10-Q 1 frp-2012930x10q.htm FORM 10-Q FRP-2012.9.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ______________________________________________________________________
 FORM 10-Q
________________________________________________________________ 
(Mark One)
x    
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
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 001-32408
______________________________________________________________________
 FairPoint Communications, Inc.
(Exact name of registrant as specified in its charter)
 ______________________________________________________________________
Delaware
 
13-3725229
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
521 East Morehead Street, Suite 500
Charlotte, North Carolina
 
28202
(Address of principal executive offices)
 
(Zip Code)
(704) 344-8150
(Registrant’s telephone number, including area code)
 ______________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
o
 
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  o
As of October 29, 2012, there were 26,290,698 shares of the registrant’s common stock, par value $0.01 per share, outstanding.


INDEX
 
 
 
Page
 
Item 1.
 
 
 
Condensed Consolidated Statements of Operations for the three months ended September 30, 2012 and 2011, the nine months ended September 30, 2012, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011 (Unaudited)
 
 
 
 
Item 2.
Item 3.
Item 4.
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some statements in this Quarterly Report on Form 10-Q for our quarter ended September 30, 2012 (this “Quarterly Report”) are known as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements may relate to, among other things:
•
future performance generally and our share price as a result thereof;
•
restrictions imposed by the agreements governing our indebtedness;
•
our ability to satisfy certain financial covenants included in the agreements governing our indebtedness;
•
financing sources and availability, and future interest expense;
•
our ability to refinance our indebtedness on commercially reasonable terms, if at all;
•
anticipated business development activities and future capital expenditures;
•
the effects of regulation, including restrictions and obligations imposed by federal and state regulators as a condition to the approval of the Merger (as defined herein) and the Plan (as defined hereinafter);
•
adverse changes in economic and industry conditions, and any resulting financial or operational impact, in the markets we serve;
•
labor matters, including workforce levels, our workforce reduction initiatives and labor negotiations, and any resulting financial or operational impact;
•
material technological developments and changes in the communications industry, including disruption of our third party suppliers’ provisioning of critical products or services;
•
change in preference and use by customers of alternative technologies;
•
the effects of competition on our business and market share;
•
risks related to our reported financial information and operating results including with respect to our adoption of fresh start accounting;
•
changes in federal and state regulatory policies, procedures and mechanisms, including but not limited to the availability and levels of regulatory support payments;
•
availability of net operating loss (“NOL”) carryforwards to offset anticipated tax liabilities;
•
the impact of changes in assumptions on our ability to meet obligations to our Company-sponsored qualified pension plans and post-retirement healthcare plans;
•
the impact of lump sum payments related to accrued vested benefits under our Company-sponsored qualified pension plans on future pension contributions; and
•
changes in accounting assumptions that regulatory agencies, including the Securities and Exchange Commission (the “SEC”), may require or that result from changes in the accounting rules or their application, which could result in an impact on earnings.
These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this Quarterly Report that are not historical facts. When used in this Quarterly Report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results, events or developments to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed in this Quarterly Report and in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Annual Report”), as amended or supplemented by "Item 1A. Risk Factors" contained in this Quarterly Report, as applicable. You should not place undue reliance on such forward-looking statements, which are based on the information currently available to us and speak only as of the date on which this Quarterly Report was filed with the SEC. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made on related subjects in our subsequent reports filed with the SEC on Forms 10-K, 10-Q and 8-K.

3

Except as otherwise required by the context, references in this Quarterly Report to:
•
“FairPoint Communications” refers to FairPoint Communications, Inc., excluding its subsidiaries.
•
“FairPoint,” the “Company,” “we,” “us” or “our” refer to the combined business of FairPoint Communications, Inc. and all of its subsidiaries after giving effect to the merger on March 31, 2008 with Northern New England Spinco Inc. (“Spinco”), a subsidiary of Verizon Communications Inc. (“Verizon”), which transaction is referred to herein as the “Merger”.
•
“Northern New England operations” refers to the local exchange business acquired from Verizon and certain of its subsidiaries after giving effect to the Merger.
•
“Telecom Group” refers to FairPoint, exclusive of our acquired Northern New England operations.
•
“Predecessor Company” refers to all periods as of and preceding the Effective Date (as defined hereinafter).

4

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, 2012 and December 31, 2011
(in thousands, except share data)
 
 
September 30, 2012
 
December 31, 2011
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash
$
22,080

 
$
17,350

Restricted cash
10,792

 
24,446

Accounts receivable, net
102,263

 
104,298

Prepaid expenses
21,173

 
18,346

Other current assets
2,850

 
3,312

Deferred income tax, net
12,949

 
17,915

Total current assets
172,107

 
185,667

Property, plant and equipment (net of $537.5 million and $280.5 million accumulated depreciation, respectively)
1,493,504

 
1,663,065

Intangible assets (net of $18.8 million and $10.4 million accumulated amortization, respectively)
119,780

 
128,145

Debt issue costs, net
1,278

 
1,779

Restricted cash
651

 
651

Other assets
10,678

 
10,338

Total assets
$
1,797,998

 
$
1,989,645

Liabilities and Stockholders’ Deficit
 
 
 
Current portion of long-term debt
$
10,000

 
$
10,000

Current portion of capital lease obligations
1,222

 
1,252

Accounts payable
52,853

 
65,184

Claims payable and estimated claims accrual
1,303

 
22,839

Accrued interest payable
670

 
508

Other accrued liabilities
74,987

 
54,348

Total current liabilities
141,035

 
154,131

Capital lease obligations
1,782

 
2,690

Accrued pension obligation
153,705

 
157,961

Employee benefit obligations
566,941

 
531,634

Deferred income taxes
183,700

 
245,369

Other long-term liabilities
11,526

 
14,003

Long-term debt, net of current portion
960,000

 
990,000

Total long-term liabilities
1,877,654

 
1,941,657

Total liabilities
2,018,689

 
2,095,788

Commitments and contingencies (See Note 12)

 

Stockholders’ deficit:
 
 
 
Common stock, $0.01 par value, 37,500,000 shares authorized, 26,240,614 and 26,197,142 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
262

 
262

Additional paid-in capital
505,209

 
502,034

Retained deficit
(536,059
)
 
(414,945
)
Accumulated other comprehensive loss
(190,103
)
 
(193,494
)
Total stockholders’ deficit
(220,691
)
 
(106,143
)
Total liabilities and stockholders’ deficit
$
1,797,998

 
$
1,989,645


See accompanying notes to condensed consolidated financial statements (unaudited).
5


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
Three Months Ended September 30, 2012 and 2011, Nine Months Ended September 30, 2012,
Two Hundred Forty-Nine Days Ended September 30, 2011 and Twenty-Four Days Ended January 24, 2011
(Unaudited)
(in thousands, except per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30, 2012
 
Two Hundred
Forty-Nine
Days Ended
September 30, 2011
 
 
Predecessor
Company
 
2012
 
2011
 
 
 
 
Twenty-Four
Days Ended
January 24, 2011
Revenues
$
242,052

 
$
257,912

 
$
733,979

 
$
708,950

 
 
$
66,378

Operating expenses:
 
 
 
 
 
 
 
 
 
 
Cost of services and sales, excluding depreciation and amortization
105,502

 
120,149

 
330,937

 
321,790

 
 
38,766

Selling, general and administrative expense, excluding depreciation and amortization
80,915

 
93,334

 
257,055

 
245,132

 
 
27,161

Depreciation and amortization
89,782

 
91,547

 
276,769

 
244,940

 
 
21,515

Reorganization related expense(income)
172

 
(3,735
)
 
(4,043
)
 
1,511

 
 
—

Impairment of intangible assets and goodwill
—

 
262,019

 
—

 
262,019

 
 
—

Total operating expenses
276,371

 
563,314

 
860,718

 
1,075,392

 
 
87,442

Loss from operations
(34,319
)
 
(305,402
)
 
(126,739
)
 
(366,442
)
 
 
(21,064
)
Other income (expense):
 
 
 
 
 
 
 
 
 
 
Interest expense
(16,991
)
 
(17,147
)
 
(51,002
)
 
(46,634
)
 
 
(9,321
)
Other
548

 
488

 
725

 
1,319

 
 
(132
)
Total other expense
(16,443
)
 
(16,659
)
 
(50,277
)
 
(45,315
)
 
 
(9,453
)
Loss before reorganization items and income taxes
(50,762
)
 
(322,061
)
 
(177,016
)
 
(411,757
)
 
 
(30,517
)
Reorganization items
—

 
—

 
—

 
—

 
 
897,313

(Loss) income before income taxes
(50,762
)
 
(322,061
)
 
(177,016
)
 
(411,757
)
 
 
866,796

Income tax benefit (expense)
13,433

 
42,620

 
55,902

 
80,796

 
 
(279,889
)
Net (loss) income
$
(37,329
)
 
$
(279,441
)
 
$
(121,114
)
 
$
(330,961
)
 
 
$
586,907

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
 
 
Basic
25,993

 
25,843

 
25,970

 
25,836

 
 
89,424

Diluted
25,993

 
25,843

 
25,970

 
25,836

 
 
89,695

(Loss) earnings per share:
 
 
 
 
 
 
 
 
 
 
Basic
$
(1.44
)
 
$
(10.81
)
 
$
(4.66
)
 
$
(12.81
)
 
 
$
6.56

Diluted
$
(1.44
)
 
$
(10.81
)
 
$
(4.66
)
 
$
(12.81
)
 
 
$
6.54


See accompanying notes to condensed consolidated financial statements (unaudited).
6


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive (Loss) Income
Three Months Ended September 30, 2012 and 2011, Nine Months Ended September 30, 2012,
Two Hundred Forty-Nine Days Ended September 30, 2011 and Twenty-Four Days Ended January 24, 2011
(Unaudited)
(in thousands)
 
 
 
 
 
 
 
 
 
 
 
Predecessor
Company
 
Three Months Ended September 30,
 
Nine Months Ended September 30, 2012
 
Two Hundred
Forty-Nine Days
Ended
September 30, 2011
 
 
Twenty-Four
Days Ended
January 24, 2011
 
2012
 
2011
 
 
 
 
Net (loss) income
$
(37,329
)
 
$
(279,441
)
 
$
(121,114
)
 
$
(330,961
)
 
 
$
586,907

Other comprehensive income, net of taxes:
 
 
 
 
 
 
 
 
 
 
Qualified pension and post-retirement healthcare plans (net of $0 million, $0, $0.8 million, $0 and $0.5 million tax expense, respectively)
52

 
—

 
3,391

 
—

 
 
493

Total other comprehensive income
52

 
—

 
3,391

 
—

 
 
493

Comprehensive (loss) income
$
(37,277
)
 
$
(279,441
)
 
$
(117,723
)
 
$
(330,961
)
 
 
$
587,400



See accompanying notes to condensed consolidated financial statements (unaudited).
7


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Stockholders’ Deficit
Nine Months Ended September 30, 2012
(Unaudited)
(in thousands)
 
 
Common Stock
 
Additional
paid-in
capital
 
Retained
deficit
 
Accumulated
other
comprehensive
loss
 
Total
stockholders’
deficit
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2011
26,197

 
$
262

 
$
502,034

 
$
(414,945
)
 
$
(193,494
)
 
$
(106,143
)
Net loss
—

 
—

 
—

 
(121,114
)
 
—

 
(121,114
)
Issuance of Common Stock
52

 
—

 
—

 
—

 
—

 
—

Forfeiture of restricted stock
(20
)
 
—

 
—

 
—

 
—

 
—

Exercise of stock options
12

 
—

 
53

 
—

 
—

 
53

Stock based compensation expense
—

 
—

 
3,122

 
—

 
—

 
3,122

Employee benefit adjustment to comprehensive income
—

 
—

 
—

 
—

 
3,391

 
3,391

Balance at September 30, 2012
26,241

 
$
262

 
$
505,209

 
$
(536,059
)
 
$
(190,103
)
 
$
(220,691
)

See accompanying notes to condensed consolidated financial statements (unaudited).
8


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2012, Two Hundred Forty-Nine Days Ended September 30, 2011
and Twenty-Four Days Ended January 24, 2011
(Unaudited)
(in thousands)
 
Nine Months
Ended
September 30, 2012
 
Two Hundred
Forty-Nine Days
Ended
September 30, 2011
 
 
Predecessor
Company
 
 
 
 
Twenty-Four
Days Ended
January 24, 2011
Cash flows from operating activities:
 
 
 
 
 
 
Net (loss) income
$
(121,114
)
 
$
(330,961
)
 
 
$
586,907

Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
 
 
 
 
 
 
Deferred income taxes
(56,743
)
 
(80,119
)
 
 
279,868

Provision for uncollectible revenue
2,951

 
15,713

 
 
3,454

Depreciation and amortization
276,769

 
244,940

 
 
21,515

Post-retirement healthcare
36,919

 
25,512

 
 
2,654

Qualified pension
(4,047
)
 
1,709

 
 
986

Impairment of intangible assets and goodwill
—

 
262,019

 
 
—

Other non cash items
1,497

 
(150
)
 
 
97

Changes in assets and liabilities arising from operations:
 
 
 
 
 
 
Accounts receivable
(861
)
 
1,839

 
 
(7,752
)
Prepaid and other assets
(2,937
)
 
2,030

 
 
(3,423
)
Restricted cash
(7,796
)
 
—

 
 
—

Accounts payable and accrued liabilities
732

 
(2,636
)
 
 
26,627

Accrued interest payable
162

 
183

 
 
9,017

Other assets and liabilities, net
(2,082
)
 
268

 
 
177

Reorganization adjustments:
 
 
 
 
 
 
Non-cash reorganization income
(5,119
)
 
(5,290
)
 
 
(917,358
)
Claims payable and estimated claims accrual
(8,803
)
 
(64,091
)
 
 
(1,096
)
Restricted cash - cash claims reserve
20,291

 
56,544

 
 
(82,764
)
Total adjustments
250,933

 
458,471

 
 
(667,998
)
Net cash provided by (used in) operating activities
129,819

 
127,510

 
 
(81,091
)
Cash flows from investing activities:
 
 
 
 
 
 
Net capital additions
(95,996
)
 
(128,538
)
 
 
(12,477
)
Distributions from investments
634

 
636

 
 
—

Net cash used in investing activities
(95,362
)
 
(127,902
)
 
 
(12,477
)
Cash flows from financing activities:
 
 
 
 
 
 
Loan origination costs
—

 
(884
)
 
 
(1,500
)
Repayments of long-term debt
(30,000
)
 
—

 
 
—

Restricted cash
1,158

 
1,675

 
 
34

Proceeds from exercise of stock options
53

 
—

 
 
—

Repayment of capital lease obligations
(938
)
 
(809
)
 
 
(201
)
Net cash used in financing activities
(29,727
)
 
(18
)
 
 
(1,667
)
Net change
4,730

 
(410
)
 
 
(95,235
)
Cash, beginning of period
17,350

 
10,262

 
 
105,497

Cash, end of period
$
22,080

 
$
9,852

 
 
$
10,262

Supplemental disclosure of cash flow information:
 
 
 
 
 
 
Capital additions included in accounts payable or claims payable and estimated claims accrual at period-end
$
—

 
$
2,777

 
 
$
1,818

Reorganization costs paid
$
621

 
$
19,282

 
 
$
11,110

Non-cash settlement of claims payable
$
7,668

 
$
—

 
 
$
—


See accompanying notes to condensed consolidated financial statements (unaudited).
9


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Unaudited)
 
(1)
Organization and Principles of Consolidation
Organization
FairPoint is a leading communications provider in rural and small urban communities offering an array of services, including broadband Internet access, local and long-distance phone, television and other high-capacity data services, to residential, business and wholesale customers. FairPoint operates in 18 states with approximately 1.3 million access line equivalents (including voice access lines and high speed data (“HSD”), which includes digital subscriber lines (“DSL”), wireless broadband, cable modem and fiber-to-the-premises) as of September 30, 2012.
Principles of Consolidation
The consolidated financial statements include all majority-owned subsidiaries of the Company. Partially owned equity affiliates are accounted for under the cost method or equity method when the Company demonstrates significant influence, but does not have a controlling financial interest. Intercompany accounts and transactions have been eliminated.
 
