UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C.  20549

 

FORM 10-Q

(Mark One)

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

 

For the quarterly period ended September 30, 2015

 

or

 

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

 

For the transition period from _________to__________

 

Commission file number:  001-11001

 

FRONTIER COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(203) 614-5600

(Registrant's telephone number, including area code)

 

N/A

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

 

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

 

Yes  X       No ___

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes  X       No ___

 

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

 

Large accelerated filer ☒           Accelerated filer ☐           Non-accelerated filer ☐          Smaller reporting company  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes           No X   

 

The number of shares outstanding of the registrant’s Common Stock as of October 26,  2015 was 1,168,212,000.

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FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

 

Index

 

 

 

 

 

 

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PART I.  FINANCIAL INFORMATION

 

Item 1.Financial Statements

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

 

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

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PART I.  FINANCIAL INFORMATION (Continued)

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

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

(Unaudited)

 

 

 

 

 

 

 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

($ in millions)

(Unaudited)

 

 

 

 

 

 

 

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

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PART I.  FINANCIAL INFORMATION (Continued)

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015

($ in millions and shares in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

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PART I.  FINANCIAL INFORMATION (Continued)

 

FRONTIER COMMUNICATIONS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014

($ in millions)

(Unaudited)

 

 

 

 

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

 

 

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(1)   Summary of Significant Accounting Policies:

(a)   Basis of Presentation and Use of Estimates:

Frontier Communications Corporation and its subsidiaries are referred to as “we,” “us,” “our,” “Frontier,” or the “Company” in this report. Our interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2014. Reclassifications of amounts previously reported in our consolidated statement of operations as “Other operating expenses” have been made to conform to the current presentation of “Network related expenses” and “Selling, general and administrative expenses”.  All significant intercompany balances and transactions have been eliminated in consolidation. These interim unaudited consolidated financial statements include all adjustments (consisting of normal recurring accruals) considered necessary, in the opinion of Frontier’s management, to present fairly the results for the interim periods shown. Revenues, net income (loss) and cash flows for any interim periods are not necessarily indicative of results that may be expected for the full year. For our interim financial statements as of and for the period ended September 30, 2015, we evaluated subsequent events and transactions for potential recognition or disclosure through the date that we filed this Form 10-Q with the Securities and Exchange Commission (SEC).

 

Effective October 24, 2014, Frontier’s scope of operations and balance sheet capitalization changed materially as a result of the completion of the Connecticut Acquisition, as described in Note 3 - Acquisitions. Financial data presented for Frontier for periods prior to that date is not indicative of the future financial position or operating results for Frontier. 

 

The preparation of our interim financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities at the date of the financial statements, (ii) the disclosure of contingent assets and liabilities, and (iii) the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. Estimates and judgments are used when accounting for the allowance for doubtful accounts,  asset impairments, indefinite-lived intangibles, depreciation and amortization, income taxes, business combinations, and pension and other postretirement benefits, among others.

 

We operate in one reportable segment. Frontier provides both regulated and unregulated voice, data and video services to residential, business and wholesale customers and is typically the incumbent voice services provider in its service areas. We have combined our six geographic operating regions because all of these regional operations share similar 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 significantly impact the economic characteristics or operating results of a particular region.

 

(b)   Revenue Recognition:

Revenue is recognized when services are provided or when products are delivered to customers. Revenue that is billed in advance includes monthly recurring network access services (including data services), special access services and monthly recurring voice, video and related charges. The unearned portion of these fees is initially deferred as a component of “Advanced billings” on our consolidated balance sheet and recognized as revenue over the period that the services are provided. Revenue that is billed in arrears includes non-recurring network access services (including data services), switched access services and non-recurring voice and video services. The earned but unbilled portion of these fees is recognized as revenue in our consolidated statements of operations and accrued in “Accounts receivable” on our consolidated balance sheet 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.

 

Frontier collects various taxes from its customers and subsequently remits these taxes to governmental authorities. Substantially all of these taxes are recorded through the consolidated balance sheet and presented on a net basis in our

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consolidated statements of operations.  We also collect Universal Service Fund (USF) surcharges from customers (primarily federal USF) that we have recorded on a gross basis in our consolidated statements of operations and included within “Revenue” and “Network related expenses” of  $38 million and $30 million, and $114 million and $90 million, for the three and nine months ended September 30, 2015 and 2014, respectively.

