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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 33339884-01
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MPOWER HOLDING CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 52-2232143
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
175 SULLY'S TRAIL, SUITE 300, PITTSFORD, NY 14534
(Address of principal executive offices) (Zip Code)
(585) 218-6550
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE PER SHARE
(Title of class)
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 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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of June 28, 2002, the aggregate market value of common stock held by
non-affiliates of the registrant, based on the last sale price of such stock in
the NASD Over the Counter Bulletin Board on June 28, 2002, was approximately
$1.5 million.
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [ ]
As of March 21, 2003, the registrant had 64,999,025 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Not Applicable
Exhibit Index is located on page 57.
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PART I
ITEM 1. BUSINESS
THE COMPANY
We are a competitive local exchange carrier ("CLEC") offering local
dial-tone, long distance, high-speed Internet access via dedicated Symmetrical
Digital Subscriber Line ("SDSL") technology, voice over SDSL ("VoSDSL"), Trunk
Level 1 ("T1"), Integrated T1 and Data-only T1 as well as other voice and data
features. Our services are offered primarily to small and medium-sized business
customers through our wholly owned subsidiary, Mpower Communications Corp.
("Communications") in Los Angeles, San Diego, Las Vegas, Northern California and
Chicago. We currently have approximately 45,000 business customers and
approximately 25,000 residential customers (primarily in the Las Vegas market).
We also bill a number of major carrier customers for the costs of originating
and terminating traffic on the Mpower network. We currently acquire
approximately 90% of our new sales through our direct sales force, with the
remainder acquired through agent relationships.
FINANCIAL HISTORY
In May 1998, we completed our initial public offering of common stock,
raising net proceeds of $63.0 million. From May 1999 to March 2000, we raised
over $900 million of additional funds through debt and equity issuances to
pursue an aggressive business plan to rapidly expand our network utilizing
low-cost, facilities-based "soft-switch" voice switching technology and
integrated voice and high-speed data over a single DSL loop ("VoDSL"). As we
were building out our new markets throughout 2000, our vendors continued to
delay the commercial release of soft-switch technology and the local exchange
carriers ("LECs") were experiencing difficulty in providing high-quality DSL
loops to us over which we had planned to provide our low-cost VoDSL service to
our target customers. To address these impediments to our business plan, we
shifted our strategy and began deploying higher-cost Class 5 circuit switching
technology in each of our markets (the same as used by Verizon, SBC, and other
major telecommunication companies) and began deploying digital loop carriers in
each collocation site. This change to our business plan required significantly
higher up-front capital expenditures in each market as well as lower recurring
margins. At the same time, the capital markets became virtually inaccessible to
early stage communications ventures. Consequently, in September 2000, we
commenced what has become a 30-month process to restructure our business, both
operationally and financially.
- - From September 2000 through May 2001, we significantly scaled back our
operations, canceling more than 500 existing collocations, and canceling
plans to enter the Northeast and Northwest Regions (representing more than
350 collocations).
- - From February 2002 through July 2002, we undertook a comprehensive
recapitalization through a Chapter 11 bankruptcy plan that eliminated
$593.9 million in carrying value of debt settled and preferred stock (as
well as $65.3 million of associated annual interest and dividend costs) in
exchange for cash and the substantial majority of our common stock.
- - From November 2002 to January 2003, we eliminated the remaining $51.3
million of carrying value of our debt for cash payments, which released
the only security interest in the vast majority of our network assets,
giving us the ability to pursue alternative financing and strategic
transactions.
- - In January 2003, we announced we had reached an agreement with RFC Capital
Corporation, a wholly owned subsidiary of Textron Financial Corporation,
for a three-year funding facility of up to $7.5 million, secured only by
certain of our receivables.
- - In January 2003, we announced a series of strategic transactions to
further strengthen us financially and focus our operations on our
California, Nevada and Illinois markets. Those transactions will bring
geographic concentration to our business by selling our customers and
assets in Florida, Georgia, Ohio, Michigan and Texas to other service
providers (the "Asset Sales"). The Asset Sales for customers and assets in
Ohio and Michigan were completed on March 18, 2003 and Texas on March 27,
2003. Completion of the remaining Asset Sales are subject to a number of
closing conditions and contingencies. When consummated, the Asset Sales
are expected to generate net proceeds to us of approximately $17.0 million
to $20.0 million over the next few months.
EMERGENCE FROM CHAPTER 11 PROCEEDINGS
On July 30, 2002, we and our subsidiary Communications, formally emerged
from Chapter 11 as our recapitalization plan (the "Plan") became effective. Also
on July 30, 2002, the Bankruptcy Court dismissed the Chapter 11 case of Mpower
Lease Corp., a subsidiary of Communications. See Note 2 in the Notes to the
Consolidated Financial Statements for a summary of the material features of the
Plan.
As of July 30, 2002, we implemented fresh-start accounting under the
provisions of Statement of Position ("SOP") 90-7. Under SOP 90-7, our
reorganization fair value was allocated to our assets and liabilities, our
accumulated deficit was eliminated, and our new equity was issued according to
the Plan as if we were a new reporting entity. In conformity with fresh-start
accounting principles, Predecessor Mpower Holding recorded a $244.7 million
reorganization charge to adjust the historical carrying value of our assets and
liabilities to fair market value reflecting the allocation of our $87.3 million
estimated reorganized equity value as of July 30, 2002. We also recorded a
$315.3 million gain on the cancellation of debt on July 30, 2002 pursuant to the
Plan. As a result, our net operating loss carryforwards, which were subject to
annual use limitations before the reorganization, may be significantly reduced.
As a result of our reorganization, the financial statements published by
us for the periods following the effectiveness of the Plan will not be
comparable to those published before the effectiveness of the Plan.
RESHAPING MPOWER
Our scaling back of operations from September 2000 through May 2001,
canceling more than 500 existing collocations and canceling plans to enter the
Northeast and Northwest regions followed by emergence from Chapter 11 and the
recapitalization of our balance sheet were significant steps in a sequential
process to reshape our company. Through the pre-negotiated Chapter 11
proceeding, we eliminated $593.9 million in carrying value of long-term debt
settled and preferred stock in exchange for $19.0 million in cash and
substantially all of the common stock of our reorganized company. This process
reduced our debt by roughly 95%. In November 2002, we repurchased $49.2 million
in carrying value of our 2004 Notes settled for $14.2 million in cash. In
January 2003, we repurchased the remaining $2.1 million in carrying value of our
2004 Notes for $2.2 million in cash. This transaction will remove the vast
majority of liens on our network equipment effective on or about April 3, 2003
and make us completely long-term debt free.
With our long-term debt eliminated, the second step in the process of
reshaping our company was to significantly bring down our cash burn rate. We
first began to see cash conservation as a priority in September 2000 when we
pulled back on our network expansion plans. Since that time, we have continued
to scale back our market footprint and have made significant operational
improvements which resulted in efficiencies including reduced headcount and
lower SG&A and capital expenditures. In early January 2003, we announced the
sale of our markets in Florida, Georgia, Ohio, Michigan and Texas. The sales of
Ohio and Michigan were completed on March 18, 2003 and Texas on March 27, 2003.
The remaining Asset Sales are anticipated to be completed by the end of April
2003 and are expected to accomplish three things: significantly reduce our cash
burn; bring additional cash through the sale of the markets; and result in
geographic concentration for the rest of our business.
The final step in reshaping our company is scaling the business for future
growth, which is intended to be our focus in 2003. As a primarily west-coast
based company, we intend to concentrate on being a significant presence and
fierce competitor in the telecommunications marketplace serving small and
medium-sized business customers in our California, Nevada and Illinois markets.
We will explore opportunities to add revenue streams to our existing network
through transactions that are accretive to shareholder value and we will
continue to invest in the success of the company by adding capacity on our
network to meet the demand for our services.
COMPANY OVERVIEW
We provide integrated voice and high-speed data services to small and
medium-sized business customers in five markets throughout California (Los
Angeles, San Diego and Northern California) and in Nevada (Las Vegas only) and
Illinois (Chicago only). Our network consists of 294 incumbent carrier central
office collocation sites providing us access to nearly 5.3 million addressable
business lines. Substantially all of our central office collocation sites are
SDSL capable and 196 are T1 capable. We have established working relationships
with Verizon, Sprint, and Southwestern Bell Corporation (including its operating
subsidiaries PacBell and Ameritech, collectively referred to as "SBC"). We have
over 260,000 lines in service.
We were one of the first competitive communications carriers to implement
a facilities-based network strategy. As a result, we own the network switches
that control how voice and data communications originate and terminate, and we
lease the telephone lines or transport systems, over which the voice and data
traffic are transmitted. We install our network equipment at collocation sites
of the incumbent carriers from whom we lease standard telephone lines. As we
have already invested and built our network, we believe our strategy has allowed
us to establish and sustain service in our markets at a comparatively low cost
while maintaining control of the access to our customers.
Our business is to deliver integrated voice and broadband data solutions.
Specifically, we provide small and medium-sized business customers with a full
suite of communications services and features integrated on one bill with the
convenience of a single source provider. We have a total of approximately 45,000
business customers in Los Angeles, San Diego, Las Vegas, Northern
California and Chicago, providing them local voice telephone service and
broadband Internet via SDSL and T1. By leveraging our existing equipment,
interconnection agreements with incumbent carriers and network capabilities, we
are able to offer fully integrated and channelized voice and data products over
a T1 connection. To serve the largest portion of our target audience, our
combined voice and data network allows us to deliver services in several
combinations over the most favorable technology: basic phone service on the
traditional phone network, SDSL service, integrated T1 voice and data service,
or data-only T1 connectivity.
We also generate revenue from a number of major carrier customers for the
costs of terminating traffic on our network.
We currently acquire approximately 90% of our new sales through our direct
sales force, with the remainder being acquired through agent relationships.
Our highest margin opportunities come from sales of our integrated T1
product, which leverages the full capability of our network.
MARKET OPPORTUNITY
We believe we have a significant market opportunity as a result of the
following factors:
IMPACT OF THE TELECOMMUNICATIONS ACT OF 1996
The Telecommunications Act of 1996 allows competitive carriers to use the
existing infrastructure established by incumbent carriers, as opposed to
building a competing infrastructure at significant cost. The Telecommunications
Act requires all incumbent carriers to allow competitive carriers to collocate
their equipment in the incumbent carrier's central offices. This enables
competitive carriers to access customers through existing telephone line
connections. The Telecommunications Act created an incentive for incumbent
carriers that were formerly part of the Bell system to cooperate with
competitive carriers by precluding each of these incumbent carriers from
providing long distance service in its region until regulators determine there
is a significant level of competition in the incumbent carriers' local market.
See "Government Regulations."
