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FRP > SEC Filings for FRP > Form 10-Q on 5-Aug-2014All Recent SEC Filings




Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly 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 the 2013 Annual Report and "Cautionary Note Regarding Forward-Looking Statements" contained elsewhere in this Quarterly Report. Our discussion and analysis of financial condition and results of operations are presented in ten sections:
•Executive Summary
•Regulatory and Legislative
•Basis of Presentation
•Results of Operations
•Non-GAAP Financial Measures
•Liquidity and Capital Resources
•Off-Balance Sheet Arrangements
•Critical Accounting Policies and Estimates
•New Accounting Standards Overview

We provide advanced data, voice and video technologies to single and multi-site businesses, public and private institutions, consumers, wireless companies and wholesale re-sellers in 17 states. Leveraging an owned, fiber-core Ethernet network, including more than 16,000 route miles of fiber in northern New England, we have the network coverage, scalable bandwidth and transport capacity to support enhanced applications, including the next generation of mobile and cloud-based communications, such as small cell wireless backhaul technology, voice over IP, data center colocation services, managed services and disaster recovery. We operate with approximately 1.2 million access line equivalents, including approximately 333,000 broadband subscribers, in service as of June 30, 2014. As of June 30, 2014, we provide cellular transport, also known as backhaul, through over 1,400 mobile Ethernet backhaul connections. We have fiber connectivity to more than 1,100 cellular telecommunications towers in our service footprint.
Executive Summary
Our executive management team is focused on our 'four pillar' strategy of improving operations, changing the regulatory environment, transforming and growing revenue and aligning our human resources strategy. Our mission is to provide reliable communications services with outstanding customer support across the 17 states we serve. During fiscal year 2013 and the first half of 2014, we continued to make substantial progress on our 'four pillar' business strategy to continue our transformation from a traditional telephone company into a provider of advanced communications services.
Access lines have historically been an important element of our business. Communications companies, including FairPoint, continue to experience a decline in access lines due to increased competition from CLECs, wireless carriers and cable television operators, increased availability of alternative communications services, including wireless and voice over IP ("VoIP"), and challenging economic conditions. Our objective is to transform our revenue by continuing to add advanced data products and services such as Ethernet, high capacity data transport and other IP-based services over our Next Generation Network in addition to HSD services, to minimize our dependence on voice access lines. We will continue our efforts to retain customers to mitigate the loss of voice access lines through bundled packages, including video and other value added services.
Over the past few years, we have made significant capital investments in our Next Generation Network to expand our business service offerings to meet the growing data needs of our customers and to increase broadband speeds and capacity in our consumer markets. We have also focused our sales and marketing efforts on these advanced data solutions. Specifically, within the last couple of years, we built and launched high capacity Ethernet services to allow us to meet the capacity needs of our business customers as well as supply high capacity infrastructure to our wholesale customers. These advanced data services are our flagship product and are laying the foundation not only for new business but also for additional IP-based voice and data services in the future.

