UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

 

 

Commission File Number: 0-30900

XO Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

 

13865 Sunrise Valley Drive
Herndon, Virginia 20171
(Address of principal executive offices, including zip code)

 

(703) 547-2000
(Registrant’s telephone number, including area code)

 

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 $0.01 per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

As of June 30, 2009, the aggregate market value of common stock held by non-affiliates of the registrant was $26.7 million based upon the closing sale price of the common stock as reported on the Over-the-Counter Bulletin Board as of the close of business on that date. Shares of common stock held by each executive officer and director and by each entity associated with our majority shareholder have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of shares of common stock outstanding as of March 9, 2010 was 182,075,165.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Items 10, 11, 12, 13 and 14 of Part III are incorporated by reference to the registrant’s proxy statement relating to its 2010 Annual Meeting of Stockholders.

 

 

XO Holdings, Inc.

 

TABLE OF CONTENTS

 

Caution Regarding Forward-Looking Statements

 

The statements contained in this Annual Report on Form 10-K that are not historical facts are forward-looking statements, as this term is defined in the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. These statements can be identified by the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “plan,” “intend,” “can,” “may,” “could” or other comparable words. Our forward-looking statements are based on currently available operational, financial and competitive information and management’s current expectations, estimates and projections. These forward-looking statements include:

 

 

Readers are cautioned that these forward-looking statements are only predictions and are subject to a number of both known and unknown risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should our underlying assumptions prove incorrect, our actual results in future periods may differ materially from the future results, performance, and/or achievements expressed or implied in this document. These risks include any failure by us to:

 

 

For a detailed discussion of risk factors affecting our business and operations, see Item 1A “Risk Factors” of this Annual Report. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. These forward-looking statements should not be relied on as representing our estimates or views as of any subsequent date.

 

 

XO Holdings, Inc., a Delaware corporation, was incorporated in December 2005 and has its principal executive offices at 13865 Sunrise Valley Drive, Herndon, Virginia 20171. XO Holdings, Inc. is a holding company for its direct and indirect operating subsidiaries, including XO Communications, LLC (XO Holdings, Inc., together with its subsidiaries, “XO Holdings,” “XOH,” or the “Company”). The Company maintains an internet website at www.xo.com. Any information included in XOH’s website is not incorporated by reference into this Annual Report. We use the terms “we”, “our” and “us” to refer to XOH in this Annual Report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements for our annual stockholders meeting, and amendments to those reports are available free of charge via a link on the investor relations section of our website to the Securities and Exchange Commission. In addition, we have posted on our website our Code of Ethics applicable to our principal executive officer, principal financial officer, controller, treasurer and other persons performing similar functions.

 

Overview

 

We are a leading facilities-based, competitive telecommunications services provider that delivers a comprehensive array of telecommunications services using both advanced IP and traditional Time Division Multiplexing (“TDM”) technologies to the telecommunications provider, business and government markets. We serve the broad telecommunications needs of our customers through an extensive telecommunications network that we operate. As one of the nation’s largest competitive communications companies, we are uniquely positioned as a leading local and national alternative to the Incumbent Local Exchange Carrier (“ILEC”) for businesses and large enterprises. We operate in a market that continues to change rapidly as a result of technological advancements and industry consolidation. The majority of market share is maintained by the legacy ILECs. However, competitive service providers, like us, have succeeded in gaining market share from the ILECs by offering comparable services at competitive prices.

 

We earned revenues in excess of $1.5 billion for 2009 with continued revenue growth and improvement in operating losses over the each of the past 3 years. We expect to further grow our share within the retail and wholesale business-to-business telecommunications market by using our network assets to offer Broadband services primarily to business and carrier customers. We have invested over $400 million during the past two years in order to enhance and expand our extensive network and improve efficiencies.

 

Strategy

 

We continue to execute our strategic business plan by focusing on several key elements:

 

Focus on Business and Carrier Customers.  XOH provides a broad portfolio of reliable, scalable and high-speed telecommunications services tailored for enterprise, business, carrier and content delivery customers. XOH offers traditional and next-generation solutions tailored to these customers. We continue to invest in rolling out new product offerings to meet the emerging needs of these customers.

 

Focus on Broadband Services.  XOH has built a state-of-the-art network designed to carry data and IP traffic. This recognizes the on-going shift from traditional telephony services to new, IP-based services. During 2009, we realized almost half of our revenue from the sale of data and IP-related services, and expect to see a continued shift in our revenue mix to these services in 2010. We continue to place significant focus on developing new IP-based services. For our carrier customers, in 2008 we rolled out several new products, including Ethernet Hub and Carrier MPLS-enabled Internet Protocol Virtual Private Network (“MPLS IP-VPN”). For our business customers, we rolled out enhancements to several of our service offerings including MPLS IP-VPN, ethernet, and integrated VoIP, including our award-winning unified communications package, “XO Anywhere.” During 2009, XOH launched, “Ethernet Everywhere”, a service availability guarantee ensuring its carrier customers can obtain ethernet service anywhere within our coverage area. In addition, XO’s Business Services launched its XO Enterprise SIP offering. This new

product gives multi-location businesses the flexibility and scalability to transform their distributed voice network architecture into a more centralized and cost-effective VoIP solution.

 

Utilize Our Network Assets.  XOH’s network is interoperable with both traditional and IP services. This allows customers to access XOH’s network with greater flexibility and enables us to offer solutions with significant appeal to business, carrier and wholesale customers. XOH’s national network includes over 950 central office collocations in over 80 major metropolitan markets across the United States. XOH’s network footprint includes an 18,000 route mile nationwide inter-city fiber optics network, over one million fiber miles, and approximately 3,000 on-network buildings. We continually update the capacity and capabilities of the network and expect to continue to do so in 2010.

 

Provide Quality Services to our Customers.  We support our nationwide network with an integrated array of systems and support personnel to ensure that our customers receive the highest quality of service. We employ a software-based single interface to all network fault management requirements and for advanced, highly accurate provisioning. XOH’s professional staff monitors the network 24/7, with subject-matter experts available to resolve issues quickly and accurately. XOH offers online tools that provide customers secure, self-service portals for the creation, maintenance, tracking and reporting of a number of services; XOH rolled out new online tools in 2008 and 2009 and plans to develop further capabilities in 2010 in order to enhance the customer’s experience and overall satisfaction. We continue to invest in operational areas including provisioning, care efficiency and billing accuracy as a way to further improve our customers’ experiences with our services.

 

Transformation.  In 2008, XOH commenced an enterprise-wide transformation initiative intended to enhance shareholder value through focusing on improving service delivery, accelerating revenue growth, and reducing our operating costs. We expect to continue this initiative over the next several years, with benefits partially being realized in 2009 and with further realization expected in 2010 and beyond. In conjunction with this transformation initiative, we intend to continue to invest in new network infrastructure, develop new service offerings and expect to continue expanding our large business and enterprise customer base.

 

Service Offerings

We use our nationwide IP network, extensive local metropolitan networks and broadband wireless facilities to offer a broad portfolio of services. The revenue from these services is aggregated into two categories: Core and Legacy/TDM. XOH’s Core Services include products using next generation IP technologies and transport services and include the following categories:

 

Broadband Services.  These services include IP Flex, Dedicated Internet Access (“DIA”), Carrier VoIP origination and termination, ethernet, and other IP-based solutions, as well as data services including Dedicated Private Line, Telco Collocation and Multi-Transport Networking (“MTNS”). Also included in this category is our MPLS IP-VPN service that allows our multi-location customers to securely connect their sites to achieve more bandwidth for the dollar, faster application deployment, lower network operating costs, and more access options. MPLS IP-VPN service is a fully managed converged voice and data network service with advanced features for application traffic prioritization by class of service for router management and for applications performance management. In addition, it offers universal site-to-site connectivity, a broader selection of access options and no rigid limits on bandwidth. Customers can select class of service options to prioritize their network traffic.

 

XOH provides private line dedicated transport services (“private line”) point-to-point connectivity. Our Dedicated Private Line service provides special access and point-to-point circuits to high volume customers, for their use as both primary and back-up circuits. In addition, fiber optic technology that enables signals to be transmitted at different wavelengths on a single fiber allows XOH to lease one or more dedicated wavelengths with connections of up to 9.6 Gbps, a transmission rate known as OC-192. This service supports a variety of transmission protocols, including ATM, Frame Relay, and Synchronous Optical Network. In addition, XOH’s facilities-based network allows us to offer data and telecommunications equipment collocation in many of our facilities across the United States. This capability allows customers to locate their equipment in secure, controlled access cabinets or cages at

XOH facilities. By placing their equipment in an XOH collocation, customers enjoy easy connection to the XOH network and other carrier networks, 24/7 monitoring, backup power, and other services that help customers increase bandwidth, reduce costs, avoid capital expenditures, and improve redundancy and business continuity capabilities.

 

XOH offers numerous solutions for DIA, from traditional 1.5 Mbps T1 services to mid-band ethernet internet access up to 10 Mbps to high speed optical internet access at speeds up to 10 Gbps. A suite of ethernet transport services, including Gigabit Ethernet (“GigE”), as well as inter-city ethernet services at 10 Mbps, 100 Mbps, 1 Gbps, and 10 Gbps between markets is available on both our fiber network and through fixed wireless capabilities. These services are designed to provide high-speed, high-capacity connections between customers’ Local Area Networks within and between metropolitan areas and reduce costs for customers as they eliminate the need for ongoing configuration, management and acquisition of equipment. XOH offers a broad portfolio of converged and VoIP services including integrated bundles, Session Initiation Protocol (“SIP”) service, and VoIP origination and termination solutions. Converged solutions allow voice and data traffic to transverse the same circuit, treating voice services as another IP application. XO SIP Service provides a native IP connection to the newest generation of IP-based PBXs. IP Flex provides a VoIP solution for customers who want to keep their existing phone equipment. XOH has one of the largest deployments of soft-switches to support both circuit switched voice traffic and packet-based VoIP traffic, carrying nearly 20 billion minutes of VoIP traffic in 2009.

 

Integrated/Voice Services.  XOH provides a portfolio of integrated and voice services for business and carrier customers. This portfolio includes traditional local and long distance services, such as PRI and our wholesale carrier long distance, Carrier Long Distance Termination (“CLDT”), as well as integrated voice and data services such as XOptions and Integrated Access. Carriers rely on XOH’s service to originate and terminate large volumes of minutes on behalf of their customers.

 

Fixed Wireless Services.  XOH provides a high-speed fixed wireless alternative to local copper and fiber connections. XOH currently offers wireless backhaul, network extensions, network redundancy and diversity services using broadband radio signals transmitted between points of presence located within line-of-sight (“LOS”). These services provide critical telecommunications links within customer networks without requiring them to construct their own facilities or purchase capacity from the regional ILECs. Fixed wireless services also provide carriers and end-user customers with network diversity and redundancy to permit them to deploy communications services that are less vulnerable to natural disasters or other disruptions than traditional, terrestrial-only telecommunications networks.