 

In 2015 we accepted the FCC’s Connect America Fund (CAF) Phase II offer of support, which replaces the USF frozen high-cost support that we had been receiving pursuant to a 2011 FCC order.  CAF Phase II funding as well as USF frozen high-cost support are programs intended to subsidize the high-cost of delivering communications services to certain high-cost unserved or underserved areas.  We are recognizing these subsidies into revenue consistent with how the costs related to these subsidies are being and are expected to be incurred, which is on a straight line basis.  

 

We categorize our products, services and other revenues among the following four categories:

 

 

 

 

 

 

The following table provides a summary of revenues from external customers by the categories of Frontier’s products and services:

 

 

 

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(c)   Goodwill and Other Intangibles:

Goodwill represents the excess of purchase price over the fair value of identifiable tangible and intangible net assets acquired. We undertake studies to determine the fair values of assets and liabilities acquired and allocate purchase prices to assets and liabilities, including property, plant and equipment, goodwill and other identifiable intangibles. We examine the carrying value of our goodwill and trade name annually as of December 31, or more frequently, as circumstances warrant, to determine whether there are any impairment losses. We test for goodwill impairment at the “operating segment” level, as that term is defined in GAAP. During the second quarter of 2015, Frontier reorganized into six regional operating segments, which are aggregated into one reportable segment.  In conjunction with the reorganization of our operating segments effective with the second quarter of 2015, we reassigned goodwill to our regional operating segments (reporting units) using a relative fair value allocation approach.  We tested for the impairment of goodwill and there was no indication of impairment at June 30, 2015.

 

Frontier amortizes finite-lived intangible assets over their estimated useful lives on the accelerated method of sum of the years digits. We review such intangible assets at least annually as of December 31 to assess whether any potential impairment exists and whether factors exist that would necessitate a change in useful life and a different amortization period. 

 

 

(2)   Recent Accounting Literature:

Debt Issuance Costs

In April, 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No. 2015-15, “Interest – Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements”. This standard permits an entity to defer and present debt issuance costs related to line-of-credit arrangements as an asset and to subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. These new standards are effective for annual and interim reporting periods beginning after December 15, 2015. Early adoption is permitted and companies must apply the requirements retrospectively. At this time, Frontier has not elected the early adoption method for this standard. Debt issuance costs are included in “Other assets” and were $208 million at September 30, 2015.

 

Revenue Recognition

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This standard requires companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This new standard is effective for annual and interim reporting periods beginning after December 15, 2017. Companies are also permitted to voluntarily adopt the new standard as of the original effective date that was for annual reporting periods beginning after December 15, 2016. Companies are permitted to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through a cumulative adjustment. Frontier is currently evaluating the impact of adopting the new standard,  but has not yet selected a transition method or determined the impact of adoption on its consolidated financial statements.   

 

(3)   Acquisitions:

The Connecticut Acquisition 

On October 24, 2014, pursuant to the stock purchase agreement dated December 16, 2013, as amended, Frontier acquired the wireline properties of AT&T Inc. (AT&T) in Connecticut (the Connecticut Acquisition) for a purchase price of $2,018 million in cash, including adjustments for working capital. Following the Connecticut Acquisition, Frontier now owns and operates the wireline business and fiber optic network servicing residential, commercial and wholesale customers in Connecticut. Frontier also acquired the AT&T U-verse® video and DISH® satellite TV customers in Connecticut.

 

In connection with the Connecticut Acquisition, Frontier incurred $38 million of operating expenses, consisting of $1 million and $37 million of acquisition and integration costs, respectively, and $23 million in capital expenditures during the nine months ended September 30, 2015. Frontier incurred $72 million of operating expenses, consisting of $3 million and $69 

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million of acquisition and integration costs, respectively, and $82 million in capital expenditures during the nine months ended September 30, 2014.

 

Our consolidated statement of operations for the nine months ended September 30, 2015 includes $792 million of revenue and $74 million of operating income related to the results of the Connecticut operations.

 

The final allocation of the purchase price presented below represents the effect of recording the fair value of assets acquired, liabilities assumed and related deferred income taxes as of the date of the Connecticut Acquisition, based on the total transaction consideration of $2,018 million. An adjustment to the allocation of the purchase price for the Connecticut Acquisition during the third quarter of 2015 resulted in a $71 million decrease to Deferred income taxes and Goodwill. 

