Fairpoint Communications 8-K 2008
Date of Report (Date of earliest event reported ) March 3, 2008
FairPoint Communications, Inc.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (704) 344-8150
(Former name or former address, if changed since last report.)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):
Item 7.01 Regulation FD Disclosure
On March 3, 2008, FairPoint Communications, Inc. (the Company) will make available to prospective lenders a confidential information memorandum (the Information Memorandum) with respect to a new $2.03 billion senior secured credit facility (the New Credit Facility).
The New Credit Facility is expected to consist of: (i) a senior secured six-year revolving credit facility in an aggregate principal amount of $200 million, (ii) a senior secured six-year term loan A facility in an aggregate principal amount of up to $500 million, (iii) a senior secured seven-year term loan B facility in an aggregate principal amount of at least $1.13 billion; and (iv) a delayed draw term loan facility in an aggregate principal amount of $200 million.
The Company intends to enter into the New Credit Facility in connection with the proposed merger of Northern New England Spinco Inc. (Spinco), a subsidiary of Verizon Communications Inc. (Verizon), with and into the Company (the Merger).
In connection with the syndication of the New Credit Facility, the Company will disclose the following information to prospective lenders.
Set forth below is information with respect to the expected sources and uses of funds to consummate the Merger and related transactions as set forth in the Information Memorandum:
Sources and Uses of Funds
The Transaction is expected to be consummated on March 31, 2008. The following table presents the sources and uses of funds as of December 31, 2007, except the expected debt balances are reflected as of March 31, 2008, assuming the Transaction is consummated as of such date. The actual amounts on the date that the Transaction is consummated may vary.
Set forth below is information with respect to the historical and pro forma capitalization of the Company as set forth in the Information Memorandum:
Pro Forma Capitalization and Credit Statistics
The Transaction is expected to be consummated on March 31, 2008. The following table presents the pro forma capitalization as of December 31, 2007, except the expected debt balances are reflected as of March 31, 2008, assuming the Transaction is consummated as of such date. The actual amounts on the date that the Transaction is consummated may vary.
Set forth below is certain historical and pro forma financial information with respect to FairPoint and the Spinco business as set forth in the Information Memorandum:
Combined Company Detailed EBITDA Bridge
The following table provides a bridge between the standalone historical financial performance of the Northern New England business and combined company bank covenant EBITDA. Because the Northern New England business operated as the local exchange carrier of Verizon in Maine, New Hampshire and Vermont and not as a standalone telecommunications provider, the historical operating results of the Northern New England business for the year ended December 31, 2007, include operating expenses for services provided by Verizon and its affiliates, including information systems and information technology, shared assets including office space outside of New England, and supplemental customer sales and service and operations. After a transition period following the merger, the combined company will receive these services from internal operations or from third-party service providers and not from Verizon. FairPoint estimates that within six months following the end of this transition period, which is expected to end in 2008, the combined company will realize net costs savings on an annual basis of approximately $110 to $115 million from internalizing these functions or obtaining these services from third-party providers. FairPoint expects that it will incur approximately $400 million in one-time costs to achieve these cost savings, including approximately $25 million related to the consummation of the merger. These costs include payments of $200 million to Capgemini under the MSA, payments of $133 million to Verizon under the TSA (assuming FairPoint no longer needs services under the TSA following the six month anniversary of the closing of the merger) and additional merger and transition related expenditures. As of December 31, 2007, FairPoint had spent $82 million, of which Verizon has agreed to reimburse $40 million. During the first quarter of 2008 and the twelve month period following the closing of the merger, FairPoint expects to spend an additional $318 million.
Description of Combined Company Bank Covenant EBITDA Adjustments
Combined Company Bank Covenant Summary EBITDA Bridge
The following table provides a bridge to bank covenant EBITDA.
Historical Financial Summary
The following table sets forth the summary historical financial results for FairPoint and the Northern New England business for the five fiscal year periods ended December 31, 2007. More detailed financial statements and Managements Discussion and Analysis for FairPoint are set forth in FairPoints SEC filings. More detailed financial statements and Managements Discussion and Analysis for the Northern New England business are available in the Information Statement / 424(b) Prospectus posted to Intralinks.
