**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended September 30, 2005.**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                  to                  **

**CommissionFile Number 333-56365**

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**FairPoint Communications, Inc.**

(Exact Name of Registrantas Specified in Its Charter)

| **Delaware**                                                            |   | **13-3725229**                        |
|-------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization)        |   | (I.R.S. Employer  Identification No.) |
| **521 East Morehead Street, Suite 250  Charlotte, North Carolina** |   | **28202**                             |
| (Address of  Principal Executive Offices)                               |   | (Zip Code)                            |

 

**(704) 344-8150**

(Registrant’s telephonenumber, including area code)

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check markwhether the registrant is an accelerated filer (as defined in R12b-2 ofthe Exchange Act). Yes o  No x

As of November 8,2005, there were 35,021,335 shares of the Registrant’s common stock, par value$0.01 per share, outstanding.

Documentsincorporated by reference: **None**

 

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**INDEX**
|                                        | ** ** | **Page**                                                                                                                                |
|----------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|
| **PART I. FINANCIAL INFORMATION** |       |                                                                                                                                    |   |
| Item 1.                                |       | Financial  Statements                                                                                                                   |   | 3 |   |
|                                   |       | Condensed  Consolidated Balance Sheets as of September 30, 2005 and  December 31, 2004                              |   | 3 |   |
|                                   |       | Condensed  Consolidated Statements of Operations for the three and nine months ended September 30,  2005and 2004                   |   | 4 |   |
|                                   |       | Condensed  Consolidated Statements of Comprehensive Income (Loss) for the three and nine  months ended September 30, 2005 and 2004 |   | 5 |   |
|                                   |       | Condensed Consolidated  Statements of Cash Flows for the nine months ended September 30, 2005  and 2004                            |   | 6 |   |
|                                   |       | Notes  to Condensed Consolidated Financial Statements                                                                                   |   | 7 |   |
| Item  2.                               |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                             |   | 21 |   |
| Item  3.                               |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                             |   | 37 |   |
| Item  4.                               |       | Controls  and Procedures                                                                                                                |   | 37 |   |
| **PART II. OTHER INFORMATION**    |       | 38                                                                                                                                      |   |
| Item 1.                                |       | Legal  Proceedings                                                                                                                      |   | 38 |   |
| Item  2.                               |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                            |   | 38 |   |
| Item  3.                               |       | Defaults  Upon Senior Securities                                                                                                        |   | 39 |   |
| Item  4.                               |       | Submission  of Matters to a Vote of Security Holders                                                                                    |   | 39 |   |
| Item 5.                                |       | Other Information                                                                                                                       |   | 39 |   |
| Item 6.                                |       | Exhibits                                                                                                                                |   | 39 |   |
|                                   |       | Signatures                                                                                                                              |   | 40 |   |

 

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**PART I—FINANCIALINFORMATION**

**Cautionary Note Regarding Forward-LookingStatements**

Some statements inthis Quarterly Report are known as “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, or theSecurities Act, and Section 21E of the Securities Exchange Act of 1934, orthe Exchange Act. Forward-looking statements may relate to, among otherthings:

·       futureperformance generally,

·       ourdividend policy and expectations regarding dividend payments,

·       businessdevelopment activities,

·       futurecapital expenditures,

·       futureinterest expense,

·       distributionsfrom minority investments and passive partnership interests,

·       netoperating loss carry forwards,

·       technologicaldevelopments and changes in the communications industry,

·       financingsources and availability,

·       regulatorysupport payments,

·       theeffects of regulation and competition, and

·       pendinglitigation.

These forward-looking statements include, butare not limited to, statements about our plans, objectives, expectations andintentions and other statements contained in this Quarterly Report that are nothistorical facts. When used in this Quarterly Report, the words “expects,” “anticipates,”“intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressionsare generally intended to identify forward looking statements. Because theseforward-looking statements involve known and unknown risks anduncertainties, there are important factors that could cause actual results,events or developments to differ materially from those expressed or implied bythese forward-looking statements, including our plans, objectives,expectations and intentions and other factors discussed in this QuarterlyReport and in Exhibit 99.1 to this Quarterly Report (filed as Exhibit 99.1to our Quarterly Report on Form 10-Q filed on August 12, 2005,and incorporated herein by reference). You should not place undue reliance onsuch forward-looking statements, which are based on the informationcurrently available to us and speak only as of the date on which this QuarterlyReport was filed with the Securities and Exchange Commission, or the SEC. Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.However, your attention is directed to any further disclosures made on relatedsubjects in our subsequent periodic reports filed with the SEC on Forms 10-K,10-Q and 8-K and Schedule 14A.

2

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**Item1.   Financial Statements.**

*Except as otherwise required by the context,references in this Quarterly Report to “FairPoint,” “our company,” “we,” “us,”or “our” refer to the combined business of FairPoint Communications, Inc.and all of its subsidiaries. Except as otherwise required by the context, allreferences to the “Company” refer to FairPoint Communications, Inc.excluding its subsidiaries.*

**FAIRPOINTCOMMUNICATIONS, INC. AND SUBSIDIARIESCondensed Consolidated Balance Sheets**

| ** **                                                         | ** ** | **September 30,  2005**         | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| ** **                                                         | ** ** | **(unaudited)**                      | ** ** | ** **                  | ** ** |
| ** **                                                         | ** ** | **(Dollars in thousands)** | ** ** |
| **Assets**                                                         |       |                                 |       |                        |       |   |   |   |   |
| Current assets:                                                    |       |                                 |       |                        |       |   |   |   |   |
| Cash                                                               |       |                                 | $          | 5,108                       |       |   |   | 3,595 |   |   |
| Accounts  receivable, net                                          |       |                                 | 32,082     |                        |       |   | 30,203 |   |   |
| Other                                                              |       |                                 | 8,852      |                        |       |   | 6,805 |   |   |
| Income tax  recoverable                                            |       |                                 | 717        |                        |       |   | — |   |   |
| Deferred income  tax, net                                          |       |                                 | 1,065      |                        |       |   | — |   |   |
| Assets of  discontinued operations                                 |       |                                 | 90         |                        |       |   | 102 |   |   |
| Total current  assets                                              |       |                                 | 47,914     |                        |       |   | 40,705 |   |   |
| Property, plant,  and equipment, net                               |       |                                 | 246,674    |                        |       |   | 252,262 |   |   |
| Other assets:                                                      |       |                                 |       |                        |       |   |   |   |   |
| Investments                                                        |       |                                 | 41,477     |                        |       |   | 37,749 |   |   |
| Goodwill                                                           |       |                                 | 480,266    |                        |       |   | 468,508 |   |   |
| Deferred income  tax, net                                          |       |                                 | 81,950     |                        |       |   | — |   |   |
| Deferred charges  and other assets                                 |       |                                 | 18,471     |                        |       |   | 19,912 |   |   |
| Total other assets                                                 |       |                                 | 622,164    |                        |       |   | 526,169 |   |   |
| Total assets                                                       |       |                                 | $          | 916,752                     |       |   |   | 819,136 |   |   |
| **Liabilities and Stockholders’ Equity (Deficit)**            |       |                                 |       |                        |       |   |   |   |   |
| Current liabilities:                                               |       |                                 |       |                        |       |   |   |   |   |
| Accounts payable                                                   |       |                                 | $          | 17,161                      |       |   |   | 14,184 |   |   |
| Current portion of  long-term debt and other long-term liabilities |       |                                 | 668        |                        |       |   | 624 |   |   |
| Demand notes  payable                                              |       |                                 | 363        |                        |       |   | 382 |   |   |
| Accrued interest  payable                                          |       |                                 | 147        |                        |       |   | 16,582 |   |   |
| Other accrued  liabilities                                         |       |                                 | 16,921     |                        |       |   | 15,872 |   |   |
| Dividends payable                                                  |       |                                 | 13,765     |                        |       |   | — |   |   |
| Liabilities of  discontinued operations                            |       |                                 | 2,227      |                        |       |   | 2,262 |   |   |
| Total current  liabilities                                         |       |                                 | 51,252     |                        |       |   | 49,906 |   |   |
| Long-term liabilities:                                             |       |                                 |       |                        |       |   |   |   |   |
| Long-term debt,  net of current portion                            |       |                                 | 609,790    |                        |       |   | 809,908 |   |   |
| Preferred shares  subject to mandatory redemption                  |       |                                 | —     |                        |       |   | 116,880 |   |   |
| Liabilities of  discontinued operations                            |       |                                 | 1,061      |                        |       |   | 1,580 |   |   |
| Deferred credits  and other long-term liabilities                  |       |                                 | 4,592      |                        |       |   | 12,667 |   |   |
| Total long-term  liabilities                                       |       |                                 | 615,443    |                        |       |   | 941,035 |   |   |
| Commitments and  contingencies                                     |       |                                 |       |                        |       |   |   |   |   |
| Minority interest                                                  |       |                                 | 9          |                        |       |   | 11 |   |   |
| Common stock  subject to put options                               |       |                                 | —     |                        |       |   | 1,136 |   |   |
| Stockholders’  equity (deficit):                              |       |                                 |       |                        |       |   |   |   |   |
| Common stock                                                       |       |                                 | 350        |                        |       |   | 94 |   |   |
| Additional paid-in  capital                                        |       |                                 | 603,817    |                        |       |   | 198,519 |   |   |
| Unearned  compensation                                             |       |                                 | (7,087     | )                           |       |   | — |   |   |
| Accumulated  deficit                                               |       |                                 | (350,731   | )                           |       |   | (371,565 | ) |   |
| Accumulated other  comprehensive income, net                       |       |                                 | 3,699      |                        |       |   | — |   |   |
| Total  stockholders’ equity (deficit)                         |       |                                 | 250,048    |                        |       |   | (172,952 | ) |   |
| Total liabilities and  stockholders’ equity (deficit)         |       |                                 | $          | 916,752                     |       |   |   | 819,136 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

3

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIESCondensed ConsolidatedStatements of Operations(Unaudited)**

| ** **                                                                                | ** ** | **Three months ended**     | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                                                                | ** ** | **2005**                             | ** ** | **2004**                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | **(Dollars in thousands)** | ** ** |
| Revenues                                                                                  |       | $                                    | 66,038     |                            | 65,437     |   | 192,909 |   | 188,838 |   |
| Operating  expenses:                                                                      |       |                                 |       |                            |       |   |   |   |   |
| Operating expenses, excluding depreciation and  amortization and stock-based compensation |       | 37,903                               |       | 34,184                          |       | 104,575 |   | 96,355 |   |
| Depreciation and amortization                                                             |       | 12,947                               |       | 12,176                          |       | 39,063 |   | 36,876 |   |
| Stock-based compensation                                                                  |       | 567                                  |       | 45                              |       | 1,659 |   | 133 |   |
| Total operating  expenses                                                                 |       | 51,417                               |       | 46,405                          |       | 145,297 |   | 133,364 |   |
| Income from  operations                                                                   |       | 14,621                               |       | 19,032                          |       | 47,612 |   | 55,474 |   |
| Other income (expense):                                                                   |       |                                 |       |                            |       |   |   |   |   |
| Net loss on sale of investments and other assets                                          |       | (15                                  | )          | (439                            | )          | (199 | ) | (240 | ) |
| Interest and dividend income                                                              |       | 398                                  |       | 572                             |       | 1,670 |   | 1,330 |   |
| Interest expense                                                                          |       | (10,026                              | )          | (26,160                         | )          | (36,584 | ) | (77,698 | ) |
| Equity in net earnings of investees                                                       |       | 2,716                                |       | 2,875                           |       | 8,168 |   | 7,929 |   |
| Realized and unrealized losses on interest rate  swaps                                    |       | —                               |       | —                          |       | — |   | (112 | ) |
| Other nonoperating, net                                                                   |       | —                               |       | —                          |       | (87,746 | ) | — |   |
| Total other  expense                                                                      |       | (6,927                               | )          | (23,152                         | )          | (114,691 | ) | (68,791 | ) |
| Income (loss)  from continuing operations before income taxes                        |       | 7,694                                |       | (4,120                          | )          | (67,079 | ) | (13,317 | ) |
| Income tax  benefit (expense)                                                             |       | (3,504                               | )          | (105                            | )          | 87,915 |   | (279 | ) |
| Minority interest  in income of subsidiaries                                              |       | (1                                   | )          | —                          |       | (2 | ) | (1 | ) |
| Income (loss)  from continuing operations                                                 |       | 4,189                                |       | (4,225                          | )          | 20,834 |   | (13,597 | ) |
| Income from  discontinued operations                                                      |       | —                               |       | —                          |       | — |   | 671 |   |
| Net income (loss)                                                                         |       | $                                    | 4,189      |                            | (4,225     | ) | 20,834 |   | (12,926 | ) |
| Weighted average shares  outstanding:                                                     |       |                                 |       |                            |       |   |   |   |   |
| Basic                                                                                     |       | 34,550                               |       | 9,468                           |       | 31,043 |   | 9,468 |   |
| Diluted                                                                                   |       | 34,590                               |       | 9,468                           |       | 31,085 |   | 9,468 |   |
| Basic and diluted  earnings (loss) from continuing operations per share              |       | $                                    | 0.12       |                            | (0.45      | ) | 0.67 |   | (1.44 | ) |
| Basic and diluted  earnings from discontinued operations per share                   |       | $                                    | —     |                            | —     |   | — |   | 0.07 |   |
| Basic and diluted  earnings (loss) per share                                              |       | $                                    | 0.12       |                            | (0.45      | ) | 0.67 |   | (1.37 | ) |

 

See accompanying notes to condensed consolidated financial statements.

4

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)**

| ** **                                                                                                                                                                                                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                             | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                             | ** ** | **(Dollars in thousands)**                 | ** ** |
| Net income (loss)                                                                                                                                                                                                                      |       |                                                 |       | $                                                   | 4,189      |   |   |   | (4,225 | ) |   |   | 20,834 |   |   |   | (12,926 | ) |
| Other comprehensive  income (loss):                                                                                                                                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Available-for-sale  securities:                                                                                                                                                                                                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding loss arising during period                                                                                                                                                                                          |       | $                                                    | —     |                                                |       |   | (109 | ) |   |   | — |   |   |   | (1,255 | ) |   |   |
| Less reclassification for gain included in net loss                                                                                                                                                                                    |       | —                                               |       |                                                |       | — |   |   |   | — |   |   |   | (214 | ) |   |   |
|                                                                                                                                                                                                                                   |       |                                                 |       | —                                              |       |   |   | (109 | ) |   |   | — |   |   |   | (1,469 | ) |
| Cash flow hedges:                                                                                                                                                                                                                      |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change in net unrealized gain, net of tax expense of  $3.3 million as of the three months ended September 30,  2005 and net of tax expense of $2.2 million for the nine  months ended September 30, 2005 |       |                                                 |       | 5,465                                               |       |   |   | — |   |   |   | 3,699 |   |   |   | — |   |
| Reclassification adjustment                                                                                                                                                                                                            |       |                                                 |       | —                                              |       |   |   | — |   |   |   | — |   |   |   | 103 |   |
| Other  comprehensive income (loss)                                                                                                                                                                                                     |       |                                                 |       | 5,465                                               |       |   |   | (109 | ) |   |   | 3,699 |   |   |   | (1,366 | ) |
| Comprehensive income  (loss)                                                                                                                                                                                                           |       |                                                 |       | $                                                   | 9,654      |   |   |   | (4,334 | ) |   |   | 24,533 |   |   |   | (14,292 | ) |
|                                                                                                                                                                                                                                        |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to condensed consolidated financial statements.