(2)
Accounting Policies
(a) Presentation and Use of Estimates
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), which require management to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates. The condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of results of operations and financial condition for the interim periods shown, including normal recurring accruals and other items.
Examples of significant estimates include fresh start accounting, the allowance for doubtful accounts, revenue reserves, the recoverability of property, plant and equipment, valuation of intangible assets, pension and post-retirement healthcare plan assumptions, stock based compensation and income taxes. In addition, estimates have been made in determining the amounts and classification of the claims reserve established to pay outstanding bankruptcy claims and various other bankruptcy related fees (the “Claims Reserve”). See note 4 for further discussion of the reorganization under chapter 11.
(b) Revenue Recognition
Revenues are recognized as services are rendered and are primarily derived from the usage of the Company’s networks and facilities or under revenue-sharing arrangements with other communications carriers. Revenues are primarily derived from: access (including pooling), voice services, Connect America Fund (“CAF”) receipts, Internet and broadband services and other miscellaneous services. Local access charges are billed to local end users under tariffs approved by each state’s Public Utilities Commission (“PUC”) or by rates, terms and conditions determined by the Company. Access revenues are derived for the intrastate jurisdiction by billing access charges to interexchange carriers and to other local exchange carriers (“LECs”). These charges are billed based on toll or access tariffs approved by the local state’s PUC. Access charges for the interstate jurisdiction are billed in accordance with tariffs filed by the National Exchange Carrier Association or by the individual company and approved by the Federal Communications Commission (the “FCC”).
Revenues are determined on a bill-and-keep basis or a pooling basis. If on a bill-and-keep basis, the Company bills the charges to either the access provider or the end user and keeps the revenue. If the Company participates in a pooling environment (interstate or intrastate), the toll or access billed is contributed to a revenue pool. The revenue is then distributed to individual companies based on their company-specific revenue requirement. This distribution is based on individual state PUCs’ (intrastate) or the FCC’s (interstate) approved separation rules and rates of return. Distribution from these pools can change relative to changes made to expenses, plant investment, or rate-of-return. Some companies participate in federal and certain state universal service programs that are pooling in nature but are regulated by rules separate from those described above. These rules vary by state. Revenues earned through the various pooling arrangements are initially recorded based on the Company’s estimates.
Long distance retail and wholesale services can be recurring due to coverage under an unlimited calling plan or usage sensitive. In either case, they are billed in arrears and recognized when earned. Internet and data services revenues are substantially all recurring revenues and are billed one month in advance and deferred until earned.

10

The majority of the Company’s miscellaneous revenue is provided from late payment charges to end users and interexchange carriers, miscellaneous project revenues, billing and collection services and directory services. In 2011, the Company began billing for late payment fees to customers who have not paid their bills in a timely manner. Late fee revenue for residential and small and large business end user customers is recognized as it is billed while it is recognized for interexchange carriers as it is collected. The Company requires customers to pay for miscellaneous projects in advance. These advance payments are included in other accrued liabilities on the condensed consolidated balance sheets. Once the miscellaneous project is completed and all project costs have been accumulated for proper accounting recognition, the advance payment is recognized as revenue with any overpayment refunded to the customer as appropriate. The Company earns revenue from billing and collecting charges for toll calls on behalf of interexchange carriers. The interexchange carrier pays a certain rate per call billed by the Company. The Company recognizes revenue from billing and collection services when the services are provided.
Non-recurring customer activation fees, along with the related costs up to, but not exceeding, the activation fees, are deferred and amortized over the customer relationship period.
Service quality index (“SQI”) penalties and certain performance assurance plan (“PAP”) penalties are recorded as a reduction to revenue. SQI penalties for Maine, New Hampshire and Vermont are recorded to other accrued liabilities on the condensed consolidated balance sheets. PAP penalties for Maine and New Hampshire are recorded as a reduction to accounts receivable since these penalties are paid by the Company in the form of credits applied to the Competitive Local Exchange Carrier (“CLEC”) bills. PAP penalties in Vermont are recorded to other accrued liabilities as a majority of these penalties are paid to the Vermont Universal Service Fund (“VUSF”), while the remaining credits assessed in Vermont are paid by the Company in the form of credits applied to CLEC bills. Effective August 10, 2012, the SQI penalty plan in New Hampshire was eliminated.
Revenue is recognized net of tax collected from customers and remitted to governmental authorities.
Management makes estimated adjustments, as necessary, to revenue and accounts receivable for billing errors, including certain disputed amounts.
(c) Restricted Cash
As of September 30, 2012, the Company had $11.4 million of restricted cash, of which $2.6 million is reserved for payment of outstanding bankruptcy claims (the “Cash Claims Reserve”), $4.4 million is reserved for broadband build-out in Vermont, $3.3 million is reserved for broadband build-out in New Hampshire, $0.4 million is reserved for removal of dual poles in Vermont and $0.7 million is restricted for other purposes. See note 4 for further discussion of the reorganization under chapter 11. During the three months ended September 30, 2012, $2.2 million of restricted cash reserved for broadband build-out in Vermont was used.
(d) Impairment of Goodwill and Indefinite-lived Intangible Assets
Goodwill
Upon the Effective Date (as defined hereinafter), the Company recorded $256.0 million of goodwill, which consists of the difference between the reorganization value of the post-emergence entity and the fair value of net assets using the acquisition method of accounting for business combinations in the Business Combinations Topic of the Accounting Standards Codification ("ASC"). During the second quarter of 2011, the Company made a $12.8 million reclassification adjustment to Property, Plant and Equipment based on fresh start accounting guidance which reduced goodwill to $243.2 million.
At September 30, 2011, as a result of the significant sustained decline in the Company's stock price since the Effective Date (as defined hereinafter), which caused the Company's market capitalization to be below its book value, the Company determined that a possible impairment of goodwill was indicated and concluded that an interim two-step goodwill impairment test was necessary. In step one, the Company calculated the discounted cash flows to arrive at a fair value, which was then compared to the carrying value, including goodwill. A combination of expected cash flows and higher discount rates resulted in the fair value, using the discounted cash flow method, being less than the carrying value, at which point the Company proceeded to step two, which compares the implied fair value of the Company's goodwill to its carrying amount. Results of the impairment test required the Company to record an impairment charge reducing the carrying value of the goodwill to zero at September 30, 2011. This non-cash impairment charge had no impact on the Company's compliance with the covenants contained in the Credit Agreement (as defined hereinafter).
The goodwill impairment fell within Level 3 of the fair value hierarchy, as defined in the Fair Value Measurement Topic of the ASC, due to the use of significant unobservable inputs to determine fair value. The fair value measurement

11

was calculated using unobservable inputs, primarily using the income approach and specifically the discounted cash flow method.
Indefinite-lived Intangible Assets
The Company assesses the fair value of the trade name based on the relief from royalty method. If the carrying amount of the trade name exceeds its estimated fair value, the asset is considered impaired. On the Effective Date (as defined hereinafter), the Company recorded a $58.0 million non-amortizable intangible asset related to the FairPoint trade name in connection with the Company's adoption of fresh start accounting.
At September 30, 2011, as a result of the significant sustained decline in the Company's stock price since the Effective Date (as defined hereinafter) which caused the Company's market capitalization to be below its book value, the Company determined that a possible impairment of the FairPoint trade name was indicated and concluded that an interim impairment test was necessary. Results of the impairment test required the Company to record an impairment charge totaling $18.8 million at September 30, 2011. This non-cash impairment charge had no impact on the Company's compliance with the covenants contained in the Credit Agreement (as defined hereinafter).
The trade name impairment fell within Level 3 of the fair value hierarchy, as defined in the Fair Value Measurement Topic of the ASC, due to the use of significant unobservable inputs to determine fair value. The fair value measurement was calculated using unobservable inputs, using the relief from royalty method.
For its non-amortizable intangible asset impairment assessments of the FairPoint trade name, the Company makes certain assumptions including an estimated royalty rate, a long-term growth rate, an effective tax rate and a discount rate and applies these assumptions to projected future cash flows, exclusive of cash flows associated with wholesale revenues as these revenues are not generated through brand recognition. Changes in one or more of these assumptions may result in the recognition of an impairment loss different from what was actually recorded.
(e) Accounting for Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
FairPoint files a consolidated income tax return with its subsidiaries. All intercompany tax transactions and accounts have been eliminated in consolidation.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management determines its estimates of future taxable income based upon the scheduled reversal of deferred tax liabilities and tax planning strategies. The Company establishes valuation allowances for deferred tax assets when it is estimated to be more likely than not that the tax assets will not be realized.
(f) Business Segments
Management views its business of providing data, video and voice communication services to residential, wholesale and business customers as one reportable segment as defined in the Segment Reporting Topic of the ASC. The Company’s services consist of retail and wholesale telecommunications and data services, including voice and HSD in 18 states. The Company’s chief operating decision maker assesses operating performance and allocates resources based on the consolidated results.
 
(3)
Recent Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2012-02 to amend and simplify the annual testing for impairment of indefinite-lived intangible assets. This amendment to the Intangibles-Goodwill and Other Topic of the ASC allows an entity the option to first assess qualitative factors to determine whether the existence of events and circumstances that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset leads to a determination that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity determines it is not likely that the indefinite-lived intangible asset is impaired, then performing the quantitative impairment test is

12

unnecessary. However, if an entity concludes otherwise, then it is required to perform a quantitative impairment test. The ASU includes examples of events and circumstances that could affect significant inputs used to determine the fair value of the indefinite-lived intangible assets that an entity should consider when evaluating whether it is more likely than not that an indefinite-lived intangible asset is impaired. This new guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company has elected to early adopt this ASU. The adoption of this amendment to the ASC did not have a material impact on the Company's condensed consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05 related to the presentation of comprehensive income, which eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. This ASU requires that all non-owner changes in stockholders' equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance was to be applied retrospectively, effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted.  In December 2011, the FASB issued ASU 2011-12, which deferred the elective date for amendments to the presentation of reclassification of items out of accumulated other comprehensive income in ASU 2011-05. The adoption of this amendment to the ASC did not have a material impact on the Company's condensed consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04 related to achieving common fair value measurements and disclosure requirements between U.S. GAAP and International Financial Reporting Standards (“IFRS”). This ASU changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and IFRS. The ASU also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs, as defined in the Fair Value Measurement Topic of the ASC. This new guidance was to be applied prospectively, effective for interim and annual periods beginning after December 15, 2011. Early adoption was not permitted. The adoption of this amendment to the ASC did not have a material impact on the Company's condensed consolidated financial statements.

(4)
Reorganization Under Chapter 11
Emergence from Chapter 11 Proceedings
On October 26, 2009 (the “Petition Date”), the Company and substantially all of its direct and indirect subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code” or “Chapter 11”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The cases are being jointly administered under the caption In re FairPoint Communications, Inc., Case No. 09-16335 (the “Chapter 11 Cases”). On January 13, 2011, the bankruptcy judge entered into an order dated as of December 29, 2010 (the “Confirmation Order”) confirming the Company’s Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (as confirmed, the “Plan”) and on January 24, 2011 (the “Effective Date”) the Company emerged from Chapter 11 protection.
On the Effective Date, the Company substantially consummated its reorganization through a series of transactions contemplated by the Plan, and the Plan became effective pursuant to its terms.
The Plan provided for, among other things: (i) the cancellation and extinguishment on the Effective Date of all of the Company’s equity interests outstanding on or prior to the Effective Date, including but not limited to all outstanding shares of the Company’s common stock, par value $0.01 per share, options and contractual or other rights to acquire any equity interests, (ii) the issuance of shares of the Company’s new common stock, par value $0.01 per share (the “Common Stock”), and warrants (“Warrants”) to purchase shares of the Company’s Common Stock to holders of certain claims in connection with a warrant agreement that the Company entered into with the Bank of New York Mellon, as warrant agent, on the Effective Date (the “Warrant Agreement”), in accordance with the Plan, (iii) the satisfaction of claims associated with (a) the credit agreement, dated as of March 31, 2008, by and among FairPoint Communications, Spinco, Bank of America, N.A. as syndication agent, Morgan Stanley Senior Funding, Inc. and Deutsche Bank Securities Inc., as co-documentation agents, and Lehman Commercial Paper Inc., as administrative agent, and the lenders party thereto (as amended, supplemented or otherwise modified from time to time, the “Pre-Petition Credit Facility”), (b) the 13-1/8% Senior Notes due April 1, 2018 (the “Old Notes”), which were issued pursuant to the Indenture, dated as of March 31, 2008, by and between Spinco and U.S. Bank National Association, as amended and (c) the 13-1/8% Senior Notes due April 2, 2018 (the “New Notes” and, together with the Old Notes, the “Pre-Petition Notes”), which were issued pursuant to the Indenture, dated as of July 29, 2009, by and between FairPoint Communications and U.S. Bank National Association and (iv) the termination by its conversion into the revolving facility of the Credit Agreement (as defined below) of the Debtor-in-Possession Credit Agreement, dated as of October 27, 2009 (as amended, the “DIP Credit Agreement”), by and among FairPoint Communications and FairPoint Logistics, Inc. (“FairPoint Logistics”, and together with FairPoint Communications, the “DIP Borrowers”), certain financial institutions (the “DIP Lenders”) and Bank of America, N.A.,

13

as the administrative agent for the DIP Lenders (the “DIP Administrative Agent”). The Company’s Common Stock began trading on the Nasdaq Stock Market LLC on January 25, 2011. In addition, on the Effective Date, FairPoint Communications and FairPoint Logistics (collectively, the “Borrowers”) entered into a $1,075.0 million senior secured credit facility with a syndicate of lenders and Bank of America, N.A., as the administrative agent for the lenders, arranged by Banc of America Securities LLC (the “Credit Agreement”) comprised of a $75 million revolving facility (the “Revolving Facility”) and a $1.0 billion term loan facility (the “Term Loan” and together with the Revolving Facility, the “Credit Agreement Loans”). In connection with the Chapter 11 Cases, the Company also negotiated with representatives of the state regulatory authorities in Maine, New Hampshire and Vermont with respect to (i) certain regulatory approvals relating to the Chapter 11 Cases and the Plan and (ii) certain modifications to the requirements imposed by state regulatory authorities as a condition to approval of the Merger (each a “Merger Order,” and collectively, the “Merger Orders”). The Company agreed to regulatory settlements with the representatives for each of Maine, New Hampshire and Vermont regarding modification of each state’s Merger Order (each a “Regulatory Settlement,” and collectively, the “Regulatory Settlements”) which were then approved by the regulatory authorities in those states.
On June 30, 2011, the Bankruptcy Court entered a final decree closing certain of the Company’s bankruptcy cases due to such cases being fully administered. Of the 80 original bankruptcy cases, only five remain open. These cases are FairPoint Communications, Inc. (Case No. 09-16335), Northern New England Telephone Operations LLC (Case No. 09-16365), Telephone Operating Company of Vermont LLC (Case No. 09-16410), MJD Services Corp. (Case No. 09-16366) and Enhanced Communications of Northern New England Inc. (Case No. 09-16349).
On October 15, 2012, the Company filed a motion in the Bankruptcy Court for final decree closing all but one of the remaining Chapter 11 Cases, including FairPoint Communications, Inc. (Case No. 09-16335), Enhanced Communications of Northern New England Inc. (Case No. 09-16349), MJD Services Corp. (Case No. 09-16366) and Telephone Operating Company of Vermont LLC (Case No. 09-16410). Upon Bankruptcy Court approval of the motion, only the Chapter 11 Case of Northern New England Telephone Operations LLC (Case No. 09-16365) will remain open.
Financial Reporting in Reorganization
The Company has applied the Reorganizations Topic of the ASC effective as of the Petition Date. The Reorganizations Topic of the ASC, which is applicable to companies in Chapter 11, generally does not change the manner in which financial statements are prepared. However, it does require that the financial statements for periods subsequent to the filing of the Chapter 11 Cases distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Amounts that can be directly associated with the reorganization and restructuring of the business must be reported separately as reorganization items in the statements of operations beginning in the quarter ending December 31, 2009. In addition, cash provided by and used for reorganization items must be disclosed separately.
The Company’s condensed consolidated statement of operations for the twenty-four days ended January 24, 2011 includes the results of operations during the Chapter 11 Cases. As such, any revenues, expenses, and gains and losses realized or incurred that are directly related to the bankruptcy case are reported separately as reorganization items due to the bankruptcy.

