Item 1.    Business

Frontier Communications Corporation (Frontier) is a communications company providing services predominantly to rural areas and small and medium-sized towns and cities in the U.S.  Frontier 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, originally under the name of Citizens Utilities Company, and was known as Citizens Communications Company from 2000 until July 31, 2008.

Our mission is to be the leader in providing communications services to residential and business customers in our markets. We are committed to delivering innovative and reliable products and solutions with an emphasis on convenience, service and customer satisfaction.  We offer a variety of voice, data, internet, and television services and products, some that are available á la carte, and others that are available as bundled or packaged solutions. We believe that our local management structure, 100% U.S.–based customer service workforce and innovative product positioning will continue to differentiate us from our competitors in the markets in which we compete.

Highlights for 2011

 

 

Communications Services

As of December 31, 2011, we operated as an incumbent local exchange carrier (ILEC) in 27 states.

Our business is with both residential and business customers and we provide the “last mile” of telecommunications services to customers in these markets.  Our services include:

•

local and long distance voice services;

•

data and Internet services;

•

access services; and

•

video services.

Competitive Strengths

 

We believe that we are distinguished by the following competitive strengths:

 

Enhanced scale and scope.   Our increased scale and scope following the Transaction allows us to leverage our common support functions and systems (such as corporate administrative functions, information technology and network systems) for both operating expense and capital expenditure synergies. See Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)—Expected Cost Savings Resulting From the Transaction.

 

Broader footprint and greater revenue opportunities.   Although prior to the Merger, we operated in 11 of the 14 states in which the Acquired Business operated, the ILEC footprints of our Frontier legacy business and the Acquired Business do not overlap.  In addition, the customers of the Acquired Business generally have a profile similar in characteristics such as age, income and property ownership to our legacy customers.  We therefore have a broader operating footprint that provides greater revenue opportunities through the expansion of our existing operating strategies into the acquired Territories, through greater broadband penetration and through new product and services offerings in the acquired Territories.

 

Strong financial profile.   For the year ended December 31, 2011, we generated revenue of approximately $5.2 billion and net cash from operating activities of approximately $1.6 billion.  We have a well-balanced debt maturity schedule and we have available liquidity of over $1 billion, comprised of cash and available credit on our $750 million Revolving Credit Facility.  On February 16, 2012, the Board of Directors set the annual cash dividend at $0.40 per share.  This represents a $0.35 per share reduction from the most recent dividend of $0.75 per share.  The reduction in dividend will result in an annual cash savings of approximately $348 million.  We believe this change will strengthen our balance sheet by allowing us to reduce our debt, improve our operational and financial flexibility and strengthen the overall financial profile of the Company.

Experienced management team with proven track record of successful business integration.   We are managed by a senior management team with a proven track record of successful business integration.  This is demonstrated by the team’s integration of former GTE Corporation, Global Crossing, Commonwealth and GVN properties, the integration of the West Virginia operations of the Acquired Business prior to the closing of the Transaction, the integration of four additional states of the Acquired Business on October 1, 2011 and the integration of 13 Acquired Business states onto the Company’s legacy financial, human resources and engineering systems on October 1, 2011, along with the team’s consolidation of five billing systems covering 2.1 million access lines into a single system  for Frontier legacy operations over the past eight years.

 

Company Strategies

 

The key elements of our strategy are as follows:

 

Enhance customer loyalty through local engagement.   We will continue our strategy of engaging the markets at the local level to ensure that we have a customer-driven sales and service focus that differentiates us from our competitors.  Our local markets are operated by local managers responsible for the customer experience, as well as the financial results, in those markets.  We invest in infrastructure improvements and enhancements each year, recognizing that the economic livelihood of the communities we serve will affect opportunities to grow the business. We therefore have a vested interest in the economic development of the communities we serve. We are also continuing our community involvement practices to create a competitive advantage through long-term customer loyalty.  We remain committed to providing best-in-class service throughout our markets and, by doing so, we expect to maximize retention of current customers and gain new customers.

