**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934.

**Forthe fiscal year ended December 31, 2006.**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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**                                  |   | ** **                            |
|-----------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction of              |   | **13-3725229**                        |
| 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)                            |

 

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Registrant’s Telephone Number, Including Area Code: **(704) 344-8150**.

Securities registeredpursuant to Section 12(b) of the Act:

| Title of Each Class                          |   | Name of Exchange  on Which Registered |
|----------------------------------------------|--------|---------------------------------------|
| **Common  Stock, par value $0.01 per share** |   | **New York  Stock Exchange**          |

 

Securities registered pursuant to Section 12(g) ofthe Act:**None**

Indicate by check mark ifthe Registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o  No x

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 mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405of this chapter) is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one).

| Large accelerated filer  o |   | Accelerated  filer  x |   | Non-accelerated  filer  o |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o  No x

The aggregate market valueof the common stock held by non-affiliates of the registrant as of June 30,2006 (based on the closing price of $14.40 per share as quoted on the New YorkStock Exchange as of such date) was approximately $386,771,000.

As of March 1, 2007,there were 35,271,910 shares of the Registrant’s common stock, par value $0.01per share, outstanding.

 

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**FAIRPOINTCOMMUNICATIONS, INC. ANNUAL REPORT ON FORM 10-KFOR THE YEAR ENDED DECEMBER 31, 2006**

| Item  Number | ** ** | ** **                                                                                                         | ** ** | ** ** | **Page  Number** |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|------------------|
|         |       | Index .                                                                                                            |       |       | i                |   |
|         |       | PART I                                                                                                        |       |       |             |   |
| 1.           |       | Business                                                                                                           |       |       | 2                |   |
| 1A.          |       | Risk  Factors                                                                                                      |       |       | 17               |   |
| 1B.          |       | Unresolved Staff Comments                                                                                          |       |       | 30               |   |
| 2.           |       | Properties.                                                                                                        |       |       | 30               |   |
| 3.           |       | Legal  Proceedings                                                                                                 |       |       | 31               |   |
| 4.           |       | Submission of Matters to a Vote of Security Holders.                                                               |       |       | 31               |   |
|         |       | PART II                                                                                                       |       |       |             |   |
| 5.           |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |       | 32               |   |
| 6.           |       | Selected  Financial Data                                                                                           |       |       | 36               |   |
| 7.           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |       | 38               |   |
| 7A.          |       | Quantitative and Qualitative Disclosures about Market  Risk.                                                       |       |       | 53               |   |
| 8.           |       | Financial Statements and Supplementary Data                                                                        |       |       | 54               |   |
| 9.           |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure.                             |       |       | 97               |   |
| 9A.          |       | Controls and Procedures                                                                                            |       |       | 97               |   |
| 9B.          |       | Other  Information                                                                                                 |       |       | 99               |   |
|         |       | PART III                                                                                                      |       |       |             |   |
| 10.          |       | Directors, Executive Officers and Corporate Governance                                                             |       |       | 100              |   |
| 11.          |       | Executive Compensation.                                                                                            |       |       | 105              |   |
| 12.          |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters.                   |       |       | 119              |   |
| 13.          |       | Certain Relationships and Related Transactions, and  Director Independence                                         |       |       | 121              |   |
| 14.          |       | Principal Accounting Fees and Services .                                                                           |       |       | 122              |   |
|         |       | PART IV                                                                                                       |       |       |             |   |
| 15.          |       | Exhibits, Financial Statement Schedules, and Reports  on Form 8-K.                                            |       |       | 123              |   |
|         |       | Signatures                                                                                                         |       |       | 124              |   |
|         |       | Exhibit Index                                                                                                 |       |       | 125              |   |

 

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**PART I**

**CAUTIONARY NOTEREGARDING FORWARD-LOOKING STATEMENTS**

Some statements inthis Annual Report are known as “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, or the SecuritiesAct, and Section 21E of the Securities Exchange Act of 1934, or theExchange Act. Forward-looking statements may relate to, among otherthings:

·       futureperformance generally,

·       ourdividend policy and expectations regarding dividend payments,

·       businessdevelopment activities,

·       futurecapital and operating expenditures, including in connection with our proposedmerger with a subsidiary of Verizon Communications Inc.,

·       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-lookingstatements include, but are not limited to, statements about our plans,objectives, expectations and intentions and other statements contained in thisAnnual Report that are not historical facts. When used in this Annual Report,the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates”and similar expressions are generally intended to identify forward lookingstatements. Because these forward-looking statements involve known andunknown risks and uncertainties, there are important factors that could causeactual results, events or developments to differ materially from thoseexpressed or implied by these forward-looking statements, including ourplans, objectives, expectations and intentions and other factors discussedunder “Item 1A. Risk Factors” and other parts of this Annual Report. You shouldnot place undue reliance on such forward-looking statements, which arebased on the information currently available to us and speak only as of thedate on which this Annual Report was filed with the Securities and ExchangeCommission, or the SEC. We undertake no obligation to publicly update or reviseany forward-looking statements, whether as a result of new information,future events or otherwise. However, your attention is directed to any furtherdisclosures made on related subjects in our subsequent periodic reports filedwith the SEC on Forms 10-K, 10-Q and 8-K andSchedule 14A.

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**ITEM1.**                BUSINESS

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

**Our Business**

We are a leading providerof communications services in rural and small urban communities, offering anarray of services, including local and long distance voice, data, Internet andbroadband product offerings. We are one of the largest telephone companies inthe United States focused on serving rural and small urban communities, and weare the 14th largest local telephone company in the United States, in each casebased on number of access lines. We operate in 18 states with 311,150 accessline equivalents (including voice access lines and high speed data lines, whichinclude digital subscriber lines, or DSL, wireless broadband and cable modem)in service as of December 31, 2006.

We were incorporated in February 1991for the purpose of acquiring and operating incumbent telephone companies inrural and small urban markets. We have acquired 35 such businesses, 31 of whichwe continue to own and operate. Many of our telephone companies have servedtheir respective communities for over 75 years. The majority of thecommunities we serve have fewer than 2,500 access lines. Most of our telephonecompanies qualify as rural local exchange carriers under the TelecommunicationsAct of 1996, or the Telecommunications Act.

Rural local exchangecarriers generally are characterized by stable operating results and strongcash flow margins and operate in supportive regulatory environments. Inparticular, existing state and federal regulations permit us to charge ratesthat enable us to recover our operating costs, plus a reasonable rate of returnon our invested capital (as determined by relevant regulatory authorities).Competition is typically limited because rural local exchange carriersprimarily serve sparsely populated rural communities with predominantlyresidential customers, and the cost of operations and capital investmentrequirements for new entrants is high. As a result, in our markets, while wehave experienced some voice competition from cable providers, it has beenlimited and we have experienced limited wireline competition. We also aresubject to competition from wireless and various other technologies which mayincrease in the future. If competition were to increase, the originating andterminating access revenues we receive may be reduced as a result of wireless,voice over internet protocol, or VoIP, or other new technology utilization. Weperiodically negotiate interconnection agreements with other telecommunicationsproviders which could ultimately result in increased competition in thosemarkets.

Access lines are animportant element of our business. Historically, rural telephone companies haveexperienced consistent growth in access lines because of positive demographictrends, insulated rural local economies and little competition. Recently,however, many rural telephone companies have experienced a loss of access linesdue to challenging economic conditions, increased competition and theintroduction of DSL services (resulting in customers canceling second lines infavor of DSL). We have not been immune to these conditions. We have been ableto mitigate our access line loss somewhat through bundling services, retentionprograms, continued community involvement and a variety of other focusedprograms.

**Recent Developments**

On January 15, 2007,we entered into an Agreement and Plan of Merger, referred to herein as theMerger Agreement, with Verizon Communications Inc., or Verizon, and NorthernNew England Spinco Inc., or Spinco, a newly formed wholly-owned subsidiary ofVerizon that will own Verizon’s local exchange and certain related businessactivities in Maine, New Hampshire and Vermont following the contribution byVerizon (directly or through one or more subsidiaries) of assets to Spinco andthe assumption by Spinco of certain related liabilities. Following thecontribution of such assets and liabilities to Spinco, and subject to the approval of the transaction by ourstockholders and the****satisfactionof other closing conditions, 

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includingreceipt of certain regulatory approvals, Verizon will distribute to itsstockholders all of the shares of capital stock of Spinco, and then Spinco willimmediately be merged with and into the Company, with the Company continuing asthe surviving corporation. Spinco stockholders will receive newly issued sharesof the Company’s common stock in exchange for their shares of Spinco. Thistransaction is referred to herein as the Merger.

Verizon and Spinco enteredinto a Distribution Agreement, dated as of January 15, 2007, under which certain specified assets andliabilities will be transferred to subsidiaries of Spinco and certaindistributions will be made and debt securities issued by Spinco. We, assuccessor by merger to Spinco, will have certain post-closing rights for specified periods to ensurethat the assets and liabilities specified in the Distribution Agreement weretransferred to Spinco. For accounting purposes, we expect that FairPointwill be the acquiree. Consequently, merger related costs will been expensed asincurred in connection with the transaction and FairPoint’s assets andliabilities will be recorded at fair value at acquisition.

In connection with theMerger, on January 15, 2007 we also entered into (i) a TransitionServices Agreement with certain subsidiaries of Verizon, (ii) an EmployeeMatters Agreement with Verizon and Spinco, (iii) a Tax Sharing Agreementwith Verizon and Spinco, and (iv) a Master Services Agreement withCapgemini U.S. LLC. The Merger and related transactions are expected to becompleted within one year.

Separately, on January 15,2007, Taconic Telephone Corp., or Taconic, a subsidiary of the Company, enteredinto a Partnership Interest Purchase Agreement, referred to herein as the O-PPurchase Agreement, with Cellco Partnership d/b/a Verizon Wireless and VerizonWireless of the East LP pursuant to which Taconic will sell its 7.5% limitedpartnership interest in Orange County-Poughkeepsie Limited Partnership toCellco Partnership. The sale is expected to be completed in the second quarterof 2007.

For additional informationregarding the Merger and related transactions, and the Merger Agreement andrelated agreements, see our Current Report on Form 8-K filed withthe SEC on January 19, 2007.

Following the Merger, ouroperations will be more focused on small urban markets and geographicallyconcentrated in the northeastern United States, we expect to face morecompetition in our business located in the northeastern United States, and weexpect to be less dependent on regulated revenues.

**Our Competitive Strengths**

Webelieve we are distinguished by the following competitive strengths:

·       **Leading market share.  **We have theleading market position in the communities we serve, with limited competition.Demand for telephone services from our residential and local business customershas historically been very stable despite changing economic conditions. As aresult, we have experienced less of a decline in access lines during the lasttwo years as compared to regional bell operating companies. Additionally, ourtelephone companies operate in generally supportive regulatory environments.These factors have permitted us to generate consistent cash flows and strongmargins.

·       **Geographically diversified markets**.   Wecurrently operate 31 local exchange companies in 18 states enabling us tocapitalize on economies of scale and operating efficiencies. Our geographicdiversity significantly enhances our cash flow stability by limiting ourexposure to competition, local economic downturns and state regulatory changes.In addition, we believe that we have achieved significant scale efficiencies bycentralizing many functions, such as sales and marketing, operations, networkplanning, accounting and customer service.

·       **Technologically advanced infrastructure.  **Ouradvanced network infrastructure enables us to provide a wide array ofcommunications services. Our network consists of central office hosts andremote sites all with digital switches (primarily manufactured by Nortel andSiemens) and operating 

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with currentsoftware. As a result of our historic capital investments, we believe that ournetwork infrastructure requires predictable capital expenditures and allows usto implement certain broadband enabled services with minimal incremental cost.As of December 31, 2006, approximately 99% of our exchanges were capableof providing broadband services and approximately 92% of our access lines arehigh speed data capable.

·       **Broadest service offerings in our markets.  **Asa result of our advanced network, switching and routing infrastructure, webelieve that we offer the only comprehensive suite of communications servicesin our markets, including local and long distance voice, data and Internetservices. In addition, we offer enhanced features such as calleridentification, call waiting, call forwarding, teleconferencing, videoconferencing and voicemail. We also offer broadband communications solutions tomost of our customers primarily through DSL technology.

·       **Management team with proven track record.  **Wehave an experienced management team that has demonstrated its ability to growour rural telephone business over the past decade. Our senior management teamhas an average of 23 years of industry experience. Our management team hassuccessfully integrated 35 business acquisitions since 1993, improving revenuesand cash flow significantly while enhancing service quality and broadeningservice offerings.

**Our Strategy**

Thekey elements of our strategy are to:

·       **Increase revenue per customer.  **We arefocused on increasing our revenues by introducing innovative product offeringsand marketing strategies for enhanced and ancillary services to meet thegrowing needs of our customers. Our long standing relationships with ourcustomers have helped us to successfully cross-sell broadband and value-addedservices, such as DSL, long distance, Internet dial-up, voicemail and otherservices. We will continue to evaluate and implement technologies that willallow us to offer new products and services and improve contribution percustomer.

·       **Continue to improve operating efficiencies andprofitability**.   We have achieved significant operatingefficiencies by applying our operational, regulatory, marketing and managementexpertise to our acquired businesses. We intend to continue to increase ouroperating efficiencies by consolidating various administrative functions andimplementing best practices across our company.

·       **Enhance customer loyalty.  **We believethat our service driven customer relationships and long-standing local presencelead to high levels of customer satisfaction and increased demand for enhancedand ancillary services. We continue to build long-term relationships with ourcustomers by actively participating in the communities we serve and by offeringan array of communications services and quality customer care.

·       **Grow through selective acquisitions.  **Webelieve that our acquisition strategy has been successful because of ourability to integrate acquisitions and improve operating efficiencies in thebusinesses we acquire. Our management team has consistently produced strongoperating cash flow improvements in our acquired businesses. We will continueto evaluate and pursue acquisitions which provide the opportunity to enhanceour revenues and cash flows. However, our ability to pursue acquisitions islimited by the Merger Agreement.

**Our Services**

We offer a broad portfolioof high-quality communications services for residential and business customersin each of the markets in which we operate. We have a long history of operatingin our markets and have a recognized identity within each of our service areas.Our companies are locally staffed, which enables us to efficiently and reliablyprovide an array of communications services to meet our customer needs. Theseinclude services traditionally associated with local telephone companies, aswell as other 

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servicessuch as long distance, Internet and broadband enabled services. Based on ourunderstanding of our local customers’ needs, we have attempted to be proactiveby offering bundled services designed to simplify the customer’s purchasing andmanagement process.

**Generation of Revenue**

We primarily generaterevenue through: (i) the provision of our basic local telephone service tocustomers within our service areas; (ii) the provision of network accessto interexchange carriers for origination and termination of interstate andintrastate long distance phone calls; (iii) Universal Service Fund highcost loop payments; and (iv) the provision of other services such as longdistance resale, data and Internet and broadband enabled services, enhancedservices, such as caller name and number identification, and billing andcollection for interexchange carriers.

See “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inthis Annual Report for more information regarding our revenue sources.

***Local CallingServices***

Local calling serviceenables the local customer to originate and receive an unlimited number ofcalls within a defined “exchange” area. Local calling services include basiclocal lines, private lines and switched data services. We provide local callingservices to residential and business customers, generally for a fixed monthlycharge and service charges for special calling features. In a rural localexchange carrier’s territory, the amount that we can charge a customer forlocal service is determined by rate proceedings involving the appropriate stateregulatory authorities.

***Network AccessCharges***

Network access enableslong distance companies to utilize our local network to originate or terminateintrastate and interstate calls. Network access charges relate to longdistance, or toll calls, that typically involve more than one company in theprovision of telephone service. Since toll calls are generally billed to thecustomer originating the call, a mechanism is required to compensate eachcompany providing services relating to the call. This mechanism is the accesscharge and we bill access charges to long distance companies and othercustomers for the use of our facilities to access the customer, as describedbelow.

*Intrastate Access Charges.*   We generate intrastate accessrevenue when an intrastate long distance call involving an interexchangecarrier is originated by a customer in one of our exchanges to a customer inanother exchange in the same state, or when such a call is terminated to acustomer in one of our rural local exchanges. The interexchange carrier pays usan intrastate access payment for either terminating or originating the call. Webill access charges relating to such calls through our carrier access billingsystem and receive the access payment from the interexchange carrier. Accesscharges for intrastate services are regulated and approved by the stateregulatory authority.

*Interstate Access Charges.*   We generate interstate accessrevenue when an interstate long distance call is originated by a customer inone of our exchanges to a customer in another state, or when such a call isterminated to a customer in one of our exchanges. We bill interstate accesscharges in the same manner as we bill intrastate access charges; however,interstate access charges are regulated and approved by the FederalCommunications Commission instead of the state regulatory authority.

***Universal ServiceFund High Cost Loop***

The Universal Service Fundsupplements the amount of local service revenue received by us to ensure thatbasic local service rates for customers in high cost rural areas are consistentwith rates charged in lower cost urban and suburban areas. The Universal ServiceFund, which is funded by monthly fees charged to interexchange carriers andlocal exchange carriers, makes payments to us on a monthly basis based upon ourcost support for local exchange carriers whose cost of providing the local loopconnections to customers is significantly greater than the national average. Thesepayments fluctuate based upon our 

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averagecost per loop compared to the national average cost per loop. For example, ifthe national average cost per loop increases and our operating costs (andaverage cost per loop) remain constant or decrease, the payments we receivefrom the Universal Service Fund would decline. Conversely, if the nationalaverage cost per loop decreases and our operating costs (and average cost perloop) remain constant or increase, the payments we receive from the UniversalService Fund would increase.

***Long DistanceServices***

We offer switched anddedicated long distance services throughout our service areas through resaleagreements with national interexchange carriers. In addition, through ourwholly-owned subsidiary FairPoint Carrier Services, Inc., or CarrierServices, we offer wholesale long distance services to communications providersthat are not affiliated with us.

***Data and InternetServices***

We offer Internet accessvia DSL technology, dedicated T-1 connections, Internet dial-up, highspeed cable modem and wireless broadband. Customers can utilize this access incombination with customer owned equipment and software to establish a presenceon the web. In addition, we offer enhanced Internet services, which includeobtaining Internet protocol addresses, basic web site design and hosting,domain name services, content feeds and web-based e-mail services. Our servicesinclude access to 24-hour, 7-day a week customer support.

***Other Services***

We seek to capitalize onour local exchange carriers’ local presence and network infrastructure byoffering enhanced services to customers, as well as billing and collectionservices for interexchange carriers.

*Cable TV and Video.*   Incertain of our markets we offer video services to our customers through cabletelevision and video-over-DSL.

*Enhanced Services.*   Our advanced digital switch andvoicemail platforms allow us to offer enhanced services such as call waiting,call forwarding and transferring, three-way calling, automatic callback, callhold, caller name and number identification, voice mail, teleconferencing,video conferencing, store-and-forward fax, follow-me numbers, Centrex servicesand direct inward dial.

*Billing and Collection.*   Many interexchange carriersprovide long distance services to our local exchange carrier customers and mayelect to use our billing and collection services. Our local exchange carrierscharge interexchange carriers a billing and collection fee for each call recordgenerated by the interexchange carrier’s customer.

*Directory Services.*   Through our local telephonecompanies, we publish telephone directories in the majority of our locations.These directories provide white page listings, yellow page listings andcommunity information listings. These directories generate revenues andoperating cash flow from the sale of yellow page and related advertisingto businesses. We contract with leading industry providers to assist in thesale of advertising and the compilation of information, as well as theproduction, publication and distribution of these directories.

**Our Markets**

Most of our 31 localexchange companies operate as the incumbent local exchange carrier in each oftheir respective markets. Our local exchange companies serve an average ofapproximately 13 access lines per square mile versus the non-rural carrieraverage of approximately 128 access lines per square mile. Approximately 77% ofour access lines serve residential customers. Our business customers accountfor approximately 23% of our access lines. Our business customers arepredominantly in the agriculture, light manufacturing and service industries.

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Thefollowing chart identifies the number of access line equivalents in each of our18 states as of December 31, 2006:

| **State**       | ** ** | ** ** | ** ** | **Access Line  Equivalents** | ** ** |
|-----------------|------------|------------|------------|-----------------------------------|------------|
| Maine           |       |       | 68,163     |                              |       |
| Florida         |       |       | 56,127     |                              |       |
| New York        |       |       | 52,877     |                              |       |
| Washington      |       |       | 47,268     |                              |       |
| Ohio            |       |       | 15,268     |                              |       |
| Missouri        |       |       | 15,133     |                              |       |
| Illinois        |       |       | 8,257      |                              |       |
| Virginia        |       |       | 8,321      |                              |       |
| Vermont         |       |       | 7,426      |                              |       |
| Idaho           |       |       | 6,860      |                              |       |
| Kansas          |       |       | 6,935      |                              |       |
| Pennsylvania    |       |       | 6,572      |                              |       |
| Oklahoma        |       |       | 4,124      |                              |       |
| Colorado        |       |       | 3,711      |                              |       |
| Other States(1) |       |       | 4,108      |                              |       |
| Total:          |       |       | 311,150    |                              |       |

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(1)          IncludesMassachusetts, New Hampshire, Georgia and Alabama.

**Sales and Marketing**

Our marketing approach emphasizes customer-orientedsales, marketing and service. We believe most communications companies devotetheir resources and attention primarily toward customers in more denselypopulated markets. To the extent we experience competition for any of ourservices, we seek to differentiate ourselves from the competitors providingsuch services by providing a superior level of service to each of ourcustomers.

Each of our local exchange companies has a longhistory in the communities it serves. It is our policy to maintain and enhancethe strong identity and reputation that each rural local exchange carrierenjoys in its markets, as we believe this is a significant competitiveadvantage. As we market new services, we will seek to continue to utilize ouridentity in order to attain higher recognition with potential customers.

To demonstrate our commitment to the markets we serve,we maintain a strong local presence in our service territories. We believe thata local presence helps facilitate a direct connection to the community, whichimproves customer satisfaction and loyalty.

In addition, our strategy is to enhance ourcommunications services by offering comprehensive bundling of services anddeploying new technologies to build upon the strong reputation we enjoy in ourmarkets and to further promote rural economic development in the ruralcommunities we serve.

Many of the companiesacquired by us traditionally have not devoted a substantial amount of theiroperating budget to sales and marketing activities. After acquiring such rurallocal exchange carriers, we typically change this practice to provideadditional support for existing products and services as well as to support theintroduction of new services. As of December 31, 2006, we had 255employees engaged in sales, marketing and customer service.

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**InformationTechnology and Support Systems**

Our approach to billing and operational supportsystems focuses on implementing best-of-class applications that allowconsistent communication and coordination throughout our entire organization.Our objective is to improve profitability by reducing individual company coststhrough the sharing of best practices, centralization or standardization offunctions and processes, and deployment of technologies and systems thatprovide for greater efficiencies and profitability.

As of December 31,2006, 17 of our operating companies had converted to a single outsourcedbilling platform (Mid America Computer Corporation, or MACC). The conversion ofthe remaining companies is expected to be completed by the middle of 2007.

**NetworkArchitecture and Technology**

Our rural local exchange carrier networks consist ofcentral office hosts and remote sites, all with advanced digital switches(primarily manufactured by Nortel and Siemens) and operating with currentsoftware. The outside plant consists of transport and distribution deliverynetworks connecting our host central office with remote central offices andultimately with our customers. We own fiber optic cable, which has beendeployed throughout our current network and is the primary transport technologybetween our host and remote central offices and interconnection points withother incumbent carriers.

Our fiber optic transport system is primarily asynchronous optical network capable of supporting increasing customer demandfor high bandwidth transport services. This system supports advanced servicesincluding Asynchronous Transfer Mode, Frame Relay and/or Internet ProtocolTransport, facilitating delivery of advanced services as demand warrants.

In our rural local exchange carrier markets,DSL-enabled integrated access technology is being deployed to providesignificant broadband capacity to our customers. As of December 31, 2006,we had deployed this technology in 152 of our 154 exchanges. Approximately 99%of our exchanges are capable of providing broadband services through cablemodem, wireless broadband and/or DSL technology.

Rapid and significantchanges in technology are expected in the communications industry. Our futuresuccess will depend, in part, on our ability to anticipate and adapt totechnological changes. We believe that our network architecture will enable usto efficiently respond to these technological changes.

**Competition**

We believe that theTelecommunications Act and other recent actions taken by the FederalCommunications Commission and state regulatory authorities promote competitionin the provision of communications services; however, many of the competitivethreats now confronting larger regulated telephone companies are limited in therural local exchange carrier marketplace. Our rural local exchange carriershistorically have experienced limited wireline competition as the incumbentcarrier in their markets because the demographic characteristics of ruralcommunications markets generally will not support the high cost of operationsand significant capital investment required for new wireline entrants to offercompetitive services. For instance, the per minute cost of operating bothtelephone switches and interoffice facilities is higher in rural areas, asrural local exchange carriers typically have fewer, more geographicallydispersed customers and lower calling volumes. Also, the distance from thetelephone switch to the customer is typically longer in rural areas, whichresults in increased distribution facilities costs. These relatively high coststend to discourage other wireline competitors from entering territories servicedby our rural local exchange carriers.

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***Wireless Competition***

In most of our ruralmarkets we face competition from wireless technology and, as technology andeconomies of scale improve, competition from wireless carriers may increase. Inaddition, the Federal Communications Commission’s requirement that telephonecompanies offer wireline-to-wireless number portability mayincrease the competition we face from wireless carriers.

***Wireline Competition***

We also face competition from new market entrants thatprovide close substitutes for the traditional telephone services we provide,such as cable television, satellite communications and electric utilitycompanies. Cable television companies are entering the communications market byupgrading their networks with fiber optics and installing facilities to providefully interactive transmission of broadband, voice, video and datacommunications. Electric utilities have existing assets and access to low costcapital that could allow them to enter a market rapidly and accelerate networkdevelopment. While we currently have limited competition for voice servicesfrom cable providers and electric utilities for basic voice services, we mayface increased competition from such providers in the future.

In addition, we have andcould continue to face increased competition from competitive local exchangecarriers, particularly in offering services to Internet service providers.

***Voice Over Internet Protocol Competition***

VoIP service isincreasingly being embraced by all industry participants. VoIP serviceessentially involves the routing of voice calls, at least in part, over theInternet through packets of data instead of transmitting the calls over theexisting public switched telephone network. This routing mechanism may giveVoIP service providers a cost advantage and enable them to offer services toend users at a lower price. While current VoIP applications typically completecalls using incumbent local exchange carrier infrastructure and networks, asVoIP services obtain acceptance and market penetration and technology advancesfurther, a greater quantity of communication may be placed without utilizingthe public switched telephone network. The proliferation of VoIP, particularlyto the extent such communications do not utilize our rural local exchangecarriers’ networks, may result in an erosion of our customer base and loss ofaccess fees and other funding.

***Internet Competition***

The Internet servicesmarket is also highly competitive, and we expect that competition will continueto intensify. Internet services, meaning both Internet access (wired andwireless) and on-line content services, are provided by Internet serviceproviders, satellite-based companies, long distance carriers and cabletelevision companies. Many of these companies provide direct access to theInternet and a variety of supporting services to businesses and individuals. Inaddition, many of these companies, such as America Online, Inc., MicrosoftNetwork and Yahoo, offer on-line content services consisting of access toclosed, proprietary information networks. Long distance companies and cabletelevision operators, among others, are aggressively entering the Internetaccess markets. Long distance carriers have substantial transmissioncapabilities, traditionally carry data to large numbers of customers and havean established billing system infrastructure that permits them to add newservices. Satellite companies are offering broadband access to the Internetfrom desktop personal computers. Many of these competitors have substantiallygreater financial, technological, marketing, personnel, name-brand recognitionand other resources than those available to us.

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***Long Distance Competition***

The long distancecommunications market is highly competitive. Competition in the long distancebusiness is based primarily on price, although service bundling, branding,customer service, billing service and quality play a role in customers’choices.

***Other Competition***

Although we currentlybelieve we offer the only comprehensive suite of communications services in ourmarkets, existing service providers such as wireline, wireless, cable andutility companies could form, and in some cases are in the process of forming,strategic alliances to offer bundled services in our markets. We may faceincreased competition from such bundled service providers in the future.

**Employees**

As of December 31,2006, we employed a total of 952 employees. 127 employees of our local exchangecompanies are represented by four unions. We believe the state of ourrelationship with our union and non-union employees is generally good. Withinour company, 109 employees are employed at our corporate offices and 843employees are employed at our local exchange companies.

**IntellectualProperty**

We believe we have thetrademarks, trade names and licenses that are necessary for the operation ofour business as we currently conduct it. We do not consider our trademarks,trade names or licenses to be material to the operation of our business.

**RegulatoryEnvironment**

The following summary does not describe all presentand proposed federal, state and local legislation and regulations affecting thecommunications industry. Some legislation and regulations are currently thesubject of judicial proceedings, legislative hearings and administrativeproposals which could change the manner in which this industry operates.Neither the outcome of any of these developments, nor their potential impact onus, can be predicted at this time. Regulation can change rapidly in the communicationsindustry, and such changes may have an adverse effect on us in the future. See “Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Risk Factors—Risks Related to our Regulatory Environment” in thisAnnual Report.

Our regulated communications services are subject toextensive federal, state and local regulation. We hold various regulatoryauthorizations for our service offerings. At the federal level, the FederalCommunications Commission generally exercises jurisdiction over all facilitiesand services of communications common carriers, such as us, to the extent thosefacilities are used to provide, originate, or terminate interstate orinternational communications. State regulatory commissions generally exercisejurisdiction over such facilities and services to the extent those facilitiesare used to provide, originate or terminate intrastate communications. Inaddition, pursuant to the Telecommunications Act, state and federal regulatorsshare responsibility for implementing and enforcing the domesticpro-competitive policies introduced by that legislation. In particular, stateregulatory agencies have substantial oversight over the provision by incumbenttelephone companies of interconnection and non-discriminatory network access tocompetitive communications providers. Local governments often regulate thepublic rights-of-way necessary to install and operate networks, and may requirecommunications services providers to obtain licenses or franchises regulatingtheir use of public rights-of-way. Additionally, municipalities and other localgovernment agencies may regulate limited aspects of our business, including ouruse of public rights-of-way, and by requiring us to obtain construction permitsand abide by building codes.

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We believe thatcompetition in our telephone service areas will increase in the future as aresult of the Telecommunications Act and through increased deployment ofvarious types of technology, although the ultimate form and degree of competitioncannot be ascertained at this time. Competition may lead to loss of revenuesand profitability as a result of: loss of customers; reduced usage of ournetwork by our existing customers who may use alternative providers for longdistance, voice and data services; and reductions in prices for our serviceswhich may be necessary to meet competition.

***Federal Regulation***

We must comply with the Communications Act whichrequires, among other things, that communications carriers offer services atjust and reasonable rates and on non-discriminatory terms and conditions. Theamendments to the Communications Act contained in the Telecommunications Actdramatically changed the landscape of the communications industry. The centralaim of the Telecommunications Act was to open local communications marketplacesto competition while enhancing universal service. Most significantly, theTelecommunications Act governs the removal of barriers to market entry intolocal telephone services, requires incumbent local exchange carriers tointerconnect with competitors, establishes procedures pursuant to whichincumbent local exchange carriers may provide other services, such as theprovision of long distance services by regional Bell operating companies, andimposes on incumbent local exchange carriers duties to negotiateinterconnection arrangements in good faith.

*Removalof Entry Barriers.*   Prior to the enactment of theTelecommunications Act, many states limited the services that could be offeredby a company competing with an incumbent local exchange carrier. TheTelecommunications Act generally preempts state and local laws that prevent competitiveentry into the provision of any communications service. However, states canmodify conditions of entry into areas served by rural local exchange carrierswhere the state regulatory commission determines that such modification iswarranted by the public interest. Since the passage of the TelecommunicationsAct, we have experienced limited wireline competition from cable providers,however recently cable service providers have been introducing VoIP localservice offerings that may increase their ability to compete for residentialcustomer lines, and we have experienced increasing competition from wirelessservice providers.

*AccessCharges.*   The Federal Communications Commissionregulates the prices that incumbent local telephone companies charge for theuse of their local telephone facilities in originating or terminatinginterstate transmissions. The Federal Communications Commission has structuredthese prices, also referred to as “access charges,” as a combination of flatmonthly charges paid by the end-users and usage sensitive charges paid by longdistance carriers. State regulatory commissions regulate intrastate accesscharges. Many states generally mirror the Federal Communications Commissionprice structure. A significant amount of our revenues come from network accesscharges, which are paid to us by intrastate and interstate long distancecarriers for originating and terminating calls in the regions served by ourrural local exchange carriers. The amount of access charge revenues that we receiveis based on rates set by federal and state regulatory bodies, and such ratesare subject to change at any time.

The Federal Communications Commission regulates thelevels of interstate access charges by imposing price caps on larger incumbentlocal telephone companies. These price caps can be adjusted based on variousformulae, such as inflation and productivity, and otherwise through regulatoryproceedings. Smaller incumbents may elect to base access charges on price caps,but are not required to do so unless they elected to use price caps in the pastor their affiliated incumbent local telephone companies base their accesscharges on price caps. Each of our 31 local telephone subsidiaries elected notto apply the Federal Communications Commission’s price caps. Instead, oursubsidiaries employ rate-of-return regulation for their interstate accesscharges.

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The Federal Communications Commission has made, and iscontinuing to consider, various reforms to the existing rate structure forcharges assessed on long distance carriers for connection to local networks.States often mirror federal rules in establishing intrastate accesscharges. In 2001, the Federal Communications Commission adopted an orderimplementing the beginning phases of the Multi Association Group plan to reformthe access charge system for rural carriers. The Multi Association Group planis revenue neutral to our operating companies. Among other things, the MultiAssociation Group plan reduces access charges and shifts a portion of cost recovery,which historically has been based on minutes-of-use, to flat-rate, monthly perline charges on end-user customers rather than long distance carriers. As aresult, the aggregate amount of access charges paid by long distance carriersto access providers, such as our rural local exchange carriers, has decreasedand may continue to decrease. In adopting the Multi Association Group plan, theFederal Communications Commission also determined that rate-of-return carrierswill continue to be permitted to set rates based on the authorized rate ofreturn of 11.25%. In addition, to the extent our rural local exchange carriersbecome subject to competition in their own local exchange areas, such accesscharges could be paid to competing local exchange carriers rather than to us.Additionally, the access charges we receive may be reduced as a result ofcompetition by other service providers such as wireless and VoIP services. Sucha circumstance could have a material adverse effect on our financial conditionand results of operations. In addition, the Federal Communications Commissionhas sought comment on broad policy changes that could harmonize the ratestructure and levels of all forms of intercarrier compensation, and could, as aresult, substantially modify the current forms of carrier-to-carrier paymentsfor interconnected traffic. In July of 2006 a diverse group oftelecommunications providers filed a comprehensive plan for intercarriercompensation reform called the “Missoula Plan” with the Federal CommunicationsCommission. This Plan would, among other things, unify state and interstateintercarrier rates, provide a restructure mechanism to replace intercarrierrevenues lost through rate unification, resolve a number of outstandingdisputes among carriers regarding interconnection and compensation obligations,and introduce an optional incentive plan for carriers currently underrate-of-return regulation. It is unclear at this time what, if anything, theFederal Communications Commission will do with the Missoula Planrecommendations. Furthermore, in the notice of proposed rulemaking on VoIPservices adopted by the Federal Communications Commission in February 2004,the Federal Communications Commission has sought comment on whether accesscharges should apply to VoIP or other Internet Protocol-based services. It isunknown at this time what additional changes, if any, the FederalCommunications Commission may eventually adopt and the effect of any suchchanges on our business.

*RuralLocal Exchange Carrier Services Regulation.*   Ourrural local exchange carrier services revenue is subject to regulationincluding regulation by the Federal Communications Commission and incentiveregulation by various state regulatory commissions. State lawmakers will likelycontinue to review the statutes governing the level and type of regulation forcommunications services. It is expected that over the next few years,legislative and regulatory actions will provide opportunities to restructurerates, introduce more flexible incentive regulation programs and possiblyreduce the overall level of regulation. We expect the election of incentiveregulation plans and the expected reduction in the overall level of regulationto allow us to introduce new services and pricing changes more expeditiously thanin the past. At the same time, however, the implementation of such new programsmay also lead to reductions in intrastate access charges.

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The Federal CommunicationsCommission generally must approve in advance most transfers of control andassignments of operating authorizations by Federal CommunicationsCommission-regulated entities. Therefore, if we seek to acquire companies thathold Federal Communications Commission authorizations, in most instances wewill be required to seek approval from the Federal Communications Commissionprior to completing those acquisitions. The Federal Communications Commissionhas the authority to condition, modify, cancel, terminate or revoke operatingauthority for failure to comply with applicable federal laws or rules,regulations and policies of the Federal Communications Commission. Fines orother penalties also may be imposed for such violations. Our interstate commoncarrier services are also subject to nondiscrimination requirements andrequirements that rates be just and reasonable.

The Federal CommunicationsCommission has required that incumbent independent local exchange carriers thatprovide interstate long distance services originating from their local exchangeservice territories must do so in accordance with “structural separation”rules. These rules require that our long distance affiliates (i) maintainseparate books of account, (ii) not own transmission or switchingfacilities jointly with the local exchange affiliate, and (iii) acquireany services from its affiliated local exchange telephone company at tariffedrates, terms and conditions. The Federal Communications Commission hasinitiated a rulemaking proceeding to examine whether there is a continuing needfor such requirements; however, we cannot predict the outcome of thatproceeding.

***State Regulation***

Most states have some form of certificationrequirement that requires providers of communications services to obtainauthority from the state regulatory commission prior to offering common carrierservices within the state. Most of our rural local exchange companies operateas the incumbent local telephone company in the states in which they operateand are certified in those states to provide local telephone services. Stateregulatory commissions generally regulate the rates incumbent local exchangecarriers charge for intrastate services, including rates for intrastate accessservices paid by providers of intrastate long distance services. Although theFederal Communications Commission has preempted certain state regulationspursuant to the Telecommunications Act, states have retained authority toimpose requirements on carriers necessary to preserve universal service,protect public safety and welfare, ensure quality of service and protectconsumers. For instance, incumbent local exchange carriers must file tariffssetting forth the terms, conditions and prices for their intrastate services, andsuch tariffs may be challenged by third parties. From time to time, statesconduct rate cases or “earnings” reviews. These reviews may result in thedisallowance of certain investments or expenses for ratemaking purposes.

Under theTelecommunications Act, state regulatory commissions have jurisdiction toarbitrate and review interconnection disputes and agreements between incumbentlocal exchange carriers and competitive local exchange carriers, in accordancewith rules set by the Federal Communications Commission. State regulatorycommissions may also formulate rules regarding fees imposed on providersof communications services within their respective states to support stateuniversal service programs. States often require prior approvals or notificationsfor certain acquisitions and transfers of assets, customers, or ownership ofregulated entities. Therefore, in most instances we will be required to seekstate approval prior to completing new acquisitions of rural local exchangecarriers. States generally retain the right to sanction a carrier or to revokecertifications if a carrier materially violates relevant laws and/orregulations.

***Local Government Authorizations***

We may be required toobtain from municipal authorities permits for street opening and constructionor operating franchises to install and expand facilities in certain rural andsmall urban communities. Some of these franchises may require the payment offranchise fees. We have obtained such municipal franchises as were required. Insome areas, we do not need to obtain such permits or franchises because the 

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subcontractorsor electric utilities with which we have contracts already possess therequisite authorizations to construct or expand our networks.

***Promotion of Local Service Competition and TraditionalTelephone Companies***

As discussed above, the Telecommunications Actprovides, in general, for the removal of barriers to entry into thecommunications industry in order to promote competition for the provision oflocal service. Congress, however, has recognized that states should not beprohibited from taking actions necessary to preserve and advance universalservice, and has further recognized that special consideration should be givento the appropriate conditions for competitive entry in areas served by ruraltelephone companies, such as our 31 local exchange carrier subsidiaries.

Pursuant to the Telecommunications Act, all localexchange carriers, including both incumbents and new competitive carriers, arerequired to: (i) allow others to resell their services at retail rates; (ii) ensurethat customers can keep their telephone numbers when changing carriers; (iii) ensurethat competitors’ customers can use the same number of digits when dialing andreceive nondiscriminatory access to telephone numbers, operator service,directory assistance and directory listing; (iv) ensure access totelephone poles, ducts, conduits and rights of way; and (v) compensatecompetitors for the competitors’ costs of completing calls to competitors’customers. Competitors are required to compensate the incumbent telephonecompany for the cost of providing these interconnection services. Under theTelecommunications Act, our rural local exchange carriers may request fromstate regulatory commissions, suspension or modification of any or all of therequirements described above. A state regulatory commission may grant such arequest if it determines that such exemption, suspension or modification isconsistent with the public interest and necessary to avoid a significantadverse economic impact on communications users and generally avoid imposing arequirement that is technically unfeasible or unduly economically burdensome.If a state regulatory commission denies some or all of any such request made byone of our rural local exchange carriers, or does not allow us adequatecompensation for the costs of providing interconnection, our costs couldincrease and our revenues could decline. In addition, with such a denial,competitors could enjoy benefits that would make their services more attractivethan if they did not receive such interconnection rights. With the exception ofour requests to modify the May 24, 2004 implementation date for localnumber portability in certain states, we have not encountered a need to fileany such requests for suspension or modification of the interconnectionrequirements.

The TelecommunicationsAct, with certain exceptions, imposes the following additional duties onincumbent telephone companies by requiring them to: (i) interconnect theirfacilities and equipment with any requesting communications carrier at anytechnically feasible point; (ii) unbundle and provide nondiscriminatoryaccess to network elements such as local loops, switches and transportfacilities, at nondiscriminatory rates and on nondiscriminatory terms andconditions; (iii) offer their retail services for resale at wholesalerates; (iv) provide reasonable notice of changes in the informationnecessary for transmission and routing of services over the incumbent telephonecompany’s facilities or in the information necessary for interoperability; and (v) provide,at rates, terms and conditions that are just, reasonable and nondiscriminatory,for the physical co-location of equipment necessary for interconnection oraccess to unbundled network elements at the premises of the incumbent telephonecompany. Competitors are required to compensate the incumbent local exchangecarrier for the cost of providing these interconnection services. However,pursuant to the Telecommunications Act, rural telephone companies, includingour rural local exchange carriers, are automatically exempt from theseadditional incumbent telephone company requirements. The exemption remainseffective until an incumbent rural local telephone company receives a bona fiderequest for these additional interconnection services and the applicable stateauthority determines that the request is not unduly economically burdensome, istechnically feasible, and is consistent with the universal service objectivesset forth in the Telecommunications Act. This exemption remains effective forall of our incumbent local telephone 

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operations,except in Florida where the legislature has determined that all incumbent localexchange carriers are required to provide the additional interconnectionservices as prescribed in the Telecommunications Act. If a request for any ofthese additional interconnection services is filed by a potential competitorwith respect to one of our other operating territories, we are likely to askthe relevant state regulatory commission to retain the exemption. If a stateregulatory commission rescinds such exemption in whole or in part and if thestate regulatory commission does not allow us adequate compensation for thecosts of providing the interconnection, our costs would significantly increase,we would face new competitors in that state and we could suffer a significantloss of customers and resulting declines in our revenues. In addition, we couldincur additional administrative and regulatory expenses as a result of theinterconnection requirements.

***Promotion of Universal Service***

The payments received by our rural local exchangecarriers from the Universal Service Fund are intended to support the high costof our operations in rural markets. Payments from the high cost loop componentof the Universal Service Fund represented 7% of our revenues for the year endedDecember 31, 2006. Under current Federal Communications Commissionregulations, the total Universal Service Fund available to all rural localtelephone companies is subject to a cap. In any given year, the cap may or maynot be reached. In any year where the cap is reached, the per access line rateat which we can recover Universal Service Fund payments may decrease. Inaddition, the consideration of changes in the federal rules governing boththe collection and distribution of Universal Service Fund is pending before theFederal Communications Commission. If our rural local exchange carriers wereunable to receive Universal Service Fund payments, or if such payments werereduced, many of our rural local exchange carriers would be unable to operateas profitably as they have historically in the absence of our implementation ofincreases in charges for other services. Moreover, if we raise prices forservices to offset loss of Universal Service Fund payments, the increasedpricing of our services may disadvantage us competitively in the marketplace,resulting in additional potential revenue loss. Payments from the UniversalService Fund fluctuate based upon our average cost per loop compared with thenational average cost per loop. For example, if the national average cost perloop increases and our operating costs (and average cost per loop) remainconstant or decrease, the payments we receive from the Universal Service Fundwould decline. Conversely, if the national average cost per loop decreases andour operating costs (and average cost per loop) remain constant or increase,the payments we receive from the Universal Service Fund would increase. Overthe past year, the national average cost per loop in relation to our averagecost per loop has increased and we believe 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 will likelydecline.

Universal service rules have been adopted by boththe Federal Communications Commission and some state regulatory commissions.Universal Service Fund funds may be distributed only to carriers that aredesignated as eligible telecommunications carriers by a state regulatorycommission. All of our rural local exchange carriers have been designated aseligible telecommunications carriers pursuant to the Telecommunications Act.However, under the Telecommunications Act, competitors could obtain the samesupport payments as we do if a state regulatory commission determined thatgranting such support payments to competitors would be in the public interest.

