FAIRPOINT COMMUNICATIONS INC - FORM 10-Q - November 2, 2016

Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - FAIRPOINT COMMUNICATIONS INCex322-frpx2016930.htm
EX-32.1 - EXHIBIT 32.1 - FAIRPOINT COMMUNICATIONS INCex321-frpx2016930.htm
EX-31.2 - EXHIBIT 31.2 - FAIRPOINT COMMUNICATIONS INCex312-frpx2016930.htm
EX-31.1 - EXHIBIT 31.1 - FAIRPOINT COMMUNICATIONS INCex311-frpx2016930.htm
EX-10.1 - EXHIBIT 10.1 - FAIRPOINT COMMUNICATIONS INCex101employment_agreementx.htm

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, 2016
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 28, 2016, there were 27,073,540 shares of the registrant's common stock, par value $0.01 per share, outstanding.


TABLE OF CONTENTS
 
 
 
Page
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
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 the quarterly period ended September 30, 2016 (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"). 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”, "should", "could", "may", "will" 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 factors discussed under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015 (the "2015 Annual Report") and other parts of this Quarterly Report and the factors set forth below:
•
future performance generally and our share price as a result thereof;
•
any change in strategic direction, including as a result of mergers, acquisitions or dispositions;
•
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 repay or refinance our indebtedness;
•
our ability to fund substantial capital expenditures;
•
anticipated business development activities and future capital expenditures;
•
the effects of regulation and enforcement, including changes in federal and state regulatory policies, procedures and their enforcement mechanisms including but not limited to the availability and levels of regulatory support payments and penalties associated with performance;
•
our ability to satisfy our Connect America Fund ("CAF") Phase II obligations;
•
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, labor negotiations and any resulting financial or operational impact;
•
material technological developments and changes in the communications industry, including declines in access lines;
•
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;
•
our ability to overcome changes to or pressure on pricing and their impact on our profitability;
•
intellectual property infringement claims by third parties;
•
failure of, or attack on, our information technology infrastructure;
•
risks related to our reported financial information and operating results;
•
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 other post-employment benefit plans;
•
the impact of lump sum payments under certain of our company-sponsored qualified pension plans on future pension contributions;
•
the effects of severe weather events, such as hurricanes, storms, tornadoes and floods, terrorist attacks, cyber-attacks or other natural or man-made disasters; 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.


3

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, changes in our expectations or otherwise, except as required by law. 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.

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., 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 the acquired Northern New England operations.

4

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, 2016 and December 31, 2015
(in thousands, except share data)
 
 
September 30, 2016
 
December 31, 2015
 
(unaudited)
 
 
Assets:
 
 
 
Cash
$
33,071

 
$
26,560

Accounts receivable (net of $3.7 million and $8.3 million allowance for doubtful accounts, respectively)
63,162

 
60,136

Prepaid expenses
23,874

 
24,410

Other current assets
3,985

 
5,030

Total current assets
124,092

 
116,136

Property, plant and equipment (net of $1,426.4 million and $1,281.2 million accumulated depreciation, respectively)
1,042,259

 
1,118,781

Intangible assets (net of $62.6 million and $54.3 million accumulated amortization, respectively)
78,701

 
83,879

Restricted cash
652

 
651

Other assets
3,061

 
3,079

Total assets
$
1,248,765

 
$
1,322,526



 
 
Liabilities and Stockholders’ Deficit:
 
 
 
Current portion of long-term debt
$
6,400

 
$
6,400

Current portion of capital lease obligations
1,207

 
918

Accounts payable
28,504

 
28,157

Accrued interest payable
3,420

 
9,983

Accrued payroll and related expenses
22,057

 
24,753

Other accrued liabilities
51,522

 
50,018

Total current liabilities
113,110

 
120,229

Capital lease obligations
1,363

 
1,223

Accrued pension obligations
143,777

 
150,562

Accrued post-employment benefit obligations
92,868

 
94,042

Deferred income taxes, net
23,036

 
35,075

Other long-term liabilities
16,801

 
22,739

Long-term debt, net of current portion
898,778

 
900,145

Total long-term liabilities
1,176,623

 
1,203,786

Total liabilities
1,289,733

 
1,324,015

Commitments and contingencies (See Note 13)

 

Stockholders’ deficit:
 
 
 
Common stock, $0.01 par value, 37,500,000 shares authorized, 27,073,540 and 26,921,066 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
271

 
269

Additional paid-in capital
526,325

 
521,842

Retained deficit
(619,502
)
 
(707,592
)
Accumulated other comprehensive income
51,938

 
183,992

Total stockholders’ deficit
(40,968
)
 
(1,489
)
Total liabilities and stockholders’ deficit
$
1,248,765

 
$
1,322,526


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


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
Three and Nine Months ended September 30, 2016 and 2015
(Unaudited)
(in thousands, except per share data)
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
 
2016
 
2015

2016
 
2015
Revenues
$
207,141


$
221,569


$
620,514


$
649,641

Operating expenses:







Cost of services and sales, excluding depreciation and amortization
95,830


100,718


294,171


333,067

Other post-employment benefit and pension expense
(67,428
)

(57,568
)

(174,142
)

(116,926
)
Selling, general and administrative expense, excluding depreciation and amortization
45,838


49,688


145,614


158,968

Depreciation and amortization
54,918


56,296


167,661


167,420

Reorganization related expense
—


6


—


33

Total operating expenses
129,158


149,140


433,304


542,562

Income from operations
77,983


72,429


187,210


107,079

Other income/(expense):


 








Interest expense
(20,698
)

(20,186
)

(61,891
)

(59,979
)
Other, net
91


153


344


425

Total other expense
(20,607
)

(20,033
)

(61,547
)

(59,554
)
Income before income taxes
57,376


52,396


125,663


47,525

Income tax (expense)/benefit
(17,169
)

658


(37,573
)

581

Net income
$
40,207


$
53,054


$
88,090


$
48,106

 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
26,870


26,676


26,847


26,640

Diluted
27,084


27,004


27,041


26,952

 
 
 
 
 
 
 
 
Income per share, basic
$
1.50


$
1.99


$
3.28


$
1.81









Income per share, diluted
$
1.48


$
1.96


$
3.26


$
1.78


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


FAIRPOINT COMMUNICATIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income/(Loss)
Three and Nine Months ended September 30, 2016 and 2015
(Unaudited)
(in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
40,207

 
$
53,054

 
$
88,090

 
$
48,106

Other comprehensive income/(loss), net of taxes:
 
 
 
 
 
 
 
Interest rate swaps (net of $(0.2) million, $0.2 million, $(0.5) million and $0.6 million tax (expense)/benefit, respectively)
355

 
(274
)
 
753

 
(897
)
Qualified pension and post-employment benefit plans (net of $11.3 million, $0 million, $49.0 million and $0 million tax benefit, respectively)
(58,792
)
 
(41,698
)
 
(132,807
)
 
573,635

Total other comprehensive income/(loss)
(58,437
)
 
(41,972
)
 
(132,054
)
 
572,738

Comprehensive income/(loss)
$
(18,230
)
 
$
11,082

 
$
(43,964
)
 
$
620,844



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, 2016
(Unaudited)
(in thousands)
 
 
Common Stock
 
Additional
paid-in
capital
 
Retained
deficit
 
Accumulated
other
comprehensive income
 
Total
stockholders' deficit
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2015
26,921

 
$
269

 
$
521,842

 
$
(707,592
)
 
$
183,992

 
$
(1,489
)
Net income
—

 
—

 
—

 
88,090

 
—

 
88,090

Stock-based compensation issued, net
153

 
2

 
(517
)
 
—

 
—

 
(515
)
Stock-based compensation expense
—

 
—

 
5,000

 
—

 
—

 
5,000

Interest rate swaps other comprehensive income before reclassifications
—

 
—

 
—

 
—

 
(341
)
 
(341
)
Interest rate swaps reclassified from accumulated other comprehensive income
—

 
—

 
—

 
—

 
1,094

 
1,094

Employee benefits other comprehensive income before reclassifications
—

 
—

 
—

 
—

 
(166
)
 
(166
)
Employee benefits reclassified from accumulated other comprehensive income
—

 
—

 
—

 
—

 
(132,641
)
 
(132,641
)
Balance at September 30, 2016
27,074

 
$
271

 
$
526,325

 
$
(619,502
)
 
$
51,938

 
$
(40,968
)

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, 2016 and 2015
(Unaudited) (in thousands)
 
Nine Months Ended September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
88,090


$
48,106

Adjustments to reconcile net income to net cash provided by operating activities:



Deferred income taxes
37,180


(1,603
)
Provision for uncollectible revenue
(704
)

5,606

Depreciation and amortization
167,661


167,420

Other post-employment benefits
(185,024
)

(127,356
)
Qualified pension
(4,517
)

(2,001
)
Stock-based compensation
5,000


5,306

Other non-cash items
3,775


3,114

Changes in assets and liabilities arising from operations:



Accounts receivable
(1,963
)

1,415

Prepaid and other assets
1,500


(2,354
)
Accounts payable and accrued liabilities
(2,910
)

(27,139
)
Accrued interest payable
(6,563
)

(6,557
)
Other assets and liabilities, net
(5,052
)

3,535

Total adjustments
8,383


19,386

Net cash provided by operating activities
96,473


67,492

Cash flows from investing activities:



Net capital additions
(82,906
)

(82,921
)
Acquisition of business
(2,729
)
 
—

Distributions from investments and proceeds from the sale of property and equipment
1,206


230

Net cash used in investing activities
(84,429
)

(82,691
)
Cash flows from financing activities:



Repayments of long-term debt
(4,800
)

(4,800
)
Restricted cash
(1
)

—

Proceeds from exercise of stock options
9


13

Repayment of capital lease obligations
(741
)

(568
)
Net cash used in financing activities
(5,533
)

(5,355
)
Net change
6,511


(20,554
)
Cash, beginning of period
26,560


37,587

Cash, end of period
$
33,071


$
17,033

Supplemental disclosure of cash flow information:
 
 
 
Capital additions included in accounts payable
$
7,640

 
$
7,848

Acquisition of property and equipment by capital lease
1,172

 
1,030


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 provider of advanced communications services to business, wholesale and residential customers within its service territories. FairPoint offers its customers a suite of advanced data services such as Ethernet, high capacity data transport and other IP-based services over an extensive fiber network with more than 21,000 miles of fiber optic cable, including approximately 17,000 miles of fiber optic cable in Maine, New Hampshire and Vermont, in addition to Internet access, high-speed data ("HSD") and local and long distance voice services. As of September 30, 2016, FairPoint's service territory spanned 17 states where it is the incumbent communications provider, primarily serving rural communities and small urban markets. Many of its local exchange carriers ("LECs") have served their respective communities for more than 80 years. As of September 30, 2016, the Company operated with approximately 310,000 broadband subscribers, approximately 15,400 Ethernet circuits and approximately 377,000 residential voice lines.
Principles of Consolidation
The condensed 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 upon consolidation.
(2) Significant Accounting Policies
(a) Presentation and Use of Estimates
The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America and the rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly, certain information and footnote disclosures have been condensed or omitted for this quarterly report and should be read in conjunction with the Company's audited consolidated financial statements and related notes included in the Company's annual report on Form 10-K for the year ended December 31, 2015. The condensed consolidated balance sheet as of December 31, 2015 is derived from audited financial statements.
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. Interim results are not necessarily indicative of results for a full year and actual results could differ from those estimates.
(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: voice services, access (including pooling), certain 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 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 ("NECA") or by the individual company and approved by the Federal Communications Commission (the "FCC"). On July 14, 2016, the FCC adopted a Declaratory Order that classifies switched access services provided by Incumbent LECs as non-dominant services. This change in classification will not impact rates or revenues as the rates continue to be subject to rules established for all access providers pursuant to the Intercarrier Compensation transition rules adopted in 2011.
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 the customer and keeps the revenue. If the Company participates in a pooling environment (interstate or intrastate), the revenue from the covered services is contributed to a revenue pool. The revenue is then distributed to individual companies based on their company-specific revenue requirement or similar distribution methods. This distribution is based on individual state

10

PUCs' (intrastate) or the FCC's (interstate) approved settlement mechanisms, 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.
On November 18, 2011, the FCC released its comprehensive landmark order to modify the nationwide system of universal support and the CAF/intercarrier compensation ("ICC") system (the "CAF/ICC Order"). Rule changes associated with the FCC's CAF/ICC Order impact the NECA interstate pooling, in that a portion of the Company's interstate Universal Service Fund ("USF") revenues, which are administered through the NECA pools and which prior to January 1, 2012 were based on costs, are now based on rules from the FCC's CAF/ICC Order, including CAF Phase II support where FairPoint accepted CAF Phase II support, continued CAF Phase I frozen support where FairPoint did not accept CAF Phase II support and CAF/ICC rules in states where FairPoint is eligible for such support under the ICC Transition Rules for price cap and rate-of-return carriers. FairPoint accepted CAF Phase II support in all states except Kansas and Colorado. The CAF Phase II revenue is being recognized on a straight-line basis, ratably over the six-year period in which the funding will be received. The accepted transition funding is being recognized monthly as received over the three-year transition period ending in July 2018. The Company is required to meet certain interim milestones over the six-year period of CAF Phase II and the Company performs a quarterly assessment of its progress.
Revenue from long distance switched retail and wholesale services can be recurring due to coverage under an unlimited calling plan or can be 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.
As of September 30, 2016 and December 31, 2015, unearned revenue of $20.4 million and $19.9 million, respectively, was included in other accrued liabilities and unearned revenue of $5.4 million and $7.6 million, respectively, was included in other long-term liabilities on the condensed consolidated balance sheets.
The majority of the Company's other miscellaneous services revenue is generated from ancillary special projects at the request of third parties, video services, directory services and late payment charges to end users and wholesale carriers. The Company generally requires customers to pay for ancillary special projects in advance. As of September 30, 2016 and December 31, 2015, customer deposits of $3.0 million and $2.1 million, respectively, were included in other accrued liabilities on the condensed consolidated balance sheets. Once the ancillary special project is completed or substantially complete and all project costs have been accumulated for proper accounting recognition, the advance payment is recognized as revenue with any overpayments refunded to the customer, as appropriate. The Company recognizes revenue upon the provision of video services in certain markets by reselling DirecTV and providing cable and IP television video-over-digital subscriber line services. The Company also publishes telephone directories in some of its Telecom Group markets and recognizes revenues associated with these publications evenly over the time period covered by the directory, which is typically twelve months. The Company bills late payment fees to customers who have not paid their bills in a timely manner. In general, late payment fee revenue is recognized based on collection of these charges.
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.
Under the Maine Public Utilities Commission ("MPUC") rules (Chapter 201), which went into effect August 1, 2014, the MPUC may open an investigation regarding the failure to meet any of the established SQI benchmarks and has the authority to impose penalties. The MPUC opened an investigation into the Company's failure to meet some third quarter 2014 SQI benchmarks and subsequently opened an investigation into the fourth quarter of 2014 and then with respect to each of the quarterly periods in 2015. On March 29, 2016, the MPUC consolidated the investigations of the six quarters into one investigation. On September 14, 2016, a hearing examiner for the MPUC issued a report recommending that the MPUC find that FairPoint had failed to meet SQI benchmarks for the period under review and impose a $500,000 penalty as allowed by statute, and provided until October 7, 2016 for comments or exceptions to be filed by interested parties. This recommendation does not constitute MPUC action. The Company promptly filed a motion to implement adjudicatory procedures prior to entry of any final order. As of October 4, 2016, the Hearing Examiner has suspended the deadline for filing comments or exceptions to the examiner’s report until further notice, pending responses to and resolution of FairPoint’s request for additional adjudicatory procedures. Subsequent legislation in Maine has superseded the SQI benchmarks applied in the examiner’s report. Effective with the new legislation, the reporting of service quality will be required only in the areas of the state where Provider of Last Resort ("POLR") is still required and will be filed and treated as confidential. The number of SQI reporting metrics has been reduced and the benchmarks are less stringent than under previous Commission rules.
The Company also adopted a separate performance assurance plan ("PAP") for certain services provided on a wholesale basis to competitive local exchange carriers ("CLECs") in each of the states of Maine, New Hampshire and Vermont. Pursuant to the PAPs, FairPoint was required to provide service credits in the event the Company was unable to meet the provisions of the respective PAP. Effective June 1, 2015, the PAP was retired and the Company began measuring and reporting certain wholesale

