**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

| (Mark One)                                                                                                                                                                                                                                  |                                                                                                 |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------|
| x                                                                                                                                                                                                                                           | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
| **For the  fiscal year ended December 31, 2005****.**                                                                                                                                                                                  |
| o                                                                                                                                                                                                                                           | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**  |
| **For the  transition period from                    to                  ** |

 

**Commission File Number 333-56365**

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**FairPoint Communications, Inc.**

(Exact Name of Registrant asSpecified in Its Charter)

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

 

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Registrant’s TelephoneNumber, 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 registeredpursuant to Section 12(g) of the 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

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one).

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

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

The aggregate market valueof the common stock held by non-affiliates of the registrant as of June 30,2005 (based on the closing price of $16.15 per share as quoted on the New YorkStock Exchange as of such date) was approximately $442,591,000.

As of March 06, 2006,there were 35,015,019 shares of the Registrant’s common stock, par value $0.01per share, outstanding.

Documents incorporated byreference: Part III of the Annual Report incorporates information byreference from the registrant’s definitive proxy statement to be filed with theSecurities and Exchange Commission not later than April 30, 2006.

 

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**FAIRPOINTCOMMUNICATIONS, INC. ANNUAL REPORT ON FORM 10-KFOR THE FISCAL YEAR ENDED DECEMBER 31, 2005**
| Item  Number | ** ** | ** **                                                                                                                      | ** ** | ** ** | ** ** | **Page  Number** |
|--------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------------|
|         |       | Index                                                                                                                           |       |       | i          |             |
|         |       | PART I                                                                                                                     |       |       |       |             |
| 1.           |       | Business                                                                                                                        |       |       | 2          |             |
| 1A.          |       | Risk  Factors                                                                                                                   |       |       | 16         |             |
| 1B.          |       | Unresolved Staff Comments                                                                                                       |       |       | 29         |             |
| 2.           |       | Properties.                                                                                                                     |       |       | 29         |             |
| 3.           |       | Legal  Proceedings                                                                                                              |       |       | 29         |             |
| 4.           |       | Submission of Matters to a Vote of Security Holders.                                                                            |       |       | 30         |             |
|         |       | PART II                                                                                                                    |       |       |       |             |
| 5.           |       | Market for Registrant’s Common Equity and Related  Stockholder Matters                                                     |       |       | 31         |             |
| 6.           |       | Selected  Financial Data                                                                                                        |       |       | 34         |             |
| 7.           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations       |       |       | 36         |             |
| 7A.          |       | Quantitative and Qualitative Disclosures about Market  Risk.                                                                    |       |       | 54         |             |
| 8.           |       | Independent Auditors’ Report and Consolidated  Financial Statements                                                        |       |       | 55         |             |
| 9.           |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure.                 |       |       | 99         |             |
| 9A.          |       | Controls and Procedures                                                                                                         |       |       | 99         |             |
| 9B.          |       | Other  Information                                                                                                              |       |       | 99         |             |
|         |       | PART III                                                                                                                   |       |       |       |             |
| 10.          |       | Directors and Executive Officers of the Registrant                                                                              |       |       | 100        |             |
| 11.          |       | Executive Compensation.                                                                                                         |       |       | 100        |             |
| 12.          |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters.                      |       |       | 100        |             |
| 13.          |       | Certain Relationships and Related Transactions.                                                                                 |       |       | 100        |             |
| 14.          |       | Principal Accounting Fees and Services .                                                                                        |       |       | 100        |             |
|         |       | PART IV                                                                                                                    |       |       |       |             |
| 15.          |       | Exhibits, Financial Statement Schedules, and Reports  on Form 8-K.                                                         |       |       | 100        |             |
|         |       | Signatures                                                                                                                      |       |       | 101        |             |
|         |       | Exhibit Index                                                                                                              |       |       | 102        |             |

 

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**PART I**

**CAUTIONARY NOTE REGARDING 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 expenditures,

·       futureinterest expense,

·       distributionsfrom minority investments and passive partnership interests,

·       netoperating loss carry forwards,

·       technologicaldevelopments and changes in the communications industry,

·       financingsources and availability,

·       regulatorysupport payments,

·       theeffects of regulation and competition, and

·       pendinglitigation.

These forward-looking statements include, butare not limited to, statements about our plans, objectives, expectations andintentions and other statements contained in this Annual Report that are nothistorical facts. When used in this Annual Report, the words “expects,” “anticipates,”“intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressionsare generally intended to identify forward looking statements. Because theseforward-looking statements involve known and unknown risks anduncertainties, there are important factors that could cause actual results,events or developments to differ materially from those expressed or implied bythese forward-looking statements, including our plans, objectives,expectations and intentions and other factors discussed under “Item 1A. RiskFactors” and other parts of this Annual Report. You should not place unduereliance on such forward-looking statements, which are based on theinformation currently available to us and speak only as of the date on whichthis Annual Report was filed with the Securities and Exchange Commission, orthe SEC. We undertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.However, your attention is directed to any further disclosures made on relatedsubjects in our subsequent periodic reports filed with the SEC on Forms 10-K,10-Q and 8-K and Schedule 14A.

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**ITEM 1.   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.excluding its subsidiaries.*

**Our Business**

We are a leading provider of communications servicesin rural communities, offering an array of services, including local and longdistance voice, data, Internet and broadband product offerings. We are one ofthe largest telephone companies in the United States focused on serving ruralcommunities, and we are the 17th largest local telephone company, in each casebased on number of access lines. We operate in 17 states with 288,899 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, 2005.

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

Rural local exchange carriers generally arecharacterized by stable operating results and strong cash flow margins andoperate in supportive regulatory environments. In particular, existing stateand federal regulations permit us to charge rates that enable us to recover ouroperating costs, plus a reasonable rate of return on our invested capital (asdetermined by relevant regulatory authorities). Competition is typicallylimited because rural local exchange carriers primarily serve sparselypopulated rural communities with predominantly residential customers, and thecost of operations and capital investment requirements for new entrants ishigh. As a result, in our markets, we have experienced virtually no wirelinecompetition and limited voice competition from cable providers. We may alreadyhave some voice over Internet protocol, or VoIP, competition but there is noway to identify or measure it. While most of our markets are served by wirelessservice providers, their impact on our business has been limited. 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.

**Our Competitive Strengths**

We believe we aredistinguished by the following competitive strengths:

·       **Leading market share.**We have the leadingmarket position in the rural 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 

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bell operating companies.Additionally, our telephone companies operate in generally supportiveregulatory environments. These factors have permitted us to generate consistentcash flows and strong margins.

·       **Geographically diversified markets**. Wecurrently operate 28 rural local exchange carriers in 17 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 with current software. As a result of our historiccapital investments, we believe that our network infrastructure requirespredictable capital expenditures and allows us to implement certain broadbandenabled services with minimal incremental cost. As of December 31, 2005,approximately 98% of our exchanges were capable of providing broadband servicesand approximately 79% of our access lines are high 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.**We have anexperienced management team that has demonstrated its ability to grow our ruraltelephone business over the past decade. Our senior management team has anaverage of 23 years of industry experience. Our management team hassuccessfully integrated 32 business acquisitions since 1993, improving revenuesand cash flow significantly while enhancing service quality and broadeningservice offerings.

**Our Strategy**

The key elements ofour 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.

·       **Continue to improve operating efficiencies andprofitability**. We have achieved significant operating efficienciesby applying our operational, regulatory, marketing and management expertise toour acquired businesses. We intend to continue to increase our operatingefficiencies by consolidating various administrative functions and implementingbest practices across the Company.

·       **Enhance customer loyalty.**We believe thatour service driven customer relationships and long-standing local presence leadto high levels of customer satisfaction and increased demand for enhanced andancillary services. We continue to build long-term relationships with ourcustomers 

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by actively participatingin the communities we serve and by offering an array of communications servicesand quality customer care.

·       **Grow through selective acquisitions.**We believe that ouracquisition strategy has been successful because of our ability to integrateacquisitions and improve operating efficiencies in the businesses we acquire.Our management team has consistently produced strong operating cash flowimprovements in our acquired businesses. We will continue to evaluate andpursue acquisitions which provide the opportunity to enhance our revenues andcash flows.

**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 services such as long distance, Internet and broadband enabledservices. Based on our understanding of our local customers’ needs, we have attemptedto be proactive by offering bundled services designed to simplify the customer’spurchasing and management process.

**Generation of Revenue**

We primarily generate revenue through: (i) theprovision of our basic local telephone service to customers within our serviceareas; (ii) the provision of network access to interexchange carriers fororigination and termination of interstate and intrastate long distance phonecalls; (iii) Universal Service Fund high cost loop payments; and (iv) theprovision of other services such as long distance resale, data and Internet andbroadband enabled services, enhanced services, such as caller name and numberidentification, and billing and collection for interexchange carriers.

See “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations” formore information regarding our revenue sources.

***Local Calling Services***

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 carriers’ territory, the amount that we can charge a customer forlocal service is determined by rate proceedings involving the appropriate stateregulatory authorities.

***Network Access Charges***

Network access enables long distance companies toutilize our local network to originate or terminate intrastate and interstatecalls. Network access charges relate to long distance, or toll calls, thattypically involve more than one company in the provision of telephone service. Sincetoll calls are generally billed to the customer originating the call, amechanism is required to compensate each company providing services relating tothe call. This mechanism is the access charge and we bill access charges tolong distance companies and other customers for the use of our facilities toaccess the customer, as described below.

*IntrastateAccess Charges.*   Wegenerate intrastate access revenue when an intrastate long distance callinvolving an interexchange carrier is originated by a customer in one of ourrural local exchanges to a customer in another exchange in the same state, orwhen such a call is terminated to a customer in one of 

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our rural local exchanges.The interexchange carrier pays us an intrastate access payment for either terminatingor originating the call. We bill access charges relating to such calls throughour carrier access billing system and receive the access payment from theinterexchange carrier. Access charges for intrastate services are regulated andapproved by the state regulatory authority.

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

***Universal Service Fund 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 UniversalService Fund, which is funded by monthly fees charged to interexchange carriersand local exchange carriers, makes payments to us on a monthly basis based uponour cost support for local exchange carriers whose cost of providing the localloop connections to customers is significantly greater than the nationalaverage. These payments fluctuate based upon our average cost per loop comparedto the national average cost per loop. For example, if the national averagecost per loop increases and our operating costs (and average cost per loop)remain constant or decrease, the payments we receive from the Universal ServiceFund would decline. Conversely, if the national average cost per loop decreasesand our operating costs (and average cost per loop) remain constant orincrease, the payments we receive from the Universal Service Fund wouldincrease.

***Long Distance Services***

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 Internet Services***

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 on our rural local exchangecarriers’ local presence and network infrastructure by offering enhancedservices to customers, as well as billing and collection services forinterexchange carriers.

*EnhancedServices.*   Ouradvanced digital switch and voicemail platforms allow us to offer enhancedservices such as call waiting, call forwarding and transferring, call hunting,three-way calling, automatic callback, call hold, caller name and numberidentification, voice mail, teleconferencing, video conferencing,store-and-forward fax, follow-me numbers, Centrex services and direct inwarddial.

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*Billingand Collection.*   Manyinterexchange carriers provide long distance services to our rural localexchange carrier customers and may elect to use our billing and collectionservices. Our rural local exchange carriers charge interexchange carriers abilling and collection fee for each call record generated by the interexchangecarrier’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 listingsand community 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, compilation of information, as well as the production,publication and distribution of these directories.

**Our Markets**

Our 28 rural local exchange carriers operate as theincumbent local exchange carrier in each of their respective markets. Our rurallocal exchange carriers serve an average of approximately 13 access lines persquare mile versus the non-rural carrier average of approximately 128 accesslines per square mile. Approximately 77% of our access lines serve residentialcustomers. Our business customers account for approximately 23% of our accesslines. Our business customers are predominantly in the agriculture, lightmanufacturing and service industries.

Thefollowing chart identifies the number of access line equivalents in each of our17 states as of December 31, 2005:

| **State**       | ** ** | ** ** | ** ** | **Access Line  Equivalents** | ** ** |
|-----------------|------------|------------|------------|-----------------------------------|------------|
| Maine           |       |       | 67,246     |                              |       |
| Florida         |       |       | 56,294     |                              |       |
| New York        |       |       | 51,979     |                              |       |
| Washington      |       |       | 46,695     |                              |       |
| Ohio            |       |       | 10,611     |                              |       |
| Illinois        |       |       | 8,218      |                              |       |
| Virginia        |       |       | 8,169      |                              |       |
| Vermont         |       |       | 7,355      |                              |       |
| Idaho           |       |       | 7,133      |                              |       |
| Kansas          |       |       | 6,892      |                              |       |
| Pennsylvania    |       |       | 6,648      |                              |       |
| Oklahoma        |       |       | 4,010      |                              |       |
| Colorado        |       |       | 3,532      |                              |       |
| Other States(1) |       |       | 4,117      |                              |       |
| Total:          |       |       | 288,899    |                              |       |

 

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

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**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 rural local exchange carriers 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 offices in many of the population centers within our serviceterritories. These offices are typically staffed by local residents and providecustomer support services in the community. We believe that a local presencehelps facilitate a direct connection to the community, which improves customersatisfaction 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 rural localexchange carriers acquired by us traditionally have not devoted a substantialamount of their operating budget to sales and marketing activities. Afteracquiring such rural local exchange carriers, we typically change this practiceto provide additional support for existing products and services as well as tosupport the introduction of new services. As of December 31, 2005, we had254 employees engaged in sales, marketing and customer service.

**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 31,2005, 17 of our operating companies had converted to a single outsourcedbilling platform. On October 7, 2005, we learned that the billing servicebureau used by us for these 17 operating companies had contracted to sell thesoftware underlying our billing system and agreed not to add any futurecustomers to its service bureau platform. In addition to the short termdifficulties experienced during the billing conversion, this potential saleraised concerns about the long-term reliability of the service bureau. On November 7,2005, we reached an agreement with this outsourced service bureau to transitionto another service provider of our choice by December 31, 2006. Subsequentto reaching this agreement, we selected Mid America Computer Corporation, orMACC, as our new provider of billing services. We expect to complete theconversion of 17 of our operating companies, or approximately two thirds of ouraccess lines, by the middle of 2006 and the remaining companies by early to mid2007.

**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, 

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which has been deployedthroughout our current network and is the primary transport technology betweenour host and remote central offices and interconnection points with otherincumbent 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, 2005,we had invested approximately $32.0 million in digital subscriber linetechnology and had deployed this technology in 145 of our 148 exchanges. Approximately98% 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 do not currentlyexist in the rural local exchange carrier marketplace. Our rural local exchangecarriers historically have experienced little wireline competition as theincumbent carrier in their markets because the demographic characteristics ofrural communications markets generally will not support the high cost ofoperations and significant capital investment required for new wirelineentrants to offer competitive services. For instance, the per minute cost of operatingboth telephone 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 territoriesserviced by our rural local exchange carriers.

***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 could faceincreased competition from competitive local exchange carriers, particularly inoffering services to Internet service providers.

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***Voice Over Internet Protocol Competition***

Voice over internetprotocol service is increasingly being embraced by all industry participants.Voice over internet protocol service essentially involves the routing of voicecalls, at least in part, over the Internet through packets of data instead oftransmitting the calls over the existing public switched telephone network.While current voice over internet protocol applications typically completecalls using incumbent local exchange carrier infrastructure and networks, asvoice over internet protocol services obtain acceptance and market penetrationand technology advances further, a greater quantity of communication may be placedwithout utilizing the public switched telephone network. The proliferation ofvoice over internet protocol, particularly to the extent such communications donot utilize our rural local exchange carriers’ networks, may result in anerosion of our customer base and loss of access 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 and wireless)and on-line content services, are provided by Internet service providers,satellite-based companies, long distance carriers and cable televisioncompanies. Many of these companies provide direct access to the Internet and avariety of supporting services to businesses and individuals. In addition, manyof these companies, such as America Online, Inc., Microsoft Network andYahoo, offer on-line content services consisting of access to closed,proprietary information networks. Long distance companies and cable televisionoperators, among others, are aggressively entering the Internet access markets.Long distance carriers have substantial transmission capabilities,traditionally carry data to large numbers of customers and have an establishedbilling system infrastructure that permits them to add new services. Satellitecompanies are offering broadband access to the Internet from desktop personalcomputers. Many of these competitors have substantially greater financial,technological, marketing, personnel, name-brand recognition and other resourcesthan those available to us.

***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 31,2005, we employed a total of 900 employees. 119 employees of our rural localexchange carriers are represented by four unions. We believe the state of ourrelationship with our union and non-union employees is generally good. Withinour company, 99 employees are employed at our corporate offices and 801employees are employed at our rural local exchange carriers.

**Intellectual Property**

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.

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**RegulatoryEnvironment**

The following summary doesnot describe all present and proposed federal, state and local legislation andregulations affecting the communications industry. Some legislation andregulations are currently the subject of judicial proceedings, legislativehearings and administrative proposals which could change the manner in which thisindustry operates. Neither the outcome of any of these developments, nor theirpotential impact on us, can be predicted at this time. Regulation can changerapidly in the communications industry, and such changes may have an adverseeffect on us in the future. See “Item 7. Management’s Discussion and analysisof Financial Condition and Results of Operations—Risk Factors—Risks Related toour Regulatory Environment.”

Our regulatedcommunications services are subject to extensive federal, state and local regulation.We hold various regulatory authorizations for our service offerings. At thefederal level, the Federal Communications Commission generally exercisesjurisdiction over all facilities and services of communications commoncarriers, such as us, to the extent those facilities are used to provide,originate, or terminate interstate or international communications. Stateregulatory commissions generally exercise jurisdiction over such facilities andservices to the extent those facilities are used to provide, originate orterminate intrastate communications. In addition, pursuant to theTelecommunications Act, state and federal regulators share responsibility forimplementing and enforcing the domestic pro-competitive policies introduced bythat legislation. In particular, state regulatory agencies have substantialoversight over the provision by incumbent telephone companies ofinterconnection and non-discriminatory network access to competitivecommunications providers. Local governments often regulate the publicrights-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.

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 ofcompetition cannot be ascertained at this time. Competition may lead to loss ofrevenues and profitability as a result of: loss of customers; reduced usage ofour network by our existing customers who may use alternative providers forlong distance, voice and data services; and reductions in prices for ourservices which 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 and are expected to continue to change the landscape ofthe communications industry. The central aim of the Telecommunications Act wasto open local communications marketplaces to competition while enhancinguniversal service. Most significantly, the Telecommunications Act governs theremoval of barriers to market entry into local telephone services, requiresincumbent local exchange carriers to interconnect with competitors, establishesprocedures pursuant to which incumbent local exchange carriers may provideother services, such as the provision of long distance services by regionalbell operating companies, and imposes on incumbent local exchange carriersduties to negotiate interconnection arrangements in good faith.

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*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 preventcompetitive entry into the provision of any communications service. However,states can modify conditions of entry into areas served by rural local exchangecarriers where the state regulatory commission determines that such modificationis warranted by the public interest. Since the passage of theTelecommunications Act, we have experienced only limited competition from cableand wireless service 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 carriers and interstate longdistance carriers for originating and terminating calls in the regions servedby our rural local exchange carriers. The amount of access charge revenues thatwe receive is based on rates set by federal and state regulatory bodies, andsuch rates are 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 28 incumbent local telephone subsidiarieselected not to apply the Federal Communications Commission’s price caps.Instead, our subsidiaries employ rate-of-return regulation for their interstateaccess charges.

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 access charges.In 2001, the Federal Communications Commission adopted an order implementingthe beginning phases of the Multi Association Group plan to reform the accesscharge system for rural carriers. The Multi Association Group plan is revenueneutral to our operating companies. Among other things, the Multi AssociationGroup plan reduces access charges and shifts a portion of cost recovery, whichhistorically has been based on minutes-of-use, to flat-rate, monthly per linecharges on end-user customers rather than long distance carriers. As a result,the aggregate amount of access charges paid by long distance carriers to accessproviders, such as our rural local exchange carriers, has decreased and maycontinue to decrease. In adopting the Multi Association Group plan, the FederalCommunications Commission also determined that rate-of-return carriers willcontinue to be permitted to set rates based on the authorized rate of return of11.25%. Additionally, the Federal Communications Commission initiated a rulemakingproceeding to investigate the Multi Association Group’s proposed incentiveregulation plan and other means of allowing rate-of-return carriers to increasetheir efficiency and competitiveness. The Multi Association Group plan expireson May 30, 2006 and will need to be renewed or replaced at such time. Inaddition, to the extent our rural local exchange carriers become subject tocompetition in their own local exchange areas, such access charges could bepaid to competing local exchange carriers rather than to us. Additionally, theaccess charges we receive may be reduced as a result of competition by otherservice providers such as wireless and voice over internet services. Such acircumstance 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-

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carrier payments forinterconnected traffic. Furthermore, in the notice of proposed rulemaking onvoice over internet protocol services adopted by the Federal CommunicationsCommission in February 2004, the Federal Communications Commission hassought comment on whether access charges should apply to voice over internetprotocol or other internet protocol based services. It is unknown at this timewhat additional changes, if any, the Federal Communications Commission mayeventually adopt and the effect of any such changes on our business.

*RuralLocal Exchange Carrier Services Regulation.*   Ourrural local exchange carrier services segment 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 expeditiouslythan in the past. At the same time, however, the implementation of such newprograms may also lead to reductions in intrastate access charges.

The Federal Communications Commission generally mustapprove in advance most transfers of control and assignments of operatingauthorizations by Federal Communications Commission-regulated entities.Therefore, if we seek to acquire companies that hold Federal CommunicationsCommission authorizations, in most instances we will be required to seekapproval from the Federal Communications Commission prior to completing thoseacquisitions. The Federal Communications Commission has the authority tocondition, modify, cancel, terminate or revoke operating authority for failureto comply with applicable federal laws or rules, regulations and policies ofthe Federal Communications Commission. Fines or other penalties also may beimposed for such violations. Our interstate common carrier services are alsosubject to nondiscrimination requirements and requirements that rates be justand 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. Each of our 28 rural local exchange carriers operates as theincumbent local telephone company in the states in which it operates and iscertified in those states to provide local telephone services. State regulatorycommissions generally regulate the rates incumbent local exchange carrierscharge for intrastate services, including rates for intrastate access servicespaid by providers of intrastate long distance services. Although the FederalCommunications Commission has preempted certain state regulations pursuant tothe Telecommunications Act, states have retained authority to imposerequirements on carriers necessary to preserve universal service, protectpublic safety and welfare, ensure quality of service and protect consumers. Forinstance, incumbent local exchange carriers must file tariffs setting forth theterms, conditions and prices for their intrastate services, and such tariffsmay be challenged by third parties. From time to time, states conduct ratecases or “earnings” reviews. These reviews may result in the disallowance ofcertain investments or expenses for ratemaking purposes.

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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 ornotifications for certain acquisitions and transfers of assets, customers, orownership of regulated entities. Therefore, in most instances we will berequired to seek state approval prior to completing new acquisitions of rurallocal exchange carriers. States generally retain the right to sanction acarrier or to revoke certifications if a carrier materially violates relevantlaws and/or regulations.

***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 ruralcommunities. Some of these franchises may require the payment of franchisefees. We have obtained such municipal franchises as were required. In somerural areas, we do not need to obtain such permits or franchises because thesubcontractors or electric utilities with which we have contracts alreadypossess the requisite 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 28 rural 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 ofthe previously referenced requests to modify the May 24, 2004implementation date for local number portability in certain states, we have notencountered a need to file any such requests for suspension or modification ofthe interconnection requirements.

The TelecommunicationsAct, with certain exceptions, imposes the following additional duties onincumbent telephone companies by requiring them to: (i) interconnect theirfacilities and equipment with 

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anyrequesting communications carrier at any technically feasible point; (ii) unbundleand provide nondiscriminatory access to network elements such as local loops,switches and transport facilities, at nondiscriminatory rates and onnondiscriminatory terms and conditions; (iii) offer their retail servicesfor resale at wholesale rates; (iv) provide reasonable notice of changesin the information necessary for transmission and routing of services over theincumbent telephone company’s facilities or in the information necessary forinteroperability; and (v) provide, at rates, terms and conditions that arejust, reasonable and nondiscriminatory, for the physical co-location ofequipment necessary for interconnection or access to unbundled network elementsat the premises of the incumbent telephone company. Competitors are required tocompensate the incumbent local exchange carrier for the cost of providing theseinterconnection services. However, pursuant to the Telecommunications Act,rural telephone companies, including our rural local exchange carriers, areautomatically exempt from these additional incumbent telephone companyrequirements. The exemption remains effective until an incumbent rural localtelephone company receives a bona fide request for these additionalinterconnection services and the applicable state authority determines whetherthe request is not unduly economically burdensome, technically feasible, andconsistent with the universal service objectives set forth in theTelecommunications Act. This exemption remains effective for all of ourincumbent local telephone operations, except in Florida where the legislaturehas determined that all incumbent local exchange carriers are required toprovide the additional interconnection services as prescribed in theTelecommunications Act. If a request for any of these additionalinterconnection services is filed by a potential competitor with respect to oneof our other operating territories, we are likely to ask the relevant stateregulatory commission to retain the exemption. If a state regulatory commissionrescinds such exemption in whole or in part and if the state regulatorycommission does not allow us adequate compensation for the costs of providingthe interconnection, our costs would significantly increase, we would face newcompetitors in that state and we could suffer a significant loss of customersand resulting declines in our revenues. In addition, we could incur additionaladministrative and regulatory expenses as a result of the interconnectionrequirements.

***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 8% of our revenues for the year endedDecember 31, 2005. Under current Federal Communications Commissionregulations, the total Universal Service Fund available to all rural localtelephone companies, including our 28 rural local exchange carriersubsidiaries, is subject to a cap. In any given year, the cap may or may not bereached. In any year where the cap is reached, the per access line rate atwhich we can recover Universal Service Fund payments may decrease. In addition,the consideration of changes in the federal rules governing thedistribution of Universal Service Fund is pending before the FederalCommunications Commission. If our rural local exchange carriers were unable toreceive Universal Service Fund payments, or if such payments were reduced, manyof our rural local exchange carriers would be unable to operate as profitablyas they have historically in the absence of our implementation of increases incharges for other services. Moreover, if we raise prices for services to offsetloss of Universal Service Fund payments, the increased pricing of our servicesmay disadvantage us competitively in the marketplace, resulting in additionalpotential revenue loss. Payments from the Universal Service Fund fluctuatebased upon our average cost per loop compared with the national average costper loop. For example, if the national average cost per loop increases and ouroperating costs (and average cost per loop) remain constant or decrease, thepayments we receive from the Universal Service Fund would decline. Conversely,if the national average cost per loop decreases and our operating costs (andaverage cost per loop) remain constant or increase, the payments we receivefrom the Universal Service Fund would increase. Over the past year, thenational average cost per loop in relation to our average cost per loop hasincreased and we believe the national average cost per loop will 

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likely continue toincrease in relation to our average cost per loop. As a result, the payments wereceive from the Universal Service Fund will likely decline.

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 same supportpayments as we do if a state regulatory commission determined that grantingsuch support payments to competitors would be in the public interest.

Two notable regulatory changes enacted by the FederalCommunications Commission in the last four 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 modifiesthe existing universal service support mechanism for rural local exchangecarriers and adopts an interim embedded, or historical, cost mechanism for afive-year period that provides predictable levels of support to rural carriers.The Federal Communication Commission has stated its intention to develop along-term plan based on forward looking costs when the five-year period expireson May 30, 2006. The Multi Association Group plan created a new universalservice support mechanism, Interstate Common Line Support, to replace carriercommon line access charges and the recovery of certain costs formerly recoveredthrough traffic sensitive access charges. A recent Federal CommunicationsCommission order merged long term support into its interstate common linesupport mechanism without reducing (at least initially) the aggregate universalservice support from the two mechanisms (both of which had been previouslytransformed from access charge revenue streams into universal service supportmechanisms). As a result of these changes, when a competitor is designated asan eligible telecommunications carrier, it also receives an increased level ofUniversal Service Fund support equal to the level received by the incumbent ona per line basis.

