Fairpoint Communications (FRP)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

Commission File Number 333-56365

FairPoint Communications, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Registrant’s Telephone Number, Including Area Code: (704) 344-8150.

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o   No x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No x

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2005 (based on the closing price of $16.15 per share as quoted on the New York Stock Exchange as of such date) was approximately $442,591,000.

As of March 06, 2006, there were 35,015,019 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.

Documents incorporated by reference: Part III of the Annual Report incorporates information by reference from the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission not later than April 30, 2006.

FAIRPOINT COMMUNICATIONS, INC. ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

Item Number						Page Number
				Index			i
				PART I
1.				Business			2
1A.				Risk Factors			16
1B.				Unresolved Staff Comments			29
2.				Properties.			29
3.				Legal Proceedings			29
4.				Submission of Matters to a Vote of Security Holders.			30
				PART II
5.				Market for Registrant’s Common Equity and Related Stockholder Matters			31
6.				Selected Financial Data			34
7.				Management’s Discussion and Analysis of Financial Condition and Results of Operations			36
7A.				Quantitative and Qualitative Disclosures about Market Risk.			54
8.				Independent Auditors’ Report and Consolidated Financial Statements			55
9.				Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.			99
9A.				Controls and Procedures			99
9B.				Other Information			99
				PART III
10.				Directors and Executive Officers of the Registrant			100
11.				Executive Compensation.			100
12.				Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.			100
13.				Certain Relationships and Related Transactions.			100
14.				Principal Accounting Fees and Services .			100
				PART IV
15.				Exhibits, Financial Statement Schedules, and Reports on Form 8-K.			100
				Signatures			101
				Exhibit Index			102

 

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PART I

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some statements in this Annual Report are known as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. Forward-looking statements may relate to, among other things:

·       future performance generally,

·       our dividend policy and expectations regarding dividend payments,

·       business development activities,

·       future capital expenditures,

·       future interest expense,

·       distributions from minority investments and passive partnership interests,

·       net operating loss carry forwards,

·       technological developments and changes in the communications industry,

·       financing sources and availability,

·       regulatory support payments,

·       the effects of regulation and competition, and

·       pending litigation.

These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this Annual Report that are not historical facts. When used in this Annual Report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward looking statements. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results, events or developments to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed under “Item 1A. Risk Factors” and other parts of this Annual Report. You should not place undue reliance on such forward-looking statements, which are based on the information currently available to us and speak only as of the date on which this Annual Report was filed with the Securities and Exchange Commission, or the SEC. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made on related subjects in our subsequent periodic reports filed with the SEC on Forms 10-K, 10-Q and 8-K and Schedule 14A.

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ITEM 1.   BUSINESS

Except as otherwise required by the context, references in this Annual Report to “FairPoint,” “our company,” “we,” “us,” or “our” refer to the combined business of FairPoint Communications, Inc. and all of its subsidiaries. Except as otherwise required by the context, all references to the “Company” refer to FairPoint Communications, Inc. excluding its subsidiaries.

Our Business

We are a leading provider of communications services in rural communities, offering an array of services, including local and long distance voice, data, Internet and broadband product offerings. We are one of the largest telephone companies in the United States focused on serving rural communities, and we are the 17th largest local telephone company, in each case based on number of access lines. We operate in 17 states with 288,899 access line equivalents (including voice access lines and high speed data lines, which include digital subscriber lines, or DSL, wireless broadband and cable modem) in service as of December 31, 2005.

We were incorporated in February 1991 for the purpose of acquiring and operating incumbent telephone companies in rural markets. We have acquired 32 such businesses, 28 of which we continue to own and operate. Many of our telephone companies have served their respective communities for over 75 years. The majority of the rural communities we serve have fewer than 2,500 access lines. All of our telephone companies qualify as rural local exchange carriers under the Telecommunications Act of 1996, or the Telecommunications Act.

Rural local exchange carriers generally are characterized by stable operating results and strong cash flow margins and operate in supportive regulatory environments. In particular, existing state and federal regulations permit us to charge rates that enable us to recover our operating costs, plus a reasonable rate of return on our invested capital (as determined by relevant regulatory authorities). Competition is typically limited because rural local exchange carriers primarily serve sparsely populated rural communities with predominantly residential customers, and the cost of operations and capital investment requirements for new entrants is high. As a result, in our markets, we have experienced virtually no wireline competition and limited voice competition from cable providers. We may already have some voice over Internet protocol, or VoIP, competition but there is no way to identify or measure it. While most of our markets are served by wireless service providers, their impact on our business has been limited. We periodically negotiate interconnection agreements with other telecommunications providers which could ultimately result in increased competition in those markets.

Access lines are an important element of our business. Historically, rural telephone companies have experienced consistent growth in access lines because of positive demographic trends, insulated rural local economies and little competition. Recently, however, many rural telephone companies have experienced a loss of access lines due to challenging economic conditions, increased competition and the introduction of DSL services (resulting in customers canceling second lines in favor of DSL). We have not been immune to these conditions. We have been able to mitigate our access line loss somewhat through bundling services, retention programs, continued community involvement and a variety of other focused programs.

Our Competitive Strengths

We believe we are distinguished by the following competitive strengths:

·       Leading market share. We have the leading market position in the rural communities we serve, with limited competition. Demand for telephone services from our residential and local business customers has historically been very stable despite changing economic conditions. As a result, we have experienced less of a decline in access lines during the last two years as compared to regional

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bell operating companies. Additionally, our telephone companies operate in generally supportive regulatory environments. These factors have permitted us to generate consistent cash flows and strong margins.

·       Geographically diversified markets. We currently operate 28 rural local exchange carriers in 17 states enabling us to capitalize on economies of scale and operating efficiencies. Our geographic diversity significantly enhances our cash flow stability by limiting our exposure to competition, local economic downturns and state regulatory changes. In addition, we believe that we have achieved significant scale efficiencies by centralizing many functions, such as sales and marketing, operations, network planning, accounting and customer service.

·       Technologically advanced infrastructure. Our advanced network infrastructure enables us to provide a wide array of communications services. Our network consists of central office hosts and remote sites all with digital switches (primarily manufactured by Nortel and Siemens) and operating with current software. As a result of our historic capital investments, we believe that our network infrastructure requires predictable capital expenditures and allows us to implement certain broadband enabled services with minimal incremental cost. As of December 31, 2005, approximately 98% of our exchanges were capable of providing broadband services and approximately 79% of our access lines are high speed data capable.

·       Broadest service offerings in our markets. As a result of our advanced network, switching and routing infrastructure, we believe that we offer the only comprehensive suite of communications services in our markets, including local and long distance voice, data and Internet services. In addition, we offer enhanced features such as caller identification, call waiting, call forwarding, teleconferencing, video conferencing and voicemail. We also offer broadband communications solutions to most of our customers primarily through DSL technology.

·       Management team with proven track record. We have an experienced management team that has demonstrated its ability to grow our rural telephone business over the past decade. Our senior management team has an average of 23 years of industry experience. Our management team has successfully integrated 32 business acquisitions since 1993, improving revenues and cash flow significantly while enhancing service quality and broadening service offerings.

Our Strategy

The key elements of our strategy are to:

·       Increase revenue per customer. We are focused on increasing our revenues by introducing innovative product offerings and marketing strategies for enhanced and ancillary services to meet the growing needs of our customers. Our long standing relationships with our customers have helped us to successfully cross-sell broadband and value-added services, such as DSL, long distance, Internet dial-up, voicemail and other services. We will continue to evaluate and implement technologies that will allow us to offer new products and services.

·       Continue to improve operating efficiencies and profitability. We have achieved significant operating efficiencies by applying our operational, regulatory, marketing and management expertise to our acquired businesses. We intend to continue to increase our operating efficiencies by consolidating various administrative functions and implementing best practices across the Company.

·       Enhance customer loyalty. We believe that our service driven customer relationships and long-standing local presence lead to high levels of customer satisfaction and increased demand for enhanced and ancillary services. We continue to build long-term relationships with our customers

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by actively participating in the communities we serve and by offering an array of communications services and quality customer care.

·       Grow through selective acquisitions. We believe that our acquisition strategy has been successful because of our ability to integrate acquisitions and improve operating efficiencies in the businesses we acquire. Our management team has consistently produced strong operating cash flow improvements in our acquired businesses. We will continue to evaluate and pursue acquisitions which provide the opportunity to enhance our revenues and cash flows.

Our Services

We offer a broad portfolio of high-quality communications services for residential and business customers in each of the markets in which we operate. We have a long history of operating in our markets and have a recognized identity within each of our service areas. Our companies are locally staffed, which enables us to efficiently and reliably provide an array of communications services to meet our customer needs. These include services traditionally associated with local telephone companies, as well as other services such as long distance, Internet and broadband enabled services. Based on our understanding of our local customers’ needs, we have attempted to be proactive by offering bundled services designed to simplify the customer’s purchasing and management process.

Generation of Revenue

We primarily generate revenue through: (i) the provision of our basic local telephone service to customers within our service areas; (ii) the provision of network access to interexchange carriers for origination and termination of interstate and intrastate long distance phone calls; (iii) Universal Service Fund high cost loop payments; and (iv) the provision of other services such as long distance resale, data and Internet and broadband enabled services, enhanced services, such as caller name and number identification, and billing and collection for interexchange carriers.

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding our revenue sources.

Local Calling Services

Local calling service enables the local customer to originate and receive an unlimited number of calls within a defined “exchange” area. Local calling services include basic local lines, private lines and switched data services. We provide local calling services to residential and business customers, generally for a fixed monthly charge and service charges for special calling features. In a rural local exchange carriers’ territory, the amount that we can charge a customer for local service is determined by rate proceedings involving the appropriate state regulatory authorities.

Network Access Charges

Network access enables long distance companies to utilize our local network to originate or terminate intrastate and interstate calls. Network access charges relate to long distance, or toll calls, that typically involve more than one company in the provision of telephone service. Since toll calls are generally billed to the customer originating the call, a mechanism is required to compensate each company providing services relating to the call. This mechanism is the access charge and we bill access charges to long distance companies and other customers for the use of our facilities to access the customer, as described below.

Intrastate Access Charges.   We generate intrastate access revenue when an intrastate long distance call involving an interexchange carrier is originated by a customer in one of our rural local exchanges to a customer in another exchange in the same state, or when such a call is terminated to a customer in one of

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our rural local exchanges. The interexchange carrier pays us an intrastate access payment for either terminating or originating the call. We bill access charges relating to such calls through our carrier access billing system and receive the access payment from the interexchange carrier. Access charges for intrastate services are regulated and approved by the state regulatory authority.

Interstate Access Charges.   We generate interstate access revenue when an interstate long distance call is originated by a customer in one of our rural local exchanges to a customer in another state, or when such a call is terminated to a customer in one of our rural local exchanges. We bill interstate access charges in the same manner as we bill intrastate access charges; however, interstate access charges are regulated and approved by the Federal Communications Commission instead of the state regulatory authority.

Universal Service Fund High Cost Loop

The Universal Service Fund supplements the amount of local service revenue received by us to ensure that basic local service rates for customers in high cost rural areas are consistent with rates charged in lower cost urban and suburban areas. The Universal Service Fund, which is funded by monthly fees charged to interexchange carriers and local exchange carriers, makes payments to us on a monthly basis based upon our cost support for local exchange carriers whose cost of providing the local loop connections to customers is significantly greater than the national average. These payments fluctuate based upon our average cost per loop compared to the national average cost per loop. For example, if the national average cost per loop increases and our operating costs (and average cost per loop) remain constant or decrease, the payments we receive from the Universal Service Fund would decline. Conversely, if the national average cost per loop decreases and our operating costs (and average cost per loop) remain constant or increase, the payments we receive from the Universal Service Fund would increase.

Long Distance Services

We offer switched and dedicated long distance services throughout our service areas through resale agreements with national interexchange carriers. In addition, through our wholly-owned subsidiary FairPoint Carrier Services, Inc., or Carrier Services, we offer wholesale long distance services to communications providers that are not affiliated with us.

Data and Internet Services

We offer Internet access via DSL technology, dedicated T-1 connections, Internet dial-up, high speed cable modem and wireless broadband. Customers can utilize this access in combination with customer owned equipment and software to establish a presence on the web. In addition, we offer enhanced Internet services, which include obtaining Internet protocol addresses, basic web site design and hosting, domain name services, content feeds and web-based e-mail services. Our services include access to 24-hour, 7-day a week customer support.

Other Services

We seek to capitalize on our rural local exchange carriers’ local presence and network infrastructure by offering enhanced services to customers, as well as billing and collection services for interexchange carriers.

Enhanced Services.   Our advanced digital switch and voicemail platforms allow us to offer enhanced services such as call waiting, call forwarding and transferring, call hunting, three-way calling, automatic callback, call hold, caller name and number identification, voice mail, teleconferencing, video conferencing, store-and-forward fax, follow-me numbers, Centrex services and direct inward dial.

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Billing and Collection.   Many interexchange carriers provide long distance services to our rural local exchange carrier customers and may elect to use our billing and collection services. Our rural local exchange carriers charge interexchange carriers a billing and collection fee for each call record generated by the interexchange carrier’s customer.

Directory Services.   Through our local telephone companies, we publish telephone directories in the majority of our locations. These directories provide white page listings, yellow page listings and community information listings. These directories generate revenues and operating cash flow from the sale of yellow page and related advertising to businesses. We contract with leading industry providers to assist in the sale of advertising, compilation of information, as well as the production, publication and distribution of these directories.

Our Markets

Our 28 rural local exchange carriers operate as the incumbent local exchange carrier in each of their respective markets. Our rural local exchange carriers serve an average of approximately 13 access lines per square mile versus the non-rural carrier average of approximately 128 access lines per square mile. Approximately 77% of our access lines serve residential customers. Our business customers account for approximately 23% of our access lines. Our business customers are predominantly in the agriculture, light manufacturing and service industries.

The following chart identifies the number of access line equivalents in each of our 17 states as of December 31, 2005:

 

(1)          Includes Massachusetts, New Hampshire, Georgia and Alabama.

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Sales and Marketing

Our marketing approach emphasizes customer-oriented sales, marketing and service. We believe most communications companies devote their resources and attention primarily toward customers in more densely populated markets. To the extent we experience competition for any of our services, we seek to differentiate ourselves from the competitors providing such services by providing a superior level of service to each of our customers.

Each of our rural local exchange carriers has a long history in the communities it serves. It is our policy to maintain and enhance the strong identity and reputation that each rural local exchange carrier enjoys in its markets, as we believe this is a significant competitive advantage. As we market new services, we will seek to continue to utilize our identity in order to attain higher recognition with potential customers.

To demonstrate our commitment to the markets we serve, we maintain offices in many of the population centers within our service territories. These offices are typically staffed by local residents and provide customer support services in the community. We believe that a local presence helps facilitate a direct connection to the community, which improves customer satisfaction and loyalty.

In addition, our strategy is to enhance our communications services by offering comprehensive bundling of services and deploying new technologies to build upon the strong reputation we enjoy in our markets and to further promote rural economic development in the rural communities we serve.

Many of the rural local exchange carriers acquired by us traditionally have not devoted a substantial amount of their operating budget to sales and marketing activities. After acquiring such rural local exchange carriers, we typically change this practice to provide additional support for existing products and services as well as to support the introduction of new services. As of December 31, 2005, we had 254 employees engaged in sales, marketing and customer service.

Information Technology and Support Systems

Our approach to billing and operational support systems focuses on implementing best-of-class applications that allow consistent communication and coordination throughout our entire organization. Our objective is to improve profitability by reducing individual company costs through the sharing of best practices, centralization or standardization of functions and processes, and deployment of technologies and systems that provide for greater efficiencies and profitability.

As of December 31, 2005, 17 of our operating companies had converted to a single outsourced billing platform. On October 7, 2005, we learned that the billing service bureau used by us for these 17 operating companies had contracted to sell the software underlying our billing system and agreed not to add any future customers to its service bureau platform. In addition to the short term difficulties experienced during the billing conversion, this potential sale raised concerns about the long-term reliability of the service bureau. On November 7, 2005, we reached an agreement with this outsourced service bureau to transition to another service provider of our choice by December 31, 2006. Subsequent to reaching this agreement, we selected Mid America Computer Corporation, or MACC, as our new provider of billing services. We expect to complete the conversion of 17 of our operating companies, or approximately two thirds of our access lines, by the middle of 2006 and the remaining companies by early to mid 2007.