11

local service performance results pursuant to the terms of a simplified measurement plan. The new plan, called the Wholesale Performance Plan ("WPP"), was developed collaboratively with CLECs over several years and was approved by the Maine, New Hampshire and Vermont regulatory commissions. Under the WPP, the Company is subject to significantly fewer performance criteria and its annual service credit exposure was reduced.
In evaluating the presentation of taxes and surcharges, such as USF charges, sales, use, value added and some excise taxes, we determine whether we are the primary obligor or principal taxpayer. In jurisdictions where we deem that we are the principal taxpayer, we record these taxes and surcharges on a gross basis and include them in our revenues and costs of services and sales. In jurisdictions where we determine that we are a pass through agent for the government authority, we record the taxes on a net basis through the condensed consolidated balance sheets.
Customer arrangements that include both equipment and services are evaluated to determine whether the elements are separable. If the elements are deemed separable and separate earnings processes exist, the revenue associated with each element is allocated to each element based on the relative estimated selling price of the separate elements. The Company has estimated the selling prices of each element by reference to vendor-specific objective evidence of selling prices when the elements are sold separately. The revenue associated with each element is then recognized as earned.
Management makes estimated adjustments, as necessary, to revenue and accounts receivable for billing errors, including certain disputed amounts.
(c) Accounts Receivable
Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is recorded as a contra-asset of accounts receivable and represents the Company's best estimate of probable credit losses in the Company's existing accounts receivable. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information. Accounts receivable balances are reviewed on an aged basis and account balances are written off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
(d) 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.
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.
In determining the income tax provision, a reserve for uncertain tax positions is established unless management determines that such positions are more likely than not to be sustained upon examination by the taxing authorities, based on their merits.  There is considerable judgment involved in determining whether positions taken on the Company’s tax return are more likely than not to be sustained.
(e) Operating Segments
Management views its business of providing data, video and voice communications services to residential, wholesale and business customers as one operating segment. The Company's services consist of retail and wholesale communications and data services, including voice and HSD in 17 states. The Company's chief operating decision maker assesses operating performance and allocates resources based on the consolidated results.
(f) Interest Rate Swap Agreements
In the third quarter of 2013, the Company entered into interest rate swap agreements. For further information regarding these interest rate swap agreements, see note (7) "Interest Rate Swap Agreements." The interest rate swap agreements, at their inception, qualified for and were designated as cash flow hedging instruments. The Company records its interest rate swaps on the condensed

12

consolidated balance sheets at fair value. The effective portion of changes in fair value are recorded in accumulated other comprehensive income and are subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Any ineffective portion is recognized in earnings. Both at inception and on a quarterly basis, the Company performs an effectiveness test.
(3) Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers, which is designed to clarify the principles used to recognize revenue for entities. The accounting guidance defines how companies report revenues from contracts with customers and also requires enhanced disclosures. In July 2015, the FASB approved a one-year deferral of the effective date of ASU 2014-09. Subsequently, the FASB has issued several additional ASUs to clarify the implementation guidance on principal versus agent considerations, identifying performance obligations, assessing collectability, presentation of sales taxes and other similar taxes collected from customers, non-cash considerations, contract modifications and completed contracts at transition. The new pronouncements will be effective for annual and interim periods beginning on or after December 15, 2017 and allows for two methods of adoption: (1) "full retrospective" adoption, meaning the standard is applied to all periods presented, or (2) "modified retrospective" adoption, meaning the cumulative effect of applying ASU 2014-09 is recognized as an adjustment to the fiscal year 2018 opening retained earnings balance. The Company is evaluating the potential impact of these pronouncements and the Company's method of adoption.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. ASU 2014-15 is effective for annual and interim periods beginning after December 15, 2016 with early adoption permitted. The Company does not believe the adoption of this pronouncement will have a material impact on its condensed consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, whereby, lessees will be required to recognize for all leases at the commencement date a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. A modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements must be applied. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Companies may not apply a full retrospective transition approach. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018. Early application is permitted. The Company is evaluating the potential impact of this pronouncement.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for share-based payment award transactions, including, but not limited to: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows. ASU 2016-09 is effective for annual and interim periods beginning after December 15, 2016. The Company does not believe the adoption of this pronouncement will have a material impact on its condensed consolidated financial statements.
(4) Dividends
The Company currently does not pay a dividend on its common stock and has no plans to pay dividends.

13

(5) Income Taxes
The Company recorded tax expense on the pre-tax net income for the three months ended September 30, 2016 of $17.2 million and tax benefit on the pre-tax net income for the three months ended September 30, 2015 of $0.7 million, which equates to an effective tax rate of 29.9% and (1.2)%, respectively, by applying the projected full year effective rate. Tax expense of $37.6 million on the pre-tax net income for the nine months ended September 30, 2016 and tax benefit of $0.6 million on the pre-tax net income for the nine months ended September 30, 2015 equates to an effective tax rate of 29.9% and (1.2)%, respectively, by applying the projected full year effective rate. For 2016, the projected annual effective tax rate differs from the 35% federal statutory rate primarily due to a decrease in the valuation allowance offset by tax expense related to state taxes. For 2015, the projected annual effective tax rate differs from the 35% federal statutory rate primarily due to a decrease in the valuation allowance offset by tax expense related to state taxes.
Deferred Income Taxes
At September 30, 2016, the Company had gross federal NOL carryforwards of $294.7 million. The Company's remaining federal NOL carryforwards will expire from 2019 to 2036. At September 30, 2016, the Company had a net, after attribute reduction, state NOL deferred tax asset of $12.0 million. The Company's remaining state NOL carryforwards will expire from 2016 to 2036; the amount that will expire in 2016 is negligible. At September 30, 2016, the Company had no alternative minimum tax credit carryover and had $5.1 million in state credit carryovers. Telecom Group completed an initial public offering on February 8, 2005, which resulted in an "ownership change" within the meaning of the United States of America 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 carryforwards and other tax attributes. The Company believes that it can use the NOLs even with these restrictions in place.
Valuation Allowance. At September 30, 2016 and December 31, 2015, the Company established a valuation allowance against its deferred tax assets of $33.5 million and $25.1 million, respectively, which consist of a $23.7 million and $14.7 million federal allowance, respectively, and a $9.8 million and $10.4 million state allowance, respectively.
Income Tax Returns
The Company and its eligible subsidiaries file consolidated income tax returns in the United States of America federal jurisdiction and certain consolidated, combined and separate entity tax returns, as required, with various state and local governments. Based solely on statutes of limitations, the Company would not be subject to United States of America federal, state and local, or non-United States of America income tax examinations by tax authorities for years prior to 2011. However, tax years prior to 2011 may be subject to examination by federal or state taxing authorities if the Company's NOL carryovers from those years are utilized in the future. As of September 30, 2016 and December 31, 2015, the Company does not have any significant jurisdictional income tax audits.

14

(6) Long-term Debt
Long-term debt for the Company at September 30, 2016 and December 31, 2015 is shown below (in thousands):
 
September 30, 2016
 
December 31, 2015
Term Loan, due 2019 (weighted average rate of 7.50%)
$
617,600

 
$
622,400

Discount on Term Loan (a)
(8,686
)
 
(11,138
)
Debt issuance costs
(3,736
)
 
(4,717
)
Notes, 8.75%, due 2019
300,000

 
300,000

Total long-term debt
905,178

 
906,545

Less: current portion
(6,400
)
 
(6,400
)
Total long-term debt, net of current portion
$
898,778

 
$
900,145

(a)
The $8.7 million and $11.1 million discount on the Term Loan (as defined below) as of September 30, 2016 and December 31, 2015, respectively, is being amortized using the effective interest method over the life of the Term Loan.
As of September 30, 2016, the Company had $60.2 million, net of $14.8 million outstanding letters of credit, available for additional borrowing under the Revolving Facility (as defined below).
The approximate aggregate maturities of long-term debt, excluding the debt discount on the Term Loan, for each of the three years subsequent to September 30, 2016 are as follows (in thousands):
Trailing twelve months ending September 30,
Balance Due
2017
$
6,400

2018
6,400

2019
904,800

Total long-term debt, including current portion
$
917,600

Refinancing. On February 14, 2013 (the "Refinancing Closing Date"), FairPoint Communications refinanced its old credit agreement (the "Refinancing"). In connection with the Refinancing, FairPoint Communications (i) issued $300.0 million aggregate principal amount of its 8.75% senior secured notes due 2019 (the "Notes") in a private offering exempt from registration under the Securities Act pursuant to an indenture (the "Indenture") that FairPoint Communications entered into on the Refinancing Closing Date with certain of its subsidiaries that guarantee the indebtedness under the Credit Agreement (as defined herein) (the "Subsidiary Guarantors") and U.S. Bank National Association, as trustee and collateral agent, and (ii) entered into a credit agreement (the "Credit Agreement"), dated as of the Refinancing Closing Date, with the lenders party thereto from time to time and Morgan Stanley Senior Funding, Inc., as administrative agent and letter of credit issuer. The Credit Agreement provides for a $75.0 million revolving credit facility (the ''Revolving Facility''), which has a sub-facility providing for the issuance of up to $40.0 million in letters of credit, and a $640.0 million term loan facility (the ''Term Loan'' and, together with the Revolving Facility, the ''Credit Agreement Loans"). On the Refinancing Closing Date, FairPoint Communications used the proceeds of the Notes offering, together with $640.0 million of borrowings under the Term Loan and cash on hand to (i) repay principal of $946.5 million outstanding on the old term loan, plus approximately $7.7 million of accrued interest and (ii) pay approximately $32.6 million of fees, expenses and other costs related to the Refinancing.
The Credit Agreement. The principal amount of the Term Loan and commitments under the Revolving Facility may be increased by an aggregate amount of up to $200.0 million, subject to certain terms and conditions specified in the Credit Agreement. The Term Loan will mature on February 14, 2019 and the Revolving Facility will mature on February 14, 2018, subject in each case to extensions pursuant to the terms of the Credit Agreement.
Interest Rates and Fees. Interest on borrowings under the Credit Agreement Loans accrue at an annual rate equal to either a British Bankers Association London Inter-Bank Offered Rate ("LIBOR") or the base rate, in each case plus an applicable margin. LIBOR is a per annum rate for dollar deposits with an interest period of one, two, three or six months (at FairPoint Communication's election), subject to a minimum LIBOR floor of 1.25% for the Term Loan. The base rate is the per annum rate equal to the greatest of (x) the federal funds effective rate plus 0.50%, (y) the rate of interest publicly quoted from time to time by The Wall Street Journal as the United States ''Prime Rate'' and (z) LIBOR with an interest period of one month plus 1.00%. The applicable margin for the Term Loan is (a) 6.25% per annum with respect to term loans bearing interest based on LIBOR or (b) 5.25% per annum with respect to term loans bearing interest based on the base rate. The applicable interest rate for the Revolving Facility is, initially, (a) 5.50% with respect to revolving loans bearing interest based on LIBOR or (b) 4.50% per annum with respect to revolving loans