 

 

 

The following unaudited pro forma financial information presents the combined results of operations of Frontier and the Connecticut operations as if the Connecticut Acquisition had occurred as of January 1, 2014. The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the Connecticut Acquisition been completed as of January 1, 2014. In addition, the unaudited pro forma financial information is not indicative of, nor does it purport to project, the future financial position or operating results of Frontier. The unaudited pro forma financial information excludes acquisition and integration costs and does not give effect to any estimated and potential cost savings or other operating efficiencies that may result from the Connecticut Acquisition.

 

 

 

The Verizon Transaction

On February 5, 2015, we entered into an agreement with Verizon Communications Inc. (Verizon) to acquire Verizon’s wireline operations that provide services to residential, commercial and wholesale customers in California, Florida and Texas for a purchase price of $10,540 million in cash and assumed debt (the Verizon Transaction), with adjustments for working capital.  Upon completion of the pending Verizon Transaction, Frontier will operate Verizon properties that included 3.5 million voice connections, 2.2 million broadband connections, and 1.2 million FiOS® video connections as

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of June 30, 2015.  The transaction is expected to close at the end of the first quarter of 2016 subject to regulatory approval and the completion of operational matters. 

 

In the third quarter of 2015, Frontier received regulatory approvals from the FCC and the Public Utilities Commission of Texas. The approval from the California Public Utilities Commission is pending. In the third quarter of 2015, Frontier reached agreement with the Communications Workers of America and the International Brotherhood of Electrical Workers, representing employees that support operations in California, Florida and Texas, to extend their existing collective bargaining agreements by two years.  In addition, Verizon has conditionally accepted $49 million in annual support in California and Texas under the CAF Phase II program.

 

Acquisition costs include legal, financial advisory, accounting, regulatory and other related costs.  Integration costs include expenses incurred to integrate the network and information technology platforms and to enable other integration initiatives. Frontier incurred $112 million of operating expenses, consisting of $37 million of acquisition costs and $75 million of integration costs, related to the pending Verizon Transaction during the nine months ended September 30, 2015. We also invested $78 million in capital expenditures related to the Verizon Transaction during the nine months ended September 30, 2015.

 

Frontier completed a private debt offering of $6,600 million of unsecured senior notes in September 2015 and entered into a credit agreement for a new $1,500 million senior secured delayed-draw term loan facility in August 2015, each for the purpose of financing the Verizon Transaction. Frontier issued $2,750 million in preferred and common stock in June 2015 for the purpose of financing the Verizon Transaction. Net proceeds from these debt and equity offerings in the amount of $8,440 million are included in “Restricted cash” in the consolidated balance sheet as of September 30, 2015. See Notes 8 and 9 for further discussion.

 

 

(4)   Accounts Receivable:

The components of accounts receivable, net are as follows:

 

 

 

We maintain an allowance for doubtful accounts based on our estimate of our ability to collect accounts receivable. Bad debt expense, which is recorded as a reduction to revenue, was $20  million and $17 million for the three months ended September 30, 2015 and 2014,  respectively, and $46 million and $41 million for the nine months ended September 30, 2015 and 2014, respectively. Our allowance for doubtful accounts declined in the first nine months of 2015, primarily as a result of the resolution of a principal carrier dispute during the first quarter.

 

(5)   Property, Plant and Equipment:

Property, plant and equipment, net is as follows:

 

 

 

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Depreciation expense is principally based on the composite group method. Depreciation expense was $245 million and $195 million, and $741 million and $598 million, for the three and nine months ended September 30, 2015 and 2014, respectively.  We adopted new estimated remaining useful lives for certain plant assets as of October 1, 2014,  as a result of our annual independent study of the estimated remaining useful lives of our plant assets, with an insignificant  impact to depreciation expense. In addition, we commissioned an independent study to determine the estimated useful lives for assets acquired during the Connecticut Acquisition. These new lives were adopted effective October 24, 2014.

