15, 1991, between the
Company and JPMorgan Chase Bank, N.A.(as successor to Chemical
Bank), as Trustee (the "August 1991 Indenture") (filed as Exhibit
4.100.1 to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 1991).*
4.4 Fourth Supplemental Indenture to the August 1991 Indenture, dated
October 1, 1994, between the Company and JPMorgan Chase Bank,
N.A. (as successor to Chemical Bank), as Trustee (filed as
Exhibit 4.100.7 to the Company's Current Report on Form 8-K filed
on January 3, 1995).*
4.5 Fifth Supplemental Indenture to the August 1991 Indenture, dated
as of June 15, 1995, between the Company and JPMorgan Chase Bank,
N.A. (as successor to Chemical Bank), as Trustee (filed as
Exhibit 4.100.8 to the Company's Current Report on Form 8-K filed
on March 29, 1996 (the "March 29, 1996 8-K")).*
4.6 Sixth Supplemental Indenture to the August 1991 Indenture, dated
as of October 15, 1995, between the Company and JPMorgan Chase
Bank, N.A. (as successor to Chemical Bank), as Trustee (filed as
Exhibit 4.100.9 to the March 29, 1996 8-K).*
4.7 Seventh Supplemental Indenture to the August 1991 Indenture,
dated as of June 1, 1996, between the Company and JPMorgan Chase
Bank, N.A. (as successor to Chemical Bank), as Trustee (filed as
Exhibit 4.100.11 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996 (the "1996 10-K")).*
4.8 Eighth Supplemental Indenture to the August 1991 Indenture, dated
as of December 1, 1996, between the Company and JPMorgan Chase
Bank, N.A. (as successor to Chemical Bank), as Trustee (filed as
Exhibit 4.100.12 to the 1996 10-K).*
4.9 Senior Indenture, dated as of May 23, 2001, between the Company
and JPMorgan Chase Bank, N.A. (as successor to The Chase
Manhattan Bank), as trustee (the "May 2001 Indenture") (filed as
Exhibit 4.1 to the Company's Current Report on Form 8-K filed on
May 24, 2001 8-K (the "May 24, 2001 8-K")).*
4.10 First Supplemental Indenture to the May 2001 Indenture, dated as
of May 23, 2001, between the Company and JPMorgan Chase Bank,
N.A. (filed as Exhibit 4.2 to the May 24, 2001 8-K).*
4.11 Form of Senior Note due 2011 (filed as Exhibit 4.4 to the May 24,
2001 8-K).*
4.12 Third Supplemental Indenture to the May 2001 Indenture, dated as
of November 12, 2004, between the Company and JPMorgan Chase
Bank, N.A. (filed as Exhibit 4.1 to the Company's Current Report
on Form 8-K filed on November 12, 2004 (the "November 12, 2004
8-K")).*
4.13 Form of Senior Note due 2013 (filed as Exhibit A to Exhibit 4.1
to the November 12, 2004 8-K).*
4.14 Indenture, dated as of August 16, 2001, between the Company and
JPMorgan Chase Bank, N.A. (as successor to The Chase Manhattan
Bank), as Trustee (including the form of note attached thereto)
(filed as Exhibit 4.1 of the Company's Current Report on Form 8-K
filed on August 22, 2001).*
4.15 Indenture, dated as of December 22, 2006, between the Company and
The Bank of New York, as Trustee (filed as Exhibit 4.1 to the
Company's Current Report on Form 8-K filed on December 29,
2006).*
41
4.16 Indenture dated as of March 23, 2007 by and between the Company
and The Bank of New York with respect to the 6.625% Senior Notes
due 2015 (including the form of such note attached thereto)
(filed as Exhibit 4.1 to the Company's Current Report on Form 8-K
filed on March 27, 2007 (the "March 27, 2007 8-K")).*
4.17 Indenture dated as of March 23, 2007 by and between the Company
and The Bank of New York with respect to the 7.125% Senior Notes
due 2019 (including the form of such note attached thereto)
(filed as Exhibit 4.2 to the March 27, 2007 8-K).*
10.1 Loan Agreement between the Company and Rural Telephone Finance
Cooperative for $200,000,000 dated October 24, 2001 (filed as
Exhibit 10.39 to the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended September 30, 2001).*
10.2 Amendment No. 1, dated as of March 31, 2003, to Loan Agreement
between the Company and Rural Telephone Finance Cooperative
(filed as Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended March 31, 2003).*
10.3 Credit Agreement, dated as of December 6, 2006, among the
Company, as the Borrower, and CoBank, ACB, as the Administrative
Agent, the Lead Arranger and a Lender, and the other Lenders
referred to therein (filed as Exhibit 10.1 to the Company's
Current Report on Form 8-K filed on December 7, 2006).*
10.4 Loan Agreement, dated as of March 8, 2007, among the Company, as
borrower, the Lenders listed therein, Citicorp North America,
Inc., as Administrative Agent, and Citigroup Global Markets Inc.,
Credit Suisse Securities (USA) LLC and J.P. Morgan Securities
Inc. as Joint-Lead Arrangers and Joint Book-Running Managers
(filed as Exhibit 10.3 to the March 9, 2007 8-K).*
10.5 Credit Agreement, dated as of May 18, 2007, among the Company,
the lenders party thereto and Deutsche Bank AG New York Branch,
as Administrative Agent, and Deutsche Bank Securities Inc., as
Sole Lead Arranger and Bookrunner (filed as Exhibit 10.5 to the
Company's Annual Report on Form 10-K for the year ended December
31, 2007 (the "2007 10-K")). *
10.6 Credit Agreement, dated as of March 10, 2008, among the Company,
as the Borrower, and CoBank, ACB, as the Administrative Agent,
the Lead Arranger and a Lender, and the other Lenders referred to
therein (filed as Exhibit 10.1 to the Company's Current Report on
Form 8-K filed on March 10, 2008).*
10.7 Non-Employee Directors' Deferred Fee Equity Plan, as amended and
restated December 29, 2008.
10.8 Non-Employee Directors' Equity Incentive Plan, as amended and
restated December 29, 2008.
10.9 Separation Agreement between the Company and Leonard Tow
effective July 10, 2004 (filed as Exhibit 10.2.4 of the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended June
30, 2004).*
10.10 Citizens Executive Deferred Savings Plan dated January 1, 1996
(filed as Exhibit 10.19 to the Company's Annual Report on Form
10-K for the year ended December 31, 1999 (the "1999 10-K")).*
10.11 1996 Equity Incentive Plan, as amended and restated December 29,
2008.
10.12 2008 Citizens Incentive Plan (filed as Appendix A to the
Company's Proxy Statement dated April 10, 2007).*
10.13 Amended and Restated 2000 Equity Incentive Plan, as amended and
restated December 29, 2008.
10.14 Amended Employment Agreement, dated as of December 29, 2008,
between the Company and Mary Agnes Wilderotter.
10.15 Amended Employment Agreement, dated as of December 24, 2008,
between the Company and Robert Larson.
10.16 Offer of Employment Letter, dated December 31, 2004, between the
Company and Peter B. Hayes ("Hayes Offer Letter") (filed as
Exhibit 10.23 to the Company's Annual Report on Form 10-K for the
year ended December 31, 2004).*
10.17 Amendment to Hayes Offer Letter, dated December 24, 2008.
10.18 Offer of Employment Letter, dated March 7, 2006, between the
Company and Donald R. Shassian ("Shassian Offer Letter") (filed
as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 31, 2006).*
10.19 Amendment to Shassian Offer Letter, dated December 30, 2008.
10.20 Separation Agreement, dated November 15, 2007, between the
Company and John H. Casey III (filed as Exhibit 10.21 to the 2007
10-K).*
10.21 Form of Arrangement with Daniel J. McCarthy and Melinda M. White
with respect to vesting of restricted stock upon a
change-in-control (filed as Exhibit 10.22 to the 2007 10-K). *
10.22 Offer of Employment Letter, dated January 13, 2006, between the
Company and Cecilia K. McKenney ("McKenney Offer Letter") (filed
as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 31, 2008). *
10.23 Amendment to McKenney Offer Letter, dated December 24, 2008.
10.24 Offer of Employment Letter, dated July 8, 2005, between the
Company and Hilary E. Glassman (the "Glassman Offer Letter").
42
10.25 Amendment to Glassman Offer Letter, dated December 29, 2008.
10.26 Form of Restricted Stock Agreement for CEO.
10.27 Form of Restricted Stock Agreement for named executive officers
other than CEO.
10.28 Summary of Non-Employee Directors' Compensation Arrangements
Outside of Formal Plans.
10.29 Membership Interest Purchase Agreement between the Company and
Integra Telecom Holdings, Inc. dated February 6, 2006 (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K filed on
February 9, 2006).*
10.30 Stock Purchase Agreement, dated as of July 3, 2007, between the
Company and Country Road Communications LLC (filed as Exhibit 2.1
to the Company's Current Report on Form 8-K filed on July 9,
2007).*
12.1 Computation of ratio of earnings to fixed charges (this item is
included herein for the sole purpose of incorporation by
reference).
21.1 Subsidiaries of the Registrant.
23.1 Auditors' Consent.
31.1 Certification of Principal Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 (the "1934
Act").
31.2 Certification of Principal Financial Officer pursuant to Rule
13a-14(a) under the 1934 Act.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 ("SOXA").
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of SOXA .
Exhibits 10.7 through 10.28 are management contracts or compensatory plans or
arrangements.
43
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FRONTIER COMMUNICATIONS CORPORATION
------------------------------------
(Registrant)
By: /s/ Mary Agnes Wilderotter
---------------------------
Mary Agnes Wilderotter
Chairman of the Board, President and Chief Executive Officer
February 26, 2009
44
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 26th day of February 2009.
Signature Title
--------- -----
/s/ Kathleen Q. Abernathy Director
------------------------------------------------
(Kathleen Q. Abernathy)
/s/ Leroy T. Barnes, Jr. Director
------------------------------------------------
(Leroy T. Barnes, Jr.)
/s/ Peter C. B. Bynoe Director
------------------------------------------------
(Peter C. B. Bynoe)
/s/ Michael T. Dugan Director
------------------------------------------------
(Michael T. Dugan)
/s/ Jeri B. Finard Director
------------------------------------------------
(Jeri B. Finard)
/s/ Lawton W. Fitt Director
------------------------------------------------
(Lawton W. Fitt)
/s/ William M. Kraus Director
------------------------------------------------
(William M. Kraus)
/s/ Robert J. Larson Senior Vice President and
------------------------------------------------ Chief Accounting Officer
(Robert J. Larson)
/s/ Howard L. Schrott Director
------------------------------------------------
(Howard L. Schrott)
/s/ Larraine D. Segil Director
------------------------------------------------
(Larraine D. Segil)
/s/ Donald R. Shassian Executive Vice President and
------------------------------------------------ Chief Financial Officer
(Donald R. Shassian)
/s/ David H. Ward Director
------------------------------------------------
(David H. Ward)
/s/ Myron A. Wick III Director
------------------------------------------------
(Myron A. Wick III)
/s/ Mary Agnes Wilderotter Chairman of the Board, President
------------------------------------------------ and Chief Executive Officer
(Mary Agnes Wilderotter)
* Incorporated by reference.
45
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Index to Consolidated Financial Statements
Item Page
---- ----
Management's Report on Internal Control Over Financial Reporting F-2
Reports of Independent Registered Public Accounting Firm F-3 and F-4
Consolidated Balance Sheets as of December 31, 2008 and 2007 F-5
Consolidated Statements of Operations for the years ended
December 31, 2008, 2007 and 2006 F-6
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2008, 2007 and 2006 F-7
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2008, 2007 and 2006 F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2008, 2007 and 2006 F-8
Notes to Consolidated Financial Statements F-9
F-1
Management's Report on Internal Control Over Financial Reporting
----------------------------------------------------------------
The Board of Directors and Shareholders
Frontier Communications Corporation:
The management of Frontier Communications Corporation and subsidiaries is
responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and
15d-15(f).
Under the supervision and with the participation of our management, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on our evaluation our management concluded that our internal control over
financial reporting was effective as of December 31, 2008 and for the period
then ended.
Our independent registered public accounting firm, KPMG LLP, has audited the
consolidated financial statements included in this report and, as part of their
audit, has issued their report, included herein, on the effectiveness of our
internal control over financial reporting.
Stamford, Connecticut
February 26, 2009
F-2
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Frontier Communications Corporation:
We have audited the accompanying consolidated balance sheets of Frontier
Communications Corporation and subsidiaries as of December 31, 2008 and 2007,
and the related consolidated statements of operations, shareholders' equity,
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 2008. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Frontier
Communications Corporation and subsidiaries as of December 31, 2008 and 2007 and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2008, in conformity with U.S. generally
accepted accounting principles.
As discussed in Note 18 to the accompanying consolidated financial statements,
the Company adopted the recognition and disclosure provisions of FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" as of
January 1, 2007. As discussed in Note 5, effective January 1, 2006, the Company
adopted Staff Accounting Bulletin No. 108, "Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements." Also, as discussed in Note 23, the Company adopted the recognition
and disclosure provisions of Statement of Financial Accounting Standards No.
158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement
Plans" as of December 31, 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Frontier Communications
Corporation's internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and
our report dated February 26, 2009 expressed an unqualified opinion on the
effectiveness of the Company's internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
February 26, 2009
F-3
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors and Shareholders
Frontier Communications Corporation:
We have audited Frontier Communications Corporation's internal control over
financial reporting as of December 31, 2008, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Frontier Communications
Corporation's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, included in the accompanying
Management's Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the Company's internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Frontier Communications Corporation maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Frontier Communications Corporation and subsidiaries as of December 31, 2008 and
2007, and the related consolidated statements of operations, shareholders'
equity, comprehensive income and cash flows for each of the years in the
three-year period ended December 31, 2008, and our report dated February 26,
2009 expressed an unqualified opinion on those consolidated financial
statements.