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Additionally, we believe the bandwidth needs of cellular backhaul will continue to grow with the continued adoption of bandwidth-intensive technology. We believe that our extensive fiber network, with over 16,000 miles of fiber optic cable, including over 1,100 cellular telecommunications towers currently served with fiber, puts us in an excellent position to grow our revenue base as demand for cellular backhaul services increases. We expect to see demand increase on existing fiber-connected towers where we would provision or expand mobile Ethernet backhaul connections or construct new fiber routes to cellular telecommunications towers.
Coupled with recent regulatory reform in the states of Maine, New Hampshire and Vermont that will serve to promote fair competition among communication services providers in the region, we believe that there is a significant organic growth opportunity within the business and wholesale markets given our extensive fiber network and IP-based product suite combined with our relative low market share in these areas.
Two of our collective bargaining agreements that cover the majority of our represented employees in northern New England expired on August 2, 2014. We are operating without contracts and should a work stoppage occur the Company has contingency plans in place to ensure services to our customers. We cannot predict the outcome of these negotiations at this time. Employees could engage in strikes or other concerted activities, which could materially adversely impact our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities. Regulatory and Legislative
We are generally subject to common carrier regulation primarily by federal and state governmental agencies. At the federal level, the FCC generally exercises jurisdiction over communications common carriers, such as FairPoint, to the extent those carriers provide, originate or terminate interstate or international communications. State regulatory commissions generally exercise jurisdiction over common carriers to the extent those carriers provide, originate or terminate intrastate communications. In addition, pursuant to the Telecommunications Act of 1996, which amended the Communications Act of 1934 (as amended, the "Communications Act"), state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies introduced by that legislation.
We are required to comply with the Communications Act which requires, among other things, that telecommunication carriers offer telecommunications services at just and reasonable rates and on terms and conditions that are not unreasonably discriminatory. The Communications Act contains requirements intended to promote competition in the provision of local services and lead to deregulation as markets become more competitive.
The FCC's CAF/ICC Order (as defined herein and sometimes referred to in the industry as the "Transformation Order") modified regulation for us beginning January 1, 2012. Effective January 1, 2012, the FCC eliminated the rural/non-rural distinction among incumbent local exchange carriers ("ILECs") and treats ILECs as either price cap or rate-of-return. Under the new rules, effective January 1, 2012, all of our ILECs are treated as price cap companies for CAF purposes, including the Telecom Group rate-of-return companies. However, the Telecom Group rate-of-return companies 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 terminating 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. Following this two-year transition and starting July 1, 2014, all terminating usage rates will transition to zero over the following four to seven years. As usage rates decrease under the FCC transition rules, resulting in decreased intercarrier compensation, carriers are allowed to increase end user access recovery charges to offset a substantial portion of the revenue losses, as described more fully below.
Overview of FCC CAF/ICC Order to Reform Universal Service and Intercarrier Compensation
On March 16, 2010, the FCC submitted the National Broadband Plan ("NBP") to the United States 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 ("ICC").
On November 18, 2011, the FCC released its comprehensive landmark order to modify the nationwide system of universal support and the ICC system (the "CAF/ICC Order"). In this order, the FCC replaced all existing USF for price cap carriers with its CAF. The intent of CAF is to bring high-speed affordable broadband services to all Americans. The CAF/ICC Order fundamentally reforms the ICC process that governs how communications companies bill one another for exchanging traffic, gradually phasing down these charges.
In conjunction with the 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

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charges, (iii) modifications to CAF for rate-of-return ILECs, (iv) development of CAF Phase II for mobility, (v) CAF Phase II competitive bidding rules,
(vi) remote areas funding and (vii) IP to IP interconnection issues. In its Order released June 10, 2014, the FCC has stated its intention to extend its offer of CAF Phase II support to price cap carriers by the end of 2014 and to implement the CAF Phase II program for price cap carriers during 2015. It has finalized a cost model and has issued competitive bidding guidelines. It is not known how these rules may impact us. CAF Phase I and Phase II Support. Pursuant to the CAF/ICC Order, beginning in 2012, we started receiving monthly CAF Phase I frozen support, which is based on and equal to all forms of USF high-cost support we received during 2011. This support is considered transitional funding while the FCC is developing its CAF Phase II program. FCC rules impose specific broadband spending obligations on CAF Phase I frozen support that we receive. According to the FCC rules, in 2013, we were required to spend, and did spend, one-third of the frozen support to "build and operate broadband-capable networks used to offer the provider's own retail broadband service in areas substantially unserved by an unsubsidized competitor." We have continued receiving CAF Phase I frozen support in 2014 and our spending obligation has increased to two-thirds. Should we continue to receive CAF Phase I frozen support in 2015 as well, this spending obligation will increase to 100%. In February of 2013, we filed a petition with the FCC for a partial waiver of the spending obligations. On October 30, 2013, the FCC issued an order denying FairPoint's petition, but clarifying the spending rules in a manner that effectively provides the relief we requested by allowing us to certify to the spending obligation at the holding company level. This relief continues into 2014 and future years. Pursuant to a Further Notice of Proposed Rulemaking released on June 10, 2014, the FCC has requested comment on how frozen support will be handled in states where the price cap carrier does not exercise its right of first refusal on CAF Phase II support. We do not yet know whether FairPoint will exercise its right of first refusal for CAF Phase II support or how frozen support will be impacted if FairPoint does not accept CAF Phase II support in one or more states. Whether the change from CAF frozen support to CAF Phase II support occurs during 2015, or to what extent it occurs during 2015, is uncertain. We currently expect the impact of the transition from CAF Phase I frozen support to CAF Phase II funding to be minimal in 2015. FCC Rules for ICC Process. The CAF/ICC Order reformed 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 revised rules, the majority of which were 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 established 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 required carriers to establish fiscal year 2011 ("FY2011") baseline compensation, which was 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 was 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 FairPoint ILEC, 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 ILECs 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 no more than $1.00 (per month) per line for multi-line business customers, for a total of $5.00 (per month) 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 $30.00 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 ILECs 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 no more than $1.00 (per month) per line for multi-line business customers for a total of $6.00 (per month) per line in the sixth year, provided that: (1) such increases would not result in regulated residential end user rates that exceed the $30.00 Residential Rate Ceiling; and (2) any multi-line business customer's total SLC plus ARC does not exceed $12.20. We began billing the ARC charges for our price cap and rate of return companies in July 2012 as outlined by the rules above. 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 in certain circumstances, though there is no guarantee that the ILEC will be made whole. Vermont Incentive Regulation Plan
Effective April 1, 2011, we entered into an Incentive Regulation Plan ("IRP") for our northern New England Vermont service territory. The IRP includes a 2011-2015 Amended Retail Service Quality Plan ("RSQP"), which significantly reduced FairPoint's exposure to retail service quality index ("SQI") penalties from $10.5 million to $1.65 million. As of March 31, 2013, the RSQP and related SQI penalties were eliminated in Vermont based upon our achievement of certain retail service metrics. We believe the IRP has allowed our Northern New England operations' retail rates in Vermont to compete with those competitive carriers under a relatively level regulatory scheme, while preserving certain regulatory protections for consumers in areas where competition may not be adequate. The IRP expires on December 31, 2014 and, on August 4, 2014, we filed a petition for a successor plan with

