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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
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333-36804
Commission file number
MADISON RIVER CAPITAL, LLC
(Exact Name of Registrant as Specified in Its Charter)
Delaware 56-2156823
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
103 South Fifth Street
Mebane, North Carolina 27302
(Address of Principal Executive Offices, Including Zip Code)
(919) 563-1500
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No ___
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
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MADISON RIVER CAPITAL, LLC
Index to Form 10-Q
Part I - Financial Information Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2003 (Unaudited)
and December 31, 2002............................................................1
Condensed Consolidated Statements of Operations and Comprehensive Loss
(Unaudited) - Three and Nine Months Ended September 30, 2003 and 2002............2
Consolidated Statement of Member's Interest (Unaudited)- Nine Months
Ended September 30, 2003.........................................................3
Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine Months
Ended September 30, 2003 and 2002................................................4
Notes to Condensed Consolidated Financial Statements (Unaudited)...................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations....................................................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risks........................27
Item 4. Controls and Procedures............................................................27
Part II - Other Information
Item 1. Legal Proceedings..................................................................28
Item 6. Exhibits and Reports on Form 8-K...................................................29
Signature....................................................................................29
i
Part I
ITEM 1 - FINANCIAL STATEMENTS
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Balance Sheets
(Dollars in thousands)
September 30, 2003 December 31, 2002
------------------ -----------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 27,043 $ 19,954
Accounts receivable, less allowance for uncollectible accounts
of $1,936 and $2,792 in 2003 and 2002, respectively 10,747 12,347
Receivables, primarily from interexchange carriers, less
allowance for uncollectible accounts of $793 and $1,693
in 2003 and 2002, respectively 7,700 7,796
Rural Telephone Finance Cooperative stock to be redeemed 1,354 2,039
Inventories 2,577 1,039
Other current assets 4,968 4,511
-------- --------
Total current assets 54,389 47,686
-------- --------
Telephone plant and equipment 470,201 471,929
Less accumulated depreciation and amortization (144,022) (112,564)
-------- --------
Telephone plant and equipment, net 326,179 359,365
-------- --------
Other assets:
Rural Telephone Finance Cooperative stock, at cost 42,659 44,013
Goodwill 366,332 366,332
Other assets 24,320 26,075
-------- --------
Total other assets 433,311 436,420
-------- --------
Total assets $ 813,879 $ 843,471
======== ========
Liabilities and member's capital
Current liabilities:
Accounts payable and accrued expenses $ 33,059 $ 37,361
Other current liabilities 6,453 8,543
Current portion of long-term debt 2,373 27,613
-------- --------
Total current liabilities 41,885 73,517
-------- --------
Noncurrent liabilities:
Long-term debt 645,790 633,955
Other liabilities 80,359 78,509
-------- --------
Total noncurrent liabilities 726,149 712,464
-------- --------
Total liabilities 768,034 785,981
Member's capital:
Member's interest 251,284 251,284
Accumulated deficit (205,439) (193,639)
Accumulated other comprehensive loss - (155)
-------- --------
Total member's capital 45,845 57,490
-------- --------
Total liabilities and member's capital $ 813,879 $ 843,471
======== ========
See Notes to Condensed Consolidated Financial Statements.
1
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Operations and Comprehensive Loss
(Dollars in thousands)
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Operating revenues:
Local service $ 32,993 $ 34,311 $ 98,858 $ 102,977
Long distance service 4,551 4,288 13,212 12,545
Internet and enhanced data service 4,657 3,971 13,388 11,298
Transport service 750 899 2,085 2,623
Miscellaneous telecommunications
service and equipment 3,481 3,376 10,059 8,157
-------- -------- -------- --------
Total operating revenues 46,432 46,845 137,602 137,600
-------- -------- -------- --------
Operating expenses:
Cost of services 12,970 14,527 36,303 43,547
Depreciation and amortization 13,869 13,453 39,359 37,901
Selling, general and administrative expenses 9,897 12,345 29,022 34,369
Restructuring (468) 2,683 (468) 2,683
-------- -------- -------- --------
Total operating expenses 36,268 43,008 104,216 118,500
-------- -------- -------- --------
Net operating income 10,164 3,837 33,386 19,100
Interest expense (16,384) (15,986) (47,119) (48,149)
Other income (expense):
Realized gains (losses) on marketable
equity securities 25 (4,480) (343) (4,449)
Impairment charges on investments accounted
for using the equity method - - - (2,098)
Other income, net 912 1,098 2,399 3,700
-------- -------- -------- --------
Loss before income taxes and minority
interest expense (5,283) (15,531) (11,677) (31,896)
Income tax expense (benefit) 392 (1,177) 123 (95)
-------- -------- -------- --------
Loss before minority interest expense (5,675) (14,354) (11,800) (31,801)
Minority interest expense - - - (275)
-------- -------- -------- --------
Net loss (5,675) (14,354) (11,800) (32,076)
Other comprehensive income (loss):
Unrealized gains (losses) on marketable
equity securities 25 (1,694) (188) (4,465)
Reclassification adjustment for realized
(gains) losses included in net loss (25) 4,480 343 4,449
-------- -------- -------- --------
Other comprehensive income (loss) - 2,786 155 (16)
-------- -------- -------- --------
Comprehensive loss $ (5,675) $ (11,568) $ (11,645) $ (32,092)
======== ======== ======== ========
See Notes to Condensed Consolidated Financial Statements.
2
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statement of Member's Capital
(Dollars in thousands)
(Unaudited)
Accumulated
Other
Member's Accumulated Comprehensive
Interest Deficit Income (Loss) Total
---------- ----------- ------------- ---------
Balance at December 31, 2002 $ 251,284 $ (193,639) $ (155) $ 57,490
Net loss - (11,800) - (11,800)
Other comprehensive loss:
Unrealized losses on marketable
equity securities - - (188) (188)
Reclassification adjustment for realized
losses included in net loss - - 343 343
--------- ---------- ------- --------
Balance at September 30, 2003 $ 251,284 $ (205,439) $ - $ 45,845
========= ========== ======= ========
See Notes to Condensed Consolidated Financial Statements.
3
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2003 2002
---------- ----------
Operating activities
Net cash provided by operating activities $ 24,345 $ 17,563
-------- --------
Investing activities
Purchases of telephone plant and equipment (6,309) (11,161)
Redemption of Rural Telephone Finance Cooperative stock, net 2,039 746
Change in other assets 1,571 185
-------- --------
Net cash used for investing activities (2,699) (10,230)
-------- --------
Financing activities
Redemption of member's interest - (2,000)
Redemption of minority interest (1,000) (1,000)
Proceeds from long-term debt - 11,778
Payments on long-term debt (13,557) (25,172)
Change in other long-term liabilities - (270)
-------- --------
Net cash used for financing activities (14,557) (16,664)
-------- --------
Net increase (decrease) in cash and cash equivalents 7,089 (9,331)
Cash and cash equivalents at beginning of year 19,954 21,606
-------- --------
Cash and cash equivalents at end of nine month period $ 27,043 $ 12,275
======== ========
See Notes to Condensed Consolidated Financial Statements.
4
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements
(Unaudited)
1. GENERAL
Madison River Capital, LLC (the "Company"), a wholly-owned subsidiary of
Madison River Telephone Company LLC ("MRTC"), was organized on August 26,
1999 as a limited liability company under the provisions of the Delaware
Limited Liability Company Act. Under the provisions of this Act, the member's
liability is limited to the Company's assets provided that the member returns
to the Company any distributions received. The Company is an established
rural local exchange company providing integrated telecommunications services
to business and residential customers in the Gulf Coast, Mid-Atlantic and
Midwest regions of the United States. Its integrated service offerings
include local and long distance voice, high speed data, internet access and
fiber transport. These consolidated financial statements include the
financial position and results of operations of the following subsidiaries of
the Company: Madison River Holdings Corp. ("MRH"), Madison River LTD Funding
Corp. ("MRLTDF"), Mebtel, Inc., Gallatin River Holdings, LLC and its
subsidiary ("GRH"), Gulf Coast Services, Inc. and its subsidiaries, Coastal
Communications, Inc. ("CCI") and its subsidiaries, Madison River Management
Company ("MRM"), Mebtel Long Distance Solutions, Inc. ("MLDS"), Madison River
Long Distance Solutions, Inc. ("MRLDS"), Madison River Communications, LLC
and its subsidiary ("MRC").
The primary purpose for which the Company was organized was the acquisition,
integration and operation of rural local exchange telephone companies. Since
January 1998, the Company has acquired four rural incumbent local exchange
carriers ("ILECs") located in North Carolina, Illinois, Alabama and Georgia.
These rural ILEC operations, which along with MLDS and MRLDS comprise the
Local Telecommunications Division (the "LTD"), served 208,787 voice access
and digital subscriber line ("DSL") connections as of September 30, 2003.
The operations of the ILECs are subject to federal, state and local
regulation.
The Company also operates as an edge-out competitive local exchange carrier
("CLEC") in markets in North Carolina, Illinois and Louisiana, as well as
provides fiber transport services to large businesses and other carriers,
primarily in the southeastern United States. The CLEC and fiber transport
operations form the Integrated Communications Division (the "ICD") and served
15,616 voice access and high speed data connections at September 30, 2003.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and are in the form prescribed
by the Securities and Exchange Commission in instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. The interim unaudited
financial statements should be read in conjunction with the audited financial
statements of the Company as of and for the year ended December 31, 2002.
Such financial statements are included in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2002 filed with the Securities
and Exchange Commission on March 31, 2003. The amounts presented in the
condensed consolidated balance sheet as of December 31, 2002 were derived
from the audited financial statements included in the Form 10-K. In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the third quarter and nine-month period ended September
30, 2003 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2003.
Certain amounts in the September 30, 2002 condensed consolidated financial
statements have been reclassified to conform to the September 30, 2003
presentation. These reclassifications had no effect on net loss or member's
capital as previously reported.
3. INVENTORIES
Inventories are comprised primarily of poles, wires and telephone equipment
and are stated at the lower of cost (average cost) or market. During the
third quarter of 2003, the Company transferred certain components of a switch
taken out of service to inventory until the components are redeployed in
other operations of the Company. The transferred components were valued at
approximately $1.6 million.
5
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
4. TELEPHONE PLANT AND EQUIPMENT
Telephone plant and equipment consisted of the following at:
September 30, December 31,
2003 2002
------------- ------------
(in thousands)
Land, buildings and general equipment $ 58,892 $ 58,144
Central office equipment 153,902 155,350
Poles, wires, cables and conduit 229,385 225,932
Leasehold improvements 2,533 2,533
Software 17,514 16,893
Construction-in-process 7,975 13,077
--------- ---------
Total telephone plant and equipment $ 470,201 $ 471,929
========= =========
5. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued Statement of Financial Accounting Standards
145, Rescission of FASB Statements Nos. 4, 44, and 62, Amendment of FASB
Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145 requires
gains and losses on extinguishments of debt to be classified as income or
loss from continuing operations rather than as extraordinary items as
previously required under Statement No. 4. Extraordinary treatment will be
required for certain extinguishments as provided in APB 30. SFAS 145 also
amends Statement No. 13 to require certain modifications to capital leases be
treated as a sale-leaseback and modified the accounting for sub-leases when
the original lessee remains a secondary obligor (or guarantor). SFAS 145,
effective for all fiscal years beginning after May 15, 2002, was adopted by
the Company on January 1, 2003. The adoption of SFAS 145 did not have a
material impact on the Company's results of operations, financial position or
cash flows.
