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Fairpoint Communications 10-K 2008 Documents found in this filing:
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Commission File
Number 001-32408
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 þ
Indicate by check mark if the Registrant is not required to file
reports pursuant to Section 13 or 15(d) of the
Act. Yes o No þ
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 þ 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. o
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).
Large accelerated
filer o
Accelerated
filer þ Non-accelerated
filer o
Indicate by check mark whether the Registrant is a shell company
(as defined in Rule 12b-2 of the
Act). Yes o No þ
The aggregate market value of the common stock held by
non-affiliates of the registrant as of June 30, 2007 (based on
the closing price of $17.75 per share as quoted on the New York
Stock Exchange as of such date) was approximately $610,510,000.
As of February 25, 2008, there were 35,264,945 shares of
the Registrant’s common stock, par value $0.01 per share,
outstanding.
Certain information required by Part III of this Annual
Report will be incorporated by reference from the
Registrant’s Proxy Statement to be filed pursuant to
Regulation 14A with respect to the Registrant’s fiscal
2008 annual meeting of stockholders.
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PART I
Some statements in this Annual Report are known as
“forward-looking statements” within the meaning of
Section 27A of the Securities Act of 1933, as amended, or
the Securities Act, and Section 21E of the Securities
Exchange Act of 1934, as amended, or the Exchange Act.
Forward-looking statements may relate to, among other things:
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 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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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.
We are a leading provider of communications services in rural
and small urban communities, offering an array of services,
including local and long distance voice, data, video and
Internet and broadband product offerings. We are one of the
largest telephone companies in the United States focused on
serving rural and small urban communities, and we are the
12th largest local telephone company in the United States,
in each case based on number of access lines as of
December 31, 2007. We operate in 18 states with
305,777 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, 2007.
We were incorporated in February 1991 for the purpose of
acquiring and operating incumbent telephone companies in rural
and small urban markets. We have acquired 35 such businesses, 30
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 communities we serve have
fewer than 2,500 access lines. Most of our existing telephone
companies qualify as rural local exchange carriers under the
Telecommunications Act of 1996, or the 1996 Act.
Rural local exchange carriers have historically been
characterized by stable operating results and strong cash flow
margins and operate in supportive regulatory environments. While
our historical results indicate a higher level of growth than
non-rural local exchange carriers, this increased growth was
principally generated through acquisitions. Excluding revenue
from acquisitions, our total revenues grew 0.9% from 2004 to
2007. In particular, existing state and federal regulations
permit rural local exchange carriers to charge rates that enable
recovery of their operating costs, plus a reasonable rate of
return on their invested capital (as determined by relevant
regulatory authorities). Historically, 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. However, in
our markets, we have experienced some voice competition from
cable providers and competitive local exchange carriers. We also
are subject to competition from wireless and other technologies.
If competition were to increase, local calling services, data
and internet services and the originating and terminating access
revenues we receive may be reduced. 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.
On January 15, 2007, we entered into an Agreement and Plan
of Merger with Verizon Communications Inc., or Verizon, and
Northern New England Spinco Inc., a subsidiary of Verizon, or
Spinco, as amended by Amendment No. 1 to Agreement and Plan
of Merger, dated as of April 20, 2007, Amendment No. 2
to Agreement and Plan of Merger, dated as of June 28, 2007,
Amendment No. 3 to Agreement and Plan of Merger, dated as
of July 3, 2007, Amendment No. 4 to Agreement and Plan
of Merger, dated as of
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November 16, 2007, and Amendment No. 5 to Agreement
and Plan of Merger, dated as of February 25, 2008, referred
to herein as the merger agreement. Pursuant to the merger
agreement, Spinco will merge with and into FairPoint and,
following completion of the merger, the separate existence of
Spinco will cease. FairPoint will survive the merger and will
hold and conduct the combined business operations of FairPoint
and Spinco. We refer collectively to the transactions described
above as the merger. When the merger is completed and prior to
the elimination of fractional shares, Verizon stockholders will
collectively own approximately 60% and FairPoint stockholders
will collectively own approximately 40% of the shares of our
common stock following the merger, on a fully diluted basis
(excluding treasury stock, certain specified options, restricted
stock units, restricted units and certain restricted shares
outstanding as of the date of the merger agreement). On
August 22, 2007, our stockholders voted to approve the
adoption of the merger agreement and to approve the issuance of
shares of our common stock to Verizon stockholders pursuant to
the merger agreement.
In connection with the merger, Verizon and Spinco entered into a
Distribution Agreement, dated as of January 15, 2007, as
amended by Amendment No. 1 to Distribution Agreement, dated
as of March 30, 2007, Amendment No. 2 to Distribution
Agreement, dated as of June 28, 2007, Amendment No. 3
to Distribution Agreement, dated as of July 3, 2007, and
Amendment No. 4 to the Distribution Agreement, dated
February 25, 2008, referred to as the distribution
agreement, under which Verizon and its subsidiaries (other than
Cellco Partnership doing business as Verizon Wireless),
collectively referred to as the Verizon Group, will transfer
certain specified assets and liabilities of the local exchange
business of Verizon New England Inc., or Verizon New England, in
Maine, New Hampshire and Vermont and the customers of the
related long distance and Internet service provider business in
those states to subsidiaries of Spinco. In exchange therefore,
Spinco will:
After the distribution and immediately prior to the merger,
Verizon will spin-off Spinco by distributing all of the shares
of Spinco common stock to a third-party distribution agent to be
held collectively for the benefit of Verizon stockholders. We
refer collectively to the transactions described above as the
spin-off.
To comply with the conditions to the approval of the merger and
related transactions imposed by state regulatory agencies, the
Verizon Group will also contribute at or prior to the spin-off
approximately $316.2 million in cash to the working capital
of Spinco in addition to the amount specified in the
distribution agreement as currently in effect. Additionally,
Verizon will not receive credit for the $12.0 million that
Verizon spent in expanding its DSL network in Maine, which the
Verizon Group was entitled to receive as an offset to its
capital contribution obligations under the distribution
agreement as currently in effect. Of the approximately
$316.2 million, the Verizon Group may contribute
$25.0 million to us on the second anniversary of the
closing date of the merger or, at its option, pay to us on the
closing date of the merger the net present value of that amount
which is estimated to be approximately $24.0 million, which
amount is to be used by us to make capital expenditures in New
Hampshire. The aggregate required capital contributions required
to be made by the Verizon Group are referred to collectively as
the required capital contribution. For purposes of this Annual
Report, it is assumed that the Verizon Group will make the
required capital contribution in the approximate amount of
$316.2 million prior to the closing of the merger.
We expect that the Verizon Group will seek to exchange the notes
issued by Spinco to the Verizon Group for certain outstanding
debt obligations of the Verizon Group. We then expect that the
notes thereby exchanged will be sold through an offering in
accordance with the provisions of Rule 144A under the
Securities Act. We refer collectively to the transactions
described above as the debt exchange.
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In addition, we expect that in connection with the merger,
FairPoint and Spinco will enter into a new $2,030 million
senior secured credit facility, referred to as the new credit
facility, consisting of a
non-amortizing
revolving facility in an aggregate principal amount of up to
$200 million, referred to as the new revolver, a senior
secured term loan A facility in an aggregate principal amount of
up to $500 million, referred to as the term loan A
facility, a senior secured term loan B facility in an aggregate
principal amount of at least $1,130 million, referred to as
the term loan B facility, and together with the term loan A
facility, referred to as the new term loan, and a delayed draw
term loan facility in the amount of $200 million, referred
to as the new delayed draw term loan. We expect that Spinco will
draw $1,160 million under the new term loan immediately
prior to the spin-off and FairPoint will draw $470 million
under the new term loan concurrently with the closing of the
merger.
We collectively refer to the merger, spin-off, the debt
exchange, the issuance of the notes to the Verizon Group,
FairPoint’s and Spinco’s entry into the new credit
facility and the borrowings thereunder as the transactions. We
currently expect the transactions to close on March 31,
2008, but we cannot assure you that the transactions will close
on such date or that the transactions will be consummated.
In connection with the merger, on January 15, 2007 we also
entered into (i) a Transition Services Agreement, or the
TSA, with certain subsidiaries of Verizon, (ii) an Employee
Matters Agreement, or the EMA, with Verizon and Spinco,
(iii) a Tax Sharing Agreement, or the tax sharing
agreement, with Verizon and Spinco, and (iv) a Master
Services Agreement, or the MSA, with Capgemini U.S. LLC, or
Capgemini, which was subsequently amended by the First Amendment
to the Master Services Agreement, dated as of July 6, 2007
and the Second Amendment to the Master Services Agreement, dated
February 25, 2008. The TSA allows for the provision of
certain services on an interim basis following the merger. The
EMA will allow for the uninterrupted continuity of employment,
compensation and benefits of Spinco employees. Through the MSA,
we intend to replicate
and/or
replace certain existing Verizon systems during a phased period
through the fourth quarter of 2008.
The parties to the merger have received orders, dated
February 1, 2008, February 15, 2008 and
February 25, 2008 of applicable state regulatory
authorities in Maine, Vermont and New Hampshire, respectively,
in each case approving the transactions subject to certain
conditions.
The orders issued by the state regulatory authorities in Maine,
New Hampshire and Vermont provide for, among other things:
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The terms of the orders also prohibit us from consummating any
acquisition with a transaction value in excess of
$100 million during a period of one year following the
completion of the cutover from the systems that will be provided
by the Verizon Group during the period of the TSA to our
systems, and for a period of up to three years following the
closing of the merger if certain financial tests are not met.
The order issued by the NHPUC also prohibits us from
consummating any acquisition until it meets specified service
quality benchmarks.
We have agreed to the appointment of an independent third-party
monitor for the cutover process contemplated by the TSA. The
monitor will consult with representatives of the Vermont
Department of Public Service, referred to as the VDPS, the Maine
Public Utilities Commission, referred to as the MPUC, and the
NHPUC. The monitor will evaluate and approve our testing and
cutover readiness process to evaluate our readiness to support
our operations after the cutover from the systems that will be
provided by the Verizon Group during the period of the TSA.
The parties have also obtained the approval of the Federal
Communications Commission, or the FCC, in an order dated
January 9, 2008 that imposed no additional conditions.
On February 25, 2008, we entered into the fifth amendment
to our existing credit facility, as amended, referred to as our
existing credit facility, in order to accommodate the expected
March 31, 2008 closing date for the merger. The fifth
amendment to our existing credit facility (i) allows us to
continue to make pre-closing expenditures related to the merger
during the three months ending March 31, 2008;
(ii) provides accommodations for certain restructuring
charges that we would incur if the merger is not consummated;
(iii) amends the interest coverage ratio maintenance
covenant to require our interest coverage ratio to be not less
than 1.85:1.00 for any fiscal quarter ending after
December 31, 2007 and on or prior to December 31,
2008, 2.50:1.00 for any fiscal quarter ending after
December 31, 2008 and on or prior to December 31, 2009
and 2.75:1:00 for any fiscal quarter ending thereafter;
(iv) amends the leverage ratio maintenance covenant to
require our leverage ratio to not exceed 6.50:1.00 for any
quarter ending after December 31, 2007 and on or
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prior to December 31, 2008, 5:00:1:00 for any fiscal
quarter ending after December 31, 2008 and on or prior to
December 31, 2009 and 4.50:1.00 for any fiscal quarter
ending thereafter; (v) prohibits us from paying dividends
on or repurchasing our common stock if (1) our total
leverage ratio exceeds 4.50:1:00 (previously 5.25:1.00) on the
dividend calculation date and/or (2) our cash on hand is
less than $20 million (previously $10 million);
(vi) provides for an amount equal to 75% of the increase in
our cumulative distributable cash as of the last day of each
fiscal quarter to be applied as a mandatory repayment of the
principal amount of outstanding B term loans under our
existing credit facility (or an amount equal to 50%, if our
leverage ratio is less than or equal to 5.25:1.00);
(vii) provides for more restrictive negative covenants,
minimum liquidity requirements and increased mandatory
prepayments from proceeds of debt and equity issuances;
(viii) provides for acceleration of the maturity of the
borrowings under our existing credit facility to June 30,
2009 if certain vendor debt incurred by us in connection with
the merger is outstanding as of such date and has a mandatory
payment date on or prior to the maturity of the borrowings under
our existing credit facility as of such date;
(ix) prohibits us from incurring additional obligations
related to the merger after March 31, 2008; provided that
we may make cash expenditures not to exceed $20 million in
the aggregate from the proceeds of equity issuances or if we
have received a reimbursement obligation from Verizon or another
third party acceptable to the lenders under our existing credit
facility and certain other conditions are satisfied;
(x) provides for higher interest rate margins (3.00% on
base rate loans and 4.00% on Eurodollar loans), a Eurodollar
rate floor of 2.50% and repayment premiums payable during the
two year period beginning on May 1, 2008 upon certain
repayments of borrowings under our existing credit facility,
which provisions would become effective as of May 1, 2008
if our existing credit facility has not been repaid in full on
or prior to such date; and (xi) provides for higher
interest rate margins (5.00% on base loans and 6.00% on
Eurodollar loans), a Eurodollar rate floor of 3.25%, which
provisions would become effective as of January 1, 2009 if
our existing credit facility has not been repaid in full on or
prior to such date. We paid the lenders an amendment fee of
$1.7 million in connection with the fifth amendment. We
have also agreed to pay additional fees of 0.25%, 1.5% and
2.5% of the aggregate amount of all outstanding term loans and
revolving commitments of the lenders outstanding on the
effective date of the fifth amendment to the lenders under the
existing credit facility on April 1, 2008, May 1, 2008
and January 1, 2009, respectively, if our existing credit
facility is not repaid in full on or prior to such dates.
We anticipate that we will not be permitted to pay dividends on
our common stock pursuant to our existing credit facility as
amended by the fifth amendment; provided that we would be
permitted to declare a dividend at any time prior to
April 30, 2008 so long as the payment of such dividend is
expressly subject to the consummation of the merger and related
transactions and we have repaid in full all of the obligations
owing under the existing credit facility.
Our management believes that the fifth amendment to our existing
credit facility was necessary to avoid events of default
relative to certain covenants as of March 31, 2008,
assuming the closing of the merger does not occur on or before
March 31, 2008.
We intend to repay our existing credit facility in full in
connection with the closing of the transactions and,
accordingly, the provisions contained in the fifth amendment to
our existing credit facility, including those restricting the
payment of dividends, would terminate as a result of such
repayment and no longer be effective. However, there can be no
assurance that the transactions will be consummated.
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.
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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.
Following the merger, we expect to be less dependent on
regulated revenues like Universal Service Fund high cost loop
payments.
See “Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations” in this
Annual Report for more information regarding our revenue sources.
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
carrier’s 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 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 exchanges to a customer in another exchange in the
same state, or when such a call is terminated to a customer in
one of 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 exchanges to a
customer in another state, or when such a call is terminated to
a customer in one of our 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 FCC instead of the state regulatory authority.
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
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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.
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.
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.
We seek to capitalize on our local exchange carriers’ local
presence and network infrastructure by offering enhanced
services to customers, as well as billing and collection
services for interexchange carriers.
Cable TV and Video. In certain of our markets
we offer video services to our customers through cable
television and video-over-DSL.
Enhanced Services. Our advanced digital switch
and voicemail platforms allow us to offer enhanced services such
as call waiting, call forwarding and transferring, 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.
Billing and Collection. Many interexchange
carriers provide long distance services to our local exchange
carrier customers and may elect to use our billing and
collection services. Our 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. We contract with leading industry providers to assist
in the sale of advertising and the compilation of information,
as well as the production, publication and distribution of these
directories.
Most of our 30 local exchange companies operate as the incumbent
local exchange carrier in each of their respective markets. Our
local exchange companies served 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 served residential
customers as of December 31, 2007. Our business customers
accounted for approximately 23% of our access lines as of
December 31, 2007. Our business customers are predominantly
in the agriculture, light manufacturing and service industries.
Following the merger, our operations will be more focused on
small urban markets and will be geographically concentrated in
the northeastern United States.
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The following chart identifies the number of access line
equivalents in each of our 18 states as of
December 31, 2007:
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 local exchange companies 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.
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 companies 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, 2007, we had 244 employees engaged in
sales, marketing and customer service.
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
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provide for greater efficiencies and profitability. As of
December 31, 2007, all of our operating companies had
converted to a single outsourced billing platform.
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, 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, 2007, we had deployed this technology in 152
of our 153 exchanges. Approximately 99% 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.
The 1996 Act and other recent actions taken by the FCC and state
regulatory authorities promote competition in the provision of
communications services; however, many of the competitive
threats now confronting larger regulated telephone companies are
limited in the rural local exchange carrier marketplace. Our
rural local exchange carriers historically have experienced
limited 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. We
estimate that as of December 31, 2007, a majority of our
current customers and a majority of our customers following the
merger had access to a cable modem offering.
Following the merger, our operations will be more focused on
small urban markets and will be geographically concentrated in
the northeastern United States. As a result, we expect to face
more competition in our business located in the northeastern
United States. In addition, Verizon has informed us of its
current intention to compete with us following the merger by
continuing to provide the following services in the northern New
England areas in which we will operate:
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Although Verizon could compete with us in the offering of long
distance services to residences and small businesses, Verizon
does not presently actively market the sale of these services to
residences and small businesses in Maine, New Hampshire and
Vermont, other than through the current local exchange business
and related landline activities in Maine, New Hampshire and
Vermont as historically operated by the Verizon Group, or the
Northern New England business. In addition, if we enter into an
agreement with Verizon or another wireless services provider to
be a mobile virtual network operator, or MVNO, we will compete
with Verizon to provide wireless services in those areas where
the Northern New England business and Cellco Partnership doing
business as Verizon Wireless currently operate.
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 FCC’s requirement that telephone companies offer
wireline-to-wireless number portability may increase the
competition we face from wireless carriers.
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 have and could continue to face increased
competition from competitive local exchange carriers,
particularly in offering services to Internet service providers.
Voice over internet protocol, or VoIP, service is increasingly
being embraced by all industry participants. VoIP 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. This routing mechanism may give VoIP service
providers a cost advantage and enable them to offer services to
end users at a lower price. While current VoIP applications
typically complete calls using incumbent local exchange carrier
infrastructure and networks, as VoIP 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 VoIP, 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.
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
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computers. Many of these competitors have substantially greater
financial, technological, marketing, personnel, name-brand
recognition and other resources than those available to us.
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.
