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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number
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CHOICE ONE COMMUNICATIONS INC.
(Exact name of Registrant as specified in its charter)
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Delaware 16-1550742
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Chestnut Street, Suite 600, Rochester, NY 14604
(Address of principal executive office) (Zip Code)
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(716) 246-4231
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Aggregate market value of all Common Stock held by non-affiliates as of March 1,
2001, was $94,382,666.
37,921,291 shares of $.01 par value Common Stock were issued and outstanding
as of March 1, 2001.
The Index of Exhibits filed with this Report begins at page 60.
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CHOICE ONE COMMUNICATIONS INC.
TABLE OF CONTENTS
Page
Part I
Item 1. Business...................................................2
Item 2. Properties................................................23
Item 3. Legal Proceedings.........................................23
Item 4. Submission of Matters to a Vote of Security Holders.......23
Item 4A. Executive Officers of the Registrant......................23
Part II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters.......................................26
Item 6. Selected Financial Data...................................27
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................29
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk ........................................35
Item 8. Financial Statements and Supplementary Data...............36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................36
Part III
Item 10. Directors and Executive Officers of the Registrant........36
Item 11. Executive Compensation....................................36
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................36
Item 13. Certain Relationships and Related Transactions............36
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.................................................37
Signatures................................................................59
Exhibits..................................................................60
1
Part I
ITEM 1: BUSINESS
General
We are an integrated communications provider offering voice and broadband data
telecommunications services primarily to small and medium-sized businesses in
second and third tier markets in the northeastern and midwestern United States.
Our services include local exchange service, long distance service, high-speed
data and Internet service, principally utilizing digital subscriber line ("DSL")
technology, and Web page design, development and hosting services. We seek to
become the leading integrated communications provider in each of our markets by
offering a single source of competitively priced, high quality, customized
telecommunications services. A key element of our strategy is to be one of the
first integrated communications providers to provide comprehensive network
coverage in each of the markets we serve. We are achieving this market coverage
by installing both voice and data equipment in multiple established telephone
company central offices. We have connected the majority of our clients directly
to our own switches, which allows us to more efficiently route traffic, ensure
quality of service and control costs. As of December 31, 2000, we were providing
service to 34,220 clients for 177,614 access lines, including 3,795 data lines.
On August 1, 2000, we acquired US Xchange, Inc., a facilities-based competitive
local exchange carrier with operations in the midwestern United States. Through
our acquisition of US Xchange, Inc., we have accelerated our entry into
midwestern markets and created a service area that now extends from Wisconsin to
Massachusetts. We have integrated US Xchange's operations and infrastructure
with ours and enhanced their product offerings to match those provided in our
northeastern markets. While US Xchange primarily offered voice services, we are
installing DSL equipment in those collocations and offering clients in the
former US Xchange markets a single source for voice and data telecommunications
services. US Xchange also resold other carriers' services to gain early entry
into a market and offered services to both residential and business clients, but
we have reduced the emphasis on resale and residential businesses in the former
US Xchange markets and are focusing on providing switch-based services to small
and medium-sized businesses.
On February 24, 2000, we acquired EdgeNet, Inc. a corporation based in Buffalo,
New York, which is engaged in the business of providing Internet home page
design and development.
In November 1999, we purchased all of the outstanding units of Atlantic
Connections, L.L.C., a local and long distance provider with operations in the
Portsmouth, New Hampshire and Worcester, Massachusetts metropolitan areas.
We currently offer telecommunications services in 26 markets in 11 states and
plan to become operational in an additional three markets during 2001. Following
the completion of our planned expansion to these 29 markets, we believe our
networks will be able to reach approximately 5.4 million business lines, which
constitute more than 70% of the estimated business lines in these markets. While
our network expansion would allow us to reach this number of business lines, the
number of business lines that we actually service will depend on our ability to
obtain market share from our competitors.
We have developed a flexible network buildout strategy which allows us to
achieve speed to market and cost efficiencies and to leverage rapidly evolving
telecommunications technology. In most of our markets, we initially deploy
digital switching platforms and lease network capacity to connect our switch
with our transmission equipment collocated in central offices of the established
telephone companies. This allows us to enter our markets more rapidly and with
lower initial costs than if we had to acquire or build fiber capacity. We
currently lease network capacity when entering a new market, and intend to
continue leasing, but may choose to own fiber capacity when and where traffic
volumes and other conditions make this alternative more cost efficient. As part
of our merger with US Xchange, we acquired rights to fiber formerly owned by US
Xchange in eight midwestern markets under an indefeasible right to use fiber
with a term of 20 years. In a separate transaction, we also purchased 20-year
indefeasible right to use fibers from Fiber Technologies, LLC for fiber capacity
in an additional 13 markets and acquired a minority interest and certain
governing rights in Fiber Technologies.
We have designed and are developing integrated operations support systems and
other back office systems. We believe these integrated systems give us
significant competitive advantages by enhancing our efficiency, allowing us to
support rapid and sustained growth and enabling us to provide exceptional client
care. We have automated most of our back office systems and are in the process
of integrating them into a seamless end-to-end system that will synchronize
multiple tasks, including installation, billing and client care. We recently
integrated our order management and billing systems in a manner that enables us
to transmit client information directly from the order management and service
fulfillment systems into the billing system, thereby eliminating redundant
keying
2
and reducing the potential for errors. In addition, in order to minimize the
time between a client order and service installation, we have also established
an on-line and real-time connection, called electronic bonding, of our
operations support systems with Verizon and Ameritech. We anticipate
establishing similar real-time connections with other established telephone
companies.
In each of our markets, we have a locally based sales force that provides high
quality, personalized client care. In addition to our direct sales force, we use
third party agencies to sell our services. These agencies include
telecommunications equipment vendors, consultants, systems integrators and
cellular phone retailers.
Business Strategy
We have an aggressive growth strategy to become the provider of choice offering
one-stop communications solutions to clients in our markets. Our future success
will depend upon our ability to implement this strategy. The key elements of our
business strategy are to:
Capitalize on Early to Market Advantage
Our goal is to continue to be among the first integrated communications
providers in an area to actively market and provide a bundled package of
integrated services to small and medium-sized businesses. We believe this
strategy provides us with a significant advantage over competitors who enter our
markets after us.
Target Underserved Clients
We are targeting small and medium-sized businesses primarily in second and third
tier markets in the northeastern and midwestern United States. We believe these
markets are currently being underserved by the established telephone companies
and other competitive telecommunications providers. We are focusing on markets
where there is a high concentration of potential business clients and a demand
for the types of services we offer. We believe we can attract and satisfy
clients in these areas by offering a simplified, comprehensive package of
services and a high level of client care.
Offer Broad Coverage
Once we enter a market, we provide broad geographic coverage within the market
by collocating in multiple locations within these markets to reach both central
business districts and outlying areas. While other companies often limit their
network buildout to highly concentrated downtown areas, our collocation strategy
is to reach 70% to 80% of the business lines within each market. As a result, we
are often the only competitor to the established telephone company to offer
integrated services to small and medium-sized businesses at many of our
collocation sites.
Offer Bundled Services with a Single Point of Contact
We strive to attract new clients and maximize client retention by offering
bundled services with a single point of contact for sales and service and
convenient, integrated billing. Our clients may bundle local exchange service,
long distance service, high-speed data and Internet service principally
utilizing DSL technology, e-mail, Web page design, development and server
hosting, voicemail and other enhanced services not generally available from the
established telephone companies, or available only at higher prices along with
their traditional local and long distance services. In addition, we have
developed a billing system which will provide our clients with a single, easy to
understand statement covering all of their services.
Lead Competition in Providing DSL Services
We believe we are and will continue to be one of the first integrated
communications providers in each of our markets to provide dedicated, high-speed
digital communications services using DSL technology. DSL technology permits
broadband transmissions over existing copper telephone lines, allowing us to
provide high-speed services economically. High-speed connectivity is becoming
increasingly important to small and medium-sized businesses due to the dramatic
growth in Internet and electronic business applications. We have installed DSL
equipment in most of our collocations and are retrofitting the existing
collocations in the former US Xchange markets with DSL equipment. We expect to
build out all new collocations with this equipment.
Maintain Our Flexible Network Buildout Strategy
We have developed a flexible network buildout strategy which allows us to
achieve speed to market and cost efficiencies and to leverage rapidly evolving
telecommunications technology. In most of our markets we initially deploy
digital switching platforms and lease network capacity to connect our switch
with our transmission equipment collocated in central offices of the established
telephone carriers. This allows us to enter our markets more rapidly and with
lower initial costs than if we had to acquire fiber capacity. We intend to
continue to lease network capacity when entering a new market, but may choose to
own fiber capacity when and where traffic volume makes this alternative more
cost-efficient.
3
Utilize Efficient Automated and Integrated Back Office Systems
Our management team is committed to having efficient operations support systems
and other back office systems that can support rapid and sustained growth. To
realize this objective, we have a team of engineering and information technology
professionals experienced in the telecommunications industry. Our systems team
is developing a seamless end-to-end system that will synchronize multiple tasks,
including installation, billing and client care. We have already integrated
software from ADC Communications, Inc. (formerly Saville Systems Inc.), MetaSolv
Software Inc. and DSET Corporation, and are currently working with other third
party vendors to integrate their software into our end-to-end system. Unlike the
legacy systems currently employed by many established telephone companies and
competitive local exchange carriers, which require multiple entries of client
information to synchronize multiple tasks, our system will require only a single
entry to transfer client information from sales to service to billing. Our
customized system will also integrate our back office systems to minimize the
time between client order and service installation and to reduce our costs. We
have implemented an electronic interface, referred to as electronic bonding,
linking our operations support systems directly to Verizon and Ameritech, so
that we can switch Verizon and Ameritech clients to our network on an automated
basis. We anticipate developing similar bonds with other established telephone
companies.
