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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
-----------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ___________
__________________________________
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
Incorporation or Organization) Identification No.)
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)
__________________________________
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the Registrant (1) has filed all reports
Required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
----- -----
The aggregate market value of the common equity of the Registrant held by
non-affiliates as of June 30, 2003 was zero. All of the 211,583,892
outstanding Class A member interests of the Registrant are owned by Madison
River Telephone Company, LLC.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
INDEX
PART I Item 1. Business 1
Item 2. Properties 29
Item 3. Legal Proceedings 29
Item 4. Submission of Matters to a Vote of Security Holders 30
PART II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 30
Item 6. Selected Financial Data 31
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 32
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 47
Item 8. Financial Statements and Supplementary Data 47
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 47
Item 9A. Controls and Procedures 47
PART III Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 50
Item 12. Security Ownership of Certain Beneficial Owners and
Management 52
Item 13. Certain Relationships and Related Transactions 53
Item 14. Principal Accountant Fees and Services 54
PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 54
SIGNATURES 56
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS F-1
EXHIBIT INDEX I-1
References in this Form 10-K to "we," "us," "our" and "Madison River" mean
Madison River Capital, LLC and its subsidiaries.
i
FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended
(the "Securities Act"), and Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), and we intend that such forward-
looking statements be subject to the safe harbors created by those laws.
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 often use these types of statements when
discussing our plans and strategies, our anticipation of revenues from
designated markets and sources and statements regarding the development of
our businesses, the markets for our services and products, our anticipated
capital expenditures, operations support systems or changes in regulatory
requirements and other statements contained in this report regarding matters
that are not historical facts.
Although we believe that the expectations reflected in such forward-
looking statements are accurate, the statements are subject to known and
unknown risks, uncertainties and other factors that could cause the actual
results to differ materially from those contemplated by the statements. Our
actual future performance could differ materially from such statements.
Factors that could cause or contribute to such differences include, but are
not limited to, the following:
* our ability to sustain our revenues;
* our inability to achieve profitability;
* our ability to service our significant amount of indebtedness;
* our dependence on economic conditions in the local markets we serve;
* continuing softness in the U.S. economy, specifically with respect to the
telecommunications industry;
* significant and growing competition in the telecommunications industry;
* the advent of new technology that may force us to expand or adapt our
network in the future;
* our dependence on market acceptance of DSL-based services;
* the passage of legislation or regulations or court decisions adversely
affecting the telecommunications industry;
* the success of efforts to expand our service offerings and grow our
business;
* our ability to execute our acquisition strategy, including successfully
integrating acquired businesses;
* our ability to raise additional capital on acceptable terms and on a
timely basis;
* our ability to protect our proprietary technology;
* the failure to implement the revised business plan for our edge-out
services successfully;
* the failure to achieve desired operating efficiencies from our
information and billing systems;
* unanticipated network disruptions;
* our ability to obtain and maintain the necessary rights-of-way for our
networks;
* the financial difficulties of other companies in the telecommunications
industry with which we have material relationships;
* the inability to comply with the minimum volume commitments and other
utilization targets in our long distance resale agreements;
* our ability to compete effectively with the Regional Bell Operating
Companies;
* future liabilities or compliance costs associated with environmental and
worker health and safety matters; and
* our dependence on our key personnel.
You should not unduly rely on these forward-looking statements, which
speak only as of the date of this Form 10-K. 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-K or to reflect the occurrence of unanticipated events.
Important factors that could cause our actual results to differ materially
from our expectations are discussed under the section "Risk Factors" and
elsewhere in this Form 10-K.
Available Information
- ---------------------
Investors may obtain access, free of charge, to this Madison River
Capital, LLC Annual Report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports by visiting the
investor relations page on our website at www.madisonriver.net. These reports
will be available as soon as reasonably practicable following electronic
filing with or furnishing to the Securities and Exchange Commission ("SEC").
In addition, the SEC's website is www.sec.gov. The SEC makes available on
this website, free of charge, reports and other information regarding
issuers, such as us, that file electronically with the SEC. Information on
our website or the SEC's website is not part of or incorporated by reference
into this document.
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PART I
Item 1. Business
Overview
- --------
We are an established rural local telephone company, or RLEC, that serves
business and residential customers in the Southeast and Midwest regions of
the United States. We offer a variety of telecommunications services,
including local and long distance voice, high-speed data and Internet access.
Since 1998, we have acquired four RLECs, each of which has been serving
its community for over 50 years. With these acquisitions, we purchased
established businesses with stable cash flows, governmental authorizations
and certifications in place, operational support systems, experienced
management and key personnel and technologically advanced facilities. We
believe our disciplined approach to operations has allowed us to improve the
operations at each of our acquired RLECs. Our four RLECs, their location,
date acquired and total number of voice access and high-speed digital
subscriber line, or DSL, connections in service at December 31, 2003 are:
Date Access Lines at
Company Location Acquired December 31, 2003
---------------------------------- ---------------------- -------------- -----------------
Mebtel, Inc. Mebane, North Carolina January 1998 14,106
Gallatin River Communications, LLC Galesburg, Illinois November 1998 83,243
Gulf Telephone Company Foley, Alabama September 1999 65,874
Coastal Utilities, Inc. Hinesville, Georgia March 2000 46,861
Our RLECs serve primarily three types of customers:
1. Residential and business customers located in our local service areas
that buy local and long distance voice, high speed data and
Internet access services;
2. Interexchange carriers, wireless and other carriers that pay for
access to long distance customers located within the respective
RLEC's local service areas; and
3. Customers that purchase miscellaneous services such as directory
advertising or customer premise equipment.
As of December 31, 2003, our RLECs had 210,084 connections consisting of
185,903 voice access and 24,181 DSL connections in service. Our RLEC's voice
access connections were comprised of 126,415 residential access lines and
59,488 business access lines. We also had 96,586 long distance accounts and
23,773 dial-up Internet access subscribers. In addition, our RLECs provided
custom calling features to customers that include voicemail, caller
identification, call waiting and call forwarding.
We were founded with the goal of acquiring, integrating and operating
RLECs. We believe that RLECs are generally stable operating companies with
strong cash flow margins that benefit from a favorable regulatory environment
and limited competition. We believe that we can add value to our business by
acquiring rural telecommunication assets and improving their cost structure
and productivity. In evaluating acquisition opportunities, we apply rigorous
selection criteria which include, among other things, opportunity to improve
cost structure, margins and operations, current and historical operating
performance, geographic location of network and proximity to our markets,
market demographic profile, quality of infrastructure and facilities,
regulatory environment and outlook, integration and management. With our
four RLEC acquisitions, our management team has developed expertise in
acquiring and integrating strategic RLEC assets into our existing operations.
We believe that these skills provide us with the leverage to grow our
business with further RLEC acquisitions. Although we cannot be certain, we
anticipate that there will be opportunities in the future to evaluate
attractive RLEC acquisition targets against our investment criteria.
An important part of our operating strategy for acquisitions is to
maintain, to the extent possible, the local identity, customer service and
management presence of the acquired company. With the exception of Gallatin
River, our RLECs continue to operate with the same corporate identity by
which they were recognized before the acquisition. The exchanges and assets
that comprise Gallatin River were acquired from Sprint and, therefore, were
renamed. The
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responsibility for the operations of each RLEC is directed by an experienced,
local management team. Our central management company, Madison River
Management, LLC, or MRM, provides certain administrative, financial and
technical support services to each RLEC in accordance with the terms of
management services agreements. We have consolidated certain functions,
including the purchase of certain products and services for the benefit of
all of our RLECs at MRM in an effort to provide efficiencies and cost
savings that could not be gained by each RLEC acting individually. In
addition, our RLECs share information between respective management teams
regarding process improvements that have been implemented and best practices
that are employed to leverage the knowledge developed by each RLEC and
further the overall improvement in operations.
We also operate as a competitive local exchange carrier, or CLEC, which
we refer to as our edge-out services, or EOS, providing local and long
distance voice services, high-speed data and Internet access services in
edge-out markets established in territories that were in close proximity to
our RLECs. By developing markets in close proximity to our RLEC operations,
or "edging out" from those operations, we were able to leverage off of the
resources that our RLECs could provide. Beginning in 2002, the
responsibility for managing and operating our edge-out services was
transitioned to the managers of our respective RLECs. Currently, our three
edge-out markets are: (i) the Triangle (Raleigh, Durham and Chapel Hill) and
Triad (Greensboro and Winston-Salem) regions of North Carolina; (ii) Peoria
and Bloomington, Illinois; and (iii) New Orleans, Louisiana and nearby
cities. Customers of our edge-out services are generally medium and large
businesses that utilize eight voice lines or more and high speed data
services. Our edge-out services provide integrated communications services
built on high speed broadband service offerings utilizing advanced bandwidth
enhancing technologies such as asynchronous transfer mode, or ATM, high speed
data and fiber optic networks.
As part of our edge-out services, we maintain approximately 2,300 route
miles of fiber optic network, the majority of which 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. We
have designated Atlanta and Dallas as our Internet egress points. Our fiber
optic network supports our dial-up, DSL and high speed Internet services
provided in our RLEC operations and edge-out services which use our network
to connect to the Internet. Because we have found the fiber transport
business to be extremely competitive and price driven, we are not actively
expanding this line of business at this time.
For the year ended December 31, 2003, we had revenue, operating income
and EBITDA of $186.4 million, $42.5 million and $98.2 million, respectively.
For the years ended December 31, 2002 and 2001, we had revenue of $184.2
million and $184.3 million, respectively, operating income of $28.9 million
and $13,000, respectively, and EBITDA of $77.1 million and $43.7 million,
respectively. At December 31, 2003, we had 225,228 connections and at
December 31, 2002 and 2001, we had 223,725 and 223,371 connections,
respectively. See footnote (d) under "Selected Financial and Operating Data"
for a definition of EBITDA and reconciliation of EBITDA to net loss.
In fiscal year 2003, revenues generated by our RLECs were approximately
$172.5 million, or 92.5% of our total operating revenues, while revenues from
our edge-out services were approximately $13.9 million, or 7.5%, of our total
operating revenues. As of December 31, 2003, our RLECs served 185,903 voice
access and 24,181 DSL connections. In our edge-out markets, we served 14,462
voice access and 682 high-speed data connections.
Corporate Organization and Ownership
- ------------------------------------
Madison River is a limited liability company that was organized in 1999
under the provisions of the Delaware Limited Liability Company Act. We are a
wholly-owned subsidiary of our parent company, Madison River Telephone
Company, LLC ("MRTC"). MRTC was founded in April 1996 by a management team
led by J. Stephen Vanderwoude, former President and Chief Operating Officer
of Centel Corporation. Equity investors in MRTC include affiliates of
Madison Dearborn Partners, Goldman Sachs & Co., Providence Equity Partners,
the former owners of Coastal Utilities, Inc. and certain members of our
management team.
Our Markets
Our RLEC markets are predominantly in rural areas and small towns and
cities. We are the incumbent provider of basic telephone services in these
markets. At December 31, 2003, our RLECs had 185,903 voice access lines in
service, of which approximately 68% were residential and 32% were business.
We believe our RLEC markets have
2
demonstrated the need and potential for a provider of a full range of
communications solutions. We strive to be the service provider of choice for
our customers in our RLEC markets by providing a full suite of integrated
communications services in local and long distance voice, high speed data,
Internet access and custom calling features.
We have dedicated and experienced senior managers and customer service
representatives located in each region in which we operate with an extensive
knowledge of the dynamics of their specific markets and the needs of our
customers. In each of our markets, we maintain business offices that provide
our customers the opportunity to meet personally with our local management,
customer service and sales representatives and pay their bills directly.
In recent months, we have seen declines in the number of voice access
lines we serve in our established markets due to a number of factors. At
December 31, 2003, our RLECs served 185,903 voice access lines, which is a
decrease of 4,350 voice access lines from 190,253 voice access lines in
service at December 31, 2002. Approximately 53.9% of the decrease during
2003 is attributed to the removal of 2,344 second lines. We believe the
decrease in second lines is the result of our increasing number of DSL
connections being place in service as our customers are dropping their second
lines when they take our DSL service.
Another factor for the decrease in voice access lines is attributed to
our Illinois operations, Gallatin River. When excluding the impact of second
lines that were removed, Gallatin River had a decrease of 2,496 primary voice
access lines. This accounts for our entire decrease in primary voice access
lines as each of our other RLECs had increases in the number of primary voice
access lines served during 2003. A persistent weakness in the local
economies that Gallatin River serves, which are predominantly industrial and
agricultural in nature, has led to some loss in the business base and higher
unemployment. We are uncertain at this time regarding the trend for
connections in this market in the near future.
We have seen strong demand for our DSL service offerings in our RLEC
markets. At December 31, 2003, we served 24,181 DSL connections which is an
increase of 7,758 connections, or 47%, from 16,423 connections in service at
December 31, 2002. The increase in DSL connections was spread across each of
our RLECs. Our penetration rate of DSL connections to voice access lines is
approximately 13% at December 31, 2003. We expect to experience strong
growth in the number of DSL connections we serve in each market as we
introduce new bundled product offerings.
In March 2004, military officials at Fort Stewart in Hinesville, Georgia,
announced that the 3rd Infantry Division stationed there has received orders
to prepare for a full deployment by February 2005. Our RLEC, Coastal
Utilities, Inc. serves the Hinesville area including the military base. We
are currently gathering information regarding this deployment and plan to
assess the impact on our operations and cash flows.
Products and services
We seek to capitalize on our local presence and network infrastructure by
offering a full suite of integrated communications services in voice, high-
speed data, fiber transport, Internet access and long distance services, as
well as value-added features such as call waiting, caller identification,
voicemail and conference bridge services, all on one bill. Set forth below
are brief descriptions of the communications services we provide to our
customers in our markets:
Local services
We provide basic local telephone service to residential and business
customers in our franchised territories. Except for customers of Gallatin
River, our customers are charged a flat monthly fee for the use of this
service. Our Gallatin River customers pay a flat fee plus local usage
pursuant to a local measured service, or LMS, type tariff. We also offer our
customers a variety of custom calling features, such as voicemail, caller
identification, call waiting and call forwarding. These custom calling
features are bundled into packages with other services and sold at a discount
as well as being offered separately. We charge a flat monthly fee for these
custom calling features that will vary depending on the bundled offering and
types of services selected.
Also included in our local service revenues are network access revenues.
Network access revenues are earned for the origination and termination of
long distance calls, and usually involve more than one carrier providing long
distance service to the customer. Long distance calls are generally billed
to the customer originating the call. Therefore, a mechanism is required to
compensate each carrier involved in providing services related to the long
distance calls such as the origination and termination of the long distance
call. This mechanism is referred to as a network access charge
3
and revenues from these charges are derived from charges to the end user of
the service as well as billings to interexchange carriers for the use of our
facilities to access our customers. In addition, contributions received from
our participation in universal service funding support mechanisms are
included as part of network access revenues. Universal service funding
mechanisms provide support for the capital invested in communications
infrastructure to promote universal telecommunications services at affordable
rates for rural customers. For the year ended December 31, 2003, local
service revenues represented 68.1% of our total revenue.
Long distance services
We provide long distance services under our own brand names in each of
our franchised territories. Long distance revenues are earned as our long
distance customers make calls. The charges are based on the length of the
calls and the rate charged per minute unless offered under one of our bundled
packages at a fixed price. In addition, some customers pay a fixed minimum
monthly charge for our long distance service independent of the actual calls
made. We bundle our long distance service with other custom calling features
to offer an attractively priced option to our customers. For the year ended
December 31, 2003, long distance service revenues represented 8.4% of our
total revenue.
Internet and enhanced data services
We provide high-speed DSL services and dial-up Internet services in our
franchised territories. Our DSL service provides high-speed access to the
Internet at upload and download speeds up to 3.0 megabytes per second. Our
DSL services are purchased by both residential and business customers for a
monthly fee. Currently, we are capable of providing DSL service to
approximately 90% of our customers. Our dial-up Internet service provides
customers, primarily residential customers, a connection for unlimited access
to the Internet over their existing phone lines for a flat monthly fee.
Customers using our Internet access services have the ability to establish an
email account and to send and receive email. We offer our customers these
services as part of discounted packages that include other services and
features. For the year ended December 31, 2003, internet and enhanced data
service revenues represented 8.7% of our total revenue.
Edge-out services
In markets near our franchised territories, we provide local, long
distance and high speed data services primarily to medium and large
businesses. In addition, as part of our edge-out services, we maintain and
market a fiber transport and Internet egress business to customers primarily
in the Southeast region of the United States. In our edge-out markets, we
provided basic local exchange services to 14,462 voice access lines and 682
high-speed data connections as of December 31, 2003. Approximately 67% of
our edge-out customers take our data product. In addition, we provide data
and Internet related services to our customers primarily using ATM switches
distributed strategically throughout our network, enabling customers to use a
single network connection to communicate with multiple sites throughout our
fiber optic network and egress to the Internet. Our transport business
customers are other interexchange carriers and major accounts and we provide
services such as intercity transport, including both high capacity and
optical wavelength transport, metro access services and Internet egress
services at a DS-3 level and above. For the year ended December 31, 2003,
edge-out service revenues represented 7.5% of our total revenue.
Telephone directory and other miscellaneous revenues
Our telephone directory and other miscellaneous revenues consist
primarily of revenues from advertising sold in our telephone directories,
revenues earned from sales of telephone equipment to business customers and
revenues earned from other carriers for billing their long-distance customers
for long-distance calls and collecting the amounts due.
Our directory service provides telephone directories in our RLEC markets
that consist of residential and business white and yellow page listings and
advertisements. We currently produce nine different directories in our
service areas. We provide this service through third-party contractors who
pay us a percentage of revenues realized from the sale of advertising placed
in these directories.
We are a reseller of telephone equipment, such as telephone systems and
handsets, primarily to business customers. As part of this service, we
provide installation and support to our customers including maintenance under
4
contract agreements for fees based on the level of services provided. For
the year ended December 31, 2003, telephone directory and other miscellaneous
revenues represented 7.3% of our total revenue.
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 for this product
offering, 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.
Sales and marketing
Our marketing approach emphasizes customer oriented sales, marketing and
service with a local presence. For our RLECs, we market our products
primarily through our customer service and sales representatives supported by
direct mail, bill inserts, newspaper advertising, website promotions, public
relations activities and sponsorship of community events. Best sales
practices are shared amongst our RLECs. In each of our RLEC markets, we
maintain business offices that allow our customers the opportunity to pay
their bills directly or meet personally with our customer service and sales
representatives. Our customer service and sales representatives are well
trained and earn incentive compensation to promote sales of services to
customers that meet their unique needs. In each RLEC, we also have quota-
carrying outside sales representatives that market to businesses by offering
focused, customized proposals.
The services we provide can be purchased separately but more often are
included in a package with selected other service offerings, often referred
to as bundling, and sold at a discount. Our sales and marketing strategy for
our RLECs focuses on the bundling of services and the benefits it provides to
our customers. We believe that a fully-integrated bundle of services
maximizes our opportunity to increase penetration of new and existing
services and reduces our risks of losing customers to increasingly aggressive
competitors. We feel that the convenience and simplicity of a single
provider and a single bill, in addition to the cost savings, is highly valued
by our customers. Because of the convenience a bundle offers, we believe
customers are more satisfied and less likely to select other vendors as their
telecommunications provider.
We have recently introduced a residential bundled offering called our "No
Limits" package. After a successful introduction in our North Carolina market
in July, a similar bundling option is now offered in each of our RLEC
markets. Our results show that the No Limits package has been successful in
increasing penetration rates. Many of our customers selecting the No Limits
package are new DSL customers and long distance customers.
The No Limits bundle is marketed to our residential customers at
approximately $85 per month, with the price varying slightly by location. We
believe our pricing points for the No Limits package is at a level equal or
better than packages offered by cable, wireless, and IXC competitors in our
markets. Customers sign a one-year service agreement with this bundled
package. The No Limits package offers:
* unlimited local telephone service;
* unlimited nationwide long distance;
* unlimited use of our most popular custom calling features including
caller identification and voicemail; and
* unlimited use of our high-speed DSL service for Internet access.
We also employ marketing campaigns to systematically move customers from
our dial-up Internet service to DSL and from purchasing single services to
purchasing bundled options like the No Limits package. Because of the
convenience a bundle offers, we believe customers are more satisfied and less
likely to seek other vendors for their voice and data services.
In our edge-out services, our sales and marketing group consists of an
agent liaison manager for each of our three edge-out operating regions that
work with 22 companies authorized as agents to market our services. In
addition, two quota-carrying outside sales representatives for Gallatin River
in Illinois also market edge-out services. Our agents and our direct sales
force market our services to medium and large businesses. These sales forces
make direct calls to prospective and existing business customers, conduct
analyses of business customers' usage histories and service needs, and
demonstrate how our service package will improve a customer's communications
capabilities and costs. Our network engineers work closely with our sales
representatives to design service products and applications, such as high
5
speed data and wholesale transport services, for our customers. For our
existing customer base, our Client Based Marketing group handles contract
renewals and upgrades. We divide our account types between General Business
and Major Accounts. General Business customers generally have under 100
access lines. Major Account business customers generally have more than 100
access lines and/or requirements for high capacity data transport and access.
We serve our edge-out markets predominantly from our established
operations in Mebane, North Carolina and Pekin, Illinois. We also have sales
and operations facilities in New Orleans, Louisiana that are managed by our
RLEC in Foley, Alabama. Our local offices are primarily responsible for
coordinating service and customer premise equipment installation activities.
Our technicians survey customer premises to assess building entry, power and
space requirements and coordinate delivery, installation and testing of
equipment.
We believe that our customers value our "single point of contact" for
meeting their telecommunications needs as well as our ability to provide a
fully integrated portfolio of services. Our ATM-based services are fully
monitored for service performance by systems in our network operations
center, enabling us to provide preventative as well as corrective maintenance
24 hours a day, 365 days a year.
We seek to maintain and enhance the strong brand identity and reputation
that each of our RLECs enjoys in its communities. We believe this provides us
with a competitive advantage. For example, in each of our major areas of
operation, we market our products and presence through our local brand names,
Mebtel Communications, Gallatin River Communications, Gulf Telephone Company
and Coastal Utilities. As we market new services, or reach out from our
established markets, we will seek to use our brand identities to attain
increased recognition with potential customers. In our edge-out markets, we
are building and enhancing our brand identity as Madison River
Communications.
Network
We offer facilities-based services in each of our markets. Our fully
integrated telecommunications network is comprised primarily of ATM core
switches, capable of handling both voice and data, and time division
modulation, or TDM, digital central office switches and our packet network
used for DSL services that reach approximately 90% of our RLEC customers.
Our network also includes approximately 3,600 route miles of local and long-
haul fiber optic network predominately based in the southeastern United
States. We currently own predominantly all of our network facilities in our
RLEC operations. In our edge-out services, we own most of our network
facilities, including substantially all of our long-haul fiber network, but
do lease certain facilities and elements to allow us to serve our customers.
We have not booked any revenues from swaps of indefeasible rights to use, or
IRUs.
We have a full suite of proven operational support systems, or OSSs, and
customer care/billing systems that we believe allow us to meet or exceed our
customers' expectations. Our OSSs include automated provisioning and service
activation systems, mechanized line record and trouble reporting systems,
inter-company provisioning and trading partner electronic data exchange
systems. We employ an Internet service provider provisioning system and
helpdesk database software to assist new data customers and to communicate
with them when necessary. We currently bill our edge-out and Gulf Telephone
Company customers using our Unix-based Single View billing system and Coastal
Utilities customers with an AS400 based billing system from Comsoft. We
outsource our billing for Mebtel and Gallatin River to a third party vendor.
We believe our OSSs are scalable to accommodate reasonable growth and
expansion we may experience.
Our network operations center located in Mebane, North Carolina monitors
all of our networks, transport and ATM elements, digital switching systems
and ISP infrastructure devices twenty-four hours a day, 365 days a year.
The majority of our fiber optic network comprises a long-haul network in
the southeast United States that connects Atlanta, Georgia and Dallas, Texas,
two of the five United States 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. We
have designated Atlanta and Dallas as our Internet egress points.
In connection with our offering of local exchange services in our edge-
out markets, we have entered into interconnection agreements to resell the
incumbent carrier's local exchange services and interconnect our network with
the incumbent carrier's network for the purpose of immediately gaining access
to the unbundled network elements necessary to provide local exchange
services and high speed data service. The interconnection agreements contain
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provisions that grant us the right to obtain the benefit of any arrangements
entered into during the term of the interconnection agreements between the
incumbent carriers and any other carrier that materially differs from the
rates, terms or conditions of our interconnection agreements. Under the
interconnection agreements, we may resell one or more unbundled network
elements of the incumbent carriers at agreed upon prices. As will be
discussed further in the Regulatory Section, the status of our
interconnection agreements with the incumbent carriers is at risk due to a
ruling by the United States Court of Appeals for the District of Columbia
Circuit, or DC Circuit, to vacate and remand portions of the Federal
Communication Commission's Triennial Review Order. As a result of this
ruling, we are uncertain whether the interconnection agreements we have with
other incumbent local exchange carriers, or ILECs, will remain in effect or
will be subject to significant modifications.
Management
Our management team has extensive experience, averaging more than 30
years, in telecommunications, network engineering and operations, customer
care, sales and marketing, project development, regulatory management and
finance. J. Stephen Vanderwoude, our Chairman and Chief Executive Officer,
has an extensive background in the telecommunications industry, including
serving as President and Chief Operating Officer and a director of Centel
Corporation and President and Chief Operating Officer of the Local
Telecommunications division of Sprint Corporation. Many of the other members
of the management team have extensive telecommunications industry experience,
including positions at Sprint Corporation, Centel Corporation and Citizens
Communications.
We have entered into employment, confidentiality and noncompetition
agreements with our key executive members of management. The agreements are
subject to termination by either party (with or without cause) at any time
subject to applicable notice provisions. Additionally, the agreements
prohibit the executives from competing with us for a maximum period of up to
15 months, following termination for cause or voluntary termination of
employment. We have not entered into employment agreements with any other
key executives.
We believe our management team has been successful in acquiring and
successfully integrating strategic assets into our existing operations.
Further, we believe the skill and experience of our management team will
continue to provide significant benefits to us as we continue to enhance and
expand our service offerings and grow our business.
Employees
As of December 31, 2003, our work force consisted of 643 full time
employees. Approximately 138 of our employees at Gallatin River are subject
to collective bargaining agreements with the International Brotherhood of
Electrical Workers ("IBEW") and with the Communications Workers of America
("CWA"). Our labor agreement with the CWA, covering employees of Gallatin
River in Galesburg, Illinois, was renegotiated during 2002 for a three-year
period that ends in April 2005. Our labor agreements with the IBEW, covering
employees of Gallatin River in Dixon and Pekin, Illinois, were also
renegotiated during 2002. The collective bargaining agreement for the
employees in Dixon was extended to November 2005 and the collective
bargaining agreement for employees in Pekin was extended to September 2005.
We believe that our future success will depend on our continued ability to
attract and retain highly skilled and qualified employees. We also believe
that our relations with our employees are good.
Industry overview and competition
Over the past several years, the telecommunications industry has
undergone significant structural change. Many of the largest service
providers have achieved growth through acquisitions and mergers while an
increasing number of competitive providers have restructured or entered
bankruptcy to obtain protection from their creditors. Recently, capital in
the form of public financing or public equity was generally not as available
to new entrants and competitive providers as compared to the levels available
in previous years. Capital constraints have caused a number of competitive
providers to change their business plans. Consolidation of competitive
providers has resulted in part due to these capital constraints. Despite
these changes, the demand for all types of telecommunications services have
not diminished, particularly high speed data services.
The passage of the Telecommunications Act of 1996, or the Telecom Act,
which amended the Communications Act of 1934, as amended, or the
Communications Act, substantially changed the regulatory structure applicable
to the telecommunications industry, with a stated goal of stimulating
competition for virtually all telecommunications services, including local
telephone service, long distance service and enhanced services. Companies are
increasingly
7
bundling these services and providing one-stop shopping for end-user
customers. There has also been an increase in competition from incumbent
local exchange companies edging out of the territories where they are the
incumbent carriers, wireless providers and other intermodal competitors,
including cable operators.
We operate in the rural telephone industry. Our industry is comprised of
hundreds of carriers ranging in size from 3.2 million access lines to family-
owned local exchange carriers with less than 5,000 access lines. The RLEC
sector has several attributes which distinguish it from urban oriented
telephone companies. These include limited competition due to the high cost
of building competitive networks in rural areas, a favorable regulatory
environment which limits the requirement to resell elements of our networks
to competing carriers and a universal service fund which compensates RLECs to
the extent they have to offset the higher costs of operating in rural areas.
Rural telephone companies owned by families or small groups of
individuals face technical, administrative and regulatory complexities of the
local telephone business which challenge the capabilities of local
management. We believe that the owners of many of these small companies will
consider selling their businesses. In addition, several larger, urban
oriented, telephone companies have sold, or are considering selling, a
portion of their rural telephone exchanges in order to focus on major
metropolitan operations that generate the majority of their revenues. As a
result, we believe that there will be further acquisition opportunities for
rural telephone operations.
Since the passage of the Communications Act, federal and state
regulations promoting the widespread availability of telephone service have
allowed rural and small urban telephone companies to maintain advanced
technology while keeping prices affordable for customers. This policy
commitment was reaffirmed and expanded by the universal service provisions of
the Telecom Act. In light of the high cost per access line of installing
lines and switches and providing telephone service in sparsely populated
areas, a system of cost recovery mechanisms has been established to, among
other things, keep customer telephone charges at a reasonable level and yet
allow owners of such telephone companies to earn a fair return on their
investment. These cost recovery mechanisms, which are less available to
larger telephone companies, have resulted in robust telecommunications
networks in many rural and small urban areas, and such capabilities may deter
entry by potential competitors in these small markets. Currently, Gallatin
River and Gulf Telephone Company are our only RLECs with facilities-based
competition.
In markets where we have implemented our edge-out strategy, we are
subject to competition from the incumbent local exchange companies and other
CLEC competitors, including cable television operators, other incumbent local
exchange companies operating outside their traditional service areas, long
distance carriers and wireless carriers. The ongoing consolidation and
constraints on capital in the telecommunications industry could change the
nature of our competitive environment.
Regulation
The following summary does not describe all present and proposed
federal, state and local legislation and regulations affecting the
telecommunications industry. Some legislation and regulations are currently
the subject of judicial proceedings, legislative hearings and administrative
proposals which could change the manner in which this industry operates.
Neither the outcome of any of these developments, nor their potential impact
on us, can be predicted at this time. Regulation can change rapidly in the
telecommunications industry, and such changes may have an adverse effect on
us in the future. See "Risk Factors-We are subject to extensive government
regulation."
Overview
We are subject to regulation by federal, state and local government
agencies. At the federal level, the Federal Communications Commission, or the
FCC, has jurisdiction over interstate and international telecommunications
services. State telecommunications regulatory commissions exercise
jurisdiction over intrastate telecommunications services. The FCC does not
directly regulate enhanced services and has preempted certain inconsistent
state regulation of enhanced services. Additionally, municipalities and other
local government agencies regulate limited aspects of our business, such as
use of government owned rights of way, construction permits and building
codes.
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Federal Regulation
We are subject to, and must comply with, the Communications Act.
Pursuant to this statute and associated FCC rules, the FCC regulates the
rates and terms for interstate access services, which are an important source
of revenues for our RLECs. The amendments to the Communications Act contained
in the Telecom Act have changed and are expected to continue to change the
telecommunications industry. Among its more significant provisions, the
Telecom Act (1) removes barriers to entry into local telephone services while
enhancing universal service, (2) requires ILECs to interconnect with
competitors, (3) establishes procedures pursuant to which ILECs may provide
other services, such as the provision of long distance services by Bell
Operating Companies and their affiliates (including their respective holding
companies), and (4) directs the FCC to establish an explicit subsidy
mechanism (while simultaneously removing implicit subsidies) for the
preservation of universal service.
Access Charges
The FCC regulates the prices that ILECs charge for the use of their local
telephone facilities in originating or terminating interstate transmissions.
State regulatory bodies regulate intrastate charges. Federal and state
charges are subject to change at any time. The FCC has structured these
prices, or access charges, as a combination of flat monthly charges paid by
the end-users and usage sensitive charges paid by long distance carriers.
The FCC regulates the levels of interstate access charges by imposing
price caps on larger ILECs. These price caps can be adjusted based on
various formulae and otherwise through regulatory proceedings. Smaller ILECs
may elect to base access charges on price caps, but are not required to do so
unless they elected to use price caps in the past or their affiliated ILECs
base their access charges on price caps. Through 2003, our RLECs elected not
to utilize federal price caps. Instead, our RLECs employ rate-of-return rate-
making for their interstate access charges. With the exception of Mebtel, our
RLECs provide service pursuant to tariffs they file with the FCC for their
interstate traffic sensitive access services and participate in interstate
common line end user tariff rates filed by the National Exchange Carrier
Association, or NECA, for a pool of rate-of-return ILECs to recover non-
traffic sensitive costs. Mebtel also participates in the NECA traffic
sensitive pool and charges the established NECA traffic sensitive tariff
rates. NECA tariff rates are established based on the pooling carriers'
expenses incurred and their investment, and a regulated rate of return on
that investment and an amount to cover their income taxes on that return. The
authorized rate of return for such interstate access services is currently
11.25%.