15

bearing interest based on the base rate, in each case subject to adjustment based on FairPoint Communication's consolidated total leverage ratio, as defined in the Credit Agreement. FairPoint Communications is required to pay a quarterly letter of credit fee on the average daily amount available to be drawn under letters of credit issued under the Revolving Facility equal to the applicable interest rate for revolving loans bearing interest based on LIBOR, plus a fronting fee of 0.125% per annum on the average daily amount available to be drawn under such letters of credit. In addition, FairPoint Communications is required to pay a quarterly commitment fee on the average daily unused portion of the New Revolving Facility, which is 0.50% initially, subject to reduction to 0.375% based on FairPoint Communication's consolidated total leverage ratio.
Security/Guarantors. All obligations under the Credit Agreement, together with certain designated hedging obligations and cash management obligations, are unconditionally guaranteed on a senior secured basis by certain subsidiaries of FairPoint Communications (the "Subsidiary Guarantors") and secured by a first-priority lien on substantially all personal property of FairPoint Communications and the Subsidiary Guarantors, subject to certain exclusions set forth in the related security documents, pari passu with the lien securing the obligations under the Notes.
Mandatory Repayments. FairPoint Communications is required to make quarterly repayments of the Term Loan in a principal amount of $1.6 million during the term of the Credit Agreement. In addition, mandatory repayments are required under the Credit Agreement with (i) a percentage, initially equal to 50% and subject to reduction to 25% based on FairPoint Communication's consolidated total leverage ratio, of FairPoint Communication's excess cash flow, as defined in the Credit Agreement, (ii) the net cash proceeds of certain asset dispositions, insurance proceeds and condemnation awards and (iii) issuances of debt not permitted to be incurred under the Credit Agreement. No premium is required in connection with prepayments.
Covenants. The Credit Agreement contains customary representations and warranties and affirmative and negative covenants for a transaction of this type, including two financial maintenance covenants: (i) a consolidated interest coverage ratio and (ii) a consolidated total leverage ratio. The Credit Agreement also contains a covenant limiting the amount of capital expenditures that FairPoint Communications and its subsidiaries may make in any fiscal year. As of September 30, 2016, FairPoint Communications was in compliance with all covenants under the Credit Agreement.
Events of Default. The Credit Agreement also contains customary events of default.
The Notes. On the Refinancing Closing Date, FairPoint Communications issued $300.0 million of the Notes pursuant to the Indenture in a private offering exempt from registration under the Securities Act.
The terms of the Notes are governed by the Indenture. The Notes are senior secured obligations of FairPoint Communications and are guaranteed by the Subsidiary Guarantors. The Notes and the guarantees thereof are secured by a first-priority lien on substantially all personal property of FairPoint Communications and the Subsidiary Guarantors, subject to certain exclusions set forth in the related security documents, pari passu with the lien securing the obligations under the Credit Agreement. The Notes will mature on August 15, 2019 and accrue interest at a rate of 8.75% per annum, which is payable semi-annually in arrears on February 15 and August 15 of each year.
Notes redeemed after February 15, 2016 and prior to February 15, 2017 may be redeemed at 104.375% of the aggregate principal amount; Notes redeemed on or after February 15, 2017 and prior to February 15, 2018 may be redeemed at 102.188% of the aggregate principal amount; and Notes redeemed on or after February 15, 2018 may be redeemed at their par value.
The holders of the Notes have the ability to require FairPoint Communications to repurchase all or any part of the Notes if FairPoint Communications experiences certain kinds of changes in control or engages in certain asset sales, in each case at the repurchase prices and subject to the terms and conditions set forth in the Indenture.
The Indenture contains certain covenants which are customary with respect to non-investment grade debt securities, including limitations on FairPoint Communication's ability to incur additional indebtedness, pay dividends on or make other distributions or repurchase FairPoint Communication's capital stock, make certain investments, enter into certain types of transactions with affiliates, create liens and sell certain assets or merge with or into other companies. These covenants are subject to a number of important limitations and exceptions. As of September 30, 2016, FairPoint Communications was in compliance with all covenants under the Indenture.
The Indenture also provides for customary events of default, including cross defaults to other specified debt of FairPoint Communications and certain of its subsidiaries.
(7) Interest Rate Swap Agreements
The Company uses interest rate swap agreements to protect the Company against future adverse fluctuations in interest rates by reducing its exposure to variability in cash flows relating to interest payments on a portion of its outstanding debt. The Company's interest rate swaps, which are designated as cash flow hedges, involve the receipt of variable amounts from counterparties in

16

exchange for the Company making fixed-rate payments over the effective term of the agreements without exchange of the underlying notional amount. The Company does not hold or issue any derivative financial instruments for speculative trading purposes.
In the third quarter of 2013, the Company entered into interest rate swap agreements with a combined notional amount of $170.0 million with three counterparties that are effective for a two year period. Such swaps became effective on September 30, 2015 and mature on September 30, 2017. Each respective swap agreement requires the Company to pay a fixed rate of 2.665% and provides that the Company will receive a variable rate based on the three month LIBOR rate subject to a minimum LIBOR floor of 1.25%. Amounts payable by or due to the Company are net settled with the respective counterparties on the last business day of each fiscal quarter.
The effect of the Company’s interest rate swap agreements on the condensed consolidated balance sheets at September 30, 2016 and December 31, 2015 is shown below (in thousands):
 
As of September 30, 2016
Derivatives designated as hedging instruments:
Balance Sheet Location
 
Fair Value
Interest rate swaps, Current
Other accrued liabilities
 
$
2,347

 
 
 
 
 
As of December 31, 2015
Derivatives designated as hedging instruments:
Balance Sheet Location
 
Fair Value
Interest rate swaps, Current
Other accrued liabilities
 
$
2,375

Interest rate swaps, Long-term
Other long-term liabilities
 
$
1,232

The gross effect of the Company’s interest rate swap agreements on the condensed consolidated statements of comprehensive income/(loss) for the three and nine months ended September 30, 2016 and 2015 is shown below (in thousands):
 
Amount Recognized in Interest Expense (Pre-Tax)
Amount of Loss/(Gain) Recognized in Other Comprehensive Income/(Loss) on Derivative (Effective Portion) (Pre-Tax)
 
Three Months Ended September 30, 2016
Three Months Ended September 30, 2015
Nine Months Ended September 30, 2016
Nine Months Ended September 30, 2015
Three Months Ended September 30, 2016
Three Months Ended September 30, 2015
Nine Months Ended September 30, 2016
Nine Months Ended September 30, 2015
Interest rate swaps
$
615

$
—

$
1,831

$
—

$
(594
)
$
460

$
(1,260
)
$
1,503


Amounts reported in accumulated other comprehensive income related to interest rate swaps will be reclassified to interest expense as interest payments are made on the Term Loan. The Company estimates that approximately $2.3 million will be reclassified as an increase to interest expense in the next 12 months.
Each interest rate swap agreement contains a provision whereby if the Company defaults on any of its indebtedness, the Company may also be declared in default under the interest rate swap agreements.
(8) Fair Value
In determining fair value, the Company uses a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1 -
Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2 -
Valuations based on quoted prices for similar instruments in active markets or quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3 -
Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
The Company's non-financial assets and liabilities, including its long-lived assets and indefinite-lived intangible assets, are measured and subsequently adjusted, if necessary, to fair value on a non-recurring basis. The Company periodically performs routine reviews of triggering events and/or an impairment test, as applicable. Based on these procedures, the Company did not require an adjustment to fair value to be recorded to these assets in the three months ended September 30, 2016 or 2015.
The Company's financial instruments, other than interest rate swap agreements and long-term debt, consist primarily of cash, restricted cash, accounts receivable and accounts payable. The carrying amounts of these financial instruments are estimated to

17

approximate fair value due to the relatively short period of time to maturity for these instruments. As of September 30, 2016, interest rate swap agreements are carried at their fair value and measured on a recurring basis as follows (in thousands):

 Fair Value Measurements Using

Level 1

Level 2

Level 3
Interest rate swaps, Current (a)
$
—


$
2,347


$
—

As of December 31, 2015, interest rate swap agreements are carried at their fair value and measured on a recurring basis as follows (in thousands):
 
 Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
Interest rate swaps, Current (a)
$
—

 
$
2,375

 
$
—

Interest rate swaps, Long-term (a)
$
—

 
$
1,232

 
$
—

(a)
The fair value is determined using valuation models which rely on the expected LIBOR based yield curve and estimates of counterparty and the Company’s non-performance risk.  Because each of these inputs are directly observable or can be corroborated by observable market data, the Company has categorized these interest rate swaps as Level 2 within the fair value hierarchy.
The estimated fair values of the Company's long-term debt as of September 30, 2016 and December 31, 2015 are as follows (in thousands):

September 30, 2016

December 31, 2015

Carrying Amount

Fair Value (a)

Carrying Amount

Fair Value (a)
Term Loan, due 2019 (b)
$
608,914


$
616,056


$
611,262


$
616,954

Notes, 8.75%, due 2019
300,000


307,500


300,000


295,500

Total
$
908,914

 
$
923,556

 
$
911,262

 
$
912,454

(a)
The Company estimated fair value based on market prices of the Company's debt securities at the balance sheet dates, which falls within Level 2 of the fair value hierarchy.
(b)
The carrying amount of the Term Loan is net of the unamortized discount of $8.7 million and $11.1 million as of September 30, 2016 and December 31, 2015, respectively.
(9) Employee Benefit Plans
The Company sponsors noncontributory qualified defined benefit pension plans ("qualified pension plans") and post-employment benefit plans which provide certain cash payments and medical, dental and life insurance benefits to eligible retired employees and their beneficiaries and covered dependents. The qualified pension plans and certain post-employment benefit plans were created as part of the acquisition of the Northern New England operations from Verizon and mirrored the prior Verizon plans.
Two of the Company's collective bargaining agreements in northern New England were ratified on February 22, 2015. The respective collective bargaining agreements expire in August 2018. Active represented employees as of February 22, 2015 are eligible for benefits in accordance with the respective plan documents and contractual obligations in the ratified collective bargaining agreements.
The remaining unrecognized prior service credit for the represented employees pension plan recorded in accumulated other comprehensive income of $37.1 million as of December 31, 2015 is being amortized over 10.82 years. As of December 31, 2015, $306.8 million of the remaining unrecognized net prior service credit and $81.9 million of the remaining unrecognized net actuarial loss for post-employment benefits recorded in accumulated other comprehensive income are being amortized in 2016.
The Company makes contributions to the qualified pension plans to meet minimum funding requirements under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and has the ability to elect to make additional discretionary contributions. The other post-employment benefit plans are unfunded and the Company funds the benefits that are paid. Annually, and as necessary, the Company remeasures the net liabilities of its qualified pension and other post-employment benefit plans.

18

Net Periodic Benefit Cost. The Company capitalizes a portion of net periodic benefit cost in conjunction with its use of internal labor resources utilized on capital projects. The Company recognized settlement charges in the qualified pension plan that covers non-represented employees of $0.5 million and $0.1 million for the three months ended September 30, 2016 and 2015, respectively and $0.5 million and $0.7 million for the nine months ended September 30, 2016 and 2015, respectively.  The settlements were incurred when the cumulative amount of lump sums paid to participants in the respective years exceeded the expected service and interest cost for the respective years. Components of the net periodic benefit cost related to the Company's qualified pension plans and other post-employment benefit plans for the three and nine months ended September 30, 2016 and 2015 are as follows (in thousands):
 
Three Months Ended September 30, 2016
 
Three Months Ended September 30, 2015
 
Qualified
Pension Plans
 
Post-
employment Benefit Plans
 
Qualified
Pension Plans
 
Post-
employment Benefit Plans
Service cost
$
1,847

 
$
9

 
$
1,653

 
$
62

Interest cost
3,719

 
929

 
3,702

 
1,005

Expected return on plan assets
(3,848
)
 
—

 
(3,688
)
 
—

Amortization of actuarial loss
1,343

 
18,118

 
1,570

 
32,775

Amortization of prior service cost
(760
)
 
(89,101
)
 
(863
)
 
(89,550
)
Plan curtailment
—

 
—

 
(4,207
)
 
—

Plan settlement
477

 
—

 
110

 
—

Net periodic benefit cost
2,778

 
(70,045
)
 
(1,723
)
 
(55,708
)
Less capitalized portion
(161
)
 
—

 
(137
)
 
—

Other post-employment benefit and pension expense
$
2,617

 
$
(70,045
)
 
$
(1,860
)
 
$
(55,708
)
 
Nine Months Ended September 30, 2016
 
Nine Months Ended September 30, 2015
 
Qualified
Pension Plans
 
Post-
employment Benefit Plans
 
Qualified
Pension Plans
 
Post-
employment Benefit Plans
Service cost
$
5,033

 
$
91

 
$
6,822

 
$
4,479

Interest cost
11,360

 
2,945

 
11,146

 
6,683

Expected return on plan assets
(11,516
)
 
—

 
(10,911
)
 
—

Amortization of actuarial loss
4,040

 
81,526

 
5,311

 
80,649

Amortization of prior service cost
(2,281
)
 
(265,377
)
 
(2,070
)
 
(215,076
)
Plan curtailment
—

 
—

 
(4,207
)
 
—

Plan settlement
477

 
—

 
717

 
—

Net periodic benefit cost
7,113

 
(180,815
)
 
6,808

 
(123,265
)
Less capitalized portion
(440
)
 
—

 
(469
)
 
—

Other post-employment benefit and pension expense
$
6,673

 
$
(180,815
)
 
$
6,339

 
$
(123,265
)
Return on Plan Assets. For the three months ended September 30, 2016 and 2015, the actual return on the pension plan assets were annualized gains/(losses) of approximately 16.1% and (5.6)%, respectively and 10.8% and (3.7)% for the nine months ended September 30, 2016 and 2015, respectively.
Contributions and Benefit Payments. During the nine months ended September 30, 2016, contributions of $11.9 million were made to the Company-sponsored qualified defined benefit pension plans and the Company funded benefit payments of $4.2 million under its post-employment benefit plans.
(10) Accumulated Other Comprehensive Income
The following table provides a reconciliation of adjustments reclassified from accumulated other comprehensive income to the condensed consolidated statement of operations (in thousands):

19

 
Three Months Ended September 30, 2016
 
Nine Months Ended September 30, 2016
Employee benefits:
 
 
 
Amortization of actuarial loss (.65 years to 11.47 years) (a)
$
19,461

 
$
85,566

Amortization of net prior service credit (.87 years to 23.91 years) (a)
(89,861
)
 
(267,658
)
Plan settlement (a)
477

 
477

Total employee benefits reclassified from accumulated other comprehensive income
(69,923
)

(181,615
)
Tax benefit
11,297

 
48,974

Total employee benefits reclassified from accumulated other comprehensive income, net
$
(58,626
)

$
(132,641
)
 
 
 
 
Interest rate swaps:
 
 
 
Interest rate swaps reclassified from accumulated other comprehensive income (b)
$
615

 
$
1,831

Tax expense
(248
)
 
(737
)
Total interest rate swaps reclassified from accumulated other comprehensive income, net
$
367

 
$
1,094

 
 
 
 
Total amounts reclassified from accumulated other comprehensive income, net
$
(58,259
)
 
$
(131,547
)
(a)
These accumulated other comprehensive income components are included in the computation of net periodic benefit cost. See note (9) "Employee Benefit Plans" for details.
(b)
These accumulated other comprehensive income components are included in interest expense. See note (7) "Interest Rate Swap Agreements" for details.
(11) Earnings Per Share
Basic earnings per share of the Company is computed by dividing net 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.
Weighted average number of common shares used for basic earnings per share excludes weighted average shares of non-vested restricted stock of 188,522 and 226,900 for the three months ended September 30, 2016 and 2015, respectively and 200,315 and 234,370 for the nine months ended September 30, 2016 and 2015, respectively. Non-vested restricted stock is included in common shares issued and outstanding in the condensed consolidated balance sheets.
Potentially dilutive shares exclude warrants and stock options in accordance with the treasury stock method primarily due to exercise prices exceeding the average market value.
The following table provides a reconciliation of the common shares used for basic earnings per share and diluted earnings per share:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016

2015
 
2016
 
2015
Weighted average number of common shares used for basic earnings per share
26,869,658

 
26,676,385

 
26,846,546

 
26,640,103

Effect of potential dilutive shares
214,517

 
327,448

 
194,475

 
312,193

Weighted average number of common shares and potential dilutive shares used for diluted earnings per share
27,084,175

 
27,003,833

 
27,041,021

 
26,952,296

Weighted average number of anti-dilutive shares outstanding at period-end that are excluded from the above reconciliation
4,531,200

 
4,146,782

 
5,134,417

 
4,148,613


20

(12) Stockholders' Deficit
At September 30, 2016, 37,500,000 shares of common stock were authorized and 27,073,540 shares of common stock (including shares of non-vested restricted stock) and 3,582,402 warrants, each eligible to purchase one share of common stock, were outstanding.
The initial exercise price applicable to the warrants is $48.81 per share of common stock. The exercise price applicable to the warrants is subject to adjustment upon the occurrence of certain events described in the warrant agreement. The warrants may be exercised at any time on or before January 24, 2018.
(13) Commitments and Contingencies
(a) Legal Proceedings
From time to time, the Company is involved in litigation and regulatory proceedings arising out of its operations. Management believes that the Company 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 the foregoing, the Company is a defendant in approximately 16 lawsuits filed by two long distance communications companies, who as plaintiffs have collectively filed over 60 lawsuits arising from switched access charges for calls originating and terminating within the same wireless major trading area. These cases have all been consolidated and transferred to federal district court (the "Court") in Dallas, Texas. The defendants filed joint motions to dismiss these actions. On November 17, 2015, the Court granted the defendants' motions dismissing the plaintiffs' federal law based claims with prejudice. The state law based claims were allowed to be amended and refiled. The Court denied the plaintiffs' request for an immediate appeal of the dismissal of the federal law based claims. Counterclaims against the plaintiffs for the failure to pay these access charges have been filed by the Company. The Company and some of the co-defendants have filed lawsuits against a third long distance communications company for the failure to pay this same type of access charge. These additional lawsuits have also been consolidated and transferred to the Court. Additional motions have been filed by the plaintiffs and defendants, which are still pending. At this time, an estimate of the impact, if any, of these claims cannot be made.
(b) Restricted Cash
As of September 30, 2016 and December 31, 2015, the Company had $0.7 million and $0.7 million, respectively, of restricted cash, which is restricted for regulatory purposes and is included in long-term restricted cash on the condensed consolidated balance sheets.