5

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIESCondensed Consolidated Statements of Cash Flows(Unaudited)**

| ** **                                                                                                          | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| ** **                                                                                                          | ** ** | **(Dollars in thousands)**                | ** ** |
| Cash flows from operating activities:                                                                               |       |                                                |       |   |   |
| Net income (loss)                                                                                                   |       | $                                                   | 20,834     |   | (12,926 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities of continuing  operations: |       |                                                |       |   |   |
| Income from  discontinued operations                                                                                |       | —                                              |       | (671 | ) |
| Dividends and  accretion on shares subject to mandatory redemption                                                  |       | 2,362                                               |       | 14,820 |   |
| Loss on preferred  stock subject to mandatory redemption                                                            |       | 9,899                                               |       | — |   |
| Deferred income  taxes                                                                                              |       | (97,921                                             | )          | — |   |
| Amortization of  debt issue costs                                                                                   |       | 1,458                                               |       | 3,452 |   |
| Depreciation and  amortization                                                                                      |       | 39,063                                              |       | 36,876 |   |
| Loss on early  retirement of debt                                                                                   |       | 77,847                                              |       | — |   |
| Minority interest  in income of subsidiaries                                                                        |       | 2                                                   |       | 1 |   |
| Income from equity  method investments                                                                              |       | (8,168                                              | )          | (7,929 | ) |
| Other non cash  items                                                                                               |       | 1,774                                               |       | (463 | ) |
| Changes in assets and  liabilities arising from operations:                                                         |       |                                                |       |   |   |
| Accounts  receivable and other current assets                                                                       |       | (1,551                                              | )          | (2,617 | ) |
| Accounts payable  and accrued expenses                                                                              |       | (15,090                                             | )          | 2,392 |   |
| Income taxes                                                                                                        |       | 8,090                                               |       | (254 | ) |
| Other  assets/liabilities                                                                                           |       | 226                                                 |       | 177 |   |
| Total adjustments                                                                                                   |       | 17,991                                              |       | 45,784 |   |
| Net cash provided  by operating activities of continuing operations                                                 |       | 38,825                                              |       | 32,858 |   |
| Cash flows from investing activities of continuing  operations:                                                     |       |                                                |       |   |   |
| Acquisitions of  telephone properties, net of cash acquired                                                         |       | (25,730                                             | )          | 45 |   |
| Acquisition of  investments                                                                                         |       | (12                                                 | )          | — |   |
| Net capital  additions                                                                                              |       | (17,905                                             | )          | (23,956 | ) |
| Distributions from  investments                                                                                     |       | 7,309                                               |       | 11,810 |   |
| Net proceeds from  sales of investments and other assets                                                            |       | 175                                                 |       | 356 |   |
| Other, net                                                                                                          |       | (629                                                | )          | (334 | ) |
| Net cash used in  investing activities of continuing operations                                                     |       | (36,792                                             | )          | (12,079 | ) |
| Cash flows from financing activities of continuing  operations:                                                     |       |                                                |       |   |   |
| Net proceeds from  issuance of common stock                                                                         |       | 431,921                                             |       | — |   |
| Debt issue and  offering costs                                                                                      |       | (9,061                                              | )          | (5,631 | ) |
| Proceeds from  issuance of long-term debt                                                                           |       | 680,709                                             |       | 137,660 |   |
| Repayments of  long-term debt                                                                                       |       | (883,370                                            | )          | (149,885 | ) |
| Repurchase of  preferred and common stock                                                                           |       | (129,278                                            | )          | (1,000 | ) |
| Payment of fees  and penalties associated with early retirement of long term debt                                   |       | (61,037                                             | )          | — |   |
| Payment of  deferred transaction fee                                                                                |       | (8,445                                              | )          | — |   |
| Proceeds from  exercise of stock options                                                                            |       | 184                                                 |       | — |   |
| Dividends paid to  common stockholders                                                                              |       | (21,533                                             | )          | — |   |
| Net cash provided  by (used in) financing activities of continuing operations                                       |       | 90                                                  |       | (18,856 | ) |
| Net cash  contributed from continuing operations to discontinued operations                                         |       | (610                                                | )          | (1,113 | ) |
| Net increase in  cash                                                                                               |       | 1,513                                               |       | 810 |   |
| Cash, beginning of  period                                                                                          |       | 3,595                                               |       | 5,603 |   |
| Cash, end of  period                                                                                                |       | $                                                   | 5,108      |   | 6,413 |   |

 

See accompanying notes to condensed consolidated financial statements.

6

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

**(1)**   Organization andBasis of Financial Reporting

Theaccompanying unaudited condensed financial statements of FairPointCommunications, Inc. and subsidiaries as of September 30, 2005 andfor the three and nine month periods ended September 30, 2005 and 2004have been prepared on the same basis as the audited consolidated financialstatements for the year ended December 31, 2004 and, in the opinion of theCompany’s management, the unaudited condensed financial statements reflect alladjustments, consisting of normal recurring adjustments, necessary for a fairpresentation of FairPoint’s results of operations, financial position, and cashflows. The results of operations for the interim periods are not necessarilyindicative of the results of operations which might be expected for the entireyear. The unaudited condensed consolidated financial statements should be readin conjunction with the Company’s Annual Report on Form 10-K for the yearended December 31, 2004. 

**(2)**   Initial PublicOffering and Other Transactions

***(a)   General***

On February 8, 2005, the Company consummated aninitial public offering, or the offering, of 25,000,000 shares of its commonstock, par value $0.01 per share, or common stock, at a price to the public of$18.50 per share. 

In connection with the offering, the Company enteredinto a new senior secured credit facility, or the credit facility, with asyndicate of financial institutions, including Deutsche Bank Trust CompanyAmericas, as administrative agent. The credit facility is comprised of arevolving facility in an aggregate principal amount of $100 million (lessamounts reserved for letters of credit) and a term facility in an aggregateprincipal amount of $588.5 million (including a $22.5 million delayeddraw facility). The revolving facility has a six year maturity and the termfacility has a seven year maturity. The offering, the credit facility and thetransactions described below are referred to herein collectively as thetransactions. 

The Company usedthe gross proceeds of $462.5 million from the offering together withborrowings of $566.0 million under the term facility of the creditfacility as follows: 

·       $176.7 millionto repay in full all outstanding loans under the Company’s old credit facility(including accrued interest); 

·       $122.1 millionto repurchase $115.0 million aggregate principal amount of the Company’s 91¤2%senior subordinated notes due 2008, or the 91¤2% notes,pursuant to the tender offer and consent solicitation for such notes (includingaccrued interest, tender premiums and consent payments); 

·       $51.8 millionto repurchase $50.8 million aggregate principal amount of the Company’sfloating rate callable securities due 2008, or the floating rate notes,pursuant to the tender offer and consent solicitation for such notes (includingaccrued interest, tender premiums and consent payments); 

·       $193.4 millionto repurchase $173.1 million aggregate principal amount of the Company’s 121¤2%senior subordinated notes due 2010, or the 121¤2% notes,pursuant to the tender offer and consent solicitation for such notes (includingaccrued interest, tender premiums and consent payments); 

7

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(2)**   Initial Public Offering and Other Transactions (Continued)

·       $274.9 millionto repurchase $223.0 million aggregate principal amount of the Company’s 117¤8%senior notes due 2010, or the 117¤8%notes, pursuant to the tender offer and consent solicitation for such notes(including accrued interest, tender premiums and consent payments); 

·       $129.2 millionto repurchase all of the Company’s series A preferred stock subject tomandatory redemption, or the series A preferred stock, from the holdersthereof (together with accrued and unpaid dividends thereon); 

·       $10.6 millionto repay a substantial portion of the Company’s subsidiaries’ outstandinglong-term debt (including accrued interest); 

·       $7.0 millionto repay in full a promissory note issued by the Company in connection with apast acquisition; 

·       $18.4 millionto invest in temporary investments pending the redemption of the 91¤2% notes andthe floating rate notes not tendered in the tender offers for such notes; and 

·       $44.4 millionto pay fees and expenses, including underwriting discounts of$27.8 million, $8.2 million of debt issuance costs associated withthe credit facility and a transaction fee of approximately $8.4 millionpaid to Kelso & Company, one of the Company’s investors. 

On March 10, 2005, the Company used the$18.4 million which it had invested in temporary investments, togetherwith $6.6 million of cash on hand, to redeem the $0.2 millionaggregate principal amount of the 91¤2% notes(including accrued interest and redemption premiums) that were not tendered inthe tender offer for such notes and the $24.2 million aggregate principalamount of the floating rate notes (including accrued interest) that were nottendered in the tender offer for such notes. 

On May 2, 2005, the Company used $22.4 millionof borrowings under the delayed draw facility of the credit facility to redeemthe $19.9 million aggregate principal amount of the 121¤2%notes (including accrued interest and redemption premiums) that were nottendered in the tender offer for such notes. In connection with suchredemption, a premium of $1.2 million was recorded and an additional$0.4 million of existing debt issuance costs has been subsequently chargedoff, resulting in the recognition of a loss of $1.6 million for retirementof debt in the second quarter of 2005. 

TheCompany reported other expense in the amount of $87.7 million, comprisedof a $77.8 million loss on early retirement of debt and a$9.9 million loss on redemption of series A preferred stock. Withrespect to the $77.8 million loss on early retirement of debt,$16.8 million was recorded for the write-off of existing debt issuancecosts and the remaining $61.0 million was fees and penalties. 

***(b)   Issuance of Common Stock***

On January 28, 2005, the Company effected a5.2773714 for one reverse stock split of the common stock, which has been givenretroactive effect in the accompanying financial statements. In connection withthe offering, the Company reclassified all of its class A common stock andclass C common stock on a one-for-one basis into a single class of commonstock of which 200 million shares are authorized. After the stock split,but prior to the issuance of any new shares in the offering, 9,451,719 sharesof common stock were outstanding. All common stock issued and outstanding has a$0.01 par value. 

8

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(2)**   Initial Public Offeringand Other Transactions (Continued)

The Company received grossproceeds of $462.5 million from the offering which, net of costs incurredof $30.6 million related to the offering, has been allocated to paid-incapital. 

***(c)   Dividends***

The Company has adopted a dividend policy under whicha substantial portion of the cash generated by the Company’s business in excessof operating needs, interest and principal payments on indebtedness, dividendson future senior classes of capital stock, if any, capital expenditures, taxesand future reserves, if any, would in general be distributed as regularquarterly dividend payments to the holders of its common stock, rather thanretained and used for other purposes. 

On September 21,2005, the Company declared a dividend of $0.39781 per share of common stock,which was paid on October 19, 2005 to holders of record as of October 3,2005. In 2005, the Company has paid dividends totaling $35.3 million, or$1.02105 per share of common stock.

**(3)   Income Taxes**

The Company’s accounting policy is to report incometax expense for interim reporting periods using an estimated annual effectiveincome tax rate. However, the effects of significant or unusual items are notconsidered in the estimated annual effective tax rate. The tax effect of suchevents is recognized in the interim period in which the event occurs. 

For the three months ended September 30, 2005,the Company recorded income tax expense of $3.5 million. The higher taxexpense in 2005 resulted primarily from taxable income during the third quarterof 2005 versus losses incurred in prior periods. During the three months ended September 30,2004, income tax expense was $0.1 million related primarily to incometaxes owed in certain states.

For the nine months ended September 30, 2005, theCompany recorded an income tax benefit of $87.9 million. The income taxbenefit and effective tax rate were primarily impacted by unusual itemsoccurring during the nine months ended September 30, 2005. Income taxbenefits of $20.3 million were recognized due to the taxable loss in thefirst nine months of 2005, resulting from losses on the extinguishment of debt.In addition, the Company recognized income tax benefits of $66.0 millionfrom the reduction of the deferred tax valuation allowance. The income taxbenefit also includes $1.6 million for an adjustment to record the Company’snet deferred tax assets at an expected federal income tax rate of 35% (from34%), in anticipation of higher levels of taxable income in subsequent periods.Exclusive of unusual items affecting the tax rate, the Company’s effectiveannual tax rate is estimated at 43.2% for 2005. This rate is higher than theanticipated statutory federal and state rates due to the dividends andaccretion on our series A preferred stock which are non-deductible for taxpurposes. During the nine months ended September 30, 2004, income taxexpense was $0.3 million related primarily to income taxes owed in certainstates. 

The valuation allowancefor deferred tax assets as of December 31, 2004 was $66.0 million. Inassessing the realizability of deferred tax assets, management considerswhether it is more likely than not that some portion or all of the deferred taxassets will not be realized. The ultimate realization of deferred tax assets isdependent upon the generation of future taxable income during the periods inwhich those temporary differences become deductible. Management considers thescheduled reversal of deferred tax 

9

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(3)**   Income Taxes (Continued)

liabilities, projected future taxable income, and taxplanning strategies in making this assessment, as well as all positive andnegative evidence that would affect the recoverability of deferred tax assets. Asa result of the offering, the Company has reduced its aggregate long term debtand expects a significant reduction in its annual interest expense. Whenconsidered together with the Company’s history of producing positive operatingresults and other evidence affecting the recoverability of deferred tax assets,the Company expects that future taxable income will more likely than not besufficient to recover net deferred tax assets. Therefore, the valuationallowance was reversed in the first quarter of 2005, subsequent to theoffering.

**(4)   Stock-BasedCompensation**

The Company accounts for its stock option plans usingthe intrinsic value based method prescribed by Accounting Principles BoardOpinion No. 25, *Accounting for StockIssued to Employees*, or APB No. 25, and relatedinterpretations. As such, compensation expense is recorded on the date of grantonly if the current market price of the underlying stock exceeds the exerciseprice. Statement of Financial Accounting Standards No. 123, *Accounting for Stock Based Compensation*,or SFAS No. 123, permits entities to recognize as expense over the vestingperiod the fair value of all stock based awards on the date of grant. SFAS No. 123allows entities to continue to apply the provisions of APB No. 25 andprovide pro forma net income (loss) disclosures as if the fair-value methoddefined in SFAS No. 123 had been applied. The Company has elected tocontinue to apply the intrinsic value based method of accounting under APB No. 25and has adopted the disclosure requirements of SFAS No. 123. 

As of September 30, 2005, the Company has granted523,716 shares of restricted stock issued under the Company’s 2005 StockIncentive Plan to certain employees. These shares vest over periods rangingfrom three to four years and certain of these shares pay current dividends. Inconnection with these grants, the Company recorded unearned compensation of$9.5 million, which has been reduced to $7.1 million as of September 30,2005. During the third quarter of 2005, 44,213 shares of restricted stock wereforfeited bringing the total number of shares of restricted stock forfeitedunder the 2005 Stock Incentive Plan to 53,687.

In the second quarter of 2005, the Company’s board ofdirectors approved an annual award to each of the Company’s non-employeedirectors of approximately $30,000 in the form of restricted stock orrestricted units, at the recipient’s option, issued under the Company’s 2005Stock Incentive Plan. The restricted stock and restricted units will vest infour equal quarterly installments on the first day of each of the first fourcalendar quarters following the grant date, commencing on July 1, 2005,and the holders thereof will be entitled to receive dividends from the date ofgrant, whether or not vested. In the second quarter of 2005, the Companygranted 1,870 shares of restricted stock with a total value at the grant dateof approximately $30,000 and 7,480 restricted units with a total value at thegrant date of approximately $120,000 to the Company’s non-employee directors. Anadditional 184 restricted units were granted in the third quarter of 2005 inlieu of dividends on the restricted units.

In total, the Company has recorded stock-basedcompensation expense of $0.6 million and $1.7 million, respectively, inthe three and nine months ended September 30, 2005. The Company recordedstock-based compensation expense of $45,000 and $133,000, respectively, in thethree and nine months ended September 30, 2004.