14

Reorganization Items
Reorganization items represent expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases and are presented separately in the condensed consolidated statement of operations for the twenty-four days ended January 24, 2011 pursuant to the Reorganizations Topic of the ASC. Such items consist of the following (in thousands):
 
 
Predecessor Company
 
Twenty-Four Days Ended
January 24, 2011
Professional fees (a)
$
(13,965
)
Cancellation of debt income (b)
1,351,057

Goodwill adjustment (c)
(351,931
)
Intangible assets adjustment (c)
(30,381
)
Property, plant and equipment adjustment (c)
(56,258
)
Qualified pension and post-retirement healthcare adjustment (c)
22,076

Other assets and liabilities adjustment (c)
(16,037
)
Tax account adjustments (c)
4,313

Other (d)
(11,561
)
Total reorganization items
$
897,313

 
(a)
Professional fees relate to legal, financial advisory and other professional costs directly associated with the reorganization process.
(b)
Net gains and losses associated with the settlement of liabilities subject to compromise, of which $1,351,055 was recognized on the Effective Date.
(c)
Revaluation of long lived assets and certain assets and liabilities upon adoption of fresh start accounting.
(d)
Includes expenses associated with the FairPoint Communications, Inc. 2010 Long Term Incentive Plan (the “Long Term Incentive Plan”) adopted as part of the Plan, the FairPoint Litigation Trust (the “Litigation Trust”), which was entered into as part of the Plan, and the write-off of the Predecessor Company’s long term incentive plan and director and officer policy.
Professional fees directly associated with the reorganization process that have been incurred after the Effective Date are included in operating expenses as Reorganization related expense in the condensed consolidated statements of operations.
Magnitude of Claims
As of October 29, 2012, claims totaling $4.9 billion were filed with the Bankruptcy Court against the Company. Through the claim resolution process, $3.8 billion of these claims have been settled and $1.1 billion of these claims have been disallowed by the Bankruptcy Court. Additionally, $10.1 million of these claims have been withdrawn by the respective creditors and $7.5 million of these claims remain open, pending completion of settlements or resolution of pending court proceedings.
On the Effective Date, the Company distributed cash, entered into the Credit Agreement, and issued shares of Common Stock and Warrants to satisfy $2.8 billion of claims. In addition, on the Effective Date, the Company established the Cash Claims Reserve of $82.8 million and reserved 72,754 shares of Common Stock and Warrants to purchase 124,012 shares of Common Stock for satisfaction of pending claims. Subsequent to the Effective Date, the Company has made additional cash distributions from its Cash Claims Reserve and issued additional shares of Common Stock to satisfy claims as they are resolved. As a result of these distributions, the Cash Claims Reserve as of October 29, 2012, has been decreased to $2.6 million. As of October 29, 2012, all of the 72,754 shares of Common Stock and all of the Warrants to purchase 124,012 shares of Common Stock reserved under the Plan on the Effective Date have been distributed in full satisfaction of allowed claims, thereby completing the Common Stock and Warrant distribution with respect to the Plan.
Fresh Start Accounting
Upon confirmation of the Plan by the Bankruptcy Court and satisfaction of the remaining material contingencies to complete the implementation of the Plan, under the Reorganizations Topic of the ASC, the Company was required to apply the provisions of fresh start accounting to its financial statements on the Effective Date because (i) the reorganization value of the assets of the emerging entity immediately before the date of confirmation was less than the total of all post-

15

petition liabilities and allowed claims and (ii) the holders of the existing voting shares of the Predecessor Company’s common stock immediately before confirmation received less than 50 percent of the voting shares of the emerging entity.
The adoption of fresh start accounting resulted in a new reporting entity. The financial statements as of January 24, 2011 and for subsequent periods report the results of a new entity with no beginning retained earnings. With the exception of deferred taxes and assets and liabilities associated with pension and post-retirement healthcare plans, which were recorded in accordance with the Income Taxes Topic of the ASC and the Compensation Topic of the ASC, respectively, all of the new entity’s assets and liabilities were recorded at their estimated fair values upon the Effective Date and the Predecessor Company’s retained deficit and accumulated other comprehensive loss were eliminated. Any presentation of the new entity’s financial position and results of operations is not comparable to prior periods.
In accordance with fresh start accounting, the Company also recorded the debt and equity at fair value utilizing the total enterprise value of approximately $1.5 billion. The enterprise value was determined in conjunction with the confirmation of the Plan. To facilitate the calculation of the enterprise value, the Company developed financial projections for the five years ending December 31, 2015 for the post-emergence company using a number of estimates and assumptions and prepared a calculation of the present value of the future cash flows. The projections were based on information available to the Company at the time of preparation of such projections in connection with the Plan and its confirmation and also in connection with negotiations regarding the Plan with certain of its lenders. The projections and calculation of the present value of the future cash flows included key assumptions, such as: (i) revenue growth beginning in 2013 through the terminal year based on the Company achieving specified business objectives, (ii) improving earnings before interest and taxes margins, (iii) reductions in capital expenditures and (iv) a risk adjusted discount rate of 7.2%. Projections are inherently subject to uncertainties and risks and the Company’s actual results and financial condition have varied from those contemplated by the projections and other financial information provided to the Bankruptcy Court. The Company believes that because such projections and other financial information are now out of date and because of developments with respect to the Company’s business since such projections were prepared, these projections should not be relied upon.
 
(5)
Dividends
The Company currently does not pay a dividend on its Common Stock and does not expect to implement the payment of dividends in the foreseeable future.

(6)
Income Taxes
The Company recorded an income tax benefit for the three months ended September 30, 2012 and 2011, the nine months ended September 30, 2012 and the 249 days ended September 30, 2011 of $13.4 million, $42.6 million, $55.9 million and $80.8 million, respectively, and an income tax expense for the 24 days ended January 24, 2011 of $279.9 million.
For the three months ended September 30, 2012, the effective tax rate to calculate the tax benefit on $50.8 million of pre-tax loss was 26.5%. The rate differs from the 35% federal statutory rate primarily due to an increase in the valuation allowance offset by state taxes and other permanent adjustments.
For the three months ended September 30, 2011, the effective tax rate to calculate the tax benefit on $322.1 million of pre-tax loss was 13.2%. The rate differs from the 35% federal statutory rate primarily due to an impairment charge reducing the carrying value of the Company's goodwill to zero and state income taxes.
For the nine months ended September 30, 2012, the effective tax rate to calculate the tax benefit on $177.0 million of pre-tax loss was 31.6%. The rate differs from the 35% federal statutory rate primarily due to an increase in the valuation allowance offset by state taxes.
For the 249 days ended September 30, 2011, the effective tax rate to calculate the tax benefit on $411.8 million of pre-tax loss was 19.6%. The rate differs from the 35% federal statutory rate primarily due to a prior period adjustment, an impairment charge reducing the carrying value of the Company's goodwill to zero and state income taxes.
For the 24 days ended January 24, 2011, the effective tax rate to calculate the tax expense on $866.8 million of pre-tax income was 32.3%. The rate differs from the 35% federal statutory rate primarily due to the release of the valuation allowance and other miscellaneous reorganization adjustments.
At September 30, 2012, the Company had gross federal NOL carryforwards of $134.8 million after taking into consideration the NOL tax attribute reduction of $581.8 million resulting from the Company’s discharge of indebtedness upon emergence from Chapter 11 protection in 2011. The Company’s remaining federal NOL carryforwards will expire from 2022 to 2032. At September 30, 2012, the Company had a net, estimated after attribute reduction, state NOL deferred tax asset of $9.1 million. Telecom Group completed an initial public offering on February 8, 2005, which resulted in an

16

“ownership change” within the meaning of the U.S. federal income tax laws addressing NOL carryforwards, alternative minimum tax credits, and other similar tax attributes. The Merger and the Company’s emergence from Chapter 11 protection also resulted in ownership changes. As a result of these ownership changes, there are specific limitations on the Company’s ability to use its NOL carryfowards and other tax attributes. The Company believes that it can use the NOLs even with these restrictions in place.
During the 24 days ended January 24, 2011, the Predecessor Company excluded from taxable income $1,045.4 million of income from the discharge of indebtedness as defined under Internal Revenue Code (“IRC”) Section 108. There was no additional income from the discharge of indebtedness for the 249 days ended September 30, 2011, however the Company did recognize additional tax benefits due to a change in the amount of its deferred tax liability related to a tax attribute reduction from the discharge of indebtedness. IRC Section 108 excludes from taxable income the amount of indebtedness discharged under a Chapter 11 case. IRC Section 108 also requires a reduction of tax attributes equal to the amount of excluded taxable income to be made on the first day of the tax year following the emergence from bankruptcy. During the three months ended September 30, 2012, the Company finalized the calculation of attribute reduction for federal regular income tax purposes. The Company has not finalized the calculation of attribute reduction for state income tax purposes or the resulting impact on the Company's federal and state tax depreciation. This estimate, as well as the Plan's effect on all tax attributes, is subject to revision, which could be significant.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management determines its estimates of future taxable income based upon the scheduled reversal of deferred tax liabilities and tax planning strategies. The Company establishes valuation allowances for deferred tax assets when it is estimated to be more likely than not that the tax assets will not be realized.
At September 30, 2012 and December 31, 2011, the Company established a valuation allowance against its deferred tax assets of $186.1 million and $172.9 million, respectively, which consist of a $156.9 million and $144.9 million federal allowance, respectively, and a $29.3 million and $28.0 million state allowance, respectively. During the three and nine months ended September 30, 2012, a decrease in the Company’s valuation allowance of approximately $0.5 million and $1.4 million, respectively, was allocated to accumulated other comprehensive loss in the consolidated balance sheet.
Unrecognized tax benefits under the Income Taxes Topic of the ASC are reserves established for probable loss contingencies that could be reasonably estimated. The Company’s unrecognized tax benefits totaled $3.6 million as of September 30, 2012 and $2.9 million as of December 31, 2011. The total unrecognized tax benefits that, if recognized, would affect the effective tax rate are $3.6 million. The Company does not expect a significant increase or decrease in its unrecognized tax benefits during the next twelve months.
The Company recognizes any interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the three months ended September 30, 2012 and 2011, the nine months ended September 30, 2012, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011, the Company did not make any payment of interest and penalties. There was nothing accrued in the condensed consolidated balance sheets for the payment of interest and penalties at September 30, 2012 and December 31, 2011 as the remaining unrecognized tax benefits would only serve to reduce the Company’s current federal and state NOL carryforwards, if ultimately recognized.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and with various state and local governments. The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years prior to 2009. NOL carryovers from closed tax years may be subject to examination by federal or state taxing authorities if utilized in a year open to examination. As of September 30, 2012 and December 31, 2011, the Company does not have any significant additional jurisdictional tax audits.
 
(7)
Long-Term Debt
Long-term debt for the Company at September 30, 2012 and December 31, 2011 is shown below (in thousands):
 
September 30, 2012
 
December 31, 2011
Senior secured credit facility, variable rate of 6.50% (weighted average rate of 6.50%) at September 30, 2012, due 2016
$
970,000

 
$
1,000,000

Less current portion
(10,000
)
 
(10,000
)
Total long-term debt, net of current portion
$
960,000

 
$
990,000

The estimated fair value of the Company’s long-term debt at September 30, 2012 and December 31, 2011 was approximately $909.2 million and $795.0 million, respectively, based on market prices of the Company’s debt securities

17

at the respective balance sheet dates, which is a Level 2 input in the fair value hierarchy, as defined by the Fair Value Measurement Topic of the ASC.
As of September 30, 2012 and December 31, 2011, the Company had $62.6 million, net of $12.4 million of outstanding letters of credit, available for additional borrowing under the Revolving Facility.
Pursuant to the Plan, the Company did not make any principal or interest payments on its pre-petition debt during the pendency of the Chapter 11 Cases. In accordance with the Reorganizations Topic of the ASC, as interest on the Pre-Petition Notes subsequent to the Petition Date was not expected to be an allowed claim, the Company did not accrue interest expense on the Pre-Petition Notes during the pendency of the Chapter 11 Cases. Accordingly, $4.8 million was not accrued during the 24 days ended January 24, 2011. The Company continued to accrue interest expense on the Pre-Petition Credit Facility, as such interest was considered an allowed claim per the Plan.
All pre-petition debt was terminated on the Effective Date.
On August 31, 2012, the Company made a $25.0 million voluntary prepayment on the Term Loan. The prepayment was allocated first to the next scheduled payment of $2.5 million due on September 30, 2012 with the remaining $22.5 million allocated to the final payment due at maturity. Voluntary prepayments of the Term Loan and mandatory amortization both reduce excess cash flow, as defined in the Company's Credit Agreement, for purposes of calculating any excess cash flow sweep.
The approximate aggregate maturities of long-term debt for each of the four years subsequent to September 30, 2012 are as follows (in thousands):
 
Trailing twelve months ending September 30,
 
2013
$
10,000

2014
21,250

2015
43,750

2016
895,000

 
$
970,000

Credit Agreement
On the Effective Date, the Borrowers entered into the Credit Agreement. The Credit Agreement is comprised of the Revolving Facility, which has a sub-facility providing for the issuance of up to $30.0 million of letters of credit, and the Term Loan. On the Effective Date, the Company paid to the lenders providing the Revolving Facility an aggregate fee equal to $1.5 million. Interest on the Credit Agreement Loans accrues at an annual rate equal to either (a) LIBOR plus 4.50%, with a minimum LIBOR floor of 2.00% for the Term Loan, or (b) a base rate plus 3.50% per annum in which base rate is equal to the highest of (x) Bank of America's prime rate, (y) the federal funds effective rate plus 0.50% and (z) the applicable LIBOR plus 1.00%. In addition, the Company is required to pay a 0.75% per annum commitment fee on the average daily unused portion of the Revolving Facility. The entire outstanding principal amount of the Credit Agreement Loans is due and payable five years after the Effective Date (the “Maturity Date”); provided that on the third anniversary of the Effective Date, the Company must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a continuation fee of $0.75 million and, on the fourth anniversary of the Effective Date, the Company must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a second continuation fee of $0.75 million. The Credit Agreement requires quarterly repayments of principal of the Term Loan after the first anniversary of the Effective Date. In the second and third years following the Effective Date, such quarterly payments shall each be in an amount equal to $2.5 million; during the fourth year following the Effective Date, such quarterly payments shall each be in an amount equal to $6.25 million; and for the first three quarters during the fifth year following the Effective Date, such quarterly payments shall each be in an amount equal to $12.5 million, with all remaining outstanding amounts owed in respect of the Term Loan being due and payable on the Maturity Date. During the nine months ended September 30, 2012, the Company made $30.0 million of principal payments on the Term Loan.
The Credit Agreement Loans are guaranteed by all of the Company’s current and future direct and indirect subsidiaries, other than (x) any subsidiary that is prohibited by applicable law from guaranteeing the obligations under the Credit Agreement Loans and/or providing any security therefor without the consent of a state public utilities commission, and (y) any subsidiary of the Company’s that is a controlled foreign corporation or a subsidiary that is held directly or indirectly by a controlled foreign corporation (the guarantor subsidiaries, together with FairPoint Communications and FairPoint Logistics, are collectively referred to as the “Financing Loan Parties”). The Credit Agreement Loans as a whole are

18

secured by liens upon substantially all existing and after-acquired assets of the Financing Loan Parties, with first lien and payment waterfall priority for the Revolving Facility and second lien priority for the Term Loan.
The Credit Agreement contains customary representations, warranties and affirmative covenants. In addition, the Credit Agreement contains restrictive covenants that limit, among other things, the ability of the Company to incur indebtedness, create liens, engage in mergers, consolidations and other fundamental changes, make investments or loans, engage in transactions with affiliates, pay dividends, make capital expenditures and repurchase capital stock. The Credit Agreement also contains minimum interest coverage and maximum total leverage maintenance covenants, along with a maximum senior leverage covenant measured upon the incurrence of certain types of debt. The ratios measured in these covenants, which are reported quarterly, periodically adjust to become more restrictive as set forth in the Credit Agreement. The initial adjustment for each of the three covenants will be reflected in the quarterly covenant reporting for the third quarter of 2013. The Credit Agreement contains certain events of default, including failure to make payments, breaches of covenants and representations, cross defaults to other material indebtedness, unpaid and uninsured judgments, changes of control and bankruptcy events of default. The lenders’ commitments to fund amounts under the Revolving Facility are subject to certain customary conditions. As of September 30, 2012, the Borrowers were in compliance with all covenants under the Credit Agreement.
The Credit Agreement also provides for mandatory prepayments of outstanding balances on the Credit Agreement Loans with the proceeds from certain asset dispositions, certain equity and debt issuances and certain extraordinary cash receipts. Proceeds from such events may be reinvested by the Borrowers in lieu of any such mandatory prepayment under certain circumstances. In addition, at the end of each fiscal year, a test is performed to determine if excess cash flow, as defined in the Credit Agreement, was generated during the year. If the calculation indicates that excess cash flow was generated, a certain percentage (determined by reference to the total leverage ratio) of such excess cash flow is required to be prepaid against outstanding balances. Any mandatory prepayments are first applied to the Revolving Facility until repaid and then to the Term Loan.
Letters of credit outstanding under the DIP Credit Agreement on the Effective Date were rolled into the Revolving Facility.
 
