FAIRPOINT COMMUNICATIONS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2002.

/ / 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 333-56365
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FAIRPOINT COMMUNICATIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 13-3725229
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

521 EAST MOREHEAD STREET, SUITE 250 28202
CHARLOTTE, NORTH CAROLINA (Zip code)
(Address of Principal Executive Offices)

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE

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 / / No /X/

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 an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes / / No /X/

As of March 25, 2003, the registrant had outstanding 45,773,784 shares of
Class A common stock and 4,269,440 shares of Class C common stock. There is no
public market for our Class A common stock or Class C common stock.

Documents incorporated by reference: None

* Although the registrant is not currently required pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934 to file this annual report, the
registrant is voluntarily filing this annual report on Form 10-K.

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FAIRPOINT COMMUNICATIONS, INC. ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

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PART I

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. All
references to the "Company" refer to FairPoint Communications, Inc. excluding
its subsidiaries and references to "Carrier Services" refer to FairPoint Carrier
Services, Inc. (formerly known as FairPoint Communications Solutions Corp.) and
its subsidiaries.

ITEM 1. BUSINESS

OUR BUSINESS

We are a leading provider of telecommunications services in rural
communities, offering an array of services including local voice, long distance,
data and Internet primarily to residential customers. According to an industry
source, we believe that we are the 16th largest local telephone company in the
United States, with over 243,000 access lines in service as of December 31,
2002.

We were incorporated in February 1991 for the purpose of acquiring and
operating telephone companies in rural markets. Since our inception, we have
acquired 29 such businesses, which are located in 18 states. All of our
telephone company subsidiaries qualify as rural local exchange carriers, or
RLECs, under the Telecommunications Act of 1996, or the Telecommunications Act.
RLECs are generally characterized by stable operating results and strong cash
flow margins and operate in generally supportive regulatory environments. In
particular, pursuant to existing state and federal regulations, we are able 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). In addition, because RLECs primarily serve sparsely populated
rural areas and small towns, competition is typically limited due to the
generally unfavorable economics of constructing and operating competitive
systems in such areas and difficulties inherent in reselling such services to a
predominantly residential customer base.

COMPETITIVE STRENGTHS

We believe we are distinguished by the following competitive strengths:

- CONSISTENT AND PREDICTABLE CASH FLOW FROM RURAL TELEPHONE BUSINESS. Demand
for telephone services from residential and small business customers in
rural parts of the country has historically been very stable despite
changing economic conditions. As a result, we have experienced a stable
access line count during the last two years, while regional bell operating
companies, or RBOCs, have lost a significant number of access lines during
the same period. Our stable access line count helps us to generate
consistent revenues. Additionally, our telephone companies operate in
generally supportive regulatory environments that enable us to generate
strong cash flow margins.

- FAVORABLE RURAL MARKET DYNAMICS. We believe that the rural
telecommunications market is attractive due to generally supportive
regulatory environments and limited competition. All of our telephone
company subsidiaries qualify as RLECs. Therefore, they are exempt from
certain interconnection requirements and are entitled to benefit from a
number of cost recovery mechanisms associated with the "rural carrier"
designation. Each of our RLECs typically experiences little competition in
its market because the low customer density and high residential component
of our customer base will not support the significant capital investment
required to offer competitive service. As a result, we have virtually no
wireline competition in any of our markets. In addition, the rural areas
in which we operate attract only limited competition from cable and
wireless service providers.

- TECHNOLOGICALLY ADVANCED INFRASTRUCTURE AND SIGNIFICANT SCALE. Our
advanced RLEC networks consist of central office hosts and remote sites
with all digital switches, primarily manufactured

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by Nortel and Siemens, operating with the most current software. As of
December 31, 2002, we maintained over 25,000 miles of copper plant and
approximately 2,200 miles of fiber optic plant in order to service our
243,000 access lines. In addition, we believe that we have achieved
significant scale efficiencies by centralizing many functions from each
RLEC, such as purchasing, network planning and accounting.

- BROADEST SERVICE OFFERINGS IN OUR MARKETS. We believe that, as a result of
our advanced network and switching infrastructure we offer the only
complete bundle of telecommunications services, including local voice,
long distance, data and Internet services, in our markets. In addition, we
offer enhanced features such as caller name and number identification,
call waiting, call forwarding, teleconferencing, video conferencing and
voicemail. We also offer high-speed Internet access via digital subscriber
line, or DSL, technology, dedicated T-1 connections and Internet dial-up.

- EXPERIENCED 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 27 years of experience working with a variety of
telephone companies. Additionally, our regional presidents have an average
of 29 years of experience in the telecommunications industry. Our
management team has successfully integrated 29 business acquisitions since
1993, improving revenues and cash flow significantly while maintaining
service quality.

BUSINESS STRATEGY

The key elements of our business strategy include:

- CONTINUE TO IMPROVE OPERATING EFFICIENCY AND PROFITABILITY. We have
achieved significant operating efficiencies at our acquired RLECs by
applying our operating, regulatory, marketing, technical and management
expertise. We intend to continue to increase our operating efficiency by
consolidating various administrative functions and implementing best
practices across all of our regions. For example, we have initiated a
process to integrate all billing systems into a single, outsourced billing
platform. When completed, we plan to use this platform to develop regional
customer service and call centers, enhancing our operating efficiency and
creating a significantly improved customer data base to allow us to
optimize our marketing initiatives.

- CROSS-SELL AND OFFER ADDITIONAL SERVICES TO INCREASE REVENUE PER CUSTOMER.
We have focused and will continue to focus on increasing our revenues by
introducing innovative marketing strategies for enhanced and ancillary
services and by offering applications and technologies to meet the growing
needs of our rural customers. Approximately 79% of our customers are
residential, and we have long standing relationships with these customers.
This has allowed us to successfully cross-sell broadband and value-added
services, such as DSL, Internet dial-up, call waiting, caller ID and
voicemail, to our customers. We intend to continue to offer new products
and services for residential and business customers in our markets to
increase revenues and cash flows.

- INCREASE CUSTOMER LOYALTY AND BRAND IDENTITY. We seek to build long-term
relationships with our customers by offering an array of
telecommunications services and ongoing, consistent customer care. We
believe that our service driven customer relationships and local presence
lead to high levels of customer satisfaction and increased demand for
enhanced and ancillary services.

- PURSUE SELECTIVE ACQUISITIONS AND DIVESTITURES. Since 1993, we have
successfully completed 29 strategic acquisitions. We continue to evaluate
and pursue opportunities to make acquisitions which would be complementary
to our existing operations and provide the opportunity for revenue
enhancement and margin improvement. Given these requirements, we believe
that such

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acquisitions will be primarily in regions where we already operate. We
would also consider selective divestitures in order to enhance our
geographic focus.

RECENT DEVELOPMENTS

On March 6, 2003, the Company issued $225.0 million aggregate principal
amount of 11 7/8% Senior Notes due 2010. Interest is payable on the senior notes
at the rate of 11- 7/8% per annum on each March 1 and September 1, commencing on
September 1, 2003. The senior notes mature on March 1, 2010.

In connection with the issuance of the senior notes, the Company entered
into an amended and restated credit agreement, dated as of March 6, 2003, among
the Company, Bank of America, N.A., as syndication agent, Wachovia Bank, N.A.,
as documentation agent, Deutsche Bank Trust Company Americas, as administrative
agent, and various lending institutions. The amended and restated credit
agreement provides for: (i) a new $70.0 million revolving credit facility ($60.0
million of which has been committed) which matures on March 31, 2007 (loans
under the revolving credit facility bear interest per annum at either a base
rate plus 3.00% or LIBOR plus 4.00%) and (ii) a new term loan A facility of
$30 million which matures on March 31, 2007 (loans under the term loan A
facility bear interest per annum at either a base rate plus 3.00% or LIBOR plus
4.00%). The new term loan A facility was drawn in full on March 6, 2003. In
addition, mandatory payments under the term loan C facility were rescheduled to
be $2.0 million, $20.9 million, $20.0 million, $29.6 million and a final
$56.0 million in 2003, 2004, 2005, 2006 and on March 31, 2007, respectively, and
the interest rate per annum on loans under the term loan C facility was
increased to a base rate plus 3.50% or LIBOR plus 4.50%.

We used the proceeds from the offering of the senior notes and the
borrowings under the new term loan A facility to: (i) repay all tranche RF and
tranche AF revolving loans under our existing credit facility; (ii) repay all
tranche B term loans under our existing credit facility; (iii) repurchase at a
35% discount $13.3 million aggregate liquidation preference of our Series A
Preferred Stock (together with accrued and unpaid dividends thereon); (iv)
repurchase $9.8 million aggregate principal amount of our outstanding 9- 1/2%
senior subordinated notes due 2008 and $7.0 million aggregate principal amount
of our outstanding 12- 1/2% senior subordinated notes due 2010; and (vi) repay
at a 30% discount $2.2 million of loans made by Wachovia Bank, National
Association, under the Carrier Services credit facility. As a result, we
recorded $2.8 million and $0.7 million non-operating gains on the extinguishment
of the senior subordinated notes and the Carrier Services loans, respectively,
in the Statement of Operations and a $2.8 million gain for the retirement of the
Series A Preferred Stock directly to stockholders' deficit in 2003.
Additionally, we recorded a non-operating loss of $5.3 million for the write-off
of debt issue costs related to this extinguishment of debt in 2003.

OUR SERVICES

We offer a broad portfolio of high-quality telecommunications services for
residential, business, government and carrier customers in each of the markets
in which we operate. Our service offerings are locally managed to better serve
the needs of each community. We believe we are able to efficiently and reliably
provide, by using local personnel, all of the telecommunications services
required by our customers, thereby allowing us to establish and maintain a
recognized and respected brand identity within each of our service areas. These
include services traditionally associated with local telephone companies, as
well as other services such as long distance, data and Internet services, and
enhanced 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.

We operate in an industry that is subject to rapid and significant changes
in technology, frequent new service introductions and evolving industry
standards. We cannot predict the effect of these changes on our competitive
position, profitability or industry. Technological developments may reduce the
competitiveness of our networks and require unbudgeted upgrades or the
procurement of

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additional products that could be expensive and time consuming. In addition, new
products and services arising out of technological developments may reduce the
attractiveness of our services. If we fail to adapt successfully to
technological changes or obsolescence or fail to obtain access to important new
technologies, we could lose customers and be limited in our ability to attract
new customers and/or sell new services to our existing customers.

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, or IXCs, for origination and
termination of interstate and intrastate long distance phone calls;
(iii) Universal Service Fund or USF payments; and (iv) the provision of
ancillary services such as long distance resale, data and Internet services,
enhanced services, such as caller name and number identification, and billing
and collection for IXCs.

The following chart summarizes each component of our revenue sources for the
year ended December 31, 2002:

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

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LOCAL CALLING SERVICES

Local calling services includes basic local lines, private lines and
switched data services. We provide local calling services to residential,
business and government customers, generally for a fixed monthly charge. In an
RLEC's territories, 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 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. 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 IXC is originated by a customer in
our RLEC exchange to a customer in another exchange in the same state. The IXC
pays us an intrastate access payment for either terminating or originating the
call. We record the details of the call through our carrier access billing
system, or CABS, and receive the access payment from the IXC. When one of our
customers originates the call, we typically provide billing and collection for
the IXC through a billing and collection agreement. The access charge for our
intrastate service is 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 calling from one state
to a customer in another state. We bill interstate access charges in the same
manner as we bill intrastate access charges; however, the interstate access
charge is regulated and approved by the FCC instead of the state regulatory
authority.

USF REVENUE

The USF 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 USF,
which is funded by monthly fees charged to IXCs and LECs, distributes funds to
us on a monthly basis based upon our costs for providing local service. USF
payments represented approximately 17% of our revenues for the year ended
December 31, 2002. Of such support payments, approximately 10% of our revenues
resulted from the high cost loop support and is based upon our average cost per
loop compared to the national average cost per loop. The remaining 7% of our USF
payments consists of local switching support, long term support and interstate
common line support and is included in our interstate access revenues. This
reflects the changes in the universal service support as a result of the MAG
plan which moved the implicit support from access charges and made it explicit.
See "--Regulatory Environment."

LONG DISTANCE SERVICES

We offer switched and dedicated long distance services throughout our
service areas through resale agreements with national IXCs. In addition, through
Carrier Services, we offer wholesale long distance services to other independent
telephone companies. Currently, we provide long distance services to over forty
independent telephone companies in the United States.

DATA AND INTERNET SERVICES

We offer Internet access via DSL technology, dedicated T-1 connections,
Internet dial-up 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

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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 RLECs' local presence and network
infrastructure by offering enhanced services to customers, as well as billing
and collection services for IXCs.

ENHANCED SERVICES. Our advanced digital switch platform allows 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, or DID.

BILLING AND COLLECTION. Many IXCs provide long distance services to our
RLEC customers and elect to use our billing and collection services. Our RLECs
charge IXCs a billing and collection fee for each call record generated by the
IXC's customer.

OUR MARKETS

Our 29 RLECs operate as the incumbent local exchange carrier in each of
their respective markets. Our RLECs 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 79% of these access lines serve
residential customers. Our business customers account for approximately 21% of
our access lines. Our business customers are predominantly in the agriculture,
light manufacturing and service industries.

SALES AND MARKETING

Our marketing approach emphasizes locally-managed, customer-oriented sales,
marketing and service. We believe most telecommunications companies devote their
resources and attention primarily toward customers in more densely populated
markets. We seek to differentiate ourself from our competitors by providing a
superior level of service to each of the customers in the rural markets we
serve.

Each of our RLECs has a long history in the communities it serves. It is our
policy to maintain and enhance the strong brand identity and reputation that
each RLEC 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 identity in order to attain higher recognition with potential customers.

To demonstrate our commitment to the markets we serve, we maintain local
offices in most of the population centers within our service territories. These
offices are typically staffed by local residents and provide sales and customer
support services in the community. We believe that local offices facilitate a
direct connection to the community, which improves customer satisfaction and
loyalty.

In addition, our strategy is to enhance our telecommunications services by
offering comprehensive bundling of services and deploying new technologies to
build upon the strong reputation we enjoy in our markets and to further promote
rural economic development in the rural communities we serve.

Many of the RLECs acquired by us traditionally have not devoted a
substantial amount of their operating budget to sales and marketing activities.
After acquiring the RLECs, we typically change this practice to provide
additional support for existing products and services as well as to support the
introduction of new services. As of December 31, 2002, we had 216 employees
engaged in sales, marketing and customer service.

We have two basic tiers of customers: (i) local customers located in our
local access and transport areas, or LATAs, who pay for local phone service and
(ii) the IXCs which pay us for access to customers located within our LATAs. In
general, the vast majority of our local customers are residential, as opposed to
business, which is typical for rural telephone companies.

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INFORMATION TECHNOLOGY AND SUPPORT SYSTEMS

Our approach to billing and OSS systems focuses on implementing
best-of-class applications that allow consistent communication and coordination
throughout our entire organization. Our objective is to improve profitability by
reducing individual company costs through the sharing of best practices,
centralization or standardization of functions and processes, and deployment of
technologies and systems that provide for greater efficiencies and
profitability.

NETWORK ARCHITECTURE AND TECHNOLOGY

Our RLEC networks consist of central office hosts and remote sites with
advanced digital switches, primarily manufactured by Nortel and Siemens,
operating with the most current software. The outside plant consists of
transport and distribution delivery networks connecting our host central office
with remote central offices and ultimately with our customers. As of
December 31, 2002, we maintained over 25,000 miles of copper plant and 2,200
miles of fiber optic plant. We own fiber optic cable, which has been deployed
throughout our current network and is the primary transport technology between
our host and remote central offices and interconnection points with other
incumbent carriers.

Our fiber optic transport system is primarily a synchronous optical network
and utilizes asynchronous optical systems for limited local or specialized
applications. Our fiber optic transport system of choice is capable of
supporting increasing customer demand for high bandwidth transport services and
applications due to its 240 gigabyte design and switching capacity. In the
future, this platform will enable direct asynchronous transfer mode, frame relay
and/or Internet protocol insertion into the synchronous optical network or
physical optical layer.

In our RLEC markets, DSL-enabled integrated access technology is being
deployed to provide significant broadband capacity to our customers. As of
December 31, 2002, we had invested approximately $7.6 million in this technology
and deployed this technology in all 29 of our RLECs, reaching 114 of 142
exchanges within these 29 RLECs.

To be successful, we will need to continue to provide our customers reliable
service over our network. Some of the risks to our network and infrastructure
include: physical damage to access lines; power surges or outages; software
defects; and disruptions beyond our control. Disruptions may cause interruptions
in service or reduced capacity for customers, either of which could cause us to
lose customers and incur expenses. In addition, rapid and significant changes in
technology are expected in the communications industry. Our future success will
depend, in part, on our ability to anticipate and adapt to technological
changes. We believe that our network architecture enables us to efficiently
respond to these technological changes.

DISCONTINUED OPERATIONS

In early 1998, we launched our competitive local exchange carrier, or CLEC,
enterprise through our wholly-owned subsidiary, Carrier Services. In
November 2001, we decided to discontinue such CLEC operations. This decision was
a proactive response to the deterioration in the capital markets, the general
slow-down of the economy and the slower-than-expected growth in Carrier
Services' CLEC operations. Carrier Services has discontinued its CLEC
operations.

Carrier Services will continue to provide wholesale long distance service
and support to our RLEC subsidiaries and other independent local exchange
companies. These services allow such companies to operate their own long
distance communication services and sell such services to their respective
customers.

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REGULATORY ENVIRONMENT

Our communications services are subject to extensive federal, state and
local regulation. We hold various regulatory authorizations for our service
offerings. At the federal level, the Federal Communications Commission, or FCC,
generally exercises jurisdiction over all facilities and services of
telecommunications 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 such facilities and services to the extent those facilities are used to
provide, originate or terminate intrastate communications. In addition, pursuant
to the Telecommunications Act, state and federal regulators share responsibility
for implementing and enforcing the domestic pro-competitive policies introduced
by that legislation. In particular, state regulatory agencies have substantial
oversight over the provision by incumbent telephone companies of interconnection
and non-discriminatory network access to competitive communications providers.
Local governments often regulate the public rights-of-way necessary to install
and operate networks, and may require communications services providers to
obtain licenses or franchises regulating their use of public rights-of-way.
Additionally, municipalities and other local government agencies may regulate
limited aspects of our business, including our use of public rights of way, and
by requiring us to obtain construction permits and abide by building codes.

We believe that competition in our telephone service areas will increase in
the future as a result of the Telecommunications Act, although the ultimate form
and degree of competition cannot be ascertained at this time. To date, we do not
believe that we have encountered significant competition in our traditional
telephone markets.

FEDERAL REGULATION

We must comply with the Communications Act of 1934, as amended, which
requires, among other things, that communications carriers offer services at
just and reasonable rates and on non-discriminatory terms and conditions. The
amendments to the Communications Act contained in the Telecommunications Act
dramatically changed and are expected to continue to change the landscape of the
telecommunications industry. The central aim of the Telecommunications Act was
to open local telecommunications marketplaces to competition while enhancing
universal service. Most significantly, the Telecommunications Act governs the
removal of barriers to market entry into local telephone services, requires
ILECs to interconnect with competitors, establishes procedures pursuant to which
ILECs may provide other services, such as the provision of long distance
services by RBOCs, and imposes on ILECs duties to negotiate in good faith.

REMOVAL OF ENTRY BARRIERS. Prior to the enactment of the Telecommunications
Act, many states limited the services that could be offered by a company
competing with an incumbent local telephone company. The Telecommunications Act
preempts state and local laws that prevent competitive entry into the provision
of any communications service. However, states can modify conditions of entry
into areas served by rural telephone companies where the state utility
commission determines that competitive entry is in the public interest. Since
the passage of the Telecommunications Act, we have experienced only limited
competition from cable and wireless service providers.

INTERCONNECTION WITH LOCAL TELEPHONE COMPANIES AND ACCESS TO OTHER
FACILITIES. In order to create an environment in which local competition is a
practical possibility, the Telecommunications Act imposes a number of access and
interconnection requirements on all local communications providers. All local
carriers must interconnect with other carriers, permit resale of their services,
provide local telephone number portability and dialing parity, provide access to
poles, ducts, conduits, and rights-of-way, and complete calls originated by
competing carriers under reciprocal compensation or mutual termination
arrangements.

8

Because all of our 29 subsidiaries qualify as RLECs under the
Telecommunications Act, they have an exemption from the incumbent local
telephone company interconnection requirements until they receive a bona fide
request for interconnection and the applicable state telecommunications
regulatory commission lifts the exemption.

ACCESS CHARGES. The FCC regulates the prices that incumbent local telephone
companies charge for the use of their local telephone facilities in originating
or terminating interstate transmissions. The FCC has structured these prices,
also referred to as "access charges," as a combination of flat monthly charges
paid by the end-users and usage sensitive charges paid by long distance
carriers. State regulatory commissions regulate intrastate access charges. Many
states generally mirror the FCC price structure. A significant amount of our
revenues come from network access charges, which are paid to us by intrastate
carriers and interstate long distance carriers for originating and terminating
calls in the regions served by our rural telephone companies. The amount of
access charge revenues that we receive is based on rates set by federal and
state regulatory bodies, and such rates are subject to change at any time.

The FCC regulates the levels of interstate access charges by imposing price
caps on larger incumbent local telephone companies. These price caps can be
adjusted based on various formulae, such as inflation and productivity, and
otherwise through regulatory proceedings. Smaller incumbents may elect to base
access charges on price caps, but are not required to do so unless they elected
to use price caps in the past or their affiliated incumbent local telephone
companies base their access charges on price caps. Each of our 29 incumbent
local telephone subsidiaries elected not to apply federal price caps. Instead,
our subsidiaries employ rate-of-return regulation for their interstate access
charges.

The FCC has made, and is continuing to consider, various reforms to the
existing rate structure for charges assessed on long distance carriers for
connection to local networks. States often mirror federal rules in establishing
intrastate access charges. In 2001, the FCC adopted an order implementing the
beginning phases of the MAG plan to reform the access charge system for rural
carriers. The MAG plan is revenue neutral to our operating companies. Among
other things, the MAG plan reduces access charges and shifts a portion of cost
recovery, which historically have been based on minutes-of-use, to flat-rate,
monthly per line charges on end-user customers rather than long distance
carriers. As a result, the aggregate amount of access charges paid by long
distance carriers to access providers, such as our rural telephone companies has
decreased and may continue to decrease. In adopting the MAG plan, the FCC also
determined that rate-of-return carriers will continue to be permitted to set
rates based on the authorized rate of return of 11.25 percent. Additionally, the
FCC initiated a rulemaking proceeding to investigate the MAG's proposed
incentive regulation plan and other means of allowing rate-of-return carriers to
increase their efficiency and competitiveness. The MAG plan expires in 2006 and
will need to be renewed or replaced at such time. In addition, to the extent our
rural telephone companies become subject to competition in their own local
exchange areas, such access charges could be paid to competing local exchange
providers rather than to us. Additionally, the access charges we receive may be
reduced as a result of wireless competition. Such a circumstance could have a
material adverse effect on our financial condition and results of operations. It
is unknown at this time what additional changes, if any, the FCC may eventually
adopt.

RLEC SERVICES REGULATION. Our RLEC services segment revenue is subject to
regulation including incentive regulation by the FCC and various state
regulatory agencies. We believe that state lawmakers will continue to review the
statutes governing the level and type of regulation for telecommunications
services. It is expected that over the next few years, legislative and
regulatory actions will provide opportunities to restructure rates, introduce
more flexible incentive regulation programs and possibly reduce the overall
level of regulation. We expect the election of incentive regulation plans and
the expected reduction in the overall level of regulation to allow us to
introduce new services more expeditiously than in the past.

9

The FCC generally must approve in advance most transfers of control and
assignments of operating authorizations by FCC-regulated entities. Therefore, if
we seek 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 the authority to condition, modify, cancel, terminate
or revoke operating authority for failure to comply with applicable federal laws
or rules, regulations and policies of the FCC. Fines or other penalties also may
be imposed for such violations.

The FCC has required that incumbent, independent, local exchange carriers,
that provide interstate long distance services originating from their local
exchange service territories, must do so in accordance with "structural
separation" rules. These rules require 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 its affiliated local exchange telephone company at tariffed rates,
terms and conditions. The FCC has initiated a rulemaking proceeding to examine
whether there is a continuing need for such requirements, however, we cannot
predict the outcome of that proceeding.

STATE REGULATION

Most states have some form of certification requirement that requires
providers of telecommunications services to obtain authority from the state
telecommunications regulatory commission prior to offering common carrier
services. Our 29 RLECs operate as the incumbent local telephone companies in
each of the 18 states in which we operate and are certified in those states to
provide local telephone services. State telecommunications regulatory
commissions generally regulate the rates incumbent local telephone companies
charge for intrastate services, including rates for intrastate access services
paid by providers of intrastate long distance services. Although the FCC has
preempted certain state regulations pursuant to the Telecommunications Act,
states have retained authority to impose requirements on carriers necessary to
preserve universal service, protect public safety and welfare, ensure quality of
service and protect consumers. For instance, incumbent local telephone companies
must file tariffs setting forth the terms, conditions and prices for their
intrastate services, and such tariffs may be challenged by third parties.
Subsidiaries of the Company recently completed rate cases in Vermont and
Illinois and have rate cases pending in Kansas and Maine.

Under the Telecommunications Act, state telecommunications regulatory
agencies have jurisdiction to arbitrate and review interconnection disputes and
agreements between incumbent local telephone companies and competitive local
telephone companies, in accordance with rules set by the FCC. However, because
all of our 29 subsidiaries qualify as RLECs under the Telecommunications Act,
they have an exemption from the incumbent local telephone company
interconnection requirements until they receive a bona fide request for
interconnection and the applicable state telecommunications regulatory
commission lifts the exemption. State regulatory commissions may also formulate
rules regarding taxes and fees imposed on providers of telecommunications
services within their respective states to support state universal service
programs. States often require prior approvals or notifications for certain
acquisitions and transfers of assets, customers, or ownership of regulated
entities. Therefore, in most instances we will be required to seek state
approval prior to completing new acquisitions of RLECs. States generally retain
the right to sanction a carrier or to revoke certifications if a carrier
materially violates relevant laws and/or regulations.