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(4)**   Stock-Based Compensation (Continued)

The Company calculatesstock-based compensation pursuant to the disclosure provisions of SFAS No. 123using the straight-line method over the vesting period of the option. Had theCompany determined compensation cost based on the fair value at the grant datefor its stock options under SFAS No. 123, the Company’s net income wouldhave been (in thousands, except per share amounts):

| ** **                                                                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss),  as reported                                                    |       | $                                                    | 4,189      |                                                | $          | (4,225 | ) | $ | 20,834 |   | $ | (12,926 | ) |
| Stock-based  compensation expense included in reported net income, net of tax |       | 354                                                  |       | 45                                                  |       | 1,035 |   | 133 |   |
| Stock-based  compensation determined under fair value based method, net of tax     |       | (342                                                 | )          | (113                                                | )          | (1,047 | ) | (593 | ) |
| Pro forma net income (loss)                                                        |       | $                                                    | 4,201      |                                                | $          | (4,293 | ) | $ | 20,822 |   | $ | (13,386 | ) |
| Basic earnings  (loss) per share:                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| As reported                                                                        |       | $                                                    | 0.12       |                                                | $          | (0.45 | ) | $ | 0.67 |   | $ | (1.37 | ) |
| Pro forma                                                                          |       | 0.12                                                 |       | (0.45                                               | )          | 0.67 |   | (1.41 | ) |
| Diluted earnings  (loss) per share:                                                |       |                                                 |       |                                                |       |   |   |   |   |
| As reported                                                                        |       | $                                                    | 0.12       |                                                | $          | (0.45 | ) | $ | 0.67 |   | $ | (1.37 | ) |
| Pro forma                                                                          |       | 0.12                                                 |       | (0.45                                               | )          | 0.67 |   | (1.41 | ) |

 

In December 2004,the FASB issued SFAS No. 123(R). This new standard requires companies toadopt the fair value methodology of valuing stock-based compensation andrecognize that valuation in the financial statements from the date of grant. Theadoption of SFAS No. 123(R)’s fair value method is not expected to have amaterial impact on the Company’s income from operations. The impact of adoptionof SFAS No. 123(R) cannot be predicted at this time because it willpartially depend on levels of share-based payments granted in the future.However, had the Company adopted SFAS No. 123(R) in prior periods,the impact of that standard would have approximated the impact of SFAS No. 123as shown in the table above. SFAS No. 123(R) also requires thebenefits of tax deductions in excess of recognized compensation cost to be reportedas a financing cash flow, rather than as an operating cash flow as requiredunder current literature. The Company expects to adopt the provisions of SFAS No. 123(R) ona modified prospective application method effective January 1, 2006, withno restatement of any prior periods. SFAS No. 123(R) is effective forthe Company as of the beginning of the first annual reporting period thatbegins after June 15, 2005.

**(5)   Acquisitions**

On May 2, 2005, the Company completed theacquisition of Berkshire Telephone Corporation, or Berkshire. The purchaseprice was approximately $20.4 million (or $16.4 million net of cashacquired), subject to adjustment. The Company incurred acquisition costs of$0.6 million. Berkshire is an independent local exchange carrier that providesvoice communication, cable and internet services. 

11

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(5)**   Acquisitions (Continued)

Berkshire’s communities ofservice are adjacent to those of Taconic Telephone Corp., one of the Company’ssubsidiaries. The acquisition is referred to herein as the Berkshireacquisition.

The Berkshire acquisition has been accounted for usingthe purchase method of accounting for business combinations and, accordingly,the acquired assets and liabilities have been recorded at their estimated fairvalues as of the date of acquisition, and its results of operations have beenincluded in the Company’s consolidated financial statements from the date ofacquisition. Based upon the Company’s preliminary purchase price allocation,subject to final settlement of an escrow, the excess of the purchase price andacquisition costs over the fair value of the net identifiable assets acquiredwas approximately $10.9 million. The Company recorded an intangible assetrelated to the acquired company’s customer relationships of $2.4 million andthe remaining $8.5 million has been recognized as goodwill. The estimateduseful life of the $2.4 million intangible asset is 15 years.

On September 1, 2005, the Company completed theacquisition of Bentleyville Communications Corporation, or Bentleyville. Thepurchase price was approximately $11.0 million (or $9.3 million net ofcash acquired), subject to adjustment. The Company incurred acquisition costsof $0.4 million. Bentleyville provides telecommunications, cable and internetservices to rural areas of Southwestern Pennsylvania which are adjacent to theCompany’s existing operations in Pennsylvania. The acquisition is referred toherein as the Bentleyville acquisition.

The Bentleyville acquisition has been accounted forusing the purchase method of accounting for business combinations and,accordingly, the acquired assets and liabilities have been recorded at theirestimated fair values as of the date of acquisition, and its results ofoperations have been included in the Company’s consolidated financialstatements from the date of acquisition. Based upon the Company’s preliminarypurchase price allocation, the excess of the purchase price and acquisitioncosts over the fair value of the net identifiable assets acquired wasapproximately $4.6 million. The Company recorded an intangible asset related tothe acquired company’s customer relationships of $1.4 million and the remaining$3.2 million has been recognized as goodwill. The estimated useful life of the$1.4 million intangible asset is 15 years.

12

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(5)**   Acquisitions(Continued)

Thefollowing unaudited pro forma information presents the combined results ofoperations of the Company as though the Berkshire acquisition and theBentleyville acquisition each had been consummated on January 1, 2004. Theseresults include certain adjustments, mainly associated with increased interestexpense on debt and amortization of intangible assets related to theacquisitions and the related income tax effects. The pro forma financialinformation does not necessarily reflect the results of operations as if theBerkshire acquisition and the Bentleyville acquisition each had beenconsummated at the beginning of the period or which may be attained in thefuture.

| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(in thousands)**                              | ** ** |
| Revenues                                  |       | $66,654                                              |       | $67,916                                             |       | $197,370 |   | $196,276 |   |
| Income (loss)  from continuing operations |       | 4,114                                                |       | (4,461                                              | )          | 20,299 |   | (14,296 | ) |
| Net income (loss)                         |       | 4,114                                                |       | (4,461                                              | )          | 20,299 |   | (13,625 | ) |
| *Earnings  (loss) per share:*             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                     |       | $                                                    | 0.12       |                                                | $          | (0.47 | ) | $ | 0.65 |   | $ | (1.44 | ) |
| Diluted                                   |       | 0.12                                                 |       | (0.47                                               | )          | 0.65 |   | (1.44 | ) |
|                                           |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

**(6)**   DiscontinuedOperations and Restructure Charges

In November 2001, the Company announced its planto discontinue the competitive communications business operations of its whollyowned subsidiary, FairPoint Carrier Services, Inc., or Carrier Services.As a result of the adoption of the plan to discontinue the competitivecommunications operations, these operating results are presented asdiscontinued operations.

Net liabilities of discontinued competitivecommunications operations as of September 30, 2005 and December 31,2004 were $3.2 million and $3.7 million, respectively. The remainingrestructuring accrual at September 30, 2005 was $2.1 million, and isprimarily associated with remaining equipment and lease obligations. The changein the restructuring accrual from December 31, 2004 to September 30,2005 was comprised of payments towards the lease obligations.

The income fromdiscontinued operations of $0.7 million for the nine months ended September 30,2004 resulted from the re-evaluation of certain accrued liabilities associatedwith the Company’s discontinued operations.

**(7)**   Interest Rate SwapAgreements

The Company assesses interest rate cash flow risk bycontinually identifying and monitoring changes in interest rate exposures thatmay adversely impact expected future cash flows and by evaluating hedgingopportunities. The Company maintains risk management control systems to monitorinterest rate cash flow risk attributable to both the Company’s outstanding andforecasted debt obligations. The risk management control systems involve theuse of analytical techniques, including cash flow sensitivity analysis, toestimate the expected impact of changes in interest rates on the Company’sfuture cash flows.

13

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(7)**   Interest Rate Swap Agreements (Continued)

The Company uses variable and fixed-rate debt tofinance its operations, capital expenditures and acquisitions. Thevariable-rate debt obligations expose the Company to variability in interestpayments due to changes in interest rates. Management believes it is prudent tolimit the variability of a portion of its interest payments. To meet thisobjective, management enters into interest rate swap agreements to managefluctuations in cash flows resulting from interest rate risk. These swapschange the variable-rate cash flow exposure on certain interest payments tofixed cash flows. Under the terms of the interest rate swaps, the Company paysa variable rate plus an additional payment if the variable rate payment isbelow a contractual rate, or it receives a payment if the variable rate paymentis above the contractual rate.

On February 8, 2005, the Company entered intothree interest rate swap agreements, with notional amounts of $130 millioneach, to effectively convert a portion of its variable rate interest exposureto fixed rates ranging from 3.76% to 4.11%, plus a 2.0% margin. These swapagreements expire beginning December 31, 2007 through December 31,2009. On April 7, 2005, the Company entered into two additional interestrate swap agreements, one with the notional amount of $50.0 million toeffectively convert a portion of its variable rate interest exposure to a fixedrate of 4.69%, plus a 2.0% margin, beginning on April 29, 2005 and endingon March 31, 2011, and one with the notional amount of $50.0 millionto effectively convert a portion of its variable rate interest exposure to afixed rate of 4.72%, plus a 2.0% margin, beginning on June 30, 2005 andending on March 31, 2012. As a result of these swap agreements, as of September 30,2005, approximately 81% of the Company’s indebtedness bore interest at fixedrates rather than variable rates. Effective on September 30, 2005, theCompany amended the terms of its credit facility. This amendment reduced the effectiveinterest rate margins applicable to the Company’s interest rate swap agreementsby 0.25% to 1.75%.

These interest rate swaps qualify as cash flow hedgesfor accounting purposes. The effect of hedge ineffectiveness on net earningswas insignificant for the three and nine months ended September 30, 2005.At September 30, 2005, the fair market value of these swaps wasapproximately $5.9 million and has been recorded, net of tax of$2.2 million, as a decrease in comprehensive income. Of the$5.9 million, $1.6 million has been included in other current assetsand $4.3 million has been included in other long-term assets.

During 2004, the Companyhad two interest rate swap agreements with a combined notional amount of$50.0 million which expired in May 2004. Amounts receivable orpayable under these interest rate swap agreements were accrued at each balancesheet date and included as adjustments to realized and unrealized gains(losses) on interest rate swaps because these interest rate swap agreements werenot considered effective accounting hedges.

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(8)**   Investments

TheCompany has a 7.5% ownership in Orange County Poughkeepsie Limited Partnership,which is accounted for under the equity method. Summary financial information forthe partnership follows (in thousands):

| ** **                          | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Current assets                      |       | $                       | 1,899      |                        |       | $ | 1,545 |   |   |
| Property, plant  and equipment, net |       | 36,488                  |       |                        | 34,525     |   |   |
| Total assets                        |       | $                       | 38,387     |                        |       | $ | 36,070 |   |   |
| Current liabilities                 |       | $                       | 262        |                        |       | $ | 3,682 |   |   |
| Partners’ capital              |       | 38,125                  |       |                        | 32,388     |   |   |
|                                |       | $                       | 38,387     |                        |       | $ | 36,070 |   |   |

 

| ** **       | ** ** | **Three months ended  June 30,** | ** ** | **Nine months ended  June 30,** | ** ** |
|------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **       | ** ** | **2005**                                        | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues         |       | $                                               | 43,302     |                                           | $          | 42,192 |   | $ | 123,946 |   | $ | 116,660 |   |
| Operating income |       | 33,565                                          |       | 36,181                                         |       | 100,922 |   | 98,527 |   |
| Net income       |       | 33,782                                          |       | 36,383                                         |       | 101,511 |   | 99,327 |   |
|                  |            |                                                 |            |                                                |            |  |  |  |  |  |  |  |  |

 

The Company also has otherinvestments in non-marketable securities which are accounted for using the costand equity methods of accounting. The Company continually monitors all of theseinvestments for possible impairment by evaluating the financial performance ofthe businesses in which it invests and comparing the carrying value of theinvestment to quoted market prices (if available), or the fair values ofsimilar investments, which in certain instances, is based on traditionalvaluation models utilizing multiples of cash flows. When circumstances indicatethat a decline in the fair value of the investment has occurred and the declineis other than temporary, the Company records the decline in value as a realizedimpairment loss and a reduction in the cost of the investment.

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(9)**   Long Term Debt

Longterm debt at September 30, 2005 and December 31, 2004 is shown below:

| ** **                                                                                                                                               | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                               | ** ** | **(In thousands)**      | ** ** |
| Senior secured  notes, variable rates ranging from 5.4375% to 7.75% (weighted average  rate of 5.607%) at September 30, 2005, due 2011 to 2012 |       |                         | $          | 605,150                     |       |   |   | $ | — |   |   |
| Senior secured  notes, variable rates ranging from 6.44% to 8.75% at December 31,  2004, due 2005 to 2007                                      |       |                         | —     |                        |       |   | 182,357 |   |   |
| Senior subordinated  notes due 2008:                                                                                                                     |       |                         |       |                        |       |   |   |   |   |
| Fixed rate notes, 9.50%                                                                                                                                  |       |                         | —     |                        |       |   | 115,207 |   |   |
| Variable rate notes, 6.4875% at December 31,  2004                                                                                                  |       |                         | —     |                        |       |   | 75,000 |   |   |
| Senior  subordinated notes, 12.50%, due 2010                                                                                                             |       |                         | —     |                        |       |   | 193,000 |   |   |
| Senior notes,  11.875%, due 2010                                                                                                                         |       |                         | 2,050      |                        |       |   | 225,000 |   |   |
| Senior notes to RTFC:                                                                                                                                    |       |                         |       |                        |       |   |   |   |   |
| Fixed rate, ranging from 8.2% to 9.20%, due 2014                                                                                                         |       |                         | 3,258      |                        |       |   | 2,278 |   |   |
| Variable rate, 6.15% at December 31, 2004, due  2009                                                                                                |       |                         | —     |                        |       |   | 3,415 |   |   |
| Subordinated  promissory notes, 7.00%, due 2005                                                                                                          |       |                         | —     |                        |       |   | 7,000 |   |   |
| First mortgage  notes to Rural Utilities Service, fixed rates ranging from 4.96% to 10.78%,  due 2005 to 2016                                            |       |                         | —     |                        |       |   | 6,034 |   |   |
| Senior notes to  RTB, fixed rates ranging from 7.50% to 8.00%, due 2008 to 2014                                                                     |       |                         | —     |                        |       |   | 1,141 |   |   |
| Total outstanding long-term debt                                                                                                                         |       |                         | 610,458    |                        |       |   | 810,432 |   |   |
| Less current  portion                                                                                                                                    |       |                         | (668       | )                           |       |   | (524 | ) |   |
| Total long-term  debt, net of current portion                                                                                                            |       |                         | $          | 609,790                     |       |   |   | $ | 809,908 |   |   |

 

Theapproximate aggregate maturities of long-term debt for each of the five yearssubsequent to September 30, 2005 are as follows: 

| **Year ending September 30,  (In thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                                              |       | $          | 668        |       |
| 2007                                                              |       | 705        |       |
| 2008                                                              |       | 743        |       |
| 2009                                                              |       | 296        |       |
| 2010                                                              |       | 2,208      |       |
| Thereafter                                                        |       | 605,838    |       |
|                                                              |       | $          | 610,458    |       |

 

The Company has entered into a credit facilityconsisting of a revolving facility in an aggregate principal amount of up to$100.0 million and a term facility in an aggregate principal amount of 

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(9)**   Long Term Debt (Continued)

$588.5 million. Onthe closing date of the offering (February 8, 2005), the Company drew$566.0 million against the term facility. In addition, on May 2,2005, the Company drew $22.4 million of borrowings under the delayed drawfacility of the credit facility. The Company incurred approximately$9.9 million of debt issuance costs associated with entering into thecredit facility and subsequent amendments thereto.

