-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, RkIK2kh4CWIGxgj76HglnArM3mMMBFnrm1xxp+Sk0Uquw7MhbrefMdvcyouLb0p9 GOyo/cL0DyOvM/qMtcJ9yA== 0000950132-95-000231.txt : 199507170000950132-95-000231.hdr.sgml : 19950717 ACCESSION NUMBER: 0000950132-95-000231 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19941231 FILED AS OF DATE: 19950714 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRONTIER CORP /NY/ CENTRAL INDEX KEY: 0000084567 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 160613330 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-20489 FILM NUMBER: 95553886 BUSINESS ADDRESS: STREET 1: ROCHESTER TEL CENTER STREET 2: 180 S CLINTON AVE CITY: ROCHESTER STATE: NY ZIP: 14646-0995 BUSINESS PHONE: 7167777100 FORMER COMPANY: FORMER CONFORMED NAME: ROCHESTER TELEPHONE CORP DATE OF NAME CHANGE: 19920703 10-K/A 1 FORM 10-K/A - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------ 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 ------------ 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:
Name of each exchange on Title of Class which registered - ----------------- ---------------- Common Stock, par value $1.00 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None 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 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 2 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 3 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. 4 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. 5 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. 6 Cellular Property Ownership Table The Company owned or was under contract to purchase the following cellular properties as of December 31, 1994:
1994 Pending Pending Estimated Ownership Adjusted Ownership Adjusted Market Population Interest Population Interest Population - ------------------------------------------------------------------- ---------- ---------- ---------- ---------- ---------- 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
- -------------------------------------- * Company managed systems; NY RSA #2 is Company managed in 1995. 7 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 8 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 9 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:
Percent of Total Company Access Telephone Properties Access Lines at Percent at December 31, 1994 Lines December 31, 1994 Digital - -------------------- ------ ----------------- -------- 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% ------- ----- ----- Total Other States.. 330,202 36.0% 95.5% Consolidated Access Lines..... 918,138 100.0% 98.4% ------- ----- -----
(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 10 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 11 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, 12 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 13 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 14 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 15 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 16 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 17 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 18 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. 19 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 20 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. 21 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. 22 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 23 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 24 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. 25 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 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 _________________________________________ Financial Review Frontier Corporation 27 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 _________________________________________ 28 Financial Review Frontier Corporation 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 ________________________________________ Financial Review Frontier Corporation 29 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. _________________________________________ 30 Financial Review Frontier Corporation 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 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 _________________________________________ 32 Financial Review Frontier Corporation 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 $8.8 million over 1992's net other expenses. This was due to administrative expenses associated with the Company's reorganization petition with the New York State Public Service Commission, debt refinancing expenses, and acquisition costs. INCOME TAXES The effective federal tax rate in 1994 was 34.4 percent, compared to 35.4 percent in 1993 and 34.2 percent in 1992. (See Note 9 to the Consolidated Financial Statements.) ________________________________________________________________________________ FINANCIAL CONDITION Management's overall objective is to maximize shareowner value. While increasing net income is an important component of the process, management believes that the primary source of value over the long term is cash generation over and above investment requirements. Key management decisions are made based on the value added to our shareowners' investment. Corporate performance, strategies, capital projects and acquisitions are evaluated and measured using cash flow analysis and investments are expected to provide a return that exceeds the risk-adjusted cost of capital of the Company, or specific business unit, as appropriate. There are a number of key financial metrics that can be used to monitor management's performance. While several of these metrics provide information on the Company's financial condition at a specific time, others, such as shareowner return, are somewhat dependent on the overall financial markets and are often more useful when viewed over an extended period of time.
KEY FINANCIAL DATA - ---------------------------------------------------------------------- ($'s in millions, except per share data) 1994 1993 1992 - ---------------------------------------------------------------------- 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 - ----------------------------------------------------------------------
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 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 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): 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
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 ________________________________________________________________________________ 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 BUSINESS SEGMENT INFORMATION
- ----------------------------------------------------------------------------------------------- In thousands of dollars Years ended December 31, 1994 1993 1992 - ----------------------------------------------------------------------------------------------- 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 ===============================================================================================
(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 CONSOLIDATED STATEMENT OF INCOME
- -------------------------------------------------------------------------------------------------------------------- In thousands of dollars, except per share data Years ended December 31, 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------------- 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 ====================================================================================+===============================
See accompanying Notes to Consolidated Financial Statements. _________________________________________ 38 Financial Review Frontier Corporation CONSOLIDATED BALANCE SHEET
- -------------------------------------------------------------------------------------------- In thousands of dollars December 31, 1994 1993 1992 - -------------------------------------------------------------------------------------------- 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 ============================================================================================
See accompanying Notes to Consolidated Financial Statements. _________________________________________ Financial Review Frontier Corporation 39 CONSOLIDATED STATEMENT OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------ In thousands of dollars Years ended December 31, 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------------ 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 =========================================================================================================================
See accompanying Notes to Consolidated Financial Statements. _________________________________________ 40 Financial Review Frontier Corporation CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
- ----------------------------------------------------------------------------------------- In thousands of dollars, except share data 1994 1993 1992 - ----------------------------------------------------------------------------------------- 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 =========================================================================================
See accompanying Notes to Consolidated Financial Statements. _________________________________________________ Financial Review Frontier Corporation 41 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: - ------------------------------------------------------ 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 - ------------------------------------------------------
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 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 _______________________________________________________________________________ 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).