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 fiber
optic facilities in certain rural communities. Some of these franchises may
require the payment of franchise fees. We have obtained such municipal
franchises as were required. In some rural areas, we do not need to obtain such
permits

10

or franchises because the subcontractors or electric utilities with which we
have contracts already possess the requisite authorizations to construct or
expand our networks.

THE PROMOTION OF LOCAL SERVICE COMPETITION AND TRADITIONAL TELEPHONE
COMPANIES

As discussed above, the Telecommunications Act provides, in general, for the
removal of barriers to entry into the telecommunications industry in order to
promote competition for the provision of local service. Congress, however, has
recognized that states should not be prohibited from taking actions necessary to
preserve and advance universal service, and has further recognized that special
consideration should be given to the appropriate conditions for competitive
entry in areas served by rural telephone companies.

Pursuant to the Telecommunications Act, local exchange carriers, including
both incumbent telephone companies and competitive communications providers, are
required to: (i) allow others to resell their services at retail rates;
(ii) ensure that customers can keep their telephone numbers when changing
carriers; (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 access
to telephone poles, ducts, conduits and rights of way; and (v) compensate
competitors for the competitors' costs of completing calls to competitors'
customers. Competitors are required to compensate the incumbent telephone
company for the cost of providing these interconnection services. Under the
Telecommunications Act, our RLECs may request from state public utility
commissions, or PUCs, exemption, suspension or modification of any or all of the
requirements described above. A PUC may grant such a request if it determines
that such exemption, suspension or modification is consistent with the public
interest and necessary to avoid a significant adverse economic impact on
communications users and generally avoid imposing a requirement that is
technically unfeasible or unduly economically burdensome. If a PUC denies some
or all of any such request made by one of our RLECs, or did not allow us
adequate compensation for the costs of providing interconnection, our costs
could increase. In addition, with such a denial, competitors could enjoy
benefits that would make their services more attractive than if they did not
receive such interconnection rights. We have not filed any such requests.

The Telecommunications Act, with certain exceptions, imposes the following
additional duties on incumbent telephone companies, by requiring them to:
(i) interconnect their facilities and equipment with any requesting
telecommunications carrier at any technically feasible point; (ii) unbundle and
provide nondiscriminatory access to network elements, such as local loops,
switches and transport facilities, at nondiscriminatory rates and on
nondiscriminatory terms and conditions; (iii) offer their retail services for
resale at wholesale rates; (iv) provide reasonable notice of changes in the
information necessary for transmission and routing of services over the
incumbent telephone company'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 unbundled network elements at the
premises of the incumbent telephone company. Competitors are required to
compensate the incumbent telephone company for the cost of providing these
interconnection services. However, pursuant to the Telecommunications Act our
RLECs are automatically exempt from these additional incumbent telephone company
requirements, except in Florida where the legislature has determined that all
local exchange carriers are required to provide interconnection services as
prescribed in the Telecommunications Act. This exemption can be rescinded or
modified by a state PUC if a competing carrier files a bona fide request for
interconnection services or access to network elements. If such a request is
filed by a potential competitor with respect to one of our operating
territories, we are likely to ask the relevant PUC to retain the exemption. A
PUC may grant such a potential competitor's request if it determines such
interconnection request is not unduly economically burdensome, is technically
feasible and is consistent with universal service obligations. If a state PUC
rescinds such exemption in whole or in part and if the state PUC does not allow
us

11

adequate compensation for the costs of providing the interconnection, our costs
would significantly increase and we could suffer a significant loss of customers
to competitors. In addition, we could incur additional administrative and
regulatory expenses as a result of the interconnection requirements.

PROMOTION OF UNIVERSAL SERVICE

The USF payments received by our RLECs from the USF Fund are intended to
support the high cost of our operations in rural markets. Such USF support
payments represented 17% of our revenues for the year ended December 31, 2002.
If our RLECs were unable to receive USF support payments, or if such support
payments were reduced, many of our RLECs would be unable to operate as
profitably as they have historically. Furthermore, under the current regulatory
scheme, as the number of access lines that we have in any given state increases,
the rate at which we can recover certain support payment decreases. Therefore,
as we implement our growth strategy, our eligibility for such support payments
may decrease.

Universal service rules have been adopted by both the FCC and the PUCs. One
of the implemented principles provides that USF funds will be distributed only
to carriers that are designated as eligible telecommunications carriers, or
ETCs, by a state PUC. All of our rural telephone companies have been designated
as ETCs pursuant to the Telecommunications Act. However, under the
Telecommunications Act, competitors could obtain the same support payments as we
do if a PUC determined that granting such support payments to competitors would
be in the public interest.

Traditional telephone companies receive USF payments pursuant to existing
mechanisms for determining the amounts of such payments with some limitations,
such as on the amount of corporate operating expense that can be recovered from
the USF.

Two notable regulatory changes enacted by the FCC in the last two years are
the adoption, with certain modifications, of the RTF's proposed framework for
rural high-cost universal service support and the implementation of the
beginning phases of the MAG plan. The RTF Order modifies the existing universal
service support mechanism for RLECs and adopts an interim embedded, or
historical, cost mechanism for a five-year period that provides predictable
levels of support to rural carriers. The FCC has stated its intention to develop
a long-term plan based on forward-looking costs when the five-year period
expires in 2006. The MAG plan creates a new universal service support mechanism,
Interstate Common Line Support, to replace implicit support for universal
service in access charges.

In addition, there are a number of appeals challenging several aspects of
the FCC's universal service rules. It is not possible to predict at this time
whether the FCC or Congress will order modification to those rules, or the
ultimate impact any such modification might have on us.

POTENTIAL INTERNET REGULATORY OBLIGATIONS

In connection with our Internet access offerings, we could become subject to
laws and regulations as they are adopted or applied to the Internet. There is
currently only a small body of laws and regulations applicable to access to or
commerce on the Internet. As the significance of the Internet expands, federal,
state and local governments may adopt rules and regulations, or apply existing
laws and regulations to the Internet. The FCC is currently reviewing the
appropriate regulatory framework governing broadband access to the Internet
through telephone and cable operators' communications networks. The outcome of
these proceedings may affect our regulatory obligations and the form of
competition for these services. We cannot predict the nature of these
regulations or their impact on our business.

12

OTHER REGULATIONS

Our operations and properties are subject to federal, state and local laws
and regulations relating to protection of the environment, natural resources,
and worker health and safety, including laws and regulations governing the
management, storage and disposal of hazardous substances, materials and wastes.
Under certain environmental laws, we could be held liable, jointly and severally
and without regard to fault, for the costs of investigating and remediating any
contamination at owned or operated properties; or for contamination arising from
the disposal by us or our predecessors of hazardous wastes at formerly-owned
properties or at third-party waste disposal sites. In addition, we could be held
responsible for third-party property or personal injury claims relating to any
such contamination or relating to violations of environmental laws. Changes in
existing laws or regulations or future acquisitions of businesses could require
us to incur substantial costs in the future relating to such matters.

COMPETITION

We believe that the Telecommunications Act and other recent actions taken by
the FCC and state regulatory authorities promote competition in the provision of
telecommunications services; however, many of the competitive threats now
confronting the large telephone companies do not currently exist in the RLEC
marketplace. Our RLECs historically have experienced little competition as the
incumbent carrier because the demographic characteristics of rural
telecommunications markets generally will not support the significant capital
investment required to offer competitive services. For instance, the per minute
cost of operating both telephone switches and interoffice facilities is higher
in rural areas, as RLECs typically have fewer, more geographically dispersed
customers and lower calling volumes. Also, the distance from the telephone
switch to the customer is typically longer in rural areas, which results in
increased distribution facilities costs. These relatively high costs tend to
discourage competitors from entering territories serviced by RLECs. As a result,
RLECs generally are not faced with the threat of significant competition. In
fact, we have virtually no wireline competition in any of our RLEC markets.

In certain of our rural markets, we face competition from wireless
technology. We do not expect this technology to represent a significant threat
in the near term, but as technology and economies of scale improve we may
experience increased competition from wireless carriers. We also face
competition from new market entrants, such as cable television and electric
utilities companies. Cable television companies are entering the
telecommunications market by upgrading their networks with fiber optics and
installing facilities to provide fully interactive transmission of broadband
voice, video and data communications. Electric utilities have existing assets
and low cost access to capital that could allow them to enter a market rapidly
and accelerate network development.

The Internet services market is also highly competitive, and we expect that
competition will continue to intensify. Internet services, meaning both Internet
access (wired and wireless) and on-line content services, are provided by
Internet service providers, satellite-based companies, long distance carriers
and cable television companies. Many of these companies provide direct access to
the Internet and a variety of supporting services to businesses and individuals.
In addition, many of these companies, such as America Online, Inc., Microsoft
Network and Yahoo, offer on-line content services consisting of access to
closed, proprietary information networks. Long distance companies and cable
television operators, among others, are aggressively entering the Internet
access markets. Long distance carriers have substantial transmission
capabilities, traditionally carry data to large numbers of customers and have an
established billing system infrastructure that permits them to add new services.
Satellite companies are offering broadband access to the Internet from desktop
PCs. Many of these competitors have substantially greater financial,
technological, marketing, personnel, name-brand recognition and other resources
than those available to us.

13

In addition, we could face increased competition from CLECs, particularly in
offering services to Internet service providers.

EMPLOYEES

As of December 31, 2002, we employed a total of 803 full-time employees,
including 126 employees of our RLEC companies represented by four unions. We
believe the state of our relationship with our union and non-union employees is
satisfactory. Within our Company, 26 employees are employed at our corporate
office, 771 employees are employed at our RLEC companies and 6 employees are
employed by Carrier Services.

ITEM 2. PROPERTIES

We own all of the properties material to our business. Our headquarters is
located in Charlotte, North Carolina. 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 RLEC business. Our administrative and maintenance
facilities are generally located in or near the rural communities served by our
RLECs and our central offices are often within the administrative building and
outlying customer service centers. 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 incumbent long distance carrier.
These facilities are located on land pursuant to permits, easements or other
agreements. Our rolling stock includes service vehicles, construction equipment
and other required maintenance equipment.

We believe each of our respective properties is suitable and adequate for
the business conducted therein, is being appropriately used consistent with past
practice and has sufficient capacity for the present intended purposes.

ITEM 3. LEGAL PROCEEDINGS

We currently and from time to time are involved in litigation and regulatory
proceedings incidental to the conduct of our business, but we are not a party to
any lawsuit or proceeding which, in our opinion, is likely to have a material
adverse effect on us.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our security holders during the
fourth quarter of the fiscal year.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

There is no established public market for the common equity of the Company.
Substantially all of the Company's outstanding common equity securities are
owned by affiliates of Kelso & Company ("Kelso"), Thomas H. Lee Equity Fund IV,
L.P. ("THL"), certain institutional investors and the Company's executive
officers and directors.

As of March 25, 2003, there were approximately 69 record holders of the
Company's Class A common stock and 14 record holders of the Company's Class C
common stock.

14

There were 6,201,546 options to purchase shares of Class A common stock
outstanding as of March 25, 2003, of which 4,303,376 were fully vested.

There are no shares of the Company's common stock that could be sold
pursuant to Rule 144 under the Securities Act or, other than pursuant to the
Company's registration rights agreement with certain of our stockholders, that
we have agreed to register under the Securities Act for sale by the security
holders.

Our ability to pay dividends is governed by restrictive covenants contained
in the indentures governing our publicly held debt as well as restrictive
covenants in our bank lending arrangements. We have never paid cash dividends on
our equity securities and currently have no intention of paying cash dividends
on our equity securities for the foreseeable future. For a description of
certain restrictions on our ability to pay dividends, see "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Description of Certain Indebtedness."

EQUITY COMPENSATION PLAN INFORMATION

Number of shares
remaining available
for
future issuance under
Number of shares Weighted-average equity compensation
to be issued upon exercise price of plans (excluding
exercise of outstanding securities reflected
outstanding options, options, warrants, in
warrants and rights and rights column (a))
Plan Category (a) (b) (c)
- --------------------- --------------------- --------------------- ---------------------
Equity compensation
plans approved by
stockholders....... 6,244,401 $2.85 3,818,009
Equity compensation
plans not approved
by stockholders.... 0 $0 0

For a description of our equity compensation plans, see "Item 11. Executive
Compensation."

ITEM 6. SELECTED FINANCIAL DATA

Certain of the selected financial data presented below under the captions
"Statement of Operations," "Operating Data," "Summary Cash Flow Data" and
"Balance Sheet Data" as of December 31, 2001 and 2002, and for each of the years
in the three-year period ended December 31, 2002, are derived from the
consolidated financial statements of FairPoint, which financial statements have
been audited by KPMG LLP, independent auditors. The consolidated financial
statements as of December 31, 2001 and 2002, and of each of the years in the
three-year period ended December 31, 2002, and the report thereon, are included
elsewhere in this report. 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 "Item 8. Independent Auditors Report
and Consolidated Financial Statements." All amounts are in thousands, except
access lines and ratios.

15

- --------------------------

(1) On January 1, 2002, the Company adopted SFAS No. 142, "Business
Combinations." Pursuant to the requirements of SFAS No. 142, the Company
ceased amortizing goodwill beginning January 1, 2002, and instead tests for
goodwill impairment annually. Amortization expense for goodwill and equity
method goodwill was $3,332, $5,497, $9,950 and $12,180 in fiscal 1998, 1999,
2000 and 2001, respectively. Depreciation and amortization excludes
amortization of debt issue costs.

16

(2) Interest expense includes amortization of debt issue costs aggregating
$1,368, $1,575, $2,362, $4,018 and 3,664 for the fiscal years ended
December 31, 1998, 1999, 2000, 2001 and 2002, respectively. In 1999,
interest expense includes $13,331 related to the retirement of put warrants
of one of our subsidiaries.

(3) On January 1, 2001, the Company adopted the provisions of SFAS No. 133,
"Accounting for Derivative Instruments and Certain Hedging Activities," as
amended by SFAS No. 138. On the date of adoption, the Company recorded a
cumulative adjustment of $4,664 in accumulated other comprehensive income
for the fair value of the interest rate swaps. Because the interest rate
swaps do not qualify as accounting hedges under SFAS No. 133, the change in
fair value of the interest rate swaps are recorded as non-operating gains or
losses, which the Company classifies in other income (expense). The Company
also recorded other income (expense) in 2001 and 2002 for the amortization
of the transition adjustment of the swaps initially recognized in
accumulated other comprehensive income.

In the second quarter of 2002, the Company adopted SFAS No. 145, "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and
Technical Corrections." This statement eliminates the requirement that gains
and losses from the extinguishment of debt be required to be aggregated and,
if material, classified as an extraordinary item, net of related income tax
effect. Accordingly, the Company has reclassified the loss and income tax
benefit associated with the extinguishment of debt in 1998, which was
previously reported as an extraordinary loss of $2,521. The
reclassifications decreased nonoperating other income (expense) by $4,276
and increased income tax benefit by $1,755 in 1998.

(4) "RLEC revenues" means revenues of the Company and its subsidiaries,
excluding Carrier Services.

(5) "EBITDA" means net income (loss) from continuing operations before interest
expense, income taxes, and depreciation and amortization. "Adjusted RLEC
EBITDA" means EBITDA of the Company and its subsidiaries, adjusted to
exclude the effects of: (i) changes in the fair value of the interest rate
swaps and related amortization of the transition adjustment required
following the adoption of SFAS No. 133, (ii) non-cash stock based
compensation expense, (iii) losses from the extinguishment of debt,
(iv) impairment losses for declines in the fair value of investments
"other-than-temporary", and (v) Carrier Services' EBITDA. We believe that
EBITDA and Adjusted EBITDA are generally considered as useful information
regarding a company's ability to incur and service debt. While providing
useful information, EBITDA should not be considered in isolation or as a
substitute for consolidated statement of operations and cash flows data
prepared in accordance with generally accepted accounting principles. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources." Adjusted RLEC
EBITDA is calculated as follows (in thousands):

(6) "Adjusted RLEC EBITDA margin" means Adjusted RLEC EBITDA as a percentage of
RLEC revenues.

(7) For purposes of determining the ratio of earnings to fixed charges, earnings
are defined as earnings (losses) from continuing operations before income
taxes, minority interest and income or loss from equity investments, plus
distributed income of equity investments, amortization of capitalized
interest, and fixed charges. Fixed charges include interest expense on
indebtedness, capitalized interest and rental expense on operating leases
representing that portion of rental expense deemed to be attributable to
interest. We had a deficiency to cover

17

fixed charges of $8,485, $15,846, $9,255, $22,854 and $4,596 for the years
ended December 31, 1998, 1999, 2000, 2001 and 2002, respectively.

(8) In 2001, the working capital deficit included $125.8 million related to the
debt under the Carrier Services credit facility classified as a current
liability.

(9) On January 1, 2002, the Company adopted the provisions of SFAS No. 144,
which required reclassification of the net liabilities of discontinued
operations to the applicable asset and liability sections on the balance
sheets. There was no change to the measurement of the Company's provisions
for discontinued operations as the Company initiated its plan of disposal
prior to December 31, 2001.

(10) "Total net debt" means long term debt of Company and its subsidiaries less
cash on hand.

(11) "RLEC total net debt" means total debt of the Company and its subsidiaries
less cash on hand, excluding Carrier Services' debt.

(12) Represents an increase or decrease in the estimated amount we would have to
pay to cancel or transfer to third parties interest rate swaps to which we
are a party. Interest rate swaps with notional amounts of $75,000 and
$100,000 expire in May 2003 and November 2003, respectively.

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

OVERVIEW

We are a leading provider of telecommunications services in rural
communities, offering an array of services including local voice, long distance,
data and Internet primarily to residential customers. According to an industry
source, we believe that we are the 16th largest local telephone company in the
United States, with over 243,000 access lines in service as of December 31,
2002.

We were incorporated in February 1991 for the purpose of acquiring and
operating telephone companies in rural markets. Since our inception, we have
acquired 29 such businesses, which are located in 18 states. All of our
telephone company subsidiaries qualify as RLECs under the Telecommunications
Act. RLECs are generally characterized by stable operating results and strong
cash flow margins and operate in generally supportive regulatory environments.
In particular, pursuant to existing state and federal regulations, we are able
to charge rates that enable us to recover our operating costs, plus a reasonable
rate of return on our invested capital (as determined by the relevant regulatory
authorities). In addition, because RLECs primarily serve sparsely populated
rural areas and small towns, competition is typically limited due to the
generally unfavorable economics of constructing and operating competitive
systems in such areas and difficulties inherent in reselling such services to a
predominantly residential customer base.

REVENUES

We derive our revenues from:

- LOCAL CALLING SERVICES. We receive revenues from providing local exchange
telephone services, including monthly recurring charges for basic service,
usage charges for local calls and service charges for special calling
features.

- UNIVERSAL SERVICE FUND, OR USF. We receive payments from the USF to
support the high cost of providing local telephone services in rural
locations.

- INTERSTATE ACCESS REVENUE. These revenues are primarily based on a
regulated return on rate base and recovery of allowable expenses
associated with the origination and termination of toll 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 REVENUE. These revenues consist primarily of charges
paid by long distance companies and other customers for access to our
networks in connection with the origination

18

and/or termination of long distance 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.

- LONG DISTANCE SERVICES. We receive revenues for long distance services to
our retail and wholesale long distance customers.

- DATA AND INTERNET SERVICES. We receive revenues from monthly recurring
charges for services, including digital subscriber line, special access,
private lines, Internet and other services.

- OTHER SERVICES. We receive revenues from other services, including billing
and collection, directory services and sale and maintenance of customer
premise equipment.

The following summarizes our percentage of revenues from continuing
operations from these sources:

OPERATING EXPENSES

Our operating expenses are categorized as operating expenses; depreciation
and amortization; and stock-based compensation.

- Operating expenses include costs incurred in connection with the operation
of our central offices and outside plant facilities and related
operations. In addition to the operational costs of owning and operating
our own facilities, we also purchase long distance services from the
RBOCs, large independent telephone companies and third party long distance
providers. In addition, our operating expenses include expenses relating
to sales and marketing, customer service and administration and corporate
and personnel administration.

- Depreciation and amortization includes depreciation of our communications
network and equipment. Prior to January 1, 2002, and the implementation of
SFAS No. 142, this category also included amortization of goodwill
relating to our acquisitions.

- Stock-based compensation consists of non-cash compensation charges
incurred in connection with the employee stock options of our executive
officers, and stockholder appreciation rights agreements granted to two
executive officers.

ACQUISITIONS

Our past acquisitions have had a major impact on our operations.

- During 2002, we made no acquisitions.

- During 2001, we acquired one RLEC and certain assets of additional
telephone exchanges for an aggregate purchase price of $24.2 million,
which included $0.7 million of acquired debt. At the respective dates of
acquisition, these businesses served an aggregate of approximately 5,600
access lines.

19

- During 2000, we acquired four RLECs for an aggregate purchase price of
$363.1 million, which included $86.9 million of acquired debt. At the
respective dates of acquisition, these companies served an aggregate of
approximately 79,500 access lines.

We expect that a portion of our future growth will result from additional
acquisitions, some of which may be material. We may not be able to succesfully
complete the integration of the businesses we have already acquired or
successfully integrate any businesses we might acquire in the future. If we fail
to do so, or if we do so at a greater cost than anticipated, or if our acquired
businesses do not experience significant growth, there will be a risk that our
business may be adversely affected.

STOCK-BASED COMPENSATION

In March 2002, we recognized a non-cash compensation benefit of
$0.2 million associated with the reduction in estimated fair market value of the
stockholder appreciation rights agreements. In December 2002, an additional
charge of $0.1 million was recognized in connection with these agreements. This
benefit was offset by a non-cash compensation charge of $1.2 million in
connection with the modification of employee stock options by one of our
executive officers.

In December 2001, we recognized a non-cash compensation charge of
$2.2 million in connection with the modification of employee stock options by
one of our executive officers. This charge was offset by a non-cash compensation
benefit of $0.9 million associated with the reduction in estimated fair market
value of the stockholder appreciation rights agreements.

In January 2000, we recognized a non-cash compensation charge of
$12.3 million. The charge consisted of compensation expense of $3.8 million
recognized in connection with the modification of employee stock options and the
settlement of employee stock options for cash by one of our principal
shareholders. The compensation expense also included the settlement of a cash
payment obligation between certain of our employee-shareholders and our
principal shareholders under their pre-existing shareholder's agreement for
$8.5 million.

DISCONTINUED OPERATIONS

In November 2001, we decided to discontinue the CLEC operations of Carrier
Services. This decision was a proactive response to the deterioration in the
capital markets, the general slow-down of the economy and the
slower-than-expected growth in Carrier Services CLEC operations.

Prior to our decision to discontinue Carrier Services' CLEC operations,
Carrier Services entered into an agreement on October 19, 2001 to sell certain
of its assets in the Northwest to ATG. On November 7, 2001, Carrier Services
entered into an agreement to sell certain of its assets in the Northeast to
Choice One. Included in the terms of the Choice One sales agreement was an
opportunity for Carrier Services to earn additional restricted shares of Choice
One common stock based on the number of access lines converted to the Choice One
operating platform. Carrier Services earned 1,000,000 restricted shares of
Choice One common stock under these provisions. These shares were recognized as
a gain of approximately $0.8 million within discontinued operations during the
second quarter of 2002.

In addition, Carrier Services notified its remaining customers in the
Southwest, Southeast, and Mid-Atlantic competitive markets to find alternative
carriers. The transition of customers to ATG, Choice One and alternative
carriers was completed in April 2002. As a result of these transactions and the
transition of all Carrier Services customers to other service providers, Carrier
Services has completed the disposition of its CLEC operations.

Carrier Services will continue to provide wholesale long distance services
and support to our RLEC subsidiaries and other independent local exchange
companies. These services allow such companies to operate their own long
distance communication services and sell such services to their

20

respective customers. Our long distance business is included as part of
continuing operations in the accompanying financial statements.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001

REVENUES FROM CONTINUING OPERATIONS. Revenues from continuing operations
increased $0.7 million to $235.9 million in 2002 compared to $235.2 million in
2001. Of this increase, $4.3 million was attributable to revenues from companies
we acquired in 2001. This was offset by a reduction of $0.8 million in revenues
from our earlier acquired RLECs and a decrease in revenues of $2.8 million
attributable to revenues from our wholesale long distance company. We derived
our revenues from the following sources.

LOCAL CALLING SERVICES. Local calling service revenues increased
$3.3 million from $52.0 million to $55.3 million, including an increase of
$2.1 million from an increase in the number of access lines and local services
provided in our earlier acquired RLEC companies, as well as an increase of
$1.2 million from the companies we acquired in 2001.

USF HIGH COST LOOP. USF high cost loop receipts increased $3.5 million to
$22.6 million in 2002 from $19.1 million in 2001. Our earlier acquired RLEC
companies accounted for $3.3 million of the increase with the balance obtained
from companies we acquired in 2001. The support from the high cost loop fund is
associated with historical expense levels of our companies that exceed the
national average cost per loop.

INTERSTATE ACCESS. Interstate access revenues were relatively flat from
year to year, decreasing $0.2 million from $68.1 million in 2001 to $67.9 in
2002. A reduction of $1.2 million from our earlier acquired RLEC's is offset by
$1.0 million associated with companies we acquired in 2001. The $1.2 million
revenue reductions are due mainly to our cost reductions at acquired entities,
which correspondingly lowered our rate base. During the last two years, the
FCC's Rural Task Force, or RTF, and Multi-Association Group, or MAG, made
certain modifications to the USF that removed implicit universal service support
from access charges and made it explicit support. Our interstate revenues
include $16.5 million in explicit support received from the USF and have been
offset by reductions in interstate access rates, resulting in an overall revenue
neutral effect on our operating companies.

INTRASTATE ACCESS. Intrastate access revenues decreased $4.6 million from
$49.3 million in 2001 to $44.7 in 2002. An increase of $1.6 million from
companies we acquired in 2001 was offset by a reduction of $6.2 million from our
earlier acquired RLECs. The decrease was mainly due to rate and state support
reductions in Maine, Kansas, Vermont and Illinois. We continue to expect
downward pressure on our intrastate access rates. To the extent these pressures
reduce our earnings levels below authorized rates of return, our companies are
allowed to file and seek approval from the state public utility commissions for
recovery of these reductions through increases in local rates and, where they
exist, state universal service funds.