 

Managed Services.  XOH managed services provide network, equipment and professional services as an integrated solution for customers through our XO One managed IP-enabled PBX (“iPBX”) offerings. The offer includes iPBX installed and managed at our customers’ premises that allows customers with single or multiple locations to outsource the deployment and management of their premise-based IP systems. This solution provides businesses with the benefits and features of IP Telephony while helping to lower their total cost of network ownership by eliminating the expenses of purchasing, maintaining and managing their own voice and data equipment. XOH also offers network-based Interactive Voice Response, (“IVR”) services that provide custom-designed voice response systems that reduce costs and improve serviceability by routing calls, capturing information, locating, retrieving and communicating data and more.

 

XOH’s Legacy/TDM services are predominantly deployed using TDM and circuit switched voice technologies. These services include the following categories:

 

Voice Services.  XOH’s traditional voice services are a proven alternative to the ILECs. XOH has negotiated and entered into interconnection agreements with applicable ILECs and certain independent carriers, and implemented permanent local number portability, which allows new customers to retain their existing telephone numbers when they choose XOH as their service provider. XOH offers a variety of traditional voice applications and services including standard dial tone (with 911 access, touch tone dialing, directory assistance, and operator-assisted calling), retail local and long distance (including international, toll-free, operator-assisted, and calling card) services, basic business lines, switched trunks, local voice features such as messaging, voice and web conferencing, and carrier reciprocal access.

Hosting and Hosted Applications.  XOH offers a range of web hosting, messaging, collaboration and Software-As-A-Service (“SaaS”) applications to help customers manage their online business and provide online business tools to our customers. These services include website hosting, business email, managed server and professional website services related to these products. XOH provides its hosted services on a patented Clustered Technology architecture, a platform that delivers greater reliability, speed and performance than traditional shared platforms. XOH’s unique technology provides virtually inexhaustible dynamic resources and multiple tiers of system and application security.

 

Business Units

 

XOH operates through three customer-centric business units: XO Business Services (“Business Services”), XO Carrier Services (“Carrier Services”) and XO Concentric (“Concentric”). Business Services markets our telecommunications solutions to government agencies and business customers, ranging in size from growing businesses to Fortune 500 companies. Business Services provides managed IP, data and end-to-end communications solutions. Carrier Services markets wholesale solutions to carriers and other telecommunications providers. Concentric is primarily marketed to small business customers. This business unit structure helps XOH focus on specific customer groups, grow revenue within each customer group, and it highlights XOH’s unique competitive advantages in serving business and carrier customers as the telecommunications industry consolidates and data and telecommunications services converge.

 

Business Services

 

Business Services provides business customers and government agencies with managed IP, data and end-to-end voice communications solutions. Business Services is focused on obtaining and retaining customers through an outstanding customer experience and profitably growing revenue through an expanding IP-based service portfolio. Business Services builds on our strong position within the small-to-medium sized business market as a platform for greater emphasis on mid-market businesses. Business Services also leverages XOH’s nationwide network to increase our penetration in the larger enterprise market.

 

The United States market for wireline business telecommunications services consists of over 14 million businesses with average monthly telecommunications spending of approximately $6.0 billion. XOH’s network footprint reaches approximately 40% of that available market.

 

To reach our markets, Business Services employs a direct sales and support organization. In addition, Business Services has agreements with over 250 third-party national, regional and local agents and agency firms, who represent a broad range of voice, data, consulting, and equipment services that they provide to end users. These business partners extend the reach of the Business Services sales organization geographically as well as addressing specific customer segments.

 

Business customers in the United States telecommunications market span a wide range of sizes and needs, from small and medium sized businesses to large multi-location enterprises. Business Services is aligning its service offerings, sales and channel strategies and customer support models to better meet the needs of these broad customer groups:

 

Small-to-Medium Business (“SMB”).  The SMB group consists of single-site or multiple-site customers. These customers may require multiple service packages or some level of customized solutions.

 

Mid-Market Business.  Business Services is ideally positioned to serve the needs of mid-market businesses. These growing companies are frequently underserved by large telecommunications providers. XOH has a range of IP based services, from bundles that are suited to branch locations, to customized solutions that meet the needs of company headquarters locations or multi-site networks. A majority of Business Services’ resources are concentrated on serving the needs of customers within this market.

 

Enterprise.  Enterprises are large commercial entities with complex communications needs. These customers require high bandwidth, secure private networks, multi-location services and unique solutions. Business Services is allocating additional resources in this segment focusing on key growth verticals that can take advantage of our national footprint and scalable IP-based service portfolio.

Government.  Government entities from local school districts to state offices and federal agencies frequently require telecommunications solutions that are similar to mid-market and enterprise businesses. Yet, government customers have unique needs and purchasing processes necessary to meet the requirements of serving the public.

 

Historically, Business Services has served a portion of all these groups, with an especially strong presence in the SMB market. During 2008, Business Services began shifting its focus to mid-market business enterprises. As a result, during 2008 a significant shift in expenditures, personnel and customer base occurred. Business Services’ concentration of resources and focus on mid-market businesses resulted in a substantial expansion in the number of mid-market customers served. Throughout 2009, Business Services continued to invest in network infrastructure, products and services, and resources to accelerate revenue growth with an even greater focus on penetrating the enterprise customer market.

 

Carrier Services

Carrier Services delivers a broad range of IP, data and wholesale voice services to ILECs, Competitive Local Exchange Carriers (“CLEC“s), Internet Service Providers (“ISPs”), interexchange carriers, non-facility based resellers, building local exchange carriers, wireless service providers, and VoIP service providers. This business unit leverages wholesale versions of the services described above as well as some unique services that are targeted to wholesale customers, specifically, ethernet and TDM Aggregation and VoIP Origination and Termination services. Ethernet and TDM Aggregation services collect end-user 1.5 Mbps to 100 Mbps from discrete end user or enterprise locations distributed across a wide geographic region at a metropolitan or regional level and delivers it to Carrier Services’ customers over a larger speed connection. This allows customers without a Point-of-Presence (“POP”) in a particular city or region where they have end-users, to use the XOH backbone to aggregate and backhaul their end user traffic to their POP. Traffic is transported securely via MPLS and allows customers to manage their own IP address space. Wholesale long distance termination services provide solutions to terminate inter- and intra-state long distance calls with only one interconnection. VoIP Origination and VoIP Termination services allow incoming calls through XOH’s IP network. VoIP Termination provides long distance connectivity to terminate IP-originated calls to the Public Switched Telephone Network (“PSTN”). These services are used by some of the nation’s leading retail VoIP service providers. Carrier Services also offers customers high-capacity, inter-city private line and inter-city ethernet services. Taking advantage of consolidation within the industry and increased customer demands for bandwidth, Carrier Services also targets international carriers and cable companies.

 

Carrier Services continues to expand infrastructure to high-traffic aggregation points across the United States in two specific areas including: 1) submarine cable landing stations; and 2) the US — Mexico border crossing, enabling connectivity to Mexico and Central and South America. The expansion of infrastructure in these two areas in addition to continued investment in long-haul Dense Wave Division Multi-plexing (“DWDM”) will enable more opportunity for high capacity bandwidth and IP services among US domestic as well as global carriers. Further, in order to capture a greater share of the metro IP and wavelength services market, Carrier Services is now providing mid-band ethernet services to customers and has deployed next-generation ethernet services enabling expanded IP-VPN and other IP-based services. The combined investments in high speed wavelength in metro IP and ethernet technologies and customer service and support, differentiates Carrier Services from competitors for future wholesale IP business growth.

 

Concentric

Concentric services the needs of small business customers. These customers are typically defined as single location businesses, less than 20 employees, with non-complex telecommunications requirements.

 

The small-business segment that Concentric serves is a highly competitive market. ILECs such as ATT and Verizon, cable companies, and other CLECs offer aggressive pricing, innovative products and services, and an ever increasing toolkit of self-directed capabilities. To improve retention and growth of our customer base, XOH proactively contacts customers to promote bundled product packages and to educate and inform customers on new services and capabilities. Our active churn management programs help predict propensity to churn, enabling Concentric to take swift action to minimize attrition.

XOH offers Concentric customers cost-effective, scalable, and secure telecommunications solutions for their voice, data, internet, and web hosting needs. In 2009, we continued to grow our portfolio of services. For example, we introduced an online, managed backup solution providing 24/7 data protection for business data. This solution reduces downtime, increases productivity and enables businesses to quickly and easily deploy data protection for the entire organization, servers, desktops, laptops and applications. We will continue to expand such hosted IT solutions to enable businesses to rely on our carrier-strength network and service and allow them to focus on their core competencies.

 

In 2010, Concentric will focus on retention of this valuable customer segment, seek opportunities to increase productivity and efficiency, and continue to develop capabilities for customers to self-manage their communications infrastructure.

 

Network

 

Our wireline network consists of assets, substantially all of which we own or control through indefeasible exclusive rights or other leasing or contractual arrangements, located across the United States making us a national facilities-based carrier. XOH’s network comprises a series of fiber optic networks located in the central business districts of numerous metropolitan areas and an inter-city fiber optic network capable of carrying high volumes of data, voice, video and internet traffic. By integrating these networks with advanced telecommunications technologies, such as wave division multiplexing transmission and advanced packet switching equipment, XOH is able to offer its customers a comprehensive array of telecommunications services primarily or entirely over a network that it owns or controls, from the initiation of the data or voice transmission to the point of termination. This integrated network provides multi-location businesses with a single-source telecommunications solution within a metropolitan area or across the country.

 

Metropolitan Fiber Networks and Local Facilities.  Our metropolitan fiber networks consist of more than 900,000 fiber miles contained in fiber optic cables serving the central business districts of numerous metropolitan areas. The number of “fiber miles” is equal to the number of route miles multiplied by the number of fibers along that path. We operate 41 metropolitan fiber networks in 24 states and Washington, D.C., including 27 of the 30 largest metropolitan areas in the United States. In the aggregate, our metropolitan area networks consist of more than 9,000 route miles of fiber optic cable connecting over 950 unique ILEC end-office collocations in 41 United States cities.

 

The core of each of our metropolitan fiber networks is one or more rings of fiber optic cable in a city’s central business district that connect to our central office locations from which we can provision services to our customers. These central offices contain the switches, routers and other electronics that direct data and voice traffic to their destinations, and also have the space to house the additional equipment necessary for future telecommunications services. A critical element of our metropolitan fiber network is the number of collocations where we have located our aggregation and transmission equipment. We are able to provision services at a lower cost per unit when we operate a collocation within a relatively short distance of our customers. We operate collocations in over 950 central offices as part of our network. Virtually all of our collocations are concentrated in the business districts in which our target customers are located. We operate one of the most extensive collocation footprints in the United States. We believe that our extensive collocations provide us with substantial market opportunities to both sell services to our targeted business customers and to serve as points of termination for traffic originated by other carriers.

