UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

Commission File Number 333-56365

FairPoint Communications, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

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

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

 

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

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

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

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

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

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

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

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

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

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

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

 

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PART I

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

·       future performance generally,

·       our dividend policy and expectations regarding dividend payments,

·       business development activities,

·       future capital expenditures,

·       future interest expense,

·       distributions from minority investments and passive partnership interests,

·       net operating loss carry forwards,

·       technological developments and changes in the communications industry,

·       financing sources and availability,

·       regulatory support payments,

·       the effects of regulation and competition, and

·       pending litigation.

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

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ITEM 1.   BUSINESS

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

Our Business

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

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

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

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

Our Competitive Strengths

We believe we are distinguished by the following competitive strengths:

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

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

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

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

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

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

Our Strategy

The key elements of our strategy are to:

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

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

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

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

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

Our Services

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

Generation of Revenue

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

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

Local Calling Services

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

Network Access Charges

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

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

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

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

Universal Service Fund High Cost Loop

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

Long Distance Services

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

Data and Internet Services

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

Other Services

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

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

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

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

Our Markets

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

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

 

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

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Sales and Marketing

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