21

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with our condensed consolidated 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" contained in the 2015 Annual Report and "Cautionary Note Regarding Forward-Looking Statements" included elsewhere in this Quarterly Report. Our discussion and analysis of financial condition and results of operations are presented in the following sections:
•Overview
•Executive Summary
•Labor Matters
•Regulatory and Legislative
•Basis of Presentation
•Results of Operations
•Non-GAAP Financial Measures
•Liquidity and Capital Resources
•Off-Balance Sheet Arrangements
•Critical Accounting Policies and Estimates
•New Accounting Standards
Overview
We are a leading provider of advanced communications services to business, wholesale and residential customers within our service territories. We offer our customers a suite of advanced services including Ethernet, SIP-Trunking, hosted PBX, managed services, data center colocation services, high capacity data transport and other IP-based services over our fiber-based network, in addition to Internet access, HSD and local and long distance voice services. Our service territory spans 17 states where we are the incumbent communications provider primarily serving rural communities and small urban markets. Many of our LECs have served their respective communities for more than 80 years. As of September 30, 2016, we operated with approximately 310,000 broadband subscribers, approximately 15,400 Ethernet circuits and approximately 377,000 residential voice lines.
We own and operate an extensive fiber-based Ethernet network with more than 21,000 miles of fiber optic cable, including approximately 17,000 miles of fiber optic cable in Maine, New Hampshire and Vermont, giving us capacity to support more HSD services and extend our fiber reach into more communities across the region. The IP/Multiple Protocol Label Switched ("IP/MPLS") network architecture of our fiber-based network allows us to provide Ethernet, transport and other IP-based services with the highest level of reliability at a lower cost of service. This fiber-based Ethernet network also supplies critical infrastructure for wireless carriers serving the region as their bandwidth needs increase, driven by mobile data from smartphones, tablets and other wireless devices. As of September 30, 2016, we provide cellular transport, also known as backhaul, through over 1,900 mobile Ethernet backhaul connections. We have fiber connectivity to approximately 1,300 cellular communications towers in our service footprint.
Executive Summary
Our mission is to empower businesses, consumers and communities with advanced data, IT and voice services by leveraging our network, technology and operational expertise to exceed their expectations. Our vision includes operating and technology platforms that will meet our customers' technology needs by providing them with reliable and secure connections and ready access to what matters most to them.
Our executive management team is focused on utilizing our network assets, our outstanding operating platform and our proven ability to develop and deploy market-driven products to build brand awareness, aid in generating new revenue and sustain existing revenue. We will enhance our network to bring new services and more robust technologies to our markets, enable effective and secure technology to ensure our product and service offerings remain competitive, and provide excellent customer service to create a loyal customer base, all while maintaining a sharp focus on managing costs.
Our objective is to transform our revenue by continuing to add advanced data products and services such as Ethernet, high capacity data transport and other IP-based services over our fiber-based network in addition to HSD services, to minimize our

22

dependence on voice access lines. Communications companies, including us, continue to experience a decline in access lines due to increased competition from wireless carriers, cable television operators and CLECs and increased availability of alternative communications services, including wireless and voice over IP ("VoIP"). We will continue our efforts to retain customers to mitigate the loss of voice access lines through bundled packages, including video and other value added services. We believe access lines as a measure of the business are increasingly less meaningful measures of trend and are being replaced by revenue generating broadband subscribers and Ethernet circuits.
Over the past few years, we have made significant capital investments in our fiber-based Ethernet network to expand our business service offerings to meet the growing data needs of our customers and to increase broadband speeds and capacity in our consumer markets. We have also focused our sales and marketing efforts on these advanced data solutions. Specifically, within the last few years, we built and launched high capacity Ethernet services to allow us to meet the capacity needs of our business customers as well as supply high capacity infrastructure to our wholesale customers. In the past year, Ethernet demand has remained strong amid increased price pressure. We continue to see a market trend, largely led by cable companies, of reduced Ethernet prices to business and wholesale customers. We continue to see growth in Ethernet units and speeds amid declining prices in the market. Ethernet high-capacity transport data services are our flagship product and are laying the foundation not only for new business but also for additional IP-based advanced services in the future.
We believe that our extensive fiber network, with more than 21,000 miles of fiber optic cable, including approximately 17,000 miles of fiber optic cable in northern New England and approximately 1,300 cellular communications towers currently served with fiber, puts us in an excellent position to serve the cellular backhaul needs in our markets. We further believe the bandwidth needs of cellular backhaul will grow with the continued adoption of bandwidth-intensive technology. As a result, we expect to see wireless carriers developing new technologies as demand increases on existing fiber-connected towers, including the use of "small cell" architecture. By satisfying additional demand for bandwidth, both traditionally and through new and evolving technology, we expect to partially offset the decline we have seen, and expect to continue to see, in legacy wholesale offerings, including TDM transport services, DS1s, DS3s and wholesale switched access.
Coupled with recent regulatory reform in the states of Maine, New Hampshire and Vermont that will serve to promote fair competition among communications service providers in the region, we believe that there is a significant organic growth opportunity within the business and wholesale markets given our extensive fiber network and IP-based product suite, combined with our relative low market share in these areas.
Labor Matters
Two of our collective bargaining agreements in northern New England were ratified on February 22, 2015 by their respective unions. Members of these two labor unions initiated a work stoppage on October 17, 2014 and returned to work on February 25, 2015. The respective collective bargaining agreements expire in August 2018. For the three and nine months ended September 30, 2015, we recognized $0.2 million and $48.8 million of labor negotiation related expenses, respectively, primarily for contracted services, contingent workforce expenses (including training) and legal, communications and public relations expenses. See note (9) "Employee Benefit Plans" to our condensed consolidated financial statements in "Part I. Financial Information - Item 1. Financial Statements" included elsewhere in this Quarterly Report for further information as well as "Results of Operations" herein.
Regulatory and Legislative
We are generally subject to common carrier regulation primarily by federal and state governmental agencies. At the federal level, the FCC generally exercises jurisdiction over common carriers, such as us, to the extent those carriers provide, originate or terminate interstate or international communications. State regulatory commissions generally exercise jurisdiction over common carriers to the extent those carriers provide, originate or terminate intrastate telecommunications. In addition, pursuant to the Telecommunications Act of 1996, which amended the Communications Act of 1934 (as amended, the "Communications Act"), state and federal regulators share responsibility for implementing and enforcing the domestic pro-competitive policies introduced by that legislation.
We are required to comply with the Communications Act, which requires, among other things, that common carriers offer communications services at just and reasonable rates and on terms and conditions that are not unreasonably discriminatory. The Communications Act also contains requirements intended to promote competition in the provision of local services and lead to deregulation as markets become more competitive.
For a detailed description of the federal and state regulatory environment in which we operate and the FCC's recently promulgated CAF/ICC Order and other recent regulatory changes, as well as the effects and potential effects of such regulation on us, see "Item 1. Business—Regulatory and Legislative" in our 2015 Annual Report. The impact of these changes for 2016 is described further below. However, in the long run, we are uncertain of the ultimate impact as federal and state regulations continue to evolve.

23

Overview of FCC CAF/ICC Order to Reform Universal Service and Intercarrier Compensation
On March 16, 2010, the FCC submitted the National Broadband Plan ("NBP") to the United States Congress. The NBP is a plan to bring high-speed Internet services to the entire country, including remote and high-cost areas. In accordance with the NBP, the FCC commenced several rulemakings that concern, among other things, reforming high-cost and low-income programs to promote universal service to make those funds more efficient while promoting broadband communications in areas that otherwise would be unserved and to address changes to interstate access charges and other forms of ICC.
On November 18, 2011, the FCC released its comprehensive landmark order to modify the nationwide system of universal support and the ICC system (the "CAF/ICC Order"). In this order, the FCC replaced all existing USF for price cap carriers with its CAF. The intent of CAF is to bring high-speed affordable broadband services to all Americans. The CAF/ICC Order fundamentally reforms the ICC process that governs how communications companies bill one another for exchanging traffic, gradually phasing down these charges.
In conjunction with the 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 competitive bidding rules, (vi) remote areas funding and (vii) IP to IP interconnection issues. In its Order released December 18, 2014, the FCC stated its intention to extend its offer of CAF Phase II support to price cap carriers in early 2015 and to implement the CAF Phase II program for price cap carriers during 2015. On April 29, 2015, the FCC released a Public Notice extending the offer of CAF Phase II funding to price cap carriers, as described in more detail below. As of September 30, 2016, the FCC has issued competitive bidding guidelines but has not finalized rules for the competitive bidding process. It is not known how these rules may impact us.
CAF Phase I and Phase II Support. Pursuant to the CAF/ICC Order, beginning in 2012, we started receiving monthly CAF Phase I frozen support, which is based on and equal to all forms of USF high-cost support we received during 2011. This support was considered transitional funding while the FCC developed its CAF Phase II program. FCC rules required that if we continued receiving CAF Phase I frozen support beyond 2012, which we have, we did have specific broadband spending obligations starting in 2013, which we have met. According to the FCC rules, in 2013, we were required to spend, and did 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." According to the FCC rules, in 2014, we were required to spend, and did spend, two-thirds 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." For the CAF Phase I frozen support we receive, this spending obligation increased to 100% of the frozen support received in 2015 and subsequent years 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." We were in compliance with the 2015 spending obligation and continue to be in compliance for 2016.
In a Public Notice released on April 29, 2015, the FCC extended an offer of CAF Phase II support to price cap carriers to fund the building and operation of voice and broadband-capable services in their service territories. In this Public Notice, the FCC offered $38.2 million of annual funding to us for six years in return for providing broadband services to a specified number of locations in eligible census blocks specified by the FCC. This compares with $39.3 million in annual CAF Phase I frozen funding that we received in 2014. On August 18, 2015, we announced our acceptance of $37.4 million in annual CAF Phase II support, which was effective retroactive to January 1, 2015. This includes support in all our operating states except Colorado and Kansas where we declined the offered CAF Phase II support.
The specific obligations associated with CAF Phase II funding include the obligation to serve approximately 105,000 locations in approximately 16,000 census blocks by December 31, 2020 (with interim milestones of 40%, 60% and 80% completion by December 2017, 2018 and 2019, respectively); to provide broadband service to those locations with speeds of 10 megabits per second down and 1 megabit per second up; to achieve latency of less than 100 milliseconds; to provide data of at least 100 gigabytes per month; and to offer pricing reasonably comparable to pricing in urban areas.
For the two states where we declined CAF Phase II support, we will continue to receive CAF Phase I frozen support until such time as the FCC conducts a competitive bidding process. The FCC intends to conduct the competitive bidding process during 2016 and has determined that price cap carriers declining CAF Phase II support can participate in the competitive bidding process along with any other interested carriers. As of September 30, 2016, the FCC has not yet adopted final rules governing the competitive bidding process.
In addition, there is a three year transition for price cap carriers that choose to accept model-based support in states where the accepted support is less than the CAF Phase I frozen support. The determination of transition funding is made at the state level. From January 1, 2015 to July 31, 2015, and as prescribed by the FCC, such carriers received 100% of the difference between the annualized amount of CAF Phase II support that they accepted and the amount of CAF Phase I frozen support that they received

24

in 2014. Beginning August 1, 2015, transitional funding stepped down to 75% of that amount. On August 1, 2016 transitional funding steps down to 50% of the difference and on August 1, 2017 transitional funding steps down to 25% of the difference. Transitional support will terminate as of July 31, 2018, after which time carriers will receive only CAF Phase II support.
As prescribed by the FCC’s transitional plan and the transitional funding calculation, we have recognized or expect to recognize transitional funding, in addition to the $37.4 million annual CAF Phase II funding, based on the following schedule:

•
January 1, 2015 - July 31, 2015: $824,000 per month in transitional funding (recognized in the third quarter of 2015)
•
August 1, 2015 - July 31, 2016: $618,000 per month in transitional funding
•
August 1, 2016 - July 31, 2017: $412,000 per month in transitional funding
•
August 1, 2017 - July 31, 2018: $206,000 per month in transitional funding
•
August 1, 2018 and after: no transitional funding
FCC Rules for ICC Process. The CAF/ICC Order reformed rules associated with local, state toll and interstate toll traffic exchanged among communications carriers including ILECs, CLECs, cable companies, wireless carriers and VoIP providers. The revised rules, the majority of which were effective beginning July 1, 2012, establish separate rules for price cap carriers and rate-of-return carriers. Although the FCC order treats our rate-of-return carriers (including companies operating under average schedules) as price cap carriers for CAF funding, it treats them as rate-of-return carriers for purposes of ICC reform. For both price cap and rate-of-return carriers, the FCC established a multi-year transition of terminating traffic compensation to "bill and keep", or zero compensation. For both price cap and rate-of-return carriers, the FCC required carriers to establish fiscal year 2011 ("FY2011") baseline compensation, which was the amount of relevant compensation billed during the period beginning October 1, 2010 and ending September 30, 2011, and collected by March 31, 2012. This FY2011 revenue was used as a starting point for revenue for the transitional period, which is six years for price cap operations and nine years for rate-of-return operations. For each FairPoint ILEC, the FY2011 baseline revenue is reduced by a specified percent during each year of the transition, resulting in a target revenue for each tariff year of the transitional period. At the same time, the FCC rules require reductions in ICC rates for specified services and jurisdictions. As the recoverable revenue declines and the rates decline, any target revenue which will not be covered by ICC revenue can be recovered, in part, from end users through an access recovery charge ("ARC"). Price cap ILECs are permitted to implement monthly end user ARCs with five annual increases of no more than $0.50 for residential/single-line business consumers, for a total monthly ARC of no more than $2.50 in the fifth year; and no more than $1.00 (per month) per line for multi-line business customers, for a total of $5.00 (per month) per line in the fifth year, provided that: (1) any such residential increases would not result in regulated residential end user rates that exceed the $30.00 residential rate ceiling; and (2) any multi-line business customer's total subscriber line charge ("SLC") plus ARC does not exceed $12.20. Rate-of-return ILECs are permitted to implement monthly end user ARCs with six annual increases of no more than $0.50 (per month) for residential/single-line business consumers, for a total ARC of no more than $3.00 in the sixth year; and no more than $1.00 (per month) per line for multi-line business customers for a total of $6.00 (per month) per line in the sixth year, provided that: (1) such increases would not result in regulated residential end user rates that exceed the $30.00 Residential Rate Ceiling; and (2) any multi-line business customer's total SLC plus ARC does not exceed $12.20. We began billing the ARC charges for our price cap and rate of return companies in July 2012 as outlined by the rules above. If the combination of ICC and ARC revenue is not sufficient to cover the targeted revenue, then additional funding will be provided by the CAF in certain circumstances, though there is no guarantee that the ILEC will be made whole.
Regulatory and Legislative for Vermont
Effective April 6, 2016, we entered into an Incentive Regulation Plan ("IRP") governing our Vermont service territory within our northern New England operations. The IRP includes retail service quality reporting requirements. The new IRP is similar to our previous IRP which expired on April 5, 2016 and we believe the IRP has allowed our northern New England operations' retail rates in Vermont to compete with those competitive carriers under a relatively level regulatory scheme, while preserving certain regulatory protections for consumers seeking basic voice services in areas where competition may not be adequate. This IRP allows the same regulatory flexibility in our Telecom Group retail operations in Vermont and is scheduled to expire on December 31, 2019.  On August 10, 2015, we concluded a retail service quality investigation by entering into a Memorandum of Understanding ("MOU") between us and the Vermont Department of Public Service ("VDPS"), which was approved by the Vermont Public Service Board ("VPSB") on December 18, 2015. In accordance with the August 10, 2015 MOU and the December 18, 2015 VPSB Order, on February 16, 2016 we requested the VPSB to open a new investigation to evaluate the appropriateness of certain service quality metrics and to determine whether customer service quality metrics should apply in the future to customers with access to an alternative telecommunications provider. This investigation is in progress and any outcome from this investigation will be incorporated into the new IRP, if necessary.
On July 15, 2016, the VPSB opened a rulemaking proceeding to consider amending VPSB Rule 3.706(D)(1) regarding the rental calculation for pole attachments. The rulemaking is in its early stages, and neither a schedule nor scope of this rulemaking has been determined.

25

Regulatory and Legislative for Maine
Under the Maine Public Utilities Commission ("MPUC") rules (Chapter 201), which went into effect August 1, 2014, the MPUC may open an investigation regarding the failure to meet any of the established SQI benchmarks and has the authority to impose penalties. The MPUC opened an investigation into our failure to meet some third quarter 2014 SQI benchmarks and subsequently opened an investigation into the fourth quarter of 2014 and then with respect to each of the quarterly periods in 2015. On March 29, 2016, the MPUC consolidated the investigations of the six quarters into one investigation. On September 14, 2016, a hearing examiner for the MPUC issued a report recommending that the MPUC find that FairPoint had failed to meet SQI benchmarks for the period under review and impose a $500,000 penalty as allowed by statute, and provided until October 7, 2016 for comments or exceptions to be filed by interested parties. This recommendation does not constitute MPUC action. The Company promptly filed a motion to implement adjudicatory procedures prior to entry of any final order. As of October 4, 2016, the Hearing Examiner has suspended the deadline for filing comments or exceptions to the examiner’s report until further notice, pending responses to and resolution of FairPoint’s request for additional adjudicatory procedures.
During 2014, we filed a rate case with the MPUC seeking increases in rates for POLR customers and seeking Maine Universal Service Fund ("MUSF") support for unrecovered costs associated with our obligation to provide POLR service to high cost areas. The MPUC allowed increases to the end user POLR rates, but denied MUSF support to us.
On April 13, 2016, LD 466, An Act to Increase Competition and Ensure Robust information and Telecommunications Market, was passed into law and became effective on July 28, 2016. The new law removes the regulation on POLR service in the most competitive municipalities on a phased in approach. The seven largest municipalities will be deregulated effective August 28, 2016 (the POLR rate is grandfathered for one year), followed by five communities every six months until reaching a total of 22. These 22 municipalities represent approximately one third of the population and POLR customers. LD 466 provides a path forward for additional municipalities to be deregulated upon petitioning the PUC. Also included in the law is the removal of POLR tariffs statewide.
Reporting of service quality will be required only in the areas of the state where POLR is still required and will be filed and treated as confidential. The number of SQI reporting metrics has been reduced and the benchmarks are less stringent than under previous Commission rules. The Commission is empowered to investigate failures to meet a service quality requirement. If the Commission concludes after investigation that the failure to meet a service quality requirement is due to factors within the control of the price cap ILEC, the Commission shall, by order, impose such steps as the Commission determines necessary to meet the requirement. If the provider fails to comply with the order, the Commission shall impose a penalty in an amount sufficient to ensure compliance with that order.
Basis of Presentation
We view our business of providing data, voice and communications services to business, wholesale and residential customers as one reportable segment.

26

Results of Operations
The following table sets forth our consolidated operating results reflected in our condensed consolidated statements of operations (in thousands, except for operating metrics):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Voice services
$
74,916

 
$
81,247

 
$
225,918

 
$
246,011

Access
59,030

 
64,304

 
181,542

 
194,552

Data and Internet services
47,479

 
46,018

 
138,198

 
133,744

Regulatory funding
12,691

 
17,927

 
38,925

 
40,675

Other
13,025

 
12,073

 
35,931

 
34,659

Total revenues
207,141

 
221,569

 
620,514

 
649,641

Operating expenses:
 
 
 
 
 
 

Cost of services and sales, excluding depreciation and amortization
95,830

 
100,718

 
294,171

 
333,067

Other post-employment benefit and pension expense
(67,428
)
 
(57,568
)
 
(174,142
)
 
(116,926
)
Selling, general and administrative expense, excluding depreciation and amortization
45,838

 
49,688

 
145,614

 
158,968

Depreciation and amortization
54,918

 
56,296

 
167,661

 
167,420

Reorganization related expense
—

 
6

 
—

 
33

Total operating expenses
129,158

 
149,140

 
433,304

 
542,562

Income from operations
77,983

 
72,429

 
187,210

 
107,079

Other income/(expense):
 
 
 
 
 
 
 
Interest expense
(20,698
)
 
(20,186
)
 
(61,891
)
 
(59,979
)
Other, net
91

 
153

 
344

 
425

Total other expense
(20,607
)
 
(20,033
)
 
(61,547
)
 
(59,554
)
Income before income taxes
57,376

 
52,396

 
125,663

 
47,525

Income tax (expense)/benefit
(17,169
)
 
658

 
(37,573
)
 
581

Net income
$
40,207

 
$
53,054

 
$
88,090

 
$
48,106

 
 
 
 
 
 
 
 
 
As of September 30,
 
 
 
 
Select Operating Metrics:
2016
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
Broadband subscribers
309,547

 
313,982

 
 
 
 
 
 
 
 
 
 
 
 
Ethernet circuits
15,444

 
14,100

 
 
 
 
 
 
 
 
 
 
 
 
Residential voice lines
377,403

 
423,667

 
 
 
 
Voice Services Revenues
We receive revenues through the provision of local calling services to business and residential customers, generally for a fixed monthly charge and service charges for special calling features. We also generate revenue through long distance services within our service areas on our network and through resale agreements with national interexchange carriers. For the periods ended September 30, 2016 and 2015, residential voice lines in service decreased 10.9% and 12.4% year-over-year, respectively, which directly impacts local voice services revenues and our opportunity to provide long distance services to our customers, resulting in a decrease of minutes of use. The decline in residential voice lines in 2015 may have been partially due to the impact of the strike on service levels. Evolving competition, including reduced voice pricing from cable competitors as well as cellular adoption, has contributed to the decrease in residential voice lines. There are very few areas within our northern New England footprint where cable voice service and cellular are not alternatives for our customers. In addition, business voice services revenue also declined in part because of reduced access lines as businesses shifted from traditional voice products to our Ethernet or other advanced services. We expect the trend of decline in voice lines in service, and thereby a decline in aggregate voice services

27

revenue, to continue as customers continue to turn to the use of alternative communication services as a result of ever-increasing competition.
Effective June 1, 2015, the Performance Assurance Plan ("PAP") that was previously adopted in each of the states of Maine, New Hampshire and Vermont was retired and we began measuring and reporting certain wholesale local service performance results pursuant to the terms of a simplified measurement plan. The new plan, called the Wholesale Performance Plan ("WPP"), was developed collaboratively with CLECs over several years and was approved by the Maine, New Hampshire and Vermont regulatory commissions. Under the WPP, we are subject to significantly fewer performance criteria and our annual service penalty exposure was reduced from a maximum of $87 million to a maximum of $12 million ($4.75 million in each of Maine and New Hampshire and $2.5 million in Vermont). A portion of the service credits resulting from these commitments were recorded to voice services revenues; however, the majority were recorded to access revenues.
The following table reflects the primary drivers of year-over-year changes in voice services revenues (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Local voice services revenues, excluding:
 
$
(4.9
)
 
 
$
(16.1
)

Long distance services revenues
 
(1.4
)
 
 
(4.2
)
 
Decrease in accrual of PAP/WPP service credits (1)
 
—

 
 
0.2

 
Total change in voice services revenues
 
$
(6.3
)
(8
)%
 
$
(20.1
)
(8
)%
(1)
There was an insignificant amount of PAP/WPP service credits during the three months ended September 30, 2016 and 2015 and the nine months ended September 30, 2016. During the nine months ended September 30, 2015, PAP/WPP service credits resulted in a decrease of $0.2 million to local voice services revenues.
Access Revenues
We receive revenues for the provision of network access through carrier Ethernet based products and legacy access products to end user customers and long distance and other competing carriers who use our local exchange facilities to provide interexchange services to their customers. Network access can be provided to carriers and end users that buy dedicated local and interexchange capacity to support their private networks (i.e. special access) or it can be derived from fixed and usage-based charges paid by carriers for access to our local network (i.e. switched access).
Carriers are migrating from legacy access products, such as DS1, DS3, frame relay, ATM and private line, to carrier Ethernet based products. At September 30, 2016 and September 30, 2015, wholesale Ethernet circuits grew by 13.9% and 26.8% year-over-year, respectively. These carrier Ethernet based products are more sustainable, but generally, at the outset, have lower average revenue per user of broadband capacity than the legacy products they are replacing, resulting in a decline in access revenues. We expect the decline in access revenues to continue with customer migration. This decline in legacy access products is expected to be partially offset with the increasing need for bandwidth, including cellular backhaul and demand for carrier Ethernet based products, both of which are expected to increase over time. With the entry of cable competitors into the wholesale market, we continue to experience an increased decline in access lines due to this new competition. However, our extensive fiber-based Ethernet network with more than 21,000 miles of fiber optic cable (of which approximately 17,000 miles are in Maine, New Hampshire and Vermont), including approximately 1,300 cellular communications towers currently served with fiber, puts us in a position to grow our revenue base as demand for cellular backhaul and other Ethernet services expands. We also construct new fiber routes to cellular communications towers when the business case presents itself. Additionally, we continue to evaluate new services to provide to carriers, including the selective use of dark fiber and professional services, to continue to meet carrier access needs.
As described above, we adopted a separate PAP for certain services provided on a wholesale basis to CLECs in each of the states of Maine, New Hampshire and Vermont, pursuant to which we are required to issue service credits in the event we are unable to meet the provisions of the respective PAP. These PAPs were retired effective June 1, 2015 and replaced with the WPP. Our maximum exposure to wholesale service credits has been reduced through the implementation of the WPP. The service credits are allocated to access revenues or voice services revenues based on services provided to the wholesale carrier.
In June 2014, Maine established a new POLR SQI standard, which may subject us to future SQI penalties.