NEEDS OF SMALL AND MEDIUM SIZE BUSINESSES FOR INTEGRATED COMMUNICATIONS
SOLUTIONS
Small and medium-sized businesses have few cost-effective alternatives for
traditional telecommunication services or for Internet access. These businesses
must often contend with productivity limitations associated with slow
transmission speeds from dial-up services. In addition, to meet their
communications needs, small and medium-sized businesses are subject to the cost
and complexity of using multiple service providers: local dial-tone providers,
long distance carriers, Internet service providers and equipment integrators. We
believe these businesses can benefit significantly from an integrated
cost-effective communications solution delivered by a single provider.
GROWING MARKET DEMAND FOR HIGH-SPEED DATA SERVICES
The rise of the Internet as a commercial medium as well as a necessary
business tool, has driven the demand for high-speed data services. Businesses
are increasingly establishing Web sites and corporate intranets and extranets to
expand their customer reach and improve their communications efficiency. To
remain competitive, small and medium-sized businesses increasingly need
high-speed data and Internet connections to access critical business information
and communicate more effectively with employees, customers, vendors and business
partners.
SHRINKING COMPETITIVE LANDSCAPE
The shake out in the telecommunications industry in recent years has
significantly reduced the number of competitive local exchange carriers and
other DSL providers in the marketplace. Many companies in the competitive
communications industry have succumbed to heavy debt loads and burdensome
interest payments without the revenue streams to compensate, and therefore have
not been able to sustain their business model. As a result, fewer competitors
are vying for the same customers.
THE MPOWER SOLUTION
We believe that we offer an attractive communications solution to small
and medium-sized business customers. In developing our solution, we have
attempted to include elements intended to create customer loyalty. Key aspects
of our solution include:
Integrated Communications Solutions. We offer cost-effective,
comprehensive and flexible communications solutions. Our customers have the
convenience of a single point of contact for a complete package of services,
eliminating the need to manage
multiple vendors.
Dedicated Support. Our account managers personally call on the small and
medium-sized businesses. This is in contrast to many other communications
companies which primarily telemarket to these businesses.
Service Reliability. Our network is designed to mirror the reliability of
the incumbent carriers. In addition, we believe we are able to offer our
customers a high degree of service reliability through efficient, timely
provisioning of lines due to our mature relationships with the incumbent
carriers.
BUSINESS STRATEGY
Targeting Small and Medium-Sized Businesses. Based on telephone lines in
service, we believe the small and medium-sized business customer base is a large
and rapidly growing segment of the communications market. We target suburban
areas of large metropolitan markets because these areas have high concentrations
of small and medium-sized businesses. In addition to being densely clustered in
the urban and suburban areas we serve, business customers generate approximately
60% of all local telephone service revenues. By providing a package of voice and
data services and focusing on small and medium-sized business sales, we believe
we will gain a competitive advantage over the incumbent carrier, our primary
competitor for these customers.
Products and Services. We focus on offering bundled communications
packages to our small and medium-sized business customers. These services
include integrated T1 services, as well as traditional voice and data services
(see Products & Services below).
Increase Market Share and Profitable Revenue. We plan to continue to
aggressively sell into our existing network footprint and target those customers
with the products which we believe will generate the highest margin revenue
streams and maximize network efficiencies. Focusing on providing integrated
solutions, feature rich lines, and a minimum size for voice only orders should
further increase the quality of our revenue streams. We expect that the majority
of network expansion will be centered around augmentation of our existing
network to further enhance our product portfolio and service delivery
capabilities.
Control Customer Relationship. By connecting the standard telephone line
originating at our customer's site to our central office collocation, we
effectively place the customer on our network. This connection serves as the
platform for delivering our current and future communications services to our
customers. Any future changes our customers want to make to their services,
including purchasing more services from us, are under our direct control. The
one exception is for repairs, which are infrequent but may require the
participation of the incumbent carrier's network maintenance staff.
Capital Efficient Network. We were one of the first competitive local
exchange carriers to implement a facilities-based network strategy of purchasing
and installing switches, collocating in the central offices of the incumbent
carrier and leasing local telephone lines, referred to as a "smart build"
strategy. This network footprint is complete and operational. We have installed
SDSL technology across our existing network, and have T1 technology in the
majority of our network collocations.
Optimize Current Network Infrastructure. The footprint of our
facilities-based network is completely built out and operational. All of our
traffic and revenue is on-switch and on-collocation, allowing us better control
over our costs. Our strategy going forward is to maximize the investment in this
infrastructure and increase market share in the areas we serve. Our network is
designed with technological flexibility that allows us to deliver our product
set in the most efficient manner regardless of the physical plant quality of the
incumbent carrier's network.
Operations Support System. We have a comprehensive operations support
system to manage our business. Our system provides integrated features
addressing customer care, billing and collections, general ledger, payroll,
fixed asset tracking, and personnel management. Our systems have the ability to
adapt to multiple incumbent carrier provisioning systems, which can improve our
operating efficiencies and effectiveness.
Timely and Accurate Provisioning for Customers. We believe one of the keys
to our success is effectively managing the provisioning process for new
customers. We have implemented a standardized service delivery process and
consolidated our service delivery centers, which has significantly reduced our
provisioning intervals and improved our provisioning quality metrics. In
addition, through electronic order interfaces with all of the incumbent
carriers, we have been able to substantially reduce the time, number of steps
and duplication of work typically involved in the provisioning process.
Quality Customer Service. We believe providing quality customer service is
essential to offering a superior product to our customers and creating customer
loyalty. We operate one main call center that handles general billing, customer
care and related
issues for all of our customers. Our call center is focused on first call
resolution, which involves an enhanced automated call distribution system that
directs callers into the customer service center based on the type of question
they have, and specially trained agents with the tools to resolve customer
issues. In addition, service delivery representatives are in contact with our
customers during the process of service conversion. Our service representatives
use our operations support system to gain immediate access to our customers'
data, enabling quick responses to customer requests and needs at any time. This
system also allows us to present our customers with one fully integrated monthly
billing statement for all communication services.
PRODUCTS & SERVICES
As an integrated service provider, we offer a variety of voice and data
services that come as a bundled solution, or can be conveniently packaged or
purchased as stand-alone products.
- - MpowerOffice integrates both voice and data services across a single pipe
- a T1 circuit. MpowerOffice delivers Internet access, local and long
distance voice service, and the most highly used local voice features and
Internet applications.
- - MpowerConnect provides customers Internet access using a T1 circuit.
Customers may choose between three data speeds, and have all the basic
services needed to connect their office with T1 speeds to the Internet.
- - Mpower's DSL Data-only solution provides customers an SDSL-based
connection to the Internet. Service includes several features such as web
hosting and custom email.
- - Data Features - We offer a variety of data features including Web hosting,
email, DNS hosting and Subnets.
- - MpowerTrunks provides customers a group of 24 trunks across our T1
service.
- - We offer POTS lines to customers as a stand-alone service for local
calling and for access to long distance service. "POTS" stands for Plain
Old Telephone Service, and is used to describe an analog voice line that
is connected to the telephone switched network for local and long-distance
calling capability.
- - Centrex is a set of services that enables our voice customers to get many
of the same features and resources they would get if they had a PBX phone
system.
- - Voice Features - We offer domestic long distance flat rate calling plans,
in addition to the most popular telephone features including Caller ID,
Call Transfer, 3-Way Calling, Call Forwarding and Remote Access to Call
Forwarding.
MARKETS
We have redefined the remaining 12 markets in our footprint as five
markets: Los Angeles, San Diego, Northern California, Las Vegas and Chicago.
As of March 2003, we operate our five markets in three states and have 294
incumbent carrier central office collocation sites providing access to an
estimated 5.3 million addressable business lines.
The table below shows the distribution of our central office collocation
sites within these markets.
ADDRESSABLE
NUMBER OF LINES WITHIN
MARKET COLLOCATIONS TARGET MARKET
Los Angeles ............................ 142 2,500,000
San Diego .............................. 28 500,000
Northern California .................... 40 725,000
Las Vegas .............................. 18 175,000
Chicago ................................ 66 1,400,000
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Totals ................................. 294 5,300,000
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In January 2003, we took steps to achieve geographic concentration by
entering into agreements to sell our markets in Florida, Georgia, Ohio, Michigan
and Texas to other telecommunications providers. The sales of Ohio and Michigan
were completed on March 18, 2003 and Texas on March 27, 2003. The remaining
Asset Sales are anticipated to be completed by the end of April 2003. Our focus
is now primarily the west coast and our efforts are directed toward building
market share within our existing service territory. We believe there is
significant scaling
potential within our existing market footprint, given our past success in market
penetration in our base of original markets. In addition, our robust network
backbone is scalable and can provide reliability and service quality across our
collocation footprint, while affording us the benefit of spreading the fixed
costs across our markets.
SALES AND MARKETING
We take a "feet-on-the-street" approach to both sales and marketing. As of
March 21, 2003, we employed approximately 150 quota-carrying sales personnel and
an additional approximately 50 sales support personnel. Approximately 90% of our
new sales are acquired through our direct sales force. Our dedicated account
managers personally meet with customers to determine the best communications
solution for them. As a result, much of our business comes through referrals and
networking. Our highly focused relationship-building approach seeks to generate
well-managed, profitable growth through increased market share with minimal
customer turnover. Our sales organization is divided into teams within markets.
Each market has a sales director who oversees the team sales managers. The
directors report to our President of sales. Our direct sales efforts
are complimented by our telemarketing and agent channels, which also target the
small and medium-sized business customer.
Our sales representatives are supported by sales coordinators, customer
account managers and service delivery personnel. These support personnel
function as the liaison between the small business customer and our operational
personnel to effect a coordinated transfer of service from the incumbent
carrier's network to our network. Field technicians are responsible for the
installation of customer premise equipment, if required.
NETWORK ARCHITECTURE AND TECHNOLOGY
We were one of the first competitive communications carriers to implement
a facilities-based network strategy. As a result, we own the network switches
that control how voice and data transmissions originate and terminate, and we
lease from the incumbent local carrier (primarily SBC) only the telephone lines
over which the voice and data traffic are transmitted. Because we have already
invested and built our network, we are able to serve a broad geographic area at
a comparatively low cost while maintaining control of the access to our
customers. By comparison, many CLECs do not control their own facilities and,
therefore, are much more dependent upon the local Bell companies and the federal
and state regulatory environment in order to ensure the viability of their
business plans.
We have implemented a strategy enabling us to own the hardware that routes
voice calls and data traffic, which we refer to as "switches", while leasing the
telephone lines and cable over which the voice calls and data traffic are
actually transmitted, which we refer to as "transport". We use three basic types
of transport to transmit voice calls and data traffic. First, we lease the
standard telephone line from the incumbent carrier. This allows us to move voice
calls and data traffic from a customer's location to the nearest central office
owned by the incumbent carrier. Inside these central offices, we have equipment
that allows us to deliver the services we sell to our customers. Second, we
lease network capacity from other communications companies, which connects the
equipment we installed in the central office of the incumbent carrier to our
switches. Third, we lease additional network capacity from other communications
companies, which connect our switches to each other and allow us to complete our
customers' long distance calls to national and international destinations. We
believe this network strategy provides us an efficient capital deployment plan,
which should allow us to achieve an attractive return on our invested capital.