In May 1997, the FCC initiated a multi-year transition designed to lead
to lower usage-sensitive access charges for larger ILECs. As part of this
transition, the FCC in August 1999 adopted an order and further notice of
proposed rulemaking aimed at introducing additional pricing flexibility and
other deregulation for these larger companies' interstate access charges,
particularly special access and dedicated transport. In May 2000, the FCC
lowered switched access rates, increased caps applicable to end-user rates
and established additional universal service funding support for these larger
companies. Previously, in May 1998, the FCC proposed to initiate a similar
transition for smaller ILECs, including our RLECs. This proceeding was
concluded and an order issued in November 2001 known as the MAG Order.
The MAG Order was released November 8, 2001 and was effective January 1,
2002. The MAG Order applies to non-price cap or "rate-of-return" exchange
carriers. The MAG Order increases the maximum Subscriber Line Charges, or
SLCs. The MAG order reduced access charges paid by long distance carriers,
increased the recovery of costs from end users and increased the amount of
costs recovered from federal universal funding. As a result, although total
revenue did not change, the aggregate amount of access charges paid by long
distance carriers to access providers, such as our rural telephone companies
has decreased and may continue to decrease. Beginning January 1, 2002, the
maximum SLCs for single line business and residential customers increased
from $3.50 per month to $5.00 per month. The maximum single line business and
residential SLCs increased to $6.00 as of July 1, 2002 and increased to $6.50
as of July 1, 2003. Maximum SLCs for multi-line business customers increased
to $9.20 effective January 1, 2002, and no further increases are scheduled.
The MAG Order included a notice of proposed rulemaking on incentive
regulation and the introduction of pricing flexibility measures for rate-of-
return carriers. This proceeding has not been completed, and no incentive
option (other than price caps, pursuant to the Coalition for Affordable Local
and Long distance Services (CALLS) plan) is currently available to our RLEC
operations.
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On February 26, 2004, the FCC released the text of its Report and Order
and Further Notice of Proposed Rulemaking in the MAG proceeding. In the
Order, the FCC eliminated the requirement for rate-of-return carriers to
obtain a waiver of FCC rules to convert acquired price cap properties to a
rate-of-return status. In the Further Notice of Proposed Rulemaking, the FCC
asked for comments on two proposals for federal alternative regulation plans.
It is not known at this time whether the FCC will establish additional
alternative regulation options for rate-of-return carriers and if so, when
such options would be available or what the terms of those options would be.
On May 22, 2001, the FCC released an order adopting the recommendation of
the Federal-State Joint Board to impose an interim freeze of the Part 36
category relationships and jurisdictional cost allocation factors for price
cap ILECs and a freeze of all allocation factors for rate-of-return ILECs.
This order also gave rate-of-return ILECs a one-time option to freeze their
Part 36 category relationships in addition to their jurisdictional allocation
factors. The freeze is in effect from July 1, 2001 through June 30, 2006, or
until the FCC has completed comprehensive separations reform, whichever comes
first. The frozen allocation factors and category relationships will be based
on carriers' separations studies for calendar year 2000. Our RLECs opted not
to freeze their allocation factors.
During 2001, the FCC released an order establishing access charge rules
for competitive local exchange carriers, or CLECs. Under FCC rules, CLECs,
can file interstate tariffs for access charges only if the access charge
rates conform to FCC safe harbor rates (essentially, the rate charged by the
largest ILEC in that market area). A CLEC wishing to charge higher rates can
do so, but cannot use the tariff process to collect such rates. Under these
rules, interexchange carriers are required to interconnect with companies
whose rates are within the FCC safe harbor guideline, and are required to pay
access charges at the tariffed rates.
Removal of Entry Barriers
Prior to the enactment of the Telecom Act, many states limited the
services that could be offered by a company competing with an ILEC. The
Telecom Act generally prohibits state and local governments from enforcing
any law, rule or legal requirement that has the effect of prohibiting any
entity from providing any interstate or intrastate telecom service. However,
states can modify conditions of entry into areas served by rural telephone
companies where the state telecommunications regulatory commission has
determined that certain universal service protections must be satisfied. The
federal law should allow us to provide a full range of local and long
distance services in most areas of any state. Following the passage of the
Telecom Act, the level of competition in the markets we serve has increased
and is expected to continue to increase.
Interconnection with Local Telephone Companies and Access to Other Facilities
The Telecom Act imposes a number of access and interconnection
requirements on all local telephone companies, including CLECs, with
additional requirements imposed on ILECs. These requirements are intended to
ensure access to certain networks under reasonable rates, terms and
conditions. Specifically, local telephone companies must provide the
following:
* Resale. Local telephone companies generally may not prohibit or place
unreasonable restrictions on the resale of their services.
* Telephone Number Portability. Local telephone companies must provide for
telephone number portability, allowing a customer to keep the same
telephone number when it switches service providers.
* Dialing Parity. Local telephone companies must provide dialing parity,
which allows customers to route their calls to a telecommunications
provider without having to dial special access codes.
* Access to Rights-of-Way. Local telephone companies must provide access to
their poles, ducts, conduits and rights-of-way on a reasonable,
nondiscriminatory basis.
* Reciprocal Compensation. The duty to establish reciprocal compensation
arrangements for the transport and termination of telecommunications
originated and terminated within a geographic scope established by FCC
rules.
All of our RLECs have implemented full equal access (dialing parity)
capabilities. The FCC's rules require our RLECs to use reasonable efforts to
implement local number portability after receiving a request from another
carrier to do so. During the first quarter of 2003, several wireless
carriers submitted requests for local number portability. On
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November 10, 2003, the FCC issued an order clarifying and defining the
requirements of wireline local exchanges carriers to port numbers to wireless
carriers. Under the terms of this Order, the Madison River incumbent local
exchange carriers are required to implement Local Number Portability for
wireline to wireline and wireless service providers by May 24, 2004. Our
RLECs therefore plan to implement Local Number Portability on May 24, 2004.
We are uncertain what impact this will have on our costs to provide service
or what impact this will have on our customer base at this time.
In addition, all ILECs must provide the following, subject to the
statutory exemptions for rural telephone companies:
* Interconnection. Interconnect their facilities and equipment with any
requesting telecommunications carrier at any technical feasible point;
* Notice of Changes. Provide reasonable notice of changes to the
information necessary for transmission and routing of services over the
incumbent telephone company's facilities or in the information
necessary for interoperability;
* Resale. Offer its retail local telephone services to resellers at a
wholesale rate that is less than the retail rate charged to end-users.
* Unbundling of Network Elements. Offer access to various unbundled
elements of their networks at cost-based rates.
* Collocation. Provide physical collocation, which allows CLECs to install
and maintain their own network termination equipment in ILECs' central
offices, or functionally equivalent forms of interconnection under some
conditions.
Competitors are required to compensate the incumbent telephone company
for the cost of providing these interconnection services.
All of our RLECs qualify as rural telephone companies under the Telecom
Act. They are, therefore, statutorily exempted from the ILEC interconnection
requirements unless and until they receive a bona fide request for wholesale
resale, unbundling or collocation, and the applicable state
telecommunications regulatory commission acts to lift the exemption. Despite
their rural status, Gallatin River agreed with the Illinois Commerce
Commission and Mebtel agreed with the North Carolina Utilities Commission
that they would not contest requests by competitive local telephone companies
for such interconnection arrangements. State commissions have jurisdiction to
review certain aspects of interconnection and resale agreements. Our RLECs
may also seek specific suspensions or modification of interconnection
obligations under the Telecom Act as a company that serves less than two
percent of the nation's access lines, where such interconnection obligations
would otherwise cause undue economic burden or are technically infeasible.
The FCC has adopted rules regulating the pricing of the provision of
unbundled network elements by ILECs. On May 13, 2002, the Supreme Court
affirmed that the FCC's rules basing unbundled network element, or UNE,
pricing on forward-looking economic costs, including total element long-run
incremental costs methodology, or TELRIC, were proper under the Telecom Act.
The Court also affirmed the FCC's requirement that ILECs combine UNEs for
competitors when they are unable to do so themselves. Although the United
States Supreme Court has upheld the FCC's authority to adopt TELRIC pricing
rules, the specific pricing guidelines created by the FCC remain subject to
review by the federal courts. In addition to proceedings regarding the FCC's
pricing rules, the FCC's other interconnection requirements remain subject to
further court and FCC proceedings.
The Telecom Act requires utilities to provide access to their poles,
ducts, conduits and rights-of-way to telecom carriers on a nondiscriminatory
basis. In October 2000, the FCC adopted rules prohibiting certain
anticompetitive contracts between carriers and owners of multi-tenant
buildings, requiring ILECs to disclose existing demarcation points in such
buildings and to afford competitors with access to rights-of-way, and
prohibiting restrictions on the use of antennae by users which have a direct
or indirect ownership or leasehold interest in such properties.
On February 20, 2003, the FCC announced a decision to revise its rules
requiring the unbundling of network elements by the ILECs which was released
in a formal Order on August 21, 2003 (the "Triennial Review Order"). This
Order was released on August 21, 2003. The new regulations limit the
obligation of the ILECs to provide access to
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broadband network facilities. The new rules do not require ILECs to make
fiber-to-the-home loops or the increased transmission capacity that exists
after the extension of fiber networks further into a neighborhood available
to CLECs. Similarly, the FCC eliminated the requirement that line-sharing,
where a CLEC offers high-speed Internet access over certain frequencies while
the ILEC provides voice telephone services over other frequencies using the
same local loop, be available as an unbundled element.
The Triennial Review Order redefined the standard for determining which
services are subject to mandatory unbundling by requiring that, for a network
element to be required to be unbundled, a CLEC must demonstrate that a lack
of access to an ILEC's network element creates barriers, including
operational and economic barriers, to its entry into the local
telecommunications market which are likely to make entry into that market
unprofitable. The FCC also eliminated its presumption that switching for
business customers served by high-capacity loops, such as DS-1, must be
unbundled to ensure competition. Instead, state utility commissions were
given 90 days from the effective date of the Triennial Review Order (August
21, 2003) to determine based on market conditions that such switching must
still be unbundled to preserve competition. No state utility commissions
made any such determinations by November 20, 2003, the deadline for doing so
under the Triennial Review Order. The FCC also eliminated the current
limited requirement for unbundling of packet switching.
The revised rules provide state utility commissions with an increased
role in determining which individual elements must be unbundled in the
markets they regulate. The state utility commissions are to make detailed
assessments of the status of competition in the markets within their states
to ensure that the unbundling requirements are applied in a manner consistent
with the newly announced standard for determining which services are subject
to mandatory unbundling. The FCC has opened a Further Notice of Proposed
Rulemaking seeking comment on whether the FCC should modify the pick-and-
choose rule that permits requesting CLECs to opt into individual portions of
interconnection agreements without accepting all the terms and conditions of
such agreements.
On March 2, 2004, the DC Circuit Court vacated and remanded portions of
the Triennial Review Order. The DC Circuit Court vacated and remanded the
FCC finding that CLECs are impaired without access to mass market switching
and dedicated transport elements based on the DC Circuit Court's view that
the FCC cannot subdelegate its responsibilities to the state utility
commissions. The DC Circuit Court upheld the FCC finding that incumbent
local exchange carriers are not required to provide UNEs for data services or
to provide line sharing. The DC Circuit Court vacated the FCC finding that
wireless carriers are impaired without access to dedicated transport
facilities. The DC Circuit Court then stayed the effective date of its
decision for 60 days, giving the telecommunications industry time to appeal
the decision and the FCC time to put interim rules in place until the vacated
and remanded issues are resolved.
At this time, we are uncertain of the impact of the DC Circuit Court's
decision to vacate and remand certain provisions of the FCC Triennial Review
Order or the implementation of these new regulations on our RLEC operations
or edge-out services. We are also uncertain as to the impact on our RLEC
operations or edge-out services of actions that may be taken by state utility
commissions based upon the new regulations, new legislation passed in
response to the new regulations or any further court decisions that result
from an appeal of the DC Circuit Court ruling. In particular, to the extent
that the FCC's limitation on access to fiber deployed in local loop
facilities limits our ability to obtain unbundled local loops for use in
serving our edge-out customers, our business could be adversely affected.
On April 27, 2001, the FCC released a notice of proposed rulemaking
addressing inter-carrier compensation issues. Under this rulemaking, the FCC
asked for comment on a "bill and keep" compensation method that would
overhaul the existing rules governing reciprocal compensation and access
charge regulation. The outcome of this proceeding could change the way we
receive compensation from other carriers and our end users. At this time, we
cannot estimate whether any such changes will occur or, if they do, what the
effect of the changes on our wireline revenues and expenses would be.
RLEC Services Regulation
Our RLEC services segment revenue is subject to regulation, including
incentive regulation by the FCC and various state regulatory bodies. We
believe that state lawmakers will continue to review the statutes governing
the level and type of regulation for telecommunications services. It is
expected that over the next few years, legislative and regulatory actions
will provide opportunities to restructure rates, introduce more flexible
incentive regulation programs and possibly reduce the overall level of
regulation. We expect the election of incentive regulation plans and the
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expected reduction in the overall level of regulation to allow us to
introduce services more expeditiously than in the past.
The FCC generally must approve in advance most transfers of control and
assignments of operating authorizations by FCC-regulated entities.
Therefore, if we seek to acquire companies that hold FCC authorizations, in
most instances we will be required to seek approval from the FCC prior to
completing those acquisitions. The FCC has the authority to condition,
modify, cancel, terminate or revoke operating authority for failure to comply
with applicable federal laws or rules, regulations and policies of the FCC.
Fines or other penalties also may be imposed for such violations. This may
impair our ability to make acquisitions.
Bell Operating Company Entry into Long Distance Services
The FCC has required that incumbent and independent local exchange
carriers that provide interstate long distance services originating from
their local exchange service territories, must do so in accordance with
"structural separation" rules. These rules require that our long distance
affiliates (i) maintain separate books of account, (ii) not own transmission
or switching facilities jointly with the local exchange affiliate, and (iii)
acquire any services from its affiliated local exchange telephone company at
tariffed rates, terms and conditions. The FCC has initiated a rulemaking
proceeding to examine whether there is a continuing need for such
requirements, but we cannot predict the outcome of that proceeding.
Our principal competitor for local services in each area where we operate
as a CLEC is an ILEC. In many of these areas, the ILEC is a Regional Bell
Operating Company, or RBOC. Although RBOCs and their affiliates were, prior
to the passage of the Telecom Act, prohibited from providing long distance
services, the Telecom Act allows a RBOC to provide long distance service in
its own local service region upon a determination by the FCC that it had
satisfied a 14- point checklist of competitive requirements. This provision
increases the RBOC's incentives to open their markets to competition, to the
benefit of CLECs; obtaining long distance service authority increases the
ability of the RBOCs to compete against providers of integrated
communications services. To date, the FCC has authorized RBOCs to provide
in-region long distance services in forty-eight states and the District of
Columbia. This list of states in which RBOC in-region authority has been
granted includes each of the states in which we operate: Illinois, North
Carolina, Georgia, Alabama, Mississippi and Louisiana.
Relaxation of Regulation
Through a series of proceedings, the FCC has decreased the regulatory
requirements applicable to carriers that do not dominate their markets. All
providers of domestic interstate services other than ILECs are classified as
non-dominant carriers. Our RLEC operations that operate as non-dominant
service providers are subject to relatively limited regulation by the FCC.
Among other requirements, these subsidiaries must offer interstate services
at just and reasonable rates in a manner that is not unreasonably
discriminatory.
The FCC phased out the ability of long distance carriers to provide
domestic interstate services pursuant to tariffs during 2001. These carriers
are no longer able to rely on tariffs as a means of specifying the prices,
terms and conditions under which they offer interstate services. The FCC has
adopted rules that require long distance carriers to make specific public
disclosures on the carriers' Internet web sites.
Universal Service
The FCC is required to establish a "universal service" program that is
intended to ensure that affordable, quality telecommunications services are
available to all Americans. The Telecom Act sets forth policies and
establishes certain standards in support of universal service, including that
consumers in rural areas should have access to telecommunications and
information services that are reasonably comparable in rates and other terms
to those services provided in urban areas. A revised universal service
support mechanism for larger ILECs went into effect on January 1, 2000. A
similar new universal service mechanism for rate-of-return ILECs, known as
the ICLS, went into effect January 1, 2002.
Per FCC rules, all ILECs were required to chose whether to disaggregate
specific rate centers for the purpose of establishing the amount of universal
service support associated with such rate centers, or maintaining an
aggregated study area approach. Our RLECs developed and filed disaggregation
studies in compliance with FCC rules. These
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studies identify the amount of portable universal service funding that would
be available to a competitor that has been certified as an Eligible
Telecommunications Carrier, or ETC, in each rate center. Information
regarding portable universal service funding associated with each ILEC is
available at the web site of the Universal Service Administrative
Corporation, or USAC.
Competitive local exchange carriers that have been granted ETC status
currently are eligible to receive the same amount of universal service per
customer as the ILEC serving the universal service area. To date, only one
carrier has been granted ETC status in an area served by our ILEC
subsidiaries. In Alabama, a cellular provider has been certified as an ETC
in areas served by Gulf Telephone Company. As this cellular provider
introduces services to customers in this geographic area and/or submits
claims for existing customers, it will be eligible to draw universal service
funds. The amounts of universal service funds paid to all ETCs, including
ILECs, can be found at the USAC web site. Under current rules and
procedures, the payment of universal service funding to an ETC in an area
served by an ILEC does not reduce the funding to the ILEC. However, the
growth of the fund due to payments to new ETCs has generated concerns of
legislative and regulatory bodies. The FCC review of the situation could
result in rules being promulgated that could reduce universal service funding
to our RLECs.
Our RLECs receive federal and state universal service support and are
required to make contributions to federal and state universal service
support. Such payments represented approximately 1.2% of our revenues for
the year ended December 31, 2003. Our contribution to federal universal
service support programs is assessed against our interstate end-user
telecommunications revenues. Furthermore, under the current regulatory
scheme, as the number of access lines that we have in any given state
increases, the rate at which we can recover certain support payments
decreases. Therefore, as we implement our growth strategy, our eligibility
for such support payments may decrease. Our contribution for such state
programs is assessed against our intrastate revenues. Although many states
are likely to adopt an assessment methodology similar to the federal
methodology, states are free to calculate telecommunications service provider
contributions in any manner they choose as long as the process is not
inconsistent with the FCC's rules.
On December 13, 2002, the FCC released rules making minor changes to the
procedures related to universal service fund assessments. This includes a
higher assessment to wireless carriers, use of a current (rather than
historical) basis of revenues for assessments, and rules limiting the charges
to individual carriers to no more than the assessment percentage on that
customer's interstate revenues. These new rules are not expected to have any
significant impacts on the operations of our RLECs. In the order, the FCC
also asked for comment on proposed changes to the way the assessments are
recovered from end users, proposing to assess end users on a per line or per
number basis rather than on the basis of retail-billed revenues. No decision
from this notice of proposed rulemaking has been issued.
In addition, there are a number of appeals challenging several aspects of
the FCC's universal service rules. It is not possible to predict at this
time whether the FCC or Congress will order modification to those rules, or
the ultimate impact any such modification might have on us.
On February 27, 2004, the Federal State Joint Board on Universal Service
released a Recommended Decision addressing a number of universal service
issues. The Recommended Decision is the product of state and federal
commissioners working together to develop a consensus recommendation. The
FCC has up to one year to act on the Recommended Decision and it can accept,
reject or modify the recommendations in any manner it chooses. In the
Recommended Decision, the Joint Board recommends the FCC adopt permissive
federal guidelines for states to consider in ETC proceedings. These
guidelines would generally make it more difficult for competitive ETCs to be
certified by requiring applicants to show a public interest benefit beyond a
simple showing of increased competition. The Joint Board goes on to
recommend that universal service support be limited to a single primary
connection that provides access to the public telephone network. It then
recommends that the Commission seek comment on three alternative proposals to
minimize impacts on rural carriers if support is limited to a single primary
connection. The Joint Board also recommends universal service support per
primary line be capped when a competitive ETC enters the market of a rural
carrier.
It is not known at this time how the FCC will act with respect to the
Recommended Decision of the Joint Board on Universal Service and, therefore,
we cannot estimate the impact of any such decision on our operations.
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Internet
In connection with our Internet access offerings, we could become subject
to laws and regulations as they are adopted or applied to the Internet.
There is currently only a small body of laws and regulations applicable to
access to or commerce on the Internet. As the significance of the Internet
expands, federal, state and local governments may adopt rules and
regulations, or apply existing laws and regulations to the Internet.
To date, the FCC has treated Internet service providers, or ISPs, as
enhanced service providers rather than common carriers. As such, ISPs have
been exempt from various federal and state regulations, including the
obligation to pay access charges and contribute to universal service funds.
As part of a reciprocal compensation order, the FCC has determined that both
dedicated and dial-up calls from a customer to an ISP are interstate, not
local, calls and, therefore, are subject to the FCC's jurisdiction. On March
24, 2000, the United States Court of Appeals for the District of Columbia
vacated and remanded this determination so that the FCC can explain more
clearly why such calls are not considered local. In April 2001, the FCC
released an order that reclassified Internet service as information access
and therefore not subject to reciprocal compensation. This finding was
appealed to the United States Court of Appeals for the District of Columbia,
which, on May 3, 2002, remanded the issue back to the FCC, finding that the
FCC's basis of its decision was insufficient. The FCC has not issued a
further order establishing a different basis for its decision.
On February 12, 2004, the FCC initiated a proceeding to examine the
manner in which it should regulate voice services provided over the Internet.
The text of the Notice of Proposed Rulemaking was released on March 10, 2004.
The FCC proposes to assert jurisdiction over IP-enabled applications and
services, including but not limited to VoIP offerings. This proceeding will
investigate the level of regulation appropriate to Internet services and
addresses important social objectives, such as public safety, emergency 911,
law enforcement access, consumer protections and disability access. It is
not known at this time what impact this proceeding will have on our
operations.
On February 12, 2004, the FCC ruled that pulver.com's Free World Dialup
service offering will remain a minimally regulated competitive option for
consumers. The Declaratory Ruling adopted emphasizes the FCC's long-standing
policy of keeping consumer Internet services free from burdensome economic
regulation at both the federal and state levels. In 2003, pulver.com filed a
petition for declaratory ruling requesting that the FCC rule pulver.com's
Free World Dialup service to be neither a "telecommunications service" nor
"telecommunications," and therefore not subject to traditional telephone
regulation. The FCC granted pulver.com's petition and also declared Free
World Dialup to be an unregulated information service that is subject to
federal jurisdiction.
Internet services are subject to a variety of other federal laws and
regulations, including those related to privacy, indecency, copyright and
tax.
Customer Information
Carriers are subject to limitations on the use of customer information
the carrier acquires by virtue of providing telecommunications services.
Protected information includes information related to the quantity, technical
configuration, type, destination and the amount of use of services. A carrier
may not use such information acquired through one of its service offerings to
market certain other service offerings without the approval of the affected
customers. These restrictions may affect our ability to market a variety of
packaged services to existing customers. We are also subject to laws and
regulations requiring the implementation of capabilities and provision of
access to information for law enforcement and national security purposes.
Preferred Carrier Selection Changes
A customer may change its preferred long distance carrier or its local
service provider at any time, but the FCC and some states regulate this
process and require that specific procedures be followed. When these
procedures are not followed, particularly if the change is unauthorized or
fraudulent, the process is known as slamming. The FCC has levied substantial
fines for slamming and has recently increased the penalties for slamming. No
such fines have been assessed against us.
Truth-in-Billing
The FCC has adopted rules designed to make it easier for customers to
understand the bills of telecommunications carriers. These new rules
establish requirements regarding the formatting of bills and the information
that must be included in bills.
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State Regulation - Incumbent Local Telephone Company
Most states have some form of certification requirement which requires
telecommunications providers to obtain authority from the state
telecommunications regulatory commission prior to offering common carrier
services. Our operating subsidiaries in Alabama, Illinois, North Carolina and
Georgia are ILECs and are certified in those states to provide local
telephone services.
State telecommunications regulatory commissions generally regulate the
rates ILECs charge for intrastate services, including rates for intrastate
local services, long distance services and access services paid by providers
of intrastate long distance services. ILECs must file tariffs setting forth
the terms, conditions and prices for their intrastate services. Under the
Telecom Act and FCC orders, state telecommunications regulatory agencies have
jurisdiction to arbitrate interconnection disputes and to review and approve
agreements between ILECs and other carriers in accordance with rules set by
the FCC. State regulatory commissions may also formulate rules regarding
fees imposed on providers of telecommunications services within their
respective states to support state universal service programs.
States often require prior approvals or notifications for certain
acquisitions and transfers of assets, customers or ownership of regulated
entities. Therefore, in most instances we will be required to seek state
approval prior to completing new acquisitions of RLECs. States generally
retain the right to sanction a carrier or to revoke certifications if a
carrier materially violates relevant laws and/or regulations.
In Alabama, Gulf Telephone Company, or GTC, is subject to regulation by
the Alabama Public Service Commission, or the APSC. GTC must have tariffs
approved by and on file with that commission for basic, non-basic and
interconnection services. GTC operates in Alabama under price regulation
rules. The APSC is currently reviewing these rules for GTC and other Alabama
local exchange carriers. It is not known how the APSC will proceed with this
plan or how the plan will impact GTC's overall revenues.
The Illinois Commerce Commission, or ICC, regulates Gallatin River
Communications, or GRC. GRC provides services pursuant to tariffs that are
filed with, and subject to the approval of, the ICC. The rates for these
services are regulated on a rate of return basis by the ICC, although GRC has
pricing flexibility with respect to services that have been deemed
competitive by the ICC, such as digital centrex, high capacity digital
service, intraLATA toll service, wide area telephone service and digital data
services. The ICC has approved several interconnection agreements under the
Telecom Act between GRC and mobile wireless carriers, as well as agreements
between GRC and facility-based CLECs. GRC is required to support state
universal service programs and is subject to ICC rules implementing these and
the federal universal service programs.
In North Carolina, our RLEC, MebTel, is regulated by the North Carolina
Utilities Commission, or NCUC. MebTel provides service pursuant to tariffs
that are filed with, and subject to the approval of, the NCUC. Effective
January 1, 2000, a price cap plan applies to MebTel's rates for intrastate
services, replacing rate of return regulation. MebTel is subject to
commission rules implementing state and federal universal service programs.
In Georgia, Coastal Utilities, Inc., or CUI, is regulated by the Georgia
Public Service Commission, or GPSC. Passage of the Telecommunications and
Competition Development Act of 1995 (the "Georgia Act") in Georgia
significantly changed the GPSC's regulatory responsibilities. Instead of
setting prices for competitive telecommunications services, the GPSC now
manages and facilitates the transition to competitive markets, establishes
and administers a universal access fund, monitors rates and service quality,
and mediates disputes between competitors. Under the alternative regulation
available pursuant to the Georgia Act, CUI has agreed to cap the rate it
charges for basic residential service; CUI is otherwise not subject to rate
regulation for the telecommunications services it offers to its end user
customers.
In Alabama and North Carolina, BellSouth has proposed changes to
compensation arrangements between itself and the rural ILECs, including our
RLECs. Under this set of proposals, the companies have agreed to "meet-
point" billing of IntraLATA private line customers. Under this arrangement,
both our RLEC and BellSouth would bill end users for their respective portion
of IntraLATA private line services with one end in our RLECs' service area
and the other end in BellSouth's service area.
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Interconnection with Wireless Carriers
The FCC has directed that IntraMTA traffic exchanged between an ILEC and
wireless carriers is subject to reciprocal compensation payments. An "MTA"
is a Major Trading Area, as defined by the FCC, for purposes of awarding PCS
spectrum licenses and often covers a significant portion of a one or two
state area. Our RLECs received wireless reciprocal compensation during 2003
based on a combination of state settlement arrangements and interconnection
agreements with wireless carriers. During 2003, BellSouth took action
throughout its region to attempt to terminate state settlement arrangements
and replace these with direct interconnection agreements between the RLECs
and the wireless carriers. These actions impact MebTel, CUI and GTC. In
response, our RLECs have worked with state industry groups to negotiate
individual state transition agreements and also have entered into a number of
interconnection agreements with individual wireless carriers. In 2004,
revised settlement arrangements will take effect, in some cases including
transitional settlements from BellSouth. In 2003, MebTel received an
$800,000 retroactive settlement from a major carrier related to wireless
traffic, which will not be repeated in 2004 or future years. Apart from
this, we expect 2004 wireless revenue, net of reciprocal compensation
payments, to be similar to 2003 net revenue amounts.
State Regulation - Competitive Local Telephone Company
Madison River Communications, LLC is certified to provide intrastate
local, toll and access services in the states of Illinois, North Carolina,
South Carolina, Tennessee, Georgia, Florida, Alabama, Mississippi, Louisiana
and Texas. In association with these certifications, Madison River
Communications, LLC has filed state local, access and toll tariffs in all
states except North Carolina, in which, pursuant to Commission rules, Madison
River Communications, LLC has filed a price list. Madison River
Communications, LLC has filed interstate access tariffs and maintains long
distance rates on its web site in conformance with FCC orders. Tariffs are
updated as needed and periodic state financial and quality of service filings
are made as required.
Madison River Communications, LLC has interconnection agreements with
Verizon in Illinois and North Carolina, with Sprint in North Carolina, with
SBC in Texas and Illinois, and with BellSouth in its nine state operating
area. These interconnection agreements govern the relationship between the
ILECs and Madison River Communications, LLC's operations in the areas of
resale of retail services, reciprocal compensation, central office
collocation, purchase of unbundled network elements and use of operational
support systems.
Local Government Authorizations
We are required to obtain from municipal authorities on-street opening
and construction permits or operating franchises to install and expand fiber
optic facilities in certain cities. We have obtained such municipal
franchises in our incumbent local telephone company territories in Alabama,
North Carolina, Illinois and Georgia. In some cities, subcontractors or
electric utilities with which we have contracts may already possess the
requisite authorizations to construct or expand our networks.
Some jurisdictions where we may provide service require license or
franchise fees based on a percent of certain revenues. There are no
assurances that jurisdictions that do not currently impose fees will not seek
to impose fees in the future. The Telecom Act requires jurisdictions to
charge nondiscriminatory fees to all telecom providers, but it is uncertain
how quickly this requirement will be implemented by particular jurisdictions
in our edge-out markets, especially regarding materially lower fees that may
be charged to ILECs.
Environmental Regulation
Our operations are subject to federal, state and local laws and
regulations governing the use, storage, disposal of, and exposure to,
hazardous materials, the release of pollutants into the environment and the
remediation of contamination. As an owner or operator of property and a
generator of hazardous wastes, we could be subject to environmental laws that
impose liability for the entire cost of cleanup of contaminated sites,
regardless of fault or the lawfulness of the activity that resulted in
contamination. We believe, however, that our operations are in substantial
compliance with applicable environmental laws and regulations.
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RISK FACTORS
In addition to the other information contained in this Annual Report on
Form 10-K, the following risk factors should be considered carefully in
evaluating us and our business. The risks and uncertainties described below
are not the only ones we face. Additional risks and uncertainties not
presently known to us or that we currently believe to be immaterial may also
adversely affect our business.
Risks Relating to our Business and Industry
We may not be able to sustain our revenues.
There is no assurance that we will be able to stabilize the recent
decline in our voice access lines. Beginning with the second quarter of
2002, we have seen the number of voice access lines we serve in certain of
our established markets decline due to a number of factors affecting our RLEC
markets, including but not limited to, competition and recession. We may not
be able to maintain our current number of voice access lines or stabilize the
decline in the number of such lines even if we were to expand the markets we
serve.
Consumers may not continue to purchase our services. Our success
depends on our ability to maintain our current customer base and revenues
from our services and otherwise implement our business plan. In order to
maintain our customer base and revenues from our services, we must continue
to provide attractive service offerings and compete effectively with other
service providers, including wireless service providers and cable companies
on, among other things, price, quality and variety of services.
Additionally, in order to remain successful, we must also increase the
variety of services used by our current customers. Although bundled service
offerings have successfully resulted in our customers using additional
services in the past, we cannot ensure that we will be able to continue to
provide additional services to our customers.
Prices may decline. The prices that we can charge our customers for
services, including voice communications, high speed data and Internet access
and egress services, could decline due to the following factors, among
others:
* lower prices offered by our competitors for similar services or bundled
services that include voice, data, Internet access or other services we
offer;
* changes in the federal or state regulations that encourage competition
have the impact of reducing the prices we may charge for our services;
* efforts by long distance carriers and others to lower the fees paid to us
for use of our network in offering their services;
* reduction of the universal support fund, or USF, established by the
Federal Communications Commission, or FCC, due to increased number of
participants accessing USF or changes in the regulation that
determines the amount of USF we receive;
* installation by us and our competitors, some of whom are expanding
capacity on their existing networks or developing new networks, of
fiber and related equipment that provides substantially more
transmission capacity than needed;
* technological advances that permit substantial increases in, or better
usage of, the capacity of transmission media;
* reduced differentiation in product quality and service resulting in
increased price competition; and
* strategic alliances or similar transactions that decrease industry
participants' costs.