28

The following table reflects the primary drivers of year-over-year changes in access revenues (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Carrier Ethernet services (1)
 
$
0.1

 
 
$
1.8

 
Legacy access services (2)
 
(5.4
)
 
 
(15.7
)
 
Decrease in accrual of PAP/WPP service credits (3)
 
—

 
 
0.9

 
Total change in access revenues
 
$
(5.3
)
(8
)%
 
$
(13.0
)
(7
)%
(1)
We offer carrier Ethernet services throughout our market to our business and wholesale customers, which include Ethernet virtual circuit technology for cellular backhaul. As of September 30, 2016, we provide cellular transport on our fiber-based Ethernet network through over 1,900 fiber-to-the-tower connections compared to over 1,900 as of September 30, 2015.
(2)
Legacy access services include products such as DS1, DS3, frame relay, ATM and private line.
(3)
During the three months ended September 30, 2016 and 2015, PAP/WPP service credits resulted in an increase of $0.1 million and a decrease of $0.1 million to access revenues, respectively. During the nine months ended September 30, 2016 and 2015, PAP/WPP service credits resulted in a decrease of $0.1 million and $1.0 million to access revenues, respectively.
Data and Internet Services Revenues
We receive revenues from monthly recurring charges for the provision of data and Internet services to residential and business customers through DSL technology, fiber-to-the-home technology, retail Ethernet, Internet dial-up, high speed cable modem and wireless broadband.
We have invested in our broadband network to extend the reach and capacity of the network to customers who did not previously have access to data and Internet products and to offer more competitive services to existing customers, including retail Ethernet products. At September 30, 2016 and September 30, 2015, retail Ethernet circuits grew by 4.0% and 14.2% year-over-year, respectively. Our broadband subscribers decreased 1.4% and 4.2% year-over-year at September 30, 2016 and September 30, 2015, respectively, which directly impacts data and Internet services revenues. We expect to continue our investment in our broadband network to further grow data and Internet services revenues in the coming years.
The following table reflects the primary drivers of year-over-year changes in data and Internet services revenues (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Retail Ethernet services (1)
 
$
0.1

 
 
$
0.5

 
Other data and Internet technology based services (2)
 
1.4

 
 
4.0

 
Total change in data and Internet services revenues
 
$
1.5

3
%
 
$
4.5

3
%
(1)
Retail Ethernet services revenue is comprised of data services provided through E-LAN, E-LINE and E-DIA technology on our fiber-based Ethernet network. We recognized $10.9 million and $10.8 million for the three months ended September 30, 2016 and 2015, respectively, and $32.0 million and $31.5 million for the nine months ended September 30, 2016 and 2015, respectively, of retail Ethernet services revenues.
(2)
Includes all other services such as DSL, dial-up, high speed cable modem and wireless broadband.
Regulatory Funding Revenues
We receive certain federal and state government funding that we classify as regulatory funding, which is further described in “Regulatory and Legislative” herein, including: CAF Phase II support effective January 1, 2015 to build and operate broadband services; CAF Phase II transition funding; CAF Phase I frozen support (for Kansas and Colorado until a reverse auction is completed); CAF funding under the CAF/ICC Order; and universal service fund support from certain states in which we operate. We recognized $12.7 million and $17.9 million for the three months ended September 30, 2016 and 2015, respectively and $38.9 million and $40.7 million for the nine months ended September 30, 2016 and 2015, respectively, of regulatory funding revenues. The year-over-year changes are primarily due to the timing of CAF Phase II transitional revenue. CAF Phase II support revenue does not include any funding for Colorado and Kansas. We expect the amount of regulatory funding revenue to decline as the amount of CAF Phase II transition funding decreases in 2016 and is phased out through 2018.

29

Other Services Revenues 
We receive revenues from other services, including special purpose projects on behalf of third parties, video services (including cable television and video-over-DSL), billing and collection, directory services, the sale and maintenance of customer premise equipment and certain other miscellaneous revenues. Other services revenues also include revenue we receive from late payment charges to end users and interexchange carriers. Due to the composition of other services revenues, it is difficult to predict future trends.
The following table reflects the primary drivers of year-over-year changes in other services revenues (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Special purpose projects (1)
 
$
—

 
 
$
0.2

 
Late payment fees (2)
 
(0.1
)
 
 
0.4

 
Other (3)
 
1.1

 
 
0.7

 
Total change in other services revenues
 
$
1.0

8
%
 
$
1.3

4
%
(1)
Special purpose projects are completed on behalf of third party requests.
(2)
Late payment fees are related to customers who have not paid their bills in a timely manner.
(3)
Other revenues were primarily attributable to revenue from value added reseller of unified communications, data networking and cabling infrastructure solutions in addition to fluctuations in directory services, billing and collections and in various other miscellaneous services revenues.
Supplementary revenue information. In addition to the revenue information discussed above, we are providing the following additional strategic revenue categorization information. Management believes that providing this additional revenue information will afford better visibility into our revenue trends as a result of product and service evolution within our industry. Management believes these metrics will enhance investors' ability to evaluate our business and assist investors in their understanding of the changing composition of our revenue (in millions).

30

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Growth (1)
 
 
 
 
 
 
 
Broadband (1a)
$
36.0

 
$
34.9

 
$
104.8

 
$
101.7

Ethernet (1b)
24.9

 
24.8

 
73.4

 
71.1

Hosted and Advanced Services (1c)
4.7

 
3.6

 
12.6

 
9.7

Subtotal Growth
65.6

 
63.3

 
190.8

 
182.5

Growth as a % of Total Revenue
31.7
%
 
28.6
%
 
30.7
%
 
28.1
%
 
 
 
 
 
 
 
 
Convertible (2)
 
 
 
 
 
 
 
Non-Ethernet Special Access (2a)
16.0

 
19.6

 
50.9

 
62.0

Business Voice (2b)
29.5

 
31.2

 
89.9

 
96.7

Other Convertible (2c)
5.0

 
6.0

 
15.4

 
18.4

Subtotal Convertible
50.5

 
56.8

 
156.2

 
177.1

Convertible as a % of Total Revenue
24.4
%
 
25.6
%
 
25.2
%
 
27.3
%
 
 
 
 
 
 
 
 
Legacy (3)
 
 
 
 
 
 
 
Residential Voice (3a)
53.9

 
57.7

 
161.2

 
172.2

Switched Access and Other (3b)
15.3

 
17.6

 
49.8

 
56.6

Subtotal Legacy
69.2

 
75.3

 
211.0

 
228.8

Legacy as a % of Total Revenue
33.4
%
 
34.0
%
 
34.0
%
 
35.2
%
 
 
 
 
 
 
 
 
Regulatory funding (4)
12.7

 
17.9

 
38.9

 
40.6

Regulatory funding as a % of Total Revenue
6.1
%
 
8.1
%
 
6.3
%
 
6.3
%
 
 
 
 
 
 
 
 
Miscellaneous (5)
9.1

 
8.3

 
23.6

 
20.6

Miscellaneous as a % of Total Revenue
4.4
%
 
3.7
%
 
3.8
%
 
3.1
%
 
 
 
 
 
 
 
 
Total Revenue
$
207.1

 
$
221.6

 
$
620.5

 
$
649.6


(1) Growth revenue is comprised of products and services that are generally viewed as in-demand by communications consumers over the medium- to long-term and are expected to increase over time.
a) Broadband revenue is comprised of both residential and business customers delivered through DSL, ADSL, VDSL or other similar services.
b) Ethernet revenue includes Ethernet over copper ("EOC") or Ethernet over fiber ("EOF") services delivered to end-users or to wholesalers, who then sell to their end-users.
c) Hosted and Advanced Services includes VoIP and other digital voice services including unified messaging and other IP features as well as revenue generated from our various advanced services including our value added reseller of unified communications, data networking and cabling infrastructure solutions, the next-generation emergency 9-1-1 contracts in several of our service territories as well as data center and managed services.
(2) Convertible revenues are revenues that could move from TDM-based technologies to Ethernet or other advanced services.
a) Non-Ethernet Special Access includes high-capacity circuits. The revenues are primarily comprised of business revenue from T1's, DS3's and SONET products.
b) Business Voice is traditional voice, long distance, ISDN and Centrex services for a business customer.
c) Other Convertible primarily includes Unbundled Network Element ("UNE"), Asynchronous Transfer Mode ("ATM"), Frame Relay, ISDN, Analog Private Line and Internet services such as dial-up.
(3) Legacy revenues are TDM-based voice related consumer revenue largely related to residential customers.
a) Residential Voice is comprised of TDM voice services to residential customers.
b) Switched Access and Other primarily includes Switched Transport, Local Switching, NECA pooling elements and colocation of miscellaneous equipment.
(4) Refer to the definition of "Regulatory Funding Revenues" above.
(5) Miscellaneous is comprised of special purpose projects, late payment fees from our customers and pole rental revenues among other various service revenues.



31

The primary drivers of the year-over-year changes in the strategic revenue categorization for the three months ended September 30, 2016 compared to the three months ended September 30, 2015 (dollars in millions) were:

•
Growth revenue increased by $2.3 million as we experienced growth in broadband revenue from speed upgrades and rate increases, which are described further above, as well as hosted and advanced services revenue, compared to the prior year.
•
Convertible revenue decreased by $6.3 million as customers continued to migrate from non-Ethernet circuits and businesses shifted from traditional voice products to VoIP and hosted products.
•
Legacy revenue decreased by $6.1 million resulting from a decline in voice access lines and legacy switched access revenue versus a year ago.
•
Regulatory funding revenue decreased by $5.2 million primarily due to the timing of CAF Phase II transitional revenue. The third quarter of 2015 included a year-to-date true-up of transitional revenue following our August 2015 acceptance of CAF Phase II funding.
•
Miscellaneous revenue increased by $0.8 million due to revenue assurance activities.
The primary drivers of the year-over-year changes in the strategic revenue categorization for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 (dollars in millions) were:

•
Growth revenue increased by $8.3 million due to growth in broadband revenue and Ethernet revenue, which are described further above, as well as increased hosted and advanced services revenue due to customer growth.
•
Convertible revenue decreased by $20.9 million as customers continued to migrate from non-Ethernet circuits and businesses shifted from traditional voice products to VoIP and hosted products.
•
Legacy revenue decreased by $17.8 million resulting from a decline in voice access lines and legacy switched access revenue versus the same period in 2015.
•
Regulatory funding revenue decreased by $1.7 million primarily due to the timing of CAF Phase II transitional revenue.
•
Miscellaneous revenue increased by $3.0 million due to lower PAP/WPP service credits, revenue assurance activities, higher late payment fees and higher special purpose projects.
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, but excluding the net periodic benefit cost of other post-employment benefit plans and qualified pension plans), 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 expenses. We expect the cost of services and sales to fluctuate with revenue and decrease due to lower employee expenses and lower labor negotiation related expense as a result of the collective bargaining agreements described in “Labor Matters” herein.
The following table reflects the primary drivers of year-over-year changes in cost of services and sales (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Employee expense (1)
 
$
(3.0
)
 
 
$
3.4

 
Labor negotiation related expense (2)
 
(0.1
)
 
 
(40.3
)
 
Severance expense (3)
 
0.5

 
 
(1.9
)
 
Other (4)
 
(2.3
)
 
 
(0.1
)
 
Total change in cost of services and sales
 
$
(4.9
)
(5
)%
 
$
(38.9
)
(12
)%
(1)
We recognized $39.4 million and $42.4 million for the three months ended September 30, 2016 and 2015, respectively, and $124.8 million and $121.4 million for the nine months ended September 30, 2016 and 2015, respectively, of employee expense as cost of services and sales. The decrease for the three months ended September 30, 2016 compared to the comparable period of 2015 is primarily due to a reduction in headcount and a lower bonus accrual. The increase for the nine months ended September 30, 2016 compared to the comparable period of 2015 is primarily due to the work stoppage described in "Labor Matters" herein partially offset by a reduction in headcount and a lower bonus accrual.
(2)
Labor negotiation related expense is related primarily to contracted services incurred during the three and nine months ended September 30, 2015 as a result of the work stoppage described in "Labor Matters" herein.

32

(3)
We recognized $0.1 million and $(0.4) million for the three months ended September 30, 2016 and 2015 and $0.8 million and $2.7 million for the nine months ended September 30, 2016 and 2015, respectively, of severance expense attributed to the reduction in our workforce.
(4)
Other cost of services and sales has decreased primarily due to lower back-office expenses.
Other Post-Employment Benefit and Pension Expense
We expect other post-employment benefit and pension expense to decrease in 2016 compared to 2015 as we continue to recognize a net benefit for the elimination of other post-employment benefits for active represented employees as a result of the collective bargaining agreements described in “Labor Matters” herein. As described further in note (9) "Employee Benefit Plans" to our condensed consolidated financial statements in "Part I. Financial Information - Item 1. Financial Statements" included elsewhere in this Quarterly Report, we expect to recognize a net benefit of approximately $42.3 million for other post-employment benefits expense and pension expense in the fourth quarter of 2016 from amortization of prior service credits and actuarial losses, absent any future events that require a remeasurement. Changes in discount rates and assumptions may impact the expense. We expect other post-employment benefits expense to increase since the prior service credit was fully amortized during the nine months ended September 30, 2016.
The following table reflects the primary drivers of year-over-year changes in other post-employment benefit and pension expense (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Other post-employment benefits expense (1)
 
$
(14.3
)
 
 
$
(57.6
)
 
Pension expense (2)
 
4.4

 
 
0.4

 
Total change in other post-employment benefit and pension expense
 
$
(9.9
)
17
%
 
$
(57.2
)
49
%
(1)
The decrease in the net periodic benefit cost for the three months ended September 30, 2016 compared to the comparable period of 2015 for our other post-employment benefit plans is primarily attributable to lower amortization of the net actuarial loss of $14.7 million in the third quarter of 2016 partially offset by lower amortization of the net prior service credits of $0.5 million compared to the comparable period of 2015. The decrease in the net periodic benefit cost for the nine months ended September 30, 2016 compared to the comparable period of 2015 for our other post-employment benefit plans is primarily attributable to the additional amortization of the net prior service credits of $50.3 million as well as decreases in service and interest costs resulting from the lower projected benefit obligation.
(2)
The increase in the net periodic benefit cost for the three months ended September 30, 2016 compared to the comparable period of 2015 for our qualified pension plans is primarily attributable to a plan curtailment in the third quarter of 2015. The increase in the net periodic benefit cost for the nine months ended September 30, 2016 compared to the comparable period of 2015 for our qualified pension plans is primarily attributable to a plan curtailment in the third quarter of 2015 partially offset by a decrease in service cost from the reduction in the projected benefit obligation and lower amortization of actuarial losses.