/s/ KPMG LLP
Stamford, Connecticut
February 26, 2009
F-4
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2008 AND 2007
($ in thousands)
2008 2007
-------------- --------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 163,627 $ 226,466
Accounts receivable, less allowances of $40,125 and $32,748, respectively 222,247 234,762
Prepaid expenses 33,265 29,437
Other current assets 48,820 33,489
-------------- --------------
Total current assets 467,959 524,154
Property, plant and equipment, net 3,239,973 3,335,244
Goodwill, net 2,642,323 2,634,559
Other intangibles, net 359,674 547,735
Investments 8,044 21,191
Other assets 170,703 193,186
-------------- --------------
Total assets $ 6,888,676 $ 7,256,069
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Long-term debt due within one year $ 3,857 $ 2,448
Accounts payable 141,940 179,402
Advanced billings 51,225 44,722
Other taxes accrued 25,585 21,400
Interest accrued 102,370 116,923
Other current liabilities 57,798 80,996
-------------- --------------
Total current liabilities 382,775 445,891
Deferred income taxes 670,489 711,645
Other liabilities 594,682 363,737
Long-term debt 4,721,685 4,736,897
Shareholders' equity:
Common stock, $0.25 par value (600,000,000 authorized shares; 311,314,000 and 327,749,000
outstanding, respectively, and 349,456,000 issued at December 31, 2008 and 2007) 87,364 87,364
Additional paid-in capital 1,117,936 1,280,508
Retained earnings 38,163 14,001
Accumulated other comprehensive loss, net of tax (237,152) (77,995)
Treasury stock (487,266) (305,979)
-------------- --------------
Total shareholders' equity 519,045 997,899
-------------- --------------
Total liabilities and shareholders' equity $ 6,888,676 $ 7,256,069
============== ==============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-5
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 and 2006
($ in thousands, except for per-share amounts)
2008 2007 2006
--------------- -------------- --------------
Revenue $ 2,237,018 $ 2,288,015 $ 2,025,367
Operating expenses:
Network access expenses 222,013 228,242 171,247
Other operating expenses 810,748 808,501 733,143
Depreciation and amortization 561,801 545,856 476,487
--------------- -------------- --------------
Total operating expenses 1,594,562 1,582,599 1,380,877
--------------- -------------- --------------
Operating income 642,456 705,416 644,490
Investment income 14,504 35,781 79,436
Other income (loss), net (5,170) (17,833) 3,007
Interest expense 362,634 380,696 336,446
--------------- -------------- --------------
Income from continuing operations before
income taxes 289,156 342,668 390,487
Income tax expense 106,496 128,014 136,479
--------------- -------------- --------------
Income from continuing operations 182,660 214,654 254,008
Discontinued operations (see Note 8):
Income from discontinued operations before
income taxes - - 147,136
Income tax expense - - 56,589
--------------- -------------- --------------
Income from discontinued operations - - 90,547
--------------- -------------- --------------
Net income available for common shareholders $ 182,660 $ 214,654 $ 344,555
=============== ============== ==============
Basic income per common share:
Income from continuing operations $ 0.58 $ 0.65 $ 0.79
Income from discontinued operations - - 0.28
--------------- -------------- --------------
Net income per common share $ 0.58 $ 0.65 $ 1.07
=============== ============== ==============
Diluted income per common share:
Income from continuing operations $ 0.57 $ 0.65 $ 0.78
Income from discontinued operations - - 0.28
--------------- -------------- --------------
Net income per common share $ 0.57 $ 0.65 $ 1.06
=============== ============== ==============
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-6
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 and 2006
($ and shares in thousands, except for per-share amounts)
Accumulated
Common Stock Additional Retained Other Treasury Stock Total
------------------- Paid-In Earnings Comprehensive --------------------- Shareholders'
Shares Amount Capital (Deficit) Loss Shares Amount Equity
--------- --------- ------------ ------------- ------------ --------- ----------- -------------
Balance December 31, 2005 343,956 $ 85,989 $1,374,610 $ (85,344) $ (123,242) (15,788) $ (210,204) $ 1,041,809
Cumulative effect adjustment
(see Note 5) - - - 36,392 - - - 36,392
Stock plans - - (1,875) - - 2,908 38,793 36,918
Conversion of EPPICS - - (2,563) - - 1,389 18,488 15,925
Dividends on common stock of
$1.00 per share - - (162,773) (160,898) - - - (323,671)
Shares repurchased - - - - - (10,200) (135,239) (135,239)
Net income - - - 344,555 - - - 344,555
Pension liability adjustment,
after adoption of SFAS No.
158, net of taxes - - - - (83,634) - - (83,634)
Other comprehensive income,
net of tax, and
reclassification adjustments - - - - 124,977 - - 124,977
--------- --------- ------------ -------------- ------------ --------- ----------- -------------
Balance December 31, 2006 343,956 85,989 1,207,399 134,705 (81,899) (21,691) (288,162) 1,058,032
Stock plans - - (6,237) 667 - 1,824 25,399 19,829
Acquisition of Commonwealth 5,500 1,375 77,939 - - 12,640 168,121 247,435
Conversion of EPPICS - - (549) - - 291 3,888 3,339
Conversion of Commonwealth notes - - 1,956 - - 2,508 34,775 36,731
Dividends on common stock of
$1.00 per share - - - (336,025) - - - (336,025)
Shares repurchased - - - - - (17,279) (250,000) (250,000)
Net income - - - 214,654 - - - 214,654
Other comprehensive income,
net of tax and
reclassification adjustments - - - - 3,904 - - 3,904
--------- --------- ------------ -------------- ------------ --------- ----------- -------------
Balance December 31, 2007 349,456 87,364 1,280,508 14,001 (77,995) (21,707) (305,979) 997,899
Stock plans - - (1,759) - - 1,096 15,544 13,785
Acquisition of Commonwealth - - 1 - - 3 38 39
Conversion of EPPICS - - (74) - - 51 664 590
Conversion of Commonwealth notes - - (801) - - 193 2,467 1,666
Dividends on common stock of
$1.00 per share - - (159,939) (158,498) - - - (318,437)
Shares repurchased - - - - - (17,778) (200,000) (200,000)
Net income - - - 182,660 - - - 182,660
Other comprehensive loss,
net of tax and
reclassification adjustments - - - - (159,157) - - (159,157)
--------- --------- ------------ -------------- ------------ --------- ----------- -------------
Balance December 31, 2008 349,456 $ 87,364 $1,117,936 $ 38,163 $ (237,152) (38,142) $ (487,266) $ 519,045
========= ========= ============ ============== ============ ========= =========== =============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 and 2006
($ in thousands)
2008 2007 2006
-------------- -------------- -------------
Net income $ 182,660 $ 214,654 $ 344,555
Other comprehensive (loss) income, net of tax
and reclassification adjustments* (159,157) 3,904 124,977
-------------- -------------- -------------
Total comprehensive income $ 23,503 $ 218,558 $ 469,532
============== ============== =============
* Consists primarily of amortization of pension and postretirement costs and
SFAS No. 158 pension/OPEB liability (see Note 20).
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-7
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 and 2006
($ in thousands)
2008 2007 2006
--------------- --------------- ----------------
Cash flows provided by (used in) operating activities:
Net income $ 182,660 $ 214,654 $ 344,555
Deduct: Gain on sale of discontinued operations, net of tax - - (71,635)
Income from discontinued operations, net of tax - - (18,912)
Adjustments to reconcile income to net cash provided by
operating activities:
Depreciation and amortization expense 561,801 545,856 476,487
Stock based compensation expense 7,788 9,022 10,340
Loss on debt exchange - - 2,433
Loss on extinguishment of debt 6,290 20,186 -
Investment gain - - (61,428)
Other non-cash adjustments (7,044) (7,598) 5,191
Deferred income taxes 33,967 81,011 132,031
Legal settlement - (7,905) -
Change in accounts receivable 9,746 (4,714) 15,333
Change in accounts payable and other liabilities (52,047) (36,257) (3,064)
Change in other current assets (3,895) 7,428 (2,148)
--------------- --------------- ----------------
Net cash provided by continuing operating activities 739,266 821,683 829,183
Cash flows provided from (used by) investing activities:
Capital expenditures (288,264) (315,793) (268,806)
Cash paid for acquisitions (net of cash acquired) - (725,548) -
Proceeds from sale of discontinued operations - - 255,305
Other assets (purchased) distributions received, net 5,489 6,629 67,050
--------------- --------------- ----------------
Net cash (used by) provided from investing activities (282,775) (1,034,712) 53,549
Cash flows provided from (used by) financing activities:
Long-term debt borrowings 135,000 950,000 550,000
Debt issuance costs (857) (12,196) (6,948)
Long-term debt payments (142,480) (946,070) (227,693)
Premium paid to retire debt (6,290) (20,186) -
Settlement of interest rate swaps 15,521 - -
Issuance of common stock 1,398 13,808 27,200
Common stock repurchased (200,000) (250,000) (135,239)
Dividends paid (318,437) (336,025) (323,671)
Repayment of customer advances for construction (3,185) (942) (264)
--------------- --------------- ----------------
Net cash used by financing activities (519,330) (601,611) (116,615)
Cash flows of discontinued operations:
Operating cash flows - - 17,833
Investing cash flows - - (6,593)
Financing cash flows - - -
--------------- --------------- ----------------
Net cash provided by discontinued operations - - 11,240
(Decrease) increase in cash and cash equivalents (62,839) (814,640) 777,357
Cash and cash equivalents at January 1, 226,466 1,041,106 263,749
--------------- --------------- ----------------
Cash and cash equivalents at December 31, $ 163,627 $ 226,466 $ 1,041,106
=============== =============== ================
Cash paid during the period for:
Interest $ 365,858 $ 364,381 $ 332,204
Income taxes $ 78,878 $ 54,407 $ 5,365
Non-cash investing and financing activities:
Change in fair value of interest rate swaps $ 7,909 $ 18,198 $ (1,562)
Conversion of EPPICS $ 590 $ 3,339 $ 15,925
Conversion of Commonwealth notes $ 1,666 $ 36,731 $ -
Debt-for-debt exchange $ - $ - $ 2,433
Shares issued for Commonwealth acquisition $ 39 $ 247,435 $ -
Acquired debt $ - $ 244,570 $ -
Other acquired liabilities $ - $ 112,194 $ -
The accompanying Notes are an integral part of these
Consolidated Financial Statements.
F-8
FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Description of Business and Summary of Significant Accounting Policies:
-----------------------------------------------------------------------
(a) Description of Business:
------------------------
Frontier Communications Corporation (formerly known as Citizens
Communications Company through July 30, 2008) and its subsidiaries are
referred to as "we," "us," "our," or the "Company" in this report. We
are a communications company providing services to rural areas and
small and medium-sized towns and cities as an incumbent local exchange
carrier, or ILEC.
(b) Basis of Presentation and Use of Estimates:
-------------------------------------------
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of
America (U.S. GAAP). Certain reclassifications of balances previously
reported have been made to conform to the current presentation. All
significant intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with U.S. GAAP
requires management to make estimates and assumptions which affect the
reported amounts of assets and liabilities at the date of the
financial statements, the disclosure of contingent assets and
liabilities, and the reported amounts of revenue and expenses during
the reporting period. Actual results may differ from those estimates.
Estimates and judgments are used when accounting for allowance for
doubtful accounts, impairment of long-lived assets, intangible assets,
depreciation and amortization, income taxes, purchase price
allocations, contingencies, and pension and other postretirement
benefits, among others.
(c) Cash Equivalents:
-----------------
We consider all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
(d) Revenue Recognition:
--------------------
Revenue is recognized when services are provided or when products are
delivered to customers. Revenue that is billed in advance includes:
monthly recurring access services, special access services and monthly
recurring local line charges. The unearned portion of this revenue is
initially deferred as a component of other liabilities on our
consolidated balance sheet and recognized in 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 this revenue is recognized in 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.
The Company collects various taxes from its customers and subsequently
remits such funds to governmental authorities. Substantially all of
these taxes are recorded through the consolidated balance sheet and
presented on a net basis in our consolidated statements of operations.
We also collect Universal Service Fund (USF) surcharges from customers
(primarily federal USF) which we have recorded on a gross basis in our
consolidated statements of operations and included in revenue and
other operating expenses at $37.1 million, $35.9 million and $37.1
million for the years ended December 31, 2008, 2007 and 2006,
respectively.
(e) Property, Plant and Equipment:
------------------------------
Property, plant and equipment are stated at original cost or fair
market value for our acquired properties, including capitalized
interest. Maintenance and repairs are charged to operating expenses as
incurred. The gross book value of routine property, plant and
equipment retired is charged against accumulated depreciation.
(f) Goodwill and Other Intangibles:
-------------------------------
Intangibles represent the excess of purchase price over the fair value
of identifiable tangible net assets acquired. We undertake studies to
determine the fair values of assets and liabilities acquired and
F-9
allocate purchase prices to assets and liabilities, including
property, plant and equipment, goodwill and other identifiable
intangibles. We annually (during the fourth quarter) examine the
carrying value of our goodwill and trade name to determine whether
there are any impairment losses and have determined for the year ended
December 31, 2008 that there was no impairment. We test for impairment
at the "operating segment" level, as that term is defined in Statement
of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets." The Company currently has four "operating
segments" which are aggregated into one reportable segment.
SFAS No. 142 requires that intangible assets with estimated useful
lives be amortized over those lives and be reviewed for impairment in
accordance with SFAS No. 144, "Accounting for Impairment or Disposal
of Long-Lived Assets" to determine whether any changes to these lives
are required. We periodically reassess the useful life of our
intangible assets to determine whether any changes to those lives are
required.
(g) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
----------------------------------------------------------------------
Of:
---
We review long-lived assets to be held and used and long-lived assets
to be disposed of, including intangible assets with estimated useful
lives, for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be
recoverable. Recoverability of assets to be held and used is measured
by comparing the carrying amount of the asset to the future
undiscounted net cash flows expected to be generated by the asset.
Recoverability of assets held for sale is measured by comparing the
carrying amount of the assets to their estimated fair market value. If
any assets are considered to be impaired, the impairment is measured
by the amount by which the carrying amount of the assets exceeds the
estimated fair value.
(h) Derivative Instruments and Hedging Activities:
----------------------------------------------
We account for derivative instruments and hedging activities in
accordance with SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended. SFAS No. 133, as amended,
requires that all derivative instruments, such as interest rate swaps,
be recognized in the financial statements and measured at fair value
regardless of the purpose or intent of holding them.
On the date we enter into a derivative contract that qualifies for
hedge accounting, we designate the derivative as either a fair value
or cash flow hedge. A hedge of the fair value of a recognized asset or
liability or of an unrecognized firm commitment is a fair value hedge.
A hedge of a forecasted transaction or the variability of cash flows
to be received or paid related to a recognized asset or liability is a
cash flow hedge. We formally document all relationships between
hedging instruments and hedged items, as well as our risk-management
objective and strategy for undertaking the hedge transaction. This
process includes linking all derivatives that are designated as fair
value or cash flow hedges to specific assets and liabilities on the
balance sheet or to specific firm commitments or forecasted
transactions.
We also formally assess, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items. If it is determined that a derivative
is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, we would discontinue hedge accounting
prospectively.
All derivatives are recognized on the balance sheet at their fair
value. Changes in the fair value of derivative financial instruments
are either recognized in income or shareholders' equity (as a
component of other comprehensive income), depending on whether the
derivative is being used to hedge changes in fair value or cash flows.
As of December 31, 2007, we had interest rate swap arrangements
related to a portion of our fixed rate debt. These arrangements were
all terminated on January 15, 2008. These hedge strategies satisfied
the fair value hedging requirements of SFAS No. 133, as amended. As a
result, the appreciation in value of the swaps through the time of
termination is included in the consolidated balance sheet and is
recognized as lower interest expense over the duration of the
remaining life of the underlying debt.
(i) Investments:
------------
Marketable Securities
We classify our cost method investments at purchase as
available-for-sale. We do not maintain a trading portfolio or
held-to-maturity securities. Our marketable securities are
insignificant.
F-10
Investments in Other Entities
Investments in entities that we do not control, but where we have the
ability to exercise significant influence over operating and financial
policies, are accounted for using the equity method of accounting (see
Note 9).
(j) Income Taxes and Deferred Income Taxes:
---------------------------------------
We file a consolidated federal income tax return. We utilize the asset
and liability method of accounting for income taxes. Under the asset
and liability method, deferred income taxes are recorded for the tax
effect of temporary differences between the financial statement basis
and the tax basis of assets and liabilities using tax rates expected
to be in effect when the temporary differences are expected to
reverse.
(k) Stock Plans:
------------
We have various stock-based compensation plans. Awards under these
plans are granted to eligible officers, management employees,
non-management employees and non-employee directors. Awards may be
made in the form of incentive stock options, non-qualified stock
options, stock appreciation rights, restricted stock, restricted stock
units or other stock-based awards. We have no awards with market or
performance conditions. Our general policy is to issue shares upon the
grant of restricted shares and exercise of options from treasury.
