Back to GetFilings.com
=============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
----------------------
333-36804
Commission file number
MADISON RIVER CAPITAL, LLC
(Exact Name of Registrant as Specified in Its Charter)
Delaware 56-2156823
(State or Other Jurisdiction of (I.R.S. Employer 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 November 9, 2004, the Registrant had 211,583,892 Class A member
interests outstanding. All member interests are owned by Madison River
Telephone Company, LLC.
=============================================================================
MADISON RIVER CAPITAL, LLC
Index to Form 10-Q
Part I - Financial Information Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2004 (Unaudited)
and December 31, 2003............................................................1
Condensed Consolidated Statements of Operations and Comprehensive Income
(Loss) (Unaudited) - Three and Nine Months Ended September 30, 2004 and 2003.....2
Condensed Consolidated Statement of Member's Capital (Unaudited) - Nine
Months Ended September 30, 2004..................................................3
Condensed Consolidated Statements of Cash Flows (Unaudited) - Nine
Months Ended September 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...........................................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................27
Item 4. Controls and Procedures...........................................................28
Part II - Other Information
Item 1. Legal Proceedings................................................................28
Item 6. Exhibits and Reports on Form 8-K.................................................29
Signature..................................................................................29
i
Part I
ITEM 1 - FINANCIAL STATEMENTS
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Balance Sheets
(Dollars in thousands)
September 30, 2004 December 31, 2003
------------------ -----------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 22,653 $ 28,143
Accounts receivable, less allowance for uncollectible accounts
of $1,462 and $1,181 in 2004 and 2003, respectively 10,771 11,339
Receivables, primarily from interexchange carriers, less
allowance for uncollectible accounts of $1,387 and $2,617
in 2004 and 2003, respectively 6,380 5,190
Rural Telephone Finance Cooperative stock to be redeemed 234 1,354
Rural Telephone Finance Cooperative patronage capital receivable 1,800 2,976
Other current assets 3,716 3,873
--------- ---------
Total current assets 45,554 52,875
--------- ---------
Telephone plant and equipment 482,523 472,262
Less accumulated depreciation and amortization (181,924) (150,727)
--------- ---------
Telephone plant and equipment, net 300,599 321,535
--------- ---------
Other assets:
Rural Telephone Finance Cooperative stock, at cost 42,425 42,659
Goodwill 366,332 366,332
Other assets 22,983 23,741
--------- ---------
Total other assets 431,740 432,732
--------- ---------
Total assets $ 777,893 $ 807,142
========= =========
Liabilities and member's capital
Current liabilities:
Accounts payable and accrued expenses $ 34,486 $ 39,898
Other current liabilities 7,350 6,174
Current portion of long-term debt 9,385 6,996
--------- ---------
Total current liabilities 51,221 53,068
--------- ---------
Noncurrent liabilities:
Long-term debt 611,369 630,217
Deferred income taxes 39,823 45,481
Other liabilities 38,564 38,888
--------- ---------
Total noncurrent liabilities 689,756 714,586
--------- ---------
Total liabilities 740,977 767,654
Member's capital:
Member's interest 251,284 251,284
Accumulated deficit (210,880) (208,308)
Accumulated other comprehensive loss (3,488) (3,488)
--------- ---------
Total member's capital 36,916 39,488
--------- ---------
Total liabilities and member's capital $ 777,893 $ 807,142
========= =========
See Notes to Condensed Consolidated Financial Statements.
1
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Operations
and Comprehensive Income (Loss)
(Dollars in thousands)
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Operating revenues:
Local services $ 34,347 $ 31,171 $ 99,014 $ 93,152
Long distance services 3,783 4,161 11,299 12,035
Internet and enhanced data services 5,361 4,159 15,146 11,842
Edge-out services 2,883 3,454 9,084 10,599
Miscellaneous telecommunications
services and equipment 4,113 3,487 12,327 9,974
-------- ------- --------- ---------
Total operating revenues 50,487 46,432 146,870 137,602
-------- ------- --------- ---------
Operating expenses:
Cost of services 16,176 12,970 43,038 36,303
Depreciation and amortization 10,173 13,869 32,989 39,359
Selling, general and administrative
expenses 10,257 9,897 30,313 29,022
Restructuring - (468) - (468)
-------- ------- --------- ---------
Total operating expenses 36,606 36,268 106,340 104,216
-------- ------- --------- ---------
Net operating income 13,881 10,164 40,530 33,386
Interest expense (14,971) (16,384) (45,258) (47,119)
Other income (expense):
Realized gains (losses) on marketable
equity securities - 25 - (353)
Other income, net 779 912 2,371 2,409
-------- ------- --------- ---------
Loss before income taxes (311) (5,283) (2,357) (11,677)
Income tax benefit (expense) 1,513 (392) (215) (123)
-------- ------- --------- ---------
Net income (loss) 1,202 (5,675) (2,572) (11,800)
Other comprehensive income (loss):
Unrealized gains (losses) on
marketable equity securities - 25 - (198)
Reclassification adjustment for realized
(gains) losses included in net loss - (25) - 353
-------- ------- --------- ---------
Other comprehensive income (loss) - - - 155
-------- ------- --------- ---------
Comprehensive income (loss) $ 1,202 $ (5,675) $ (2,572) $ (11,645)
======== ======= ========= =========
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 (unaudited) - (2,572) - (2,572)
--------- ---------- --------- --------
Balance at September 30, 2004 (unaudited) $ 251,284 $ (210,880) $ (3,488) $ 36,916
========= ========== ========= ========
See Notes to Condensed Consolidated Financial Statements.