Network Architecture and Technology

Our rural local exchange carrier networks consist of central office hosts and remote sites, all with advanced digital switches (primarily manufactured by Nortel and Siemens) and operating with current software. The outside plant consists of transport and distribution delivery networks connecting our host central office with remote central offices and ultimately with our customers. We own fiber optic cable,

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which has been deployed throughout our current network and is the primary transport technology between our host and remote central offices and interconnection points with other incumbent carriers.

Our fiber optic transport system is primarily a synchronous optical network capable of supporting increasing customer demand for high bandwidth transport services. This system supports advanced services including Asynchronous Transfer Mode, Frame Relay and/or Internet Protocol Transport, facilitating delivery of advanced services as demand warrants.

In our rural local exchange carrier markets, DSL-enabled integrated access technology is being deployed to provide significant broadband capacity to our customers. As of December 31, 2005, we had invested approximately $32.0 million in digital subscriber line technology and had deployed this technology in 145 of our 148 exchanges. Approximately 98% of our exchanges are capable of providing broadband services through cable modem, wireless broadband and/or DSL technology.

Rapid and significant changes in technology are expected in the communications industry. Our future success will depend, in part, on our ability to anticipate and adapt to technological changes. We believe that our network architecture will enable us to efficiently respond to these technological changes.

Competition

We believe that the Telecommunications Act and other recent actions taken by the Federal Communications Commission and state regulatory authorities promote competition in the provision of communications services; however, many of the competitive threats now confronting larger regulated telephone companies do not currently exist in the rural local exchange carrier marketplace. Our rural local exchange carriers historically have experienced little wireline competition as the incumbent carrier in their markets because the demographic characteristics of rural communications markets generally will not support the high cost of operations and significant capital investment required for new wireline entrants to offer competitive services. For instance, the per minute cost of operating both telephone switches and interoffice facilities is higher in rural areas, as rural local exchange carriers typically have fewer, more geographically dispersed customers and lower calling volumes. Also, the distance from the telephone switch to the customer is typically longer in rural areas, which results in increased distribution facilities costs. These relatively high costs tend to discourage other wireline competitors from entering territories serviced by our rural local exchange carriers.

Wireless Competition

In most of our rural markets, we face competition from wireless technology and as technology and economies of scale improve competition from wireless carriers may increase. In addition, the Federal Communications Commission’s requirement that telephone companies offer wireline-to-wireless number portability may increase the competition we face from wireless carriers.

Wireline Competition

We also face competition from new market entrants that provide close substitutes for the traditional telephone services we provide, such as cable television, satellite communications and electric utility companies. Cable television companies are entering the communications market by upgrading their networks with fiber optics and installing facilities to provide fully interactive transmission of broadband, voice, video and data communications. Electric utilities have existing assets and access to low cost capital that could allow them to enter a market rapidly and accelerate network development. While we currently have limited competition for voice services from cable providers and electric utilities for basic voice services, we may face increased competition from such providers in the future.

In addition, we could face increased competition from competitive local exchange carriers, particularly in offering services to Internet service providers.

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Voice Over Internet Protocol Competition

Voice over internet protocol service is increasingly being embraced by all industry participants. Voice over internet protocol service essentially involves the routing of voice calls, at least in part, over the Internet through packets of data instead of transmitting the calls over the existing public switched telephone network. While current voice over internet protocol applications typically complete calls using incumbent local exchange carrier infrastructure and networks, as voice over internet protocol services obtain acceptance and market penetration and technology advances further, a greater quantity of communication may be placed without utilizing the public switched telephone network. The proliferation of voice over internet protocol, particularly to the extent such communications do not utilize our rural local exchange carriers’ networks, may result in an erosion of our customer base and loss of access fees and other funding.

Internet Competition

The Internet services market is also highly competitive, and we expect that competition will continue to intensify. Internet services, meaning both Internet access (wired and wireless) and on-line content services, are provided by Internet service providers, satellite-based companies, long distance carriers and cable television companies. Many of these companies provide direct access to the Internet and a variety of supporting services to businesses and individuals. In addition, many of these companies, such as America Online, Inc., Microsoft Network and Yahoo, offer on-line content services consisting of access to closed, proprietary information networks. Long distance companies and cable television operators, among others, are aggressively entering the Internet access markets. Long distance carriers have substantial transmission capabilities, traditionally carry data to large numbers of customers and have an established billing system infrastructure that permits them to add new services. Satellite companies are offering broadband access to the Internet from desktop personal computers. Many of these competitors have substantially greater financial, technological, marketing, personnel, name-brand recognition and other resources than those available to us.

Long Distance Competition

The long distance communications market is highly competitive. Competition in the long distance business is based primarily on price, although service bundling, branding, customer service, billing service and quality play a role in customers’ choices.

Other Competition

Although we currently believe we offer the only comprehensive suite of communications services in our markets, existing service providers such as wireline, wireless, cable and utility companies could form, and in some cases are in the process of forming, strategic alliances to offer bundled services in our markets. We may face increased competition from such bundled service providers in the future.

Employees

As of December 31, 2005, we employed a total of 900 employees. 119 employees of our rural local exchange carriers are represented by four unions. We believe the state of our relationship with our union and non-union employees is generally good. Within our company, 99 employees are employed at our corporate offices and 801 employees are employed at our rural local exchange carriers.

Intellectual Property

We believe we have the trademarks, trade names and licenses that are necessary for the operation of our business as we currently conduct it. We do not consider our trademarks, trade names or licenses to be material to the operation of our business.

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Regulatory Environment

The following summary does not describe all present and proposed federal, state and local legislation and regulations affecting the communications industry. Some legislation and regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change the manner in which this industry operates. Neither the outcome of any of these developments, nor their potential impact on us, can be predicted at this time. Regulation can change rapidly in the communications industry, and such changes may have an adverse effect on us in the future. See “Item 7. Management’s Discussion and analysis of Financial Condition and Results of Operations—Risk Factors—Risks Related to our Regulatory Environment.”

Our regulated communications services are subject to extensive federal, state and local regulation. We hold various regulatory authorizations for our service offerings. At the federal level, the Federal Communications Commission generally exercises jurisdiction over all facilities and services of communications common carriers, such as us, to the extent those facilities are used to provide, originate, or terminate interstate or international communications. State regulatory commissions generally exercise jurisdiction over such facilities and services to the extent those facilities are used to provide, originate or terminate intrastate communications. In addition, pursuant to the Telecommunications Act, state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies introduced by that legislation. In particular, state regulatory agencies have substantial oversight over the provision by incumbent telephone companies of interconnection and non-discriminatory network access to competitive communications providers. Local governments often regulate the public rights-of-way necessary to install and operate networks, and may require communications services providers to obtain licenses or franchises regulating their use of public rights-of-way. Additionally, municipalities and other local government agencies may regulate limited aspects of our business, including our use of public rights of way, and by requiring us to obtain construction permits and abide by building codes.

We believe that competition in our telephone service areas will increase in the future as a result of the Telecommunications Act and through increased deployment of various types of technology, although the ultimate form and degree of competition cannot be ascertained at this time. Competition may lead to loss of revenues and profitability as a result of: loss of customers; reduced usage of our network by our existing customers who may use alternative providers for long distance, voice and data services; and reductions in prices for our services which may be necessary to meet competition.

Federal Regulation

We must comply with the Communications Act which requires, among other things, that communications carriers offer services at just and reasonable rates and on non-discriminatory terms and conditions. The amendments to the Communications Act contained in the Telecommunications Act dramatically changed and are expected to continue to change the landscape of the communications industry. The central aim of the Telecommunications Act was to open local communications marketplaces to competition while enhancing universal service. Most significantly, the Telecommunications Act governs the removal of barriers to market entry into local telephone services, requires incumbent local exchange carriers to interconnect with competitors, establishes procedures pursuant to which incumbent local exchange carriers may provide other services, such as the provision of long distance services by regional bell operating companies, and imposes on incumbent local exchange carriers duties to negotiate interconnection arrangements in good faith.

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Removal of Entry Barriers.   Prior to the enactment of the Telecommunications Act, many states limited the services that could be offered by a company competing with an incumbent local exchange carrier. The Telecommunications Act generally preempts state and local laws that prevent competitive entry into the provision of any communications service. However, states can modify conditions of entry into areas served by rural local exchange carriers where the state regulatory commission determines that such modification is warranted by the public interest. Since the passage of the Telecommunications Act, we have experienced only limited competition from cable and wireless service providers.

Access Charges.   The Federal Communications Commission regulates the prices that incumbent local telephone companies charge for the use of their local telephone facilities in originating or terminating interstate transmissions. The Federal Communications Commission has structured these prices, also referred to as “access charges,” as a combination of flat monthly charges paid by the end-users and usage sensitive charges paid by long distance carriers. State regulatory commissions regulate intrastate access charges. Many states generally mirror the Federal Communications Commission price structure. A significant amount of our revenues come from network access charges, which are paid to us by intrastate carriers and interstate long distance carriers for originating and terminating calls in the regions served by our rural local exchange carriers. The amount of access charge revenues that we receive is based on rates set by federal and state regulatory bodies, and such rates are subject to change at any time.

The Federal Communications Commission regulates the levels of interstate access charges by imposing price caps on larger incumbent local telephone companies. These price caps can be adjusted based on various formulae, such as inflation and productivity, and otherwise through regulatory proceedings. Smaller incumbents may elect to base access charges on price caps, but are not required to do so unless they elected to use price caps in the past or their affiliated incumbent local telephone companies base their access charges on price caps. Each of our 28 incumbent local telephone subsidiaries elected not to apply the Federal Communications Commission’s price caps. Instead, our subsidiaries employ rate-of-return regulation for their interstate access charges.

The Federal Communications Commission has made, and is continuing to consider, various reforms to the existing rate structure for charges assessed on long distance carriers for connection to local networks. States often mirror federal rules in establishing intrastate access charges. In 2001, the Federal Communications Commission adopted an order implementing the beginning phases of the Multi Association Group plan to reform the access charge system for rural carriers. The Multi Association Group plan is revenue neutral to our operating companies. Among other things, the Multi Association Group plan reduces access charges and shifts a portion of cost recovery, which historically has been based on minutes-of-use, to flat-rate, monthly per line charges on end-user customers rather than long distance carriers. As a result, the aggregate amount of access charges paid by long distance carriers to access providers, such as our rural local exchange carriers, has decreased and may continue to decrease. In adopting the Multi Association Group plan, the Federal Communications Commission also determined that rate-of-return carriers will continue to be permitted to set rates based on the authorized rate of return of 11.25%. Additionally, the Federal Communications Commission initiated a rulemaking proceeding to investigate the Multi Association Group’s proposed incentive regulation plan and other means of allowing rate-of-return carriers to increase their efficiency and competitiveness. The Multi Association Group plan expires on May 30, 2006 and will need to be renewed or replaced at such time. In addition, to the extent our rural local exchange carriers become subject to competition in their own local exchange areas, such access charges could be paid to competing local exchange carriers rather than to us. Additionally, the access charges we receive may be reduced as a result of competition by other service providers such as wireless and voice over internet services. Such a circumstance could have a material adverse effect on our financial condition and results of operations. In addition, the Federal Communications Commission has sought comment on broad policy changes that could harmonize the rate structure and levels of all forms of intercarrier compensation, and could, as a result, substantially modify the current forms of carrier-to-

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carrier payments for interconnected traffic. Furthermore, in the notice of proposed rulemaking on voice over internet protocol services adopted by the Federal Communications Commission in February 2004, the Federal Communications Commission has sought comment on whether access charges should apply to voice over internet protocol or other internet protocol based services. It is unknown at this time what additional changes, if any, the Federal Communications Commission may eventually adopt and the effect of any such changes on our business.

Rural Local Exchange Carrier Services Regulation.   Our rural local exchange carrier services segment revenue is subject to regulation including regulation by the Federal Communications Commission and incentive regulation by various state regulatory commissions. State lawmakers will likely continue to review the statutes governing the level and type of regulation for communications services. It is expected that over the next few years, legislative and regulatory actions will provide opportunities to restructure rates, introduce more flexible incentive regulation programs and possibly reduce the overall level of regulation. We expect the election of incentive regulation plans and the expected reduction in the overall level of regulation to allow us to introduce new services and pricing changes more expeditiously than in the past. At the same time, however, the implementation of such new programs may also lead to reductions in intrastate access charges.

The Federal Communications Commission generally must approve in advance most transfers of control and assignments of operating authorizations by Federal Communications Commission-regulated entities. Therefore, if we seek to acquire companies that hold Federal Communications Commission authorizations, in most instances we will be required to seek approval from the Federal Communications Commission prior to completing those acquisitions. The Federal Communications Commission has the authority to condition, modify, cancel, terminate or revoke operating authority for failure to comply with applicable federal laws or rules, regulations and policies of the Federal Communications Commission. Fines or other penalties also may be imposed for such violations. Our interstate common carrier services are also subject to nondiscrimination requirements and requirements that rates be just and reasonable.

The Federal Communications Commission has required that incumbent independent local exchange carriers that provide interstate long distance services originating from their local exchange service territories must do so in accordance with “structural separation” rules. These rules require that our long distance affiliates (i) maintain separate books of account, (ii) not own transmission or switching facilities jointly with the local exchange affiliate, and (iii) acquire any services from its affiliated local exchange telephone company at tariffed rates, terms and conditions. The Federal Communications Commission has initiated a rulemaking proceeding to examine whether there is a continuing need for such requirements; however, we cannot predict the outcome of that proceeding.

State Regulation

Most states have some form of certification requirement that requires providers of communications services to obtain authority from the state regulatory commission prior to offering common carrier services. Each of our 28 rural local exchange carriers operates as the incumbent local telephone company in the states in which it operates and is certified in those states to provide local telephone services. State regulatory commissions generally regulate the rates incumbent local exchange carriers charge for intrastate services, including rates for intrastate access services paid by providers of intrastate long distance services. Although the Federal Communications Commission has preempted certain state regulations pursuant to the Telecommunications Act, states have retained authority to impose requirements on carriers necessary to preserve universal service, protect public safety and welfare, ensure quality of service and protect consumers. For instance, incumbent local exchange carriers must file tariffs setting forth the terms, conditions and prices for their intrastate services, and such tariffs may be challenged by third parties. From time to time, states conduct rate cases or “earnings” reviews. These reviews may result in the disallowance of certain investments or expenses for ratemaking purposes.

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Under the Telecommunications Act, state regulatory commissions have jurisdiction to arbitrate and review interconnection disputes and agreements between incumbent local exchange carriers and competitive local exchange carriers, in accordance with rules set by the Federal Communications Commission. State regulatory commissions may also formulate rules regarding fees imposed on providers of communications services within their respective states to support state universal service programs. States often require prior approvals or notifications for certain acquisitions and transfers of assets, customers, or ownership of regulated entities. Therefore, in most instances we will be required to seek state approval prior to completing new acquisitions of rural local exchange carriers. States generally retain the right to sanction a carrier or to revoke certifications if a carrier materially violates relevant laws and/or regulations.

Local Government Authorizations

We may be required to obtain from municipal authorities permits for street opening and construction or operating franchises to install and expand facilities in certain rural communities. Some of these franchises may require the payment of franchise fees. We have obtained such municipal franchises as were required. In some rural areas, we do not need to obtain such permits or franchises because the subcontractors or electric utilities with which we have contracts already possess the requisite authorizations to construct or expand our networks.

Promotion of Local Service Competition and Traditional Telephone Companies

As discussed above, the Telecommunications Act provides, in general, for the removal of barriers to entry into the communications industry in order to promote competition for the provision of local service. Congress, however, has recognized that states should not be prohibited from taking actions necessary to preserve and advance universal service, and has further recognized that special consideration should be given to the appropriate conditions for competitive entry in areas served by rural telephone companies, such as our 28 rural local exchange carrier subsidiaries.