We have a history of losses and may experience losses in the future.
We have incurred losses for the last several fiscal years and we may
continue to incur losses in the future. For example, we incurred net losses
of $14.7 million and $39.4 million for the fiscal years ended December 31,
2003 and 2002, respectively. We may not achieve profitability in the future
or be able to generate cash flow sufficient to meet
18
our interest and principal payment obligations and other capital needs such
as working capital for future growth and capital expenditures.
Our significant amount of long-term indebtedness could limit our operational
flexibility or otherwise affect our financial health.
We have a significant amount of long-term indebtedness. As of December
31, 2003, we had:
* total indebtedness of $637.2 million;
* member's capital of $39.5 million; and
* a debt to equity ratio of 16.1 to 1.
For the year ended December 31, 2003, earnings would have been
insufficient to cover our fixed charges by $16.5 million.
The covenants in the indenture governing our senior notes and the
covenants that we are subject to under our credit facilities with the Rural
Telephone Finance Cooperative, or RTFC, limit our ability to undertake
certain transactions including restrictions on our ability to:
* incur additional indebtedness;
* pay dividends on, redeem or repurchase our member interests or equity
of our subsidiaries;
* make various investments;
* make acquisitions without obtaining RTFC consent;
* exceed certain levels of capital expenditures without lender approval;
* sell certain assets or utilize certain asset sale proceeds;
* create certain liens or use assets as security in other transactions;
* make intercompany advances or loans;
* enter into certain transactions with affiliates; and
* merge or consolidate with or into other companies, or dispose of all or
substantially all of our assets and the assets of our subsidiaries.
These covenants are subject to a number of important exceptions. In
addition, the terms of the RTFC credit facilities also require us to meet or
maintain specified financial ratios and tests. Our ability to meet these
financial ratios could be affected by events beyond our control, and no
assurance can be given that we will be able to comply with these provisions.
A breach of any of these covenants could result in an event of default under
these credit facilities and/or the indenture.
Our substantial long-term indebtedness and the related covenants that
restrict certain actions we may take could have important consequences for
us. For example, they could:
* make it more difficult for us to satisfy our obligations with respect
to all of our indebtedness;
* limit our flexibility to adjust to changing market conditions, reduce
our ability to withstand competitive pressures and increase our
vulnerability to general adverse economic and industry conditions;
* limit our ability to borrow additional amounts for working capital,
capital expenditures, future business opportunities and other general
corporate requirements or hinder us from obtaining such financing on
terms favorable to us or at all;
* require us to dedicate a substantial portion of our cash flow from
operations to payments on our indebtedness, thereby reducing the
availability of our cash flow to fund working capital, capital
expenditures, future business opportunities and other general
corporate purposes;
* limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate;
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* restrict our ability to access additional capital;
* place us at a competitive disadvantage compared to our competitors that
have less debt; and
* make us vulnerable to increases in prevailing interest rates.
We may incur substantial additional indebtedness in the future. This
could further exacerbate the risks described above. The terms of our current
indebtedness do not fully prohibit us from incurring additional indebtedness.
Our credit facilities currently permit additional borrowing of up to $31.0
million.
Our ability to service our long-term indebtedness will depend on our
subsidiaries' ability to generate cash, our financial and operating
performance, the implementation of our business plan and our ability to
access cash from our subsidiaries.
We are a holding company with no business operations of our own. Our
only significant assets are the capital stock and member interests in our
subsidiaries that we own. Accordingly, our only sources of cash to service
our long-term indebtedness are cash on hand and distributions from our
subsidiaries from their net earnings and cash flows. Therefore, we are
dependent on our subsidiaries' ability to generate adequate cash in the
future from their operations, their financial and operating performance and
their ability to successfully execute our business plan. This, to a certain
extent, is subject to general economic, financial, competitive, legislative,
regulatory and other factors that are beyond our control.
In addition, our credit facilities with the RTFC contain (and credit
facilities that we may enter into in the future may contain) restrictive
covenants, including covenants that restrict the timing and amount of
dividends, distributions and other intercompany advances or loans of cash and
assets that our subsidiaries, subject to the terms of the credit facilities
and related guarantees and security agreements, may pay or advance to us.
Therefore, even if our subsidiaries determine to pay a dividend on, or make a
distribution in respect of, their capital stock or member interests or elect
to advance or loan cash or other assets to us, we cannot be certain that our
subsidiaries will be permitted to pay such dividend or distribution or to
make such advance or loan under the terms of our credit facilities.
We operate in local regions and, as a result, are highly dependant on
economic conditions in the local markets we serve.
We are sensitive to, and our success will be substantially affected by,
local economic and other factors affecting the local communities that we
serve. In recent months, we have seen declines in the number of voice access
lines we serve in our established markets due to a number of factors. At
December 31, 2003, our RLECs served 185,903 voice access lines, which is a
decrease of 4,350 voice access lines from 190,253 voice access lines in
service at December 31, 2002. The predominant share of voice access line
losses have occurred in our Illinois operations, Gallatin River, which
accounted for approximately 78% of the decrease. A persistent weakness in
the local economies that Gallatin River serves, which are predominantly
industrial and agricultural in nature, has led to some loss in the business
base and unemployment. Consequently, we have experienced a decline in the
number of voice access lines served by this RLEC. We are uncertain at this
time regarding the trend for connections in this market in the near future.
Furthermore, in March 2004, military officials at Fort Stewart in Hinesville,
Georgia, announced that the 3rd Infantry Division stationed there has
received orders to prepare for a full deployment by February 2005. Our RLEC,
Coastal Utilities, Inc., serves the Hinesville area including the military
base. We are currently gathering information regarding this deployment and
plan to assess the impact on our operations and cash flows. The full extent
of the impact on our operations is difficult to predict and will vary
depending on, among other factors, the duration of the troop deployment.
Therefore, we are unable at this time to project the range of the impact of
this deployment on Coastal Utilities or our operations as a whole.
Continuing softness in the U.S. economy is having a negative effect on the
telecommunications industry.
In 2001, the business environment for the telecommunications industry
deteriorated significantly and rapidly and currently remains weak. This was
primarily due to the general weakness in the U.S. economy, which was
exacerbated
20
by the events of September 11, 2001, and concerns regarding terrorism,
pressure on prices for broadband services due to substantial excess fiber
capacity in most markets, forecasted demand for broadband services not being
realized as a state of the economy, the bankruptcy or liquidation of a
substantial number of Internet companies and financial difficulties
experienced by many telecommunications customers. We expect these trends to
continue, including reduced business from financially troubled customers and
downward pressure on prices due to reduced demand and overcapacity. As a
result, our business has been and continues to be adversely affected by
softness in the U.S. economy.
We face significant and growing competition in the markets where we operate.
We operate primarily as a rural ILEC in an industry that is highly
competitive. However, due to the rural, low-density characteristics of our
existing operating areas, the high cost of entry into these markets and the
lack of concentration of medium and large business users, we believe that
compared to local exchange carriers serving more urban and densely populated
areas, we have historically faced less competition in our existing markets.
As characteristics of our markets change, regulatory barriers are removed and
entry costs decrease, the likelihood of local competitors entering our
markets may increase. Significant and potentially larger competitors could
enter our markets at almost any time.
We may face competition from future market entrants, including cable
television companies, wireless telecommunications providers, CLECs, electric
utilities, microwave carriers, Internet service providers and private
networks built by large end users and municipalities. With wireless
telephone companies offering significant minutes of use, including long
distance calls, for a flat fee, customers may believe it is more cost
effective to substitute their wireless telephones for wireline telephones and
to use their wireless telephones to make long distance calls, and we may
experience a decrease in our local, long distance and network access service
revenues. The introduction of wireline to wireless intermodal number
portability, or the ability of a customer to change from a traditional
wireline service provider to a wireless service provider while retaining his
or her telephone number, may increase the attractiveness of wireless service
as a substitute for our wireline services. In addition, we face or expect to
face competition for high speed access to the Internet from cable TV
companies in each of our RLEC markets. Further, cable TV companies are
developing the ability to provide voice services over their network
facilities which could create additional competition for our voice services.
We also have facilities-based interconnection agreements at Gallatin River
and Gulf Telephone and could potentially enter into more interconnection
agreements in the future, some of which may allow competitors to provide
additional voice services to our customers. Market entry by new competitors
is encouraged by the FCC's pick-and-choose rule, which allows any new
competitor in a market to pick and choose any portion of or all of an
existing interconnection agreement for itself. This obviates the need for a
lengthy and often costly negotiation or arbitration for a new interconnection
agreement, thereby easing entry into such a market for a new competitor, but
it can reduce the incentive of the incumbent carrier to negotiate different
terms with different competitors. The FCC has proposed changes to this rule
which would eliminate the ability to "pick and choose" among the provisions
of different agreements, and require a competitor to adopt all of an existing
agreement, negotiate or arbitrate a new agreement, or choose interconnection
terms from a state-approved statement of generally available terms, however
we cannot predict the outcome of these proposed changes. Our ability to
compete effectively will also depend upon our continued ability to maintain
price competitiveness.
In each of the edge-out markets where we provide competitive local
services, the services we offer compete principally with the services offered
by the ILEC serving that area. These local telephone companies have long-
standing relationships with their customers and have the potential to fund
their competitive services with their monopoly service revenues. As a
result of FCC interconnection and access orders, the ILECs serving areas
where we provide competitive local services are afforded a degree of pricing
flexibility for certain services. Pursuant to the Telecom Act, it is likely
that as competition increases, the FCC will forbear from exercising
regulatory authority over additional aspects of the operations of ILECs;
similar changes may occur with respect to state regulation. As a result,
ILECs may be afforded increased pricing flexibility for their services and
other regulatory relief, which could adversely effect our competitive local
operations. The ILECs with which we compete may be allowed by regulators to
lower rates for their services, engage in substantial volume and term
discount pricing practices for their customers or seek to charge us
substantial fees for interconnection to their networks.
Many potential competitors for our services have, and some potential
competitors are likely to enjoy, substantial competitive advantages,
including the following:
* greater name recognition;
* greater financial, technical, marketing and other resources;
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* longstanding or established national contracts;
* more extensive knowledge of the telecommunications business and
industry; and
* well established relationships with a larger installed base of current
and potential customers.
Other ILECs can also adversely affect the pace at which we add new
customers to our edge-out business by prolonging the process of providing
unbundled network elements, collocations, intercompany trunks and operations
support system interfaces, which allow the electronic transfer between ILECs
and CLECs of needed information about customer accounts, service orders and
repairs. Although the Telecom Act requires ILECs to provide the unbundled
network elements, interconnections and operations support system interfaces
needed to allow the CLECs and other new entrants to the local exchange market
to obtain service comparable to that provided by the ILECs to their own
customers in terms of installation time, repair response time, billing and
other administrative functions, in many cases the ILECs have not complied
with the mandates of the Telecom Act to the satisfaction of many competitors.
In addition, the interconnection regulations may be affected by the outcome
of pending court decisions and FCC rulemaking.
Increased competition could lead to continued declines in our voice
access lines, price reductions, fewer sales, reduced operating margins and
loss of market share.
Rapidly changing communications technology and other factors may require us
to expand or adapt our network in the future.
The telecommunications industry is subject to rapid and significant
changes in technology. We cannot predict the effect of these technological
changes on our business. These changes could require us to incur significant
capital expenditures to maintain or improve our competitive position. We may
not be able to obtain timely access to new technology on satisfactory terms
or incorporate new technology into our systems in a cost effective manner, or
at all. Further, new technologies and products may not be compatible with
our existing technologies and systems. New technologies and products may
reduce the prices for our services or be superior to, and render obsolete,
the products and technologies we use. If we do not replace or upgrade our
technology and equipment that becomes obsolete, we will not be able to
compete effectively. We cannot be certain that technological changes in the
communications industry will not have a material adverse effect on our
business and our ability to achieve sufficient cash flow to provide adequate
working capital and to service our indebtedness.
In addition to technological advances, other factors could require us to
further expand or adapt our network, including an increasing number of
customers, demand for greater data transmission capacity, failure of our
technology and equipment to support operating results anticipated in our
business plan and changes in our customers' service requirements. Expanding
or adapting our network could require substantial additional financial,
operational and managerial resources, any of which may not be available to
us.
While peak digital data transmission speeds across our network between a
central office and the end user can exceed 3.0 megabits per second, the
actual data transmission speed over our network may fluctuate due to various
factors. If our network is unable to provide services to our customers at
speeds that are competitive, we may lose our customers to competitors, which
would adversely affect our revenues.
We are increasingly dependent on market acceptance of DSL-based services to
support growth in our revenues.
We expect that an increasing amount of our revenues will come from
providing DSL-based services. The market for business and residential high-
speed Internet access is in the early stages of development and is highly
competitive. Because we offer and expect to expand our offering of services
to a new and evolving market and because current and future competitors are
likely to introduce competing services, it is difficult for us to predict the
rate at which this market will grow. Various providers of high-speed digital
communications services are testing products from various suppliers for
various applications, and it is unclear if DSL will offer the same or more
attractive price-performance characteristics. The markets for our DSL-based
services could fail to develop, grow more slowly than anticipated or become
saturated with competitors. This could have an adverse effect on our results
of operations.
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We are subject to extensive government regulation.
We are subject to varying degrees of federal, state and local regulation
and a majority of our revenues come from the provision of services regulated
by the FCC and various state regulatory bodies. We cannot predict the impact
of future developments or changes to the regulatory environment or the impact
such developments or changes would have on our operations, any such changes
could materially increase our compliance costs, require redesign of rate
structures, or prevent us from implementing our business plan. Regulation of
the telecommunications industry is changing rapidly, which affects our
opportunities, competition and other aspects of our business. The regulatory
environment varies substantially from state to state. In the states in which
we provide service, we are generally required to obtain and maintain
certificates of authority from regulatory bodies and file tariffs where we
offer intrastate services.
Existing federal and state rules impose obligations and limitations on
us, as the ILEC in some of our markets, that are not imposed on our
competitors. Federal obligations to share facilities, justify tariffs,
maintain certain types of accounts and file certain types of reports are all
examples of disparate regulation. While our edge-out and long distance
businesses are also subject to government regulation, our RLECs, in
particular, are highly regulated at both the federal and state levels.
The Telecom Act requires ILECs to enter into agreements to interconnect
with, sell unbundled network elements to and sell services for resale to
CLECs. In addition, the FCC has required state regulatory bodies to initiate
proceedings to determine whether to discontinue and replace specific
unbundling rules. Our ability to compete in the local exchange market as a
CLEC may be adversely affected by the ILEC's pricing of such offerings and
related terms, such as the availability of operation support systems and
local number portability, and would be adversely affected if such
requirements of the Telecom Act were repealed. Furthermore, the FCC's recent
Triennial Review Order reduces certain of the ILEC's obligations, and may
result in the elimination of additional obligations, to provide CLECs like
ours with access to their network elements. This may increase the costs of
providing services to our edge-out customers, require us to make extensive
investments in new network equipment to serve edge-out customers, or delay or
otherwise limit or affect our ability to expand our edge-out operations. The
general uncertainty regarding proposed changes to the unbundling rules
results in additional instability for our operations, which may possibly lead
to further reductions in revenues.
In addition, depending on the implementation of the Telecom Act, our
RLECs may be forced to interconnect with, and sell such services and elements
to, competitors at prices that do not fully recover our costs of providing
such services. If we continue to be unable to charge rates that fairly
compensate us for providing unbundled network services, our financial and
operating results could be adversely affected. In addition, it is possible
that in each state in which we have ILEC operations, interexchange carriers
that pay our ILECs intrastate access charges may initiate proceedings to
reduce our intrastate access charge rates. The outcome of any such
proceedings could further adversely affect our financial results.
We currently receive revenues as a result of state and federal USF
programs and make payments to such funds. Various reform proceedings are
under way at the FCC to change the method of calculating the amount of
contributions paid into the USF by all carriers and the amount of
contributions we receive from the USF, as well as the amount of support
received by our competitors. We cannot predict at this time whether or when
any change in the method of calculating support may affect our business. If
these programs are modified or discontinued, our financial results and cash
flows may be adversely affected. The Telecom Act also provides that
competitors can be designated as eligible telecommunications carriers, or
ETCs, and receive "specific" USF support. The FCC has ruled that ETCs are to
receive portable USF in the same amount as the ILEC serving the universal
service area. If such USF support were to become available to potential
competitors where we operate, we might not be able to compete as effectively
or otherwise continue to operate as profitably in our markets.
The rates we charge our local telephone customers are based, in part, on
a rate of return authorized by regulators. These authorized rates, as well
as allowable investment and expenses, are subject to review and change by
those regulators at any time. We are required to file with state regulators,
on a periodic basis, information relating to our cost of services and rates
of return. State regulators review these filings with a view to determining
whether our businesses are over-earning or under-earning and they may also
require that we publish our rates several months prior to their
effectiveness. To the extent that any business is over-earning, the state
regulators may issue an order requiring us to reduce our rates. Similarly,
to the extent that any business is under-earning, the state regulators may
allow us to
23
increase our rates. While we have not been required to reduce our rates in
the past, if regulators order us to reduce our rates, our competitive
position, revenues and our earnings will be adversely affected.
FCC regulations also affect rates that are charged to our customers. The
FCC approves tariffs for interstate access and subscriber line charges, both
of which contribute to our revenue. The FCC currently is considering
proposals to reduce interstate access charges for carriers like ours, and may
require us to recover the forgone revenue from our end users. If the FCC
lowers interstate access charges, we may be required to recover more revenue
through subscriber line charges or forego this revenue altogether. This
could reduce our revenue and impair our competitive position.
With the passage of the Telecom Act, the regulation of our services has
been subject to numerous administrative proceedings at the federal and state
level, litigation in federal and state courts, and legislation in federal and
state legislatures. We cannot predict the outcome of the various
proceedings, litigation and legislation or whether and to what extent they
may adversely affect our business or operations.
Many other aspects of our services and operations are subject to federal
and state regulation, including the introduction and pricing of new services,
compliance with demands from law enforcement and national security agencies,
privacy of customers' information and our use of radio frequencies.
Expanding our services and growing our business entail a number of risks.
Currently, we operate our business and provide our services primarily as
an RLEC. Our business plan is to expand our business by adding new customers
for both our RLEC operations and, to a limited degree, our edge-out services.
In addition, we are providing new services to our existing customers. If we
expand our telecommunications businesses, we will face certain additional
risks, including increased operational, legal and regulatory risks. The
telecommunications businesses in which we operate are highly competitive. We
may be at a disadvantage to competitors that are stronger financially than we
are or have more or better access to capital than we do.
We may not be successful in expanding our services or entering new
markets. In addition, demand and market acceptance for any new products and
services we introduce, whether in existing or new markets, are subject to a
high level of uncertainty. Our inability to expand our services or to enter
new markets effectively could have a material adverse effect on our business
and results of operations, including our ability to service our notes or pay
dividends related to our equity.
Our business plan will, if successfully implemented, result in growth of
our operations, which may place a significant strain on our management,
financial and other resources. To achieve and sustain growth we must, among
other things, monitor operations, meet competitive challenges, control costs,
maintain regulatory compliance, maintain effective quality controls and
significantly expand our internal management, technical, provisioning,
information, billing, customer service and accounting systems. We cannot
guarantee that we will successfully obtain, integrate and use the employee,
management, operational and financial resources necessary to manage a
developing and expanding business in an evolving, regulated and increasingly
competitive industry.
We may not find suitable businesses to acquire or we may be unsuccessful in
integrating acquired businesses.
Our business plan focuses on growing our business through acquisitions.
Any future acquisitions will depend on our ability to identify suitable
acquisition candidates, to negotiate acceptable terms for their acquisition
and to finance those acquisitions. We will also face competition for
suitable acquisition candidates that may increase our costs and limit the
number of suitable acquisition candidates available. In addition, future
acquisitions by us could result in the incurrence of additional indebtedness
and contingent liabilities, which could have a material adverse effect on our
ability to achieve sufficient cash flow, provide adequate working capital and
service our indebtedness. Any future acquisitions could also expose us to
increased risks, including, among others:
* the difficulty of integrating the acquired operations and personnel;
* the potential disruption of our ongoing business and diversion of
resources and management time;
* the inability to generate revenues from acquired businesses sufficient
to offset acquisition costs;
* the inability of management to maintain uniform standards, controls,
procedures and policies;
24
* the risks of entering markets in which we have little or no direct
prior experience;
* the risk that federal or state regulators may condition approval of a
proposed acquisition on our acceptance of conditions that may
adversely affect our overall financial results;
* difficulties in the integration of departments, systems, including
accounting systems, technologies, books and records and procedures,
as well as in maintaining uniform standards, controls, including
internal accounting controls, procedures and policies;
* expenses of any undisclosed or potential legal liabilities;
* the impairment of relationships with employees, unions or customers as
a result of changes in management; and
* the impairment of supplier relationships.
As a result, we cannot guarantee that we will be able to consummate any
acquisitions in the future or that any acquisitions, if completed, would be
successfully integrated into our existing operations.
To date, we have grown in large part through the acquisition of local
telephone companies and other operating assets. Our future operations depend
largely upon our ability to manage our business successfully. If we are
successful in making additional acquisitions, our management team will have
to manage a more complex organization and a larger number of operations than
we have previously operated. There can be no assurance that we will be
successful in integrating the various acquisitions. In addition, we may
discover information in the course of the integration of these acquisitions
that may have an adverse effect on our business and results of operations.
We may need to raise more capital to fund our obligations.
We may need to raise more capital in the future to:
* provide adequate working capital to fund our working capital deficit,
continuing operations and capital expenditures;
* provide resources to service or refinance our existing indebtedness;
and
* provide liquidity to fund any unexpected expenses or obligations.
Based on our business plan and anticipated future capital requirements,
we believe that the 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 at least the next 12
months. However, we may need additional capital sooner than planned. While
possible sources of additional capital include commercial bank borrowings,
sales of assets, vendor financing or the sale or issuance of equity and debt
securities to one or more investors, our ability to arrange additional
capital and the terms and cost of that financing will depend upon many
factors, some of which are beyond our control. We may be unable to raise
additional capital, and such failure to do so could have a material adverse
effect on our business and our ability to service our indebtedness.
Our ability to protect our proprietary technology is limited, and
infringement claims against us could adversely affect our ability to conduct
our business.
We currently rely on a combination of copyright, trademark and trade
secret laws and contractual confidentiality provisions to protect the
proprietary information that we have developed. Our ability to protect our
proprietary technology is limited, and we cannot be certain that our means of
protecting our proprietary rights will be adequate or that our competitors
will not independently develop similar technology. Also, we cannot be certain
that the intellectual property that local telephone companies or others claim
to hold and that may be necessary for us to provide our services will be
available on commercially reasonable terms. If we were found to be infringing
upon the intellectual property rights of others, we might be required to
enter into royalty or licensing agreements, which may be costly or not
available on commercially reasonable terms. A successful claim of
infringement against us or our inability to license the infringed or similar
technology on terms acceptable to us could adversely affect our business.
25
Our edge-out services may adversely affect our cash flow and financial
results.
During the past 24 months, we have made significant changes to our
business plan for our edge-out services, formerly referred to as our
Integrated Communications Division, or ICD, that will allow, we believe, for
a sustainable line of business capable of generating adequate cash to fund
its operations. In 2002, our edge-out operating results reflected a
significant decrease in the utilization of cash. In 2003, our edge-out
services generated positive cash flow and for the year ended December 31,
2003, our edge-out operations had a net operating loss of approximately $12.0
million. We continue to focus on developing this line of business and we
expect to sustain positive cash flow in the near future. However, there is
no assurance that we will be able to grow or sustain our current positive
cash flow from this line of business or that our revised business plan will
result in a viable, sustainable line of business capable of funding its own
operations in future years in our edge-out markets as a whole. Growth and
profitability in our edge-out line of business may also require
interconnection and resale terms and pricing which depend, in part, on
federal and state regulatory decisions and court interpretations of
legislation, all of which are outside of our control and subject to change in
ways that are difficult to predict.
We may not be able to achieve desired operating efficiencies from our
information and billing systems.
Sophisticated information and billing systems are vital to our growth and
ability to monitor and control costs, bill customers, process customer
orders, provide customer service and achieve operating efficiencies. We
currently rely on internal systems and third party vendors to provide certain
of our information and processing systems. Some of our billing, customer
service and management information systems have been developed by third
parties for us and may not perform as anticipated. Our plans for developing
and implementing our information and billing systems rely primarily on the
delivery of products and services by third party vendors. We may not be able
to develop new business, identify revenues and expenses, service customers,
collect revenues or develop and maintain an adequate work force if any of the
following occurs:
* vendors fail to deliver proposed products and services in a timely and
effective manner or at acceptable costs;
* we fail to identify adequately our information and processing needs;
* our related processing or information systems fail;
* we fail to maintain or upgrade systems when necessary; and
* we fail to integrate our systems with those of our major customers.
In addition, our right to use these systems is dependent upon license
agreements with third party vendors. Some of these agreements may be
cancelable by the vendor, and the cancellation or nonrenewable nature of
these agreements could impair our ability to process orders or bill our
customers. Since we rely on third party vendors to provide some of these
services, any switch in vendors could potentially be costly and affect
operating efficiencies.
Network disruptions could adversely affect our operating results.
The success of our operations will require that our network provide
competitive reliability, capacity and security. Some of the risks to our
network and infrastructure include:
* physical damage;
* power loss from, among other things, adverse weather conditions;
* capacity limitations;
* software and hardware defects;
* breaches of security, including sabotage, tampering, computer viruses
and break-ins; and
* other disruptions that are beyond our control.
26
Disruptions or system failures may cause interruptions in service or
reduced capacity for customers. If service is not restored in a timely
manner, agreements with our customers may obligate us to provide credits or
other remedies to them, and this would reduce our revenues. Service
disruptions could also damage our reputation with customers causing us to
lose existing customers or have difficulty attracting new ones. Many of our
customers' communications needs are extremely time sensitive, and delays in
signal delivery may cause significant losses to a customer using our network.
We may not be successful in obtaining and maintaining the necessary rights-
of-way for our network.
We may need to obtain supplemental rights-of-way and other permits from
railroads, utilities, state highway authorities, local governments and
transit authorities to install conduit and related telecom equipment for any
expansion of our network in our markets. We may not be successful in
obtaining and maintaining these right-of-way agreements or obtaining these
agreements on acceptable terms whether in new markets or in our existing
markets. Although as of December 31, 2003, we had acquired all material,
necessary nonexclusive right-of-way agreements covering our current
operations, some of these agreements may be short-term or revocable at will,
and we cannot be certain that we will continue to have access to existing
rights-of-way after they have expired or terminated. Although we believe that
alternative supplemental rights-of-way will be available, if any of these
agreements were terminated or could not be renewed, we may be forced to
remove our fiber optic cable from under the streets or abandon our networks.
Our utility right-of-way agreements are subject to certain conditions and
limitations on access and use and are subject to termination upon customary
default provisions. In some cases, these agreements require our fiber network
to be moved or removed in the event that the utility needs its right-of-way
for public utility purposes or no longer owns its right-of-way. We may not be
able to maintain all of our existing rights and permits or obtain and
maintain the additional rights and permits needed to implement our business
plan. In addition, our failure to maintain the necessary rights-of-way,
franchises, easements, licenses and permits may result in an event of default
under certain of our credit facilities.
Our relationships with other companies in the telecommunications industry are
material to our operations and their financial difficulties may affect our
business.
We generate a significant portion of our local service revenues from
originating and terminating phone calls for interexchange carriers. We
originate and terminate long distance phone calls for other interexchange
carriers over our networks and for that service we receive revenues from the
interexchange carriers, some of which are our largest customers in terms of
revenues. As of December 31, 2003, revenues from such interexchange carriers
comprised 18.8% of our total revenues. Some of these interexchange carriers
have declared bankruptcy in recent years or are experiencing substantial
financial difficulties. Two major interexchange carriers with which we
conduct business, MCI WorldCom and Global Crossing, declared bankruptcy.
These bankruptcies negatively impacted our financial results and cash flows.
Additional bankruptcies or disruptions in the businesses for these
interexchange carriers and others could further adversely effect on our
financial results and cash flows. In addition, we are aware that certain
interexchange carriers are or are seeking to bypass or avoid access charges
by originating traffic on and routing traffic through unregulated Internet
facilities.
We also depend on many telecommunications vendors and suppliers to
conduct our business. We use many vendors and suppliers that derive
significant amounts of business from customers in the telecommunications
business. For example, we have a resale agreement with Global Crossing to
provide our long distance transmission services. Associated with the
difficulties facing many companies in the telecommunications industry, some
of these third party vendors and suppliers have experienced substantial
financial difficulties in recent years, in some cases leading to bankruptcies
and liquidations. Any disruptions that these third party companies
experience as a result of their financial difficulties that impact the
delivery of products or services that we purchase from them could have an
adverse affect on our business.
Resale agreements with long distance carriers may contain minimum volume
commitments and/or underutilization penalties.
As part of our offering of bundled telecommunications services to our
customers, we offer long distance services. The long distance business is
extremely competitive and prices have declined substantially in recent years.
In addition, the long distance industry has historically had a high average
churn rate, as customers frequently change long distance
27
providers in response to the offering of lower rates or promotional
incentives by competitors. We rely on other carriers to provide transmission
and termination services for all of our long distance traffic. Our primary
underlying carrier currently is Global Crossing, which has until recently
operated under Chapter 11 bankruptcy protection. We must enter into resale
agreements with long distance carriers to provide us with transmission
services. These agreements typically provide for the resale of long distance
services on a per-minute basis and may contain minimum volume commitments.
Negotiation of these agreements involves estimates of future supply and
demand for transmission capacity as well as estimates of the calling patterns
and traffic levels of our future customers. In the event we fail to meet our
minimum volume commitments, we may be obligated to pay underutilization
charges and in the event we underestimate our need for transmission capacity,
we may be required to obtain capacity through more expensive means. The
incurrence of any underutilization charges, rate increases or termination
charges could have an adverse effect on our business.
We may not be able to compete effectively with the Regional Bell Operating
Companies, or RBOCs, in the provision of long distance services.
RBOCs have received authorization to provide certain types of long
distance telephone service in forty-eight states and the District of
Columbia. This list of states in which RBOC in-region authority has been
granted includes each of the states in which we operate: Illinois, North
Carolina, Georgia, Alabama, Mississippi and Louisiana. RBOCs have succeeded
in capturing substantial market shares in long distance services in several
states where they are authorized to provide such services, including New York
and Texas. By obtaining such authorizations, a major incentive that the
RBOCs have to cooperate with businesses such as our edge-out operations to
foster competition within their service areas has been removed. When RBOCs
offer both long distance and local exchange services, they reduce a
competitive advantage which businesses like our edge-out operations currently
are able to offer in those regions.
We may face significant future liabilities or compliance costs in connection
with environmental and worker health and safety matters.
Our operations and properties are subject to federal, state and local
laws and regulations relating to protection of the environment, natural
resources, and worker health and safety, including laws and regulations
governing the management, storage and disposal of hazardous substances,
materials and wastes. Under certain environmental laws, we could be held
liable, jointly and severally and without regard to fault, for the costs of
investigating and remediating any contamination at owned or operated
properties; or for contamination arising from the disposal by us or our
predecessors of hazardous wastes at formerly-owned properties or at third-
party waste disposal sites. In addition, we could be held responsible for
third-party property or personal injury claims relating to any such
contamination or relating to violations of environmental laws. Changes in
existing laws or regulations or future acquisitions of businesses could
require us to incur substantial costs in the future relating to such matters.
We depend on key personnel.
Our business is dependent upon a small number of key executive officers.
We have entered into employment, confidentiality and noncompetition
agreements with Messrs. J. Stephen Vanderwoude, Paul H. Sunu, James D. Ogg,
Kenneth Amburn, Michael T. Skrivan and Bruce J. Becker providing for
employment of each executive for specified periods of time ranging up to
three years. The agreements are subject to termination by either party (with
or without cause) at any time subject to applicable notice provisions.
Additionally, the agreements prohibit the executives from competing with us
for a maximum period of up to 15 months, following termination for cause or
voluntary termination of employment. We have not entered into employment
agreements with any other key executives.
We cannot guarantee that we will be able to attract or retain other
skilled management personnel in the future. The loss of the services of key
personnel, or the inability to attract additional qualified personnel, could
have a material adverse effect on our business and results of operations.
28
Item 2. Properties
We own and lease offices and space in a number of locations within our
regions of operation, primarily for our corporate and administrative offices,
central office switches and business offices, network operations centers,
customer service centers, sales offices and network equipment installations.
Our corporate headquarters and our accounting center are located in
approximately 24,100 square feet of leased space in two separate buildings in
Mebane, North Carolina. The lease for the corporate headquarters, including
our renewal options, will expire in approximately 15 years. The leases for
the accounting center, including our renewal options, will expire at various
times in six to eight years.