3
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2004 2003
------------ ------------
Operating activities
Net cash provided by operating activities $ 21,386 $ 24,345
---------- ----------
Investing activities
Purchases of telephone plant and equipment (11,661) (6,309)
Redemption of Rural Telephone Finance Cooperative stock, net 1,354 2,039
Change in other assets 1,221 1,571
---------- ----------
Net cash used for investing activities (9,086) (2,699)
---------- ----------
Financing activities
Redemption of minority interest (1,000) (1,000)
Repurchase of outstanding 131/4% senior notes (2,140) -
Payments on long-term debt (14,650) (13,557)
---------- ----------
Net cash used for financing activities (17,790) (14,557)
---------- ----------
Net (decrease) increase in cash and cash equivalents (5,490) 7,089
Cash and cash equivalents at beginning of year 28,143 19,954
---------- ----------
Cash and cash equivalents at end of nine month period $ 22,653 $ 27,043
========== ==========
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
221,024 voice access and DSL connections as of September 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
September 30, 2004, the EOS operations served 13,180 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 nine-month periods ended September 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 $ 54,351 $ 53,652
Central office equipment 163,177 157,572
Poles, wires, cables and conduit 234,222 230,772
Leasehold improvements 2,541 2,533
Software 18,698 18,600
Construction-in-process 9,534 9,133
---------- ----------
Total telephone plant and equipment $ 482,523 $ 472,262
========== ==========
4. RESTRUCTURING CHARGE
In the fourth quarter of 2001, 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 Emerging Issues Task Force Abstract 94-3 ("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 September 30, 2004, the
following amounts were recorded related to this restructuring charge:
Balance at 2004 Balance at
December 31, 2003 payments September 30, 2004
----------------- ------------- ------------------
(in thousands)
Future lease obligations $ 542 $ 128 $ 414
Legal related expenses 31 - 31
------ ----- ------
$ 573 $ 128 $ 445
====== ===== ======
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 Louisiana 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
September 30, 2004, the following amounts were recorded related to this
restructuring charge:
Balance at 2004 Balance at
December 31, 2003 payments September 30, 2004
----------------- ------------- ------------------
(in thousands)
Future lease obligations $ 271 $ 77 $ 194
====== ====== ======
The remaining liability for both restructuring charges as of September
30, 2004 is recorded as $0.3 million in accrued expenses and $0.3 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:
September 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% (6.3% at September 30, 2004). $ 11,615 $ 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). 5,891 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). 946 951
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). 101,923 102,486
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). 5,527 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). 67,014 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). 3,524 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*). 121,391 122,063
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). 7,735 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). 98,680 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%. - 10,000
Mortgage note payable due in January 2004, interest at a fixed rate of 8.0%,
secured by land and building. - 2,303
Unsecured 13 1/4% senior notes payable, due March 1, 2010, with interest
payable semiannually on March 1 and September 1, net of debt discount
of $1,885 and $2,076, respectively. 196,115 197,924
Convertible note payable to related party 393 393
--------- ---------
620,754 637,213
Less current portion 9,385 6,996
--------- ---------
$ 611,369 $ 630,217
========= =========
* Fixed interest rate expired on October 7, 2004, note currently bears
interest at RTFC variable rate plus a 1.0% interest rate adder, or 6.3%.
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.
Under the terms of MRLTDF's agreement with the RTFC, quarterly principal
payments through 2010 are $2.3 million. 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 loan
agreement, for the RLECs 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. Mandatory prepayments, if any, will be made in the
second quarter of the year in which the calculation is made.
Interest rates on outstanding term loans are based on the 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 loan agreement, decreases.
The RTFC loan agreement 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 in an amount up to
$2.0 million in one quarter and up to $6.0 million in one year. At September
30, 2004, the Company was in compliance with the terms and conditions of the
loan agreement.
The loan facilities are secured by a first mortgage lien on the operating
assets and revenues of GRH, MRH, MLDS, MRLDS and MRLTDF and its subsidiaries
consisting of Mebtel, GCSI, CCI and MRM. In addition, substantially all of
the outstanding equity interests of these entities have been pledged in
support of the loan facilities. Therefore, the RTFC holds a first lien
security interest in all of the assets, revenues and substantially all of the
equity interests of the RLECs. In addition, 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. 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. This outstanding
balance was repaid during the first quarter of 2004.
The Company also has an undrawn $10.0 million line of credit that is
fully available to Coastal Utilities, Inc., a subsidiary of CCI. 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, MRLTDF granted the RTFC a first lien security interest in the assets of
Coastal Utilities, Inc. to secure this line of credit.
Each of the above lines of credit expire in March 2005. The Company has
been notified by the RTFC that a new secured line of credit in the amount of
$41.0 million for a term of five years has been approved for MRLTDF. This
new line of credit will replace the two existing lines of credit and is
subject to satisfactory completion of documentation for the new agreement and
all conditions precedent to closing being satisfied.
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 131/4% 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 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, 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 September 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 8.0% 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 September 30, 2004. The
note payable accrues interest at 8.0% 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 equity of
MRTC.
6. BENEFIT PLANS
The Company's net periodic benefit costs for the pension plan for the
third quarter and nine months ended September 30, 2004 and 2003 are as
follows:
Third quarter ended Nine months ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
(in thousands)
Service cost $ 98 $ 105 $ 294 $ 315
Interest cost 187 172 560 517
Expected return on plan assets (190) (148) (569) (445)
Amortization of net loss (gain) 79 23 238 71
------ ------ ------ ------
Total net periodic benefit cost $ 174 $ 152 $ 523 $ 458
====== ====== ====== ======
The Company's net periodic benefit costs for the postretirement benefit
plans for the third quarter and nine months ended September 30, 2004 and 2003
are as follows:
Third quarter ended Nine months ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
(in thousands)
Service cost $ 15 $ 10 $ 41 $ 28
Interest cost 27 24 80 73
Amortization of net loss (gain) (78) (25) (151) (103)
Amortization of prior service cost (22) (9) (64) (57)
------ ------ ------ ------
Total net periodic benefit cost $ (58) $ - $ (94) $ (59)
====== ====== ====== ======
The Company expects to contribute approximately $2.1 million to its
pension plan in 2004. The Company made contributions of $1.6 million in the
first nine 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 of 2003
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, 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 taxable C corporations that include, MRLTDF, Mebtel, GCSI and
its subsidiaries, CCI and its subsidiaries, MLDS and MRLDS. 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 that 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 lawsuits against two of the Company's subsidiaries, GCSI and
Coastal Utilities, Inc., that received the refunds from the amended 1998
returns and subsequently recognized the benefit. The lawsuits claim that the
refunds were erroneous refunds and demand repayment 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 the remaining $2.0 million in income tax
expense and also accrued $0.4 million in related interest expense during the