On January 1, 2006, we adopted the provisions of SFAS No. 123 (revised
2004), "Share-Based Payment" (SFAS No. 123R) and elected to use the
modified prospective transition method. The modified prospective
transition method requires that compensation cost be recognized in the
financial statements for all awards granted after the date of adoption
as well as for existing awards for which the requisite service had not
been rendered as of the date of adoption. Compensation cost for awards
that were outstanding at the effective date are recognized over the
remaining service period using the compensation cost previously
calculated for pro forma disclosure purposes.
On November 10, 2005, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position SFAS No. 123R-3, "Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards."
We elected to adopt the alternative transition method provided for
calculating the tax effects of share-based compensation pursuant to
SFAS No. 123R. The alternative transition method includes a simplified
method to establish the beginning balance of the additional paid-in
capital pool (APIC pool) related to the tax effects of employee
share-based compensation, which is available to absorb tax
deficiencies recognized subsequent to the adoption of SFAS No. 123R.
The compensation cost recognized is based on awards ultimately
expected to vest. SFAS No. 123R requires forfeitures to be estimated
and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates.
(l) Net Income Per Common Share Available for Common Shareholders:
--------------------------------------------------------------
Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period being
reported on. Except when the effect would be antidilutive, diluted net
income per common share reflects the dilutive effect of the assumed
exercise of stock options using the treasury stock method at the
beginning of the period being reported on as well as common shares
that would result from the conversion of convertible preferred stock
(EPPICS) and convertible notes. In addition, the related interest on
debt (net of tax) is added back to income since it would not be paid
if the debt was converted to common stock.
(2) Recent Accounting Literature and Changes in Accounting Principles:
------------------------------------------------------------------
Accounting for Endorsement Split-Dollar Life Insurance Arrangements
-------------------------------------------------------------------
In September 2006, the FASB reached consensus on the guidance provided
by Emerging Issues Task Force (EITF) No. 06-4, "Accounting for
Deferred Compensation and Postretirement Benefit Aspects of
Endorsement Split-Dollar Life Insurance Arrangements." The guidance is
applicable to endorsement split-dollar life insurance arrangements,
whereby the employer owns and controls the insurance policies, that
are associated with a postretirement benefit. EITF No. 06-4 requires
that for a split-dollar life insurance arrangement within the scope of
the issue, an employer should recognize a liability for future
benefits in accordance with SFAS No. 106 (if, in substance, a
postretirement benefit plan exists) or Accounting Principles Board
Opinion (APB) No. 12 (if the arrangement is, in substance, an
individual deferred compensation contract) based on the substantive
agreement with the employee. EITF No. 06-4 was effective for fiscal
years beginning after December 15, 2007. Our adoption of the
accounting requirements of EITF No. 06-4 in the first quarter of 2008
had no impact on our financial position, results of operations or cash
flows.
F-11
Fair Value Measurements
-----------------------
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements," which defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value
measurements. In February 2008, the FASB amended SFAS No. 157 to defer
the application of this standard to nonfinancial assets and
liabilities until 2009. The provisions of SFAS No. 157 related to
financial assets and liabilities were effective as of the beginning of
our 2008 fiscal year. Our adoption of SFAS No. 157 in the first
quarter of 2008 had no impact on our financial position, results of
operations or cash flows. We do not expect the adoption of SFAS No.
157, as amended, in the first quarter of 2009 with respect to its
effect on nonfinancial assets and liabilities to have a material
impact on our financial position, results of operations or cash flows.
Nonfinancial assets and liabilities for which we have not applied the
provisions of SFAS No. 157 include those measured at fair value in
impairment testing and those initially measured at fair value in a
business combination.
The Fair Value Option for Financial Assets and Financial Liabilities
----------------------------------------------------------------------
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities - Including an
Amendment of FASB Statement No. 115," which permits entities to choose
to measure many financial instruments and certain other items at fair
value. The provisions of SFAS No. 159 were effective as of the
beginning of our 2008 fiscal year. Our adoption of SFAS No. 159 in the
first quarter of 2008 had no impact on our financial position, results
of operations or cash flows.
Accounting for Collateral Assignment Split-Dollar Life Insurance
----------------------------------------------------------------------
Arrangements
------------
In March 2007, the FASB ratified the consensus reached by the EITF on
Issue No. 06-10, "Accounting for Collateral Assignment Split-Dollar
Life Insurance Arrangements." EITF No. 06-10 provides guidance on an
employers' recognition of a liability and related compensation costs
for collateral assignment split-dollar life insurance arrangements
that provide a benefit to an employee that extends into postretirement
periods, and the asset in collateral assignment split-dollar life
insurance arrangements. EITF No. 06-10 was effective for fiscal years
beginning after December 15, 2007. Our adoption of the accounting
requirements of EITF No. 06-10 in the first quarter of 2008 had no
impact on our financial position, results of operations or cash flows.
Accounting for the Income Tax Benefits of Dividends on Share-Based
----------------------------------------------------------------------
Payment Awards
--------------
In June 2007, the FASB ratified EITF No. 06-11, "Accounting for the
Income Tax Benefits of Dividends on Share-Based Payment Awards." EITF
No. 06-11 provides that tax benefits associated with dividends on
share-based payment awards be recorded as a component of additional
paid-in capital. EITF No. 06-11 was effective, on a prospective basis,
for fiscal years beginning after December 15, 2007. The implementation
of this standard in the first quarter of 2008 had no material impact
on our financial position, results of operations or cash flows.
Business Combinations
---------------------
In December 2007, the FASB revised SFAS No. 141, "Business
Combinations." The revised statement, SFAS No. 141R, requires an
acquiring entity to recognize all the assets acquired and liabilities
assumed in a transaction at the acquisition date at fair value, to
remeasure liabilities related to contingent consideration at fair
value in each subsequent reporting period and to expense all
acquisition related costs. The effective date of SFAS No. 141R is for
business combinations for which the acquisition date is on or after
the beginning of the first annual reporting period beginning on or
after December 15, 2008. This standard does not impact our currently
reported results and we do not expect the adoption of SFAS No. 141R in
the first quarter of 2009 to have a material impact on our financial
position, results of operations or cash flows.
Noncontrolling Interests in Consolidated Financial Statements
-------------------------------------------------------------
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements." SFAS No. 160
establishes requirements for ownership interest in subsidiaries held
by parties other than the Company (sometimes called "minority
interest") be clearly identified, presented and disclosed in the
consolidated statement of financial position within shareholder
equity, but separate from the parent's equity. All changes in the
parent's ownership interest are required to be accounted for
consistently as equity transactions and any noncontrolling equity
F-12
investments in unconsolidated subsidiaries must be measured initially
at fair value. SFAS No. 160 is effective, on a prospective basis, for
fiscal years beginning after December 15, 2008. However, presentation
and disclosure requirements must be retrospectively applied to
comparative financial statements. We do not expect the adoption of
SFAS No. 160 in the first quarter of 2009 to have a material impact on
our financial position, results of operations or cash flows.
The Hierarchy of Generally Accepted Accounting Principles
---------------------------------------------------------
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles." This standard identifies the sources
of accounting principles and the framework for selecting the
principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with U.S.
GAAP. The effective date of SFAS No. 162 was November 15, 2008. Our
adoption of SFAS No. 162 during the fourth quarter of 2008 did not
result in any changes to our current accounting practices or policies
and thereby has not impacted the preparation of the consolidated
financial statements.
Determining Whether Instruments Granted in Share-Based Payment
----------------------------------------------------------------------
Transactions are Participating Securities
-----------------------------------------
In June 2008, the FASB ratified FSP EITF 03-6-1, "Determining Whether
Instruments Granted in Share-Based Payment Transactions are
Participating Securities." FSP EITF 03-6-1 addresses whether
instruments granted in share-based payment transactions are
participating securities prior to vesting and, therefore, should be
included in the earnings allocation in computing earnings per share
under the two-class method. FSP EITF 03-6-1 is effective, on a
retrospective basis, for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods within those
years. The Company has concluded that our outstanding non-vested
restricted stock is a participating security in accordance with FSP
EITF 03-6-1 and that we will be required to adjust our previously
reported basic and diluted income per common share. The Company
expects that our adoption of FSP EITF 03-6-1 in the first quarter of
2009 will increase our weighted average shares outstanding and will
reduce our basic and diluted income per common share from that
previously reported.
Employers' Disclosures about Postretirement Benefit Plan Assets
---------------------------------------------------------------
In December 2008, the FASB issued FSP SFAS 132 (R)-1, "Employers'
Disclosures about Postretirement Benefit Plan Assets." FSP SFAS 132
(R)-1 amends SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits," to provide guidance on an employers'
disclosures about plan assets of a defined benefit pension or other
postretirement plan. FSP SFAS 132 (R)-1 requires additional
disclosures about investment policies and strategies, categories of
plan assets, fair value measurements of plan assets and significant
concentrations of risk. The disclosures about plan assets required by
FSP SFAS 132 (R)-1 are effective for fiscal years ending after
December 15, 2009. We do not expect the adoption of FSP SFAS 132 (R)-1
to have a material impact on our financial position, results of
operations or cash flows. We will adopt the disclosure requirements of
FSP SFAS 132 (R)-1 in the annual report for our fiscal year ending
December 31, 2009.
(3) Acquisition of Commonwealth Telephone and Global Valley Networks:
-----------------------------------------------------------------
On March 8, 2007, we acquired Commonwealth Telephone Enterprises, Inc.
("Commonwealth" or "CTE") in a cash-and-stock taxable transaction, for a
total consideration of approximately $1.1 billion. We paid $804.1 million
in cash ($663.7 million net, after cash acquired) and issued common stock
with a value of $249.8 million.
On October 31, 2007, we acquired Global Valley Networks, Inc. and GVN
Services (together GVN) through the purchase from Country Road
Communications, LLC of 100% of the outstanding common stock of Evans
Telephone Holdings, Inc., the parent Company of GVN. The purchase price of
$62.0 million was paid with cash on hand.
We have accounted for the acquisitions of Commonwealth and GVN as purchases
under U.S. GAAP. Under the purchase method of accounting, the assets and
liabilities of Commonwealth and GVN are recorded as of their respective
acquisition dates, at their respective fair values, and consolidated with
those of Frontier. The reported consolidated financial condition of
Frontier as of December 31, 2008, reflects the final allocation of these
fair values for Commonwealth and GVN.
F-13
The following schedule provides a summary of the final purchase price paid
by Frontier in the acquisitions of Commonwealth and GVN:
($ in thousands)
---------------- Commonwealth GVN
------------------ ---------------
Cash paid $ 804,085 $ 62,001
Value of Frontier common stock issued 249,804 -
Accrued closing costs 469 -
------------------ ---------------
Total Purchase Price $ 1,054,358 $ 62,001
================== ===============
With respect to our acquisitions of Commonwealth and GVN, the purchase
price has been allocated based on fair values to the net tangible and
intangible assets acquired and liabilities assumed. The final allocations
are as follows:
($ in thousands)
----------------
Commonwealth GVN
------------------ ---------------
Allocation of purchase price:
Current assets (1) $ 187,986 $ 1,581
Property, plant and equipment 387,343 23,578
Goodwill 690,262 34,311
Other intangibles 273,800 7,250
Other assets 11,285 812
Current portion of debt (35,000) (17)
Accounts payable and other current liabilities (80,375) (626)
Deferred income taxes (143,539) (3,740)
Convertible notes (209,553) -
Other liabilities (27,851) (1,148)
------------------ ---------------
Total Purchase Price $ 1,054,358 $ 62,001
================== ===============
(1) Includes $140.6 million of total acquired cash.
F-14
The following unaudited pro forma financial information presents the
combined results of operations of Frontier, Commonwealth and GVN as if the
acquisitions had occurred at the beginning of each period presented. The
historical results of the Company include the results of Commonwealth from
the date of its acquisition on March 8, 2007, and GVN from the date of its
acquisition on October 31, 2007. The pro forma information is not
necessarily indicative of what the financial position or results of
operations actually would have been had the acquisitions been completed at
the beginning of each period presented. In addition, the unaudited pro
forma financial information does not purport to project the future
financial position or operating results of Frontier after completion of the
acquisitions.
2007 2006
-------------- ---------------
($ in thousands, except per share amounts)
------------------------------------------
Revenue $ 2,362,695 $ 2,371,143
Operating income $ 720,476 $ 717,312
Income from continuing operations $ 218,428 $ 285,434
Income from discontinued operations $ - $ 90,547
Net income available for common shareholders $ 218,428 $ 375,981
Basic income per common share:
Income from continuing operations $ 0.66 $ 0.83
Income from discontinued operations - 0.26
-------------- ---------------
Net income per common share $ 0.66 $ 1.09
============== ===============
Diluted income per common share:
Income from continuing operations $ 0.66 $ 0.83
Income from discontinued operations - 0.26
-------------- ---------------
Net income per common share $ 0.66 $ 1.09
============== ===============
(4) Property, Plant and Equipment:
------------------------------
The components of property, plant and equipment at December 31, 2008 and
2007 are as follows:
Estimated
($ in thousands) Useful Lives 2008 2007
---------------- ------------------- ----------------- ------------------
Land N/A $ 22,631 $ 23,347
Buildings and leasehold improvements 41 years 344,839 343,826
General support 5 to 17 years 508,825 492,771
Central office/electronic circuit equipment 5 to 11 years 2,959,440 2,855,645
Cable and wire 15 to 60 years 3,623,193 3,484,838
Other 20 to 30 years 24,703 46,620
Construction work in progress 97,429 128,250
----------------- ------------------
7,581,060 7,375,297
Less: Accumulated depreciation (4,341,087) (4,040,053)
----------------- ------------------
Property, plant and equipment, net $ 3,239,973 $ 3,335,244
================= ==================
Depreciation expense is principally based on the composite group method.
Depreciation expense was $379.5 million, $374.4 million and $350.1 million
for the years ended December 31, 2008, 2007 and 2006, respectively.
Effective with the completion of an independent study of the estimated
useful lives of our plant assets we adopted new lives beginning October 1,
2008.
F-15
(5) Retained Earnings - Cumulative Effect Adjustment:
-------------------------------------------------
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB)
Topic 1N (SAB No. 108), "Financial Statements - Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements". SAB No. 108 provides guidance on how prior year
misstatements should be taken into consideration when quantifying
misstatements in current year financial statements for purposes of
determining whether the financial statements are materially misstated.
Under this guidance, companies should take into account both the effect of
a misstatement on the current year balance sheet as well as the impact upon
the current year income statement in assessing the materiality of a current
year misstatement. Once a current year misstatement has been quantified,
the guidance in SAB Topic 1M, "Financial Statements Materiality," (SAB No.
99) will be applied to determine whether the misstatement is material.