Increase Our Market Share by Providing Service-Driven Client
Relationships and a Local Presence
We seek to attract and retain clients by establishing local sales offices in
each of our markets and providing a highly experienced, locally based account
management team which will provide face-to-face sales and personalized client
care. We are dedicated to building long-term relationships with our clients,
which we believe have not typically received a satisfying level of local support
from the established telephone companies. Our service guarantee provides that if
a client is not satisfied with the quality of our service and we cannot remedy
the problem within 30 days, we will incur all of the costs to switch the client
back to its previous provider. In addition, we are committed to supporting and
further developing the communities in which our clients live and work. Our
employees live in these communities and many of them participate in local
charities, organizations and chambers of commerce. We believe that this local
presence builds strong, positive Choice One name recognition within these
communities.
Accelerate Growth Through Acquisitions
We intend to continue to accelerate our growth into new market regions and
expand our presence in our existing target market regions by acquiring
telecommunications companies and related businesses and assets. We seek
acquisition targets that offer similar services to ours which can be integrated
into our existing operations and networks. We also seek acquisition targets
which would allow us to offer additional value-added or other related services
as well as new technologies that we may seek to implement. Once we have acquired
a company, we intend to integrate the company by expanding its offered services
to the full range of Choice One services, centralizing administrative, billing
and client care functions and reducing redundant overhead. We currently have no
definitive agreements relating to any material acquisitions.
Leverage Management Experience
Our management team has extensive experience and success in the
telecommunications industry, especially in our target markets. We believe that
our ability to draw upon the collective talent and expertise of our senior
management gives us a competitive advantage in the execution of network
deployment, sales and marketing, service installation, billing and collection,
back office and operations support systems, finance, regulatory affairs and
client care.
Our Telecommunications Services
Our service offerings are tailored to meet the specific needs of small and
medium-sized businesses in our markets. In all of our markets, we offer both
voice and data services, which can be purchased by our clients either as a
bundled package or as individual services.
Bundled Services
Through our InfiniteChoiceSM plans, our clients may bundle local, long distance
and high-speed Internet services in a variety of combinations to meet their
particular needs. Our InfiniteChoiceSM bundled plans can save our clients up to
20% off the regular price lists disclosed by established telephone companies for
the same services. The rates that we use as a baseline for our services are
established telephone companies' tariff rates, which do not include special
price promotions.
4
Individual Services
As an alternative to choosing an InfiniteChoiceSM plan, clients can select one
or more individual services. Our clients can choose from the following services:
Local Calling Services. Our local exchange services are offered through our
ChoiceXchangeSM service plan. This service includes dialing parity, simplified
local rates, local number portability, listing in white and yellow page
directories and access to 911 and directory assistance. Also available through
the service are enhanced features, such as three-way conference calling, line
rollover, call forwarding, call waiting, caller identification and voice mail.
Our voice mail service, known as ChoiceMessageSM, includes free call forwarding,
remote access, paging notification, personalized greetings and password
protection. In certain of our markets we also originate and terminate
interexchange calls placed or received by our clients at no additional charge
and offer free local calling between our clients.
Long Distance Services. Through our ChoiceOnePlusSM service, we offer a full
range of domestic and international long distance services, including "1+"
outbound calling, six second incremental billing, inbound toll free service, and
complementary services such as calling cards with operator assistance and
conference calling. To provide easy to understand billing to our clients, we
also offer one rate on any calls within the U.S. We do not offer long distance
as a stand-alone service to new clients.
Internet Access and DSL High-speed Data Services. With our ChoiceOneOnLineSM
suite of Internet services, we offer a comprehensive solution to our clients'
requirements including Internet access, e-mail, domain name hosting and other
value-added services. We offer Internet access via DSL technology; dedicated
digital transmission links with a capacity equivalent to 24 standard telephone
lines, known as T-1 connections; and dial-up. We provide high-speed data
communications and Internet access to our targeted small and medium-sized
businesses at rates that we believe are very attractive when compared to the
cost and performance of other available data service offerings.
Our Choice NetJetSM service, powered by DSL technology, is highlighted by
the following key elements:
o Customizable Bandwidth. We offer our clients speeds ranging from 128kps
to 1.544 mbps. Our clients choose the speed and bandwidth capacity that
meets their needs.
o Always On. Through Choice NetJetSM, our clients are connected 24 hours
a day, 7 days a week.
o Symmetric Connections. Our service allows for data transmission at the
same speed in both directions.
o Security. Our server is designed to prevent unauthorized access to our
clients' information and enable the safe and secure transmission of
sensitive information and applications.
o No Usage Fees. Our clients may use their Choice NetJetSM connection for
any period of time without per minute usage charges.
Dedicated T-1 Services. We offer ChoicePathSM dedicated T-1 services as an
integrated low cost solution for dedicated access for bundling Internet/data,
local and long distance services over a single connection. ChoicePathSM permits
digital connections to be purchased in blocks of 24 circuits or on an individual
basis.
Virtual Private Network Services. Our Choice One DataLinkSM services combine our
DSL and dedicated T-1 access services with our virtual private network equipment
to provide clients with high-speed and secure connections to their corporate
local area network and the Internet. This flexible and cost-effective solution
supports both telecommuters and site-to-site connections.
Web Hosting. We offer a range of shared web hosting products targeted to meet
the needs of most small to medium-sized businesses. We provide clients with a
reliable web presence they need to meet their Internet-related objectives
without the initial capital expense required to purchase and maintain their own
equipment. We also provide e-mail hosting solutions and domain name registration
and hosting.
Web Design Services. We offer web design solutions that accommodate a range of
client needs, from establishing a simple web presence to creating sophisticated
web sites. We offer three different web design options that combine the economy
of a packaged design product with the flexibility to create a customized look.
Our clients can choose the layouts, colors, and content they desire to create a
web site suitable to their particular needs. When clients are ready to expand
their web presence, we also offer custom web design services for higher-end
applications.
5
Other Planned Services
Network Based Services. By leveraging our network resources, we plan to provide
network based services, such as firewall security, basic routing and network
monitoring, for which clients would pay a combined monthly charge. We believe
these products will be attractive to small to medium-sized businesses that
require high-end network services, but do not want to make the large capital
investments required to perform these functions themselves.
Hosted Application Services. We plan to offer a suite of advanced software
applications that can be accessed via our high-speed data services. Clients
would pay a monthly charge per user, per application, which would eliminate the
need for them to purchase and support these applications themselves.
Sales and Client Care
We attract and retain clients by establishing local sales offices in each of our
markets and providing a highly experienced, locally based, dedicated account
management team which provides face-to-face sales and personalized client care.
In each market we have a sales force that uses a consultative selling approach
to offer clients a full range of sophisticated and cost-effective
telecommunications solutions. We are committed to support and development of the
communities in which our clients and our employees live and work.
In each of our markets, we have a sales teams led by a general manager who is
responsible for the acquisition and retention of all revenue in that market.
Each team includes direct salespersons, service order coordinators, client
development representatives and technical consultants. Our direct salespersons
target various segments of business clients with the goal of calling on every
qualified prospective business client in the territory. Sales teams use a
variety of methods to qualify leads and set up initial appointments, including
telemarketing and building canvassing. Client development representatives are
assigned to each client to manage our relationship with the client on an
on-going basis. These representatives are responsible for client service and
retention as well as responding to and supporting our client's on-going needs by
identifying their evolving requirements and up-selling a broader array of
comprehensive telecommunications services. In addition to our direct sales
force, we use independent third-party sales agencies who sell our products and
services directly to their unique client bases. These agencies include
telecommunications equipment vendors, consultants, system integrators and
cellular phone retailers.
We target our sales recruitment efforts to experienced sales representatives
with significant local market experience and business contacts. Each member of
our sales and sales support team is required to participate in a training
program designed to enhance knowledge of telecommunications, sales processes and
activity management. This program also promotes our quality client care and
personalized local service principles and ensures a consistent market message in
all our territories. We have designed commission plans and incentive programs to
reward and retain our top performers and to encourage strong client
relationships.
We focus on providing responsive client care 24 hours a day, seven days a week.
Our commitment is demonstrated by our service guarantee, which provides that if
a client is not satisfied with the quality of our service and we cannot remedy
the problem within 30 days, we will incur all of the costs to switch the client
back to its previous provider. Our automatic call distribution system enables us
to efficiently manage our client contacts. In addition to basic call
distribution features, this system allows for computer telephony integration,
allowing access to client information at the time of a call; task queuing,
enabling automatic distribution of a phone call, fax or e-mail; and geographic
routing, which allows client services representatives to receive incoming
contacts from an assigned geographic area.
As of December 31, 2000, we had 572 persons in our sales and sales support
staff, not including our independent third-party sales agencies.
6
Our Markets
We offer telecommunications services in 26 markets, comprising 34 basic trading
areas, and have plans to expand into three additional markets during 2001. In
selecting our markets, we estimate market demand for our services using data
gathered from interexchange carriers, the FCC, local sources, site visits and
specific market studies. In addition to market demand, we also consider the
established telephone companies' level of service as well as the level of
penetration within the market by other integrated communication providers.
We are currently operating in the following markets:
Akron, OH(1) Green Bay, WI(2) Providence, RI
Albany, NY Harrisburg, PA(3) Rochester, NY
Allentown, PA Hartford, CT Rockford, IL
Buffalo, NY Kalamazoo, MI(4) Scranton, PA
Columbus, OH Madison, WI South Bend, IN(6)
Dayton, OH Manchester, NH Springfield, MA
Evansville, IN Milwaukee, WI Syracuse, NY
Fort Wayne, IN New Haven, CT(5) Worcester, MA
Grand Rapids, MI Pittsburgh, PA
(1) Also includes the basic trading area for Youngstown, OH.
(2) Also includes the basic trading areas for Appleton, WI and Oshkosh, WI.
(3) Also includes the basic trading area for Lancaster, PA.
(4) Also includes the basic trading area for Battlecreek, MI.
(5) Also includes the basic trading areas for Bridgeport, CT and Stamford, CT.
(6) Also includes the basic trading area for Elkhart, IN.
We are constructing voice and data switching facilities in the following three
markets: Ann Arbor/Lansing, MI; Richmond, VA; and Indianapolis, IN. We expect
these markets to be operational during 2001.
As of December 31, 2000, we had applications accepted to collocate our network
equipment in 467 established telephone company central offices, had completed
410 of these collocations and had 57 additional collocations in progress in our
operational and under construction markets. Most of these collocations also
include equipment to provide DSL services.