 

Increase revenue per customer.   We continue to apply the sales and marketing practices that we have historically employed throughout our markets, including the sale of voice, data and video services as bundled packages and the use of promotions and incentives to drive market share.  We believe these marketing strategies yield increased revenue per customer, strengthened customer relationships and improved customer retention.  We tailor our services to the needs of our residential and business customers in the markets we serve and continually evaluate the introduction of new and complimentary products and services.  We are increasing broadband availability to the customer base in the acquired Territories and, through innovative packages and promotions, plan to improve subscription rates for broadband services.  We continue to provide direct broadcast satellite services from DirecTV and DISH, fiber optic video services in certain states and over-the-top internet video on our www.TumTiki.com website that launched in November 2011.  As we strive to provide consumers with a diverse range of communications services, we continuously evaluate the viability of other communications product alliances.  In addition, we have implemented, and will continue to implement, several growth initiatives, including launching new products and services with a focus on areas that are growing or demonstrate meaningful demand, such as wireless HSI, satellite video products, Internet advertising and “Frontier Secure” computer  security and technical support. We will continue to focus on growing those products and services and to offer new ones, should we determine that they would be attractive to our customers.

 

Expand broadband footprint.   We are concentrating on broadband as a core component of our service offering and growth.

Consequently, we have earmarked capital expenditures for the expansion of broadband availability in the acquired Territories and view this expansion as an opportunity to satisfy customer needs and expectations, retain a greater number of customers and increase average revenue per customer.  These capital expenditures include enhancing the existing outside plant by pushing fiber deeper into the network, enhancing interoffice transport and expanding the capability of our data backbone.

 

As of December 31, 2011, approximately 81% of the households in the acquired Territories had access to our broadband products with at least 1 Mbps.  As of December 31, 2011, approximately 91% of the households in our legacy territories had access to our broadband products with at least 1 Mbps.  In addition, in connection with the approval of the Transaction by the Federal Communications Commission (FCC) and certain state regulatory commissions, we have committed to expand broadband availability in certain areas of the acquired Territories.  See “—Regulatory Environment—Regulation of our business.”

 

Ensure integration of the Acquired Business.   Effective with the closing of the Transaction, the Acquired Business (other than in West Virginia) operated on a common Verizon replicated information systems platform on an independent basis, and the Acquired Business in West Virginia was integrated on to our existing systems.  The main integration effort required for us to operate the Acquired Business (in West Virginia) immediately following the Transaction was successfully completed prior to the closing of the Transaction, freeing up our resources to implement further strategies to achieve cost savings and drive revenue enhancements, including the information and network integration described below and the expansion of the broadband footprint.

In October 2011, the Company converted all operating systems in four states of the Acquired Business to our legacy systems and converted all of the remaining nine Acquired Business states onto the Company’s legacy financial, human resources and engineering systems.  In March 2012, the Company expects to commence the conversion of the other operating systems in the remaining nine states of the Acquired Business onto the Company’s legacy systems.  The completion of the conversions will significantly enhance the Company’s ability to manage the business and further reduce costs.

Increase operating efficiencies and realize cost savings.   We achieve cost savings by applying our corporate administrative functions and information technology and network systems to cover certain former Acquired Business functions (including certain functions formerly provided by Verizon, or other third-party service providers, to the Acquired Business).  Based on current estimates and assumptions, we expect that our annualized cost savings will reach approximately $650 million by the end of 2012.

Growth through selective acquisitions.   We continue to evaluate and may pursue select strategic acquisitions that would enhance revenues and cash flows, although until July 2012 we are subject to certain restrictions on the acquisition, issuance, repurchase, or change of ownership of our capital stock.  We will continue to adhere to our selective criteria in any acquisition analysis.

 

Services

 

We offer a broad portfolio of high-quality communications services for residential and business customers in each of our markets.  These include services traditionally associated with local telephone companies, as well as other services such as long distance, Internet access, broadband-enabled services and video services. We offer these services both  á la carte and, increasingly, as bundled packages which are purposely designed to simplify customer purchasing decisions and to provide the customer with pricing discounts.  We also offer incentives and promotions such as gifts to influence customers to purchase or retain certain services.  We also enhance customer retention by offering one-, two- and three-year price protection plans under which customers commit to a term in exchange for predictable pricing or other incentives and promotions.  We are staffed locally with skilled technicians and supervisory personnel, which enables us to provide efficiently and reliably an array of communications services to meet our customers’ needs.  Our call center operations and field technicians are staffed with 100% U.S.-based personnel.

 

Generation of Revenue

 

We generate revenue primarily by providing: (1) basic local and long distance voice wireline services to residential and business customers in our service areas; (2) data and Internet services and wireless data services; (3) network access to interexchange carriers for origination and termination of long distance voice and data traffic; (4) sales of third party and owned video services; and (5) sales of customer premise equipment.