Two notable regulatory changes enacted by the FederalCommunications Commission in the last six years are the adoption, with certainmodifications, of the Rural Task Force proposed framework for rural high-costuniversal service support and the implementation of the Multi Association Groupplan. The Federal Communications Commission’s Rural Task Force order modifiedthe existing universal service support mechanism for rural local exchangecarriers and adopted an interim embedded, or historical, cost mechanism for afive-year period that provides predictable levels of support to rural carriers.The Federal 

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Communication Commissionstated its intention to develop a long-term plan based on forward looking costsupon the expiration of the five-year period on May 30, 2006. Prior to thisexpiration date, the Commission extended the embedded-cost mechanism until suchtime as the Federal-State Joint Board on Universal Service recommends and theCommission approves a replacement universal service distribution mechanism. TheMulti Association Group plan created a new universal service support mechanism,Interstate Common Line Support, to replace carrier common line access chargesand the recovery of certain costs formerly recovered through traffic sensitiveaccess charges. A recent Federal Communications Commission order merged longterm support into its interstate common line support mechanism without reducing(at least initially) the aggregate universal service support from the twomechanisms (both of which had been previously transformed from access chargerevenue streams into universal service support mechanisms). As a result ofthese changes, when a competitor is designated as an eligibletelecommunications carrier, it also receives an increased level of UniversalService Fund support equal to the level received by the incumbent on a per linebasis.

The Federal-State Joint Board on Universal Service andthe Federal Communications Commission are currently considering revisions toboth the collection and distribution mechanisms for universal service funds. Universalservice funding is currently collected through a surcharge on interstate andinternational end-user revenues. Declining long distance revenues, thepopularity of service bundles that include local and long distance services,and the growth in the size of the fund, due primarily to increased funding tocompetitive eligible telecommunications carriers, are all causing the FederalCommunications Commission to consider alternative and more sustainable meansfor collecting this funding. An alternative under active consideration would beto impose some form of surcharge on telephone numbers and/or networkconnections. Concerning fund distribution, in March of 2005 the FederalCommunications Commission issued new rules to set more stringentrequirements for competitive eligible telecommunications carriers to obtainuniversal service funding. Despite these changes, the overall size of the fundcontinues to grow, and the Joint Board and the Federal CommunicationsCommission are seeking means to control this growth. In August of 2006 theJoint Board released a Public Notice requesting comment on the possible use ofreverse auctions to determine recipients of high-cost universal service reform.It is unknown at this time exactly what course the Federal CommunicationsCommission will take on universal service distribution reform, but it ispossible the remedy ultimately selected by the Commission could materiallyaffect the amount of universal service funding we receive.

In addition, there are anumber of judicial appeals challenging several aspects of the FederalCommunications Commission’s universal service rules. It is not possible topredict at this time whether the Federal Communications Commission or Congresswill require modification to those rules, or the ultimate impact any suchmodification might have on us.

***Potential Internet Regulatory Obligations***

In connection with our Internet access offerings, wecould become subject to laws and regulations as they are adopted or applied tothe Internet. There is currently only limited regulation applicable to theInternet. As the significance of the Internet expands, federal, state and localgovernments may adopt rules and regulations, or apply existing laws andregulations to the Internet, and related matters are under consideration inboth federal and state legislative and regulatory bodies. The FederalCommunications Commission is currently reviewing the appropriate regulatoryframework governing broadband access to the Internet through telephone andcable operators’ communications networks. We cannot predict whether the outcomewill prove beneficial or detrimental to our competitive position. In February 2004,the Federal Communications Commission initiated a proceeding to examine theregulatory implications of VoIP technology. We cannot predict the results ofthese proceedings, the nature of these regulations or their impact on ourbusiness. Recently there have also been discussions of “net neutrality” or thepotential 

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requirement fornon-discriminatory treatment of traffic over broadband networks. It is tooearly to predict what, if any, impact this may have on our business.

In 2005, the FederalCommunications Commission adopted FCC Order 05-150, which puts wirelinebroadband Internet access service, commonly delivered by DSL technology, on anequal regulatory footing with cable modem service. This approach is consistentwith a 2005 United States Supreme Court decision upholding the FederalCommunications Commission’s light regulatory treatment of cable modem service. Specifically,the Federal Communications Commission determined that wireline broadbandInternet access services are defined as information services functionallyintegrated with a telecommunications component. In the past, the FederalCommunications Commission required facilities-based providers to offer wirelinebroadband transmission components separately from their Internet service as astand alone service on a common-carrier basis, and thus classified thatcomponent as a telecommunications service. The Federal Communications Commission order provides an option whichallows rate of return carriers, such as our operating companies, the option tocontinue providing DSL service as a common carrier (status quo) offering butcarriers are no longer required to do so.

***Environmental Regulations***

Like all other localtelephone companies, our 31 local exchange carrier subsidiaries are subject tofederal, state and local laws and regulations governing the use, storage,disposal of, and exposure to hazardous materials, the release of pollutantsinto the environment and the remediation of contamination. As an owner ofproperty, we could be subject to environmental laws that impose liability forthe entire cost of cleanup at contaminated sites, regardless of fault or thelawfulness of the activity that resulted in contamination. We believe, however,that our operations are in substantial compliance with applicable environmentallaws and regulations.

**Other Information**

We make available on ourwebsite, www.fairpoint.com, our Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-Kand all amendments to such reports as soon as reasonably practical after wefile such material with, or furnish such material to, the SEC.

**ITEM 1A.   RISKFACTORS**

Any of the following riskscould materially adversely affect our business, consolidated financialcondition, results of operations or liquidity or the market price of our commonstock. The risks described below are not the only risks facing us. Additionalrisks and uncertainties not currently known to us or that we currently deem tobe immaterial may also materially and adversely affect our business operations.

***Risks Related to our Common Stock and our SubstantialIndebtedness***

**Our stockholders may not receive the level ofdividends provided for in the dividend policy our board of directors hasadopted or any dividends at all.**

Our board of directors hasadopted a dividend policy which reflects an intention to distribute asubstantial portion of the cash generated by our business in excess ofoperating needs, interest and principal payments on our indebtedness, dividendson our future senior classes of capital stock, if any, capital expenditures,taxes and future reserves, if any, as regular quarterly dividends to ourstockholders. Our board of directors may, in its discretion, amend or repealthis dividend policy. Our dividend policy is based upon our directors’ currentassessment of our business and the environment in which we operate, and that assessmentcould change based on regulatory, competitive or technological developments(which could, for example, increase our need for capital expenditures) or newgrowth opportunities. In addition, future dividends with respect to shares ofour common stock, if any, will depend on, among other things, 

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our cashflows, cash requirements, financial condition, contractual restrictions,provisions of applicable law and other factors that our board of directors maydeem relevant. Our board of directors may decrease the level of dividendsprovided for in the dividend policy or entirely discontinue the payment ofdividends. Our credit facility contains significant restrictions on our abilityto make dividend payments. There can be no assurance that we will generatesufficient cash from continuing operations in the future, or have sufficientsurplus or net profits, as the case may be, under Delaware law, to paydividends on our common stock in accordance with the dividend policy. If wewere to use borrowings under our credit facility’s revolving facility to funddividends, we would have less cash available for future dividends. Thereduction or elimination of dividends may negatively affect the market price ofour common stock.

**To expand our business through acquisitions andservice our indebtedness, we will require a significant amount of cash. Ourability to generate cash depends on many factors beyond our control. We may notgenerate sufficient funds from operations to consummate acquisitions, paydividends with respect to shares of our common stock or repay or refinance ourindebtedness at maturity or otherwise.**

We may not retain a sufficient amount of cash tofinance a material expansion of our business, or to fund our operationsconsistent with past levels of funding in the event of a significant businessdownturn. In addition, because a substantial portion of cash available to paydividends will be distributed to holders of our common stock under our dividendpolicy, our ability to pursue any material expansion of our business, includingthrough acquisitions or increased capital spending, will depend more than itotherwise would on our ability to obtain third party financing. There can be noassurance that such financing will be available to us at all, or at an acceptablecost.

Our ability to consummate acquisitions and to makepayments on our indebtedness will depend on our ability to generate cash flowfrom operations in the future. This ability, to a certain extent, is subject togeneral economic, financial, competitive, legislative, regulatory and otherfactors that are beyond our control. There can be no assurance that ourbusiness will generate sufficient cash flow from operations or that futureborrowings will be available to us in an amount sufficient to enable us to payour indebtedness or to fund our other liquidity needs.

A significant amount of our cash flow from operationswill be dedicated to capital expenditures and debt service. In addition, wecurrently expect to distribute a significant portion of our cash flow to ourstockholders in the form of quarterly dividends. As a result, we may not retaina sufficient amount of cash to finance growth opportunities, includingacquisitions, or unanticipated capital expenditures or to fund our operations.In addition, if we reduce capital expenditures, the regulatory settlementpayments we receive may decline.

Borrowings under our credit facility bear interest atvariable interest rates. Accordingly, if any of the base reference interestrates for the borrowings under our credit facility increase, our interestexpense will increase, which could negatively impact our ability to paydividends on our common stock. We have entered into interest rate swapagreements which effectively convert a significant portion of our variable rateinterest exposure to fixed rates. As a result of these swap agreements, asignificant portion of our indebtedness bears interest at fixed rates ratherthan variable rates. After these interest rate swap agreements expire, ourannual debt service obligations with respect to borrowings under our creditfacility will vary from year to year unless we enter into a new interest rateswap or purchase an interest rate cap or other interest rate hedge. If wechoose to enter into a new interest rate swap or purchase an interest rate capor other interest rate hedge in the future, the amount of cash available to paydividends on our common stock may decrease. However, to the extent interestrates increase in the future, we may not be able to enter into a new interestrate swap or purchase an interest rate cap or other interest rate hedge onacceptable terms.

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In addition, prior to the maturity of our creditfacility, we will not be required to make any payments of principal on ourcredit facility, and it is not likely that we will generate sufficient fundsfrom operations to repay the principal amount of our indebtedness at maturity.We therefore will need to refinance our debt. We may not be able to refinanceour outstanding indebtedness under our credit facility, or if refinanced, therefinancing may occur on less favorable terms, which may materially adverselyaffect our ability to pay dividends. If we were unable to refinance our creditfacility, our failure to repay all amounts due on the maturity date would causea default under our credit facility. We expect our required principalrepayments under the term loan facility of our credit facility to beapproximately $588.5 million at its maturity in February 2012. Ourinterest expense may increase significantly if we refinance our credit facilityon terms that are less favorable to us than the terms of our credit facility.

We may also be forced toraise additional capital or sell assets and, if we are forced to pursue any ofthese options under distressed conditions, our business and the value of yourinvestment in our common stock could be adversely affected. In addition, thesealternatives may not be available to us when needed or on satisfactory termsdue to prevailing market conditions, a decline in our business, legislative andregulatory factors or restrictions contained in the agreements governing ourindebtedness.

**If we have insufficient cash flow to cover theexpected dividend payments under our dividend policy due to costs associatedwith the Merger or other factors we would need to reduce or eliminate dividendsor, to the extent permitted under the agreements governing our indebtedness,fund a portion of our dividends with additional borrowings.**

If we do not have sufficient cash to fund dividend payments,we would either reduce or eliminate dividends or, to the extent we werepermitted to do so under our credit facility and the agreements governingfuture indebtedness we may incur, fund a portion of our dividends withborrowings or from other sources. If we were to use borrowings under our creditfacility’s revolving facility to fund dividends, we would have less cashavailable for future dividends and other purposes, which could negativelyimpact our financial condition, our results of operations and our ability tomaintain or expand our business.

Prior to the closing ofthe Merger, we expect to invest approximately $95 million to $110 million intransition and other costs in connection with the transaction. Verizon hasagreed to reimburse us for up to $40 million of these pre-closing transitioncosts as described in the Merger Agreement. We expect to partially offset thesepre-closing transition costs with proceeds we expect to receive from the saleof our interest in Orange County Poughkeepsie Limited Partnership to anaffiliate of Verizon, which sale is expected to occur during the second quarterof 2007. However, there can be no assurance that the sale will close during thesecond quarter of 2007 or at all.

**Our substantial indebtedness could restrict ourability to pay dividends on our common stock and have an adverse impact on ourfinancing options and liquidity position.**

Our substantialindebtedness could have important adverse consequences to the holders of ourcommon stock, including:

·       limitingour ability to pay dividends on our common stock or make payments in connectionwith our other obligations, including under our credit facility;

·       limitingour ability in the future to obtain additional financing for working capital,capital expenditures or acquisitions;

·       causingus to not be able to refinance our indebtedness on terms acceptable to us or atall;

·       limitingour flexibility in planning for, or reacting to, changes in our business andthe communications industry generally;

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·       requiringa significant portion of our cash flow from operations to be dedicated to thepayment of the principal and interest on our indebtedness, thereby reducingfunds available for future operations, acquisitions, dividends on our commonstock and/or capital expenditures;

·       makingus more vulnerable to economic and industry downturns and conditions, includingincreases in interest rates; and

·       placingus at a competitive disadvantage compared to those of our competitors that haveless indebtedness.

Subject to certain covenants,our credit facility permits us to incur additional indebtedness. Any additionalindebtedness that we may incur would exacerbate the risks described above.

**In anticipation of the Merger, we will spend asignificant amount of money on assets and services that are not useful in ourexisting business.**

Prior to the closing ofthe Merger, we expect to invest approximately $95 million to $110 million intransition and other costs in connection with the transaction. Verizon hasagreed to reimburse us for up to $40 million of these pre-closing transitioncosts as described in the Merger Agreement. A significant portion of the amountwe expect to spend on pre-closing transition costs will be spent on assets andservices will not be useful in our existing business. In addition, the amountsactually spent on such transition costs may exceed budgeted amounts.

**The Company is a holding company and relies ondividends, interest and other payments, advances and transfers of funds fromits operating subsidiaries and investments to meet its debt service and otherobligations.**

The Company is aholding company and conducts all of its operations through its operatingsubsidiaries. The Company currently has no significant assets other than equityinterests in its first tier subsidiaries. These first tier subsidiaries have nosignificant assets other than a direct or indirect equity interest in theCompany’s operating subsidiaries. As a result, the Company will rely ondividends and other payments or distributions from its operating subsidiariesto pay dividends with respect to its common stock and to meet its debt serviceobligations generally. The ability of the Company’s subsidiaries to paydividends or make other payments or distributions to the Company will depend ontheir respective operating results and may be restricted by, among otherthings:

·       thelaws of their jurisdiction of organization;

·       therules and regulations of state regulatory authorities;

·       agreementsof those subsidiaries;

·       theterms of our credit facility; and

·       thecovenants of any future outstanding indebtedness the Company or itssubsidiaries incur.

The Company’s operating subsidiaries have noobligation, contingent or otherwise, to make funds available to the Company,whether in the form of loans, dividends or other distributions. In addition, wehave minority investments and passive partnership interests from which wereceive distributions. We do not control the timing or amount of distributionsfrom such investments or interests and we may not have access to the cash flowsof these entities.

Accordingly, our abilityto pay dividends with respect to shares of our common stock and to repay ourcredit facility at maturity or otherwise may be dependent upon factors beyondour control. Subject to limitations in our credit facility, the Company’ssubsidiaries may also enter into agreements that contain covenants prohibitingthem from distributing or advancing funds or transferring assets to the Company

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undercertain circumstances, including to pay dividends. Certain regulatory ordersmay similarly restrict or prohibit the Company’s subsidiaries from taking suchactions.

**Our credit facility contains covenants that limit ourbusiness flexibility by imposing operating and financial restrictions on ouroperations and the payment of dividends.**

Covenants in ourcredit facility impose significant operating and financial restrictions on us.These restrictions prohibit or limit, among other things:

·       theincurrence of additional indebtedness and the issuance by our subsidiaries ofpreferred stock;

·       thepayment of dividends on, and purchases or redemptions of, capital stock;

·       anumber of other restricted payments, including investments;

·       thecreation of liens;

·       theability of our subsidiaries to guarantee our and their indebtedness;

·       specifiedsales of assets;

·       thecreation of encumbrances or restrictions on the ability of our subsidiaries todistribute and advance funds or transfer assets to us or any other subsidiary;

·       specifiedtransactions with affiliates;

·       saleand leaseback transactions;

·       ourability to enter lines of business outside the communications business; and

·       certainconsolidations and mergers and sales and/or transfers of assets by or involvingus.

Our credit facility alsocontains covenants which require us to maintain specified financial ratios andsatisfy financial condition tests, including, without limitation, a maximumtotal leverage ratio and a minimum interest coverage ratio.

As a result of generaleconomic conditions, conditions in the lending markets, the results of ourbusiness or for any other reason, we may elect or be required to amend orrefinance our credit facility, at or prior to maturity, or enter intoadditional agreements for indebtedness. Any such amendment, refinancing or additionalagreement may contain covenants which could limit in a significant manner ouroperations and our ability to pay dividends on our common stock.

**If we are unable to comply with the covenants in theagreements governing our indebtedness, we could be in default under ourindebtedness which could result in our inability to make dividend payments onour common stock.**

Our ability to comply withthe covenants, ratios or tests contained in our credit facility or in theagreements governing our future indebtedness may be affected by events beyondour control, including prevailing economic, financial and industry conditions.A breach of any of these covenants, ratios or tests could result in a defaultunder our credit facility. Certain events of default under our credit facilitywould prohibit us from making dividend payments on our common stock. Inaddition, upon the occurrence of an event of default under our credit facility,the lenders could elect to declare all amounts outstanding under our creditfacility, together with accrued interest, to be immediately due and payable. Ifwe were unable to repay those amounts, the lenders could proceed against thesecurity granted to them to secure that indebtedness. If the lenders acceleratethe payment of the indebtedness under our credit facility, our assets may notbe sufficient to repay in full the indebtedness under our credit facility andour other indebtedness, if any.

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**Limitations on usage of net operating loss carryforwards, and other factors requiring us to pay cash taxes in future periods,may affect our ability to pay dividends.**

Our initial publicoffering in February 2005 resulted in an “ownership change” within themeaning of the U.S. federal income tax laws addressing net operating loss carryforwards, alternative minimum tax credits and other similar tax attributes. Asa result of such ownership change, there are specific limitations on ourability to use our net operating loss carry forwards and other tax attributesfrom periods prior to our initial public offering. Although it is not expectedthat such limitations will materially affect our U.S. federal and state incometax liability in the near-term, it is possible in the future that suchlimitations could limit our ability to utilize such tax attributes and,therefore, result in an increase in our U.S. federal and state income taxpayments. In addition, in the future we may be required to pay cash income taxesbecause all of our net operating loss carry forwards have been used or haveexpired. Limitations on our usage of net operating loss carry forwards, andother factors requiring us to pay cash taxes in the future, would reduce thefunds available for the payment of dividends and might require us to reduce oreliminate the dividends on our common stock.

**The price of our common stock may fluctuatesubstantially, which could negatively affect holders of our common stock.**

The market price of ourcommon stock may fluctuate widely as a result of various factors, such asperiod-to-period fluctuations in our operating results, sales of our commonstock by principal stockholders, developments in the communications industry,the failure of securities analysts to cover our common stock or changes infinancial estimates by analysts, competitive factors, regulatory developments,economic and other external factors, general market conditions and marketconditions affecting the stock of communications companies in particular.Communications companies have in the past experienced extreme volatility in thetrading prices and volumes of their securities, which has often been unrelatedto operating performance. Any such market volatility may have a significantadverse effect on the market price of our common stock.

**Future sales or the possibility of future sales of asubstantial amount of our common stock may depress the price of our commonstock.**

Future sales, or theavailability for sale in the public market, of substantial amounts of ourcommon stock could adversely affect the prevailing market price of our commonstock, and could impair our ability to raise capital through future sales ofequity securities. We may issue shares of our common stock, or othersecurities, from time to time as consideration for future acquisitions andinvestments. In the event any such acquisition or investment is significant,the number of shares of our common stock, or the number or aggregate principalamount, as the case may be, of other securities that we may issue may in turnbe significant. We may also grant registration rights covering those shares orother securities in connection with any such acquisitions and investments.

In connection with theMerger, we will issue an estimated 53.8 million shares of our common stock tostockholders of Spinco. We plan to register the issuance of such sharespursuant to a registration statement to be filed with the SEC.

**Our restated certificate of incorporation and amendedand restated by-laws and several other factors could limit another party’sability to acquire us and deprive our investors of the opportunity to obtain atakeover premium for their securities.**

A number of provisions inour restated certificate of incorporation and amended and restated by-laws makeit difficult for another company to acquire us and for you to receive anyrelated takeover premium 

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for yoursecurities. For example, our restated certificate of incorporation providesthat certain provisions of our restated certificate of incorporation can onlybe amended by a vote of two-thirds or more in voting power of all theoutstanding shares of capital stock and that stockholders generally may not actby written consent and only stockholders representing at least 50% in votingpower may request that our board of directors call a special meeting. Ourrestated certificate of incorporation provides for a classified board ofdirectors and authorizes the issuance of preferred stock without stockholderapproval and upon such terms as the board of directors may determine. Therights of the holders of shares of our common stock will be subject to, and maybe adversely affected by, the rights of holders of any class or series ofpreferred stock that may be issued in the future.

**We may, under certain circumstances, suspend therights of stock ownership the exercise of which would result in anyinconsistency with, or violation of, any applicable communications law.**

Our restated certificateof incorporation provides that so long as we hold any authorization, license,permit, order, filing or consent from the Federal Communications Commission orany state regulatory commission having jurisdiction over us, we will have theright to request certain information from our stockholders. If any stockholderfrom whom such information is requested should fail to respond to such arequest or we conclude that the ownership of, or the existence or exercise ofany rights of stock ownership with respect to, shares of our capital stock bysuch stockholder, could result in any inconsistency with, or violation of, anyapplicable communications law, we may suspend those rights of stock ownershipthe existence or exercise of which would result in any inconsistency with, orviolation of, any applicable communications law, and we may exercise any andall appropriate remedies, at law or in equity, in any court of competentjurisdiction, against any stockholder, with a view towards obtaining suchinformation or preventing or curing any situation which would cause aninconsistency with, or violation of, any provision of any applicablecommunications law.

***Risks Related toour Business***

**We provide services to our customers over accesslines, and if we lose access lines, our business and results of operations maybe adversely affected.**

Our business generatesrevenue by delivering voice and data services over access lines. We haveexperienced net voice access line losses, adjusted for acquisitions anddivestitures, of 10.2% for the period from January 1, 2002 through December 31,2006 and 3.5% for the period from December 31, 2005 through December 31,2006, due mainly to challenging economic conditions and the introduction ofdigital subscriber line services. We may continue to experience net access linelosses in our markets. Our inability to retain access lines could adverselyaffect our business and results of operations.

**The Merger may present significant challenges to ourmanagement that could divert management’s attention from day-to-day operationsand have a negative impact on our business.**

There is a significantdegree of difficulty and management distraction inherent in the process ofclosing the Merger and preparing to integrate our business and Spinco’sbusiness which could cause an interruption of, or loss of momentum in, theactivities of our existing business. Prior to the closing of the Merger, ourmanagement team may be required to devote considerable amounts of time to thisintegration process, which will decrease the time they will have to manage ourbusiness, service existing customers, attract new customers and develop newproducts or strategies. One potential consequence of such distractions could bethe failure of management to realize opportunities to respond to the increasingforms of competition that our business is facing, which could increase the rateof access line loss that our business has experienced in recent years. If oursenior management is not able to effectively manage the process 

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leadingup to the Merger, or if any significant business activities are interrupted asa result of the integration process, our business could suffer.

**We are subject to competition that may adverselyimpact us.**

As an incumbent carrier,we historically have experienced little competition in our rural telephonecompany markets. Nevertheless, the market for communications services is highlycompetitive. Regulation and technological innovation change quickly in thecommunications industry, and changes in these factors historically have had,and may in the future have, a significant impact on competitive dynamics. Inmost of our rural markets, we face competition from wireless technology, whichmay increase as wireless technology improves. We also face competition fromwireline and cable television operators. We may face additional competition fromnew market entrants, such as providers of wireless broadband, VoIP, satellitecommunications and electric utilities. The Internet services market is alsohighly competitive, and we expect that competition will intensify. Many of ourcompetitors have brand recognition, offer online content services and havefinancial, personnel, marketing and other resources that are significantlygreater than ours. In addition, consolidation and strategic alliances withinthe communications industry or the development of new technologies could affectour competitive position. We cannot predict the number of competitors that willemerge, especially as a result of existing or new federal and state regulatoryor legislative actions, but increased competition from existing and newentities could have a material adverse effect on our business.

Competitionmay lead to loss of revenues and profitability as a result of numerous factors,including:

·       lossof customers (in general, when we lose a customer for local service we also losethat customer for all related services);

·       reducedusage of our network by our existing customers who may use alternativeproviders for long distance and data services;

·       reductionsin the prices for our services which may be necessary to meet competition;and/or

·       increasesin marketing expenditures and discount and promotional campaigns.

In addition, our provisionof long distance service is subject to a highly competitive market served bylarge nation-wide carriers that enjoy brand name recognition.

**We may not be able to successfully integrate newtechnologies, respond effectively to customer requirements or provide newservices.**

The communicationsindustry is subject to rapid and significant changes in technology, frequentnew service introductions and evolving industry standards. We cannot predictthe effect of these changes on our competitive position, profitability orindustry. Technological developments may reduce the competitiveness of ournetworks and require unbudgeted upgrades or the procurement of additionalproducts that could be expensive and time consuming. In addition, new productsand services arising out of technological developments may reduce theattractiveness of our services. If we fail to adapt successfully totechnological changes or obsolescence or fail to obtain access to important newtechnologies, we could lose customers and be limited in our ability to attractnew customers and/or sell new services to our existing customers. Our abilityto respond to new technological developments may be diminished or our responsethereto delayed while our management devotes significant effort and resourcesto closing the Merger and preparing to integrate our business and Spinco’sbusiness. An element of our business strategy is to deliver enhanced andancillary services to customers. The successful delivery of new services isuncertain and dependent on many factors, and we may not generate anticipatedrevenues from such services.

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**Our relationships with other communications companiesare material to our operations and their financial difficulties may adverselyaffect our business and results of operations.**

We originate and terminatecalls for long distance carriers and other interexchange carriers over ournetwork and for that service we receive payments for access charges. Thesepayments represent a significant portion of our revenues. Should these carriersgo bankrupt or experience substantial financial difficulties, our inability tothen collect access charges from them could have a negative effect on ourbusiness and results of operations.

**We face risks associated with acquired businesses andpotential acquisitions.**

Wehave grown rapidly by acquiring other businesses and we expect that a portionof our future growth will result from additional acquisitions, some of whichmay be material. Growth through acquisitions, including the Merger, entailsnumerous risks, including:

·       strainon our financial, management and operational resources, including thedistraction of our management team in identifying potential acquisitiontargets, conducting due diligence and negotiating acquisition agreements;

·       difficultiesin integrating the network, operations, personnel, products, technologies andfinancial, computer, payroll and other systems of acquired businesses;

·       difficultiesin enhancing our customer support resources to adequately service our existingcustomers and the customers of acquired businesses;

·       thepotential loss of key employees or customers of the acquired businesses;

·       unanticipatedliabilities or contingencies of acquired businesses;

·       unbudgetedcosts which we may incur in connection with pursuing potential acquisitionswhich are not consummated;

·       failureto achieve projected cost savings or cash flow from acquired businesses;

·       fluctuationsin our operating results caused by incurring considerable expenses to acquirebusinesses before receiving the anticipated revenues expected to result fromthe acquisitions;

·       difficultiesin finding suitable acquisition candidates;

·       difficultiesin making acquisitions on attractive terms due to a potential increase incompetitors; and

·       difficultiesin obtaining and maintaining any required regulatory authorizations inconnection with acquisitions.

The size of Spinco’sbusiness in relation to our existing business may exacerbate the above riskswith respect to the Merger.

In addition, futureacquisitions by us could result in the incurrence of indebtedness or contingentliabilities, which could have a material adverse effect on our business and ourability to pay dividends on our common stock, provide adequate working capitaland service our indebtedness.

There can be no assurancethat we will be able to successfully complete the integration of Spinco or ofother businesses that we have already acquired or successfully integrate anybusinesses that we might acquire in the future. If we fail to do so, or if wedo so but at greater cost than we anticipated, there will be a risk that ourbusiness may be adversely affected.

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**We may need additional capital to continue growingthrough acquisitions.**

We may need additionalcapital to continue growing through acquisitions. Such additional capital maybe in the form of additional debt, which would increase our leverage. We maynot be able to raise sufficient additional capital at all or on terms that weconsider acceptable.

**A system failure could cause delays or interruptionsof service, which could cause us to lose customers.**

To besuccessful, we will need to continue to provide our customers reliable serviceover our network. Some of the risks to our network and infrastructure include:

·       physicaldamage to access lines;

·       powersurges or outages;

·       softwaredefects; and

·       disruptionsbeyond our control.

Disruptions may causeinterruptions in service or reduced capacity for customers, either of whichcould cause us to lose customers and incur expenses.

**Our billing systems may not function properly.**

The failure of any of ourbilling systems could result in our inability to adequately bill and provideservice to our customers. We are in the process of converting all of ourcompanies to a single outsourced billing platform. The conversion is expectedto be complete by the middle of 2007. At the completion of this project, wewill have a single integrated billing platform for our end-user customers.  The failure to successfully complete thisconversion or the failure of any of our billing systems could have a materialadverse effect on our business, financial condition and results of operations.

**We depend on third parties for our provision of longdistance and bandwidth services.**

Our provision of longdistance and bandwidth services is dependent on underlying agreements withother carriers that provide us with transport and termination services. Theseagreements are based, in part, on our estimate of future supply and demand andmay contain minimum volume commitments. If we overestimate demand, we may beforced to pay for services we do not need. If we underestimate demand, we mayneed to acquire additional capacity on a short-term basis at unfavorableprices, assuming additional capacity is available. If additional capacity isnot available, we will not be able to meet this demand. In addition, if wecannot meet any minimum volume commitments, we may be subject to underutilizationcharges, termination charges, or rate increases which may adversely affect ourresults of operations.

**We may not be able to maintain the necessaryrights-of-way for our networks.**

We are dependent onrights-of-way and other permits from railroads, utilities, state highwayauthorities, local governments and transit authorities to install and maintainconduit and related communications equipment for any expansion of our networks.We may need to renew current rights-of-way for our networks and cannot assureyou that we would be successful in renewing these agreements on acceptableterms. Some of our agreements may be short-term, revocable at will, or subjectto termination upon customary default provisions, and we may not have access toexisting rights-of-way after they have expired or terminated. If any of theseagreements were terminated or could not be renewed, we may be 

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requiredto remove our existing facilities from under the streets or abandon ournetworks. Similarly, we may not be able to obtain right-of-way agreements onfavorable terms, or at all, in new service areas, and, if we are unable to doso, our ability to expand our networks, if we decide to do so, could beimpaired.

**Our success depends on our ability to attract andretain qualified management and other personnel.**

Our success depends uponthe talents and efforts of our senior management team. With the exception ofEugene B. Johnson, our Chairman and Chief Executive Officer, none of thesesenior executives are employed by us pursuant to an employment agreement. Theloss of any member of our senior management team, due to retirement orotherwise, and the inability to attract and retain highly qualified technicaland management personnel in the future, could have a material adverse effect onour business, financial condition and results of operations.

**We may face significant future liabilities orcompliance costs in connection with environmental and worker health and safetymatters.**

Our operations andproperties are subject to federal, state and local laws and regulationsrelating to protection of the environment, natural resources, and worker healthand safety, including laws and regulations governing the management, storageand disposal of hazardous substances, materials and wastes. Under certainenvironmental laws, we could be held liable, jointly and severally and withoutregard to fault, for the costs of investigating and remediating anycontamination at owned or operated properties; or for contamination arisingfrom the disposal by us or our predecessors of hazardous wastes at formerlyowned properties or at third party waste disposal sites. In addition, we couldbe held responsible for third party property or personal injury claims relatingto any such contamination or violations of environmental laws. Changes inexisting laws or regulations or future acquisitions could require us to incursubstantial future costs relating to such matters.

**We are exposed to risks relating to evaluations ofcontrols required by Section 404 of the Sarbanes-Oxley Act.**

Changing laws, regulationsand standards relating to corporate governance and public disclosure, includingthe Sarbanes-Oxley Act and related regulations implemented by the SEC,the New York Stock Exchange and the Public Company Accounting Oversight Board,are creating uncertainty for public companies, increasing legal and financialcompliance costs and making some activities more time consuming. We evaluateour internal controls systems to allow management to report on, and ourindependent auditors to attest to, our internal controls as required bySection 404 of the Sarbanes-Oxley Act. Our evaluation of our internalcontrols may result in our identifying material weaknesses in our internalcontrols. If we fail to maintain effective controls and procedures, we may beunable to provide financial information in a timely and reliable manner.

***Risks Related toour Regulatory Environment***

**We are subject to significant regulations that couldchange in a manner adverse to us.**

We operate in a heavilyregulated industry, and the majority of our revenues generally have beensupported by regulations, including access revenue and Universal Service Fundsupport for the provision of telephone services in rural areas. Laws andregulations applicable to us and our competitors may be, and 

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have been, challenged in the courts, and could bechanged by Congress or regulators. In addition, any of the following have thepotential to have a significant impact on us:

*Riskof loss or reduction of network access charge revenues.*   Asignificant portion of our revenues come from network access charges, which arepaid to us by intrastate and interstate long distance carriers for originatingand terminating calls in the regions served. This also includes UniversalService Fund payments for local switching support, long term support andinterstate common line support. In recent years, several of these long distancecarriers have declared bankruptcy. Future declarations of bankruptcy by one ormore carriers that utilize our access services could negatively impact ourfinancial results. The amount of access charge revenues that we receive isbased on rates set by federal and state regulatory bodies, and such rates couldchange. Further, from time to time federal and state regulatory bodies conductrate cases and/or “earnings” reviews, which may result in rate changes. TheFederal Communications Commission has reformed and continues to reform thefederal access charge system. States often mirror these federal rules inestablishing intrastate access charges. In October 2001, the FederalCommunications Commission reformed the system to reduce interstate accesscharges and shift a portion of cost recovery, which historically has been basedon minutes-of-use, to flat-rate, monthly per line charges on end-user customersrather than long distance carriers. As a result, the aggregate amount of accesscharges paid by long distance carriers to access providers, such as our rurallocal exchange carriers, has decreased and may continue to decrease. Althoughthese changes were implemented on a revenue neutral basis (with commensurateincreases in other charges and Universal Service Fund support), there is noassurance that future changes in access charge rates will be implemented on arevenue neutral basis. Furthermore, to the extent our rural local exchangecarriers become subject to competition, such access charges could be paid tocompeting communications providers rather than to us. Additionally, theoriginating and terminating access revenues we receive may be reduced as a resultof wireless, VoIP, or other new technology utilization. Finally, the FederalCommunications Commission is currently weighing several proposals tocomprehensively reform the intercarrier compensation regime in order to createa uniform system of intercarrier payments. Any such proposal eventually adoptedby the Federal Communications Commission will likely involve significantchanges in the access charge system and could potentially result in asignificant decrease or elimination of access charges altogether. Decreases orlosses of access charges may or may not result in offsetting increases inlocal, subscriber line or Universal Service Fund revenues. Regulatorydevelopments of this type could adversely affect our business, revenue and/orprofitability.

*Riskof loss or reduction of Universal Service Fund support.*   Wereceive Universal Service Fund revenues to support the high cost of ouroperations in rural markets. The high cost loop support we receive from theUniversal Service Fund is based upon our average cost per loop compared to thenational average cost per loop. This revenue stream fluctuates based upon ouraverage cost per loop compared to the national average cost per loop. Forexample, if the national average cost per loop increases and our operatingcosts (and average cost per loop) remain constant or decrease, the payments wereceive from the Universal Service Fund would decline. Conversely, if thenational average cost per loop decreases and our operating costs (and averagecost per loop) remain constant or increase, the payments we receive from the UniversalService Fund would increase. The national average cost per loop in relation toour average cost per loop has increased and we believe that the nationalaverage cost per loop will likely continue to increase in relation to ouraverage cost per loop. As a result, the payments we receive from the UniversalService Fund have declined and will likely continue to decline. This supportfluctuates based upon the historical costs of our operating companies. Inaddition to the Universal Service Fund high cost loop support, we also receiveother Universal Service Fund support payments, which include local switchingsupport, long term support, and interstate common line support that used to beincluded in our interstate access charge revenues (the Federal CommunicationsCommission has recently merged long term support into interstate common linesupport). If our rural local exchange carriers were unable to receive supportfrom the Universal Service Fund, or if such support was reduced, many of ourrural local exchange carriers would be unable to operate as profitably as theyhave historically, in the absence of our implementation of 

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increases in charges forother services. Moreover, if we raise prices for services to offset loss ofUniversal Service Fund payments, the increased pricing of our services maydisadvantage us competitively in the marketplace, resulting in additionalpotential revenue loss.

The Telecommunications Act provides that eligiblecommunications carriers, including competitors to rural local exchangecarriers, may obtain the same per line support as the rural local exchangecarriers receive if a state commission determines that granting such support tocompetitors would be in the public interest. In fact, wireless communicationsproviders in certain of our markets have obtained matching support paymentsfrom the Universal Service Fund, but that has not led to a loss of revenues forour rural local exchange carriers under existing regulations. Any shift inuniversal service regulation, however, could have an adverse effect on ourbusiness, revenue and/or profitability.

During the last four years, pursuant torecommendations made by the Multi Association Group and the Rural Task Force,the Federal Communications Commission has made certain modifications to theuniversal service support system that changed the sources of support and themethod for determining the level of support. These changes have been revenueneutral to our operations. It is unclear whether the changes in methodologywill continue to accurately reflect the costs incurred by our rural localexchange carriers, and whether it will provide for the same amount of UniversalService Fund support that our rural local exchange carriers have received inthe past. In addition, several parties have raised objections to the size ofthe Universal Service Fund and the types of services eligible for support. Anumber of issues regarding the source and amount of contributions to, andeligibility for payments from, the Universal Service Fund are pending and willlikely be addressed by the Federal Communications Commission or Congress in thenear future. For example, a number of proposals to be examined by the FederalCommunications Commission in its current rulemaking with respect to the reformof the intercarrier compensation system include reforms of the UniversalService Fund. The outcome of any regulatory proceedings or legislative changescould affect the amount of Universal Service Fund support that we receive, andcould have an adverse effect on our business, revenue or profitability.

On February 28, 2005, the Federal CommunicationsCommission issued a press release announcing additional requirements for thedesignation of competitive Eligible Telecommunications Carriers for receipt ofhigh-cost support. In its corresponding order, released on March 17, 2005,the Federal Communications Commission adopted additional mandatory requirementsfor Eligible Telecommunications Carriers designation in cases where it hasjurisdiction, and encourages states that have jurisdiction to designateEligible Telecommunications Carriers to adopt similar requirements. The FederalCommunications Commission is still considering revisions to the methodology bywhich contributions to the Universal Service Fund are determined. The FederalCommunications Commission adopted interim changes to this methodology in June 2006,and further revisions will be part of an overall rulemaking regarding UniversalService Support that remains pending.

*Riskof loss of statutory exemption from burdensome interconnection rules imposedon incumbent local exchange carriers.**  *Our rural local exchange carriers are exempt from theTelecommunications Act’s more burdensome requirements governing the rights ofcompetitors to interconnect to incumbent local exchange carrier networks and toutilize discrete network elements of the incumbent’s network at favorablerates. If state regulators decide that it is in the public’s interest to imposethese more burdensome interconnection requirements on us, we would be requiredto provide unbundled network elements to competitors. As a result, morecompetitors could enter our traditional telephone markets than are currentlyexpected and we could incur additional administrative and regulatory expenses,and experience additional revenue losses.

*Risksposed by costs of regulatory compliance.*   Regulationscreate significant compliance costs for us. Our subsidiaries that provideintrastate services are generally subject to certification, tariff filing andother ongoing regulatory requirements by state regulators. Our interstateaccess services are provided in accordance with tariffs filed with the FederalCommunications Commission. Challenges to our tariffs by 

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regulators or thirdparties or delays in obtaining certifications and regulatory approvals couldcause us to incur substantial legal and administrative expenses, and, ifsuccessful, such challenges could adversely affect the rates that we are ableto charge our customers.

Our business also may beimpacted by legislation and regulation imposing new or greater obligationsrelated to assisting law enforcement, bolstering homeland security, minimizingenvironmental impacts, or addressing other issues that impact our business. Forexample, existing provisions of the Communications Assistance for LawEnforcement Act and Federal Communications Commission regulations implementingthe Communications Assistance for Law Enforcement Act require communicationscarriers to ensure that their equipment, facilities, and services are able tofacilitate authorized electronic surveillance. We cannot predict whether andwhen the Federal Communications Commission might modify its CommunicationsAssistance for Law Enforcement Act rules or any other rules or whatcompliance with new rules might cost. Similarly, we cannot predict whetheror when federal or state legislators or regulators might impose new security,environmental or other obligations on our business.

**Regulatory changes in the communications industrycould adversely affect our business by facilitating greater competition againstus, reducing potential revenues or raising our costs.**

The Telecommunications Actprovides for significant changes and increased competition in thecommunications industry, including the local communications and long distanceindustries. This statute and the Federal Communications Commission’simplementing regulations remain subject to judicial review and additionalrulemakings of the Federal Communications Commission, thus making it difficultto predict what effect the legislation will have on us, including ouroperations and our revenues and expenses, and our competitors. Severalregulatory and judicial proceedings have recently concluded, are underway ormay soon be commenced, that address issues affecting our operations and thoseof our competitors. We cannot predict the outcome of these developments, norcan we assure that these changes will not have a material adverse effect on usor our industry.

**The failure to obtain necessary regulatory approvalscould impede the consummation of a potential acquisition.**

Our acquisitions likely will be subject to federal,state and local regulatory approvals. We cannot assure you that we will be ableto obtain any necessary approvals, in which case a potential acquisition couldbe delayed or not consummated.

Theconsummation of the Merger is subject to certain state and federal regulatoryapprovals. We cannot assure you that we will be able to obtain the necessaryapprovals, that could delay or prevent the consummation of the Merger.

**ITEM 1B.   UNRESOLVEDSTAFF COMMENTS**

On or about November 22,2006, we received a comment letter from the SEC regarding our Annual Report on Form 10-Kfor our fiscal year ended December 31, 2005. All comments were resolvedthrough correspondence with the SEC.

**ITEM 2.**                PROPERTIES

We own all of the properties material to our business.Our headquarters is located in Charlotte, North Carolina in a leased facility.We also have administrative offices, maintenance facilities, rolling stock,central office and remote switching platforms and transport and distributionnetwork facilities in each of the 18 states in which we operate our rural localexchange carrier business. Our administrative and maintenance facilities aregenerally located in or near the rural communities served by our rural localexchange carriers and our central offices are often within the administrativebuilding and/or outlying 

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customer service centers.Auxiliary battery or other non-utility power sources are at each central officeto provide uninterrupted service in the event of an electrical power failure.Transport and distribution network facilities include fiber optic backbone andcopper wire distribution facilities, which connect customers to remote switchlocations or to the central office and to points of presence or interconnectionwith the long distance carriers. These facilities are located on land pursuantto permits, easements or other agreements. Our rolling stock includes servicevehicles, construction equipment and other required maintenance equipment.

We believe each of ourrespective properties is suitable and adequate for the business conductedtherein, is being appropriately used consistent with past practice and hassufficient capacity for the present intended purposes.

**ITEM 3.**                LEGALPROCEEDINGS

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 has contestedthe appeal and filed a Motion to Dismiss the action. The Magistrate, on February 9,2006, issued a Memorandum and a Recommendation to the District Court Judge thatthe Motion to Dismiss be granted and that the complaint be dismissed withprejudice. The plaintiff has filed a Notice of Objection to the Magistrate’sRecommendation. Both the appeal of denial of the Motion to Remand and theMotion to Dismiss are pending before the District Court Judge. We believe thatthis action is without merit and intend to continue to defend the litigationvigorously.

From time to time, we areinvolved in other litigation and regulatory proceedings arising out of ouroperations. Management believes that we are not currently a party to any legalproceedings, the adverse outcome of which, individually or in the aggregate,would have a material adverse effect on our financial position or results ofoperations.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our securityholders during the fourth quarter of fiscal 2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**General**

Our common stock began trading on the New York StockExchange under the symbol “FRP” on February 4, 2005. Prior to that time,there was no trading market for our common stock.

Thefollowing table shows the high and low closing sales prices per share of ourcommon stock as reported on the New York Stock Exchange for the periodsindicated:

| **Year ended December 31, 2006** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First quarter                                        |       | $          | 14.41      |     | $          | 10.92   |       |
| Second quarter                                       |       | 14.40      |       | 12.91    |       |
| Third quarter                                        |       | 18.10      |       | 13.81    |       |
| Fourth quarter                                       |       | 19.74      |       | 17.40    |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

| **Year ended December 31, 2005** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First quarter                                        |       | $          | 18.05      |     | $          | 14.97   |       |
| Second quarter                                       |       | 16.55      |       | 14.49    |       |
| Third quarter                                        |       | 16.66      |       | 14.32    |       |
| Fourth quarter                                       |       | 14.30      |       | 10.36    |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

Thefollowing table shows the dividends which have been declared and/or paid on ourcommon stock during 2006 and 2005:

| **Year ended December 31, 2006** | ** ** | ** ** | ** ** | **Per Share  Dividend  Declared** | ** **           | **Date Declared** | ** **           | **Record Date**   | ** **           | **Date  Paid/Payable** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------------------------------------|----------------------|------------------------|----------------------|------------------------|----------------------|------------------------|------------|
| First quarter                                        |       | $          | 0.39781    |                                   | March 15,  2006 |                   | March 31,  2006 |                   | April 18,  2006 |                   |
| Second quarter                                       |       | 0.39781    |       | June 21,  2006                    |                 | July 6,  2006     |                 | July 21,  2006    |                 |
| Third quarter                                        |       | 0.39781    |       | September 19,  2006               |                 | October 3,  2006  |                 | October 18,  2006 |                 |
| Fourth quarter                                       |       | 0.39781    |       | December 13, 2006                 |                 | December 29, 2006 |                 | January 16, 2007  |                 |
|                                                      |            |            |            |                                        |                      |                        |                      |                        |                      |                        |            |  |

 

| **Year ended December 31, 2005** | ** ** | ** ** | ** ** | **Per Share  Dividend  Declared** | ** **          | **Date Declared** | ** **           | **Record Date**   | ** **           | **Date  Paid/Payable** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------------------------------------|---------------------|------------------------|----------------------|------------------------|----------------------|------------------------|------------|
| First quarter(1)                                     |       | $          | 0.22543    |                                   | March 3,  2005 |                   | March 31,  2005 |                   | April 15,  2005 |                   |
| Second quarter                                       |       | 0.39781    |       | June 16,  2005                    |                | June 30,  2005    |                 | July 19,  2005    |                 |
| Third quarter                                        |       | 0.39781    |       | September 21,  2005               |                | October 3,  2005  |                 | October 19,  2005 |                 |
| Fourth quarter                                       |       | 0.39781    |       | December 14, 2005                 |                | December 30, 2005 |                 | January 18, 2006  |                 |
|                                                      |            |            |            |                                        |                     |                        |                      |                        |                      |                        |            |  |

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(1)          Our initial publicoffering occurred in February 2005 and, therefore, we paid a partialquarterly dividend for the first quarter of 2005.

