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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
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333-36804
Commission file number
MADISON RIVER CAPITAL, LLC
(Exact Name of Registrant as Specified in Its Charter)
Delaware 56-2156823
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
103 South Fifth Street
Mebane, North Carolina 27302
(Address of Principal Executive Offices, Including Zip Code)
(919) 563-1500
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No ___
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
As of August 12, 2004, the Registrant had 211,583,892 Class A member
interests outstanding. All member interests are owned by Madison River
Telephone Company, LLC.
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MADISON RIVER CAPITAL, LLC
Index to Form 10-Q
Part I - Financial Information Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - June 30, 2004 (Unaudited)
and December 31, 2003............................................................1
Condensed Consolidated Statements of Operations and Comprehensive
Loss (Unaudited) - Three and Six Months Ended June 30, 2004 and 2003.............2
Condensed Consolidated Statement of Member's Capital (Unaudited) - Six
Months Ended June 30, 2004.......................................................3
Condensed Consolidated Statements of Cash Flows (Unaudited) - Six
Months Ended June 30, 2004 and 2003..............................................4
Notes to Condensed Consolidated Financial Statements (Unaudited)...................5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...........................................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................24
Item 4. Controls and Procedures...........................................................25
Part II - Other Information
Item 1. Legal Proceedings................................................................26
Item 6. Exhibits and Reports on Form 8-K.................................................26
Signature..................................................................................27
i
Part I
ITEM 1 - FINANCIAL STATEMENTS
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Balance Sheets
(Dollars in thousands)
June 30, 2004 December 31, 2003
-------------- -----------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 25,859 $ 28,143
Accounts receivable, less allowance for uncollectible accounts
of $1,179 and $1,181 in 2004 and 2003, respectively 10,988 11,339
Receivables, primarily from interexchange carriers, less
allowance for uncollectible accounts of $1,795 and $2,617
in 2004 and 2003, respectively 6,841 5,190
Rural Telephone Finance Cooperative stock to be redeemed - 1,354
Rural Telephone Finance Cooperative patronage capital receivable 1,200 2,976
Other current assets 3,467 3,873
-------- --------
Total current assets 48,355 52,875
-------- --------
Telephone plant and equipment 480,391 472,262
Less accumulated depreciation and amortization (172,479) (150,727)
-------- --------
Telephone plant and equipment, net 307,912 321,535
-------- --------
Other assets:
Rural Telephone Finance Cooperative stock, at cost 42,659 42,659
Goodwill 366,332 366,332
Other assets 23,626 23,741
-------- --------
Total other assets 432,617 432,732
-------- --------
Total assets $ 788,884 $ 807,142
======== ========
Liabilities and member's capital
Current liabilities:
Accounts payable and accrued expenses $ 40,178 $ 39,898
Other current liabilities 6,550 6,174
Current portion of long-term debt 9,385 6,996
-------- --------
Total current liabilities 56,113 53,068
-------- --------
Noncurrent liabilities:
Long-term debt 613,657 630,217
Other liabilities 83,400 84,369
-------- --------
Total noncurrent liabilities 697,057 714,586
-------- --------
Total liabilities 753,170 767,654
Member's capital:
Member's interest 251,284 251,284
Accumulated deficit (212,082) (208,308)
Accumulated other comprehensive loss (3,488) (3,488)
-------- --------
Total member's capital 35,714 39,488
-------- --------
Total liabilities and member's capital $ 788,884 $ 807,142
======== ========
See Notes to Condensed Consolidated Financial Statements.
1
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Operations and Comprehensive Loss
(Dollars in thousands)
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Operating revenues:
Local services $ 31,974 $ 31,047 $ 64,667 $ 61,981
Long distance services 3,710 4,060 7,516 7,874
Internet and enhanced data services 4,945 3,869 9,785 7,683
Edge-out services 3,070 3,544 6,201 7,145
Miscellaneous telecommunications
services and equipment 4,105 3,510 8,214 6,487
-------- -------- -------- --------
Total operating revenues 47,804 46,030 96,383 91,170
-------- -------- -------- --------
Operating expenses:
Cost of services 13,427 12,297 26,862 23,333
Depreciation and amortization 10,707 13,136 22,816 25,490
Selling, general and administrative expenses 9,888 9,831 20,056 19,125
-------- -------- -------- --------
Total operating expenses 34,022 35,264 69,734 67,948
-------- -------- -------- --------
Net operating income 13,782 10,766 26,649 23,222
Interest expense (15,114) (15,066) (30,287) (30,735)
Other income, net 727 618 1,592 1,118
-------- -------- -------- --------
Loss before income tax expense (605) (3,682) (2,046) (6,395)
Income tax expense (benefit) 1,889 77 1,728 (269)
-------- -------- -------- --------
Net loss (2,494) (3,759) (3,774) (6,126)
Other comprehensive income (loss):
Unrealized losses on marketable
equity securities - - - (198)
Reclassification adjustment for losses
included in net loss - 140 - 353
-------- -------- -------- --------
Other comprehensive income (loss) - 140 - 155
-------- -------- -------- --------
Comprehensive loss $ (2,494) $ (3,619) $ (3,774) $ (5,971)
======== ======== ======== ========
See Notes to Condensed Consolidated Financial Statements.
2
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statement of Member's Capital
(Dollars in thousands)
Accumulated
Other
Member's Accumulated Comprehensive
Interest Deficit Income (Loss) Total
---------- ----------- ------------- ---------
Balance at December 31, 2003 $ 251,284 $ (208,308) $ (3,488) $ 39,488
Net loss - (3,774) - (3,774)
--------- ---------- --------- --------
Balance at June 30, 2004 (unaudited) $ 251,284 $ (212,082) $ (3,488) $ 35,714
========= ========== ========= ========
See Notes to Condensed Consolidated Financial Statements.
3
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Six Months Ended June 30,
----------------------------
2004 2003
---------- ----------
Operating activities
Net cash provided by operating activities $ 19,028 $ 18,022
-------- --------
Investing activities
Purchases of telephone plant and equipment (8,285) (4,029)
Redemption of Rural Telephone Finance Cooperative stock, net 1,354 2,039
Change in other assets 62 1,470
-------- --------
Net cash used for investing activities (6,869) (520)
-------- --------
Financing activities
Redemption of minority interest - (1,000)
Repurchase of outstanding 13 1/4% senior notes (2,140) -
Payments on long-term debt (12,303) (13,550)
-------- --------
Net cash used for financing activities (14,443) (14,550)
-------- --------
Net (decrease) increase in cash and cash equivalents (2,284) 2,952
Cash and cash equivalents at beginning of year 28,143 19,954
-------- --------
Cash and cash equivalents at end of second quarter $ 25,859 $ 22,906
======== ========
See Notes to Condensed Consolidated Financial Statements.
4
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements
(Unaudited)
1. GENERAL
Madison River Capital, LLC (the "Company"), a wholly-owned subsidiary of
Madison River Telephone Company, LLC ("MRTC"), was organized on August 26,
1999 as a limited liability company under the provisions of the Delaware
Limited Liability Company Act. Under the provisions of this Act, the member's
liability is limited to the Company's assets provided that the member returns
to the Company any distributions received. The Company 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 219,600 voice access and DSL connections as of June 30, 2004.