 

(6)   Goodwill and Other Intangibles:

The activity in our goodwill from January 1, 2015 through September 30, 2015 is as follows:  

 

 

 

 

The components of other intangibles are as follows:

 

 

Amortization expense was $80 million and $66 million, and $260 million and $218 million, for the three and nine months ended September 30, 2015 and 2014, respectively. Amortization expense represents the amortization of our customer lists acquired as a result of the Connecticut Acquisition and the acquisition of certain Verizon properties in 2010 (the 2010 Acquisition) with each based on a useful life of 9 to 12 years on an accelerated method.    

 

(7)   Fair Value of Financial Instruments:

The following table summarizes the carrying amounts and estimated fair values for long-term debt at September 30, 2015 and December 31, 2014.  For the other financial instruments including cash, accounts receivable, long-term debt due within one year, accounts payable and other current liabilities, the carrying amounts approximate fair value due to the relatively short maturities of those instruments.

 

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

 

 

 

 

 

 

 

 

 

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(8)   Long-Term Debt:

The activity in our long-term debt from January 1, 2015 through September 30, 2015 is summarized as follows:

 

 

 

 

* Interest rate includes amortization of debt issuance costs and debt premiums or discounts. The interest rates at September 30, 2015 represent a weighted average of multiple issuances.

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Additional information regarding our senior unsecured debt and subsidiary debentures is as follows:

 

 

 

*      Represents borrowings under the 2011 CoBank Credit Agreement, as defined below.

**    Represents borrowings under the 2014 CoBank Credit Agreement, as defined below.

***  Interest rate represents a weighted average of the stated interest rates of multiple issuances.

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On September 25, 2015, Frontier completed a private offering of $6,600 million aggregate principal amount of unsecured Senior Notes, as follows: $1,000 million of 8.875% Senior Notes due 2020; $2,000 million of 10.500% Senior Notes due 2022; and $3,600 million of 11.000% Senior Notes due 2025. Each was issued at a price equal to 100% of its principal amount. Frontier intends to use the proceeds from the offering to finance a portion of the cash consideration payable in connection with the Verizon Transaction and to pay related fees and expenses. The net proceeds of the debt offering (after deducting underwriting fees) of $6,485 million are included in “Restricted cash” in the consolidated balance sheet as of September 30, 2015.  These funds were deposited in an escrow account to partially fund the acquisition or, if the acquisition is terminated or otherwise not consummated on or before August 6, 2016, to redeem the new Senior Notes at par plus accrued interest.

 

On August 12, 2015, Frontier entered into a credit agreement with JPMorgan Chase Bank, N.A., as the administrative agent, and the lenders party thereto, for a $1,500 million senior secured delayed-draw term loan facility (the 2015 Credit Agreement).  The term loan will be drawn at the closing of the Verizon Transaction.  The final maturity date is the earlier of the fifth anniversary of the draw date or March 31, 2021.  Repayment of the outstanding principal balance will be made in quarterly installments, initially in the amount of $19 million per installment, commencing one full fiscal quarter after the draw date.  The quarterly installments will increase to $38 million, beginning with the 13th quarterly installment.  The remaining outstanding principal balance will be repaid on the final maturity date.  Borrowings under the term loan will bear interest based on margins over the Base Rate (as defined in the 2015 Credit Agreement) or LIBOR, at the election of Frontier.  Interest rate margins under the facility (ranging from 0.75% to 1.75% for Base Rate borrowings and 1.75% to 2.75% for LIBOR borrowings) are subject to adjustment based on Frontier’s Total Leverage Ratio (as defined in the 2015 Credit Agreement).  Borrowings under the 2015 Credit Agreement will be secured by a pledge of the stock of Frontier North Inc., a wholly owned subsidiary.

 

On February 5, 2015, we entered into a commitment for a bridge loan facility (the Verizon Bridge Facility) and recognized related interest expense of $52 million and $184 million during the three and nine months ended September 30, 2015, respectively. The accrued liabilities related to the Verizon Bridge Facility of $173 million are included in “Other current liabilities” in the consolidated balance sheet as of September 30, 2015.  The Verizon Bridge Facility terminated, in accordance with its terms, on September 25, 2015.

 

During the first nine months of 2015, we entered into secured financings totaling $3 million with four year terms and no stated interest rate for certain equipment purchases.