second quarter of 2004 to recognize the remaining potential exposure under
the lawsuits. The Company continues to accrue interest quarterly related to
this exposure. 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 vigorously
defend 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 nine month
periods ended September 30, 2004 and 2003:
Three Month Period Ended Nine Month Period Ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
(in thousands)
Total revenues
RLEC operations $ 48,347 $ 43,698 $ 139,986 $ 129,289
EOS 2,920 3,486 9,186 10,819
-------- -------- -------- --------
51,267 47,184 149,172 140,108
Less intersegment revenues (780) (752) (2,302) (2,506)
-------- -------- -------- --------
Total reported revenues $ 50,487 $ 46,432 $ 146,870 $ 137,602
======== ======== ======== ========
Net operating income (loss):
RLEC operations $ 16,445 $ 13,279 $ 48,228 $ 42,256
EOS (2,564) (3,115) (7,698) (8,870)
-------- -------- -------- --------
Total reported net operating
income $ 13,881 $ 10,164 $ 40,530 $ 33,386
======== ======== ======== ========
At September 30, 2004 and December 31, 2003, total assets by segment, net
of intersegment investments and other intersegment balances, were as follows:
September 30, December 31,
2004 2003
------------- ------------
(in thousands)
Total assets:
RLEC operations $ 834,010 $ 868,472
EOS 434,483 432,326
----------- -----------
1,268,493 1,300,798
Less intersegment assets (490,600) (493,656)
----------- -----------
Total reported assets $ 777,893 $ 807,142
=========== ===========
11
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
10. OTHER CHARGES
The Company's rural local exchange company located in Foley, Alabama
provides service to the Gulf Coast area of Alabama from the western border of
the Florida panhandle to the East side of Mobile Bay, including the coastal
communities of Gulf Shores, Orange Beach and Fort Morgan where a hurricane
came ashore in September 2004. Although the Company's central office, remote
switch locations, business offices and administrative facilities incurred
only minimal damage from the hurricane, more substantial damage was incurred
in certain outside plant facilities, primarily its transmission and
distribution plant in the coastal areas. The Company has evaluated the
extent of the damage to its properties and is repairing or rebuilding, where
necessary, its damaged facilities. Accordingly, the Company has accrued
approximately $1.7 million in the third quarter of 2004 for estimated
building and equipment repairs, restoration of services to customers and
other hurricane-related expenses. In addition, the Company anticipates
making capital expenditures of approximately $2.5 million, the majority of
which will replace damaged transmission and distribution facilities. The
Company expects that substantially all of these expenditures will be made in
the fourth quarter of 2004. The Company has received authorization from the
Alabama Public Service Commission to accelerate depreciation of these capital
expenditures related to the hurricane completely into the fourth quarter of
2004.
12
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:
* our ability to service our significant amount of indebtedness;
* our ability to sustain our revenues;
* our inability to achieve profitability;
* our ability to raise additional capital on acceptable terms and on a
timely basis;
* our dependence on economic conditions in the local markets we serve;
* continuing softness in the U.S. economy, specifically with respect to the
telecommunications industry;
* significant and growing competition in the telecommunications industry;
* the advent of new technology that may force us to expand or adapt our
network in the future;
* our dependence on market acceptance of DSL-based services;
* the passage of legislation or regulations or court decisions adversely
affecting the telecommunications industry;
* the success of efforts to expand our service offerings and grow our
business;
* our ability to execute our acquisition strategy, including successfully
integrating acquired businesses;
* our ability to protect our proprietary technology;
* the failure to implement the revised business plan for our edge-out
services successfully;
* the failure to achieve desired operating efficiencies from our
information and billing systems;
* unanticipated network disruptions;
* our ability to obtain and maintain the necessary rights-of-way for our
networks;
* the financial difficulties of other companies in the telecommunications
industry with which we have material relationships;
* the inability to comply with the minimum volume commitments and other
utilization targets in our long distance resale agreements;
* our ability to compete effectively with the Regional Bell Operating
Companies;
* future liabilities or compliance costs associated with environmental and
worker health and safety matters; and
* our dependence on our key personnel.
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 September 30, 2004, we had 234,204 voice, DSL and high speed
data connections in service in our RLEC operations and our edge-out services.
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
13
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 utilize rigorous criteria for evaluating new customers and
the desirability of renewing existing contracts.
Factors Affecting Future Operations
- -----------------------------------
The following is a discussion of the primary factors that we believe will
affect our operations over the next few years.
Revenues
To date, our revenues have been derived principally from the sale of
voice and data communications services to business and residential customers
in our established RLEC markets. For the nine months ended September 30,
2004, approximately 93.8% of our operating revenues came from our RLEC
operations and 6.2% from our edge-out services. For the same period in 2003,
approximately 92.3% of our operating revenues came from our RLEC operations
and 7.7% from our edge-out services. We intend to focus on continuing to
generate increasing revenues in our RLEC operations 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 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. Our transport facilities will
primarily be used to support our retail Internet service business in our RLEC
operations.
At September 30, 2004, we had 234,204 connections in service compared to
224,403 connections in service at September 30, 2003, an increase of 9,801
connections or 4.4%. Our RLEC operations had 221,024 connections in service
at September 30, 2004 and 208,787 connections in service at September 30,
2003, an increase of 12,237 connections or 5.9%. For the edge-out services,
connections in service at September 30, 2004 and September 30, 2003 were
13,180 and 15,616, respectively, a decrease of 2,436 connections or 15.6%.
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 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.
14
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 existing 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 $16. We
intend to continue to offer other combined service discounts and programs
designed to give customers incentives to buy bundled services.
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 as the number of DSL subscribers we
serve in our RLECs has continued to increase. 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. With the introduction of our No Limits package, we have
experienced significant growth in DSL subscribers in the first three quarters
of 2004 compared to prior quarters. As of September 30, 2004, our
penetration rate for residential DSL connections as a percentage of primary
residential voice access lines was 29.4% compared to 16.0% at September 30,
2003. 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. As of September 30, 2004, we had 37,064 DSL connections in
service, an increase of 2,810 connections from 34,254 DSL connections in
service at June 30, 2004 and an increase of 15,870 connections from 21,194
DSL connections in service at September 30, 2003.
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 September 30, 2004, we had 16,653 dial-up Internet customers which was a
decrease of 8,313 customers, or 33.3%, from 24,966 dial-up Internet customers
at September 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 September 30, 2004, we
had 100,931 long distance accounts compared to 95,466 long distance accounts
at September 30, 2003. In addition, our penetration rates for voicemail,
caller identification, call waiting and call forwarding have increased over
September 30, 2003.
During the second quarter of 2004, we introduced a new variation of our
No Limits 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. During the third quarter of
2004, we have continued to develop the marketing for this bundle in our North
Carolina market and assess its performance before determining when, or if, we
will introduce it in our larger RLECS.