The Company's RLECs manage and operate an edge-out competitive local
exchange carrier ("CLEC") business serving business customers primarily in
markets in North Carolina, Illinois and Louisiana. Through its CLEC
operations, the Company also provides fiber transport services to other
businesses, primarily in the southeastern United States. 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
June 30, 2004, the EOS operations served approximately 14,700 voice access
and high speed data connections.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed 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
These financial statements have been prepared by the Company in
accordance with generally accepted accounting principles for interim
financial information and are in the form prescribed by the Securities and
Exchange Commission in instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. The interim unaudited financial statements should be read in
conjunction with the audited financial statements of the Company as of and
for the year ended December 31, 2003. Such financial statements are included
in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2003 filed with the Securities and Exchange Commission on March
30, 2004. The amounts presented in the condensed consolidated balance sheet
as of December 31, 2003 were derived from the audited financial statements
included in the Form 10-K. In the opinion of management, all adjustments
(consisting only of normal recurring adjustments) considered necessary for a
fair presentation have been included. Operating results for the three-month
and six-month periods ended June 30, 2004 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2004.
Certain amounts in the 2003 condensed consolidated financial statements
have been reclassified to conform to the 2004 presentation. These
reclassifications had no effect on net loss or member's capital as previously
reported.
5
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
3. TELEPHONE PLANT AND EQUIPMENT
Telephone plant and equipment consisted of the following:
June 30, December 31,
2004 2003
--------- ------------
(in thousands)
Land, buildings and general equipment $ 54,241 $ 53,652
Central office equipment 161,101 157,572
Poles, wires, cables and conduit 232,814 230,772
Leasehold improvements 2,535 2,533
Software 18,698 18,600
Construction-in-process 11,002 9,133
--------- ---------
Total telephone plant and equipment $ 480,391 $ 472,262
========= =========
4. RESTRUCTURING CHARGE
In the fourth quarter of 2001, a subsidiary of the Company, MRC, recorded
a $2.8 million restructuring charge associated with the subsidiary's decision
to reduce its sales and marketing efforts and eliminate redundant support
services. The charge was recognized in accordance with EITF 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring)." The
amounts recorded consist primarily of the costs associated with future
obligations on non-cancelable leases for closed sales offices, redundant
network operations centers and future switching facilities, net of any
estimated sublease income, losses from the abandonment of fixed assets and
leasehold improvements associated with those leased facilities and legal
related expenses. As of June 30, 2004, the following amounts were recorded
related to this restructuring charge:
Balance at 2004 Balance at
December 31, 2003 payments June 30, 2004
----------------- ------------- --------------
(in thousands)
Future lease obligations $ 542 $ 90 $ 452
Legal related expenses 31 - 31
------ ----- ------
$ 573 $ 90 $ 483
====== ===== ======
In the third quarter of 2002, in completing the development of the EOS as
a true edge-out CLEC operation, the Company realigned the management of the
EOS's operating regions in North Carolina, Illinois and New Orleans under the
Company's RLECs in those respective regions. Correspondingly, the Company
recognized a restructuring charge of $2.8 million related to the realignment
for the elimination of redundant management, marketing and support services
and the structuring of a more efficient network. The charge was recognized
in accordance with EITF 94-3. The amounts recorded consisted primarily of
the costs associated with future obligations on non-cancelable leases for
certain facilities that were no longer used, net of estimated sublease
income, losses from the abandonment of fixed assets and leasehold
improvements associated with those leased facilities, expenses associated
with the elimination of thirty employees and related expenses. As of June
30, 2004, the following amounts were recorded related to this restructuring
charge:
Balance at 2004 Balance at
December 31, 2003 payments June 30, 2004
----------------- ------------- --------------
(in thousands)
Future lease obligations $ 271 $ 51 $ 220
====== ====== ======
The remaining liability for both restructuring charges as of June 30,
2004 is recorded as $0.3 million in accrued expenses and $0.4 million in
other long-term liabilities.
6
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
5. LONG-TERM DEBT AND LINES OF CREDIT
Long-term debt and lines of credit outstanding consist of the following at:
June 30, December 31,
2004 2003
---------- ------------
(in thousands)
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% (5.35% at June 30, 2004). $ 11,680 $ 11,680
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 5,924
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). 951 951
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). 102,486 102,486
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 5,557
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 67,384
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 3,544
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). 122,063 122,063
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 99,226
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% (5.3% at June 30, 2004). - 10,000
Mortgage note payable due in January 2004, interest at a fixed rate of 8%,
secured by land and building. - 2,303
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 $1,944 and $2,076, respectively. 196,056 197,924
Convertible note payable to related party 393 393
-------- --------
623,042 637,213
Less current portion 9,385 6,996
-------- --------
$ 613,657 $ 630,217
======== ========
7
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
5. LONG-TERM DEBT AND LINES OF CREDIT, Continued
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. Quarterly principal payments
through 2010 are $2.3 million with the first scheduled principal payment
occurring in the third quarter of 2004. Beginning in 2011, scheduled
principal payments increase, ranging from $8.9 million to $17.5 million per
quarter, through the end of 2016. 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. 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 RTFC loan agreement, including the Amendment, contains certain
financial ratios that are tested on an annual basis and other administrative
covenants. The financial ratios are based on the combined financial results
of MRLTDF and its subsidiaries, GRH, MRLDS and MLDS. Certain of the
administrative covenants restrict, among other things, the ability of these
combined entities to (i) declare or pay dividends to their respective parents
under specified circumstances, (ii) 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. In addition, the administrative covenants
require that the RTFC approve a three-year rolling capital expenditure budget
and give its consent to any acquisitions or disposals of local exchange
assets. Finally, MRLTDF and MRH have the ability to acquire the Company's
senior notes within certain limits as defined in the Amendment. At June 30,
2004, the Company was in compliance with the terms and conditions of the loan
agreement, including the Amendment.
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.
MRLTDF has an undrawn $31.0 million secured revolving line of credit with
the RTFC that is fully available and 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 $10.0 million under this line of
credit, which was repaid during the first quarter of 2004. The Company
intends to negotiate with the RTFC to extend this line of credit beyond its
expiration in March 2005.
The Company also has an undrawn $10.0 million line of credit that is
fully available to Coastal Utilities, Inc., a subsidiary of CCI, that expires
in March 2005. This line of credit 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. Effective April 30, 2004, as required by the Amendment, MRLTDF
granted the RTFC a first lien security interest in the assets of Coastal
Utilities, Inc. to secure this line of credit. The Company intends to
negotiate with the RTFC to extend this line of credit beyond its expiration
in March 2005.
8
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
5. LONG-TERM DEBT AND LINES OF CREDIT, Continued
The Company has outstanding 13 1/4% senior notes that mature in March
2010 and have semiannual interest payments due on March 1 and September 1 of
each year. In June 2004, as permitted under the terms of the Amendment with
the RTFC, MRLTDF acquired $2.0 million in outstanding senior notes for
approximately $2.1 million. The senior notes, which are held by MRLTDF, are
considered to be retired and the Company recognized approximately $0.2
million as a loss from the extinguishment of long-term debt in the second
quarter of 2004, which is reflected as other expense in the accompanying
condensed financial statements.
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 June 30, 2004, the Company was in compliance with the
terms of its indenture.
The Company had 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 $0.4 million as of June 30, 2004. 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
MRTC.
6. BENEFIT PLANS
The Company's net periodic benefit costs for the pension plan for the
second quarter and six months ended June 30, 2004 and 2003 are as follows:
Second quarter ended Six months ended
-------------------- -------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands)
Service cost $ 98 $ 105 $ 196 $ 210
Interest cost 186 173 373 345
Expected return on plan assets (189) (149) (379) (297)
Amortization of net loss (gain) 80 24 159 48
----- ----- ----- -----
Total net periodic benefit cost $ 175 $ 153 $ 349 $ 306
===== ===== ===== =====
The Company's net periodic benefit costs for the other postretirement
benefit plans for the second quarter and six months ended June 30, 2004 and
2003 are as follows:
Second quarter ended Six months ended
-------------------- -------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands)
Service cost $ 14 $ 9 $ 26 $ 18
Interest cost 27 25 53 49
Amortization of net loss (gain) (36) (39) (73) (78)
Amortization of prior service cost (21) (24) (42) (48)
----- ----- ----- -----
Total net periodic benefit cost $ (16) $ (29) $ (36) $ (59)
===== ===== ===== =====
The Company expects to contribute approximately $2.1 million to its
pension plan in 2004. The Company made contributions of $1.0 million in the
first six months of 2004.
