Annual Reports

  • 10-K (Mar 5, 2014)
  • 10-K (Mar 7, 2013)
  • 10-K (Mar 9, 2012)
  • 10-K (Mar 31, 2011)
  • 10-K (Sep 29, 2010)
  • 10-K (May 28, 2010)

 
Quarterly Reports

 
8-K

 
Other

Fairpoint Communications 10-K 2012
FORM 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the fiscal year ended December 31, 2011.

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from            to            

Commission File Number 001-32408

 

 

FairPoint Communications, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   13-3725229
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation or Organization)   Identification No.)
521 East Morehead Street, Suite 500   28202
Charlotte, North Carolina   (Zip code)
(Address of Principal Executive Offices)  

 

 

Registrant’s Telephone Number, Including Area Code:

(704) 344-8150

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

 

Title of Each Class

 

Name of Exchange on Which Registered

Common Stock, par value $0.01 per share  

The Nasdaq Stock Market LLC

(Nasdaq Capital Market)

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  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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.  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2011 (based on the closing price of $9.21 per share) was $237,682,166.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨

As of March 2, 2012, there were 26,194,442 shares of the registrant’s common stock, par value $0.01 per share, outstanding.

 

 

Documents incorporated by reference: Part III incorporates information by reference from the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act within 120 days after the close of the registrant’s fiscal year.

 

 

 


Table of Contents

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2011

 

Item

Number

        

Page

Number

 
   Index   
   PART I      5   

  1.

   Business      5   

1A.

   Risk Factors      25   

1B.

   Unresolved Staff Comments      37   

  2.

   Properties      37   

  3.

   Legal Proceedings      37   

  4.

   Mine Safety Disclosures      37   
   PART II      38   

  5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      38   

  6.

   Selected Financial Data      40   

  7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      42   

7A.

   Quantitative and Qualitative Disclosures About Market Risk      61   

  8.

   Financial Statements and Supplementary Data      62   

  9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      119   

9A.

   Controls and Procedures      119   

9B.

   Other Information      121   
   PART III      121   

10.

   Directors, Executive Officers and Corporate Governance      121   

11.

   Executive Compensation      121   

12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      121   

13.

   Certain Relationships and Related Transactions, and Director Independence      121   

14.

   Principal Accounting Fees and Services      121   
   PART IV      121   

15.

   Exhibits, Financial Statement Schedules      122   
   Signatures   
   Exhibit Index      123   

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some statements in this Annual Report on Form 10-K for our fiscal year ended December 31, 2011 (this “Annual Report”) are known as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements may relate to, among other things:

 

   

future performance generally and our share price as a result thereof;

 

   

restrictions imposed by the agreements governing our indebtedness;

 

   

our ability to satisfy certain financial covenants included in the agreements governing our indebtedness;

 

   

financing sources and availability, and future interest expense;

 

   

our ability to refinance our indebtedness on commercially reasonable terms, if at all;

 

   

anticipated business development activities and future capital expenditures;

 

   

the effects of regulation, including restrictions and obligations imposed by federal and state regulators as a condition to the approval of the Merger (as defined herein) and the Plan (as defined herein);

 

   

adverse changes in economic and industry conditions, and any resulting financial or operational impact, in the markets we serve;

 

   

labor matters, including workforce levels, our recently announced workforce reduction and labor negotiations, and any resulting financial or operational impact;

 

   

material technological developments and changes in the communications industry, including disruption of our third party suppliers’ provisioning of critical products or services;

 

   

change in preference and use by customers of alternative technologies;

 

   

the effects of competition on our business and market share;

 

   

risks related to our reported financial information and operating results including with respect to our adoption of fresh start accounting;

 

   

changes in federal and state regulatory policies, procedures and mechanisms including but not limited to the availability and levels of regulatory support payments;

 

   

availability of net operating loss (“NOL”) carryforwards to offset anticipated tax liabilities;

 

   

the impact of changes in assumptions on our ability to meet obligations to our Company-sponsored pension plans and post-retirement healthcare plans; and

 

   

changes in accounting assumptions that regulatory agencies, including the Securities and Exchange Commission (the “SEC”), may require or that result from changes in the accounting rules or their application, which could result in an impact on earnings.

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.

 

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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 periodic reports filed with the SEC on Forms 10-K, 10-Q and 8-K and Schedule 14A.

 

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PART I

ITEM 1. BUSINESS

Except as otherwise required by the context, references in this Annual Report to:

 

   

“FairPoint Communications” refers to FairPoint Communications, Inc., excluding its subsidiaries.

 

   

“FairPoint,” the “Company,” “we,” “us” or “our” refer to the combined business of FairPoint Communications, Inc. and all of its subsidiaries after giving effect to the merger on March 31, 2008 with Northern New England Spinco Inc. (“Spinco”), a subsidiary of Verizon Communications Inc. (“Verizon”), which transaction is referred to herein as the “Merger”.

 

   

“Northern New England operations” refers to the local exchange business acquired from Verizon and certain of its subsidiaries after giving effect to the Merger.

 

   

“Telecom Group” refers to FairPoint, exclusive of our acquired Northern New England operations.

 

   

“Verizon Northern New England business” refers to the local exchange business of Verizon New England Inc. (“Verizon New England”) in Maine, New Hampshire and Vermont and the customers of Verizon and its subsidiaries’ (other than Cellco Partnership) (collectively, the “Verizon Group”) related long distance and Internet service provider business in those states prior to the Merger.

Our Business

We are a leading provider of communications services in rural and small urban communities, offering an array of services, including high speed data (“HSD”), Internet access, data transport, voice, video and other broadband enabled product offerings. We operate in 18 states with approximately 1.3 million access line equivalents (including voice access lines and HSD lines, which include digital subscriber lines (“DSL”), wireless broadband, cable modem and fiber-to-the-premises) in service as of December 31, 2011.

We were incorporated in Delaware in February 1991 for the purpose of acquiring and operating incumbent telephone companies in rural and small urban markets. Many of our telephone companies have served their respective communities for over 80 years.

Access lines have historically been an important element of our business. Over the past several years, communications companies, including FairPoint, have experienced a decline in access lines due to increased competition, including competition from Competitive Local Exchange Carriers (“CLECs”), wireless carriers and cable television operators, increased availability of alternative communications services, including wireless and voice over IP (“VoIP”), and challenging economic conditions. While voice access lines are expected to continue to decline, we expect to offset a portion of this lost revenue with growth in special access, HSD and other broadband service revenue as we continue to build out our network to customers who did not previously have access to such products and to offer more competitive services to existing customers. In addition, due to the issues associated with the cutover (the “Cutover”) from the systems of Verizon in February 2009 with respect to our Northern New England operations and the filing for bankruptcy protection under chapter 11 of title 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in October 2009, we lost significant market share in recent years. Our strategy is to leverage our ubiquitous network in our Northern New England operations to regain market share, particularly in the business and wholesale markets and for data services.

We offer our IP/Multiple Protocol Label Switched (“IP/MPLS”) network that is fiber-optic based (the “Next Generation Network”) to support more high-speed data services and extend fiber into more communities across our Northern New England operations. This fiber-optic build also supplies critical infrastructure known as “backhaul” for wireless traffic in the region, and addresses the increasing bandwidth needs being driven by new applications for smart phones, tablets and other wireless devices. Today we provide cellular backhaul connectivity to more than 1,600 towers in our Northern New England footprint. Recent Ethernet network expansion allows us to provide fiber based Ethernet cellular backhaul to more than half of these towers.

We are subject to regulation primarily by federal and state governmental agencies. At the federal level, the Federal Communications Commission (the “FCC”) generally exercises jurisdiction over the facilities and services of communications common carriers, such as FairPoint, 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

 

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extent those facilities are used to provide, originate or terminate intrastate communications. In addition, pursuant to the Telecommunications Act of 1996 (the “1996 Act”), which amended the Communications Act of 1934 (the “Communications Act”), state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies introduced by that legislation.

The Telecom Group and our Northern New England operations operate under different regulatory regimes in certain respects. For example, concerning interstate access, all of the Telecom Group’s regulated interstate services of FairPoint were regulated under a rate-of-return model, while all of the rate-regulated interstate services provided by the Verizon Northern New England business were regulated under a price cap model. See “Item 1. Business – Regulatory Environment” for further information regarding rate-of-return and price cap models. On May 10, 2010, we received FCC approval to convert our Telecom Group operations in Maine and Vermont to the price cap model. These operations converted to price cap regulation on July 1, 2010. We have obtained permission to continue to operate our Telecom Group incumbent local exchange carriers (“ILECs”) outside of Maine and Vermont under the rate-of-return or average schedule regime until the FCC completes its general review of whether to modify or eliminate the “all-or-nothing” rule. Without this permission, the all-or-nothing rule would require that all of our regulated operations be operated under the price cap model for federal regulatory purposes. In addition, while all of our operations generally are subject to obligations that apply to all local exchange carriers (“LECs”), our non-rural operations are subject to additional requirements concerning interconnection, non-discriminatory network access for competitive communications providers and other matters, subject to substantial oversight by state regulatory commissions. In addition, the FCC has ruled that our Northern New England operations must comply with the regulations applicable to the Bell Operating Companies. Our rural and non-rural operations are also subject to different regimes concerning universal service.

Overview of FCC Order to Reform Universal Service and Intercarrier Compensation

On October 27, 2011, the FCC adopted an Order and Further Notice of Proposed Rulemaking (“NPRM”) on Universal Service and Intercarrier Compensation reform. On November 18, 2011, the FCC released its comprehensive and landmark order to modify the nationwide system of universal support and the Intercarrier Compensation system (referred to hereafter as the “FCC CAF/ICC Order”). In this order, the FCC replaced all existing Universal Support Funding (“USF”) for price cap carriers with its Connect America Fund (“CAF”). The intent of the CAF is to bring high speed affordable broadband services to all Americans. The FCC CAF/ICC Order fundamentally reforms the Intercarrier Compensation (“ICC”) system that governs how communications companies bill one another for handling traffic, gradually phasing down these charges. Together, the modifications to the CAF and ICC rules are intended to benefit consumers and promote the goals of the National Broadband Plan (the “NBP”), which called for overhauling these two complex systems to address the modern-day mission of supporting broadband deployment as cost-effectively as possible.

In conjunction with the FCC CAF/ICC Order, the FCC adopted a Notice of Proposed Rulemaking to deal with related matters, including but not limited to: (i) the actual cost model to be adopted for CAF Phase II funding, (ii) treatment of originating access charges, (iii) modifications to CAF for rate-of-return ILECs, (iv) development of CAF Phase II for mobility, (v) CAF Phase II reverse auction rules, (vi) remote areas funding and (vii) IP to IP interconnection issues. It is not known what decisions will be made on these issues nor how they may impact us. See “Item 1. Business – Regulatory Environment” for further information regarding these matters.

Emergence from Chapter 11 Proceedings

On October 26, 2009 (the “Petition Date”), we filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) (Case No. 09-16335) (collectively, the “Chapter 11 Cases”). On January 24, 2011 (the “Effective Date”), we substantially consummated our reorganization through a series of transactions contemplated by our Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (as confirmed by the Bankruptcy Court, the “Plan”). The Plan provided for, among other things: (i) the cancellation and extinguishment on the Effective Date of all our equity interests outstanding on or prior to the Effective Date, including but not limited to all outstanding shares of our common stock, par value $0.01 per share (the “Old Common Stock”), options and contractual or other rights to acquire any equity interests, (ii) the issuance of shares of our new common stock, par value $0.01 per share (the “New Common Stock” or “Common Stock”), and warrants to purchase shares of our new common stock to holders of certain claims in accordance with the Plan, (iii) the satisfaction of claims associated with the Credit Agreement, dated as of March 31, 2008, by and among FairPoint Communications, Spinco, Bank of America, N.A. as syndication agent, Morgan Stanley Senior Funding, Inc. and Deutsche Bank Securities Inc., as co-documentation agents, and Lehman Commercial Paper Inc., as administrative agent, and the lenders party thereto (as amended, supplemented or otherwise modified from time to time, the “Pre-Petition Credit Facility”) and the indentures

 

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governing (a) the 13-1/8% Senior Notes due April 1, 2018 (the “Old Notes”), which were issued pursuant to the Indenture, dated as of March 31, 2008, by and between Spinco and U.S. Bank National Association, as amended, and (b) the 13-1/8% Senior Notes due April 2, 2018 (the “New Notes” and, together with the Old Notes, the “Pre-Petition Notes”) and (iv) the termination by its conversion into the revolving facility of the Credit Agreement (as defined below) of the Debtor-in-Possession Credit Agreement, dated as of October 27, 2009 (as amended, the “DIP Credit Agreement”), by and among FairPoint Communications and FairPoint Logistics, Inc. (“FairPoint Logistics”, and together with FairPoint Communications, the “DIP Borrowers”), certain financial institutions (the “DIP Lenders”) and Bank of America, N.A., as the administrative agent for the DIP Lenders (the “DIP Administrative Agent”). Our New Common Stock began trading on the Nasdaq Stock Market LLC (the “NASDAQ”) on January 25, 2011. In addition, on the Effective Date, FairPoint Communications and FairPoint Logistics (collectively, the “Borrowers”) entered into a $1,075.0 million senior secured credit facility with a syndicate of lenders and Bank of America, N.A., as the administrative agent for the lenders, arranged by Banc of America Securities LLC (the “Credit Agreement”). In connection with the Chapter 11 Cases, we also negotiated with representatives of the state regulatory authorities in Maine, New Hampshire and Vermont with respect to (i) certain regulatory approvals relating to the Chapter 11 Cases and the Plan and (ii) certain modifications to the requirements imposed by state regulatory authorities as a condition to approval of the Merger (each a “Merger Order,” and collectively, the “Merger Orders”). We agreed to regulatory settlements with the representatives for each of Maine, New Hampshire and Vermont regarding modification of each state’s Merger Order (each a “Regulatory Settlement,” and collectively, the “Regulatory Settlements”) which were then approved by the regulatory authorities in these states. For more information regarding the Regulatory Settlements, see “Item 1. Business – Regulatory Environment – State Regulation – Regulatory Conditions to the Merger, as Modified in Connection with the Plan.”

As of the Effective Date, we were required to adopt fresh start accounting in accordance with guidance under the applicable reorganization accounting rules, pursuant to which our reorganization value, which represented the fair value of the entity before considering liabilities, and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, was allocated to the fair value of assets in conformity with guidance under the applicable accounting rules for business combinations, using the purchase method of accounting for business combinations. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets was reflected as goodwill, which is subject to periodic evaluation for impairment. In addition to fresh start accounting, our post-emergence consolidated financial statements reflect all effects of the transactions contemplated by the Plan. Therefore, our post-emergence consolidated statements of financial position and consolidated statements of operations are not comparable in many respects to our consolidated statements of financial position and consolidated statements of operations for periods prior to our adoption of fresh start accounting and prior to accounting for the effects of the reorganization, including the historical financial statements contained herein.

Our Services

We offer a broad portfolio of communications services for residential, business (includes governmental and educational institutions) and wholesale 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 operating companies are locally staffed, which enables us to reliably provide an array of communications services to meet our customer needs. These include voice and voice related services, as well as HSD, Internet access, data transport, video and other broadband enabled services. Based on our understanding of our local customers’ needs, we offer bundled services designed to simplify the customer’s purchasing and management process.

Generation of Revenue

We primarily generate revenue through: (i) the provision of local voice service to customers within our service areas; (ii) the provision of network access through dedicated transport facilities for data and voice to business and wholesale customers and to interexchange carriers for origination and termination of interstate and intrastate long-distance phone calls; (iii) HSD services; (iv) Universal Service Fund high-cost loop and high-cost model payments; and (v) the provision of other services such as long-distance resale, other data and Internet and broadband enabled services, enhanced services and billing and collection services.

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.

 

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Voice Services

Local calling service enables the local customer to originate and receive an unlimited number of calls within a defined “exchange” area. Local calling services include basic local lines, local 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 LEC’s territory, the amount that we can charge a customer for local service is determined by rate proceedings involving the appropriate state regulatory authorities.

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

Network Access Charges / Intercarrier Compensation

Network Transport Services. We offer network transport services to wholesale customers for their use in connecting end users to the interexchange networks of the wholesale customer. These network transport services include special access services, which are primarily DS-1 and DS-3 services, and high speed digital services, which are primarily Ethernet-based services provisioned over fiber and copper facilities.

Network Switched Access Service. Network access enables long-distance companies to utilize our local network to originate or terminate intrastate and interstate communications. Network switched access charges relate to long-distance, or toll calls, that typically involve more than one company in the provision of telephone service as well as to the termination of interexchange private line services. Since toll calls and private line services are generally billed to the customer originating the call or ordering the private line service, a mechanism is required to compensate each company providing services relating to the service. 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. Network switched access compensation is subject to the FCC CAF/ICC Order, as described below in “Item 1. Business – Regulatory Environment”. Under the new rules, network switched access revenues are expected to continue to decline, but on a more predictable basis with fewer disputes.

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 local exchanges. We also generate intrastate access revenue when an interexchange carrier orders special access to connect interexchange private line services, such as HSD services, to a customer in one of our local exchanges. The interexchange carrier pays us an intrastate access payment for either terminating or originating the communication. We bill access charges relating to such service 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 also generate interstate access revenue when an interexchange carrier orders special access to connect interexchange private line services, such as HSD services, to a customer in one of our local exchanges. We bill interstate access charges in the same manner as we bill intrastate access charges; however, interstate access charges are regulated and approved by the FCC instead of the state regulatory authority.

Universal Service Fund High-Cost Loop. As described below in “Item 1. Business – Regulatory Environment”, the Universal Service Funding mechanisms are being replaced, effective January 1, 2012, with Connect America Funding. Prior to 2012, the Universal Service Fund supplemented the amount of local service revenue received by us to ensure that basic local service rates for customers in high-cost areas are consistent with rates charged in lower cost areas. The Universal Service Fund and its successor, CAF, are funded by monthly fees charged to interexchange carriers and LECs. Until 2012, the Universal Service Fund made payments to us on a monthly basis based upon our cost support for LECs whose cost of providing the local loop connections to customers is significantly greater than the national average. For our rural service areas, these payments fluctuated based upon our average cost per loop compared to the national average cost per loop. For example, if the national average cost per loop increased and our operating costs (and average cost per loop) remained constant or decreased, the payments we received from the Universal Service Fund would decline. Conversely, if the national average cost per loop decreased and our operating costs (and average cost per loop) remained constant or increased, the payments we received from the Universal Service Fund would increase. For our non-rural service areas, these payments were based on cost models which estimate the cost to provide services and generate universal service support payments for high-cost areas. Universal Service Fund high-cost support revenue accounted for less than 2% of our total revenue in the year ended December 31, 2011. As described below in “Item 1. Business – Regulatory Environment”, we expect 2012 CAF to be equivalent to our 2011 high-cost support. Starting in 2013, our CAF will depend on the resolution of the FCC’s proceeding to adopt a CAF cost model and develop CAF Phase II for our operating areas and our right to accept or refuse that funding based on our evaluation of the cost of our obligations associated with the funding.

 

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Data and Internet Services

We offer an extensive array of high capacity data services including: private line special access, fast packet, optical, Ethernet and IP services. We work with large businesses and carriers to deliver network capacity to meet their specific needs, including migrating networks from time division multiplexing to Ethernet-based high capacity circuits. In particular, wireless carriers are a high growth sector within our wholesale segment as they expand 3G networks and roll out 4G networks to meet the demand for broadband services driven by smartphones, tablets, mobile broadband and mobile video.

We offer broadband Internet access via DSL technology, fiber-to-the-home 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 World Wide Web. We offer enhanced Internet services, which include obtaining IP addresses, basic web site design and hosting, domain name services, content feeds and web-based e-mail services. We also offer carrier ethernet services throughout our market to our business and wholesale customers.

Other Services

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

Billing and Collection. Many interexchange carriers provide long-distance services to our LEC customers and may elect to use our billing and collection services. Our LECs 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 some 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.

Video. In certain of our markets, we offer video services to our customers by reselling DirectTV content and providing cable and IP television video-over-DSL.

Our Markets

Most of our 34 local exchange carriers operate as the ILEC in each of their respective markets. Approximately 63% of our voice access lines served residential customers as of December 31, 2011. Our business customers accounted for approximately 30% of our voice access lines as of December 31, 2011 and wholesale customers accounted for approximately 7% of our voice access lines as of December 31, 2011.

In addition to voice access lines, we offer HSD service to our customers. At December 31, 2011, we had 314,135 HSD subscribers. HSD subscribers include DSL, wireless broadband, cable modem and fiber-to-the-premises.

Our operations are primarily focused on rural and small urban markets and are geographically concentrated in the northeastern United States.

The following chart identifies the number of access line equivalents in each of our 18 states as of December 31, 2011:

 

State

   Access Line Equivalents  

Maine

     480,559   

New Hampshire

     386,407   

Vermont

     274,958   

Florida

     49,087   

New York

     45,500   

Washington

     41,536   

Missouri

     13,476   

Ohio

     12,534   

Virginia

     8,436   

Kansas

     6,398   

Illinois

     5,769   

Pennsylvania

     5,757   

Idaho

     5,536   

Oklahoma

     4,160   

Colorado

     3,597   

Other States(1)

     3,184   
  

 

 

 

Total:

     1,346,894   
  

 

 

 

 

(1) Includes Massachusetts, Georgia and Alabama.

 

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Sales and Marketing

We have a customer-oriented marketing approach that emphasizes our reliable service and advanced network. 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 brand recognition and reputation that each LEC 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 brand recognition in order to attain higher recognition with potential customers. We have approximately 3,500 employees that work and live in the markets where we provide service. VantagePointSM services, through our IP-based network in three contiguous states, has a level of coverage and capacity that we believe is unmatched in our marketplace. We have divided our Northern New England operations efforts into four distinct markets: residential, small and medium business, large business and wholesale. Marketing plans, distribution strategies, opportunities and tactics are tailored to each of these markets using call center or direct sales based approaches.

Our sales organization utilizes customer service representatives to service our residential customers. This includes all sales activities driven by our residential marketing programs. We utilize a combination of call center personnel and our direct sales force to sell to the small and medium segment and our other markets are handled by professional direct sales teams emphasizing account management and high touch customer service. Our direct sales personnel are assigned key customers, with large business and wholesale customers assigned a complete account team.

Information Technology and Support Systems

We have a customer-focused approach to information technology (“IT”) which allows for efficient business operations and supports revenue growth. Our approach is to simplify and standardize processes in order to optimize the benefits of our back-office and operation support systems. Specifically, our “simplify and optimize” initiative targets the reduction of redundant and manual processes to reduce cycle times, improve efficiency and deliver enhanced customer service.