We believe that leasing the standard telephone line from the incumbent
carrier's central office to the end-user provides a cost-efficient solution for
gaining control of access to our customers. Leasing costs are not incurred until
we have acquired a customer and revenue can be generated. It is our experience
that the network required to connect our collocation equipment located at an
incumbent carrier's central office to our switching hardware and the network
required to connect our customers' voice calls and data traffic to the Internet
and other telephones is available at reasonable prices in all of our current
markets. Because the network connection required to transport voice calls and
data traffic has become a readily available service from numerous other
communications companies, we focused our efforts on owning and installing the
hardware that determines where to route voice calls and data traffic and on
selling and delivering our services to our customers.
We have seven operational voice switches. All of our current voice
switches are DMS-500 switches manufactured by Nortel Networks. These switches
offer a flexible and cost efficient way for us to provide local and long
distance services to our customers.
Once we install equipment in the collocation sites we rent from the
incumbent carrier, we initiate service to a customer by arranging for the
incumbent carrier to physically disconnect a standard telephone line from their
equipment and reconnect the same standard telephone line to our equipment. When
the standard telephone line has been connected to our equipment, we have direct
access to the customer and can deliver our voice and data services. Any future
changes the customer wishes to make, such as purchasing more services from us,
are under our direct control.
We have installed our equipment in 294 collocation sites as of March 21,
2003. We believe this network allows us to sell our services to an estimated
universe of small and medium-sized business customers which utilize
approximately 5.3 million lines. Our seven host switching sites are connected to
each other by fiber, which allows us to transmit data traffic using asynchronous
transfer mode (ATM) technology. Asynchronous transfer mode technology allows
both voice calls and data traffic to be transported in digital form over a
single cable connection at high speeds and reasonable costs. By deploying SDSL
and T1 technology into our network, we are now able to transport both voice
calls and data traffic in digital form on a single telephone line from a
customer's location to one of our switches.
Using SDSL technology, we can increase the amount of information we carry
on a standard telephone line, which we refer to as bandwidth, to more than 1.5
million bits per second or "Mbps". This bandwidth is the equivalent of 24
regular voice telephone lines. Our SDSL equipment is programmed to allocate the
available bandwidth. For example, voice calls are carried at 64 thousand bits
per second or "Kbps"; if a customer has eight phone lines and all are in use at
the same time, then 512 Kbps (eight phone lines multiplied by 64 Kbps each) of
the total 1.5 Mbps are allocated for the voice calls. The remaining bandwidth,
1024 Kbps, is available to carry the data traffic.
We believe the SDSL technology significantly reduces our customers'
potential for service outages when the incumbent carrier moves the standard
telephone line from their equipment to ours. Additionally, we believe this
technology reduces our costs since we lease a reduced number of standard
telephone lines per customer from the incumbent carrier. For example, if a
customer today has eight voice lines, we must order from and provision through
the incumbent carrier eight individual standard telephone lines. If the same
customer were to buy our service offering and we deliver the service using SDSL
technology, we only order and provision one standard telephone line from the
incumbent carrier.
T1 TECHNOLOGY
With 4-wire T1 technology we reduce the impact of distance limitations and
service quality sometimes associated with SDSL. A T1 will consistently offer 1.5
million Mbps data speed. With this technology, we now have an alternative to
SDSL when network restrictions will not facilitate SDSL usage. Our T1 product
offerings provide customers a choice between integrated service, data-only
service and trunks. All use the same underlying transport and equipment
technology.
"Integrated" service refers to the combination of both traditional voice
services such as local and long distance service, and high speed Internet
connectivity. It refers to a product that offers both elements, voice and data,
across a single cable. Hardware specifically designed to manage these various
types of traffic is needed at both the customer premise and within our network.
This product will allocate unused bandwidth from on-hook telephone lines to the
usable data bandwidth. For example: A customer purchases a package of 16 voice
lines and 1 Mbps of data bandwidth. When the customer is not using any of his
voice lines, he will get the full 1.5 Mbps for data. However, if he is using all
his voice lines only 1 Mbps will be available for data.
The "data-only" product provides a more robust and higher bandwidth data
offering that routes Internet traffic directly to the Internet backbone. Here a
customer will not receive any voice lines, but likewise there will be no voice
lines to limit bandwidth. Even though no voice lines come with the package, the
same customer premise device is used in order to maintain a consistency of
equipment in our network.
CUSTOMER PREMISE EQUIPMENT (CPE)
We use two basic types of equipment at the customer premise. One is called
a "modem" and the other an Integrated Access Device ("IAD"). A modem is used for
an SDSL data-only connection. Here, no voice ports are needed and therefore the
modem is adequate to support the SDSL connection. The modem communicates with
our collocation via a DSL link and the customer's network via an Ethernet link.
The IAD is used for SDSL integrated access, T1 integrated access and T1 Data
Only. Within our network on the Wide Area Network (WAN), the IAD has a built-in
modem which communicates with the SDSL and/or T1 link. From the customers'
perspective, the IAD appears as regular phone service for the voice channels,
and an Ethernet port for data traffic. An IAD is also used for the Data-Only T1
product to reduce the number of devices used at the customer premise.
INTERCONNECTION AGREEMENTS AND COMPETITIVE CARRIER CERTIFICATIONS
We have interconnection agreements for all of the markets in which we
currently operate. These agreements are with Sprint in Nevada, Verizon for parts
of California, and SBC (through one of its operating subsidiaries) also in
California and Illinois. We are certified as a competitive carrier in all of our
existing markets.
SERVICE DEPLOYMENT AND OPERATIONS
Customer Service. We strive to provide high quality customer service through:
- - Personnel. Our customer service representatives and sales personnel are
well trained and attentive to our customers' needs.
- - Call Center. Our centralized customer service center provides
comprehensive customer support. Calls from our customers are answered and
responded to with minimal wait time.
- - Coordination of Service Provisioning. We coordinate service installation
with our customers and the incumbent carriers to ensure a smooth
transition of services from the incumbent carrier to us.
- - Close Customer Contact. We proactively monitor our network and keep our
customers informed of installation or repair problems and allocate the
necessary resources to resolve any problems.
- - Billing. We provide our customers with accurate, timely and easily
understood bills.
- - Process Automation. We have a comprehensive operations support system to
manage our business. Our system provides integrated features addressing
customer care, billing and collections, general ledger, payroll, fixed
asset tracking and personnel management. Our customer service
representatives are able to handle all customer service inquiries,
including billing questions and repair calls, with the information
available from our integrated system.
GOVERNMENT REGULATIONS
OVERVIEW
Our services are regulated at the federal, state and local levels. The FCC
exercises jurisdiction over all facilities of, and services offered by,
communications common carriers like us, when those facilities are used in
connection with interstate or international communications. State regulatory
commissions have some jurisdiction over most of the same facilities and services
when they are used in connection with communications within the state. In recent
years, there has been a dramatic change in the regulation of telephone services
at both federal and state levels as both legislative and regulatory bodies seek
to enhance competition in both the local exchange and interexchange service
markets. These efforts are ongoing and many of the legislative measures and
regulations adopted are subject to judicial review. We cannot predict the impact
on us of the results of these ongoing legislative and regulatory efforts or the
outcome of any judicial review.
FEDERAL REGULATION
The FCC regulates interstate and international communications services,
including access to local telephone facilities to place and receive interstate
and international calls. We provide these services as a common carrier. The FCC
imposes more regulation on common carriers that have some degree of market
power, such as incumbent local exchange carriers. The FCC imposes less
regulation on common carriers without market power, including competitive
carriers like us. The FCC grants automatic authority to carriers to provide
interstate long distance service, but requires common carriers to receive an
authorization to construct and operate communications facilities, and to provide
or resell communications services, between the United States and international
points.
The FCC has required competitive carriers like us to cancel their tariffs
for domestic interstate and international long distance services, which were
schedules listing the rates, terms and conditions of all these services offered.
Even without tariff filing, however, carriers offering interstate and
international services must charge just and reasonable rates and must not
discriminate among customers for like services. The FCC may adjudicate
complaints against carriers alleging violations of these requirements.
Our charges for interstate access services, which includes the use of our
local facilities by other carriers to originate and terminate interstate calls,
remain governed by tariffs. In April 2001, the FCC adopted new rules that limit
our rates for these services. Under these rules, which took effect on June 20,
2001, competitive carriers were required to reduce their switched access charges
to rates no higher than 2.5 cents per minute. After one year (effective June
2002), the rate ceiling was reduced to 1.8 cents and after two years (effective
June 2003) to 1.2 cents per minute. After three years (effective June 2004), all
competitive carriers will be required to charge rates no higher than the
incumbent telephone company.
The FCC imposes numerous other regulations on carriers subject to its
jurisdiction, some of the most important of which are discussed below. The FCC
also hears complaints against carriers filed by customers or other carriers and
levies various charges and fees.
Except for certain restrictions placed on the Bell operating companies,
the Telecommunications Act permits virtually any entity, including cable
television companies and electric and gas utilities, to enter any communications
market. The Telecommunications Act takes precedence over inconsistent state
regulation. However, entities that enter communications markets must follow
state regulations relating to safety, quality, consumer protection and other
matters. Implementation of the Telecommunications Act continues to be affected
by numerous federal and state policy rulemaking proceedings and review by
courts. We are uncertain as to how our business may be affected by these
proceedings.
The Telecommunications Act is intended to promote competition. The
Telecommunications Act opens the local services market to competition by
requiring incumbent carriers to permit interconnection to their networks and by
establishing incumbent carrier and competitive carrier obligations with respect
to:
Reciprocal Compensation. All incumbent carriers and competitive
carriers are currently required to complete local calls originated by each
other under reciprocal arrangements at prices based on tariffs or
negotiated prices.
Resale. All incumbent carriers and competitive carriers are required
to permit resale of their communications services without unreasonable
restrictions or conditions. In addition, incumbent carriers are required
to offer wholesale versions of all retail services to other common
carriers for resale at discounted rates, based on the costs avoided by the
incumbent carrier by offering these services on a wholesale basis.
Interconnection. All incumbent carriers and competitive carriers are
required to permit their competitors to interconnect with their
facilities. All incumbent carriers are required to permit interconnection
at any feasible point within their networks, on nondiscriminatory terms,
at prices based on cost, which may include a reasonable profit. At the
option of the carrier requesting interconnection, collocation of the
requesting carrier's equipment in the incumbent carriers' premises must be
offered.
