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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
------------------
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 May 10, 2004, the Registrant had 211,583,892 Class A member interests
outstanding. All member interests are owned by Madison River Telephone
Company, LLC.
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MADISON RIVER CAPITAL, LLC
Index to Form 10-Q
Part I - Financial Information Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - March 31, 2005 (Unaudited)
and December 31, 2004............................................................1
Condensed Consolidated Statements of Operations (Unaudited) - Three Months
Ended March 31, 2005 and 2004....................................................2
Condensed Consolidated Statement of Member's Capital (Unaudited)- Three Months
Ended March 31, 2005.............................................................3
Condensed Consolidated Statements of Cash Flows (Unaudited) - Three Months
Ended March 31, 2005 and 2004....................................................4
Notes to Condensed Consolidated Financial Statements (Unaudited)...................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations....................................................................11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........................25
Item 4. Controls and Procedures............................................................25
Part II - Other Information
Item 1. Legal Proceedings..................................................................26
Item 6. Exhibits...........................................................................26
Signature....................................................................................26
i
Part I
Item 1. FINANCIAL STATEMENTS
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Balance Sheets
(Dollars in thousands)
March 31, 2005 December 31, 2004
-------------- -----------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 30,663 $ 34,486
Accounts receivable, less allowance for uncollectible accounts
of $1,062 and $1,416 in 2005 and 2004, respectively 9,028 9,855
Receivables, primarily from interexchange carriers, less
allowance for uncollectible accounts of $1,122 and $1,310
in 2005 and 2004, respectively 5,652 5,862
Rural Telephone Finance Cooperative stock to be redeemed 235 469
Rural Telephone Finance Cooperative patronage capital receivable 575 2,910
Other current assets 5,569 4,454
--------- ---------
Total current assets 51,722 58,036
--------- ---------
Telephone plant and equipment 486,372 484,608
Less accumulated depreciation and amortization (200,342) (191,715)
--------- ---------
Telephone plant and equipment, net 286,030 292,893
--------- ---------
Other assets:
Rural Telephone Finance Cooperative stock, at cost 41,955 42,190
Goodwill 366,332 366,332
Other assets 22,201 21,553
--------- ---------
Total other assets 430,488 430,075
--------- ---------
Total assets $ 768,240 $ 781,004
========= =========
Liabilities and member's capital
Current liabilities:
Accounts payable and accrued expenses $ 674 $ 1,753
Accrued expenses 22,002 32,048
Other current liabilities 6,477 6,306
Current portion of long-term debt 9,385 9,385
--------- ---------
Total current liabilities 38,538 49,492
--------- ---------
Noncurrent liabilities:
Long-term debt 606,408 608,691
Other liabilities 78,147 78,268
--------- ---------
Total noncurrent liabilities 684,555 686,959
--------- ---------
Total liabilities 723,093 736,451
Member's capital:
Member's interest 251,684 251,684
Accumulated deficit (202,344) (202,938)
Accumulated other comprehensive loss (4,193) (4,193)
--------- ---------
Total member's capital 45,147 44,553
--------- ---------
Total liabilities and member's capital $ 768,240 $ 781,004
========= =========
See Notes to Condensed Consolidated Financial Statements.
1
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Operations
(Dollars in thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
2005 2004
---------- ----------
Operating revenues:
Local services $ 31,373 $ 32,693
Long distance services 3,859 3,806
Internet and enhanced data services 5,766 4,840
Edge-out services 2,725 3,131
Miscellaneous telecommunications service and equipment 4,207 4,109
--------- ---------
Total operating revenues 47,930 48,579
--------- ---------
Operating expenses:
Cost of services and sales (exclusive of depreciation
and amortization) 13,804 13,435
Depreciation and amortization 9,274 12,109
Selling, general and administrative expenses 9,496 10,168
--------- ---------
Total operating expenses 32,574 35,712
--------- ---------
Net operating income 15,356 12,867
Interest expenses (14,415) (15,173)
Other income, net 1,022 865
--------- ---------
Income (loss) before income taxes 1,963 (1,441)
Income tax (expense) benefit (1,369) 160
--------- ---------
Net income (loss) $ 594 $ (1,281)
========= =========
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 Loss Total
---------- ----------- ------------- ---------
Balance at January 1, 2005 $ 251,684 $ (202,938) $ (4,193) $ 44,553
Net income - 594 - 594
--------- ---------- ------- --------
Balance at March 31, 2005 (unaudited) $ 251,684 $ (202,344) $ (4,193) $ 45,147
========= ========== ======= ========
See Notes to Condensed Consolidated Financial Statements.
3
MADISON RIVER CAPITAL, LLC
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
2005 2004
---------- ----------
Operating activities
Net cash provided by operating activities $ 363 $ 3,020
--------- ---------
Investing activities
Purchases of telephone plant and equipment (2,148) (4,945)
Redemption of Rural Telephone Finance Cooperative stock, net 469 1,354
Change in other assets (161) (21)
--------- ---------
Net cash used for investing activities (1,840) (3,612)
--------- ---------
Financing activities
Payments on long-term debt (2,346) (12,303)
--------- ---------
Net cash used for financing activities (2,346) (12,303)
--------- ---------
Net decrease in cash and cash equivalents (3,823) (12,895)
Cash and cash equivalents at beginning of year 34,486 28,143
--------- ---------
Cash and cash equivalents at end of first quarter $ 30,663 $ 15,248
========= =========
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 by the member as the result of an
accounting or similar error.
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 services, Internet access
services, high-speed data and fiber transport. The Company was founded for
the primary purpose of the acquisition, integration and operation of rural
local exchange telephone companies, or RLECs. Since January 1998, the
Company has acquired four RLECs located in North Carolina, Illinois, Alabama
and Georgia. These RLECs served 221,245 voice access and digital subscriber
line, or DSL, connections as of March 31, 2005.
The Company's RLECs manage and operate edge-out competitive local
exchange carrier, or CLEC, businesses in markets in North Carolina, Illinois
and Louisiana, and provide fiber transport services to other businesses,
primarily in the Southeast. These operations are referred to as Edge-Out
Services, or EOS. The EOS markets were developed in close proximity, or
edged-out, from the RLEC operations by utilizing a broad range of experienced
and efficient resources provided by the RLECs. At March 31, 2005, the EOS
operations served 12,340 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, 2004. Such financial statements are included
in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2004 filed with the Securities and Exchange Commission. The
amounts presented in the condensed consolidated balance sheet as of December
31, 2004 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 period ended March
31, 2005 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2005.
Certain amounts in the 2004 condensed consolidated financial statements
have been reclassified to conform to the 2005 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:
March 31, December 31,
2005 2004
--------- ------------
(in thousands)
Land, buildings and general equipment $ 54,579 $ 54,485
Central office equipment 167,321 165,744
Poles, wires, cables and conduit 238,713 237,509
Leasehold improvements 2,541 2,541
Software 18,524 18,522
Construction-in-process 4,694 5,807
--------- ---------
Total telephone plant and equipment $ 486,372 $ 484,608
========= =========
4. RESTRUCTURING CHARGE
As of March 31, 2005, the following amounts were recorded related to
restructuring charges recorded by the Company in the third quarter of 2002
and the fourth quarter of 2001:
2005
Balance at first quarter Balance at
December 31, 2004 payments March 31, 2005
----------------- ------------- --------------
(in thousands)
Future lease obligations $ 540 $ 66 $ 474
Legal related expenses 31 - 31
------ ------ ------
$ 571 $ 66 $ 505
====== ====== ======
The remaining liability as of March 31, 2005 is recorded as $0.2 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:
March 31, December 31,
2005 2004
---------- ------------
(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% (7.15% at March 31, 2005). $ 11,487 $ 11,551
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). 5,826 5,858
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). 935 941
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at RTFC's base variable rate
plus 1.00% (7.15% at March 31, 2005). 100,795 101,359
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). 5,466 5,496
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). 66,272 66,643
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). 3,485 3,505
RTFC note payable in quarterly principal installments plus interest
through November 2016, interest accrued at RTFC's base variable rate
plus 1.00% (7.15% at March 31, 2005). 120,049 120,720
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). 7,650 7,692
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). 97,589 98,135
Unsecured 131/4% senior notes payable, due March 1, 2010, with interest
payable semiannually on March 1 and September 1, net of debt discount
of $1,761 and $1,824, respectively. 196,239 196,176
--------- ---------
615,793 618,076
Less current portion 9,385 9,385
--------- ---------
$ 606,408 $ 608,691
========= =========
7
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
5. LONG-TERM DEBT AND LINES OF CREDIT, Continued
The Company's secured loan facilities are provided by the Rural Telephone
Finance Cooperative ("RTFC"). These secured loan facilities are primarily
with the Company's indirect wholly-owned subsidiary, MRLTDF, under a loan
agreement that matures in November 2016. Under the terms of the loan
agreement, quarterly principal payments through 2010 are approximately $2.3
million. Beginning in 2011 and continuing through November 2016, scheduled
principal payments will vary between $8.9 million and $17.5 million per
quarter as provided for in the loan agreement. In addition, by the second
quarter of each year, the Company is required to calculate excess cash flow,
as defined in the loan agreement, using the preceding year's financial
results for the RLECs subject to the loan agreement. 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. The Company has no requirements for a mandatory prepayment in 2005
based on financial results for 2004.