Although we currently believe we offer the most comprehensive
suite of communications services in our markets, existing
service providers such as wireline, wireless, cable and utility
companies are beginning to offer bundled services in our
markets. We may face increased competition from such bundled
service providers in the future.
As of December 31, 2007, we employed a total of
1,087 employees. 130 employees of our local exchange
companies are covered by six Collective Bargaining Agreements.
We believe the state of our relationship with our union and
non-union employees is generally good. Within our company,
262 employees are employed at our corporate offices and
825 employees are employed at our local exchange companies.
Following the merger, we expect to have approximately
3,800 employees covered by eight collective bargaining
agreements.
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.
We are subject to extensive federal, state and local regulation.
At the federal level, the FCC generally exercises jurisdiction
over 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 common carriers’ facilities and services
to the extent those facilities are used to provide, originate or
terminate intrastate communications. In addition, pursuant to
the 1996 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 exercise substantial oversight over the
provision by incumbent telephone companies of interconnection
and non-discriminatory network access to competitive
communications providers.
Most of our existing telephone companies qualify as rural local
exchange carriers under the 1996 Act. Following the
transactions, the Northern New England business will comprise
the vast majority of our lines nationwide. The Northern New
England business is predominately non-rural, and is referred to
as the non-rural operations. The regulation of the operations
historically conducted by the Northern New England business
differs in certain respects from that applicable to our
traditional, rural local exchange operations, referred to as our
existing rural operations.
We are required to comply with the Communications Act of 1934,
or the Communications Act, which requires, among other things,
that communications carriers offer telecommunications services
at just and reasonable rates and on terms and conditions that
are not unreasonably discriminatory. We are also required to
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comply with the 1996 Act, which amended the Communications Act
by adding provisions intended to promote competition in the
provision of local service, and to lead to deregulation as
markets become more competitive.
Our local exchange subsidiaries receive compensation from
long-distance telecommunications providers for the use of their
network to originate and terminate interstate inter-exchange
traffic. With respect to intrastate traffic, the FCC regulates
the prices we may charge for this purpose, referred to as access
charges, as a combination of flat monthly charges paid by
end-users and usage-sensitive charges paid by long-distance
carriers, and recurring monthly charges for use of dedicated
facilities by long distance carriers. The amount of access
charge revenue that we will receive is subject to change.
Following the transactions, the non-rural operations will be
subject to price cap regulation of access charges. Under price
cap regulation, limits are imposed on a company’s
interstate rates without regard to its costs or revenue
requirements. These limits are adjusted annually based on
FCC-specified formulae, such as for inflation, as well as
through occasional regulatory proceedings, but will generally
give us flexibility to adjust our rates within these limits. In
contrast, our existing rural operations will be subject to
interstate rate of return regulation, permitting us to set rates
for those operations based upon our allowed costs and projected
revenue requirement, including an authorized rate of return of
11.25%. In an order dated January 25, 2008, the FCC granted
our request for a waiver of the “all or nothing” rule,
which will allow us to continue to operate the non-rural and
existing rural operations under these respective regimes until
the FCC completes its general review of whether to modify or
eliminate the all or nothing rule.
The FCC has made various reforms to the existing rate structure
for access charges, which, combined with the development of
competition, have generally caused the aggregate amount of
access charges paid by long-distance carriers to decrease over
time. Other reform proposals are now pending. The FCC has not
yet announced whether it will take any action with respect to
its comprehensive reform proposal for intercarrier compensation,
which seeks, among other things, to unify state and interstate
intercarrier charges in certain circumstances, provide a
mechanism to replace intercarrier revenues lost through rate
unification, and resolve a number of outstanding disputes among
carriers regarding interconnection and compensation obligations.
The FCC has also sought comment on whether access charges should
apply to VoIP or other Internet protocol-based service
providers. We cannot predict what changes, if any, the FCC may
eventually adopt and the effect that any of these changes may
have on our business.
Current FCC rules provide different methodologies for the
determination of universal service payments to rural and
non-rural telephone companies. In general, the rules provide
high-cost support to rural telephone companies where the
company’s actual costs exceed a nationwide benchmark level.
High-cost support for non-rural telephone companies, on the
other hand, is determined by nationwide proxy cost model. Under
the current FCC rules, following the transactions our non-rural
operations will receive support under the non-rural model
methodology in Maine and Vermont. The FCC’s current rules
for support to high-cost areas served by non-rural local
telephone companies were remanded by the U.S. Court of
Appeals for the Tenth Circuit, which had found that the FCC had
not adequately justified these rules. The FCC has initiated a
rulemaking proceeding in response to the court’s remand,
but its rules remain in effect pending the results of the
rulemaking. The FCC is also considering proposals to update the
proxy model upon which non-rural high-cost funding is
determined, as well as other possible reforms to the support
mechanism for non-rural carriers.
The payments that are received by the existing rural operations
from the Universal Service Fund will be intended to support the
high cost of our operations in rural markets. Under current FCC
regulations, the total Universal Service Fund support available
for high-cost loops operated by rural local telephone companies
is subject to a cap. The FCC prescribes the “national
average cost per loop” each year to keep the total
available funding within the cap. Payments from the Universal
Service Fund will 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
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increases and our operating costs and average cost per loop
remain constant or decrease, the payments we will receive from
the Universal Service Fund will decline. Based on historical
trends, we believe the total payments from the Universal Service
Fund to our existing rural operations likely will continue to
decline.
Universal Service Fund disbursements may be distributed only to
carriers that are designated as “eligible
telecommunications carriers” by a state regulatory
commission. Following the transactions, all of our non-rural and
rural local exchange carriers will be designated as eligible
telecommunications carriers. However, under current regulations,
competitors can obtain the same per-line support payments as we
do, if a state regulatory commission determines that granting
such support is in the public interest.
The FCC is currently considering revisions to the distribution
mechanisms for Universal Service Fund high-cost support. The
proposals under consideration include using “reverse
auctions” to determine recipients of rural high-cost
support and creating separate funds for wireless, broadband, and
“carriers of last resort,” which might be the
incumbent local exchange carrier. These and other proposed rule
changes could reduce our support in the future, reduce the
support available to our competitors or provide for new support,
such as for broadband services. We cannot predict what course
the FCC will take on universal service distribution reform, but
it is possible that the remedy selected by the FCC could
materially affect the amount of universal service funding we
will receive. If our existing rural local exchange carriers were
unable to receive Universal Service Fund payments, or if those
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 the 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.
Following the transactions, we will receive additional support
under the FCC’s rules in the forms of Interstate Access
Support and Interstate Common Line Support. We will receive
Interstate Access Support in all three of our price cap study
areas (Maine, New Hampshire and Vermont). We will also continue
to receive Interstate Common Line Support in our rate-of-return
study areas. These forms of support replace revenues previously
collected through interstate access charges. We will have no
assurance that these support programs will remain unchanged if
the FCC revises its rules governing universal service and
inter-carrier compensation.
Federal universal service programs are currently funded through
a surcharge on interstate and international end-user
telecommunications revenues. Declining long-distance revenues,
the popularity of service bundles that include local and
long-distance services, and the growth in size of the fund, due
primarily to increased funding to competitive eligible
telecommunications carriers, all prompted the FCC to consider
alternative means for collecting this funding. As an interim
step, the FCC has ordered that providers of certain VoIP
services must contribute to federal universal service funding.
The FCC also increased the percentage of revenues subject to
federal universal service contribution obligations that wireless
providers may use as their methodology for funding universal
service. One alternative under active consideration would be to
impose surcharges on telephone numbers or network connections
instead of carrier revenues. Any further change in the current
assessment mechanism could result in a change in the total
contribution that local telephone companies, wireless carriers
or others must make and that would be collected from customers.
We cannot predict whether the FCC or Congress will require
modification to any of the universal contribution rules, or the
ultimate impact that any such modification might have on us.
The 1996 Act provides, in general, for the removal of barriers
to market entry in order to promote competition in the provision
of local telecommunications services. As a result, competition
in our local exchange service areas will continue to increase
from competitive local exchange carriers, wireless providers,
cable companies, Internet service providers, electric companies
and other providers of network services. Many of these
competitors have a significant market presence and brand
recognition, which could lead to more competition and a greater
challenge to our future revenue growth.
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Under the 1996 Act, all local exchange carriers, including both
incumbents and new competitive carriers, are required to:
(i) allow others to resell their services; (ii) ensure
that customers can keep their telephone numbers when changing
carriers, referred to as local number portability;
(iii) ensure that competitors’ customers can use the
same number of digits when dialing and receiving
nondiscriminatory access to telephone numbers, operator service,
directory assistance and directory listing; (iv) ensure
competitive access to telephone poles, ducts, conduits and
rights of way; and (v) compensate competitors for the cost
of completing calls to competitors’ customers from the
other carrier’s customers.
In addition to these obligations, incumbent local exchange
carriers, such as our telephone operating subsidiaries, are
required to: (i) interconnect their facilities and
equipment with any requesting telecommunications carrier at any
technically feasible point; (ii) unbundle and provide
nondiscriminatory access to network elements, referred to as
unbundled network elements, or UNEs, such as local loops and
transport facilities, at regulated rates and on
nondiscriminatory terms and conditions, to competing carriers
that would be “impaired” without them;
(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 local exchange carrier’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 UNEs at
the premises of the incumbent local exchange carrier.
Competitors are required to compensate the incumbent local
exchange carrier for the cost of providing these services.
Following the transactions, our non-rural operations will be
subject to all of the above requirements. In addition, following
the transactions, as a Bell Operating Company, our non-rural
operations will be subject to additional unbundling obligations
that apply only to Bell Operating Companies. In contrast to the
unbundling obligations that apply generally to incumbent local
exchange carriers, these Bell Operating Company-specific
requirements mandate access to certain facilities (such as
certain types of local loops and inter-office transport, and
local circuit switching) even where other carriers would not be
“impaired” without them.
Our existing rural operations will be exempt from the additional
incumbent telephone company requirements until the applicable
rural telephone company receives a bona fide request for these
additional services and the applicable state authority
determines that the request is not unduly economically
burdensome, is technically feasible, and is consistent with the
universal service objectives set forth in the 1996 Act. This
exemption will be effective for all of our existing rural
incumbent local telephone operations, except in Florida where
the legislature has determined that all incumbent local exchange
carriers are required to provide the additional services as
prescribed in the 1996 Act. If a request for any of these
additional services is filed by a potential competitor with
respect to one of our other existing rural operating
territories, we will likely ask the relevant state regulatory
commission to retain the exemption. If a state regulatory
commission rescinds an exemption in whole or in part and does
not allow us adequate compensation for the costs of providing
the interconnection, our costs could increase significantly; we
could face new competitors in that state; and we could suffer a
significant loss of customers and incur a material adverse
effect on our business, financial condition and results of
operations. In addition, we could incur additional
administrative and regulatory expenses as a result of the
interconnection requirements. Any of these could result in a
material adverse effect on our results of operations and
financial condition.
Under the 1996 Act, 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 doing so is consistent with the public interest and is
necessary to avoid a significant adverse economic impact on
communications users, and where imposing the requirement would
be technically infeasible or unduly economically burdensome. If
a state regulatory commission denies all or a portion of a
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 interconnection
rights. With the exception of certain requests by us to modify
the May 24, 2004 implementation date for local number
portability in certain states, we have not encountered a need to
file any requests for suspension or modification of the
interconnection requirements.
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The FCC has required that independent incumbent local exchange
carriers that provide interstate long-distance services
originating from their local exchange service territories must
do so in accordance with “non-structural separation”
rules. These rules have required 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 their affiliated local exchange telephone company
at tariffed rates, terms and conditions. The Bell Operating
Companies have been subject to additional requirements to
separate their long-distance operations form their local
exchange operations in the regions where they operate as Bell
Operating Companies. In addition, the Northern New England
business’ local exchange carriers have been obligated under
the FCC’s “equal access” scripting requirement to
read new customers a list of all available long-distance
carriers presented in random order. Not all of our competitors
must comply with these requirements. Therefore, these
requirements may put us at a competitive disadvantage in the
interstate long-distance market. The FCC recently ruled that the
Bell Operating Companies need no longer comply with these rules
for their long-distance services in order to avoid
classification as a dominant carrier, and that their
independent/incumbent local exchange carrier affiliates need no
longer comply with the separation rules for their long distance
services, provided that they comply with certain existing and
additional safeguards, such as providing special access
performance metrics, offering low-volume calling plans, and
making available certain monthly usage information on
customers’ bills. The FCC also has ruled that the Bell
Operating Companies and their independent incumbent local
exchange carrier affiliates are no longer required to comply
with the equal access scripting requirement. In approving the
transfer of authorizations, the FCC stated that following the
transactions, we would be entitled to this same relief.
We are subject to a number of other statutory and regulatory
obligations at the federal level. For example, the
Communications Assistance for Law Enforcement Act, or CALEA,
requires telecommunications carriers to modify equipment,
facilities and services to allow for authorized electronic
surveillance based on either industry or FCC standards. Under
CALEA and other federal laws, we may be required to provide law
enforcement officials with call records, content or call
identifying information, pursuant to an appropriate warrant.
The FCC limits how carriers may use or disclose customer
proprietary network information, referred to as CPNI, and
specifies what carriers must do to safeguard CPNI provided to
third parties. The U.S. Congress has enacted, and state
legislatures are considering, legislation to criminalize the
sale of call detail records and to further restrict the manner
in which carriers make such information available. The FCC has
recently amended its rules to address these practices, and such
rule changes could result in additional costs to us, including
administrative or operational burdens on our customer care,
sales, marketing and information technology systems.
In addition, if we seek in the future to acquire companies that
hold FCC authorizations, in most instances we will be required
to seek approval from the FCC prior to completing those
acquisitions. The FCC has broad 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 FCC. Fines or other penalties also may be
imposed for such violations. The interstate common carrier
services that we will provide will also be subject to
nondiscrimination requirements and requirements that rates be
just and reasonable.
The FCC has adopted a series of orders that recognize the
competitive nature of broadband and Internet-based services, and
impose lesser regulatory requirements on broadband services and
facilities than apply to narrowband operations.
With respect to our local network facilities, the FCC has
determined that certain unbundling requirements that apply to
narrowband facilities do not apply to broadband facilities such
as fiber-to-the-premises loops and packet switches. The FCC
recently has ruled that broadband Internet access services
offered by telephone companies (using DSL technology), cable
operators, electric utilities and wireless providers qualify as
largely deregulated information services. Telephone companies or
their affiliates may offer the underlying broadband
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transmission services that are used as an input to Internet
access services through private carriage arrangements on
negotiated commercial terms. The FCC order also allows
rate-of-return carriers the option to continue providing DSL
service as a common carrier (status quo) offering.
In addition, a Verizon petition asking the FCC to forbear from
applying common carrier regulation to certain broadband services
sold primarily to larger business customers when those services
are not used for Internet access was deemed granted by operation
of law on March 19, 2006 when the FCC did not deny the
petition by the statutory deadline. The U.S. Court of
Appeals for the District of Columbia Circuit has rejected a
challenge to that outcome.
The FCC has imposed particular regulatory obligations on
broadband services. It has concluded that interconnected VoIP
providers and broadband Internet access providers must comply
with CALEA. The FCC has also required interconnected VoIP
providers to provide enhanced 911 emergency calling
capabilities, to comply with certain disability access
requirements, to comply with the FCC’s rules protecting
CPNI, and to provide local number portability. Recently there
have also been discussions among policymakers concerning
“net neutrality,” or the potential requirement for
non-discriminatory treatment of traffic over broadband networks.
The FCC has sought comment on industry practices in connection
with this issue. However, we cannot predict what impact, if any,
this may have on our business. Finally the FCC has preempted
some state regulation of VoIP.
Following the transactions, because our non-rural operations
will be classified as a Bell Operating Company, they will be
subject to additional requirements in connection with their
provision of enhanced services. Specifically, our non-rural
operations generally must provide enhanced services consistent
with the FCC’s so-called Computer Inquiry rules,
which require each Bell Operating Company to ensure that
unaffiliated enhanced service providers have nondiscriminatory
access to the telecommunications transmission capability
underlying any enhanced services provided by the Bell Operating
Company, except for where the FCC specifically has provided
relief from some or all of these requirements.
Additional rules and regulations may be extended to the
Internet. A variety of proposals are under consideration in both
federal and state legislative and regulatory bodies. We cannot
predict whether the outcome of pending or future proceedings
will prove beneficial or detrimental to our competitive position.
The local service rates and intrastate access charges of
substantially all of our telephone subsidiaries will be
regulated by state regulatory commissions which typically have
the power to grant and revoke franchises authorizing companies
to provide communications services. In some states, our
intrastate long-distance rates are also subject to state
regulation. States typically regulate local service quality,
billing practices and other aspects of our business as well.
Most state commissions have traditionally regulated local
exchange carrier pricing through cost-based
“rate-of-return” regulation. In recent years, however,
state legislatures and regulatory commissions in most of the
states in which our telephone companies operate have either
reduced the regulation of local exchange carriers or have
announced their intention to do so, and we expect this trend
will continue. Such relief may take the form of mandatory
deregulation of particular services or rates; or it may consist
of optional alternative forms of regulation, referred to as
AFOR, which may involve price caps or other flexible pricing
arrangements. Some of these deregulatory measures are described
in greater detail below. We believe that some AFOR plans allow
us to offer new and competitive services faster than under the
traditional regulatory regimes.
The following summary addresses significant regulatory actions
by regulatory agencies in Maine, New Hampshire and Vermont that
have affected or are expected to affect the Northern New England
business:
The parties to the merger have received the orders, dated
February 1, 2008, February 15, 2008 and
February 25, 2008, of applicable state regulatory
authorities in Maine, Vermont and New Hampshire, respectively,
in each case approving the transactions, subject to certain
conditions.
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The orders issued by the state regulatory authorities in Maine,
New Hampshire and Vermont provide for, among other things:
The terms of the orders also prohibit us from consummating any
acquisition with a transaction value in excess of
$100 million during a period of one year following the
completion of the cutover from the systems that will be provided
by the Verizon Group during the period of the transition
services agreement to our systems, and for a period of up to
three years following the closing of the merger if certain
financial tests are not met. The order issued by the NHPUC also
prohibits us from consummating any acquisition until it meets
specified service quality benchmarks.
