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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
Amendment No. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1994
Commission File Number 1-4166
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FRONTIER CORPORATION
(Previously Rochester Telephone Corporation)
(Exact name of Registrant as specified in its charter)
New York 16-0613330
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
180 South Clinton Avenue, 14646-0700
Rochester, New York (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (716) 777-7100
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
Name of each exchange on
Title of Class which registered
- ----------------- ----------------
<S> <C>
Common Stock, par value
$1.00 per share New York Stock Exchange
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
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The Registrant hereby amends the following items, financial statements, exhibits
or other portions of its Annual Report on Form 10-K for the fiscal year ended
December 31, 1994 (the "Form 10-K") as set forth below:
PART I
ITEM 1. BUSINESS
Item I is hereby amended and restated in its entirety as follows:
Frontier Corporation, formerly known as Rochester Telephone Corporation,
("Frontier" or the "Company") is a major U.S. diversified telecommunications
firm with headquarters in Rochester, New York. The Company was incorporated in
1920 under the laws of New York State to take over and unify the properties of a
predecessor company and certain properties of the New York Telephone Company
which were located in the same general territory. Currently, the Company's
principal lines of business are Telecommunication Services and Telephone
Operations. Telecommunication Services consists of a major regional long
distance company, cellular and paging operations, and equipment sales.
Telephone Operations consists of 36 local telephone companies which serve, as of
December 31, 1994, approximately 918,000 access lines in thirteen states.
Effective January 1, 1995, Frontier reorganized into a holding company
structure.
Historically, Telephone Operations has provided the majority of the
Company's revenues and income. However, an increasing percentage of Frontier's
revenues and income is being generated by the Company's long distance and
wireless operations. In 1982, the Company made the strategic decision to enter
the long distance business. It now provides long distance voice, video and data
communication services throughout the United States with its major marketing and
sales focus in New York State, New England, and the Mid-Atlantic and Midwest
regions. The Company first began providing cellular communications services in
the Rochester, New York metropolitan area in 1985. Today, it has ownership
interests in wireless communications operations in five states and manages
wireless operations serving over 4.4 million potential subscribers. The
geographic reach of the Company's long distance operations will soon expand
nationwide as a result of strategic acquisitions such as American Sharecom,
Inc., which closed in early 1995, and WCT Communications Inc., which is also
expected to close in 1995. Expansion through strategic acquisition and business
alliances remains a key growth vehicle for the Company.
Prior to 1988, the Company's Telephone Operations were heavily concentrated
in New York State. Since 1988, the Company has acquired 29 local telephone
companies and has significantly diversified its geographic base. The Company's
largest telephone operation is in Rochester, New York and serves approximately
502,000 access lines. The Company refers to the 35 telephone companies outside
of Rochester, New York as "Regional Telephone Operations". The latter group
includes approximately 416,000 access lines with an aggregate revenue level
nearly equal to that of the Rochester, New York operating company. As part of
the Company's reorganization into a holding company which was effected January
1, 1995, the assets and businesses of the Rochester, New York operating company
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were divided between two new subsidiaries, Frontier Communications of Rochester,
Inc. ("FCR") and Rochester Telephone Corp. ("RTC"). Because this division
occurred after the close of the 1994 fiscal year, references in this Form 10-K
will refer to the Company's operations prior to this division, unless otherwise
indicated.
A key growth strategy for the Company is to provide integrated
communications services for its customers. These integrated services include
long distance, wireless, and local telephone service as well as selected
products and services that the Company will remarket to customers as a single
source provider. Frontier is committed to growth through expansion of its
existing businesses, the development of value added products and services, and
selected acquisitions. Certain financial data relating to the Company's
business segments is presented under "Business Segment Information" in Exhibit
13 to this Form 10-K.
Frontier and NYNEX have formed a joint venture, the Upstate Cellular
Network (the "Supersystem"), to manage and operate certain of their cellular
properties located within New York State. This joint venture serves a territory
that includes approximately 3.5 million potential customers and includes the
cities of Buffalo, Syracuse, Rochester, Utica, and Watertown, New York. One of
Frontier's subsidiaries serves as managing partner of Upstate Cellular Network.
This is described in more detail under the caption "Wireless Communications", at
page 5, infra.
On February 15, 1994, the Company completed a public offering of its common
stock. A total of 2,549,000 new shares were issued in connection with this
offering. The public offering also included the sale of 2,885,000 shares that
were held by a subsidiary of Sprint Corporation. In April 1994, the Company
effected a stock split in the form of a 100% stock dividend.
The principal executive offices of the Company are located at 180 South
Clinton Avenue, Rochester, New York 14646-0700. The telephone number is (716)
777-1000.
Telecommunication Services
General
Frontier's Telecommunication Services segment is comprised of Network
Systems and Services, which provides long distance services, customer premises
equipment, and wireless services. The Company's major deregulated business is
long distance service. While regionally focused
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currently in the Northeast, Mid-Atlantic and Midwest states from a marketing and
sales perspective, customers of the Company's long distance business enjoy
nationwide and international connectivity. Telecommunication Services' revenues
have increased significantly over the past few years and have accounted for 38
percent of Frontier's total revenues for the year ended December 31, 1994. The
Company intends to expand Telecommunication Services by increasing its existing
commercial and residential customer base, continuing to develop new products,
and effecting selected acquisitions.
Long Distance Services
The Company provides long distance services primarily through a subsidiary,
Frontier Communications International, Inc. (previously RCI Long Distance, Inc.,
or "FCI"). FCI routes long distance traffic over its 100 percent digital
state-of-the-art network and resells services obtained from
other suppliers to route calls to areas where it does not have its own
facilities. FCI currently owns and operates eight switching sites. These are
located in Rochester, New York; New York City; Washington, D.C.; Atlanta,
Georgia; Chicago, Illinois; Philadelphia, Pennsylvania; Cleveland, Ohio; and
Burlington, Vermont. FCI's switched services include basic long distance or
measured toll service which is accessible through "l + dialing", 800 services, a
variety of long distance products targeted at specific consumer and business
segments, and value-added services such as travel cards, prepaid cards and
information services. In addition, FCI provides flexible billing services such
as multi-location billing, customized accounting codes and electronic billing
features.
FCI currently focuses its marketing efforts in New York State, New England
and the Mid-Atlantic, Southeast and Midwest regions. In these regions, FCI
markets its products through a direct sales force, direct marketing campaigns,
sales agents, and affiliated local exchange carriers. The majority of FCI's
revenues are derived from small to medium-sized business customers. FCI has
introduced a number of programs designed to attract new long distance
customers. For example, the "Budget Call" feature enables any telephone user
to dial an access code and complete a call through FCI's long distance network.
The cost of the call is invoiced by the customer's local telephone company.
The rates for such calls are typically 10 to 20 percent lower than the rates
charged by a major long distance carrier such as AT&T. At December 31, 1994,
Budget Call was available in nineteen states. This program is anticipated to
continue expanding through 1995.
As part of the Company's overall service integration strategy, FCI has
significantly increased residential usage through its "Visions Long Distance"
program (as described in "Telephone Operations-General" at page 8) where
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FCI's long distance services are marketed through Company-owned as well as non-
affiliated local exchange service providers. Through the Visions Long Distance
program, the Company has achieved substantial penetrations in several markets as
a result of customer preference for unified billing and service. Because
residential long distance calling volumes peak in the evenings, on weekends and
on holidays, when commercial traffic tends to be lowest, expanding the
residential business increases revenues with virtually no need to increase
existing switching and transmission facilities.
During 1994, FCI signed definitive agreements to acquire two long distance
companies. In November, it completed negotiations to acquire WCT
Communications, Inc., a long distance company based in Santa Barbara,
California, and announced that it had signed a definitive agreement to acquire
American Sharecom, Inc., headquartered in Minneapolis, Minnesota. When these
acquisitions are completed, the geographic reach of the Company's long distance
business will extend from coast to coast, and the Company is projected to become
the seventh largest long distance carrier in the nation. Both acquisitions are
intended to further implement FCI's strategy to expand its customer and market
base and are subject to regulatory approval. The Company intends to continue to
pursue additional acquisitions to provide greater economies of size and scale to
its operation and to enhance its customer and market reach.
The long distance industry is dominated on a volume basis by the nation's
three largest long distance providers, AT&T, MCI and Sprint, which generate an
aggregate of approximately 84 percent of the nation's long distance revenue of
approximately $61 billion. In each of its markets FCI competes with AT&T, MCI
and Sprint, as well as with other national and regional long distance companies,
for intercity communications transmission services such as 1+, dedicated access,
800 service and private line service. The primary bases for competition in the
long distance business are pricing, product offering, and service. One element
of service includes billing and customer information. FCI provides long
distance services at prices often below the three large carriers, but generally
above smaller third-tier carriers. In addition to basic long distance, 800
services, and private line services, FCI products include prepaid calling card
services and operator services. FCI's prepaid calling card product has expanded
the markets for such products through its use of innovative technology, and is
designed to meet standard needs while at the same time offering enhanced audio-
text services to users. Although FCI does not currently offer some of the
enhanced voice or data services provided by the three large carriers (such as
frame relay and ATM), it is able to meet the needs of its targeted general
business and residential markets. The Company intends to compete aggressively
in the long distance business.
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Wireless Communications
Since 1985, the Company has provided cellular service in the Rochester
Metropolitan Statistical Area ("MSA"), which has a population of approximately
one million, in a partnership with ALLTEL Corporation. Frontier historically had
an 85 percent interest in this partnership. In June, 1994 the Company and NYNEX
Mobile formed a 50/50 joint venture and the Rochester MSA was contributed to the
Upstate Cellular Network ("UCN" or the "Supersystem"). A Frontier subsidiary is
the managing partner of that cellular "Supersystem" which provides service in
much of upstate New York. The Supersystem provides the Company a larger
geographic footprint than it would otherwise have. The greater concentration of
customers resulting from the Supersystem's formation will enable the Company to
take advantage of the efficiencies normally inherent with the economies of
scale. By combining marketing and service efforts and integrating networks, the
Company and NYNEX will be able to provide seamless cellular service to a
population of approximately 3.5 million potential subscribers in upstate New
York. The Company also manages a cellular system in Alabama with over 255,000
potential subscribers and has investments in wireless properties elsewhere in
New York State and in Georgia, Illinois and Iowa. Through its subsidiaries,
Frontier is a member of the MobiLink marketing alliance, a nationwide consortium
of wireless operators. Frontier intends to continue to pursue additional
investments in cellular or wireless operations with a preference for investment
in properties which are adjacent to existing Company-owned properties or where a
controlling interest can be obtained.
In September, 1994 the Company signed a definitive agreement to purchase
the Minnesota Cellular Telephone Company ("Minnesota Cellular") which owns the
business and assets of a cellular company serving Rural Service Area ("RSA")
Number 10 in Minnesota with a population of approximately 225,000 potential
subscribers. The transaction, expected to close in the first quarter 1995, is
anticipated to involve the issuance of the Company's Common Stock and is
contingent upon regulatory approval.
Despite intense price competition during the construction of its network in
the Rochester, New York market, the Company's cellular business has remained
profitable since its first full year of service. This business has consistently
increased its subscriber base while maintaining an efficient cost structure.
With the formation of the Supersystem, and the corresponding increase in
geographic scope of the Company's cellular reach, overall the Company's wireless
business has remained profitable. Nevertheless, price competition remains
strong within all the Company's properties.
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Cellular systems compete principally on the basis of network quality,
customer service, price and coverage area. Each market currently has two
cellular providers, and the Company's chief competition in each market is from
the other cellular licensee in that market. In some markets additional entities
resell cellular service and compete with the holders of cellular licenses. The
Company believes that its technological expertise, emphasis on customer service
and development of new products and services make it a strong competitor.
Several recent FCC initiatives indicate that the Company is likely to face
greater wireless competition in the future. The FCC has licensed specialized
mobile radio ("SMR") system operators to construct digital mobile communications
systems on existing SMR frequencies in many metropolitan areas throughout the
United States. Also, in September 1993, the FCC announced its decision to
allocate radio frequency spectrum for personal communications services ("PCS"),
a form of wireless communication using lower power and more cell sites than
current cellular service. The FCC's decision will permit the grant of seven new
licenses: two 30 MHz blocks, one 20 MHz block and up to four 10 MHz blocks. (By
comparison, the two cellular carriers in each market currently have 25 MHz of
spectrum each.) The bidding for the two 30 Mhz blocks will be completed by May
1995. The Company has committed resources to evaluating the expansion of
wireless communications to include PCS offerings, but has elected, thus far, not
to participate in the bidding for PCS licenses.
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Cellular Property Ownership Table
The Company owned or was under contract to purchase the following cellular
properties as of December 31, 1994:
<TABLE>
<CAPTION>
1994 Pending Pending
Estimated Ownership Adjusted Ownership Adjusted
Market Population Interest Population Interest Population
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<S> <C> <C> <C> <C> <C>
New York
Buffalo*........................................................... 1,187,000 50.0% 594,000 50.00% 594,000
Rochester*......................................................... 1,024,000 42.5% 435,000 42.50% 435,000
Syracuse*.......................................................... 673,000 27.5% 185,000 27.50% 185,000
Utica-Rome*........................................................ 315,000 50.0% 158,000 50.00% 158,000
RSA #1*............................................................ 262,000 20.0% 52,000 20.00% 52,000
Total UCN Core Markets............................................. 3,461,000 1,424,000 1,424,000
NY RSA #2.......................................................... 232,000 12.5% 29,000 18.75% 44,000
NY RSA #3*......................................................... 482,000 22.5% 109,000 22.50% 109,000
NY RSA #4.......................................................... 359,000 0.0% 0 27.00% 97,000
Binghamton......................................................... 306,000 24.0% 73,000 32.50% 99,000
Elmira............................................................. 95,000 0.0% 0 50.00% 48,000
Alabama
AL RSA #4*......................................................... 137,000 69.54% 95,000 69.54% 95,000
AL RSA #6*......................................................... 118,000 69.54% 82,000 69.54% 82,000
Managed Markets* 4,198,000 1,710,000 1,710,000
Pennsylvania
PA RSA #3, B2...................................................... 58,000 0.0% 0 13.89% 8,000
PA RSA #4, B2...................................................... 72,000 0.0% 0 16.67% 12,000
Minnesota
Minnesota RSA #10.................................................. 227,000 0.0% 0 100.00% 227,000
Minority Interests
Orange-Poughkeepsie NY 597,000 15.00% 89,000 15.00% 89,000
Des Moines IA MSA.................................................. 420,000 4.00% 17,000 4.00% 17,000
GA RSA #3.......................................................... 205,000 25.00% 51,000 25.00% 51,000
IL RSA #2.......................................................... 252,000 6.67% 17,000 6.67% 17,000
IL RSA #3.......................................................... 200,000 6.38% 13,000 6.38% 13,000
Total.............................................................. 7,221,000 1,999,000 2,432,000
</TABLE>
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* Company managed systems; NY RSA #2 is Company managed in 1995.
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For each market listed above, the number in the "Adjusted Population" column
represents an estimate of the Company's proportionate share of the number of
potential cellular customers in such market as of December 31, 1994 and is
calculated by multiplying the 1994 estimated population of such market by the
Company's ownership interest in the cellular system serving that market as of
such date. Similarly, the number in the "Pending Adjusted Population" column
represents an estimate of the Company's proportionate share of the number of
potential cellular customers in each such market as of December 31, 1994, and is
calculated by multiplying the 1994 estimated population of such market by the
Company's ownership interest in the cellular system serving that market,
assuming completion of the proposed or pending transaction.
Customer Premises Equipment
Frontier Network Systems Inc., ("FNS") (previously "Rotelcom Inc."), was
established in 1978. It markets and services a wide range of telecommunications
and data equipment for mid- to large-size business customers, and competes
directly with other interconnect vendors that market telephone systems to
businesses and other enterprises. FNS's product line includes: private branch
exchanges ("PBXs") from Siemens/ROLM and Northern Telecom; data communications
equipment from leading manufacturers including Dowty and Newbridge; and
videoconferencing equipment from PictureTel. Product lines purchased by FNS
from its two largest suppliers, Siemens/ROLM and Northern Telecom, account for
more than a majority of its purchases from suppliers. The Company believes
FNS's relationships with its various suppliers is good. All of FNS's customers
are in New York State. FNS is also a partner in Anixter-Rotelcom, a
telecommunications supply joint venture with Anixter Bros., Inc., which was
established in 1986 to combine Anixter Bros.' experience in computer-assisted,
just-in-time telecommunications inventory delivery systems with FNS's
interconnect (private telephone system) business and to provide just-in-time
inventory control for the Company's regional telephone companies.
Telephone Operations
General
As of December 31, 1994, the Rochester, New York operating company and the
35 other local exchange companies served approximately 918,000 access lines in
13 states. The local exchange carriers provide local, toll access
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and resale services; sell, install and maintain customer premises equipment; and
provide directory services.
Effective January 1, 1995, the Company reorganized into a holding company
structure. The assets of the Rochester local exchange company were transferred
to two wholly-owned subsidiary companies. Rochester Telephone Corp. is a
regulated telephone and network transportation corporation which offers retail
services to existing customers as well as sells and markets wholesale network
services and other services to retailers of telecommunications services in the
Rochester, New York market. Its rates are subject to price cap regulation.
Frontier Communications of Rochester, Inc., is a lightly regulated provider of
telecommunications services to residential and business customers located,
initially, in the Rochester, New York market. The Company has other existing
subsidiaries, including many which provide local exchange services outside the
Rochester, New York market.
Since the beginning of 1988, the Company has invested over $620 million in
upgrading its Telephone Operations business and over $480 million for the
acquisition of independent telephone companies. Over this period, the Company
installed advanced digital switching platforms throughout much of its switching
network. The Company's network in Rochester, New York is fully digital, making
Rochester one of the largest cities in the United States to be served by an all-
digital network. In aggregate, the 35 local exchange companies outside of
Rochester, New York have over 95 percent digital capability. This is
illustrated in the "Access Line Table" located below.
Frontier has achieved substantial cost reductions through the elimination
of duplicative services and procedures and the consolidation of administrative
functions. As of December 31, 1994, Telephone Operations had 34 employees per
ten thousand access lines. The Company has reduced the number of telephone
employees per ten thousand access lines by over 27 percent since 1990. The
Company believes that additional reductions in employee levels will be necessary
to further improve the competitive position of its Telephone Operations. The
Company intends to vigorously pursue additional gains in productivity through
reengineering while simultaneously improving customer service.
In May 1994, the Company sold its Minot Telephone Company property located
in Minot, North Dakota. In September 1994 it announced that a definitive
agreement had been reached to sell the Ontonagon County Telephone Company and
the Midway Telephone Company, both located in the Upper Peninsula of Michigan,
and completed the transaction in March
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1995. In each case, the telephone properties no longer fit the strategic
purposes of the Company.
Access Line Table
The Table below sets forth certain information with respect to access lines
as of December 31, 1994:
<TABLE>
<CAPTION>
Percent of Total
Company Access
Telephone Properties Access Lines at Percent
at December 31, 1994 Lines December 31, 1994 Digital
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<S> <C> <C> <C>
Rochester, NY....... 501,811 54.7% 100.0%
Other NY Companies.. 86,125 9.3% 100.0%
Total New York...... 587,936 64.0% 100.0%
Alabama(1).......... 28,833 3.1% 100.0%
Georgia............. 22,420 2.4% 100.0%
Illinois(1)......... 17,782 1.9% 100.0%
Indiana............. 4,605 0.5% 100.0%
Iowa................ 52,125 5.7% 87.0%
Michigan(1)......... 26,623 3.0% 100.0%
Minnesota........... 101,992 11.1% 92.0%
Mississippi......... 5,284 0.6% 100.0%
Pennsylvania........ 34,682 3.8% 100.0%
Wisconsin........... 35,856 3.9% 100.0%
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Total Other States.. 330,202 36.0% 95.5%
Consolidated
Access Lines..... 918,138 100.0% 98.4%
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</TABLE>
(1) These companies also have properties in one or more other states. (An
Alabama company has access lines in Florida, an Illinois company has access
lines in Iowa, and a Michigan company has access lines in Ohio).
The Company operates 71 central office and remote switching centers in
Rochester, New York, and a total of 275 central office and remote switching
centers in its other telephone territories. Of the 918,138 access lines in
service on December 31, 1994, 663,293 were residence lines and 254,835 were
business lines. Long distance network service to and from
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points outside of the telephone companies' operating territories is provided by
interconnection with the lines of interexchange carriers.
As part of the Company's continuing strategy to provide a greater selection
of value-added products, the Rochester, New York operating company has
introduced advanced services such as Caller ID, distinctive ringing, directory-
assisted call completion, and an enhanced voice mail platform. The Company is
introducing similar advanced services, where appropriate, at its other telephone
properties.