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 GRH, MLDS, MRLDS and MRLTDF
and its subsidiaries consisting of Mebtel, GCSI, CCI and MRM. Certain of the
administrative covenants restrict, among other things, 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 amounts not to exceed $2.0 million in one quarter or $6.0
million in one year. At March 31, 2005, the Company was in compliance with
the terms and conditions of the loan agreement.
The loan facilities with the RTFC are secured by a first mortgage lien on
the operating assets and revenues of the Company's rural telephone companies
and their subsidiaries, MRH, MRLTDF and MRM. In addition, substantially all
of the outstanding equity interests of these entities have been pledged in
support of the loan facilities. In the event that the Company's senior notes
are fully retired, the Company will grant the RTFC a first mortgage lien on
the operating assets and revenues of Madison River Communications, LLC.
MRLTDF has an undrawn $31.0 million secured revolving line of credit with
RTFC that is fully available. Interest is payable quarterly at the RTFC's
line of credit base rate plus 0.5% per annum (7.2% at March 31, 2005). The
Company also has an undrawn $10.0 million line of credit that is fully
available to Coastal Utilities, Inc., a subsidiary of CCI. 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 (7.7% at March 31,
2005).
Each line of credit is scheduled to expire in September 2005. The Company
has been notified by the RTFC that if the lines of credit are not refinanced
with another lender prior to September 2005, a new secured line of credit in
the amount of $41.0 million for a term ending in March 2010 has been
approved. Completion of the new line of credit is subject to satisfactory
completion of documentation for the new agreements and all conditions
precedent to closing being satisfied.
The Company has outstanding $198.0 million of 13 1/4% senior notes that
mature in March 2010 and have semiannual interest payments due on March 1 and
September 1 of each year. In June 2004, as permitted under the terms of the
loan agreement with the RTFC, MRLTDF acquired $2.0 million in outstanding
senior notes that are considered to be retired.
8
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
5. LONG-TERM DEBT AND LINES OF CREDIT, Continued
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 March 31, 2005, the Company was in compliance with the
terms of its indenture.
6. BENEFIT PLANS
Net periodic benefit costs for the Company's pension plan and other
postretirement benefit plans for the quarters ended March 31, 2005 and 2004
are as follows:
Defined benefit pension plan Other postretirement benefits
---------------------------- -----------------------------
March 31, March 31, March 31, March 31,
2005 2004 2005 2004
--------- --------- --------- ---------
(in thousands)
Service cost $ 99 $ 98 $ 15 $ 12
Interest cost 196 187 28 26
Expected return on plan assets (211) (190) - -
Amortization of net loss (gain) 54 79 (46) (37)
Amortization of prior service cost - - (27) (21)
------ ------ ------ ------
Total net periodic benefit cost $ 138 $ 174 $ (30) $ (20)
====== ====== ====== ======
The Company expects to contribute approximately $1.0 million to its
pension plan in 2005. The Company did not make any contribution to its
pension plan in the first quarter of 2005.
7. INCOME TAXES
Effective January 1, 2005, the Company elected to convert from being
treated as a partnership for federal and state income tax purposes to a C
corporation. As of the effective date of the conversion, the Company will
begin filing a consolidated federal income tax return that includes the
Company and its subsidiaries pursuant to tax sharing agreements entered into
with the Company's subsidiaries.
During 2004, the Alabama Department of Revenue performed an audit of the
2002 and 2001 combined state income tax returns filed by the Company's
subsidiary, Gulf Coast Services, Inc., with the State of Alabama. For 2002,
as permitted under Alabama's income tax regulations, Gulf Coast Services,
Inc. filed a combined return which included its consolidated financial
results as well as the financial results for certain other subsidiaries of
the Company with Alabama operations. In March 2005, the Alabama Department
of Revenue issued a Notice of Preliminary Assessment ("the Alabama Notice")
based on this audit in which it contends that the Company lacked the
necessary nexus to file its 2002 state income tax returns on a combined
basis. The Alabama Notice would not result in any additional taxes being due
for 2002 due to offsetting adjustments. However, if this Alabama Notice is
allowed to stand after appeals, the Company's state income tax liability to
Alabama will increase for tax years subsequent to 2002. For 2003, the
Company filed a combined return using the same basis as 2002 and accordingly,
the return would be amended to reflect the findings in the Alabama Notice if
the Company's appeals are unsuccessful. As such, upon receiving the Alabama
Notice in the first quarter of 2005, the Company accrued a contingent income
tax liability of approximately $0.9 million to recognize the additional
income tax expense for 2003 that would be due if a combined return was not
filed. The Company also accrued approximately $0.1 million for potential
interest expense related to this income tax assessment. For 2004, in
establishing its liability for state income taxes, the Company did not
recognize a $1.4 million benefit from the filing of a combined return.
The Company believes its position in the combined returns is appropriate
and intends to appeal this finding. Accordingly, the Company filed a Request
for Review with the Alabama Department of Revenue in April 2005. However, at
this time, the Company is uncertain as to the outcome of this matter.
9
MADISON RIVER CAPITAL, LLC
Notes To Condensed Consolidated Financial Statements, Continued
(Unaudited)
8. 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 month periods ended
March 31, 2005 and 2004:
Three month period ended
--------------------------
March 31, March 31,
2005 2004
--------- ---------
(in thousands)
Total revenues:
RLEC operations $ 45,817 $ 46,113
EOS 2,824 3,163
-------- --------
48,641 49,276
Less intersegment revenues (711) (697)
-------- --------
Total reported revenues $ 47,930 $ 48,579
======== ========
Net operating income (loss):
RLEC operations $ 17,815 $ 15,733
EOS (2,459) (2,866)
-------- --------
Total reported net
operating income $ 15,356 $ 12,867
======== ========
Total assets by segment, net of intersegment investments and other
intersegment balances, were as follows:
March 31, December 31,
2005 2004
--------- ------------
(in thousands)
Total assets:
RLEC operations $ 837,367 $ 840,537
EOS 419,737 433,952
--------- ---------
1,257,104 1,274,489
Less intersegment assets (488,864) (493,485)
--------- ---------
Total reported assets $ 768,240 $ 781,004
========= =========
10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements, other than statements of historical fact, included in
this Form 10-Q are "forward-looking statements." Forward-looking statements
generally can be identified by the use of forward-looking terminology such as
"may," "will," "expect," "intend," "estimate," "anticipate," "plan," "seek"
or "believe." 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 future performance could differ
materially from such statements. Factors that could cause or contribute to
such differences include, but are not limited, to the following:
* our ability to service our significant amount of indebtedness;
* our inability to achieve profitability;
* our ability to sustain our revenues;
* our dependence on economic conditions in the local markets we serve;
* 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 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 implement our business plan for our edge-out services
successfully;
* 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;
* our ability to compete effectively with the regional Bell operating
companies;
* our dependence on our key personnel;
* our ability to raise additional capital on acceptable terms and on a
timely basis;
* a reduction in universal service fund payments; and
* our regulatory environment.
You should not unduly rely on these forward-looking statements, which
speak only as of the date of this Form 10-Q. 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 date of
this Form 10-Q or to reflect the occurrence of unanticipated events.
Important factors that could cause our actual results to differ
materially from our expectations are discussed in the "Risk Factors" section
beginning on page 21 of our Annual Report on Form 10-K for the fiscal year
ended December 31, 2004 (File No. 333-36804) as filed with the Securities and
Exchange Commission.
References in this Form 10-Q to "we," "us" and "our" mean Madison River
Capital, LLC and its subsidiaries.