SAB No. 108 allowed for a one-time transitional cumulative effect
adjustment to retained earnings as of January 1, 2006 for errors that were
not previously deemed material as they were being evaluated under a single
method but were material when evaluated under the dual approach prescribed
by SAB No. 108. The Company adopted SAB No. 108 in connection with the
preparation of its financial statements for the year ended December 31,
2006. The adoption did not have any impact on the Company's cash flow or
prior year financial statements. As a result of adopting SAB No. 108 in the
fourth quarter of 2006 and electing to use the one-time transitional
cumulative effect adjustment, the Company made adjustments to the beginning
balance of retained earnings as of January 1, 2006 in the fourth quarter of
2006 for the following errors (all of which were determined to be
immaterial under the Company's previous methodology):
Summary of SAB No. 108 entry recorded January 1, 2006:
Increase/
($ in thousands) (Decrease)
---------------- --------------
Property, Plant & Equipment $ 1,990
Goodwill (3,716)
Other Assets (20,081)
--------------
$ (21,807)
==============
Current Liabilities $ (2,922)
Deferred Taxes (17,339)
Other Long-Term Liabilities (13,037)
Long-Term Debt (24,901)
Retained Earnings 36,392
--------------
$ (21,807)
==============
Deferred Tax Accounting. As a result of adopting SAB No. 108 in the fourth
quarter of 2006 we recorded a decrease in deferred income tax liabilities
in the amount of approximately $23.5 million and an increase in retained
earnings of approximately $23.5 million as of January 1, 2006. The change
in deferred tax and retained earnings is a result of excess deferred tax
liabilities that built up in periods prior to 2004 (approximately $4
million in 2003, $5.4 million in 2002 and $14.1 million in 2001 and prior),
resulting primarily from differences between actual state income tax rates
and the effective composite state rate utilized for estimating the
Company's book state tax provisions.
Goodwill. During 2002, we estimated and booked impairment charges (pre-tax)
of $1.07 billion. We subsequently discovered that the impairment charge
recorded was overstated as it exceeded the underlying book value by
approximately $8.1 million. The result was an understatement of goodwill.
We corrected this error by reversing the negative goodwill balance of $8.1
million with an offset to increase retained earnings.
F-16
Unrecorded Liabilities. The Company changed its accounting policies
associated with the accrual of utilities and vacation expense.
Historically, the Company's practice was to expense utility and vacation
costs in the period these items were paid, which generally resulted in a
full year of utilities and vacation expense in the consolidated statements
of operations. The utility costs are now accrued in the period used and
vacation costs are accrued in the period earned. The cumulative amount of
these changes as of the beginning of fiscal 2006 was approximately $3.0
million and, as provided in SAB No. 108, the impact was recorded as a
reduction of retained earnings as of the beginning of fiscal 2006.
We established an accrual of $4.5 million for advance billings associated
with certain revenue at two telephone properties that the Company operated
since the 1930's. For these two properties, the Company's records have not
reflected the liability. This had no impact on the revenue reported for any
of the five years reported in this Form 10-K.
We recorded a long-term liability of $2.5 million to recognize a
postretirement annuity payment obligation for two former executives of the
Company. The liability should have been established in 1999 at the time the
two employees elected to exchange their death benefit rights for an annuity
payout in accordance with the terms of their respective split-dollar life
insurance agreements. We established the liability effective January 1,
2006 in accordance with SAB No. 108 by reducing retained earnings by a like
amount.
Long-Term Debt. We recorded a reclassification of $20.1 million from other
assets to long-term debt. The amount represents debt discounts which the
Company historically accounted for as a deferred asset. For certain debt
issuances the Company amortized the debt discount using the straight line
method instead of the effective interest method. We corrected this error by
increasing the debt discount by $4.8 million and increasing retained
earnings by a like amount.
Customer Advances for Construction. Amounts associated with "construction
advances" remaining on the Company's balance sheet ($92.4 million at
December 31, 2005) included approximately $7.3 million of such contract
advances that were transferred to the purchaser of our water and wastewater
operations on January 15, 2002 and accordingly should have been included in
the gain recognized upon sale during that period. Upon the adoption of SAB
No. 108 in the fourth quarter of 2006, this error was corrected as of
January 1, 2006 through a decrease in other long-term liabilities and an
increase in retained earnings.
Purchase Accounting. During the period 1991 to 2001, Frontier acquired a
number of telecommunications businesses, growing its asset base from
approximately $400.0 million in 1991 to approximately $6.0 billion by the
end of 2001. As a result of these acquisitions, we recorded in accordance
with purchase accounting standards, all of the assets and liabilities
associated with these properties. We have determined that approximately
$18.8 million (net) of liabilities were established in error. Approximately
$18.0 million of the liabilities should have been recorded as a decrease to
goodwill and $4.2 million should have been an increase to property, plant
and equipment ($1.99 million after amortization of $2.21 million). In
addition, $4.964 million of liabilities should have been reversed in 2001.
We corrected this error by reversing the liability to retained earnings.
As permitted by the adoption of SAB No. 108, we have adjusted our
previously recorded acquisition entries as follows:
Increase/
($ in thousands) (Decrease)
---------------- --------------
Property, Plant & Equipment $ 1,990
Goodwill (18,049)
--------------
$ (16,059)
==============
Current Liabilities $ (10,468)
Other Long-Term Liabilities (8,345)
Retained Earnings 2,754
--------------
$ (16,059)
==============
F-17
Tax Effect. The net effect on taxes (excluding the $23.5 million entry
described above) resulting from the adoption of SAB No. 108 was an increase
to deferred tax liabilities of $6.2 million and an increase to goodwill of
$6.2 million.
(6) Accounts Receivable:
--------------------
The components of accounts receivable, net at December 31, 2008 and 2007
are as follows:
($ in thousands) 2008 2007
---------------- -------------- ---------------
End user $ 244,395 $ 244,592
Other 17,977 22,918
Less: Allowance for doubtful accounts (40,125) (32,748)
-------------- ---------------
Accounts receivable, net $ 222,247 $ 234,762
============== ===============
An analysis of the activity in the allowance for doubtful accounts for the
years ended December 31, 2008, 2007 and 2006 is as follows:
Additions
--------------------------------------------
Balance at Balance of Charged to Charged to other Balance at
beginning of acquired bad debt accounts - end of
Allowance for doubtful accounts Period properties expense* Revenue Deductions Period
------------------------------- ------------- ----------- ------------ ----------------- ------------ -------------
2006 $ 31,385 $ - $ 20,257 $ 80,003 $ 23,108 $ 108,537
2007 108,537 1,499 31,131 (77,898) 30,521 32,748
2008 32,748 1,150 31,700 2,352 27,825 40,125
----------------------------------------------------------------------------------------------------------------------
* Such amounts are included in bad debt expense and for financial reporting
purposes are classified as contra-revenue.
We maintain an allowance for estimated bad debts based on our estimate of
collectability of our accounts receivable. Bad debt expense is recorded as
a reduction to revenue.
Our allowance for doubtful accounts increased by approximately $78.3
million in 2006 as a result of carrier activity that was in dispute. Our
allowance for doubtful accounts (and "end user" receivables) declined from
December 31, 2006, primarily as a result of the resolution of our principal
carrier dispute. On March 12, 2007, we entered into a settlement agreement
with a carrier pursuant to which we were paid $37.5 million, resulting in a
favorable impact on our revenue in the first quarter of 2007 of $38.7
million.
(7) Other Intangibles:
------------------
The components of other intangibles at December 31, 2008 and 2007 are as
follows:
($ in thousands) 2008 2007
---------------- --------------- ----------------
Customer base $ 1,265,052 $ 1,271,085
Trade name 132,664 132,381
--------------- ----------------
Other intangibles 1,397,716 1,403,466
Less: Accumulated amortization (1,038,042) (855,731)
--------------- ----------------
Total other intangibles, net $ 359,674 $ 547,735
=============== ================
Amortization expense was $182.3 million, $171.4 million and $126.4 million
for the years ended December 31, 2008, 2007 and 2006, respectively.
Amortization expense for 2008 is comprised of $126.3 million for
amortization associated with our "legacy" Frontier properties and $56.0
million for intangible assets (customer base and trade name) that were
acquired in the Commonwealth and Global Valley acquisitions. As of December
31, 2008, $263.5 million has been allocated to the customer base (five year
life) and $10.3 million to the trade name (five year life) acquired in the
Commonwealth acquisition, and $7.3 million to the customer base (five year
life) acquired in the Global Valley acquisition. Amortization expense,
based on our estimate of useful lives, is estimated to be $113.9 million in
2009, $56.2 million in 2010 and 2011 and $11.3 million in 2012.
F-18
(8) Discontinued Operations:
------------------------
Electric Lightwave
------------------
On July 31, 2006, we sold our CLEC business, Electric Lightwave, LLC
(ELI), for $255.3 million (including a later sale of associated real
estate) in cash plus the assumption of approximately $4.0 million in
capital lease obligations. We recognized a pre-tax gain on the sale of
ELI of approximately $116.7 million. Our after-tax gain on the sale
was $71.6 million. Our cash liability for taxes as a result of the
sale was approximately $5.0 million due to the utilization of existing
tax net operating losses on both the Federal and state level.
In accordance with SFAS No. 144, any component of our business that we
dispose of, or classify as held for sale, that has operations and cash
flows clearly distinguishable from continuing operations for financial
reporting purposes, and that will be eliminated from the ongoing
operations, should be classified as discontinued operations.
Accordingly, we have classified the results of operations of ELI as
discontinued operations in our consolidated statements of operations.
We ceased to record depreciation expense for ELI effective February
2006.
Summarized financial information for ELI for the year ended December
31, 2006 is set forth below:
($ in thousands)
---------------- 2006
-----------------
Revenue $ 100,612
Operating income $ 27,882
Income taxes $ 11,583
Net income $ 18,912
Gain on disposal of ELI, net of tax $ 71,635
(9) Investments:
------------
Investments at December 31, 2008 and 2007 include equity method investments
of $8,044 and $21,191, respectively. Our investments in entities that are
accounted for under the equity method of accounting consist of the
following: (1) a 50% interest in the C-Don Partnership, acquired in the
purchase of Commonwealth, which publishes, manufactures and distributes
classified telephone directories in the Commonwealth service territory; (2)
a 16.8% interest in the Fairmount Cellular Limited Partnership which is
engaged in cellular mobile telephone service in the Rural Service Area
(RSA) designated by the FCC as Georgia RSA No. 3; and (3) our investments
in CU Capital and CU Trust with relation to our convertible preferred
securities that were fully redeemed in the fourth quarter of 2008.
(10) Fair Value of Financial Instruments:
------------------------------------
The following table summarizes the carrying amounts and estimated fair
values for certain of our financial instruments at December 31, 2008 and
2007. For the other financial instruments, representing cash, accounts
receivables, long-term debt due within one year, accounts payable and other
accrued liabilities, the carrying amounts approximate fair value due to the
relatively short maturities of those instruments. Other equity method
investments for which market values are not readily available are carried
at cost, which approximates fair value.
F-19
The fair value of our long-term debt is estimated based on quoted market
prices at the reporting date for those financial instruments.
($ in thousands) 2008 2007
---------------- ----------------------------------- ---------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- ------------------ ---------------- ----------------
Long-term debt (1) $ 4,721,685 $ 3,651,924 $ 4,736,897 $ 4,708,217
(1) 2007 includes interest rate swaps of $7.9 million and EPPICS of $14.5
million.
(11) Long-Term Debt:
---------------
The activity in our long-term debt from December 31, 2007 to December 31,
2008 is summarized as follows:
Year Ended December 31, 2008
-----------------------------------------------------------------
Reclassification Interest
Interest of Rate* at
December 31, New Rate Conversion to Related Party December 31, December 31,
($ in thousands) 2007 Payments Borrowings Swap Common Stock Debt 2008 2008
---------------- -------------- ---------- ----------- ---------- --------------- ---------------- ------------- ----------
Rural Utilities Service
Loan Contracts $ 17,555 $ (948) $ - $ - $ - $ - $ 16,607 6.07%
Senior Unsecured Debt 4,715,013 (138,107) 135,000 (7,909) (1,666) - 4,702,331 7.54%
EPPICS (see Note 15) 14,521 (3,425) - - (590) (10,506) -
Industrial Development
Revenue Bonds 13,550 - - - - - 13,550 6.31%
-------------- ----------- ----------- ---------- --------------- ---------------- -------------
TOTAL LONG-TERM DEBT $ 4,760,639 $(142,480) $135,000 $(7,909) $(2,256) $(10,506) $4,732,488 7.54%
============== =========== =========== ========== =============== ================ =============
Less: Debt Discount (21,294) (6,946)
Less: Current Portion (2,448) (3,857)
-------------- -------------
$ 4,736,897 $4,721,685
============== =============
* Interest rate includes amortization of debt issuance costs, debt premiums
or discounts, and deferred gain on interest rate swap terminations. The
interest rates for Rural Utilities Service Loan Contracts, Senior Unsecured
Debt, and Industrial Development Revenue Bonds represent a weighted average
of multiple issuances.
F-20
Additional information regarding our Senior Unsecured Debt at December 31:
2008 2007
---------------------------------- ------------------------------------
Principal Interest Principal Interest
($ in thousands) Outstanding Rate Outstanding Rate
---------------- ---------------- ------------- ----------------- ---------------
Senior Notes:
Due 5/15/2011 $ 921,276 9.250% $ 1,050,000 9.250%
Due 10/24/2011 200,000 6.270% 200,000 6.270%
Due 12/31/2012 147,000 2.448% (Variable) 148,500 6.750% (Variable)
Due 1/15/2013 700,000 6.250% 700,000 6.250%
Due 12/31/2013 133,988 2.250% (Variable) -
Due 3/15/2015 300,000 6.625% 300,000 6.625%
Due 3/15/2019 450,000 7.125% 450,000 7.125%
Due 1/15/2027 400,000 7.875% 400,000 7.875%
Due 8/15/2031 945,325 9.000% 945,325 9.000%
---------------- -----------------
4,197,589 4,193,825
Debentures due 2025 - 2046 468,742 7.137% 468,742 7.137%
Subsidiary Senior
Notes due 12/1/2012 36,000 8.050% 36,000 8.050%
CTE Convertible Notes due 7/23/2023 - 8,537 3.250%
Fair value of interest rate swaps - 7,909
---------------- -----------------
Total $ 4,702,331 $ 4,715,013
================ =================
During 2008, we retired an aggregate principal amount of $144.7 million of
debt, consisting of $128.7 million of 9.25% Senior Notes due 2011, $12.0
million of other senior unsecured debt and rural utilities service loan
contracts, and $4.0 million of 5% Company Obligated Mandatorily Redeemable
Convertible Preferred Securities due 2036 (EPPICS).
On March 28, 2008, we borrowed $135.0 million under a senior unsecured term
loan facility that was established on March 10, 2008. The loan matures in
2013 and bears interest of 2.250% as of December 31, 2008 based on the
prime rate or LIBOR, at our election, plus a margin which varies depending
on our debt leverage ratio. We used the proceeds to repurchase, during the
first quarter of 2008, $128.7 million principal amount of our 9.25% Senior
Notes due 2011 and to pay for the $6.3 million of premium on early
retirement of these notes.
As of December 31, 2008, EPPICS representing a total principal amount of
$197.8 million have been converted into 15,969,645 shares of our common
stock. There were no outstanding EPPICS as of December 31, 2008. As a
result of the redemption of all outstanding EPPICS as of December 31, 2008,
the $10.5 million in debt with related parties was reclassified by the
Company against an offsetting investment.
As of December 31, 2008, we had an available line of credit with seven
financial institutions in the aggregate amount of $250.0 million.
Associated facility fees vary, depending on our debt leverage ratio, and
were 0.225% per annum as of December 31, 2008. The expiration date for this
$250.0 million five year revolving credit agreement is May 18, 2012. During
the term of the credit facility we may borrow, repay and reborrow funds,
subject to customary borrowing conditions. The credit facility is available
for general corporate purposes but may not be used to fund dividend
payments.
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with
our Senior Notes due in 2011 and 2013. Cash proceeds on the swap
terminations of approximately $15.5 million were received in January 2008.
The related gain has been deferred on the consolidated balance sheet, and
is being amortized into interest expense over the term of the associated
debt.