In recent quarters, we have seen a decline in the number of voice access
lines in service in our RLECs. As of September 30, 2004, the RLECs had
183,960 voice access lines in service, which is a decrease of 3,633 voice
access lines, or 1.9%, from 187,593 voice access lines in service at
September 30, 2003. The decrease in voice access lines is attributed to
three primary factors. First, the number of second lines in service in our
RLEC markets has decreased. Second lines in service at September 30, 2004
decreased to 6,846 voice access lines from 8,928 voice access lines at
September 30, 2003, a decrease of 2,082 second lines, or 23.3%. 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 continue to experience a decrease in the number of second lines we
serve. Second, we have seen a decrease in primary voice access lines, which
we define as total voice access lines less second lines, in our Illinois
operations, Gallatin River Communications, which served 2,670 fewer primary
voice access lines at September 30, 2004 compared to September 30, 2003. The
decrease in primary voice access lines is the result of a persistent weakness
in the local economies in which Gallatin River Communications operates.
These areas are predominantly industrial and agricultural in nature and have
had some losses in their business base, resulting in higher unemployment. We
are uncertain at this time regarding the future trend for voice access lines
at Gallatin River Communications. Finally, storm-related damages from
Hurricane Ivan in September 2004 resulted in approximately 1,000 voice access
lines being disconnected as of September 30, 2004 at our Alabama RLEC, Gulf
Telephone Company. We believe that the decrease in voice access lines as a
result of damages from the hurricane could total approximately 5,700 lines.
The predominant percentage of these voice access lines estimated to be out of
service is due to damage at the customer premises making the location
unusable or uninhabitable until repairs or rebuilding, if necessary, can be
completed. We believe that the restoration process in this area will proceed
quickly and that we will recover these voice access lines. Excluding these
losses related to the hurricane, which we believe are temporary, our decrease
in voice access lines would have been 1.4%.
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.,
15
serves the Hinesville area including the military base. We are currently
gathering information regarding this transition and future deployment. We
continue to monitor the progress as it is reported publicly and we are
working to understand the impact of this transformation on Coastal Utilities'
operations. 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.
In September 2004, Hurricane Ivan made landfall at Gulf Shores, Alabama.
Our rural local exchange company located in Foley, Alabama provides service
to the Gulf Coast area of Alabama from the western border of the Florida
panhandle to the East side of Mobile Bay, including the coastal communities
of Gulf Shores, Orange Beach and Fort Morgan. Our central office, remote
switch locations, business offices and administrative facilities incurred
only minimal damage from the hurricane. However, we did incur more
substantial damage in certain outside plant facilities, primarily our
transmission and distribution plant, in the coastal areas. Damage from the
hurricane to residences, businesses and our facilities has resulted in voice
access lines, DSL connections and other services being temporarily
disconnected. As a result, we estimate that our revenues will decrease
approximately $0.3 million in the fourth quarter of 2004. We have evaluated
the extent of the damage to our properties and intend to move quickly to
repair and, where necessary, to rebuild our damaged facilities. Accordingly,
we have developed a plan based on our evaluation of the damages and accrued
approximately $1.7 million in the third quarter of 2004 for estimated
building and equipment repairs, restoration of services to customers and
other hurricane-related expenses. In addition, we anticipate making capital
expenditures of approximately $2.5 million, the majority of which will
replace damaged transmission and distribution facilities. We expect that
substantially all of these expenditures will be made in the fourth quarter of
2004. We have received authorization from the Alabama Public Service
Commission to accelerate depreciation of these capital expenditures related
to Hurricane Ivan completely into the fourth quarter of 2004.
A portion of our local service revenues consist of universal service
funding payments received from the Universal Service Administration Company,
or USAC. As directed by the Federal Communications Commission, or FCC, USAC
can no longer incur obligations for which it does not have readily available
funds in hand as USAC was determined to be subject to the rules of the Anti-
Deficiency Act. One implication of this change was that funding commitments
under the Schools and Libraries Universal Service Support Mechanism were
determined to be obligations of USAC. Therefore, USAC was required to
suspend making new funding commitments as the funds for these obligations
will not be received until future periods. The implications for the larger
Universal Service system are currently being reviewed by the FCC. On a
quarterly basis, USAC makes estimates of projected costs that are used to
determine the amount of high cost support payments it will make which
includes High Cost Loop and other universal service funding that we receive.
If it is determined that these projected costs are funding commitments, and
therefore obligations, of USAC, then USAC may be forced to suspend these
payments until the funds have been collected from the appropriate sources.
At this time, we are uncertain as to whether or not these estimates of high
cost funds to be distributed will be considered obligations of USAC. If
these estimates do constitute obligations, and an alternative solution is not
developed, we believe that two quarters of universal service funding payments
from USAC could be suspended. Based on published USAC estimates, payments
from USAC to us for the first quarter of 2005 are projected to be
approximately $3.2 million. Extending that projection, suspending USAC
payments for two quarters could potentially total $6.4 million.
We have experienced a decrease in revenues from our edge-out services in
the first nine months of 2004 compared to the first nine months of 2003 as
sales of new services and renewals of expiring customer contracts have not
been enough to replace customers that do not continue with our service. At
September 30, 2004, our edge-out services had 12,519 voice access lines and
661 high speed data connections in service. At September 30, 2003, our edge-
out services served 14,915 voice access lines and 701 high-speed data
connections. A customer in our edge-out services, representing recurring
monthly revenues of approximately $55,000, replaced our service during the
third quarter of 2004. The expenses to provide services to this customer
were minimal. In terms of business development, 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.
Bankruptcies by interexchange carriers in recent years, including MCI
WorldCom and Global Crossing, have impacted our financial results including
our revenues and cash flows. 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
16
telecommunication providers. At September 30, 2004, we had approximately
$1.4 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, on August 20, 2004, the FCC
released its Order and Notice of Proposed Rulemaking in the Matter of
Unbundled Access to Network Elements (the "Interim Order"). The Interim
Order established interim rules for terms, rates and conditions associated
with unbundled network access pending an order expected within the next
twelve months that will establish permanent rules. 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 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
amendments 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.
17
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
thirty-three 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
- ---------------------
Nine Months ended September 30, 2004 compared to Nine Months ended September
- ----------------------------------------------------------------------------
30, 2003
- --------
Total revenues were $146.9 million in the nine month period ended
September 30, 2004 and $137.6 million in the nine month period ended
September 30, 2003, an increase of approximately $9.3 million, or 6.7%.