Overview
We operate four rural telephone companies that serve business and
residential customers in the Southeast and Midwest regions of the United
States. We offer our customers a variety of telecommunications services,
including local and long distance services, Internet and enhanced data
services, telephone directory and other miscellaneous services and edge-out
services. At March 31, 2005, we had 233,585 voice access line, DSL and high-
speed data connections in service in our RLEC operations and our edge-out
services.
On December 23, 2004, Madison River Communications Corp., an entity
formed to serve as the successor to MRTC, filed a Registration Statement on
Form S-1 with the SEC for the purpose of registering its common stock in
connection with an initial public offering. The Form S-1 has not yet become
effective. These securities may not be sold nor may offers to buy be accepted
prior to the time the Form S-1 becomes effective. This Form 10-Q shall not
constitute an offer to sell or the solicitation of an offer to buy nor shall
there by any sale of these securities in any state in which such offer,
solicitation or sale would be unlawful prior to registration or qualification
under the securities laws of any such state.
The consummation of the initial public offering is subject to various
contingencies, including the closing of new credit facilities and market
conditions. There can be no assurance that the initial public offering and
the related transactions will be completed on the terms described in the Form
S-1 or at all. See " - Proposed Initial Public Offering of Common Stock by
Madison River Communications Corp. and Related Transactions" for further
information.
11
Our rural telephone markets are located in Alabama, Georgia, Illinois and
North Carolina. We also provide edge-out services as a competitive local
exchange carrier in territories that are in close proximity to our rural
telephone markets. We currently provide edge-out services to medium and large
customers in three markets: (i) the Triangle (Raleigh, Durham and Chapel
Hill) and the Triad (Greensboro and Winston-Salem) in North Carolina; (ii)
Peoria and Bloomington in Illinois and (iii) New Orleans, Louisiana and
nearby cities. The management and operating responsibility for the edge-out
operations are provided by the managers of the respective rural telephone
companies.
Our edge-out services include not only local exchange carrier services
but also a transport service that provides transport and Internet Protocol,
or IP, transit services to other carriers and large businesses along
approximately 2,300 route miles of fiber optic network. The majority of this
network comprises a long-haul network in the Southeast United States that
connects Atlanta, Georgia and Dallas, Texas, two of the five Tier I Network
Access Points. Further, the route connects other metropolitan areas such as
Mobile and Montgomery, Alabama; Biloxi, Mississippi; New Orleans, Louisiana;
and Houston, Texas. We have designated Atlanta and Dallas as our Internet
egress points. Because we have found the fiber transport business to be
extremely competitive, we are not actively expanding this line of business at
this time. The main value being derived from our fiber optic network is
through support for our dial-up, DSL and high-speed access services which
require the use of our fiber optic network to connect to the Internet.
Since our inception, our principal activities have been the acquisition,
integration, operation and improvement of rural telephone companies. In
acquiring our four rural telephone companies, we purchased established
businesses with stable cash flows, governmental authorizations and
certifications in place, operational support systems, experienced management
and key personnel and technologically advanced facilities. We continue to
develop the established markets in which our rural telephone companies
operate with successful marketing of related services and DSL products and
are controlling expenses through the use of business process management tools
and other methods. For our edge-out services, our objective 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. Accordingly, we have established a rigorous set of criteria for
evaluating new customers and determining the desirability of renewing
existing contracts for customers of our edge-out services.
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
Our revenues are derived principally from the sale of voice and data
communications services to business and residential customers in our
established rural telephone markets. For the first quarter ended March 31,
2005, approximately 94.3% of our operating revenues came from our RLEC
operations and 5.7% from our edge-out services. For the year ended December
31, 2004, approximately 93.9% of our operating revenues came from our RLEC
operations and 6.1% 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. We believe 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 with
the objective 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. Our fiber 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 fiber transport facilities will primarily be used to
support our retail Internet access business in our RLEC operations.
At March 31, 2005, we had 233,585 voice access lines, DSL and high-speed
data connections in service compared to 230,809 connections in service at
March 31, 2004, an increase of 2,776 connections, or 1.2%. Our RLEC
operations had 221,245 connections in service at March 31, 2005 and 216,099
connections in service at March 31, 2004, an increase of 5,146 connections,
or 2.4%. For our edge-out services, connections in service at March 31, 2005
and March 31, 2004 were 12,340 and 14,710, respectively, a decrease of 2,370
connections, or 16.1%. Voice access lines refer to local telephone service
provided to residential and business customers. DSL connections are the high-
speed connections provided to end users for purposes of accessing the
Internet. Most DSL customers are residential customers who also subscribe to
our local telephone service. In our edge-out services, our customers are
primarily medium and large businesses that we actively market our services to
through sales calls. Our revenues are highly dependent on the number of
connections in service.
12
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 RLEC operations
emphasizes the bundling of services and the benefits it provides to our
customers. We have branded our primary residential bundled offering as our
"No Limits" package. The No Limits bundle is marketed to our residential
customers at a price that varies slightly by location. 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.
Our results show that the No Limits package has been successful in
increasing penetration rates in services such as DSL and long distance. 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 No
Limits bundle. We intend to continue to enhance our bundled service offerings
with promotional pricing and new service additions.
We have entered an agreement with the National Rural Telecommunications
Cooperative that will allow us to offer DIRECTV satellite television service
to our customers. We expect that this will be an attractive enhancement to
our bundled service offerings. We anticipate that introduction of this
product offering will commence by the second quarter of 2005.
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 RLEC operations 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
experienced significant growth in DSL subscribers compared to prior years. As
of March 31, 2005, our penetration rate for residential DSL connections as a
percentage of primary residential voice access lines was 34.2% compared to
32.2% at December 31, 2004 and 23.8% at March 31, 2004. Although we cannot be
certain, we anticipate that our DSL product will continue to provide a source
of increasing revenues for our RLEC operations in future quarters. As of
March 31, 2005, we had 41,857 DSL connections in service, an increase of
2,295 connections from 39,562 DSL connections in service at December 31, 2004
and an increase of 11,211 connections from 30,646 DSL connections in service
at March 31, 2004. As discussed further below, we have lost DSL connections
as a result of hurricane-related damages in Alabama and a full deployment of
troops stationed at Fort Stewart and Hunter Army Airfield near Hinesville,
Georgia. Excluding the loss of DSL connections from these events, which we
believe are temporary, our increase in DSL connections served would have been
approximately 12,270 connections, or 40.0%.
As we have increased the number of DSL connections we serve, we have
experienced a decrease in the number of dial-up Internet accounts in service.
At March 31, 2005, we had 14,513 dial-up Internet customers, which was a
decrease of 6,150 customers, or 29.8%, from 20,663 dial-up Internet customers
at March 31, 2004. 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 DSL service.
We have also been successful in growing penetration rates in our RLEC
operations for the provision of long distance and related telecommunications
services to our customers. At March 31, 2005, we had 102,636 long distance
accounts compared to 99,172 long distance accounts at March 31, 2004. In
addition, our penetration rates for our primary custom calling features
including voicemail, caller identification, call waiting and call forwarding
as of March 31, 2005 have increased since March 31, 2004. A substantial
portion of the growth in long distance accounts served and custom calling
features provided can be attributed to the success of our No Limits bundle.
As of March 31, 2005, the number of voice access lines served by our RLEC
operations declined compared to the number of voice access lines in service
at March 31, 2004. As of March 31, 2005, the RLEC operations had 179,388
voice access lines in service, which is a decrease of 6,065 voice access
lines, or 3.3%, from 185,453 voice access lines in service at March 31, 2004.
The decrease in voice access lines can be attributed primarily to four
factors affecting our business. First, storm-related damages from Hurricane
Ivan in September 2004 resulted in approximately 2,935 voice access lines
being disconnected as of March 31, 2005 at our Alabama rural telephone
company, Gulf Telephone Company, up from our estimate of approximately 2,840
voice access lines being disconnected at December 31, 2004. Substantially
all of these disconnected voice access lines are 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 these voice
access lines should return to service as repairs and restorations in this
area are completed.
13
Second, at our rural telephone company in Illinois, Gallatin River
Communications, a persistent weakness in the local economies served by
Gallatin River continues to impact the number of voice access lines in
service. In this market, primary voice access lines, which we define as
total voice access lines less second lines, declined by 3,041 lines from
March 31, 2004 to March 31, 2005, accounting for approximately 50% of the
total decline in voice access lines during this period. This market is
predominantly industrial and agricultural in nature and has experienced
significant losses in its business base, resulting in higher unemployment. We
are uncertain at this time regarding the future trend for voice access lines
at Gallatin River but absent any improvement in the local economies
comprising this market, we expect access lines in service will continue to
decline.
