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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, 2001
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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(585) 246-4231
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:COMMON STOCK,
PAR VALUE $.01
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,
2002, was $17,201,123.
40,300,877 shares of $.01 par value Common Stock were issued and outstanding as
of March 1, 2002.
The Index of Exhibits filed with this Report begins at
page 68.
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CHOICE ONE COMMUNICATIONS INC.
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business.......................................................2
Item 2. Properties....................................................24
Item 3. Legal Proceedings.............................................24
Item 4. Submission of Matters to a Vote of Security Holders...........25
Item 4A. Executive Officers of the Registrant..........................25
PART II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters..........................................27
Item 6. Selected Financial Data.......................................28
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................30
Item.7A. Quantitative and Qualitative Disclosures About
Market Risk..................................................39
Item 8. Financial Statements and Supplementary Data...................40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.....................................40
PART III
Item 10. Directors and Executive Officers of the Registrant............40
Item 11. Executive Compensation........................................40
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters...................40
Item 13. Certain Relationships and Related Transactions................40
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K..................................................41
Signatures..................................................................67
Exhibits....................................................................68
PART I
ITEM 1: BUSINESS
GENERAL
We are an integrated communications provider offering facilities-based voice and
data telecommunications services and web 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 and long distance
service, high-speed data and Internet service, and web hosting and design
services. We seek to become the leading integrated service provider in each of
our markets by offering a single source for competitively priced, high quality,
customized telecommunications and web-based services. A key element of our
strategy has been to be one of the first integrated service providers to provide
comprehensive 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, a process known as collocation.
We have connected the majority of our clients directly to our own switches,
which allows us to more efficiently route traffic, ensure quality of service and
control costs. As of December 31, 2001, we were providing service to
approximately 80,000 clients with 383,975 access lines, including 11,634 data
lines.
In December 2001, we completed the purchase of certain assets from FairPoint
Communications Solutions Corp. Through this asset acquisition, we strengthened
our competitive foothold in the Northeast by expanding our presence and
eliminating a competitor in several existing markets. Additionally, the asset
purchase expanded our presence into new territories, including Portland/Augusta,
Maine and Erie, Pennsylvania.
We offer telecommunications services in 30 markets in 12 states with no current
plans to expand into additional markets. Following the integration of the
FairPoint assets, our networks reach approximately 5.4 million business lines,
which constitute more than 70% of the estimated business lines in these markets.
While our network expansion allows us to reach this number of business lines,
the number of business lines that we actually service will depend on our ability
to obtain market share from our competitors.
We have a flexible network which allows us to achieve speed to market and cost
efficiencies and to leverage rapidly evolving telecommunications technology. In
most of our markets, we have deployed digital switching platforms and lease
network capacity to connect our switch with our transmission equipment
collocated in central offices of the established telephone companies. This
allowed us to enter our markets more rapidly and with lower initial costs than
if we had to acquire or build fiber capacity. When we entered our markets, we
initially leased network capacity 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. We acquired rights to fiber formerly owned
by US Xchange in eight midwestern markets under an indefeasible right to use
fiber agreement with a term of 20 years. In a separate transaction, we also
entered into an agreement to purchase 20-year indefeasible rights to use fiber
from FiberTech Networks, LLC. for fiber capacity in an additional 13 markets and
acquired a minority interest and certain governing rights in FiberTech Networks.
As of December 31, 2001, 12 of our markets were operational on local fiber rings
and our markets within Wisconsin, Illinois and Michigan were operational on an
inter-city fiber network.
We have designed and developed 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 continue to integrate them into a
seamless end-to-end system that synchronizes multiple tasks, including
installation, billing and client care. We integrated our order management and
billing systems in a manner that enables us to transmit client information
directly from the order management and service fulfillment systems into the
billing system, thereby eliminating redundant keying 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 SBC/Ameritech.
In each of our markets, we have a locally based sales force as well as dedicated
client care representatives. In addition to our direct sales force, we use third
party agencies to sell our services. These agencies include telecommunications
equipment vendors, consultants, systems integrators and cellular phone
retailers.
1
BUSINESS STRATEGY
We have had an aggressive growth strategy to become the provider of choice,
offering one-stop communications solutions to clients in our markets. We have
been successful in executing that strategy. Our continued success will depend
upon our ability to increase penetration in our 30 markets to achieve
profitability. The key elements of our business strategy are to:
TARGET UNDERSERVED CLIENTS
We will continue to target small and medium-sized businesses primarily in the 30
markets we serve in the northeastern and midwestern United States. We believe
these markets are currently underserved by the established telephone companies
and other competitive telecommunications providers. We have focused on the
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 retain
clients in these areas by offering a simplified, comprehensive package of
services and a high level of client care.
OFFER BROAD COVERAGE
We provide broad geographic coverage within our markets by collocating in
multiple central office locations to reach both central business districts and
outlying areas. While other companies often limit their network buildout to
highly concentrated downtown areas, our collocation strategy has been 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 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 and 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
provides our clients with a single, easy to understand statement covering all of
their services.
INCREASE OUR MARKET SHARE BY PROVIDING SERVICE-DRIVEN CLIENT
RELATIONSHIPS AND A LOCAL PRESENCE
We seek to attract and retain clients by providing local sales offices in each
of our markets with an experienced account management team that provides
face-to-face sales and personalized client care. We 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, we will incur the reasonable and customary tariffed
charges for a standard conversion 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.
LEAD COMPETITION IN PROVIDING DSL SERVICES
We believe we have been 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
substantially all of our existing collocations.
MAINTAIN OUR FLEXIBLE NETWORK BUILDOUT STRATEGY
We have a flexible network buildout strategy which allowed us to achieve speed
to market and cost efficiencies and to leverage rapidly evolving
telecommunications technology. In most of our markets we deployed digital
switching platforms and leased network capacity to connect our switch with our
transmission equipment collocated in central offices of the established
telephone companies. This allowed us to enter our markets more rapidly and with
lower initial costs than if we had to acquire or build fiber capacity. When we
entered our markets, we initially leased network capacity 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. We have begun to
deploy fiber in many of our markets, which will replace the leased local network
facilities and decrease our leasing costs. In our markets in Wisconsin, Michigan
and Illinois we already have operational intra-city fiber in place and, as a
result, our leasing costs in these markets are significantly less than in the
markets where fiber has not been deployed. Additionally, we had deployed fiber
in all four of our New York markets as of December 31, 2001, for a total of 12
markets with local fiber.
2
The benefits of this fiber include network redundancy,
reduced provisioning intervals (provisioning onto our own network, versus
relying on the established telephone company for provisioning) and reduced per
unit costs with additional product offerings. Future network capacity will be
deployed when technologically feasible and economically justified.
UTILIZE EFFICIENT AUTOMATED AND INTEGRATED BACK OFFICE SYSTEMS
Our management team is committed to having efficient operations support systems
and other back office systems that can support rapid and sustained growth. To
realize this objective, we have a team of engineering and information technology
professionals experienced in the telecommunications industry. Our systems team
continues to integrate our back office systems into a seamless end-to-end system
that synchronizes 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 requires only a single entry to transfer client
information from sales to service to billing. Our customized system also
integrates our back office systems to minimize the time between client order and
service installation and to reduce our costs. We have established an on-line and
real-time connection, called electronic bonding, of our operations support
systems with Verizon and SBC/Ameritech so that we can switch Verizon and
SBC/Ameritech clients to our network on an automated basis.