As of March 1, 2007,there were approximately 119 holders of record of our common stock.

**Performance Graph**

Set forth below is a line graph comparing the yearlypercentage change in the cumulative total stockholder return on shares of ourcommon stock against (i) the cumulative total return of all companieslisted on the New York Stock Exchange and (ii) the cumulative total returnof the peer group set forth below which was selected by us. The period comparedcommences on January 1, 2006 and ends on 

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December 31, 2006. Thisgraph assumes that $100 was invested on January 1, 2006 in our commonstock and in each of the market index and the peer group index at the closingprice for the Company and the other companies, and that all cash distributionswere reinvested. Our common stock price performance shown on the graph is notindicative of future price performance.

Our peer group consists of the following companies:  CenturyTel, Inc., CitizensCommunications Company, Consolidated Communications Holdings, Inc., IowaTelecommunications Services, Inc. and Windstream Corporation.

****

**Dividend Policy andRestrictions**

***General***

Our board ofdirectors has adopted a dividend policy which reflects an intention that asubstantial portion of the cash generated by our business in excess ofoperating needs, interest and principal payments on our indebtedness, dividendson our future senior classes of capital stock, if any, capital expenditures,taxes and future reserves, if any, would in general be distributed as regularquarterly dividend payments to the holders of our common stock, rather thanretained by us and used for other purposes, including to finance growthopportunities. This policy reflects our judgment that our stockholders would bebetter served if we distributed to them such substantial portion of the excesscash generated by our business instead of retaining it in our business.However, our stockholders may not receive any dividends as a result of thefollowing factors:

·       nothingrequires us to pay dividends;

·       whileour current dividend policy contemplates the distribution of a substantialportion of our cash in excess of operating needs, interest and principalpayments on our indebtedness, dividends on our future senior classes of capitalstock, if any, capital expenditures, taxes and future reserves, if any, thispolicy could be modified or revoked by our board of directors at any time;

·       evenif our dividend policy was not modified or revoked, the actual amount ofdividends distributed under this policy and the decision to make anydistributions are entirely at the discretion of our board of directors;

·       theamount of dividends distributed is subject to covenant restrictions under ourcredit facility;

·       theamount of dividends distributed is subject to restrictions under Delaware law;

·       ourstockholders have no contractual or other legal right to receive dividends; and

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·       wemay not have enough cash to pay dividends due to changes in our cash fromoperations, distributions we receive from minority investments and passivepartnership interests, working capital requirements and/or anticipated cashneeds.

We believe that our dividend policy limits, but doesnot preclude, our ability to pursue growth. If we continue paying dividends atthe level currently anticipated under our dividend policy, we expect that wewould need additional financing to fund significant acquisitions or to pursuegrowth opportunities requiring capital expenditures that are significantlybeyond our current expectations.

Prior to the closing ofthe Merger, we expect to invest approximately $95 million to $110 million intransition and other costs in connection with the transaction. Verizon hasagreed to reimburse us for up to $40 million of these pre-closing transitioncosts as described in the Merger Agreement. A significant portion of the amountwe expect to spend on pre-closing transition costs will be spent on assets andservices which will not be useful in our existing business. We expect to fundthese expenditures principally from the proceeds we expect to receive from thesale of our interest in Orange County Poughkeepsie Limited Partnership to anaffiliate of Verizon, which sale is expected to occur during the second quarterof 2007. See “—Restrictions on Payment of Dividends” below.

***Restrictions on 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 our cumulative distributable cash to pay dividends, but maynot in general pay dividends in excess of the amount of ourcumulative distributable cash. “Cumulative distributable cash” is defined inour credit facility as the amount of “available cash” generated beginning on April 1,2005 through the end of the Company’s most recent fiscal quarter for whichfinancial statements are available and a compliance certificate has beendelivered (a) minus the aggregate amount of dividends paid after July 30,2005 and the aggregate amount of investments made after April 1, 2005using such cash, (b) plus the aggregate amount of distributions receivedfrom such investments (not to exceed the amount originally invested). “Availablecash” is defined in our credit facility as Adjusted EBITDA (a) minus (i) cashinterest expense (adjusted for amortization and swap interest), (ii) scheduledprincipal payments on indebtedness, (iii) consolidated capitalexpenditures, (iv) investments, (v) cash income taxes, and (vi) non-cashitems excluded from Adjusted EBITDA and paid in cash and (b) plus (i) thecash amount of any extraordinary gains and gains realized on asset sales otherthan in the ordinary course of business and (ii) cash received on accountof non-cash gains and non-cash income excluded from Adjusted EBITDA. “AdjustedEBITDA” is defined in our 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, consolidated interest expense, depreciation, amortization,losses on sales of assets and other extraordinary losses, certain one-timecharges recorded as operating expenses related to the transactions contemplatedby the Merger Agreement and certain other non-cash items, each as defined, (b) minusgains on sales of assets and other extraordinary gains and all non-cash itemsincreasing Consolidated Net Income.

·       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 5.25 to 1.00 or if we do not haveat least $10 million of cash on hand (including unutilized commitmentsunder our credit facility’s revolving facility).

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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—Liquidity”in this Annual Report for a more detailed description of our credit facilityand these restrictions.

**Equity CompensationPlan Information**

Thetable below provides information, as of the end of the most recently completedfiscal year, concerning securities authorized for issuance under our equitycompensation plans.

| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights(1)** | ** ** | **Weighted average  exercise price of  outstanding options,  warrants, and rights(1)** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans(2)** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by our stockholders     |       |       | 1,077,417  |                                                                                                                                                |       |                                                                                                                 | $          | 15.52                                                                                                                                      |       |   |   | 280,880 |   |   |
| Equity compensation  plans not approved by our stockholders |       |       | 0          |                                                                                                                                                |       |                                                                                                                 | $          | 0                                                                                                                                          |       |   |   | 0 |   |   |

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(1)          Includes 832,888 optionsto purchase shares of our common stock under the FairPoint Communications, Inc.(formerly MJD Communications, Inc.) 1998 Stock Incentive Plan, 209,075options to purchase shares of our common stock under the FairPoint Communications, Inc.2000 Employee Stock Incentive Plan, 14,549 restricted units granted under theFairPoint Communications, Inc. 2000 Employee Stock Incentive Plan and20,905 restricted units granted under the FairPoint Communications, Inc.2005 Stock Incentive Plan.

(2)          Includes280,880 shares under the FairPoint Communications, Inc. 2005 StockIncentive Plan. Available shares shown above for the FairPoint Communications, Inc.2005 Stock Incentive Plan include shares that have become available due toforfeitures or have been re-acquired by the Company for any reasons withoutdelivery of the stock, as allowed under the terms of the plan.

**Purchases of EquitySecurities by the Company and Affiliated Purchasers**

None of our equitysecurities registered pursuant to Section 12 of the Exchange Act  were purchased by us or affiliatedpurchasers, as defined in Rule 10b-18(a)(3) under the ExchangeAct, during 2006.

**Unregistered Salesof Equity Securities**

We did not sell anyunregistered equity securities during 2006.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Thefollowing financial information should be read in conjunction with “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and our consolidated financial statements and notes thereto containedelsewhere in this Annual Report. Amounts are in thousands, except access linesand per share data.

| ** **                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Statement of Operations:**                                            |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                                                |       | $                                          | 270,069    |   | $ | 262,843 |   | $ | 252,645 |   | $ | 231,432 |   | $ | 230,819 |   |
| Operating expenses:                                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Operating expenses                                                      |       | 155,463                                    |       | 143,425 |   | 128,804 |   | 111,203 |   | 111,189 |   |
| Depreciation and  amortization                                          |       | 53,236                                     |       | 52,390 |   | 50,287 |   | 48,089 |   | 46,310 |   |
| Total operating  expenses                                               |       | 208,699                                    |       | 195,815 |   | 179,091 |   | 159,292 |   | 157,499 |   |
| Income from  operations                                                 |       | 61,370                                     |       | 67,028 |   | 73,554 |   | 72,140 |   | 73,320 |   |
| Interest  expense(1)                                                    |       | (39,665                                    | )          | (46,416 | ) | (104,315 | ) | (90,224 | ) | (69,520 | ) |
| Other income  (expense), net(2)                                         |       | 28,671                                     |       | (75,156 | ) | 6,926 |   | 9,600 |   | (11,974 | ) |
| Income (loss) from  continuing operations before income taxes           |       | 50,376                                     |       | (54,544 | ) | (23,835 | ) | (8,484 | ) | (8,174 | ) |
| Income tax  (expense) benefit(3)                                        |       | (19,858                                    | )          | 83,096 |   | (516 | ) | 236 |   | (518 | ) |
| Minority interest  in income of subsidiaries                            |       | (2                                         | )          | (2 | ) | (2 | ) | (2 | ) | (2 | ) |
| Income (loss) from  continuing operations                               |       | 30,516                                     |       | 28,550 |   | (24,353 | ) | (8,250 | ) | (8,694 | ) |
| Income from  discontinued operations                                    |       | 574                                        |       | 380 |   | 671 |   | 9,921 |   | 21,933 |   |
| Net income (loss)                                                       |       | 31,090                                     |       | 28,930 |   | (23,682 | ) | 1,671 |   | 13,239 |   |
| Redeemable  preferred stock dividends and accretion(1)                  |       | —                                     |       | — |   | — |   | (8,892 | ) | (11,918 | ) |
| Gain on repurchase  of redeemable preferred stock                       |       | —                                     |       | — |   | — |   | 2,905 |   | — |   |
| Net income (loss)  attributable to common shareholders                  |       | $                                          | 31,090     |   | $ | 28,930 |   | $ | (23,682 | ) | $ | (4,316 | ) | $ | 1,321 |   |
| Basic shares  outstanding                                               |       | 34,629                                     |       | 31,927 |   | 9,468 |   | 9,483 |   | 9,498 |   |
| Diluted shares  outstanding                                             |       | 34,754                                     |       | 31,957 |   | 9,468 |   | 9,483 |   | 9,498 |   |
| Basic and diluted  earnings (loss) from continuing operations per share |       | $                                          | 0.88       |   | $ | 0.89 |   | $ | (2.57 | ) | $ | (1.50 | ) | $ | (2.17 | ) |
| **Operating Data:**                                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                   |       | $                                          | 32,317     |   | $ | 28,099 |   | $ | 36,492 |   | $ | 33,595 |   | $ | 38,803 |   |
| Access line  equivalents(4)                                             |       | 311,150                                    |       | 288,899 |   | 271,150 |   | 264,308 |   | 248,581 |   |
| Residential access  lines                                               |       | 194,119                                    |       | 188,206 |   | 189,668 |   | 196,145 |   | 189,803 |   |
| Business access  lines                                                  |       | 57,587                                     |       | 55,410 |   | 49,606 |   | 50,226 |   | 51,810 |   |
| High Speed Data  subscribers                                            |       | 59,444                                     |       | 45,283 |   | 31,876 |   | 17,937 |   | 6,968 |   |
| **Summary Cash Flow Data:**                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Net cash provided  by operating activities of continuing operations     |       | $                                          | 81,766     |   | $ | 61,682 |   | $ | 45,975 |   | $ | 32,834 |   | $ | 55,632 |   |
| Net cash used in  investing activities of continuing operations         |       | (27,361                                    | )          | (42,807 | ) | (20,986 | ) | (54,010 | ) | (30,258 | ) |
| Net cash used in  financing activities of continuing operations         |       | (54,668                                    | )          | (16,647 | ) | (23,966 | ) | (1,976 | ) | (12,546 | ) |
| **Balance Sheet Data (at period end):**                                 |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash                                                                    |       | $                                          | 3,805      |   | $ | 5,083 |   | $ | 3,595 |   | $ | 5,603 |   | $ | 5,394 |   |
| Property, plant  and equipment, net                                     |       | 246,264                                    |       | 242,617 |   | 252,262 |   | 266,706 |   | 271,690 |   |
| Total assets                                                            |       | 885,230                                    |       | 908,139 |   | 819,136 |   | 843,068 |   | 829,253 |   |
| Total long term  debt                                                   |       | 607,986                                    |       | 607,425 |   | 810,432 |   | 825,560 |   | 804,190 |   |
| Preferred shares  subject to mandatory redemption(5)                    |       | —                                     |       | — |   | 116,880 |   | 96,699 |   | 90,307 |   |
| Total  stockholders’ equity (deficit)                              |       | 224,719                                    |       | 246,848 |   | (172,952 | ) | (147,953 | ) | (146,150 | ) |

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(1)           Interest expense includes amortization of debt issuecosts aggregating $1,571, $1,859, $4,603, $4,171 and $3,664 for the fiscalyears ended December 31, 2006, 2005, 2004, 2003 and 2002. We prospectivelyadopted the 

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provisions of Statement ofFinancial Accounting Standards (SFAS) No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Liabilities and Equity,”effective July 1, 2003. SFAS No. 150 requires us to classify as along-term liability our series A preferred stock and to reclassifydividends and accretion from the series A preferred stock as interestexpense. Such stock is described as “Preferred Shares Subject to MandatoryRedemption” in the balance sheet and dividends and accretion on these sharesare included in pre-tax income prior to repurchase in 2005 whereas previouslythey were presented as a reduction to equity (a dividend), and, therefore, areduction of net income available to common stockholders. For the years ended December 31,2005, 2004 and 2003, interest expense includes $2,362, $20,181 and $9,049,respectively, related to dividends and accretion on preferred shares subject tomandatory redemption.

(2)           In 2003, other income (expense) includes a $3,465 gainon the extinguishment of debt and a $4,967 loss for the write-off of debt issuecosts related to this extinguishment of debt. In 2004, other income (expense)includes a $5,951 loss for the write-off of debt issuance and offering costsassociated with an abandoned offering of Income Deposit Securities. In 2005,other income (expense) includes an $87.7 million loss on early retirement ofdebt and loss on repurchase of series A preferred stock. In 2006, other income(expense) includes gains on sales of investments and other assets of $14.7million.

(3)           In 2005, we recorded an income tax benefit of $83.1million which is primarily the result of the recognition of deferred taxbenefits of $66.0 million from the reversal of the deferred tax valuationallowance that resulted from our expectation of generating future taxableincome following the recapitalization that occurred as part of our initial publicoffering in February 2005.

(4)           Total access line equivalents includes voice accesslines and high speed data lines, which include DSL lines, wireless broadbandand cable modem.

(5)          Inconnection with our initial public offering, we repurchased all of our series Apreferred stock from the holders thereof.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunctionwith our financial statements and the notes thereto included elsewhere in thisAnnual Report. The following discussion includes certain forward-lookingstatements. For a discussion of important factors, including the continuingdevelopment of our business, actions of regulatory authorities and competitorsand other factors which could cause actual results to differ materially fromthe results referred to in the forward-looking statements, see “Item 1A.—RiskFactors” in this Annual Report.

**Overview**

We are a leading provider of communications servicesin rural and small urban communities, offering an array of services, includinglocal and long distance voice, data, Internet and broadband product offerings.We are one of the largest telephone companies in the United States focused onserving rural and small urban communities, and we are the 14th largest localtelephone company in the United States, in each case based on number of accesslines. We operate in 18 states with 311,150 access line equivalents (includingvoice access lines and high speed data lines, or HSD, which include DSL,wireless broadband and cable modems) in service as of December 31, 2006.

We were incorporated in February 1991 for thepurpose of acquiring and operating local exchange carriers in rural markets.Since 1993, we have acquired 35 such businesses, 31 of which we continue to ownand operate. Many of our telephone companies have served their respectivecommunities for over 75 years. The majority of the communities we servehave fewer than 2,500 access lines. Most of our telephone companies qualify asrural local exchange carriers under 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 is high.However, in our markets, we have experienced some voice competition from cableproviders and competitive local exchange carriers. We also are subject tocompetition from wireless and various other technologies which may increase inthe future. If competition were to increase, the originating and terminatingaccess revenues we receive may be reduced as a result of wireless, VoIP, orother new technology utilization. We periodically negotiate interconnectionagreements with other telecommunications providers which could ultimatelyresult in increased 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 DSL services(resulting in customers canceling second lines in favor of DSL). We have notbeen immune to these conditions. We have been able to mitigate our access lineloss somewhat through bundling services, retention programs, continuedcommunity involvement and a variety of other focused programs.

During 2006, we completed the conversion of all accesslines previously billed on the ICMS platform to the MACC Customer Masterplatform (approximately 65% of total access line equivalents).  The conversion of the remaining companies isexpected to be completed by the middle of 2007.

Our board of directors has adopted a dividend policythat 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 

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classes of our capitalstock, if any, capital expenditures, taxes and future reserves, if any, asregular quarterly dividend payments to the holders of our common stock, ratherthan retained and used for other purposes.

We are subject to regulation primarily by federal andstate governmental agencies. At the federal level, the Federal CommunicationsCommission has jurisdiction over interstate and international communicationsservices. State telecommunications regulators exercise jurisdiction overintrastate communications services.

On January 15, 2007,we entered into the Merger Agreement pursuant to which Spinco will merge withand into the Company with the Company continuing as the surviving corporation. Followingthe Merger, our operations will be more focused on small urban markets andgeographically concentrated in the northeastern United States, we expect toface more competition in our business located in the northeastern UnitedStates, and we expect to be less dependent on regulated revenue.

**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, or USF, to support the highcost of our operations in rural markets. This revenue stream fluctuates basedupon our average cost per loop compared to the national average cost per loop.For example, if the national average cost per loop increases and our operatingcosts (and average cost per loop) remain constant or decrease, the payments wereceive from the USF would decline. Conversely, if the national average costper loop decreases and our operating costs (and average cost per loop) remainconstant or increase, the payments we receive from the USF would increase. Thenational average cost per loop in relation to our average cost per loop hasincreased, and we believe that the national average cost per loop will likelycontinue to increase in relation to our average cost per loop. As a result, thepayments we receive from the USF have declined and will likely continue todecline.

·       *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 USF payments forlocal switching support, long term support and interstate 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.

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·       *Other services*.   We receive revenuesfrom other services, including video services (including cable television andvideo-over-DSL), billing and collection, directory services and sale andmaintenance of customer premise equipment.

Thefollowing summarizes our revenues and percentage of revenues from continuingoperations from these sources:

| ** **                            | ** ** | **Year ended December 31,** | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **Revenue (in thousands)**       | ** ** | **% of Revenue**                 | ** ** |
| Local calling  services               |       | $                                          | 67,656     |                                       | $          | 65,105 |   | $ | 63,150 |   |   | 25 | % |   |   | 25 | % |   |   | 25 | % |   |
| Universal Service Fund high cost loop |       | 20,046                                     |       | 19,737                                     |       | 22,151 |   |   | 7 |   |   |   | 8 |   |   |   | 9 |   |   |
| Interstate access                     |       | 72,392                                     |       | 75,287                                     |       | 70,297 |   |   | 27 |   |   |   | 29 |   |   |   | 28 |   |   |
| Intrastate access                     |       | 37,352                                     |       | 40,009                                     |       | 42,389 |   |   | 14 |   |   |   | 15 |   |   |   | 17 |   |   |
| Long distance  services               |       | 23,537                                     |       | 20,868                                     |       | 17,766 |   |   | 9 |   |   |   | 7 |   |   |   | 7 |   |   |
| Data and Internet  services           |       | 28,242                                     |       | 24,168                                     |       | 19,054 |   |   | 10 |   |   |   | 9 |   |   |   | 7 |   |   |
| Other services                        |       | 20,844                                     |       | 17,669                                     |       | 17,838 |   |   | 8 |   |   |   | 7 |   |   |   | 7 |   |   |
| Total                                 |       | $270,069                                   |       | $262,843                                   |       | $252,645 |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |
|                                       |            |                                            |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Operating Expenses**

Our operatingexpenses are categorized as operating expenses and depreciation and amortization.

·       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. Also included in operating expenses are non-cashexpenses related to stock based compensation. Stock based compensation consistsof compensation charges incurred in connection with the employee stock options,stock units and non-vested stock granted to our executive officers anddirectors.

·       Depreciation andamortization includes depreciation of our communications network and equipmentand amortization of intangible assets.

**Acquisitions and Mergers**

We intend tocontinue to pursue selective acquisitions and mergers. Recent transactions arelisted below.

·       OnJanuary 15, 2007, we entered into the Merger Agreement pursuant to whichthe Company and Spinco will merge, with the Company continuing as the survivingcorporation for legal purposes. Spinco is a newly formed wholly-ownedsubsidiary of Verizon that will own Verizon’s local exchange and relatedbusiness activities in Maine, New Hampshire and Vermont. For accountingpurposes, we expect that FairPoint will be the acquiree. Consequently, mergerrelated costs will been expensed as incurred in connection with the transactionand FairPoint’s assets and liabilities will be recorded at fair value atacquisition.

·       OnNovember 15, 2006, we completed a merger with The Germantown IndependentTelephone Company, or GITC. The merger consideration was $10.7 million (or $9.2million net of cash acquired). GITC is a single exchange rural incumbent localexchange carrier located in the Village 

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of Germantown, Ohio,serving approximately 4,400 access line equivalents, as of the date ofacquisition.

·       OnAugust 17, 2006, we completed the purchase of Unite Communications Systems, Inc.,or Unite, for approximately $11.5 million (or $11.4 million net of cashacquired). Unite owns ExOp of Missouri, Inc., which is a facilities-basedvoice, data and video service provider located outside of Kansas City, Missouri.Unite served approximately 4,200 access lines in Kearney and Platte City,Missouri, approximately 50 miles north of the Cass County service territory, asof the date of acquisition.

·       OnJuly 26, 2006, we completed the purchase of the assets of Cass CountyTelephone Company Limited Partnership and LEC Long Distance, Inc., or CassCounty, for approximately $33.0 million (or $28.7 million net of liabilitiesassumed), subject to adjustment. Cass County served approximately 8,600 accessline equivalents, as of the date of acquisition, in Missouri and Kansas.

·       OnMay 2, 2005, we completed the acquisition of Berkshire TelephoneCorporation, or Berkshire, for a purchase price of approximately$20.3 million (or $16.4 million net of cash acquired). Berkshire is anindependent local exchange carrier that provides voice communication, cable andinternet services to over 7,200 access line equivalents, as of the date ofacquisition, serving five communities in New York State. Berkshire’scommunities of service are adjacent to those of Taconic Telephone Corp., one ofthe Company’s subsidiaries.

·       OnSeptember 1, 2005, we completed the acquisition of BentleyvilleCommunications Corporation, or Bentleyville, for a purchase price ofapproximately $11.0 million (or $9.3 million net of cash acquired).Bentleyville, which had approximately 3,600 access line equivalents as of the dateof acquisition, provides telecommunications, cable and internet services torural areas of Southwestern Pennsylvania that are adjacent to our existingoperations 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 payments could restrictour ability to obtain such financing on acceptable terms or at all.

**DiscontinuedOperations**

In November 2001, we decided to discontinue thecompetitive local exchange carrier operations of Carrier Services. Thisdecision was a proactive response to the deterioration in the capital markets,the general slow-down of the economy and the slower-than-expected growth inCarrier Services’ competitive local exchange carrier operations. CarrierServices now provides wholesale long distance services and support to our rurallocal exchange carriers and communications providers not affiliated with us.These services allow such companies to operate their own long distancecommunication services and sell such services to their respective customers.Our long distance business is included as part of continuing operations in theaccompanying financial statements.

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The information in ouryear to year comparisons below represents only our results from continuingoperations.

**Results of Operations**

The following table setsforth the percentages of revenues represented by selected items reflected inour consolidated statements of operations. The year to year comparison offinancial results are not necessarily indicative of future results:

| ** **                                                    | ** ** | **Year Ended   December 31,** | ** ** | **Year Ended   December 31,** | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                     | ** ** | **% of   revenue**                 | ** ** | **2005**                               | ** ** | **% of   revenue** | ** ** | **2004** | ** ** | **% of   revenue** | ** ** |
| Revenues                                                      |       | $                                            | 270,069    |                                         |       | 100.0                                  | %          |   | $ | 262,843 |   |   | 100.0 | % |   | $ | 252,645 |   |   | 100.0 | % |   |
| Operating expenses, excluding depreciation and  amortization  |       | 155,463                                      |       |                                         | 57.6       |                                   |       | 143,425 |   |   | 54.6 |   |   | 128,804 |   |   | 51.0 |   |   |
| Depreciation and amortization                                 |       | 53,236                                       |       |                                         | 19.7       |                                   |       | 52,390 |   |   | 19.9 |   |   | 50,287 |   |   | 19.9 |   |   |
| Total operating  expenses                                     |       | 208,699                                      |       |                                         | 77.3       |                                   |       | 195,815 |   |   | 74.5 |   |   | 179,091 |   |   | 70.9 |   |   |
| Income from  operations                                       |       | 61,370                                       |       |                                         | 22.7       |                                   |       | 67,028 |   |   | 25.5 |   |   | 73,554 |   |   | 29.1 |   |   |
| Other income (expense):                                       |       |                                         |       |                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net gain (loss) on sale of investments and other  assets      |       | 14,740                                       |       |                                         | 5.5        |                                   |       | (11 | ) |   | — |   |   | 104 |   |   | — |   |   |
| Interest and dividend income                                  |       | 3,315                                        |       |                                         | 1.2        |                                   |       | 2,499 |   |   | 1.0 |   |   | 2,335 |   |   | 0.9 |   |   |
| Interest expense                                              |       | (39,665                                      | )          |                                         | (14.7      | )                                      |       | (46,416 | ) |   | (17.7 | ) |   | (104,315 | ) |   | (41.3 | ) |   |
| Impairment of investments                                     |       | —                                       |       |                                         | —     |                                   |       | (1,200 | ) |   | (0.5 | ) |   | (349 | ) |   | 0.1 |   |   |
| Equity in net earnings of investees                           |       | 10,616                                       |       |                                         | 3.9        |                                   |       | 11,302 |   |   | 4.3 |   |   | 10,899 |   |   | 4.3 |   |   |
| Realized and unrealized losses on interest rate  swaps        |       | —                                       |       |                                         | —     |                                   |       | — |   |   | — |   |   | (112 | ) |   | — |   |   |
| Other nonoperating, net                                       |       | —                                       |       |                                         | —     |                                   |       | (87,746 | ) |   | 33.4 |   |   | (5,951 | ) |   | (2.5 | ) |   |
| Total other  expense                                          |       | (10,994                                      | )          |                                         | (4.1       | )                                      |       | (121,572 | ) |   | 46.3 |   |   | (97,389 | ) |   | (38.5 | ) |   |
| Income (loss)  from continuing operations before income taxes |       | 50,376                                       |       |                                         | 18.6       |                                   |       | (54,544 | ) |   | (20.8 | ) |   | (23,835 | ) |   | (9.4 | ) |   |
| Income tax  benefit (expense)                                 |       | (19,858                                      | )          |                                         | (7.3       | )                                      |       | 83,096 |   |   | 31.6 |   |   | (516 | ) |   | (0.2 | ) |   |
| Minority interest  in income of subsidiaries                  |       | (2                                           | )          |                                         | —     |                                   |       | (2 | ) |   | — |   |   | (2 | ) |   | — |   |   |
| Income (loss) from  continuing operations                     |       | $                                            | 30,516     |                                         |       | 11.3                                   | %          |   | $ | 28,550 |   |   | 10.9 | % |   | $ | (24,353 | ) |   | (9.6 | )% |   |

 

***Year Ended December 31,2006 Compared with Year Ended December 31, 2005***

***Revenues***

Revenues increased $7.2million to $270.1 million in 2006 compared to 2005. Operations acquired in 2005and 2006 contributed $10.6 million to the increased total revenues. Excludingthe impact of acquired operations, revenues from our existing operationsdecreased $3.4 million. We derived our revenues from the following sources:

*Local*callingservices.**   Local calling service revenuesincreased $2.6 million to $67.7 million in 2006. Acquired operations increasedlocal calling service revenues by $3.0 million. Revenues from our existingoperations decreased $0.4 million compared to 2005. The decrease in localrevenues from existing operations is primarily due to a 3.4% decline in netvoice access lines.

*Universal*Service Fundhigh cost loop support.**   USF high cost looppayments increased $0.3 million to $20.0 million in 2006. Acquired operationsadded $0.6 million in USF revenue and USF revenues from our 

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existing operationsdeclined $0.3 million. The national average cost per loop in relation to ouraverage cost per loop has increased and, as a result, our receipts from the USFhave declined. We expect this trend to continue as we anticipate the nationalaverage cost per loop will likely continue to increase in relation to ouraverage cost per loop.

*Interstate*access.*  *Interstateaccess revenues decreased $2.9 million to $72.4 million in 2006 compared to2005. Acquired operations added $2.8 million in interstate access revenues in2006. Interstate access revenues from our existing operations decreased $5.7million. In 2006, we recognized certain negative interstate revenue settlementadjustments related to prior years in the amount of $0.8 million. In addition,in 2005, we recognized certain positive interstate revenue settlementadjustments related to prior years which accounted for approximately $4.3million of interstate access revenue. Excluding these prior year adjustmentsand acquired operations, interstate access revenue would have declined $0.6million in 2006.

*Intrastate *access.**   Intrastateaccess revenues decreased $2.7 million to $37.4 million in 2006 compared to2005. Acquired operations added $1.3 million in intrastate access revenues in2006. Intrastate access revenues from our existing operations decreased  $4.0 million. Intrastate access revenuesdeclined primarily due to a decrease in access rates and a decrease in minutesof use compared to 2005. The rate decrease is primarily due to intrastate ratereductions implemented in Maine in the second quarter of 2005. Intrastate accessrevenues are expected to continue to decline.

*Long*distanceservices.**   Long distance services revenuesincreased $2.7 million to $23.5 million in 2006 compared to 2005. Of thisincrease, $0.3 million was attributable to acquired companies and $2.4 millionwas attributable to our existing operations. This increase was primarily aresult of promotional efforts and bundled product offerings with unlimited longdistance designed to generate more revenue.

*Data *and Internetservices.**   Data and Internet servicesrevenues increased $4.1 million to $28.2 million in 2006 compared to 2005. Ofthis increase, $1.1 million was attributable to acquired companies and $3.0million was attributable to our existing operations. The increase from existingoperations is due primarily to increases in HSD customers as we continue toaggressively market our HSD services. Our HSD subscriber customer base as of December 31,2006 increased to 59,444 subscribers compared to 45,365 subscribers as of December 31,2005, a 31% increase during this period.

*Other *services.**   Otherservices revenues increased $3.2 million to $20.8 million in 2006 compared to2005. Of this increase, $1.5 million was attributable to acquired companies and$1.7 million was attributable to our existing operations. This increase isprincipally due to an increase in directory revenues in 2006.

***Operating Expenses***

*Operating *expenses andcost of goods sold, excluding depreciation and amortization.**   Operatingexpenses increased $12.0 million to $155.5 million in 2006 compared to 2005. Ofthe increase, $5.9 million is related to our existing operations and $6.1million is related to expenses of the acquired operations. The increase fromexisting operations is principally due to $2.4 million in transaction expensesrelated to the Merger, an increase in compensation and benefit expenses of $1.6million, an increase in expenses related to data and long distance services of$1.4 million, an increase in billing expenses of $1.2 million, an increase inaudit and tax fees of $0.7 million and an increase in operating taxes of $0.6million. These increases were partially offset by a decrease in bad debtexpense of $1.5 million and a decrease in consulting expenses of $2.2 million.

Included in operatingexpenses are non-cash stock based compensation expenses associated with theaward of restricted stock and restricted units. Stock based compensationexpenses totaled $2.9 million and $2.4 million for the twelve months ended December 31,2006 and 2005, respectively.

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*Depreciation *andamortization.**   Depreciation and amortizationfrom continuing operations increased $0.8 million to $53.2 million in 2006compared to 2005. Acquired operations added $2.0 million to depreciationexpense. Depreciation expense from our existing operations decreased $1.2 million.

*Income *from operations.**   Incomefrom operations decreased $5.7 million to $61.4 million in 2006 compared to2005. This decrease is principally due to the increase in expenses discussedabove.

*Other*income(expense).**   Total other expense decreased$110.6 million to $11.0 million in 2006 compared to 2005. Interest expensedecreased $6.8 million to $39.7 million in 2006 mainly due to lower debtbalances throughout the year. Earnings from equity investments decreased $0.7million to $10.6 million in 2006. Gain (loss) on sale of investments increased$14.7 million compared to 2005, principally due to the sale of two non-coreequity investments. In 2005, in connection with our initial public offering, werefinanced our old credit facility and repurchased and/or redeemed the 9 1⁄2%senior subordinated notes due 2008, or the 9 1⁄2% notes, the floating ratecallable securities due 2008, or the floating rate notes, the 12 1⁄2% seniorsubordinated notes due 2010, or the 12 1⁄2% notes, and the 11 7/8%senior notes due 2010, or the 11 7/8% notes, which resulted in significantcharges of $87.7 million due to fees and penalties paid on therepurchase/redemption and for the write-off of unamortized debt issuance costs.

*Income *tax expense.**   Incometax expense of $19.9 million was recorded for the year ended December 31,2006, resulting in an effective rate of 39.4%.

At the time of our initialpublic offering in February 2005, we had net operating loss, or NOL,carryforwards of $265.3 million. Prior to February 2005, we did not expectto generate sufficient taxable income in future years to fully utilize theseNOL carryforwards and, as a result, reduced the expected benefit of these NOLcarryforwards by $66.0 million. Subsequent to our initial public offering andrelated transactions, we re-evaluated our expectation of future taxable incomeand concluded that our future taxable income would be sufficient to fullyutilize the benefits of the NOL carryforwards. As a result of thisre-evaluation, we recognized an income tax benefit of $66.0 million for theyear ended December 31, 2005. Additional income tax benefits of $21.9million were recognized in 2005 due to the taxable loss which resulted mainlyfrom additional costs associated with the extinguishment of debt. These twoitems contributed to the net income tax benefit of $83.1 million for the yearended December 31, 2005.

As of December 31,2006, we had $235.1 million of federal and state NOL carryforwards. As aresult, the income tax expense we record is generally greater than the incometaxes actually paid by us.

*Discontinued *operations.**   Duringthe twelve months ended December 31, 2006 and 2005, we recorded areduction to our liability associated with the discontinuation of ourcompetitive local exchange carrier operations, which, net of tax, resulted in a$0.6 million and $0.4 million adjustment to income from discontinuedoperations, respectively. The adjustments in 2006 and 2005 related to thesettlement of certain lease obligations which reduced our future obligationunder these leases and the expiration of certain statutes of limitations asthey relate to certain contingency reserves.

*Net *income (loss).**   Netincome for the year ended December 31, 2006 was $31.1 million compared to$28.9 million for the year ended December 31, 2005.  The difference between 2006 and 2005 is aresult of the factors discussed above.

***Year Ended December 31,2005 Compared with Year Ended December 31, 2004***

***Revenues***

Revenues increased $10.2million to $262.8 million in 2005 compared to $252.6 million in 2004. Of thisincrease, $5.7 million was attributable to the Berkshire and Bentleyvilleacquisitions in 2005 and $4.5 million was attributable to our existingoperations. We derived our revenues from the following sources:

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*Local *callingservices.**   Local calling service revenuesincreased $2.0 million to $65.1 million in 2005. Of this increase, $1.2 millionwas attributable to the Berkshire and Bentleyville acquisitions in 2005 and$0.8 million was attributable to our existing operations. The increase in localrevenues from existing operations is primarily due to increases in localcalling features and local interconnection revenues, despite a 2.5% decline innet voice access lines.

*Universal *Service Fundhigh cost loop support.**   Universal ServiceFund high cost loop payments decreased $2.4 million to $19.7 million in 2005.Our existing operations accounted for all of this decrease. The nationalaverage cost per loop in relation to our average cost per loop has increasedand, as a result, our receipts from the Universal Service Fund have declined.

*Interstate *access.*  *Interstateaccess revenues increased $5.0 million to $75.3 million in 2005 from $70.3million in 2004. Of the increase, $1.6 million was attributable to theBentleyville and Berkshire acquisitions. Our existing operations accounted forthe remaining $3.4 million increase. In 2005, we recognized certain positiveinterstate revenue settlement adjustments related to prior years whichaccounted for approximately $4.3 million of interstate access revenue. Excludingthese unusual items and acquired operations, interstate access revenue wouldhave declined $0.9 million in 2005.

*Intrastate *access.**   Intrastateaccess revenues decreased to $40.0 million in 2005 from $42.4 million in 2004.The decrease from our existing operations was $3.3 million. The decrease wasmainly attributable to rate reductions as provided for under a ratere-balancing agreement in Maine.

*Long *distanceservices.**   Long distance services revenuesincreased $3.1 million to $20.9 million in 2005 compared to 2004. This increasewas attributable primarily to our existing operations as a result ofpromotional efforts and bundles with unlimited long distance designed togenerate more revenue.

*Data *and Internetservices.**   Data and Internet servicesrevenues increased $5.1 million to $24.2 million in 2005 from $19.1 million in2004. The increase is due primarily to increases in DSL customers as wecontinue to aggressively market our HSD services. Our HSD subscriber customerbase as of December 31, 2005, increased to 45,365 subscribers compared to34,824 subscribers as of December 31, 2004, a 30% increase duringthis period. The Bentleyville and Berkshire acquisitions contributed theremaining revenue increase of $0.5 million.

*Other *services.**   Otherservices revenues decreased to $17.7 million in 2005 from 2004. The Berkshireand Bentleyville acquisitions increased other services revenues by $1.3 million.Excluding the impact of the Berkshire and Bentleyville acquisitions, otherservices revenue decreased $1.5 million. A portion of this decrease fromexisting operations was due to a $1.2 million one-time sale and installation ofE911 system equipment in 2004. The remaining decrease was due to reductions inbilling and collections revenues, as interexchange carriers continue to takeback the billing function for their more significant long distance customers. Weexpect this billing and collections trend to continue.

***Operating Expenses***

*Operating *expenses andcost of goods sold, excluding depreciation and amortization.**   Operatingexpenses increased $14.6 million to $143.4 million in 2005 compared to 2004. Ofthe increase, $9.3 million is related to our existing operations and $5.3million is related to expenses of the acquired operations in 2005. Consultingfees increased $1.8 million primarily related to preparation for compliancewith Section 404 of the Sarbanes-Oxley Act of 2002. Expenses related todata and long distance services increased $2.3 million principally due to theincrease in HSD and long distance subscribers. Bad debt expense was $1.4million higher in 2005 than 2004 due primarily to difficulties experienced inour billing conversion related to the delay of non-pay disconnect notices. Billingcosts have increased $2.0 million as we incurred costs associated with theconversion of our billing systems into an integrated platform and recurringexpenses from our outsourced billing service provider.

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Included in operatingexpenses are non-cash stock based compensation expenses associated with theaward of restricted stock and restricted units. Stock based compensationexpenses totaled $2.4 million and $49,000 for the twelve months ended December 31,2005 and 2004, respectively. The increase is due primarily to the issuance ofrestricted stock and restricted units to certain key employees and directorsunder the 2005 Stock Incentive Plan.

*Depreciation *andamortization.**   Depreciation and amortizationfrom continuing operations increased $2.1 million to $52.4 million in 2005 from$50.3 million in 2004. The Berkshire and Bentleyville acquisitions accountedfor $1.0 million of the increase and the remaining increase was attributable tothe increased investment in our communications network for existing operations.

*Income *from operations.**   Incomefrom operations decreased $6.5 million to $67.0 million in 2005 compared to2004. This decrease is principally due to the increase in expenses discussedabove.

*Other *income(expense).**   Total other expense increased$24.2 million to $121.6 million in 2005 from $97.4 million in 2004. Interestexpense decreased $57.9 million to $46.4 million in 2005 mainly due to thetransactions associated with the offering which substantially de-leveraged usand provided a decrease in interest expense. In addition, in connection withthe offering we repurchased our series A preferred stock (together withaccrued and unpaid dividends thereon) which eliminated dividends and accretionon our series A preferred stock for the twelve months ended December 31,2005. The dividends and accretion on our series A preferred stock were beingreported as interest expense under SFAS No. 150. In connection with ourinitial public offering, we also refinanced our old credit facility andrepurchased and/or redeemed the 9 1⁄2% notes, the floating rate notes, the 12 1⁄2%notes and the 11 7/8% notes, which resulted in significant charges of$87.7 million due to fees and penalties paid on the repurchase/redemptionand for the write-off of unamortized debt issuance costs. Earnings from equityinvestments increased $0.4 million to $11.3 million in 2005. For the twelvemonths ended December 31, 2004, other non-operating income (expense)includes the write-off of debt issuance and offering costs of $6.0 millionassociated with an abandoned offering of Income Deposit Securities.

*Income *tax expense.**   In2005, income tax benefits of $83.1 million are primarily the result of therecognition of deferred tax benefits of $66.0 million from the reversal of thedeferred tax valuation allowance that resulted from our expectation ofgenerating future taxable income following the recapitalization. The income taxbenefit for 2005 also includes deferred tax benefits of $29.3 million relatedto the extinguishment of debt and $1.6 million for an adjustment of ournet deferred tax assets to an expected federal income tax rate of 35% from 34%,in anticipation of higher levels of taxable income in subsequent periods. Thesebenefits were partially offset by income tax expense associated with taxableincome generated following the recapitalization. During the twelve months endedDecember 31, 2004, the income tax expense related primarily to incometaxes owed in certain states.

*Discontinued *operations.**   Duringthe twelve months ended December 31, 2005 and 2004, we recorded areduction to our liability associated with the discontinuation of ourcompetitive local exchange carrier operations, which, net of tax, resulted in a$0.4 million and $0.7 million adjustment to income from discontinuedoperations, respectively. The adjustment in 2005 related to the settlement of alease obligation which reduced our future obligation under this lease. In 2004,the adjustment was mainly attributable to excise tax refunds received from theInternal Revenue Service as well as a reduction in liabilities associated withpotential property tax payments.

*Net *income (loss).**   Netincome for the year ended December 31, 2005 was $28.9 million. Our 2004net loss was $23.7 million. The difference between 2005 and 2004 is a result ofthe factors discussed above.

**Liquidity and Capital Resources**

Our short-term andlong-term liquidity needs arise primarily from: (i) interest paymentsprimarily related to our credit facility; (ii) capital expenditures; (iii) workingcapital requirements as may be needed 

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tosupport the growth of our business; (iv) dividend payments on our commonstock; and (v) potential acquisitions. Our board of directors has adopteda dividend policy which reflects our judgment that our stockholders would bebetter served if we distributed a substantial portion of our cash available fordistribution to them instead of retaining it in our business.

We expect to fund ouroperations, interest expense, capital expenditures not related to the Mergerand dividend payments on our common stock for the next twelve monthsprincipally from cash from operations and distributions from investments. Tofund future acquisitions, we intend to use cash from operations and borrowingsunder our credit facility, or, subject to the restrictions in our creditfacility, proceeds from the sale of non-core assets or to arrange additionalfunding through the sale of public or private debt and/or equity securities, orobtain additional senior bank debt.

For the years ended December 31,2006, 2005 and 2004, net cash provided by operating activities of continuingoperations was $81.8 million, $61.7 million and $46.0 million,respectively. The increase in net cash provided by operating activities in 2006was primarily due to a decrease in accrued interest resulting from ourrecapitalization in February 2005.

Our ability to service ourindebtedness depends on our ability to generate cash in the future. We are notrequired to make any scheduled principal payments under our credit facility’sterm loan facility prior to maturity in February 2012. We will need torefinance all or a portion of our indebtedness on or before maturity. We maynot be able to refinance our indebtedness on commercially reasonable terms orat all. If we were unable to renew or refinance our credit facility, ourfailure to repay all amounts due on the maturity date would cause a defaultunder our credit facility.

Borrowings under ourcredit facility bear interest at variable interest rates. We have entered intovarious interest rate swap agreements which are detailed in Note 1(m) toour consolidated financial statements included in this Annual Report. As aresult of these swap agreements, as of December 31, 2006, approximately90% of our indebtedness bore interest at fixed rates rather than variable rates.After these interest rate swap agreements expire, our annual debt serviceobligations on such portion of the term loans will vary from year to yearunless we enter into a new interest rate swap or purchase an interest rate capor other interest rate hedge. To the extent interest rates increase in thefuture, we may not be able to enter into new interest rate swaps or to purchaseinterest rate caps or other interest rate hedges on acceptable terms. Anincrease of 10% in the annual interest rates on our variable rate indebtedness(excluding variable rate indebtedness which has its interest rate effectivelyfixed under interest rate swap agreements) would result in an increase ofapproximately $0.1 million in our annual cash interest expense.