Frontier is pursuing several alternatives to provide expanded broadband
services to its customers. To date, the Company has installed over 10,000 miles
of fiber optic facilities (over 500 sheath miles) in the Rochester, New York
area to provide its customers with enhanced capacity and product capability.
Throughout its telephone operations, Frontier has over 24,000 miles of fiber
optic facilities in place. The Company also conducted marketing trials and
tests of new technologies such as a video on demand service utilizing a hybrid
fiber-optic/coaxial cable network. The Company marketed this technology to
selected customers in its Rochester, New York service area during 1994. The
Company provides expanded broadband services to select customers outside the
Rochester, New York service area. These include video-distance learning
arrangements at certain Midwest region telephone properties.
In connection with its integration strategy, the Company has developed a
new program known as "Visions Long Distance", where its local exchange companies
resell FCI's long distance services. The Company believes that many customers
prefer the convenience of obtaining their long distance service through their
local telephone company and receiving a single bill. Visions Long Distance was
introduced at nine local telephone exchange companies in 1993 and extended to
two additional subsidiaries in 1994. The results of Visions Long Distance
operations are included as part of the Telecommunication Services segment.
Technological innovation and regulatory change are accelerating the level
of competition in both local exchange and long distance services. New
competitors now have the ability to provide basic local telephone service in
some areas, including Rochester, New York. To benefit from these technological
advances and broaden the scope and quality of its own product and service
offerings, the Company has increased its fiber and digital switching capacity
throughout its networks and has pursued regulatory alternatives such as the Open
Market Plan, which is described in more detail below. Currently, the Company
may be considered the primary provider of basic local telephone service in its
Rochester, New York property and may be
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considered the only provider of basic local exchange service in the various
other geographic areas where it has telephone properties.
Open Market Plan
On February 3, 1993, the Company filed its Open Market Plan with the New
York State Public Service Commission ("NYSPSC"). The plan was approved by an
Order of the New York State Public Service Commission dated November 10, 1994,
was approved by the Company's shareowners on December 19, 1994, and was
implemented effective January 1, 1995. The Open Market Plan has formally opened
the Rochester, New York local exchange market to competition. Frontier was the
first communications company in the nation to propose such a plan for full open
local competition. The Open Market Plan enables customers to choose their local
telephone service provider and to select from a broad array of products,
services and prices. It also gives Frontier the flexibility to broaden the
scope and quality of its own competitive service offerings.
Under the Open Market Plan, the Company's Rochester, New York local
exchange operations were divided into two companies-a wholesale provider of
basic network services ("Rochester Telephone Corp." or "RTC") and a retail
provider of telecommunications services ("Frontier Communications of Rochester,
Inc." or "FCR"). RTC and FCR are subsidiaries of the Company, which has become
an unregulated parent holding company. The parent holding company structure
provides financial flexibility for the Company to continue the acquisition and
diversification efforts that are necessary for its long-term growth.
RTC is a regulated company which sells basic network services such as
access to the network, transport between offices, and switching services to FCR
and all other local telecommunications companies. These local
telecommunications companies, including FCR, may then package services for
resale to local customers. RTC also provides services directly to end users,
except for Centrex and high capacity private line services which it offers only
on a wholesale basis. Under the Open Market Plan Agreement, RTC is subject to
price cap regulation rather than rate of return regulation. This will enable the
Company to retain the benefit of all productivity and revenue gains since its
rate of return is subject to price cap regulation. Please see the Rate
Stabilization Plan and Open Market Plan discussions at pages 14 and 15.
FCR is an unregulated full service provider of a broad array of integrated
telecommunications services, including local, long distance, cellular and,
potentially, video and other value-added offerings. In addition,
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FCR is able to package the network elements purchased from RTC and other
network providers with services such as flat rate service, measured rate
service, Centrex and ISDN. The Company intends that FCR will eventually offer
products and services outside of the Rochester, New York market.
Regulatory Matters
Each of Frontier's local telephone service companies is regulated by the
public utility regulatory agency of the state in which that company provides
local telephone service. The respective states are listed on the Access Line
Table on page 10. The competitive evolution of the telecommunications industry
has resulted in a more fluid regulatory framework than was in place
historically. In general, state regulatory agencies exercise authority over the
prices charged for the provision of local telephone service and intrastate long
distance service, the quality of service provided, the issuance of securities,
the construction of facilities and other matters. Each of the Company's long
distance and wireless companies may be regulated to a limited extent by the
public utility regulatory agency of the state in which each is providing
service. The Company's long distance and wireless service providers are also
subject to FCC jurisdiction.
(a) Royalty Proceeding. In 1984, the NYSPSC initiated a proceeding to
investigate the issue of whether the Company's competitive subsidiaries should
pay a royalty to the Rochester, New York local telephone service provider
primarily for the alleged intangible benefits received from the use of the
Rochester Telephone name and reputation. Under the Open Market Plan Agreement,
the NYSPSC will not impute a royalty on either the Company or on Rochester
Telephone Corp. during the term of the Rate Stabilization Plan (the "Rate
Period") which was a component of the Open Market Plan or any prior period,
subject to certain limited exceptions. After the termination of the Rate
Period, however, the NYSPSC may impute a royalty for the period beginning on the
termination date, subject to the outcome of any litigation regarding the
royalty. The Company is continuing to pursue the litigation it instituted to
challenge the Royalty Order. This proceeding remains unresolved and is
discussed in more detail in Item 3, Legal Proceedings.
(b) Incentive Regulation. In January 1990, the NYSPSC approved an incentive
regulation agreement for the Rochester, New York operating company. This
agreement expired at the end of 1992, and the Company proposed a new incentive
regulation agreement in January 1993. An interim settlement was approved by the
NYSPSC in February 1994. The settlement reduced the Company's revenue
requirement in 1993 by $5 million and by an additional $4.5 million in 1994.
Each of these reductions was subject to adjustment for depreciation changes and
the outcome in the Generic Financing Proceeding, which is discussed on page 15.
These issues were
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settled in the Open Market Plan. The amount of allowable depreciation was the
subject of a contested proceeding before the NYSPSC, but that issue was also
resolved in the Open Market Plan Settlement. As part of the Open Market Plan
Settlement, Rochester Telephone Corp. ("RTC") agreed to share with ratepayers
fifty percent of earnings above a threshold rate of return. In addition, that
company's revenue requirement was reduced by $5 million in 1993 and $9.5 million
in 1994. The 1993 sharing amount was refunded through customer billing credits.
The 1994 revenue requirement reduction, plus interest, was credited to RTC's
depreciation reserve to alleviate a reserve deficiency rather than refunding
cash to ratepayers. There was no 1994 sharing amount.
(c) Rate Stabilization Plan. The Open Market Plan provides for a total of $21
million in rate reductions for Rochester Telephone Corp. (the "Rate
Stabilization Plan") over a seven year period beginning January 1, 1995, subject
to termination by either the Company or the NYSPSC after five years (the "Rate
Period"). The Rate Stabilization Plan also precludes RTC from increasing basic
residential and business telephone service rates during the rate period. In
consideration of the rate reductions, the Rate Stabilization Plan provides that
RTC's local exchange services be subject to price-cap regulation rather than
rate of return regulation. The rates provided in the Rate Stabilization Plan
are designed to permit RTC to recover its costs and to earn a reasonable rate of
return, calculated using a methodology utilized by the NYSPSC to set the rate of
return earned by providers of local exchange services in New York State.
(d) Ice Storm. In March 1991, Rochester, New York experienced a severe ice
storm which caused the Rochester, New York Operating Company to spend
approximately $9.7 million to repair and replace outside plant facilities and to
provide customers billing credits for service disruptions. The Rochester, New
York operating company filed a petition with the NYSPSC requesting that it be
allowed to defer and amortize the portion of those costs which were intrastate
expenses. In November 1991, the NYSPSC approved the deferral and amortization
of $5.2 million of the intrastate local service expenses over a forty-eight
month period beginning January 1, 1992 and the amortization of $1.6 million of
the intrastate long distance service expenses through June 1993. The Rochester,
New York Operating Company also filed a petition with the FCC requesting that it
be allowed to defer and amortize the portion of the ice storm expenses that were
allocated to or assigned the interstate jurisdiction. The FCC approved an order
effective January 23, 1992, which permitted the Company to begin the
amortization of $2.0 million of interstate expenses over an eighteen month
period. In order to recover the expenses, the FCC permitted the Rochester, New
York Operating Company to establish a temporary surcharge on interstate switched
access charges to be billed to interexchange carriers and a monthly increase in
the interstate customer
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access line charges applicable to Centrex and multiline business customers. All
recovery was completed by the end of the first quarter of 1994.
(e) FAS 106. The Company adopted Financial Accounting Standards Board
Statement 106 (FAS 106), "Employers' Accounting for Postretirement Benefits
Other Than Pensions." It had previously adopted FAS 87, "Employers' Accounting
for Pension Benefits." For the Rochester company, the accumulated
postretirement benefit obligation as of January 1, 1994 was approximately $89.8
million, and the projected pension benefit obligation was approximately $275.7
million. The Company elected to defer the recognition of the accrued Transition
Benefit Obligation over a period of twenty years. Each state regulatory agency
may treat these obligations differently in the rate-making process. On
September 7, 1993, the NYSPSC issued its Statement of Policy and Order
concerning postretirement benefit and pension accounting. Consistent with this
NYSPSC policy the Rochester, New York operating company included the FAS 106
costs in its incentive regulation settlement agreement discussed on page 13.
The FCC originally suspended the Company's petition to include the
incremental costs associated with adopting FAS 106 in its 1993 price cap filing.
The Company, along with all other local exchange carriers (LECs) subject to
price cap regulation, filed an appeal of the FCC's ruling with the United States
Court of Appeals. In the court's decision, dated July 12, 1994, the FCC's
original order was vacated and the FCC was remanded to reconsider the merits of
the LECs' request for exogenous cost treatment under the price cap rules. The
FCC has reopened its investigation of the carriers' filings. The Company is
evaluating its options in light of the Court's decision and cannot predict the
final outcome of the FCC's investigation.
(f) Open Market Plan. The Company filed a petition in February 1993 with the
NYSPSC in which the Company requested approval to reorganize the corporation.
This Open Market Plan, which was implemented effective January 1, 1995, is
discussed in more detail on pages 12 and 13.
(g) Frontier Communications of Minnesota (formerly Vista Telephone Company of
Minnesota). Frontier Communications of Minnesota filed with the Minnesota
Public Service Commission a request to increase rates in March 1993. A
stipulated settlement was executed by all parties and was submitted for approval
to the Minnesota Public Service Commission. In April 1994, the Minnesota Public
Service Commission granted the Company authority to increase annual revenues by
$4.4 million.
(h) Generic Financing Proceeding. In May 1993, the NYSPSC instituted a
Generic Financing Proceeding to review its financial policy guidelines and to
determine if there should be established a generic rate of return methodology
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for New York State local exchange companies. The Company favors a generic
methodology because it would streamline the ratemaking process, provide all
stakeholders a much greater sense of predictability, and create an environment
more conducive to long term planning. The Company supports the implementation
of a generic rate of return methodology, but it cannot, at this time, predict
the outcome of this proceeding. Because the Open Market Plan provides for "pure
price cap regulation" rather than rate of return regulation, the outcome of this
Generic Financing Proceeding will not apply to RTC during the Rate Period of the
Rate Stabilization Plan component of the Open Market Plan. However, Frontier's
other New York subsidiary telephone companies remain subject to rate of return
regulation.
(i) Frontier Communications of Iowa (formerly Vista Telephone Company of
Iowa). Frontier Communications of Iowa filed in August 1993 for a rate increase
in Iowa of approximately $4.5 million including a temporary increase of $4.1
million. In February 1994, the Iowa State Utilities Board issued an order
approving a proposed settlement of this case. Under the terms of that order,
the Board granted Vista Iowa an annual revenue increase of $2.9 million.
(j) Undergrounding Proceeding. The NYSPSC, in an order dated September 21,
1993, stated that the Company's New York local exchange service providers
should, for the next five years, accrue funds for the purposes of
"undergrounding" construction of distribution plant in "visually significant
areas." Any unspent amounts are to be carried over to the next year until
expensed. The amount of the accrual is determined in accordance with a NYSPSC
approved formula. The Company currently estimates the total amount of the
accrual to be approximately $408,000 for all of its New York local exchange
companies. The NYSPSC has also indicated that it intends to release an order
requiring a pilot program to underground some existing plant in certain areas.
The Company will consider its options to file for reconsideration or appeal if
and when the Order is issued. However, the Company cannot predict the outcome
at this time.
Competition
Traditionally, telecommunications industry businesses were considered
monopolies. This industry has experienced a significant increase in competition
in recent years. Factors such as technological advancement and a more fluid
regulatory framework have encouraged competition. Frontier is intent on meeting
and taking advantage of the various business opportunities which competition
provides in the markets where it operates. The Open Market Plan, described in
more detail at pages 12 and 13 is one way in which the Company is proactively
meeting competition. The
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Company is also addressing competition by focusing on improved customer
satisfaction, by developing and offering products and services, and by reducing
its cost base and becoming more efficient.
(a) Local Exchange Networks. Prior to 1968, the telephone industry alone
provided and maintained the telephones and lines of the public switched
telecommunications network. In that year, an FCC order declared unlawful
certain AT&T tariffs which prohibited customers from attaching their own
equipment to the telephone network. However, the telephone equipment provided
by telephone companies which remained in place on customers' premises remained
regulated. By a subsequent FCC order, effective January 1, 1983, telephone
companies were required to deregulate all new telephone equipment. Although
Frontier experiences different levels of network regulation throughout the
geographic territory of its telephone properties, in general the Company is
subject to numerous competitors in the provision of equipment and facilities
used in connection with the local exchange network. In the Rochester market
competitors who have stated they will enter or have actually entered the local
exchange market include Time Warner Communications and AT&T.
Since the deregulation of telephone equipment, sales of telephone equipment
have become commonplace throughout all geographic areas of the United States.
Frontier has responded to this competition through operation of its retail Phone
Centers for the direct sale of telephone sets, inside wire and telephone
outlets. The Phone Centers also perform as maintenance centers where customers
who lease equipment from the company can pick up or exchange telephones and
receive a credit on their bills if they bring in a telephone that needs repair.
In 1982, the Rochester, New York operating company formed its Consumer Equipment
Services division to maintain all company provided leased equipment as well as
maintain customer-owned equipment on a fee for service or contract basis. Many
of the Company's other local exchange companies also sell, lease and maintain
telephone sets and equipment.
Business consumer equipment needs are another segment of the
telecommunications network equipment market. Several of the Company's local
exchange companies market equipment and facilities directly to business
consumers. In addition, Frontier Network Systems, which was established in 1978
under the name Rotelcom Inc., markets and services a wide range of
telecommunications and data equipment for mid-to large-size business customers,
and competes directly with other interconnect vendors that offer for sale
telephone systems to businesses and other enterprises. FNS's product line
includes: private branch exchanges (PBX's) from ROLM, Siemens and Northern
Telecom; data communications equipment from leading manufacturers including
Dowty and Newbridge; and
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videoconferencing equipment from PictureTel. The majority of FNS's customers are
in New York State. FNS is also a partner in Anixter-Rotelcom, a joint
telecommunications supply venture with Anixter Bros., Inc.
Although competitive providers of local exchange basic service are not
expected to be active for the near future at the Company's smaller rural
properties, local exchange basic service competition is occurring today in the
Rochester, New York marketplace. For example, MFS Telecom, Inc. ("MFS") and
Time Warner Communications ("Time Warner") are alternative local exchange
service providers in Rochester. AT&T Communications ("AT&T") is also actively
remarketing local exchange service in the Rochester, New York marketplace as a
reseller of RTC's services, as is Frontier's subsidiary, Frontier Communications
of Rochester, Inc. ("FCR"). The Company is unaware of the exact revenues and
market share of the local exchange market that MFS, Time Warner, AT&T or FCR
account for in the Rochester, New York service area.
On February 3, 1993, Frontier filed a plan with the NYSPSC, to open the
local telephone market in the Rochester, New York service area to competition.
This plan enables customers to choose their local telephone service company and
will potentially provide them a broader selection of products, services and
prices. It will also give the Company greater flexibility to broaden the scope
and quality of its own competitive offerings. See the discussion on the Open
Market Plan on pages 12 and 13 and Regulatory Matters on pages 13 through 16.
Long distance companies largely access their end users through
interconnection with local telephone companies. Those long distance companies
pay access fees to the local telephone companies for this service. This is one
reason the Company derives at least ten percent of its consolidated gross
revenues from AT&T. The Company provides a number of other services to AT&T,
such as billing and collection.
Alternate Access Vendors are companies which provide alternative
transmission services and provide access services to local exchange and long
distance companies. Alternate Access Vendors compete with traditional local
exchange companies. Currently, MFS, AT&T and Time Warner are the primary
Alternate Access Vendors active in the Rochester, New York area and no
significant Alternate Access Vendors are believed to be active in any of the
Company's other properties.
(b) Interexchange Service. During the past two decades, rulings by the FCC
and associated court decisions have restructured the market for the provision of
interexchange telecommunications services and have opened up this market to
competition. The Company recognized an opportunity to compete
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in this market. In 1984, Frontier Communications International, Inc., ("FCI")
(previously RCI Long Distance) was launched and a digital switching and
transmission system was built throughout the Northeast. Today FCI operates in
New York, New England and the Mid-Atlantic and Midwest regions, an area which
accounts for nearly 25 percent of the nation's total interexchange revenues.
Through arrangements with other interexchange carriers, FCI provides
connectivity to the entire United States and to over 200 countries around the
world.
In addition to growing its customer base in its original operating
territory, FCI has expanded its network coverage and customer base through the
acquisition of long distance companies in the Northeast: RCI Long Distance New
England Inc., (previously operating as Long Distance North and now named
Frontier Communications of New England, Inc., January 1991) and Taconic Long
Distance Service Corp. (now named Frontier Communications of Taconic, Inc., July
1991), Mid Atlantic Telecom, Inc. (now named Frontier Communications of the Mid
Atlantic, September 1994), and Budget Call Long Distance, Inc. (June 1993). In
October 1994, the Company announced that it would purchase WCT Communications,
Inc., ("WCT") a long distance reseller headquartered in California with annual
revenues in excess of $100 million, and in November 1994, the Company announced
that it would acquire American Sharecom, Inc., ("ASI") headquartered in
Minnesota, with revenues of approximately $125 million. The ASI acquisition,
completed in March 1995, and the prospective WCT acquisition will extend the
geographic coverage nationwide and together are projected to make FCI the
seventh largest long distance carrier in the nation.
A number of companies, including AT&T, MCI, Sprint and smaller regional
long distance companies, compete with FCI and offer interexchange services such
as Wide Area Telephone Service ("WATS"), private line and switched message toll.
Given the competitive nature of the interexchange service industry, FCI is not
aware of its exact market share in any specific market. However FCI does not
believe that it holds a dominant market position in any market in which it
operates.
(c) Wireless. The Company is the managing partner of Upstate Cellular Network
("UCN"), which is a partnership with NYNEX Mobile. The partnership operates a
cellular system in central and western New York State. Frontier also manages,
through a subsidiary, an Alabama cellular partnership and has investments in
other cellular properties. Please see the Cellular Property Ownership Table at
page 7 for a listing of the various cellular properties which the Company
manages or in which it has investment interests.
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Cellular systems generally have at least one competitor in each market.
For example, in the Rochester, New York MSA the other cellular system is Genesee
Telephone Company ("GTC") which does business as Cellular One. In 1994
Southwestern Bell acquired a controlling interest in GTC. Additionally, Time
Warner Communications has recently begun to resell cellular service in the
Rochester, New York MSA. In the cellular industry, competitive characteristics
include the geographic coverage area, transmission clarity and the price of the
service offerings. The Company believes that the transmission quality of its
systems is generally comparable to or better than the quality of its competitor
in each market. The Company also competes through pricing packages which
provide certain benefits to customers. For example, one pricing package
provides significantly reduced roaming rates throughout most of Upstate New
York. In addition, the Company's strong geographical service coverage of much
of the upstate New York area makes the Company a strong competitor. This
coverage, which includes handheld level service in downtown Rochester and in
most of its major commuting areas, is believed to be comparable or superior to
the coverage of its competitors. Because the Company does not have information
regarding its competitors' customer bases, the Company is unable to calculate
any specific assessment of its market share in its various markets.
In addition to UCN, the Company has partnership interests in various other
MSAs and RSAs (Rural Service Areas.) Please see the "Cellular Property
Ownership Table" on page 7 for a list of the Company's cellular ownership
interests and the estimated population in each of the indicated cellular
markets. Although in the future the Company may divest itself of selected
cellular properties, the Company will continue to seek cellular service growth
and expansion. To this end, the Company in 1994 entered into a definitive
agreement for the purchase of a partnership which owns the business and assets
of a cellular provider serving Minnesota RSA #10. Please also see the discussion
of Upstate Partners on pages 2 and 5.
