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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-29279
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CHOICE ONE COMMUNICATIONS INC.
(Exact name of Registrant as specified in its charter)
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Delaware 16-1550742
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Chestnut Street, Suite 600, Rochester, NY 14604
(Address of principal executive office) (Zip Code)
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(585) 246-4231
(Registrant's telephone number, including area code)
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Securities registered pursuant to
Section 12(b) of the Act: None
Securities registered pursuant to
Section 12(g) of the Act: Common Stock, $.01 par value
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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Aggregate market value of all Common Stock held by non-affiliates as of June 28,
2002, was $8,739,125.
43,585,603 shares of $.01 par value Common Stock were issued and outstanding as
of March 1, 2003.
The Index of Exhibits filed with this Report begins at page 85.
Documents Incorporated by Reference:
Certain portions of our definitive proxy statement to be distributed in
connection with the 2003 annual meeting of stockholders are incorporated by
reference into Part III of this Form 10-K.
93 Total pages
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CHOICE ONE COMMUNICATIONS INC.
TABLE OF CONTENTS
Page
Part I
Item 1. Description of Business.....................................................................................2
Item 2. Properties.................................................................................................23
Item 3. Legal Proceedings..........................................................................................23
Item 4. Submission of Matters to a Vote of Security Holders........................................................23
Item 4A. Executive Officers of the Registrant.......................................................................24
Part II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters......................................25
Item 6. Selected Financial Data....................................................................................28
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations......................30
Item. 7A. Quantitative and Qualitative Disclosures about Market Risk.................................................46
Item 8. Financial Statements and Supplementary Data................................................................48
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................48
Part III
Item 10. Directors and Executive Officers of the Registrant.........................................................48
Item 11. Executive Compensation.....................................................................................48
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.............48
Item 13. Certain Relationships and Related Transactions.............................................................48
Item 14. Controls and Procedures....................................................................................49
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...........................................49
Signatures...................................................................................................................82
Certifications...............................................................................................................83
Exhibit Index................................................................................................................85
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Part I
ITEM 1: DESCRIPTION OF BUSINESS
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
From time to time, we make oral and written statements that may constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. We desire to take advantage of the "safe harbor"
provisions in the Private Securities Litigation Reform Act of 1995for
forward-looking statements made by us from time to time, including, but not
limited to, the forward-looking information contained in the "Description of
Business", "Risk Factors", "Management's Discussion and Analysis of Financial
Condition and Results of Operations", and elsewhere in this Form 10-K and in
other filings with the Securities and Exchange Commission ("SEC"). The words or
phrases "believes", "expects", "estimates", "anticipates", "will", "will be",
"could", "may" and "plans" and the negative or other similar words or
expressions identify forward-looking statements made by or on behalf of the
Company.
Forward-looking statements may discuss our future expectations, as well as
certain projections of our results of operations and financial condition. We
caution readers that any such forward-looking statements made by or on behalf of
us involve risks, uncertainties and other unknown factors. Actual results,
levels of activity and performance could differ materially from those expressed
or implied in the forward-looking statements.
Factors that could impact our Company include, but are not limited to:
o Successful marketing of our services to current and new customers;
o The ability to generate positive working capital by timely collections from
customers and obtaining favorable payment terms from our vendors;
o The availability of additional financing;
o Compliance with covenants for borrowing under our bank credit facility;
o Technological, regulatory or other developments in the Company's business;
and
o Shifts in market demand and other changes in the competitive
telecommunications sector.
These and other applicable risks are summarized under the caption "Risk
Factors", and elsewhere in this Form 10-K. You should consider all of our
written and oral forward-looking statements only in light of such cautionary
statements. You should not place undue reliance on these forward-looking
statements and you should understand that they represent management's view only
as of the dates we make them.
GENERAL DEVELOPMENTS
We are an integrated communications provider offering facilities-based voice and
data telecommunications services. We market and provide these services primarily
to small and medium-sized businesses in 29 second and third tier markets in 12
states in the northeastern and midwestern United States. Our services include:
o local exchange and long distance service; and
o high-speed data and Internet service.
We offer a single source for competitively priced, high quality, customized
telecommunications. We achieve comprehensive coverage in the markets we serve by
installing both voice and data equipment in multiple established telephone
company central offices, a process known as collocation.
We have connected the majority of our clients directly to our own switches,
which allows us to more efficiently route traffic, ensure quality of service and
control costs. Our networks reach approximately 5.7 million business lines,
which constitute approximately 72% of the estimated business lines in these
markets. While our network allows us to reach this number of business lines, the
number of business lines that we actually service will depend on our ability to
obtain market share from our competitors.
During September 2002, we committed to a plan to close operations in our Ann
Arbor and Lansing, Michigan market. We completed the closing in December 2002.
We have no current plans to expand into additional markets
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or close existing markets. As of December 31, 2002, we were providing service
with 500,923 access lines, including 16,658 data lines.
As of December 31, 2002, we had completed the collocation of our network
equipment in 530 established telephone company central offices in our markets.
All of our collocations also include equipment to provide DSL services.
We have a flexible network which allows us to achieve cost efficiencies and
leverage rapidly evolving telecommunications technology and build for growth. In
most of our markets, we have deployed digital switching platforms and lease
network capacity to connect our switch with our transmission equipment
collocated in central offices of the established telephone companies. This
allowed us to enter our markets more rapidly and with lower initial costs than
if we had acquired or built capacity. We lease fiber capacity in certain markets
when economically justified by traffic volume growth in order to reduce the
overall cost of local transport and reduce our reliance on the established
telephone company.
Fiber deployment provides the bandwidth necessary to support substantial
incremental growth and allows us to reduce our network costs and enhance the
quality and reliability of our network, which strengthens our competitive
advantage in the markets. We currently have or plan to have fiber capacity in 22
markets. As of December 31, 2002, 18 of our markets were operational on local
fiber rings with plans to add local fiber rings in 4 additional markets during
2003. Our markets within Indiana, Michigan and Connecticut were operational on
inter-city fiber networks as of December 31, 2002.
We were incorporated under the laws of the State of Delaware on June 2, 1998. We
began generating revenue in 1999 when our first markets, Albany and Buffalo, New
York, became operational. Soon after, markets in Pennsylvania, New Hampshire,
Massachusetts and Rhode Island became operational for a total of nine markets at
the end of 1999. We continued to expand into new markets in eastern Pennsylvania
and Connecticut in 2000, and added nine markets in the midwest with our
acquisition of US Xchange, Inc. ("US Xchange") in August 2000. In 2001, we
substantially completed our market expansion into thirty markets, with new
markets in Ohio. We ended 2002 with 29 markets after the closing of the Ann
Arbor and Lansing, Michigan market in December 2002.
BUSINESS STRATEGY
We have a growth strategy to be the telecommunications provider of choice,
offering one-stop communications solutions to clients in our markets. We have
been successful in executing that strategy. Our continued success will depend
upon our ability to increase penetration in our 29 markets to achieve
profitability. The key elements of our business strategy are to:
Attract and Retain Business Clients
We continue to target small and medium-sized businesses primarily in the 29
markets we serve in the northeastern and midwestern United States. We focus on
the markets where there is a high concentration of potential business clients
and a demand for the types of services we offer. We continue to attract and
retain clients in these areas by offering a simplified, comprehensive package of
services and a high level of client care. Our services are priced competitively
compared to the established telephone companies, providing savings to our
clients.
Offer Broad Coverage
We provide broad geographic coverage within our markets by collocating in
multiple central office locations to reach both central business districts and
outlying areas. While other companies often limit their network buildout to
highly concentrated downtown areas, our collocation strategy has been able to
reach 70% to 80% of the business lines within each market. As a result, we are
one of a few competitors to the established telephone company to offer
integrated services to small and medium-sized businesses at many of our
collocation sites.
Offer Bundled Services with a Single Point of Contact
We attract new clients and retain established clients by offering bundled
services with a single point of contact for sales and convenient, integrated
billing. Our clients may bundle local exchange service, long distance service,
high-speed data and Internet service principally utilizing DSL technology,
e-mail, voicemail and other enhanced services. In addition, our billing system
provides our clients with a single, easy to understand statement covering all of
their services.
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Increase Our Market Share by Providing Service-Driven Client
Relationships and a Local Presence
We attract and retain clients by providing local sales offices in each of our
markets with an experienced account management team that provides face-to-face
sales and personalized client care. We focus on building long-term relationships
with our clients, which we believe have not typically received a satisfying
level of local support from the established telephone companies. We believe that
our local presence builds strong, positive Choice One name recognition within
these communities.
Lead Competition in Providing DSL Services
We provide dedicated, high-speed digital communications services using DSL
technology. DSL technology permits broadband transmissions over existing copper
telephone lines, allowing us to provide high-speed services economically.
High-speed connectivity is becoming increasingly important to small and
medium-sized businesses due to the dramatic growth in Internet and electronic
business applications. We have installed DSL equipment in all of our existing
collocations.
Maintain Our Flexible Network Buildout Strategy
Our flexible network buildout strategy allows us to achieve speed to market and
cost efficiencies and to leverage rapidly evolving telecommunications
technology. In most of our markets we have deployed digital switching platforms
and leased network capacity to connect our switch with our transmission
equipment collocated in central offices of the established telephone companies.
This allowed us to enter our markets more rapidly and with lower initial costs
than if we had acquired or built transport capacity. We lease network capacity
and we acquire fiber capacity when and where traffic volumes and other
conditions make this alternative more cost efficient. We have deployed fiber in
many of our markets, which replaced the leased local network facilities and
decreased our network leasing costs. At December 31, 2002, we have deployed
fiber in 18 of our markets with plans to deploy fiber in 4 additional markets
during 2003. The benefits of this fiber include network redundancy, reduced
provisioning intervals (provisioning onto our own network, versus relying on the
established telephone company for provisioning), reduced per unit costs with
additional product offerings, and guaranteed available capacity to meet our
demands. Future network capacity will be deployed when technologically feasible
and economically justified.
Utilize Efficient Automated and Integrated Back Office Systems
Our management team is committed to having efficient operations support systems
and other back office systems that can support rapid and sustained growth. To
realize this objective, we have a team of engineering and information technology
professionals experienced in the telecommunications industry. We have automated
most of our back office systems and continue to integrate them into a seamless
end-to-end system that synchronizes multiple activities, including installation,
billing and client care. We integrated our order management and billing systems
in a manner that enables us to transmit client information directly from the
order management and service fulfillment systems into the billing system. This
allows us to eliminate redundant keying, reducing the potential for errors, and
to share information between the various components of our systems. Unlike the
legacy systems currently employed by many established telephone companies and
competitive local exchange carriers, which require multiple entries of client
information to synchronize multiple tasks, our system requires only a single
entry to transfer client information from sales to service to billing. Our
customized system also integrates our back office systems to minimize the time
between client order and service installation and to reduce our costs.