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 the revolving facility of our creditfacility. As a result, we may not retain a sufficient amount of cash to financegrowth opportunities, including acquisitions, or unanticipated capitalexpenditures or to fund our operations. If we do not have sufficient cash forthese purposes, our financial condition and our business will suffer. However,our board of directors may, in its discretion, amend or repeal the dividendpolicy to decrease the level of dividends provided for or discontinue entirelythe payment of dividends.

On February 8, 2005,we used net proceeds received from our initial public offering, together withapproximately $566.0 million of borrowings under the term loan facility ofour credit facility, to, among other things, repay all outstanding loans underour old credit facility, repurchase all of our series A preferred stockand consummate 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. We redeemed the remaining outstanding 121¤2%notes on May 2, 2005 with borrowings of $22.4 million under the delayeddraw facility of our credit facility.

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Net cash used in investingactivities of continuing operations was $27.4 million, $42.8 million and$21.0 million for the years ended December 31, 2006, 2005 and 2004,respectively. These cash flows primarily reflect capital expenditures of $32.3million, $28.1 million and $36.5 million for the years ended December 31,2006, 2005 and 2004, respectively, and acquisitions of telephone properties,net of cash acquired, of $49.8 million and $26.3 million for the yearsended December 31, 2006 and 2005, respectively. There were no acquisitionsduring 2004.

Offsetting capitalexpenditures were distributions from investments of $10.7 million, $10.9million and $15.0 million for the years ended December 31, 2006, 2005 and2004, respectively. The $15.0 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. All ofthese distributions represent passive ownership interests in partnership investments.We do not control the timing or amount of distributions from such investments. Inaddition, in 2006, we received proceeds of $43.8 million principally related tothe sale of our investments in the Rural Telephone Bank and Southern IllinoisCellular Corporation. On January 15, 2007, Taconic entered into the O-PPurchase Agreement pursuant to which Taconic has agreed to sell its 7.5%limited partnership interest in Orange County-Poughkeepsie Limited Partnershipto Cellco Partnership. The transaction is expected to close in the secondquarter of 2007, and we will no longer receive distributions from OrangeCounty-Poughkeepsie Limited Partnership following such closing.

Net cash used in financingactivities from continuing operations was $54.7 million, $16.6 million and$24.0 million for the years ended December 31, 2006, 2005 and 2004,respectively. For the year ended December 31, 2006, net proceeds from theissuance of long-term debt were $0.5 million and we paid dividends in theamount of $55.2 million. For the year ended December 31, 2005, netproceeds from the issuance of common stock of $431.9 million was used forthe net repayment of long term debt of $205.7 million and the repurchaseof series A preferred stock and common stock of $129.3 million. Theremaining proceeds were used to pay fees and penalties associated with theearly retirement of long term debt of $61.0 million, to pay a deferredtransaction fee of $8.4 million and to pay debt issuance costs of$9.0 million. For the year ended December 31, 2004, these cash flowsprimarily represented net repayment of long-term debt of $15.2 million and$7.8 million in debt issuance and initial public offering related costs.

Our annual capitalexpenditures for our rural telephone operations have historically beensignificant. Because existing regulations allow us to recover our operating andcapital costs, plus a reasonable return on our invested capital in regulatedtelephone assets, capital expenditures have historically constituted anattractive use of our cash flow. Capital expenditures were approximately$32.3 million, $28.1 million and $36.5 million for the yearsended December 31, 2006, 2005 and 2004, respectively.

We expect that our annualcapital expenditures will be approximately $73 to $75 million for fiscal2007, including $44 million (net of $40 million which Verizon has to reimburseus per the Merger Agreement) related to the Merger. A portion of these capitalexpenditures will be paid for with proceeds from the pending sale of our OrangeCounty-Poughkeepsie Limited Partnership investment to Cellco Partnership for$55 million. The remaining capital expenditures are expected to be fundedthrough our cash flow from operations and borrowings under our credit facility,if necessary. If cash is available beyond what is required to support ourdividend policy, we may consider additional capital expenditures if we believethey are beneficial. Although the amount of our capital expenditures canfluctuate from quarter to quarter, on an annual basis we do not expect capitalexpenditures for our existing operations through fiscal 2009 to varysignificantly from our estimated amounts.

We expect to fund theMerger through the issuance of approximately 53.8 million shares of our commonstock to existing Verizon stockholders at an implied value of $18.88 per sharetotaling $1.015 billion in equity and the incurrence of $1.7 billion of newindebtedness. We anticipate that the new indebtedness will consist of bank debtand senior unsecured notes in proportions that have yet to be determined. Wehave obtained commitment letters for up to $2.080 billion of bank financing tofacilitate the re-financing of our existing bank debt with the bank debt to beincurred at the time of the Merger.

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Our credit facilityconsists of a revolving facility, or the revolver, in a total principal amountof up to $100.0 million, of which $83.7 million was available at March 1,2007 and a term loan facility, or the term loan, in a total principal amount of$588.5 million with $588.5 million outstanding at March 1, 2007.The term loan matures in February 2012and the revolver matures in February 2011. The revolver has a swinglinesubfacility in an amount of $5.0 million and a letter of creditsubfacility in an amount of $10.0 million, which will allow issuances ofstandby letters of credit for our account. Borrowings under our revolver bearinterest, at our option, at either (i) the Eurodollar rate plus 2.0% or (ii) abase rate, as such term is defined in the credit agreement, plus 1.0%. Effectiveon September 30, 2005, the Company amended its credit facility to reducethe effective interest rate margins on the $588.5 million term loan by 0.25% to1.75% on Eurodollar loans and to 0.75% for Base rate loans.

On January 25, 2007,we entered into an amendment to our credit facility that is intended tofacilitate certain transactions related to the Merger. Among other things, suchamendment: (i) permits us to consummate the sale of our interest in OrangeCounty-Poughkeepsie Limited Partnership and retain the proceeds thereof up toan amount equal to $55 million; (ii) excludes the gain on the sale of ourinterest in Orange County-Poughkeepsie Limited Partnership from the “AvailableCash”, (iii) amends the definition of “Adjusted Consolidated EBITDA” toallow for certain one-time add-backs to the calculation thereof foroperating expenses incurred in connection with the Merger; (iv) amendsthe definition of “Consolidated Capital Expenditures” to exclude certainexpenditures incurred by us in connection with transition and integrationexpenses prior to consummation of the Merger; and (v) increases theleverage covenant and dividend suspension test to 5.50:1.00 and 5.25:1.00,respectively.

The credit facilitycontains financial covenants, including, without limitation, the followingtests: a minimum interest coverage ratio equal to or greater than 3.0:1 and amaximum leverage ratio equal to or less than 5.50:1. The credit facilitycontains customary affirmative covenants. The credit facility also contains negativecovenants and restrictions, including, among others, with respect to redeemingand repurchasing our other indebtedness, loans and investments, additionalindebtedness, liens, capital expenditures, changes in the nature of ourbusiness, mergers, acquisitions, asset sales and transactions with affiliates. Subjectto certain limitations set forth in the credit facility, we may use all of ourCumulative Distributable Cash (as defined in the credit facility) accumulatedafter April 1, 2005 to declare and pay dividends, but we may not ingeneral pay dividends in excess of such amount. On March 11, 2005, April 29,2005 and September 14, 2005, we entered into technical amendments to ourcredit facility.

Our credit facilityrequires us first to prepay outstanding term loans under the credit facilityand, thereafter, to repay loans under the revolver and/or to reduce revolvercommitments (or commitments under the delayed draw facility) under the creditfacility with, subject to certain conditions and exceptions, 100% of the netcash proceeds we receive from any sale, transfer or other disposition of anyassets, 100% of net casualty insurance proceeds and 100% of the net cashproceeds we receive from the issuance of permitted securities and, at certaintimes if we are not permitted to pay dividends, with 50% of the increase in ourcumulative distributable cash during the prior fiscal quarter. Reductions tothe revolving commitments under the credit facility from the foregoingrecapture events will not reduce the revolving commitments under the creditfacility below $50.0 million. Our credit facility provides for voluntaryprepayments of the revolver and the term loan and voluntary commitmentreductions of the revolver (and the delayed draw facility), subject to givingproper notice and compensating the lenders for standard Eurodollar breakagecosts, if applicable.

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

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In 1998, the Companyissued $125.0 million aggregate principal amount of the 91¤2%notes and $75.0 million aggregate principal amount of floating rate notes.Both series of notes were to mature on May 1, 2008. On February 9,2005, we repurchased $115.0 million principal amount of 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 Companyissued $200.0 million aggregate principal amount of 121¤2%notes. These notes were to mature on May 10, 2010. On February 9,2005, we repurchased $173.1 million principal amount of the 121¤2%notes tendered pursuant to the tender offer for such notes. We redeemed theremaining outstanding 121¤2%notes on May 2, 2005.

In 2003, the Companyissued $225.0 million aggregate principal amount of 117¤8%notes. On February 9, 2005, we repurchased $223.0 million principalamount of the 117¤8%notes tendered pursuant to the tender offer for such notes. At December 31,2005, $2.1 million principal amount of the 117¤8% notesremained outstanding.

**Off-Balance Sheet Arrangements**

We do not have anyoff-balance sheet arrangements.

**Summary of Contractual Obligations**

The tables set forth belowcontain information with regard to disclosures about contractual obligationsand commercial commitments.

Thefollowing table discloses aggregate information about our contractualobligations as of December 31, 2006 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:            |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Long term debt                      |       | $                                         | 607,986    |   |   | $ | 714 |   |   | $ | 914 |   | $ | 17,381 |   | $ | 588,977 |   |
| Fixed interest  payments            |       | 119,051                                   |       |   | 32,695 |   |   | 58,942 |   | 26,369 |   | 1,045 |   |
| Variable interest  payments         |       | 79,634                                    |       |   | 3,274 |   |   | 17,348 |   | 52,954 |   | 6,058 |   |
| Operating leases                    |       | 7,851                                     |       |   | 1,112 |   |   | 2,017 |   | 1,108 |   | 3,614 |   |
| Minimum purchase  contracts         |       | 414                                       |       |   | 286 |   |   | 107 |   | 21 |   | — |   |
| Total contractual cash  obligations |       | $                                         | 814,936    |   |   | $ | 38,081 |   |   | $ | 79,328 |   | $ | 97,833 |   | $ | 599,694 |   |

 

The following tablediscloses aggregate information about our derivative financial instruments asof December 31, 2006, the source of fair value of these instruments andtheir 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) |       | $                                                                  | 8,615      |   |   | 5,424 |   |   |   | 2,685 |   |   |   | 496 |   |   |   | 10 |   |   |
|                                      |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Fairvalue of interest rate swaps at December 31, 2006 was provided by thecounterparties to the underlying contracts using consistent methodologies.

**Critical AccountingPolicies**

Our criticalaccounting policies are as follows:

·       Revenuerecognition;

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·       Allowancefor doubtful accounts;

·       Accountingfor income taxes; and

·       Valuationof long-lived assets, including goodwill.

***Revenue recognition.******  ***Certain of ourinterstate network access and data revenues are based on tariffed accesscharges filed directly with the Federal Communications Commission; theremainder of such revenues are derived from revenue sharing arrangements withother local exchange carriers administered by the National Exchange CarrierAssociation.

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 of theCompany’s telephone subsidiaries file interstate tariffs directly with theFederal Communication Commission using this streamlined filing approach. As of December 31,2006, the amount of our earnings in excess of the authorized rate of returnreflected as a liability on the balance sheet for the 2005 to 2006 monitoringperiods was approximately $0.4 million. The settlement period related to (i) the2003 to 2004 monitoring period lapses on September 30, 2007 and (ii) the2005 to 2006 monitoring period lapses on September 30, 2009. We willcontinue to monitor the legal status of any pending or future proceedings thatcould impact its entitlement to these funds, and may recognize as revenue someor all of the over-earnings at the end of the settlement period or as the legalstatus 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.*****  **Aspart of the process of preparing our consolidated financial statements we wererequired to estimate our income taxes. This process involves estimating ouractual current tax exposure and assessing temporary differences resulting fromdifferent treatment of items for tax and accounting purposes. These differencesresult in deferred tax assets and liabilities, which are included within ourconsolidated balance sheets. We must then assess the likelihood that our deferredtax assets will be recovered from future taxable income and to the extent webelieve the recovery is not likely, we must establish a valuation allowance.Further, to the extent that we establish a valuation allowance or increase thisallowance in a financial accounting period, we must include a tax provision, orreduce our tax benefit in our consolidated statement of operations. Inperforming the assessment, management considers the scheduled reversal ofdeferred tax liabilities, projected future taxable income, and tax planningstrategies. We use our judgment to determine our provision or benefit forincome taxes, deferred tax assets and liabilities and any valuation allowancerecorded 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 of significantchanges to the U.S. federal and state income tax laws and regulations on aregular basis and update the assumptions and estimates used to prepare ourfinancial statements when new regulation and legislation is enacted.

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Based on certain assumptions, we had$235.1 million in federal and state net operating loss carry forwards asof December 31, 2006. In February 2005, we completed our initialpublic offering which resulted in an “ownership change” within the meaning ofthe U.S. federal income tax laws addressing net operating loss carry forwards,alternative minimum tax credits and other similar tax attributes. As a resultof such ownership change, there will be specific limitations on our ability touse our NOL carry forwards and other tax attributes. In order to fully utilizethe deferred tax assets, mainly generated by the NOLs, we will need to generatefuture taxable income of approximately $165.2 million prior to the expirationof the NOL carry forwards beginning in 2019 through 2025.

***Valuation of long-lived assets, including goodwill.*****  **We review our long-lived assets,including goodwill for impairment whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. Several factors couldtrigger 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 $499.2 million at December 31,2006. We have recorded intangible assets related to the acquired companies’customer relationships of $13.8 million. These intangible assets are beingamortized over 15 years. The intangible assets are included in IntangibleAssets on our consolidated balance sheet.

We are required to performan annual impairment review of goodwill as required by SFAS No. 142, “Goodwilland Other Intangible Assets”. No impairment of goodwill resulted from theannual valuation of goodwill in 2006.

**New AccountingStandards**

In July 2006, the Financial Accounting StandardsBoard (FASB) issued FASB Interpretation No. (FIN) 48, “Accounting forUncertainty in Income Taxes.”  FIN 48requires applying a “more likely than not” threshold to the recognition andde-recognition of tax positions. FIN 48 is effective for fiscal years beginningafter December 15, 2006. We have determined that the impact of theadoption of this interpretation will not have a material impact on ourfinancial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements.” SFAS No. 157 is definitional and disclosureoriented and addresses how companies should approach measuring fair value whenrequired by generally accepted accounting principles, or GAAP; it does notcreate or modify any current GAAP requirements to apply fair value accounting.SFAS No. 157 provides a single definition for fair value that is to beapplied consistently for all accounting applications, and also generallydescribes and prioritizes according to reliability the methods and inputs usedin valuations. The new measurement and disclosure requirements of SFAS No. 157are effective for us in the first quarter 2008. We do not expect a significantimpact from adopting SFAS No. 157.

In September 2006, the SEC issued StaffAccounting Bulletin (SAB) No. 108, “Considering the Effects of PriorYear Misstatements When Quantifying Misstatements in Current Year FinancialStatements”, which provides interpretive guidance on how the effects of thecarryover or reversal of prior year misstatements should be considered inquantifying a current year misstatement. We were required to adopt theprovisions of SAB No. 108 in our financial statements for the fiscalyear ended December 31, 2006. The adoption of SAB No. 108 didnot have an impact on our consolidated financial statements.

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In June 2006, theFASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 06-3,“How Sales Taxes Collected From Customers and Remitted to GovernmentalAuthorities Should Be Presented in the Income Statement” (“EITF 06-3”).EITF 06-3 requires a company to disclose its accounting policy (i.e.gross vs. net basis) relating to the presentation of taxes within the scope ofEITF 06-3. Furthermore, for taxes reported on a gross basis, anenterprise should disclose the amounts of those taxes in interim and annualfinancial statements for each period for which an income statement ispresented. The guidance is effective for all periods beginning after December 15,2006. The adoption of this guidance will have no impact on our consolidated financialstatements.

**Inflation**

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

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of December 31, 2006, approximately 90% of ourindebtedness bore interest at fixed rates or effectively at fixed rates. Ourearnings 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 rate indebtedness(excluding variable rate indebtedness which has its interest rate effectivelyfixed under interest rate swap agreements) outstanding at December 31,2006 increased by 10%, our interest expense would have increased, and ourincome from continuing operations before taxes would have decreased, byapproximately $0.1 million for the year ended December 31, 2006.

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$8.6 million at December 31, 2006. The fair value indicates anestimated amount we would have received to cancel the contracts or transferthem to other parties.

We usevariable and fixed-rate debt to finance our operations, capitalexpenditures and acquisitions. The variable-rate debt obligations exposeus to variability in interest payments due to changes in interest rates. Webelieve it is prudent to limit the variability of a portion of our interestpayments. To meet this objective, we enter into interest rate swap agreementsto manage fluctuations in cash flows resulting from interest rate risk. Theseswaps change the variable-rate cash flow exposure on the debt obligationsto fixed cash flows. Under the terms of the interest rate swaps, we pay avariable interest rate plus an additional payment if the variable rate paymentis below a contractual rate, or we receive a payment if the variable ratepayment is above the contractual rate.  The chart below provides details of each ofour interest rate swap agreements.

| **Effective Date:** | ** ** | ** ** | ** **    | **Notional Amount** | ** ** | **Rate** | ** ** | **Rate, including  applicable margin** | ** ** | **Expiration Date** | ** **             |
|--------------------------|------------|------------|---------------|--------------------------|------------|----------|------------|--------------------------------------------------|------------|--------------------------|------------------------|
| February 8,  2005   |       | $          | 130.0 Million |                     | 3.76       | %        |       | 5.51                                             | %          |                     | December 31, 2007 |   |
| February 8,  2005   |       | $          | 130.0 Million |                     | 3.98       | %        |       | 5.73                                             | %          |                     | December 31, 2008 |   |
| February 8,  2005   |       | $          | 130.0 Million |                     | 4.11       | %        |       | 5.86                                             | %          |                     | December 31, 2009 |   |
| April 29,  2005     |       | $          | 50.0 Million  |                     | 4.72       | %        |       | 6.47                                             | %          |                     | March 31, 2012    |   |
| June 30,  2005      |       | $          | 50.0 Million  |                     | 4.69       | %        |       | 6.44                                             | %          |                     | March 31, 2011    |   |
| June 30,  2006      |       | $          | 50.0 Million  |                     | 5.36       | %        |       | 7.11                                             | %          |                     | December 31, 2009 |   |
| December 31,  2007  |       | $          | 65.0 Million  |                     | 4.91       | %        |       | 6.66                                             | %          |                     | December 30, 2011 |   |
| December 31, 2008   |       | $          | 100.0 Million |                     | 5.02       | %        |       | 6.77                                             | %          |                     | December 31, 2010 |   |

 

In addition, effective on September 30,2005, we amended our credit facility to reduce the effective interest ratemargins on the $588.5 million term facility by 0.25% to 1.75% on Eurodollarloans and to 

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0.75%for Base rate loans. This amendment also effectively reduced the fixed interestrates on our interest rate swap agreements by 0.25%.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**INDEXTO FINANCIAL STATEMENTS**

|                                                                                                                            | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| FAIRPOINT  COMMUNICATIONS, INC. AND SUBSIDIARIES:                                                                          |       |     |       |
| Report of Independent Registered Public Accounting  Firm                                                                   |       | 55       |       |
| CONSOLIDATED  FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND  2004:                             |       |     |       |
| Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                         |       | 56       |       |
| Consolidated Statements of Operations for the Years  Ended December 31, 2006, 2005, and 2004                          |       | 57       |       |
| Consolidated Statements of Stockholders’ Equity  (Deficit) for the Years Ended December 31, 2006, 2005, and 2004 |       | 58       |       |
| Consolidated Statements of Comprehensive Income (Loss)  for the Years Ended December 31, 2006, 2005, and 2004         |       | 59       |       |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2006, 2005, and 2004                          |       | 60       |       |
| Notes to Consolidated Financial Statements for the  Years Ended December 31, 2006, 2005, and 2004                     |       | 62       |       |

 

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and StockholdersFairPoint Communications, Inc.:

We have audited the accompanying consolidated balancesheets of FairPoint Communications, Inc. and subsidiaries (the Company) asof December 31, 2006 and 2005, and the related consolidated statements ofoperations, stockholders’ equity (deficit), comprehensive income (loss), andcash flows for each of the years in the three-year period ended December 31,2006. These consolidated financial statements are the responsibility ofFairPoint Communications, Inc.’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the consolidated financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the consolidated financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallconsolidated financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financial positionof the Company as of December 31, 2006 and 2005, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2006, in conformity with U.S. generally acceptedaccounting principles.

As discussed in notes 1 and 13 to the consolidatedfinancial statements, the Company adopted the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 123 (revised 2004), *Share Based Payment*, effective January 1, 2006.

We also have audited, in accordancewith the standards of the Public Company Accounting Oversight Board (UnitedStates), the effectiveness of the Company’s internal control over financialreporting as of December 31, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 9,2007 expressed an unqualified opinion on management’s assessment of, and theeffective operation of, internal control over financial reporting.

/s/ KPMG LLP

Omaha, NebraskaMarch 12, 2007

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Balance SheetsDecember 31, 2006 and 2005(in thousands, except share data)**

| ** **                                                                                                                                                                  | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **Assets**                                                                                                                                                                  |       |        |        |        |       |
| Current assets:                                                                                                                                                             |       |        |        |        |       |
| Cash                                                                                                                                                                        |       | $           | 3,805       |        | $          | 5,083 |   |
| Accounts receivable, net                                                                                                                                                    |       | 27,940      |        | 30,034      |       |
| Other receivables                                                                                                                                                           |       | 593         |        | 4,951       |       |
| Material and supplies                                                                                                                                                       |       | 5,128       |        | 4,285       |       |
| Prepaid and other                                                                                                                                                           |       | 2,631       |        | 1,786       |       |
| Deferred income tax                                                                                                                                                         |       | 33,648      |        | 29,190      |       |
| Interest rate swaps                                                                                                                                                         |       | 5,425       |        | 3,129       |       |
| Assets of discontinued operations                                                                                                                                           |       | —      |        | 90          |       |
| **Total current assets**                                                                                                                                                    | ** ** | **79,170**  | ** **  | **78,548**  | ** ** |
| Property, plant, and equipment, net                                                                                                                                         |       | 246,264     |        | 242,617     |       |
| Goodwill                                                                                                                                                                    |       | 499,184     |        | 481,343     |       |
| Investments                                                                                                                                                                 |       | 12,057      |        | 39,808      |       |
| Intangible assets, net                                                                                                                                                      |       | 13,197      |        | 3,662       |       |
| Debt issue costs, net                                                                                                                                                       |       | 7,574       |        | 9,145       |       |
| Deferred income tax                                                                                                                                                         |       | 23,830      |        | 47,160      |       |
| Interest rate swaps                                                                                                                                                         |       | 3,190       |        | 5,649       |       |
| Other                                                                                                                                                                       |       | 764         |        | 207         |       |
| **Total assets**                                                                                                                                                            | ** ** | **$**       | **885,230** | ** **  | **$**      | **908,139** | ** ** |
| **Liabilities and Stockholders’ Equity**                                                                                                                               |       | ** **  | ** **  | ** **  | ** ** |
| Current liabilities:                                                                                                                                                        |       |        |        |        |       |
| Accounts payable                                                                                                                                                            |       | $           | 14,337      |        | $          | 12,030 |   |
| Dividend payable                                                                                                                                                            |       | 13,908      |        | 13,789      |       |
| Other accrued liabilities                                                                                                                                                   |       | 12,713      |        | 14,021      |       |
| Accrued interest payable                                                                                                                                                    |       | 560         |        | 288         |       |
| Accrued bonuses                                                                                                                                                             |       | 3,304       |        | 2,975       |       |
| Deferred credits                                                                                                                                                            |       | —      |        | 3,812       |       |
| Current portion of long-term debt                                                                                                                                           |       | 714         |        | 677         |       |
| Demand notes payable                                                                                                                                                        |       | 312         |        | 338         |       |
| Liabilities of discontinued operations                                                                                                                                      |       | 486         |        | 2,495       |       |
| **Total current liabilities**                                                                                                                                               | ** ** | **46,334**  | ** **  | **50,425**  | ** ** |
| Long-term  liabilities:                                                                                                                                                     |       |        |        |        |       |
| Long-term debt, net of current portion                                                                                                                                      |       | 607,272     |        | 606,748     |       |
| Other liabilities                                                                                                                                                           |       | 6,897       |        | 4,108       |       |
| **Total long-term liabilities**                                                                                                                                             | ** ** | **614,169** | ** **  | **610,856** | ** ** |
| Minority interest                                                                                                                                                           |       | 8           |        | 10          |       |
| Stockholders’  equity:                                                                                                                                                 |       |        |        |        |       |
| Common stock, $0.01 par value, 200,000,000 shares  authorized, issued and outstanding 35,218,443 shares at December 31,  2006 and 35,021,335 at December 31, 2005 |       | 352         |        | 350         |       |
| Additional paid-in capital                                                                                                                                                  |       | 530,536     |        | 590,131     |       |
| Unearned compensation                                                                                                                                                       |       | —      |        | (6,475      | )          |
| Accumulated other comprehensive income, net                                                                                                                                 |       | 5,376       |        | 5,477       |       |
| Accumulated deficit                                                                                                                                                         |       | (311,545    | )           | (342,635    | )          |
| **Total stockholders’ equity**                                                                                                                                         | ** ** | **224,719** | ** **  | **246,848** | ** ** |
| **Total  liabilities and stockholders’ equity**                                                                                                                        | ** ** | **$**       | **885,230** | ** **  | **$**      | **908,139** | ** ** |

 

See accompanying notes to consolidated financial statements.

56

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES**Consolidated Statements of OperationsYears ended December 31, 2006, 2005, and 2004(in thousands, except per share data)

| ** **                                                    | ** ** | **2006**   | ** **  | **2005**   | ** ** | **2004**    | ** ** |
|---------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| **Revenues**                                                  | ** ** | **$**      | **270,069** | ** ** | **$**      | **262,843** | ** ** | **$** | **252,645** | ** ** |
| Operating  expenses:                                          |       |       |        |       |       |        |       |
| Operating expenses, excluding depreciation and amortization   |       | 155,463    |        | 143,425    |       | 128,804     |       |
| Depreciation and amortization                                 |       | 53,236     |        | 52,390     |       | 50,287      |       |
| Total operating expenses                                      |       | 208,699    |        | 195,815    |       | 179,091     |       |
| **Income from operations**                                    | ** ** | **61,370** | ** **  | **67,028** | ** ** | **73,554**  | ** ** |
| Other income (expense):                                       |       |       |        |       |       |        |       |
| Net gain (loss) on sale of investments and other  assets      |       | 14,740     |        | (11        | )          | 104         |       |
| Interest and dividend income                                  |       | 3,315      |        | 2,499      |       | 2,335       |       |
| Interest expense                                              |       | (39,665    | )           | (46,416    | )          | (104,315    | )          |
| Impairment on investments                                     |       | —     |        | (1,200     | )          | (349        | )          |
| Equity in net earnings of investees                           |       | 10,616     |        | 11,302     |       | 10,899      |       |
| Realized and unrealized losses on interest rate  swaps        |       | —     |        | —     |       | (112        | )          |
| Other nonoperating, net                                       |       | —     |        | (87,746    | )          | (5,951      | )          |
| Total other expense                                           |       | (10,994    | )           | (121,572   | )          | (97,389     | )          |
| Income (loss) from continuing operations before  income taxes |       | 50,376     |        | (54,544    | )          | (23,835     | )          |
| Income tax  (expense) benefit                                 |       | (19,858    | )           | 83,096     |       | (516        | )          |
| Minority interest  in income of subsidiaries                  |       | (2         | )           | (2         | )          | (2          | )          |
| **Income (loss) from continuing operations**                  | ** ** | **30,516** | ** **  | **28,550** | ** ** | **(24,353** | **)**      |
| Discontinued operations:                                      |       |       |        |       |       |        |       |
| Income on disposal of assets of discontinued  operations      |       | 574        |        | 380        |       | 671         |       |
| Income from discontinued operations                           |       | 574        |        | 380        |       | 671         |       |
| **Net income (loss)**                                         | ** ** | **$**      | **31,090**  | ** ** | **$**      | **28,930**  | ** ** | **$** | **(23,682** | **)** |
| Basic weighted average shares outstanding                     |       | 34,629     |        | 31,927     |       | 9,468       |       |
| Diluted weighted  average shares outstanding                  |       | 34,754     |        | 31,957     |       | 9,468       |       |
| *Basic  earnings (loss) per common share:*                    |       |       |        |       |       |        |       |
| Continuing operations                                         |       | $          | 0.88        |       | $          | 0.89        |       | $ | (2.57 | ) |
| Discontinued operations                                       |       | 0.02       |        | 0.02       |       | 0.07        |       |
| Net income                                                    |       | 0.90       |        | 0.91       |       | (2.50       | )          |
| *Diluted earnings (loss) per  common share:*                  |       |       |        |       |       |        |       |
| Continuing operations                                         |       | $          | 0.88        |       | $          | 0.89        |       | $ | (2.57 | ) |
| Discontinued operations                                       |       | 0.01       |        | 0.02       |       | 0.07        |       |
| Net income                                                    |       | 0.89       |        | 0.91       |       | (2.50       | )          |

 

See accompanying notes to consolidated financial statements.

57

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES**Consolidated Statements of Stockholders’ Equity (Deficit)Years ended December 31, 2006, 2005, and 2004(in thousands)

| ** **                                                   | ** ** | ** **            | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** | ** **     | ** ** | ** **        | ** ** | ** **      | ** ** | ** **       | ** ** | **Accumulated**        | ** **     | ** **  | ** ** | **Total**                             | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|------------|------------|------------------|------------|------------------|------------|----------------|------------|-------------------|------------|-----------------|------------|------------------|------------|------------------------|----------------|-------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | ** **            | ** ** | ** ** | ** ** | **Class A** | ** ** | **Class C** | ** ** | **Additional** | ** ** | ** **        | ** ** | **other**       | ** ** | ** **       | ** ** | **stockholders’** | ** **     |
| ** **                                                   | ** ** | **Common Stock** | ** ** | **Common** | ** ** | **Common**       | ** ** | **paid-in**      | ** ** | **Unearned**   | ** ** | **comprehensive** | ** ** | **Accumulated** | ** ** | **equity**       | ** ** |
| ** **                                                   | ** ** | **Shares**            | ** ** | **Amount** | ** ** | **Shares**       | ** ** | **Amount**       | ** ** | **Shares**     | ** ** | **Amount**        | ** ** | **capital**     | ** ** | **compensation** | ** ** | **income (loss)** | ** **     | **deficit** | ** ** | **(deficit)**                         | ** ** |
| Balance at December 31, 2003                            |       | —                |       |       | —     |             | 8,643      |             |       | 86             |       |              | 809        |            |       | 8                |       |                   | 198,470        |        |       | —                                |       |   | 1,366 |   |   | (347,883 | ) |   | (147,953 | ) |
| Net income                                                   |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | — |   |   | (23,682 | ) |   | (23,682 | ) |
| Compensation expense for stock-based awards                  |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 49             |        |       | —                                |       |   | — |   |   | — |   |   | 49 |   |
| Other comprehensive loss from available-for-sale  securities |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | (1,469 | ) |   | — |   |   | (1,469 | ) |
| Other comprehensive income from  cash flow hedges            |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | 103 |   |   | — |   |   | 103 |   |
| Balance at December 31, 2004                            |       | —                |       |       | —     |             | 8,643      |             |       | 86             |       |              | 809        |            |       | 8                |       |                   | 198,519        |        |       | —                                |       |   | — |   |   | (371,565 | ) |   | (172,952 | ) |
| Net income                                                   |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | — |   |   | 28,930 |   |   | 28,930 |   |
| Net proceeds from issuance of common stock                   |       | 25,000                |       |       | 250        |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 431,671        |        |       | —                                |       |   | — |   |   | — |   |   | 431,921 |   |
| Transfer of Class A and Class C to common  stock   |       | 9,452                 |       |       | 94         |             | (8,643     | )                |       | (86            | )          |              | (809       | )               |       | (8               | )          |                   | —         |        |       | —                                |       |   | — |   |   | — |   |   | — |   |
| Exercise of stock options                                    |       | 98                    |       |       | 1          |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 183            |        |       | —                                |       |   | — |   |   | — |   |   | 184 |   |
| Issuance of restricted shares, net of forfeitures            |       | 471                   |       |       | 5          |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 8,545          |        |       | (8,550                                | )          |   | — |   |   | — |   |   | — |   |
| Recognition of compensation expense                          |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 275            |        |       | 2,075                                 |       |   | — |   |   | — |   |   | 2,350 |   |
| Dividends declared                                           |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | (49,062        | )           |       | —                                |       |   | — |   |   | — |   |   | (49,062 | ) |
| Other comprehensive income from  cash flow hedges            |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | 5,477 |   |   | — |   |   | 5,477 |   |
| Balance at December 31, 2005                            |       | 35,021                |       |       | $ 350 |             | —     |             |       | $ —  |       |              | —     |            |       | $ —    |       |                   | $ 590,131 |        |       | $ (6,475                         | )          |   | $ 5,477 |   |   | $ (342,635 | ) |   | $ 246,848 |   |
| Net income                                                   |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | — |   |   | 31,090 |   |   | 31,090 |   |
| Issuance of restricted shares                                |       | 216                   |       |       | 2          |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | — |   |   | — |   |   | 2 |   |
| Restricted stock cancelled for withholding tax               |       | (42                   | )          |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | (633           | )           |       | —                                |       |   | — |   |   | — |   |   | (633 | ) |
| Exercise of stock options and restricted units               |       | 23                    |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 24             |        |       | —                                |       |   | — |   |   | — |   |   | 24 |   |
| Stock based compensation expense                             |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | 2,859          |        |       | —                                |       |   | — |   |   | — |   |   | 2,859 |   |
| Reclassify unearned compensation                             |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | (6,475         | )           |       | 6,475                                 |       |   | — |   |   | — |   |   | — |   |
| Dividends declared                                           |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | (55,370        | )           |       | —                                |       |   | — |   |   | — |   |   | (55,370 | ) |
| Other comprehensive loss from cash flow hedges               |       | —                |       |       | —     |             | —     |             |       | —         |       |              | —     |            |       | —           |       |                   | —         |        |       | —                                |       |   | (101 | ) |   | — |   |   | (101 | ) |
| Balance at  December 31, 2006                           |       | 35,218                |       |       | $ 352 |             | —     |             |       | $ —  |       |              | —     |            |       | $ —    |       |                   | $ 530,536 |        |       | $     — |       |   | $ 5,376 |   |   | $ (311,545 | ) |   | $ 224,719 |   |

 

See accompanying notes to consolidated financial statements.

58

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES**Consolidated Statements of Comprehensive Income (Loss)Years ended December 31, 2006, 2005, and 2004(in thousands)

| ** **                                                                                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**     | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|--------------|------------|
| Net income (loss)                                                                                                                                                          |       |     |       | $        | 31,090     |         |       |   | 28,930 |   |   |   | $ | (23,682 | ) |
| Other comprehensive  income (loss):                                                                                                                                        |       |     |       |     |       |         |       |   |   |   |   |   |   |
| Available-for-sale  securities:                                                                                                                                            |       |     |       |     |       |         |       |   |   |   |   |   |   |
| Unrealized holding losses                                                                                                                                                  |       | $        | —     |     |       |         | —     |   |   |   | (1,243 | ) |   |   |
| Less reclassification adjustment for gain realized in  net income (loss)                                                                                                   |       | —   |       |     |       | —       |       |   |   | (226 | ) |   |   |
| Reclassification for other than temporary loss included  in net income                                                                                                     |       | —   |       | —   |       | —       |       | — |   | — |   | (1,469 | ) |
| Cash flow hedges:                                                                                                                                                          |       |     |       |     |       |         |       |   |   |   |   |   |   |
| Change in net unrealized gain, net of tax expense  (benefit) of $0.1 million and $3.3 million as of the twelve months ended  December 31, 2006 and 2005, respectively |       | (101     | )          |     |       | 5,477   |       |   |   | — |   |   |   |
| Reclassification adjustment                                                                                                                                                |       | —   |       | (101     | )          | —       |       | 5,477 |   | 103 |   | 103 |   |
| Other  comprehensive income (loss)                                                                                                                                         |       |     |       | (101     | )          |         |       | 5,477 |   |   |   | (1,366 | ) |
| Comprehensive income  (loss)                                                                                                                                               |       |     |       | $        | 30,989     |         |       |   | 34,407 |   |   |   | $ | (25,048 | ) |
|                                                                                                                                                                            |            |          |            |          |            |              |            |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financial statements.

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES** Consolidated Statements of Cash Flows Years ended December 31, 2006, 2005, and 2004 (in thousands)

| ** **                                                                                                                 | ** ** | **2006**            | ** ** | **2005**            | ** ** | **2004**       | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|---------------------|------------|----------------|------------|
| Cash flows from operating activities:                                                                                      |       |                |       |                |       |           |       |
| Net income (loss)                                                                                                          |       | $  31,090 |       | $  28,930 |       | $ (23,682 | )          |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities of continuing  operations:        |       |                |       |                |       |           |       |
| Income from  discontinued operations                                                                                       |       | (574                | )          | (380                | )          | (671           | )          |
| Dividends and  accretion on shares subject to mandatory redemption                                                         |       | —              |       | 2,362               |       | 20,181         |       |
| Depreciation and  amortization                                                                                             |       | 53,236              |       | 52,390              |       | 50,287         |       |
| Loss of preferred  stock subject ot mandatory redemption                                                                   |       | —              |       | 9,899               |       | —         |       |
| Amortization of  debt issue costs                                                                                          |       | 1,571               |       | 1,859               |       | 4,603          |       |
| Provision for  uncollectible revenue                                                                                       |       | 1,798               |       | 3,245               |       | 1,718          |       |
| Deferred income  taxes                                                                                                     |       | 17,474              |       | (84,208             | )          | —         |       |
| Income from  equity method investments                                                                                     |       | (10,616             | )          | (11,302             | )          | (10,899        | )          |
| Deferred patronage  dividends                                                                                              |       | (1                  | )          | (77                 | )          | (84            | )          |
| Minority interest  in income of subsidiaries                                                                               |       | 2                   |       | 2                   |       | 2              |       |
| Loss on early  retirement of debt                                                                                          |       | —              |       | 77,847              |       | —         |       |
| Write-off of  offering costs                                                                                               |       | —              |       | —              |       | 5,951          |       |
| Net (gain) loss  on sale of investments and other assets                                                                   |       | (14,740             | )          | 11                  |       | (104           | )          |
| Impairment on  investments                                                                                                 |       | —              |       | 1,200               |       | 349            |       |
| Amortization of  investment tax credits                                                                                    |       | (12                 | )          | (16                 | )          | (27            | )          |
| Stock-based  compensation                                                                                                  |       | 2,859               |       | 2,350               |       | 49             |       |
| Other non-cash  item                                                                                                       |       | (637                | )          | (212                | )          | —         |       |
| Change in fair  value of interest rate swaps and reclassification of transition adjustment  recorded in comprehensive loss |       | —              |       | —              |       | (772           | )          |
| Changes in assets and  liabilities arising from continuing operations, net of acquisitions:                                |       |                |       |                |       |           |       |
| Accounts  receivable                                                                                                       |       | 5,500               |       | (3,103              | )          | (3,068         | )          |
| Prepaid and other  assets                                                                                                  |       | (790                | )          | 576                 |       | (89            | )          |
| Accounts payable                                                                                                           |       | (1,289              | )          | (3,428              | )          | (390           | )          |
| Accrued interest  payable                                                                                                  |       | 272                 |       | (16,309             | )          | (44            | )          |
| Other accrued  liabilities                                                                                                 |       | (2,647              | )          | 338                 |       | 2,302          |       |
| Income taxes                                                                                                               |       | 29                  |       | (363                | )          | (138           | )          |
| Other  assets/liabilities                                                                                                  |       | (759                | )          | 71                  |       | 501            |       |
| Total adjustments                                                                                                          |       | 50,676              |       | 32,752              |       | 69,657         |       |
| **Net  cash provided by operating activities of continuing operations**                                                    | ** ** | **81,766**          | ** ** | **61,682**          | ** ** | **45,975**     | ** ** |
| Cash flows from  investing activities of continuing operations:                                                            |       |                |       |                |       |           |       |
| Acquisition of telephone  properties, net of cash acquired                                                                 |       | (49,837             | )          | (26,258             | )          | (225           | )          |
| Acquisition of property,  plant, and equipment                                                                             |       | (32,317             | )          | (28,099             | )          | (36,492        | )          |
| Proceeds from  sale of property, plant, and equipment                                                                      |       | 327                 |       | 698                 |       | 531            |       |
| Distributions  from investments                                                                                            |       | 10,654              |       | 10,859              |       | 15,017         |       |
| Payment on  covenants not to compete                                                                                       |       | (20                 | )          | (110                | )          | (145           | )          |
| Acquisition of  investments                                                                                                |       | —              |       | (12                 | )          | —         |       |
| Proceeds from  sale of investments and other assets                                                                        |       | 43,832              |       | 115                 |       | 328            |       |
| **Net cash used in investing activities of  continuing operations**                                                        | ** ** | **(27,361**         | **)**      | **(42,807**         | **)**      | **(20,986**    | **)**      |

See accompanying notes to consolidated financial statements.

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES** Consolidated Statements of Cash Flows (Continued) Years ended December 31, 2006, 2005, and 2004 (in thousands)

 

| Cash flows from  financing activities of continuing operations:                             |       |                                                                      |       |                                     |       |                                                                      |       |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| Proceeds from issuance  of long-term debt                                                   |       | 129,200                                                                   |       | 699,959                                  |       | 178,550                                                                   |       |
| Repayment of long-term  debt                                                                |       | (128,651                                                                  | )          | (905,675                                 | )          | (193,761                                                                  | )          |
| Payment of fees and  penalties associated with early retirement of long term debt           |       | —                                                                    |       | (61,037                                  | )          | —                                                                    |       |
| Payment of deferred  transaction fee                                                        |       | —                                                                    |       | (8,445                                   | )          | —                                                                    |       |
| Repurchase of shares of  common stock subject to put options                                |       | —                                                                    |       | (136                                     | )          | (1,000                                                                    | )          |
| Repurchase of redeemable  preferred stock                                                   |       | —                                                                    |       | (129,141                                 | )          | —                                                                    |       |
| Loan origination and  offering costs                                                        |       | —                                                                    |       | (8,975                                   | )          | (7,750                                                                    | )          |
| Dividends paid to  minority stockholders                                                    |       | (4                                                                        | )          | (4                                       | )          | (5                                                                        | )          |
| Proceeds from the  exercise of stock options                                                |       | 24                                                                        |       | 184                                      |       | —                                                                    |       |
| Net proceeds from  issuance of common stock                                                 |       | —                                                                    |       | 431,921                                  |       | —                                                                    |       |
| Dividends paid to  common stockholders                                                      |       | (55,237                                                                   | )          | (35,298                                  | )          | —                                                                    |       |
| **Net cash used in financing  activities of continuing operations**                         | ** ** | **(54,668**                                                               | **)**      | **(16,647**                              | **)**      | **(23,966**                                                               | **)**      |
| Cash flows of discontinued operations:                                                      |       |                                                                      |       |                                     |       |                                                                      |       |
| Operating cash  flows                                                                       |       | (1,015                                                                    | )          | (740                                     | )          | (3,031                                                                    | )          |
| Net increase  (decrease) in cash                                                            |       | (1,278                                                                    | )          | 1,488                                    |       | (2,008                                                                    | )          |
| Cash, beginning  of year                                                                    |       | 5,083                                                                     |       | 3,595                                    |       | 5,603                                                                     |       |
| **Cash,  end of year**                                                                      | ** ** | **$     3,805**                                  | ** ** | **$     5,083** | ** ** | **$     3,595**                                  | ** ** |
| Supplemental disclosures of cash flow information:                                          | ** ** | ** **                                                                | ** ** | ** **                               | ** ** | ** **                                                                | ** ** |
| Interest paid                                                                               |       | $  37,822                                                       |       | 58,494                                   |       | $  80,736                                                       |       |
| Income taxes  paid, net of refunds                                                          |       | $     2,369                                      |       | 946                                      |       | $     1,055                                      |       |
| Supplemental disclosures of noncash financing  activities:                                  |       |                                                                      |       |                                     |       |                                                                      |       |
| Redeemable  preferred stock dividends paid in-kind                                          |       | $           — |       | —                                   |       | $           — |       |
| Gain on  repurchase of redemmable preferred stock                                           |       | $           — |       | —                                   |       | $           — |       |
| Accretion of redeemable  preferred stock                                                    |       | $           — |       | —                                   |       | $           — |       |
| Long-term debt  issued in connection with Carrier Services’ Tranche B interest payment |       | $           — |       | —                                   |       | $        115                      |       |

 

See accompanying notes to consolidated financial statements.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements**

**(1)   Organizationand Summary of Significant Accounting Policies**

***(a) Organization***

FairPoint Communications, Inc. (FairPoint)provides management services to its wholly owned subsidiaries: ST Enterprises,Ltd. (STE); MJD Ventures, Inc. (Ventures); MJD Services Corp. (Services);FairPoint Carrier Services, Inc. (Carrier Services); FairPointBroadband, Inc. (Broadband); and MJD Capital Corp. STE, Ventures, andServices also provide management services to their wholly owned subsidiaries.