Pursuant to the Telecommunications Act, all local exchange carriers, including both incumbents and new competitive carriers, are required to: (i) allow others to resell their services at retail rates; (ii) ensure that customers can keep their telephone numbers when changing carriers; (iii) ensure that competitors’ customers can use the same number of digits when dialing and receive nondiscriminatory access to telephone numbers, operator service, directory assistance and directory listing; (iv) ensure access to telephone poles, ducts, conduits and rights of way; and (v) compensate competitors for the competitors’ costs of completing calls to competitors’ customers. Competitors are required to compensate the incumbent telephone company for the cost of providing these interconnection services. Under the Telecommunications Act, our rural local exchange carriers may request from state regulatory commissions, suspension or modification of any or all of the requirements described above. A state regulatory commission may grant such a request if it determines that such exemption, suspension or modification is consistent with the public interest and necessary to avoid a significant adverse economic impact on communications users and generally avoid imposing a requirement that is technically unfeasible or unduly economically burdensome. If a state regulatory commission denies some or all of any such request made by one of our rural local exchange carriers, or does not allow us adequate compensation for the costs of providing interconnection, our costs could increase and our revenues could decline. In addition, with such a denial, competitors could enjoy benefits that would make their services more attractive than if they did not receive such interconnection rights. With the exception of the previously referenced requests to modify the May 24, 2004 implementation date for local number portability in certain states, we have not encountered a need to file any such requests for suspension or modification of the interconnection requirements.

The Telecommunications Act, with certain exceptions, imposes the following additional duties on incumbent telephone companies by requiring them to: (i) interconnect their facilities and equipment with

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any requesting communications carrier at any technically feasible point; (ii) unbundle and provide nondiscriminatory access to network elements such as local loops, switches and transport facilities, at nondiscriminatory rates and on nondiscriminatory terms and conditions; (iii) offer their retail services for resale at wholesale rates; (iv) provide reasonable notice of changes in the information necessary for transmission and routing of services over the incumbent telephone company’s facilities or in the information necessary for interoperability; and (v) provide, at rates, terms and conditions that are just, reasonable and nondiscriminatory, for the physical co-location of equipment necessary for interconnection or access to unbundled network elements at the premises of the incumbent telephone company. Competitors are required to compensate the incumbent local exchange carrier for the cost of providing these interconnection services. However, pursuant to the Telecommunications Act, rural telephone companies, including our rural local exchange carriers, are automatically exempt from these additional incumbent telephone company requirements. The exemption remains effective until an incumbent rural local telephone company receives a bona fide request for these additional interconnection services and the applicable state authority determines whether the request is not unduly economically burdensome, technically feasible, and consistent with the universal service objectives set forth in the Telecommunications Act. This exemption remains effective for all of our incumbent local telephone operations, except in Florida where the legislature has determined that all incumbent local exchange carriers are required to provide the additional interconnection services as prescribed in the Telecommunications Act. If a request for any of these additional interconnection services is filed by a potential competitor with respect to one of our other operating territories, we are likely to ask the relevant state regulatory commission to retain the exemption. If a state regulatory commission rescinds such exemption in whole or in part and if the state regulatory commission does not allow us adequate compensation for the costs of providing the interconnection, our costs would significantly increase, we would face new competitors in that state and we could suffer a significant loss of customers and resulting declines in our revenues. In addition, we could incur additional administrative and regulatory expenses as a result of the interconnection requirements.

Promotion of Universal Service

The payments received by our rural local exchange carriers from the Universal Service Fund are intended to support the high cost of our operations in rural markets. Payments from the high cost loop component of the Universal Service Fund represented 8% of our revenues for the year ended December 31, 2005. Under current Federal Communications Commission regulations, the total Universal Service Fund available to all rural local telephone companies, including our 28 rural local exchange carrier subsidiaries, is subject to a cap. In any given year, the cap may or may not be reached. In any year where the cap is reached, the per access line rate at which we can recover Universal Service Fund payments may decrease. In addition, the consideration of changes in the federal rules governing the distribution of Universal Service Fund is pending before the Federal Communications Commission. If our rural local exchange carriers were unable to receive Universal Service Fund payments, or if such payments were reduced, many of our rural local exchange carriers would be unable to operate as profitably as they have historically in the absence of our implementation of increases in charges for other services. Moreover, if we raise prices for services to offset loss of Universal Service Fund payments, the increased pricing of our services may disadvantage us competitively in the marketplace, resulting in additional potential revenue loss. Payments from the Universal Service Fund fluctuate based upon our average cost per loop compared with the national average cost per loop. For example, if the national average cost per loop increases and our operating costs (and average cost per loop) remain constant or decrease, the payments we receive from the Universal Service Fund would decline. Conversely, if the national average cost per loop decreases and our operating costs (and average cost per loop) remain constant or increase, the payments we receive from the Universal Service Fund would increase. Over the past year, the national average cost per loop in relation to our average cost per loop has increased and we believe the national average cost per loop will

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likely continue to increase in relation to our average cost per loop. As a result, the payments we receive from the Universal Service Fund will likely decline.

Universal service rules have been adopted by both the Federal Communications Commission and some state regulatory commissions. Universal Service Fund funds may be distributed only to carriers that are designated as eligible telecommunications carriers by a state regulatory commission. All of our rural local exchange carriers have been designated as eligible telecommunications carriers pursuant to the Telecommunications Act. However, under the Telecommunications Act, competitors could obtain the same support payments as we do if a state regulatory commission determined that granting such support payments to competitors would be in the public interest.

Two notable regulatory changes enacted by the Federal Communications Commission in the last four years are the adoption, with certain modifications, of the Rural Task Force proposed framework for rural high-cost universal service support and the implementation of the Multi Association Group plan. The Federal Communications Commission’s Rural Task Force order modifies the existing universal service support mechanism for rural local exchange carriers and adopts an interim embedded, or historical, cost mechanism for a five-year period that provides predictable levels of support to rural carriers. The Federal Communication Commission has stated its intention to develop a long-term plan based on forward looking costs when the five-year period expires on May 30, 2006. The Multi Association Group plan created a new universal service support mechanism, Interstate Common Line Support, to replace carrier common line access charges and the recovery of certain costs formerly recovered through traffic sensitive access charges. A recent Federal Communications Commission order merged long term support into its interstate common line support mechanism without reducing (at least initially) the aggregate universal service support from the two mechanisms (both of which had been previously transformed from access charge revenue streams into universal service support mechanisms). As a result of these changes, when a competitor is designated as an eligible telecommunications carrier, it also receives an increased level of Universal Service Fund support equal to the level received by the incumbent on a per line basis.

The Federal State Joint Board is currently considering recommendations on the question of which carriers can obtain Universal Service Fund support in a market. The Federal State Joint Board recommended that:

·       a set of permissive federal guidelines be developed to ensure that the public interest is served before eligible telecommunications carriers are designated;

·       support be limited to a single connection that provides access to the public telephone network; and

·       the basis for providing support be considered and further clarified during the comprehensive review of the Universal Service Fund to be completed in 2006.

On February 28, 2005, the Federal Communications Commission issued a press release announcing additional requirements for the designation of competitive eligible telecommunications carriers for receipt of high-cost support. The written text of the Federal Communications Commission order was released on March 1, 2005 in which the Federal Communications Commission adopted additional mandatory requirements for eligible telecommunications carriers designation in cases where it has jurisdiction, and encourages states that have jurisdiction to designate eligible telecommunications carriers to adopt similar requirements. The Federal Communications Commission is still considering revisions to the methodology by which contributions to the Universal Service Fund are determined. These revisions will be part of an overall rulemaking regarding Universal Service Support which will be dealt with sometime in 2006.

In addition, there are a number of judicial appeals challenging several aspects of the Federal Communications Commission’s universal service rules. It is not possible to predict at this time whether the Federal Communications Commission or Congress will require modification to those rules, or the ultimate impact any such modification might have on us.

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Potential Internet Regulatory Obligations

In connection with our Internet access offerings, we could become subject to laws and regulations as they are adopted or applied to the Internet. There is currently only limited regulations applicable to the Internet. As the significance of the Internet expands, federal, state and local governments may adopt rules and regulations, or apply existing laws and regulations to the Internet, and related matters are under consideration in both federal and state legislative and regulatory bodies. The Federal Communications Commission is currently reviewing the appropriate regulatory framework governing broadband access to the Internet through telephone and cable operators’ communications networks. We cannot predict whether the outcome will prove beneficial or detrimental to our competitive position. In February 2004, the Federal Communications Commission initiated a proceeding to examine the regulatory implications of voice over Internet protocol technology. We cannot predict the results of these proceedings, the nature of these regulations or their impact on our business.

The Federal Communications Commission adopted FCC Order 05-150. This Order puts wireline broadband Internet access service, commonly delivered by digital subscriber line (DSL) technology, on an equal regulatory footing with cable modem service. This approach is consistent with a recent United States Supreme Court decision upholding the FCC’s light regulatory treatment of cable modem service. Specifically, the FCC determined that wireline broadband Internet access services are defined as information services functionally integrated with a telecommunications component. In the past, the FCC required facilities-based providers to offer wireline broadband transmission components separately from their Internet service as a stand alone service on a common-carrier basis, and thus classified that component as a telecommunications service. The FCC order also provides an option which allows rate of return carriers, such as our operating companies, the option to continue providing DSL service as a common carrier (status quo) offering.

Environmental Regulations

Like all other local telephone companies, our 28 rural local exchange carrier subsidiaries are subject to federal, state and local laws and regulations governing the use, storage, disposal of, and exposure to hazardous materials, the release of pollutants into the environment and the remediation of contamination. As an owner of property, we could be subject to environmental laws that impose liability for the entire cost of cleanup at contaminated sites, regardless of fault or the lawfulness of the activity that resulted in contamination. We believe, however, that our operations are in substantial compliance with applicable environmental laws and regulations.

ITEM 1A.        RISK FACTORS

Any of the following risks could materially adversely affect our business, consolidated financial condition, results of operations or liquidity or the market price of our common stock. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations.

Risks Related to our Common Stock and our Substantial Indebtedness

Our stockholders may not receive the level of dividends provided for in the dividend policy our board of directors has adopted or any dividends at all.

Our board of directors has adopted a dividend policy which reflects an intention to distribute a substantial portion of the cash generated by our business in excess of operating needs, interest and principal payments on our indebtedness, dividends on our future senior classes of capital stock, if any, capital expenditures, taxes and future reserves, if any, as regular quarterly dividends to our stockholders. Our board of directors may, in its discretion, amend or repeal this dividend policy. Our dividend policy is

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based upon our directors’ current assessment of our business and the environment in which we operate, and that assessment could change based on competitive or technological developments (which could, for example, increase our need for capital expenditures) or new growth opportunities. In addition, future dividends with respect to shares of our common stock, if any, will depend on, among other things, our cash flows, cash requirements, financial condition, contractual restrictions, provisions of applicable law and other factors that our board of directors may deem relevant. Our board of directors may decrease the level of dividends provided for in the dividend policy or entirely discontinue the payment of dividends. Our credit facility contains significant restrictions on our ability to make dividend payments. There can be no assurance that we will generate sufficient cash from continuing operations in the future, or have sufficient surplus or net profits, as the case may be, under Delaware law, to pay dividends on our common stock in accordance with the dividend policy. If we were to use borrowings under our credit facility’s revolving facility to fund dividends, we would have less cash available for future dividends. The reduction or elimination of dividends may negatively affect the market price of our common stock.

To expand our business through acquisitions and service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control. We may not generate sufficient funds from operations to consummate acquisitions, pay dividends with respect to shares of our common stock or repay or refinance our indebtedness at maturity or otherwise.

We may not retain a sufficient amount of cash to finance a material expansion of our business, or to fund our operations consistent with past levels of funding in the event of a significant business downturn. In addition, because a substantial portion of cash available to pay dividends will be distributed to holders of our common stock under our dividend policy, our ability to pursue any material expansion of our business, including through acquisitions or increased capital spending, will depend more than it otherwise would on our ability to obtain third party financing. There can be no assurance that such financing will be available to us at all, or at an acceptable cost.

Our ability to consummate acquisitions and to make payments on our indebtedness will depend on our ability to generate cash flow from operations in the future. This ability, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs.

A significant amount of our cash flow from operations will be dedicated to capital expenditures and debt service. In addition, we currently expect to distribute a significant portion of our cash flow to our stockholders in the form of quarterly dividends. As a result, we may not retain a sufficient amount of cash to finance growth opportunities, including acquisitions, or unanticipated capital expenditures or to fund our operations. In addition, if we reduce capital expenditures, the regulatory settlement payments we receive may decline.

Borrowings under our credit facility bear interest at variable interest rates. Accordingly, if any of the base reference interest rates for the borrowings under our credit facility increase, our interest expense will increase, which could negatively impact our ability to pay dividends on our common stock. On February 8, 2005, we entered into three interest rate swap agreements, with notional amounts of $130 million each, to effectively convert a portion of our variable rate interest exposure to fixed rates ranging from 5.76% to 6.11%. These swap agreements expire beginning December 31, 2007 through December 31, 2009. On April 7, 2005, we entered into two additional interest rate swap agreements, one with the notional amount of $50.0 million to effectively convert a portion of our variable rate interest exposure to a fixed rate of 6.69% beginning on April 29, 2005 and ending on March 31, 2011, and one with the notional amount of $50.0 million to effectively convert a portion of our variable rate interest exposure to a fixed rate of 6.72% beginning on June 30, 2005 and ending on March 31, 2012. As a result of these swap agreements, as of

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December 31, 2005, approximately 82% of our indebtedness bore interest at fixed rates rather than variable rates. After these interest rate swap agreements expire, our annual debt service obligations with respect to borrowings under our credit facility will vary from year to year unless we enter into a new interest rate swap or purchase an interest rate cap or other interest rate hedge. If we choose to enter into a new interest rate swap or purchase an interest rate cap or other interest rate hedge in the future, the amount of cash available to pay dividends on our common stock may decrease. However, to the extent interest rates increase in the future, we may not be able to enter into a new interest rate swap or purchase an interest rate cap or other interest rate hedge on acceptable terms.

In addition, prior to the maturity of our credit facility, we will not be required to make any payments of principal on our credit facility, and it is not likely that we will generate sufficient funds from operations to repay the principal amount of our indebtedness at maturity. We therefore will need to refinance our debt. We may not be able to refinance our outstanding indebtedness under our credit facility, or if refinanced, the refinancing may occur on less favorable terms, which may materially adversely affect our ability to pay dividends. If we were unable to refinance our credit facility, our failure to repay all amounts due on the maturity date would cause a default under our credit facility. We expect our required principal repayments under the term loan facility of our credit facility to be approximately $588.5 million at its maturity in February 2012. Our interest expense may increase significantly if we refinance our credit facility on terms that are less favorable to us than the terms of our credit facility.

We may also be forced to raise additional capital or sell assets and, if we are forced to pursue any of these options under distressed conditions, our business and the value of your investment in our common stock could be adversely affected. In addition, these alternatives may not be available to us when needed or on satisfactory terms due to prevailing market conditions, a decline in our business, legislative and regulatory factors or restrictions contained in the agreements governing our indebtedness.

If we have insufficient cash flow to cover the expected dividend payments under our dividend policy we would need to reduce or eliminate dividends or, to the extent permitted under the agreements governing our indebtedness, fund a portion of our dividends with additional borrowings.

If we do not have sufficient cash to fund dividend payments, we would either reduce or eliminate dividends or, to the extent we were permitted to do so under our credit facility and the agreements governing future indebtedness we may incur, fund a portion of our dividends with borrowings or from other sources. If we were to use borrowings under our credit facility’s revolving facility to fund dividends, we would have less cash available for future dividends and other purposes, which could negatively impact our financial condition, our results of operations and our ability to maintain or expand our business.

Our substantial indebtedness could restrict our ability to pay dividends on our common stock and have an adverse impact on our financing options and liquidity position.

As of December 31, 2005, we had approximately $607.4 million of total consolidated indebtedness. Our substantial indebtedness could have important adverse consequences to the holders of our common stock, including:

·       limiting our ability to pay dividends on our common stock or make payments in connection with our other obligations, including under our credit facility;

·       limiting our ability in the future to obtain additional financing for working capital, capital expenditures or acquisitions;

·       causing us to not be able to refinance our indebtedness on terms acceptable to us or at all;

·       limiting our flexibility in planning for, or reacting to, changes in our business and the communications industry generally;

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·       requiring a significant portion of our cash flow from operations to be dedicated to the payment of the principal and interest on our indebtedness, thereby reducing funds available for future operations, acquisitions, dividends on our common stock and/or capital expenditures;

·       making us more vulnerable to economic and industry downturns and conditions, including increases in interest rates; and

·       placing us at a competitive disadvantage compared to those of our competitors that have less indebtedness.

Subject to certain covenants, our credit facility permits us to incur additional indebtedness. Any additional indebtedness that we may incur would exacerbate the risks described above.

The Company is a holding company and relies on dividends, interest and other payments, advances and transfers of funds from its operating subsidiaries and investments to meet its debt service and other obligations.