Growth Through Acquisitions
In past years, we have completed acquisitions of businesses or purchases of
other businesses' assets that have been integrated into our operations. We
currently have no definitive agreements relating to any material acquisitions,
nor do we have any current plans of acquisition.
Leverage Management Experience
Our management team has extensive experience and success in the
telecommunications industry, especially in our 29 markets. We believe that our
ability to draw upon the collective talent and expertise of our senior
management gives us a competitive advantage in the execution of network
optimization, sales and marketing, service installation, billing and collection,
back office and operations support systems, finance, regulatory affairs and
client care.
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OUR TELECOMMUNICATIONS SERVICES
Our service offerings are tailored to meet the specific needs of small and
medium-sized businesses in our markets. In all of our markets, we offer both
voice and data services, which can be purchased by our clients either as a
bundled package or as individual services.
Bundled Services
Through our new Select Savings plans, our clients may bundle local, long
distance and high-speed Internet services in a variety of combinations to meet
their particular needs. Local and long distance calling plans are bundled in a
variety of sizes, enabling clients to customize plans that correspond with the
specific calling patterns of their business.
Our bundled plans can provide our clients substantial savings as compared to the
same services offered by established telephone companies. The rates that we use
as a baseline for our services are established telephone companies' tariff
rates, which do not include special price promotions. Our Select Savings plans
provide our clients with a cost-effective alternative to the traditional pricing
plans offered by local telephone companies.
Individual Services
As part of our Select Savings plans, our clients can choose from the following
services:
Local Calling Services. Our local exchange services are offered through our
ChoiceXchangeSM service plan. This service includes dialing parity, simplified
local rates, local number portability, listing in white and yellow page
directories and access to 911 and directory assistance. Also available through
the service are enhanced features, such as three-way conference calling, line
rollover, call forwarding, call waiting, caller identification, voice mail, call
pickup, and distinctive ring. Our voice mail service, known as ChoiceMessageSM,
includes remote access, paging notification, personalized greetings and password
protection. In certain markets we also originate and terminate interexchange
calls placed or received by our clients at no additional charge and offer free
local calling between client locations.
Long Distance Services. Through our ChoiceOnePlusSM service, we offer a full
range of domestic and international long distance services, including "1+"
outbound calling, inbound toll free service, and complementary services such as
calling cards with operator assistance and conference calling. To provide easy
to understand billing to our clients, we also offer one rate on any calls within
the U.S.
Internet Access and DSL High-speed Data Services. Our comprehensive suite of
Internet services provides our clients with a total solution for all of their
data needs. These services include high-speed Internet access, e-mail, web
hosting, domain name hosting and other value-added services. We offer Internet
access via DSL technology and dedicated digital transmission links with a
capacity equivalent to 24 standard telephone lines, known as T-1 connections. We
provide high-speed data communications and Internet access to our targeted small
and medium-sized businesses at rates that we believe are very attractive when
compared to the cost and performance of other available data service offerings.
Our ChoiceNetJet service, powered by DSL technology, is highlighted by the
following key elements:
o Customizable Bandwidth. We offer our clients speeds ranging from
128kps to 1.544 mbps. Our clients choose the speed and bandwidth
capacity that meets their needs.
o Always On. Through ChoiceNetJet, our clients are connected 24 hours a
day, 7 days a week.
o Symmetric Connections. Our service allows for data transmission at the
same speed in both directions.
o Security. Our server is designed to prevent unauthorized access to our
clients' information and enable the safe and secure transmission of
sensitive information and applications.
o No Usage Fees. Our clients may use their ChoiceNetJet connection for
any period of time without per minute usage charges.
Dedicated T-1 Services. We offer ChoicePathSM dedicated T-1 services as an
integrated low cost solution for dedicated access for bundling Internet/data,
local and long distance services over a single connection. ChoicePathSM permits
digital connections to be purchased in blocks of 24 channels or on an individual
basis.
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Virtual Private Network Services. Our Virtual Private Network (VPN) services
allow businesses with multiple locations to securely connect these locations for
high-speed data transmission. We combine our DSL and dedicated T-1 access
services with our virtual private network service to provide clients with
high-speed and secure connections to their corporate local area network and the
Internet. This flexible and cost-effective solution supports both telecommuters
and site-to-site connections.
Enhanced Data Features. We offer a full array of Enhanced Data Features
products. The product set includes network address translation that enables
computers to connect simultaneously to the Internet without additional costs,
and firewall security that protects electronic files from network intruders.
These products eliminate the need for businesses to purchase, configure and
maintain their own equipment typically associated with these applications.
Web Hosting. We offer a range of shared web hosting products targeted to meet
the needs of small to medium-sized businesses. We provide clients with a
reliable web presence they need to meet their Internet-related objectives
without the initial capital expense required to purchase and maintain their own
equipment. We also provide e-mail hosting solutions and domain name registration
and hosting.
Web Design Services. We offer web design solutions that accommodate a range of
client needs, from establishing a simple web presence to creating sophisticated
web sites. We offer web design options that combine the economy of a packaged
design product with the flexibility to create a customized look. Our clients can
choose the layouts, colors, and content they desire to create a web site
suitable to their particular needs. When clients are ready to expand their web
presence, we also offer custom web design services for higher-end applications.
Private Line Services: Our Choice Path Private Line (or often referred to as
"Point-to-Point") service is a dedicated circuit that enables the efficient
transmission of high volumes of voice and data traffic between service locations
and business partners. Importantly, the Choice Path Private Line provides
clients with the flexibility to allocate individual T-1 channels for voice
and/or data transmission as dictated by their specific business needs. Clients
pay a fixed monthly price for this service and can potentially realize
substantial savings compared with traditional usage-based services.
Sales and Client Care
In each of our markets, we have a locally based sales force as well as dedicated
client care representatives. In addition to our direct sales force, we use third
party agencies to sell our services. These agencies include telecommunications
equipment vendors, consultants, systems integrators and cellular phone
retailers.
We attract clients by providing local sales offices in each of our markets with
a highly trained, dedicated account management team that personally meets with
each prospective new client during the sales process. This local sales force
uses a consultative selling approach and offers clients a full range of
sophisticated and cost-effective telecommunications solutions. Sales teams use a
variety of methods to qualify leads and set up initial appointments.
Each market's account management team is led by a general manager who is
responsible for attracting and retaining clients which generate profitable
margins in that market. The general manager oversees a local sales team that is
composed of direct salespersons and an indirect sales force. The indirect sales
force consists of an alternate channel manager and various sales agents,
including telecommunications equipment vendors, consultants, system integrators
and cellular phone retailers.
As of December 31, 2002, we had 391 employees in our direct sales staff, not
including our independent third-party sales agents, as compared to 516 employees
at December 31, 2001.
Our client services organization is composed of a client care team, who handles
routine client inquiries, and dedicated client development representatives
(CDRs), who focus on client retention and selling additional services to
existing clients.
Members of the client care team are located in one of our two centralized client
care facilities, located in Rochester, New York and Green Bay, Wisconsin. These
facilities are staffed to maximize the coverage during the business week and to
extend coverage beyond normal business hours to better serve our clients.
Additionally, these facilities utilize common operating systems, which provides
redundancy and automatically route callers to the next available representative,
regardless of location.
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Members of the client development organization are located in each market and
work alongside the sales organization. The CDRs provide one-on-one client
service to our larger clients and assist these clients in finding ways to best
utilize their telecommunications services.
New Products and Services Development
Our sales, marketing and engineering departments are responsible for new product
development, quality assurance, and engineering. Our new product development
process ensures input from consumers, clients, and internal functional areas
before a new product or service is brought to market. We also focus on the
development of related products and services, as well as modifications of
existing products and services. The amount expensed during the last three fiscal
years on company-sponsored and customer-sponsored research activities relating
to the development of new products and services or the improvement of existing
products and services has not been material.
In October 2002, we developed and introduced the Select Savings plans on a
limited basis. The Select Savings plans offer clients a full range of services
including basic telephone service, T-1 and DSL, local and long distance calling
plans and features. Local and long distance calling plans are bundled in a
variety of sizes, enabling clients to design plans that correspond with the
specific calling patterns of their businesses. With the basic Select Savings
plan, clients can realize considerable savings on their telecommunications
services as compared with the established telephone companies. The benefits and
savings increase as clients subscribe to additional services or bundled plans.
Based on the positive response to this product, we are offering this service in
all of our markets beginning in early 2003.
OUR MARKETS
We offer telecommunications services in 29 markets, comprising 38 basic trading
areas. We are currently operating in the following markets:
Akron, OH (1) Green Bay, WI (3) Portland, ME (7)
Albany, NY (2) Harrisburg, PA (4) Providence, RI
Allentown, PA Hartford, CT Rochester, NY
Buffalo, NY Indianapolis, IN Rockford, IL
Columbus, OH Kalamazoo, MI (5) Scranton, PA
Dayton, OH Madison, WI South Bend, IN (8)
Erie, PA Manchester, NH Springfield, MA
Evansville, IN Milwaukee, WI Syracuse, NY (9)
Fort Wayne, IN New Haven, CT (6) Worcester, MA
Grand Rapids, MI Pittsburgh, PA
(1) Also includes the basic trading area for Youngstown, OH.
(2) Also includes the basic trading areas for Schenectady, NY and Kingston, NY.
(3) Also includes the basic trading areas for Appleton, WI and Oshkosh, WI.
(4) Also includes the basic trading area for Lancaster, PA.
(5) Also includes the basic trading area for Battlecreek, MI.
(6) Also includes the basic trading areas for Bridgeport, CT and Stamford, CT.
(7) Also includes the basic trading area for Bangor, ME.
(8) Also includes the basic trading area for Elkhart, IN.
(9) Also includes the basic trading areas for Binghamton, NY and Ithaca, NY.
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NETWORK INFRASTRUCTURE
Our flexible network has allowed us to enter markets quickly, achieve cost
efficiencies, add incremental network capacity as needed, and integrate and
benefit from new telecommunications technologies.
We have a Class 5 digital switch in each of our operational markets, other than
Worcester, MA, New Haven, CT, Erie, PA and Portland, ME. We have installed a
packet-based switch network in each market in order to establish a widespread
coverage area for the offering of high bandwidth digital connections utilizing
DSL technology. We have installed our network equipment, including both voice
and data components, in established telephone company central offices in a
manner that enables us to address 70% to 80% of the business lines in each
market. We lease unbundled loops from the established telephone company or T-1
facilities from the established telephone company or competitive network
provider to connect our equipment in the telephone company central office to the
client locations.