- ----------------------------------------------------------------------------------------------------------- Total Properties Managed Frontier Assuming 100% Ownership Proportionate Share (a) ------------------------------------ ----------------------------------- Dollars in thousands (Unaudited) 1994 1993 1992 1994 1993 1992 - ----------------------------------------------------------------------------------------------------------- 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 ===========================================================================================================
(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 _______________________________________________________________________________ 4. OTHER INCOME (EXPENSE), NET The major components included in this caption are as follows (amounts in thousands):
- ----------------------------------------------------------------- Income (Expense) 1994 1993 1992 - ----------------------------------------------------------------- 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) =================================================================
________________________________________________________________________________ 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:
- --------------------------------------------------------------------------------------- In thousands of dollars 1994 1993 1992 - --------------------------------------------------------------------------------------- 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 =======================================================================================
________________________________________________________________________________ 7. NOTES PAYABLE AND LINES OF CREDIT At December 31, the Company had outstanding notes payable as follows:
- ------------------------------------------------- In thousands of dollars Amount Interest Rate - ------------------------------------------------- 1992 $6,194 4.00%--9.00% 1993 $ 303 6.00%--9.00% 1994 $ 106 9.00% - -------------------------------------------------
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 ________________________________________________________________________________ 8. LONG-TERM DEBT
- ----------------------------------------------------------------------------------------------------------------------- In thousands of dollars At December 31, 1994 1993 1992 - ----------------------------------------------------------------------------------------------------------------------- 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 =======================================================================================================================
/(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:
- ------------------------------------------------------------------------- In thousands of dollars 1995 1996 1997 1998 1999 - ------------------------------------------------------------------------- $4,525 $4,663 $4,511 $4,408 $124,500 - -------------------------------------------------------------------------
_________________________________________________ 46 Financial Review Frontier Corporation ________________________________________________________________________________ 9. INCOME TAXES The provision for income taxes consists of the following:
- ---------------------------------------------------------------------------------- In thousands of dollars 1994 1993 1992 - ---------------------------------------------------------------------------------- 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 ==================================================================================
The reconciliation of the federal statutory income tax rate with the effective income tax rate reflected in the financial statements is as follows:
- ---------------------------------------------------------------------------------- In thousands of dollars 1994 1993 1992 - ---------------------------------------------------------------------------------- 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% ==================================================================================
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:
- --------------------------------------------------------------------------------- In thousands of dollars 1994 1993 1992 - --------------------------------------------------------------------------------- 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 =================================================================================
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 ________________________________________________________________________________ 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.
- ------------------------------------------------------------------------------------------------------------ Plans for Plans for which assets which exceed accumulated December 31, 1994 accumulated benefits In thousand of dollars benefits exceed assets Total - ------------------------------------------------------------------------------------------------------------ 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 ============================================================================================================
- ------------------------------------------------------------------------------------------------------------ Plans for Plans for which assets which exceed accumulated December 31, 1993 accumulated benefits In thousand of dollars benefits exceed assets Total - ------------------------------------------------------------------------------------------------------------ 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 ============================================================================================================
_________________________________________________ 48 Financial Review Frontier Corporation
- ------------------------------------------------------------------------------------------------------------------- Plans for Plans for which assets which exceed accumulated December 31, 1992 accumulated benefits In thousand of dollars benefits exceed assets Total - ------------------------------------------------------------------------------------------------------------------- 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 ===================================================================================================================
The net periodic pension cost consists of the following:
- ------------------------------------------------------------------------------------------------------------------- In thousands of dollars Years Ended December 31, 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------- 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 ===================================================================================================================
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 - -------------------------------------------------------------------------------- 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:
- ------------------------------------------------------------------------- In thousands of dollars December 31, 1994 1993 - ------------------------------------------------------------------------- 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 =========================================================================
The components of the estimated postretirement benefit cost are as follows:
- ------------------------------------------------------------------------- In thousands of dollars December 31, 1994 1993 - ------------------------------------------------------------------------- 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 =========================================================================
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 - -------------------------------------------------------------------------------- 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:
- --------------------------------------------------------------------------- Option Price Shares Per Share Aggregate - --------------------------------------------------------------------------- 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 ===========================================================================
At December 31, 1994, 129,069 shares were exercisable and 2,283,482 shares were available for future grant. ____________________________________________________ Financial Review Frontier Corporation 51 ________________________________________________________________________________ 15. PREFERRED STOCK (CUMULATIVE)-PAR VALUE $100
- ---------------------------------------------------------------------------------------- In thousands of dollars, except share data 1994 1993 1992 - ---------------------------------------------------------------------------------------- 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 ========================================================================================
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:
- ------------------------------------------------------------- In thousands of dollars Non-Cancellable Leases License ---------------------- Years Buildings Equipment Agreements 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 =============================================================
________________________________________________________________________________ 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 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 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.
- ---------------------------------------------------------- In thousands of dollars, Pro Forma (Unaudited) except per share data 1994 1993 1992 - ---------------------------------------------------------- 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 - ----------------------------------------------------------
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:
- -------------------------------------------------------------------------------------------------------------------------------- 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 - -------------------------------------------------------------------------------------------------------------------------------- 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 ===================================================== - --------------------------------------------------------------------------------------------------------------------------------
/(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 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) EXHIBIT INDEX Exhibit Number Description - -------------- ----------- 23 Consent of Independent Filed herewith Accountants, Price Waterhouse EX-23 2 CONSENT OF ACCOUNTANT 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 -----END PRIVACY-ENHANCED MESSAGE-----