 

Frontier has a credit agreement with CoBank, ACB, as administrative agent, lead arranger and a lender, and the other lenders party thereto, for a $350 million senior unsecured delayed draw term loan facility (the 2014 CoBank Credit Agreement). The facility was drawn upon closing of the Connecticut Acquisition with proceeds used to partially finance the acquisition. The maturity date is October 24, 2019. Repayment of the outstanding principal balance will be made in quarterly installments of $9 million, which commenced on March 31, 2015, with the remaining outstanding principal balance to be repaid on the maturity date. Borrowings under the 2014 CoBank Credit Agreement bear interest based on the margins over the Base Rate (as defined in the 2014 CoBank Credit Agreement) or LIBOR, at the election of Frontier. Interest rate margins under the facility (ranging from 0.875% to 2.875% for Base Rate borrowings and 1.875% to 3.875% for LIBOR borrowings) are subject to adjustments based on our Total Leverage Ratio, as such term is defined in the 2014 CoBank Credit Agreement. The interest rate on this facility at September 30, 2015 was LIBOR plus 3.375%.

 

Frontier has a credit agreement with CoBank, ACB, as administrative agent, lead arranger and a lender, and the other lenders party thereto, for a $575 million senior unsecured term loan facility with a final maturity of October 14, 2016 (the 2011 CoBank Credit Agreement). The entire facility was drawn upon execution of the 2011 CoBank Credit Agreement in October 2011. Repayment of the outstanding principal balance is made in quarterly installments of $14 million, which commenced on March 31, 2012, with the remaining outstanding principal balance to be repaid on the final maturity date. Borrowings under the 2011 CoBank Credit Agreement bear interest based on the margins over the Base Rate (as defined in the 2011 CoBank Credit Agreement) or LIBOR, at the election of Frontier. Interest rate margins under the facility (ranging from 0.875% to 2.875% for Base Rate borrowings and 1.875% to 3.875% for LIBOR borrowings) are subject to adjustments based on our Total Leverage Ratio, as such term is defined in the 2011 CoBank Credit Agreement. The interest rate on this facility at September 30, 2015 was LIBOR plus 2.375%. 

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Frontier has a revolving credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, the lenders party thereto and the other parties named therein (the Revolving Credit Agreement), for a $750 million revolving credit facility (the Revolving Credit Facility) with a scheduled termination date of May 31, 2018. As of September 30, 2015,  the Revolving Credit Facility was fully available and no borrowings had been made thereunder.  Associated commitment fees under the Revolving Credit Facility will vary from time to time depending on our debt rating (as defined in the Revolving Credit Agreement) and were 0.450% per annum as of September 30, 2015. During the term of the Revolving Credit Facility, Frontier may borrow, repay and reborrow funds, and may obtain letters of credit, subject to customary borrowing conditions. Loans under the Revolving Credit Facility will bear interest based on the alternate base rate or the adjusted LIBO Rate (each as determined in the Revolving Credit Agreement), at our election, plus a margin based on our debt rating (ranging from 0.50% to 1.50% for alternate base rate borrowings and 1.50% to 2.50% for adjusted LIBO Rate borrowings). The interest rate on this facility at September 30, 2015 would have been the alternate base rate plus 1.50% or the adjusted LIBO Rate plus 2.50%, respectively. Letters of credit issued under the Revolving Credit Facility will also be subject to fees that vary depending on our debt rating. The Revolving Credit Facility is available for general corporate purposes but may not be used to fund dividend payments.

 

Upon the drawdown of the term loan under the 2015 Credit Agreement in connection with the closing of the Verizon Transaction, borrowings under the 2014 CoBank Credit Agreement, the 2011 CoBank Credit Agreement and the Revolving Credit Facility will become secured debt. These borrowings will be secured, equally and ratably with borrowings under the 2015 Credit Agreement, by a pledge of the stock of Frontier North Inc., a wholly owned subsidiary.

 

As of September 30, 2015, we were in compliance with all of our debt and credit facility financial covenants.

 

Our scheduled principal payments are as follows as of September 30, 2015:  

 

 

 

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(9)   Capital Stock:

 

Common Stock Offering

On June 10, 2015, we completed a registered offering of 150,000,000 shares of our common stock, par value $0.25 per share, at an offering price of $5 per share. On June 24, 2015, Frontier issued an additional 15,000,000 shares of common stock in connection with the over-allotment option that was exercised in full by the underwriters. Aggregate net proceeds were approximately $799 million after deducting commissions and estimated expenses. We intend to use the net proceeds from this offering to fund a portion of the acquisition price of the Verizon Transaction and related fees and expenses.  