Revenues in the RLEC operations increased approximately $10.8 million, or
8.5%, to $137.8 million in the first nine months of 2004 from $127.0 million
in the first nine months of 2003. In the first nine months of 2004, revenues
from local services increased approximately $5.9 million, Internet and
enhanced data services increased approximately $3.3 million and miscellaneous
revenues increased approximately $2.4 million when compared to the same
period in 2003. Local service revenues increased primarily as a result of
higher network access revenues from certain one-time wireless settlements and
other carrier access revenues and settlements for updated cost study filings
which include filings to reflect the impact of storm-related expenses. The
increase in Internet and enhanced data revenues is attributed to an increase
in the number of DSL subscribers. At September 30, 2004, our RLECs served
37,064 DSL subscribers compared to 21,194 at September 30, 2003, an increase
of 15,870 connections, or 74.9%. The growth in DSL connections has been
generated by strong demand for our No Limits bundled offering. The increase
in miscellaneous telecommunications service and equipment revenues is
attributed largely to an increase in revenues from a construction project and
two equipment installation projects totaling approximately $1.7 million and a
decrease in bad debt expenses of approximately $0.2 million. These increases
in RLEC revenues were partially offset by a decrease of approximately $0.8
million in private label long distance revenues. The decrease in long
distance revenues is attributed primarily to the success of the No Limits
bundle as more customer billings reflect a
18
flat rate charge for long distance service compared to the higher usage-based
charges for these customers in prior periods. Revenues from our edge-out
services decreased approximately $1.5 million, or 14.3%, to $9.1 million in
the first nine months of 2004 from $10.6 million in the first nine months of
2003. The decrease is attributed primarily to a $0.9 million decrease in
local service revenues as the result of a decrease in the number of
connections served. At September 30, 2004 and 2003, our edge-out services
served approximately 13,180 and 15,616 voice access and high speed data
connections, respectively, representing a 15.6% decrease.
During the first nine months of 2004, our RLECs entered into reciprocal
compensation agreements with most of the major wireless carriers that 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. Our RLECs are continuing to negotiate agreements with the
remaining wireless carriers with significant traffic providing wireless
services in our RLEC serving areas.
For the first nine months of 2004, our RLEC operations and edge-out
services provided approximately 93.8% and 6.2%, respectively, of our
revenues. Comparatively, for the first nine months of 2003, our RLEC
operations provided 92.3% of our revenues and our edge-out services provided
7.7% of our revenues. Revenues from voice services, which are comprised of
local, network access and long distance services, as a percentage of total
revenues, were approximately 79.0% and 81.4% for the nine months ended
September 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 certain construction and equipment
installation projects on our 2004 financial results.
Total operating expenses increased approximately $2.1 million from $104.2
million, or 75.7% of total revenues in the first nine months of 2003, to
$106.3 million, or 72.4% of total revenues in the first nine months of 2004.
The increase can be attributed largely 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 nine months ended
September 30, 2004 were $89.6 million, an increase of $4.9 million, or 5.7%,
from operating expenses of $84.7 million in the first nine months of 2003.
Approximately $2.1 million of the increase can be attributed to the pension
curtailment gain recorded in the first quarter of 2003. In addition,
operating expenses increased in the first nine months of 2004 compared to the
same period in 2003 from the accrual of $1.7 million for hurricane-related
expenses such as repairs to facilities and restoration of services to
customers, increased access expenses of $1.4 million for costs to terminate
long distance calls primarily from an increase in access minutes of use and
increased costs of $1.1 million related to a construction project and two
equipment installation projects performed for certain customers. Finally,
operating expenses increased $0.9 million for DSL modems used in the RLEC
operations in the first nine 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. Partially offsetting these increases in operating expenses
was a decrease in depreciation and amortization expenses of $3.6 million and
a reduction in long-term incentive expense of $1.4 million in the first nine
months of 2004 when compared to the first nine 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 $2.7
million from $19.5 million in the first nine months of 2003 to $16.8 million
in the first nine months of 2004. Depreciation expenses in the nine months
ended September 30, 2004 decreased $2.7 million compared to the nine months
ended September 30, 2003. The decrease in depreciation expenses is primarily
attributed to certain assets becoming fully depreciated. 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 in recent quarters. In
addition, nonrecurring settlements from several disputes arising out of
interconnection agreements, totaling approximately $0.6 million, reduced cost
of services in the first nine months of 2004 whereas no comparable
settlements were recorded in the first nine months of 2003. Partially
offsetting these decreases were the $0.6 million noncash gain from the
pension curtailment that reduced pension expenses and a $0.4 million
adjustment to restructuring accruals that further reduced operating expenses
in the edge-out services in the first nine months of 2003. No similar
pension curtailment gains or adjustments to restructuring accruals were
recorded in the first nine months of 2004.
Net operating income increased approximately $7.1 million from $33.4
million, or 24.3% of total revenues in the first nine months of 2003, to
$40.5 million, or 27.6% of total revenues in the first nine months of 2004.
The
19
increase is primarily attributable to the increase in revenues in the RLEC
operations. Net operating income in the RLEC operations increased $5.9
million, or 14.1%, to $48.2 million in the first nine months of 2004 from
$42.3 million in the first nine months of 2003. This represented 35.0% and
33.3% of total revenues, respectively. For the edge-out services, the net
operating loss improved $1.2 million, or 13.2%, to $7.7 million in the nine
month period ended September 30, 2004 from $8.9 million in the nine month
period ended September 30, 2003.
Interest expense decreased $1.9 million to $45.2 million, or 30.8% of
total revenues, in the first nine months of 2004 compared to $47.1 million,
or 34.2% of total revenues, in the first nine months of 2003. The decrease
is partially attributed to an accrual of $1.3 million in interest expense in
the third quarter of 2003 related to certain income tax return audit
adjustments made by the Internal Revenue Service as part of an audit they
were conducting. The remaining decrease in interest expense is attributed
primarily to a lower average outstanding balance of long-term debt during the
first nine months of 2004 compared to same period of 2003. 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 nine month period ended September 30, 2004, we had other income
of $2.4 million compared to other income of $2.1 million in the nine month
period ended September 30, 2003, a change of $0.3 million, or 15.4%. The
increase is attributed primarily to approximately $0.4 million in realized
losses on the disposal of marketable equity securities recognized in the
first nine months of 2003 whereas no comparable realized losses were
recognized in the first nine months of 2004.