Our RLECs own predominantly all of the properties used for their central
office switches, business offices, regional headquarters and warehouse space
in their operating regions. The poles, lines, wires, cable, conduits and
related equipment owned by the RLECs are located primarily on properties that
we do not own, but are available for the RLECs' use pursuant to consents of
various governmental bodies or subject to leases, permits, easements or other
agreements with the owners. Our RLECs own approximately 1,300 route miles of
fiber in its operating regions.
In our edge-out markets, we lease properties primarily for sales and
administrative offices, collocations, ATM switches and data transmission
equipment. We also lease local loop lines that connect its customers to its
network as well as leasing space for central offices for our RLECs for
collocating transmission equipment. In our edge-out markets we closed
certain sales and administrative offices and we are currently evaluating our
options related to disposal or sublease of these spaces. We have leases on
office space in Peoria, Illinois and Atlanta, Georgia that are no longer used
by our edge-out services and have been sublet. In addition, we have office
space in Greensboro, North Carolina and New Orleans, Louisiana that is being
actively marketed on a sublet basis. We own approximately 2,300 route miles
of fiber in North Carolina, Illinois and across the southeast from Atlanta to
Houston and Dallas that is used in providing our edge-out services.
Substantially all of our RLEC properties and telephone plant and
equipment are pledged as collateral for our senior indebtedness. We believe
our current facilities are adequate to meet our needs in our incumbent local
and competitive local markets for the foreseeable future.
Item 3. Legal Proceedings
(a) 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 to be 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,
29
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 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 provided proposed corrections to be made for the
operational failures disclosed in the first application as well as presented
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 completed the final
Compliance Statement and it was issued in February 2004 allowing us 150 days,
or until July 4, 2004 to implement all of the corrections. As of the end of
February 2004, we had implemented substantially all of the required
corrections outlined in the final Compliance Statement and made a
distribution of substantially all of the cash assets held in the ESOP to
participants. The ESOP, which holds a 48.2% interest in an escrow fund
established in connection with our acquisition of Gulf Coast Services in
September 1999, will remain open until mid-2006 pending final distribution of
the remaining amounts in the escrow fund. Under the terms of the final
Compliance Statement, we contributed approximately $0.2 million to the ESOP
to provide adequate funds for the corrections.
In May 2002, the escrow committee for the escrow fund authorized the
transfer of $1.7 million from the escrow fund to the ESOP as required by the
initial application for a compliance statement. Pursuant to the terms of the
final Compliance Statement issued in February 2004, the $1.7 million was no
longer necessary to complete the corrections to the ESOP. In March 2004, we
requested the return of this amount from the ESOP trust, together with
interest earned from the date of the initial transfer, to the escrow fund.
(b) We are involved in other various claims, legal actions and
regulatory proceedings arising in the ordinary course of business. In the
opinion of management, the ultimate disposition of these matters will not
have a material adverse effect on our consolidated financial position,
results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No items were submitted to a vote of security holders during the fourth
quarter of 2003.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
We are a limited liability company with one member, our parent company,
Madison River Telephone Company, LLC, or Madison River Telephone. Therefore,
we do not have common stock registered on a public trading market.
All of our Class A member interests are held by Madison River Telephone. We
have not paid any cash dividends to Madison River Telephone in the past two
years. Under the terms of the indenture governing our senior notes, we are
limited in our ability to pay dividends to Madison River Telephone unless we
achieve certain cash flows from our operations and exceed certain ratios as
defined in the indenture. At March 15, 2004, we do not have the ability to
pay any dividends to Madison River Telephone under the terms of our indenture
and do not expect to have this ability in the next 12 months.
30
Item 6. Selected Financial Data
MADISON RIVER CAPITAL, LLC
Selected Financial and Operating Data
(Dollars in thousands)
Year Ended December 31,
----------------------------------------------------------------
1999 (a) 2000 (b) 2001 2002 2003
-------- -------- -------- -------- --------
Statement of Operations Data:
Revenues $ 81,517 $ 167,101 $ 184,263 $ 184,201 $ 186,460
Operating expenses:
Cost of services 24,909 61,559 68,512 56,298 50,214
Depreciation and
amortization 21,508 50,093 58,471 50,649 52,054
Selling, general and
administrative expenses 29,608 55,457 54,488 45,673 42,402
Restructuring - - 2,779 2,694 (718)
------------------------------------------------------------------
Total operating expenses 76,025 167,109 184,250 155,314 143,952
------------------------------------------------------------------
Operating income (loss) 5,492 (8) 13 28,887 42,508
Interest expense (22,443) (61,267) (64,624) (63,960) (62,649)
Other income (expense) 3,386 4,899 (14,813) (2,486) 3,626
------------------------------------------------------------------
Loss before income taxes and
minority interest expense (13,565) (56,376) (79,424) (37,559) (16,515)
Income tax (expense) benefit (1,625) (2,460) 5,570 (1,584) 1,846
Minority interest expense - (750) (1,075) (275) -
------------------------------------------------------------------
Net loss $ (15,190) $ (59,586) $ (74,929) $ (39,418) $ (14,669)
==================================================================
Balance Sheet Data (at period end):
Cash and cash equivalents $ 83,729 $ 63,410 $ 21,606 $ 19,954 $ 28,143
Telephone plant and
equipment, net 293,322 400,319 396,794 359,365 321,535
Total assets 785,290 992,017 896,578 844,771 807,142
Long-term debt, including
current portion 535,611 678,114 680,018 661,568 637,213
Total member's capital 165,994 129,101 59,393 57,490 39,488
Other Financial Data:
Capital expenditures $ 37,756 $ 89,644 $ 39,936 $ 12,344 $ 12,223
Net cash provided by
(used in) operating
activities 12,938 23,964 (19,770) 32,092 43,769
Net cash used in investing
Activities (374,582) (214,649) (24,013) (10,714) (10,019)
Net cash provided by
(used in) financing
activities 439,019 170,366 1,979 (23,030) (25,561)
Ratio of earnings to
fixed charges (c) - - - - -
EBITDA (d) 30,386 54,984 43,671 77,050 98,188
Other Operating Data:
Access lines 150,000 205,547 211,540 206,597 200,365
DSL and high speed
data connections 273 4,536 11,831 17,128 24,863
Employees 745 1,073 783 664 643
(a) Represents the historical consolidated financial information of Madison
River Capital, which includes the results of operations of Madison River
Capital and its subsidiaries, including Gulf Coast Services (acquired on
September 29, 1999).
(b) Represents the historical consolidated financial information of Madison
River Capital, which includes the results of operations of Madison River
Capital and its subsidiaries, including Coastal Communications (acquired
on March 30, 2000).
(c) The ratio of earnings to fixed charges is computed by dividing income
before income taxes and fixed charges (other than capitalized interest)
by fixed charges. Fixed charges consist of interest charges,
amortization of debt expense and discount or premium related to
indebtedness, whether expensed or capitalized, and that portion of
rental expense we believe to be representative of interest. For the
years ended December 31, 1999, 2000, 2001, 2002 and 2003, earnings of
Madison River were insufficient to cover fixed charges by $13,565,
$56,376, $79,424, $37,559 and $16,515, respectively.
(d) EBITDA consists of our net loss before interest expense, income tax
(expense) benefit, depreciation and amortization. This measure is a
non-GAAP financial measure, defined as a numerical measure of our
financial performance that excludes or includes amounts so as to be
different than the most directly comparable measure calculated and
presented in accordance with GAAP in our statement of operations,
balance sheet or statement of cash flows. Pursuant to the requirements
of Regulation G under the Securities Act, we have provided a
reconciliation of this non-GAAP financial measure to the most directly
comparable GAAP financial measure.
31
EBITDA is presented because we believe it is frequently used by
investors and other interested parties in the evaluation of a company's
ability to meet its future debt service, capital expenditures and
working capital requirements. However, other companies in our industry
may present EBITDA differently than we do. EBITDA is not a measurement
of financial performance under generally accepted accounting principles
and should not be considered as an alternative to cash flows from
operating activities or as a measure of liquidity or as an alternative
to net loss as an indicator of our operating performance or any other
measure of performance derived in accordance with generally accepted
accounting principles. See our Consolidated Statements of Cash Flows
included elsewhere in this prospectus. See reconciliation below.
Year Ended December 31,
----------------------------------------------------------------
1999 (a) 2000 (b) 2001 2002 2003
-------- -------- -------- -------- --------
Computation of EBITDA:
Net loss $ (15,190) $ (59,586) $ (74,929) $ (39,418) $ (14,669)
Income tax expense (benefit) 1,625 2,460 (5,570) 1,584 (1,846)
Interest expense 22,443 61,267 64,624 63,960 62,649
Minority interest expense - 750 1,075 275 -
Depreciation and
amortization 21,508 50,093 58,471 50,649 52,054
------------------------------------------------------------------
EBITDA $ 30,386 $ 54,984 $ 43,671 $ 77,050 $ 98,188
==================================================================
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain statements set forth below constitute "forward-looking
statements" that involve risks and uncertainties. Our actual results may
differ materially from those anticipated in these forward-looking statements
as a result of various factors. For further discussion of these factors, see
the section of this Form 10-K titled "Risk Factors."
Included in our discussion and analysis of our operating results are
comparisons of EBITDA. EBITDA is a non-GAAP financial measure, defined as a
numerical measure of our financial performance that excludes or includes
amounts so as to be different than the most directly comparable measure
calculated and presented in accordance with GAAP in our statement of
operations, balance sheet or statement of cash flows. See footnote (d) under
"Selected Financial and Operating Data" for a reconciliation of EBITDA to net
loss. EBITDA is presented because we believe it is frequently used by
investors and other interested parties in the evaluation of a company's
ability to meet its future debt service, capital expenditure and working
capital requirements. However, other companies in our industry may present
EBITDA differently than we do. EBITDA is not a measurement of financial
performance under generally accepted accounting principles and should not be
considered as an alternative to cash flows from operating activities or as a
measure of liquidity or as an alternative to net loss as an indicator of our
operating performance or any other measure of performance derived in
accordance with generally accepted accounting principles.
Historically, our operations have been organized into two operating
divisions, which we referred to as the Local Telecommunications Division, or
LTD, and the Integrated Communications Division, or ICD. The LTD was
responsible for the integration, operation and development of our established
markets that consist of our four rural local exchange carriers acquired since
January 1998. The ICD was responsible for developing and managing our edge-
out strategy as a competitive local exchange carrier as well as maintaining
and marketing a fiber transport and Internet egress business. We no longer
view the provision of such competitive services as a separate division, but
as a line of business within our RLEC operations as the management
responsibility for our edge-out operations is within the respective RLECs.
Our RLEC operations, which include the LTD, represent the operations of our
four RLECS providing a variety of telecommunications services, including
local and long distance voice services, high-speed data and Internet access
to business and residential customers predominantly in the Southeast and
Midwest regions of the United States. Included within our RLEC operations as
a separate line of business are our edge-out services, or EOS, that are
similar to those provided by the ICD. Accordingly, in the following
discussion of our operations we refer to our historical LTD operations as the
operations of our RLECs and our historical ICD operations as our edge-out
services.
Overview
We are an established RLEC providing communications services and
solutions to business and residential customers in the Southeast 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 December 31, 2003, we had 225,228 voice, DSL and high speed
data connections in service.
32
Our RLECs are located in North Carolina, Illinois, Alabama and Georgia.
We also provide edge-out services as a CLEC in territories that are in close
proximity to our RLECs. We currently provide edge-out services to medium and
large customers in three markets: (i) the Triangle (Raleigh, Durham and
Chapel Hill) and the Triad (Greensboro and Winston-Salem) in North Carolina;
(ii) Peoria and Bloomington in Illinois and (iii) New Orleans, Louisiana and
nearby cities. The management and operating responsibility for the edge-out
operations are provided by the managers of the respective RLECs.
As part of our edge-out services, we maintain a 2,300 route mile fiber
optic network, the majority of which 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. We have designated
Atlanta and Dallas as our Internet egress points. We use our fiber optic
network to support our dial-up, DSL and high speed Internet services provided
in our RLEC operations and our edge-out services which use our network to
connect to the Internet. Because we have found the fiber transport business
to be extremely competitive and price driven, we do not anticipate actively
expanding this line of business at this time.
The objective of our current business plan is to maintain and grow our
cash flows and to be a leading provider of telecommunications services in our
operating markets in the Southeast and Midwest. Since our inception, our
principal activities have been the acquisition, integration, operation and
improvement of our RLECs. In acquiring our four RLECs, we purchased
businesses with positive cash flow, government and regulatory authorizations
and certifications, operating support systems, management and key personnel
and facilities. Our RLECs are continuing to develop these established
markets with successful marketing of vertical services and DSL, primarily
through bundling of products, and is controlling expenses through the use of
business process management tools and other methods. In our edge-out
services, our strategy is focused on developing a profitable customer base
and maintaining sustainable positive cash flow from this division. We have
established rigorous criteria for evaluating new customers and the
desirability of renewing existing contracts.
Factors Affecting Future Operations
The following is a discussion of the primary factors that we believe will
affect our operations over the next few years.
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 RLEC markets. For the year ended December 31, 2003,
approximately 92.5% of our operating revenues came from our RLEC operations
and 7.5% from our edge-out services. For the year ended December 31, 2002,
approximately 91.7% of our operating revenues came from our RLEC operations
and 8.3% from our edge-out services. We intend to focus on continuing to
generate increasing revenues in our RLEC operations and edge-out services
from voice services (local and long distance), Internet access and enhanced
data and other services. The sale of communications services to customers in
our RLEC markets will continue to provide the predominant share of our
revenues for the foreseeable future. We do not anticipate significant growth
in revenues from our edge-out services as we continue to focus on a business
plan that provides sustainable positive cash flows from that line of
business. 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 December 31, 2003, we had 225,228 connections in service compared to
223,725 connections in service at December 31, 2002, an increase of 1,503
connections or 0.7%. Our RLEC operations had 210,084 connections in service
at December 31, 2003 and 206,676 connections in service at December 31, 2002,
an increase of 3,408 connections or 1.6%. For the edge-out services,
connections in service at December 31, 2003 and December 31, 2002 were 15,144
and 17,049, respectively, a decrease of 1,905 connections or 11.2%.
We are currently experiencing a decline in the number of voice access
lines in service in our RLECs. For the year ended December 31, 2003, the
RLECs finished with approximately 185,903 voice access lines in service,
which is a decrease of 4,350 voice access lines from approximately 190,253
voice access lines in service at December 31, 2002. Approximately 54% of the
decrease in voice access lines served was the result of a decrease in second
lines. As we increase the number of DSL connections we serve,
correspondingly, we are experiencing a decrease in the number of second lines
we serve. This is the result of our existing customers migrating from our
dial-up Internet service where they also purchase a second line to our DSL
service where they no longer need a second line. At December 31, 2003, we
have approximately 8,200 second lines remaining in service. In addition, our
Illinois operations accounted for all of our losses of primary voice access
lines, defined as total voice access lines less second lines. A persistent
weakness in the local
33
economies that Gallatin River Communications in Illinois serves has led to
unemployment and certain business losses and, therefore, a decline in voice
access lines served in this market. We are uncertain at this time regarding
the trend for voice access lines in this market in the near future. Our
remaining three RLECs showed growth in the number of primary voice access
lines served at December 31, 2003 when compared to December 31, 2002.
In March 2004, military officials at Fort Stewart in Hinesville, Georgia,
announced that the 3rd Infantry Division stationed there has received orders
to prepare for a full deployment by February 2005. Our RLEC, Coastal
Utilities, Inc., serves the Hinesville area including the military base. We
are currently gathering information regarding this deployment and plan to
assess the impact on our operations and cash flows. The full extent of the
impact on our operations is difficult to predict and will vary depending on,
among other factors, the duration of the troop deployment. Therefore, we are
unable at this time to project the range of the impact of this deployment on
Coastal Utilities or our operations as a whole.
The number of DSL subscribers we serve in our RLECs 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 our RLECs. As of December 31,
2003, we had 24,181 DSL connections in service, an increase of 7,758
connections from 16,423 DSL connections at December 31, 2002. Our
penetration rate for installed DSL connections reached 13.0% of our RLEC
voice access lines at December 31, 2003 compared to 8.6% at December 31,
2002.
We have also been successful in growing other revenues in our RLECs
including the provision of long distance and vertical services to our
customers. At December 31, 2003, we had 96,586 long distance accounts
compared to 91,234 long distance accounts at December 31, 2002. In addition,
our penetration rates for voicemail, caller identification, call waiting and
call forwarding have increased over December 31, 2002. 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 December 31, 2003, we had 23,773 dial-up Internet customers
which was a decrease of 3,983 customers, or 14.4%, from 27,756 dial-up
Internet customers at December 31, 2002. We believe that a large percentage
of the decrease in dial-up Internet customers is the result of customers
migrating from our dial-up Internet service to our high-speed DSL.
The services we provide can be purchased separately but more often are
included in a package with selected other service offerings, often referred
to as bundling, and sold at a discount. Our sales and marketing strategy for
our RLECs focuses on the bundling of services and the benefits it provides to
our customers. We have recently introduced a residential bundled offering
called our "No Limits" package. After a successful introduction in our North
Carolina market in July, a similar bundling option is now offered in each of
our RLEC markets. Our results show that the No Limits package has been
successful in increasing penetration rates and we expect this trend to
continue in 2004. Many of our customers selecting the No Limits package are
new DSL customers and long distance customers which has led to an overall
increase in our average revenue per unit. We intend to continue to offer
other combined service discounts and programs designed to give customers
incentives to buy bundled services.
We have experienced a decrease in revenues from our edge-out services in
2003 compared to 2002 as new sales of services and renewals of expiring
customer contracts have not been enough to replace customers that do not
continue with our service. At December 31, 2003, our edge-out services had
14,462 voice access lines and 682 high speed data connections in service. At
December 31, 2002, our edge-out services served 16,344 voice access lines and
705 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.
Recent bankruptcies by interexchange carriers, including MCI WorldCom and
Global Crossing, have impacted our financial results including our revenues,
EBITDA (See footnote (d) under "Selected Financial and Operating Data" for a
definition of EBITDA and reconciliation of EBITDA to net loss) and cash
flows. The final resolution of these bankruptcies through the legal process
and/or any regulatory changes that may arise from these events may have a
material impact on our business. Without additional clarification or
regulatory changes that recognize the additional financial burdens placed on
LECs, we may be unable to appropriately protect ourselves against the
financial impact associated with any future bankruptcies of interexchange
carriers or other telecommunication providers.
34
Expenses
With the completion of each of our four RLEC acquisitions in 1998, 1999
and 2000, we focused on integrating the acquired operations into our existing
business and on identifying opportunities to leverage off of common resources
and to use best practices to increase productivity and efficiencies in our
operations. To accomplish this, we implemented business process management
tools and shared information on successful operating practices across the
enterprise. We have centralized many of our business and back office
functions, including network management, network operations, information
technology, procurement, regulatory, finance, accounting, legal and human
resources. Accordingly, we experienced fairly significant decreases in
operating expenses in our RLEC operations in recent years. More recently,
the rate at which operating expenses in the RLECs were decreasing has slowed,
producing fairly comparable results from period to period. We seek to
maintain the expense reductions that we have achieved in the RLECs in recent
years.
Our edge-out services have 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 we were adding new voice
and high speed data connections in the edge-out services. 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 edge-out services as a true edge-
out CLEC by placing the responsibility for managing and operating the edge-
out service markets with the managers of our respective RLECs. This allowed
for additional reductions in operating expenses as we were able to eliminate
a number of redundant operations in the edge-out services. We also focused
on grooming our 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 our edge-out services. Since the fourth
quarter of 2002, operating expenses in our edge-out services 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 a resale agreement with Global Crossing to provide long distance
transmission services. This agreement 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.
We have entered into interconnection agreements with BellSouth, Verizon,
Sprint and SBC which allow, among other things, the edge-out services to
lease unbundled network elements from these ILECs, at contracted rates
contained in the interconnection agreements. We use these network elements
to connect our edge-out services customers with our network. Other
interconnection agreements may be required by our edge-out services. In
addition, the edge-out services currently has the necessary certifications to
operate in the states where it has customers.
Selling, general and administrative expenses
Selling, general and administrative expenses include:
* selling and marketing expenses;
35
* expenses associated with customer care;
* billing and other operating support systems; and
* corporate expenses.
We market our business services through agency relationships and
professional sales people. We market our consumer services primarily through
our professional 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. Our regulated RLEC operations use straight-line rates approved
by the public utility commissions in the states where we have regulated
telephone plant in service. The composite annualized rate of depreciation
for telephone plant and equipment in the regulated operations approximated
7.93%, 7.57% and 6.87% for 2003, 2002, and 2001 respectively. In our
unregulated RLEC operations and in our edge-out services, telephone plant and
equipment is depreciated over lives, determined according to the class of the
asset, ranging from three years to 33 years.
Amortization expense is recognized primarily for our intangible assets
considered to have finite lives on a straight-line basis. In June 2001, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), which
was effective for fiscal years beginning after December 15, 2001. Under the
new rules, goodwill and intangible assets deemed to have indefinite lives are
no longer permitted to be amortized after December 31, 2001, but are subject
to impairment tests at least annually in accordance with the tenets of SFAS
142. Other intangible assets will continue to be amortized over their
estimated useful lives. We adopted the new rules on accounting for goodwill
and other intangible assets beginning in the first quarter of 2002. In 2001
and prior years, goodwill was amortized using the straight-line method over
25 years.
We anticipate that in the next year, most of our capital expenditures
will be directed at maintaining our existing networks and accommodating
growth in demand for our services, primarily from high speed Internet access
services. Our revenues may not increase or even continue at their current
levels, and we may not achieve or maintain our target levels for expenses or
profitability. We may not be able to generate cash from operations in future
periods at the levels we currently project or at all. Our actual future
operating results may differ from our current projections, and those
differences may be material.
Critical Accounting Estimates
Accounting estimates and assumptions discussed in this section are those
that we consider to be the most critical to an understanding of our financial
statements because they inherently involve significant judgments and
uncertainties. In making these estimates, we considered various assumptions
and factors that will differ from the actual results achieved and will need
to be analyzed and adjusted in future periods. These differences may have a
material impact on our financial condition, results of operations or cash
flows.
Allowance for Uncollectible Accounts
We evaluate the collectibility of our accounts receivable using a
combination of estimates and assumptions. 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 the customer's account based on our
estimate of the net realizable value of what we believe can be reasonably
collected. For our other accounts receivable, we estimate the net realizable
value of the accounts 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 review the adequacy of the allowance and our
estimates of the net realizable value.
36
Revenues
We recognize revenues from universal service funding and charges to
interexchange carriers for switched and special access services. In certain
cases, our RLEC subsidiaries participate in revenue sharing arrangements with
other telephone companies, sometimes referred to as pools. 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 estimates we
make regarding our costs to provide services. These estimates are then
subject to adjustment in future accounting periods as actual operating
results become available.
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 the provisions of Statement of Financial Accounting
Standard 142, Goodwill and Other Intangible Assets ("SFAS 142"), we test
goodwill for impairment annually and whenever events or circumstances make it
more likely than not that an impairment may have occurred, such as
significant underperformance by a reporting unit relative to its historical
or its projected future operating results, significant regulatory changes
that would impact the financial condition or future operating results of the
reporting unit or significant adverse industry or economic trends. In
performing our review of goodwill under the terms of SFAS 142, we make
certain estimates regarding the implied fair value of our individual
operating companies where goodwill is recorded. Determining whether an
impairment has occurred requires valuation of the respective reporting unit,
which we estimate using undiscounted cash flows and comparative market
multiples when available and appropriate. In completing our analysis of the
carrying value of goodwill, we rely on a number of factors, including actual
operating results, market data and future business plans.
If our analysis indicates goodwill is impaired, measuring its impairment
requires a fair value estimate of each identified tangible and intangible
asset. In determining an estimate of fair value in the case of an impairment
of goodwill, we would use the best information available, which may include
among other things, quoted market prices, prices for similar assets and
liabilities or present value techniques as allowed under SFAS 142. See Note
1 to the consolidated financial statements for further discussion regarding
goodwill.
We review the carrying value of our long-lived assets, primarily our
fiber network, in accordance with Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
("SFAS 144"), to determine if the carrying value of these assets has been
impaired. Our review on the carrying value of long-lived assets is conducted
on an annual basis or more frequently if events or circumstances indicate
that an impairment may exist. In accordance with the terms of SFAS 144, we
estimate the undiscounted future cash flows to be generated by our long-lived
assets and compare them to the carrying value of the respective assets. If
the carrying value of the fiber network exceeds the undiscounted expected
future cash flows, an impairment exists for the amount by which the carrying
value of the asset exceeds its estimated fair value. Our estimate of the
fair value of the long-lived asset would be made using the best information
available, which may include among other things, quoted market prices, prices
for similar assets and liabilities or present value techniques as allowed
under SFAS 144.
Results of Operations
Year Ended December 31, 2003 compared to Year Ended December 31, 2002
Total revenues for the year ended December 31, 2003 were $186.4 million,
an increase of $2.2 million from $184.2 million for the year ended December
31, 2002. Revenues in the RLEC operations were $172.5 million in 2003, an
increase of $3.6 million, or 2.1%, from revenues of $168.9 million in 2002.
Revenues from Internet and enhanced data services were $2.8 million higher in
2003 than in 2002 as a result of growth in the number of DSL connections.
The RLECs finished 2003 with 24,181 DSL connections in service compared to
16,423 DSL connections in service at the end of 2002, an increase of 7,758
connections or 47.2%. Likewise, long distance revenues in 2003 increased
$1.0 million compared to 2002 due to an increase in the number of long
distance accounts served. At December 31, 2003, the RLECs served 96,586 long
distance accounts, an increase of 5,352 long distance accounts, or 5.9%, from
91,234 accounts served at December 31, 2002. Finally, miscellaneous revenues
increased $1.9 million in 2003 compared to 2002 and is attributed to the
impact on miscellaneous revenues in 2002 from approximately $1.5 million in
bad debts being 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 2003. These increases in RLEC revenues were offset by a
decrease of $2.0 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 receipts, in 2003
compared to 2002. In addition, local service revenues were impacted by the
decrease in voice access lines. At December 31, 2003, the RLECs served
185,903 voice access lines, a decrease of 4,350 voice access lines, or 2.3%,
from 190,253 voice access lines served at December 31, 2002. Revenues in our
edge-out services in 2003 were $13.9 million, a decrease of $1.4 million, or
8.6%, from the prior year revenues of $15.3 million, as a result of a
decrease in the average number of voice and high speed data connections in
service during 2003 compared to 2002. Revenues from voice services, which are
comprised of local, network access and long distance service, as a percentage
of total revenues, were approximately 81.4% and 83.5% for the years ended
December 31, 2003 and 2002, respectively.
Total operating expenses decreased $11.4 million from $155.3 million, or
84.3%, of total revenues in 2002, to $143.9 million, or 77.2%, of total
revenues in 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
37
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 plan 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 was
allocated between our operating subsidiaries who participate in the pension
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 our RLECs and $0.6 million
as a reduction of pension expenses in our edge-out services. Approximately
$3.4 million of the decrease in operating expenses resulted from changes in
restructuring expenses, with the majority of the decrease, or $3.2 million,
in the edge-out services. In 2003, we recognized a benefit of approximately
$0.7 million for adjustments made to restructuring accruals to recognize
differences between actual operating results and our original estimates of
restructuring expenses properly recorded in prior years in accordance with
Emerging Issues Task Force Issue 94-3 ("EITF 94-3"). In 2002, we recorded
restructuring expenses of $2.7 million. The remaining decreases in operating
expenses are attributed to further expense reductions realized primarily in
our edge-out services and to a lesser degree in the RLECs when compared to
the prior year. The benefits from the changes we implemented to our cost
structure in our edge-out services in the fourth quarter of 2001 and the
third quarter of 2002 were fully realized in 2003. In the RLECs, in addition
to the impact of slower growth on our operating expenses, we also realized a
full year of cost reductions in 2003 from the implementation of more cost
efficient methods of managing our business processes in earlier years.
These operating expense reductions were partially offset by certain
higher operating expenses. Our short-term incentive accruals increased $2.5
million in 2003 compared to 2002. In addition, during the fourth quarter of
2003, we accrued a one-time charge of $1.1 million for potential sales tax
liabilities that may be retroactively imposed on the RLECs. We also
recognized $0.9 million in expenses for DSL modems used in the RLEC
operations. Prior to the third quarter of 2003, under the Company's
accounting policies, the cost of DSL modems were capitalized. However,
beginning in the third quarter of 2003, the Company began expensing DSL
modems as their cost fell below the threshold for capitalization.
Cost of services, as a percentage of total revenues, decreased from 30.6%
in 2002 to 26.9% in 2003, and selling, general and administrative expenses,
as a percentage of total revenues, decreased from 26.3% in 2002 to 22.4% in
2003. Depreciation and amortization expenses, as a percentage of total
revenues, increased from 27.5% in 2002 to 27.9% in 2003.
Operating expenses in the RLECs in 2003 were $118.0 million, a decrease
of $1.2 million, or 1.0%, from 2002 operating expenses of $119.2 million.
Cost of services were $41.9 million in 2003, a decrease of $1.6 million, or
3.6%, from $43.5 million in 2002. Selling, general and administrative
expenses decreased $1.1 million, or 2.7%, from $40.4 million in 2002 to $39.3
million in 2003. Restructuring expenses in the RLECs were $0.1 million in
2002 compared to a benefit of $0.1 million in 2003, a change of $0.2 million.
These decreases were offset by an increase of $1.7 million in depreciation
and amortization expenses to $36.9 million in 2003 from $35.2 million in
2002.
In our edge-out services, operating expenses in 2003 were $25.9 million
compared to operating expenses in 2002 of $36.1 million, a decrease of $10.2
million or 28.3%. Cost of services decreased approximately $4.5 million, or
35.4%, to $8.3 million in 2003 from $12.8 million in 2002. Depreciation and
amortization was $15.1 million in 2003 and $15.4 million in 2002, a decrease
of $0.3 million, or 1.7%. Selling, general and administrative expenses
decreased $2.2 million, or 41.2%, to $3.1 million in 2003 from $5.3 million
in 2002. Restructuring expenses in the edge-out services were $2.6 million
in 2002 compared to a benefit of $0.6 million in 2003, a change of $3.2
million.
Net operating income increased approximately $13.6 million, or 47.2%,
from net operating income of $28.9 million, or 15.7% of total revenues in
2002 to net operating income of $42.5 million, or 22.8% of total revenues in
2003. The increase is attributed primarily to the reductions in operating
expenses in the RLECs and edge-out services. Net operating income in the
RLECs increased $4.7 million, or 9.5%, to $54.5 million in 2003 from $49.8
million in 2002. In our edge-out services, our net operating loss improved
$8.9 million, or 42.6%, to a net operating loss of $12.0 million in 2003 from
a net operating loss of $20.9 million in 2002.
Interest expense decreased $1.3 million to $62.7 million, or 33.6% of
total revenues, in 2003 compared to $64.0 million, or 34.7% of total
revenues, in 2002. The decrease in interest expense is primarily attributable
to a lower average balance of long-term debt outstanding and slightly lower
weighted average interest rates during 2003 compared to 2002. The benefit of
this decrease was partially offset by the accrual of $1.4 million in interest
expense related to a potential income tax liability.
For 2003, we had other income, net of approximately $3.6 million compared
to other expenses, net of $2.5 million in 2002, a change of $6.1 million.
Included in other expenses for 2002 is a $4.5 million realized loss for a
decrease in the fair
38
market value of an investment in US Unwired, Inc. common stock that was
deemed to be other than temporary and an impairment charge of $2.1 million
taken against the carrying value of our investment in US Carrier Telecom, LLC
that is accounted for using the equity method. No such comparable charges
were recorded in 2003.
We recorded an income tax benefit of $1.8 million in 2003 compared to
income tax expense of $1.6 million in 2002, a change of $3.4 million. The
change is attributable primarily to the recognition of a $2.7 million in
income tax refunds in 2003 that offset income tax expense. During 2002,
after consultation with our tax advisors, we amended certain prior year
income tax returns that resulted in refunds of approximately $7.8 million.
We received the refunds in 2002 and recorded them as deferred income tax
liabilities. In the third quarter of 2003, the Internal Revenue Service, as
part of an audit, verbally notified us that our position in the amended
income tax returns would be disallowed and in the fourth quarter, we received
formal notice of disallowance. The refunds impacted by this IRS notification
totaled $5.1 million and remain as part of our deferred income tax
liabilities. The remaining $2.7 million was recognized as an income tax
benefit.
Our net loss improved $24.7 million from a net loss of $39.4 million, or
21.4% of total revenues, in 2002, to a net loss of $14.7 million, or 7.9% of
total revenues, in 2003, as a result of the factors discussed above. We
reported net income in our RLEC operations of $24.2 million in 2003 compared
to net income of $8.5 million in 2002, an increase of $15.7 million, or
185.1%. For 2003 and 2002, our edge-out services reported a net loss of
$38.9 million and $47.9 million, respectively, an improvement of $9.0
million, or 18.8%. Our EBITDA increased $21.1 million from $77.1 million, or
41.8% of total revenues, in 2002, to $98.2 million, or 52.7% of total
revenues, in 2003. (See footnote (d) under "Selected Financial and Operating
Data" for a definition of EBITDA and reconciliation of EBITDA to net loss.)