The Federal State JointBoard is currently considering recommendations on the question of whichcarriers can obtain Universal Service Fund support in a market. The FederalState Joint Board recommended that:

·       aset of permissive federal guidelines be developed to ensure that the publicinterest is served before eligible telecommunications carriers are designated;

·       supportbe limited to a single connection that provides access to the public telephonenetwork; and

·       thebasis for providing support be considered and further clarified during thecomprehensive review of the Universal Service Fund to be completed in 2006.

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. The written text of the Federal Communications Commissionorder was released on March 1, 2005 in which the Federal CommunicationsCommission adopted additional mandatory requirements for eligibletelecommunications carriers designation in cases where it has jurisdiction, andencourages states that have jurisdiction to designate eligibletelecommunications carriers to adopt similar requirements. The FederalCommunications Commission is still considering revisions to the methodology bywhich contributions to the Universal Service Fund are determined. Theserevisions will be part of an overall rulemaking regarding Universal ServiceSupport which will be dealt with sometime in 2006.

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.

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***Potential Internet Regulatory Obligations***

In connection with our Internet access offerings, wecould become subject to laws and regulations as they are adopted or applied to theInternet. There is currently only limited regulations 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 the regulatoryimplications of voice over Internet protocol technology. We cannot predict theresults of these proceedings, the nature of these regulations or their impacton our business.

The Federal CommunicationsCommission adopted FCC Order 05-150. This Order puts wireline broadbandInternet access service, commonly delivered by digital subscriber line (DSL)technology, on an equal regulatory footing with cable modem service. Thisapproach is consistent with a recent United States Supreme Court decision upholdingthe FCC’s light regulatory treatment of cable modem service. Specifically, theFCC determined that wireline broadband Internet access services are defined asinformation services functionally integrated with a telecommunicationscomponent. In the past, the FCC required facilities-based providers to offerwireline broadband transmission components separately from their Internetservice as a stand alone service on a common-carrier basis, and thus classifiedthat component as a telecommunications service. The FCC order also provides an option which allows rate of returncarriers, such as our operating companies, the option to continue providing DSLservice as a common carrier (status quo) offering.

***Environmental Regulations***

Like all other localtelephone companies, our 28 rural local exchange carrier subsidiaries aresubject to federal, state and local laws and regulations governing the use,storage, disposal of, and exposure to hazardous materials, the release ofpollutants into the environment and the remediation of contamination. As anowner of property, we could be subject to environmental laws that imposeliability for the entire cost of cleanup at contaminated sites, regardless offault or the lawfulness of the activity that resulted in contamination. Webelieve, however, that our operations are in substantial compliance withapplicable environmental laws and regulations.

**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 stockholdersmay not receive the level of dividends provided for in the dividend policy ourboard of directors has adopted or any dividends at all.**

Our board of directors has adopted a dividend policywhich reflects an intention to distribute a substantial portion of the cashgenerated by our business 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, asregular quarterly dividends to our stockholders. Our board of directors may, inits discretion, amend or repeal this dividend policy. Our dividend policy is 

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based upon our directors’current assessment of our business and the environment in which we operate, andthat assessment could change based on 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, our cash flows,cash requirements, financial condition, contractual restrictions, provisions ofapplicable law and other factors that our board of directors may deem relevant.Our board of directors may decrease the level of dividends provided for in thedividend policy or entirely discontinue the payment of dividends. Our creditfacility contains significant restrictions on our ability to make dividendpayments. There can be no assurance that we will generate sufficient cash fromcontinuing operations in the future, or have sufficient surplus or net profits,as the case may be, under Delaware law, to pay dividends on our common stock inaccordance with the dividend policy. If we were to use borrowings under ourcredit facility’s revolving facility to fund dividends, we would have less cashavailable for future dividends. The reduction or elimination of dividends maynegatively affect the market price of our common stock.

**To expand ourbusiness through acquisitions and service our indebtedness, we will require asignificant amount of cash. Our ability to generate cash depends on manyfactors beyond our control. We may not generate sufficient funds fromoperations to consummate acquisitions, pay dividends with respect to shares ofour common stock or repay or refinance our indebtedness at maturity orotherwise.**

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 anacceptable cost.

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. On February 8, 2005, we entered into threeinterest rate swap agreements, with notional amounts of $130 million each, toeffectively convert a portion of our variable rate interest exposure to fixedrates ranging from 5.76% to 6.11%. These swap agreements expire beginning December 31,2007 through December 31, 2009. On April 7, 2005, we entered into twoadditional interest rate swap agreements, one with the notional amount of $50.0million to effectively convert a portion of our variable rate interest exposureto a fixed rate of 6.69% beginning on April 29, 2005 and ending on March 31,2011, and one with the notional amount of $50.0 million to effectively converta portion of our variable rate interest exposure to a fixed rate of 6.72%beginning on June 30, 2005 and ending on March 31, 2012. As a resultof these swap agreements, as of 

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December 31, 2005,approximately 82% of our indebtedness bore interest at fixed rates rather thanvariable rates. After these interest rate swap agreements expire, our annualdebt service obligations with respect to borrowings under our credit facilitywill vary from year to year unless we enter into a new interest rate swap orpurchase an interest rate cap or other interest rate hedge. If we choose toenter into a new interest rate swap or purchase an interest rate cap or otherinterest 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.

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 to raise additional capital orsell assets and, if we are forced to pursue any of these options underdistressed conditions, our business and the value of your investment in ourcommon stock could be adversely affected. In addition, these alternatives maynot be available to us when needed or on satisfactory terms due to prevailingmarket conditions, a decline in our business, legislative and regulatoryfactors or restrictions contained in the agreements governing our indebtedness.

**If we haveinsufficient cash flow to cover the expected dividend payments under ourdividend policy we would need to reduce or eliminate dividends or, to theextent permitted under the agreements governing our indebtedness, fund aportion of our dividends with additional borrowings.**

If we do not have sufficient cash to fund dividendpayments, we would either reduce or eliminate dividends or, to the extent wewere permitted 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.

**Our substantialindebtedness could restrict our ability to pay dividends on our common stockand have an adverse impact on our financing options and liquidity position.**

As of December 31,2005, we had approximately $607.4 million of total consolidated indebtedness.Our substantial indebtedness could have important adverse consequences to theholders of our common 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 certaincovenants, our credit facility permits us to incur additional indebtedness. Anyadditional indebtedness that we may incur would exacerbate the risks describedabove.

**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.**

TheCompany is a holding company and conducts all of its operations through itsoperating subsidiaries. The Company currently has no significant assets otherthan equity interests in its first tier subsidiaries. These first tiersubsidiaries have no significant assets other than a direct or indirect equityinterest in the Company’s operating subsidiaries. As a result, the Company willrely on dividends and other payments or distributions from its operatingsubsidiaries to pay dividends with respect to its common stock and to meet itsdebt service obligations generally. The ability of the Company’s subsidiariesto pay dividends or make other payments or distributions to the Company willdepend on their respective operating results and may be restricted by, amongother things:

·       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 operatingsubsidiaries have no obligation, contingent or otherwise, to make fundsavailable to the Company, whether in the form of loans, dividends or otherdistributions. In addition, we have a number of minority investments andpassive partnership interests from which we receive distributions. We do notcontrol the timing or amount of distributions from such investments orinterests and we may not have access to the cash flows of these entities.

Accordingly,our ability to pay dividends with respect to shares of our common stock and torepay our credit facility at maturity or otherwise may be dependent uponfactors beyond our control. Subject to limitations in our credit facility, theCompany’s subsidiaries may also enter into agreements that contain covenantsprohibiting them from distributing or advancing funds or transferring assets tothe Company under certain circumstances, including to pay dividends.

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

Covenantsin our credit facility impose significant operating and financial restrictionson 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;

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·       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 oradditional agreement may contain covenants which could limit in a significantmanner our operations 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 our indebtednesswhich could result in our inability to make dividend payments on our commonstock.**

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.

**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 to you.**

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 tax payments. Inaddition, in the future we may be required to pay cash income taxes because allof our net operating loss carry forwards have been used or have expired.Limitations on our usage of net operating loss carry forwards, and otherfactors requiring us to pay cash taxes in the future, would reduce 

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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, economicand other external factors, general market conditions and market conditionsaffecting the stock of communications companies in particular. Communicationscompanies have in the past experienced extreme volatility in the trading pricesand volumes of their securities, which has often been unrelated to operatingperformance. Any such market volatility may have a significant adverse effecton the market price of our common stock. In addition, in the past, securitiesclass action litigation has often been instituted against a company followingperiods of volatility in its stock price. This type of litigation could resultin substantial costs and divert our management’s attention and resources.

**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. Pursuant to a registration rights agreement entered into inconnection with the offering, we registered 7,599,430 shares of commonstock which would otherwise be restricted securities within the meaning ofRule 144 under the Securities Act and are held by persons who acquired ourcommon stock before the offering.

We may issue shares of ourcommon stock, or other securities, from time to time as consideration forfuture acquisitions and investments. In the event any such acquisition orinvestment is significant, the number of shares of our common stock, or thenumber or aggregate principal amount, as the case may be, of other securitiesthat we may issue may in turn be significant. We may also grant registrationrights covering those shares or other securities in connection with any suchacquisitions and investments.

**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 for your securities. For example, our restatedcertificate of incorporation provides that certain provisions of our restatedcertificate of incorporation can only be amended by a vote of two-thirds ormore in voting power of all the outstanding shares of capital stock and thatstockholders generally may not act by written consent and only stockholdersrepresenting at least 50% in voting power may request that our board ofdirectors call a special meeting. Our restated certificate of incorporationprovides for a classified board of directors and authorizes the issuance ofpreferred stock without stockholder approval and upon such terms as the boardof directors may determine. The rights of the holders of shares of our commonstock will be subject to, and may be adversely affected by, the rights ofholders of any class or series of preferred stock that may be issued in thefuture.

**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 

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commissionhaving jurisdiction over us, we will have the right to request certaininformation from our stockholders. If any stockholder from whom suchinformation is requested should fail to respond to such a request or weconclude that the ownership of, or the existence or exercise of any rights ofstock ownership with respect to, shares of our capital stock by suchstockholder, 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 and allappropriate 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 generates revenueby delivering voice and data services over access lines. We have experienced anet voice access line loss, adjusted for acquisitions and divestitures, of 7.1%for the period from January 1, 2002 through December 31, 2005 and2.5% for the period from December 31, 2004 through December 31, 2005due to challenging economic conditions and the introduction of digitalsubscriber line services. We may continue to experience net access line lossesin our markets. Our inability to retain access lines could adversely affect ourbusiness and results of operations.

**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 competitionfrom new market entrants, such as providers of wireless broadband, voice overinternet protocol, satellite communications and electric utilities. TheInternet services market is also highly competitive, and we expect thatcompetition will intensify. Many of our competitors 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 alsolose that 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.

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**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 to technologicalchanges or obsolescence or fail to obtain access to important new technologies,we could lose customers and be limited in our ability to attract new customersand/or sell new services to our existing customers. An element of our businessstrategy is to deliver enhanced and ancillary services to customers. Thesuccessful delivery of new services is uncertain and dependent on many factors,and we may not generate anticipated revenues from such services.

**We rely on a limited number of key suppliers and vendorsto operate our business. If these suppliers or vendors experience problems orfavor our competitors, we could fail to obtain sufficient quantities ofproducts and services we require to operate our business successfully.**

We depend on a limitednumber of suppliers and vendors for equipment and services relating to ournetwork infrastructure. If these suppliers experience interruptions or otherproblems delivering these network components on a timely basis, subscribergrowth and our operating results could suffer significantly. Proprietarytechnology of certain suppliers is an integral component of our network and,accordingly, we have become reliant upon a limited number of network equipmentmanufacturers, including Nortel Networks Corporation and Siemens Informationand Communication Networks, Inc. In addition, when our new billingplatform is completed, we will rely on a single outsourced supplier to supportour billing and related customer care services. In the event it becomesnecessary to seek alternative suppliers and vendors, we may be unable to obtainsatisfactory replacement suppliers or vendors on economically attractive terms,on a timely basis, or at all, which could increase costs and may causedisruptions in services.

**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. Since 1993, we have acquired32 rural telephone businesses and we continue to own and operate 28 suchbusinesses. We expect that a portion of our future growth will result fromadditional acquisitions, some of which may be material. Growth throughacquisitions entails numerous 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;

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·       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;

·       notachieving 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.

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 the businessesthat we have already acquired or successfully integrate any businesses that wemight acquire in the future. If we fail to do so, or if we do so but at greatercost than we anticipated, there will be a risk that our business may beadversely affected.

**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.

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**Our billing systemsmay not function properly.**

The failure of any of ourbilling systems could result in our inability to adequately bill and providecustomer service to our customers. We are in the process of converting all ofour companies on the ICMS platform, approximately two thirds of our accesslines, to a new platform by the middle of 2006 and we plan to convert ourremaining companies to this same platform by the middle of 2007. At thecompletion of this project, we will have a single integrated billing platformfor our end-user customers.  The failureto successfully complete this conversion or the failure of any of our billingsystems could have a material adverse effect on our business, financialcondition and results of operations.

**We depend on thirdparties for our provision of long distance services.**

Our provision of longdistance services is dependent on underlying agreements with other carriersthat provide us with transport and termination services. These agreements arebased, in part, on our estimate of future supply and demand and may containminimum volume commitments. If we overestimate demand, we may be forced to payfor services we do not need. If we underestimate demand, we may need to acquireadditional capacity on a short-term basis at unfavorable prices, assumingadditional capacity is available. If additional capacity is not available, wewill not be able to meet this demand. In addition, if we cannot meet anyminimum volume commitments, we may be subject to underutilization charges,termination charges, or rate increases which may adversely affect our resultsof operations.

**We may not be ableto maintain the necessary rights-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 conduit andrelated communications equipment for any expansion of our networks. We may needto renew current rights-of-way for our networks and cannot assure you that wewould be successful in renewing these agreements on acceptable terms. Some ofour agreements may be short-term, revocable at will, or subject to terminationupon customary default provisions, and we may not have access to existingrights-of-way after they have expired or terminated. If any of these agreementswere terminated or could not be renewed, we may be required to remove ourexisting facilities from under the streets or abandon our networks. Similarly,we may not be able to obtain right-of-way agreements on favorable terms, or atall, in new service areas, and, if we are unable to do so, our ability toexpand our networks, if we decide to do so, could be impaired.

**Our success dependson our ability to attract and retain 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. The lossof any member of our senior management team, due to retirement or otherwise,and the inability to attract and retain highly qualified technical andmanagement personnel in the future, could have a material adverse effect on ourbusiness, financial condition and results of operations.

**We may facesignificant future liabilities or compliance costs in connection withenvironmental and worker health and safety matters.**

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 formerly 

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ownedproperties or at third party waste disposal sites. In addition, we could beheld responsible for third party property or personal injury claims relating toany such contamination or relating to violations of environmental laws. Changesin existing laws or regulations or future acquisitions of businesses couldrequire us to incur substantial costs in the future relating to such matters.

**We will be exposedto risks relating to evaluations of controls required by Section 404 ofthe 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 will beevaluating our internal controls systems to allow management to report on, andour independent auditors to attest to, our internal controls as required by Section 404of the Sarbanes-Oxley Act. Our evaluation of our internal controls may resultin our identifying material weaknesses in our internal controls. While weanticipate being able to complete our initial controls assessment andremediation of any identified material weaknesses prior to the  December 31, 2006 deadline applicable tous, we cannot be certain as to the timing of such completion or the impact ofthe same on our operations. If we are not able to complete the assessmentprocess required by Section 404 in a timely manner, or are unable toremediate any identified material weaknesses prior to December 31, 2006,we might be subject to sanctions or investigation by regulatory authorities,such as the SEC or the New York Stock Exchange. Any such action could adverselyaffect our financial results or investors’ confidence in us, and could causeour stock price to fall. If we fail to maintain effective controls andprocedures, we may be unable to provide financial information in a timely andreliable manner.

***Risks Related to our Regulatory Environment***

**We are subject tosignificant regulations that could change in a manner adverse to us.**

We operate in a heavily regulated industry, and themajority of our revenues generally have been supported by regulations,including access revenue and Universal Service Fund support for the provisionof telephone services in rural areas. Laws and regulations applicable to us andour competitors may be, and 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.*   Forthe year ended December 31, 2005, almost 44% of our revenues came fromnetwork access charges, which are paid to us by intrastate and interstate longdistance carriers for originating and terminating calls in the regions served.This 44% also includes Universal Service Fund payments for local switchingsupport, long term support and interstate common line support. In recent years,several of these long distance carriers have declared bankruptcy. Futuredeclarations of bankruptcy by a carrier that utilizes our access services couldnegatively impact our financial results. The amount of access charge revenuesthat we receive is based on rates set by federal and state regulatory bodies,and such rates could change. Further, from time to time federal and stateregulatory bodies conduct rate cases and/or “earnings” reviews, which mayresult in rate changes. The Federal Communications Commission has reformed andcontinues to reform the federal access charge system. States often mirror thesefederal rules in establishing intrastate access charges. In October 2001,the Federal Communications Commission reformed the system to reduce interstateaccess charges and shift a portion of cost recovery, which historically hasbeen based on minutes-of-use, to flat-rate, monthly per line charges onend-user customers rather than long distance carriers. As a result, theaggregate amount of access charges paid by long distance carriers to accessproviders, such as our rural local exchange carriers, has decreased and maycontinue to decrease. Although these changes were implemented on a revenueneutral basis (with commensurate increases in other charges and Universal 

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Service Fund support),there is no assurance that future changes in access charge rates will beimplemented on a revenue neutral basis. Furthermore, to the extent our rurallocal exchange carriers become subject to competition, such access chargescould be paid to competing communications providers rather than to us.Additionally, the access charges we receive may be reduced as a result ofwireless competition. Finally, the Federal Communications Commission iscurrently weighing several proposals to comprehensively reform the intercarriercompensation regime in order to create a uniform system of intercarrierpayments. Any such proposal eventually adopted by the Federal CommunicationsCommission will likely involve significant changes in the access charge systemand could potentially result in a significant decrease or elimination of accesscharges altogether. Decreases or losses of access charges may or may not resultin offsetting increases in local, subscriber line or Universal Service Fundrevenues. Regulatory developments of this type could adversely affect ourbusiness, revenue and/or profitability.

*Riskof loss or reduction of Universal Service Fund support.*   Wereceive Universal Service Fund revenues to support the high cost of ouroperations in rural markets. For the year ended December 31, 2005,approximately 8% of our revenues resulted from the high cost loop support wereceived from the Universal Service Fund and was based upon our average costper loop compared to the national average cost per loop. This revenue streamfluctuates based upon our average cost per loop compared to the nationalaverage cost per loop. For example, if the national average cost per loopincreases and our operating costs (and average cost per loop) remain constantor decrease, the payments we receive from the Universal Service Fund woulddecline. Conversely, if the national average cost per loop decreases and ouroperating costs (and average cost per loop) remain constant or increase, thepayments we receive from the Universal Service Fund 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 Universal Service Fund have declined and willlikely continue to decline. This support fluctuates based upon the historicalcosts of our operating companies. In addition to the Universal Service Fundhigh cost loop support, we also receive other Universal Service Fund supportpayments, which include local switching support, long term support, andinterstate common line support that used to be included in our interstateaccess charge revenues (the Federal Communications Commission has recentlymerged long term support into interstate common line support). If our rurallocal exchange carriers were unable to receive support from the UniversalService Fund, or if such support was reduced, many of our rural local exchangecarriers would be unable to operate as profitably as they have historically, inthe absence of our implementation of increases in charges for other services. Moreover,if we raise prices for services to offset loss of Universal Service Fundpayments, the increased pricing of our services may disadvantage uscompetitively in the marketplace, resulting in additional potential revenueloss.

The Telecommunications Act of 1996, or theTelecommunications Act, provides that eligible communications carriers,including competitors to rural local exchange carriers, may obtain the same perline support as the rural local exchange carriers receive if a state commissiondetermines that granting such support to competitors would be in the publicinterest. In fact, wireless communications providers in certain of our marketshave obtained matching support payments from the Universal Service Fund, butthat has not led to a loss of revenues for our rural local exchange carriersunder existing regulations. Any shift in universal service regulation, however,could have an adverse effect on our business, revenue and/or profitability.

During the last four years, pursuant to recommendationsmade by the Multi Association Group and the Rural Task Force, the FederalCommunications Commission has made certain modifications to the universalservice support system that changed the sources of support and the method fordetermining the level of support. These changes have been revenue neutral toour operations. It is unclear whether the changes in methodology will continueto accurately reflect the costs incurred by our rural local exchange carriers,and whether it will provide for the same amount of Universal Service Fundsupport that our rural 

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local exchange carriershave received in the past. In addition, several parties have raised objectionsto the size of the Universal Service Fund and the types of services eligiblefor support. A number of issues regarding the source and amount ofcontributions to, and eligibility for payments from, the Universal Service Fundare pending and will likely be addressed by the Federal CommunicationsCommission or Congress in the near future. For example, a number of proposalsto be examined by the Federal Communications Commission in its currentrulemaking with respect to the reform of the intercarrier compensation systeminclude reforms of the Universal Service Fund. The outcome of any regulatoryproceedings or legislative changes could affect the amount of Universal ServiceFund support that we receive, and could 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. Theserevisions will be part of an overall rulemaking regarding Universal ServiceSupport which will be dealt with sometime in 2006.

*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 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 be impacted by legislation andregulation imposing new or greater obligations related to assisting lawenforcement, bolstering homeland security, minimizing environmental impacts, oraddressing other issues that impact our business. For example, existingprovisions of the Communications Assistance for Law Enforcement Act and FederalCommunications Commission regulations implementing the CommunicationsAssistance for Law Enforcement Act require communications carriers to ensurethat their equipment, facilities, and services are able to facilitateauthorized electronic surveillance. We cannot predict whether and when theFederal Communications Commission might modify its Communications Assistancefor Law Enforcement Act rules or any other rules or what compliancewith new rules might cost. Similarly, we cannot predict whether or whenfederal or state legislators or regulators might impose new security,environmental or other obligations on our business.

For a more thoroughdiscussion of the regulatory issues that may affect our business, see “Item 1.Business—Regulatory Environment.”

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**Regulatory changes in thecommunications industry could adversely affect our business by facilitatinggreater competition against us, reducing potential revenues or raising ourcosts.**

The Telecommunications Act provides for significantchanges and increased competition in the communications industry, including thelocal communications and long distance industries. This statute and the FederalCommunications Commission’s implementing regulations remain subject to judicialreview and additional rulemakings of the Federal Communications Commission,thus making it difficult to predict what effect the legislation will have onus, including our operations and our revenues and expenses, and ourcompetitors. Several regulatory and judicial proceedings have recentlyconcluded, are underway or may soon be commenced, that address issues affectingour operations and those of our competitors. We cannot predict the outcome ofthese developments, nor can we assure that these changes will not have amaterial adverse effect on us or our industry.

For a more thoroughdiscussion of the regulatory issues that may affect our business, see “Item 1.Business—Regulatory Environment.”

**The failure toobtain necessary regulatory approvals could impede the consummation of apotential acquisition.**

Our acquisitions likelywill be subject to federal, state and local regulatory approvals. We cannotassure you that we will be able to obtain any necessary approvals, in whichcase a potential acquisition could be delayed or not consummated.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

We have received nowritten comments from the Securities and Exchange Commission staff regardingour periodic or current reports less than 180 days before the end of our fiscalyear ended December 31, 2005 that remain unresolved.

**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 17 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 customer service centers. Auxiliary battery or othernon-utility power sources are at each central office to provide uninterruptedservice in the event of an electrical power failure. Transport and distributionnetwork facilities include fiber optic backbone and copper wire distributionfacilities, which connect customers to remote switch locations or to thecentral office and to points of presence or interconnection with the longdistance carriers. These facilities are located on land pursuant to permits,easements or other agreements. Our rolling stock includes service vehicles,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 

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Officer, certain of theCompany’s current and former directors and certain of the Company’s stockholders.The complaint alleges violations of Sections 11 and 12(a)(2) and liabilityunder Section 15 of the Securities Act, and alleges that the Company’sregistration statement on Form S-1 (which was declared effective bythe SEC on February 3, 2005) and the related prospectus dated February 3,2005, each relating to the Company’s initial public offering of common stock,contained certain material misstatements and omitted certain materialinformation necessary to be included relating to the Company’s broadbandproducts and access line trends. The plaintiff, who has been a plaintiff inseveral other securities cases, seeks rescission rights and unspecified damageson behalf of a purported class of purchasers of the common stock “issuedpursuant and/or traceable to the Company’s IPO during the period from February 3,2005 through March 21, 2005”. The Company removed the action to FederalCourt. The plaintiff filed a motion to remand the action to the North CarolinaState Court, which was denied by the Federal Magistrate. The plaintiff hasobjected to and appealed the Magistrate’s decision to the District Court Judge.The Company has contested the appeal and filed a Motion to Dismiss the action. TheMagistrate, on February 9, 2006, issued a Memorandum and Recommendation tothe District Court Judge that the Motion to Dismiss be granted and that thecomplaint be dismissed with prejudice. The plaintiff has filed a Notice ofObjection to the Magistrate’s Recommendation. Both the appeal of denial of theMotion to Remand and the Motion to Dismiss are pending before the DistrictCourt Judge. The Company believes that this action is without merit and intendsto continue to defend the litigation vigorously.

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

**ITEM 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 2005.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

**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 theCompany’s Common Stock as reported on the New York Stock Exchange for theperiods indicated:

| **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 2005:

| **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)          The Company’s initialpublic offering occurred in February 2005 and therefore, the Company paida partial quarterly dividend in the first quarter of 2005.

As of March 6, 2006,there were approximately 80 holders of record of our common stock.

**Dividend Policy and Restrictions**

***General***

Our board ofdirectors has adopted a dividend policy under which a substantial portion of thecash generated by our business in excess of operating needs, interest andprincipal payments on our indebtedness, dividends on our future senior classesof capital stock, if any, capital expenditures, taxes and future reserves, ifany, would in general be distributed as regular quarterly dividend payments tothe holders of our common stock, rather than retained by us and used for otherpurposes, including to finance growth opportunities. This policy reflects ourjudgment that our stockholders would be better served if we distributed to themsuch substantial portion of the excess cash generated by our business insteadof retaining it in our business. However, our stockholders may not receive anydividends as a result of the following 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;

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·       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

·       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 ourdividend policy limits, but does not preclude, our ability to pursue growth. Ifwe continue paying dividends at the level currently anticipated under ourdividend policy, we expect that we would need additional financing to fundsignificant acquisitions or to pursue growth opportunities requiring capitalexpenditures that are significantly beyond our current expectations. However,we intend to retain sufficient cash after the distribution of dividends topermit the pursuit of growth opportunities that do not require material capitalinvestment.

***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 all of our available cash accumulated after April 1, 2005 pluscertain incremental funds to pay dividends, but we may not in general paydividends in excess of such amount. “Available cash” is defined in our creditfacility as Adjusted EBITDA (a) minus (i) interest expense, (ii) repaymentsof indebtedness other than repayments of the revolving facility (unless funded bydebt or equity), (iii) capital expenditures (unless funded by long-termdebt, equity or the proceeds from asset sales or insurance recovery events), (iv) cashtaxes, (v) cash consideration paid for acquisitions (unless funded by debtor equity), (vi) cash paid to make certain investments, and (vii) certainnon-cash items excluded from Adjusted EBITDA and paid in cash and (b) plus(i) the cash amount of extraordinary gains and gains on sales of assetsand (ii) certain non-cash items excluded from Adjusted EBITDA and receivedin cash. “Adjusted EBITDA” is defined in our credit facility as ConsolidatedNet Income (which is defined in our credit facility and includes distributionsfrom investments) (a) plus the following to the extent deducted fromConsolidated Net Income: provision for income taxes, interest expense,depreciation, amortization, losses on sales of assets and other extraordinarylosses, and certain other non-cash items, and (b) minus, to the extentincluded in Consolidated Net Income, gains on sales of assets and otherextraordinary gains and all non-cash items.