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the Vermont Public Service Board ("VPSB") in order to maintain favorable regulatory treatment in Vermont, which includes pricing flexibility, reduced regulatory oversight and more flexible rate filing options. Legislation for Maine and New Hampshire
During the middle of fiscal year 2012, legislation was enacted into law in both Maine and New Hampshire, which decreased the scope of retail telecommunications regulation for us, eliminating many of the state-specific Merger conditions and providing us with increased ability to compete in the Maine and New Hampshire telecommunications marketplace.
Effective August 10, 2012, the New Hampshire legislation was enacted Chapter 177 (known as Senate Bill 48) ("SB 48") in its Session Laws of 2012. SB 48 created a new class of telecommunications carriers known as "excepted local exchange carriers" ("ELECs") and our Northern New England operations qualify as an ELEC in New Hampshire. SB 48 essentially leveled the regulatory scheme imposed upon New Hampshire telecommunications carriers and states that the New Hampshire PUC ("NHPUC") has no authority to impose or enforce any obligation on a specific ELEC that also is not applicable to all other ELECs in New Hampshire except with respect to:
(i) Obligations that arise pursuant to the Communications Act, as amended;

(ii) Obligations imposed on our Northern New England operations that arose prior to February 1, 2011 that relate to the availability of broadband services, soft disconnect processes and capital expenditure commitments within New Hampshire;

(iii) Obligations that relate to the provision of services to CLECs, interexchange carriers and wireless carriers, regardless of technology; or

(iv) Certain obligations related to telephone poles and carrier of last resort responsibilities.

In New Hampshire, beginning with the August 10, 2012 effective date of SB 48, our exposure to annual SQI penalties was eliminated (from $12.5 million to zero) and we have pricing discretion with respect to existing and new retail telecommunications services other than basic local exchange service and certain services provided to customers who qualify for the federal lifeline discount. On April 12, 2012, Maine Governor Paul LePage signed Public Law 2011, Chapter
623 (also known as P.L. 2011, c.623) (the "Maine Deregulation Legislation") into law. The Maine Deregulation Legislation significantly deregulates retail telecommunications service offerings and reduces regulation applicable to ILECs, such as our Northern New England operations. The legislation eliminated regulatory oversight on all retail services other than the basic exchange service defined in Maine as Provider of Last Resort ("POLR") service and significantly reduced FairPoint's maximum exposure to SQI penalties, and reduced the number of reportable retail metrics. Under the Maine Deregulation Legislation, our maximum exposure to annual SQI penalties, beginning with Maine's fiscal year ending July 31, 2013, decreased from $12.5 million to $2.0 million. From August 1, 2013 until July 31, 2014 we were not subject to SQI penalties. On June 26, 2014, the Maine PUC ("MPUC") adopted a final rule (Chapter 201), establishing new POLR SQI standards and reporting requirements which began August 1, 2014. Under Chapter 201, the MPUC may open an investigation into the failure to meet any of the established standards and has the authority to impose penalties of up to $500,000 per standard. We estimate that these significant changes in both federal and state regulation did not have a material impact through June 30, 2014 and will not have a material impact in the remainder of 2014. However, in the long run, we are uncertain of the ultimate impact as federal and state regulation continues to evolve. The MPUC issued a show cause order on March 19, 2013 (the "Show Cause Order"), which required us to show cause by written comments filed by April 5, 2013, stating: (1) why the MPUC should not establish August 14, 2013, April 14, 2014 and April 14, 2015 as the deadlines for the remainder of our broadband build-out obligations which the Show Cause Order described as 85%, 87% and 90%, respectively, in Maine; and (2) why the MPUC should not require us to prepare and file, by April 30, 2013, a detailed engineering plan for the remaining portions of our build-out project. The Show Cause Order also required us to file, by April 5, 2013, a detailed report cataloging the number and percentage of addressable lines as of February 28, 2013. On August 14, 2013, the MPUC issued an Order Approving a Stipulation between Northern New England Telephone Operations LLC and the Office of the Maine Public Advocate (the "stipulation order"). In exchange for the termination of the show cause proceeding, the stipulation order requires us to achieve, in Maine, 85% broadband addressability by August 14, 2013 and 87% by April 14, 2014. If either of these commitments is not met, we must achieve 90% broadband addressability in Maine by May 14, 2015. In calculating these percentages, there is no speed requirement for lines served by the legacy Asynchronous Transfer Mode ("ATM") network. Additionally, we must
(1) contribute $100,000 to ConnectME upon completion of the broadband commitment; and (2) spend an additional $11 million during the period from January 1, 2014 to December 31, 2016 on broadband facilities and services that benefit small businesses and residences in Maine. Additionally, we made a good faith effort to obtain CAF Phase I incremental funding for Maine in the amount corresponding to a broadband expenditure by us of $2.8 million, which was expected to result