 

We strive to build and own these metropolitan fiber networks or obtain indefeasible rights of use (“IRU”) fiber so that we can control the design and technology used to best meet our customers’ needs. Our IRUs allow us to use a specified amount of fiber on those cables for terms ranging from 10 to 30 years. We built our high capacity metropolitan fiber networks using a backbone density ranging between 72 and 432 strands of fiber per cable. Fiber optic cables have the bandwidth to carry tens of thousands of times the amount of traffic as traditionally-configured copper wire. Our high-count fiber cables allow us to augment the scale of our broadband and voice services without incurring significant additional construction costs.

The following table details the 41 metropolitan fiber networks in the 85 markets we serve:

 

Our metropolitan fiber networks are connected by our own switching, routing and optical equipment. The metropolitan networks are connected to wavelengths of transmission capacity on our inter-city fiber optic network. By using our own switching and routing equipment, we maximize the capacity and enhance the performance of our inter-city network as needed to meet our customers’ current and future telecommunications needs.

 

Inter-city Network.  We have designed and built an advanced and reliable inter-city fiber optic transmission network using XOH fiber and long-haul dense wave division multiplexing transmission equipment. There are at least two physically diverse fiber paths connecting most of our markets to their adjacent markets. This allows us to reroute traffic around inter-city fiber cuts to ensure end-to-end connectivity to our customers. Metropolitan fiber rings are diversely routed to the XOH POP. This ensures that we can reroute customer traffic around network impairments.

 

Our inter-city fiber network primarily comprises a twenty-year IRU for 18 fiber optic strands pursuant to arrangements with Level 3 Communications, Inc. (“Level 3”). This fiber network traverses over 16,000 miles and connects more than 60 cities in the United States and Canada, including most of the major metropolitan markets served by our metropolitan fiber networks. In addition, we have inter-city fiber IRUs from Abovenet Communications, Inc. (“Abovenet”) and Qwest Communications Corporation (“QCC”) for routes totaling another 3,000 route miles, including a recently lit QCC dark fiber IRU for a Salt Lake City to Sacramento route.

 

We have lit 2 of our 18 fiber optic strands with 400G-capable transmission equipment and have lit an additional 2 fiber optic strands on segments of our network that required additional capacity with the 800G technology. During the fourth quarter of 2008, we began to deploy 1.6 Tbps capable systems on select inter-city routes, and we continued to deploy 1.6 Tbps capable systems on additional inter-city routes in 2009. We believe that lighting our inter-city fiber network is strategically beneficial to us. Using our own inter-city fiber optic network and associated transmission and switching equipment provides a lower cost basis for running our network and a higher level of service for our customers.

 

IP Network.  Our IP network consists of a 10 Gbps ethernet-based high-capacity backbone that runs along the same routes as our inter-city fiber optic and transmission network. This Nx10G IP/MPLS backbone connects to ten IP core nodes in the US, three IP core nodes in Europe and one IP core node in Hong Kong, as well as 70 IP POPs located in 38 US markets and provides connectivity to one XOH-operated hosting data center. The European and Asian core nodes connect to XO’s North American backbone via 3^rd party leased facilities. These IP backbone nodes and POPs provide inter-city IP transport between the XOH metropolitan fiber networks and the connectivity to other ISPs which is commonly referred to as peering. Peering with other ISPs is done in each of our fourteen IP core nodes. The IP POPs house customer termination and aggregating routers, as well as VoIP media gateways for XOH’s softswitch platform.

 

Our IP/MPLS network architecture, constructed with our own 10 Gbps wavelengths, provides the highest level of restoration available to IP networks today. Redundant routes and capacity are identified and reserved so that in the event of a failure, the network will automatically restore traffic in the shortest time possible without the need for manual intervention. In 2008, we deployed additional high-speed Provider Edge (PE) routers in our backbone nodes and IP POPs to provide a scalable platform for 1 Gigabit Ethernet (GE) and 10GE ports for high-speed transit customers, as well as added additional 10GE-capable peering routers to support substantially greater traffic exchange with other internet backbones. In 2009, we began a program to upgrade the pairs of PE routers in our metro IP POPs that aggregate traffic from smaller customer-aggregating routers, as well as provide cost-effective customer terminations at 1GE and 10GE. The modern ethernet-based PE routers have the potential to support 40Gbps and 100Gbps trunks and customer terminations in the future.

 

Wireless Network.  We hold 91 licenses in the LMDS wireless spectrum (28-31 GHz range) and ten 39 GHz licenses. These licenses cover 75 basic trading areas (“BTA”), which are typically cities or metropolitan areas located throughout the United States. For every license, the license holder must make both a license renewal filing and a demonstration of “substantial service” at the Federal Communications Commission (“FCC”). Our licenses are renewable for additional ten year terms. The renewal dates for 90 of our LMDS licenses are in 2018, one LMDS license has a renewal date in 2016 and our 39 GHz licenses will be up for renewal in 2010.

In order to secure renewal of our LMDS licenses, we must generally be in compliance with all relevant FCC rules and demonstrate that we are providing “substantial service” in our licensed areas. As of December 31, 2009, substantial service showings for 43 of our LMDS licensed markets have been approved by the FCC. The remaining 48 LMDS substantial service demonstrations have been granted an extension until June 1, 2012 by the FCC. While management expects that we will be able to secure FCC approval of any substantial service filings in relation to the 48 licenses for which we received an extension, there is no assurance that we will receive such FCC approval.

 

Our wireless services are provisioned through exclusively licensed LMDS fixed wireless spectrum or common carrier spectrum. The properties of XOH’s LMDS spectrum allow it to deliver voice and data connectivity to customers at rates of up to 1 Gbps, providing them access to high bandwidth applications. In addition, unlike the spectrum deployed by many other fixed wireless providers, XOH’s LMDS spectrum allows point-to-multipoint applications, making its services useful in the deployment of aggregation networks. However, unlike lower frequency transmissions, the signals transmitted through XOH’s LMDS spectrum generally will not penetrate trees, walls, glass or other path-obstructing materials. We typically address these Line-Of-Sight (LOS) challenges by installing intermediate sites to overcome transmission obstacles. This solution is generally sufficient for services to telecommunications carriers, who sell directly to end-users. However, these LOS challenges, along with the complexities of installation, billing, and caring for end-user customers limit XOH’s plan to market wireless services directly to retail end-users.

 

Competition

 

The telecommunications industry is an intensely competitive environment with numerous competitors including ILECs, CLECs, ISPs, VoIP carriers, cable-based communications providers and fixed wireless carriers. The attributes that we believe differentiate us from our competition are the integration of our nationwide high-capacity fiber and wireless networks, advanced IP and converged communications services, and a responsive, customer-focused orientation. We compete in the markets for wireline and fixed wireless telecommunications services within the United States. These markets are rapidly changing due to the emergence of new technologies and service offerings, industry consolidation, and an evolving regulatory environment.

 

CLECs and other competitive network providers such as XOH have provided telecommunications services for many years; nevertheless, the market for telecommunications services remains dominated by the ILECs, each of which owns the majority of the local exchange network in its respective operating region of the United States and extensive national and often international networks and operations. The ILECs are our primary competitors for voice, data and internet services provided to business customers. We compete on the basis of a superior value proposition composed of our ability to provide nationwide service, innovative offerings, a competitive price and our commitment to customer service. While we believe that we have competitive advantages over the ILECs, each ILEC has significantly more resources available to expand its penetration into the business marketplace.

 

In addition to competing with ILECs, we also compete with many CLECs, some of which are regionally focused. We believe that our national reach, breadth of services, and competitive pricing makes us competitive with CLECs. Recent industry consolidation has eliminated a number of these, resulting in larger competitors that may have greater economies of scale and more extensive service footprints and are likely to result in the combined companies becoming even more formidable competitors.

 

In addition, new competitors such as VoIP providers and cable companies have entered the market to compete with traditional, facilities-based telecommunications services providers. Several companies provide integrated telecommunications services exclusively by means of IP. Many hosted VoIP providers also aggressively compete for business customers; to date, most of these providers operate on a local or regional basis. Cable companies, such as Cox Communications, Comcast and Time Warner have begun aggressively marketing their voice and broadband data connection services into the business telecommunications market. Several regional

fiber-based network providers have initiated operations by buying up and integrating smaller local and regional fiber networks.

 

As a result of increasing competitive forces, including technological advances, service providers have reduced the prices charged for telecommunication services in recent years. We expect to continue experiencing downward price pressure with respect to our service offerings. Our ability to reduce prices in response to competitive pressures may be limited by our reliance on some of our principal competitors to provide key network elements that we need to provide network services, our ability to successfully deploy technologies that improve our network operating efficiencies, and our ability to continue to drive other cost structure improvements.

 

Regulatory environments at both the state and federal levels have considerable influence on our industry. We continually monitor regulatory developments and remain active in our participation in regulatory issues. See “Description of Business — Regulatory” and “Risk Factors” for further discussion of the regulatory environment and its impact on us.

 

Several new technologies are being adopted by telecommunications carriers that could cause significant changes and opportunities in the competitive landscape for telecommunications services. Such technologies include (but are not limited to):

 

 

We are continuing to experience revenue growth from customers using our IP-based network infrastructure. This revenue growth is partially offset by the continued and expected decline in our traditional legacy services. We have deployed our own suite of IP data and VoIP solutions and anticipate adding new services with more IP-enabled features to target larger customers. Within IP, we are seeing ethernet becoming the accepted standard for high-speed connections. The continued rapid growth of the internet, including the acceptance of video being delivered over the internet, has led to various customers requiring faster connections.

 

We believe the continued market growth for mobile wireless telecommunications services, including the rapid adoption of data and internet enabled mobile devices, and increased demand for high-speed broadband services will require wireless telecommunications carriers and our business customers to need significantly greater bandwidth. Upgrades to our IP-based network infrastructure in recent years and anticipated continued enhancements will position us well to meet this demand.

 

Regulatory

 

Overview.  We offer wireline and fixed wireless communications services to small and medium sized businesses, large enterprises, government agencies, and wireline and wireless telecommunications providers. We are therefore subject to regulation by federal, state and local government agencies.

 

With a few limited exceptions, the FCC has exclusive jurisdiction over our provision of interstate and international telecommunications services, and the state regulatory commissions regulate our provision of intrastate telecommunications services. Additionally, municipalities and other local government agencies may regulate limited aspects of our business, such as use of government-owned rights-of-way, and may require permits such as zoning approvals and building permits.