 

Local and long distance voice services.   We provide basic telephone wireline services to residential and business customers in our service areas.  Our service areas are largely residential and generally less densely populated than the primary service areas of the largest ILECs.  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.  Long distance network service to and from points outside our operating territories are provided by interconnection with the facilities of interexchange carriers.  Our long distance services are billed either as unlimited/fixed number of minutes in advance or on a per minute-of-use basis.

 

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, video and Internet services for a monthly fee or usage fee depending on the plan.

 

We are continuing our efforts to increase the penetration of our enhanced services which may produce revenue with higher operating margins due to the relatively low marginal operating costs necessary to offer such services.  Integrating these services with other services may provide the opportunity to capture an increased percentage of our customers’ communications expenditures.

 

Data and Internet services. We offer a wide range of wireline data services to our residential, commercial and carrier customers.  Residential services include HSI, dial up Internet, portal and e-mail products, and Frontier Secure services, such as hard drive back-up and computer technical support.  Commercial services include Ethernet, Dedicated Internet,  Multiprotocol Label Switching (MPLS), and TDM data transport services. These services are all supported by a 24x7 help desk and an advanced Network Operations Center.  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.

We also offer wireless data services (using unlicensed WiFi spectrum) in select markets utilizing networks that we own or operate.  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.  Hourly, daily and weekly casual end-users are billed by credit card at the time of use.

Access services.   Our switched access services allow other carriers to use our facilities to originate and terminate their local and long distance voice traffic. These services are generally offered on a month-to-month basis and the service billed primarily on a minutes-of-use basis. Switched access charges have been based on access rates filed with the FCC for interstate services and with the respective state regulatory agency for intrastate services. On November 18, 2011, the FCC released an Order that, beginning in July 2012, will transition terminating switched access over time to near zero by July 2017. While the FCC has asserted jurisdiction over these terminating access rates, during the transition the charges will continue to be based on tariffs filed with both the FCC and state regulatory agencies.  In addition, subsidies that are received from state and federal authorities based on the higher cost of providing telephone service to certain rural areas are a part of our access services revenue. Beginning in July 2012, the Company will also be eligible to receive federal subsidies for the deployment of broadband in unserved and high cost areas. Monthly recurring access service fees are billed in advance.

Video services.   We offer video services under an agency relationship with DISH in our legacy markets and with DirecTV in the acquired Territories (other than West Virginia and the four states of the Acquired Business that we converted to legacy systems in October 2011, where we sell the DISH product and continue to support existing customers who have the DirecTV product). We receive from the applicable satellite provider and recognize as revenue activation fees, other residual fees and nominal management, billing and collection fees. Additionally, we offer fiber optic video services on a limited basis in the states of Indiana, Oregon and Washington pursuant to franchises, permits and similar authorizations issued by local franchising authorities utilizing fiber optic delivery transport to the home.

The following table sets forth the aggregate number of our access lines and HSI subscribers in the states in which we operated as of December 31, 2011.

 

 

_______________________

Note:  This table includes fiber optic and DSL High-Speed Internet subscribers and excludes approximately 28,600 Multiple Dwelling Units (MDUs).

 

(1) Includes Tennessee, Nevada, Iowa, Nebraska, Alabama, Utah, Georgia, New Mexico, Montana, Mississippi and Florida.

 

Change in the number of our access lines is one factor that is important to our revenue and profitability.  We have lost access lines primarily as a result of competition and business downsizing, and because of changing consumer behavior (including wireless substitution and disconnections of second lines upon an HSI addition), economic conditions and changing technology. Our Frontier operations lost approximately 479,000 access lines (net) during the year ended December 31, 2011, but added approximately 45,000 HSI subscribers (net) during this same period.  With respect to the access lines we lost in 2011, 368,000 were residential customer lines and 111,000 were business customer lines.  We expect to continue to lose access lines but anticipate partially offsetting those losses with an increase in HSI subscribers during 2012.  A substantial further loss of access lines, combined with increased competition and the other factors discussed in Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations, may cause our revenues, profitability and cash flows to decrease during 2012.

Our Company, like others in the industry, utilizes reporting metrics focused on units. Consistent with our strategy to focus on the customer, we also utilize residential and business customer metrics that, when combined with unit counts, provides additional insight into the results of our strategic initiatives described above.