(8)
Employee Benefit Plans
The Company sponsors noncontributory qualified pension plans and post-retirement healthcare plans which provide certain cash payments and medical and dental benefits to covered retired employees and their beneficiaries and covered dependents. These plans were assumed as part of the acquisition of the Northern New England operations from Verizon. The pension plan and the post-retirement healthcare plan which cover non-represented employees are frozen. Therefore, no new benefits are being earned by participants and no new participants are becoming eligible for benefits in these plans. Participants in the pension plan and the post-retirement healthcare plan covering represented employees continue to accrue benefits in accordance with the respective plan documents and contractual requirements in the collective bargaining agreements. Eligibility to participate in the plans is based on an employee’s age and years of service. The Company makes required contributions to the pension plans to meet minimum Employee Retirement Income Security Act of 1974, as amended ("ERISA"), funding requirements and has the ability to elect to make additional discretionary contributions. Payments of benefits under the post-retirement healthcare plans are funded by the Company as the benefits are paid.
Annually, the Company remeasures the net liabilities of its pension and other post-retirement healthcare benefits, in accordance with the Compensation—Retirement Benefits Topic of the ASC. As of December 31, 2011, these remeasurements were based on a weighted average discount rate of approximately 4.65%, as well as certain other valuation assumptions.

19

Components of the net periodic benefit cost related to the Company’s pension and post-retirement healthcare plans for the three months ended September 30, 2012 and 2011, the nine months ended September 30, 2012, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011 are presented below (in thousands).
 
 
Three Months Ended September 30, 2012
 
Three Months Ended September 30, 2011
 
Qualified
Pension
 
Post-
retirement
Healthcare
 
Qualified
Pension
 
Post-
retirement
Healthcare
Service cost
$
3,649

 
$
5,923

 
$
3,597

 
$
6,935

Interest cost
3,695

 
5,774

 
3,660

 
7,194

Expected return on plan assets
(3,356
)
 
(8
)
 
(3,894
)
 
(5
)
Amortization of actuarial loss
575

 
1,398

 
—

 
—

Plan settlement
89

 
—

 
—

 
—

Net periodic benefit cost
$
4,652

 
$
13,087

 
$
3,363

 
$
14,124

 
 
 
 
 
 
 
Predecessor Company
 
Nine Months Ended September 30, 2012
 
Two Hundred Forty-Nine Days Ended September 30, 2011
 
Twenty-Four Days
Ended
January 24, 2011
 
Qualified
Pension
 
Post-
retirement
Healthcare
 
Qualified
Pension
 
Post-
retirement
Healthcare
 
Qualified
Pension
 
Post-
retirement
Healthcare
Service cost
$
11,841

 
$
19,491

 
$
8,892

 
$
14,118

 
$
849

 
$
1,167

Interest cost
10,994

 
18,139

 
9,752

 
15,216

 
934

 
1,252

Expected return on plan assets
(9,887
)
 
(25
)
 
(9,950
)
 
(10
)
 
(1,089
)
 
(1
)
Amortization of prior service cost
—

 
—

 
—

 
—

 
98

 
276

Amortization of actuarial loss
1,617

 
4,762

 
—

 
—

 
283

 
368

Plan settlement
445

 
—

 
—

 
—

 
—

 
—

Net periodic benefit cost
$
15,010

 
$
42,367

 
$
8,694

 
$
29,324

 
$
1,075

 
$
3,062

As of September 30, 2012, the Company completed its 2012 contributions to its qualified pension plans totaling $19.8 million. The Company’s pension plan funding requirements are based on the Pension Protection Act of 2006. The Company expects to contribute approximately $3.3 million to its post-retirement healthcare plans during 2012 to cover benefit payments paid by the plans and has contributed $2.2 million during the first nine months of 2012.
On July 6, 2012, the Moving Ahead for Progress in the 21st Century Act was signed into law. This act contains a pension funding stabilization provision which allows pension plan sponsors to use higher interest rate assumptions when determining funded status and funding obligations. On September 25, 2012 the Company elected to defer use of the higher segment rates under the act until the first plan year beginning on or after January 1, 2013 solely for determination of the adjusted funding target attainment percentage ("AFTAP") used to determine benefit restrictions under IRC Section 436.
For the three and nine months ended September 30, 2012, the actual return on the pension plan assets were gains of approximately 4.1% and 7.7%, respectively. For the three and nine months ended September 30, 2011, the actual return on the pension plan assets were losses of approximately (7.2)% and (2.5)%, respectively. Net periodic benefit cost for 2012 assumes a weighted average annualized expected return on plan assets of approximately 7.52%. Should the Company’s actual return on plan assets be lower than the expected return assumption, the net periodic benefit cost may increase in future periods and the Company may be required to contribute additional funds to its qualified pension plans.
 
(9)
Earnings Per Share
Earnings per share has been computed in accordance with the Earnings Per Share Topic of the ASC. Basic earnings per share of the Company is computed by dividing net (loss) income by the weighted average number of shares of common stock outstanding for the period. Except when the effect would be anti-dilutive, the diluted earnings per share calculation calculated using the treasury stock method includes the impact of stock units, shares of non-vested restricted stock and shares that could be issued under outstanding stock options.

20

The following table provides a reconciliation of the common shares used for basic earnings per share and diluted earnings per share (in thousands):
 
 
Three Months Ended September 30,
 
  
 
 
 
Predecessor
Company
 
2012
 
2011
 
Nine Months Ended September 30, 2012
 
Two Hundred Forty-Nine Days Ended September 30, 2011
 
Twenty-
Four Days
Ended
January 24, 2011
Weighted average number of common shares used for basic earnings per share
25,993

 
25,843

 
25,970

 
25,836

 
89,424

Effect of potential dilutive shares
—

 
—

 
—

 
—

 
271

Weighted average number of common shares and potential dilutive shares used for diluted earnings per share
25,993

 
25,843

 
25,970

 
25,836

 
89,695

Anti-dilutive shares outstanding at period-end that are excluded from the above reconciliation
4,853

 
4,818

 
4,853

 
4,818

 
712

Weighted average number of common shares used for basic earnings per share excludes 242,844, 353,584, 246,351, 356,222 and 16,666 weighted average shares of non-vested restricted stock as of the three months ended September 30, 2012 and 2011, the nine months ended September 30, 2012, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011, respectively. Since the Company incurred a loss for the three months ended September 30, 2012 and 2011, the nine months ended September 30, 2012 and the 249 days ended September 30, 2011, all potentially dilutive securities are anti-dilutive for these periods and are, therefore, excluded from the determination of diluted earnings per share. Anti-dilutive shares outstanding at period-end that are excluded from the above reconciliation include Warrants and non-vested restricted stock and stock options issued under the Long Term Incentive Plan.
 
(10)
Stockholders’ Deficit
On the Effective Date, the Company issued 25,659,877 shares of Common Stock and 3,458,390 Warrants to purchase Common Stock, and reserved 610,309 shares of Common Stock and 124,012 Warrants for satisfaction of certain pending claims related to the Chapter 11 Cases. During the nine months ended September 30, 2012 and the 341 days ended December 31, 2011 the Company issued 21,610 and 541,115 shares of Common Stock, respectively, and 1,142 and 6,069 Warrants, respectively, from this reserve. At September 30, 2012, 37,500,000 shares of Common Stock were authorized, 26,240,614 shares of Common Stock and 3,465,601 Warrants to purchase Common Stock were outstanding, and 47,584 shares of Common Stock and 116,801 Warrants remained reserved for satisfaction of pending claims related to the Chapter 11 Cases. Subsequent to September 30, 2012, the remaining reserved shares of Common Stock and Warrants were distributed in full satisfaction of allowed claims.
 
(11)
Operational Restructuring Charges
On September 8, 2011, the Company announced plans to reduce its workforce to better ensure that the Company is staffed appropriately to serve its customers well, while prudently managing expenses. The reduction eliminated approximately 400 positions, beginning in September 2011 and continuing through the end of 2011. Workforce reductions resulted in restructuring charges of $3.3 million during the three months ended September 30, 2011, consisting of severance and one-time incentive payments, which are included within cost of services and sales and selling, general and administrative expense in the condensed consolidated statement of operations.

(12)
Commitments and Contingencies
(a) Leases
The Company does not have any leases with contingent rental payments or any leases with contingency renewal, purchase options, or escalation clauses.
(b) Legal Proceedings
From time to time, the Company is involved in litigation and regulatory proceedings arising out of its operations. The Company’s management believes that it is not currently a party to any legal or regulatory proceedings, the adverse outcome of which, individually or in the aggregate, would have a material adverse effect on the Company’s financial position or results of operations. Notwithstanding that the Company emerged from Chapter 11 protection on the Effective

21

Date, five of the Chapter 11 Cases are still being resolved. On October 15, 2012, the Company filed a motion in the Bankruptcy Court for final decree closing four of the five remaining Chapter 11 Cases, subject to Bankruptcy Court approval.

(c) Service Quality Penalties
The Company’s Northern New England operations are subject to certain retail service quality requirements under separate SQI plans in Maine and Vermont. Effective August 10, 2012, the SQI penalty plan in New Hampshire was eliminated. The Company’s actual operating performance is measured by certain metrics set forth in the respective SQI plans and failure to meet the stated benchmarks for those performance metrics may result in the assessment of penalties under the respective plans. The Merger Orders or subsequent regulation plan in each state provide that any penalties assessed under the plans be paid by the Company in the form of credits applied to retail customer bills. However, as the result of separate orders in New Hampshire and Vermont issued in 2012, certain previously assessed penalties under the SQI plans in each respective state may be used for expansion of broadband services to unserved and underserved areas in those states as described below.
As of September 30, 2012 and December 31, 2011, the Company has an estimated liability of $4.8 million and $7.5 million, respectively, for service quality penalties based on the Company’s actual results relative to the benchmarks for the performance metrics set forth in the respective SQI plans. Of the estimated December 31, 2011 liability, $3.9 million was included in other accrued liabilities, while the remainder was included in the Claims Reserve. None of the liability is recorded in the Claims Reserve as of September 30, 2012.
All penalties incurred under Maine’s SQI plan through the plan year ended July 31, 2011 have been issued as credits to residential customers. For the plan year ended July 31, 2012, Maine SQI penalties of $1.7 million were incurred and will be issued in the form of credits applied to retail customers' bills in the amount of $0.48 per access line per month for twelve months beginning in December 2012.
During the quarter ended March 31, 2012, the Vermont Public Service Board (“VPSB”) approved the Company’s request to use $2.5 million of the Amended Retail Service Quality Plan penalties to deploy broadband into unserved areas. Approximately $1.1 million of this amount is a pre-bankruptcy liability and, therefore, was included in the Claims Reserve as of December 31, 2011 and has subsequently been reclassified to other accrued liabilities.
In New Hampshire, as the result of a New Hampshire PUC (“NHPUC”) recommendation and the approval by the governor and executive council of New Hampshire of a certain broadband expansion agreement, the Company has received authorization to move forward with the next phase of developing a detailed engineering plan for use of $2.8 million in penalties incurred under the New Hampshire SQI penalty plan in 2009, 2010 and 2011, together with another $0.5 million of Company funds, to build out broadband connections to customers in rural areas beyond the commitments made in the Merger Order in New Hampshire. This plan must be filed with the NHPUC by November 1, 2012 and was timely filed. Until final approval of the detailed project plan, these SQI penalties will be classified as a SQI liability in other accrued liabilities.
Based on the Company’s current estimate of its service quality penalties in the Northern New England operations, changes in the accrual impacting revenue and payments are as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30, 2012
 
Two Hundred Forty-Nine Days Ended September 30, 2011
 
 
Predecessor
Company
 
2012
 
2011
 
 
 
 
Twenty-Four
Days Ended
January 24, 2011
Increase (decrease) in liability recorded as a reduction (increase) to revenue
$
471

 
$
2,030

 
$
(90
)
 
$
(517
)
 
 
$
401

SQI penalties paid out in the form of customer rebates
$
(89
)
 
$
(2,396
)
 
$
(89
)
 
$
(6,598
)
 
 
$
(631
)

(d) Performance Assurance Plan Credits
As part of the Merger Orders, the Company adopted a PAP that measures the Company’s performance in the provision of wholesale services to CLECs in Maine, New Hampshire and Vermont. Failure to meet specified performance standards as defined in the provisions of the separate plans in each state may result in penalties being incurred and, in general, issued in the form of credits applied to affected CLEC bills. However, as a result of a Vermont order in 2012, certain previously assessed penalties under the PAP in Vermont will be used for expansion of broadband services to unserved areas of Vermont as described below.

22

As of September 30, 2012 and December 31, 2011, the Company has recorded a reserve of $0.7 million and $4.9 million, respectively, for the estimated amount of PAP penalties incurred that have not yet been credited to CLECs. Penalties assessed in Maine and New Hampshire are recorded as a reduction to accounts receivable since they are paid by the Company in the form of credits applied to CLEC bills. Penalties for Vermont are recorded as liabilities since a significant portion of these penalty amounts are paid to the VUSF, while the remaining credits assessed in Vermont are paid by the Company in the form of credits applied to CLEC bills. At December 31, 2011, $4.1 million of the total reserve was recorded in the Claims Reserve. None of the reserve is recorded in the Claims Reserve as of September 30, 2012.
During the quarter ended March 31, 2012, the VPSB approved the Company’s request to use $4.1 million of certain accrued PAP penalties to deploy broadband into unserved areas. These accrued PAP penalties were pre-bankruptcy penalties designated to be paid into the VUSF and, therefore, were included in the Claims Reserve as of December 31, 2011 and have subsequently been reclassified to other accrued liabilities.
Based on the Company’s current estimate of its PAP credits in the Northern New England operations, changes in the accrual impacting revenue and payments are as follows (in thousands):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30, 2012
 
Two Hundred Forty-Nine Days Ended September 30, 2011
 
 
Predecessor
Company
 
2012
 
2011
 
 
 
 
Twenty-Four
Days Ended
January 24, 2011
Increase (decrease) in estimated reserve recorded as a reduction (increase) to revenue
$
787

 
$
351

 
$
1,529

 
$
195

 
 
$
629

PAP credits paid out
$
(788
)
 
$
(1,183
)
 
$
(1,562
)
 
$
(4,107
)
 
 
$
(531
)
During early 2011, the NHPUC ordered an audit of the Company’s existing PAP in the state of New Hampshire, which commenced in October 2011 and is ongoing. The existing PAP in Maine and Vermont may also be subject to audit, as determined by the Maine PUC and the VPSB, respectively.
(e) Capital Expenditure Obligations
Under a regulatory settlement in New Hampshire, the Company is required to make certain capital expenditures in New Hampshire. Beginning from the date of the Merger, the Company is required to spend $350.4 million through March 31, 2015 in New Hampshire, of which approximately $311.4 million has been spent as of September 30, 2012. The Company expects to timely satisfy the expenditure requirements.

(13)
Subsequent Events
As of October 11, 2012, all of the 72,754 shares of Common Stock and all of the Warrants to purchase 124,012 shares of Common Stock reserved under the Plan on the Effective Date have been distributed in full satisfaction of allowed claims, thereby completing the Common Stock and Warrant distribution with respect to the Plan.
On October 15, 2012, the Company filed a motion in the Bankruptcy Court for final decree closing all but one of the remaining Chapter 11 Cases, including FairPoint Communications, Inc. (Case No. 09-16335), Enhanced Communications of Northern New England Inc. (Case No. 09-16349), MJD Services Corp. (Case No. 09-16366) and Telephone Operating Company of Vermont LLC (Case No. 09-16410). Upon Bankruptcy Court approval of the motion, only the Chapter 11 Case of Northern New England Telephone Operations LLC (Case No. 09-16365) will remain open.