Our back-office and operations support systems are a combination of integrated off-the-shelf packages that have been customized to support our operations as well as software as a service solution. Our Northern New England operations carrier access billing and our Telecom Group billing operations are supported by fully outsourced third-party platforms.

Our systems are supported by a combination of employees and contractors. Our internal IT group supports data center operations, data network operations, internal helpdesk, desktop support and phases of the systems development life cycle. We use professional services firms for the majority of software development and maintenance.

Network Architecture and Technology

Rapid and significant changes in technology are underway in the communications industry. Our success depends, in part, on our ability to anticipate and adapt to technological changes. With this in mind, we continue to build and expand our advanced Next Generation Network in our Northern New England operations. The Next Generation Network is an IP/MPLS network with over 14,800 miles of fiber optic cable. We believe this network architecture will enable us to efficiently respond to these technological changes.

 

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Our LEC network consists of 95 host central offices and 417 remote central offices, all with advanced digital switches. Approximately 98.0% of our central offices are served by fiber optic facilities, which we own. The primary interconnection with other incumbent carriers is also fiber optic. Our outside plant consists of both fiber optic and copper distribution networks.

Our Telecom Group and Next Generation Networks transport systems are a combination of Synchronous Optical Network, Dense Wave Division Multiplexing, and Ethernet transport capable of satisfying customer demand for high bandwidth transport services. This system supports advanced services including Carrier Ethernet Services and legacy data products such as Frame Relay and Asynchronous Transfer Mode, facilitating delivery of advanced services as demand warrants.

In our LEC markets, DSL-enabled access technology has been deployed to provide significant broadband capacity to our customers. As of December 31, 2011, nearly all of our central offices are capable of providing broadband services through DSL technology, cable modem and/or wireless broadband.

Competition

We face intense competition from a variety of sources for our voice and data services in most of the areas we now serve, and expect that such competition will continue to intensify in the future. We face competition from many communications providers, including cable operators offering video, data and VoIP products, wireless carriers, long distance service providers, competitive local exchange carriers, Internet service providers, satellite companies and other wireline carriers. This competition has had an adverse impact on our access lines, HSD growth rates and revenues.

Regulations and technology change quickly in the communications industry, and these changes have historically had, and are expected to continue in the future to have, a significant impact on competitive dynamics. For instance, the ubiquity of wireless networks coupled with technology changes, such as VoIP, and data-driven devices (i.e. computer tablets and netbooks), are creating increased competition and technology substitution, a trend we expect will continue for the foreseeable future. Public monies in the form of stimulus funds to build broadband networks are also providing a new source of competition for us. In addition, many of our competitors have access to larger workforces or have substantially greater name-brand recognition and financial, technological and other resources than we do. Moreover, some of our competitors, including wireline, wireless and cable have formed and may continue to form strategic alliances to offer bundled services in our service areas.

We estimate that, as of December 31, 2011, most of the customers that we serve have access to voice, network transport and Internet services through a cable television company. In addition, increasingly, both CLECs and cable companies have begun to penetrate the market for high capacity circuits for large businesses and carriers, including interexchange and wireless providers. Lastly, in most of our service areas, we face competition from wireless carriers for voice services.

We use numerous strategies to offset these competitive pressures and changes in customer behavior. Our strategies are focused on maintaining connections with our customers through enhanced products and services and generating new revenues through new customer growth, win-backs of former customers and new product development. We offer attractive packages of value-added services that features HSD along with local, long distance calling, enhanced telephone features and video offerings.

For our business customers, we believe that the reliability and reach of our network is a competitive advantage particularly with regionally based enterprises in segments like health care and banking. Business customers seek reliable high capacity bandwidth services such as high-level transport services to wireless cell towers we provide in our territories. We are expanding the number and quality of people selling and servicing our enterprise customers with sophisticated products and services.

Employees

As of December 31, 2011, we employed a total of 3,541 employees, 2,254 of whom were covered by fourteen collective bargaining agreements. As of December 31, 2011, 72 of our employees were covered by four collective bargaining agreements that expire during the next calendar year.

 

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Intellectual Property

We believe we own or have the right to use all of the intellectual property that is necessary for the operation of our business as we currently conduct it.

Regulatory Environment

We are subject to extensive federal, state and local regulation. At the federal level, the FCC generally exercises jurisdiction over facilities and services of 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, services and rates to the extent those facilities are used to provide, originate or terminate intrastate communications. In addition, pursuant to local competition provisions of the Communications Act, as amended by the 1996 Act, state and federal regulators share responsibility for implementing and enforcing certain pro-competitive policies. In particular, state regulatory agencies exercise substantial oversight over the offerings of ILECs to competing carriers of interconnection and non-discriminatory access to certain facilities and services designated as essential for local competition.

Telecom Group and our Northern New England operations operate under different regulatory regimes in certain respects. For example, concerning interstate access, all of the Telecom Group regulated interstate services of FairPoint were regulated under a rate-of-return model, while all of the rate-regulated interstate services provided by the Verizon Northern New England business were regulated under a price cap model. On May 10, 2010, we received FCC approval to convert our Telecom Group operations in Maine and Vermont to the price cap model. Our Telecom Group operations in Maine and Vermont converted to price cap regulation on July 1, 2010. 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 a company flexibility to adjust its rates within these limits. In contrast, rate-of-return regulation permits a company to set rates based upon its allowed costs and projected revenue requirement, including an authorized rate-of-return determined by the FCC. We have obtained permission to continue to operate our Telecom Group ILECs outside of Maine and Vermont under the rate-of-return or average schedule regime until the FCC completes its general review of whether to modify or eliminate the “all-or-nothing” rule. Without this permission, the all-or-nothing rule would require that all of our regulated operations be operated under the price cap model for federal regulatory purposes. In addition, while all of our operations generally are subject to obligations that apply to all LECs, our non-rural operations are subject to additional requirements concerning interconnection, non-discriminatory network access for competitive communications providers and other matters, subject to substantial oversight by state regulatory commissions. In addition, the FCC has ruled that our Northern New England operations must comply with the regulations applicable to the Bell Operating Companies. Our rural and non-rural operations are also subject to different regimes concerning universal service.

As described in more detail below, the FCC CAF/ICC Order will modify regulation for us beginning January 1, 2012. Effective January 1, 2012, the FCC has eliminated the rural/non-rural distinction among ILECs and treats ILECs as either price cap or rate-of-return. Under the new rules, effective January 1, 2012, our ILECs will be treated as price cap companies for CAF purposes, including the Telecom Group rate-of-return companies. The Telecom Group rate-of-return companies will continue to be treated as rate-of-return for regulation of interstate switched and special access services. In addition, the FCC has preempted certain state regulation over our ILECs including capping all state originating and terminating switched access charges and reducing state switched access charges beginning July 1, 2012 in a two year transition to make state switched access charges equal to interstate switched access charges.

Federal Regulation

We are required to comply with the Communications Act which requires, among other things, that telecommunications carriers offer telecommunications services at just and reasonable rates and on terms and conditions that are not unreasonably discriminatory. The Communications Act, as amended by the 1996 Act, contains requirements intended to promote competition in the provision of local services and to lead to deregulation as markets become more competitive.

On March 16, 2010, the FCC submitted the NBP to the United States Congress (“Congress”). The NBP is a plan to bring high-speed Internet services to the entire country, including remote and high-cost areas. In accordance with the NBP, the FCC commenced several rulemakings that concern, among other things, reforming high-cost and low-income programs to promote universal service, to make those funds more efficient while promoting broadband communications in areas that otherwise would be unserved and to address changes to interstate access charges and other forms of intercarrier compensation. As described in

 

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more detail below, the FCC has issued a major order addressing universal service funding and intercarrier compensation and has announced its intentions to undertake other significant regulatory activity including the methodology for contributing to universal service funding. In addition, the FCC has a number of universal services and intercarrier compensation issues under consideration in a Further Notice of Proposed Rulemaking. We cannot predict the outcome of these proceedings or the effect the resulting decisions may have on our business.

Overview of FCC Order to Reform Universal Service and Intercarrier Compensation

On October 27, 2011, the FCC adopted an Order and Further Notice of Proposed Rulemaking on Universal Service and Intercarrier Compensation reform. On November 18, 2011, the FCC released the FCC CAF/ICC Order. In this order, the FCC replaced all existing USF for price cap carriers with its CAF. The intent of the CAF is to bring high speed affordable broadband services to all Americans. The FCC CAF/ICC Order fundamentally reforms the ICC system that governs how communications companies bill one another for handling traffic, gradually phasing down these charges. Together, the modifications to the CAF and ICC rules are intended to benefit consumers and promote the goals of the NBP, which called for overhauling these two complex systems to address the modern-day mission of supporting broadband deployment as cost-effectively as possible.

In conjunction with the FCC CAF/ICC Order, the FCC adopted a NPRM to deal with related matters, including but not limited to: (i) the actual cost model to be adopted for CAF Phase II funding, (ii) treatment of originating access charges, (iii) modifications to CAF for rate-of-return ILECs, (iv) development of CAF Phase II for Mobility, (v) CAF Phase II reverse auction rules, (vi) remote areas funding and (vii) IP to IP interconnection issues. It is not known what decisions will be made on these issues or how they may impact us.

FCC CAF Phase I Overview

Under the new rules adopted in the FCC CAF/ICC Order, all of our rural operations will be treated under the CAF rules for price cap carriers. Under those rules, all of our ILEC operations will receive CAF Phase I frozen support funding in 2012 that is equal to all forms of high cost universal service funding received during 2011. We may also be eligible in 2012 for the one-time CAF Phase I Incremental Support, which would include a portion of a nationwide funding pool in the amount of $300 million that is being made available to price cap ILECs based on a cost regression run of the High Cost Proxy Model used, through 2011, to establish High Cost Model Support for non-rural ILECs. It is not clear at this time how much, if any, of this funding will be made available to us, nor is it clear whether we will be able to accept any or all of the potential funding, given the restrictions placed on the CAF Phase I Incremental Support by the new rules adopted by the FCC. Various companies and industry associations are seeking reconsideration of the new CAF rules and it is not known whether the FCC will modify its rules or what impact any such modifications may have on us.

FCC CAF Phase II Overview

Under the new FCC rules, the FCC intends to adopt a new cost model during 2012 that will be used to establish Phase II CAF funding effective January 1, 2013. The nature and timing of the model adopted are subject to regulatory and legal processes and the exact nature of the model and the timing of its implementation are not known at this time. Under the new rules, the FCC intends to establish CAF funding for geographic areas defined by the Census Bureau that contain approximately 400 households (“Census Blocks”) that have no unsubsidized competition. In effect, we expect the FCC to identify specific Census Blocks in our operating territories, identify a five year funding commitment, identify specific service obligations, and offer the funding to us, as a price cap ILEC, on a “right of first refusal” basis. If we accept the funding we will be obligated to provide service to all customer locations in the specified Census Blocks by the end of the five years and offer broadband services with minimum speeds of 4 megabit per second (“MBPS”) service down (to the customer) and 1 MBPS service up (from the customer to the Internet). There will also be additional obligations, including but not limited to latency and rates. In the event we choose not to exercise our right of first refusal for CAF Phase II funding, the FCC intends to use reverse auctions to allow carriers to bid for the funding. At this point, the specific Census Blocks which will be included in CAF Phase II have not been identified, and the cost model has not been adopted. Accordingly, we do not know how much funding will be offered for each of our operations and we do not know whether we will accept funding for any or all of our operating areas. CAF Phase II funding will be offered based on all “study areas” in a state operation operated by each ILEC.

 

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FCC New Rules for Intercarrier Compensation Overview

The FCC CAF/ICC Order establishes rules to reform historical rules associated with local, state toll and interstate toll traffic exchanged among communications carriers including ILECs, CLECs, cable companies, wireless carriers and VoIP providers. The new rules, the majority of which are effective beginning July 1, 2012, establish separate rules for price cap carriers and rate-of-return carriers. Although the FCC order treats our rate-of-return carriers (including companies operating under average schedules) as price cap carriers for CAF funding, it treats them as rate-of-return carriers for purposes of ICC reform. For both price cap and rate-of-return carriers the FCC establishes a multi-year transition of terminating traffic compensation to “bill and keep”, or zero compensation. For both price cap and rate-of-return carriers, the FCC requires carriers to establish fiscal year 2011 (“FY2011”) baseline compensation, which is the amount of relevant compensation billed during the period beginning October 1, 2010 and ending September 30, 2011, and collected by March 31, 2012. This FY2011 revenue is used as a starting point for revenue for the transitional period, which is six years for price cap operations and nine years for rate-of-return operations. For each operation, the FY2011 baseline revenue is reduced by a specified percent during each year of the transition, resulting in a target revenue for each tariff year. At the same time, the FCC rules require reductions in ICC rates for specified services and jurisdictions. As the recoverable revenue declines and the rates decline, any target revenue which will not be covered by ICC revenue can be recovered, in part, from end users through an access recovery charge (“ARC”). Price cap incumbent LECs are permitted to implement monthly end user ARCs with five annual increases of no more than $0.50 for residential/single-line business consumers, for a total monthly ARC of no more than $2.50 in the fifth year; and $1.00 (per month) per line for multi-line business customers, for a total of $5.00 per line in the fifth year, provided that: (1) any such residential increases would not result in regulated residential end-user rates that exceed the $30 residential rate ceiling; and (2) any multi-line business customer’s total subscriber line charge (“SLC”) plus ARC does not exceed $12.20. Rate-of-return incumbent LECs are permitted to implement monthly end user ARCs with six annual increases of no more than $0.50 (per month) for residential/single-line business consumers, for a total ARC of no more than $3.00 in the sixth year; and $1.00 (per month) per line for multi-line business customers for a total of $6.00 per line in the sixth year, provided that: (1) such increases would not result in regulated residential end-user rates that exceed the $30 Residential Rate Ceiling; and (2) any multi-line business customer’s total SLC plus ARC does not exceed $12.20. If the combination of ICC and ARC revenue is not sufficient to cover the targeted revenue, then additional funding will be provided by the CAF.

Interstate Access Charges

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 interstate 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, usage-sensitive charges paid by long-distance carriers, and recurring monthly charges for use of dedicated facilities paid by long-distance carriers. The amount of access charge revenue that we will receive is subject to change. As previously described, the FCC has adopted a plan to resolve certain billing disputes related to intercarrier compensation and to transition all terminating state and interstate intercarrier compensation to zero over a six or nine year period for price cap and rate-of-return companies, respectively.

Our ILEC operations in Maine, New Hampshire and Vermont and, effective July 1, 2010, our Telecom Group operations in Maine and Vermont, are 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 rural operations are 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 allows us to continue to operate under both of these regimes until the FCC completes its general review of whether to modify or eliminate the all or nothing rule, or makes other comprehensive changes to its access charge rules. As previously discussed, the state and interstate terminating switched access rates for our rate-of-return regulated ILECs are impacted by the FCC CAF/ICC Order, which establishes a transition of these rates to zero over nine years. During this transition these rates will no longer be based on costs but will be subject to a complex transition mechanism established by the FCC.

The FCC CAF/ICC Order significantly changes the existing rates for access charges, which, combined with the development of competition, have generally caused the aggregate amount of switched access charges paid by long-distance carriers to decrease over time. The FCC also is considering whether to modify price cap rules as they apply to special access and whether to restrict some of the pricing flexibility enjoyed by price cap ILECs, which includes some of our Northern New England operations. 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.

 

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Universal Service Support

Rules effective through December 31, 2011 provided different methodologies for the determination of universal service payments to rural and non-rural carriers. In general, the rules provide high-cost support to rural carriers where the company’s actual costs exceed a nationwide benchmark level. High-cost support for non-rural carriers, on the other hand, was determined by a nationwide cost proxy model. Under the pre-2012 FCC rules, our non-rural operations received support under the non-rural model methodology in Maine and Vermont. The FCC’s rules for support to high-cost areas served by non-rural LECs 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. In 2010, in response to the Tenth Circuit remand, the FCC issued an order which justified its prior conclusion. As previously described, the FCC has replaced all pre-2012 universal service programs with its new CAF programs.

Universal Service Fund disbursements were distributed only to carriers that are designated as “eligible telecommunications carriers” (“ETCs”) by a state regulatory commission. All of our non-rural and rural LECs were designated as ETCs.

We also benefit indirectly from support to low-income users under the Lifeline and Linkup universal service programs. The FCC has asked the Federal-State Joint Board for Universal Service to recommend changes to these low-income programs to address, among other things, access to broadband and eligibility for support. On February 6, 2012, the FCC adopted and released an order reforming the Lifeline and Linkup low-income programs. Effective April 1, 2012, the Linkup program will be eliminated for all low-income subscribers except for Native Americans. Linkup is a program which pays 50% of the non-recurring charges, not to exceed $30.00, associated with establishment of local telecommunications service. Also effective April 1, 2012, there are major reforms to the Lifeline program. Prior to the changes, Lifeline credits were based on four tiers of support. The first three tiers of federal support will be replaced by a flat credit of $9.25 per month. The fourth tier, which relates to Native Americans, is unchanged. In addition, the FCC is establishing revised eligibility criteria effective April 1, 2012. The FCC order requires the Universal Service Administration Company (“USAC”) to establish a national database by the end of 2013 which will be used to eliminate duplicate funding. The FCC Lifeline order establishes a limited trial to evaluate Lifeline support for broadband services. It is not known how these changes will impact us. The elimination of duplicate support could result in fewer customers choosing us for Lifeline service, with the potential that a portion of our Lifeline customers may prefer to use other carriers for this service.

Universal Service Contributions

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 ETCs, 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 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 LECs, 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 or our customers.

Local Service Competition

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 and information services. As a result, competition in our local exchange service areas will continue to increase from CLECs, 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.

Under the 1996 Act, all LECs, including both ILECs and CLECs, 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 receive 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.

 

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In addition to these obligations, ILECs are subject to additional requirements to: (i) interconnect their facilities and equipment with any requesting telecommunications carrier at any technically feasible point; (ii) unbundle and provide nondiscriminatory access to certain network elements, referred to as unbundled network elements (“UNEs”), including some types of 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 ILEC’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 ILEC’s premises. Competitors are required to compensate the ILEC for the cost of providing these services.

Our non-rural operations are subject to all of the above requirements. In addition, our non-rural operations are subject to additional unbundling obligations that apply only to Bell Operating Companies. In contrast to the unbundling obligations that apply generally to ILECs, 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 Telecom Group rural operations are exempt from the additional ILEC requirements until the applicable rural carrier 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 the Telecom Group operations, except in Florida where the legislature has determined that all ILECs 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, results of operations and liquidity. 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 business, financial condition, results of operations and liquidity.

Under the 1996 Act, rural LECs 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 LECs, 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.

Long-Distance Operations

The FCC has required that ILECs 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 LEC at tariffed rates, terms and conditions. The Bell Operating Companies are subject to a different set of rules allowing them to offer both long-distance and local exchange services in the regions where they operate as Bell Operating Companies, subject to certain conditions with which we comply. In addition, our operations 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 ILEC 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 ILEC affiliates are no longer required to comply with the equal access scripting requirement. However, until similar relief is granted in each state by the state public utility commission (“PUC”), we will continue to comply with the equal access scripting requirements.

 

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Other Obligations under Federal Law

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 (“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 or subpoena.

The FCC limits how carriers may use or disclose customer proprietary network information (“CPNI”), and specifies what carriers must do to safeguard CPNI provided to third parties. Congress has enacted, and state legislatures are considering, legislation to criminalize the unauthorized sale of call detail records and to further restrict the manner in which carriers make such information available.

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.

Broadband and Internet Regulation

The FCC has adopted a series of orders that recognize the competitive nature of certain services that utilize advanced technologies.

With respect to our local network facilities, the FCC has determined that certain unbundling requirements do not apply to certain fiber facilities such as certain types of loops and packet switches.

The FCC has ruled that dedicated broadband Internet access services offered by telephone companies (using DSL technology), cable operators, electric utilities and terrestrial wireless providers qualify as largely deregulated information services. LECs or their affiliates may offer the underlying broadband transmission services that are used as an input to dedicated broadband Internet access services through private carrier arrangements on negotiated commercial terms. The FCC order also allows rural rate-of-return carriers, including most of our Telecom Group operations, the option to continue providing DSL service as a common carrier (status quo) offering. The FCC also has concluded that broadband Internet access service providers must comply with CALEA. Despite the FCC’s previous ruling that broadband Internet access is an information service, the FCC continues to evaluate this finding and is expected to issue a NPRM that could re-regulate broadband Internet access. We can provide no assurance about the outcome of such NPRM and how it may affect our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

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 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 forbearance deemed granted to Verizon has been extended to our Northern New England operations by the FCC in its order approving the Merger. In October 2007, the FCC stated its intention to define more precisely the scope of forbearance obtained by Verizon, but it has not yet done so. On October 4, 2011, tw telecom, Inc. filed a petition with the FCC asking it to reverse the forbearance granted to Verizon by operation of law on March 19, 2006. Comments have been filed in this proceeding by FairPoint and other parties. Following reply comments, the FCC may issue an order on this petition. We do not know how this would be resolved or the impact it may have on us if the FCC reversed, eliminated or modified the forbearance granted to Verizon in 2006.

The FCC has imposed particular regulatory obligations on IP-based telephony. It has concluded that interconnected VoIP providers must comply with CALEA; provide enhanced 911 emergency calling capabilities; comply with certain disability access requirements; comply with the FCC’s rules protecting CPNI; provide local number portability; and pay regulatory fees. Recently there have also been discussions among policymakers concerning “net neutrality.” The FCC released a statement of principles favoring customer choice of content and services available over broadband networks. It has adopted open Internet access rules applicable to all broadband Internet access providers. However, we cannot predict what impact, if any, this may have on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock. The FCC has preempted some state regulation of VoIP.

 

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Additional rules and regulations may be extended to the Internet and to broadband Internet access. A variety of proposals are under consideration in both federal and state legislative and regulatory bodies. For example, the FCC is considering reclassifying the transport component of broadband service as a “telecommunications service.” In addition, there has been increasing review to increase regulatory oversight of third party billing on telephone bills and for cyber security. We cannot predict whether the outcome of pending or future proceedings will prove beneficial or detrimental to our competitive position and our regulatory compliance costs.

On February 17, 2009, Congress enacted the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) which, among other programs, provides for $7.2 billion for broadband development in unserved and underserved areas of the United States. We applied for stimulus funding under the Recovery Act, but did not receive any grant funding. However, there were several grants of stimulus funding under the Recovery Act in our Northern New England operating area and our other service areas and in particular for the overbuilding of our Next Generation Network. Networks built with these funds in such areas may provide competition for our products and services.

State Regulation

The local service rates and intrastate access charges of substantially all of our telephone subsidiaries are regulated by state regulatory commissions which typically have the power to grant and revoke authority for 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. As described above, intrastate access charges are subject to the transition plan established by the FCC in its recent FCC CAF/ICC Order.