The table below provides selected key operational data as of the years ended
December 31:
2000 1999
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Markets Served 26 9
Number of switches-voice 24 8
Number of switches-data 45 10
Total Central Office Collocations 410 141
Estimated Addressable Market (Business Lines) 4.1 million 1.5 million
Lines in service-total 177,614 20,096
Lines in service-voice 173,819 19,890
Lines in service-data 3,795 206
Total Employees 1,420 390
Sales Employees 572 156
7
Network Infrastructure
We have developed a flexible network buildout strategy to allow us to enter
markets quickly, to achieve cost efficiencies and attractive rates of return on
capital by adding incremental network capacity as needed, and to integrate and
benefit from new telecommunications technologies.
We have a Lucent Series 5ESS(R) digital switch in each of our operational
markets, other than Worcester, MA and New Haven, CT. We are serving the
Worcester market by connecting our equipment in the Worcester market to our
Springfield, MA switch. A similar network configuration is utilized between the
Hartford and New Haven, CT markets. We are also installing a packet based switch
network in each market in order to establish a widespread coverage area for the
offering of high bandwidth digital connections utilizing DSL technology. As of
December 31, 2000, we had 24 Lucent 5-ESS(R) switches in service and 45 data
switches in service. Our switches are connected to established telephone
companies' networks and long distance and Internet service provider
points-of-presence.
We are pursuing a collocation strategy under which we are installing voice
concentrators, referred to as integrated digital loop carriers, and related
equipment in numerous established telephone company central offices in each of
our markets. Additionally, we are installing data concentrators, referred to as
digital subscriber line access modules, in the same central offices so that we
can provide high-speed DSL data access using the existing established telephone
company network. Our goal is to install our network equipment, including both
voice and data components, in sufficient established telephone company central
offices to address 70% to 80% of the business lines in each market. Because US
Xchange did not offer DSL service prior to its acquisition by us, we are
currently retrofitting the former US Xchange voice collocations with data
concentrators. Work is progressing on the completion of these data installations
and we anticipate that the remaining sites will be completed by the end of 2001.
We lease unbundled loops from the established telephone company or T-1
facilities from the established telephone company or competitive network
provider to connect our equipment in the telephone company central office to the
client locations.
When entering into a market, we lease local network facilities from the
established telephone company and/or one or more competitive network providers
to connect our switch to established telephone company central offices.
Initially leasing these facilities allows us to begin operations more quickly
and at a lower upfront cost than if we had to acquire or build them, but we may
choose to own local fiber network capacity when and where traffic volume and
other conditions make this alternative more cost effective. We received a
20-year indefeasible right to use fiber for operational intra-city fiber in
eight markets as part of our acquisition of US Xchange and are replacing leased
capacity with our own network in numerous other markets. Additionally as part of
the acquisition, we acquired a 20-year indefeasible right to use fiber for a
1,691 mile inter-city fiber network between nine markets in Wisconsin, Illinois,
Indiana and Michigan. We expect this inter-city fiber network to be operational
during the first half of 2001.
We have also entered into an agreement with Fiber Technologies, LLC. ("Fiber
Technologies"), to become the anchor tenant on its local fiber loops in certain
markets. We acquired 20-year indefeasible right to use fiber capacity in 13
markets, with additional markets to be determined. Fiber Technologies commenced
construction in three of our markets during the third quarter of 2000. Our
contract with Fiber Technologies calls for preferred pricing for the first five
years of the agreement. We expect that benefits of these indefeasible right to
use fibers will include network redundancy, reduced provisioning intervals
(provisioning onto our own network, versus relying on the incumbent local
exchange carriers for provisioning) and reduced per unit costs with additional
product offerings. In addition to this arrangement, we have acquired a minority
interest in Fiber Technologies, have the right to appoint one representative to
the board of directors, and will have a vote in determining the new markets in
which Fiber Technologies will develop and build fiber.
We operate a network operations control center, or NOCC, facility in Grand
Rapids, Michigan, which provides monitoring of the switching and fiber
facilities across our entire network 24 hours per day, seven days per week.
We have had ongoing market tests of voice over DSL with clients since late 1999.
This technology allows us to provide both voice and high-speed data
communications over one established telephone company line, thereby reducing our
network costs. Our network architecture, comprised of both DSL or voice and data
switching technologies, enables us to integrate this traffic over DSL from the
client location to our access equipment, and then to our regional switching
center. At the regional center, this traffic is split into its voice and data
components. Data traffic is switched via a data switch to its appropriate
destination. The voice components are switched through the Lucent 5ESS(R)
switch, which is interconnected to the public switched telephone network.
Rapid and significant changes in technology are expected in the
telecommunications industry. Our future success will depend, in part, on our
ability to anticipate and adapt to technological changes. For example, we are
currently evaluating new switching devices, from leading equipment manufacturers
that are significantly smaller and less expensive than the switches that we have
deployed to date. We believe that this network design positions us to rapidly
implement our future voice-switching infrastructure. Using various
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combinations of voice and data switching, our network uses a distributed design
that creates network efficiencies, closely correlates capital costs with traffic
volumes, and distributes access/routing elements closer to our clients. Many
switch and product elements are centralized to serve multiple markets. This
design encourages capital efficiencies while enabling enhanced feature and
service functionality.
Information Systems
We are implementing an integration strategy for our operations support systems
and other back office systems that we believe will provide significant
competitive advantages in terms of efficiency, capacity to process large order
volumes and the ability to deliver exceptional client care. We are developing a
seamless end-to-end system that will synchronize multiple activities. This
system will allow information to be entered once and at the appropriate time
within our sales, client care, trouble management and billing process.
Information will then be shared between the various components of our systems.
We believe that our single entry system will be superior to systems requiring
multiple entries of client information. Duplicate information entered into
multiple systems can result in billing problems, service interruptions, and
delays in installation. Our single entry process is less labor intensive and
will reduce the margin for error. In addition, the sales to billing interval
will be significantly shortened. We expect that our customized, integrated
system will also enable us to support rapid and sustained growth.
The individual components of our system are as follows:
Order Entry, Process Flow, Network Inventory, Billing and Administration
We have entered into an agreement with MetaSolv Software Inc. to license its
Telecom Business Solution, or TBS, software to manage our back office operations
support system. MetaSolv's software manages our order entry, service
installation, network element inventory, gateway interconnects and workflow
business functions and will allow our sales team to monitor the status of the
order from initiation through service implementation.
We have entered into an agreement with ADC Communications to utilize its
Convergent Billing Platform AS/400 software which enables us to combine and bill
current and future service offerings and present the information on a single
bill for our clients. This system supports client care functions, including
billing inquiries and collection processes. Call detail records, such as the
billing records generated by our voice or data switches will be automatically
processed by the billing services provider in order to calculate and produce
bills in a variety of formats.
Our MetaSolv system has been integrated with our ADC Communications billing and
administration system to ensure data integrity and eliminate redundant data
entry. This integrated software solution allows us to efficiently bill for
multiple products on a single statement and provides a central point of contact
for handling orders and activities.
Electronic Bonding
Through software that we have licensed from DSET Corporation and have integrated
with our MetaSolv software, we have established electronic bonding with Verizon
and Ameritech. We have implemented an electronic interface linking our
operations support systems directly to the established telephone company system
so that we can process orders on an automated basis for our clients which are
switching service from an established telephone company. Additionally, we can
confirm receipt and installation of service on-line and in real-time. We
anticipate forming similar connections with other established telephone
companies, although some established telephone companies are just beginning to
develop automated interfaces. We intend to continue to take a lead role with
selected established telephone companies to create standards for automation of
these interfaces.
Trouble Ticketing
We have created a system that logs information related to and monitors the
resolution of network problems. This system acts as a central repository for
logging client trouble calls, assigning responsibility for addressing the
problem to the appropriate party, and tracking the status of the response to the
calls, including automatically escalating the response process, as appropriate.
Sales Force Automation and Contact Management
Our sales force utilizes software referred to as contact automated sales helper.
This software assists us in the management of potential customer contacts, the
distribution of lists of potential clients, the preparation of client forecast
materials, the management of the sales process with particular client prospects
and the preparation of proposals, correspondence and order forms.
9
Service Introduction
Prior to offering services in a market, we must secure certification from state
regulatory commissions. Typically, we must file tariffs, or price lists, for the
services that we will offer. The certification process varies from state to
state; however, the fundamental requirements are largely the same. State
regulators require new entrants to demonstrate that they have secured adequate
financial resources to establish and maintain good client service. New entrants
are also required to show that they have the requisite technical and managerial
ability required to establish and operate a telecommunications network. Our
operating subsidiaries have already received certificates of authority to
provide local exchange and interexchange telecommunications services in each of
the states in which we currently operate and Virginia. In addition, we have
received authority under Section 214 of the Communications Act of 1934 to
provide international switched services.
Before providing local service, we must also negotiate and execute an
interconnection agreement with the established telephone company. While such
agreements can be voluminous and may take months to negotiate, most of the key
interconnection issues have now been thoroughly addressed and regulatory
commissions in most states have ruled on arbitrations between the established
telephone companies and new entrants. New entrants may adopt an interconnection
agreement already entered into by the established telephone company and another
carrier. We will selectively adopt such an approach so that we can enter markets
quickly. At the same time, we will preserve our right to replace the adopted
agreement with a customized interconnection agreement that can be negotiated
once service has already been established. We have adopted interconnection
agreements with the established telephone companies in each of the states in
which we currently operate and Virginia. Some established telephone companies,
such as Verizon, have sought to limit the rights of competitive
telecommunications providers to adopt existing interconnection agreements. We
cannot predict whether we will be able to adopt such interconnection agreements
in the future.
While interconnection agreements include key terms and prices for
interconnection circuits, a significant joint implementation effort must be made
with the established telephone company in order to establish operationally
efficient and reliable traffic interchange arrangements. Interchange
arrangements must include those between the new entrant's network and the
facilities of other service providers as well as public service agencies.