Collectively, the wholly owned subsidiaries of STE,Ventures, and Services primarily provide telephone local exchange services invarious states. Operations also include resale of long distance services,internet services, cable services, equipment sales, and installation and repairservices. MJD Capital Corp. leases equipment to other subsidiaries ofFairPoint. Carrier Services provides wholesale long distance services.Broadband provides wireless broadband services and wholesale data products.

STE’s wholly ownedsubsidiaries include Sunflower Telephone Company, Inc. (Sunflower);Northland Telephone Company of Maine, Inc.; FairPoint Vermont, Inc.;ST Computer Resources, Inc.; and ST Long Distance, Inc. (ST LongDistance). Ventures’ wholly owned subsidiaries include Bentleyville CommunicationsCorporation (Bentleyville), Berkshire Telephone Corporation (Berkshire), SidneyTelephone Company (Sidney); C-R Communications, Inc. (C-R);Taconic Telephone Corp. (Taconic); Ellensburg Telephone Company (Ellensburg);Chouteau Telephone Company (Chouteau); Utilities, Inc. (Utilities);Chautauqua and Erie Telephone Corporation (C&E); The Columbus GroveTelephone Company (Columbus Grove); The Orwell Telephone Company (Orwell); GTCCommunications, Inc. (GT Com); Peoples Mutual Telephone Company (Peoples);Fremont Telcom Co. (Fremont); Fretel Communications, LLC (Fretel); Comerco, Inc.(Comerco); Marianna and Scenery Hill Telephone Company (Marianna); CommunityService Telephone Co. (CST); Commtel Communications Inc. (Commtel); TelephoneService Company; and The Germantown Independent Telephone Company (GITC).Services’ wholly owned subsidiaries include Bluestem Telephone Company(Bluestem); Big Sandy Telecom, Inc. (Big Sandy); FairPointCommunications Missouri, Inc.; Columbine Telecom Company (Columbine); OdinTelephone Exchange, Inc. (Odin); Ravenswood Communications, Inc.(Ravenswood); Unite Communications Systems, Inc.; and Yates City TelephoneCompany (Yates).

***(b) Principles of Consolidation and Basis ofPresentation***

The consolidated financial statements include theaccounts of FairPoint and its subsidiaries (the Company). All intercompanytransactions and accounts have been eliminated in consolidation.

The Company’s telephonesubsidiaries follow the accounting for regulated enterprises prescribed byStatement of Financial Accounting Standards (SFAS) No. 71, *Accounting for the Effects of Certain Types of Regulation*.This accounting recognizes the economic effects of rate regulation by recordingcosts and a return on investment; as such, amounts are recovered through ratesauthorized by regulatory authorities. Accordingly, SFAS No. 71 requiresthe Company’s telephone subsidiaries to depreciate telephone plant over usefullives that would otherwise be determined by management. SFAS No. 71 alsorequires deferral of certain costs and obligations based upon approvalsreceived from regulators to permit recovery of such amounts in future years.Criteria that would give rise to the discontinuance of SFAS No. 71 include(1) increasing competition restricting the wireline subsidiaries’ abilityto establish prices to recover specific costs and (2) significant changesin the manner in which rates are set by regulators from cost-based regulationto another form of regulation. The Company’s telephone subsidiaries periodicallyreview the 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements**(Continued)

applicabilityof SFAS No. 71 based on the developments in their current regulatory andcompetitive environments.

***(c) Use of Estimates***

The Company’s managementhas made a number of estimates and assumptions relating to the reporting ofassets and liabilities, the reported amounts of revenues and expenses, and thedisclosure of contingent assets and liabilities to prepare these consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America. Actual results could differ fromthose estimates.

***(d) Revenue Recognition***

Revenues are recognized as services are rendered andare primarily derived from the usage of the Company’s networks and facilitiesor under revenue-sharing arrangements with other communications carriers.Revenues are primarily derived from: access, pooling, local calling services,Universal Service Fund receipts, long distance services, Internet and dataservices, and other miscellaneous services. Local access charges are billed tolocal end users under tariffs approved by each state’s public utilitiescommission. Access revenues are derived for the intrastate jurisdiction bybilling access charges to interexchange carriers and to regional Bell operatingcompanies. These charges are billed based on toll or access tariffs approved bythe local state’s public utilities commission. Access charges for theinterstate jurisdiction are billed in accordance with tariffs filed by theNational Exchange Carrier Association (NECA) or by the individual company andapproved by the Federal Communications Commission.

Revenues are determined on a bill-and-keep basis or apooling basis. If on a bill-and-keep basis, the Company bills the charges toeither the access provider or the end user and keeps the revenue. If theCompany participates in a pooling environment (interstate or intrastate),the toll or access billed is contributed to a revenue pool. The revenue is thendistributed to individual companies based on their company-specific revenuerequirement. This distribution is based on individual state public utilitiescommissions (intrastate) or the Federal Communication Commission’s (interstate)approved separation rules and rates of return. Distribution from thesepools can change relative to changes made to expenses, plant investment, orrate of return. Some companies participate in federal and certain stateuniversal service programs that are pooling in nature but are regulated by rules separatefrom those described above. These rules vary by state. Revenues earnedthrough the various pooling arrangements are initially recorded based on theCompany’s estimates.

Long distance retail andwholesale services are usage sensitive and are billed in arrears and recognizedwhen earned. Internet and data services revenues are substantially allrecurring revenues and are billed one month in advance and deferred untilearned. The majority of the Company’s miscellaneous revenue is provided frombilling and collection and directory services. The Company earns revenue frombilling and collecting charges for toll calls on behalf of interexchangecarriers. The interexchange carrier pays a certain rate per each message billedby the Company. The Company recognizes revenue from billing and collection serviceswhen the services are provided. The Company recognizes directory servicesrevenue over the subscription period of the corresponding directory. Billingand collection is normally billed under contract or tariff supervision.Directory services are normally billed under contract.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements**(Continued)

***(e) Accounts Receivable***

Accounts receivable are recorded at the invoicedamount and do not bear interest. The allowance for doubtful accounts is theCompany’s best estimate of the amount of probable credit losses in the Company’sexisting accounts receivable. The Company establishes an allowance for doubtfulaccounts based upon factors surrounding the credit risk of specific customers,historical trends, and other information. Receivable balances are reviewed onan aged basis and account balances are written off against the allowance afterall means of collection have been exhausted and the potential for recovery isconsidered remote.

Thefollowing is activity in the Company’s allowance for doubtful accountsreceivable for the years ended December 31 (in thousands):

| ** **                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Balance,  beginning of period           |       | $        | 2,121      |     | $          | 1,255    |       | $ | 1,028 |   |
| Acquisition  adjustments                |       | 212      |       | 28       |       | (143     | )          |
| Provision charged  to expense           |       | 1,798    |       | 3,245    |       | 1,718    |       |
| Amounts written  off, net of recoveries |       | (2,316   | )          | (2,407   | )          | (1,348   | )          |
| Balance, end of period                  |       | $        | 1,815      |     | $          | 2,121    |       | $ | 1,255 |   |

 

***(f) Credit Risk***

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of cash and trade receivables. The Company places its cash withhigh-quality financial institutions. Concentrations of credit risk withrespect to trade receivables are principally related to receivables from otherinterexchange carriers and are otherwise limited to the Company’s large numberof customers in several states.

***(g) Investments***

Investments consist of stock in CoBank, ACB (CoBank),the Rural Telephone Finance Cooperative (RTFC), various cellular companies andpartnerships and other minority equity investments, and Non-QualifiedDeferred Compensation Plan assets. The stock in CoBank and the RTFC isnonmarketable and stated at cost. For investments in partnerships, the equitymethod of accounting is used.

Non-Qualified Deferred Compensation Plan assetsare classified as trading. The Company uses fair value reporting for marketableinvestments in debt and equity securities classified as either available-for-saleor trading. For available-for-sale securities, the unrealizedholding gains and losses, net of the related tax effect, are excluded from earningsand are reported as a separate component of comprehensive income until realizedor at such time as the Company determines a decline in value has occurred thatis deemed to be other-than-temporary. Unrealized holding gains and losses ontrading securities are included in other income.

To determine if an impairment of an investment exists,the Company monitors and evaluates the financial performance of the business inwhich it invests and compares the carrying value of the investee to quotedmarket prices (if available), or the fair values of similar investments,which in certain instances, is based on traditional valuation models utilizingmultiples of cash flows. When circumstances indicate that a decline in the fairvalue of the investment has occurred and the decline is other than temporary,the 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements**(Continued)

Company records thedecline in value as a realized impairment loss and a reduction in the cost ofthe investment.

The Company currentlyreceives patronage dividends from its investments in businesses organized ascooperatives for Federal income tax purposes (CoBank and RTFC stock).Patronage dividends represent cash distributions of the cooperative’s earningsand notices of allocations of earnings to the Company. Deferred and uncollectedpatronage dividends are included as part of the basis of the investment untilcollected. The Company’s investment in the Rural Telephone Bank (RTB) paiddividends annually at the discretion of its board of directors. The investmentin the RTB was liquidated in April of 2006.

***(h) Property, Plant, and Equipment***

Property, plant, and equipment is carried at cost.Repairs and maintenance are charged to expense as incurred and major renewalsand improvements are capitalized. For traditional telephone companies, theoriginal cost of depreciable property retired, together with removal cost, lessany salvage realized, is charged to accumulated depreciation. For all othercompanies, the original cost and accumulated depreciation are removed from theaccounts and any gain or loss is included in the results of operations.Depreciation is determined using the straight-line method for financialreporting purposes.

In 2005 and 2004, the Company developed andimplemented, with CSG Systems, Inc., an integrated end-user billingsystem. The costs to develop the system were accounted for in accordance withStatement of Position 98-1, *Accounting for the Costsof Computer Software Developed or Obtained for Internal Use,* or SOP98-1*.*Aggregate capitalized costs (beforeaccumulated amortization) totaled $8.6 million (of which, $5.1 million wascapitalized in 2004), of which the majority represents payments for licensefees and third-party consultants. As a result of the Company’s decision toconvert to a new end-user billing system in November 2005, the capitalizedcosts associated with the CSG Systems, Inc. billing system was amortizedover its remaining useful life which was estimated to be 8 months (reduced from5 years).

In November 2005, the Company reached anagreement with CSG Systems, Inc. in which the Company received totalcompensation from CSG Systems, Inc. of $5.1 million in order to relieve itfrom its responsibilities under the original service bureau contract. TheCompany recorded the $5.1 million as a deferred credit which was amortized overthe remaining life of the CSG contract (8 months). When amortized, a portion ofthe credit offset depreciation expenses and a portion offset billing expenses. Ofthis deferred credit, $1.3 million was recognized in 2005 and $3.8 million wasrecognized in 2006.

As of December 31,2006, the Company has incurred costs to develop and implement the new billingsystem. The costs to develop the new billing system were accounted for inaccordance with SOP 98-1. As of December 31, 2006, aggregatecapitalized costs (before accumulated amortization) totaled $2.3 million (ofwhich, $0.1 million was capitalized in 2005), of which the majority representspayments for license fees and third-party consultants. These capitalizedbilling system costs will be amortized over its estimated useful life of 5years.

***(i) Debt Issue Costs***

Debt issue costs are being amortized over the life ofthe related debt, ranging from 3 to 10 years. During 2004, the Companywrote-off debt issuance and offering costs of $6.0 million associated withan abandoned offering of Income Deposit Securities (IDSs), classified as othernonoperating expense in the statements of operations. The offering of IDSs wasabandoned in December of 2004 in favor of the transactions described innote 2. In 2005, the Company entered into a new senior secured creditfacility 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements**(Continued)

consisting of a revolvingfacility in an aggregate principal amount of up to $100.0 million and aterm facility in an aggregate principal amount of $588.5 million. TheCompany incurred a total of $10.4 million of debt issuance costsassociated with entering into the credit facility and subsequent amendmentsthereto.

Accumulated amortizationof debt issue costs was $2.9 million, $1.4 million and $14.9 millionat December 31, 2006, 2005 and 2004, respectively.

***(j) Goodwill and Other Intangible Assets***

Goodwill consists of the difference between thepurchase price incurred in acquisitions using the purchase method of accountingand the fair value of net assets acquired. In accordance with SFAS No. 142,*Goodwill and Other Intangible Assets,*whichthe Company adopted effective January 1, 2002, goodwill is no longeramortized, but instead is assessed for impairment at least annually. Duringthis assessment, management relies on a number of factors, including operatingresults, business plans, and anticipated future cash flows.

Other intangible assetsrecorded by the Company consist of acquired customer relationships. Theseintangible assets are amortized over their estimated useful lives which theCompany determined to be 15 years.

***(k) Impairment of Long-lived Assets***

Long-lived assets,such as property, plant, and equipment and purchased intangibles subject toamortization, are reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to estimated undiscounted futurecash flows expected to be generated by the asset. If the carrying amount of anasset exceeds its estimated future cash flows, an impairment charge isrecognized by the amount by which the carrying amount of the asset exceeds thefair value of the asset. Assets to be disposed of are reported at the lower ofthe carrying amount or fair value less costs to sell and depreciation ceases.

***(l) Income Taxes***

Income taxes are accounted for under the asset andliability method. Deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases and operating loss and tax credit carryforwards. Deferredtax assets and liabilities are measured using enacted tax rates expected toapply to taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date.

FairPoint files a consolidated income tax return withits subsidiaries. FairPoint has a tax-sharing agreement in which allsubsidiaries are participants. All intercompany tax transactions and accountshave been eliminated in consolidation.

As part of the income taxprovision process of preparing the Company’s consolidated financial statements,the Company is required to estimate its income taxes. This process involvesestimating current tax expenses together with assessing temporary differencesresulting from differing treatment of items for tax and accounting purposes.These differences result in deferred tax assets and liabilities. In assessingthe 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements**(Continued)

realizabilityof deferred tax assets, management considers whether it is more likely than notthat some portion or all of the deferred tax assets will not be realized. Theultimate realization of deferred tax assets is dependent upon the generation offuture taxable income during the periods in which those temporary differencesbecome deductible. Management considers the scheduled reversal of deferred taxliabilities, projected future taxable income, and tax planning strategies inmaking this assessment, as well as all positive and negative evidence thatwould affect the recoverability of deferred tax assets. As a result of theoffering, the Company has reduced its aggregate long term debt and expects asignificant reduction in its annual interest expense. When considered togetherwith the Company’s history of producing positive operating results and other evidenceaffecting the recoverability of deferred tax assets, the Company expects thatfuture taxable income will more likely than not be sufficient to recover netdeferred tax assets.

***(m) Interest Rate Swap Agreements***

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.

TheCompany uses variable and fixed-rate debt to finance its operations,capital expenditures, and acquisitions. The variable-rate debtobligations expose the Company to variability in interest payments due tochanges in interest rates. The Company believes it is prudent to limit thevariability of a portion of its interest payments. To meet this objective, theCompany enters into interest rate swap agreements to manage fluctuations incash flows resulting from interest rate risk. These swaps change the variable-ratecash flow exposure on the debt obligations to fixed cash flows. Under the termsof the interest rate swaps, the Company pays a variable interest rate plus anadditional payment if the variable rate payment is below a contractual rate, orit receives a payment if the variable rate payment is above the contractualrate. The chart below provides details of each of the Company’s interest rateswap agreements.

| **Effective Date:** | ** ** | ** **      | ** ** | ** ** | **Notional Amount** | ** ** | ** ** | ** ** | **Rate** | ** ** | ** ** | ** **              | **Rate, including  applicable margin** | ** ** | ** ** | ** ** | **Expiration Date** | ** ** |
|--------------------------|------------|-----------------|------------|------------|--------------------------|------------|------------|------------|----------|------------|------------|-------------------------|--------------------------------------------------|------------|------------|------------|--------------------------|------------|
| February 8, 2005    |       | $130.0  Million |       |       | 3.76                     | %          |       |       | 5.51     | %          |       | December 31,  2007 |
| February 8, 2005    |       | $130.0  Million |       |       | 3.98                     | %          |       |       | 5.73     | %          |       | December 31,  2008 |
| February 8, 2005    |       | $130.0  Million |       |       | 4.11                     | %          |       |       | 5.86     | %          |       | December 31,  2009 |
| April 29, 2005      |       | $50.0  Million  |       |       | 4.72                     | %          |       |       | 6.47     | %          |       | March 31,  2012    |
| June 30, 2005       |       | $50.0  Million  |       |       | 4.69                     | %          |       |       | 6.44     | %          |       | March 31,  2011    |
| June 30, 2006       |       | $50.0 Million   |       |       | 5.36                     | %          |       |       | 7.11     | %          |       | December 31,  2009 |
|                          |            |                 |            |            |                          |            |            |            |          |            |            |                         |                                                  |            |            |            |                          |            |  |  |  |  |

 

As a result of these swap agreements, as of December 31,2006, approximately 90% 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 theeffective interest rate margins applicable to the Company’s interest rate swapagreements by 0.25% to 1.75%.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

These interest rate swaps qualify as cash flow hedgesfor accounting purposes. The effect of hedge ineffectiveness on net earningswas insignificant for the twelve months ended December 31, 2006 and 2005.At December 31, 2006, the fair market value of these swaps wasapproximately $8.6 million and has been recorded, net of tax of$3.2 million, as a increase in accumulated other comprehensive income. Ofthe $8.6 million, $5.4 million has been included in other currentassets and $3.2 million has been included in other long-term assets.

The Company entered into two additional swapagreements in November 2006 and January 2007. One swap agreement isfor a notional amount of $65 million at a rate of 4.91% (or 6.66% including theapplicable margin). This agreement is effective as of December 31, 2007and expires on December 30, 2011. The second swap agreement is for anotional amount of $100.0 million at a rate of 5.02% (or 6.77% including theapplicable margin). This agreement is effective as of December 31, 2008 andexpires on December 31, 2010.

In June 1998, the Financial Accounting StandardsBoard (FASB) issued SFAS No. 133, *Accounting for DerivativeInstruments and Certain Hedging Activities*. In June 2000, theFASB issued SFAS No. 138, *Accounting for Certain DerivativeInstruments and Certain Hedging Activities, an Amendment to SFAS No. 133*.SFAS No. 133 and SFAS No. 138 require that all derivative instrumentsbe recorded on the balance sheet at their respective fair values. The Companyadopted SFAS No. 133 and SFAS No. 138 on January 1, 2001. Inaccordance with the transition provisions of SFAS No. 133, the Companyrecorded a cumulative-effect-type loss adjustment(the transition adjustment) of $(4.7) million in other comprehensiveincome (loss) to recognize at fair value all interest rate swap agreements. Asof December 31, 2004, the Company has reclassified to nonoperating income(expense) the entire transition adjustment that was recorded in othercomprehensive income (loss). The fair value of the Company’s interest rate swapagreements is determined from valuations received from financial institutions.The fair value indicates an estimated amount the Company would pay if thecontracts were canceled or transferred to other parties.

Amounts receivable or payable under interest rate swapagreements are accrued at each balance sheet date and gains and losses relatedto effective hedges are reported, net of tax effect, as a separate component ofcomprehensive income. Changes associated with swap agreements that did notqualify as accounting hedges are included as adjustments to realized andunrealized gains (losses) on interest rate swaps.

Thefollowing is a summary of amounts included in realized and unrealized gains(losses) on interest rate swaps that did not qualify as accounting hedges forthe twelve months ended December 31, 2004 (in thousands):

| ** **                                                                               | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------|------------|
| Change in fair  value of interest rate swaps                                             |       | $   | 874        |   |
| Reclassification  of transition adjustment included in other comprehensive income (loss) |       | (103     | )          |
| Realized losses                                                                          |       | (883     | )          |
| Total                                                                                    |       | $        | (112       | ) |

 

***(n)***   Stock Option Plans

Effective January 1, 2006, the Company adoptedthe provisions of SFAS No. 123(R), “Share-Based Payment” (SFAS No. 123(R)).SFAS No. 123(R) establishes accounting for stock-based awards grantedin 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

exchange for employeeservices. Accordingly, for employee awards which are expected to vest,stock-based compensation cost is measured at the grant date, based on the fairvalue of the award, and is recognized as expense on a straight-line basis over therequisite service period, which generally begins on the date the award isgranted through the date the award vests. The Company elected to adopt theprovisions of SFAS No. 123(R) using the prospective applicationmethod for awards granted prior to becoming a public company and valued usingthe minimum value method, and using the modified prospective application methodfor awards granted subsequent to becoming a public company. There were nomodifications to outstanding stock options prior to the adoption of SFAS No. 123(R).

Priorto the adoption of SFAS No. 123(R), the Company accounted for its stockoption plans using the intrinsic-value-based method prescribed by AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. As such, compensation expense wasrecorded on the date of grant only if the current market price of theunderlying stock exceeded the exercise price.

***(o)***   Business Segments

Underthe provisions of SFAS No. 131, *Disclosures about Segmentsof an Enterprise and Related Information,*the Company’s onlyseparately reportable business segment is its traditional telephone operations.The Company’s traditional telephone operations are conducted in rural,suburban, and small urban communities in various states. The operating incomeof this segment is reviewed by the chief operating decision maker to assessperformance and make business decisions. Due to the sale of the Company’scompetitive communications operations, such operations (which werepreviously reported as a separate segment) are classified as discontinuedoperations.

***(p)***   Earnings Per Share

Earnings per share has been computed in accordancewith SFAS No. 128, *Earnings Per Share.*Basicearnings per share is computed by dividing net income (loss) by the weightedaverage number of common shares outstanding for the period. Except when theeffect would be anti-dilutive, the diluted earnings per share calculationincludes the impact of restricted units, restricted stock and shares that couldbe issued under outstanding stock options.

Thenumber of potential common shares excluded from the calculation of diluted netincome (loss) per share, prior to the application of the treasury stock method,is as follows (in thousands):

| ** **                                         | ** ** | **Year ended December 31** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Contingent stock  options                          |       | 833                                       |       | 833 |   | 833 |   |
| Shares excluded as  effect would be anti-dilutive: |       |                                      |       |   |   |   |   |
| Stock options                                      |       | 209                                       |       | 241 |   | 356 |   |
| Restricted stock                                   |       | 543                                       |       | 471 |   | — |   |
| Restricted units                                   |       | 25                                        |       | 34 |   | 26 |   |
|                                               |       | 1,610                                     |       | 1,579 |   | 1,215 |   |

 

***(q)***   New AccountingPronouncements

In July 2006, the FASB issued FASB InterpretationNo. (FIN) 48, “Accounting for Uncertainty in Income Taxes.”  FIN 48 requires applying a “more likely thannot” threshold to the recognition and de-

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

recognition of taxpositions. FIN 48 is effective for fiscal years beginning after December 15,2006. The Company has determined that the impact of the adoption of thisinterpretation will not have a material impact on its financial position,results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements.” SFAS No. 157 is definitional and disclosureoriented and addresses how companies should approach measuring fair value whenrequired by generally accepted accounting principles, or GAAP; it does notcreate or modify any current GAAP requirements to apply fair value accounting.SFAS No. 157 provides a single definition for fair value that is to beapplied consistently for all accounting applications, and also generallydescribes and prioritizes according to reliability the methods and inputs usedin valuations. The new measurement and disclosure requirements of SFAS No. 157are effective for the Company in the first quarter 2008. The Company does notexpect a significant impact from adopting SFAS No. 157.

In September 2006, the SEC issued StaffAccounting Bulletin (SAB) No. 108, “Considering the Effects of PriorYear Misstatements When Quantifying Misstatements in Current Year FinancialStatements”, which provides interpretive guidance on how the effects of thecarryover or reversal of prior year misstatements should be considered inquantifying a current year misstatement. The Company was required to adopt theprovisions of SAB No. 108 in its financial statements for the fiscalyear ended December 31, 2006. The adoption of SAB No. 108 didnot have an impact on the Company’s consolidated financial statements.

In June 2006,the FASB ratified the consensus reached by the Emerging Issues Task Force onIssue No. 06-3, “How Sales Taxes Collected From Customers andRemitted to Governmental Authorities Should Be Presented in the IncomeStatement” (“EITF 06-3”). EITF 06-3 requires a company todisclose its accounting policy (i.e. gross vs. net basis) relating to thepresentation of taxes within the scope of EITF 06-3. Furthermore,for taxes reported on a gross basis, an enterprise should disclose the amountsof those taxes in interim and annual financial statements for each period forwhich an income statement is presented. The guidance is effective for allperiods beginning after December 15, 2006. The adoption of this guidancewill have no impact on the Company’s consolidated financial statements.

**(2)   InitialPubic Offering 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 Companyreceived gross proceeds of $462.5 million from the offering which, net ofcosts incurred of $30.6 million related to the offering, was allocated topaid-in capital. The Company used the gross 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

proceedsof $462.5 million from the offering together with borrowings of$566.0 million under the term facility of the credit facility 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);

·       $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$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 2005.

71

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

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)   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 December 13,2006, the Company declared a dividend of $0.39781 per share of common stock,which was paid on January 16, 2007 to holders of record as of December 29,2006. In 2006, the Company declared dividends totaling $55.4 million, or$1.59124 per share of common stock. In 2005, the Company declared dividendstotaling $49.1 million, or $1.41886 per share of common stock.

**(3)   Acquisitions**

On November 15, 2006, the Company and certainsubsidiaries completed its merger with The Germantown Independent TelephoneCompany, or GITC. The merger consideration is $10.7 million (or $9.2 millionnet of cash acquired). Goodwill on this transaction will not be deductible forincome tax purposes. The Company incurred acquisition costs of $0.3 million. GITCis a single exchange rural incumbent local exchange carrier located in theVillage of Germantown, Ohio.

The GITC acquisition has been accounted for using thepurchase method of accounting for business combinations and, accordingly, theacquired 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 (for potential contingentliabilities), the excess of the purchase price and acquisition costs over thefair value of the net tangible assets acquired was approximately $6.5 million.The Company recorded an intangible asset related to the acquired company’scustomer relationships of $1.8 million and the remaining $4.7 million has beenrecognized as goodwill. The estimated useful life of the $1.8 millionintangible asset is 15 years.

On August 17, 2006, the Company completed thepurchase of Unite Communications Systems, Inc., or Unite, forapproximately $11.5 million (or $11.4 million net of cash acquired). Goodwillon this transaction will be deductible for income tax purposes. The Companyincurred acquisition costs of $58,000. Unite owns ExOp of Missouri, Inc.,which is a facilities-based voice, data and video service provider locatedoutside of Kansas City, Missouri.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

The Unite acquisition has been accounted for using thepurchase method of accounting for business combinations and, accordingly, theacquired 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 determination of the working capital adjustment and finalsettlement of an escrow (for potential contingent liabilities), the excess ofthe purchase price and acquisition costs over the fair value of the nettangible assets acquired was approximately $5.8 million. The Company recordedan intangible asset related to the acquired company’s customer relationships of$2.9 million and the remaining $2.9 million has been recognized asgoodwill. The estimated useful life of the $2.9 million intangible assetis 15 years.

On July 26, 2006, the Company completed the purchaseof the assets of Cass County Telephone Company Limited Partnership and LEC LongDistance, Inc., or Cass County, for approximately $28.7 million,subject to adjustment. Goodwill on this transaction will be deductible forincome tax purposes. The Company incurred acquisition costs of $0.2 million.

The acquisition of the assets of Cass County has beenaccounted for using the purchase method of accounting for business combinationsand, 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, subject to final settlement of an escrow (forpotential contingent liabilities), the excess of the purchase price andacquisition costs over the fair value of the net tangible assets acquired wasapproximately $14.5 million. The Company recorded an intangible asset relatedto the acquired company’s customer relationships of $5.3 million and theremaining $9.2 million has been recognized as goodwill. The estimated usefullife of the $5.3 million intangible asset is 15 years.

On May 2, 2005, the Company completed theacquisition of Berkshire Telephone Corporation, or Berkshire. The purchaseprice was approximately $20.3 million (or $16.4 million net of cashacquired). Goodwill on this transaction will not be deductible for income taxpurposes. The Company incurred acquisition costs of $0.6 million. Berkshire isan independent local exchange carrier that provides voice communication, cableand internet services. Berkshire’s communities of service are adjacent to thoseof Taconic Telephone Corp., one of the Company’s subsidiaries. The acquisitionis referred to herein as the Berkshire acquisition.

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 purchase price allocation, the excess ofthe purchase price and acquisition costs over the fair value of the netidentifiable assets acquired was approximately $11.0 million. The Companyrecorded an intangible asset related to the acquired company’s customerrelationships of $2.4 million and the remaining $8.6 million has beenrecognized as goodwill. The estimated useful life of the $2.4 millionintangible 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). Goodwill on this transaction will not be deductible for incometax purposes. The Company incurred acquisition costs of $0.4 million. Bentleyvilleprovides telecommunications, cable and internet 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

services to rural areas ofSouthwestern Pennsylvania which are adjacent to the Company’s existingoperations in Pennsylvania. The acquisition is referred to herein as theBentleyville 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 purchaseprice allocation, the excess of the purchase price and acquisition costs overthe fair value of the net identifiable assets acquired was approximately $4.6million. The Company recorded an intangible asset related to the acquiredcompany’s customer relationships of $1.4 million and the remaining $3.2 millionhas been recognized as goodwill. The estimated useful life of the $1.4 millionintangible asset is 15 years.

Theallocation of the total net purchase price of the GITC, Unite and Cass Countyacquisitions, which occurred in 2006, is shown in the table below (inthousands):

| Current assets                                      |   | $      | 3,226  |   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Property, plant,  and equipment                     |   | 28,166 |   |
| Investments                                         |   | 869    |   |
| Excess cost over  fair value of net assets acquired |   | 16,869 |   |
| Intangible assets                                   |   | 10,000 |   |
| Current  liabilities                                |   | (5,751 | )      |
| Other liabilities                                   |   | (1,913 | )      |
| Total net  purchase price                           |   | $      | 51,466 |   |

 

Theallocation of the total net purchase price of the Berkshire and Bentleyvilleacquisitions, which occurred in 2005, is shown in the table below (inthousands):

| Current assets                                      |   | $      | 8,067  |   |
|-----------------------------------------------------|--------|--------|--------|--------|
| Property, plant,  and equipment                     |   | 14,585 |   |
| Investments                                         |   | 2,770  |   |
| Excess cost over  fair value of net assets acquired |   | 12,835 |   |
| Other assets                                        |   | 25     |   |
| Intangible assets                                   |   | 3,800  |   |
| Current  liabilities                                |   | (2,317 | )      |
| Long term debt                                      |   | (2,690 | )      |
| Other liabilities                                   |   | (4,703 | )      |
| Total net  purchase price                           |   | $      | 32,372 |   |

 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

Thefollowing unaudited pro forma information presents the combined results ofoperations of the Company as though the GITC, Unite, Cass County, Berkshire andBentleyville acquisitions each had been consummated on January 1, 2005. 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 theGermantown, Unite, Cass County, Berkshire and Bentleyville acquisitions eachhad been consummated at the beginning of the period or which may be attained inthe future (in thousands, except per share data). 

| ** **                                             | ** ** | **Pro forma year**     | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                             | ** ** | **ended December 31,** | ** ** |
| ** **                                             | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(unaudited)**                  | ** ** |
| Revenues                                               |       | $                                | 280,015    |   | $ | 282,478 |   |
| Income from  continuing operations                     |       | 31,238                           |       | 28,997 |   |
| Net income                                             |       | 31,812                           |       | 29,377 |   |
| Earnings per  common share from continuing operations: |       |                             |       |   |   |
| Basic                                                  |       | $                                | 0.90       |   | $ | 0.91 |   |
| Diluted                                                |       | 0.90                             |       | 0.91 |   |
| Earnings per common  share:                            |       |                             |       |   |   |
| Basic                                                  |       | $                                | 0.92       |   | $ | 0.92 |   |
| Diluted                                                |       | 0.92                             |       | 0.92 |   |

 

**(4)   Subsequent Events**

On January 16,2007, the Company announced that it signed definitive agreements to merge witha subsidiary of Verizon Communications Inc. owning the wireline operations ofVerizon in Maine, New Hampshire and Vermont. The Company expects that FairPointwill be the acquiree for accounting purposes. Consequently, merger relatedcosts have been expensed as incurred in connection with the transaction andFairPoint’s assets and liabilities will be recorded at fair value atacquisition. The Company incurred expenses related to this transaction,principally legal and consultant fees, of approximately $2.4 million in2006, which were expensed as incurred. This transaction is subject toregulatory approval. In a separate but related transaction, the Company alsoagreed on January 16, 2007 to sell its investment in OrangeCounty-Poughkeepsie Limited Partnership to Verizon Wireless for $55 million.

**(5)   Goodwill and Other Intangible Assets**

Changesin the carrying amount of goodwill were as follows (in thousands):

| Balance,  December 31, 2004             |   | $       | 468,508 |   |
|----------------------------------------------|--------|---------|---------|--------|
| Acquisition of Berkshire and Bentleyville    |   | 12,835  |    |
| Balance,  December 31, 2005             |   | 481,343 |    |
| Acquisition of GITC, Unite and Cass County   |   | 16,869  |    |
| Acquisition adjustment to Berkshire goodwill |   | 972     |    |
| Balance,  December 31, 2006             |   | $       | 499,184 |   |

 

As required under SFAS No. 142, the Companyupdated its annual impairment testing of goodwill as of December 31, 2006,2005, and 2004, and determined that no impairment loss was required to berecognized.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

Aspart of the Unite, Cass County, GITC, Berkshire and Bentleyville acquisitions,the Company has recorded intangible assets related to the acquired companies’customer relationships of $13.8 million. These intangible assets will beamortized over 15 years using the straight-line method. As of December 31,2006, accumulated amortization related to the customer relationship intangibleswas $0.6 million. The intangible assets are included in Intangible Assets, neton the Consolidated Balance Sheet. Amortization expense related to thesecustomer relationship intangibles is expected to be approximately $0.9 millionper year over the next five years.

**(6)   Property,Plant, and Equipment**

A summary of property, plant, and equipment fromcontinuing operations is shown below (in thousands):

| ** **                           | ** ** | **Estimated**                 | ** **               | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------------------|--------------------------|------------|------------|------------|------------|
| ** **                           | ** ** | **life (in years)** | ** **               | **2006**   | ** ** | **2005**   | ** ** |
| Land                                 |       |                          |  —   |       |       | $          | 4,256      |   | $ | 4,096 |   |
| Buildings and leasehold improvements |       |                          | 2–40                |       |       | 41,486     |       | 39,889 |   |
| Telephone equipment                  |       |                          | 3–50                |       |       | 714,246    |       | 649,465 |   |
| Cable equipment                      |       |                          | 3–20                |       |       | 12,190     |       | 10,287 |   |
| Furniture and equipment              |       |                          | 3–34                |       |       | 22,718     |       | 19,219 |   |
| Vehicles and equipment               |       |                          | 3–20                |       |       | 27,458     |       | 25,105 |   |
| Computer software                    |       |                          | 3–5            |       |       | 6,880      |       | 11,861 |   |
| Total property, plant, and equipment |       |                          |                     |       |       | 829,234    |       | 759,922 |   |
| Accumulated depreciation             |       |                          |                     |       |       | (582,970   | )          | (517,305 | ) |
| Net property, plant, and equipment   |       |                          |                     |       |       | $          | 246,264    |   | $ | 242,617 |   |

 

The telephone companycomposite depreciation rate for property and equipment was 7.29%, 7.38%, and7.32% in 2006, 2005, and 2004, respectively. Depreciation expense fromcontinuing operations, excluding amortization of intangible assets andpreviously disclosed deferred billing system credits, for the years ended December 31,2006, 2005, and 2004 was $56.1 million, $53.5 million, and$50.3 million, respectively.

**(7)   Investments**

The Company’s non-currentinvestments at December 31, 2006 and 2005 consist of the following:

| ** **                                                         | ** ** | **2006**                | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                         | ** ** | **(in thousands)** | ** ** |
| Equity method  investments in cellular companies and partnerships: |       |                    |       |     |       |
| Orange County—Poughkeepsie Limited Partnership                |       | $                       | 5,006      |     | $          | 4,138 |   |
| Chouteau Cellular Telephone Company                                |       | 28                      |       | 46       |       |
| Illinois Valley Cellular RSA 2, Inc.                          |       | —                  |       | 1,409    |       |
| Syringa Networks, LLC                                              |       | 1,277                   |       | 1,063    |       |
| Other equity method investments                                    |       | 961                     |       | 41       |       |
| Investments in  securities carried at cost:                        |       |                    |       |     |       |
| RTB stock                                                          |       | —                  |       | 22,796   |       |
| CoBank stock and unpaid  deferred CoBank patronage                 |       | 3,630                   |       | 4,664    |       |
| RTFC secured  certificates and unpaid deferred RTFC patronage      |       | 263                     |       | 480      |       |
| Southern Illinois  Cellular Corp.                                  |       | —                  |       | 4,552    |       |
| Other nonmarketable  minority equity investments                   |       | 166                     |       | 55       |       |
| Nonqualified deferred  compensation plan assets                    |       | 726                     |       | 564      |       |
| Total investments                                                  |       | $                       | 12,057     |     | $          | 39,808 |   |

 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

***(a)   Marketable Equity Securities***

As ofDecember 31, 2006, the Company no longer holds any marketable equityinvestments classified as available-for-sale. Following an August 2, 2004announcement by Choice One of a financial restructuring under Chapter 11 of theUnited States Bankruptcy Code, the quoted market value of the Company’s investmentin Choice One Communications Inc.’s common stock declined to $33,000. TheCompany determined that the decline in fair value was other-than-temporary andrecorded an impairment loss of $0.5 million in 2004, of which$0.4 million was recorded as an expense in the consolidated statement ofoperations and $0.1 million was recorded as a reduction in accumulatedother comprehensive income. On November 8, 2004, Choice One exited Chapter11 and, in accordance with its plan of reorganization, Choice One’s preferredstockholders and common stockholders did not receive any recovery and all ofthe preferred stock and common stock has now been cancelled. Total proceeds from sales ofavailable-for-sale securities were $0.3 million in 2004. Grossgains of $0.1 million were realized on those sales in 2004.

***(b)   EquityMethod Investments***

TheCompany records its share of the earnings or losses of the investmentsaccounted for under the equity method on a three-month lag. Theinvestments accounted for under the equity method and the Company’s ownershippercentage as of December 31, 2006 and 2005 are summarized below:

| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Chouteau Cellular  Telephone Company                 |       | 33.7     | %          | 33.7     | %          |
| ILLINET  Communications, LLC                         |       | 9.1      | %          | 9.1      | %          |
| Orange  County—Poughkeepsie Limited Partnership |       | 7.5      | %          | 7.5      | %          |
| ILLINET  Communications of Central IL LLC            |       | 5.2      | %          | 5.2      | %          |
| Syringa Networks,  LLC                               |       | 11.5     | %          | 11.7     | %          |
| Illinois Valley Cellular  RSA 2, Inc.           |       | 0.0      | %          | 25.0     | %          |

 

Earningsin equity investments for the years ended December 31, 2006, 2005, and2004 consisted of the following (in thousands):

| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Orange  County—Poughkeepsie Limited Partnership |       | $        | 10,018     |     | $          | 10,523   |       | $ | 10,249 |   |
| Syringa Networks,  LLC                               |       | 213      |       | 81       |       | 26       |       |
| Illinois Valley  Cellular RSA 2, Inc.           |       | 49       |       | 477      |       | 372      |       |
| Chouteau Cellular  Telephone Company                 |       | —   |       | —   |       | 2        |       |
| Other, net                                           |       | 336      |       | 221      |       | 250      |       |
| Total                                                |       | $        | 10,616     |     | $          | 11,302   |       | $ | 10,899 |   |

 

Distributionsfrom investments during the years ended December 31, 2006, 2005, and 2004consisted of the following (in thousands):

| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Orange  County—Poughkeepsie Limited Partnership |       | $        | 9,150      |     | $          | 9,975    |       | $ | 11,775 |   |
| Illinois Valley  Cellular RSA 2, Inc.           |       | —   |       | —   |       | 375      |       |
| Chouteau Cellular  Telephone Company                 |       | —   |       | 40       |       | 2,524    |       |
| CoBank, ACB                                          |       | 1,034    |       | 634      |       | —   |       |
| Distributions  from other equity investments         |       | 470      |       | 210      |       | 343      |       |
| Total                                                |       | $        | 10,654     |     | $          | 10,859   |       | $ | 15,017 |   |

 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

Chouteau Cellular Telephone Company (a limitedpartnership in which the Company holds a 1.0% general partner interest and a32.67% limited partner interest) (Chouteau) is an investment vehicle that holdsa 25% member interest in Independent Cellular Telephone, LLC (ICT). ICT, inturn, is an investment vehicle that holds a 44.45% member interest in UnitedStates Cellular Telephone of Greater Tulsa, LLC (Tulsa, LLC).

In January 2004, ICT sold its membership interestin Tulsa, LLC and, as a result, Chouteau Cellular Telephone Company made a$2.5 million distribution to the Company. Subsequent to the sale, theCompany continues to have an investment in Chouteau Cellular Telephone Company,but the partnership assets are minimal and do not include any interests in thecellular telephone business of Chouteau.

During2005, the Company determined that the carrying amount of its investment inIllinois Valley Cellular RSA No. 2, which is accounted for under theequity method, exceeded the estimated fair value and such decline was “other-than-temporary.”  As a result, the Company recorded a non-cashimpairment charge of $1.2 million. This charge is classified as impairment oninvestments in the consolidated statements of operations. The Company sold itsinvestment in Illinois Valley Cellular RSA No. 2 during 2006 and recordeda gain of $0.1 million.

***(c)   Investments in Equity Securities Carried atCost***

The aggregate cost of the Company’s cost methodinvestments totaled $4.1 million at December 31, 2006. These investmentsconsist primarily of investments in stock of governmental agencies and minorityinterests in limited partnerships or corporations. Therefore, the investmentsare highly illiquid and there is no readily available market for thesesecurities which makes it impracticable to estimate a fair value. As a result,these investments were not evaluated for impairment because (a) theCompany did not estimate the fair value of those investments in accordance withparagraphs 14 and 15 of SFAS No. 107 *DisclosuresAbout Fair Value of Financial Instruments,* and (b) the Companydid not identify any events or circumstances that may have had a significantadverse effect on the fair value of those investments.

On August 4, 2005, the Board of Directors of theRTB approved the liquidation and dissolution of the RTB. As part of suchliquidation and dissolution, all RTB loans were to be transferred to the RuralUtilities Service and all shares of the RTB’s Class A Stock, Class BStock and Class C Stock were to be redeemed at par value. The Company hadno outstanding loans with the RTB but owned 2,477,493 shares of Class BStock and 24,380 shares of Class C Stock. This liquidation was completedin April 2006, and, as a result, the Company received proceeds of $26.9million from the RTB liquidation. The Company recorded a gain on thisinvestment of approximately $4.1 million in 2006. Some portion of the proceedsreceived from the RTB, while not estimable at this time, may be subject toreview by regulatory authorities who may require us to record a portion thereofas a regulatory liability.  In October 2006,the Company was notified that the state of Washington opened a docket to reviewthe proceeds received by companies from the RTB in that state.  In November 2006, the Company alsoreceived an information request from the state of Maine regarding the RTBtransaction. At this time, the Company can not determine the impact of thesereviews.

On May 1, 2006, theCompany completed the sale of its investment in Southern Illinois CellularCorp., or SICC, from which it received total proceeds of $16.9 million. As partof this sale, the Company received a portion of total proceeds, approximately$2.1 million, in the form of a dividend. In addition to the dividend income of$2.1 million, the Company recorded a gain on this investment of approximately$10.2 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

millionin 2006. Additional proceeds of approximately $2.6 million are held in escrowand the Company will not record the gain on this portion of the transactionuntil the proceeds are received.

**(8) Long-termDebt**

Long-termdebt at December 31, 2006 and 2005 is shown below (in thousands):

| ** **                                                                                                                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| 2005 Senior  secured notes, variable rates ranging from 7.125% to 9.25% (weighted average  rate of 7.2%) at December 31, 2006, due 2011 to 2012 |       | $        | 603,500    |     | $          | 602,275 |   |
| 2003 Senior  notes, 11.875%, due 2010                                                                                                                |       | 2,050    |       | 2,050    |       |
| Senior notes to RTFC:                                                                                                                                |       |     |       |     |       |
| Fixed rate, ranging from 8.2% to 9.20%, due 2009 to  2014                                                                                            |       | 2,436    |       | 3,100    |       |
| Total outstanding long-term debt                                                                                                                     |       | 607,986  |       | 607,425  |       |
| Less current  portion                                                                                                                                |       | (714     | )          | (677     | )          |
| Total long-term  debt, net of current portion                                                                                                        |       | $        | 607,272    |     | $          | 606,748 |   |

 

Theapproximate aggregate maturities of long-term debt for each of the fiveyears subsequent to December 31, 2006 are as follows (in thousands):

| Fiscal year: |   |    |    |
|--------------|--------|---------|---------|
| 2007         |   | $       | 714     |   |
| 2008         |   | 753     |    |
| 2009         |   | 161     |    |
| 2010         |   | 2,210   |    |
| 2011         |   | 15,171  |    |
| Thereafter   |   | 588,977 |    |
|         |   | $       | 607,986 |   |

 

***(a)   2005 Senior Secured Notes***

On February 8, 2005, the Company entered into acredit facility consisting of a revolving facility in an aggregate principalamount of up to $100.0 million and a term facility in an aggregateprincipal amount of $588.5 million. On the closing date of the Company’sinitial public offering, the Company drew $566.0 million against the termfacility. In addition, on May 2, 2005, the Company drew $22.5 million ofborrowings under the delayed draw term facility of the credit facility. TheCompany incurred approximately $10.4 million of debt issuance costsassociated with entering into the credit facility and subsequent amendmentsthereto.