9
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
6. BENEFIT PLANS, Continued
During the first quarter of 2003, the Company notified its employees who
are not members of bargaining units that the accrual of benefits in the non-
contributory, defined benefit pension plan, sponsored by MRTC, in which the
employees participated was frozen effective February 28, 2003. As a result
of this action, Statement of Financial Accounting Standards No. 88,
Employer's Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits became effective. The curtailment
resulted in an immediate net gain of $2.8 million, of which $2.7 million was
recognized as a reduction of pension expenses in the first quarter and $0.1
million as a reduction of capital expenditures. The impact of the gain was
allocated between the Company and its subsidiaries, who also participate in
the plan. Although the accrual of benefits in the pension plan is frozen,
the Company has a continuing obligation to fund the plan and will continue to
recognize an annual net periodic pension expense while the plan is still in
existence.
7. 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 a C
corporation to a limited liability corporation for income tax purposes.
MRH, a wholly-owned subsidiary of the Company, is the holding company for
the Company's other taxable C corporations that include, MRLTDF, Mebtel, GCSI
and its subsidiaries, CCI and its subsidiaries, MLDS, MRLDS, and MRM. 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.
During the fourth quarter of 2003, the Company recognized an income tax
benefit of $2.7 million for refunds received in 2002 from amendments to its
1998 income tax returns. The benefit was recognized after the Company was
advised the statute of limitations for taxing authorities to make audit
adjustments to the 1998 income tax returns had expired during 2003. However,
in June 2004, the Department of Justice, on behalf of the Internal Revenue
Service, filed suits against two of the Company's subsidiaries that received
the refunds and recognized the benefit, Gulf Coast Services, Inc. and Coastal
Utilities, Inc., claiming that the refunds were erroneous refunds. The suits
included claims in the amount of approximately $2.9 million for income tax
refunds plus related interest expense. Approximately $0.9 million of this
claim was paid in the first quarter of 2004 as part of a separate year income
tax audit adjustment. Accordingly, the Company accrued approximately $2.0
million in income tax expense and $0.4 million in interest expense during the
second quarter of 2004 to recognize the remaining potential exposure under
the suits. Based on discussions with its tax advisors, the Company believes
that its position taken in the amended income tax returns was appropriate
under current tax laws and the Company intends to review all alternatives
including vigorously defending against these claims.
8. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities" ("VIEs"), 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 and to determine
when and which business enterprise should consolidate the VIEs. This new
model applies when either (1) the equity investors (if any) do not have a
controlling financial interest or (2) the equity investment at risk is
insufficient to finance the entity's activities without additional financial
support. FIN 46 also requires additional disclosures. The Interpretation was
effective immediately for interests acquired subsequent to January 31, 2003
and was effective March 31, 2004 for interests in VIEs created before
February 1, 2003. The Company has not obtained an interest in any VIEs since
January 31, 2003. The Company determined that an unconsolidated company in
which it holds an investment accounted for under the equity method is a VIE
under FIN 46 but the Company is not the primary beneficiary of the VIE. As a
result, the provisions of FIN 46 did not have an impact on the Company's
financial condition or results of operations.
10
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
9. 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 for each segment for the three and six month periods
ended June 30, 2004 and 2003:
Three Month Period Ended Six Month Period Ended
------------------------ ----------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
(in thousands)
Total revenues
RLEC operations $ 45,396 $ 43,388 $ 91,509 $ 85,591
EOS 3,103 3,718 6,266 7,334
------- ------- ------- -------
48,499 47,106 97,775 92,925
Less intersegment revenues (695) (1,076) (1,392) (1,755)
------- ------- ------- -------
Total reported revenues $ 47,804 $ 46,030 $ 96,383 $ 91,170
======= ======= ======= =======
Net operating income (loss):
RLEC operations $ 16,050 $ 13,946 $ 31,783 $ 28,977
EOS (2,268) (3,180) (5,134) (5,755)
------- ------- ------- -------
Total reported net operating
income $ 13,782 $ 10,766 $ 26,649 $ 23,222
======= ======= ======= =======
At June 30, 2004 and December 31, 2003, total assets by segment, net of
intersegment investments and other intersegment balances, were as follows:
June 30, December 31,
2004 2003
--------- ------------
(in thousands)
Total assets:
RLEC operations $ 833,913 $ 868,472
EOS 446,212 432,326
---------- ----------
1,280,125 1,300,798
Less intersegment assets (491,241) (493,656)
---------- ----------
Total reported assets $ 788,884 $ 807,142
========== ==========
11
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements in this Form 10-Q constitute "forward-looking
statements" that involve risks and uncertainties. Forward-looking statements
generally can be identified by the use of forward-looking words such as
"may," "will," "expect," "intend," "estimate," "anticipate," "plan," "seek"
or "believe," or by discussion of strategy that involves risks and
uncertainties. We believe that the expectations reflected in such forward-
looking statements are accurate. However, we cannot assure you that such
expectations will occur. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of various
factors, including, but not limited to:
* the competition in, and the financial stability of, the
telecommunications industry;
* the passage of legislation, court decisions or regulatory changes
adversely affecting the telecommunications industry;
* our ability to repay our outstanding indebtedness;
* our ability to raise additional capital on acceptable terms and on a
timely basis; and
* the advent of new technology.
For more information, see the "Risk Factors" section beginning on page
18 of our Annual Report on Form 10-K for the fiscal year ended December 31,
2003 (File No. 333-36804) filed with the Securities and Exchange Commission.
Except as required by law, we are not obligated to publicly release any
revisions to these forward-looking statements to reflect events or
circumstances occurring after the filing of this Form 10-Q or to reflect the
occurrence of unanticipated events.
References in this Form 10-Q to "we," "us" and "our" mean Madison River
Capital, LLC and its subsidiaries.
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 June 30, 2004, we had 234,272 voice, DSL and high speed data
connections in service.
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 are controlling expenses through the use of
business process management tools and other methods. In our edge-out
services, our strategy is to maintain sustainable positive cash flow from
this line of business and to continue the development of a profitable
customer base. We have established rigorous criteria for evaluating new
customers and the desirability of renewing existing contracts.
12
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 six months ended June 30, 2004,
approximately 93.6% of our operating revenues came from our RLEC operations
and 6.4% from our edge-out services. For the same period in 2003,
approximately 92.2% of our operating revenues came from our RLEC operations
and 7.8% 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 increase 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 June 30, 2004, we had 234,272 connections in service compared to
223,660 connections in service at June 30, 2003, an increase of 10,612
connections or 4.7%. Our RLEC operations had 219,585 connections in service
at June 30, 2004 and 206,982 connections in service at June 30, 2003, an
increase of 12,603 connections or 6.1%. For the edge-out services,
connections in service at June 30, 2004 and June 30, 2003 were 14,687 and
16,678, respectively, a decrease of 1,991 connections or 11.9%.
The services we offer to customers may be purchased separately, but are
increasingly being included in a package with selected other service
offerings, often referred to as bundling, and sold at a discount. An
important part of our sales and marketing strategy for our RLECs emphasizes
the bundling of services and the benefits it provides to our customers.
During the past year, we have introduced a residential bundled offering which
we have branded as our "No Limits" package. The No Limits bundle is marketed
to our residential customers at approximately $85 per month, with the price
varying slightly by location. 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.