GROWTH THROUGH ACQUISITIONS
Over the past three years, we have completed acquisitions of businesses or
purchases of other businesses' assets which have been integrated into our
operations. These have included Atlantic Connections in 1999, EdgeNet and US
Xchange in 2000, and FairPoint in 2001. We will continue to seek acquisition
targets that offer similar services to ours which can be successfully integrated
into our existing operations and networks and offer opportunities to increase
profitability. We also seek acquisition targets which would allow us to offer
additional value-added or other related services as well as new success based
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 30 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 provide our clients
substantial savings 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.
3
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 remote access, paging
notification, personalized greetings and password protection. In certain markets
we also originate and terminate interexchange calls placed or received by our
clients at no additional charge and offer free local calling between client
locations.
LONG DISTANCE SERVICES. Through our ChoiceOnePlusSM service, we offer a full
range of domestic and international long distance services, including "1+"
outbound calling, 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 and dedicated
digital transmission links with a capacity equivalent to 24 standard telephone
lines, known as T-1 connections. We provide high-speed data communications and
Internet access to our targeted small and medium-sized businesses at rates that
we believe are very attractive when compared to the cost and performance of
other available data service offerings.
Our ChoiceNetJetSM 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 ChoiceNetJetSM, 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 ChoiceNetJetSM 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 ChoiceOneDataLinkSM 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.
ENHANCED DATA FEATURES. We offer a full array of Enhanced Data Features
products. The product set includes network address translation which enables
computers to connect simultaneously to the Internet without additional costs,
firewall security that protects electronic files from network intruders, and
Virtual Private Network services that allow businesses with multiple locations
to securely connect these locations for high-speed data transmission. These
products eliminate the need for businesses to purchase, configure and maintain
their own equipment typically associated with these applications.
WEB HOSTING. We offer a range of shared web hosting products targeted to meet
the needs of small to medium-sized businesses. We provide clients with a
reliable web presence they need to meet their Internet-related objectives
without the initial capital expense required to purchase and maintain their own
equipment. We also provide e-mail hosting solutions and domain name registration
and hosting.
4
WEB DESIGN SERVICES. We offer web design solutions that accommodate a range of
client needs, from establishing a simple web presence to creating sophisticated
web sites. We offer web design options that combine the economy of a packaged
design product with the flexibility to create a customized look. Our clients can
choose the layouts, colors, and content they desire to create a web site
suitable to their particular needs. When clients are ready to expand their web
presence, we also offer custom web design services for higher-end applications.
SALES AND CLIENT CARE
We attract clients by providing local sales offices in each of our markets with
a highly trained, dedicated account management team that personally meets with
each prospective new client during the sales process. This local sales force
uses a consultative selling approach and offers clients a full range of
sophisticated and cost-effective telecommunications solutions. Sales teams use a
variety of methods to qualify leads and set up initial appointments, including
telemarketing and building canvassing.
Each market's account management team is led by a general manager who is
responsible for attracting and retaining clients which generate profitable
margins in that market. The general manager oversees a local sales team that is
composed of direct salespersons and an indirect sales force. The indirect sales
force consists of an alternate channel manager and various sales agents,
including telecommunications equipment vendors, consultants, system integrators
and cellular phone retailers.
As of December 31, 2001, we had 786 persons in our sales and sales support
staff, not including our independent third-party sales agents.
Our client services organization is composed of a client care team, who handles
routine client inquiries, and dedicated client development representatives
(CDRs), who focus on client retention and selling additional services to
existing clients.
Members of the client care team are located in one of our two centralized client
care facilities, located in Rochester, New York and Green Bay, Wisconsin. These
facilities are staffed to maximize the coverage during the business week and to
extend coverage beyond normal business hours to better serve our clients.
Additionally, these facilities utilize common operating systems, which provides
redundancy and automatically route callers to the next available representative,
regardless of location.
Members of the client development organization are located in each market and
work alongside the sales organization. The CDRs provide one-on-one client
service to our larger clients and assist these clients in finding ways to best
utilize their telecommunications services. CDRs are also responsible for selling
additional services to existing clients and have monthly sales quotas.
OUR MARKETS
We offer telecommunications services in 30 markets, comprising 39 basic trading
areas. In selecting our markets, we estimated market demand for our services
using data gathered from interexchange carriers, the Federal Communications
Commission, local sources, site visits and specific market studies. In addition
to market demand, we consider the established telephone companies' level of
service as well as the level of penetration within the market by other
integrated communication providers.
5
We are currently operating in the following markets:
Akron, OH (1) Green Bay, WI (3) Providence, RI
Albany, NY (2) Harrisburg, PA (4) Rochester, NY
Allentown, PA Hartford, CT Rockford, IL
Ann Arbor, MI Indianapolis, IN Scranton, PA
Buffalo, NY Kalamazoo, MI (5) South Bend, IN (8)
Columbus, OH Madison, WI Springfield, MA
Dayton, OH Manchester, NH Syracuse, NY (9)
Erie, PA Milwaukee, WI Worcester, MA
Evansville, IN New Haven, CT (6)
Fort Wayne, IN Pittsburgh, PA
Grand Rapids, MI Portland, ME (7)
(1) Also includes the basic trading area for Youngstown, OH.
(2) Also includes the basic trading areas for Schenectady, NY and Kingston, NY.
(3) Also includes the basic trading areas for Appleton, WI and Oshkosh, WI.
(4) Also includes the basic trading area for Lancaster, PA.
(5) Also includes the basic trading area for Battlecreek, MI.
(6) Also includes the basic trading areas for Bridgeport, CT and Stamford, CT.
(7) Also includes the basic trading area for Bangor, ME.
(8) Also includes the basic trading area for Elkhart, IN.
(9) Also includes the basic trading areas for Binghamton, NY and Ithaca, NY.
As of December 31, 2001, we had applications accepted to collocate our network
equipment in 526 established telephone company central offices, had completed
517 of these collocations and had 9 additional collocations in progress in our
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:
2001 2000
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Markets served 30 26
Number of switches-voice 26 24
Number of switches-data 63 45
Total central office collocations 517 410
Estimated addressable market (Business lines) 5.4 million 4.1 million
Lines in service-total 383,975 177,614
Lines in service-voice 372,341 173,819
Lines in service-data 11,634 3,795
Total employees 1,758 1,420
Sales employees 786 572
6
NETWORK INFRASTRUCTURE
We have a flexible network which has allowed 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 Class 5 digital switch in each of our operational markets, other than
Worcester, MA, New Haven, CT, Erie, PA and Portland, ME. We are serving the
Worcester market by connecting our equipment in the Worcester market to our
Springfield, MA switch. Similar network configurations are utilized between the
Hartford and New Haven, CT markets, Pittsburgh and Erie, PA markets and
Manchester, NH and Portland, ME markets. We have installed a packet-based switch
network in each market in order to establish a widespread coverage area for the
offering of high bandwidth digital connections utilizing DSL technology. As of
December 31, 2001, we had 26 Class 5 switches in service and 63 data switches in
service. Our switches are connected to established telephone companies' networks
and long distance and Internet service provider points-of-presence.
We use a collocation strategy under which we install 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 have installed 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. We have installed our network equipment, including both voice
and data components, in established telephone company central offices that
enables us to address 70% to 80% of the business lines in each market. We lease
unbundled loops from the established telephone company or T-1 facilities from
the established telephone company or competitive network provider to connect our
equipment in the telephone company central office to the client locations.