Unbundled Access. All incumbent carriers are required to provide
access to specified individual components of their networks, which are
sometimes referred to as unbundled network elements or UNE's, on
nondiscriminatory terms and at prices based on cost, which may include a
reasonable profit.
Number Portability. All incumbent carriers and competitive carriers
are required to permit users of communications services to retain their
existing telephone numbers without impairing quality, reliability or
convenience when switching from one common carrier to another.
Dialing Parity. All incumbent carriers and competitive carriers are
required to provide "1+" equal access dialing to competing providers of
long distance service, and to provide nondiscriminatory access to
telephone numbers, operator services, directory assistance and directory
listing, with no unreasonable dialing delays.
Access to Rights-of-Way. All incumbent carriers and competitive
carriers are required to permit competing carriers access to their poles,
ducts, conduits and rights-of-way at regulated prices.
Incumbent carriers are required to negotiate in good faith with carriers
requesting any or all of the above arrangements. If the negotiating carriers
cannot reach agreement within a predetermined amount of time, either carrier may
request arbitration of the disputed issues by the state regulatory commission.
Our business relies to a considerable degree on the use of incumbent
carrier network elements, which we access through collocation arrangements in
incumbent carrier offices. The terms and conditions, including prices, of these
network elements and collocation elements are largely dictated by regulatory
decisions, and changes in the availability or pricing of these facilities can
have significant effects on our business plan and operating results.
The requirement that incumbent carriers unbundle their network elements
has been implemented through rules adopted by the FCC. In January 1999, the
United States Supreme Court confirmed the FCC's broad authority to issue these
rules, but vacated a particular rule that defined the network elements the
incumbent carriers must offer. In a November 1999 order, the FCC reaffirmed that
incumbent carriers must provide unbundled access to a minimum of six network
elements including local loop and transport facilities (the elements in primary
use by us). In December 2001, the FCC initiated a review of the network element
unbundling rules, and requested comments on whether to expand, reduce or change
the list of required elements. We anticipate that the proceeding will be
concluded during early 2003. Also, in February 2002, the FCC requested comments
on a number of issues relating to regulation of broadband Internet access
services offered over telephone company facilities, including whether the
incumbent carriers should continue to be required to offer the elements of these
services on an unbundled basis. Any change in the existing rules that would
reduce the obligation of incumbent carriers to offer network elements to us on
an unbundled basis could adversely affect our business plan.
In May 2002, the prices that incumbent carriers may charge for access to
these network elements was determined by the Supreme Court, which affirmed that
incumbent carriers are required to price these network elements based on the
efficient replacement cost of existing technology, as the FCC methodology now
requires, rather than on their historical costs. The Court also determined that
the FCC may require incumbent carriers to combine certain previously uncombined
elements at the request of a competitive carrier.
In November 2001, the FCC initiated two rulemaking proceedings to
establish a core set of national performance measurements and standards for
evaluating an incumbent carrier's performance in provisioning wholesale
facilities and services to competitors. It sought comment on a set of specific
performance measurements and on related issues of implementation, reporting
requirements, and enforcement mechanisms. We cannot predict the ultimate outcome
of these proceedings.
The Telecommunications Act also contains special provisions that replace
prior antitrust restrictions that prohibited the regional Bell operating
companies from providing long distance services and engaging in communications
equipment manufacturing. Before the passage of the Telecommunications Act, the
regional Bell operating companies were restricted to providing services within a
distinct geographical area known as a local access and transport area (LATA).
The Telecommunications Act permits the regional Bell operating companies to
provide interLATA long distance service immediately in areas outside of their
market regions and within their market regions once they have satisfied several
procedural and substantive requirements, including:
- a showing that the regional Bell operating company is subject to
meaningful local competition in the area in which it seeks to offer
long distance service; and
- a determination by the FCC that the regional Bell operating
company's entry into long distance markets is in the public
interest.
Verizon has obtained authority to provide interLATA long distance services
in substantially all of its operating areas and SBC has obtained authority to
provide interLATA long distance services in approximately half of its operating
areas. During 2003, the regional Bell operating companies are likely to complete
this process and be authorized to compete throughout their operating areas with
packages of bundled services, or "one stop shopping." With the completion of
this process, incentives for incumbent carriers to improve service to
competitive carriers like us in order to obtain interLATA long distance
authority will be virtually eliminated while at the same time, the regional Bell
operating companies will be in a position to become more efficient and
attractive competitors.
In December 2001, the FCC initiated a review of the current regulatory
requirements for incumbent carriers' broadband telecommunications services.
Incumbent carriers are generally treated as dominant carriers, and hence are
subject to certain regulatory requirements, such as tariff filings and pricing
requirements. In this proceeding, the FCC seeks to determine what regulatory
safeguards and carrier obligations, if any, should apply when a carrier that is
dominant in the provision of traditional local exchange and exchange access
services provides broadband service. A decision by the FCC to exempt the
incumbent carriers' broadband services from traditional regulation could have a
significant adverse competitive impact.
Also in December 2001, the FCC initiated its "triennial review" of which
unbundled network elements or UNEs the incumbent carriers are required to sell
to competitive carriers such as us at forward looking or TELRIC (total element
long run incremental cost) rates, which reflect efficient costs plus a
reasonable profit. Competitive carriers such as us may depend upon their ability
to obtain access to these UNEs in order to provision services to their
customers. On February 20, 2003, the FCC announced its decision on the
"triennial review" of UNEs. Although the Order has not yet been released, the
FCC announced that it generally would de-regulate access to the incumbent
carriers' fiber/broadband network but would continue to require that incumbents
provide access to their copper network and to DS-1 and DS-3 loops and transport.
We primarily buy access to the incumbents' copper network and to DS-1s/T-1s. The
"triennial review" decision is complex and when issued, it is likely to be
litigated. It will have a significant impact on telecommunications competition,
but it is not possible at this time to predict the full extent of its impact
upon us or our competition. A modification of the decision by the FCC or the
courts could result in an order that could have a significant adverse
competitive impact.
In several orders adopted in recent years, the FCC has made major changes
in the structure of the access charges incumbent carriers impose for the use of
their facilities to originate or complete interstate and international calls.
Under the FCC's plan, per-minute access charges have been significantly reduced,
and replaced in part with higher monthly fees to end-users and in part with a
new interstate universal service support system. Under this plan, the largest
incumbent carriers are required to reduce their average access charge to $0.0055
per minute over a period of time, and some of these carriers have already
reduced their charges to the target level.
In August 1999, the FCC adopted an order providing additional pricing
flexibility to incumbent carriers subject to price cap
regulation in their provision of interstate access services, particularly
special access and dedicated transport. The FCC eliminated rate scrutiny for
"new services" and permitted incumbent carriers to establish additional
geographic zones within a market that would have separate rates. Additional and
more substantial pricing flexibility will be given to incumbent carriers as
specified levels of competition in a market are reached through the collocation
of competitive carriers and their use of competitive transport. This flexibility
includes, among other items, customer specific pricing, volume and term
discounts for some services and streamlined tariffing.
In May 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy program. This order established new
subsidies for telecommunications and information services provided to qualifying
schools, libraries and rural health providers. The FCC also expanded federal
subsidies for local dial-tone services provided to low-income consumers.
Providers of interstate telecommunications service, including us, must
contribute to these subsidies. In later years, the FCC created additional
subsidies that primarily benefit incumbent telephone companies. On a quarterly
basis, the FCC announces the contribution factor proposed for the next quarter.
For the first quarter of the year 2003, the contribution factor is $0.072805 of
a provider's interstate and international revenue for the third quarter of 2002.
We intend to recover our share of these costs through charges assessed directly
to our customers and participation in federally subsidized programs. The FCC is
considering proposals to change the way contributions are assessed, but we
cannot predict when or whether the FCC will act on these proposals.
In 1994, Congress passed the Communications Assistance for Law Enforcement
Act ("CALEA") to ensure that law enforcement agencies would be able to conduct
properly authorized electronic surveillance of digital and wireless
telecommunications services CALEA requires telecommunications carriers to modify
their equipment, facilities and services to ensure that they are able to comply
with authorized electronic surveillance requests. For circuit-switched
facilities, carriers such as us were required to comply with CALEA by November
19, 2001. As a result of litigation, the FCC extended the deadline for carriers
to implement the Department of Justice/Federal Bureau of Investigation "punch
list" capabilities until June 30, 2002. We have now complied with the CALEA
requirements.
STATE REGULATION
To provide services within a state, we generally must obtain a certificate
of public convenience and necessity from the state regulatory agency and comply
with state requirements for telecommunications utilities, including state
tariffing requirements. We have satisfied state requirements to provide local
and intrastate long distance services in the states in which we currently
operate.
State regulatory agencies have jurisdiction over our intrastate services,
including our rates. State agencies require us to file periodic reports, pay
various fees and assessments and comply with rules governing quality of service,
consumer protection and similar issues. These agencies may also have to approve
the transfer of assets or customers located in the state, a change of control of
our company or our issuance of securities or assumption of debt. The specific
requirements vary from state to state. State regulatory agencies also must
approve our interconnection agreements with incumbent carriers. Price cap or
rate of return regulation for competitive carriers does not apply in any of our
current markets. However, we cannot assure you that the imposition of new
regulatory burdens in a particular state will not affect the profitability of
our services in that state.
LOCAL REGULATION
Our networks must comply with numerous local regulations such as building
codes, municipal franchise requirements and licensing. These regulations vary on
a city by city and county by county basis. In some of the areas where we provide
service, we may have to comply with municipal franchise requirements and may be
required to pay license or franchise fees based on a percentage of gross revenue
or other factors. Municipalities that do not currently impose fees may seek to
impose fees in the future. We cannot assure you that fees will remain at their
current levels following the expiration of existing franchises.
COMPETITION
The communications industry is highly competitive. We believe the
principal competitive factors affecting our business will be:
- pricing levels and policies
- transmission speed
- customer service
- breadth of service availability
- network security
- ease of access and use
- bundled service offerings
- brand recognition
- operating experience
- capital availability
- exclusive contracts
- accurate billing
- variety of services.
To maintain our competitive posture, we believe we must be in a position
to reduce our prices to meet any reductions in rates by our competitors. Any
reductions could adversely affect us. Many of our current and potential
competitors have financial, personnel and other resources, including brand name
recognition, substantially greater than ours, as well as other competitive
advantages over us. In addition, competitive alternatives may result in
substantial customer turnover in the future. Many providers of communications
and networking services experience high rates of customer turnover.
A continuing trend toward consolidation of communications companies and
the formation of strategic alliances within the communications industry, as well
as the development of new technologies, could give rise to significant new
competitors which could put us at a competitive disadvantage.
LOCAL DIAL-TONE SERVICES
Incumbent Carriers
In each of the markets we target, we will compete principally with the
incumbent carrier serving that area. We have not achieved and do not expect to
achieve a significant market share for any of our services. The incumbent
carriers have long-standing relationships with their customers, have financial,
technical and marketing resources substantially greater than ours and have the
potential to subsidize competitive services with revenues from a variety of
businesses.