As of December 31, 2002, we had 25 Class 5 switches in service and 63 data
switches in service. Our switches are connected to established telephone
companies' networks and long distance and Internet service provider
points-of-presence.
We lease local network facilities from the established telephone company and/or
one or more competitive network providers to connect our switch to established
telephone company central offices. Initially leasing these facilities allowed us
to begin operations more quickly and at a lower up front cost than if we had
acquired or built them. However we have chosen to acquire local fiber network
capacity when and where traffic volume and other conditions have made this
alternative more cost effective. We have a 20-year agreement for indefeasible
right to use fiber (IRU) that provides us with operational intra-city fiber
miles and inter-city fiber miles in and between nine markets in Wisconsin,
Illinois, Indiana and Michigan.
During 2002, our fiber provider in our eastern markets completed construction of
fiber miles in six of our markets bringing the total number of our markets with
fiber miles to 18. Our agreement includes preferred pricing for the first five
years of the agreement. We are in the third year of the agreement. We expect
that benefits of IRUs will include network redundancy, reduced provisioning
intervals (provisioning onto our own network, versus relying on the established
telephone company for provisioning) and reduced per unit costs with additional
product offerings.
We operate a network operations control center, or NOCC, facility in Grand
Rapids, Michigan, which provides monitoring of the switching and fiber
facilities across our entire network 24 hours per day, seven days per week. We
also have locally based switch engineers and technicians to manage each switch
and other network equipment.
Rapid and significant changes in technology are expected in the
telecommunications industry. Our continued success will depend, in part, on our
ability to anticipate and adapt to technological changes. For instance, we have
selected Lucent Technologies to provide us new technology to upgrade our access
transport network. We believe that our network design positions us to rapidly
implement future voice and data switching technology.
INFORMATION SYSTEMS
We have designed, developed and implemented integrated operations support
systems and other back office systems. We believe these integrated systems give
us significant competitive advantages by enhancing our efficiency, providing us
capacity to process large order volumes, allowing us to support rapid and
sustained growth and enabling us to provide exceptional client care. We have
automated most of our back office systems and continue to integrate them into a
seamless end-to-end system that synchronizes multiple activities, including
installation, billing and client care. We integrated our order management and
billing systems in a manner that enables us to transmit client information
directly from the order management and service fulfillment systems into the
billing system. This allows us to eliminate redundant keying, reducing the
potential for errors, and to share information between the various components of
our systems.
The individual components of our system are as follows:
Order Entry, Process Flow, Network Inventory, Billing and
Administration, Network Activation
We have an agreement with MetaSolv Software Inc. to license its Telecom Business
Solution, or TBS, software to manage our back office operations support system.
MetaSolv's software manages our order entry, service installation, network
element inventory, gateway interconnects and workflow business functions and
allows our sales team to monitor the status of the order from initiation through
service implementation.
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We have an agreement with ADC Communications to utilize its Convergent Billing
Platform AS/400 software which enables us to combine and bill current and future
service offerings and present the information on a single statement for our
clients. This system supports client care functions, including billing inquiries
and collection processes. Call detail records, such as the billing records
generated by our voice or data switches are automatically processed by the
billing platform in order to calculate and produce bills in a variety of
formats. We also have an agreement with PCR, Inc. to utilize their billing
platform. This system was acquired with the acquisition of US Xchange. We are
evaluating the benefits of migrating the clients billed on the PCR, Inc. billing
platform to the ADC Communications billing platform, but no timeline for such a
migration has been set. All new clients are billed from the ADC Communications
billing platform.
Our MetaSolv system has been integrated with our ADC Communications billing and
administration system to ensure data integrity and eliminate redundant data
entry. This integrated software solution allows us to efficiently bill for
multiple products on a single statement and provides a central point of contact
for handling orders and activities.
We have licensed software from Harris Corp. that enables network activation of
client orders. This software enables the automated processing of line activation
in our Class 5 switches, distinctive remote modules and voicemail platform
within New York, Pennsylvania, Massachusetts, Rhode Island, New Hampshire,
Connecticut, Maine and Ohio. The software is scheduled to be used for the
processing of line activation in our remaining markets at the end the third
quarter of 2003.
Electronic Bonding
Through software that we have licensed from DSET Corporation and have integrated
with our MetaSolv software, we have established electronic bonding with Verizon
and SBC/Ameritech. We have implemented an electronic interface linking our
operations support systems directly to the established telephone company system
so that we can process orders on an automated basis for our clients which are
switching service from an established telephone company. Additionally, we can
confirm receipt and installation of service on-line and in real-time.
Trouble Ticketing
We have created a system that logs information related to and monitors the
resolution of network problems. This system acts as a central repository for
logging client trouble calls, assigning responsibility for addressing the
problem to the appropriate party, and tracking the status of the response to the
calls, including automatically escalating the response process, as appropriate.
Sales Force Automation and Contact Management
We utilize internally developed software to assist us in the management of
potential customer contacts, the management of the sales process with particular
client prospects and the preparation of proposals, correspondence and order
forms.
REGULATION
The following summary of regulatory and legislative developments describes the
primary present and proposed federal, state, and local regulations and
legislation that is related to the telecommunications and Internet service
industries that could have a material effect on our business. Existing federal
and state regulations are currently subject to judicial proceedings, legislative
hearings and administrative proposals that could change, in varying degrees, the
manner in which our industries operate. We cannot predict the outcome of these
proceedings or their impact upon the telecommunications and Internet service
industries, or Choice One.
Overview
Our telecommunications services are subject to federal, state, and, at times,
local regulation. The Federal Communications Commission ("FCC") exercises
jurisdiction over all facilities and services of telecommunications carriers to
the extent those facilities are used to provide, originate, or terminate
state-to-state or international communications (e.g. interstate). Generally,
state regulatory commissions exercise jurisdiction over facilities and services
to the extent those facilities are used to provide, originate or terminate
in-state communications. In addition, as a result of the passage of the
Telecommunications Act of 1996, state and federal regulators share
responsibility for implementing and enforcing the domestic pro-competitive
policies of the Telecommunications Act. In particular, state regulatory
commissions have substantial oversight over the provision of interconnection and
non-discriminatory network access to established telephone companies. Local
governments often regulate public rights-of-way necessary to install
telecommunications facilities.
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Federal Regulation
We are regulated at the federal level as a nondominant common carrier subject to
minimal regulation under Title II of the Communications Act of 1934 and the
Telecommunications Act of 1996. The Telecommunications Act of 1996 was a
comprehensive reform of the nation's telecommunications laws and was designed to
enhance competition in the local telecommunications marketplace by requiring
established telephone companies to provide competitors like Choice One with
access and interconnection to their facilities and to open their local markets
to competition. Under the Telecommunications Act, regional Bell operating
companies have the opportunity to provide long distance services in any state in
which they offer local service if they comply with 14 market-opening conditions
under Section 271 of the Telecommunications Act. Established telephone companies
are no longer prohibited from providing specified cable TV services. In
addition, the Telecommunications Act eliminates particular restrictions on
utility holding companies, thus clearing the way for companies to diversify into
telecommunications services.
Before a regional Bell operating company can provide in-region long distance
services, it must obtain FCC approval upon showing that it has satisfied a
14-point "checklist" of competitive requirements and that such entry is in the
public interest. To date, Verizon has been granted such authority in all states
that overlap Choice One's service territory (New York, Massachusetts,
Connecticut, Pennsylvania, Rhode Island, Vermont, Maine and, New Hampshire). SBC
Communications has not yet been granted authority in Michigan, Indiana,
Illinois, Ohio and Wisconsin. Several additional requests for such authority
either have been or will soon be filed. The provision of in-region long distance
services by the regional Bell operating companies has permitted them to offer
"one-stop shopping" of bundled local and long distance services, thereby
eliminating this aspect of our current marketing advantage for certain areas.
FCC Rules Implementing the Local Competition Provisions of the
Telecommunications Act
Over the last six years, the FCC has established a framework of national rules
enabling local competition. Some of those rules have important bearing on our
business, particularly:
Interconnection. Established telephone companies are required to provide
interconnection for telephone exchange or exchange access service, or both, to
any requesting telecommunications carrier at any technically feasible point. The
interconnection must be at least equal in quality to that provided by the
company to itself or subsidiaries, affiliates or any other party to which it
provides interconnection, and must be provided on rates, terms and conditions
that are just, reasonable and nondiscriminatory.
We have obtained agreements with the established telephone companies in our
service areas. These agreements must be renegotiated periodically and Choice One
is working to renew these documents on a continual basis. Renewal terms may be
more or less favorable and could affect our overall costs.
Access to Unbundled Elements. Established telephone companies are required to
lease portions of their networks to requesting telecommunications carriers by
providing them with nondiscriminatory access to network elements on an unbundled
basis at any technically feasible point, on rates, terms, and conditions that
are just, reasonable, and nondiscriminatory and TELRIC-based (FCC cost mechanism
Total Element Long Run Incremental Cost). This is important, because it
minimizes our need to make major investments in building our network. At a
minimum, established telephone companies must provide competitors with access to
various network elements used to originate and terminate telephone calls, call
routing database facilities, and computerized operations support systems. The
prices for these unbundled elements are set by the states under guidelines
established by the FCC.
Recently, the FCC announced that it would change, in many respects, the
regulatory rules with respect to unbundled network elements. On February 20,
2003, the FCC announced revised established telephone company obligations to
make elements of their networks available on an unbundled basis to competitors
and new entrants. This Triennial Review decision, which is expected to be made
official later in this year, resolves various local phone competition and
broadband competition issues. Following is a brief summary of the key issues
resolved in the FCC's decision:
Impairment Standard - The FCC defined "impairment" as when lack of access
to an established telephone company network element poses barriers to
entry, including operational and economic barriers. Such barriers include
scale economies, sunk costs, first-mover advantages and barriers within the
control of the established telephone company. The FCC's unbundling analysis
specifically considers market specific variations, such as customer class,
geography and service.
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Broadband Issues - The FCC provides substantial unbundling relief for loops
utilizing fiber facilities: no unbundling of fiber-to-the-home loops, no
unbundling of bandwidth for the provision of broadband services for loops
where the established telephone company deploys fiber further into the
neighborhood but short of the customer's home (hybrid loops) and no
line-sharing as an unbundled element. For the hybrid loops, the requesting
carriers that provide broadband services over high capacity facilities will
continue to obtain that same access. The FCC also provides clarification on
its unbundled network element pricing rules.