We lease local network facilities from the established telephone company and/or
one or more competitive network providers to connect our switch to established
telephone company central offices. Initially leasing these facilities allowed us
to begin operations more quickly and at a lower 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 have an agreement with RVP L.L.C. for a 20-year indefeasible
right to use fiber. This agreement provides us with operational intra-city fiber
miles in eight markets and inter-city fiber miles between nine markets in
Wisconsin, Illinois, Indiana and Michigan. The inter-city fiber network became
operational in Wisconsin, Illinois and Michigan in 2001. Indiana became
operational in 2002.
We have an agreement with FiberTech Networks, LLC. (FiberTech), to become the
anchor tenant on its local fiber loops in certain markets. We acquired 20-year
indefeasible rights to use fiber capacity in 13 markets, with additional markets
to be determined. FiberTech completed construction of certain fiber miles within
four of our New York markets during 2001. Our contract with FiberTech calls for
preferred pricing for the first five years of the agreement. We expect that
benefits of these indefeasible rights to use fiber will include network
redundancy, reduced provisioning intervals (provisioning onto our own network,
versus relying on the established telephone company for provisioning) and
reduced per unit costs with additional product offerings. In addition to this
arrangement, we have acquired a minority interest in FiberTech, have the right
to appoint one representative to its board of managers, and have a vote in
determining the new markets in which FiberTech 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
also have locally based switch engineers and technicians to manage each switch
and other network equipment.
On a limited basis, we use voice over DSL. 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 Class 5 switch, which is interconnected to the public
switched telephone network.
Rapid and significant changes in technology are expected in the
telecommunications industry. Our continued success will depend, in part, on our
ability to anticipate and adapt to technological changes. For 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 our network design positions us to rapidly
implement our future voice-switching infrastructure.
7
INFORMATION SYSTEMS
We have implemented an integration strategy for our operations support systems
and other back office systems that provides significant competitive advantages
in terms of efficiency, capacity to process large order volumes and the ability
to deliver exceptional client care. We have developed a seamless end-to-end
system that synchronizes multiple activities. This system allows information to
be entered once and at the appropriate time within our sales, client care,
trouble management and billing process. Information is then shared between the
various components of our systems.
We believe that our single entry system is 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
reduces the opportunity for error. In addition, it significantly shortens the
sales to billing interval. Our customized, integrated system enables 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,
NETWORK ACTIVATION
We have an agreement with MetaSolv Software Inc. to license its Telecom Business
Solution, or TBS, software to manage our back office operations support system.
MetaSolv's software manages our order entry, service installation, network
element inventory, gateway interconnects and workflow business functions and
allows our sales team to monitor the status of the order from initiation through
service implementation.
We have an agreement with ADC Communications to utilize its Convergent Billing
Platform AS/400 software which enables us to combine and bill current and future
service offerings and present the information on a single statement for our
clients. This system supports client care functions, including billing inquiries
and collection processes. Call detail records, such as the billing records
generated by our voice or data switches are automatically processed by the
billing platform in order to calculate and produce bills in a variety of
formats. We also have an agreement with PCR, Inc. to utilize their billing
platform. This system was acquired with the acquisition of US Xchange. Migration
of the clients billed on the PCR, Inc. billing platform to the ADC
Communications billing platform is expected to be completed during 2002. All new
clients are billed from the ADC Communications billing platform.
Our MetaSolv system has been integrated with our ADC Communications billing and
administration system to ensure data integrity and eliminate redundant data
entry. This integrated software solution allows us to efficiently bill for
multiple products on a single statement and provides a central point of contact
for handling orders and activities.
We have licensed software from Harris Corp. that enables network activation of
client orders. This software enables the automated processing of line activation
in our Class 5 switches, distinctive remote modules and voicemail platform
within New York, Pennsylvania, Massachusetts, Rhode Island, New Hampshire,
Connecticut, Maine and Ohio.
ELECTRONIC BONDING
Through software that we have licensed from DSET Corporation and have integrated
with our MetaSolv software, we have established electronic bonding with Verizon
and SBC/Ameritech. We have implemented an electronic interface linking our
operations support systems directly to the established telephone company system
so that we can process orders on an automated basis for our clients which are
switching service from an established telephone company. Additionally, we can
confirm receipt and installation of service on-line and in real-time.
TROUBLE TICKETING
We have created a system that logs information related to and monitors the
resolution of network problems. This system acts as a central repository for
logging client trouble calls, assigning responsibility for addressing the
problem to the appropriate party, and tracking the status of the response to the
calls, including automatically escalating the response process, as appropriate.
SALES FORCE AUTOMATION AND CONTACT MANAGEMENT
We utilize internally developed software to assist us in the management of
potential customer contacts, the management of the sales process with particular
client prospects and the preparation of proposals, correspondence and order
forms.
REGULATION
THE FOLLOWING SUMMARY OF REGULATORY 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.
8
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 carriers to the extent those facilities are used to provide,
originate, or terminate state-to-state or international communications. State
regulatory commissions exercise jurisdiction over facilities and services to the
extent those facilities are used to provide, originate or terminate in-state
communications. In addition, as a result of the passage of the
Telecommunications Act of 1996, state and federal regulators share
responsibility for implementing and enforcing the domestic pro-competitive
policies of the Telecommunications Act. In particular, state regulatory
commissions have substantial oversight over the provision of interconnection and
non-discriminatory network access to established telephone companies. Local
governments often regulate public rights-of-way necessary to install and operate
networks.
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. The
Telecommunications Act of 1996 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 to open their
local markets to competition.
One of our advantages, in many of our markets, 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 any state 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,
Massachusetts, Connecticut, Rhode Island, and Pennsylvania, and Southwestern
Bell has been granted such authority in Texas, Arkansas, Missouri, Kansas and
Oklahoma. Several additional requests for such authority either have been or
will soon be filed. The provision of in-region long distance services by the
regional Bell operating companies could permit them to offer "one-stop shopping"
of bundled local and long distance services, thereby eliminating this aspect of
our current marketing advantage.
FCC RULES IMPLEMENTING THE LOCAL COMPETITION PROVISIONS OF THE
TELECOMMUNICATIONS ACT
Over the last six years, the FCC has established a framework of national rules
enabling local competition. Some of those rules have important bearing on our
business, particularly:
INTERCONNECTION. Established telephone companies are required to provide
interconnection for telephone exchange or exchange access service, or both, to
any requesting telecommunications carrier at any technically feasible point. The
interconnection must be at least equal in quality to that provided by the
company to itself or subsidiaries, affiliates or any other party to which it
provides interconnection, and must be provided on rates, terms and conditions
that are just, reasonable and nondiscriminatory.
We have obtained or will obtain agreements with all the established telephone
companies in our service areas. These agreements must be renegotiated
periodically. Renewal terms may be more or less favorable and could affect our
overall costs.
ACCESS TO UNBUNDLED ELEMENTS. Established telephone companies are required to
lease portions of their networks to requesting telecommunications carriers by
providing them with nondiscriminatory access to network elements on an unbundled
basis at any technically feasible point, on rates, terms, and conditions that
are just, reasonable, and nondiscriminatory. This is important, because it
minimizes our need to make major investments in building our network. At a
minimum, established telephone companies must provide competitors with access to
various network elements used to originate and terminate telephone calls, call
routing database facilities, and computerized operations support systems. The
prices for these unbundled elements are set by the states under guidelines
established by the FCC.
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The FCC 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." This rule has
reduced the costs of providing DSL service but both the availability and the
prices of line sharing arrangements may be affected by future judicial or
regulatory decisions.
In December 2001, the FCC announced that it will review its rules defining the
network elements that established telephone companies must unbundle for
competitors. This proceeding will likely be completed during 2002. In February
2002, the FCC proposed to change the regulatory classification of high-speed
broadband services delivered over wires. This proposal could eliminate the
unbundling provisions and other pro-competition provisions of the
Telecommunications Act of 1996. Although we cannot yet predict the outcome of
these actions, any change in the availability of network elements could
potentially affect our business plans and operations.