LONG DISTANCE SERVICES. Long distance services revenues decreased
$2.8 million from $20.0 million in 2001 to $17.2 million in 2002, all attributed
to reduction in Carrier Services long distance wholesale operations. Wholesale
customers were lost when one of our underlying wholesale carriers declared
bankruptcy.

DATA AND INTERNET SERVICES. Data and Internet services revenues increased
$2.2 million from $7.4 million in 2001 to $9.6 million in 2002, including an
increase of $0.1 million from acquisitions and an increase of $2.1 million as a
result of increased service offerings to our customers of our earlier acquired
RLEC businesses.

21

OTHER. Other revenues decreased by $0.8 million from $19.2 million in 2001
to $18.4 million in 2002 as other revenue contributed by the companies we
acquired in 2001 of $0.1 million was offset by a reduction in other revenues of
$0.9 million from our earlier acquired RLEC operations. This decrease is mainly
associated with reductions in billing and collections revenues, as interexchange
carriers, or IXCs, "take back" the billing function for their long distance
customers. This trend is expected to continue.

OPERATING EXPENSES OF CONTINUING OPERATIONS

OPERATING EXPENSES. Operating expenses from continuing operations decreased
$5.5 million, or 4.7%, to $112.3 million in 2002 from $117.8 million in 2001.
Expenses of our wholesale long distance company decreased $2.5 million as a
result of lower minutes of use from our wholesale customers. In addition,
expenses of our earlier acquired RLECs decreased by $4.4 million, mainly
attributable to overall cost reduction efforts throughout the company. This
decrease was offset by an increase of $1.4 million attributable to expenses of
RLEC telephone companies we acquired in 2001.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization from
continuing operations decreased $9.0 million to $47.1 million in 2002 from
$56.1 million in 2001. The decrease of $12.2 million attributable to the
discontinuance of amortizing goodwill upon the implementation of SFAS No. 142
was offset by increases in depreciation of property, plant and equipment
consisting of $2.5 million attributable to the increased investment in our
communications network by RLEC companies we acquired prior to 2001 and
$0.7 million related to the companies we acquired in 2001.

STOCK-BASED COMPENSATION. For the year ended December 31, 2002, stock-based
compensation of $0.9 million was related to a non-cash stock-based compensation
charge of $1.2 million related to a modification of an employee stock option
agreement with an executive officer, offset by the decrease in the estimated
value of fully vested stockholder appreciation rights agreements of
$0.3 million between certain members of our management and our principal
stockholders. For the year ended December 31, 2001, stock-based compensation of
$0.9 million was related to the decrease in the estimated value of fully vested
stockholder appreciation rights agreements between certain members of our
management and our principal stockholders. This is offset by a $2.2 million
non-cash stock-based compensation charge related to a modification of an
employee stock option agreement with an executive officer. The net charge for
the year ended December 31, 2001 was $1.3 million.

INCOME FROM OPERATIONS. Income from continuing operations increased
$15.6 million to $75.6 million in 2002 from $60.0 million in 2001. Of this
increase, $13.5 million was attributable to our earlier acquired RLEC telephone
companies and $2.1 million was attributable to the RLEC telephone companies we
acquired in 2001. Income from our wholesale long distance company decreased
$0.4 million, and stock based compensation expense decreased $0.4 million.

OTHER INCOME (EXPENSE). Total other expense from continuing operations
decreased $1.6 million to $81.3 million in 2002 from $82.9 million in 2001. The
expense consists primarily of interest expense on long-term debt. Interest
expense decreased $1.3 million to $79.8 million in 2002 from $81.1 million in
2001. During 2002, we recorded non-cash impairment of investments of
$12.6 million which is associated with other than temporary declines in fair
value of approximately $8.2 million of Choice One stock and a write-down of
$4.4 million for certain investments accounted for under the equity method.
Earnings in equity investments increased $2.9 million to $7.9 million in 2002
from $5.0 million in 2001. Other nonoperating income (expense) includes
mark-to-market adjustments for interest rate swaps that do not qualify as
accounting hedges under SFAS No. 133. In 2001, mark-to-market losses of
$8.1 million were accrued to record the Company's estimated liability value for
the swaps as compared to mark-to-market gains of $0.7 million in 2002. These
noncash adjustments to the fair value of the swaps resulted in an increase in
nonoperating income (expense) of $8.8 million in 2002 as compared to 2001.

22

INCOME TAX EXPENSE. Income tax expense from continuing operations increased
$0.1 million to $0.5 million in 2002 from $0.4 million in 2001. The income tax
expense relates primarily to income taxes owed in certain states.

DISCONTINUED OPERATIONS. Income from discontinued operations was
$19.5 million in 2002 primarily as a result of a gain on extinguishment of debt
of $17.5 million. Losses from discontinued operations for 2001 were
$188.3 million. This loss was associated with a loss on the disposition of the
CLEC operations of $95.3 million and losses from the discontinued operations of
$93.0 million.

NET LOSS. Our 2002 net income attributable to common shareholders was
$1.3 million after giving effect to $11.9 million in dividends and accretion
related to the Redeemable Preferred Stock. Our net loss was $211.6 million for
2001, as a result of the factors discussed above and mainly associated with the
loss from discontinued operations.

YEAR ENDED DECEMBER 31, 2001 COMPARED WITH YEAR ENDED DECEMBER 31, 2000

REVENUES FROM CONTINUING OPERATIONS. Revenues from continuing operations
increased $39.5 million to $235.2 million in 2001 compared to $195.7 million in
2000. Of this increase, $30.7 million was attributable to revenues from
companies we acquired in 2001 and 2000, $6.2 million was attributable to
revenues from our wholesale long distance company and $2.6 million was related
to the internal growth of our earlier acquired RLEC businesses. We derived our
revenues from the following sources.

LOCAL CALLING SERVICES. Local calling service revenues increased
$8.4 million from $43.6 million to $52.0 million, including an increase of
$1.0 million from an increase in the number of access lines and local services
provided in our earlier acquired RLEC companies, as well as an increase of
$7.4 million from the companies we acquired in 2001 and 2000.

USF HIGH COST LOOP. USF high cost loop receipts increased $6.7 million to
$19.1 million in 2001 from $12.4 million in 2000. Our earlier acquired RLEC
companies accounted for $1.2 million of the increase with the balance of
$5.5 million coming from companies we acquired in 2001 and 2000. The support
from the high cost loop fund is associated with historical expense levels of our
companies that exceed the national average cost per loop.

INTERSTATE ACCESS. Interstate access revenues increased $15.0 million from
$53.1 million in 2000 to $68.1 in 2001. Companies we acquired in 2001 and 2000
accounted for $9.9 million of the increase. The remaining increase of
$5.1 million from our earlier acquired RLEC companies is mainly attributable to
cost study true-ups received in 2001 related to the expense levels and return on
rate base of the operating companies. During 2001, the RTF and MAG made certain
modifications to the USF that removed implicit universal service support from
access charges and made it explicit support. Our interstate revenues include
$11.6 million in explicit support received from the USF and have been offset by
reductions in interstate access rates, resulting in an overall revenue neutral
effect on our operating companies.

INTRASTATE ACCESS. Intrastate access revenues decreased $0.6 million from
$49.9 million in 2000 to $49.3 million in 2001. An increase of $4.2 million from
companies we acquired in 2001 and 2000 was offset by a reduction of
$4.8 million from our earlier acquired RLECs. The decrease was mainly due to
intrastate rate reductions in Maine. Intrastate access will continue to decline
in 2002 as additional rate reductions are required in Maine.

LONG DISTANCE SERVICES. Long distance services revenues increased
$7.2 million, of which $6.2 million is attributed to new long distance wholesale
customers of Carrier Services, and the remainder is associated with companies
acquired in 2001 and 2000.

23

DATA AND INTERNET SERVICES. Data and Internet services revenues increased
$2.9 million, including an increase of $0.8 million from acquisitions and an
increase of $2.1 million as a result of increased service offerings to our
customers of our earlier acquired RLEC businesses.

OTHER. Other revenues decreased by $0.1 million as other revenue
contributed by the companies we acquired in 2001 and 2000 of $2.0 million was
offset by a reduction in other revenues of $2.1 million from our earlier
acquired RLEC operations. This decrease is mainly associated with reductions in
billing and collections revenues, as IXCs "take back" the billing function for
their long distance customers. This trend is expected to continue.

OPERATING EXPENSES OF CONTINUING OPERATIONS

OPERATING EXPENSES. Operating expenses from continuing operations increased
$20.2 million to $117.8 million in 2001 from $97.6 million in 2000. Expenses of
RLEC telephone companies we acquired in 2001 and 2000 made up $11.5 million of
the increase. Wholesale long distance costs increased $4.6 million as a result
of the new long distance wholesale customers. In addition, expenses of our
earlier acquired RLECs increased by $4.1 million, mainly associated with
increased health insurance costs and legal and consulting expenses incurred in
connection with several rate proceedings.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization from
continuing operations increased $9.0 million to $56.1 million in 2001 from
$47.1 million in 2000. This increase consisted of $1.9 million attributable to
the increased investment in our communication network by our RLECs acquired
prior to 2000 and $7.1 million related to the companies we acquired in 2001 and
2000.

STOCK-BASED COMPENSATION. For the year ended December 31, 2001, stock-based
compensation of $0.9 million was related to the decrease in the estimated value
of fully vested stockholder appreciation rights agreements between certain
members of our management and our principal stockholders. This is offset by a
$2.2 million non-cash stock-based compensation charge related to a modification
of an employee stock option agreement with an executive officer. The net charge
for the year ended December 31, 2001 was $1.3 million. As discussed above, in
January 2000 we recognized non-cash compensation charges of $12.3 million for
the year ended December 31, 2000.

INCOME FROM OPERATIONS. Income from continuing operations increased
$21.3 million to $60.0 million in 2001 from $38.7 million in 2000. This increase
was primarily attributable to an $11.0 million decrease in stock-based
compensation charges, while $12.1 million was attributable to the companies we
acquired in 2001 and 2000 and $1.6 million was attributable to our wholesale
long distance company. Operating income of our earlier acquired RLECs decreased
$3.4 million as higher expenses (predominately health insurance costs and legal
and consulting expenses) outpaced revenue growth.

OTHER INCOME (EXPENSE). Total other expense from continuing operations
increased $36.6 million to $82.9 million in 2001 from $46.3 million in 2000. The
expense consists primarily of interest expense on long-term debt and a
$7.3 million decrease in net gain on sale of stock and cellular investments for
the year ended December 31, 2001, compared to the year ended December 31, 2000.
In addition, other nonoperating income (expense) includes mark-to-market
adjustments for interest rate swaps that do not qualify as accounting hedges
under SFAS No. 133. In 2001, mark-to-market losses of $8.1 were accrued to
record the Company's estimated liability value as compared to no corresponding
amount in 2000.

INCOME TAX EXPENSE. Income tax expense from continuing operations decreased
$5.2 million to $0.4 million in 2001 from $5.6 million in 2000. The income tax
expense in 2001 relates primarily to income taxes owed in certain states. In
2000, income tax expense relates to $2.4 million in Federal income tax as well
as income taxes owed in certain states.

DISCONTINUED OPERATIONS. Losses from discontinued operations for 2001 were
$188.3 million, an increase of $112.4 from a loss of $75.9 million for the
comparable period in 2000. This increase is

24

primarily associated with a loss on the disposition of the CLEC operations of
$95.3 million, which consists of the net loss on disposition and impairment of
assets of $67.2 million and a provision of $28.1 million for operating losses
during the phase-out period. The loss from the CLEC operations increased
$17.1 million to $93.0 million from the loss of $75.9 million in 2000.

NET LOSS. Our net loss was $211.6 million for 2001, compared to a loss of
$89.1 million for 2000, as a result of the factors discussed above and mainly
associated with the loss from discontinued operations.

LIQUIDITY AND CAPITAL RESOURCES

We intend to fund our operations, capital expenditures, interest expense and
working capital requirements from internal cash from operations. To fund future
acquisitions, we intend to use borrowings under our revolving credit facility,
or we will need to secure additional funding through the sale of public or
private debt and/or equity securities or enter into another bank credit
facility. Our ability to make principal payments on our indebtedness will depend
on our ability to generate cash in the future. We will need to refinance all or
a portion of our indebtedness on or before maturity. We may not be able to
refinance our indebtedness on commercially reasonable terms or at all. For the
years ended December 31, 2002, 2001 and 2000, cash provided by operating
activities of continuing operations was $58.8 million, $38.8 million and
$48.1 million, respectively.

Net cash used in investing activities from continuing operations was
$31.2 million, $57.9 million and $285.9 million for the years ended
December 31, 2002, 2001 and 2000, respectively. These cash flows primarily
reflect capital expenditures of $39.5 million, $43.7 million and $50.3 million
for the years ended December 31, 2002, 2001 and 2000, respectively and
acquisitions of telephone properties, net of cash acquired $0 million,
$18.9 million, and $256.1 million for the years ended December 31, 2002, 2001
and 2000, respectively.

Net cash provided by (used in) financing activities from continuing
operations was $(12.5) million, $101.2 million and $300.1 million for the years
ended December 31, 2002, 2001 and 2000, respectively. These cash flows primarily
represent net proceeds of long term debt of $104.2 million and $150.6 million
for the years ended December 31, 2001 and 2000, respectively. For the year ended
December 31, 2002, net repayments were $11.5 million.

Our annual capital expenditures for our rural telephone operations have
historically been significant. Because existing regulations allow us to recover
our operating and capital costs, plus a reasonable return on our invested
capital in regulated telephone assets, capital expenditures constitute an
attractive use of our cash flow. Net capital expenditures were approximately
$39.1 million in 2002 and are expected to be approximately $30.7 million in
2003.

Our credit facility was amended and restated on March 6, 2003. Our amended
and restated credit facility consists of a $70.0 million revolving facility
($60.0 million of which has been committed) and two term facilities, a tranche A
term loan facility of $30.0 million that matures on March 31, 2007, and a
tranche C term loan facility with $128.5 million principal amount outstanding as
of March 25, 2003 that matures on March 31, 2007. All $30.0 million was drawn
under the tranche A term loan facility on March 6, 2003. See "--Description of
Certain Indebtedness."

In 1998, the Company issued $125.0 million aggregate principal amount of
9 1/2% senior subordinated notes and $75.0 million aggregate principal amount of
floating rate notes. Both series of these notes mature on May 1, 2008. These
notes are general unsecured obligations of the Company, subordinated in right of
payment to all of the Company's senior debt. In 2000, the Company issued
$200.0 million aggregate principal amount of 12 1/2% senior subordinated notes.
These notes mature on May 10, 2010. These notes are general unsecured
obligations of the Company, subordinated in right of payment to all of the
Company's senior debt. In addition, on March 6, 2003, the Company issued
$225.0 million aggregate principal amount of 11 7/8% senior notes. These notes
mature on March 1,

25

2010. These notes are general unsecured obligations of the Company, ranking PARI
PASSU in right of payment with all existing and future senior debt of the
Company, including all obligations under our credit facility, and senior in
right of payment to all existing and future subordinated indebtedness of the
Company. See "--Description of Certain Indebtedness."

The proceeds from the offering of the senior notes and the borrowings under
the tranche A term loan facility were used to: (i) repay the entire amount of
all loans outstanding under the revolving facility, the acquisition facility and
the tranche B term loan facility of our credit facility; (ii) repurchase
$13.3 million aggregate liquidation preference of our Series A Preferred Stock
(together with accrued and unpaid dividends thereon) at 65% of its liquidation
preference; (iii) repurchase $9.8 million aggregate principal amount of the
Company's outstanding 9 1/2% senior subordinated notes due 2008 (together with
accrued and unpaid interest thereon) for approximately $7.9 million:
(iv) repurchase $7.0 million aggregate principal amount of the Company's
outstanding 12 1/2% senior subordinated notes due 2010 (together with accrued
and unpaid interest thereon) for approximately $6.1 million; (v) make a capital
contribution of approximately $1.5 million to Carrier Services, which used these
proceeds to retire a portion of its debt; and (vi) pay transaction fees.

In May 2002, Carrier Services entered into an amended and restated credit
facility with its lenders to restructure its obligations under its credit
facility. In the restructuring, (i) Carrier Services paid certain of its lenders
$5.0 million to satisfy $7.0 million of obligations under the credit facility,
(ii) the lenders converted approximately $93.9 million of the loans under the
credit facility into shares of the Company's Series A Preferred Stock and
(iii) the remaining loans under the credit facility and certain swap obligations
were converted into $27.9 million of new term loans. The Series A Preferred
Stock is non-voting, and is not convertible into common stock of the Company.
The Series A Preferred Stock has a dividend rate equal to 17.428% per annum,
payable either in cash or in additional shares of Series A Preferred Stock, at
our option. See "--Description of Certain Indebtedness."

Carrier Services has completed the cessation of its competitive
communications business operations. Carrier Services' cash flow requirements
include general corporate expenditures, expenses related to discontinued
operations and debt service. We expect Carrier Services' cash flow requirements,
other than debt amortization, will be funded primarily from cash flows from
operations. Our amended and restated credit facility and the indentures
governing the Company's senior subordinated notes and senior notes contain
certain restrictions on our ability to make investments in Carrier Services. In
the event Carrier Services is unable to make a scheduled amortization payment or
to pay any amount due at maturity, the lenders' sole remedy will be to convert
their debt under the Carrier Services credit facility into shares of our
Series A Preferred Stock.

The Company is also obligated under certain leases of Carrier Services and
would therefore be obligated to make certain lease and other payments if Carrier
Services and/or certain sublessee's default on their obligations. See "Summary
of Contractual Obligations."

Under a tax sharing agreement, the Company has been and continues to be
obligated to reimburse Carrier Services for any tax benefits the Company and its
affiliates receive from net operating losses attributable to Carrier Services,
including net operating losses attributable to Carrier Services carried forward
from prior taxable years. As of December 31, 2002, approximately $210 million of
the $258 million of combined net operating losses of the Company and its
affiliates were attributable to Carrier Services. As of December 31, 2002, the
amount payable to Carrier Services under the tax sharing agreement was
approximately $3.1 million. The Company does not anticipate making substantial
payments under the tax sharing agreement for taxable income with respect to
taxable years 2003 to 2007.

26

In January 2000, we completed an equity financing and recapitalization
transaction, pursuant to which THL, Kelso and certain other institutional
investors and members of management acquired an aggregate of $408.8 million of
our equity securities. We received $158.9 million of net proceeds in such
transaction, which we used to repay debt, to finance certain acquisitions and to
fund the expansion of our telecommunications business. This transaction
represented an initial investment from THL and a follow-on investment from
Kelso.

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 and the periods in which payments are due, after giving effect to
the transactions described in "Item 1. Business--Recent Developments":

- ------------------------

(1) The Company has the option to redeem any portion of the outstanding
Series A Preferred Stock at any time. Under certain circumstances, the
Company would be required to pay a premium of up to 6% in connection with
the redemption. The Company is required to redeem the Series A Preferred
Stock upon the occurrence of one of the following events: (i) a merger,
consolidation, sale, transfer or disposition of at least 50% of the assets
or business of the Company and its subsidiaries, (ii) a public offering of
the Company's common stock which yields in the aggregate at least
$175.0 million, or (iii) the first anniversary of the maturity of the
Company's senior subordinated notes (which first anniversary will occur in
May 2011), unless prohibited by its credit facility or the indentures
governing its senior subordinated notes.

(2) Operating lease obligations represent $15.6 million associated with the
discontinued operations discussed in note (2) to our consolidated financial
statements and are stated in this table at total contractual amounts.
However, the Company intends to negotiate lease terminations or subleases on
these properties to reduce the total obligation. Operating leases from
continuing operations of $2.3 million are also included.

(3) Payable to affiliates of Kelso upon the occurrence of certain events. See
"Item 13. Certain Relationships and Related Party Transactions."

(4) Carrier Services has obligations to purchase a minimum amount of wholesale
toll minutes from an interexchange carrier. To date, purchases have exceeded
the minimum requirements.

27

The following table discloses aggregate information about our commercial
commitments as of December 31, 2002. Commercial commitments are items that we
could be obligated to pay in the future. They are not included in our condensed
consolidated balance sheets.

The following table discloses aggregate information about our derivative
financial instruments as of December 31, 2002, the source of fair value of these
instruments and their maturities.

- ------------------------

(1) Fair value of interest rate swaps at December 31, 2002 was provided by the
counterparties to the underlying contracts using consistent methodologies.

DESCRIPTION OF CERTAIN INDEBTEDNESS

We have utilized a variety of debt instruments to fund our business and we
have a significant amount of debt outstanding. Our high level of debt could
significantly affect our business by: making it more difficult for us to satisfy
our obligations, including making scheduled interest payments under our debt
obligations; limiting our ability to obtain additional financing; increasing our
vulnerability to generally adverse economic and communications industry
conditions, including changes in interest rates; requiring us to dedicate a
substantial portion of our cash flow from operations to payments on our debt,
thereby reducing the availability of our cash flow for other purposes; limiting
our flexibility in planning for, or reacting to, changes in our business and the
communications industry; and placing us at a competitive disadvantage compared
to those of our competitors that have less debt.

In addition, our amended and restated credit facility, the Carrier Services
credit facility and the indentures governing our senior subordinated notes and
our senior notes contain covenants that limit our operating flexibility and
restrict our ability to take specific actions, even if we believe such actions
are in our best interest. These include restrictions on our ability to: incur
additional debt; pay dividends or distributions on, or redeem or repurchase,
capital stock; create liens or negative pledges with respect to our assets; make
investments, loans or advances, including to Carrier Services; make capital
expenditures; issue, sell or allow distributions on capital stock of specified
subsidiaries; enter into sale and leaseback transactions; prepay or defease
specified indebtedness; enter into transactions with affiliates; enter into
specified hedging arrangements; merge, consolidate or sell our assets; or engage
in any business other than communications. We also are required to maintain
specified financial ratios and/or meet financial tests prescribed by our amended
and restated credit facility. We may not be able to meet these requirements or
satisfy these covenants in the future. If we fail to do so, our debts could
become immediately payable at a time when we are unable to pay them, which could
have an adverse effect on our business.

OUR CREDIT FACILITY. We are a party to a credit facility with various lenders,
Wachovia Bank, National Association, as documentation agent, Deutsche Bank Trust
Company Americas, as administrative agent, and Bank of America, N.A., as
syndication agent. The credit facility was amended and restated as part

28

of a refinancing completed on March 6, 2003. Our amended and restated credit
facility provides for, among other things, rescheduled amortization and an
excess cash flow sweep with respect to the tranche C term facility. Our credit
facility consists of term loan facilities (consisting of tranche A loans and
tranche C loans) in an aggregate principal amount of $158.5 million and a
revolving credit facility in an aggregate principal amount of up to
$70.0 million ($60.0 million of which has been committed). All of our
obligations under our credit facility are unconditionally and irrevocably
guaranteed jointly and severally by four of our mid-tier subsidiaries.
Outstanding debt under our credit facility is secured by a first priority
perfected security interest in all of the capital stock of certain of our
subsidiaries.

Our amended and restated credit agreement is comprised of the following
facilities:

REVOLVING LOAN FACILITY. A revolving loan facility of up to $70 million
($60 million of which has been committed). These loans mature on March 31, 2007
and bear interest per annum at either a base rate plus 3.00% or LIBOR plus
4.00%.

TRANCHE A TERM LOAN FACILITY. A tranche A term loan facility of
$30 million. As of March 25, 2003, $30.0 million of tranche A term loans were
outstanding. These loans mature on March 31, 2007 and bear interest per annum at
either a base rate plus 3.00% or LIBOR plus 4.00%.

TRANCHE C TERM LOAN FACILITY. As of March 25, 2003, approximately
$128.5 million of tranche C term loans remained outstanding. These loans mature
on March 31, 2007. Mandatory repayments under the tranche C term loan facility
are scheduled to be $2.0 million, $20.9 million, $20.0 million $29.6 million and
a final $56.0 million in 2003, 2004, 2005, 2006 and on March 31, 2007,
respectively. Tranche C term loans bear interest per annum at either a base rate
plus 3.50% or LIBOR plus 4.50%.

COVENANTS AND EVENTS OF DEFAULT

Our amended and restated credit facility contains certain customary
covenants and other credit requirements of the Company and its subsidiaries and
certain customary events of default. Our amended and restated credit facility
limits our ability to downstream money to Carrier Services and its subsidiaries.

PREPAYMENTS

Net cash proceeds from asset sales are required to be applied as mandatory
prepayments of principal on outstanding loans unless such proceeds are used by
us to finance acquisitions permitted under our amended and restated credit
facility within 180 days of our receipt of such proceeds. Change of control
transactions trigger a mandatory prepayment obligation. Voluntary prepayments of
loans, including interim prepayments of revolving loans with proceeds of asset
sales that are not used to prepay term loans in anticipation of being
subsequently applied to fund a permitted acquisition or acquisitions within
180 days of the asset sale may be made at any time without premium or penalty,
provided that voluntary prepayments of eurodollar loans made on a date other
than the last day of an interest period applicable thereto shall be subject to
customary breakage costs.

In addition, our amended and restated credit facility provides that on the
date occurring ninety days after the last day of each of our fiscal years,
commencing December 31, 2003, 50% of excess cash flow (as defined in our credit
facility) for the immediately preceding fiscal year shall be applied as a
mandatory repayment of the then outstanding tranche C term loan facility;
provided, however, that such requirement shall terminate at such time as (i) we
first meet a senior secured leverage ratio (as defined in our credit facility)
of less than or equal to 1.00 to 1.00 and (ii) no default or event of default
exists under our amended and restated credit facility.

SENIOR SUBORDINATED NOTES AND FLOATING RATE NOTES ISSUED IN 1998. The Company
issued $125.0 million of senior subordinated notes and $75.0 million of floating
rate notes in 1998. The senior subordinated notes bear interest at the rate of
9( 1)(2)% per annum and the floating rate notes bear interest at a rate

29

per annum equal to LIBOR plus 418.75 basis points, in each case payable
semi-annually in arrears. The LIBOR rate on the floating rate notes is
determined semi-annually.