Unbundled Network Element Platform (UNE-P) Issue - The FCC will no longer
require the unbundling of switching for business customers served by
high-capacity loops such as DS-1, based on a presumptive finding of no
impairment. States will have 90 days to rebut the FCC finding. For
mass-market customers, the FCC sets out specific criteria that states shall
apply to determine, on a granular basis, whether economic and operational
impairment exists in a particular market. State commissions must complete
such proceedings within nine months. Upon a state finding of no impairment,
the FCC sets forth a three year period for carriers to transition from
UNE-P.
Roles of States - The states have a substantial role in applying the FCC's
impairment standard according to specific guidelines tailored to individual
elements.
Dedicated Transport - The FCC found that requesting carriers are not
impaired without Optical Carrier level transport circuits. However, the FCC
found that requesting carriers are impaired without access to dark fiber,
DS-3 and DS-1 capacity transport, each independently subject to a
route-specific review by states to identify available wholesale facilities.
Dark fiber and DS-3 transport are also each subject to a route-specific
review by the states to identify where competing carriers are able to
provide their own facilities.
The impacts of this Triennial Review decision mean that the FCC is poised to
eliminate unbundling provisions with respect to fiber and copper-fiber plant.
Although we cannot yet predict the outcome of these actions, or any potential
legal challenge, any change in the availability of network elements could affect
our business plans and operations.
Collocation. Established telephone companies are required to provide space in
their switching offices so that requesting telecommunications carriers can
physically "collocate" equipment necessary for interconnection or access to
unbundled network elements at the company's premises, except that the
established telephone company may provide off-site "virtual" collocation, if it
demonstrates to the state regulatory commission that physical collocation is not
practical for technical reasons, or because of space limitations.
Other Regulations
In general, the FCC has historically had a policy of encouraging newer
competitors, such as us, in the telecommunications industry and preventing
anti-competitive practices. Therefore, the FCC has established different levels
of regulation for dominant carriers, such as the established telephone
companies, and nondominant carriers, such as integrated communications providers
and competitive local exchange carriers.
Interstate and International Services. As a nondominant carrier, we may install
and operate facilities for the transmission of domestic interstate
communications without the time and expense of obtaining prior FCC
authorization.
Nondominant carriers are required to obtain FCC authorization pursuant to
Section 214 of the Communications Act before providing international
communications services. We have obtained such authority. Under recent FCC
decisions, the rates, terms, and conditions of domestic interstate and
international services are no longer filed with or regulated by the FCC,
although we remain subject to the FCC's jurisdiction over complaints regarding
these services. We also must comply with various FCC rules regarding disclosure
of our rates, the contents and format of our bills, payment of various
regulatory fees and contributions, and the like.
The FCC has adopted rules for a multi-year transition to lower international
settlement payments by U.S. common carriers. We believe that these rules are
likely to lead to lower rates for some international services and increased
demand for these services, including capacity on the U.S. facilities, like ours,
that provide these services.
Established Telephone Company Pricing Regulation Reform. The FCC has adopted a
number of changes to its rules that significantly reduce its regulation of
established telephone company pricing. These changes may greatly enhance the
ability of established telephone companies to compete against us, particularly
by targeting price cuts to particular clients, which could have a material
adverse effect on our ability to compete based on price. We expect that the FCC
will consider further initiatives along these lines in the future, but we cannot
predict the specific effects of future FCC reforms.
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Access Charges. The FCC has also made various changes to the existing rate
structure for charges assessed on long distance carriers for allowing them to
connect to local networks. These changes will reduce access charges and will
shift charges, which had historically been based on minutes-of-use, to flat
rate, monthly per line charges on end-user clients rather than long distance
carriers. As a result, the aggregate amount of access charges paid by long
distance carriers to access providers like us may decrease. Under the FCC rules,
the rates charged by the largest established telephone companies for network
access are targeted to be reduced to 0.45 cents per minute after a transition
period, and some of the larger companies have already completed the transition
to this level.
In 2001, the FCC adopted new rules to limit the access charges of nondominant
local carriers like us. Under these rules, competitive carriers, such as us, are
required to reduce their interstate access charges to rates no higher than 2.5
cents per minute. After one year, this rate ceiling will be reduced to 1.8 cents
and after two years to 1.2 cents per minute. After three years, all competitive
carriers will be required to charge rates no higher than the established
telephone company. However, the new FCC rules are under petitions for
reconsideration and/or judicial review, and we are unable to predict the outcome
of these proceedings.
Universal Service Reform. Universal telephone service is a long-standing policy
initiative designed to assure that as many people as possible have access to
quality telephone service at affordable rates, particularly in rural and
high-cost areas, as well as providing advanced telecommunications services for
schools, health care providers and libraries. All telecommunications carriers
providing interstate telecommunications services, including us, must contribute
to the universal service support fund.
Various states are in the process of implementing their own universal service
programs, which also may increase our overall costs.
Slamming. The FCC has adopted rules to govern the process by which end-users
choose their carriers. Under their rules, a user may change service providers at
any time, but specific client authentication procedures must be followed. When
they are not, particularly if the change is unauthorized or fraudulent, the
change in service providers is referred to as "slamming." Slamming is such a
significant problem that it was addressed in detail in the Telecommunications
Act and by the FCC in recent orders. The FCC has levied significant fines for
slamming. The risk of financial damage and harm to business reputation from
slamming is significant. Even one slamming complaint could cause extensive
litigation expenses for us. The FCC recently decided to apply its slamming
rules, which originally covered only long distance, to local service.
State Regulation. All states we operate in require a registration, certification
or other authorization, and continued regulatory compliance, to offer intrastate
services. Many of the states in which we operate are addressing issues relating
to the regulation of competitive local exchange carriers. In most states, we are
required to file tariffs setting forth the terms, conditions and prices for
services that are classified as intrastate.
We have received, through our operating subsidiaries, certificates of authority
to provide local exchange and interexchange telecommunications services in
Connecticut, Illinois, Indiana, Maine, Massachusetts, Michigan, New Hampshire,
New York, Ohio, Pennsylvania, Rhode Island, Virginia, and Wisconsin.
In addition to tariff filing requirements, some states also impose reporting,
client service and quality requirements, as well as unbundling and universal
service requirements. In addition, we are subject to the outcome of generic
proceedings held by state utility commissions to determine new state regulatory
policies. Some states have adopted or have pending proceedings to adopt specific
universal service funding obligations. These state proceedings may result in
obligations that are equal to or more burdensome than the federal universal
service obligations.
We believe that, as the degree of intrastate competition increases, the states
will offer the established telephone companies increasing pricing flexibility.
This flexibility may present the established telephone companies with an
opportunity to subsidize services that compete with our services with revenue
generated from non-competitive services, thereby allowing established telephone
companies to offer competitive services at lower prices. This could have a
material adverse effect on our ability to attract and retain clients at
profitable margins.
We are also subject to requirements in some states to obtain prior approval for,
or notify the state commission of, specified events such as transfers of
control, sales of assets, corporate reorganizations, issuances of stock or debt
instruments and related transactions.
As noted above, the states set most of the prices for unbundled network elements
for the unbundled network elements we purchase from the established telephone
companies to connect our network to customers. Recently, several states
including New York, Maine, and Rhode Island have lowered prices on these
unbundled elements, and several more states have open cases. While we cannot
predict the final outcome of cases and their affect on our business, changes in
unbundled element prices directly affect and are a large portion of our network
costs.
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Internet. Our Internet operations are not currently subject to direct regulation
by the FCC or any other telecommunications regulatory agency, although they are
subject to regulations applicable to businesses generally. However, the future
Internet service provider regulatory status continues to be uncertain. Congress
and other federal entities have adopted or are considering other legislative and
regulatory proposals that would further regulate the Internet. Various states
have adopted and are considering Internet-related legislation. Increased U.S.
regulation of the Internet may slow its growth or reduce potential revenue,
particularly if other governments follow suit, which may increase the cost of
doing business over the Internet.
Under the Telecommunications Act, competitive local exchange carriers are
entitled to receive compensation from established telephone companies for
delivering traffic to their customers. A dispute has existed for several years
over whether this compensation applies to calls bound for Internet service
provider clients of the competitive local exchange carriers. Most states have
required established telephone companies to pay this compensation to competitive
local exchange carriers. However the FCC has adopted new rules limiting the
right of competitive local exchange carriers to collect compensation on calls
that terminate to Internet service providers, and preempting inconsistent state
rules. Under the new rules, which took effect in June 2001, the amount of
compensation payable on calls to Internet service providers will be limited to
0.15 cents per minute for the first six months after the rules took effect, 0.10
cents per minute for the next eighteen months, and 0.07 cents per minute
thereafter. In addition, the overall amount of compensation payable in each
state is limited by a formula based upon the number of minutes of Internet
traffic terminated in the first quarter of 2001. The FCC rules permit carriers
to continue collecting the existing higher rates on calls that terminate to
customers who are not Internet service providers. Any traffic exchanged between
carriers that exceeds a three-to-one ratio of terminating to originating minutes
is presumed to be Internet calls, although either carrier may attempt to rebut
this presumption and show a different level of Internet traffic. However, this
ratio and the per minute rate may be modified by agreements between the
established telephone company and the competitive local exchange carrier. We
have such arrangements in several of the states we operate in.
State and Federal Legislation
State and federal legislatures periodically consider or pass legislation that
can affect our business. In 2002, the U.S. House of Representatives passed the
Internet Freedom and Broadband Deployment Act of 2001 (H.R. 1542), also known as
the Tauzin-Dingell bill, by a vote of 273-157. The legislation is aimed at
encouraging competition and consumer access to broadband Internet technology by
freeing the established telephone companies from the market-opening requirements
of the Telecommunications Act of 1996, discussed above, and the requirement to
offer certain unbundled elements to us, making it much easier for these
companies to compete with us. This legislation must be considered again by
Congress and signed by the President before it can become law. We cannot predict
if this or other legislation will be introduced and if it will be enacted into
law or what effect such legislation would have on our business.
Competition
We operate in a competitive environment. Some of our actual and potential
competitors have substantially greater financial, technical, marketing and other
resources, including brand name recognition, than we do. The increasingly
reduced regulatory and technological barriers to entry in the data and Internet
services markets could give rise to significant new competition. We believe that
the principal competitive factors affecting our business are pricing, client
service, accurate billing and, to a lesser extent, variety of services. Our
ability to compete effectively depends upon our ability to provide high quality
market-driven services at prices generally equal to or below those charged by
established telephone companies. To maintain our competitive posture, we believe
that we must be in a position to reduce our prices in order to meet reductions
in rates, if any, by others.