Bank Covenant EBITDA and Adjusted EBITDA are non-GAAP financial measures commonly used by financial analysts in evaluating the performance of companies, including communications companies. In addition, certain financial covenants in the New Credit Facility will contain ratios based on Bank Covenant EBITDA and the restricted payment and debt incurrence covenants in the indenture governing the new senior unsecured notes to be issued by Spinco in connection with the Merger will be based on Bank Covenant EBITDA. Accordingly, management believes that Bank Covenant EBITDA and Adjusted EBITDA may be useful for potential purchasers of notes in assessing the Companys operating performance and ability to meet the Companys debt service requirements. Management also believes that these measures allow a standardized comparison between companies in the communications industry, while minimizing the differences from depreciation policies, financial leverage and tax strategies. Bank Covenant EBITDA and Adjusted EBITDA, as used herein, are not necessarily comparable to similarly titled measures of other companies. The items excluded from Bank Covenant EBITDA and Adjusted EBITDA are significant in assessing the Companys operating results and liquidity. Bank Covenant EBITDA and Adjusted EBITDA (including pro forma presentations thereof) have limitations as analytical tools and should not be considered in isolation from, or as an alternative to, operating income, cash flow or other combined income or cash flow data prepared in accordance with GAAP. Some of these limitations are:
Because of these limitations, Bank Covenant EBITDA and Adjusted EBITDA (including pro forma presentations thereof) and the related ratios should not be considered as measures of discretionary cash available to invest in business growth or reduce indebtedness
Set forth below is the industry overview portion of the Information Memorandum:
There are two predominant types of local telephone service providers, or carriers, in the telecommunications industry: incumbent local exchange carriers (ILECs) and competitive local exchange carriers (CLECs). An ILEC refers to both the regional bell operating companies (RBOCs), which were the local telephone companies created from the break up of AT&T in 1984 and small and midsize independent telephone companies, which sell local telephone service. These ILECs were the traditional monopoly providers of local telephone service prior to the passage of the Telecommunications Act of 1996, which amended the Communications Act of 1934. A CLEC is a competitor to local telephone companies that has been granted permission by a state regulatory commission to offer local telephone service in an area already served by an ILEC. Over the past few years, CLECs have for the most part redefined their business models to target business customers instead of residential customers. Within the ILEC sector, there are rural local exchange carriers (RLECs), which by definition operate in rural areas. Rural local exchange carriers generally are characterized by stable operating results given lower competition levels than in more urban areas and strong cash flow margins and operate in supportive regulatory environments.
In general, telecommunications service in rural areas is more costly to provide than service in urban areas due to the large fixed cost nature of the upfront investment and the relatively low customer density. In rural areas, local access line density is relatively low, typically less than 100 local access lines per square mile, versus urban areas that can be well in excess of 300 local access lines per square mile. As a result, the average operating and capital cost per line is higher for RLECs than non-rural operators.
The RLECs higher cost structure has two important consequences. First, it is generally not commercially viable to overbuild an RLEC. However, in urban areas, where population density is higher, some CLECs have built redundant wireline telephone networks within the incumbent providers service territory. These facilities-based CLECs compete with the incumbent providers on their own stand-alone networks. Because it is comparatively more expensive to build a redundant network in rural areas, overbuilding is less common in RLEC service territories.
The second consequence associated with the RLECs higher cost structure is the existence of subsidies designed to promote widely available, high-quality telephone service at affordable prices in rural areas. This is accomplished through two principal mechanisms. The first mechanism is through network access fees which regulators historically have allowed to be set at higher rates in rural areas than the actual cost of originating or terminating interstate and intrastate calls. The second mechanism is through explicit transfers to RLECs via the Universal Service Fund and state funds such as the TUSF. Furthermore, RLECs face less regulatory oversight than the larger carriers and are exempt from the more burdensome interconnection requirements of the Telecommunications Act of 1996, such as unbundling of network elements, information sharing and co-location.
In recent years, the U.S. telecommunications industry has undergone significant structural changes. Many of the largest service providers have achieved growth through acquisitions and mergers, while an increasing number of competitive providers have restructured their balance sheets and product offerings to more effectively address market dynamics and customers expectations. In the past, capital in the form of public financing was generally difficult to obtain for new entrants and competitive providers. Capital constraints caused a number of competitive providers to change their business plans, resulting in consolidation. As a result of consolidation and the larger scale of some industry participants, improved operating performance has been exhibited throughout the industry. EBITDA margins in the industry remain at very healthy levels of 47% in 3Q07.(2)
Broadband penetration of total US households in rural areas continues to grow, currently estimated at 31%, but it lags the penetration found in suburban and urban areas, representing an attractive opportunity for RLECs. In order to address the relatively low penetration, rural telecom providers have focused their efforts by expanding their broadband footprint and bundling products to accommodate customer demand for broadband. As a result of the additional broadband focus and bundling efforts, average revenue per customer has increased from $73.60 in 1Q05 to $74.76 in 3Q07.(2),(3) As the charts below indicate, broadband penetration in the U.S. is expected to grow to ~71% by 2011 with significant growth anticipated in rural communities.