In July 2002, the FASB issued Statement of Financial Accounting Standards
146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS
146"). SFAS 146, which nullified EITF Issue 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) ("EITF 94-3"), requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF 94-3, a liability for
an exit cost was recognized at the date of an entity's commitment to an exit
plan. The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The adoption of SFAS
146 by the Company, effective January 1, 2003, did not have a material impact
on the Company's results of operations, financial position or cash flows.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45"). The Interpretation requires
recognition of liabilities at their fair value for newly issued guarantees
and certain other disclosures. The Company adopted FIN 45 in 2003 and it did
not have a material impact on its results of operations, financial position,
or cash flows.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"), the primary objective of which is to
provide guidance on the identification of entities for which control is
achieved through means other than voting rights, defined as variable interest
entities ("VIEs") and to determine when and which business enterprise should
consolidate the VIE as the "primary beneficiary." This new model applies
when either (1) the equity investors, if any, do not have a controlling
financial interest or (2) the equity investment at risk is insufficient to
finance that entity's activities without additional financial support. In
addition, FIN 46 requires additional disclosures. This interpretation applies
immediately to VIEs created after January 31, 2003 and to VIEs in which an
enterprise obtains an interest after that date. As a result of FASB Staff
Position 46-6, the application of FIN 46 for interests in VIEs or potential
VIEs before February 1, 2003 has been deferred until the amended effective
date of December 31, 2003 in anticipation of additional guidance to be
provided by the FASB. The Company has determined that an unconsolidated
company it holds an investment in that is accounted for under the equity
method is a VIE under FIN 46 but the Company is not the primary beneficiary
of the VIE. The Company provides services to the VIE for which it has
recorded revenues of $0.3 million and recognized expenses of $0.1 million for
services provided by the VIE to the Company in the nine months ended
September 30, 2003. The Company's maximum exposure to loss as a result of
its involvement with the VIE is the $0.3 million carrying value of its
investment at September 30, 2003. The Company does not expect the adoption
of FIN 46 to have a material impact on its results of operations, financial
position, or cash flows.
6
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
5. RECENT ACCOUNTING PRONOUNCEMENTS, Continued
In May 2003, the FASB issued Statement of Financial Accounting Standards 150,
Accounting for Certain Financial Instruments with Characteristics of
Liabilities and Equity ("SFAS 150"). SFAS 150 requires certain financial
instruments that embody obligations of the issuer and have characteristics of
both liabilities and equity to be classified as liabilities. Many of these
instruments previously were classified as equity or temporary equity and as
such, SFAS 150 represents a significant change in practice in the accounting
for a number of financial instruments, including mandatorily redeemable
equity instruments. SFAS 150 was effective for public companies for all
financial instruments created or modified after May 31, 2003, and to other
instruments at the beginning of the first interim period beginning after June
15, 2003. The Company adopted SFAS 150 during the third quarter of 2003.
Upon adoption, the Company reclassified the redeemable minority interest of
$4.0 million on its balance sheet from its mezzanine level presentation
between liabilities and equity to current and long-term other liabilities.
Beyond the reclassification of redeemable minority interest, the adoption of
SFAS 150 did not have a material impact on the Company's results of
operations, financial position or cash flows.
6. RESTRUCTURING
In the fourth quarter of 2001, a subsidiary of the Company, MRC, recorded a
$2.8 million restructuring charge associated with the subsidiary's decision
to reduce its sales and marketing efforts and eliminate redundant support
services. The charge was recognized in accordance with EITF 94-3.
Substantially all of the payments charged against this restructuring accrual
related to payments made under lease agreements. As of September 30, 2003,
the following amounts were recorded in connection with this restructuring:
Balance at 2003 Balance at
December 31, 2002 payments September 30, 2003
----------------- -------- ------------------
(in thousands)
Future lease obligations $ 788 $ (209) $ 579
Legal related expenses 31 - 31
------- ------- -------
$ 819 $ (209) $ 610
======= ======= =======
In the third quarter of 2002, in completing the development of the ICD as a
true edge-out CLEC, the Company realigned each of the ICD's operating regions
in North Carolina, Illinois and New Orleans under the Company's rural ILECs
in those respective regions. The rural ILECs, therefore, assumed
responsibility for managing and directing the ICD's operations in those
regions. Correspondingly, the Company recognized a restructuring charge of
$2.8 million related to the realignment for the elimination of redundant
management, marketing and support services and the structuring of a more
efficient network. Of the restructuring charge, MRC recognized $2.7 million
and MRM recognized $0.1 million. The charge, recognized in accordance with
EITF 94-3, consisted primarily of the costs associated with future
obligations on non-cancelable leases for certain facilities that were no
longer used, net of estimated sublease income, losses from the abandonment of
fixed assets and leasehold improvements associated with those leased
facilities, the expenses associated with decommissioning a switch, expenses
associated with the elimination of thirty employees, primarily in the ICD,
and related expenses. During the third quarter of 2003, the Company adjusted
certain accruals that were included in the initial restructuring charge to
recognize its actual results and to reflect changes in its assumptions
related to future periods. In addition, approximately $0.4 million of the
restructuring charge related to the decommissioning of a switch was reversed
as the Company decided to redeploy certain elements of the switch elsewhere
in its operation. As a result of these adjustments, the Company recognized a
benefit of $0.5 million in its restructuring expenses. Substantially all of
the payments charged against this restructuring accrual in 2003 related to
payments made under lease agreements. As of September 30, 2003, the
following amounts were recorded in connection with this restructuring:
Balance at 2003 2003 Balance at
December 31, 2002 payments adjustments September 30, 2003
----------------- -------- ----------- ------------------
(in thousands)
Future lease obligations $ 1,345 $ (187) $ 150 $ 1,308
Telephone plant and equipment 158 (13) (145) -
Employee separation expenses 77 (4) (73) -
------- ------- ------- -------
$ 1,580 $ (204) $ (68) $ 1,308
======= ======= ======= =======
The remaining balance in our restructuring accruals as of September 30, 2003
is recorded as $0.9 million in accrued expenses and $1.0 million in other
long-term liabilities.
7
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
7. LONG-TERM DEBT AND LINES OF CREDIT
Long-term debt and lines of credit outstanding consisted of the following at:
September 30, December 31,
2003 2002
------------- ------------
(in thousands)
First mortgage notes collateralized by substantially all LTD assets:
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at the
RTFC's base rate plus 1.0% (5.4% at September 30, 2003). $ 11,680 $ 12,103
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 5.65% (rate expires August 2006). 5,924 6,138
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 5.65% (rate expires August 2006). 951 983
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 6.95% (rate expires November 2004). 102,486 105,780
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 5.65% (rate expires August 2006). 5,557 5,722
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 5.65% (rate expires August 2006). 67,384 70,684
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 5.65% (rate expires August 2006). 3,543 3,648
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 9.05% (rate expires October 2004). 122,063 125,561
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 5.65% (rate expires August 2006). 7,778 7,778
RTFC note payable in escalating quarterly principal installments
through November 2016, interest payments due quarterly at a
fixed rate of 9.0% (rate expires April 2005). 99,226 101,734
RTFC secured line of credit loan, maturing March 2005 with
interest payments due quarterly at the RTFC's line
of credit base rate plus 0.5% (5.4% at September 30, 2003). 21,000 21,000
Mortgage note payable in monthly installments of $18 with a
balloon payment of $2,238 in April 2006, interest at a
fixed rate of 8%, secured by land and building. 2,308 2,326
Unsecured 131/4% senior notes payable, due March 1, 2010, with
interest payable semiannually on March 1 and September 1, net of
debt discount of $2,130 and $2,282, respectively. 197,870 197,718
Other 393 393
-------- --------
648,163 661,568
Less current portion 2,373 27,613
-------- --------
$ 645,790 $ 633,955
======== ========
8
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
7. LONG-TERM DEBT AND LINES OF CREDIT, Continued
The loan facilities provided by the Rural Telephone Finance Cooperative (the
"RTFC") are primarily with MRLTDF, a subsidiary of the Company. In July
2003, MRLTDF executed an amendment to its loan agreement with the RTFC (the
"Amendment"). Under the terms of the Amendment, the loan agreement is
extended to November 2016. The Amendment also provides a reduction in
scheduled principal payments through 2010 as compared to the existing
agreement with the first scheduled principal payment occurring in the third
quarter of 2004. The Company will continue to make quarterly interest
payments to the RTFC. Annually, beginning in 2005, the Company will be
required to calculate excess cash flow for the LTD, as defined in the
Amendment, using the preceding year's financial results. If the calculation
indicates excess cash flow, the Company will be required to make mandatory
prepayments of principal to the RTFC equivalent to the amount of excess cash
flow. Such mandatory prepayments will be made in the second quarter of the
year in which the calculation is made.
Under the Amendment, interest rates on the outstanding term loans are at
their prevailing RTFC fixed or variable base rate plus a 1.0% interest rate
adder, which replaced the existing interest rate adders. Prior to the
Amendment, interest rates on these term loans were at the prevailing RTFC
fixed or variable base rate plus interest rate adders ranging from 0.35% to
0.75%. The 1.0% interest rate adder is subject to performance pricing which
will provide for a reduction in the interest rate adder as the Total Leverage
Ratio, as defined in the Amendment, decreases. The prior interest rate
adders had no performance pricing associated with them. In addition, the
financial ratio requirements were revised under the Amendment including
requiring annual RTFC approval of a three-year rolling capital expenditure
budget and obtaining RTFC consent for any acquisitions or disposals of local
exchange assets.
During the third quarter, the Company fixed the interest rates on
approximately $91.1 million consisting of six term loans outstanding to the
RTFC. The rates on these term loans were fixed at 5.65% for three years. In
September, the fixed interest rate on one of the Company's notes expired and
at September 30, 2003, this note bore interest at its prevailing RTFC
variable base interest rate plus the 1.0% interest rate adder, or 5.4%.
Prior to the expiration of its fixed rate, the note bore interest at 7.0%.
The terms of the RTFC loan agreement, including the Amendment, require MRLTDF
to meet and adhere to various financial and administrative covenants on an
annual basis. MRLTDF is, among other things, restricted in its ability to
(i) declare or pay dividends to MRH, its parent, under specified
circumstances, (ii) limited in its ability to make intercompany loans or
enter into other affiliated transactions, (iii) sell assets and make use of
the proceeds, and (iv) incur additional indebtedness above certain amounts
without the consent of the RTFC. At September 30, 2003, MRLTDF was in
compliance with the terms and conditions of the loan agreement.