 

Mandatory Convertible Preferred Stock (Series A) Offering

On June 10, 2015, we also completed a registered offering of 17,500,000 shares of our 11.125% Mandatory Convertible Preferred Stock, Series A, par value $0.01 per share (the “Series A Preferred Stock”), at an offering price of $100 per share. On June 24, 2015, Frontier issued an additional 1,750,000 shares of Series A Preferred Stock in connection with the over-allotment option that was exercised in full by the underwriters. Aggregate net proceeds of the offering were $1,866 million after deducting commissions and estimated expenses. We intend to use the net proceeds from this offering to fund a portion of the acquisition price of the Verizon Transaction and related fees and expenses.

 

Unless converted earlier, each share of the Series A Preferred Stock will automatically convert on June 29, 2018 into between 17.0213 and 20.0000 shares of common stock, depending on the applicable market value of our common stock, subject to anti-dilution adjustments. Subject to certain restrictions, at any time prior to June 29, 2018, holders of the Series A Preferred Stock may elect to convert all or a portion of their shares into common stock at the minimum conversion rate then in effect.

 

Dividends on shares of the Series A Preferred Stock are payable on a cumulative basis when, as and if declared by our Board of Directors (or an authorized committee thereof) at an annual rate of 11.125% on the liquidation preference of $100.00 per share, on the last business day of March, June, September and December of each year, commencing on September 30, 2015 to, and including, the mandatory conversion date.    Series A Preferred Stock dividends of $67 million were paid on September 30, 2015.

 

Pursuant to the terms of the Verizon Transaction, $1,955 million of the $2,665 million in net proceeds from the equity offerings were deposited into escrow and are included in “Restricted cash” in the consolidated balance sheet as of September 30, 2015.  Upon closing of the Verizon Transaction, the funds will be released and used to fund a portion of the purchase price.  If the Verizon Transaction is terminated, the funds will be released and become unrestricted cash of Frontier.

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(10)  Income Taxes: 

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

 

 

 

Income taxes for the nine months ended September 30, 2015 include the impact of an $11 million benefit primarily resulting from the adjustment of deferred tax balances due to state tax law changes.    Income taxes for the three and nine months ended September 30, 2015 also include the impact of a $2 million benefit from the adjustment of federal research and development credits and a $7 million benefit from the domestic production activities deductions.

 

Income taxes for the nine months ended September 30, 2014 include the impact of a $4 million benefit from federal research and development credits, a $9 million benefit from the domestic production activities deduction and a $3 million benefit arising from state tax law changes, partially offset by a net increase in reserves for uncertain tax positions of $1 million.

 

Amounts pertaining to income tax related accounts of $71 million and $97 million are included in “Income taxes and other current assets” in the consolidated balance sheets as of September 30, 2015 and December 31, 2014, respectively.

 

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(11)  Net Income (Loss) Per Share:

The reconciliation of the net income (loss) per share calculation is as follows:

 

 

 

Stock Options

For the three and nine months ended September 30, 2015 and 2014, options to purchase 68,000 and 83,000 shares,  respectively, issuable under employee compensation plans were excluded from the computation of diluted earnings per share (EPS) for those periods because the exercise prices were greater than the average market price of our common stock and, therefore, the effect would be antidilutive. In calculating diluted EPS, we apply the treasury stock method and include future unearned compensation as part of the assumed proceeds.

 

Stock Units

At September 30, 2015 and 2014, we had 1,334,633 and 1,050,568 stock units, respectively, issued under our Non-Employee Directors’ Deferred Fee Equity Plan (Deferred Fee Plan) and the Non-Employee Directors’ Equity Incentive Plan (Directors’ Equity Plan). These securities have not been included in the diluted income per share of common stock calculation because their inclusion would have an antidilutive effect. Compensation costs associated with the issuance of stock units were $(1) million and $3 million for the nine months ended September 30, 2015 and 2014, respectively.

 

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Mandatory Convertible Preferred Stock

The impact of the common share equivalents associated with the 19,250,000 shares of Series A Preferred stock described above were not included in the calculation of diluted EPS as of September 30, 2015, as their impact was anti-dilutive.

 

In calculating diluted net loss per share for the three and nine months ended September 30, 2015, the effect of all common stock equivalents is excluded from the computation as the effect would be antidilutive.  