Third, we have seen a decrease in voice access lines at our rural
telephone company in Georgia, Coastal Utilities, Inc., as a result of the
full deployment of troops stationed at Fort Stewart and Hunter Army Airfield
to Iraq. The deployment was completed in February 2005. Coastal Utilities
serves the Hinesville area, including the military bases where the troops
were deployed from. According to military officials, the deployment could
last up to 14 months. 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. We are unable to project the range of the
impact of this deployment on Coastal Utilities, Inc. or our operations or
cash flows as a whole at this time. However, we estimate that primary voice
access lines in service at Coastal Utilities have decreased by approximately
1,270 lines at March 31, 2005 as a result of the deployment. We believe that
we will recover the predominant share of these voice access lines as the
troops return to these military bases from the deployment.
A final factor impacting the number of voice access lines served is
attributed to the growth in our DSL connections and corresponding decrease in
the number of second lines served. We believe that as our existing customers
migrate 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 voice
access line to connect to the Internet, they often remove the second line
from service. Accordingly, the number of second lines in service decreased
by 988 lines, or 13.1% from 7,532 second lines in service at March 31, 2004
to 6,544 second lines in service at March 31, 2005. 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.
Excluding the voice access line losses related to hurricane damage in
Alabama and the troop deployment in Georgia, both of which we believe are
temporary, our decrease in voice access lines would have been approximately
1,860 lines, or 1.0%, during the twelve month period ended March 31, 2005.
Effective April 30, 2005, our North Carolina rural telephone company,
Mebtel, Inc., completed the acquisition of certain assets comprising the
Milton and Gatewood exchanges in North Carolina. The exchanges serve
approximately 3,500 voice access lines and 1,200 long distance accounts. We
expect revenues from the two exchanges to be approximately $2.7 million
annually.
On May 6, 2005, the State of Alabama signed into law the Alabama
Communications Reform Act of 2005, or the Alabama Act. Our rural telephone
company, Gulf Telephone Company, serves customers in Foley, Alabama and
surrounding areas. The Alabama Act becomes effective August 1, 2005,
although many of its provisions become effective at a later date. The
Alabama Public Service Commission, or APSC, retains its jurisdiction over
regulated telephone services through January 31, 2007, except for bundled
offerings, contract service offerings and broadband services which are
subject to different deregulation dates. After January 31, 2007, the APSC
will only regulate basic residential services and business customers with up
to four lines to the extent such services are not included in a bundled
offering. In order to qualify for deregulation under the Alabama Act, rural
telephone companies must show certain competitive activity and, based on
information we currently have, we believe Gulf Telephone Company will qualify
for deregulation under the provisions of the Alabama Act. We anticipate that
the Alabama Act will provide Gulf Telephone Company with more flexibility to
address market conditions and we believe that it will not have a material
impact on our financial position, operations or cash flows.
Our RLEC operations benefit from statutory and regulatory requirements
that rates in rural areas be reasonably comparable to rates in urban areas,
which results in state and federal universal service fund payments in high
cost rural areas. For the quarters ended March 31, 2005 and March 31, 2004,
revenues attributable to such payments represented 6.5% and 6.2%,
respectively, of our total revenues. Under the current regulatory scheme, as
the number of access lines that we have in any given state increases, the
rate at which we can recover certain payments decreases. Therefore, as we
implement our growth strategy, our eligibility for such payments or the
amount of such payments may decrease.
In our edge-out services, revenues decreased in the first quarter of 2005
compared to the first quarter of 2004 as sales of new services and renewals
of expiring customer contracts have not been enough to replace customers that
ceased purchasing our services. At March 31, 2005, our edge-out services had
11,682 voice access lines and 658 high-speed data connections in service. At
March 31, 2004, our edge-out services served 14,030 voice access lines and
680 high-speed data connections. Our objective for the edge-out services has
been to maintain a line of business
14
that generates sufficient cash flows to fund its own operations and capital
requirements and does not harm the enterprise as a whole. 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 local
exchange carriers, we may be unable to appropriately protect ourselves
against the financial impact associated with any future bankruptcies of
interexchange carriers or other telecommunication providers. At March 31,
2005, we had approximately $1.1 million reserved against our interexchange
carrier receivables. We evaluate the adequacy of this allowance on a regular
basis.
Operating Expenses
Our primary operating expenses consist of cost of services and sales
(exclusive of depreciation and amortization), selling, general and
administrative expenses and depreciation and amortization.
Cost of services and sales
Our cost of services and sales 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, Internet service
provider, or ISP, external help desk costs, network administration,
outside plant administration, power and engineering;
* materials and contract labor costs related to construction of certain
telecommunication facilities and telecommunication equipment
installations for customers;
* the cost of collocating in incumbent local exchange carrier central
offices and leasing unbundled copper loop lines and high capacity
digital lines from the incumbent local exchange carriers to connect our
customers and other carriers' networks to our network; and
* the cost of leasing transport from incumbent local exchange carriers or
other providers where our fiber transport capacity is not available.
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 incumbent local exchange
carriers, 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.
Effective in April 2005, we entered into two new agreements with carriers
to provide long distance transmission services for our customers. With our
new agreements, we are not subjected to any minimum volume commitments as
existed under our expiring contract.
On April 28, 2005, we completed a new collective bargaining agreement,
covering 56 employees of Gallatin River Communications located in Galesburg,
Illinois, for a period of five years. The existing agreement expired on
April 30, 2005. Our remaining two collective bargaining agreements with the
International Brotherhood of Electrical Workers cover 54 employees in Pekin,
Illinois and 28 employees in Dixon, Illinois. These agreements expire on
September 30, 2005 and November 30, 2005, respectively, and we intend to
initiate formal union negotiations on each contract approximately 30-45 days
in advance of the contract expiration date.
In response to a decision by the United States Court of Appeals for the
District of Columbia, or the DC Circuit Court, to vacate certain portions of
the 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 and initiated a proceeding to review and revise its
unbundling rules. In response to the reversal of its rules by the DC Circuit
Court, the FCC issued interim rules on August 20, 2004, and initiated a
proceeding to review and revise its unbundling rules. On December 15, 2004,
the FCC adopted new rules which were released February 4, 2005. The new rules
reduce incumbent local exchange carriers' obligations to lease interoffice
transport and high-capacity loops, and eliminate the requirement to lease
mass market local circuit switching, including the unbundled network element
platform (a combination of loop, switching and transport which allows
competitive local exchange carriers to offer service without their own
infrastructure). The revised rules took effect March 11, 2005 and, subject to
a twelve
15
month transition, eliminate incumbent local exchange carriers' obligations to
provide unbundled network element platform services nationwide, certain high
speed interoffice facilities and certain high capacity unbundled network
element loops in larger incumbent local exchange carrier wire centers.
Several challenged those rules in court and it is not possible to predict the
result of any subsequent reconsideration or appeal. It is not possible to
predict the outcome or the ultimate impact on our RLEC operations or our
edge-out services. We are also uncertain as to the impact on our RLEC
operations or edge-out services of actions that may be taken by state utility
commissions based upon the new regulations or new legislation that may be
considered and passed in response to the new regulations or any further court
decisions. 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. The FCC is also
considering changes in the rules it applies to the pricing of unbundled
network elements. Significant increases in pricing of unbundled network
elements, currently based on FCC total element long-run incremental cost
pricing rules, would significantly increase the cost of obtaining facilities
necessary to provide services to customers in our edge-out markets. However,
based on information currently available, we believe the impact to our edge-
out services will not be material. 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. We continue to analyze its financial and operating
results to determine that our objective for this line of business is being
accomplished.
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 and administrative 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.
As of March 31, 2005, we have incurred approximately $1.5 million in
professional service fees and other expenses related to the registration
statement filed by Madison River Communications Corp. These amounts are
included in other current assets in our condensed consolidated balance sheet.
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 plants 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.
We have seen a decline in recent quarters in our depreciation expense as
a result of certain asset classes becoming fully depreciated. As a result of
damages incurred in our Alabama rural telephone company related to Hurricane
Ivan, we made capital expenditures of approximately $2.6 million with
substantially all of these expenditures being made in the fourth quarter of
2004. We received authorization from the Alabama Public Service Commission to
accelerate depreciation of these capital expenditures completely in the
fourth quarter of 2004. Beyond this one-time event, we anticipate that our
depreciation expense will continue to decrease in the near-term.
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.