Prior to the Amendment, the loan facilities were secured by a first mortgage
lien on substantially all of the operating assets and revenues of the LTD.
In addition, substantially all of the outstanding equity interests of the
subsidiaries that comprise the LTD were pledged in support of the facilities.
As part of the Amendment, the RTFC was additionally granted a first mortgage
lien on the assets of MRH, MLDS and MRLDS and the equity interests in those
entities were pledged in support of the loan facilities thereby providing the
RTFC a security interest in all of the assets, revenues and substantially all
of the equity interests of the LTD.
The $31.0 million secured revolving line of credit between the RTFC and
MRLTDF expires in March 2005. Interest is payable quarterly at the RTFC's
line of credit base rate plus 0.5% per annum. At September 30, 2003, MRLTDF
had drawn down $21.0 million under this line of credit with the remaining
$10.0 million fully available to MRLTDF.
9
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
7. LONG-TERM DEBT AND LINES OF CREDIT, Continued
The Company also has a $10.0 million unsecured line of credit that is fully
available to Coastal Utilities, Inc., a subsidiary of CCI, and expires in
March 2005. Under the terms of the Amendment, MRLTDF agreed to secure this
line of credit with the assets of Coastal Utilities, Inc. within six months
of signing the Amendment. This unsecured line of credit currently contains
an annual paydown provision which requires that the balance outstanding
against the line of credit be reduced to zero for five consecutive days in
every 360-day period. Interest is payable quarterly at the RTFC's line of
credit base rate plus 1.0% per annum.
Under the terms of the indenture that governs the senior notes, the Company
must comply with certain financial and administrative covenants. The Company
is, among other things, restricted in its ability to (i) incur additional
indebtedness, (ii) pay dividends, (iii) redeem or repurchase equity
interests, (iv) make various investments or other restricted payments, (v)
create certain liens or use assets as security in other transactions, (vi)
sell certain assets or utilize certain asset sale proceeds, (vii) merge or
consolidate with or into other companies and (viii) enter into transactions
with affiliates. At September 30, 2003, the Company was in compliance with
the terms of the senior notes indenture.
8. SEGMENT INFORMATION
The Company is a provider of integrated communications services and
solutions. The Company's operations are classified into two reportable
business segments, the LTD and the ICD. Although both segments provide
telecommunication services, financial and operating results of the segments
are evaluated separately by the chief operating decision maker. The
reporting segments follow the same accounting principles and policies used
for the Company's consolidated financial statements. The following tables
summarize the revenues and net operating income (loss) for each segment for
the three and nine month periods ended September 30, 2003 and 2002:
Three Month Period Ended Nine Month Period Ended
----------------------------- ----------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
(in thousands)
Total revenues:
LTD $ 43,698 $ 44,025 $ 129,289 $ 128,756
ICD 3,486 3,872 10,819 11,619
--------- --------- --------- ---------
47,184 47,897 140,108 140,375
Less intersegment revenues (752) (1,052) (2,506) (2,775)
--------- --------- --------- ---------
Total reported revenues $ 46,432 $ 46,845 $ 137,602 $ 137,600
========= ========= ========= =========
Net operating income (loss):
LTD $ 13,279 $ 12,560 $ 42,256 $ 36,651
ICD (3,115) (8,723) (8,870) (17,551)
--------- --------- --------- ---------
Total reported net operating
income $ 10,164 $ 3,837 $ 33,386 $ 19,100
========= ========= ========= =========
At September 30, 2003 and December 31, 2002, total assets by segment, net of
intersegment investments and other intersegment balances, were as follows:
September 30, December 31,
2003 2002
------------- ------------
(in thousands)
Total assets:
LTD $ 856,892 $ 869,730
ICD 444,491 468,172
----------- -----------
1,301,383 1,337,902
Less intersegment assets (487,504) (494,431)
----------- -----------
Total reported assets $ 813,879 $ 843,471
=========== ===========
10
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
9. PENSION CURTAILMENT
During the first quarter of 2003, the Company notified its employees who are
not members of bargaining units that the accrual of benefits in the non-
contributory, defined benefit pension plan, sponsored by MRTC, in which the
employees participated was frozen effective February 28, 2003. As a result
of this action, Statement of Financial Accounting Standards No. 88,
Employer's Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits became effective. The curtailment
resulted in an immediate net gain of $2.8 million, of which $2.7 million was
recognized as a reduction of pension expenses in the first quarter and $0.1
million as a reduction of capital expenditures. The impact of the gain will
be allocated between the Company and its subsidiaries, who also participate
in the plan. Although the accrual of benefits in the pension plan is frozen,
the Company has a continuing obligation to fund the plan and will continue to
recognize an annual net periodic pension expense while the plan is still in
existence.
11
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements in this Form 10-Q constitute "forward-looking statements"
that involve risks and uncertainties. Forward-looking statements generally
can be identified by the use of forward-looking words such as "may," "will,"
"expect," "intend," "estimate," "anticipate," "plan," "seek" or "believe," or
by discussion of strategy that involves risks and uncertainties. We believe
that the expectations reflected in such forward-looking statements are
accurate. However, we cannot assure you that such expectations will occur.
Our actual results may differ materially from those anticipated in these
forward-looking statements as a result of various factors, including, but not
limited to:
* the competition in, and the financial stability of, the
telecommunications industry;
* the passage of legislation, court decisions or regulatory changes
adversely affecting the telecommunications industry;
* our ability to repay our outstanding indebtedness;
* our ability to raise additional capital on acceptable terms and on a
timely basis; and
* the advent of new technology.
For more information, see the "Risk Factors" section beginning on page 16 of
our Annual Report on Form 10-K for the fiscal year ended December 31, 2002
(File No. 333-36804) filed with the Securities and Exchange Commission.
Except as required by law, we are not obligated to publicly release any
revisions to these forward-looking statements to reflect events or
circumstances occurring after the filing of this Form 10-Q or to reflect the
occurrence of unanticipated events.
References in this Form 10-Q to "we," "us" and "our" mean Madison River
Capital, LLC and its subsidiaries.
Critical Accounting Policies
Revenue Recognition
Revenues are recognized when the corresponding services are provided
regardless of the period in which they are billed. Recurring local service
revenues are billed in advance, and recognition is deferred until the service
has been provided. Nonrecurring revenues, such as long distance toll charges
and other usage-based billings, are billed in arrears and are recognized when
earned.
Network access service revenues are based on universal service funding and
charges to interexchange carriers for switched and special access services
and are recognized in the period when earned. Our rural ILEC subsidiaries
participate in revenue sharing arrangements, sometimes referred to as pools,
with other telephone companies for interstate revenues and for certain
intrastate revenues. Such sharing arrangements are funded by national
universal service funding, subscriber line charges and access charges in the
interstate market. Revenues earned through the sharing arrangements are
initially recorded based on our estimates. These estimates are then subject
to adjustment in future accounting periods as refined operating results
become available. Traffic sensitive and special access revenues for
interstate services are billed under tariffs approved by the appropriate
regulatory authority and retained by us.
Revenues from billing and collection services provided to interexchange
carriers, advertising sold in telephone directories and the sale and
maintenance of customer premise equipment are recorded as miscellaneous
revenues. These revenues are recognized when the service has been provided
or over the life of the contract, as appropriate.
12
Goodwill and Long-Lived Assets
Goodwill represents the excess of the purchase price of our acquisitions over
the fair value of the net assets acquired and has an indefinite life. In
accordance with Statement of Financial Accounting Standard 142 ("SFAS 142"),
the carrying value of goodwill is reviewed on an annual basis during the
fourth quarter or, as appropriate, if facts and circumstances suggest
impairment. We are currently reviewing the carrying value of our goodwill.
In performing the review of goodwill under the terms of SFAS 142, we make
certain estimates regarding the implied fair value of our individual
operating companies where the goodwill is recorded. If our review indicates
that the carrying value of an operating company including its goodwill is
greater than its implied fair value, then an impairment of goodwill exists.
We then compare the implied fair value of the goodwill to the carrying value
of the goodwill for the operating company and, accordingly, if the carrying
value exceeds the implied fair value, we recognize an impairment charge to
reduce the carrying value by the difference.
In addition, we are currently reviewing the carrying value of our fiber
network in accordance with Statement of Financial Accounting Standard 144,
Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"),
to determine if the carrying value has been impaired. We review the carrying
value of our fiber network on an annual basis or sooner if events or
circumstances indicate that an impairment may exist. In accordance with the
terms of SFAS 144, we compare the sum of the undiscounted expected future
cash flows from our fiber network to the carrying value of the fiber network.
If the carrying value of the fiber network exceeds the undiscounted expected
future cash flows, we would recognize an impairment charge by writing-down
the carrying value of the fiber network to its estimated fair market value
based on discounted expected future cash flows from the fiber network.
Allowance for Uncollectible Accounts
We evaluate the collectibility of our accounts receivable based on a
combination of factors. In circumstances where we are aware of a specific
customer's inability to meet its financial obligations to us, such as a
bankruptcy filing or substantial down-grading of credit scores, we record a
specific allowance against amounts due to reduce the net recognized
receivable to the amount we reasonably believe will be collected. For all
other customers, we reserve a percentage of the remaining outstanding
accounts receivable balance as a general allowance based on a review of
specific customer balances, our trends and experience with prior receivables,
the current economic environment and the length of time the receivables are
past due. If circumstances change, we will review the adequacy of the
allowance, and our estimates of the recoverability of amounts due us could be
reduced by a material amount.
Overview
We are an established rural local exchange company providing communications
services and solutions to business and residential customers in the Gulf
Coast, Mid-Atlantic and Midwest regions of the United States. Our integrated
service offerings include local and long distance voice, high-speed data,
Internet access and fiber transport. At September 30, 2003, we had
approximately 224,400 voice, DSL and high speed data connections in service.
We are organized into two operating divisions, the LTD and the ICD. The LTD
is responsible for the integration, operation and development of our rural
ILEC markets that consist of four ILECs acquired since January 1998. The
ILECs are located in North Carolina, Illinois, Alabama and Georgia. The ICD
operates as an edge-out CLEC whereby its markets are in territories that are
in close proximity to our rural ILECs. The ICD currently provides services
to medium and large customers in three edge-out markets: the Triangle
(Raleigh, Durham and Chapel Hill) and the Triad (Greensboro and Winston-
Salem) in North Carolina; Peoria and Bloomington in Illinois; and the New
Orleans, Louisiana region. The management and operating responsibility for
the ICD's operating regions is provided by the managers of the respective
ILECs.
13
In addition to its CLEC operations, the ICD has a transport business that
provides transport and IP transit services to other carriers and large
businesses along its approximately 2,300 route miles of fiber optic network.