 

(12)  Stock Plans:

At September 30, 2015, we had  six  stock-based compensation plans under which grants were made and awards remained outstanding. No further awards may be granted under four of the plans: the 1996 Equity Incentive Plan (the 1996 EIP), the Amended and Restated 2000 Equity Incentive Plan (the 2000 EIP), the 2009 Equity Incentive Plan (the 2009 EIP) and the Deferred Fee Plan. At September 30, 2015, there were 22,541,000 shares authorized for grant and 12,629,000 shares available for grant under the 2013 Equity Incentive Plan (the 2013 EIP and together with the 1996 EIP, the 2000 EIP and the 2009 EIP, the EIPs) and the Directors’ Equity Plan. Our general policy is to issue shares from treasury upon the grant of restricted shares and the exercise of options.

 

Performance Shares

On February 25, 2015, the Compensation Committee of our Board of Directors granted approximately 665,000 performance shares under the Frontier Long Term Incentive Plan (the LTIP) and set the operating cash flow performance goal for 2015, which applies to the first year in the 2015-2017  measurement period, the second year of the 2014-2016 measurement period and the third year of the 2013-2015 measurement period.

 

The following summary presents information regarding LTIP target performance shares as of September 30, 2015 and changes during the nine months then ended with regard to LTIP shares awarded under the 2009 EIP and the 2013 EIP:

 

 

 

For purposes of determining compensation expense, the fair value of each performance share is measured at the end of each reporting period and, therefore, will fluctuate based on the price of Frontier common stock as well as performance relative to the targets. For the nine months ended September 30, 2015 and 2014,  we recognized an expense of $6 million and $3 million, respectively, for the LTIP.

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Restricted Stock

The following summary presents information regarding unvested restricted stock as of September 30, 2015 and changes during the nine months then ended with regard to restricted stock under the 2009 EIP and the 2013 EIP:

 

 

 

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 September 30, 2015 was $29 million and the weighted average period over which this cost is expected to be recognized is approximately 1.5 years.

 

Shares granted during the first nine months of 2014 totaled 3,836,000. The total fair value of shares of restricted stock granted and vested at September 30, 2014 was approximately $25 million and $15 million, respectively. The total fair value of unvested restricted stock at September 30, 2014 was $48 million.  The weighted average grant date fair value of restricted shares granted during the nine months ended September 30, 2014 was $4.74 per share.

 

We have granted restricted stock awards to employees in the form of our common stock. 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. Compensation expense, recognized in “Selling, general and administrative expenses”, of $13 million and $12 million for the nine months ended September 30, 2015 and 2014, respectively, has been recorded in connection with these grants.

 

 

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(13)  Comprehensive Income (Loss):

Comprehensive income consists of net income (loss) and other gains and losses affecting shareholders’ investment and pension/postretirement benefit (OPEB) liabilities that, under GAAP, are excluded from net income (loss).

 

The components of accumulated other comprehensive loss, net of tax at September 30, 2015 and 2014, and changes for the nine months then ended, are as follows:

 

 

The significant items reclassified from each component of accumulated other comprehensive loss for the three and nine months ended September 30, 2015 and 2014 are as follows:

 

(a) Amounts in parentheses indicate losses.

(b) These accumulated other comprehensive loss components are included in the computation of net periodic pension and OPEB costs (see Note 14 - Retirement Plans for additional details).

 

 

 

 

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(14)  Retirement Plans: 

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

 

 

 

 

 

During the first nine months of 2015 and 2014, we capitalized $15 million and $11 million, respectively, of pension and OPEB expense into the cost of our capital expenditures, as the costs relate to our engineering and plant construction activities. Based on current assumptions and plan asset values, we estimate that our 2015 pension and OPEB expenses will be approximately $90 million to $100 million before amounts capitalized into the cost of capital expenditures and the impact of pension settlement costs, if any, as compared to $74 million in 2014. We made total cash contributions to our pension plan during the nine months ended September 30, 2015 of $62 million and estimate that there are no further contributions required in 2015.

 

Our pension plan assets decreased from $1,673 million at December 31, 2014 to  $1,576 million at September 30, 2015, a decrease of $97 million, or 6%.  This decrease is a result of benefit payments of $104 million and negative investment returns of $60 million, offset by asset transfers from the AT&T pension plan trust of $5 million related to the Connecticut Acquisition and cash contributions of $62 million during the first nine months of 2015.  