The term facility matures in February 2012 andthe revolving facility matures in February 2011.

Borrowings bear interest, at the Company’s option, forthe revolving facility and for the term facility at either (a) theEurodollar rate (as defined in the credit facility) plus an applicable marginor (b) the Base rate (as defined in the credit facility) plus anapplicable margin. The Eurodollar rate applicable margin and the Base rateapplicable margin for loans under the credit facility are 2.0% and 1.0%,respectively. Effective on September 30, 2005, the Company amended itscredit facility to reduce the effective interest rate margins on the $588.5million term facility by 0.25% to 1.75% on Eurodollar loans and to 0.75% forBase rate loans. Interest with respect to Base rate loans is payable quarterlyin arrears and interest with respect to Eurodollar loans is payable at the endof the applicable interest period and every three months in the case ofinterest periods in excess of three months.

The credit facility provides for payment to thelenders of a commitment fee on any unused commitments equal to 0.5% per annum,payable quarterly in arrears, as well as other fees.

The credit facility requires certain mandatoryprepayments, including first to prepay outstanding term loans under the creditfacility and, thereafter, to repay loans under the revolving facility and/or toreduce revolving facility commitments with, subject to certain conditions andexceptions, 100% of the net cash proceeds the Company receives from any sale,transfer or other disposition of any assets, 100% of net casualty insuranceproceeds and 100% of the net cash proceeds the Company receives from theissuance of permitted securities and, at certain times if the Company is notpermitted to pay dividends, with 50% of the increase in the Company’sCumulative Distributable Cash (as defined in the credit facility) during theprior fiscal quarter. Reductions to the revolving commitments under the creditfacility from the foregoing recapture events will not reduce the revolvingcommitments under the credit facility below $50.0 million.

The credit facility provides for voluntary prepaymentsof the revolving facility and the term facility and voluntary commitmentreductions of the revolving facility, subject to giving proper notice andcompensating the lenders for standard Eurodollar breakage costs, if applicable.

The credit facility requires that the Company maintaincertain financial covenants. The credit facility contains customary affirmativecovenants. The credit facility also contains negative covenants and restrictions,including, among others, with respect to redeeming and repurchasing otherindebtedness, loans and investments, additional indebtedness, liens, capitalexpenditures, changes in the nature of the Company’s business, mergers,acquisitions, asset sales and transactions with the Company’s affiliates.

The credit facilityrestricts the Company’s ability to declare and pay dividends on its commonstock as follows:

·       TheCompany may use all of its available cash accumulated after April 1, 2005plus certain incremental funds to pay dividends, but may not in general paydividends in excess of such amount. “Available cash” is defined in the creditfacility as Adjusted EBITDA (a) minus (i) interest expense, (ii) repaymentsof indebtedness (unless funded by debt or equity), (iii) capitalexpenditures (unless 

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(9)**   Long Term Debt (Continued)

funded by long-term debt,equity or the proceeds from asset sales or insurance recovery events), (iv) cashtaxes, (v) cash consideration paid for acquisitions (unless funded by debtor equity), (vi) cash paid to make certain investments, and (vii) certainnon-cash items excluded from Adjusted EBITDA and paid in cash and (b) pluscertain non-cash items excluded from Adjusted EBITDA and received in cash. “AdjustedEBITDA” is defined in the credit facility as Consolidated Net Income (which isdefined in the credit facility and includes distributions from investments) (a) plusthe following to the extent deducted from Consolidated Net Income: provisionfor income taxes, interest expense, depreciation, amortization, losses on salesof assets and other extraordinary losses, and certain other non-cash items, and(b) minus, to the extent included in Consolidated Net Income, gains onsales of assets and other extraordinary gains and all non-cash items.

·       TheCompany may not pay dividends if a default or event of default under the creditfacility has occurred and is continuing or would exist after giving effect tosuch payment, if the Company’s leverage ratio is above 5.00 to 1.00 or if theCompany does not have at least $10 million of cash on hand (includingunutilized commitments under the credit facility’s revolving facility).

The credit facility also permits the Company to useavailable cash to repurchase shares of its capital stock, subject to the sameconditions.

The Company may obtain letters of credit under therevolving facility to support obligations of the Company and/or obligations ofits subsidiaries incurred in the ordinary course of business in an aggregateprincipal amount not to exceed $5.0 million and subject to limitations onthe aggregate amount outstanding under the revolving facility. As of September 30,2005, a letter of credit had been issued for $1.2 million.

The credit facility is guaranteed, jointly andseverally, subject to certain exceptions, by all first tier subsidiaries of theCompany. The Company has provided to Deutsche Bank Trust Company Americas, ascollateral agent for the benefit of the lenders under the credit facility andcertain hedging creditors under permitted hedging agreements, collateralconsisting of (subject to certain exceptions) 100% of the Company’s equityinterests in the subsidiary guarantors and certain other intermediate holdingcompany subsidiaries. Newly acquired or formed direct or indirect subsidiariesof the Company which own equity interests of any subsidiary that is anoperating company will be required to provide the collateral described above.

The credit facilitycontains customary events of default, including but not limited to, failure topay principal, interest or other amounts when due, breach of covenants orrepresentations, cross-defaults to certain other indebtedness in excessof specified amounts, judgment defaults in excess of specified amounts, certainERISA defaults, the failure of any guaranty or security document supporting thecredit facility and certain events of bankruptcy and insolvency.

**(10)**   Earnings Per Share

Earnings per share has been computed in accordancewith SFAS No. 128, *Earnings Per Share*.Basic earnings per share is computed by dividing net income (loss) by theweighted average number of shares of common stock outstanding for the period.Except when the effect would be anti-dilutive, the diluted earnings per sharecalculation includes the impact of restricted stock units, shares of restrictedcommon 

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(10)**   Earnings Per Share (Continued)

stock and shares thatcould be issued under outstanding stock options. For the three and nine monthsended September 30, 2005, diluted weighted average shares of common stockoutstanding included 39,660 and 41,597 shares associated with outstandingstock options and non-vested restricted stock and restricted stock units.

The number of potentialshares of common stock excluded from the calculation of diluted net income(loss) per share, prior to the application of the treasury stock method, is asfollows (in thousands): 

| ** **                                         | ** ** | **Three months ended  September 30,**     | ** ** | **Nine months ended  September 30,**      | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                         | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** |
| Contingent stock  options                          |       |                                                     | 833        |                                                     |       |   | 833 |   |   |   | 833 |   |   |   | 833 |   |   |
| Shares excluded  as effect would be anti-dilutive: |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock options                                      |       |                                                     | 242        |                                                     |       |   | 416 |   |   |   | 241 |   |   |   | 416 |   |   |
| Restricted stock                                   |       |                                                     | 452        |                                                     |       |   | — |   |   |   | 471 |   |   |   | — |   |   |
| Restricted stock units                             |       |                                                     | 30         |                                                     |       |   | 27 |   |   |   | 34 |   |   |   | 27 |   |   |
| Total                                              |       |                                                     | 1,557      |                                                     |       |   | 1,276 |   |   |   | 1,579 |   |   |   | 1,276 |   |   |

 

**(11)**   Litigation

On June 6, 2005, a purported class actioncomplaint was filed in the General Court of Justice, Superior Court Division,of the State of North Carolina by Robert Lowinger on behalf of himself and allother similarly situated persons against the Company, the Company’s Chairmanand Chief Executive Officer, certain of the Company’s current and formerdirectors and certain of the Company’s stockholders. The complaint allegesviolations of Sections 11 and 12(a)(2) and liability under Section 15of the Securities Act, and alleges that the Company’s registration statement onForm S-1 (which was declared effective by the SEC on February 3,2005) and the related prospectus dated February 3, 2005, each relating tothe offering, contained certain material misstatements and omitted certainmaterial information necessary to be included relating to the Company’sbroadband products and access line trends. The plaintiff seeks rescissionrights and unspecified damages on behalf of a purported class of purchasers ofthe common stock “issued pursuant and/or traceable to the Company’s IPO duringthe period from February 3, 2005 through March 21, 2005”. The Companyremoved the action to Federal Court. The plaintiff filed a motion to remand theaction to the North Carolina State Court, which was denied by the FederalMagistrate. The plaintiff has objected to and appealed the Magistrate’sdecision to the District Court Judge. The Company will contest the appeal. TheCompany believes that the complaint is without merit and intends to continue todefend the litigation vigorously.

The Company currently andfrom time to time is involved in other litigation and regulatory proceedingsincidental to the conduct of its business, but currently the Company is not aparty to any lawsuit or proceeding which, in its opinion, is likely to have amaterial adverse effect on the Company.

**(12)**   Subsequent Event

On November 7, 2005, the Company reached anagreement to terminate, at the conclusion of the transition period, a servicebureau arrangement with an outsourced service provider that provides billing 

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)**

**(12)**   Subsequent Event (Continued)

services to several of theCompany’s subsidiaries. The Company will receive $4.0 million in cash from theoutsourced service provider and the Company will not have to pay an additional$1.2 million which was scheduled to be paid to the service provider over thenext 21 months. In addition, the Company has selected another billing serviceprovider and plans to convert all of its subsidiaries to the billing platformof the new service provider. The Company will continue to use the currentservice provider until this conversion is completed. The Company hascapitalized, net of accumulated amortization, approximately $7.7 million ofinternal and external costs associated with software development costs for itsend-user billing platform related to this arrangement. Due to the agreementreached in November 2005, the Company has performed an impairment testwhich indicated that the asset group containing this asset is not impaired. However,the Company is re-evaluating the estimated useful life of this asset as aresult of the settlement.

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

The following discussionand analysis provides information that the Company’s management believes isrelevant to an assessment and understanding of the consolidated results ofoperations and financial condition of FairPoint Communications, Inc. andits subsidiaries. The discussion should be read in conjunction with FairPoint’sConsolidated Financial Statements for the year ended December 31, 2004included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2004.

**Overview**

We are a leading provider of communications servicesin rural communities, offering an array of services including local voice, longdistance, data, Internet and broadband product offerings. We are one of thelargest telephone companies in the United States focused on serving ruralcommunities, and we are the 17th largest local telephone company, ineach case based on number of access lines. We operate in 17 states with 291,072access line equivalents (voice access lines and high speed data lines, whichinclude digital subscriber lines, or DSL, wireless broadband and cable modem)in service as of September 30, 2005.

We were incorporated in February 1991 for thepurpose of operating and acquiring incumbent telephone companies in ruralmarkets. We have acquired 32 such businesses, 28 of which we continue to ownand operate. Many of our telephone companies have served their respectivecommunities for over 75 years. The majority of the rural communities weserve have fewer than 2,500 access lines. All of our telephone companysubsidiaries qualify as rural local exchange carriers under theTelecommunications Act of 1996, or the Telecommunications Act.

Rural local exchange carriers generally arecharacterized by stable operating results and strong cash flow margins andoperate in supportive regulatory environments. In particular, existing stateand federal regulations permit us to charge rates that enable us to recover ouroperating costs, plus a reasonable rate of return on our invested capital (asdetermined by relevant regulatory authorities). Competition is typicallylimited because rural local exchange carriers primarily serve sparselypopulated rural communities with predominantly residential customers, and thecost of operations and capital investment requirements for new entrants ishigh. As a result, in our markets, we have experienced virtually no wirelinecompetition and limited voice competition from cable providers. While most ofour markets are served by wireless service providers, their impact on ourbusiness has been limited. We occasionally negotiate interconnection agreementsfrom other telecommunications providers which could ultimately result inincreased competition in those markets.

Access lines are an important element of our business.Historically, rural telephone companies have experienced consistent growth inaccess lines because of positive demographic trends, insulated rural localeconomies and little competition. Recently, however, many rural telephonecompanies have experienced a loss of access lines due to challenging economicconditions, increased competition and the introduction of digital subscriberline services. We have not been immune to these conditions. We have been ableto mitigate our access line loss through bundling services, retention programs,continued community involvement and a variety of other focused programs.

At September 30, 2005, 17 of our operatingcompanies (representing 68% of access line equivalents) had converted to asingle outsourced billing platform, unchanged from June 30, 2005. Thesebilling conversions had resulted in delays in late notices, disconnect noticesand non-pay disconnects at some of the converted companies. During the thirdquarter, these processes were corrected and in the quarter through October,non-pay disconnects were effected as appropriate. On October 7, 2005, welearned that the billing service bureau used by us contracted to sell thesoftware underlying our new billing system and agreed not to add any futurecustomers to its service bureau platform. In addition to the short termdifficulties experienced during the billing conversion, this potential saleraises concerns about the long-term reliability of the service bureau.

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Subsequent to September 30, 2005, we haveprocessed the majority of the non-pay disconnects that were delayed as a resultof the billing conversion. As a result, during October 2005 wedisconnected approximately 1,300 voice access lines as a result of non-pay andwe have resumed our normal disconnect processes.

On November 7, 2005, we reached an agreement withour outsourced service provider to transition to another service provider ofour choice by December 31, 2006. As part of this settlement, we willreceive $4.0 million in cash as compensation from the outsourced billingprovider in order to relieve it from its responsibilities under the originalservice bureau contract. In addition, we do not have to pay an additional $1.2million which was scheduled to be paid to the service provider over the next 18months. We have selected Mid America Computer Corporation (“MACC”) as our newprovider of billing services. We plan to convert all of our companies to theMACC platform by early 2007.

We are subject to regulation primarily by federal andstate governmental agencies. At the federal level, the FCC has jurisdictionover interstate and international communications services. Statetelecommunications regulators exercise jurisdiction over intrastatecommunications services.

On February 8, 2005, we consummated the offeringand entered into the credit facility. We used net proceeds received from theoffering, together with borrowings under the term facility of the creditfacility, to, among other things, repay all outstanding loans under our oldcredit facility, repurchase all of our series A preferred stock andconsummate tender offers and consent solicitations in respect of ouroutstanding 91¤2%notes, floating rate notes, 121¤2%notes and 117¤8%notes. On March 10, 2005, we redeemed the remaining outstanding 91¤2%notes and floating rate notes. On May 2, 2005, we redeemed the remainingoutstanding 121¤2%notes.

Our board of directors has adopted a dividend policywhich reflects our judgment that our stockholders would be better served if wedistributed a substantial portion of the cash generated by our business inexcess of operating needs, interest and principal payments on our indebtedness,dividends on future senior classes of our capital stock, if any, capitalexpenditures, taxes and future reserves, if any, as regular quarterly dividendpayments to the holders of our common stock, rather than retained and used suchcash for other purposes.

As a result of the offering, we have and will continueto incur higher expenses as a public company. These expenses have and willinclude additional accounting and finance expenses, audit fees, legal fees andincreased premiums for director and officer liability insurance. We estimatethat these additional expenses will be approximately $2.0 millionannually, excluding costs associated with our preparation for compliance with Section 404of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act.

We face risks that couldmaterially adversely affect our business, consolidated financial condition,results of operations or liquidity or the market price of our common stock. Fora discussion of certain of the risks facing us, see Exhibit 99.1 to thisQuarterly Report (filed as Exhibit 99.1 to our Quarterly Report on Form 10-Qfiled on August 12, 2005, and incorporated herein by reference).

**Revenues**

We derive ourrevenues from:

·       *Local calling services*.   We receiverevenues from providing local exchange telephone services, including monthlyrecurring charges for basic service, usage charges for local calls and servicecharges for special calling features.