Most state commissions have traditionally regulated LEC 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 LECs 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 (“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 our Northern New England operations:

Regulatory Conditions to the Merger, as Modified in Connection with the Plan

As required by the Plan as a condition precedent to the effectiveness of the Plan, we were required to obtain certain regulatory approvals, including approvals from the public utility commissions in Maine and New Hampshire and the Vermont Public Service Board (the “Vermont Board”). In connection with the Chapter 11 Cases, we negotiated with representatives of the state regulatory authorities in each of Maine, New Hampshire and Vermont with respect to (i) certain regulatory approvals relating to the Chapter 11 Cases and the Plan and (ii) the Merger Orders. We agreed to the Regulatory Settlements described below.

New Hampshire Regulatory Settlement

On July 7, 2010, the New Hampshire Public Utilities Commission (“NHPUC”) provided its approvals for New Hampshire, including the Regulatory Settlement for New Hampshire (the “New Hampshire Regulatory Settlement”). The New Hampshire Regulatory Settlement provides for, among other things, the following:

Service Quality Requirements:

 

   

We committed to meet the broadband build out and capital investment requirements and continue operating under the service quality index (“SQI”) service quality program of the January 23, 2008 Settlement Agreement (the “NH 2008 Settlement”) among Verizon, the Company and the staff of the NHPUC and Order No. 24,823 in Docket DT 07-011 (the “NH 2008 Order”), subject to certain modifications described in the New Hampshire Regulatory Settlement.

 

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In connection with the NHPUC Order No. 25,129 in Docket No. DT 10-025, final settlement of our SQI penalties for 2009 were deferred until our 2010 SQI results were approved by the NHPUC. The order identified five key performance metrics, and for each metric that we met in 2010, the 2009 penalties would be reduced by 20%. The 2010 SQI results indicated that we had met three of the five key metrics, reducing the 2009 penalties by 60%. In January of 2011, the NHPUC initiated an audit of our 2010 SQI plan. The audit was completed in the third quarter of 2011, and the results confirmed that we had met three of the five key metrics during 2010. The NHPUC staff agreed with this assessment and made a recommendation to the NHPUC that such assessment be accepted. The NHPUC approved this assessment in an order dated February 6, 2012.

Broadband Commitments:

 

   

We agreed to adhere to the broadband coverage commitments prescribed in the NH 2008 Order; however, certain broadband build-out commitments with a deadline of April 1, 2010 were extended to December 31, 2010. We believe that we have fulfilled this broadband coverage commitment as of December 31, 2010.

 

   

We confirmed our commitment to spend a total of at least $56.4 million on our New Hampshire broadband build-out by March 31, 2015 and we have spent $52.3 million as of December 31, 2011.

 

   

We have the option to resell terrestrial (non-satellite) based service providers’ broadband service offerings in order to fulfill our broadband build out and/or service requirements with respect to the last eight percent (8%) of our broadband availability requirements as contained within the NH 2008 Settlement, provided that the services meet or exceed all requirements of the NH 2008 Order, and the resold services are purchased through and serviced by us.

 

   

Pricing restrictions regarding stand-alone DSL service terminated on April 1, 2011; provided, however, that we will continue to honor the “for life” pricing that Verizon had offered to certain customers. We believe that we are in compliance with this commitment.

 

   

The first $500,000 of any penalty amounts resulting from any failure to meet broadband commitments will be paid to the New Hampshire Telecommunications Planning and Development Fund. Any penalties above $500,000 will be invested within three years of the date of the penalty as additional expenditures for our network, subject to NHPUC approval.

Expenditure Commitments:

 

   

We reconfirmed our commitment to spend $285.4 million in capital expenditures through March 31, 2013, of which $273.5 million has been spent through December 31, 2011; provided, however, that the amounts expended toward the $56.4 million broadband commitment described above may be applied to the $285.4 million capital expenditure commitment.

 

   

We agreed to reduce our $65.0 million “other expenditure” commitment by $10.0 million and reallocate the $10.0 million to recurring maintenance capital expenditures to be spent on or before March 31, 2013. This $10.0 million increases the $285.4 million capital expenditure commitment to $295.4 million.

 

   

We may further reduce our $65.0 million “other expenditure” commitment by up to $10.5 million to the extent such amounts are needed and are actually expended beyond the original $56.4 million broadband commitment in order to achieve 95% broadband availability by March 31, 2013.

 

   

We may further reduce our $65.0 million “other expenditure” commitment by $4.5 million of capital expenditures already expended in excess of amounts estimated to develop our Next Generation Network.

 

   

We will have from April 1, 2010 to March 31, 2015 to meet whatever “other expenditure” commitment remains after the preceding reductions, which will be spent on “network enhancing activities.”

 

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Financial Commitments:

 

   

Certain of the financial conditions of the NH 2008 Settlement and the NH 2008 Order are replaced by the terms of the New Hampshire Regulatory Settlement and are satisfied or rendered moot by the debt reductions resulting from the Plan.

Management Commitments:

 

   

Our board of directors is required to consist of a supermajority of newly appointed independent directors, and at least one member of the board of directors must reside in northern New England. We are in compliance with this obligation.

 

   

Our board of directors is required to appoint a “regulatory sub-committee” that will monitor compliance with the terms of the NH 2008 Order, as modified by the New Hampshire Regulatory Settlement, and all other regulatory matters involving the States of Vermont, New Hampshire and Maine. We appointed a regulatory committee on the Effective Date.

 

   

We are required to maintain a state president who will provide a senior regulatory presence in New Hampshire and is able to reasonably respond to various future Company-based NHPUC dockets or regulatory issues relating to telecommunications. We fulfilled this obligation in February of 2010.

 

   

We agreed to seek to have a Chief Information Officer in place by June 30, 2010. We fulfilled this obligation in March of 2010.

 

   

We agreed that any management bonuses and the FairPoint Communications, Inc. 2010 Success Bonus Plan (the “Success Bonus Plan”) would be based on a combination of EBITDAR (EBITDA plus restructuring costs) and service metrics goals and the weighting for each of these categories would be computed and clearly stated for the incentive and bonus plans for each individual and for the Company in total. We believe that we are in compliance with this commitment.

Other:

 

   

We were required to reimburse the State of New Hampshire for certain costs and expenses. We fulfilled this obligation in January 2011.

 

   

During the first two years following the Effective Date of the Plan, we are barred from paying dividends if we are in material breach of the New Hampshire Regulatory Settlement until we cure such breach.

Maine Regulatory Settlement

On July 6, 2010, the Maine Public Utilities Commission (the “MPUC”) provided its approvals for Maine, including of the Regulatory Settlement for Maine (the “Maine Regulatory Settlement”). The Maine Regulatory Settlement provides for, among other things, the following:

General:

 

   

We agreed to comply with the MPUC’s February 1, 2008 Order issued in Docket Nos. 2007-67 and 2005-155, and all stipulations approved thereby (the “ME 2008 Merger Order”), including provisions regarding broadband build-out, capital investment, the SQI program and other provisions of the ME 2008 Merger Order, subject to certain modifications described in the Maine Regulatory Settlement.

Service Quality Requirements:

 

   

We and the MPUC agreed to submit a joint consent order to the Bankruptcy Court which provided for the implementation of the SQI rebates for the 2008-2009 SQI year, starting with bills issued in March 2010. The Company issued the first nine months of credits through November 2010, at which time the remaining three months were combined with the credits to be issued for the 2009-2010 penalties and were issued over the period of December 2010 to November 2011.

 

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Broadband Commitments:

 

   

The deadline for the initial 83% broadband build-out requirement was extended from April 1, 2010 to December 31, 2010. We believe that we have fulfilled this broadband coverage commitment as of December 31, 2010. An additional interim requirement of 85% was established with a July 31, 2012 deadline, and the final requirement, with a March 31, 2013 deadline, was reduced from 90% to 87%. However, if we fail to meet any of these requirements, we shall be further required to achieve 90% by March 31, 2014. We further agreed that by March 31, 2013, we would achieve 82% for lines in UNE Zone 3. If we meet the 87% requirement by March 31, 2013, we will contribute $100,000 to the ConnectME Authority on July 1, 2013. We believe we have already met our obligation to achieve an 87% broadband build-out; however this has been the subject of a PUC proceeding and the decision in this proceeding has been appealed to the Maine Supreme Court.

 

   

In meeting our broadband build-out requirements beyond 85%, we may resell the broadband service offerings of other non-satellite providers in order to meet our build-out and/or service requirements, provided that the services meet or exceed all requirements of the ME 2008 Merger Order, the resold services are purchased through and serviced by us, and the MPUC staff approves the provider(s).

Financial Commitments:

 

   

The financial conditions in the ME 2008 Merger Order were replaced by the terms of the Maine Regulatory Settlement, which provided that such financial conditions were satisfied or were rendered moot by the debt reductions resulting from the Plan.

Management Commitments:

 

   

Our board of directors is required to consist of a supermajority of newly appointed independent directors and at least one member of the board of directors must reside in northern New England. We are in compliance with this obligation.

 

   

The board of directors is required to appoint a “regulatory sub-committee” that will monitor compliance with the terms of the ME 2008 Merger Order, as modified by the Maine Regulatory Settlement, and all other regulatory matters involving the States of Vermont, New Hampshire and Maine. We appointed a regulatory committee on the Effective Date.

 

   

We agreed to seek to have a Chief Information Officer in place by June 30, 2010. We fulfilled this obligation in March of 2010.

 

   

We agreed that any management bonuses and the Success Bonus Plan would be based on a combination of EBITDAR (EBITDA plus restructuring costs) and service metrics and the weighting for each of these categories would be computed and clearly stated for the incentive and bonus plans for each individual and for the Company in total, and that we would disclose such metrics to the MPUC and the Office of the Public Advocate of the State of Maine (the “Maine Public Advocate”). We believe that we are in compliance with this commitment.

Other:

 

   

We were required to reimburse the MPUC and Maine Public Advocate for certain costs and expenses. We fulfilled this obligation in January 2011.

 

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Vermont Regulatory Settlement

On December 23, 2010, the Vermont Board provided its approvals in Vermont, including the Regulatory Settlement for Vermont (the “Vermont Regulatory Settlement”). The Vermont Regulatory Settlement provides for, among other things, the following:

Service Quality Requirements:

 

   

In general, all of the service quality programs contained in the January 8, 2008 settlement agreement among Verizon, the Company and the Department of Public Service (“DPS”) (the “VT 2008 Settlement”) and the February 15, 2008 Order RE: MODIFIED PROPOSAL IN Docket Number 7270 (the “VT 2008 Order”) will remain in place subject to certain modifications described in the Vermont Regulatory Settlement.

 

   

Final settlement of SQI penalties for 2008 and 2009 was deferred until our 2010 SQI results were approved by the Vermont Board. Ten performance metrics were identified, and for each metric that we met in 2010, the 2008 and 2009 penalties would be reduced by 10%. Our final 2010 SQI results in Vermont indicated that we had met nine of the ten service level requirements resulting in 90% of the deferred SQI penalties for 2008 and 2009 being waived. We requested that the remaining Amended Retail Service Quality Plan and performance assurance plan (“PAP”) Mode of Entry penalties of $6.6 million be used to deploy broadband into unserved areas of Vermont. The Vermont Board has approved this request.

Broadband Commitments:

 

   

We would undertake to deploy broadband services to 95% of all access lines in those exchanges that had been identified for 100% broadband availability in the VT 2008 Order (the “100% Exchanges”) by June 30, 2011. We believe we met this obligation. With respect to the remaining 5% of lines in the 100% Exchanges, we will deploy broadband to any requesting customer using an extended service interval of 90 days from the date of the receipt of the order from the customer, provided such order was made no sooner than June 30, 2011. Failure to meet such requirements will require us to waive certain service charges.

 

   

We also will request that the Vermont Board authorize us to use high-cost USF funds for three consecutive years to upgrade local loop plant and infrastructure in order to improve our service quality and network reliability. If the Vermont Board authorizes us to use the high-cost USF funds, and to the extent permitted by FCC rules, we may invest the high-cost USF funds in network infrastructure that will support the deployment of broadband services to an additional 5% of access lines on a timeline that varies depending on the date of the Vermont Board’s authorization. This request is no longer applicable due to a similar provision included in a successor incentive regulation plan (the “2011 Incentive Regulation Plan”) which is further described below.

 

   

We will have the option to resell terrestrial (non-satellite) based service providers’ broadband service offerings in order to fulfill our broadband build-out and/or service requirements as contained in the VT 2008 Order, provided that the services meet or exceed all requirements of the VT 2008 Order as modified by the Vermont Regulatory Settlement and the resold services are purchased through and serviced by us.

 

   

Penalty amounts resulting from any failure to meet broadband deployment requirements will be managed by us with funds deposited into an escrow account with an escrow agent, which will reimburse us for costs incurred for additional network projects completed within 18 months of the date of the penalty, such projects subject to the approval of the DPS. We believe that we have completed the build-out obligation and are not subject to any penalties.

Capital Investment Commitments:

 

   

We believe that we have met the capital commitment of the VT 2008 Order to invest $120 million by March 31, 2011.

Financial Commitments:

 

   

Certain of the financial conditions of the VT 2008 Settlement and the VT 2008 Order are replaced by the terms of the Vermont Regulatory Settlement and are satisfied or rendered moot by the debt reductions resulting from the Plan.

Management Commitments:

 

   

Our board of directors is required to consist of a supermajority of newly appointed independent directors and at least one member of the board of directors must reside in northern New England. We are in compliance with this obligation.

 

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The board of directors is required to appoint a “regulatory sub-committee” that will monitor compliance with the terms of the VT 2008 Order, as modified by the Vermont Regulatory Settlement, and all other regulatory matters involving the States of Vermont, New Hampshire and Maine. We appointed a regulatory committee on the Effective Date.

 

   

We are required to maintain a state president who will provide a senior regulatory presence in Vermont and be able to reasonably respond to various future Company-based dockets or regulatory issues relating to telecommunications. We fulfilled this obligation in January of 2010.

 

   

We agreed to seek to have a Chief Information Officer in place by June 30, 2010. We fulfilled this obligation in March of 2010.

 

   

We agreed that management bonuses and the Success Bonus Plan would be based on a combination of EBITDAR (EBITDA plus restructuring costs) and service metrics goals and the weighting for each of these categories would be computed and clearly stated for the incentive and bonus plans for each individual and for the Company in total. We believe that we are in compliance with this commitment.

Other:

 

   

We were required to reimburse the State of Vermont for certain costs and expenses. We fulfilled this obligation in January 2011.

 

   

During the first two years following the Effective Date of the Plan, we are barred from paying dividends if we are in material breach of the Vermont Regulatory Settlement until we cure such breach.

 

   

On February 13, 2012, the VT Public Service Board approved our request to use $6.6 million of the Amended Retail Service Quality Plan and PAP Mode of Entry penalties to deploy broadband into unserved areas of Vermont. Approximately $5.3 million of this amount is associated with pre-bankruptcy claims and, therefore, is included in the Cash Claims Reserve.

Other State Regulatory Matters

Maine — Retail Regulation

Our Northern New England operations in Maine currently operate under an AFOR implemented upon consummation of the Merger. 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. Under the terms of the ME 2008 Merger Order, among other things, we reduced the caps on monthly basic exchange rates effective as of August 1, 2008 by an amount designed to decrease revenues by approximately $1.5 million per month (depending on the applicable number of access lines). The current AFOR caps basic exchange rates in Maine at the new level for five years after August 1, 2008. The AFOR also includes an SQI requirement for our Northern New England operations in Maine, which establishes benchmarks for certain performance categories and imposes penalties for the failure to meet the benchmarks. Our Telecom Group operations in Maine converted to price cap regulation on July 1, 2010. All telephone companies in Maine were 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 tariff requirements of the MPUC. 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.

Maine — Unbundling of Network Elements

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 our Northern New England operations must satisfy to sell long-distance services, and in particular to define the elements that our Northern New England operations 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 our Northern New England operations to provide access to elements that the FCC had held are not required to be provided as UNEs under Section 251 of the Communications Act. Prior to the Merger, Verizon New England, Inc. (“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

 

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court remanded the matter for further proceedings by the District Court, which subsequently dismissed the case at our and the MPUC’s request. On November 25, 2009, the MPUC petitioned the FCC for a declaratory ruling requiring us to provide certain UNEs, which is still pending.

New Hampshire

Our ILEC business operations in New Hampshire are subject to intrastate rate-of-return regulation. We have adopted the contractual and tariffed rates and terms and conditions that were in effect for the Verizon Northern New England business prior to the Merger. Within this regulatory structure, the NHPUC has instituted rules and policies to expedite offerings of new services, but we are 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 maintain two New Hampshire wholesale tariffs, one for interconnection, co-location 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 retail, wholesale and DSL services for up to five years following the closing of the Merger to those in effect as of the closing date of the Merger.

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 Verizon 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. Verizon Northern New England 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.

In 2008, the NHPUC issued an order determining that intra-LATA carrier common line switched access charges did not apply to certain interexchange calls where neither the calling nor the called party is served by our Northern New England operations. This decision was reversed by the New Hampshire Supreme Court on appeal. Following this decision, the NHPUC directed us to file tariff revisions to remove such charges prospectively and we objected to this requirement. The tariff revisions went into effect on January 21, 2012.

The New Hampshire legislature recently allowed a statutory exemption applicable to telecommunications providers from certain municipal property taxes to expire; as such our New Hampshire operations are now subject to the imposition of municipal property taxes on our utility telephone poles and conduit. Also, as a result of a recent court case, municipalities are now allowed to assess property taxes on the use of municipal rights of way. The Company estimates it will be billed approximately $6.5 million for these taxes of which $4.9 million was expensed for the nine months ended December 31, 2011. All of these municipal property tax bills may be reduced through abatement proceedings that we may initiate no later than March 1, 2012. At present, we cannot predict our total exposure based upon the abatement proceedings. During the fourth quarter of 2011, we made a tariff filing with the NHPUC requesting permission to levy a municipal property tax surcharge on certain retail and resold access lines in the amount not to exceed $0.99 per line up to a total of 25 access lines per billing account number. The NHPUC issued an Order on December 28, 2011, granting our request to apply the surcharge on a temporary basis effective April 1, 2012, pending further regulatory proceedings to be undertaken during 2012.

Vermont

In Vermont, our Northern New England service territory operated under an alternative form of regulation since 2006 known as an Amended Incentive Regulation Plan. That plan expired on March 31, 2011. On March 23, 2011, we entered into a Memorandum of Understanding with the Vermont Department of Public Services whereby they agreed to seek approval of the 2011 Incentive Regulation Plan before the Vermont Public Service Board. The Board approved the 2011 Incentive Regulation Plan on January 18, 2012, and that plan is effective retroactively to April 1, 2011. We believe the 2011 Incentive Regulation Plan will decrease the scope of regulation for us, providing us with increased ability to compete in the Vermont telecommunications marketplace. Under the 2011 Incentive Regulation Plan, our exposure to annual retail service quality penalties has been decreased from $10.5 million to $1.65 million and we have pricing discretion with respect to existing and new services other than basic local exchange service.

 

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Local Government Authorizations

We may be required to obtain from municipal authorities permits for street opening and construction or operating franchises to install and expand facilities in certain communities. If 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 the subcontractors or electric utilities with which we will have contracts already possess the requisite authorizations to construct or expand our networks. In association with the Recovery Act, there may be an increase in our requirements associated with road move requests pursuant to new funding for roads. It is not certain whether funding will be available to us for this potential obligation.

Environmental Regulations

Like all other local telephone companies, our 34 LEC 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 real 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.

Other Information

We make available free of charge 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.

ITEM 1A. RISK FACTORS

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

Risks Related to our Common Stock and Our Substantial Indebtedness

The price of our Common Stock may be volatile and 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, including but not limited to, period-to-period fluctuations in our operating results, the volume of sales of our Common Stock, dilution, developments in the communications industry, the failure of securities analysts to cover our Common Stock, changes in financial estimates by securities analysts, short interest in our Common Stock, competitive factors, regulatory developments, economic and other external factors, general market conditions and market conditions affecting the stock of communications companies in general. 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, which could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

In addition, shares of our Common Stock were listed on the NASDAQ effective as of January 25, 2011. There has been a public market for our Common Stock for only a short period of time. An active, liquid and orderly market for our Common Stock may not be sustained, which could depress the market price of our Common Stock. An inactive market may also impair our ability to raise capital.

 

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We have substantial indebtedness which could have a negative impact on our financing options and liquidity position.

As of December 31, 2011, we had $1.0 billion of total debt outstanding (including approximately $3.9 million of capital leases). In addition, as of December 31, 2011, we had approximately $62.6 million, net of outstanding letters of credit, available for additional borrowing under our $75.0 million revolving loan facility (the “Revolving Facility”).

Our overall indebtedness and the terms of our Credit Agreement could:

 

   

require us to dedicate a significant portion of our cash flow from operations to paying the principal of and interest on our indebtedness, thereby limiting the availability of our cash flow to fund future capital expenditures, working capital and other corporate purposes;

 

   

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

 

   

limit our ability to refinance our indebtedness on terms acceptable to us or at all;

 

   

restrict us from making strategic acquisitions or cause us to make non-strategic divestitures;

 

   

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

 

   

place us at a competitive disadvantage compared with competitors that have a less significant debt burden; and

 

   

make us more vulnerable to economic downturns and limit our ability to withstand competitive pressures.

Our ability to continue to fund our debt requirements and to reduce debt may be affected by general economic, financial market, competitive, legislative and regulatory factors, among other things. An inability to fund our debt requirements, reduce debt or satisfy debt covenant requirements could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

In addition, all of our indebtedness under the Credit Agreement bears interest at variable rates. If market interest rates increase, variable rate debt will create higher debt service requirements, which could adversely affect our cash flow. In addition, interest payments on the $1.0 billion term loan facility in our Credit Agreement (the “Term Loan”) are subject to a British Bankers Association LIBOR rate (“LIBOR”) floor of 2.00%. While LIBOR remains below 2.00% we will incur interest costs above market rates. While we may enter into agreements limiting our exposure to higher interest rates, these agreements may not offer complete protection from this risk.

We are a holding company and rely on dividends, interest and other payments, advances and transfers of funds from our operating subsidiaries and investments to meet our debt service and other obligations and to pay dividends, if any, on our Common Stock.

We are a holding company and conduct no operations. Accordingly, our cash flow and our ability to make payments on, or repay or refinance, our indebtedness and to fund planned capital expenditures and other cash needs will depend largely upon the cash flows of our operating subsidiaries and the payment of funds by those subsidiaries to us in the form of repayment of loans, dividends, management fees or otherwise. Distributions to us from our subsidiaries will depend on their respective operating results and will be subject to restrictions under, among other things,

 

   

the laws of their jurisdiction of organization;

 

   

the rules and regulations of state and federal regulatory authorities;

 

   

agreements of those subsidiaries, including agreements governing their indebtedness; and

 

   

regulatory restrictions.