The Company is a holding company and conducts all of its operations through its operating subsidiaries. The Company currently has no significant assets other than equity interests in its first tier subsidiaries. These first tier subsidiaries have no significant assets other than a direct or indirect equity interest in the Company’s operating subsidiaries. As a result, the Company will rely on dividends and other payments or distributions from its operating subsidiaries to pay dividends with respect to its common stock and to meet its debt service obligations generally. The ability of the Company’s subsidiaries to pay dividends or make other payments or distributions to the Company will depend on their respective operating results and may be restricted by, among other things:

·       the laws of their jurisdiction of organization;

·       the rules and regulations of state regulatory authorities;

·       agreements of those subsidiaries;

·       the terms of our credit facility; and

·       the covenants of any future outstanding indebtedness the Company or its subsidiaries incur.

The Company’s operating subsidiaries have no obligation, contingent or otherwise, to make funds available to the Company, whether in the form of loans, dividends or other distributions. In addition, we have a number of minority investments and passive partnership interests from which we receive distributions. We do not control the timing or amount of distributions from such investments or interests and we may not have access to the cash flows of these entities.

Accordingly, our ability to pay dividends with respect to shares of our common stock and to repay our credit facility at maturity or otherwise may be dependent upon factors beyond our control. Subject to limitations in our credit facility, the Company’s subsidiaries may also enter into agreements that contain covenants prohibiting them from distributing or advancing funds or transferring assets to the Company under certain circumstances, including to pay dividends.

Our credit facility contains covenants that limit our business flexibility by imposing operating and financial restrictions on our operations and the payment of dividends.

Covenants in our credit facility impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things:

·       the incurrence of additional indebtedness and the issuance by our subsidiaries of preferred stock;

·       the payment of dividends on, and purchases or redemptions of, capital stock;

·       a number of other restricted payments, including investments;

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·       the creation of liens;

·       the ability of our subsidiaries to guarantee our and their indebtedness;

·       specified sales of assets;

·       the creation of encumbrances or restrictions on the ability of our subsidiaries to distribute and advance funds or transfer assets to us or any other subsidiary;

·       specified transactions with affiliates;

·       sale and leaseback transactions;

·       our ability to enter lines of business outside the communications business; and

·       certain consolidations and mergers and sales and/or transfers of assets by or involving us.

Our credit facility also contains covenants which require us to maintain specified financial ratios and satisfy financial condition tests, including, without limitation, a maximum total leverage ratio and a minimum interest coverage ratio.

As a result of general economic conditions, conditions in the lending markets, the results of our business or for any other reason, we may elect or be required to amend or refinance our credit facility, at or prior to maturity, or enter into additional agreements for indebtedness. Any such amendment, refinancing or additional agreement may contain covenants which could limit in a significant manner our operations and our ability to pay dividends on our common stock.

If we are unable to comply with the covenants in the agreements governing our indebtedness, we could be in default under our indebtedness which could result in our inability to make dividend payments on our common stock.

Our ability to comply with the covenants, ratios or tests contained in our credit facility or in the agreements governing our future indebtedness may be affected by events beyond our control, including prevailing economic, financial and industry conditions. A breach of any of these covenants, ratios or tests could result in a default under our credit facility. Certain events of default under our credit facility would prohibit us from making dividend payments on our common stock. In addition, upon the occurrence of an event of default under our credit facility, the lenders could elect to declare all amounts outstanding under our credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the security granted to them to secure that indebtedness. If the lenders accelerate the payment of the indebtedness under our credit facility, our assets may not be sufficient to repay in full the indebtedness under our credit facility and our other indebtedness, if any.

Limitations on usage of net operating loss carry forwards, and other factors requiring us to pay cash taxes in future periods, may affect our ability to pay dividends to you.

Our initial public offering in February 2005 resulted in an “ownership change” within the meaning of the U.S. federal income tax laws addressing net operating loss carry forwards, alternative minimum tax credits and other similar tax attributes. As a result of such ownership change, there are specific limitations on our ability to use our net operating loss carry forwards and other tax attributes from periods prior to our initial public offering. Although it is not expected that such limitations will materially affect our U.S. federal and state income tax liability in the near-term, it is possible in the future that such limitations could limit our ability to utilize such tax attributes and, therefore, result in an increase in our U.S. federal and state income tax payments. In addition, in the future we may be required to pay cash income taxes because all of our net operating loss carry forwards have been used or have expired. Limitations on our usage of net operating loss carry forwards, and other factors requiring us to pay cash taxes in the future, would reduce

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the funds available for the payment of dividends and might require us to reduce or eliminate the dividends on our common stock.

The price of our common stock may fluctuate substantially, which could negatively affect holders of our common stock.

The market price of our common stock may fluctuate widely as a result of various factors, such as period-to-period fluctuations in our operating results, sales of our common stock by principal stockholders, developments in the communications industry, the failure of securities analysts to cover our common stock or changes in financial estimates by analysts, competitive factors, regulatory developments, economic and other external factors, general market conditions and market conditions affecting the stock of communications companies in particular. Communications companies have in the past experienced extreme volatility in the trading prices and volumes of their securities, which has often been unrelated to operating performance. Any such market volatility may have a significant adverse effect on the market price of our common stock. In addition, in the past, securities class action litigation has often been instituted against a company following periods of volatility in its stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources.

Future sales or the possibility of future sales of a substantial amount of our common stock may depress the price of our common stock.

Future sales, or the availability for sale in the public market, of substantial amounts of our common stock could adversely affect the prevailing market price of our common stock, and could impair our ability to raise capital through future sales of equity securities. Pursuant to a registration rights agreement entered into in connection with the offering, we registered 7,599,430 shares of common stock which would otherwise be restricted securities within the meaning of Rule 144 under the Securities Act and are held by persons who acquired our common stock before the offering.

We may issue shares of our common stock, or other securities, from time to time as consideration for future acquisitions and investments. In the event any such acquisition or investment is significant, the number of shares of our common stock, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be significant. We may also grant registration rights covering those shares or other securities in connection with any such acquisitions and investments.

Our restated certificate of incorporation and amended and restated by-laws and several other factors could limit another party’s ability to acquire us and deprive our investors of the opportunity to obtain a takeover premium for their securities.

A number of provisions in our restated certificate of incorporation and amended and restated by-laws make it difficult for another company to acquire us and for you to receive any related takeover premium for your securities. For example, our restated certificate of incorporation provides that certain provisions of our restated certificate of incorporation can only be amended by a vote of two-thirds or more in voting power of all the outstanding shares of capital stock and that stockholders generally may not act by written consent and only stockholders representing at least 50% in voting power may request that our board of directors call a special meeting. Our restated certificate of incorporation provides for a classified board of directors and authorizes the issuance of preferred stock without stockholder approval and upon such terms as the board of directors may determine. The rights of the holders of shares of our common stock will be subject to, and may be adversely affected by, the rights of holders of any class or series of preferred stock that may be issued in the future.

We may, under certain circumstances, suspend the rights of stock ownership the exercise of which would result in any inconsistency with, or violation of, any applicable communications law.

Our restated certificate of incorporation provides that so long as we hold any authorization, license, permit, order, filing or consent from the Federal Communications Commission or any state regulatory

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commission having jurisdiction over us, we will have the right to request certain information from our stockholders. If any stockholder from whom such information is requested should fail to respond to such a request or we conclude that the ownership of, or the existence or exercise of any rights of stock ownership with respect to, shares of our capital stock by such stockholder, could result in any inconsistency with, or violation of, any applicable communications law, we may suspend those rights of stock ownership the existence or exercise of which would result in any inconsistency with, or violation of, any applicable communications law, and we may exercise any and all appropriate remedies, at law or in equity, in any court of competent jurisdiction, against any stockholder, with a view towards obtaining such information or preventing or curing any situation which would cause an inconsistency with, or violation of, any provision of any applicable communications law.

Risks Related to our Business

We provide services to our customers over access lines, and if we lose access lines, our business and results of operations may be adversely affected.

Our business generates revenue by delivering voice and data services over access lines. We have experienced a net voice access line loss, adjusted for acquisitions and divestitures, of 7.1% for the period from January 1, 2002 through December 31, 2005 and 2.5% for the period from December 31, 2004 through December 31, 2005 due to challenging economic conditions and the introduction of digital subscriber line services. We may continue to experience net access line losses in our markets. Our inability to retain access lines could adversely affect our business and results of operations.

We are subject to competition that may adversely impact us.

As an incumbent carrier, we historically have experienced little competition in our rural telephone company markets. Nevertheless, the market for communications services is highly competitive. Regulation and technological innovation change quickly in the communications industry, and changes in these factors historically have had, and may in the future have, a significant impact on competitive dynamics. In most of our rural markets, we face competition from wireless technology, which may increase as wireless technology improves. We also face competition from wireline and cable television operators. We may face additional competition from new market entrants, such as providers of wireless broadband, voice over internet protocol, satellite communications and electric utilities. The Internet services market is also highly competitive, and we expect that competition will intensify. Many of our competitors have brand recognition, offer online content services and  have financial, personnel, marketing and other resources that are significantly greater than ours. In addition, consolidation and strategic alliances within the communications industry or the development of new technologies could affect our competitive position. We cannot predict the number of competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions, but increased competition from existing and new entities could have a material adverse effect on our business.

Competition may lead to loss of revenues and profitability as a result of numerous factors, including:

·       loss of customers (in general, when we lose a customer for local service we also lose that customer for all related services);

·       reduced usage of our network by our existing customers who may use alternative providers for long distance and data services;

·       reductions in the prices for our services which may be necessary to meet competition; and/or

·       increases in marketing expenditures and discount and promotional campaigns.

In addition, our provision of long distance service is subject to a highly competitive market served by large nation-wide carriers that enjoy brand name recognition.

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We may not be able to successfully integrate new technologies, respond effectively to customer requirements or provide new services.

The communications industry is subject to rapid and significant changes in technology, frequent new service introductions and evolving industry standards. We cannot predict the effect of these changes on our competitive position, profitability or industry. Technological developments may reduce the competitiveness of our networks and require unbudgeted upgrades or the procurement of additional products that could be expensive and time consuming. In addition, new products and services arising out of technological developments may reduce the attractiveness of our services. If we fail to adapt successfully to technological changes or obsolescence or fail to obtain access to important new technologies, we could lose customers and be limited in our ability to attract new customers and/or sell new services to our existing customers. An element of our business strategy is to deliver enhanced and ancillary services to customers. The successful delivery of new services is uncertain and dependent on many factors, and we may not generate anticipated revenues from such services.

We rely on a limited number of key suppliers and vendors to operate our business. If these suppliers or vendors experience problems or favor our competitors, we could fail to obtain sufficient quantities of products and services we require to operate our business successfully.

We depend on a limited number of suppliers and vendors for equipment and services relating to our network infrastructure. If these suppliers experience interruptions or other problems delivering these network components on a timely basis, subscriber growth and our operating results could suffer significantly. Proprietary technology of certain suppliers is an integral component of our network and, accordingly, we have become reliant upon a limited number of network equipment manufacturers, including Nortel Networks Corporation and Siemens Information and Communication Networks, Inc. In addition, when our new billing platform is completed, we will rely on a single outsourced supplier to support our billing and related customer care services. In the event it becomes necessary to seek alternative suppliers and vendors, we may be unable to obtain satisfactory replacement suppliers or vendors on economically attractive terms, on a timely basis, or at all, which could increase costs and may cause disruptions in services.

Our relationships with other communications companies are material to our operations and their financial difficulties may adversely affect our business and results of operations.

We originate and terminate calls for long distance carriers and other interexchange carriers over our network and for that service we receive payments for access charges. These payments represent a significant portion of our revenues. Should these carriers go bankrupt or experience substantial financial difficulties, our inability to then collect access charges from them could have a negative effect on our business and results of operations.

We face risks associated with acquired businesses and potential acquisitions.

We have grown rapidly by acquiring other businesses. Since 1993, we have acquired 32 rural telephone businesses and we continue to own and operate 28 such businesses. We expect that a portion of our future growth will result from additional acquisitions, some of which may be material. Growth through acquisitions entails numerous risks, including:

·       strain on our financial, management and operational resources, including the distraction of our management team in identifying potential acquisition targets, conducting due diligence and negotiating acquisition agreements;

·       difficulties in integrating the network, operations, personnel, products, technologies and financial, computer, payroll and other systems of acquired businesses;

·       difficulties in enhancing our customer support resources to adequately service our existing customers and the customers of acquired businesses;

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·       the potential loss of key employees or customers of the acquired businesses;

·       unanticipated liabilities or contingencies of acquired businesses;

·       unbudgeted costs which we may incur in connection with pursuing potential acquisitions which are not consummated;

·       not achieving projected cost savings or cash flow from acquired businesses;

·       fluctuations in our operating results caused by incurring considerable expenses to acquire businesses before receiving the anticipated revenues expected to result from the acquisitions;

·       difficulties in finding suitable acquisition candidates;

·       difficulties in making acquisitions on attractive terms due to a potential increase in competitors; and

·       difficulties in obtaining and maintaining any required regulatory authorizations in connection with acquisitions.

In addition, future acquisitions by us could result in the incurrence of indebtedness or contingent liabilities, which could have a material adverse effect on our business and our ability to pay dividends on our common stock, provide adequate working capital and service our indebtedness.

There can be no assurance that we will be able to successfully complete the integration of the businesses that we have already acquired or successfully integrate any businesses that we might acquire in the future. If we fail to do so, or if we do so but at greater cost than we anticipated, there will be a risk that our business may be adversely affected.

We may need additional capital to continue growing through acquisitions.

We may need additional capital to continue growing through acquisitions. Such additional capital may be in the form of additional debt, which would increase our leverage. We may not be able to raise sufficient additional capital at all or on terms that we consider acceptable.

A system failure could cause delays or interruptions of service, which could cause us to lose customers.

To be successful, we will need to continue to provide our customers reliable service over our network. Some of the risks to our network and infrastructure include:

·       physical damage to access lines;

·       power surges or outages;

·       software defects; and

·       disruptions beyond our control.

Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur expenses.

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Our billing systems may not function properly.

The failure of any of our billing systems could result in our inability to adequately bill and provide customer service to our customers. We are in the process of converting all of our companies on the ICMS platform, approximately two thirds of our access lines, to a new platform by the middle of 2006 and we plan to convert our remaining companies to this same platform by the middle of 2007. At the completion of this project, we will have a single integrated billing platform for our end-user customers.  The failure to successfully complete this conversion or the failure of any of our billing systems could have a material adverse effect on our business, financial condition and results of operations.

We depend on third parties for our provision of long distance services.

Our provision of long distance services is dependent on underlying agreements with other carriers that provide us with transport and termination services. These agreements are based, in part, on our estimate of future supply and demand and may contain minimum volume commitments. If we overestimate demand, we may be forced to pay for services we do not need. If we underestimate demand, we may need to acquire additional capacity on a short-term basis at unfavorable prices, assuming additional capacity is available. If additional capacity is not available, we will not be able to meet this demand. In addition, if we cannot meet any minimum volume commitments, we may be subject to underutilization charges, termination charges, or rate increases which may adversely affect our results of operations.

We may not be able to maintain the necessary rights-of-way for our networks.

We are dependent on rights-of-way and other permits from railroads, utilities, state highway authorities, local governments and transit authorities to install conduit and related communications equipment for any expansion of our networks. We may need to renew current rights-of-way for our networks and cannot assure you that we would be successful in renewing these agreements on acceptable terms. Some of our agreements may be short-term, revocable at will, or subject to termination upon customary default provisions, and we may not have access to existing rights-of-way after they have expired or terminated. If any of these agreements were terminated or could not be renewed, we may be required to remove our existing facilities from under the streets or abandon our networks. Similarly, we may not be able to obtain right-of-way agreements on favorable terms, or at all, in new service areas, and, if we are unable to do so, our ability to expand our networks, if we decide to do so, could be impaired.

Our success depends on our ability to attract and retain qualified management and other personnel.

Our success depends upon the talents and efforts of our senior management team. With the exception of Eugene B. Johnson, our Chairman and Chief Executive Officer, none of these senior executives are employed by us pursuant to an employment agreement. The loss of any member of our senior management team, due to retirement or otherwise, and the inability to attract and retain highly qualified technical and management personnel in the future, could have a material adverse effect on our business, financial condition and results of operations.

We may face significant future liabilities or compliance costs in connection with environmental and worker health and safety matters.