Incumbent carriers also have long-standing relationships with regulatory
authorities at the federal and state levels. While regulatory initiatives which
allow competitive carriers to interconnect with incumbent carrier facilities
provide increased business opportunities for us, interconnection opportunities
have been and likely will continue to be accompanied by increased pricing
flexibility for, and relaxation of regulatory oversight of, the incumbent
carriers. If the incumbent carriers are allowed by regulators to offer discounts
to large customers through contract tariffs, engage in aggressive volume and
term discount pricing practices for their customers, and/or seek to charge
competitors excessive fees for interconnection to their networks, our operating
margins could be materially adversely affected. Future regulatory decisions
which give the incumbent carriers increased pricing flexibility or other
regulatory relief could have a material adverse effect on us.
Competitive Carriers/Long Distance Carriers/Other Market Entrants
We face, and expect to continue to face, competition from long distance
carriers, including AT&T, MCI WorldCom, and Sprint, seeking to enter, reenter or
expand entry into the local exchange market. We also compete with other
competitive carriers, resellers of local dial-tone services, cable television
companies, electric utilities, microwave carriers and wireless telephone system
operators.
The Telecommunications Act includes provisions which impose regulatory
requirements on all incumbent carriers and competitive carriers but grants the
FCC expanded authority to reduce the level of regulation applicable to these
common carriers. The manner in which these provisions of the Telecommunications
Act are implemented and enforced could have a material adverse effect on our
ability to successfully compete against incumbent carriers and other
communications service providers.
The Telecommunications Act radically altered the market opportunity for
competitive carriers. Many existing competitive carriers
which entered the market before 1996 had to build a fiber infrastructure before
offering services. With the Telecommunications Act requiring unbundling of the
incumbent carrier networks, competitive carriers are now able to enter the
market more rapidly by installing switches and leasing standard telephone lines
and cable or by means of a type of resale known as an unbundled network element
platform or UNE-P.
A number of competitive carriers have entered or announced their intention
to enter one or more of our markets. We believe that not all competitive
carriers, however, are pursuing the same target customers we pursue. We intend
to keep our prices at competitive levels while providing, in our opinion, a
higher level of service and responsiveness to our customers. Innovative
packaging and pricing of basic telephone services are expected to provide
competitive differentiation for us in each of our markets.
LONG DISTANCE SERVICES
The long distance services industry is very competitive and many long
distance providers experience a high average turnover rate as customers
frequently change long distance providers in response to offerings of lower
rates or promotional incentives by competitors. Prices in the long distance
market have declined significantly in recent years. We expect to face increasing
competition from companies offering long distance data and voice services over
the Internet. Companies offering these services over the Internet could enjoy a
significant cost advantage because they do not currently pay common carrier
access charges or universal service fees.
DATA AND INTERNET SERVICES
We expect the level of competition with respect to data and Internet
services to intensify in the future. We expect significant competition from:
- Incumbent Carriers. Most incumbent carriers have announced
deployment of commercial DSL services. Some incumbent carriers have
announced they intend to aggressively market these services to their
residential customers at attractive prices. In addition, most
incumbent carriers are combining their DSL service with their own
Internet service provider businesses. We believe incumbent carriers
have the potential to quickly overcome many of the issues that have
delayed widespread deployment of DSL services in the past. The
incumbent carriers have an established brand name in their service
areas, possess sufficient capital to deploy DSL services rapidly and
are in a position to offer service from central offices where we may
be unable to secure collocation space. When the regional Bell
operating companies begin providing long distance service, they may
be able to offer "one stop shopping" that would be competitive with
our offerings.
- Traditional Long Distance Carriers. Many of the leading traditional
long distance carriers, including AT&T, MCI WorldCom and Sprint, are
expanding their capabilities to support high-speed, end-to-end
networking services. We expect them to offer combined data, voice
and video services over their networks. These carriers have
extensive fiber networks in many metropolitan areas that primarily
provide high-speed data and voice services to large companies. They
could deploy DSL services in combination with their current fiber
networks. They also have interconnection agreements with many
incumbent carriers and have secured collocation space from which
they could begin to offer competitive DSL services.
- Newer Long Distance Carriers. Numerous long distance carriers are
managing high-speed networks nationwide, with direct sales forces,
and are partnering with Internet service providers to offer services
directly to business customers. They could extend their existing
networks and offer high-speed services using DSL, either alone or in
partnership with others.
- Cable Modem Service Providers. Cable modem service providers are
offering, or are preparing to offer, high-speed Internet access over
cable networks to consumers and businesses. These networks provide
high-speed data services similar to our services, and in some cases
at higher speeds. These companies use a variety of new and emerging
technologies, including point-to-point and point-to-multipoint
wireless services, satellite-based networking and high-speed
wireless digital communications.
- Internet Service Providers. Internet service providers offer
Internet portal services which compete with our service. We offer
basic web hosting and e-mail services and anticipate offering an
enhanced set of Internet products in the future. The competitive
Internet service providers generally provide more features and
functions than our current Internet portal.
- Wholesale DSL Carriers. DSL carriers, including Covad Communications
Group, Inc., offer DSL services and have significant strategic
equity investors, marketing alliances and product development
partners.
Many of these competitors are offering, or may soon offer, DSL technologies
and services that will directly compete with us.
PERSONNEL
As of March 21, 2003, we had approximately 900 employees, a 55% decrease
from the approximate 2,000 employees at December 31, 2001.
We have non-disclosure and non-compete agreements with our executive
employees. None of our employees are represented by a collective bargaining
agreement.
RISK FACTORS
Investors should carefully consider the following risk factors before
making investment decisions regarding our stock.
FAILURE TO CLOSE ONE OR MORE OF A SERIES OF STRATEGIC AND FINANCIAL TRANSACTIONS
CURRENTLY PENDING COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND OPERATING
RESULTS
On January 8, 2003, we announced a series of strategic and financial
transactions to further strengthen the business financially, and focus on our
operations in California, Nevada and Illinois. We are bringing geographic
concentration and operating efficiencies to the business by selling our
customers and assets in Florida, Georgia, Ohio, Michigan and Texas to other
service providers (the "Asset Sales"). The Asset Sales in Ohio and Michigan were
completed on March 18, 2003 and Texas on March 27, 2003. Completion of the
remaining Asset Sales are subject to a number of closing conditions and
contingencies, and all are expected to be completed by the end of April 2003,
although we cannot assure investors that all or any of the remaining Asset Sales
will occur. The Asset Sales are expected to generate net proceeds to us of
approximately $17.0 million to $20.0 million over the next few months.
Our inability to close one or more of these transactions could have a
material adverse effect on our results of operations and financial condition.
WE MAY NEED ADDITIONAL FUNDS THAT WE MAY NOT BE ABLE TO OBTAIN
We will require capital to fund the development of our business and services as
well as our operating costs. If we cannot generate or otherwise obtain
sufficient funds, this may have a negative impact on our growth and our ability
to compete in the communications industry. We expect to fund any capital
requirements through existing resources, internally generated funds and debt or
equity financing, if needed. The inability to close one or more of the Asset
Sales as planned could have a material adverse effect on our liquidity. We
cannot assure you we will be successful in raising sufficient debt or equity
financing, if needed, on acceptable terms or at all.
THE VALUE OF THE EQUITY SECURITIES MAY BE NEGATIVELY AFFECTED BY ADDITIONAL
ISSUANCES OF EQUITY SECURITIES BY THE REORGANIZED COMPANY AND GENERAL MARKET
FACTORS
Issues or sales of equity by us will likely be heavily dilutive. There can
be no certainty as to the effect, if any, that future issuances or sales of
equity securities by us, or the availability of such equity securities for
future issue or sale, would have on the price of our common stock prevailing
from time to time. Sales of substantial amounts of equity securities of ours in
the public or private market, a perception in the market that such sales could
occur, or the issuance of securities exercisable or convertible into our stock
could adversely affect the prevailing price of our stock.
LACK OF TRADING MARKET FOR OUR SECURITIES
Our common stock is traded on the NASD OTC Bulletin Board (under the
symbol "MPOW.OB"). As a result, it is expected that our stockholders will find
it more difficult to buy or sell shares of, or obtain accurate quotations as to
the market value of, our common stock. In addition, our common stock may be
substantially less attractive as collateral for margin borrowings and loan
purposes, for investment by financial institutions under their internal policies
or state legal investment laws, or as consideration in future capital raising
transactions.
THE MARKET FOR SECURITIES OF TELECOMMUNICATIONS COMPANIES HAS HISTORICALLY BEEN
VOLATILE
The prices for securities of emerging companies in the telecommunications
industry have been highly volatile. In addition, the stock market has
experienced volatility that has affected the market prices of equity securities
of many companies and that often has been unrelated to the operating performance
of such companies. These broad market fluctuations may adversely affect the
prevailing price of our securities.
WE HAVE HISTORICALLY RECORDED LOSSES AND NEGATIVE CASH FLOW
We recorded net losses of $94.4 million in 2002, $467.7 million in 2001
and $244.7 million in 2000. In addition, we had negative cash flow from
operations of $124.2 million in 2002, $219.3 million in 2001 and $141.3 million
in 2000. At the present time, we do not generate enough cash flow to cover our
operating and investing expenses. We expect to record significant net losses and
generate negative cash flow from operations for the first six months of 2003. If
the Asset Sales are not completed as planned, there could be a material adverse
effect on our cash flow. We cannot assure you that we will achieve or sustain
profitability or generate sufficient positive cash flow from operations to meet
our planned capital expenditures, working capital and any future debt service
requirements.
FUTURE DEBT MAY CREATE FINANCIAL AND OPERATING RISK
Debt we may incur in the future could have important consequences to you,
including the following:
- It could limit our ability to obtain additional financing for
working capital, capital expenditures, and general corporate
purposes;
- It could require us to dedicate a substantial portion of our cash
flow from operations to payments of principal and interest on our
debt, thereby reducing the funds available to us for other
purposes, including working capital, capital expenditures, and
general corporate purposes;
- It could make us more vulnerable to changes in general economic
conditions or increases in prevailing interest rates; limiting our
ability to withstand competitive pressures and reducing our
flexibility in responding to changing business and economic
conditions;
- It could limit our flexibility in planning for, or reacting to,
changes in our business and the industry in which we operate;
- It could place us at a competitive disadvantage compared to our
competitors that have less debt; and
- Our failure to comply with the restrictions contained in any of our
financing agreements could lead to a default which could result in
our being required to repay all of our outstanding debt.
- Future agreements which may govern the terms of debt we may incur
may contain covenants that may restrict our ability to:
- incur additional debt;
- pay dividends and make other distributions;
- prepay subordinated debt;
- make investments and other restricted payments;
- create liens and sell assets; and
- engage in transactions with affiliates.
OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF ANY FUTURE
INDEBTEDNESS WHEN DUE
Our ability to make payments on and to refinance any future indebtedness
will depend on our ability to generate cash flow in the future. We cannot assure
you that our business will generate sufficient cash flow from operations to meet
any future debt service requirements. Our cash flow from operations may be
insufficient to repay any future indebtedness at scheduled maturity and some or
all of any such indebtedness may have to be refinanced. If we are unable to
refinance our debt or if additional financing is not available on acceptable
terms, or at all, we could be forced to dispose of assets under certain
circumstances that might not be favorable to realizing the highest price for the
assets or to default on our obligations with respect to our indebtedness.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE AND WILL BE DIFFICULT TO PREDICT
Our annual and quarterly operating results are likely to fluctuate
significantly as a result of numerous factors, many of which are outside of our
control. These factors include:
- our limited operating history, which makes predicting future results
difficult;
- delays in the generation of revenue because certain network elements
have lead times that are controlled by incumbent carriers and other
third parties
- the ability to develop and commercialize new services by us or our
competitors
- the ability to deploy on a timely basis our services to adequately
satisfy customer demand
- our ability to successfully operate and maintain our networks
- the rate at which customers subscribe to our services
- decreases in the prices for our services due to competition,
volume-based pricing and other factors
- the development and operation of our billing and collection systems
and other operational systems and processes
- the rendering of accurate and verifiable bills from the incumbent
carriers from whom we lease transport and resolution of billing
disputes
- the incorporation of enhancements, upgrades and new software and
hardware products into our network and operational processes that
may cause unanticipated disruptions
- the interpretation and enforcement of regulatory developments and
court rulings concerning the 1996 Telecommunications Act,
interconnection agreements and the antitrust laws
OUR SUCCESS DEPENDS ON THE EFFECTIVENESS AND RETENTION OF OUR MANAGEMENT TEAM
Our business is managed by a small number of key management personnel, the
loss of some of whom could impair our ability to carry out our business plan. We
believe our future success will depend in large part on our ability to attract
and retain highly skilled and qualified personnel. We cannot assure you that our
senior management team will remain with us. Under our circumstances, it may be
difficult to find suitable replacements for any departing management personnel.
We do not maintain key man insurance on our officers.
IF OUR EQUIPMENT DOES NOT PERFORM AS WE EXPECT, IT COULD DELAY OUR INTRODUCTION
OF NEW SERVICES
In implementing our strategy, we may use new or existing technologies to
offer additional services. We also plan to use equipment manufactured by
multiple vendors to offer our current services and future services in each of
our markets. If we cannot successfully install and integrate the technology and
equipment necessary to deliver our current services and any future services
within the time frame and with the cost effectiveness we currently contemplate,
we could be forced to delay or abandon the introduction of new services. This
could also affect our ability to attract and retain customers.
THE FAILURE OF OUR OPERATIONS SUPPORT SYSTEM TO PERFORM AS WE EXPECT COULD
IMPAIR OUR ABILITY TO RETAIN CUSTOMERS AND OBTAIN NEW CUSTOMERS OR RESULT IN
INCREASED CAPITAL EXPENDITURES
Our operations support system is expected to be an important factor in our
success. If the operations support system fails or is unable to perform as
expected, we could suffer customer dissatisfaction, loss of business or the
inability to add customers on a timely basis, any of which would adversely
affect our revenues. Furthermore, problems may arise with higher processing
volumes or with additional automation features, which could potentially result
in system breakdowns and delays and additional, unanticipated expense to remedy
the defect or to replace the defective system with an alternative system.
OUR FAILURE TO MANAGE GROWTH COULD RESULT IN INCREASED COSTS
We may be unable to manage our growth effectively. This could result in
increased costs and delay our introduction of additional services. The
development of our business will depend on, among other things, our ability to
achieve the following goals in a timely
manner, at reasonable costs and on satisfactory terms and conditions:
- purchase, install and operate equipment, including DSL and T1
equipment;
- negotiate suitable interconnection agreements with, and arrangements
for installing our equipment at the central offices of, incumbent
carriers on satisfactory terms and conditions;
- hire and retain qualified personnel;
- lease suitable access to transport networks; and
- obtain required government authorizations.
While we had experienced rapid growth since our inception through 2001, we
do not anticipate significant rapid growth in 2003. However, any sustained
growth will place a strain on our operational, human and financial resources.
Any significant growth will also increase our operating complexity as well as
the level of responsibility for both existing and new management personnel. Our
ability to manage our growth effectively will depend on the continued
development of plans, systems and controls for our operational, financial and
management needs and on our ability to expand, train and manage our employee
base.
OUR SERVICES MAY NOT ACHIEVE SUFFICIENT MARKET ACCEPTANCE TO BECOME PROFITABLE
To be successful, we must develop and market services that are widely
accepted by businesses at profitable prices. Our success will depend upon the
willingness of our target customers to accept us as an alternative provider of
local, long distance, high-speed data and Internet services. Although we are in
the process of rolling out additional products and services, we might not be
able to provide the range of communication services our target business
customers need or desire.
OUR FAILURE TO ACHIEVE OR SUSTAIN MARKET ACCEPTANCE AT DESIRED PRICING LEVELS
COULD IMPAIR OUR ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW
Prices for data communication services have fallen historically, a trend
which may continue. Accordingly, we cannot predict to what extent we may need to
reduce our prices to remain competitive or whether we will be able to sustain
future pricing levels as our competitors introduce competing services or similar
services at lower prices. Our ability to meet price competition may depend on
our ability to operate at costs equal to or lower than our competitors or
potential competitors. There is a risk that competitors, perceiving us to lack
capital resources, may undercut our rates or increase their services or take
other actions in an effort to force us out of business. Our failure to achieve
or sustain market acceptance at desired pricing levels could impair our ability
to achieve profitability or positive cash flow.
IF WE ARE UNABLE TO NEGOTIATE AND ENFORCE FAVORABLE INTERCONNECTION AGREEMENTS,
WE COULD HAVE DIFFICULTY OPERATING PROFITABLY IN OUR EXISTING MARKETS
We must renew favorable interconnection agreements with other companies,
including incumbent carriers, in markets we have entered. The rates charged to
us under the interconnection agreements might not continue to be low enough for
us to attract a sufficient number of customers and to operate the business on a
profitable basis. In addition, our interconnection agreements provide for our
connection and maintenance orders to receive attention on the same basis as the
incumbent carriers' customers and for the incumbent carriers to provide adequate
capacity to keep blockage within industry standards. However, from time to time,
we have experienced excessive blockage in the delivery of calls to and from the
incumbent carriers due to an insufficient number of trunk circuits installed
between incumbent carriers' switches and our switches. Blocked calls result in
customer dissatisfaction, which may result in the loss of business.
DELAYS BY THE INCUMBENT CARRIERS IN CONNECTING OUR CUSTOMERS TO OUR NETWORK
COULD RESULT IN CUSTOMER DISSATISFACTION AND LOSS OF BUSINESS
We rely on the timeliness of incumbent carriers and competitive carriers
in processing our orders for customers switching to our service and in
maintaining the customers' standard telephone lines to assure uninterrupted
service. The incumbent carriers are our competitors and have limited experience
leasing standard telephone lines to other companies. Therefore, the incumbent
carriers might not be able to provide and maintain leased standard telephone
lines in a prompt and efficient manner as the number of standard telephone lines
requested by competitive carriers increases.
WE MAY NOT BE ABLE TO SERVICE OUR CUSTOMERS IF WE CANNOT SECURE SUFFICIENT
TELEPHONE LINES AND CABLE TO MEET OUR FUTURE NEEDS
We may not be able to renew our lease arrangements or obtain comparable
arrangements from other carriers in our existing markets. Because we lease
rather than construct telephone lines and cable in each of our markets, we would
be unable to service our customers if we are not able to obtain sufficient
telephone lines and cable. Our inability to lease sufficient telephone lines and
cable could result in the loss of customers and the inability to add new
customers.
OUR RELIANCE ON A LIMITED NUMBER OF EQUIPMENT SUPPLIERS COULD RESULT IN
ADDITIONAL EXPENSES
We currently rely and expect to continue to rely on a limited number of
third party suppliers to manufacture the equipment we require to implement our
DSL and T1 technologies. If our suppliers enter into competition with us, or if
our competitors enter into exclusive or restrictive arrangements with our
suppliers it may materially and adversely affect the availability and pricing of
the equipment we purchase. Our reliance on third-party vendors involves a number
of additional risks, including the absence of guaranteed supply and reduced
control over delivery schedules, quality assurance, production yields and costs.
We cannot assure you that our vendors will be able to meet our needs in a
satisfactory and timely manner in the future or that we will be able to obtain
alternative vendors when and if needed. It could take a significant period of
time to establish relationships with alternative suppliers for critical
technologies and to introduce substitute technologies into our network. In
addition, if we change vendors, we may need to replace all or a portion of the
equipment deployed within our network at significant expense in terms of
equipment costs and loss of revenues in the interim.
THE TELECOMMUNICATIONS INDUSTRY IS HIGHLY COMPETITIVE WITH PARTICIPANTS THAT
HAVE GREATER RESOURCES THAN WE DO, AND WE MAY NOT BE ABLE TO COMPETE
SUCCESSFULLY
Our success depends upon our ability to compete with other
telecommunications providers in each of our markets, many of which have
substantially greater financial, marketing and other resources than we have. In
addition, competitive alternatives may result in substantial customer turnover
in the future. A growing trend towards consolidation of communications companies
and the formation of strategic alliances within the communications industry, as
well as the development of new technologies, could give rise to significant new
competitors. We cannot assure you that we will be able to compete successfully.
For more information regarding the competitive environment in which we operate,
please see "Competition."
IF WE ARE NOT ABLE TO OBTAIN OR IMPLEMENT NEW TECHNOLOGIES, WE MAY LOSE BUSINESS
AND LIMIT OUR ABILITY TO ATTRACT NEW CUSTOMERS
We may be unable to obtain access to new technology on acceptable terms or
at all. We may be unable to adapt to new technologies and offer services in a
competitive manner. If these events occur, we may lose customers to competitors
offering more advanced services and our ability to attract new customers would
be hindered. Rapid and significant changes in technology are expected in the
communications industry. We cannot predict the effect of technological changes
on our business. Our future success will depend, in part, on our ability to
anticipate and adapt to technological changes, evolving industry standards and
changing needs of our current and prospective customers.
A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS AND RESULT IN CUSTOMER DISSATISFACTION
Interruptions in service, capacity limitations or security breaches could
have a negative effect on customer acceptance and, therefore, on our revenues
and ability to attract new customers. Our networks may be affected by physical
damage, power loss, capacity limitations, software defects, breaches of security
by computer viruses, break-ins or otherwise and other factors which may cause
interruptions in service or reduced capacity for our customers.