·       *Universal Service Fund high cost loop support*.   Wereceive payments from the Universal Service Fund to support the high cost ofour operations in rural markets. This revenue stream fluctuates based upon ouraverage cost per loop compared to the national average cost per loop. Forexample, 

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if the national averagecost per loop increases and our operating costs (and average cost per loop)remain constant or decrease, the payments we receive from the Universal ServiceFund would decline. Conversely, if the national average cost per loop decreasesand our operating costs (and average cost per loop) remain constant orincrease, the payments we receive from the Universal Service Fund wouldincrease. The national average cost per loop in relation to our average costper loop has increased, and we believe that the national average cost per loopwill likely continue to increase in relation to our average cost per loop. As aresult, the payments we receive from the Universal Service Fund have declinedand will likely continue to decline.

·       *Interstate access revenue*.   Theserevenues are primarily based on a regulated return on rate base and recovery ofallowable expenses associated with the origination and termination of tollcalls both to and from our customers. Interstate access charges to longdistance carriers and other customers are based on access rates filed with theFederal Communications Commission. These revenues also include UniversalService Fund payments for local switching support, long term support andinterstate common line support.

·       *Intrastate access revenue*.   Theserevenues consist primarily of charges paid by long distance companies and othercustomers for access to our networks in connection with the origination andtermination of long distance telephone calls both to and from our customers.Intrastate access charges to long distance carriers and other customers arebased on access rates filed with the state regulatory agencies.

·       *Long distance services*.   We receiverevenues from long distance services we provide to our residential and businesscustomers. In addition, Carrier Services provides communications providers notaffiliated with us with wholesale long distance services.

·       *Data and Internet services*.   Wereceive revenues from monthly recurring charges for services, including highspeed data, special access, private lines, Internet and other services.

·       *Other services*.   We receive revenuesfrom other services, including billing and collection, directory services andsale and maintenance of customer premise equipment.

Thefollowing summarizes our revenues and percentage of revenues from continuingoperations from these sources (in thousands):

| ** **                                  | ** ** | **Revenues**                                         | ** ** | **% of Revenues**                         | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
| ** **                                  | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** |
| **Revenue Source**                          |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Local calling  services                     |       | $                                                    | 16,586     |                                                | $          | 15,974 |   | $ | 48,185 |   | $ | 47,322 |   |   | 25 | % |   |   | 24 | % |   |   | 25 | % |   |   | 25 | % |   |
| Universal service  fund-high cost loop |       | 5,045                                                |       | 5,807                                               |       | 14,548 |   | 17,110 |   |   | 8 | % |   |   | 9 | % |   |   | 8 | % |   |   | 9 | % |   |
| Interstate access  revenues                 |       | 17,697                                               |       | 17,382                                              |       | 54,660 |   | 52,061 |   |   | 27 | % |   |   | 27 | % |   |   | 28 | % |   |   | 28 | % |   |
| Intrastate access  revenues                 |       | 10,227                                               |       | 10,844                                              |       | 29,844 |   | 31,879 |   |   | 15 | % |   |   | 16 | % |   |   | 15 | % |   |   | 17 | % |   |
| Long distance  services                     |       | 5,694                                                |       | 5,009                                               |       | 15,174 |   | 13,258 |   |   | 9 | % |   |   | 8 | % |   |   | 8 | % |   |   | 7 | % |   |
| Data and Internet  services                 |       | 6,230                                                |       | 5,064                                               |       | 17,759 |   | 13,550 |   |   | 9 | % |   |   | 8 | % |   |   | 9 | % |   |   | 7 | % |   |
| Other services                              |       | 4,559                                                |       | 5,357                                               |       | 12,739 |   | 13,658 |   |   | 7 | % |   |   | 8 | % |   |   | 7 | % |   |   | 7 | % |   |
| Total                                       |       | $                                                    | 66,038     |                                                | $          | 65,437 |   | $ | 192,909 |   | $ | 188,838 |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |

 

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**Operating Expenses**

Our operatingexpenses are categorized as operating expenses, depreciation and amortization,and stock-based compensation.

·       Operatingexpenses include cash expenses incurred in connection with the operation of ourcentral offices and outside plant facilities and related operations. Inaddition to the operational costs of owning and operating our own facilities,we also purchase long distance services from the regional bell operatingcompanies, large independent telephone companies and third party long distanceproviders. In addition, our operating expenses include expenses relating tosales and marketing, customer service and administration and corporate andpersonnel administration.

·       Depreciationand amortization includes depreciation of our communications network andequipment.

·       Stock based compensationconsists of non-cash compensation charges incurred in connection with theemployee stock options, restricted stock units, restricted units and restrictedstock granted to our executive officers and directors, and stockholderappreciation rights agreements granted to one of our current executive officersand one of our former executive officers. The stockholder appreciation rightsagreements were all settled during March of 2005.

**Acquisitions**

We intend tocontinue to pursue selective acquisitions:

·       OnMay 2, 2005, we completed the Berkshire acquisition for a purchase priceof approximately $20.4 million, subject to adjustment. Berkshire is anindependent local exchange carrier that provides voice communication, cable andinternet services to over 7,200 access line equivalents serving fivecommunities in New York State. Berkshire’s communities of service are adjacentto those of Taconic Telephone Corp., one of the Company’s subsidiaries.

·       OnSeptember 1, 2005, we completed the Bentleyville acquisition forapproximately $11.0 million in cash, subject to adjustment. Bentleyville,which has approximately 3,600 access line equivalents, provides telecommunications,cable and internet services to rural areas of Southwestern Pennsylvania whichare adjacent to our existing operations in Pennsylvania.

·       During2004, we did not complete any acquisitions.

In the normal course ofbusiness, we evaluate selective acquisitions and may enter into non-bindingletters of intent with respect to such acquisitions, subject to customaryconditions. Management currently intends to fund future acquisitions throughthe use of the revolving facility of our credit facility or additional debtfinancing or the issuance of additional shares of our common stock. However,our substantial amount of indebtedness and our dividend policy could restrictour ability to obtain such financing on acceptable terms or at all.

**Stock Based Compensation**

In February 2005 and September 2005, weissued 473,716 shares and 50,000 shares, respectively, of restricted stockunder our 2005 Stock Incentive Plan. This issuance will result in recognitionof an additional compensation expense of approximately $2.2 million in2005. At September 30, 2005, 467,878 shares of our common stock maybe issued in the future pursuant to awards authorized under our 2005 StockIncentive Plan which could result in an additional compensation expense. In thesecond quarter of 2005, the Company’s board of directors approved an annualaward to each of the Company’s non-employee directors in the form ofrestricted stock or restricted units, at the recipient’s option, which willvest on a quarterly basis, issued under the Company’s 2005 Stock IncentivePlan. The 2005 

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non-employeedirector awards began to vest on July 1, 2005. In addition, the Companygranted restricted stock units to certain employees in December 2003 ofwhich 26,442 remain outstanding at September 30, 2005. Non-cashcompensation charges associated with restricted units, restricted stock unitsand restricted stock was $0.6 million and $1.7 million for the three andnine months ended September 30, 2005, respectively. We did not recognizeany additional charges associated with stockholder appreciation rights thatwere settled during the first quarter of 2005.

Non-cash compensationcharges associated with restricted stock units were $45,000 and $0.1 millionfor the three and nine months ended September 30, 2004, respectively.

**Results of Operations**

The following tables setforth the percentages of revenues represented by selected items reflected inour consolidated statements of operations. The quarter-to-quarter andyear-to-date comparisons of financial results are not necessarily indicative offuture results.

**ThreeMonths Ended September 30, 2005 Compared with Three Months Ended September 30,2004**

| ** **                                                    | ** ** | **Three months ended  September 30,** | ** ** | **Three months ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                                             | ** ** | **% of revenue**                           | ** ** | **2004** | ** ** | **% of revenue** | ** ** |
| Revenues                                                      |       | $                                                    | 66,038     |                                                 |       | 100.0 | % |   | $ | 65,437 |   |   | 100.0 | % |   |
| Operating expenses                                            |       | 37,903                                               |       |                                                 | 57.4       | % |   | 34,184 |   |   | 52.2 | % |   |
| Depreciation and  amortization                                |       | 12,947                                               |       |                                                 | 19.6       | % |   | 12,176 |   |   | 18.6 | % |   |
| Stock based  compensation                                     |       | 567                                                  |       |                                                 | 0.9        | % |   | 45 |   |   | 0.1 | % |   |
| Total operating  expenses                                     |       | 51,417                                               |       |                                                 | 77.9       | % |   | 46,405 |   |   | 70.9 | % |   |
| Income from  operations                                       |       | 14,621                                               |       |                                                 | 22.1       | % |   | 19,032 |   |   | 29.1 | % |   |
| Net (loss) gain on sale of investments  and other assets |       | (15                                                  | )          |                                                 | (0.0       | )% |   | (439 | ) |   | (0.7 | )% |   |
| Interest and  dividend income                                 |       | 398                                                  |       |                                                 | 0.6        | % |   | 572 |   |   | 0.9 | % |   |
| Interest expense                                              |       | (10,026                                              | )          |                                                 | (15.2      | )% |   | (26,160 | ) |   | (40.0 | )% |   |
| Equity in net  earnings of investees                          |       | 2,716                                                |       |                                                 | 4.1        | % |   | 2,875 |   |   | 4.4 | % |   |
| Total other expense                                           |       | (6,927                                               | )          |                                                 | (10.5      | )% |   | (23,152 | ) |   | (35.4 | )% |   |
| Income (loss) before income taxes                             |       | 7,694                                                |       |                                                 | 11.6       | % |   | (4,120 | ) |   | (6.3 | )% |   |
| Income tax benefit  (expense)                                 |       | (3,504                                               | )          |                                                 | (5.3       | )% |   | (105 | ) |   | (0.2 | )% |   |
| Minority interest  in income of subsidiaries                  |       | (1                                                   | )          |                                                 | (0.0       | )% |   | — |   |   | — |   |   |
| Net income (loss)                                             |       | $                                                    | 4,189      |                                                 |       | 6.3 | % |   | $ | (4,225 | ) |   | (6.5 | )% |   |

 

**Revenues**

*Revenues.**  *Revenues increased$0.6 million to $66.0 million in 2005 compared to $65.4 millionin 2004. We derived our revenues from the following sources:

*Localcalling services.**  *Localcalling service revenues increased $0.6 million to $16.6 million in 2005compared to $16.0 million in 2004. Excluding the impact of acquired operations,local calling service revenues increased $0.2 million compared to the thirdquarter of 2004. Voice access lines, including lines acquired, increased 2.0%from the third quarter of 2004 and increased sequentially from the secondquarter of 2005 by 0.5%. Voice access lines, excluding acquired lines,decreased 0.8% from the second quarter of 2005.

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*UniversalService Fund high cost loop.**  *Universal Service Fund high cost loop receiptsdecreased $0.8 million to $5.0 million in 2005. The national averagecost per loop in relation to our average cost per loop has increased and, as aresult, our receipts from the Universal Service Fund have declined. We expectthat this trend will continue as we anticipate the national average cost perloop will likely continue to increase in relation to our average cost per loop.

*Interstateaccess revenues.**  *Interstateaccess revenues were $17.7 million for the three months ended September 30,2005 compared to $17.4 million for the three months ended September 30,2004. Excluding the impact of acquired companies, interstate access revenuesdecreased $0.3 million compared to 2004. In total, increased revenues due tothe recovery of allowable expenses are more than offset by revenue reductionsdue to returns on a lower rate base.

*Intrastateaccess revenues.**  *Intrastateaccess revenues decreased $0.6 million from $10.8 million in 2004 to$10.2 million in 2005. Excluding the impact of acquired companies,intrastate access revenues decreased $0.9 million compared to 2004. Thedecrease was mainly attributed to declines in total minutes of use combinedwith rate reductions implemented in Maine.

*Longdistance services.**  *Longdistance services revenues increased $0.7 million from $5.0 millionin 2004 to $5.7 million in 2005. This is attributable to the increase insubscribers and minutes related to bundles and packages sold to our existingcustomers. Interstate long distance penetration as of September 30, 2005was 42.3% of voice access lines as compared to 36.0% as of September 30,2004.

*Dataand Internet services.**  *Dataand Internet services revenues increased $1.2 million to $6.2 millionin 2005 compared to 2004. This increase is due primarily to increases in highspeed data customers as we continue to market our broadband services. Our highspeed data subscribers increased from 33,007 as of September 30, 2004 to43,020 as of September 30, 2005 and represents a 17.3% penetration ofvoice access lines.

*Other services.**  *Other revenues decreased from$5.4 million in 2004 to $4.6 million in 2005. Excluding the impact ofacquired companies, other revenues decreased $1.2 million compared to 2004. Theprimary reason for this decrease was a $1.2 million one-time sale and installationof E911 system equipment in the third quarter of 2004.

**Operating Expenses**

*Operatingexpenses, excluding depreciation and amortization.**  *Operating expenses increased$3.7 million to $37.9 million in 2005 from $34.2 million in 2004.Approximately $1.0 million of this increase is related to operating expenses ofthe companies acquired during 2005. In addition, this increase is primarilydriven by an increase in bad debt expense of $0.8 million, an increase inconsulting expenses of $0.5 million primarily related to preparation forcompliance with Section 404 of the Sarbanes-Oxley Act, an increase inbilling expenses of $0.5 million and an increase in legal expenses of $0.4million. The increase in bad debt expense is primarily associated with theconversion and outsourcing of our billing function which has resulted in atemporary delay in late notices, disconnect notices and non-pay disconnects atsome of the converted companies.

*Depreciationand amortization.**  *Depreciationand amortization expense increased $0.8 million to $12.9 million in2005.

*Stock-basedcompensation.**  *Forthe three months ended September 30, 2005, stock-based compensationassociated with the award of restricted stock, restricted units and restrictedstock units was $0.6 million. During the three months ended September 30,2004, stock-based compensation associated with restricted stock units was$45,000.

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*Incomefrom operations.**  *Incomefrom operations decreased $4.4 million to $14.6 million in 2005 from$19.0 million in 2004. This was driven principally by the increasedpercentage of lower margin unregulated revenues in our total business mix dueto DSL and long distance revenue growth, which offset higher margin regulatedrevenues. In addition to the increase in unregulated products, we haveexperienced declines in Universal Service Fund and intrastate revenues whichhave significantly higher margins and we have also experienced an increase inoperating expenses.

*Otherincome (expense).**  *Totalother expense decreased $16.2 million to $6.9  million in 2005 from $23.2 million in2004. Interest expense decreased $16.1 million to $10.0 million in2005, mainly attributable to the transactions which substantially de-leveragedus and provided a decrease in interest expense. In addition, our series Apreferred stock was repurchased which eliminated dividends and accretion on ourseries A preferred stock for the three months ended September 30,2005, which under Statement of Financial Accounting Standards No. 150, orSFAS No. 150, were being reported as interest expense.

*Incometax (expense) benefit.**  *Incometax expense of $3.5 million was recorded for the three months ended September 30,2005. The higher tax expense in 2005 resulted primarily from taxable incomeduring the third quarter of 2005 versus losses incurred in prior periods. Ouraccounting policy is to report income tax expense for interim reporting periodsusing an estimated annual effective income tax rate. However, the effects ofsignificant or unusual items are not considered in the estimated annualeffective tax rate. The tax effect of such events is recognized in the interimperiod in which the event occurs. The effective rate, exclusive of unusualitems, for the nine months ended September 30, 2005 is higher than theanticipated statutory federal and state rates due to the dividends andaccretion on our series A preferred stock which are non-deductible for taxpurposes. During the three months ended September 30, 2004, income taxexpense was $0.1 million related primarily to income taxes owed in certainstates.

*Net income (loss).**  *Net income was $4.2 millionfor the three months ended September 30, 2005 as compared to a loss of$4.2 million for the three months ended September 30, 2004. Thedifferences between 2005 and 2004 are a result of the factors discussed above.