After a successful introduction in our North Carolina market in July
2003, the No Limits bundled offering was introduced in each of our other
three RLEC markets in the latter part of the fourth quarter of 2003. Our
results show that the No Limits package has been successful in increasing
penetration rates in services such as DSL and long distance and we expect
this trend to continue during 2004. Many of our customers selecting the No
Limits package are new DSL subscribers and long distance customers and this
has led to an overall increase in our monthly average revenue per unit for a
subscriber of the bundle of approximately $15. We intend to continue to
offer other combined service discounts and programs designed to give
customers incentives to buy bundled services.
The number of DSL subscribers we serve in our RLECs has continued to
increase. With the introduction of our No Limits package, we have seen the
rate of net additions in DSL subscribers accelerate in the first two quarters
of 2004 compared to prior quarters. We believe we have been successful in
addressing competition from new high speed Internet access product
introductions, particularly by cable operators, in our markets in recent
years. We believe that the execution of our strategy and our ability to
deliver a quality DSL product at a competitive price and in a timely manner
has made us the provider of choice in our markets. As of June 30, 2004, our
penetration rate for residential DSL connections as a percentage of primary
residential voice access lines was 26.9% compared to 14.7% at June 30, 2003.
Our analysis indicates that our penetration rate for residential DSL is among
the highest penetration rates of high-speed broadband service in the United
States. Although we cannot be certain, we anticipate that our DSL product
will continue to provide a source of increasing revenues for our RLECs in
future quarters although we don't expect to maintain the rate of net
additions that we have experienced in the first two quarters of 2004. As of
June 30, 2004, we had 34,254 DSL connections in service, an increase of 3,608
connections from 30,646 DSL connections in service at March 31, 2004 and an
increase of 14,817 connections from 19,437 DSL connections in service at June
30, 2003.
13
As we have increased the number of DSL connections we serve, we have
experienced a decrease in the number of dial-up Internet accounts we service.
At June 30, 2004, we had 18,190 dial-up Internet customers which was a
decrease of 7,591 customers, or 29.4%, from 25,781 dial-up Internet customers
at June 30, 2003. 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.
We have also been successful in growing penetration rates in our RLECs
for the provision of long distance and vertical services to our customers,
primarily as a result of our No Limits offering. At June 30, 2004, we had
100,713 long distance accounts compared to 93,898 long distance accounts at
June 30, 2003. In addition, our penetration rates for voicemail, caller
identification, call waiting and call forwarding have increased over June 30,
2003.
During the second quarter of 2004, we introduced a new bundled offering
in our North Carolina market on a test basis. The new offering, which we are
referring to as No Limits Voice, is essentially our No Limits bundle without
the DSL service. We intend to develop the marketing for this bundle in our
North Carolina market and assess its performance before determining when we
will introduce it in our larger RLECS, if at all.
In recent quarters, we have seen a decline in the number of voice access
lines in service in our RLECs. For the quarter ended June 30, 2004, the
RLECs finished with 185,331 voice access lines in service, which is a
decrease of 2,214 voice access lines from 187,545 voice access lines in
service at June 30, 2003. The decrease in voice access lines is primarily
attributed to the decrease in second lines in service in our RLEC markets.
Second lines in service at June 30, 2004 decreased to 7,336 voice access
lines from 9,554 voice access lines at June 30, 2003, a decrease of 2,218
second lines. We believe this is the result of our existing customers
migrating from our dial-up Internet service, where they may also purchase a
second line from us, to our DSL service where they no longer need a second
line. Therefore, we believe as we increase the number of DSL connections we
serve, correspondingly, we will experience a decrease in the number of second
lines we serve. In terms of primary voice access lines, which we define as
total voice access lines less second lines, our Illinois operations, Gallatin
River Communications, continued to lose primary voice access lines as a
result of the slow economic environment in which it operates. Although we
are uncertain at this time regarding the future trend for voice access lines
at Gallatin River Communications, the rate at which voice access lines in
this market is decreasing has slowed during the past two quarters compared to
previous quarters. Our remaining three RLECs showed growth in the number of
primary voice access lines served at June 30, 2004 when compared to June 30,
2003.
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 transition and future
deployment. However, as it is early in the process, we continue to monitor
the progress as it is reported and we are working to understand the impact of
this transformation on Coastal Utilities' operations. We intend to assess
the impact on our operations and cash flows at a future date. 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. As
many details regarding this troop deployment are currently unavailable, we
are unable to project the range of the impact of this deployment on Coastal
Utilities or our operations as a whole at this time.
We are also continuing to assess the potential benefits of adding a video
offering to our current suite of voice products we offer to our customers.
However, at this time our evaluation of different alternatives is ongoing and
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 revenues from our edge-out services in
the first six months of 2004 compared to the first six months of 2003 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 June
30, 2004, our edge-out services had 14,012 voice access lines and 675 high
speed data connections in service. At June 30, 2003, our edge-out services
served 15,965 voice access lines and 713 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 in the third quarter of
2003. In addition, a customer in our edge-out services, representing
recurring monthly revenues of approximately $55,000, notified us of its
intention to replace our service during the third quarter of 2004. 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.
14
Bankruptcies by interexchange carriers in recent years, including MCI
WorldCom and Global Crossing, have impacted our financial results including
our revenues 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. At June 30,
2004. we had approximately $1.8 million reserved against our interexchange
carrier receivables.
Expenses
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, DSL costs
including modems, peripheral materials and egress and transport,
information origination/termination expense, underlying carrier costs
for long distance transmissions services and cable and wire facilities
expense;
* plant nonspecific costs, such as testing, provisioning, ISP external help
desk costs, network administration, outside plant administration, power
and engineering;
* the cost of collocating in ILEC central offices and leasing unbundled
copper loop lines and high capacity digital lines from the ILECs to
connect our customers and other carriers' networks to our network; and
* the cost of leasing transport from ILECs or other providers where our
fiber transport capacity is not available.
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. During the third quarter of
2003, we renewed our agreement with Global Crossing until April 2005 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, each of the edge-out services currently has the necessary
certifications to operate in the states where it has customers.
In response to a decision by the United States Court of Appeals for the
District of Columbia to vacate certain portions of the Federal Communication
Commission's, or FCC's, Triennial Review Order, SBC and BellSouth have
notified us of their intent to use change of law provisions in our
interconnection agreements to reduce or eliminate requirements they have to
provide network facilities at unbundled network elements, or UNE, pricing.
We are unclear if the court order would allow SBC or BellSouth to take such
an action, or whether state commissions would support such changes in the
event the interconnection agreements are subjected to arbitration. Further,
it is not clear what actions, if any, the FCC may take to establish interim
or permanent rules addressing the obligations of SBC and BellSouth to provide
such UNEs at their current pricing. Pending further clarification and
guidance from the FCC, we may enter into good faith discussions with SBC and
BellSouth on amendment to these provisions of our interconnection agreements.
Although we do not expect any changes to our UNE rates in 2004, significant
increases in UNE pricing, currently based on FCC TELRIC pricing rules, would
significantly increase the cost of obtaining facilities necessary to provide
services to customers in our edge-out markets and would have a material
impact on the results of operations and cash flows of our edge-out services.
Our objective for the edge-out services has been to maintain a line of
business that generates sufficient cash flows to fund its own operations and
capital requirements and does not harm the enterprise as a whole. Given the
developments with the edge-out services discussed herein, we intend to
analyze its financial and operating results to determine that our objective
is being accomplished.
15
Selling, general and administrative expenses
Selling, general and administrative expenses include:
* selling and marketing expenses;
* expenses associated with customer care;
* billing and other operating support systems; and
* corporate expenses.
We market our business services through agency relationships and
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. 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 accordance with
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"), goodwill and intangible assets deemed to have
indefinite lives are no longer permitted to be amortized but are subject to
impairment tests at least annually in accordance with the tenets of SFAS 142.