During 2007, we retired an aggregate principal amount of $967.2 million of
debt, including $3.3 million of EPPICS and $17.8 million of 3.25%
Commonwealth convertible notes that were converted into our common stock.
As further described below, we temporarily borrowed and repaid $200.0
million during the month of March 2007, utilized to temporarily fund our
acquisition of Commonwealth.
F-21
In connection with the acquisition of Commonwealth, we assumed $35.0
million of debt under a revolving credit facility and approximately $191.8
million face amount of Commonwealth convertible notes (fair value of
approximately $209.6 million). During March 2007, we paid down the $35.0
million credit facility, and through December 31, 2007, we retired
approximately $183.3 million face amount (for which we paid $165.4 million
in cash and $36.7 million in common stock) of the convertible notes
(premium paid of $18.9 million was recorded as $17.8 million to goodwill
and $1.1 million to other income (loss), net). The remaining outstanding
balance of $8.5 million was fully redeemed in the fourth quarter of 2008.
On March 23, 2007, we issued in a private placement an aggregate $300.0
million principal amount of 6.625% Senior Notes due 2015 and $450.0 million
principal amount of 7.125% Senior Notes due 2019. Proceeds from the sale
were used to pay down $200.0 million principal amount of indebtedness
borrowed on March 8, 2007 under a bridge loan facility in connection with
the acquisition of Commonwealth, and redeem, on April 26, 2007, $495.2
million principal amount of our 7.625% Senior Notes due 2008.
During the first quarter of 2007, we incurred and expensed approximately
$4.1 million of fees associated with the bridge loan facility established
to temporarily fund our acquisition of Commonwealth. In the second quarter
of 2007, we completed an exchange offer (to publicly register the debt) on
the $750.0 million in total of private placement notes described above, in
addition to the $400.0 million principal amount of 7.875% Senior Notes
issued in a private placement on December 22, 2006, for registered Senior
Notes due 2027. On April 26, 2007, we redeemed $495.2 million principal
amount of our 7.625% Senior Notes due 2008 at a price of 103.041% plus
accrued and unpaid interest. The debt retirement generated a pre-tax loss
on the early extinguishment of debt at a premium of approximately $16.3
million in the second quarter of 2007 and is included in other income
(loss), net. As a result of this debt redemption, we also terminated three
interest rate swap agreements hedging an aggregate $150.0 million notional
amount of indebtedness. Payments on the swap terminations of approximately
$1.0 million were made in the second quarter of 2007.
For the year ended December 31, 2006, we retired an aggregate principal
amount of $251.0 million of debt, including $15.9 million of EPPICS that
were converted into our common stock.
During the first quarter of 2006, we entered into two debt-for-debt
exchanges of our debt securities. As a result, $47.5 million of our 7.625%
notes due 2008 were exchanged for approximately $47.4 million of our 9.00%
notes due 2031. During the fourth quarter of 2006, we entered into four
debt-for-debt exchanges and exchanged $157.3 million of our 7.625% notes
due 2008 for $149.9 million of our 9.00% notes due 2031. The 9.00% notes
are callable on the same general terms and conditions as the 7.625% notes
exchanged. No cash was exchanged in these transactions. However, with
respect to the first quarter debt exchanges, a non-cash pre-tax loss of
approximately $2.4 million was recognized in accordance with EITF No.
96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," which is included in other income (loss), net, for the year
ended December 31, 2006.
On June 1, 2006, we retired at par our entire $175.0 million principal
amount of 7.60% Debentures due June 1, 2006.
On June 14, 2006, we repurchased $22.7 million of our 6.75% Senior Notes
due August 17, 2006 at a price of 100.181% of par.
On August 17, 2006, we retired at par the $29.1 million remaining balance
of the 6.75% Senior Notes.
On December 22, 2006, we issued in a private placement, an aggregate $400.0
million principal amount of 7.875% Senior Notes due January 15, 2027.
Proceeds from the sale were used to partially finance the Commonwealth
acquisition.
In December 2006, we borrowed $150.0 million under a senior unsecured term
loan agreement. The loan matures in 2012 and bears interest based on an
average prime rate or London Interbank Offered Rate or LIBOR plus 1 3/8%,
at our election. Proceeds were used to partially finance the Commonwealth
acquisition.
As of December 31, 2008 we were in compliance with all of our debt and
credit facility covenants.
F-22
Our principal payments for the next five years are as follows:
Principal
($ in thousands) Payments
---------------- ---------------
2009 $ 3,857
2010 $ 7,236
2011 $ 1,125,143
2012 $ 180,366
2013 $ 829,131
(12) Derivative Instruments and Hedging Activities:
----------------------------------------------
Interest rate swap agreements were used to hedge a portion of our debt that
is subject to fixed interest rates. Under our interest rate swap
agreements, we agreed to pay an amount equal to a specified variable rate
of interest times a notional principal amount, and to receive in return an
amount equal to a specified fixed rate of interest times the same notional
principal amount. The notional amounts of the contracts were not exchanged.
No other cash payments are made unless the agreement is terminated prior to
maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination and represents the
market value, at the then current rate of interest, of the remaining
obligations to exchange payments under the terms of the contracts.
On January 15, 2008, we terminated all of our interest rate swap agreements
representing $400.0 million notional amount of indebtedness associated with
our Senior Notes due in 2011 and 2013. Cash proceeds on the swap
terminations of approximately $15.5 million were received in January 2008.
The related gain has been deferred on the consolidated balance sheet, and
is being amortized into interest expense over the term of the associated
debt. For the year ended December 31, 2008, we recognized $5.0 million of
deferred gain and anticipate recognizing $3.4 million during 2009.
As of January 16, 2008, we no longer have any derivative instruments. The
following disclosure is necessary to understand our historical financial
statements.
The interest rate swap contracts are reflected at fair value in our
consolidated balance sheets and the related portion of fixed-rate debt
being hedged is reflected at an amount equal to the sum of its book value
and an amount representing the change in fair value of the debt obligations
attributable to the interest rate risk being hedged. Changes in the fair
value of interest rate swap contracts, and the offsetting changes in the
adjusted carrying value of the related portion of the fixed-rate debt being
hedged, are recognized in the consolidated statements of operations in
interest expense. The notional amounts of interest rate swap contracts
hedging fixed-rate indebtedness as of December 31, 2007 was $400.0 million.
Such contracts required us to pay variable rates of interest (average pay
rates of approximately 8.54% as of December 31, 2007) and receive fixed
rates of interest (average receive rates of 8.50% as of December 31, 2007).
The fair value of these derivatives is reflected in other assets as of
December 31, 2007 in the amount of $7.9 million. The related underlying
debt was increased in 2007 by a like amount. For the years ended December
31, 2007 and 2006, the interest expense resulting from these interest rate
swaps totaled approximately $2.4 million and $4.2 million, respectively.
F-23
(13) Investment Income:
------------------
The components of investment income for the years ended December 31, 2008,
2007 and 2006 are as follows:
($ in thousands) 2008 2007 2006
---------------- ---------------- ---------------- ----------------
Interest and dividend income $ 10,928 $ 32,986 $ 22,172
Gain from Rural Telephone Bank
dissolution - - 61,428
Equity earnings/minority interest
in joint ventures, net 3,576 2,795 (4,164)
---------------- ---------------- ----------------
Total investment income $ 14,504 $ 35,781 $ 79,436
================ ================ ================
(14) Other Income (Loss), net:
-------------------------
The components of other income (loss), net for the years ended December 31,
2008, 2007 and 2006 are as follows:
($ in thousands) 2008 2007 2006
---------------- ----------------- ----------------- -----------------
Bridge loan fee $ - $ (4,069) $ -
Premium on debt repurchases (6,290) (18,217) -
Legal fees and settlement costs (1,037) - (1,000)
Gain on expiration/settlement of customer advances, net 4,520 2,031 3,539
Loss on exchange of debt - - (2,433)
Gain on forward rate agreements - - 430
Other, net (2,363) 2,422 2,471
----------------- ----------------- -----------------
Total other income (loss), net $ (5,170) $ (17,833) $ 3,007
================= ================= =================
During the first quarter of 2008, we retired certain debt and recognized a
pre-tax loss of $6.3 million on the early extinguishment of debt at a
premium, mainly for the 9.25% Senior Notes due 2011. During the first
quarter of 2007, we incurred $4.1 million of fees associated with a bridge
loan facility. In 2007, we retired certain debt and recognized a pre-tax
loss of $18.2 million on the early extinguishment of debt at a premium,
mainly for the 7.625% Senior Notes due 2008. During 2008, 2007 and 2006, we
recognized income of $4.5 million, $2.0 million and $3.5 million,
respectively, in connection with certain retained liabilities, that have
terminated, associated with customer advances for construction from our
disposed water properties. During 2008 and 2006, we recorded legal fees and
settlement costs in connection with the Bangor, Maine legal matter of $1.0
million in each year. In connection with our exchange of debt during the
first quarter of 2006, we recognized a non-cash, pre-tax loss of $2.4
million. 2006 also includes a gain for the changes in fair value of our
forward rate agreements of $0.4 million.
F-24
(15) Company Obligated Mandatorily Redeemable Convertible Preferred Securities:
--------------------------------------------------------------------------
As of December 31, 2008, we fully redeemed the EPPICS related debt
outstanding to third parties. The following disclosure provides the history
regarding this issue.
In 1996, our consolidated wholly-owned subsidiary, Citizens Utilities Trust
(the Trust), issued, in an underwritten public offering, 4,025,000 shares
of EPPICS, representing preferred undivided interests in the assets of the
Trust, with a liquidation preference of $50 per security (for a total
liquidation amount of $201.3 million). These securities had an adjusted
conversion price of $11.46 per share of our common stock. The conversion
price was reduced from $13.30 to $11.46 during the third quarter of 2004 as
a result of the $2.00 per share of common stock special, non-recurring
dividend. The proceeds from the issuance of the Trust Convertible Preferred
Securities and a Company capital contribution were used to purchase $207.5
million aggregate liquidation amount of 5% Partnership Convertible
Preferred Securities due 2036 from another wholly-owned subsidiary,
Citizens Utilities Capital L.P. (the Partnership). The proceeds from the
issuance of the Partnership Convertible Preferred Securities and a Company
capital contribution were used to purchase from us $211.8 million aggregate
principal amount of 5% Convertible Subordinated Debentures due 2036. The
sole assets of the Trust were the Partnership Convertible Preferred
Securities, and our Convertible Subordinated Debentures were substantially
all the assets of the Partnership. Our obligations under the agreements
related to the issuances of such securities, taken together, constituted a
full and unconditional guarantee by us of the Trust's obligations relating
to the Trust Convertible Preferred Securities and the Partnership's
obligations relating to the Partnership Convertible Preferred Securities.
In accordance with the terms of the issuances, we paid the annual 5%
interest in quarterly installments on the Convertible Subordinated
Debentures in 2008, 2007 and 2006. Cash was paid (net of investment
returns) to the Partnership in payment of the interest on the Convertible
Subordinated Debentures. The cash was then distributed by the Partnership
to the Trust and then by the Trust to the holders of the EPPICS.
As of December 31, 2008, EPPICS representing a total principal amount of
$197.8 million have been converted into 15,969,645 shares of our common
stock. There were no outstanding EPPICS as of December 31, 2008. As a
result of the redemption of all outstanding EPPICS as of December 31, 2008,
the $10.5 million in debt with related parties was reclassified by the
Company against an offsetting investment.
We adopted the provisions of FIN No. 46R (revised December 2003) (FIN No.
46R), "Consolidation of Variable Interest Entities," effective January 1,
2004. Accordingly, the Trust holding the EPPICS and the related Citizens
Utilities Capital L.P. were deconsolidated.
(16) Capital Stock:
--------------
We are authorized to issue up to 600,000,000 shares of common stock. The
amount and timing of dividends payable on common stock are, subject to
applicable law, within the sole discretion of our Board of Directors.
(17) Stock Plans:
------------
At December 31, 2008, we had five stock-based compensation plans under
which grants have been made and awards remained outstanding. These plans,
which are described below, are the Management Equity Incentive Plan (MEIP),
the 1996 Equity Incentive Plan (1996 EIP), the Amended and Restated 2000
Equity Incentive Plan (2000 EIP), the Non-Employee Directors' Deferred Fee
Plan (Deferred Fee Plan) and the Non-Employee Directors' Equity Incentive
Plan (Directors' Equity Plan, and together with the Deferred Fee Plan, the
Director Plans).
In accordance with the adoption of SFAS No. 123R as of January 1, 2006, we
recorded stock-based compensation expense for the cost of our stock
options. Compensation expense, recognized in other operating expenses, of
$0.0 million, $0.8 million and $2.2 million in 2008, 2007 and 2006,
respectively, has been recorded for the cost of our stock options. Our
general policy is to issue shares upon the grant of restricted shares and
exercise of options from treasury. At December 31, 2008, there were
16,058,182 shares authorized for grant under these plans and 4,170,361
shares available for grant. No further awards may be granted under the
MEIP, the 1996 EIP or the Deferred Fee Plan.
F-25
In connection with the Director Plans, compensation costs associated with
the issuance of stock units was $0.8 million, $1.6 million and $2.0 million
in 2008, 2007 and 2006, respectively. Cash compensation associated with the
Director Plans was $0.5 million in each of 2008, 2007 and 2006. These costs
are recognized in other operating expenses.
We have granted restricted stock awards to key employees in the form of our
common stock. The number of shares issued as restricted stock awards during
2008, 2007 and 2006 were 887,000, 722,000 and 732,000, respectively. None
of the restricted stock awards may be sold, assigned, pledged or otherwise
transferred, voluntarily or involuntarily, by the employees until the
restrictions lapse, subject to limited exceptions. The restrictions are
time based. At December 31, 2008, 1,702,000 shares of restricted stock were
outstanding. Compensation expense, recognized in other operating expenses,
of $6.9 million, $6.6 million and $6.0 million, for the years ended
December 31, 2008, 2007 and 2006, respectively, has been recorded in
connection with these grants.
Management Equity Incentive Plan
--------------------------------
Prior to its expiration on June 21, 2000, awards of our common stock could
have been granted under the MEIP to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, stock appreciation rights (SARs), restricted
stock or other stock-based awards.
Since the expiration of the MEIP, no awards have been or may be granted
under the MEIP. The exercise price of stock options issued was equal to or
greater than the fair market value of the underlying common stock on the
date of grant. Stock options were not ordinarily exercisable on the date of
grant but vested over a period of time (generally four years). All stock
options granted under the MEIP are vested. Under the terms of the MEIP,
subsequent stock dividends and stock splits have the effect of increasing
the option shares outstanding, which correspondingly decreases the average
exercise price of outstanding options.
1996 and 2000 Equity Incentive Plans
------------------------------------
Since the expiration date of the 1996 EIP on May 22, 2006, no awards have
been or may be granted under the 1996 EIP. Under the 2000 EIP, awards of
our common stock may be granted to eligible officers, management employees
and non-management employees in the form of incentive stock options,
non-qualified stock options, SARs, restricted stock or other stock-based
awards. As discussed under the Non-Employee Directors' Compensation Plans
below, prior to May 25, 2006 non-employee directors received an award of
stock options under the 2000 EIP upon commencement of service.
At December 31, 2008, there were 13,517,421 shares authorized for grant
under the 2000 EIP and 1,940,083 shares available for grant, as adjusted to
reflect stock dividends. No awards will be granted more than 10 years after
the effective date (May 18, 2000) of the 2000 EIP plan. The exercise price
of stock options and SARs under the 2000 and 1996 EIP generally shall be
equal to or greater than the fair market value of the underlying common
stock on the date of grant. Stock options are not ordinarily exercisable on
the date of grant but vest over a period of time (generally four years).