The senior subordinated notes and floating rate notes mature on May 1, 2008.
The Company may redeem the senior subordinated notes on or after May 1, 2003 and
the floating rate notes at any time, in each case, at the redemption prices
stated in the indenture under which those notes were issued, together with
accrued and unpaid interest, if any, to the redemption date. In the event of a
change of control, the Company must offer to repurchase the outstanding senior
subordinated notes and floating rate notes for cash at a purchase price of 101%
of the principal amount of such notes, together with all accrued and unpaid
interest, if any, to the date or repurchase.

The subordinated notes and floating rate notes are general unsecured
obligations of the Company, subordinated in right of payment to all existing and
future senior indebtedness of the Company, including all obligations under our
amended and restated credit facility.

The indenture governing the Company's senior subordinated notes and floating
rate notes contains certain customary covenants and events of default. In
particular, since Carrier Services and its subsidiaries are treated as
unrestricted subsidiaries under such indenture, our ability to downstream funds
to Carrier Services and its subsidiaries is limited by the restrictive payments
covenant in such indenture.

SENIOR SUBORDINATED NOTES ISSUED IN 2000. The Company issued $200.0 million of
senior subordinated notes in 2000. The senior subordinated notes bear interest
at the rate of 12( 1)(2)% per annum payable semi-annually in arrears.

The senior subordinated notes mature on May 1, 2010. The Company may redeem
the senior subordinated notes on or after May 1, 2005 at the redemption price
stated in the indenture under which the senior subordinated notes were issued,
together with accrued and unpaid interest, if any, to the redemption date. In
the event of a change of control, the Company must offer to repurchase the
outstanding senior subordinated notes for cash at a purchase price of 101% of
the principal amount of such notes, together with all accrued and unpaid
interest, if any, to the date of repurchase.

The senior subordinated notes are general unsecured obligations of the
Company, subordinated in right of payment to all existing and future senior
indebtedness of the Company, including all obligations under our amended and
restated credit facility.

The indenture governing the senior subordinated notes contains certain
customary covenants and events of default. In particular, since Carrier Services
and its subsidiaries are treated as unrestricted subsidiaries under such
indenture, our ability to downstream funds to Carrier Services and its
subsidiaries is limited by the restrictive payments covenant in such indenture.

SENIOR NOTES ISSUED IN 2003. The Company issued $225.0 million of senior notes
in March 2003. The senior notes bear interest at the rate of 11 7/8% per annum
payable semi-annually in arrears.

The senior notes mature on March 1, 2010. The Company may redeem the senior
notes on or after March 1, 2007 at the redemption price stated in the indenture
under which the senior notes were issued, together with accrued and unpaid
interest, if any, to the redemption date. In the event of a change of control,
the Company must offer to repurchase the outstanding senior notes for cash at a
purchase price of 101% of the principal amount of such notes, together with all
accrued and unpaid interest, if any, to the date of repurchase.

The senior notes are general unsecured obligations of the Company, ranking
PARI PASSU in right of payment with all existing and future senior debt of the
Company, including all obligations under our credit facility, and senior in
right of payment to all existing and future subordinated indebtedness of the
Company.

30

The indenture governing the senior notes contains certain customary
covenants and events of default. In particular, since Carrier Services and its
subsidiaries are treated as unrestricted subsidiaries under such indenture, our
ability to downstream funds to Carrier Services and its subsidiaries is limited
by the restrictive payments covenant in such indenture.

CARRIER SERVICES CREDIT FACILITY. On May 10, 2002, Carrier Services entered
into an amended and restated credit agreement with its lenders to restructure
the obligations of Carrier Services and its subsidiaries under the Carrier
Services credit facility. In connection with such restructuring, (i) Carrier
Services paid certain of its lenders $5.0 million to satisfy $7.0 million of the
obligations under the Carrier Services credit facility, (ii) the lenders
converted $93.9 million of the loans and obligations under the Carrier Services
credit facility into shares of the Company's Series A Preferred Stock having a
liquidation preference equal to the amount of the loans and obligations under
the Carrier Services credit facility, and (iii) the remaining loans under the
Carrier Services credit facility and Carrier Services' obligations under its
swap arrangements were converted into $27.9 million aggregate principal amount
of new term loans.

The converted loans under the new Carrier Services amended and restated
credit agreement consist of two term loan facilities: (i) tranche A loans in the
aggregate principal amount of approximately $8.7 million and (ii) tranche B
loans in the aggregate principal amount of approximately $19.2 million, each of
which matures in May 2007. Interest on the new loans is payable monthly and
accrues at a rate of 8% per annum; provided, however, that upon an event of
default the interest rate shall increase to 10% per annum. Interest on the
tranche A loans must be paid in cash and interest on tranche B loans may be
paid, at the option of Carrier Services, either in cash or in kind. For the
period ended December 31, 2002, $0.9 million in additional debt was issued to
satisfy the accrued in kind interest on the tranche B loans. The principal of
the tranche A loans is due at maturity and the principal of the tranche B loans
is payable as follows: (a) $2,062,000 is due on September 30, 2004;
(b) $4,057,000 is due on September 30, 2005; (c) $5,372,000 is due on
September 30, 2006; and (d) the remaining principal balance is due at maturity.

The loans under the Carrier Services amended and restated credit agreement
are guaranteed by certain of Carrier Services' subsidiaries and are secured by
substantially all of the assets of Carrier Services and its subsidiaries. The
Company has not guaranteed the debt owed to the lenders under the Carrier
Services amended and restated credit agreement nor does the Company have any
obligation to invest any additional funds in Carrier Services. Further, our
amended and restated credit facility and the indentures governing the Company's
senior subordinated notes and senior notes contain certain restrictions on the
Company's ability to make investments in Carrier Services.

Voluntary prepayments of loans may be made under the Carrier Services
amended and restated credit agreement at any time without premium or penalty.
Carrier Services is also required to make mandatory prepayments of principal
from certain sources including the net proceeds from asset sales and from excess
cash flow generated by the long distance business. Under a tax sharing
agreement, the Company has been and continues to be obligated to reimburse
Carrier Services for any tax benefits the Company and its affiliates receive
from net operating losses attributable to Carrier Services, including net
operating losses attributable to Carrier Services carried forward from prior
taxable years. As of December 31, 2002, approximately $210 million of the
$258 million of combined net operating losses of the Company and its affiliates
were attributable to Carrier Services. As of December 31, 2002, the amount
payable to Carrier Services under the tax sharing agreement was approximately
$3.1 million. The Company does not anticipate making substantial payments under
the tax sharing agreement for taxable income with respect to taxable years 2003
to 2007.

Upon a payment default under the Carrier Services amended and restated
credit agreement, or in the event of a bankruptcy of Carrier Services or the
Company, at the option of any lender, such lender's loans under the Carrier
Services amended and restated credit agreement may be converted

31

into shares of the Company's Series A Preferred Stock pursuant to the terms of
the Amended and Restated Preferred Stock Issuance and Capital Contribution
Agreement dated as of May 10, 2002 by and among the Company, the Administrative
Agent and the lenders.

The Series A Preferred Stock is non-voting, except as required by applicable
law, and is not convertible into common stock of the Company. The Series A
Preferred Stock provides for the payment of dividends at a rate equal to 17.428%
per annum. Dividends on the Series A Preferred Stock are payable, at the option
of the Company, either in cash or in additional shares of Series A Preferred
Stock. The Company has the option to redeem any outstanding Series A Preferred
Stock at any time. The redemption price for such shares is payable in cash in an
amount equal to $1,000 per share plus any accrued but unpaid dividends thereon
(the "Preference Amount"). Under certain circumstances, the Company would be
required to pay a premium of up to 6% of the Preference Amount in connection
with the redemption of the Series A Preferred Stock. In addition, upon the
occurrence of certain events, such as (i) a merger, consolidation, sale,
transfer or disposition of at least 50% of the assets or business of the Company
and its subsidiaries, (ii) a public offering of the Company's common stock which
yields in the aggregate at least $175.0 million, or (iii) the first anniversary
of the maturity of the Company's senior subordinated notes issued in 2000 (which
first anniversary will occur in May 2011), unless prohibited by its credit
facility or by the indentures governing its senior subordinated notes, the
Company would be required to redeem all outstanding shares of the Series A
Preferred Stock at a price per share equal to the Preference Amount. Certain
holders of the Series A Preferred Stock have agreed with the Company to reduce
the dividend rate payable on the shares they hold for a period of two years.

On March 6, 2003, Carrier Services entered into the First Amendment to the
amended and restated credit facility, pursuant to which, amount other things,
THL purchased the outstanding loans held by certain lenders and Carrier Services
repaid, in full, the outstanding loans of Wachovia Bank.

CRITICAL ACCOUNTING POLICIES

Our critical accounting policies are as follows:

- Accounting for discontinued and restructured operations;

- Accounting for income taxes; and

- Valuation of long-lived assets, including goodwill.

DISCONTINUED AND RESTRUCTURED OPERATIONS. The discontinuation and
restructuring of Carrier Services' CLEC operations required management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities associated with the phase-out period of the discontinued operations
and the accruals associated with the December 2000 and January and June 2001
restructurings. Management analyzed historical costs, current status of lease
negotiations and projected phase-out cash flows to determine the adequacy of the
accrual of estimated costs to close down Carrier Services' competitive
communications operations. Differences might result in the amount of these
projected assets and liabilities if management were to make different judgments
or utilize different estimates. Management does not believe these differences
would be material to the overall amounts of net assets and liabilities resulting
from discontinuing the operations.

ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements we were required to estimate our income taxes.
This process involves estimating our actual current tax exposure and assessing
temporary differences resulting from different treatment of items for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included within our consolidated balance sheets. We must
then assess the realizability of our deferred tax assets. In performing the
assessment, management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies.

32

We had $258.1 million in federal and state net operating loss carryforwards
as of December 31, 2002. In order to fully utilize the deferred tax assets,
mainly generated by the net operating losses, we will need to generate future
taxable income of approximately $196.5 million prior to the expiration of the
net operating loss carryforwards beginning in 2019 through 2021. Based upon the
level of projections for future taxable income over the periods in which the
deferred tax assets are deductible, we believe we will realize the benefits of
these deductible differences, net of the valuation allowance of $71.7 million at
December 31, 2002. The amount of the deferred tax assets considered realizable,
however, could be reduced in the near term if estimates of future taxable income
during the carry forward period are reduced.

VALUATION OF LONG-LIVED ASSETS, INCLUDING GOODWILL. We review our
long-lived assets, including goodwill for impairment whenever events or changes
in circumstances indicate that the carrying value may not be recoverable.
Several factors could trigger an impairment review such as (1) significant
under-performance relative to expected historical or projected future operating
results, (2) significant regulatory changes that would impact future operating
revenues, (3) significant negative industry or economic trends and
(4) significant changes in the overall strategy in which we operate our overall
business. Net goodwill was $454.3 million at December 31, 2002.

In 2002, Statement of Financial Accounting Standards (SFAS) No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS, became effective and as a result, we will
cease to amortize goodwill and equity method goodwill. We had recorded
amortization of approximately $12.2 million for the year ended December 31, 2001
and would have recorded approximately the same amount in 2002. In lieu of
amortization, we are required to perform an initial impairment review of our
goodwill in 2002 and an annual impairment review thereafter. We implemented SFAS
No. 142 effective January 1, 2002 and no impairment of goodwill or other
long-lived assets resulted from the initial and annual valuations of goodwill.

NEW ACCOUNTING STANDARDS

The Financial Accounting Standards Board (FASB) issued SFAS No. 143,
ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, which is effective January 1, 2003.
This statement requires, among other things, the accounting and reporting of
legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development or normal operation of a
long-lived asset. The Company has not yet determined the impact of the adoption
of this standard on its financial position, results of operations and cash
flows.

The FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and
64, AMENDMENT OF FASB STATEMENT NO. 13 AND TECHNICAL CORRECTIONS (SFAS
No. 145). This statement eliminates the requirement that gains and losses from
extinguishments of debt be required to be aggregated and, if material,
classified as an extraordinary item, net of related income tax effect. The
statement requires gains and losses from extinguishment of debt to be classified
as extraordinary items only if they meet the criteria in Accounting Principles
Board Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS REPORTING THE EFFECTS
OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND
INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS, which provides guidance for
distinguishing transactions that are part of an entity's recurring operations
from those that are unusual or infrequent or that meet the criteria for
classification as an extraordinary item. We adopted SFAS No. 145 in the second
quarter of 2002. During 2002, we recognized a $17.5 million gain for the
extinguishment of certain of Carrier Services' debt and settlement of its
interest rate swap agreements. This gain is classified within discontinued
operations.

In July 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED
WITH EXIT OR DISPOSAL ACTIVITIES (SFAS 146). SFAS 146 will apply to exit
("restructuring") plans initiated after December 31, 2002. Under SFAS 146,
restructuring costs associated with a plan to exit an activity are required to
be

33

recognized when incurred. Currently, the Company's accounting policy is to
recognize exit costs when the Company commits to an exit plan, consistent with
the guidance in EITF 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)."

In October 2002, the Emerging Issues Task Force of the FASB reached
tentative conclusion on the accounting for revenues in transactions that involve
multiple deliverables. The expected guidance will govern how to identify whether
goods or services or both, that are to be delivered separately in a bundled
sales arrangement, should be accounted for separately. The guidance from the
tentative conclusion would be effective for fiscal years beginning after
December 15, 2002, if the EITF ultimately reaches a consensus on the issue. The
Company would, therefore, be required to adopt the guidance in the financial
statements for the quarter ended March 31, 2003. The Company has not yet
determined the impact of this issue on the consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," an interpretation of SFAS No. 5, 57 and
107 and rescission of FASB Interpretation No. 34. This interpretation requires
additional disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it has
issued. It also specifies the requirements for liability recognition (at fair
value) for obligations undertaken in issuing the guarantee. The disclosure
requirements are effective for interim and annual financial statements ending
after December 15, 2002 (December 31, 2002 financial statements for calendar
year companies). The initial recognition and measurement provisions are
effective for all guarantees within the scope of Interpretation 45 issued or
modified after December 31, 2002. The Company has not yet determined the effect
of Interpretation No. 45 on its financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation--Transition and Disclosure," which amends SFAS No. 123. SFAS
No. 148 provides alternative methods of transition for a voluntary adoption of
the fair value method of recognizing compensation expense for employee stock
options. In addition SFAS No. 148 expands the disclosure requirements for
employee stock options and the Company's related accounting policies. The
additional disclosure requirements will apply to the Company's annual and
interim financial reports for periods ending after December 15, 2002.

INFLATION

We do not believe inflation has a significant effect on our operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At December 31, 2002, we recorded our marketable available-for-sale equity
securities at a fair value of $0.6 million. These securities have exposure to
price risk. A hypothetical ten percent adverse change in quoted market prices
would decrease the recorded value by approximately $0.1 million.

We have limited our exposure to material future earnings or cash flow
exposures from changes in interest rates on long-term debt, since approximately
74% of our debt bears interest at fixed rates or effectively at fixed rates
through the use of interest rate swaps. However, our earnings are affected by
changes in interest rates as our long-term debt under our credit facilities have
variable interest based on either the prime rate or LIBOR. If interest rates on
our variable rate debt averaged 10% more, our interest expense would have
increased, and our loss from continuing operations before taxes would have
increased by approximately $2.2 million for the year ended December 31, 2002.

We have entered into interest rate swaps to manage our exposure to
fluctuations in interest rates on our variable rate debt. Our liability for the
fair value of these swaps was approximately $8.6 million

34

at December 31, 2002. The fair value indicates an estimated amount we would have
to pay to cancel the contracts or transfer them to other parties. In connection
with our credit facility, we used six interest rate swap agreements, with
notional amounts of $25.0 million each, to effectively convert a portion of our
variable interest rate exposure to fixed rates ranging from 8.07% to 10.34%. The
swap agreements expire from November 2003 to May 2004. In connection with our
floating rate notes, we used an interest rate swap agreement, with a notional
amount of $75.0 million to effectively convert our variable interest rate
exposure to a fixed rate of 10.78%. This swap agreement expires in May 2003.

35

ITEM 8. INDEPENDENT AUDITORS' REPORT AND CONSOLIDATED FINANCIAL STATMENTS

INDEX TO FINANCIAL STATEMENTS

36

INDEPENDENT AUDITORS' REPORT

The Board of Directors
FairPoint Communications, Inc.:

We have audited the accompanying consolidated balance sheets of FairPoint
Communications, Inc. and subsidiaries (the Company) as of December 31, 2001 and
2002, and the related consolidated statements of operations, stockholders'
equity (deficit), comprehensive income (loss), and cash flows for each of the
years in the three-year period ended December 31, 2002. These consolidated
financial statements are the responsibility of FairPoint Communications, Inc.'s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2001 and 2002, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.

As described in Note 1 to the consolidated financial statements, the Company
adopted the provisions of Statement of Financial Accounting Standards (SFAS)
No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as
amended by SFAS No. 138, on January 1, 2001.

As described in Note 1 to the consolidated financial statements, the Company
adopted the provisions of SFAS No. 142, BUSINESS COMBINATIONS, as required for
goodwill and intangible assets effective January 1, 2002.

/s/ KPMG LLP

Omaha, Nebraska

February 19, 2003

except Note 19
which is as of
March 6, 2003

37

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2001 AND 2002

ASSETS

See accompanying notes to consolidated financial statements.

38

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2001 AND 2002

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

See accompanying notes to consolidated financial statements.

39

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002

See accompanying notes to consolidated financial statements.

40

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002
(AMOUNTS IN THOUSANDS)

See accompanying notes to consolidated financial statements.

41

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002

See accompanying notes to consolidated financial statements.

42

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002

See accompanying notes to consolidated financial statements.

43

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002

See accompanying notes to consolidated financial statements.

44

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002

See accompanying notes to consolidated financial statements.

45

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(A) ORGANIZATION

FairPoint Communications, Inc. (FairPoint) provides management services to
its wholly owned subsidiaries: ST Enterprises, Ltd. (STE); MJD Ventures, Inc.
(Ventures); MJD Services Corp. (Services); FairPoint Carrier Services, Inc.
(Carrier Services) (formerly known as FairPoint Communications Solutions Corp.);
FairPoint Broadband, Inc. (Broadband); and MJD Capital Corp. STE, Ventures, and
Services also provide management services to their wholly owned subsidiaries.

Collectively, the wholly owned subsidiaries of STE, Ventures, and Services
primarily provide telephone local exchange services in various states.
Operations also include resale of long distance services, internet services,
cable services, equipment sales, and installation and repair services. MJD
Capital Corp. leases equipment to other subsidiaries of FairPoint. Carrier
Services was a competitive communications business offering local and long
distance, internet, and data services in various states. Carrier Services'
competitive communications operations were discontinued in 2001. However,
Carrier Services continues to provide wholesale long distance services.
Broadband provides wholesale data products.

STE's wholly owned subsidiaries include Sunflower Telephone Company
(Sunflower); Northland Telephone Company of Maine, Inc. and Northland Telephone
Company of Vermont, Inc. (the Northland Companies); and ST Long Distance, Inc.
(ST Long Distance). Ventures' wholly owned subsidiaries include Sidney Telephone
Company (Sidney); C-R Communications, Inc. (C-R); Taconic Telephone Corp.
(Taconic); Ellensburg Telephone Company (Ellensburg); Chouteau Telephone Company
(Chouteau); Utilities, Inc. (Utilities); Chautauqua & Erie Telephone Corporation
(C&E); Columbus Grove Telephone Company (Columbus Grove); The Orwell Telephone
Company (Orwell); Telephone Services Company (TSC); GT Communications, Inc. (GT
Com); Peoples Mutual Telephone Company (Peoples); Fremont Telcom Co. (Fremont);
Fretel Communications LLC (Fretel); Comerco, Inc. (Comerco); and Marianna and
Scenery Hill Telephone Company (Marianna). Services' wholly owned subsidiaries
include Bluestem Telephone Company (Bluestem); Big Sandy Telecom, Inc. (Big
Sandy); Columbine Telecom Company (Columbine); Odin Telephone Exchange, Inc.
(Odin); Kadoka Telephone Co. (Kadoka); Ravenswood Communications, Inc.
(Ravenswood); Union Telephone Company of Hartford (Union); Armour Independent
Telephone Co. (Armour); Yates City Telephone Company (Yates); and WMW Cable TV
Co. (WMW).

(B) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The consolidated financial statements include the accounts of FairPoint
Communications, Inc. and its subsidiaries (the Company). All intercompany
transactions and accounts have been eliminated in consolidation.

On November 7, 2001, the Company announced Carrier Services' plan to sell
certain of its assets and to discontinue competitive communications operations.
As a result of the adoption of this plan, the financial results have been
reclassified in the accompanying consolidated financial statements to present
these operations as discontinued (see Note 2).

The Company's telephone subsidiaries follow the accounting for regulated
enterprises prescribed by Statement of Financial Accounting Standards (SFAS)
No. 71, ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION (SFAS
No. 71). This accounting recognizes the economic effects of rate regulation

46

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
by recording costs and a return on investment, as such amounts are recovered
through rates authorized by regulatory authorities. Accordingly, SFAS No. 71
requires the Company's telephone subsidiaries to depreciate telephone plant over
useful lives that would otherwise be determined by management. SFAS No. 71 also
requires deferral of certain costs and obligations based upon approvals received
from regulators to permit recovery of such amounts in future years. The
Company's telephone subsidiaries periodically review the applicability of SFAS
No. 71 based on the developments in their current regulatory and competitive
environments.

(C) USE OF ESTIMATES

Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities, the reported amounts of
revenues and expenses, and the disclosure of contingent assets and liabilities
to prepare these consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America. Actual results
could differ from those estimates.

(D) REVENUE RECOGNITION

Revenues are recognized as services are rendered and are primarily derived
from the usage of the Company's networks and facilities or under revenue sharing
arrangements with other communications carriers. Revenues are primarily derived
from: access, pooling, long distance services, internet and data services, and
other miscellaneous services. Local access charges are billed to local end users
under tariffs approved by each state's Public Utilities Commission. Access
revenues are derived on the intrastate jurisdiction by billing access charges to
interexchange carriers and to regional Bell operating companies. These charges
are billed based on toll or access tariffs approved by the local state's Public
Utilities Commission. Access charges for the interstate jurisdiction are billed
in accordance with tariffs filed by the National Exchange Carrier Association
(NECA) or by the individual company and approved by the Federal Communications
Commission.

Revenues are determined on a bill and keep basis or a pooling basis. If on a
bill and keep basis, the Company bills the charges to either the access provider
or the end user and keeps the revenue. If the Company participates in a pooling
environment (interstate or intrastate), the toll or access billed are
contributed to a revenue pool. The revenue is then distributed to individual
companies based on their company-specific revenue requirement. This distribution
is based on individual state Public Utilities Commission (intrastate) or Federal
Communications Commission's (interstate) approved separation rules and rates of
return. Distribution from these pools can change relative to changes made to
expenses, plant investment, or rate of return. Some companies participate in
federal and certain state universal service programs that are pooling in nature
but are regulated by rules separate from those described above. These rules vary
by state.

Long distance retail and wholesale services are usage sensitive and are
billed in arrears and recognized when earned. Internet and data services
revenues are substantially all recurring revenues and billed one month in
advance and deferred until earned. The majority of the Company's miscellaneous
revenue is provided from billing and collection and directory services. The
Company earns revenue from billing and collecting charges for toll calls on
behalf of interexchange carriers. The interexchange carrier pays a certain rate
per each message billed by the Company. The Company

47

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recognizes revenue from billing and collection services when the services are
provided. The Company recognizes directory services revenue over the
subscription period of the corresponding directory. Billing and collection is
normally billed under contract or tariff supervision. Directory services are
normally billed under contract.

(E) ACCOUNTS RECEIVABLE

Accounts receivable are recorded at the invoiced amount and do not bear
interest. The allowance for doubtful accounts is the Company's best estimate of
the amount of probable credit losses in the Company's existing accounts
receivable. The Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of specific customers, historical
trends, and other information. Receivable balances are reviewed on an aged basis
and account balances are charged off against the allowance after all means of
collection have been exhausted and the potential for recovery is considered
remote.

(F) CREDIT RISK

Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and trade receivables.
The Company places its cash with high-quality financial institutions.
Concentrations of credit risk with respect to trade receivables are limited due
to the Company's large number of customers in several states.

The Company is also exposed to credit losses in the event of nonperformance
by the counterparties to its interest rate swap agreements. The Company
anticipates, however, that the counterparties will be able to fully satisfy
their obligations under the contracts.

(G) INVESTMENTS

Investments consist of stock in CoBank, Rural Telephone Bank (RTB), the
Rural Telephone Finance Cooperative (RTFC), Choice One Communications Inc.
(Choice One), and various cellular companies and partnerships and other minority
equity investments, and Non-Qualified Deferred Compensation Plan assets. The
stock in CoBank, RTB, and the RTFC is nonmarketable and stated at cost. For the
investments in partnerships, the equity method of accounting is used.

The investment in Choice One stock is a marketable security classified as
available for sale. Non-Qualified Deferred Compensation Plan assets are
classified as trading. The Company uses fair value reporting for marketable
investments in debt and equity securities classified as either
available-for-sale or trading. For available-for-sale securities, the unrealized
holding gains and losses, net of the related tax effect, are excluded from
earnings and are reported as a separate component of comprehensive income until
realized. Unrealized holding gains and losses on trading securities are included
in other income.

To determine if an impairment of an investment exists, the Company monitors
and evaluates the financial performance of the business in which it invests and
compares the carrying value of the investee to quoted market prices (if
available), or the fair values of similar investments, which in certain
instances, is based on traditional valuation models utilizing multiples of cash
flows. When circumstances indicate that a decline in the fair value of the
investment has occurred and the decline is

48

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
other than temporary, the Company records the decline in value as a realized
impairment loss and a reduction in the cost of the investment.