Established Telephone Companies
In each of our markets, we compete principally with the established telephone
company serving that area, such as Verizon, SBC, SNET and Frontier Telephone of
Rochester. Established telephone companies are the established providers of
dedicated and local telephone services to the majority of telephone subscribers
within their respective service areas. In addition, established telephone
companies generally have long-standing relationships with their clients and with
federal and state regulatory authorities and have financial, technical and
marketing resources substantially greater than we do, and the potential to
subsidize competitive services from a variety of businesses.
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While recent regulatory initiatives provide increased competitive opportunities
to voice, data, and Internet-service providers such as us, they also provide the
established telephone companies with increased pricing flexibility for their
private line, special access, and switched access services. With respect to
competitive access services, the fees to connect to an established telephone
companies' facilities, the FCC has increased established telephone company
pricing flexibility for such services, under certain circumstances. As the
established telephone companies are allowed additional flexibility to offer
discounts to large clients, engage in aggressive volume and term discount
pricing practices, and/or charge competitors with additional fees for
interconnection to their local networks, the future revenue of integrated
communications providers and competitive local exchange carriers could be
adversely affected.
Competitive Telecommunications Providers
We face competition from other current and potential market entrants, including
long distance carriers seeking to enter, reenter or expand entry into the local
exchange market such as AT&T, MCI WorldCom, and Sprint, and from resellers of
local exchange services and competitive access providers. We also face
competition from other competitive local exchange carriers with overlap in our
markets, such as TDS Metrocom, McLeod USA, Time Warner Telecom and Conversant.
Even the established telephone companies, particularly the regional Bell
operating companies, have established independent competitive local exchange
carrier subsidiaries to compete with each other. Some of these competitors have
significantly greater financial resources than we do.
Services Which Compete With Our DSL Services
The established telephone companies represent the dominant competition for DSL
services in all our markets. These companies have an established brand name,
possess sufficient capital to deploy DSL equipment rapidly, have their own
telephone wires and can bundle digital data services with their existing analog
voice services to achieve economies of scale in serving clients. Cable modem
service providers have deployed high-speed Internet services over cable
networks. Where deployed, these networks provide similar and, in some cases,
higher speed Internet access than we provide.
Many competitive telecommunications companies have deployed large-scale Internet
access networks, and have high brand recognition. Internet service providers
also provide Internet access to residential and business clients, generally at
lower speeds than we offer.
Other Competitors
Other companies that currently offer, or are capable of offering, local switched
services include: cable television companies, electric utilities, microwave
carriers, and large business clients who build private networks. These entities,
upon entering into appropriate interconnection agreements or resale agreements
with established telephone companies, could offer single source local and long
distance services like those that we offer. We also expect to face increasing
competition from cellular carriers and companies offering long distance data and
voice services over the Internet. We face competition from equipment companies
that enter into third party agent agreements to sell services. Some of these
companies could enjoy a significant cost advantage because they do not currently
pay carrier access charges or universal service fees.
In addition, two Bell operating companies have begun offering single source
local and long distance services in certain states. . In general, regional Bell
operating companies cannot provide long-distance service that originates, or in
some cases terminates, in one of its in-region states until the regional Bell
operating company has satisfied statutory conditions in that state, and has
received the approval of the FCC. For example, Verizon has been granted the
authority to provide long distance service in the states of New York,
Massachusetts, Connecticut, Rhode Island, Pennsylvania, Maine and New Hampshire
and other states outside our operating region. BellSouth is authorized to
provide long distance service in states outside of our operating region. Once
the regional Bell operating companies are allowed to offer in-region long
distance services, they will offer single-source local and long distance
service, which will cause increased competition to us.
Competitive Environment
During 2002, some of our competitors continued to exit territories throughout
our operating region. The departure of these companies has generated a more
favorable operating environment for us and we expect to gain market share as
small and medium sized businesses seek a reliable, comprehensive package of
services.
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INTELLECTUAL PROPERTY
We regard our products, services and technology as proprietary and attempt to
protect them with copyrights, trademarks, trade secret laws, restrictions on
disclosure and other methods. We also generally enter into confidentiality or
license agreements with our employees and consultants, and generally control
access to and distribution of our documentation and other proprietary
information. Currently we have 16 servicemark applications or registrations.
Despite our precautions, we may not be able to prevent misappropriation or
infringement of our products, services and technology.
Our logo and some titles and logos of our services mentioned in this Form 10-K
are either our service marks or service marks that have been licensed to us.
Each trademark, trade name or service mark of any other company appearing in
this prospectus belongs to its holder.
SIGNIFICANT CUSTOMERS
We do not have any customers from whom revenue equals 10 percent or more of our
net sales.
EMPLOYEES
As of December 31, 2002, we had 1,539 employees compared to 1,758 employees at
December 31, 2001. We believe that our future success will depend on our
continued ability to attract and retain highly skilled and qualified employees.
None of our employees are currently represented by collective bargaining
agreements nor have we experienced any work stoppage due to labor disputes. We
believe that we enjoy good relationships with our employees.
RISK FACTORS
RISKS RELATED TO OUR BUSINESS
WE WILL NEED A SIGNIFICANT AMOUNT OF CASH TO OPERATE OUR BUSINESS, WHICH WE MAY
BE UNABLE TO OBTAIN
Our viability is dependent upon our ability to continue to execute under our
business strategy and to begin to generate positive cash flows from operations
during 2003. The success of our business strategy includes obtaining and
retaining a significant number of customers, and generating significant and
sustained growth in our operating cash flows to be able to fully satisfy our
operating expenses, meet our debt service obligations and fund our capital
expenditures. At December 31, 2002 we had $29.4 million in cash and cash
equivalents. In addition, we had $3.5 million available under our Term D loan
facility that may be accessed in equal quarterly installments through December
31, 2003. The continued availability of the Term D loan is subject to conditions
to borrowing, including no "material adverse change" in the business, as defined
in our Credit Agreement. The amount of cash available after December 31, 2003 is
dependent upon factors that could differ materially from our estimates.
Our 2003 plan is predicated upon the following assumptions:
o Sustained growth due to increased penetration for data and voice
offerings in our operational markets;
o Continued improvement in operational efficiencies through economies of
scale that translates into lower network costs and lower selling,
general and administrative expenses as a percentage of revenue; and
o Decreased capital expenditures.
Our revenue and costs may also be dependent upon factors that are not within our
control, including regulatory changes, changes in technology, and increased
competition. Due to the uncertainty of these factors, actual revenue and costs
may vary from expected amounts, possibly to a material degree, and such
variations could affect our future funding requirements and our ability to
substantially achieve our 2003 plan. If we are unable to substantially achieve
our 2003 plan objectives, we may need to raise additional capital. Additional
financing may also be required in response to changing conditions within the
industry or unanticipated competitive pressures. We can make no assurances that
we would be successful in raising additional capital, if needed, on favorable
terms or at all. Failure
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to raise sufficient funds under these circumstances may affect our ability to
continue to operate our business. There are conditions to our ability to borrow
under our senior credit facility, including the continued satisfaction of
covenants. These covenants require the Company to maintain an aggregate minimum
amount of cash and committed financing of $10.0 million at all times through
July 1, 2004, and limit the Company to a maximum amount of capital expenditures.
As of December 31, 2002, we were in compliance with these covenants and if we
are able to substantially execute our 2003 plan, we expect to be in compliance
with these covenants during 2003.
We may also require additional financing in order to develop new services or to
otherwise respond to changing business conditions or unanticipated competitive
pressures. Sources of additional financing may include commercial bank
borrowings, capital leasing, vendor financing, or the private or public sale of
equity or debt securities. We can make no assurances that we will be successful
in raising sufficient additional capital on favorable terms or at all. Failure
to raise sufficient funds as and when needed or advisable, may require us to
engage in asset sales or pursue other alternatives designed to enhance our
liquidity or obtain relief from our obligations. Any or all of these scenarios
could have a material adverse effect on our business, financial condition and
results of operations and in such case there is no assurance we could continue
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations --Liquidity and Capital Resources."
WE ANTICIPATE HAVING FUTURE OPERATING LOSSES AS WE CONTINUE TO GROW OUR BUSINESS
IN 29 MARKETS
For the year ended December 31, 2002, we had operating losses of $418.3 million,
net losses applicable to common stockholders of $524.1 million and negative
adjusted earnings before income taxes, depreciation, amortization and other
non-cash charges ("EBITDA") of $14.8 million. Adjusted EBITDA represents
earnings before interest, income taxes, depreciation and amortization, and other
non-cash charges. Adjusted EBITDA is used by management and certain investors as
an indicator of a company's liquidity and should not be substituted for cash
flow from/(used) by operations determined in accordance with accounting
principles generally accepted in the United States of America ("GAAP"), the most
directly comparable financial measure under GAAP. A reconciliation of our cash
flow from operations to adjusted EBITDA can be found in Management's Discussion
and Analysis of Financial Condition and Results of Operations ("MD&A").
We have suffered recurring losses from operations and have a net capital
deficiency that raises substantial doubt about our ability to continue as a
going concern. Our continuation as a going concern is dependent on our ability
to substantially meet our 2003 plan. Our 2003 plan is predicated upon sustained
growth through increased penetration for data and voice offerings, continued
improvement in operational efficiencies that translate into lower network costs
and lower selling, general and administrative expenses as a percentage of
revenue, and decreased capital expenditures. We expect our operating losses and
net losses to decline as our operations mature and we achieve greater operating
efficiencies. We also expect that our adjusted EBITDA will be positive in 2003.
However, we can make no assurances that we will substantially achieve our 2003
plan or generate sufficient adjusted EBITDA to meet our working capital and debt
service requirements, which could have a material adverse effect on our
business, financial condition and results of operations. Our revenue and costs
may also be dependent upon factors that are not within our control, including
regulatory changes, changes in technology, and increased competition. Due to the
uncertainty of these factors, actual revenue and costs may vary from expected
amounts, possibly to a material degree, and such variations could affect our
future funding requirements.
OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND
COULD PREVENT US FROM FULFILLING OBLIGATIONS
We are highly leveraged and have significant debt service and related
obligations. As of December 31, 2002, our aggregate outstanding financial
institution indebtedness was $595.9 million (net of unamortized discount of $6.9
million), our capital lease obligations were $32.4 million and our redeemable
preferred stock was $243.5 million. We have the ability to incur up to an
aggregate of $425.0 million under our senior credit facility subject to approval
from a majority of our lenders. We have $398.9 million which has been committed
under our senior credit facility and may incur additional indebtedness subject
to certain limitations in our credit facility. The amount outstanding under our
senior credit facility at December 31, 2002 was $396.4 million. We also had
$206.4 million outstanding in subordinated notes that are subordinated to our
credit facility.