 

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Our subsidiaries have no obligation, contingent or otherwise, to make funds available, whether in the form of loans, dividends or other distributions, to us. Any inability to receive distributions from our subsidiaries could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

To operate and expand our business, service our indebtedness and meet our other cash needs, we will require a significant amount of cash, which may not be available to us. We may not generate sufficient funds from operations to repay or refinance our indebtedness at maturity or otherwise or to fund our operations.

Our ability to make payments on, or repay or refinance, our indebtedness, to fund our operations and to fund planned capital expenditures, unanticipated capital expenditures and other cash needs will depend largely upon our future operating performance, including our ability to execute on our business plan. Our future operating performance, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors, such as any pension contributions required by the Employee Retirement Income Security Act of 1974 (“ERISA”), that are beyond our control. In addition, our ability to borrow funds in the future will depend on the satisfaction of the covenants in the agreements governing our indebtedness. Specifically, we will need to maintain specified financial ratios and satisfy financial condition tests. In addition, the limitations imposed by any financing arrangements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing.

In addition, we can provide no assurance that we would be able to refinance any of our indebtedness on commercially reasonable terms, or at all. If we are unable to make payments on or refinance our debt or obtain new financing under these circumstances, we would have to consider other options, including:

 

   

sales of assets;

 

   

reduction or delay of capital expenditures, strategic acquisitions, investments and alliances; or

 

   

negotiations with our lenders to restructure the applicable debt.

The agreements governing our indebtedness may restrict, or market or business conditions may limit, our ability to take some of these actions or the effectiveness of these actions.

An inability to generate sufficient funds from operations to repay or refinance our indebtedness at maturity or otherwise fund our operations could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

Our financing arrangements subject us to various restrictions that could limit our operating flexibility, our ability to service our indebtedness and to fund dividends, if any, on our Common Stock.

The Credit Agreement contains restrictions, covenants and events of default that, among other things, require us to satisfy certain financial tests and maintain certain financial ratios and restrict our ability to incur additional indebtedness and to refinance our existing indebtedness. The terms of the Credit Agreement impose, and the agreements governing any future indebtedness may impose, various restrictions and covenants on us that could limit our ability to respond to market conditions, provide for capital investment needs or take advantage of business opportunities by limiting the amount of additional borrowings we may incur. These restrictions may include compliance with, or maintenance of, certain financial tests and ratios and may limit or prohibit our ability to, among other things:

 

   

incur additional debt or issue preferred stock;

 

   

pay dividends in the future or make other distributions on our stock or repurchase or redeem stock;

 

   

create liens;

 

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redeem or prepay certain debt;

 

   

make certain investments;

 

   

engage in specified sales of assets;

 

   

enter into transactions with affiliates;

 

   

enter new lines of business;

 

   

engage in consolidation, mergers and acquisitions; and

 

   

make certain capital expenditures.

These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financing, merger and acquisition and other corporate opportunities.

Various risks, uncertainties and events beyond our control could affect our ability to comply with these covenants and maintain these financial tests and ratios. Failure to comply with any of the covenants in the Credit Agreement could result in a default thereunder. In addition, the limitations imposed by any financing arrangements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing. Any of these events could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

Limitations on our ability to use NOL carryforwards, and other factors requiring us to pay cash to satisfy our tax liabilities in future periods, may affect our ability to repay our indebtedness.

As of December 31, 2011, our NOLs have been substantially reduced by the recognition of gains on the discharge of certain debt pursuant to the Plan. In addition, our emergence from bankruptcy resulted in an ownership change for federal income tax purposes under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). This followed previous ownership changes resulting from our initial public offering in February 2005 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. Moreover, the Merger with Spinco resulted in a further ownership change for these purposes. As a result of these ownership changes, there are specific limitations on our ability to use these NOL carryforwards and other tax attributes from periods prior to the initial public offering and the Merger. Although we do not expect 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 if we were to generate taxable income in excess of the limitation on usage of NOL 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 over the amount we otherwise would have, had we not experienced an ownership change. In addition, in the future we will be required to pay cash to satisfy our tax liabilities when all of our NOL carryforwards have been used or have expired. Limitations on our usage of NOL carryforwards, and other factors requiring us to pay cash taxes in the future, would reduce the funds available to fund our operations, make capital expenditures, service our indebtedness and pay dividends, if any, in the future, which could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

Concentration of ownership among stockholders may prevent new investors from influencing significant corporate decisions.

Based on Schedules 13D and 13G filed by the respective holders, as of March 25, 2011, there are some institutional holders who own 5% or more of our outstanding Common Stock. As a result, these stockholders may be able to exercise significant control over all matters requiring stockholder approval, including the election of directors, amendment of our certificate of incorporation and approval of corporate transactions and could gain significant control over our management and policies as a result thereof.

 

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Future sales or the possibility of future sales of a substantial amount of our Common Stock may depress the price of our Common Stock.

Future sales, or the availability for sale in the public market, of substantial amounts of our Common Stock could adversely affect the prevailing market price of our Common Stock, and could impair our ability to raise capital through future sales of equity securities. 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.

As of March 2, 2012, we had 26,194,442 shares of Common Stock outstanding. All such shares are freely tradable except for any shares of our Common Stock that may be held or acquired by our directors, executive officers, employee insiders and other affiliates, as that term is defined in the Securities Act, which will be restricted securities under the Securities Act. Restricted securities may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available. In addition, Angelo Gordon & Co., L.P. (“Angelo Gordon”) and entities advised by Angelo Gordon have certain registration rights with respect to the Common Stock they hold or may acquire in the future.

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 these shares or other securities in connection with any such acquisitions and investments.

We do not expect to pay any cash dividends for the foreseeable future.

We do not anticipate that we will pay any cash dividends on shares of our Common Stock for the foreseeable future. Because we are a holding company, our ability to pay dividends depends on our receipt of dividends from our operating subsidiaries. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon limitations imposed by orders of state regulatory authorities, results of operations, financial condition, contractual restrictions contained in the agreements governing our Credit Agreement or indebtedness we may incur in the future, restrictions imposed by applicable law and other factors our board of directors may then deem relevant.

Our actual financial results and financial condition are likely to vary significantly from the projections and other financial information provided to the Bankruptcy Court and investors should not rely on such information in making investment decisions.

In connection with the Chapter 11 Cases, we filed with the Bankruptcy Court a disclosure statement containing financial projections and other financial information to demonstrate the feasibility of the Plan and our ability to continue operations upon emergence from Chapter 11 bankruptcy protection. The projections and other financial information provided were based on information available to us and assumptions known to us as of March 2010, however, certain projected financial information was revised in connection with a subsequent review of our financial forecast in December 2010. Projections are inherently subject to uncertainties and risks and our actual results and financial condition have varied from those contemplated by the projections and other financial information provided to the Bankruptcy Court and these variations may be material. We believe that because such projections and other financial information are now out of date and because of developments with respect to our business since the information was prepared, investors should not rely on them in making investment decisions.

Our actual operating results may differ significantly from our guidance.

From time to time, we have released and may continue to release guidance regarding our future performance that represents our management’s estimates as of the date of release. This guidance, which consists of forward-looking statements, is prepared by our management and is qualified by, and subject to, the assumptions and the other information contained or referred to in the release. Our guidance is not prepared with a view toward compliance with the published guidelines of the American Institute of Certified Public Accountants, and neither our independent registered public accounting firm nor any other independent expert or outside party compiles or examines the guidance and, accordingly, no such person expresses any opinion or any other form of assurance with respect thereto.

 

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Guidance is based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and are based upon specific assumptions with respect to future business decisions, some of which will change. We generally state possible outcomes as high and low ranges which are intended to provide a sensitivity analysis as variables are changed but are not intended to represent our actual results which could fall outside of the suggested ranges. The principal reason that we release this data is to provide a basis for our management to discuss our business outlook with analysts and investors. Notwithstanding this, we do not accept any responsibility for any projections or reports published by any such outside analysts or investors.

Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions or the guidance furnished by us will not materialize or will vary significantly from actual results. Accordingly, our guidance is only an estimate of what management believes is realizable as of the date of release. Actual results may vary from the guidance and the variations may be material. Investors should also recognize that the reliability of any forecasted financial data diminishes the farther in the future that the data is forecast. In light of the foregoing, investors are urged to put the guidance in context and not to place undue reliance on it.

Any inability to successfully implement our operating strategy or the occurrence of any of the events or circumstances discussed therein could result in the actual operating results being different than the guidance, and such differences may be materially adverse.

Because our post-emergence consolidated financial statements reflect fresh start accounting adjustments made upon emergence from bankruptcy, and because of the effects of the transactions that became effective pursuant to the Plan, financial information in our post-emergence financial statements will not be comparable to our financial information from prior periods, including certain statements contained herein.

Upon our emergence from Chapter 11 protection on January 24, 2011, we adopted fresh start accounting in accordance with guidance under the applicable reorganization accounting rules, pursuant to which our reorganization value, which represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, has been allocated to the fair value of assets in conformity with guidance under the applicable accounting rules for business combinations, using the purchase method of accounting for business combinations. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets was reflected as goodwill, which is subject to periodic evaluation for impairment. In addition to fresh start accounting, our post-emergence consolidated financial statements reflect all effects of the transactions contemplated by the Plan. Therefore, our post-emergence consolidated statements of financial position and consolidated statements of operations are not comparable in many respects to our consolidated statements of financial position and consolidated statements of operations for periods prior to our adoption of fresh start accounting and prior to accounting for the effects of the reorganization, including the financial statements contained herein.

In addition, as the Chapter 11 Cases remained open, our consolidated balance sheet upon our emergence from Chapter 11 included accruals for unresolved claims related to the Chapter 11 Cases. These accruals were based on management’s best estimate of future settlements of such unresolved claims and are subject to adjustment subsequent to the Effective Date. To the extent that our negotiations result in favorable or unfavorable settlements in relation to the amount accrued, we recognize gains and/or losses in our consolidated statement of operations subsequent to the Effective Date.

Risks Related to Our Business

We provide services to customers over access lines, and if we lose access lines, our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock may be materially adversely affected.

We generate revenue primarily by delivering voice and data services over access lines. During the years ended December 31, 2011 and 2010, respectively, we experienced access line equivalent loss of 5.0% and 8.3%. These losses resulted mainly from competition, including competition from bundled offerings by cable companies, the use of alternate technologies as well as challenging economic conditions and the offering of DSL services, which prompts some customers to cancel second line service. We believe that the Chapter 11 Cases and certain issues associated with the Cutover have had and may continue to have an adverse effect on our ability to retain customers.

We expect to continue to experience net access line losses. Our inability to retain access lines could adversely affect our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

 

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We provide access services to other communications companies, and if these companies were to find alternative means of providing services, become insolvent or experience substantial financial difficulties, our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock may be materially adversely affected.

We originate and terminate calls on behalf of long-distance carriers and other interexchange carriers over our network in exchange for access charges. Interstate and intrastate access charges represented approximately 35.9% of our total revenues in 2011. Should one or more of these carriers find alternative means of providing services, loss of revenues from these carriers could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock. In addition, should one or more of the carriers that we do business with become insolvent or experience substantial financial difficulties, our inability to timely collect access charges from them could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

We are subject to competition that may materially adversely impact our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

We face intense competition from a variety of sources for our voice and Internet services in most of the areas we now serve. 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 services areas, we face competition from wireless carriers for voice services. As technology and economies of scale have improved, competition from wireless carriers has increased and is expected to further increase. We also face increasing competition from wireline and cable television companies for our voice and Internet services. We estimate that as of December 31, 2011, most of the customers that we serve had access to voice and Internet services through a cable television company. Wireline and cable television companies have the ability to bundle their services, which has and is expected to continue to intensify the competition we face from these providers. VoIP providers, Internet service providers and satellite companies also compete with our services, and such competition has increased and is expected to continue to increase in the future. In addition, many of our competitors have access to a larger workforce and have substantially greater name-brand recognition and financial, technological and other resources than we do.

In addition, consolidation and strategic alliances within the communications industry or the development of new technologies have had and may continue to have an effect on our competitive position. We cannot predict the number of competitors that will emerge, particularly in light of possible regulatory or legislative actions that could facilitate or impede market entry, but increased competition from existing and new entities could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

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

 

   

loss of customers (given the likelihood that when we lose customers for local service, we will also lose them for all related services);

 

   

reduced network usage by existing customers who may use alternative providers for voice and data services;

 

   

reductions in the service prices that may be necessary to meet competition; and

 

   

increases in marketing expenditures and discount and promotional campaigns.

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

Rapid and significant changes in technology and new service introductions occur frequently in the communications industry and industry standards evolve continually, including but not limited to a transition in the industry from primarily voice products to data services. 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 sell new services to our existing customers, which could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

 

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The geographic concentration of our operations in Maine, New Hampshire and Vermont make our business susceptible to local economic and regulatory conditions and consumer trends, and an economic downturn, recession or unfavorable regulatory action in any of those states may materially adversely affect our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

As of December 31, 2011, we operate in 18 states with approximately 1.3 million access line equivalents, of which approximately 85% are located in Maine, New Hampshire and Vermont. As a result of this geographic concentration, our financial results will depend significantly upon economic conditions and consumer trends in these markets. From January 1, 2011 through December 31, 2011, our Northern New England operations experienced a 5.3% decline in total access line equivalents in service, compared to a decline of 3.5% for the Telecom Group during the same period. A deterioration in economic conditions in any of these markets could result in a further decrease in demand for our services and resulting loss of access line equivalents which could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

In addition, if state regulators in Maine, New Hampshire or Vermont were to take an action that is 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.

We depend on third party providers for certain of our billing functions, information technology services, including network support and improvements, and for the provision of our long-distance and bandwidth services.

We have agreements with outside service providers to perform a portion of our billing functions and for our provision of long-distance and bandwidth services. We also rely on certain third parties for information technology services, including network support and improvements.

If these service providers are unable to adequately perform such services or if one of them experiences a significant degradation or failure with respect to such services, it could result in disruptions in our billing, information technology systems and/or our long-distance and bandwidth services. Furthermore, if these agreements are terminated for any reason, we may be unable to find an alternative service provider in a timely manner or on terms acceptable to us, and may be unable ourselves to perform the services they provide.

With respect to the agreements governing our long-distance and bandwidth 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.

If any of the foregoing events occurs with respect to our third-party providers, our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock could be materially 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:

 

   

physical damage to access lines;

 

   

widespread power surges or outages;

 

   

software defects in critical systems;

 

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disruptions beyond our control; and

 

   

capacity limitations resulting from changes in our customers’ usage patterns.

From time to time, in the ordinary course of business, we have experienced and in the future may experience short disruptions in our service due to factors such as cable damage, inclement weather and service failures of our third-party service providers. We could experience more significant disruptions in the future. In addition, certain portions of our network may lack adequate redundancy to allow for expedient recovery of service to affected customers. Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur expenses, which could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

A cyber-attack that bypasses our IT security systems causing an IT security breach may lead to theft of customer data, unauthorized use or publication of our intellectual property and/or confidential business information and could harm our competitive position or otherwise adversely affect our business.

Attempts by others to gain unauthorized access to organizations’ IT systems are becoming more sophisticated and are sometimes successful. These attempts include covertly introducing malware to companies’ computers and networks and impersonating authorized users, among others. We seek to detect and investigate all security incidents and to prevent their recurrence, but in some cases, we might be unaware of an incident or its magnitude and effects. The theft, unauthorized use or publication of our intellectual property and/or confidential business information could harm our competitive position, reduce the value of our investment in research and development and other strategic initiatives or otherwise adversely affect our business. To the extent that any security breach results in inappropriate disclosure of our customers’ or licensees’ confidential information, we may incur liability as a result.

Our success will depend 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. 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, results of operations, liquidity and/or the market price of our Common Stock.

Our ability to successfully manage reductions in our workforce could have a material adverse impact on our results of operations.

We recently announced a workforce reduction and will continue to evaluate the need for additional reductions in the future. Reductions in our workforce could adversely impact our ability to operate effectively and, therefore, could adversely impact our customer service, result in higher regulatory penalties and/or reduce our ability to achieve our operational goals.

A significant portion of our workforce is represented by labor unions and therefore subject to collective bargaining agreements. If disputes arise, or if we are unable to successfully renegotiate these agreements at an appropriate time, workers subject to these agreements could engage in strikes or other work stoppages or slowdowns, which could materially adversely impact our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

As of December 31, 2011, 2,254 of our 3,541 employees were covered by fourteen collective bargaining agreements. Disputes with regard to the terms of these agreements or our potential inability to negotiate acceptable contracts with these unions in the future as our current contracts expire could result in, among other things, strikes, work stoppages or other slowdowns by the affected workers. If unionized workers were to engage in a strike, work stoppage or other slowdown, or other employees were to become unionized, we could experience a significant disruption of our operations or higher ongoing labor costs, either of which could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock. Additionally, future renegotiation of labor agreements or provisions of labor agreements could adversely impact our service reliability and significantly increase our costs for healthcare, wages and other benefits, which could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

 

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We have identified a material weakness in our internal controls over financial reporting which existed as of December 31, 2011. If the steps we take to remedy this material weakness are not successful or we otherwise fail to maintain an effective system of internal controls, such a failure could result in additional material misstatements in our financial statements, prevent us from providing timely financial statements or prevent us from meeting our reporting requirements both with the SEC and under our debt obligations, cause investors to lose confidence in our reported financial information and have a negative effect on the market price of our Common Stock.

As discussed in “Part II – Item 9A. Controls and Procedures,” we concluded that the following material weakness in our internal controls over financial reporting which was previously identified in our 2010 Annual Report on Form 10-K and our quarterly reports on Form 10-Q for the quarters ending March 31, 2011, June 30, 2011 and September 30, 2011 continues to exist as of December 31, 2011:

 

   

Procedures for the review of our income tax provision and supporting schedules were not adequate to identify and correct errors in a timely manner.

As a result of this material weakness, our management concluded that our disclosure controls were not effective as of December 31, 2011. Our management has initiated steps to remediate this issue. If the remediation is not successful or we otherwise fail to maintain an effective system of internal controls, such a failure could result in material misstatements in our financial statements, prevent us from providing timely financial statements or prevent us from meeting our reporting requirements both with the SEC and under our debt obligations, cause investors to lose confidence in our reported financial information and have a negative impact on the market price of our Common Stock.

We will be exposed to risks relating to evaluations of internal control systems 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 accelerated reporting requirements and expanded disclosures regarding evaluations of internal control systems. With respect to internal control over financial reporting, standards established by the Public Company Accounting Oversight Board define a material weakness as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. If our management identifies one or more material weaknesses in internal control over financial reporting in the future in accordance with the annual assessments and quarterly evaluations required by the Sarbanes-Oxley Act, we will be unable to assert that our internal controls are effective which could result in sanctions or investigation by regulatory authorities. In addition, any such material weakness could result in material misstatements in our financial statements, prevent us from providing timely financial statements or meeting our reporting requirements both with the SEC and under our debt obligations and cause investors to lose confidence in our reported financial information.

We note that we have identified a material weakness in our internal controls over financial reporting which existed as of December 31, 2011 and had previously identified certain other material weaknesses in our internal controls over financial reporting which existed as of December 31, 2010 and for the quarters ending March 31, 2011, June 30, 2011 and September 30, 2011, which material weaknesses are discussed in greater detail in “Item 9A. Controls and Procedures”.

Our required pension contributions and estimated future pension and post-retirement benefit plan liabilities may be impacted by several factors and an increase in our required contributions could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

We sponsor qualified pension and post-retirement medical and dental plans for certain employees which require significant amounts of cash to maintain. The accrual of future benefits by employees and retirees in these qualified pension plans that are not covered by a collective bargaining agreement have been frozen. However, under the terms of our qualified pension plans for participants and retirees covered by a collective bargaining agreement, contractual increases in benefits will continue each year through 2014, at which time the collective bargaining agreements will terminate and be renegotiated. Future increases in benefits earned by participants and retirees in these plans will require increasing amounts of cash to maintain and may limit our operational flexibility. These future cash requirements could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

Our qualified pension plans have funding requirements as defined under ERISA. These required pension contributions may be impacted by several factors, including fluctuations in the discount rate used to calculate the funding target, the performance of our pension asset portfolio, the number of retirees who elect to receive lump sum distributions and the demographics of plan participants. Fluctuations or adverse changes in any of these factors are beyond our control and may diminish the funded status of our pension plans thereby significantly increasing the contributions we are required to make under ERISA. For example, economic factors have led to a significant decrease in our discount rate for our pension plans and certain workforce reductions have resulted in a large amount of lump-sum payments being made to participants in 2011. These factors will increase our future contributions to the pension plans. The extent of such increases in our required contributions could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

During the year ended December 31, 2011, we experienced actual gains on pension plan assets totaling approximately 1.6%. The actuarially-determined funded status of our pension plans is dependent on the market value of the assets held by each plan. As such, a significant decline in the market value of the pension plans’ assets could result in us having to make additional contributions to these plans. Furthermore, if the third party trustee who holds these plan assets were to become insolvent, access to the plan assets could be limited and we could be required to pay lump-sum payments and benefits from our assets. Such required contributions and other payments could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

Our long-lived assets may become impaired in the future.

Upon our adoption of fresh start accounting, we recorded our property, plant and equipment at fair value and we recorded amortizable intangible assets of $99.4 million and a non-amortizable intangible asset of $58.0 million. Amortizable long-lived assets must be reviewed for impairment whenever indicators of impairment exist. Non-amortizable long-lived assets are required to be reviewed for impairment on an annual basis or more frequently whenever indicators of impairment exist. At September 30, 2011, an $18.8 million impairment charge was recorded which reduced the carrying value of our non-amortizable intangible asset to $39.2 million. Indicators of impairment could include, but are not limited to:

 

   

an inability to perform at levels that were forecasted;

 

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a permanent decline in market capitalization;

 

   

implementation of restructuring plans;

 

   

changes in industry trends; and/or

 

   

unfavorable changes in our capital structure, cost of debt, interest rates or capital expenditures levels.

Situations such as these could result in an impairment that would require a material non-cash charge to our results of operations and could have a material adverse effect on our consolidated results of operations.

Our operations require substantial capital expenditures.

We require significant capital expenditures to maintain, upgrade and enhance our network facilities and operations. While we have historically been able to fund capital expenditures from cash generated from operations and borrowings under our revolver, the other risk factors described in this section could materially reduce cash available from operations or significantly increase our capital expenditure requirements, and these outcomes may result in our inability to fund the necessary level of capital expenditures to maintain, upgrade or enhance our network. This could adversely affect our business.