The Company currently receives patronage dividends from its investments in
businesses organized as cooperatives for Federal income tax purposes (CoBank and
RTFC stock). Patronage dividends represent cash distributions of the
cooperative's earnings and notices of allocations of earnings to the Company.
Deferred and uncollected patronage dividends are included as part of the basis
of the investment until collected. The RTB investment pays dividends annually,
at the discretion of its board of directors.

(H) PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are carried at cost. Repairs and maintenance
are charged to expense as incurred and major renewals and improvements are
capitalized. For traditional telephone companies, the original cost of
depreciable property retired, together with removal cost, less any salvage
realized, is charged to accumulated depreciation. For all other companies, the
original cost and accumulated depreciation are removed from the accounts and any
gain or loss is included in the results of operations. Depreciation is
determined using the straight-line method for financial reporting purposes.

(I) DEBT ISSUE COSTS

Debt issue costs are being amortized over the life of the related debt,
ranging from 3 to 10 years. Accumulated amortization of loan origination costs
from continuing operations was $9.3 million and $13.0 million at December 31,
2001 and 2002, respectively.

(J) GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill consists of the difference between the purchase price incurred in
acquisitions using the purchase method of accounting and the fair value of net
assets acquired.

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, BUSINESS COMBINATIONS (SFAS No. 141) and SFAS No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS (SFAS No. 142). SFAS No. 141 requires that the purchase
method of accounting be used for all business combinations initiated after
June 30, 2001, as well as all purchase method business combinations completed
after June 30, 2001. SFAS No. 141 also specifies criteria for the recognition of
intangible assets acquired apart from goodwill. SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives, including the
excess cost relating to investments accounted for using the equity method of
accounting (equity method goodwill), no longer be amortized, but instead be
tested for impairment at least annually. SFAS No. 142 also requires that
intangible assets with estimable useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 144 ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS (SFAS No. 144).

49

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

As required by SFAS No. 141, the Company adopted the provisions of SFAS
No. 141 on July 1, 2001 and SFAS No. 142 was fully adopted on January 1, 2002.
Goodwill and intangible assets determined to have an indefinite useful life
acquired in a purchase business combination completed after June 30, 2001 were
not amortized in 2001 or thereafter. Goodwill and indefinite useful life
intangible assets acquired in business combinations completed before July 1,
2001 continued to be amortized through December 31, 2001. Prior to the adoption
of SFAS No. 142, goodwill acquired in business combinations was amortized using
the straight-line method over an estimated useful life of 40 years. Amortization
of such assets ceased on January 1, 2002 upon adoption of SFAS No. 142.
Accumulated amortization of goodwill at December 31, 2001 and 2002 is
$34.3 million.

In connection with the transitional goodwill impairment evaluation performed
as of January 1, 2002, SFAS No. 142 required the Company to perform an
assessment of whether there was an indication that goodwill was impaired as of
the date of adoption. To accomplish this, the Company was required to identify
its reporting units and determine the carrying value of each reporting unit by
assigning the assets and liabilities, including the existing goodwill and
intangible assets, to those reporting units as of January 1, 2002. The Company
was required to determine the fair value of each reporting unit and compare it
to the carrying amount of the reporting unit within six months of January 1,
2002. In performing the initial transitional impairment test, the Company
determined that the carrying amount of its reporting unit did not exceed its
estimated fair value and, therefore, the Company did not record an impairment
loss upon adoption of SFAS No. 142. The Company updated its annual impairment
testing of goodwill as of October 1, 2002, and determined that no impairment
loss was required to be recognized in 2002.

As of the date of adoption of SFAS No. 142, the Company had unamortized
goodwill of $454.3 million and equity method goodwill of $10.3 million.
Following is the December 31, 2000 and 2001 loss from continuing operations,
adjusted as if SFAS No. 142 had been effective as of January 1, 2000, compared
to actual results for the year ended 2002.

As of the date of adoption, the Company had $1.8 million in covenants not to
compete that are intangible assets subject to amortization under SFAS No. 142.
The covenants not to compete are being amortized over their useful lives of
three to five years. Accumulated amortization of covenants not to compete was
$3.9 million and $4.9 million at December 31, 2001 and 2002, respectively. The
Company recorded amortization of $1.2 million, $1.2 million, and $1.0 million
for the years ended December 31, 2000, 2001, and 2002, respectively. The Company
will continue to amortize the covenants over their remaining estimated useful
lives and will record amortization of $0.7 million during 2003 and $0.1 million
during 2004.

50

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(K) IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets, such as property, plant, and equipment, and purchased
intangibles subject to amortization, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell, and depreciation ceases.

Goodwill and intangible assets not subject to amortization are tested
annually for impairment following the adoption of SFAS No. 142. Prior to the
adoption of SFAS No. 142, the Company evaluated the recoverability of goodwill
pursuant to Accounting Principles Board Opinion No. 17, INTANGIBLE ASSETS, and
used estimates of future cash flows in periodically evaluating goodwill for
impairment. An impairment loss is recognized to the extent that the carrying
amount exceeds the asset's estimated fair value.

(L) INCOME TAXES

Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

FairPoint Communications, Inc. files a consolidated income tax return with
its subsidiaries. The Company has a tax sharing agreement in which all
subsidiaries are participants. All intercompany tax transactions and accounts
have been eliminated in consolidation.

(M) INTEREST RATE SWAP AGREEMENTS

The Company assesses interest rate cash flow risk by continually identifying
and monitoring changes in interest rate exposures that may adversely impact
expected future cash flows and by evaluating hedging opportunities. The Company
maintains risk management control systems to monitor interest rate cash flow
risk attributable to both the Company's outstanding or forecasted debt
obligations. The risk management control systems involve the use of analytical
techniques, including cash flow sensitivity analysis, to estimate the expected
impact of changes in interest rates on the Company's future cash flows.

The Company uses variable and fixed-rate debt to finance its operations,
capital expenditures, and acquisitions. The variable-rate debt obligations
expose the Company to variability in interest payments due to changes in
interest rates. Management believes it is prudent to limit the variability of a
portion of its interest payments. To meet this objective, management enters into
interest rate swap agreements to manage fluctuations in cash flows resulting
from interest rate risk. These swaps change the

51

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
variable-rate cash flow exposure on the debt obligations to fixed cash flows.
Under the terms of the interest rate swaps, the Company receives variable
interest rate payments and makes fixed interest rate payments, thereby creating
the equivalent of fixed-rate debt. As of December 31, 2002, the Company had
seven interest rate swap agreements with a combined notional amount of
$225.0 million and expiration dates ranging from May 2003 through May 2004.

In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND CERTAIN HEDGING ACTIVITIES (SFAS No. 133). In June 2000, the
FASB issued SFAS No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND
CERTAIN HEDGING ACTIVITIES, AN AMENDMENT TO SFAS 133 (SFAS No. 138). SFAS
No. 133 and SFAS No. 138 require that all derivative instruments be recorded on
the balance sheet at their respective fair values. The Company adopted SFAS
No. 133 and SFAS No. 138 on January 1, 2001. In accordance with the transition
provisions of SFAS No. 133, the Company recorded a cumulative-effect-type loss
adjustment (the "transition adjustment") of $(4.7) million in other
comprehensive income (loss) to recognize at fair value all interest rate swap
agreements. The fair value of the Company's interest rate swap agreements is
determined from valuations received from financial institutions. The fair value
indicates an estimated amount the Company would pay if the contracts were
cancelled or transferred to other parties. At December 31, 2002, the Company
expects to reclassify to nonoperating income (expense) during the next
12 months $1.0 million from the transition adjustment that was recorded in other
comprehensive income (loss).

Effective January 1, 2001, the Company discontinued hedge accounting
prospectively on its existing interest rate swap agreements because the
agreements do not qualify as accounting hedges under SFAS No. 133. As of
December 31, 2001 and 2002, the fair value of all outstanding interest rate swap
agreements used in continuing operations was $10.7 million and $8.6 million,
respectively. The change in the fair value of the interest rate swap agreements
of $6.9 million and $(2.1) million during 2001 and 2002, respectively, has been
recorded in the statement of operations as a charge (credit) to nonoperating
income (expense). In addition, $1.2 million and $1.4 million has been
reclassified as nonoperating income (expense) from the transition adjustment
recorded in other comprehensive income (loss) during 2001 and 2002,
respectively.

On May 1, 2001, the Company entered into an interest swap with a notional
amount of $25 million that was being accounted for as a cash flow hedge under
the provisions of SFAS No. 133. The effective portion of the loss on this
interest rate swap ($0.6 million) was being recorded in other comprehensive
income (loss) through the third quarter of 2001. In association with the
discontinued operations of the competitive communications business at Carrier
Services and the bank negotiations in relation to the Carrier Services' Credit
Facility (see Note 2), as of December 31, 2001, the Company discontinued hedge
accounting on this swap. As of December 31, 2001, the fair value of this
interest rate swap was $0.6 million, and was recorded in the statement of
operations as a charge to discontinued operations. In addition, the Company
reclassified $0.6 million from other comprehensive income (loss) to discontinued
operations from the translation adjustment recorded on January 1, 2001 for the
other remaining interest rate swap (notional amount of $50 million) used by the
Company for the Carrier Services' Credit Facility. The fair market value of this
swap was $2.6 million at December 31, 2001. At December 31, 2001, these interest
rate swaps were classified as current liabilities of discontinued operations on
the consolidated balance sheet at their respective fair values. These interest
rate swaps were settled in May 2002 in conjunction with the restructuring of
Carrier Services' Credit Facility (see Note 2).

52

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Amounts receivable or payable under interest rate swap agreements are
accrued at each balance sheet date and included as adjustments to interest
expense.

(N) STOCK APPRECIATION RIGHTS

Stock appreciation rights have been granted to certain members of management
by principal shareholders of the Company. The Company accounts for stock
appreciation rights in accordance with Financial Accounting Standards Board
Interpretation No. 28, ACCOUNTING FOR STOCK APPRECIATION RIGHTS AND OTHER
VARIABLE STOCK OPTION OR AWARD PLANS. The Company measures compensation as the
amount by which the market value of the shares of the Company's stock covered by
the grant exceeds the option price or value specified, by reference to a market
price or otherwise, subject to any appreciation limitations under the plan and a
corresponding credit to additional paid-in capital. Changes, either increases or
decreases, in the market value of those shares between the date of the grant and
the measurement date result in a change in the measure of compensation for the
right. Valuation of stock appreciation rights is typically based on traditional
valuation models utilizing multiples of cash flows, unless there is a current
market value for the Company's stock.

(O) STOCK OPTION PLANS

At December 31, 2002, the Company has three stock-based employee
compensation plans, which are described more fully in Note 11. The Company
accounts for its stock option plans using the intrinsic value-based method
prescribed by Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES (APB No. 25), and related interpretations. As such,
compensation expense is recorded on the date of grant only if the current market
price of the underlying stock exceeds the exercise price. SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION (SFAS No. 123), permits entities to
recognize as expense over the vesting period the fair value of all stock-based
awards on the date of grant. SFAS No. 123 allows entities to continue to apply
the provisions of APB No. 25 and provide pro forma net income disclosures as if
the fair-value method defined in SFAS No. 123 had been applied. The Company has
elected to continue to apply the intrinsic value-based method of accounting
under APB No. 25 and has adopted the disclosure requirements of SFAS No. 123.

Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No. 123, the Company's net income
(loss) would have been:

The pro forma impact on income for the year ended December 31, 2000 assumes
no options will be forfeited. During 2000, the Company recorded compensation
expense under the provisions of APB

53

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
No. 25 in excess of the amounts that would have been recognized under the
provisions of SFAS No. 123. The pro forma impact on income for the year ended
December 31, 2001 assumes estimated forfeitures for those employees subject to
termination due to the discontinued competitive communications operations. The
pro forma impact on income for the year ended December 31, 2002 assumes
estimated forfeitures for an employee who retired in January 2003. The
stock-based compensation expense does not agree to the consolidated statement of
operations due to the credit adjustments related to the stock appreciation
rights of $(0.9) million and $(0.3) million for the years ended December 31,
2001 and 2002, respectively. The pro forma effects are not representative of the
effects on reported net income for future years.

(P) RECLASSIFICATIONS

Certain amounts have been reclassified to conform to the 2002 consolidated
financial statement presentation. One of these reclassifications include
mark-to-market adjustments for interest rate swaps (previously classified as
interest expense) to other nonoperating income (expense).

On January 1, 2002, the Company adopted the provisions of SFAS No. 144. SFAS
No. 144 addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. Based on the provisions of SFAS No. 144, the
assets and liabilities related to the discontinued competitive communications
operations are presented separately in the asset and liability sections,
respectively, on the accompanying December 31, 2002 consolidated balance sheet.
The December 31, 2001 consolidated balance sheet has been reclassified for
comparative purposes. There was no change to the measurement of the Company's
provisions for discontinued operations as the Company initiated its plan of
disposal prior to December 31, 2001.

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES

On October 19, 2001, Carrier Services entered into an agreement to sell
certain assets of its competitive communications operations relating to its
business and operations in the northwest United States to Advanced
TelCom, Inc., a wholly owned subsidiary of Advance TelCom Group, Inc. (ATG). The
sale of these assets was completed on December 10, 2001. Total proceeds from the
sale of these assets was $3.4 million, including $0.9 million from the sale of
accounts receivable. The Company recorded a gain of $0.4 million from the sale
of these assets.

On November 7, 2001, Carrier Services entered into an agreement with Choice
One and certain affiliates of Choice One to sell certain assets of its
competitive communications operations relating to its business and operations in
the northeast United States. The sale of these assets was completed on
December 19, 2001. Total proceeds from the sale of these assets was
$5.6 million in cash, including $3.5 million from the sale of accounts
receivable, and 2,500,000 restricted shares of Choice One common stock (valued
at $7.9 million at December 19, 2001). The Company recorded a loss of
$31.5 million from the sale of these assets. Included in the terms of the Choice
One sales agreement was an opportunity for the Company to earn additional
restricted shares of Choice One common stock based on the number of access lines
converted to the Choice One operating platform 120 days after closing. In
April 2002, Carrier Services earned an additional 1,000,000 restricted shares of
Choice One common stock under these provisions, bringing the total shares
received to 3,500,000. The 1,000,000

54

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES (CONTINUED)
additional shares earned was recognized in 2002 as a gain of $0.8 million,
classified within discontinued operations.

In connection with the sale of assets to Choice One, on November 7, 2001,
the Company announced its plan to discontinue the remaining operations of its
competitive communications business within its wholly owned subsidiary, Carrier
Services, and notified its remaining customers in the southwest, southeast, and
mid-Atlantic competitive markets to find alternative carriers.

The transition of customers to ATG, Choice One, or alternative carriers was
completed in April 2002.

As a result of the adoption of the plan to discontinue the operations of the
competitive communications operations, these operating results are presented as
discontinued operations. The financial results of the competitive operations for
2000 and through November 7, 2001 are presented in the consolidated statements
of operations as losses from discontinued competitive communications operations.
In connection with the discontinuance of the competitive operations, the Company
also recognized a charge in 2001 of $95.3 million to recognize a loss on
disposal of its competitive communications operations. This charge included the
gain of $0.4 million and loss of $31.5 million from the sale of assets to ATG
and Choice One, respectively, the write off of the remaining competitive
operating assets, including property, plant, and equipment of $36.1 million, and
$28.1 million for expenses the Company estimated it would incur during the
phase-out period, net of estimated revenue to be received from customers until
they were transitioned to other carriers and ATG and Choice One for transition
services. The estimated expenses for the phase-out period included interest
expense. Interest expense was allocated to discontinued operations based on the
interest incurred by the Company under its senior secured credit facility (the
Carrier Services' Credit Facility) and the two interest rate swaps related to
this facility.

On November 28, 2001, Carrier Services completed an amendment to the Carrier
Services' Credit Facility, pursuant to which Carrier Services' lenders waived
certain restrictions with respect to the sale by Carrier Services of certain of
its northwest assets to ATG. On December 19, 2001, Carrier Services completed
another amendment on this credit facility which provided for such lenders'
consent to the sale of certain of Carrier Services' northeast assets to Choice
One and for the lenders' forbearance, until March 31, 2002, from exercising
their remedies under the Carrier Services' Credit Facility for certain
enumerated potential covenant breaches and potential events of default
thereunder.

On May 10, 2002, Carrier Services entered into an Amended and Restated
Credit Agreement with its lenders to restructure the obligations of Carrier
Services and its subsidiaries under the Carrier Services' Credit Facility. In
connection with such restructuring, (i) Carrier Services paid certain of its
lenders $5.0 million to satisfy $7.0 million of the obligations under the
Carrier Services' Credit Facility, (ii) the lenders converted $93.9 million of
the loans and obligations under the Carrier Services' Credit Facility into
shares of the Company's Series A Preferred Stock having a liquidation preference
equal to the amount of the loans and obligations under the Carrier Services'
Credit Facility, and (iii) the remaining loans under the Carrier Services'
Credit Facility and Carrier Services' obligations under its swap arrangements
were converted into $27.9 million aggregate principal amount of new term loans.

55

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES (CONTINUED)

As a result of this restructuring, in 2002, the Company recorded a gain in
discontinued operations of $17.5 million for the extinguishment of debt and
settlement of its interest rate swap agreements. The gain represents the
difference between the May 10, 2002 carrying value of $128.8 million of retired
debt ($125.8 million) and related swap obligations ($3.0 million) and the sum of
the aggregate value of the cash paid ($5.0 million) plus principal amount of new
term loans ($27.9 million) plus the estimated fair value of the Company's
Series A Preferred Stock issued ($78.4 million).

See Note 6 and Note 7 for the terms of the new loans and the Company's
Series A Preferred Stock, respectively.

Under the provisions of SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, the Company had previously reported two
segments: traditional telephone operations and competitive communications
operations. The traditional telephone operations provide local, long distance
and other communication services to customers in rural communities in which
competition is currently limited for local telecommunications services. The
competitive communications operations provided local, long distance, and other
communication services to customers in markets outside of the Company's
traditional telephone markets. The Company's reportable segments were strategic
business units that offered similar telecommunications related products and
services in different markets. They were managed separately because each segment
required different marketing and operational strategies related to the providing
of local and long distance communications services.

Selected information from discontinued operations for the years ended
December 31, 2000 and 2001 follows:

56

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES (CONTINUED)
Assets and liabilities of discontinued operations as of December 31, 2001
and 2002 follows:

At December 31, 2001, Carrier Services' outstanding debt ($125.8 million)
and the fair value of its interest rate swaps ($3.2 million) was classified in
current liabilities of discontinued operations. In connection with Carrier
Services' debt restructuring, as of May 10, 2002, the converted loans of
$27.9 million have been classified as long-term debt as these loans will be
serviced through continuing operations. Investments in marketable securities
(consisting of Choice One stock) were also reclassified from discontinued
operations to other current assets as these investments upon liquidation will
fund the debt service requirements of Carrier Services' debt.

In December 2000, the Company initiated a realignment and restructuring of
its competitive communications business, which resulted in the Company recording
an initial charge of $16.5 million to losses from discontinued operations.

Of the initial restructuring charge, $3.3 million related to employee
termination benefits and other employee termination related costs. The Company
terminated 360 positions in December 2000. These reductions resulted from
organizational changes within the operations and sales offices of Carrier
Services, including closing facilities in several states. The operation centers
in Birmingham, Alabama and Dallas, Texas were closed and consolidated to Carrier
Services' central operating facility in Albany, New York. Carrier Services also
closed 15 of 41 district sales offices, including all those in the southeast and
southwest regions of the United States.

The restructuring charge included $10.3 million in contractual obligations
for equipment, occupancy, and other lease terminations and other facility exit
costs incurred as a direct result of this plan. The restructuring charge also
included $2.9 million, net of salvage value, for the write-down of property,
plant, and equipment. These assets primarily included leasehold improvements,
furniture, and office equipment. Estimated salvage values were based on
estimates of proceeds upon sale of certain of

57

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES (CONTINUED)
the affected assets. There were also $0.1 million of other incremental costs
incurred as a direct result of the restructuring plan.

In the first quarter of 2001, the Company completed its plans for the
restructuring of operations at Carrier Services, which resulted in recording a
charge of $33.6 million. Of the total first quarter 2001 restructuring charge,
$3.4 million related to employee termination benefits and other employee
termination related costs. The Company terminated 365 positions in
January 2001. Certain positions were eliminated at the central operating
facility in Albany, New York, and at the corporate office in Charlotte, North
Carolina. In addition, another 11 sales offices were closed and staff at the
remaining sales offices were reduced.

The restructure charge in the first quarter of 2001 included $12.2 million
in contractual obligations for equipment, occupancy, and other lease
terminations and other facility exit costs incurred as a direct result of the
plan. The restructuring charge also included $17.9 million, net of salvage
value, for the write-down of property, plant, and equipment. There were also
$0.1 million of other incremental costs incurred as a direct result of the
restructuring plan.

At December 31, 2001, the remaining liabilities associated with the
restructuring were limited to contractual obligations related to equipment and
lease terminations. These liabilities were re-evaluated and the original
obligation of $22.5 million was increased by $1.9 million. The original
estimates associated with the other obligations were adjusted as reflected in
the following table and the obligations were satisfied as of December 31, 2001.
During 2002, the Company entered into arrangements related to certain leases and
revised its assumptions on certain other remaining leases. For these reasons,
there was a reduction to the remaining restructure obligation of $1.2 million.
This reduction has been recognized as a gain and classified within discontinued
operations for the year ended December 31, 2002.

58

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES (CONTINUED)
Selected information relating to the restructuring charge follows:

In June 2001, the Company restructured the operations of Carrier Services'
NetLever division, which resulted in a charge of $1.5 million. NetLever was
Carrier Services' internal group responsible for web site development and web
hosting services. The Company's management undertook a review of NetLever and
decided to discontinue supporting these web-related services internally. The
restructure charge included $0.3 million relating to employee termination
benefits and other employee termination related costs. The Company terminated 22
positions in June 2001 and an additional seven positions in October 2001.

The restructure charge also included $0.1 million in lease terminations and
other facility exit costs incurred as a direct result of the plan and
$0.9 million, net of salvage value, for the write-down of property, plant, and
equipment. There were also $0.2 million of other incremental costs incurred as a
direct result of the restructuring plan. In the fourth quarter of 2001, the
Company recognized an additional restructure charge of $1.9 million and
adjustments were made among restructuring expense classifications to properly
reflect the actual costs incurred. At December 31, 2001, there were no
obligations remaining related to the NetLever restructuring.

59

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(2) DISCONTINUED OPERATIONS AND RESTRUCTURE CHARGES (CONTINUED)
Selected information relating to the NetLever restructure charge follows:

(3) ACQUISITIONS

On April 3, 2000, the Company acquired 100% of the common stock of GT Com
and Peoples. On June 1, 2000, the Company acquired 100% of the common stock of
Fremont and Fretel. On July 3, 2000, the Company acquired 100% of the common
stock of Comerco. The aggregate purchase price for these acquisitions was
$276.2 million, including $6.0 million issued in common stock. The Fremont
acquisition was completed using cash and the issuance of 457,318 shares of
Class A common stock of the Company valued at $13.12 per share.

On September 4, 2001, the Company acquired 100% of the common stock of
Marianna. On September 28, 2001, the Company acquired certain assets of Illinois
Consolidated Telephone Company. The aggregate purchase price for these
acquisitions was $23.5 million.

Acquisition costs were $1.0 million and $0.3 million in 2000 and 2001,
respectively. The acquisitions have been accounted for using the purchase method
and, accordingly, the results of their operations have been included in the
Company's consolidated financial statements from the date of acquisition. The
excess of the purchase price and acquisition costs over the fair value of the
net identifiable assets acquired was $231.2 million and $14.4 million and has
been recognized as goodwill in 2000 and 2001, respectively.

60

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(3) ACQUISITIONS (CONTINUED)
The allocation of the total net purchase price for the 2000 and 2001
acquisitions are shown in the table below:

The following unaudited pro forma information presents the combined results
of operations of the Company as though the acquisitions occurred at the
beginning of the preceding year. These results include certain adjustments,
including increased interest expense on debt related to the acquisitions,
certain preacquisition transaction costs, and related income tax effects. The
pro forma financial information does not necessarily reflect the results of
operations if the acquisitions had been in effect at the beginning of the period
or which may be attained in the future.

(4) PROPERTY, PLANT, AND EQUIPMENT

A summary of property, plant, and equipment from continuing operations is
shown below:

61

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(4) PROPERTY, PLANT, AND EQUIPMENT (CONTINUED)
The telephone company composite depreciation rate for property and equipment
was 7.80%, 7.58%, and 7.48% in 2000, 2001, and 2002, respectively. Depreciation
expense from continuing operations for the years ended December 31, 2000, 2001,
and 2002 was $35.8 million, $42.5 million, and $45.9 million, respectively.

(5) INVESTMENTS

The cost, unrealized holding gains and losses, and fair value of the
Company's marketable equity investments classified as available-for-sale, at
December 31, 2001 and 2002 are summarized below:

At December 31, 2001, the fair value of the Choice One stock of $7,900,000
was classified with the net current liabilities of discontinued operations. As
discussed in Note 2, during 2002, the Choice One stock was reclassified from
discontinued operations to investments available for sale.

Proceeds from sales of available-for-sale securities were $14.4 million,
$1.1 million, and $0.4 million in 2000, 2001, and 2002, respectively. Gross
gains of $4.0 million, $1.0 million, and approximately $7,000 in 2000, 2001, and
2002, respectively, were realized on those sales.

The Company's noncurrent investments at December 31, 2001 and 2002 consist
of the following:

62

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(5) INVESTMENTS (CONTINUED)

The Company records its share of the earnings or losses of the investments
accounted for under the equity method on a three month lag. The investments
accounted for under the equity method and the Company's ownership percentage as
of December 31, 2001 and 2002 are summarized below:

Proceeds from sales of investments accounted for under the equity method
were $4.5 million and $0.2 million in 2000 and 2001, respectively. Gross gains
of $2.0 million and approximately $43,000, respectively, were realized on those
sales. There were no sales of investments accounted for under the equity method
during 2002.