Our debt is subject to covenants customary to these types of arrangements. Our
ability to comply with these covenants will depend on our future financial and
operating performance, which, in turn, will be subject to prevailing economic
and competitive conditions and to certain financial, business, regulatory and
other factors, many of which are beyond our control. These factors could include
operating difficulties, increased operating costs, significant customer churn,
pricing pressures, the response of competitors, regulatory developments and
delays in implementing
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strategic projects. We can make no assurances that we will continue to maintain
compliance with our debt covenants should the factors above occur and adversely
affect our business, financial condition and results of operations. These
covenants require the Company to maintain an aggregate minimum amount of cash
and committed financing of $10.0 million at all times through July 1, 2004, and
limit the Company to a maximum amount of capital expenditures. As of December
31, 2002, we were in compliance with these covenants and if we are able to
substantially execute our 2003 plan, we expect to be in compliance with these
covenants during 2003. If new indebtedness is added to our current levels, the
related risks that we face could intensify.
Our substantial leverage could have important consequences to us. For example,
it could:
o make it more difficult for us to obtain additional financing for
working capital, capital expenditures, acquisitions or general
corporate purposes;
o require us to dedicate a substantial portion of our cash flow from
operations to the payment of principal and interest on our
indebtedness, thereby reducing the funds available to us for our
operations and other purposes, including investments in service
development, capital spending and acquisitions;
o place us at a competitive disadvantage to our competitors that are not
as highly leveraged as we are;
o impair our ability to adjust to changing market conditions; and
o make us more vulnerable in the event of a downturn in general economic
conditions or in our business or of changing market conditions and
regulations.
SERVICING OUR INDEBTEDNESS WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH AND OUR
ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL
We can make no assurances that we will be able to meet our debt service
obligations. If we are unable to generate sufficient cash flow or otherwise
obtain funds necessary to make required payments, or if we otherwise fail to
comply with the various covenants in our debt obligations, we would be in
default under such agreements, which would permit our lenders to declare all
amounts owed them immediately due and payable and could cause defaults under
other debt related agreements. Our ability to repay or to refinance our
obligations with respect to our indebtedness will depend on our future financial
and operating performance, which, in turn, will be subject to prevailing
economic and competitive conditions and to certain financial, business,
regulatory and other factors, many of which are beyond our control. These
factors could include operating difficulties, increased operating costs,
significant customer churn, pricing pressures, the response of competitors,
regulatory developments and delays in implementing strategic initiatives.
Our adjusted EBITDA for the year ended December 31, 2002 is currently
insufficient to pay our fixed charges. See "Selected Financial Data" and "MD&A
- --Results of Operations". The successful execution of our business strategy,
including obtaining and retaining a significant number of clients, and
significant and sustained growth in our cash flow are necessary for us to be
able to meet our debt service obligations and working capital requirements. We
can make no assurances that the anticipated results of our strategy will be
realized, or that we will be able to generate sufficient cash flow from
operating activities to meet our debt service obligations and working capital
requirements. See "Description of Business - Business Strategy". If our cash
flow and capital resources are insufficient to fund our debt service obligations
and working capital requirements, we could be forced to sell assets, seek to
obtain additional equity capital, or refinance or restructure our debt. A
disposition of assets in order to make up for any shortfall in the payments due
on our indebtedness could take place under circumstances that might not be
favorable to realizing the highest price for such assets. We can make no
assurance that such efforts would succeed, and if unsuccessful our business,
financial condition and results of operations could be materially adversely
affected, with no assurance in such case we could continue operations.
WE MAY FAIL TO ACHIEVE ACCEPTABLE PROFITS DUE TO PRICING
Prices in the local exchange business have remained stable. However, future
technological advances could result that will affect the prices for such
service. In addition, recent changes in prices have been from usage based prices
to flat rate prices.
Prices in the long distance business have declined substantially in recent
years. We rely on other carriers to provide us with a major portion of our long
distance transmission network. Such agreements typically provide for the resale
of long distance services on a per-minute basis and may contain minimum volume
commitments. The negotiation of these agreements involves estimates of future
supply and demand for transmission capacity as well as estimates of the calling
patterns and traffic levels of our future clients. In the event that we fail to
meet such minimum volume commitments, we may be obligated to pay
underutilization charges, and, in the event we underestimate our need for
transmission capacity, we may be required to obtain capacity through more
expensive means.
-17-
Our failure to achieve acceptable profits on our local exchange and long
distance services due to pricing declines could have a material adverse effect
on our business, financial condition and results of operation.
WE MAY NOT BE SUCCESSFUL IN MAINTAINING OUR HIGH CUSTOMER RETENTION RATE
We maximize customer retention by offering a simplified, comprehensive package
of services and providing a high level of customer care. Our churn of customers
for the year ended December 31, 2002 of our facilities-based business clients
was approximately 1.6% per month. Our ability to retain our customers is
dependent upon a number of factors, including our ability to provide quality
service, customer care, accurate and timely billing and our ability to provide
competitive pricing, the economic viability of our customers, and the customers'
perception of our economic viability. We can make no assurances that we will
continue to maintain high retention of customers.
WE EXPECT TO GROW OUR BUSINESS AND CANNOT GUARANTEE THAT WE WILL BE ABLE TO
EFFECTIVELY MANAGE OUR FUTURE GROWTH
The growth of our business and the provision of bundled telecommunications
services on a widespread basis could place a significant strain on our
management, operations, financial and other resources and increase demands on
our systems and controls. Failure to manage our future growth effectively could
adversely affect the expansion of our client base and service offerings. We can
make no assurances that we will be able to successfully maintain efficient
operations and financial systems, procedures and controls or successfully
obtain, integrate and utilize the employees and management, operations,
financial and other resources necessary to manage an expanding business in our
evolving, highly regulated and increasingly competitive industry. Any failure to
expand in these areas and to improve such systems, procedures and controls in an
efficient manner at a pace consistent with the growth of our business could have
a material adverse effect on our business, financial condition and results of
operations.
If we were unable to hire sufficient qualified personnel or successfully
maintain our operations and financial systems, procedures and controls, our
clients could experience delays in connection of service and/or lower levels of
client service, our resources may be strained and we may be subjected to
additional expenses. Our failure to meet client demands and to manage the
expansion of our business and operations could have a material adverse effect on
our business, financial condition and results of operations.
The success of our business is dependent upon, among other things, the
effectiveness of our sales personnel in the promotion and sale of our services,
the acceptance of such services by potential clients, and our ability to hire
and train qualified personnel and further enhance our services in response to
future technological changes. We can make no assurances that we will be
successful with respect to these matters. If we are not successful with respect
to these matters, it could have a material adverse effect on our business,
financial condition and results of operations.
WE RELY ON THE EFFECTIVE OPERATION OF OUR INFORMATION AND PROCESSING SYSTEMS
Sophisticated back office information and processing systems are vital to our
business and our ability to monitor costs, bill clients, provision client
orders, and achieve operating efficiencies. Our maintenance of these systems
relies, for the most part, on choosing products and services offered by third
party vendors and integrating such products and services in-house to produce
efficient operational solutions. We can make no assurances that the system
maintenance and upgrades will be successfully implemented on a timely basis,
that they will be implemented at all or that, once implemented, they will
perform as expected. Risks to our business associated with our systems include:
o failure by our vendors to deliver their products and services in a
timely and effective manner and at acceptable costs;
o failure by us to adequately identify all of our information and
processing needs;
o failure of our related processing or information systems; and
o failure by us to effectively integrate new products or services.
Furthermore, as our suppliers revise and upgrade their hardware, software and
equipment technology, we could encounter difficulties in integrating the new
technology into our business or the new systems may not be appropriate for our
business. In addition, our right to use these systems is dependent upon license
agreements with third party vendors. Some of these agreements may be cancelled
by the vendor and the cancellation or nonrenewal of these agreements may have an
adverse effect on us.
-18-
WE RELY ON THE ESTABLISHED LOCAL TELEPHONE COMPANIES TO IMPLEMENT SUCCESSFULLY
OUR SWITCHED AND ENHANCED SERVICES WHOSE FAILURE TO COOPERATE WITH US COULD
AFFECT THE SERVICES WE OFFER
As a participant in the competitive local telecommunications services industry,
we may encounter numerous operating complexities associated with providing local
exchange services. We have been required to develop new products, services and
systems and to develop new marketing initiatives to sell these services. We can
make no assurances that we will be able to continue to develop such products and
services.
We have deployed high capacity voice and data switches in the cities in which we
operate networks. We rely on the networks of established telephone companies or
those of competitive local exchange carriers for some aspects of transmission.
Federal law requires most of the established telephone companies to lease or
"unbundle" elements of their networks and permit us to purchase the call
origination and call termination services we need, thereby decreasing our
operating expenses. We can make no assurances that such unbundling will continue
to occur in a timely manner or that the prices for such elements will be
favorable to us. In addition, our ability to successfully provide our switched
and enhanced services has and will continue to require the negotiation of
interconnection and collocation agreements with established telephone companies
and competitive local exchange carriers, which can take considerable time,
effort and expense and are subject to federal, state and local regulation.
We may experience difficulties in working with the established telephone
companies with respect to ordering, interconnecting, and leasing premises. We
can make no assurances that these established telephone companies will continue
to cooperate with us. If we are unable to obtain the cooperation of an
established telephone company in a region, whether or not such company has been
authorized to offer long distance service, our ability to continue to offer
local services in such region on a timely and cost-effective basis may be
adversely affected.
We depend significantly on the quality and maintenance of the copper telephone
lines we lease from the established telephone companies that are providing
services in our markets to provide DSL services. We can make no assurances that
we will be able to continue to lease the copper telephone lines and the services
we require from these established telephone companies on a timely basis or at
quality levels, prices, terms and conditions satisfactory to us or that such
established telephone companies will maintain the lines in a satisfactory
manner.
IF WE ARE UNABLE TO TRANSITION FROM LEASED NETWORK FACILITIES TO FIBER, IT MAY
AFFECT OUR ABILITY TO REDUCE COSTS
For a material portion of our network, we lease from established telephone
companies and competitive local exchange carriers local transmission lines
connecting our switch to particular telephone company central offices. We may
seek to replace this leased capacity with fiber networks if and when warranted
by traffic volume growth. We can make no assurances that fiber network capacity
will be available to us on a timely basis or on favorable terms. The failure to
replace leased network capacity with fiber may affect our ability to reduce our
cost structure and may adversely effect our financial condition and results of
operations.