COLLOCATION. Established telephone companies are required to provide space in
their switching offices so that requesting telecommunications carriers can
physically "collocate" equipment necessary for interconnection or access to
unbundled network elements at the company's premises, except that the
established telephone company may provide off-site "virtual" collocation, if it
demonstrates to the state regulatory commission that physical collocation is not
practical for technical reasons, or because of space limitations.
OTHER REGULATIONS
In general, the FCC has historically had a policy of encouraging new
competitors, such as us, in the telecommunications industry and preventing
anti-competitive practices. Therefore, the FCC has established different levels
of regulation for dominant carriers, such as the established telephone
companies, and nondominant carriers, such as integrated communications providers
and competitive local exchange carriers.
INTERSTATE AND INTERNATIONAL SERVICES. As a nondominant carrier, we may install
and operate facilities for the transmission of domestic interstate
communications without the time and expense of obtaining prior FCC
authorization.
Nondominant carriers are required to obtain FCC authorization pursuant to
Section 214 of the Communications Act before providing international
communications services. We have obtained such authority. Under recent FCC
decisions, the rates, terms, and conditions of domestic interstate and
international services are no longer filed with or regulated by the FCC,
although we remain subject to the FCC's jurisdiction over complaints regarding
these services. We also must comply with various FCC rules regarding disclosure
of our rates, the contents and format of our bills, payment of various
regulatory fees and contributions, and the like.
The FCC has adopted rules for a multi-year transition to lower international
settlement payments by U.S. common carriers. We believe that these rules are
likely to lead to lower rates for some international services and increased
demand for these services, including capacity on the U.S. facilities, like ours,
that provide these services.
ESTABLISHED TELEPHONE COMPANY PRICING REGULATION REFORM. The FCC has adopted a
number of changes to its rules that significantly reduce its regulation of
established telephone company pricing. These changes may greatly enhance the
ability of established telephone companies to compete against us, particularly
by targeting price cuts to particular clients, which could have a material
adverse effect on our ability to compete based on price. We expect that the FCC
will consider further initiatives along these lines in the future, but we cannot
predict the specific effects of future FCC reforms.
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ACCESS CHARGES. The FCC has also made various changes to the existing rate
structure for charges assessed on long distance carriers for allowing them to
connect to local networks. These changes will reduce access charges and will
shift charges, which had historically been based on minutes-of-use, to flat
rate, monthly per line charges on end-user clients rather than long distance
carriers. As a result, the aggregate amount of access charges paid by long
distance carriers to access providers like us may decrease. Under the FCC rules,
the rates charged by the largest established telephone companies for network
access are targeted to be reduced to 0.45 cents per minute after a transition
period, and some of the larger companies have already completed the transition
to this level.
In April 2001, the FCC adopted new rules to limit the access charges of
nondominant local carriers like us. Under these rules, which took effect on June
20, 2001, competitive carriers, such as us, are required to reduce their
interstate access charges to rates no higher than 2.5 cents per minute. After
one year, this rate ceiling will be reduced to 1.8 cents and after two years to
1.2 cents per minute. After three years, all competitive carriers will be
required to charge rates no higher than the established telephone company.
However, the new FCC rules are under petitions for reconsideration and/or
judicial review, and we are unable to predict the outcome of these proceedings.
UNIVERSAL SERVICE REFORM. Universal telephone service is a long-standing policy
initiative designed to assure that as many people as possible have access to
quality telephone service at affordable rates, particularly in rural and
high-cost areas, as well as providing advanced telecommunications services for
schools, health care providers and libraries. All telecommunications carriers
providing interstate telecommunications services, including us, must contribute
to the universal service support fund.
The FCC is considering various proposals to change the way these contributions
are calculated (currently, the contribution is approximately 6.8% of each
carrier's end-user revenue for interstate and international services for the
previous six month period). 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. All states we operate in require a registration, certification
or other authorization, and continued regulatory compliance, to offer intrastate
services. Many of the states in which we operate are addressing issues relating
to the regulation of competitive local exchange carriers. In most states, we are
required to file tariffs setting forth the terms, conditions and prices for
services that are classified as intrastate.
We have received, through our operating subsidiaries, certificates of authority
to provide local exchange and interexchange telecommunications services in
Connecticut, Illinois, Indiana, Maine, Massachusetts, Michigan, New Hampshire,
New York, Ohio, Pennsylvania, Rhode Island, Virginia, and Wisconsin.
In addition to tariff filing requirements, some states also impose reporting,
client service and quality requirements, as well as unbundling and universal
service requirements. In addition, we are subject to the outcome of generic
proceedings held by state utility commissions to determine new state regulatory
policies. Some states have adopted or have pending proceedings to adopt specific
universal service funding obligations. These state proceedings may result in
obligations that are equal to or more burdensome than the federal universal
service obligations.
We believe that, as the degree of intrastate competition increases, the states
will offer the established telephone companies increasing pricing flexibility.
This flexibility may present the established telephone companies with an
opportunity to subsidize services that compete with our services with revenue
generated from non-competitive services, thereby allowing established telephone
companies to offer competitive services at lower prices. This could have a
material adverse effect on our ability to attract and retain clients at
profitable margins.
We are also subject to requirements in some states to obtain prior approval for,
or notify the state commission of, specified events such as transfers of
control, sales of assets, corporate reorganizations, issuances of stock or debt
instruments and related transactions.
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As noted above, the states set most of the prices for unbundled network elements
for the unbundled network elements we purchase from the established telephone
companies to connect our network to customers. Recently, several states
including New York, Maine, and Rhode Island have lowered prices on these
unbundled elements, and several more states have open cases. While we cannot
predict the final outcome of cases and their affect on our business, changes in
unbundled element prices directly affect and are a large portion of our network
costs.
INTERNET. Our Internet operations are not currently subject to direct regulation
by the FCC or any other telecommunications regulatory agency, although they are
subject to regulations applicable to businesses generally. However, the future
Internet service provider regulatory status continues to be uncertain. Congress
and other federal entities have adopted or are considering other legislative and
regulatory proposals that would further regulate the Internet. Various states
have adopted and are considering Internet-related legislation. Increased U.S.
regulation of the Internet may slow its growth or reduce potential revenue,
particularly if other governments follow suit, which may increase the cost of
doing business over the Internet.
Under the Telecommunications Act, competitive local exchange carriers are
entitled to receive compensation from established telephone companies for
delivering traffic to their customers. A dispute has existed for several years
over whether this compensation applies to calls bound for Internet service
provider clients of the competitive local exchange carriers. Most states have
required established telephone companies to pay this compensation to competitive
local exchange carriers. In April 2001, however, the FCC adopted new rules
limiting the right of competitive local exchange carriers to collect
compensation on calls that terminate to Internet service providers, and
preempting inconsistent state rules. Under the new rules, which took effect on
June 14, 2001, the amount of compensation payable on calls to Internet service
providers will be limited to 0.15 cents per minute for the first six months
after the rules took effect, 0.10 cents per minute for the next eighteen months,
and 0.07 cents per minute thereafter. In addition, the overall amount of
compensation payable in each state is limited by a formula based upon the number
of minutes of Internet traffic terminated in the first quarter of 2001. The FCC
rules permit carriers to continue collecting the existing higher rates on calls
that terminate to customers who are not Internet service providers. Any traffic
exchanged between carriers that exceeds a three-to-one ratio of terminating to
originating minutes is presumed to be Internet calls, although either carrier
may attempt to rebut this presumption and show a different level of Internet
traffic. However, this ratio and the per minute rate may be modified by
agreements between the established telephone company and the competitive local
exchange carrier. We have such arrangements in several of the states we operate
in.