16
Results of Operations
Quarter Ended March 31, 2005 compared to Quarter Ended March 31, 2004
Revenues
Total revenues for the first quarter ended March 31, 2005 were $47.9
million, a decrease of $0.7 million, or 1.3%, from $48.6 million for the
first quarter ended March 31, 2004. Revenues in the RLEC operations were
$45.2 million in the first quarter of 2005, a decrease of $0.3 million, or
0.5%, from revenues of $45.5 million in the first quarter of 2004. In our
edge-out services, revenues decreased $0.4 million, or 13.0%, to $2.7 million
in the first quarter of 2005 compared to $3.1 million in the first quarter of
2004.
For the quarter ended March 31, 2005, our RLEC operations and edge-out
services provided approximately 94.3% and 5.7%, respectively, of our
revenues. Comparatively, for the year ended December 31, 2004, our RLEC
operations provided 93.9% of our revenues and our edge-out services provided
6.1% of our revenues.
Revenues from voice services, which are comprised of our revenues from
provision of local services, which includes our network access revenues, and
our revenues from provision of long distance services, as a percentage of
total revenues, were approximately 73.5% and 75.1% for the quarters ended
March 31, 2005 and 2004, respectively.
Local Services. Revenues from local services, which are comprised of
local services and network access services, as a percentage of total
revenues, were approximately 65.5% and 67.3% for the quarters ended March 31,
2005 and 2004, respectively.
Local service revenues in the first quarter of 2005 were $31.4 million, a
decrease of $1.3 million, or 4.0%, from local service revenues in the first
quarter of 2004 of $32.7 million. The decrease in local service revenues is
attributed primarily to lower end user revenues as the result of a decrease
in voice access lines in service. Our RLEC operations served 179,388 voice
access lines at March 31, 2005 compared to 185,453 voice access lines in
service at March 31, 2004, a decrease of 6,065 lines or 3.3%. In addition,
local service revenues decreased as a result of a decrease in network access
revenues.
Long Distance Services. Long distance revenues in 2004 were
approximately $3.8 million in the first quarters of 2005 and 2004,
respectively. An increase in the number of long distance subscribers was
offset by a decrease in customer billing. As the number of subscribers to the
No Limits bundle increased, 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.
Internet and Enhanced Data Services. Revenues from Internet and
enhanced data services increased $1.0 million, or 19.1% to $5.8 million in
the first quarter of 2005 compared to $4.8 million in the first quarter of
2004. The increase in revenues is attributable to the increase in the number
of DSL connections served in our RLEC operations. At March 31, 2005, our RLEC
operations served 41,857 DSL connections compared to 30,646 at March 31,
2004, an increase of 11,211 connections, or 36.6%.
Edge-Out Services. Revenues from our edge-out services in the first
quarter of 2005 were $2.7 million, a decrease of approximately $0.4 million,
or 13.0%, from revenues of $3.1 million in the first quarter of 2004. The
decrease was attributable primarily to a $0.3 million decrease in local
service revenues as the result of a decrease in the number of connections
served. At March 31, 2005 and 2004, our edge-out services served
approximately 11,682 and 14,030 voice access lines, respectively,
representing a 16.7% decrease. In addition, revenues from enhanced data
services provided in our edge-out services decreased $0.1 million, or 11.5%,
in the first quarter of 2005 compared to the first quarter of 2004 as a
result of a decrease in the number of high speed data connections in service.
At March 31, 2005, our edge-out services served 658 connections compared to
680 connections at March 31, 2004, a decrease of 22 connections or 3.2%.
Revenues from transport services were $0.6 million in the first quarters of
2005 and 2004, respectively. We have found the fiber transport business to be
extremely competitive and we are not actively expanding this line of business
at this time. The main value being derived from our fiber optic network is
through support for our dial-up, DSL and high-speed access services which
require the use of our fiber optic network to connect to the Internet.
Miscellaneous telecommunications revenues increased $0.1 million in the first
quarter of 2005 when compared to the first quarter of 2004.
Miscellaneous Telecommunications Revenues. Miscellaneous
telecommunications revenues were $4.2 million in the first quarter of 2005,
an increase of $0.1 million, or 2.4%, compared to miscellaneous
telecommunications revenues of $4.1 million in the first quarter of 2004. The
increase in miscellaneous telecommunications revenues is attributed primarily
to a decrease in uncollectible expenses, which are included in miscellaneous
telecommunications revenues, in the first quarter of 2005 compared to the
first quarter of 2004.
17
Operating Expenses
Total operating expenses decreased approximately $3.1 million from $35.7
million, or 73.5% of total revenues in the first quarter of 2004, to $32.6
million, or 68.0% of total revenues in the first quarter of 2005. The
decrease is primarily attributable to a decrease of $2.8 million in
depreciation and amortization expenses in the first quarter of 2005 compared
to the same period in 2004. The decrease in depreciation and amortization
expenses is largely due to certain classes of assets becoming fully
depreciated.
Cost of services and sales (exclusive of depreciation and amortization),
as a percentage of total revenues, increased to 28.8% in the first quarter of
2005 from 27.7% in the first quarter of 2004, and selling, general and
administrative expenses, as a percentage of total revenues, decreased from
20.9% in the first quarter of 2004 to 19.8% in the first quarter of 2005.
Depreciation and amortization expenses, as a percentage of total revenues,
decreased from 24.9% in the first quarter of 2004 to 19.4% in the first
quarter of 2005.
RLEC Operations Operating Expenses. In the RLEC operations, operating
expenses in the quarter ended March 31, 2005 were $27.4 million, a decrease
of $2.3 million, or 7.8%, from operating expenses of $29.7 million in the
quarter ended March 31, 2004. Depreciation and amortization expense in the
first quarter of 2005 was $6.7 million, a decrease of $2.1 million, or 23.7%,
from depreciation and amortization expense of $8.8 million in the first
quarter of 2004. The decrease was attributable to certain classes of assets
becoming fully depreciated during the past year. Cost of services and sales
(exclusive of depreciation and amortization) in the RLEC operations increased
approximately $0.3 million, or 2.6%, to $11.9 million in the first quarter of
2005 from $11.6 million in the first quarter of 2004. The increase is
attributed primarily to additional expenses related to storm damage
restoration in Alabama and higher contract labor expenses for a special
project in Georgia in the first quarter of 2005 compared to the prior year.
These increases were partially offset by a reduction in expenses for DSL
modems as the number of new DSL connections placed in service was lower in
the first quarter of 2005 compared to the first quarter of 2004. Selling,
general and administrative expenses decreased approximately $0.5 million, or
5.7%, to $8.7 million in the first quarter of 2005 from $9.2 million in the
first quarter of 2004. The decrease is attributed primarily to a $0.4
million decrease in long-term incentive plan expenses.
Edge-Out Services Operating Expenses. Operating expenses in our edge-
out services decreased approximately $0.8 million from $6.0 million in the
first quarter of 2004 to $5.2 million in the first quarter of 2005,
attributable primarily to a decrease in depreciation and amortization
expense. Depreciation and amortization expense decreased $0.8 million, or
22.6%, to $2.5 million in the first quarter of 2005 from $3.3 million in the
first quarter of 2004. The decrease in depreciation expenses is primarily
attributable to certain assets becoming fully depreciated. Cost of services
and sales (exclusive of depreciation and amortization) increased
approximately $0.1 million to $1.9 million in the first quarter of 2005 from
$1.8 million in the first quarter of 2004, while selling, general and
administrative expenses decreased $0.1 million to $0.8 million in the first
quarter of 2005 from $0.9 million in the first quarter of 2004.
Net Operating Income
Net operating income increased approximately $2.4 million from $12.9
million, or 26.5% of total revenues in the first quarter of 2004 to $15.3
million, or 32.0% of total revenues in the first quarter of 2005. The
increase is attributable primarily to the decrease in depreciation and
amortization expense in both the RLEC operations and the edge-out services.
Net operating income in the RLEC operations increased $2.0 million, or 13.2%,
to $17.8 million in the first quarter of 2005 from $15.8 million in the first
quarter of 2004. For the edge-out services, the net operating loss improved
$0.4 million, or 14.2%, to $2.5 million in the first quarter of 2005 from
$2.9 million in the first quarter of 2004.
Interest Expense
Interest expense decreased $0.8 million, or 5.0% to $14.4 million, or
30.1% of total revenues, in the first quarter of 2005 from $15.2 million, or
31.2% of total revenues, in the first quarter of 2004. Lower weighted average
outstanding balances and lower weighted average interest rates on long-term
debt with the RTFC resulted in a decrease of approximately $0.9 million in
interest expense. Other interest expense, related primarily to certain income
tax-related exposures, increased approximately $0.1 million in the first
quarter of 2005.