WE DEPEND ON CERTAIN KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR
SERVICES
We are managed by a number of key executive officers. We believe that our
success will depend in large part on our ability to continue to attract and
retain qualified management, technical, marketing and sales personnel and the
continued contributions of such management and personnel. Competition for
qualified employees and personnel in the telecommunications industry remains
strong and there are a limited number of persons with knowledge of and expertise
in the industry. We do not maintain key person life insurance for any of our
executive officers. We do have employment agreements with key executive
officers. Although we have been successful in attracting and retaining qualified
personnel, we can make no assurances that we will be able to hire or retain
necessary personnel in the future. The loss of services of one or more of our
key executives, or the inability to attract and retain additional qualified
personnel, could materially and adversely affect us.
WE MAY NOT HAVE THE ABILITY TO DEVELOP STRATEGIC ALLIANCES, MAKE INVESTMENTS OR
ACQUIRE ASSETS NECESSARY TO COMPLEMENT OUR EXISTING BUSINESS
We may seek, as part of our business strategy, to continue to develop strategic
alliances or to make investments or acquire assets or other businesses that will
relate to and complement our existing business. We are unable to predict whether
or when any planned or prospective strategic alliances or acquisitions will
occur or the likelihood of a material transaction being completed on favorable
terms and conditions. Our ability to finance strategic alliances and
acquisitions may be constrained by our degree of leverage at the time of such
strategic alliance or acquisition. In addition, our credit facility may
significantly limit our ability to enter into strategic alliances or make
acquisitions and to incur indebtedness in connection with strategic alliances
and acquisitions.
-19-
We can make no assurances that any acquisition will be made or that we will be
able to obtain financing needed to fund such acquisition. We currently have no
definitive agreements with respect to any material acquisition, although from
time to time we may have discussions with other companies and assess
opportunities on an ongoing basis. We do not have any current plans of
acquisition.
In addition, if we were to proceed with one or more significant strategic
alliances, acquisitions or investments in which the consideration consists of
cash, we could use a substantial portion of our available cash to consummate the
strategic alliances, acquisitions or investments. The financial impact of
strategic alliances, acquisitions and investments could have a material adverse
effect on our business, financial condition and results of operations and could
cause substantial fluctuations in our quarterly and yearly operating results.
Furthermore, if we use our common stock as consideration for acquisitions our
shareholders could experience dilution of their existing shares.
OUR PRIOR YEARS' FINANCIAL STATEMENTS HAVE BEEN AUDITED BY ARTHUR ANDERSEN LLP
Our consolidated financial statements for the years ended December 31, 2001 and
2000 were audited by Arthur Andersen LLP, independent public accountants. On
August 31, 2002, Arthur Andersen ceased practicing before the SEC. Therefore,
Arthur Andersen did not participate in the preparation of this Form 10-K, did
not reissue its audit report with respect to the financial statements included
in this Form 10-K, and did not consent to the inclusion of its audit report in
this Form 10-K. As a result, holders of our securities may have no effective
remedy against Arthur Andersen in connection with a material misstatement or
omission in the financial statements to which its audit report relates. In
addition, even if such holders were able to assert such a claim, because it has
ceased operations, Arthur Andersen may fail or otherwise have insufficient
assets to satisfy claims made by holders of our securities that might arise
under federal securities laws or otherwise with respect to Arthur Andersen's
audit report.
OUR STOCK PRICE HAS DECLINED SIGNIFICANTLY
Our stock price has experienced significant price fluctuations. The market price
for our common stock may continue to be subject to wide fluctuations in response
to a variety of factors, including but not limited to the following, some of
which are beyond our control:
o revenues and operating results failing to meet the expectations of
securities analysts or investors in any period;
o failure to successfully implement our business strategy;
o announcements of operating results and business conditions by our
clients and competitors; o technological innovations by competitors or
in competing technologies;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o announcements by third parties of significant claims or proceedings
against us;
o investor perception of our industry or our prospects;
o economic developments in the telecommunications industry and general
market conditions; or
o regulatory changes.
Our common stock is listed on the OTC Bulletin Board (OTCBB) and as such is
subject to certain requirements for continued listing.
RISKS RELATED TO OUR INDUSTRY
We face a high level of competition in the telecommunications industry
The telecommunications industry is highly competitive, and one of the primary
purposes of the Telecommunications Act of 1996 is to foster further competition.
In each of our markets, we compete principally with the established telephone
company serving such market. The established telephone companies have
long-standing relationships with their clients, financial, technical and
marketing resources substantially greater than ours and the potential to fund
competitive services with cash flows from a variety of businesses. Established
telephone companies also benefit from existing regulations that favor them over
integrated communications providers and competitive local exchange carriers in
some respects. Furthermore, one large group of established telephone companies,
the regional Bell operating companies, have pricing flexibility under particular
conditions from federal regulators with regard to some services with which we
compete. This presents established telephone companies with an opportunity to
subsidize services that compete with our services and offer such competitive
services at lower prices.
-20-
It is likely that we will also face competition from other integrated
communications providers, facilities-based competitive local exchange carriers
and other competitors in some of our markets. We believe that second and third
tier markets will support only a limited number of competitors and that
operations in such markets with multiple competitive providers are likely to be
unprofitable for one or more of such providers.
We can make no assurances that we will be able to achieve or maintain adequate
market share or margins, or compete effectively, in any of our markets.
Moreover, many of our current and potential competitors have financial,
technical, marketing, personnel and other resources, including brand name
recognition, substantially greater than ours as well as other competitive
advantages over us. Any of the foregoing factors could have a material adverse
effect on our business, financial condition or results of operations. See
"Description of Business - Competition."
WIRELINE PROVIDERS FACE INCREASED COMPETITION FROM WIRELESS SERVICES
Wireless services constitute another significant source of competition to our
wireline telecommunications services. Wireless carriers such as Verizon
Wireless, AT&T Wireless and Cingular Wireless have expanded and improved their
network coverage, started to provide bundled wireless products and lowered their
prices to end-users. As a result, customers are beginning to substitute wireless
services for basic wireline service. Wireless telephone services can also be
used for data transmission. These factors could also have a material adverse
effect on our business, financial condition or results of operations.
FINANCIAL DIFFICULTIES OF OUR COMPETITORS COULD ADVERSELY AFFECT OUR BUSINESS
Many of our competitors have experienced substantial and highly publicized
financial difficulties over the past year. The financial difficulties of these
companies could reflect poorly on the telecommunications industry and increased
scrutiny of our own financial and operational stability. As a result, this could
diminish our ability to obtain additional capital and adversely affect the
number of customers willing to place their telecommunications services with us.
Additionally, some of these competitors have emerged from bankruptcy and have
been able to reduce their debt or otherwise recapitalize. These companies may be
able to reduce their prices to a point lower than our prices and yet still be
able to make a profit because of their reduced debt or lower capital structure.
We may lose business as a result of this price competition. Any of the foregoing
factors could have a material adverse effect on our business, financial
condition or results of operations.
FCC AND STATE REGULATIONS MAY LIMIT THE SERVICES WE CAN OFFER
Our networks and the provision of telecommunications services are subject to
significant regulation at the federal, state and local levels. The costs of
complying with these regulations and the delays in receiving required regulatory
approvals or the enactment of new adverse regulation or regulatory requirements
may have a material adverse effect upon our business, financial condition and
results of operations.
We can make no assurances that the FCC or state commissions will grant required
authority or refrain from taking action against us if we are found to have
provided services without obtaining the necessary authorizations. If we do not
fully comply with the rules of the FCC or state regulatory agencies, third
parties or regulators could challenge our authority to do business. Such
challenges could cause us to incur substantial legal and administrative
expenses.
Our Internet operations are not currently subject to direct regulation by the
FCC or any other governmental agency, other than regulations applicable to
businesses generally. However, the FCC continues to examine the regulatory
status of some services offered over the Internet. New laws or regulations
relating to Internet services, or existing laws found to apply to them, may have
a material adverse effect on our business, financial condition or results of
operations.
The Telecommunications Act of 1996 remains subject to judicial review and
additional FCC rulemaking, and thus it is difficult to predict what effect the
legislation will have on us and our operations. There are currently many
regulatory actions underway and being contemplated by federal and state
authorities regarding interconnection pricing and other issues that could result
in significant changes to the business conditions in the telecommunications
industry. We can make no assurances that these changes will not have a material
adverse effect on our business, financial condition or results of operations.
-21-
REGULATION OF INTERCONNECTION WITH ESTABLISHED TELEPHONE COMPANIES INVOLVES
UNCERTAINTIES, AND THE RESOLUTION OF THESE UNCERTAINTIES COULD ADVERSELY AFFECT
OUR BUSINESS
Although the established telephone companies are required under the
Telecommunications Act of 1996 to unbundle and make available elements of their
network and permit us to purchase only the origination and termination services
that we need, thereby decreasing our operating expenses, such unbundling may not
be done as quickly as we require and may be priced higher than we expect. This
is important because we rely on the facilities of these other carriers to
connect to our switches so that we can provide services to our customers. Our
ability to obtain these interconnection agreements on favorable terms, and the
time and expense involved in negotiating them, can be adversely affected by
legal developments.
We have interconnection agreements with a number of established telephone
companies through negotiations or, in some cases, adoption of another
competitive local carrier's approved agreement. These agreements remain in
effect, although in some cases one or both parties may be entitled to demand
renegotiation of particular provisions based on intervening changes in the law,
if any. However, it is uncertain whether any of these agreements will be so
renegotiated or whether we will be able to obtain renewal of these agreements on
as favorable terms when they expire.
A Supreme Court decision vacated a FCC rule determining which network elements
the established telephone companies must provide to competitors on an unbundled
basis. On November 5, 1999, the FCC released an order revising its unbundled
network element rules to conform to the Supreme Court's interpretation of the
law, and reaffirmed the availability of the basic network elements, such as
local loops, the connection from a customer's location to the established
telephone company, and dedicated transport, used by us. In May 2002, the Supreme
Court upheld the FCC's revised rules. In the same case, the Supreme Court also
upheld the FCC's total element long-run incremental (TELRIC) pricing rules.
Favorable resolution of these cases will not necessarily affect future
uncertainties inherent in the regulation of interconnection with established
telephone companies.
On February 20, 2003, in its Triennial Review Decision, the FCC announced
revised established telephone company obligations to make elements of their
networks available on an unbundled basis to competitors and new entrants. The
impacts of this Triennial Review decision mean that the FCC is poised to
eliminate unbundling provisions with respect to fiber and copper-fiber plant.
Although the final order has not been issued by the FCC, any change in the
availability of network elements could affect our business plans and operations.
IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE TELECOMMUNICATIONS
INDUSTRY OUR BUSINESS COULD BE ADVERSELY AFFECTED
The telecommunications industry is subject to rapid and significant changes in
technology, including continuing developments in DSL technology, which does not
presently have widely accepted standards, and alternative technologies for
providing high-speed data transport and networking. The absence of widely
accepted standards may delay or increase the cost of our market entry due to
changes in equipment specifications and customer needs and expectations. If we
fail to adapt successfully to technological changes or obsolescence, fail to
adopt technology that becomes an industry standard or fail to obtain access to
important technologies, our business, financial condition or results of
operations could be materially adversely affected. We may also be dependent on
third parties for access to new technologies. Also, if we acquire new
technologies, we may not be able to implement them as effectively as other
companies with more experience with those technologies and in their markets.
ADDITIONAL INFORMATION
You may read and copy this Form 10-K, including the attached exhibits, and any
reports, statements or other information that we may file, at the SEC's Public
Reference Room at 450 Fifth Street, N.W., Room 1024, Washington, D.C.
20549-1004. You can request copies of these documents, upon payment of the
duplicating fee, by writing to the SEC at its principal office at 450 Fifth
Street, N.W., Washington, D.C. 20549-1004. Please call the SEC at 1-800-SEC-0330
for further information on the operation of the Public Reference Room. Our SEC
filings are also available to the public, free of charge, on the SEC's Internet
site (www.sec.gov) or our Internet site (www.choiceonecom.com). None of the
materials posted on our Internet site are incorporated in this Form 10-K.
-22-
ITEM 2. PROPERTIES
We are headquartered in Rochester, New York. We occupy office space in Rochester
under a market-rate lease that expires in 2009. As of December 31, 2002, this
lease covered 105,680 square feet. We also have administrative offices under a
lease for 109,000 square feet of space in Grand Rapids, Michigan. The leases for
this space expire in 2003 and 2009. In addition, we lease space in a number of
locations, primarily for sales offices and network equipment installations. We
believe that our leased facilities are adequate to meet our current needs and
that additional facilities are available to meet our development and expansion
needs in existing markets.
ITEM 3. LEGAL PROCEEDINGS
On January 26, 2002, the Company and its wholly owned subsidiary US Xchange
(referred to collectively for purposes of this paragraph as the Company), filed
suit against AT&T Corp ("AT&T"). This action is now pending in the United States
District Court for the Western District of New York (02-CV-6090L). The Company
is seeking damages from AT&T for breach of contract, based upon AT&T's failure
to pay, either on time or in full, the Company's invoices for access services
provided to AT&T. On April 26, 2002, the Company filed a motion for partial
summary judgment based upon AT&T's failure to pay the Company's invoices on
account, and for a declaration that AT&T materially breached its agreements for
failure to pay. AT&T cross-moved for partial summary judgment, seeking dismissal
of several of the Company's causes of action. On September 24, 2002, following
oral argument, a decision dismissing some of the Company's causes of action, but
preserving for trial the Company's claim for breach of contract and declaratory
judgment, based upon AT&T's failure to pay, either on time or in full, the
Company's invoices for access services provided to AT&T. On February 6, 2003,
the Company amended its complaint, eliminating the causes of action that had
been dismissed. The parties are now engaged in the discovery process.
On November 20, 2001, the Company and three of its officers were named in a
complaint filed in the United States District Court for the Southern District of
New York on behalf of a class of persons consisting of certain purchasers of the
Company's common stock in its initial public offering which was completed on
February 23, 2000. The complaint seeks damages based on allegations that the
Company's Registration Statement and Prospectus relating to the offering
contained material misstatements and/or omissions regarding the compensation
received by the underwriters of the offering and certain transactions engaged in
by the underwriters. This case, which has been consolidated with more than 300
other cases against other companies involving similar allegations, also names
six underwriters of the Company's offering and the offerings of other issuers,
and alleges that the underwriters engaged in a pattern of conduct to extract
inflated commissions in excess of the amounts disclosed in offering materials
and manipulated the post-offering markets in connection with hundreds of
offerings by engaging in stabilizing transactions and issuing misleading and
fraudulent analyst and research reports. The underwriters are also the subject
of publicly disclosed investigations by several governmental agencies. The
complaint alleges that the Company is strictly liable under Section 11 of the
Securities Act of 1933 because Item 508 of Regulation S-K allegedly required the
disclosure of commissions to be paid to underwriters and of stabilizing
transactions, and that the Company and its officers acted with scienter, or
recklessness, in failing to disclose these facts, in violation of Section 10(b)
of the Securities Exchange Act and Rule 10b-5 promulgated thereunder. The claims
against the individual defendants have been dismissed without prejudice, by an
agreement with the plaintiffs. The court recently denied motions to dismiss the
cases, and the parties are discussing a framework for conducting discovery,
including a process for limiting discovery involving issuers such as the Company
in all but a few test cases. Settlement discussions with the plaintiffs are
ongoing, under the guidance of a mediator, but it is not possible to predict
whether and when, and on what terms, any settlement might eventually be
finalized.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
-23-
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning our executive officers and
other key personnel, including their ages, as of December 31, 2002.
Name Age Title
---- --- ------
Steve M. Dubnik....................... 40 Chairman of the Board and Director, President and Chief
Executive Officer
Kevin S. Dickens...................... 39 Co-Chief Operating Officer
Ajay J. Sabherwal..................... 36 Executive Vice President, Finance and Chief Financial Officer
Mae H. Squier-Dow..................... 41 Co-Chief Operating Officer
Philip H. Yawman...................... 37 Executive Vice President, Corporate Development
Robert O. Bailey...................... 56 Senior Vice President, Technology
Linda S. Chapman...................... 39 Senior Vice President, Human Resources
Scott D. Deverell..................... 37 Vice President, Accounting, Treasurer and Controller
Elizabeth A. Ellis.................... 44 Senior Vice President, Information Technology
Elizabeth J. McDonald................. 49 Vice President, Legal and Regulatory Affairs, and General Counsel
Terry Nulty........................... 47 Senior Vice President, Sales
Kevin Stephens........................ 40 Senior Vice President, Marketing
Steve M. Dubnik, our Chairman of the Board, President, Chief Executive
Officer and Co-Founder, has worked in the telecommunications industry for 19
years. Prior to founding Choice One in June 1998, Mr. Dubnik served in various
capacities with ACC Corp., including as the President and Chief Operating
Officer of North American Operations of ACC from November 1996 to April 1998 and
as Chairman of the Board of Directors of ACC TelEnterprises Ltd. from July 1994
to April 1998. From December 1997 to April 1998, he also jointly performed the
functions of Chief Executive Officer of ACC. Mr. Dubnik currently serves on the
Board of Managers of FiberTech Networks, LLC.
Kevin S. Dickens, our Co-Chief Operating Officer since August 2000 and
prior to that Senior Vice President, Operations and Engineering, and Co-Founder
since July 1998, has worked in the telecommunications industry for 14 years.
Prior to joining us, Mr. Dickens was President and Chief Executive Officer of
ACC Corp.'s Canadian subsidiary, ACC TelEnterprises Ltd., from May 1997 to June
1998. Prior thereto, Mr. Dickens was Vice President of Network Planning and
Optimization at Frontier Corporation, from September 1996 to May 1997, with
responsibility for Frontier's long distance network.
Ajay J. Sabherwal, our Executive Vice President, Finance and Chief
Financial Officer since September 1999, has worked both directly in the
telecommunications industry and as an equity analyst covering the
telecommunications industry for over 13 years. Mr. Sabherwal was most recently
executive director of institutional equity research for Toronto-based CIBC World
Markets from June 1996 to September 1999. Prior to joining CIBC World Markets as
a senior research analyst in June of 1996, Mr. Sabherwal was the
telecommunications analyst for BZW (Barclays de Zoete Wedd) Canada and its
successor company from November 1993 until June 1996.
Mae H. Squier-Dow, our Co-Chief Operating Officer since August 2000 and
prior to that Senior Vice President, Sales, Marketing and Service, and
Co-Founder since June 1998, has worked in the telecommunications industry for 18
years. Ms. Squier-Dow served as President of ACC Telecom, a U.S. subsidiary of
ACC Corp., from June 1996 to May 1998, and in several positions at ACC Long
Distance U.K. Ltd., including as Commercial Director from April 1995 to June
1996, and as Director of Client Relations and Marketing, Vice President of
International Planning and Operations Director from October 1993 to April 1995.
Philip H. Yawman, our Executive Vice President, Corporate Development and
Co-Founder since July 1998, has worked in the telecommunications industry for 15
years. Prior to joining us, Mr. Yawman was Vice President of Investor Relations
and Corporate Communications at ACC Corp. from April 1997 to January 1998. Mr.
Yawman also served in various positions at Frontier Corporation from July 1989
to April 1997, including as head of investor relations' activities and in
several product management positions.
-24-
Robert O. Bailey, our Senior Vice President, Technology since September
1999, is responsible for engineering and operation of the Choice One network. In
addition, he is responsible for evaluating and selecting the technology to be
deployed by Choice One in the next generation of switching systems architecture,
including the evolution from circuit switching systems to packet and ATM-based
infrastructure. Most recently, he was Vice President and Chief Technology
Officer for the Upstate Cellular Network (Frontier Cellular), a joint venture of
Verizon Mobile and Frontier Corporation, from January 1985 until April 1999,
where he was responsible for engineering and operations of a cellular network
that covered 5.5 million population units in upstate New York.
Linda S. Chapman, our Senior Vice President, Human Resources since May 2001
and prior to that Vice President, Human Resources since August 1998, was the
Director of Human Resources of ACC Corp.'s U.S. subsidiary, ACC Telecom, from
June 1997 to July 1998. Prior thereto, Ms. Chapman held various management
positions with MCI from March 1994 to May 1997.
Scott D. Deverell, our Vice President, Accounting, Treasurer and Controller
since September 2002, and prior to that our Vice President, Accounting, and
Controller since March 2000 and Director of Accounting since December 1998, is a
certified public accountant. Prior to joining us, Mr. Deverell was employed by
PSC Inc. as Assistant Treasurer from September 1997 to December 1998 and as
Controller from 1990 until September 1997.
Elizabeth A. Ellis, our Senior Vice President, Information Technology since
August 2000 and prior to that Vice President, Information Technology since July
1998, has worked in the information technology field for over 22 years,
including the past seven years in the telecommunications industry. Prior to
joining us in July 1998, Ms. Ellis was Commercial Director for ACC Telecom's
subsidiaries in the United Kingdom and Germany from August 1994 to June 1998
where she was responsible for all aspects of network, operations, client
service, telemarketing and information technology.
Elizabeth J. McDonald, our Vice President, Legal and Regulatory Affairs and
General Counsel since December 2002, served as Associate General Counsel since
November 2001. Prior to joini