Our operations and properties are subject to federal, state and local laws and regulations relating to protection of the environment, natural resources, and worker health and safety, including laws and regulations governing the management, storage and disposal of hazardous substances, materials and wastes. Under certain environmental laws, we could be held liable, jointly and severally and without regard to fault, for the costs of investigating and remediating any contamination at owned or operated properties; or for contamination arising from the disposal by us or our predecessors of hazardous wastes at formerly

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owned properties or at third party waste disposal sites. In addition, we could be held responsible for third party property or personal injury claims relating to any such contamination or relating to violations of environmental laws. Changes in existing laws or regulations or future acquisitions of businesses could require us to incur substantial costs in the future relating to such matters.

We will be exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act and related regulations implemented by the SEC, the New York Stock Exchange and the Public Company Accounting Oversight Board, are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. We will be evaluating our internal controls systems to allow management to report on, and our independent auditors to attest to, our internal controls as required by Section 404 of the Sarbanes-Oxley Act. Our evaluation of our internal controls may result in our identifying material weaknesses in our internal controls. While we anticipate being able to complete our initial controls assessment and remediation of any identified material weaknesses prior to the  December 31, 2006 deadline applicable to us, we cannot be certain as to the timing of such completion or the impact of the same on our operations. If we are not able to complete the assessment process required by Section 404 in a timely manner, or are unable to remediate any identified material weaknesses prior to December 31, 2006, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC or the New York Stock Exchange. Any such action could adversely affect our financial results or investors’ confidence in us, and could cause our stock price to fall. If we fail to maintain effective controls and procedures, we may be unable to provide financial information in a timely and reliable manner.

Risks Related to our Regulatory Environment

We are subject to significant regulations that could change in a manner adverse to us.

We operate in a heavily regulated industry, and the majority of our revenues generally have been supported by regulations, including access revenue and Universal Service Fund support for the provision of telephone services in rural areas. Laws and regulations applicable to us and our competitors may be, and have been, challenged in the courts, and could be changed by Congress or regulators. In addition, any of the following have the potential to have a significant impact on us:

Risk of loss or reduction of network access charge revenues.   For the year ended December 31, 2005, almost 44% of our revenues came from network access charges, which are paid to us by intrastate and interstate long distance carriers for originating and terminating calls in the regions served. This 44% also includes Universal Service Fund payments for local switching support, long term support and interstate common line support. In recent years, several of these long distance carriers have declared bankruptcy. Future declarations of bankruptcy by a carrier that utilizes our access services could negatively impact our financial results. The amount of access charge revenues that we receive is based on rates set by federal and state regulatory bodies, and such rates could change. Further, from time to time federal and state regulatory bodies conduct rate cases and/or “earnings” reviews, which may result in rate changes. The Federal Communications Commission has reformed and continues to reform the federal access charge system. States often mirror these federal rules in establishing intrastate access charges. In October 2001, the Federal Communications Commission reformed the system to reduce interstate access charges and shift a portion of cost recovery, which historically has been based on minutes-of-use, to flat-rate, monthly per line charges on end-user customers rather than long distance carriers. As a result, the aggregate amount of access charges paid by long distance carriers to access providers, such as our rural local exchange carriers, has decreased and may continue to decrease. Although these changes were implemented on a revenue neutral basis (with commensurate increases in other charges and Universal

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Service Fund support), there is no assurance that future changes in access charge rates will be implemented on a revenue neutral basis. Furthermore, to the extent our rural local exchange carriers become subject to competition, such access charges could be paid to competing communications providers rather than to us. Additionally, the access charges we receive may be reduced as a result of wireless competition. Finally, the Federal Communications Commission is currently weighing several proposals to comprehensively reform the intercarrier compensation regime in order to create a uniform system of intercarrier payments. Any such proposal eventually adopted by the Federal Communications Commission will likely involve significant changes in the access charge system and could potentially result in a significant decrease or elimination of access charges altogether. Decreases or losses of access charges may or may not result in offsetting increases in local, subscriber line or Universal Service Fund revenues. Regulatory developments of this type could adversely affect our business, revenue and/or profitability.

Risk of loss or reduction of Universal Service Fund support.   We receive Universal Service Fund revenues to support the high cost of our operations in rural markets. For the year ended December 31, 2005, approximately 8% of our revenues resulted from the high cost loop support we received from the Universal Service Fund and was based upon our average cost per loop compared to the national average cost per loop. This revenue stream fluctuates based upon our average cost per loop compared to the national average cost per loop. For example, if the national average cost per loop increases and our operating costs (and average cost per loop) remain constant or decrease, the payments we receive from the Universal Service Fund would decline. Conversely, if the national average cost per loop decreases and our operating costs (and average cost per loop) remain constant or increase, the payments we receive from the Universal Service Fund would increase. The national average cost per loop in relation to our average cost per loop has increased and we believe that the national average cost per loop will likely continue to increase in relation to our average cost per loop. As a result, the payments we receive from the Universal Service Fund have declined and will likely continue to decline. This support fluctuates based upon the historical costs of our operating companies. In addition to the Universal Service Fund high cost loop support, we also receive other Universal Service Fund support payments, which include local switching support, long term support, and interstate common line support that used to be included in our interstate access charge revenues (the Federal Communications Commission has recently merged long term support into interstate common line support). If our rural local exchange carriers were unable to receive support from the Universal Service Fund, or if such support was reduced, many of our rural local exchange carriers would be unable to operate as profitably as they have historically, in the absence of our implementation of increases in charges for other services. Moreover, if we raise prices for services to offset loss of Universal Service Fund payments, the increased pricing of our services may disadvantage us competitively in the marketplace, resulting in additional potential revenue loss.

The Telecommunications Act of 1996, or the Telecommunications Act, provides that eligible communications carriers, including competitors to rural local exchange carriers, may obtain the same per line support as the rural local exchange carriers receive if a state commission determines that granting such support to competitors would be in the public interest. In fact, wireless communications providers in certain of our markets have obtained matching support payments from the Universal Service Fund, but that has not led to a loss of revenues for our rural local exchange carriers under existing regulations. Any shift in universal service regulation, however, could have an adverse effect on our business, revenue and/or profitability.

During the last four years, pursuant to recommendations made by the Multi Association Group and the Rural Task Force, the Federal Communications Commission has made certain modifications to the universal service support system that changed the sources of support and the method for determining the level of support. These changes have been revenue neutral to our operations. It is unclear whether the changes in methodology will continue to accurately reflect the costs incurred by our rural local exchange carriers, and whether it will provide for the same amount of Universal Service Fund support that our rural

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local exchange carriers have received in the past. In addition, several parties have raised objections to the size of the Universal Service Fund and the types of services eligible for support. A number of issues regarding the source and amount of contributions to, and eligibility for payments from, the Universal Service Fund are pending and will likely be addressed by the Federal Communications Commission or Congress in the near future. For example, a number of proposals to be examined by the Federal Communications Commission in its current rulemaking with respect to the reform of the intercarrier compensation system include reforms of the Universal Service Fund. The outcome of any regulatory proceedings or legislative changes could affect the amount of Universal Service Fund support that we receive, and could have an adverse effect on our business, revenue or profitability.

On February 28, 2005, the Federal Communications Commission issued a press release announcing additional requirements for the designation of competitive Eligible Telecommunications Carriers for receipt of high-cost support. In its corresponding order, released on March 17, 2005, the Federal Communications Commission adopted additional mandatory requirements for Eligible Telecommunications Carriers designation in cases where it has jurisdiction, and encourages states that have jurisdiction to designate Eligible Telecommunications Carriers to adopt similar requirements. The Federal Communications Commission is still considering revisions to the methodology by which contributions to the Universal Service Fund are determined. These revisions will be part of an overall rulemaking regarding Universal Service Support which will be dealt with sometime in 2006.

Risk of loss of statutory exemption from burdensome interconnection rules imposed on incumbent local exchange carriers.   Our rural local exchange carriers are exempt from the Telecommunications Act’s more burdensome requirements governing the rights of competitors to interconnect to incumbent local exchange carrier networks and to utilize discrete network elements of the incumbent’s network at favorable rates. If state regulators decide that it is in the public’s interest to impose these more burdensome interconnection requirements on us, we would be required to provide unbundled network elements to competitors. As a result, more competitors could enter our traditional telephone markets than are currently expected and we could incur additional administrative and regulatory expenses, and experience additional revenue losses.

Risks posed by costs of regulatory compliance.   Regulations create significant compliance costs for us. Our subsidiaries that provide intrastate services are generally subject to certification, tariff filing and other ongoing regulatory requirements by state regulators. Our interstate access services are provided in accordance with tariffs filed with the Federal Communications Commission. Challenges to our tariffs by regulators or third parties or delays in obtaining certifications and regulatory approvals could cause us to incur substantial legal and administrative expenses, and, if successful, such challenges could adversely affect the rates that we are able to charge our customers.

Our business also may be impacted by legislation and regulation imposing new or greater obligations related to assisting law enforcement, bolstering homeland security, minimizing environmental impacts, or addressing other issues that impact our business. For example, existing provisions of the Communications Assistance for Law Enforcement Act and Federal Communications Commission regulations implementing the Communications Assistance for Law Enforcement Act require communications carriers to ensure that their equipment, facilities, and services are able to facilitate authorized electronic surveillance. We cannot predict whether and when the Federal Communications Commission might modify its Communications Assistance for Law Enforcement Act rules or any other rules or what compliance with new rules might cost. Similarly, we cannot predict whether or when federal or state legislators or regulators might impose new security, environmental or other obligations on our business.

For a more thorough discussion of the regulatory issues that may affect our business, see “Item 1. Business—Regulatory Environment.”

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Regulatory changes in the communications industry could adversely affect our business by facilitating greater competition against us, reducing potential revenues or raising our costs.

The Telecommunications Act provides for significant changes and increased competition in the communications industry, including the local communications and long distance industries. This statute and the Federal Communications Commission’s implementing regulations remain subject to judicial review and additional rulemakings of the Federal Communications Commission, thus making it difficult to predict what effect the legislation will have on us, including our operations and our revenues and expenses, and our competitors. Several regulatory and judicial proceedings have recently concluded, are underway or may soon be commenced, that address issues affecting our operations and those of our competitors. We cannot predict the outcome of these developments, nor can we assure that these changes will not have a material adverse effect on us or our industry.

For a more thorough discussion of the regulatory issues that may affect our business, see “Item 1. Business—Regulatory Environment.”

The failure to obtain necessary regulatory approvals could impede the consummation of a potential acquisition.

Our acquisitions likely will be subject to federal, state and local regulatory approvals. We cannot assure you that we will be able to obtain any necessary approvals, in which case a potential acquisition could be delayed or not consummated.

ITEM 1B.       UNRESOLVED STAFF COMMENTS

We have received no written comments from the Securities and Exchange Commission staff regarding our periodic or current reports less than 180 days before the end of our fiscal year ended December 31, 2005 that remain unresolved.

ITEM 2.                PROPERTIES

We own all of the properties material to our business. Our headquarters is located in Charlotte, North Carolina in a leased facility. We also have administrative offices, maintenance facilities, rolling stock, central office and remote switching platforms and transport and distribution network facilities in each of the 17 states in which we operate our rural local exchange carrier business. Our administrative and maintenance facilities are generally located in or near the rural communities served by our rural local exchange carriers and our central offices are often within the administrative building and/or outlying customer service centers. Auxiliary battery or other non-utility power sources are at each central office to provide uninterrupted service in the event of an electrical power failure. Transport and distribution network facilities include fiber optic backbone and copper wire distribution facilities, which connect customers to remote switch locations or to the central office and to points of presence or interconnection with the long distance carriers. These facilities are located on land pursuant to permits, easements or other agreements. Our rolling stock includes service vehicles, construction equipment and other required maintenance equipment.

We believe each of our respective properties is suitable and adequate for the business conducted therein, is being appropriately used consistent with past practice and has sufficient capacity for the present intended purposes.

ITEM 3.                LEGAL PROCEEDINGS

On June 6, 2005, a purported class action complaint was filed in the General Court of Justice, Superior Court Division, of the State of North Carolina by Robert Lowinger on behalf of himself and all other similarly situated persons against the Company, the Company’s Chairman and Chief Executive

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Officer, certain of the Company’s current and former directors and certain of the Company’s stockholders. The complaint alleges violations of Sections 11 and 12(a)(2) and liability under Section 15 of the Securities Act, and alleges that the Company’s registration statement on Form S-1 (which was declared effective by the SEC on February 3, 2005) and the related prospectus dated February 3, 2005, each relating to the Company’s initial public offering of common stock, contained certain material misstatements and omitted certain material information necessary to be included relating to the Company’s broadband products and access line trends. The plaintiff, who has been a plaintiff in several other securities cases, seeks rescission rights and unspecified damages on behalf of a purported class of purchasers of the common stock “issued pursuant and/or traceable to the Company’s IPO during the period from February 3, 2005 through March 21, 2005”. The Company removed the action to Federal Court. The plaintiff filed a motion to remand the action to the North Carolina State Court, which was denied by the Federal Magistrate. The plaintiff has objected to and appealed the Magistrate’s decision to the District Court Judge. The Company has contested the appeal and filed a Motion to Dismiss the action. The Magistrate, on February 9, 2006, issued a Memorandum and Recommendation to the District Court Judge that the Motion to Dismiss be granted and that the complaint be dismissed with prejudice. The plaintiff has filed a Notice of Objection to the Magistrate’s Recommendation. Both the appeal of denial of the Motion to Remand and the Motion to Dismiss are pending before the District Court Judge. The Company believes that this action is without merit and intends to continue to defend the litigation vigorously.

We currently and from time to time are involved in other litigation and regulatory proceedings incidental to the conduct of our business, but currently we are not a party to any lawsuit or proceeding which, in our opinion, is likely to have a material adverse effect on us.

ITEM 4.                SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our security holders during the fourth quarter of fiscal 2005.

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PART II

ITEM 5.                MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

General

Our common stock began trading on the New York Stock Exchange under the symbol “FRP” on February 4, 2005. Prior to that time, there was no trading market for our common stock.

The following table shows the high and low closing sales prices per share of the Company’s Common Stock as reported on the New York Stock Exchange for the periods indicated:

 

The following table shows the dividends which have been declared and/or paid on our common stock during 2005:

(1)          The Company’s initial public offering occurred in February 2005 and therefore, the Company paid a partial quarterly dividend in the first quarter of 2005.

As of March 6, 2006, there were approximately 80 holders of record of our common stock.

Dividend Policy and Restrictions

General

Our board of directors has adopted a dividend policy under which a substantial portion of the cash generated by our business in excess of operating needs, interest and principal payments on our indebtedness, dividends on our future senior classes of capital stock, if any, capital expenditures, taxes and future reserves, if any, would in general be distributed as regular quarterly dividend payments to the holders of our common stock, rather than retained by us and used for other purposes, including to finance growth opportunities. This policy reflects our judgment that our stockholders would be better served if we distributed to them such substantial portion of the excess cash generated by our business instead of retaining it in our business. However, our stockholders may not receive any dividends as a result of the following factors:

·       nothing requires us to pay dividends;

·       while our current dividend policy contemplates the distribution of a substantial portion of our cash in excess of operating needs, interest and principal payments on our indebtedness, dividends on our future senior classes of capital stock, if any, capital expenditures, taxes and future reserves, if any, this policy could be modified or revoked by our board of directors at any time;

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·       even if our dividend policy was not modified or revoked, the actual amount of dividends distributed under this policy and the decision to make any distributions are entirely at the discretion of our board of directors;

·       the amount of dividends distributed is subject to covenant restrictions under our credit facility;

·       the amount of dividends distributed is subject to restrictions under Delaware law;

·       our stockholders have no contractual or other legal right to receive dividends; and

·       we may not have enough cash to pay dividends due to changes in our cash from operations, distributions we receive from minority investments and passive partnership interests, working capital requirements and/or anticipated cash needs.

We believe that our dividend policy limits, but does not preclude, our ability to pursue growth. If we continue paying dividends at the level currently anticipated under our dividend policy, we expect that we would need additional financing to fund significant acquisitions or to pursue growth opportunities requiring capital expenditures that are significantly beyond our current expectations. However, we intend to retain sufficient cash after the distribution of dividends to permit the pursuit of growth opportunities that do not require material capital investment.

Restrictions on Payment of Dividends

Under Delaware law, our board of directors may declare dividends only to the extent of our “surplus” (which is defined as total assets at fair market value minus total liabilities, minus statutory capital) or, if there is no surplus, out of our net profits for the then current and/or immediately preceding fiscal year.