Prior to the closing of the transactions, the Company, Verizon
and Spinco will amend the transaction documents as necessary to
reflect the terms of the final orders of the state regulatory
authorities. In particular, the Verizon Group will be required
to provide at, or prior to, closing a contribution to Spinco
that would increase Spinco’s working capital in the amount
of not less that approximately $316.2 million. This
contribution would be in addition to the amount specified for
working capital in the distribution agreement between Verizon
and Spinco and Spinco will not be entitled to receive credit for
amounts up to $12.0 million
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that Verizon spent in expanding its DSL network in Maine in
excess of the $1.9 million previously anticipated for that
purposes (which amounts would otherwise have been offset against
Spinco’s required working capital at closing of the merger).
We have agreed to the appointment of an independent third-party
monitor for the cutover process contemplated by the TSA. The
monitor will consult with representatives of the VDPS, the MPUC
and the NHPUC. The monitor will evaluate and approve our testing
and cutover readiness process to evaluate our readiness to
support our operations after the cutover from the systems that
will be provided by the Verizon Group during the period of the
TSA. Any delay caused by the evaluation and approval process
would result in the payment of monthly fees to Verizon for an
additional period and may limit our ability to introduce new
services.
There can be no assurance that the orders issued by state
regulatory authorities in Vermont and New Hampshire approving
the transactions will not be appealed or that third parties will
not seek reconsideration of these orders. The period for appeals
in Maine has expired.
The Northern New England business in Maine currently operates
under an AFOR implemented by the MPUC. The AFOR provides for the
capping of rates for basic local exchange services and allows
pricing flexibility for other services, including intrastate
long distance, optional services and bundled packages. Our
existing telephone companies in Maine currently operate under
traditional rate of return regulation and have limited forms of
pricing flexibility. All telephone companies in Maine are
required to establish intrastate access rates which do not
exceed their interstate access rates as they existed on
January 1, 2003. Certain intrastate wholesale services are
also subject to tariffing requirements of the MPUC. The AFOR
also includes a service quality indexing, or SQI, requirement
for the Northern New England business, which establishes
benchmarks for certain performance categories and imposes
penalties for the failure to meet the benchmarks. In 2006, the
MPUC established temporary service quality benchmarks for
measuring service quality improvements by our existing telephone
companies, which have been satisfied. In addition to the
regulation of rates and service, telephone companies are
generally subject to regulation by the MPUC in other areas,
including transactions with affiliates, financing and
reorganizations. In June 2001, the MPUC ordered the continuation
of the AFOR applicable to the Northern New England
business’s operations in Maine for a second five-year term.
This was appealed by the Maine Office of the Public Advocate and
after proceedings the MPUC’s order approved a final
settlement for these proceedings subject to the closing of the
transactions. Under the terms of the order, among other things,
we would reduce monthly basic exchange rates effective as of
August 1, 2008 by an amount designed to decrease revenues
by $1.5 million per month. The new AFOR would cap basic
exchange rates in Maine at that level for five years after
August 1, 2008.
In orders issued in 2004 and 2005, the MPUC ruled that it had
the authority under federal law to regulate compliance with
certain conditions that the Northern New England business must
satisfy to sell long-distance services, and in particular to
define the elements that the Northern New England business must
provide on a wholesale basis to competitive carriers under
Section 271 of the Communications Act. The MPUC ruled that
it had the authority to set rates for Section 271 elements
and interpreted Section 271 to require the Northern New
England business to provide access to elements that the FCC had
held are not required to be proved as unbundled network elements
under Section 251 of the Communications Act. Verizon New
England challenged the ruling in the U.S. District Court of
Maine. Following an unfavorable ruling, Verizon New England
appealed to the First Circuit Court of Appeals. The First
Circuit vacated the District Court’s decision and held that
the MPUC has no such authority. The court remanded the matter
for further proceedings by the District Court. Once these
matters are resolved, the court’s decision is expected to
reduce to some extent our wholesale service obligations.
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Following the transactions, our incumbent local exchange carrier
business operations in New Hampshire will be subject to rate of
return regulation. We will adopt the contractual and tariffed
rates and terms and conditions rates that were in effect for the
Northern New England business prior to the merger. No rate
proceeding is pending. Within this regulatory structure, the
NHPUC has instituted rules and policies to expedite offerings of
new services, but we will be subject to regulations, such as
tariff filing and cost allocation requirements, that are not
applicable to our competitors. In addition to our access tariff,
we will maintain two New Hampshire wholesale tariffs, one for
interconnection, collocation and UNEs and another for services
offered to carriers for resale. The order of the NHPUC approving
the spin-off and the merger includes conditions generally
limiting rates for existing retain, wholesale and DSL services
during the three years following the closing of the merger to
those in effect as of the close date of the merger.
The intrastate access tariff applicable to the Northern New
England business that we will adopt includes provisions that are
the subject of a pending NHPUC proceeding. In response to a
complaint by a competitive local exchange carrier, the NHPUC is
investigating the application of switched access carrier common
line charges under this tariff in circumstances where the
Northern New England business did not, and we will not, provide
a common line. The investigation addresses both prior charges
and the interpretation of the tariff prospectively. Hearings
have been held and the matter is awaiting decision by the NHPUC.
The outcome of this proceeding and its impact on our New
Hampshire operations after the transactions cannot be predicted.
In a case similar to that of the MPUC described under
“— Maine — Unbundling of Network
Elements,” the NHPUC had entered orders asserting authority
under federal law to require the Northern New England business
to continue offering certain network elements no longer required
to be offered pursuant to Section 251 of the 1996 Act, and
at existing total element long run incremental cost rates until
the NHPUC decided otherwise. The Northern New England business
challenged the orders in the United States District Court for
the District of New Hampshire and obtained an order enjoining
the NHPUC from enforcing the orders. The recent First Circuit
decision that considered the MPUC order also considered this New
Hampshire decision and affirmed the District Court’s
opinion.
The NHPUC is considering a complaint brought by a competitive
local exchange carrier seeking a ruling that access charges, or
at least the carrier common line rate element, do not apply to
certain interexchange calls where neither the calling nor the
called party is served by Verizon New England. Verizon New
England is contesting this complaint. The proceeding, which was
expanded to include similar claims by other competitive
carriers, may result in refunds of access charges collected in
the past and a prohibition on charging some or all of these
charges by us in the future, which could result in reduced
revenues for us. Hearings have been held, and the matter is
awaiting the decision of the NHPUC.
In April 2006, the Vermont Public Service Board issued a final
order adopting an amended alternative regulatory plan, referred
to as the amended Incentive Regulation Plan, for the
Northern New England business to replace a plan adopted in 2000.
The Amended Incentive Regulation Plan is retroactive to
July 1, 2005, and runs through December 31, 2010.
Under the amended plan, the Northern New England business
committed to make broadband capability available to 75% of its
access lines in Vermont by 2008 and 80% of its access lines in
Vermont by 2010 with milestones of 65% and 77% for 2007 and
2009, respectively. The Amended Incentive Regulation Plan
provides pricing flexibility for all new services, and no price
increases are permitted for existing services such as basic
exchange service, message toll service and most vertical
services. The final order also continues a service quality plan
with a $10.5 million penalty cap. Other provisions of the
order include lifeline credits for qualified customers that
subscribe to bundled services and a requirement to separately
public and distribute while and Yellow Pages directories. The
Vermont Public Service board’s order approving the
transaction is conditioned on our being subject to the terms and
conditions of the Amended Incentive Regulation Plan. As a
part of our settlement with the VDPS, we have agreed to exceed
the existing Amended Incentive Regulation Plan’s
broadband buildout milestones and have agreed to a condition
that requires us to reach 100% broadband availability in 50% of
our exchanges in Vermont. This requirement has
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been adopted by the Vermont Public Service Board as a condition
of approval and is in addition to the broadband expansion
requirements contained in the existing Amended Incentive
Regulation Plan. We have also agreed in our settlement with
the VDPS to implement a performance enhancement plan, which has
been adopted by the Vermont Public Service Board as a condition
of approval (in addition to the retail service quality plan
required under the Amended Incentive Regulation Plan).
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 communities. As we
enter into the video markets, municipal franchises may be
required for us to operate as a cable television provider. Some
of these franchises may require the payment of franchise fees.
We have historically obtained municipal franchises as required.
In some areas, we will not need to obtain permits or franchises
because of the subcontractors or electric utilities with which
we will have contracts already possess the requisite
authorizations to construct or expand our networks.
Like all other local telephone companies, our 30 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.
We make available on our website, www.fairpoint.com, our Annual
Reports on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K
and all amendments to such reports as soon as reasonably
practical after we file such material with, or furnish such
material to, the SEC. Our filings with the SEC are available to
the public over the Internet at the SEC’s website at
www.sec.gov, or at the SEC’s public reference room
located at 100 F Street, N.E., Washington, DC 20549.
Please call the SEC at
1-800-SEC-0330
for further information on the operation of the public reference
room.
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 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 based upon our directors’ current
assessment of our business and the environment in which we
operate, and that assessment could change based on regulatory,
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
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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 existing credit
facility contains significant restrictions on our ability to
make dividend payments and the terms of our future indebtedness
are expected to contain similar restrictions.
As a condition to the approval of the transactions by state
regulatory authorities, we have agreed that we will be subject
to reductions in our dividend rate and certain other
restrictions on the payment of dividends following the merger.
Until the termination of conditions date, we may not pay annual
dividends in excess of approximately $1.03 per share. Beginning
with the third full quarter following the closing of the merger
until the termination of conditions date, we may not declare or
pay any dividend unless (i) for the three preceding
quarters, the ratio of adjusted EBITDA to interest expense is at
least 2.25 and the ratio of our indebtedness to adjusted EBITDA
does not exceed (a) 5.50 or (b) after the fifth full
quarter following the closing of the merger, 5.0 and
(ii) for the immediately preceding quarter, the interest
coverage ratio is at least 2.5 and the ratio of indebtedness to
adjusted EBITDA does not exceed 5.0. Beginning with the third
full quarter following the closing of the merger until the
termination of conditions date, we will limit the cumulative
amount of dividends on our common stock to not more than the
cumulative adjusted free cash flow we generate after the closing
of the merger. If on December 31, 2011, our ratio of total
indebtedness to adjusted EBITDA is 3.6 or higher, then we will
reduce our debt by $150 million by December 31, 2012,
and if our debt is not reduced by $150 million by
December 31, 2012, then we will suspend the payment of
dividends until the debt under the new credit facility is
refinanced. See “Item 1. Business — Recent
Developments — Regulatory Conditions,”
“Item 1. Business — Regulatory
Environment — State Regulation — Regulatory
Conditions to the Merger” and “Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities — Dividend
Policy and Restrictions.” In addition to these conditions
and requirements imposed by the regulatory orders, the new
credit facility and the indenture governing the notes will
contain conditions and requirements with respect to our payment
of dividends, and certain of these conditions and requirements
may be more restrictive than the conditions and requirements
imposed by the regulatory orders. See “Item 5. Market
for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities — Dividend
Policy and Restrictions.”
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,
or be permitted under the terms of the regulatory orders and the
agreement governing our indebtedness to pay dividends on our
common stock in accordance with the dividend policy. The
reduction or elimination of dividends may negatively affect the
market price of our common stock.
Based on the dividend restrictions contained in the fifth
amendment to our existing credit facility, we anticipate that we
will not be permitted to pay dividends on our common stock
pursuant to our existing credit facility; provided that we would
be permitted to declare a divided payment at any time prior to
April 30, 2008, so long as the payment of such dividend is
expressly subject to the consummation of the merger and related
transactions and we have repaid in full all of the obligations
owing under our existing credit facility.
To operate and expand our business, service our indebtedness
and complete future acquisitions, we will require a significant
amount of cash. Our ability to generate cash will depend on many
factors beyond our control. We may not generate sufficient funds
from operations to pay dividends with respect to shares of our
common stock, repay or refinance our indebtedness at maturity or
otherwise, to consummate future acquisitions or fund our
operations.
A significant amount of our cash flow from operations will be
dedicated to capital expenditures and debt service. The fifth
amendment to our existing credit facility requires us to use a
significant portion of our excess cash flow to reduce the
indebtedness outstanding under our existing credit facility. In
addition, we currently expect to distribute a significant
portion of our remaining cash flow to our stockholders in the
form of a quarterly dividend (subject to restrictions imposed by
the regulatory orders approving the transactions and the
agreements governing our existing and future indebtedness). As a
result, there can be no assurance that the
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cash that we retain will be sufficient to finance growth
opportunities, including acquisitions, or may be required to
devote additional cash to unanticipated capital expenditures or
to fund our operations.
Our ability 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, will be subject to general
economic, financial, competitive, legislative, regulatory and
other factors that will be 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 service our
indebtedness, to make payments of principal at maturity or to
fund our other liquidity needs.
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 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.
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.
We have a significant amount of indebtedness. This substantial
indebtedness could have important adverse consequences to the
holders of our common stock, including:
Based on the dividend restrictions contained in the fifth
amendment to our existing credit facility, we anticipate that we
will not be permitted to pay dividends on our common stock
pursuant to our existing credit facility; provided that we would
be permitted to declare a divided payment at any time prior to
April 30, 2008, so long as the payment of such dividend is
expressly subject to the consummation of the merger and related
transactions and we have repaid in full all of the obligations
owing under our existing credit facility.
In connection with the merger and other transactions we will
incur a substantial amount of indebtedness. We expect that
immediately following the transactions we will have
approximately $2.2 billion of total debt outstanding, and
we will have approximately $400 million available for
additional borrowing under our new credit facility. We currently
expect that we will borrow at least $110 million under the
new delayed draw term loan during the one-year period following
the closing of the merger to fund certain capital expenditures
and other expenses associated with the merger. Subject to the
covenants expected to be included in the agreements governing
our indebtedness following the merger, we may incur additional
indebtedness, including to pay dividends. Any additional
indebtedness that we may incur would exacerbate the risks
described above.
Borrowings under our existing credit facility bear (and
borrowings under our new credit facility are expected to bear)
interest at variable interest rates. Accordingly, if any of the
base reference interest rates for
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the borrowings under our existing credit facility or our new
credit facility increase, our interest expense will increase,
which could negatively affect our ability to pay dividends on
our common stock or repay or refinance our indebtedness. We seek
to enter into interest rate swap agreements which will
effectively convert a significant portion of our variable rate
interest exposure to fixed rates. If these swap agreements are
in force, a significant portion of our indebtedness will
effectively bear 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 existing credit facility or our new credit facility will
vary unless we enter into new interest rate swap agreements or
purchase an interest rate cap or other form of interest rate
hedge. However, we may not be able to enter into new interest
rate swap agreements or purchase an interest rate cap or other
form of interest rate hedge on acceptable terms, which could
negatively affect our ability to pay dividends on our common
stock or repay or refinance our indebtedness.
In anticipation of the merger, we have spent and will
continue to spend a significant amount of money on assets and
services that are not useful in our existing business.
We expect to spend $200 million on systems integration
pursuant to the MSA in connection with the merger,
$70.7 million of which we had spent as of December 31,
2007. Verizon has agreed to reimburse us for up to
$40 million of pre-closing transition costs (subject to
specific terms contained in the merger agreement). As of
December 31, 2007, we had received $34.2 million of
the $40 million from Verizon, and as of the date of filing
of this Annual Report, Verizon had reimbursed the full
$40 million. A significant portion of the amount we spend
on system integration and other pre-closing transition costs has
been spent and will be spent on assets and services which will
not be useful in our existing business. In addition, the amounts
actually spent on such transition costs may exceed budgeted
amounts.
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 subsidiaries. As a result, the Company relies 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 Company’s subsidiaries have no obligation, contingent
or otherwise, to make funds available to the Company, whether in
the form of loans, dividends or other distributions.
Our existing credit facility and other agreements governing
our indebtedness contain covenants that limit our business
flexibility by imposing operating and financial restrictions on
our operations and the payment of dividends.
Our existing credit facility imposes significant operating and
financial restrictions on us. These restrictions prohibit or
limit, among other things:
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Our existing credit facility also requires 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.
We expect the new credit facility and the indenture governing
the notes to contain similar restrictions in favor of the
lenders and holders, respectively.
Our ability to comply with these covenants, ratios or tests
contained in the agreements governing our 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
the agreements governing our indebtedness. Under certain
conditions, covenants prohibit us from making dividend payments
on our common stock. In addition, upon the occurrence of an
event of default, the lenders under our existing credit facility
(or the new credit facility following the consummation of the
transactions) could elect to declare all amounts outstanding,
together with accrued interest, to be immediately due and
payable. If we were to be unable to repay those amounts, the
lenders under our existing credit facility (or the new credit
facility following the consummation of the transactions) could
proceed against the security granted to them to secure that
indebtedness or the lenders could commence collection or
bankruptcy proceedings against us. If the lenders accelerate the
payment of any outstanding indebtedness, our assets may not be
sufficient to repay all of our indebtedness.
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
existing credit facility (or the new credit facility following
the consummation of the transactions), 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.
Pursuant to the fifth amendment to our existing credit facility,
we agreed to significant restrictions on the operation of our
business, including with respect to the payment of dividends,
capital expenditures and future acquisitions. See
“Item 1. Business — Recent
Developments — Amendment to Our Existing Credit
Facility.”
Limitations on usage of net operating loss carryforwards, and
other factors requiring us to pay cash to satisfy our tax
liabilities in future periods, may affect our ability to pay
dividends to our stockholders.
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
carryforwards, alternative minimum tax credits and other similar
tax attributes. Moreover, the merger will result in a further
ownership change for these purposes. As a result of these
ownership changes, there are specific limitations on our ability
to use our net operating loss carryforwards and other tax
attributes from periods prior to the initial public offering and
the merger. Although it is not expected that these limitations
will materially affect our U.S. federal and state income
tax liability in the near-term, it is possible in the future
that if we were to generate taxable income in excess of the
limitation on usage of net operating loss carryforwards that
these limitations could limit our ability to utilize the
carryforwards and, therefore, result in an increase in our
U.S. federal and state income tax payments. In addition, in
the future we will be required to pay cash to satisfy our tax
liabilities when all of our net operating loss carryforwards
have been used or have expired. Limitations on our usage of net
operating
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loss carryforwards, and other factors requiring us to pay cash
taxes in the future, would reduce the funds available to service
our debt and pay dividends.
Investors holding shares of our common stock immediately
prior to the merger will, in the aggregate, have a significantly
reduced ownership and voting interest after the merger and will
exercise less influence over management.