·       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 (total debt (net of cash) divided byAdjusted EBITDA) is above 5.00 to 1.00 or if we do not have at least $10million of cash on hand (including unutilized commitments under our creditfacility’s revolving facility).

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

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See “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Liquidity”for a more detailed description of our credit facility and these restrictions.

**EquityCompensation Plan 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     |       |       | 1,125,869  |                                                                                                                                                |       |                                                                                                                 | $          | 15.91                                                                                                                                      |       |   |   | 467,654 |   |   |
| 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, 18,013options to purchase shares of our common stock under the FairPointCommunications, Inc. 1995 Stock Option Plan, 240,638 options to purchaseshares of our common stock under the FairPoint Communications, Inc. 2000Employee Stock Incentive Plan, 26,442 restricted units granted under theFairPoint Communications, Inc. 2000 Employee Stock Incentive Plan and7,888 restricted units granted under the FairPoint Communications, Inc.2005 Stock Incentive Plan.

(2)          Includes 467,654 sharesunder the 2005 Stock Incentive Plan. Available shares shown above for the 2005Stock Incentive Plan include shares that have become available due toforfeitures or have been reacquired by the Company for any reasons withoutdelivery of the stock, as allowed under the terms of the plan.

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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 theretocontained elsewhere in this Annual Report. Amounts are in thousands, exceptaccess lines and per share data.

| ** **                                                                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Statement of Operations:**                                                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                                                      |       | $                                          | 262,843    |   | $ | 252,645 |   | $ | 231,432 |   | $ | 230,819 |   | $ | 230,176 |   |
| Operating expenses:                                                           |       |                                       |       |   |   |   |   |   |   |   |   |
| Operating expenses                                                            |       | 141,075                                    |       | 128,755 |   | 111,188 |   | 110,265 |   | 115,763 |   |
| Depreciation and amortization(1)                                              |       | 52,390                                     |       | 50,287 |   | 48,089 |   | 46,310 |   | 55,081 |   |
| Stock based compensation expense                                              |       | 2,350                                      |       | 49 |   | 15 |   | 924 |   | 1,337 |   |
| Total operating  expenses                                                     |       | 195,815                                    |       | 179,091 |   | 159,292 |   | 157,499 |   | 172,181 |   |
| Income from  operations                                                       |       | 67,028                                     |       | 73,554 |   | 72,140 |   | 73,320 |   | 57,995 |   |
| Interest  expense(2)                                                          |       | (46,416                                    | )          | (104,315 | ) | (90,224 | ) | (69,520 | ) | (76,314 | ) |
| Other income  (expense), net(3)                                               |       | (75,156                                    | )          | 6,926 |   | 9,600 |   | (11,974 | ) | (6,670 | ) |
| Loss from  continuing operations before income taxes                          |       | (54,544                                    | )          | (23,835 | ) | (8,484 | ) | (8,174 | ) | (24,989 | ) |
| Income tax  (expense) benefit(4)                                              |       | 83,096                                     |       | (516 | ) | 236 |   | (518 | ) | (431 | ) |
| Minority interest  in income of subsidiaries                                  |       | (2                                         | )          | (2 | ) | (2 | ) | (2 | ) | (2 | ) |
| Income (loss) from  continuing operations                                     |       | 28,550                                     |       | (24,353 | ) | (8,250 | ) | (8,694 | ) | (25,422 | ) |
| Income (loss) from  discontinued operations                                   |       | 380                                        |       | 671 |   | 9,921 |   | 21,933 |   | (186,178 | ) |
| Net income (loss)                                                             |       | 28,930                                     |       | (23,682 | ) | 1,671 |   | 13,239 |   | (211,600 | ) |
| Redeemable  preferred stock dividends and accretion(2)                        |       | —                                     |       | — |   | (8,892 | ) | (11,918 | ) | — |   |
| Gain on repurchase  of redeemable preferred stock                             |       | —                                     |       | — |   | 2,905 |   | — |   | — |   |
| Net income (loss)  attributable to common shareholders                        |       | $                                          | 28,930     |   | $ | (23,682 | ) | $ | (4,316 | ) | $ | 1,321 |   | $ | (211,600 | ) |
| Basic shares  outstanding(5)                                                  |       | 31,927                                     |       | 9,468 |   | 9,483 |   | 9,498 |   | 9,499 |   |
| Diluted shares  outstanding(5)                                                |       | 31,957                                     |       | 9,468 |   | 9,483 |   | 9,498 |   | 9,499 |   |
| Basic and diluted  earnings (loss) from continuing operations per share(5)    |       | $                                          | 0.89       |   | $ | (2.57 | ) | $ | (1.50 | ) | $ | (2.17 | ) | $ | (2.68 | ) |
| **Operating  Data:**                                                          |       |                                       |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                         |       | $                                          | 28,099     |   | $ | 36,492 |   | $ | 33,595 |   | $ | 38,803 |   | $ | 43,175 |   |
| Access line  equivalents(6)                                                   |       | 288,899                                    |       | 271,150 |   | 264,308 |   | 248,581 |   | 247,862 |   |
| Residential access lines                                                      |       | 188,206                                    |       | 189,668 |   | 196,145 |   | 189,803 |   | 191,570 |   |
| Business access lines                                                         |       | 55,410                                     |       | 49,606 |   | 50,226 |   | 51,810 |   | 53,056 |   |
| High Speed Data subscribers                                                   |       | 45,283                                     |       | 31,876 |   | 17,937 |   | 6,968 |   | 3,236 |   |
| **Summary  Cash Flow Data:**                                                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Net cash provided  by operating activities of continuing operations      |       | $                                          | 61,682     |   | $ | 45,975 |   | $ | 32,834 |   | $ | 55,632 |   | $ | 35,717 |   |
| Net cash used in  investing activities of continuing operations               |       | (42,807                                    | )          | (20,986 | ) | (54,010 | ) | (30,258 | ) | (57,161 | ) |
| Net cash provided  by (used in) financing activities of continuing operations |       | (16,647                                    | )          | (23,966 | ) | (1,976 | ) | (12,546 | ) | 101,234 |   |
| **Balance  Sheet Data (at period end):**                                      |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash                                                                          |       | $                                          | 5,083      |   | $ | 3,595 |   | $ | 5,603 |   | $ | 5,394 |   | $ | 2,919 |   |
| Property, plant  and equipment, net                                           |       | 242,617                                    |       | 252,262 |   | 266,706 |   | 271,690 |   | 278,277 |   |
| Total assets                                                                  |       | 908,139                                    |       | 819,136 |   | 843,068 |   | 829,253 |   | 875,015 |   |
| Total long term  debt                                                         |       | 607,425                                    |       | 810,432 |   | 825,560 |   | 804,190 |   | 907,602 |   |
| Preferred shares  subject to mandatory redemption(7)                          |       | —                                     |       | 116,880 |   | 96,699 |   | 90,307 |   | — |   |
| Total stockholders’  equity (deficit)                                    |       | 246,848                                    |       | (172,952 | ) | (147,953 | ) | (146,150 | ) | (149,510 | ) |

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(1)             On January 1, 2002, we adopted SFAS No. 142, “Goodwilland Other Intangible Assets.” Pursuant to the requirements of SFAS No. 142,we ceased amortizing goodwill beginning January 1, 2002, and instead testfor goodwill impairment annually. Amortization expense for goodwill and equitymethod goodwill was $11,962 in 2001. Depreciation and amortization excludesamortization of debt issue costs.

(2)             Interest expense includes amortization of debt issuecosts aggregating $1,859, $4,603, $4,171, $3,664 and $4,018 for the fiscalyears ended December 31, 2005, 2004, 2003, 2002 and 2001. We prospectivelyadopted the provisions of SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of Liabilities and Equity,” effective July 1,2003. SFAS No. 150 requires us to classify as a long-term liability ourseries A preferred stock and to reclassify dividends and accretion from 

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the series A preferredstock as interest expense. Such stock is described as “Preferred Shares Subjectto Mandatory Redemption” in the balance sheet and dividends and accretion onthese shares are included in pre-tax income prior to repurchase in 2005 whereaspreviously they were presented as a reduction to equity (a dividend), and,therefore, a reduction of net income available to common stockholders. For theyears ended December 31, 2005, 2004 and 2003, interest expense includes$2,362, $20,181 and $9,049, respectively, related to dividends and accretion onpreferred shares subject to mandatory redemption.

(3)             On January 1, 2001, we adopted the provisions ofSFAS No. 133, “Accounting for Derivative Instruments and Certain HedgingActivities,” as amended by SFAS No. 138. On the date of adoption, werecorded a cumulative adjustment of $4,664 in accumulated other comprehensiveincome for the fair value of interest rate swaps. Because the interest rateswaps did not qualify as accounting hedges under SFAS No. 133, the changein fair value of the interest rate swaps were recorded as non operating gains orlosses, which we classify in other income (expense). We also recorded otherincome (expense) in 2003, 2002 and 2001 for the amortization of the transitionadjustment of the swaps initially recognized in accumulated other comprehensiveincome. In the second quarter of 2002, we adopted SFAS No. 145 “Rescissionof FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13and Technical Corrections.” This statement eliminates the requirement thatgains and losses from the extinguishment of debt be required to be aggregatedand, if material, classified as an extraordinary item, net of related incometax effect. In 2003, other income (expense) includes a $3,465 gain on theextinguishment of debt and a $4,967 loss for the write-off of debt issue costsrelated 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.

(4)             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 initialpublic offering, or the offering, in February 2005.

(5)             In connection with the offering we effected a 5.2773714for 1 reverse stock split of our common stock. All share and per share amountsrelated to our common stock have been restated to reflect the reverse stocksplit.

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

(7)             In connection with the offering, werepurchased all of our series A preferred stock from the holders thereof.

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

The following discussionshould be read in conjunction with our financial statements and the notesthereto included elsewhere in this Annual Report. The following discussionincludes certain forward-looking statements. For a discussion ofimportant factors, including the continuing development of our business,actions of regulatory authorities and competitors and other factors which couldcause actual results to differ materially from the results referred to in theforward-looking statements, see “Item 1A.—Risk Factors.”

**Overview**

We are a leading provider of communications servicesin rural communities, offering an array of services, including local and longdistance voice, data, Internet and broadband product offerings. We are one ofthe largest telephone companies in the United States focused on serving ruralcommunities and we are the 17th largest local telephone company, in each casebased on number of access lines. We operate in 17 states with 288,899 accessline equivalents in service as of December 31, 2005.

We were incorporated in February 1991 for thepurpose of acquiring and operating incumbent telephone companies in ruralmarkets. Since 1993, we have acquired 32 such businesses, 28 of which wecontinue to own and operate. Many of our telephone companies have served theirrespective communities for over 75 years. The majority of the ruralcommunities we serve have fewer than 2,500 access lines. All of our telephonecompanies qualify as rural local exchange carriers under the TelecommunicationsAct.

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

Access lines are an important element of our business.Historically, rural telephone companies have experienced consistent growth inaccess lines because of positive demographic trends, insulated rural localeconomies and little competition. Recently, however, many rural telephonecompanies have experienced a loss of access lines due to challenging economicconditions, increased competition and the introduction of 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.

Despite our net loss of voice access lines, we havegenerated growth in our revenues each year since 2001. We have accomplishedthis by providing our customers with services not previously available in mostof our markets, such as enhanced voice services and data services, includingdigital subscriber line services, and through acquisitions.

During 2005, 17 of our operating companies wereconverted to a single outsourced billing platform. On October 7, 2005, welearned that the billing service bureau used by us for these 17 operatingcompanies had contracted to sell the software underlying our billing system andagreed not to add any future customers to its service bureau platform. Inaddition to the short term difficulties we experienced during 

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the billing conversion,this potential sale raised concerns about the long-term reliability of theservice bureau. On November 7, 2005, we reached an agreement with thisoutsourced service bureau to transition to another service provider of ourchoice by December 31, 2006. As part of this settlement, we will receive$4.0 million in cash as compensation from the outsourced billing provider inorder to relieve it from its responsibilities under the original service bureaucontract. In addition, we do not have to pay an additional $1.1 million whichwas scheduled to be paid to the service provider. We have selected MACC as ournew provider of billing services. We expect to complete the conversion of 17 ofour operating companies, or approximately two thirds of our access lines, bythe middle of 2006 and the remaining companies by the middle of 2007.

Our dividend policy reflectsour judgment that our stockholders would be better served if we distributed asubstantial portion of the cash generated by our business in excess ofoperating needs, interest and principal payments on our indebtedness, dividendson future senior classes of our capital stock, if any, capital expenditures,taxes and future reserves, if any, as regular quarterly dividend payments tothe holders of our common stock, rather than retained and used such cash forother purposes.

We are subject toregulation primarily by federal and state governmental agencies. At the federallevel, the FCC has jurisdiction over interstate and internationalcommunications services. State telecommunications regulators exercisejurisdiction over intrastate communications services.

**Our Initial Public Offering**

On February 8, 2005, we consummated our initialpublic offering of 25,000,000 shares of our common stock at a price to thepublic of $18.50 per share. In connection with the offering, we entered into anew senior secured credit facility with a syndicate of financial institutions,including Deutsche Bank Trust Company Americas, as administrative agent, whichwe refer to as our credit facility.

We used the grossproceeds of $462.5 million from the offering together with borrowings of$566.0 million under the term facility of our credit facility as follows:

·       $176.7 millionto repay in full all outstanding loans under our old credit facility (includingaccrued interest);

·       $122.1 millionto repurchase $115.0 million aggregate principal amount of our 9 1¤2% senior subordinated notes due2008, which we refer to as the 9 1¤2% notes, pursuant to the tenderoffer and consent solicitation for such notes (including accrued interest,tender premiums and consent payments);

·       $51.8 millionto repurchase $50.8 million aggregate principal amount of our floatingrate callable securities due 2008, which we refer to as the floating ratenotes, pursuant to the tender offer and consent solicitation for such notes(including accrued interest, tender premiums and consent payments);

·       $193.4 millionto repurchase $173.1 million aggregate principal amount of our 12 1¤2% senior subordinated notes due2010, which we refer to as the 12 1¤2% notes, pursuant to the tenderoffer and consent solicitation for such notes (including accrued interest,tender premiums and consent payments);

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·       $274.9 millionto repurchase $223.0 million aggregate principal amount of our 117¤8%senior notes due 2010, which we refer to as 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 our series A preferred stock (together with accruedand unpaid dividends thereon) from the holders thereof;

·       $10.6 millionto repay a substantial portion of our subsidiaries’ outstanding long-term debt(including accrued interest);

·       $7.0 millionto repay in full a promissory note issued by us in connection with a pastacquisition;

·       $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 withour credit facility and a transaction fee of approximately $8.4 millionpaid to Kelso & Company, one of our investors.

On March 10, 2005, we used the $18.4 millionwhich we had invested in temporary investments, together with $6.6 millionof cash on hand, to redeem the $0.2 million aggregate principal amount ofthe 9 1¤2% notes (including accruedinterest and redemption premiums) that were not tendered in the tender offersfor such notes and the $24.2 million aggregate principal amount of thefloating rate notes (including accrued interest) that were not tendered in thetender offer for such notes.

On May 2, 2005, we used $22.5 million ofborrowings under the delayed draw facility of our credit facility to redeem theremaining $19.9 million aggregate principal amount of the 12 1¤2% notes (including accruedinterest and redemption premiums) that were not tendered in the tender offerfor such notes.

**Revenues**

We derive ourrevenues from:

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

·       *Universal Service Fund high cost loop support*.   Wereceive payments from the Universal Service Fund to support the high cost ofour operations in rural markets. This revenue stream fluctuates based upon ouraverage cost per loop compared to the national average cost per loop. Forexample, 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 theUniversal Service Fund would increase. The national average cost per loop inrelation to our average cost per loop has increased, and we believe that thenational average cost per loop will likely continue to increase in relation toour average cost per loop. As a result, the payments we receive from theUniversal Service Fund have declined and will likely continue to decline.

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

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

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

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

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

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

| ** **                             | ** ** | **Year ended December 31,** | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                             | ** ** | **Revenue (in thousands)**       | ** ** | **% of Revenue**                 | ** ** |
| Local calling  services                |       | $                                          | 65,105     |                                       | $          | 63,150 |   | $ | 56,078 |   |   | 25 | % |   |   | 25 | % |   |   | 24 | % |   |
| Universal Service  Fund high cost loop |       | 19,737                                     |       | 22,151                                     |       | 18,903 |   |   | 8 |   |   |   | 9 |   |   |   | 8 |   |   |
| Interstate access                      |       | 75,287                                     |       | 70,297                                     |       | 66,564 |   |   | 29 |   |   |   | 28 |   |   |   | 29 |   |   |
| Intrastate access                      |       | 40,009                                     |       | 42,389                                     |       | 43,969 |   |   | 15 |   |   |   | 17 |   |   |   | 19 |   |   |
| Long distance  services                |       | 20,868                                     |       | 17,766                                     |       | 15,440 |   |   | 7 |   |   |   | 7 |   |   |   | 7 |   |   |
| Data and Internet  services            |       | 24,168                                     |       | 19,054                                     |       | 13,431 |   |   | 9 |   |   |   | 7 |   |   |   | 6 |   |   |
| Other services                         |       | 17,669                                     |       | 17,838                                     |       | 17,047 |   |   | 7 |   |   |   | 7 |   |   |   | 7 |   |   |
| Total                                  |       | $                                          | 262,843    |                                       | $          | 252,645 |   | $ | 231,432 |   |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |

 

**Operating Expenses**

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

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

·       Depreciationand amortization includes depreciation of our communications network andequipment.

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

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**Acquisitions**

We intend tocontinue to pursue selective acquisitions:

·       OnJanuary 25, 2006, we agreed to purchase the assets of Cass CountyTelephone Company Limited Partnership, or Cass County Telephone, forapproximately $33.0 million in cash, subject to adjustment. Cass CountyTelephone serves approximately 8,600 access line equivalents in Missouri andKansas. This acquisition is expected to close in the second quarter of 2006after regulatory approvals.

·       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), subject toadjustment. Berkshire is an independent local exchange carrier that providesvoice communication, cable and internet services to over 7,200 access line equivalents,as of the date of acquisition, serving five communities in New York State.Berkshire’s communities of service are adjacent to those of Taconic TelephoneCorp., one of the Company’s subsidiaries.

·       OnSeptember 1, 2005, we completed the acquisition of BentleyvilleCommunications Corporation,  orBentleyville, for approximately $11.0 million (or $9.3 million net of cashacquired), subject to adjustment. Bentleyville, which had approximately 3,600access line equivalents at the date of acquisition, providestelecommunications, cable and internet services to rural areas of SouthwesternPennsylvania which are adjacent to our existing operations in Pennsylvania.

·       During2004 we did not complete any acquisitions.

·       OnDecember 1, 2003, we purchased all of the capital stock of CommunityService Telephone Co. and Commtel Communications Inc., which we refer to as theMaine acquisition. Community Service Telephone and Commtel Communicationsprovided communication services to approximately 13,280 access line equivalentsin central Maine as of the date of such acquisition.

·       During2002, 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.

**Stock Based Compensation**

In February 2005 and September 2005, weissued 473,716 shares and 50,000 shares, respectively, of restricted stockunder our 2005 Stock Incentive Plan to our employees. Also, during 2005, 53,687shares of restricted stock were forfeited bringing the total number ofrestricted shares outstanding under the 2005 Stock Incentive Plan to 470,029shares. At December 31, 2005, 467,654 shares of our common stock may beissued in the future pursuant to awards authorized under our 2005 StockIncentive Plan which could result in an additional compensation expense. In thesecond quarter of 2005, our board of directors approved an annual award to eachof our non-employee directors in the form of restricted stock or restrictedunits, at the recipient’s option, which will vest on a quarterly basis, issuedunder the Company’s 2005 Stock Incentive Plan. The 2005 non-employee directorawards began to vest on July 1, 2005. During 2005, we granted 1,870 sharesof restricted stock with a total value at the grant date of approximately$30,000 and 7,480 restricted units with a total value at the grant date ofapproximately $120,000 to our non-employee directors. An additional 408restricted units were granted in 2005 in lieu of dividends on the restrictedunits. In addition, we granted restricted units to certain employees in December 2003of which 

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26,442 remain outstandingat December 31, 2005. Non-cash compensation charges associated withrestricted units and restricted stock were $2.4 million for the twelvemonths ended December 31, 2005. We did not recognize any additionalcharges associated with the stockholder appreciation rights that were settledin 2005.

Non-cashcompensation charges associated with restricted units totaled $49,000 in 2004. Thesecharges consisted of compensation charges of $0.2 million for restricted units,a charge of $0.3 million in connection with the modification of employee stockoptions and a non-cash benefit of $0.4 million associated with the reduction inestimated fair market value of stockholder appreciation rights. Non-cashcompensation charges in 2003 were not material, primarily due to the fact thatthe fair market value per share of our common stock remained relatively stable.

**Discontinued Operations**

On September 30, 2003, MJD Services Corp., or MJDServices, a wholly-owned subsidiary of the Company, completed the sale of allof the capital stock owned by MJD Services of Union Telephone Company ofHartford, Armour Independent Telephone Co., WMW Cable TV Co. and KadokaTelephone Co. to Golden West Telephone Properties, Inc. The sale wascompleted in accordance with the terms of the South Dakota purchase agreement.MJD Services received approximately $24.2 million in proceeds from theSouth Dakota disposition. The companies sold to Golden West providedcommunication services to approximately 4,150 voice access lines located inSouth Dakota as of the date of such disposition. The operations of thesecompanies were presented as discontinued operations beginning in the secondquarter of 2003. Therefore, the balances associated with these activities werereclassified as “held for sale.” All prior period financial statements havebeen restated accordingly. We recorded a gain on disposal of the South Dakotacompanies of $7.7 million during the third quarter of 2003.

In November 2001, we decided to discontinue thecompetitive local exchange carrier operations of FairPoint Carrier Services, Inc.,or Carrier Services. This decision was a proactive response to thedeterioration in the capital markets, the general slow-down of the economy andthe slower-than-expected growth in Carrier Services’ competitive local exchangecarrier operations. Carrier Services now provides wholesale long distanceservices and support to our rural local exchange carriers and communicationsproviders not affiliated with us. These services allow such companies tooperate their own long distance communication services and sell such servicesto their respective customers. Our long distance business is included as partof continuing operations in the accompanying financial statements.

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

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**Results of Operations**

Thefollowing table sets forth the percentages of revenues represented by selecteditems reflected in our consolidated statements of operations. The year to yearcomparison of financial results are not necessarily indicative of futureresults:

| ** **                                                                                | ** ** | **Year Ended December 31,** | ** ** | **Year Ended December 31,** | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                   | ** ** | **% of revenue**                 | ** ** | **2004**                                   | ** ** | **% of revenue** | ** ** | **2003** | ** ** | **% of revenue** | ** ** |
| Revenues                                                                                  |       | $                                          | 262,843    |                                       |       | 100.0                                      | %          |   | $ | 252,645 |   |   | 100.0 | % |   | $ | 231,432 |   |   | 100.0 | % |   |
| Operating expenses, excluding depreciation and  amortization and stock-based compensation |       | 141,075                                    |       |                                       | 53.7       |                                       |       | 128,755 |   |   | 50.9 |   |   | 111,188 |   |   | 48.0 |   |   |
| Depreciation and amortization                                                             |       | 52,390                                     |       |                                       | 19.9       |                                       |       | 50,287 |   |   | 19.9 |   |   | 48,089 |   |   | 20.8 |   |   |
| Stock based compensation                                                                  |       | 2,350                                      |       |                                       | 0.9        |                                       |       | 49 |   |   | 0.1 |   |   | 15 |   |   | — |   |   |
| Total operating expenses                                                                  |       | 195,815                                    |       |                                       | 74.5       |                                       |       | 179,091 |   |   | 70.9 |   |   | 159,292 |   |   | 68.8 |   |   |
| Income from operations                                                                    |       | 67,028                                     |       |                                       | 25.5       |                                       |       | 73,554 |   |   | 29.1 |   |   | 72,140 |   |   | 31.2 |   |   |
| Other income  (expense):                                                                  |       |                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net gain (loss) on sale of investments and other  assets                                  |       | (11                                        | )          |                                       | —     |                                       |       | 104 |   |   | — |   |   | 608 |   |   | 0.3 |   |   |
| Interest and dividend income                                                              |       | 2,499                                      |       |                                       | 1.0        |                                       |       | 2,335 |   |   | 0.9 |   |   | 1,792 |   |   | 0.8 |   |   |
| Interest expense                                                                          |       | (46,416                                    | )          |                                       | (17.7      | )                                          |       | (104,315 | ) |   | (41.3 | ) |   | (90,224 | ) |   | (39.0 | ) |   |
| Impairment of investments                                                                 |       | (1,200                                     | )          |                                       | (0.5       | )                                          |       | (349 | ) |   | 0.1 |   |   | - |   |   | — |   |   |
| Equity in net earnings of investees                                                  |       | 11,302                                     |       |                                       | 4.3        |                                       |       | 10,899 |   |   | 4.3 |   |   | 10,092 |   |   | 4.4 |   |   |
| Realized and unrealized losses on interest rate  swaps                                    |       | —                                     |       |                                       | —     |                                       |       | (112 | ) |   | — |   |   | (1,387 | ) |   | (0.6 | ) |   |
| Other nonoperating, net                                                                   |       | (87,746                                    | )          |                                       | 33.4       |                                       |       | (5,951 | ) |   | (2.5 | ) |   | (1,505 | ) |   | (0.7 | ) |   |
| Total other expense                                                                       |       | (121,572                                   | )          |                                       | 46.3       |                                       |       | (97,389 | ) |   | (38.5 | ) |   | (80,624 | ) |   | (34.8 | ) |   |
| Loss from continuing operations before income taxes                                       |       | (54,544                                    | )          |                                       | (20.8      | )                                          |       | (23,835 | ) |   | (9.4 | ) |   | (8,484 | ) |   | (3.6 | ) |   |
| Income tax benefit (expense)                                                              |       | 83,096                                     |       |                                       | 31.6       |                                       |       | (516 | ) |   | (0.2 | ) |   | 236 |   |   | 0.1 |   |   |
| Minority interest in income of subsidiaries                                               |       | (2                                         | )          |                                       | —     |                                       |       | (2 | ) |   | — |   |   | (2 | ) |   | — |   |   |
| Income (loss)  from continuing operations                                                 |       | 28,550                                     |       |                                       | 10.9       | %                                          |       | $ | (24,353 | ) |   | (9.6 | )% |   | $ | (8,250 | ) |   | (3.5 | )% |   |
|                                                                                           |            |                                            |            |                                            |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

***Revenues***

*Revenues.*   Revenuesincreased $10.2 million to $262.8 million in 2005 compared to $252.6 million in2004. Of this increase, $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:

*Localcalling services.*   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 local callingfeatures and local interconnection revenues, despite a 2.5% decline in netvoice access lines.

*UniversalService Fund high cost loop support.*   UniversalService Fund high cost loop payments decreased $2.4 million to $19.7 million in2005. 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. Weexpect this trend to continue as we anticipate the national average cost perloop will likely continue to increase in relation to our average cost per loop.

*Interstateaccess.**  *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.

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

*Longdistance services.*   Long distance servicesrevenues increased $3.1 million to $20.9 million in 2005 compared to 2004. Thisincrease was attributable primarily to our existing operations as a result ofpromotional efforts and bundles with unlimited long distance designed togenerate more revenue.