Year Ended December 31, 2002 compared to Year Ended December 31, 2001
Total revenues for the year ended December 31, 2002 were $184.2 million,
a decrease of $0.1 million from $184.3 million for the year ended December
31, 2001. Revenues in the RLECs were $168.9 million in 2002, a decrease of
$2.3 million, or 1.3%, from revenues of $171.3 million in 2001. Revenues
from Internet and enhanced data services were $4.4 million higher in 2002
than in 2001 as a result of growth in the number of DSL connections. The
RLECs finished 2002 with approximately 16,420 DSL connections compared to
approximately 11,140 DSL connections at the end of 2001, an increase of 5,280
connections. The increase in Internet and enhanced data services was offset
by lower local service revenues, which decreased $3.1 million in 2002, and
miscellaneous telecommunications service and equipment revenues, which
decreased $3.2 million in 2002. Local service revenues were unfavorably
impacted by decreases in our voice access lines in service and lower network
access revenues. In addition, we sold two exchanges in Illinois in May 2001
that contributed approximately $1.2 million in revenues in 2001 prior to the
date of their disposal for which no comparable revenues were reported in
2002. Miscellaneous telecommunications service and equipment revenues
decreased primarily as a result of higher bad debt charges being recognized
in 2002 compared to 2001. The most significant bad debt charges were
recognized in connection with the bankruptcies of two interexchange carriers,
MCI WorldCom and Global Crossing. Revenues generated by the edge-out
services in 2002 grew $2.1 million over the prior year, or 16.3%, to $15.3
million, as a result of an increase in the average number of voice and high
speed data connections in service during 2002. Revenues from voice services,
which are comprised of local, network access and long distance service, as a
percentage of total revenues, were approximately 83.5% and 84.9% for the
years ended December 31, 2002 and 2001, respectively.
Total operating expenses decreased $29.0 million from $184.3 million, or
100.0% of total revenues in 2001, to $155.3 million, or 84.3% of total
revenues in 2002. Cost of services, as a percentage of total revenues,
decreased from 37.2% in 2001 to 30.6% in 2002, and selling, general and
administrative expenses, as a percentage of total revenues, decreased from
31.0% in 2001 to 26.3% in 2002. Depreciation and amortization expenses, as a
percentage of total revenues, decreased from 31.7% in 2001 to 27.5% in 2002.
The decrease is attributable to lower operating expenses in both the RLECs
and the edge-out services.
Operating expenses in our RLEC operations in 2002 were $119.2 million, a
decrease of $15.1 million, or 11.3%, from 2001 operating expenses of $134.3
million. The decrease is primarily the result of lower amortization expenses
in 2002 than in 2001. Effective with the adoption of SFAS 142 in the first
quarter of 2002, we were no longer permitted to amortize our goodwill. In
2001, expenses associated with the amortization of goodwill were
approximately $16.5 million in the RLECs for which no comparable amortization
expense was recognized in 2002. In addition, the RLEC's cost of services
were approximately $3.1 million lower in 2002 than 2001 primarily as a result
of expense reduction measures and impact on expenses from the disposal of the
two exchanges in Illinois in the second quarter of 2001. These reductions in
operating expenses in the RLECs were offset by an increase in depreciation
expense and selling, general and administrative expenses. Depreciation
expense increased approximately $3.5 million as a result of a higher average
balance of telephone plant and equipment in service in 2002 than in 2001.
Selling, general and administrative expenses increased $0.9 million in 2002
compared to 2001 due to an increase in non-cash, long-term incentive plan
expenses of $3.8 million. Excluding the
39
impact of these long-term incentive plan expenses, selling, general and
administrative expenses would have decreased $2.9 million in 2002.
For our edge-out services, operating expenses in 2002 were $36.1 million
compared to operating expenses in 2001 of $49.9 million, a decrease of $13.8
million or 27.6%. The decrease in operating expenses reflects the strategy
for the edge-out services to achieve positive cash flow with a slower
targeted growth rate and significant cost reductions as well as the
realignment of its operations under the responsibility of the managers of the
respective RLECs. Cost of services decreased approximately $9.2 million, or
41.8%, primarily as a result of lower personnel costs and circuit expenses.
Selling, general and administrative expenses decreased $9.7 million, or
55.3%, primarily attributed to a smaller sales, marketing and engineering
support function and lower overhead expenses. Operating expenses in the
edge-out services reflect restructuring charges of $2.6 million accrued in
the third quarter of 2002 and $2.8 million accrued in the fourth quarter of
2001.
Net operating income increased approximately $28.9 million from net
operating income of $13,000 to net operating income of $28.9 million, or
15.7% of total revenues in 2002. The increase is primarily attributable to
non-amortization of goodwill and expense reductions realized in both the
RLECs and the edge-out services. Net operating income in the RLECs increased
$13.0 million, or 35.2%, to $49.8 million in 2002 from $36.8 million in 2001.
In our edge-out services, the net operating loss improved $15.9 million, or
43.3%, to a net operating loss of $20.9 million 2002 from a net operating
loss of $36.8 million in 2001.
Interest expense decreased $0.6 million to $64.0 million, or 34.7% of
total revenues, in 2002 compared to $64.6 million, or 35.1% of total
revenues, in 2001. The decrease in interest expense is primarily attributable
to a lower average outstanding balance of long-term debt during 2002 compared
to 2001, partially offset by a higher weighted average interest rate.
For 2002, we had other net expenses of approximately $2.5 million
compared to other net expenses of $14.8 million in 2001, a change of $12.3
million. Included in other expense for 2002 is a $4.0 million realized loss
for a decrease in the fair market value of our investment in US Unwired, Inc.
common stock that was deemed to be other than temporary and an impairment
charge of $2.1 million taken against the carrying value of our investment in
US Carrier Telecom, LLC that is accounted for using the equity method.
Included in other net expenses for 2001 are realized losses on the disposal
of marketable equity securities of approximately $9.5 million and impairment
losses on investments accounted for using the equity method of $8.9 million.
Our net loss improved $35.5 million from a net loss of $74.9 million, or
40.7% of total revenues, in 2001, to a net loss of $39.4 million, or 21.4% of
total revenues, in 2002, as a result of the factors discussed above. The
RLECs reported net income of $8.5 million in 2002 compared to a net loss of
$11.1 million in 2001, an improvement of $19.6 million. For 2002 and 2001,
the edge-out services had a net loss of $47.9 million and $63.9 million,
respectively, an improvement of $16.0 million. Our EBITDA increased $33.4
million from $43.7 million, or 23.7% of total revenues, in 2001, to $77.1
million, or 41.8% of total revenues, in 2002. (See footnote (d) under
"Selected Financial and Operating Data" for a definition of EBITDA and
reconciliation of EBITDA to net loss.)
Liquidity and Capital Resources
We are a holding company with no business operations of our own. 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
interests, we cannot guarantee 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 year ended December 31, 2003, we generated
net cash from operating activities of $43.8 million and for the year ended
December 31, 2002, we generated net cash from operating activities of $32.1
million, an increase of $11.7 million, or 36.3%. In 2003, we continued to
reduce our expenses in both the RLEC operations and the edge-out services
which resulted in a lower use of cash. Operating expenses, excluding non-
cash depreciation and amortization expenses, in 2003 were $91.9 million in
2003 compared to $104.7 million in 2002, a decrease of $12.8 million. For
the year ended December 31, 2002, we generated net cash from operating
activities of $32.1 million and for the year ended December 31, 2001, we used
net cash in our operating activities of $19.8 million, a change in net cash
flows from operating activities of approximately $51.9 million. For 2002,
our net loss before non-cash charges of depreciation, amortization, long-term
incentive plan expenses, realized losses on marketable equity securities and
investment impairment charges and equity losses in unconsolidated
subsidiaries reflect net cash provided of $23.9 million compared to $5.6
million
40
for 2001, an improvement of $18.3 million. In addition, net cash used for
current liabilities in 2002 was approximately $20.8 million lower in 2002
than in 2001. Also, in 2002, we received income tax refunds of approximately
$6.5 million for which no comparable refunds were received in 2001.
Investing Activities. For the year ended December 31, 2003, net cash
used in investing activities was $10.0 million. This consisted primarily of
capital expenditures of $12.2 million and was partially offset by the
redemption of $2.0 million in RTFC subordinated capital certificates. For
the year ended December 31, 2002, net cash used in investing activities was
$10.7 million, primarily due to capital expenditures of $12.3 million. This
was offset by net cash of $0.7 million from redemption of SCCs and a decrease
in other assets of $0.9 million. For the year ended December 31, 2001, we
used $24.0 million in cash for investing activities. Cash used for investing
activities was primarily for the purchase of telephone plant and equipment in
the amount of $39.9 million. This was offset by proceeds from the sale of
telephone plant and equipment of $13.5 million and decreases in other assets
of $2.4 million.
Financing Activities. For the year ended December 31, 2003, net cash
used in financing activities was $25.6 million and is attributed to scheduled
principal payments on long-term debt of $13.6 million, the repayment of $21.0
million outstanding on a line of credit and the redemption of $1.0 million of
a minority interest in Coastal Communications. These uses of cash were
partially offset by the proceeds of a $10.0 million advance on a line of
credit. For the year ended December 31, 2002, net cash used in financing
activities was $23.0 million. The net use of cash for financing activities
is attributed to scheduled principal payments on long-term debt of $20.4
million and the repayment of an outstanding line of credit of $10.0 million.
In addition, during 2002, we redeemed $2.0 million in member's interest and
$1.0 million in minority interest in Coastal Communications and advanced $1.4
million to our managing directors. These uses of cash were offset by the
proceeds of $4.0 million from advances on a line of credit and $7.8 million
from borrowings under a term loan. For the year ended December 31, 2001, net
cash provided by financing activities was $2.0 million. The primary
components of this increase in cash were proceeds from long-term debt of
$17.0 million, offset by repayments on long-term debt of $15.3 million.
At December 31, 2003, we had negative working capital of $193,000
compared to negative working capital of $21.8 million at December 31, 2002,
an improvement of $21.6 million. 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, which is further
described below, and an increase in our cash and cash equivalents of $8.2
million. Under the amendment, we do not make any scheduled principal
payments to the RTFC until the third quarter of 2004. Therefore, our current
portion of long-term debt was $7.0 million at December 31, 2003 compared to
$27.6 million at December 31, 2002, a change of $20.6 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 our
RLECs 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 and fourth quarter
principal payments to the RTFC under the terms of the amendment. These
increases in cash were partially offset by our $11.0 million net reduction in
the amounts outstanding under our secured line of credit with the RTFC.
At December 31, 2003, we had total liquidity of $59.1 million which
consists of cash and cash equivalents of $28.1 million and available
borrowings on our lines of credit with the RTFC of $31.0 million. As a
result of our amendment with the RTFC, our liquidity position has been
enhanced. The reductions in the scheduled principal payments under the
amendment provide us with additional liquidity and greater operating
flexibility during the next several years. In addition, we have remained
focused on implementing operating improvements and efficiencies in our
business processes to reduce our operating expenses and accordingly, our use
of cash to fund our operations.
Off-Balance Sheet Arrangements
As of December 31, 2003, we had no off-balance sheet arrangements as
defined under Regulation S-K 303(a)(4).
41
Material Contractual Cash Obligations
The following table contains a summary of our material contractual cash
obligations as of December 31, 2003:
Cash Payments Due by Period
(amounts in thousands)
Total Year 1 Years 2-3 Years 4-5 Thereafter
----------------------------------------------------------------
Long-term debt
- principal (a) $ 639,289 $ 6,996 $ 28,770 $ 18,770 $ 584,753
Long-term debt
- interest (b) 426,993 59,210 106,239 104,751 156,793
Operating leases (c) 7,626 1,375 1,996 1,289 2,966
Redemption of minority
interest (d) 4,000 1,000 2,000 1,000 -
Other contractual cash
obligations (e) 7,161 3,137 1,768 1,110 1,146
----------------------------------------------------------------
Material contractual
cash obligations $ 1,085,069 $ 71,718 $ 140,773 $ 126,920 $ 745,658
================================================================
(a) Includes scheduled principal repayments per long-term debt agreements.
Amount excludes the unamortized discount of $2,076 on our senior notes.
Our long-term debt is discussed further below and in Note 6 to our
consolidated financial statements.
(b) Includes estimates of interest expense on long-term debt amounts
currently outstanding based on scheduled principal repayments and
certain interest rate assumptions for our various tranches of long-term
debt. Our long-term debt is discussed further below and in Note 6 to
our consolidated financial statements.
(c) Amount is shown net of estimated sublease income from current subleases.
(d) See Note 13 to our consolidated financial statements.
(e) Includes miscellaneous other commitments represented by contracts or
other agreements requiring scheduled cash outlays in future periods.
Amounts presented are on an undiscounted basis and include, among other
things, maintenance agreements, service agreements, professional fees
and employment agreements.
Long-Term Debt and Revolving Credit Facilities
We or our subsidiaries have outstanding term and revolving credit
facilities totaling $436.6 million with the RTFC, which were entered into in
connection with our four RLEC acquisitions. In addition, we have outstanding
$200.0 million in 13 1/4% senior notes that are due in March 2010, a $2.3
million mortgage note payable on property acquired in the Coastal
Communications acquisition and a $0.4 million miscellaneous note payable.
The $2.3 million mortgage note payable was repaid in full in January 2004.
RTFC Debt Facilities
Our subsidiary, Madison River LTD Funding Corp., or MRLTDF, is the
borrower under a loan agreement with the RTFC. MRLTDF is the holding company
for three of our RLECs: Mebtel, Gulf Coast Services and Coastal
Communications. Our fourth RLEC, Gallatin River Holdings, LLC, or GRH, has
provided a guaranty to the RTFC and its operating assets and revenues are
subject to a first mortgage lien in favor of the RTFC.
As of December 31, 2003, MRLTDF 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 7.7%. 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 interest
rate on a term loan to remain variable or to choose a fixed rate as is then
available and in effect for similar loans for any portion or all of the
principal amount then outstanding on the term loan, provided the RTFC offers
a fixed rate. The remaining $11.7 million term loan has a variable interest
rate of 5.2% at December 31, 2003.
In July 2003, MRLTDF executed an amendment to its loan agreement with the
RTFC which, among other things, allows greater operating flexibility through
an increase in our available liquidity. Under the terms of the amendment,
our loan agreement was extended to November 2016. The amendment also provided
us with a reduction in scheduled principal payments through 2011 with the
first scheduled principal payment occurring in the third quarter of 2004. We
continue to pay quarterly interest payments to the RTFC. We also may be
required to make annual prepayments of principal based on our financial
results. Annually, beginning in 2005, we will calculate excess cash flow as
defined in the amendment using the preceding year's financial results. If
the calculation indicates excess cash flow, we will make a mandatory
prepayment equivalent to the amount of excess cash flow to reduce the
principal outstanding to the RTFC. The payment will be required to be made
in the second quarter of the year in which the calculation is made.
Under the terms of the amendment, interest rates on our 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 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
42
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 covenants were added or revised under the amendment
and we will continue to test our compliance with our financial ratios, as
defined in the amendment, on an annual basis. Included in our covenants,
among others, are requirements that we obtain RTFC approval of a forward-
looking, three-year capital expenditure budget on an annual basis and obtain
RTFC consent before completing 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.
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 RLECs. In addition, substantially all of the outstanding equity
interests of the RLECs 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 Madison River Holdings, the parent of MRLTDF or MRH, Mebtel Long
Distance Solutions, Inc., or MLDS, and Madison River Long Distance Solutions,
Inc, or 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 RLECs. In addition, as provided for in the amendment, in the event
that the senior notes are retired, we will grant the RTFC a first mortgage
lien on the operating assets and revenues of Madison River Communications,
LLC.
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 December 31, 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
December 31, 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 which is
currently a fifteen year 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 at MRLTDF 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 5.15% at
December 31, 2003. We had advanced $10.0 million against this line of credit
at December 31, 2003, and the remaining $21.0 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. We intend to negotiate the extension of these lines of
credit with the RTFC during 2004.
As discussed above, the terms of the RTFC loan agreement, as amended,
contains various financial and administrative covenants including ratios that
are tested on an annual basis. The ratios are tested against the combined
financial results of MRLTDF and its subsidiaries, GRH, MRLDS and MLDS. In
addition, among other things, these combined entities are restricted in their
ability to: (i) declare or pay dividends to their respective parents, under
specified circumstances, (ii) limited in their 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. As a result of these provisions of
the loan agreement, as amended, any cash generated by MRLTDF and its
subsidiaries, GRH, MRLDS or MLDS and any amounts available under the line of
credit facilities discussed above may only be available to those
43
entities and not to us or our other subsidiaries to fund our obligations. At
December 31, 2003, MRLTDF was in compliance with the terms of its loan
agreement, as amended, with the RTFC.
Senior Notes
Madison River Capital is the issuer of $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 SEC and are subject to the terms and conditions
of an indenture. At December 31, 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, Madison River Capital and its
restricted subsidiaries must comply with certain financial and administrative
covenants. Among other things, Madison River Capital and its restricted
subsidiaries are limited in their ability to: (i) incur additional
indebtedness, (ii) pay dividends or make other distributions to Madison River
Telephone or others holding an equity interest in a restricted subsidiary,
(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 or (vii)
enter into transactions with affiliates. At December 31, 2003, Madison River
Capital was in compliance with the terms of its senior notes indenture.
Other Long-Term Debt
Our other indebtedness includes a $2.3 million note payable to the former
Coastal shareholders for the purchase of land and a building used in our
operations. The note, secured by the land and building, was repaid in full
in January 2004.
In addition, Madison River Capital also has 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
2004 will be approximately $13.0 million. For the year ended December 31,
2003, our capital expenditures were approximately $12.2 million. Our use of
cash for capital expenditures in 2003 and 2002 was significantly less than we
have 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, 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 2004 will be
directed toward maintaining our existing facilities. Second, we have
experienced slower growth in recent quarters for our RLEC operations
including losses in the number of voice access lines we serve. In addition,
we have not expanded our edge-out services into any new markets, nor do we
have any current intentions to expand into new markets, and our existing
edge-out operations have not demonstrated any growth as part of our business
plan to generate sustainable cash flow. Therefore, there is minimal demand
currently to expand our telephone plant or network facilities. During 2004,
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
44
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.
As part of the consideration paid in the Coastal Communications, Inc. ("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.
During 2002, after consultation with our tax advisors, we amended certain
prior year income tax returns that resulted in refunds to the Company of
approximately $7.8 million. We received the refunds in 2002 and recorded
them as deferred income tax liabilities. In the third quarter of 2003, the
Internal Revenue Service, as part of an audit, verbally notified us that our
position taken in the amended tax returns would be disallowed and in the
fourth quarter, we received formal notice of disallowance. The refunds
impacted by this IRS notification totaled $5.1 million. The remaining $2.7
million was recognized as an income tax benefit in the fourth quarter of
2003. Based on discussions with our tax advisors, we believe that our
position is appropriate under current tax laws and we intend to defend the
position taken in our amended income tax returns. In the third quarter of
2003, in accordance with Financial Accounting Standard No. 5, the Company
accrued interest expense of $1.3 million to recognize a contingent liability
meeting the criteria for accrual for interest expense on the disputed
refunds. The Company accrued an additional $0.1 million in interest expense
in the fourth quarter of 2003. The Company anticipates that interest
expense related to this liability will be approximately $0.4 million annually
until the issue is resolved. At this time, we cannot assure you that we will
prevail in our defense of our position taken in the amended income tax
returns. If we are not successful, we may be required to repay the amounts
received for refunds plus accrued interest. We believe this matter may take
up to two years to resolve.
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
be required to fund this obligation of our parent company.
Based on our business plan, we currently project that cash and cash
equivalents on hand, available borrowings under our credit facilities and our
cash flow from operations will be adequate to meet our foreseeable
operational liquidity needs, including funding our negative working capital
position, 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 edge-out
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 credit or other borrowing
agreements that restrict the payment of dividends or making 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
45
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.
Recent Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Accounting
Standards 145, Rescission of FASB Statements No. 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 4. Extraordinary treatment will be
required for certain extinguishments as provided in APB 30. SFAS 145 also
amends Statement 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 is
effective for all fiscal years beginning after May 15, 2002 and was adopted
by us 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)", requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF Issue 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, or VIEs, and to determine when and which business enterprise should
consolidate the VIE as the "primary beneficiary". This new consolidation
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. We have
not obtained an interest in any VIE's since January 31, 2003. We have
determined that an unconsolidated company in which we hold an investment 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 $0.4 million and we have recognized expenses of
$0.2 million for services provided by the VIE to us in the year ended
December 31, 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 December 31, 2003. According to FASB Interpretation No. 46 (revised
December 2003), entities shall apply the Interpretation only to special-
purpose entities subject to the Interpretation no later than December 31,
2003 and all other entities no later than March 31, 2004. Special-purpose
entities are defined as any entity whose activities are primarily related to
securitizations or other forms of asset-backed financings or single-lessee
leasing arrangements. Given that we have no significant variable interests in
special-purpose entities, the Interpretation is effective March 31, 2004.
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 its mezzanine level presentation between liabilities and equity to
current and long-term liabilities. Beyond the reclassification of redeemable
minority interest, the adoption of SFAS 150 did not have a material impact on
our results of operations, financial position or cash flows.
46
Item 7A. 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 agreement
and 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.
Our long term secured debt facilities with the RTFC mature in 2016. As of
December 31, 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 term loans expire
beginning October 2004 through August 2006. 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 interest rate on a term loan to remain variable or to choose a
fixed rate as is then available and in effect for similar loans for any
portion or all of the principal amount then outstanding on the term loan,
provided the RTFC offers a fixed rate. In addition, we have two
miscellaneous notes that total $2.7 million at December 31, 2003 with each
bearing fixed rate interest at 8.0%. One of these two miscellaneous notes,
totaling $2.3 million at December 31, 2003, was repaid in January 2004. 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 $10.0 million under
a secured line of credit with the RTFC that bear variable interest rates
approximating a blended average rate of 5.2%. A one percent change in the
underlying interest rates for the variable rate debt would have an immaterial
impact of less than $225,000 per year on interest expense. Accordingly, we
are subject to only minimal interest rate risk on our long-term debt while
our fixed rates are in place.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements begin on page F-1 of this Form 10-K.
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to
ensure that information required to be disclosed in our annual and periodic
reports filed with the SEC is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms. These
disclosure controls and procedures are further designed to ensure that such
information is accumulated and communicated to our management, including our
Chairman and Chief Executive Officer and our Chief Financial Officer, to
allow timely decisions regarding required disclosure.
As required by Rule 13a-15(b) under the Exchange Act, under the direction
of our CEO and CFO, we evaluated the design and operation of our disclosure
controls and procedures including a review of the controls' objectives and
design, the controls' implementation by the company and the effect of the
controls on the information generated for use in this Form 10-K. In the
course of the evaluation, we sought to identify data errors, control problems
or acts of fraud and to confirm that appropriate corrective action, including
process improvements, were being undertaken if necessary. Our disclosure
controls and procedures are also evaluated on an ongoing basis by the
following:
* personnel in our finance organization;
* members of our internal certification committee;
* members of the audit committee of the Company's Board of Directors; and
* our independent auditors in connection with their audit and review
activities.
Among other matters, we sought in our evaluation to determine whether
there were any "significant deficiencies" or "material weaknesses" in our
disclosure controls and procedures, or whether we had identified any acts of
fraud involving personnel who have a significant role in our disclosure
controls and procedures. In the professional auditing literature,
"significant deficiencies" are referred to as "reportable conditions," which
are control issues that could have a significant adverse effect on the
ability to record, process, summarize and report financial data in the
financial statements. A "material weakness" is defined in the auditing
literature as a particularly serious reportable condition where the internal
control does
47
not reduce to a relatively low level the risk that misstatements caused by
error or fraud may occur in amounts that would be material in relation to the
financial statements and not be detected within a timely period by employees
in the normal course of performing their assigned functions.
The Company's management, including the CEO and CFO, does not expect that
our disclosure controls and procedures will prevent all error and all fraud.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of disclosure controls and procedures must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under
all potential future conditions. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
and not be detected.
Based on the evaluation, the CEO and CFO concluded that our disclosure
controls and procedures are effective as of December 31, 2003 to ensure that
material information relating to us and our consolidated subsidiaries is made
known to management, including the CEO and CFO, particularly during the
period when our periodic reports are being prepared, and that our disclosure
controls and procedures are effective to provide reasonable assurance that
our financial statements are fairly presented in conformity with GAAP.
Changes in Internal Control Over Financial Reporting
There have been no changes in the internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that have occurred during the quarter ended December 31, 2003
that have materially affected, or are reasonably likely to materially affect,
such internal control over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant
Board of Managers and Executive Officers
We are a wholly-owned subsidiary and are managed by our sole member,
MRTC. The Board of Managers of MRTC and, accordingly, our Board of Managers,
consist of the following nine individuals at March 15, 2004: J. Stephen
Vanderwoude, Chairman, Paul H. Sunu, James N. Perry, Jr., Michael P. Cole,
Sanjeev K. Mehra, Joseph P. DiSabato, Mark A. Pelson and Richard A. May. At
present, all managers, other than Richard A. May, who is an independently
elected member, are appointed by certain groups that comprise the members of
MRTC. The members holding a majority of MRTC's member units, which include
affiliates of Madison Dearborn Partners, affiliates of Goldman Sachs and
affiliates of Providence Equity Partners, are each entitled to appoint up to
two individuals to the Board of Managers. The members holding a majority of
the member units held by management personnel subject to employment
agreements are entitled to appoint up to three individuals to the Board of
Managers, at least two of whom must be investors in MRTC and members of
management. In the event that an appointed Manager ceases to serve as a
member of the Board of Managers, the resulting vacancy on the Board of
Managers must be filled by a person appointed by the members that appointed
the withdrawn Manager.
We currently have an audit committee consisting of Richard A. May,
Michael P. Cole and Mark A. Pelson, none of whom are officers or employees of
our Company or any of our operating subsidiaries. The Board of Managers has
not determined that any of these individuals are "audit committee financial
experts" as such term is defined in Item 401(h)(2) of Regulation S-K. The
Board of Managers has identified one individual as a nominee to the Board of
Managers that is qualified to be an "audit committee financial expert" and,
we expect that concurrent with his election to the Board of Managers, he
would agree to serve in that role.
48
The following table sets forth certain information regarding the members of
MRTC's and our Board of Managers as well as executive officers and other key
officers of Madison River Capital and its operating subsidiaries at March 15,
2004:
Name Age Position
- ---------------------- --- -----------------------------------------------------------------
J. Stephen Vanderwoude 60 Managing Director - Chairman and Chief Executive Officer; Member
of Board of Managers
Paul H. Sunu 47 Managing Director - Chief Financial Officer and Secretary; Member
of Board of Managers
James D. Ogg 64 Managing Director
Kenneth Amburn 61 Managing Director - Chief Operating Officer
Bruce J. Becker 57 Managing Director - Chief Technology Officer
Michael T. Skrivan 49 Managing Director - Revenues
Michael P. Cole 31 Member of Board of Managers
Joseph P. DiSabato 37 Member of Board of Managers
Richard A. May 59 Member of Board of Managers
Sanjeev K. Mehra 45 Member of Board of Managers
Mark A. Pelson 41 Member of Board of Managers
James N. Perry, Jr. 43 Member of Board of Managers
The following sets forth certain biographical information with respect to
the members of our Board of Managers and our executive officers:
Mr. J. Stephen Vanderwoude, a founding member of MRTC in 1996, serves as
Managing Director - Chairman and Chief Executive Officer of MRTC. Mr.
Vanderwoude is also Chairman and Chief Executive Officer of MRCL. He has
over 35 years of telecommunications experience including serving as President
and Chief Operating Officer and a Director of Centel Corporation and
President and Chief Operating Officer of the Local Telecommunications
division of Sprint Corporation. He is currently a director of Centennial
Communications and First Midwest Bancorp.
Mr. Paul H. Sunu, a founding member of MRTC in 1996, serves as Managing
Director - Chief Financial Officer and Secretary of MRTC and MRCL. Mr. Sunu
is a certified public accountant and a member of the Illinois Bar with 22
years of experience in finance, tax, treasury, securities and law.
Mr. James D. Ogg, a founding member of MRTC in 1996, serves as a
Managing Director of MRTC and MRCL. Mr. Ogg has over 45 years of
telecommunications experience including serving as President of Centel-
Illinois and Vice President and General Manager of Centel-Virginia and
Centel-North Carolina. Mr. Ogg has also served as Vice President-Strategic
Pricing and Vice President for Governmental Relations for Centel Corporation.
In this capacity, Mr. Ogg managed Centel's Washington, D.C. office and was
responsible for advocacy of corporate policy on telecommunications, cable and
electric businesses before Congress and federal regulatory agencies. Mr. Ogg
has successfully testified in or managed 17 rate cases and brings extensive
experience in dealing with federal and state regulatory processes.
Mr. Kenneth W. Amburn serves as a Managing Director - Chief Operating
Officer of MRTC and MRCL and joined Madison River in 1998. Mr. Amburn has
over 37 years of telecommunications experience including service as Vice
President - Operations for Centel-Texas where he had oversight for operations
involving over 280,000 access lines and for customer services, network
maintenance, construction and overall business operations for Texas. Mr.
Amburn has also served as Vice President, East Region Telecommunications for
Citizens Utilities where he was responsible for establishing the operations
and completing the transition of 1,400 employees to Citizens Utilities in
connection with a 500,000 access line purchase from GTE.
Mr. Bruce J. Becker serves as Managing Director - Chief Technology
Officer of MRTC and MRCL and joined Madison River in 1999. From 1997 to 1998,
Mr. Becker founded and served as President of BTC Partners LTD., a
telecommunications consulting firm providing services to an array of CLECs,
ILECs, CATV providers, telecommunications and data transport equipment
manufacturers and investment groups. He has over 39 years of
telecommunications experience and has served as the Senior Vice President of
Operations and Planning for ICG Telecommunications, Chief Information Officer
for ICG's Telecommunications Group and Vice President of Strategic and
Technical Planning for Centel Corporation. Mr. Becker has also served as a
voting director of the T1 Committee, a director on the UNLV School of
Engineering Board, a senior member of Northern Telecom's technical advisory
board, an active member of USTA and has testified as an expert witness at the
state and federal level on numerous rate and technology proceedings and
inquiries.
49
Mr. Michael T. Skrivan serves as Managing Director - Revenues for MRTC
and MRCL and joined Madison River in 1999. He is a certified public
accountant and a certified management accountant with 24 years of experience
in the telecommunications industry. Prior to joining MRTC, Mr. Skrivan was a
founding member in the consulting firm of Harris, Skrivan & Associates, LLC,
which provides regulatory and financial services to local exchange carriers
from 1995 to 1999. Mr. Skrivan is a member of the Telecom Policy Committee
of the United States Telecom Association.
Mr. Michael P. Cole is a director of Madison Dearborn Partners LLC
focusing on investments in the media and communications industries since
1997. Mr. Cole is currently a member of the board of directors of Omne
Holdings, Ltd., Star Technology Group Limited and the Chicago Entrepreneurial
Center within the Chicagoland Chamber of Commerce.
Mr. Joseph P. DiSabato is a member of the Board of Managers and a
Managing Director of Goldman, Sachs & Co. in the Merchant Banking Division
where he has been employed since 1994. Mr. DiSabato serves on the Board of
Directors of Amscan Holdings, Inc., P.N.Y. Technologies, Inc., TBG
Information Investors, L.L.C., and several privately held companies on behalf
of Goldman Sachs.
Mr. Richard A. May is a member of the Board of Managers. Mr. May is
also the Chairman and CEO of Great Lakes REIT, a position he has held since
he co-founded the real estate investment trust in 1992.
Mr. Sanjeev K. Mehra is a member of the Board of Managers and a Managing
Director in Goldman Sachs' Merchant Banking Division since 1996. Mr. Mehra
serves on the boards of Adam Aircraft Industries, Inc., Burger King Holdings,
L.L.C., Amscan Holdings, Inc., Hexcel Corporation Nalco Company, North
American Railnet, Inc., TBG Information Investors, L.L.C. and on the boards
of several portfolio companies. He is a member of the Principal Investment
Area's Investment Committee.
Mr. Mark A. Pelson is a member of the Board of Managers and a Managing
Director of Providence Equity Partners where he has been employed since 1996.
Mr. Pelson is currently also a director of Consolidated Communications, Inc.,
Global Metro Networks, Language Line Services and W2N Holdings.
Mr. James N. Perry, Jr. is a member of the Board of Managers and a
Managing Director and co-founder of Madison Dearborn Partners. Mr. Perry
concentrates on investments in the communications industry and currently also
serves on the boards of directors of Allegiance Telecom, Inc., Band-x,
Cbeyond Communications, Focal Communications Corporation, Nextel Partners and
XM Satellite Radio Inc.