Summary
Our actual future operating results may differ from our current
projections, and those differences may be material. 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. 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.
Results of Operations
Six Months ended June 30, 2004 compared to Six Months ended June 30, 2003
- -------------------------------------------------------------------------
Total revenues were $96.4 million and $91.2 million for the six month
periods ended June 30, 2004 and June 30, 2003, respectively, an increase of
$5.2 million, or 5.7%. Revenues in the RLEC operations increased
approximately $6.2 million, or 7.3%, to $90.2 million in the first six months
of 2004 from $84.0 million in the first six months of 2003. In the first six
months of 2004, revenues from local services increased $2.7 million, Internet
and enhanced data services increased approximately $2.1 million and
miscellaneous revenues increased approximately $1.7 million compared to the
same period in 2003. Local service revenues increased primarily as a result
of higher network access revenues from certain non-recurring revenues from
wireless settlements and other carrier access revenues and settlements for
updated cost study filings. The increase in Internet and enhanced data
revenues is attributed to an increase in the number of DSL subscribers. At
June 30, 2004, our RLECs served 34,254 DSL subscribers compared to 19,437 at
June 30, 2003, an increase of 14,817 connections, or 76.2%. The growth in
DSL connections has been generated by increased acceptance of our No Limits
bundled offering. We introduced the No Limits package in our North Carolina
market during the third quarter of 2003. Based on our successful results in
North Carolina, we introduced the No Limits package in our remaining three
RLECs during the fourth quarter of 2003 where it has also received strong
market acceptance. The increase in miscellaneous telecommunications service
and equipment revenues is attributed largely to higher revenues of
approximately $1.4 million from one-time construction projects and a decrease
in uncollectibles of approximately $0.2 million. These increases in RLEC
revenues were partially offset by a decrease of approximately $0.4 million in
private label long distance revenues. The decrease in long distance revenues
16
is attributed to two factors. First, as a result of the success of the No
Limits bundle, more customer billings reflect a flat rate charge for long
distance service compared to the higher usage based billings for these
customers in prior periods. Second, in the second quarter of 2004, we
reclassified approximately $0.1 million of private label long distance
revenues to local service revenues to properly reflect the nature of these
certain revenues. Revenues from our edge-out services decreased
approximately $1.0 million, or 13.2%, to $6.2 million in the first half of
2004 from $7.2 million in the first half of 2003. The decrease is attributed
primarily to a $0.7 million decrease in local service revenues as the result
of a decrease in the number of connections served. At June 30, 2004 and 2003,
our edge-out services served approximately 14,687 and 16,678 voice access and
high speed connections, respectively, representing an 11.9% decrease.
During the first six months of 2004, our RLECs entered into reciprocal
compensation agreements with most of the major wireless carriers which
provide service in our RLEC service territories. These agreements establish
mutual compensation rates for termination of local traffic originated by the
other party's customers. These agreements generally replace other settlement
arrangements and add stability to our reciprocal compensation revenues and
expenses. In the near future, our RLECs expect to complete agreements with
the remaining wireless carriers with significant traffic providing wireless
services in our RLEC serving areas.
For the first six months of 2004, our RLEC operations and edge-out
services provided approximately 93.6% and 6.4%, respectively, of our
revenues. Comparatively, for the first six months of 2003, our RLEC
operations provided 92.2% of our revenues and our edge-out services provided
7.8% of our revenues. Revenues from voice services, which are comprised of
local, network access and long distance service, as a percentage of total
revenues, were approximately 79.0% and 81.7% for the six months ended June
30, 2004 and 2003, respectively. The decrease in the percentage of our
revenues coming from voice services reflects the growth in our high-speed DSL
business and the impact of the one-time construction projects on our 2004
financial results.
Total operating expenses increased approximately $1.7 million from $68.0
million, or 74.5% of total revenues in the first six months of 2003, to $69.7
million, or 72.4% of total revenues in the first six months of 2004. The
increase can be attributed to a one-time, non-cash gain of approximately $2.7
million from a pension curtailment in the first quarter of 2003. The gain
resulted in a reduction in 2003 pension expense in the RLEC operations and
the edge-out services whereas no comparable gain was recognized in the first
quarter of 2004. Approximately $2.1 million of the net gain was recognized
as a reduction of pension expenses in the RLEC operations and $0.6 million as
a reduction of pension expenses in the edge-out services.
In the RLEC operations, operating expenses in the six months ended June
30, 2004 were $58.4 million, an increase of $3.3 million, or 6.1%, from
operating expenses of $55.1 million in the first six months of 2003.
Approximately $2.1 million of the increase is the result of the pension
curtailment gain recorded in the first quarter of 2003. In addition,
operating expenses increased in the first six months of 2004 as a result of
an increase of $0.9 million from an increase in costs to terminate long
distance calls primarily as a result of an increase in access minutes of use
related to the No Limits package, and a $0.9 million increase in operating
expenses for DSL modems used in the RLEC operations in the first six months
of 2004. In the first six months of 2003, DSL modems were capitalized under
the Company's accounting policies. Beginning in the third quarter of 2003,
the Company began expensing DSL modems as the cost of a DSL modem fell below
the threshold for capitalization. Finally, operating expenses in the first
six months of 2004 include approximately $1.1 million for costs related to
nonrecurring construction projects. Partially offsetting these increases in
operating expenses were a decrease in depreciation and amortization expenses
of $1.5 and a reduction in long-term incentive expense of $1.2 million in the
first six months of 2004 when compared to the first six months of 2003. The
decrease in depreciation and amortization expenses is largely due to certain
classes of assets becoming fully depreciated.
Operating expenses in our edge-out services decreased approximately $1.6
million from $12.9 million in the first six months of 2003 to $11.3 million
in the first six months of 2004. Approximately $0.6 million can be
attributed to the pension curtailment gain. In addition, nonrecurring
settlements from several disputes arising out of interconnection agreements
totaling approximately $0.6 million reduced cost of services in the first six
months of 2004 whereas no comparable settlements were recorded in the first
six months of 2003. Also, depreciation expenses in the six months ended June
30, 2004 decreased $1.2 million compared to the six months ended June 30,
2003. The decrease in depreciation expenses is primarily attributed to
certain assets becoming fully depreciated while no significant capital
investment has been made in the edge-out services in recent years. The
strategy to achieve positive cash flow in the edge-out services with a slower
targeted growth rate and the realignment of the edge-out service operations
under the responsibility of the RLECs has significantly reduced the amount of
capital expenditures made to support this line of business.
Net operating income increased approximately $3.5 million from $23.2
million, or 25.5% of total revenues in the first six months of 2003, to $26.7
million, or 27.7% of total revenues in the first six months of 2004. The
17
increase is primarily attributable to the increase in revenues in the RLEC
operations. Net operating income in the RLEC operations increased $2.9
million, or 9.7%, to $31.8 million in the first six months of 2004 from $28.9
million in the first six months of 2003. For the edge-out services, the net
operating loss improved $0.6 million, or 10.8%, to $5.1 million in the six
month period ended June 30, 2004 from $5.7 million in the six month period
ended June 30, 2003.
Interest expense decreased $0.4 million to $30.3 million, or 31.4% of
total revenues, in the first six months of 2004 compared to $30.7 million, or
33.7% of total revenues, in the first six months of 2003. The decrease in
interest expense is attributed primarily to a lower average outstanding
balance of long-term debt during the first six months of 2003 compared to the
first six months of 2002. This decrease was partially offset by an accrual
for interest expense of approximately $0.4 million in the second quarter of
2004 related to income tax refunds that are the subject of two lawsuits filed
against us as further discussed herein.