Examples of traffic interchange and interconnection arrangements utilizing the
established telephone companies network include connectivity to its out-of-band
signaling facilities, interconnectivity to the established telephone company's
operator services and directory assistance personnel, and access through the
established telephone company to the networks of wireless companies and
interexchange carriers.
Regulation
The following summary of regulatory developments and legislation describes
the primary present and proposed federal, state, and local regulations and
legislation that is related to the telecommunications and Internet service
industries that would have a material effect on our business. Existing federal
and state regulations are currently subject to judicial proceedings, legislative
hearings and administrative proposals that could change, in varying degrees, the
manner in which our industries operate. We cannot predict the outcome of these
proceedings or their impact upon the telecommunications and Internet service
industries or upon us.
Overview
Our telecommunications services are subject to federal, state and local
regulation. The FCC exercises jurisdiction over all facilities and services of
telecommunications common carriers to the extent those facilities are used to
provide, originate, or terminate interstate or international communications.
State regulatory commissions exercise jurisdiction over facilities and services
to the extent those facilities are used to provide, originate or terminate
intrastate communications. In addition, as a result of the passage of the
Telecommunications Act of 1996, state and federal regulators share
responsibility for implementing and enforcing the domestic pro-competitive
policies of the Telecommunications Act. In particular, state regulatory
commissions have substantial oversight over the provision of interconnection and
non-discriminatory network access to established telephone companies. Local
governments often regulate public rights-of-way necessary to install and operate
networks.
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Federal Regulation
We are regulated at the federal level as a nondominant common carrier subject to
minimal regulation under Title II of the Communications Act of 1934. Recent
legislation amending the Communications Act provides for comprehensive reform of
the nation's telecommunications laws and is designed to enhance competition in
the local telecommunications marketplace by requiring established telephone
companies to provide us with access and interconnection to their facilities and
open their local markets to competition.
One of our current market advantages is our ability to offer both local and long
distance service, while the largest established telephone companies can only
offer local service in their region. Under the Telecommunications Act, regional
Bell operating companies have the opportunity to provide long distance services
in the same region in which they offer local service if they comply with
market-opening conditions. Established telephone companies are no longer
prohibited from providing specified cable TV services. In addition, the
Telecommunications Act eliminates particular restrictions on utility holding
companies, thus clearing the way for them to diversify into telecommunications
services.
Before a regional Bell operating company can provide in-region long distance
services, it must obtain FCC approval upon showing that it has entered into
interconnection agreements with competitive local exchange carriers in the
states where it seeks authority, that the interconnection agreements satisfy a
14-point "checklist" of competitive requirements and that such entry is in the
public interest. To date, Verizon has been granted such authority in New York,
and Southwestern Bell has been granted such authority in Texas, Kansas and
Oklahoma. Several additional requests for such authority either have or soon
will be filed. The provision of in-region long distance services by the regional
Bell operating companies could permit them to offer "one-stop shopping" of
bundled local and long distance services, thereby eliminating our current
marketing advantage.
FCC Rules Implementing the Local Competition Provisions of the
Telecommunications Act
Over the last four years, the FCC has established a framework of national rules
enabling local competition. Some of those rules have important bearing on our
business, particularly:
Interconnection. Established telephone companies are required to provide
interconnection for telephone exchange or exchange access service, or both, to
any requesting telecommunications carrier at any technically feasible point. The
interconnection must be at least equal in quality to that provided by the
company to itself or subsidiaries, affiliates or any other party to which it
provides interconnection, and must be provided on rates, terms and conditions
that are just, reasonable and nondiscriminatory.
We have obtained or will obtain agreements with some established telephone
companies. These agreements must be renegotiated periodically. Renewal terms may
be less favorable and could affect our overall costs.
Access to Unbundled Elements. Established telephone companies are required to
lease portions of their networks to requesting telecommunications carriers by
providing them with nondiscriminatory access to network elements on an unbundled
basis at any technically feasible point, on rates, terms, and conditions that
are just, reasonable, and nondiscriminatory. This is important, because it
minimizes our need to make major investments in building our network. At a
minimum, established telephone companies must provide competitors with access to
various network elements used to originate and terminate telephone calls, call
routing database facilities, and computerized operations support systems.
For example, the FCC recently adopted additional rules that direct established
telephone companies to share their local telephone lines so that competitors
could make use of the high frequency portion of the line. This will enable
competitive carriers like us to use DSL technology to provide high-speed data
services over the same telephone lines simultaneously used by established
telephone companies to provide basic telephone service, a technique referred to
as "line sharing." The short term effect of this order is difficult to predict,
as the FCC left it to the states to determine how this should be done, and what
rates the incumbent local exchange carriers may charge. This process could take
some time, even without considering any appeals of this order that may be filed.
In the long term, however, this rule could have the effect of sharply reducing
our costs of providing DSL service.
Collocation. Established telephone companies are required to provide space in
their switching offices so that requesting telecommunications carriers can
physically "collocate" equipment necessary for interconnection or access to
unbundled network elements at the company's premises, except that the
established telephone company may provide off-site "virtual" collocation, if it
demonstrates to the state regulatory commission that physical collocation is not
practical for technical reasons, or because of space limitations.
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Other Regulations
In general, the FCC has a policy of encouraging new competitors, such as us, in
the telecommunications industry and preventing anti-competitive practices.
Therefore, the FCC has established different levels of regulation of dominant
carriers, the established telephone companies, and nondominant carriers,
integrated communications providers and competitive local exchange carriers.
Tariffs. As a nondominant carrier, we may install and operate facilities for the
transmission of domestic interstate communications without the time and expense
of obtaining prior FCC authorization. Our primary regulation obligations are to
file schedules of rates and terms of service, called tariffs, and making
periodic reports. A filed tariff benefits us because it relieves us from
negotiating contracts with each customer.
In October 1996, the FCC adopted its de-tariffing order, which eliminated the
requirement that nondominant interstate carriers like us maintain tariffs on
file with the FCC for domestic interstate services, and provided that, after a
nine-month transition period, relationships between interstate carriers and
their clients would be set by contract, not tariff. Although the effectiveness
of these rules was stayed for more than three years, they were ultimately
upheld. The de-tariffing order is now scheduled to become effective in early
2001, after which time nondominant interstate services providers will no longer
be able to rely on the simple filing of tariffs with the FCC as a means of
providing notice to clients of prices, terms and conditions under which they
offer their interstate services. If we cancel our FCC tariffs as a result of the
de-tariffing order, we will need to implement replacement contracts with each
customer, which could result in substantial administrative and selling expenses.
International Services. Nondominant carriers such as us also are required to
obtain FCC authorization pursuant to Section 214 of the Communications Act and
file tariffs before providing international communications services. We have
obtained such authority. The FCC has adopted rules for a multi-year transition
to lower international settlement payments by U.S. common carriers. We believe
that these rules are likely to lead to lower rates for some international
services and increased demand for these services, including capacity on the U.S.
facilities, like ours, that provide these services.
Established Telephone Company Pricing Regulation Reform. The FCC has adopted a
number of proposals to significantly reduce its regulation of established
telephone company pricing which would greatly enhance the ability of established
telephone companies to compete against us, particularly by targeting price cuts
to particular clients, which could have a material adverse effect on our ability
to compete based on price. Review of these FCC decisions is currently pending
before the District of Columbia Circuit.
Access Charges. The FCC has also made various reforms to the existing rate
structure for charges assessed on long distance carriers for allowing them to
connect to local networks. These changes will reduce access charges and will
shift charges, which had historically been based on minutes-of-use, to flat
rate, monthly per line charges on end-user clients rather than long distance
carriers. As a result, the aggregate amount of access charges paid by long
distance carriers to access providers like us may decrease.
At the same time, the FCC, noting the proliferation of fixed monthly charges on
the bills of long distance customers, has recently initiated a public inquiry on
the impact of these charges on consumers.
Moreover, major long distance carriers are attempting to undermine our ability
to set access charges as we choose. In October 1998, AT&T initiated a proceeding
in which it sought a declaration from the FCC that AT&T may avoid competitive
local exchange carrier access charges by declining to direct calls to the
clients of those competitive local exchange carriers. In addition, AT&T and
Sprint have sent letters to virtually every competitive local exchange carrier
stating that competitive local exchange carriers access charges for in-bound
long distance calls are unreasonable, and demanding a reduction in rates to a
"competitive" level. If competitive local exchange carriers are unwilling to
comply, AT&T and Sprint threaten to no longer deliver those calls. The FCC has
instituted a proceeding to investigate the issues surrounding competitive local
exchange carriers' access charges, including whether regulation of competitive
local exchange carriers' rates is warranted. If long distance providers may in
fact refuse to purchase competitive telecommunications providers' switched
assess services, or if such services are ultimately regulated, competitive
telecommunications providers like us may be adversely affected.
Universal Service Reform. Universal telephone service is a long-standing policy
initiative designed to assure that as many people as possible have access to
quality telephone service at affordable rates, particularly in rural and
high-cost areas, as well as providing advanced telecommunications services for
schools, health care providers and libraries. All telecommunications carriers
providing interstate telecommunications services, including us, must contribute
to the universal service support fund.
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In October 1999, the FCC issued an order changing the way that universal service
contributions are calculated to eliminate revenues from intrastate services from
the calculation. In November 1999, the FCC issued an order revising its rules
for calculating the size of the universal service fund, which shifts more of the
costs of universal service to the federal program. The changes resulting from
these orders are likely to increase the overall burden of the federal universal
service program on carriers providing interstate services, such as long
distance. Various states also are in the process of implementing their own
universal service programs, which also may increase our overall costs.
Slamming. The FCC has adopted rules to govern the process by which end users
choose their carriers. Under their rules, a user may change service providers at
any time, but specific client authentication procedures must be followed. When
they are not, particularly if the change is unauthorized or fraudulent, the
change in service providers is referred to as "slamming." Slamming is such a
significant problem that it was addressed in detail in the Telecommunications
Act and by the FCC in recent orders. The FCC has levied significant fines for
slamming. The risk of financial damage and harm to business reputation from
slamming is significant. Even one slamming complaint could cause extensive
litigation expenses for us. The FCC recently decided to apply its slamming
rules, which originally covered only long distance, to local service.