The majority of this network comprises a long-haul network in the southeast
United States that connects Atlanta, Georgia and Dallas, Texas, two of the
five Tier I Network Access Points. Further, the route connects other
metropolitan areas such as Mobile and Montgomery, Alabama; Biloxi,
Mississippi; New Orleans, Louisiana; and Houston, Texas. The Company has
designated Atlanta and Dallas as its Internet egress points. The ICD's
transport business is currently providing services in Atlanta, Georgia; New
Orleans, Louisiana; and Houston and Dallas, Texas. Because we have found the
fiber transport business to be extremely competitive, we are not actively
expanding this line of business at this time. The main value being derived
from our fiber optic network is through support for our dial-up, DSL and high
speed access services provided in both the LTD and the ICD, which use our
network to connect to the Internet.
Our current business plan is focused on improving cash flows for the
enterprise. Since our inception, our principal activities have been the
acquisition, integration, operation and improvement of ILECs in rural
markets. In acquiring our four ILECs, we purchased businesses with positive
cash flow, government and regulatory authorizations and certifications,
operating support systems, management and key personnel and facilities. The
LTD is continuing to develop these established markets with successful
marketing of vertical services and DSL products and is controlling expenses
through the use of business process management tools and other methods. In
the ICD, our strategy is focused on developing a profitable customer base and
maintaining sustainable positive cash flow from this division. The ICD has
established more rigorous criteria for evaluating new customers and the
desirability of renewing existing contracts.
Revenues
- --------
To date, our revenues have been derived principally from the sale of voice
and data communications services to business and residential customers in our
established ILEC markets. For the nine months ended September 30, 2003,
approximately 92.3% of our operating revenues came from the LTD and 7.7% from
the ICD. For the year ended December 31, 2002, approximately 91.7% of our
operating revenues came from the LTD and 8.3% from the ICD. We intend to
focus on continuing to generate increasing revenues in our LTD and ICD
operations from voice services (local and long distance), Internet access and
enhanced data and other services, including an evaluation of the impact from
providing video services to our customers. The sale of communications
services to customers in our ILEC markets will continue to provide the
predominant share of our revenues for the foreseeable future. We do not
anticipate significant growth in revenues for the ICD, if any, as we continue
to focus on a business plan that provides sustainable positive cash flows in
that division. Our transport business, which provides services to other
carriers and major accounts, will grow revenues only if certain profit
margins are obtained without making significant additional capital
investments and will primarily continue to support our retail Internet
service business.
At September 30, 2003, we had 224,403 connections in service compared to
224,890 connections in service at September 30, 2002, a decrease of 487
connections or 0.2%. The LTD had 208,787 connections in service at September
30, 2003 and 208,100 connections in service at September 30, 2002, an
increase of 687 connections or 0.3%. For the ICD, connections in service at
September 30 ,2003 and September 30, 2002 were 15,616 and 16,790,
respectively, a decrease of 1,174 connections or 7.0%.
For the nine months ended September 30, 2003, we experienced a decline in the
number of voice access lines in service in the LTD, primarily from losses in
the Illinois ILEC. At September 30, 2003, the LTD had 187,593 voice access
lines in service, which is a decrease of 5,410 voice access lines from
193,003 voice access lines in service at September 30, 2002. The predominant
share of voice access line losses have occurred in our Illinois operations
which accounted for approximately 65% of the decrease. A persistent weakness
in the local economies that Gallatin River Communications in Illinois serves
has led to unemployment and certain business losses and, therefore, a decline
in voice access lines in this market. We are uncertain at this time
regarding the trend for voice access lines in this market in the near future.
14
The number of DSL subscribers we serve in the LTD continues to increase. We
believe we have been successful in addressing competition from new high speed
Internet access product introductions, particularly by cable operators, in
our markets during 2002 and 2003. We believe that the execution of our
strategy and our ability to deliver a quality DSL product in a timely manner
has made us the provider of choice in our markets. Although we cannot be
certain, we anticipate that our DSL product will continue to provide a source
of increasing revenues for the LTD. As of September 30, 2003, we had 21,194
DSL connections in service, an increase of 6,097 connections from 15,097 DSL
connections at September 30, 2002. Our penetration rate for installed DSL
connections reached 11.3% of our LTD voice access lines at September 30, 2003
compared to 7.8% at September 30, 2002.
We have also been successful in growing other revenues in the LTD including
the provision of long distance and vertical services to our customers. At
September 30, 2003, we had 95,466 long distance accounts compared to 90,496
long distance accounts at September 30, 2002. In addition, our penetration
rates for voicemail and caller ID have continued to increase. We are
currently in the preliminary stages of assessing the potential benefits of
adding video services to the suite of products we offer to our customers.
Since we are early in the planning process, at this time we are not certain
what types of video services we may offer, if any, or what types of
technology we may use to deliver these services to our customers.
We have experienced a decrease in the number of dial-up Internet accounts we
service. At September 30, 2003, we had 24,966 dial-up Internet customers
which was a decrease of 2,990 customers, or 10.7%, from 27,956 dial-up
Internet customers at September 30, 2002. We believe that a large percentage
of the decrease in dial-up Internet customers comes from customers switching
from our dial-up product to our high-speed DSL product.
We have experienced a decrease in revenues for the first nine months of 2003
compared to the same period in 2002 as new sales of new services and renewals
of expiring customer contracts have not been enough to replace customers that
do not continue with our service. At September 30, 2003, the ICD had 14,915
voice access lines and 701 high speed data connections in service. At
December 31, 2002, the ICD served approximately 16,340 voice access lines and
710 high speed data connections. The decrease in voice access lines is
attributed primarily to the loss of one customer in North Carolina as the
result of a merger. We are focusing our efforts on only adding customers
that meet certain profitability criteria and on increasing our profitability
and margins for services provided to existing customers when renegotiating
their contracts at expiration.
We will continue to offer bundled services and to competitively price our
services in each of our markets. In our North Carolina ILEC operation, we
have recently begun offering a bundled plan that includes unlimited local and
long distance calling in the domestic United States, several custom calling
features such as Caller ID and voicemail, and high speed DSL service for a
single monthly fee subject to a one-year contract. This new plan has been
well accepted by our customers since introduction. Based on results to date,
we have found that over 50% of customers taking this new plan did not have
our DSL service previously which has led to an overall increase in our
average revenue per unit. Based on the success of this bundle plan in our
North Carolina ILEC, we are evaluating the feasibility of introducing similar
plans in our other ILEC operations. In addition, we intend to continue to
offer other combined service discounts and programs designed to give
customers incentives to buy bundled services.
Bankruptcies by interexchange carriers, including MCI WorldCom and Global
Crossing in 2002, have impacted our financial results, including our
revenues, operating income and cash flows. Without additional clarification
or regulatory changes that recognize the additional financial burdens placed
on local exchange carriers, we may be unable to appropriately protect
ourselves against the financial impact on revenues or results of operations
and cash flows associated with any future bankruptcies of interexchange
carriers or other telecommunication service providers.
15
Expenses
- --------
Operating expenses reported in the LTD have been fairly consistent from
period to period in recent quarters. After completion of our last
acquisition in March 2000, we focused on integrating our ILEC acquisitions
and implementing business process management tools to better manage expenses.
Accordingly, we have experienced fairly significant decreases in operating
expenses in our ILEC operations since 2000. In more recent quarters, the
rate of decrease has slowed. We will seek to maintain the expense reductions
that we have achieved in the LTD.
In recent quarters, the ICD has been focused on achieving sustainable
positive cash flow. An important part of this strategy was the decision, in
the fourth quarter of 2001, to slow the rate at which the ICD was adding new
voice and high speed data connections. With slower planned growth, fewer
sales personnel were needed and, as a result, fewer provisioners, sales
engineers, customer care and other support personnel were required. In
addition, certain fixed facility and overhead costs were reduced or
eliminated. In addition to our strategy of slower planned growth, we also
completed the transformation of the ICD as a true edge-out CLEC by placing
the responsibility for managing and operating the ICD's markets with the
managers of our respective ILECs. This allowed for additional reductions in
operating expenses as we were able to eliminate a number of redundant
operations in the ICD. The ICD also focused on grooming its network to
reduce the costs of delivering services to its customers by replacing more
expensive special access circuits with circuits provided for in our
interconnection agreements with the incumbent local exchange carriers. In
combination, these adjustments led to significant decreases in operating
expenses in the ICD.
Since the fourth quarter of 2002, the ICD's operating expenses have remained
relatively consistent. In the near term, barring any unforeseen events, we
expect that further decreases in operating expenses, if any, should be
minimal.
Our primary operating expenses consist of cost of services, selling, general
and administrative expenses and depreciation and amortization.
Cost of services
Our cost of services includes:
* plant specific costs and expenses, such as network and general support
expense, central office switching and transmission expense, information
origination/termination expense and cable and wire facilities expense;
* plant nonspecific costs, such as testing, provisioning, network,
administration, power and engineering;
* the cost of leasing unbundled copper loop lines and high capacity
digital lines from the ILECs to connect our customers and other
carriers' networks to our network;
* the cost of leasing transport from ILECs or other providers where our
fiber transport capacity is not available; and
* the cost of collocating in ILEC central offices.
We have entered into interconnection agreements with BellSouth, Verizon,
Ameritech, Sprint and SBC which allow, among other things, the ICD to lease
unbundled network elements from these ILECs, at contracted rates contained in
the interconnection agreements. The ICD uses these network elements to
connect its customers with its network. Other interconnection agreements may
be required by the ICD. In addition, the ICD currently has the necessary
certifications to operate in the states where it has customers.
We have a resale agreement with Global Crossing to provide long distance
transmission services that contains minimum volume commitments. Although we
believe that we will meet these commitments, we may not be successful in
generating adequate long distance business to absorb our minimum volume
commitment and will be required to pay for long distance transmission
services that we are not using. We renewed our agreement with Global
Crossing during the third quarter of 2003 on a long-term basis with lower
minimum volume commitments than existed in the previous contract.
16
Selling, general and administrative expenses
Selling, general and administrative expenses include:
* selling and marketing expenses;
* expenses associated with customer care;
* billing and other operating support systems; and
* corporate expenses.
We market our business services through agency relationships and direct sales
people. We market our consumer services primarily through our customer sales
and service representatives. We offer competitive compensation packages
including sales commissions and incentives.
We have operating support and other back office systems that we use to enter,
schedule, provision and track customer orders, test services and interface
with trouble management, inventory, billing, collection and customer care
service systems for the access lines in our operations. We may review and
consider the benefits offered by the latest generation of systems and, if we
implement new systems, we expect that our operating support systems and
customer care expenses may increase.
Depreciation and amortization expenses
We recognize depreciation expense for our telephone plant and equipment that
is in service and is used in our operations, excluding land which is not
depreciated. Depreciation is calculated using composite straight-line rates.
As we are a regulated entity, such rates are approved by the public utility
commissions in the states where we have regulated telephone plant in service.