Our credit facility restricts our ability to declare and pay dividends on our common stock as follows:

·       We may use all of our available cash accumulated after April 1, 2005 plus certain incremental funds to pay dividends, but we may not in general pay dividends in excess of such amount. “Available cash” is defined in our credit facility as Adjusted EBITDA (a) minus (i) interest expense, (ii) repayments of indebtedness other than repayments of the revolving facility (unless funded by debt or equity), (iii) capital expenditures (unless funded by long-term debt, equity or the proceeds from asset sales or insurance recovery events), (iv) cash taxes, (v) cash consideration paid for acquisitions (unless funded by debt or equity), (vi) cash paid to make certain investments, and (vii) certain non-cash items excluded from Adjusted EBITDA and paid in cash and (b) plus (i) the cash amount of extraordinary gains and gains on sales of assets and (ii) certain non-cash items excluded from Adjusted EBITDA and received in cash. “Adjusted EBITDA” is defined in our credit facility as Consolidated Net Income (which is defined in our credit facility and includes distributions from investments) (a) plus the following to the extent deducted from Consolidated Net Income: provision for income taxes, interest expense, depreciation, amortization, losses on sales of assets and other extraordinary losses, and certain other non-cash items, and (b) minus, to the extent included in Consolidated Net Income, gains on sales of assets and other extraordinary gains and all non-cash items.

·       We may not pay dividends if a default or event of default under our credit facility has occurred and is continuing or would exist after giving effect to such payment, if our leverage ratio (total debt (net of cash) divided by Adjusted EBITDA) is above 5.00 to 1.00 or if we do not have at least $10 million of cash on hand (including unutilized commitments under our credit facility’s revolving facility).

Our credit facility also permits us to use available cash to repurchase shares of our capital stock, subject to the same conditions.

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See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity” for a more detailed description of our credit facility and these restrictions.

Equity Compensation Plan Information

The table below provides information, as of the end of the most recently completed fiscal year, concerning securities authorized for issuance under our equity compensation plans.

(1)          Includes 832,888 options to purchase shares of our common stock under the FairPoint Communications, Inc. (formerly MJD Communications, Inc.) 1998 Stock Incentive Plan, 18,013 options to purchase shares of our common stock under the FairPoint Communications, Inc. 1995 Stock Option Plan, 240,638 options to purchase shares of our common stock under the FairPoint Communications, Inc. 2000 Employee Stock Incentive Plan, 26,442 restricted units granted under the FairPoint Communications, Inc. 2000 Employee Stock Incentive Plan and 7,888 restricted units granted under the FairPoint Communications, Inc. 2005 Stock Incentive Plan.

(2)          Includes 467,654 shares under the 2005 Stock Incentive Plan. Available shares shown above for the 2005 Stock Incentive Plan include shares that have become available due to forfeitures or have been reacquired by the Company for any reasons without delivery of the stock, as allowed under the terms of the plan.

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ITEM 6.                SELECTED FINANCIAL DATA

The following financial information should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto contained elsewhere in this Annual Report. Amounts are in thousands, except access lines and per share data.

(1)             On January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” Pursuant to the requirements of SFAS No. 142, we ceased amortizing goodwill beginning January 1, 2002, and instead test for goodwill impairment annually. Amortization expense for goodwill and equity method goodwill was $11,962 in 2001. Depreciation and amortization excludes amortization of debt issue costs.

(2)             Interest expense includes amortization of debt issue costs aggregating $1,859, $4,603, $4,171, $3,664 and $4,018 for the fiscal years ended December 31, 2005, 2004, 2003, 2002 and 2001. We prospectively adopted the provisions of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Liabilities and Equity,” effective July 1, 2003. SFAS No. 150 requires us to classify as a long-term liability our series A preferred stock and to reclassify dividends and accretion from

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the series A preferred stock as interest expense. Such stock is described as “Preferred Shares Subject to Mandatory Redemption” in the balance sheet and dividends and accretion on these shares are included in pre-tax income prior to repurchase in 2005 whereas previously they were presented as a reduction to equity (a dividend), and, therefore, a reduction of net income available to common stockholders. For the years ended December 31, 2005, 2004 and 2003, interest expense includes $2,362, $20,181 and $9,049, respectively, related to dividends and accretion on preferred shares subject to mandatory redemption.

(3)             On January 1, 2001, we adopted the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended by SFAS No. 138. On the date of adoption, we recorded a cumulative adjustment of $4,664 in accumulated other comprehensive income for the fair value of interest rate swaps. Because the interest rate swaps did not qualify as accounting hedges under SFAS No. 133, the change in fair value of the interest rate swaps were recorded as non operating gains or losses, which we classify in other income (expense). We also recorded other income (expense) in 2003, 2002 and 2001 for the amortization of the transition adjustment of the swaps initially recognized in accumulated other comprehensive income. In the second quarter of 2002, we adopted SFAS No. 145 “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections.” This statement eliminates the requirement that gains and losses from the extinguishment of debt be required to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. In 2003, other income (expense) includes a $3,465 gain on the extinguishment of debt and a $4,967 loss for the write-off of debt issue costs related to this extinguishment of debt. In 2004, other income (expense) includes a $5,951 loss for the write-off of debt issuance and offering costs associated with an abandoned offering of Income Deposit Securities. In 2005, other income (expense) includes an $87.7 million loss on early retirement of debt and loss on repurchase of series A preferred stock.

(4)             In 2005, we recorded an income tax benefit of $83.1 million which is primarily the result of the recognition of deferred tax benefits of $66.0 million from the reversal of the deferred tax valuation allowance that resulted from our expectation of generating future taxable income following the recapitalization that occurred as part of our initial public offering, or the offering, in February 2005.

(5)             In connection with the offering we effected a 5.2773714 for 1 reverse stock split of our common stock. All share and per share amounts related to our common stock have been restated to reflect the reverse stock split.

(6)             Total access line equivalents includes voice access lines and high speed data lines, which include DSL lines, wireless broadband and cable modem.

(7)             In connection with the offering, we repurchased all of our series A preferred stock from the holders thereof.

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ITEM 7.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements and the notes thereto included elsewhere in this Annual Report. The following discussion includes certain forward-looking statements. For a discussion of important factors, including the continuing development of our business, actions of regulatory authorities and competitors and other factors which could cause actual results to differ materially from the results referred to in the forward-looking statements, see “Item 1A.—Risk Factors.”

Overview

We are a leading provider of communications services in rural communities, offering an array of services, including local and long distance voice, data, Internet and broadband product offerings. We are one of the largest telephone companies in the United States focused on serving rural communities and we are the 17th largest local telephone company, in each case based on number of access lines. We operate in 17 states with 288,899 access line equivalents in service as of December 31, 2005.

We were incorporated in February 1991 for the purpose of acquiring and operating incumbent telephone companies in rural markets. Since 1993, we have acquired 32 such businesses, 28 of which we continue to own and operate. Many of our telephone companies have served their respective communities for over 75 years. The majority of the rural communities we serve have fewer than 2,500 access lines. All of our telephone companies qualify as rural local exchange carriers under the Telecommunications Act.

Rural local exchange carriers generally are characterized by stable operating results and strong cash flow margins and operate in supportive regulatory environments. In particular, existing state and federal regulations permit us to charge rates that enable us to recover our operating costs, plus a reasonable rate of return on our invested capital (as determined by relevant regulatory authorities). Competition is typically limited because rural local exchange carriers primarily serve sparsely populated rural communities with predominantly residential customers, and the cost of operations and capital investment requirements for new entrants is high. As a result, in our markets, we have experienced virtually no wireline competition and limited voice competition from cable providers. We may already have VoIP competition but there is no way to identify or measure it. While most of our markets are served by wireless service providers, their impact on our business has been limited. We periodically negotiate interconnection agreements with other telecommunications providers which could ultimately result in increased competition in those markets.

Access lines are an important element of our business. Historically, rural telephone companies have experienced consistent growth in access lines because of positive demographic trends, insulated rural local economies and little competition. Recently, however, many rural telephone companies have experienced a loss of access lines due to challenging economic conditions, increased competition and the introduction of DSL services (resulting in customers canceling second lines in favor of DSL). We have not been immune to these conditions. We have been able to mitigate our access line loss somewhat through bundling services, retention programs, continued community involvement and a variety of other focused programs.

Despite our net loss of voice access lines, we have generated growth in our revenues each year since 2001. We have accomplished this by providing our customers with services not previously available in most of our markets, such as enhanced voice services and data services, including digital subscriber line services, and through acquisitions.

During 2005, 17 of our operating companies were converted to a single outsourced billing platform. On October 7, 2005, we learned that the billing service bureau used by us for these 17 operating companies had contracted to sell the software underlying our billing system and agreed not to add any future customers to its service bureau platform. In addition to the short term difficulties we experienced during

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the billing conversion, this potential sale raised concerns about the long-term reliability of the service bureau. On November 7, 2005, we reached an agreement with this outsourced service bureau to transition to another service provider of our choice by December 31, 2006. As part of this settlement, we will receive $4.0 million in cash as compensation from the outsourced billing provider in order to relieve it from its responsibilities under the original service bureau contract. In addition, we do not have to pay an additional $1.1 million which was scheduled to be paid to the service provider. We have selected MACC as our new provider of billing services. We expect to complete the conversion of 17 of our operating companies, or approximately two thirds of our access lines, by the middle of 2006 and the remaining companies by the middle of 2007.

Our dividend policy reflects our judgment that our stockholders would be better served if we distributed a substantial portion of the cash generated by our business in excess of operating needs, interest and principal payments on our indebtedness, dividends on future senior classes of our capital stock, if any, capital expenditures, taxes and future reserves, if any, as regular quarterly dividend payments to the holders of our common stock, rather than retained and used such cash for other purposes.

We are subject to regulation primarily by federal and state governmental agencies. At the federal level, the FCC has jurisdiction over interstate and international communications services. State telecommunications regulators exercise jurisdiction over intrastate communications services.

Our Initial Public Offering

On February 8, 2005, we consummated our initial public offering of 25,000,000 shares of our common stock at a price to the public of $18.50 per share. In connection with the offering, we entered into a new senior secured credit facility with a syndicate of financial institutions, including Deutsche Bank Trust Company Americas, as administrative agent, which we refer to as our credit facility.

We used the gross proceeds of $462.5 million from the offering together with borrowings of $566.0 million under the term facility of our credit facility as follows:

·       $176.7 million to repay in full all outstanding loans under our old credit facility (including accrued interest);

·       $122.1 million to repurchase $115.0 million aggregate principal amount of our 9 1¤2% senior subordinated notes due 2008, which we refer to as the 9 1¤2% notes, pursuant to the tender offer and consent solicitation for such notes (including accrued interest, tender premiums and consent payments);

·       $51.8 million to repurchase $50.8 million aggregate principal amount of our floating rate callable securities due 2008, which we refer to as the floating rate notes, pursuant to the tender offer and consent solicitation for such notes (including accrued interest, tender premiums and consent payments);

·       $193.4 million to repurchase $173.1 million aggregate principal amount of our 12 1¤2% senior subordinated notes due 2010, which we refer to as the 12 1¤2% notes, pursuant to the tender offer and consent solicitation for such notes (including accrued interest, tender premiums and consent payments);

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·       $274.9 million to repurchase $223.0 million aggregate principal amount of our 117¤8% senior notes due 2010, which we refer to as the 117¤8% notes, pursuant to the tender offer and consent solicitation for such notes (including accrued interest, tender premiums and consent payments);

·       $129.2 million to repurchase all of our series A preferred stock (together with accrued and unpaid dividends thereon) from the holders thereof;

·       $10.6 million to repay a substantial portion of our subsidiaries’ outstanding long-term debt (including accrued interest);

·       $7.0 million to repay in full a promissory note issued by us in connection with a past acquisition;

·       $18.4 million to invest in temporary investments pending the redemption of the 91¤2% notes and the floating rate notes not tendered in the tender offers for such notes; and

·       $44.4 million to pay fees and expenses, including underwriting discounts of $27.8 million, $8.2 million of debt issuance costs associated with our credit facility and a transaction fee of approximately $8.4 million paid to Kelso & Company, one of our investors.

On March 10, 2005, we used the $18.4 million which we had invested in temporary investments, together with $6.6 million of cash on hand, to redeem the $0.2 million aggregate principal amount of the 9 1¤2% notes (including accrued interest and redemption premiums) that were not tendered in the tender offers for such notes and the $24.2 million aggregate principal amount of the floating rate notes (including accrued interest) that were not tendered in the tender offer for such notes.

On May 2, 2005, we used $22.5 million of borrowings under the delayed draw facility of our credit facility to redeem the remaining $19.9 million aggregate principal amount of the 12 1¤2% notes (including accrued interest and redemption premiums) that were not tendered in the tender offer for such notes.

Revenues

We derive our revenues from:

·       Local calling services.   We receive revenues from providing local exchange telephone services, including monthly recurring charges for basic service, usage charges for local calls and service charges for special calling features.

·       Universal Service Fund high cost loop support.   We receive payments from the Universal Service Fund to support the high cost of our operations in rural markets. This revenue stream fluctuates based upon our average cost per loop compared to the national average cost per loop. For example, if the national average cost per loop increases and our operating costs (and average cost per loop) remain constant or decrease, the payments we receive from the Universal Service Fund would decline. Conversely, if the national average cost per loop decreases and our operating costs (and average cost per loop) remain constant or increase, the payments we receive from the Universal Service Fund would increase. The national average cost per loop in relation to our average cost per loop has increased, and we believe that the national average cost per loop will likely continue to increase in relation to our average cost per loop. As a result, the payments we receive from the Universal Service Fund have declined and will likely continue to decline.

·       Interstate access revenue.   These revenues are primarily based on a regulated return on rate base and recovery of allowable expenses associated with the origination and termination of toll calls both to and from our customers. Interstate access charges to long distance carriers and other customers are based on access rates filed with the Federal Communications Commission. These revenues also include Universal Service Fund payments for local switching support, long term support and interstate common line support.

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·       Intrastate access revenue.   These revenues consist primarily of charges paid by long distance companies and other customers for access to our networks in connection with the origination and termination of long distance telephone calls both to and from our customers. Intrastate access charges to long distance carriers and other customers are based on access rates filed with the state regulatory agencies.

·       Long distance services.   We receive revenues from long distance services we provide to our residential and business customers. In addition, Carrier Services provides communications providers not affiliated with us with wholesale long distance services.

·       Data and Internet services.   We receive revenues from monthly recurring charges for services, including high speed data, special access, private lines, Internet and other services.

·       Other services.   We receive revenues from other services, including billing and collection, directory services and sale and maintenance of customer premise equipment.

The following summarizes our revenues and percentage of revenues from continuing operations from these sources:

 

Operating Expenses

Our operating expenses are categorized as operating expenses, depreciation and amortization, and stock-based compensation.

·       Operating expenses include cash expenses incurred in connection with the operation of our central offices and outside plant facilities and related operations. In addition to the operational costs of owning and operating our own facilities, we also purchase long distance services from the regional bell operating companies, large independent telephone companies and third party long distance providers. In addition, our operating expenses include expenses relating to sales and marketing, customer service and administration and corporate and personnel administration.

·       Depreciation and amortization includes depreciation of our communications network and equipment.

·       Stock based compensation consists of non-cash compensation charges incurred in connection with the employee stock options, restricted units and restricted stock granted to our executive officers and directors, and stockholder appreciation rights agreements granted to one of our current executive officers and one of our former executive officers. The stockholder appreciation rights agreements were all settled during March of 2005.

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Acquisitions

We intend to continue to pursue selective acquisitions:

·       On January 25, 2006, we agreed to purchase the assets of Cass County Telephone Company Limited Partnership, or Cass County Telephone, for approximately $33.0 million in cash, subject to adjustment. Cass County Telephone serves approximately 8,600 access line equivalents in Missouri and Kansas. This acquisition is expected to close in the second quarter of 2006 after regulatory approvals.

·       On May 2, 2005, we completed the acquisition of Berkshire Telephone Corporation, or Berkshire, for a purchase price of approximately $20.3 million (or $16.4 million net of cash acquired), subject to adjustment. Berkshire is an independent local exchange carrier that provides voice communication, cable and internet services to over 7,200 access line equivalents, as of the date of acquisition, serving five communities in New York State. Berkshire’s communities of service are adjacent to those of Taconic Telephone Corp., one of the Company’s subsidiaries.