For the six month period ended June 30, 2004, we had other income of $1.6
million compared to other income of $1.1 million in the six month period
ended June 30, 2003, a change of $0.5 million, or 42.4%. The increase is
attributed primarily to approximately $0.4 million in realized losses on the
disposal of marketable equity securities in the first six months of 2003
whereas no comparable realized losses were recognized in the first six months
of 2004.
Income tax expense in the first six months of 2004 was $1.7 million, an
increase of $2.0 million from an income tax benefit of $0.3 million
recognized in the first six months of 2003. In the fourth quarter of 2003,
we recognized an income tax benefit of $2.7 million for refunds received in
2002 from amendments made to our 1998 income tax returns. The benefit was
recognized after we were advised that the statute of limitations for taxing
authorities to make audit adjustments to our 1998 income tax returns had
expired in 2003. However, in June 2004, the Department of Justice, on behalf
of the Internal Revenue Service, filed suits against two of our subsidiaries
that received the refunds and recognized the benefit, Gulf Coast Services,
Inc. and Coastal Utilities, Inc. The lawsuits claim that the refunds were
erroneous refunds in the amount of approximately $2.9 million. Approximately
$0.9 million of these claims were paid in the first quarter of 2004 as part
of a separate year income tax audit adjustment. Accordingly, we accrued the
remaining $2.0 million in income tax expense and $0.4 million in interest
expense during the second quarter of 2004 to recognize the remaining
potential exposure under the suits. Based on discussions with our tax
advisors, we believe that our position taken in the amended income tax
returns was appropriate under current tax laws and we intend to review all
alternatives including vigorously defending against these claims.
Our net loss improved $2.3 million from a net loss of $6.1 million, or
6.7% of total revenues, in the first six months of 2003, to $3.8 million, or
3.9% of total revenues, in the first six months of 2004, as a result of the
factors discussed above. The RLEC operations reported net income of $14.5
million in the first six months of 2004 compared to net income of $13.1
million in the first six months of 2003, an increase of $1.4 million. For
the six month periods ended June 30, 2004 and 2003, our edge-out services had
net losses of $18.3 million and $19.2 million, respectively, an improvement
of $0.9 million.
Second Quarter Ended June 30, 2004 compared to Second Quarter Ended June 30,
2003
- ----------------------------------------------------------------------------
Total revenues for the second quarter ended June 30, 2004 were $47.8
million, an increase of $1.8 million, or 3.9%, from total revenues of $46.0
million for the second quarter ended June 30, 2003. The increase is
attributable to a $2.3 million increase in revenues in the RLEC operations
that was partially offset by a decrease of $0.5 million in revenues from
edge-out services. For the second quarter of 2004, the RLEC operations
reported revenues of $44.8 million, an increase of $2.3 million, or 5.3%,
from revenues in the second quarter of 2003 of $42.5 million. The increase
in revenues consists primarily of a $1.1 million increase in Internet and
enhanced data revenues, a $0.9 million increase in local service revenues and
a $0.6 million increase in miscellaneous telecommunications revenues. The
increase in Internet and enhanced data revenues is attributed to the increase
in DSL connections in the second quarter of 2004 compared to the second
quarter of 2003. The increase in local service revenues is attributed
primarily to an increase in network access revenues from certain non-
recurring revenues from wireless settlements and other carrier access
revenues and settlements for updated cost study filings. The increase in
miscellaneous telecommunications service and equipment revenues is attributed
largely to revenues of approximately $0.8 million from one-time construction
projects. The increases in RLEC revenues were partially offset by a $0.3
million decrease in long distance revenues. Long distance revenues decreased
as a result of the No Limits bundle where more customer billings reflect a
flat rate charge for long distance service compared to the higher usage based
billings for these customers in prior periods and a reclassification of
approximately $0.1 million in private label long distance revenues to local
service revenues that was made in the second quarter of 2004.
Revenues in the edge-out services in the second quarter of 2004 were $3.0
million, a decrease of $0.5 million, or 13.4%, from revenues of $3.5 million
in the second quarter of 2003. The decrease in revenues from our edge-out
18
services is largely due to a decrease in the number of connections in service
during the second quarter of 2004 compared to the same period in 2003.
Revenues from voice services, which are comprised of local, network
access and long distance services, as a percentage of total revenues, were
approximately 78.7% and 81.3% for the quarters ended June 30, 2004 and 2003,
respectively. The RLEC operations and the edge-out services provided
approximately 93.6% and 6.4% of total revenues, respectively, in the second
quarter of 2004.
Total operating expenses decreased $1.2 million from $35.2 million, or
76.6% of total revenues in the second quarter of 2003, to $34.0 million, or
71.2% of total revenues in the second quarter of 2004. Operating expenses in
the RLEC operations were approximately $28.7 million in the second quarter of
2004 compared to $28.5 million in the second quarter of 2003, an increase of
$0.2 million, or 0.5%. Cost of services in the RLEC operations increased
$1.9 million, or 18.3%, to $12.1 million in the second quarter of 2004 from
$10.2 million in the second quarter of 2003. The increase is attributed
largely to an increase of approximately $0.8 million in expenses for
nonrecurring construction projects, an increase of approximately $0.3 million
in expenses for DSL modems used in the RLEC operations and an increase of
approximately $0.3 million in costs to terminate long distance calls
primarily as a result of an increase in access minutes of use related to the
No Limits package. Depreciation and amortization expense in the second
quarter of 2004 decreased approximately $1.6 million when compared to the
second quarter of 2003. The decrease in depreciation and amortization
expenses is largely due to certain classes of assets becoming fully
depreciated. Selling, general and administrative expenses decreased
approximately $0.1 million in the second quarter of 2004 compared to the
second quarter of 2003. In the edge-out services, operating expenses in the
second quarter of 2004 were approximately $1.4 million lower than operating
expenses in the second quarter of 2003. The decrease is attributed primarily
to a $0.8 million decrease in depreciation and amortization expenses and $0.6
million from nonrecurring settlements from several disputes arising out of
interconnection agreements.
Net operating income increased $3.0 million, or 28.0%, from $10.8 million
in the second quarter of 2003, or 23.4% of total revenues to $13.8 million in
the second quarter of 2004, or 28.8% of total revenues. Net operating income
for the RLEC operations in the first quarter of 2004 was $16.1 million
compared to $14.0 million in the second quarter of 2003, an increase of $2.1
million, or 15.1%. The net operating loss in the edge-out services improved
$0.9 million, from a net operating loss of $3.2 million in the first quarter
of 2003 to a net operating loss of $2.3 million in the second quarter of
2004.
Interest expense was $15.1 million in both the second quarter of 2004 and
the second quarter of 2003. This represented 31.6% and 32.7% of total
revenues in 2004 and 2003, respectively. A decrease in interest expense as a
result of a lower weighted average balance of long-term debt outstanding in
the second quarter of 2004 compared to the second quarter of 2003 was offset
by the $0.4 million accrual of interest expense in the second quarter of 2004
related to certain income tax refunds that are the subject of two lawsuits
that were filed in June 2004.
Other income was $0.7 million in the second quarter of 2004 compared to
$0.6 million in the second quarter of 2003, an increase of $0.1 million. The
increase is attributed largely to approximately $0.2 million in realized
losses on the disposal of marketable equity securities in the second quarter
of 2003 whereas no comparable realized losses were recognized in the second
quarter of 2004.
Income tax expense was $1.9 million in the second quarter of 2004, an
increase of $1.8 million from income tax expense of $0.1 million reported in
the second quarter of 2003. The increase in income tax expense is attributed
to the accrual of $2.0 million in income tax expense to reverse the
recognition of an income tax benefit for two refunds that are the subject of
lawsuits claiming that such refunds were made erroneously.