Federal Regulation.  XOH has authority from the FCC for the installation, acquisition and operation of its wireline network facilities to provide facilities-based interstate and international telecommunications services. In addition, XOH is authorized by the FCC to operate its 28 to 31 GHz LMDS and 39 GHz broadband wireless facilities. Because we are not dominant in any of our markets, unlike ILECs, our telecommunications services are not subject to price cap or rate of return regulation. Thus, our pricing policies for interstate and international end user telecommunications services are only subject to the federal requirements that charges for such services be just, reasonable, and non-discriminatory. The FCC allows us to file interstate tariffs for our interstate access services (rates charged by us to other carriers for access to our network). As for interstate and international long distance telecommunications services, the FCC requires us to make the terms, conditions and rates of the detariffed services available to the public on our web site.

 

The Telecom Act includes a number of provisions designed to encourage competition in local telephone service, including requirements related to interconnection; intercarrier compensation; local number portability; access to poles, conduits, rights of way and resale; as well as specific requirements imposed on ILECs related to interconnection, collocation, and access to unbundled network elements (“UNE”) available at forward looking economic costs. As governed by the Telecom Act, CLEC access to ILEC networks and utility poles are implemented through individually negotiated contracts that conform to applicable FCC rules. Although the rights established in the Telecom Act are a necessary prerequisite to the introduction of full local competition, they must be properly implemented and enforced to permit competitive telephone companies like us to compete effectively with the ILECs. In a series of orders and related court challenges that date back to 1996, the FCC has put into effect rules implementing the market-opening provisions of the Telecom Act, including the requirement that the ILECs lease UNEs to competitors at cost-based rates. At the core of the series of FCC orders is the FCC’s evolving effort to define and list which ILEC network facilities must be made available as UNEs. Under pressure from the ILECs, the FCC has subsequently reduced the list. However, to date the FCC has preserved access to those network elements critical to the operation of our business.

 

FCC Regulation of Wireless Services.  XOH is the licensee of authorizations issued by the FCC in LMDS and 39 GHz services. As an FCC licensee, XOH is subject to regulatory oversight, including limits on the amount of foreign investment in certain FCC licenses, the transfer and assignment of FCC licenses, and regulations governing the construction, technical aspects and the nature of services that can be provided by operators of wireless communications systems. The FCC regulates the use of the electromagnetic spectrum, and has exclusive jurisdiction over licensing and technical rules governing the operation of wireless services.

 

The majority of our FCC licenses are in the LMDS spectrum range, which is one of the several FCC-licensed services that permit licensees and/or their customers to transmit high capacity wireless broadband traffic on a LOS basis. Generally, only LOS operations may be offered today because of where in the spectrum LMDS frequencies are situated. Other FCC-licensed services with high-capacity broadband wireless LOS capabilities include the 24 GHz band and the 39 GHz band. For discussion of the FCC’s approval of our demonstrations of substantial service in licensed areas and LMDS license extensions granted see “Description of Business — Licenses.”

 

Additional Federal Regulations

 

The following discussion summarizes some additional specific areas of federal regulation that directly affect our business.

 

Verizon and Qwest Petitions for Forbearance from Unbundling Requirements.  On September 6, 2006 and on April 27, 2007, pursuant to section 10 of the Communications Act of 1934, as amended (the “Communications Act”), the regulated, wholly owned subsidiaries of Verizon Communications, Inc. (collectively “Verizon”) and Qwest Corporation (“Qwest”), respectively, filed petitions for forbearance from loop and transport unbundling obligations imposed by section 251(c), price cap regulations, dominant carrier tariff regulation, computer III requirements, and section 214 dominant carrier regulations. Verizon sought relief in six markets: Boston, New York, Pittsburgh, Philadelphia, Providence, RI and Virginia Beach, VA. Qwest’s request included relief in four markets: Denver, Minneapolis, Phoenix and Seattle. On December 4, 2007, the FCC, in a unanimous decision, found that the current evidence of competition does not satisfy the section 10 forbearance standard

with respect to any of Verizon’s requests. Accordingly, the Commission denied the requested relief in all six MSAs. On January 14, 2008, Verizon filed an appeal in the United States Court of Appeals for the DC Circuit (“DC Circuit”). On July 25, 2008, in a unanimous decision, the FCC adopted a Memorandum Opinion and Order denying Qwest’s four petitions in their entirety. On July 29, 2008, Qwest filed an appeal of the FCC’s decision with the United States Court of Appeals for the DC Circuit. We intervened in the appeals of the FCC’s decisions in the Verizon and Qwest Forbearance cases in support of the FCC. On June 19, 2009, the DC Circuit ruled on Verizon’s appeal, remanding to the FCC a very limited question regarding how the FCC reached its rejection of the forbearance petitions — but not overturning the actual decision. While the Qwest appeal is still pending in the DC Circuit, on July 17, 2009, the FCC asked the DC Circuit to remand the pending Qwest appeal back to the FCC so that the issues in the Qwest forbearance case can be decided simultaneously with the remand of the Verizon forbearance case. In addition, on March 24, 2009, Qwest re-filed its petition for forbearance for the Phoenix market, citing greater intermodal competition since July 25, 2008 when the FCC rejected Qwest’s first petition for forbearance for the Phoenix market. The FCC asked interested parties to file comments and reply on both the Verizon and Qwest remand docket as well as the Qwest re-filed Phoenix petition by September 21, 2009 and October 21, 2009, respectively. It is not possible to predict the outcome of, or potential effect upon, our operations of the pending Verizon and Qwest remand docket or Qwest’s re-filed forbearance petition for the Phoenix market.

 

VoIP.  Like a growing number of carriers, we use IP technology for the transmission of a portion of our network traffic. The regulatory status and treatment of IP-enabled services is unresolved. The FCC has held that Vonage’s VoIP services and similar offerings by other providers are subject to the FCC’s interstate jurisdiction, preempting state efforts to regulate VoIP providers as intrastate telecommunications providers. Four separate state commissions have appealed this ruling and the case is currently pending. On June 27, 2006, the FCC released an order holding that providers of “interconnected VoIP services” must contribute to the Federal Universal Service Fund (“USF”), finding that such providers are “providers of interstate telecommunications” under 47 U.S.C. 254(d) and also asserting its ancillary jurisdiction over such providers under Title I of the Communications Act. The FCC, however, explicitly left open the question of whether interconnected VoIP providers provide “telecommunications services” or enhanced “information services.” Generally, telecommunications service providers, including traditional local and long distance telecommunications companies, are regulated under the Communications Act; information service providers are generally unregulated. On June 1, 2007, the United States Court of Appeals for the DC Circuit upheld the FCC’s order requiring VoIP providers to pay into the USF. The FCC has initiated a rulemaking proceeding to address the classification of VoIP and other IP-enabled service offerings. It is not possible to predict the outcome of this proceeding or its effect on our operations.

 

Intercarrier Compensation Reform and Treatment of VoIP Services.  On July 8, 2008, the United States Court of Appeals for the D.C. Circuit directed the FCC to either justify its intercarrier compensation rules for traffic bound for ISPs or such rules will be vacated on November 6, 2008. Several interested parties filed various proposals on how the FCC might justify its intercarrier compensation rules for ISP- bound traffic as well as how the FCC may reform the entire intercarrier compensation and universal service fund regimes. We actively participated at the FCC in response to those proposals. On November 5, 2008, the FCC released an Order responding to the United States Court of Appeals for the DC Circuit specifically keeping the current ISP-bound traffic rules in effect, including a $0.0007 cap on traffic above a 3:1 ratio. Also on November 5, 2008, the FCC released a Further Notice of Proposed Rulemaking requesting comment on three alternative proposals for reform of the intercarrier compensation and universal service rules. The three proposals include a proposed draft order circulated by the FCC Chairman, a narrower draft addressing only USF reform issues, and a revised version of the Chairman’s proposal that includes suggestions made by rural and wireless carriers as well as consumer groups. The FCC has taken no action on the three proposals to date. On March 17, 2010, the FCC released its National Broadband Plan which outlines a roadmap for the delivery of broadband to all Americans. The Plan does not have the effect of law but is a blueprint for how the FCC may address various issues. With respect to possible reform to intercarrier compensation, the FCC specifically recommended that during the 2012-2016 timeframe, intrastate terminating switched access rate levels should be moved down to interstate terminating switched access rate levels over a period of two to four years. In the 2017-2020 timeframe, the FCC should continue reducing intercarrier compensation rates by phasing out the per-minute

rates for the origination and termination of telecommunications traffic. The FCC would have to take action through an open rulemaking or begin a new rulemaking in order to turn these recommendations into regulations. For this reason, we cannot predict what, if any, actions the FCC will take, when it may act or the effect this will have on our future financial results.

 

Universal Service Administrative Corporation.  The Universal Service Administrative Corporation is in the process of auditing the Company’s compliance with universal service contribution reporting obligations in connection with services provided during 2007. The Company believes that it complied with applicable FCC rules in all material respects; however an adverse audit determination could result in significant retroactive assessment of USF contribution liability and associated interest, penalties, fines or forfeitures.

 

State and Local Regulation

Most state regulatory commissions require companies that wish to provide intrastate common carrier services to register or seek certification to provide these services. These certifications generally require a showing that the carrier has adequate financial, managerial and technical resources to offer the proposed services in a manner consistent with the public interest. We are certified in all of the states in which we conduct business. In most states, we are also required to file tariffs setting forth the terms, conditions and prices for services that are classified as intrastate, and to update or amend our tariffs as rates change or new services are added. We may also be subject to various reporting and record-keeping requirements.

 

In some municipalities, where we choose to deploy our own POPs, we may be required to obtain street opening and construction permits, permission to use rights-of-way, zoning variances and other approvals from municipal authorities. We also may be required to obtain a franchise to place facilities in public rights-of-way. In some areas, we may be required to pay license or franchise fees for these approvals. We cannot provide assurances that fees will remain at current levels, or that our competitors will face the same expenses, although the Telecom Act requires that any fees charged by municipalities be reasonable and non-discriminatory among telecommunications carriers.

 

Wireless Services Affected by State Regulations.  While we anticipate that the dedicated wireless communications links that XOH currently provides and expects to provide will be used by our customers as part of their interstate mobile wireless communications networks, we market point-to-point wireless services designed to carry a customer’s telecommunications traffic from a customer’s facility to the facilities of a telecommunications carrier or to another of the customer’s offices, primarily within one state. To the extent necessary, XOH has applied for and anticipates that it will receive and maintain Certificates of Public Convenience and Necessity, file tariffs and reports, and fulfill other administrative and financial obligations, such as state universal service fund obligations, as appropriate relative to its services. XOH has received certificates from 28 state commissions.