Environmental and Other Matters
Underground duct systems are often used to house telephone cable. Some of
the existing ducts are made of a material containing asbestos. This material
poses a potential removal and disposal problem if a realignment of the duct
system is necessary due to road construction or similar projects. The Company
is in the process of identifying the portions of the duct system that contain
this material so necessary action may be taken in a timely fashion to minimize
the cost of removal and disposal of such material. The asbestos presents no
known health risk as long as it remains buried and undisturbed. It cannot be
determined how much of the affected underground duct system will undergo future
reconstruction and, therefore, an estimate of
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the cost of asbestos removal and disposal cannot be made at this time. See Item
3. Legal Proceedings, for discussion of environmental litigation.
Employees and Labor Relations
As of December 31, 1994, the Company had 4,240 employees, of which 3,156
were employees of the various Telephone Operations businesses, and 1,084 were
employees of the various Telecommunication Services businesses. At the
Rochester, New York Operating Company, 663 clerical and service workers were
represented by the Rochester Telephone Workers Association (RTWA) and 726 craft
and clerical employees were represented by the Communications Workers of America
(CWA), Local 1170.
Under the current three-year contract between Rochester Telephone Corp.
and the RTWA, effective August 12, 1994 bargaining unit employees received a 2.0
percent general increase. On February 12, 1995 they will receive a 1.0 percent
general increase. The contract provides that they will receive the same amount
of increase on February 18, 1996 and February 16, 1997. The RTWA contract will
expire on August 12, 1997.
Under the current three-year contract between Rochester Telephone Corp. and
the CWA, Local 1170, effective January 1, 1994 bargaining unit employees
received a wage increase of up to 4.5 percent, and on January 1, 1995, those
employees received a wage increase of up to 4.25 percent plus a "Cost of Living
Allowance" increase based on 70 percent of the movement of the Consumer Price
Index above 9.25 percent during the period from November 1992 to November 1994.
The CWA contract will expire on January 31, 1996.
The International Brotherhood of Electrical Workers (IBEW) represents 159
employees at Frontier Communications of New York (previously Highland), 16
employees at Frontier Communications of Sylvan Lake and 11 employees at Frontier
Communications of AuSable Valley. On May 25, 1993, Highland and the IBEW,
Local 503, entered into a contract which expires February 13, 1997, and
provides for an increase of 4 percent in September 1994, 4 percent in September
1995, and no increase thereafter until the contract is renegotiated. On
September 29, 1992, Sylvan Lake and the IBEW, Local 320, entered into a
three-year contract extension which provides for an increase of 3.0 percent in
year one, 3.5 percent in year two, and 5.0 percent in year three of the
contract. The current three-year contract between AuSable Valley and the IBEW,
Local 2176, granted bargaining unit employees an average wage increase of 3.6
percent effective May 1993, and also provides for an average 3.4 percent wage
increase in the final year of the contract. That contract will expire May 10,
1995.
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The IBEW, Local 51, represents 22 employees of Frontier Communications of
Michigan (previously C, C & S Telco, Inc.) On October 9, 1994, they entered
into a three year contract which granted bargaining unit employees a 3.0 percent
increase in October 1994, a 3.0 percent increase in October 1995, a 2.5 percent
increase in October 1996 and a 2.25 percent increase in October 1997. That
contract will expire October 8, 1997. The IBEW additionally represents through
its Local 1106, 7 employees at Frontier Communications of Illinois (previously
Midland), 5 employees at Frontier Communications - Inland, 1 employee at
Frontier Communications - Lakeside, 1 employee at Frontier Communications
- -Prairie, and 4 employees at Frontier Communications of Mt. Pulaski. On
November 1, 1994, each of these companies entered into three-year contracts
with the IBEW that provided for a $.60 per hour wage increase on November 1,
1994, a $.55 per hour wage increase on November 1, 1995, and a $.50 per hour
wage increase on November 1, 1996.
The CWA, Local 7270, represents 172 employees at Frontier Communications of
Minnesota (previously Vista Minnesota). On June 21, 1993, Vista Minnesota and
the CWA entered into a three-year contract which provided for a wage increase of
3.0 percent in June 1994, and a minimum of 2 percent in June 1995, with an
opportunity to receive, also in June 1995, up to an additional 1.25 percent
based upon the performance of the Vista Minnesota telephone operation. The
contract expires June 21, 1996. The CWA, Local 7171, represents 93 employees at
Frontier Communications of Iowa (previously Vista Iowa). On May 1, 1993, Vista
Iowa and the CWA entered into a three-year contract which provides for wage
increases of 2.7 percent in May 1994, and a minimum of 2 percent in May 1995,
with an opportunity to receive, also in May 1995, up to an additional 1.25
percent based upon the performance of the Vista Iowa telephone operation. The
contract expires April 30, 1996.
The Company believes that its labor relations are, overall, very good.
Since 1980, the Company has only experienced two minor work stoppages, both
involving contract negotiations between the Rochester, New York Operating
Company and the CWA, Local 1170. On February 16, 1984, the Rochester, New York
Operating Company experienced a six (6) hour work stoppage and on February 16-
18, 1987, the Rochester, New York Operating Company experienced a work stoppage
of a little more than two (2) days in duration.
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ITEM 3. LEGAL PROCEEDINGS
Item 3 is hereby amended and restated in its entirety as follows:
On June 11, 1992, a group of corporate plaintiffs consisting of Cooper
Industries, Inc.; Keystone Consolidated Industries, Inc.; The Monarch Machine
Tool Company; Niagara Mohawk Corporation; and Overhead Door Corporation
commenced an action in the United States District Court for the Northern
District of New York seeking contribution from Rotelcom Inc., a wholly-owned
subsidiary of the registrant held through intervening subsidiaries (now named
Frontier Network Systems, Inc. or "FNS") and fourteen other corporate defendants
for environmental "response costs" in the approximate amount of $1.5 million
incurred by the plaintiffs pursuant to a consent decree entered into by
plaintiffs with the United States Environmental Protection Agency (the "EPA").
Two additional defendants were named in 1994. In addition to FNS, the current
defendants are: Agway, Inc.; BMC Industries, Inc.; Borg-Warner Corporation; Elf
Atochem North America, Inc.; Mack Trucks, Inc.; Motor Transportation Services,
Inc.; Pall Trinity Micro Corporation; The Raymond Corporation; Redding-Hunter,
Inc.; Smith Corona Corporation; Sola Basic Industries, Inc.; Wilson Sporting
Goods Company; Phillip A. Rosen; Harvey M. Rosen; City of Cortland; and New York
State Electric & Gas Corporation.
The consent decree concerned the clean-up of an environmental Superfund
site located in Cortland, New York. It is alleged that the corporate defendants
disposed of hazardous substances at the site and are therefore liable under the
Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA").
Frontier Network Systems has not been named as a Potentially Responsible
Party under CERCLA, does not consider itself a Potentially Responsible Party,
and has denied liability for the site. The Company anticipates that a final
Record of Decision ("ROD") will be issued by the EPA in March 1995
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and will prescribe the remediation requirements for the site. The aggregate
amount of remediation costs to be incurred by the plaintiffs will be based on
the requirements of the ROD. The total cost of remediation at the site is
uncertain, although estimates have recently ranged from $25 million and $100
million. There has been no allocation of liability as among or between the
plaintiffs or defendants. The extent to which plaintiffs can recover any of
these costs from the defendants, including FNS, will be determined at a trial
which is scheduled to begin in July 1995. The action is currently in discovery.
FNS has been vigorously defending this lawsuit. The Company believes that it
will ultimately be successful, but it is unable to predict the outcome with any
certainty at this time.
In its Opinion and Order in Case 87-C-8959, issued July 6, 1993, the New
York State Public Service Commission (NYSPSC), by a three-to-two vote, imposed a
royalty upon the Company in the amount of two percent of the total
capitalization of the Company's unregulated operations. The NYSPSC justified
the royalty on two grounds; first, that ratepayers are entitled to protection
from the potential for cost misallocations and increased risk that accompany
diversification of the Company's basic telephone business; and second, that the
Company's unregulated operations benefit from their use of the Rochester name
and reputation. The NYSPSC rejected the Company's statutory and constitutional
defenses and concluded that it possessed the authority under the Public Service
Law to impose a royalty and that its imposition is not unconstitutional. Based
upon an initial interpretation of the Order, the company estimates that its
potential effect is in the range of two million dollars per year. The royalty,
if implemented, would be an imputation against the Rochester, New York operating
Company's revenue requirement from regulated intrastate operations. The NYSPSC
ordered the Rochester, New York operating company to file, by August 5, 1993, an
accounting plan to account for the royalty amount, together with a plan for
returning such amount to ratepayers. Although the Rochester, New York operating
company requested the NYSPSC to waive this requirement, the NYSPSC denied this
request. In compliance with the order of the NYSPSC, on August 5, 1993, the
Rochester, New York operating company filed its plan.
On August 6, 1993, the Rochester, New York operating company filed with
Supreme Court, Albany County, its petition pursuant to Article 78 of the New
York Civil Practice Law and Rules seeking judicial review of the NYSPSC's
Opinion and Order. By order dated October 7, 1993, this proceeding was
transferred to the Appellate Division, Third Department. The Company filed its
Brief on December 16, 1993. Respondents' briefs were filed on February 28,
1994, and reply briefs were filed on March 16, 1994. Oral argument was held on
April 26, 1994. On June 30, 1994, the Appellate Division unanimously upheld the
NYPSC's Order. On July 29, 1994, the
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Company filed a Notice of Appeal and a Motion for Leave To Appeal with the New
York Court of Appeals. On December 8, 1994, the Court of Appeals accepted the
Company's appeal and denied the Motion for Leave To Appeal as unnecessary. The
Company filed its brief on February 6, 1995. Respondent's briefs are due on
March 23, 1995 and the Company's Reply Brief is due April 3, 1995. On February
27, 1995, the NYPSC moved to dismiss the appeal as moot as a result of the Open
Market Plan Settlement. The Company filed its opposition to that motion on
March 13, 1995, and the motion is now before the Court for decision. The
Company is vigorously contesting this case and is of the opinion that it will
ultimately prevail, but cannot predict the outcome with any certainty at this
time. This royalty issue has been settled for the Rochester, New York operating
company for the duration of the Rate Period of the Rate Stabilization Plan,
which is part of the Open Market Plan.
The Regulatory Matters discussion in management's discussion of Business in
Part 1, Item 1, on pages 13 through 16 is incorporated herein by reference.
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ITEM 7. MANAGEMENT'S DISCUSSION OF RESULTS OF OPERATIONS AND ANALYSIS OF
FINANCIAL CONDITION
Item 7 is hereby amended and restated in its entirety as follows:
________________________________________________________________________________
DESCRIPTION OF BUSINESS
Frontier Corporation (formerly Rochester Telephone Corporation) is a diversified
telecommunications company, serving more than 1.5 million customers in 32 states
throughout the United States. Frontier Corporation's principal lines of business
are reported in two segments: Telecommunication Services and Telephone
Operations. Telecommunication Services includes Frontier's long distance
operations, cellular and paging operations, and telecommunications equipment
sales. Telephone Operations is comprised of 36 local telephone companies
providing service to over 900,000 access lines in the Northeast, Midwest and
South.
________________________________________________________________________________
1994 OVERVIEW
Frontier Corporation (the Company) completed a landmark year in 1994, both
financially and organizationally. Revenues increased 8.7 percent to just under
$1 billion, and operating income surpassed $200 million for the first time in
the Company's history. Earnings per share increased 23.9 percent in 1994 to
$1.50 per share, before the impact of a change in accounting for certain
employee benefits. Significantly, late in 1994, the Company secured state
regulatory and shareowner approval of an unprecedented plan to open the
Rochester, New York local service market to competition in return for local
service "price cap" regulation in the Rochester market and approval for the
formation of a holding company. The new regulatory plan for Rochester, New York
removes the limit on earnings that was present under "rate of return" regulation
for the duration of the plan. Finally, in recognition of the changing nature and
expanding geographic presence of the Company, our shareowners approved changing
the name of our company to Frontier Corporation.
FINANCIAL HIGHLIGHTS
The Company continued its recent pattern of substantial growth, driven mainly by
its competitive long distance business which had revenues of $334 million in
1994, an increase of $71.5 million, or 27.2 percent, over 1993. Overall,
Frontier Corporation's revenue mix continues to shift away from dependence upon
regulated revenue sources and more toward non-regulated revenue streams, with
the Telecommunication Services segment accounting for 38 percent of total
revenue in 1994. This compares to 29 percent in 1992. As a result of the
diversification efforts of the Company over the past several years, the
Rochester, New York operating telephone company accounted for only 31 percent of
total revenues in 1994, down from 46 percent in 1990.
Operating income for 1994 was $223.3 million, which represents an increase of
14.5 percent over 1993. Consolidated net income reached an all time high in 1994
at a level of $102.7 million, a 24.2 percent increase over 1993. The percentage
growth in net income was significantly higher than the corresponding percentage
growth in operating income due to the combined impact of lower borrowing costs
($3.0 million), higher investment income ($5.0 million) and the sale of our only
regional telephone company in North Dakota, which resulted in an $11.3 million
pre-tax gain. Including a one-time charge relating to a change in the method of
accounting for certain post-employment benefits, earnings per share were $1.40
for the year. Excluding both the one-time charge for the accounting change and
the gain from the sale of the telephone company in North Dakota, earnings per
share were also $1.40, an increase of 15.7 percent over 1993.
The number of common shares outstanding in 1994 was impacted by two events. In
February 1994, the Company sold 5.4 million shares of its common stock at $42
per share in a public offering. As part of the offering, 2.5 million new primary
shares were issued and sold directly by the Company and 2.9 million shares were
sold by C FON Corporation, a subsidiary of Sprint Corporation. In April 1994,
the Company implemented a 2-for-1 split of the Company's common stock, effected
in the form of a 100 percent stock dividend with no change in the $1.00 per
share par value. All historical share and per share data have been retro-
actively adjusted to reflect the split, unless specifically indicated otherwise.
CORPORATE NAME CHANGE AND RESTRUCTURING
In December 1994, upon receiving shareowner approval, the Company reorganized as
a holding company and changed its name from Rochester Telephone Corporation to
Frontier Corporation. The new name reflects not only the pioneering heritage of
our past but also our willingness to embrace the challenges of the future. The
name also symbolizes the change from a company focused primarily in Rochester,
New York to a company that is expanding geographically and currently operates in
32 states.
________________________________________
26 Financial Review Frontier Corporation
<PAGE>
Also in December 1994, shareowners approved an unprecedented and landmark
restructuring plan, referred to as the Open Market Plan Agreement, between the
Company, the staff of the New York State Public Service Commission (PSC), and
certain other interested parties. This seven year Agreement, with an effective
date of January 1, 1995, was approved by the PSC on October 13, 1994 and allowed
the Company to permanently reorganize into a holding company structure. The
restructuring into a holding company allows the Company to pursue acquisitions
and diversification initiatives without many of the financial and regulatory
constraints present under its prior corporate status. Under the Agreement, the
Rochester, New York local exchange market has been opened to competition. The
Rochester, New York operating company, which formerly was subject to rate of
return regulation, will operate under "price" regulation for the life of the
agreement. This removes the limit on the Rochester operating company's earnings
that was present under rate of return regulation.
Frontier Corporation (formerly Rochester Telephone Corporation) now owns
directly or indirectly all of the stock of:
. Rochester Telephone Corp., a new regulated telephone and network transport
company which holds virtually all of the local service assets used in
Rochester, New York market. Rochester Telephone offers retail local telephone
service and also markets wholesale network services and other services to
other retail providers of telecommunication services in the Rochester market,
. Frontier Communications of Rochester, Inc., a new retail provider of
telecommunication services to residential and business customers located in
the Rochester, New York market,
. Frontier Information Technologies Inc. (formerly Distributed Solutions, Inc.,
or DSI), an existing subsidiary of the Company, providing computer, billing
and other information processing services primarily to the Company's
affiliates,
. Frontier Communications International Inc. (formerly RCI Long Distance, Inc.),
an existing subsidiary of the Company providing long distance
telecommunication services to business and residential customers, and
. the Company's other existing subsidiaries, including our wireless operations
and 35 companies which provide local telephone service outside the Rochester,
New York market, as well as companies that provide telecommunication equipment
and services in the Rochester market and other markets.
Renamed as Frontier Corporation after shareowner approval on December 19,
1994, the Company is entitled to issue securities and effect acquisitions or
expand existing lines of business without obtaining the approval of the PSC,
subject only to the same exceptions as any other holding company operating in
New York State. As a result, the Company should be able to respond more quickly
to customer needs and new opportunities.
The establishment of Frontier Communications of Rochester, Inc. allows us to
provide integrated communications services to customers. Frontier Communications
of Rochester will buy network access from Rochester Telephone Corp. or other
carriers, and package these services with its own and others' product lines such
as long distance, wireless, data services and voice mail. Initially, Frontier
Communications of Rochester's customer base includes Centrex and digital private
line customers previously serviced by the former Rochester local operating
company. Beginning on January 1, 1995, Frontier Communications of Rochester and
other competitors were authorized to compete for local service customers from
Rochester Telephone Corp.'s current customer base. Frontier Communications of
Rochester intends to create value by becoming the single point of contact for
sales and service for its customers. Its competitive strength will be the
ability to create market-demanded packages of telecommunications products and
services, and to provide a single bill for all of these services. While its
services will initially be limited to customers in the Rochester, New York
market, Frontier Communications anticipates that it may offer its services
elsewhere.
CERTAIN CONSIDERATIONS RELATED TO THE OPEN MARKET PLAN
Management believes there are significant market and business opportunities
associated with the Company's Open Market Plan. However, there are also
uncertainties associated with the Plan and the corporate restructuring. In our
opinion, these are the most significant:
(a) Increased Competition in the Rochester, New York Market. The Open Market
Plan is expected to hasten local telephone competition in the Rochester, New
York market by providing for (1) the full interconnection of competing local
networks including reciprocal compensation for terminating traffic, (2) equal
access to network databases, (3) access to local telephone numbers and (4)
telephone number portability. Some competitors have already announced an
intention to provide basic local exchange services in the Rochester market. The
inherent risk associated with opening the Rochester market to competition is
that some customers will purchase services from competitors, which would reduce
the number of customers of the Company and potentially cause a decrease in the
Company's revenues and profitability. The Company believes, however, that usage
of its network following implementation of the Open Market Plan will increase,
and that new revenue will offset, to some extent, the loss of revenues from end-
user customers. Increased competition may also lead to additional price
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Financial Review Frontier Corporation 27
<PAGE>
decreases for services of the Company, adversely impacting the Company's
margins. However, price cap regulation will not require Rochester Telephone
Corp. to rebate any additional earnings achieved through operating efficiencies
that previously would have been shared with customers. Moreover, services in the
Rochester, New York market are already subject to competition. This trend will
probably continue with or without the Open Market Plan. The Open Market Plan
allows the Company to anticipate the erosion of its market share in local
exchange services on terms that the Company believes will be in the best
interests of its customers, employees and shareowners.
(b) Risk of Rate Stabilization Plan. The Rate Stabilization Plan incorporated in
the Open Market Plan Agreement provides for a total of $21 million in rate
reductions for Rochester Telephone Corp. over the life of the Agreement. During
this time, the rates charged by Rochester Telephone Corp. for basic residential
and business telephone service may not be increased for any reason. But, since
Rochester Telephone Corp. will operate under a price cap environment with no
rate of return regulation, the Company will be able to retain the full value of
any cost savings it introduces over the life of the plan. Even though the rates
provided in the Rate Stabilization Plan were designed to permit the Company to
recover its costs and to earn a reasonable rate of return, there is no assurance
that this will occur. The effect on the Company's results of operations cannot
be predicted because of uncertainty about Rochester Telephone Corp.'s network
usage and its costs.
(c) Restraints on the Company's Control of Rochester Telephone Corp. The Open
Market Plan Agreement limits the number of inside directors on the Board of
Directors of Rochester Telephone Corp. and the ways in which its officers and
senior management employees are compensated. The Open Market Plan also prohibits
payment of dividends by Rochester Telephone Corp. to Frontier Corporation if (i)
Rochester Telephone Corp.'s senior debt has been downgraded to "BBB" by Standard
& Poor's ("S&P"), or the equivalent rating by other rating agencies or is placed
on credit watch for such a downgrade, or (ii) a service quality penalty is
imposed under the Open Market Plan Agreement. Dividends paid to the parent,
Frontier Corporation, also are prohibited unless Rochester Telephone Corp.'s
directors certify that such dividends will neither impair Rochester Telephone
Corp.'s service quality nor its ability to finance its short and long term
capital needs on reasonable terms while maintaining an S&P debt rating target of
"A". Other financial covenants exist to ensure that Rochester Telephone Corp.
will have the financial strength to provide quality service. The Company
believes that these conditions will not affect the opportunities for either
Frontier Corporation or Rochester Telephone Corp.