Income tax expense in the first nine months of 2004 was $0.2 million, an
increase of $0.1 million from an income tax expense of $0.1 million in the
first nine months of 2003. In the third quarter of 2004, based upon our
completed income tax returns for 2003, we recorded certain entries to
recognize the positions we took in those income tax returns and made related
adjustments to reduce our valuation allowance against our deferred income tax
assets. Accordingly, this resulted in an income tax benefit of $1.5 million
being recognized in the third quarter of 2004. Offsetting this benefit was
income tax expense of $2.0 million recorded in the second quarter of 2004
related to two lawsuits filed against subsidiaries of the Company by the
Department of Justice. In the fourth quarter of 2003, we recognized an
income tax benefit of $2.7 million related to refunds received in 2002. We
received the refunds after making certain amendments to our 1998 income tax
returns. The benefit was recognized after we were advised that the statute of
limitations for taxing authorities to assert audit adjustments against 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, Gulf Coast Services, Inc. and Coastal
Utilities, Inc., that received the refunds from the amended 1998 returns and
subsequently recognized the benefit. The lawsuits claim that the refunds were
erroneous refunds and demand repayment in the amount of approximately $2.9
million. We had paid approximately $0.9 million related to these claims in
the first quarter of 2004 as part of a separate year income tax audit
adjustment. Accordingly, during the second quarter of 2004, we accrued the
remaining $2.0 million as income tax expense and also accrued $0.4 million in
related interest expense to recognize the 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 vigorously defend against these claims.
Our net loss improved $9.2 million from a net loss of $11.8 million, or
8.6% of total revenues, in the first nine months of 2003, to $2.6 million, or
1.8% of total revenues, in the first nine months of 2004, as a result of the
factors discussed above. The RLEC operations reported net income of $24.9
million in the first nine months of 2004 compared to net income of $17.1
million in the first nine months of 2003, an increase of $7.8 million. For
the nine month periods ended September 30, 2004 and 2003, our edge-out
services had net losses of $27.5 million and $28.9 million, respectively, an
improvement of $1.4 million.
Third Quarter Ended September 30, 2004 compared to Third Quarter Ended
- ----------------------------------------------------------------------
September 30, 2003
- ------------------
Total revenues in the third quarter ended September 30, 2004 were $50.5
million, an increase of $4.1 million, or 8.7%, from total revenues of $46.4
million for the third quarter ended September 30, 2003. The increase is
attributable to a $4.6 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 third quarter of 2004, the RLEC operations
reported revenues of $47.6 million, an increase of $4.6 million, or 10.8%,
from revenues in the third quarter of 2003 of $43.0 million. The increase in
revenues consists primarily of a $3.2 million increase in local service
revenues, a $1.2 million increase in Internet and enhanced data revenues and
a $0.6 million increase in miscellaneous telecommunications revenues. The
increase in local service revenues is attributed primarily to an increase in
network access revenues from certain one-time wireless settlements and other
carrier access revenues and settlements for updated cost study filings which
include filings to reflect the impact of storm-related expenses. The
increase in Internet and enhanced data revenues is attributed to the increase
in DSL connections in the third quarter of 2004 compared to the third quarter
of 2003. The increase in miscellaneous telecommunications service and
20
equipment revenues is attributed largely to an increase in revenues of
approximately $0.5 million from a construction project and two equipment
installation projects. The increases in RLEC revenues were partially offset
by a $0.4 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 charges for these customers in prior periods.
Revenues in the edge-out services in the third quarter of 2004 were $2.9
million, a decrease of $0.5 million, or 16.5%, from revenues of $3.4 million
in the third quarter of 2003. The decrease in revenues from our edge-out
services is largely due to a decrease in the number of connections in service
during the third 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 79.2% and 80.9% for the quarters ended September 30, 2004 and
2003, respectively. The RLEC operations and the edge-out services provided
approximately 94.3% and 5.7% of total revenues, respectively, in the third
quarter of 2004.
Total operating expenses increased $0.3 million from $36.3 million, or
78.1% of total revenues in the third quarter of 2003, to $36.6 million, or
72.5% of total revenues in the third quarter of 2004. Operating expenses in
the RLEC operations were $31.2 million in the third quarter of 2004 compared
to $29.7 million in the third quarter of 2003, an increase of $1.5 million,
or 4.9%. Cost of services in the RLEC operations increased $3.4 million, or
30.9%, to $14.5 million in the third quarter of 2004 from $11.1 million in
the third quarter of 2003. The increase is attributed largely to the accrual
of $1.7 million for hurricane-related expenses such as repairs to facilities
and restoration of services to customers. In addition, costs to terminate
long distance calls primarily as a result of an increase in access minutes of
use related to the No Limits package increased $0.5 million and expenses for
a construction project and two equipment installations performed for certain
customers increased $0.4 million in the third quarter of 2004 compared to the
same period in 2003. Depreciation and amortization expenses in the third
quarter of 2004 decreased approximately $2.2 million when compared to the
third 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 increased
approximately $0.2 million in the third quarter of 2004 compared to the third
quarter of 2003. In the edge-out services, operating expenses in the third
quarter of 2004 were approximately $1.1 million lower than operating expenses
in the third quarter of 2003. The decrease is attributed primarily to a $1.5
million decrease in depreciation and amortization expenses. Partially
offsetting this decrease was the impact of a $0.4 million benefit on
operating expenses in the third quarter of 2003 from an adjustment to
restructuring accruals in the edge-out services. No similar adjustment was
made in the third quarter of 2004.
Net operating income increased $3.8 million, or 36.6%, from $10.1 million
in the third quarter of 2003, or 21.9% of total revenues to $13.9 million in
the third quarter of 2004, or 27.5% of total revenues. Net operating income
for the RLEC operations in the third quarter of 2004 was $16.4 million
compared to $13.3 million in the third quarter of 2003, an increase of $3.1
million, or 23.8%. The net operating loss in the edge-out services improved
$0.7 million, from a net operating loss of $3.2 million in the third quarter
of 2003 to a net operating loss of $2.5 million in the third quarter of 2004.
Interest expense was $15.0 million in third quarter of 2004, a decrease
of $1.4 million, or 8.6%, from interest expense of $16.4 million in the third
quarter of 2003. Interest expense represented 29.7% and 35.3% of total
revenues in third quarter of 2004 and 2003, respectively. The decrease is
due largely to an accrual of $1.3 million in interest expense in the third
quarter of 2003 related to certain income tax return audit adjustments made
by the Internal Revenue Service as part of an audit they were conducting. No
similar accrual was made in the third quarter of 2004. The remaining
decrease in interest expense is the result of a lower weighted average
balance of long-term debt outstanding in the third quarter of 2004 compared
to the third quarter of 2003.