Summary financial information for the Orange County-Poughkeepsie Limited
Partnership accounted for under the equity method follows:

Chouteau Cellular Telephone Company (a limited partnership in which the
Company holds a 1.0% general partner interest and a 32.67% limited partner
interest) is an investment vehicle which holds a 25% member interest in
Independent Cellular Telephone, LLC ("ICT"). ICT in turn is an investment
vehicle which holds a 44.45% member interest in United States Cellular Telephone
of Greater Tulsa,

63

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(5) INVESTMENTS (CONTINUED)
LLC ("Tulsa, LLC"). Because Tulsa, LLC is the actual operating entity within the
overall investment structure, its summary financial information is presented
below, rather than summary information for the Chouteau Cellular Telephone
Company, which is the actual entity accounted for under the equity method on the
books of the Company:

In addition to holding the 44.45% member interest in Tulsa, LLC, ICT has
long-term debt consisting of variable rate borrowings (5.50% at December 31,
2002) under a loan agreement with RTFC, due in quarterly installments of
$0.7 million including interest through 2006. The note is collateralized by the
assets of ICT, including its investment in Tulsa, LLC. The RTFC debt balance at
December 31, 2002 was $8.4 million. The Company has issued an unsecured
guarantee on the RTFC debt. As of December 31, 2002, the unsecured guarantee was
$2.1 million.

64

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(5) INVESTMENTS (CONTINUED)
Summary combined financial information for the Illinois Valley Cellular RSA
2--I Partnership and Illinois Valley Cellular RSA 2--III Partnership accounted
for under the equity method follows:

The Company continually evaluates its investment holdings for evidence of
impairment. During 2002, the Company determined that the decline in market value
of its Choice One common stock was "other than temporary." As such, the Company
recorded a noncash charge of $8.2 million. This charge is classified with the
impairment on investments in the consolidated statement of operations.

During 2002, the Company determined that the carrying amount exceeded the
estimated fair value of some investments accounted for under the equity method.
As such, the Company recorded a noncash charge of $1.7 million and
$2.7 million, respectively, for the Chouteau Cellular Telephone Company and
Illinois Valley Cellular RSA 2--I, II and III partnership investments. These
charges are classified with the impairment on investments in the consolidated
statement of operations.

65

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(6) LONG-TERM DEBT

Long-term debt at December 31, 2001 and 2002 is shown below:

As discussed in Note 2, the December 31, 2001 outstanding balance on the
Carrier Services' senior secured notes is classified with current liabilities of
discontinued operations in the accompanying consolidated balance sheet. In
connection with Carrier Services' debt restructuring, as of May 10, 2002, the
converted loans (December 31, 2002 balance of $28.8 million) have been
classified as long-term debt as these loans will be serviced through continuing
operations.

The approximate aggregate maturities of long-term debt for each of the five
years subsequent to December 31, 2002 are as follows (dollars in thousands):

Fiscal year:
2003...................................................... $ 5,704
2004...................................................... 175,171
2005...................................................... 102,414
2006...................................................... 79,796
2007...................................................... 35,065
Thereafter................................................ 406,040
--------
$804,190
========

66

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(6) LONG-TERM DEBT (CONTINUED)
SENIOR SECURED NOTES

On March 30, 1998, the Company closed a $315 million senior secured credit
facility (the Credit Facility) which committed $75 million of term debt (tranche
C) amortized over nine years, $155 million of term debt (tranche B) amortized
over eight years, and an $85 million reducing revolving credit facility
(revolving facility) with a term of 6.5 years. On March 14, 2000, an additional
$165 million reducing revolving credit facility (acquisition facility) with a
term of 4.5 years was committed and available to the Company under the Credit
Facility. At December 31, 2002, $60 million was outstanding on the revolving
facility and $97.7 million was outstanding on the revolving acquisition
facility. The Credit Facility requires that the Company maintain certain
financial covenants. As of December 31, 2002, these financial covenants limited
the commitment available under the revolving and revolving acquisition
facilities to $66.0 million. Borrowings under the Credit Facility bear interest
at a rate based, at the option of the Company, on the participating banks' prime
rate or Eurodollar rate, plus an incremental rate of 2.5%, 2.25%, 1.75%, and
1.75% for the prime rate and 4.0%, 3.75%, 2.75%, and 2.75% for the Eurodollar
margins for the tranche C, tranche B, revolving facility, and acquisition
facility, respectively. In addition to annual administrative agent's fees, the
Company pays fees of 1/2% per annum on the aggregate unused portion of the
tranche B, revolving facility, and acquisition facility commitments.

The Company used six interest rate swap agreements, with notional amounts of
$25 million each, to effectively convert a portion of its variable interest rate
exposure under the Credit Facility to fixed rates ranging from 8.07% to 10.34%.
The expiration dates of the swap agreements range from November 2003 to
May 2004.

The Credit Facility contains various restrictions, including those relating
to payment of dividends by the Company. In management's opinion, the Company has
complied with all such requirements. The Credit Facility is also secured by a
perfected first priority pledge of the stock of certain subsidiaries of the
Company. The Credit Facility is guaranteed by four of the Company's intermediary
holding companies, subject to contractual or regulatory restrictions.

The Company amended its Credit Facility in July 2002 to provide for a letter
of credit sub-facility. The amendment will provide the ability to request
letters of credit to support obligations of the Company incurred in the ordinary
course of business in an aggregate principal amount not to exceed $5.0 million
and subject to limitations on the aggregate amount outstanding under the Credit
Facility. As of December 31, 2002, $0.4 million had been issued under this
letter of credit.

SENIOR SUBORDINATED NOTES DUE 2008

On May 5, 1998, the Company consummated a debt offering consisting of
$125 million in aggregate principal amount of Senior Subordinated Notes due 2008
(the Fixed Rate Notes), and $75 million in aggregate principal amount of
Floating Rate Callable Securities due 2008 (the Floating Rate Notes). The notes
are unsecured obligations of the Company and are subordinated to all existing
and future senior indebtedness. Interest on the notes is payable semiannually.
Interest on the Fixed Rate Notes is 9.5% and interest on the Floating Rate Notes
is equal to a rate per annum at LIBOR plus 418.75 basis points. As to the
Floating Rate Notes, the Company used an interest rate swap agreement, with a
notional amount of $75 million, to manage its exposure on its variable interest
rate

67

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(6) LONG-TERM DEBT (CONTINUED)
risk by converting the interest cost to a fixed rate of 10.78% for a substantial
portion (though not entirely) of the term of the notes. The swap agreement
expires in May 2003.

The Fixed Rate Notes are redeemable, in whole or in part, at the option of
the Company, at any time on or after May 1, 2003 at redemption prices (expressed
as a percentage of the principal amount) declining annually from 104.7%
beginning May 1, 2003 to 100% beginning May 1, 2006 and thereafter, together
with accrued interest to the redemption date and subject to certain conditions.
Notwithstanding the foregoing, the Company may redeem up to 35% of the aggregate
principal amount of the Fixed Rate Notes at a redemption price of 109.5% of the
principal amount thereof plus accrued and unpaid interest, if any, to the
redemption date, with the proceeds of an equity offering.

The Floating Rate Notes are redeemable, in whole or in part, at any time at
the option of the Company, at redemption prices (expressed as a percentage of
the principal amount) declining annually from 105% beginning May 1, 1998 to 100%
beginning May 1, 2003 and thereafter, together with accrued interest to the
redemption date and subject to certain conditions.

The Fixed and Floating Rate Notes' indenture places certain restrictions on
the ability of the Company to (i) incur additional indebtedness, (ii) make
restricted payments (dividends, redemptions, and certain other payments),
(iii) incur liens, (iv) issue and sell stock of a subsidiary, (v) sell or
otherwise dispose of property, business, or assets, (vi) enter into sale and
leaseback transactions, (vii) engage in business other than the communications
business, and (viii) engage in transactions with affiliates. In management's
opinion, the Company has complied with all such requirements.

SENIOR SUBORDINATED NOTES DUE 2010

On May 24, 2000, the Company consummated a debt offering consisting of
$200 million in aggregate principal amount of Senior Subordinated Notes due 2010
(the 2010 Notes). The 2010 Notes are unsecured obligations of the Company and
are subordinated to all existing and future senior indebtedness. Interest on the
2010 Notes is 12.5%, payable semiannually.

The 2010 Notes are redeemable, in whole or in part, at the option of the
Company, at any time on or after May 1, 2005 at redemption prices (expressed as
a percentage of the principal amount) declining annually from 106.25% beginning
May 1, 2005 to 100% beginning May 1, 2008 and thereafter, together with accrued
interest to the redemption date and subject to certain conditions.
Notwithstanding the foregoing, on or prior to May 1, 2003, the Company may
redeem up to 35% of the aggregate principal amount of the 2010 Notes at a
redemption price of 112.5% of the principal amount thereof plus accrued and
unpaid interest, if any, to the redemption date, with the proceeds of an equity
offering.

The 2010 Notes indenture places certain restrictions on the ability of the
Company to (i) incur additional indebtedness, (ii) make restricted payments
(dividends, redemptions, and certain other payments), (iii) incur liens,
(iv) issue and sell stock of a subsidiary, (v) sell or otherwise dispose of
property, business, or assets, (vi) enter into sale and leaseback transactions,
(vii) engage in business other than the telecommunications business, and
(viii) engage in transactions with affiliates. In management's opinion, the
Company has complied with all such requirements.

68

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(6) LONG-TERM DEBT (CONTINUED)
CARRIER SERVICES' SENIOR SECURED NOTES

On May 10, 2002, Carrier Services entered into an Amended and Restated
Credit Agreement with its lenders to restructure the obligations of Carrier
Services and its subsidiaries under the Carrier Services' Credit Facility. In
connection with such restructuring, (i) Carrier Services paid certain of its
lenders $5.0 million to satisfy $7.0 million of the obligations under the
Carrier Services' Credit Facility, (ii) the lenders converted $93.9 million of
the loans and obligations under the Carrier Services' Credit Facility into
shares of the Company's Series A Preferred Stock having a liquidation preference
equal to the amount of the loans and obligations under the Carrier Services'
Credit Facility, and (iii) the remaining loans under the Carrier Services'
Credit Facility and Carrier Services' obligations under its swap arrangements
were converted into $27.9 million aggregate principal amount of new term loans.

As a result of this restructuring, in 2002, the Company recorded a gain
classified within discontinued operations of $17.5 million for the
extinguishment of debt and settlement of its interest rate swap agreements. The
gain represents the difference between the May 10, 2002 carrying value of
$128.8 million of retired debt ($125.8 million) and related swap obligations
($3.0 million) and the sum of the aggregate value of the cash paid
($5.0 million) plus principal amount of new term loans ($27.9 million) plus the
estimated fair value of the Company's Series A Preferred Stock issued
($78.4 million).

The converted loans under the new Carrier Services' Amended and Restated
Credit Agreement consist of two term loan facilities: (i) Tranche A Loans in the
aggregate principal amount of $8.7 million and (ii) Tranche B Loans in the
aggregate principal amount of $19.2 million, each of which matures in May 2007.
Interest on the new loans is payable monthly and accrues at a rate of 8% per
annum; provided, however, that upon an event of default the interest rate shall
increase to 10% per annum. Interest on the Tranche A Loans must be paid in cash
and interest on Tranche B Loans may be paid, at the option of Carrier Services,
either in cash or in kind. For the year ended December 31, 2002, $0.9 million in
additional debt was issued to satisfy the accrued in kind interest on the
Tranche B loans. The principal of the Tranche A Loans is due at maturity and the
principal of the Tranche B Loans is payable as follows: (a) $2,062,000 is due on
September 30, 2004; (b) $4,057,000 is due on September 30, 2005; (c) $5,372,000
is due on September 30, 2006; and (d) the remaining principal balance is due at
maturity.

The loans under the new Carrier Services' Amended and Restated Credit
Agreement are guaranteed by certain of Carrier Services' subsidiaries and are
secured by substantially all of the assets of Carrier Services and its
subsidiaries. The Company has not guaranteed the debt owed to the lenders under
the new Carrier Services' Amended and Restated Credit Agreement nor does the
Company have any obligation to invest any additional funds in Carrier Services.
Further, the Company's Credit Facility and the indentures governing the
Company's senior subordinated notes contain significant restrictions on the
Company's ability to make investments in Carrier Services. Under a tax sharing
agreement, FairPoint is obligated to reimburse Carrier Services for any tax
benefits it receives from net operating losses generated by Carrier Services. At
December 31, 2002, the amount payable to Carrier Services under the tax sharing
agreement was approximately $3.1 million.

Voluntary prepayments of the new loans may be made at any time without
premium or penalty. Carrier Services is also required to make mandatory
prepayments of principal from certain sources including the net proceeds from
asset sales and from excess cash flow generated by its long distance business.

69

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(6) LONG-TERM DEBT (CONTINUED)

Upon an event of default under the new Carrier Services' Amended and
Restated Credit Agreement and the acceleration of the loans thereunder, at the
option of the relevant lender, such loans may be converted into the Company's
Series A Preferred Stock pursuant to the terms of the Amended and Restated
Preferred Stock Issuance and Capital Contribution Agreement (Preferred Stock
Issuance Agreement).

OTHER

In conjunction with the senior notes payable to the RTFC and the RTB and the
first mortgage notes payable to the Rural Utilities Service, certain of the
Company's subsidiaries are subject to restrictive covenants limiting the amounts
of dividends that may be paid.

The Company also has $0.4 million unsecured demand notes payable to various
individuals and entities with interest payable at 5.25% at December 31, 2002.

The FASB issued SFAS No. 145, RECISSION OF FASB STATEMENTS NO. 4, 44, AND
64, AMENDMENT OF FASB STATEMENT NO. 13 AND TECHNICAL CORRECTIONS (SFAS No. 145)
during 2002. This statement eliminates the requirement that gains and losses
from extinguishments of debt be required to be aggregated and, if material,
classified as an extraordinary item, net of related income tax effect. The
statement requires gains and losses from extinguishment of debt be classified as
extraordinary items only if they meet the criteria in Accounting Principles
Board Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS--REPORTING THE EFFECTS
OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND
INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS, which provides guidance for
distinguishing transactions that are part of an entity's recurring operations
from those that are unusual or infrequent or that meet the criteria for
classification as an extraordinary item. The Company adopted SFAS No. 145 in the
second quarter of 2002. The adoption of SFAS No. 145 did not affect the
financial statements in 2000, 2001, and 2002, as there were no extinguishments
of debt during these periods. During 2002, the Company recognized a
$17.5 million gain for the extinguishment of the Carrier Services' debt and
settlement of its interest rate swap agreements. This gain is classified within
discontinued operations.

(7) REDEEMABLE PREFERRED STOCK

The Series A Preferred Stock issued to the lenders in connection with
Carrier Services debt restructuring, and any Series A Preferred Stock issuable
pursuant to the Preferred Stock Issuance Agreement, is nonvoting, except as
required by applicable law, and is not convertible into common stock of the
Company. The Series A Preferred Stock provides for the payment of dividends at a
rate equal to 17.428% per annum. Dividends on the Series A Preferred Stock are
payable, at the option of the Company, either in cash or in additional shares of
Series A Preferred Stock. The Company has the option to redeem any outstanding
Series A Preferred Stock at any time. The redemption price for such shares is
payable in cash in an amount equal to $1,000 per share plus any accrued but
unpaid dividends thereon (the Preference Amount). Under certain circumstances,
the Company would be required to pay a premium of up to 6% of the Preference
Amount in connection with the redemption of the Series A Preferred Stock. In
addition, upon the occurrence of certain events, such as (i) a merger,
consolidation, sale, transfer or disposition of at least 50% of the assets or
business of the Company and its subsidiaries, (ii) a public offering of the
Company's common stock which yields in the aggregate at least $175.0 million, or
(iii) the first anniversary of the maturity of the Company's senior subordinated
notes

70

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(7) REDEEMABLE PREFERRED STOCK (CONTINUED)
(which first anniversary will occur in May 2011), the Company would be required
to redeem all outstanding shares of the Series A Preferred Stock at a price per
share equal to the Preference Amount.

The initial carrying amount of the Series A Preferred Stock has been
recorded at its fair value at the date of issuance ($78.4 million). The carrying
amount is being increased by periodic accretions, using the interest method, so
that the carrying amount will equal the mandatory redemption amount
($93.9 million) at the mandatory redemption date (May 2011). For the year ended
December 31, 2002, the Series A Preferred Stock has been increased by
$1.0 million to reflect the periodic accretions. The carrying amount of the
Series A Preferred Stock has been further increased by $10.9 million in
connection with dividends paid in-kind on the outstanding shares of the
Series A Preferred Stock. Additional paid-in capital has been decreased for the
increases in the carrying balance of the Series A Preferred Stock.

(8) EMPLOYEE BENEFIT PLANS

The Company sponsors a voluntary 401(k) savings plan (the 401(k) Plan) that
covers substantially all eligible employees. Each 401(k) Plan year, the Company
contributes to the 401(k) Plan an amount of matching contributions determined by
the Company at its discretion. For the 401(k) Plan years ended December 31,
2000, 2001, and 2002, the Company matched 100% of each employee's contribution
up to 3% of compensation and 50% of additional contributions up to 6%. The
401(k) Plan also allows for a profit sharing contribution that is made based
upon management discretion. Total Company contributions to the 401(k) Plan were
$1.7 million, $1.8 million, and $1.4 million for the years ended December 31,
2000, 2001, and 2002, respectively.

In 1999, the Company began a Non-Qualified Deferred Compensation Plan (the
NQDC Plan) that covers certain employees. The NQDC Plan allows highly
compensated individuals to defer additional compensation beyond the limitations
of the 401(k) Plan. Company matching contributions are subject to the same
percentage as the 401(k) Plan. Total Company contributions to the NQDC Plan were
approximately $38,000, $16,000, and $1,000 for the years ended December 31,
2000, 2001, and 2002, respectively. At December 31, 2001 and 2002, the NQDC Plan
assets were $0.6 million and $0.5 million, respectively. The related deferred
compensation obligation is included in other liabilities in the accompanying
consolidated balance sheets.

C&E, Taconic, and GT Com also sponsor defined contribution 401(k) retirement
savings plans for union employees. C&E, Taconic, and GT Com match contributions
to these plans based upon a percentage of pay of all qualified personnel and
make certain profit sharing contributions. Contributions to the plans were
$0.2 million, $0.2 million, and $0.3 million for the years ended December 31,
2000, 2001, and 2002, respectively.

71

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(9) INCOME TAXES

Income tax expense from continuing operations for the years ended
December 31, 2000, 2001, and 2002 consists of the following components:

Total income tax expense from continuing operations was different than that
computed by applying U. S. Federal income tax rates to losses from continuing
operations before income taxes for the years ended December 31, 2000, 2001, and
2002. The reasons for the differences are presented below:

72

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(9) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of
December 31, 2001 and 2002 are presented below:

The valuation allowance for deferred tax assets as of December 31, 2001 and
2002 was $76.6 million and $71.7 million, respectively. The change in the
valuation allowance was an increase of $72.9 million and a decrease of $(4.9)
million of which $4.1 million and $1.9 million was allocated to continuing
operations and $68.8 million and $(6.8) million to discontinued operations for
the years ended December 31, 2001 and 2002, respectively. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. In order to fully realize the deferred tax
asset, the Company will need to generate future taxable income of
$196.5 million prior to the expiration of the net operating loss carryforwards
in 2022. Taxable loss for the years ended December 31, 2001 and 2002 was
$151.4 million and $11.2 million, respectively. Based upon the level of
projections for future taxable income over the periods which the deferred tax
assets are deductible, management believes it is more likely than not the
Company will realize the benefits of these deductible differences, net of the
existing valuation allowance at December 31, 2002. The amount of the deferred
tax assets considered realizable, however, could be reduced in the near term if
estimates of future taxable income during the carry forward period are reduced.

73

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(9) INCOME TAXES (CONTINUED)
At December 31, 2002, federal and state net operating loss carryforwards of
$258.1 million expire in 2019 to 2022. At December 31, 2002, the Company has
alternative minimum tax credits of $2.3 million which may be carried forward
indefinitely.

(10) STOCKHOLDERS' EQUITY

A number of events occurred which affected the capitalization of the
Company. Those events included a stock-split in the form of a stock dividend,
authorizing additional classes of capital stock, issuing and reacquiring capital
stock for net proceeds of $158.9 million, the cancellation of put options on the
Company's common stock, issuing common stock subject to put obligations related
to a business combination, and recognizing costs for stock-based compensation to
employees.

STOCK-SPLIT

In January 2000, the Company declared a twenty-for-one stock split in the
form of a stock dividend. This stock split has been given retroactive effect in
the accompanying consolidated financial statements.

ADDITIONAL CLASSES OF CAPITAL STOCK

In April 2000, the Company amended its articles of incorporation to
authorize an aggregate of 500,000,000 shares of capital stock. Following the
amendment, the authorized share capital of the Company includes the following:

CLASS A COMMON STOCK--authorized 236,200,000 voting common shares at a
par value of $0.01 per share. Class A common shares carry one vote per
share.

CLASS B COMMON STOCK--authorized 150,000,000 nonvoting, convertible
common shares at a par value of $0.01 per share.

CLASS C COMMON STOCK--authorized 13,800,000 nonvoting, convertible
common shares at a par value of $0.01 per share. The Class C common shares
are automatically convertible into Class A common shares upon either the
completion of an initial public offering of at least $150 million of the
Company's Class A common stock or the occurrence of certain conversion
events, as defined in the articles of incorporation. The conversion rate for
the Class C common shares to Class A common shares is one-for-one.

SERIES D PREFERRED STOCK--authorized 100,000,000 nonvoting, convertible,
cumulative participating preferred shares at a par value of $0.01 per share.

Effective August 8, 2000, all regulatory approvals necessary to effectuate a
change in control were received and all outstanding Class B common and Series D
preferred shares issued during 2000 were automatically converted into an equal
number of Class A common shares. The Series D preferred shares did not provide
for the payment of dividends for up to one year following their issuance; as
such, no dividends were paid on the preferred shares during 2000.

74

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(10) STOCKHOLDERS' EQUITY (CONTINUED)

In May 2002, the Company amended and restated its certificate of
incorporation to eliminate the Series D preferred stock and to designate and
authorize the issuance of up to 1,000,000 shares of Series A preferred stock.

ISSUANCE AND REACQUISITION OF CAPITAL STOCK

In January 2000, at a price of $13.12 per share, the Company issued
4,673,920 shares of Series D preferred stock, 100,160 shares of Class A common
stock, 4,243,728 shares of Class B common stock, and 4,269,440 shares of
Class C common stock. Net proceeds from the issuance of capital stock was
$158.9 million. Direct costs of $23.9 million associated with the issuance of
this capital stock were recorded as a reduction to paid-in capital. These costs
included $9.6 million of transaction fees and expenses paid to a new principal
shareholder, transaction fees of $8.4 million which were accrued to be paid to
an existing shareholder upon liquidation of their holdings, and $0.4 million for
services rendered in consummating the transaction paid to a law firm in which a
partner of the firm is a shareholder of the Company.

In January 2000, the Company reacquired 25,087,800 Class A common shares in
exchange for 16,787,800 shares of Series D preferred stock and 8,300,000 shares
of Class B common stock. The Class A common shares were retired upon
reacquisition.

CANCELLATION OF PUT OBLIGATIONS

During 1998, certain major shareholders of the Company pledged 1,752,000
shares of the Company's common stock as collateral under various loan
agreements. Under the terms of the loan agreements, the Company was required, in
the event of default by the shareholders, to repurchase the pledged shares for
the lesser of (i) 100% of outstanding indebtedness plus accrued and unpaid
interest, or (ii) $3.0 million. The Company classified $3.0 million of equity as
temporary equity for the value of common stock issued and subject to put options
under these arrangements.

In January 2000, these put options were canceled. As a result, the Company
reclassified $3.0 million from temporary equity to the permanent capital
accounts of the Company.

ISSUANCE OF COMMON STOCK SUBJECT TO PUT OBLIGATIONS

In connection with the acquisition of Fremont, the Company issued 457,318
shares of Class A common stock to certain of the former owners of Fremont. Under
the terms of the agreements, these shares can be put back to the Company at any
time. The purchase price for such stock is the higher of the current fair market
value or the fair market value of the Company's common stock on the date of the
acquisition of Fremont. Such former owners of Fremont exercised their put
options on 75,418 shares in December 2000 and on 66,676 shares in March 2001.
The Company has recorded the common stock subject to put options as temporary
equity in the accompanying consolidated balance sheets. In May 2001, the Company
loaned $999,980 to such former owners of Fremont. In January 2002, these loans
were paid with 76,218 shares subject to the put options. In January 2003, put
options on 76,218 shares were exercised for $999,980.

75

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(10) STOCKHOLDERS' EQUITY (CONTINUED)

COMPENSATION EXPENSE

In January 2000, shares of Class A common stock issued under stock options
and warrants included 35,300 shares issued under the MJD Communications, Inc.
Stock Incentive Plan (1998 Plan), 255,320 shares issued under the 1995 Stock
Option Plan (1995 Plan), and 16,580 shares issued pursuant to warrants to
purchase shares of the Company's common stock in a cashless exercise. Options
surrendered in lieu of cash were 5,300 under the 1998 Plan and 5,020 under the
1995 Plan. Following the conversion of these Class A common shares into
Series D preferred shares, the newly issued Series D preferred shares were sold
to a new principal shareholder of the Company. The Company's board of directors
amended the grant of options to purchase 40,600 shares of the Company's Class A
common stock under the 1998 Plan to make those options immediately exercisable
and fully vested. The options were previously exercisable only upon the
occurrence of a qualifying liquidating event, as defined under the 1998 Plan. A
compensation charge of $0.5 million was recognized in connection with the
amendment of the options in 2000. As a result of the exercise of options to
purchase 260,340 shares of Class A common stock under the 1995 Plan, the Company
recorded a compensation charge of $3.3 million in 2000.

In 1997, two of the Company's shareholders entered into shareholder
agreements with the Company and its founding shareholders, including two
employee shareholders. Under the shareholder agreements, the Company's founding
shareholders are entitled to a cash payment as a result of the sale of the
Company's common stock to a third party by either of the two shareholders. In
January 2000, one of these shareholders sold newly issued Series D preferred
shares for cash to a third party. The transaction was subject to the
requirements of the shareholder agreements. As the cash payment to the two
employee shareholders was contingent upon their continued employment, the
Company recognized the cash payment as compensation expense. Also in
January 2000, the other shareholder transferred 1,093,060 shares of Series D
preferred shares to the employee-shareholders in settlement of its cash payment
obligation under the shareholder agreements. As a result of these transactions,
the Company recognized a compensation charge of $8.5 million in 2000.