*Dataand Internet services.*   Data and internetservices revenues increased $5.1 million to $24.2 million in 2005 from $19.1million in 2004. The increase is due primarily to increases in DSL customers aswe continue to aggressively market our high speed data services. Our high speeddata subscriber customer base as of December 31, 2005, increased to 45,283subscribers compared to 34,824 subscribers as of December 31, 2004,a 30% increase during this period. The Bentleyville and Berkshireacquisitions contributed the remaining 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 acquisitions, other services revenue decreased $1.5million. A portion of this decrease from existing operations was due to a $1.2million one-time sale and installation of E911 system equipment in 2004. Theremaining decrease was due to reductions in billing and collections revenues,as interexchange carriers continue to take back the billing function for theirmore significant long distance customers. We expect this billing andcollections trend to continue.

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***Operating Expenses***

*Operatingexpenses and cost of goods sold, excluding depreciation and amortization.*   Operatingexpenses increased $12.3 million to $141.1 million in 2005 compared to 2004. Ofthe increase, $9.3 million is related to our existing operations and $3.0million 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. Expenses related to high speeddata 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. The balance of theincrease is attributable to smaller miscellaneous items.

*Depreciationand amortization.*   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.

*Stockbased compensation.*   For the year ended December 31,2005, stock based compensation increased $2.3 million to $2.4 million in 2005primarily due to the issuance of restricted stock and restricted units tocertain key employees and directors under the 2005 Stock Incentive Plan.

*Incomefrom operations.*   Income from operationsdecreased $6.5 million to $67.0 million in 2005 compared to 2004. This decreaseis principally due to the increase in expenses discussed above.

*Otherincome (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 150. In connection with the offering,we also refinanced our old credit facility and repurchased and/or redeemed the9 1¤2%notes, the floating rate notes, the 12 1¤2% notes andthe 11 7¤8%notes, which resulted in significant charges of $87.7 million due to feesand penalties paid on the repurchase/redemption and for the write-off ofunamortized debt issuance costs. Earnings from equity investments increased$0.4 million to $11.3 million in 2005. For the twelve months ended December 31,2004, other non-operating income (expense) includes the write-off of debtissuance and offering costs of $6.0 million associated with an abandoned offeringof Income Deposit Securities.

*Incometax expense.*   In 2005, income tax benefits of$83.1 million are 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 taxable incomefollowing the recapitalization. The income tax benefit for 2005 also includesdeferred tax benefits of $29.3 million related to the extinguishment of debtand $1.6 million for an adjustment of our net deferred tax assets to anexpected federal income tax rate of 35% from 34%, in anticipation of higherlevels of taxable income in subsequent periods. These benefits were partiallyoffset by income tax expense associated with taxable income generated followingthe recapitalization. During the twelve months ended December 31, 2004,the income tax expense related primarily to income taxes owed in certainstates.

*Discontinuedoperations.*   During the twelve months ended December 31,2005 and 2004, we recorded a reduction to our liability associated with the discontinuationof our competitive local exchange carrier 

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operations, which, net oftax, resulted in a $0.4 million and $0.7 million adjustment to income fromdiscontinued operations, respectively. The adjustment in 2005 related to thesettlement of a lease obligation which reduced our future obligation under thislease. In 2004, the adjustment was mainly attributable to excise tax refundsreceived from the Internal Revenue Service as well as a reduction inliabilities associated with potential 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.

***Year Ended December 31, 2004 Compared with YearEnded December 31, 2003***

***Revenues***

*Revenues.*   Revenuesincreased $21.2 million to $252.6 million in 2004 compared to $231.4 million in2003. Of this increase, $8.2 million was attributable to the Maine acquisitionand $13.0 million was attributable to our existing operations. We derived ourrevenues from the following sources:

*Localcalling services.*   Local calling service revenuesincreased $7.1 million from $56.1 million in 2003 to $63.2 million in 2004.Revenue from our existing operations increased $4.2 million. Of this increase,$3.6 million is attributable to the implementation of Basic Service CallingAreas in the state of Maine, which changes and expands basic service callingareas and has the effect of shifting revenues from intrastate access to localservices. The remaining increase of $0.6 million in local revenues fromexisting operations is due to increases in local calling features and localinterconnection revenues, despite a 2.9% decline in net voice access lines. Theremaining increase in local calling service revenues was attributable to theMaine acquisition.

*UniversalService Fund high cost loop support.*   UniversalService Fund high cost loop payments increased $3.3 million to $22.2 million in2004 from $18.9 million in 2003. Our existing operations accounted for all ofthis increase. A reclassification of plant increased our Universal Service Fundpayments in our Maine and Idaho companies which more than offset a drop inpayments from the Universal Service Fund related to increases in the nationalaverage cost per loop.

*Interstateaccess.**  *Interstateaccess revenues increased $3.7 million from $66.6 million in 2003 to $70.3million in 2004. Of the increase, $3.1 million was attributable to the Maineacquisition. Our existing operations accounted for the remaining $0.6 millionincrease. This increase was due to expense increases from our regulatedoperations that resulted in higher interstate revenue requirements.

*Intrastateaccess.*   Intrastate access revenues decreasedfrom $44.0 million in 2003 to $42.4 million in 2004. The decrease from ourexisting operations was $2.6 million before being offset by $1.0 million inrevenues contributed by the Maine acquisition. The decrease was mainlyattributable to the Basic Service Calling Areas plan implemented in Maine asdiscussed above in local calling services.

*Longdistance services.*   Long distance servicesrevenues increased $2.3 million from $15.4 million in 2003 to $17.7 million in2004. This increase was all attributable to our existing operations as a resultof promotional efforts and bundles with unlimited long distance designed togenerate more revenue.

*Dataand Internet services.*   Data and internetservices revenues increased $5.7 million from $13.4 million in 2003 to $19.1million in 2004. The increase is due primarily to increases in DSL customers aswe aggressively marketed our high speed data products. Our high speed datasubscriber customer base increased to 34,824 subscribers as of December 31,2004, a 78% increase during the year. The Maine acquisition contributedthe remaining revenue increase of $0.6 million.

*Other services.*   Otherservices revenues increased from $17.0 million in 2003 to $17.8 million in 2004.Of the increase, $0.6 million was attributable to the Maine acquisition. Anincrease of $0.2 million from existing operations was due to a $1.2 millionone-time sale and installation of E911 system equipment. This 

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was offset byapproximately $1.0 million of reductions in billing and collections revenues,as inter-exchange carriers continued to take back the billing function fortheir more significant long distance customers.

***Operating Expenses***

*Operatingexpenses and cost of goods sold, excluding depreciation and amortization.*   Operatingexpenses increased $17.6 million to $128.8 million in 2004 from $111.2 millionin 2003. Of the increase, $13.5 million is related to our existing operationsand $4.1 million is related to expenses of the companies we acquired in 2003 inthe Maine acquisition. Wages and benefits increased $4.4 million due to meritsalary increases, an increase in our bonus compensation and an increase in thenumber of our employees compared to a year ago. Network operations expense,wholesale digital subscriber line charges and transport and network costsassociated with our broadband initiatives increased $4.0 million. Cost of goodssold associated with the one-time sale and installation of E911 systemequipment was $1.0 million in 2004. Bad debt expense was $1.6 million higher in2004 than 2003 due primarily to a recovery received in 2003. Marketing andpromotion expenses increased $0.6 million due to higher levels of activityrelated to the promotion of custom calling features, data services and otherproducts. Billing costs have increased $1.0 million as we incurred costsassociated with the conversion of our billing systems into an integratedplatform. The balance of the increase is attributable to smaller miscellaneousitems.

*Depreciationand amortization.*   Depreciation and amortizationfrom continuing operations increased $2.2 million to $50.3 million in 2004 from$48.1 million in 2003. The Maine acquisition accounted for $1.2 million of theincrease and $0.3 million was attributable to the increased investment in ourcommunications network for existing operations we acquired prior to 2003. Theother $0.7 million was related to accelerated depreciation on wirelessequipment due to a decision to exit certain wireless markets.

*Stockbased compensation.*   For the year ended December 31,2004, stock based compensation of $49,000 was incurred as a result ofmodification of an employee stock option agreement with an executive officer,offset by the decrease in the estimated value of fully vested stockholderappreciation rights agreements. The restricted units issued in December of2003 resulted in a compensation charge of $0.2 million. Stock basedcompensation for the year ended December 31, 2003 was $15,000.

*Incomefrom operations.*   Income from operationsincreased $1.5 million to $73.6 million in 2004 from $72.1 million in 2003. A$1.5 million decrease attributable to our existing operations was offset by a$3.0 million increase attributable to the Maine acquisition.

*Otherincome (expense).*   Total other expense increased$16.8 million to $97.4 million in 2004 from $80.6 million in 2003. The increaseconsisted primarily of interest expense on long-term debt, which increased$14.1 million to $104.3 million in 2004 from $90.2 million in 2003, which wasmainly attributable to the extinguishment of debt in connection with ourissuance of the 11 7¤8%notes during the first quarter of 2003 and the adoption of Statement ofFinancial Accounting Standards 150 as of July 1, 2003, the latter of whichresulted in our recording $20.2 million in interest expense related todividends and accretion on our series A preferred stock for the year ended December 31,2004 compared to $9.0 million for the year ended December 31, 2003. Earningsfrom equity investments increased $0.8 million to $10.9 million in 2004 from$10.1 million in 2003. For the twelve months ended December 31, 2004,other non-operating income (expense) includes the write-off of debt issuanceand offering costs of $6.0 million associated with an abandoned offering ofIncome Deposit Securities. For the year ended December 31, 2003, othernon-operating income (expense) of $1.5 million represents the net loss on theextinguishment of debt and expenses related to the loss on the write-off ofloan origination costs. In conjunction with the issuance of $225.0 million ofthe 117¤8%notes during the first quarter of 2003, we recorded $3.5 million innon-operating gains on the extinguishment of a portion of the 9 1¤2% notes, the12 1¤2%notes and loans under 

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Carrier Services’ creditfacility. These gains were offset by a non-operating loss of $5.0 million forthe write-off of debt issue costs related to this extinguishment of debt in2003.

Thefollowing is a summary of amounts included in realized and unrealized gains(losses) on interest rate swaps (dollars in thousands):

| ** **                                                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Change in fair  value of interest rate swaps                                             |       | $        | 874        |     | $          | 7,693 |   |
| Reclassification  of transition adjustment included in other comprehensive income (loss) |       | (103     | )          | (1,029   | )          |
| Realized losses                                                                          |       | (883     | )          | (8,051   | )          |
| Total                                                                                    |       | $        | (112       | )        | $          | (1,387 | ) |

 

*Incometax expense.*   Income tax expense from continuingoperations increased $0.7 million to $0.5 million in 2004 from a benefit of$0.2 million in 2003. The income tax expense relates primarily to income taxesowed in certain states offset by investment tax credits in certain states.

*Discontinuedoperations.*   Net income from discontinuedoperations of our existing operations sold in the South Dakota disposition was$1.9 million in 2003. The companies were sold on September 30, 2003 andresulted in the recognition of a gain on disposal of the discontinuedoperations of $7.7 million during 2003. During the twelve months ended December 31,2004 and 2003, we recorded a reduction to our liability associated with thediscontinuation of our competitive local exchange carrier operations of $0.7million and $0.3 million, respectively. This was mainly attributable to excisetax refunds received from the Internal Revenue Service as well as a reductionin liabilities associated with potential property tax payments.

*Net income (loss).*   Netloss attributable to common stockholders for the year ended December 31,2004 was $23.7 million. Our 2003 net loss attributable to common shareholderswas $4.3 million after giving effect to $8.9 million in dividends and accretionrelated to our series A preferred stock and the repurchase of our series Apreferred stock at a discount of $2.9 million. The difference between 2004 and2003 is a result of the factors discussed above.

**Liquidity and Capital Resources**

Our short-term and long-term liquidity needs ariseprimarily from: (i) interest payments primarily related to our creditfacility; (ii) capital expenditures; (iii) working capitalrequirements as may be needed to support the growth of our business; (iv) dividendpayments on our common stock; and (v) potential acquisitions. Our board ofdirectors has adopted a dividend policy which reflects our judgment that ourstockholders would be better served if we distributed a substantial portion ofour cash available for distribution to them instead of retaining it in ourbusiness.

We expect to fund our operations, interest expense,capital expenditures, working capital requirements and dividend payments on ourcommon stock 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, to arrange additional funding through the sale of public or privatedebt and/or equity securities, or obtain additional senior bank debt.

For the years ended December 31, 2005, 2004 and2003, net cash provided by operating activities of continuing operations was$61.7 million, $46.0 million and $32.8 million, respectively.The increase in net cash provided by operating activities in 2005 was primarilydue to a decrease in accrued interest resulting from our recapitalization inFebruary 2005.

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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 to refinanceall or a portion of our indebtedness on or before maturity. We may not be ableto refinance our indebtedness on commercially reasonable terms or at all. If wewere unable to renew or refinance our credit facility, our failure to repay allamounts due on the maturity date would cause a default under our creditfacility. In addition, borrowings under our credit facility bear interest atvariable interest rates. On February 8, 2005, we entered into threeinterest rate swap agreements, with notional amounts of $130.0 millioneach, to effectively convert a portion of our variable rate interest exposureto fixed rates ranging from 3.76% to 4.11%, plus a 2.0% margin. These swapagreements expire beginning December 31, 2007 through December 31,2009. On April 7, 2005, we entered into two additional interest rate swapagreements, one with the notional amount of $50.0 million to effectivelyconvert a portion of our variable rate interest exposure to a fixed rate of4.69%, plus a 2.0% margin, beginning on April 29, 2005 and ending on March 31,2011, and one with the notional amount of $50.0 million to effectivelyconvert a portion of our variable rate interest exposure to a fixed rate of4.72%, plus a 2.0% margin, beginning on June 30, 2005 and ending on March 31,2012.

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 0.75% for Base rate loans. This amendment also effectively reducedthe fixed interest rates on our interest rate swap agreements by 0.25%.

As a result of these swapagreements, as of December 31, 2005, approximately 82% of our indebtednessbore interest at fixed rates rather than variable rates. After these interestrate swap agreements expire, our annual debt service obligations on suchportion of the term loans will vary from year to year unless we enter into anew interest rate swap or purchase an interest rate cap or other interest ratehedge. To the extent interest rates increase in the future, we may not be ableto enter into new interest rate swaps or to purchase interest rate caps orother interest rate hedges on acceptable terms. An increase of 10% in theannual interest rates on our variable rate indebtedness (excluding variablerate indebtedness which has its interest rate effectively fixed under interestrate swap agreements) would result in an increase of approximately$0.7 million in our annual cash interest expense. To the extent interestrates increase in the future, we may not be able to enter into a new interestrate swap or to purchase an interest rate cap or other interest rate hedge onacceptable terms.

Based on the dividendpolicy with respect to our common stock, we may not have any significant cashavailable to meet any unanticipated liquidity requirements, other thanavailable borrowings, if any, under 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.

We used net proceedsreceived from the offering, together with approximately $566.0 million ofborrowings under the term loan facility of our credit facility, to, among otherthings, repay all outstanding loans under our old credit facility, repurchaseall of our series A preferred stock and consummate tender offers andconsent solicitations in respect of our outstanding 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 1, 2005 with borrowings under the delayed draw facility ofour credit facility.

Net cash used in investingactivities of continuing operations was $42.8 million, $21.0 millionand $54.0 million for the years ended December 31, 2005, 2004 and2003, respectively. These cash flows primarily reflect capital expenditures of$28.1 million, $36.5 million and $33.6 million for the yearsended December 31, 2005, 2004 and 2003, respectively, and acquisitions oftelephone properties, net of cash 

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acquired,of $25.7 million and $33.1 million for the years ended December 31,2005 and December 31, 2003. There were no acquisitions during 2004.

Offsetting capitalexpenditures were distributions from investments of $10.9 million,$15.0 million and $10.8 million for the years ended December 31,2005, 2004 and 2003, respectively. The $15.0 million received in 2004included a one time $2.5 million distribution from our equity interest inChouteau Cellular Telephone Company as the partnership sold the majority of itsassets. In addition, distributions for the twelve months ended December 31,2005 included $10.0 million from our equity interest in Orange CountyPoughkeepsie Limited Partnership as compared to $11.8 million during thetwelve months ended December 31, 2004. The distributions declined mainlydue to the timing of an additional distribution in 2004. All of thesedistributions represent passive ownership interests in partnership investments.We do not control the timing or amount of distributions from such investments.

Net cash used in financingactivities from continuing operations was $16.6 million,$24.0 million and $2.0 million for the years ended December 31,2005, 2004 and 2003, respectively. For the year ended December 31, 2005,net proceeds from the issuance of common stock of $431.9 million was usedfor the net repayment of long term debt of $205.7 million and therepurchase of series A preferred stock and common stock of $129.3 million.The remaining 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 offering related costs. For the yearended December 31, 2003, net proceeds from the issuance of long term debtof $23.3 million were offset by debt issuance costs of $15.6 millionand the repurchase of our series A preferred stock and class A commonstock of $8.6 million.

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$28.1 million, $36.5 million and $33.6 million for the yearsended December 31, 2005, 2004 and 2003, respectively.

We expect that our annualcapital expenditures for our existing operations will be approximately $28.0 to$30.0 million for fiscal 2006. We expect to fund all of these capitalexpenditures through our cash flow from operations. If cash is available beyondwhat is required to support our dividend policy, we may consider additionalcapital expenditures if we believe they are beneficial. Although the amount ofour capital expenditures can fluctuate from quarter to quarter, on an annual basiswe do not expect capital expenditures for our existing operations throughfiscal 2009 to vary significantly from our estimated amounts.

On January 5, 2006,we announced that we expect to receive proceeds of $26.7 million from theliquidation of our investment in the Rural Telephone Bank. We expect to receivethe proceeds in the middle of 2006. On February 20, 2006, we announcedthat we had entered into an agreement to sell our investment in SouthernIllinois Cellular Corp. Upon closing of this transaction, which is anticipatedto be in the second quarter of 2006, we expect to receive proceeds of $16 to$17 million. On January 25, 2006, we agreed to purchase the assets ofCass County Telephone for approximately $33.0 million in cash, subject toadjustment.

On May 2, 2005, weused borrowings under our credit facility’s revolving facility to fund theBerkshire acquisition (including the repayment of $1.3 million ofBerkshire’s debt). On September 1, 2005, we used borrowings under ourcredit facility’s revolving facility to fund the Bentleyville acquisition. Weexpect to fund the acquisition of Cass County Telephone through proceeds fromthe previously discussed asset sales and/or borrowings under our creditfacility’s revolving facility.

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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 termfacilities, a tranche A term loan facility of $40.0 million with$40.0 million outstanding at December 31, 2004 that was to mature on March 31,2007 and a tranche C term loan facility with $102.4 millionoutstanding as of December 31, 2004 that was to mature on March 31,2007. We repaid all of the borrowings under our old credit facility with aportion of net proceeds from the offering together with borrowings under ourcredit facility.

Our credit facilityconsists of a revolving facility, or the revolver, in a total principal amountof up to $100.0 million, of which $86.7 million was available at March 1,2006 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, 2006.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. Net borrowings under therevolver were $12.0 million from February 8, 2005 through March 1,2006 and were used primarily to fund the Berkshire acquisition and theBentleyville acquisition (including the repayment of $1.3 million ofBerkshire’s debt). A $1.3 million letter of credit was also outstanding asof March 1, 2006. Borrowings under ourrevolving facility bear interest, at our option, at either (i) theEurodollar rate plus 2.0% or (ii) a base rate, as such term is defined inthe credit agreement, plus 1.0%. 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 andto 0.75% for Base rate loans.

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 5.25:1. 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 are permitted topay dividends for the period from the closing date of the offering through July 30,2005. In addition, we may use all of our Cumulative Distributable Cash (asdefined in the credit facility) accumulated after April 1, 2005 to declareand pay dividends after July 30, 2005, but we may not in general paydividends in excess of such amount. On March 11, 2005, April 29, 2005and September 14, 2005, we entered into technical amendments to our creditfacility.

Our credit facilityrequires us first to prepay outstanding term loans under the credit facilityand, thereafter, to repay loans under the new revolver and/or to reducerevolver commitments (or commitments under the delayed draw facility) under thecredit facility with, subject to certain conditions and exceptions, 100% of thenet cash proceeds we receive from any sale, transfer or other disposition ofany assets, 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.

In 1998, the Companyissued $125.0 million aggregate principal amount of the 91¤2%notes and $75.0 million aggregate principal amount of the floating ratenotes. Both series of these notes were to mature on May 1, 2008. On February 9,2005, we repurchased $115.0 million principal amount of the 91¤2% notes and$50.8 million principal amount of the floating rate notes tenderedpursuant to the tender offers 

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for suchnotes. We redeemed the remaining outstanding 91¤2% notes andfloating rate notes on March 10, 2005.

In 2000, the Companyissued $200.0 million aggregate principal amount of the 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 the 117¤8%notes. These notes were to mature on March 1, 2010. These notes aregeneral unsecured obligations of the Company, ranking *pari passu* in right of payment with allexisting and future senior debt of the Company, including all obligations underour credit facility, and senior in right of payment to all existing and futuresubordinated indebtedness of the Company. On February 9, 2005, werepurchased $223.0 million principal amount of the 117¤8% notestendered pursuant to the tender offer for such notes. At December 31,2005, $2.1 million principal amount of the 117¤8% notesremains outstanding.

**Summaryof 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, 2005 and the periods in which payments aredue:

| ** **                         | ** ** | **Payments due by period** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1–3  years** | ** ** | **3–5  years** | ** ** | **More than  5 years** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)**      | ** ** |
| Contractual obligations:           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Long term debt                     |       | $                                         | 607,425    |   |   | $ | 677 |   |   | $ | 1,467 |   | $ | 2,359 |   | $ | 602,922 |   |
| Operating leases(1)                |       | 8,088                                     |       |   | 2,339 |   |   | 2,105 |   | 1,331 |   | 2,313 |   |
| Minimum purchase  contracts        |       | 2,438                                     |       |   | 1,878 |   |   | 477 |   | 83 |   | — |   |
| Total contractual cash obligations |       | $                                         | 617,951    |   |   | $ | 4,894 |   |   | $ | 4,049 |   | $ | 3,773 |   | $ | 605,235 |   |

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(1)          Real property leaseobligations of $1.2 million associated with the discontinued operationsdiscussed in note 13 to our consolidated financial statements are statedin this table at total contractual amounts. However, we have negotiated leaseterminations on these properties to reduce the total obligation. Operatingleases from continuing operations of $6.9 million are also included.

Thefollowing table discloses aggregate information about our derivative financialinstruments as of December 31, 2005, the source of fair value of theseinstruments and their maturities. 

| ** **                           | ** ** | **Fair Value of Contracts at Period-End** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Total**                                                          | ** ** | **Less than  1 year** | ** ** | **1–3 years** | ** ** | **3–5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)**                               | ** ** |
| Source of fair value:                |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Derivative  financial instruments(1) |       | $                                                                  | 8,779      |   |   | 3,130 |   |   |   | 5,429 |   |   |   | 207 |   |   |   | 13 |   |   |
|                                      |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Fairvalue of interest rate swaps at December 31, 2005 was provided by thecounterparties to the underlying contracts using consistent methodologies.

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**Critical Accounting Policies**

Our criticalaccounting policies are as follows:

·       Revenuerecognition;

·       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 ofthe Company’s telephone subsidiaries file interstate tariffs directly with theFederal Communication Commission using this streamlined filing approach. As of December 31,2005, 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 $1.6 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 ourdeferred tax assets will be recovered from future taxable income and to theextent we believe the recovery is not likely, we must establish a valuationallowance. Further, to the extent that we establish a valuation allowance orincrease this allowance in a financial accounting period, we must include a taxprovision, or reduce our tax benefit in our consolidated statement ofoperations. In performing the assessment, management considers the scheduledreversal of deferred tax liabilities, projected future taxable income, and taxplanning strategies. We use our judgment to determine our provision or benefitfor income taxes, deferred tax assets and liabilities and any valuationallowance recorded against our net deferred tax assets.

There are various factors that may cause those taxassumptions to change in the near term. We cannot predict whether future U.S.federal income tax laws and regulations might be passed that could have a 

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material effect on ourresults of operations. We assess the impact of significant changes to the U.S.federal and state income tax laws and regulations on a regular basis and updatethe assumptions and estimates used to prepare our financial statements when newregulation and legislation is enacted.

Based on certain assumptions, we had$291.9 million in federal and state net operating loss carry forwards asof December 31, 2005. In February 2005, we completed the offeringwhich resulted in an “ownership change” within the meaning of the U.S. federalincome tax laws addressing net operating loss carry forwards, alternativeminimum tax credits and other similar tax attributes. As a result of suchownership change, there will be specific limitations on our ability to use ournet operating loss carry forwards and other tax attributes. In order to fullyutilize the deferred tax assets, mainly generated by the net operating losses,we will need to generate future taxable income of approximately $219 millionprior to the expiration of the net operating loss carry forwards beginning in2019 through 2025.

The valuation allowance for deferred tax assets as of December 31,2004 was $66.0 million. In assessing the realizability of deferred taxassets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during the periods in which those temporary differences becomedeductible. 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, we have reduced our aggregate long term debt and expect a significantreduction in its annual interest expense. When considered together with ourhistory of producing positive operating results and other evidence affectingthe recoverability of deferred tax assets, we expect that future taxable incomewill more likely than not be sufficient to recover net deferred tax assets. Therefore,the valuation allowance was reversed in the first quarter of 2005, subsequentto the offering.

***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 $481.3 million at December 31,2005. As part of the Berkshire and Bentleyville acquisitions, the Company hasrecorded intangible assets related to the acquired companies’ customerrelationships of $2.4 million and $1.4 million, respectively. These intangibleassets will be amortized over 15 years. The intangible assets are included inIntangible Assets on the Consolidated Balance Sheet.

We are required to performan annual impairment review of goodwill as required by Statement of FinancialAccounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets.No impairment of goodwill resulted from the annual valuation of goodwill.

**New Accounting Standards**

In December 2004, the FASB issued SFAS No. 123(R).This new standard requires companies to adopt the fair value methodology ofvaluing stock-based compensation and recognizing that valuation in thefinancial statements from the date of grant. Accordingly, the adoption of SFAS No. 123(R)’sfair value method is not expected to have a significant impact on our resultsof operations. However, had we adopted SFAS No. 123(R) in priorperiods, the impact of that standard would have approximated the impact of SFASNo. 123 as disclosed in Note 1(n). SFAS No. 123(R) also requiresthe benefits of tax deductions in 

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excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current literature. We expect to adoptthe provisions 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. The Company willadopt SFAS No. 123(R) effective January 1, 2006, with norestatement of any prior periods.

In March 2005, theFASB issued FIN 47, “Accounting for Conditional Asset Retirement Obligations,”an interpretation of FASB No. 143. FIN 47 clarifies that the term conditional asset retirement obligation asused in FASB No. 143 refers to a legal obligation to perform an assetretirement activity in which the timing or method of settlement are conditionalon a future  event that may or may not bewithin the control of the entity. FIN 47 also clarifies when an entity wouldhave sufficient information to reasonably estimate the fair value of an assetretirement obligation. FIN 47 is effective for the year ended December 31,2005. We account for our wireline operations under SFAS No. 71, “Accountingfor the Effects of Certain Types of Regulation”. Therefore, in accordance withfederal and state regulations, we are following the FCC’s Part 32accounting. As a result of our accounting under SFAS No. 71, the adoptionof FIN 47 had no impact on us.

**Inflation**

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

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

As of December 31, 2005, approximately 82% 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 rateindebtedness (excluding variable rate indebtedness which has its interest rateeffectively fixed under interest rate swap agreements) outstanding at December 31,2005 increased by 10%, our interest expense would have increased, and ourincome from continuing operations before taxes would have decreased, byapproximately $0.7 million for the twelve months ended December 31,2005.