Other income was $0.8 million in the third quarter of 2004 compared to
$0.9 million in the third quarter of 2003, a decrease of $0.1 million.
In the third quarter of 2004, we had an income tax benefit of $1.5
million compared to income tax expense of $0.4 million in the third quarter
of 2003, a change of $1.9 million. The benefit in the third quarter of 2004
resulted primarily from entries recorded to recognize the positions we took
in our income tax returns filed in the third quarter of 2004 and related
adjustments to reduce our valuation allowance against our deferred income tax
assets.
In the third quarter of 2004, net income was $1.2 million compared to a
net loss of $5.7 million in the third quarter of 2003, an improvement of $6.9
million as a result of the factors discussed above. The RLEC operations
reported net income of $10.4 million in the third quarter of 2004, an
increase of $6.3 million, or 155.6%, compared to net income of $4.1 million
in the third quarter of 2003. The edge-out services reported a net loss of
$9.2 million in the third quarter of 2004 compared to a net loss of $9.8
million in the third quarter of 2003, an improvement of $0.6 million, or
5.7%.
21
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.
At September 30, 2004, we had total liquidity of $63.7 million which
consists of cash and cash equivalents of $22.7 million and available
borrowings on our lines of credit with the RTFC of $41.0 million. Our
liquidity position has been enhanced by our reduced schedule of principal
payments which also provides us with 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.
At September 30, 2004, we had a working capital deficit of approximately
$5.7 million compared to positive working capital of $12.5 million at
September 30, 2003, a change of $18.2 million. The change is attributed
primarily to an increase of $7.0 million in the current portion of long-term
debt as a result of an amendment entered into with the RTFC in the third
quarter of 2003. Under the amendment, we did not have any scheduled
principal payments to the RTFC until the third quarter of 2004. Therefore,
at September 30, 2003, our current portion of long-term debt was $2.4 million
compared to $9.4 million at September 30, 2004. Our current liabilities
other than the current portion of long-term debt at September 30, 2004
reflect the accrual of $1.7 million for hurricane-related expenses whereas no
similar accrual was recorded in current liabilities at September 30, 2003.
At September 30, 2004, our current assets were $8.8 million lower than our
current assets at September 30, 2003, primarily from a $4.4 million decrease
in cash and cash equivalents and a $1.8 million decrease in inventories. The
decrease in cash and cash equivalents is largely due to the repayment of
approximately $6.4 million in long-term debt and $21.0 million on revolving
credit facilities with the RTFC. The decrease in inventories is attributed
to certain switching equipment, valued at $1.6 million, being included in
inventory at September 30, 2003 during the period of time it was being
transferred between operations within the Company. No comparable amounts
were recorded in inventories at September 30, 2004.
As discussed below, we may be required to make annual mandatory
prepayments equivalent to any excess cash flow as defined in our loan
agreement in addition to our scheduled principal payments. These mandatory
payments for excess cash flow will begin in 2005 and will be based on our
financial results in our RLECs for 2004. We currently do not anticipate
making a mandatory prepayment in 2005 based on 2004 financial results and are
uncertain what mandatory prepayments will have to be made in future years, if
any, at this time.
Operating Activities. For the nine months ended September 30, 2004 and
2003, we generated cash from operating activities of $21.4 million and $24.3
million, respectively. For the nine months ended September 30, 2004, taking
our net loss before non-cash charges such as depreciation, amortization and
long-term incentive plan expenses reflect net cash provided of $29.3 million,
a decrease of $4.2 million compared to $33.7 million for the first nine
months of 2003.
Investing Activities. For the nine months ended September 30, 2004, net
cash used for investing activities was $9.1 million and consisted of $11.7
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 and changes in other
assets of $1.2 million. For the nine months ended September 30, 2003, net
cash used in investing activities was $2.7 million and consisted of $6.3
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 $1.6 million from changes in other
assets. We anticipate our purchases of telephone plant and equipment to be
approximately $15.5 million in 2004 compared to $12.2 million in 2003 and
$12.3 million in 2002. The increase is attributed largely to capital
expenditures we anticipate making in the fourth quarter of 2004, primarily
for the transmission and distribution facilities, related to hurricane
damages.
Financing Activities. For the nine months ended September 30, 2004, net
cash used for financing activities included $14.7 million used to repay long-
term debt, $2.1 million for the repurchase of a portion of our 131/4% senior
notes in the open market and $1.0 million for the partial redemption of a
minority interest in a subsidiary. For the nine months ended September 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 a subsidiary.
22
Long-Term Debt and Revolving Credit Facilities
- ----------------------------------------------
We or our subsidiaries have outstanding term and revolving credit
facilities totaling $424.2 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 September 30, 2004, MRLTDF had approximately $424.2 million in term
loans outstanding with the RTFC. Of this amount, $412.6 million in term
loans bear fixed interest rates that range between 5.65% and 9.05%, with a
weighted average rate approximating 7.8%. The fixed interest rates expire at
various times, beginning in October 2004 through August 2006, depending on
the terms of the note. Upon the expiration of the fixed interest rates, the
term loans will convert to the RTFC's prevailing base variable interest rate
plus a 1.0% interest rate adder. We have the ability to allow the 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 $11.6 million term loan has a variable interest
rate of 6.3% at September 30, 2004. In total, as of September 30, 2004, our
weighted average interest rate on all RTFC term debt is 7.7%. See further
discussion of interest rates below.
Our loan agreement with the RTFC matures in November 2016. Quarterly
principal payments through 2010 are approximately $2.3 million. 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 loan agreement 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 loan agreement, interest rates on our outstanding
term loans are based on the 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 loan agreement,
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, our loan agreement requires us to test our compliance with
the financial ratios as defined in the loan agreement 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 exchange assets. We also have restrictions regarding
payment of dividends by MRLTDF and GRH. In addition, our loan agreement
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.
The loan facilities are secured by a first mortgage lien on substantially
all of the operating assets and revenues of the RLEC operations including
MRLTDF and MRH. In addition, substantially all of the outstanding equity
interests of these entities were pledged in support of the facilities.
Therefore, the RTFC has a first lien security interest in all of the assets
and revenues and substantially all of the equity interests of the RLEC
operations. In addition, 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 September 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, at
September 30, 2004, based on the principal payment of $2.3 million made in
the third quarter of 2004, we have approximately $0.2 million in SCCs
eligible to be redeemed in 2005. In March 2004 and March 2003, the RTFC
redeemed approximately $1.4 million and approximately $2.0 million,
respectively, of our SCCs.