IF WE ARE UNABLE TO EFFECTIVELY DELIVER DSL AND T1 SERVICES TO A SUBSTANTIAL
NUMBER OF CUSTOMERS, WE MAY NOT ACHIEVE OUR REVENUE GOALS
We cannot guarantee our network will be able to connect and manage a
substantial number of customers at high transmission speeds. If we cannot
achieve and maintain digital transmission speeds that are otherwise available in
the market, we may lose customers to competitors with higher transmission speeds
and we may not be able to attract new customers. While digital transmission
speeds of up to 1.5 Mbps are possible on portions of our network, that speed may
not be available over a majority of our network. Actual transmission speeds on
our network will depend on a variety of factors many of which are beyond our
control, including the distance an end user is located from a central office,
the quality of the telephone lines, the presence of interfering transmissions on
nearby lines and other factors.
WE MAY LOSE CUSTOMERS OR POTENTIAL CUSTOMERS BECAUSE THE TELEPHONE LINES WE
REQUIRE MAY BE UNAVAILABLE OR IN POOR CONDITION
Our ability to provide DSL services to potential customers depends on the
quality, physical condition, availability and maintenance of telephone lines
within the control of the incumbent carriers. If the telephone lines are not
adequate, we may not be able to provide DSL services to many of our target
customers and our expected revenues will be diminished. We believe the current
condition of telephone lines in many cases may be inadequate to permit us to
fully implement our DSL services. In addition, the incumbent carriers may not
maintain the telephone lines in a condition that will allow us to implement our
DSL services effectively or may claim they are not of sufficient quality to
allow us to fully implement or operate our DSL services. Further, some customers
use technologies other than copper lines to provide telephone services, and as a
result, DSL services might not be available to these customers.
INTERFERENCE OR CLAIMS OF INTERFERENCE COULD RESULT IN CUSTOMER DISSATISFACTION
Interference, or claims of interference by the incumbent carriers, if
widespread, could adversely affect our speed of deployment, reputation, brand
image, service quality and customer satisfaction and retention. Technologies
deployed on copper telephone lines, such as DSL, have the potential to interfere
with other technologies on the copper telephone lines. Interference could
degrade the performance of our services or make us unable to provide service on
selected lines and the customers served by those lines. Although we believe our
DSL technologies, like other technologies, do not interfere with existing voice
services, incumbent carriers may claim the potential for interference permits
them to restrict or delay our deployment of DSL services. The procedures to
resolve interference issues between competitive carriers and incumbent carriers
are still being developed. We may be unable to successfully resolve interference
issues with incumbent carriers.
OUR SUCCESS WILL DEPEND ON GROWTH IN THE DEMAND FOR INTERNET ACCESS AND
HIGH-SPEED DATA SERVICES
If the markets for the services we offer, including Internet access and
high-speed data services, fail to develop, grow more slowly than anticipated or
become saturated with competitors, we may not be able to achieve our projected
revenues. The markets for business Internet and high-speed data services are in
the early stages of development. Demand for Internet services is highly
uncertain and depends on a number of factors, including the growth in consumer
and business use of new interactive technologies, the development of
technologies that facilitate interactive communication between organizations and
targeted audiences, security concerns and increases in data transport capacity.
In addition, the market for high-speed data transmission via DSL
technology is relatively new and evolving. Various providers of high-speed
digital services are testing products from various suppliers for various
applications, and no industry standard has been broadly adopted. Critical issues
concerning commercial use of DSL for Internet and high-speed data access,
including security, reliability, ease of use and cost and quality of service,
remain unresolved and may impact the growth of these services.
THE DESIRABILITY AND MARKETABILITY OF OUR INTERNET SERVICE MAY BE ADVERSELY
AFFECTED IF WE ARE NOT ABLE TO MAINTAIN RECIPROCAL RELATIONSHIPS WITH OTHER
INTERNET SERVICE PROVIDERS
The Internet is comprised of many Internet service providers and
underlying transport providers who operate their own networks and interconnect
with other Internet service providers at various points. As we continue the
operation of Internet services, connections to the Internet will be provided
through wholesale carriers. We anticipate as our volume increases, we will enter
into reciprocal agreements with other Internet service providers. We cannot
assure you other national Internet service providers will maintain reciprocal
relationships with us. If we are unable to maintain these relationships, our
Internet services may not be attractive to our target customers, which would
impair our ability to retain and attract customers. In addition, the
requirements associated with maintaining relationships with the major national
Internet service providers may change. We cannot assure you that we will be able
to expand or adapt our network infrastructure to meet any new requirements on a
timely basis, at a reasonable cost, or at all.
WE MAY INCUR LIABILITIES AS A RESULT OF OUR INTERNET SERVICE OFFERINGS
United States law relating to the liability of on-line service providers
and Internet service providers for information carried on, disseminated through,
or hosted on their systems is currently unsettled. If liability is imposed on
Internet service providers, we would likely implement measures to minimize our
liability exposure. These measures could require us to expend substantial
resources or discontinue some of our product or service offerings. In addition,
increased attention to liability issues, as a result of litigation, legislation
or legislative proposals could adversely affect the growth and use of Internet
services.
CHANGES IN LAWS OR REGULATIONS COULD RESTRICT THE WAY WE OPERATE OUR BUSINESS
AND NEGATIVELY AFFECT OUR COSTS AND COMPETITIVE POSITION
A significant number of the services we offer are regulated at the
federal, state and/or local levels. If these laws and regulations change or if
the administrative implementation of laws develops in an adverse manner, there
could be an adverse impact on our costs and competitive position. In addition,
we may expend significant financial and managerial resources to participate in
administrative proceedings at either the federal or state level, without
achieving a favorable result. We believe incumbent carriers and others may work
aggressively to modify or restrict the operation of many provisions of the
Telecommunications Act. We expect incumbent carriers and others to continue to
pursue litigation in courts, institute administrative proceedings with the FCC
and other state regulatory agencies and lobby the United States Congress, all in
an effort to affect laws and regulations in a manner favorable to them and
against the interest of competitive carriers. We believe that the recent changes
in the make-up of the FCC and leadership changes in the Congress may create an
atmosphere that is more favorable to the incumbent carriers. For more details
about our regulatory situation, please see "Government Regulations".
WE MAY FACE CHALLENGES TO THE USE OF THE MPOWER TRADEMARK
Other companies utilizing trademarks that are similar to our trademark may
at some time challenge our use of the Mpower mark. A challenge to the mark could
result in litigation to defend our mark and could ultimately require us to adopt
a new trademark for our services and products.
A FAILURE TO OBTAIN APPROVAL OF A SETTLEMENT OF OUR CLASS ACTION LAWSUIT AND A
SUBSEQUENT ADVERSE DECISION IN AN APPEAL OF THAT LAWSUIT COULD ADVERSELY AFFECT
OUR FINANCIAL CONDITION.
In September 2000, a class action lawsuit was commenced against us,
alleging violations of the Securities Exchange Act of 1934 and rule 10(b)-5
thereunder (the "Exchange Act") and Section 11 of the Securities Act of 1933. On
February 11, 2002, the United States District Court for the Western District of
New York entered its Decision and Order dismissing the class action lawsuit.
That Decision and Order have been appealed to the United States Court of Appeals
for the Second Circuit. On April 8, 2002, we filed a petition for a relief under
Chapter 11 of the Bankruptcy Code, and as of the effective date of our First
Amended Joint Plan of Reorganization (July 30, 2002), we were was discharged and
released from any "Claim, Debt and Interest," except as otherwise stated in the
Plan, as set forth in the final Confirmation Order entered by the United States
Bankruptcy Court for the District of Delaware on July 17, 2002. Although we are
no longer a defendant in the class action lawsuit and can have no direct
liability to the plaintiffs; we nevertheless remain obligated to indemnify the
remaining individual defendants in the event of an adverse decision against them
in the lawsuit. The plaintiffs and the remaining individual defendants have
entered into a tentative settlement of the class action lawsuit, and have
submitted a Preliminary Approval Order to the Court, seeking approval of the
settlement in accordance with a Stipulation of Settlement dated February 6,
2003. If approved, the settlement would dismiss the action with prejudice. All
settlement payments and remaining attorneys fees and other legal expenses
incurred by the defendants are to be paid by our insurance carrier. A hearing is
scheduled for October 1, 2003 to determine whether the proposed settlement of
the action on the terms and conditions provided for in the Stipulation is fair,
reasonable and adequate and should be approved by the Court. While we believe
the remaining individual defendants anticipate that the proposed Settlement will
be approved, will continue to deny any wrongdoing and will vigorously contest
the suit if not settled, any judgment which we must indemnify the remaining
defendants for that is significantly larger than our available insurance
coverage could have a material adverse effect on our results of operations
and/or financial condition.
THE PRICES WE CHARGE FOR OUR SERVICES AND PAY FOR THE USE OF SERVICES OF
INCUMBENT CARRIERS AND OTHER COMPETITIVE CARRIERS MAY BE NEGATIVELY AFFECTED IN
REGULATORY PROCEEDINGS, WHICH COULD RESULT IN DECREASED REVENUES, INCREASED
COSTS AND LOSS OF BUSINESS
If we were required to decrease the prices we charge for our services or
to pay higher prices for services we purchase from incumbent carriers and other
competitive carriers, it would have an adverse effect on our ability to achieve
profitability and offer competitively priced services. We must file tariffs with
state and federal regulators which indicate the prices we charge for our
services. In addition, we purchase some tariffed services from incumbent
carriers and/or competitive carriers. The rates we pay for other services we
purchase from incumbent carriers and other competitive carriers are set by
negotiations between the parties. All of the tariffed prices may be challenged
in regulatory proceedings by customers, including incumbent carriers,
competitive carriers and long distance carriers who purchase these services.
These negotiated rates are also subject to regulatory review. In April 2001, the
FCC released an order establishing benchmark rates for competitive local carrier
switched access charges. Under the order, competitive local carrier access rates
that are at or below the benchmark rates will be presumed to be just and
reasonable, and carriers like us may impose them by tariff. Above the benchmark,
these carriers' access service will be mandatorily detariffed, so the
competitive local carriers must negotiate higher rates with long distance
carriers. During the pendency of the negotiations, or if the parties cannot
agree, the local carrier must charge the long distance carrier the appropriate
benchmark rate. This could have an adverse impact on our expected revenues and
operating results. The prices charged by incumbent carriers for unbundled
network elements, collocations and other services upon which we rely are subject
to periodic review by state regulatory agencies. Change in these prices may
adversely affect our business. For more details about our regulatory situation,
please see "Government Regulations".