	As of or for the year ended December 31,
	2011		2010 (1)
Residential Customer Metrics:
Customers	3,103,766		3,445,193
Revenue (in 000’s)	$   2,270,527		$   1,693,354
Products per residential customer          - Frontier Legacy (2)	2.72		2.60
Average monthly residential revenue per       Customer - Frontier Legacy   (3)                         - Total Company (3)	$          60.65 $          57.34		$          60.03
Percent of customers      on price protection plans - Frontier Legacy	63.1%		58.4%
Customer monthly churn - Frontier Legacy                                                 - Total Company	1.33% 1.61%		1.33%

Business Customer Metrics:
Customers	309,900		343,823
Revenue (in 000’s)	$     2,353,375		$   1,606,546
Average monthly business revenue per       Customer - Frontier Legacy                         - Total Company	$          530.17 $          600.38		$     502.41

(1)    Revised from the previously disclosed amounts to reflect the reclassification of certain revenues from business to residential.

(2) Products per residential customer: primary residential voice line, HSI and video products have a value of 1.  Long distance, Frontier Secure, second lines, feature packages and dial-up have a value of 0.5.

 

(3)   Calculation excludes the Mohave Cellular Limited Partnership.

 

Network Architecture and Technology

 

Our local exchange carrier networks consist of central office hosts and remote sites, primarily equipped with digital and Internet Protocol switches.  The outside plant consists of transport and distribution delivery networks connecting our host central office with remote central offices and ultimately with our customers.  We own fiber optic and copper cable, which have been deployed in our networks and are the primary transport technologies between our host and remote central offices and interconnection points with other incumbent carriers.

 

Our fiber optic and copper transport system is capable of supporting increasing customer demand for high bandwidth transport services.  We are currently upgrading our network with the latest Internet Protocol Transport and routing equipment, Reconfigurable Optical ADM Add/Drop Multiplexers (ROADM) transport systems, Very High Bit-Rate DSL (VDSL) HSI equipment, and Voice over Internet Protocol (VoIP) switches.  These systems will support advanced service such as Metro Ethernet, Dedicated Internet, Multiprotocol Label Switching (MPLS) transport, and VoIP.  The network is designed with redundancy and auto-failover capability on our major circuits.

As of December 31, 2011, approximately 91% of the households in our legacy territories had access to our broadband products with at least 1 Mbps.  As of December 31, 2011, approximately 81% of the households in the acquired Territories had access to broadband products with at least 1 Mbps.

Rapid and significant changes in technology are expected to continue to occur in the communications industry.  Our success will depend, in part, on our ability to anticipate and adapt to technological changes.  We believe that our existing network architecture will enable us to respond to these technological changes efficiently.  In addition, we anticipate reducing costs through the sharing of best practices across operations, centralization or standardization of functions and processes, and deployment of technologies and systems that provide for greater efficiencies and profitability.

 

Competition

 

Competition in the communications industry is intense. We experience competition from many communications service providers, including cable operators offering video, data and VoIP products, wireless carriers, long distance providers, competitive local exchange carriers, Internet providers and other wireline carriers.  We believe that as of December 31, 2011, approximately 93% of the households in our territories could receive voice, data and video services from a competitive provider.

Residential and business customer behavior is affected by the ongoing economic uncertainty. Customers have reduced their spending by not purchasing our services or by discontinuing some or all of our services.  These trends may continue and may result in a continued challenging revenue environment.  The weak economic environment may produce increased delinquencies and bankruptcies and, therefore, affect our ability to collect money owed to us by residential and business customers.

We employ a number of strategies to combat the competitive pressures and changes in customer behavior noted above.  Our strategies are focused on preserving and generating new revenues through customer retention, upgrading and up-selling services to existing customers, new customer growth, win-backs of former customers, new product deployment, and by managing our profitability and cash flow through targeted reductions in operating expenses and capital expenditures.

We are focused on enhancing the customer experience to differentiate us from our competition.  Our commitment to providing customer service is demonstrated by our 100% U.S.-based workforce, our expanded customer service hours, shorter scheduling windows for in-home appointments, call reminders and follow-up calls for service appointments.  Additionally, we seek to achieve our customer retention goals by offering attractive packages of value-added services to our local access line customers. Our bundled services include HSI, unlimited long distance calling, enhanced telephone features and video offerings.