STATE AND FEDERAL LEGISLATION
State and federal legislatures periodically consider or pass legislation that
can affect our business. In February 2002, the U.S. House of Representatives
passed the Internet Freedom and Broadband Deployment Act of 2001 (H.R. 1542),
also known as the Tauzin-Dingell bill, by a vote of 273-157. The legislation is
aimed at encouraging competition and consumer access to broadband Internet
technology by freeing the established telephone companies from the
market-opening requirements of The Telecommunications Act of 1996, discussed
above, and the requirement to offer certain unbundled elements to us, making it
much easier for these companies to compete with us. This legislation must be
passed in the U.S. Senate and signed by the President before it can become law.
We cannot predict if this or other legislation will be enacted into law or what
effect such legislation would have on our business.
COMPETITION
We operate in a competitive environment. Some of our actual and potential
competitors have substantially greater financial, technical, marketing and other
resources, including brand name recognition, than we do. 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 are
pricing, client service, accurate billing and, to a lesser extent, variety of
services. Our ability to compete effectively depends upon our ability to provide
high quality market-driven services at prices generally equal to or below those
charged by established telephone companies. To maintain our competitive posture,
we believe that we must be in a position to reduce our prices in order to meet
reductions in rates, if any, by others.
ESTABLISHED TELEPHONE COMPANIES
In each of our target markets, we 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.
12
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 revenue of integrated communications providers and
competitive local exchange carriers could be adversely affected.
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, MCI WorldCom, and Sprint, and from
resellers of local exchange services and competitive access providers. We also
face competition from other competitive local exchange carriers with overlap in
our markets, such as TDS Metrocom, Network Plus, McLeod USA 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 reselling 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 Time
Warner with AOL, WorldCom, Inc. with MCI, 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.
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.
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 cellular carriers and companies offering long distance data and
voice services over the Internet. Some of these companies could enjoy a
significant cost advantage because they do not currently pay carrier access
charges or universal service fees.
In addition, 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 has been granted the authority to provide long distance
service in New York, Massachusetts, Connecticut, Rhode Island and Pennsylvania
and Southwestern Bell is authorized to offer long distance service in the states
of Texas, Arkansas, Missouri, 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.
13
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.
COMPETITIVE ENVIRONMENT
During 2001, a number of competitors exited certain markets where we do
business. The departure of such companies as Telergy Inc., CTSI Inc. and
FairPoint Communications Solutions Corp. has generated a more favorable
operating environment for us. We expect to gain market share as small and medium
sized businesses seek a reliable, comprehensive package of services.
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 17 servicemark applications or registrations.
Despite our precautions, we may not be able to prevent misappropriation or
infringement of our products, services and technology.
Our logo and some titles and logos of our services mentioned in this Form 10-K
are either our service marks or service marks that have been licensed to us.
Each trademark, trade name or service mark of any other company appearing in
this prospectus belongs to its holder.
EMPLOYEES
As of December 31, 2001, we had 1,758 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.
14
RISK FACTORS
RISKS RELATED TO OUR BUSINESS
TO EXPAND OUR BUSINESS WE WILL NEED A SIGNIFICANT AMOUNT OF CASH,
WHICH WE MAY BE UNABLE TO OBTAIN
The expansion of our business and the deployment of our networks, services and
systems has required, and may continue to require, significant capital
expenditures, working capital and debt service, and the ability to sustain
substantial cash flow deficits. At December 31, 2001 we had $14.4 million in
cash and cash equivalents. In addition, we had $55.0 million available under the
revolving credit facility. Our viability is dependent upon our ability to
continue to execute under our business strategy and to begin to generate
positive cash flows from operations during 2002. The success of our business
strategy includes obtaining and retaining a significant number of customers, and
generating significant and sustained growth in our operating cash flows to be
able to meet our debt service obligations and fund capital expenditures.
Despite our net losses in prior years, we believe we have the necessary funding
available to execute our short- and long-term business strategy. However, our
revenue and costs may also be dependent upon factors that are not within our
control, including regulatory changes, changes in technology, and increased
competition. Due to the uncertainty of these factors, actual revenue and costs
may vary from expected amounts, possibly to a material degree, and such
variations could affect our future funding requirements. Additional financing
may be required in response to changing conditions within the industry or
unanticipated competitive pressures. We can make no assurances that we would be
successful in raising additional capital, if needed, on favorable terms or at
all. Failure to raise sufficient funds may require us to modify, delay or
abandon some of our future expenditures. There are conditions to our ability to
borrow under our senior credit facility, including the continued satisfaction of
covenants. As of December 31, 2001, we were in compliance with these covenants
and expect to be in compliance with these covenants in 2002.
Our 2002 plan is predicated upon the following assumptions: sustained growth due
to end-user demand for data and voice offerings in our operational markets;
continued improvement in operational efficiencies through economies of scale
that translates into lower network costs and selling, general and administrative
expenses as a percent of revenue; decreased capital expenditures and decreased
interest expense payable in cash. The 2002 plan assumes that we have positive
cash and cash equivalents and borrowings available under our senior credit
facility at December 31, 2002. The amount of cash and borrowings available under
the senior credit facility as of December 31, 2002 is dependent upon factors
that could differ materially from the estimates. Despite our net losses in prior
years, we believe we have the necessary funding available to execute our short-
and long-term business strategy.
We also expect that we may require additional financing or require financing
sooner than anticipated if our business 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 our
business. Failure to raise sufficient funds may require us to modify, delay or
abandon some of our 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."
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WE ANTICIPATE HAVING FUTURE OPERATING LOSSES AS WE CONTINUE TO GROW OUR BUSINESS
IN 30 MARKETS
The expansion of our business and the deployment of our networks, services and
systems has required significant capital expenditures. We expect that our
adjusted EBITDA will become positive during 2002 while we expand our
telecommunications services business. Adjusted EBITDA represents earnings before
interest, income taxes, depreciation and amortization, non-cash 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, 2001, we had operating losses of $197.6 million, net losses
applicable to common stockholders of $287.0 million and negative adjusted EBITDA
of $75.2 million. We expect our operating losses and net losses to decline as
our operations mature and we achieve greater operating efficiencies. However, 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. Our revenue and costs may also be
dependent upon factors that are not within our control, including regulatory
changes, changes in technology, and increased competition. Due to the
uncertainty of these factors, actual revenue and costs may vary from expected
amounts, possibly to a material degree, and such variations could affect our
future funding requirements. Additional financing may be required in response to
changing conditions within the industry or unanticipated competitive pressures.
We can make no assurances that we would be successful in raising additional
capital, if needed, on favorable terms or at all. Failure to raise sufficient
funds may require us to modify, delay or abandon some of our future
expenditures.
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, 2001, our aggregate outstanding indebtedness and
obligations was $473.3 million, our stockholders' equity was $3.4 million and
our redeemable preferred stock was $200.8 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, 2001 was $295.0 million. We also had $178.3 million outstanding in
subordinated notes which are subordinated to our credit facility. Our debt is
subject to covenants customary to these types of arrangement. Our ability to
comply with these covenants will depend on our future financial and operating
performance, which, in turn, will be subject to prevailing economic and
competitive conditions and to certain financial, business, regulatory and other
factors, many of which are beyond our control. These factors could include
operating difficulties, increased operating costs, pricing pressures, the
response of competitors, regulatory developments and delays in implementing
strategic projects. We can make no assurances that we will continue to maintain
compliance with our debt covenants should the factors above occur and adversely
affect our business, financial condition and results of operations.