However, access lines remain an important element of the industry. Historically, rural telephone companies experienced growth in access lines because of positive demographic trends, insulated rural local economies and little competition. Recently, however, many rural telephone companies have experienced a loss of access lines due to challenging economic conditions, increased competition and the introduction of DSL services (resulting in customers canceling second lines in favor of DSL). RLECs have been able to mitigate such access line loss through bundling services, retention programs, continued community involvement and a variety of other focused programs. Access lines have declined approximately 5% annually over the last 2 years.(4),(5)
As recently noted, [despite access line decline] the industry has nonetheless experienced strong take rates for high-speed data services. As highlighted in the exhibit below, high-speed data lines as a percent of total voice access lines has more than doubled from 1Q05 (10%) to 3Q07 (24%), driven by strong demand for the service as well as declining overall access lines.(6)
As a result, bundling of services and robust growth in high-speed data services will continue to provide strong and steady cash flow generation. Analysts anticipate that the RLEC industrys ability to generate free cash flows (EBITDA less capex less net cash interest expense less cash taxes) will remain solid for the foreseeable future as the industry harvests its traditional voice business while growing its broadband data service offering. Analysts expect FCF for the publicly traded RLEC group to hover around $2.4 billion over the next two years and FCF excluding cash taxes to be around $3.5 billion.(7),(8) This steady cash flow will allow for sustainable dividends and continued deleveraging.
As the industry continues to evolve, increases in high-speed data, long distance and bundled services penetration are likely to offset the financial impact of voice line losses and declining regulatory subsidies.
While long distance will provide further upside, the main driver of growth potential remains in broadband.
Set forth below is certain historical financial information with respect to FairPoint and the Spinco business as set forth in the Information Memorandum:
HISTORICAL FINANCIAL OVERVIEW
FairPoint Communications, Inc. Historical Financial Summary
The following table sets forth the summary historical financial results for FairPoint Communications, Inc. for the five fiscal year periods ended December 31, 2007. More detailed financial statements and Managements Discussion and Analysis for FairPoint Communications, Inc. are set forth in FairPoints SEC filings.
Northern New England Business Historical Financial Summary
The following table sets forth the summary historical financial results for the Northern New England business for the five fiscal year periods ended December 31, 2007. More detailed financial statements and Managements Discussion and Analysis for the Northern New England business are set forth in Information Statement / 424(b) Prospectus filed February 28, 2008.
Set forth below is information with respect to the Companys anticipated cost savings in connection with the Merger as set forth in the Information Memorandum:
Combined Company Cost Savings Detail
Northern New England business LEC operations were allocated $254 million in
2007 for services performed outside the three-state region. This expense will
be eliminated upon the closing of the Transaction. Additionally, Verizon
assigned $121 million to the Northern New England business for the total
non-regulated costs of the Verizon Groups non-regulated business. This expense
will also be eliminated upon the closing of the Transaction. The $38 million Shared
Assets expense at the Northern New England business is made up entirely of
out-of-region allocations from the Verizon Group and other service companies
(including approximately $35 million in rent expense for corporate
The Shared Assets expense represents a pure allocation from the Verizon Group of shared assets that will be eliminated at closing with very little new facilities expense under FairPoint. FairPoint will take advantage of unused space in to-be-acquired facilities (approximately 4 million ft(2)) for most new hires.
Information Systems / Information Technology Strategy
The Company will also disclose in the Information Memorandum that it intends to spend $52.1 million during the eighteen months following the closing of the Merger to increase high-speed data capability in the Spinco markets to be acquired in the Merger.
The Company will also disclose in the Information Memorandum that following the Merger, the Company expects (i) Universal Service Fund revenues to account for approximately 3% of the Companys revenues versus 7% prior to the Merger and (ii) interstate and intrastate access revenues together with Universal Service Fund revenues to be less than 25% of the Companys revenues versus 50% prior to the Merger.
For more information about the Company, Spinco and the Merger and related transactions, see the Companys Annual Report on Form 10-K for the year ended December 31, 2007 (the Annual Report) and the Information Statement/Prospectus, dated February 28, 2008 (the Prospectus), both of which were filed with the Securities and Exchange Commission (the SEC) on February 29, 2008.
The Company intends to furnish another Current Report on Form 8-K in the near future which will contain a reconciliation of certain of the non-GAAP financial measures presented in this Current Report to the most comparable financial measure or measures calculated and presented in accordance with GAAP.
Some statements in this Current Report are known as forward-looking
statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These forward-looking
statements include, but are not limited to, statements about the Companys
plans, objectives, expectations and
intentions and other statements contained in this Current Report that are not historical facts. When used herein, 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 the Companys plans, objectives, expectations and intentions and other factors discussed under Item 1A. Risk Factors in the Annual Report and Risk Factors in the Prospectus. You should not place undue reliance on such forward-looking statements, which are based on the information currently available to the Company and speak only as of the date hereof. The Company undertakes 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 the Companys subsequent periodic reports filed with the SEC on Forms 10-K, 10-Q and 8-K and Schedule 14A.
The information in this Current Report is being furnished and shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of such section. The information in this Current Report shall not be incorporated by reference into any registration statement or other document pursuant to the Securities Act.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 3, 2008