State Regulation. We believe that most, if not all, states in which we propose
to operate will require a registration, certification or other authorization to
offer intrastate services. Many of the states in which we operate or intend to
operate are in the process of addressing issues relating to the regulation of
competitive local exchange carriers. We will also be subject to tariff filing
requirements. In most states, we are required to file tariffs setting forth the
terms, conditions and prices for services that are classified as intrastate.
We have received, through our operating subsidiaries, certificates of authority
to provide local exchange and interexchange telecommunications services in
Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, New
York, Ohio, Pennsylvania, Rhode Island, Virginia, and Wisconsin. Applications
for such authority are pending in Maine and Vermont.
In addition to tariff filing requirements, some states also impose reporting,
client service and quality requirements, as well as unbundling and universal
service requirements. In addition, we will be subject to the outcome of generic
proceedings held by state utility commissions to determine new state regulatory
policies. Some states, including some of our target states, have adopted or have
pending proceedings to adopt specific universal service funding obligations.
These state proceedings may result in obligations that are equal to or more
burdensome than the federal universal service obligations.
We believe that, as the degree of intrastate competition increases, the states
will offer the established telephone companies increasing pricing flexibility.
This flexibility may present the established telephone companies with an
opportunity to subsidize services that compete with our services with revenue
generated from non-competitive services, thereby allowing established telephone
companies to offer competitive services at lower prices. This could have a
material adverse effect on our revenue.
We are also subject to requirements in some states to obtain prior approval for,
or notify the state commission of, specified events such as transfers of
control, sales of assets, corporate reorganizations, issuances of stock or debt
instruments and related transactions.
Local Authorizations. When constructing a network, such as fiber optic cables,
we generally must obtain municipal franchises and other permits. These rights
are typically the subject of non-exclusive agreements of finite duration and
provide for the payment of fees or the provision of services to the
municipality. In addition, we must secure rights-of-way, pole attachments and
other access rights, which are typically provided under non-exclusive multi-year
agreements that generally contain renewal options. In some municipalities we
will be required to pay license or franchise fees based on a percentage of gross
revenue or on a per linear foot basis, as well as post-performance bonds or
letters of credit.
Internet. Our Internet operations are not currently subject to direct regulation
by the FCC or any other telecommunications regulatory agency, although they are
subject to regulations applicable to businesses generally. However, the future
Internet service provider regulatory status continues to be uncertain. In an
April 1998 report, the FCC concluded that while some Internet service providers
should not be treated as telecommunications carriers, some services offered over
the Internet, such as phone-to-phone telephony, may be functionally
indistinguishable from traditional telecommunications service offerings, and
that their non-regulated status may have to be re-examined. Moreover, although
the FCC has decided not to allow local telephone companies to impose per-minute
access charges on Internet service providers, and that decision has been upheld
by the reviewing court, further regulatory and legislative consideration of this
issue is likely. The imposition of access charges would affect our costs of
serving dial-up clients and could have a material adverse effect on our
business, financial condition and results of operations. In addition, Congress
and other federal entities have adopted or are considering other legislative and
regulatory proposals that would further regulate the Internet. Various states
have adopted and are considering Internet-related legislation. Increased U.S.
regulation of the Internet may slow its growth or reduce potential revenue,
particularly if other governments follow suit, which may increase the cost of
doing business over the Internet.
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We believe that, under the Telecommunications Act, competitive local exchange
carriers are entitled to receive compensation from established telephone
companies for delivering traffic bound for Internet service provider clients of
the competitive local exchange carriers, despite the objections of established
telephone companies. While most states have required established telephone
companies to pay this compensation to competitive local exchange carriers, the
FCC is expected to issue a decision phasing out reciprocal compensation payments
over the next few years. If such a decision is made, there is a risk that state
public utility commissions that have previously considered this issue and
ordered the payment of reciprocal compensation by the established telephone
companies to the competitive local exchange carriers may be asked by the
established telephone companies to revisit their determinations, or may revisit
their determinations on their own motion.
Competition
We operate in a highly competitive environment and currently do not have a
significant market share in any of our markets. Most of our actual and potential
competitors have substantially greater financial, technical, marketing and other
resources, including brand name recognition, than we do. Also, the continuing
trend toward business alliances in the telecommunications industry, and the
increasingly reduced regulatory and technological barriers to entry in the data
and Internet services markets, could give rise to significant new competition.
We believe that the principal competitive factors affecting our business will be
pricing, client service, accurate billing and, to a lesser extent, variety of
services. Our ability to compete effectively will depend upon our ability to
provide high quality market-driven services at prices generally equal to or
below those charged by our competitors. To maintain our competitive posture, we
believe that we must be in a position to reduce our prices in order to meet
reductions in rates, if any, by others.
Established Telephone Companies
In each of our target markets, we will compete principally with the established
telephone company serving that area, such as Verizon, Frontier Telephone of
Rochester, Southern New England Telephone, SBC/Ameritech and GTE. Established
telephone companies are the established providers of dedicated and local
telephone services to the majority of telephone subscribers within their
respective service areas. In addition, established telephone companies generally
have long-standing relationships with their clients and with federal and state
regulatory authorities and have financial, technical and marketing resources
substantially greater than we do, and the potential to subsidize competitive
services from a variety of businesses.
While recent regulatory initiatives provide increased competitive opportunities
to voice, data, and Internet-service providers such as us, they also provide the
established telephone companies with increased pricing flexibility for their
private line, special access, and switched access services. With respect to
competitive access services, the fees to connect to an established telephone
companies' facilities, the FCC recently decided to increase established
telephone company pricing flexibility and deregulation for such services, either
automatically or after specified criteria are met. If the established telephone
companies are allowed additional flexibility to offer discounts to large
clients, engage in aggressive volume and term discount pricing practices, and/or
charge competitors with excessive fees for interconnection to their local
networks, the potential income of integrated communications providers and
competitive local exchange carriers, could be adversely affected.
Services Which Compete With Our DSL Services
The established telephone companies represent the dominant competition for DSL
services in all our markets. These companies have an established brand name,
possess sufficient capital to deploy DSL equipment rapidly, have their own
telephone wires and can bundle digital data services with their existing analog
voice services to achieve economies of scale in serving clients.
Cable modem service providers are deploying high-speed Internet services over
cable networks. Where deployed, these networks provide similar and in some cases
higher speed Internet access than we provide. We believe the cable modem service
providers face a number of challenges that providers of DSL service do not face.
For example, different regions within a metropolitan area may be served by
different cable modem service providers, making it more difficult to offer the
blanket coverage required by potential business clients. Also, much of the
current cable infrastructure in the U.S. must be upgraded to support cable
modems, a process which we believe is significantly more expensive and
time-consuming than the deployment of DSL-based networks.
Many competitive telecommunications companies have deployed large-scale Internet
access networks, and have high brand recognition. Internet service providers
also provide Internet access to residential and business clients, generally at
lower speeds than we offer.
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Competitive Telecommunications Providers
We also face competition from other current and potential market entrants,
including long distance carriers seeking to enter, reenter or expand entry into
the local exchange market such as AT&T and MCI WorldCom, and from resellers of
local exchange services and competitive access providers. We also face
competition from other competitive local exchange carriers with overlap in our
targeted markets, such as Adelphia Business Solutions, Inc. and Time Warner
Telecom. Even the established telephone companies, particularly the regional
Bell operating companies, have established independent competitive local
exchange carrier subsidiaries to compete with each other. Some of these
competitors have significantly greater financial resources than we do. For
example, AT&T, MCI WorldCom, and Sprint, which historically were only long
distance carriers, have each begun to offer local telecommunications services in
major U.S. markets using their own facilities or by resale of the other
providers' services. In addition, a continuing trend toward consolidation of
telecommunications companies and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies,
could give rise to significant new competitors. For example, the merger of
WorldCom, Inc. with MCI, Global Crossing's purchase of Frontier Corp., SBC's
merger with Ameritech, Qwest's merger with US WEST, and AT&T's acquisition of
Teleport Communications Group, Inc. and Telecommunications Inc. are examples of
these competitive alliances. Such combined entities may provide a "bundled
package" of telecommunications products, such as local, long distance, and
Internet telephony, that directly competes with the products we offer. These
types of consolidations and strategic alliances could put us at a competitive
disadvantage.
Fixed Wireless Companies
We also face competition from companies using radio and microwave spectrum
instead of physical wiring, known as fixed wireless services. These companies
utilize various wireless communications systems, and unlicensed wireless radio
services. The FCC has issued, or is in the process of issuing, licenses for
these services to provide broadband integrated telecommunications services on a
point-to-point and/or point-to-multi-point basis. Some of these service
providers, such as WinStar, Advanced Radio Telecom and Teligent, are operating
their wide-area networks in many top-50 urban areas. These service providers
offer integrated voice and data services to small and medium-sized businesses.
Several equipment manufacturers have developed still other low data-rate
transmission devices, such as infrared, that may provide non-regulated
competition to us.
The FCC has authorized mobile cellular personal communications services and
other commercial mobile radio services providers to offer wireless services to
fixed locations. Previously, cellular providers could provide service to fixed
locations only on an ancillary or incidental basis. This authority to provide
fixed as well as mobile services will enable these commercial providers to offer
"wireless" local loop service and other services to high density fixed
locations, such as office and apartment buildings, in direct competition with us
and other providers of traditional telephone service.
Other Competitors
Other companies that currently offer, or are capable of offering, local switched
services include: cable television companies, electric utilities, microwave
carriers, and large business clients who build private networks. These entities,
upon entering into appropriate interconnection agreements or resale agreements
with established telephone companies, could offer single source local and long
distance services like those that we offer. We also expect to increasingly face
competition from companies offering long distance data and voice services over
the Internet. Such companies could enjoy a significant cost advantage because
they do not currently pay carrier access charges or universal service fees.
In addition, at least two Bell operating companies have begun offering single
source local and long distance services in limited areas and others may follow.
Currently, Verizon is providing long distance service in New York State and
Southwestern Bell is offering long distance service in the state of Texas and is
authorized to offer long distance service in the states of Kansas and Oklahoma.