We are also focused on increasing sales of existing products, including unlimited long distance minutes, bundles of long distance minutes, wireless data, Internet portal advertising, and the Frontier Secure product suite.  This last category is a suite of products that is aimed at managing the personal computing experience for our customers and is designed to provide value and simplicity to meet customers’ ever-changing needs.  The Frontier Secure products and services suite includes services such as an in-home, full installation of the Company’s HSI product, two hour appointment windows for the installation, hard drive back-up services, 24-7 help desk PC support and inside wire maintenance (when bundled).  In 2011, the Frontier Secure products generated approximately $27.5 million in revenue.  Our www.TumTiki.com   website, that launched in November 2011, provides easy online access to free television programs, video on demand movies and other entertainment. Hard drive back-up services, 24-7 help desk PC support and our www.TumTiki.com website are also available to consumers and small businesses throughout the United States.  Although we are optimistic about the opportunities to increase revenue and reduce customer churn (i.e., customer attrition) that are provided by each of these initiatives, we cannot provide assurance about their long term profitability or impact on revenue.

On the commercial side of our business, we are focused on many of the same strategies and enhancements described above as well as providing state-of-the-art transport services to wireless cell towers in our territories and expanding the number of people selling and servicing our medium, enterprise and government customers with sophisticated products and services (e.g., IP PBX,  E911 equipment, Ethernet, SIP trunking).

The goal of offering multiple products and services to our customers pursuant to price protection programs, billing on a single bill, on-line bill pay, providing superior customer service, and being active in our local communities is to generate customer loyalty which should help us generate new, and retain existing, customer revenue.

For additional discussion of our competitive strategies, see “Company Strategies” above.

Regulatory Environment

The majority of our operations are regulated by the FCC and various state regulatory agencies, often called public service or utility commissions.

 

Some 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 and revise the statutes governing the level and type of regulation for telecommunications services.

 

Regulation of our business

 

We are subject to federal, state and local regulation.  We have various regulatory authorizations for our regulated service offerings.  At the federal level, the FCC generally exercises jurisdiction over facilities and services of common carriers, such as our company, to the extent those facilities are used to provide, originate or terminate interstate or international telecommunications services.  State regulatory commissions generally exercise jurisdiction over common carriers’ facilities and services to the extent those facilities are used to provide, originate or terminate intrastate telecommunications services. In particular, state regulatory agencies have substantial oversight over the provision by incumbent telephone companies of interconnection and non-discriminatory network access to competitive providers.  In addition, local governments often regulate the public rights-of-way necessary to install and operate networks, and may require service providers to obtain licenses or franchises regulating their use of public rights-of-way.  Municipalities and other local government agencies also may regulate other limited aspects of our business, by requiring us to obtain construction permits and to abide by building codes.

 

We believe that competition in our telephone service areas will continue to increase in the future as a result of the Telecommunications Act of 1996 (the “1996 Act” or the “Telecommunications Act”) and actions taken by the FCC and state regulatory authorities, and through increased deployment of various types of technology, although the ultimate form and degree of competition cannot be predicted at this time.  Competition may lead to loss of revenues and profitability as a result of loss of customers; reduced usage of our network by our customers who may use alternative providers for voice and data services; and reductions in prices for our services which may be necessary to meet competition.

 

Under the 1996 Act, state regulatory commissions have jurisdiction to arbitrate and review interconnection disputes and agreements between ILECs and competitive local exchange carriers, in accordance with rules set by the FCC.  State regulatory commissions also may impose fees on providers of telecommunications services within their respective states to support state universal service programs.  Many of the states in which we operate require prior approvals or notifications for certain acquisitions and transfers of assets, customers, or ownership of regulated entities.

 

In connection with granting their approvals of the Transaction, the FCC and certain state regulatory commissions specified certain capital expenditure and operating requirements for the acquired Territories for specified periods of time post-closing.  These requirements focus primarily on certain capital investment commitments to expand broadband availability to at least 85% of the households throughout the acquired Territories with minimum speeds of 3 megabits per second (Mbps) by the end of 2013 and 4 Mbps by the end of 2015.  To satisfy all or part of certain capital investment commitments to three state regulatory commissions, we placed an aggregate amount of $115.0 million in cash into escrow accounts and obtained a letter of credit for $190.0 million in 2010.  Another $72.4 million of cash in an escrow account (with a cash balance of $62.9 million and an associated liability of $14.3 million as of December 31, 2011) was acquired in connection with the Transaction to be used for service quality initiatives in the state of West Virginia.  As of December 31, 2011, $43.0 million had been released from these escrow accounts.  In addition, as of this date, the letter of credit has been reduced to $100.0 million.  The aggregate amount of these escrow accounts and the letter of credit has decreased and will continue to decrease over time as Frontier makes the required capital expenditures in the respective states.