(d) Holding Company Structure. The Company no longer directly owns any material
assets other than its interest in the capital stock of its subsidiaries. As
noted above, dividends from Rochester Telephone Corp. to Frontier Corporation
are subject to the financial covenants of the Open Market Plan.
(e) Potential Diversification Risk. The Company is now able to make acquisitions
and investments, enter into new lines of business and geographic areas, issue
equity securities and incur long-term indebtedness without PSC approval, subject
to certain exceptions. The Company may pursue opportunities with both greater
potential profits and greater business risk than it could pursue as a telephone
company subject to the authority of the PSC. There can be no assurance that any
expansion of the Company's business will be successful. However, it is the
current intention of the Company to engage only in telecommunications-related
businesses.
(f) Other Considerations. (i) Although the royalty order discussed below, under
Regulatory Matters, remains in litigation, the Open Market Plan Agreement
precludes the PSC from seeking royalties for the next seven years. After that,
subject to the outcome of the pending litigation, the PSC may be able to assert
its authority to do so. (ii) Because Rochester Telephone Corp. and Frontier
Communications of Rochester will, at least initially, be competing for the same
customers, there may be some duplication of sales and service expenses in the
consolidated company. Over time, this duplication is expected to reach minimal
levels.
INDUSTRY OUTLOOK AND STRATEGIES
As evidenced by the revolutionary change occurring in the Company's Rochester,
New York market, the Company believes competition will increasingly be
recognized and promoted in public policy, and that consumers will increasingly
have opportunities to make real choices for their telecommunications needs. We
believe that regulation has created artificial distinctions among local, long
distance, wireless and cable services, and that convergence among these industry
segments is unavoidable. We expect the overall marketplace to expand as
customers increasingly rely on communications products and services to improve
productivity and profitability in their businesses, as well as to add
convenience and time to their personal lives. Our objective is to serve our
customers as their single source for integrated telecommunications solutions.
Frontier Corporation's Vision is to become the premier company in the
telecommunications industry by providing products, services and applications
that delight our customers, by being a team of qualified employees committed and
accountable to this Vision, and by delivering exceptional returns to
shareowners. Our goal is to expand our role as a "value creator"--that is, to
enhance the benefits that all of our stakeholders obtain from their ongoing
relationships with us. We realize that changes in the industry are occurring
rapidly and
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28 Financial Review Frontier Corporation
<PAGE>
that this will continue for the foreseeable future. We believe that Frontier
Corporation's strong operating performance and our marketing and regulatory
initiatives have firmly positioned the Company as a leader in our industry.
One important challenge for the Company over the remainder of the decade is to
increase significantly the size of our business. We want to grow. Such growth
will give us the opportunity to provide more services to more customers, while
taking advantage of size and scale economies. In 1994, the Company served
customers in 32 states. In 1995, we expect to become a truly national company by
serving customers in virtually every state in the union. Since 1990, the
Company's revenue has grown on average by 13.2 percent per year. Frontier
Corporation will continue to focus on expanding its existing customer and
revenue base.
We are proactively seeking acquisition opportunities and strategic alliances
that can enhance our overall net-work and service offerings. Acquisitions are a
function of both price and opportunity. Frontier is interested in acquisition
opportunities that will significantly add to shareowner value. The areas that we
believe have the strongest growth potential are long distance and wireless
communications. We acknowledge the increasing importance of video technology and
video services in the marketplace and are evaluating opportunities to
participate more actively in the video arena in the future. We also maintain our
interest in additional local exchange properties, particularly where we believe
there are synergistic opportunities with our existing operations, or where the
opportunity exists to add new concentrations of customers who are candidates for
Frontier integrated services solutions. We have evaluated the potential benefits
of Personal Communication Services (PCS), a short-range wireless service similar
to cellular. We want to find value-conscious ways to use additional wireless
spectrum to serve customers. Our current focus is on growing the Company in the
continental U.S., but we are reviewing many international opportunities as well,
as we expect our long-term growth will move us beyond domestic boundaries.
Consistent with this growth strategy, the Company announced several
acquisitions during 1994. In October, we announced our intent to acquire
California-based WCT Communications, Inc., a long distance company which has
annualized revenues in excess of $100 million. And in November, the Company
announced an agreement to acquire American Sharecom, Inc., a long distance
company headquartered in Minneapolis, Minnesota with annual revenues totaling
approximately $125 million. The combination of WCT and American Sharecom with
Frontier Communications International will bring Frontier's annual long distance
revenues to over $550 million, establish our coast-to-coast network and make
Frontier the seventh largest long distance company in the country. In July, the
Company agreed to purchase the Minnesota Cellular Telephone Company, a non-
wireline cellular telephone service provider whose territory is located in an
area south of Minneapolis. All of these pending acquisitions are expected to be
completed in early 1995.
In June 1994, we finalized the formation of the Upstate Cellular Network
(UCN), a wireless joint venture with NYNEX Corporation that is managed by
Frontier. The formation of this joint venture allowed Frontier to significantly
expand its presence in the wireless sector. Through the Upstate Cellular Network
and our majority ownership interests in several Rural Service Areas (RSA) in
Alabama and New York, the Company now manages cellular properties which have a
total coverage that reaches 4.2 million people.
Our pending acquisitions will further accelerate the transformation of the
Company from one with a predominant base in local telephony to one that is more
heavily focused on the long distance segment and on achieving communication
services integration. In 1995, we expect that a significant majority of our
total revenues will come from sources that no longer fall under traditional rate
of return regulation.
_______________________________________________________________________________
RESULTS OF OPERATIONS
CONSOLIDATED
Consolidated revenues and sales were $985.5 million in 1994, a $79.0 million, or
8.7 percent, increase over 1993. This performance followed a 12.7 percent
increase in 1993 over 1992. The primary factor in these increases has been the
rapid growth in the Company's long distance business, which has been driven by
both increased market penetration and acquisitions. Consolidated costs and
expenses were $762.2 million, $711.5 million, and $628.9 million in 1994, 1993
and 1992, respectively, reflecting 7.1 percent and 13.1 percent increases in
1994 and 1993. The Company continued to focus its efforts on cost containment,
process redesign and operating synergies during 1994, as reflected in the
improvement in consolidated operating margins from 21.8 percent in 1992 to 21.9
percent in 1993 and to 22.7 percent in 1994, excluding the impact of a $3.3
million software write-off in 1993.
Several one-time events have occurred during the past three years that have
impacted the comparability of the Company's results from operations. These items
are summarized below.
1. ACQUISITIONS/DIVESTITURES
In July 1994, the Company and NYNEX Corporation combined certain cellular
interests and formed a 50/50 joint venture to operate a cellular network in
upstate New York. Financial results of the joint venture have been reported by
the Company on the equity method of accounting, reflecting Frontier's
proportionate share of the joint venture's earnings in the "Other income and
expense" section on the Consolidated Statement
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Financial Review Frontier Corporation 29
<PAGE>
Financial Review Frontier Corporation
of Income. Previously, the revenues and expenses of the Company's wireless
operations in New York had been consolidated. (See Note 3 to the Consolidated
Financial Statements.)
In May 1994, we sold our only telephone operating company in North Dakota,
Minot Telephone, for cash. Minot served approximately 27,000 access lines. The
transaction resulted in a pre-tax gain of $11.3 million.
In December 1993, the Company increased its cellular ownership from 50.6
percent to 69.6 percent in the South Alabama cellular partnership. This
transaction gave the Company the right to manage the two cellular properties,
Alabama RSA #4 and #6, which serve a territory with a population of
approximately 252,000. As a result of this increased ownership, we began
reporting the South Alabama cellular interests on a consolidated basis of
accounting in 1994, whereas previously this partnership had been accounted for
on the equity method.
In September 1993, Frontier Communications of the Mid Atlantic, Inc. (formerly
Mid Atlantic Telecom, Inc.) was acquired using 143,587 shares of treasury stock
(before the 1994 stock split). In June 1993, we acquired Budget Call Long
Distance, Inc. for $7.5 million in cash. Both transactions were accounted for as
purchase acquisitions.
Also in September 1993, the Company sold its interest in the S&A Telephone
Company in Kansas (approximately 800 access lines) and its related minority
cellular interest. In addition, the Company sold a substantial portion of its
investment in a Canadian long distance company in November 1993. These sales
resulted in pre-tax gains totaling $4.4 million.
In April 1993, we acquired a 70 percent ownership interest in the Utica-Rome
Cellular Partnership by issuing 702,737 shares of the Company's common stock
(before the 1994 stock split). We recorded this transaction using the purchase
method of accounting.
In August 1992, we acquired Frontier Communications of Georgia (formerly
Statesboro Telephone Company), a company with more than 15,000 access lines. A
total of 1.5 million shares of common stock were issued in the transaction
(before the 1994 stock split), which was accounted for as a pooling of
interests.
2. ACCOUNTING FOR POSTEMPLOYMENT BENEFITS
The Company changed its method of accounting for certain employee benefits in
1994. This change was necessitated by the Financial Accounting Standards Board,
the authoritative body for accounting rules. This new rule, referred to as
Financial Accounting Standards Board Statement No. 112 (FAS 112), "Employers'
Accounting for Postemployment Benefits," addresses the manner in which companies
must record expenses for postemployment benefits, including payments for
disability, pre-pension leave (salary continuation) and severance pay. FAS 112
requires that projected future costs of providing postemployment benefits be
recognized as an expense as employees render service rather than when the
benefits are paid. This accounting change is very similar to the change made in
1993 for postretirement benefits, which was addressed by FAS 106, "Employers'
Accounting for Postretirement Benefits Other than Pensions." Adoption of FAS 112
required the Company to calculate, and record in 1994, the cumulative effect of
the change in accounting methodology for all years prior to 1994. The cumulative
effect of the change in accounting methodology for FAS 112 amounted to an after-
tax charge of $7.2 million, net of taxes of $3.9 million. As required by the
pronouncement, the Company reported this one-time charge as a special line item
on the Consolidated Statement of Income in 1994. This accounting change does not
have a material impact on the Company's cash flows or its earnings from
continuing operations.
3. TAX RATE CHANGE
The 1993 income tax provision includes the retroactive impact of the federal
income tax rate increase from 34 percent to 35 percent. The overall impact of
the tax rate change was approximately $2 million and includes approximately
$400,000 attributable to years prior to 1993. (See Note 9 to the Consolidated
Financial Statements.)
4. SOFTWARE WRITE-OFF
In 1993, the Company recorded a $3.3 million pre-tax charge to write-off certain
deferred costs associated with a project to redesign customer account records,
order flow and customer billing systems. (See Note 5 to the Consolidated
Financial Statements.)
5. FIRST MORTGAGE BOND REFINANCING
In 1992, the Company recorded an extraordinary, after-tax charge of $1.1 million
relating to costs incurred for the early extinguishment of its Series H, 9 1/2%
first mortgage bonds. The bonds were retired using internally generated cash and
the private placement of $35 million of debt at a telephone subsidiary. (See
Note 5 to the Consolidated Financial Statements.)
________________________________________________________________________________
TELECOMMUNICATION SERVICES
The Telecommunication Services segment is comprised of the Company's long
distance business, wireless operations (where the Company has sufficient
ownership to report on a consolidated basis), and equipment sales. This segment
is the fastest growing part of the Company, as evidenced by its increasing
contribution to our overall financial results. In 1994, revenues from
Telecommunication Services comprised 38 percent of total revenue, up from 29
percent only two years ago. Similarly, operating income from this business
segment accounted for 18 percent of the Company's total, as compared with 13
percent in 1992.
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30 Financial Review Frontier Corporation
<PAGE>
Telecommunication Services revenues include long distance usage and fixed
monthly fee revenues, wireless access and usage charges, and sales of
telecommunication systems and services. Principal expenses associated with these
revenues consist of costs for leasing of transmission facilities and the payment
of local access charges for our long distance business, charges for
interconnection of cellular and paging operations with telephone companies,
costs of cellular telephones and paging units sold, cost of telecommunications
equipment sold, and labor.
Revenues and expenses derived from our majority-owned cellular operations are
reflected in the consolidated financial statements. Our minority interests,
including the 50/50 joint venture with NYNEX in upstate New York that was formed
in July 1994, are accounted for using the equity method. This method of
accounting results in the Company's proportionate share of earnings (losses)
being reflected in a single line item below operating income on the Company's
Consolidated Statement of Income, entitled "Equity earnings (loss) from
unconsolidated wireless interests." Prior to the formation of the wireless joint
venture with NYNEX in July 1994, the revenues and expenses of our wireless
operations in upstate New York had been consolidated. (See Note 3 to the
Consolidated Financial Statements for additional information concerning our
wireless operations.)
Telecommunication Services sales were $375.8 million in 1994, up $63.2
million, or 20.2 percent, over 1993. This compares to an increase of $75.8
million, or 32.0 percent, the previous year. This growth in both years was
driven by our long distance operation, Frontier Communications International,
(formerly RCI Long Distance). Revenues in our Network Systems and Services line
of business, which includes long distance, rose 24.2 percent in 1994 due to
sales of services to additional customers, greater usage, growth in consumer
services, price changes and an additional $17.5 million related to the impact
of the acquisitions of Budget Call Long Distance in July 1993 and Frontier
Communications of the Mid Atlantic, Inc. (formerly Mid Atlantic Telecom, Inc.)
in September 1993. Another factor for the growth in the long distance operation
is a $7.4 million increase at our Visions Long Distance subsidiary, which
resells services from Frontier Communications International to customers of a
number of our local telephone subsidiaries under the brand name used by the
local telephone company.
Revenues from our Wireless Communications line of business decreased $5.0
million, or 16.8 percent, in 1994 because of the change in the method of
accounting for the upstate New York cellular operation in July 1994. Through the
first six months of 1994, the period prior to the adoption of equity accounting
for the Upstate Cellular partnership, the Company's wireless revenues had
increased 68.5 percent to $20.9 million from $12.4 million in 1993. In 1993,
wireless revenues rose $8.5 million, or 40.1 percent, over 1992. Despite the
change in the manner of reporting wireless operations, we are very committed to
this business as indicated by the growth of our proportionate share of wireless
revenues for properties we manage, which rose 30.2 percent in 1994, reaching
$35.6 million. Although prices were relatively stable for cellular service in
1994, new customers generated a lower average volume of calls resulting in a 7.2
percent decrease in average revenue per customer. This is consistent with
industry trends. The 40.1 percent increase in Wireless Communications revenues
in 1993 over 1992 was a result of the combination of the acquisition of the
Utica-Rome partnership in April 1993 ($2.9 million), price increases and a
growing customer base.
Costs and expenses for Telecommunication Services in 1994 totaled $335.8
million, reflecting an increase of 19.1 percent over 1993. The increase for 1993
versus 1992 was 31.9 percent. The increases in both years are primarily due to
the increased volume of long distance traffic carried by the Company and the
associated costs to originate and terminate the traffic on local telephone
company facilities. As a percentage of sales, long distance costs of access
continue to decrease (from 58 percent in 1993 to 56 percent in 1994) as we
improve the efficiency of our network and as the charges from local telephone
companies and other access providers continue to decline. Incremental expenses
related to the acquisition of long distance companies that were completed during
1993 amounted to $12.5 million in 1993 and $17.5 million in 1994. Marketing and
selling expenses have also risen in line with sales, with increases of $6.8
million and $10.4 million in 1993 and 1994, respectively. The increase in 1994
expenses was partially offset by the change in the method of reporting cellular
results for the upstate New York joint venture.
Operating margins for Telecommunication Services improved to 10.6 percent in
1994, following a margin of 9.8 percent in both 1992 and 1993. The gain in 1994
results is driven by better long distance margins which rose to 10.4 percent in
1994. Wireless operating margins were adversely affected by the accounting
change for cellular properties in New York.
________________________________________________________________________________
TELEPHONE OPERATIONS
Telephone Operations produced the majority of the Company's overall revenues and
income in 1994. This segment, which is comprised of our local exchange telephone
companies, continues to be very important to the Company. In addition to
providing strong cash and overall financial returns, the local companies serve a
large customer base that represents service integration sales opportunities. For
several years the Company complemented the internal growth of telephone revenues
with acquisitions in order to diversify its regulatory risks and increase the
size of its customer base. The Company has further refined this strategy by
disposing of certain telephone operating subsidiaries that no longer fit the
Company's overall expansion plans. Both the sale of Minot Telephone in North
Dakota in May 1994 and the pending divestiture of Ontonagon
_________________________________________
Financial Review Frontier Corporation 31
<PAGE>
Telephone in Michigan are results of the limited opportunity to expand the
Company's presence in the respective geographic areas. The Company remains
committed to the local telephone business and will consider additional
acquisitions of local telephone properties if they are consistent with the
Company's overall growth strategy. In 1994, Telephone Operations generated 62
percent of total revenues and 82 percent of operating income for the total
company. Comparatively, in 1992, Telephone Operations generated 71 percent of
total revenues and 87 percent of operating income.
Revenues for this segment are derived from local telephone service and access
fees from long distance companies, directory advertising, billing services and
other services such as sales of telephone equipment and voice mail. As a result
of recent regulatory reforms, traditional rate of return regulation is no longer
applicable to much of our telephone revenues. Increasingly, a more flexible form
of regulation called price, or price cap, regulation is replacing rate of return
regulation, focusing on price levels as opposed to earnings levels. Telephone
Operations expenses are mainly related to the development and maintenance of the
local exchange networks. Additional expenses include the costs associated with
customer service and billing.
Telephone Operations revenues increased $15.8 million to $609.7 million in
1994, representing an increase of 2.7 percent over 1993. For 1993 versus 1992,
revenues increased 4.7 percent to $593.9 million. Revenue growth resulted from
increases in access lines, higher feature revenue, and rate increases at our
regional telephone companies (which generated additional revenues of $4 million
in 1994); offset partially by the sale of Minot Telephone in North Dakota which
was completed in May 1994 and had annual revenues in 1993 of $13.3 million.
Access line growth was 3.0 percent in 1994 and 2.3 percent in 1993, after
adjusting for acquisitions and divestitures. The average revenue per employee
for Telephone Operations in 1994 was $193,181, an increase of 12 percent over
the prior year. Growth in toll revenues, primarily in network access service
which represents fees charged to long distance companies for the use of our
network, also contributed to the segment's revenue increase. Minutes of use
related to long distance traffic increased 9.5 percent in 1994 and 7.7 percent
in 1993. In general, prices being charged to long distance companies for access
service usage have declined slightly over the past two years in order to address
the need of our local telephone operating companies to remain competitive in
their respective markets. We expect that this price decline will continue as
competition increases. Telephone Operations revenues were reduced by $8.2
million in 1994 when compared with 1993 as a result of the divestitures made
during the past two years.
During 1994 and 1993, we continued to gain increased market penetration of
enhanced services such as custom calling features and advanced number
identification products like Caller ID. Revenue growth was also positively
impacted in both years by rate increases at our regional telephone companies
(see Regulatory Proceedings caption). Regulatory revenue reductions at our
Rochester, New York operating company partially offset these increases.
Costs and expenses for Telephone Operations decreased .7 percent in 1994 and
increased 3.5 percent in 1993. The divestitures in 1993 and 1994 accounted for a
reduction in expenses of $5.9 million in 1994. After adjusting for the impacts
from divestitures and the $3.3 million software write-off in 1993, costs and
expenses were flat in 1994 after increasing 2.7 percent between 1993 and 1992.
In 1994, the Company continued to achieve benefits from redesigning work
processes and combining administrative operations throughout the Telephone
Operations segment. In addition, an early retirement program in March 1994 and
lower employee benefits costs helped to contain expenses. Aside from the one-
time software write-off, the primary reasons for expense increases in 1993 were
higher wages and benefits, increased severance and other expenses associated
with streamlining operations to arrive at a reduced cost structure, and an
increase in right-to-use fees associated with network software upgrades.
Operating margins for Telephone Operations were 30.1 percent in 1994, 28.2
percent in 1993 (after adjusting for the software write-off) and 26.8 percent in
1992. The composite depreciation rate for this segment was 6.4 percent in 1994,
compared with 6.2 percent in 1993 and 6.4 percent in 1992. Through its
interaction with regulatory authorities, the Company continues to pursue better
alignment of depreciation rates with the economic lives of depreciable property.
A common measure of the efficiency for telephone companies is the number of
employees per 10,000 access lines. We continue to make efficiency improvements
as evidenced by the decrease in this metric from 43 in 1992 and 38 in 1993, to
34 in 1994, near the best in our industry.