Risks Relating 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. 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, the following factors could have a significant impact on us:

Risk of loss or reduction of network access charge revenues. A portion of our revenues comes from network access charges, which are paid to us by intrastate and interstate interexchange carriers for originating and terminating communications in the regions served. Through 2011, this also includes Universal Service Support payments for local switching support, long-term support, and Interstate Common Line Support (“ICLS”). Starting in 2012, these forms of universal service funding will be replaced by CAF which is described below and more fully in “Item 1. Business – Regulatory Environment.” Further, in recent years, several of the long-distance carriers have declared bankruptcy. Future declarations of bankruptcy by a carrier that utilizes our access services could negatively affect our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

The amount of access charge revenues that we receive is based on rates set by federal and state regulatory bodies, and those rates will change according to the schedule established by the FCC in its recent order on universal service funding and intercarrier compensation. These impacts are described below and in “Item 1. Business – Regulatory Environment.” 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.

On November 18, 2011, the FCC released the FCC CAF/ICC Order. In this order, the FCC replaced all existing USF for price cap carriers with its CAF. The amount of CAF that will be available to us has not been determined nor have the specific obligations that would be associated with such funding. We risk reductions in the amount of CAF that will be made available to us compared to current USF amounts. The specific obligations that will be associated with future CAF funding have not been determined and we risk not being able to accept CAF if the obligations exceed the funding. The FCC CAP/ICC Order fundamentally reforms the ICC system that governs how communications companies bill one another for handling traffic, gradually phasing down these charges. Additional reforms have been proposed. The reforms adopted by the FCC in their order will significantly change 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 materially adversely affect our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

 

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Risk of loss or reduction of Universal Service Fund support. We receive federal Universal Service Fund Support, referred to as the Universal Service Fund, and in some cases, state universal support, to support our operations in high-cost areas. Through 2011, these federal revenues include Universal Service Support payments for local switching support, ICLS, or Interstate Access Support (“IAS”). High-cost support for our Northern New England operations, referred to as our non-rural operations or non-rural LECs, and for Telecom Group’s traditional, rural local exchange operations, referred to as our rural operations or rural LECs, is determined pursuant to different methodologies, aspects of which are now under review. Effective January 1, 2012, the FCC has replaced all pre-2012 universal service programs with new CAF programs. These changes could result in a reduction to the USF revenues we receive. If we were unable to receive such support, or if that support was reduced, our Telecom operations would be unable to operate as profitably as they have historically. Moreover, if we raise prices for services to offset these 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. See discussion of FCC CAF/ICC Order in “Item 1. Business – Regulatory Environment.”

The FCC also is considering changes to its rules governing who contributes to the Universal Service Fund Support mechanisms, and on what basis. Any changes in the FCC’s rules governing the manner in which entities contribute to the Universal Service Fund could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

Risk of loss of statutory exemption from burdensome interconnection rules imposed on ILECs. Our rural LECs generally are exempt from the more burdensome requirements of the 1996 Act governing the rights of competitors to interconnect to ILEC networks and to utilize discrete network elements of the incumbent’s network at favorable rates. To the extent state regulators decide that it is in the public interest to extend some or all of these requirements to our rural LECs, we may be required to provide UNEs 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, results of operations, liquidity and/or the market price of our Common Stock.

Risks posed by costs of regulatory compliance. Regulations create significant compliance costs for us. Subsidiaries that provide intrastate services are generally subject to certification, tariff filing and other ongoing regulatory requirements by state regulators. Our interstate and intrastate access services are currently provided in accordance with tariffs filed with the FCC and state regulatory authorities, respectively. 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, which could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.

In addition, our non-rural operations are subject to regulations not applicable to our rural operations, including but not limited to requirements relating to interconnection, the provision of UNEs, and the other market-opening obligations set forth in the 1996 Act. In approving the transfer of authorizations to us in the Merger, the FCC determined that our non-rural operations would be regulated as a Bell Operating Company following the completion of the Merger, 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 had obtained in the region. 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, results of operations, liquidity and/or the market price of our Common Stock. Moreover, we cannot predict the precise manner in which the FCC will apply the Bell Operating Company regulatory framework to us.

State regulators have also imposed conditions in various regulatory proceedings that could materially adversely affect our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock. For example, in connection with the Merger and the Chapter 11 Cases, state regulatory authorities in Maine, New Hampshire and Vermont imposed certain requirements with respect to our operations in those states. See “Item 1. Business – Regulatory Environment – State Regulation – Regulatory Conditions to the Merger, as Modified in Connection with the Plan.”

Our business also may be affected by legislation and regulation imposing new or greater obligations related to open Internet access, assisting law enforcement, bolstering homeland security, minimizing environmental impacts, protecting customer privacy or addressing other issues that affect our business. We cannot predict whether or to what extent the FCC might modify its rules or what compliance with those new rules might cost. Similarly, we cannot predict whether or to what extent federal or state legislators or regulators might impose new network access, security, environmental or other obligations on our business.

 

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Risk of losses 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, results of operations, liquidity and/or the market price of our Common Stock.

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

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

We own or lease 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 LEC business. Our administrative and maintenance facilities are generally located in or near the communities served by our LECs 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 thereon, is being appropriately used consistent with past practice and has sufficient capacity for the present intended purposes.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we are involved in litigation and regulatory proceedings arising out of our operations. Management believes that we are not currently a party to any legal or regulatory proceedings, the adverse outcome of which, individually or in the aggregate, would have a material adverse effect on our financial position or results of operations. Notwithstanding that we emerged from Chapter 11 protection on the Effective Date, five of the Chapter 11 Cases are still in the process of being resolved.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

General

Our Common Stock is listed on the NASDAQ under the symbol “FRP”.

Prior to January 25, 2011, our Old Common Stock traded (i) on the Pink Sheets under the symbol “FRCMQ” from October 26, 2009 to January 24, 2011 and (ii) on the New York Stock Exchange under the symbol “FRP” from our initial public offering on February 4, 2005 until October 23, 2009. All of our Old Common Stock was extinguished in accordance with the Plan on the Effective Date. Our existing Common Stock began trading on the NASDAQ on January 25, 2011.

Because the value of our Old Common Stock bears no relation to the value of our existing Common Stock, only the trading prices of our existing Common Stock, following its listing on the NASDAQ, are set forth below.

The following table shows the high and low sales prices per share of our New Common Stock as reported on the NASDAQ, from January 25, 2011 to December 31, 2011. The stock price information is based on published financial sources.

 

Year Ended December 31, 2011

   High      Low  

First quarter (January 25, 2011 through March 31, 2011)

   $ 25.50       $ 16.00   

Second quarter

     17.50         8.74   

Third quarter

     9.86         4.06   

Fourth quarter

     6.43         3.13   

No dividends were declared on any class of our common stock in 2011 or 2010. We currently do not anticipate that we will pay any cash dividends on shares of our Common Stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon limitations imposed by orders of state regulatory authorities, results of operations, financial condition, contractual restrictions relating to indebtedness, restrictions imposed by applicable law and other factors our board of directors may deem relevant at the time.

As of March 2, 2012, there were approximately 134 holders of record of our Common Stock.

 

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Performance Graph

Set forth below is a line graph comparing the cumulative total stockholder return on shares of our common stock against (i) the cumulative total return of all companies listed on the S&P 500 and (ii) the cumulative total return of the S&P 500 Telecom sector. The period compared commences on January 25, 2011, the date our Common Stock began trading on the NASDAQ after we emerged from Chapter 11 bankruptcy protection, and ends on December 31, 2011. Because the value of our Old Common Stock bears no relation to the value of our existing Common Stock, the graph below reflects only our existing Common Stock. This graph assumes that $100 was invested on January 25, 2011 in our Common Stock and in each of the market index and the sector index at the closing price for FairPoint Communications and the respective indices, and that all cash distributions were reinvested.

 

LOGO

Securities Authorized for Issuance under Equity Compensation Plans

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. As of December 31, 2011, the FairPoint Communications, Inc. 2010 Long Term Incentive Plan (the “Long Term Incentive Plan”) was the only equity compensation plan under which securities of the Company were authorized for issuance. The Long Term Incentive Plan was approved by the Bankruptcy Court in connection with the emergence from bankruptcy. For a description of the material features of the Long Term Incentive Plan, see note 15 of our financial statements contained in Item 8 herein.

Equity Compensation Plan Information

 

     (a)      (b)      (c)  

Plan Category

   Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights (1)
     Weighted average
exercise price of
outstanding options,
warrants and rights
     Number of securities
remaining available
for future issuance
under equity
compensation plans
excluding securities
reflected in column (a)
 

Equity compensation plans approved by our stockholders

     —           N/A         —     

Equity compensation plans not approved by our stockholders

     947,737       $ 24.29         1,642,924   
  

 

 

    

 

 

    

 

 

 

Total

     947,737       $ 24.29         1,642,924   
  

 

 

    

 

 

    

 

 

 

 

(1) Includes 947,737 options to purchase shares of Common Stock under the Long Term Incentive Plan.

 

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Repurchase of Equity Securities

We did not repurchase any equity securities during the three months ended December 31, 2011.

Unregistered Sales of Equity Securities

During the quarter ended December 31, 2011, pursuant to the Plan, the Company issued (i) 1,102 shares of Common Stock in the aggregate to holders of allowed unsecured claims against FairPoint Communications (the “FairPoint Communications Unsecured Claims”) under the Plan, and (ii) warrants to purchase an aggregate of 1,878 shares of Common Stock, subject to adjustment upon the occurrence of certain events described in the Warrant Agreement that the Company entered into with the Bank of New York Mellon, as warrant agent, on the Effective Date, to holders of FairPoint Communications Unsecured Claims under the Plan.

Based on the Confirmation Order, the Company relied on Section 1145(a)(1) of the Bankruptcy Code to issue the new securities described above.

ITEM 6. SELECTED FINANCIAL DATA

On March 31, 2008, we completed the acquisition of Spinco, pursuant to which Spinco merged with and into FairPoint, with FairPoint continuing as the surviving corporation for legal purposes. Spinco was a wholly-owned subsidiary of Verizon and prior to the Merger the local exchange business of Verizon New England Inc. in Maine, New Hampshire and Vermont and the customers of Verizon and its subsidiaries (other than Cellco Partnership) (collectively, the “Verizon Group”) transferred certain specified assets and liabilities of the local exchange businesses of Verizon New England in Maine, New Hampshire and Vermont and the customers of the related voice and Internet service provider businesses in those states to subsidiaries of Spinco. The Merger was accounted for as a “reverse acquisition” of FairPoint by Spinco under the purchase method of accounting because Verizon stockholders owned a majority of the shares of the consolidated Company following the Merger and, therefore, Spinco is treated as the acquirer for accounting purposes. The following financial information reflects the transaction as if Spinco had issued consideration to FairPoint’s shareholders. As a result, for the year ended December 31, 2008, financial information derived from the statement of operations reflects the consolidated financial results of the Company by including the financial results of the Verizon Northern New England business for the three months ended March 31, 2008, the financial results of Spinco for the nine months ended December 31, 2008 and the financial results of FairPoint for the nine months ended December 31, 2008. Financial information derived from the statement of operations for all periods prior to April 1, 2008 reflects the actual results of the Verizon Northern New England business for such periods. Financial information derived from the balance sheet reflects the consolidated assets and liabilities of FairPoint and Spinco at December 31, 2008.

As of the Effective Date, we adopted fresh start accounting in accordance with guidance under the applicable reorganization accounting rules, pursuant to which our reorganization value, which represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, was allocated to the fair value of assets in conformity with guidance under the applicable accounting rules for business combinations, using the purchase method of accounting for business combinations. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets was reflected as goodwill, which is subject to periodic evaluation for impairment and was determined to be completely impaired at September 30, 2011. In addition to fresh start accounting, our post-emergence consolidated financial statements reflect all effects of the transactions contemplated by the Plan. Therefore, our post-emergence statements of financial position and statements of operations are not comparable in many respects to our consolidated statements of financial position and consolidated statements of operations for periods prior to our adoption of fresh start accounting and prior to accounting for the effects of the reorganization, including the historical financial statements contained herein.

On the Effective Date, in accordance with the Plan, all equity compensation plans in effect at the end of 2010 were terminated and all awards thereunder were cancelled and extinguished. In addition, on the Effective Date, in accordance with the Plan, (i) certain of our employees and a consultant of ours received Common Stock awards, consisting of restricted shares of Common Stock and/or

 

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options to purchase shares of Common Stock, pursuant to the terms of the Long Term Incentive Plan, and (ii) members of the board of directors received restricted shares of Common Stock and options to purchase Common Stock pursuant to the terms of the Long Term Incentive Plan. As of March 2, 2012, we had 26,194,442 shares of Common Stock outstanding.

All periods after the Effective Date are referred to as the “Successor Company,” whereas all periods as of and preceding the Effective Date are referred to as the “Predecessor Company”.

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.

 

     Successor
Company
    Predecessor Company  
     Three Hundred
Forty-One Days
Ended

December 31,
2011
    Twenty-Four
Days Ended
January 24,
2011
    Year Ended December 31,  
         2010     2009     2008     2007  

Statement of Operations:

              

Revenues

   $ 963,112      $ 66,378      $ 1,070,986      $ 1,119,090      $ 1,274,619      $ 1,197,465   

Operating expenses:

              

Cost of services and sales

     438,619        38,766        525,728        515,394        576,786        555,954   

Selling, general and administrative expenses

     332,020        27,161        365,373        417,512        384,388        288,762   

Depreciation and amortization

     336,891        21,515        289,824        275,334        255,032        233,231   

Reorganization related (income) expense

     (232     —          —          —          —          —     

Impairment of intangible assets and goodwill

     262,019        —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,369,317        87,442        1,180,925        1,208,240        1,216,206        1,077,947   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     (406,205     (21,064     (109,939     (89,150     58,413        119,518   

Interest expense (1)

     (63,807     (9,321     (140,896     (204,919     (162,040     (70,581

Gain (loss) on derivative instruments

     —          —          —          12,320        (11,800     —     

Gain on early retirement of debt

     —          —          —          12,357        —          —     

Other income, net

     1,791        (132     2,715        2,000        3,494        3,350   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before reorganization items and income taxes

     (468,221     (30,517     (248,120     (267,392     (111,933     52,287   

Reorganization items

     —          897,313        (41,120     (53,018     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes

     (468,221     866,796        (289,240     (320,410     (111,933     52,287   

Income tax benefit (expense)

     53,276        (279,889     7,661        79,014        43,408        (19,459
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (414,945   $ 586,907      $ (281,579   $ (241,396   $ (68,525   $ 32,828   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic shares outstanding

     25,838        89,424        89,424        89,271        80,443        53,761   

Diluted shares outstanding

     25,838        89,695        89,424        89,271        80,443        53,761   

Basic (loss) earnings per share

   $ (16.06   $ 6.56      $ (3.15   $ (2.70   $ (0.85   $ 0.61   

Diluted (loss) earnings per share

   $ (16.06   $ 6.54      $ (3.15   $ (2.70   $ (0.85   $ 0.61   

Cash dividends per share

   $ —        $ —        $ —        $ 0.2575      $ 0.773      $ —     

Operating Data:

              

Capital expenditures

   $ 163,648      $ 12,477      $ 197,795      $ 178,752      $ 296,992      $ 149,458   

Access line equivalents (2)

     1,346,894        N/A        1,417,290        1,545,976        1,721,709        1,600,971   

Residential access lines

     645,453        N/A        712,591        802,668        926,610        882,933   

Business access lines

     311,241        N/A        327,812        357,605        392,496        371,041   

Wholesale access lines (3)

     76,065        N/A        87,142        97,161        107,243        124,123   

HSD subscribers

     314,135        N/A        289,745        288,542        295,360        222,874   

Summary Cash Flow Data:

              

Net cash provided by (used in) operating activities

   $ 170,099      $ (81,091   $ 191,626      $ 150,323      $ 57,505      $ 264,504   

Net cash used in investing activities

     (162,850     (12,477     (197,268     (177,391     (283,332     (137,216

Net cash (used in) provided by financing activities

     (161     (1,667     1,784        66,098        296,152        (127,288

Balance Sheet Data (at period end)(4):

              

Cash, excluding restricted cash (5)

   $ 17,350      $ 10,262      $ 105,497      $ 109,355      $ 70,325      $ —     

Property, plant and equipment, net

     1,663,065        1,823,670        1,859,700        1,950,435        2,013,515        1,628,066   

Total assets

     1,989,645        2,516,871        2,973,794        3,172,122        3,335,940        1,938,172   

Total long-term debt (6)

     1,000,000        1,000,000        2,520,959        2,515,446        2,470,253        —     

Total stockholders’ (deficit) equity

     (106,143     498,486        (587,418     (218,427     23,786        1,119,162   

 

(1) Interest expense includes amortization of debt issue costs aggregating $0.6 million, $0.1 million, $2.0 million and $3.8 million for the 341 days ended December 31, 2011, the 24 days ended January 24, 2011 and the fiscal years ended December 31, 2010 and 2009, respectively, as well as amortization of debt discount of $0.5 million for the fiscal year ended December 31, 2009. Debt issue costs of $23.8 million on the Pre-Petition Credit Facility and, following the filing of the Chapter 11 Cases, $9.9 million of discount on the Pre-Petition Notes were written off in order to adjust the carrying amount of our pre-petition debt to the Bankruptcy Court approved amount of the allowed claims for our pre-petition debt. These write-offs are included in Reorganization items for the year ended December 31, 2009.

 

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(2) Total access line equivalents includes voice access lines and HSD lines, which include DSL, wireless broadband, cable modem and fiber-to-the-premises.
(3) Wholesale access lines include residential and business resale lines and unbundled network element platform (“UNEP”) lines.
(4) The balance sheet data reflected at January 24, 2011 is representative of the Successor Company after application of the Plan and the adoption of fresh start accounting.
(5) Excludes restricted cash of $25.1 million, $4.1 million, $4.0 million, $68.5 million and $0 at December 31, 2011, 2010, 2009, 2008 and 2007 and $86.8 million at January 24, 2011.
(6) Long-term debt at December 31, 2010 and 2009 is included in Liabilities subject to compromise (see note 2 to the consolidated financial statements for further information).

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

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

Overview

We are a leading provider of communications services in rural and small urban communities, offering an array of services, including HSD, Internet access, data transport, voice, video and other broadband enabled product offerings. We operate in 18 states with approximately 1.3 million access line equivalents (including voice access lines and HSD lines, which include DSL, wireless broadband, cable modem and fiber-to-the-premises) in service as of December 31, 2011.

We were incorporated in Delaware in February 1991 for the purpose of acquiring and operating incumbent telephone companies in rural and small urban markets. Many of our telephone companies have served their respective communities for over 80 years.

Access lines have historically been an important element of our business. Over the past several years, communications companies, including FairPoint, have experienced a decline in access lines due to increased competition, including competition from CLECs, wireless carriers and cable television operators, increased availability of alternative communications services, including wireless and VoIP, and challenging economic conditions. While voice access lines are expected to continue to decline, we expect to offset a portion of this lost revenue with growth in special access, HSD and other broadband service revenue as we continue to build out our network to customers who did not previously have access to such products and to offer more competitive services to existing

 

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customers. In addition, due to the issues associated with the Cutover from the systems of Verizon in February 2009 with respect to our Northern New England operations and the filing for bankruptcy protection under Chapter 11 of the Bankruptcy Code in October 2009, we lost significant market share in recent years. Our strategy is to leverage our ubiquitous network in our Northern New England operations to regain market share, particularly in the business and wholesale markets and for data services.

We offer our Next Generation Network to support more HSD services and extend fiber into more communities across our Northern New England operations. This fiber-optic build also supplies critical infrastructure known as “backhaul” for wireless traffic in the region, and addresses the increasing bandwidth needs being driven by new applications for smart phones, tablets and other wireless devices. Today we provide cellular backhaul connectivity to more than 1,600 towers in our Northern New England footprint. Recent Ethernet network expansion allows us to provide fiber based Ethernet cellular backhaul to more than half of these towers.

From 2007 through January 2009, we were in the process of developing and deploying new systems, processes and personnel to replace those used by Verizon to operate and support our network and back-office functions in the Maine, New Hampshire and Vermont operations acquired from Verizon. These services were provided by Verizon under the Transition Services Agreement, dated as of January 15, 2007, which we entered into with certain subsidiaries of Verizon in connection with the Merger, as amended (the “Transition Services Agreement”), from March 31, 2008 through January 30, 2009. On January 30, 2009, we began the Cutover, and on February 9, 2009, we began operating our new platform of systems independently from the Verizon systems, processes and personnel.

Following the Cutover, many of these systems functioned without significant problems, but a number of the key back-office systems, such as order entry, order management and billing, experienced certain functionality issues as well as issues with communication among the systems. As a result of these systems functionality issues, as well as work force inexperience on the new systems, we experienced increased handle time by customer service representatives for new orders, and reduced levels of order flow-through across the systems, which caused delays in provisioning and installation and delays in the processing of bill cycles and collection treatment efforts. These issues impacted customer satisfaction and resulted in large increases in customer call volumes into our customer service centers. While many of these issues were anticipated, the magnitude of difficulties experienced was beyond our expectations. Because of these Cutover issues, we have incurred incremental costs in order to operate our business, including third-party contractor costs and internal labor costs in the form of overtime pay. By the end of 2010, we had substantially stabilized the back-office systems. We continue to work on improving our processes and systems to support revenue growth, enhance customer service and increase operational efficiency.

We are subject to regulation primarily by federal and state governmental agencies. At the federal level, the FCC generally exercises jurisdiction over the facilities and services of communications common carriers, such as FairPoint, 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, which amended the Communications Act, state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies introduced by that legislation.

The Telecom Group and our Northern New England operations operate under different regulatory regimes in certain respects. For example, concerning interstate access, all of the Telecom Group regulated interstate services of FairPoint were regulated under a rate-of-return model, while all of the rate-regulated interstate services provided by the Verizon Northern New England business were regulated under a price cap model. See “Item 1. Business – Regulatory Environment” for further information regarding rate-of-return and price cap models. On May 10, 2010, we received FCC approval to convert our Telecom group operations in Maine and Vermont to the price cap model. These operations converted to price cap regulation on July 1, 2010. We have obtained permission to continue to operate our Telecom Group ILECs outside of Maine and Vermont under the rate-of-return or average schedule regime until the FCC completes its general review of whether to modify or eliminate the “all-or-nothing” rule. Without this permission, the all-or-nothing rule would require that all of our regulated operations be operated under the price cap model for federal regulatory purposes. In addition, while all of our operations generally are subject to obligations that apply to all LECs, our non-rural operations are subject to additional requirements concerning interconnection, non-discriminatory network access for competitive communications providers and other matters, subject to substantial oversight by state regulatory commissions. In addition, the FCC has ruled that our Northern New England operations must comply with the regulations applicable to the Bell Operating Companies. Our rural and non-rural operations are also subject to different regimes concerning universal service.