In general, regional Bell operating companies cannot provide long-distance
service that originates, or in some cases terminates, in one of its in-region
states until the regional Bell operating company has satisfied statutory
conditions in that state, and has received the approval of the FCC. Once the
regional Bell operating companies are allowed to offer in-region long distance
services, they will undoubtedly offer single-source local and long distance
service, which will give rise to increased competition to us. In the spring of
1998, four of the regional Bell operating companies petitioned the FCC to be
relieved of some particular regulatory requirements in connection with their
provision of high-speed data services, including obligations to unbundle
high-speed data loops and to resell such services. In October 1998, the FCC
ruled that high-speed services are telecommunications services subject to the
unbundling and resale obligations of the Telecommunications Act. However, the
FCC has initiated a proceeding to determine whether regional Bell operating
companies can create separate affiliates for their high-speed data services that
would be free from these obligations.
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Intellectual Property
We regard our products, services and technology as proprietary and attempt to
protect them with copyrights, trademarks, trade secret laws, restrictions on
disclosure and other methods. We also generally enter into confidentiality or
license agreements with our employees and consultants, and generally control
access to and distribution of our documentation and other proprietary
information. Currently we have 15 servicemark applications or registrations.
Despite our precautions, we may not be able to prevent misappropriation or
infringement of our products, services and technology.
Our logo and some titles and logos of our services mentioned in this prospectus
are either our service marks or service marks that have been licensed to us.
Each trademark, trade name or service mark of any other company appearing in
this prospectus belongs to its holder.
Employees
As of December 31, 2000, we had 1,420 employees. We believe that our future
success will depend on our continued ability to attract and retain highly
skilled and qualified employees. None of our employees are currently represented
by collective bargaining agreements nor have we experienced any work stoppage
due to labor disputes. We believe that we enjoy good relationships with our
employees.
RISK FACTORS
Risks Related to Our Business
WE ANTICIPATE HAVING FUTURE NEGATIVE EBITDA AND OPERATING LOSSES AS WE CONTINUE
TO EXPAND OUR BUSINESS AND ENTER INTO NEW MARKETS
The expansion and development of our business and the deployment of our
networks, services and systems will require significant capital expenditures, a
substantial portion of which will need to be incurred before the realization of
sufficient revenue. We expect that our adjusted EBITDA will be negative while we
emphasize development, construction and expansion of our telecommunications
services business and until we establish a sufficient revenue-generating client
base. Adjusted EBITDA represents earnings before interest, income taxes,
depreciation and amortization, non-cash deferred compensation, non-cash
management allocation charges, accretion on preferred stock and accrued PIK
(paid in kind) dividends on preferred stock. Adjusted EBITDA is used by
management and certain investors as an indicator of a company's historical
ability to service debt. For the year ended December 31, 2000, after giving pro
forma effect to the acquisitions of US Xchange and Atlantic Connections and the
incurrence of debt in connection therewith, we would have had operating losses
of $262.1 million, net losses applicable to common stock of $317.2 million and
negative adjusted EBITDA of $91.1 million. We expect that each of our markets
will generally produce negative adjusted EBITDA for at least 18 to 30 months
after operations commence in such market, and we expect to experience increasing
operating losses, net losses and negative adjusted EBITDA as we expand our
operations. We can make no assurances that we will achieve or sustain
profitability or generate sufficient adjusted EBITDA to meet our working capital
and debt service requirements, which could have a material adverse effect on our
business, financial condition and results of operations.
TO EXPAND AND DEVELOP OUR BUSINESS WE WILL NEED A SIGNIFICANT AMOUNT OF CASH,
WHICH WE MAY BE UNABLE TO OBTAIN
The expansion and development of our business and the deployment of our
networks, services and systems will require significant capital expenditures,
working capital and debt service, and the ability to sustain substantial cash
flow deficits.
The actual amount and timing of our future capital requirements may differ
materially from our estimates as a result of, among other things, the demand for
our services and regulatory, technological and competitive developments,
including additional market developments and new opportunities in our industry.
Our revenue and costs may also be dependent upon factors that are not within our
control, including regulatory changes, changes in technology, and increased
competition. Due to the uncertainty of these factors, actual revenue and costs
may vary from expected amounts, possibly to a material degree, and such
variations are likely to affect our future capital requirements.
We also expect that we may require additional financing or require financing
sooner than anticipated if our development plans change or prove to be
inaccurate. We may also require additional financing in order to develop new
services or to otherwise respond to changing business conditions or
unanticipated competitive pressures. Sources of additional financing may include
commercial bank borrowings, vendor financing, or the private or public sale of
equity or debt securities. We can make no assurances that we will be
successful in raising sufficient additional capital on favorable terms or at all
or that the terms of any indebtedness we may incur will not impair our ability
to expand and develop our business. Failure to raise sufficient funds may
require us to modify, delay or abandon some of our planned future expansion or
expenditures, which could have a material adverse effect on our business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
16
OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND
COULD PREVENT US FROM FULFILLING OBLIGATIONS
We are highly leveraged and have significant debt service and related
obligations. As of December 31, 2000, our aggregate outstanding indebtedness and
obligations was $447.0 million, our stockholders' equity was $259.5 million and
our redeemable preferred stock was $162.5 million. We have the ability to incur
up to an aggregate of $350.0 million under our senior credit facility and may
incur additional indebtedness subject to certain limitations in our credit
facility. The amount outstanding under our senior credit facility at December
31, 2000 was $267.0 million. We also had $180.0 million outstanding under our
subordinated debt facility. If new indebtedness is added to our current levels,
the related risks that we face could intensify.
Our substantial leverage could have important consequences to us. For example,
it could:
o make it more difficult for us to obtain additional financing for working
capital, capital expenditures, or acquisitions;
o require us to dedicate a substantial portion of our cash flow from
operations to the payment of principal and interest on our indebtedness,
thereby reducing the funds available to us for our operations and other
purposes, including investments in service development, capital spending
and acquisitions;
o place us at a competitive disadvantage to our competitors that are not as
highly leveraged as we are;
o impair our ability to adjust to changing market conditions; and
o make us more vulnerable in the event of a downturn in general economic
conditions or in our business or of changing market conditions and
regulations.
SERVICING OUR INDEBTEDNESS WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH AND OUR
ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL
We can make no assurances that we will be able to meet our debt service
obligations. If we are unable to generate sufficient cash flow or otherwise
obtain funds necessary to make required payments, or if we otherwise fail to
comply with the various covenants in our debt obligations, we would be in
default under the terms thereof, which would permit the holders of such
indebtedness to accelerate the maturity of such indebtedness and could cause
defaults under other debt related agreements. Our ability to repay or to
refinance our obligations with respect to our indebtedness will depend on our
future financial and operating performance, which, in turn, will be subject to
prevailing economic and competitive conditions and to certain financial,
business, regulatory and other factors, many of which are beyond our control.
These factors could include operating difficulties, increased operating costs,
pricing pressures, the response of competitors, regulatory developments and
delays in implementing strategic projects.
Our adjusted EBITDA is currently insufficient to pay our fixed charges. See
"Selected Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations". The successful
implementation of our business strategy, including deployment of our networks
and obtaining and retaining a significant number of clients, and significant and
sustained growth in our cash flow are necessary for us to be able to meet our
debt service obligations and working capital requirements. We can make no
assurances that we will successfully implement our business strategy, that the
anticipated results of our strategy will be realized, or that we will be able to
generate sufficient cash flow from operating activities to meet our debt service
obligations and working capital requirements. See "Business--Business Strategy".
If our cash flow and capital resources are insufficient to fund our debt service
obligations and working capital requirements, we could be forced to reduce or
delay capital expenditures (including switch and network expenditures), sell
assets, seek to obtain additional equity capital, or refinance or restructure
our debt. A disposition of assets in order to make up for any shortfall in the
payments due on our indebtedness could take place under circumstances that might
not be favorable to realizing the highest price for such assets.
17
WE EXPECT TO GROW OUR BUSINESS AND CANNOT GUARANTEE THAT WE WILL BE ABLE TO
EFFECTIVELY MANAGE OUR FUTURE GROWTH
The successful implementation of our business plan will result in rapid
expansion of our operations and the provision of bundled telecommunications
services on a widespread basis, which could place a significant strain on our
management, operations, financial and other resources and increase demands on
our systems and controls. Failure to manage our future growth effectively could
adversely affect the expansion of our client base and service offerings. We can
make no assurances that we will be able to successfully implement and maintain
efficient operations and financial systems, procedures and controls or
successfully obtain, integrate and utilize the employees and management,
operations, financial and other resources necessary to manage a developing and
expanding business in our evolving, highly regulated and increasingly
competitive industry. Any failure to expand in these areas and to implement and
improve such systems, procedures and controls in an efficient manner at a pace
consistent with the growth of our business could have a material adverse effect
on our business, financial condition and results of operations.
If we were unable to hire sufficient qualified personnel or develop, acquire and
integrate successfully our operations and financial systems, procedures and
controls, our clients could experience delays in connection of service and/or
lower levels of client service, our resources may be strained and we may be
subjected to additional expenses. Our failure to meet client demands and to
manage the expansion of our business and operations could have a material
adverse effect on our business, financial condition and results of operations.
IF WE ARE UNABLE TO DEVELOP OR INTEGRATE OUR INFORMATION AND PROCESSING SYSTEMS
OR PROPERLY MAINTAIN AND UPGRADE THEM, WE MAY NOT BE ABLE TO EFFECTIVELY BILL
OUR CLIENTS OR PROVIDE ADEQUATE CLIENT SERVICE
Sophisticated back office information and processing systems are vital to our
growth and our ability to monitor costs, bill clients, provision client orders
and achieve operating efficiencies. Our plans for the development and
implementation of these systems rely, for the most part, on choosing products
and services offered by third party vendors and integrating such products and
services in-house to produce efficient operational solutions. We can make no
assurances that these systems will be successfully implemented on a timely
basis, that they will be implemented at all or that, once implemented, they will
perform as expected. Risks to our business associated with our systems include:
o failure by our vendors to deliver their products and services in a timely
and effective manner and at acceptable costs;
o failure by us to adequately identify all of our information and processing
needs;
o failure of our related processing or information systems; and
o failure by us to effectively integrate new products or services.