In April 2000, the Company issued stock options under the 1998 Plan to
employee participants in the FairPoint Communications Corp. Stock Incentive Plan
(Carrier Services' Plan) in consideration of the cancellation of all options
previously granted under the Carrier Services' Plan. The Company issued
1,620,465 and 73,200 options to purchase Class A common shares of the Company at
an exercise price of $3.28 per share and $13.12 per share, respectively. The
Company was recognizing a compensation charge on these options for the amount
the market value of the Company's common stock exceeded the exercise price on
the date of grant. In order to maintain the same economic benefits as previously
existed under the Carrier Services' Plan, Carrier Services also intended to
provide a cash bonus to its employees for each option exercised. The Company was
amortizing the compensation charge related to the option grant and the cash
bonus over the vesting period of five years. For the year ended December 31,
2000, compensation expense of $3.1 million and $1.0 million was recognized for
these options and bonuses, respectively, and are classified within discontinued
operations. During 2000, 320,250 unvested options subject to the option and
bonus compensation charge were forfeited. As of December 31, 2000, unearned
compensation on the converted Carrier Services' Plan options was $9.7 million.
As of December 31, 2001, the Company estimated the number of options subject to
the

76

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(10) STOCKHOLDERS' EQUITY (CONTINUED)

option and bonus compensation charge that would be ultimately exercised during
the discontinued operation phase-out period. The remaining unvested options were
forfeited.

On December 31, 2001, the Company extended the exercise period on 284,200
1995 Plan stock options. The Company recognized a compensation charge of
$2.2 million related to the modification of these options during 2001. On
December 31, 2002, the Company extended the exercise period on 213,200 1995 Plan
Stock Options. The Company recognized a compensation charge of $1.2 million
related to the modification of these options during 2002.

Certain principal shareholders of the Company granted stock appreciation
rights to certain members of management. The stock appreciation rights are fully
vested. The stock appreciation rights may be settled in cash or stock, at the
option of the granting shareholders. In connection with the stock appreciation
rights, the Company recognized a benefit of $0.9 million and $0.3 million in
2001 and 2002, respectively, as the value associated with the stock appreciation
rights declined. No compensation expense was recorded in 2000 related to the
stock appreciation rights.

(11) STOCK OPTION PLANS

1995 STOCK OPTION PLAN

The Company sponsors the 1995 Plan that covers officers, directors, and
employees of the Company. The Company may issue qualified or nonqualified stock
options to purchase up to 1,136,800 shares of the Company's Class A common stock
to employees that will vest equally over 5 years from the date of employment of
the recipient and are exercisable during years 5 through 10. In 1995, the
Company granted options to purchase 852,800 shares at $0.25 per share. There
were no options granted since 1995.

The per share weighted average fair value of stock options granted during
1995 was $0.13 on the date of grant using the Black Scholes option-pricing
model. Input variables used in the model included no expected dividend yields, a
risk-free interest rate of 6.41%, and an estimated option life of five years.
Because the Company was nonpublic on the date of the grant, no assumption as to
the volatility of the stock price was made.

77

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(11) STOCK OPTION PLANS (CONTINUED)

Stock option activity for 2000, 2001, and 2002 under the 1995 Plan is
summarized as follows:

See Note 10 for a description of options exercised under the 1995 Plan
during 2000.

MJD COMMUNICATIONS, INC. STOCK INCENTIVE PLAN

In August 1998, the Company adopted the 1998 Plan. The 1998 Plan provides
for grants of up to 6,952,540 nonqualified stock options to executives and
members of management, at the discretion of the compensation committee of the
board of directors. Options vest in 25% increments on the second, third, fourth,
and fifth anniversaries of an individual grant. In the event of a change in
control, outstanding options will vest immediately.

Pursuant to the terms of the grant, options granted in 1998 and 1999 become
exercisable only in the event that the Company is sold, an initial public
offering of the Company's common stock results in the principal shareholders
holding less than 10% of their original ownership, or other changes in control,
as defined, occur. The number of options that may become ultimately exercisable
also depends upon the extent to which the price per share obtained in the sale
of the Company would exceed a minimum selling price of $4.28 per share. All
options have a term of 10 years from date of grant. For those options granted in
1998 and 1999, the Company will accrue compensation expense for the excess of
the estimated market value of its common stock over the exercise price of the
options when and if a sale of the Company, at the prices necessary to result in
exercisable options under the grant, becomes imminent or likely.

Pursuant to the terms of the grant, options granted in 2000 become
exercisable immediately upon vesting. The per share weighted average fair value
of stock options granted under the 1998 Plan during 2000 was $11.17 on the date
of grant using the Black Scholes option-pricing model. Input variables used in
the model included no expected dividend yields, a risk-free interest rate of
6.52%, and an estimated option life of 10 years. Because the Company was
nonpublic on the date of the grant, no assumption as to the volatility of the
stock price was made.

78

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(11) STOCK OPTION PLANS (CONTINUED)
Stock option activity for 2000, 2001, and 2002 under the 1998 Plan is
summarized as follows:

The weighted average remaining contractual life for the options outstanding
at December 31, 2002 is 6.8 years.

FAIRPOINT COMMUNICATIONS CORP. STOCK INCENTIVE PLAN

In December 1998, the Company adopted the Carrier Services' Plan for
employees of its subsidiary, Carrier Services. Under the Carrier Services' Plan,
participating employees were granted options to purchase common stock of Carrier
Services at exercise prices not less than the market value of Carrier Services'
common stock at the date of the grant. The Carrier Services' Plan authorized
grants of options to purchase up to 1,000,000 shares of authorized, but unissued
common stock. All stock options had 10 year terms and vested in 25% increments
on the second, third, fourth, and fifth

79

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(11) STOCK OPTION PLANS (CONTINUED)
anniversaries of an individual grant. In the event of a change in control,
outstanding options would vest immediately.

The per share weighted average fair value of stock options granted under the
Carrier Services' Plan during 2000 was $11.80 on the date of grant using the
Black Scholes option-pricing model. Input variables used in the model included
no expected dividend yields, a risk-free interest rate of 6.68%, and an
estimated option life of 10 years. Because Carrier Services was nonpublic on the
date of the grant, no assumption as to the volatility of the stock price was
made.

Stock option activity for 2000 under the Carrier Services' Plan is
summarized as follows:

See Note 10 for a description of the cancellation of the majority of options
granted under the Carrier Services' Plan during 2000.

FAIRPOINT COMMUNICATIONS, INC. 2000 EMPLOYEE STOCK OPTION PLAN

In May 2000, the Company adopted the FairPoint Communications, Inc. 2000
Employee Stock Option Plan (2000 Plan). The 2000 Plan provided for grants to
members of management of up to 10,019,200 options to purchase Class A common
stock, at the discretion of the compensation committee. During 2002, the Company
amended the 2000 Plan to limit the number of shares available for grant to
2,365,510. Options granted under the 2000 Plan may be of two types:
(i) incentive stock options and (ii) nonstatutory stock options. Unless the
compensation committee shall otherwise specify at the time of grant, any option
granted under the 2000 Plan shall be a nonstatutory stock option.

Under the 2000 Plan, unless otherwise determined by the compensation
committee at the time of grant, participating employees are granted options to
purchase Class A common stock at exercise prices not less than the market value
of the Company's Class A common stock at the date of grant. Options have a term
of 10 years from date of grant. Options vest in increments of 10% on the first
anniversary, 15% on the second anniversary, and 25% on the third, fourth, and
fifth anniversaries of an individual grant. Subject to certain provisions, in
the event of a change of control, the Company will cancel each option in
exchange for a payment in cash of an amount equal to the excess, if any, of the
highest price per share of Class A common stock offered in conjunction with any
transaction resulting in a change of control over the exercise price for such
option.

On August 3, 2001, the Company made an offer to its employees to cancel
their existing options issued under the 2000 Plan in exchange for new options to
be granted on the date that is on or after six months and one day following the
expiration date of the offer. As a result of this offer, 3,274,935 options were
canceled. The remaining shares outstanding under this plan were forfeited during
2001. On March 13, 2002, 880,819 stock options were issued under this exchange
offer.

80

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(11) STOCK OPTION PLANS (CONTINUED)
Stock option activity for 2000, 2001, and 2002 under the 2000 Plan is
summarized as follows:

The remaining contractual life for the options outstanding at December 31,
2002 was 9.3 years, and 197,507 options were exercisable.

The per share weighted average fair value of stock options granted under the
2000 Plan during 2000 and 2002 were $1.85 and $2.84, respectively, on the date
of grant using the Black Scholes option-pricing model. Input variables used in
the model included no expected dividend yields, a weighted average risk free
interest rate of 6.49% and 5.28% in 2000 and 2002, respectively, and an
estimated option life of 10 years. Because the Company was nonpublic on the date
of grant, no assumption as to the volatility of the stock price was made.

(12) RELATED PARTY TRANSACTIONS

The Company has entered into financial advisory agreements with certain
equity investors, pursuant to which the equity investors provide certain
consulting and advisory services related but not limited to equity financings
and strategic planning. The Company paid $1.0 million for each of the years
ended December 31, 2000, 2001, and 2002 in such fees to the equity investors and
this expense is classified within operating expenses. The agreements also
provide that the Company will reimburse the equity investors for travel relating
to the Company's boards of directors meetings. The Company reimbursed the equity
investors $0.1 million, $0.1 million, and approximately $43,000 for the years
ended December 31, 2000, 2001, and 2002, respectively, for travel and related
expenses. Per the financial advisory agreements, the advisory and consulting
fees to be paid to each of the principal shareholders through December 31, 2006
is $0.5 million per annum. In January 2000, the Company

81

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(12) RELATED PARTY TRANSACTIONS (CONTINUED)
entered into an agreement whereby the Company must obtain consent from its two
principal shareholders in order to incur debt in excess of $5.0 million.

In 2000, a law firm in which a partner of such law firm is a director of the
Company, was paid $1.5 million, of which $0.3 million was for general counsel
services, $1.1 million was for services related to financings, and $0.1 million
was for services related to acquisitions. In 2001, this same law firm was paid
$0.8 million, of which $0.3 million was for general counsel services,
$0.1 million was for services related to financings, and $0.4 million was for
services related to the restructure and discontinuance of the competitive
communications operations. In 2002, this same law firm was paid $0.8 million, of
which $0.3 million was for general counsel services, $0.3 million was for
services related to the discontinuance of the competitive communications
operations, and $0.2 million was for services related to acquisitions. All
payments made by the Company for general counsel services and unsuccessful
acquisition bids are classified within operating expenses on the statement of
operations. All payments made for services related to financings have been
recorded as debt or equity issue costs. All payments made for services related
to successful acquisition bids have been capitalized as direct costs of the
acquisitions. All services related to the restructure and discontinuance of the
competitive communications operations have been classified in discontinued
operations.

(13) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

In the first quarter of 2001, the Company recognized a restructuring charge
of $33.6 million, which is included in discontinued operations. In the fourth
quarter of 2001, the Company recognized a loss of $95.3 million for the disposal
of its competitive communications business, which is included in discontinued
operations.

In the second quarter of 2002, the Company recorded a gain in discontinued
operations of $17.5 million related to the extinguishment of debt and settlement
of its interest rate swap agreements. In the second, third, and fourth quarters
of 2002, the Company recorded a noncash charge of $5.6 million, $1.8 million and
$0.8 million, respectively, related to the other than temporary decline in
market value of its Choice One common stock. In the fourth quarter of 2002, the
Company recorded a noncash charge of $4.4 million related to the other than
temporary decline in market value of investments accounted for under the equity
method. During the fourth quarter of 2002, the Company identified errors in the
fair value calculations of the interest rate swaps and recorded an adjustment of

82

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(13) QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (CONTINUED)
$0.9 million to increase expense that related to prior periods. The effect of
this entry was not material to previously reported results.

(14) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS

CASH, ACCOUNTS RECEIVABLE, ACCOUNTS PAYABLE, AND DEMAND NOTES PAYABLE

The carrying amount approximates fair value because of the short maturity of
these instruments.

INVESTMENTS

Investments classified as available for sale and trading are carried at
their fair value which approximates $8.6 million and $0.6 million, respectively,
at December 31, 2001 and $0.6 million and $0.5 million, respectively, at
December 31, 2002 (see Note 5 and Note 8).

LONG-TERM DEBT

The fair value of the Company's long-term debt is estimated by discounting
the future cash flows of each instrument at rates currently offered to the
Company for similar debt instruments of comparable maturities. At December 31,
2001 and 2002, the Company had long-term debt with a carrying value of
$907.6 million and $804.2 million, respectively, and estimated fair values of
$860.0 million and $683.6 million, respectively.

REDEEMABLE PREFERRED STOCK

The fair value of the Company's redeemable preferred stock is estimated
utilizing a cash flow analysis at a discount rate equal to rates available for
debt with terms similar to the preferred stock. At December 31, 2002, the
Company's carrying value and estimated fair value of its redeemable preferred
stock was $90.3 million and $68.1 million, respectively.

LIMITATIONS

Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.

(15) REVENUE CONCENTRATIONS

Revenues for interstate access services are based on reimbursement of costs
and an allowed rate of return. Revenues of this nature are received from NECA in
the form of monthly settlements. Such revenues amounted to 24.9%, 26.8%, and
26.7% of the Company's total revenues from continuing operations for the years
ended December 31, 2000, 2001, and 2002, respectively.

(16) REVENUE SETTLEMENTS

Certain of the Company's telephone subsidiaries participate in revenue
sharing arrangements with other telephone companies for interstate revenue and
for certain intrastate revenue. Such sharing

83

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(16) REVENUE SETTLEMENTS (CONTINUED)
arrangements are funded by toll revenue and/or access charges within state
jurisdiction and by access charges in the interstate market. Revenues earned
through the various sharing arrangements are initially recorded based on the
Company's estimates. The Company recognized $2.2 million, $7.2 million, and
$3.1 million of revenue for settlements and adjustments related to prior years
during 2000, 2001, and 2002, respectively.

(17) OPERATING LEASES

Future minimum lease payments under noncancellable operating leases as of
December 31, 2002 are as follows:

Total rent expense from continuing operations was $3.1 million,
$3.4 million, and $3.1 million in 2000, 2001, and 2002, respectively.

(18) COMMITMENT WITH TELECOMMUNICATION COMPANY

The Company has an agreement with Global Crossing Bandwidth, Inc. (Global
Crossing) to use Global Crossing's network in its delivery of telecommunication
services. This agreement, entered into in August 2002, requires monthly net
usage commitments of $100,000 for months one through three, $150,000 for months
four through six, $200,000 for months seven through nine, $225,000 for months
ten through twelve, and $250,000 for months thirteen through twenty-four, for a
total of $5,025,000. In the event such monthly commitments are not met, the
Company is required to pay the shortfall. Shortfalls in usage commitments, if
any, are recorded as operating expenses in the period identified. As of
December 31, 2002, there have been no shortfalls.

(19) SUBSEQUENT EVENTS

On March 6, 2003, FairPoint issued $225.0 million aggregate principal amount
of 11 7/8% Senior Notes due 2010. Interest is payable on the Senior Notes at the
rate of 11 7/8% per annum on each

84

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2000, 2001, AND 2002

(19) SUBSEQUENT EVENTS (CONTINUED)
March 1 and September 1, commencing on September 1, 2003. The Senior Notes
mature on March 1, 2010.

In connection with the issuance of the Senior Notes, FairPoint entered into
an Amended and Restated Credit Agreement, dated as of March 6, 2003, among
FairPoint, Bank of America, N.A., as syndication agent, Wachovia Bank, N.A., as
documentation agent, Deutsche Bank Trust Company Americas, as administrative
agent, and various lending institutions. The Amended and Restated Credit
Agreement provides for: (i) a new $70.0 million revolving credit facility
($60.0 million of which has been committed) which matures on March 31, 2007
(loans under the revolving credit facility bear interest per annum at either a
base rate plus 3.00% or LIBOR plus 4.00%) and (ii) a new term loan A facility of
$30 million which matures on March 31, 2007 (loans under the term loan A
facility bear interest per annum at either a base rate plus 3.00% or LIBOR plus
4.00%). The new term loan A facility was drawn in full on March 6, 2003. In
addition, mandatory payments under the term loan C facility were rescheduled to
be $2.0 million, $20.9 million, $20.0 million, $29.6 million and a final
$56.0 million in 2003, 2004, 2005, 2006 and on March 31, 2007, respectively, and
the interest rate per annum on loans under the term loan C facility was
increased to a base rate plus 3.50% or LIBOR plus 4.50%.

FairPoint used the proceeds from the offering of the Senior Notes and the
borrowings under the new term loan A facility to: (i) repay all tranche RF and
tranche AF revolving loans under its existing credit facility; (ii) repay all
tranche B term loans under its existing credit facility; (iii) repurchase at a
35% discount $13.3 million aggregate liquidation preference of its Series A
Preferred Stock (together with accrued and unpaid dividends thereon);
(iv) repurchase $9.8 million aggregate principal amount of its outstanding
9 1/2% Senior Subordinated Notes due 2008 and $7.0 million aggregate principal
amount of its outstanding 12 1/2% Senior Subordinated Notes due 2010; and
(vi) repay at a 30% discount $2.2 million of loans made by Wachovia Bank,
National Association, under the Carrier Services credit facility. As a result,
FairPoint recorded $2.8 million and $0.7 million non-operating gains on the
extinguishment of the Senior Subordinated Notes and the Carrier Services loans,
respectively, in the Statement of Operations and a $2.8 million gain for the
retirement of the Series A Preferred Stock directly to stockholders' deficit in
2003. Additionally, FairPoint recorded a non-operating loss of $5.3 million for
the write-off of debt issue costs related to this extinguishment of debt in 2003

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information with respect to our directors,
executive officers and other key personnel. Executive officers are generally
appointed annually by the board of directors to serve, subject to the discretion
of the board of directors, until their successors are appointed.

EUGENE B. JOHNSON. Mr. Johnson has served as our Chairman since January 1,
2003 and as our Chief Executive Officer since January 1, 2002. Prior to his
current responsibilities, Mr. Johnson was Chief Development Officer from
April 2000 to December 2002 and Vice Chairman from August 1998 to
December 2002. Mr. Johnson also served as our Executive Vice President from
February 1998 to December 2001 and as our Senior Vice President from 1993 to
1998. Mr. Johnson is a co-founder and has been a director of our company since
1991. From 1997 to 2002, Mr. Johnson served as a director of OPASTCO, the
primary industry organization for small independent telephone companies. From
1987 to 1993, Mr. Johnson served as President and principal shareholder of
JC&A, Inc., an investment banking and brokerage firm providing services to the
cable television, telephone and related industries. From 1985 to 1987,
Mr. Johnson served as the director of the mergers and acquisitions department of
Cable Investments, Inc., an investment banking firm. Mr. Johnson currently is a
member of OPASTCO's finance committee and chairman of the USF committee.

PETER G. NIXON. Mr. Nixon has served as our Chief Operating Officer since
November 2002. Previously, Mr. Nixon was our Senior Vice President of Corporate
Development from February 2002 to November 2002 and President of our Telecom
Group from April 2001 to February 2002. Prior to this, Mr. Nixon served as
President of our Eastern Region Telecom Group from June 1999 to April 2001 and
President of Chautauqua & Erie Telephone Corporation ("C&E") from July 1997 to
June 1999 when we acquired C&E. From April 1, 1989 to June 1997, Mr. Nixon
served as Executive Vice President of C&E. From April 1, 1978 to March 31, 1989,
Mr. Nixon served as Vice President of Operations for C&E. Mr. Nixon has served
as the past Chairman of the New York State Telephone Association, in addition to
his involvement in several community and regional organizations.

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WALTER E. LEACH, JR. Mr. Leach has served as our Chief Financial Officer
since October 1994 and our Senior Vice President since February of 1998. From
October 1994 to December 2000, Mr. Leach was our Secretary. From 1984 through
September 1994, Mr. Leach served as Executive Vice President of Independent
Hydro Developers, where he had responsibility for all project acquisition,
financing and development activities.

JOHN P. DUDA. Mr. Duda has served as our President since April 2001. As
President, Mr. Duda is primarily responsible for industry relations, policy
development and regulatory and legislative affairs. Prior to his current
responsibilities, Mr. Duda was our Chief Operating Officer from April 2001 to
November 2002. Mr. Duda also served as President and Chief Executive Officer of
our Telecom Group and was responsible for all aspects of our RLEC operations
from August 1998 to April 2001. From January 1994 to August 1998, Mr. Duda
served as our Chief Operating Officer. Prior to 1994, Mr. Duda served as Vice
President, Operations and Engineering of Rochester Tel Mobile Communications,
State Vice President Minnesota, Nebraska and Wyoming and Director of Network
Planning and Operations for Pennsylvania and New Jersey for Sprint and served in
various management positions with C&P Telephone and Bell Atlantic. Mr. Duda is
currently a member of the United States Telecom Association's Board of Directors
and serves on its Midsize Company committee.

SHIRLEY J. LINN. Ms. Linn has served as our Vice President and General
Counsel since October 2000 and our Secretary since December 2000. Prior to
joining us, Ms. Linn was a partner, from 1984 to 2000, in the Charlotte, North
Carolina law firm of Underwood Kinsey Warren & Tucker, P.A., where she
specialized in general business matters, particularly mergers and acquisitions.

TIMOTHY W. HENRY. Mr. Henry has served as our Vice President of Finance and
Treasurer since December 1997. From 1992 to December 1997, Mr. Henry served as
Vice President/Portfolio Manager at CoBank, ACB, and managed a $225 million
telecommunications loan portfolio, which included responsibility for CoBank's
relationship with us.

LISA R. HOOD. Ms. Hood has served as our Vice President and Controller
since December 1993. Prior to joining our company, Ms. Hood served as manager of
a local public accounting firm in Kansas. Ms. Hood is a certified public
accountant.

DANIEL G. BERGSTEIN. Mr. Bergstein is a co-founder and has been a director
of our company since 1991. Mr. Bergstein served as Chairman of our board of
directors from 1991 until August 1998. Since 1988, Mr. Bergstein has been a
senior partner in the New York office of the international law firm Paul,
Hastings, Janofsky & Walker LLP, where he is the Chairman of the Firm's National
Telecommunications Practice.

FRANK K. BYNUM, JR. Mr. Bynum has served as a director of our company since
May 1998. He is also a Managing Director of Kelso. Mr. Bynum joined Kelso in
1987 and has held positions of increasing responsibility at Kelso prior to
becoming a Managing Director. Mr. Bynum is a director of CDT Holdings, plc,
Citation Corporation and 21st Century Newspapers, Inc.

ANTHONY J DINOVI. Mr. DiNovi has served as a director of our company since
January 2000. He is currently a Managing Director of Thomas H. Lee Partners,
L.P., where he has been employed since 1988. Mr. DiNovi is a director of
Endurance Specialty Holdings Ltd., Eye Care Centers of America Inc., Fisher
Scientific International, Inc., National Waterworks, Inc., US LEC Corp.,
Vertis, Inc. and various private corporations.

GEORGE E. MATELICH. Mr. Matelich has served as a director of our company
since July 1997. Mr. Matelich is currently a Managing Director of Kelso, with
which he has been associated since 1985. Mr. Matelich is also a Trustee of the
University of Puget Sound.

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JACK H. THOMAS. Mr. Thomas is a co-founder and has been a director of our
company since 1991. Mr. Thomas was Chairman of our board of directors from
August 1998 to December 31, 2002 and served as our President from 1993 to
April 2000. Mr. Thomas served as our Chief Executive Officer from 1993 until his
retirement, effective December 31, 2001. From 1985 to 1993, Mr. Thomas was Chief
Operating Officer of C-TEC Corporation, a diversified communications company,
which at the time owned Commonwealth Telephone Company, a 240,000 access line
telephone company. Prior to 1985, Mr. Thomas worked at United Telephone Company
of Ohio and C&P Telephone in various management capacities.

KENT R. WELDON. Mr. Weldon has served as a director of our company since
January 2000. He is currently a Managing Director of Thomas H. Lee Partners,
L.P. Mr. Weldon worked at the firm from 1991 to 1993 and rejoined it in 1995.
Prior to 1991, Mr. Weldon worked at Morgan Stanley & Co. Incorporated in the
Corporate Finance Department. Mr. Weldon is a director of Fisher Scientific
International, Inc. and Syratech Corporation.

COMMITTEES OF THE BOARD OF DIRECTORS

Our board of directors has standing audit and compensation committees.

AUDIT COMMITTEE

Our audit committee currently consists of Frank K. Bynum, Jr., George E.
Matelich and Kent R. Weldon. Among other functions, our audit committee:

- makes recommendations to our board of directors regarding the selection of
independent auditors;

- reviews the results and scope of the audit and other services provided by
our independent auditors;

- reviews our financial statements; and

- reviews and evaluates our internal control functions.

COMPENSATION COMMITTEE

Our compensation committee currently consists of Anthony J. DiNovi and
George E. Matelich. The compensation committee makes recommendations to our
board of directors regarding the following matters:

- executive compensation;

- salaries and incentive compensation for our employees; and

- the administration of our stock option plans and defined contribution
plans.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

For the fiscal year ended December 31, 2002, our compensation committee
consisted of Anthony J. DiNovi and George E. Matelich. Mr. DiNovi has served as
a director of our company since January 2000. Mr. Matelich has served as a
director of our company since July 1998. None of our executive officers has
served as a member of the compensation committee (or other committee serving an
equivalent function) of any other entity, whose executive officers served as a
director of our company or member of our compensation committee.

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NON-EMPLOYEE DIRECTOR COMPENSATION

We reimburse directors for any expenses incurred in attending meetings of
our board of directors and committees of our board of directors.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth information for the fiscal year ended
December 31, 2002 concerning compensation paid to our chief executive officer
and our other four most highly compensated executive officers during 2002.

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(1) Reflects the value of certain benefits provided pursuant to employment
arrangements.