We have entered into interest rate swaps to manage ourexposure to fluctuations in interest rates on our variable rate indebtedness.The fair value of these swaps was a net asset of approximately$8.8 million at December 31, 2005. The fair value indicates anestimated amount we would have received to cancel the contracts or transferthem to other parties. In connection with our credit facility, on February 8,2005, we entered into three interest rate swap agreements, with notionalamounts of $130.0 million each, to effectively convert a portion of ourvariable interest rate exposure to fixed rates ranging from 3.76% to 4.11%,plus a 2.0% margin. These swap agreements expire beginning December 31,2007 through December 31, 2009. On April 7, 2005, we entered into twoadditional interest rate swap agreements, one with the notional amount of$50.0 million which will fix the interest rate at 4.69%, plus a 2.0% marginbeginning on April 29, 2005 and ending on March 31, 2011 and one withthe notional amount of $50.0 million which will fix the interest rate at4.72%, plus a 2.0% margin, beginning on June 30, 2005 and ending on March 31,2012.

**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 0.75% for Base rate loans. This amendment also effectively reducedthe fixed interest rates on our interest rate swap agreements by 0.25%.**

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**ITEM 8.**                INDEPENDENTAUDITORS’ REPORT AND CONSOLIDATED FINANCIAL STATEMENTS

**INDEX TO FINANCIAL STATEMENTS**

| ** **                                                                                                                  | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| FAIRPOINT  COMMUNICATIONS, INC. AND SUBSIDIARIES:                                                                           |       |     |       |
| Report of Independent  Registered Public Accounting Firm                                                                    |       | 56       |       |
| CONSOLIDATED FINANCIAL  STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003:                               |       |     |       |
| Consolidated  Balance Sheets as of December 31, 2005 and 2004                                                          |       | 57       |       |
| Consolidated  Statements of Operations for the Years Ended December 31, 2005, 2004,  and 2003                          |       | 58       |       |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the Years Ended  December 31, 2005, 2004, and 2003 |       | 59       |       |
| Consolidated  Statements of Comprehensive Income (Loss) for the Years Ended  December 31, 2005, 2004, and 2003         |       | 60       |       |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2005, 2004,  and 2003                          |       | 61       |       |
| Notes to  Consolidated Financial Statements for the Years Ended December 31, 2005,  2004, and 2003                     |       | 63       |       |

 

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and StockholdersFairPoint Communications, Inc.:

We have audited the accompanying consolidated balancesheets of FairPoint Communications, Inc. and subsidiaries(the Company) as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations, stockholders’ equity (deficit),comprehensive income (loss), and cash flows for each of the years in the three-yearperiod ended December 31, 2005. These consolidated financial statementsare the responsibility of FairPoint Communications, Inc.’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

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, 2005 and 2004, and the results of theiroperations and their cash flows for each of the years in the three-yearperiod ended December 31, 2005 in conformity with U.S. generally acceptedaccounting principles.

As described in notes 1 and 8 to the consolidatedfinancial statements, the Company adopted the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities and Equity,*effective July 1, 2003.

/s/ KPMG LLP

Omaha, NebraskaMarch 13, 2006

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**FAIRPOINTCOMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Balance SheetsDecember 31, 2005 and 2004(in thousands, except share data)**

| **Assets**                                                                | ** ** | **2005**    | ** **  | **2004**     | ** ** |
|---------------------------------------------------------------------------|------------|-------------|-------------|--------------|------------|
| Current assets:                                                           |       |        |        |         |       |
| Cash                                                                      |       | $           | 5,083       |         | $          | 3,595 |   |
| Accounts receivable, net                                                  |       | 30,034      |        | 28,550       |       |
| Other receivables                                                         |       | 4,951       |        | 1,653        |       |
| Material and supplies                                                     |       | 4,285       |        | 3,866        |       |
| Prepaid and other                                                         |       | 1,786       |        | 1,939        |       |
| Notes receivable - related party                                          |       | —      |        | 1,000        |       |
| Deferred income tax                                                       |       | 29,190      |        | —       |       |
| Interest rate swaps                                                       |       | 3,129       |        | —       |       |
| Assets of discontinued operations                                         |       | 90          |        | 102          |       |
| **Total current assets**                                                  | ** ** | **78,548**  | ** **  | **40,705**   | ** ** |
| Property, plant, and equipment, net                                       |       | 242,617     |        | 252,262      |       |
| Goodwill                                                                  |       | 481,343     |        | 468,508      |       |
| Investments                                                               |       | 39,808      |        | 37,749       |       |
| Intangible assets, net                                                    |       | 3,662       |        | —       |       |
| Debt issue costs, net                                                     |       | 9,145       |        | 18,812       |       |
| Deferred income tax                                                       |       | 47,160      |        | —       |       |
| Interest rate swaps                                                       |       | 5,649       |        | —       |       |
| Other                                                                     |       | 207         |        | 1,100        |       |
| **Total assets**                                                          | ** ** | **$**       | **908,139** | ** **   | **$**      | **819,136** | ** ** |
| **Liabilities and Stockholders’  Equity (Deficit)**                  | ** ** | ** **  | ** **  | ** **   | ** ** |
| Current liabilities:                                                      |       |        |        |         |       |
| Accounts payable                                                          |       | $           | 12,030      |         | $          | 14,184 |   |
| Dividend payable                                                          |       | 13,789      |        | —       |       |
| Other accrued liabilities                                                 |       | 14,021      |        | 13,115       |       |
| Accrued interest payable                                                  |       | 288         |        | 16,582       |       |
| Accrued bonuses                                                           |       | 2,975       |        | 2,857        |       |
| Deferred Credits                                                          |       | 3,812       |        | —       |       |
| Current portion of long-term debt                                         |       | 677         |        | 524          |       |
| Demand notes payable                                                      |       | 338         |        | 382          |       |
| Liabilities of discontinued operations                                    |       | 2,495       |        | 2,262        |       |
| **Total current liabilities**                                             | ** ** | **50,425**  | ** **  | **49,906**   | ** ** |
| Long-term liabilities:                                                    |       |        |        |         |       |
| Long-term debt, net of current portion                                    |       | 606,748     |        | 809,908      |       |
| Preferred shares subject to mandatory redemption                          |       | —      |        | 116,880      |       |
| Other liabilities                                                         |       | 4,108       |        | 12,667       |       |
| Liabilities of discontinued operations                                    |       | —      |        | 1,580        |       |
| **Total long-term liabilities**                                           | ** ** | **610,856** | ** **  | **941,035**  | ** ** |
| Minority interest                                                         |       | 10          |        | 11           |       |
| Common stock subject to put options, 16 shares at  December 31, 2004 |       | —      |        | 1,136        |       |
| Stockholders’ equity  (deficit):                                     |       |        |        |         |       |
| Common stock:                                                             |       |        |        |         |       |
| Common stock                                                              |       | 350         |        | —       |       |
| Class A voting stock                                                 |       | —      |        | 86           |       |
| Class C nonvoting, convertible stock                                 |       | —      |        | 8            |       |
| Additional paid-in capital                                                |       | 590,131     |        | 198,519      |       |
| Unearned compensation                                                     |       | (6,475      | )           | —       |       |
| Accumulated other comprehensive income, net                               |       | 5,477       |        | —       |       |
| Accumulated deficit                                                       |       | (342,635    | )           | (371,565     | )          |
| **Total stockholders’ equity (deficit)**                             | ** ** | **246,848** | ** **  | **(172,952** | **)**      |
| **Total  liabilities and stockholders’ equity (deficit)**            | ** ** | **$**       | **908,139** | ** **   | **$**      | **819,136** | ** ** |

 

 

See accompanying notes to consolidated financial statements

57

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**FAIRPOINTCOMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Statements of OperationsYears ended December 31, 2005, 2004, and 2003(in thousands, except per share data)**

| ** **                                                                                | ** ** | **2005**   | ** **  | **2004**    | ** ** | **2003**    | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|-------------|-------------|------------|-------------|------------|
| **Revenues**                                                                              | ** ** | **$**      | **262,843** | ** **  | **$**      | **252,645** | ** ** | **$** | **231,432** | ** ** |
| Operating expenses:                                                                       |       |       |        |        |       |        |       |
| Operating expenses, excluding depreciation and amortization  and stock-based compensation |       | 141,075    |        | 128,755     |       | 111,188     |       |
| Depreciation and amortization                                                             |       | 52,390     |        | 50,287      |       | 48,089      |       |
| Stock-based compensation                                                                  |       | 2,350      |        | 49          |       | 15          |       |
| Total operating expenses                                                                  |       | 195,815    |        | 179,091     |       | 159,292     |       |
| **Income from operations**                                                                | ** ** | **67,028** | ** **  | **73,554**  | ** ** | **72,140**  | ** ** |
| Other income (expense):                                                                   |       |       |        |        |       |        |       |
| Net gain (loss) on sale of investments and other  assets                                  |       | (11        | )           | 104         |       | 608         |       |
| Interest and dividend income                                                              |       | 2,499      |        | 2,335       |       | 1,792       |       |
| Interest expense                                                                          |       | (46,416    | )           | (104,315    | )          | (90,224     | )          |
| Impairment on investments                                                                 |       | (1,200     | )           | (349        | )          | —      |       |
| Equity in net earnings of investees                                                       |       | 11,302     |        | 10,899      |       | 10,092      |       |
| Realized and unrealized losses on interest rate  swaps                                    |       | —     |        | (112        | )          | (1,387      | )          |
| Other nonoperating, net                                                                   |       | (87,746    | )           | (5,951      | )          | (1,505      | )          |
| Total other expense                                                                       |       | (121,572   | )           | (97,389     | )          | (80,624     | )          |
| Loss from continuing operations before income taxes                                       |       | (54,544    | )           | (23,835     | )          | (8,484      | )          |
| Income tax  benefit (expense)                                                             |       | 83,096     |        | (516        | )          | 236         |       |
| Minority interest  in income of subsidiaries                                              |       | (2         | )           | (2          | )          | (2          | )          |
| **Income (loss) from continuing operations**                                              | ** ** | **28,550** | ** **  | **(24,353** | **)**      | **(8,250**  | **)**      |
| Discontinued operations:                                                                  |       |       |        |        |       |        |       |
| Income from discontinued operations                                                       |       | —     |        | —      |       | 1,929       |       |
| Income on disposal of assets of discontiued  operations                                   |       | 380        |        | 671         |       | 7,992       |       |
| Income from discontinued operations                                                       |       | 380        |        | 671         |       | 9,921       |       |
| **Net income (loss)**                                                                     | ** ** | **28,930** | ** **  | **(23,682** | **)**      | **1,671**   | ** ** |
| Redeemable  preferred stock dividends and accretion                                       |       | —     |        | —      |       | (8,892      | )          |
| Gain on  repurchase of redeemable preferred stock                                         |       | —     |        | —      |       | 2,905       |       |
| **Net  income (loss) attributed to common shareholders**                                  |       | $          | 28,930      |        | $          | (23,682     | )          | $ | (4,316 | ) |
| Basic weighted  average shares outstanding                                                |       | 31,927     |        | 9,468       |       | 9,483       |       |
| Diluted weighted  average shares outstanding                                              |       | 31,957     |        | 9,468       |       | 9,483       |       |
| Basic and diluted  earnings (loss) per common share:                                      |       |       |        |        |       |        |       |
| Continuing operations                                                                     |       | $          | 0.89        |        | $          | (2.57       | )          | $ | (1.50 | ) |
| Discontinued operations                                                                   |       | 0.02       |        | 0.07        |       | 1.04        |       |
| Net income                                                                                |       | 0.91       |        | (2.50       | )          | (0.46       | )          |

 

See accompanying notes to consolidated financial statements.

58

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**FAIRPOINTCOMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Statements of Stockholders’ Equity (Deficit) Years ended December 31, 2005, 2004, and 2003(in thousands)**

| ** ** | ** ** | **Common Stock** | ** ** | **Class A  Common** | ** ** | **Class C  Common** | ** ** | **Additional  paid-in** | ** ** | **Unearned** | ** ** | **Accumulated  other  comprehensive** | ** ** | **Accumulated** | ** ** | **Total  stockholders’  equity** | ** ** |
|------------|------------|-----------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|--------------|------------|---------------------------------------|------------|-----------------|------------|---------------------------------------|------------|
| ** ** | ** ** | **Shares**            | ** ** | **Amount**               | ** ** | **Shares**               | ** ** | **Amount**              | ** ** | **Shares**   | ** ** | **Amount**                            | ** ** | **capital**     | ** ** | **compensation**                      | ** ** | **income (loss)** | ** ** | **deficit** | ** ** | **(deficit)** | ** ** |
|            |            |                       |            |                          |            |                          |            |                         |            |              |            |                                       |            |                 |            |                                       |            |  |  |  |  |  |  |

| Balance at  December 31, 2002                           |   |   | — |   |   |   | $      | — |   |   |   | 8,643  |   |   |   | $      | 86     |   |   |   | 809    |   |   |   | $      | 8      |    |   |   | $      | 207,347 |   |   |   | $      | — |   |   |     | $      | (1,132 | )      |     |   | $      | (352,459 | ) |   |   | $ | (146,150 | )      |   |
|--------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|----------|--------|--------|--------|----------|--------|--------|----------|---|--------|--------|---|----------|--------|--------|
| Net income                                                   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |   | —  |   |   |   | — |   |   |   | 1,671    |   |   |   | 1,671    |   |   |
| Compensation  expense for stock-based awards                 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 15      |   |   |   | —  |   |   |   | — |   |   |   | —   |   |   |   | 15       |   |   |
| Other comprehensive  loss from available-for-sale securities |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |   | —  |   |   |   | 1,469  |   |   |   | —   |   |   |   | 1,469    |   |   |
| Other  comprehensive income from cash flow hedges            |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |   | —  |   |   |   | 1,029  |   |   |   | —   |   |   |   | 1,029    |   |   |
| Repurchase  redeemable preferred stock                       |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | —  |   |   |   | —  |   |   |   | — |   |   |   | 2,905    |   |   |   | 2,905    |   |   |
| Preferred stock  accretion                                   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (729    | )      |   |   | —  |   |   |   | — |   |   |   | —   |   |   |   | (729     | )      |   |
| Preferred stock  dividends                                   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (8,163  | )      |   |   | —  |   |   |   | — |   |   |   | —   |   |   |   | (8,163   | )      |   |
| 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 fromavailable-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  |   |   |

 

See accompanying notes to consolidated financial statements.

59

 

----

**FAIRPOINTCOMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Statements of Comprehensive Income (Loss)Years ended December 31, 2005, 2004, and 2003(in thousands)**
|                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss)                                                        |       |     |       | $        | 28,930     |     |       |   | (23,682 | ) |   |   | $ | 1,671 |   |
| Other comprehensive  income (loss):                                      |       |     |       |     |       |     |       |   |   |   |   |   |   |
| Available-for-sale  securities:                                          |       |     |       |     |       |     |       |   |   |   |   |   |   |
| Unrealized holding gains (losses)                                        |       | $        | —     |     |       |     | (1,243     | ) |   |   | 1,618 |   |   |   |
| Less reclassification adjustment for gain realized in  net income (loss) |       | —   |       |     |       | (226     | )          |   |   | (149 | ) |   |   |
| Reclassification for other than temporary loss  included in net income   |       | —   |       | —   |       | —   |       | (1,469 | ) | — |   | 1,469 |   |
| Cash flow hedges:                                                        |       |     |       |     |       |     |       |   |   |   |   |   |   |
| Change in net unrealized gain, net of tax expense of  $3.3 million       |       | 5,477    |       |     |       | —   |       |   |   | — |   |   |   |
| Reclassification adjustment                                              |       | —   |       | 5,477    |       | 103      |       | 103 |   | 1,029 |   | 1,029 |   |
| Other  comprehensive income (loss)                                       |       |     |       | 5,477    |       |     |       | (1,366 | ) |   |   | 2,498 |   |
| Comprehensive  income (loss)                                             |       |     |       | $        | 34,407     |     |       |   | (25,048 | ) |   |   | $ | 4,169 |   |
|                                                                          |            |          |            |          |            |          |            |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financial statements.

60

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**FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Statementsof Cash FlowsYears ended December 31, 2005, 2004, and 2003(in thousands)**
|                                                                                                                                           | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Cash flows from  operating activities:                                                                                                    |       |        |       |        |       |        |       |
| Net income (loss)                                                                                                                         |       | $           | 28,930     |        | $          | (23,682     | )          | $ | 1,671 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by operating  activities of continuing operations:                       |       |        |       |        |       |        |       |
| Income from discontinued operations                                                                                                       |       | (380        | )          | (671        | )          | (9,921      | )          |
| Dividends and accretion on shares subject to  mandatory redemption                                                                        |       | 2,362       |       | 20,181      |       | 9,049       |       |
| Depreciation and amortization                                                                                                             |       | 52,390      |       | 50,287      |       | 48,089      |       |
| Loss of preferred stock subject ot mandatory  redemption                                                                                  |       | 9,899       |       | —      |       | —      |       |
| Amortization of debt issue costs                                                                                                          |       | 1,859       |       | 4,603       |       | 4,171       |       |
| Provision for uncollectible revenue                                                                                                       |       | 3,245       |       | 1,718       |       | 1,028       |       |
| Deferred income taxes                                                                                                                     |       | (84,208     | )          | —      |       | —      |       |
| Income from equity method investments                                                                                                     |       | (11,302     | )          | (10,899     | )          | (10,092     | )          |
| Deferred patronage dividends                                                                                                              |       | (77         | )          | (84         | )          | (233        | )          |
| Minority interest in income of subsidiaries                                                                                               |       | 2           |       | 2           |       | 2           |       |
| Loss on early retirement of debt                                                                                                          |       | 77,847      |       | —      |       | 1,503       |       |
| Write-off of offering costs                                                                                                               |       | —      |       | 5,951       |       | —      |       |
| Net (loss) gain on sale of investments and other  assets                                                                                  |       | 11          |       | (104        | )          | (608        | )          |
| Impairment on investments                                                                                                                 |       | 1,200       |       | 349         |       | —      |       |
| Amortization of investment tax credits                                                                                                    |       | (16         | )          | (27         | )          | (37         | )          |
| Stock-based compensation                                                                                                                  |       | 2,350       |       | 49          |       | 15          |       |
| Other non-cash item                                                                                                                       |       | (212        | )          | —      |       | —      |       |
| Change in fair value of interest rate swaps and  reclassification of transition  adjustment recorded in comprehensive income (loss)  |       | —      |       | (772        | )          | (6,664      | )          |
| Changes  in assets and liabilities arising from continuing operations, net of  acquisitions:                                              |       |        |       |        |       |        |       |
| Accounts receivable                                                                                                                       |       | (3,103      | )          | (3,068      | )          | (3,801      | )          |
| Prepaid and other assets                                                                                                                  |       | 576         |       | (89         | )          | (771        | )          |
| Accounts payable                                                                                                                          |       | (3,428      | )          | (390        | )          | (7,185      | )          |
| Accrued interest payable                                                                                                                  |       | (16,309     | )          | (44         | )          | 7,786       |       |
| Other accrued liabilities                                                                                                                 |       | 338         |       | 2,302       |       | 418         |       |
| Income taxes                                                                                                                              |       | (363        | )          | (138        | )          | (149        | )          |
| Other assets/liabilities                                                                                                                  |       | 71          |       | 501         |       | (1,437      | )          |
| Total adjustments                                                                                                                         |       | 32,752      |       | 69,657      |       | 31,163      |       |
| **Net cash provided by operating activities of  continuing operations**                                                                   | ** ** | **61,682**  | ** ** | **45,975**  |       | **32,834**  | ** ** |
| Cash flows from  investing activities of continuing operations:                                                                           |       |        |       |        |       |        |       |
| Acquisition of telephone properties, net of cash  acquired                                                                                |       | (26,258     | )          | (225        | )          | (33,114     | )          |
| Acquisition of property, plant, and equipment                                                                                             |       | (28,099     | )          | (36,492     | )          | (33,595     | )          |
| Proceeds from sale of property, plant, and equipment                                                                                      |       | 698         |       | 531         |       | 377         |       |
| Distributions from investments                                                                                                            |       | 10,859      |       | 15,017      |       | 10,775      |       |
| Payment on covenants not to compete                                                                                                       |       | (110        | )          | (145        | )          | (536        | )          |
| Acquisition of investments                                                                                                                |       | (12         | )          | —      |       | (17         | )          |
| Proceeds from sale of investments and other assets                                                                                        |       | 115         |       | 328         |       | 2,100       |       |
| **Net cash used in investing activities of  continuing operations**                                                                       | ** ** | **(42,807** | **)**      | **(20,986** | **)**      | **(54,010** | **)**      |
|                                                                                                                                           |            |             |            |             |            |             |            |  |  |  |

 

See accompanying notes to consolidated financial statements.

61

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**FAIRPOINTCOMMUNICATIONS, INC. AND SUBSIDIARIESConsolidated Statements of Cash Flows (Continued)Years ended December 31, 2005, 2004, and 2003(in thousands)**

|                                                                                              | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|------------|------------|
| Cash flows from  financing activities of continuing operations:                              |       |        |       |        |       |       |       |
| Proceeds from issuance of long-term debt                                                     |       | 699,959     |       | 178,550     |       | 317,680    |       |
| Repayment of long-term debt                                                                  |       | (905,675    | )          | (193,761    | )          | (294,414   | )          |
| 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      | )          | (1,000     | )          |
| Repurchase of redeemable preferred stock                                                     |       | (129,141    | )          | —      |       | (8,645     | )          |
| Loan origination and offering costs                                                          |       | (8,975      | )          | (7,750      | )          | (15,593    | )          |
| Dividends paid to minority stockholders                                                      |       | (4          | )          | (5          | )          | (4         | )          |
| Proceeds from the exercise of stock options                                                  |       | 184         |       | —      |       | —     |       |
| Net proceeds from issuance of common stock                                                   |       | 431,921     |       | —      |       | —     |       |
| Dividends paid to common stockholders                                                        |       | (35,298     | )          | —      |       | —     |       |
| **Net cash used in financing activities of  continuing operations**                          | ** ** | **(16,647** | **)**      | **(23,966** | **)**      | **(1,976** | **)**      |
| Cash  flows of discontinued operations (revised—see note 1(r)):                         |       |        |       |        |       |       |       |
| Operating cash flows                                                                         |       | (740        | )          | (3,031      | )          | (134       | )          |
| Investing cash flows                                                                         |       | —      |       | —      |       | 23,495     |       |
| Net increase (decrease) in cash                                                              |       | 1,488       |       | (2,008      | )          | 209        |       |
| Cash, beginning of year                                                                      |       | 3,595       |       | 5,603       |       | 5,394      |       |
| **Cash, end of year**                                                                        | ** ** | **$**       | **5,083**  | ** **  | **$**      | **3,595**  | ** ** | **$** | **5,603** | ** ** |
| Supplemental disclosures  of cash flow information:                                          |       |        |       |        |       |       |       |
| Interest paid                                                                                |       | $           | 58,494     |        | $          | 80,736     |       | $ | 77,351 |   |
| Income taxes paid, net of refunds                                                            |       | $           | 946        |        | $          | 1,055      |       | $ | 701 |   |
| Supplemental disclosures  of noncash financing activities:                                   |       |        |       |        |       |       |       |
| Redeemable preferred stock dividends paid in-kind                                            |       | $           | —     |        | $          | —     |       | $ | 8,163 |   |
| Gain on repurchase of redemmable preferred stock                                             |       | $           | —     |        | $          | —     |       | $ | 2,905 |   |
| Accretion of redeemable preferred stock                                                      |       | $           | —     |        | $          | —     |       | $ | 729 |   |
| Long-term debt issued in connection with Carrier  Services’ Tranche B interest  payment |       | $           | —     |        | $          | 115        |       | $ | 1,548 |   |

 

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)(formerly known as FairPoint Communications Solutions Corp.); 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’swholly owned subsidiaries include Sunflower Telephone Company, Inc.(Sunflower); Northland Telephone Company of Maine, Inc. and STE/NEAcquisition Corp. (d.b.a. Northland Telephone Co. of Vermont), (collectively,the Northland Companies); and ST Long Distance, Inc. (ST LongDistance). Ventures’ wholly owned subsidiaries include BentleyvilleCommunications Corporation (Bentleyville), Berkshire Telephone Corporation(Berkshire), Sidney Telephone 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 ColumbusGrove Telephone Company (Columbus Grove); The Orwell Telephone Company(Orwell); GTC Communications, Inc. (GT Com); Peoples Mutual TelephoneCompany (Peoples); Fremont Telcom Co. (Fremont); Fretel Communications, LLC(Fretel); Comerco, Inc. (Comerco); Marianna and Scenery Hill TelephoneCompany (Marianna); Community Service Telephone Co. (CST); and CommtelCommunications Inc. (Commtel). Services’ wholly owned subsidiaries includeBluestem Telephone Company (Bluestem); Big Sandy Telecom, Inc.(Big Sandy); Columbine Telecom Company (Columbine); Odin TelephoneExchange, Inc. (Odin); Ravenswood Communications, Inc. (Ravenswood);and Yates City Telephone Company (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.

TheCompany’s telephone subsidiaries follow the accounting for regulatedenterprises prescribed by Statement of Financial Accounting Standards (SFAS) No. 71,*Accounting for the Effects of Certain Types ofRegulation*. This accounting recognizes the economic effects of rateregulation by recording costs and a return on investment; as such, amounts arerecovered through rates authorized by regulatory authorities. Accordingly, SFASNo. 71 requires the Company’s telephone subsidiaries to depreciatetelephone plant over useful lives that would otherwise be determined bymanagement. SFAS No. 71 also requires deferral of certain costs and obligationsbased upon approvals received from regulators to permit recovery of suchamounts in future years. Criteria that would give rise to the discontinuance ofSFAS No. 71 include (1) increasing competition restricting thewireline subsidiaries’ ability to establish prices to recover specific costsand (2) significant changes in the manner in which rates are set byregulators from cost-based regulation to another form of regulation. TheCompany’s telephone subsidiaries periodically review the 

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

applicability of SFAS No. 71 based on thedevelopments in their current regulatory and competitive environments.

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

TheCompany’s management has made a number of estimates and assumptions relating tothe reporting of assets and liabilities, the reported amounts of revenues andexpenses, and the disclosure of contingent assets and liabilities to preparethese consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America. Actual resultscould differ from those 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 the Companyparticipates in a pooling environment (interstate or intrastate), the tollor access billed is contributed to a revenue pool. The revenue is thendistributed to individual companies based on their company-specificrevenue requirement. This distribution is based on individual state publicutilities commissions (intrastate) or the Federal Communication Commission’s(interstate) approved separation rules and rates of return. Distributionfrom these pools can change relative to changes made to expenses, plantinvestment, or rate of return. Some companies participate in federal andcertain state universal service programs that are pooling in nature but areregulated by rules separate from those described above. These rules varyby state. Revenues earned through the various pooling arrangements areinitially recorded based on the Company’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 collectionservices when the services are provided. The Company recognizes directoryservices revenue over the subscription period of the corresponding directory.Billing and 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):

| ** **                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Balance,  beginning of period                 |       | $        | 1,255      |     | $          | 1,028    |       | $ | 1,235 |   |
| Acquisition  adjustments                      |       | 28       |       | (143     | )          | 202      |       |
| Provision charged  to expense                 |       | 3,245    |       | 1,718    |       | 1,028    |       |
| Amounts written  off, net of recoveries  |       | (2,407   | )          | (1,348   | )          | (1,437   | )          |
| Balance, end of period                        |       | $        | 2,121      |     | $          | 1,255    |       | $ | 1,028 |   |

 

***(f) Credit Risk***

Financialinstruments, which potentially subject the Company to concentrations of creditrisk, consist principally of cash and trade receivables. The Company places itscash with high-quality financial institutions. Concentrations of creditrisk with respect to trade receivables are principally related to receivablesfrom other interexchange carriers and are otherwise limited to the Company’slarge number of customers in several states.