Amortization expense is recognized primarily for our intangible assets
considered to have finite lives on a straight-line basis.
Results of Operations
Nine Months ended September 30, 2003 compared to Nine Months ended September
30, 2002
Total revenues were $137.6 million for each of the nine month periods ended
September 30, 2003 and September 30, 2002. Revenues in the LTD increased
approximately $1.0 million, or 0.8%, to $127.0 million in the first nine
months of 2003 from $126.0 million in the first nine months of 2002. In the
first nine months of 2003, revenues from Internet and enhanced data services
increased approximately $2.0 million, long distance revenues increased $0.7
million and miscellaneous revenues increased approximately $1.7 million
compared to the same period in 2002. The increase in Internet and enhanced
data revenues is attributed to an increase in the number of DSL subscribers.
The LTD served 21,194 DSL connections at September 30, 2003, an increase of
6,097 connections, or 40.4%, from the 15,097 connections in service at
September 30, 2002. Likewise, long distance revenues increased due to an
increase in the number of long distance accounts served. At September 30,
2003, the LTD had 95,466 long distance accounts, an increase of 4,970 long
distance accounts, or 5.5%, from 90,496 accounts served at September 30,
2002. Finally, the increase in miscellaneous revenues is attributed to the
impact on miscellaneous revenues in the first nine months of 2002 due to
approximately $1.5 million in bad debts charged against revenues for pre-
petition amounts of two customers, MCI WorldCom and Global Crossing, which
filed for bankruptcy during the second quarter of 2002. No comparable bad
debt charges were recognized in the first nine months of 2003. These
increases in LTD revenues were offset by a decrease of $3.3 million in local
service revenues. The decrease in local service revenues is primarily
attributable to anticipated lower network access revenues, as a result of
lower Universal Support Fund receipts, in the first nine months of 2003
compared to the same period of 2002. In addition, local service revenues
were impacted by the decrease in voice access lines. At September 30, 2003,
the LTD served 187,593 voice access lines, a decrease of 5,410 voice access
lines, or 2.8%, from 193,003 voice access lines served at September 30, 2002.
Revenues in the ICD decreased approximately $1.0 million, or 8.5%, to $10.6
million in the first nine months of 2003 compared to $11.6 million in the
first nine months of 2002. The decrease is attributed primarily to a $0.8
million decrease in local service revenues primarily from lower voice access
lines and lower network access revenues. At September 30, 2003 and 2002, the
ICD had 15,616 and 16,790 voice access and high speed connections in service,
respectively, representing a decrease of 1,174 connections, or 7.0%.
17
Revenues from voice services, which are comprised of local, network access
and long distance services, as a percentage of total revenues, were
approximately 81.4% and 84.0% for the nine months ended September 30, 2003
and 2002, respectively. The LTD and the ICD provided approximately 92.3% and
7.7% of total revenues, respectively.
Total operating expenses decreased $14.3 million from $118.5 million, or
86.1% of total revenues in the first nine months of 2002, to $104.2 million,
or 75.7% of total revenues, in the first nine months of 2003. Approximately
$2.7 million of the decrease is the result of a one-time, non-cash gain from
a pension curtailment in the first quarter of 2003. Accrual of benefits for
qualified plan participants who are not members of bargaining units in our
non-contributory, defined benefit pension plan was frozen in the first
quarter of 2003. As a result, Statement of Financial Accounting Standards
No. 88, Employer's Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits became effective. The
pension curtailment resulted in an immediate net gain of $2.8 million, of
which $2.7 million resulted in a reduction in pension expenses and $0.1
million went to reduce capital additions. The gain was recognized in the
first quarter of 2003 and allocated between the subsidiaries who participate
in the plan. Although further accrual of benefits by plan participants is
frozen, we have a continuing obligation to fund the plan and continue to
recognize net periodic pension expense. Approximately $2.1 million of the
net gain was recognized as a reduction of pension expenses in the LTD and
$0.6 million as a reduction of pension expenses in the ICD. In addition,
approximately $3.2 million of the decrease came from changes in restructuring
expenses. In the third quarter of 2003, we recognized a benefit of
approximately $0.5 million for adjustments made to restructuring accruals for
differences between our actual results and the initial restructuring expenses
of $2.7 million that were recognized in the third quarter of 2002 in
accordance with EITF 94-3. Alternatively, in the third quarter of 2002, we
recognized a restructuring charge of $2.7 million. Approximately $0.2
million of the change impacted the LTD and $3.0 million impacted the ICD.
The remaining decrease is attributable to other expense reductions in both
the LTD and the ICD.
In the LTD, operating expenses decreased $4.6 million, or 5.2%, to $84.7
million in the first nine months of 2003 from $89.4 million in the first nine
months of 2002. Approximately $2.1 million of the decrease is the result of
the pension curtailment gain in the first quarter of 2003 and $0.2 million of
the decrease came from the change in the restructuring expenses. The
remaining decrease is due to expense reductions from business process
improvements. In the ICD, operating expenses in the first nine months of
2003 were approximately $19.5 million, which is $9.7 million, or 33.2%, lower
than operating expenses of $29.1 million in the first nine months of 2002.
Approximately $0.6 million of the decrease is the result of the pension
curtailment gain and $3.0 million of the decrease is due to the change in
restructuring expenses. The remainder of the decrease in operating expenses
reflects the impact of the adjustments made in the ICD's operations in the
third quarter of 2002 for the realignment of its operations under the
responsibility of the LTD. The ICD's operating expenses reflect the benefit
of those cost reductions for a full nine months of 2003 compared to one month
of benefit in 2002.
Net operating income increased approximately $14.3 million from $19.1
million, or 13.9% of total revenues in the first nine months of 2002, to
$33.4 million, or 24.3% of total revenues in the first nine months of 2003.
The increase is primarily attributable to expense reductions recognized in
both the LTD and the ICD. Net operating income in the LTD increased $5.6
million, or 15.3%, to $42.3 million in the first nine months of 2003 from
$36.7 million in the first nine months of 2002. For the ICD, the net
operating loss improved $8.7 million, or 49.5%, to an operating loss of $8.9
million in the nine month period ended September 30, 2003 from an operating
loss of $17.6 million in the nine month period ended September 30, 2002.
18
Interest expense decreased $1.0 million to $47.1 million, or 34.2% of total
revenues, in the first nine months of 2003 compared to $48.1 million, or
35.0% of total revenues, in the first nine months of 2002. The decrease in
interest expense is attributed to a lower weighted average interest rate and
a lower average outstanding balance of long-term debt during the first nine
months of 2003 compared to the first nine months of 2002. This decrease was
offset by a $1.3 million accrual for interest expense recorded in the third
quarter of 2003 related to potential income tax payments. During 2002, in
consultation with our tax advisors, we elected to amend certain prior year
income tax returns resulting in refunds. We received the refunds during 2002
and reflected them as deferred income tax liabilities in recognition of the
nature of the amendments. In the third quarter of 2003, we were verbally
notified by the Internal Revenue Service, as part of an audit, that our
position in the amended income tax returns would be disallowed requiring the
return of approximately $5.8 million of the refunds received. Subsequent to
September 30, 2003, one operating company received formal written
notification from the IRS stating the disallowance of our position and we
anticipate that written notifications will be provided to our other operating
companies. In accordance with Statement of Financial Accounting Standards 5
("SFAS 5"), we determined that a $1.3 million liability existed that met the
criteria for accrual for interest expense on the income tax refunds at
September 30, 2003. Until we have resolved this uncertainty, which we expect
may take one to two years, we will continue to accrue additional interest
expense of approximately $0.4 million per year.
For the nine month period ended September 30, 2003, we had other income of
$2.1 million compared to other expense of $2.8 million in the nine month
period ended September 30, 2002, an improvement of $4.9 million. The
improvement is primarily attributed to two charges taken in the first nine
months of 2002 for a $4.5 million loss from the writedown of our investment
in the common stock of US Unwired Inc. and a $2.1 impairment charge that
reduced the carrying value of an investment accounted for using the equity
method. The impact of these charges was offset by the recognition of a gain
on the sale of assets of $0.6 million and approximately $0.9 million in
interest income related to certain income tax refunds in the first nine
months of 2002. No comparable gains or interest income were recorded in the
first nine months of 2003.
Our net loss improved $20.3 million from a net loss of $32.1 million, or
23.3% of total revenues, in the first nine months of 2002, to $11.8 million,
or 8.6% of total revenues, in the first nine months of 2003, as a result of
the factors discussed above. The LTD had net income of $17.1 million in the
first nine months of 2003 compared to net income of $5.8 million in the first
nine months of 2002, an increase of $11.3 million. For the nine month
periods ended September 30, 2003 and 2002, the ICD had a net loss of $28.9
million and $37.9 million, respectively, an improvement of $9.0 million.
Three Months Ended September 30, 2003 compared to Three Months Ended
September 30, 2002
Our total revenues decreased $0.4 million, or 0.9%, to $46.4 million for the
three months ended September 30, 2003 from $46.8 million for the three months
ended September 30, 2002. Revenues in the LTD for the third quarter of 2003
and 2002 were $43.0 million in each period. Increases of $0.3 million in
long distance revenues, $0.7 million in Internet and enhanced data revenues
and $0.1 million in miscellaneous revenues offset a $1.1 million decrease in
local service revenues. For the three months ended September 30, 2003, the
ICD had revenues of $3.4 million, a $0.4 million, or 10.4%, decrease from
revenues of $3.8 million for the three months ended September 30, 2002. The
decrease is attributed to a $0.3 million decrease in local service revenues
and a $0.1 million decrease in transport revenues. Revenues from voice
services, as a percentage of total revenues, were approximately 80.9% and
82.4% for the three months ended September 30, 2003 and 2002, respectively.
19
Our total operating expenses decreased $6.7 million from $43.0 million, or
91.8% of total revenues, in the three month period ended September 30, 2002
to $36.3 million, or 78.1% of total revenues, in the three month period ended
September 30, 2003. Operating expenses in the LTD were $29.7 million in the
three months ended September 30, 2003 and $30.4 million in the three months
ended September 30, 2002, a decrease of $0.7 million, or 2.4%. A decrease in
selling, general and administrative expenses of $1.7 million was offset by
increases in cost of services of $0.3 million and depreciation and
amortization expenses of $0.7 million. The decrease in selling, general and
administrative expenses is attributed primarily to expense reductions as a
result of business process improvements. In addition, selling, general and
administrative expenses decreased approximately $0.5 million due to lower
long-term incentive plan expenses in the third quarter of 2003 compared to
the third quarter of 2002 and $0.2 million from the change in the
restructuring expenses. The increase in cost of services is attributed
primarily to $0.3 million in expenses in the third quarter of 2003 for DSL
modems used in the LTD. Prior to the third quarter of 2003, the LTD
capitalized the cost of DSL modems as telephone plant and equipment. In the
ICD, operating expenses decreased $6.0 million, or 47.8%, to $6.6 million in
the third quarter of 2003 from $12.6 million in the third quarter of 2002.