23

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with our financial statements and the notes thereto included elsewhere in this Quarterly Report. The following discussion includes certain forward-looking statements. For a discussion of important factors, including the continuing development of our business, actions of regulatory authorities and competitors and other factors which could cause actual results to differ materially from the results referred to in the forward-looking statements, see “Item 1A. Risk Factors” of the 2011 Annual Report and “Cautionary Note Concerning Forward-Looking Statements” and "Item 1A. Risk Factors" contained in this Quarterly Report. Our discussion and analysis of financial condition and results of operations are presented in twelve sections:
•
Overview
•
Regulatory and Legislative
•
Fresh Start Accounting
•
Basis of Presentation
•
Revenues
•
Operating Expenses
•
Operational Restructuring Charges
•
Results of Operations
•
Off-Balance Sheet Arrangements
•
Critical Accounting Policies
•
New Accounting Standards
•
Liquidity and Capital Resources
Overview
We are a leading communications provider in rural and small urban communities, offering an array of services, including broadband Internet access, local and long-distance phone, television and other high-capacity data services to residential, business and wholesale customers. We operate in 18 states with approximately 1.3 million  access line equivalents (including voice access lines and HSD lines, which include DSL, wireless broadband, cable modem and fiber-to-the-premises) in service as of September 30, 2012.
We were incorporated in Delaware in February 1991 for the purpose of acquiring and operating incumbent telephone companies in rural and small urban markets. Many of our telephone companies have served their respective communities for over 80 years.
Access lines have historically been an important element of our business. Communications companies, including FairPoint, continue to experience a decline in access lines due to increased competition, including competition from CLECs, wireless carriers and cable television operators, increased availability of alternative communications services, including wireless and VoIP, and challenging economic conditions. While voice access lines are expected to continue to decline, we expect to offset a portion of this lost revenue with growth in special access, HSD and other broadband service revenue as we continue to build out our network to customers who did not previously have access to such products and to offer more competitive services to existing customers. In addition, due to issues with transitioning certain back-office functions from Verizon’s integrated systems to our systems and the filing for bankruptcy protection under Chapter 11 of the Bankruptcy Code in October 2009, we lost significant market share in recent years. Our strategy is to leverage our ubiquitous network in our Northern New England operations to regain market share, particularly in the business and wholesale markets and for data services.
We offer our IP/Multiple Protocol Label Switched network that is fiber-optic based (the “Next Generation Network”) to support more HSD services and extend fiber into more communities across our Northern New England operations. This fiber-optic build supplies critical infrastructure known as “backhaul” for wireless carriers’ traffic in the region, and addresses the increasing bandwidth needs being driven by new applications for smart phones, tablets and other wireless devices. There are more than 1,600 wireless towers in our Northern New England footprint, most of which we currently provide with cellular backhaul connectivity. Our recent Ethernet network expansion allows us to provide fiber based Ethernet cellular backhaul to more than half of these towers.

Regulatory and Legislative
We are subject to regulation primarily by federal and state governmental agencies. At the federal level, the FCC generally exercises jurisdiction over the facilities and services of communications common carriers, such as FairPoint, to the extent those facilities are used to provide, originate or terminate interstate or international communications. State regulatory commissions generally exercise jurisdiction over common carriers’ facilities and services to the extent those facilities are used to provide,

24

originate or terminate intrastate communications. In addition, pursuant to the Telecommunications Act of 1996, which amended the Communications Act of 1934, state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies introduced by that legislation.
The Telecom Group and our Northern New England operations operate under different regulatory regimes in certain respects. For example, concerning interstate access, all of the Telecom Group regulated interstate services of FairPoint were regulated under a rate-of-return model, while all of the rate-regulated interstate services provided by the Northern New England operations were regulated under a price cap model. On May 10, 2010, we received FCC approval to convert our Telecom Group operations in Maine and Vermont to the price cap model. These operations converted to interstate price cap regulation on July 1, 2010. We have obtained permission to continue to operate our Telecom Group ILECs outside of Maine and Vermont under the rate-of-return or average schedule regime by obtaining a waiver of the FCC’s “all-or-nothing” rule. Without this permission, the all-or-nothing rule would require that all of our regulated operations be operated under the price cap model for federal regulatory purposes. In March 2012, we filed a petition with the FCC to convert the interstate special access services of our rate-of-return Telecom Group companies to price cap regulation, effective January 1, 2013. The FCC has not yet issued an order on this petition. In addition, while all of our operations generally are subject to obligations that apply to all LECs, our non-rural operations are subject to additional requirements concerning interconnection, non-discriminatory network access for competitive communications providers and other matters, subject to substantial oversight by state regulatory commissions. In addition, the FCC has ruled that our Northern New England operations must comply with the regulations applicable to the Bell Operating Companies.
On October 27, 2011, the FCC adopted an Order and Further Notice of Proposed Rulemaking on Universal Service and Intercarrier Compensation reform. On November 18, 2011, the FCC released its comprehensive and landmark order to modify the nationwide system of universal support and the Intercarrier Compensation system (referred to hereafter as the “FCC CAF/ICC Order”). In this order, the FCC replaced the existing Universal Service Fund (“USF”) for price cap carriers with its CAF. The intent of the CAF is to bring high speed affordable broadband services to all Americans. The FCC CAF/ICC Order fundamentally reforms the Intercarrier Compensation (“ICC”) system that governs how communications companies bill one another for handling traffic, gradually phasing down these charges. Together, the modifications to the CAF and ICC rules are intended to benefit consumers and promote the goals of the National Broadband Plan, which called for overhauling these two complex systems to address the goal of supporting broadband deployment as cost-effectively as possible.
In conjunction with the FCC CAF/ICC Order, the FCC adopted a Notice of Proposed Rulemaking to deal with related matters, including but not limited to: (i) the actual cost model to be adopted for CAF Phase II funding, (ii) treatment of originating access charges, (iii) modifications to CAF for rate-of-return ILECs, (iv) development of CAF Phase II for mobility, (v) CAF Phase II reverse auction rules, (vi) remote areas funding and (vii) IP to IP interconnection issues. It is not known what decisions will be made on these issues or how they may impact us. In general, CAF Phase I is interim support provided to price cap carriers during the period in which the FCC establishes its permanent CAF funding rules for CAF Phase II. CAF Phase I includes certain support structures, including frozen support and optional interim support. CAF Phase I will continue until CAF Phase II is implemented, which is dependent on how long it takes the FCC to complete its CAF Phase II proceeding.
Pursuant to the FCC CAF/ICC Order, during 2012, we are receiving monthly CAF Phase I frozen support, which is based on and equal to all forms of high-cost support we received during 2011. This support is considered transitional funding while the FCC is developing its CAF Phase II program. The FCC CAF/ICC Order anticipates that CAF Phase I frozen support payments in 2012 will be replaced by CAF Phase II starting in 2013. However, it is likely that it may take longer for the FCC to complete its CAF Phase II proceeding and that CAF Phase I frozen support will continue into a portion or all of 2013. FCC rules require that if we continue receiving CAF Phase I frozen support beyond 2012, we will have specific broadband spending obligations starting in 2013. According to the FCC rules, in 2013 we will need to spend one-third of the frozen support to “build and operate broadband-capable networks used to offer the provider’s own retail broadband service in areas substantially unserved by an unsubsidized competitor.” Should we continue to receive CAF Phase I frozen support in 2014 we will need to spend two-thirds of that support to “build and operate broadband-capable networks used to offer the provider’s own retail broadband service in areas substantially unserved by an unsubsidized competitor” and in 2015 this spend obligation goes to 100%.

Pursuant to the revised CAF programs, we were offered $4.8 million of one-time funding under the FCC’s CAF Phase I incremental support program. Under this program we can use some or all of this support subject to certain restrictions. Those restrictions exclude the use of the funding in census blocks where there is an unsubsidized competitor, where we have capital spending plans in the next three years to provide broadband services, or where we have made a regulatory commitment. Further, we must build to one currently unserved location for every $775 in funding and must complete construction within three years and provide services at minimum speeds of 4 megabits per second down to the subscriber and 1 megabits per second up from the subscriber. We have notified the FCC that we will accept $2.0 million of CAF Phase I incremental support funding, which will primarily be used in Vermont. On September 10, 2012, we filed a petition with the FCC asking it to waive its rules to allow us to use the remaining $2.8 million of CAF Phase I incremental support funding to bring high speed broadband services to 697 customer locations in the state of Maine.

25

In compliance with the FCC revised rules for ICC, we have revised intrastate access offerings in all operating areas to reduce terminating switched access rates as the first step in the ICC transition. FCC rules allow us to recover a portion of the lost intercarrier compensation from end users through an access recovery charge (“ARC”). For the 2012 interstate tariff period (July 1, 2012 through June 30, 2013), the maximum ARC rate for residential and single line businesses is $0.50 and for multi-line businesses is $1.00. We have filed ARC rates ranging from $0.00 up to the maximum ARC rates for our operating areas, with the rates varying by operating area based on calculations in accordance with FCC rules. Where the ARC rates are not sufficient to recover the eligible amount for recovery, we are eligible to recover such additional amounts through the CAF/ICC. Beginning July 1, 2012, we became eligible and will recover CAF/ICC for our rate-of-return regulated Telecom Group operations. ARC rates and CAF/ICC amounts are reset effective July 1 of each year in the annual FCC tariff filings.
In Vermont, our Northern New England service territory operated under an alternative form of regulation since 2006 known as an Amended Incentive Regulation Plan. That plan expired on March 31, 2011. On March 23, 2011, we entered into a Memorandum of Understanding with the Vermont Department of Public Services whereby they agreed to seek approval of the 2011 Incentive Regulation Plan (“2011 IRP”) before the VPSB. The Board approved the 2011 IRP on January 18, 2012, and that plan is effective retroactively to April 1, 2011. We believe the 2011 IRP will decrease the scope of retail telecommunications regulation for us in Vermont, providing us with increased ability to compete in the Vermont telecommunications marketplace. Under the 2011 IRP, our exposure to annual retail service quality penalties has been decreased from $10.5 million to $1.65 million and we have pricing discretion with respect to existing and new services other than basic local exchange service. Pursuant to pricing flexibility in Vermont under the incentive regulation plan, we have discontinued issuing customer credits for federal USF amounts received. Prior to this order, we were required to return a portion of the USF we received to our customers through credits on their bills. This change is expected to reduce USF credits returned to our customers by up to approximately $2.4 million in 2012 and will continue as a permanent change.
New legislation was recently signed into law in both Maine and New Hampshire, which we believe will decrease the scope of retail telecommunications regulation for us, eliminating many of the state specific Merger conditions and providing us with increased ability to compete in the Maine and New Hampshire telecommunications marketplace. Under the Maine legislation, our exposure to annual retail service quality penalties, beginning with Maine’s fiscal year ending July 31, 2013, will be decreased from $12.5 million to $2.0 million and we will have pricing discretion with respect to existing and new telecommunications services other than provider of last resort services. In New Hampshire, beginning August 10, 2012, the effective date of the legislation, our exposure to annual retail service quality penalties was eliminated and we have pricing discretion with respect to existing and new telecommunications services other than basic local exchange service and certain services provided to customers who qualify for the federal lifeline discount.
We anticipate that, together, these significant changes in both federal and state regulation will not have a material impact in 2012. However, in the long run, we are uncertain of the ultimate impact as federal and state regulation continues to evolve.
Fresh Start Accounting
On October 26, 2009, we filed the Chapter 11 Cases. On January 13, 2011, the Bankruptcy Court entered the Confirmation Order, which confirmed the Plan.
On January 24, 2011, the Effective Date, we substantially consummated our reorganization through a series of transactions contemplated by the Plan, and the Plan became effective pursuant to its terms.
As of the Effective Date, we were required to adopt fresh start accounting in accordance with guidance under the applicable reorganization accounting rules, pursuant to which our reorganization value, which represents the fair value of an entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, was allocated to the fair value of assets in conformity with guidance under the applicable accounting rules for business combinations, using the purchase method of accounting for business combinations. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets was reflected as goodwill, which was subject to periodic evaluation for impairment and was later determined to be completely impaired at September 30, 2011. In addition to fresh start accounting, our condensed consolidated financial statements reflect all effects of the transactions contemplated by the Plan. Therefore, our condensed consolidated statements of financial position and condensed consolidated statements of operations are not comparable in many respects to our condensed consolidated statements of financial position and condensed consolidated statements of operations for periods prior to our adoption of fresh start accounting and prior to accounting for the effects of the Plan, including certain of the historical financial statements contained herein.
While the adoption of fresh start accounting presents the results of operations of a new reporting entity, we believe the comparison of combined results of the nine months ended September 30, 2012 versus the nine months ended September 30, 2011 provides the best analysis of the results of operations. The only statement of operations items impacted by the reorganization are

26

depreciation expense, interest expense and reorganization items. Those effects of fresh start accounting are discussed in more detail in the respective sections below.
Basis of Presentation
We view our business of providing data, voice and communication services to residential, business and wholesale customers as one reportable segment as defined in the Segment Reporting Topic of the ASC.
Beginning in the second quarter of 2012, we reclassified certain revenues from voice services revenues to data and Internet services revenues to more accurately reflect the underlying service provided. For comparative purposes, we have reclassified the prior periods to be consistent with the current period presentation.
Revenues
We derive our revenues from:
•
Voice services. We receive revenues from our telephone operations from the provision of local exchange, long-distance, local private line, wire maintenance, voice messaging and value-added services. Included in long-distance services revenue are revenues received from regional toll calls. Value-added services are a family of services that expand the utilization of the network, including products such as caller ID, call waiting and call return. The provision of local exchange services not only includes retail revenues but also includes local wholesale revenues from unbundled network elements, interconnection revenues from CLECs and wireless carriers, and some data transport revenues. Voice services revenues in 2011 also include USF payments for high-cost support, local switching support, long-term support and Interstate Common Line Support. Voice services revenues in 2012 include CAF Phase I frozen support payments which replaced all forms of high-cost USF payments pursuant to the FCC CAF/ICC Order.
•
Access. We receive revenues for the provision of network access, including interstate access and intrastate access.
Network access revenues are earned from end-user customers and long-distance and other competing carriers who use our local exchange facilities to provide usage services to their customers. Special access revenues originate from carriers and end-users that buy dedicated local and interexchange capacity to support their private networks, including wireless carriers to backhaul voice and data traffic from cell towers to mobile telephone switching offices. Switched access revenues are derived from fixed and usage-based charges paid by carriers for access to our local network.
Interstate access revenues are earned on charges to long-distance carriers and other customers for access to our networks in connection with the origination and termination of interstate telephone calls both to and from our customers. Interstate access charges to long-distance carriers and other customers are based on access rates filed with the FCC.
Intrastate access revenues consist primarily of charges paid by long-distance companies and other customers for access to our networks in connection with the origination and termination of intrastate telephone calls both to and from our customers. Intrastate access charges to long-distance carriers and other customers are based on access rates filed with the state regulatory agencies.
•
Data and Internet services. We receive revenues from monthly recurring charges for services, including HSD, Internet and other services.
•
Other services. We receive revenues from other services, including miscellaneous projects on behalf of third party requests, video services (including cable television and video-over-DSL), billing and collection, directory services, public (coin) telephone and the sale and maintenance of customer premise equipment. Other services also includes revenue we receive from late payment charges to end-users and interexchange carriers.

27

The following table summarizes revenues and the percentage of revenues from these sources (in thousands, except for percentage of revenues data):
 
 
Three Months Ended September 30, 2012
 
Three Months Ended September 30, 2011
 
$
 
% of
Revenue
 
$
 
% of
Revenue
Revenue Source:
 
 
 
 
 
 
 
Voice services
$
111,337

 
46
%
 
$
117,583

 
45
%
Access
82,015

 
34
%
 
94,646

 
37
%
Data and Internet services
36,793

 
15
%
 
32,854

 
13
%
Other services
11,907

 
5
%
 
12,829

 
5
%
Total
$
242,052

 
100
%
 
$
257,912

 
100
%
 
 
 
 
 
 
 
Predecessor
Company
 
Combined
 
Nine Months Ended September 30, 2012
 
Two Hundred Forty-Nine Days Ended September 30, 2011
 
 
Twenty-Four Days
Ended
January 24, 2011
 
Nine Months Ended September 30, 2011
 
$
 
% of
Revenue
 
$
 
% of
Revenue
 
 
$
 
% of
Revenue
 
$
 
% of
Revenue
Revenue Source:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Voice services
$
337,639

 
46
%
 
$
332,632

 
47
%
 
 
$
32,554

 
49
%
 
$
365,186

 
47
%
Access
253,524

 
35
%
 
256,109

 
36
%
 
 
23,023

 
35
%
 
279,132

 
36
%
Data and Internet services
106,243

 
14
%
 
86,945

 
12
%
 
 
7,960

 
12
%
 
94,905

 
12
%
Other services
36,573

 
5
%
 
33,264

 
5
%
 
 
2,841

 
4
%
 
36,105

 
5
%
Total
$
733,979

 
100
%
 
$
708,950

 
100
%
 
 
$
66,378

 
100
%
 
$
775,328

 
100
%
The following table summarizes access line equivalents (including voice access lines and HSD lines, which include DSL, wireless broadband, cable modem and fiber-to-the-premises) as of September 30, 2012 and 2011:
 
 
September 30, 2012
 
September 30, 2011
 
% Change
Access Line Equivalents:
 
 
 
 
 
Residential access lines
602,530

 
662,562

 
(9.1
)%
Business access lines
303,904

 
314,290

 
(3.3
)%
Wholesale access lines (1)
67,886

 
80,025

 
(15.2
)%
Total switched access lines
974,320

 
1,056,877

 
(7.8
)%
HSD subscribers
322,551

 
312,475

 
3.2
 %
Total access line equivalents
1,296,871

 
1,369,352

 
(5.3
)%
 
(1)
Wholesale access lines include residential and business resale lines and unbundled network element platform lines.