***(g) Investments***

Investments consist of stock in CoBank, ACB (CoBank),Rural Telephone Bank (RTB), the Rural Telephone Finance Cooperative (RTFC),various cellular companies and partnerships and other minority equityinvestments, and Non-Qualified Deferred Compensation Plan assets. Thestock in CoBank, RTB, and the RTFC is nonmarketable and stated at cost. Forinvestments in partnerships, the equity method 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 fromearnings and are reported as a separate component of comprehensive income untilrealized or at such time as the Company determines a decline in value hasoccurred that is deemed to be other-than-temporary. Unrealized holding gainsand losses on trading 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 quoted marketprices (if available), or the fair values of similar investments, which incertain instances, is based on traditional valuation models utilizing multiplesof cash flows. When circumstances indicate that a decline in the fair value ofthe investment has occurred and the decline is other than temporary, the 

65

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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.

TheCompany currently receives patronage dividends from its investments inbusinesses organized as cooperatives for Federal income tax purposes(CoBank and RTFC stock). Patronage dividends represent cash distributionsof the cooperative’s earnings and notices of allocations of earnings to theCompany. Deferred and uncollected patronage dividends are included as part ofthe basis of the investment until collected. The RTB investment pays dividendsannually at the discretion of its board of directors.

***(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 2004 and 2005, the Company developed andimplemented, with CSG Systems, Inc., an integrated end-user billingsystem. The costs to develop such system were accounted for in accordance withStatement of Position 98-1, *Accounting for the Costsof Computer Software Developed or Obtained for Internal Use.*Aggregatecapitalized costs (before accumulated amortization) totaled $8.6 million (ofwhich, $5.1 million was capitalized in 2004) as of December 31, 2005, ofwhich the majority represents payments for license fees and third-partyconsultants. As a result of the Company’s decision to convert to a new end-userbilling system in November 2005, the capitalized costs associated with theCSG Systems, Inc. billing system will be amortized over its remaininguseful life which was estimated to be 8 months (reduced from 5 years). TheCompany will capitalize certain costs associated with its new (MACC) billingsystem and these capitalized billing system costs will be amortized over its estimateduseful life.

Alsoin November 2005, we reached an agreement with CSG Systems, Inc. inwhich we will receive total compensation from CSG Systems, Inc. of $5.1million in order to relieve it from its responsibilities under the originalservice bureau contract. The Company recorded the $5.1 million as a deferredcredit which will be amortized over the remaining life of the CSG contract (8months). When amortized, a portion of the credit will offset depreciationexpenses and a portion will offset billing expenses. Of this deferred credit,$1.3 million was recognized in 2005 and therefore, the balance of the deferredcredit at December 31, 2005 was $3.8 million.

***(i) Debt Issue and Offering Costs***

Debt issue costs are being amortized over the life ofthe related debt, ranging from 3 to 10 years. During 2003, $5.0 million innet book value of debt issue costs were written off in association withrefinancing activity classified as other nonoperating expense in the statementsof operations. During 2004, the Company wrote-off debt issuance and offeringcosts of $6.0 million associated with an abandoned offering of IncomeDeposit Securities (IDSs), classified as other nonoperating expense in thestatements of operations. The offering of IDSs was abandoned in December of2004 in favor of the transactions described in note 2. As of December 31,2005, debt issue and offering costs of $1.0 million remained capitalizedafter the write-off that are a direct and incremental benefit to thetransactions described in note 2. In 2005, the Company entered into a newsenior secured credit facility consisting of a revolving 

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

facility in an aggregateprincipal amount of up to $100.0 million and a term facility in anaggregate principal amount of $588.5 million. Including the $1.0 millionincurred during 2004, the Company incurred a total of $10.4 million ofdebt issuance costs associated with entering into the credit facility andsubsequent amendments thereto.

Accumulatedamortization of loan origination costs from continuing operations was $1.4million, $14.9 million and $10.3 million at December 31, 2005,2004 and 2003, 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 intangibleassets recorded 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-livedassets, such as property, plant, and equipment and purchased intangiblessubject to amortization, are reviewed for impairment whenever events or changesin circumstances 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 and liabilitiesof a change in tax rates is recognized in income in the period that includesthe 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.

Aspart of the income tax provision process of preparing the Company’sconsolidated financial statements, the Company is required to estimate itsincome taxes. This process involves estimating current tax expenses togetherwith assessing temporary differences resulting from differing treatment ofitems for tax and accounting purposes. These differences result in deferred taxassets and liabilities. In assessing the 

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

realizability of deferred tax assets, managementconsiders whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The ultimate realization of deferredtax assets is dependent upon the generation of future taxable income during theperiods in which those temporary differences become deductible. Managementconsiders the scheduled reversal of deferred tax liabilities, projected futuretaxable income, and tax planning strategies in making this assessment, as wellas all positive and negative evidence that would affect the recoverability ofdeferred tax assets. As a result of the offering, the Company has reduced itsaggregate long term debt and expects a significant reduction in its annualinterest expense. When considered together with the Company’s history ofproducing positive operating results and other evidence affecting therecoverability of deferred tax assets, the Company expects that future taxableincome will more likely than not be sufficient to recover net deferred taxassets.

***(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.

The Company uses variable and fixed-rate debt tofinance its operations, capital expenditures, and acquisitions. The variable-ratedebt obligations 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. As of December 31, 2005, the Company had five interest rate swapagreements with a combined notional amount of $490.0 million that expire in2007 to 2012. These interest rate swap agreements qualify as accounting hedgesunder SFAS No. 133. As of December 31, 2003, the Company had twointerest rate swap agreements with a combined notional amount of$50.0 million that expired in May 2004. These interest rate swapagreements did not qualify as accounting hedges under SFAS No. 133.

On February 8, 2005, the Company entered into threeinterest rate swap agreements, with notional amounts of $130 million each, toeffectively convert a portion of its variable rate interest exposure to fixedrates ranging from 3.76% to 4.11%, plus a 2.0% margin. These swap agreementsexpire beginning December 31, 2007 through December 31, 2009. On April 7,2005, the Company entered into two additional interest rate swap agreements,one with the notional amount of $50.0 million to effectively convert a portionof its variable rate interest exposure to a fixed rate of 4.69%, plus a 2.0%margin, beginning on April 29, 2005 and ending on March 31, 2011, andone with the notional amount of $50.0 million to effectively convert a portionof its variable rate interest exposure to a fixed rate of 4.72%, plus a 2.0%margin, beginning on June 30, 2005 and ending on March 31, 2012. As aresult of these swap agreements, as of December 31, 2005, approximately82% of the Company’s indebtedness bore interest at fixed rates rather thanvariable rates. Effective on September 30, 2005, the Company amended theterms of its credit facility. This amendment reduced the effective interestrate margins applicable to the Company’s interest rate swap agreements by 0.25%to 1.75%.

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

These interest rate swapsqualify as cash flow hedges for accounting purposes. The effect of hedgeineffectiveness on net earnings was insignificant for the twelve months ended December 31,2005. At December 31, 2005, the fair market value of these swaps wasapproximately $8.8 million and has been recorded, net of tax of$3.3 million, as a decrease in comprehensive income. Of the$8.8 million, $3.1 million has been included in other current assetsand $5.7 million has been included in other long-term assets.

In June 1998, theFinancial Accounting Standards Board (FASB) issued SFAS No. 133, *Accounting for Derivative Instruments and Certain Hedging Activities*.In June 2000, the FASB issued SFAS No. 138, *Accountingfor Certain Derivative Instruments and Certain Hedging Activities, an Amendmentto SFAS No. 133*. SFAS No. 133 and SFAS No. 138require that all derivative instruments be recorded on the balance sheet attheir respective fair values. The Company adopted SFAS No. 133 and SFAS No. 138on January 1, 2001. In accordance with the transition provisions of SFAS No. 133,the Company recorded 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 orpayable under interest rate swap agreements are accrued at each balance sheetdate and gains and losses related to effective hedges are reported, net of taxeffect, as a separate component of comprehensive income. Changes associatedwith swap agreements that did not qualify as accounting hedges are included asadjustments to realized and unrealized gains (losses) on interest rate swaps.

The following is a summaryof amounts included in realized and unrealized gains (losses) on interest rateswaps for the twelve months ended December 31, 2004 and 2003 (inthousands):

| ** **                                                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Change in fair  value of interest rate swaps                                             |       | $        | 874        |     | $          | 7,693 |   |
| Reclassification  of transition adjustment included in other comprehensive income (loss) |       | (103     | )          | (1,029   | )          |
| Realized losses                                                                          |       | (883     | )          | (8,051   | )          |
| Total                                                                                    |       | $        | (112       | )        | $          | (1,387 | ) |

 

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

At December 31, 2005,the Company had four stock-based employee compensation plans. The Companyaccounts for its stock option plans using the intrinsic-value-based methodprescribed by Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations. As such, compensation expense is recorded on the date of grantonly if the current market price of the underlying stock exceeds the exerciseprice. SFAS No. 123, *Accounting for Stock-BasedCompensation*, permits entities to recognize as expense over thevesting period the fair value of all stock-based awards on the date ofgrant. SFAS No. 123 allows entities to continue to apply the provisions ofAPB No. 25 and provide pro forma net income disclosures as if the fair-valuemethod defined in SFAS 

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

No. 123had been applied. The Company has elected to continue to apply theintrinsic-value-based method of accounting under APB No. 25 and hasadopted the disclosure requirements of SFAS No. 123.

The Company calculatesstock-based compensation pursuant to the disclosure provisions of SFAS No. 123using the straight-line method over the vesting period of the option. Hadthe Company determined compensation cost based on the fair value at the grantdate for its stock options under SFAS No. 123, the Company’s net pro formaincome (loss) would have been (in thousands, except per share data):

| ** **                                                                                                                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income  (loss), as reported                                                                                                 |       | $        | 28,930     |     | $          | (23,682  | )          | $ | 1,671 |   |
| Stock-based  compensation expense included in reported net income (loss), net of related  tax effect in 2005 of $0.9 million(1) |       | 1,466    |       | 49       |       | 15       |       |
| Stock-based  compensation determined under fair value based method, net of related tax  effect in 2005 of $0.9 million(1)       |       | (1,447   | )          | (656     | )          | (658     | )          |
| Pro forma net income (loss)                                                                                                     |       | $        | 28,949     |     | $          | (24,289  | )          | $ | 1,028 |   |
| Basic and diluted  earnings per common share, as reported:                                                                      |       | $        | 0.91       |     | $          | (2.50    | )          | $ | (0.46 | ) |
| Basic and diluted earnings per common share,  proforma:                                                                         |       | $        | 0.91       |     | $          | (2.57    | )          | $ | (0.52 | ) |

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(1)          Amountsshown for 2004 and 2003 are not net of tax effect due to the recognition of avaluation allowance associated with net operating losses.

***(o) Certain Financial Instruments with Characteristicsof Liabilities and Equity***

The Company prospectivelyadopted SFAS No. 150 effective July 1, 2003. The SFAS No. 150adoption had no impact on net income (loss) attributed to common shareholdersfor any of the periods presented. SFAS No. 150 requires the Company toclassify as a long-term liability its Series A preferred stock andto reclassify dividends and accretion from the Series A preferred stock asinterest expense. Such stock is described as “preferred shares subject tomandatory redemption” in the consolidated balance sheets as of December 31,2004 and dividends and accretion on these shares are included in pretax incomeprior to the repurchase of these shares whereas previously they were presentedas a reduction to equity (a dividend) and, therefore, a reduction of netincome available to common shareholders.

***(p) BusinessSegments***

Under the provisions ofSFAS 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.

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

***(q) Earnings PerShare***

Earnings per share hasbeen computed in accordance with SFAS No. 128, *Earnings PerShare.*Basic earnings per share is computed by dividing net income(loss) less dividends accrued on Series A preferred shares subject tomandatory redemption and plus discounts on the redemption of such shares by theweighted average number of common shares outstanding for the period. Exceptwhen the effect would be anti-dilutive, the diluted earnings per sharecalculation includes the impact of restricted units, restricted stock andshares that could be issued under outstanding stock options.

The number of potentialcommon shares excluded from the calculation of diluted net loss per share,prior to the application of the treasury stock method, is as follows (inthousands):

| ** **                                         | ** ** | **Year ended December 31** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| Contingent stock  options                          |       | 833                                       |       | 833 |   | 833 |   |
| Shares excluded  as effect would be anti-dilutive: |       |                                      |       |   |   |   |   |
| Stock options                                      |       | 241                                       |       | 356 |   | 416 |   |
| Restricted stock                                   |       | 471                                       |       | — |   | — |   |
| Restricted units                                   |       | 34                                        |       | 26 |   | 27 |   |
|                                               |       | 1,579                                     |       | 1,215 |   | 1,276 |   |

 

***(r) DiscontinuedOperations***

In 2005, the Company hasseparately disclosed the operating, investing and financing portions of thecash flows attributable to its discontinued operations, which in prior periodswere reported on a combined basis as a single amount.

***(s) New AccountingPronouncements***

In December 2004, theFASB issued SFAS No. 123(R). This new standard requires companies to adoptthe fair value methodology of valuing stock-based compensation andrecognize that valuation in the financial statements from the date of grant.The adoption of SFAS No. 123(R)’s fair value method is not expected tohave an adverse impact on our income from operations. However, had we adoptedSFAS No. 123(R) in prior periods, the impact of that standard wouldhave approximated the impact of SFAS No. 123 as disclosed above. SFAS No. 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. We expect to adopt the provisions ofSFAS No. 123(R) using the prospective application method, for awardsgranted prior to becoming a public company and valued using the minimum valuemethod, and using the modified prospective application method for awardsgranted subsequent to becoming a public company. The Company will adopt SFAS No. 123(R) effectiveJanuary 1, 2006, with no restatement of any prior periods.

In March 2005, theFASB issued FIN 47, “Accounting for Conditional Asset Retirement Obligations,”an interpretation of FASB No. 143. FIN 47 clarifies that the term conditional asset retirement obligation asused in FASB No. 143 refers to a legal obligation to perform an assetretirement activity in which the timing or method of settlement are conditionalon a future  event that may or may not bewithin the control of the entity. FIN 47 also clarifies when an entity wouldhave sufficient information to reasonably estimate the fair value of an assetretirement obligation. FIN 47 is effective for the year ended 

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

December 31,2005 and was adopted by the Company in the fourth quarter of 2005. The Companyaccounts for its wireline operations under SFAS No. 71, “Accounting forthe Effects of Certain Types of Regulation”. Therefore, in accordance with federaland state regulations, the Company is following the FCC’s Part 32accounting. As a result of the Company’s accounting under SFAS No. 71, theadoption of FIN 47 had no impact on the Company. The Company evaluated theimpact of FIN 47 on its non-regulated assets and determined that the impact wasimmaterial.

**(2)**   InitialPubic Offering and Other Transactions

***(a) General***

On February 8, 2005,the Company consummated an initial public offering, or the offering, of25,000,000 shares of its common stock, par value $0.01 per share, or commonstock, at a price to the public of $18.50 per share.

In connection with theoffering, the Company entered into a new senior secured credit facility, or thecredit facility, with a syndicate of financial institutions, including DeutscheBank Trust Company Americas, as administrative agent. The credit facility iscomprised of a revolving facility in an aggregate principal amount of$100 million (less amounts reserved for letters of credit) and a termfacility in an aggregate principal amount of $588.5 million (including a$22.5 million delayed draw facility). The revolving facility has a sixyear maturity and the term facility has a seven year maturity. The offering,the credit facility and the transactions described below are referred to hereincollectively as the transactions.

The Company received grossproceeds of $462.5 million from the offering which, net of costs incurredof $30.6 million related to the offering, was allocated to paid-incapital. The Company used the gross proceeds of $462.5 million from theoffering together with borrowings of $566.0 million under the termfacility 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 9 1¤2% senior subordinated notes due2008, or the 9 1¤2% notes, pursuant to the tenderoffer and consent solicitation for such notes (including accrued 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’s12 1¤2% senior subordinated notes due2010, or the 12 1¤2% notes, pursuant to the tenderoffer and consent solicitation for such notes (including accrued interest,tender premiums and consent payments);

·       $274.9 millionto repurchase $223.0 million aggregate principal amount of the Company’s11 7¤8% senior notes due 2010, or the11 7¤8% notes, pursuant to the tenderoffer and consent solicitation for such notes (including accrued interest,tender premiums and consent payments);

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

·       $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 9 1¤2% notes and the floating rate notes nottendered 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 temporaryinvestments, together with $6.6 million of cash on hand, to redeem the$0.2 million aggregate principal amount of the 9 1¤2% notes (including accruedinterest and redemption premiums) that were not tendered in the tender offerfor such notes and the $24.2 million aggregate principal amount of thefloating rate notes (including accrued interest) that were not tendered in thetender offer for such notes.

On May 2, 2005, theCompany used $22.4 million of borrowings under the delayed draw facilityof the credit facility to redeem the $19.9 million aggregate principalamount of the 12 1¤2% notes (including accruedinterest and redemption premiums) that were not tendered in the tender offerfor such notes. In connection with such redemption, a premium of$1.2 million was recorded and an additional $0.4 million of existingdebt issuance costs has been subsequently charged off, resulting in therecognition of a loss of $1.6 million for retirement of debt in the secondquarter of 2005.

The Company reported otherexpense in the amount of $87.7 million, comprised of a $77.8 millionloss on early retirement of debt and a $9.9 million loss on redemption ofseries A preferred stock. With respect to the $77.8 million loss onearly retirement of debt, $16.8 million was recorded for the write-off ofexisting debt issuance costs and the remaining $61.0 million was fees and penalties.

***(b) Dividends***

The Company has adopted adividend policy under which a substantial portion of the cash generated by theCompany’s business in excess of operating needs, interest and principalpayments on indebtedness, dividends on future senior classes of capital stock,if any, capital expenditures, taxes and future reserves, if any, would ingeneral be distributed as regular quarterly dividend payments to the holders ofits common stock, rather than retained and used for other purposes.

On December 14, 2005,the Company declared a dividend of $0.39781 per share of common stock, whichwas paid on January 18, 2006 to holders of record as of December 30,2005. In 2005, the Company has paid dividends totaling $35.3 million, or$1.41886 per share of common stock.

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

**(3)**   Acquisitions

On December 1, 2003,the Company acquired 100% of the capital stock of CST and Commtel. The purchaseprice for this acquisition was $32.6 million. The Company believes theentire amount of goodwill will be deductible for income tax purposes. Acquisitioncosts were $0.3 million in 2003. This acquisition has been accounted forusing the purchase method and, accordingly, the results of operations have beenincluded in the Company’s consolidated financial statements from the date ofacquisition. The excess of the purchase price and acquisition costs over thefair value of the net identifiable assets acquired was $25.1 million andhas been recognized as goodwill.

On May 2, 2005, theCompany completed the acquisition of Berkshire Telephone Corporation, orBerkshire. The purchase price was approximately $20.3 million (or $16.4million net of cash acquired). Goodwill on this transaction will not bedeductible for income tax purposes. The Company incurred acquisition costs of$0.6 million. Berkshire is an independent local exchange carrier that providesvoice communication, cable and internet services. Berkshire’s communities ofservice are adjacent to those of Taconic Telephone Corp., one of the Company’ssubsidiaries. The acquisition is referred to herein as the Berkshireacquisition.

The Berkshire acquisitionhas been accounted for using the purchase method of accounting for businesscombinations and, accordingly, the acquired assets and liabilities have beenrecorded at their estimated fair values as of the date of acquisition, and itsresults of operations have been included in the Company’s consolidatedfinancial statements from the date of acquisition. Based upon the Company’spreliminary purchase price allocation, subject to final settlement of an escrow,the excess of the purchase price and acquisition costs over the fair value ofthe net identifiable assets acquired was approximately $11.0 million. TheCompany recorded 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 the acquisition of Bentleyville CommunicationsCorporation, or Bentleyville. The purchase price was approximately$11.0 million (or $9.3 million net of cash acquired). Goodwill on thistransaction will not be deductible for income tax purposes. The Companyincurred acquisition costs of $0.4 million. Bentleyville providestelecommunications, cable and internet services to rural areas of SouthwesternPennsylvania which are adjacent to the Company’s existing operations inPennsylvania. The acquisition is referred to herein as the Bentleyvilleacquisition.

The Bentleyvilleacquisition has been accounted for using the purchase method of accounting forbusiness combinations and, accordingly, the acquired assets and liabilitieshave been recorded at their estimated fair values as of the date ofacquisition, and its results of operations have been included in the Company’sconsolidated financial statements from the date of acquisition. Based upon theCompany’s preliminary purchase price allocation, subject to final settlement ofescrow, the excess of the purchase price and acquisition costs over the fairvalue of the net identifiable assets acquired was approximately $4.6 million. TheCompany recorded an intangible asset related to the acquired company’s customerrelationships of $1.4 million and the remaining $3.2 million has beenrecognized as goodwill. The estimated useful life of the $1.4 millionintangible asset is 15 years.

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

The allocation of the total net purchase price of theBerkshire and Bentleyville acquisitions 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 |   |

 

The following unaudited pro forma information presentsthe combined results of operations of the Company as though the Berkshireacquisition and the Bentleyville acquisition each had been consummated on January 1,2004. These results include certain adjustments, mainly associated withincreased interest expense on debt and amortization of intangible assetsrelated to the acquisitions and the related income tax effects. The pro formafinancial information does not necessarily reflect the results of operations asif the Berkshire acquisition and the Bentleyville acquisition each had beenconsummated at the beginning of the period or which may be attained in thefuture (in thousands, except per share data).

| ** **                                                    | ** ** | **Pro forma year**     | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **ended December 31,** | ** ** |
| ** **                                                    | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Revenues                                                      |       | $                                | 267,303    |   | $ | 262,562 |   |
| Income (loss)  from continuing operations                     |       | 27,962                           |       | (25,401 | ) |
| Net income (loss)                                             |       | 28,342                           |       | (24,730 | ) |
| Earnings (loss)  per common share from continuing operations: |       |                             |       |   |   |
| Basic                                                         |       | $                                | 0.88       |   | $ | (2.68 | ) |
| Diluted                                                       |       | 0.87                             |       | (2.68 | ) |
| Earnings (loss)  per common share:                            |       |                             |       |   |   |
| Basic                                                         |       | $                                | 0.89       |   | $ | (2.61 | ) |
| Diluted                                                       |       | 0.89                             |       | (2.61 | ) |

 

**(4)**   Goodwilland Other Intangible Assets

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

| Balance,  December 31, 2003           |   | $       | 468,845 |   |
|--------------------------------------------|--------|---------|---------|--------|
| Acquisition adjustments of CST and Commtel |   | (337    | )       |
| Balance,  December 31, 2004           |   | 468,508 |    |
| Acquisition of Berkshire and Bentleyville  |   | 12,835  |    |
| Balance,  December 31, 2005           |   | $       | 481,343 |   |

 

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

As required under SFAS No. 142, the Companyupdated its annual impairment testing of goodwill as of December 31, 2005,2004, and 2003, and determined that no impairment loss was required to berecognized.

In2005, as part of the Berkshire and Bentleyville acquisitions, the Company hasrecorded intangible assets related to the acquired companies’ customerrelationships of $2.4 million and $1.4 million, respectively. These intangibleassets will be amortized over 15 years using the straight-line method. As of December 31,2005, accumulated amortization related to the customer relationship intangibleswas $0.1 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 $0.3 millionper year over the next five years.

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

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

| ** **                            | ** ** | **Estimated**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|------------|------------|------------|------------|
| ** **                            | ** ** | **life (in years)** | ** ** | **2005**   | ** ** | **2004**   | ** ** |
| Land                                  |       |                          | —     |       |       | $          | 4,096      |   | $ | 3,851 |   |
| Buildings and  leasehold improvements |       |                          | 2-40       |       |       | 39,889     |       | 36,339 |   |
| Telephone  equipment                  |       |                          | 3-50       |       |       | 649,465    |       | 615,976 |   |
| Cable equipment                       |       |                          | 3-20       |       |       | 10,287     |       | 3,143 |   |
| Furniture and  equipment              |       |                          | 3-34       |       |       | 19,219     |       | 17,098 |   |
| Vehicles and  equipment               |       |                          | 3-20       |       |       | 25,105     |       | 22,011 |   |
| Computer software                     |       |                          | 3-5        |       |       | 11,861     |       | 4,577 |   |
| Total property, plant, and equipment  |       |                          |       |       |       | 759,922    |       | 702,995 |   |
| Accumulated  depreciation             |       |                          |       |       |       | (517,305   | )          | (450,733 | ) |
| Net property,  plant, and equipment   |       |                          |       |       |       | $          | 242,617    |   | $ | 252,262 |   |

 

Thetelephone company composite depreciation rate for property and equipment was7.38%, 7.32%, and 7.46% in 2005, 2004, and 2003, respectively. Depreciationexpense from continuing operations, excluding amortization of intangible assetsand previously disclosed deferred billing system credits, for the years ended December 31,2005, 2004, and 2003 was $53.5 million, $50.3 million, and$47.1 million, respectively.

**(6)**   Investments

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

As of December 31, 2005, the Company no longerholds any marketable equity investments classified as available-for-sale. Followingan August 2, 2004 announcement by Choice One of a financial restructuringunder Chapter 11 of the United States Bankruptcy Code, the quoted market valueof the Company’s investment in Choice One Communications Inc.’s common stockdeclined to $33,000. The Company determined that the decline in fair value wasother-than-temporary and recorded an impairment loss of $0.5 million inthe third quarter of 2004, of which $0.4 million was recorded as anexpense in the consolidated statement of operations and $0.1 million wasrecorded as a reduction in accumulated other comprehensive income. On November 8,2004, Choice One exited Chapter 11 and, in accordance with its 

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

plan of reorganization,Choice One’s preferred stockholders and common stockholders did not receive anyrecovery and all of the preferred stock and common stock has now been cancelled.

Proceeds from sales of available-for-salesecurities were $0.3 million and $0.3 million in 2004 and 2003,respectively. Gross gains of $0.1 million and $0.1 million wererealized on those sales in 2004 and 2003, respectively.

The Company’s noncurrent investments at December 31,2005 and 2004 consist of the following:

| ** **                                                         | ** ** | **2005**                | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                         | ** ** | **(in thousands)** | ** ** |
| Equity method  investments in cellular companies and partnerships: |       |                    |       |     |       |   |   |
| Orange County—Poughkeepsie Limited Partnership                |       |                    | $          | 4,138    |       |   | $ | 3,590 |   |
| Chouteau Cellular Telephone Company                                |       |                    | 46         |     |       | 72 |   |
| Illinois Valley Cellular RSA 2, Inc.                          |       |                    | 1,409      |     |       | 2,037 |   |
| Other equity method investments                                    |       |                    | 1,104      |     |       | 1,132 |   |
| Investments in  securities carried at cost:                        |       |                    |       |     |       |   |   |
| RTB stock                                                          |       |                    | 22,796     |     |       | 20,125 |   |
| CoBank stock and unpaid deferred CoBank patronage                  |       |                    | 4,664      |     |       | 5,221 |   |
| RTFC secured certificates and unpaid deferred RTFC  patronage      |       |                    | 480        |     |       | 419 |   |
| Southern Illinois Cellular Corp.                                   |       |                    | 4,552      |     |       | 4,552 |   |
| Other nonmarketable minority equity investments                    |       |                    | 55         |     |       | 33 |   |
| Nonqualified  deferred compensation plan assets                    |       |                    | 564        |     |       | 568 |   |
| Total investments                                                  |       |                    | $          | 39,808   |       |   | $ | 37,749 |   |

 

***(b) Equity Method 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, 2005 and 2004 are summarized below:

| ** **                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| 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                               |       | 13.9     | %          | 13.9     | %          |
| Illinois Valley Cellular  RSA 2, Inc.           |       | 25.0     | %          | 25.0     | %          |

 

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

Earnings in equity investments for the years ended December 31,2005, 2004, and 2003 consisted of the following (in thousands):

| ** **                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Orange  County—Poughkeepsie Limited Partnership                     |       | $        | 10,523     |     | $          | 10,249   |       | $ | 8,939 |   |
| Illinois Valley  Cellular RSA 2, Inc.                               |       | 477      |       | 372      |       | 543      |       |
| Illinois Valley  Cellular RSA 2-I, RSA 2- II, and RSA 2-III Partnerships |       | —   |       | —   |       | 35       |       |
| Chouteau Cellular  Telephone Company                                     |       | —   |       | 2        |       | 471      |       |
| Other, net                                                               |       | 302      |       | 276      |       | 104      |       |
| Total                                                                    |       | $        | 11,302     |     | $          | 10,899   |       | $ | 10,092 |   |

 

Distributions from investments during the years ended December 31,2005, 2004, and 2003 consisted of the following (in thousands):

| ** **                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Orange  County—Poughkeepsie Limited Partnership                     |       | $        | 9,975      |     | $          | 11,775   |       | $ | 10,125 |   |
| Illinois Valley  Cellular RSA 2, Inc.                               |       | —   |       | 375      |       | 325      |       |
| Illinois Valley  Cellular RSA 2-I, RSA 2- II, and RSA 2-III Partnerships |       | —   |       | —   |       | 147      |       |
| Chouteau Cellular  Telephone Company                                     |       | 40       |       | 2,524    |       | —   |       |
| CoBank, ACB                                                              |       | 634      |       | —   |       | —   |       |
| Distributions  from other equity investments                             |       | 210      |       | 343      |       | 178      |       |
| Total                                                                    |       | $        | 10,859     |     | $          | 15,017   |       | $ | 10,775 |   |

 

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.