Furthermore, as our suppliers revise and upgrade their hardware, software and
equipment technology, we could encounter difficulties in integrating the new
technology into our business or the new systems may not be appropriate for our
business. In addition, our right to use these systems is dependent upon license
agreements with third party vendors. Some of these agreements may be cancelled
by the vendor and the cancellation or nonrenewal of these agreements may have an
adverse effect on us.
WE MAY NEED TO RELY ON THE ESTABLISHED LOCAL TELEPHONE COMPANIES TO IMPLEMENT
SUCCESSFULLY OUR SWITCHED AND ENHANCED SERVICES WHOSE FAILURE TO COOPERATE WITH
US COULD AFFECT THE SERVICES WE OFFER
We are a recent entrant into the newly created competitive local
telecommunications services industry. The local exchange services market in most
states was only recently opened to competition. There are numerous operating
complexities associated with providing these services. We are required to
develop new products, services and systems and need to develop new marketing
initiatives to sell these services. We can make no assurances that we will be
able to continue to develop such products and services.
We are deploying high capacity voice and data switches in the cities in which we
will operate networks. We initially rely on the networks of established
telephone companies or those of new market entrants, known as competitive local
exchange carriers, for some aspects of transmission. Federal law requires most
of the established telephone companies to lease or "unbundle" elements of their
networks and permit us to purchase the call origination and call termination
services we need, thereby decreasing our operating expenses. We can make no
assurances that such unbundling will continue to occur in a timely manner or
that the prices for such elements will be favorable to us. In addition, our
ability to implement successfully our switched and enhanced services will
require the negotiation of interconnection and collocation agreements with
established telephone companies and competitive local exchange carriers, which
can take considerable time, effort and expense and are subject to federal, state
and local regulation.
18
Many new carriers have experienced difficulties in working with the established
telephone companies with respect to ordering, interconnecting, leasing premises,
and implementing the systems used by these new carriers to order and receive
unbundled network elements and wholesale services from the established telephone
companies. We can make no assurances that these established telephone companies
will continue to cooperate with us once they are permitted to offer long
distance service. If we are unable to obtain the cooperation of an established
telephone company in a region, whether or not such company has been authorized
to offer long distance service, our ability to offer local services in such
region on a timely and cost-effective basis would be adversely affected. In
addition, both proposed and recently completed mergers involving regional Bell
operating companies and other competitors could facilitate such a combined
entity's ability to provide many of the services offered by us, thereby making
it more difficult to compete against them.
Our data and voice services may not be profitable due to, among other factors,
lack of client demand, inability to secure access to established telephone
company facilities on acceptable terms, and competition and pricing pressure
from the established telephone companies and competitive local exchange
carriers. We can make no assurances that we will be able to successfully
implement our switched and enhanced services strategy. Implementation of our
data and voice services is also dependent upon equipment manufacturers' ability
to meet our equipment deployment schedule. We can make no assurances that
switches will be deployed on the schedule contemplated by us or that, if
deployed, such switches will be utilized to the degree contemplated by us. Any
of the foregoing factors could have a material adverse effect on our business,
financial condition and results of operations.
WE DEPEND ON PORTIONS OF THE ESTABLISHED TELEPHONE COMPANIES' NETWORKS FOR DSL
TECHNOLOGY, AND THIS TECHNOLOGY MAY NOT OPERATE AS EXPECTED ON ESTABLISHED
TELEPHONE COMPANY NETWORKS AND MAY INTERFERE WITH OR BE AFFECTED BY OTHER
TRANSPORT TECHNOLOGIES
We depend significantly on the quality and maintenance of the copper telephone
lines we lease from the established telephone companies which are providing
services in our markets to provide DSL services. We can make no assurances that
we will be able to lease the copper telephone lines and the services we require
from these established telephone companies on a timely basis or at quality
levels, prices, terms and conditions satisfactory to us or that such established
telephone companies will maintain the lines in a satisfactory manner.
All transport technologies using copper telephone lines have the potential to
interfere with, or to be interfered with by, other traffic on adjacent copper
telephone lines. This interference could degrade the performance of our services
or make us unable to provide service on selected lines. In addition, established
telephone companies may claim that the potential for interference by DSL
technology permits them to restrict or delay our deployment of DSL services. The
telecommunications industry and regulatory agencies are still developing
procedures to resolve interference issues between competitive carriers and
established telephone companies, and these procedures may not be effective. We
may be unable to successfully negotiate interference resolution procedures with
established telephone companies. Interference, or claims of interference, if
widespread, would adversely affect our speed of deployment, reputation, brand
image, service quality and client retention and satisfaction and may have a
material adverse effect on our business, financial condition and results of
operations.
IF WE FAIL TO OBTAIN ACCESS TO TRANSMISSION LINES, IT MAY AFFECT OUR ABILITY TO
DEVELOP OUR NETWORKS
Under our network buildout strategy, we will initially seek to lease from
established telephone companies and competitive local exchange carriers local
transmission lines connecting our switch to particular telephone company central
offices. In the future, we may seek to replace this leased capacity with our own
fiber optic lines if warranted by traffic volume growth. We can make no
assurances that all required transmission line capacity will be available to us
on a timely basis or on favorable terms. If we fail to obtain such leased fiber
optic lines, we could be delayed in our ability to penetrate some of our markets
or required to make additional unexpected up-front capital expenditures to
install our own fiber optic lines. If and when we seek to install our own fiber
optic lines, we must obtain local franchises and other permits, as well as
rights-of-way to utilize underground conduit and aerial pole space and other
rights-of-way from entities such as established telephone companies and other
utilities, railroads, long distance companies, state highway authorities, local
governments and transit authorities. We can make no assurances that we will be
able to obtain and maintain the franchises, permits and rights needed to
implement our network buildout on favorable terms. The failure to enter into and
maintain any such required arrangements for a particular network may affect our
ability to develop that network and may have a material adverse effect on our
business, financial condition and results of operations. See "Business--Service
Introduction."
19
WE DEPEND ON CERTAIN KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR
SERVICES
We are managed by a number of key executive officers. We believe that our
success will depend in large part on our ability to continue to attract and
retain qualified management, technical, marketing and sales personnel and the
continued contributions of such management and personnel. Competition for
qualified employees and personnel in the telecommunications industry is intense
and there is a limited number of persons with knowledge of and expertise in the
industry. We do not maintain key person life insurance for any of our executive
officers, other than Steve M. Dubnik, our Chairman, President and Chief
Executive Officer. Although we have been successful in attracting and retaining
qualified personnel, we can make no assurances that we will be able to hire or
retain necessary personnel in the future. The loss of services of one or more of
our key executives, or the inability to attract and retain additional qualified
personnel, could materially and adversely affect us.
WE MAY NOT HAVE THE ABILITY TO DEVELOP STRATEGIC ALLIANCES, ACQUIRE ASSETS OR
MAKE INVESTMENTS NECESSARY TO COMPLEMENT OUR EXISTING BUSINESS
We may seek, as part of our growth strategy, to continue to develop strategic
alliances or to make investments or acquire assets or other businesses that will
relate to and complement our existing business. We are unable to predict whether
or when any planned or prospective strategic alliances or acquisitions will
occur or the likelihood of a material transaction being completed on favorable
terms and conditions. Our ability to finance strategic alliances and
acquisitions may be constrained by our degree of leverage at the time of such
strategic alliance or acquisition. In addition, our credit facility may
significantly limit our ability to enter into strategic alliances or make
acquisitions and to incur indebtedness in connection with strategic alliances
and acquisitions.
We can make no assurances that any acquisition will be made or that we will be
able to obtain financing needed to fund such acquisition. We currently have no
definitive agreements with respect to any material acquisition, although from
time to time we may have discussions with other companies and assess
opportunities on an ongoing basis.
In addition, if we were to proceed with one or more significant strategic
alliances, acquisitions or investments in which the consideration consists of
cash, we could use a substantial portion of our available cash to consummate the
strategic alliances, acquisitions or investments. The financial impact of
strategic alliances, acquisitions and investments could have a material adverse
effect on our business, financial condition and results of operations and could
cause substantial fluctuations in our quarterly and yearly operating results.
Furthermore, if we use our common stock as consideration for acquisitions our
shareholders could experience dilution of their existing shares.
WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE ACQUIRED BUSINESSES AND OPERATIONS
Recently we acquired US Xchange, a local exchange carrier, and as part of our
business strategy, we may seek to acquire complementary assets or businesses or
develop strategic alliances. Any future acquisitions or strategic alliances
would be accompanied by the risks commonly encountered in such transactions.
Such risks include, among others:
o the difficulty of assimilating the acquired operations and personnel;
o the disruption of our ongoing business and diversion of resources and
management time;
o the inability to maximize our financial and strategic position by the
successful incorporation of licensed or acquired technology and rights into
our service offerings;
o the inability of management to maintain uniform standards, controls,
procedures and policies;
o the risks of entering markets in which we have little or no direct prior
experience; and
o the impairment of relationships with employees or clients as a result of
changes in management or otherwise arising out of such transactions.
We can make no assurances that we will be able to successfully integrate
acquired businesses or operations that we may acquire in the future.
Risks Related to our Industry
20
WE FACE A HIGH LEVEL OF COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY
The telecommunications industry is highly competitive, and one of the primary
purposes of the Telecommunications Act of 1996 is to foster further competition.
In each of our markets, we compete principally with the established telephone
company serving such market. We currently do not have a significant market share
in any of our markets. The established telephone companies have long-standing
relationships with their clients, financial, technical and marketing resources
substantially greater than ours and the potential to fund competitive services
with cash flows from a variety of businesses. Established telephone companies
also benefit from existing regulations that favor them over integrated
communications providers and competitive local exchange carriers in some
respects. Furthermore, one large group of established telephone companies, the
regional Bell operating companies, recently have been granted, pricing
flexibility under particular conditions from federal regulators with regard to
some services with which we compete. This may present established telephone
companies with an opportunity to subsidize services that compete with our
services and offer such competitive services at lower prices.