After the merger’s completion, our current stockholders
will, in the aggregate, own a significantly smaller percentage
of the Company than they will own immediately prior to the
merger. Following completion of the merger and prior to the
elimination of fractional shares, our stockholders immediately
prior to the merger collectively will own approximately 40% of
the Company on a fully-diluted basis (excluding treasury stock,
certain specified options, restricted stock units, restricted
units and certain restricted shares outstanding as of the date
of the merger agreement). Consequently, our current
stockholders, collectively, will be able to exercise less
influence over the management and policies of the Company than
they could exercise immediately prior to the merger. In
addition, Verizon has exercised its right to designate four of
the nine members of our board of directors following the merger.
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, the volume of sales of our common
stock, 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. High levels of 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
companies following periods of volatility in their stock prices.
This type of litigation could result in substantial costs and
divert management’s attention and resources.
Future sales or the possibility of future sales of a
substantial amount of our common stock, including as a result of
the merger, 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. The market price of our common stock could
decline as a result of sales of a large number of shares of our
common stock in the market or the perception that these sales
could occur. These sales, or the possibility that these sales
may occur, may also make it more difficult for us to obtain
additional capital by selling equity securities in the future at
a time and at a price that we deem appropriate.
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.
In connection with the merger, we will issue an estimated
53.8 million shares of our common stock to stockholders of
Verizon. We have registered the issuance of such shares pursuant
to a registration statement filed with and declared effective by
the SEC.
Immediately after the merger, prior to the elimination of
fractional shares, Verizon stockholders will collectively hold
approximately 60% of our common stock on a fully diluted basis
(excluding treasury stock, certain specified options, restricted
stock units, restricted units and certain restricted shares
outstanding as of the date of the merger agreement). Currently,
Verizon’s common stock is included in index funds and
exchange-traded funds tied to the Dow Jones Industrial Average
and the Standard & Poor’s 500 Index. Because we
are not expected to be included in these indices at the time of
the merger and may not meet the investing guidelines of
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certain institutional investors that may be required to maintain
portfolios reflecting these indices, these index funds,
exchange-traded funds and institutional investors may be
required to sell shares of our common stock that they receive in
the merger. These sales may negatively affect the price of our
common stock.
Our certificate of incorporation and 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 certificate of incorporation and
by-laws make it difficult for another company to acquire us and
for our stockholders to receive any related takeover premium for
their securities. For example, our certificate of incorporation
provides that certain provisions of the 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, that stockholders generally may not act by written
consent, and only stockholders representing at least 50% in
voting power may request that the board of directors call a
special meeting. Our 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 are 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.
In addition, the tax sharing agreement entered into in
connection with the merger may limit another party’s
ability to acquire us following the consummation of the
transactions.
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 certificate of incorporation provides that so long as we
hold any authorization, license, permit, order, filing or
consent from the FCC or any state regulatory 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.
We provide services to customers over access lines, and if we
lose access lines, our business, financial condition and results
of operations may be adversely affected.
We generate revenue primarily by delivering voice and data
services over access lines. We have experienced net voice access
line losses in the past few years. We experienced a 15.3%
decline in the number of voice access lines (adjusted for
acquisitions and divestitures) for the period from
January 1, 2003 through December 31, 2007 and a 5.2%
decrease for the period from January 1, 2007 through
December 31, 2007. These losses resulted mainly from
competition and use of alternative technologies and, to a lesser
degree, challenging economic conditions and the offering of DSL
services, which prompts some customers to cancel second line
service. Our 2007 revenues from switched access lines comprised
approximately 80% of our total 2007 revenues, down from 89% in
2003. Our revenues from switched access lines have declined by
2.2% from 2003 to 2007, while the number of access lines has
declined by 13.9% excluding acquisitions. We may continue to
experience net access line losses in our markets. Our inability
to retain access lines could adversely affect our business,
financial condition and results of operations.
In addition, the local exchange business and related landline
activities in Maine, New Hampshire and Vermont as historically
operated by the Verizon Group have experienced net voice access
line losses in the past few years. The Northern New England
business’s 2007 revenues from switched access lines
comprised 77% of
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total 2007 revenues, down from 84% in 2003. Since 2003, the
Northern New England businesses’ revenues from switched
access line have declined by 10.0%, while the number of switched
access lines has declined by 22.6%. The Spinco business we
acquire may continue to experience net access line losses in its
markets.
The merger may present significant challenges to our
management that could divert management’s attention from
day-to-day operations and have a negative impact on our
business.
There is a significant degree of difficulty and management
distraction inherent in the process of closing the merger and
integrating our business and the Spinco business which could
cause an interruption of, or loss of momentum in, the activities
of our existing business. Prior to and immediately following the
closing of the merger, our management team may be required to
devote considerable amounts of time to this integration process,
which will decrease the time they will have to manage our
existing business, service existing customers, attract new
customers and develop new products or strategies. One potential
consequence of such distractions could be the failure of
management to realize opportunities to respond to the increasing
forms of competition that our business is facing, which could
increase the rate of access line loss that our business has
experienced in recent years. If our senior management is not
able to effectively manage the process leading up to and
immediately following the merger, or if any significant business
activities are interrupted as a result of the integration
process, our business could suffer.
We are subject to competition that may adversely impact our
business, financial condition and results of operations.
As an incumbent carrier, we historically have experienced little
competition in our rural telephone company markets. However,
many of the competitive threats now confronting large
communications companies, such as competition from cable
providers, will be more prevalent in the small urban markets
that we will serve following the merger. Regulations and
technology 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 and small urban markets, we will face
competition from wireless technology, which may increase as
wireless technology improves. We will also face competition from
wireline and cable television operators. We may face additional
competition from new market entrants, such as providers of
wireless broadband, VoIP, 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. We estimate
that as of December 31, 2007, a majority of our current
customers and a majority of our customers following the merger
had access to a cable modem offering.
Following the merger, our operations will be more focused on
small urban markets and will be geographically concentrated in
the northeastern United States. We expect to face more
competition in our business located in the northeastern United
States. In addition, Verizon has informed us of its current
intention to compete with us following the merger by continuing
to provide the following services in the northern New England
areas in which we will operate:
Although Verizon could compete with us in the offering of long
distance services to residences and small businesses, Verizon
does not actively market the sale of these services to
residences and small businesses in Maine, New Hampshire and
Vermont, other than through the Northern New England business.
In addition, if we enter into an agreement with Verizon or
another wireless services provider to be a MVNO we will compete
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with Verizon to provide wireless services in those areas where
the Northern New England business and Cellco Partnership doing
business as Verizon Wireless currently operate.
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,
financial condition and results of operations.
Competition may lead to loss of revenues and profitability as a
result of numerous factors, including:
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.
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. Our ability to respond
to new technological developments may be diminished or our
response thereto delayed while our management devotes
significant effort and resources to closing the merger and
integrating our business and the Spinco business.
Our relationships with other communications companies are
material to our operations and their financial difficulties may
adversely affect our business, financial condition and results
of operations.
We originate and terminate calls for long distance carriers and
other interexchange carriers over our network. For that service,
we receive payments for access charges. These payments represent
a significant portion of our revenues and are expected to be
material to our business following the merger. If 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, financial condition and
results of operations.
Our business, financial condition and results of operations
could be adversely affected if we fail to maintain satisfactory
labor relations.
Following the merger, approximately 66% of our employees will be
members of unions employed under seven collective bargaining
agreements. The two principal collective bargaining agreements
to which Verizon is currently a party expire in August 2008.
Upon the expiration of any of these collective bargaining
agreements, we may not be able to negotiate new agreements on
favorable terms to us or at all. Furthermore, the process of
renegotiating the collective bargaining agreements could result
in labor disputes or other difficulties and delays. These
potential labor disruptions could have a material adverse effect
on our results of operations and financial condition. In the
event of any work stoppage or other disruption, we will be
required to engage third-party contractors. Labor disruptions,
strikes or significant negotiated wage or benefits increases
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could reduce our sales or increase our costs and, accordingly,
could have a material adverse effect on our business, financial
condition and results of operations.
Both of the labor unions representing Spinco employees objected
to the merger in certain regulatory proceedings. The
International Brotherhood of Electrical Workers, referred to as
the IBEW, filed four grievances alleging that the transaction
violates their collective bargaining agreements with respect to
job security, benefit plans, transfer of work and hiring
restrictions. The IBEW’s grievances were submitted to
arbitration under the labor arbitration rules of the American
Arbitration Association pursuant to the parties’ collective
bargaining agreements. On November 30, 2007, the arbitrator
hearing the grievances filed by the IBEW concerning benefit
plans and hiring restrictions issued a decision finding no merit
to those grievances and denied them. On December 10, 2007,
the arbitrator hearing the grievances filed by the IBEW
concerning benefit plans and hiring restrictions issued a
decision finding no merit to those grievances and denied them.
The decision in each arbitration has become final. The
Communications Workers of America filed four grievances which
are identical to those of the IBEW. Those grievances have been
denied by Verizon, and the Communications Workers of America has
not sought to have them arbitrated.
We face risks associated with acquired businesses and
potential acquisitions.
Prior to entering into the merger agreement, we grew rapidly by
acquiring other businesses. Subject to restrictions in the tax
sharing agreement that limit our ability to take certain actions
during the two years following the spin-off that could
jeopardize the tax-free status of the spin-off or merger and
restrictions imposed by the orders of state regulatory
authorities in connection with the approval of the transactions,
we expect that a portion of our future growth may result from
additional acquisitions. Growth through acquisitions, including
the merger, entails numerous risks, including:
The size of the Spinco business in relation to our existing
business may exacerbate the above risks with respect to the
merger.
In the future, we may need additional capital to continue
growing through acquisitions. This additional capital may be
raised in the form of additional debt, which would increase our
leverage and could have an adverse effect on our ability to pay
dividends. We may not be able to raise sufficient capital on
terms we consider acceptable, or at all.
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We may not be able to successfully complete the integration of
Spinco or other businesses that we have previously 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, our business, financial condition and
results of operation may be adversely affected.
A network disruption 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 expanded network. Some of
the risks to our network and infrastructure include:
Disruptions may cause interruptions in service or reduced
capacity for customers, either of which could cause us to lose
customers and incur expenses.
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 service to our
customers. We recently completed the conversion of all of our
companies to a single integrated outsourced billing platform for
our end-user customers and we will install a new billing system
for the Spinco business. 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
and bandwidth services.
Our provision of long distance and bandwidth 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 that may adversely affect
our business, financial condition and 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 and maintain
conduit and related communications equipment for any expansion
of our networks. We may need to renew current rights-of-way for
our networks and there can be no assurance that we would be
successful in renewing these agreements on acceptable terms or
at all. 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 are terminated or not renewed, we could be required
to remove our then-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 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. While we are not aware that any of our senior
executives or any senior executives of the Northern New England
business necessary to operate the business of the combined
company following the transactions has indicated an intention to
leave as a result of the merger, none of our senior executives
or those of the Northern New England business, with the
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exception of Eugene B. Johnson, our Chairman and Chief Executive
Officer, are employed pursuant to an employment agreement.
Mr. Johnson is expected to continue as the Chairman and
Chief Executive Officer of the Company following the
transactions. Mr. Johnson’s employment agreement
expires on December 31, 2008. 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, and
remediation of contaminated sites. 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 regulated materials at formerly owned or
operated 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 any violations of environmental laws. Changes in
existing laws or regulations, future acquisitions of businesses
or any newly discovered information could require us to incur
substantial costs in the future relating to these matters.
We are exposed to risks relating to evaluations of controls
required by Section 404 of the Sarbanes-Oxley Act.
As a public reporting company, we are required to comply with
the Sarbanes-Oxley Act and the related rules and regulations of
the SEC, including expanded disclosures and accelerated
reporting requirements. If our management identifies one or more
material weaknesses in our internal control over financial
reporting in the future in accordance with the annual assessment
required by the Sarbanes-Oxley Act, we will be unable to assert
that our internal control is effective. We have identified a
material weakness in our internal controls over financial
reporting as of December 31, 2007, see “Item 1A.
Risk Factors — We have identified a material weakness
in our internal controls over financial reporting as of
December 31, 2007. If we fail to remedy this material
weakness, such failure could result in material misstatements in
our financial statements, cause investors to lose confidence in
our reported financial information and have a negative effect on
the trading price of our common stock.”
In addition, following the merger, we will begin evaluating our
internal control systems with respect to the Spinco business to
allow management to report on, and our independent auditors to
attest to, the internal controls of the Spinco business as
required by Section 404 of the Sarbanes-Oxley Act. We will
be performing the systems and process evaluation and testing
(and any necessary remediation) required to comply with the
management certification and independent registered public
accounting firm attestation requirements of Section 404 of
the
Sarbanes-Oxley
Act.
While we expect that we will be able to fully implement the
requirements relating to internal controls and all other aspects
of Section 404 with respect to the Spinco business for the
year ending December 31, 2009, due to the magnitude of the
merger and the new processes and controls being developed in
conjunction with the integration of the Spinco business, we may
not be able to successfully perform this assessment for the year
ending December 31, 2009.
If we are not able to implement the requirements of
Section 404 with respect to the Spinco business in a timely
manner or with adequate compliance or if we are otherwise unable
to assert that our internal control over financial reporting is
effective for any fiscal year, we might be subject to sanctions
or investigation by regulatory authorities.
We have identified a material weakness in our internal
controls over financial reporting as of December 31, 2007.
If we fail to remedy this material weakness, that failure could
result in material
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misstatements in our financial statements, cause investors to
lose confidence in our reported financial information and have a
negative effect on the trading price of our common stock.
Section 404 of the Sarbanes-Oxley Act requires our
management to make an assessment of the design and operating
effectiveness of our disclosure controls and procedures.
Standards established by the Public Company Accounting Oversight
Board define a material weakness in these disclosure controls
and procedures as a deficiency in internal control over
financial reporting that results in a reasonable possibility
that a material misstatement of a company’s annual or
interim financial statements will not be prevented or detected
on a timely basis. As discussed below in “Item 9A.
Controls and Procedures,” we have concluded that the
following material weakness in our internal controls over
financial reporting existed as of December 31, 2007:
If we fail to remedy this material weakness, that failure could
result in material misstatements in our financial statements,
cause investors to lose confidence in our reported financial
information and have a negative effect on the trading price of
our common stock.
Risks
to the Company If the Transactions are Consummated
The integration of our business and Spinco’s business
may not be successful.
The acquisition of the Spinco business is the largest and most
significant acquisition we have undertaken. Our management will
be required to devote a significant amount of time and attention
to the process of integrating the operations of our business and
Spinco’s business, which will decrease the time they will
have to manage our business, service existing customers, attract
new customers, develop new services or strategies and respond to
increasing forms of competition. Due to, among other things, the
size and complexity of the Northern New England business and the
activities required to separate Spinco’s operations from
Verizon’s, we may be unable to integrate the Spinco
business into our operations in an efficient, timely and
effective manner. Our inability to complete this integration
successfully could have a material adverse effect on our
business, financial condition and results of operations.
All of the risks associated with the integration process could
be exacerbated by the fact that we may not have a sufficient
number of employees to integrate our and Spinco’s
businesses or to operate our business. Furthermore, Spinco
offers services that we have no experience in providing, the
most significant of which are competitive local exchange carrier
wholesale services. Our failure or inability to hire or retain
employees with the requisite skills and knowledge to run our
business following the merger, may have a material adverse
effect on our business. The inability of our management to
manage the integration process effectively, or any significant
interruption of business activities as a result of the
integration process, could have a material adverse effect on our
business, financial condition and results of operations.
In addition, if we continue to require services from Verizon
under the TSA after the one-year anniversary of the closing of
the merger, the fees payable by us to Verizon pursuant to the
TSA will increase significantly, which could have a material
adverse effect on our business, financial condition and results
of operations. The aggregate fees expected to be payable by us
under the TSA for the six-month period following the merger will
be approximately $132.9 million. However, if we require
twelve months or eighteen months of transition services
following the merger, the aggregate fees expected to be payable
will be approximately $226.9 million and
$336.2 million, respectively.
We have agreed to the appointment of an independent third-party
monitor for the cutover process contemplated by the TSA. The
monitor will consult with representatives of the VDPS, the MPUC,
and the NHPUC. The monitor will evalute and approve our testing
and cutover readiness process to evaluate our readiness to
support operations after the cutover from the systems that will
be provided by the Verizon Group during the period of the TSA.
Any delay caused by the evaluation and approval process would
result in the
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payment of monthly fees to Verizon for an additional period and
may limit our ability to introduce new services. See
“Item 1. Business — Regulatory
Environment — State Regulation — Regulatory
Conditions to the Merger.”
The integration of our business and Spinco’s business
may present significant systems integration risks, including
risks associated with the ability to convert from Spinco’s
customer sales, service and support operations platform into our
new customer care, service delivery and network monitoring and
maintenance platforms.
In order to operate following the merger, we will be required to
identify, acquire or develop, test, implement, maintain and
manage systems and processes which provide the functionality
currently performed for the Northern New England business by
over 600 systems of Verizon. Of these Verizon systems,
approximately one third relate to customer sales, service and
support. Another third of the Verizon systems support network
monitoring and related field operations. The remaining Verizon
systems enable finance, payroll, logistics and other
administrative activities. Over 80% of the information systems
used in support of the Northern New England business are Verizon
proprietary systems.
We entered into the MSA with Capgemini to assist in the
identification and conversion of systems to be deployed
following the merger. The collective experience and knowledge of
FairPoint, Capgemini (during the term of the MSA) and Verizon
(during the pre-closing period and the period of the TSA) will
be essential to the success of the integration. The
parties’ inability or failure to implement successfully
their plans and procedures or the insufficiency of those plans
and procedures could result in failure of or delays in the
merger integration and could adversely impact our business,
results of operations and financial condition. This could
require us to acquire and deploy additional systems, extend the
TSA and pay increasing monthly fees under the TSA.
The failure of any of our systems could result in our inability
to adequately bill and provide service to our customers or meet
our financial and regulatory reporting obligations. The failure
of any of our billing and operational support services systems
could have a material adverse effect on our business, financial
condition and results of operations. We are also implementing
new systems to provide for and meet financial and regulatory
reporting obligations. A failure of these systems may result in
us not being able to meet our financial and regulatory reporting
obligations.
We may not realize the anticipated synergies, cost savings
and growth opportunities from the merger.
The success of the merger will depend, in part, on our ability
to realize the anticipated synergies, cost savings and growth
opportunities from integrating our and Spinco’s businesses.
Our success in realizing these synergies, cost savings and
growth opportunities, and the timing of this realization,
depends on the successful integration of our and Spinco’s
businesses and operations. Even if we are able to integrate our
and Spinco’s business operations successfully, this
integration may not result in the realization of the full
benefits of synergies, cost savings and growth opportunities
that we currently expect from this integration within the
anticipated time frame or at all. For example, we may be unable
to eliminate duplicative costs, or the benefits from the merger
may be offset by costs incurred or delays in integrating the
companies.