 

(15)  Commitments and Contingencies:  

We anticipate total capital expenditures for our current business operations of approximately $700 million to $750 million for 2015, excluding the expenditure of funds previously received from the Connect America Fund Phase I program and capital expenditures related to our integration activities. Although from time to time we make short-term purchasing commitments to vendors with respect to these capital expenditures, we generally do not enter into firm, written contracts for such activities. 

 

In connection with the Verizon Transaction, we will incur additional operating expenses and capital expenditures in 2015 related to integration activities.    

 

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On April 29, 2015, the Federal Communications Commission (FCC) released its right of first refusal offer of support to price cap carriers under the Connect America Fund (CAF) Phase II program, which is intended to provide long-term support for broadband in high-cost unserved or underserved areas.  In June 2015, Frontier accepted the CAF Phase II offer, which provides for $283 million in annual support from 2015 through 2020 to deliver 10Mbps/1Mbps broadband service to approximately 660,000 households across the 28 states where we operate.

 

To the extent we do not enable the required number of households with 10  Mbps/1  Mbps broadband service by the end of the CAF Phase II term, we will be required to return a portion of the funds previously received.  While we have accepted the CAF Phase II offer of support, we have until December 31, 2015 to make modifications to the amount of households we ultimately accept and return a pro-rata share of the funding without penalty. 

 

On October 16, 2015, the FCC announced that the Wireline Competition Bureau is conducting an inquiry into whether certain terms and conditions contained in specifically identified special access tariff pricing plans offered by four carriers, including Frontier, are just and reasonable.  The focus of the inquiry is term and volume discounts under pricing plans for business data TDM services, specifically DS1s and DS3s, and exclude pricing for IP-based services.  At the conclusion of this inquiry, FCC staff will make recommendations to the FCC Commissioners regarding the reasonableness of certain terms and conditions.  The Commissioners will then determine whether the tariffs under review may need to be revised prospectively.  The final pleadings for parties in the proceeding are due February 22, 2016.   When and how the FCC will address the issues subject to this inquiry is unknown, but we do not anticipate that any proposed revisions to the specific tariffs under review would have a material impact on our results or operations.  

 

In our normal course of business, we have obligations under non-cancelable arrangements for services. During 2012, we entered into a “take or pay” arrangement for the purchase of future long distance and carrier services. Our remaining commitment under the arrangement is $141 million for the year ending December 31, 2015.  As of September 30, 2015, we expect to utilize the services included within the arrangement and no liability for the “take or pay” provision has been recorded.

 

We are party to various legal proceedings (including individual, class and putative class actions) arising in the normal course of our business covering a wide range of matters and types of claims including, but not limited to, general contracts, billing disputes, rights of access, taxes and surcharges, consumer protection, trademark and patent infringement, employment, regulatory, tort, claims of competitors and disputes with other carriers. 

 

We accrue an expense for pending litigation when we determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. Legal defense costs are expensed as incurred.  None of our existing accruals for pending matters, after considering insurance coverage, is material.  We monitor our pending litigation for the purpose of adjusting our accruals and revising our disclosures accordingly, when required. Litigation is, however, subject to uncertainty, and the outcome of any particular matter is not predictable. We will vigorously defend our interests in pending litigation, and as of this date, we believe that the ultimate resolution of all such matters, after considering insurance coverage or other indemnities to which we are entitled, will not have a material adverse effect on our consolidated financial position, results of operations, or our cash flows. 

 

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 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 for the remainder of the agreement (which runs through 2015). Our pro-rata share of the purchase power obligation is 10%.  GAAP rules require that we disclose “the maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee.” GAAP rules also state that we must make such disclosure “…even if the likelihood of the guarantor’s having to make any payments under the guarantee is remote…” As noted above, our obligation would only arise 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

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that all other members of the VJO simultaneously default, an unlikely scenario given that all VJO members are regulated utility providers with regulated cost recovery. Despite the remote chance that such an event could occur, or that the State of Vermont could or would allow such an event, assuming that all the other members of the VJO defaulted on November 1, 2015 and remained in default for the duration of the contract (another 2 months), we estimate that our undiscounted purchase obligation through 2015 would be approximately $24 million. In such a scenario, Frontier 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.