 

In addition, in certain states, we are subject to operating restrictions such as rate caps (including maintenance of existing rates on residential and business products and wholesale prices and terms of interconnection agreements with competitive local exchange carriers and arrangements with carriers that, in each case, existed as of the time of the Transaction), continuation of product bundle offerings that we offered before the Transaction, and restrictions on how early termination fees are calculated, restrictions on caps on usage of broadband capacity, and certain minimum service quality standards for a defined period of time (the failure of which to meet may result in penalties, including, in one state, cash management limitations on certain of our subsidiaries in that one state). In one other state, our subsidiaries are subject to restrictions on the amount of dividends up to the parent company for a period of approximately four years.  We are also required to report certain financial information and adhere for a period of time to certain conditions regulating competition and consumer protection. Although most of these requirements are generally consistent with our business plans, they may restrict our flexibility in operating our business during the specified periods, including our ability to raise rates in a declining revenue environment and to manage cash transfers from our subsidiaries in two states if we do not meet certain operating service criteria.

 

Some legislation and regulations are, or could in the future be, the subject of judicial proceedings, legislative hearings and administrative proposals or challenges which could change the manner in which the entire industry operates.  Neither the outcome of any of these developments, nor their potential impact on us, can be predicted at this time.  Regulation can change rapidly in the communications industry, and such changes may have an adverse effect on us.  See “Risk Factors—Risks Related to Regulation—Changes in federal or state regulations may reduce the switched access charge revenues we  receive.”

 

Regulation of the telecommunications industry at the federal and state level

 

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. Approximately 1,858,000 access lines, or 35% of our total access lines, at December 31, 2011 are in state jurisdictions under the rate of return regulatory model.  The FCC’s National Broadband Plan, a non-binding set of recommendations released in March 2010 and described further below, recommends requiring all incumbent local exchange carriers to be regulated for interstate services, if at all, under incentive regulation.  On November 18, 2011, the FCC released a Report and Order and Further Notice of Proposed Rulemaking on the subject of Universal Service Fund and intercarrier compensation reform (USF/ICC Report & Order).  The USF/ICC Report & Order stated that carriers that are generally considered price cap carriers, such as Frontier, with remaining rate-of-return operations would have those operations included as part of the carrier’s overall price-cap based Universal Service calculation.  The FCC also sought comment on how to transition away from the current rate-of-return system in the future.  We will continue to advocate our position for no or reduced regulation with various regulatory agencies.  In some of our states, we have already been successful in reducing or eliminating price regulation on end-user services subject to state commission jurisdiction.

 

Federal subsidies have historically been driven by many factors, including the National Average Cost per Local Loop (NACPL).  The USF/ICC Report & Order changes how federal subsidies will be calculated and disbursed, with this change being phased in beginning in 2012.  These changes will transition the federal Universal Service High-Cost Fund, which supports voice services in high-cost areas, to the Connect America Fund (CAF), which will support broadband deployment in high-cost areas.  CAF Phase I will be implemented in 2012, and price cap carriers will receive the same amount of support from all USF high-cost programs as in 2011.  In addition, the FCC in CAF Phase I will make available for price cap ILECs an additional $300 million in incremental high cost broadband support to be used for broadband deployment to unserved areas.  The FCC anticipates that it will replace this interim program with a Phase II CAF long-term solution in 2013, though the interim program will continue if no such solution is put in place.  Frontier will receive a portion of the $300 million CAF Phase I interim support, although the extent is not yet known.  The USF/ICC Report and Order requires carriers receiving the CAF Phase I interim support to deploy broadband in areas that are currently unserved based on an FCC formula that is currently under reconsideration at the FCC and the outcome of that decision is not yet known. Some states where Frontier operates continue to evaluate the manner in which they will determine state subsidy eligibility.

 

Telephone companies are subject to FCC rules governing privacy of certain customer information.  Among other things, these rules obligate carriers to implement procedures to: protect certain customer information from inappropriate disclosure; obtain customer permission to use certain information in marketing; authenticate customers before disclosing account information; and annually certify compliance with the FCC’s rules.