If the assets transferred to Spinco by Verizon are
insufficient to operate our business, it could adversely affect
our business, financial condition and results of operations.
Pursuant to the distribution agreement, the Verizon Group will
contribute to Spinco and entities that will become Spinco’s
subsidiaries (i) specified assets and liabilities
associated with the local exchange business of Verizon New
England in Maine, New Hampshire and Vermont, and (ii) the
customers of the Verizon Group’s related long distance and
Internet service provider businesses in those states. The
contributed assets may not be sufficient to operate our
business. Accordingly, we may have to use assets or resources
from our existing business or acquire additional assets in order
to operate the Spinco business, which could adversely affect our
business, financial condition and results of operations.
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Pursuant to the distribution agreement, we have certain rights
to cause Verizon to transfer to us any assets required to be
transferred to Spinco or its subsidiaries under that agreement
which were not transferred as required. If Verizon were unable
or unwilling to transfer those assets to us, or Verizon and we
were to disagree about whether those assets were required to be
transferred to Spinco under the distribution agreement, we might
not be able to obtain those assets or similar assets from others.
Conditions imposed by state regulatory authorities in
connection with their approval of the spin-off and the merger
may diminish the anticipated benefits of the merger.
Completion of the spin-off and the merger is conditioned upon
the receipt of certain government consents, approvals, orders
and authorizations. The parties have received the required
approvals of the FCC and of state regulatory authorities.
However, the state regulatory authorities in Maine, New
Hampshire and Vermont that approved the spin-off and the merger
have imposed conditions on us that could have a material adverse
effect on our business, financial condition and results of
operations. These conditions include mandatory capital
expenditures, minimum service quality standards, commitments to
expand substantially the availability of broadband service and
restrictions on our payment of dividends. See “Item 1.
Business — Regulatory Environment — State
Regulation — Regulatory Conditions to the Merger.”
Our business, financial condition and results of operations
may be adversely affected following the merger if we are not
able to replace certain contracts which will not be assigned to
Spinco.
Certain contracts, including supply contracts used in the
Northern New England business, will not be assigned to Spinco by
the Verizon Group. Accordingly, we will have to obtain new
agreements for the goods and services covered by these contracts
in order to operate the Spinco business following the merger.
There can be no assurance that we will be able to replace these
contracts on terms favorable to us or at all. Our failure to
enter into new agreements prior to the closing of the merger may
have a material adverse impact on our business, financial
conditions and results of operations following the merger.
In addition, certain wholesale, large business, Internet service
provider and other customer contracts which are required to be
assigned to Spinco by the Verizon Group require the consent of
the customer party to the contract to effect this assignment.
The Company and the Verizon Group may be unable to obtain these
consents on terms favorable to us or at all, which could have a
material adverse impact on our business, financial condition and
results of operations following the merger.
The geographic concentration of our operations in Maine, New
Hampshire and Vermont following the merger will make our
business susceptible to local economic and regulatory
conditions, and an economic downturn, recession or unfavorable
regulatory action in any of those states may adversely affect
our business, financial condition and results of operations.
We currently operate 30 different rural local exchange carriers
in 18 states. No single state accounted for more than 22%
of our access line equivalents as of December 31, 2007,
which limited our exposure to competition, local economic
downturns and state regulatory changes. Following the merger, we
expect that 88% of our access line equivalents will be located
in Maine, New Hampshire and Vermont. As a result of this
geographic concentration, our financial results will depend
significantly upon economic conditions in these markets. A
deterioration or recession in any of these markets could result
in a decrease in demand for our services and resulting loss of
access lines which could have a material adverse effect on our
business, financial condition and results of operations.
In addition, if state regulators in Maine, New Hampshire or
Vermont were to take action that was adverse to our operations
in those states, we could suffer greater harm from that action
by state regulators than we would from action in other states
because of the concentration of our operations in those states
following the merger.
If the spin-off does not constitute a tax-free spin-off under
section 355 of the Internal Revenue Code, or the merger
does not constitute a tax-free reorganization under
section 368(a) of the Internal Revenue Code, including as a
result of actions taken in connection with the spin-off or the
merger or as
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a result of subsequent acquisitions of stock of Verizon or
our stock, then Verizon, us or Verizon stockholders may be
responsible for payment of substantial United States federal
income taxes.
The spin-off and merger are conditioned upon Verizon’s
receipt of a private letter ruling from the Internal Revenue
Service to the effect that the spin-off, including (i) the
contribution of specified assets and liabilities associated with
the local exchange business of Verizon New England in Maine, New
Hampshire and Vermont, and the customers of the Verizon
Group’s related long distance and Internet service provider
businesses in those states, to Spinco, (ii) the receipt by
the Verizon Group of the Spinco securities and the special cash
payment and (iii) the exchange by the Verizon Group of the
Spinco securities for Verizon Group debt, will qualify as
tax-free to Verizon, Spinco and the Verizon stockholders for
United States federal income tax purposes under Section 355
and related provisions of the Internal Revenue Code, referred to
as the Code. The private letter ruling was issued by the
Internal Revenue Service on October 5, 2007. Although a
private letter ruling from the Internal Revenue Service
generally is binding on the Internal Revenue Service, if the
factual representations or assumptions made in the letter ruling
request are untrue or incomplete in any material respect, then
Verizon and we will not be able to rely on the ruling.
The spin-off and merger are also conditioned upon the receipt by
Verizon of an opinion of its counsel to the effect that the
spin-off will be tax-free to Verizon, Spinco and the
stockholders of Verizon under Section 355 and other related
provisions of the Code. The opinion will rely on the Internal
Revenue Service letter ruling as to matters covered by the
ruling. Lastly, the spin-off and the merger are conditioned on
Verizon’s receipt of an opinion of its counsel and our
receipt of an opinion of our counsel, each to the effect that
the merger will be treated as a tax-free reorganization within
the meaning of Section 368(a) of the Code. All of these
opinions will be based on, among other things, current law and
certain representations and assumptions as to factual matters
made by Verizon, Spinco and us. Any change in currently
applicable law, which may or may not be retroactive, or the
failure of any factual representation or assumption to be true,
correct and complete in all material respects, could adversely
affect the conclusions reached by counsel in their respective
opinions. The opinions will not be binding on the Internal
Revenue Service or the courts, and the Internal Revenue Service
or the courts may not agree with the opinions.
The spin-off would become taxable to Verizon pursuant to
Section 355(e) of the Code if 50% or more of the shares of
either Verizon common stock or Spinco common stock (including
our common stock, as successor to Spinco) were acquired,
directly or indirectly, as part of a plan or series of related
transactions that included the spin-off. Because Verizon
stockholders will own more than 50% of our common stock
following the merger, the merger, standing alone, will not cause
the spin-off to be taxable to Verizon under Section 355(e).
However, if the Internal Revenue Service were to determine that
other acquisitions of Verizon common stock or our common stock,
either before or after the spin-off and the merger, were part of
a plan or series of related transactions that included the
spin-off, this determination could result in the recognition of
gain by Verizon under Section 355(e). In that case, the
gain recognized by Verizon likely would be substantial. In
connection with the request for the Internal Revenue Service
private letter rulings and the opinion of Verizon’s
counsel, Verizon represented that the spin-off is not part of
any such plan or series of related transactions.
In certain circumstances, under the tax sharing agreement, we
would be required to indemnify Verizon against tax-related
losses to Verizon that arise as a result of a disqualifying
action taken by us or our subsidiaries after the distribution
(including for two years after the spin-off (i) entering
into any agreement, understanding or arrangement or engaging in
any substantial negotiations with respect to any transaction
involving the acquisition or issuance of our stock,
(ii) repurchasing any shares of our stock, except to the
extent consistent with guidance issued by the Internal Revenue
Service, (iii) ceasing or permitting certain subsidiaries
to cease the active conduct of the Spinco business and
(iv) voluntarily dissolving, liquidating, merging or
consolidating with any other person unless the Company is the
survivor of the merger or consolidation, except in accordance
with the restrictions in the tax sharing agreement) or a breach
of certain representations and covenants. See
“— We may be affected by significant restrictions
following the merger with respect to certain actions that could
jeopardize the tax-free status of the spin-off and the
merger.” If Verizon were to recognize a gain on the
spin-off for reasons not related to a disqualifying action or
breach by us, Verizon would not be entitled to be indemnified
under the tax sharing agreement.
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We may be affected by significant restrictions following the
merger with respect to certain actions that could jeopardize the
tax-free status of the spin-off or the merger.
The tax sharing agreement restricts FairPoint from taking
certain actions that could cause the spin-off to be taxable to
Verizon under Section 355(e) or otherwise jeopardize the
tax-free status of the spin-off or the merger, which the tax
sharing agreement refers to as disqualifying actions, including:
Nevertheless, we will be permitted to take any of the actions
described above in the event that it obtains Verizon’s
consent, or an opinion of counsel or a supplemental Internal
Revenue Service ruling to the effect that the disqualifying
action will not affect the tax-free status of the spin-off and
the merger. To the extent that the tax-free status of the
transactions is lost because of a disqualifying action taken by
the Company or any of its subsidiaries after the distribution
date, whether or not the required consent, opinion or ruling was
obtained, we generally would be required to indemnify, defend
and hold harmless Verizon and its subsidiaries (or any successor
to any of them) from and against any resulting tax-related
losses incurred by Verizon.
Because of these restrictions, we may be limited in the amount
of capital stock that we can issue to make acquisitions or raise
additional capital in the two years subsequent to the spin-off
and merger. Also, our indemnity obligation to Verizon might
discourage, delay or prevent a change of control during this
two-year period that our stockholders may consider favorable.
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 are 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
revenues. A significant portion of our revenues
comes 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 and for providing
special access services which connect interexchange third-party
private line carriers to their end users in our service areas.
This also includes Universal Service Fund payments for local
switching support, long term support and interstate common line
support. In recent years, several long distance carriers have
declared bankruptcy. Future declarations of bankruptcy by a
carrier, although less likely due to recent industry
consolidation, that utilizes our access services could
negatively impact our business, financial condition and results
of operations.
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The amount of access charge revenues that we currently receive
is based on rates set by federal and state regulatory bodies,
and those rates could change in the future. Further, from time
to time federal and state regulatory bodies conduct rate cases,
“earnings” reviews, or make adjustments to price cap
formulas that may result in rate changes. In addition, reforms
of the federal and state access charge systems, combined with
the development of competition, have caused the aggregate amount
of access charges paid by long distance carriers to decrease.
See “Item 1. Business — Regulatory
Environment — Federal Regulation —
Interstate Access Charges.” If any of the currently
proposed reforms were adopted by the FCC it would likely involve
significant changes in the access charge system and, if not
offset by a revenue replacement mechanism, could potentially
result in a significant decrease in or elimination of access
charges. Decreases in or loss of access charges may or may not
result in offsetting increases in local, subscriber line or
universal service support revenues. Regulatory developments of
this type could adversely affect our business, financial
condition and results of operations.
Risk of loss or reduction of Universal Service Fund
support. We receive Universal Service Fund
revenues (and equivalent state universal service support) to
support our operations in high cost areas. These federal
revenues include universal service service support payments for
local switching support, interstate common line support or
interstate access support. High cost support for our rural and
non-rural operations is determined pursuant to different
methodologies, aspects of which are now under review. See
“Item 1. Business — Regulatory
Environment — Federal Regulation — Universal
Service Support.” Any changes to the existing rules could
reduce the Universal Service Fund revenues we receive following
the merger. Corresponding changes in state universal service
support could likewise have a negative effect on the revenues we
receive.
Further, the total payments from the Universal Service Fund to
our rural operations will fluctuate based upon our rural company
average cost per loop compared to the national average cost per
loop and are likely to decline based on historical trends. See
“Item 1. Business — Regulatory
Environment — Federal Regulation — Universal
Service Support.” We will also receive other Universal
Service Fund support payments, including Interstate Access
Support, in all three of our price cap study areas following the
merger (Maine, New Hampshire and Vermont) and Interstate Common
Line Support in our rate-of-return study areas. If we were
unable to receive such support, or if that support was reduced,
many of the operations of the Northern New England business
would be unable to operate as profitably as they have
historically. Moreover, if we raise prices for services to
offset losses of Universal Service Fund payments, the increased
pricing of our services may disadvantage us competitively in the
marketplace, resulting in additional potential revenue loss.
Furthermore, any changes in the FCC’s rules governing the
distribution of such support or the manner in which entities
contribute to the Universal Service Fund could have a material
adverse effect on our business, financial condition or results
of operations. See “Item 1. Business —
Regulatory Environment — Federal
Regulation — Universal Service Support.”
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 1996 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. To
the extent that state regulators decide that it is in the public
interest to extend some or all of these requirements to our
rural local exchange carriers, we would be required to provide
unbundled network elements to competitors in our rural telephone
company areas. As a result, more competitors could enter our
traditional telephone markets than are currently expected, which
could have a material adverse effect on our business, financial
condition and results of operations.
Risks posed by costs of regulatory
compliance. Regulations create significant
compliance costs for us, and are expected to continue to do so.
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 currently provided in accordance with
tariffs filed with the FCC and state regulatory authorities.
Challenges in the future 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, these challenges
could adversely affect the rates that we are able to charge our
customers.
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In addition, our non-rural operations following the merger will
be subject to extensive regulations not applicable to the rural
operations, including but not limited to requirements relating
to interconnection, the provision of unbundled network elements,
and the other market-opening obligations set forth in the 1996
Act. See “Item 1. Business — Regulatory
Environment — Federal Regulation — Local
Service Competition” for a description of these
requirements. In approving the transfer of authorizations to us,
the FCC determined that
non-rural
operations would be considered a Bell Operating Company
following the completion of the transactions, and will be
subject to the same regulatory requirements that currently apply
to the other Bell Operating Companies. The FCC also stated that
we would be entitled to the same regulatory relief that Verizon
New England has obtained in the region. See “Item 1.
Business — Regulatory Environment — Federal
Regulation” for a description of these requirements.
Any changes made in connection with these obligations could
increase our non-rural operations’ costs or otherwise have
a material adverse effect on our business, financial condition,
and results of operations. Moreover, we cannot predict the
precise manner in which the FCC will apply the Bell Operating
Company regulatory framework to our company.
State regulators in Maine, New Hampshire and Vermont have also
imposed conditions on their approval of the transactions that
could adversely affect our business, financial condition or
results of operations. See “Item 1.
Business — Recent Developments — Regulatory
Conditions” and “Item 1. Business —
Regulatory Environment.”
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, protecting customer privacy or addressing
other issues that impact our business. For example, existing
provisions of the Communications Assistance for Law Enforcement
Act and FCC regulations implementing that legislation require
communications carriers to ensure that their equipment,
facilities, and services are able to facilitate authorized
electronic surveillance. We cannot predict whether or to what
extent the FCC 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 to what extent 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.”
Risk of loss from rate reduction. Our local
exchange companies that operate pursuant to intrastate rate of
return regulation are subject to state regulatory authority over
their intrastate telecommunications service rates. State review
of these rates could lead to rate reductions, which in turn
could have a material adverse effect on our business, financial
condition and results of operations.
Regulatory changes in the communications industry could
adversely affect our business by facilitating greater
competition, reducing potential revenues or raising our
costs.
The 1996 Act provides for significant changes and increased
competition in the communications industry, including
competition for local communications and long distance services.
This statute and the FCC’s implementing regulations could
be submitted for judicial review or affected by future rulings
of the FCC’s thus making it difficult to predict whether
the legislation will have a material adverse effect on our
business, financial condition or results of operations and our
competitors. Several regulatory and judicial proceedings have
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 there
be any assurance 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.”
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We have received no written comments from the SEC staff
regarding our periodic or current reports less than
180 days before the end of our fiscal year ended
December 31, 2007 that remain unresolved.
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 18 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.
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.
From time to time, the Company is involved in other litigation
and regulatory proceedings arising out of its operations.
Management believes that the Company is not currently a party to
any legal proceedings, the adverse outcome of which,
individually or in the aggregate, would have a material adverse
effect on the Company’s financial position or results of
operations.
No matters were submitted to a vote of our security holders
during the fourth quarter of fiscal 2007.
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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 our 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 2007 and 2006:
As of February 20, 2008, there were approximately 150
holders of record of our common stock.
Set forth below is a line graph comparing the yearly percentage
change in the cumulative total stockholder return on shares of
our common stock against (i) the cumulative total return of
all companies listed on the New York Stock Exchange and
(ii) the cumulative total return of the peer group set
forth below which was selected by us. The period compared
commences on February 4, 2005 and ends on December 31,
2007. This graph assumes that $100 was invested on
February 4, 2005 (the date of the initial public offering
of our common stock) in our common stock and in each of the
market index and the peer group index at the closing price for
the Company and the other companies, and that all cash
distributions were reinvested. Our common stock price
performance shown on the graph is not necessarily indicative of
future price performance.
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Our peer group consists of the following
companies: CenturyTel, Inc., Citizens Communications
Company, Consolidated Communications Holdings, Inc., Iowa
Telecommunications Services, Inc. and Windstream Corporation.
Comparison
of Cumulative Total Return Among FairPoint Communications,
Inc.,
NYSE Index and Peer Group Index
Our board of directors has adopted a dividend policy which
reflects an intention that 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 a
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:
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As a condition to the approval of the transactions by state
regulatory authorities, we have agreed that we will be subject
to reductions in our dividend rate and certain other
restrictions on the payment of dividends following the merger.
See “Item 1. Business — Recent
Developments — Regulatory Conditions,”
“Item 1. Business — Regulatory
Environment — State Regulation — Regulatory
Conditions to the Merger” and “— Resections
on Payment of Dividends.”
Based on the dividend restrictions contained in the fifth
amendment to our existing credit facility, we anticipate that we
will not be permitted to pay dividends on our common stock
pursuant to our existing credit facility; provided that we may
declare a dividend at any time prior to April 30, 2008 so
long as the repayment of such dividend is expressly subject to
the consummation of the merger and related transactions and the
repayment in full of all obligations owing under our existing
credit facility.
We believe that our dividend policy limits, but does not
preclude, our ability to pursue growth. If we pay dividends at
the level currently anticipated under our expected 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.
At the time that our board of directors approved the merger, we
expected to maintain our current dividend policy for the Company
following the transactions, subject to the limitations and
restrictions described below under
“— Restrictions on Payments of Dividends.”