 

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Overview of FCC Order to Reform Universal Service and Intercarrier Compensation

On October 27, 2011, the FCC adopted an Order and Further Notice of Proposed Rulemaking on Universal Service and Intercarrier Compensation reform. On November 18, 2011, the FCC released the FCC CAF/ICC Order. In this order, the FCC replaced all existing USF for price cap carriers with its CAF. The intent of the CAF is to bring high speed affordable broadband services to all Americans. The FCC CAF/ICC Order fundamentally reforms the ICC system that governs how communications companies bill one another for handling traffic, gradually phasing down these charges. Together, the modifications to the CAF and ICC rules are intended to benefit consumers and promote the goals of the National Broadband Plan, which called for overhauling these two complex systems to address the modern-day mission of supporting broadband deployment as cost-effectively as possible.

In conjunction with the FCC CAF/ICC Order, the FCC adopted a NPRM to deal with related matters, including but not limited to: (i) the actual cost model to be adopted for CAF Phase II funding, (ii) treatment of originating access charges, (iii) modifications to CAF for rate-of-return ILECs, (iv) development of CAF Phase II for mobility, (v) CAF Phase II reverse auction rules, (vi) remote areas funding and (vii) IP to IP interconnection issues. It is not known what decisions will be made on these issues or how they may impact us.

Fresh Start Accounting

On October 26, 2009, we filed the Chapter 11 Cases. On January 13, 2011, the Bankruptcy Court entered the Confirmation Order which confirmed the Plan.

On January 24, 2011, the Effective Date, we substantially consummated our reorganization through a series of transactions contemplated by the Plan, and the Plan became effective pursuant to its terms.

As of the Effective Date, we were required to adopt fresh start accounting in accordance with guidance under the applicable reorganization accounting rules, pursuant to which our reorganization value, which represents the fair value of an entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, was allocated to the fair value of assets in conformity with guidance under the applicable accounting rules for business combinations, using the purchase method of accounting for business combinations. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets was reflected as goodwill, which was subject to periodic evaluation for impairment and was later determined to be completely impaired at September 30, 2011. In addition to fresh start accounting, our consolidated financial statements reflect all effects of the transactions contemplated by the Plan. Therefore, our consolidated statements of financial position and consolidated statements of operations are not comparable in many respects to our consolidated statements of financial position and consolidated statements of operations for periods prior to our adoption of fresh start accounting and prior to accounting for the effects of the Plan, including certain of the historical financial statements contained herein.

While the adoption of fresh start accounting presents the results of operations of a new reporting entity, we believe the comparison of combined results of the year ended December 31, 2011 versus the years ended December 31, 2010 and 2009 provides the best analysis of the results of operations. The only statement of operations items impacted by the reorganization are depreciation expense, interest expense and reorganization items. Those effects of fresh start accounting are discussed in more detail in the respective sections below.

Basis of Presentation

We view our business of providing data, voice and communication services to residential, business and wholesale customers as one business segment as defined in the Segment Reporting Topic of the Accounting Standards Codification (“ASC”).

Revenues

We derive our revenues from:

 

   

Voice services. We receive revenues from our telephone operations from the provision of local exchange, long distance, local private line, wire maintenance, voice messaging and value-added services. Included in long-distance services revenue are revenues received from regional toll calls. Value-added services are a family of services that expand the utilization of the network, including products such as caller ID, call waiting and call return. The provision of local exchange services not only

 

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includes retail revenues but also includes local wholesale revenues from UNEs, interconnection revenues from CLECs and wireless carriers, and some data transport revenues. Voice services revenues also include Universal Fund payments for high-cost support, local switching support, long-term support and ICLS.

 

   

Access. We receive revenues for the provision of network access, including interstate access and intrastate access.

Network access revenues are earned from end-user customers and long-distance and other competing carriers who use our local exchange facilities to provide usage services to their customers. Special access revenues originate from carriers and end-users that buy dedicated local and interexchange capacity to support their private networks, including wireless carriers to backhaul voice and data traffic from cell towers to mobile telephone switching offices. Switched access revenues are derived from fixed and usage-based charges paid by carriers for access to our local network.

Interstate access revenues are earned on charges to long-distance carriers and other customers for access to our networks in connection with the origination and termination of interstate telephone calls both to and from our customers. Interstate access charges to long-distance carriers and other customers are based on access rates filed with the FCC.

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

 

   

Data and Internet services. We receive revenues from monthly recurring charges for services, including HSD, Internet and other services.

 

   

Other services. We receive revenues from other services, including video services (including cable television and video-over-DSL), billing and collection, directory services, public (coin) telephone and the sale and maintenance of customer premise equipment.

The following table summarizes revenues and the percentage of revenues from these sources (in thousands, except for percentage of revenues data):

 

     Successor Company     Predecessor Company     Combined  
     Three Hundred  Forty-
One Days Ended
December 31, 2011
    Twenty-Four Days
Ended

January 24, 2011
    Year Ended
December 31, 2011
 
     $      % of
Revenue
    $      % of
Revenue
    $      % of
Revenue
 

Revenue Source:

                 

Voice services

   $ 460,337         48   $ 32,977         50   $ 493,314         48

Access

     346,313         36     23,023         35     369,336         36

Data and Internet services

     110,238         11     7,537         11     117,775         11

Other services

     46,224         5     2,841         4     49,065         5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 963,112         100   $ 66,378         100   $ 1,029,490         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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     Predecessor Company  
     Year Ended
December 31, 2010
    Year Ended
December 31, 2009
 
     $      % of
Revenue
    $      % of
Revenue
 

Revenue Source:

       

Voice services

   $ 531,623         50   $ 581,653         52

Access

     381,089         36     380,502         34

Data and Internet services

     110,223         10     109,942         10

Other services

     48,051         4     46,993         4
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,070,986         100   $ 1,119,090         100
  

 

 

    

 

 

   

 

 

    

 

 

 

The following table summarizes access line equivalents (including voice access lines and HSD lines, which include DSL, wireless broadband, cable modem and fiber-to-the-premises) as of December 31, 2011, 2010 and 2009:

 

     Successor Company          Predecessor Company  
     December  31,
2011
         December 31,
2010
     December 31,
2009
 

Access Line Equivalents:

           

Residential access lines

     645,453            712,591         802,668   

Business access lines

     311,241            327,812         357,605   

Wholesale access lines(1)

     76,065            87,142         97,161   
  

 

 

       

 

 

    

 

 

 

Total switched access lines

     1,032,759            1,127,545         1,257,434   
 

HSD subscribers

     314,135            289,745         288,542   
  

 

 

       

 

 

    

 

 

 

Total access line equivalents

     1,346,894            1,417,290         1,545,976   
  

 

 

       

 

 

    

 

 

 

 

(1) Wholesale access lines include residential and business resale lines and UNEP lines.

Operating Expenses

Our operating expenses consist of cost of services and sales, selling, general and administrative expenses, and depreciation and amortization.

 

   

Cost of Services and Sales. Cost of services and sales includes the following costs directly attributable to a service or product: salaries and wages, benefits, materials and supplies, contracted services, network access and transport costs, customer provisioning costs, computer systems support and cost of products sold. Aggregate customer care costs, which include billing and service provisioning, are allocated between cost of services and sales and selling, general and administrative expenses.

 

   

Selling, General and Administrative Expense. Selling, general and administrative expense includes salaries and wages and benefits not directly attributable to a service or product, bad debt charges, taxes other than income, advertising and sales commission costs, customer billing, call center and information technology costs, professional service fees and rent for administrative space. Also included in selling, general and administrative expenses are non-cash expenses related to stock based compensation. Stock based compensation consists of compensation charges incurred in connection with the employee stock options, stock units and non-vested restricted stock granted to executive officers, other employees and directors.

 

   

Depreciation and amortization. Depreciation and amortization includes depreciation of our communications network and equipment and amortization of intangible assets.

 

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Because the Verizon Northern New England business had been operating as the LEC of Verizon in Maine, New Hampshire and Vermont, and not as a standalone telecommunications provider, we operated under the Transition Services Agreement for the one month ended January 2009, under which we incurred $15.9 million of expenses. Subsequent to January 30, 2009, we performed those services internally or obtained them from third-party service providers and not from Verizon.

Results of Operations

Year Ended December 31, 2011 Compared with Year Ended December 31, 2010

The following table sets forth the percentages of revenues represented by selected items reflected in our consolidated statements of operations. The year-to-year comparisons of financial results are not necessarily indicative of future results (in thousands, except percentage of revenues data):

 

     Successor
Company
    Predecessor
Company
    Combined     Predecessor Company  
     Three
Hundred
Forty-One
Days Ended
December 31,
2011
    Twenty-Four
Days Ended
January 24,
2011
    Year Ended
December 31, 2011
    Year Ended
December 31, 2010
 
         $     % of
Revenue
    $     % of
Revenue
 

Revenues

   $ 963,112      $ 66,378      $ 1,029,490        100   $ 1,070,986        100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

              

Costs of services and sales

     438,619        38,766        477,385        46        525,728        49   

Selling, general and administrative

     332,020        27,161        359,181        35        365,373        34   

Depreciation and amortization

     336,891        21,515        358,406        35        289,824        27   

Reorganization related (income) expense

     (232     —          (232     —          —          —     

Impairment of intangible assets and goodwill

     262,019        —          262,019        26        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,369,317        87,442        1,456,759        142        1,180,925        110   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (406,205     (21,064     (427,269     (42     (109,939     (10

Interest expense

     (63,807     (9,321     (73,128     (6     (140,896     (13

Other income (expense)

     1,791        (132     1,659        —          2,715        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before reorganization items and income taxes

     (468,221     (30,517     (498,738     (48     (248,120     (23

Reorganization items

     —          897,313        897,313        87        (41,120     (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes

     (468,221     866,796        398,575        39        (289,240     (27

Income tax benefit (expense)

     53,276        (279,889     (226,613     (22     7,661        1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (414,945   $ 586,907      $ 171,962        17   $ (281,579     (26 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Revenues

Revenues decreased $41.5 million to $1,029.5 million in 2011 compared to 2010. We derived our revenues from the following sources:

Voice services. Voice services revenues decreased $38.3 million to $493.3 million during 2011 compared to 2010, of which $35.0 million of the decrease is attributable to local calling services revenues and $3.3 million of the decrease is attributable to long distance service revenues. This decrease in voice services revenues is primarily due to the impact of an 8.4% decline in total switched access lines in service at December 31, 2011 compared to December 31, 2010, partially offset by a $2.8 million decline in SQI penalties and a $4.8 million decrease in PAP credits recorded during 2011 as compared to 2010. Due to various factors, adjustments to SQI and PAP reserves resulted in a net increase in voice services revenue of $2.2 million in 2011. The decrease in the number of voice access lines is due to an increase in competition and our customers’ use of alternative technologies.

Access. Access revenues decreased $11.8 million to $369.3 million in 2011 compared to 2010. Growth in special access revenue is being offset by declines in switched access revenues as minutes of use decline. Special access revenue increased primarily due to revenue assurance activities, including back-billing. Switched access revenues decreased primarily due to an 8.4% decline in total switched access lines in service at December 31, 2011 compared to December 31, 2010.

Data and Internet services. Data and Internet services revenues increased $7.6 million to $117.8 million in 2011 compared to 2010. The increase was primarily attributable to an 8.4% increase in the number of HSD subscribers from December 31, 2010 to December 31, 2011 resulting from our expanded HSD footprint, bundling and other marketing efforts.

Other services. Other services revenues increased $1.0 million to $49.1 million in 2011 compared to 2010.

Operating Expenses

Cost of services and sales. Cost of services and sales decreased $48.3 million to $477.4 million in 2011 compared to 2010. In 2011, we experienced an $5.2 million decrease in employee expenses, a $7.8 million decrease in deferred charges related to customer activation fees and a $15.1 million reduction in expense associated with the abandonment of capital projects. These decreases in 2011 were partially offset by severance expenses of $6.6 million associated with the workforce reduction announced in September 2011. In addition, cost of services and sales in 2010 included certain non-recurring expenses totaling $13.3 million which contributed to the decrease in 2011.

As a result of fresh start accounting, we wrote off all deferred charges which had been deferred in prior periods and were being amortized into expense over an average customer life. After fresh start, we began to defer any new expenses incurred associated with customer activation fees. Prior to the Effective Date, the amortization of expense each year was greater than the deferral (resulting in a net increase in expense), whereas after fresh start the deferral is greater than the amortization (resulting in a net decrease in expense).

Selling, general and administrative. Selling, general and administrative expenses decreased $6.2 million to $359.2 million in 2011 compared to 2010. The decrease is primarily attributable to reductions in general and administrative expenses associated with our efforts to streamline expenses. These improvements were offset by a $1.3 million increase in bad debt expense, increasing from $20.5 million in 2010 to $21.8 million in 2011, a $7.0 million increase in pension and post-retirement healthcare plan expenses recorded during 2011 and $1.3 million of severance expense related to the workforce reduction that was announced in September 2011.

Depreciation and amortization. Depreciation and amortization increased $68.6 million to $358.4 million in 2011 compared to 2010. This increase is comprised of a $79.3 million increase in depreciation expense offset by a $10.7 million decrease in amortization of intangible assets. In conjunction with the adoption of fresh start accounting, our assets and liabilities were recorded at fair value. On the Effective Date, while the carrying value of property, plant and equipment was written down to fair value, the remaining useful lives established were, in general, shorter than their original estimated useful lives. This has resulted in an increase in depreciation expense from the prior year.

Reorganization related expense. Reorganization related expense represents expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases, occurring after the Effective Date. During 2011, reorganization related expense is comprised of a $7.3 million reversal of a portion of the claims reserve established to pay outstanding bankruptcy claims and various other bankruptcy related fees (the “Claims Reserve”) due to several favorable settlements during the year and an estimation of future favorable settlements, offset by $7.0 million of restructuring professional fees primarily related to fresh start accounting and continuing work to settle outstanding claims.

 

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Impairment of intangible assets and goodwill. Impairment of long-lived assets and goodwill for 2011 is comprised of an impairment of $243.2 million to reduce the carrying value of goodwill to zero and an impairment of $18.8 million to reduce the carrying value of a non-amortizable intangible asset related to our trade name to fair value.

Included in operating expenses are non-cash stock based compensation expenses associated with the award of restricted stock and stock options. Stock based compensation expenses totaled $9.3 million and $0.5 million for the years ended December 31, 2011 and 2010, respectively.

Other Results

Interest expense. Interest expense decreased $67.8 million to $73.1 million in 2011 compared to 2010. Upon the filing of the Chapter 11 Cases, in accordance with the Reorganizations Topic of the ASC, we ceased the accrual of interest expense on the Pre-Petition Notes and the interest rate swap agreements under the ISDA Master Agreement with Wachovia Bank, N.A., dated as of December 12, 2000, as amended and restated as of February 1, 2008, and the ISDA Master Agreement with Morgan Stanley Capital Services Inc., dated as of February 1, 2005 (collectively, the “Swaps”), as it was unlikely that such interest expense would be paid or would become an allowed priority secured or unsecured claim. We continued to accrue interest expense on the Pre-Petition Credit Facility, as such interest was considered an allowed claim pursuant to the Plan. Upon the Effective Date, we entered into the Credit Agreement and began accruing interest on the Revolving Facility and Term Loan (together, the “Credit Agreement Loans”).

Other income (expense). Other income (expense) includes non-operating gains and losses such as those incurred on the sale or disposal of equipment. Other income was $1.7 million in 2011 compared to other income of $2.7 million in 2010.

Reorganization items. Reorganization items represent expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases, prior to the Effective Date. For more information, see note 2 to the consolidated financial statements.

Income taxes. The effective income tax rate is the provision for income taxes stated as a percentage of income before the provision for income taxes. The effective income tax rate for the years ended December 31, 2011 and 2010 was 56.9% expense and 2.6% benefit, respectively. The effective tax rate for the year ended December 31, 2011 was primarily impacted by an impairment charge reducing the carrying value of goodwill to zero and from certain non-taxable cancellation of indebtedness income resulting from our emergence from bankruptcy. The effective tax rate for the year ended December 31, 2010 was impacted by a one-time, non-cash income tax charge of $6.8 million, as a result of the enactment of the Health Care Act (as hereinafter defined). The effective tax rate was also impacted by non-deductible restructuring charges and post-petition interest, as well as a significant increase in our valuation allowance for deferred tax assets due to our inability, by rule, to rely on future earnings to offset our NOLs during the Chapter 11 Cases. Upon the Effective Date, our NOLs were substantially reduced by the recognition of gains on the discharge of certain debt pursuant to the Plan.

Net income (loss). Net income for the year ended December 31, 2011 was $172.0 million compared to a net loss of $(281.6) million for the year ended December 31, 2010. The difference in net income (loss) between 2011 and 2010 is a result of the factors discussed above.

Year Ended December 31, 2010 Compared with Year Ended December 31, 2009

The following table sets forth the percentages of revenues represented by selected items reflected in our consolidated statements of operations. The year-to-year comparisons of financial results are not necessarily indicative of future results (in thousands, except percentage of revenues data):

 

     Predecessor Company  
     Year Ended December 31, 2010     Year Ended December 31, 2009  
     $     % of revenue     $     % of revenue  

Revenues

   $ 1,070,986        100   $ 1,119,090        100

Operating expenses:

        

Cost of services and sales

     525,728        49        515,394        46   

Selling, general and administrative

     365,373        34        417,512        37   

Depreciation and amortization

     289,824        27        275,334        25   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,180,925        110        1,208,240        108   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (109,939     (10     (89,150     (8

Interest expense

     (140,896     (13     (204,919     (18

Gain on derivative instruments

     —          —          12,320        1   

Gain on early retirement of debt

     —          —          12,357        1   

Other income (expense)

     2,715        —          2,000        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before reorganization items and income taxes

     (248,120     (23     (267,392     (24

Reorganization items

     (41,120     (4     (53,018     (5
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (289,240     (27     (320,410     (29

Income tax benefit

     7,661        1        79,014        7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (281,579     (26 )%    $ (241,396     (22 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Revenues

Revenues decreased $48.1 million to $1,071.0 million in 2010 compared to 2009. Revenues in each of our revenue categories have been impacted by continued weakness of the economy during 2010, which has caused a decrease in discretionary consumer spending and resulted in an increase in access line losses and a decrease in usage. Our voice revenues have also been adversely impacted by the effects of competition and the use of alternative technologies. Additionally, because of Cutover issues that prevented us from executing fully on our operating plan for 2009, as well as detrimental effects of the Chapter 11 Cases, our revenue has continued to decline. We derived our revenues from the following sources:

Voice services. Voice services revenues decreased $50.0 million to $531.6 million in 2010. This decrease consists of a $30.8 million decrease in long distance services revenues and a $19.2 million decrease in local calling services revenues and is primarily attributable to a 10.3% decline in total voice access lines in service at December 31, 2010 compared to December 31, 2009, largely offset by a $13.6 million decline in SQI penalties in addition to a $12.7 million reduction of an accrual for forgiveness of fiscal 2008 and 2009 SQI penalties in New Hampshire and Vermont. SQI penalties are settled by crediting customer accounts and are recorded as a reduction to revenue. The decrease in the number of voice access lines is due to an increase in competition from technology substitution and the weakness of the economy.

Access. Access revenues were steady in 2010, increasing $0.6 million to $381.1 million in 2010 compared to 2009. Of this increase, $12.2 million is attributable to an increase in interstate access revenues, largely offset by an $11.6 million decrease in intrastate access revenues. A significant decrease in switched access revenues was primarily attributable to a 10.3% decline in total voice access lines in service at December 31, 2010 compared to December 31, 2009. However, this decline was completely offset by an increase in special access revenues driven by increased efforts to sell our excess network capacity to other carriers as well as the availability of such excess capacity resulting from the build-out of our Next Generation Network.

Data and Internet services. Data and Internet services revenues increased $0.3 million to $110.2 million in 2010 compared to 2009. This increase is primarily attributable to an increase in HSD subscribers resulting from our bundling and other marketing efforts.

Other services. Other services revenues increased $1.1 million to $48.1 million in 2010 compared to 2009.

Operating Expenses

Cost of services and sales. Cost of services and sales increased $10.3 million to $525.7 million in 2010 compared to 2009. This increase is primarily attributable to the write-off of abandoned projects in 2010 of approximately $15.1 million. Cost of services and sales was also impacted by certain non-recurring items totaling approximately $13.3 million. Excluding the abandonment charges and the non-recurring items, cost of services and sales would have declined approximately $18.1 million.

 

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Selling, general and administrative. Selling, general and administrative expenses decreased $52.1 million to $365.4 million in 2010 compared to 2009. The decrease is primarily attributable to a $27.9 million reduction in bad debt expense due to improved cash collections during 2010 and settlements with CLECs related to the Chapter 11 Cases. Additionally, prior to the Petition Date, all expenses related to restructuring activities were classified as selling, general and administrative expenses. During the Chapter 11 Cases, such expenses have been classified as Reorganization items. Accordingly, the year ended December 31, 2009 included $11.1 million in restructuring expenses as compared to zero for the year ended December 31, 2010.

Depreciation and amortization. Depreciation and amortization increased $14.5 million to $289.8 million in 2010 compared to 2009, due primarily to significant capital expenditures in 2010 and the placement of plant assets into service.

Included in operating expenses are non-cash stock based compensation expenses associated with the award of restricted stock and stock units. Stock based compensation expenses totaled $0.5 million and $2.1 million for the years ended December 31, 2010 and 2009, respectively.

Other Results

Interest expense. Interest expense decreased $64.0 million to $140.9 million in 2010 compared to 2009. Upon the filing of the Chapter 11 Cases, in accordance with the Reorganizations Topic of the ASC, we ceased the accrual of interest expense on the Pre-Petition Notes and the Swaps as it was unlikely that such interest expense would be paid or would become an allowed priority secured or unsecured claim, resulting in a significant decrease in 2010 interest expense. We continued to accrue interest expense on the Pre-Petition Credit Facility, as such interest is considered an allowed claim pursuant to the Plan.

Gain (loss) on derivative instruments. Gain (loss) on derivative instruments represents net gains and losses recognized on the change in fair market value of interest rate swap derivatives. During the year ended December 31, 2009 we recognized a net non-cash gain of $12.3 million related to our derivative financial instruments. In connection with the filing of the Chapter 11 Cases, the Swaps were terminated by the counterparties and have been recorded on the consolidated balance sheet at the termination values provided by the counterparties. Accordingly, we recognized no gain or loss on derivative instruments during the year ended December 31, 2010.