Net loss decreased $1.3 million from $3.8 million, or 8.2% of total
revenues, in the second quarter of 2003, to $2.5 million, or 5.2% of total
revenues, in the second quarter of 2004, as a result of the factors discussed
above. The RLEC operations reported net income of $6.2 million in the second
quarter of 2004, an increase of $0.1 million, or 2.2%, compared to net income
of $6.1 million in the second quarter of 2003. The edge-out services
reported a net loss of $8.7 million in the second quarter of 2004 compared to
a net loss of $9.9 million in the second quarter of 2003, an improvement of
$1.2 million, or 11.5%.
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 flows. 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.
19
At June 30, 2004, we had total liquidity of $66.9 million which consists
of cash and cash equivalents of $25.9 million and available borrowings on our
lines of credit with the RTFC of $41.0 million. As a result of our amendment
to our loan agreement with the RTFC, which is further described below, our
liquidity position has been enhanced. We believe 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 and maintaining
operating improvements and efficiencies in our business processes to reduce
our operating expenses as well as the execution of a disciplined approach to
evaluating and making capital expenditures and accordingly, our use of cash
to fund our operations and facilities has been reduced.
At June 30, 2004, we had a working capital deficit of approximately $7.8
million compared to a working capital deficit of $23.4 million at June 30,
2003. The improvement is attributed to the change in the current portion of
long-term debt as a result of the amendment entered into with the RTFC in the
third quarter of 2003. 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 $9.4 million at June 30, 2004
compared to $28.7 million at June 30, 2003, a change of $19.3 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 begin in 2005
and will be based on our RLECs 2004 financial results. We are uncertain what
mandatory prepayments will have to be made, if any, at this time.
Operating Activities. For the six months ended June 30, 2004 and 2003,
we generated cash from operating activities of $19.0 million and $18.0
million, respectively.
Investing Activities. For the six months ended June 30, 2004, net cash
used for investing activities was $6.9 million and consisted of $8.3 million
in cash used for the purchase of telephone plant and equipment partially
offset by cash received from the redemption of subordinated capital
certificates by the RTFC in the amount of $1.4 million. For the six months
ended June 30, 2003, net cash used in investing activities was $0.5 million
and consisted primarily of $4.0 million used for the purchase of telephone
plant and equipment partially offset by $2.0 million in cash received from
the redemption of subordinated capital certificates by the RTFC and $1.4
million from changes in other assets.
Financing Activities. For the six months ended June 30, 2004, net cash
used for financing activities included $12.3 million used to retire long-term
debt and $2.1 million for the repurchase of a portion of our 131/4% senior
notes in the open market. For the six months ended June 30, 2003, net cash
used in financing activities included $13.6 million used for repayment of
long-term debt and $1.0 million for the partial redemption of a minority
interest in CCI.
Long-Term Debt and Revolving Credit Facilities
We or our subsidiaries have outstanding term and revolving credit
facilities totaling $426.6 million with the RTFC, which were entered into in
connection with our four RLEC acquisitions. In addition, we have outstanding
$198.0 million in 131/4% senior notes that are due in March 2010 and a $0.4
million miscellaneous note payable. In January 2004, a $2.3 million mortgage
note payable entered into at the time of the Coastal Communications
acquisition, and secured by land and buildings used in those operations, was
repaid in full.
RTFC Debt Facilities
- --------------------
Our subsidiary, MRLTDF, is the borrower under a loan agreement with the
RTFC. MRLTDF is the holding company for three of our RLECs: Mebtel, GCSI and
CCI. Each of these RLECs and 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 June 30, 2004, 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 5.35% at June 30, 2004.
In July 2003, MRLTDF executed an amendment to its loan agreement with the
RTFC which, among other things, created greater operating flexibility through
an increase in our available liquidity. Under the terms of the amendment,
20
our loan agreement was extended to November 2016. The amendment also provided
us with a reduction in scheduled principal payments through 2010. Quarterly
principal payments through 2010 are approximately $2.3 million with the first
scheduled principal payment occurring in the third quarter of 2004. Beginning
in 2011, scheduled principal payments increase, ranging from $8.9 million to
$17.5 million per quarter through the end of 2016. 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 calculated as 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. The 1.0% interest rate adder is subject to performance
pricing which will provide for a reduction in the interest rate adder as our
Total Leverage Ratio, as defined in the amendment, decreases. The interest
rate adder will remain at 1.0% while the Total Leverage Ratio is greater than
5.0 to 1.0. It decreases to 0.75% when the Total Leverage Ratio is between
4.0 to 1.0 and 5.0 to 1.0 and decreases to 0.5% when the Total Leverage Ratio
is less than 4.0 to 1.0.
In addition, certain covenants were added or revised under the amendment
and we will continue to test our compliance with the 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 131/4% 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 MRH, MLDS and MRLDS, and the equity interests in those entities
were pledged in support of the loan facilities thereby providing the RTFC
with a first lien security interest in all of the assets and 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 June 30, 2004, we owned $42.7 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, in the
first quarter of 2004, based on principal payments of $13.5 million made to
the RTFC in 2003, we received approximately $1.4 million in cash for SCCs
that were eligible to be redeemed. In March 2003, the RTFC redeemed
approximately $2.0 million of our SCCs for cash. As we have made no
principal payments yet in 2004 to the RTFC, we currently have no SCCs that
are eligible for redemption in 2005.
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 two secured revolving lines
of credit with the RTFC. One line of credit is a $31.0 million facility at
MRLTDF and has no annual paydown provisions. This 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 5.3% at June 30, 2004. During the first
quarter of 2004, we repaid the $10.0 million we had advanced against this
line of credit at December 31, 2003. The entire $31.0 million is fully
available to be drawn. The second line of credit is a $10.0 million facility
that is available to Coastal Utilities, Inc. for general corporate purposes
and expires in March 2005. Under the terms of this line of credit facility,
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. This 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. This line of credit was initially
unsecured. Under the terms of the amendment executed in July 2003, we agreed
to provide the RTFC with a first lien security interest in the assets of
Coastal Utilities, Inc. to secure this line of credit which we completed in
21
April 2004. 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,
contain 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, as well as 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 entities and not to us or our other subsidiaries
to fund our obligations. At June 30, 2004, 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
131/4% 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. In June 2004, as permitted under the terms of the amendment
to its loan agreement with the RTFC, MRLTDF acquired $2.0 million in
outstanding senior notes for approximately $2.1 million. The senior notes,
which are held by MRLTDF, are considered to be retired and the Company
recognized approximately $0.2 million as a loss from the extinguishment of
long-term debt in the second quarter of 2004. At June 30, 2004, the senior
notes had a carrying value of $196.1 million, which is net of a $1.9 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 June 30, 2004, Madison River
Capital was in compliance with the terms of its senior notes indenture.
Other Long-Term Debt
- --------------------
Our other indebtedness consists of a miscellaneous note payable of $0.4
million that bears interest at 8.0% and is due on demand. 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 MRTC.
Capital Requirements
Our working capital needs, including our working capital deficit, our
debt service requirements and our capital expenditures are funded from our
cash flow from operations and our existing liquidity on-hand, including our
fully available lines of credit with the RTFC. 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;
* funding redemptions of Series A stock put to CCI per the terms of a
shareholders agreement with the former shareholders of Coastal
Utilities, Inc.;
* 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 to our loan agreement 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.
22
We currently estimate that cash required to fund capital expenditures in
2004 will be approximately $13.0 million. For the first six months ended June
30, 2004, our capital expenditures were approximately $8.3 million and 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
additions 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
continuing to assess the potential benefits of adding video services to the
suite of products we offer to our customers. Since we are early in the
planning process, at this time we are not certain what types of video
services we may offer, if any, or what types of technology we may use to
deliver these services to our customers. Depending on the outcome of this
process, we may see an increase in our capital expenditures in future periods
to support the delivery of this service to our customers.