The term facility matures in February 2012 andthe revolving facility matures in February 2011. Borrowings bear interest,at the Company’s option, for the revolving facility and for the term facilityat either (a) the Eurodollar rate (as defined in the credit facility) plusan applicable margin or (b) the Base rate (as defined in the creditfacility) plus an applicable margin. The Eurodollar rate applicable margin andthe Base rate applicable margin for loans under the credit facility are 2.0%and 1.0%, respectively. Effective on September 30, 2005, the Companyamended its credit facility to reduce the effective interest rate margins onthe $588.5 million term facility by 0.25% to 1.75% on Eurodollar loans and to0.75% for Base rate loans. Interest with respect to Base rate loans is payablequarterly in arrears and interest with respect to Eurodollar loans is payableat the end of the applicable interest period and every three months in the caseof interest periods in excess of three months.

79

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

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.

On January 25, 2007, the Company entered into anamendment to its credit facility which is intended to facilitate certaintransactions related to the Merger. Among other things, such amendment: (i) permitsthe Company to consummate the sale of its interest in OrangeCounty-Poughkeepsie Limited Partnership and retain the proceeds thereof up toan amount equal to $55 million; (ii) excludes the gain on the sale of ourinterest in Orange County-Poughkeepsie Limited Partnership from the “AvailableCash”, (iii) amends the definition of “Adjusted Consolidated EBITDA”to allow for certain one-time add-backs to the calculation thereof foroperating expenses incurred in connection with the Merger; (iv) amendsthe definition of “Consolidated Capital Expenditures” to exclude certainexpenditures incurred by the Company in connection with transition andintegration expenses prior to consummation of the Merger; and (v) increasesthe leverage covenant and dividend suspension test to 5.50:1.00 and 5.25:1.00,respectively.

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 not permittedto pay dividends, with 50% of the increase in the Company’s CumulativeDistributable Cash (as defined in the credit facility) during the prior fiscalquarter. Reductions to the revolving commitments under the credit facility fromthe foregoing recapture events will not reduce the revolving commitments underthe 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 facilityrequires that the Company maintain certain financial covenants. The creditfacility contains customary affirmative covenants, including, withoutlimitation, the following tests:  aminimum interest coverage ratio equal to or greater than 3.0:1 and a maximumleverage ratio equal to or less than 5.50:1. The credit facility also containsnegative covenants and restrictions, including, among others, with respect toredeeming and repurchasing other indebtedness, loans and investments,additional indebtedness, liens, capital expenditures, changes in the nature ofthe Company’s business, mergers, acquisitions, asset sales and transactionswith the Company’s affiliates. The credit facility restricts the Company’sability to declare and pay dividends on its common stock 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 other than repayments of the revolving facility (unless fundedby debt or equity), (iii) consolidated capital expenditures (unless fundedby long-term debt, equity or the proceeds from asset sales or insurancerecovery events), (iv) cash taxes, (v) cash consideration paid for acquisitions(unless funded by debt or equity), (vi) cash paid to make certaininvestments, and (vii) certain non-cash items excluded from AdjustedEBITDA and paid in cash and (b) plus (i) the cash amount ofextraordinary gains and gains on sales of assets and (ii) certain non-cashitems excluded from Adjusted EBITDA and received in cash. “Adjusted EBITDA” isdefined in the 

80

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

credit facility asConsolidated Net Income (which is defined in the credit facility and includesdistributions from investments) (a) plus the following to the extentdeducted from Consolidated Net Income: provision for income taxes, interestexpense, depreciation, amortization, losses on sales of assets and otherextraordinary losses, certain one-time charges recorded as operating expensesrelated to the transactions contemplated by the Merger Agreement and certainother non-cash items, and (b) minus, to the extent included inConsolidated Net Income, gains on sales of assets and other extraordinary gainsand 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 5.25 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 $10.0 million and subject to limitations onthe aggregate amount outstanding under the revolving facility. As of December 31,2006, a letter of credit had been issued for $1.4 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.

***(b) Senior Notes Issued in 2003***

FairPoint issued $225.0 million aggregateprincipal amount of senior notes in 2003 (the 2003 Notes). The 2003 Notesbear interest at the rate of 11 7/8% per annum, payable semiannually inarrears.

The 2003 Notes mature on March 1, 2010. FairPointmay redeem the 2003 Notes at any time on or after March 1, 2007 at theredemption prices stated in the indenture under which the 2003 Notes wereissued, together with accrued and unpaid interest, if any, to the redemptiondate. In the event of a change of control, FairPoint must offer to repurchasethe outstanding 2003 Notes for cash at a purchase price of 101% of theprincipal amount of such notes, together with all accrued and unpaid interest,if any, to the date of repurchase.

81

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

The 2003 Notes are general unsecured obligations ofFairPoint, ranking pari passu in right of payment with all existing and futuresenior debt of FairPoint, including all obligations under the Company’s amendedand restated credit facility, and senior in right of payment to all existingand future subordinated indebtedness of FairPoint.

The indenture governing the 2003 Notes containscertain customary covenants and events of default.

Of the 2003 Notes, $223.0million were repaid in 2005 using proceeds from the Company’s initial publicoffering and borrowings under the 2005 Senior Secured Notes.

***(c) Other***

In conjunction with the senior notes payable to theRTFC and the RTB and the first mortgage notes payable to the Rural UtilitiesService, certain of the Company’s subsidiaries are subject to restrictivecovenants limiting the amounts of dividends that may be paid. A portion of theRTFC notes, the full amount of the RTB notes and notes payable to the RuralUtilities Service were repaid in 2005 using proceeds from the Company’s initialpublic offering and borrowings under the 2005 Senior Secured Notes.

The Company also has$0.3 million unsecured demand notes payable to various individuals andentities with interest payable at 5.25% at December 31, 2006 and 2005.

**(9) Redeemable PreferredStock**

The Series A preferred stock was issued to thelenders in connection with the Carrier Services debt restructuring.

The initial carrying amount of the Series Apreferred stock was recorded at its fair value at the date of issuance($78.4 million). The carrying amount was increased by periodic accretions,using the interest method, so that the carrying amount equaled the mandatoryredemption amount ($82.3 million) at the mandatory redemption date (May 2011).On March 6, 2003, in connection with the Company’s issuance of the 2003Notes, the Company used a portion of these proceeds to repurchase$13.3 million aggregate liquidation preference of its Series Apreferred stock at a 35% discount (together with accrued and unpaiddividends thereon). For the years ended December 31, 2005 and 2004, the Series Apreferred stock was increased by $0.2 million and $1.4 million, respectively,to reflect the periodic accretions. The carrying amount of the Series Apreferred stock was further increased by $2.2 million and $18.8 million inconnection with dividends paid in kind on the outstanding shares of the Series Apreferred stock for the years ended December 31, 2005 and 2004,respectively.

In February 2005, theCompany repurchased all of the Company’s outstanding Series A preferredstock for $129.2 million. The Company recorded a loss of $9.9 million on theredemption.

**(10) EmployeeBenefit Plans**

The Company sponsors a voluntary 401(k) savingsplan (the 401(k) Plan) that covers substantially all eligibleemployees. Each 401(k) Plan year, the Company contributes to the 401(k) Planan amount of matching contributions determined by the Company at its discretion.For the 401(k) Plan years ended December 31, 2006, 2005, and 2004,the Company matched 100% of each employee’s contribution up to 3% ofcompensation and 50% of additional contributions up to 6%. The 401(k) Planalso allows for a profit sharing contribution that is made based uponmanagement discretion. Total Company contributions 

82

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

to the 401(k) Planwere $1.5 million, $1.3 million, and $2.4 million for the yearsended December 31, 2006, 2005, and 2004, respectively.

In 1999, the Company began a Non-QualifiedDeferred Compensation Plan (the NQDC Plan) that covers certain employees.The NQDC Plan allows highly compensated individuals to defer additionalcompensation beyond the limitations of the 401(k) Plan. Company matchingcontributions are subject to the same percentage as the 401(k) Plan. TotalCompany contributions to the NQDC Plan were approximately $3,000, $26,000, and$7,000 for the years ended December 31, 2006, 2005, and 2004,respectively. At December 31, 2006 and 2005, the NQDC Plan assets were$0.7 million and $0.6 million, respectively. The related deferredcompensation obligation is included in other liabilities in the accompanyingconsolidated balance sheets.

C&E, Taconic, and GTCom also sponsor defined contribution 401(k) retirement savings plans forunion employees. C&E, Taconic, and GT Com match contributions to theseplans based upon a percentage of pay of all qualified personnel and makecertain profit sharing contributions. Contributions to these plans were$0.3 million, $0.3 million, and $0.2 million for the years endedDecember 31, 2006, 2005, and 2004, respectively.

**(11) Income Taxes**

Incometax benefit (expense) from continuing operations for the years ended December 31,2006, 2005, and 2004 consists of the following components (in thousands):

| ** **                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:                                                                |       |     |       |     |       |     |       |
| Federal                                                                 |       | $        | (1,422     | )        | $          | —   |       | $ | — |   |
| State                                                                   |       | (1,456   | )          | (1,128   | )          | (543     | )          |
| Total current income tax expense from continuing  operations            |       | (2,878   | )          | (1,128   | )          | (543     | )          |
| Investment tax credits                                                  |       | 12       |       | 16       |       | 27       |       |
| Deferred:                                                               |       |     |       |     |       |     |       |
| Federal                                                                 |       | (15,806  | )          | 78,385   |       | —   |       |
| State                                                                   |       | (1,186   | )          | 5,823    |       | —   |       |
| Total deferred income tax benefit (expense) from  continuing operations |       | (16,992  | )          | 84,208   |       | —   |       |
| Total income tax  benefit (expense) from continuing operations          |       | $        | (19,858    | )        | $          | 83,096   |       | $ | (516 | ) |

 

Income tax expense of $0.3 million and $0.2 millionhas also been recognized associated with income from discontinued operations in2006 and 2005, respectively.

83

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

Totalincome tax benefit (expense) from continuing operations was different than thatcomputed by applying U.S. Federal income tax rates to losses from continuingoperations before income taxes for the years ended December 31, 2006,2005, and 2004. The reasons for the differences are presented below (inthousands):

| ** **                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed “expected”  Federal tax benefit (expense) from continuing operations |       | $        | (17,632    | )        | $          | 19,090   |       | $ | 8,104 |   |
| State income tax  benefit (expense), net of Federal income tax expense                  |       | (2,251   | )          | 167      |       | (358     | )          |
| Dividends and  loss on redemption on preferred stock                                    |       | —   |       | (4,291   | )          | (6,862   | )          |
| Dividends  received deduction                                                           |       | 605      |       | 153      |       | 103      |       |
| Rate change                                                                             |       | —   |       | 1,585    |       | —   |       |
| Change in  valuation allowance (Federal and state)                                      |       | —   |       | 66,011   |       | (1,858   | )          |
| Other                                                                                   |       | (580     | )          | 381      |       | 355      |       |
| Total income tax benefit  (expense) from continuing operations                          |       | $        | (19,858    | )        | $          | 83,096   |       | $ | (516 | ) |

 

The Company had a valuation allowance for deferred taxassets of $66.0 million as of December 31, 2004. These deferred tax assetsprimarily related to the Company NOL carryforwards. In assessing therealizability of the deferred tax assets, management considered whether it wasmore likely than not that some portion or all of the deferred tax assets wouldnot be realized. The ultimate realization of the deferred tax assets wasdependent upon the generation of future taxable income during periods in whichthose temporary differences become deductible. Management considered thescheduled reversal of deferred tax liabilities, 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 (as described in Note 2), the Company had reduced itsaggregate long term debt with a corresponding significant reduction in itsannual interest expense. When considered together with the Company’s history ofproducing positive operating results and other evidence affectingrecoverability of deferred tax assets, the Company expected that future taxableincome would more likely than not be sufficient to recover net deferred taxassets. Therefore, the valuation allowance was reversed in the 2005, subsequentto the offering.

84

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

Thetax effects of temporary differences that give rise to significant portions ofthe deferred tax assets and deferred tax liabilities as of December 31,2006 and 2005 are presented below (in thousands):

| ** **                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:                              |       |     |       |     |       |
| Federal and state tax loss carryforwards           |       | $        | 84,934     |     | $          | 109,569 |   |
| Employee benefits                                  |       | 1,756    |       | 1,865    |       |
| Self insurance reserves                            |       | 1,110    |       | 1,389    |       |
| Restructure charges and exit liabilities           |       | —   |       | 493      |       |
| Allowance for doubtful accounts                    |       | 697      |       | 800      |       |
| Alternative minimum tax and other state credits    |       | 3,210    |       | 1,857    |       |
| Total gross deferred tax assets                    |       | 91,707   |       | 115,973  |       |
| Deferred tax  liabilities:                         |       |     |       |     |       |
| Property, plant, and equipment, principally due to |       |     |       |     |       |
| depreciation differences                           |       | 8,967    |       | 11,996   |       |
| Goodwill and other intangible assets               |       | 21,189   |       | 17,883   |       |
| Change in fair market value of swaps               |       | 3,240    |       | 3,301    |       |
| Basis in investments                               |       | 833      |       | 6,443    |       |
| Total gross deferred tax liabilities               |       | 34,229   |       | 39,623   |       |
| Net deferred tax  assets                           |       | $        | 57,478     |     | $          | 76,350 |   |

 

In assessing the realizability of deferred tax assets,management considers whether it is more likely than not that some portion orall of the deferred tax assets will not be realized. The ultimate realizationof deferred tax assets is dependent upon the generation of future taxableincome during the periods in which those temporary differences becomedeductible. Management considers the scheduled reversal of deferred tax liabilities,projected future taxable income, and tax planning strategies in making thisassessment. In order to fully realize the deferred tax asset, the Companyestimates that it will need to generate future taxable income of$165.6 million prior to the expiration of the net operating losscarryforwards in 2025. Taxable income (losses) for the years ended December 31,2006 and 2005 were $65.0 million and $(41.0) million, respectively.Based upon the level of projections for future taxable income over the periodsin which the deferred tax assets are deductible, management believes it is morelikely than not the Company will realize the benefits of these deductibledifferences based on facts and circumstances known as of December 31,2006.

At December 31, 2006,the Company had federal and state net operating loss carryforwards of$235.1 million that will expire in 2019 to 2025. At December 31,2006, the Company has alternative minimum tax credits of $2.7 million thatmay be carried forward indefinitely. The Company completed an initial publicoffering on February 8, 2005, which resulted in an “ownership change”within the meaning of the U.S. Federal income tax laws addressing net operatingloss carryforwards, alternative minimum tax credits, and other similar taxattributes. As a result of such ownership change, there are specificlimitations on the Company’s ability to use its net operating loss carryfowardsand other tax attributes however, it is the Company’s belief that it can usethe net operating losses even with these restrictions in place because of netunrealized built in gains.

85

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

**(12) Stockholders’Equity**

On February 8, 2005, the Company consummated itsinitial public offering of 25,000,000 shares of common stock, par value $.01per share. At December 31, 2006, there were 35,218,443 shares of commonstock outstanding and 200,000,000 shares of common stock were authorized.

On January 28, 2005, the board of directorsapproved a 5.2773714 for 1 reverse stock split of the Company’s common stock,which has been given retroactive effect in the accompanying financialstatements. In connection with the Company’s initial public offering in February 2005,the Company reclassified all of its class A common stock and class C commonstock on a one-for-one basis into a single class of common stock of which 200million shares are authorized. After the stock split but prior to the issuanceof any new shares in the offering, 9,451,719 shares of common stock wereoutstanding. All common stock issued and outstanding has a $0.01 par value.

At December 31, 2004,there were 8,643,000 shares of Class A voting stock outstanding. The Class Avoting stock had a par value of $0.01 per share and 44,757,000 shares wereauthorized. In addition, at December 31, 2004, there were 809,000 sharesof Class C nonvoting, convertible stock outstanding. The Class Cnonvoting, convertible stock had a par value of $0.01 per share and 2,615,000shares were authorized.

**(13) Stock OptionPlans**

Effectiveon January 1, 2006, the Company adopted the provisions of SFAS 123(R). Asa result of this adoption, amounts previously included in stockholders’ equityas unearned compensation are included in additional paid-in capital as of December 31,2006. At December 31, 2006, the Company had $7.8 million of total unearnedcompensation cost related to non-vested share-based payment arrangementsgranted under the Company’s four stock-based compensation plans. That cost isexpected to be recognized over a weighted average period of 2.1 years. Anyfuture share awards under any of these plans will be made using newly issuedshares. Amounts recognized in the financial statements with respect to theseplans are as follows (in thousands):

| ** **                                                    | ** ** | **For the year ended  December 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Amounts charged  against income, before income tax  benefit   |       | $                                                        | 2,859      |   | $ | 2,350 |   |   | $ | 49 |   |   |
| Amount of related income tax benefit recognized in  income(1) |       | 1,075                                                    |       | 884 |   |   | — |   |   |
| Total net income  impact                                      |       | $                                                        | 1,784      |   | $ | 1,466 |   |   | $49 |   |   |

----

(1)          Amounts shown for 2004are not tax effected due to the recognition of a valuation allowance associatedwith deferred tax assets.

86

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

***(a) 1995 Stock Incentive Plan***

In February 1995, the Company adopted theFairPoint Communications, Inc. (formerly MJD Communications, Inc.)1995 Stock Incentive Plan (the 1995 Plan). The 1995 Plan covers officers,directors, and employees of the Company. The Company was allowed to issuequalified or nonqualified stock options to purchase up to 215,410 shares of theCompany’s Class A common stock to employees that would vest equally over 5years from the date of employment of the recipient and are exercisable duringyears 5 through 10. In 1995, the Company granted options to purchase 161,596shares at $1.32 per share. No options have been granted since 1995. Effectivein February 2005, the Company may no longer grant awards under the 1995Plan. As of January 1, 2006, only 18,013 options remained outstanding. Thelife of these options had previously been extended to May 21, 2008. In March 2006the remaining 18,013 options outstanding were exercised. The intrinsic value ofthese options on the date of exercise was $230,000, the cash received was$24,000 and the tax benefit was $87,000.

These stock options were granted by the Company priorto becoming a public company and therefore the Company is accounting for theseoptions under the prospective method under SFAS 123(R). The per share weightedaverage fair value of stock options granted during 1995 was $0.69 on the dateof grant using the Black-Scholes option-pricing model. Input variablesused in the model included no expected dividend yield, a risk-freeinterest rate of 6.41%, and an estimated option life of five years. Because theCompany was not public on the date of the grant, no assumption as to thevolatility of the stock price was made.

Stockoption activity under the 1995 Plan is summarized as follows:

|                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Outstanding at  January 1:                             |       | 18,013   |       | 112,265  |       | 112,265  |       |
| Granted                                                     |       | —   |       | —   |       | —   |       |
| Exercised                                                   |       | (18,013  | )          | (94,252  | )          | —   |       |
| Forfeited                                                   |       | —   |       | —   |       | —   |       |
| Outstanding at December 31                             |       | —   |       | 18,013   |       | 112,265  |       |
| Exercisable at December 31, 2006                       |       | —   |       |     |       |     |       |
| Stock options  available to grant at December 31, 2006 |       | —   |       |     |       |     |       |

 

***(b) 1998 Stock Incentive Plan***

In August 1998, the Company adopted the FairPointCommunications, Inc. (formerly MJD Communications, Inc.) StockIncentive Plan (the 1998 Plan). The 1998 Plan provided for grants of up to1,317,425 of nonqualified stock options to executives and members ofmanagement, at the discretion of the compensation committee of the board ofdirectors. Options vest in 25% increments on the second, third, fourth, andfifth anniversaries of an individual grant. In the event of a change incontrol, outstanding options will vest immediately. Effective in February 2005,the Company may no longer grant awards under the 1998 Plan.

Pursuant to the terms of the grant, options granted in1998 and 1999 become exercisable only in the event that the Company is sold, aninitial public offering of the Company’s common stock results in the principalshareholders holding less than 10% of their original ownership, or otherchanges in control, as defined, occur. The number of options that may becomeultimately exercisable also depends upon the 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

extent to which the priceper share obtained in the sale of the Company would exceed a minimum sellingprice of $22.59 per share. All options have a term of 10 years from date ofgrant. For those options granted in 1998 and 1999, the Company will recordcompensation expense for the excess of the estimated market value of its commonstock over the exercise price of the options when and if a sale of the Company,at the prices necessary to result in exercisable options under the grant,becomes imminent or likely. The initial public offering did not triggerexercisability of these options. Upon termination of a plan participant’semployment with the Company, the Company may repurchase all or any portion ofthe vested options for a cash payment equal to the excess of the fair marketvalue of the shares over the option exercise price. The Company has notpreviously exercised this right and does not currently intend to exercise thisright in the future.

These stock options were granted by the Company priorto becoming a public company and therefore the Company is accounting for theseoptions under the prospective method under SFAS 123(R). The per share weightedaverage fair value of stock options granted under the 1998 Plan was $58.95 onthe date of grant using the Black-Scholes option-pricing model. Inputvariables used in the model included no expected dividend yield, a risk-freeinterest rate of 6.52%, and an estimated option life of 10 years. Because theCompany was not public on the date of the grant, no assumption as to thevolatility of the stock price was made. As of December 31, 2006 and December 31,2005, options to purchase 832,888 shares of common stock were outstanding witha weighted average exercise price of $10.80.

Stockoption activity under the 1998 Plan is summarized as follows:

| ** **                                                  | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|-------------------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                                  | ** ** | ** **      | ** ** | **average**  | ** ** |
| ** **                                                  | ** ** | **Options**     | ** ** | **exercise** | ** ** |
| ** **                                                  | ** ** | **outstanding** | ** ** | **price**    | ** ** |
| Outstanding at  December 31, 2003 and 2004             |       |            | 836,356    |         |       |   | $ | 10.87 |   |   |
| Granted                                                     |       |            | —     |         |       |   | — |   |   |
| Exercised                                                   |       |            | (3,468     | )            |       |   | 17.31 |   |   |
| Forfeited                                                   |       |            | —     |         |       |   | — |   |   |
| Outstanding at December 31, 2005                       |       |            | 832,888    |         |       |   | 10.80 |   |   |
| Granted                                                     |       |            | —     |         |       |   | — |   |   |
| Exercised                                                   |       |            | —     |         |       |   | — |   |   |
| Forfeited                                                   |       |            | —     |         |       |   | — |   |   |
| Outstanding at December 31, 2006                       |       |            | 832,888    |         |       |   | $ | 10.80 |   |   |
| Stock options  available to grant at December 31, 2006 |       |            | —     |         |       |   |   |   |   |

 

|            | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|------------|------------|------------------------------|------------|------------------------------|------------|
| ** ** | ** ** | ** **                   | ** ** | **Number**                   | ** ** | ** ** | ** ** | **Aggregate** | ** ** | **Number** | ** ** |
| ** ** | ** ** | ** **                   | ** ** | **outstanding at**      | ** ** | **Remaining** | ** ** | **Intrinsic** | ** ** | **exercisable at** | ** ** |
| ** ** | ** ** | **Exercise**                 | ** ** | **December 31,**        | ** ** | **contractual** | ** ** | **Value** | ** ** | **December 31,** | ** ** |
| ** ** | ** ** | **price**                    | ** ** | **2006**                     | ** ** | **life (years)** | ** ** | **(in thousands)** | ** ** | **2006** | ** ** |
|       |       |                         | $          | 9.02                         |       |   |   | 756,332 |   |   |   | 1.6 |   |   |   | 7,510 |   |   |   | — |   |   |
|       |       |                         | 14.46      |                         |       |   | 29,183 |   |   |   | 2.5 |   |   |   | 131 |   |   |   | — |   |   |
|       |       |                         | 36.94      |                         |       |   | 47,373 |   |   |   | 5.0 |   |   |   | — |   |   |   | — |   |   |
|       |       |                         |       |                         |       |   | 832,888 |   |   |   |   |   |   |   | 7,641 |   |   |   | — |   |   |

 

88

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

The weighted average remaining contractual life forthe options outstanding at December 31, 2006 is 1.8 years. The aggregateintrinsic value in the preceding table represents total pre-tax intrinsic valuebased on the closing price of the Company’s stock of $18.95 on December 31,2006.

In February 2007, allthe options outstanding under the 1998 Plan were cancelled, except the 47,373options with a $36.94 exercise price. This cancellation was triggered bycertain events noted in the 1998 Plan.

***(c) 2000 Employee Stock Incentive Plan***

In May 2000, the Company adopted the FairPointCommunications, Inc. 2000 Employee Stock Incentive Plan (the2000 Plan). The 2000 Plan provided for grants to members of management ofup to 1,898,521 options to purchase common stock, at the discretion of thecompensation committee. During 2002, the Company amended the 2000 Plan to limitthe number of shares available for grant to 448,236. In December 2003, theCompany amended the 2000 Plan to allow for the grant to members of managementof up to 1,898,521 shares of stock units in addition to shares available forstock options. Options granted under the 2000 Plan may be of two types: (i) incentivestock options and (ii) non-statutory stock options. Unless the compensationcommittee shall otherwise specify at the time of grant, any option grantedunder the 2000 Plan shall be a non-statutory stock option. Effective in February 2005,the Company may no longer grant awards under the 2000 Plan.

Under the 2000 Plan, unless otherwise determined bythe compensation committee at the time of grant, participating employees aregranted options to purchase common stock at exercise prices not less than themarket value of the Company’s common stock at the date of grant. Options have aterm of 10 years from date of grant. Options vest in increments of 10% on thefirst anniversary, 15% on the second anniversary, and 25% on the third, fourth,and fifth anniversaries of an individual grant. Stock units vest in incrementsof 33% on each of the third, fourth, and fifth anniversaries of the award.Subject to certain provisions, the Company can cancel each option in exchangefor a payment in cash of an amount equal to the excess of the fair market valueof the shares over the exercise price for such option. The Company has notpreviously exercised this right and does not currently intend to exercise thisright in the future.

The 2000 Plan stock options and stock units weregranted by the Company prior to becoming a public company and therefore theCompany is accounting for these awards under the prospective method under SFAS123(R). The per share weighted average fair value of stock options grantedunder the 2000 Plan during 2003 was $8.39 on the date of grant using the BlackScholes option-pricing model. Input variables used in the model includedno expected dividend yield, a weighted average risk free interest rate of 4.26%in 2003 and an estimated option life of 10 years. Because the Company wasnot public on the date of grant, no assumption as to the volatility of thestock price was made.

89

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

Stockoption activity under the 2000 Plan is summarized as follows:

| ** **                                                  | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|-------------------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                                  | ** ** | ** **      | ** ** | **average**  | ** ** |
| ** **                                                  | ** ** | **Options**     | ** ** | **exercise** | ** ** |
| ** **                                                  | ** ** | **outstanding** | ** ** | **price**    | ** ** |
| Outstanding at  December 31, 2003                      |       |            | 300,734    |         |       |   | $ | 36.94 |   |   |
| Granted                                                     |       |            | —     |         |       |   | — |   |   |
| Exercised                                                   |       |            | —     |         |       |   | — |   |   |
| Canceled or forfeited                                       |       |            | (60,096    | )            |       |   | 36.94 |   |   |
| Outstanding at December 31, 2004                       |       |            | 240,638    |         |       |   | 36.94 |   |   |
| Granted                                                     |       |            | —     |         |       |   | — |   |   |
| Exercised                                                   |       |            | —     |         |       |   | — |   |   |
| Canceled or forfeited                                       |       |            | —     |         |       |   | — |   |   |
| Outstanding at December 31, 2005                       |       |            | 240,638    |         |       |   | 36.94 |   |   |
| Granted                                                     |       |            | —     |         |       |   | — |   |   |
| Exercised                                                   |       |            | —     |         |       |   | — |   |   |
| Canceled or forfeited                                       |       |            | (31,563    | )            |       |   | 36.94 |   |   |
| Outstanding at December 31, 2006                       |       |            | 209,075    |         |       |   | $ | 36.94 |   |   |
| Stock options  available to grant at December 31, 2006 |       |            | —     |         |       |   |   |   |   |

 

The remaining contractual life for the optionsoutstanding at December 31, 2006 was 5.8 years, and209,075 options were exercisable. Based upon the fair market value of thestock as of December 31, 2006 of $18.95, these options do not have anyintrinsic value.

As of December 31,2006, there were 14,549 stock units outstanding with a grant date fair valueper share of $32.51. During 2006, 6,555 stock units were cancelled or forfeitedand 5,338 stock units vested and were converted to common shares. None of theseremaining awards were vested as of December 31, 2006 or December 31,2005.

***(d) 2005 Stock Incentive Plan***

In February 2005, the Company adopted theFairPoint Communications, Inc. 2005 Stock Incentive Plan (the 2005 Plan). The2005 Plan provides for the grant of up to 947,441 shares of non-vested stock,stock units and stock options to members of the Company’s board of directorsand certain key members of the Company’s management. Shares granted toemployees under the 2005 Plan vest over periods ranging from three to fouryears and certain of these shares pay current dividends. At December 31,2006, up to 280,880 additional shares of common stock may be issued in thefuture pursuant to awards authorized under the 2005 Plan.

In March 2006, the Company’s board of directorsapproved the grant of an additional 100,000 shares to the Company’s chiefexecutive officer. These shares will be granted under the 2005 Plan, or areplacement plan approved by the Company’s shareholders, in two installments of50,000 shares each on January 1, 2007 and January 1, 2008. Theseshares are considered to have been granted in March 2006 under SFAS 123(R) ata grant date fair value of $14.02 per share.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

In 2006 and 2005, the Company’s board of directorsapproved an annual award to each of the Company’s non-employee directors ofapproximately $30,000 in the form of non-vested stock or stock units, at therecipient’s option, issued under the 2005 Plan. The non-vested stock and stockunits will vest in four equal quarterly installments on the first day of eachof the first four calendar quarters following the grant date and the holdersthereof will be entitled to receive dividends from the date of grant, whetheror not vested. In 2005, the Company granted 1,870 shares of non-vested stockwith a total value at the grant date of approximately $30,000 and 7,480 stockunits with a total value at the grant date of approximately $120,000 to theCompany’s non-employee directors. In 2006, the Company granted an additional2,200 shares of non-vested stock with a total value at the grant date ofapproximately $30,000 and 11,000 stock units with a total value at the grantdate of approximately $150,000 to the Company’s non-employee directors. As of December 31,2006, an additional 2,017 stock units were granted in lieu of dividends on thestock units. In addition, in February 2006, 467 stock units were grantedto a newly appointed non-employee director. These stock units vested on April 1,2006.

The fair value of the awards is calculated as the fairmarket value of the shares on the date of grant. Beginning on January 1,2006, the Company adopted the provisions of SFAS 123(R) using the modifiedprospective method for the awards under the 2005 Plan as all awards weregranted subsequent to the Company becoming public. Under this methodology, theCompany is required to estimate expected forfeitures related to these grantsand, for the non-dividend paying shares, the compensation expense is reduced bythe present value of the dividends which were not paid on those shares prior totheir vesting.

The following table presents information regardingnon-vested stock granted to employees under the 2005 Plan during 2006:

| ** **                            | ** ** | ** **      | ** ** | **Weighted**                  | ** ** |
|---------------------------------------|------------|-----------------|------------|-------------------------------|------------|
| ** **                            | ** ** | ** **      | ** ** | **average grant**        | ** ** |
| ** **                            | ** ** | **Shares**      | ** ** | **date fair value** | ** ** |
| ** **                            | ** ** | **outstanding** | ** ** | **per share**            | ** ** |
| Non-vested stock                 |       |            |       |                          |       |   |   |   |   |
| Non-vested at December 31, 2004  |       |            | —     |                          |       |   | $ | — |   |   |
| Granted                               |       |            | 523,716    |                          |       |   | 18.16 |   |   |
| Vested                                |       |            | —     |                          |       |   | — |   |   |
| Forfeited                             |       |            | (53,687    | )                             |       |   | 18.50 |   |   |
| Non-vested at December 31, 2005  |       |            | 470,029    |                          |       |   | 18.13 |   |   |
| Granted                               |       |            | 233,926    |                          |       |   | 16.93 |   |   |
| Vested                                |       |            | (88,773    | )                             |       |   | 18.17 |   |   |
| Forfeited                             |       |            | (62,369    | )                             |       |   | 18.27 |   |   |
| Non-vested at  December 31, 2006 |       |            | 552,813    |                          |       |   | 17.60 |   |   |
|                                       |            |                 |            |                               |            |  |  |  |  |  |

 

The weighted average fair market value of the 88,773shares that vested in 2006 was $14.14.

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

** (14)   Discontinued Operations andRestructure Charges**

***(a)   Competitive Communications BusinessOperations***

In November 2001, in connection with the sale ofcertain of certain assets of its competitive communications operations, theCompany announced its plan to discontinue the competitive communicationsbusiness operations of its wholly owned subsidiary, Carrier Services. As aresult of the adoption of the plan to discontinue the competitivecommunications operations, these results are presented as discontinuedoperations.

During 2004, the Company revised its assumptions oncertain lease obligations related to the restructuring accrual and as a result,increased the obligation by $0.1 million in 2004. Also during 2004, accruedliabilities associated with the discontinued operations were re-evaluated, orsettled for less than original estimates and as a result, these obligationswere adjusted by $0.6 million.

In 2006 and 2005, the Company settled certain leaseobligations which reduced the remaining obligations related to discontinuedoperations. As a result, the Company reduced the obligation by $0.9 million and$0.6 million, respectively, to properly reflect the on-going obligations of theCompany.

Assetsand liabilities of discontinued operations of Carrier Services as of December 31,2006 and 2005 follows (in thousands):

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Accounts  receivable                            |       | $        | —     |     | $          | 90 |   |
| Current assets of discontinued operations       |       | $        | —     |     | $          | 90 |   |
| Accrued  liabilities                            |       | $        | (486       | )        | $          | (1,133 | ) |
| Restructuring  accrual                          |       | —   |       | (1,312   | )          |
| Accrued property  taxes                         |       | —   |       | (50      | )          |
| Current  liabilities of discontinued operations |       | $        | (486       | )        | $          | (2,495 | ) |

 

Selectedinformation relating to the restructuring charge follows (in thousands):

| ** **                                          | ** ** | **Equipment,**     | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **occupancy,**     | ** ** |
| ** **                                          | ** ** | **and other** | ** ** |
| ** **                                          | ** ** | **lease**          | ** ** |
| ** **                                          | ** ** | **terminations**   | ** ** |
| Restructuring  accrual as of December 31, 2003 |       |               | $          | 5,253 |   |   |
| Adjustments from  initial estimated charges         |       |               | 80         |   |   |
| Cash payments                                       |       |               | (2,682     | ) |   |
| Restructuring  accrual as of December 31, 2004 |       |               | 2,651      |   |   |
| Adjustments from  initial estimated charges         |       |               | (600       | ) |   |
| Cash payments                                       |       |               | (739       | ) |   |
| Restructuring  accrual as of December 31, 2005 |       |               | 1,312      |   |   |
| Adjustments from  initial estimated charges         |       |               | (270       | ) |   |
| Cash payments                                       |       |               | (1,042     | ) |   |
| Restructuring accrual as  of December 31, 2006 |       |               | $          | — |   |   |

 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

 

**(15)   Related Party Transactions**

The Company had enteredinto financial advisory agreements with certain equity investors, pursuant towhich the equity investors provided certain consulting and advisory servicesrelated, but not limited to, equity financings and strategic planning. In 2005,the Company paid approximately $0.1 million related to these agreements. Theseagreements were cancelled on February 8, 2005. The Company paid$1.0 million for the year ended December 31, 2004 in such fees to theequity investors and this expense was classified within operating expenses. Theagreements also provided that the Company reimburse the equity investors fortravel relating to the Company’s board of directors meetings. The Companyreimbursed the equity investors $123,000 for the year ended December 31,2004 for travel and related expenses. In connection with our initial publicoffering, we terminated these agreements and paid a transaction fee of $8.4million to one of these equity advisors.

A law firm, in which apartner of such law firm is the husband of an executive officer, was paid$88,000, $303,000 and $4,000 for the years ended December 31, 2006, 2005,and 2004, respectively, for legal services and expenses.

On July 31, 2003, theCompany loaned $1.0 million to two employees that are the former owners ofFremont. These loans were settled on January 2, 2005.

**(16)   Quarterly Financial Information (Unaudited)**

| ** **                                                         | ** ** | **First**                                                          | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                                         | ** ** | **quarter**                                                        | ** ** | **quarter** | ** ** | **quarter** | ** ** | **quarter** | ** ** |
| ** **                                                         | ** ** | **(in thousands, except per share data)** | ** ** |
| 2006:                                                              |       |                                                               |       |        |       |        |       |        |       |
| Revenue                                                            |       | $                                                                  | 64,791     |        | 64,196     |        | 70,700     |        | 70,382     |   |
| Income from continuing operations                                  |       | 5,720                                                              |       | 15,074      |       | 5,977       |       | 3,745       |       |
| Net income                                                         |       | 5,720                                                              |       | 15,074      |       | 5,977       |       | 4,319       |       |
| Earnings per from  continuing operations                           |       |                                                               |       |        |       |        |       |        |       |
| Basic and diluted earnings per share from continuing    operations |       | 0.13                                                               |       | 0.44        |       | 0.17        |       | 0.11        |       |
| Basic and diluted earnings per share                               |       | 0.13                                                               |       | 0.44        |       | 0.17        |       | 0.12        |       |
| 2005:                                                              |       |                                                               |       |        |       |        |       |        |       |
| Revenue                                                            |       | $                                                                  | 61,665     |        | 65,206     |        | 66,038     |        | 69,934     |   |
| Income from continuing operations                                  |       | 11,042                                                             |       | 5,603       |       | 4,189       |       | 7,716       |       |
| Net income                                                         |       | 11,042                                                             |       | 5,603       |       | 4,189       |       | 8,096       |       |
| Basic and diluted earnings per share from continuing    operations |       | 0.46                                                               |       | 0.16        |       | 0.12        |       | 0.22        |       |
| Basic and diluted  earnings per share                              |       | 0.46                                                               |       | 0.16        |       | 0.12        |       | 0.23        |       |

 

In the second quarter of2006, the Company recorded gains on the sale of two non-core assets resultingin pre-tax gains of $16.4 million. In addition, in the fourth quarter of 2006,the Company incurred $2.4 million in expenses related to the merger agreementwith Verizon Communications Inc.

In connection with the Company’sinitial public offering in February 2005, the Company recognized, in thefirst quarter of 2005, non-operating losses of $86.2 million related to feesand penalties paid on the 

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

redemptionof its Series A preferred stock and the write-off of unamortized debtissuance costs. Also in connection with the offering, the Company repaidportions of its previously outstanding debt and therefore, interest expense wassignificantly reduced in the first quarter of 2005. In addition, the Companyrecorded an income tax benefit of $66.0 million in the first quarter of 2005due to the reversal of its valuation allowance.

** (17)   DisclosuresAbout the Fair Value of Financial Instruments**

***(a)   Cash,Accounts Receivable, Accounts Payable, and Demand Notes Payable***

Thecarrying amount approximates fair value because of the short maturity of theseinstruments.

***(b)   Investments***

Investments classified astrading securities are carried at their fair value, which was approximately$0.7 million and $0.6 million at December 31, 2006 and 2005,respectively. (see note 7 and note 10)

At December 31, 2006,the Company had cost method investments with a carrying value of $4.1 million.The Company did not estimate the fair value of these investments as to do sowould involve significant judgment and a value could not be determined with anydegree of accuracy.

***(c)   Long-termDebt***

Thefair value of the Company’s long-term debt is estimated by discountingthe future cash flows of each instrument at rates currently offered to theCompany for similar debt instruments of comparable maturities. At December 31,2006 and 2005, the Company had long-term debt with a carrying value of$608.0 million and $607.4 million, respectively, and estimated fairvalues of $608.4 million and $608.3 million, respectively.

***(d)   Limitations***

Fair value estimates aremade at a specific point in time, based on relevant market information andinformation about the financial instrument. These estimates are subjective innature and involve uncertainties and matters of significant judgment and,therefore, cannot be determined with precision. Changes in assumptions couldsignificantly affect the estimates.

** (18)   RevenueConcentrations**

Revenues for interstateaccess services are based on reimbursement of costs and an allowed rate ofreturn. A substantial portion of revenues of this nature are received from NECAin the form of monthly settlements. Such revenues amounted to 24.5%, 26.7%, and25.7% of the Company’s total revenues from continuing operations for the yearsended December 31, 2006, 2005, and 2004, respectively.

** (19)   RevenueSettlements**

Certain of the Company’stelephone subsidiaries participate in revenue-sharing arrangements with othertelephone companies for interstate revenue-sharing arrangements and for certainintrastate revenue. Such sharing arrangements are funded by toll revenue and/oraccess charges within the state jurisdiction 

94

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

and byaccess charges in the interstate market. Revenues earned through the varioussharing arrangements are initially recorded based on the Company’s estimates.The Company recognized $0.8 million, $3.3 million, and$3.1 million of revenue for settlements and adjustments related to prioryears during 2006, 2005, and 2004, respectively.

** (20)   Commitmentsand Contingencies**

***(a)   OperatingLeases***

Futureminimum lease payments under noncancelable operating leases as of December 31,2006 are as follows (in thousands):

| ** **                     | ** ** | **Continuing** | ** ** |
|--------------------------------|------------|----------------|------------|
| ** **                     | ** ** | **operations** | ** ** |
| Year ending  December 31: |       |           |       |   |   |
| 2007                           |       |           | $          | 1,112 |   |   |
| 2008                           |       |           | 1,077      |   |   |
| 2009                           |       |           | 940        |   |   |
| 2010                           |       |           | 528        |   |   |
| 2011                           |       |           | 580        |   |   |
| Thereafter                     |       |           | 3,614      |   |   |
| Total minimum  lease payments  |       |           | $          | 7,851 |   |   |

 

In January 2006, the Company reached an agreementto amend the remaining lease related to its discontinued operations; therefore,as of January 2006, there are no longer any sublease arrangements in place.Total rent expense from continuing operations was $3.8 million,$3.5 million, and $3.2 million in 2006, 2005, and 2004, respectively.All leases associated with discontinued operations have been settled as of December 31,2006.

TheCompany does not have any leases with contingent rental payments or any leaseswith contingency renewal, purchase options, or escalation clauses.

***(b)   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 

95

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**FairPoint Communications, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)**

remand the action to theNorth Carolina State Court, which was denied by the Federal Magistrate. Theplaintiff has objected to and appealed the Magistrate’s decision to theDistrict Court Judge. The Company has contested the appeal and filed a Motionto Dismiss the action. The Magistrate, on February 9, 2006, issued aMemorandum and a Recommendation to the District Court Judge that the Motion toDismiss be granted and that the complaint be dismissed with prejudice. Theplaintiff has filed a Notice of Objection to the Magistrate’s Recommendation. Boththe appeal of denial of the Motion to Remand and the Motion to Dismiss arepending before the District Court Judge. The Company believes that this actionis without merit and intends to continue to defend the litigation vigorously.

From time to time, the Company is involved inlitigation and regulatory proceedings arising out of its operations. TheCompany is not currently a party to any legal proceedings, the adverse outcomeof which, individually or in the aggregate, that management believes would havea material adverse effect on the Company’s financial position or results ofoperations.

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**Evaluation ofDisclosure Controls and Procedures**

An evaluation of theeffectiveness of the design and operation of our “disclosure controls andprocedures” (as defined in Rule 13a-15(e) under the ExchangeAct) as of the end of the period covered by this Annual Report was made underthe supervision and with the participation of our management, including ourchief executive officer and chief financial officer. Based upon thisevaluation, our chief executive officer and chief financial officer have eachconcluded that our disclosure controls and procedures (a) are effective toensure that information required to be disclosed by us in reports filed orsubmitted under the Exchange Act is timely recorded, processed, summarized andreported and (b) include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by us in reportsfiled or submitted under the Exchange Act is accumulated and communicated toour management, including our chief executive officer and chief financialofficer, as appropriate to allow timely decisions regarding requireddisclosure.

**Management’s Reporton Internal Control Over Financial Reporting**

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, and forperforming an assessment of the effectiveness of internal control overfinancial reporting as of December 31, 2006. Internal control overfinancial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles. Our system of internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect our transactions and dispositions of assets; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and our receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of our assets that could have a materialeffect on our financial statements.

All internal control systems, no matter how welldesigned, have inherent limitations. Therefore, even those systems determinedto be effective can provide only reasonable assurance with respect to financialstatement preparation and presentation.

Management performed an assessment of theeffectiveness of our internal control over financial reporting as of December 31,2006 based upon criteria in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission. Based on suchassessment, management determined that our internal control over financialreporting was effective as of December 31, 2006.

We acquired GITC, Unite and Cass County during theyear ended December 31, 2006. Accordingly, management excluded from itsassessment of the effectiveness of our internal control over financialreporting as of December 31, 2006, GITC’s, Unite’s, and Cass County’sinternal control over financial reporting associated with total assets of$36.6 million and total revenues of $6.6 million included in ourconsolidated financial statements as of and for the year ended December 31,2006.

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Our management’s assessment of the effectiveness ofour internal control over financial reporting as of December 31, 2006 hasbeen audited by KPMG LLP, an independent registered public accounting firm, asstated in their report which appears herein.