 

Most states have certification requirements that require providers of telecommunications services to obtain authority from the state regulatory commission prior to offering common carrier services.  Most of the local exchange companies that are operated by us operate as incumbent carriers in the states in which they operate and are certified in those states to provide local telecommunications services.  State regulatory commissions generally regulate the rates ILECs charge for intrastate services, including rates for intrastate access services paid by providers of intrastate long distance services.  The FCC’s USF/ICC Report & Order, however, removes much of the states’ authority to set terminating intrastate switched access rates.  This aspect of the USF/ICC Report & Order has been challenged by certain parties in court.

 

Recent and potential regulatory developments

 

Federal legislators, the FCC and state regulators are currently considering a number of proposals for changing the manner in which eligibility for federal subsidies is determined as well as the amounts of such subsidies.

 

On March 16, 2010, the FCC released its National Broadband Plan. The National Broadband Plan proposes a series of actions that could result in additional regulatory requirements for broadband services as well as a series of other regulatory reforms. The FCC has completed some of the proceedings proposed in the National Broadband Plan on a broad number of topics, including Universal Service and intercarrier compensation reform.  There are many outstanding questions regarding future support distributions and intercarrier compensation reform that remain open, the outcome of which may significantly change Federal Universal Service funding and disbursement mechanisms and interstate, intrastate and local intercarrier compensation. The outcome and timing of these proceedings are unknown and, accordingly, we are unable to predict the impact of future changes on our results of operations.

On November 18, 2011, the FCC adopted an Order to reform the federal Universal Service High-Cost Fund and Intercarrier Compensation.  Intercarrier Compensation, which is the payment framework that governs how carriers compensate each other for the  exchange of traffic, will transition over a number of years beginning in mid-2012 to a near zero rate for terminating traffic by 2017.  Carriers will be able to recover a portion of those revenues through end user rates and other replacement support mechanisms.  Additionally, the USF/ICC Report & Order requires VoIP providers to pay interstate terminating interconnection charges and requires all carriers terminating traffic to provide appropriate call information, thus prohibiting so-called “phantom traffic.”  The USF/ICC Report & Order preempts the states with regard to the regulation of intrastate terminating access rates.  The reform of the Universal Service Fund shifts the existing High-Cost portion of the fund from supporting voice services to supporting broadband deployment in high-cost areas.  The USF/ICC Report & Order has been challenged by certain parties in court and certain parties have also petitioned the FCC to reconsider various aspects of the USF/ICC Report & Order.  Accordingly, Frontier cannot predict the long-term impact at this time but believes that the USF/ICC Report & Order will provide a stable regulatory framework to facilitate Frontier’s ongoing focus on the deployment of broadband into its rural markets.

The FCC also has an ongoing proceeding considering whether to make changes in its regulatory regime governing special access services, including whether to mandate lower rates, change standards for deregulation and pricing flexibility, or to require changes to other terms and conditions.  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 or switched access revenues may directly affect our profitability and cash flows as those regulatory revenues do not have the same level of associated variable expenses.  Both switched access and subsidy revenues continued to decline in 2011, as compared to 2010, and are likely to decline further in 2012.

Certain states also have their own open proceedings to address reform to intrastate access charges and other intercarrier compensation.  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.  Although the FCC has pre-empted state jurisdiction on certain access charges, many states are still considering moving forward with their proceedings. We cannot predict when or how these matters will be decided or the effect on our subsidy or switched access revenues.  However, future reductions in our subsidy or switched access revenues may directly affect our profitability and cash flows as those regulatory revenues do not have an equal level of associated variable expenses.

 

Regulators at both the federal and state levels continue to address whether VoIP services are subject to the same or different regulatory and intercarrier compensation regimes as traditional voice telephony.  The FCC, through the USF/ICC Report & Order, has determined that VoIP-originated traffic terminating on the Public Switched Telephone Network is subject to interstate access rates.  The FCC declined to address other VoIP-related issues.  The FCC has stated its intent to address open questions regarding the treatment of VoIP services in its ongoing “IP-Enabled Services Proceeding.” Internet telephony may have an advantage in the marketplace over our traditional services if it remains less regulated.

 

In past years, some state regulators have in the past considered imposing on regulated companies (including us) cash management practices that could limit the ability of a company to transfer cash among 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.