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. Under the terms of the note payable, as amended, the
first payment of principal and accrued interest is due on December 31, 2004
in the amount of $4.3 million. MRTC is a holding company with no business
operations of its own and its only significant asset is its equity interest
in us. Therefore, its only sources of cash to pay this obligation will be a
cash distribution from us, which may not be allowed under the terms of the
indenture governing our senior notes, through a borrowing or an infusion
of capital. The current equity holders of MRTC are not obligated to provide
MRTC with additional capital and the former shareholders of CCI have not
agreed to any new modifications to the terms of the note payable at this
time.
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. 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. Accordingly, the former shareholders
put 30 shares of Series A stock to CCI in July 2004 and CCI redeemed the
shares for approximately $1.0 million shortly thereafter. After the
redemption in July 2004, the former shareholders continue to hold 90 shares
of Series A stock with the next available put right for 30 shares occurring
in August 2005.
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 such action by the IRS. The
refunds impacted by this IRS notification totaled approximately $5.1 million
and these amounts continue to be included in our deferred income tax
liabilities. Based on discussions with our tax advisors, we believe that our
position is appropriate under current tax laws and we intend to vigorously
defend the position taken in our amended income tax returns. We continue to
accrue interest expense of approximately $0.1 million quarterly related to
these refunds 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 and we are uncertain as to the amount of time it will take
to resolve. If we are not successful, we may be required to repay the
amounts received as refunds plus accrued interest. We believe this matter
may take up to two years to resolve.
The remaining $2.7 million in refunds for 1998 amended income tax
returns, which were not included in the IRS notification and for which we
were advised the statute of limitations for audit adjustments had expired,
were recognized as an income tax benefit in the fourth quarter of 2003.
However, in June 2004, the Department of Justice filed suit against two of
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our subsidiaries, Gulf Coast Services, Inc. and Coastal Utilities, Inc.,
claiming that these were erroneous refunds of income taxes that our
subsidiaries received which the United States of America is entitled to have
returned. The amount of erroneous refunds being sought in the lawsuits total
approximately $2.9 million. In the first quarter of 2004, as the result of
certain income tax audit adjustments made related to the examination of a
separate year, we paid approximately $0.9 million of these claims.
Accordingly, to recognize our potential exposure under the lawsuits, we
accrued the remaining $2.0 million as deferred income taxes payable during
the second quarter of 2004. We also recognized $0.4 million in interest
expense on these refunds. Based on discussions with our tax advisors, we
believe that our position taken in the amended income tax returns is
appropriate under current tax laws and we intend to review all alternatives
including vigorously defending against these claims. However, if we are not
successful, we may be required to repay the amounts received as refunds plus
the accrued interest and plaintiff's costs.
Under the terms of MRTC's Operating Agreement, at any time on or after
January 16, 2006, certain of our members may require MRTC to purchase all of
their member units at an amount equal to the fair market value of the units.
If permitted under the terms of our senior note indenture, 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 working capital deficit,
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 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.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Although we invest our short-term excess cash balances, the nature and
quality of these investments are restricted under our internal investment
policies. These investments are limited primarily to U.S. Treasury 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
June 30, 2004, we had fixed rate secured debt with the RTFC of $414.9 million
at a weighted average rate of 7.7%. 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 a miscellaneous
note for $0.4 million bearing an 8.0% fixed interest rate. Our senior notes
have a stated fixed rate of 13.25%. In addition to our fixed rate
facilities, we have an $11.7 million term loan with the RTFC that bears
24
variable interest at 5.35% at June 30, 2004. A one percent change in the
underlying interest rates for the variable rate debt would have an immaterial
impact of less than $117,000 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 4 - CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures
Our management, with the participation of our Chairman and Chief
Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")), as of the end of the period covered
by this report. Based on such evaluation, the Chairman and Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of
such period, our disclosure controls and procedures are effective.
(b) Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
25
Part II
Item 1. LEGAL PROCEEDINGS
On May 7, 2004, a lawsuit was filed in the United States District Court
for the Southern District of Alabama that named as defendants our
subsidiaries, Gulf Telephone Company and Gulf Coast Services, Inc., our
parent, Madison River Telephone Company, LLC, and certain of our officers and
directors among others including former directors and officers and other
third party plan administrators and advisors to the Gulf Telephone Company
Employee Stock Ownership Plan. The suit, entitled David Eslava, et. al. vs.
Gulf Telephone Company, et. al. Civil Action No. 04-297-MJ-B, alleges certain
ERISA violations. In conjunction with the acquisition of Gulf Telephone
Company in September 1999, an escrow fund was established and continues to
remain in effect to provide support in part for lawsuits such as this. We
have engaged legal counsel and we intend to vigorously defend against all
such claims. On June 30, 2004, we replied to the complaint and on July 25,
2004, we filed a Motion for Summary Judgment on the majority of the claims.
In June 2004, the Department of Justice for the United States of America
filed lawsuits against two of our subsidiaries, Gulf Coast Services, Inc. and
Coastal Utilities, Inc. In each lawsuit, the Department of Justice claimed
that our subsidiary received an erroneous refund of income taxes and related
interest to which the United States of America is entitled to have returned.
The amount being sought in the lawsuits totals approximately $3.5 million of
which $2.9 million is erroneous income tax refunds and $0.6 million is
related interest expense. Approximately $0.9 million of these erroneous
refund claims were paid in the first quarter of 2004 as part of a separate
year income tax audit adjustment. Therefore, we have responded to the
lawsuits accordingly and believe the claims to be approximately $2.0 million
for erroneous income tax refunds plus related interest which we estimate to
be $0.4 million. Based on discussions with our tax advisors, we believe that
our position taken in the amended income tax returns is appropriate under
current tax laws and we intend to review all alternatives including
vigorously defending against these claims.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------- ----------------------------------------------------------
3.1 Certificate of Formation of the Registrant (incorporated
by reference to Exhibit 3.1 to the Registrant's
Registration Statement on Form S-4 (File No. 333-36804)
filed with the Securities and Exchange Commission on May
11, 2000 (the "May Form S-4"))
3.2 Limited Liability Company Agreement of the Registrant
(incorporated by reference to Exhibit 3.2 to the May Form
S-4)
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
26
Item 6. EXHIBITS AND REPORTS ON FORM 8-K, Continued
(b) Reports on Form 8-K
On April 14, 2004, we filed a Current Report on Form 8-K containing a
presentation made on April 14, 2004 by Paul H. Sunu, Chief Financial
Officer of Madison River Capital, LLC, at the Wachovia Securities
Fixed Income Media & Communications Conference in New York, New York.
On May 5, 2004, we filed a Current Report on Form 8-K containing a
press release announcing our financial and operating results for the
first quarter ended March 31, 2004.
On May 19, 2004, we filed a Current Report on Form 8-K containing a
presentation made on May 19, 2004 by Paul H. Sunu, Chief Financial
Officer of Madison River Capital, LLC, at the Bear Stearns 13th Annual
Global Credit Conference in New York, New York.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MADISON RIVER CAPITAL, LLC
Date: August 16, 2004 /s/ PAUL H. SUNU
-----------------------------------
Name: Paul H. Sunu
Title: Managing Director, Chief Financial
Officer and Secretary
27
EXHIBIT INDEX
Exhibit
Number Description
------- -------------------------------------------------------------
3.1 Certificate of Formation of the Registrant (incorporated by
reference to Exhibit 3.1 to the Registrant's Registration
Statement on Form S-4 (File No. 333-36804) filed with the
Securities and Exchange Commission on May 11, 2000 (the "May
Form S-4"))
3.2 Limited Liability Company Agreement of the Registrant
(incorporated by reference to Exhibit 3.2 to the May
Form S-4)
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
29