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.
16
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
execution of our business strategy, including obtaining and retaining a
significant number of clients, and significant and sustained growth in our cash
flow are necessary for us to be able to meet our debt service obligations and
working capital requirements. We can make no assurances that the anticipated
results of our strategy will be realized, or that we will be able to generate
sufficient cash flow from operating activities to meet our debt service
obligations and working capital requirements. See "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, sell assets, seek to obtain additional equity
capital, or refinance or restructure our debt. A disposition of assets in order
to make up for any shortfall in the payments due on our indebtedness could take
place under circumstances that might not be favorable to realizing the highest
price for such assets.
WE MAY FAIL TO ACHIEVE ACCEPTABLE PROFITS DUE TO PRICING
Prices in the local exchange business have remained stable. However, future
technological advances could result that will affect the prices for such
service. In addition, recent changes in prices have been from usage based prices
to flat rate prices.
Prices in the long distance business have declined substantially in recent years
and are expected to continue to decline. We rely on other carriers to provide us
with a major portion of our long distance transmission network. Such agreements
typically provide for the resale of long distance services on a per-minute basis
and may contain minimum volume commitments. The negotiation of these agreements
involves estimates of future supply and demand for transmission capacity as well
as estimates of the calling patterns and traffic levels of our future clients.
In the event that we fail to meet such minimum volume commitments, we may be
obligated to pay underutilization charges, and, in the event we underestimate
our need for transmission capacity, we may be required to obtain capacity
through more expensive means.
Our failure to achieve acceptable profits on our local exchange and long
distance services due to pricing declines could have a material adverse effect
on our business, financial condition and results of operation.
WE MAY NOT BE SUCCESSFUL IN MAINTAINING OUR HIGH CUSTOMER RETENTION RATE
We maximize customer retention by offering a simplified, comprehensive package
of services and providing a high level of customer care. Our churn of customers
for the year ended December 31, 2001 of our facilities-based customers was below
1% per month. Our ability to retain our customers is dependent upon a number of
factors, including providing quality service and competitive pricing, and the
economic viability of our customers. We can make no assurances that will
continue to maintain high retention of customers.
17
WE EXPECT TO GROW OUR BUSINESS AND CANNOT GUARANTEE THAT WE WILL BE ABLE TO
EFFECTIVELY MANAGE OUR FUTURE GROWTH
The growth of our business and the provision of bundled telecommunications
services on a widespread basis could place a significant strain on our
management, operations, financial and other resources and increase demands on
our systems and controls. Failure to manage our future growth effectively could
adversely affect the expansion of our client base and service offerings. We can
make no assurances that we will be able to successfully maintain efficient
operations and financial systems, procedures and controls or successfully
obtain, integrate and utilize the employees and management, operations,
financial and other resources necessary to manage an expanding business in our
evolving, highly regulated and increasingly competitive industry. Any failure to
expand in these areas and to improve such systems, procedures and controls in an
efficient manner at a pace consistent with the growth of our business could have
a material adverse effect on our business, financial condition and results of
operations.
If we were unable to hire sufficient qualified personnel or successfully
maintain our operations and financial systems, procedures and controls, our
clients could experience delays in connection of service and/or lower levels of
client service, our resources may be strained and we may be subjected to
additional expenses. Our failure to meet client demands and to manage the
expansion of our business and operations could have a material adverse effect on
our business, financial condition and results of operations.
WE RELY ON THE EFFECTIVE OPERATION OF OUR INFORMATION AND PROCESSING SYSTEMS
Sophisticated back office information and processing systems are vital to our
business and our ability to monitor costs, bill clients, provision client orders
and achieve operating efficiencies. Our maintenance of these systems relies, for
the most part, on choosing products and services offered by third party vendors
and integrating such products and services in-house to produce efficient
operational solutions. We can make no assurances that the system maintenance and
upgrades will be successfully implemented on a timely basis, that they will be
implemented at all or that, once implemented, they will perform as expected.
Risks to our business associated with our systems include: o failure by our
vendors to deliver their products and services in a timely and effective manner
and at acceptable costs;
o failure by us to adequately identify all of our information and
processing needs;
o failure of our related processing or information systems; and
o failure by us to effectively integrate new products or services.
Furthermore, as our suppliers revise and upgrade their hardware, software and
equipment technology, we could encounter difficulties in integrating the new
technology into our business or the new systems may not be appropriate for our
business. In addition, our right to use these systems is dependent upon license
agreements with third party vendors. Some of these agreements may be cancelled
by the vendor and the cancellation or nonrenewal of these agreements may have an
adverse effect on us.
WE RELY ON THE ESTABLISHED LOCAL TELEPHONE COMPANIES TO IMPLEMENT SUCCESSFULLY
OUR SWITCHED AND ENHANCED SERVICES WHOSE FAILURE TO COOPERATE WITH US COULD
AFFECT THE SERVICES WE OFFER
As a participant in the competitive local telecommunications services industry,
we may encounter numerous operating complexities associated with providing local
exchange services. We have been required to develop new products, services and
systems and to develop new marketing initiatives to sell these services. We can
make no assurances that we will be able to continue to develop such products and
services.
We have deployed high capacity voice and data switches in the cities in which we
operate networks. We rely on the networks of established telephone companies or
those of competitive local exchange carriers for some aspects of transmission.
Federal law requires most of the established telephone companies to lease or
"unbundle" elements of their networks and permit us to purchase the call
origination and call termination services we need, thereby decreasing our
operating expenses. We can make no assurances that such unbundling will continue
to occur in a timely manner or that the prices for such elements will be
favorable to us. In addition, our ability to successfully provide our switched
and enhanced services has and will continue to require the negotiation of
interconnection and collocation agreements with established telephone companies
and competitive local exchange carriers, which can take considerable time,
effort and expense and are subject to federal, state and local regulation.
18
We may experience difficulties in working with the established telephone
companies with respect to ordering, interconnecting, and leasing premises. We
can make no assurances that these established telephone companies will continue
to cooperate with us. If we are unable to obtain the cooperation of an
established telephone company in a region, whether or not such company has been
authorized to offer long distance service, our ability to continue to offer
local services in such region on a timely and cost-effective basis may be
adversely affected. 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 for us to compete against them.
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 continue to lease the copper telephone lines and the services
we require from these established telephone companies on a timely basis or at
quality levels, prices, terms and conditions satisfactory to us or that such
established telephone companies will maintain the lines in a satisfactory
manner.
IF WE FAIL TO OBTAIN ACCESS TO TRANSMISSION LINES, IT MAY AFFECT OUR ABILITY TO
DEVELOP OUR NETWORKS
Under our network buildout strategy, we 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 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.
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. Although we have been successful in attracting and retaining qualified
personnel, we can make no assurances that we will be able to hire or retain
necessary personnel in the future. The loss of services of one or more of our
key executives, or the inability to attract and retain additional qualified
personnel, could materially and adversely affect us.
WE MAY NOT HAVE THE ABILITY TO DEVELOP STRATEGIC ALLIANCES, MAKE INVESTMENTS OR
ACQUIRE ASSETS NECESSARY TO COMPLEMENT OUR EXISTING BUSINESS
We may seek, as part of our business strategy, to continue to develop strategic
alliances or to make investments or acquire assets or other businesses that will
relate to and complement our existing business. We are unable to predict whether
or when any planned or prospective strategic alliances or acquisitions will
occur or the likelihood of a material transaction being completed on favorable
terms and conditions. Our ability to finance strategic alliances and
acquisitions may be constrained by our degree of leverage at the time of such
strategic alliance or acquisition. In addition, our credit facility may
significantly limit our ability to enter into strategic alliances or make
acquisitions and to incur indebtedness in connection with strategic alliances
and acquisitions.