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in CAF funding of approximately $1.0 million, but for which we actually received $0.9 million. Northern New England Telephone Operations LLC advised the MPUC on August 14, 2013 of the achievement of 85% broadband addressability by August 14, 2013 and advised the MPUC on April 14, 2014 of the achievement of 87% broadband addressability by April 14, 2014.
Basis of Presentation
We view our business of providing data, voice and communication services to business, wholesale and residential customers as one reportable segment as defined in the Segment Reporting Topic of the Accounting Standards Codification ("ASC").
Results of Operations
The following table sets forth our consolidated operating results reflected in our condensed consolidated statements of operations. The comparisons of financial results are not necessarily indicative of future results (in thousands, except for access line equivalents):

                                                 Three Months Ended June 30,          Six Months Ended June 30,
                                                   2014               2013               2014              2013
Voice services                               $      94,838       $     101,660     $     190,333       $  205,377
Access                                              75,123              79,235           152,063          160,867
Data and Internet services                          44,089              40,054            86,432           78,228
Other                                               11,547              13,551            27,326           25,497
Total revenues                                     225,597             234,500           456,154          469,969
Operating expenses:
Costs of services and sales, excluding
depreciation and amortization                      101,661             108,163           217,227          224,774
Selling, general and administrative expense         78,376              84,083           161,392          172,969
Depreciation and amortization                       55,080              84,523           109,151          175,956
Reorganization related expense (income)                 47                (398 )              65             (561 )
Total operating expenses                           235,164             276,371           487,835          573,138
Loss from operations                                (9,567 )           (41,871 )         (31,681 )       (103,169 )
Other income (expense):
Interest expense                                   (20,023 )           (20,097 )         (40,031 )        (38,099 )
Loss on debt refinancing                                 -                   -                 -           (6,787 )
Other income (expense)                                (224 )                10                (9 )            435
Total other expense                                (20,247 )           (20,087 )         (40,040 )        (44,451 )
Loss before income taxes                           (29,814 )           (61,958 )         (71,721 )       (147,620 )
Income tax benefit                                   7,134              18,850            16,804           46,983
Loss from continuing operations                    (22,680 )           (43,108 )         (54,917 )       (100,637 )
Gain on sale of discontinued operations, net
of taxes                                                 -                   -                 -           10,044
Net loss                                     $     (22,680 )     $     (43,108 )   $     (54,917 )     $  (90,593 )

                                                                                            As of June 30,
Access line equivalents:                                                                 2014              2013
Residential                                                                              502,759          556,584
Business                                                                                 290,246          295,319
Wholesale                                                                                 55,569           61,911
Total voice access lines                                                                 848,574          913,814
Broadband subscribers                                                                    333,421          332,620
Total access line equivalents (1)                                                      1,181,995        1,246,434

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(1) In August 2012, we divested our pay phone operations in our northern New England footprint and completed the process of transitioning these pay phone stations to the buyer in 2013. We currently retain access lines for any pay phone stations the buyer continues to operate, which accounted for 727 and 1,136 access line equivalents as of June 30, 2014 and 2013, respectively. Voice Services Revenues
We receive revenues through the provision of local calling services to business . . .

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