23
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 bears
interest at the RTFC base rate for a standard line of credit plus 50 basis
points, or 6.3% at September 30, 2004. During the first quarter of 2004, we
repaid the $10.0 million we had advanced against this line of credit as of
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. 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. In April, 2004, we provided the RTFC
with a first lien security interest in the assets of Coastal Utilities, Inc.
to secure this line of credit. Each line of credit was scheduled to expire
in March 2005. We have been notified by the RTFC that a new secured line of
credit in the amount of $41.0 million for a term of five years has been
approved for MRLTDF. This new line of credit will replace the two existing
lines of credit and is subject to satisfactory completion of documentation
for the new agreement and all conditions precedent to closing being
satisfied.
The terms of our loan agreement with the RTFC contain various financial
and administrative covenants including financial 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. In addition, this combined group is
required to 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 exchange assets. These
combined entities are permitted 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. As a result of these provisions of the loan agreement, 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 September 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. The senior notes
are callable beginning in March 2005 at 106.625. 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 our 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 September 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 September 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
24
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.
Interest Rates
- --------------
On October 7, 2004, the fixed interest rate on one of our RTFC notes with
an outstanding principal balance of $121.4 million expired. The note, with a
fixed interest rate of 9.05% prior to expiration, converted to the RTFC's
prevailing variable base rate plus 1.0% interest rate adder, or 6.3% on
October 7, 2004. We anticipate that we will maintain the interest rate as
variable in the short term. After conversion of this interest rate, our
fixed rate term loans with the RTFC total $291.2 million at a weighted
average interest rate of 7.2% and our variable rate term loans with the RTFC
total $133.0 million at a variable interest rate of 6.3%. Therefore, as of
October 7, 2004, our weighted average interest rate on all our secured debt
with the RTFC is approximately 6.95% and our weighted average interest rate
on all outstanding long-term debt is 8.95%.
On November 20, 2004, a second note with an outstanding principal balance
of $101.9 million and a fixed interest rate of 6.95% will convert to the
RTFC's prevailing variable interest rate plus the 1.0% interest rate adder.
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 revolving credit facility with the RTFC. In the near term,
we expect that our primary uses of cash will include:
* building and equipment repairs, restoration of services to customers and
other operating expenses as well as capital expenditures for the
transmission and distribution plant damaged by Hurricane Ivan;
* 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.
We currently estimate that cash required to fund capital expenditures in
2004 will be approximately $15.5 million. Included in the $15.5 million is
approximately $2.5 million in capital expenditures to replace certain
telephone plant and equipment, primarily our transmission and distribution
facilities used to serve the coastal areas of our RLEC operations in Alabama,
as a result of damages from Hurricane Ivan. For the first nine months of
2004, our capital expenditures were approximately $11.7 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 the first nine
months of 2004 and 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. A large
portion of our capital expenditures in 2004 have been directed toward
maintaining our existing facilities. In the fourth quarter of 2004, we
anticipate making approximately $2.5 million in capital expenditures for
hurricane-related repairs. 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. In 2004 and 2005, the demand for use
of capital in the expansion of our telephone plant and network facilities has
been assessed and will continue to 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 potentially adding video
services to the suite of products we offer to our customers. 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.
25
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, or 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 of 2003, 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
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 vigorously defend 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.
26
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 accuracy of our estimates for capital needed to make hurricane-
related repairs and restoration of services;
* 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. On
October 7, 2004, the fixed rate on one of our notes with an outstanding
principal balance of $121.4 million expired and the interest rate converted
to the RTFC's variable rate of interest plus the 1.0% interest rate adder, or
6.3%, and it currently remains variable. Therefore, as of October 7, 2004,
our fixed rate secured debt with the RTFC was $291.2 million at a weighted
average rate of 7.2%. The remaining fixed rates on these term loans expire
beginning November 2004 through August 2006. Upon the expiration of the
fixed interest rates, these 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. Our other fixed rate long-term debt
consists of our senior notes that have a stated fixed rate of 13.25% and a
miscellaneous note for $0.4 million bearing an 8.0% fixed interest rate. As
of October 7, 2004, we also have $133.0 million in term loans with the RTFC
that accrue interest at a variable rate of 6.3%. A one percent change in the
underlying interest rates for this variable rate debt would have an
immaterial impact of approximately $1.3 million per year on interest expense.
Accordingly, we are subject to only minimal interest rate risk on our long-
term debt while our remaining fixed rates are in place. As of October 7,
2004, our weighted average interest rate on our fixed rate and variable rate
secured debt with the RTFC is approximately 6.95% and our weighted average
interest rate on all outstanding long-term debt is 8.95%.
27
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.
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.
The Court has stayed discovery pending a ruling on the Motion for Summary
Judgment which has not yet been received.
In June 2004, the Department of Justice for the United States of America
filed lawsuits against two of our subsidiaries, Gulf Coast Services, Inc. in
the United States District Court for the Southern District of Alabama and
Coastal Utilities, Inc. in the United States District Court for the Southern
District of Georgia. 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 vigorously defend against these claims. On
August 31, 2004, the parties entered into a Joint Motion to Stay the
proceeding in Alabama pending resolution of the Georgia proceeding which is
scheduled to go to trial in the summer of 2005.
28
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------- ----------------------------------------------------------
3.1 Certificate of Formation of the Registrant (incorporated
by reference to Exhibit 3.1 to the Registrant's
Registration Statement on Form S-4 (File No. 333-36804)
filed with the Securities and Exchange Commission on May
11, 2000 (the "May Form S-4"))
3.2 Limited Liability Company Agreement of the Registrant
(incorporated by reference to Exhibit 3.2 to the May Form
S-4)
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
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MADISON RIVER CAPITAL, LLC
Date: November 15, 2004 /s/ PAUL H. SUNU
-----------------------------------
Name: Paul H. Sunu
Title: Managing Director, Chief Financial
Officer and Secretary
29
EXHIBIT INDEX
Exhibit
Number Description
------- -------------------------------------------------------------
3.1 Certificate of Formation of the Registrant (incorporated by
reference to Exhibit 3.1 to the Registrant's Registration
Statement on Form S-4 (File No. 333-36804) filed with the
Securities and Exchange Commission on May 11, 2000 (the "May
Form S-4"))
3.2 Limited Liability Company Agreement of the Registrant
(incorporated by reference to Exhibit 3.2 to the May
Form S-4)
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
30