Gain on early retirement of debt. Gain on early retirement of debt represents $13.2 million net gains recognized on the repurchase of $19.9 million aggregate principal amount of the Old Notes during the year ended December 31, 2009, partially offset by a loss of $0.8 million attributable to writing off a portion of the unamortized debt issue costs associated with the Pre-Petition Credit Facility. We did not retire any debt during the year ended December 31, 2010 and thus did not recognize any gain or loss on early retirement of debt during such period.

Other income (expense). Other income (expense) includes non-operating gains and losses such as those incurred on sale or disposal of equipment. Other income was $2.7 million in 2010 compared to other income of $2.0 million in 2009. This increase is primarily attributable to a $3.0 million lease contract settlement with a vendor that occurred during the third quarter of 2010.

Reorganization items. Reorganization items represent expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases. For more information, see note 2 to the consolidated financial statements.

Income taxes. The effective income tax rate is the provision for income taxes stated as a percentage of income before the provision for income taxes. The effective income tax rate for the years ended December 31, 2010 and 2009 was 2.6% benefit and 24.7% benefit, respectively. The effective tax rate for the year ended December 31, 2010 was impacted by a one-time, non-cash income tax charge of $6.8 million, as a result of the enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, both of which became law in March 2010 (collectively, the “Health Care Act”). The effective tax rate was also impacted by non-deductible restructuring charges and post-petition interest, as well as a significant increase in our valuation allowance for deferred tax assets due to our inability, by rule, to rely on future earnings to offset our NOLs during the Chapter 11 Cases. Upon the Effective Date, our NOLs were substantially reduced by the recognition of gains on the discharge of certain debt pursuant to the Plan.

Net loss. Net loss for the year ended December 31, 2010 was $(281.6) million compared to net loss of $(241.4) million for the year ended December 31, 2009. The difference in net loss between 2010 and 2009 is a result of the factors discussed above.

 

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Liquidity and Capital Resources

Overview

Upon our emergence from Chapter 11 on January 24, 2011, we adopted fresh start accounting in accordance with guidance under the applicable reorganization accounting rules. Accordingly, our post-emergence consolidated statements of financial position, consolidated statements of operations and statements of cash flows are not comparable in many respects to our consolidated statements of financial position, consolidated statements of operations and statements of cash flows for periods prior to the adoption of fresh start accounting and prior to accounting for the effects of the reorganization.

Our short-term and long-term liquidity needs arise primarily from: (i) interest and principal payments on our indebtedness; (ii) capital expenditures; (iii) working capital requirements as may be needed to support and grow our business; and (iv) contributions to our defined pension plan and payments under our post-retirement healthcare plans. Our current and future liquidity is greatly dependent upon our operating results. We expect that our primary sources of liquidity will be cash flow from operations, cash on hand and funds available under the Revolving Facility.

Based on our current and anticipated levels of operations and conditions in our markets, we believe that cash on hand (including amounts available under our Revolving Facility) as well as cash flow from operations will enable us to meet our working capital, capital expenditure, debt service and other funding requirements for at least the next 12 months. We expect to be in compliance with the maintenance covenants contained in the Credit Agreement for 2012. However, our anticipated results are subject to significant uncertainty and our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions. The breach of certain covenants set forth in our financing agreements could result in an event of default thereunder. An event of default, if not cured within defined cure periods, if any, would permit the lenders under a defaulted financing agreement to declare all indebtedness thereunder to be due and payable prior to maturity. Moreover, the lenders under our Revolving Facility would have the option to terminate their commitments to make further extensions of revolving credit thereunder. If we are unable to repay our obligations under our Credit Agreement, the lenders could proceed against any assets that were pledged to secure such facility.

Cash and cash equivalents at December 31, 2011 totaled $17.4 million compared to $105.5 million at December 31, 2010, excluding restricted cash of $25.1 million and $4.1 million, respectively. On the Effective Date, we significantly reduced our cash on hand by approximately $89.9 million to establish the cash claims reserve (the “Cash Claims Reserve”). Tax related claims were not included in the Cash Claims Reserve. As of the Effective Date, cash and cash equivalents totaled $10.3 million, excluding the Cash Claims Reserve of $82.8 million, following payment of $7.1 million in claims on the Effective Date. In accordance with the Plan, to the extent that claims are settled for amounts lower than estimated in the Cash Claims Reserve, we could reclaim restricted cash of up to $22.9 million. As of December 31, 2011, we had reclaimed $6.2 million of restricted cash. There is no certainty that we will reclaim any, or all, of the $22.9 million balance remaining at December 31, 2011.

Cash Flows

Net cash provided by (used in) operating activities was $170.1 million, ($81.1) million, $191.6 million and $150.3 million for the 341 days ended December 31, 2011, the 24 days ended January 24, 2011 and the years ended December 31, 2010 and 2009, respectively. Net cash provided by operating activities for the 341 days ended December 31, 2011 represents the operating activities of the Successor Company; however, it includes payment of $66.7 million in claims of the Predecessor Company, of which $59.9 million of these claims were paid using funds from the Cash Claims Reserve established on the Effective Date by the Predecessor Company. After a $7.1 million payment of claims on the Effective Date, the Cash Claims Reserve totaled $82.8 million and is reflected in net cash used in operating activities during the 24 days ended January 24, 2011. Upon the filing of the Chapter 11 Cases, we continued to accrue interest expense on the Pre-Petition Credit Facility, as such interest was considered an allowed claim pursuant to the Plan. During the 24 days ended January 24, 2011, the year ended December 31, 2010 and the sixty-six days from the Petition Date to December 31, 2009, no payments of interest were made, resulting in an increase in cash provided by operations of $9.0 million, $137.1 million and $61.3 million, respectively. Upon the Effective Date, we began paying interest on our outstanding debt in the normal course during the 341 days ended December 31, 2011.

Net cash used in investing activities was $162.9 million, $12.5 million, $197.3 million and $177.4 million for the 341 days ended December 31, 2011, the 24 days ended January 24, 2011 and the years ended December 31, 2010 and 2009, respectively, and is mainly comprised of capital expenditures for all periods.

 

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Net cash (used in) provided by financing activities was ($0.2) million, ($1.7) million, $1.8 million and $66.1 million for the 341 days ended December 31, 2011, the 24 days ended January 24, 2011 and the years ended December 31, 2010 and 2009, respectively. We paid $2.4 million of loan origination costs on the Credit Agreement, of which $0.9 million and $1.5 million were paid during the 341 days ended December 31, 2011 and the 24 days ended January 24, 2011, respectively. For the year ended December 31, 2010, we drew down $5.5 million on letters of credit under the Pre-Petition Credit Facility and incurred $1.5 million of loan origination costs on the DIP Credit Agreement, which was terminated by its conversion into the Revolving Facility, and all notes, security agreements and other agreements related to the DIP Credit Agreement. For the year ended December 31, 2009, net proceeds from our issuance of long-term debt were $50.0 million, repayment of long-term debt was $20.8 million and dividends paid to stockholders was $23.0 million. Additionally, $65.1 million was released from restricted cash during the year ended December 31, 2009.

We made contributions to our Company sponsored qualified pension plans and post-retirement healthcare plans of $6.8 million and $0.8 million, respectively, in 2011. In addition, we made $1.8 million in post-retirement healthcare plan expenditures in 2011. We expect to contribute approximately $19.8 million to our Company sponsored qualified pension plans, as required by the Pension Protection Act of 2006, and approximately $5.5 million to our post-retirement healthcare plans in 2012. In 2011, due to lower interest rates and higher healthcare rate increases, we had a significant cost increase in our qualified pension and post-retirement healthcare liabilities. While this may not affect our short-term cash position, it may indicate the need for higher cash contributions in the future.

Capital Expenditures

We require significant capital expenditures to maintain, upgrade and enhance our network facilities and operations. In 2011, our capital expenditures totaled $176.1 million. We anticipate that we will fund future capital expenditures through cash flows from operations, cash on hand and funds available under the Revolving Facility.

We have a five year contract with our primary IT vendor, which was executed in 2009. In the years ended December 31, 2011 and 2010, we spent approximately $22.1 million and $28.7 million, respectively, for services under such contract, of which approximately $9.2 million and $12.8 million, respectively, was capitalized in accordance with the Intangibles – Goodwill and Other Topic and the Interest Topic of the ASC and approximately $12.9 million and $15.9 million, respectively, was included in operating expenses. In 2011, we provided notice to the vendor of our intent to in-source or alternatively source certain functions which we expected would result in a future reduction of approximately 95% of the baseline service costs commencing on April 11, 2012 from this vendor. We expect that these savings will be largely offset in the near term by other vendors for these functions and other IT initiatives.

Debt

Credit Agreement

On the Effective Date, the Borrowers entered into the Credit Agreement. The Credit Agreement is comprised of the Revolving Facility, which has a sub-facility providing for the issuance of up to $30.0 million of letters of credit, and the Term Loan. On the Effective Date, we paid to the lenders providing the Revolving Facility an aggregate fee equal to $1.5 million. Interest on the Credit Agreement Loans accrues at an annual rate equal to either (a) LIBOR plus 4.50%, with a minimum LIBOR floor of 2.00% for the Term Loan, or (b) a base rate plus 3.50% per annum, which base rate is equal to the highest of (x) Bank of America’s prime rate, (y) the federal funds effective rate plus 0.50% and (z) LIBOR (with minimum LIBOR floor of 2.00%) plus 1.00%. In addition, we are required to pay a 0.75% per annum commitment fee on the average daily unused portion of the Revolving Facility. The entire outstanding principal amount of the Credit Agreement Loans is due and payable five years after the Effective Date (the “Maturity Date”); provided that on the third anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a continuation fee of $0.75 million and, on the fourth anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a second continuation fee of $0.75 million. The Credit Agreement requires quarterly repayments of principal of the Term Loan after the first anniversary of the Effective Date. In the second and third years following the Effective Date, such quarterly payments shall each be in an amount equal to $2.5 million; during the fourth year following the Effective Date, such quarterly payments shall each be in an amount equal to $6.25 million; and for the first three quarters during the fifth year following the Effective Date, such quarterly payments shall each be in an amount equal to $12.5 million, with all remaining outstanding amounts owed in respect of the Credit Agreement being due and payable on the Maturity Date. As of December 31, 2011, we had approximately $62.6 million, net of approximately $12.4 million outstanding letters of credit, available for additional borrowing under our Revolving Facility.

 

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The Credit Agreement Loans are guaranteed by all of our current and future direct and indirect subsidiaries, other than (x) any subsidiary that is prohibited by applicable law from guaranteeing the obligations under the Credit Agreement Loans and/or providing any security therefor without the consent of a state public utilities commission, and (y) any subsidiary of ours that is a controlled foreign corporation or a subsidiary that is held directly or indirectly by a controlled foreign corporation (the guarantor subsidiaries, together with FairPoint Communications and FairPoint Logistics, are collectively referred to as the “Financing Loan Parties”). The Credit Agreement Loans as a whole are secured by liens upon substantially all existing and after-acquired assets of the Financing Loan Parties, with first lien and payment waterfall priority for the Revolving Facility and second lien priority for the Term Loan.

The Credit Agreement contains customary representations, warranties and affirmative covenants. In addition, the Credit Agreement contains restrictive covenants that limit, among other things, the ability of the Financing Loan Parties to incur indebtedness, create liens, engage in mergers, consolidations and other fundamental changes, make investments or loans, engage in transactions with affiliates, pay dividends, make capital expenditures and repurchase capital stock. The Credit Agreement also contains minimum interest coverage and maximum total leverage maintenance covenants, along with a maximum senior leverage covenant measured upon the incurrence of certain types of debt. The ratios measured in these covenants, which are reported quarterly, periodically adjust to become more restrictive as set forth in the Credit Agreement. The initial adjustment for each of the three covenants will be reflected in the quarterly covenant reporting for the third quarter of 2013. The Credit Agreement contains certain events of default, including failure to make payments, breaches of covenants and representations, cross defaults to other material indebtedness, unpaid and uninsured judgments, changes of control and bankruptcy events of default. The lenders’ commitments to fund amounts under the Revolving Facility are subject to certain customary conditions. As of December 31, 2011, the Borrowers were in compliance with all covenants under the Credit Agreement.

The Credit Agreement also provides for mandatory prepayments of outstanding balances on the Credit Agreement Loans with the proceeds from certain asset dispositions, certain equity and debt issuances, and certain extraordinary cash receipts. Proceeds from such events may be reinvested by the Borrowers in lieu of any such mandatory prepayment under certain circumstances. In addition, at the end of each fiscal year, a test is performed to determine if excess cash flow, as defined in the Credit Agreement, was generated during the year. If the calculation indicates that excess cash flow was generated, a certain percentage (determined by reference to the total leverage ratio) of such excess cash flow is required to be prepaid against outstanding balances. Any mandatory prepayments are first applied to the Revolving Facility until repaid and then to the Term Loan.

The above summary of the material terms of the Credit Agreement Loans does not purport to be complete and is qualified in its entirety by reference to the text of (i) the Credit Agreement, (ii) the Pledge Agreement, dated as of the Effective Date, made by the pledgors party thereto in favor of Bank of America, N.A., as administrative agent, for the benefit of certain secured parties, (iii) the Security Agreement, dated as of the Effective Date, by and among FairPoint Communications, FairPoint Logistics, our subsidiaries party thereto and Bank of America, N.A., as administrative agent, for the benefit of certain secured parties and (iv) the Continuing Guaranty Agreement, dated as of the Effective Date, made by and among the guarantors party thereto in favor of Bank of America, N.A., as administrative agent, for the benefit of certain secured parties.

Our DIP Facility

In connection with the Chapter 11 Cases, on October 27, 2009, the DIP Borrowers entered into the DIP Credit Agreement with the DIP Lenders and the DIP Administrative Agent. The DIP Credit Agreement provided for a revolving facility in an aggregate principal amount of up to $75.0 million, of which up to $30.0 million was also available in the form of one or more letters of credit that may be issued to third parties for our account (the “DIP Financing”). Pursuant to an Order of the Bankruptcy Court, dated October 28, 2009 (the “Interim Order”), the DIP Borrowers were authorized to enter into and immediately draw upon the DIP Credit Agreement on an interim basis in an aggregate amount of $20.0 million, pending a final hearing before the Bankruptcy Court. Pursuant to a final order of the Bankruptcy Court, dated March 11, 2010 (the “Final DIP Order”), the DIP Borrowers were permitted access to the total $75.0 million of the DIP Financing, subject to the terms and conditions of the DIP Credit Agreement and related orders of the Bankruptcy Court, of which up to $30.0 million was available in the form of one or more letters of credit that could be issued to third parties for our account. As of December 31, 2010 and 2009, we had not borrowed any amounts under the DIP Credit Agreement other than letters of credit totaling $18.7 million and $1.6 million, respectively, that had been issued and were outstanding under the DIP Credit Agreement.

On the Effective Date, the DIP Credit Agreement was converted into the new $75.0 million Revolving Facility with a five-year term. All letters of credit outstanding under the DIP Credit Agreement were transferred to the Credit Agreement on the Effective Date.

 

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Our Pre-Petition Credit Facility

Our $2,030.0 million Pre-Petition Credit Facility consisted of a non-amortizing revolving facility in an aggregate principal amount of $200.0 million, a senior secured term loan A facility in an aggregate principal amount of $500.0 million (the “Term Loan A Facility”), a senior secured term loan B facility in the aggregate principal amount of $1,130.0 million (the “Term Loan B Facility” and, together with the Term Loan A Facility, the “Pre-Petition Term Loan”) and a delayed draw term loan facility in an aggregate principal amount of $200.0 million (the “Delayed Draw Term Loan”). Spinco drew $1,160.0 million under the Pre-Petition Term Loan immediately prior to being spun off by Verizon, and then FairPoint drew $470.0 million under the Pre-Petition Term Loan and $5.5 million under the Delayed Draw Term Loan concurrently with the closing of the Merger. Subsequent to the Merger, we borrowed the remaining $194.5 million available under the Delayed Draw Term Loan. These funds were used for certain capital expenditures and other expenses associated with the Merger.

On the Effective Date, the Pre-Petition Credit Facility and all obligations thereunder were terminated (except that the Pre-Petition Credit Facility continues in effect solely for the purposes of allowing creditors under the Pre-Petition Credit Facility to receive distributions under the Plan and to preserve certain rights of the administrative agent).

Our Pre-Petition Notes

Spinco issued, and we assumed in the Merger, $551.0 million aggregate principal amount of the Old Notes. The Old Notes were to mature on April 1, 2018 and were not redeemable at our option prior to April 1, 2013. The Old Notes were issued at a discount and, accordingly, at the date of their distribution, the Old Notes had a carrying value of $539.8 million (principal amount at maturity of $551.0 million less discount of $11.2 million). Following the filing of the Chapter 11 Cases, $9.9 million of discount on the Pre-Petition Notes was written off in order to adjust the carrying amount of our pre-petition debt to the Bankruptcy Court approved amount of the allowed claims for our pre-petition debt.

Pursuant to our offer to exchange the Old Notes for the New Notes (the “Exchange Offer”), on July 29, 2009, we exchanged $439.6 million in aggregate principal amount of the Old Notes (which amount was equal to approximately 83% of the then outstanding Old Notes) for $458.5 million in aggregate principal amount of the New Notes (which amount included New Notes issued to tendering noteholders as payment for accrued and unpaid interest on the exchanged Old Notes up to, but not including, the July 29, 2009 settlement date of the Exchange Offer).

On the Effective Date, all outstanding obligations under the Pre-Petition Notes and the indentures governing the Pre-Petition Notes were terminated.

Other Pre-Petition Agreements

As a condition to the approval of the Merger and related transactions by state regulatory authorities we agreed to make certain capital expenditures following the completion of the Merger. The Merger Orders have been modified by Regulatory Settlements agreed to with representatives for each of Maine, New Hampshire and Vermont, and approved by the applicable regulatory authorities in Maine, New Hampshire and Vermont, and approved by the Bankruptcy Court as part of the Plan. For a description of these capital expenditure requirements, see “Item 1. – Business – Regulatory Environment – State Regulation – Regulatory Conditions to the Merger, as Modified in Connection with the Plan.”

On January 30, 2009, we entered into the Transition Agreement with Verizon in connection with the Cutover of certain back-office systems, as contemplated by the Transition Services Agreement. The Transition Services Agreement and related agreements had required us to make payments totaling approximately $45.4 million to Verizon in the first quarter of 2009, including a one-time fee of $34.0 million due at Cutover, with the balance related to the purchase of certain Internet access hardware. The settlement set forth in the Transition Agreement resulted in a $22.7 million improvement in our cash flow for the year ended December 31, 2009.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

 

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Summary of Contractual Obligations

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

The following table discloses aggregate information about our contractual obligations as of December 31, 2011 and the periods in which payments are due:

 

     Payments due by period  
     Total      Less
than

1 year
     1-3
years
     3-5
years
     More
than

5  years
 
     (Dollars in thousands)  

Contractual obligations:

              

Long-term debt, including current maturities

   $ 1,000,000       $ 10,000       $ 35,000       $ 955,000       $ —     

Interest payments on long-term debt obligations (a)

     254,688         65,226         128,136         61,326         —     

Capital lease obligations

     4,776         1,679         2,992         105         —     

Operating leases

     32,380         9,871         14,551         5,701         2,257   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations

   $ 1,291,844       $ 86,776       $ 180,679       $ 1,022,132       $ 2,257   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(a) Excludes amortization of estimated capitalized debt issuance costs.

On the Effective Date our Pre-Petition Credit Facility and our DIP Facility were terminated and we entered into the Credit Agreement. At December 31, 2011, our long-term debt obligations totaled $1,000.0 million. In addition, as of December 31, 2011 we had letters of credit totaling $12.4 million outstanding under the Revolving Facility.

Critical Accounting Policies and Estimates

Our accounting policies are more fully described in the notes to our consolidated financial statements contained in Item 8 hereof. As disclosed in note 3 to our consolidated financial statements, the preparation of our financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments. Our critical accounting policies are as follows:

 

   

Fresh start accounting;

 

   

Revenue recognition;

 

   

Allowance for doubtful accounts;

 

   

Accounting for pension and other post-retirement benefits;

 

   

Accounting for income taxes;

 

   

Depreciation of property, plant and equipment;

 

   

Stock-based compensation;

 

   

Valuation of long-lived assets, including goodwill; and

 

   

Accounting for software development costs.

 

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Fresh Start Accounting. Upon the Effective Date, we applied fresh start accounting principles in accordance with guidance under the applicable reorganization accounting rules. With the exception of deferred taxes and assets and liabilities associated with pension and post-retirement health plans, all Successor Company assets and non-interest bearing liabilities are recorded at their estimated fair values upon the Effective Date. The fair value estimates for property, plant and equipment were based on various valuation methods, including but not limited to, the market approach, the indirect cost approach, the direct replacement cost approach and the “percent of cost” market approach. The fair value estimates of identifiable assets were based on the cost method for our customer lists and the relief from royalty for our trade name.

We also recorded the Successor Company debt and equity at fair value utilizing the total enterprise value of approximately $1.5 billion, which was determined in conjunction with the confirmation of the Plan in part based on a set of financial projections for the Successor Company. The calculation of the enterprise value was dependent upon achieving the estimated future financial results set forth in our projections, as well as the realization of certain other assumptions.

Our actual performance against these projections and assumptions made in applying fresh start accounting could result in an impairment of the value attributed to our long-lived assets, including goodwill and the trade name, on the Effective Date. In fact, as further discussed in our accounting policy of the valuation for long-lived assets, including goodwill below, an impairment to goodwill and our trade name was recorded at September 30, 2011. Although an impairment charge could have a material effect on our results of operations, this non-cash expense would have no impact on our compliance with the covenants contained in the Credit Agreement.

Revenue Recognition. We recognize service revenues based upon usage of our local exchange network and facilities and contract fees. Fixed fees for voice services, Internet services and certain other services are recognized in the month the service is provided. Revenue from other services that are not fixed fee or that exceed contracted amounts is recognized when those services are provided. Non-recurring customer activation fees, along with the related costs up to, but not exceeding, the activation fees, are deferred and amortized over the customer relationship period. SQI penalties and certain PAP penalties are recorded as a reduction to revenue. SQI penalties for Maine, New Hampshire and Vermont are recorded to other accrued liabilities on the consolidated balance sheets. PAP penalties for Maine and New Hampshire are recorded as a reduction to accounts receivable since these penalties are paid by the Company in the form of credits applied to the CLEC bills. PAP penalties in Vermont are recorded to other accrued liabilities as a majority of these penalties are paid to the Vermont Universal Service Fund, while the remaining credits assessed in Vermont are paid by the Company in the form of credits applied to CLEC bills. All SQI and Vermont PAP penalties related to the Predecessor Company are recorded to the Claims Reserve at December 31, 2011 and to liabilities subject to compromise at December 31, 2010.