Operating Expenses
Our recurring operating expenses consist of cost of services and sales, selling, general and administrative expenses and depreciation and amortization.
•
Cost of Services and Sales. Cost of services and sales includes the following costs directly attributable to a service or product: salaries and wages, benefits (including stock based compensation), materials and supplies, contracted services, network access and transport costs, customer provisioning costs, computer systems support and cost of products sold. Aggregate customer care costs, which include billing and service provisioning, are allocated between cost of services and sales and selling, general and administrative expense.

28

•
Selling, General and Administrative Expense. Selling, general and administrative expense includes salaries and wages and benefits (including stock based compensation), not directly attributable to a service or product, bad debt charges, taxes other than income, advertising and sales commission costs, customer billing, call center and information technology costs, professional service fees and rent for administrative space.
•
Depreciation and Amortization. Depreciation and amortization includes depreciation of our communications network and equipment and amortization of intangible assets.

Operational Restructuring Charges
On September 8, 2011, we announced plans to reduce our workforce to better ensure that we are staffed appropriately to serve our customers well, while prudently managing expenses. The reduction eliminated approximately 400 positions, beginning in September 2011 and continuing through the end of 2011. Workforce reductions resulted in restructuring charges of $3.3 million during the three months ended September 30, 2011, consisting of severance and one-time incentive payments, which are included within cost of services and sales and selling, general and administrative expense in the condensed consolidated statement of operations.
Results of Operations
Three Months Ended September 30, 2012 Compared with Three Months Ended September 30, 2011
The following table sets forth the percentages of revenues represented by selected items reflected in our condensed consolidated statements of operations. The year-to-year comparisons of financial results are not necessarily indicative of future results (in thousands, except percentage of revenues data):
 
 
Three Months Ended September 30, 2012
 
Three Months Ended September 30, 2011
 
$
 
% of
Revenue
 
$
 
% of
Revenue
Revenues
$
242,052

 
100
 %
 
$
257,912

 
100
 %
Operating expenses:
 
 
 
 
 
 
 
Costs of services and sales
105,502

 
44

 
120,149

 
47

Selling, general and administrative expense
80,915

 
33

 
93,334

 
36

Depreciation and amortization
89,782

 
37

 
91,547

 
35

Reorganization related expense (income)
172

 
—

 
(3,735
)
 
(1
)
Impairment of intangible assets and goodwill
—

 
—

 
262,019

 
102

Total operating expenses
276,371

 
114

 
563,314

 
219

Loss from operations
(34,319
)
 
(14
)
 
(305,402
)
 
(119
)
Interest expense
(16,991
)
 
(7
)
 
(17,147
)
 
(6
)
Other (expense) income
548

 
—

 
488

 
—

Loss before income taxes
(50,762
)
 
(21
)
 
(322,061
)
 
(125
)
Income tax benefit
13,433

 
6

 
42,620

 
17

Net loss
$
(37,329
)
 
(15
)%
 
$
(279,441
)
 
(108
)%
Revenues
Revenues decreased $15.9 million (6%) to $242.1 million in the third quarter of 2012 compared to the same period in 2011. We derive our revenues from the following sources:
Voice services. Voice services revenues decreased $6.2 million (5%) to $111.3 million during the third quarter of 2012 compared to the same period in 2011. This decrease in voice services revenues is attributable to reductions in both local services revenues and long distance revenues. Local services revenues have been impacted by a 7.8% decline in total switched access lines in service at September 30, 2012 compared to September 30, 2011, which is primarily driven by an increase in competition and our customers’ use of alternative technologies. In addition, the three months ended September 30, 2012 and 2011 include reductions of local services revenues of $1.2 million and $2.3 million, respectively, due to increases in SQI and PAP penalty reserves. SQI and PAP penalty reserves during the three months ended September 30, 2011 were higher than the same period in 2012 primarily due to an $0.8 million increase in SQI penalty reserves following service outages related to Hurricane Irene. This $1.1 million increase in local services revenues partially offset the impact of the decline in total switched access lines in service. The decline

29

in long distance revenues is the result of declining minutes of use driven by our customers' use of alternative technologies for their long distance needs.
Access. Access revenues decreased $12.6 million (13%) to $82.0 million during the third quarter of 2012 compared to the same period in 2011. The declines in access revenues are primarily driven by lower switched access revenues and the impact of customers migrating from legacy access products such as DS1, DS3, frame relay and private line to Ethernet based products. Switched access revenues decreased primarily due to a 7.8% decline in total switched access lines in service at September 30, 2012 compared to September 30, 2011, which results in lower minutes of use. Our special access revenues related to Ethernet based products is growing significantly but is more than offset by the loss of revenues from legacy based access products. Revenues from Ethernet based products are more sustainable but generally, at the outset, have lower average revenue per user than legacy products, resulting in a decline in total access revenue. With increasing need for bandwidth, demand for Ethernet based products is expected to increase over time.
Data and Internet services. Data and Internet services revenues increased $3.9 million (12%) to $36.8 million in the third quarter of 2012 compared to the same period in 2011. The increase was primarily attributable to a 3.2% increase in the number of HSD subscribers from September 30, 2011 to September 30, 2012 resulting from our expanded HSD footprint, bundling, other marketing efforts and an increase in Ethernet product revenues.
Other services. Other services revenues decreased $0.9 million (7%) to $11.9 million in the third quarter of 2012 compared to the same period in 2011.
Operating Expenses
Cost of services and sales. Cost of services and sales decreased $14.6 million (12%) to $105.5 million in the third quarter of 2012 compared to the same period in 2011. The decrease is primarily attributable to a reduction in employee expenses, a decline in access expense associated with providing long distance, data and broadband Internet services and incremental operating costs incurred as a result of Hurricane Irene in 2011. In the third quarter of 2011, we recorded $2.7 million of severance expense related to the workforce reductions that began in September 2011. This, along with cost savings recognized as a result of these workforce reductions, resulted in a decline in employee expenses when comparing the three months ended September 30, 2012 to the same period in 2011. The reduction of employee expenses due to the workforce reductions is partially offset by a decrease in capitalized labor during the third quarter of 2012 associated with the reduced capital expenditures in 2012. In addition, in the third quarter of 2011, we sustained service outages due to equipment, pole and cable damages created by Hurricane Irene. We incurred approximately $3.2 million of incremental operating costs associated with clean-up and repair efforts from the hurricane.
Selling, general and administrative. Selling, general and administrative expenses decreased $12.4 million (13%) to $80.9 million for the third quarter of 2012 compared to the same period in 2011. This decrease is largely attributable to a $4.0 million decrease in bad debt expense and a decrease in employee expenses. The reduction in bad debt expense is primarily due to settlements with wholesale carriers and an improvement in accounts receivable aging. In the third quarter of 2011, we recorded $0.6 million of severance expense related to the workforce reductions that began in September 2011. This, along with cost savings recognized as a result of these workforce reductions, resulted in a decline in employee expenses when comparing the three months ended September 30, 2012 to the same period in 2011.
Depreciation and amortization. Depreciation and amortization expense decreased $1.8 million (2%) to $89.8 million in the third quarter of 2012 compared to the same period in 2011. This decrease in comprised of a $2.4 million decrease in depreciation expense and a $0.6 million increase in amortization of intangible assets.
Reorganization related expense (income). Reorganization related expense (income) represents expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases, occurring after the Effective Date. Reorganization related expense of $0.2 million was recognized in the third quarter of 2012 as compared to $3.7 million of income in the same period of 2011. During the three months ended September 30, 2012, reorganization related expense is comprised of $0.4 million of restructuring professional fees primarily related to continuing work to settle outstanding claims, offset by a $0.2 million reversal of a portion of the Claims Reserve due to an estimation of future settlements. During the three months ended September 30, 2011, reorganization related expense is comprised of a $4.5 million reversal of a portion of the Claims Reserve due to several favorable settlements during the quarter and an estimation of future settlements, offset by $0.8 million of restructuring professional fees primarily related to continuing work to settle outstanding claims.
Impairment of intangible assets and goodwill. Impairment of long-lived assets and goodwill for the third quarter of 2011 is comprised of an impairment of $243.2 million to reduce the carrying value of goodwill to zero and an impairment of $18.8 million to reduce the carrying value of a non-amortizable asset related to our trade name.

30

Other Results
Interest expense. Interest expense remained relatively flat for the third quarter of 2012 compared to the same period in 2011.
Other (expense) income. Other (expense) income includes non-operating gains and losses such as those incurred on sale or disposal of equipment. Other income of $0.5 million recognized in the third quarter of 2012 was consistent with other income of $0.5 million during the same period in 2011.
Income taxes. The effective income tax rate is the provision for income taxes stated as a percentage of income (loss) before the provision for income taxes. The effective income tax rate to calculate the tax benefit for the three months ended September 30, 2012 and 2011 was 26.5% and 13.2%, respectively. The effective income tax rate for the three months ended September 30, 2012 was primarily impacted by an increase in the valuation allowance, offset by state taxes. The effective tax rate for the three months ended September 30, 2011 was primarily impacted by an impairment charge reducing the carrying value of goodwill to zero and an impairment charge reducing the carrying value of a non-amortizable intangible asset related to the trade name.
Net loss. Net loss for the three months ended September 30, 2012 was $37.3 million compared to $279.4 million for the same period in 2011. The difference in net loss between 2012 and 2011 is a result of the factors discussed above.
Nine Months Ended September 30, 2012 Compared with Nine Months Ended September 30, 2011
The following table sets forth the percentages of revenues represented by selected items reflected in our condensed consolidated statements of operations. The year-to-year comparisons of financial results are not necessarily indicative of future results (in thousands, except percentage of revenues data):
 
 
 
 
 
 
Two Hundred Forty-Nine Days Ended September 30, 2011
 
 
Predecessor
Company
 
Combined
 
Nine Months Ended September 30, 2012
 
 
 
Twenty-Four
Days Ended
 
Nine Months Ended September 30, 2011
 
$
 
% of
Revenue
 
 
 
January 24,
2011
 
$
 
% of
Revenue
Revenues
$
733,979

 
100
 %
 
$
708,950

 
 
$
66,378

 
$
775,328

 
100
 %
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Costs of services and sales
330,937

 
45

 
321,790

 
 
38,766

 
360,556

 
47

Selling, general and administrative expense
257,055

 
35

 
245,132

 
 
27,161

 
272,293

 
35

Depreciation and amortization
276,769

 
38

 
244,940

 
 
21,515

 
266,455

 
34

Reorganization related (income) expense
(4,043
)
 
(1
)
 
1,511

 
 
—

 
1,511

 
—

Impairment of intangible assets and goodwill
—

 
—

 
262,019

 
 
—

 
262,019

 
34

Total operating expenses
860,718

 
117

 
1,075,392

 
 
87,442

 
1,162,834

 
150

Loss from operations
(126,739
)
 
(17
)
 
(366,442
)
 
 
(21,064
)
 
(387,506
)
 
(50
)
Interest expense
(51,002
)
 
(7
)
 
(46,634
)
 
 
(9,321
)
 
(55,955
)
 
(7
)
Other income (expense)
725

 
—

 
1,319

 
 
(132
)
 
1,187

 
—

Loss before reorganization items and income taxes
(177,016
)
 
(24
)
 
(411,757
)
 
 
(30,517
)
 
(442,274
)
 
(57
)
Reorganization items
—

 
—

 
—

 
 
897,313

 
897,313

 
116

(Loss) income before income taxes
(177,016
)
 
(24
)
 
(411,757
)
 
 
866,796

 
455,039

 
59

Income tax benefit (expense)
55,902

 
7

 
80,796

 
 
(279,889
)
 
(199,093
)
 
(26
)
Net (loss) income
$
(121,114
)
 
(17
)%
 
$
(330,961
)
 
 
$
586,907

 
$
255,946

 
33
 %


31

Revenues
Revenues decreased $41.3 million (5%) to $734.0 million in the first nine months of 2012 compared to the same period in 2011. We derive our revenues from the following sources:
Voice services. Voice services revenues decreased $27.5 million (8%) to $337.6 million during the first nine months of 2012 compared to the same period in 2011. This decrease in voice services revenues is primarily attributable to reductions in both local services revenues and long distance revenues. Local services revenues have been impacted by a 7.8% decline in total switched access lines in service at September 30, 2012 compared to September 30, 2011, which is primarily driven by an increase in competition and our customers’ use of alternative technologies. In addition, the first nine months of 2012 and 2011 include reductions of local services revenues of $1.3 million and $0.6 million, respectively, due to an increase in SQI and PAP penalty reserves. The decline in long distance revenues is the result of declining minutes of use driven by our customers' use of alternative technologies for their long distance needs.
Access. Access revenues decreased $25.6 million (9%) to $253.5 million during the first nine months of 2012 compared to the same period in 2011. The declines in access revenues are primarily driven by lower switched access revenues and the impact of customers migrating from legacy access products such as DS1, DS3, frame relay and private line to Ethernet based products. Switched access revenues decreased primarily due to a 7.8% decline in total switched access lines in service at September 30, 2012 compared to September 30, 2011, which results in lower minutes of use. Our special access revenues related to Ethernet based products is growing significantly but is more than offset by the loss of revenues from legacy based access products. Revenues from Ethernet based products are more sustainable but generally, at the outset, have lower average revenue per user than legacy products, resulting in a decline in total access revenue. With increasing need for bandwidth, demand for Ethernet based products is expected to increase over time.
Data and Internet services. Data and Internet services revenues increased $11.3 million (12%) to $106.2 million in the first nine months of 2012 compared to the same period in 2011. The increase was primarily attributable to a 3.2% increase in the number of HSD subscribers from September 30, 2011 to September 30, 2012 resulting from our expanded HSD footprint, bundling, other marketing efforts and an increase in Ethernet product revenues.
Other services. Other services revenues increased $0.5 million (1%) to $36.6 million in the first nine months of 2012 compared to the same period in 2011.
Operating Expenses
Cost of services and sales. Cost of services and sales decreased $29.6 million (8%) to $330.9 million in the first nine months of 2012 compared to the same period in 2011. The decrease is primarily attributable to a reduction in employee expenses, a decline in access expense associated with providing long distance, data and broadband Internet services and incremental operating costs incurred in 2011 as a result of Hurricane Irene in 2011. The decrease in employee expenses is attributable to cost savings recognized as a result of the workforce reductions that began in September 2011, partially offset by a decrease in capitalized labor during the nine months of 2012 associated with the reduced capital expenditures in 2012. In addition, in the third quarter of 2011, we sustained service outages due to equipment, pole and cable damages created by Hurricane Irene. We incurred approximately $3.2 million of incremental operating costs associated with clean-up and repair efforts from the hurricane during the nine months ended September 30, 2011.
Selling, general and administrative. Selling, general and administrative expenses decreased $15.2 million (6%) to $257.1 million for the first nine months of 2012 compared to the same period in 2011. This decrease is largely attributable to a $16.2 million decrease in bad debt expense and a decrease in employee expenses. The reduction in bad debt expense is primarily due to settlements with wholesale carriers and an improvement in accounts receivable aging. The decrease in employee expenses is attributable to cost savings recognized as a result of the workforce reductions that began in September 2011. These reductions were partially offset by a $14.5 million increase in qualified pension and post-retirement healthcare expenses during the nine months ended September 30, 2012. The increase in qualified pension and post-retirement healthcare expenses are primarily a reflection of changes in the discount rate and certain other assumptions utilized in net periodic benefit cost in 2012.
Depreciation and amortization. Depreciation and amortization expense increased $10.3 million (4%) to $276.8 million in the first nine months of 2012 compared to the same period in 2011. This increase is comprised of an $11.0 million increase in depreciation expense offset by a $0.7 million decrease in amortization of intangible assets. In conjunction with the adoption of fresh start accounting, our assets and liabilities were recorded at fair value. On the Effective Date, while the carrying value of property, plant and equipment was written down to fair value, the remaining useful lives established were, in general, shorter than their original estimated useful lives. This has resulted in an increase in depreciation expense from the prior year.