·       On September 1, 2005, we completed the acquisition of Bentleyville Communications Corporation,  or Bentleyville, for approximately $11.0 million (or $9.3 million net of cash acquired), subject to adjustment. Bentleyville, which had approximately 3,600 access line equivalents at the date of acquisition, provides telecommunications, cable and internet services to rural areas of Southwestern Pennsylvania which are adjacent to our existing operations in Pennsylvania.

·       During 2004 we did not complete any acquisitions.

·       On December 1, 2003, we purchased all of the capital stock of Community Service Telephone Co. and Commtel Communications Inc., which we refer to as the Maine acquisition. Community Service Telephone and Commtel Communications provided communication services to approximately 13,280 access line equivalents in central Maine as of the date of such acquisition.

·       During 2002, we did not complete any acquisitions.

In the normal course of business, we evaluate selective acquisitions and may enter into non-binding letters of intent with respect to such acquisitions, subject to customary conditions. Management currently intends to fund future acquisitions through the use of the revolving facility of our credit facility or additional debt financing or the issuance of additional shares of our common stock. However, our substantial amount of indebtedness and our dividend payments could restrict our ability to obtain such financing on acceptable terms or at all.

Stock Based Compensation

In February 2005 and September 2005, we issued 473,716 shares and 50,000 shares, respectively, of restricted stock under our 2005 Stock Incentive Plan to our employees. Also, during 2005, 53,687 shares of restricted stock were forfeited bringing the total number of restricted shares outstanding under the 2005 Stock Incentive Plan to 470,029 shares. At December 31, 2005, 467,654 shares of our common stock may be issued in the future pursuant to awards authorized under our 2005 Stock Incentive Plan which could result in an additional compensation expense. In the second quarter of 2005, our board of directors approved an annual award to each of our non-employee directors in the form of restricted stock or restricted units, at the recipient’s option, which will vest on a quarterly basis, issued under the Company’s 2005 Stock Incentive Plan. The 2005 non-employee director awards began to vest on July 1, 2005. During 2005, we granted 1,870 shares of restricted stock with a total value at the grant date of approximately $30,000 and 7,480 restricted units with a total value at the grant date of approximately $120,000 to our non-employee directors. An additional 408 restricted units were granted in 2005 in lieu of dividends on the restricted units. In addition, we granted restricted units to certain employees in December 2003 of which

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26,442 remain outstanding at December 31, 2005. Non-cash compensation charges associated with restricted units and restricted stock were $2.4 million for the twelve months ended December 31, 2005. We did not recognize any additional charges associated with the stockholder appreciation rights that were settled in 2005.

Non-cash compensation charges associated with restricted units totaled $49,000 in 2004. These charges consisted of compensation charges of $0.2 million for restricted units, a charge of $0.3 million in connection with the modification of employee stock options and a non-cash benefit of $0.4 million associated with the reduction in estimated fair market value of stockholder appreciation rights. Non-cash compensation charges in 2003 were not material, primarily due to the fact that the fair market value per share of our common stock remained relatively stable.

Discontinued Operations

On September 30, 2003, MJD Services Corp., or MJD Services, a wholly-owned subsidiary of the Company, completed the sale of all of the capital stock owned by MJD Services of Union Telephone Company of Hartford, Armour Independent Telephone Co., WMW Cable TV Co. and Kadoka Telephone Co. to Golden West Telephone Properties, Inc. The sale was completed in accordance with the terms of the South Dakota purchase agreement. MJD Services received approximately $24.2 million in proceeds from the South Dakota disposition. The companies sold to Golden West provided communication services to approximately 4,150 voice access lines located in South Dakota as of the date of such disposition. The operations of these companies were presented as discontinued operations beginning in the second quarter of 2003. Therefore, the balances associated with these activities were reclassified as “held for sale.” All prior period financial statements have been restated accordingly. We recorded a gain on disposal of the South Dakota companies of $7.7 million during the third quarter of 2003.

In November 2001, we decided to discontinue the competitive local exchange carrier operations of FairPoint Carrier Services, Inc., or Carrier Services. This decision was a proactive response to the deterioration in the capital markets, the general slow-down of the economy and the slower-than-expected growth in Carrier Services’ competitive local exchange carrier operations. Carrier Services now provides wholesale long distance services and support to our rural local exchange carriers and communications providers not affiliated with us. These services allow such companies to operate their own long distance communication services and sell such services to their respective customers. Our long distance business is included as part of continuing operations in the accompanying financial statements.

The information in our year to year comparisons below represents only our results from continuing operations.

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Results of Operations

The following table sets forth the percentages of revenues represented by selected items reflected in our consolidated statements of operations. The year to year comparison of financial results are not necessarily indicative of future results:

 

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Year Ended December 31, 2005 Compared with Year Ended December 31, 2004

Revenues

Revenues.   Revenues increased $10.2 million to $262.8 million in 2005 compared to $252.6 million in 2004. Of this increase, $5.7 million was attributable to the Berkshire and Bentleyville acquisitions in 2005 and $4.5 million was attributable to our existing operations. We derived our revenues from the following sources:

Local calling services.   Local calling service revenues increased $2.0 million to $65.1 million in 2005. Of this increase, $1.2 million was attributable to the Berkshire and Bentleyville acquisitions in 2005 and $0.8 million was attributable to our existing operations. The increase in local revenues from existing operations is primarily due to increases in local calling features and local interconnection revenues, despite a 2.5% decline in net voice access lines.

Universal Service Fund high cost loop support.   Universal Service Fund high cost loop payments decreased $2.4 million to $19.7 million in 2005. Our existing operations accounted for all of this decrease. The national average cost per loop in relation to our average cost per loop has increased and, as a result, our receipts from the Universal Service Fund have declined. We expect this trend to continue as we anticipate the national average cost per loop will likely continue to increase in relation to our average cost per loop.

Interstate access.   Interstate access revenues increased $5.0 million to $75.3 million in 2005 from $70.3 million in 2004. Of the increase, $1.6 million was attributable to the Bentleyville and Berkshire acquisitions. Our existing operations accounted for the remaining $3.4 million increase. In 2005, we recognized certain positive interstate revenue settlement adjustments related to prior years which accounted for approximately $4.3 million of interstate access revenue. Excluding these unusual items and acquired operations, interstate access revenue would have declined $0.9 million in 2005.

Intrastate access.   Intrastate access revenues decreased to $40.0 million in 2005 from $42.4 million in 2004. The decrease from our existing operations was $3.3 million. The decrease was mainly attributable to rate reductions as provided for under a rate re-balancing agreement in Maine.

Long distance services.   Long distance services revenues increased $3.1 million to $20.9 million in 2005 compared to 2004. This increase was attributable primarily to our existing operations as a result of promotional efforts and bundles with unlimited long distance designed to generate more revenue.

Data and Internet services.   Data and internet services revenues increased $5.1 million to $24.2 million in 2005 from $19.1 million in 2004. The increase is due primarily to increases in DSL customers as we continue to aggressively market our high speed data services. Our high speed data subscriber customer base as of December 31, 2005, increased to 45,283 subscribers compared to 34,824 subscribers as of December 31, 2004, a 30% increase during this period. The Bentleyville and Berkshire acquisitions contributed the remaining revenue increase of $0.5 million.

Other services.   Other services revenues decreased to $17.7 million in 2005 from 2004. The Berkshire and Bentleyville acquisitions increased other services revenues by $1.3 million. Excluding the impact of the acquisitions, other services revenue decreased $1.5 million. A portion of this decrease from existing operations was due to a $1.2 million one-time sale and installation of E911 system equipment in 2004. The remaining decrease was due to reductions in billing and collections revenues, as interexchange carriers continue to take back the billing function for their more significant long distance customers. We expect this billing and collections trend to continue.

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Operating Expenses

Operating expenses and cost of goods sold, excluding depreciation and amortization.   Operating expenses increased $12.3 million to $141.1 million in 2005 compared to 2004. Of the increase, $9.3 million is related to our existing operations and $3.0 million is related to expenses of the acquired operations in 2005. Consulting fees increased $1.8 million primarily related to preparation for compliance with Section 404 of the Sarbanes-Oxley Act. Expenses related to high speed data and long distance services increased $2.3 million principally due to the increase in HSD and long distance subscribers. Bad debt expense was $1.4 million higher in 2005 than 2004 due primarily to difficulties experienced in our billing conversion related to the delay of non-pay disconnect notices. Billing costs have increased $2.0 million as we incurred costs associated with the conversion of our billing systems into an integrated platform and recurring expenses from our outsourced billing service provider. The balance of the increase is attributable to smaller miscellaneous items.

Depreciation and amortization.   Depreciation and amortization from continuing operations increased $2.1 million to $52.4 million in 2005 from $50.3 million in 2004. The Berkshire and Bentleyville acquisitions accounted for $1.0 million of the increase and the remaining increase was attributable to the increased investment in our communications network for existing operations.

Stock based compensation.   For the year ended December 31, 2005, stock based compensation increased $2.3 million to $2.4 million in 2005 primarily due to the issuance of restricted stock and restricted units to certain key employees and directors under the 2005 Stock Incentive Plan.

Income from operations.   Income from operations decreased $6.5 million to $67.0 million in 2005 compared to 2004. This decrease is principally due to the increase in expenses discussed above.

Other income (expense).   Total other expense increased $24.2 million to $121.6 million in 2005 from $97.4 million in 2004. Interest expense decreased $57.9 million to $46.4 million in 2005 mainly due to the transactions associated with the offering which substantially de-leveraged us and provided a decrease in interest expense. In addition, in connection with the offering we repurchased our series A preferred stock (together with accrued and unpaid dividends thereon) which eliminated dividends and accretion on our series A preferred stock for the twelve months ended December 31, 2005. The dividends and accretion on our series A preferred stock were being reported as interest expense under SFAS 150. In connection with the offering, we also refinanced our old credit facility and repurchased and/or redeemed the 9 1¤2% notes, the floating rate notes, the 12 1¤2% notes and the 11 7¤8% notes, which resulted in significant charges of $87.7 million due to fees and penalties paid on the repurchase/redemption and for the write-off of unamortized debt issuance costs. Earnings from equity investments increased $0.4 million to $11.3 million in 2005. For the twelve months ended December 31, 2004, other non-operating income (expense) includes the write-off of debt issuance and offering costs of $6.0 million associated with an abandoned offering of Income Deposit Securities.

Income tax expense.   In 2005, income tax benefits of $83.1 million are primarily the result of the recognition of deferred tax benefits of $66.0 million from the reversal of the deferred tax valuation allowance that resulted from our expectation of generating future taxable income following the recapitalization. The income tax benefit for 2005 also includes deferred tax benefits of $29.3 million related to the extinguishment of debt and $1.6 million for an adjustment of our net deferred tax assets to an expected federal income tax rate of 35% from 34%, in anticipation of higher levels of taxable income in subsequent periods. These benefits were partially offset by income tax expense associated with taxable income generated following the recapitalization. During the twelve months ended December 31, 2004, the income tax expense related primarily to income taxes owed in certain states.

Discontinued operations.   During the twelve months ended December 31, 2005 and 2004, we recorded a reduction to our liability associated with the discontinuation of our competitive local exchange carrier

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operations, which, net of tax, resulted in a $0.4 million and $0.7 million adjustment to income from discontinued operations, respectively. The adjustment in 2005 related to the settlement of a lease obligation which reduced our future obligation under this lease. In 2004, the adjustment was mainly attributable to excise tax refunds received from the Internal Revenue Service as well as a reduction in liabilities associated with potential property tax payments.

Net income (loss).   Net income for the year ended December 31, 2005 was $28.9 million. Our 2004 net loss was $23.7 million. The difference between 2005 and 2004 is a result of the factors discussed above.

Year Ended December 31, 2004 Compared with Year Ended December 31, 2003

Revenues

Revenues.   Revenues increased $21.2 million to $252.6 million in 2004 compared to $231.4 million in 2003. Of this increase, $8.2 million was attributable to the Maine acquisition and $13.0 million was attributable to our existing operations. We derived our revenues from the following sources:

Local calling services.   Local calling service revenues increased $7.1 million from $56.1 million in 2003 to $63.2 million in 2004. Revenue from our existing operations increased $4.2 million. Of this increase, $3.6 million is attributable to the implementation of Basic Service Calling Areas in the state of Maine, which changes and expands basic service calling areas and has the effect of shifting revenues from intrastate access to local services. The remaining increase of $0.6 million in local revenues from existing operations is due to increases in local calling features and local interconnection revenues, despite a 2.9% decline in net voice access lines. The remaining increase in local calling service revenues was attributable to the Maine acquisition.

Universal Service Fund high cost loop support.   Universal Service Fund high cost loop payments increased $3.3 million to $22.2 million in 2004 from $18.9 million in 2003. Our existing operations accounted for all of this increase. A reclassification of plant increased our Universal Service Fund payments in our Maine and Idaho companies which more than offset a drop in payments from the Universal Service Fund related to increases in the national average cost per loop.

Interstate access.   Interstate access revenues increased $3.7 million from $66.6 million in 2003 to $70.3 million in 2004. Of the increase, $3.1 million was attributable to the Maine acquisition. Our existing operations accounted for the remaining $0.6 million increase. This increase was due to expense increases from our regulated operations that resulted in higher interstate revenue requirements.

Intrastate access.   Intrastate access revenues decreased from $44.0 million in 2003 to $42.4 million in 2004. The decrease from our existing operations was $2.6 million before being offset by $1.0 million in revenues contributed by the Maine acquisition. The decrease was mainly attributable to the Basic Service Calling Areas plan implemented in Maine as discussed above in local calling services.

Long distance services.   Long distance services revenues increased $2.3 million from $15.4 million in 2003 to $17.7 million in 2004. This increase was all attributable to our existing operations as a result of promotional efforts and bundles with unlimited long distance designed to generate more revenue.

Data and Internet services.   Data and internet services revenues increased $5.7 million from $13.4 million in 2003 to $19.1 million in 2004. The increase is due primarily to increases in DSL customers as we aggressively marketed our high speed data products. Our high speed data subscriber customer base increased to 34,824 subscribers as of December 31, 2004, a 78% increase during the year. The Maine acquisition contributed the remaining revenue increase of $0.6 million.

Other services.   Other services revenues increased from $17.0 million in 2003 to $17.8 million in 2004. Of the increase, $0.6 million was attributable to the Maine acquisition. An increase of $0.2 million from existing operations was due to a $1.2 million one-time sale and installation of E911 system equipment. This

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was offset by approximately $1.0 million of reductions in billing and collections revenues, as inter-exchange carriers continued to take back the billing function for their more significant long distance customers.

Operating Expenses

Operating expenses and cost of goods sold, excluding depreciation and amortization.   Operating expenses increased $17.6 million to $128.8 million in 2004 from $111.2 million in 2003. Of the increase, $13.5 million is related to our existing operations and $4.1 million is related to expenses of the companies we acquired in 2003 in the Maine acquisition. Wages and benefits increased $4.4 million due to merit salary increases, an increase in our bonus compensation and an increase in the number of our employees compared to a year ago. Network operations expense, wholesale digital subscriber line charges and transport and network costs associated with our broadband initiatives increased $4.0 million. Cost of goods sold associated with the one-time sale and installation of E911 system equipment was $1.0 million in 2004. Bad debt expense was $1.6 million higher in 2004 than 2003 due primarily to a recovery received in 2003. Marketing and promotion expenses increased $0.6 million due to higher levels of activity related to the promotion of custom calling features, data services and other products. Billing costs have increased $1.0 million as we incurred costs associated with the conversion of our billing systems into an integrated platform. The balance of the increase is attributable to smaller miscellaneous items.

Depreciation and amortization.   Depreciation and amortization from continuing operations increased $2.2 million to $50.3 million in 2004 from $48.1 million in 2003. The Maine acquisition accounted for $1.2 million of the increase and $0.3 million was attributable to the increased investment in our communications network for existing operations we acquired prior to 2003. The other $0.7 million was related to accelerated depreciation on wireless equipment due to a decision to exit certain wireless markets.

Stock based compensation.   For the year ended December 31, 2004, stock based compensation of $49,000 was incurred as a result of modification of an employee stock option agreement with an executive officer, offset by the decrease in the estimated value of fully vested stockholder appreciation rights agreements. The restricted units issued in December of 2003 resulted in a compensation charge of $0.2 million. Stock based compensation for the year ended December 31, 2003 was $15,000.

Income from operations.   Income from operations increased $1.5 million to $73.6 million in 2004 from $72.1 million in 2003. A $1.5 million decrease attributable to our existing operations was offset by a $3.0 million increase attributable to the Maine acquisition.