 

Additional State and Local Regulation

XOCS Complaints Against Verizon.  On April 18, 2008, XO Communications Services, Inc. (“XOCS”) an indirect subsidiary of XOH, filed a formal complaint against Verizon Pennsylvania Inc. before the Pennsylvania Public Utilities Commission. On December 14, 2009, XOCS filed a formal complaint against Verizon New Jersey before the New Jersey Board of Public Utilities (the “BPU”) and sought consolidation of the XOCS complaint proceeding with an on-going proceeding involving a similar complaint that One Communications filed against Verizon New Jersey in May, 2009. In the Pennsylvania and New Jersey complaints, XOCS claimed that Verizon was erroneously, and in violation of its tariffs, assessing switched access dedicated tandem trunk port charges on local interconnection trunks used to jointly provide switched access services to third party interexchange carriers. In Pennsylvania, evidentiary hearings have been held, and briefs have been submitted. The Pennsylvania Commission has not issued a final decision in this matter. However, in an almost identical complaint filed by One Communications (“One”) and CTC Communications (’CTC”) against Verizon regarding dedicated tandem trunk port charges on local interconnection trunks, the Pennsylvania PUC on January 28, 2010 adopted the administrative law judge’s initial decision, which orders Verizon to discontinue the imposition of the disputed charges on One and CTC and orders Verizon to reimburse One and CTC for all dedicated tandem trunk port charges on local interconnection trunks previously paid by these entities. In

New Jersey, XOCS’ motion for consolidation is still pending. In New Jersey, XOCS’ motion for consolidation is still pending. If granted, hearings in this matter would be held in July 2010. No schedule has been set for the XOCS complaint proceeding should the BPU deny XOCS’ motion for consolidation. The outcomes of the XOCS complaint proceedings are not known at this time.

 

Qwest Complaints Against XO.  On June 24, 2008, Qwest Communications Corporation (“QCC”) filed a formal complaint against XOCS and numerous other telecommunications providers before the Public Utilities Commission of the State of Colorado. On August 1, 2008, QCC filed a formal complaint against XOCS and numerous other telecommunications providers before the Public Utilities Commission for the State of California. On July 2, 2009, QCC filed a formal complaint against XOCS and numerous other telecommunications providers before the Public Service Commission for the State of New York. On December 11, 2009, QCC filed a formal complaint against XOCS and numerous other telecommunications providers before the Public Service Commission of the State of Florida. In the complaints, QCC claimed that XOCS and the other telecommunications providers violated state statutes and regulations and, in certain cases the provider’s respective tariffs, subjecting QCC to unjust and unreasonable rate discrimination in connection with the provision of intrastate access services. On August 1, 2008, September 22, 2008, August 27, 2009 and January 29, 2010, XOCS filed its answers to the Colorado, California, New York and Florida complaints, respectively, denying QCC’s claims and setting forth affirmative defenses. The likely outcomes of these proceedings are not known at this time.

Glossary

 

In order to assist the reader in understanding certain terms relating to the telecommunications industry that are used in this report, a glossary is included.

 

3G.  The third generation of mobile phone standards and technology. 3G technology enables network operators to offer users a wider range of more advanced services while achieving greater network capacity through improved spectral efficiency. Services include wide-area wireless voice telephony and broadband wireless data, all in a mobile environment. Typically, they provide service at 5-10 megabits per second.

 

4G.  A term used to describe the next step in wireless communications. A 4G system will be able to provide a comprehensive IP solution where voice, data and streamed multimedia can be given to users at higher data rates than previous generations.

 

Access Charges.  The fees paid for the local connections with carriers’ networks.

 

Advanced Packet Switching Equipment.  Packet switches based on technologies such as IP, MPLS, or Ethernet that typically provide multiple classes of service, connection-oriented services, significant operations and maintenance functionality, and rapid protection switching.

 

Asynchronous Transfer Mode, or ATM.  An information transfer standard that is one of a general class of packet technologies that relay traffic at varying rates, permitting a mix of data, voice and video.

 

Backbone.  A high-speed network that interconnects smaller, independent networks. It is the through-portion of a transmission network, as opposed to spurs which branch off the through-portions.

 

Backhaul.  A telephone or data transmission from a remote network to a main or central site.

 

Bandwidth.  The difference between the upper and lower cutoff frequencies of, for example, a filter, a communication channel, or a signal spectrum, and is typically measured in hertz. Also, the capacity of a communications channel, typically measured in bits per second (bps).

 

Capacity.  The information carrying ability of a telecommunications facility.

 

Carrier.  A company which provides communications circuits.

 

Central Offices.  A telecommunications center where switches and other telecommunications facilities are housed. CLECs may connect with ILEC networks either at this location or through a remote location.

 

Competitive Local Exchange Carrier, or CLEC.  A company that provides local exchange services, including dedicated service, in competition with ILECs.

 

Collocation.  Central offices within our local markets where we can interconnect our network to an ILEC’s network by extending our facilities to the ILEC’s central office and placing telecommunications equipment in the ILEC’s office.

 

Conduit.  A pipe usually made of metal, ceramic or plastic, that protects buried cables.

 

Dark Fiber.  Unused fiber through which no light is transmitted or installed fiber optic cable not carrying a signal.

 

Dedicated.  Telecommunications lines dedicated to, or reserved for use by, a particular customer along predetermined routes.

 

Dense Wave Division Multi-plexing, or DWDM .  A means of increasing the capacity of fiber-optic data transmission systems through the multiplexing of multiple wavelengths of light.

 

Digital.  A means of storing, processing and transmitting information by using distinct electronic or optical pulses that represent the binary digits 0 and 1. Digital transmission and switching technologies use a sequence of these pulses to represent information as opposed to the continuously variable analog signal. The precise digital numbers preclude distortion (such as graininess or snow in the case of video transmission, or static or other background distortion in the case of audio transmission).

DS3.  Standard North American telecommunications industry digital signal format, which is distinguishable by bit rate (the number of binary digits transmitted per second). DS3 service has a bit rate of 44.736 megabits per second.

 

DSL (digital subscriber line).  A family of technologies that provide digital data transmission over the wires of a local telephone network.

 

Ethernet.  A network configuration in which data is separated into “frames” for transmission. Ethernet equipment scans the network to find the least-congested route for frames to travel from Point A to Point B, thus resulting in greater speed and fewer errors in frame transmission.

 

Fiber Optics.  Fiber optic technology involves sending laser light pulses across glass strands in order to transmit digital information. Fiber optic cable is the medium of choice for the telecommunications and cable industries. Fiber is immune to electrical interference and environmental factors that affect copper wiring and satellite transmission.

 

Frame Relay.  A data transmission technique used to send digital information in a relay of frames to one or many destinations from one or many end-points.

 

Gbps (gigabits per second).  One billion bits of information per second. The information-carrying capacity of a circuit may be measured in Gbps.

 

GHz.  One billion hertz, or cycles per second. A hertz is one cycle per second, and is the basic measurement for bandwidth in analog terms.

 

GE or Gigabit Ethernet.  A Copper or fiber-based ethernet network service, connection or port operating at one billion bits per second.

 

Incumbent Local Exchange Carrier, or ILEC.  Large local phone companies, such as Verizon Communications Inc., AT&T Inc. and Qwest Communications, Inc., which each owns the majority of the local exchange network in its respective operating regions of the United States and dominates the market for telecommunications services.

 

Indefeasible rights to use, or IRU.  The right to use another company’s fiber optic circuit specifying the time and bandwidth.

 

Interconnection.  Interconnection of facilities between or among the networks of carriers, including potential physical collocation of one carrier’s equipment in the other carrier’s premises to facilitate such interconnection.

 

Interactive Voice Response, or IVR.  A phone technology that allows a computer to detect voice and touch tones using a normal phone call. The IVR system can respond with pre-recorded or dynamically generated audio to further direct callers on how to proceed. IVR systems can be used to control almost any function where the interface can be broken down into a series of simple menu choices.

 

Internet Service Provider, or ISP.  Companies formed to provide access to the internet to consumers and business customers via local networks.

 

Interexchange Carrier.  A telecommunications company that provides telecommunications services between local exchanges on an interstate or intrastate basis.

 

Local Area Network, or LAN.  The interconnection of computers for the purpose of sharing files, programs, and peripheral devices such as printers and high-speed modems. LANs may include dedicated computers or file servers that provide a centralized source of shared files and programs.

 

Line-of-Sight, or LOS.  Some through the air transmission media that operates at a frequency which transmits in a perfectly straight line requiring the area between a transmitter and a receiver is clear of obstructions.

 

Local Exchange.  A geographic area defined by the appropriate state regulatory authority in which telephone calls generally are transmitted without toll charges to the calling or called party.

Local Loop.  The physical connection from the subscriber’s location to the carrier’s Point-of-Presence.

 

Local Multipoint Distribution System, or LMDS.  A broadband wireless access technology that commonly operates on microwave frequencies in the 28 GHz — 31 GHz range, as well as 39 GHz and other common carrier spectrum in the 6 GHz, 11 GHz and 18 GHz bands.

 

Mbps (megabits per second).  One million bits of information per second. The information carrying capacity of a circuit may be measured in Mbps.

 

MPLS, or Multi-Protocol Label Switching.  A standards-approved technology for speeding up network traffic flow and making it easier to manage. MPLS involves setting up a specific path for a given sequence of packets, identified by a label put in each packet, thus saving the time needed for a router or switch to look up the address to the next node to forward the packet to.

 

Node.  A point of connection into a fiber optic network.

 

OC — 192.  A data communications circuit capable of transmitting data at approximately 9.9 Gbps.

 

Peering.  The commercial practice under which ISPs exchange traffic with each other.

 

Point-of-Presence, or POP.  Collocation centers located centrally in an area where telecommunications traffic can be aggregated for transport and distribution.

 

PBX, or Private Bank eXchange.  An in-house telephone switching system that connects office telephones with each other as well as to the outside PSTN. IP PBXs support VoIP by converting them into traditional circuit-switched TDM connections.

 

Private Line Dedicated Transport Services, or Private Line.  A private, dedicated telecommunications link between different customer locations.

 

Provider Edge.  A Provider Edge (PE) router or switch is service provider equipment that terminates customer access circuits and provides packet network ingress and egress functionality such as rate shaping, policing, packet classification and so on. PE routers typically connect to larger Provider (P) routers that carry large traffic aggregates across the wide area. P-routers do not directly terminate customer connections.

 

Public Switched Telephone Network, or PSTN.  The switched network available to all users generally on a shared basis.

 

Reciprocal Compensation.  An arrangement in which two local exchange carriers agree to terminate traffic originating on each other’s networks in exchange for a negotiated level of compensation.

 

Route Mile.  The number of miles along which fiber optic cables are installed.

 

Router.  Equipment placed between networks that relay data to those networks based upon a destination address contained in the data packets being routed.

 

SaaS, or Software-As-A-Service.  Software that is rented as opposed to purchased. Since SaaS is subscription based, all upgrades are provided during the subscription term.

 

Synchronous Optical Network, or SONET.  A set of standards for optical communications transmission systems that define the optical rates and formats, signal characteristics, performance, management and maintenance information to be embedded within the signals and the multiplexing techniques to be employed in optical communications transmission systems. SONET facilitates the interoperability of dissimilar vendor’s equipment. SONET benefits business customers by minimizing the equipment necessary for various telecommunications applications and supports networking diagnostic and maintenance features.