It is likely that we will also face competition from other integrated
communications providers, facilities-based competitive local exchange carriers
and many other competitors in some of our markets. We believe that second and
third tier markets will support only a limited number of competitors and that
operations in such markets with multiple competitive providers are likely to be
unprofitable for one or more of such providers.
We expect to experience declining prices and increasing price competition. We
can make no assurances that we will be able to achieve or maintain adequate
market share or margins, or compete effectively, in any of our markets.
Moreover, substantially all of our current and potential competitors have
financial, technical, marketing, personnel and other resources, including brand
name recognition, substantially greater than ours as well as other competitive
advantages over us. Any of the foregoing factors could have a material adverse
effect on our business, financial condition or results of operations. See
"Business--Competition."
FCC AND STATE REGULATIONS MAY LIMIT THE SERVICES WE CAN OFFER
Our networks and the provision of telecommunications services are subject to
significant regulation at the federal, state and local levels. The costs of
complying with these regulations and the delays in receiving required regulatory
approvals or the enactment of new adverse regulation or regulatory requirements
may have a material adverse effect upon our business, financial condition and
results of operations.
We can make no assurances that the Federal Communications Commission, called the
FCC, or state commissions will grant required authority or refrain from taking
action against us if we are found to have provided services without obtaining
the necessary authorizations. If we do not fully comply with the rules of the
FCC or state regulatory agencies, third parties or regulators could challenge
our authority to do business. Such challenges could cause us to incur
substantial legal and administrative expenses.
Our Internet operations are not currently subject to direct regulation by the
FCC or any other governmental agency, other than regulations applicable to
businesses generally. However, the FCC has recently indicated that the
regulatory status of some services offered over the Internet may have to be
re-examined. New laws or regulations relating to Internet services, or existing
laws found to apply to them, may have a material adverse effect on our business,
financial condition or results of operations.
The Telecommunications Act remains subject to judicial review and additional FCC
rulemaking, and thus it is difficult to predict what effect the legislation will
have on us and our operations. There are currently many regulatory actions
underway and being contemplated by federal and state authorities regarding
interconnection pricing and other issues that could result in significant
changes to the business conditions in the telecommunications industry. We can
make no assurances that these changes will not have a material adverse effect on
our business, financial condition or results of operations.
IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE TELECOMMUNICATIONS
INDUSTRY OUR BUSINESS COULD BE ADVERSELY AFFECTED
The telecommunications industry is subject to rapid and significant changes in
technology, including continuing developments in DSL technology, which does not
presently have widely accepted standards, and alternative technologies for
providing high-speed data transport and networking. The absence of widely
accepted standards may delay or increase the cost of our market entry due to
changes in equipment specifications and customer needs and expectations. If we
fail to adapt successfully to technological changes or obsolescence, fail to
adopt technology that becomes an industry standard or fail to obtain access to
important technologies, our
21
business, financial condition or results of operations could be materially
adversely affected. We may also be dependent on third parties for access to new
technologies. Also, if we acquire new technologies, we may not be able to
implement them as effectively as other companies with more experience with those
technologies and in their markets.
WE MAY FAIL TO ACHIEVE ACCEPTABLE PROFITS ON OUR LONG DISTANCE BUSINESS DUE TO
DECLINING PRICES, LOW CUSTOMER RETENTION RATES AND OUR CONTRACTUAL OBLIGATIONS
Prices in the long distance business have declined substantially in recent years
and are expected to continue to decline. In addition, the long distance industry
has a low customer retention rate, as clients frequently change long distance
providers in response to the offering of lower rates or promotional incentives
by competitors. We will rely on other carriers to provide us with a major
portion of our long distance transmission network. Such agreements typically
provide for the resale of long distance services on a per-minute basis and may
contain minimum volume commitments. The negotiation of these agreements involves
estimates of future supply and demand for transmission capacity as well as
estimates of the calling patterns and traffic levels of our future clients. In
the event that we fail to meet such minimum volume commitments, we may be
obligated to pay underutilization charges, and, in the event we underestimate
our need for transmission capacity, we may be required to obtain capacity
through more expensive means. Our failure to achieve acceptable profits on our
long distance business could have a material adverse effect on our business,
financial condition and results of operation.
AS A NEW ENTRANT IN THE DATA TRANSMISSION MARKET, WE MAY INITIALLY GENERATE LOW
OR NEGATIVE GROSS MARGINS
As a new entrant in the data transmission business, we expect to generate low or
negative gross margins and substantial start-up expenses as we begin to offer
data transmission services. The success of our data transmission business will
be dependent upon, among other things, the effectiveness of our sales personnel
in the promotion and sale of our data transmission services, the acceptance of
such services by potential clients, and our ability to hire and train qualified
personnel and further enhance our services in response to future technological
changes. We can make no assurances that we will be successful with respect to
these matters. If we are not successful with respect to these matters, it could
have a material adverse effect on our business, financial condition and results
of operations.
RISKS REGARDING FORWARD-LOOKING STATEMENTS
We have made some statements in this Form 10-K, including some under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere, which constitute
forward-looking statements. These statements may discuss our future expectations
or contain projections of our results of operations or financial condition or
expected benefits to us resulting from acquisitions or transactions and involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, levels of activity, performance or achievements to be materially
different from any results, levels of activity, performance or achievements
expressed or implied by any forward-looking statements. These factors include,
among other things, those listed under "Risk Factors" and elsewhere in this
prospectus. In some cases, forward-looking statements can be identified by
terminology such as "may," "will," "should," "could," "expects," "intends,"
"plans," "anticipates," "believes," "estimates," "predicts," "potential" or
"continue" or the negative of these terms or other comparable terminology.
Although we believe that the expectations reflected in forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
22
ITEM 2. PROPERTIES
We are headquartered in Rochester, New York. We occupy office space in
Rochester under a market-rate lease that expires in 2009. As of December 31,
2000, this lease covered 73,830 square feet. In addition, we lease space in a
number of locations, primarily for sales offices and network equipment
installations. We believe that our leased facilities are adequate to meet our
current needs and that additional facilities are available to meet our
development and expansion needs in existing and projected target markets.
ITEM 3. LEGAL PROCEEDINGS
We are not party to any pending legal proceedings that we believe would,
individually or in the aggregate, have a material adverse effect on our
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security-holders during the fourth
quarter of the fiscal year ended December 31, 2000.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning our executive
officers and other key personnel, including their ages, as of December 31, 2000.
Name Age Title
Steve M. Dubnik...... 38 Chairman of the Board and Director,
President and Chief Executive Officer
Kevin S. Dickens..... 37 Co-Chief Operating Officer
Ajay Sabherwal....... 34 Executive Vice President, Finance and Chief
Financial Officer
Mae H. Squier-Dow.... 39 Co-Chief Operating Officer
Philip H. Yawman..... 35 Executive Vice President, Corporate
Development
Robert O. Bailey..... 54 Vice President, Planning and Technology
Douglas R. Black..... 30 Vice President, Operations
Joseph A. Calzone.... 37 Senior Vice President, Engineering
Linda S. Chapman..... 37 Vice President, Human Resources
James R. Currie...... 53 Vice President, Operations
Michael A. D'Angelo.. 35 Vice President, Sales, Eastern Region
Scott D. Deverell.... 35 Vice President, Accounting, and Controller
Elizabeth A. Ellis... 42 Senior Vice President, Information Technology
Daniel S. Fabry...... 37 Vice President, Network Development
Robert J. Merrill.... 45 Vice President, Business Development
Stephen R. Oyer...... 39 Vice President, Sales, Western Region
Michelle C. Paroda... 37 Senior Vice President, Client Services
Ricky G. Pigeon...... 36 Vice President, Billing Services
Joseph M. Schaal..... 34 Vice President, Internet and Emerging Technologies
Kim Robert Scovill... 47 Vice President, Legal and Regulatory Affairs,
and General Counsel
Lee Thibaudeau....... 48 Vice President, Business Services
John J. Zimmer....... 42 Vice President, Finance, and Treasurer
- --------------
23
Steve M. Dubnik, our Chairman of the Board, President, Chief Executive
Officer and Co-Founder, has worked in the telecommunications industry for 16
years. Prior to founding Choice One in June 1998, Mr. Dubnik served in various
capacities with ACC Corp., including as the President and Chief Operating
Officer of North American Operations of ACC from November 1996 to April 1998 and
as Chairman of the Board of Directors of ACC TelEnterprises Ltd. from July 1994
to April 1998. From December 1997 to April 1998, he also jointly performed the
functions of Chief Executive Officer of ACC.
Kevin S. Dickens, our Co-Chief Operating Officer and Co-Founder since
August 2000 and prior to that Senior Vice President, Operations and Engineering
since July 1998, has worked in the telecommunications industry for 12 years.
Prior to joining us, Mr. Dickens was President and Chief Executive Officer of
ACC Corp.'s Canadian subsidiary, ACC TelEnterprises Ltd., from May 1997 to June
1998. Prior thereto, Mr. Dickens was Vice President of Network Planning and
Optimization at Frontier Corporation, from September 1996 to May 1997, with
responsibility for Frontier's long distance network.
Ajay Sabherwal, our Executive Vice President, Finance and Chief Financial
Officer since September 1999, has worked both directly in the telecommunications
industry and as an equity analyst covering the telecommunications industry for
over 11 years. Mr. Sabherwal was most recently executive director of
institutional equity research for Toronto-based CIBC World Markets from June
1996 to September 1999. Prior to joining CIBC World Markets as a senior research
analyst in June of 1996, Mr. Sabherwal was the telecommunications analyst for
BZW (Barclays de Zoete Wedd) Canada and its successor company from November 1993
until June 1996
Mae H. Squier-Dow, our Co-Chief Operating Officer and Co-Founder since
August 2000 and prior to that Senior Vice President, Sales, Marketing and
Service since June 1998, has worked in the telecommunications industry for 16
years. Ms. Squier-Dow served as President of ACC Telecom, a U.S. subsidiary of
ACC Corp., from June 1996 to May 1998, and in several positions at ACC Long
Distance U.K. Ltd., including as Commercial