Dated:  March 13, 2007

| /s/ Eugene B. Johnson    |   | /s/ John P.  Crowley     |
|--------------------------|--------|--------------------------|
| Chief Executive  Officer |   | Chief Financial  Officer |

 

**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and Stockholders

FairPoint Communications, Inc.:

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting appearing under item 9A*,*thatFairPoint Communications, Inc. and subsidiaries (the Company) maintainedeffective internal control over financial reporting as of December 31,2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with U.S. generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with U.S. generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2006, is fairly stated, in all material respects, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). Also, in our opinion, the Company maintained, in all 

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material respects,effective internal control over financial reporting as of December 31,2006, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

The Company acquired The Germantown IndependentTelephone Company (GITC), Unite Communications Systems, Inc. (Unite), andCass County Telephone Company Limited Partnership and LEC Long Distance, Inc.(Cass County) during the year ended December 31, 2006, and managementexcluded from its assessment of the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2006, internal controlover financial reporting of GITC, Unite, and Cass County associated with totalassets of $36.6 million and total revenues of $6.6 million includedin the consolidated financial statements of the Company as of and for the yearended December 31, 2006. Our audit of internal control over financialreporting of the Company also excluded an evaluation of the internal controlover financial reporting of GITC, Unite and Cass County.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of theCompany as of December 31, 2006 and 2005, and the related consolidated statements ofoperations, stockholders’ equity (deficit), comprehensive income (loss), andcash flows for each of the years in the three-year period ended December 31,2006, and our report dated March 12, 2007**expressed an unqualifiedopinion on those consolidated financial statements.

/s/ KPMG LLP

Omaha, NebraskaMarch 12, 2007

**Changes in InternalControls**

There have been nosignificant changes in our “internal control over financial reporting” (asdefined in Rule 13a-15(f) of the Exchange Act) that occurredduring the quarter ended December 31, 2006 that have materially affectedor are reasonably likely to materially affect our internal control overfinancial reporting.

**ITEM 9B.  OTHER INFORMATION**

Not applicable.

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**PART III**

**ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATEGOVERNANCE**

**Board of Directorsand Committees of the Board of Directors**

As of December 31, 2006, our board of directorsconsisted of seven directors. Three of our directors, Eugene B. Johnson, FrankK. Bynum, Jr. and Kent R. Weldon, served on our board of directors priorto our initial public offering in February 2005. Three of our directors,Patricia Garrison-Corbin, David L. Hauser and Claude C. Lilly, were appointedas directors in connection with our initial public offering. Robert S. Lilienwas appointed as a director by our board of directors in December of 2005to fill the vacancy which existed on our board of directors since our initialpublic offering. Our directors are divided into three classes having staggeredthree-year terms, so that the term of one class expires at each annual meetingof stockholders. As of December 31, 2006, the classes were comprised asfollows:

·       *Class I directors*. Eugene B. Johnson and PatriciaGarrison-Corbin are Class I directors whose terms will expire at theannual meeting of stockholders held in 2009;

·       *Class II directors*. Frank K. Bynum, Jr. and DavidL. Hauser are Class II directors whose terms will expire at the annualmeeting of stockholders held in 2007; and

·       *Class III directors*. Kent R. Weldon, Claude C. Lillyand Robert S. Lilien are Class III directors whose terms will expire atthe annual meeting of stockholders held in 2008.

Frank K. Bynum, Jr.and Kent R. Weldon resigned from our board of directors and all committeesthereof effective as of January 16, 2007.

**Directors**

The following sets forth selected biographicalinformation for our directors.

*EugeneB. Johnson—**Mr*. Johnson, age 59, has served asour Chairman since January 1, 2003 and as our Chief Executive Officersince January 1, 2002. Prior to his current responsibilities, Mr. Johnsonwas our Chief Development Officer from May 1993 to December 2002 andVice Chairman from August 1998 to December 2002. Mr. Johnson isa founder and has been a director of our Company since 1991. From 1997 to 2002,Mr. Johnson served as a director of the Organization for the Promotion andAdvancement of Small Telecommunications Companies, the primary industryorganization for small independent telephone companies. From 1987 to 1993, Mr. Johnsonserved as President and principal stockholder of JC&A, Inc., aninvestment banking and brokerage firm providing services to the cabletelevision, telephone and related industries. From 1985 to 1987, Mr. Johnsonserved as a director of the mergers and acquisitions department of CableInvestments, Inc., an investment banking firm. Mr. Johnson is also onthe Board of Trustees of the University of North Carolina at Charlotte and ison the Board of Directors of the Foundation of the University of North Carolinaat Charlotte, Inc.

*PatriciaGarrison-Corbin—**Ms.*Corbin, age 59, has served as aDirector of the Company since February 2005. Ms. Corbin has served asPresident of P.G. Corbin & Company, Inc., Financial AdvisoryServices, Municipal Finance, since 1986. Ms. Corbin has also served asPresident and Chief Information Officer of P.G. Corbin Asset Management, Inc.,Fixed Income Investment Management, since 1987. Ms. Corbin has served asChairman of the Board of Directors and Chief Executive Officer of DelanceyCapital Group, LP, Equity Management, since 1996, and Chairman of the Board ofDirectors of P.G. Corbin Group, Inc., Investment and Financial AdvisoryServices since 1996. Ms. Corbin has also served as a director for the ErieInsurance Company since 1999.

*FrankK. Bynum, Jr.—**Mr.*Bynum, age 44, served as adirector of our company from July 1997 to January 16, 2007. He isalso a Managing Director of Kelso & Company. Mr. Bynum joinedKelso & 

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Company in 1987 and has heldpositions of increasing responsibility at Kelso & Company prior tobecoming a Managing Director. Mr. Bynum is a director of CDT Holdings PLC,Custom Buildings Products, Inc., Endurance Business Media, Inc. andeMarkets, Inc. He is also a Trustee of Prep for Prep and a member of theBoard of Trustees of the College Foundation of the University of Virginia.Mr. Bynum was designated to the Board of Directors by Kelso &Company pursuant to Kelso & Company’s designation rights under ourstockholders agreement which was terminated in connection with our initialpublic offering.

*DavidL. Hauser—**Mr.*Hauser, age 55, was appointedas a director of our company in February 2005. He is currently the GroupExecutive and Chief Financial Officer of Duke Energy Corporation, where he hasbeen employed for 30 years. Mr. Hauser is a certified public accountantand a certified purchasing manager. Mr. Hauser is on the Board ofDirectors of Charlotte’s Blumenthal Center for the Performing Arts and is thechair of the UNCC Business School Advisory Board. He is a member of the NorthCarolina Association of Certified Public Accountants and the American Instituteof Certified Public Accountants. Mr. Hauser is on the board of directorsof Enpro Industries and serves on the audit and compensation committees.

*KentR. Weldon—**Mr.* Weldon, age 39, served as adirector of our company from January 2000 until January 16, 2007. Heis currently a Managing Director of Thomas H. Lee Partners, L.P. Mr. Weldonworked at the firm from 1991 to 1993 and rejoined it in 1995. Prior to 1991, Mr. Weldonworked at Morgan Stanley & Co. Incorporated in the Corporate FinanceDepartment. Mr. Weldon is a director of Michael Foods, Inc., Nortek, Inc.and THL-PMPL Holding Corp. From April 1997 to June 2005, Mr. Weldon servedas a director of Syratech Corporation which, together with its subsidiaries,Wallace International de P.R. and Chi International, Inc., filed for bankruptcyunder Chapter 11 in February 2005 and emerged from bankruptcy pursuant toa confirmed Chapter 11 plan in June 2005. Mr. Weldon was designatedto the Board of Directors of FairPoint by Thomas H. Lee Equity Fund inconnection with Thomas H. Lee Equity Fund’s designation rights under ourstockholders agreement which was terminated in connection with our initialpublic offering.

*Claude C. Lilly*—Dr. Lilly,age 60, was appointed as a director of our company in February 2005.Dr. Lilly is currently dean and James J. Harris Chair of Risk Managementand Insurance in The Belk College of Business Administration at The Universityof North Carolina at Charlotte. Dr. Lilly has served as Assistant DeputyInsurance Commissioner for the State of Georgia and as a director of severalcorporations. Mr. Lilly currently serves on the audit committees of theboard of directors of TIAA CREF Trust Company FSB, Erie Indemnity Company andsubsidiaries thereof. He holds the Chartered Property Casualty Underwriters andChartered Life Underwriter designations and is a member of numerousprofessional associations.

*RobertS. Lilien—**Mr.*Lilien, age 59, was appointedas a director of our company in December 2005. Mr. Lilien iscurrently a partner in the law firm of Robinson, Bradshaw & Hinson,located in Charlotte, North Carolina, where he has worked since April 2002,and the managing member of Trilogy Capital Partners, LLC, a captive privateequity fund with equity provided by a single family group, where he has alsoworked since April 2002. From 1993 to 2002, he held various positions atDuke Energy Corporation, including Senior Vice President—Duke Ventures of DukeEnergy Corporation, Chairman and Chief Executive Officer of Crescent Resources,LLC, Chairman of DukeNet Communications, Inc. and Chairman of Duke CapitalPartners, LLC. Mr. Lilien is also on the finance and audit committees ofthe board of directors of the Lynnwood Foundation.

**Committees of theBoard of Directors**

Our board of directors hasthree standing committees: an audit committee, a compensation committee and acorporate governance committee.

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***Audit Committee***

Our audit committee, consisting of Claude C. Lilly,David L. Hauser and Robert S. Lilien, met nine times during fiscal 2006. ClaudeC. Lilly is the chair of our audit committee. All audit committee members meetthe independence criteria set forth in the listing standards of the New YorkStock Exchange and Rule 10A-3 under the Exchange Act. Mr. Hauseris qualified as an audit committee financial expert within the meaning of item401(h) of Regulation S-K under the Exchange Act and our board ofdirectors has determined that he has the accounting and related financialmanagement expertise within the meaning of the listing standards of the NewYork Stock Exchange. The SEC has determined that the audit committee financialexpert designation does not impose on the person with that designation anyduties, obligations or liability that are greater than the duties, obligationsor liability imposed on such person as a member of the audit committee of theboard of directors in the absence of such designation. Effective as of January 16,2007, Ms. Garrison-Corbin was appointed to the audit committee.

Among other functions, the principal duties andresponsibilities of our audit committee are to appoint our independentauditors, oversee the quality and integrity of our financial reporting and theaudit of our financial statements by our independent auditors and, infulfilling its obligations, our audit committee reviews with our management andindependent auditors the scope and result of the annual audit, our auditors’independence and our accounting policies.

The audit committee is required to report regularly toour board of directors to discuss any issues that arise with respect to thequality or integrity of our financial statements, our compliance with legal orregulatory requirements, the performance and independence of our independentauditors, or the performance of the internal audit function.

A copy of the charter ofour audit committee can be found on our website at www.fairpoint.com under the “InvestorRelations” caption.

***Compensation Committee***

Our compensation committee, consisting of David L.Hauser, Patricia Garrison-Corbin and Kent R. Weldon, met three timesduring fiscal 2006. David L. Hauser is the chair of our compensation committee.All compensation committee members meet the independence criteria set forth inthe listing standards of the New York Stock Exchange. Among other functions,the compensation committee oversees the compensation of our chief executiveofficer and other executive officers and senior management, including plans andprograms relating to cash compensation, incentive compensation, equity-basedawards and other benefits and perquisites and administers any such plans orprograms as required by the terms thereof. Mr. Weldon resigned from ourboard of directors and our compensation committee effective as of January 16,2007. Effective as of January 16, 2007, Mr. Lilly and Mr. Lilienwere appointed to the compensation committee.

A copy of our compensationcommittee charter can be found on our website at www.fairpoint.com under the “InvestorRelations” caption.

***Compensation Committee Interlocks and InsiderParticipation***

During 2006, decisions on various elements ofexecutive compensation were made by our compensation committee. No officer,employee or former officer of the Company served as a member of ourcompensation committee during 2006. No committee member had any interlockingrelationships requiring disclosure under applicable rules and regulations.

For a description ofcertain relationships and transactions with members of our board of directorsor their affiliates, see “Certain Relationships and Related Party Transactions.”

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***Corporate Governance Committee***

Our corporate governance committee consisting ofPatricia Garrison-Corbin, Claude C. Lilly and Robert S. Lilien met threetimes during fiscal 2006. Patricia Garrison-Corbin is the chair of ourcorporate governance committee. All of the members of our corporate governancecommittee meet the independence criteria set forth in the listing standards ofthe New York Stock Exchange. Among other functions, the principal duties andresponsibilities of our corporate governance committee are to identifyqualified individuals to become board members, recommend to the boardindividuals to be designated as nominees for election as directors at theannual meetings of shareholders, and develop and recommend to the board ourcorporate governance guidelines. Effective as of January 16, 2007, Mr. Hauserwas appointed to the corporate governance committee.

A copy of our corporategovernance committee charter can be found on our website at www.fairpoint.comunder the “Investor Relations” caption.

**Executive Officers**

The following tablesets forth the names and positions of our currentexecutive officers and their ages as of December 31, 2006.

| Name                       | ** ** | ** ** | ** ** | **Age**                                                                     | ** ** | ** ** | **Position** | ** ** |
|----------------------------|------------|------------|------------|-----------------------------------------------------------------------------|------------|------------|--------------|------------|
| Eugene B. Johnson          |       | 59         |       | Co-Founder, Chairman of the Board of Directors  and Chief Executive Officer |
| Peter G. Nixon             |       | 54         |       | Chief Operating  Officer                                                    |
| John P. Crowley            |       | 52         |       | Executive Vice  President and Chief Financial Officer                       |
| Walter E.  Leach, Jr. |       | 55         |       | Executive Vice  President, Corporate Development                            |
| Shirley J. Linn            |       | 56         |       | Executive Vice  President, General Counsel and Secretary                    |
| Lisa R. Hood               |       | 41         |       | Senior Vice  President and Controller                                       |
| Thomas Griffin             |       | 46         |       | Treasurer                                                                   |

 

**The following sets forth selectedbiographical information for our executive officers who are not directors.**

***Peter G. Nixon.  ******Mr. Nixon has served as ourChief Operating Officer since November 2002. Previously, Mr. Nixonwas our Senior Vice President of Corporate Development from February 2002to November 2002 and President of our Telecom Group from April 2001to February 2002. Prior to this, Mr. Nixon served as President of ourEastern Region Telecom Group from June 1999 to April 2001 andPresident of Chautauqua & Erie Telephone Corporation, or C&E, fromJuly 1997, when we acquired C&E, to June 1999. From April 1,1989 to June 1997, Mr. Nixon served as Executive Vice President ofC&E. From April 1, 1978 to March 31, 1989, Mr. Nixon servedas Vice President of Operations for C&E. Mr. Nixon has served as thepast Chairman of the New York State Telephone Association, in addition to hisinvolvement in several community and regional organizations.***

***John P. Crowley.******   In June 2005, Mr. Crowleywas appointed as Executive Vice President and Chief Financial Officer.Mr. Crowley served as Executive Vice President, Finance and Treasurer fromMay 2005 to June 2005. From 2000 to 2004, Mr. Crowley was anindependent consultant in telecommunications investment banking. From 1999 to2000, he was a Director in corporate finance at PricewaterhouseCoopers, andfrom 1996 to 1999, Mr. Crowley was a Managing Director in investmentbanking at BT/Alex Brown and its predecessor company. Previously he was activein telecommunications finance both as a principal and in banking.***

***Walter E. Leach, Jr.******   In June 2005, Mr. Leachwas appointed as the company’s Executive Vice President, Corporate Development.Mr. Leach served as our Executive Vice President and Chief Financial***

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***Officer from July 2004 to June 2005. Mr. Leachserved as our Senior Vice President from February 1998 to July 2004.From October 1994 to December 2000, Mr. Leach was our Secretary.From 1984 through September 1994, Mr. Leach served as Executive VicePresident of Independent Hydro Developers, where he had responsibility for allproject acquisition, financing and development activities.***

***Shirley J. Linn.******   In March 2006, Ms. Linnwas appointed our Executive Vice President, General Counsel and Secretary. MsLinn served as our Senior Vice President, General Counsel and Secretary from September 2004to March 2006. Ms. Linn has served as our General Counsel since October 2000,our Vice President since October 2000 and our Secretary since December 2000.Prior to joining us, Ms. Linn was a partner, from 1984 to 2000, in theCharlotte, North Carolina law firm of Underwood Kinsey Warren &Tucker, P.A., where she specialized in general business matters, particularlymergers and acquisitions.***

***Lisa R. Hood.******   In July 2004, Ms. Hoodwas appointed our Senior Vice President and Controller. Ms. Hood hasserved as our Controller since December 1993 and served as our VicePresident from December 1993 to July 2004. Prior to joining ourcompany, Ms. Hood served as manager of a local public accounting firm inKansas. Ms. Hood is certified as a public accountant in Kansas.***

***Thomas Griffin.  ******In December 2005, Mr. Griffinwas appointed our Treasurer. Mr. Griffin jointed the Company in January 2000as Assistant Treasurer and served as our General Manager of Wireless Broadbandoperations from December 2003 through March 2005. Prior to joiningour Company, Mr. Griffin was employed by Sealand Service, Inc. asAssistant Treasurer from September 1997 to January 2000 where he wasresponsible for worldwide cash management and as Director of Financial Planningfor Europe from September 1995 to September 1997.***

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) of the Exchange Act requiresour officers and directors, and persons who own, or are part of a group thatowns, more than ten percent of a registered class of our equity securities, tofile reports of ownership and changes in ownership with the SEC and the NewYork Stock Exchange. Officers, directors and greater than ten percentshareholders are required by regulation of the SEC to furnish us with copies ofall Section 16(a) forms they file.

Based solely on our review of Forms 3, 4 and 5 andamendments thereto available to us and other information obtained from ourdirectors and officers and certain 10% shareholders or otherwise available tous, we believe that no director or officer or beneficial owner of more than 10%of our common stock failed to file on a timely basis reports required pursuantto Section 16(a) of the Exchange Act with respect to 2006.

The Company has adopted aCode of Ethics for Financial Professionals that applies to its principalexecutive officer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions and a Code of BusinessConduct and Ethics that applies to all employees, directors and officers of theCompany, its subsidiaries and its controlled affiliates. The Company has postedits Code of Ethics for Financial Professionals and its Code of Business Conductand Ethics on its website (www.fairpoint.com). The Company intends to post anyamendments to or any waivers from a provision of its Code of Ethics forFinancial Professionals or its Code of Business Conduct and Ethics on its website.

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**ITEM 11.   EXECUTIVECOMPENSATION**

**CompensationCommittee Report**

Our executive compensation program for our executiveofficers named in the Summary Compensation Table below (“NEOs”) is administeredby the compensation committee of our board of directors.

The compensation committee is generally responsiblefor strategic decisions relating to our compensation structure, including,recommending salary-based compensation, incentive compensation, and equitybased awards for NEOs; non-employee director compensation; recommending theamount of stock option and restricted stock awards as retention incentivecompensation for executives, directors, non-directors, and non-executiveofficers; and deferred compensation for executives and other key employees.

On behalf of stockholders, the compensation committeehas carefully monitored our executive compensation programs. The CompensationDiscussion and Analysis and tables that follow will show, we believe,structures for executive compensation that strike an appropriate balancebetween preserving capital for stockholders and providing our NEOs withincentives and protections that are designed both to reward them for superiorcorporate and individual performance, and to provide competitive compensationthat encourages them to remain with FairPoint.

In fiscal year 2006, we struck this balance throughcompensating our NEOs with competitive base salaries and restricted stockawards that aligned their interests with stockholders. Overall, the undersignedbelieve that the compensation provided for NEOs in fiscal year 2006 wasentirely appropriate given our business achievements, including the completionof three acquisitions, our progress on the conversion of our operatingcompanies to one outsourced billing system, the consolidation of our callcenters, and the general increase in cash available for dividends under theterms of our credit facility, in fiscal year 2006.

The members of the compensation committee responsiblefor determining salary and incentive compensation awards for the 2006 fiscalyear were the undersigned. From time to time, the compensation committeeselects and engages outside compensation consultants and other experts forsurvey data and other information as it deems appropriate.

The compensation committeehas reviewed the following Compensation Discussion and Analysis withmanagement, and recommends to the board of directors that it be included in theCompany’s Annual Report on Form 10-K and the Company’s proxystatement.

**Messrs. David L. Hauser,Claude C. Lilly, Robert S. Lilien and Ms. Patricia Garrison-Corbin**

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**CompensationDiscussion and Analysis**

***1.   General Principals and Procedures***

*General ProgramObjectives.*

The compensation committee’s principal objective indesigning compensation policies is to develop and administer a comprehensiveprogram to attract, motivate and retain outstanding managers who are likely toenhance our profitability and create value for our stockholders. Within thisoverall compensation philosophy, the compensation committee seeks to: (1) recognizeand reward sustained superior performance by individual officers and keyemployees; (2) pay for performance on both an individual and corporatelevel; (3) align stockholder and executive interests by placing asignificant portion of executive compensation “at risk”; (4) tie executivecompensation to the achievement of certain short-term and long-term performanceobjectives of FairPoint; and (5) offer a total compensation program thattakes into account the compensation practices of comparable companies.

In order to more closelyalign NEO compensation with the long-term interests of our stockholders, theintent of the compensation committee is to generally provide less incentivecompensation in the form of cash bonuses than it does in the form ofstock-based compensation having service and performance based future vestingrequirements. The compensation committee used an independent consultant in 2006to review its stock award levels and to benchmark the levels of all componentsof compensation.

***2*.   *Specific Principals for Determining Executive Compensation***

Thetable below identifies and explains the reason for each component of NEOcompensation. See “—Executive Compensation Decisions for 2006” for amounts andfurther detail.
| Element:                | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | ** ** | **Reason for   Element** |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|
| Salary                  |       | Our career-oriented  philosophy toward executive compensation requires a competitive base salary  as a starting point. The compensation committee establishes the base salaries  for our NEOs as fixed amounts in order to provide a reliable indication of  the minimum amount of compensation that each NEO will receive in a given  year.                                                                                                                                                              |
| Bonus                   |       | We maintain an  Annual Incentive Plan under which our NEOs and other key employees may earn  annual cash and/or restricted stock bonuses based on corporate and individual  performance. The Annual Incentive Plan is designed to provide an incentive  for executives to attain goals. The compensation committee establishes and  approves the goals of the chief executive officer and the chief executive  officer approves the goals of the other NEOs and the compensation committee  reviews them. |
| Restricted Stock Awards |       | We maintain the  2005 Stock Incentive Plan, which allows for a variety of stock-based awards  that are available to link employee compensation to stockholders’ interest  and encourage the creation of long-term value for our stockholders by  increasing the retention of qualified key employees. In 2006, the  compensation committee relied on restricted stock awards for this purpose.                                                                                                       |

 

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| Element:                 | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **Reason for   Element** |
|--------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|
| Deferred Compensation    |       | We maintain a  Non-Qualified Deferred Compensation Plan (the “NQDC Plan”) that covers  certain employees. The NQDC Plan allows highly compensated individuals to  defer additional compensation beyond the limitations of the 401(k) Plan.  Company matching contributions are made according to the same percentage of  deferrals as is made under our 401(k) plan, but only with respect to  compensation that exceeds the limits for the 401(k) plan. |
| Perquisites              |       | Our NEOs have  received some or all of the following perquisites: supplemental life and  disability insurance, use of a company vehicle, spousal travel benefits, and  in one instance, payment of country club dues. Perquisites paid to our chief  executive officer were eliminated in March 2006 as part of a new  employment agreement. All other perquisites for NEOs have been eliminated as  of January 1, 2007.                                                |
| Post-employment Benefits |       | *Retirement*.   We  maintain a standard 401(k) plan that includes an employer matching  contribution up to an amount equal to 41⁄2% of each participant’s compensation.                                                                                                                                                                                                                                                                                    |
|                     |       | *Welfare  Benefits*.   We provide, on equal terms for all  employees, group term life insurance, group health insurance, and short-term  and long-term disability insurance.                                                                                                                                                                                                                                                                                            |
|                     |       | *Severance and Change in Control  Benefits*.   We will provide severance benefits to  Mr. Johnson, Mr. Leach, Mr. Nixon, Mr. Crowley and  Ms. Linn at levels that we consider conservative yet competitive when  compared to those offered by our peers. We believe that the foregoing  benefits are necessary and appropriate in order to attract and retain  qualified NEOs.                                                                 |

 

***Method forDetermining Amounts***

*Base Salary*

The compensation committeedetermines the level of base salary for our chief executive officer and theother executive officers with the general goal of providing competitivesalaries. Decisions take into account independent studies and surveys preparedby consultants based on publicly available information with respect to othercomparable communications companies. In addition, with respect to eachexecutive officer, including the chief executive officer, the compensationcommittee considers the individual’s performance, including that individual’s totallevel of experience in the communications industry, his or her record ofperformance and contribution to our success relative to his or her jobresponsibilities and annual goals, as well as his or her overall service toFairPoint.

*Annual Incentive Compensation Awards*

The annual incentiveawards are based on a combination of corporate and individual goals havingspecific financial and operational objectives such as the following: FairPoint achieving a specified EBITDA target,FairPoint working within a specified total debt to EBITDA ratio, FairPointachieving certain free cash flow and revenue targets, FairPoint generatingsufficient cash available for dividends, FairPoint accomplishing certainbudgetary, operational and regulatory goals and providing company and industryleadership. We generally establish bonus targets and performance criteria atthe end of each year for the following year.

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*Long-Term Incentive Awards*

In determining thelong-term incentive component of the chief executive officer’s compensation,the compensation committee considers, among other factors selected by thecompensation committee, FairPoint’s performance and relative shareholderreturn, the value of similar incentive awards to chief executive officers atcomparable companies, and the awards given to the chief executive officer inpast years. With respect to the amount of long-term incentive awards fornon-chief executive officer management and key employees, the compensationcommittee considers the recommendation of the chief executive officer and takesinto account the amount of long term incentive awards granted to peerexecutives among comparable companies. The compensation committee obtainsmarket compensation data from a compensation consultant.

The compensation committeedetermines the vesting schedule for future stock awards under the 2005 StockIncentive Plan and considers past award levels and their vesting when makingcurrent determinations.

The compensation committeeis considering the adoption of a policy relating to the re-coupment of stockawards and their proceeds if an NEO’s fraud or misconduct triggers a materialfinancial restatement. No such policy currently exists. The Company does not inany way time its stock awards to the release of material non-public information.

*Deferred Compensation*

We maintain a nonqualifieddeferred compensation plan (the NQDC Plan) for NEOs and other select executivesin order to enable them to defer compensation in excess of the limitsapplicable to them under our 401(k) plan. Company matching contributionsare made according to the same percentage of deferrals as is made under our 401(k) plan,but only with respect to compensation that exceeds the limits for the 401(k).

*Perquisites*

Prior to 2007, certain ofour executive officers received Company-provided supplemental life anddisability insurance, use of a Company-provided vehicle and, for our chiefexecutive officer, payment of country club dues. The compensation committeeprovides perquisites to certain key executives that it believes are reasonableand consistent with its overall compensation program to better enable us toattract and retain superior employees for key positions.

*Retirement and Welfare Benefits*

Our NEOs participate inour standard broad-based 401(k) and welfare plans, and thereby receive,for example, group health insurance, group term life insurance and short-termand long-term disability insurance. The costs of these benefits constitutesonly a small percentage of each of our executive officer’s total compensation.

*Post-employment Severance and Change-in-ControlBenefits*

We provide post-employmentseverance and change-in-control benefits to Mr. Johnson, pursuant to anemployment agreement, and to Mr. Leach, Mr. Nixon, Mr. Crowleyand Ms. Linn, pursuant to offer letters. The severance benefits for theseexecutives are generally paid only if the executives are terminated withoutcause and they do not voluntarily resign. The severance benefits are alsoprovided if are termination of employment occurs because of a change in control.In addition to severance payments, each executive is entitled to continuedwelfare benefits for a limited period. Mr. Johnson’s severance benefitsare also subject to a covenant not to compete with us.

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***3.   ExecutiveCompensation Decisions for 2006***

Discussed below are thekey components of the compensation that our NEOs received in 2006 ascategorized in the Summary Compensation Table. Based on the fair value ofequity awards granted to NEOs in 2006, their base salaries generally accountedfor approximately 28% of their total compensation, while incentivecompensation, including annual bonuses, accounted for approximately 69% oftheir total compensation. The compensation committee believes that the balancedescribed below of 2006 levels for salary, cash bonus, restricted stock, andother benefits reflect both (i) an appropriate and performance-orientedstructure for total compensation, and (ii) a suitable correlation of totalNEO compensation to the Company’s strong financial and business performance in2006. Note that the Summary Compensation Table below reports the value ofcertain equity awards based on the compensation expense recorded under FAS 123(R) valuerather than based on their current fair value.

*Base Salary.*

In March of 2006,upon the recommendation of the compensation committee, our board of directorsapproved a new employment agreement for Mr. Johnson which, among otherthings, provided for an increase in his annual base salary to $460,000 and eliminatedall executive perquisites. The base salaries of the other NEOs increasedapproximately 2% compared to 2005.

*Cash Bonus.*

The compensation committeeestablished the 2006 target bonuses and related performance goals for certainmembers of our senior management under the FairPoint Communications, Inc.Annual Incentive Plan, or the Annual Incentive Plan, on December 14, 2005and, accordingly, we paid bonuses equal to the established target levelsdiscussed below.

Belowis a chart that identifies the target bonus for each NEO, who was eligible toparticipate in the Annual Incentive Plan in 2006 and the performance criteriaused to evaluate the NEO’s performance. The performance criteria were weightedas indicated. The compensation committee, in its sole discretion but with inputfrom the chief executive officer for all NEOs other than himself, determineswhether or not individual performance goals were satisfied. Any bonus awardsare subject to the terms of the Annual Incentive Plan.
| Executive         | ** ** | ** **               | ** ** | **Position** | ** ** | **Bonus Target  (% of 2006 annual Base Salary)** | ** ** | **Performance Criteria**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|-------------------|------------|--------------------------|------------|--------------|------------|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Eugene B. Johnson |       | Chief Executive Officer  |       |         | 100        | %                                                |       | (i) 50%—FairPoint  achieving a specified EBITDA target for 2006; (ii) 20%—FairPoint not  exceeding a specified total debt to EBITDA ratio for 2006; (iii) 10%—providing  company and industry leadership to the public policy debate around USF and  intercarrier compensation; (iv) 10%—leading succession planning efforts  for all key positions in FairPoint; and (v) 10%—continuing to foster a culture that places a premium on  high standards of ethical behavior and integrity.        |
| Peter G. Nixon    |       | Chief Operating  Officer |       |         | 50         | %                                                |       | (i) 70%—FairPoint  achieving a specified EBITDA target for 2006; (ii) 15%—effecting certain  operational improvements; (iii) 5%—developing FairPoint’s employees;  (iv) 5%—supporting public policy initiatives and FairPoint complying  with the internal control requirements of the Sarbanes-Oxley Act;  (v) 2.5%—achieving specified customer service and community relations  goals; and (v) 2.5%—promoting workers’ safety and reducing workers  compensation claims. |

 

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| Executive                 | ** ** | ** **                                               | ** ** | **Position** | ** ** | **Bonus Target  (% of 2006 annual Base Salary)** | ** ** | **Performance Criteria**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|---------------------------|------------|----------------------------------------------------------|------------|--------------|------------|--------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| John P. Crowley           |       | Executive Vice President  and Chief Financial Officer    |       |         | 50         | %                                                |       | (i) 60%—FairPoint  achieving a specified EBITDA target for 2006 and generating sufficient cash  available for dividends to maintain the current dividend level; (ii) 20%—improving  FairPoint’s investor relations efforts; (iii) 15%—FairPoint complying  with the internal control requirements of the Sarbanes-Oxley Act and  effecting certain operating efficiencies; and (iv) 5%—complying with  FairPoint’s safety, ethics and business conduct initiatives.              |
| Walter E. Leach, Jr. |       | Executive Vice  President, Corporate Development         |       |         | 50         | %                                                |       | (i) 55%—FairPoint  completing a specified amount of RLEC acquisitions which satisfy certain  criteria; (ii) 25%—developing new lines of business; and (iii) 15%—managing  FairPoint’s non-strategic assets.                                                                                                                                                                                                                                                                                     |
| Shirley J. Linn           |       | Executive Vice President,  General Counsel and Secretary |       |         | 40         | %                                                |       | (i) 40%—meeting the  needs of FairPoint’s various departments; (ii) 30%—standardizing and  enhancing FairPoint’s compliance with public company and corporate governance  requirements; (iii) 10%—assisting in FairPoint’s compliance with the  internal control requirements of the Sarbanes-Oxley Act; (iv) 10%—assessing  performance and cost of FairPoint’s outside legal advisors; and (v) 10%—facilitating  board and board committee communications. |

 

The compensation committee made bonus decisions in January 2007to the general effect that each NEO had satisfied all (or substantially all) oftheir performance goals for 2006. Cash bonus awards were consequently paid atvarious levels from 88% to 120% of the target levels based on the NEOs actualperformance against these goals.

*Restricted StockAwards.*

Mr. Johnson’s March 2006 employmentagreement provided for the grant of 50,000 shares of restricted stockcoincident with the execution of his employment agreement. In addition, hisemployment agreement provides for anadditional grant of 50,000 shares of restricted stock on each of January 1,2007 and January 1, 2008 provided Mr. Johnson is not terminated forcause and/or voluntarily resigns. Mr. Johnson received 50,000 shares ofrestricted stock on January 1, 2007. The compensation committee alsoawarded 50,000 shares of restricted stock to Ms. Linn and Mr. Crowleyin December 2006. Both Ms. Linn and Mr. Crowley received theawards at the discretion of the compensation committee, for excellentindividual corporate performance in 2006.

In September 2006, the compensation committeealso approved grants to various employees based on their title and current salary.For example, all employees that were executive vice presidents or abovereceived a grant valued on the date of grant to equal 75% of their base salary.Each of the NEOs received shares of restricted stock as part of this grant,except the chief executive officer.

*Perquisites*

In 2006, we provided NEOs with limited perquisites andother personal benefits (such as use of Company automobiles, additional lifeand disability insurance benefits and, for the chief executive officer,reimbursement of country club dues). The compensation committee believes theseperquisites were reasonable and consistent with the objective of betterenabling us to attract and retain superior employees 

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for key positions. Thecompensation committee has eliminated all perquisites beginning on January 1,2007.

*Post-employmentBenefits*

Mr. Johnson’s 2006 employment agreement entitleshim to receive the following severance and/or change-in-control benefitsprovided he continues to work as chief executive officer until the end of histerm of employment (currently, December 31, 2008),  provided we do not terminate his employmentfor cause, or he does not voluntarily resign: payment of his base salary as ofthe termination date for the remainder of the employment period plus one yearthereafter (subject to suspension for a breach of Mr. Johnson’s covenantnot to compete with us);  continuedmedical coverage for Mr. Johnson and his wife for the life of each underour medical benefits plans; and, continued vesting of all restricted stock grantedas of the termination date under the 2005 Stock Incentive Plan.

Pursuant to a letter agreement between Mr. Leachand us, upon termination of Mr. Leach’s employment by us without cause(including upon a change of control), Mr. Leach is entitled to a lump sumpayment amount equal to twelve months of his base salary (as of the date oftermination), and continued long-term disability, term life insurance andmedical benefits for twelve months following such date of termination.

Pursuant to letter agreements, upon termination ofemployment without cause (including upon a change of control), Mr. Nixon, Mr. Crowleyand Ms. Linn are entitled to receive from us in a lump sum payment anamount equal to twelve months of base salary as of the date of termination,plus the continuation of certain benefits, including medical benefits, fortwelve months.

*Tax Considerations*

Section 162(m) of the Internal Revenue Code,or the Code, generally disallows a tax deduction to public corporations forcompensation, other than performance-based compensation, over $1.0 million paidfor any fiscal year to any of the corporation’s chief executive officer andfour other highly compensated executive officers as of the end of any fiscalyear. The Company’s policy is to qualify its executive officers’ fordeductibility under Section 162(m) to the extent the compensationcommittee determines such to be appropriate. In 2006, compensation did notexceed the deductibility limits of Section 162(m) for any NEO. Thecompensation committee remains aware of the Code Sections 162(m) and 409Alimitations and the available exemptions and special rules, and will addressthe issue of 162(m) deductibility and 409A compliance when and ifcircumstances warrant the use of such exemptions or other considerations.

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**SUMMARY COMPENSATION TABLE**

The table below summarizesthe total compensation paid or earned by each of the NEOs for the fiscal yearended December 31, 2006.

**SUMMARYCOMPENSATION TABLE**

| (a)                                  | ** ** | **(b)**    | ** ** | **(c)**    | ** ** | **(d)**        | ** ** | **(e)**        | ** ** | **(f)**        | ** ** | **(g)**          | ** ** | **(h)**                 | ** ** | **(i)**          | ** ** | **(j)**           | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|----------------|------------|----------------|------------|----------------|------------|------------------|------------|-------------------------|------------|------------------|------------|-------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **     | ** ** | ** **     | ** ** | **Non-equity**   | ** ** | **Change in**      | ** ** | ** **       | ** ** | ** **        | ** ** |
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **     | ** ** | ** **     | ** ** | **Incentive**    | ** ** | **pension volume** | ** ** | **All**          | ** ** | ** **        | ** ** |
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Stock**      | ** ** | **Option**     | ** ** | **Plan**         | ** ** | **and NQ**         | ** ** | **Other**        | ** ** | ** **        | ** ** |
| ** **                           | ** ** | ** ** | ** ** | **Salary** | ** ** | **Bonus**      | ** ** | **Awards**     | ** ** | **Awards**     | ** ** | **Compensation** | ** ** | **DC Earnings**    | ** ** | **Compensation** | ** ** | **Total**         | ** ** |
| **Name and Principal Position** | ** ** | ** ** | ** ** | **Year**   | ** ** | **$ (1)** | ** ** | **$ (2)** | ** ** | **$ (3)** | ** ** | **$**            | ** ** | **$**                   | ** ** | **$**            | ** ** | **$ (4)(5)** | ** ** | **$** | ** ** |
| **Eugene B. Johnson**                |       |       | 2006       |       |       | 434,740        |       | 394,140        |       | 1,171,158      |       |             | —     |                    |       |             | —     |              |       |   | — |   |   |   | 25,647 |   |   | 2,025,685 |   |
| Chairman of the Board of             |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Directors and Chief                  |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Executive Officer                    |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **John Crowley**                     |       |       | 2006       |       |       | 234,808        |       | 104,629        |       | 233,840        |       |             | —     |                    |       |             | —     |              |       |   | — |   |   |   | 21,577 |   |   | 594,854 |   |
| Executive  Vice President,           |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Chief  Financial Officer             |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Shirley J. Linn**                  |       |       | 2006       |       |       | 204,808        |       | 99,100         |       | 176,209        |       |             | —     |                    |       |             | —     |              |       |   | — |   |   |   | 11,835 |   |   | 491,952 |   |
| Executive Vice President,            |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| General Counsel and                  |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Secretary                            |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Peter G. Nixon**                   |       |       | 2006       |       |       | 219,755        |       | 97,641         |       | 189,063        |       |             | —     |                    |       |             | —     |              |       |   | — |   |   |   | 30,674 |   |   | 537,133 |   |
| Chief  Operating Officer             |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Walter E. Leach, Jr.**        |       |       | 2006       |       |       | 214,808        |       | 129,325        |       | 302,060        |       |             | —     |                    |       |             | —     |              |       |   | — |   |   |   | 40,102 |   |   | 686,295 |   |
| **Executive Vice President,**        |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
| **Corporate Development**            |       |       |       |       |       |           |       |           |       |           |       |             |       |                    |       |             |       |              |       |   |   |   |   |   |   |   |   |   |   |
|                                      |            |            |            |            |            |                |            |                |            |                |            |                  |            |                         |            |                  |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)             The amounts shown in column (c) include amounts ofsalary compensation deferred by the executive officer in 2006 under the NQDCPlan. The amount of deferrals under this plan in 2006 were $36,221 by Mr. Crowley,$2,055 by Ms. Linn, $4,562 by Mr. Nixon and $6,950 by Mr. Leach.

(2)             For the year ended December 31, 2006, amounts incolumn (d) represent bonuses which were earned during 2006 and paid in February 2007.The amounts in column (d) include amounts of bonus compensation deferredunder the NQDC Plan by Mr. Crowley in the amount of $51,965, Ms. Linnin the amount of $1,968, Mr. Nixon in the amount of $1,939 and Mr. Leachin the amount of $4,945.

(3)             The amounts in column (e) reflect the dollaramount recognized for financial statement reporting purposes for the fiscalyear ended December 31, 2006, in accordance with SFAS 123(R) ofawards pursuant to the 2005 Stock Incentive Plan and thus may include amountsfrom awards granted during and prior to 2006.

(4)             The amount shown in column (i) reflectsfor each NEO:

·        Matching contributions made by us to our401(k) savings plan in the amounts of $9,900 for Mr. Johnson, $9,900for Mr. Crowley, $9,900 for Ms. Linn, $9,900 for Mr. Nixon and$9,900 for Mr. Leach;

·        Contributions made by us to term lifeinsurance plans in the amounts of $1,312 for Mr. Johnson, $690 for Mr. Crowley,$1,304 for Ms. Linn, $713 for Mr. Nixon and $704 for Mr. Leach;

·        Additional life insurance benefits of$4,699 for Mr. Leach;

·        Contributions made by the Company to theNQDC Plan in the amount of $155 for Mr. Crowley, $631 for Ms. Linn,$998 for Mr. Nixon and $1,575 for Mr. Leach;

·        Vehicle fringe benefits of $4,679 paid to Mr. Johnson,$6,499 paid to Mr. Crowley, $11,438 paid to Mr. Nixon and $9,773 paidto Mr. Leach;

·        Amounts paid to effectively “gross-up”certain bonus payments during the year for payment of taxes in the amount of$5,774 for Mr. Johnson, $4,333 for Mr. Crowley, $7,625 for Mr. Nixonand $11,169 for Mr. Leach; and

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·        Other miscellaneous perquisites in the amount of $3,982are included for Mr. Johnson and in the amount of $2,281 for Mr. Leach.

(5)             The value attributable to personal use ofcompany-provided automobiles (as calculated in accordance with Internal RevenueService guidelines) are included as compensation on the W-2 of NEOs whoreceive such benefit. Each such NEO is responsible for paying income tax onsuch amount.

**Grants of Plan Based Awards**

|                               | ** ** | ** ** | ** ** | **Estimated future payouts  under Non-equity  incentive plan awards** | ** ** | **Estimated Future  payouts under equity  incentive plan awards** | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|-------------|------------|---------------|------------|------------|------------|
| **(a)**                       | ** ** | **(b)**    | ** ** | **(c)**                                                                                        | ** ** | **(d)**                                                                                    | ** ** | **(e)**     | ** ** | **(f)**       | ** ** | **(g)**    | ** ** | **(h)** | ** ** | **(i)** | ** ** | **(j)** | ** ** | **(k)** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                                                                                     | ** ** | ** **                                                                                 | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **All other** | ** ** | **All other** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                                                                                     | ** ** | ** **                                                                                 | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **stock** | ** ** | **option** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                                                                                     | ** ** | ** **                                                                                 | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **awards:** | ** ** | **awards:** | ** ** | **Exercise** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                                                                                     | ** ** | ** **                                                                                 | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **number of** | ** ** | **number of** | ** ** | **or base** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                                                                                     | ** ** | ** **                                                                                 | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **shares of** | ** ** | **securities** | ** ** | **price of** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** **                                                                                     | ** ** | ** **                                                                                 | ** ** | ** **  | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | **stock or** | ** ** | **underlying** | ** ** | **option** | ** ** |
| ** **                    | ** ** | **Grant**  | ** ** | **Treshold**                                                                                   | ** ** | **Target**                                                                                 | ** ** | **Maximum** | ** ** | **Threshold** | ** ** | **Target** | ** ** | **Maximum** | ** ** | **units** | ** ** | **options** | ** ** | **awards** | ** ** |
| **Name**                      | ** ** | ** ** | ** ** | **date**                                                                                       | ** ** | **($)**                                                                                    | ** ** | **($)**     | ** ** | **($)**       | ** ** | **(#)**    | ** ** | **(#) (1)** | ** ** | **(#)** | ** ** | **(#)(2)** | ** ** | **(#)** | ** ** | **($/Sh)** | ** ** |
| **Eugene B. Johnson**         |       | 17-Mar-06  |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 50,000 |   |   |   | — |   |   |   | — |   |   |
| Chairman of the Board         |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| of Directors and Chief        |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Executive Officer             |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **John Crowley**              |       | 8-Sep-06   |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 12,589 |   |   |   | — |   |   |   | — |   |   |
| Executive Vice                |       | 5-Dec-06   |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 50,000 |   |   |   | — |   |   |   | — |   |   |
| President,  Chief             |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Financial  Officer            |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Shirley J. Linn**           |       | 8-Sep-06   |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 10,982 |   |   |   | — |   |   |   | — |   |   |
| Executive Vice                |       | 5-Dec-06   |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 50,000 |   |   |   | — |   |   |   | — |   |   |
| President, General            |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Counsel and Secretary         |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Peter G. Nixon**            |       | 8-Sep-06   |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 11,783 |   |   |   | — |   |   |   | — |   |   |
| Chief  Operating Officer      |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Walter E. Leach, Jr.** |       | 8-Sep-06   |       |                                                                                           | —     |                                                                                       |       |        | —     |          |       |       | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 11,518 |   |   |   | — |   |   |   | — |   |   |
| Executive Vice                |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| President, Corporate          |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Development                   |       |       |       |                                                                                           |       |                                                                                       |       |        |       |          |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                               |            |            |            |                                                                                                |            |                                                                                            |            |             |            |               |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

 

(1)             In accordance with Mr. Johnson’s employmentagreement, he is scheduled to receive additional grants of restricted stock on January 1,2007 and January 1, 2008 in the amount of 50,000 shares on each date. Theseshares are not included in this table as they had not been granted as of December 31,2006.