 

Switch.  A mechanical or electronic device that opens or closes circuits or selects the paths or circuits to be used for the transmission of information. Switching is a process of linking different circuits to create a temporary transmission path between users.

T1.  A data communications circuit capable of transmitting data at 1.544 Mbps.

 

Tbps (terabits per second).  10¹² bits of information per second. The information carrying capacity of a circuit may be measured in Tbps.

 

Time Division Multiplexing, or TDM.  A technique used to combine multiple signals into one single high-speed transmission path. TDM assigns each signal (voice, data or video) a time slot within a set that enables multiple lower-speed signals to be transmitted simultaneously over one high-speed transmission.

 

Unbundled Network Elements, or UNE.  The telecommunications network that the ILECs are required to make available to CLECs. Together, these parts make up a local loop that connects to a digital subscriber line access multiplexer, a voice switch or both. The loop allows non-facilities-based telecommunications providers to deliver service without laying network infrastructure, such as copper wire, optical fiber, and coaxial cable.

 

Universal Service Fund, or USF.  The USF was created by the FCC in 1997 as part of the goals mandated in the Telecommunications Act of 1996. USF’s creation requires telecommunications service providers to contribute to support USF’s programs which involve making quality services available at affordable rates throughout the country and especially targets low-income, rural health care, schools, libraries and high cost areas.

 

Voice over Internet Protocol, or VoIP.  The technology used to transmit voice conversations over a data network using the Internet Protocol.

 

Virtual Private Network, or VPN.  A private network that operates securely within a public network by means of encrypting transmissions.

 

Wave Division Multiplexing, or WDM.  Equipment that effectively multiplies the carrying capacity of fiber by integrating multiple signals or channels onto a single fiber strand, with each channel corresponding to a unique wavelength of light, typically in the 1530-1565 nanometer range (infrared). WDM equipment is classified as Dense Wave Division Multiplexing (“DWDM”) or Coarse Wave Division Multiplexing (“CWDM”), depending on the spacing between wavelengths and hence the density of wavelengths.

 

Wave Division Multiplexing Transmission.  The conveyance of multiple communications signals using WDM equipment.

 

Wavelength.  A point-to-point communications channel provisioned on a fiber optic network built using WDM equipment.

 

Wireless Backhaul.  Movement of telecommunications traffic between cell sites and points of connection to wired networks.

Employees

 

As of February 28, 2010, we had 4,021 employees, including 1,725 in Business Services, 338 in Carrier Services, 73 in Concentric, 1,244 in Network Services, 344 in Information Technology, 158 in Finance and 139 in Corporate. None of our employees are represented by a labor union and we have experienced no labor-related work stoppages.

 

 

Risks Related to Liquidity, Financial Resources, and Capitalization

 

We have incurred a net loss from operations in the past and may not generate funds from operations or financing activities sufficient to meet all of our operating or capital cash requirements and, if we are unable to meet our needs for additional funding in the future, we may be required to limit, scale back or cease our operations.

 

For each period since inception, we have incurred net losses from operations. For 2009, 2008 and 2007 our net losses from operations were $47.2 million, $84.8 million and $110.1 million, respectively. Our negative free cash flow (cash flow from operations less our capital expenditures) was $50.4 million, $145.3 million and $75.6 million for 2009, 2008 and 2007, respectively.

 

If we are unable to raise additional capital, we may not generate sufficient funds from operations to execute our long-term, strategic business plan. Consequently, we may be required to delay or reduce the scope of our capital expenditure activities, eliminate certain expenditures on long-term initiatives and/or implement cash preservation measures. In such a capital restricted situation, we may be forced to sell assets or securities or borrow funds on an untimely or unfavorable basis.

 

We may seek additional financing to fund the redemption of shares of our Class A preferred stock, to acquire capital assets in support of our operations, to capitalize on opportunities which may arise to enhance our competitive position, or for general corporate purposes.

 

Based on our current level of operations, we believe that cash flow from operations as well as cash on hand and marketable securities will enable us to meet our working capital, capital expenditure, Class A preferred stock redemption and other obligations for at least the next 12 months. However, our ability to fund our capital needs depends on our future operating performance and cash flow, which are subject to prevailing economic conditions and other factors, many of which are beyond our control. We may seek additional financing to operate and grow our business, including, without limitation, the possibility of a rights offering. There can be no assurance that such financing will be available on terms acceptable to us or at all. If available financing is limited or we are forced to fund our operations at a higher cost, we may need to curtail our business activities or increase our cost of financing, both of which could have an adverse effect on our operating results and financial condition.

 

The original terms of our 6% Class A Convertible Preferred Stock (“Class A Preferred Stock”) required that by January 15, 2010, we redeem in cash and in a manner provided for therein all of the shares of Class A Preferred Stock then outstanding at a redemption price equal to 100% of its liquidation preference. On February 5, 2009, ACF Industries Holding Corp. (“ACF Holding”), an affiliate of Mr. Carl Icahn, the Chairman of our Board of Directors and our majority stockholder (the “Chairman”), agreed to extend the date on which we would be required to redeem the shares of Class A Preferred Stock held by ACF Holding (the “ACF Holding Shares”) from January 15, 2010 to a date no later than April 15, 2010. The extension did not affect the redemption date of any of the shares of Class A Preferred Stock other than the ACF Holding Shares. On July 9, 2009, we redeemed 304,314 shares of Class A preferred stock from entities unaffiliated with us at an aggregate purchase price of approximately $18.4 million, which reduced the number of outstanding shares of Class A preferred stock to 3,695,686. On January 15, 2010, we redeemed all 599,137 shares of Class A preferred stock held by entities unaffiliated with the Chairman at an aggregate purchase price of approximately $41.4 million. As of March 31, 2010 ACF Holding is the holder of 100% of the remaining 3,096,549 shares of Class A preferred stock. We are required to redeem any outstanding ACF Holding Shares for cash at an

aggregate liquidation preference of up to $217.4 million at a date no later than April 15, 2010. Any future reductions in our cash balance following the redemption of the Class A Preferred Stock and recent market volatility in the corporate debt markets may adversely impact our ability to raise additional capital on financially favorable terms.

 

The continuing effects of recent economic conditions could negatively impact our operating results and financial condition.

 

Unfavorable general economic conditions, including the recent recession in the United States and the ongoing financial crisis affecting the banking system and financial markets, could negatively affect our business. Although it is difficult to predict the impact of general economic conditions on our business, these conditions could adversely affect the affordability of, and customer demand for, some of our products and services and could cause customers to delay or forgo purchases of our products and services. One or more of these circumstances could cause our revenue to decline. Also, our customers may not be able to obtain adequate access to credit, which could affect their ability to make timely payments to us. Additionally, our business is dependent on third-party suppliers for hardware, software and services integral to our business. If these suppliers encounter financial difficulties, their ability to supply hardware, software and services to us may be curtailed. If we are unable to quickly identify suitable alternatives, we may incur significant additional costs or may not be able to provide certain products or services to customers. For these reasons, among others, if the current economic conditions persist or worsen, this could adversely affect our operating results and financial condition.

 

Risks Related to our Operations

 

Our rights to use the fiber that makes up our network may be affected by the financial health of, or disputes with, our fiber providers.

 

We possess rights to the fiber that is included in our networks, particularly in our inter-city network, through long-term leases or IRU agreements. A bankruptcy or financial collapse of one of these fiber providers could result in a loss of our rights under such leases and IRUs. If this were to occur, it could have a negative impact on the integrity and quality of our network, on our ability to expand the capacity of our network, and ultimately on our results of operations. If one or more of our fiber providers, as a result of a dispute with us, were to prevent us from lighting more fiber, such actions could have similar negative impacts on our operations and results.

 

We depend on third-parties for the performance of certain network services and business operations.

 

We depend on various third parties, including ILECs, CLECs, and regional fiber providers, to provide us with high-quality, reliable service for portions of our wireline network through long-term leases or IRU agreements. Furthermore, our network is made up of hardware and software provided by various third parties, including Cisco, Juniper, Nortel, Sonus, and Broadsoft. We are continually adding new hardware and software into our network as we expand or replace older equipment. In addition, we receive periodic hardware and software updates from our vendors. To operate effectively, all the various network elements must operate smoothly. Although we test new equipment before we add it to our network, there can be no assurance testing will identify all potential problems. To the extent that problems arise from third party hardware or software including interoperability with other network elements, the performance of our network may diminish.

 

We use third parties to perform certain aspects associated with operating our network, including the signaling associated with completing voice calls. Additionally, we rely on third parties, including other carriers and equipment vendors, to perform certain maintenance and repair network services for us, including routine maintenance and repair work to correct network outages that may occur from time to time. If these third parties do not perform the specified services required under the terms of our contracts with them, or in a timely manner, the performance of our network could be adversely impacted.

 

If any of the above referenced third parties fail to fully perform their obligations, were to experience significant reduction in quality, or terminate their agreements with us, such actions could result in a negative

impact on our results of operations. We may not be able to locate alternative providers of such services or do so at economical rates.

 

Certain aspects of our service delivery, billing services and other support functions are outsourced to third party providers. As part of our transformation plan, we continue to consider and review outsourcing additional processes. If any of these third-party providers were to experience significant interruptions in their business operations or terminate their agreements with us, our own processing could be materially and adversely affected for an indefinite period of time. There can be no assurance that we would be able to locate alternative providers of such services or that we could do so at economical rates.

 

The failure of one or more of our operations support centers could impair our ability to retain customers, provision their services, or result in increased capital expenditures.

 

In the event of a substantial failure of one or more of our operations support centers, our disaster recovery framework is not fully redundant and may not permit the timely recovery of our complete systems operations and/or performance of critical aspects of our services for an extended period. We may incur and/or suffer the costs, delays and customer complaints associated with system failures and may not be able to efficiently and accurately provision new orders for services on a timely basis to begin to generate revenue related to those services.

 

We may not be able to continue to connect our network to ILEC networks or to maintain Internet peering arrangements on favorable terms, which could impair our growth and performance.

 

We need interconnection agreements with ILECs in order to connect our customers to the PSTN. If we are unable to renegotiate or maintain interconnection agreements in all of our markets on favorable terms, it could adversely affect our ability to provide services in the affected markets or our ability to provide services on a price-competitive basis. We maintain peering agreements with various ISPs that allow us to exchange internet traffic with these providers. These exchanges are made under short-term contracts and may be made without the payment of settlement charges by either party (“settlement-free peering”) or may specify the payment of fees by one party to the other (“paid peering”). In the future, ISPs may change the terms of these peering relationships; including reducing or eliminating peering relationships, establishing more restrictive criteria for settlement-free peering, or imposing new or larger fees. Increases in costs associated with the exchange of internet traffic could adversely affect our margins for internet based services. We may not be able to renegotiate or maintain peering arrangements on favorable terms, which could impair our growth and performance.