________________________________________________________________________________
OTHER INCOME STATEMENT ITEMS
INTEREST EXPENSE
Interest expense decreased 6.4 percent in 1994 and 7.0 percent in 1993 due to
lower levels of debt outstanding throughout the year. In February 1994, we
retired $9.4 million of debt at our regional telephone subsidiaries. In December
1994, as a part of our Open Market Plan implementation, we issued $120 million
of debt and repurchased $30 million of outstanding debentures. These December
transactions did not have a significant impact on 1994's interest expense.
During 1993, we recalled a total of $115.4 million of debt.
GAIN ON SALE OF ASSETS
The gain on sales of assets in 1994 amounted to $10.1 million, a $5.6 million
increase when compared to 1993. The 1994 amount resulted mainly from the sale
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32 Financial Review Frontier Corporation
<PAGE>
of our only telephone property in North Dakota in May 1994. In 1993, we
recognized gains on sales of our only telephone property in Kansas, S&A
Telephone Company, and a portion of our minority investment in a Canadian long
distance company.
EQUITY EARNINGS (lOSS) FROM UNCONSOLIDATED
WIRELESS INTERESTS
Equity earnings from the Company's interests in wireless partnerships in 1994
were $3.2 million, an increase of $1.9 million over 1993. This increase was the
result of the change in accounting related to the formation of our 50/50 joint
venture in July 1994 with NYNEX Corporation in order to operate a unified
cellular network in upstate New York. Financial results for the joint venture
have been reported on the equity method of accounting, reflecting our
proportionate share of the joint venture's earnings. Previously, the Company's
revenues and expenses associated with its Rochester and Utica-Rome cellular
partnerships in New York State had been fully consolidated.
OTHER INCOME (EXPENSE), NET
In 1994, other income (expense), on a net basis, improved $2.3 million, or 10.1
percent, over 1993. This improvement is primarily related to higher interest
income ($6.0 million) associated with increased cash balances, offset in part by
higher business development and strategic planning activities and costs, and
administrative expenses associated with the Company's restructuring.
In 1993, net other expenses were $22.5 million, an increase of $8.8 million
over 1992's net other expenses. This was due to administrative expenses
associated with the Company's reorganization petition with the New York State
Public Service Commission, debt refinancing expenses, and acquisition costs.
INCOME TAXES
The effective federal tax rate in 1994 was 34.4 percent, compared to 35.4
percent in 1993 and 34.2 percent in 1992. (See Note 9 to the Consolidated
Financial Statements.)
________________________________________________________________________________
FINANCIAL CONDITION
Management's overall objective is to maximize shareowner value. While increasing
net income is an important component of the process, management believes that
the primary source of value over the long term is cash generation over and above
investment requirements. Key management decisions are made based on the value
added to our shareowners' investment. Corporate performance, strategies, capital
projects and acquisitions are evaluated and measured using cash flow analysis
and investments are expected to provide a return that exceeds the risk-adjusted
cost of capital of the Company, or specific business unit, as appropriate.
There are a number of key financial metrics that can be used to monitor
management's performance. While several of these metrics provide information on
the Company's financial condition at a specific time, others, such as shareowner
return, are somewhat dependent on the overall financial markets and are often
more useful when viewed over an extended period of time.
<TABLE>
<CAPTION>
KEY FINANCIAL DATA
- ----------------------------------------------------------------------
($'s in millions, except per share data) 1994 1993 1992
- ----------------------------------------------------------------------
<S> <C> <C> <C>
Total debt $ 583 $ 497 $ 591
Total capital $1,406 $1,172 $1,213
Debt ratio 41.5% 42.4% 48.8%
Operating margin 22.7% 21.5% 21.8%
Pre-tax interest coverage 4.7x 3.9x 3.2x
Capital expenditures $ 89 $ 106 $ 124
Dividends declared per share $ .815 $ .795 $ .775
Dividends paid per share $ .810 $ .790 $ .770
Dividend yield 3.9% 3.6% 4.4%
Dividend payout ratio 57.9% 65.3% 75.1%
Total shareowner return (2.8%) 31.1% 15.7%
Year-end stock price $21.13 $22.57 $17.82
- ----------------------------------------------------------------------
</TABLE>
CASH FLOWS FROM OPERATING ACTIVITIES
Cash flows from operations amounted to $212.5 million in 1994, a decrease of
$16.2 million from 1993. In 1993, cash from operations was $228.6 million, an
increase of $12.4 million over 1992. In 1994, higher net income and depreciation
and amortization was offset in part by increased working capital requirements
for our rapidly growing businesses. Cash from operations was negatively impacted
by higher taxes of $4.2 million associated with the gain on the sale of the
Minot property in North Dakota in May 1994. The cash proceeds from this sale
appears in the "Cash Flows from Investing Activities" section of the
Consolidated Statement of Cash Flows. In 1993, the increase was the result of
increases in net income, depreciation and amortization coupled with a small
impact from an increase in accounts payable caused by the timing of purchases
associated with the Company's capital expenditures from 1992.
CASH FLOWS FROM INVESTING ACTIVITIES
Cash used for investing activities decreased $58.6 million in 1994, from $109.1
million to $50.5 million. In 1993, cash used for investing activities decreased
$12.4 million versus 1992. Capital expenditures continue to be the single-
largest recurring use of the Company's funds. In 1994, capital spending, net of
salvage, amounted to $87.0 million, a decrease of $15.1 million from 1993. An
$8.7 million increase in the Company's liquid investments that have maturities
of greater than three months but less than one year also resulted in a use of
funds in 1994. Offsetting these cash outflows in 1994 were the $55.7 million
proceeds from the sale of our telephone property in North Dakota. The decline in
1993's investing activities was caused by lower capital spending ($21.7 million)
offset in part by an increased usage of cash related to acquisitions ($11.3
million).
_________________________________________
Financial Review Frontier Corporation 33
<PAGE>
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows from financing activities amounted to an inflow of $123.9 million in
1994, compared with outflows of $157.6 million in 1993 and $70.0 million in
1992. The increase for 1994 resulted from $106 million in proceeds from the
Company's equity offering in February 1994 and the net increase of $90 million
of debt in December 1994 as a part of the Company's reorganization, offset in
part by the $59 million payment of dividends to shareowners and the retirement
of certain high cost debt earlier in the year. The decreases for 1993 and 1992
resulted from the retirement of long-term debt ($95 million, net of proceeds)
and the payment of dividends ($54 million).
LIQUIDITY AND CAPITAL RESOURCES
The Company must generate adequate amounts of cash to meet both short-term and
long-term needs. The Company's liquidity is a function of our capital spending
program, debt service requirements, internal generation of funds and access to
securities markets.
Management has emphasized the importance of cash throughout the organization
by providing training and establishing cash measures that are critical in the
determination of performance-based compensation. The Company closely monitors
the components of its working capital in order to maximize cash flows. However,
the timing of purchases for capital additions has a significant impact on the
balance of accounts payable until refinanced or liquidated using internally
generated funds.
During 1994, we entered the capital markets on several occasions to finance
the growth of our businesses (including acquisitions and new product
development), as well as to retire certain high cost debt. In February 1994, new
shares of common stock were issued that netted proceeds of $106 million. In
August 1994, $125 million in committed credit facilities were negotiated with
five commercial banks to provide the Company with sources of funds for the
backup of its short-term commercial paper program, as well as for general
corporate purposes. At year end, the Company had not borrowed against these
facilities. In December 1994, a $160 million revolving credit facility with
seven banks was established in order to provide debt for the Rochester, New York
operating company as required under the Open Market Plan Agreement with the New
York State Public Service Commission. At year end, $120 million was borrowed
under this facility. A portion of the proceeds were used to retire other more
costly long-term debt.
At a special shareowners' meeting in December 1994, shareowners approved an
increase in the number of authorized shares of common stock from 100 million
shares to 300 million shares. Additionally, shareowners gave their approval to
authorize 4 million shares of a new class of preferred stock which have been
designated as Class A Preferred Stock. The Company proposed these changes so as
to provide greater flexibility to raise capital and to structure acquisition
transactions.
At December 31, 1994, aggregate debt maturities amounted to $4.5 million for
1995, $4.7 million for 1996 and $4.5 million for 1997. During 1994 the Company
met individually with its debt rating agencies to review the Company's financial
performance. In May 1994, Duff and Phelps upgraded the Company's senior
unsecured bond rating from A-to A. In January 1995, Standard and Poor's upgraded
its rating on the Company's senior unsecured debt from A to A+, Moody's upgraded
from A3 to A2 and Fitch upgraded from A to A+.
The financing requirements associated with the Company's network modernization
programs have remained relatively stable. We have in place a switching network
that is essentially 100 percent digital, while a significant amount of fiber has
been installed throughout our telephone and long distance operating territories.
Total gross expenditures for property, plant and equipment in 1995 are
anticipated to be $125 million. The total capital program represents an increase
of $36 million over 1994. The increase is largely driven by capital requirements
associated with the growth of our long distance and wireless operations and the
integration of our pending long distance acquisitions.
As discussed previously, the Company had three acquisitions pending at the end
of 1994, each of which will play an important strategic role in the growth of
the Company. Approximately 9.6 million new shares of common stock will be used
for the acquisition of American Sharecom, Inc. (ASI) and the Minnesota Cellular
properties which are anticipated to close early in 1995. As a result of the
transaction with ASI, the two largest shareowners of ASI (Steven C. Simon,
president, and James J. Weinert, vice president) are projected to become the
largest individual shareowners of Frontier Corporation. Once the deal is
consummated, they will hold a combined 10.6 percent of the outstanding common
shares of the Company. For the pending acquisition of WCT Communications, Inc.
in California, we plan to expend approximately $79.8 million in cash. It is
expected that acquisitions will continue to be a significant factor in the
growth of the Company, as will building alliances through partnering or forming
joint ventures. Any investment opportunity will have the ultimate goal of
improving shareowner value.
In December 1994, the Board of Directors increased the quarterly dividend paid
on common stock to 20.75 cents per share, payable February 1, 1995, to
shareowners of record on January 13, 1995. This 2.5 percent increase raises the
annualized common stock dividend to $0.83 per share. This represents the 35th
consecutive annual increase in our dividend.
________________________________________________________________________________
REGULATORY MATTERS
OPEN MARKET PLAN
At its public meeting on October 13, 1994, the New York State Public Service
Commission (PSC) unanimously approved the Company's Open Market Plan and
Corporate Restructuring (Open Market Plan) and subsequently issued a written
Order in November 1994. As previously discussed in more detail in the
_________________________________________
34 Financial Review Frontier Corporation
<PAGE>
section entitled "Corporate Name Change and Restructuring," the Open Market Plan
was approved by shareowners in December 1994 and became effective on January 1,
1995.
During the seven year period of the Open Market Plan Agreement, rate
reductions of $21 million will be implemented for Rochester area consumers and
rates charged for basic residential and business telephone service may not be
increased. Although these rates have been designed to permit Rochester Telephone
Corp. to recover its costs and to earn a reasonable rate of return, there is no
assurance that this will actually happen. Also, under the Open Market Plan
Agreement, Rochester Telephone Corp. will no longer be subject to rate of return
regulation and thus the company is able to retain any expense savings or any
additional revenue from the sale of increased services or usage. In addition, a
total of $17 million will be credited to the depreciation reserve over the seven
year life of the plan.
Although Rochester Telephone Corp. is a wholly-owned subsidiary of Frontier
Corporation, Frontier's ability to control the management and operations of
Rochester Telephone Corp. are partially restricted by various provisions of the
Open Market Plan. The Plan contains certain financial covenants that are
intended to insure that Rochester Telephone Corp. will not lack the financial
strength to provide quality service, including covenants relating to dividends
that may be paid to the parent company and the level of debt that may be
maintained at the subsidiary company.
During its seven year duration, the Open Market Plan Agreement resolves
certain financial questions that are linked to the royalty proceeding, a
contested proceeding that has been in litigation for several years. In 1984, the
PSC initiated a proceeding to investigate whether or not the Company's
unregulated subsidiaries should pay a royalty to the Rochester, New York
operating company for alleged intangible benefits received from the use of the
Rochester Telephone name and reputation. The proceeding was reopened in 1990. In
July 1993, the PSC imposed a royalty in the amount of two percent of the total
capitalization of Frontier Corporation's unregulated operations. Based upon an
initial interpretation of the PSC's Order, the Company estimated that the effect
of the Order was in the range of $2 million per year. The Company vigorously
disagreed with the PSC's determination and is pursuing judicial review of the
PSC's Opinion and Order. The Appellate Division, on June 30, 1994, confirmed the
PSC's Order and the Company appealed to the New York State Court of Appeals. On
December 8, 1994, the Court of Appeals accepted the Company's appeal. The case
is now being briefed before the Court of Appeals.
The Open Market Plan temporarily resolves the royalty issue in that the PSC
has agreed that the royalty will not be imposed by the PSC against the Company
or Rochester Telephone during the seven year period of the Plan, subject to
limited exceptions. However, the PSC is not precluded from seeking any royalties
pursuant to the Royalty Order, on a prospective basis only, as it may be
modified as a result of judicial appeal, subsequent to the expiration of the
Open Market Plan. Under the Open Market Plan, the Company is permitted to
continue its litigation challenging the Royalty Order, and it intends to pursue
the case to conclusion.
INCENTIVE REGULATION
Prior to the Open Market Plan Agreement which became effective in January 1995,
an incentive regulation agreement had been in effect for the Rochester, New York
operating company. As part of that agreement, Rochester Telephone Corp. agreed
to share with ratepayers 50 percent of earnings above a threshold rate of
return. In addition, the company's revenue requirement was reduced by $5 million
in 1993 and $9.5 million in 1994. The 1993 sharing amount was refunded through
customer billing credits. The 1994 revenue requirement reduction, plus interest,
was credited to the company's depreciation reserve to alleviate a reserve
deficiency rather than refunding cash to ratepayers. There was no 1994 sharing
amount.
RATE AWARDS
In 1994, two of the Company's telephone subsidiaries completed rate increase
proceedings with state regulatory agencies that were initiated in 1993. In
February 1994, the Iowa State Utilities Board approved a $2.9 million annual
revenue increase for Frontier Communications of Iowa (formerly Vista Telephone
Company of Iowa), effective retroactively to November 1993. In April 1994,
Frontier Communications of Minnesota (formerly Vista Telephone Company of
Minnesota) was granted the authority by the Minnesota Public Service Commission
to increase annual revenues by $4.4 million. Frontier Communications of
Minnesota had previously increased rates temporarily in May 1993.
REGULATORY ACCOUNTING
As discussed in Note 1 of the Notes to the Consolidated Financial Statements,
the Company's regulated telephone operations comply with the provisions of
Financial Accounting Standards Board Statement No. 71 (FAS 71), "Accounting for
the Effects of Certain Types of Regulation." FAS 71 requires regulated entities
to apply special accounting treatment to certain revenues and expenses that are
recoverable through rates (prices) to be set by regulators in future periods.
The major components of regulatory assets and liabilities of the Company as of
December 31, 1994 are (in thousands of dollars):
<TABLE>
<S> <C>
Assets
- ------
Net deferred tax adjustments required to adopt FAS 109 $10,181
Deferred intercompany profits 1,464
Internally developed software costs 834
Liabilities
- -----------
Pension funding in excess of FAS 87 accruals $11,625
Interest on unfunded OPEB accruals 932
</TABLE>
The applicability of FAS 71 is appropriate only if the Company expects that
rates will be designed to recover costs from customers. The effect of FAS 71 on
the financial statements of the Company is to reflect assets used in regulated
telephone operations depreciated in accordance with the lives prescribed by the
regulators, rather than the generally shorter economic lives that would be used
by companies not applying FAS 71. Certain costs related to those operations (in
the Company's case, such as internally developed software costs) are
understated, as compared to how they would be reflected on the financial
statements of a company not applying FAS 71. In addition, certain liabilities
created by the regulators (such as deferred liabilities for pension
funding in excess of FAS 87 accruals and interest on unfunded OPEB accruals) are
reflected on the financial statements of the Company that would not be reflected
under GAAP for a company that does not apply FAS 71.
The Company continues to evaluate the applicability of FAS 71 given the growth
of competition in the marketplace and the changing nature of regulation.
However, at this time, the Company's financial statements reflect the effects of
FAS 71.
__________________________________________
Financial Review Frontier Corporations 35
<PAGE>
________________________________________________________________________________
OTHER ITEMS
The information presented in this Management's Discussion of Results of
Operations and Analysis of Financial Condition should be read in conjunction
with the Company's financial statements and accompanying Notes for the three
years ended December 31, 1994.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
Item 8 is hereby amended and restated in its entirety as follows:
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareowners of
Frontier Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, shareowners' equity and cash flows present
fairly, in all material respects, the financial position of Frontier Corporation
(formerly Rochester Telephone Corporation) and its subsidiaries at December 31,
1994, 1993 and 1992, and the results of their operations and their cash flows
for the years then ended in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 12 to the financial statements, during the first quarter
of 1994 the Company adopted the provisions of Statement of Financial Accounting
Standards No. 112, "Employers' Accounting for Postemployment Benefits."
As discussed in Note 11 to the financial statements, during the first quarter
of 1993 the Company adopted the provisions of Statement of Financial Accounting
Standards No. 106, "Employers' Accounting for Post-retirement Benefits Other
than Pensions."
/s/ Price Waterhouse LLP
January 16, 1995
1900 Chase Square
Rochester, NY 14604
________________________________________________________________________________
REPORT OF MANAGEMENT
The integrity and objectivity of the financial information presented in this
Annual Report is the responsibility of the management of Frontier Corporation.
The financial statements report on management's accountability for corporate
operations and assets. To this end management maintains a highly developed
system of internal controls and procedures designed to provide reasonable
assurance that the Company's assets are protected and that all transactions are
accounted for in conformity with generally accepted accounting principles. The
system includes documented policies and guidelines, augmented by a comprehensive
program of internal and independent audits conducted to monitor overall accuracy
of financial information and compliance with established procedures.
Price Waterhouse LLP, an independent accounting firm, provides an objective
assessment of the degree to which management meets its responsibility for
financial reporting. They regularly evaluate the system of internal accounting
controls and perform such tests and other procedures they consider necessary to
express an opinion that the financial statements present fairly the financial
position of the Company.
/s/Louis L. Massaro
Louis L. Massaro
Corporate Vice President--Finance
_______________________________________________________________________________
REPORT OF AUDIT COMMITTEE CHAIR
The Audit Committee of the Board of Directors is comprised of three independent
directors who are not officers or employees of the corporation. The committee
oversees the Company's financial reporting process on behalf of the Board of
Directors. The Audit Committee recommends to the Board of Directors the
independent accountants for election by the shareowners. The committee also
meets regularly with management and the independent accountants and internal
auditors to review accounting, auditing, internal accounting controls, pending
litigation and financial reporting matters.
As a matter of policy, the internal auditors and independent accountants have
unrestricted access to the Audit Committee.
/s/Douglas H. McCorkindale
Douglas H. McCorkindale
Chair, Audit Committee
_________________________________________
36 Financial Review Frontier Corporation
<PAGE>
BUSINESS SEGMENT INFORMATION
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
In thousands of dollars Years ended December 31, 1994 1993 1992
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
TELEPHONE OPERATIONS
REVENUES
Local service $ 240,687 $ 231,676 $ 214,181
Network access service 230,938 220,196 203,768
Long distance network service 25,619 26,978 29,210
Directory advertising, billing services, and other 118,221 120,459 123,112
Less: Uncollectibles 5,787 5,438 2,999
- -----------------------------------------------------------------------------------------------
TOTAL REVENUES $ 609,678 $ 593,871 $ 567,272
===============================================================================================
OPERATING INCOME $ 183,259 $ 164,271 $ 152,032
===============================================================================================
DEPRECIATION $ 101,897 $ 99,995 $ 100,692
===============================================================================================
CONSTRUCTION $ 60,711 $ 89,823 $ 114,930
===============================================================================================
IDENTIFIABLE ASSETS(1) $1,655,379 $1,398,019 $1,416,630
===============================================================================================
TELECOMMUNICATION SERVICES
SALES
Network Systems and Services:
Non-Affiliate $ 350,769 $ 282,747 $ 215,633
Affiliate 8,032 6,036 1,511
Wireless Communications 24,623 29,586 21,113
Eliminations (7,610) (5,790) (1,480)
- -----------------------------------------------------------------------------------------------
TOTAL SALES $ 375,814 $ 312,579 $ 236,777
===============================================================================================
OPERATING INCOME
Network Systems and Services $ 38,624 $ 27,344 $ 18,918
Wireless Communications 1,307 3,256 4,110
Eliminations 74 74 74
- -----------------------------------------------------------------------------------------------
TOTAL OPERATING INCOME $ 40,005 $ 30,674 $ 23,102
===============================================================================================
DEPRECIATION $ 15,427 $ 14,816 $ 13,335
===============================================================================================
CONSTRUCTION $ 27,904 $ 15,677 $ 8,941
===============================================================================================
IDENTIFIABLE ASSETS(1) $ 310,760 $ 281,701 $ 191,989
===============================================================================================
</TABLE>
(1) Includes intercompany accounts that are eliminated in consolidation of
$205,188, $169,519, and $94,722 in 1994, 1993 and 1992, respectively.