However, following the transactions we will pay dividends at a
reduced annual rate of no more than $1.03 per share beginning
with the first full fiscal quarter following the closing of the
merger. See “Item 1. Business — Recent
Developments — Regulatory Conditions” and
“Item 1. Business — Regulatory
Environment — State Regulation — Regulatory
Conditions to the Merger.”
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 existing credit facility restricts our ability to declare
and pay dividends on our common stock as follows:
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Our existing credit facility also permits us to use available
cash to repurchase shares of our capital stock, subject to the
same conditions. See “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Liquidity and Capital Resources” for
a more detailed description of our existing credit facility and
these restrictions.
Based on the dividend restrictions contained in the fifth
amendment to our existing credit facility, we anticipate that we
will not be permitted to pay dividends on our common stock
pursuant to our existing credit facility; provided that we may
declare a dividend at any time prior to April 30, 2008 so
long as the payment of such dividend is expressly subject to the
consummation of the merger and related transactions and the
repayment in full of all obligations owing under our existing
credit agreement.
Our new credit facility is expected to restrict our ability to
declare and pay dividends on our common stock as follows:
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Our new credit facility is also expected to permit us to use
available cash to repurchase shares of our capital stock,
subject to the same conditions.
The indenture governing the notes is expected to restrict our
ability to pay dividends on our common stock as follows:
The parties to the merger have received orders, dated
February 1, 2008, February 15, 2008 and
February 25, 2008, of applicable state regulatory
authorities in Maine, Vermont and New Hampshire, respectively,
in each case approving the transactions, subject to certain
conditions.
The orders issued by the state regulatory authorities in Maine,
New Hampshire and Vermont provided for, among other things:
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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.
None of our equity securities registered pursuant to
Section 12 of the Exchange Act were purchased by us or
affiliated purchasers, as defined in
Rule 10b-18(a)(3)
under the Exchange Act, during 2007.
We did not sell any unregistered equity securities during 2007.
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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.
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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,
48
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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” in this
Annual Report.
We are a leading provider of communications services in rural
and small urban 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 and
small urban communities, and we are the 12th largest local
telephone company in the United States, in each case based on
number of access lines as of December 31, 2007. We operate
in 18 states with 305,777 access line equivalents
(including voice access lines and high speed data lines, or HSD,
which include DSL, wireless broadband and cable modems) in
service as of December 31, 2007.
We were incorporated in February 1991 for the purpose of
acquiring and operating local exchange carriers in rural
markets. Since 1993, we have acquired 35 such businesses, 30 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 communities we serve have
fewer than 2,500 access lines. Most of our telephone companies
qualify as rural local exchange carriers under the 1996 Act.
Rural local exchange carriers have historically been
characterized by stable operating results and strong cash flow
margins and operate in supportive regulatory environments. While
our historical results indicate a higher level of growth than
non-rural local exchange carriers, this increased growth was
principally generated through acquisitions. Excluding revenue
from acquisitions, our total revenues grew 0.9% from 2004 to
2007. Existing state and federal regulations permit rural local
exchange carriers to charge rates that enable recovery of their
operating costs, plus a reasonable rate of return on their
invested capital (as determined by relevant regulatory
authorities). Historically, 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. However, in our markets,
we have experienced some voice competition from cable providers
and competitive local exchange carriers. We also are subject to
competition from wireless and other technologies. If competition
were to increase, local calling services, data and internet
services and the originating and terminating access revenues we
receive may be reduced. 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 substituting DSL for a
second line). We have not been immune to these conditions but 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 board of directors has adopted a dividend policy that
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 for other purposes. 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. As a condition
to the approval of the transactions by state regulatory
authorities, we have agreed that we will be subject to
reductions in the dividend rate and certain other restrictions
on the payment of dividends following the transactions. See
“Item 1. Business — Recent
Developments — Regulatory Conditions,”
“Item 1. Business — Regulatory
Environment — State Regulation — Regulatory
Conditions to the Merger” and “Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities — Dividend
Policy and
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Restrictions.” In addition to these conditions and
requirements imposed by the regulatory orders, the new credit
facility and the indenture governing the notes will contain
conditions and requirement with respect to the payment of
dividends by us, and certain of these conditions and
requirements may be more restrictive than the conditions and
requirements imposed by the regulatory orders. The indenture
governing the notes will also contain covenants restricting the
payment of dividends by us. See “Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities — Dividend
Policy and Restrictions.”
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. In
connection with the approval of the transactions by the
regulatory authorities in Maine, New Hampshire and Vermont, we
will be subject to restrictions on our operations and capital
expenditures. See
“Item. 1. Business—Regulatory
Environment—State Regulation—Regulatory Conditions to
the Merger.”
On January 15, 2007, we entered into the merger agreement
pursuant to which Spinco will merge with and into the Company
with the Company continuing as the surviving corporation. For
accounting purposes, we expect that FairPoint will be the
acquiree. Consequently, merger related costs are being expensed
as incurred in connection with the merger and related
transactions and FairPoint’s assets and liabilities will be
recorded at fair value at acquisition.
Following the merger, our operations will be more focused on
small urban markets and will be geographically concentrated in
the northeastern United States. We expect to face more
competition in our business located in the northeastern United
States and we expect to be less dependent on access and
Universal Service Fund revenue.
Pursuant to the fifth amendment to our existing credit facility,
we agreed to significant restrictions on the operation of our
business, including with respect to the payment of dividends,
capital expenditures and future acquisitions. See
“Item 1. Business — Recent
Developments — Amendment to Our Existing Credit
Facility.”
On January 15, 2007, we entered into the MSA with
Capgemini. Through the MSA, we intend to replicate
and/or
replace certain existing Verizon systems during a phased period
through the fourth quarter of 2008. We are currently in the
application development stage of the project and are recognizing
costs in accordance with Statement of Position
98-1,
“Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use.” We have recognized both
external and internal service costs associated with the MSA
based on total labor incurred as of December 31, 2007
compared to the total estimated labor to substantially complete
the implementation project.
In connection with our evaluation of the effectiveness of our
internal control over financial reporting for the year ended
December 31, 2007, our management determined that our
internal control over financial reporting was not effective as
of December 31, 2007 because a material weakness in
internal control over financial reporting existed as of
December 31, 2007. Specifically, our management’s
oversight and review procedures designed to monitor the
effective of control activities in our northern New England
division were ineffective. As a result, errors existed in
capitalized software costs, operating expenses, accounts
receivable, prepaid expenses, accounts payable and accrued
expenses in our preliminary 2007 consolidated financial
statements. These identified errors were corrected prior to the
finalization of those financial statements. We believe that
progress has been made in the remediation of this material
weakness.
Management views our business of providing voice, data and
communication services to residential and business customers as
one business segment and currently aggregates these revenue
streams under the quantitative and qualitative thresholds
defined in SFAS No. 131, “Disclosures about
Segments of an Enterprise and Related Information.”
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We derive our revenues from:
Following the merger, we expect to be less dependent on certain
regulated revenues, including USF payments and access charges.
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The following summarizes our revenues and percentage of revenues
from continuing operations from these sources:
Our operating expenses are categorized as operating expenses and
depreciation and amortization.
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Discontinued
Operations
In November 2001, we decided to discontinue the competitive
local exchange carrier operations of 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 consolidated financial statements.
The information in our year to year comparisons below represents
only our results from continuing operations.
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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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Revenues increased $13.4 million to $283.5 million in
2007 compared to 2006. Operations acquired in 2006 contributed
$11.8 million to the increased total revenues. Excluding
the impact of acquired operations, revenues from our existing
operations increased $1.6 million. We derived our revenues
from the following sources:
Local calling services. Local calling service
revenues increased $2.0 million to $69.7 million in
2007. Acquired operations increased local calling service
revenues by $3.8 million. Revenues from our existing
operations decreased $1.8 million compared to 2006. The
decrease in local revenues from existing operations is primarily
due to a 5.2% decline in net voice access lines.
Universal Service Fund high-cost loop
support. USF high-cost loop payments decreased
$1.0 million to $19.1 million in 2007. Acquired
operations added $1.0 million in USF revenue and USF
revenues from our existing operations declined
$2.0 million. The national average cost per loop in
relation to our average cost per loop has increased and, as a
result, our receipts from the USF 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
decreased $0.8 million to $71.6 million in 2007
compared to 2006. Acquired operations contributed
$3.2 million to interstate access revenues. Interstate
access revenues from our existing operations decreased
$4.0 million. In 2007, we recognized certain negative
interstate revenue settlement adjustments related to prior years
in the amount of $1.3 million. In addition, in 2006, we
recognized certain negative interstate revenue settlement
adjustments related to prior years in the amount of
$0.8 million. Excluding these prior year adjustments and
acquired operations, interstate access revenue declined
$3.5 million in 2007. This decrease is partially due to
lower expenses and lower net property, plant and equipment
balance at the operating companies.
Intrastate access. Intrastate access revenues
increased $4.1 million to $41.4 million in 2007
compared to 2006. Acquired operations added $1.3 million in
intrastate access revenues in 2007. Intrastate access revenues
from our existing operations increased $2.8 million. The
increase is due to the settlement of certain previously disputed
access charges during 2007 totaling $5.0 million. Excluding
this settlement, intrastate revenues would have decreased due to
a decrease in access rates and a decrease in minutes of use
compared to 2006. Intrastate access revenues are expected to
continue to decline.
Long distance services. Long distance services
revenues increased $6.1 million to $30.2 million in
2007 compared to 2006. Of this increase, $0.1 million was
attributable to acquired companies and $6.0 million was
attributable to our existing operations. This increase was
primarily a result of promotional efforts and bundled product
offerings with unlimited long distance designed to generate more
revenue.
Data and Internet services. Data and Internet
services revenues increased $5.4 million to
$33.6 million in 2007 compared to 2006. Of this increase,
$1.3 million was attributable to acquired companies and
$4.1 million was attributable to our existing operations.
The increase from existing operations is due primarily to
increases in HSD customers as we continue to aggressively market
our HSD services. Our HSD subscriber customer base as of
December 31, 2007 increased to 67,703 subscribers compared
to 59,444 subscribers as of December 31, 2006, a 14%
increase during this period.
Other services. Other services revenues
decreased $2.4 million to $18.0 million in 2007
compared to 2006. Acquired operations added $0.9 million in
other services revenues in 2007. Other services revenues from
our existing operations decreased $3.3 million. This
decrease is principally due to a decrease in directory revenues
in 2007.
Operating expenses, excluding depreciation and
amortization. Operating expenses increased
$63.1 million to $218.6 million in 2007 compared to
2006. Of the increase, $52.1 million is related to
transition expenses related to the merger and $6.2 million
is related to expenses of the acquired operations. The remaining
increase from our existing operations is principally due an
increase in cost of goods sold of $3.4 million
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(principally related to HSD and long distance services), an
increase in operating taxes of $1.3 million, an increase in
bad debt expense of $0.9 million, and an increase in
various network expenses of $1.2 million. These increases
were partially offset by decreases in employee related costs of
$0.9 million and billing expenses of $0.8 million.
Included in operating expenses are non-cash stock based
compensation expenses associated with the award of restricted
stock and restricted units. Stock based compensation expenses
totaled $4.0 million and $2.9 million for the years
ended December 31, 2007 and 2006, respectively.
Depreciation and amortization. Depreciation
and amortization from continuing operations decreased
$2.4 million to $50.8 million in 2007 compared to
2006. Acquired operations added $2.4 million to
depreciation expense. Depreciation expense from our existing
operations decreased $4.8 million primarily due to the
maturing nature of our plant assets.
Income from operations. Income from operations
decreased $45.1 million to $16.2 million in 2007
compared to 2006. This decrease is principally due to the
increase in merger related expenses of $52.1 million
incurred in 2007.
Other income (expense). Total other expense
decreased $9.6 million to $1.4 million in 2007. Net
gains on sale of investments and other assets increased
$34.7 million, principally as a result of the sale of our
investment in O-P Disposition. Equity in net earnings of
investees decreased $5.6 million in 2007 due to the O-P
Disposition in April 2007. In addition, interest and dividend
income decreased $2.4 million in 2007 and we recorded a
loss on derivative instruments for the change in fair value of
$17.2 million in 2007.
Income tax expense. Income tax expense of
$9.1 million was recorded for the year ended
December 31, 2007, resulting in an effective rate of 61.4%.
Our effective tax rate for the year ended December 31, 2007
differs from the federal statutory income tax rate primarily due
to nondeductible permanent differences. In 2007, we determined
that certain expenses related to the merger were not deductible
for tax purposes.
As of December 31, 2007, we had $183.5 million of
federal and state net operating loss, or NOL, carryforwards. As
a result, the income tax expense we record is generally greater
than the income taxes we currently pay.
Discontinued operations. During the years
ended December 31, 2007 and 2006, we recorded a reduction
to our liability associated with the discontinuation of our
competitive local exchange carrier operations, which, net of
tax, resulted in a $0.3 million and $0.6 million
adjustment to income from discontinued operations, respectively.
The adjustment in 2007 related to the expiration of the statute
of limitations on certain liabilities. The adjustments in 2006
related to the settlement of certain lease obligations which
reduced our future obligation under these leases and the
expiration of certain statutes of limitations as they relate to
certain contingency reserves.
Net income. Net income for the year ended
December 31, 2007 was $6.0 million compared to
$31.1 million for the year ended December 31, 2006.
This decrease is principally due to merger related expenses and
losses on contingent interest rate swaps incurred in 2007. The
remaining difference between 2007 and 2006 is a result of the
other factors discussed above.
Revenues increased $7.2 million to $270.1 million in
2006 compared to 2005. Operations acquired in 2005 and 2006
contributed $10.6 million to the increased total revenues.
Excluding the impact of acquired operations, revenues from our
existing operations decreased $3.4 million. We derived our
revenues from the following sources:
Local calling services. Local calling service
revenues increased $1.8 million to $67.7 million in
2006. Acquired operations increased local calling service
revenues by $3.0 million. Revenues from our existing
operations decreased $1.2 million compared to 2005. The
decrease in local revenues from existing operations is primarily
due to a 3.4% decline in net voice access lines.
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Universal Service Fund high-cost loop
support. USF high-cost loop payments increased
$0.3 million to $20.0 million in 2006. Acquired
operations added $0.6 million in USF revenue and USF
revenues from our existing operations declined
$0.3 million. The national average cost per loop in
relation to our average cost per loop has increased and, as a
result, our receipts from the USF 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
decreased $2.9 million to $72.4 million in 2006
compared to 2005. Acquired operations added $2.8 million in
interstate access revenues in 2006. Interstate access revenues
from our existing operations decreased $5.7 million. In
2006, we recognized certain negative interstate revenue
settlement adjustments related to prior years in the amount of
$0.8 million. In addition, 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 prior year
adjustments and acquired operations, interstate access revenue
would have declined $0.6 million in 2006.
Intrastate access. Intrastate access revenues
decreased $1.9 million to $37.3 million in 2006
compared to 2005. Acquired operations added $1.3 million in
intrastate access revenues in 2006. Intrastate access revenues
from our existing operations decreased $3.2 million.
Intrastate access revenues declined primarily due to a decrease
in access rates and a decrease in minutes of use compared to
2005. The rate decrease is primarily due to intrastate rate
reductions implemented in Maine in the second quarter of 2005.
Intrastate access revenues are expected to continue to decline.
Long distance services. Long distance services
revenues increased $3.1 million to $24.1 million in
2006 compared to 2005. Of this increase, $0.3 million was
attributable to acquired companies and $2.8 million was
attributable to our existing operations. This increase was
primarily a result of promotional efforts and bundled product
offerings with unlimited long distance designed to generate more
revenue.
Data and Internet services. Data and Internet
services revenues increased $4.0 million to
$28.2 million in 2006 compared to 2005. Of this increase,
$1.1 million was attributable to acquired companies and
$2.9 million was attributable to our existing operations.
The increase from existing operations is due primarily to
increases in HSD customers as we continue to aggressively market
our HSD services. Our HSD subscriber customer base as of
December 31, 2006 increased to 59,444 subscribers compared
to 45,365 subscribers as of December 31, 2005, a 31%
increase during this period.
Other services. Other services revenues
increased $2.8 million to $20.4 million in 2006
compared to 2005. Of this increase, $1.5 million was
attributable to acquired companies and $1.3 million was
attributable to our existing operations. This increase is
principally due to an increase in directory revenues in 2006.
Operating expenses, excluding depreciation and
amortization. Operating expenses increased
$12.0 million to $155.5 million in 2006 compared to
2005. Of the increase, $5.9 million is related to our
existing operations and $6.1 million is related to expenses
of the acquired operations. The increase from existing
operations is principally due to $2.4 million in
transaction expenses related to the merger, an increase in
compensation and benefit expenses of $1.6 million, an
increase in expenses related to data and long distance services
of $1.4 million, an increase in billing expenses of
$1.2 million, an increase in audit and tax fees of
$0.7 million and an increase in operating taxes of
$0.6 million. These increases were partially offset by a
decrease in bad debt expense of $1.5 million and a decrease
in consulting expenses of $2.2 million.
Included in operating expenses are non-cash stock based
compensation expenses associated with the award of restricted
stock and restricted units. Stock based compensation expenses
totaled $2.9 million and $2.4 million for the years
ended December 31, 2006 and 2005, respectively.
Depreciation and amortization. Depreciation
and amortization from continuing operations increased
$0.8 million to $53.2 million in 2006 compared to
2005. Acquired operations added $2.0 million to
depreciation expense. Depreciation expense from our existing
operations decreased $1.2 million.
Income from operations. Income from operations
decreased $5.7 million to $61.4 million in 2006
compared to 2005. This decrease is principally due to the
increase in expenses discussed above.
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Other income (expense). Total other expense
decreased $110.6 million to $11.0 million in 2006
compared to 2005. Interest expense decreased $6.8 million
to $39.7 million in 2006 mainly due to lower debt balances
throughout the year. Earnings from equity investments decreased
$0.7 million to $10.6 million in 2006. Gain (loss) on
sale of investments increased $14.7 million compared to
2005, principally due to the sale of two non-core equity
investments. In 2005, in connection with our initial public
offering, we refinanced our old credit facility and repurchased
and/or
redeemed the
91/2% senior
subordinated notes due 2008, or the
91/2% notes,
the floating rate callable securities due 2008, or the floating
rate notes, the
121/2% senior
subordinated notes due 2010, or the
121/2% notes,
and the
117/8% senior
notes due 2010, or the
117/8% notes,
which resulted in 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.