 

We may not be able to adequately protect our intellectual property or rights to licenses for use of third-party intellectual property, and may be subject to claims that we infringe the intellectual property of others, which could substantially harm our business.

 

We rely on a combination of patents, copyrights, and other proprietary technology that we license from third parties. We have been issued several United States and foreign trademarks and may consider filing for additional trademarks in the future. We have also been issued one United States patent, with a second United States application pending, and may consider filing for additional patents in the future. However, we cannot assure that any additional patents or trademarks will be issued or that our issued patent or trademarks will be upheld in all cases. We cannot guarantee that these and other intellectual property protection measures will be sufficient to prevent misappropriation of our trademarks or technology or that our competitors or licensors will not independently develop technologies that are substantially equivalent to or superior to ours. In addition, the legal systems in many other countries do not protect intellectual property rights to the same extent as the legal system of the United States. If we are unable to adequately protect our proprietary interests and business information or our present license arrangements, our business, financial condition and results of operations could be adversely affected. Furthermore, the dependence of the telecommunications industry on proprietary technology has resulted in frequent litigation based on allegations of the infringement of patents and other intellectual property. In the future, we may be subject to litigation to defend against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others.

Future litigation also may be necessary to enforce and protect our trade secrets and other intellectual property rights. Any intellectual property litigation could be costly and cause diversion of management’s attention from the operation of our business. Adverse determinations in any litigation could result in the loss of proprietary rights, subject us to significant liabilities or require us to seek licenses from third parties that may not be available on commercially reasonable terms, if at all. We could also be subject to court orders preventing us from providing certain services in connection with the delivery of services to our customers.

 

Our spectrum licenses may not be renewed upon expiration, which could harm our business.

 

Our spectrum licenses in the Local Multipoint Distribution System (“LMDS”) and 39 GHz bands are granted for ten-year terms. The renewal dates for our ten 39 GHz licenses are in 2010. As of June 30, 2009, the FCC had granted renewal of all 90 of our 28 GHz licenses that were up for renewal in 2008.

 

In order to secure renewal of our LMDS licenses, we must generally be in compliance with all relevant FCC rules and demonstrate that we are providing “substantial service” in our licensed areas. During 2008, the FCC granted our extension request to demonstrate substantial service until June 1, 2012 for the 48 LMDS licenses for which we sought an extension. As of June 30, 2009, substantial service showings for our remaining 43 LMDS licensed markets have been approved by the FCC. Failure to demonstrate substantial service in any licensed market could have an adverse effect on our operations and financial results. While management expects that we will be able to secure FCC approval for renewal of our 39 GHz licenses in 2010 as well as approval of any substantial service filings in relation to the 48 licenses for which we received an extension until 2012 to demonstrate substantial service, there is no assurance that we will receive such FCC approvals.

 

Risks Related to Competition and our Industry

 

The telecommunications industry is highly competitive, and has experienced the consolidation of many existing competitors and the introduction of significant new competitors. If we are not able to successfully compete against existing and new competitors, our financial condition could be materially and adversely affected.

 

The communications industry is highly competitive. We compete with AT&T, Verizon, Qwest Communications, Level 3 Communications, other ILECs and CLECs, cable operators and a host of other competitors in the provision of network services. Many of these competitors generate greater revenue, and possess significantly greater assets and financial resources than us, especially in light of mergers between AT&T and SBC, Verizon and MCI, and AT&T and Bell South. The significant financial resources of our larger competitors enable greater capability in deploying new technologies, new product offerings and enhanced service levels. In addition, we expect increased competition from the entry of non-traditional telecommunications companies, such as cable television companies, microwave carriers, wireless telephone system operators and private networks built by large end-users, into our metropolitan markets. If we are not able to successfully compete against our larger competitors and the new entrants into the telecommunications market, our financial condition and results of operations could be materially and adversely affected.

 

We face intense price competition in the market for network services which could result in adverse effects on our revenues, future cash flows, growth and profitability.

 

We compete with AT&T, Verizon, Qwest Communications, Level 3 Communications, other ILECs and CLECs, cable operators and a host of other competitors in the provision of network services. Many of these competitors have high-capacity, IP-based fiber-optic networks capable of supporting large amounts of data, IP and voice traffic. Some of these competitors claim certain cost structure advantages that, among other factors, may allow them to offer services at a price below that which we can offer profitably.

 

As a result of increasing competitive forces, including technological advances, service providers have reduced the prices charged for network services in recent years. Additionally, in light of the mergers between AT&T and SBC, between Verizon and MCI, and between AT&T and Bell South, we face significant price and service competition with respect to our network services from these incumbents, which are the largest incumbent carriers in the United States, as well as from many other large telecommunications service providers that are

the dominant competitors in all of our service areas. We expect to continue experiencing downward pricing pressure with respect to our network service offerings. Our ability to reduce prices in response to competitive pressures may be limited by our reliance on some of our principal competitors to provide key network elements that we need to provide network services, our ability to successfully deploy technologies that improve our network operating efficiencies, and our ability to continue to drive other cost structure improvements. If we are unable to competitively price our services to meet marketplace demand, we could experience adverse effects on revenues, future cash flows, growth and profitability.

 

Our success is highly dependent on our ability to retain and recruit talented employees.

 

We depend on the performance of our executive officers and key sales, engineering, and operations personnel, many of whom have significant experience in the telecommunications industry. If we were to experience the loss of a significant number of our professionals in the future, it could adversely affect our results of operations, including our ability to continue performing certain functions and to complete certain initiatives in accordance with our existing budgets and operating plans. To attract and retain the number of employees we need to grow our business, we may have to increase our compensation levels or incur higher recruiting costs in the future.

 

We have substantial business relationships with several large telecommunications carriers, and some of our customer agreements may not continue due to bankruptcies, acquisitions, non-renewal, or other factors, which could materially and adversely affect our revenue and results of operations.

 

We have substantial business relationships with several large telecommunications carriers for whom we provide wireless, local and long distance transport services. However, as of December 31, 2009, we did not have any individual customers who generated more than ten percent of our total revenue. The highly competitive environment and the industry consolidation in the long distance and wireless markets has challenged the financial condition and growth prospects of some of our carrier customers, and has caused such carrier customers to optimize the telecommunications capacity that they use among competing telecommunications services providers’ networks, including ours. Replacing this revenue may be difficult because individual enterprise and small to medium business customers tend to place smaller service orders than our larger carrier customers. In addition, pricing pressure on services that we sell to our carrier customers may challenge our ability to grow revenue from carrier customers. As a result, if our larger carrier customers terminate the services they receive from us, our revenues and results of operations could be materially and adversely affected.

 

Technological advances and regulatory changes are eroding traditional barriers between formerly distinct telecommunications markets, which could increase the competition we face and put downward pressure on prices, which could impair our results.

 

New technologies, such as VoIP, and regulatory changes are blurring the distinctions between traditional and emerging telecommunications markets. Additionally, some of our biggest competitors have been freed from certain regulatory requirements that required such competitors to make certain elements of their networks available to CLECs on just, reasonable, and non-discriminatory rates, terms and conditions. Furthermore, the increasing importance of data services has focused the attention of most telecommunications companies on this growing sector. This increased competition could impair our prospects, put downward pressure on prices and adversely affect our operating results.

 

We are subject to comprehensive and continually evolving regulation, which could increase our costs and adversely affect our ability to implement our business plan.

 

XOH and some of our services and facilities are regulated by the FCC, states, local zoning authorities, and other governmental entities in a regulatory environment that is becoming more challenging for CLECs. These regulators routinely conduct rulemaking proceedings and issue interpretations of existing rules. These regulatory proceedings could impose additional obligations on us, give rights to competitors, increase our costs, and otherwise adversely affect our ability to implement our business plan. Attempts to limit the basic competitive framework of the Telecom Act could be detrimental to the successful implementation of our business plan.

Risks Related to our Common Stock

 

An entity owned and controlled by our Chairman is our majority stockholder.

 

As disclosed in amendments to its Schedule 13D filed with the SEC by the Chairman and certain affiliated entities, the Chairman beneficially owns approximately 89% of the aggregate vote of shares of XO Holdings. As a result, the Chairman has the power to elect all of our directors. Under applicable law and our certificate of incorporation and by-laws, certain actions can be taken with the approval of holders of a majority of our voting stock, including mergers, sale of substantially all of our assets and amendments to our certificate of incorporation and by-laws.

 

Future sales or issuances of our common stock could adversely affect our stock price and/or our ability to raise capital.

 

Future sales or issuances of substantial amounts of our common stock, or the perception that such sales or issuances could occur, could adversely affect the prevailing market price of the common stock and our ability to raise capital. As of December 31, 2009, there were 182,075,035 shares of our common stock outstanding, with additional common shares potentially issuable based on the exercise of warrants, stock options or preferred stock.

 

There are options outstanding to purchase 7.4 million shares of our common stock that have been reserved for issuance under the XO Communications, Inc. 2002 Stock Incentive Plan as of December 31, 2009. Unless surrendered or canceled earlier under the terms of the 2002 Stock Incentive Plan, those options will begin to expire in 2013. In addition, the 2002 Stock Incentive Plan authorizes future grants of options to purchase our common stock, or awards of our restricted common stock, with respect to 8.2 million additional shares of our common stock.

 

Pursuant to the terms of the Class A preferred stock, the number of shares of common stock into which the Class A preferred stock is convertible increases quarterly. On February 5, 2009, ACF Industries Holding Corp. (“ACF Holding”), an affiliate of Mr. Carl Icahn, the Chairman of our Board of Directors and our majority stockholder (the “Chairman”), agreed to extend the date on which we would be required to redeem the shares of Class A Preferred Stock held by ACF Holding (the “ACF Holding Shares”) from January 15, 2010 to a date no later than April 15, 2010. The extension did not affect the redemption date of any of the shares of Class A Preferred Stock other than the ACF Holding Shares. On July 9, 2009, the Company redeemed 304,314 shares of Class A preferred stock from entities unaffiliated with the Company at an aggregate purchase price of approximately $18.4 million, which reduced the number of outstanding shares of Class A preferred stock to 3,695,686. On January 15, 2010, the Company redeemed all 599,137 shares of Class A preferred stock held by entities unaffiliated with the Chairman at an aggregate purchase price of approximately $41.4 million. As of March 31, 2010 ACF Holding is the holder of 100% of the remaining 3,096,549 shares of Class A preferred stock. The Company is required to redeem any outstanding ACF Holding Shares for cash at an aggregate liquidation preference of up to $217.4 million at a date no later than April 15, 2010. ACF Holding has the right to require us to register for resale the Class A preferred stock and the shares of common stock into which it is convertible under the Securities Act, and to include such preferred stock and/or common stock in certain registration statements filed by us from time to time. As of December 31, 2009, approximately half of the Class A preferred stock shares have been registered.