32

Reorganization related (income) expense. Reorganization related (income) expense represents expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases, occurring after the Effective Date. Reorganization related income of $4.0 million was recognized in the first nine months of 2012 as compared to $1.5 million expense in the same period of 2011. During the nine months ended September 30, 2012, reorganization related income is comprised of a $5.1 million gain from the reversal of a portion of the Claims Reserve due to several favorable settlements during the year and an estimation of future settlements, offset by $1.1 million of restructuring professional fees primarily related to continuing work to settle outstanding claims. During the nine months ended September 30, 2011, reorganization related expense is comprised of $6.7 million of restructuring professional fees related to fresh start accounting and continuing work to settle outstanding claims, offset by a $5.2 million reversal of a portion of the Claims Reserve due to several favorable settlements during the year and an estimation of future settlements.
Impairment of intangible assets and goodwill. Impairment of long-lived assets and goodwill for the first nine months of 2011 is comprised of an impairment of $243.2 million to reduce the carrying value of goodwill to zero and an impairment of $18.8 million to reduce the carrying value of a non-amortizable asset related to our trade name.
Other Results
Interest expense. Interest expense decreased $5.0 million to $51.0 million in the first nine months of 2012 compared to the same period in 2011. This decrease is mainly driven by a reduction in long-term debt on the Effective Date.
Other income (expense). Other income (expense) includes non-operating gains and losses such as those incurred on sale or disposal of equipment. Other income decreased $0.5 million to $0.7 million in the first nine months of 2012 compared to the same period in 2011.
Reorganization items. Reorganization items represent expense or income amounts that have been recognized as a direct result of the Chapter 11 Cases, prior to the Effective Date. For more information, see note 4 to the condensed consolidated financial statements.
Income taxes. The effective income tax rate is the provision for income taxes stated as a percentage of income (loss) before the provision for income taxes. The effective income tax rate to calculate the tax benefit (expense) for the nine months ended September 30, 2012 and 2011 was 31.6% and (43.8%), respectively. The effective income tax rate for the nine months ended September 30, 2012 was primarily impacted by an increase in the valuation allowance, offset by state taxes. The effective tax rate for the nine months ended September 30, 2011 was primarily impacted by an impairment charge reducing the carrying value of goodwill to zero and an impairment charge reducing the carrying value of a non-amortizable intangible asset related to the trade name.
Net (loss) income. Net loss for the nine months ended September 30, 2012 was $121.1 million compared to net income of $255.9 million for the same period in 2011. The difference in net (loss) income between 2012 and 2011 is a result of the factors discussed above.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Critical Accounting Policies
Our critical accounting policies are as follows:
•
Fresh start accounting;
•
Revenue recognition;
•
Allowance for doubtful accounts;
•
Accounting for qualified pension and other post-retirement healthcare benefits;
•
Accounting for income taxes;
•
Depreciation of property, plant and equipment;
•
Stock-based compensation;
•
Valuation of long-lived assets, including goodwill; and
•
Accounting for software development costs.
There have been no material changes to our critical accounting policies described in our 2011 Annual Report.


33

New Accounting Standards
In July 2012, the FASB issued ASU 2012-02 to amend and simplify the annual testing for impairment of indefinite-lived intangible assets. This amendment to the Intangibles-Goodwill and Other Topic of the ASC allows an entity the option to first assess qualitative factors to determine whether the existence of events and circumstances that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset leads to a determination that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity determines it is not likely that the indefinite-lived intangible asset is impaired, then performing the quantitative impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform a quantitative impairment test. The ASU includes examples of events and circumstances that could affect significant inputs used to determine the fair value of the indefinite-lived intangible assets that an entity should consider when evaluating whether it is more likely than not that a indefinite-lived intangible asset is impaired. This new guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. We have elected to early adopt this ASU. The adoption of this amendment to the ASC did not have a material impact on our condensed consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05 related to the presentation of comprehensive income, which eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. This ASU requires that all non-owner changes in stockholders' equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance was to be applied retrospectively, effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted.  In December 2011, the FASB issued ASU 2011-12, which deferred the elective date for amendments to the presentation of reclassification of items out of accumulated other comprehensive income in ASU 2011-05. The adoption of this amendment to the ASC did not have a material impact on our condensed consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04 related to achieving common fair value measurements and disclosure requirements between U.S. GAAP and IFRS. This ASU changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and IFRS. The ASU also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs, as defined in the Fair Value Measurement Topic of the ASC. This new guidance was to be applied prospectively, effective for interim and annual periods beginning after December 15, 2011. Early adoption was not permitted. The adoption of this amendment to the ASC did not have a material impact on our condensed consolidated financial statements.
Liquidity and Capital Resources
Summary
Upon our emergence from Chapter 11 protection on January 24, 2011, we adopted fresh start accounting in accordance with guidance under the applicable reorganization accounting rules. The adoption of fresh start accounting resulted in a new reporting entity. Accordingly, our condensed consolidated statements of financial position, condensed consolidated statements of operations and condensed consolidated statements of cash flows are not comparable in many respects to our condensed consolidated statements of financial position, condensed consolidated statements of operations and condensed consolidated statement of cash flows for periods prior to the adoption of fresh start accounting and prior to accounting for the effects of the reorganization.
Our short-term and long-term liquidity needs primarily arise from: (i) interest and principal payments on our indebtedness; (ii) capital expenditures; (iii) working capital requirements as may be needed to support and grow our business; and (iv) contributions to our qualified pension plan and payments under our post-retirement healthcare plans. Our current and future liquidity is greatly dependent upon our operating results. We expect that our primary sources of liquidity will be cash flow from operations, cash on hand and funds available under the Revolving Facility.
Based on our current and anticipated levels of operations and conditions in our markets, we believe that cash on hand (including amounts available under our Revolving Facility) as well as cash flow from operations will enable us to meet our working capital, capital expenditure, debt service and other funding requirements for at least the next 12 months. We expect to be in compliance with the maintenance covenants contained in the Credit Agreement for 2012. However, our anticipated results are subject to significant uncertainty and our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions.
Cash and cash equivalents at September 30, 2012 totaled $22.1 million compared to $17.4 million at December 31, 2011, excluding restricted cash of $11.4 million and $25.1 million, respectively. In August 2012, we made a $25.0 million voluntary prepayment on the Term Loan using cash on hand. On the Effective Date, we significantly reduced our cash on hand by approximately $89.9 million to establish the Cash Claims Reserve. Tax related claims were not included in the Cash Claims Reserve. As of the Effective Date, cash and cash equivalents totaled $10.3 million, excluding the Cash Claims Reserve of $82.8 million, following payment of $7.1 million in claims on the Effective Date. In accordance with the Plan, to the extent that

34

claims are settled for amounts lower than estimated in the Cash Claims Reserve, we are permitted to reclaim restricted cash from the Cash Claims Reserve of up to $32.6 million. As of September 30, 2012, we had reclaimed $15.1 million of such restricted cash, of which $8.8 million was reclaimed during the nine months ended September 30, 2012. There is no certainty that we will reclaim any, or all, of the $2.6 million restricted cash balance remaining in the Cash Claims Reserve at September 30, 2012.

Cash Flows
Net cash provided by (used in) operating activities was $129.8 million, $127.5 million and ($81.1) million for the nine months ended September 30, 2012, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011, respectively. Net cash provided by operating activities for the nine months ended September 30, 2012 and the 249 days ended September 30, 2011 represents the operating activities of the Company after the Effective Date; however, it includes payment of $8.8 million and $64.1 million, respectively, in claims of the Predecessor Company, of which $3.8 million and $56.5 million, respectively, of these claims were paid using funds of the Cash Claims Reserve established on the Effective Date by the Predecessor Company. In addition, during the first nine months of 2012, $5.3 million and $2.4 million, respectively, of the Cash Claims Reserve were reclassified to another restricted cash account in conjunction with the VPSB’s approval of our request to use these funds to deploy broadband in unserved areas of Vermont and the NHPUC’s approval, together with the approval of the New Hampshire governor and executive council, of our request to use these funds to deploy broadband in unserved areas of New Hampshire and $8.8 million was reclaimed by the Company. After a $7.1 million payment of claims on the Effective Date, the Cash Claims Reserve totaled $82.8 million and is reflected in net cash used in operating activities during the 24 days ended January 24, 2011. Upon the filing of the Chapter 11 Cases, we continued to accrue interest expense on the Pre-Petition Credit Facility, as such interest was considered an allowed claim pursuant to the Plan. During the 24 days ended January 24, 2011, no payments of interest were made on the Pre-Petition Credit Facility, resulting in an increase in cash provided by operations of $9.0 million. Upon the Effective Date, we began paying interest on our outstanding debt in the normal course, which is reflected as cash used by operations during the nine months ended September 30, 2012 and the 249 days ended September 30, 2011.
Net cash used in investing activities was $95.4 million, $127.9 million and $12.5 million for the nine months ended September 30, 2012, the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011, respectively, and is mainly comprised of capital expenditures for all periods.
Net cash used in financing activities was $29.7 million and $1.7 million for the nine months ended September 30, 2012 and the 24 days ended January 24, respectively. Net cash used in financing activities for the 249 days ended September 30, 2011 was immaterial. During the first nine months of 2012, we made $30.0 million of principal payments on our Term Loan, of which $22.5 million exceeds the scheduled payments and was allocated to the final payment due at maturity. We paid $2.4 million of loan origination costs on the Credit Agreement, of which $0.9 million and $1.5 million were paid during the 249 days ended September 30, 2011 and the 24 days ended January 24, 2011, respectively.
Through September 30, 2012, we have contributed approximately $19.8 million to our Company sponsored qualified pension plans and, accordingly, have met the minimum funding requirements under the Pension Protection Act of 2006 for 2012. We do not expect to make any additional contributions to our pension plans in 2012. As of September 30, 2012, we have made benefit payments of $2.2 million under our post-retirement healthcare plans. We expect to make total benefit payments of approximately $3.3 million under our post-retirement healthcare plans in 2012.
On July 6, 2012, the Moving Ahead for Progress in the 21st Century Act was signed into law. This act contains a pension funding stabilization provision which allows pension plan sponsors to use higher interest rate assumptions when determining funded status and funding obligations. As a result, our 2013 minimum required pension plan contribution is expected to be approximately $6.0 million, which is lower than it would have been in the absence of this stabilization provision. The actual amount contributed in 2013 may be materially higher if we elect to make discretionary contributions. We believe that the intent of the stabilization provision is to alter the timing of pension plan contributions, not to reduce the long-term funding of pension plans. Accordingly, the relief we will receive as a result of the stabilization provision may be temporary in nature in that our near-term required contributions will be less than they otherwise would have been and will increase in the medium to long-term.
On September 25, 2012, we elected to defer use of the higher segment rates under the act until the first plan year beginning on or after January 1, 2013 solely for determination of the AFTAP used to determine benefit restrictions under IRC Section 436.
Capital Expenditures
We require significant capital expenditures to maintain, upgrade and enhance our network facilities and operations. During the first nine months of 2012, our capital expenditures totaled $96.0 million compared to $141.0 million during the same period in 2011. Capital expenditures were higher in 2011 due primarily to two projects, fiber-to-the-tower and the regulatory broadband build out, which were completed during 2011. We expect capital expenditures will increase for the remainder of 2012 as compared to the first nine months of 2012, primarily due to expansion of our broadband footprint in New Hampshire in accordance with a

35

regulatory commitment to reach 95% of our customers in the state by March 31, 2013. We anticipate that we will fund future capital expenditures through cash flows from operations, cash on hand and funds available under the Revolving Facility.

Debt
Credit Agreement
On the Effective Date, the Borrowers entered into the Credit Agreement. The Credit Agreement is comprised of the Revolving Facility, which has a sub-facility providing for the issuance of up to $30.0 million of letters of credit, and the Term Loan. On the Effective Date, we paid to the lenders providing the Revolving Facility an aggregate fee equal to $1.5 million. Interest on the Credit Agreement Loans accrues at an annual rate equal to either (a) LIBOR plus 4.50%, with a minimum LIBOR floor of 2.00% for the Term Loan, or (b) a base rate plus 3.50% per annum, which base rate is equal to the highest of (x) Bank of America’s prime rate, (y) the federal funds effective rate plus 0.50% and (z) the applicable LIBOR plus 1.00%. In addition, we are required to pay a 0.75% per annum commitment fee on the average daily unused portion of the Revolving Facility. The entire outstanding principal amount of the Credit Agreement Loans is due and payable on the Maturity Date; provided that on the third anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a continuation fee of $0.75 million and, on the fourth anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a second continuation fee of $0.75 million. The Credit Agreement requires quarterly repayments of principal of the Term Loan after the first anniversary of the Effective Date. In the second and third years following the Effective Date, such quarterly payments shall each be in an amount equal to $2.5 million; during the fourth year following the Effective Date, such quarterly payments shall each be in an amount equal to $6.25 million; and for the first three quarters during the fifth year following the Effective Date, such quarterly payments shall each be in an amount equal to $12.5 million, with all remaining outstanding amounts owed in respect of the Credit Agreement being due and payable on the Maturity Date. During the nine months ended September 30, 2012, we made $30.0 million of principal payments on the Term Loan, which includes a voluntary prepayment of $25.0 million made in the third quarter. The prepayment was allocated first to the scheduled payment of $2.5 million due on September 30, 2012, with the remaining $22.5 million allocated to the final payment due at maturity. As of September 30, 2012, we had approximately $62.6 million, net of approximately $12.4 million outstanding letters of credit, available for additional borrowing under our Revolving Facility.
The Credit Agreement Loans are guaranteed by the Financing Loan Parties. The Credit Agreement Loans as a whole are secured by liens upon substantially all existing and after-acquired assets of the Financing Loan Parties, with first lien and payment waterfall priority for the Revolving Facility and second lien priority for the Term Loan.
The Credit Agreement contains customary representations, warranties and affirmative covenants. In addition, the Credit Agreement contains restrictive covenants that limit, among other things, the ability of the Financing Loan Parties to incur indebtedness, create liens, engage in mergers, consolidations and other fundamental changes, make investments or loans, engage in transactions with affiliates, pay dividends, make capital expenditures and repurchase capital stock. The Credit Agreement also contains minimum interest coverage and maximum total leverage maintenance covenants, along with a maximum senior leverage covenant measured upon the incurrence of certain types of debt. The ratios measured in these covenants, which are reported quarterly, periodically adjust to become more restrictive as set forth in the Credit Agreement. The initial adjustment for each of the three covenants will be reflected in the quarterly covenant reporting for the third quarter of 2013. The Credit Agreement contains certain events of default, including failure to make payments, breaches of covenants and representations, cross defaults to other material indebtedness, unpaid and uninsured judgments, changes of control and bankruptcy events of default. The lenders’ commitments to fund amounts under the Revolving Facility are subject to certain customary conditions. As of September 30, 2012, the Borrowers were in compliance with all covenants under the Credit Agreement.
The Credit Agreement also provides for mandatory prepayments of outstanding balances on the Credit Agreement Loans with the proceeds from certain asset dispositions, certain equity and debt issuances, and certain extraordinary cash receipts. Proceeds from such events may be reinvested by the Borrowers in lieu of any such mandatory prepayment under certain circumstances. In addition, at the end of each fiscal year, a test is performed to determine if excess cash flow, as defined in the Credit Agreement, was generated during the year. If the calculation indicates that excess cash flow was generated, a certain percentage (determined by reference to the total leverage ratio) of such excess cash flow is required to be prepaid against outstanding balances. Voluntary prepayments of the Term Loan and mandatory amortization both reduce excess cash flow, as defined in the Company's Credit Agreement, for purposes of calculating any excess cash flow sweep. Any mandatory prepayments are first applied to the Revolving Facility until repaid and then to the Term Loan.