Code of Ethics
We have adopted a written code of ethics that is recertified annually by
our Chief Executive Officer, our Chief Financial Officer, our Controller and
other key managers of the Company in accordance with Section 406 of the
Sarbanes-Oxley Act of 2002 and the rules of the SEC promulgated thereunder.
Our code of ethics, called the Madison River Telephone Company, LLC Code of
Conduct, is available on the investor relations page of our corporate website
at www.madisonriver.net. In the event that we make changes in, or provide
waivers from, the provisions of this code of ethics, we intend to disclose
these events on our corporate website.
Item 11. Executive Compensation
The following table sets forth certain information regarding the cash and
non-cash compensation paid to the Chief Executive Officer and to each of our
four most highly compensated executive officers other than the Chief
Executive Officer, whose combined salary and bonus exceeded $100,000 during
the fiscal years ended December 31, 2003, 2002 and 2001 (collectively, the
"Named Executive Officers"). The managers of Madison River Capital do not
receive any compensation for serving on the Board of Managers. J. Stephen
Vanderwoude, our current CEO, participated in deliberations of our Board of
Managers concerning executive officer compensation during fiscal year 2003,
other than such deliberations concerning his own compensation.
50
Summary Compensation Table
Long-term
Compensation
Name Annual Compensation Awards
- ---- ----------------------------------------------- ------------
Securities
Underlying
Other Annual Unit Option All Other
Year Salary Bonus Compensation (1) Grants Compensation (2)
---- --------- --------- ---------------- ----------- ----------------
J. Stephen Vanderwoude 2003 $ 284,275 $ 380,000 $ 1,800 - $ 6,209
(Chairman and CEO) 2002 285,425 250,000 1,817 - 5,500
2001 195,720 240,000 1,625 - 5,100
Paul H. Sunu 2003 224,498 510,524 2,520 - 6,000
(Chief Financial Officer 2002 225,111 198,398 1,817 - 5,500
and Secretary) 2001 199,050 140,000 875 - 5,100
Kenneth W. Amburn 2003 180,000 88,000 - - 6,322
(Chief Operating Officer) 2002 180,000 70,000 - - 6,514
2001 179,616 66,000 - - 6,255
Bruce J. Becker 2003 180,000 111,657 - - -
(Chief Technology Officer) 2002 180,000 58,398 - - -
2001 179,616 60,000 - - 798
Michael T. Skrivan 2003 180,000 88,000 - - 6,000
(Managing Director
- Revenues) 2002 160,000 60,000 - - 5,500
2001 160,000 44,000 - - 5,100
(1) Other annual compensation consists of an auto allowance.
(2) Includes matching contributions for the 401(k) savings plan and group
term life insurance premiums paid on behalf of certain officers.
401(k) Savings Plans
In 1998, we established a 401(k) savings plan covering substantially all
of our employees, except for employees of Gulf Telephone Company that have
their own 401(k) savings plan, that meet certain age and employment criteria.
Pursuant to the plan, eligible employees may elect to reduce their current
compensation up to certain dollar amounts that do not exceed legislated
maximums. We have agreed to contribute an amount equal to 50% of employee
contributions for the first 6% of compensation contributed on behalf of all
participants. We made matching contributions to this plan of approximately
$606,000, $687,000 and $859,000 in 2003, 2002 and 2001, respectively. The
401(k) plan is intended to qualify under Section 401 of the Internal Revenue
Code of 1986, as amended, so that contributions by employees or by us to the
plan, and income earned on plan contributions, are not taxable to employees
until withdrawn and our contributions are deductible by us when made.
Long-Term Incentive Plan
In 1998, we adopted a long-term incentive plan arrangement which provides
for annual incentive awards for certain employees as approved by the Board of
Managers. Under the terms of the plan, annual awards are expensed over the
succeeding 12 months after the award is determined. The incentive awards vest
automatically at the time of a qualified event as defined under the plan. No
incentive awards are vested at this time. Vested awards are payable under
certain circumstances as defined under the long-term incentive plan
arrangement. We recognized compensation expense of $5,429,000, $5,284,000 and
$1,271,000 in the years ended December 31, 2003, 2002 and 2001, respectively,
related to the long-term incentive awards.
Pension Plan
In May 1998, we adopted a noncontributory defined benefit pension plan, which
was transferred to us from our subsidiary, Mebtel, Inc. The plan covers all
full-time employees, except employees of Gulf Coast Services, who have met
certain age and service requirements and provides benefits based upon the
participants' final average compensation and years of service. Further
accrual of benefits under the pension plan were frozen effective February 28,
2003. We have a continued obligation to fund the plan and our policy is to
comply with the funding requirements of the Employee Retirement Income
Security Act of 1974, as amended.
51
Employment Agreements
Madison River Telephone has entered into employment agreements with
Messrs. Vanderwoude, Sunu, Ogg, Becker, Amburn and Skrivan. The agreements
provide for employment of each executive except Mr. Ogg through December 31,
2005. Mr. Ogg's agreement runs through December 31, 2004. The agreements
are subject to termination by either party (with or without cause) at any
time subject to applicable notice provisions. If the executive's employment
is terminated by Madison River Telephone other than for cause, or due to his
death or disability, or the executive terminates his employment for good
reason, the executive is entitled to receive his continued base salary for
six months after the date of termination, plus his bonus on a pro rata basis.
The executive will also be entitled to receive a cash lump sum equal to any
compensation payments deferred by the executive and any unpaid amounts in
respect of any bonus for the fiscal year prior to the year of termination.
In some instances, these payments could total in excess of $100,000. The
agreements provide that the executives may not disclose any confidential
information while employed by Madison River Telephone or thereafter. The
agreements also provide that the executive will not compete with Madison
River Telephone during their employment or for a period of up to a maximum of
15 months following termination of employment. Additionally, the agreements
prohibit the executives for a period of 15 months from soliciting for
employment any person who at any time during the executive's employment was
an employee of Madison River Telephone. Under the agreements, Madison River
Telephone is obligated to indemnify the executives for all expenses,
liabilities and losses reasonably incurred by them in connection with their
employment. On December 31, 2003, Mr. Sunu's employment agreement was
amended to, among other things, increase the amount of bonus payable to Mr.
Sunu. Such bonuses are payable annually on December 31 beginning in 2003 and
continuing through 2007, provided Mr. Sunu remains employed by Madison River
Telephone on the date of payment for each such annual bonus.
Item 12. Security Ownership of Certain Beneficial Owners and Management
All of our outstanding member units are owned by MRTC. The following
table sets forth certain information regarding the beneficial ownership of
MRTC's member units as of March 15, 2004 by (A) each holder known by MRTC to
beneficially own five percent or more of such member units, (B) each Manager
and named executive officer of MRTC and (C) all executive officers and
managers as a group. Beneficial ownership is determined in accordance with
the rules of the SEC and generally includes voting or investment power with
respect to securities. Options or warrants to purchase member units that are
currently exercisable or exercisable within 60 days of March 15, 2004 are
deemed to be outstanding and to be beneficially owned by the person holding
such options or warrants for the purpose of computing the percentage
ownership of such person but are not treated as outstanding for the purpose
of computing the percentage ownership of any other person.
Number of Class A
Units, Warrants or
Options Held by Percentage
Name Member of Units
- ---- ------------------ ----------
J. Stephen Vanderwoude 5,454,696.70 (1) 2.36%
Paul H. Sunu 1,198,684.24 (1) *
Bruce J. Becker 421,710.68 (1) *
Kenneth Amburn - -
Michael T. Skrivan - -
Madison Dearborn Partners group (2) 85,962,015.42 37.22%
Goldman Sachs group (3) 71,635,012.69 31.01%
Providence Equity Partners group (4) 47,279,108.13 20.47%
Daniel M. Bryant (5) 12,000,000.00 5.20%
G. Allan Bryant (6) 12,000,000.00 5.20%
All executive officers and managers
as a group (12 persons) 212,970,875.32 92.21%
* Represents less than one percent (1%).
52
(1) Excludes the following incentive interests granted to management. The
units granted to the named executive officers below vest over time while
the units granted to the Madison River Long Term Incentive Plan contain
vesting provisions which are contingent upon the occurrence of certain
liquidity events, including the sale of the company or an initial public
offering:
Class B Units Class C Units
------------- -------------
J. Stephen Vanderwoude 3,000 1,550 (a)
Paul H. Sunu 1,000 1,150
Bruce J. Becker - 770
Madison River Long Term
Incentive Plan 3,835 -
Madison River Long Term
Incentive Stock Plan - 5,067
(a) Includes 1,200 units that the named executive officer gifted in
trust to his three adult children for which the named executive
officer disclaims beneficial ownership.
(2) Includes 392,610 units which Madison Dearborn Capital Partners, L.P. has
the right to acquire upon conversion of existing indebtedness and
76,569,405.42 units held by Madison Dearborn Capital Partners II, L.P.;
8,711,355.10 units held by Madison Dearborn Capital Partners III, L.P.;
193,429.77 units held by Madison Dearborn Special Equity III, L.P.;
75,000.00 units held by Madison Dearborn Special Advisors Fund I, LLC;
and 20,215.13 units held by Madison Dearborn Special Co-Invest Partners
I.
(3) Includes 44,945,863.44 units held by GS Capital Partners II, L.P.;
1,657,820.36 units held by GSCPII Germany Mad River Holding, L.P.;
17,867,826.82 units held by GSCPII Offshore Mad River Holding, L.P.;
2,341,390.43 units held by Bridge Street Fund 1997, L.P.; and
4,822,111.85 units held by Stone Street Fund 1997, L.P.
(4) Includes 46,628,924.50 units held by Providence Equity Partners, L.P.
and 650,183.63 units held by Providence Equity Partners II L.P.
(5) Includes 6,000,000 units held by Daniel M. Bryant and 6,000,000 units
held by The Michael E. Bryant Life Trust of which Daniel M. Bryant is a
trustee. Daniel M. Bryant disclaims beneficial ownership of the units
held by The Michael E. Bryant Life Trust.
(6) Includes 6,000,000 units held by G. Allan Bryant and 6,000,000 units
held by The Michael E. Bryant Life Trust of which G. Allan Bryant is a
trustee. G. Allan Bryant disclaims beneficial ownership of the units
held by The Michael E. Bryant Life Trust.
Item 13. Certain Relationships and Related Transactions
On April 10, 2002, MRTC announced the completion of an agreement with the
former shareholders of Coastal Utilities, Inc., which, among other things,
modified certain provisions of the CCI shareholders agreement that was
entered into when CCI acquired Coastal Utilities in March 2000. Under the
terms of the agreement, the former shareholders exchanged all of their Series
B stock and 40% of their Series A stock in CCI for 18.0 million Class A units
in MRTC valued at $1 per unit and three term notes issued by MRTC, in the
aggregate principal amount of $20.0 million, payable over eight years and
bearing interest at approximately 8.4%. In addition, CCI redeemed 30 shares
of Series A stock 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.
On January 4, 2002, ORVS Madison River sold its interest in MRTC, which
consisted of 5,550,253.16 Class A units at December 31, 2001, to certain
members of management and to MRTC for approximately $1.21 to $1.23 per unit.
MRTC repurchased 1,632,427.40 of the Class A units and retired them. Members
of management purchasing Class A units from ORVS Madison River were J.
Stephen Vanderwoude (2,489,450.97 units), James D. Ogg (544,142.74 units),
Paul H. Sunu (462,521.37 units) and Bruce J. Becker (421,710.68 units). To
finance a portion of their purchase of Class A units from ORVS Madison River,
Mr. Sunu, Mr. Ogg and Mr. Becker each borrowed $466.7 thousand, or a total of
$1.4 million, from Madison River Capital. The loans, payable on demand, bear
interest at 5% and are secured by the respective individual's Class A
interests purchased. As of March 15, 2004, $1.4 million remained outstanding
under these loans.
Mr. Sunu and Mr. Ogg also each have loans outstanding that are payable to
MRTC. The proceeds of these loans were used to purchase 250,000.00 Class A
units in MRTC. The loans, payable on demand, bear interest at 5% and are
secured by the respective individual's Class A interests. Pursuant to an
amendment to Mr. Sunu's employment agreement dated December 31, 2003, Mr.
Sunu received an additional bonus in 2003 that was applied to the outstanding
principal and accrued interest on his loans used to purchase Class A units in
MRTC. Accordingly, in 2003, Mr. Sunu's additional bonus was used to repay
$153.1 thousand of the outstanding balance due to MRTC. Mr. Sunu will
receive an additional bonus in each of the next four years with the proceeds
used to repay the remaining balances outstanding on his notes to MRTC and
Madison River Capital. As of March 15, 2004, Mr. Sunu and Mr. Ogg had
outstanding loan amounts of $145.5 thousand and $299.8 thousand on the loans
payable to MRTC, respectively.
53
Item 14. Principal Accountant Fees and Services
Fees Paid to the Independent Auditor
The following table sets forth the aggregate fees (including expenses)
for professional services provided by our independent public accounting firm,
Ernst & Young LLP, for the audit of our annual financial statements for the
years ended December 31, 2003 and 2002 and other services rendered by Ernst &
Young LLP during those periods:
December 31, December 31,
2003 2002
------------ ------------
(amounts in thousands)
Audit fees (1) $ 645 $ 469
Audit-related fees (2) 89 158
Tax fees (3) 379 767
All other fees (4) - -
--------- ---------
Total $ 1,113 $ 1,394
========= =========
(1) Audit fees are fees we paid Ernst & Young for professional services for
the audit of our consolidated financial statements included in the Form
10-K and review procedures carried out on our quarterly Form 10-Qs
(2) Audit-related fees are fees for assurance and related services that are
reasonably related to the performance of the audit or review of our
financial statements including audits of employee benefit plans and [X].
(3) Tax fees are fees for tax compliance, tax advice and tax planning.
These fees related primarily to the preparation of our income tax
returns and tax consulting services.
(4) All other fees include aggregate fees for services other than services
included in audit fees, audit-related fees and tax fees. Ernst & Young
did not bill any fees that would be categorized as all other fees during
either of the years ended December 31, 2003 or 2002.
Pre-Approval Policies and Procedures of the Audit Committee
Our audit committee has adopted a policy regarding the review and pre-
approval of all audit, audit-related, tax and other non-audit services
provided by Ernst & Young above a de minimus amount. Fees for approval are
based upon quotes for the services plus estimated related administrative and
out-of-pocket expenses. The audit committee may delegate pre-approval
authority to one or more of its members. The member to whom such authority
is delegated must report, for informational purposes, any pre-approval
decisions to the audit committee at its next scheduled meeting.
During 2003, 100% of Ernst & Young's fees billed for audit services,
audit-related services and tax services were approved by our audit committee.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following consolidated financial statements of Madison River
Capital, LLC and report of independent auditors are included in the F
pages of this Form 10-K:
Report of independent auditors.
Consolidated balance sheets as of December 31, 2003 and 2002.
Consolidated statements of operations and comprehensive loss for the
years ended December 31, 2003, 2002 and 2001.
Consolidated statements of member's capital for the years ended
December 31, 2003, 2002 and 2001.
Consolidated statements of cash flows for the years ended December
31, 2003, 2002 and 2001.
Notes to consolidated financial statements.
54
(a)(2) The following financial statement schedules are filed as part of this
report on pages F-31 to F-34 and incorporated into this Item 15(a) by
reference:
Schedule I - Condensed Financial Information of Registrant; and
Schedule II - Valuation and Qualifying Accounts.
All other schedules for which provision is made in the applicable
accounting regulations of the SEC either have been included in our
consolidated financial statements or the notes thereto, are not required
under the related instructions or are inapplicable, and therefore have been
omitted.
(a)(3) Exhibits are either provided with this Form 10-K or are incorporated
herein by reference:
The information called for by this item is incorporated herein by
reference to the Exhibit Index on pages I-1 to I-3 of this Form 10-K.
(b) Reports on Form 8-K.
On October 30, 2003, we filed a Current Report on Form 8-K dated
October 30, 2003 announcing our third quarter and nine-month
operating and financial results for the period ended September 30,
2003.
On November 20, 2003, we filed a Current Report on Form 8-K dated
November 20, 2003 containing a presentation made on November 20, 2003
by Paul H. Sunu, Chief Financial Officer of Madison River Capital,
LLC, at the CSFB High Yield Media and Telecom Conference in New York,
New York.
Supplemental Information to be Furnished with Reports Filed Pursuant to
Section 15(d) of the Act by Registrants Which Have not Registered Securities
Pursuant to Section 12 of the Act
No annual reports covering fiscal year 2003 nor proxy materials with respect
to any annual or other meeting of security holders were sent to security
holders.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
MADISON RIVER CAPITAL, LLC
By: /s/J. STEPHEN VANDERWOUDE
------------------------------------
J. Stephen Vanderwoude
Managing Director, Chairman and
Chief Executive Officer
Date: March 30, 2004
----------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of March 30, 2004.
By: /s/ J. STEPHEN VANDERWOUDE
----------------------------------
J. Stephen Vanderwoude
Managing Director, Chairman and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ PAUL H. SUNU
----------------------------------
Paul H. Sunu
Managing Director, Chief Financial Officer
and Secretary
(Principal Financial Officer)
By: /s/ JOHN T. HOGSHIRE
----------------------------------
John T. Hogshire
Vice President-Controller
(Principal Accounting Officer)
56
/s/ MICHAEL P. COLE
----------------------------------
Michael P. Cole
Manager
/s/ JOSEPH P. DISABATO
----------------------------------
Joseph P. DiSabato
Manager
/s/ RICHARD A. MAY
----------------------------------
Richard A. May
Manager
/s/ SANJEEV K. MEHRA
----------------------------------
Sanjeev K. Mehra
Manager
/s/ MARK A. PELSON
----------------------------------
Mark A. Pelson
Manager
/s/ JAMES N. PERRY, JR.
----------------------------------
James N. Perry, Jr.
Manager
57
Madison River Capital, LLC
Consolidated Financial Statements
As of December 31, 2003 and 2002 and
for the Three Year Period Ended December 31, 2003
Index to Consolidated Financial Statements
Report of Independent Auditors ......................................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets ........................................ F-3
Consolidated Statements of Operations and Comprehensive Loss ....... F-5
Consolidated Statements of Member's Capital ........................ F-6
Consolidated Statements of Cash Flows .............................. F-7
Notes to Consolidated Financial Statements ......................... F-8
Schedule I - Condensed Financial Information of Registrant ............. F-31
Schedule II - Valuation and Qualifying Accounts ........................ F-34
F-1
Report of Independent Auditors
Member
Madison River Capital, LLC
We have audited the accompanying consolidated balance sheets of Madison River
Capital, LLC as of December 31, 2003 and 2002, and the related consolidated
statements of operations and comprehensive loss, member's capital, and cash
flows for each of the three years in the period ended December 31, 2003. Our
audits also included the financial statement schedules listed in the index on
page F-1. These financial statements and schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Madison River
Capital, LLC at December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/ ERNST & YOUNG LLP
Raleigh, North Carolina
February 6, 2004 (except for Note 16, as to which
the date is February 27, 2004)
F-2
Madison River Capital, LLC
Consolidated Balance Sheets
(in thousands)
December 31
2003 2002
---------------------
Assets
Current assets:
Cash and cash equivalents $ 28,143 $ 19,954
Accounts receivable, less allowance for uncollectible
accounts of $ 1,723 and $2,792 in 2003 and 2002,
respectively 10,797 12,971
Receivables, primarily from interexchange carriers, less
allowance for uncollectible accounts of $2,075 and $1,693
in 2003 and 2002, respectively 5,732 7,796
Inventories 1,327 1,039
Rural Telephone Finance Cooperative stock to be redeemed 1,354 2,039
Rural Telephone Finance Cooperative patronage capital receivable 2,976 2,766
Deferred income taxes 915 1,300
Other current assets 1,631 1,745
-------- --------
Total current assets 52,875 49,610
-------- --------
Telephone plant and equipment:
Land, buildings and general equipment 53,652 58,144
Central office equipment 157,572 155,350
Poles, wires, cables and conduit 230,772 225,932
Leasehold improvements 2,533 2,533
Software 18,600 16,893
Construction-in-progress 9,133 13,077
-------- --------
472,262 471,929
Accumulated depreciation and amortization (150,727) (112,564)
-------- --------
Telephone plant and equipment, net 321,535 359,365
-------- --------
Other assets:
Rural Telephone Bank stock, at cost 10,079 10,078
Rural Telephone Finance Cooperative stock, at cost 42,659 44,013
Goodwill, net of accumulated amortization of $41,259 366,332 366,332
Other assets 13,662 15,373
-------- --------
Total other assets 432,732 435,796
-------- --------
Total assets $ 807,142 $ 844,771
======== ========
See accompanying notes.
F-3
Madison River Capital, LLC
Consolidated Balance Sheets, Continued
(in thousands)
December 31
2003 2002
---------------------
Liabilities and member's capital
Current liabilities:
Accounts payable $ 920 $ 1,551
Accrued expenses 38,978 35,810
Advance billings and customer deposits 5,155 5,349
Other current liabilities 1,019 1,061
Current portion of long-term debt 6,996 27,613
-------- --------
Total current liabilities 53,068 71,384
-------- --------
Noncurrent liabilities:
Long-term debt 630,217 633,955
Deferred income taxes 45,481 49,945
Other liabilities 38,888 31,997
-------- --------
Total noncurrent liabilities 714,586 715,897
-------- --------
Total liabilities 767,654 787,281
Member's capital:
Member's interest 251,284 251,284
Accumulated deficit (208,308) (193,639)
Accumulated other comprehensive loss (3,488) (155)
-------- --------
Total member's capital 39,488 57,490
-------- --------
Total liabilities and member's capital $ 807,142 $ 844,771
======== ========
See accompanying notes.
F-4
Madison River Capital, LLC
Consolidated Statements of Operations and Comprehensive Loss
(in thousands)
December 31
2003 2002 2001
---------------------------------
Operating revenues:
Local service $ 126,975 $ 128,985 $ 132,108
Long distance service 15,754 14,787 15,144
Internet and enhanced data service 16,252 13,497 9,051
Edge-out services 13,947 15,265 13,126
Miscellaneous telecommunications service
and equipment 13,532 11,667 14,834
-------- -------- --------
Total operating revenues 186,460 184,201 184,263
-------- -------- --------
Operating expenses:
Cost of services 50,214 56,298 68,512
Depreciation and amortization 52,054 50,649 58,471
Selling, general and administrative expenses 42,402 45,673 54,488
Restructuring charge (718) 2,694 2,779
-------- -------- --------
Total operating expenses 143,952 155,314 184,250
-------- -------- --------
Net operating income 42,508 28,887 13
Interest expense (62,649) (63,960) (64,624)
Other income (expense):
Net realized losses on marketable equity securities (343) (3,985) (9,452)
Impairment charges on investments in
unconsolidated subsidiaries - (2,098) (8,940)
Other income, net 3,969 3,597 3,579
-------- -------- --------
Loss before income taxes and minority
interest expense (16,515) (37,559) (79,424)
Income tax benefit (expense) 1,846 (1,584) 5,570
-------- -------- --------
Loss before minority interest expense (14,669) (39,143) (73,854)
Minority interest expense - (275) (1,075)
-------- -------- --------
Net loss (14,669) (39,418) (74,929)
Other comprehensive income (loss):
Minimum pension liability adjustment (3,488) - -
Unrealized (losses) gains on marketable
equity securities:
Unrealized holding losses arising during the
year, net of tax (188) (4,170) (1,351)
Reclassification adjustment for realized
losses included in net loss, net of tax 343 3,985 6,042
-------- -------- --------
Other comprehensive (loss) income (3,333) (185) 4,691
-------- -------- --------
Comprehensive loss $ (18,002) $ (39,603) $ (70,238)
======== ======== ========
See accompanying notes.
F-5
Madison River Capital, LLC
Consolidated Statements of Member's Capital
(in thousands)
Accumulated
Other
Member's Accumulated Comprehensive
Interest Deficit Income (Loss) Total
-------- ------------ ------------- -----
Balance at December 31, 2000 $ 213,054 $ (79,292) $ (4,661) $ 129,101
Member's capital contribution 530 - - 530
Net loss - (74,929) - (74,929)
Other comprehensive income:
Unrealized gains on marketable
equity securities:
Unrealized holding gains
arising during the year - - (1,351) (1,351)
Reclassification adjustment
for realized losses
included in net loss - - 6,042 6,042
-------- -------- -------- --------
Balance at December 31, 2001 213,584 (154,221) 30 59,393
Member's capital redemption (2,000) - - (2,000)
Advances to managing directors
(see Note 15) (1,400) - - (1,400)
Exchange of minority interest
(see Note 14) 41,100 - - 41,100
Net loss - (39,418) - (39,418)
Other comprehensive loss:
Unrealized losses on marketable
equity securities:
Unrealized holding losses
arising during the year - - (4,170) (4,170)
Reclassification adjustment
for realized losses
included in net loss - - 3,985 3,985
-------- -------- -------- --------
Balance at December 31, 2002 251,284 (193,639) (155) 57,490
Net loss - (14,669) - (14,669)
Other comprehensive loss:
Minimum pension liability
adjustment - - (3,488) (3,488)
Unrealized losses on marketable
equity securities:
Unrealized holding losses
arising during the year - - (188) (188)
Reclassification adjustment
for realized losses
included in net loss - - 343 343
-------- -------- -------- --------
Balance at December 31, 2003 $ 251,284 $(208,308) $ (3,488) $ 39,488
======== ======== ======== ========
See accompanying notes.
F-6
Madison River Capital, LLC
Consolidated Statements of Cash Flows
(in thousands)
December 31
2003 2002 2001
---------------------------------
Operating activities
Net loss $ (14,669) $ (39,418) $ (74,929)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation 50,391 47,400 39,766
Amortization 1,663 3,249 18,705
Gain on sale of telephone plant and equipment - - (1,210)
Writedown of telephone plant and equipment - 689 -
Deferred long-term compensation 5,429 5,284 1,271
Deferred income taxes (4,117) 6,771 (4,585)
Writedown of investments carried on equity method - 2,098 8,940
Equity losses in investments carried on equity method 193 1,240 2,366
Realized losses on marketable equity securities 343 3,985 9,452
Amortization of debt discount 206 180 158
Minority interest expense - 275 1,075
Rural Telephone Finance Cooperative patronage capital (899) (829) (1,101)
Changes in operating assets and liabilities:
Accounts receivable 2,174 1,958 734
Receivables, primarily from interexchange carriers 2,064 1,031 759
Income tax recoverable 405 (187) 136
Inventories (289) 91 1,210
Other current assets (438) 734 3,183
Accounts payable (631) 393 (5,044)
Accrued expenses 3,168 (4,139) (20,099)
Advance billings and customer deposits (194) 963 (517)
Other liabilities (1,030) 324 (40)
-------- -------- --------
Net cash provided by (used in) operating activities 43,769 32,092 (19,770)
Investing activities
Proceeds from sale of telephone plant and equipment - - 13,547
Purchases of telephone plant and equipment (12,223) (12,344) (39,936)
Redemption of Rural Telephone Finance Cooperative stock, net 2,039 746 -
Decrease in other assets 165 884 2,376
-------- -------- --------
Net cash used in investing activities (10,019) (10,714) (24,013)
Financing activities
Capital contributions from members - - 530
Redemption of member's interest - (2,000) -
Advances to managing directors - (1,400) -
Redemption of minority interest (1,000) (1,000) -
Proceeds from long-term debt 10,000 11,778 17,000
Payments on long-term debt (34,561) (30,408) (15,254)
Decrease in other long-term liabilities - - (297)
-------- -------- --------
Net cash (used in) provided by financing activities (25,561) (23,030) 1,979
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 8,189 (1,652) (41,804)
Cash and cash equivalents at beginning of year 19,954 21,606 63,410
-------- -------- --------
Cash and cash equivalents at end of year $ 28,143 $ 19,954 $ 21,606
======== ======== ========
Supplemental disclosures of cash flow information
Cash paid for interest $ 60,667 $ 63,073 $ 64,172
======== ======== ========
Cash paid for income taxes $ 1,544 $ 1,661 $ 4,055
======== ======== ========
Supplemental disclosure of a non-cash transaction
Redemption of minority interest for member's
interest (see Note 13) $ - $ 41,100 $ -
======== ======== ========
See accompanying notes.
F-7
Madison River Capital, LLC
Notes to Financial Statements
December 31, 2003
(amounts in thousands, except for operating and share data)
1. Summary of Significant Accounting Policies
Description of Business
Madison River Capital, LLC (the "Company"), a wholly-owned subsidiary of
Madison River Telephone Company LLC (the "Parent"), 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 offers a variety of
telecommunications services to business and residential customers in the
Southeast and Midwest regions of the United States including local and long
distance voice, high speed data, Internet access and fiber transport.
The primary purpose for which the Company was founded was the
acquisition, integration and operation of rural local exchange telephone
companies ("RLECs"). Since January 1998, the Company has acquired four RLECs
located in North Carolina, Illinois, Alabama and Georgia. These RLECs served
approximately 210,100 voice access and DSL connections as of December 31,
2003.
The Company's RLECs also manage and operate edge-out competitive local
exchange carrier ("CLEC") businesses in markets in North Carolina, Illinois
and Louisiana, as well as providing fiber transport services to other
businesses, primarily in the Southeast. These operations are referred to as
Edge-Out Services, or EOS. The EOS markets were developed in close
proximity, or edged-out, from the RLEC operations by utilizing a broad range
of experienced and efficient resources provided by the RLECs. At December
31, 2003, the EOS operations served approximately 15,140 voice access and
high speed data connections.
Basis of Presentation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly-owned and majority-owned subsidiaries as
follows:
* Gallatin River Holdings, LLC and its subsidiary ("GRH"), a wholly-owned
subsidiary
* Madison River Communications, LLC and its subsidiary ("MRC"), a wholly-
owned subsidiary
* Madison River Holdings Corp. ("MRH"), a wholly-owned subsidiary
* Madison River LTD Funding Corp. ("MRLTDF"), a wholly-owned subsidiary
* Mebtel, Inc. ("Mebtel"), a wholly-owned subsidiary
* Gulf Coast Services, Inc. and its subsidiaries ("GCSI"), a
wholly-owned subsidiary
* Coastal Communications, Inc. and its subsidiaries ("CCI"), a
majority-owned subsidiary
* Madison River Management, LLC ("MRM"), a wholly-owned subsidiary
* Madison River Long Distance Solutions, Inc. ("MRLDS"), a wholly-owned
subsidiary
* Mebtel Long Distance Solutions, Inc. ("MLDS"), a wholly-owned
subsidiary
All material intercompany accounts and transactions have been eliminated
in the consolidated financial statements. The minority interest expense
reflected periodic accretions in the carrying value of a minority interest in
CCI to reflect contractual call amounts payable by CCI if it elected to
redeem the minority interest subject to the terms of a shareholders
agreement. The shareholders agreement was amended in 2002 and the periodic
accretions were no longer necessary as discussed in Note 13.
F-8
Madison River Capital, LLC
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Reclassifications
In certain instances, amounts previously reported in the 2002 and 2001
consolidated financial statements have been reclassified to conform with the
2003 consolidated financial statement presentation. Such reclassifications
had no effect on net loss or member's capital as previously reported.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
the accompanying notes. Actual results could differ from those estimates.
Regulatory Assets and Liabilities
The Company's rural ILECs are regulated entities and, therefore, are
subject to the provisions of Statement of Financial Accounting Standards No.
71, "Accounting for the Effects of Certain Types of Regulation" ("SFAS 71").
Accordingly, the Company records certain assets and liabilities that result
from the economic effects of rate regulation, which would not be recorded
under generally accepted accounting principles for nonregulated entities.
These assets and liabilities relate primarily to regulatory impact of the
rate-making process on accounts receivable, accounts payable and fixed
assets.
Telephone plant and equipment used in the RLEC operations has been
depreciated using the straight-line method over lives approved by regulators.
Such depreciable lives have generally exceeded the depreciable lives used by
nonregulated entities. In addition, certain costs and obligations are
deferred based upon approvals received from regulators to permit recovery of
such amounts in future years. The Company's operations that are not subject
to regulation by state and federal regulators are not accounted for under the
guidelines of SFAS 71.
Statement of Financial Accounting Standards No. 101, "Regulated
Enterprises Accounting for the Discontinuance of Application of FASB
Statement No. 71" ("SFAS 101"), specifies the accounting required when an
enterprise ceases to meet the criteria for application of SFAS 71. SFAS 101
requires the elimination of the effects of any actions of regulators that
have been recognized as assets and liabilities in accordance with SFAS 71 but
would not have been recognized as assets and liabilities by enterprises in
general, along with an adjustment of certain accumulated depreciation
accounts to reflect the difference between recorded depreciation and the
amount of depreciation that would have been recorded had the Company's
telephone operations not been subject to rate regulation.
The ongoing applicability of SFAS 71 to the Company's regulated telephone
operations is being monitored due to the changing regulatory, competitive and
legislative environments, and it is possible that changes in these areas or
in the demand for regulated services or products could result in the
Company's telephone operations no longer being subject to SFAS 71 in the
future. If the regulated operations of the Company no longer qualify for the
application of SFAS 71, the net adjustments required by SFAS 101 could result
in a material, noncash charge against earnings.