During 2003, the Company sold its ownershippercentages of Illinois Valley Cellular RSA 2-I Partnership, IllinoisValley Cellular RSA 2-II Partnership, and Illinois Valley Cellular RSA 2-IIIPartnership. Proceeds from the sales of these investments were$1.8 million and gross gains of approximately $0.4 million wererealized on these sales.

During 2005, the Companydetermined that the carrying amount of its investment in Illinois ValleyCellular RSA No. 2, which is accounted for under the equity 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.

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

***(c) Investments in Equity Securities Carried at Cost***

The aggregate cost of the Company’s cost methodinvestments totaled $33.1 million at December 31, 2005. These investmentswere not evaluated for impairment because (a) the Company did not estimatethe fair value of those investments in accordance with paragraphs 14 and 15 ofSFAS No. 107 *Disclosures About FairValue of Financial Instruments,* and (b) the Company did notidentify any events or circumstances that may have had a significant adverseeffect on the fair value of those investments.

**(7)   Long-term Debt**

Long-term debt at December 31, 2005 and2004 is shown below (in thousands):

| ** **                                                                                                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| 2005 Senior  secured notes, variable rates ranging from 5.82% to 7.97% (weighted average  rate of 5.85%) at December 31, 2005, due 2011 to 2012 |       | $   | 602,275    |     | $     | — |   |
| 1998 Senior  secured notes, variable rates ranging from 6.44% to 8.75% at  December 31, 2004                                                    |       | —   |       | 182,357  |       |
| Senior subordinated  notes due 2008:                                                                                                                 |       |     |       |     |       |
| Fixed rate notes, 9.50%                                                                                                                              |       | —   |       | 115,207  |       |
| Variable rate notes, 6.4875% at December 31, 2004                                                                                               |       | —   |       | 75,000   |       |
| Senior  subordinated notes, 12.50%, due 2010                                                                                                         |       | —   |       | 193,000  |       |
| Senior notes,  11.875%, due 2010                                                                                                                     |       | 2,050    |       | 225,000  |       |
| Senior notes to RTFC:                                                                                                                                |       |     |       |     |       |
| Fixed rate, ranging from 8.2% to 9.20%, due 2009 to  2014                                                                                            |       | 3,100    |       | 2,278    |       |
| Variable rate, 6.15% at December 31, 2004, due  2009                                                                                            |       | —   |       | 3,415    |       |
| Subordinated  promissory notes, 7.00%, due 2005                                                                                                      |       | —   |       | 7,000    |       |
| First mortgage  notes to Rural Utilities Service, fixed rates ranging from 4.96% to 10.78%,  due 2005 to 2016                                   |       | —   |       | 6,034    |       |
| Senior notes to  RTB, fixed rates ranging from 7.50% to 8.00%, due 2008 to 2014                                                                      |       | —   |       | 1,141    |       |
| Total outstanding long-term debt                                                                                                                     |       | 607,425  |       | 810,432  |       |
| Less current  portion                                                                                                                                |       | (677     | )          | (524     | )          |
| Total long-term  debt, net of current portion                                                                                                        |       | $        | 606,748    |     | $          | 809,908 |   |

 

The approximateaggregate maturities of long-term debt for each of the five yearssubsequent to December 31, 2005 are as follows (in thousands):

| Fiscal year: |   |    |    |
|--------------|--------|---------|---------|
| 2006         |   | $       | 677     |   |
| 2007         |   | 714     |    |
| 2008         |   | 753     |    |
| 2009         |   | 149     |    |
| 2010         |   | 2,210   |    |
| Thereafter   |   | 602,922 |    |
|         |   | $       | 607,425 |   |

 

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

***(a) 2005 SeniorSecured Notes***

On February 8, 2005,the Company entered into a credit facility consisting of a revolving facilityin an aggregate principal amount of up to $100.0 million and a termfacility in an aggregate principal amount of $588.5 million. On the closingdate of the Company’s initial public offering, the Company drew$566.0 million against the term facility. In addition, on May 2,2005, the Company drew $22.5 million of borrowings under the delayed draw termfacility of the credit facility. The Company incurred approximately$10.4 million of debt issuance costs associated with entering into thecredit facility and subsequent amendments thereto.

The term facility maturesin February 2012 and the revolving facility matures in February 2011.Borrowings bear interest, at the Company’s option, for the revolving facilityand for the term facility at either (a) the Eurodollar rate (as defined inthe credit facility) plus an applicable margin or (b) the Base rate (asdefined in the credit facility) plus an applicable margin. The Eurodollar rateapplicable margin and the Base rate applicable margin for loans under thecredit facility are 2.0% and 1.0%, respectively. Effective on September 30,2005, the Company amended its credit facility to reduce the effective interestrate margins on the $588.5 million term facility by 0.25% to 1.75% onEurodollar loans and to 0.75% for Base rate loans. Interest with respect toBase rate loans is payable quarterly in arrears and interest with respect toEurodollar loans is payable at the end of the applicable interest period andevery three months in the case of interest periods in excess of three months.

The credit facilityprovides for payment to the lenders of a commitment fee on any unusedcommitments equal to 0.5% per annum, payable quarterly in arrears, as well asother fees.

The credit facilityrequires certain mandatory prepayments, including first to prepay outstandingterm loans under the credit facility and, thereafter, to repay loans under therevolving facility and/or to reduce revolving facility commitments with,subject to certain conditions and exceptions, 100% of the net cash proceeds theCompany receives from any sale, transfer or other disposition of any assets,100% of net casualty insurance proceeds and 100% of the net cash proceeds theCompany receives from the issuance of permitted securities and, at certaintimes if the Company is not permitted to pay dividends, with 50% of theincrease in the Company’s Cumulative Distributable Cash (as defined in thecredit facility) during the prior fiscal quarter. Reductions to the revolvingcommitments under the credit facility from the foregoing recapture events willnot reduce the revolving commitments under the credit facility below$50.0 million.

The credit facility providesfor voluntary prepayments of the revolving facility and the term facility andvoluntary commitment reductions of the revolving facility, subject to givingproper notice and compensating the lenders for standard Eurodollar breakagecosts, if applicable.

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

Thecredit facility requires that the Company maintain certain financial covenants.The credit facility contains customary affirmative covenants, including,without limitation, the following tests: a minimum interest coverage ratio equal to or greater than 3.0:1 and amaximum leverage ratio equal to or less than 5.25:1. The credit facility alsocontains negative covenants and restrictions, including, among others, withrespect to redeeming and repurchasing other indebtedness, loans andinvestments, additional indebtedness, liens, capital expenditures, changes inthe nature of the Company’s business, mergers, acquisitions, asset sales andtransactions with the Company’s affiliates. The credit facility restricts theCompany’s ability 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) capital expenditures (unless funded by long-termdebt, equity or the proceeds from asset sales or insurance recovery events), (iv) cashtaxes, (v) cash consideration paid for acquisitions (unless funded by debtor equity), (vi) cash paid to make certain investments, and (vii) certainnon-cash items excluded from Adjusted EBITDA and paid in cash and (b) plus(i) the cash amount of extraordinary gains and gains on sales of assetsand (ii) certain non-cash items excluded from Adjusted EBITDA and receivedin cash. “Adjusted EBITDA” is defined in the credit facility as ConsolidatedNet Income (which is defined in the credit facility and includes distributionsfrom investments) (a) plus the following to the extent deducted fromConsolidated Net Income: provision for income taxes, interest expense,depreciation, amortization, losses on sales of assets and other extraordinarylosses, and certain other non-cash items, and (b) minus, to the extentincluded in Consolidated Net Income, gains on sales of assets and otherextraordinary gains and all non-cash items.

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

The credit facility alsopermits the Company to use available cash to repurchase shares of its capitalstock, subject to the same conditions.

The Company may obtainletters of credit under the revolving facility to support obligations of theCompany and/or obligations of its subsidiaries incurred in the ordinary courseof business in an aggregate principal amount not to exceed $10.0 millionand subject to limitations on the aggregate amount outstanding under therevolving facility. As of December 31, 2005, a letter of credit had beenissued for $1.2 million.

The credit facility isguaranteed, jointly and severally, subject to certain exceptions, by all firsttier subsidiaries of the Company. The Company has provided to Deutsche BankTrust Company Americas, as collateral agent for the benefit of the lendersunder the credit facility and certain hedging creditors under permitted hedgingagreements, collateral consisting of (subject to certain exceptions) 100% ofthe Company’s equity interests in the subsidiary guarantors and certain otherintermediate holding company subsidiaries. Newly acquired or formed direct orindirect subsidiaries of the Company which own equity 

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

interestsof any subsidiary that is an operating company will be required to provide thecollateral 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) 1998 SeniorSecured Notes***

On March 30, 1998,the Company closed a $315 million senior secured credit facility(the Credit Facility) which committed $75 million of term debt(tranche C) amortized over 9 years, $155 million of term debt(tranche B) amortized over 8 years, and $85 million of reducingrevolving credit facility debt with a term of 6.5 years. On March 14,2000, an additional $165 million reducing revolving credit facility with aterm of 4.5 years was committed and made available to the Company under theCredit Facility. The Credit Facility required that the Company maintain certainfinancial covenants.

The credit facility wasamended and restated as part of a refinancing completed on March 6, 2003.The amended and restated credit facility provides for, among other things,rescheduled amortization and an excess cash flow sweep with respect to thetranche C term facility. The amended and restated credit facilityconsisted of term loan facilities (consisting of tranche A loans andtranche C loans) in an aggregate principal amount of $156.4 millionand a revolving credit facility in an aggregate principal amount of$70.0 million. All of the Company’s obligations under the credit facilitywere unconditionally and irrevocably guaranteed jointly and severally by fourof its mid-tier subsidiaries. Outstanding debt under the amended andrestated credit facility was secured by a first priority perfected security interestin all of the capital stock of certain of the Company’s subsidiaries.

On January 30, 2004,the Company amended its amended and restated credit facility to increase itsrevolving loan facility from $70.0 million to $85.0 million and itstranche A term loan facility from $30.0 million to$40.0 million. The Company used all of the additional borrowing under thetranche A term loan facility and a portion of the borrowings under therevolving loan facility to repay in full all of the indebtedness under the CarrierServices’ senior secured notes. There was no gain or loss on the extinguishmentof this indebtedness.

The 1998 Senior SecuredNotes were repaid in full in 2005 using proceeds from the Company’s initialpublic offering and borrowings under the 2005 Senior Secured Notes.

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

***(c) Fixed Rate and Floating Rate Senior SubordinatedNotes Issued in 1998***

FairPoint issued $125.0 million aggregateprincipal amount of senior subordinated notes (the 1998 Fixed-Rate Notes)and $75.0 million of floating-rate notes (the 1998 Floating-Rate Notes)in 1998. The 1998 Fixed-Rate Notes bore interest at the rate of 9.5% per annumand the 1998 Floating Rate Notes bore interest at a rate per annum equal toLIBOR plus 418.75 basis points, in each case payable semiannually in arrears.The LIBOR rate on the 1998 Floating-Rate Notes was determined semiannually.

At December 31, 2004 the Company’s restrictedcovenants on its fixed-rate and floating-rate senior subordinated notes issuedin 1998, its senior subordinated notes issued in 2000, and its senior notesissued in 2003 did not allow the Company to make any dividend payments.

The 1998 Fixed Rate Notesand the 1998 Floating-Rate Notes were repaid in full in 2005 using proceedsfrom the Company’s initial public offering and borrowings under the 2005 SeniorSecured Notes.

***(d) Senior Subordinated Notes Issued in 2000***

FairPoint issued $200.0 million aggregateprincipal amount of senior subordinated notes (the 2000 Notes) in 2000.The 2000 Notes bore interest at the rate of 12.5% per annum, payablesemiannually in arrears.

The 2000 Notes were repaidin full in 2005 using proceeds from the Company’s initial public offering andborrowings under the 2005 Senior Secured Notes.

***(e) 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.

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.

As a result of the issuance of the 2003 Notes, theCompany recorded $2.8 million and $0.7 million of nonoperating gainson the extinguishment of the 1998 Fixed Rate Notes and 2000 Notes and theCarrier Services debt, respectively. The Company also repurchased some Series Apreferred stock at a discount of $2.9 million. Additionally, the Companyrecorded a nonoperating loss of $5.0 million for the write-off ofdebt issue costs related to this extinguishment of debt in 2003.

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.

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

***(f) 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 Companywas in compliance with all of these covenants as of December 31, 2005.

The Company also has$0.4 million unsecured demand notes payable to various individuals andentities with interest payable at 5.25% at December 31, 2005 and 2004.

**(8)   Redeemable preferred stock**

The Series A preferred stock was issued to thelenders in connection with the Carrier Services debt restructuring. The Series Apreferred stock is nonvoting and is not convertible into common stock of theCompany. The Series A preferred stock provides for the payment ofdividends at a rate equal to 17.428% per annum. Dividends on the Series Apreferred stock are payable, at the option of the Company, either in cash or inadditional shares of Series A preferred stock. The Company has the optionto redeem any outstanding Series A preferred stock at any time. Theredemption price for such shares is payable in cash in an amount equal to$1,000 per share plus any accrued but unpaid dividends thereon(the Preference Amount). Under certain circumstances, the Company would berequired to pay a premium of up to 6% of the Preference Amount in connectionwith the redemption of the Series A preferred stock. In addition, upon theoccurrence of certain events such as (i) a merger, consolidation, sale,transfer, or disposition of at least 50% of the assets or business of theCompany and its subsidiaries; (ii) a public offering of the Company’scommon stock which yields in the aggregate at least $175.0 million; or (iii) thefirst anniversary of the maturity of the Company’s senior subordinated notes(which first anniversary will occur in May 2011), the Company wouldbe required to redeem all outstanding shares of the Series A preferredstock at a price per share equal to the Preference Amount, unless prohibited bythe Company’s credit facility or by the indentures governing its seniorsubordinated notes. In connection with the March refinancing, certainholders of the Series A preferred stock agreed to reduce the dividend ratepayable on the shares they hold from 17.428% to 15% for the period from March 6,2003 to March 6, 2005.

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity.*SFAS No. 150 establishes standardsfor how an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. SFAS No. 150 appliesspecifically to financial instruments that companies have historicallypresented within their financial statements either as equity or between theliabilities section and the equity section, rather than as liabilities. SFAS No. 150is effective for financial instruments entered into or modified after May 31,2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003, except for mandatorily redeemable financialinstruments of a nonpublic entity, in which this statement shall be effectivefor fiscal periods beginning after December 15, 2003. For purposes ofadoption of SFAS No. 150, the Company met the definition of a nonpublicentity. The Company prospectively adopted SFAS No. 150 effective July 1,2003. The SFAS No. 150 adoption had no impact on net income (loss)attributed to common shareholders for any of the periods presented.

SFAS No. 150 requires the Company to classify asa long-term liability its Series A preferred stock and to classifydividends and accretion from the Series A preferred stock as interestexpense. Such stock is 

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

described as “PreferredShares Subject to Mandatory Redemption” in the Balance Sheet as of December 31,2004 and dividends and accretion on these shares are included in pretax incomebeginning July 1, 2003, whereas previously they were presented as areduction to equity (a dividend) and, therefore, a reduction of net incomeavailable to common shareholders.

The initial carrying amount of the Series Apreferred stock has been recorded at its fair value at the date of issuance($78.4 million). The carrying amount is being increased by periodicaccretions, using the interest method, so that the carrying amount will equalthe mandatory redemption amount ($82.3 million) at the mandatoryredemption date (May 2011). On March 6, 2003, in connection with theCompany’s issuance of the 2003 Notes, the Company used a portion of theseproceeds to repurchase $13.3 million aggregate liquidation preference ofits Series A preferred stock at a 35% discount (together with accruedand unpaid dividends thereon). For the years ended December 31, 2005, 2004and 2003, the Series A preferred stock has been increased by $0.2 million,$1.4 million and $1.4 million, respectively, to reflect the periodicaccretions. The carrying amount of the Series A preferred stock has beenfurther increased by $2.2 million, $18.8 million and $16.5 million inconnection with dividends paid in kind on the outstanding shares of the Series Apreferred stock for the years ended December 31, 2005, 2004 and 2003,respectively. Prior to the adoption of SFAS No. 150, additional paid-incapital has been decreased $8.9 million for the increases in the carryingbalance of the Series A preferred stock for the period ended June 30,2003. Upon the adoption of SFAS No. 150, pretax income has been decreased$2.4 million, $20.2 million and $9.0 million for the increases in thecarrying balance of the Series A preferred stock for the years ended December 31,2005 and 2004 and the period July 1, 2003 through December 31, 2003,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.

**(9)   Employee Benefit Plans**

The Company sponsors a voluntary 401(k) savingsplan (the 401(k) Plan) that covers substantially all eligible employees.Each 401(k) Plan year, the Company contributes to the 401(k) Plan anamount of matching contributions determined by the Company at its discretion.For the 401(k) Plan years ended December 31, 2005, 2004, and 2003,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 to the 401(k) Plan were$1.3 million, $2.4 million, and $2.7 million for the years endedDecember 31, 2005, 2004, and 2003, 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 $26,000, $7,000, and$7,000 for the years ended December 31, 2005, 2004, and 2003,respectively. At December 31, 2005 and 2004, the NQDC Plan assets were$0.6 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 

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

theseplans were $0.3 million, $0.2 million, and $0.2 million for theyears ended December 31, 2005, 2004, and 2003, respectively.

**(10)   Income Taxes**

Incometax benefit (expense) from continuing operations for the years ended December 31,2005, 2004, and 2003 consists of the following components (in thousands):

| ** **                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:                                                                      |       |     |       |     |       |     |       |
| Federal                                                                       |       | $        | —     |     | $          | —   |       | $ | — |   |
| State                                                                         |       | (1,128   | )          | (543     | )          | 199      |       |
| Total current income tax benefit (expense) from  continuing operations   |       | (1,128   | )          | (543     | )          | 199      |       |
| Investment tax  credits                                                       |       | 16       |       | 27       |       | 37       |       |
| Deferred:                                                                     |       |     |       |     |       |     |       |
| Federal                                                                       |       | 78,385   |       | —   |       | —   |       |
| State                                                                         |       | 5,823    |       | —   |       | —   |       |
| Total deferred income tax benefit (expense) from continuing  operations  |       | 84,208   |       | —   |       | —   |       |
| Total income tax  benefit (expense) from continuing operations           |       | $        | 83,096     |     | $          | (516     | )          | $ | 236 |   |

 

Income tax expense of $0.2 million has also beenrecognized associated with income from discontinued operations.

Total income tax benefit (expense) from continuingoperations was different than that computed by applying U.S. Federal income taxrates to losses from continuing operations before income taxes for the yearsended December 31, 2005, 2004, and 2003. The reasons for the differencesare presented below (in thousands):

| ** **                                                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed  “expected” Federal tax benefit (expense) from continuing operations |       | $        | 19,090     |     | $          | 8,104    |       | $ | 2,880 |   |
| State income tax benefit  (expense), net of                                             |       |     |       |     |       |     |       |
| Federal income tax expense                                                              |       | 167      |       | (358     | )          | 131      |       |
| Dividends and loss on redemption on preferred stock                                     |       | (4,291   | )          | (6,862   | )          | (3,077   | )          |
| Dividends  received deduction                                                           |       | 153      |       | 103      |       | 94       |       |
| Rate change                                                                             |       | 1,585    |       | —   |       | —   |       |
| Change in  valuation allowance (Federal and state)                                      |       | 66,011   |       | (1,858   | )          | —   |       |
| Other                                                                                   |       | 381      |       | 355      |       | 208      |       |
| Total income tax  benefit (expense) from continuing operations                          |       | $        | 83,096     |     | $          | (516     | )          | $ | 236 |   |

 

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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 31,2005 and 2004 are presented below (in thousands):

| ** **                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                                                         |       |     |       |     |       |
| Federal and state tax loss carryforwards                                     |       | $        | 109,569    |     | $          | 91,929 |   |
| Employee benefits                                                            |       | 1,865    |       | 1,620    |       |
| Self insurance reserves                                                      |       | 1,389    |       | 968      |       |
| Restructure charges and exit liabilities                                     |       | 493      |       | 458      |       |
| Allowance for doubtful accounts                                              |       | 800      |       | —   |       |
| Alternative minimum tax and other state credits                              |       | 1,857    |       | 2,218    |       |
| Total gross deferred tax assets                                              |       | 115,973  |       | 97,193   |       |
| Valuation  allowance                                                         |       | —   |       | (66,011  | )          |
| Net deferred tax assets                                                      |       | 115,973  |       | 31,182   |       |
| Deferred tax  liabilities:                                                   |       |     |       |     |       |
| Property, plant, and equipment, principally due to depreciation  differences |       | 11,996   |       | 11,527   |       |
| Goodwill and other intangible assets                                         |       | 17,883   |       | 13,496   |       |
| Change in fair market value of swaps                                         |       | 3,301    |       |     |       |
| Basis in investments                                                         |       | 6,443    |       | 6,159    |       |
| Total gross deferred tax liabilities                                         |       | 39,623   |       | 31,182   |       |
| Net deferred tax  assets                                                     |       | $        | 76,350     |     | $          | — |   |

 

The valuation allowance for deferred tax assets as of December 31,2004 was $66.0 million. In assessing the realizability of deferred taxassets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during the periods in which those temporary differences becomedeductible. 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 otherevidence affecting the recoverability of deferred tax assets, the Companyexpects that future taxable income will more likely than not be sufficient torecover net deferred tax assets. Therefore, the valuation allowance wasreversed in the first quarter of 2005, subsequent to the offering.

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 realization ofdeferred tax assets is dependent upon the generation of future taxable incomeduring the periods in which those temporary differences become deductible.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 Company willneed to generate future taxable income of $219.2 million prior to theexpiration of the net operating loss carryforwards in 2025. Taxable losses forthe years ended December 31, 2005 and 2004 were $(41.0) million and$(10.9) million, respectively. Based upon the level of projections forfuture taxable income over the periods in which the deferred tax assets aredeductible, management believes it is more likely than not the Company willrealize the benefits of these deductible differences based on facts andcircumstances known as of December 31, 2005.

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

At December 31, 2005,the Company had federal and state net operating loss carryforwards of$291.9 million that will expire in 2019 to 2025. At December 31,2005, the Company has alternative minimum tax credits of $1.4 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.

**(11)   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, 2005, there were 35,021,335 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 shares 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.

**(12)   Stock Option Plans**

***(a) Compensation Expense***

For the twelve months ended December 31, 2005,2004 and 2003, the Company, in total, has recorded stock-based compensationexpense of $2.4 million, $49,000 and $15,000, respectively.

On October 1, 2004, the Company extended theexercise period on 18,013 options under the FairPoint Communications, Inc.(formerly MJD Communications, Inc.) 1995 Stock Option Plan (the 1995 Plan).The Company recognized a compensation charge of $0.3 million related tothe modification of these options during 2004.

Certain principalshareholders of the Company granted stock appreciation rights to certainmembers of management. In connection with the stock appreciation rights, theCompany recognized a benefit of $0.4 million in 2004 as the valueassociated with the stock appreciation rights declined. No additional chargeswere recognized in the year ended December 31, 2005 associated withstockholder appreciation rights. There were no adjustments to the stockappreciation rights in the year ended December 31, 2003, as the fairmarket value per share of the Company’s common stock remained flat during theyear. All outstanding stock appreciation rights were settled by the Company in2005.

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

***(b) 1995 Stock Option Plan***

In February 1995, the Company adopted the 1995Plan. The 1995 Plan covers officers, directors, and employees of the Company.The Company was allowed to issue qualified or nonqualified stock options topurchase up to 215,410 shares of the Company’s Class A common stock toemployees that would vest equally over 5 years from the date of employment ofthe recipient and are exercisable during years 5 through 10. In 1995, theCompany granted options to purchase 161,596 shares at $1.32 per share. Nooptions have been granted since 1995. Effective in February 2005, theCompany may no longer grant awards under the 1995 Plan.

The per share weighted average fair value of stockoptions granted during 1995 was $0.69 on the date of grant using theBlack-Scholes option-pricing model. Input variables used in the modelincluded no expected dividend yields, a risk-free interest rate of 6.41%,and an estimated option life of five years. Because the Company was nonpublicon the date of the grant, no assumption as to the volatility of the stock pricewas made.

Stock option activity under the 1995 Plan issummarized as follows:

| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Outstanding at  January 1:        |       | 112,265  |       | 112,265  |       | 112,265  |       |
| Granted                                |       | —   |       | —   |       | —   |       |
| Exercised                              |       | (94,252  | )          | —   |       | —   |       |
| Forfeited                              |       | —   |       | —   |       | —   |       |
| Outstanding at  December 31       |       | 18,013   |       | 112,265  |       | 112,265  |       |
| Exercisable at  December 31, 2005 |       | 18,013   |       |     |       |     |       |
| Stock options  available to grant at   |       |     |       |     |       |     |       |
| December 31, 2005                 |       | —   |       |     |       |     |       |

 

***(c) MJD Communications, Inc. Stock Incentive Plan***

In August 1998, the Company adopted 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 in control,outstanding options will vest immediately. Effective in February 2005, theCompany 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 extent to which the price pershare obtained in the sale of the Company would exceed a minimum selling priceof $22.59 per share. All options have a term of 10 years from date of grant.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 

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

public offering of theCompany’s common stock that occurred on February 8, 2005, as described innote 2, did not trigger exercisability of these options.

Pursuant to the terms of the grant, options granted in2000 become exercisable immediately upon vesting. The per share weightedaverage fair value of stock options granted under the 1998 Plan during 2000 was$58.95 on the date of grant using the Black-Scholes option-pricing model.Input variables used in the model included no expected dividend yields, a risk-freeinterest rate of 6.52%, and an estimated option life of 10 years. Because theCompany was nonpublic on the date of the grant, no assumption as to thevolatility of the stock price was made.