The decrease is attributed to lower cost of services of $1.9 million and
lower selling, general and administrative expenses of $3.9 million from
expense reductions taken in the ICD in the prior year as it implemented its
strategy to slow its growth and completed its transition to being an edge-out
CLEC. In addition, approximately $3.0 million of the decrease is attributed
to the changes in restructuring expenses.
Our net operating income for the three month period ended September 30, 2003
increased approximately $6.3 million to $10.1 million from $3.8 million for
the three month period ended September 30, 2002. As a percentage of total
revenues, our net operating income was 21.9% in the third quarter of 2003 and
8.2% in the third quarter of 2002. The increase in net operating income is
primarily attributed to reductions in operating expenses in both the LTD and
the ICD as discussed above. Net operating income in the LTD in the third
quarter of 2003 was $13.3 million, an increase of $0.7 million, or 5.7%, from
$12.6 million in the third quarter of 2002. The ICD reported a net operating
loss of $3.1 million in the third quarter of 2003 and $8.7 million in the
third quarter of 2002, an improvement of $5.6 million, or 64.3%.
Interest expense increased $0.4 million, or 2.5%, to $16.4 million for the
third quarter of 2003 compared to $16.0 million in the third quarter of 2002.
Interest expense represented 35.3% and 34.1% of total revenues in the third
quarter of 2003 and 2002, respectively. The increase is attributed to the
$1.3 million interest accrual recorded in the third quarter of 2003 for
interest expense related to potential income tax refunds. Excluding this
increase, interest expense in the LTD would have decreased $0.9 million as a
result of a lower average outstanding balance and lower weighted-average
interest rates in the third quarter of 2003 compared to the third quarter of
2002.
For the third quarter of 2003, we had other income of $0.9 million compared
to other expense of $3.4 million in the third quarter of 2002, an improvement
of $4.3 million. The improvement is attributed to a $4.5 million loss from
the writedown of our investment in the common stock of US Unwired Inc. in the
third quarter of 2002 for which no comparable writedown was recognized in the
third quarter of 2003. In the third quarter of 2003, the LTD had other
income of $0.9 million compared to other expense of $3.4 million in the third
quarter of 2002. The ICD had other income of $82,000 and $13,000 in the
third quarters ended September 30, 2003 and 2002, respectively.
Our net loss improved $8.7 million to $5.7 million, or 12.2% of total
revenues, in the three months ended September 30, 2003 from $14.4 million, or
30.6% of total revenues, in the three months ended September 30, 2002. Net
income in the LTD was $4.1 million in the third quarter of 2003 compared to
net income of $1.0 million for the third quarter of 2002, an increase of $3.0
million, or 289.7%. The net loss in the ICD was $9.7 million for the third
quarter of 2003 compared to a net loss of $15.4 million for the third quarter
of 2002, an improvement of $5.7 million, or 36.8%.
20
Liquidity and Capital Resources
We are a holding company with no business operations of our own. Since our
inception, we have funded our operations through cash flow generated by our
subsidiaries, long-term debt borrowings and equity contributions from our
member. Our only significant assets are the capital stock/member interests of
our subsidiaries. Accordingly, our only sources of cash to pay our
obligations are cash on hand and distributions from our subsidiaries from
their net earnings and cash flow. Even if our subsidiaries determine to pay a
dividend on, or make a distribution in respect of, their capital stock/member
interest, we cannot assure you that our subsidiaries will generate sufficient
cash flow to pay such a dividend or distribute such funds or that they will
be permitted to pay such dividend or distribution under the terms of their
credit facilities.
Operating Activities. For the nine months ended September 30, 2003 and 2002,
we generated cash from operating activities of $24.3 million and $17.6
million, respectively. The increase of $6.7 million in cash from operating
activities in the first nine months of 2003 compared to the first nine months
of 2002 is attributable to an improvement in our net loss of $20.3 million
from business process improvements in the LTD and cost reductions in the ICD.
Investing Activities. For the nine months ended September 30, 2003, we used
cash for investing activities in the amount of $2.7 million compared to cash
used for investing activities of $10.2 million in the nine month period ended
September 30, 2002. Cash used in investing activities in the first nine
months of 2003 was primarily for the purchase of telephone plant and
equipment in the amount of $6.3 million. This was offset by $2.0 million
received from the redemption of RTFC subordinated capital certificates and
$1.6 million from changes in other assets. For the nine months ended
September 30, 2002, we used cash primarily for purchases of telephone plant
and equipment of $11.2 million. This was offset by proceeds from the
redemption of RTFC subordinated capital certificates, net of additional
purchases of subordinated capital certificates, of $0.7 million and changes
in other assets of $0.2 million.
Financing Activities. For the nine months ended September 30, 2003, net cash
used in financing activities was $14.6 million and consisted of payments on
long-term debt of $13.6 million and the redemption of $1.0 million in
minority interest. For the nine months ended September 30, 2002, net cash
used for financing activities was $16.7 million and consisted primarily of
payments on long-term debt of $25.2 million, the redemption of $1.0 million
in minority interest and a $2.0 million redemption of member's interest.
These uses of cash were offset by proceeds from long-term debt borrowings of
$11.8 million.
At September 30, 2003, we had positive working capital of $12.5 million
compared to negative working capital of $25.8 million at December 31, 2002.
The improvement is attributed primarily to the change in the current portion
of long-term debt due to the amendment entered into with the RTFC in the
third quarter of 2003, described below, and an increase in our cash of $7.1
million. Under the amendment, we do not have to make any scheduled principal
payments to the RTFC until the third quarter of 2004. Therefore, our current
portion of long-term debt was $2.4 million at September 30, 2003 compared to
$27.6 million at December 31, 2002, a change of $25.2 million. Under the
terms of the amendment, our scheduled principal payments through 2010 are
significantly less than under our previous agreement. As discussed below, we
may be required to make annual mandatory prepayments equivalent to any excess
cash flow as defined in the amendment in addition to our scheduled principal
payments. These mandatory payments for excess cash flow will be based on the
LTD's year-end financial results, beginning in 2005 based on the results of
the 2004 fiscal year. We are uncertain what mandatory prepayments will have
to be made, if any, at this time. The increase in cash is attributed to
lower operating expenses and the deferral of our third quarter principal
payment of approximately $6.9 million to the RTFC under the terms of the
amendment.
As a result of the amendment, our liquidity position has been enhanced. The
reductions in the scheduled principal payments under the amendment should
provide us with additional liquidity and greater operating flexibility in the
near-term.
21
Long-Term Debt and Revolving Credit Facilities
We or our subsidiaries have outstanding term and revolving credit facilities
with the RTFC, which were entered into in connection with the acquisitions of
Mebcom, Gallatin River, Gulf Coast Services and Coastal Communications. In
addition, we have outstanding $200.0 million in 13 1/4% senior notes that are
due in March 2010, a mortgage note payable on property acquired in the
Coastal Communications acquisition and a miscellaneous note payable.
RTFC Debt Facilities
- --------------------
As of September 30, 2003, we had approximately $426.6 million in term loans
outstanding with the RTFC. Of this amount, $414.9 million in term loans bear
fixed interest rates that range between 5.65% and 9.05%, with a weighted
average rate approximating 7.8%. The fixed interest rates expire at various
times, beginning in October 2004 through August 2006, depending on the terms
of the note. Upon the expiration of the fixed interest rates, the term loans
will convert to the RTFC's prevailing base variable interest rate plus a 1.0%
interest rate adder. We have the ability to allow the rates to remain
variable or to fix the interest rates at the RTFC's then-prevailing base
interest rate for long-tem debt with similar maturities. The remaining $11.7
million term loan has a variable interest rate of 5.4% at September 30, 2003.
The fixed interest rate on this term loan expired in the third quarter of
2003 at which time it converted to the RTFC's variable base rate plus 100
basis points, or 5.4%. Prior to expiration, the interest rate on this note
was fixed at 7.0%.
In July 2003, MRLTDF executed an amendment to its loan agreement with the
RTFC which, among other things, allows us greater operating flexibility
through an increase in our available liquidity. Under the terms of the
amendment, our loan agreement is extended to November 2016. The amendment
also provides us with a reduction in scheduled principal payments through
2011 as compared to our existing agreement. We will not make any quarterly
principal payments, only quarterly interest payments, through the second
quarter of 2004. Beginning in the third quarter of 2004, we will begin
making scheduled principal payments in amounts as outlined in the amendment.
We also may be required to make annual prepayments of principal based on our
financial results. Annually, beginning in 2005, we will calculate the LTD's
excess cash flow, as defined in the amendment, using the preceding year's
financial results. If the calculation indicates excess cash flow, we must
make a mandatory prepayment equivalent to that excess cash flow to reduce the
principal outstanding to the RTFC. The payment will be required to be made
by the second quarter of the year in which the calculation is made.
Effective with completion of the amendment, interest rates on our outstanding
term loans are now at their prevailing RTFC fixed or variable base rate plus
a 1.0% interest rate adder, which replaced the existing interest rate adders.
Prior to the amendment, interest rates on these term loans were at their
prevailing RTFC fixed or variable base rate plus interest rate adders ranging
from 0.35% to 0.75%. The 1.0% interest rate adder is subject to performance
pricing which will provide for a reduction in the interest rate adder as our
Total Leverage Ratio, as defined in the amendment, decreases. The interest
rate adder will remain at 1.0% while the Total Leverage Ratio is greater than
5.0 to 1.0. It decreases to 0.75% when the Total Leverage Ratio is between
4.0 to 1.0 and 5.0 to 1.0 and decreases to 0.5% when the Total Leverage Ratio
is less than 4.0 to 1.0. The prior interest rate adders had no performance
pricing associated with them.
In addition, certain of our covenants were revised under the amendment, but
we will continue to test our compliance with our financial ratios defined in
the amendment on an annual basis. In addition to our financial ratios, our
covenants require that we obtain RTFC approval of a forward-looking, three-
year capital expenditure budget on an annual basis and any acquisitions or
disposals of local exchanges. Our covenants regarding payment of dividends
by MRLTDF and GRH remained substantially the same as under the existing
agreement. In addition, the amendment allows us to repurchase our senior
notes without RTFC consent in amounts not to exceed $2.0 million per quarter
and $6.0 million per year.
Finally, as part of the amendment, RTFC was granted a first mortgage lien on
the assets of MRH, MLDS and MRLDS and the equity interests in those entities
were pledged in support of the loan facilities. The loan facilities as a
whole are secured by a first mortgage lien on all of the property, assets and
revenue of the LTD. In addition, substantially all of the outstanding equity
interests of the subsidiaries that comprise the LTD are pledged in support of
the debt facilities.