33

Selling, General and Administrative Expense
Selling, general and administrative ("SG&A") expense includes salaries and wages and benefits (including stock based compensation, but excluding the net periodic benefit cost of other post-employment benefit plans and qualified pension plans) 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. We expect SG&A expense to decrease primarily due to lower employee expenses and lower labor negotiation related expense as a result of the collective bargaining agreements described in “Labor Matters” herein.
The following table reflects the primary drivers of year-over-year changes in SG&A expense (dollars in millions):
 
 
Three Months Ended September 30, 2016 vs. September 30, 2015
 
Nine Months Ended September 30, 2016 vs. September 30, 2015
 
 
Increase (Decrease)
%
 
Increase (Decrease)
%
Employee expense (1)
 
$
(3.6
)
 
 
(1.7
)
 
Labor negotiation related expense (2)
 
(0.1
)
 
 
(7.8
)
 
Operating taxes (3)
 
2.2

 
 
0.9

 
Bad debt expense (4)
 
(1.1
)
 
 
(6.3
)
 
Severance expense (5)
 
(0.3
)
 
 
(0.6
)
 
Other (6)
 
(1.0
)
 
 
2.1

 
Total change in SG&A expense
 
$
(3.9
)
(8
)%
 
$
(13.4
)
(8
)%
(1)
We recognized $23.9 million and $27.5 million for the three months ended September 30, 2016 and 2015, respectively, and $78.1 million and $79.8 million for the nine months ended September 30, 2016 and 2015, respectively, of employee expense in SG&A expense. The decrease for the three months ended September 30, 2016 compared to the comparable period of 2015 is primarily due to a reduction in headcount and a lower bonus accrual. The decrease for the nine months ended September 30, 2016 compared to the comparable period of 2015 is primarily due to a reduction in headcount and a lower bonus accrual partially offset by the work stoppage described in "Labor Matters" herein.
(2)
Labor negotiation related expense is primarily related to contingent workforce expenses as well as communications and public relations, legal and training expenses incurred during the third quarter of 2015 and the nine months ended September 30, 2015.
(3)
The three and nine months ended September 30, 2015 includes an operating tax settlement.
(4)
We recognized $0.4 million and $1.5 million for the three months ended September 30, 2016 and 2015, respectively, and $(0.7) million and $5.6 million for the nine months ended September 30, 2016 and 2015, respectively, of bad debt expense. Bad debt expense was lower for the three and nine months ended September 30, 2016 compared to the comparable periods of 2015 due to increased recoveries and overall decreased aging of receivables. The nine months ended September 30, 2016 also includes nonrecurring write-off recoveries.
(5)
We recognized $0.3 million for the three months ended September 30, 2015 and $0.7 million and $1.3 million for the nine months ended September 30, 2016 and 2015, respectively, of severance expense attributed to the reduction in our workforce. There was no severance expense during the three months ended September 30, 2016.
(6)
The change in other expenses for the three and nine months ended September 30, 2016 compared to the comparable periods of 2015 was primarily due to the timing of spending for contracted services and advertising costs.
Depreciation and Amortization
Depreciation and amortization includes depreciation of our communications network and equipment and amortization of intangible assets. We require significant capital expenditures to maintain, upgrade and enhance our network facilities and operations. We expect our capital expenditures and depreciation expense to remain consistent in the coming years. We expect amortization expense to remain consistent throughout the remainder of our intangible assets' useful lives.
We recognized $52.1 million and $53.5 million for the three months ended September 30, 2016 and 2015, respectively, and $159.4 million and $159.0 million for the nine months ended September 30, 2016 and 2015, respectively, of depreciation expense. We recognized $2.8 million of amortization expense in each of the quarters ended September 30, 2016 and 2015, respectively and $8.3 million in each of the nine months ended September 30, 2016 and 2015, respectively.

34

Interest Expense
The following table reflects a summary of interest expense (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Credit Agreement Loans (as defined hereinafter)
 
$
12.2

 
$
12.4

 
$
36.5

 
$
36.8

Notes (as defined hereinafter)
 
6.6

 
6.6

 
19.7

 
19.7

Amortization of debt issue costs
 
0.3

 
0.3

 
0.9

 
0.9

Amortization of debt discount
 
0.8

 
0.8

 
2.5

 
2.3

Interest rate swap agreements
 
0.6

 
—

 
1.8

 
—

Other interest expense
 
0.1

 
0.1

 
0.5

 
0.3

Total interest expense
 
$
20.6

 
$
20.2

 
$
61.9

 
$
60.0

Interest expense increased $0.4 million (2%) in the three months ended September 30, 2016 as compared to the same period in 2015 and increased $1.9 million (3%) in the nine months ended September 30, 2016 as compared to the same period in 2015.
On February 14, 2013, we issued $300.0 million aggregate principal amount of the Notes and entered into the Credit Agreement Loans, which include the $640.0 million Term Loan outstanding and the undrawn $75.0 million Revolving Facility (as defined in "—Liquidity and Capital Resources—Debt". The Notes accrue interest at a rate of 8.75% per annum. Interest on borrowings under the Credit Agreement Loans accrues at an annual rate equal to either LIBOR or the base rate, in each case plus an applicable margin. In addition, the Term Loan was issued at a $19.4 million discount, which is being amortized using the effective interest method. As of September 30, 2016, we were party to interest rate swap agreements, which became effective as of September 30, 2015.
For further information regarding the Credit Agreement Loans and the Notes, see "—Liquidity and Capital Resources—Debt" herein and note (6) "Long-term Debt" and note (7) "Interest Rate Swap Agreements" to our condensed consolidated financial statements in "Part I. Financial Information - Item 1. Financial Statements" included elsewhere in this Quarterly Report.
Income Taxes
The Company recorded tax expense on the pre-tax net income for the three months ended September 30, 2016 of $17.2 million and tax benefit on the pre-tax net income for the three months ended September 30, 2015 of $0.7 million, which equates to an effective tax rate of 29.9% and (1.2)%, respectively, by applying the projected full year effective rate. Tax expense of $37.6 million on the pre-tax net income for the nine months ended September 30, 2016 and tax benefit of $0.6 million on the pre-tax net income for the nine months ended September 30, 2015 equates to an effective tax rate of 29.9% and (1.2)%, respectively, by applying the projected full year effective rate. For 2016, the projected annual effective tax rate differs from the 35% federal statutory rate primarily due to a decrease in the valuation allowance offset by tax expense related to state taxes. For 2015, the projected annual effective tax rate differs from the 35% federal statutory rate primarily due to a decrease in the valuation allowance offset by tax expense related to state taxes.
Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The table below includes certain non-GAAP financial measures and the adjustments to the most directly comparable GAAP measure used to determine the non-GAAP measures. Management believes that the non-GAAP measures may be useful to investors in understanding period-to-period operating performance and in identifying historical and prospective trends that may not otherwise be apparent when relying solely on GAAP financial measures. In addition, management believes the non-GAAP measures are useful for investors because they enable them to view performance in a manner similar to the method used by the Company's management. Management believes earnings before interest, taxes, depreciation and amortization ("EBITDA"), as adjusted to exclude the effect of items that are further described below ("Adjusted EBITDA"), provides a useful measure of covenant compliance and Unlevered Free Cash Flow (as defined below) may be useful to investors in assessing the Company's ability to generate cash and meet its debt service requirements. The maintenance covenants contained in the Company's credit facility are based on Consolidated EBITDA, which is consistent with the calculation of Adjusted EBITDA below.
For purposes of calculating Adjusted EBITDA (in accordance with the definition of Consolidated EBITDA in our Credit Agreement), costs, expenses and charges related to the renegotiation of labor contracts including, but not limited to, expenses for third-party vendors and losses related to disruption of operations (including any associated penalties under service level agreements and regulatory performance plans) are permitted to be excluded from the calculation. We believe this includes, among others, the costs paid to third-parties for the contingent workforce and service quality penalties due to the disruption of operations. On October

35

17, 2014, two of our labor unions in northern New England initiated a work stoppage and returned to work on February 25, 2015. As a result, significant union employee and vehicle and other related expenses related to northern New England were not incurred between January 1, 2015 and February 24, 2015 (the "work stoppage period"). Therefore, to assist in the evaluation of the Company's operating performance without the impact of the work stoppage, we estimated the union employee and vehicle and other related expenses using historical data for the work stoppage period that we believe would have been incurred absent the work stoppage ("Estimated Avoided Costs"). Estimated Avoided Costs is a pro forma estimate only. Actual costs absent the strike may have been different. In the first quarter of 2015, had our incumbent workforce been in place, actual labor costs during the work stoppage period may have been higher than the $27 million recorded as Estimated Avoided Costs due to significant winter storm activity that increased our service demands; however, those incremental storm-related costs would have been an allowed add back to Adjusted EBITDA under the Credit Agreement. Estimated employee expenses avoided during the work stoppage period include salaries and wages, bonus, overtime, capitalized labor, benefits, payroll taxes, travel expenses and other employee related costs based on a trailing 12-month average calculated per striking employee per day during the work stoppage period less any actual expense incurred. Estimated vehicle fuel and maintenance expense savings, which resulted from the contingent workforce utilizing their own vehicles, for the work stoppage period were estimated based on a trailing 12-month average of historical costs less actual expense incurred. Management believes "Adjusted EBITDA minus Estimated Avoided Costs" and "Unlevered Free Cash Flow minus Estimated Avoided Costs" may be useful to investors in understanding our operating performance without the impact of the two unions' work stoppage in northern New England as described elsewhere in this Quarterly Report.
The non-GAAP financial measures, as used herein, are not necessarily comparable to similarly titled measures of other companies. Furthermore, these non-GAAP measures have limitations as analytical tools and should not be considered in isolation from, or as an alternative to, net income or loss, operating income, cash flow or other combined income or cash flow data prepared in accordance with GAAP. Because of these limitations, Adjusted EBITDA, Adjusted EBITDA minus Estimated Avoided Costs, Unlevered Free Cash Flow and Unlevered Free Cash Flow minus Estimated Avoided Costs should not be considered as measures of discretionary cash available to invest in business growth or reduce indebtedness. The Company compensates for these limitations by relying primarily on its GAAP results and using the non-GAAP measures only supplementally.
A reconciliation of Adjusted EBITDA, Adjusted EBITDA minus Estimated Avoided Costs, Unlevered Free Cash Flow and Unlevered Free Cash Flow minus Estimated Avoided Costs to net income is provided in the table below (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
40,207

 
$
53,054

 
$
88,090

 
$
48,106

Income tax (expense)/benefit
17,169

 
(658
)
 
37,573

 
(581
)
Interest expense
20,698

 
20,186

 
61,891

 
59,979

Depreciation and amortization
54,918

 
56,296

 
167,661

 
167,420

Pension expense (1a)
2,617

 
(1,861
)
 
6,673

 
6,338

Other post-employment benefits expense (1a)
(70,045
)
 
(55,707
)
 
(180,815
)
 
(123,263
)
Compensated absences (1b)
(2,838
)
 
(6,084
)
 
1,223

 
2,350

Severance
73

 
(106
)
 
1,570

 
4,012

Reorganization costs (1c)
—

 
5

 
—

 
32

Other non-cash items, net (1d)
1,083

 
1,441

 
5,178

 
5,954

Labor negotiation related expense (1e)
—

 
160

 
—

 
48,838

All other allowed adjustments, net (1e)
7

 
(35
)
 
(121
)
 
(150
)
Adjusted EBITDA (1)
63,889

 
66,691

 
188,923

 
219,035

Estimated Avoided Costs (2)
—

 
—

 
—

 
(27,000
)
Adjusted EBITDA minus Estimated Avoided Costs
$
63,889

 
$
66,691

 
$
188,923

 
$
192,035

 
 
 
 
 
 
 
 
Adjusted EBITDA (1)
$
63,889

 
$
66,691

 
$
188,923

 
$
219,035

Pension contributions
(7,632
)
 
(3,958
)
 
(11,190
)
 
(8,340
)
Other post-employment benefits payments
(1,614
)
 
(1,457
)
 
(4,210
)
 
(4,092
)
Capital expenditures
(30,221
)
 
(28,193
)
 
(82,906
)
 
(82,921
)
Unlevered Free Cash Flow (3)
24,422

 
33,083

 
90,617

 
123,682

Estimated Avoided Costs (2)
—

 
—

 
—

 
(27,000
)
Unlevered Free Cash Flow minus Estimated Avoided Costs
$
24,422

 
$
33,083

 
$
90,617

 
$
96,682


36


(1) For purposes of calculating Adjusted EBITDA (in accordance with the definition of Consolidated EBITDA in the Company's credit agreement), the Company adjusts net income for interest, income taxes, depreciation and amortization, in addition to:
(a)the add-back of aggregate pension and other post-employment benefits expense,
(b)the add-back (or subtraction) of the adjustment to the compensated absences accrual to eliminate the impact of changes in the accrual,
(c)the add-back of costs related to the reorganization, including professional fees for advisors and consultants,
(d)the add-back of other non-cash items, including stock compensation expense, except to the extent they will require a cash payment in a future period, and
(e)the add-back (or subtraction) of other items, including facility and office closures, labor negotiation related expenses (including losses related to disruption of operations), non-cash gains/losses and non-operating dividend and interest income and other extraordinary gains/losses.
(2) See paragraphs preceding the table above for information regarding the calculation of this non-GAAP measure.
(3) Unlevered Free Cash Flow refers to Adjusted EBITDA (calculated in accordance with the definition of Consolidated EBITDA in the Company's credit agreement) minus capital expenditures, cash pension contributions and other post-employment benefits cash payments.
Liquidity and Capital Resources
Overview
Our current and future liquidity is dependent upon our operating results. We expect that our primary sources of liquidity will be net cash provided by operating activities, cash on hand and funds available under the Revolving Facility. Our short-term and long-term liquidity needs arise primarily 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 plans and payments under our other post-employment benefit plans.
Based on our current and anticipated levels of operations and conditions in our markets, we believe that cash on hand, the Revolving Facility and net cash provided by operating activities will enable us to meet our working capital, capital expenditure, debt service, acquisitions and other funding requirements for at least the next 12 months. We may from time to time seek to purchase our outstanding debt and/or equity through cash purchases in the open market, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. We were in compliance with the maintenance covenants contained in the Credit Agreement (as defined below) as of September 30, 2016 and expect to remain in compliance for the remainder of 2016.
Cash Flows
Cash at September 30, 2016 totaled $33.1 million compared to $26.6 million at December 31, 2015, excluding restricted cash of $0.7 million and $0.7 million, respectively. During the nine months ended September 30, 2016, the change in net cash was due to cash flows from operations of $96.4 million, which included outflows due to the scheduled semi-annual interest payments on the Notes and the payment of 2015 annual performance bonuses, partially offset by cash outflows for capital expenditures of $82.9 million. During the nine months ended September 30, 2015, the change in net cash was due to cash outflows for capital expenditures of $82.9 million, partially offset by cash flows from operations of $67.5 million, which included outflows due to the scheduled semi-annual interest payments on the Notes and the payment of 2014 annual performance bonuses.