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**NineMonths Ended September 30, 2005 Compared with Nine Months Ended September 30,2004**

| ** **                                               | ** ** | **Nine months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                               | ** ** | **2005**                                            | ** ** | **% of revenue**                          | ** ** | **2004** | ** ** | **% of revenue** | ** ** |
| Revenues                                                 |       | $                                                   | 192,909    |                                                |       | 100.0 | % |   | $ | 188,838 |   |   | 100.0 | % |   |
| Operating expenses                                       |       | 104,575                                             |       |                                                | 54.2       | % |   | 96,355 |   |   | 51.0 | % |   |
| Depreciation and  amortization                           |       | 39,063                                              |       |                                                | 20.2       | % |   | 36,876 |   |   | 19.5 | % |   |
| Stock based  compensation                                |       | 1,659                                               |       |                                                | 0.9        | % |   | 133 |   |   | 0.1 | % |   |
| Total operating  expenses                                |       | 145,297                                             |       |                                                | 75.3       | % |   | 133,364 |   |   | 70.6 | % |   |
| Income from  operations                                  |       | 47,612                                              |       |                                                | 24.7       | % |   | 55,474 |   |   | 29.4 | % |   |
| Net (loss) gain on sale of investments and other  assets |       | (199                                                | )          |                                                | (0.1       | )% |   | (240 | ) |   | (0.1 | )% |   |
| Interest and  dividend income                            |       | 1,670                                               |       |                                                | 0.9        | % |   | 1,330 |   |   | 0.7 | % |   |
| Interest expense                                         |       | (36,584                                             | )          |                                                | (19.0      | )% |   | (77,698 | ) |   | (41.2 | )% |   |
| Equity in net earnings  of investees                     |       | 8,168                                               |       |                                                | 4.2        | % |   | 7,929 |   |   | 4.2 | % |   |
| Realized and  unrealized losses on interest rate swaps   |       | —                                              |       |                                                | —     |   |   | (112 | ) |   | (0.1 | )% |   |
| Other non-operating,  net                                |       | (87,746                                             | )          |                                                | (45.5      | )% |   | — |   |   | — |   |   |
| Total other expense                                      |       | (114,691                                            | )          |                                                | (59.5      | )% |   | (68,791 | ) |   | (36.5 | )% |   |
| Loss from continuing operations before income taxes      |       | (67,079                                             | )          |                                                | (34.8      | )% |   | (13,317 | ) |   | (7.1 | )% |   |
| Income tax  benefit (expense)                            |       | 87,915                                              |       |                                                | 45.6       | % |   | (279 | ) |   | (0.1 | )% |   |
| Minority interest  in income of subsidiaries             |       | (2                                                  | )          |                                                | (0.0       | )% |   | (1 | ) |   | (0.0 | )% |   |
| Income (loss)  from continuing operations                |       | 20,834                                              |       |                                                | 10.8       | % |   | (13,597 | ) |   | (7.2 | )% |   |
| Income from discontinued operations                      |       | —                                              |       |                                                | —     |   |   | 671 |   |   | 0.4 | % |   |
| Net income (loss)                                        |       | $                                                   | 20,834     |                                                |       | 10.8 | % |   | $ | (12,926 | ) |   | (6.8 | )% |   |

 

**Revenues**

*Revenues.**  *Revenues increased$4.1 million to $192.9 million in 2005 compared to$188.8 million in 2004. We derived our revenues from the followingsources:

*Localcalling services.**  *Localcalling service revenues increased $0.9 million for the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. Excluding theimpact of acquired companies, local calling services revenues increased $0.3million compared to 2004. Voice access lines increased 2.0% from September 30,2004. Voice access lines, excluding acquired lines, decreased 1.9% from September 30,2004. Also impacting local calling service revenues was the implementation ofBasic Service Calling Areas in Maine which changes and expands basic servicecalling areas and has the effect of shifting revenues from intrastate access tolocal service.

*UniversalService Fund high cost loop.**  *Universal Service Fund high cost loop receiptsdecreased $2.6 million to $14.5 million in 2005 from$17.1 million in 2004. The national average cost per loop in relation toour average cost per loop has increased and, as a result, our receipts from theUniversal Service Fund have declined. We expect that this trend will continueas we anticipate the national average cost per loop will likely continue toincrease in relation to our average cost per loop.

*Interstateaccess revenues.**  *Interstateaccess revenues increased $2.6 million to $54.7 million for the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004. Excluding the impact of acquired companies, interstate access revenuesincreased $1.7 million compared to 2004. This increase is primarily due to anincrease in revenue settlements and adjustments related to prior years of $1.9million.

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*Intrastateaccess revenues.**  *Intrastateaccess revenues for the nine months ended September 30, 2005 decreased$2.0 million to $29.8 million. Excluding the impact of acquiredcompanies, intrastate access revenues decreased $2.4 million compared to 2004. Thedecrease was mainly attributed to declines in total minutes of use combinedwith rate reductions implemented in Maine that effectively shifted revenues tolocal calling services.

*Longdistance services.**  *Longdistance services revenues increased $1.9 million for the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004. This increase is attributable to the increase in subscribers and minutesrelated to bundles and packages sold to our existing customers. Interstate longdistance penetration as of September 30, 2005 was 42.3% of voice accesslines as compared to 36.0% as of September 30, 2004.

*Dataand Internet services.**  *Dataand Internet services revenues increased $4.2 million from$13.6 million in 2004 to $17.8 million in 2005. This increase is dueprimarily to increases in high speed data customers as we continue toaggressively market our broadband services. Our high speed data subscribersincreased from 33,007 as of September 30, 2004 to 43,020 as of September 30,2005 and represents a 17.3% penetration of voice access lines.

*Other services.**  *Other services revenues declined$0.9 million for the nine months ended September 30, 2005 compared tothe nine months ended September 30, 2004. Excluding the impact of acquiredcompanies, other services revenues decreased $1.7 million compared to 2004. Theprimary reason for this decrease was a $1.2 million one-time sale and installationof E911 system equipment in the third quarter of 2004. In addition,contributing to the decrease are reductions in billing and collections revenuesas interexchange carriers continue to take back the billing function for theirmore significant long distance customers. We expect this trend to continue.

**Operating Expenses**

*Operatingexpenses, excluding depreciation and amortization.**  *Operating expenses increased$8.2 million to $104.6 million in 2005 from $96.4 million in2004. The increase in operating expenses is due primarily to an increase inconsulting fees of $2.0 million primarily related to preparation for compliancewith Section 404 of the Sarbanes-Oxley Act, an increase in expensesrelated to high speed data and long distance services of $1.8 million drivenprincipally by the increase in our high speed data initiatives and longdistance revenue growth, a $1.6 million increase in expenses due to theBerkshire acquisition and the Bentleyville acquisition, an increase in bad debtexpense of $1.2 million, an increase in billing expenses of $1.2 million and anincrease in employee expenses of $0.5 million. The increase in billing expensesof $1.2 million relates to the conversion and outsourcing of our billingfunction. The increase in bad debt expense also relates to the billingconversion which resulted in a temporary delay in late notices, disconnectnotices and non-pay disconnects at some of the converted companies.

*Depreciationand amortization.**  *Depreciationand amortization increased $2.2 million to $39.1 million in 2005 from$36.9 million in 2004.

*Stockbased compensation.**  *Forthe nine months ended September 30, 2005, stock-based compensationassociated with the award of restricted stock, restricted units and restrictedstock units increased $1.5 million compared to the nine months ended September 30,2004.

*Incomefrom operations.**  *Incomefrom operations decreased $7.9 million to $47.6 million in 2005. Thiswas driven principally by the increased percentage of lower margin unregulatedrevenues in our total business mix due to DSL and long distance revenue growth,which offset higher margin regulated revenues. In addition to the increase inunregulated products, we have experienced declines in Universal Service Fundand intrastate revenues which have significantly higher margins and haveexperienced an increase in operating expenses.

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*Otherincome (expense).**  *Totalother expense increased $45.9 million to $114.7 million in 2005.Interest expense decreased $41.1 million to $36.6 million in 2005,mainly attributable to the transactions which substantially de-leveraged us andprovided a decrease in interest expense. In addition, our series Apreferred stock was repurchased which also eliminated dividends and accretionon our series A preferred stock for the nine months ended September 30,2005, which under SFAS 150 were being reported as interest expense. Therefinancing of our old credit facility and the repurchase and/or redemption ofthe 91¤2%notes, floating rate notes, 121¤2%notes and 117¤8%notes resulted in significant charges of $87.7 million due to fees andpenalties paid on the repurchase/redemption and for the write-off ofunamortized debt issuance costs.

*Incometax (expense) benefit.**  *Incometax benefits of $20.3 million were recorded primarily due to the taxableloss in the nine months ended September 30, 2005, driven by the expensesincurred from the transactions. In addition, we reported income tax benefits of$66.0 million from the recognition of deferred tax benefits from thereversal of the deferred tax valuation allowance resulting from the Company’sexpectation of generating future taxable income following the transactions.During the nine months ended September 30, 2004, the income tax expenserelated primarily to income taxes owed in certain states. Our accounting policyis to report income tax expense for interim reporting periods using an estimatedannual effective income tax rate. However, the effects of significant orunusual items are not considered in the estimated annual effective tax rate.The tax effect of such events is recognized in the interim period in which theevent occurs. The tax rate for the nine months ended September 30, 2005was approximately 131.1%. The tax rate increased from the same period in 2004primarily as a result of unusual items occurring during the first nine monthsof 2005, which included a reduction of the valuation allowance for deferred taxassets of $66.0 million and deferred tax benefits of $29.3 millionrelated to the extinguishment of debt. The income tax benefit for 2005 alsoincludes $1.6 million for an adjustment of our net deferred tax assets toan expected federal income tax rate of 35% from 34%, in anticipation of higherlevels of taxable income in subsequent periods. During the nine months ended September 30,2004, income tax expense was $0.3 million related primarily to incometaxes owed in certain states. Exclusive of unusual items affecting the taxrate, we are anticipating an effective annual tax rate of 43.2% for 2005, whichis higher due primarily to certain non-deductible items.

*Net income (loss).**  *Net income was $20.8 millionfor the nine months ended September 30, 2005 as compared to a loss of$12.9 million for the nine months ended September 30, 2004. Thedifferences between 2005 and 2004 are a result of the factors discussed above.

**Liquidity and Capital Resources**

Our short-term and long-term liquidity needs ariseprimarily from: (i) interest payments, which are expected to beapproximately $41.0 to $43.0 million in 2005 taking into account ourcapital structure costs before and after the transactions (including interestrate swap agreements), primarily related to our credit facility; (ii) capitalexpenditures, which are expected to be approximately $27.0 to$28.0 million in 2005; (iii) working capital requirements as may beneeded to support the growth of our business; (iv) dividend payments on ourcommon stock; and (v) potential acquisitions.

On September 21, 2005, the Company declared adividend of $0.39781 per share of common stock, which was paid on October 19,2005 to holders of record as of October 3, 2005. In 2005, the Company haspaid dividends totaling $35.3 million, or $1.02105 per share of common stock. Inaccordance with our dividend policy, we currently intend to continue to payquarterly dividends at an annual rate of $1.59125 per share for the four fiscalquarters ending March 31, 2006. However, we are not required to paydividends, and our board of directors may modify or revoke our dividend policyat any time. Dividend payments are within the sole discretion of our board ofdirectors and will depend upon, among other things, our results of operations,our financial condition, future developments that could differ materially 

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from our currentexpectations, including competitive or technological developments (which could,for example, increase our need for capital expenditures), acquisitionopportunities or other factors.

We expect to fund our operations, interest expense,capital expenditures and dividend payments on our common stock for the nexttwelve months principally from cash from operations. To fund futureacquisitions, we intend to use cash from operations and borrowings under ourcredit facility, or, subject to the restrictions in our credit facility, toarrange additional funding through the sale of public or private debt and/orequity securities, or obtain additional senior bank debt.

For the nine months ended September 30, 2005 and2004, cash provided by operating activities of continuing operations was $38.8million and $32.9 million, respectively. As a result of the transactionswhich substantially de-leveraged us, accrued interest balances were reduced by$16.4 million, resulting in a significant use of cash from operatingactivities for the nine months ended September 30, 2005.

Our ability to service our indebtedness depends on ourability to generate cash in the future. We are not required to make anyscheduled principal payments under our credit facility’s term facility prior tomaturity in February 2012. We will need to refinance all or a portion ofour indebtedness on or before maturity. We may not be able to refinance ourindebtedness on commercially reasonable terms or at all. If we were unable torenew or refinance our credit facility, our failure to repay all amounts due onthe maturity date would cause a default under our credit facility. In addition,borrowings under our credit facility bear interest at variable interest rates.On February 8, 2005, we entered into three interest rate swap agreements,with notional amounts of $130 million each, to effectively convert a portion ofour variable rate interest exposure to fixed rates ranging from 3.76% to 4.11%,plus a 2.0% margin. These swap agreements expire beginning December 31,2007 through December 31, 2009. On April 7, 2005, we entered into twoadditional interest rate swap agreements, one with the notional amount of $50.0million to effectively convert a portion of our variable rate interest exposureto a fixed rate of 4.69%, plus a 2% margin, beginning on April 29, 2005and ending on March 31, 2011, and one with the notional amount of $50.0million to effectively convert a portion of our variable rate interest exposureto a fixed rate of 4.72%, plus a 2% margin, beginning on June 30, 2005 andending on March 31, 2012.

Effective on September 30, 2005, we amended ourcredit facility to reduce the effective interest rate margins on the $588.5million term facility by 0.25% to 1.75% on Eurodollar loans and to 0.75% forBase rate loans. This amendment also effectively reduced the fixed interestrates on our interest rate swap agreements by 0.25%.

As a result of these swap agreements, as of September 30,2005, approximately 81% of our indebtedness bore interest at fixed rates ratherthan variable rates. After these interest rate swap agreements expire, ourannual debt service obligations on such portion of the term loans will varyfrom year to year unless we enter into a new interest rate swap or purchase aninterest rate cap or other interest rate hedge. To the extent interest ratesincrease in the future, we may not be able to enter into new interest rateswaps or to purchase interest rate caps or other interest rate hedges onacceptable terms.

Based on the dividendpolicy with respect to our common stock, we may not have any significant cashavailable to meet any unanticipated liquidity requirements, other thanavailable borrowings, if any, under our revolving facility. As a result, we maynot retain a sufficient amount of cash to finance growth opportunities,including acquisitions, or unanticipated capital expenditures or to fund ouroperations. If we do not have sufficient cash for these purposes, our financialcondition and our business will suffer. However, our board of directors may, inits discretion, amend or repeal the dividend policy to decrease the level ofdividends provided for or discontinue entirely the payment of dividends.

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We used netproceeds received from the offering, together with approximately$566.0 million of borrowings under the term facility of our creditfacility, to, among other things, repay all outstanding loans under our oldcredit facility, repurchase all of our series A preferred stock andconsummate tender offers and consent solicitations in respect of ouroutstanding 91¤2%notes, floating rate notes, 121¤2%notes and 117¤8%notes. On March 10, 2005, we redeemed the remaining outstanding 91¤2%notes and floating rate notes. On May 2, 2005, we redeemed the remainingoutstanding 121¤2%notes with borrowings of $22.4 million under the delayed draw facility ofour credit facility.

