Frontier's First Quarter Raises Concern

Frontier Communications (NAS: FTR) , defying analysts' optimistic earnings estimates, took a 51% net profit hit for the first quarter compared to the same period last year. That dropped its earnings per share to $0.03. Analysts had foreseen $0.06 EPS.

The company explained that difference by saying that excluding a one-time charge of $12.4 million in pension-related costs, and the $6.5 million it paid out for severance and early retirements, the EPS would have been $0.05. But there's more to it than that. Revenues had decreased 1.2% over the previous quarter to $1.27 billion, down 5.8% over the same period last year.

Last month, Frontier had also encouraged the analysts' Pollyanna view by announcing it had completed integrating the Verizon (NYS: VZ) properties it acquired in 2010 with its own legacy resources, and nine months early, to boot. That acquisition tripled Frontier's customer base and complicated its billing operations. It seemed to some that the carrier had bitten off more than it could digest, much less chew. Hence, a sigh of relief from investors and analysts after hearing the integration news.

But with Frontier's less-than-stellar earnings report, those investors -- many mainly in it for the company's large dividend -- should be a little nervous about that dividend's continuation, at least at its present level. It's a rightful concern, as the present dividend was almost twice its current size before the company made the hard, but financially correct, decision to lower it at the end of the previous quarter.

To counter that concern, the company calculates that its dividend-to-free-cash-flow ratio works out to 39%, which isn't bad. However Frontier made a special note in its earnings statement that to reach its FCF figure of $253 million, it added back the severance and pension numbers noted above. It also added back into "Net Cash Provided by Operating Activities," income tax expense, and integration costs. As for capital expenditures to subtract from the net cash figure, it did not include what it called "Capital expenditures -- Integration activities."

Using the free cash flow equation I believe most people use when looking at an earnings statement -- net cash from operating activities minus capital expenditures -- I come up with free cash flow of $158 million. That number changes the dividend-to-free-cash-flow ratio to 63%.

Frontier is well aware that its biggest draw for investors has been its dividend, so that payout ratio is one of the first things shareholders will look at. I am not an accountant, but this seems to me like the company is using this non-GAAP free cash flow equation to come up with a dividend payout ratio that will quell dividend nervousness.

Download the SEC filing and check it yourselves. If I am wrong about this, please let me know in the comments section below.

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At the time thisarticle was published Fool contributorDan Radovskyowns shares of Frontier. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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