 

Current and potential Internet regulatory obligations

In connection with our Internet access offerings, we could become subject to laws and regulations as they are adopted or applied to the Internet.  There is currently only limited regulation applicable to these services.  As the significance of the Internet expands, federal, state and local governments may pass laws and adopt rules and regulations, or apply existing laws and regulations to the Internet (including Internet access services), and related matters are under consideration in both federal and state legislative and regulatory bodies.  We cannot predict whether the outcome of pending or future proceedings will prove beneficial or detrimental to our competitive position.

The FCC adopted orders which put wireline broadband Internet access service, commonly delivered by DSL or fiber technology, as well as mobile wireless based broadband Internet access service and other forms of broadband Internet access services on an equal regulatory footing with cable modem service.  This approach is consistent with a United States Supreme Court decision upholding the FCC’s classification of cable modem services as “information services” not subject to mandatory common carriage regulation.  Specifically, the FCC has determined that these information services are functionally integrated with any underlying telecommunications component, and that there is no obligation to separate out and offer that transmission component subject to common carriage regulation.  The FCC has imposed particular regulatory obligations on broadband services.  For example, it has concluded that VoIP and facilities-based broadband Internet access providers must comply with the Communications Assistance for Law Enforcement Act, a decision that the United States Court of Appeals for the District of Columbia Circuit has upheld.  The FCC has also required VoIP providers to provide enhanced 911 emergency calling capabilities.

 

In October 2009, the FCC issued a proposed rulemaking looking at rules to “Preserve a Free and Open Internet,” including a reconsideration of the legal classification of broadband and proposed restrictions on broadband network management practices. On December 21, 2010, the FCC adopted an order imposing some regulations on Internet service providers.  These regulations affect fixed and mobile broadband providers differently.  These regulations became effective November 20, 2011, and Frontier is in compliance with these regulations.  These regulations are currently subject to court challenge by multiple parties, and the outcome and its effect on Frontier is unknown.

 

Video programming.   Federal, state and local governments extensively regulate the video services industry.  Our fiber optic video service is subject to, among other things, subscriber privacy regulations; requirements that we carry a local broadcast station or obtain consent to carry a local or distant broadcast station; rules for franchise renewals and transfers; the manner in which program packages are marketed to subscribers; and program access requirements.

 

We provide video programming, on a limited basis, in Oregon, Washington and Indiana pursuant to franchises, permits and similar authorizations issued by local franchising authorities utilizing fiber optic delivery transport to the home.  Most franchises are subject to termination proceedings in the event of a material breach.  In addition, most franchises require payment of a franchise fee as a requirement to the granting of authority.

 

Many franchises establish comprehensive facilities and service requirements, as well as specific customer service standards and monetary penalties for non-compliance.  In many cases, franchises are terminable if the franchisee fails to comply with significant provisions set forth in the franchise agreement governing system operations.  Franchises are generally granted for fixed terms of at least ten years and must be periodically renewed.  Local franchising authorities may resist granting a renewal if either past performance or the prospective operating proposal is considered inadequate.

 

For information regarding approvals by local franchising authorities in connection with the transactions, see “— Regulatory Environment - Regulation of our business.”

 

Environmental regulation

 

Like all other local telephone companies, the local exchange carrier subsidiaries we operated are subject to federal, state and local laws and regulations governing the use, storage, disposal of, and exposure to hazardous materials, the release of pollutants into the environment and the remediation of contamination.  As an owner and former owner of property, we are subject to environmental laws that could impose liability for the entire cost of cleanup at contaminated sites, including sites formerly owned by us or the Acquired Business, regardless of fault or the lawfulness of the activity that resulted in contamination.  We believe that our operations are in substantial compliance with applicable environmental laws and regulations.

 

Segment Information

We currently operate in only one reportable segment.

Financial Information about Foreign and Domestic Operations and Export Sales

We have no foreign operations.

General

Order backlog is not a significant consideration in our business.  We have no material contracts or subcontracts that may be subject to renegotiation of profits or termination at the election of the Federal government.

Intellectual Property

 

We believe that we have the trademarks, trade names and intellectual property licenses that are necessary for the operation of our business.

 

Employees

As of December 31, 2011, we had approximately 15,400 employees.  Approximately 10,000 of our employees are affiliated with a union.  The number of union employees covered by collective bargaining agreements expiring during 2012 is approximately 3,100.  We consider our relations with our employees to be good.

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.

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 our Annual Report available in printed form upon request at no charge.

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 .