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.
19
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
As part of our business strategy, we may seek to develop strategic alliances or
acquire complementary assets or businesses. 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.
In December 2001, we acquired certain assets from FairPoint Communications
Solutions Corp. which included selected collocation sites and the related
business lines. Integration of these collocation sites and migration of the
related business lines into our operations began in 2001. The migration is
expected to be completed in April 2002. We can make no assurances that the
migration will not encounter the risks identified above, which risks could
adversely impact our business, financial condition and results of operations.
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
WE FACE A HIGH LEVEL OF COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY
The telecommunications industry is highly competitive, and one of the primary
purposes of the Telecommunications Act of 1996 is to foster further competition.
In each of our markets, we compete principally with the established telephone
company serving such market. The established telephone companies have
long-standing relationships with their clients, financial, technical and
marketing resources substantially greater than ours and the potential to fund
competitive services with cash flows from a variety of businesses. Established
telephone companies also benefit from existing regulations that favor them over
integrated communications providers and competitive local exchange carriers in
some respects. Furthermore, one large group of established telephone companies,
the regional Bell operating companies, 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 other competitors in some of our markets. We believe that second and third
tier markets will support only a limited number of competitors and that
operations in such markets with multiple competitive providers are likely to be
unprofitable for one or more of such providers.
We can make no assurances that we will be able to achieve or maintain adequate
market share or margins, or compete effectively, in any of our markets.
Moreover, many of our current and potential competitors have financial,
technical, marketing, personnel and other resources, including brand name
recognition, substantially greater than ours as well as other competitive
advantages over us. Any of the foregoing factors could have a material adverse
effect on our business, financial condition or results of operations. See
"Business--Competition."
20
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 continues to examine the regulatory
status of some services offered over the Internet. New laws or regulations
relating to Internet services, or existing laws found to apply to them, may have
a material adverse effect on our business, financial condition or results of
operations.
The Telecommunications Act 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.
REGULATION OF INTERCONNECTION WITH ESTABLISHED TELEPHONE COMPANIES INVOLVES
UNCERTAINTIES, AND THE RESOLUTION OF THESE UNCERTAINTIES COULD ADVERSELY AFFECT
OUR BUSINESS
Although the established telephone companies are required under the
Telecommunications Act of 1996 to unbundle and make available elements of their
network and permit us to purchase only the origination and termination services
that we need, thereby decreasing our operating expenses, such unbundling may not
be done as quickly as we require and may be priced higher than we expect. This
is important because we rely on the facilities of these other carriers to
connect to our switches so that we can provide services to our customers. Our
ability to obtain these interconnection agreements on favorable terms, and the
time and expense involved in negotiating them, can be adversely affected by
legal developments.
A Supreme Court decision vacated a FCC rule determining which network elements
the established telephone companies must provide to competitors on an unbundled
basis. On November 5, 1999, the FCC released an order revising its unbundled
network element rules to conform to the Supreme Court's interpretation of the
law, and reaffirmed the availability of the basic network elements, such as
local loops, the connection from a customer's location to the established
telephone company, and dedicated transport, used by us. This order is subject to
further agency reconsideration and/or court review. We have interconnection
agreements with a number of established telephone companies through negotiations
or, in some cases, adoption of another competitive local carrier's approved
agreement. These agreements remain in effect, although in some cases one or both
parties may be entitled to demand renegotiation of particular provisions based
on intervening changes in the law. However, it is uncertain whether any of these
agreements will be so renegotiated or whether we will be able to obtain renewal
of these agreements on as favorable terms when they expire.
21
On July 19, 2000, in a decision on remand from the Supreme Court, the United
States Court of Appeals for the Eighth Circuit vacated certain of the FCC's
total element long run incremental (TELRIC) pricing rules. While sustaining the
FCC's use of a forward-looking incremental cost methodology to set rates for
interconnection and unbundled network elements, the Court rejected the FCC's
conclusion that the costs should be based on the use of the most efficient
technology currently available and the lowest cost network configuration.
Instead, the Court stated that the statute required that costs be based on the
use of the established telephone company's existing facilities and actual
network equipment but that these costs should not be based on the historic costs
actually paid by such carrier for network elements. The Court also found that
the FCC erred in using avoidable, rather than actually avoided, costs to
calculate the wholesale discount for resale products. Interconnection and
unbundled network element rates set using the Court's methodology may be higher
than and the wholesale discounts set using the Court's methodology may be lower
than the comparable rates established using the FCC's methodology. The Supreme
Court has agreed to review the Eighth Circuit's decision and the Eighth Circuit
in turn has stayed issuance of the mandate vacating the TELRIC rules pending the
Supreme Court's decision that is expected in 2002. It is difficult to evaluate
the potential impact of this ruling on the prices we pay established telephone
companies for unbundled network elements until the Supreme Court rules. We
believe that the pricing of unbundled network elements approved by many state
commissions and reflected in many of our interconnection agreements is already
materially in compliance with the standard set forth in the Eighth Circuit's
ruling. This ruling could have a material adverse effect on us, however, if it
is interpreted to authorize materially higher charges for unbundled network
elements than those prevailing in our current interconnection agreements.
OUR STOCK HAS BEEN EXTREMELY VOLATILE
Our stock has experienced significant price and volume fluctuations. The market
price for our common stock may continue to be subject to wide fluctuations in
response to a variety of factors, including but not limited to the following,
some of which are beyond our control:
o revenues and operating results failing to meet the expectations of
securities analysts or investors in any period;
o failure to successfully implement our business strategy;
o announcements of operating results and business conditions by our
clients and competitors;
o technological innovations by competitors or in competing technologies;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o announcements by third parties of significant claims or proceedings
against us;
o investor perception of our industry or our prospects;
o economic developments in the telecommunications industry and general
market conditions; or
o regulatory changes.
Our common stock is listed on The Nasdaq National Market and as such is subject
to certain requirements for continued listing. We can make no assurances that we
will continue to be able to meet The Nasdaq National Market maintenance
requirements.
IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE TELECOMMUNICATIONS
INDUSTRY OUR BUSINESS COULD BE ADVERSELY AFFECTED
The telecommunications industry is subject to rapid and significant changes in
technology, including continuing developments in DSL technology, which does not
presently have widely accepted standards, and alternative technologies for
providing high-speed data transport and networking. The absence of widely
accepted standards may delay or increase the cost of our market entry due to
changes in equipment specifications and customer needs and expectations. If we
fail to adapt successfully to technological changes or obsolescence, fail to
adopt technology that becomes an industry standard or fail to obtain access to
important technologies, our business, financial condition or results of
operations could be materially adversely affected. We may also be dependent on
third parties for access to new technologies. Also, if we acquire new
technologies, we may not be able to implement them as effectively as other
companies with more experience with those technologies and in their markets.
22
WE MAY NOT BE SUCCESSFUL IN GROWING OUR DATA TRANSMISSION SERVICES
We have incurred substantial start-up expenses offering 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.
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,
2001, this lease covered 105,680 square feet. We also have administrative
offices under a lease for 109,000 square feet of space in Grand Rapids,
Michigan. The leases for this space expire in 2002 and 2009. In addition, we
lease space in a number of locations, primarily for sales offices and network
equipment installations. We believe that our leased facilities are adequate to
meet our current needs and that additional facilities are available to meet our
development and expansion needs in existing markets.