Stockoption activity under the 1998 Plan is summarized as follows:

| ** **                                                  | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|-------------------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                                  | ** ** | ** **      | ** ** | **average**  | ** ** |
| ** **                                                  | ** ** | **Options**     | ** ** | **exercise** | ** ** |
| ** **                                                  | ** ** | **outstanding** | ** ** | **price**    | ** ** |
| Outstanding at  December 31, 2002                      |       |            | 839,672    |         |       |   | $ | 10.87 |   |   |
| Granted                                                     |       |            | —     |         |       |   | — |   |   |
| Exercised                                                   |       |            | —     |         |       |   | — |   |   |
| Forfeited                                                   |       |            | (3,316     | )            |       |   | 9.02 |   |   |
| 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 |   |   |
| Stock options available  to grant at December 31, 2005 |       |            | —     |         |       |   |   |   |   |

 

| ** **   | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|--------------|------------|------------------------------|------------|------------------------------|------------|
| ** **   | ** ** | **Number**                   | ** ** | ** **                   | ** ** | **Number** | ** ** | **Weighted** | ** ** |
| ** **   | ** ** | **outstanding at**      | ** ** | **Remaining**                | ** ** | **exercisable at** | ** ** | **average** | ** ** |
| **Exercise** | ** ** | **December 31,**        | ** ** | **contractual**              | ** ** | **December 31,** | ** ** | **exercise** | ** ** |
| **price**    | ** ** | **2005**                     | ** ** | **life (years)**        | ** ** | **2005** | ** ** | **price** | ** ** |
|         | $          | 9.02                         |       |                         |       | 756,332 |   |   |   | 2.60 |   |   |   | — |   |   |   | $ | — |   |   |
|         | 14.46      |                         |       |                         | 29,183     |   |   |   | 3.50 |   |   |   | — |   |   |   | — |   |   |
|         | 36.94      |                         |       |                         | 47,373     |   |   |   | 6.00 |   |   |   | — |   |   |   | — |   |   |
|         |       |                         |       |                         | 832,888    |   |   |   |   |   |   |   | — |   |   |   | $ | — |   |   |

 

The weighted averageremaining contractual life for the options outstanding at December 31,2005 is 2.8 years.

***(d) FairPoint Communications, Inc. 2000 EmployeeStock 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 Class A common stock, at thediscretion of the compensation committee. During 2002, the Company amended the2000 Plan to limit the number of shares available for grant to 448,236. In December 2003,the Company amended the 2000 Plan to allow for the grant to members ofmanagement of up to 1,898,521 shares of restricted stock in addition to sharesavailable for stock options. Options granted under the 2000 Plan may be of twotypes: (i) incentive stock options and (ii) nonstatutory 

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

stock options. Unless thecompensation committee shall otherwise specify at the time of grant, any optiongranted under the 2000 Plan shall be a nonstatutory 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 Class A common stock at exercise prices notless than the market value of the Company’s Class A common stock at thedate of grant. Options have a term of 10 years from date of grant. Options vestin increments of 10% on the first anniversary, 15% on the second anniversary,and 25% on the third, fourth, and fifth anniversaries of an individual grant.Subject to certain provisions, in the event of a change of control, the Companywill cancel each option in exchange for a payment in cash of an amount equal tothe excess, if any, of the highest price per share of Class A common stockoffered in conjunction with any transaction resulting in a change of controlover the exercise price for such option.

Restricted units vest in increments of 33% on each ofthe third, fourth, and fifth anniversaries of the award. In December 2003,27,382 units were awarded with an aggregate value of $890,000. At December 31,2004, 26,442 units remain outstanding as 940 units were forfeited in 2004. TheCompany recognized compensation expense of $178,000, $177,000 and $15,000during 2005, 2004 and 2003, respectively, related to these awards and willrecognize the balance of compensation expense over the remaining vestingperiod.

Stockoption activity under the 2000 Plan is summarized as follows:

| ** **                                                  | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|-------------------------------------------------------------|------------|-----------------|------------|--------------|------------|
| ** **                                                  | ** ** | ** **      | ** ** | **average**  | ** ** |
| ** **                                                  | ** ** | **Options**     | ** ** | **exercise** | ** ** |
| ** **                                                  | ** ** | **outstanding** | ** ** | **price**    | ** ** |
| Outstanding at  December 31, 2002                      |       |            | 231,331    |         |       |   | $ | 36.94 |   |   |
| Granted                                                     |       |            | 90,580     |         |       |   | 36.94 |   |   |
| Exercised                                                   |       |            | —     |         |       |   | — |   |   |
| Canceled or forfeited                                       |       |            | (21,177    | )            |       |   | 36.94 |   |   |
| 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 |   |   |
| Stock options available  to grant at December 31, 2005 |       |            | —     |         |       |   |   |   |   |

 

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

The remaining contractual life for the optionsoutstanding at December 31, 2005 was 6.9 years, and191,104 options were exercisable.

The per share weightedaverage fair value of stock options granted under the 2000 Plan during 2003,was $8.39 on the date of grant using the Black Scholes option-pricingmodel. Input variables used in the model included no expected dividend yields,a weighted average risk free interest rate of 4.26% in 2003 and an estimatedoption life of 10 years. Because the Company was nonpublic on the date ofgrant, no assumption as to the volatility of the stock price was made. No stockoptions were granted under the 2000 Plan during 2004 or 2005.

***(e) 2005 Stock Incentive Plan***

In February 2005, the Company adopted the 2005Stock Incentive Plan. The 2005 Plan provided for the grant of up to 947,441shares of restricted stock, restricted units and stock options to members ofthe Company’s board of directors and certain key members of the Company’smanagement. At December 31, 2005, 467,654 shares of common stock may beissued in the future pursuant to awards authorized under the 2005 StockIncentive Plan.

As of December 31, 2005, the Company has granted523,716 shares of restricted stock issued under the Company’s 2005 StockIncentive Plan to certain employees. These shares vest over periods rangingfrom three to four years and certain of these shares pay current dividends. Inconnection with these grants, the Company recorded unearned compensation of$9.5 million, which has been reduced to $6.5 million as of December 31,2005. During 2005, 53,687 shares of restricted stock were forfeited bringingthe total number of restricted shares outstanding under the 2005 StockIncentive Plan to 470,029 shares.

In the second quarter of2005, the Company’s board of directors approved an annual award to each of theCompany’s non-employee directors of approximately $30,000 in the form ofrestricted stock or restricted units, at the recipient’s option, issued underthe Company’s 2005 Stock Incentive Plan. The restricted stock and restrictedunits will vest in four equal quarterly installments on the first day of eachof the first four calendar quarters following the grant date, commencing on July 1,2005, and the holders thereof will be entitled to receive dividends from thedate of grant, whether or not vested. In the second quarter of 2005, theCompany granted 1,870 shares of restricted stock with a total value at thegrant date of approximately $30,000 and 7,480 restricted units with a totalvalue at the grant date of approximately $120,000 to the Company’s non-employeedirectors. An additional 408 restricted units were granted in the third andfourth quarters of 2005 in lieu of dividends on the restricted units.

**(13)**   DiscontinuedOperations and Restructure Charges

***(a) Competitive Communications Business Operations***

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 communications businessoperations of its wholly owned subsidiary, Carrier Services. As a result of theadoption of the plan to discontinue the competitive communications operations,these results are presented as discontinued operations. The Company recognizeda total charge of $95.3 million on the disposal of its competitivecommunications operations, including the $31.1 million loss on the sale ofassets; $36.1 million for the write-off of the remaining operatingassets, including property, plant, and equipment; and $28.1 million forexpenses the Company estimated it would incur during the phase-outperiod, net of estimated revenue to be received from customers until they weretransitioned to other 

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

carriers. Estimatedexpense for the phase-out period included interest expense. Interestexpense was allocated to discontinued operations based on the interest incurredby the Company under the Carrier Services’ credit facility and the two interestrate swaps related to this facility.

On May 2002, Carrier Services entered into anamended and restated credit facility with its lenders to restructure theobligations under its credit facility. In the restructuring, (i) CarrierServices paid certain of its lenders $5.0 million to satisfy$7.0 million of obligations under the credit facility, (ii) thelenders converted approximately $93.9 million of the loans under thecredit facility into shares of FairPoint’s Series A preferred stock havinga liquidation preference equal to the amount of such loans, and (iii) theremaining loans under the credit facility and certain swap obligations wereconverted into $27.9 million of new term loans.

As a result of this restructuring in 2002, the Companyrecorded a gain in discontinued operations of $17.5 million for theextinguishment of debt and settlement of its interest rate swap agreements. Thegain represents the difference between the May 10, 2002 carrying value of$128.8 million of retired debt ($125.8 million) and related swapobligations ($3.0 million) and the sum of the aggregate value of the cashpaid ($5.0 million) plus principal amount of new term loans($27.9 million) plus the estimated fair value of the Company’s Series Apreferred stock issued ($78.4 million).

During 2004 and 2003, the Company revised itsassumptions on certain lease obligations related to the restructuring accrualand as a result, increased the obligation by $0.1 million in 2004 and reducedthe obligation by $0.2 million in 2003. Also during 2004, accrued liabilitiesassociated with the discontinued operations were re-evaluated, or settled forless than original estimates and as a result, these obligations were adjustedby $0.6 million.

In January 2006, the Company reached a settlementon certain lease obligations which reduced the remaining obligations related todiscontinued operations. As a result, the Company reduced the obligation by$0.6 million to properly reflect the on-going obligations of the Company.

Assetsand liabilities of discontinued operations of Carrier Services as of December 31,2005 and 2004 follows (in thousands):

| ** **                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Accounts  receivable                                         |       | $        | 90         |     | $          | 102 |   |
| Current assets of discontinued operations                    |       | $        | 90         |     | $          | 102 |   |
| Accrued  liabilities                                         |       | $        | (1,133     | )        | $          | (1,141 | ) |
| Restructuring  accrual                                       |       | (1,312   | )          | (1,071   | )          |
| Accrued property  taxes                                      |       | (50      | )          | (50      | )          |
| Current liabilities of discontinued operations               |       | $        | (2,495     | )        | $          | (2,262 | ) |
| Restructuring  accrual                                       |       | $        | —     |     | $          | (1,580 | ) |
| ***Long-term liabilities of discontinued operations *** |       | $        | —     |     | $          | (1,580 | ) |

 

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

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

| ** **                                          | ** ** | **Equipment,**     | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **occupancy,**     | ** ** |
| ** **                                          | ** ** | **and other** | ** ** |
| ** **                                          | ** ** | **lease**          | ** ** |
| ** **                                          | ** ** | **terminations**   | ** ** |
| Restructuring  accrual as of December 31, 2002 |       |               | $          | 7,182 |   |   |
| Adjustments from  initial estimated charges         |       |               | (246       | ) |   |
| Cash payments                                       |       |               | (1,683     | ) |   |
| 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 |   |   |

 

***(b) Rural Local Exchange Carrier Operations***

On September 30, 2003, the Company completed thesale of all of the capital stock owned by Services of Union Telephone Companyof Hartford, Armour Independent Telephone Co., WMW Cable TV Co., and KadokaTelephone Co. to Golden West Telephone Properties, Inc.(Golden West). The sale was completed in accordance with the terms of thepurchase agreement, dated as of May 9, 2003, with Golden West. The Companyreceived $24.2 million in sales proceeds. The South Dakota properties weregeographically isolated from other Company properties making it increasinglydifficult to realize additional operating efficiencies. These properties wereadjacent to Golden West’s operations and offered Golden West numerousoperational synergies. The proceeds from this divestiture were used to fundacquisitions completed in 2003. The operations of these companies are presentedas discontinued operations.

Income from the South Dakota divestiture operationsconsists of the following (in thousands):

| ** **                           | ** ** | **Nine months**   | ** ** |
|--------------------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **ended**              | ** ** |
| ** **                           | ** ** | **September 30,** | ** ** |
| ** **                           | ** ** | **2003**               | ** ** |
| Revenue                              |       |                   | $          | 4,028 |   |   |
| Income from discontinued  operations |       |                   | 1,929      |   |   |

 

The Company recorded again on disposal of the South Dakota companies of $7.7 million.

**(14)   Related Party Transactions**

The Company had entered into financial advisoryagreements with certain equity investors, pursuant to which the equityinvestors provided certain consulting and advisory services related, but notlimited to, equity financings and strategic planning. In 2005, the Company paidapproximately $0.1 million related to these agreements. These agreements werecancelled on February 8, 2005. The Company paid $1.0 million for eachof the years ended December 31, 2004 and 2003 in such fees to the equityinvestors 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 

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

Company reimbursed theequity investors $123,000 and $21,000 for the years ended December 31,2004 and 2003, respectively, for travel and related expenses. In connectionwith our initial public offering, we terminated these agreements and paid atransaction fee of $8.4 million to one of these equity advisors.

In 2004, a law firm in which a partner of such lawfirm was a director of the Company through February 8, 2005. In 2005, nofees were paid by the Company to this law firm prior to February 8, 2005. Totalfees paid to this law firm in 2005 were $1.4 million. In 2004, the law firm waspaid $3.5 million, of which $0.1 million was for general counsel services and$3.4 million was for services related to financing and equity offering costs.In 2003, this same law firm was paid $1.3 million, of which $0.4 million wasfor general counsel services and $0.9 million was for services related tofinancings.

A law firm, in which a partner of such law firm is thehusband of an executive officer, was paid $303,000, $4,000 and $127,000 for theyears ended December 31, 2005, 2004, and 2003, respectively, for legalservices and expenses.

All payments made by the Company for general servicesand unsuccessful acquisition bids are classified within operating expenses onthe consolidated statements of operations. All payments made for servicesrelated to financings have been recorded as debt or equity issue costs. Allpayments made for services related to successful acquisition bids have beencapitalized as direct costs of the acquisitions. All services related to therestructure and discontinuance of the competitive communications operationshave been classified in discontinued operations.

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.

**(15)**   QuarterlyFinancial Information (Unaudited)

| ** **                                                             | ** ** | **First**                                                          | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                                             | ** ** | **quarter**                                                        | ** ** | **quarter** | ** ** | **quarter** | ** ** | **quarter** | ** ** |
| ** **                                                             | ** ** | **(in thousands, except per share data)** | ** ** |
| 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        |       |
| 2004:                                                                  |       |                                                               |       |        |       |        |       |        |       |
| Revenue                                                                |       | $                                                                  | 60,985     |        | 62,416     |        | 65,437     |        | 63,807     |   |
| Loss from continuing operations                                        |       | (4,608                                                             | )          | (4,765      | )          | (4,225      | )          | (10,755     | )          |
| Net loss                                                               |       | (4,608                                                             | )          | (4,094      | )          | (4,225      | )          | (10,755     | )          |
| Basic and diluted loss from continuing operations per  share           |       | (0.49                                                              | )          | (0.50       | )          | (0.45       | )          | (1.13       | )          |
| Basic and diluted  loss per share                                      |       | (0.49                                                              | )          | (0.43       | )          | (0.45       | )          | (1.13       | )          |

 

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

 

In connection with the Company’s initial publicoffering in February 2005, the Company recognized, in the first quarter of2005, non-operating losses of $86.2 million related to fees and penalties paidon the redemption of its Series A preferred stock and the write-off ofunamortized debt issuance costs. Also in connection with the offering, theCompany repaid portions of its previously outstanding debt and therefore,interest expense was significantly reduced in the first quarter of 2005. Inaddition, the Company recorded an income tax benefit of $66.0 million in thefirst quarter of 2005 due to the reversal of its valuation allowance.

In the fourth quarter of2004, the Company recognized a $6.0 million nonoperating loss related tothe write-off of debt issuance and offering costs associated with anabandoned offering of income deposit securities.

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

***(a) Cash, Accounts Receivable, Accounts Payable, andDemand Notes Payable***

The carrying amountapproximates fair value because of the short maturity of these instruments.

***(b) Investments***

Investments classified as trading securities arecarried at their fair value, which was approximately $0.6 million at December 31,2005 and 2004, respectively. (see note 6 and note 9)

At December 31, 2005,the Company had cost method investments with a carrying value of $33.1 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-term Debt***

The fair value of theCompany’s publicly registered long-term debt is stated at quoted marketprices. The fair value of the Company’s remaining long-term debt isestimated by discounting the future cash flows of each instrument at ratescurrently offered to the Company for similar debt instruments of comparablematurities. At December 31, 2005 and 2004, the Company had long-termdebt with a carrying value of $607.4 million and $810.4 million,respectively, and estimated fair values of $608.3 million and$865.2 million, respectively.

***(d) Redeemable preferred stock***

The fair value of theCompany’s redeemable preferred stock is estimated utilizing a cash flowanalysis at a discount rate equal to rates available for debt with termssimilar to the preferred stock. At December 31, 2004 the Company’s carryingvalue of its redeemable preferred stock was $116.9 million and estimatedfair value was $126.8 million.

***(e) 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.

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

**(17)**   Revenue Concentrations

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 26.7%, 25.7%, and26.3% of the Company’s total revenues from continuing operations for the yearsended December 31, 2005, 2004, and 2003, respectively.

**(18)**   Revenue Settlements

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 state jurisdiction and by access charges in theinterstate market. Revenues earned through the various sharing arrangements areinitially recorded based on the Company’s estimates. The Company recognized $3.3 million,$3.1 million, and $3.0 million of revenue for settlements andadjustments related to prior years during 2005, 2004, and 2003, respectively.

**(19)**   Commitments andContingencies

***(a) Operating Leases***

Future minimum lease payments under noncancelableoperating leases as of December 31, 2005 are as follows (in thousands):

| ** **                                                                           | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|
| ** **                                                                           | ** ** | **operations** | ** ** | **operations**   | ** ** |
| Year ending  December 31:                                                       |       |           |       |             |       |   |   |   |   |
| 2006                                                                                 |       |           | $          | 1,143            |       |   |   | $ | 1,196 |   |   |
| 2007                                                                                 |       |           | 1,076      |             |       |   | — |   |   |
| 2008                                                                                 |       |           | 1,029      |             |       |   | — |   |   |
| 2009                                                                                 |       |           | 887        |             |       |   | — |   |   |
| 2010                                                                                 |       |           | 444        |             |       |   | — |   |   |
| Thereafter                                                                           |       |           | 2,313      |             |       |   | — |   |   |
| Total minimum  lease payments                                                        |       |           | $          | 6,892            |       |   |   | 1,196 |   |   |
| Less estimated  rentals to be received under subleases                          |       |           |       |             |       |   | — |   |   |
| Estimated minimum lease  payments included in liabilities of discontinued operations |       |           |       |             |       |   | $ | 1,196 |   |   |

 

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 $3.5 million,$3.2 million, and $3.1 million in 2005, 2004, and 2003, respectively.

The Company does not haveany leases with contingent rental payments or any leases with contingencyrenewal, purchase options, or escalation clauses.

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

***(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 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. The Companybelieves that this action is without merit and intends to continue to defendthe 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

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

Based upon this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that our disclosure controlsand procedures were effective in ensuring that information required to bedisclosed as of the period covered by this Annual Report has been timelyrecorded, processed, summarized and reported within the time periods specifiedin the rules of the SEC.

There have been no changesin our “internal controls over financial reporting” (as defined in Rule 3a-15(f) ofthe Exchange Act) during the fiscal quarter ended December 31, 2005 thathave materially affected, or that are reasonably likely to materially affect,our internal controls over financial reporting. In response to the Sarbanes-OxleyAct, we are continuing a comprehensive review of our disclosure controls andprocedures and will improve such controls and procedures as necessary to assuretheir effectiveness.

**ITEM 9B.**       OTHERINFORMATION

Not applicable.

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**PARTIII**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

The information requiredby Items 401 and 405 of Regulation S-K is incorporated herein by reference tothe Company’s definitive proxy statement to be filed not later than April 30,2005 with the SEC pursuant to Regulation 14A under the Exchange Act.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredby Item 402 of Regulation S-K is incorporated herein by reference to theCompany’s definitive proxy statement to be filed not later than April 30, 2005with the SEC pursuant to Regulation 14A under the Exchange Act.

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

The information requiredby Items 201(a) and 403 of Regulation S-K is incorporated herein by referenceto the Company’s definitive proxy statement to be filed not later than April30, 2005 with the SEC pursuant to Regulation 14A under the Exchange Act.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information requiredby Item 404 of Regulation S-K is incorporated herein by reference to theCompany’s definitive proxy statement to be filed not later than April 30, 2005with the SEC pursuant to Regulation 14A under the Exchange Act.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information requiredby Item 9(e) of Schedule 14A is incorporated herein by reference to theCompany’s definitive proxy statement to be filed not later than April 30, 2005with the SEC pursuant to Regulation 14A under the Exchange Act.

**PARTIV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENT SCHEDULES

**(a)**          FinancialStatements

The financial statementsfiled as part of this Annual Report are listed in the index to the financialstatements under “Item 8. Independent Auditors’ Reports and Consolidated FinancialStatements,” which index to the financial statements is incorporated herein byreference. In addition, certain financial statements of equity methodinvestments owned by the Company are included as exhibit 99.1 to thisAnnual 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, 2006 |   | 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, 2006 |
| Eugene B. Johnson            |           | Chief Executive Officer  (Principal Executive    |       |           |
|                         |           | Officer)                                         |       |           |
| /s/ JOHN P. CROWLEY          |           | Executive Vice  President and Chief              |       | March 13, 2006 |
| John P. Crowley              |           | Financial Officer  (Principal Financial Officer) |       |           |
| /s/ LISA R. HOOD             |           | Senior Vice  President and Controller            |       | March 13, 2006 |
| Lisa R. Hood                 |           | (Principal Accounting  Officer)                  |       |           |
| /s/ FRANK K. BYNUM, JR.      |           | Director                                         |       | March 13, 2006 |
| Frank K. Bynum, Jr.          |           |                                             |       |           |
| /s/ PATRICIA GARRISON-CORBIN |           | Director                                         |       | March 13, 2006 |
| Patricia Garrison-Corbin     |           |                                             |       |           |
| /s/ DAVID L. HAUSER          |           | Director                                         |       | March 13, 2006 |
| David L. Hauser              |           |                                             |       |           |
| /s/ ROBERT S. LILIEN         |           | Director                                         |       | March 13, 2006 |
| Robert S. Lilien             |           |                                             |       |           |
| /s/ CLAUDE C. LILLY          |           | Director                                         |       | March 13, 2006 |
| Claude C. Lilly              |           |                                             |       |           |
| /s/ KENT R. WELDON           |           | Director                                         |       | March 13, 2006 |
| Kent R. Weldon               |           |                                             |       |           |

 

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**Exhibit Index**

| Exhibit   No. | ** ** | **Description** |
|---------------|------------|-----------------|
|          |  2.1  |            |   | Agreement and Plan of  Merger, dated as of June 18, 2003, by and among FairPoint, MJD  Ventures, Inc., FairPoint Berkshire Corporation and Berkshire Telephone  Corporation.(1) |
|          |  2.2  |            |   | Agreement and Plan of  Merger, dated as of April 22, 2005, by and among FairPoint, MJD  Ventures, Inc., FairPoint Bentleyville Corporation and Bentleyville  Communications Corporation.(2) |
|          |  2.3  |            |   | Asset Purchase  Agreement, dated as of December 14, 2005, by and among FairPoint, Local  Exchange Company LLC, Cass County Telephone Company Limited Partnership and  LEC Long Distance, Inc.* |
|          |  2.4  |            |   | Stock Purchase  Agreement, dated February 17, 2006, by and among Southern Illinois  Cellular Corp. and Crosslink Wireless, Inc., Egyptian Communication  Services, Inc., Hamilton County Communications, Inc., HTC Holding  Co., MJD Services Corp., Shawnee Communications, Inc. and Wabash  Independent Networks, Inc. and Alltel Communications, Inc.* |
|          |  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) |
|          | 10.3       |            |   | Second Amendment and  Consent to Credit Agreement, dated as of April 29, 2005, among  FairPoint, various lending institutions, Bank of America, N.A., CoBank ACB,  General Electric Capital Corporation and Deutsche Bank Trust Company  Americas.(5) |
|          | 10.4       |            |   | Third Amendment to  Credit Agreement, dated as of September 14, 2005, among FairPoint,  various lending institutions, Bank of America, N.A., CoBank ACB, General  Electric Capital Corporation and Deutsche Bank Trust Company Americas.(6) |
|          | 10.5       |            |   | Pledge Agreement, dated  as of February 8, 2005, by FairPoint, ST Enterprises, Ltd., FairPoint  Broadband, Inc., MJD Services Corp., MJD Ventures, Inc., C-R  Communications, Inc., Comerco, Inc., GTC Communications, Inc.,  Ravenswood Communications, Inc., Utilities, Inc., FairPoint Carrier  Services, Inc. and St. Joe Communications, Inc.(3) |

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|        | 10.6  |   |   | Subsidiary Guaranty, dated as of February 8,  2005, by FairPoint Broadband, Inc., MJD Ventures, Inc., MJD  Services Corp., ST Enterprises, Ltd. and FairPoint Carrier  Services, Inc.(2) |
|--------|-------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 10.7  |   |   | Form of Swingline  Note.(3)                                                                                                                                                                             |
|   | 10.8  |   |   | Form of RF Note.(3)                                                                                                                                                                                     |
|   | 10.9  |   |   | Form of B Term  Note.(3)                                                                                                                                                                                |
|   | 10.10 |   |   | Amended and Restated Tax  Sharing Agreement, dated as of November 9, 2000, by and among FairPoint  and its Subsidiaries.(7)                                                                             |
|   | 10.11 |   |   | Nominating Agreement,  dated as of February 8, 2005.(3)                                                                                                                                                 |
|   | 10.12 |   |   | Affiliate Registration  Rights Agreement, dated as of February 8, 2005.(3)                                                                                                                              |
|   | 10.13 |   |   | Employment Agreement,  dated as of December 31, 2002, by and between FairPoint and Eugene B. Johnson.(4)                                                                                                |
|   | 10.14 |   |   | Letter Agreement, dated  as of October 1, 2004, by and between FairPoint and Eugene B.  Johnson.(8)                                                                                                     |
|   | 10.15 |   |   | Employment Agreement,  dated as of January 20, 2000, by and between FairPoint and Walter E.  Leach, Jr.(9)                                                                                         |
|   | 10.16 |   |   | Letter Agreement, dated  as of December 15, 2003, by and between FairPoint and Walter E.  Leach, Jr.(10)                                                                                           |
|   | 10.17 |   |   | Letter Agreement, dated  as of November 11, 2002, by and between FairPoint and Peter G. Nixon.(4)                                                                                                       |
|   | 10.18 |   |   | Letter Agreement, dated  as of November 13, 2002, by and between FairPoint and Shirley J. Linn.(4)                                                                                                      |
|   | 10.19 |   |   | Letter Agreement, dated  as of May 16, 2005, by and between FairPoint and John P. Crowley.(12)                                                                                                          |
|   | 10.20 |   |   | FairPoint 1995 Stock  Option Plan.(13)                                                                                                                                                                       |
|   | 10.21 |   |   | FairPoint Amended and  Restated 1998 Stock Incentive Plan.(13)                                                                                                                                               |
|   | 10.22 |   |   | FairPoint Amended and  Restated 2000 Employee Stock Incentive Plan.(10)                                                                                                                                      |
|   | 10.23 |   |   | FairPoint 2005 Stock  Incentive Plan.(3)                                                                                                                                                                     |
|   | 10.24 |   |   | FairPoint Annual  Incentive Plan.(3)                                                                                                                                                                         |
|   | 10.25 |   |   | Form of Restricted  Stock Agreement.(8)                                                                                                                                                                 |
|   | 10.26 |   |   | Form of Director  Restricted Stock Agreement.(14)                                                                                                                                                       |
|   | 10.27 |   |   | Restricted Stock  Agreement, dated as of September 21, 2005, by and between FairPoint and  John P. Crowley.(15)                                                                                         |
|   | 10.28 |   |   | Form of Director  Restricted Unit Agreement.(14)                                                                                                                                                        |
|   | 14.1  |   |   | FairPoint Code of  Business Conduct and Ethics.*                                                                                                                                                             |
|   | 14.2  |   |   | FairPoint Code of Ethics  for Financial Professionals.(11)                                                                                                                                                   |

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|        | 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.*† |
|   | 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, 2005, 2004 and 2003.*           |

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*                    Filedherewith.

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

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

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

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

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

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

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

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

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

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

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

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(11)   Incorporated by reference tothe Annual Report on Form 10-K of FairPoint for the year ended December 31,2004.

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

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

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

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

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