Cash Equivalents
It is the Company's policy to consider highly liquid investments with a
maturity of three months or less at the date of purchase to be cash
equivalents.
Inventories
Inventories are comprised primarily of poles, wires and telephone
equipment and are stated at the lower of cost (average cost) or market.
F-9
Madison River Capital, LLC
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Allowance for Uncollectible Accounts
The Company evaluates the collectibility of its accounts receivable based
on a combination of factors. In circumstances where the Company is aware of a
specific customer's inability to meet its financial obligations to it, such
as a bankruptcy filing or substantial down-grading of credit scores, the
Company records a specific allowance against amounts due from the customer to
reduce the net recognized receivable to the amount reasonably believed to be
collectible. For other customer receivables, the Company reserves a
percentage of the remaining outstanding accounts receivable as a general
allowance based on a review of specific customer balances, the Company's
trends and experience with prior receivables, the current economic
environment and the length of time the receivables have been outstanding or
are past due. As circumstances change, the Company reviews the adequacy of
the allowance and the assumptions used in calculating the allowance.
Telephone Plant and Equipment
Telephone plant and equipment is stated at cost, which for certain assets
may include labor and direct costs associated with the installation of those
assets.
Maintenance, repairs and minor renewals are expensed as incurred.
Additions, renewals and betterments are capitalized to telephone plant and
equipment accounts. For the regulated RLEC operations, except for certain
assets defined by the Federal Communications Commission, including artwork,
land, and switching equipment sold with traffic, which are accounted for with
corresponding gain or loss, the original cost of depreciable property retired
is removed from telephone plant and equipment accounts and charged to
accumulated depreciation, which is credited with the salvage value less
removal cost. Under this method, no gain or loss is recognized on ordinary
retirements of depreciable property. For retirements of telephone plant and
equipment in the Company's unregulated operations, the original cost and
accumulated depreciation are removed from the accounts and the corresponding
gain or loss is included in the results of operations.
Depreciation is provided using the straight-line method over the
estimated useful lives of the respective assets. The regulated RLEC
operations use straight-line rates approved by regulators. The composite
annualized rate of depreciation for telephone plant and equipment in the
regulated operations approximated 7.93%, 7.57% and 6.87% for 2003, 2002 and
2001, respectively. In the unregulated operations, telephone plant and
equipment is depreciated over lives, determined according to the class of the
asset, ranging from three years to 33 years.
Investments in Unconsolidated Companies
At December 31, 2003 and 2002, a subsidiary of the Company, CCI, held an
investment in US Carrier Telecom, LLC, an unconsolidated company that was
accounted for using the equity method of accounting which reflects the
Company's share of income or loss of the investee, reduced by distributions
received and increased by contributions made. The Company's share of losses
in US Carrier was $193, $550 and $806 for the years ended December 31, 2003,
2002 and 2001, respectively. In addition, during 2002 and 2001, the Company
recognized an impairment charge of $2,098 and $1,000, respectively, for a
decline in the fair value of US Carrier deemed to be other than temporary.
The Company's carrying value for this investment was $300 and $336 at
December 31, 2003 and 2002, respectively.
CCI also had an investment in Georgia PCS Management, L.L.C., an
unconsolidated company also accounted for using the equity method of
accounting. The Company's interest in Georgia PCS was acquired by US
Unwired, Inc. in March 2002 for approximately 786,000 shares of common stock
in US Unwired, Inc. The Company also exercised options it held for
additional units in Georgia PCS and received approximately 20,000 additional
shares of US Unwired, Inc. common stock. In 2002 and 2001, the Company's
share of losses in this investment was $690 and $1,560, respectively, and in
2001, the Company recognized an impairment charge of $7,940 for a decline in
the fair value of Georgia PCS deemed to be other than temporary.
F-10
Madison River Capital, LLC
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Revenues
Revenues are recognized when the corresponding services are provided.
Services billed in advance are recorded as deferred revenues. 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 that are billed in
arrears, are accrued and recognized in the period 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. The Company's RLEC
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 the Company's estimates. These
estimates are then subject to adjustment in future accounting periods as
actual 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 the Company.
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.
Income Taxes
The Company and its wholly-owned subsidiaries, MRC, GRH and MRM for a
partial year, are limited liability corporations and are treated as
partnerships for federal and state income tax purposes. Accordingly, income,
losses and credits are passed through directly to the members of these
partnerships. Effective November 29, 2003, MRM converted from being a C
corporation to a limited liability corporation for income tax purposes.
MRH, a wholly-owned subsidiary of the Company, is a holding company for
the Company's other taxable C corporations that include, MRLTDF, Mebtel,
GCSI, CCI, MLDS, MRLDS, and MRM, for a partial year as noted above. Income
taxes for the C corporations are accounted for using the liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. Deferred tax assets are reduced by a
valuation allowance to the extent that it is unlikely that the asset will be
realized.
Allocation of Distributions
Distributions to its member, if any, are allocated in accordance with the
terms outlined in the Company's Operating Agreement subject to conditions of
its senior note indenture.
Goodwill
Goodwill represents the excess of the purchase price of our acquisitions
over the fair value of the net assets acquired. In June 2001, the Financial
Accounting Standards Board issued Statements of Financial Accounting
Standards No. 141, "Business Combinations", and No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill and intangible assets
deemed to have indefinite lives are no longer permitted to be amortized after
December 31, 2001 but are subject to annual impairment tests in accordance
with the statements. Other intangible assets continue to be amortized over
their useful lives. The Company adopted the new rules on accounting for
goodwill and other intangible assets beginning in the first quarter of 2002.
F-11
Madison River Capital, LLC
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Goodwill (continued)
The Company determined that the goodwill related to its acquisitions, net
of accumulated amortization, was not impaired as of January 1, 2002, the date
of adoption of SFAS 142. During the fourth quarter of 2003 and 2002, the
Company again performed the required annual impairment tests in accordance
SFAS 142 with no determination of impairment. However, if an impairment of
the carrying value of goodwill is indicated by the tests performed in
accordance with SFAS 142, then a corresponding charge will be recorded as
part of operating expenses on the statement of operations.
During the third quarter of 2002, the Company elected to decommission a
switch and remove it from service. Net goodwill associated with the switch
of $868, which represented the excess of the purchase price paid for the
switch over its fair market value at the date of purchase, was deemed to be
impaired and was charged to amortization expense in accordance with SFAS 142.
During the fourth quarter of 2002, the Company decreased goodwill by $526
for the reversal of certain deferred income taxes established in connection
with the allocation of the purchase price for its acquisition of Coastal
Utilities.
In 2001 and prior years, the Company's goodwill was amortized using the
straight-line method over 25 years. For the year ended December 31, 2001, had
the Company been subject to the provisions of SFAS 142, net loss would have
been reported as follows (in thousands):
Goodwill
amortization
As reported expense Pro forma
----------- ------------ ---------
Net loss $ (74,929) $ 16,533 $ (58,396)
======== ======= ========
Concentration of Credit Risk
The Company's principal financial instruments subject to potential
concentration of credit risk are accounts receivable which are unsecured. The
Company provides an allowance for uncollectible receivables based on an
analysis of the likelihood of collection of outstanding amounts.
Impairment of Long-Lived Assets
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 supersedes Statement
of Financial Accounting Standards No. 121 and establishes a single accounting
model for long-lived assets to be disposed of by sale as well as resolves
certain implementation issues related to SFAS 121. The Company adopted SFAS
144 as of January 1, 2002. Adoption of SFAS 144 did not have a material
impact on the financial position, net loss or cash flows of the Company.
In accordance with the provisions of SFAS 144, the Company reviews long-
lived assets and certain identifiable intangibles for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of the assets to future
undiscounted net cash flows expected to be generated by the assets. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets.
Comprehensive Income (Loss)
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," requires that total comprehensive income (loss) be
disclosed with equal prominence as the Company's net loss. Comprehensive
income (loss) is defined as changes in member's capital exclusive of
transactions with owners such as capital contributions and distributions.
For 2003, 2002 and 2001, the Company had comprehensive income (loss), net of
income taxes, of $155, ($185) and $4,691, respectively, from unrealized gains
and losses on marketable equity securities available for sale. In addition,
in 2003, the Company recognized other comprehensive loss for an adjustment to
its minimum pension liability of ($3,488).
F-12
Madison River Capital, LLC
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Accounting
Standards 145, Rescission of FASB Statements No. 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 4. Extraordinary treatment will be
required for certain extinguishments as provided in APB 30. SFAS 145 also
amends Statement 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 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 superseded 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)", requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF Issue 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 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, or VIEs, and to determine when and which business enterprise should
consolidate the VIE as the "primary beneficiary". This new consolidation
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. The
Company has not obtained an interest in any VIE's since January 31, 2003.
The Company determined that an unconsolidated company in which it holds an
investment 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 $0.4
million and it has recognized expenses of $0.2 million for services provided
by the VIE to it in the year ended December 31, 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 December 31, 2003. According to
FASB Interpretation No. 46 (revised December 2003), entities shall apply the
Interpretation only to special-purpose entities subject to the Interpretation
no later than December 31, 2003 and all other entities no later than March
31, 2004. Special-purpose entities are defined as any entity whose activities
are primarily related to securitizations or other forms of asset-backed
financings or single-lessee leasing arrangements. Given that we have no
significant variable interests in special-purpose entities, the
Interpretation is effective March 31, 2004.
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 may have been 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 on its balance sheet from its mezzanine level presentation between
liabilities and equity to current and long-term 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.
F-13
Madison River Capital, LLC
Notes to Financial Statements (continued)
2. Rural Telephone Bank Stock
The Company's investment in Rural Telephone Bank ("RTB") stock is carried
at cost and consists of 26,478 shares of $1,000 par value Class C stock at
December 31, 2003. At December 31, 2002, the Company's investment in RTB
consisted of 26,477 shares of $1,000 par value Class C stock and 223 shares
of $1 par value Class B stock. During 2003, the Company purchased an
additional 777 shares of Class B stock and exchanged the 1,000 Class B shares
it held for one Class C share. For 2003, 2002 and 2001, the Company received
cash dividends from the RTB of $1,112, $1,112 and $1,413, respectively which
are included in other income in the consolidated statements of operations.
3. Rural Telephone Finance Cooperative Equity
The Company's investment in Rural Telephone Finance Cooperative ("RTFC")
stock is carried at cost and consists of Subordinated Capital Certificates
("SCCs") acquired as a condition of obtaining long-term financing from the
RTFC. The SCCs are redeemed for cash by the RTFC proportionately as the
principal of the long-term financing is repaid to the RTFC. In 2003 and
2002, the Company received $2,039 and $1,524, respectively, from the
redemption of SCCs.
In addition, as a cooperative, the RTFC allocates its net margins to
borrowers on a pro rata basis based on each borrower's patronage ownership in
the RTFC. Therefore, the Company receives an annual patronage capital
allocation from the RTFC that it records at cost. As determined by the
RTFC's board of directors, a percentage of the patronage capital allocations
are retired with cash in the following year with the remainder being
distributed in the form of patronage capital certificates that will be
retired for cash on a scheduled 15-year cycle or as determined by the RTFC's
board of directors. For 2003, the Company's allocation of patronage capital
from the RTFC was $2,976 of which $2,083 was retired with cash in January
2004 and $893 received in patronage capital certificates. For 2002, the
Company received an allocation of patronage capital from the RTFC of $2,789
of which $1,952 was retired with cash in January 2003 and $837 received in
patronage capital certificates. For 2001, the Company's allocation of
patronage capital was $3,671 of which $2,570 was retired with cash in January
2002 and $1,101 received in patronage capital certificates. At December 31,
2003 and 2002, the Company had $4,485 and $3,592, respectively, in patronage
capital certificates related to these allocations.
4. Available for Sale Equity Securities
In March 2002, Georgia PCS Management, L.L.C., a limited liability
company in which the Company owned approximately 15% of the outstanding
member interests and accounted for as an equity method investment, was
acquired by US Unwired, Inc., a publicly traded Sprint PCS affiliate. In
exchange for its ownership interest in Georgia PCS, the Company received
approximately 806,000 shares of US Unwired, Inc. Class A common stock. The
Company recorded the common stock in other assets at its fair market value of
$4,565 at the date of the exchange. At that date, approximately 151,000
shares were being held in escrow pending the completion of certain provisions
of the acquisition agreement. In addition, the remaining shares were subject
to certain restrictions that prevented the Company from selling or otherwise
disposing of the shares for a specified period of time. As the restrictions
elapsed periodically, specified percentages of the shares were released and
available for disposal by the Company. The final restrictions elapsed March
27, 2003.
The Company accounted for the common stock in US Unwired, Inc. as
available for sale marketable equity securities in accordance with Statement
of Financial Accounting Standard No. 115, Accounting for Certain Investments
in Debt and Equity Securities ("SFAS 115"). Accordingly, the common stock
was carried at its estimated fair value based on current market quotes with
changes in the fair market value reflected as other comprehensive income or
loss. During 2002, the Company deemed that a decline in the fair market
value of the common stock from the date of the exchange was other than a
temporary decline and, accordingly, recognized a realized loss of $4,015 in
the carrying value. At December 31, 2002, the fair value of the common stock
was $395.
During 2003, the Company sold approximately 655,000 shares of US Unwired,
Inc. common stock for approximately $182 and recorded a realized loss, net of
income tax benefits, of $262. In addition, as a result of certain purchase
price adjustments made under the acquisition agreement, the shares held in
escrow were retained by US Unwired, Inc. and the Company recognized a
realized loss, net of income tax benefits, for these shares of $106.
F-14
Madison River Capital, LLC
Notes to Financial Statements (continued)
4. Available for Sale Equity Securities (continued)
In 2003, the Company received and disposed of a miscellaneous investment
in a marketable equity security for proceeds of $25 and recognized a realized
gain of $25 on the disposal.
At December 31, 2001, the Company had an investment in a miscellaneous
marketable equity security with a fair value of $30. The Company disposed of
this investment during 2002 for a realized gain of $30.
As part of the acquisition of Coastal Utilities, Inc., the Company
acquired a marketable equity security investment in Illuminet, Inc. that was
classified as available for sale in accordance with SFAS 115. During January
2001, the Company sold the remaining shares of this investment for
approximately $6,331 and realized a loss, net of income tax benefits, of
$5,333.
5. Restructuring Charges
In the third quarter of 2002, in completing the development of the EOS as
true edge-out CLEC operations, the Company realigned each of the EOS's
operating regions in North Carolina, Illinois and New Orleans under the
Company's RLECs in those respective regions. The RLECs assumed
responsibility for managing and directing the EOS operations in those
regions. Correspondingly, the Company recognized a restructuring charge of
$2,808 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 $2,677
million and MRM recognized $131. The charge was recognized in accordance
with EITF 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)." The amounts recorded consisted
primarily of the costs associated with future obligations on non-cancelable
leases for certain facilities, net of estimated sublease income, losses from
the abandonment of fixed assets and leasehold improvements associated with
those leased facilities, the expense associated with decommissioning a
switch, expenses associated with the elimination of thirty employees and
related expenses. During the third and fourth quarter of 2003, the Company
adjusted certain accruals that were included in the initial restructuring
charge to recognize actual results of the realignment and to reflect changes
in its estimates related to future periods. In addition, approximately $387
of the restructuring charge related to the decommissioning of a switch was
reversed as the Company later elected to redeploy certain elements of the
switch elsewhere in its operation. As a result of these adjustments, the
Company recognized a benefit of $718 in its restructuring expenses during
2003. Substantially all of the payments charged against this restructuring
accrual in 2003 related to payments made under lease agreements. As of
December 31, 2003, the following amounts were recorded in connection with the
restructuring charge:
Balance at 2003 2003 Balance at
December 31, 2002 payments adjustments December 31, 2003
----------------- -------- ----------- -----------------
Future lease obligations $ 1,345 $ (974) $ (100) $ 271
Telephone plant and equipment 158 - (158) -
Employee separation expenses 77 (4) (73) -
------- ------- ------- -------
$ 1,580 $ (978) $ (331) $ 271
======= ======= ======= =======
In the fourth quarter of 2001, MRC recorded a $2,779 restructuring charge
associated with MRC'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 December 31, 2003, the following amounts were recorded in connection
with this restructuring charge:
Balance at 2003 Balance at
December 31, 2002 payments December 31, 2003
----------------- -------- -----------------
Future lease obligations $ 788 $ (246) $ 542
Legal related expenses 31 - 31
------- ------- -------
$ 819 $ (246) $ 573
======= ======= =======
The remaining liability for these two restructuring accruals as of
December 31, 2003 is recorded as $307 in accrued expenses and $537 in other
long-term liabilities.
F-15
Madison River Capital, LLC
Notes to Financial Statements (continued)
6. Long-Term Debt and Lines of Credit
Long-term debt and lines of credit outstanding consist of the following
at:
December 31
2003 2002
-----------------------
First mortgage notes collateralized by substantially all RLEC assets:
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at RTFC's base variable rate
plus 1.00% (5.20% at December 31, 2003). $ 11,680 $ 12,103
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 5.65%
(rate expires August 2006). 5,924 6,138
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 5.65%
(rate expires August 2006). 951 983
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 6.95%
(rate expires November 2004). 102,486 105,780
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 5.65%
(rate expires August 2006). 5,557 5,722
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 5.65%
(rate expires August 2006). 67,384 70,684
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 5.65%
(rate expires August 2006). 3,544 3,648
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 9.05%
(rate expires October 2004). 122,063 125,561
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual rate of 5.65%
(rate expires August 2006). 7,778 7,778
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at a fixed annual 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% (5.15% at
December 31, 2003). 10,000 21,000
RTFC unsecured line of credit loan, maturing March 2005 with interest payments
due quarterly at the RTFC's line of credit base rate plus 1.0%. - -
Mortgage note payable due in January 2004, interest at a fixed rate of 8%,
secured by land and building. 2,303 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 $2,076 and
$2,282, respectively. 197,924 197,718
Convertible note payable to related party 393 393
-------- --------
637,213 661,568
Less current portion 6,996 27,613
-------- --------
$ 630,217 $ 633,955
======== ========
F-16
Madison River Capital, LLC
Notes to Financial Statements (continued)
6. Long-Term Debt and Lines of Credit (continued)
Principal maturities on long-term debt at December 31, 2003 are as
follows:
2004 $ 6,996
2005 19,385
2006 9,385
2007 9,385
2008 9,385
Thereafter 582,677
--------
$ 637,213
========
The loan facilities provided by the RTFC are primarily with MRLTDF. 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 was
extended to November 2016. The Amendment also provided a reduction in
scheduled principal payments through 2010 with the first scheduled principal
payment occurring in the third quarter of 2004. Beginning in 2011, scheduled
principal payments increase, ranging from $8,900 to $17,490 per quarter
through the end of 2016. The Company continues to make quarterly interest
payments to the RTFC. Annually, beginning in 2005, the Company will be
required to calculate excess cash flow, as defined in the Amendment, for the
RLECs subject to the loan agreement using the preceding year's financial
results. If the calculation indicates excess cash flow, the Company will be
required to make a mandatory prepayment of principal to the RTFC equivalent
to the amount of excess cash flow. Such mandatory prepayment 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.
The terms of the RTFC loan agreement, including the Amendment, contains
various financial and administrative covenants that are tested on an annual
basis. The covenants are based on the combined financial results of MRLTDF
and its subsidiaries, GRH, MRLDS and MLDS. In addition, among other things,
these combined entities are restricted in their ability to (i) declare or pay
dividends to their respective parents, under specified circumstances, (ii)
limited in their 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 December 31, 2003, the Company 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 the operating assets and revenues of GRH and MRLTDF and its
subsidiaries consisting of Mebtel, GCSI, CCI and MRM. In addition,
substantially all of the outstanding equity interests of the RLECs 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
RLECs. In addition, as provided for in the Amendment, in the event that the
senior notes are retired, the Company will grant the RTFC a first mortgage
lien on the operating assets and revenues of MRC.
The $31,000 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 December 31, 2003, MRLTDF had drawn
down $10,000 under this line of credit with the remaining $21,000 fully
available to MRLTDF.
F-17
Madison River Capital, LLC
Notes to Financial Statements (continued)
6. Long-Term Debt and Line of Credit (continued)
The Company also has an undrawn $10,000 unsecured line of credit that is
fully available to Coastal Utilities, Inc., a subsidiary of CCI, and expires
in March 2005. 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 Amendment, MRLTDF is in the
process of granting the RTFC a first lien security interest in the assets of
Coastal Utilities, Inc. to secure this line of credit.
The Company has outstanding 131/4% senior notes that mature in March 2010
and have semiannual interest payments due on March 1 and September 1 of each
year. 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 or (viii) enter into transactions
with affiliates. At December 31, 2003 and 2002, the Company was in
compliance with the terms of its indenture.
The Company has a note payable to the former shareholders of Coastal
Utilities that was secured by land and buildings used in Coastal Utilities
operations. The note bore interest at 8% and was fully repaid in January
2004.
The Company has a convertible note payable to a member of MRTC with an
outstanding principal balance of $393 as of December 31, 2003 and 2002. The
note payable accrues interest at 8% per annum. The principal amount and
unpaid interest are due in October 2011. The note is unsecured and, at any
time prior to the payment of the entire principal amount, the holder may
convert all unpaid principal and accrued interest into Class A members'
equity of the Parent.
7. Leases
The Company leases various facilities used primarily for offices and
networking equipment under noncancelable operating lease agreements that
expire at various dates through 2015. The leases contain certain provisions
for renewal of the agreements, base rent escalation clauses and additional
rentals. Future minimum lease payments for years subsequent to December 31,
2003 are as follows.
2004 $ 1,482
2005 1,272
2006 910
2007 763
2008 655
Thereafter 2,837
--------
$ 7,919
========
Total rent expense was approximately $2,099, $2,481 and $2,895 for the
years ended December 31, 2003, 2002 and 2001, respectively.
8. Income Taxes
Income taxes for the Company's corporate subsidiaries, that include MRH,
MRLTDF, Mebtel, GCSI, CCI, MRLDS and MLDS ("Consolidated Tax Group") are
calculated using the liability method, which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences
of events that have been recognized in each subsidiaries' respective
financial statements or tax returns. Deferred income taxes arise from
temporary differences between the income tax basis and financial reporting
basis of assets and liabilities.
F-18
Madison River Capital, LLC
Notes to Financial Statements (continued)
8. Income Taxes (continued)
In accordance with the terms of a tax sharing agreement, MRH files a
consolidated federal income tax return for the Consolidated Tax Group. Until
April 2002, CCI was not able to file federal income tax returns as part of
the Consolidated Tax Group and, therefore, filed its own federal income tax
return. In April 2002, upon completion of a transaction with minority
shareholders, CCI became eligible to be included in the Consolidated Tax
Group for filing federal income taxes. Each entity files state income tax
returns according to the tax requirement for its respective state in which
they operate.
Effective December 1, 2003, MRM converted to a limited liability
corporation for income tax purposes from being a C Corporation. MRM will
file as a C Corporation for the period from January 1, 2003 through November
28, 2003 and as a limited liability corporation from November 29, 2003
through December 31, 2003.
In 2002, the Company, after consultation with its tax advisors, filed
amended state and federal income tax returns which, under Internal Revenue
Code Section 118, elected to characterize certain Universal Service Fund
payments as contributions that reduced the tax basis of certain telephone
plant rather than as taxable income. The amended income tax returns,
covering the years 1998 to 2000, resulted in refunds of $7,836. These
refunds were recorded as deferred income tax liabilities pending the audit of
the amended returns. In addition, this position was also taken in the 2001
income tax returns for the Company when originally filed.
In 2003, the Company's income tax returns were audited by the Internal
Revenue Service ("IRS"). The IRS disallowed the Company's position on the
USF receipts for 1999 to 2001. The Company believes that its position is
appropriate under current tax laws and the Company intends to defend the
position taken in its amended income tax returns. The Company is uncertain at
this time as to the ultimate outcome of this matter. The statute of
limitations for audit adjustments for 1998 expired during 2003. Accordingly,
the Company recorded an income tax benefit of $2,726 for the net amount of
the 1998 refunds received.
Components of income tax (benefit) expense for the years ended December
31 are as follows:
2003 2002 2001
-------------------------------------------
Current:
Federal $ (157) $ (4,829) $ (3,129)
State 1,532 (339) 1,356
Deferred:
Federal (7,742) 5,417 (3,362)
State (961) (146) (352)
-------- -------- --------
Subtotal (7,328) 103 (5,487)
Investment tax credits, net - (19) (19)
Change in valuation allowance 5,482 1,500 (64)
-------- -------- --------
Total income tax (benefit) expense $ (1,846) $ 1,584 $ (5,570)
======== ======== ========
Net income (loss) before income taxes of the corporate subsidiaries for
the years ended December 31, 2003, 2002, and 2001 was approximately $(72),
$4,700 and $(31,603), respectively. Differences between income tax expense
(benefit) computed by applying the statutory federal income tax rate to loss
before income taxes and reported income tax expense (benefit) for the years
ended December 31 are as follows:
2003 2002 2001
-------------------------------------------
Amount computed at statutory rate $ (24) $ 1,598 $ (10,745)
Non-deductible goodwill
amortization - - 3,761
Increase in tax valuation allowance 5,482 1,500 (64)
Realized losses on marketable
equity securities - 2,236 -
Income from LLC not includible in
taxable income (2,177) (2,951) -
Prior year refund realized (2,726) - -
Nontaxable benefit curtailment (537) - -
Expense pass through from
partnership investment (2,761) (1,109) -
State income taxes, net of federal
benefit (628) (485) 1,004
Amortization of investment
tax credits - (19) (19)
Other, net 1,525 814 493
-------- -------- --------
Total income tax (benefit) expense $ (1,846) $ 1,584 $ (5,570)
======== ======== ========
F-19
Madison River Capital, LLC
Notes to Financial Statements (continued)
8. Income Taxes (continued)
The Company had federal and state net operating loss carryforwards of
approximately $11,962 and $9,468 for the years ending December 31, 2003 and
2002, respectively. The federal net operating loss carryforwards begin to
expire in 2020 and the state net operating loss carryforwards begin to expire
in 2015.
The tax effects of temporary differences that gave rise to significant
portions of deferred tax assets and deferred tax liabilities at December 31
are as follows:
2003 2002
----------------------
Deferred tax assets:
Accrued employee benefits $ 1,698 $ 1,897
Allowance for uncollectible accounts 533 915
Deferred compensation 6,352 5,619
Net operating loss carryforwards 2,441 2,562
Other deferred assets 358 4,612
-------- --------
Total deferred tax assets 11,382 15,605
Valuation allowance for deferred tax assets (9,223) (3,741)
-------- --------
Net deferred tax assets 2,159 11,864
Deferred tax liabilities:
Book basis of property, plant and equipment
in excess of tax basis (42,486) (50,771)
Basis difference in investment (3,203) (3,568)
Other deferred liabilities (1,036) (6,170)
-------- --------
Total deferred tax liabilities (46,725) (60,509)
-------- --------
Net deferred tax liabilities $ (44,566) $ (48,645)
======== ========
9. Benefit Plans
Pension Plans
The Company adopted a noncontributory defined benefit pension plan (the
"Pension plan"), which was transferred to the Company from its wholly-owned
subsidiary, Mebtel, in May 1998, that covers all full-time employees, except
employees of GCSI, who have met certain age and service requirements. Prior
to March 2002, the Company's subsidiary, CCI, sponsored a separate defined
benefit pension plan for its employees that met certain age and service
requirements. In March 2002, the CCI plan was merged into the Pension plan.
The Pension plan provides benefits based on participants' final average
compensation and years of service. The Company's policy is to comply with the
funding requirements of the Employee Retirement Income Security Act of 1974.
On January 14, 2003, the Company notified its non-bargaining employees
that the accrual of benefits in the Pension plan would be frozen effective
February 28, 2003. As a result of the notification, 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
$2,781 which was recognized in 2003. Although the accrual of benefits in the
pension plan was frozen, the Company has a continued obligation to fund the
plan and will continue to recognize an annual net periodic pension expense
while the plan is still in existence.
F-20
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
Pension Plans (continued)
The following table sets forth the funded status of the Company's Pension
plan and amounts recognized in the Company's financial statements at December
31, 2003 and December 31, 2002:
2003 2002
----------------------
Projected benefit obligation at
beginning of year $ (11,404) $ (12,402)
Service cost (420) (1,136)
Interest cost (690) (796)
Actuarial (loss) gain (1,318) 30
Curtailment 759 -
Benefit payments 454 2,900
-------- --------
Projected benefit obligation at
end of year (12,619) (11,404)
-------- --------
Fair value of plan assets at beginning of year 7,633 8,886
Actual return on plan assets, net 688 (369)
Contributions 730 2,016
Benefit payments (454) (2,900)
-------- --------
Fair value of plan assets at end of year 8,597 7,633
-------- --------
Funded status of the plan (4,022) (3,771)
Unrecognized prior service costs - (2,793)
Unrecognized net obligation - 12
Unrecognized net loss 3,488 3,119
-------- --------
Net pension liability $ (534) $ (3,433)
======== ========
Amounts recognized in the consolidated balance sheets
Prepaid benefit cost - -
Accrued benefit liability (4,022) (3,433)
Intangible asset - -
Accumulated other comprehensive income 3,488 -
-------- --------
Net amount recognized $ (534) $ (3,433)
======== ========
The following table sets forth the net periodic pension cost for the
Pension plan for 2003 and 2002 and the Pension plan and CCI plan as
individual plans and on a combined basis for 2001:
2001
----------------------------
2003 2002 Combined Company CCI
----------------------------------------------------------------
Service cost $ 420 $ 1,136 $ 1,101 $ 783 $ 318
Interest cost 690 796 811 215 596
Estimated return on
plan assets (594) (798) (782) (269) (513)
Net amortization and
deferral 95 (241) (252) 7 (259)
------- ------- ------- ------- -------
Net periodic pension
cost $ 611 $ 893 $ 878 $ 736 $ 142
======= ======= ======= ======= =======
2003 2002
----------------------
Additional information:
Increase in minimum liability included in
other comprehensive income $ 3,488 $ -
Accrued benefit liability 3,488 -
F-21
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
Pension Plans (continued)
Weighted-average assumptions used for the Pension plan for 2003 and 2002
and the Pension plan and CCI plan as individual plans for 2001 are as
follows:
2003 2002 2001
-------------------------------------------
Plan discount rates:
Pension plan 6.00% 7.00% 7.50%
CCI plan - - 7.50%
Rates of increase in future
compensation levels:
Pension plan 0.00%* 3.00% 3.00%
CCI plan - - 3.00%
Expected long-term rates of return
on assets
Pension plan 8.00% 8.00% 8.00%
CCI plan - - 8.00%
*Based on freeze of further accrual of Pension plan benefits
The Company's pension plan weighted-average asset allocations at December
31 by asset category are as follows:
2003 2002
----------------------
Plan assets:
Equity securities 60% 30%
Debt securities 40% 69%
Other 0% 1%
----- -----
Total 100% 100%
===== =====
The expected long-term rate of return for the plan's total assets is
based on the expected return of each of the categories of assets, weighted
based on the median of the target allocation for each class. Equity
securities are expected to return 10% to 11% over the long-term, while fixed
income is expected to return between 5% and 6%, with a goal of achieving a
total return of 8% per year.
The Company's investment policy is to broadly diversify the investments
in order to reduce risk and to produce incremental return, while observing
the requirements of state law and the principles of prudent investment
management. The Pension plan's assets will be diversified among economic
sector, industry, quality, and size. The purpose of diversification is to
provide reasonable assurance that no single security or class of securities
will have a disproportionate impact on the performance of the Pension plan.
As a result, the risk level associated with the portfolio should be reduced.
The Company's target allocation for 2004 by asset category is as follows:
2004
Plan assets:
Equity securities 25 - 75%
Debt securities 25 - 75%
F-22
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
Pension Plans (continued)
The Company expects to contribute approximately $2,100 to the Pension
plan in 2004.
The following benefit payments, which reflect expected future service, as
appropriate, are estimated to be paid:
2004 $ 359
2005 396
2006 440
2007 514
2008 647
2009 to 2013 5,290
Postretirement Benefits Other Than Pensions
The Company sponsors two plans providing medical coverage to retirees and
their dependents.
The Company provides limited medical coverage to retirees and their
dependents for all companies, except GCSI and its subsidiaries, through a
traditional indemnity plan administered by a third party. Participation in
the retiree medical plan begins upon retirement at age 55 with 10 years of
service.
The Company provides a monthly contribution of $10.00 for each year of
service with the Company to retirees to use for medical benefits. In
addition, the Company provides the lesser of $25,000 or half of the retiree's
final base pay in life insurance benefits. The plan is unfunded.