ITEM 3. LEGAL PROCEEDINGS
On November 20, 2001, the Company and three of its officers were named in
a complaint filed in the Southern District of New York on behalf of a class of
persons consisting of certain purchasers of the Company's common stock in its
initial public offering which was completed on February 23, 2000. The complaint
seeks damages based on allegations that the Company's Registration Statement and
Prospectus relating to the offering contained material misstatements and/or
omissions regarding the compensation received by the underwriters of the
offering and certain transactions engaged in by the underwriters. This case,
which also names six of the underwriters of the offering, alleges that the
underwriters engaged in a pattern of conduct to extract inflated commissions in
excess of the amounts disclosed in offering materials and manipulated the
markets by engaging in stabilizing transactions. The underwriters are also the
subject of publicly disclosed investigations by several governmental agencies.
The Complaint does not allege that the Company or the individuals were aware of
or had reason to know of the alleged acts of the underwriters. The theory of
liability against the Company and its officers, as alleged in the complaint, is
that the Company is strictly liable under Section 11 of the Securities Act of
1933 because Item 508 of Regulation S-K allegedly required the disclosure of
commissions to be paid to underwriters and of stabilizing transactions. The
individual defendants are claimed to be liable as officers who signed the
Registration Statement or as controlling persons of the Company under Section 15
of the Securities Act of 1933. At this time, this case has been consolidated
with the hundreds of other cases involving similar allegations and the matter is
in its very preliminary procedural stage.
23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended December 31, 2001, the
Company obtained the requisite consent of holders of a majority of its common
stock to amend its 1998 Employee Stock Option Plan (May 2000 Restatement) to
increase the number of shares of common stock available for issuance under the
plan.
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, 2001.
NAME AGE TITLE
Steve M. Dubnik.....39 Chairman of the Board and Director, President and
Chief Executive Officer
Kevin S. Dickens....38 Co-Chief Operating Officer
Ajay Sabherwal......35 Executive Vice President, Finance and Chief Financial
Officer
Mae H. Squier-Dow...40 Co-Chief Operating Officer
Philip H. Yawman....36 Executive Vice President, Corporate Development
Robert O. Bailey....55 Senior Vice President, Technology
Joseph A. Calzone...38 Senior Vice President, Engineering
Linda S. Chapman....38 Senior Vice President, Human Resources
Michael A. D'Angelo.36 Senior Vice President, Sales
Scott D. Deverell...36 Vice President, Accounting, and Controller
Elizabeth A. Ellis..43 Senior Vice President, Information Technology
Michelle C. Paroda..38 Senior Vice President, Client Services
Kim Robert Scovill..48 Vice President, Legal and Regulatory Affairs, and
General Counsel
Kevin Stephens......40 Senior Vice President, Marketing
John J. Zimmer......43 Vice President, Finance, and Treasurer
--------------
STEVE M. DUBNIK, our Chairman of the Board, President, Chief Executive
Officer and Co-Founder, has worked in the telecommunications industry for 18
years. Prior to founding Choice One in June 1998, Mr. Dubnik served in various
capacities with ACC Corp., including as the President and Chief Operating
Officer of North American Operations of ACC from November 1996 to April 1998 and
as Chairman of the Board of Directors of ACC TelEnterprises Ltd. from July 1994
to April 1998. From December 1997 to April 1998, he also jointly performed the
functions of Chief Executive Officer of ACC. Mr. Dubnik currently serves on the
Board of Managers of FiberTech Networks, LLC.
KEVIN S. DICKENS, our Co-Chief Operating Officer since August 2000 and
prior to that Senior Vice President, Operations and Engineering, and Co-Founder
since July 1998, has worked in the telecommunications industry for 13 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 12 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.
24
MAE H. SQUIER-DOW, our Co-Chief Operating Officer since August 2000 and
prior to that Senior Vice President, Sales, Marketing and Service, and
Co-Founder since June 1998, has worked in the telecommunications industry for
17 years. Ms. Squier-Dow served as President of ACC Telecom, a U.S. subsidiary
of ACC Corp., from June 1996 to May 1998, and in several positions at ACC Long
Distance U.K. Ltd., including as Commercial Director from April 1995 to June
1996, and as Director of Client Relations and Marketing, Vice President of
International Planning and Operations Director from October 1993 to April 1995.
PHILIP H. YAWMAN, our Executive Vice President, Corporate Development and
Co-Founder since July 1998, has worked in the telecommunications industry for
14 years. Prior to joining us, Mr. Yawman was Vice President of Investor
Relations and Corporate Communications at ACC Corp. from April 1997 to January
1998. Mr. Yawman also served in various positions at Frontier Corporation from
July 1989 to April 1997, including as head of investor relations' activities
and in several product management positions.
ROBERT O. BAILEY, our Senior Vice President, Technology since September
1999, is responsible is responsible for engineering and operation of the Choice
One network. In addition, he is responsible for evaluating and selecting the
technology to be deployed by Choice One in the next generation of switching
systems architecture, including the evolution from circuit switching systems to
packet and ATM-based infrastructure. Most recently, he was Vice President and
Chief Technology Officer for the Upstate Cellular Network (Frontier Cellular), a
joint venture of Verizon Mobile and Frontier Corporation, from January 1985
until April 1999, where he was responsible for engineering and operations of a
cellular network that covered 5.5 million population units in upstate New York.
JOSEPH A. CALZONE, our Senior Vice President, Engineering since August
2000 and prior to that Vice President, Engineering and Network Operations since
July 1998, has worked in the telecommunications industry for 16 years. Prior to
joining us, Mr. Calzone held various key management positions at Citizens
Communications from October 1995 to May 1998, most recently as head of the
National Sales and Services organization and as Vice President of Long Distance
Engineering and Operations.
LINDA S. CHAPMAN, our Senior Vice President, Human Resources since May
2001 and prior to that Vice President, Human Resources since August 1998, was
the Director of Human Resources of ACC Corp.'s U.S. subsidiary, ACC Telecom,
from June 1997 to July 1998. Prior thereto, Ms. Chapman held various management
positions with MCI from March 1994 to May 1997.
MICHAEL A. D'ANGELO, our Senior Vice President, Sales, since May 2001 and
prior to that Vice President of Sales, since September 1998, has worked in the
telecommunications industry for over 14 years. Prior to joining us, Mr. D'Angelo
was the Director of Sales, Southeast Regional Manager at ICG Communications from
November 1997 to September 1998. Prior thereto, Mr. D'Angelo was Regional Sales
Manager for Citizens Communications from January 1995 to November 1997.
SCOTT D. DEVERELL, our Vice President, Accounting, and Controller since
March 2000 and Director of Accounting since December 1998, is a certified public
accountant. Prior to joining us, Mr. Deverell was employed by PSC Inc. as
Assistant Treasurer from September 1997 to December 1998 and as Controller from
1990 until September 1997.
ELIZABETH A. ELLIS, our Senior Vice President, Information Technology
since August 2000 and prior to that Vice President, Information Technology since
July 1998, has worked in the information technology field for over 21 years,
including the past seven years in the telecommunications industry. Prior to
joining us in July 1998, Ms. Ellis was Commercial Director for ACC Telecom's
subsidiaries in the United Kingdom and Germany from August 1994 to June 1998
where she was responsible for all aspects of network, operations, client
service, telemarketing and information technology.
MICHELLE C. PARODA, our Senior Vice President, Client Services since
August 2000 and prior to that Vice President, Client Care since July 1998, has
wor