(2) Reflects matching contributions made under our 401(k) plan and the value of
group term life insurance coverage.

1995 STOCK OPTION PLAN

Our 1995 Stock Option Plan was adopted on February 22, 1995. The 1995 plan
provides for the grant of options to purchase up to an aggregate of 1,136,800
shares of our Class A common stock. The 1995 plan is administered by our
compensation committee, which makes discretionary grants of options to our
officers, directors and employees.

Options granted under the 1995 plan may be incentive stock options, which
qualify for favorable Federal income tax treatment under Section 422A of the
Internal Revenue Code, or nonstatutory stock options.

The selection of participants, allotment of shares, determination of price
and other conditions of purchase of such options is determined by our
compensation committee, in its sole discretion. Each option grant is evidenced
by a written incentive stock option agreement or nonstatutory stock option

89

agreement dated as of the date of grant and executed by us and the optionee.
Such agreement also sets forth the number of options granted, the option price,
the option term and such other terms and conditions as may be determined by the
board of directors. As of March 25, 2003, a total of 592,460 options to purchase
shares of our Class A common stock were outstanding under the 1995 plan. Such
options were exercisable at a price of $.25 per share.

Options granted under the 1995 plan are nontransferable, other than by will
or by the laws of descent and distribution.

1998 STOCK INCENTIVE PLAN

In August 1998, we adopted our 1998 Stock Incentive Plan. The 1998 Plan
provides for grants to members of management of up to 6,952,540 nonqualified
options to purchase our Class A common stock, at the discretion of the
compensation committee. These options generally vest in 25% increments on the
second, third, fourth, and fifth anniversaries of an individual grant. In the
event of a change in control (as defined in the 1998 Plan), outstanding options
will vest immediately. As of March 25, 2003, a total of 4,413,700 options were
outstanding under the 1998 Plan.

Pursuant to the terms of the grant, 4,395,400 options become exercisable
only in the event that we are sold, an initial public offering of our common
stock occurs, or other changes in control (as defined in the 1998 Plan) occur.
The number of options that may ultimately become exercisable also depends upon
the extent to which the price per share obtained in a sale of the Company would
exceed a minimum selling price of $4.28 per share. These options have a term of
ten years from date of grant. We will accrue as compensation expense the excess
of the estimated fair value of our common stock over the exercise price of the
options when and if a sale of the Company, at the prices necessary to result in
exercisable options under the grant, becomes imminent or likely.

On December 31, 2001, 450,000 options were forfeited and the vesting
schedule of 200,000 options was modified. These options were rescheduled to vest
equally over the ensuing 24 months on a monthly vesting schedule of 8,333.34
options per month such that all 200,000 options will be fully vested by
December 2003.

On January 1, 2002, an additional 250,000 shares were issued at $7.00 per
option. At issuance, 41,667 options were vested immediately. The remaining
208,333 options will vest equally over 15 months at a rate of 13,888.87 options
per month such that all 250,000 options will be fully vested by March 2003.

In April 2000, all of the options outstanding under Carrier Services' stock
option plan were converted to options to purchase our Class A common stock under
the 1998 Plan. As a result, 925,500 options to purchase common stock of Carrier
Services were converted into an aggregate of 1,693,665 options to purchase our
Class A common stock, which become immediately exercisable upon vesting. As of
March 25, 2003, 18,300 options to purchase our Class A common stock at an
exercise price of $3.28 per share were outstanding under this grant. Upon
completion of the conversion, the Carrier Services stock option plan was
terminated.

2000 EMPLOYEE STOCK OPTION PLAN

In May 2000, the Company adopted the 2000 Employee Stock Option Plan. The
2000 Plan provides for grants to members of management of up to 10,019,200
options to purchase our Class A common stock, at the discretion of the
compensation committee. During 2002, the Company amended the 2000 Plan to limit
the number of shares available for grant to 2,365,510. Options granted under the
2000 Plan may be of two types: (i) incentive stock options and
(ii) nonstatutory stock options. Unless the compensation committee shall
otherwise specify at the time of grant, any option granted under the 2000 Plan
shall be a nonstatutory stock option.

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Under the 2000 Plan, unless otherwise determined by the compensation
committee at the time of grant, participating employees are granted options to
purchase our Class A common stock at exercise prices not less than the market
value of our Class A common stock at the date of grant. Options have a term of
10 years from date of grant. Options vest in increments of 10% on the first
anniversary, 15% on the second anniversary, and 25% on the third, fourth, and
fifth anniversaries of an individual grant. Subject to certain provisions, in
the event of a change of control, the Company will cancel each option in
exchange for a payment in cash of an amount equal to the excess, if any, of the
highest price per share of Class A common stock offered in conjunction with any
transaction resulting in a change of control over the exercise price for such
option.

On August 3, 2001, the Company made an offer to its employees to cancel
their existing options issued under the 2000 Plan in exchange for new options to
be granted on the date that is on or after six months and one day following the
expiration date of the offer. As a result of this offer, 3,274,935 options were
cancelled. The remaining options outstanding under this plan were forfeited
during 2001. In March 2002, an additional 1,337,109 shares were issued at $7.00
per option. As of March 25, 2003, 1,195,386 options were outstanding under the
2000 Plan.

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END
OPTION/SAR VALUES

The following table sets forth the information with respect to the executive
officers set forth in the Summary Compensation Table concerning the exercise of
options during fiscal year 2002, the number of securities underlying options as
of December 31, 2002 and the year-end value of all unexercised in-the-money
options held by such individuals.

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(1) Represents the difference between the exercise price and the fair market
value of our common stock at December 31, 2002.

EMPLOYMENT AGREEMENTS

In December 2002, we entered into an employment agreement with Eugene B.
Johnson, pursuant to which we named Mr. Johnson Chief Executive Officer of the
Company and/or Chairman of the Company's Board of Directors from December 31,
2002 to December 31, 2006. The employment agreement provides that Mr. Johnson
will receive an annual base salary of $350,000, an annual discretionary bonus,
and Mr. Johnson shall be entitled to participate in all incentive, savings,
stock option and retirement plans, practices, policies and programs applicable
generally to other senior management. The employment agreement also provides
that upon (i) the expiration of Mr. Johnson's employment period, or (ii) the
termination of Mr. Johnson's employment as Chief Executive Officer without
cause, Mr. Johnson is entitled to receive certain benefits. These benefits
include continued medical coverage for Mr. Johnson and his wife until each has
reached age 65, the accelerated vesting of all options granted to Mr. Johnson
under the Company's 1998 Plan and 2000 Plan and extension of Mr. Johnson's right
to exercise all of his vested options under the 1995 Plan and the 2000 Plan
within certain time periods. If we terminate Mr. Johnson for cause or he
voluntarily resigns he is not entitled

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to any benefits under the employment agreement. If Mr. Johnson's employment is
terminated without cause during the term of his employment agreement he is
entitled to receive payment of his salary as of the termination event for two
years, subject to suspension for a breach of Mr. Johnson's covenant not to
compete with us. Upon the expiration of the term of Mr. Johnson's employment
agreement at December 31, 2006, unless extended, he is entitled to receive
payment of his salary as of such expiration date for one year thereafter,
subject to suspension for a breach of Mr. Johnson's covenant not to compete with
us. The employment agreement supersedes and terminates all prior employment
agreements and severance arrangements between Mr. Johnson and us.

In December 2001, we entered into a succession agreement with Jack H.
Thomas, pursuant to which Mr. Thomas resigned from his position as Chief
Executive Officer of the Company and we retained him to serve as a non-executive
Chairman of the Board of Directors and/or member of the Board of Directors from
December 31, 2001 through December 31, 2003. The succession agreement provides
for payment of an annual compensation of $50,000, reimbursement of supplemental
life insurance premiums not to exceed $7,000 per annum, extension of
Mr. Thomas' right to exercise all of his vested options until the termination of
the succession period and the immediate vesting of all unvested options upon a
change of control or an early termination of the agreement without cause. In
addition, the succession agreement provides that upon the earliest of (i) the
expiration of the succession period, (ii) the termination of Mr. Thomas'
retention without cause or (iii) a change of control, Mr. Thomas is entitled to
receive certain benefits, including Company-provided health insurance for both
himself and his wife until each is 65 years of age. If Mr. Thomas' retention is
terminated for cause, Mr. Thomas shall not be entitled to any benefits pursuant
to the terms of his succession agreement. The succession agreement supersedes
and terminates all prior employment agreements between Mr. Thomas and us.

For purposes of both Mr. Johnson's employment agreement and Mr. Thomas'
succession agreement, a change of control shall be deemed to have occurred if:
(i) the stockholders of the Company as of the date of such agreement no longer
own, either directly or indirectly, shares of the Company's capital stock
entitling them to 51% in the aggregate of the voting power for the election of
the directors of the Company, as a result of a merger or consolidation of the
Company, a transfer of the Company's capital stock or otherwise; or (ii) the
Company sells, assigns, conveys, transfers, leases or otherwise disposes of, in
one transaction or a series of related transactions, all or substantially all of
its property or assets to another person or entity.

In January 2000, we entered into employment agreements with each of Walter
E. Leach, Jr. and John P. Duda. Each of the employment agreements provides for
an employment period from January 20, 2000 until December 31, 2003 and provides
that upon the termination of the executive's employment due to a change of
control, the executive is entitled to receive from us in a lump sum payment an
amount equal to such executive's base salary as of the date of termination for a
period ranging from twelve months to twenty-four months. For purposes of the
previous sentence, a change of control shall be deemed to have occurred if:
(a) certain of our stockholders no longer own, either directly or indirectly,
shares of our capital stock entitling them to 51% in the aggregate of the voting
power for the election of our directors as a result of a merger or consolidation
of the Company, a transfer of our capital stock or otherwise; or (b) we sell,
assign, convey, transfer, lease or otherwise dispose of, in one transaction or a
series of related transactions, all or substantially all of our property or
assets to any other person or entity. In addition, we have agreed to maintain
the executives' long term disability and medical benefits for a similar period
following a change of control. In the event that any executive's employment with
us was terminated without cause and not as a result of a change of control, such
executive is entitled to receive a lump sum payment from us in an amount equal
to such executive's base salary for a period ranging from six months to twelve
months and is also entitled to long term disability and medical benefits for a
similar period. In the event that any executive's

92

employment is terminated by us for cause or by such executive without good
reason, such executive is not entitled to any benefits under his employment
agreement.

In November 2002, we entered into a letter agreement with Mr. Duda,
supplementing and modifying the employment agreement entered into in
January 2000. The letter agreement provides that upon voluntary termination of
Mr. Duda's employment by him, at any time between November 21, 2002 and
December 31, 2003, Mr. Duda is entitled to receive from us in a lump sum payment
an amount equal to Mr. Duda's base salary as of the date of termination for the
period from the date of termination through December 31, 2003, plus all accrued
and unpaid base salary and benefits as of the date of termination. The letter
agreement also provides that upon the expiration of Mr. Duda's employment with
the Company Mr. Duda is entitled to receive certain benefits. These benefits
include continued long-term disability, term life insurance and medical benefits
for twelve months and a lump sum payment from us in an amount equal to twelve
months of his base salary as of the date of termination, plus accrued and unpaid
base salary and benefits as of the date of termination.

In November 2002, we entered into a letter agreement with each of Peter G.
Nixon and Shirley J. Linn. The letter agreements provide that upon the
termination of their respective employment with the Company without cause, each
is entitled to receive from us in a lump sum payment an amount equal to twelve
months of such executive's base salary as of the date of termination, plus the
continuation of certain benefits, including medical benefits, for twelve months.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The following table sets forth information regarding beneficial ownership of
our Class A common stock as of March 25, 2003 for (i) each executive officer
named in the "Annual Compensation Table"; (ii) each director, (iii) all of our
executive officers and directors as a group, and (iv) each person who
beneficially owns 5% or more of the outstanding shares of our Class A common
stock. All persons listed have sole voting and investment power with respect to
their shares unless otherwise indicated.

The amounts and percentages of common stock reflected in this table assume
the conversion of all of our shares of Class C common stock into shares of our
Class A common stock. Our shares of Class C common stock are convertible into
shares of Class A common stock only upon the occurrence of certain events,
including (i) the consummation by the Company of an offering of its Class A
common stock to the public pursuant to which the Company raises at least
$150 million in gross

93

proceeds or (ii) any transfer of shares of Class C common stock to any person or
persons who are not affiliates of the transferor.

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* Less Than 1%.

(1) Unless otherwise indicated below, the persons and entities named in the
table have sole voting and sole investment power with respect to all shares
beneficially owned by them, subject to community property laws where
applicable. The percentage of beneficial ownership is based on 50,918,559
shares of common stock outstanding as of March 25, 2003, which includes
799,117 shares of common stock securities deemed outstanding pursuant to
Rule 13d-3(d)(1) under the Securities Exchange Act of 1934.

(2) Includes 240,233 shares of Class A common stock issuable upon exercise of
options that are either currently exercisable or become exercisable during
the next 60 days. Does not include 1,526,098 shares of Class A common stock
issuable upon exercise of options that are not currently exercisable or do
not become exercisable during the next 60 days.

94

(3) Includes 5,115 shares of Class A common stock issuable upon exercise of
options that are either currently exercisable or become exercisable during
the next 60 days. Does not include 139,311 shares of Class A common stock
issuable upon exercise of options that are not currently exercisable or do
not become exercisable during the next 60 days.

(4) Includes 102,070 shares of Class A common stock issuable upon exercise of
options that are either currently exercisable or become exercisable during
the next 60 days. Does not include 915,608 shares of Class A common stock
issuable upon exercise of options that are not currently exercisable or do
not become exercisable during the next 60 days.

(5) Includes 116,470 shares of Class A common stock issuable upon exercise of
options that are either currently exercisable or become exercisable during
the next 60 days. Does not include 674,230 shares of Class A common stock
issuable upon exercise of options that are not currently exercisable or do
not become exercisable during the next 60 days.

(6) Includes 8,951 shares of Class A common stock issuable upon exercise of
options that are either currently exercisable or become exercisable during
the next 60 days. Does not include 39,643 shares of Class A common stock
issuable upon exercisable of options that are not currently exericisable or
do not become exercisable during the next 60 days.

(7) Includes 2,135,140 shares of Class A common stock owned by JED
Communications Associates, Inc., a corporation owned 100% by Mr. Bergstein
and members of his immediate family and 165,000 shares of Class A common
stock owned by certain of Mr. Bergstein's family members, for which
Mr. Bergstein has both voting and disposition power.

(8) Includes 16,427,726 shares of Class A common stock owned by Kelso Investment
Associates V, L.P. ("KIAV") and 1,771,770 shares of Class A common stock
owned by Kelso Equity Partners V, L.P. ("KEPV"). KIAV and KEPV, due to their
common control, could be deemed to beneficially own each other's shares, but
each disclaims such beneficial ownership. Joseph S. Schuchert, Frank T.
Nickell, Thomas R. Wall, IV, George E. Matelich, Michael B. Goldberg, David
I. Wahrhaftig, Frank K. Bynum, Jr. and Philip E. Berney may be deemed to
share beneficial ownership of shares of Class A common stock owned of record
by KIAV and KEPV, by virtue of their status as general partners of the
general partner of KIAV and as general partners of KEPV. Messrs. Schuchert,
Nickell, Wall, Matelich, Goldberg, Wahrhaftig, Bynum and Berney share
investment and voting power with respect to securities owned by KIAV and
KEPV, but disclaim beneficial ownership of such securities.

(9) Shares of Class A common stock held by Thomas H. Lee Equity Fund IV, L.P.
may be deemed to be beneficially owned by THL Equity Advisors IV, LLC, the
general partner of Thomas H. Lee Equity Fund IV, L.P., Thomas H. Lee
Partners, L.P., Thomas H. Lee Advisors, LLC, the general partner of Thomas
H. Lee, L.P., Mr. DiNovi, Mr. Weldon and the other members of Thomas H. Lee
Advisors, LLC. Each of such persons disclaims beneficial ownership of such
shares.

(10) Includes 284,200 shares of Class A common stock issuable upon exercise of
options that are either currently exercisable or become exercisable during
the next 60 days. Does not include 850,000 shares of Class A common stock
issuable upon exercise of options that are not currently exercisable or do
not become exercisable during the next 60 days.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

FINANCIAL ADVISORY AGREEMENTS

We entered into a Management Services Agreement with THL Equity Advisors IV,
LLC, or THL Advisors, dated as of January 20, 2000 and an Amended and Restated
Financial Advisory Agreement dated as of January 20, 2000 with Kelso, pursuant
to which THL Advisors and Kelso provide certain

95

consulting and advisory services related, but not limited to, equity financings
and strategic planning. Each of these agreements expires on the earlier to occur
of (i) December 31, 2006 or (ii) solely with respect to the Management Services
Agreement, the date that THL Advisors cease to own, and solely with respect to
the Amended and Restated Financial Advisory Agreement, the date that Kelso
Investment Associates V, L.P. or KIAV, and Kelso Equity Partners V, L.P., or
KEPV, collectively cease to own, at least 10% of the number of shares of our
stock they held as of January 20, 2002. Pursuant to these agreements, we pay to
each of THL Advisors and Kelso annual advisory fees of $500,000 payable on a
quarterly basis, we reimburse them for out of pocket expenses, and we have
agreed to indemnify them against certain liabilities they may incur in
connection with their provision of advisory services. Further, we agreed to pay
a transaction fee of approximately $8.4 million to Kelso, which fee is payable
upon the earlier of (i) an initial public offering of our Class A common stock,
(ii) a sale of the Company to a third party or parties, whether structured as a
merger, sale of stock, sale of assets, recapitalization or otherwise or
(iii) KIAV and KEPV ceasing to own, collectively, at least 10% of the number of
shares of our stock they held collectively as of January 20, 2000. In connection
with our equity financing and recapitalization in January 2000, we terminated
our financial advisory agreement with Carousel Capital Partners, L.P., a former
significant stockholder, and the original financial advisory agreement with
Kelso. We paid advisory fees and out of pocket expenses of $1,042,662 in the
aggregate to THL Advisors and Kelso in the year ended December 31, 2002.

LEGAL SERVICES

Daniel G. Bergstein, a director of the Company, is a senior partner of Paul,
Hastings, Janofsky & Walker LLP, a law firm which provides legal services to us.
For the year ended December 31, 2002, we paid Paul Hastings approximately
$791,724 for legal services and expenses.

STOCKHOLDERS AGREEMENT AND REGISTRATION RIGHTS AGREEMENT

In connection with our January 2000 equity financing and recapitalization,
we entered into a stockholders agreement with our stockholders, dated as of
January 20, 2000, which contains provisions relating to, among other things:
(i) the designation of members to our board of directors (including two members
to be designated by THL, two members by Kelso and, initially, the designation of
Daniel G. Bergstein, Eugene B. Johnson and Jack H. Thomas, and upon the receipt
of all required regulatory approvals and the conversion of certain shares of our
equity securities, such three remaining members to be designated jointly by THL
and Kelso), (ii) restrictions on transfers of shares, (iii) procedures to be
followed under certain circumstances with respect to a sale of the Company,
(iv) the requirement that our stockholders take certain actions in connection
with an initial public offering or a sale of FairPoint, (v) the requirement of
FairPoint to sell shares to the stockholders under certain circumstances upon
authorization of an issuance or sale of additional shares, (vi) the
participation rights of stockholders in connection with a sale of shares by
other stockholders, and (vii) our right to purchase all (but not less than all)
of the shares of a management stockholder in the event of resignation,
termination of employment, death or disability. The stockholders agreement also
provides that we must obtain the consent of THL and Kelso in order for us to
incur debt in excess of $5 million.

We entered into a registration rights agreement with certain of our
stockholders, dated as of January 20, 2000, pursuant to which such stockholders
have the right in certain circumstances and, subject to certain conditions, to
require us to register shares of our common stock held by them under the
Securities Act of 1933. Under the registration rights agreement, except in
limited circumstances, we are obligated to pay all expenses in connection with
such registration.

In connection with the execution of the stockholders agreement and the
registration rights agreement, we terminated our previous stockholders agreement
and registration rights agreement, each dated as of July 31, 1997.

96

FOUNDER COMPENSATION ARRANGEMENTS

Daniel G. Bergstein, Jack H. Thomas, Meyer Haberman and Eugene B. Johnson,
the founding stockholders of the Company, have entered into an arrangement with
Walter E. Leach, Jr. and John P. Duda pursuant to which such stockholders have
agreed to provide compensation to Mr. Leach and Mr. Duda upon the occurrence of
certain specified liquidation events with respect to the Company, based on the
value of the Company at the time of such liquidation event.

ITEM 14. CONTROLS AND PROCEDURES

(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.

Within 90 days prior to the filing date of this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the Company's disclosure controls and
procedures (as defined in rule 15d-14(c) of the Securities Exchange Act of
1934).

Based upon that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures (a) are effective to ensure that information required to be disclosed
by the Company in this report has been timely recorded, processed, summarized
and reported and (b) include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by the Company in
this report has been accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.

(B) CHANGES IN INTERNAL CONTROLS.

There have been no significant changes in the Company's internal controls or
in other factors that could significantly affect these controls subsequent to
the date of the Company's evaluation.

97

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT:

(1) Financial Statements

The following items are included in Part II, Item 8 of this report:

INDEPENDENT AUDITORS' REPORT
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2000, 2001 AND 2002:
Consolidated Balance Sheets as of December 31, 2001 and 2002
Consolidated Statements of Operations for the Years Ended
December 31, 2000, 2001 and 2002
Consolidated Statements of Stockholders' Equity (Deficit) for the
Years Ended December 31, 2000, 2001 and 2002
Consolidated Statements of Comprehensive Income (Loss) for the
Years Ended December 31, 2000, 2001 and 2002
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000, 2001 and 2002
Notes to Consolidated Financial Statements for the Years Ended
December 31, 2000, 2001 and 2002

In addition, certain financial statements required by Section 309 of
Regulation S-X have been filed as exhibits hereto and are
incorporated by reference herein.

(2) Financial Statement Schedules

The following financial statement schedule is filed below:
Schedule II--Valuation and Qualifying Accounts.

(3) The Exhibits filed as part of this report are listed in the Index to
Exhibits immediately preceding such exhibits, which Index to Exhibits
is incorporated herein by reference.

(B) REPORTS ON FORM 8-K

On November 14, 2002, the Company filed a Current Report on Form 8-K
announcing its financial results for the quarter and nine-month period that
ended September 30, 2002.

98

INDEPENDENT AUDITORS' REPORT

The Board of Directors
FairPoint Communications, Inc.:

Under date of February 19, 2003, except Note 19 which is as of March 6,
2003, we reported on the consolidated balance sheets of FairPoint
Communications, Inc. and subsidiaries as of December 31, 2001 and 2002 and the
related consolidated statements of operations, stockholders' equity (deficit),
comprehensive income (loss), and cash flows for each of the years in the
three-year period ended December 31, 2002, which are included in this
Form 10-K. In connection with our audits of the aforementioned consolidated
financial statements, we also audited the accompanying related consolidated
financial statement Schedule II. This consolidated financial statement schedule
is the responsibility of the Company's management. Our responsibility is to
express an opinion on this consolidated financial statement schedule based on
our audits.

In our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.

/s/ KMPG LLP

Omaha, Nebraska
February 19, 2003

99

SCHEDULE II

FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2000, 2001, AND 2002

Note: Customers' accounts written-off, net of recoveries.

See accompanying independent auditors' report.

100

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

FAIRPOINT COMMUNICATIONS, INC.

By: /s/ WALTER E. LEACH, JR.
-----------------------------------------
Name: Walter E. Leach, Jr.
Title: Senior Vice President and Chief
Financial Officer

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed by the following persons in
the capacities and on the dates indicated.

101

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a) Exhibits

102

103

104

- --------------------------

* Filed herewith.

(1) Incorporated by reference to the annual report of FairPoint for the year
ended 1999, filed on Form 10-K.

(2) Incorporated by reference to the registration statement on Form S-4 of
FairPoint, declared effective as of October 1, 1998.

(3) Incorporated by reference to the registration statement on Form S-4 of
FairPoint, declared effective as of August 9, 2000.

(4) Incorporated by reference to the quarterly report of FairPoint for the
period ended September 30, 2000, filed on Form 10-Q.

(5) Incorporated by reference to the quarterly report of FairPoint for the
period ended June 30, 2001, filed on Form 10-Q.

(6) Incorporated by reference to the current report on Form 8-K, filed on
November 18, 2001.

(7) Incorporated by reference to the annual report of FairPoint for the year
ended 2001, filed on Form 10-K.

(8) Incorporated by reference to the quarterly report of FairPoint for the
period ended March 31, 2002, filed on Form 10-Q.

105

CERTIFICATION

I, Eugene B. Johnson, certify that:

1. I have reviewed this annual report on Form 10-K of FairPoint
Communications, Inc. (the "Company");

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Company as of, and for, the periods presented in this annual report;

4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in rule 13a -14 and 15d-14 under the Securities Exchange Act of 1934, as
amended) for the Company and we have:

(i) designed such disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report was being
prepared;

(ii) evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

(iii) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;

5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of
Company's board of directors (or persons performing the equivalent
function):

(i) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for the
Company's auditors any material weaknesses in internal controls; and

(ii) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
controls; and

6. The Company's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the Evaluation Date, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: March 27, 2003

/s/ EUGENE B. JOHNSON
- ---------------------------------------------
Eugene B. Johnson
Chief Executive Officer

CERTIFICATION

I, Walter E. Leach, Jr., certify that:

1. I have reviewed this annual report on Form 10-K of FairPoint
Communications, Inc. (the "Company");

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Company as of, and for, the periods presented in this annual report;

4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as
amended) for the Company and we have:

(i) designed such disclosure controls and procedures to ensure that material
information relating to the Company, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report was being
prepared;

(ii) evaluated the effectiveness of the Company's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

(iii) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;

5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of
Company's board of directors (or persons performing the equivalent
function):

(i) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for the
Company's auditors any material weaknesses in internal controls; and

(ii) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
controls; and

6. The Company's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the Evaluation Date, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: March 27, 2003

/s/ WALTER E. LEACH, JR.
- ---------------------------------------------
Walter E. Leach, Jr.
Chief Financial Officer