Other Income
Other income in the first quarter of 2005 was $1.0 million, an increase
of $0.2 million, or 18.2%, from other income of $0.8 million in the first
quarter of 2004. Other income represented 2.1% and 1.8% of total revenues in
the first quarters of 2005 and 2004, respectively. The increase is due to an
increase in interest income as a result of higher cash balances and an
increase in accruals for dividends from the Rural Telephone Bank.
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Income Tax Expense / Benefit
We reported income tax expense of $1.4 million in the quarter ended March
31, 2005 compared to an income tax benefit of $0.2 million in the quarter
ended March 31, 2004, a change of $1.6 million. The change is attributed
primarily to a one-time accrual of $0.9 million in state income tax expense
related to a proposed audit adjustment from an audit by the Alabama
Department of Revenue conducted in 2004. The audit covered the 2002 and 2001
combined state income tax returns filed by our subsidiary, Gulf Coast
Services, Inc., with the State of Alabama. For 2002, as permitted under
Alabama's income tax regulations, Gulf Coast Services, Inc. filed a combined
return which included its consolidated financial results as well as the
financial results for certain other subsidiaries of the Company with Alabama
operations. In March, 2005, the Alabama Department of Revenue issued a
Notice of Preliminary Assessment ("the Alabama Notice") in which it contended
that we lacked the necessary nexus to file our 2002 state income tax returns
on a combined basis. The Alabama Notice, if upheld, would not result in any
additional taxes being due for 2002 due to offsetting adjustments. However,
if the Alabama Notice is upheld after appeals, our state income tax liability
to Alabama will increase for tax years subsequent to 2002. For 2003, we
filed a combined return using the same basis as 2002 and accordingly, if
appeals are unsuccessful, the return would be amended to reflect the findings
in the Alabama Notice. As such, upon receiving the Alabama Notice in the
first quarter of 2005 and after consultation with our advisors, we accrued a
deferred income tax liability of approximately $0.9 million to recognize the
additional income tax expense for 2003 that would be due if a combined return
was not filed. We also accrued approximately $0.1 million for potential
interest expense related to this income tax assessment. We believe our
position in the combined returns is appropriate and we intend to appeal this
finding. Accordingly, we filed a Request for Review with the Alabama
Department of Revenue in April, 2005. However, at this time, we are
uncertain as to the outcome of this matter.
The remaining change in income taxes is attributed to an increase in our
pre-tax income in the first quarter of 2005 compared to the first quarter of
2004. In the first quarter of 2005, our pre-tax income was approximately
$2.0 million compared to a pre-tax loss of $1.4 million in the first quarter
of 2004, an improvement of $3.4 million.
Net Income (Loss)
We reported net income of $0.6 million in the first quarter of 2005, or
1.2% of total revenues. Our net income of $0.6 million was an improvement of
$1.9 million from our net loss of $1.3 million, or 2.6% of total revenues, in
the first quarter of 2004, as a result of the factors discussed above. The
RLEC operations reported net income of $8.5 million in the first quarter of
2005 compared to net income of $8.3 million in the first quarter of 2004, an
increase of $0.2 million, or 2.9%. For the quarters ended March 31, 2005 and
2004, our edge-out services reported net losses of $7.9 million and $9.6
million, respectively, an improvement of $1.7 million.
Liquidity and Capital Resources
We are a holding company with no business operations of our own. Our only
significant assets are the capital stock/member interests of our
subsidiaries. Accordingly, our only sources of cash to pay our obligations
are cash on hand and distributions from our subsidiaries from their net
earnings and cash flow. Even if our subsidiaries determine to pay a dividend
on, or make a distribution in respect of, their capital stock/member
interests, we cannot guarantee that our subsidiaries will generate sufficient
cash flow to pay such a dividend or distribute such funds or that they will
be permitted to pay such dividend or distribution under the terms of their
credit facilities, their contractual obligations or the laws of their
jurisdiction of incorporation.
At March 31, 2005, we had total liquidity of $71.7 million, which
consisted of cash and cash equivalents of $30.7 million and available
borrowings under our lines of credit with the RTFC of $41.0 million. As
discussed further below, our lines of credit are scheduled to expire in
September 2005. We have been notified by the RTFC that, assuming the lines
of credit are not refinanced with another lender prior to September 2005, a
new secured line of credit in the amount of $41.0 million for a term ending
in March 2010 has been approved.
At March 31, 2005, we had positive working capital of approximately $13.2
million compared to a working capital deficit of $8.6 million at March 31,
2004, a change of $21.8 million. The change is attributable primarily to an
increase in our cash balance of $15.4 million and a decrease of $8.6 million
in our accounts payable and accrued expenses at March 31, 2005 compared to
March 31, 2004. These amounts were partially offset by an increase of $2.3
million in the current portion of long-term debt at March 31, 2005 compared
to March 31, 2004. We believe our working capital position continues to be
enhanced by our reduced schedule of principal payments as the result of the
credit facility amendment with the RTFC entered into in July 2003. 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.
Operating Activities. For the quarters ended March 31, 2005 and 2004, we
generated cash from operating activities of $0.4 million and $3.0 million,
respectively, a decrease of $2.6 million. The decrease is attributed
primarily to cash used to reduce accounts payable and accrued expenses. In
the first quarter of 2005, we used
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approximately $11.1 million of cash to reduce accounts payable and accrued
expenses compared to approximately $8.7 million in the first quarter of 2004,
an increased use of cash of $2.4 million.
Investing Activities. For the quarter ended March 31, 2005, net cash used
for investing activities was $1.8 million and consisted of $2.1 million in
cash used for the purchase of telephone plant and equipment and changes in
other assets of $0.2 million. Partially offsetting these amounts was cash
received from the redemption of subordinated capital certificates by the RTFC
in the amount of $0.5 million. For the quarter ended March 31, 2004, net
cash used for investing activities was $3.6 million and consisted of $4.9
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.
Financing Activities. For the quarters ended March 31, 2005 and 2004, net
cash used in financing activities was $2.3 million and $12.3 million and
consisted of payments on long-term debt.
Long-Term Debt and Revolving Credit Facilities
At March 31, 2005, we had outstanding term loans totaling $419.6 million
under our existing secured credit facilities with the RTFC. In addition, we
had outstanding $198.0 million in 13 1/4% unsecured senior notes that are due
in March 2010.
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 rural telephone
companies and our management company: Mebtel, Inc., Gulf Coast Services,
Inc., Coastal Communications, Inc. and Madison River Management LLC. Each of
our rural telephone companies, our management company and Gallatin River
Holdings, LLC have provided a guaranty to the RTFC and their operating assets
and revenues are subject to a first mortgage lien in favor of the RTFC.
As of March 31, 2005, MRLTDF had approximately $419.6 million in secured
term loans outstanding with the RTFC. Of this amount, a $97.6 million term
loan bore a fixed interest rate of 9.0% that expired in April 2005. An
additional $89.6 million in term loans bear fixed interest at 5.65% with such
fixed interest rates expiring in August 2006. Upon the expiration of the
fixed interest rates under the loan agreement with the RTFC, 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 $232.4 million in outstanding term loans have a variable interest
rate of 7.15% at March 31, 2005. In total, as of March 31, 2005, our weighted
average interest rate on all RTFC term debt is 7.24%.
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. In addition, during the
second quarter of each year, we are required to calculate excess cash flow,
as defined in our loan agreement, using the preceding year's financial
results for the rural telephone companies subject to the loan agreement. If
the calculation indicates excess cash flow, we are required to make a
mandatory prepayment of principal to the RTFC equivalent to the amount of
excess cash flow. Based on financial results for 2004, no mandatory
prepayment is required to be made to the RTFC in 2005.
Under the terms of our loan agreement, interest rates on our outstanding
term loans are at their prevailing RTFC fixed or variable base rate plus a
1.0% interest rate adder. The 1.0% interest rate adder is subject to
performance pricing which will provide for a reduction in the interest rate
adder as our Total Leverage Ratio, as defined in the 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. At March 31,
2005, our Total Leverage Ratio remained above 5.0 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 exchanges. We also have restrictions on the payment of
dividends by MRLTDF and GRH. In addition, our loan agreement allows us to
repurchase our senior notes without RTFC consent in amounts not to exceed
$2.0 million per quarter and $6.0 million per year.