The above summary of the material terms of the Credit Agreement Loans does not purport to be complete and is qualified in its entirety by reference to the text of (i) the Credit Agreement, (ii) the Pledge Agreement, dated as of the Effective Date, made by the pledgors party thereto in favor of Bank of America, N.A., as administrative agent, for the benefit of certain secured parties, (iii) the Security Agreement, dated as of the Effective Date, by and among FairPoint Communications, FairPoint Logistics, our

36

subsidiaries party thereto and Bank of America, N.A., as administrative agent, for the benefit of certain secured parties and (iv) the Continuing Guaranty Agreement, dated as of the Effective Date, made by and among the guarantors party thereto in favor of Bank of America, N.A., as administrative agent, for the benefit of certain secured parties.
Our DIP Facility
In connection with the Chapter 11 Cases, on October 27, 2009, the DIP Borrowers entered into the DIP Credit Agreement with the DIP Lenders and the DIP Administrative Agent. The DIP Credit Agreement provided for a revolving facility in an aggregate principal amount of up to $75.0 million, of which up to $30.0 million was also available in the form of one or more letters of credit that could have been issued to third parties for our account (the “DIP Financing”). Pursuant to an Order of the Bankruptcy Court, dated October 28, 2009, the DIP Borrowers were authorized to enter into and immediately draw upon the DIP Credit Agreement on an interim basis in an aggregate amount of $20.0 million, pending a final hearing before the Bankruptcy Court. On March 11, 2010, the Bankruptcy Court issued a final order relating to the DIP Financing, permitting the DIP Borrowers access to the total $75.0 million of the DIP Financing, subject to the terms and conditions of the DIP Credit Agreement and related orders of the Bankruptcy Court, of which up to $30.0 million was available in the form of one or more letters of credit that were issued to third parties for the DIP Borrowers’ account.
On the Effective Date, the DIP Credit Agreement was converted into the new Revolving Facility with a five-year term. All letters of credit outstanding under the DIP Credit Agreement were transferred to the Credit Agreement on the Effective Date.
Our Pre-Petition Credit Facility
Our $2,030.0 million Pre-Petition Credit Facility consisted of a non-amortizing revolving facility in an aggregate principal amount of $200.0 million, a senior secured term loan A facility in an aggregate principal amount of $500.0 million, a senior secured term loan B facility in the aggregate principal amount of $1,130.0 million (together with the term loan A facility, the “Pre-Petition Term Loan”) and a delayed draw term loan facility in an aggregate principal amount of $200.0 million (the “Pre-Petition Delayed Draw Term Loan”). Spinco drew $1,160.0 million under the Pre-Petition Term Loan immediately prior to being spun off by Verizon, and then FairPoint drew $470.0 million under the Pre-Petition Term Loan and $5.5 million under the Pre-Petition Delayed Draw Term Loan concurrently with the closing of the Merger. Subsequent to the Merger, we borrowed the remaining $194.5 million available under the Pre-Petition Delayed Draw Term Loan. These funds were used for certain capital expenditures and other expenses associated with the Merger.
On the Effective Date, the Pre-Petition Credit Facility and all obligations thereunder were terminated (except that the Pre-Petition Credit Facility continues in effect solely for the purposes of allowing creditors under the Pre-Petition Credit Facility to receive distributions under the Plan and to preserve certain rights of the administrative agent).
Our Pre-Petition Notes
Spinco issued, and we assumed in the Merger, $551.0 million aggregate principal amount of the Old Notes. The Old Notes were to mature on April 1, 2018 and were not redeemable at our option prior to April 1, 2013. The Old Notes were issued at a discount and, accordingly, at the date of their distribution, the Old Notes had a carrying value of $539.8 million (principal amount at maturity of $551.0 million less discount of $11.2 million). Following the filing of the Chapter 11 Cases, $9.9 million of discount on the Pre-Petition Notes was written off in order to adjust the carrying amount of our pre-petition debt to the Bankruptcy Court approved amount of the allowed claims for our pre-petition debt.
Pursuant to our offer to exchange the Old Notes for the New Notes (the “Exchange Offer”), on July 29, 2009, we exchanged $439.6 million in aggregate principal amount of the Old Notes (which amount was equal to approximately 83% of the then outstanding Old Notes) for $458.5 million in aggregate principal amount of the New Notes (which amount included New Notes issued to tendering note holders as payment for accrued and unpaid interest on the exchanged Old Notes up to, but not including, the July 29, 2009 settlement date of the Exchange Offer).

On the Effective Date, all outstanding obligations under the Pre-Petition Notes and the indentures governing the Pre-Petition Notes were terminated.
Other Pre-Petition Agreements
As a condition to the approval of the Merger and related transactions by state regulatory authorities we agreed to make certain capital expenditures following the completion of the Merger. The Merger Orders have been modified by Regulatory Settlements agreed to with representatives for each of Maine, New Hampshire and Vermont, and approved by the applicable regulatory authorities in Maine, New Hampshire and Vermont, and approved by the Bankruptcy Court as part of the Plan.

37

We are required to make certain capital expenditures pursuant to the Regulatory Settlements. See note 12.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
As of September 30, 2012, we had total debt of $970.0 million, consisting of variable rate debt with an interest rate of 6.50% per annum, including applicable margins. As of September 30, 2012, the fair value of our debt was approximately $909.2 million based on the market price of our debt at that date. Our Credit Agreement Loans mature in 2016, provided that on the third anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a continuation fee of $0.75 million and, on the fourth anniversary of the Effective Date, we must elect (subject to the absence of events of default under the Credit Agreement) to continue the maturity of the Revolving Facility and must pay a second continuation fee of $0.75 million.
As of September 30, 2012, we had $62.6 million, net of $12.4 million outstanding letters of credit, available for additional borrowing under our Revolving Facility. Interest payments on the Term Loan are subject to a LIBOR floor of 2.00%. While LIBOR remains below 2.00% we will incur interest costs above market rates.
We use variable rate debt to finance our operations, capital expenditures and acquisitions. The variable rate debt obligations expose us to variability in interest payments due to changes in interest rates. We believe it is prudent to limit the variability of a portion of our interest payments. To meet this objective, from time to time, we may enter into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk.
We do not hold or issue derivative financial instruments for trading or speculative purposes.
We are also exposed to market risk from changes in the fair value of our pension plan assets and from changes to rates at which benefit payments are discounted. For the three and nine months ended September 30, 2012, the actual rate of return on the pension plan assets was a gain of approximately 4.1% and 7.7%, respectively. Net periodic benefit cost for 2012 assumes a weighted average annualized expected return on plan assets of approximately 7.52%. Payment of significant lump sum payments, lower returns on plan assets and lower discount rates could negatively impact the funded status of the plan and we may be required to make larger contributions to the pension plan than currently anticipated.

Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report, we carried out an evaluation under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.
Based upon this evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were not effective due to the following material weakness which was identified in our 2011 Annual Report and which remains in existence as of the date of this report:
•
Procedures for the review of our income tax provision and supporting schedules were not adequate to identify and correct errors in a timely manner.
Our management has initiated a number of steps designed to remediate this issue and further improve tax provision processes related to interim periods as discussed below. However, this material weakness will be tested for closure upon the evaluation of the December 31, 2012 annual tax provision, which is expected to occur in February 2013.
Changes in Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.

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During the year ended December 31, 2011, our management completed the following improvements to address the material weakness relating to our review of our internal tax provision and supporting schedules which were not adequate to identify and correct errors in a timely manner:
•
Streamlined the process for preparation of quarterly income tax provisions; and
•
Contracted with a major accounting firm to assist with the preparation and review of the quarterly and year-end tax provision and related schedules.
We are committed to continuing to improve our internal control processes and will continue to review our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may identify additional measures to address the material weakness described above or other deficiencies. Our management, with the oversight of the audit committee of our board of directors, will continue to assess and take steps to enhance the overall design and capability of our control environment in the future.
During the quarter ended September 30, 2012, we began utilizing our enterprise resource planning ("ERP") system for the calculation of depreciation on assets which are in service in the ERP system.

With the exception of the foregoing, there have been no changes in our internal control over financial reporting during the quarter ended September 30, 2012 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

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PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, we are involved in litigation and regulatory proceedings arising out of our operations. Management believes that we are not currently a party to any legal or regulatory proceedings, the adverse outcome of which, individually or in the aggregate, would have a material adverse effect on our business, financial position or results of operations. Notwithstanding that we emerged from Chapter 11 protection on the Effective Date, five of the Chapter 11 Cases are still in the process of being resolved. On October 15, 2012, we filed a motion in the Bankruptcy Court for final decree closing four of the five remaining Chapter 11 Cases, subject to Bankruptcy Court approval.
Item 1A. Risk Factors.
The risk factor presented below amends and restates the corresponding risk factor previously disclosed in "Item 1A. Risk Factors" of the 2011 Annual Report.
Our required pension contributions and estimated future pension and post-retirement benefit plan liabilities may be impacted by several factors and an increase in our required contributions could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.
We sponsor qualified pension and post-retirement medical and dental plans for certain employees which require significant amounts of cash to maintain. The accrual of future benefits by employees and retirees in these qualified pension and post-retirement healthcare plans that are not covered by a collective bargaining agreement have been frozen. However, under the terms of our qualified pension and post-retirement healthcare plans for participants and retirees covered by a collective bargaining agreement, contractual increases in benefits will continue each year through 2014, at which time the collective bargaining agreements will terminate and be renegotiated. Future increases in benefits earned by participants and retirees in these plans will require increasing amounts of cash to maintain and may limit our operational flexibility. These future cash requirements could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.
During 2012, as a condition of our collective bargaining agreements, qualified pension plan participants covered by a collective bargaining agreement did not have the option to elect a lump sum payment if they voluntarily terminated their employment with us. Beginning January 1, 2013, this restriction will no longer be in effect and retirees after that point will again have the ability to elect to receive a portion of their accrued vested benefit in the form of a lump sum payment. In addition, the discount rates used to calculate lump sum payments are currently lower than the discount rate used to calculate the actuarial liabilities of the plan. As a result, the value of a lump sum payment is more than the respective actuarial liability, which creates an actuarial loss. As such, a lump sum payment depletes the plan's assets more than the corresponding reduction in the plan's liability, which reduces the funded status of the plan. If more participants covered by a collective bargaining agreement retire after January 1, 2013 than expected and elect to receive a portion of their accrued vested benefit in the form of a lump sum payment, which is beyond our control, we could experience a significant reduction in the funded status of our qualified pension plan covering these participants. If the funded status of our qualified pension plans decrease below certain percentage thresholds as defined in ERISA, as amended, then certain restrictions and other requirements would be placed on us and the participants in the respective plans which would significantly increase the cost of these plans. Accordingly, to maintain the funded status above these percentage thresholds may require us to make significantly higher contributions to these plans in the future. The extent of such increases in our contributions could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.
Our qualified pension plans are subject to funding requirements as defined under ERISA, as amended. These required pension contributions may be impacted by several factors, including fluctuations in the discount rate used to calculate the funding target, the performance of our pension asset portfolio, the number of retirees who elect to receive lump sum distributions and the demographics of plan participants. Fluctuations or adverse changes in any of these factors are beyond our control and may diminish the funded status of our pension plans thereby significantly increasing the contributions we are required to make under ERISA, as amended. For example, economic factors have led to a significant decrease in our discount rate for our pension plans and certain workforce reductions resulted in a large amount of lump-sum payments made to participants in 2011 and in 2012. These factors will increase our future contributions to the pension plans. The extent of such increases in our required contributions could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.
During the year ended December 31, 2011, we experienced actual returns on pension plan assets totaling approximately 1.6%. The actuarially-determined funded status of our pension plans is dependent on the market value of the assets held by each plan. As such, a significant decline in the market value of the pension plans' assets could result in us having to make additional contributions to these plans. Furthermore, if the third party trustee who holds these plan assets were to become insolvent, access to the plan assets could be limited for a period of time and we could be required to pay lump sum payments and benefits from our

40

assets. Such required contributions and other payments could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our Common Stock.
There have been no other material changes to the risk factors disclosed in “Item 1A. Risk Factors” of the 2011 Annual Report.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits.
The exhibits filed as part of this Quarterly Report are listed in the index to exhibits immediately preceding such exhibits, which index to exhibits is incorporated herein by reference.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
FAIRPOINT COMMUNICATIONS, INC.
 
 
 
 
Date: November 2, 2012
 
By:
 
/s/ Ajay Sabherwal
 
 
Name:
 
Ajay Sabherwal
 
 
Title:
 
Executive Vice President and Chief Financial Officer
 
 
 
 
(duly authorized officer and principal financial officer)


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Exhibit Index
 
Exhibit
No.
 
Description
2.1
 
Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code.(1)
3.1
 
Ninth Amended and Restated Certificate of Incorporation of FairPoint.(2)
3.2
 
Second Amended and Restated By Laws of FairPoint.(2)
4.1
 
Warrant Agreement, dated as of January 24, 2011, by and between FairPoint and The Bank of New York Mellon.(3)
4.2
 
Specimen Stock Certificate.(2)
4.3
 
Specimen Warrant Certificate.(3)
10.1
 
Credit Agreement, dated as of January 24, 2011, by and among FairPoint, FairPoint Logistics, Bank of America, N.A., as administrative agent, the other lenders party thereto and Banc of America Securities LLC, as sole lead arranger and sole book manager.(3)
10.2
 
Pledge Agreement, dated as of January 24, 2011, made by the pledgors party thereto in favor of Bank of America, N.A. as administrative agent, for the benefit of certain secured parties.(3)
10.3
 
Security Agreement, dated as of January 24, 2011, by and among FairPoint, FairPoint Logistics, the subsidiaries of FairPoint party thereto and Bank of America, N.A., as administrative agent.(3)
10.4
 
Continuing Guaranty Agreement, dated as of January 24, 2011, made by and among the guarantors party thereto in favor of Bank of America, N.A., as administrative agent, for the benefit of certain secured parties.(3)
10.5
 
Registration Rights Agreement, dated as of January 24, 2011, by and between FairPoint Communications, Inc. and Angelo, Gordon & Co., L.P.(3)
10.6
 
FairPoint Litigation Trust Agreement, dated as of January 24, 2011.(3)
10.7
 
Form of Director Indemnity Agreement.(4)
10.8
 
Amended and Restated Tax Sharing Agreement, dated as of November 9, 2000, by and among FairPoint and its Subsidiaries.(5)
10.9
 
Employment Agreement, dated as of August 16, 2010, by and between FairPoint and Paul H. Sunu.†(6)
10.10
 
Change in Control and Severance Agreement, dated as of March 14, 2007, by and between FairPoint and Peter G. Nixon.†(7)
10.11
 
Change in Control and Severance Agreement, dated as of March 14, 2007, by and between FairPoint and Shirley J. Linn.†(7)
10.12
 
Change in Control and Severance Agreement, dated as of September 3, 2008, by and between FairPoint and Ajay Sabherwal.†(6)
10.13
 
FairPoint Communications, Inc. 2010 Long Term Incentive Plan.†(1)
10.14
 
Form of Restricted Share Award Agreement—FairPoint Communications, Inc. 2010 Long Term Incentive Plan.†(1)
10.15
 
FairPoint Communications, Inc. Incentive Recoupment Policy. †(16)
10.16
 
Stipulation filed with the Maine Public Utilities Commission, dated December 12, 2007.(8)
10.17
 
Amended Stipulation filed with the Maine Public Utilities Commission dated December 21, 2007.(9)
10.18
 
Stipulation filed with the Vermont Public Service Board, dated January 8, 2008.(10)
10.19
 
Stipulation filed with the New Hampshire Public Utilities Commission, dated January 23, 2008.(11)
10.20
 
Letter Agreement, dated as of March 30, 2008, by and between the Staff of the New Hampshire Public Utilities Commission and Verizon Communications Inc.(9)

43

Exhibit
No.
 
Description
10.21
 
Letter, dated as of May 12, 2009, from the Staff of the New Hampshire Public Utilities Commission to FairPoint.(12)
10.22
 
Post Filing Regulatory Settlement—New Hampshire, dated as of February 5, 2010, by and between FairPoint and New Hampshire Public Utilities Commission Staff Advocates.(1)
10.23
 
Post Filing Regulatory Settlement—Maine, dated as of February 9, 2010, by and among FairPoint, Maine Public Utilities Commission and Maine Office of the Public Advocate.(1)
10.24
 
Post Filing Regulatory Settlement—Vermont, dated as of February 5, 2010, by and between FairPoint and Vermont Department of Public Service.(1)
11
 
Statement Regarding Computation of Per Share Earnings (included in the financial statements contained in this Quarterly Report).
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
 
Order Confirming Debtors’ Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code, dated as of December 29, 2010.(1)
99.2
 
Order of the Maine Public Utilities Commission, dated February 1, 2008.(13)
99.3
 
Order of the Vermont Public Service Board, dated February 15, 2008.(14)
99.4
 
Order of the New Hampshire Public Utilities Commission, dated February 25, 2008.(15)
101.INS
 
XBRL Instance Document.**
101.SCH
 
XBRL Taxonomy Extension Schema Document.**
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.**
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.**
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.**
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.**
*
Filed herewith.
†
Indicates a management contract or compensatory plan or arrangement.
‡
Submitted herewith. Pursuant to SEC Release No. 33-8238, this certification will be treated as “accompanying” this Quarterly Report on Form 10-Q and not “filed” as part of such report for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of Section 18 of the Exchange Act and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
**
Pursuant to Rule 406T of Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

(1)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on January 14, 2011.
(2)
Incorporated by reference to the Registration Statement on Form 8-A of FairPoint filed on January 24, 2011.
(3)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on January 25, 2011, Film Number 11544980.
(4)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on January 25, 2011, Film Number 11544991.

44

(5)
Incorporated by reference to the Quarterly Report on Form 10-Q of FairPoint for the period ended September 30, 2000.
(6)
Incorporated by reference to the Quarterly Report on Form 10-Q of FairPoint for the period ended September 30, 2010.
(7)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on March 19, 2007.
(8)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on December 13, 2007.
(9)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on April 3, 2008.
(10)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on January 8, 2008.
(11)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on January 24, 2008.
(12)
Incorporated by reference to the Quarterly Report on Form 10-Q of FairPoint for the period ended June 30, 2009.
(13)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on February 6, 2008.
(14)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on February 21, 2008.
(15)
Incorporated by reference to the Current Report on Form 8-K of FairPoint filed on February 25, 2008.
(16)
Incorporated by reference to the Quarterly Report on Form 10-Q of FairPoint for the period ended March 31, 2012.

45