Net cash used in investing activities from continuingoperations was $36.8 million and $12.1 million for the nine monthsended September 30, 2005 and 2004, respectively. These cash flowsprimarily reflect net capital expenditures of $17.9 million and$24.0 million for the nine months ended September 30, 2005 and 2004,respectively, and acquisitions of telephone properties, net of cash acquired,of $25.7 million for the nine months ended September 30, 2005. Offsettingcapital expenditures were distributions from investments of $7.3 millionand $11.8 million for the nine months ended September 30, 2005 and2004, respectively. The $11.8 million received in 2004 included a one time$2.5 million distribution from our equity interest in Chouteau CellularTelephone Company as the partnership sold the majority of its assets. Inaddition, distributions for the nine months ended September 30, 2004included $8.9 million from our equity interest in Orange County PoughkeepsieLimited Partnership as compared to $6.7 million during the nine months ended September 30,2005. The distributions declined mainly due to the timing of an additionaldistribution in 2004. All of these distributions represent passive ownershipinterests in partnership investments. We do not control the timing or amount ofdistributions from such investments.

On August 4, 2005 the Board of Directors of theRural Telephone Bank, or RTB, approved the liquidation and dissolution of theRTB, pending action by Congress in its 2006 Appropriations Act to remove anylegal restrictions to the redemption of the RTB’s Class A Stock. As partof any such liquidation and dissolution, all RTB loans will be transferred tothe Rural Utilities Service and all of the RTB’s Class A Stock, Class BStock and Class C Stock will be redeemed at par value. We have nooutstanding loans with the RTB, but we own 2,301,834 shares of Class BStock and 24,380 shares of Class C Stock. Our current carrying value ofthe RTB investment is $22.8 million, which is less than the par value of thestock.  Assuming appropriate approval byCongress, payment for the redeemed stock is expected to occur within 180 daysafter such Congressional action. We have historically received dividends ofapproximately $1.4 million per year from our investment in the RTB, which weexpect to continue in 2005 but not thereafter if the dissolution is approved.

Net cash provided by financing activities fromcontinuing operations was $0.1 million for the nine months ended September 30,2005. Net cash used in financing activities from continuing operations was$18.9 million for the nine months ended September 30, 2004. For thenine months ended September 30, 2005, net proceeds from the issuance ofcommon stock of $431.9 million was used for the net repayment of long termdebt of $202.7 million and the repurchase of preferred and common stock of$129.3 million. Remaining proceeds were used to pay fees and penaltiesassociated with the early retirement of long term debt of $61.0 million,to pay a deferred transaction fee of $8.4 million and pay debt issuancecosts of $9.1 million. For the nine months ended September 30, 2004,these cash flows primarily represent net repayment of long term debt of$12.2 million.

Our annual capital expenditures for our ruraltelephone operations have historically been significant. Because existingregulations allow us to recover our operating and capital costs, plus areasonable return on our invested capital in regulated telephone assets,capital expenditures generally constitute an attractive use of our cash flow.Net capital expenditures were approximately $17.9 million for the ninemonths ended September 30, 2005.

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On May 2, 2005, we used borrowings under ourcredit facility’s revolving facility to fund the Berkshire acquisition(including the repayment of $1.3 million of Berkshire’s debt). On September 1,2005, we used borrowings under our credit facility’s revolving facility to fundthe Bentleyville acquisition.

Our old credit facility consisted of an$85.0 million revolving loan facility, of which $45.0 million was availableat December 31, 2004, and two term facilities, a tranche A term loanfacility of $40.0 million with $40.0 million outstanding at December 31,2004 that was to mature on March 31, 2007 and a tranche C term loanfacility with $102.4 million outstanding as of December 31, 2004 thatwas to mature on March 31, 2007. We repaid all of the borrowings under ourold credit facility with a portion of net proceeds from the offering togetherwith borrowings under our credit facility.

Our credit facility consists of a $100.0 millionrevolving facility, of which $78.8 million was available at November 8,2005, that matures in February 2011 and a term facility of$588.5 million with $588.5 million outstanding at November 8,2005 that matures in February 2012. Net borrowings under the revolvingfacility were $20.0 million from February 8, 2005 through November 8,2005 and were used primarily to fund the Berkshire acquisition and theBentleyville acquisition (including the repayment of $1.3 million ofBerkshire’s debt). A $1.2 million letter of credit was also outstanding asof November 8, 2005. On March 11, 2005, April 29, 2005 and September 14,2005, we entered into technical amendments to our credit facility.

In 1998, the Company issued $125.0 millionaggregate principal amount of the 91¤2 % notes and$75.0 million aggregate principal amount of the floating rate notes. Bothseries of these notes were to mature on May 1, 2008. On February 9,2005, we repurchased $115.0 million principal amount of the 91¤2% notes and$50.8 million principal amount of the floating rate notes tenderedpursuant to the tender offers for such notes. We redeemed the remainingoutstanding 91¤2%notes and floating rate notes on March 10, 2005.

In 2000, the Company issued $200.0 millionaggregate principal amount of the 121¤2% notes. Thesenotes were to mature on May 10, 2010. On February 9, 2005, werepurchased $173.1 million principal amount of the 121¤2% notestendered pursuant to the tender offer for such notes. We redeemed the remainingoutstanding 121¤2%notes on May 2, 2005.

In 2003, the Company issued $225.0 millionaggregate principal amount of the 117¤8% notes. Thesenotes were to mature on March 1, 2010. These notes are general unsecuredobligations of the Company, ranking *paripassu* in right of payment with all existing and future senior debtof the Company, including all obligations under our credit facility, and seniorin right of payment to all existing and future subordinated indebtedness of theCompany. On February 9, 2005, we repurchased $223.0 million principalamount of the 117¤8%notes tendered pursuant to the tender offer for such notes. $2.1 millionprincipal amount of the 117¤8%notes remains outstanding.

For a summary descriptionof our credit facility and the 117¤8% notes, see “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Description of Certain Indebtedness” in our Annual Report on Form 10-Kfor the year ended December 31, 2004.

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**Summary of Contractual Obligations**

The tables setforth below contain information with regard to disclosures about contractualobligations and commercial commitments.

Thefollowing table discloses aggregate information about our contractualobligations as of September 30, 2005 and the periods in which payments aredue: 

| ** **                          | ** ** | **Payments due by period** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| ** **                          | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)**      | ** ** |
| Contractual obligations:            |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Debt maturing within one year       |       | $                                         | 668        |   |   | $ | 668 |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | — |   |
| Long term debt                      |       | 609,790                                   |       |   | — |   |   |   | 1,448 |   |   |   | 2,504 |   |   | 605,838 |   |
| Operating leases(1)                 |       | 11,088                                    |       |   | 3,054 |   |   |   | 4,141 |   |   |   | 1,468 |   |   | 2,425 |   |
| Non-compete agreements              |       | 55                                        |       |   | 20 |   |   |   | 35 |   |   |   | — |   |   | — |   |
| Minimum purchase contract           |       | 5,072                                     |       |   | 4,664 |   |   |   | 408 |   |   |   | — |   |   | — |   |
| Total contractual  cash obligations |       | $                                         | 626,673    |   |   | $ | 8,406 |   |   |   | $ | 6,032 |   |   |   | $ | 3,972 |   |   | $ | 608,263 |   |

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(1)          Real property leaseobligations of $3.9 million associated with the discontinued operationsdiscussed in note (6) to our condensed consolidated financialstatements are stated in this table at total contractual amounts. However, wehave negotiated lease terminations or subleases on these properties to reducethe total obligation. Operating leases from continuing operations of$7.2 million are also included.

Thefollowing table discloses aggregate information about our derivative financialinstruments as of September 30, 2005, the source of fair value of theseinstruments and their maturities. 

| ** **                           | ** ** | **Fair Value of Contracts at Period-End** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Total**                                                          | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)**                               | ** ** |
| Source of fair  value:               |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Derivative  financial instruments(1) |       | $                                                                  | 5,928      |   |   | 1,585 |   |   |   | 3,554 |   |   |   | 786 |   |   |   | 3 |   |   |
|                                      |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Fairvalue of interest rate swaps at September 30, 2005 was provided by thecounterparties to the underlying contracts using consistent methodologies.

**Critical Accounting Policies**

Our criticalaccounting policies are as follows:

·       Revenuerecognition;

·       Allowancefor doubtful accounts;

·       Accountingfor income taxes; and

·       Valuationof long-lived assets, including goodwill.

***Revenuerecognition.******  ***Certain of our interstate networkaccess and data revenues are based on tariffed access charges filed directlywith the Federal Communications Commission; the remainder of such revenues arederived from revenue sharing arrangements with other local exchange carriersadministered by the National Exchange Carrier Association.

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The Telecommunications Act allows local exchangecarriers to file access tariffs on a streamlined basis and, if certain criteriaare met, deems those tariffs lawful. Tariffs that have been “deemed lawful” ineffect nullify an interexchange carrier’s ability to seek refunds should theearnings from the tariffs ultimately result in earnings above the authorizedrate of return prescribed by the Federal Communications Commission. Certain ofthe Company’s telephone subsidiaries file interstate tariffs directly with theFederal Communication Commission using this streamlined filing approach. Thesettlement period related to (i) the 2003 to 2004 monitoring period lapseson September 30, 2007 and (ii) the 2005 to 2006 monitoring periodlapses on September 30, 2009. We will continue to monitor the legal statusof any pending or future proceedings that could impact our entitlement to thesefunds, and may recognize as revenue some or all of the over-earnings at the endof the settlement period or as the legal status becomes more certain.

***Allowance fordoubtful accounts.******  ***In evaluating the collectibilityof our accounts receivable, we assess a number of factors, including a specificcustomer’s or carrier’s ability to meet its financial obligations to us, thelength of time the receivable has been past due and historical collectionexperience. Based on these assessments, we record both specific and generalreserves for uncollectible accounts receivable to reduce the related accountsreceivable to the amount we ultimately expect to collect from customers andcarriers. If circumstances change or economic conditions worsen such that ourpast collection experience is no longer relevant, our estimate of therecoverability of our accounts receivable could be further reduced from thelevels reflected in our accompanying consolidated balance sheet.

***Accounting forincome taxes.******  ***As part of the process of preparingour consolidated financial statements we are required to estimate our incometaxes. This process involves estimating our actual current tax exposure andassessing temporary differences resulting from different treatment of items fortax and accounting purposes as well as estimating an annual effective tax ratefor purposes of allocating income tax expense to interim periods. Thesedifferences result in deferred tax assets and liabilities, which are includedwithin our consolidated balance sheets. We must then assess the likelihood thatour deferred tax assets will be recovered from future taxable income and to theextent we believe the recovery is not likely, we must establish a valuationallowance. Further, to the extent that we establish a valuation allowance orincrease this allowance in a financial accounting period, we must include a taxprovision, or reduce our tax benefit in our consolidated statement ofoperations. In performing the assessment, management considers the scheduledreversal of deferred tax liabilities, projected future taxable income, and taxplanning strategies. We use our judgment to determine our provision or benefitfor income taxes, deferred tax assets and liabilities and any valuationallowance recorded against our net deferred tax assets.

There are various factors that may cause those taxassumptions to change in the near term. We cannot predict whether future U.S.federal income tax laws and regulations might be passed that could have amaterial effect on our results of operations. We assess the impact ofsignificant changes to the U.S. federal and state income tax laws andregulations on a regular basis and update the assumptions and estimates used toprepare our financial statements when new regulation and legislation isenacted.

We had $251.9 million in federal and state netoperating loss carry forwards as of December 31, 2004. On February 8,2005, we completed the offering which resulted in an “ownership change” withinthe meaning of the U.S. federal income tax laws addressing net operating losscarry forwards, alternative minimum tax credits and other similar taxattributes. As a result of such ownership change, there will be specificlimitations on our ability to use our net operating loss carry forwards andother tax attributes. In addition, as a result of the offering, we havesubstantially reduced our aggregate long term debt and expect a significantreduction in our annual interest expense. When considered together with ourhistory of producing positive operating results and other evidence affectingthe recoverability of deferred tax assets, we expect that future taxable incomewill more likely than not be sufficient to recover net deferred tax assets. Wehave analyzed both positive and negative evidence and have concluded that thetransactions resulted in a significant change in circumstances that results inpositive evidence to support that it is more 

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likely than not that thedeferred tax asset will be utilized in the future, prior to the expiration ofthe net operating loss carryforwards. In order to fully realize the deferredtax assets, we will need to generate future taxable income of approximately$250 million prior to the expiration of the net operating losscarryforwards in 2024. Current projections indicate that the net operatinglosses will be fully utilized by 2011.

***Valuation of long-lived assets, including goodwill.******  ***We review ourlong-lived assets, including goodwill for impairment whenever events or changesin circumstances indicate that the carrying value may not be recoverable.Several factors could trigger an impairment review such as:

·       significantunderperformance relative to expected historical or projected future operatingresults;

·       significantregulatory changes that would impact future operating revenues;

·       significantnegative industry or economic trends; and

·       significantchanges in the overall strategy in which we operate our overall business.

Goodwill was $480.3 million at September 30,2005. As part of the Berkshire and Bentleyville acquisitions, the Company hasrecorded intangible assets related to the acquired companies’ customerrelationships of $2.4 million and $1.4 million, respectively. These intangibleassets will be amortized over 15 years. The intangible assets are included inDeferred Charges and Other Assets on the Condensed Consolidated Balance Sheet.

We are required to performan annual impairment review of goodwill as required by Statement of FinancialAccounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets.No impairment of goodwill or other long-lived assets resulted from the annualvaluation of goodwill.

**New Accounting Standards**

In December 2004, the FASB issued SFAS No. 123(R).This new standard requires companies to adopt the fair value methodology ofvaluing stock-based compensation and recognize that valuation in thefinancial statements from the date of grant. The adoption of SFAS No. 123(R)’sfair value method is not expected to have an adverse impact on our income fromoperations. The impact of the adoption of SFAS No. 123(R) cannot bepredicted at this time because it will partially depend on levels of share-basedpayments granted in the future. However, had we adopted SFAS No. 123(R) inprior periods, the impact of that standard would have approximated the impactof SFAS No. 123 as shown in the Stock-Based Compensation table(see Note 4). SFAS No. 123(R) also requires the benefits oftax deductions in excess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow as required undercurrent literature. We expect to elect to adopt the provisions of SFAS No. 123(R) ona modified prospective application method effective January 1, 2006, withno restatement of any prior periods. SFAS No. 123(R) is effective forus as of the beginning of the first annual reporting period that begins after June 15,2005.

In March 2005, theFASB issued FIN 47, “Accounting for Conditional Asset Retirement Obligations,”an interpretation of FASB No. 143. FIN 47 clarifies that the termconditional asset retirement obligation as used in FASB No. 143 refers toa legal obligation to perform an asset retirement activity in which the timingor method of settlement are conditional on a future event that may or may notbe within the control of the entity. FIN 47 also clarifies when an entity wouldhave sufficient information to reasonably estimate the fair value of an assetretirement obligation. FIN 47 is effective for the year ended December 31,2005. Accordingly, we will adopt FIN 47 during the fourth quarter of 2005. Wehave not yet determined the impact of the adoption of this interpretation onour financial position, results of operations and cash flows.

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**Inflation**

We do not believeinflation has a significant effect on our operations.

**Item 3. Quantitative and Qualitative Disclosures aboutMarket Risk.**

As of September 30, 2005, approximately 81% ofour indebtedness bore interest at fixed rates or effectively at fixed rates.Our earnings are affected by changes in interest rates as our long-termindebtedness under our credit facility has variable interest rates based oneither the prime rate or LIBOR. If interest rates on our variable rateindebtedness (excluding variable rate indebtedness which has its interest rateeffectively fixed under interest rate swap agreements) outstanding at September 30,2005 increased by 10%, our interest expense would have increased, and ourincome from continuing operations before taxes would have decreased, byapproximately $0.3 million for the nine months ended September 30,2005.