37

The following table sets forth our condensed consolidated cash flow results reflected in our condensed consolidated statements of cash flows (in millions):
 
Nine Months Ended September 30,
Net cash flows provided by (used in):
2016
 
2015
Operating activities
$
96.4

 
$
67.5

Investing activities
(84.4
)
 
(82.7
)
Financing activities
(5.5
)
 
(5.4
)
Net increase/(decrease) in cash
$
6.5

 
$
(20.6
)
Operating activities. Net cash provided by operating activities is our primary source of funds. Net cash provided by operating activities for the nine months ended September 30, 2016 increased $28.9 million compared to the same period in 2015, primarily due to lower labor negotiation related expenses and lower operating expenses, partially offset by a reduction in revenues.
Investing activities. Net cash used in investing activities for the nine months ended September 30, 2016 increased $1.7 million compared to the same period in 2015. Capital expenditures were $82.9 million and $82.9 million for the nine months ended September 30, 2016 and 2015, respectively. In addition, we completed an immaterial business acquisition during the nine months ended September 30, 2016.
Financing activities. Net cash used in financing activities for the nine months ended September 30, 2016 increased $0.1 million compared to the same period in 2015.
Pension Contributions and Post-Employment Benefit Plan Expenditures
During the nine months ended September 30, 2016, we contributed $11.9 million to our Company-sponsored qualified defined benefit pension plans and funded benefit payments of $4.2 million under our post-employment benefit plans.
On August 8, 2014, the Highway and Transportation Funding Act (the "Act") was signed into law. This Act contained a pension funding stabilization provision which allows pension plan sponsors to use higher discount rate assumptions when determining the funded status and, accordingly, the funding obligations for its pension plans. The provisions of the Act will result in our 2016 minimum required pension plan contribution being lower than it would have been in the absence of this stabilization provision. 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 minimum required contributions will be less than they otherwise would have been without the passage of this Act and will increase in the medium to long-term.
In 2016, we expect our aggregate cash pension contributions and cash post-employment benefit payments to be approximately $22 million. In 2017, we expect our aggregate cash pension contributions and cash other post-employment benefit plan payments to be approximately $24 million. See "Item 1A. Risk Factors in our 2015 Annual Report —The amount we are required to contribute to our qualified pension plans and post-employment benefit plans is impacted by several factors that are beyond our control and changes in those factors may result in a significant increase in future cash contributions."
Capital Expenditures
We require significant capital expenditures to maintain, upgrade and enhance our network facilities and operations. During the nine months ended September 30, 2016, our net capital expenditures totaled $82.9 million, compared to $82.9 million during the comparable period in 2015. We anticipate that we will fund future capital expenditures through cash flows from operations and cash on hand. In 2016, capital expenditures are expected to be approximately $115 million. Our capital expenditures in the coming years will be impacted by our CAF Phase II elections as further described in "Regulatory and Legislative" herein.
Debt
February 2013 Refinancing. On February 14, 2013 (the "Refinancing Closing Date"), we completed the refinancing of our old credit agreement (the "Refinancing"). In connection with the Refinancing, we (i) issued $300.0 million aggregate principal amount of 8.75% senior secured notes due in 2019 (the "Notes") in a private offering exempt from registration under the Securities Act pursuant to an indenture that we entered into on the Refinancing Closing Date (the "Indenture") and (ii) entered into a new credit agreement (the "Credit Agreement"), dated as of the Refinancing Closing Date. The Credit Agreement provides for a $75.0 million revolving credit facility, including a sub-facility for the issuance of up to $40.0 million in letters of credit (the "Revolving Facility"), and a $640.0 million term loan facility (the "Term Loan" and, together with the Revolving Facility, the " Credit Agreement Loans"). On the Refinancing Closing Date, we used the proceeds of the Notes offering, together with $640.0 million of borrowings

38

under the Term Loan and cash on hand to (i) repay principal of $946.5 million outstanding on the old term loan, plus approximately $7.7 million of accrued interest and (ii) pay approximately $32.6 million of fees, expenses and other costs related to the Refinancing.
The Credit Agreement. In connection with the Refinancing, we entered into the Credit Agreement, which provides for the $75.0 million Revolving Facility, including a sub-facility for the issuance of up to $40.0 million in letters of credit, and the $640.0 million Term Loan. The principal amount of the Term Loan and commitments under the Revolving Facility may be increased by an aggregate amount up to $200.0 million, subject to certain terms and conditions specified in the Credit Agreement. The Term Loan will mature on February 14, 2019 and the Revolving Facility will mature on February 14, 2018, subject in each case to extensions pursuant to the terms of the Credit Agreement. As of September 30, 2016, we had $60.2 million, net of $14.8 million of outstanding letters of credit, available for borrowing under the Revolving Facility.
Interest Rates and Fees. Interest on borrowings under the Credit Agreement Loans accrue at an annual rate equal to either LIBOR or the base rate, in each case plus an applicable margin. LIBOR is the per annum rate for an interest period of one, two, three or six months (at our election), with a minimum LIBOR floor of 1.25% for the Term Loan. The base rate for any date is the per annum rate equal to the greatest of (x) the federal funds effective rate plus 0.50%, (y) the rate of interest publicly quoted from time to time by The Wall Street Journal as the United States ''Prime Rate'' and (z) LIBOR with an interest period of one month plus 1.00%. The applicable margin for the Term Loan is (a) 6.25% per annum with respect to term loans bearing interest based on LIBOR or (b) 5.25% per annum with respect to term loans bearing interest based on the base rate. The applicable rate for the Revolving Facility is, initially, (a) 5.50% with respect to revolving loans bearing interest based on LIBOR or (b) 4.50% per annum with respect to revolving loans bearing interest based on the base rate, in each case subject to adjustment based on our consolidated total leverage ratio, as defined in the Credit Agreement. We are required to pay a quarterly letter of credit fee on the average daily amount available to be drawn under letters of credit issued under the Revolving Facility equal to the applicable rate for revolving loans bearing interest based on LIBOR plus a fronting fee of 0.125% per annum on the average daily amount available to be drawn under such letters of credit. In addition, we are required to pay a quarterly commitment fee on the average daily unused portion of the Revolving Facility, which is 0.50% initially, subject to reduction to 0.375% based on our consolidated total leverage ratio. In the third quarter of 2013, we entered into interest rate swap agreements with a combined notional amount of $170.0 million with three counterparties that are effective for a two year period beginning on September 30, 2015 and maturing on September 30, 2017. Each respective swap agreement requires us to pay a fixed rate of 2.665% and provides that we will receive a variable rate based on the three month LIBOR rate, subject to a minimum LIBOR floor of 1.25%. Amounts payable by or due to us will be net settled with the respective counterparties on the last business day of each fiscal quarter, commencing December 31, 2015. For further information regarding these agreements, see note (7) "Interest Rate Swap Agreements" to our condensed consolidated financial statements in “Item 1. Financial Statements” included elsewhere in this Quarterly Report.
Security/Guarantors. All obligations under the Credit Agreement, together with certain designated hedging obligations and cash management obligations, are unconditionally guaranteed on a senior secured basis by certain subsidiaries of FairPoint Communications (the "Subsidiary Guarantors") and secured by a first-priority lien on substantially all personal property of FairPoint Communications and the Subsidiary Guarantors, subject to certain exclusions set forth in the related security documents, pari passu with the lien securing the obligations under the Notes.
Mandatory Repayments. We are required to make quarterly repayments of the Term Loan in a principal amount equal to $1.6 million during the term of the Credit Agreement, with such repayments being reduced based on the application of mandatory and optional prepayments of the Term Loan made from time to time. In addition, mandatory repayments are due under the Credit Agreement with (i) a percentage, initially equal to 50% and subject to reduction to 25% in subsequent fiscal years based on our consolidated total leverage ratio, of our excess cash flow, as defined in the Credit Agreement, (ii) the net cash proceeds of certain asset dispositions, insurance proceeds and condemnation awards and (iii) issuances of debt not permitted to be incurred under the Credit Agreement. No premium is required in connection with prepayments. We did not make any optional or mandatory prepayments under the Credit Agreement, excluding mandatory quarterly repayments discussed above, during the nine months ended September 30, 2016.
Covenants. The Credit Agreement contains customary representations and warranties and affirmative and negative covenants for a transaction of this type, including two financial maintenance covenants: (i) a consolidated interest coverage ratio and (ii) a consolidated total leverage ratio. The Credit Agreement also contains a covenant limiting the maximum amount of capital expenditures that we and our subsidiaries may make in any fiscal year.
Events of Default. The Credit Agreement also contains customary events of default.
The Notes. On the Refinancing Closing Date, we issued $300.0 million in aggregate principal amount of the Notes pursuant to the Indenture in a private offering exempt from registration under the Securities Act.
The terms of the Notes are governed by the Indenture. The Notes are senior secured obligations of FairPoint Communications and are guaranteed by the Subsidiary Guarantors. The Notes and the guarantees thereof are secured by a first-priority lien on

39

substantially all personal property of FairPoint Communications and the Subsidiary Guarantors, subject to certain exclusions set forth in the related security documents, pari passu with the lien securing the obligations under the Credit Agreement. The Notes will mature on August 15, 2019 and accrue interest at a rate of 8.75% per annum, which is payable semi-annually in arrears on February 15 and August 15 of each year.
Notes redeemed after February 15, 2016 and prior to February 15, 2017 may be redeemed at 104.375% of the aggregate principal amount; Notes redeemed on or after February 15, 2017 and prior to February 15, 2018 may be redeemed at 102.188% of the aggregate principal amount; and Notes redeemed on or after February 15, 2018 may be redeemed at their par value.
The holders of the Notes have the ability to require us to repurchase all or any part of the Notes if we experience certain kinds of changes in control or engage in certain asset sales, in each case at the repurchase prices and subject to the terms and conditions set forth in the Indenture.
The Indenture contains certain covenants which are customary with respect to non-investment grade debt securities, including limitations on our ability to incur additional indebtedness, pay dividends on or make other distributions or repurchase our capital stock, make certain investments, enter into certain types of transactions with affiliates, create liens and sell certain assets or merge with or into other companies. These covenants are subject to a number of important limitations and exceptions.
The Indenture also provides for customary events of default, including cross defaults to other specified debt of FairPoint Communications and certain of its subsidiaries.
Off-Balance Sheet Arrangements
As of September 30, 2016 and December 31, 2015 we had $14.8 million and $14.2 million, respectively, in outstanding letters of credit under the Revolving Facility and $4.1 million and $4.0 million, respectively, of surety bonds. We do not have any other off-balance sheet arrangements, other than our operating lease obligations, which are not reflected on our balance sheets.
Critical Accounting Policies and Estimates
Our critical accounting policies are as follows:
•Revenue recognition;
•Allowance for doubtful accounts;
•Accounting for qualified pension and other post-employment benefits;
•Accounting for income taxes;
•Depreciation of property, plant and equipment;
•Stock-based compensation; and
•Valuation of long-lived assets and indefinite-lived intangible assets.
There have been no material changes to our critical accounting policies described in the 2015 Annual Report.
New Accounting Standards
For details of recent Accounting Standards Updates and our evaluation of their adoption on our condensed consolidated financial statements, see note (3) "Recent Accounting Pronouncements" to our condensed consolidated financial statements in "Part I. Financial Information - Item I. Financial Statements" included elsewhere in this Quarterly Report.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
We are exposed to market risk in the normal course of our business operations due to ongoing investing and funding activities, including those associated with the variable interest rate in our Credit Agreement and our qualified pension plan assets. Market risk refers to the potential change in fair value of a financial instrument as a result of fluctuations in interest rates, fixed income securities and equity prices. We do not hold or issue derivative instruments, derivative commodity instruments or other financial instruments for trading or speculative purposes. Our primary market risk exposures are interest rate risk and investment risk as follows:
Interest Rate Risk - Long-Term Debt. We are exposed to interest rate risk, primarily as it relates to the variable interest rates we are charged under credit agreements to which we are a party. As of September 30, 2016, our interest rate risk exposure was attributable to the Credit Agreement, which includes the Term Loan and the Revolving Facility, each of which is subject to variable interest rates. We use our variable rate debt, in addition to fixed rate debt, to finance our operations and capital expenditures and

40

believe it is prudent to limit the variability of our interest payments on our variable rate debt. To meet this objective, from time to time, we may enter into interest rate derivative agreements to manage fluctuations in cash flows resulting from interest rate risk.
As of September 30, 2016, we were party to interest rate swap agreements in connection with borrowings under the Credit Agreement covering a combined notional amount of $170.0 million. These agreements became effective on September 30, 2015. Accordingly, on September 30, 2016, only $447.6 million principal balance of the Term Loan was subject to interest rate risk. Interest payments on the Term Loan are subject to a LIBOR floor of 1.25%. As a result, while LIBOR remains below 1.25%, we incur interest at above market rates. To the extent that LIBOR remains below 1.25%, we are buffered from the full financial impact of interest rate risk; however, as LIBOR rises, a change in interest rates could materially affect our condensed consolidated financial statements. For example, with the principal balance of the Term Loan as of September 30, 2016, a 1% increase in the interest rate above the LIBOR floor of 1.25% would unfavorably impact interest expense and pre-tax earnings by approximately $4.5 million on an annual basis.
For further information regarding the Credit Agreement, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources," and note (6) "Long-Term Debt" and note (7) "Interest Rate Swap Agreements" to our condensed consolidated financial statements in "Part I. Financial Information - Item 1. Financial Statements" included elsewhere in this Quarterly Report.
Interest Rate and Investment Risk - Pension Plans. We are exposed to risks related to the fair value of our pension plan assets and the discount rate used to value our pension plan liabilities and the amount of lump-sum payments made to certain participants. Our pension plan assets consist of a portfolio of fixed income securities, equity securities and cash. Changes in the fair value of this portfolio can occur due to changes in interest rates and the general economy. In addition, interest rates are a primary factor in the determination of our actuarially determined liabilities and, if applicable, the amount of the accrued benefit paid in the form of a lump-sum to a pension plan retiree when requested. Our qualified pension plan assets have historically funded a large portion of the benefits paid under our qualified pension plans. Lower returns on plan assets, decreases in the fair value of plan assets and lower discount rates could negatively impact the funded status of our pension plans and we may be required to make larger contributions to our pension plans than currently anticipated. Due to uncertainties in the pension funding calculation, the amount and timing of pension contributions are unknown other than as disclosed in this Quarterly Report. For activity in our qualified pension plan assets, see note (9) "Employee Benefit Plans" to our condensed consolidated financial statements in "Part I. Financial Information - Item 1. Financial Statements" included elsewhere in this Quarterly Report.
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 Rule 13a-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 effective as of September 30, 2016.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2016 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
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. For details of legal proceedings, see note (13) "Commitments and Contingencies" to our condensed consolidated financial statements in "Item 1. Financial Statements" included elsewhere in this Quarterly Report. 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.

41

Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in "Item 1A. Risk Factors" of the 2015 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.

42

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, 2016
By:
/s/ Karen D. Turner
 
 
Name:
Karen D. Turner
 
 
Title:
Executive Vice President and Chief Financial Officer
 
 
 
(duly authorized officer and principal financial officer)


43

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)
4.4
 
Indenture, dated as February 14, 2013, among FairPoint Communications, Inc., the Subsidiary Guarantors and U.S. Bank National Association, as trustee.(4)
4.5
 
First Supplemental Indenture, dated as of September 16, 2013, among FairPoint Communications, Inc., the Subsidiary Guarantors and U.S. Bank National Association, as trustee.(5)
10.1
 
Employment Agreement, made and entered into as of September 6, 2016, by and between FairPoint and Bruce F. Metge.†*
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.‡
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.

(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 February 14, 2013.
(5)
Incorporated by reference to the Quarterly Report on Form 10-Q of FairPoint for the period ended September 30, 2013.

44

FAIRPOINT COMMUNICATIONS INC Reports

Also read