(2)             The amounts shown in column (i) reflectthe number of shares of stock granted to each NEO in 2006 pursuant to the 2005Stock Incentive Plan.

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**Outstanding EquityAwards at Fiscal Year-End**

|                                | ** ** | ** ** | ** ** | **Option Awards** | ** ** | **Stock Awards** | ** ** |               |
|--------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|--------------------|
| **(a)**                        | ** ** | ** ** | ** ** | **(b)**                | ** ** | **(c)**               | ** ** | **(d)**            | ** ** | **(e)** | ** ** | **(f)** | ** ** | **(g)** | ** ** | **(h)** | ** ** | **(i)** | ** ** | **(j)** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **             | ** ** | ** **            | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Equity** | ** ** | **Equity** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **             | ** ** | ** **            | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **incentive** | ** ** | **incentive** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **             | ** ** | ** **            | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **plan** | ** ** | **plan** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **             | ** ** | ** **            | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **awards:** | ** ** | **awards:** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **             | ** ** | ** **            | ** ** | **Equity**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **number** | ** ** | **market or** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **             | ** ** | **Number**            | ** ** | **incentive**      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **of** | ** ** | **payout** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **Number **       | ** ** | **of **          | ** ** | **plan**           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **unearned** | ** ** | **value of** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **of**                 | ** ** | **securities**        | ** ** | **awards:**        | ** ** | ** ** | ** ** | ** ** | ** ** | **Number** | ** ** | **Market** | ** ** | **shares,** | ** ** | **unearned** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **securities**         | ** ** | **underlying**        | ** ** | **number of** | ** ** | ** ** | ** ** | ** ** | ** ** | **of shares** | ** ** | **value of** | ** ** | **units ** | ** ** | **shares,** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **underlying**         | ** ** | **unexer-**           | ** ** | **securities**     | ** ** | ** ** | ** ** | ** ** | ** ** | **or units** | ** ** | **shares or** | ** ** | **or other** | ** ** | **units or** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **unexer-**            | ** ** | **cisable**           | ** ** | **underlying**     | ** ** | ** ** | ** ** | ** ** | ** ** | **of stock** | ** ** | **units of** | ** ** | **rights** | ** ** | **other** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **cised**              | ** ** | **options**           | ** ** | **unexercised**    | ** ** | **Option** | ** ** | ** ** | ** ** | ** that** | ** ** | **stock that** | ** ** | **that** | ** ** | **right that** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | **options**            | ** ** | **(#)**               | ** ** | **unearned**       | ** ** | **exercise** | ** ** | **Option** | ** ** | **have not** | ** ** | **have not** | ** ** | **have not** | ** ** | **have not** | ** ** |
| ** **                     | ** ** | **Grant**  | ** ** | **(#) exer-**     | ** ** | **unexer-**           | ** ** | **options**        | ** ** | **price** | ** ** | **expiration** | ** ** | **vested** | ** ** | **vested** | ** ** | **vested** | ** ** | **vested** | ** ** |
| **Name**                       | ** ** | ** ** | ** ** | **Date**               | ** ** | **cisable**           | ** ** | **cisable**        | ** ** | **(#)** | ** ** | **($)(1)** | ** ** | **date** | ** ** | **(#)** | ** ** | **(#)** | ** ** | **(#)** | ** ** | **($)** | ** ** |
| **Eugene B. Johnson**          |       | 5/21/1998  |       |                   | —     |                  |       |               | 226,439 |   |   |   | — |   |   |   | 9.02 |   |   | 5/21/2008 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Chairman of the                |       | 1/1/2002   |       |                   | —     |                  |       |               | 47,373 |   |   |   | — |   |   |   | 36.94 |   |   | 1/1/2012 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Board of Directors             |       | 3/12/2002  |       |                   | 20,490     |                  |       |               | — |   |   |   | — |   |   |   | 36.94 |   |   | 3/12/2012 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| and Chief Executive            |       | 2/8/2005   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 126,325 |   |   |   | 2,393,859 |   |   |   | — |   |   |   | — |   |   |
| Officer                        |       | 3/17/2006  |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 50,000 |   |   |   | 947,500 |   |   |   | — |   |   |   | — |   |   |
| **John Crowley**               |       | 9/21/2005  |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 37,500 |   |   |   | 710,625 |   |   |   | — |   |   |   | — |   |   |
| Executive  Vice                |       | 9/8/2006   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 12,589 |   |   |   | 238,562 |   |   |   | — |   |   |   | — |   |   |
| President,  Chief              |       | 12/5/2006  |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 50,000 |   |   |   | 947,500 |   |   |   | — |   |   |   | — |   |   |
| Financial  Officer             |       |       |       |                   |       |                  |       |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Shirley J. Linn**            |       | 3/12/2002  |       |                   | 9,209      |                  |       |               | — |   |   |   | — |   |   |   | 36.94 |   |   | 3/12/2012 |   |   | — |   |   |   | — |   |   |   | — |   | ** ** | ** ** | **—** |   |   |
| Executive Vice                 |       | 12/12/2003 |       |                   | 7,106      |                  |       |               | 7,106 |   |   |   | — |   |   |   | 36.94 |   |   | 12/12/2013 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| President, General             |       | 12/12/2003 |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 2,369 |   |   |   | 44,893 |   |   |   | — |   |   |   | — |   |   |
| Counsel and                    |       | 2/8/2005   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 33,159 |   |   |   | 628,363 |   |   |   | — |   |   |   | — |   |   |
| Secretary                      |       | 9/8/2006   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 10,982 |   |   |   | 208,109 |   |   |   | — |   |   |   | — |   |   |
|                                |       | 12/5/2006  |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 50,000 |   |   |   | 947,500 |   |   |   | — |   |   |   | — |   |   |
| **Peter G. Nixon**             |       | 5/21/1998  |       |                   | —     |                  |       |               | 18,949 |   |   |   | — |   |   |   | 9.02 |   |   | 5/21/2008 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Chief  Operating               |       | 3/12/2002  |       |                   | 8,419      |                  |       |               | — |   |   |   | — |   |   |   | 36.94 |   |   | 3/12/2012 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Officer                        |       | 12/12/2003 |       |                   | 11,893     |                  |       |               | 11,893 |   |   |   | — |   |   |   | 36.94 |   |   | 12/12/2013 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                           |       | 12/12/2003 |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 3,965 |   |   |   | 75,137 |   |   |   | — |   |   |   | — |   |   |
|                           |       | 2/8/2005   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 42,634 |   |   |   | 807,914 |   |   |   | — |   |   |   | — |   |   |
|                           |       | 9/8/2006   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 11,783 |   |   |   | 223,288 |   |   |   | — |   |   |   | — |   |   |
| **Walter E.  Leach, Jr.** |       | 5/21/1998  |       |                   | —     |                  |       |               | 115,475 |   |   |   | — |   |   |   | 9.02 |   |   | 5/21/2008 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Executive Vice                 |       | 3/12/2002  |       |                   | 77,364     |                  |       |               | — |   |   |   | — |   |   |   | 36.94 |   |   | 3/12/2012 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| President,                     |       | 12/12/2003 |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 3,159 |   |   |   | 59,863 |   |   |   | — |   |   |   | — |   |   |
| Corporate                      |       | 2/8/2005   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 71,058 |   |   |   | 1,346,549 |   |   |   | — |   |   |   | — |   |   |
| Development                    |       | 9/8/2006   |       |                   | —     |                  |       |               | — |   |   |   | — |   |   |   | — |   |   | — |   |   | 11,518 |   |   |   | 218,266 |   |   |   | — |   |   |   | — |   |   |
|                                |            |            |            |                        |            |                       |            |                    |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

 

(1)             Options granted to certain NEOs on May 21, 1998were subject to certain conditions and therefore, were not exercisable. Theseoptions were subsequently cancelled on February 5, 2007.

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**Option Exercises and Stock Vested**

Noneof the NEOs exercised any stock options during the fiscal year ended December 31,2006.

| ** **                    | ** ** | **Option Awards** | ** ** | **Stock Awards** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **Number of**     | ** ** | **Value**             | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Shares**             | ** ** | **Realized**          | ** ** | **shares** | ** ** | **Value** | ** ** |
| ** **                    | ** ** | **Acquired on**   | ** ** | **upon**              | ** ** | **acquired on** | ** ** | **realized on** | ** ** |
| ** **                    | ** ** | **Exercise**           | ** ** | **Exercise**          | ** ** | **vesting** | ** ** | **vesting** | ** ** |
| ** **                    | **Name**   | ** **             | ** ** | **(#)**               | ** ** | **($)** | ** ** | **(#)** | ** ** | **($)** | ** ** |
| **Eugene  B. Johnson**        |       |                   | —     |                  |       |   | — |   |   |   | 63,163 |   |   |   | 872,913 |   |   |
| Chairman of the Board of      |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Directors and  Chief          |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Executive Officer             |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **John Crowley**              |       |                   | —     |                  |       |   | — |   |   |   | 12,500 |   |   |   | 213,125 |   |   |
| Executive Vice  President,    |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Chief Financial  Officer      |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Shirley J. Linn**           |       |                   | —     |                  |       |   | — |   |   |   | 11,054 |   |   |   | 152,766 |   |   |
| Executive Vice  President,    |       |                   |       |                  |       |   |   |   |   |   | 1,184 |   |   |   | 22,851 |   |   |
| General Counsel  and          |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Secretary                     |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Peter G. Nixon**            |       |                   | —     |                  |       |   | — |   |   |   | 14,212 |   |   |   | 196,410 |   |   |
| Chief Operating  Officer      |       |                   |       |                  |       |   |   |   |   |   | 1,982 |   |   |   | 38,253 |   |   |
| **Walter E. Leach, Jr.** |       |                   | —     |                  |       |   | — |   |   |   | 23,686 |   |   |   | 327,341 |   |   |
| Executive Vice  President,    |       |                   |       |                  |       |   |   |   |   |   | 1,579 |   |   |   | 30,475 |   |   |
| Corporate Development         |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                               |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**NonqualifiedDeferred Compensation**

Pursuant to the NQDC Plan,certain executives, including NEOs, may defer a portion of their annual salaryand bonuses. Deferral elections are made by eligible executives in each yearfor amounts to be earned in the following year. An executive can defer up to50% of their annual salary and up to 100% of their annual bonuses. 

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**NON-QUALIFIED DEFERRED COMPENSATION**

| **(a)**                       | ** ** | **(b)**                  | ** ** | **(c)**                  | ** ** | **(d)**                  | ** ** | **(e)**           | ** ** | **(f)**                   | ** ** |
|-------------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------|------------|---------------------------|------------|
| ** **                    | ** ** | **Executive**            | ** ** | **Registrant**           | ** ** | **Aggregate**            | ** ** | **Aggregate**     | ** ** | **Aggregate**             | ** ** |
| ** **                    | ** ** | **Contributions**        | ** ** | **Contributions**        | ** ** | **Earnings**             | ** ** | **Withdrawals/**  | ** ** | **Balance**               | ** ** |
| ** **                    | ** ** | **in Last FY** | ** ** | **in Last FY** | ** ** | **in Last FY** | ** ** | **Distributions** | ** ** | **at Last FYE** | ** ** |
| **Name**                      | ** ** | **($)**                  | ** ** | **($)**                  | ** ** | **($)**                  | ** ** | **($)**           | ** ** | **($)**                   | ** ** |
| **Eugene  B. Johnson**        |       |                     | —     |                     |       |                     | —     |              |       |                      | 12,499     |   |   |   | — |   |   |   | 12,499 |   |   |
| Chairman of the Board of      |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Directors and  Chief          |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Executive Officer             |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| **John Crowley**              |       |                     | 88,186     |                     |       |                     | 155        |              |       |                      | 4,048      |   |   |   | — |   |   |   | 92,389 |   |   |
| Executive Vice  President,    |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Chief Financial  Officer      |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| **Shirley J. Linn**           |       |                     | 4,023      |                     |       |                     | 631        |              |       |                      | 2,079      |   |   |   | — |   |   |   | 6,733 |   |   |
| Executive Vice  President,    |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| General Counsel  and          |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Secretary                     |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| **Peter G. Nixon**            |       |                     | 6,501      |                     |       |                     | 998        |              |       |                      | 334        |   |   |   | — |   |   |   | 7,833 |   |   |
| Chief Operating Officer       |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| **Walter E. Leach, Jr.** |       |                     | 11,895     |                     |       |                     | 1,575      |              |       |                      | 4,881      |   |   |   | — |   |   |   | 18,351 |   |   |
| Executive Vice  President,    |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Corporate Development         |       |                     |       |                     |       |                     |       |              |       |                      |       |   |   |   |   |   |   |   |   |   |   |

 

**Potential PaymentsUpon Termination or Change of Control**

The Company has an employment agreement with Eugene B.Johnson and letter agreements with Peter G. Nixon, John P. Crowley,****Walter E. Leach, Jr. and Shirley J. Linn. Theseagreements are summarized below.

*EugeneB. Johnson.**  *InMarch 2006, we extended the existing employment agreement with Mr. Johnson,originally entered into in December 2002, pursuant to Mr. Johnsonwill continue as our chief executive officer and/or chairman of our board ofdirectors from until December 31, 2008. The employment agreement providesthat Mr. Johnson will receive an annual base salary of $460,000, an annualdiscretionary bonus, and Mr. Johnson shall be entitled to participate inall incentive, savings, stock option and retirement plans, practices, policiesand programs applicable generally to other senior management. If Mr. Johnson’semployment is terminated without cause during the term of his employmentagreement (including upon a change in control) he is entitled to receivepayment of his salary as of the termination date for the remainder of theemployment period, subject to suspension for a breach of Mr. Johnson’scovenant not to compete with us. Upon the expiration of the term of Mr. Johnson’semployment agreement at December 31, 2008, unless extended, he is entitledto receive payment of his salary as of the expiration date for one yearthereafter. The employment agreement also provides that upon (i) theexpiration of Mr. Johnson’s employment period, or (ii) thetermination of Mr. Johnson’s employment as chief executive officer withoutcause, Mr. Johnson is entitled to receive certain benefits. These benefitsinclude continued medical coverage for Mr. Johnson and his wife for thelife of each under our medical benefits plans and continued vesting of allrestricted stock granted as of the termination date under the 2005 StockIncentive Plan. The employment agreement supersedes and terminates all prioremployment agreements and severance arrangements between Mr. Johnson andus.

*WalterE. Leach, Jr.**  *InJanuary 2000, we entered into an employment agreement with Mr. Leach,which agreement expired on December 31, 2003. In December 2003, weentered into a letter agreement 

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with Mr. Leach,supplementing and modifying his employment agreement. The letter agreementprovides that following the expiration of his employment agreement, Mr. Leachshall continue as an employee at will. During this period, Mr. Leach isentitled to receive certain benefits. The letter agreement also provides thatupon termination of Mr. Leach’s employment by us without cause (includingupon a change of control), Mr. Leach is entitled to receive from us in alump sum payment an amount equal to his base salary as of the date oftermination for a period of twelve months, plus all accrued and unpaid basesalary and benefits as of the date of termination. In addition, Mr. Leachis also entitled to receive continued long-term disability, term lifeinsurance and medical benefits following his termination for twelve monthsfollowing such date of termination.

*Peter G. Nixon**,**John P. Crowley andShirley J. Linn *In November 2002, we entered into aletter agreement with each of Mr. Nixon and Ms. Linn. In May 2005,**we entered into a letter agreement with Mr.* *Crowley.****The letteragreements provide that upon the termination of each person’s respectiveemployment with us without cause (including upon a change of control), eachperson is entitled to receive from us a lump sum payment in an amount equal totwelve months of such executive’s base salary as of the date of termination,plus the continuation of certain benefits, including medical benefits, fortwelve months.

| ** **                                | ** ** | **Value of Amounts Payable** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                | ** ** | ** **                                  | ** ** | **Acceleration and** | ** ** | **Continuation of** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | ** **                                  | ** ** | **Continuation of Equity ** | ** ** | **Medical/Welfare** | ** ** | **Total** | ** ** |
| ** **                                | ** ** | **Cash**                                    | ** ** | **Awards (unamortized** | ** ** | **Benefits** | ** ** | **Termination** | ** ** |
| **Reason for payment:**         | ** ** | ** **                                  | ** ** | **Severance** | ** ** | **expense as of 12/31/06)** | ** ** | **(present value)** | ** ** | **Benefits** | ** ** |
| *Eugene  B. Johnson*                      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Involuntary termination                   |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Voluntary retirement                      |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Without cause or after change in control  |       |                                        | $          | 460,000 |   |   |   | $ | 2,448,225 |   |   |   | $ | 137,754 |   |   |   | $ | 3,045,979 |   |   |
| *John Crowley*                            |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Involuntary termination                   |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Voluntary retirement                      |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Without cause or after change in control  |       |                                        | $          | 251,500 |   |   |   | 0 |   |   |   | $ | 6,048 |   |   |   | $ | 257,548 |   |   |
| *Shirley J. Linn*                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Involuntary termination                   |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Voluntary retirement                      |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Without cause or after change in control  |       |                                        | $          | 220,000 |   |   |   | 0 |   |   |   | $ | 15,132 |   |   |   | $ | 235,132 |   |   |
| *Peter G. Nixon*                          |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Involuntary termination                   |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Voluntary retirement                      |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Without cause or after change in control  |       |                                        | $          | 245,000 |   |   |   | 0 |   |   |   | $ | 15,132 |   |   |   | $ | 260,132 |   |   |
| *Walter E. Leach, Jr.*               |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Involuntary termination                   |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Voluntary retirement                      |       |                                        | 0          |   |   |   | 0 |   |   |   | 0 |   |   |   | 0 |   |   |
| Without cause or  after change in control |       |                                        | $          | 237,500 |   |   |   | 0 |   |   |   | $ | 15,132 |   |   |   | $ | 252,632 |   |   |
|                                           |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**DirectorCompensation**

We use a combination of cash and stock-based incentivecompensation to attract and retain qualified candidates to serve on our boardof directors. In setting director compensation, we consider the significantamount of time that directors expend in fulfilling their duties to us as wellas the skill-level required by the members of our board of directors.

For fiscal 2006, each non-employee director receivedan annual fee of $45,000 for serving as a director. In addition, an annual feeof $5,000 was paid for serving as the chair of our compensation 

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committee or corporategovernance committee and an annual fee of $10,000 was paid for serving as thechair of our audit committee. An annual fee of $2,500 was paid to the memberswho were not serving as chair of our compensation committee and corporategovernance committee and $5,000 for members who were not serving as chair ofour audit committee. An annual fee of $5,000 was paid to our lead director.

Our non-employee directors also receive an annualaward of approximately $30,000 in the form of restricted stock or restrictedunits, at the recipient’s option, which are issued under our 2005 StockIncentive Plan. These awards vest in four quarterly installments from the grantdate, and the holders thereof are entitled to receive dividends or dividendequivalents on such awards from the date of grant, whether or not vested.

Our employee directors do not receive any compensationfor serving on our board of directors.

**Summary Director Compensation**

| **(a)**                  | ** ** | **(b)**         | ** ** | **(c)**     | ** ** | **(d)**    | ** ** | **(e)**          | ** ** | **(f)**          | ** ** | **(g)**          | ** ** | **(h)**    | ** ** |
|--------------------------|------------|-----------------|------------|-------------|------------|------------|------------|------------------|------------|------------------|------------|------------------|------------|------------|------------|
| ** **               | ** ** | ** **      | ** ** | ** **  | ** ** | ** ** | ** ** | ** **       | ** ** | **Change in**    | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **      | ** ** | ** **  | ** ** | ** ** | ** ** | ** **       | ** ** | **Pension**      | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **      | ** ** | ** **  | ** ** | ** ** | ** ** | ** **       | ** ** | **Value and**    | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Fees Earned** | ** ** | ** **  | ** ** | ** ** | ** ** | **Non-equity**   | ** ** | **Nonqualified** | ** ** | **All**          | ** ** | ** ** | ** ** |
| ** **               | ** ** | **or Paid**     | ** ** | **Stock**   | ** ** | **Option** | ** ** | **Plan**         | ** ** | **Deferred**     | ** ** | **Other**        | ** ** | ** ** | ** ** |
| ** **               | ** ** | **in Cash**     | ** ** | **Awards**  | ** ** | **Awards** | ** ** | **Compensation** | ** ** | **Compensation** | ** ** | **Compensation** | ** ** | **Total**  | ** ** |
| **Name**                 | ** ** | **($) (1)**     | ** ** | **($) (2)** | ** ** | **($)**    | ** ** | **($)**          | ** ** | **Earnings**     | ** ** | **($)**          | ** ** | **($)**    | ** ** |
| Frank K. Bynum, Jr. |       | 45,000          |       | 23,126      |       | —     |       | —           |       | —           |       | —           |       | 68,126     |       |
| Patricia Garrison-Corbin |       | 52,500          |       | 23,126      |       | —     |       | —           |       | —           |       | —           |       | 75,626     |       |
| David L. Hauser          |       | 55,000          |       | 23,126      |       | —     |       | —           |       | —           |       | —           |       | 78,126     |       |
| Claude C. Lilly          |       | 62,500          |       | 23,126      |       | —     |       | —           |       | —           |       | —           |       | 85,626     |       |
| Robert S. Lilien         |       | 52,500          |       | 21,448      |       | —     |       | —           |       | —           |       | —           |       | 73,948     |       |
| Kent R. Weldon           |       | 47,500          |       | 23,126      |       | —     |       | —           |       | —           |       | —           |       | 70,626     |       |

(1)          See the discussionpreceding this table for the general method used to determine each non-employeedirector’s cash compensation. For fiscal 2006, the particular components paidas cash compensation in excess of each non-employee director’s $45,000 retainerwere as follows:  Garrison-Corbin ($5,000for chair of corporate governance committee and $2,500 as a member of thecompensation committee); Hauser ($5,000 for chair of compensation committee and$5,000 as a member of the audit committee); Lilly ($5,000 as lead director,$10,000 as chair of the audit committee and $2,500 as a member of the corporategovernance committee); Lilien ($5,000 as member of the audit committee and$2,500 as a member of the corporate governance committee); Weldon ($2,500 as amember of the compensation committee).

(2)          Column (c) reflectsthe dollar amount recognized for financial statement reporting purposes for thefiscal year ended December 31, 2006 in accordance with FAS 123(R), andthus includes amounts from awards granted in and prior to 2006. As of December 31,2006, each director has the following number of restricted stock unitsoutstanding: Mr. Bynum, 4,606; Ms. Garrison-Corbin, 4,606; Mr. Hauser,4,606; Mr. Lilly, 4,606; and Mr. Lilien, 2,874. Included in thesetotals are restricted stock units that were granted to the directors in lieu ofdividends. Mr. Weldon has 1,100 shares of restricted stock which have notvested and are therefore outstanding as of December 31, 2006. These awardsvest in four quarterly installments from the grant date, and the holdersthereof are entitled to receive dividends on such awards from the date ofgrant, whether or not vested.

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**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The following table sets forth the beneficialownership of our common stock as of March 1, 2007 for each director, eachNEO, by all directors and executive officers of the Company as a group and byeach person known to us to be the beneficial owner of 5% or more of theoutstanding shares of our common stock.

The information (other than with respect to ourdirectors and executive officers) is based on a review of statements filed withthe SEC pursuant to Sections 13(d), 13(f) and 13(g) of the ExchangeAct with respect to our common stock. The amounts and percentages of commonstock beneficially owned are reported on the basis of regulations of the SECgoverning the determination of beneficial ownership of securities. Under the rules ofthe SEC, a person is deemed to be a “beneficial owner” of a security if thatperson has or shares “voting power,” which includes the power to vote or todirect the voting of such security, or “investment power,” which includes thepower to dispose of or direct the disposition of such security. A person isalso deemed to be a beneficial owner of any securities of which that person hasa right to acquire beneficial ownership within 60 days. All persons listed havesole voting and investment power with respect to their shares unless otherwiseindicated.

| ** **                                                                                 | ** ** | **Common Stock Beneficially  Owned (1)** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Name**                                                                                   | ** ** | ** **                                              | ** ** | **Number** | ** ** | **Percent of Class** | ** ** |
| **Executive Officers and  Directors:**                                                     |       |                                                    |       |   |   |   |   |
| Eugene B. Johnson  (2)                                                                     |       | 471,826                                                 |       |   | 1.3 | % |   |
| Peter G. Nixon  (3)                                                                        |       | 87,472                                                  |       |   | 0.2 | % |   |
| Walter E.  Leach, Jr. (4)                                                             |       | 184,295                                                 |       |   | 0.5 | % |   |
| John P. Crowley  (5)                                                                       |       | 128,533                                                 |       |   | 0.4 | % |   |
| Shirley J. Linn  (6)                                                                       |       | 118,723                                                 |       |   | 0.3 | % |   |
| Patricia  Garrison-Corbin (7)                                                              |       | 300                                                     |       |   | * |   |   |
| David L. Hauser  (8)                                                                       |       | 1,300                                                   |       |   | * |   |   |
| Robert S. Lilien  (9)                                                                      |       | —                                                  |       |   | * |   |   |
| Claude C. Lilly  (10)                                                                      |       | 1,500                                                   |       |   | * |   |   |
| All directors and  executive officers of the Company as a group (9 persons) (11) |       | 993,949                                                 |       |   | 2.8 | % |   |
| **5%  Stockholders:**                                                                      |       |                                                    |       |   |   |   |   |
| Wellington  Management Company LLP (12)                                                    |       | 3,283,300                                               |       |   | 9.3 | % |   |
| 75 State Street                                                                            |       |                                                    |       |   |   |   |   |
| Boston, Massachusetts  02109                                                               |       |                                                    |       |   |   |   |   |
| Lehman Brothers  Holdings Inc                                                              |       | 2,362,965                                               |       |   | 6.7 | % |   |
| 745 Seventh Avenue                                                                         |       |                                                    |       |   |   |   |   |
| New York, NY 10019                                                                         |       |                                                    |       |   |   |   |   |
|                                                                                            |            |                                                         |            |  |  |  |  |  |  |

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                 * Less than 0.1%.

       (1) Unless otherwise indicated below, the persons and entities named inthe table have sole voting and sole investment power with respect to all sharesbeneficially owned by them, subject to community property laws where applicable.The percentage of beneficial ownership is based on 35,271,910****shares of our common stock outstanding as of March 1**,** 2007.

       (2) With respect to shares beneficially owned: (i) includes 20,490shares of our common stock issuable upon exercise of stock options that areeither currently exercisable or become exercisable during the next 60 days, (ii) doesnot include 273,812****shares of ourcommon stock issuable upon exercise of stock 

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options that are notcurrently exercisable or do not become exercisable during the next 60 days and (iii)** **includes 226,325 shares of restricted stock awardedunder our 2005 Stock Incentive Plan.

       (3) With respect to shares beneficially owned: (i) includes 20,312****shares of our common stock issuable upon exercise of stockoptions that are either currently exercisable or become exercisable during thenext 60 days, (ii) does not include 30,842****sharesof our common stock issuable upon exercise of stock options that are notcurrently exercisable or do not become exercisable during the next 60 days, (iii) doesnot include 3,965****shares of common stock underlyingunvested restricted stock units**,** (iv)** **includes 54,417****shares ofrestricted stock awarded under our 2005 Stock Incentive****Planand (v) includes 60 shares of common stock owned by Mr. Nixon’sspouse and children.

       (4) With respect to shares beneficially owned: (i) includes 77,364****shares of our common stock issuable upon exercise of stockoptions that are either currently exercisable or become exercisable during thenext 60 days, (ii) does not include 115,474 shares of our common stockissuable upon exercise of stock options that are not currently exercisable ordo not become exercisable during the next 60 days, (iii) does not include 3,159****shares of common stock underlying unvested restricted stockunits and (iv) includes 82,576 shares of restricted stock awarded underour 2005 Stock Incentive Plan.

       (5) With respect to shares beneficially owned includes 100,089****shares of restricted stock awarded under our 2005 StockIncentive Plan.

       (6) With respect to shares beneficially owned: (i) includes 16,315 sharesof our common stock issuable upon exercise of stock options that are eithercurrently exercisable or become exercisable during the next 60 days, (ii) doesnot include 7,106****shares of our common stockissuable upon exercise of stock options that are not currently exercisable ordo not become exercisable during the next 60 days, (iii) does not include 2,369****shares of common stock underlying unvested restricted stockunits and (iv)  includes 94,141 shares of restricted stock awarded underour 2005 Stock Incentive Plan.

       (7) With respect to shares beneficially owned: (i) does not include589 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare subject to certain vesting requirements and (ii) does not include4,017 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare vested but for which shares of common stock will not be issued until theoccurrence of certain events set forth in our 2005 Stock Incentive Plan.

       (8) With respect to shares beneficially owned: (i) does not include589 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare subject to certain vesting requirements, (ii) does not include 4,017restricted units awarded under our 2005 Stock Incentive Plan, which units arevested but for which shares of common stock will not be issued until theoccurrence of certain events set forth in our 2005 Stock Incentive Plan and (iii) includes800 shares of common stock owned by Mr. Hauser’s spouse.

       (9) With respect to shares beneficially owned: (i) does not include589 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare subject to certain vesting requirements and (ii) does not include2,285 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare vested but for which shares of common stock will not be issued until theoccurrence of certain events set forth in our 2005 Stock Incentive Plan.

(10) With respect to shares beneficially owned: (i) does not include589 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare subject to certain vesting requirements and (ii) does not include4,017 restricted units awarded under our 2005 Stock Incentive Plan, which unitsare vested but for which shares of common stock will not be issued until the occurrenceof certain events set forth in our 2005 Stock Incentive Plan.

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(11) With respect to shares beneficially owned: (i) includes 134,481shares of our common stock issuable upon exercise of stock options that areeither currently exercisable or become exercisable during the next 60 days, (ii) doesnot include 427,234 shares of our common stock issuable upon exercise of stockoptions that are not currently exercisable or do not become exercisable duringthe next 60 days, (iii) does not include 9,493 shares of common stockunderlying unvested restricted stock units, (iv) includes 557,548 sharesof restricted stock awarded under our 2005 Stock Incentive Plan and (v) doesnot include 16,692 restricted units awarded under our 2005 Stock Incentive Plan.

(12) The securities beneficially owned by Wellington Management Company,LLP, in its capacity as investment advisor, are owned of record by clients ofWellington Management Company, LLP.

See “Item 5. Market forRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities” in this Annual Report for information regarding securitiesauthorized for issuance under the Company’s equity compensation plans.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

**NominatingAgreement and Registration Rights Agreement**

In connection with our initial public offering in February 2005,we entered into a nominating agreement with THL Equity Fund, Kelso InvestmentAssociates and Kelso Equity Partners pursuant to which we, acting through ourcorporate governance committee, agreed, subject to the requirements of ourdirectors’ fiduciary duties, that (i) THL Equity Fund would be entitled todesignate one Class III director to be nominated for election to our boardof directors and Kelso Investment Associates and Kelso Equity Partners would beentitled to designate one Class II director to be nominated for electionto our board of directors as long as THL Equity Fund and its affiliates, KelsoInvestment Associates and Kelso Equity Partners own in the aggregate at least40% of the shares of our common stock which they owned immediately prior to theclosing of our initial public offering or (ii) THL Equity Fund would beentitled to designate one Class III director to be nominated for electionto our board of directors as long as THL Equity Fund and its affiliates, KelsoInvestment Associates and Kelso Equity Partners owned in the aggregate lessthan 40% and at least 20% of the shares of our common stock which they owned immediatelyprior to the closing of our initial public offering. In addition, at any timeafter Kelso Investment Associates and Kelso Equity Partners no longer own anyof our common stock, as long as THL Equity Fund and its affiliates own at least40% of the shares of our common stock which THL Equity Fund and its affiliates,Kelso Investment Associates and Kelso Equity Partners owned immediately priorto the closing of our initial public offering, THL Equity Fund would beentitled to designate one Class II director to be nominated for electionto our board of directors in addition to its right to designate one Class IIIdirector to be nominated for election to our board of directors. The nominatingagreement was terminated effective as of February 1, 2007.

In connection with ourinitial public offering in February 2005, we also entered into aregistration rights agreement with THL Equity Fund, certain affiliates of THLEquity Fund, Kelso Investment Associates and Kelso Equity Partners, certainother significant stockholders and certain members of our management. Thisagreement required us to use our commercially reasonable efforts to file withthe SEC on the 181st day following the closing of the offering a shelfregistration statement covering the shares of our common stock held by suchparties and to use our commercially reasonable efforts to have such shelfregistration statement declared effective by the SEC as soon as reasonablypracticable thereafter. A shelf registration statement meeting theserequirements was declared effective by the SEC on September 1, 2005.

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**DirectorIndependence**

Our board of directorsconsidered transactions and relationships between each director or any memberof his or her immediate family and the Company and its subsidiaries and affiliates.Our board of directors has determined that, other than Eugene B. Johnson andFrank K. Bynum, Jr.**,** all of ourdirectors are independent under the criteria for independence set forth in thelisting standards of the New York Stock Exchange, and therefore meet the NewYork Stock Exchange requirement for a majority of independent directors servingon the board of directors.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

**PrincipalAccounting Fee Information**

Thefollowing table sets forth the aggregate fees billed by KPMG LLP for auditservices and other professional services rendered in fiscal year 2005 andfiscal year 2006: 

| ** **              | ** ** | **Fiscal Year  2005** | ** ** | **Fiscal Year  2006** | ** ** |
|-------------------------|------------|----------------------------|------------|----------------------------|------------|
| Audit Fees (1)          |       |                       | $          | 904,000                    |       |   | $ | 1,175,000 |   |
| Audit-Related  Fees (2) |       |                       | 30,000     |                       |       | 12,000 |   |
| Tax Fees (3)            |       |                       | 394,000    |                       |       | 237,000 |   |
|                         |            |                            |            |                            |            |  |  |  |  |

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(1)          Audit fees includeamounts billed to us related to annual financial statement audit work andquarterly financial statement reviews. In 2005, this category includes servicesassociated with our initial public offering, including the related registrationstatements.

(2)          Audit-Related Feesconsist of fees for assurance and related services that are reasonably relatedto the performance of the audit or review of the Company’s financial statements.This category includes services associated with the initial public offering,including the related registration statements, research and consultationrelated to our implementation of the Sarbanes-Oxley Act, due diligence relatedto acquisitions and divestitures, consulting related to financial accountingand reporting standards and the annual benefit plan audit.

(3)          TaxFees consist of fees for professional services for tax compliance, tax adviceand tax planning. These services include assistance regarding federal and statetax compliance, return preparation and tax audits.

*Audit CommitteePre-Approval Policy*

In accordance with our audit committee pre-approvalpolicy, all audit and non-audit services performed for us by our independentaccountants were pre-approved by our audit committee. Our audit committee hasconsidered whether the provision of non-audit services is compatible withmaintaining the independence of KPMG LLP and has concluded that it is.

Our audit committee’s pre-approval policyprovides that our independent auditors shall not provide services that have thepotential to impair or appear to impair the independence of the audit role. Thepre-approval policy requires our independent auditors to provide anannual engagement letter to our audit committee outlining the scope of theaudit services proposed to be performed during the fiscal year. Upon the auditcommittee’s acceptance of and agreement with such engagement letter, theservices within the scope of the proposed audit services shall be deemed pre-approvedpursuant to the policy.

The pre-approval policy provides for categoricalpre-approval of specified audit and permissible non-audit servicesand requires the specific pre-approval by the audit committee, prior toengagement, of such services, other than audit services covered by the annualengagement letter. In addition, services to be provided by our independentauditors that are not within the category of pre-approved services mustbe 

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approved by the auditcommittee prior to engagement, regardless of the service being requested or thedollar amount involved.

Requests or applications for services that requirespecific separate approval by the audit committee are required to be submittedto the audit committee by both management and the independent auditors, and mustinclude a detailed description of the services to be provided and a jointstatement confirming that the provision of the proposed services does notimpair the independence of the independent auditors.

The audit committee maydelegate pre-approval authority to one or more of its members. The memberor members to whom such authority is delegated shall report any pre-approvaldecisions to the audit committee at its next scheduled meeting. The auditcommittee is prohibited from delegating to management its responsibilities topre-approve services to be performed by our independent auditors.

**PART IV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENT SCHEDULES

**(a)**                               FinancialStatements

The financial statements filed as part of this AnnualReport are listed in the index to the financial statements under “Item 8.Financial Statements and Supplementary Data” in this Annual Report, which indexto the financial statements is incorporated herein by reference. In addition, certain financial statements of equitymethod investments owned by the Company are included as Exhibit 99.1 tothis Annual Report.

**(b)**                               Exhibits

The exhibits filed as part of this Annual Report arelisted 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 Annual Report to be signed onits behalf by the undersigned, thereunto duly authorized.

|                           |   | FAIRPOINT  COMMUNICATIONS, INC. |
|---------------------------|--------|--------------------------------------|
|                      |   |                                 |
| Date: March 13, 2007 |   | By:                                  | /s/ EUGENE B.  JOHNSON |   |
|                      |   | Name:                                | Eugene B. Johnson |
|                      |   | Title:                               | Chairman of the Board of Directors and Chief  Executive Officer |
|                           |        |                                      |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this Annual Reporthas been signed below by the following persons on behalf of the Registrant andin the capacities and on the dates indicated.

|                              | **Signatures** | ** **                              | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------------|----------------|-----------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
|                         |           |                                    |       |                 |
| /s/ EUGENE B. JOHNSON        |           | Chairman of the Board of  Directors and |       | March 13, 2007  |
| Eugene B. Johnson            |           | Chief Executive Officer  (Principal     |       |                 |
|                         |           | Executive Officer)                      |       |                 |
| /s/ JOHN P. CROWLEY          |           | Executive Vice  President and Chief     |       | March 13,  2007 |
| John P. Crowley              |           | Financial Officer  (Principal Financial |       |                 |
|                         |           | Officer)                                |       |                 |
| /s/ LISA R. HOOD             |           | Senior Vice  President and Controller   |       | March 13,  2007 |
| Lisa R. Hood                 |           | (Principal Accounting  Officer)         |       |                 |
| /s/ PATRICIA GARRISON-CORBIN |           | Director                                |       | March 13,  2007 |
| Patricia Garrison-Corbin     |           |                                    |       |                 |
| /s/ DAVID L. HAUSER          |           | Director                                |       | March 13,  2007 |
| David L. Hauser              |           |                                    |       |                 |
| /s/ ROBERT S. LILIEN         |           | Director                                |       | March 13,  2007 |
| Robert S. Lilien             |           |                                    |       |                 |
| /s/ CLAUDE C. LILLY          |           | Director                                |       | March 13,  2007 |
| Claude C. Lilly              |           |                                    |       |                 |

 

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**Exhibit Index**

| Exhibit   No. | ** **       | **Description** |
|---------------|------------------|-----------------|
|          | 2.1    |            |   | Agreement and Plan of Merger, dated  September 13, 2006, among FairPoint, MJD Ventures, Inc., FairPoint  Germantown Corporation and The Germantown Independent Telephone Company.(1) |
|          | 2.2    |            |   | Agreement and Plan of  Merger, dated as of January 15, 2007, by and among Verizon  Communications Inc., Northern New England Spinco Inc. and FairPoint.(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 11 7¤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) |
|          | 10.7   |            |   | 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) |
|          | 10.8   |            |   | Form of Swingline Note.(3) |
|          | 10.9   |            |   | Form of RF Note.(3) |
|          | 10.10            |            |   | Form of B Term  Note.(3) |
|          | 10.11            |            |   | Transition Services  Agreement, dated as of January 15, 2007, by and among Verizon  Information Technologies LLC, Northern New England Telephone Operations Inc.,  Enhanced Communications of Northern New England Inc. and FairPoint.(2) |
|          | 10.12            |            |   | Distribution Agreement,  dated as of January 15, 2007, by and between Verizon Communication Inc.  and Northern New England Spinco Inc.(2) |
|          | 10.13            |            |   | Master Services  Agreement, dated as of January 15, 2007, by and between FairPoint and  Capgemini U.S. LLC. (2) |
|          | 10.14            |            |   | Employee Matters  Agreement, dated as of January 15, 2007, by and among Verizon  Communications Inc., Northern New England Spinco Inc. and FairPoint.(2) |
|          | 10.15            |            |   | Partnership Interest  Purchase Agreement, dated as of January 15, 2007, by and among Verizon  Wireless of the East LP, Cellco Partnership d/b/a Verizon Wireless and  Taconic Telephone Corp.(2) |

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|        | 10.16                            |   |   | Tax Sharing Agreement,  dated as of January 15, 2007, by and among FairPoint, Verizon  Communications Inc. and Northern New England Spinco Inc.(2) |
|--------|----------------------------------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10.17                            |   |   | Amended and Restated Tax  Sharing Agreement, dated as of November 9, 2000, by and among FairPoint  and its Subsidiaries.(9)                        |
|   | 10.18                            |   |   | Affiliate Registration  Rights Agreement, dated as of February 8, 2005.(3)                                                                         |
|   | 10.19                            |   |   | Employment Agreement,  dated as of March 17, 2006, by and between FairPoint and Eugene B.  Johnson.(10)                                            |
|   | 10.20                            |   |   | Employment Agreement,  dated as of January 20, 2000, by and between FairPoint and Walter E.  Leach, Jr.(11)                                   |
|   | 10.21                            |   |   | Letter Agreement, dated  as of December 15, 2003, by and between FairPoint and Walter E.  Leach, Jr.(12)                                      |
|   | 10.22                            |   |   | Letter Agreement, dated  as of November 11, 2002, by and between FairPoint and Peter G. Nixon.(4)                                                  |
|   | 10.23                            |   |   | Letter Agreement, dated  as of November 13, 2002, by and between FairPoint and Shirley J.  Linn.(4)                                                |
|   | 10.24                            |   |   | Letter Agreement, dated  as of May 16, 2005, by and between FairPoint and John P. Crowley.(13)                                                     |
|   | 10.25                            |   |   | FairPoint 1995 Stock  Option Plan.(14)                                                                                                                  |
|   | 10.26                            |   |   | FairPoint Amended and  Restated 1998 Stock Incentive Plan.(14)                                                                                          |
|   | 10.27                            |   |   | FairPoint Amended and  Restated 2000 Employee Stock Incentive Plan.(12)                                                                                 |
|   | 10.28                            |   |   | FairPoint 2005 Stock  Incentive Plan.(3)                                                                                                                |
|   | 10.29                            |   |   | FairPoint Annual  Incentive Plan.(3)                                                                                                                    |
|   | 10.30                            |   |   | Form of  February 2005 Restricted Stock Agreement.(15)                                                                                        |
|   | 10.31                            |   |   | Form of Director  Restricted Stock Agreement.(16)                                                                                                  |
|   | 10.32                            |   |   | Form of Director  Restricted Unit Agreement.(16)                                                                                                   |
|   | 10.33                            |   |   | Form of  Non-Director Restricted Stock Agreement.(17)                                                                                              |
|   | 14.1                   |   |   | FairPoint Code of  Business Conduct and Ethics.(18)                                                                                                     |
|   | 14.2                   |   |   | FairPoint Code of Ethics  for Financial Professionals.(3)                                                                                               |
|   | 21      |   |   | Subsidiaries of  FairPoint.*                                                                                                                            |
|   | 23.1                   |   |   | Consent of KPMG LLP.*                                                                                                                                   |
|   | 23.2                   |   |   | Consent of  Deloitte & Touche LLP.*                                                                                                            |
|   | 31.1                   |   |   | Certification as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*                                                              |
|   | 31.2                   |   |   | Certification 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.*†  |

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|        | 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   |   |   | Audited financial  statements for the Orange County-Poughkeepsie Limited Partnership for the  years ended December 31, 2006, 2005 and 2004.*      |

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*                    Filedherewith.

†                    Pursuantto Securities 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)          Incorporatedby reference to the Quarterly Report on Form 10-Q of FairPoint forthe period ended September 30, 2006.

(2)          Incorporatedby reference to the Current Report on Form 8-K of FairPoint filed onJanuary 19, 2007.

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

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

(5)          Incorporatedby reference to the Current Report on Form 8-K of FairPoint filed onMay 4, 2005.

(6)          Incorporatedby reference to the Current Report on Form 8-K of FairPoint filed onOctober 3, 2005.

(7)          Incorporatedby reference to the Current Report on Form 8-K of FairPoint filed onJanuary 26, 2007.

(8)          Incorporatedby reference to the Quarterly Report on Form 10-Q of FairPoint for theperiod ended March 31, 2005.

(9)          Incorporatedby reference to the Quarterly Report on Form 10-Q of FairPoint forthe period ended September 30, 2000.

(10) Incorporated by reference to the QuarterlyReport on Form 10-Q of FairPoint for the period ended March 31,2006.

(11) Incorporated by reference to the Annual Reporton Form 10-K of FairPoint for the year ended December 31, 1999.

(12) Incorporated by reference to the Annual Reporton Form 10-K of FairPoint for the year ended December 31, 2003.

(13) Incorporated by reference to the Current Reporton Form 8-K of FairPoint filed on May 24, 2005.

(14) Incorporated by reference to the RegistrationStatement on Form S-4 of FairPoint, declared effective as of August 9,2000.

(15) Incorporated by reference to the RegistrationStatement on Form S-1 of FairPoint, declared effective as of February 3,2005.

(16) Incorporated by reference to the Current Reporton Form 8-K of FairPoint filed on June 20, 2005.

(17) Incorporated by reference to the Current Reporton Form 8-K of FairPoint filed on September 23, 2005.

(18) Incorporated by reference to the Annual Reporton Form 10-K of FairPoint for the year ended December 31, 2005.

127

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