We have entered into interest rate swaps to manage ourexposure to fluctuations in interest rates on our variable rate indebtedness.The fair value of these swaps was a net asset of approximately$5.9 million at September 30, 2005. The fair value indicates anestimated amount we would have paid to cancel the contracts or transfer them toother parties. In connection with our credit facility, on February 8,2005, we entered into three interest rate swap agreements, with notionalamounts of $130.0 million each, to effectively convert a portion of ourvariable interest rate exposure to fixed rates ranging from 3.76% to 4.11%,plus a 2.0% margin. These swap agreements expire beginning December 31,2007 through December 31, 2009. On April 7, 2005, we entered into twoadditional interest rate swap agreements, one with the notional amount of$50.0 million which will fix the interest rate at 4.69%, plus a 2.0%margin beginning on April 29, 2005 and ending on March 31, 2011 andone with the notional amount of $50.0 million which will fix the interestrate at 4.72%, plus a 2.0% margin, beginning on June 30, 2005 and endingon March 31, 2012.

Our Annual Report on Form 10-Kfor the year ended December 31, 2004 contains information about marketrisks under “Item 7A. Quantitative and Qualitative Disclosures about MarketRisk.”

**Item 4. Controls and Procedures.**

As of the end of the period covered by this QuarterlyReport, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of our “disclosure controls andprocedures” (as defined in Rule 13a-15(e) of the Exchange Act).Disclosure controls and procedures are controls and other procedures of anissuer that are designed to ensure that information required to be disclosed bythe issuer in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the SEC.

Based upon this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that our disclosure andcontrol procedures were effective in ensuring that information required to bedisclosed by us in this Quarterly Report has been timely recorded, processed,summarized and reported within the time periods specified in the rules ofthe SEC.

There have been no changes in our “internal controlsover financial reporting” (as defined in Rule 3a-15(f) of theExchange Act) during the period covered by this Quarterly Report that havematerially affected, or that are reasonably likely to materially affect, ourinternal controls over financial reporting. In response to the Sarbanes-OxleyAct, we are continuing a comprehensive review of our disclosure controls andprocedures and will improve such controls and procedures as necessary to assuretheir effectiveness.

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**PART II—OTHER INFORMATION**

**Item 1. Legal Proceedings.**

On June 6, 2005, a purported class actioncomplaint was filed in the General Court of Justice, Superior Court Division,of the State of North Carolina by Robert Lowinger on behalf of himself and allother similarly situated persons against the Company, the Company’s Chairmanand Chief Executive Officer, certain of the Company’s current and formerdirectors and certain of the Company’s stockholders. The complaint allegesviolations of Sections 11 and 12(a)(2) and liability under Section 15of the Securities Act, and alleges that the Company’s registration statement onForm S-1 (which was declared effective by the SEC on February 3,2005) and the related prospectus dated February 3, 2005, each relating tothe Company’s initial public offering of common stock, contained certainmaterial misstatements and omitted certain material information necessary to beincluded relating to the Company’s broadband products and access line trends.The plaintiff, who has been a plaintiff in several prior securities cases,seeks rescission rights and unspecified damages on behalf of a purported classof purchasers of the common stock “issued pursuant and/or traceable to theCompany’s IPO during the period from February 3, 2005 through March 21,2005”. The Company removed the action to Federal Court. The plaintiff filed amotion to remand the action to the North Carolina State Court, which was deniedby the Federal Magistrate. The plaintiff has objected to and appealed theMagistrate’s decision to the District Court Judge. The Company will contest theappeal. The Company believes that the complaint is without merit and intends tocontinue to defend the litigation vigorously.

We currently and from timeto time are involved in other litigation and regulatory proceedings incidentalto the conduct of our business, but currently we are not a party to any lawsuitor proceeding which, in our opinion, is likely to have a material adverseeffect on us.

**Item 2. Unregistered Sales of Equity Securities andUse of Proceeds.**

**UnregisteredSales of Equity Securities**

We did not sell anyunregistered equity securities during the quarter ended September 30,2005.

**Restrictionson Payment of Dividends**

Under Delaware law, our board of directors may declaredividends only to the extent of our “surplus” (which is defined as total assetsat fair market value minus total liabilities, minus statutory capital) or, ifthere is no surplus, out of our net profits for the then current and/orimmediately preceding fiscal year.

Our credit facilityrestricts our ability to declare and pay dividends on our common stock asfollows:

·       Wemay use all of our available cash accumulated after April 1, 2005 pluscertain incremental funds to pay dividends, but we may not in general paydividends in excess of such amount. “Available cash” is defined in our creditfacility as Adjusted EBITDA (a) minus (i) interest expense, (ii) repaymentsof indebtedness (unless funded by debt or equity), (iii) capitalexpenditures (unless funded by long-term debt, equity or the proceeds fromasset sales or insurance recovery events), (iv) cash taxes, (v) cashconsideration paid for acquisitions (unless funded by debt or equity), (vi) cashpaid to make certain investments, and (vii) certain non-cash itemsexcluded from Adjusted EBITDA and paid in cash and (b) plus certainnon-cash items excluded from Adjusted EBITDA and received in cash. “AdjustedEBITDA” is defined in our credit facility as Consolidated Net Income (which isdefined in our credit facility and includes distributions from investments) (a) plusthe following to the extent deducted from Consolidated Net Income: provisionfor income taxes, interest expense, depreciation, amortization, losses on salesof assets and other extraordinary losses, and certain other non-cash items, and(b) minus, to the extent included in Consolidated Net Income, gains onsales of assets and other extraordinary gains and all non-cash items.

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·       Wemay not pay dividends if a default or event of default under our creditfacility has occurred and is continuing or would exist after giving effect tosuch payment, if our leverage ratio is above 5.00 to 1.00 or if we donot have at least $10 million of cash on hand (including unutilizedcommitments under our credit facility’s revolving facility).

Our credit facility also permits us to use availablecash to repurchase shares of our capital stock, subject to the same conditions.

See “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Descriptionof Certain Indebtedness—Credit Facility” in our Annual Report on Form 10-Kfor the year ended December 31, 2004 for a more detailed description ofour credit facility and these restrictions.

**Item 3. Defaults Upon Senior Securities.**

Not applicable.

**Item 4. Submission of Matters to a Vote of SecurityHolders.**

Not applicable.

**Item 5. Other Information.**

Not applicable.

**Item 6. Exhibits.**

The exhibits filed as part of this Quarterly Reportare listed in the index to exhibits immediately preceding such exhibits, whichindex to exhibits is incorporated herein by reference.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this Quarterly Report to be signedon its behalf by the undersigned, thereunto duly authorized, and theundersigned also has signed this Quarterly Report in his capacity as theRegistrant’s Executive Vice President and Chief Financial Officer (PrincipalFinancial Officer). 
|                               | FAIRPOINT  COMMUNICATIONS, INC. |
|-------------------------------|--------------------------------------|
| Date: November 10,  2005 | By:                                  | /s/  JOHN P. CROWLEY |
|                          |                                 | Name: | John P. Crowley |
|                          |                                 | Title: | Executive Vice President  and Chief Financial Officer |

 

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**Exhibit Index**
| Exhibit No. | ** ** | **Description** |
|------------------|------------|-----------------|
| 2.1              |       |            | Agreement and Plan of Merger, dated as of  June 18, 2003, by and among FairPoint, MJD Ventures, Inc.,  FairPoint Berkshire Corporation and Berkshire Telephone Corporation.(1) |
| 2.2              |       |            | Agreement and Plan of  Merger, dated as of April 22, 2005, by and among FairPoint, MJD  Ventures, Inc., FairPoint Bentleyville Corporation and Bentleyville  Communications Corporation.(2) |
| 3.1              |       |            | Eighth Amended and  Restated Certificate of Incorporation of FairPoint.(3) |
| 3.2              |       |            | Amended and Restated By  Laws of FairPoint.(3) |
| 4.1              |       |            | Indenture, dated as of  March 6, 2003, by and between FairPoint and The Bank of New York,  relating to FairPoint’s $225,000,000 117¤8%  Senior Notes due 2010.(4) |
| 4.2              |       |            | Supplemental Indenture,  dated as of January 20, 2005, by and between FairPoint and The Bank of  New York, amending the Indenture dated as of March 6, 2003 between  FairPoint and The Bank of New York.(3) |
| 4.3              |       |            | Form of Initial  Senior Note due 2010.(4) |
| 4.4              |       |            | Form of Exchange  Senior Note due 2010.(4) |
| 10.1             |       |            | Credit Agreement, dated  as of February 8, 2005, by and among FairPoint, various lending  institutions, Bank of America, N.A., CoBank ACB, General Electric Capital  Corporation and Deutsche Bank Trust Company Americas.(3) |
| 10.2             |       |            | First Amendment to  Credit Agreement, dated as of March 11, 2005, among FairPoint, various  lending institutions, Bank of America, N.A., CoBank ACB, General Electric  Capital Corporation and Deutsche Bank Trust Company Americas.(3) |
| 10.3             |       |            | Second Amendment and  Consent to Credit Agreement, dated as of April 29, 2005, among  FairPoint, various lending institutions, Bank of America, N.A., CoBank ACB,  General Electric Capital Corporation and Deutsche Bank Trust Company  Americas.(5) |
| 10.4             |       |            | Third Amendment to  Credit Agreement, dated as of September 14, 2005, among FairPoint,  various lending institutions, Bank of America, N.A., CoBank ACB, General  Electric Capital Corporation and Deutsche Bank Trust Company Americas.(6) |
| 10.5             |       |            | Pledge Agreement, dated  as of February 8, 2005, by FairPoint, ST Enterprises, Ltd., FairPoint  Broadband, Inc., MJD Services Corp., MJD Ventures, Inc., C-R  Communications, Inc., Comerco, Inc., GTC Communications, Inc.,  Ravenswood Communications, Inc., Utilities, Inc., FairPoint Carrier  Services, Inc. and St. Joe Communications, Inc.(3) |
| 10.6             |       |            | Subsidiary Guaranty,  dated as of February 8, 2005, by FairPoint Broadband, Inc., MJD  Ventures, Inc., MJD Services Corp., ST Enterprises, Ltd. and FairPoint  Carrier Services, Inc.(2) |
| 10.7             |       |            | Form of Swingline  Note.(3) |
| 10.8             |       |            | Form of RF Note.(3) |
| 10.9             |       |            | Form of B Term  Note.(3) |
| 10.10            |       |            | Amended and Restated Tax  Sharing Agreement, dated as of November 9, 2000, by and among FairPoint  and its Subsidiaries.(7) |
| 10.11            |       |            | Nominating Agreement,  dated as of February 8, 2005.(3) |
| 10.12            |       |            | Affiliate Registration  Rights Agreement, dated as of February 8, 2005.(3) |

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| 10.13 |   |   | Employment Agreement,  dated as of December 31, 2002, by and between FairPoint and Eugene B.  Johnson.(4)                                         |
|-------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14 |   |   | Letter Agreement,  dated as of October 1, 2004, by and between FairPoint and Eugene B.  Johnson.(8)                                               |
| 10.15 |   |   | Agreement, dated as of  October 1, 2004, by and between FairPoint and John P. Duda.(8)                                                            |
| 10.16 |   |   | Employment Agreement,  dated as of January 20, 2000, by and between FairPoint and Walter E.  Leach, Jr.(9)                              |
| 10.17 |   |   | Letter Agreement, dated  as of December 15, 2003, by and between FairPoint and Walter E.  Leach, Jr.(10)                                     |
| 10.18 |   |   | Letter Agreement, dated  as of November 11, 2002, by and between FairPoint and Peter G. Nixon.(4)                                                 |
| 10.19 |   |   | Letter Agreement, dated  as of October 25, 2004, by and between FairPoint and Valeri A. Marks.(8)                                                 |
| 10.20 |   |   | Letter Agreement, dated  as of November 13, 2002, by and between FairPoint and Shirley J.  Linn.(4)                                               |
| 10.21 |   |   | Letter Agreement, dated  as of May 16, 2005, by and between FairPoint and John P. Crowley.(11)                                                    |
| 10.22 |   |   | FairPoint 1995 Stock  Option Plan.(12)                                                                                                                 |
| 10.23 |   |   | FairPoint Amended and  Restated 1998 Stock Incentive Plan.(12)                                                                                         |
| 10.24 |   |   | FairPoint Amended and  Restated 2000 Employee Stock Incentive Plan.(10)                                                                                |
| 10.25 |   |   | FairPoint 2005 Stock  Incentive Plan.(3)                                                                                                               |
| 10.26 |   |   | FairPoint Annual  Incentive Plan.(3)                                                                                                                   |
| 10.27 |   |   | Form of Restricted  Stock Agreement.(8)                                                                                                           |
| 10.28 |   |   | Form of Director  Restricted Stock Agreement.(13)                                                                                                 |
| 10.29 |   |   | Restricted Stock  Agreement, dated as of September 21, 2005, by and between FairPoint and  John P. Crowley.(14)                                   |
| 10.30 |   |   | Form of Director  Restricted Unit Agreement.(13)                                                                                                  |
| 21    |   |   | Subsidiaries of  FairPoint.*                                                                                                                           |
| 31.1  |   |   | Certification required  by 18 United States Code Section 1350, as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.*       |
| 31.2  |   |   | Certification required  by 18 United States Code Section 1350, as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.*       |
| 32.1  |   |   | Certification required  by 18 United States Code Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.*† |
| 32.2  |   |   | Certification required  by 18 United States Code Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.*† |
| 99.1  |   |   | Risk factors (filed as  Exhibit 99.1 to our Quarterly Report on Form 10-Q on  August 12, 2005, and incorporated herein by reference).   |

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*                    Filedherewith.

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†                    Pursuant toSecurities and Exchange Commission Release No. 33-8238, thiscertification will be treated as “accompanying” this Quarterly Report on Form 10-Qand not “filed” as part of such report for purposes of Section 18 of theSecurities Exchange Act of 1934, or otherwise subject to the liability of Section 18of the Securities Exchange Act of 1934 and this certification will not bedeemed to be incorporated by reference into any filing under the Securities Actof 1933 or the Securities Exchange Act of 1934, except to the extent that theregistrant specifically incorporates it by reference.

(1)          Incorporated byreference to the Registration Statement on Form S-4 of FairPoint,declared effective as of July 22, 2003.

(2)          Incorporated byreference to the Quarterly Report on Form 10-Q of FairPoint for thequarter ended March 31, 2005.

(3)          Incorporated byreference to the Annual Report on Form 10-K of FairPoint for theyear ended December 31, 2004.

(4)          Incorporated byreference to the Annual Report on Form 10-K of FairPoint for theyear ended December 31, 2002.

(5)          Incorporated byreference to the Current Report on Form 8-K of FairPoint filed on May 4,2005.

(6)          Incorporated byreference to the Current Report on Form 8-K of FairPoint filed on October 3,2005.

(7)          Incorporated byreference to the Quarterly Report on Form 10-Q of FairPoint for theperiod ended September 30, 2000.

(8)          Incorporated byreference to the Registration Statement on Form S-1 of FairPoint,declared effective as of February 3, 2005.

(9)          Incorporated byreference to the Annual Report on Form 10-K of FairPoint for theyear ended December 31, 1999.

(10)   Incorporated by reference tothe Annual Report on Form 10-K of FairPoint for the year ended December 31,2003.

(11)   Incorporated by reference tothe Current Report on Form 8-K of FairPoint filed on May 24,2005.

(12)   Incorporated by reference tothe Registration Statement on Form S-4 of FairPoint, declaredeffective as of August 9, 2000.

(13)   Incorporated by reference tothe Current Report on Form 8-K of FairPoint filed on June 20,2005.

(14)   Incorporated by reference tothe Current Report on Form 8-K of FairPoint filed on September 23,2005.

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