Under the terms of the EIPs, subsequent stock dividends and stock splits
have the effect of increasing the option shares outstanding, which
correspondingly decrease the average exercise price of outstanding options.
On March 17, 2008, the Company adopted the Long-Term Incentive Program
(LTIP). The LTIP covers the named executive officers and certain other
officers. The LTIP is designed to incent and reward the Company's senior
executives if they achieve aggressive growth goals over three-year
performance periods (the Measurement Periods). LTIP awards will be granted
in shares of the Company's common stock following the applicable
Measurement Period if pre-established goals are achieved over the
Measurement Period. At the time that the LTIP was adopted, the Compensation
Committee approved LTIP target award opportunities for senior executives,
as well as the target level for each performance metric, for the 2008-2010
Measurement Period. Minimum financial performance "gates" were set that had
to be achieved with respect to revenue and free cash flow growth over the
2008-2010 Measurement Period for any LTIP award to be granted. In February
2009, the Compensation Committee determined that the minimum performance
gates were no longer achievable and cancelled the award opportunities for
the 2008-2010 Measurement Period. Accordingly, there will be no payouts
under the LTIP for the 2008-2010 Measurement Period.
F-26
The following summary presents information regarding outstanding stock
options and changes with regard to options under the MEIP and the EIPs:
Weighted Weighted
Shares Average Average Aggregate
Subject to Option Price Remaining Intrinsic
Option Per Share Life in Years Value
-----------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2006 7,985,000 $ 11.52 5.3 $ 13,980,000
Options granted 22,000 $ 12.55
Options exercised (2,695,000) $ 9.85 $ 9,606,000
Options canceled, forfeited or lapsed (70,000) $ 10.13
----------------------------------------------------------------------------
Balance at December 31, 2006 5,242,000 $ 12.41 4.4 $ 14,490,000
Options granted - $ -
Options exercised (1,254,000) $ 10.19 $ 6,033,000
Options canceled, forfeited or lapsed (33,000) $ 10.79
----------------------------------------------------------------------------
Balance at December 31, 2007 3,955,000 $ 13.13 3.4 $ 5,727,000
Options granted - $ -
Options exercised (187,000) $ 7.38 $ 743,000
Options canceled, forfeited or lapsed (55,000) $ 10.40
----------------------------------------------------------------------------
Balance at December 31, 2008 3,713,000 $ 13.46 2.5 $ 495,000
============================================================================
The following table summarizes information about shares subject to options
under the MEIP and the EIPs at December 31, 2008:
Options Outstanding Options Exercisable
----------------------------------------------------------------------------------------- -----------------------------------------
Weighted Average Weighted
Number Range of Weighted Average Remaining Number Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
------------------------------------------------------------------------------------------------------------------------------------
525,000 $ 6.45 - 8.19 $ 7.80 2.66 525,000 $ 7.80
541,000 10.44 - 10.44 10.44 4.40 541,000 10.44
200,000 11.15 - 11.15 11.15 1.80 200,000 11.15
476,000 11.79 - 11.79 11.79 2.38 476,000 11.79
167,000 11.90 - 14.27 13.44 4.77 160,000 13.45
582,000 15.02 - 15.02 15.02 1.75 582,000 15.02
640,000 15.94 - 16.74 16.67 1.73 640,000 16.67
582,000 18.46 - 18.46 18.46 1.75 582,000 18.46
------------------- ----------------
3,713,000 $ 6.45 - 18.46 $ 13.46 2.50 3,706,000 $ 13.46
=================== ================
The number of options exercisable at December 31, 2007 and 2006 were
3,938,000 and 4,791,000, with a weighted average exercise price of $13.13
and $12.58, respectively.
Cash received upon the exercise of options during 2008, 2007 and 2006 was
$1.4 million, $13.8 million and $27.2 million, respectively. There is no
remaining unrecognized compensation cost associated with unvested stock
options at December 31, 2008.
For purposes of determining compensation expense, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model which requires the use of various assumptions
including expected life of the option, expected dividend rate, expected
volatility, and risk-free interest rate. The expected life (estimated
period of time outstanding) of stock options granted was estimated using
the historical exercise behavior of employees. The risk free interest rate
is based on the U.S. Treasury yield curve in effect at the time of the
grant. Expected volatility is based on historical volatility for a period
equal to the stock option's expected life, calculated on a monthly basis.
F-27
The following table presents the weighted average assumptions used for
stock option grants in 2006. No stock option grants were issued in 2007 and
2008 under the MEIP or the EIPs.
2006
--------------------------- ---------------
Dividend yield 7.55%
Expected volatility 44%
Risk-free interest rate 4.89%
Expected life 5 years
--------------------------- ---------------
The following summary presents information regarding unvested restricted
stock and changes with regard to restricted stock under the MEIP and the
EIPs:
Weighted
Average
Number of Grant Date Aggregate
Shares Fair Value Fair Value
--------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2006 1,456,000 $ 12.47 $ 17,808,000
Restricted stock granted 732,000 $ 12.87 $ 10,494,000
Restricted stock vested (642,000) $ 12.08 $ 9,226,000
Restricted stock forfeited (372,000) $ 12.60
----------------------------------------------------------------------------
Balance at December 31, 2006 1,174,000 $ 12.89 $ 16,864,000
Restricted stock granted 722,000 $ 15.04 $ 9,187,000
Restricted stock vested (587,000) $ 12.94 $ 7,465,000
Restricted stock forfeited (100,000) $ 13.95
----------------------------------------------------------------------------
Balance at December 31, 2007 1,209,000 $ 14.06 $ 15,390,000
Restricted stock granted 887,000 $ 11.02 $ 7,757,000
Restricted stock vested (367,000) $ 13.90 $ 3,209,000
Restricted stock forfeited (27,000) $ 13.39
----------------------------------------------------------------------------
Balance at December 31, 2008 1,702,000 $ 12.52 $ 14,876,000
============================================================================
For purposes of determining compensation expense, the fair value of each
restricted stock grant is estimated based on the average of the high and
low market price of a share of our common stock on the date of grant. Total
remaining unrecognized compensation cost associated with unvested
restricted stock awards at December 31, 2008 was $15.2 million and the
weighted average period over which this cost is expected to be recognized
is approximately two to three years.
Non-Employee Directors' Compensation Plans
------------------------------------------
Upon commencement of his or her service on the Board of Directors, each
non-employee director receives a grant of 10,000 stock options. These
options are currently awarded under the Directors' Equity Plan. Prior to
effectiveness of the Directors' Equity Plan on May 25, 2006, these options
were awarded under the 2000 EIP. The exercise price of these options, which
become exercisable six months after the grant date, is the fair market
value (as defined in the relevant plan) of our common stock on the date of
grant. Options granted under the Directors' Equity Plan expire on the
earlier of the tenth anniversary of the grant date or the first anniversary
of termination of service as a director. Options granted to non-employee
directors under the 2000 EIP expire on the tenth anniversary of the grant
date.
Each non-employee director also receives an annual grant of 3,500 stock
units. These units are currently awarded under the Directors' Equity Plan
and prior to effectiveness of that plan, were awarded under the Deferred
Fee Plan. Since the effectiveness of the Directors' Equity Plan, no further
grants have been made under the Deferred Fee Plan. Prior to April 20, 2004,
each non-employee director received an award of 5,000 stock options. The
exercise price of such options was set at 100% of the fair market value on
the date the options were granted. The options were exercisable six months
after the grant date and remain exercisable for ten years after the grant
date.
F-28
In addition, each year, each non-employee director is also entitled to
receive a retainer, meeting fees, and, when applicable, fees for serving as
a committee chair or as Lead Director. For 2008, each non-employee director
had to elect, by December 31 of the preceding year, to receive $40,000 cash
or 5,760 stock units as an annual retainer and to receive meeting fees and
Lead Director and committee chair stipends in the form of cash or stock
units. Stock units are awarded under the Directors' Equity Plan. Directors
making a stock unit election must also elect to convert the units to either
common stock (convertible on a one-to-one basis) or cash upon retirement or
death.
The number of shares of common stock authorized for issuance under the
Directors' Equity Plan is 2,540,761, which includes 540,761 shares that
were available for grant under the Deferred Fee Plan on the effective date
of the Directors' Equity Plan. In addition, if and to the extent that any
"plan units" outstanding on May 25, 2006 under the Deferred Fee Plan are
forfeited or if any option granted under the Deferred Fee Plan terminates,
expires, or is cancelled or forfeited, without having been fully exercised,
shares of common stock subject to such "plan units" or options cancelled
shall become available under the Directors' Equity Plan. At December 31,
2008, there were 2,230,278 shares available for grant. There were 12
directors participating in the Directors' Plans during all or part of 2008.
In 2008, the total options, plan units, and stock earned were 0, 102,673,
and 0, respectively. In 2007, the total options, plan units, and stock
earned were 10,000, 98,070 and 0, respectively. In 2006, the total options,
plan units, and stock earned were 20,000, 81,000 and 0, respectively.
Options granted prior to the adoption of the Directors' Equity Plan were
granted under the 2000 EIP. At December 31, 2008, 182,951 options were
outstanding and exercisable under the Director Plans at a weighted average
exercise price of $12.68.
For 2008, each non-employee director received fees of $2,000 for each
in-person Board of Directors and committee meeting attended and $1,000 for
each telephone Board and committee meeting attended. The chairs of the
Audit, Compensation, Nominating and Corporate Governance and Retirement
Plan Committees were paid an additional annual fee of $25,000, $15,000,
$7,500 and $5,000, respectively. In addition, the Lead Director, who heads
the ad hoc committee of non-employee directors, received an additional
annual fee of $15,000. A director must elect, by December 31 of the
preceding year, to receive meeting and other fees in cash, stock units, or
a combination of both. All fees paid to the non-employee directors in 2008
were paid quarterly. If the director elects stock units, the number of
units credited to the director's account is determined as follows: the
total cash value of the fees payable to the director are divided by 85% of
the closing prices of our common stock on the last business day of the
calendar quarter in which the fees or stipends were earned. Units are
credited to the director's account quarterly. Effective January 1, 2009,
the annual fee for the chairs of the Compensation and Retirement Plan
Committees were increased to $20,000 and $7,500, respectively. All other
fees and retainers remain the same.
We account for the Deferred Fee Plan and Directors' Equity Plan in
accordance with SFAS No. 123R. To the extent directors elect to receive the
distribution of their stock unit account in cash, they are considered
liability-based awards. To the extent directors elect to receive the
distribution of their stock unit accounts in common stock, they are
considered equity-based awards. Compensation expense for stock units that
are considered equity-based awards is based on the market value of our
common stock at the date of grant. Compensation expense for stock units
that are considered liability-based awards is based on the market value of
our common stock at the end of each period.
We had also maintained a Non-Employee Directors' Retirement Plan providing
for the payment of specified sums annually to our non-employee directors,
or their designated beneficiaries, starting at the director's retirement,
death or termination of directorship. In 1999, we terminated this Plan. As
of December 31, 2008, the liability for such payments was reduced to $0 as
the obligation was fully settled during the second quarter of 2007.
F-29
(18) Income Taxes:
-------------
The following is a reconciliation of the provision for income taxes for
continuing operations computed at Federal statutory rates to the effective
rates for the years ended December 31, 2008, 2007 and 2006:
2008 2007 2006
------------ ----------- -----------
Consolidated tax provision at federal statutory rate 35.0% 35.0% 35.0%
State income tax provisions, net of federal income tax benefit 2.8% 1.8% 2.1%
Tax reserve adjustment (1.4)% 1.0% 0.2%
All other, net 0.4% (0.4)% (2.4)%
------------ ----------- -----------
36.8% 37.4% 34.9%
============ =========== ===========
The components of the net deferred income tax liability (asset) at December
31 are as follows:
($ in thousands) 2008 2007
---------------- ------------ -----------
Deferred income tax liabilities:
--------------------------------
Property, plant and equipment basis differences $ 642,598 $ 624,426
Intangibles 248,520 275,102
Other, net 15,946 10,431
------------ -----------
907,064 909,959
------------ -----------
Deferred income tax assets:
---------------------------
SFAS No. 158 pension/OPEB liability 146,997 58,587
Tax operating loss carryforward 72,434 83,203
Alternative minimum tax credit carryforward - 26,658
Employee benefits 62,482 68,791
State tax liability 7,483 10,361
Accrued expenses 19,726 14,818
Bad debts 12,026 4,971
Other, net 14,550 12,700
------------ -----------
335,698 280,089
Less: Valuation allowance (67,331) (59,566)
------------ -----------
Net deferred income tax asset 268,367 220,523
------------ -----------
Net deferred income tax liability $ 638,697 $ 689,436
============ ===========
Deferred tax assets and liabilities are reflected in the
--------------------------------------------------------
following captions on the consolidated balance sheet:
-----------------------------------------------------
Deferred income taxes $ 670,489 $ 711,645
Other current assets (31,792) (22,209)
------------ -----------
Net deferred income tax liability $ 638,697 $ 689,436
============ ===========
Our state tax operating loss carryforward as of December 31, 2008 is
estimated at $952.3 million. A portion of our state loss carryforward
begins to expire in 2009.
F-30
The provision (benefit) for Federal and state income taxes, as well as the
taxes charged or credited to shareholders' equity, includes amounts both
payable currently and deferred for payment in future periods as indicated
below:
($ in thousands) 2008 2007 2006
---------------- ------------ ----------- -----------
Income taxes charged to the consolidated statement of
operations for continuing operations:
Current:
Federal $ 68,114 $ 37,815 $ 772
State 4,415 9,188 3,676
------------ ----------- -----------
Total current 72,529 47,003 4,448
------------ ----------- -----------
Deferred:
Federal 32,984 75,495 128,534
State 983 5,516 3,497
------------ ----------- -----------
Total deferred 33,967 81,011 132,031
------------ ----------- -----------
Subtotal income taxes for continuing operations 106,496 128,014 136,479
------------ ----------- -----------
Income taxes charged to the consolidated statement of
operations for discontinued operations:
Current:
Federal - - 3,018
State - - 2,004
------------ ----------- -----------
Total current - - 5,022
------------ ----------- -----------
Deferred:
Federal - - 47,732
State - - 3,835
------------ ----------- -----------
Total deferred - - 51,567
------------ ----------- -----------
Subtotal income taxes for discontinued operations - - 56,589
------------ ----------- -----------
Total income taxes charged to the consolidated statement of
operations (a) 106,496 128,014 193,068
------------ ----------- -----------
Income taxes charged (credited) to shareholders' equity:
Deferred income tax benefits on unrealized/realized gains or
losses on securities classified as available-for-sale - (11) (35)
Current benefit arising from stock options exercised and
restricted stock (4,877) (552) (3,777)
Deferred income taxes (benefits) arising from the
recognition of additional pension/OPEB liability (88,410) (6,880) 24,707
Deferred tax benefit from recording adjustments from the
adoption of SAB No. 108 - - (17,339)
------------ ----------- -----------
Income taxes charged (credited) to shareholders'
equity (b) (93,287) (7,443) 3,556
------------ ----------- -----------
Total income taxes: (a) plus (b) $ 13,209 $ 120,571 $ 196,624
============ =========== ===========
In July 2006, the FASB issued FASB Interpretation No. (FIN) 48, "Accounting
for Uncertainty in Income Taxes." Among other things, FIN No. 48 requires
applying a "more likely than not" threshold to the recognition and
derecognition of uncertain tax positions either taken or expected to be
taken in the Company's income tax returns. We adopted the provisions of FIN
No. 48 in the first quarter of 2007. The total amount of our gross FIN No.