Our loan facilities with the RTFC are secured by a first mortgage lien on
the operating assets and revenues of our rural telephone companies and their
subsidiaries, Madison River Holdings Corp., Madison River LTD Funding Corp.
and Madison River Management LLC. In addition, substantially all of the
outstanding equity interests of these entities have been pledged in support
of the loan facilities. In addition, in the event that our senior notes are
20
fully 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 that represent ownership
interests in the RTFC equal to 10% of the amount borrowed. The RTFC financed
the purchase of the subordinated capital certificates by increasing the
balance advanced for a loan by an amount equal to the subordinated capital
certificates purchased.
At March 31, 2005, we owned $42.2 million in subordinated capital
certificates. The subordinated capital certificates are redeemed for cash on
an annual basis, at par, in an amount equivalent to 10% of the term loan
principal repaid in the prior year. Therefore, during the first quarter of
2005, based on principal payments of approximately $4.7 million made in 2004,
approximately $0.5 million in subordinated capital certificates were redeemed
for cash by the RTFC. In March 2004, the RTFC redeemed approximately $1.4
million of our subordinated capital certificates. In connection with our
repayment of outstanding obligations under the credit facilities, our
remaining subordinated capital certificates will be redeemed by the RTFC.
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 fifteen-year rotation
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 7.2% at March 31, 2005. 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, 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, or 7.7% at March 31, 2005.
Each line of credit is scheduled to expire in September 2005. We have
been notified by the RTFC that, assuming the lines of credit are not
refinanced with another lender prior to September 2005, a new secured line of
credit in the amount of $41.0 million for a term ending in March 2010 has
been approved. Completion of the new line of credit is subject to
satisfactory completion of documentation for the new agreements and all
conditions precedent to closing being satisfied.
The terms of the RTFC loan agreement, as amended, contain various
financial and administrative covenants including ratios that are tested on an
annual basis. The ratios are tested against the combined financial results
of MRLTDF and its subsidiaries, Gallatin River Holdings, LLC, Madison River
Long Distance Solutions, Inc. and Mebtel Long Distance Solutions, Inc. In
addition, among other things, these combined entities are restricted in their
ability to: (i) declare or pay dividends to their respective parents, under
specified circumstances, (ii) limited in their ability to make intercompany
loans or enter into other affiliated transactions, (iii) sell assets and make
use of the proceeds, and (iv) incur additional indebtedness above certain
amounts without the consent of the RTFC. As a result of these provisions of
the loan agreement, as amended, any cash generated by MRLTDF and its
subsidiaries, Gallatin River Holdings, LLC, Madison River Long Distance
Solutions, Inc. and Mebtel Long Distance Solutions, Inc. 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 March 31, 2005, MRLTDF was in compliance with the terms
of its loan agreement, as amended, with the RTFC.
Senior Notes
We currently have outstanding $198.0 million in publicly-traded 13 1/4%
senior notes that are due in March 2010. The senior notes are currently
callable at 106.625%. Interest is payable semiannually on March 1 and
September 1 of each year. The senior notes are registered with the Securities
and Exchange Commission and are subject to the terms and conditions of an
indenture. At March 31, 2005, the senior notes had a carrying value of $196.2
million, which is net of a $1.8 million unamortized discount.
Under the terms of our indenture, we and our restricted subsidiaries must
comply with certain financial and administrative covenants. Among other
things, we are limited in our 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
21
certain asset sale proceeds, (vii) merge or consolidate with or into other
companies or (vii) enter into transactions with affiliates. At March 31,
2005, we were in compliance with the terms of our senior notes indenture.
Interest Rates
On April 5, 2005, the fixed interest rate on one of our RTFC notes with
an outstanding principal balance of $97.6 million expired. The note, with a
fixed interest rate of 9.0% prior to expiration, converted to the RTFC's
prevailing variable base rate plus 1.0% interest rate adder, or 7.15%, using
the rate in effect as of March 31, 2005. After conversion of this interest
rate, our fixed rate term loans with the RTFC totaled $89.6 million at an
interest rate of 5.65% and our variable rate term loans with the RTFC totaled
$329.9 million at a variable interest rate of 7.15% using the rate in effect
as of March 31, 2005. After the expiration of the fixed interest rate, our
weighted average interest rate for all RTFC secured debt was 6.81% and the
weighted average interest rate for all of our outstanding long-term debt was
8.87%.
Minority Interest in Coastal Communications, Inc.
As part of the consideration paid in the Coastal Communications, Inc.
acquisition in March 2000, MRTC issued to the Coastal shareholders 300 shares
of Series A stock and 300 shares of Series B non-voting common stock of
Coastal Communications, Inc. 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 Coastal Communications, Inc. In April
2002, MRTC completed an agreement with the Coastal shareholders that, among
other things, modified certain provisions of the shareholders' agreement.
Under the terms of the agreement, the Coastal shareholders exchanged certain
of their equity interests in Coastal Communications, Inc. for equity in MRTC
and the notes payable from MRTC that were repaid in December 2004.
Coastal Communications, Inc. redeemed 30 shares of Series A Stock
retained by the Coastal shareholders for $33,333.33 per share, or
approximately $1.0 million, at the closing of the transaction in April 2002.
Under the terms of the amended shareholders' agreement, the Coastal
shareholders have the right to require Coastal Communications, Inc. to redeem
their remaining 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 Coastal shareholders put 30 shares of
Series A stock to Coastal Communications, Inc. in June 2003 and July 2004
and, in each case, Coastal Communications, Inc. redeemed the shares for
approximately $1.0 million shortly thereafter. After the redemption in July
2004, the Coastal shareholders continue to hold 90 shares of Series A stock
with the next available put right for 30 shares occurring in August 2005.
Under the terms of the agreement, we may at any time require the Coastal
shareholders to sell their shares of Series A stock to us for a purchase
price of $33,333.33.
Deferred Income Tax Contingency
During 2002, 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. 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.
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 $2.1 million as income tax expense during the second
quarter of 2004. At the same time, we also recognized $0.4 million in
interest expense related to these erroneous refunds. 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.
22
During 2004, the Alabama Department of Revenue performed an audit of the
2002 and 2001 combined state income tax returns filed by our subsidiary, Gulf
Coast Services, Inc., with the State of Alabama. For 2002, as permitted
under Alabama's income tax regulations, Gulf Coast Services, Inc. filed a
combined return which included its consolidated financial results as well as
the financial results for certain other subsidiaries of the Company with
Alabama operations. In March 2005, the Alabama Department of Revenue issued
a Notice of Preliminary Assessment, or the Alabama Notice, based on its audit
findings in which it contends that we lacked the necessary nexus to file our
2002 state income tax return on a combined basis. The Alabama Notice would
not result in any additional taxes being due for 2002 due to offsetting
adjustments. However, if this Alabama Notice is allowed to stand after
appeals, our state income tax liability to Alabama will increase for tax
years subsequent to 2002. For 2003, we filed a combined return using the
same basis as 2002 and accordingly, this return would be amended to reflect
the findings in the Alabama Notice if our appeals are unsuccessful. As such,
upon receiving the Alabama Notice in the first quarter of 2005, we accrued a
contingent income tax liability of approximately $0.9 million to recognize
the additional income tax expense for 2003 that would be due if a combined
return was not filed. We also accrued approximately $0.1 million for
potential interest expense related to this income tax assessment. For 2004,
in establishing our liability for state income taxes, we did not recognize a
benefit from the filing of a combined return which resulted in an accrual of
state income taxes of approximately $1.4 million.
We believe our position for filing the combined returns is appropriate
and intend to appeal this finding. Accordingly, we filed a Request for
Review with the Alabama Department of Revenue in April 2005. However, at
this time, we are uncertain as to the outcome of this matter. If we are not
successful, we may be required to pay the amount accrued as a contingent
income tax liability plus the accrued interest.
Capital and Liquidity Requirements
Our working capital needs, our debt service requirements and our capital
expenditures will be funded from our cash flow from operations and our
existing liquidity on-hand, including available borrowings under the
revolving portion of our credit facilities. In the near term, we expect that
our primary uses of cash will include:
* scheduled principal and interest payments on our credit facilities;
* the maintenance and growth of our telephone plant and network
infrastructure;
* the maintenance, upgrade and integration of operating support systems and
other automated back office systems;
* required federal and state income taxes;
* funding redemptions of Series A stock put to CCI per the terms of a
shareholders agreement with the former shareholders of Coastal
Utilities, Inc.;
* sales and marketing expenses;
* corporate overhead; and
* personnel and related expenses.