See accompanying Notes to Consolidated Financial Statements.
_________________________________________
Financial Review Frontier Corporation 37
<PAGE>
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
In thousands of dollars, except per share data Years ended December 31, 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES AND SALES
Telephone Operations $609,678 $593,871 $567,272
Telecommunication Services 375,814 312,579 236,777
- --------------------------------------------------------------------------------------------------------------------
Total Revenues and Sales 985,492 906,450 804,049
- --------------------------------------------------------------------------------------------------------------------
COSTS AND EXPENSES
Operating expenses 579,326 525,488 448,422
Cost of goods sold 18,850 20,819 21,634
Depreciation 117,324 114,811 114,027
Taxes other than income taxes 46,728 47,087 44,832
Software write-off -- 3,300 --
- --------------------------------------------------------------------------------------------------------------------
Total Costs and Expenses 762,228 711,505 628,915
- --------------------------------------------------------------------------------------------------------------------
OPERATING INCOME 223,264 194,945 175,134
Interest expense 43,594 46,550 50,066
Other income and expense:
Allowance for funds used during construction 1,096 1,330 1,309
Gain on sale of assets 10,063 4,449
Equity earnings (loss) from unconsolidated wireless interests 3,185 1,296 (661)
Other income (expense), net (20,237) (22,518) (13,686)
- --------------------------------------------------------------------------------------------------------------------
INCOME BEFORE TAXES, EXTRAORDINARY ITEM AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 173,777 132,952 112,030
Income taxes 63,843 50,232 41,527
- --------------------------------------------------------------------------------------------------------------------
INCOME BEFORE EXTRAORDINARY ITEM AND CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 109,934 82,720 70,503
Extraordinary item, net of income taxes -- -- (1,072)
Cumulative effect of change in accounting principle for
postemployment benefits (7,197) -- --
- --------------------------------------------------------------------------------------------------------------------
CONSOLIDATED NET INCOME 102,737 82,720 69,431
Dividends on preferred stock 1,186 1,187 1,188
- --------------------------------------------------------------------------------------------------------------------
INCOME APPLICABLE TO COMMON STOCK $101,551 $ 81,533 $ 68,243
====================================================================================+===============================
EARNINGS PER COMMON SHARE
Primary:
Income before extraordinary item and cumulative effect
of change in accounting principle $ 1.50 $ 1.21 $ 1.04
Extraordinary item -- -- (.02)
Cumulative effect of change in accounting principle (.10) -- --
- --------------------------------------------------------------------------------------------------------------------
Earnings Per Common Share--Primary $ 1.40 $ 1.21 $ 1.02
====================================================================================+===============================
Fully Diluted:
Income before extraordinary item and cumulative effect
of change in accounting principle $ 1.50 $ 1.20 $ 1.04
Extraordinary item -- -- (.02)
Cumulative effect of change in accounting principle (.10) -- --
- --------------------------------------------------------------------------------------------------------------------
Earnings Per Common Share--Fully Diluted $ 1.40 $ 1.20 $ 1.02
====================================================================================+===============================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
_________________________________________
38 Financial Review Frontier Corporation
<PAGE>
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
In thousands of dollars December 31, 1994 1993 1992
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 317,137 $ 31,284 $ 69,347
Short-term investments 9,047 349 634
Accounts receivable 168,542 157,320 133,973
Material and supplies 8,585 11,208 15,892
Prepayments and other 25,196 21,583 21,821
- --------------------------------------------------------------------------------------------
Total Current Assets 528,507 221,744 241,667
- --------------------------------------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT
Telephone plant in service 1,554,856 1,561,032 1,577,985
Telephone plant under construction 36,130 33,048 36,619
- --------------------------------------------------------------------------------------------
1,590,986 1,594,080 1,614,604
Less-Accumulated depreciation 713,869 652,578 657,682
- --------------------------------------------------------------------------------------------
Net Telephone Plant 877,117 941,502 956,922
- --------------------------------------------------------------------------------------------
Telecommunications property 168,691 153,954 140,476
Less-Accumulated depreciation 75,944 68,265 57,723
- --------------------------------------------------------------------------------------------
Net Telecommunications Property 92,747 85,689 82,753
- --------------------------------------------------------------------------------------------
GOODWILL 139,572 166,283 135,964
- --------------------------------------------------------------------------------------------
DEFERRED AND OTHER ASSETS 123,008 94,983 96,591
- --------------------------------------------------------------------------------------------
TOTAL ASSETS $1,760,951 $1,510,201 $1,513,897
============================================================================================
LIABILITIES AND SHAREOWNERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 142,968 $ 147,152 $ 125,518
Notes payable 106 303 6,194
Advance billings 12,719 12,572 12,546
Dividends payable 15,487 14,058 13,462
Long-term debt due within one year 4,525 3,962 59,495
Taxes accrued 13,495 14,729 11,480
Interest accrued 12,305 13,583 16,434
- --------------------------------------------------------------------------------------------
Total Current Liabilities 201,605 206,359 245,129
- --------------------------------------------------------------------------------------------
LONG-TERM DEBT 578,600 492,555 525,597
- --------------------------------------------------------------------------------------------
DEFERRED INCOME TAXES 111,369 116,967 118,876
- --------------------------------------------------------------------------------------------
DEFERRED EMPLOYEE BENEFITS OBLIGATION 46,001 16,121 --
- --------------------------------------------------------------------------------------------
MINORITY INTERESTS 252 3,100 2,701
- --------------------------------------------------------------------------------------------
SHAREOWNERS' EQUITY
Common stock 73,161 34,025 33,319
Capital in excess of par value 266,378 201,591 174,226
Retained earnings 460,808 418,889 391,256
- --------------------------------------------------------------------------------------------
800,347 654,505 598,801
Less-Treasury stock, at cost -- 2,191 --
- --------------------------------------------------------------------------------------------
Common Shareowners' Equity 800,347 652,314 598,801
Preferred stock 22,777 22,785 22,793
- --------------------------------------------------------------------------------------------
Total Shareowners' Equity 823,124 675,099 621,594
- --------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY $1,760,951 $1,510,201 $1,513,897
============================================================================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
_________________________________________
Financial Review Frontier Corporation 39
<PAGE>
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
In thousands of dollars Years ended December 31, 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $102,737 $ 82,720 $ 69,431
- ------------------------------------------------------------------------------------------------------------------------
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and amortization 136,460 132,723 121,554
Gain on sale of assets (10,063) (4,449) --
Equity (earnings) loss from unconsolidated wireless interests (3,185) (1,296) 661
Extraordinary item -- -- 1,564
Cumulative effect of change in accounting principle 11,072 -- --
Minority interests 511 399 183
Changes in operating assets and liabilities, exclusive
of impacts of purchase acquisitions:
(Increase) in accounts receivable (15,082) (12,644) (12,822)
Decrease in material and supplies 1,824 4,728 3,253
Decrease in prepayments and other current assets 343 229 786
(Increase) in deferred and other assets (14,967) (2,423) (360)
Increase in accounts payable 9,073 11,516 26,509
Increase in advance billings 188 26 72
Increase (decrease) in accrued interest and taxes (5,089) 1,498 (3,182)
Increase in deferred employee benefits obligation 6,958 14,302 --
Increase (decrease) in deferred income taxes (8,325) 1,308 8,545
- ------------------------------------------------------------------------------------------------------------------------
Total Adjustments 109,718 145,917 146,763
- ------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 212,455 228,637 216,194
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for property, plant and equipment (87,042) (102,156) (123,847)
(Increase) decrease in investment securities (11,386) 8,610 2,980
Investment in cellular (3,939) (4,342) (665)
Proceeds from asset sales 866 1,006 --
Investment in nonaffiliated entities (713) (1,161) --
Purchase of companies (4,355) (11,343) --
Proceeds from sale of company 55,689 -- --
Other investing activities 343 264 --
- --------------------------------------------------------------------------------------------------------------------------
Net Cash (Used in) Investing Activities (50,537) (109,122) (121,532)
- -------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in notes payable (197) (5,806) 184
Proceeds from long-term debt 120,485 35,500 980
Repayments of long-term debt (43,071) (130,063) (19,585)
Dividends paid (59,388) (54,492) (51,582)
(Purchase) issuance of treasury stock 2,302 (2,744) --
Issuance of common stock 103,812 35 --
Redemptions of preferred stock (8) (8) (10)
- -------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities 123,935 (157,578) (70,013)
- -------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 285,853 (38,063) 24,649
Cash and Cash Equivalents at Beginning of Year 31,284 69,347 44,698
- -------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $317,137 $ 31,284 $ 69,347
=========================================================================================================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
_________________________________________
40 Financial Review Frontier Corporation
<PAGE>
CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
In thousands of dollars, except share data 1994 1993 1992
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
COMMON STOCK
300,000,000 shares authorized, par value $1.00
Balance, January 1 (shares issued 1994--34,024,532;
1993--33,318,943; 1992--33,323,165) $ 34,025 $ 33,319 $ 33,323
Equity offering (1994--2,549,087) 2,549 -- --
Stock split (1994--36,573,619 shares) 36,574 -- --
Retirement of treasury stock (1992--63 shares) -- -- --
Other subsidiary acquisitions (1993--697,623 shares;
1992--4,850 shares) -- 698 (5)
Exercise of stock options (1994--13,595 shares;
1993--1,109 shares) 13 1 --
Conversion of:
4 3/4% Convertible debentures (1993--6,857 shares;
1992--691 shares) -- 7 1
- -----------------------------------------------------------------------------------------
Balance, December 31 (shares issued 1994--73,160,833;
1993--34,024,532; 1992--33,318,943) 73,161 34,025 33,319
- -----------------------------------------------------------------------------------------
CAPITAL IN EXCESS OF PAR VALUE
Balance, January 1 201,591 174,226 174,358
Equity offering 101,565 -- --
Stock split (36,574) -- --
Stock issuance expenses (545) -- --
Issuance/retirement of treasury stock 111 -- (2)
Other subsidiary acquisitions/divestitures -- 27,259 (137)
Exercise of stock options 230 34 --
Conversion of:
4 3/4% Convertible debentures -- 72 7
- -----------------------------------------------------------------------------------------
Balance, December 31 266,378 201,591 174,226
- -----------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance, January 1 418,889 391,256 373,949
Net income 102,737 82,720 69,431
Dividends declared in cash:
Preferred stock at required annual rates (1,186) (1,187) (1,188)
Common stock (59,632) (53,900) (50,936)
- -----------------------------------------------------------------------------------------
Balance, December 31 460,808 418,889 391,256
- -----------------------------------------------------------------------------------------
LESS-TREASURY STOCK, AT COST
Balance, January 1 (1994--56,413; 1992--63) 2,191 -- 2
Common shares repurchased for acquisitions
(1993--304,720) -- 12,572 --
Retirement of treasury stock (1992--63) -- -- (2)
Common shares reissued for acquisitions/equity offering
(1994--56,413; 1993--248,307) (2,191) (10,381) --
- -----------------------------------------------------------------------------------------
Balance, December 31 (1993--56,413 shares) -- 2,191 --
- -----------------------------------------------------------------------------------------
COMMON SHAREOWNERS' EQUITY 800,347 652,314 598,801
- -----------------------------------------------------------------------------------------
PREFERRED STOCK
Balance, January 1 (shares outstanding 1994--227,848;
1993--227,928; 1992--228,025) 22,785 22,793 22,803
Redemptions (8) (8) (10)
- -----------------------------------------------------------------------------------------
Balance, December 31 (shares outstanding 1994--227,768;
1993--227,848; 1992--227,928) 22,777 22,785 22,793
- -----------------------------------------------------------------------------------------
Total Shareowners' Equity $823,124 $675,099 $621,594
=========================================================================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
_________________________________________________
Financial Review Frontier Corporation 41
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of Frontier
Corporation, formerly Rochester Telephone Corporation, and its affiliates (the
Company). Intercompany transactions have been eliminated except for intercompany
profit on regulated Company purchases (affiliate sales) from Telecommunication
Services. In the opinion of management, prices charged by Telecommunication
Services are comparable to prices the regulated companies would be required to
pay other suppliers.
BASIS OF ACCOUNTING
The accounting policies of Frontier Corporation and its affiliates are in
conformity with generally accepted accounting principles. In accordance with the
provisions of Financial Accounting Standards Board Statement No. 71 (FAS 71),
"Accounting for the Effects of Certain Types of Regulation," the Company
conforms to the accounting principles as prescribed by federal and various state
regulatory bodies, where applicable. The provisions of FAS 71 require, among
other things, that regulated enterprises reflect rate actions of regulators in
their financial statements, when appropriate. These rate actions can provide
reasonable assurance of the existence of an asset, reduce or eliminate the value
of an asset, or impose a liability on a regulated enterprise.
MATERIAL AND SUPPLIES
Material and supplies are stated at the lower of cost or market, based on
weighted average unit cost. The caption "Cost of Goods Sold" relates to certain
sales of Telecommunication Services equipment which amounted to $28.0 million,
$29.5 million and $32.2 million in 1994, 1993, and 1992, respectively.
TELEPHONE PLANT
Additions to and replacements of telephone plant are capitalized at original
cost, including the costs for benefits and supervision applicable to
construction labor. The cost of depreciable property units retired, plus removal
costs, less salvage is charged to accumulated depreciation. Replacements,
renewals and betterments of units of property are capitalized. Replacement of
items not considered units of property and all repairs and maintenance are
charged to operating expense.
TELECOMMUNICATION PROPERTY
Property is recorded at cost. Improvements that significantly add to productive
capacity or extend useful life are capitalized, while maintenance and repairs
are expensed. Upon retirement or disposal of assets, the cost and related
accumulated depreciation are removed from the accounts and the gain or loss, if
any, is reflected in earnings for the period.
DEPRECIATION
Depreciation is computed on the straight-line method using estimated service
lives of the various classes of plant. The range of service lives for property,
plant and equipment is as follows:
<TABLE>
- ------------------------------------------------------
<S> <C>
Furniture and fixtures 12 to 20 years
Central office, switches and
network equipment 10 to 20 years
Local and toll service lines 27 to 35 years
Station equipment 10 to 21 years
Buildings and building improvements 5 to 35 years
- ------------------------------------------------------
</TABLE>
GOODWILL
The excess of the cost of companies purchased over the net assets acquired is
being amortized on a straight-line basis over 25 to 40 years. Accumulated
amortization is $20.1 million, $15.6 million and $10.4 million at the end of
1994, 1993, and 1992, respectively. Management continually reviews the
appropriateness of the carrying value of the excess acquisition cost of its
subsidiaries and the related amortization periods. This is accomplished
by determining whether the undiscounted future cash flows from operating
activities exceed the carrying value of goodwill as of the assessment date.
SERVICE PENSIONS AND BENEFITS
The Company has contributory and noncontributory plans providing for service
pensions and certain death benefits for substantially all employees. The plans
also provide disability pensions and sickness, accident and death benefits
(resulting from accidents occurring during employment) for all employees, which
are paid and charged to current operating expense. The Company's provisions for
service pensions and certain death benefits are remitted, at least annually, to
the trustees. In addition to providing pension benefits, the Company provides
health care, life insurance, and certain other retirement benefits for many of
its employees.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and cash equivalents are valued at their carrying amounts, which are
reasonable estimates of fair value. The fair value of long-term debt is
estimated using rates currently available to the Company for debt with similar
terms and maturities. The fair value of all other financial instruments
approximates cost as stated.
_________________________________________________
42 Financial Review Frontier Corporation
<PAGE>
FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return.
Tax deferrals resulting from the elimination of gross profit on intercompany
sales in the consolidated tax return are amortized to offset income taxes to be
paid over the cost recovery periods of telephone plant.
Deferred income taxes are provided by the unregulated operations on items
recognized for financial reporting purposes in different periods than are
recognized for income tax purposes. Deferred income taxes are recorded by
regulated operations in compliance with the normalization provisions of current
tax law and regulatory orders. The major temporary differences reflected in the
deferred tax liability are depreciation and investment tax credits. Excess
deferred taxes applicable to Telephone Operations are amortized in compliance
with the normalization provisions of current tax law and regulatory orders. This
amortization is normalized over the same time period as the related asset
generating the deferral.
Deferred income taxes have not been provided by Telephone Operations for the
flow-through of temporary differences where the regulatory agencies permit only
income taxes actually paid to be recognized. At December 31, 1994, the
cumulative balance of tax reductions not previously offset by provisions for
deferred federal income taxes amounted to $42 million. Similarly, the cumulative
balance of tax reductions not previously offset by provision for deferred state
income taxes amounted to $19 million at December 31, 1994. A deferred tax
liability and a long-term deferred asset have been recorded to reflect the
impact applicable to these cumulative reductions and the future revenue to be
recovered when these taxes become payable.
In January 1992, the Company elected early adoption of the Financial
Accounting Standards Board Statement No. 109 (FAS 109), "Accounting for
Income Taxes," which supersedes Financial Accounting Standards Board Statement
No. 96 (FAS 96) previously used to account for income taxes.
FAS 109 requires the asset and liability method of accounting for income
taxes and calls for the recognition of deferred tax assets and liabiities
for the expected future tax consequences of events that have been included
in the financial statements or tax returns. In prior years, the company
used the FAS 96 accounting method that gave little recognition to future
events other than the recovery of assets and settlements of liability at
their carrying amounts. Due to the implementation of FAS 109, $10.1 million
was reclassified from taxes accrued to deferred income taxes. This is the
only impact of implementation.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION
The Company includes in its telephone plant accounts an imputed cost of debt and
equity funds used for the construction of telephone plant and credits such
amounts to other income. The rates used in determining the allowance for funds
used during construction are based on the assumption that construction funds are
provided from sources of capital in the same proportion as each telephone
company's capital structure.
The rates used to calculate the allowance for funds used during construction
for companies in Telephone Operations during 1994 ranged from 6 percent to 10.68
percent.
EARNINGS PER SHARE
Primary earnings applicable to each share of common stock and common stock
equivalent are based on the weighted average number of shares outstanding during
each year. The average number of common shares outstanding for each period was:
72,575,206 in 1994, 67,453,438 in 1993 and 66,637,904 in 1992.
Computations of earnings per share on a fully diluted basis are determined by
increasing the average outstanding common shares for contingent issuances that
would reduce earnings per share. In computing the per share effect of the
assumed conversions, convertible debenture interest (net of income taxes) has
been added to income applicable to common stock. The number of common shares
used to compute earnings per share on a fully diluted basis for each period was:
72,821,707 in 1994, 67,972,016 in 1993 and 67,165,512 in 1992.
CASH FLOWS
For purposes of the Statement of Cash Flows, the Company considers all highly
liquid investments with a maturity of three months or less when purchased to be
cash equivalents.
Actual interest paid was $44.9 million in 1994, $49.4 million in 1993 and
$48.4 million in 1992. Actual income taxes paid were $76.0 million in 1994,
$46.6 million in 1993 and $37.2 million in 1992.
STOCK SPLIT
In November 1993, the Board of Directors approved a 2-for-1 split of the common
stock of the Company effected in the form of a 100 percent stock dividend with
no change in the $1.00 per share par value. The New York State Public Service
Commission (PSC) approved the stock split in March 1994 and distribution of
certificates began on April 29, 1994. Historical share and per share data have
been retroactively adjusted to reflect the split where appropriate.
________________________________________________________________________________
2. ACQUISITIONS
In April 1993, the Company acquired 70 percent ownership of the Utica-Rome
Cellular Partnership using 702,737 shares of original issue common stock (prior
to the April 1994 stock split). The transaction was accounted for as a purchase
acquisition. In addition, the Telecommunication Services group acquired Budget
Call Long Distance, Inc. in June 1993 for $7.5 million in cash and acquired
Frontier Communications of the Mid Atlantic, Inc. (formerly Mid Atlantic
Telecom, Inc.) in September 1993 using 143,587 shares of treasury stock (prior
to the April 1994 stock split). Both transactions were accounted for as purchase
acquisitions.
In 1992, the Company acquired Frontier Communications of Georgia (formerly
Statesboro Telephone Company) and accounted for the acquisition as a pooling of
interests. Revenues and net income for the period January 1, 1992 to the
acquisition date for Frontier Communications of Georgia were $6.1 million and
$1.2 million, respectively. A total of 1.5 million shares of common stock (prior
to the April 1994 stock split) were exchanged for all of the outstanding stock
of Frontier Communications of Georgia.