We make estimated adjustments, as necessary, to revenue or accounts receivable for billing errors, including certain disputed amounts.

Allowance for Doubtful Accounts. In evaluating the collectability 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 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.

On the Effective Date, the accounts receivable balances were valued at fair value using the net realizable value approach. The net realizable value approach was determined by reducing the gross receivable balance by our allowance for doubtful accounts. Due to the relatively short collection period, the net realizable value approach was determined to result in a reasonable indication of fair value of the assets.

Accounting for Pension and Other Post-retirement Benefits. Some of our employees participate in our pension plans and other post-retirement healthcare plans. In the aggregate, the benefit obligations of the pension plans and the benefit obligations of the post-retirement healthcare plans each exceed the fair value of their respective assets, resulting in expense. Significant pension and other post-retirement healthcare plan assumptions, including the discount rate used, the long-term rate-of-return on plan assets, and medical cost trend rates are periodically updated and impact the amount of benefit plan income, expense, assets and obligations reflected in our consolidated financial statements. The actuarial assumptions we used in determining our pension and post-retirement healthcare plans obligations may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience or changes in assumptions might materially affect our financial position or results of operations.

Our pension and post-retirement liabilities are highly sensitive to changes in the discount rate. We currently estimate that a movement of 1% in the discount rate would change our pension plan benefit obligations by approximately 19%. We currently estimate that a 1% fluctuation in the discount rate would change our post-retirement healthcare benefit obligations by approximately 23%.

The post-retirement healthcare benefit obligations are also highly sensitive to the medical trend rate assumption. A 1% increase in the medical trend rate assumed for post-retirement healthcare benefits at December 31, 2011 would result in an increase in the post-retirement healthcare benefit obligations of approximately $134.1 million and a 1% decrease in the medical trend rate assumed at December 31, 2011 would result in a decrease in the post-retirement healthcare benefit obligations of approximately $101.1 million.

 


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Accounting for Income Taxes. Our current and deferred income taxes are affected by events and transactions arising in the normal course of business, as well as in connection with the adoption of new accounting standards and non-recurring items. Assessment of the appropriate amount and classification of income taxes is dependent on several factors, including estimates of the timing and realization of deferred income tax assets and the timing of income tax payments. Actual payments may differ from these estimates as a result of changes in tax laws, as well as unanticipated future transactions affecting related income tax balances. We account for tax benefits taken or expected to be taken in our tax returns utilizing a two step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions.

Depreciation of Property, Plant and Equipment. We recognize depreciation on property, plant and equipment principally on the composite group remaining life method and straight-line composite rates over estimated useful lives ranging from three to 50 years. This method provides for the recognition of the cost of the remaining net investment in telephone plant, less anticipated net salvage value (if any), over the remaining asset lives. This method requires the periodic revision of depreciation rates. We review the depreciable lives annually. Changes in the estimated useful lives of property, plant and equipment or depreciation methods could have a material effect on our results of operations. However, a change in this non-cash expense would have no impact on our compliance with the covenants contained in the Credit Agreement.

Stock-based Compensation. Compensation expense for share-based awards made to employees and directors are recognized based on the estimated fair value of each award over the award’s vesting period. We estimate the fair value of share-based payment awards on the date of grant using either an option-pricing model for stock options or the closing market value of our stock for restricted stock, and expense the value of the portion of the award that is ultimately expected to vest over the requisite service period in the statement of operations.

We utilize the Black-Scholes option pricing model to calculate the fair value of our stock option grants. The key assumptions used in the Black-Scholes option pricing model are the expected life of the stock option, the expected dividend rate, the risk-free interest rate and expected volatility. The expected life of the stock options granted represents the period of time that the options are expected to be outstanding. The risk-free interest rates are based on United States Treasury yields in effect at the date of grant consistent with the expected exercise timeframes. The expected volatility reflects the historical volatility for a duration consistent with the contractual life of the options. Given the lack of historical data of employee behavior and our company, our assumptions of these key inputs in addition to our assumption made about the portion of the awards that will ultimately vest requires subjective judgment.

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. In addition, we review goodwill and non-amortizable intangible assets for impairment on an annual basis as of the first day of the fourth quarter of each year. Several factors could trigger an impairment review such as:

 

   

significant underperformance relative to expected historical or projected future operating results;

 

   

significant regulatory changes that would impact future operating revenues;

 

   

significant negative industry or economic trends; and

 

   

significant changes in the overall strategy in which we operate our overall business.

At December 31, 2011, we have no goodwill and $138.6 million of gross intangible assets related to customer relationships, the FairPoint trade name and favorable leasehold agreements as of December 31, 2011. The customer relationships and favorable leasehold agreements are being amortized over a weighted average life of approximately 9.0 years and 2.7 years, respectively. As of December 31, 2011, there is $10.4 million of accumulated amortization recorded. The trade name has an indefinite life and is, therefore, not amortized. The intangible assets are included in intangible assets on our consolidated balance sheet. In addition, we have recorded $1.9 billion of gross property, plant and equipment as of December 31, 2011, net of $280.5 million accumulated depreciation. These assets are depreciated over lives ranging from three to 50 years.

 

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As of December 31, 2010, as a result of changes to our financial projections related to the Chapter 11 Cases, we determined that a possible impairment of our long-lived assets – the property, plant and equipment and customer relationships of the Predecessor Company – was indicated. In accordance with the guidance related to impairment of long-lived assets, we performed recoverability tests, based on undiscounted projected future cash flows associated with our long-lived assets, and determined that long-lived assets were not impaired at December 31, 2010.

At September 30, 2011, given the significant sustained decline in our stock price since the Effective Date and the September 30, 2011 impairment of goodwill and the FairPoint trade name, as further described below, we determined that a possible impairment of our long-lived assets – the property, plant and equipment, customer relationships and favorable leasehold agreements – was present. However, we concluded that long-lived assets were recoverable based on the Company’s estimated gross cash flows being greater than the carrying value.

As of December 31, 2011, we performed our routine review of impairment triggering events specified by the guidance related to impairment of long-lived assets and concluded that we do not believe a triggering event has occurred.

Goodwill impairment is determined using a two-step process. Step one compares the estimated fair value of our single wireline reporting unit (calculated using both the market approach and the income approach) to its carrying amount, including goodwill. The market approach compares our fair value, as measured by our market capitalization, to our carrying amount, which represents our stockholders’ equity balance. The income approach is based upon projected future cash flows discounted to present value using factors that consider the timing and risk associated with the future cash flows. The fair value of the Company’s single wireline reporting unit was estimated using a probability weighted scenario of future cash flow projections based on management’s long range estimates of market conditions over a multiple year horizon. An estimated growth rate was used to arrive at an estimated terminal value. A discount rate was based upon a cost of capital calculated using various inputs, such as the risk-free rate, equity risk premium, size premium, company specific premium, etc., as of the date of the goodwill impairment test.

Step two compares the implied fair value of our goodwill (i.e., our fair value less the fair value of our assets and liabilities, including identifiable intangible assets) to our goodwill carrying amount. If the carrying amount of our goodwill exceeds the implied fair value of our goodwill, the excess is required to be recorded as an impairment.

At October 1, 2010, we performed step one of our annual goodwill impairment assessment and concluded that there was no indication of impairment at that time.

At September 30, 2011, given the significant sustained decline in our stock price since the Effective Date which had caused our market capitalization to be below our book value, we determined that a possible impairment of goodwill was indicated and concluded that an interim goodwill impairment test was necessary. In step one, we calculated the discounted cash flows to arrive at a fair value, which was then compared to the carrying value, including goodwill. A combination of expected cash flows and higher discount rates resulted in the fair value, using the discounted cash flow method, being less than the carrying value, at which point we proceeded to step two, as outlined above. Results of the impairment test required us to record an impairment charge reducing the carrying value of the goodwill to zero at September 30, 2011. This non-cash impairment charge had no impact on our compliance with the covenants contained in the Credit Agreement.

Our only non-amortizable intangible asset other than goodwill is the FairPoint trade name. Consistent with the valuation methodology used to value the trade name at the Effective Date, we assessed the fair value of the trade name based on the relief from royalty method. If the carrying amount of our trade name exceeds its estimated fair value, the asset is considered impaired. For our non-amortizable intangible asset impairment assessments of the FairPoint trade name, we made certain assumptions including an estimated royalty rate, a long-term growth rate, an effective tax rate and a discount rate, and applied these assumptions to projected future cash flows, exclusive of cash flows associated with wholesale revenues as these revenues are not generated through brand recognition. Changes in one or more of these assumptions may result in the recognition of an impairment loss different from what was actually recorded.

We performed our annual non-amortizable intangible asset impairment assessment as of October 1, 2010 and concluded that there was no indication of impairment at that time. As of December 31, 2010, as a result of changes to our financial projections related to the Chapter 11 Cases, we determined that a possible impairment of our non-amortizable intangible assets was indicated. We performed an interim non-amortizable intangible asset impairment assessment as of December 31, 2010 and determined that our trade name was not impaired.

 

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At September 30, 2011, given that the significant sustained decline in our stock price since the Effective Date had caused its market capitalization to be below its book value, we determined that a possible impairment of the FairPoint trade name was indicated and concluded that an interim non-amortizable intangible asset impairment test on the trade name was necessary. Results of the impairment test required us to record an impairment charge totaling $18.8 million at September 30, 2011. Since this interim impairment test was performed on the last day of the 2011 third fiscal quarter, it effectively serves as our annual non-amortizable intangible asset impairment test for the fiscal year.

Accounting for Software Development Costs. We capitalize certain costs incurred in connection with developing or obtaining internal use software. 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.

New Accounting Standards

In June 2011, the FASB issued ASU 2011-05 related to the presentation of comprehensive income which eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This ASU requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is to be applied retrospectively, and is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. In December 2011, the FASB issued ASU 2011-12 which deferred the elective date for amendments to the presentation of reclassification of items out of accumulated other comprehensive income in ASU 2011-05. We do not expect this amendment to the ASC to have a material impact on our consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04 related to achieving common fair value measurements and disclosure requirements between U.S. GAAP and International Financial Reporting Standards (“IFRS”). This ASU changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and IFRS. The ASU also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively, and is effective for interim and annual periods beginning after December 15, 2011. Early adoption is not permitted. We do not expect the adoption of this amendment to the ASC to have a material impact on our consolidated financial statements.

On January 1, 2011, we adopted ASU 2010-28 regarding when to perform step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts. This ASU modifies step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating an impairment may exist. The qualitative factors are consistent with the previously existing guidance, which required that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this ASU are effective for fiscal year, and interim periods within those years, beginning after December 15, 2010. The adoption of this amendment to the ASC did not have a material impact on our consolidated financial statements.

In October 2009, the FASB issued ASU 2009-13 regarding revenue recognition for multiple deliverable arrangements. This method allows a vendor to allocate revenue in an arrangement using its best estimate of selling price if neither vendor specific objective evidence nor third party evidence of selling price exists. Accordingly, the residual method of revenue allocation will no longer be permissible. This ASU must be adopted no later than the beginning of the first fiscal year beginning on or after June 15, 2010. The adoption of this amendment to the ASC did not have a material impact on our consolidated financial statements.

Inflation

There are cost of living adjustment clauses in certain of the collective bargaining agreements covering our labor union employees. Considerable fluctuations in cost of living due to inflation could result in an adverse effect on our operations.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of December 31, 2011, we had total debt of $1,000.0 million, consisting of variable rate debt with an interest rate of 6.50% per annum, including applicable margins. As of December 31, 2011, the fair value of our debt was approximately $795.0 million based on the market prices of our debt at that date. Our Credit Agreement Loans mature in 2016, provided that on the third anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a continuation fee of $0.75 million and, on the fourth anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a second continuation fee of $0.75 million.

As of December 31, 2011, we had $62.6 million, net of $12.4 million outstanding letters of credit, available for additional borrowing under our Revolving Facility. Interest payments on the Term Loan are subject to a LIBOR floor of 2.00%. While LIBOR remains below 2.00% we will incur interest costs above market rates.

We use variable 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, from time to time, we may enter into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk.

We do not hold or issue derivative financial instruments for trading or speculative purposes.

We are also exposed to market risk from changes in the fair value of our pension plan assets and from changes to rates at which benefit payments are discounted. For the year ended December 31, 2011, the actual gain on the pension plan assets was approximately 1.6%. Net periodic benefit cost for 2011 assumes a weighted average annualized expected return on plan assets of approximately 8.3%. Lower returns on plan assets and lower discount rates could negatively impact the funded status of the plan and we may be required to contribute additional funds to the pension plan.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

 

     Page  
FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES:   
Report of Management on Internal Control Over Financial Reporting      63   
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting      64   
Report of Independent Registered Public Accounting Firm      64   
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009:   

Consolidated Balance Sheets as of December 31, 2011 (Successor Company) and December  31, 2010 (Predecessor Company)

     65   

Consolidated Statements of Operations for the 341 Days Ended December  31, 2011 (Successor Company), the 24 Days Ended January 24, 2011 (Predecessor Company) and the Years Ended December 31, 2010 and 2009 (Predecessor Company)

     66   

Consolidated Statements of Comprehensive (Loss) Income for the 341 Days Ended December  31, 2011 (Successor Company), the 24 Days Ended January 24, 2011 (Predecessor Company) and the Years Ended December 31, 2010 and 2009 (Predecessor Company)

     67   

Consolidated Statements of Stockholders’ Equity (Deficit) for the 341 Days Ended December  31, 2011 (Successor Company), the 24 Days Ended January 24, 2011 (Predecessor Company) and the Years Ended December 31, 2010 and 2009 (Predecessor Company)

     68   

Consolidated Statements of Cash Flows for the 341 Days Ended December  31, 2011 (Successor Company), the 24 Days Ended January 24, 2011 (Predecessor Company) and the Years Ended December 31, 2010 and 2009 (Predecessor Company)

     69   

Notes to Consolidated Financial Statements

     70   

 

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Report of Management on Internal Control Over Financial Reporting

We, the management of FairPoint Communications, Inc., are responsible for establishing and maintaining adequate internal control over financial reporting of the Company. Management has evaluated internal control over financial reporting of the Company using the criteria for effective internal control established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Based on such evaluation, management determined that the Company’s internal control over financial reporting was not effective as of December 31, 2011 because the following material weakness in internal control over financial reporting existed during 2011:

 

   

Procedures for the review of our income tax provision and supporting schedules were not adequate to identify and correct errors in a timely manner.

Ernst & Young, LLP, our independent registered public accounting firm who audited the financial statements included in this Annual Report, has issued an attestation report on the Company’s internal control over financial reporting. This report appears on the following page.

 

/s/ Paul H. Sunu

Paul H. Sunu
Chief Executive Officer

/s/ Ajay Sabherwal

Ajay Sabherwal
Executive Vice President and Chief Financial Officer

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of FairPoint Communications, Inc.

We have audited FairPoint Communications, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FairPoint Communications, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. Management has identified a material weakness in controls related to the Company’s review of its income tax provision. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FairPoint Communications, Inc. as of December 31, 2011 (Successor) and 2010 (Predecessor), and the related consolidated statements of operations, stockholders’ equity (deficit), comprehensive (loss) income and cash flows for the period from January 25, 2011 to December 31, 2011 (Successor), the period from January 1, 2011 to January 24, 2011 (Predecessor), and the years ended December 31, 2010 and 2009 (Predecessor). This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the 2011 financial statements and this report does not affect our report dated March 9, 2012, which expressed an unqualified opinion on those financial statements

In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, FairPoint Communications, Inc. has not maintained effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.

Ernst & Young LLP

Charlotte, NC

March 9, 2012

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of FairPoint Communications, Inc.

We have audited the accompanying consolidated balance sheets of FairPoint Communications, Inc. (the Company) as of December 31, 2011 (Successor) and 2010 (Predecessor), and the related consolidated statements of operations, stockholders’ equity (deficit), comprehensive (loss) income and cash flows for the period from January 25, 2011 to December 31, 2011 (Successor), the period from January 1, 2011 to January 24, 2011 (Predecessor), and the years ended December 31, 2010 and 2009 (Predecessor). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of FairPoint Communications, Inc. at December 31, 2011 (Successor) and 2010 (Predecessor), and the consolidated results of its operations and its cash flows for the period from January 25, 2011 to December 31, 2011 (Successor), the period from January 1, 2011 to January 24, 2011 (Predecessor), and the years ended December 31, 2010 and 2009 (Predecessor), in conformity with US generally accepted accounting principles.

As discussed in Notes 1 and 2 to the consolidated financial statements, on January 13, 2011, the Bankruptcy Court entered an order confirming the plan of reorganization, which became effective on January 24, 2011. Accordingly, the accompanying consolidated financial statements have been prepared in conformity with Accounting Standards Codification 852-10, Reorganizations, for the Successor Company as a new entity with assets, liabilities and a capital structure having carrying amounts not comparable with prior periods as described in Notes 1 and 2.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), FairPoint Communications, Inc.’s internal control over financial reporting as of December 31, 2011 (Successor), based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2012 expressed an adverse opinion thereon.

/s/ Ernst & Young LLP

Charlotte, North Carolina

March 9, 2012

 

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FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2011 and 2010

(in thousands, except share data)

 

     Successor Company     Predecessor Company  
     December 31,
2011
    December 31,
2010
 
Assets       

Current assets:

      

Cash

   $ 17,350      $ 105,497   

Restricted cash

     24,446        2,420   

Accounts receivable, net

     104,298        125,170   

Materials and supplies

     935        22,193   

Prepaid expenses

     18,346        18,841   

Other current assets

     2,377        6,092   

Deferred income tax, net

     17,915        31,400   
  

 

 

   

 

 

 

Total current assets

     185,667        311,613   

Property, plant and equipment, net

     1,663,065        1,859,700   

Goodwill

     —          595,120   

Intangible assets, net

     128,145        189,247   

Prepaid pension asset

     —          2,960   

Debt issue costs, net

     1,779        119   

Restricted cash

     651        1,678   

Other assets

     10,338        13,357   
  

 

 

   

 

 

 

Total assets

   $ 1,989,645      $ 2,973,794   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Deficit       

Liabilities not subject to compromise:

      

Current portion of long-term debt

   $ 10,000      $ —     

Current portion of capital lease obligations

     1,252        1,321   

Accounts payable

     65,184        66,557   

Claims payable and estimated claims accrual

     22,839        —     

Accrued interest payable

     508        3   

Other accrued liabilities

     54,348        63,279   
  

 

 

   

 

 

 

Total current liabilities

     154,131        131,160   
  

 

 

   

 

 

 

Capital lease obligations

     2,690        3,943   

Accrued pension obligation

     157,961        92,246   

Employee benefit obligations

     531,634        344,463   

Deferred income taxes

     245,369        67,381   

Unamortized investment tax credits

     —          4,310   

Other long-term liabilities

     14,003        12,398   

Long-term debt, net of current portion

     990,000        —     
  

 

 

   

 

 

 

Total long-term liabilities

     1,941,657        524,741   
  

 

 

   

 

 

 

Total liabilities not subject to compromise

     2,095,788        655,901   
 

Liabilities subject to compromise

     —          2,905,311   
  

 

 

   

 

 

 

Total liabilities

     2,095,788        3,561,212   
  

 

 

   

 

 

 

Commitments and contingencies (See Note 21)

      
 

Stockholders’ deficit:

      

Predecessor Company common stock, $0.01 par value, 200,000,000 shares authorized, 89,440,334 shares issued and outstanding at December 31, 2010

     —          894   

Additional paid-in capital, Predecessor Company

     —          725,786   

Successor Company common stock, $0.01 par value, 37,500,000 shares authorized, 26,197,142 shares issued and outstanding at December 31, 2011

     262        —     

Additional paid-in capital, Successor Company

     502,034        —     

Retained deficit

     (414,945     (1,101,294

Accumulated other comprehensive loss

     (193,494     (212,804
  

 

 

   

 

 

 

Total stockholders’ deficit

     (106,143     (587,418
  

 

 

   

 

 

 

Total liabilities and stockholders’ deficit

   $ 1,989,645      $ 2,973,794   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

341 Days ended December 31, 2011, 24 Days ended January 24, 2011

and Years ended December 31, 2010 and 2009

(in thousands, except per share data)

 

    

Successor

Company

                   
             Predecessor Company  
     Three Hundred  Forty-
One Days Ended
December 31, 2011
          Twenty-Four
Days Ended
January 24, 2011
             
            Year Ended December 31,  
            2010     2009  

Revenues

   $ 963,112           $ 66,378      $ 1,070,986      $ 1,119,090   
  

 

 

        

 

 

   

 

 

   

 

 

 

Operating expenses:

             

Cost of services and sales, excluding depreciation and amortization

     438,619             38,766        525,728        515,394   

Selling, general and administrative expense, excluding depreciation and amortization

     332,020             27,161        365,373        417,512   

Depreciation and amortization

     336,891             21,515        289,824        275,334   

Reorganization related (income) expense

     (232          —          —          —     

Impairment of intangible assets and goodwill

     262,019             —          —          —     
  

 

 

        

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,369,317             87,442        1,180,925        1,208,240   
  

 

 

        

 

 

   

 

 

   

 

 

 

Loss from operations

     (406,205          (21,064     (109,939     (89,150
  

 

 

        

 

 

   

 

 

   

 

 

 

Other income (expense):

             

Interest expense

     (63,807          (9,321     (140,896     (204,919

Gain on derivative instruments

     —               —          —          12,320   

Gain on early retirement of debt

     —               —          —          12,357   

Other

     1,791             (132     2,715        2,000   
  

 

 

        

 

 

   

 

 

   

 

 

 

Total other expense

     (62,016          (9,453     (138,181     (178,242
  

 

 

        

 

 

   

 

 

   

 

 

 

Loss before reorganization items and income taxes

     (468,221          (30,517     (248,120     (267,392

Reorganization items

     —               897,313        (41,120     (53,018
  

 

 

        

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes

     (468,221          866,796        (289,240     (320,410

Income tax benefit (expense)

     53,276             (279,889     7,661        79,014   
  

 

 

        

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (414,945        $ 586,907      $ (281,579   $ (241,396
  

 

 

        

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

             

Basic

     25,838             89,424        89,424        89,271   
  

 

 

        

 

 

   

 

 

   

 

 

 

Diluted

     25,838             89,695        89,424        89,271   
  

 

 

        

 

 

   

 

 

   

 

 

 

(Loss) earnings per share:

             

Basic

   $ (16.06        $ 6.56      $ (3.15   $ (2.70
  

 

 

        

 

 

   

 

 

   

 

 

 

Diluted

   $ (16.06        $ 6.54      $ (3.15   $ (2.70
  

 

 

        

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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