22
As a condition of obtaining long-term financing from the RTFC, we purchased
subordinated capital certificates ("SCCs") that represent ownership interests
in the RTFC equal to 10% of the amount borrowed. The RTFC financed the
purchase of the SCCs by increasing the balance advanced for a loan by an
amount equal to the SCCs purchased.
At September 30, 2003, we owned $44.0 million in SCCs. The SCCs are redeemed
for cash on an annual basis, at par, in an amount equivalent to 10% of the
term loan principal that was repaid in the prior year. Therefore, at
September 30, 2003, based on principal payments of $13.5 million made to the
RTFC in 2003, we have approximately $1.4 million in SCCs eligible to be
redeemed in 2004. In March 2003 and 2002, the RTFC redeemed approximately
$2.0 million and $1.5 million, respectively, of our SCCs.
We also receive a share of the RTFC's net margins in the form of patronage
capital refunds. Patronage capital is allocated based on the percentage that
our interest payments contribute to the RTFC's gross margins. Currently, 70%
of the RTFC's patronage capital allocation is retired with cash after the end
of the year, and 30% is paid in the form of patronage capital certificates.
The patronage capital certificates will be retired with cash in accordance
with the RTFC's board-approved rotation cycle.
In addition to the term loans, we also have a secured line of credit and an
unsecured line of credit with the RTFC. The secured line of credit is a
$31.0 million facility and has no annual paydown provisions. The secured
line of credit expires in March 2005 and bears interest at the RTFC base rate
for a standard line of credit plus 50 basis points, or 5.4% at September 30,
2003. We had advanced $21.0 million against this line of credit at September
30, 2003, and the remaining $10.0 million is fully available to be drawn.
The unsecured line of credit is a $10.0 million facility at that is available
for general corporate purposes to Coastal Utilities, Inc. and expires in
March 2005. Under the terms of the unsecured revolving line of credit
agreement, we must repay all amounts advanced under this facility within 360
days of the first advance and bring the outstanding amount to zero for a
period of five consecutive days in each 360-day period. The unsecured line
of credit is fully available to be drawn and bears interest at the RTFC base
rate for a standard line of credit plus 100 basis points. Under the terms of
the amendment as discussed above, we have agreed to provide the RTFC with a
security interest in the assets of Coastal Utilities, Inc. to secure this
line of credit.
As discussed above, the terms of the RTFC loan agreement, as amended, require
MRLTDF to meet and adhere to various financial and administrative covenants.
MRLTDF is, among other things, limited in its ability to declare or pay
dividends to its parent, MRH; limited in its ability to make intercompany
loans or enter into other affiliated transactions and restricted from
incurring additional indebtedness above certain amounts without the consent
of the RTFC. As a result of these provisions of the amendment and loan
agreement, any amounts available under the line of credit facilities
discussed above may only be available to MRLTDF and its subsidiaries and not
to us or our other subsidiaries to fund our obligations. MRLTDF is required
to test its compliance with certain financial ratios on an annual basis. At
September 30, 2003, MRLTDF was in compliance with the terms of its loan
agreement, as amended, with the RTFC.
Senior Notes
- ------------
We currently have $200.0 million in publicly traded 13 1/4% senior notes
outstanding that are due in March 2010. Interest is payable semiannually on
March 1 and September 1 of each year. The senior notes are registered with
the Securities and Exchange Commission and are subject to the terms and
conditions of an indenture. At September 30, 2003, the senior notes had a
carrying value of $197.9 million, which is net of a $2.1 million unamortized
discount.
Under the terms of the indenture, we must comply with certain financial and
administrative covenants. Among other things, we are restricted in our
ability to incur additional indebtedness, pay dividends to our member, redeem
or repurchase equity interests, make various investments or other restricted
payments, create certain liens or use assets as security in other
transactions, sell certain assets or utilize certain asset sale proceeds,
merge or consolidate with or into other companies or enter into transactions
with affiliates. At September 30, 2003, we were in compliance with the terms
of our senior notes indenture.
23
Other Long-Term Debt
- --------------------
Our other indebtedness includes a $2.3 million note payable to the former
shareholders of Coastal Utilities, Inc. for the purchase of a building used
in our operations. The note, which is secured by the building and bears
interest at 8.0%, is being repaid in monthly installments of $17,500 with a
balloon payment of approximately $2.2 million due in April 2006. In
addition, we also have a miscellaneous note payable of $0.4 million that
bears interest at 8.0% and is due on demand.
Capital Requirements
We require significant capital to fund our working capital needs, including
our debt service requirements and capital expenditures. In the near term, we
expect that our primary uses of cash will include:
* scheduled principal and interest payments on our long-term debt;
* the maintenance and growth of our telephone plant and network
infrastructure;
* the maintenance, upgrade and integration of operating support systems
and other automated back office systems;
* sales and marketing expenses;
* corporate overhead; and
* personnel and related expenses.
As discussed above, our amendment with the RTFC has significantly lowered our
scheduled principal payments to the RTFC through 2010, thereby reducing the
capital required to service our financing and increasing our liquidity.
We currently estimate that cash required to fund capital expenditures in 2003
will be approximately $12.0 million to $13.0 million. For the nine months
ended September 30, 2003, our capital expenditures were approximately $6.3
million. Our use of cash for capital expenditures in 2003 has been
significantly less than we incurred in prior years. This is a result of
several factors. First, we invested a significant amount in capital
expenditures during 2000 and 2001 to build-out and enhance our telephone
plant and network facilities in our markets. Absent major changes in the
technology that we employ or the introduction of new product lines, we
believe that we have facilities in place capable of providing a high level of
service to our customers without significant alterations or enhancements. We
anticipate that a large portion of our capital expenditures in 2003 will be
directed toward maintaining our existing facilities. Second, we have
experienced slower growth in recent quarters for the LTD than experienced in
previous years including voice access line losses. In addition, the ICD has
not entered into any new markets and its existing operations have not
demonstrated any growth as part of its business plan to generate sustainable
cash flow. Therefore, there is minimal demand currently to expand our
telephone plant or network facilities. During 2003, the demand for use of
capital in the expansion of our telephone plant and network facilities will
be assessed, in part, using factors such as the increase in demand for access
lines and communications services and the introduction of new technologies
that will provide an appropriate return on capital invested. We are
currently in the preliminary stages of assessing the potential benefits of
adding video services to the suite of products we offer to our customers.
Since we are early in the planning process, at this time we are not certain
what types of video services we may offer, if any, or what types of
technology we may use to deliver these services to our customers. Depending
on the outcome of this process, we may see an increase in our capital
expenditures in future periods to support the delivery of this service to our
customers.
24
As part of the consideration paid in the CCI acquisition in March 2000, we
issued to the former shareholders of Coastal Utilities 300 shares of Series A
non-voting common stock and 300 shares of Series B non-voting common stock of
CCI in the face amount of $10.0 million and $5.0 million, respectively. The
Series A and Series B stock had put and call features that were defined
pursuant to the terms of a shareholders agreement and were exercisable by the
holders and CCI. In 2002, MRTC, our parent, completed an agreement with
these former shareholders that, among other things, modified certain
provisions of the shareholders agreement. Under the terms of the agreement,
the former shareholders exchanged certain of their equity interests in CCI
for equity in MRTC and a note payable from MRTC. In addition, CCI redeemed
30 shares of Series A stock in CCI retained by the former shareholders for
$33,333.33 per share, or approximately $1.0 million, at the closing of the
transaction. CCI redeemed an additional 30 shares of Series A stock in June
2003 for approximately $1.0 million. Under the terms of CCI's amended
shareholders agreement, the former shareholders have the right to require CCI
to redeem their remaining 120 shares of Series A stock in increments not to
exceed 30 shares at $33,333.33 per share, or an aggregate value of $1.0
million, in any thirteen-month period. We expect that the next redemption of
30 shares of $1.0 million will take place in July 2004.
Under the terms of MRTC's Operating Agreement, at any time on or after
January 16, 2006, certain members may require MRTC to purchase all of their
member units at an amount equal to the fair market value of the units. We may
potentially fund this obligation of our parent company, but we do not have a
contractual obligation to do so.
Based on our business plan, we currently project that available borrowings
under our credit facilities, cash and investments on hand and our cash flow
from operations will be adequate to meet our foreseeable operational
liquidity needs for the next 12 months. However, our actual cash needs may
differ from our estimates, and those differences could be material. Our
future capital requirements will depend on many factors, including, among
others:
* the extent to which we consummate any significant additional
acquisitions;
* our success in maintaining a net positive cash flow in our ICD
operations;
* the demand for our services in our existing markets;
* our ability to acquire, maintain, develop, upgrade and integrate the
necessary operating support systems and other back office systems; and
* regulatory, technological and competitive developments.
We may be unable to access the cash flow of our subsidiaries since certain of
our subsidiaries are parties to borrowing agreements that restrict the
payment of dividends and limit the availability of intercompany loans and
investments, and those subsidiaries are likely to continue to be subject to
such restrictions and prohibitions for the foreseeable future. In addition,
future agreements that our subsidiaries may enter into governing the terms of
indebtedness may restrict our subsidiaries' ability to pay dividends or
advance cash in any other manner to us.
To the extent that our business plans or projections change or prove to be
inaccurate, we may require additional financing or require financing sooner
than we currently anticipate. Sources of additional financing may include
commercial bank borrowings, other strategic debt financing, sales of non-
strategic assets, vendor financing or the private or public sales of equity
and debt securities. We cannot assure you that we will generate sufficient
cash flow from operations in the future, that anticipated revenue growth will
be realized or that future borrowings or equity contributions will be
available in amounts sufficient to provide adequate working capital, service
our indebtedness or make anticipated capital expenditures. Failure to obtain
adequate financing, if necessary, could require us to significantly reduce
our operations or level of capital expenditures which could have a material
adverse effect on our projected financial condition and results of
operations.
25
Recent Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Accounting Standards
145, Rescission of FASB Statements Nos. 4, 44, and 62, Amendment of FASB
Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145 requires
gains and losses on extinguishments of debt to be classified as income or
loss from continuing operations rather than as extraordinary items as
previously required under Statement No. 4. Extraordinary treatment will be
required for certain extinguishments as provided in APB 30. SFAS 145 also
amends Statement No. 13 to require certain modifications to capital leases be
treated as a sale-leaseback and modified the accounting for sub-leases when
the original lessee remains a secondary obligor (or guarantor). SFAS 145,
effective for all fiscal years beginning after May 15, 2002, was adopted by
the Company on January 1, 2003. The adoption of SFAS 145 did not have a
material impact on our results of operations, financial position or cash
flows.