The following table sets forth the status of the Company's plan and
amounts recognized in the Company's financial statements at December 31:
2003 2002
----------------------
Accumulated plan benefit obligation at
beginning of period $ (1,592) $ (1,234)
Service cost (37) (63)
Interest cost (93) (107)
Plan participants' contributions - -
Amendments - -
Actuarial loss (gain) 113 (339)
Benefits paid 47 151
-------- --------
Accumulated plan benefit obligation at
end of period (1,562) (1,592)
-------- --------
Fair value of plan assets at beginning of period - -
Employer contribution 47 151
Plan participants' contributions - -
Benefits paid (47) (151)
-------- --------
Fair value of plan assets at end of period - -
-------- --------
Funded status of plan (1,562) (1,592)
Unrecognized prior service costs 601 671
Unrecognized net loss 221 336
-------- --------
Accrued postretirement benefit cost $ (740) $ (585)
======== ========
F-23
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
Postretirement Benefits Other Than Pensions (continued)
2003 2002
----------------------
Amounts recognized in the consolidated
balance sheets
Prepaid benefit cost $ - $ -
Accrued benefit liability (740) (585)
Intangible asset - -
Accumulated other comprehensive income - -
------ ------
Net amount recognized $ (740) $ (585)
====== ======
2003 2002 2001
-------------------------------------------
Components of net periodic
postretirement benefit cost:
Service cost $ 37 $ 63 $ 64
Interest cost 93 107 79
Actuarial loss (gain) 2 (33) (1)
------- ------- -------
Net periodic postretirement
benefit cost 132 137 142
Prior service costs 70 70 70
------- ------- -------
Total postretirement benefit
cost accrual $ 202 $ 207 $ 212
======= ======= =======
Weighted-average assumptions:
Discount rate 7.00% 7.00% 7.00%
Initial medical trend rate - * 8.50% 9.00%
Initial dental and vision trend rate - * 8.50% 9.00%
Ultimate trend rate - * 5.00% 5.00%
Years to ultimate trend rate - * 7 8
Other information:
One percent increase in trend rates:
Effect on service and
interest cost $ 3 $ 130 $ 146
Effect on accumulated plan
benefit obligation 58 1,274 1,183
One percent decrease in trend rates:
Effect on service and
interest cost (3) (103) (141)
Effect on accumulated plan
benefit obligation (51) (1,043) (1,113)
* Trend rates are no longer applicable to this plan as only contribution
made by the Company, other than for a small group of retirees, is a monthly
amount equal to $10.00 for each year of service retiree had with the Company
and it is not anticipated that this contribution rate will increase with
medical inflation. For the small group of retirees who still receive
benefits under a different plan formula, the trend rate was 11.0% graded
down to 6.0% in four years.
There are no assets in the Company's plan. The Company estimates that it
will contribute approximately $71 to its other postretirement benefit plan in
2004. The following benefit payments, which reflect expected future service,
as appropriate, are estimated to be paid:
2004 $ 71
2005 80
2006 88
2007 95
2008 102
2009 to 2013 653
F-24
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
Postretirement Benefits Other Than Pensions (continued)
GCSI provides medical coverage to retirees and their dependents through a
traditional indemnity plan administered by a third party. The plan provisions
are the same as those for active participants. Eligibility to participate in
the retiree medical plan upon retirement is defined as age 55 with 25 years
of service.
GCSI required retirees to contribute 67% of medical, dental and eye care
premium rates in 2003. The additional cost of the plan was paid by GCSI. In
2004 and future years, the retirees will contribute 100% of the premiums.
GCSI's retirees also receive free local phone service and a $100 long
distance credit per month. GCSI does not anticipate any changes in the cost-
sharing provisions of the existing written plan, and there is no commitment
to increase monetary benefits in the future. The plan is unfunded.
The following table sets forth the status of GCSI's plan and amounts
recognized in GCSI's financial statements at December 31:
2003 2002
----------------------
Accumulated plan benefit obligation at
beginning of period $ (1,199) $ (1,551)
Service cost - (38)
Interest cost (4) (77)
Plan participants' contributions - -
Amendments (179) -
Actuarial gain 1,156 404
Benefits paid 29 63
-------- --------
Accumulated plan benefit obligation at
end of period (197) (1,199)
-------- --------
Fair value of plan assets at beginning of period - -
Employer contribution 29 63
Plan participants' contributions - -
Benefits paid (29) (63)
-------- --------
Fair value of plan assets at end of period - -
-------- --------
Funded status of plan (197) (1,199)
Unrecognized prior service costs (2,395) (1,397)
Unrecognized net gain (1,815) (2,160)
-------- --------
Accrued postretirement benefit cost $ (4,407) $ (4,756)
======== ========
Amounts recognized in the consolidated
balance sheets
Prepaid benefit cost $ - $ -
Accrued benefit liability (4,407) (4,756)
Intangible asset - -
Accumulated other comprehensive income - -
-------- --------
Net amount recognized $ (4,407) $ (4,756)
======== ========
F-25
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
Postretirement Benefits Other Than Pensions (continued)
2003 2002 2001
-------------------------------------------
Components of net periodic
postretirement benefit cost:
Service cost $ - $ 38 $ 49
Interest cost 4 77 102
Actuarial gain (158) (24) (56)
--------- ------- -------
Net periodic postretirement
benefit cost (154) 91 95
Prior service costs (166) (166) (166)
--------- ------- -------
Total postretirement benefit
cost accrual $ (320) $ (75) $ (71)
========= ======= =======
Weighted-average assumptions:
Discount rate 7.00% 7.00% 7.00%
Initial medical trend rate - * 8.50% 8.50%
Initial dental and vision trend rate - * 8.50% 8.00%
Ultimate trend rate - * 5.00% 5.00%
Years to ultimate trend rate - * 7 8
Other information:
One percent increase in trend rates:
Effect on service and interest cost - * $ 130 $ 170
Effect on accumulated plan benefit
obligation - * 1,274 1,661
One percent decrease in trend rates:
Effect on service and interest cost - * (103) (135)
Effect on accumulated plan benefit
obligation - * (1,043) (1,361)
* Trend rates are no longer applicable to this plan due to participants
paying all premiums due under the plan beginning in 2004.
There are no assets in the Company's plan. The Company estimates that it
will contribute approximately $15 to its other postretirement benefit plan in
2004. The following benefit payments, which reflect expected future service,
as appropriate, are estimated to be paid:
2004 $ 15
2005 14
2006 11
2007 12
2008 14
2009 to 2013 91
401(k) Savings Plans
The Company sponsors a 401(k) savings plan covering substantially all
employees who meet certain age and employment criteria, except for employees
of GCSI. Employees may elect to contribute a percentage of their compensation
to the plan not to exceed certain dollar limitations. The Company matches the
first 6% of compensation deferred at the rate of 50% of employee
contributions. The Company made matching contributions of approximately $606,
$687 and $859 in the years ended 2003, 2002 and 2001.
GCSI sponsors a 401(k) savings plan for all of its employees who meet
certain age and employment criteria. Employees may elect to contribute a
percentage of their compensation to the plan not to exceed certain dollar
limitations. The Company matches the first 6% of compensation deferred at the
rate of 50% of employee contributions. The Company made matching
contributions of approximately $148, $178 and $243 in the years ended 2003,
2002 and 2001.
F-26
Madison River Capital, LLC
Notes to Financial Statements (continued)
9. Benefit Plans (continued)
GCSI Employee Stock Ownership Plan
A GCSI subsidiary sponsors a non-contributory employee stock ownership
plan ("ESOP") which covered certain employees who had completed one year of
service and attained the age of nineteen. Additionally, all participants in
a former profit sharing plan became eligible for the ESOP effective with the
formation of the ESOP.
Prior to September 1999, the ESOP operated as a leveraged ESOP. On
September 29, 1999, GCSI was acquired by the Company. As part of the
acquisition, all shares held by the ESOP were acquired subject to an escrow
holdback for contingent liabilities and unpaid obligations and the
outstanding loan of the ESOP was retired. The Company adopted a resolution
to terminate the ESOP effective December 31, 1999 subject to final resolution
of certain matters relating to the ESOP and the receipt of a favorable letter
of determination from the Internal Revenue Service regarding the termination
of the ESOP. Accordingly, all accruals of benefits under the plan were
suspended as of that date, and no further contributions were required to be
made by GCSI. At December 31, 2003, the ESOP continued to operate pending
final resolution of those matters as more fully discussed in Note 16 below.
Upon final resolution, all remaining assets will be distributed to plan
participants and the ESOP will be terminated.
In November 1999 and June 2000, GCSI distributed approximately 20% and
60% of accumulated benefits under the ESOP as of December 31, 1998. In
addition to the remaining cash, the ESOP continues to hold a 48.8% interest
in the escrow holdback.
10. Long-Term Incentive Plan
In 1998, MRTC adopted a long-term incentive plan arrangement that
provides for annual incentive awards to certain employees as approved by the
Board of Directors. Under the terms of the plan, awards are earned over the
succeeding 12 months after the award eligibility is determined. Eligible
employees forfeit any awards earned upon cessation of employment with the
Company.
Incentive awards vest automatically at the time of a qualified event as
defined under the plan. Vested awards are payable under certain circumstances
as defined in the long-term incentive plan arrangement. The Company
recognized compensation expense related to the long-term incentive awards of
$5,429, $5,284 and $1,271 in the years ended December 31, 2003, 2002 and
2001, respectively. At December 31, 2003, 2002 and 2001, the Company had
approximately $19,511, $14,097 and $8,817, respectively, accrued for the
long-term incentive plan. No incentive awards are vested as of December 31,
2003.
11. Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair
value of the Company's financial instruments:
Cash and cash equivalents, accounts receivable, inventories, other
current assets, accounts payable, accrued expenses and other current
liabilities - the carrying value approximates fair value due to the short
maturity of these instruments.
The fair value and carrying value of long-term debt and lines of credit
at December 31, 2003 were $631,404 and $637,213, respectively. At December
31, 2002, the fair value and carrying value of the long-term debt and lines
of credit were $589,735 and $661,568, respectively. The fair value of the
Company's $200,000 senior notes is based on the quoted value at the close of
business on December 31. The fair value of the secured long-term debt is
estimated by discounting the scheduled payment streams to their present value
based on current rates for similar instruments with comparable maturities.
F-27
Madison River Capital, LLC
Notes to Financial Statements (continued)
12. Segment Information
The Company offers a variety of telecommunications services to business
and residential customers including local and long distance voice, high speed
data, Internet access and fiber transport. In accordance with the
requirements of Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information," ("SFAS
131") the Company's operations are classified into two reportable business
segments. The first segment consists of the Company's four RLECs that
provide regulated and nonregulated telecommunication services in their
franchised territories. The second segment consists of the EOS operations
that are in close proximity to the RLEC territories and are managed and
operated as a line of business of the RLECs. Although both segments provide
similar types of telecommunication services, are operated and managed by
common management teams and share common resources, certain differences exist
in the businesses of the RLECs and the EOS that the Company has evaluated to
indicate two segments. Included in these differences between the RLECs and
the EOS are: (i) the extent to which each segment's operations are regulated,
(ii) different approaches in the way each segment markets its services, (iii)
positions within their respective markets and therefore how they price their
services and (iv) composition of each segment's customer base. In addition,
each segment's financial and operating results are evaluated separately by
the chief operating decision maker of the Company. Periodically, the Company
will analyze these factors, among others, to determine the appropriate
reportable business segments required under SFAS 131.
The Company's two reportable segments follow the same accounting
principles and policies used for the Company's consolidated financial
statements. Revenues by product line are disclosed in the Consolidated
Statement of Operations. The RLEC generates revenues from the provision of
local and long distance voice services, Internet and enhanced data services
and miscellaneous services. The EOS generates revenues from provision of
local and long distance voice services, Internet and enhanced data services,
transport services and miscellaneous services. All operations and assets are
located in the United States. The following tables summarize the revenues
and net operating income (loss) for each segment for the years ended December
31, 2003, 2002 and 2001:
December 31
2003 2002 2001
----------------------------------------
Total revenues
RLEC operations $ 175,265 $ 172,422 $ 173,647
EOS 14,199 15,318 13,177
--------- --------- ---------
189,464 187,740 186,824
Less intersegment revenues (3,004) (3,539) (2,561)
--------- --------- ---------
Total reported revenues $ 186,460 $ 184,201 $ 184,263
========= ========= =========
Net operating income (loss)
RLEC operations $ 54,478 $ 49,748 $ 36,801
EOS (11,970) (20,861) (36,788)
--------- --------- ---------
Total reported net
operating income $ 42,508 $ 28,887 $ 13
========= ========= =========
As of December 31, 2003, 2002 and 2001, total assets by segment, net of
intersegment investments and other intersegment balances, were as follows:
December 31
2003 2002 2001
----------------------------------------
Total assets:
RLEC operations $ 868,472 $ 871,030 $ 819,584
EOS 432,326 473,172 506,239
--------- --------- ---------
1,300,798 1,344,202 1,325,823
Less intersegment assets (493,656) (499,431) (429,245)
--------- --------- ---------
Total reported assets $ 807,142 $ 844,771 $ 896,578
========= ========= =========
F-28
Madison River Capital, LLC
Notes to Financial Statements (continued)
13. Redeemable Minority Interest
As part of the consideration paid in the acquisition of Coastal
Utilities, the Company 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 $10,000 and
$5,000, respectively. The Series A and Series B stock had put and call
features defined pursuant to the terms of a shareholders' agreement and
exercisable by the holders and CCI. In February 2001, the holders of the
Series B stock notified the Company of their exercise of the put option. On
April 10, 2002, MRTC completed an agreement with the former shareholders of
Coastal Utilities which, among other things, modified certain provisions of
the CCI shareholders agreement.
Under the terms of the new agreement, the former shareholders exchanged
all of their Series B stock and 40% of their Series A stock in CCI for 18.0
million Class A member units in MRTC valued at $1 per unit and three
unsecured term notes issued by MRTC, in the aggregate principal amount of
$20,000, payable over eight years and bearing interest at approximately 8.4%.
In addition, CCI redeemed 30 shares of Series A stock retained by the former
shareholders for $33,333.33 per share, or approximately $1,000, at the
closing of the transaction. Under the terms of CCI's amended shareholders
agreement, the former shareholders have the right, beginning May 31, 2003 and
ending September 30, 2007, to require CCI to redeem their remaining 150
shares of Series A stock in increments not to exceed 30 shares at $33,333.33
per share, or an aggregate value of $1,000, in any thirteen-month period. In
June 2003, CCI redeemed 30 shares of the Series A stock for $1,000.
As a result of the transaction, the Company recorded an increase in
members' interest of $21,100 and long-term debt of $20,000 to reflect the
consideration exchanged for a portion of the minority shareholders' equity
interests. A portion of the increase in members' interest in the amount of
$3,100 represents the difference between the $47,100 carrying value of the
minority interest before the transaction and the $44,000 in value held by the
minority shareholders after the transaction.
Upon adoption of SFAS 150, the Company reclassified the redeemable
minority interest on its balance sheet from its mezzanine level presentation
between liabilities and equity to current and long-term liabilities and
reclassified the prior year presentation to be consistent. Accordingly, at
December 31, 2003 and 2002, other current liabilities include $1,000 for the
current portion of the redeemable minority interest and other liabilities
include $3,000 and $4,000, respectively, for the portion redeemable beyond
one year.
14. Related Party Transactions
On January 4, 2002, the Company loaned approximately $467 to each of
three managing directors of MRTC to finance a portion of their purchase of
Class A units in MRTC from an investor. The loans, payable on demand, bear
interest at 5% and are secured by the MRTC Class A interests purchased with
the proceeds of the loans. At December 31, 2003 and 2002, $1,400 was
outstanding under these loans and is reflected as a reduction of member's
capital. The Company recognized interest income of $71 and $70 in 2003 and
2002, respectively. All accrued interest had been paid by the managing
directors as of December 31, 2003 and 2002.
15. Commitments and Contingencies
The Company has a resale agreement with a vendor to provide long distance
transmission services. Under the terms of the agreement, the Company must
utilize certain contracted minimum volume commitments.
GCSI's ESOP was the subject of an application before the Internal Revenue
Service ("IRS") for a compliance statement under the Voluntary Compliance
Resolution Program filed with the IRS on May 17, 2000. The compliance
statement was requested in order to address certain issues related to
contributions made during 1997 and 1998, prior to the acquisition of GCSI by
the Company, to employees' accounts in the ESOP and a 401(k) plans in excess
of the limits allowed by Section 415 of the Internal Revenue Code of 1986, as
amended. 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.
F-29
Madison River Capital, LLC
Notes to Financial Statements (continued)
15. Commitments and Contingencies (continued)
The estimated cost to the ESOP of the corrective allocation described in
the initial compliance statement was approximately $3,300. In its
application, the Company 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
$1,600, and the ESOP Loan Suspense Account had a value in excess of the
$1,700 needed for the full correction. However, based on discussions with
the IRS and upon the recommendation of its advisors, during the second
quarter of 2001, the Company withdrew its 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 a Section 415 Compliance Statement and
provided the Company 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 new errors, the Company performed an extensive
review of the ESOP administration for the plan years 1995 through 1999. As
part of the process, on June 7, 2002, the Company submitted a new application
for a compliance statement under the Walk-In-Closing Agreement Program with
the IRS. The new application restated the Company's proposed corrections to
be made for the operational failures disclosed in the first application as
well as addressed the proposed corrections for the additional failures found
in the administration of the ESOP. In October 2003, the Company received a
preliminary compliance statement from the IRS documenting their conclusions
related to the second application. See Note 16 for further discussion of the
compliance statement.
In May 2002, $1,700 was transferred into the ESOP from an escrow account
established in connection with the acquisition of GCSI as required under the
terms of the initial compliance statement. Pursuant to the terms of the
second compliance statement issued in February 2004, the $1,700 was no longer
necessary to complete the corrections to the ESOP. In March 2004, the
Company requested the return of this amount from the ESOP trust, together
with interest earned from the date of initial transfer, to the escrow
account. At December 31, 2003, the Company had accrued approximately $160
related to the corrections to be made under the second compliance statement.
The Company may pursue other options currently available to it to obtain
reimbursement of a portion of this amount, which may include seeking
additional reimbursement from the escrow account. However, there is no
assurance that the Company will be able to obtain any reimbursement from
another source. The Company does not believe that any future amounts
required to be contributed to the ESOP as part of this corrective action, if
any, will have a material adverse effect on its financial condition, results
of operations or cash flows.
The Company is involved in various other claims, legal actions and
regulatory proceedings arising in the ordinary course of business. The
Company does not believe the ultimate disposition of these matters will have
a material adverse effect on its consolidated financial position, results of
operations or cash flows.
16. Subsequent Event
The Company and the IRS reached a resolution on the terms of the new
compliance statement for GCSI's ESOP and it was issued on February 5, 2004
allowing the Company 150 days, or until July 4, 2004, to implement the
required corrections. As of February 27, 2004, the Company had implemented
the required corrections outlined in the second compliance statement and made
a distribution of substantially all of the cash assets held in the ESOP trust
to participants.
F-30
Madison River Capital, LLC
Schedule I - Condensed Financial Information of the Registrant
As of December 31, 2003 and 2002
and for the Three-Year Period Ended December 31, 2003
(in thousands)
Condensed Balance Sheets of Registrant
December 31
2003 2002
---------------------
Assets
Current assets:
Cash $ 1,355 $ 41
Prepaid expenses - 1
-------- --------
Total current assets 1,355 42
-------- --------
Other assets:
Note receivable from subsidiary 30,000 30,000
Investment in subsidiaries 203,811 215,375
Other investments 209 209
Unamortized debt issuance costs 4,518 5,250
-------- --------
Total other assets 238,538 250,834
-------- --------
Total assets $ 239,893 $ 250,876
======== ========
Liabilities and member's capital
Current liabilities:
Amounts due to subsidiaries 24,878 23,123
Accrued interest expense 9,142 9,090
-------- --------
Total current liabilities 34,020 32,213
-------- --------
Noncurrent liabilities:
Long-term debt, net of discount 198,316 198,111
Other long-term liabilities 9,169 4,007
-------- --------
Total noncurrent liabilities 207,485 202,118
-------- --------
Total liabilities 241,505 234,331
Member's capital:
Member's interest 210,184 210,184
Accumulated deficit (208,308) (193,639)
Accumulated other comprehensive loss (3,488) -
-------- --------
Total member's capital (1,612) 16,545
-------- --------
Total liabilities and member's capital $ 239,893 $ 250,876
======== ========
F-31
Madison River Capital, LLC
Schedule I - Condensed Financial Information of the Registrant, continued
Condensed Statements of Operations of Registrant
December 31
2003 2002 2001
---------------------------------
Operating expenses:
Amortization $ 733 $ 733 $ 753
Selling, general and administrative expenses 1 17 19
------- ------- -------
Net operating loss (734) (750) (772)
Interest expense (26,757) (26,728) (26,704)
Other income 6,071 6,072 4,613
------- ------- -------
Loss before equity in income (losses)
of subsidiaries (21,420) (21,406) (22,863)
Equity in income (losses) of subsidiaries 6,751 (18,012) (52,066)
------- ------- -------
Net loss $(14,669) $(39,418) $(74,929)
======= ======= =======
Condensed Statements of Cash Flows of Registrant
December 31
2003 2002 2001
---------------------------------
Operating activities
Net loss $ (14,669) $ (39,418) $ (74,929)
Adjustments to reconcile net loss to net
cash used in operating activities:
Amortization of debt issuance costs 732 732 753
Amortization of discount 206 180 158
Equity in losses of subsidiaries (6,751) 18,012 52,066
Changes in operating assets and liabilities:
Accrued interest receivable - 4,500 (4,383)
Dividends receivable - - 487
Prepaid expenses 1 1 -
Amounts due to subsidiaries 6,916 13,783 (7,552)
Accrued interest payable 52 48 46
Other accrued liabilities (3,488) - -
-------- -------- --------
Net cash used in operating activities (17,001) (2,162) (33,354)
-------- -------- --------
Investing activities
Distributions from subsidiaries 18,315 2,135 8,028
Changes in other assets - - (240)
-------- -------- --------
Net cash provided by financing activities 18,315 2,135 7,788
-------- -------- --------
Financing activities
Contribution from member - - 528
Redemption of member's interest - (2,000) -
Advances to managing directors - (1,400) -
-------- -------- --------
Net cash (used in) provided by investing activities - (3,400) 528
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 1,314 (3,427) (25,038)
Cash and cash equivalents at beginning of year 41 3,468 28,506
-------- -------- --------
Cash and cash equivalents at end of year $ 1,355 $ 41 $ 3,468
======== ======== ========
F-32
Madison River Capital, LLC
Schedule I - Condensed Financial Information of the Registrant, continued
Notes to Condensed Financial Statements of Registrant
(in thousands)
1 - Basis of Presentation
These financial statements present the financial condition, results of
operations and cash flows of Madison River Capital, LLC (the "Company") on a
parent-company-only basis. The Company's investment in its subsidiaries is
stated at cost plus its equity in the undistributed earnings of its
subsidiaries since the date of acquisition. These financial statements
should be read in conjunction with the Company's consolidated financial
statements on pages F-1 to F-30.
2 - Long-term Debt
Long-term debt consisted of the following at December 31, 2003 and 2002:
December 31
2003 2002
-------------------------
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 $2,076 and
$2,282, respectively. $ 197,924 $ 197,718
Convertible note payable to related party 393 393
--------- ---------
Total long term debt $ 198,317 $ 198,111
========= =========
None of this long-term debt matures within the five years succeeding December
31, 2003. Further information regarding this long-term debt is in Note 6 to
the consolidated financial statements of the Company.
3 - Other Long-term Liabilities
The Company sponsors a pension plan and two post-retirement benefit plans for
employees of its operating subsidiaries. Further information regarding these
plans is in Note 9 to the consolidated financial statements of the Company.
F-33
Madison River Capital, LLC
Schedule II - Valuation and Qualifying Accounts
Years Ended December 31, 2003, 2002 and 2001
(in thousands)
Allowance for uncollectible accounts:
Additions
Balance at Charged to Deductions Balance at
Beginning Costs and from End
of Period Expenses Reserves of Period
----------------------------------------------------------
Year ended December 31, 2003:
Allowance for uncollectible accounts $ 2,792 $ 617 $ (1,686) $ 1,723
======= ======= ========= =======
Year ended December 31, 2002:
Allowance for uncollectible accounts $ 1,815 $ 1,673 $ (696) $ 2,792
======= ======= ========= =======
Year ended December 31, 2001:
Allowance for uncollectible accounts $ 1,150 $ 4,922 $ (4,257) $ 1,815
======= ======= ========= =======
Allowance for uncollectible accounts, primarily from interexchange carriers:
Additions
Balance at Charged to Deductions Balance at
Beginning Costs and from End
of Period Expenses Reserves of Period
----------------------------------------------------------
Year ended December 31, 2003:
Allowance for uncollectible accounts $ 1,693 $ 1,280 $ (898) $ 2,075
======= ======= ========= =======
Year ended December 31, 2002:
Allowance for uncollectible accounts $ 111 $ 1,626 $ (44) $ 1,693
======= ======= ========= =======
Year ended December 31, 2001:
Allowance for uncollectible accounts $ 531 $ - $ (420) $ 111
======= ======= ========= =======
Valuation allowance for deferred income tax assets:
Additions
Balance at Charged to Deductions Balance at
Beginning Costs and from End
of Period Expenses Reserves of Period
----------------------------------------------------------
Year ended December 31, 2003:
Valuation allowance for deferred
income tax assets $ 3,741 $ 5,482 $ - $ 9,223
======= ======= ======= =======
Year ended December 31, 2002:
Valuation allowance for deferred
income tax assets $ 2,241 $ 1,500 $ - $ 3,741
======= ======= ======= =======
Year ended December 31, 2001:
Valuation allowance for deferred
income tax assets $ 2,305 $ - $ (64) $ 2,241
======= ======= ======= =======
F-34
EXHIBIT INDEX
EXHIBIT
NUMBER Description of Exhibits
- ------- -----------------------
3.1* Certificate of Formation of Madison River Capital, LLC
3.2* Limited Liability Company Agreement of Madison River Capital, LLC
3.3* Certificate of Incorporation of Madison River Finance Corp.
3.4* By-Laws of Madison River Finance Corp.
4.1* Form of the Series B 131/4% Senior Notes due 2010
4.2* Purchase Agreement, dated as of February 17, 2000, between Madison
River Capital, LLC, Madison River Finance Corp. and Goldman, Sachs &
Co., Bear, Stearns & Co., Inc., Chase Securities Inc. and Morgan
Stanley & Co. Incorporated
4.3* Indenture, dated as of February 17, 2000, between Madison River
Capital,LLC, Madison River Finance Corp. and Norwest Bank Minnesota,
National Association
4.4* Exchange and Registration Rights Agreement, dated as of February 17,
2000, between Madison River Capital,LLC, Madison River Finance Corp.
and Goldman, Sachs & Co., Bear, Stearns & Co. Inc., Chase Securities
Inc. and Morgan Stanley & Co. Incorporated
10.1* Contribution and Stock Purchase Agreement, dated November 23, 1999,
by and among, Madison River Telephone Company, LLC, Coastal
Communications, LLC, Coastal Utilities, Inc., Daniel M. Bryant, G.
Allan Bryant and The Michael E. Bryant Life Trust
10.1.1* First Amendment to Contribution and Stock Purchase Agreement, dated
March 20, 2000, by and among, Madison River Telephone Company, LLC,
Coastal Communications, LLC, Coastal Utilities, Inc., Daniel M.
Bryant, G. Allan Bryant and The Michael E. Bryant Life Trust
10.1.2* Second Amendment to Contribution and Stock Purchase Agreement, dated
March 29, 2000, by and among, Madison River Telephone Company, LLC,
Coastal Communications, LLC, Coastal Utilities, Inc., Daniel M.
Bryant, G. Allan Bryant and The Michael E. Bryant Life Trust
10.1.3* Shareholders Agreement, dated March 30, 2000, by and among Coastal
Communications, Inc. and Daniel M. Bryant, G. Allan Bryant, The
Michael E. Bryant Life Trust and Madison River Capital, LLC
10.2* Agreement and Plan of Merger, dated May 9, 1999, by and between
Madison River Telephone Company, LLC and Gulf Coast Services, Inc.
10.2.1* First Amendment to Agreement and Plan of Merger, dated July 2, 1999,
by and between Madison River Telephone Company, LLC and Gulf Coast
Services, Inc.
10.2.2* Second Amendment to Agreement and Plan of Merger, dated August 24,
1999, by and between Madison River Telephone Company, LLC and Gulf
Coast Services, Inc.
10.2.3* Third Amendment to Agreement and Plan of Merger, dated September 28,
1999, by and between Madison River Telephone Company, LLC and Gulf
Coast Services, Inc.
10.3* Asset Purchase Agreement, dated April 21, 1998, among Madison River
Telephone Company,LLC, Gallatin River Communications L.L.C., Central
Telephone Company of Illinois and Centel Corporation
10.3.1* Amendment No. 1 to Asset Purchase Agreement, dated September 22,
1998, by and between Gallatin River Communications, LLC, Madison
River Telephone Company, LLC, Central Telephone Company of Illinois
and Centel Corporation
10.3.2* Amendment No. 2 to Asset Purchase Agreement, dated October 29, 1998,
by and between Gallatin River Communications, LLC, Madison River
Telephone Company, LLC, Central Telephone Company of Illinois and
Centel Corporation
10.4* Stock Purchase Agreement, dated September 12, 1997, by and among
Madison River Telephone Company, LLC and Mebcom Communications, Inc.
and its stockholders
I-1
EXHIBIT INDEX, Continued
EXHIBIT
NUMBER Description of Exhibits
- ------- -----------------------
10.5 ## Employment Agreement, dated November 1, 2002, between Madison River
Telephone Company, LLC and J. Stephen Vanderwoude **
10.6 Amended and Restated Employment Agreement, dated January 1, 2004,
between Madison River Telephone Company, LLC and James D. Ogg **
10.8 ## Employment Agreement, dated November 1, 2002, between Madison River
Telephone Company, LLC and Paul H. Sunu **
10.8.1 First Amendment to Employment Agreement, dated December 31, 2003,
between Madison River Telephone Company, LLC and Paul H. Sunu **
10.9 ## Employment Agreement, dated November 1, 2002, between Madison River
Telephone Company, LLC and Bruce J. Becker **
10.10* Terms of the Madison River Telephone Company, LLC Long Term
Incentive Plan effective November 1, 1998
10.11* Loan Agreement and Promissory Notes, dated as of September 29,
1999, between Gulf Telephone Company and the Rural Telephone
Finance Cooperative (the "RTFC")
10.12* Secured Revolving Line of Credit Agreement, dated as of September
29, 1999, between Gulf Telephone Company and the RTFC
10.13* Loan Agreement, dated as of January 16, 1998, between Mebtel, Inc.
and the RTFC
10.14* Secured Revolving Line of Credit Agreement, dated as of January 16,
1998, between Mebtel, Inc. and the RTFC
10.15* Loan Agreement, dated as of October 30, 1998, between Gallatin
River Communications, LLC and the RTFC
10.16* Loan Agreement, dated as of October 30, 1998, between Madison River
Communications, Inc. and the RTFC
10.17* Secured Revolving Line of Credit Agreement, dated as of October 30,
1998, between Gallatin River Communications, LLC and the RTFC
10.18* Loan Agreement, dated as of March 29, 2000, between Coastal
Utilities, Inc. and the RTFC
10.19* Secured Revolving Line of Credit Agreement, dated as of March 29,
2000, between Coastal Utilities, Inc. and the RTFC
10.20* Unsecured Revolving Line of Credit Agreement, dated as of March 29,
2000, between Coastal Utilities, Inc. and the RTFC
10.26+++ Loan Agreement and Secured Promissory Notes, dated as of December
29, 2000, by and between Madison River LTD Funding Corp. and the
RTFC
10.27+++ Secured Revolving Line of Credit Agreement, dated as of December
29, 2000, by and between Madison River LTD Funding Corp. and the
RTFC
10.28 ## Employment Agreement, dated November 1, 2002, between Madison River
Telephone Company, LLC and Ken Amburn **
10.29 ## Employment Agreement, dated December 1, 2002, between Madison River
Telephone Company, LLC and Michael Skrivan **
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
10.31 # Exchange Agreement, dated as of April 10, 2002, by and among
Madison River Telephone Company, LLC, Coastal Communications, Inc.,
Daniel M. Bryant, G. Allan Bryant and The Michael E. Bryant Life
Trust.
14 Code of Conduct for Madison River Telephone Company, LLC
I-2
EXHIBIT INDEX, Continued
EXHIBIT
NUMBER Description of Exhibits
- ------- -----------------------
21.1 Subsidiaries of the Registrant
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
* Incorporated herein by reference 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.
** Denotes management contract or compensatory plan or arrangement required
to be filed as an exhibit hereto.
*** Incorporated herein by reference to the Registrant's First Amendment to
the Registration Statement on Form S-4 (File No. 333-36804) filed with
the Securities and Exchange Commission on June 23, 2000.
++ Incorporated herein by reference to the Registrant's Quarterly Report on
Form 10-Q filed with the Securities and Exchange Commission on November
13, 2000.
+++ Incorporated herein by reference to the Registrant's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on April 2,
2001.
# Incorporated herein by reference to the Registrant's Form 8-K filed with
the Securities and Exchange Commission on April 11, 2002.
## Incorporated herein by reference to the Registrant's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March 31,
2003.
### Incorporated herein by reference to the Registrant's Form 8-K filed with
the Securities and Exchange Commission on July 31, 2003.
I-3