Income tax expense. Income tax expense of
$19.9 million was recorded for the year ended
December 31, 2006, resulting in an effective rate of 39.4%.
At the time of our initial public offering in February 2005, we
had NOL carryforwards of $265.3 million. Prior to February
2005, we did not expect to generate sufficient taxable income in
future years to fully utilize these NOL carryforwards and, as a
result, reduced the expected benefit of these NOL carryforwards
by $66.0 million. Subsequent to our initial public offering
and related transactions, we re-evaluated our expectation of
future taxable income and concluded that our future taxable
income would be sufficient to fully utilize the benefits of the
NOL carryforwards. As a result of this re-evaluation, we
recognized an income tax benefit of $66.0 million for the
year ended December 31, 2005. Additional income tax
benefits of $21.9 million were recognized in 2005 due to
the taxable loss which resulted mainly from additional costs
associated with the extinguishment of debt. These two items
contributed to the net income tax benefit of $83.1 million
for the year ended December 31, 2005.
As of December 31, 2006, we had $235.1 million of
federal and state NOL carryforwards. As a result, the income tax
expense we record is generally greater than the income taxes
actually paid by us.
Discontinued operations. During the twelve
months ended December 31, 2006 and 2005, we recorded a
reduction to our liability associated with the discontinuation
of our competitive local exchange carrier operations, which, net
of tax, resulted in a $0.6 million and $0.4 million
adjustment to income from discontinued operations, respectively.
The adjustments in 2006 and 2005 related to the settlement of
certain lease obligations which reduced our future obligation
under these leases and the expiration of certain statutes of
limitations as they relate to certain contingency reserves.
Net income (loss). Net income for the year
ended December 31, 2006 was $31.1 million compared to
$28.9 million for the year ended December 31, 2005.
The difference between 2006 and 2005 is a result of the factors
discussed above.
Historical
Our short-term and long-term liquidity needs arise primarily
from: (i) interest payments primarily related to our
existing credit facility; (ii) capital expenditures,
including those related to the merger; (iii) working
capital requirements as may be needed to support the growth of
our business, including those related to the merger;
(iv) dividend payments on our common stock; and
(v) potential acquisitions.
Our board of directors has adopted a dividend policy, which the
board of directors intends to continue following the
transactions, which reflects our judgment that our stockholders
would be better served if we distributed a substantial portion
of our cash available for distribution to our stockholders
instead of retaining it in our business. For the twelve months
ended December 31, 2007, we paid dividends on our common
stock totaling $55.7 million, or $1.59 per share. The
annual per share amount of dividends we pay following the merger
is required to be reduced as a result of conditions imposed by
regulatory authorities in connection with the approval of the
merger and financial covenants in the new credit facility and
the indenture governing the notes. See “Item 1.
Business — Recent Developments — Regulatory
Conditions,” “Item 1. Business —
Regulatory Environment — State Regulation —
Regulatory Conditions to the Merger” and “Item 5.
Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities —
Dividend Policy and Restrictions.”
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For the years ended December 31, 2007, 2006 and 2005, net
cash provided by operating activities of continuing operations
was $35.8 million, $81.8 million and
$61.7 million, respectively. The decrease in net cash
provided by operating activities in 2007 was primarily due to
merger related costs incurred during 2007.
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 existing credit
facility’s term loan facility prior to maturity in February
2012. However, we will need to refinance all or a portion of our
indebtedness on or before maturity and may not be able to
refinance our indebtedness on commercially reasonable terms or
at all. If we are unable to renew or refinance our existing
credit facility, our failure to repay all amounts due on the
maturity date would cause a default under our existing credit
facility.
Our existing credit facility consists of a revolving facility,
referred to in this section as the revolver, in a total
principal amount of up to $100.0 million, of which
$95.4 million was outstanding at February 22, 2008 (we
had $52.2 million of cash on hand at February 22,
2008), and a term loan facility, referred to in this section as
the term loan, in a total principal amount of
$588.5 million with $588.5 million outstanding at
February 22, 2008. The term loan matures in February 2012
and the revolver matures in February 2011. The revolver has a
swingline sub-facility in an amount of $5.0 million and a
letter of credit sub-facility in an amount of
$10.0 million, which will allow issuances of standby
letters of credit for our account. Borrowings under the term
loan and revolver bear interest, at our option, for the
revolving facility and for the term facility at either
(a) the Eurodollar rate (as defined in our existing credit
facility) plus an applicable margin or (b) the Base rate
(as defined in our existing credit facility) plus an applicable
margin. The Eurodollar rate applicable margin and the Base rate
applicable margin for loans under our existing credit facility
are 2.0% and 1.0%, respectively. 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. Pursuant to the fifth amendment to our existing
credit facility, if our existing credit facility is not repaid
in full prior to May 1, 2008, the margin on base rate loans
will increase to 3.00% and the margin on Eurodollar loans will
increase to 4.00% with a Eurodollar rate floor of 2.50% and if
our existing credit facility is not repaid in full prior to
January 1, 2009, the margin on base rate loans will
increase to 5.00% and the margin on Eurodollar loans will
increase to 6.00% with a Eurodollar rate floor of 3.25%
On January 25, 2007, we entered into an amendment to our
existing credit facility that was intended to facilitate certain
transactions related to the merger. Among other things, such
amendment: (i) permitted us to consummate the O-P
Disposition and retain the proceeds thereof up to an amount
equal to $55.0 million; (ii) excluded the gain on the
O-P Disposition from the calculation of “Available
Cash” under our existing credit facility;
(iii) amended the definition of “Adjusted Consolidated
EBITDA” to allow for certain one-time add-backs to the
calculation thereof for operating expenses incurred in
connection with the Merger (subject to an overall cap on the
amount of such add-backs); (iv) amended the definition of
“Consolidated Capital Expenditures” to exclude certain
expenditures incurred by us in connection with transition and
integration costs prior to consummation of the merger (subject
to an overall cap on the amount of such exclusions); and
(v) increased the leverage covenant and dividend suspension
test to 5.50 to 1.00 and 5.25 to 1.00, respectively.
On February 25, 2008, we entered into the fifth amendment
to our existing credit facility in order to accommodate the
expected March 31, 2008 closing date for the merger. The
fifth amendment to our existing credit facility (i) allows
us to continue to make pre-closing expenditures related to the
merger during the three months ending March 31, 2008;
(ii) provides accommodations for certain restructuring
charges (including $17.8 million of cash restructuring
charges) that we would incur if the merger is not consummated;
(iii) amends the interest coverage ratio maintenance
covenant to require our interest coverage ratio to be not less
than 1.85:1.00 for any fiscal quarter ending after
December 31, 2007 and on or prior to December 31,
2008, 2.50:1.00 for any fiscal quarter ending after
December 31, 2008 and on or prior to December 31, 2009
and 2.75:1:00 for any fiscal quarter ending thereafter;
(iv) amends the leverage ratio maintenance covenant to
require our leverage ratio to not exceed 6.50:1.00 for any
quarter ending after December 31, 2007 and on or prior to
December 31, 2008, 5:00:1:00 for any fiscal quarter ending
after December 31, 2008 and on or prior to
December 31, 2009 and 4.50:1.00 for any fiscal quarter
ending thereafter; (v) prohibits us from paying dividends
on or repurchasing our common stock if (1) our total
leverage ratio exceeds 4.50:1:00 (previously 5.25:1.00) on the
dividend calculation date and/or (2) our cash on hand is
less than $20 million (previously $10.0 million);
(vi) provides for an amount equal to 75% of the increase in
our cumulative distributable cash
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as of the last day of each fiscal quarter to be applied as a
mandatory repayment of the principal amount of outstanding
B term loans under our existing credit facility (or an
amount equal to 50%, if our leverage ratio is less than or equal
to 5.25:1.00); (vii) provides for more restrictive negative
covenants, minimum liquidity requirements and increased
mandatory prepayments from proceeds of debt and equity
issuances; (viii) provides for acceleration of the maturity
of the borrowings under our existing credit facility to
June 30, 2009 if certain vendor debt incurred by us in
connection with the merger is outstanding as of such date and
has a mandatory payment date on or prior to the maturity of the
borrowings under our existing credit facility as of such date;
(ix) prohibits us from incurring additional obligations of
more than $58.4 million (subject to certain reductions
contained in the fifth amendment to our existing credit
facility) related to the merger after March 31, 2008;
provided that we may make cash expenditures not to exceed
$20 million in the aggregate from the proceeds of equity
issuances or if we have received a reimbursement obligation from
Verizon or another third party acceptable to the lenders under
our existing credit facility and certain other conditions are
satisfied; (x) provides for higher interest rate margins
(3.00% on base rate loans and 4.00% on Eurodollar loans), a
Eurodollar rate floor of 2.50% and repayment premiums payable
during the two year period beginning on May 1, 2008 upon
certain repayments of borrowings under our existing credit
facility, which provisions would become effective as of
May 1, 2008 if our existing credit facility has not been
repaid in full on or prior to such date; and (xi) provides
for higher interest rate margins (5.00% on base loans and 6.00%
on Eurodollar loans), a Eurodollar rate floor of 3.25%, which
provisions would become effective as of January 1, 2009 if
our existing credit facility has not been repaid in full on or
prior to such date. We paid the lenders an amendment fee of
$1.7 million in connection with the fifth amendment. We
have also agreed to pay additional fees of 0.25%, 1.5% and
2.5% of the aggregate amount of all outstanding term loans and
revolving commitments of the lenders outstanding on the
effective date of the fifth amendment to the lenders under the
existing credit facility on April 1, 2008, May 1, 2008
and January 1, 2009, respectively, if our existing credit
facility is not repaid in full on or prior to such dates.
We anticipate that we will not be permitted to pay dividends on
our common stock pursuant to our existing credit facility as
amended by the fifth amendment to our existing credit facility;
provided that we would be permitted to declare a dividend at any
time prior to April 30, 2008 so long as the payment of such
dividend is expressly subject to the consummation of the merger
and related transactions and we have repaid in full all of the
obligations owing under the existing credit facility. Our
management believes that the fifth amendment to our existing
credit facility was necessary to avoid events of default
relative to certain covenants in our existing credit facility as
of March 31, 2008, assuming the closing of the merger does
not occur on or before March 31, 2008. We intend to repay
our existing credit facility in full in connection with the
closing of the transactions, and accordingly, the provisions
contained in the fifth amendment to our existing credit
facility, including those restricting the payment of dividends,
would terminate as a result of such repayment and no longer be
effective. However, there can be no assurance that the
transactions will be consummated.
The fifth amendment to our existing credit facility requires us
to use a significant portion of our excess cash flow to reduce
the indebtedness outstanding under our existing credit facility.
As a result, the cash that we retain may not be sufficient to
finance growth opportunities or unanticipated capital
expenditures or to fund our operations.
Our existing credit facility contains customary affirmative
covenants and 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. Pursuant to the fifth
amendment to our existing, we agreed to significant restrictions
on the operation of our business, including with respect to the
payment of dividends, capital expenditures and future
acquisitions. On March 11, 2005, April 29, 2005 and
September 14, 2005, we entered into technical amendments to
our existing credit facility.
Borrowings under our existing credit facility bear interest at
variable interest rates. We have entered into various interest
rate swap agreements which are detailed in note 1 of the
notes to our condensed consolidated financial statements for the
years ended December 31, 2007 and 2006 included in this
Annual Report. As a result of these swap agreements, as of
December 31, 2007, approximately 89% 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
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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.
On February 8, 2005, we used net proceeds received from our
initial public offering, together with approximately
$566 million of borrowings under the term loan facility of
our existing 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 the
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 2, 2005 with borrowings of $22 million under
the delayed draw facility of our credit facility.
In 2003, we 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
existing 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.
$2.1 million principal amount of the
117/8% notes
remains outstanding. We expect to redeem the outstanding
principal amount of these notes in connection with the
transactions.
Net cash provided by (used in) investing activities of
continuing operations was $3.8 million,
($27.4) million and ($42.8) million for the years
ended December 31, 2007, 2006 and 2005, respectively. These
cash flows primarily reflect capital expenditures of
$59.2 million, $32.3 million and $28.1 million
for the years ended December 31, 2007, 2006 and 2005,
respectively. The increase in capital expenditures in 2007 is
due to merger related expenditures. Net cash used in investing
activities also includes acquisitions of telephone properties,
net of cash acquired, of $49.8 million and
$26.3 million for the years ended December 31, 2006
and 2005, respectively and proceeds from the sale of operating
assets, investments and other assets of $59.9 million and
$43.8 million for the years ended December 31, 2007
and 2006, respectively. In 2007, we received proceeds of
$59.9 million principally related to the O-P Disposition
and the sale of Yates. In 2006, we received proceeds of
$43.8 million principally related to the sale of our
investments in the Rural Telephone Bank and Southern Illinois
Cellular Corporation.
Distributions from investments totaled $2.7 million,
$10.7 million and $10.9 million for the years ended
December 31, 2007, 2006 and 2005, respectively. These
distributions decreased in 2007 primarily as a result of the
O-P Disposition.
All of these distributions represent passive ownership interests
in partnership investments. We do not control the timing or
amount of distributions from such investments.
On January 15, 2007, Taconic entered into the Orange
County-Poughkeepsie Limited Partnership Interest Purchase
Agreement pursuant to which Taconic agreed to effect the O-P
Disposition. This transaction closed on April 10, 2007 and
therefore we no longer receive distributions from Orange
County-Poughkeepsie Limited Partnership effective as of such
date. In August 2007, we received $2.7 million from the
escrow account related to the sale of our investment in Southern
Illinois Cellular Corporation, which was completed in 2006. The
$2.7 million was recorded as a gain on sale of investments
during 2007.
Net cash used in financing activities from continuing operations
was $40.5 million, $54.7 million and
$16.6 million for the years ended December 31, 2007,
2006 and 2005, respectively. For the year ended
December 31, 2007, net proceeds from the issuance of
long-term debt were $17.0 million and we paid dividends in
the amount of $55.7 million. For the year ended
December 31, 2006, net proceeds from the issuance of
long-term debt were $0.5 million and we paid dividends in
the amount of $55.2 million. For the year ended
December 31, 2005, net proceeds from the issuance of common
stock of $431.9 million were 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.
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
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our invested capital in regulated telephone assets, capital
expenditures have historically constituted an attractive use of
our cash flow. Capital expenditures, excluding merger related
capital expenditures, were approximately $29.2 million,
$32.3 million and $28.1 million for the years ended
December 31, 2007, 2006 and 2005, respectively.
Our cash capital expenditures related to the merger were
approximately $30.0 million in 2007. In addition, in 2007,
we incurred other merger related expenses of $52.1 million.
A portion of these expenditures and expenses was paid for with
proceeds from the O-P Disposition which was completed in April
2008. The remaining expenditures and expenses were funded
through cash flow from operations and borrowings under our
existing credit facility. As of December 31, 2007, we had
received $34.2 million in cash and, as of February 22,
2008, we had received $40.0 million in cash, associated
with qualified transition cost reimbursement from Verizon for
certain of these expenditures and expenses. Our accounting
treatment of these expenditures and expenses may cause the
financial statement impact of these expenditures to be different
than the cash flow impact.
We expect to make additional cash expenditures of approximately
$35.0 million related to the merger through the closing of
the merger, assuming the merger closes on March 31, 2008.
Pursuant to the fifth amendment to our existing credit facility,
we are prohibited from incurring additional obligations related
to the merger after March 31, 2008; provided that we may
make expenditures not to exceed $20 million in the
aggregate from the proceeds of equity issuances or if we have
received a reimbursement obligation from Verizon or another
third party acceptable to our lenders and certain other
conditions are satisfied.
We expect to effect the merger through the issuance of
approximately 54.0 million shares of our common stock to
existing Verizon stockholders and the incurrence of debt under
the new $2,030 million credit facility consisting of a
non-amortizing
revolving facility in an aggregate principal amount of up to
$200 million, a term loan A facility in an aggregate
principal amount of up to $500 million, a term loan B
facility in an aggregate principal amount of at least
$1,130 million and a delayed draw term loan facility in an
aggregate principal amount of $200 million. We expect that
Spinco will draw $1,160 million under the new term loan
immediately prior to the spin-off and we will draw
$470 million under the new term loan concurrently with the
closing of the merger. We expect that the amounts borrowed by
us, together with cash on hand at Spinco, will be used to repay
in full all outstanding loans under our existing credit facility
(approximately $684 million as of February 22,
2008) and $4 million of other outstanding indebtedness
and to pay fees and expenses relating to the transactions. We
also expect to borrow at least $110 million under the new
delayed draw term loan during the one-year period following the
closing of the merger to fund certain capital expenditures and
other expenses associated with the merger. Following the merger,
we will also be the obligor on approximately $540 million
in aggregate principal amount of the notes.
If the merger is not consummated, we expect to incur
approximately $17.8 million of cash restructuring costs, a
substantial portion of which are expected to be paid in the
second quarter of 2008, primarily related to the termination of
contracts and employees associated with the transactions.
Following consummation of the transactions our short-term and
long-term liquidity needs will arise primarily from:
(i) interest payments on our indebtedness;
(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, to
the extent permitted by the agreements governing our
indebtedness, including the new credit facility, and
restrictions imposed by state regulatory authorities as
conditions to their approval of the merger; and
(v) potential acquisitions.
We anticipate that our primary source of liquidity following the
transactions will continue to be cash flow from operations. We
are also expected to have available funds under our new
revolving credit facility and the delayed draw term loan
facility of the new credit facility, subject to certain
conditions.
As a result of the conditions imposed by regulatory authorities
in connection with the approval of the merger, until the
termination of conditions date, the annual dividend rate paid by
us on our common stock following the merger may not exceed $1.03
per share. Financial covenants in the new credit facility and
the indenture governing the notes are also expected to restrict
our ability to pay dividends. See “Item 1.
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Business — Recent Developments — Regulatory
Conditions,” “Item 1. Business —
Regulatory Environment — State Regulation —
Regulatory Conditions to the Merger” and “Item 5.
Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities —
Dividend Policy and Restrictions.”
We expect that our annual maintenance capital expenditures
following the transactions will be approximately
$180 million to $190 million in the first full year
following the closing of the merger. Assuming the merger closes
on March 31, 2008, we expect that we will spend
approximately $120 million to $130 million following
the closing of the merger, primarily on network and system
upgrades related to the integration of the Spinco business. We
anticipate that we will fund these expenditures through cash
flow from operations, borrowings under the delayed draw term
loan facility of the new credit facility and, if necessary,
borrowings under the revolving credit facility of the new credit
facility, if necessary.