Other income (expense).   Total other expense increased $16.8 million to $97.4 million in 2004 from $80.6 million in 2003. The increase consisted primarily of interest expense on long-term debt, which increased $14.1 million to $104.3 million in 2004 from $90.2 million in 2003, which was mainly attributable to the extinguishment of debt in connection with our issuance of the 11 7¤8% notes during the first quarter of 2003 and the adoption of Statement of Financial Accounting Standards 150 as of July 1, 2003, the latter of which resulted in our recording $20.2 million in interest expense related to dividends and accretion on our series A preferred stock for the year ended December 31, 2004 compared to $9.0 million for the year ended December 31, 2003. Earnings from equity investments increased $0.8 million to $10.9 million in 2004 from $10.1 million in 2003. For the twelve months ended December 31, 2004, other non-operating income (expense) includes the write-off of debt issuance and offering costs of $6.0 million associated with an abandoned offering of Income Deposit Securities. For the year ended December 31, 2003, other non-operating income (expense) of $1.5 million represents the net loss on the extinguishment of debt and expenses related to the loss on the write-off of loan origination costs. In conjunction with the issuance of $225.0 million of the 117¤8% notes during the first quarter of 2003, we recorded $3.5 million in non-operating gains on the extinguishment of a portion of the 9 1¤2% notes, the 12 1¤2% notes and loans under

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Carrier Services’ credit facility. These gains were offset by a non-operating loss of $5.0 million for the write-off of debt issue costs related to this extinguishment of debt in 2003.

The following is a summary of amounts included in realized and unrealized gains (losses) on interest rate swaps (dollars in thousands):

 

Income tax expense.   Income tax expense from continuing operations increased $0.7 million to $0.5 million in 2004 from a benefit of $0.2 million in 2003. The income tax expense relates primarily to income taxes owed in certain states offset by investment tax credits in certain states.

Discontinued operations.   Net income from discontinued operations of our existing operations sold in the South Dakota disposition was $1.9 million in 2003. The companies were sold on September 30, 2003 and resulted in the recognition of a gain on disposal of the discontinued operations of $7.7 million during 2003. During the twelve months ended December 31, 2004 and 2003, we recorded a reduction to our liability associated with the discontinuation of our competitive local exchange carrier operations of $0.7 million and $0.3 million, respectively. This was mainly attributable to excise tax refunds received from the Internal Revenue Service as well as a reduction in liabilities associated with potential property tax payments.

Net income (loss).   Net loss attributable to common stockholders for the year ended December 31, 2004 was $23.7 million. Our 2003 net loss attributable to common shareholders was $4.3 million after giving effect to $8.9 million in dividends and accretion related to our series A preferred stock and the repurchase of our series A preferred stock at a discount of $2.9 million. The difference between 2004 and 2003 is a result of the factors discussed above.

Liquidity and Capital Resources

Our short-term and long-term liquidity needs arise primarily from: (i) interest payments primarily related to our credit facility; (ii) capital expenditures; (iii) working capital requirements as may be needed to support the growth of our business; (iv) dividend payments on our common stock; and (v) potential acquisitions. Our board of directors has adopted a dividend policy which reflects our judgment that our stockholders would be better served if we distributed a substantial portion of our cash available for distribution to them instead of retaining it in our business.

We expect to fund our operations, interest expense, capital expenditures, working capital requirements and dividend payments on our common stock from cash from operations and distributions from investments. To fund future acquisitions, we intend to use cash from operations and borrowings under our credit facility, or, subject to the restrictions in our credit facility, to arrange additional funding through the sale of public or private debt and/or equity securities, or obtain additional senior bank debt.

For the years ended December 31, 2005, 2004 and 2003, net cash provided by operating activities of continuing operations was $61.7 million, $46.0 million and $32.8 million, respectively. The increase in net cash provided by operating activities in 2005 was primarily due to a decrease in accrued interest resulting from our recapitalization in February 2005.

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Our ability to service our indebtedness depends on our ability to generate cash in the future. We are not required to make any scheduled principal payments under our credit facility’s term loan facility prior to maturity in February 2012. We will need to refinance all or a portion of our indebtedness on or before maturity. We may not be able to refinance our indebtedness on commercially reasonable terms or at all. If we were unable to renew or refinance our credit facility, our failure to repay all amounts due on the maturity date would cause a default under our credit facility. In addition, borrowings under our credit facility bear interest at variable interest rates. On February 8, 2005, we entered into three interest rate swap agreements, with notional amounts of $130.0 million each, to effectively convert a portion of our variable rate interest exposure to fixed rates ranging from 3.76% to 4.11%, plus a 2.0% margin. These swap agreements expire beginning December 31, 2007 through December 31, 2009. On April 7, 2005, we entered into two additional interest rate swap agreements, one with the notional amount of $50.0 million to effectively convert a portion of our variable rate interest exposure to a fixed rate of 4.69%, plus a 2.0% margin, beginning on April 29, 2005 and ending on March 31, 2011, and one with the notional amount of $50.0 million to effectively convert a portion of our variable rate interest exposure to a fixed rate of 4.72%, plus a 2.0% margin, beginning on June 30, 2005 and ending on March 31, 2012.

Effective on September 30, 2005, we amended our credit facility to reduce the effective interest rate margins on the $588.5 million term facility by 0.25% to 1.75% on Eurodollar loans and to 0.75% for Base rate loans. This amendment also effectively reduced the fixed interest rates on our interest rate swap agreements by 0.25%.

As a result of these swap agreements, as of December 31, 2005, approximately 82% of our indebtedness bore interest at fixed rates rather than variable rates. After these interest rate swap agreements expire, our annual debt service obligations on such portion of the term loans will vary from year to year unless we enter into a new interest rate swap or purchase an interest rate cap or other interest rate hedge. To the extent interest rates increase in the future, we may not be able to enter into new interest rate swaps or to purchase interest rate caps or other interest rate hedges on acceptable terms. An increase of 10% in the annual interest rates on our variable rate indebtedness (excluding variable rate indebtedness which has its interest rate effectively fixed under interest rate swap agreements) would result in an increase of approximately $0.7 million in our annual cash interest expense. To the extent interest rates increase in the future, we may not be able to enter into a new interest rate swap or to purchase an interest rate cap or other interest rate hedge on acceptable terms.

Based on the dividend policy with respect to our common stock, we may not have any significant cash available to meet any unanticipated liquidity requirements, other than available borrowings, if any, under the revolving facility of our credit facility. As a result, we may not retain a sufficient amount of cash to finance growth opportunities, including acquisitions, or unanticipated capital expenditures or to fund our operations. If we do not have sufficient cash for these purposes, our financial condition and our business will suffer. However, our board of directors may, in its discretion, amend or repeal the dividend policy to decrease the level of dividends provided for or discontinue entirely the payment of dividends.

We used net proceeds received from the offering, together with approximately $566.0 million of borrowings under the term loan facility of our credit facility, to, among other things, repay all outstanding loans under our old credit facility, repurchase all of our series A preferred stock and consummate tender offers and consent solicitations in respect of our outstanding 91¤2% notes, floating rate notes, 121¤2% notes and 117¤8% notes. On March 10, 2005, we redeemed the remaining outstanding 91¤2% notes and floating rate notes. We redeemed the remaining outstanding 121¤2% notes on May 1, 2005 with borrowings under the delayed draw facility of our credit facility.

Net cash used in investing activities of continuing operations was $42.8 million, $21.0 million and $54.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. These cash flows primarily reflect capital expenditures of $28.1 million, $36.5 million and $33.6 million for the years ended December 31, 2005, 2004 and 2003, respectively, and acquisitions of telephone properties, net of cash

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acquired, of $25.7 million and $33.1 million for the years ended December 31, 2005 and December 31, 2003. There were no acquisitions during 2004.

Offsetting capital expenditures were distributions from investments of $10.9 million, $15.0 million and $10.8 million for the years ended December 31, 2005, 2004 and 2003, respectively. The $15.0 million received in 2004 included a one time $2.5 million distribution from our equity interest in Chouteau Cellular Telephone Company as the partnership sold the majority of its assets. In addition, distributions for the twelve months ended December 31, 2005 included $10.0 million from our equity interest in Orange County Poughkeepsie Limited Partnership as compared to $11.8 million during the twelve months ended December 31, 2004. The distributions declined mainly due to the timing of an additional distribution in 2004. All of these distributions represent passive ownership interests in partnership investments. We do not control the timing or amount of distributions from such investments.

Net cash used in financing activities from continuing operations was $16.6 million, $24.0 million and $2.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. For the year ended December 31, 2005, net proceeds from the issuance of common stock of $431.9 million was used for the net repayment of long term debt of $205.7 million and the repurchase of series A preferred stock and common stock of $129.3 million. The remaining proceeds were used to pay fees and penalties associated with the early retirement of long term debt of $61.0 million, to pay a deferred transaction fee of $8.4 million and to pay debt issuance costs of $9.0 million. For the year ended December 31, 2004, these cash flows primarily represented net repayment of long-term debt of $15.2 million and $7.8 million in debt issuance and offering related costs. For the year ended December 31, 2003, net proceeds from the issuance of long term debt of $23.3 million were offset by debt issuance costs of $15.6 million and the repurchase of our series A preferred stock and class A common stock of $8.6 million.

Our annual capital expenditures for our rural telephone operations have historically been significant. Because existing regulations allow us to recover our operating and capital costs, plus a reasonable return on our invested capital in regulated telephone assets, capital expenditures have historically constituted an attractive use of our cash flow. Capital expenditures were approximately $28.1 million, $36.5 million and $33.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.

We expect that our annual capital expenditures for our existing operations will be approximately $28.0 to $30.0 million for fiscal 2006. We expect to fund all of these capital expenditures through our cash flow from operations. If cash is available beyond what is required to support our dividend policy, we may consider additional capital expenditures if we believe they are beneficial. Although the amount of our capital expenditures can fluctuate from quarter to quarter, on an annual basis we do not expect capital expenditures for our existing operations through fiscal 2009 to vary significantly from our estimated amounts.

On January 5, 2006, we announced that we expect to receive proceeds of $26.7 million from the liquidation of our investment in the Rural Telephone Bank. We expect to receive the proceeds in the middle of 2006. On February 20, 2006, we announced that we had entered into an agreement to sell our investment in Southern Illinois Cellular Corp. Upon closing of this transaction, which is anticipated to be in the second quarter of 2006, we expect to receive proceeds of $16 to $17 million. On January 25, 2006, we agreed to purchase the assets of Cass County Telephone for approximately $33.0 million in cash, subject to adjustment.

On May 2, 2005, we used borrowings under our credit facility’s revolving facility to fund the Berkshire acquisition (including the repayment of $1.3 million of Berkshire’s debt). On September 1, 2005, we used borrowings under our credit facility’s revolving facility to fund the Bentleyville acquisition. We expect to fund the acquisition of Cass County Telephone through proceeds from the previously discussed asset sales and/or borrowings under our credit facility’s revolving facility.

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Our old credit facility consisted of an $85.0 million revolving loan facility, of which $45.0 million was available at December 31, 2004, and two term facilities, a tranche A term loan facility of $40.0 million with $40.0 million outstanding at December 31, 2004 that was to mature on March 31, 2007 and a tranche C term loan facility with $102.4 million outstanding as of December 31, 2004 that was to mature on March 31, 2007. We repaid all of the borrowings under our old credit facility with a portion of net proceeds from the offering together with borrowings under our credit facility.

Our credit facility consists of a revolving facility, or the revolver, in a total principal amount of up to $100.0 million, of which $86.7 million was available at March 1, 2006 and a term loan facility, or the term loan, in a total principal amount of $588.5 million with $588.5 million outstanding at March 1, 2006. The term loan matures in February 2012 and the revolver matures in February 2011. The revolver has a swingline subfacility in an amount of $5.0 million and a letter of credit subfacility in an amount of $10.0 million, which will allow issuances of standby letters of credit for our account. Net borrowings under the revolver were $12.0 million from February 8, 2005 through March 1, 2006 and were used primarily to fund the Berkshire acquisition and the Bentleyville acquisition (including the repayment of $1.3 million of Berkshire’s debt). A $1.3 million letter of credit was also outstanding as of March 1, 2006. Borrowings under our revolving facility bear interest, at our option, at either (i) the Eurodollar rate plus 2.0% or (ii) a base rate, as such term is defined in the credit agreement, plus 1.0%. Effective on September 30, 2005, the Company amended its credit facility to reduce the effective interest rate margins on the $588.5 million term facility by 0.25% to 1.75% on Eurodollar loans and to 0.75% for Base rate loans.

The credit facility contains financial covenants, including, without limitation, the following tests: a minimum interest coverage ratio equal to or greater than 3.0:1 and a maximum leverage ratio equal to or less than 5.25:1. The credit facility contains customary affirmative covenants. The credit facility also contains negative covenants and restrictions, including, among others, with respect to redeeming and repurchasing our other indebtedness, loans and investments, additional indebtedness, liens, capital expenditures, changes in the nature of our business, mergers, acquisitions, asset sales and transactions with affiliates. Subject to certain limitations set forth in the credit facility, we are permitted to pay dividends for the period from the closing date of the offering through July 30, 2005. In addition, we may use all of our Cumulative Distributable Cash (as defined in the credit facility) accumulated after April 1, 2005 to declare and pay dividends after July 30, 2005, but we may not in general pay dividends in excess of such amount. On March 11, 2005, April 29, 2005 and September 14, 2005, we entered into technical amendments to our credit facility.

Our credit facility requires us first to prepay outstanding term loans under the credit facility and, thereafter, to repay loans under the new revolver and/or to reduce revolver commitments (or commitments under the delayed draw facility) under the credit facility with, subject to certain conditions and exceptions, 100% of the net cash proceeds we receive from any sale, transfer or other disposition of any assets, 100% of net casualty insurance proceeds and 100% of the net cash proceeds we receive from the issuance of permitted securities and, at certain times if we are not permitted to pay dividends, with 50% of the increase in our cumulative distributable cash during the prior fiscal quarter. Reductions to the revolving commitments under the credit facility from the foregoing recapture events will not reduce the revolving commitments under the credit facility below $50.0 million. Our credit facility provides for voluntary prepayments of the revolver and the term loan and voluntary commitment reductions of the revolver (and the delayed draw facility), subject to giving proper notice and compensating the lenders for standard Eurodollar breakage costs, if applicable.

In 1998, the Company issued $125.0 million aggregate principal amount of the 91¤2% notes and $75.0 million aggregate principal amount of the floating rate notes. Both series of these notes were to mature on May 1, 2008. On February 9, 2005, we repurchased $115.0 million principal amount of the 91¤2% notes and $50.8 million principal amount of the floating rate notes tendered pursuant to the tender offers

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for such notes. We redeemed the remaining outstanding 91¤2% notes and floating rate notes on March 10, 2005.

In 2000, the Company issued $200.0 million aggregate principal amount of the 121¤2% notes. These notes were to mature on May 10, 2010. On February 9, 2005, we repurchased $173.1 million principal amount of the 121¤2% notes tendered pursuant to the tender offer for such notes. We redeemed the remaining outstanding 121¤2% notes on May 2, 2005.

In 2003, the Company issued $225.0 million aggregate principal amount of the 117¤8% notes. These notes were to mature on March 1, 2010. These notes are general unsecured obligations of the Company, ranking pari passu in right of payment with all existing and future senior debt of the Company, including all obligations under our credit facility, and senior in right of payment to all existing and future subordinated indebtedness of the Company. On February 9, 2005, we repurchased $223.0 million principal amount of the 117¤8% notes tendered pursuant to the tender offer for such notes. At December 31, 2005, $2.1 million principal amount of the 117¤8% notes remains outstanding.

Summary of Contractual Obligations

The tables set forth below contain information with regard to disclosures about contractual obligations and commercial commitments.

The following table discloses aggregate information about our contractual obligations as of December 31, 2005 and the periods in which payments are due:

(1)          Real property lease obligations of $1.2 million associated with the discontinued operations discussed in note 13 to our consolidated financial statements are stated in this table at total contractual amounts. However, we have negotiated lease terminations on these properties to reduce the total obligation. Operating leases from continuing operations of $6.9 million are also included.

The following table discloses aggregate information about our derivative financial instruments as of December 31, 2005, the source of fair value of these instruments and their maturities.

(1)          Fair value of interest rate swaps at December 31, 2005 was provided by the counterparties to the underlying contracts using consistent methodologies.

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