_________________________________________________
Financial Review Frontier Corporation 43
<PAGE>
_______________________________________________________________________________
3. UPSTATE CELLULAR NETWORK
In March 1993, the Company signed a definitive agreement with a subsidiary of
NYNEX Corporation to form a cellular supersystem joint venture in upstate and
western New York State to provide cellular telephone customers with expanded
geographic coverage. The supersystem includes the cellular markets in Buffalo,
Rochester, Syracuse, Utica-Rome and New York Rural Service Area #1, which
includes Jefferson, St. Lawrence, and Lewis counties. The structure of the
transaction is a 50/50 joint venture partnership, with Frontier as the managing
partner. The Upstate Cellular Network (UCN) joint venture began operating on
July 1, 1994.
In accordance with generally accepted accounting principles (GAAP), revenues,
expenses and operating income in the Consolidated Statement of Income and
Business Segment Information reflect results of wireless operations for only the
affiliates in which the Company has an ownership interest of greater than 50
percent. The formation of UCN in July 1994 caused the Company to adopt the
equity method of accounting for the financial results of the UCN cellular
interests, reflecting only its proportionate share of earnings in the other
income and expense section of the Consolidated Statement of Income.
Consequently, the Consolidated Statement of Income and Business Segment
Information, beginning with third quarter 1994 results, no longer reflect the
revenues, expenses and operating income of the Company's New York State wireless
properties.
In order to provide more complete information about the Company's involvement
in Wireless Communications, the following table sets forth unaudited, summarized
financial data for this business segment. This table reflects both a full 100
percent consolidation and a proportionate share consolidation of entities in
which the Company has a significant ownership interest or acts as managing
partner. The proportionate results presented reflect the Company's ownership
percentage of cellular interests consolidated for financial reporting purposes
and the Company's ownership percentage of its significant unconsolidated
cellular interests (which are accounted for on the equity method for financial
reporting purposes).
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Total Properties Managed Frontier
Assuming 100% Ownership Proportionate Share (a)
------------------------------------ -----------------------------------
Dollars in thousands (Unaudited) 1994 1993 1992 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Revenues--Wireless $67,125 $36,900 $25,943 $35,602 $27,352 $19,767
- -----------------------------------------------------------------------------------------------------------
Operating Expenses 38,203 21,361 14,903 20,074 15,319 10,826
Cost of Goods Sold 9,787 6,590 4,205 5,582 5,078 3,231
Depreciation 6,688 3,648 2,620 3,276 2,165 1,654
Taxes Other Than Income Taxes 2,580 1,409 1,079 1,303 1,086 847
- -----------------------------------------------------------------------------------------------------------
Total Costs and Expenses 57,258 33,008 22,807 30,235 23,648 16,558
- -----------------------------------------------------------------------------------------------------------
Operating Income--Wireless $ 9,867 $ 3,892 $ 3,136 $ 5,367 $ 3,704 $ 3,209
===========================================================================================================
Number of Customers 146,614 58,097 37,616 60,357 44,869 30,397
Total POPs 4,198,000 2,081,705 1,733,968 1,710,625 1,328,980 1,088,885
===========================================================================================================
</TABLE>
(a) At December 31, 1994, the Company's proportionate ownership interests in the
various partnerships it manages were: 50% of UCN (which includes 100% of
Buffalo, 100% of Utica-Rome, 85% of Rochester, 55% of Syracuse, 40% of NY RSA
#1, and 100% of PageCo), 70% of Alabama RSA #4 and #6, and 22.5% of NY RSA #3.
At December 31, 1993, the Company's proportionate ownership interests were 85%
of Rochester, 70% of Utica-Rome, 100% of PageCo, 70% of Alabama RSA #4 and #6,
and 22.5% of NY RSA #3. At December 31, 1992, the Company's proportionate
ownership interests were 85% of Rochester, 50% of Alabama RSA #4 and #6, 100% of
PageCo and 20% of NY RSA #3.
_________________________________________________
44 Financial Review Frontier Corporation
<PAGE>
_______________________________________________________________________________
4. OTHER INCOME (EXPENSE), NET
The major components included in this caption are as follows (amounts in
thousands):
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
Income (Expense)
1994 1993 1992
- -----------------------------------------------------------------
<S> <C> <C> <C>
Interest income $ 6,676 $ 1,659 $ 2,257
Joint venture income 749 727 1,682
Goodwill amortization (3,078) (3,928) (3,692)
Corporate expenses (20,066) (14,707) (10,267)
Miscellaneous income
(expense), net (4,518) (6,269) (3,666)
- -----------------------------------------------------------------
Total $(20,237) $(22,518) $(13,686)
=================================================================
</TABLE>
________________________________________________________________________________
5. EXTRAORDINARY AND UNUSUAL ITEMS
In May 1994, the Company completed the sale of Minot Telephone Company in Minot,
North Dakota to a subsidiary of the Souris River Telecommunications Cooperative.
Minot Telephone was the Company's only holding in North Dakota and the Company
had reassessed its prospects for expansion in North Dakota. The sale of Minot
Telephone Company resulted in a $7.1 million after-tax gain, or $.10 per share.
As part of the Rochester, New York operating company's Settlement Agreement
with the PSC finalized in the third quarter of 1993, the Company agreed to
write-off one-half of the costs ($3.3 million) previously deferred as part of a
project to redesign customer account records, order flow and customer billing
systems. The costs were incurred from January 1990 to December 1992 and the
project was abandoned after it was determined that the cost to complete it was
substantially greater than initially estimated. The remaining one-half of the
costs previously deferred are being amortized to expense and recovered in rates.
This charge is reflected on the Consolidated Statement of Income in the caption
"Software write-off."
In December 1992, the Executive Committee of the Board of Directors approved
the refinancing of the $40 million Series H, 9 1/2 percent first mortgage bonds.
The Company recorded a charge of $1.1 million (net of taxes of $.5 million) in
1992 relating to the write-off of the call premium, the remaining initial
discount and associated expenses of the transaction. The bonds were retired in
January 1993 using internally generated cash and the private placement of $35
million of debt at a telephone subsidiary.
________________________________________________________________________________
6. PROPERTY, PLANT AND EQUIPMENT
Major classes of property, plant, and equipment are summarized below:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
In thousands of dollars 1994 1993 1992
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Land and Buildings $103,235 $ 107,165 $ 105,928
Local and Toll Service Lines 752,366 743,028 718,866
Central Office Equipment 584,434 583,928 572,507
Station Equipment 33,926 34,740 96,549
Switching and Network Facilities 119,598 106,701 92,080
Furniture, Office, Equipment, Vehicles, Tools, etc. 129,988 139,424 132,531
Plant Under Construction 36,130 33,048 36,619
Less: Accumulated Depreciation 789,813 720,843 715,405
- ---------------------------------------------------------------------------------------
$969,864 $1,027,191 $1,039,675
=======================================================================================
</TABLE>
________________________________________________________________________________
7. NOTES PAYABLE AND LINES OF CREDIT
At December 31, the Company had outstanding notes payable as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------
In thousands of dollars Amount Interest Rate
- -------------------------------------------------
<S> <C> <C>
1992 $6,194 4.00%--9.00%
1993 $ 303 6.00%--9.00%
1994 $ 106 9.00%
- -------------------------------------------------
</TABLE>
Also at December 31, 1994, the Company had $165 million of unused bank lines
of credit, which were available for general corporate purposes. Of the $165
million, $125 million is available to provide support for commercial paper
borrowings. No compensating balances are required and the commitment fees are
.05 percent of the unused portion of the $125 million facility.
_________________________________________________
Financial Review Frontier Corporation 45
<PAGE>
________________________________________________________________________________
8. LONG-TERM DEBT
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
In thousands of dollars At December 31, 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
First Mortgage Bonds
Series E, 4 3/4%, due September 1, 1993 -- -- $ 12,000/(a)/
Series F, 4 1/2%, due May 1, 1994 -- -- 18,000/(a)/
Series G, 7 5/8%, due March 1, 2001 -- -- 30,000/(a)/
Series H, 9 1/2%, due March 1, 2005 -- -- 40,000/(b)/
Frontier Communications of Minnesota, Inc.(formerly Vista
Telephone Company of Minnesota) Senior Notes, 7.61%,
due February 1, 2003 $ 35,000 $ 35,000 --
Rural Electrification Administration debt, 2%--9% due 1993 to 2026 77,045 80,667 85,048
Other debt issued by affiliates, 7.5%--12 3/4% -- -- 15,840
- -----------------------------------------------------------------------------------------------------------------------
112,045/(c)/ 115,667 200,888
- -----------------------------------------------------------------------------------------------------------------------
DEBENTURES
4 3/4% Convertible, due March 1, 1994 -- -- 137/(d)/
10.46% Convertible, due October 27, 2008 5,300/(e)/ 5,300 5,300
9%, due January 1, 2020 69,785/(f)/ 100,000 100,000
9%, due August 15, 2021 100,000 100,000 100,000
- -----------------------------------------------------------------------------------------------------------------------
175,085 205,300 205,437
- -----------------------------------------------------------------------------------------------------------------------
Medium-Term Notes, 8.77%--9.30%,
due 2000 to 2004 179,000 179,000 179,000
Revolving Credit and Term Loan Agreements 120,000/(g)/ -- 3,200
- -----------------------------------------------------------------------------------------------------------------------
Sub-total 586,130/(h)/ 499,967 588,525
Less-Discount on long-term debt, net of premium 3,005 3,450 3,433
Current portion of long-term debt 4,525 3,962 59,495
- -----------------------------------------------------------------------------------------------------------------------
Total Long-Term Debt $578,600 $492,555 $525,597
=======================================================================================================================
</TABLE>
/(a)/ In July 1993, the Company redeemed all of its Series E, F and G First
Mortgage Bonds.
/(b)/ In December 1992, the Company entered into an agreement to repurchase its
Series H $40 million, 9 1/2%, First Mortgage Bonds on January 15, 1993. The
bonds were originally due March 1, 2005. As such, these bonds were
reclassified from long-term to short-term at December 31, 1992. (See Note 5.)
/(c)/ Certain assets of Telephone Operations are pledged as security for
Mortgage Bonds, Rural Electrification Administration debt and other debt.
/(d)/ In December 1992, the Company called its 4 3/4% convertible debentures. As
such, they were reclassified from long-term to short-term debt at December 31,
1992. The redemption of these debentures occurred in January 1993. Prior to
redemption, the debentures were convertible at any time into common stock at
$5.75 per share subject to certain adjustments. During 1993, $79,000 face value
of the debentures were converted into 13,714 shares of common stock and in 1992,
$8,000 face value of the debentures were converted into 1,382 shares.
/(e)/ The debenture is convertible into common stock at any time after October
26, 1998 for $10.5375 per share. A total of 502,966 shares of common stock are
reserved for such conversion.
/(f)/ In December 1994, the Company redeemed $30.2 million of its 9% debentures
due January 1, 2020. This redemption was consummated through an open market
purchase at a price of 99 percent of face value.
/(g)/ On December 19, 1994, the Company entered into a Revolving Credit
Agreement with seven commercial banks as part of its implementation of the Open
Market Plan Agreement. The agreement established a $160 million secured line of
credit until December 18, 1999. The debt is secured by the assets owned as of
January 1, 1995 by Rochester Telephone Corp. Commitment fees during the
revolving loan period are .08 percent per year on the outstanding commitment.
Interest on amounts drawn down are based on either the prime rate, the London
Interbank Offered Rate (LIBOR) plus .17 percent, or a competitive bid rate. On
December 29, 1994, the Company drew down $120 million under this facility at
LIBOR plus .17 percent, which resets monthly over the five year period of the
loan.
/(h)/ In accordance with Financial Accounting Standards Board Statement No. 107
(FAS 107), "Disclosures about Fair Value of Financial Instruments," the Company
estimates that the fair value of the debt, based on rates currently available to
the Company for debt with similar terms and remaining maturities, is $597.3
million.
At December 31, 1994, aggregate debt maturities were:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
In thousands of dollars 1995 1996 1997 1998 1999
- -------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$4,525 $4,663 $4,511 $4,408 $124,500
- -------------------------------------------------------------------------
</TABLE>
_________________________________________________
46 Financial Review Frontier Corporation
<PAGE>
________________________________________________________________________________
9. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
In thousands of dollars 1994 1993 1992
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal:
Current $65,978 $45,013 $28,394
Deferred (8,353) 391 8,253
- ----------------------------------------------------------------------------------
57,625 45,404 36,647
- ----------------------------------------------------------------------------------
State:
Current 6,190 3,911 4,663
Deferred 28 917 217
- ----------------------------------------------------------------------------------
6,218 4,828 4,880
- ----------------------------------------------------------------------------------
Total income taxes $63,843 $50,232 $41,527
==================================================================================
</TABLE>
The reconciliation of the federal statutory income tax rate with the effective
income tax rate reflected in the financial statements is as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
In thousands of dollars 1994 1993 1992
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Federal income tax expense at
statutory rate $58,645 35.0% $44,844 35.0% $36,431 34.0%
Accelerated depreciation 2,699 1.6 2,656 2.0 2,415 2.3
Investment tax credit (1,964) (1.2) (2,044) (1.6) (2,223) (2.1)
Miscellaneous (1,755) (1.0) (52) -- 24 --
- ----------------------------------------------------------------------------------
Total federal income tax $57,625 34.4% $45,404 35.4% $36,647 34.2%
==================================================================================
</TABLE>
As a result of the Revenue Reconciliation Act of 1993, the 1993 income tax
provision includes the impact of the federal tax rate increase from 34 percent
to 35 percent. The impact amounts to approximately $2 million, of which
approximately $400,000 is attributable to prior years.
Deferred tax liabilities (assets) are comprised of the following at December 31:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
In thousands of dollars 1994 1993 1992
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Accelerated depreciation $150,069 $153,910 $152,230
Investment tax credit 5,354 6,828 8,047
Miscellaneous 7,386 8,734 10,137
- ---------------------------------------------------------------------------------
Gross deferred tax liabilities 162,809 169,472 170,414
- ---------------------------------------------------------------------------------
Basis adjustment--purchased telephone companies (31,851) (42,741) (45,368)
Employee Benefits Obligation (12,955) (5,415) --
Deferred compensation (1,664) (1,648) (1,081)
Other (4,970) (2,701) (5,089)
- ---------------------------------------------------------------------------------
Gross deferred tax assets (51,440) (52,505) (51,538)
- ---------------------------------------------------------------------------------
Total Deferred Income Taxes $111,369 $116,967 $118,876
=================================================================================
</TABLE>
Gross profit on affiliate sales to telephone companies is deferred by
Telecommunication Services and is amortized to offset income taxes to be paid
over the cost recovery periods of the telephone plant. The amortization of gross
profit deferred in prior years exceeded current year deferrals by $332,000 in
1994, $558,000 in 1993 and $927,000 in 1992 resulting in deferred tax reversals
of $116,000, $195,000 and $315,000, respectively.
_________________________________________________
Financial Review Frontier Corporation 47
<PAGE>
________________________________________________________________________________
10. Service Pensions and Benefits
The Company provides retirement benefits for substantially all employees through
various contributory and non-contributory defined benefit pension plans.
Benefits, in general, are based on years-of-service and average salary.
The majority of the Company's pension plans have plan assets that exceed
accumulated benefit obligations. There are certain plans, however, with
accumulated benefit obligations which exceed plan assets. The following tables
summarize the funded status of the Company's pension plans and the related
amounts that are recognized in the Consolidated Balance Sheet.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Plans for Plans for
which assets which
exceed accumulated
December 31, 1994 accumulated benefits
In thousand of dollars benefits exceed assets Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $ 294,140 $ 15,494 $ 309,634
Accumulated benefit obligation $ 308,432 $ 17,223 $ 325,655
============================================================================================================
Plan assets at fair value,
primarily fixed income
securities and common stock $ 373,446 $ 6,641 $ 380,087
Projected benefit obligation (326,858) (20,774) (347,632)
- ------------------------------------------------------------------------------------------------------------
Funded status 46,588 (14,133) 32,455
Unrecognized net (gain)/loss (23,244) 2,980 (20,264)
Unrecognized net transition asset (3,935) 18 (3,917)
Unrecognized prior service cost 6,563 5,240 11,803
Adjustment required to recognize minimum liability -- (4,728) (4,728)
- ------------------------------------------------------------------------------------------------------------
Pension asset (liability) reflected in Consolidated Balance Sheet $ 25,972 $(10,623) $ 15,349
============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
Plans for Plans for
which assets which
exceed accumulated
December 31, 1993 accumulated benefits
In thousand of dollars benefits exceed assets Total
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $ 280,941 $ 2,626 $ 283,567
Accumulated benefit obligation $ 304,359 $ 2,657 $ 307,016
============================================================================================================
Plan assets at fair value,
primarily fixed income
securities and common stock $ 395,698 $ 2,143 $ 397,841
Projected benefit obligation (350,946) (3,119) (354,065)
- ------------------------------------------------------------------------------------------------------------
Funded status 44,752 (976) 43,776
Unrecognized net (gain)/loss (29,311) 582 (28,729)
Unrecognized net transition asset (5,291) (151) (5,442)
Unrecognized prior service cost 9,018 209 9,227
- ------------------------------------------------------------------------------------------------------------
Pension asset (liability) reflected in Consolidated Balance Sheet $ 19,168 $ (336) $ 18,832
============================================================================================================
</TABLE>
_________________________________________________
48 Financial Review Frontier Corporation
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Plans for Plans for
which assets which
exceed accumulated
December 31, 1992 accumulated benefits
In thousand of dollars benefits exceed assets Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $ 240,147 $ 3,160 $ 243,307
Accumulated benefit obligation $ 254,592 $ 3,301 $ 257,893
===================================================================================================================
Plan assets at fair value,
primarily fixed income
securities and common stock $ 367,841 $ 2,870 $ 370,711
Projected benefit obligation (312,169) (4,166) (316,335)
- -------------------------------------------------------------------------------------------------------------------
Funded status 55,672 (1,296) 54,376
Unrecognized net (gain)/loss (42,977) 405 (42,572)
Unrecognized net transition asset (4,732) (209) (4,941)
Unrecognized prior service cost 6,058 1,013 7,071
- -------------------------------------------------------------------------------------------------------------------
Pension asset (liability) reflected in Consolidated Balance Sheet $ 14,021 $ (87) $ 13,934
===================================================================================================================
</TABLE>
The net periodic pension cost consists of the following:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
In thousands of dollars Years Ended December 31, 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost--benefits earned during the period $ 7,934 $ 7,758 $ 7,033
Interest cost on projected benefit obligation 25,565 23,932 23,123
Actual return on plan assets 2,229 (40,484) (24,860)
Net amortization and deferral (37,863) 7,623 (9,033)
- -------------------------------------------------------------------------------------------------------------------
Net periodic pension cost determined under FAS 87 (2,135) (1,171) (3,737)
Amount expensed due to regulatory agency actions (1,743) (1,537) 6,787
- -------------------------------------------------------------------------------------------------------------------
Net periodic pension cost (benefit) recognized $ (3,878) $ (2,708) $ 3,050
===================================================================================================================
</TABLE>
The projected benefit obligation at December 31, 1994, 1993 and 1992 was
determined using an assumed weighted average discount rate of 8.5 percent, 7.25
percent and 7.7 percent, respectively, and an assumed weighted average rate of
increase in future compensation levels of 5.5 percent, 5.0 percent and 5.2
percent, respectively. The weighted average expected long-term rate of return on
plan assets was assumed to be 9.0 percent in 1994, 8.75 percent in 1993 and 9.4
percent in 1992. The unrecognized net transition asset as of January 1, 1987 is
being amortized over the estimated remaining service lives of employees, ranging
from 12 to 26 years.
The Company's funding policy is to make contributions for pension benefits
based on actuarial computations which reflect the long-term nature of the
pension plan. However, under Financial Accounting Standards Board Statement No.
87 (FAS 87), "Employers' Accounting for Pensions," the development of the
projected benefit obligation essentially is computed for financial reporting
purposes and may differ from the actuarial determination for funding due to
varying assumptions and methods of computation.
During 1994, 1993 and 1992, the Company funded $ 1.0 million, $.2 million and
$4.8 million, respectively, for employees' service pensions and certain death
benefits.
On November 30, 1992, a voluntary pension incentive plan was offered to the
Rochester, New York operating company's employees who were pension-eligible and
retired on or before December 31, 1992. A 7.5 percent additional pension benefit
will supplement the normal pension benefit for up to five years or until age 65,
whichever is earlier. Accordingly, pension costs for the fourth quarter of 1992
included a one-time charge of $.8 million. Payments will be made from pension
plan assets.
The Company has established a rabbi trust separate from the pension plan
assets to provide funding for the benefits payable under its Supplemental
Management Pension Plan ("SMPP"). The SMPP is a defined benefit plan under which
the Company will pay supplemental pension benefits to key executives in addition
to amounts received under the Company's retirement plan. The trust is
irrevocable and assets contributed to the trust can only be used to pay such
benefits with certain exceptions. The assets held in trust at December 31, 1994
amounted to $7.1 million consisting of primarily fixed income securities and
common stock.