OUR FORWARD-LOOKING STATEMENTS MAY MATERIALLY DIFFER FROM ACTUAL EVENTS OR
RESULTS
This Report contains "forward-looking statements," which you can generally
identify by our use of forward-looking words including "believe," "expect,"
"intend," "may," "will," "should," "could," "anticipate" or "plan" or the
negative or other variations of these terms or comparable terminology, or by
discussion of strategies that involve risks and uncertainties. We often use
these types of statements when discussing:
- our plans and strategies;
- our anticipation of profitability or cash flow from operations;
- the development of our business;
- the expected market for our services and products;
- our anticipated capital expenditures;
- changes in regulatory requirements; and
- other statements contained in this Report regarding matters that are
not historical facts.
We caution you these forward-looking statements are only predictions and
estimates regarding future events and circumstances. We cannot assure you we
will achieve the future results reflected in these statements.
ITEM 2. PROPERTY
We have leased office space in Pittsford, New York, a suburb of
Rochester, where we maintain our corporate headquarters. The lease expires in
March 2005.
We also lease space in Las Vegas, Nevada for our national customer
service operations, national network operating center and local sales personnel.
This lease expires in November 2004.
As described further in Item 1, in January 2003, we decided to bring
geographic concentration to our business by selling our business, assets and
customers in Florida, Georgia, Ohio, Michigan and Texas to other service
providers.
We are now geographically focused in five markets in California, Nevada,
and Illinois. We own property housing three of our switches in California and
one in Illinois. We also lease switch sites for our three remaining switches in
Nevada and California with lease terms expiring in 2010 and 2011. In addition,
we have leased facilities to house our local sales and administration staff in
the markets in which we operate.
ITEM 3. LEGAL PROCEEDINGS
We are party to numerous state and federal administrative proceedings. In
these proceedings, we are seeking to define and/or enforce incumbent carrier
performance requirements related to:
- the cost and provisioning of those network elements we lease;
- the establishment of customer care and provisioning;
- the allocation of subsidies; and
- collocation costs and procedures.
The outcome of these proceedings will establish the rates and procedures
by which we obtain and provide leased network elements and could have a material
effect on our operating costs.
We have intervened on behalf of the FCC in an appeal filed by AT&T seeking
to overturn the FCC's declaratory ruling in
CCB/CPD No. 01-02, in which the FCC concluded that a long distance carrier may
not refuse a call from/to an access line served by a competitive local carrier
with presumptively reasonable access rates. We have appealed the FCC's order in
CC Docket No. 96-262, in which the FCC, among other things, established
benchmark rates for competitive local carrier switched access charges. We cannot
predict the outcome of these appeals.
In September 2000, a class action lawsuit was commenced against us,
alleging violations of the Securities Exchange Act of 1934 and rule 10(b)-5
thereunder (the "Exchange Act") and Section 11 of the Securities Act of 1933. In
February 2002, the United States District Court for the Western District of New
York entered its Decision and Order dismissing the class action lawsuit. That
Decision and Order have been appealed to the United States Court of Appeals for
the Second Circuit. On April 8, 2002, we filed a petition for relief under
Chapter 11 of the Bankruptcy Code, and as of the effective date of our First
Amended Joint Plan of Reorganization (July 30, 2002), we were was discharged and
released from any "Claim, Debt and Interest," except as otherwise stated in the
Plan, as set forth in the final Confirmation Order entered by the United States
Bankruptcy Court for the District of Delaware on July 17, 2002. Although we are
no longer a defendant in the class action lawsuit and can have no direct
liability to the plaintiffs, we nevertheless remain obligated to indemnify the
remaining individual defendants in the event of an adverse decision against them
in the lawsuit. The plaintiffs and the remaining individual defendants have
entered into a tentative settlement of the class action lawsuit, and have
submitted a Preliminary Approval Order to the Court, seeking approval of the
settlement in accordance with a Stipulation of Settlement dated February 6,
2003. If approved, the settlement would dismiss the action with prejudice. All
settlement payments and remaining attorneys fees and other legal expenses
incurred by the defendant are to be paid by our insurance carrier. A hearing is
scheduled for October 1, 2003 to determine whether the proposed settlement of
the action on the terms and conditions provided for in the Stipulation is fair,
reasonable and adequate and should be approved by the Court. We believe the
remaining individual defendants anticipate that the proposed Settlement will be
approved, will continue to deny any wrongdoing and will vigorously contest the
suit if not settled. We cannot predict the final outcome of this lawsuit.
From time to time, we engage in other litigation and governmental
proceedings in the ordinary course of our business. We do not believe any other
pending litigation or governmental proceeding will have a material adverse
effect on our results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Our common stock, $0.001 par value, traded on the NASDAQ National Market
(the "NASDAQ") under the symbol "MPWR" until March 22, 2002, when we voluntarily
moved from the NASDAQ to the NASD Over the Counter ("OTC") Bulletin Board, a
regulated service that displays real-time quotes, last-sale prices and volume
information in over-the-counter equity securities. On July 31, 2002, in
connection with our emergence from Chapter 11 proceedings, our new common stock,
$0.001 par value, began trading under the symbol "MPOW.OB" on the OTC Bulletin
Board. As of March 21, 2003, the closing price of our common stock was $0.20.
The following sets forth the reported high and low sale prices for the common
stock for each quarterly period in fiscal 2001 and 2002.
HIGH LOW
---- ---
Quarter Ending March 31, 2001......................... $9.94 $2.38
Quarter Ending June 30, 2001.......................... $3.01 $0.90
Quarter Ending September 30, 2001..................... $1.05 $0.18
Quarter Ending December 31, 2001...................... $1.15 $0.09
Quarter Ending March 31, 2002......................... $0.69 $0.04
Quarter Ending June 30, 2002.......................... $0.06 $0.02
Quarter Ending September 30, 2002..................... $0.60 $0.01
Period from July 1, 2002 - July 30, 2002.......... $0.02 $0.01
Period from July 31, 2002 - September 30, 2002.... $0.60 $0.09
Quarter Ending December 31, 2002...................... $0.42 $0.07
As of March 21, 2003, there were approximately 250 holders of record of
our common stock.
The stock prices indicated above for periods before and after July 31,
2002, are not comparable in that the common stock outstanding before our
emergence from bankruptcy on July 30, 2002 was exchanged for 974,025 shares of
new common stock, on the basis of approximately one share for each 61 shares
previously outstanding, and 64,025,000 shares of new common stock were issued to
the holders of our senior debt and preferred stock. The stock prices indicated
for periods before July 31, 2002, have not been adjusted for this exchange.
DIVIDENDS
No cash dividends have ever been declared by us on our common stock. We
intend to retain earnings to finance the development and growth of our business.
We do not anticipate that any dividends will be declared on our common stock for
the foreseeable future. Future payments of cash dividends, if any, will depend
on our financial condition, results of operations, business conditions, capital
requirements, restrictions contained in agreements, future prospects and other
factors deemed relevant by our board of directors. Our ability to declare and
pay dividends on our common stock may in the future be restricted by convenants
in debt indentures we may enter into.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table provides information regarding options, warrants or
other rights to acquire equity securities under our equity compensation plans:
NUMBER OF
SECURITIES REMAINING
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE AVAILABLE FOR
ISSUED UPON EXERCISE EXERCISE PRICE OF FUTURE ISSUANCE
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, UNDER EQUITY
WARRANTS AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS
------------------- ------------------- ------------------
Equity compensation plans approved by security holders .... -- -- --
Equity compensation plans not approved by security holders 11,103,832 $0.49 2,118,390
---------- ----- ---------
Total ..................................................... 11,103,832 $0.49 2,118,390
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is as follows:
REORGANIZED PREDECESSOR PREDECESSOR PREDECESSOR PREDECESSOR PREDECESSOR
MPOWER MPOWER MPOWER MPOWER MPOWER MPOWER
HOLDING HOLDING HOLDING HOLDING HOLDING HOLDING
2002 2002 2001 2000 1999 1998
---- ---- ---- ---- ---- ----
(IN THOUSANDS EXCEPT PER SHARE DATA)
Operating revenues .............. $ 62,815 $ 83,289 $ 136,116 $ 111,292 $ 43,732 $ 17,172
Income (loss) before discontinued
operations .................... 17,754 (43,204) (400,343) (211,738) (59,626) (27,888)
Income (loss) before discontinued
operations per common share (1) 0.27 (0.79) (7.13) (4.56) (2.30) (1.31)
Total assets (2) ................ 127,423 -- 613,647 1,172,460 402,429 252,119
Long-term debt and capital lease
obligations including current
maturities (2) ................ 5,009 -- 430,686 485,081 161,935 157,295
Predecessor Mpower Holding
Series B Convertible Redeemable
Preferred Stock (2) ........... -- -- -- -- 55,363 --
Predecessor Mpower Holding
Series C Convertible Redeemable
Preferred Stock (2) ........... -- -- 46,610 42,760 29,610 --
Predecessor Mpower Holding
Series D Convertible Redeemable
Preferred Stock (2) ........... -- -- 156,220 202,126 -- --
- ----------
(1) See Note 1 to accompanying consolidated financial statements
(2) Not provided for "Predecessor Mpower Holding 2002" column since year end
information is indicated in "Reorganized Mpower Holding 2002" column.
The numbers reflected above may not be comparable because of our rapid
growth until 2000, reduction of markets thereafter and the elimination of a
substantial portion of our debt and all of our preferred stock in connection
with our reorganization in 2002.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
COMPANY OVERVIEW
We are a competitive local exchange carrier ("CLEC") offering local
dial-tone, long distance, high-speed Internet access via dedicated Symmetrical
Digital Subscriber Line ("SDSL") technology, voice over SDSL ("VoSDSL"), Trunk
Level 1 ("T1"), Integrated T1 and Data-only T1, as well as other voice and data
features. Our services are offered primarily to small and medium-sized business
customers through our wholly owned subsidiary, Mpower Communications Corp.
("Communications").
We provide integrated voice and high-speed data services to small and
medium-sized business customers in five markets in California, Nevada and
Illinois. Our network consists of 294 incumbent carrier central office
collocation sites providing us access to an estimated 5.3 million addressable
business lines. All of our central office collocation sites are SDSL capable and
196 are T1 capable. We have established working relationships with Verizon,
Sprint, and Southwestern Bell Corporation (including its operating subsidiaries
PacBell and Ameritech collectively referred to as "SBC"). We have over 260,000
lines currently in service.
We were one of the first competitive communications carriers to implement
a facilities-based network strategy. As a result, we own the network switches
that control how voice and data communications originate and terminate, and we
lease the telephone lines or transport systems, over which the voice and data
traffic are transmitted. We install our network equipment at collocation sites
of the incumbent carriers from whom we rent standard telephone lines. As we have
already invested in and built out our own network, we believe that our strategy
has allowed us to establish and sustain service in our markets at a
comparatively low cost, while maintaining control of the access to our
customers.
Our business is to deliver integrated voice and broadband data solutions.
Specifically, we provide small and medium-sized business customers with a full
suite of communications services and features, integrated on one b