48 tax liability for tax positions that may not be sustained under a "more
likely than not" threshold amounts to $52.9 million as of December 31,
2008. A decrease of $16.2 million in the balance, including $4.9 million of
accrued interest, since December 31, 2007 resulted from the expiration of
certain statute of limitations on April 15, 2008. The amount of our total
FIN No. 48 tax liabilities reflected above that would positively impact the
calculation of our effective income tax rate, if our tax positions are
sustained, is $33.4 million as of December 31, 2008.
The Company's policy regarding the classification of interest and penalties
is to include these amounts as a component of income tax expense. This
treatment of interest and penalties is consistent with prior periods. We
have recognized in our consolidated statement of operations for the year
ended December 31, 2008, additional interest in the amount of $2.9 million.
We are subject to income tax examinations generally for the years 2005
forward for both our Federal and state filing jurisdictions. We also
maintain uncertain tax positions in various state jurisdictions. Amounts
related to uncertain tax positions that may change within the next twelve
months are not material.
F-31
The following table sets forth the changes in the Company's balance of
unrecognized tax benefits for the years ended December 31, 2008 and 2007 in
accordance with FIN No. 48:
($ in thousands)
---------------- 2008 2007
------------ ----------
Unrecognized tax benefits - beginning of year $ 59,717 $ 30,332
Gross increases - unrecognized tax benefits acquired
via acquisitions - 8,977
Gross decreases - prior year tax positions (2,070) -
Gross increases - current year tax positions 2,379 20,408
Gross decreases - expired statute of limitations (11,315) -
------------ ----------
Unrecognized tax benefits - end of year $ 48,711 $ 59,717
============ ==========
The amounts above exclude $4.2 million of accrued interest that we have
recorded and would be payable should the Company's tax positions not be
sustained.
(19) Net Income Per Common Share:
----------------------------
The reconciliation of the net income per common share calculation for the
years ended December 31, 2008, 2007 and 2006 is as follows:
($ in thousands, except per-share amounts)
------------------------------------------ 2008 2007 2006
------------------ ------------------ ------------------
Net income used for basic and diluted
-------------------------------------
earnings per common share:
--------------------------
Income from continuing operations $ 182,660 $ 214,654 $ 254,008
Income from discontinued operations - - 90,547
------------------ ------------------ ------------------
Total basic net income available for common shareholders $ 182,660 $ 214,654 $ 344,555
Effect of conversion of preferred securities - EPPICS 130 152 401
------------------ ------------------ ------------------
Total diluted net income available for common shareholders $ 182,790 $ 214,806 $ 344,956
================== ================== ==================
Basic earnings per common share:
--------------------------------
Weighted-average shares outstanding - basic 317,501 331,037 322,641
================== ================== ==================
Income from continuing operations $ 0.58 $ 0.65 $ 0.79
Income from discontinued operations - - 0.28
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 0.58 $ 0.65 $ 1.07
================== ================== ==================
Diluted earnings per common share:
----------------------------------
Weighted-average shares outstanding - basic 317,501 331,037 322,641
Effect of dilutive shares 435 940 931
Effect of conversion of preferred securities - EPPICS 306 401 973
------------------ ------------------ ------------------
Weighted-average shares outstanding - diluted 318,242 332,378 324,545
================== ================== ==================
Income from continuing operations $ 0.57 $ 0.65 $ 0.78
Income from discontinued operations - - 0.28
------------------ ------------------ ------------------
Net income per share available for common shareholders $ 0.57 $ 0.65 $ 1.06
================== ================== ==================
F-32
Stock Options
-------------
For the years ended December 31, 2008, 2007 and 2006, options to purchase
shares of 2,647,000 (at exercise prices ranging from $11.15 to $18.46),
1,804,000 (at exercise prices ranging from $15.02 to $18.46), and 1,917,000
(at exercise prices ranging from $13.45 to $18.46), respectively, issuable
under employee compensation plans were excluded from the computation of
diluted earnings per share (EPS) for those periods because the exercise
prices were greater than the average market price of our common stock and,
therefore, the effect would be antidilutive. In calculating diluted EPS we
apply the treasury stock method and include future unearned compensation as
part of the assumed proceeds.
In addition, for the years ended December 31, 2008, 2007 and 2006,
restricted stock awards of 1,702,000, 1,209,000 and 1,174,000 shares,
respectively, are excluded from our basic weighted average shares
outstanding and included in our dilutive shares until the shares are no
longer subject to restriction after the satisfaction of all specified
conditions.
EPPICS
------
There were no outstanding EPPICS at December 31, 2008. At December 31,
2007, we had 80,307 shares of potentially dilutive EPPICS, which were
convertible into our common stock at a 4.3615 to 1 ratio at an exercise
price of $11.46 per share. If all EPPICS that remained outstanding as of
December 31, 2007 were converted, we would have issued approximately
350,259 shares of our common stock. As a result of the September 2004
special, non-recurring dividend, the EPPICS exercise price for conversion
into common stock was reduced from $13.30 to $11.46. These securities have
been included in the diluted income per common share calculation for the
periods ended December 31, 2007 and 2006.
Stock Units
-----------
At December 31, 2008, 2007 and 2006, we had 324,806, 225,427 and 319,423
stock units, respectively, issued under the Director Plans and the
Non-Employee Directors' Retirement Plan. These securities have not been
included in the diluted income per share of common stock calculation
because their inclusion would have had an antidilutive effect.
Share Repurchase Programs
-------------------------
In February 2008, our Board of Directors authorized us to repurchase up to
$200.0 million of our common stock in public or private transactions over
the following twelve-month period. This share repurchase program commenced
on March 4, 2008 and was completed on October 3, 2008. During 2008, we
repurchased approximately 17.8 million shares of our common stock at an
aggregate cost of $200.0 million.
In February 2007, our Board of Directors authorized us to repurchase up to
$250.0 million of our common stock in public or private transactions over
the following twelve-month period. This share repurchase program commenced
on March 19, 2007 and was completed on October 15, 2007. During 2007, we
repurchased approximately 17.3 million shares of our common stock at an
aggregate cost of $250.0 million.
In February 2006, our Board of Directors authorized us to repurchase up to
$300.0 million of our common stock in public or private transactions over
the following twelve-month period. This share repurchase program commenced
on March 6, 2006. During 2006, we repurchased approximately 10.2 million
shares of our common stock at an aggregate cost of $135.2 million. No
further purchases were made prior to expiration of this authorization.
(20) Comprehensive Income:
---------------------
Comprehensive income consists of net income and other gains and losses
affecting shareholders' investment and SFAS No. 158 pension/OPEB
liabilities that, under GAAP, are excluded from net income.
F-33
The components of accumulated other comprehensive loss, net of tax at
December 31, 2008 and 2007 are as follows:
($ in thousands) 2008 2007
---------------- --------------- ---------------
Pension Costs $ 376,086 $ 134,276
Postretirement Costs 8,045 2,292
Deferred taxes on pension and OPEB costs (146,997) (58,587)
All other 18 14
--------------- ---------------
$ 237,152 $ 77,995
=============== ===============
Our other comprehensive income (loss) for the years ended December 31,
2008, 2007 and 2006 is as follows:
2008
---------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- --------------- --------------- -------------
Net actuarial loss $ (252,358) $ (90,122) $(162,236)
Amortization of pension and postretirement costs 4,795 1,712 3,083
All other (4) - (4)
--------------- --------------- -------------
Other comprehensive (loss) $ (247,567) $ (88,410) $(159,157)
=============== =============== =============
2007
---------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- --------------- --------------- -------------
Amortization of pension and postretirement costs $ (3,023) $ (6,880) $ 3,857
All other 35 (12) 47
--------------- --------------- -------------
Other comprehensive income $ (2,988) $ (6,892) $ 3,904
=============== =============== =============
2006
---------------------------------------------
Before-Tax Tax Expense/ Net-of-Tax
($ in thousands) Amount (Benefit) Amount
---------------- --------------- --------------- -------------
Net unrealized holding losses on securities
arising during period $ (92) $ (35) $ (57)
SFAS No. 158 pension/postretirement liability 199,653 74,619 125,034
--------------- --------------- -------------
Other comprehensive income $ 199,561 $ 74,584 $ 124,977
=============== =============== =============
(21) 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 SFAS No. 131, we have utilized the aggregation criteria in
combining our operating segments because all of our Frontier properties
share similar economic characteristics, in that they provide the same
products and services to similar customers using comparable technologies in
all of the states in which we operate. The regulatory structure is
generally similar. Differences in the regulatory regime of a particular
state do not materially impact the economic characteristics or operating
results of a particular property.
F-34
(22) Quarterly Financial Data (Unaudited):
-------------------------------------
($ in thousands, except per share amounts)
------------------------------------------
2008 First Quarter Second Quarter Third Quarter Fourth Quarter Total Year
---- ------------- -------------- ------------- -------------- -----------
Revenue $ 569,205 $ 562,550 $ 557,871 $ 547,392 $ 2,237,018
Operating income 164,312 161,969 164,241 151,934 642,456
Net income 45,589 55,778 46,995 34,298 182,660
Net income available for common shareholders per
basic share $ 0.14 $ 0.17 $ 0.15 $ 0.11 $ 0.58
Net income available for common shareholders per
diluted share $ 0.14 $ 0.17 $ 0.15 $ 0.11 $ 0.57
2007
----
Revenue $ 556,147 $ 578,826 $ 575,814 $ 577,228 $ 2,288,015
Operating income 193,302 171,298 165,925 174,891 705,416
Net income 67,667 40,559 47,415 59,013 214,654
Net income available for common shareholders per
basic share $ 0.21 $ 0.12 $ 0.14 $ 0.18 $ 0.65
Net income available for common shareholders per
diluted share $ 0.21 $ 0.12 $ 0.14 $ 0.18 $ 0.65
The quarterly net income per common share amounts are rounded to the
nearest cent. Annual net income per common share may vary depending on the
effect of such rounding. Our quarterly results include the results of
operations of Commonwealth from the date of its acquisition on March 8,
2007 and of GVN from the date of its acquisition on October 31, 2007. See
Notes 13 and 14 for a description of miscellaneous transactions impacting
our quarterly results.
(23) Retirement Plans:
-----------------
We sponsor a noncontributory defined benefit pension plan covering a
significant number of our former and current employees and other
postretirement benefit plans that provide medical, dental, life insurance
and other benefits for covered retired employees and their beneficiaries
and covered dependents. The benefits are based on years of service and
final average pay or career average pay. Contributions are made in amounts
sufficient to meet ERISA funding requirements while considering tax
deductibility. Plan assets are invested in a diversified portfolio of
equity and fixed-income securities and alternative investments.
The accounting results for pension and other postretirement benefit costs
and obligations are dependent upon various actuarial assumptions applied in
the determination of such amounts. These actuarial assumptions include the
following: discount rates, expected long-term rate of return on plan
assets, future compensation increases, employee turnover, healthcare cost
trend rates, expected retirement age, optional form of benefit and
mortality. We review these assumptions for changes annually with our
independent actuaries. We consider our discount rate and expected long-term
rate of return on plan assets to be our most critical assumptions.
The discount rate is used to value, on a present value basis, our pension
and other postretirement benefit obligations as of the balance sheet date.
The same rate is also used in the interest cost component of the pension
and postretirement benefit cost determination for the following year. The
measurement date used in the selection of our discount rate is the balance
sheet date. Our discount rate assumption is determined annually with
assistance from our actuaries based on the pattern of expected future
benefit payments and the prevailing rates available on long-term, high
quality corporate bonds that approximate the benefit obligation. In making
this determination we consider, among other things, the yields on the
Citigroup Pension Discount Curve, the Citigroup Above-Median Pension Curve,
the general movement of interest rates and the changes in those rates from
one period to the next. This rate can change from year-to-year based on
market conditions that impact corporate bond yields. Our discount rate was
6.50% at year-end 2008 and 2007.
F-35
The expected long-term rate of return on plan assets is applied in the
determination of periodic pension and postretirement benefit cost as a
reduction in the computation of the expense. In developing the expected
long-term rate of return assumption, we considered published surveys of
expected market returns, 10 and 20 year actual returns of various major
indices, and our own historical 5-year, 10-year and 20-year investment
returns. The expected long-term rate of return on plan assets is based on
an asset allocation assumption of 35% to 55% in fixed income securities,
35% to 55% in equity securities and 5% to 15% in alternative investments.
We review our asset allocation at least annually and make changes when
considered appropriate. Our asset return assumption is made at the
beginning of our fiscal year. In 2008, we did not change our expected
long-term rate of return from the 8.25% used in 2007. Our pension plan
assets are valued at actual market value as of the measurement date. The
measurement date used to determine pension and other postretirement benefit
measures for the pension plan and the postretirement benefit plan is
December 31.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans" (SFAS No. 158). We
adopted SFAS No. 158 prospectively on December 31, 2006. SFAS No. 158
requires that we recognize all obligations related to defined benefit
pensions and other postretirement benefits. SFAS No. 158 also requires that
we quantify the plans' funded status as an asset or a liability on our
consolidated balance sheets.
SFAS No. 158 requires that we measure the plan's assets and obligations
that determine our funded status as of the end of the fiscal year. We are
also required to recognize as a component of Other Comprehensive Income
"OCI" the changes in funded status that occurred during the year that are
not recognized as part of net periodic benefit cost as explained in SFAS
No. 87, "Employers' Accounting for Pensions," or SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions."
Based on the funded status of our defined benefit pension and
postretirement benefit plans as of December 31, 2006, we reported a gain
(net of tax) to our AOCI of $41.4 million, a decrease of $66.1 million to
accrued pension obligations and an increase of $24.7 million to accumulated
deferred income taxes. Our adoption of SFAS No. 158 on December 31, 2006,
had no impact on our earnings. The following tables present details about
our pension plans.
F-36
Pension Benefits
----------------
The following tables set forth the plan's projected benefit obligations and
fair values of plan assets as of December 31, 2008 and 2007 and net
periodic benefit cost for the years ended December 31, 2008, 2007 and 2006:
($ in thousands) 2008 2007
---------------- ------------- --------------
Change in projected benefit obligation
--------------------------------------
Projected benefit obligation at beginning of year $ 820,404 $ 780,719
Commonwealth plan as of acquisition date - 107,047
Service cost 6,005 9,175
Interest cost 52,851 50,948
Actuarial loss/(gain) 20,230 (26,524)
Benefits paid (69,465) (87,049)
Curtailment - (14,379)
Special termination benefits 1,662 467
------------- --------------
Projected benefit obligation at end of year $ 831,687 $ 820,404
------------- --------------
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 822,165 $ 770,182
Commonwealth plan as of acquisition date - 92,175
Actual return on plan assets (162,924) 46,857
Benefits paid (69,465) (87,049)
------------- --------------
Fair value of plan assets at end of year $ 589,776 $ 822,165
------------- --------------
(Accrued)/Prepaid benefit cost
------------------------------
Funded status $(241,911) $ 1,761
============= ==============
Amounts recognized in the consolidated balance sheet
----------------------------------------------------
Other assets/(other long-term liabilities) $(241,911) $ 1,761
============= ==============
Accumulated other comprehensive income $ 376,086 $ 134,276
============= ==============
Expected
($ in thousands) 2009 2008 2007 2006
---------------- ------------- -------------- --------------- ----------------
Components of net periodic benefit cost
---------------------------------------
Service cost $ 6,005 $ 9,175 $ 6,811
Interest cost on projected benefit obligation 52,851 50,948 45,215
Expected return on plan assets (65,256) (67,467) (60,759)
Amortization of prior service cost/(credit) (255) (255) (255) (255)
Amortization of unrecognized loss 26,824 6,855 7,313 11,871
-------------- --------------- ----------------
Net periodic benefit cost/(income) 200 (286) 2,883
Plan curtailment gain - (14,379) -
Special termination charge 1,662 467 1,809
-------------- --------------- ----------------
Total periodic benefit cost/(income) $ 1,862 $ (14,198) $ 4,692
============== =============== ================
F-37
Effective December 30, 2007, the CTE Employees' Pension Plan was frozen for
all non-union Commonwealth employees. No additional benefit accruals for
service rendered subsequent to December 30, 2007 will occur for those
participants. As a result of this plan change and in accordance with SFAS
No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits," a gain on pension
curtailment of $14.4 million was recorded in 2007 and included in other
operating expenses in the consolidated statement of operations. Also,
effective December 31, 2007, the CTE Employees' Pension Plan was merged
into the Frontier Pension Plan.