In July 2002, the FASB issued Statement of Financial Accounting Standards
146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS
146"). SFAS 146, which nullified EITF Issue 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) ("EITF 94-3"), requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF 94-3, a liability for
an exit cost was recognized at the date of an entity's commitment to an exit
plan. The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. Our adoption of SFAS
146, effective January 1, 2003, did not have a material impact on our results
of operations, financial position or cash flows.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45"). The Interpretation requires
recognition of liabilities at their fair value for newly issued guarantees
and certain other disclosures. We adopted FIN 45 in 2003 and it did not have
a material impact on our results of operations, financial position, or cash
flows.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"), the primary objective of which is to
provide guidance on the identification of entities for which control is
achieved through means other than voting rights, defined as variable interest
entities ("VIEs") and to determine when and which business enterprise should
consolidate the VIE as the "primary beneficiary". This new model applies when
either (1) the equity investors, if any, do not have a controlling financial
interest or (2) the equity investment at risk is insufficient to finance that
entity's activities without additional financial support. In addition, FIN 46
requires additional disclosures. This interpretation applies immediately to
VIEs created after January 31, 2003 and to VIEs in which an enterprise
obtains an interest after that date. As a result of FASB Staff Position 46-6,
the application of FIN 46 for interests in VIEs or potential VIEs before
February 1, 2003 has been deferred until the amended effective date of
December 31, 2003 in anticipation of additional guidance to be provided by
the FASB. We have determined that an unconsolidated company we hold an
investment in that is accounted for under the equity method is a VIE under
FIN 46 but we are not the primary beneficiary of the VIE. We provide
services to the VIE for which we have recorded revenues of $0.3 million and
we have recognized expenses of $0.1 million for services provided by the VIE
to us in the nine months ended September 30, 2003. Our maximum exposure to
loss as a result of our involvement with the VIE is the $0.3 million carrying
value of our investment at September 30, 2003. We do not expect the adoption
of FIN 46 to have a material impact on our results of operations, financial
position, or cash flows.
In May 2003, the FASB issued Statement of Financial Accounting Standards 150,
Accounting for Certain Financial Instruments with Characteristics of
Liabilities and Equity ("SFAS 150"). SFAS 150 requires certain financial
instruments that embody obligations of the issuer and have characteristics of
both liabilities and equity to be classified as liabilities. Many of these
instruments previously were classified as equity or temporary equity and as
such, SFAS 150 represents a significant change in practice in the accounting
for a number of financial instruments, including mandatorily redeemable
equity instruments. SFAS 150 was effective for public companies for all
financial instruments created or modified after May 31, 2003, and to other
instruments at the beginning of the first interim period beginning after June
15, 2003. We adopted SFAS 150 during the third quarter of 2003. Upon
adoption, we reclassified the redeemable minority interest on our balance
sheet from a mezzanine level, between liabilities and equity, to current and
long-term liabilities. Beyond the reclassification of the redeemable
minority interest, the adoption of SFAS 150 did not have a material impact on
our results of operations, financial position or cash flows.
26
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Although we invest our short-term excess cash balances, the nature and
quality of these investments are restricted under our internal investment
policies. These investments are limited primarily to U.S. Treasury agency
securities, certain time deposits and high quality repurchase agreements and
commercial paper. We do not invest in any derivative or commodity type
instruments. Accordingly, we are subject to minimal market risk on our
investments.
As discussed above, MRLTDF executed an amendment with the RTFC in July 2003.
Under the terms of the amendment, our long-term secured debt facilities with
the RTFC will amortize through November 2016. As of September 30, 2003, we
had fixed rate secured debt with the RTFC of $414.9 million at a blended rate
of 7.77%. The fixed rates on the facilities expire from October 2004 to
August 2006 at which time they will convert to variable rates. In addition,
we have two miscellaneous notes that total $2.7 million at September 30, 2003
with each bearing fixed rate interest at 8.0%. Our senior notes have a
stated fixed rate of 13.25%. In addition to our fixed rate facilities, we
have $11.7 million in term loans and $21.0 million outstanding under a
secured line of credit with the RTFC that bear variable interest rates
approximating a blended average rate of 5.4%. A one percent change in the
underlying interest rates for the variable rate debt would have an impact of
approximately $0.3 million per year on interest expense. Therefore, we are
subject to minimal interest rate risk on our long-term debt while our fixed
rates are in place.
ITEM 4 - CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
Our management, with the participation of the Chairman and Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-
15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")), as of the end of the period covered by this report.
Based on such evaluation, the Chairman and Chief Executive Officer and Chief
Financial Officer have concluded that, as of the end of such period, our
disclosure controls and procedures are effective.
(b) Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
27
Part II
Item 1. Legal Proceedings
Our subsidiary, Gulf Coast Services, sponsors an Employee Stock Ownership
Plan ("ESOP") that was the subject of an application before the Internal
Revenue Service ("IRS") for a compliance statement under the Voluntary
Compliance Resolution Program. The application was filed with the IRS on May
17, 2000. According to the application, Gulf Coast Services made large
contributions to the ESOP and to its 401(k) plan during 1997 and 1998, which
caused the two plans to allocate amounts to certain employees in excess of
the limits set forth in Section 415 of the Internal Revenue Code of 1986, as
amended (the "Code"). The administrative committees for both plans sought to
comply with the requirements of Code Section 415 by reducing employees'
allocations under the ESOP before any reductions of allocations under the
401(k) plan. Although this approach was consistent with Treasury Regulations
under Code Section 415, it may not have been consistent with the terms of the
plan documents. The application requested a compliance statement to the
effect that any failure to comply with the terms of the plans would not
adversely affect the plans' tax-qualified status, conditioned upon the
implementation of the specific corrections set forth in the compliance
statement.
We estimated that the cost to the ESOP of the corrective allocation described
above was approximately $3.3 million. In the application, Gulf Coast
Services requested that the assets held in the Section 415 Suspense Account
and in the ESOP Loan Suspense Account be used by the ESOP for the correction.
The 415 Suspense Account had an approximate value of $1.6 million, and the
ESOP Loan Suspense Account had a value in excess of the $1.7 million needed
for the full correction. However, based on discussions with the IRS and upon
the recommendation of our advisors, during the second quarter of 2001, we
withdrew our proposal to use the assets in the ESOP Loan Suspense Account as
a source of funds to satisfy the obligation. Shortly thereafter, the IRS
issued our Section 415 Compliance Statement and provided us with 150 days to
institute the corrective actions. The correction period was then
subsequently extended for thirty days to December 17, 2001. During the
course of making the corrections as required by the compliance statement,
additional administrative errors in the operation of the ESOP were found that
affected years beginning January 1, 1995 through December 31, 1999. The
newly discovered operational failures were interrelated with and directly
affected the failures subject to the original compliance statement, and,
therefore, the corrections under the original compliance statement could not
be accurately completed.
In response to these newly discovered operational failures, we underwent an
extensive review of the ESOP administration for the plan years 1995 through
1999. As part of this process, on June 7, 2002, we submitted a new
application for a compliance statement under the Walk-In-Closing Agreement
Program with the IRS. The new application restates our proposed corrections
to be made for the operational failures disclosed in the first application as
well as addresses our proposed corrections for the additional failures found
in the administration of the ESOP. In October 2003, we received a
preliminary Compliance Statement from the IRS documenting their conclusions
related to our second VCO application. With our advisors, we are currently
reviewing the preliminary Compliance Statement in relation to our proposed
corrections. We are uncertain as to the timing of when the final Compliance
Statement will be issued, but upon final issuance, we will have 150 days to
make the final corrections.
In May 2002, the escrow committee authorized the transfer of $1.7 million
from the escrow account, established in connection with our acquisition of
Gulf Coast Services, to the ESOP as required by the initial application. If
future amounts are required to be contributed to the ESOP to comply with the
Code, we will pursue other options currently available to us to obtain
reimbursement of those funds, which may include seeking additional
reimbursement from the escrow account. However, there is no assurance that
we will be able to obtain any reimbursement from another source, and,
therefore, we may be required to contribute to the Plan the funds needed to
make up any shortfall. We do not believe that any future amounts required to
be contributed to the ESOP as part of this corrective action will have a
material adverse effect on our financial condition, results of operations or
cash flows.
28
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------- -----------------------------------------------------------
3.1 Certificate of Formation of the Registrant (incorporated by
reference to Exhibit 3.1 to the Registrant's Registration
Statement on Form S-4 (File No. 333-36804) filed with the
Securities and Exchange Commission on May 11, 2000 (the
"May Form S-4"))
3.2 Limited Liability Company Agreement of the Registrant
(incorporated by reference to Exhibit 3.2 to the May Form
S-4)
10.30 Amendment to Loan Agreement, dated July 30, 2003, amending
the Loan Agreement dated as of December 29, 2000 by and
between MRLTDF and the RTFC (incorporated by reference to
Exhibit 99.1 of the Form 8-K filed on July 31, 2003)
31.1 Certification of Chief Executive Officer of Madison River
Capital, LLC pursuant to Rule 13a-14(a)/Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended
31.2 Certification of Chief Financial Officer of Madison River
Capital, LLC pursuant to Rule 13a-14(a)/Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended
32.1 Certification of Chief Executive Officer of Madison River
Capital, LLC pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer of Madison River
Capital, LLC pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On July 31, 2003, we filed a Current Report on Form 8-K dated July
31, 2003 announcing our second quarter and six month operating and
financial results for the period ended June 30, 2003. In addition,
we announced the completion of the amendment to our loan agreement
with the Rural Telephone Finance Cooperative. Our press release,
dated July 31, 2003, and the amendment were attached as exhibits to
the Form 8-K.
On September 23, 2003, we filed a Current Report on Form 8-K dated
September 23, 2003 announcing a presentation made on September 23,
2003 by Paul H. Sunu, our Chief Financial Officer, at the Jefferies
& Company, Inc. High Yield Communications and Media Conference in
New York, New York on that date. A copy of the presentation was
attached as an exhibit to the Form 8-K.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MADISON RIVER CAPITAL, LLC
Date: November 13, 2003 /s/ PAUL H. SUNU
--------------------------------------------
Name: Paul H. Sunu
Title: Managing Director, Chief Financial
Officer and Secretary
29
EXHIBIT INDEX
Exhibit
Number Description
------- -----------------------------------------------------------
3.1 Certificate of Formation of the Registrant (incorporated by
reference to Exhibit 3.1 to the Registrant's Registration
Statement on Form S-4 (File No. 333-36804) filed with the
Securities and Exchange Commission on May 11, 2000 (the
"May Form S-4"))
3.2 Limited Liability Company Agreement of the Registrant
(incorporated by reference to Exhibit 3.2 to the May Form
S-4)
10.30 Amendment to Loan Agreement, dated July 30, 2003, amending
the Loan Agreement dated as of December 29, 2000 by and
between MRLTDF and the RTFC (incorporated by reference to
Exhibit 99.1 of the Form 8-K filed on July 31, 2003)
31.1 Certification of Chief Executive Officer of Madison River
Capital, LLC pursuant to Rule 13a-14(a)/Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended
31.2 Certification of Chief Financial Officer of Madison River
Capital, LLC pursuant to Rule 13a-14(a)/Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended
32.1 Certification of Chief Executive Officer of Madison River
Capital, LLC pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer of Madison River
Capital, LLC pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002