We currently estimate that capital expenditures in 2005 will be
approximately $13.0 million. For 2004, our capital expenditures were
approximately $14.6 million, which included approximately $2.6 million in
capital expenditures to replace certain telephone and plant 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 years ended December 31, 2003 and 2002, our capital
expenditures were approximately $12.2 million and $12.3 million,
respectively. Our use of cash for capital expenditures in 2004, 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. 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 recently entered into
an agreement with the National Rural Telecommunications Cooperative that will
allow us to offer DIRECTV satellite television
23
service to our customers. This agreement will not require us to make any
significant capital expenditures to provide this service. We anticipate that
introduction of this product offering will commence by the second quarter of
2005.
Effective January 1, 2005, we converted from being treated as a
partnership for federal and state income tax purposes to a C corporation.
Accordingly, rather than passing through our income, losses and credits to
our parent, we will begin filing a consolidated federal income tax return
with our corporate subsidiaries pursuant to tax sharing agreements we will
enter into with those subsidiaries. In addition, we will begin filing the
appropriate state income tax returns. Prior to this conversion, our
corporate subsidiary, Madison River Holdings Corp., filed a consolidated
federal income tax return on behalf of itself and its corporate subsidiaries.
We do not expect this conversion will have a material impact on financial
position, results of operations or cash flows.
Based on our business plan, we currently project that cash and cash
equivalents on hand, available borrowings under our new credit facilities and
our cash flow from operations will be adequate to meet our foreseeable
operational liquidity needs, including funding our working capital deficit,
for the next 12 months. However, our actual cash needs may differ from our
estimates, and those differences could be material. Our future capital
requirements will depend on many factors, including, among others:
* the extent to which we consummate any significant additional
acquisitions;
* our success in maintaining a net positive cash flow in our edge-out
operations;
* the demand for our services in our existing markets;
* our ability to acquire, maintain, develop, upgrade and integrate the
necessary operating support systems and other back office systems; and
* regulatory, technological and competitive developments.
We may be unable to access the cash flow of our subsidiaries since
certain of our subsidiaries are parties to credit facilities or other
borrowing agreements that restrict paying 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. Our subsidiaries'
ability to pay dividends or make distributions to us is also subject to the
laws of their jurisdiction of incorporation.
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, including additional borrowings under our
new credit facilities, 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 or
that future borrowings or other financings will be available to us in amounts
sufficient to provide adequate working capital, service our indebtedness,
make anticipated capital expenditures or pay income taxes. 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 or results of operations.
Under the terms of MRTC's Operating Agreement, at any time on or after
January 16, 2006, certain members may require MRTC to purchase all of their
member units at an amount equal to the fair market value of the units. We may
be required to fund this obligation of our parent company.
Proposed Initial Public Offering of Common Stock by Madison River
Communications Corp. and Related Transactions
On December 23, 2004, Madison River Communications Corp., an entity
formed to serve as the successor to MRTC, filed a Registration Statement on
Form S-1 with the SEC for the purpose of registering its common stock in
connection with an initial public offering. The Form S-1 has not yet become
effective. These securities may not be sold nor may offers to buy be accepted
prior to the time the Form S-1 becomes effective. This Quarterly Report on
Form 10-Q shall not constitute an offer to sell or the solicitation of an
offer to buy nor shall there by any sale of these securities in any state in
which such offer, solicitation or sale would be unlawful prior to
registration or qualification under the securities laws of any such state.
Concurrently with the closing of the initial public offering, we expect
Madison River Capital will enter into new credit facilities, which include a
term loan facility and a revolving credit facility. As amended through the
date hereof, the Form S-1 contemplates that the proceeds from the initial
public offering of common stock by Madison River Communications Corp.,
together with the proceeds from borrowings under the new credit facilities
and cash on hand, will be used to (i) repurchase shares of common stock from
certain of our existing equity investors, (ii) satisfy and discharge the
obligations of Madison River Capital under its outstanding $198.0 million in
publicly traded 13.25% senior notes due March 2010, (iii) repay the
obligations, including accrued and unpaid interest and prepayment premiums,
of MRLTDF under the RTFC credit facilities, (iv) repay the outstanding
borrowings plus
24
accrued and unpaid interest under a credit agreement to which MRTC is a
party, (v) repurchase the minority interest in Coastal Communications, Inc.
for an aggregate purchase price of $3.0 million and (vi) pay the bonuses,
fees and expenses relating to the offering and the other transactions. Our
senior notes are callable at a redemption price of 106.625% of the principal
amount of the notes redeemed, plus accrued and unpaid interest thereon.
Following the closing of the initial public offering, we expect to redeem the
senior notes in full in accordance with the provisions of the indenture
governing our senior notes.
The consummation of the initial public offering is subject to various
contingencies, including the closing of the new credit facilities and market
conditions. There can be no assurance that the initial public offering and
the related transactions will be completed on the terms described in the Form
S-1 or at all.
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 term loan facilities with the RTFC mature in 2016.
Our primary market risk related to our long-term debt is our interest rate
risk associated with the RTFC variable interest rate. As of March 31, 2005,
we had $232.4 million in term loans with the RTFC that accrue interest at a
variable rate of 7.15%. As of March 31, 2005, our fixed rate secured debt
with the RTFC was $187.2 million at a weighted average rate of 7.4%. A $97.6
million term loan with a 9.0% fixed interest rate had its fixed interest rate
expire in April 2005 and the remaining $89.6 million in term loans carry a
5.65% fixed interest rate that expires in August 2006. Upon the expiration of
fixed interest rates on RTFC term loans, the term loans 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. As the fixed interest rates
on our term loans have expired, we have elected to maintain the RTFC's
prevailing base variable rate on these loans. Although the variable rate
subjects us to additional market risk if interest rates rise, we are able to
prepay the term loans bearing variable interest rates without incurring
certain make-whole payments as described in the loan agreement with the RTFC.
Our remaining long-term debt consists of our senior notes that have a
stated fixed rate of 13.25%. As of March 31, 2005, our weighted average
interest rate on our fixed and variable rate secured debt with the RTFC was
approximately 6.81% and our weighted average interest rate on all outstanding
long-term debt was 8.87%.
On April 5, 2005, the fixed interest rate on one of our RTFC notes with
an outstanding principal balance of $97.6 million expired. This note, with a
fixed interest rate of 9.0% before the expiration of the fixed rate,
converted to the RTFC's prevailing variable base rate plus 1.0% interest rate
adder, or 7.15%, using the rate in effect as of March 31, 2005. After
conversion of this interest rate, our fixed rate term loans with the RTFC
totaled $89.6 million at a fixed interest rate of 5.65% and our variable rate
term loans with the RTFC totaled $329.9 million at a variable interest rate
of 7.15% using the rate in effect as of March 31, 2005. Accordingly, a one
percent change in the RTFC's underlying variable interest rate for this
variable rate debt would result in an increase of approximately $3.3 million
in interest expense on an annual basis.
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. The Company, however, continues
its comprehensive effort to comply with Section 404 of the Sarbanes-Oxley Act
of 2002. This effort includes the process of documenting, assessing,
improving and formalizing its system of internal controls over financial
reporting. As a result of this review, the Company is implementing and is
expected to continue to implement certain new controls and improvements to
its internal controls over financial reporting.
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Part II
Item 1. LEGAL PROCEEDINGS
On March 3, 2005, our subsidiary, Madison River Communications, LLC,
entered into a consent decree with the FCC on behalf of itself, Madison River
Telephone and the affiliated companies under the common control and ownership
of Madison River Telephone. The purpose of the consent decree was to resolve
an investigation by the Enforcement Bureau of the FCC into allegations that
the subject companies were blocking ports used for voice over Internet
protocol, or VOIP, applications, thereby affecting customers' ability to use
VOIP through one or more VOIP service providers. Under the terms of the
consent decree, we agreed to pay $15,000.00 and that we shall not block ports
used for VOIP applications or otherwise prevent customers from using VOIP
applications.
On March 30, 2005, we received a letter from counsel to Vonage Holdings
Corporation ("Vonage") seeking formal redress for Vonage's injuries
purportedly caused by our past alleged unlawful blocking of ports used for
VoIP services provided by Vonage to its customers. We have denied any
wrongdoing, engaged counsel, and will vigorously defend any claims which may
be brought in this regard.
Item 6. EXHIBITS
(a) Exhibits
Exhibit
Number Description
------- ----------------------------------------------------------
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: May 12, 2005 /s/ PAUL H. SUNU
---------------------------------------
Name: Paul H. Sunu
Title: Managing Director, Chief
Financial Officer and Secretary
26
EXHIBIT INDEX
Exhibit
Number Description
------- -------------------------------------------------------------
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
27