The plan's weighted average asset allocations at December 31, 2008 and 2007
by asset category are as follows:
2008 2007
------------- --------------
Asset category:
---------------
Equity securities 42% 51%
Debt securities 48% 38%
Alternative investments 9% 9%
Cash and other 1% 2%
------------- --------------
Total 100% 100%
============= ==============
The plan's expected benefit payments over the next 10 years are as follows:
($ in thousands)
----------------
Year Amount
--------------- --------------
2009 $ 60,601
2010 61,944
2011 63,272
2012 66,642
2013 67,678
2014 - 2018 343,791
--------------
Total $ 663,928
==============
We expect that no contribution will be made by us to the pension plan in
2009.
The accumulated benefit obligation for the plan was $818.9 million and
$805.0 million at December 31, 2008 and 2007, respectively.
Assumptions used in the computation of annual pension costs and valuation
of the year-end obligations were as follows:
2008 2007 2006
---- ---- ----
Discount rate - used at year end to value obligation 6.50% 6.50% 6.00%
Discount rate - used to compute annual cost 6.50% 6.00% 5.625%
Expected long-term rate of return on plan assets 8.25% 8.25% 8.25%
Rate of increase in compensation levels 3.00% 3.50% 4.00%
F-38
Postretirement Benefits Other Than Pensions - "OPEB"
----------------------------------------------------
The following table sets forth the plans' benefit obligations, fair values
of plan assets and the postretirement benefit liability recognized on our
consolidated balance sheets at December 31, 2008 and 2007 and net periodic
postretirement benefit costs for the years ended December 31, 2008, 2007
and 2006.
($ in thousands) 2008 2007
---------------- ------------- --------------
Change in benefit obligation
----------------------------
Benefit obligation at beginning of year $ 174,602 $ 159,931
Commonwealth plan as of date of acquisition - 996
Service cost 444 533
Interest cost 11,255 10,241
Plan participants' contributions 3,753 3,370
Actuarial loss 3,917 15,620
Benefits paid (15,261) (15,064)
Plan change (95) (1,025)
------------- --------------
Benefit obligation at end of year $ 178,615 $ 174,602
------------- --------------
Change in plan assets
---------------------
Fair value of plan assets at beginning of year $ 9,369 $ 11,869
Actual return on plan assets 388 814
Plan participants' contributions 3,753 3,370
Employer contribution 9,888 8,380
Benefits paid (15,261) (15,064)
------------- --------------
Fair value of plan assets at end of year $ 8,137 $ 9,369
------------- --------------
Accrued benefit cost
--------------------
Funded status $(170,478) $(165,233)
============= ==============
Amounts recognized in the consolidated balance sheet
----------------------------------------------------
Current liabilities $ (8,916) $ (8,498)
============= ==============
Other long-term liabilities $(161,562) $(156,735)
============= ==============
Accumulated other comprehensive income $ 8,045 $ 2,292
============= ==============
($ in thousands) Expected
---------------- 2009 2008 2007 2006
------------- -------------- --------------- ----------------
Components of net periodic postretirement benefit cost
Service cost $ 444 $ 533 $ 664
Interest cost on projected benefit obligation 11,255 10,241 8,974
Expected return on plan assets (514) (578) (889)
Amortization of prior service cost (7,750) (7,751) (7,735) (7,589)
Amortization of unrecognized loss 5,514 5,946 6,099 4,678
-------------- --------------- ----------------
Net periodic postretirement benefit cost $ 9,380 $ 8,560 $ 5,838
============== =============== ================
Assumptions used in the computation of annual OPEB costs and valuation of
the year-end OPEB obligations were as follows:
2008 2007 2006
---- ---- ----
Discount rate - used at year end to value obligation 6.50% 6.50% 6.00%
Discount rate - used to compute annual cost 6.50% 6.00% 5.625%
Expected long-term rate of return on plan assets 6.00% 6.00% 8.25%
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The plans' weighted average asset allocations at December 31, 2008 and 2007
by asset category are as follows:
2008 2007
------------- --------------
Asset category:
---------------
Equity securities 0% 0%
Debt securities 100% 100%
Cash and other 0% 0%
------------- --------------
Total 100% 100%
============= ==============
The plans' expected benefit payments over the next 10 years are as follows:
($ in thousands)
----------------
Gross Medicare Part D
Year Benefits Subsidy Total
--------------- -------------- ------------- --------------
2009 $ 13,137 $ 397 $ 12,740
2010 13,578 464 13,114
2011 14,146 533 13,613
2012 14,314 647 13,667
2013 14,657 748 13,909
2014 - 2018 75,959 5,330 70,629
-------------- ------------- --------------
Total $ 145,791 $ 8,119 $ 137,672
============== ============= ==============
Our expected contribution to the plans in 2009 is $12.7 million.
For purposes of measuring year-end benefit obligations, we used, depending
on medical plan coverage for different retiree groups, a 9% annual rate of
increase in the per-capita cost of covered medical benefits, gradually
decreasing to 5% in the year 2017 and remaining at that level thereafter.
The effect of a 1% increase in the assumed medical cost trend rates for
each future year on the aggregate of the service and interest cost
components of the total postretirement benefit cost would be $0.7 million
and the effect on the accumulated postretirement benefit obligation for
health benefits would be $10.0 million. The effect of a 1% decrease in the
assumed medical cost trend rates for each future year on the aggregate of
the service and interest cost components of the total postretirement
benefit cost would be $(0.6) million and the effect on the accumulated
postretirement benefit obligation for health benefits would be $(8.7)
million.
In December 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) became law. The Act introduces a
prescription drug benefit under Medicare. It includes a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that
is at least actuarially equivalent to the Medicare Part D benefit. The
amount of the federal subsidy is based on 28% of an individual
beneficiary's annual eligible prescription drug costs ranging between $250
and $5,000. We have determined that the Company-sponsored postretirement
healthcare plans that provide prescription drug benefits are actuarially
equivalent to the Medicare Prescription Drug benefit. The impact of the
federal subsidy has been incorporated into the calculation.
The amounts in accumulated other comprehensive income that have not yet
been recognized as components of net periodic benefit cost at December 31,
2008 and 2007 are as follows:
($ in thousands) Pension Plan OPEB
---------------- ------------------------------------- ------------------------------------
2008 2007 2008 2007
----------------- ---------------- ---------------- -------------------
Net actuarial loss $ 377,183 $ 135,627 $ 47,252 $ 49,154
Prior service cost/(credit) (1,097) (1,351) (39,207) (46,862)
----------------- ---------------- ---------------- -------------------
Total $ 376,086 $ 134,276 $ 8,045 $ 2,292
================= ================ ================ ===================
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The amounts recognized as a component of accumulated comprehensive income
for the years ended December 31, 2008 and 2007 are as follows:
Pension Plan OPEB
---------------------------- -----------------------------
($ in thousands) 2008 2007 2008 2007
---------------- ------------- ------------- ------------- --------------
Accumulated other comprehensive income at
beginning of year $ 134,276 $ 147,248 $ 2,292 $ (13,703)
------------- ------------- ------------- --------------
Net actuarial gain (loss) recognized during year (6,855) (7,313) (5,946) (6,099)
Prior service (cost)/credit recognized during year 255 255 7,751 7,735
Net actuarial loss (gain) occurring during year 248,410 (5,914) 4,043 15,384
Prior service cost (credit) occurring during year - - (95) (1,025)
------------- ------------- ------------- --------------
Net amount recognized in comprehensive income
for the year 241,810 (12,972) 5,753 15,995
------------- ------------- ------------- --------------
Accumulated other comprehensive income at end
of year $ 376,086 $ 134,276 $ 8,045 $ 2,292
============= ============= ============= ==============
401(k) Savings Plans
--------------------
We sponsor employee retirement savings plans under section 401(k) of the
Internal Revenue Code. The plans cover substantially all full-time
employees. Under the plans, we provide matching contributions and also
provide certain profit-sharing contributions to certain employees upon the
attainment of pre-established financial criteria. Employer contributions
were $5.0 million, $4.9 million and $4.7 million for 2008, 2007 and 2006,
respectively. The amount for 2007 includes employer contributions of $0.4
million for CTE employees under a separate Commonwealth plan. Also,
effective December 31, 2007, the Commonwealth Builder 401(k) Plan was
merged into the Frontier 401(k) Savings Plan.
(24) Commitments and Contingencies:
------------------------------
On June 24, 2004, one of our subsidiaries, Frontier Subsidiary Telco, Inc.,
received a "Notice of Indemnity Claim" from Citibank, N.A., that is related
to a complaint pending against Citibank and others in the U.S. Bankruptcy
Court for the Southern District of New York as part of the Global Crossing
bankruptcy proceeding. Citibank bases its claim for indemnity on the
provisions of a credit agreement that was entered into in October 2000
between Citibank and our subsidiary. We purchased Frontier Subsidiary
Telco, Inc., in June 2001 as part of our acquisition of the Frontier
telephone companies. The complaint against Citibank, for which it seeks
indemnification, alleges that the seller improperly used a portion of the
proceeds from the Frontier transaction to pay off the Citibank credit
agreement, thereby defrauding certain debt holders of Global Crossing North
America Inc. Although the credit agreement was paid off at the closing of
the Frontier transaction, Citibank claims the indemnification obligation
survives. Damages sought against Citibank and its co-defendants could
exceed $1.0 billion. In August 2004, we notified Citibank by letter that we
believe its claims for indemnification are invalid and are not supported by
applicable law. In 2005, Citibank moved to dismiss the underlying complaint
against it. That motion is currently pending. We have received no further
communications from Citibank since our August 2004 letter.
We are party to various other legal proceedings arising in the normal
course of our business. The outcome of individual matters is not
predictable. However, we believe that the ultimate resolution of all such
matters, after considering insurance coverage, will not have a material
adverse effect on our financial position, results of operations, or our
cash flows.
We anticipate capital expenditures of approximately $250.0 million to
$270.0 million for 2009. Although we from time to time make short-term
purchasing commitments to vendors with respect to these expenditures, we
generally do not enter into firm, written contracts for such activities.
F-41
We conduct certain of our operations in leased premises and also lease
certain equipment and other assets pursuant to operating leases. The lease
arrangements have terms ranging from 1 to 99 years and several contain rent
escalation clauses providing for increases in monthly rent at specific
intervals. When rent escalation clauses exist, we record total expected
rent payments on a straight-line basis over the lease term. Certain leases
also have renewal options. Renewal options that are reasonably assured are
included in determining the lease term. Future minimum rental commitments
for all long-term noncancelable operating leases as of December 31, 2008
are as follows:
($ in thousands) Operating
---------------- Leases
--------------
Year ending December 31:
2009 $ 22,654
2010 11,288
2011 10,211
2012 6,835
2013 5,946
Thereafter 9,566
--------------
Total minimum lease payments $ 66,500
==============
Total rental expense included in our consolidated statements of operations
for the years ended December 31, 2008, 2007 and 2006 was $24.3 million,
$23.6 million and $16.3 million, respectively.
We are a party to contracts with several unrelated long distance carriers.
The contracts provide fees based on traffic they carry for us subject to
minimum monthly fees.
At December 31, 2008, the estimated future payments for obligations under
our noncancelable long distance contracts and service agreements are as
follows:
($ in thousands)
----------------
Year Amount
--------------- -------------
2009 $ 23,286
2010 9,937
2011 259
2012 165
2013 165
Thereafter 330
-------------
Total $ 34,142
=============
We sold all of our utility businesses as of April 1, 2004. However, we have
retained a potential payment obligation associated with our previous
electric utility activities in the State of Vermont. The Vermont Joint
Owners (VJO), a consortium of 14 Vermont utilities, including us, entered
into a purchase power agreement with Hydro-Quebec in 1987. The agreement
contains "step-up" provisions that state that if any VJO member defaults on
its purchase obligation under the contract to purchase power from
Hydro-Quebec, then the other VJO participants will assume responsibility
for the defaulting party's share on a pro-rata basis. Our pro-rata share of
the purchase power obligation is 10%. If any member of the VJO defaults on
its obligations under the Hydro-Quebec agreement, then the remaining
members of the VJO, including us, may be required to pay for a
substantially larger share of the VJO's total power purchase obligation for
the remainder of the agreement (which runs through 2015). Paragraph 13 of
FIN No. 45 requires that we disclose "the maximum potential amount of
future payments (undiscounted) the guarantor could be required to make
under the guarantee." Paragraph 13 also states that we must make such
disclosure "... even if the likelihood of the guarantor's having to make
any payments under the guarantee is remote..." As noted above, our
obligation only arises as a result of default by another VJO member, such
as upon bankruptcy. Therefore, to satisfy the "maximum potential amount"
disclosure requirement we must assume that all members of the VJO
simultaneously default, a highly unlikely scenario given that the two
members of the VJO that have the largest potential payment obligations are
publicly traded with credit ratings equal to or superior to ours, and that
all VJO members are regulated utility providers with regulated cost
recovery. Despite the remote chance that such an event could occur, or that
the State of Vermont could or would allow such an event, assuming that all
the members of the VJO defaulted on January 1, 2009 and remained in default
for the duration of the contract (another 7 years), we estimate that our
undiscounted purchase obligation for 2009 through 2015 would be
F-42
approximately $0.8 billion. In such a scenario the Company would then own
the power and could seek to recover its costs. We would do this by seeking
to recover our costs from the defaulting members and/or reselling the power
to other utility providers or the northeast power grid. There is an active
market for the sale of power. We could potentially lose money if we were
unable to sell the power at cost. We caution that we cannot predict with
any degree of certainty any potential outcome.
At December 31, 2008, we have outstanding performance letters of credit as
follows:
($ in thousands)
----------------
CNA $ 20,844
State of New York 1,042
--------------
Total $ 21,886
==============
CNA serves as our agent with respect to general liability claims (auto,
workers compensation and other insured perils of the Company). As our
agent, they administer all claims and make payments for claims on our
behalf. We reimburse CNA for such services upon presentation of their
invoice. To serve as our agent and make payments on our behalf, CNA
requires that we establish a letter of credit in their favor. CNA could
potentially draw against this letter of credit if we failed to reimburse
CNA in accordance with the terms of our agreement. The value of the letter
of credit is reviewed annually and adjusted based on claims history.
None of the above letters of credit restrict our cash balances.
F-43