The Company also sponsors a number of defined contribution plans. The most
significant plan covers substantially all non-union employees, who make contri-
butions through payroll deduction. The Company matches up to 75 percent of that
contribution up to 6 percent of gross compensation. The total cost recognized
for all defined contribution plans was $4.8 million for 1994 and $4.1 million
for 1993.
_________________________________________
Financial Review Frontier Corporation 49
<PAGE>
- --------------------------------------------------------------------------------
11. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company provides health care, life insurance, and certain other retirement
benefits for substantially all employees. Effective January 1, 1993, the Company
adopted Financial Accounting Standards Board Statement No. 106 (FAS 106),
"Employers' Accounting for Postretirement Benefits Other Than Pensions." FAS 106
requires that employers reflect in current expenses an accrual for the cost of
providing postretirement benefits to current and future retirees. Prior to 1993,
the Company recognized these costs as they were paid. Total postretirement
benefit cost recognized during 1992 was approximately $2.5 million. Plan assets
consist principally of life insurance policies and money market instruments.
In adopting FAS 106, the Company elected to defer the recognition of the
accrued obligation of $125 million over a period of twenty years. For 1993, the
adoption of this standard resulted in additional operating expenses in the
amount of $7.8 million, net of a deferred income tax benefit of $4.1 million.
However, a substantial portion of this increase was offset by a change in
accounting for pensions for rate making purposes at the Rochester, New York
operating company. The change requires that the company amortize, over a ten
year period, the cumulative amount of pension funding from January 1, 1987 over
the amount of pension expense which would have been recognized through December
31, 1992 under FAS 87, reducing pension expense throughout the amortization
period. The net impact of adopting FAS 106 and recording the accounting change
for FAS 87 actually resulted in $3.8 million of additional operating expenses,
net of the income tax benefit, in 1993.
The funded status of the plans is as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
In thousands of dollars December 31, 1994 1993
- -------------------------------------------------------------------------
<S> <C> <C>
Accumulated postretirement benefit
obligation (APBO) attributable to:
Retirees $ 79,935 $ 63,749
Fully eligible plan participants 22,812 44,399
Other active plan participants 28,877 34,892
- -------------------------------------------------------------------------
Total APBO 131,624 143,040
Plan assets at fair value 5,545 3,944
- -------------------------------------------------------------------------
APBO in excess of plan assets 126,079 139,096
Unrecognized transition obligation (109,730) (117,706)
Unrecognized net prior service cost (6,003) (1,458)
Unrecognized net gain (loss) 15,502 (3,811)
- -------------------------------------------------------------------------
Accrued postretirement
benefit obligation $ 25,848 $ 16,121
=========================================================================
</TABLE>
The components of the estimated postretirement benefit cost are as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
In thousands of dollars December 31, 1994 1993
- -------------------------------------------------------------------------
<S> <C> <C>
Service cost $ 1,323 $ 2,746
Interest on accumulated post-
retirement benefit obligation 9,666 10,046
Amortization of transition
obligation 6,094 6,241
Return on plan assets (385) (290)
Amortization of prior service cost 383 --
Amortization of gains and losses (704) --
- -------------------------------------------------------------------------
Net postretirement benefit cost $16,377 $18,743
=========================================================================
</TABLE>
To estimate these costs, health care costs were assumed to increase 11.2
percent in 1995 with the rate of increase declining consistently to 5.75 percent
by 2006 and thereafter. The weighted discount rate and salary increase rate were
assumed to be 8.5 percent and 5.5 percent, respectively. The expected long-term
rate of return on plan assets was 9.0 percent. If the health care cost trend
rates were increased by one percentage point, the accumulated postretirement
benefit health care obligation as of December 31, 1994 would increase by $14.7
million while the sum of the service and interest cost components of the net
postretirement benefit health care cost for 1994 would increase by $1.3 million.
- --------------------------------------------------------------------------------
12. POSTEMPLOYMENT BENEFITS
In 1992 the Financial Accounting Standards Board released Statement No. 112 (FAS
112), "Employers' Accounting for Postemployment Benefits" which was required to
be implemented by January 1, 1994. FAS 112 requires that the projected future
costs of providing postemployment, but pre-retirement, benefits, such as
disability, pre-pension leave (salary continuation) and severance pay, be
recognized as an expense as employees render service rather than when the
benefits are paid.
The Company adopted the provisions of FAS 112 effective January 1, 1994. The
Company recognized the obligation for postemployment benefits through a
cumulative effect charge to net income of $7.2 million, net of taxes of $3.9
million. The adoption of FAS 112 is not expected to significantly impact future
operating expense or the Company's cash flow.
- --------------------------------------------------------------------------------
13. STOCK OFFERING
In February 1994, the Company sold 5.4 million shares of its common stock at $42
per share in a public offering. As part of the offering, 2.5 million new primary
shares were issued and sold directly by the Company and 2.9 million shares were
sold by C FON Corporation, a subsidiary of Sprint Corporation. All share and per
share data is prior to the 2-for-1 stock split in April 1994.
_________________________________________
50 Financial Review Frontier Corporation
<PAGE>
- --------------------------------------------------------------------------------
14. STOCK OPTION PLANS
In 1992, the Company implemented a Directors Stock Option Plan and an Executive
Stock Option Plan ("Plans"). Under the original Plans, which were approved by
shareowners in 1990, the Company was authorized to issue a maximum of 400,000
shares of common stock over a ten-year period.
At the April 1994 Annual Meeting, shareowners approved amendments to both
Plans which increased the total number of option shares to 1.5 million. The
amendments also provided for automatic increases in the number of shares that
may be issued as a result of a stock split. Consequently, since the stock was
split subsequent to the 1994 Annual Meeting, there is currently a maximum of 3
million option shares available for issuance.
Under both plans, the exercise price is the fair market value of the stock on
the date of the grant of the stock option. One third of the options become
exercisable on the first year anniversary of the grant date. Another third
become exercisable on the second year anniversary and the final third become
exercisable on the third year anniversary of the grant date. The options expire
ten years after the date of grant.
Information with respect to options under the above plans follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
Option Price
Shares Per Share Aggregate
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding at August 1, 1992 -- --
Granted in 1992 96,400 $15.75--$15.69 $ 1,515,925
- ---------------------------------------------------------------------------
Outstanding at December 31, 1992 96,400 1,515,925
Granted in 1993 258,038 $19.75--$18.44 4,935,175
Cancelled in 1993 (9,500) $19.06--$15.75 (176,125)
Exercised in 1993 (2,218) $15.75--$15.69 (34,892)
- ---------------------------------------------------------------------------
Outstanding at December 31, 1993 342,720 6,240,083
Granted in 1994 408,400 $22.69--$21.19 8,826,975
Cancelled in 1994 (36,820) $22.69--$15.75 (737,529)
Exercised in 1994 (13,595) $19.75--$15.69 (243,385)
- ---------------------------------------------------------------------------
Outstanding at December 31, 1994 700,705 $14,086,144
===========================================================================
</TABLE>
At December 31, 1994, 129,069 shares were exercisable and 2,283,482 shares
were available for future grant.
____________________________________________________
Financial Review Frontier Corporation 51
<PAGE>
________________________________________________________________________________
15. PREFERRED STOCK (CUMULATIVE)-PAR VALUE $100
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
In thousands of dollars, except share data 1994 1993 1992
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Frontier Corporation--850,000 shares authorized
5.00% Series-redeemable at $101 per share
Shares Outstanding 100,000 100,000 100,000
Amount Outstanding $ 10,000 $ 10,000 $ 10,000
5.65% Series-redeemable at $101 per share
Shares Outstanding 50,000 50,000 50,000
Amount Outstanding $ 5,000 $ 5,000 $ 5,000
4.60% Series-redeemable at $101 per share
Shares Outstanding 50,000 50,000 50,000
Amount Outstanding $ 5,000 $ 5,000 $ 5,000
Frontier Communications of New York, Inc.
(formerly Highland Telephone Company)
--40,000 shares authorized
5.875% Series A-redeemable at par
Shares Outstanding 18,694 18,694 18,694
Amount Outstanding $ 1,869 $ 1,869 $ 1,869
7.80% Series B-redeemable at $100.80--$105.00 per share
Shares Outstanding 6,320 6,400 6,480
Amount Outstanding $ 632 $ 640 $ 648
Frontier Communications of AuSable Valley, Inc.
(formerly AuSable Valley Telephone Company, Inc.)
--4,000 shares authorized
5.50% Series-redeemable at par
Shares Outstanding 2,754 2,754 2,754
Amount Outstanding $ 276 $ 276 $ 276
- ----------------------------------------------------------------------------------------
Total Shares Outstanding 227,768 227,848 227,928
========================================================================================
Total Amount Outstanding $ 22,777 $ 22,785 $ 22,793
========================================================================================
</TABLE>
At the special meeting in December 1994, Frontier Corporation shareowners
authorized 4 million shares of a new class of preferred stock, having a value of
$100.00 per share and designated as Class A Preferred Stock. This class of stock
will rank junior to the cumulative preferred stock as to dividends and
distributions, and upon the liquidation, dissolution or winding up of the
Company.
________________________________________________________________________________
16. LEASES AND LICENSE AGREEMENTS
The Company leases buildings, land, office space, fiber optic network, computer
hardware and other equipment, and has license agreements for rights-of-way for
the construction and operation of a fiber optic communications system. Total
rental expense amounted to $17.8 million in 1994, $15.5 million in 1993 and
$16.4 million in 1992.
Minimum annual rental commitments under non-cancellable operating leases and
license agreements in effect on December 31, 1994 were as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------
In thousands of dollars Non-Cancellable Leases License
----------------------
Years Buildings Equipment Agreements
<S> <C> <C> <C>
1995 $ 6,189 $ 5,080 $ 8,625
1996 5,869 4,544 8,853
1997 5,901 1,786 9,097
1998 5,578 333 9,326
1999 5,248 1 9,557
2000 and thereafter 20,128 0 21,128
- -------------------------------------------------------------
Total $48,913 $11,744 $66,586
=============================================================
</TABLE>
________________________________________________________________________________
17. OPEN MARKET PLAN AND CORPORATE RESTRUCTURING
Effective December 19, 1994, upon receiving shareowner approval, the Company
changed its name from Rochester Telephone Corporation to Frontier Corporation.
The new name reflects not only the pioneering heritage of our past but our
willingness to embrace the challenges of the future. The name also symbolizes
the change from a company focused in Rochester, New York to a company that is
expanding geographically and currently has customers in 32 states.
At its public meeting in October 1994, the New York State Public Service
Commission (PSC) unanimously approved the Company's Open Market Plan and
Corporate Restructuring (Open Market Plan) and subsequently issued a written
order in November 1994. This landmark decision resulted in opening up the
Rochester, New York local exchange market to competition and simultaneously
allowed the Company to form a holding Company. The Open Market Plan was approved
by shareowners in December 1994 and became operational on January 1, 1995.
________________________________________________
52 Financial Review Frontier Corporation
<PAGE>
As a result of the Open Market Plan, two new companies have been formed from
the operating assets of the former Rochester operating telephone company. One
company (Frontier Communications of Rochester, Inc.) is a competitive
telecommunications company which will provide an array of services on a retail
basis in the Rochester marketplace. This company has the flexibility to price
and introduce services as necessary to compete. The second company (Rochester
Telephone Corp.) is a network company which is regulated and will provide
services to the new competitive subsidiary company and all other
telecommunications providers on an equal basis. The network company also will
continue to provide services to individual retail customers. This configuration
has been established to better meet the current and emerging competition in the
marketplace.
For the seven-year period of the Open Market Plan, Rochester Telephone Corp.
will no longer be subject to rate of return regulation. In its place, the
company will be subject to price regulation. The local market for telephone
service in Rochester will be opened to full competition. Over the course of the
next seven years, rate reductions of $21 million will be implemented for
Rochester area consumers. In addition, a total of $17 million will be credited
to the depreciation reserve.
The Open Market Plan temporarily resolves certain financial questions that are
linked to the royalty proceeding, a contested proceeding that has been in
litigation since 1984. In particular, the PSC has agreed that a royalty will not
be imposed by the PSC against the Company or Rochester Telephone Corp. during
the seven year period of the Plan, subject to limited exceptions. However, the
PSC is not precluded from seeking any royalties pursuant to the Royalty Order,
on a prospective basis only, as it may be modified as a result of judicial
appeal, subsequent to the expiration of the Open Market Plan. Under the Open
Market Plan, the Company is permitted to continue its litigation challenging the
Royalty Order, and the Company intends to pursue it to conclusion.
The Company has also reorganized into a holding company structure as allowed
under the Open Market Plan Agreement. This structure provides additional
financing flexibility to continue the acquisition and diversification efforts
necessary for the long-term growth of the business. (See "Management's
Discussion and Analysis of Results of Operations and Financial Condition" for
additional information regarding the Open Market Plan.)
________________________________________________________________________________
18. COMMITMENTS AND CONTINGENCIES
It is anticipated that the Company will expend $125.0 million for additions to
property, plant, and equipment during 1995. In connection with this construction
program, the Company has made certain commitments for the purchase of material
and equipment.
In July 1994, the Company signed a definitive agreement to purchase the
Minnesota Cellular Telephone Company (MSCTC) in a tax-deferred stock-for-stock
transaction. MSCTC is the non-wireline cellular provider of service in Minnesota
Rural Service Area #10. The transaction is expected to close in the first
quarter of 1995, subject to regulatory approvals, and will be accounted for as a
pooling of interests.
In September 1994, the Company announced its intent to sell Ontonagon County
Telephone Company and its subsidiary, Midway Telephone, to Mid-South
Telecommunications. The pending sale is the result of the Company's plans to
expand in areas other than Michigan's Upper Peninsula. The sale is expected to
be completed in the first half of 1995, pending regulatory approvals.
On November 8, 1994, the Company signed a definitive agreement to acquire WCT
Communications, Inc., an interexchange carrier based in Santa Barbara,
California that operates long distance and telemanagement businesses in
California and other western states. Under the definitive agreement, as amended,
each public WCT shareowner will receive $5.875 per share pursuant to a cash
merger, with the exception of Richard Frockt, WCT's chairman and 24 percent
shareholder, who will receive $3.75 per share. Mr. Frockt and Christopher
Edgecomb, WCT's Executive Vice President and 7 percent shareholder, have agreed
to vote their shares in favor of the merger. The total cash consideration to be
paid by Frontier Corporation for all the outstanding shares of WCT will be
approximately $79.8 million. When the transaction is consummated, WCT's
interexchange operations, which generated $102 million of revenues in its fiscal
year ended June 30, 1994, will be merged into Frontier Corporation's long
distance operation, Frontier Communications International. The transaction will
be accounted for as a purchase acquisition and is subject to necessary
regulatory approvals. The expected closing date for the acquisition is in 1995.
In November 1994, the Company announced an agreement to acquire all of the
outstanding shares of American Sharecom, Inc. (ASI), a long distance company
headquartered in Minneapolis, Minnesota. ASI is one of the largest privately
owned long distance companies in the country with annual revenues of
approximately $125 million. ASI's sales operations are concentrated in the
Midwest, Northwest and California. Under the agreement, the Company will acquire
all of the outstanding shares of ASI in exchange for 8.7 million shares (valued
at $184 million at December 31, 1994) of Frontier common stock. The transaction
will be accounted for as a pooling of interests, subject to regulatory approval
and the completion of appropriate due diligence. The transaction is expected to
close in the first quarter of 1995.
The following pro forma summary reflects the results of operations of the
Company for its pending acquisitions of WCT and ASI. The pro forma results of
_________________________________________________
Financial Review Frontier Corporation 53
<PAGE>
operations include WCT for 1994 only as this acquisition will be accounted for
using the purchase method of accounting. The pro forma results of operations
include ASI for 1994, 1993 and 1992 as this acquisition will be accounted for
using the pooling of interests method of accounting. These pro forma results
have been prepared for comparative purposes only and are not necessarily
indicative of results that would have been achieved had the transactions been
consummated at the beginning of 1994 or of results which may occur in the
future.
<TABLE>
<CAPTION>
- ----------------------------------------------------------
In thousands of dollars, Pro Forma (Unaudited)
except per share data 1994 1993 1992
- ----------------------------------------------------------
<S> <C> <C> <C>
Total Revenues and Sales $1,224,304 $995,195 $866,287
Consolidated Net Income 107,740 87,992 73,303
Earnings Per Common
Share-Primary $ 1.31 $ 1.14 $ .96
- ----------------------------------------------------------
</TABLE>
During 1994, the Company provided interconnection and billing and collection
services to AT&T which accounted for greater than ten percent of consolidated
gross revenues. There were no other individual customers that accounted for
greater than ten percent of consolidated gross revenues.
________________________________________________________________________________
19. BUSINESS SEGMENT INFORMATION
Revenues and sales, operating income, depreciation, construction and
identifiable assets by business segment are set forth in the Business Segment
Information included on page 29 of this report.
________________________________________________________________________________
20. Interim Data (Unaudited)
Selected quarterly data follow:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Revenues and Sales Income Per Share
-------------------------- -------------------- -------------------------------------------
Earnings
Before
Extraor-
Tele- dinary
communi- Items and Market Price
(In thousands of dollars, cation Telephone Operating Net Cumulative -------------------
except per share data) Services Operations Total Income Income Effect Earnings High Low
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1994 First Quarter $ 90,814 $150,999 $241,813 $ 52,063 $ 15,205/(1)/ $ .32 $ .22 $22.44 $20.25
Second Quarter 96,922 154,905 251,827 56,033 34,896 .47 .47 $25.25 $20.81
Third Quarter 92,957 150,149 243,106 54,914 26,200 .35 .35 $24.75 $21.63
Fourth Quarter 95,121 153,625 248,746 60,254 26,436 .36 .36 $24.63 $20.50
-----------------------------------------------------
Full Year $375,814 $609,678 $985,492 $223,264 $102,737 $1.50 $1.40
=====================================================
- --------------------------------------------------------------------------------------------------------------------------------
1993 First Quarter $ 66,395 $144,574 $210,969 $ 44,364 $ 18,018 $ .27 $ .27 $19.44 $17.32
Second Quarter 74,549 148,303 222,852 48,949 19,830 .29 .29 $21.75 $18.25
Third Quarter 82,743 147,763 230,506 48,373 19,237 .28 .28 $24.38 $20.50
Fourth Quarter 88,892 153,231 242,123 53,259 25,635 .37 .37 $25.13 $21.69
-----------------------------------------------------
Full Year $312,579 $593,871 $906,450 $194,945 $ 82,720 $1.21 $1.21
=====================================================
- --------------------------------------------------------------------------------------------------------------------------------
1992 First Quarter $ 55,802 $137,708 $193,510 $ 40,412 $ 15,291 $ .23 $ .23 $17.00 $15.07
Second Quarter 57,801 140,677 198,478 43,176 16,518 .24 .24 $16.88 $14.57
Third Quarter 59,478 142,116 201,594 46,118 18,448 .27 .27 $16.44 $15.13
Fourth Quarter 63,696 146,771 210,467 45,428 19,174/(2)/ .30 .28 $17.88 $15.32
-----------------------------------------------------
Full Year $236,777 $567,272 $804,049 $175,134 $ 69,431 $1.04 $1.02
=====================================================
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
/(1)/ Includes cumulative effect charge related to change in accounting
principle of $7.2 million (see Note 12).
/(2)/ Includes extraordinary loss on retirement of debt of $1.1 million (see
Note 5).
__________________________________________________
54 Financial Review Frontier Corporation
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this amendment to be signed on its behalf by
the undersigned, thereunto duly authorized.
FRONTIER CORPORATION
(Registrant)
Date: , 1995
---------- By: /s/ Richard A. Smith
-----------------------
Richard A. Smith
Controller
(and Principal Accounting Officer)
<PAGE>
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
23 Consent of Independent Filed herewith
Accountants, Price Waterhouse
<PAGE>
EXHIBIT 23
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Prospectuses
constituting part of the Registration Statements on Form S-3 (File Nos.
33-40824, 33-69420, 33-61784 and 33-57895), Form S-4 (File No. 33-61992)
and in the Registration Statement on Form S-8 (File Nos. 33-67430, 33-67432,
33-67324, 33-51331, 33-51885, 33-52025, 33-54511, 33-54519 and 33-59579)
of Frontier Corporation of our report dated January 16, 1995, appearing
on page 28 of Exhibit No. 13 which is incorporated by reference in this
Annual Report on Form 10-K/A. We also consent to the incorporation by reference
of our report on the Financial Statement Schedule, which appears on page
35 of this Form 10-K/A.
PRICE WATERHOUSE LLP
Rochester, New York
July 13, 1995