In addition, as a condition to the approval of the transactions
by state regulatory authorities, we have agreed to make
additional capital expenditures following the completion of the
merger. As a condition to the approval of the transactions by
the state regulatory authority in Maine, we have agreed that,
following the closing of the merger, we will make capital
expenditures in Maine during the first three years after the
closing of $48 million in the first year and an average of
$48 million in the first two years and $47 million in
the first three years. We are also required to expend not less
than $40 million (in addition to the $12 million
obligation of the Verizon Group discussed in “Item 1.
Business — Recent Developments — Regulatory
Conditions,” “Item 1. Business —
Regulatory Environment — State Regulation —
Retail Regulation” and our separate $17.6 million
obligation to implement a two-year DSL deployment plan) on
equipment and infrastructure to expand the availability of
broadband services in Maine.
The order issued by the state regulatory authority in Vermont
also requires us to make capital expenditures in Vermont during
the first three years after the closing of the merger in the
amount of $41 million for the first year and averaging
$40 million per year in the first two years and
$40 million per year in the first three years following the
closing of the merger. Pursuant to the Vermont order, we are
required to remove double poles in Vermont, make service quality
improvements and address certain broadband buildout commitments
under a performance enhancement plan in Vermont, using, in the
case of double pole removal, $6.7 million provided by the
Verizon Group and, in the case of service quality improvements
under the performance enhancement plan, $25 million
provided by the Verizon Group.
We are also required to make capital expenditures in New
Hampshire of at least $52 million during each of the first
three years after the closing of the merger and $49 million
during each of the fourth and fifth years after the closing of
the merger. The amount of any shortfall in any year must be
expended in the following year, and the amount of any excess in
any year may be deducted from the amount required to be expended
in the following year. If any shortfall in any year exceeds
$3 million, then the amount that we are required to spend
in the following year shall be increased by 150% of the amount
of such shortfall. If there is any shortfall at the end of the
fifth year after the closing of the merger, we will be required
to spend 150% of the amount of such shortfall at the direction
of the NHPUC. We are required to spend at least
$56.4 million over the
60-month
period following the closing of the merger on broadband
infrastructure in New Hampshire. We also are obligated to use a
$25 million contribution by the Verizon Group to the
working capital of Spinco prior to the closing and a
$25 million payment by the Verizon Group to us following
the closing, or its net present value at the closing, to make
capital expenditures in New Hampshire in addition to those
described above. See “Item 1. Business —
Recent Developments — Regulatory Conditions” and
“Item 1. Business — Regulatory
Environment — State Regulation — Regulatory
Conditions to the Merger.”
In connection with the transactions, we will incur or assume
substantial amounts of indebtedness, including amounts
outstanding under the new credit facility and the notes.
Interest payments on this indebtedness will be a significant use
of our cash flow from operations following the transactions. We
expect that immediately following the transactions we will have
total debt of approximately $2.2 billion and annual
interest expense of approximately $175 million. However,
the amount of indebtedness following the transactions is subject
to change, including as a result of market conditions.
We anticipate that our new credit facility will consist of a
senior secured six-year revolving credit facility in an
aggregate principal amount of $200.0 million, a senior
secured six-year term loan A facility in an
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aggregate principal amount of up to $500.0 million, a
senior secured seven-year term loan B facility in an aggregate
principal amount of up to $1.18 billion and a delayed draw
term loan facility available to be drawn until the first
anniversary of the closing date of the merger in an aggregate
principal amount of up to $200.0 million.
Our ability to service our indebtedness following the
transactions will depend on our ability to generate cash in the
future. Scheduled amortization payments are expected to begin on
the term loan A facility of the new credit facility in 2009, on
the term loan B facility of the new credit facility in 2010 and
on the delayed draw facility of the new credit facility in 2011.
We will be required to refinance all or a portion of our
indebtedness on or before the maturity date and may not be able
to refinance our indebtedness on commercially reasonable terms
or at all. If we are unable to renew or refinance the new credit
facility, our failure to repay all amounts due on the respective
maturity dates would cause a default under the new credit
facility.
On January 17, 2008, we entered into a letter agreement
with Capgemini, which agreement was amended on February 28,
2008, in connection with the transactions. This agreement, as
amended, provides that, if, following the nine month anniversary
of the consummation of the merger, we continue to receive or
request certain services under the TSA, Capgemini will pay an
amount not to exceed $49.5 million of such fees for the
tenth through twelfth months following the consummation of the
merger, if applicable. In exchange for the payment of any fees
under the TSA, we expect to issue to Capgemini shares of
FairPoint preferred stock having a liquidation preference equal
to the aggregate amount of such fees paid by Capgemini. The
preferred stock will have a stated liquidation value of $1,000
per share, a 6.75% cumulative annual dividend in year one and an
8.75% cumulative annual dividend in year two and each succeeding
year, which dividend will be payable in additional shares of
preferred stock. The preferred stock issued to Capgemini will be
non-voting, will not be convertible and will have no other
rights or preferences. The preferred stock will be redeemable,
in whole or in part, only after the expiration of the TSA, after
payment to the supplier of the deferred payment obligations
under the TSA and after we meet certain financial tests.
We believe that following the transactions that cash generated
from operations will be sufficient to meet our debt service,
dividend, capital expenditure and working capital requirements
and employee benefit plan obligations for the foreseeable
future, and to complete the back office and systems integration
after the merger. We believe that following the transactions we
may consider additional capital expenditures if cash is
available beyond these requirements and we believe they are
beneficial. Subject to restrictions in the agreements governing
our indebtedness, we may incur more indebtedness for working
capital, capital expenditures, dividends, acquisitions and for
other purposes. In addition, we may require additional financing
or may be required to reduce our dividend payments if our
results of operations or plans materially change in an adverse
manner or prove to be materially inaccurate. Additional
financing, even if permitted under the terms of the agreements
governing the our indebtedness following the transactions, may
not be available on terms acceptable to us or at all.
Off-Balance
Sheet Arrangements
We do not have any off-balance sheet arrangements.
The tables set forth below contain information with regard to
disclosures about contractual obligations and commercial
commitments.
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The following table discloses aggregate information about our
contractual obligations as of December 31, 2007 and the
periods in which payments are due:
The following table discloses aggregate information about our
derivative financial instruments as of December 31, 2007,
the source of fair value of these instruments and their
maturities.
Our critical accounting policies are as follows:
Revenue recognition. Certain of our
interstate network access and data revenues are based on
tariffed access charges filed directly with the FCC; the
remainder of such revenues are derived from revenue sharing
arrangements with other local exchange carriers administered by
the National Exchange Carrier Association.
The 1996 Act allows local exchange carriers to file access
tariffs on a streamlined basis and, if certain criteria are met,
deems those tariffs lawful. Tariffs that have been “deemed
lawful” in effect nullify an interexchange carrier’s
ability to seek refunds should the earnings from the tariffs
ultimately result in earnings above the authorized rate of
return prescribed by the FCC. Certain of the Company’s
telephone subsidiaries file interstate tariffs directly with the
FCC using this streamlined filing approach. As of
December 31, 2007, our earnings were lower than the
authorized rate of return, and therefore we did not have a
liability on the balance sheet for the 2005 to 2006 monitoring
periods. The settlement period related to the 2005 to 2006
monitoring period lapses on September 30, 2009. We will
continue to monitor the legal status of any pending or future
proceedings that could impact its entitlement to these funds,
and may recognize as revenue some or all of the over-earnings at
the end of the settlement period or as the legal status becomes
more certain.
Allowance for doubtful accounts. In
evaluating the collectibility of our accounts receivable, we
assess a number of factors, including a specific customer’s
or carrier’s ability to meet its financial obligations to
us, the length of time the receivable has been past due and
historical collection experience. Based on these assessments, we
record both specific and general reserves for uncollectible
accounts receivable to reduce the related accounts receivable to
the amount we ultimately expect to collect from customers and
carriers. If
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circumstances change or economic conditions worsen such that our
past collection experience is no longer relevant, our estimate
of the recoverability of our accounts receivable could be
further reduced from the levels reflected in our accompanying
consolidated balance sheet.
Accounting for income taxes. As part of
the process of preparing our consolidated financial statements
we were required to estimate our income taxes. This process
involves estimating our actual current tax exposure and
assessing temporary differences resulting from different
treatment of items for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheets. We must
then assess the likelihood that our deferred tax assets will be
recovered from future taxable income and to the extent we
believe the recovery is not likely, we must establish a
valuation allowance. Further, to the extent that we establish a
valuation allowance or increase this allowance in a financial
accounting period, we must include a tax provision, or reduce
our tax benefit in our consolidated statement of operations. In
performing the assessment, management considers the scheduled
reversal of deferred tax liabilities, projected future taxable
income, and tax planning strategies. We use our judgment to
determine our provision or benefit for income taxes, deferred
tax assets and liabilities and any valuation allowance recorded
against our net deferred tax assets.
There are various factors that may cause those tax assumptions
to change in the near term. We cannot predict whether future
U.S. federal income tax laws and regulations might be
passed that could have a material effect on our results of
operations. We assess the impact of significant changes to the
U.S. federal and state income tax laws and regulations on a
regular basis and update the assumptions and estimates used to
prepare our financial statements when new regulation and
legislation is enacted.
We adopted FASB Interpretation No. (FIN) 48, Accounting
For Uncertainty in Income Taxes — an Interpretation of
FASB Statement No. 109, on January 1, 2007. FIN 48
requires applying a “more likely than not” threshold
to the recognition and
de-recognition
of tax positions. Our unrecognized tax benefits totaled
$3.7 million as of January 1, 2007 and
$1.0 million as of December 31, 2007, of which
$1.0 million would impact its effective tax rate, if
recognized.
Based on certain assumptions, we had $183.5 million in
federal and state NOL carryforwards as of December 31,
2007. In February 2005, we completed our initial public offering
which resulted in an “ownership change” within the
meaning of the U.S. federal income tax laws addressing NOL
carryforwards, alternative minimum tax credits and other similar
tax attributes. As a result of such ownership change, there will
be specific limitations on our ability to use our NOL
carryforwards and other tax attributes. In order to fully
utilize the deferred tax assets, mainly generated by the NOLs,
we will need to generate future taxable income of approximately
$136.5 million prior to the expiration of the NOL
carryforwards beginning in 2019 through 2025.
Valuation of long-lived assets, including
goodwill. We review our long-lived assets,
including goodwill for impairment whenever events or changes in
circumstances indicate that the carrying value may not be
recoverable. Several factors could trigger an impairment review
such as:
Goodwill was $498.7 million at December 31, 2007. We
have recorded intangible assets related to the acquired
companies’ customer relationships of $13.8 million and
accumulated amortization of $1.5 million as of
December 31, 2007. These intangible assets are being
amortized over 15 years. The intangible assets are included
in intangible assets on our consolidated balance sheet.
We are required to perform an annual impairment review of
goodwill as required by SFAS No. 142, “Goodwill
and Other Intangible Assets.” No impairment of goodwill
resulted from the annual valuation of goodwill in 2007.
Accounting for software development
costs. We capitalize certain costs incurred
in connection with developing or obtaining internal use software
in accordance with American Institute of Certified Public
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Accountants Statement of Position
98-1,
“Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use”
(98-1).
Capitalized costs include direct development costs associated
with internal use software, including direct labor costs and
external costs of materials and services. Costs incurred during
the preliminary project stage, as well as maintenance and
training costs, are expensed as incurred.
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements.” SFAS No. 157 is
definitional and disclosure oriented and addresses how companies
should approach measuring fair value when required by generally
accepted accounting principles, or GAAP; it does not create or
modify any current GAAP requirements to apply fair value
accounting. SFAS No. 157 provides a single definition
for fair value that is to be applied consistently for all
accounting applications, and also generally describes and
prioritizes according to reliability the methods and inputs used
in valuations. The new measurement and disclosure requirements
of SFAS No. 157 are effective for us in the first
quarter of 2008. The impact of adopting SFAS No. 157
did not have a material impact on our consolidated financial
statements.
In February 2007, the FASB issued SFAS No. 159
“The Fair Value Option for Financial Assets and Financial
Liabilities — Including an Amendment of
SFAS No. 115,” which permits an entity to measure
many financial assets and financial liabilities at fair value
that are not currently required to be measured at fair value.
Entities that elect the fair value option will report unrealized
gains and losses in earnings at each subsequent reporting date.
The fair value option may be elected on an
instrument-by-instrument
basis, with a few exceptions. SFAS No. 159 amends
previous guidance to extend the use of the fair value option to
available-for-sale and held-to-maturity securities.
SFAS No. 159 also establishes presentation and
disclosure requirements to help financial statement users
understand the effect of the election. SFAS No. 159 is
effective for the first fiscal year beginning after
November 15, 2007. The impact of adopting
SFAS No. 159 did not have a material impact on our
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R),
Business Combinations, or SFAS 141(R), which
replaces SFAS 141. SFAS 141(R) establishes principles
and requirements for how an acquirer in a business combination
recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any
controlling interest; recognizes and measures the goodwill
acquired in the business combination or a gain from a bargain
purchase; and determines what information to disclose to enable
users of the financial statements to evaluate the nature and
financial effects of the business combination. SFAS 141(R)
is to be applied prospectively to business combinations for
which the acquisition date is on or after an entity’s
fiscal year that begins after December 15, 2008. We will
assess the impact of SFAS 141(R) if and when a future
acquisition occurs.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements — an amendment of ARB No. 51, or
SFAS 160. SFAS 160 establishes new accounting and
reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary.
Specifically, this statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the
consolidated financial statements and separate from the
parent’s equity. The amount of net income attributable to
the noncontrolling interest will be included in consolidated net
income on the face of the income statement. SFAS 160
clarifies that changes in a parent’s ownership interest in
a subsidiary that do not result in deconsolidation are equity
transactions if the parent retains its controlling financial
interest. In addition, this statement requires that a parent
recognize a gain or loss in net income when a subsidiary is
deconsolidated. Such gain or loss will be measured using the
fair value of the noncontrolling equity investment on the
deconsolidation date. SFAS 160 also includes expanded
disclosure requirements regarding the interests of the parent
and its noncontrolling interest. SFAS 160 is effective for
fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. Earlier adoption
is prohibited. We are currently evaluating the impact, if any,
the adoption of SFAS 160 will have on our consolidated
financial statements.
We do not believe inflation has a significant effect on our
operations.
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As of December 31, 2007, approximately 89% of our
indebtedness bore interest at fixed rates or effectively at
fixed rates. Our earnings are affected by changes in interest
rates as our long-term indebtedness under our existing credit
facility has variable interest rates based on either the prime
rate or LIBOR. If interest rates on our variable rate
indebtedness (excluding variable rate indebtedness which has its
interest rate effectively fixed under interest rate swap
agreements) outstanding at December 31, 2007 increased by
10%, our interest expense would have increased, and our income
from continuing operations before taxes would have decreased, by
approximately $0.1 million for the year ended
December 31, 2007.
We have entered into interest rate swaps to manage our exposure
to fluctuations in interest rates on our variable rate
indebtedness. The fair value of these swaps was a net liability
of approximately $34.1 million at December 31, 2007.
The fair value indicates an estimated amount we would have paid
to cancel the contracts or transfer them to other parties.
Subsequent to December 31, 2007, we entered into two
additional swap agreements that are contingent on the merger.
One swap agreement is for a notional amount of $300 million
at a rate of 4.49% (or 6.24% including the applicable margin).
This agreement is effective as of December 31, 2010 and
expires on December 31, 2012. The second swap agreement is
for a notional amount of $250 million at a rate of 3.25%
(or 5.00% including the applicable margin). This agreement
expires on December 31, 2010.
Subsequent to December 31, 2007, events in the global
credit markets have impacted the expectation of near-term
variable borrowing rates. As a result, we have experienced an
adverse impact to the fair value liability of our interest rate
swaps. As of February 15, 2008, the fair value liability
has increased approximately $24.3 million from a balance of
$34.1 million as of December 31, 2007 to
$58.4 million as of February 15, 2008.
We use variable and fixed-rate debt to finance our operations,
capital expenditures and acquisitions. The variable-rate debt
obligations expose us to variability in interest payments due to
changes in interest rates. We believe it is prudent to limit the
variability of a portion of our interest payments. To meet this
objective, we enter into interest rate swap agreements to manage
fluctuations in cash flows resulting from interest rate risk.
These swaps change the variable-rate cash flow exposure on the
debt obligations to fixed cash flows. Under the terms of the
interest rate swaps, we pay a variable interest rate plus an
additional payment if the variable rate payment is below a
contractual rate, or we receive a payment if the variable rate
payment is above the contractual rate. The chart below provides
details of each of our interest rate swap agreements as of
December 31, 2007.
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The Board of Directors and Stockholders
FairPoint Communications, Inc.:
We have audited the accompanying consolidated balance sheets of
FairPoint Communications, Inc. and subsidiaries (the Company) as
of December 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders’ equity (deficit),
comprehensive (loss) income, and cash flows for each of the
years in the three-year period ended December 31, 2007.
These consolidated financial statements are the responsibility
of the Company’s management. Our responsibility is to
express an opinion on these consolidated financial statements
based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of FairPoint Communications, Inc. and subsidiaries as
of December 31, 2007 and 2006, and the results of their
operations and their cash flows for each of the years in the
three-year period ended December 31, 2007, in conformity
with U.S. generally accepted accounting principles.
As discussed in note 2 to the accompanying consolidated
financial statements, the Company adopted the provisions of
Financial Accounting Standards Board (FASB) Interpretation
No. 48, Accounting for Uncertainty in Income
Taxes — an interpretation of FASB Statement
No. 109, effective January 1, 2007, and the
provisions of Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004), Share-Based Payment,
effective January 1, 2006.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
Company’s internal control over financial reporting as of
December 31, 2007, based on criteria established in
Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated February 28, 2008
expressed an adverse opinion on the effectiveness of the
Company’s internal control over financial reporting.
/s/ KPMG
LLP
Charlotte, North Carolina
February 28, 2008
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FAIRPOINT
COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets December 31, 2007 and 2006 (in thousands, except share data)
See accompanying notes to consolidated financial statements.
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FAIRPOINT
COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations Years ended December 31, 2007, 2006, and 2005 (in thousands, except per share data)
See accompanying notes to consolidated financial statements.
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FAIRPOINT
COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity (Deficit) Years ended December 31, 2007, 2006, and 2005 (in thousands)
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