 

On July 25, 2008, 555,000 shares of our 7% Class B convertible preferred stock were issued to affiliates of our Chairman for an aggregate purchase price of $555.0 million. These shares are convertible at the option of the holder into shares of our common stock. As of December 31, 2009, the Class B convertible preferred stock was convertible into 408,863,667 shares of our common stock. However, pursuant to the terms of the Class B convertible preferred stock, the number of shares of common stock into which the Class B convertible preferred stock is convertible increases quarterly unless we elect to pay cash dividends in lieu of such accretion for any quarterly period. All of the Class B preferred stock is held by various affiliates of the Chairman. The holders of the Class B convertible preferred stock have the right to require us to register for resale the Class B convertible preferred stock and the shares of common stock into which it is convertible under the Securities Act, and to include such preferred stock and/or common stock in certain registration

statements filed by us from time to time. As of December 31, 2009, none of the Class B convertible preferred stock shares have been registered.

 

Our common stock may be affected by limited trading volume and may fluctuate significantly.

 

Currently our common stock is quoted on the Over-the-Counter Bulletin Board and on the Pink Sheets and the trading volume developed to date is limited by the fact that many major institutional investment funds and mutual funds, as well as many individual investors, follow a policy of not investing in Over-the-Counter Bulletin Board and/or Pink Sheets stocks and, moreover, certain major brokerage firms restrict their brokers from recommending such stocks because they are considered speculative, volatile and thinly traded. The Over-the-Counter Bulletin Board and Pink Sheets market is an inter-dealer market and is much less regulated than the major stock exchanges, and trading in our common stock is potentially subject to abuses, volatilities and shorting.

 

In addition, there has been a limited public market for our common stock, and an active trading market for our common stock may not develop. As a result, this could reduce our stockholders’ ability to sell our common stock in short time periods, or possibly at all. Our common stock has experienced, and is likely to experience in the future, significant price and volume fluctuations which could reduce the market price of our common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in our financial results and changes in the overall economy or the condition of the financial markets could cause the price of our common stock to fluctuate substantially.

 

 

None.

 

 

We lease facilities for our administrative and sales offices, central switching offices, network nodes and warehouse space in various cities throughout the United States. These leases have various expiration dates through 2019. Our corporate headquarters is located at 13865 Sunrise Valley Drive, Herndon, VA, where we occupy approximately 105,000 square feet of administrative space. We do not own any real property.

 

We currently have facilities in excess of our needs and have entered into various sublease agreements for our unused office and technical space in order to reduce our ongoing operating expenses regarding such space. As a result of fresh start accounting upon our emergence from bankruptcy, included in our other current liabilities and other liabilities are costs to be incurred through 2019 related to facilities that are subleased or are expected to be subleased at rates below our costs. We believe the facilities we are retaining are suitable and adequate for our business operations. For additional information regarding our obligations under leases, see Note 19 of our consolidated financial statements in Item 8 of this Annual Report.

 

 

XOH is involved in lawsuits, claims, investigations and proceedings consisting of commercial, securities, tort and employment matters, which arise in the ordinary course of its business. XOH believes it has adequate provisions for any such matters. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially and adversely affected in any particular period by the unfavorable resolution of one or more of these contingencies. Legal costs related to litigation in these matters are expensed as incurred.

Nashville Electric Service

 

On June 5, 2008, the Nashville Electric Service, part of Metropolitan Government of Nashville, (“NES”) served XO Communication Services, Inc. (“XOCS”) with a complaint and a motion for temporary injunction filed in Chancery Court, Davidson County, Tennessee. The dispute between NES and XOCS is based on a disagreement regarding the legality and enforceability of certain provisions of a fiber optics license agreement, commonly referred to as a “pole attachment” agreement, previously signed by NES and XOCS. The pole attachment agreement between NES and XOCS contains a provision that states XOCS would provide certificates of title to six strands of optic fiber to NES in our fiber optic bundles on poles and on conduits controlled by NES. The pole attachment agreement also contains a “gross revenue” provision that provides that XOCS would pay to NES either 4% of XOCS’ gross revenue derived from rent or sale of fiber optic network services provided on XOCS’ fiber network in Nashville, or a set per-pole fee, whichever is greater, based upon XOCS’ financial statements, which per the agreement XOCS is also allegedly obligated to provide to NES. Based upon certain court decisions in Tennessee, XOCS had previously informed NES that XOCS believed that the gross revenue and title to six strands of fiber provisions of the pole attachment agreement were contrary to law and invalid and therefore unenforceable. XOCS then invoiced NES for the use of the six fiber optic strands. XOCS has not provided title to the six strands of optic fiber (although XOCS allows NES to utilize six strands of optic fiber for its fiber network). XOCS has not provided financial statements to NES, and while XOCS is currently up to date on the payment of pole attachment fees, it has not paid to NES under the “gross revenue” provisions. The pole attachment expired in January of 2005, and NES has refused to renegotiate the terms of the pole attachment agreement, and has attempted to treat the agreement as extending from month-to-month, although no such provisions exist in the pole attachment agreement. The NES Complaint of June 5, 2008 alleges breach of contract, unjust enrichment, and violation of the Tennessee Consumer Protection Act. The complaint and the motion for temporary injunctive relief also seeks specific performance of the terms of the pole attachment agreement in the form of XOCS providing certificates of title to the six strands of optic fiber, an accounting for a determination of amounts allegedly due under the gross revenue provision, and injunctive relief in the form of non-interference by XOCS with the right of NES to continue to utilize the six strands of optic fiber. On June 23, 2008, XOCS filed a notice of removal to federal court (the US District Court, Middle District of Tennessee). On June 30, 2008, NES filed a motion to remand the case back to state court but that motion was denied by the Court. On July 7, 2008, XOCS filed its answer and counterclaim in federal court. The XOCS counterclaim alleges that compensation paid by XOCS to NES has been in excess of fair and reasonable compensation for access to NES’ poles and conduit, in violation of the Communications Act, the US and Tennessee Constitutions (unconstitutional taking), and resulted in unjust enrichment to NES. On July 24, 2008, NES filed a partial motion to dismiss certain portions of XOCS’ counterclaim. On January 7, 2009, the Court denied NES’ motion to dismiss. In July of 2009, the parties renewed settlement discussions. On January 27, 2010, the parties signed a settlement agreement. Among other things, the agreement provides that the case will remain administratively stayed until April 27, 2010 at which time, assuming that the conditions of the settlement agreement have been met, the case will be dismissed with prejudice.

 

R2 Derivative Litigation

 

On April 28, 2009, R2 Investments, LDC filed a complaint in the Supreme Court of the State of New York (New York County) naming individual members of the Company’s Board of Directors and certain entities controlled by Carl C. Icahn, the Chairman of the Company’s Board of Directors and majority shareholder, as defendants and naming the Company as the nominal defendant in connection with derivative claims. The plaintiff alleges that the defendants breached fiduciary duties in connection with the financing transaction consummated in July 2008 and other related matters. The complaint seeks equitable relief as well as damages in an unspecified amount. On July 24, 2009 the Defendants filed a Motion to Dismiss the Complaint, which was denied on December 10, 2009. Discovery in this case is ongoing. The effect of this case on the Company, if any, is not known at this time.

Hillenmeyer Derivative Litigation

 

On July 21, 2009, an XOH shareholder, Don Hillenmeyer, filed under seal in the Delaware Court of Chancery a Complaint titled “Verified Derivative and Class Action Complaint.” On August 6, 2009, XOH filed a redacted version of the Complaint in the Chancery Court. The Complaint names as defendants individual members of the Company’s Board of Directors and ACF Industries Holding Corp. (“ACF Holding”), an entity controlled by Carl C. Icahn, the Chairman of our Board of Directors and majority shareholder, and names XOH as the nominal defendant. The Complaint challenges, among other things, ACF Holding’s recent proposal to acquire all of the outstanding XOH common shares which it does not already own, and alleges various breaches of fiduciary duties. The parties have entered into a Stipulation and Order Extending Time to Answer and agreed to stay proceeding with the case until Plaintiff filed an Amended Complaint. On December 15, 2009, based on plaintiff’s motion, the court entered an order dismissing that portion of the suit that sought to enjoin ACF Industries Holding Corp.’s July 9, 2009 proposal to acquire all of the shares of XO common stock that ACF and its affiliates did not already own. On January 7, 2010 the Defendants filed a motion to stay or dismiss the remaining portion of the suit in favor of the NY litigation (R-2 v Icahn et al). On January 26, 2010, Plaintiff filed an Amended Complaint. On February 18, 2010, Defendants filed a supporting brief for its motion to dismiss. On March 26, 2010, plaintiff filed its answering brief to defendants’ motion to dismiss or stay. The effect of this case on the Company, if any, is not known at this time.

 

 

NA.

 

 

Market Information

 

XO Holdings, Inc. common stock is traded on the OTCBB and in the Pink Sheets under the symbol “XOHO.OB.” The following table shows the range of high and low bid information for XOH’s common stock for the quarterly periods indicated as quoted in the OTCBB. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

 

 

Holders

 

As of March 11, 2010, there were 145 stockholders of record of XOH’s common stock.

 

Dividends

 

We have never paid any cash dividend and do not intend to pay any cash dividend in the foreseeable future.

Securities Authorized For Issuance Under Equity Compensation Plans

 

The following table summarizes information regarding XOH’s equity compensation plans as of December 31, 2009:

 

 

 

 

For information regarding compensation plans under which equity securities are authorized for issuance, see Note 14 of our consolidated financial statements in Item 8 of this Annual Report.

Stock Performance Graph

 

The graph compares the cumulative total return of our common stock for the five year period from 2004 through 2009 with the Nasdaq Telecommunications Index and the Nasdaq Composite Index for US Companies. The graph assumes that the value of the investment was $100 on December 31, 2004 and that all dividends and other distributions were reinvested.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN

Among XO Holdings Inc, The NASDAQ Composite Index

And The NASDAQ Telecommunications Index

 

 

 

The following selected consolidated financial data should be read in conjunction with the audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations. The statement of operations and cash flow data set forth below for 2009, 2008 and 2007 and the balance sheet data as of December 31, 2009 and 2008 are derived from XOH’s audited consolidated financial statements which are included in Item 8 of this Annual Report. The statement of operations and cash flows data for 2006 and 2005 and the balance sheet data as of December 31, 2007, 2006 and 2005 are derived from audited consolidated financial statements of XOH not included in this Annual Report.

 

Our loss from operations, net income (loss), net loss allocable to common shareholders and net loss allocable to common shareholders per common share for 2009, 2008, 2007, 2006 and 2005 were materially affected by certain items which affect the comparability of the information presented with other years’ results. See explanations below.

 

Selected annual financial data for XOH is summarized in the following table (in thousands, except per share data):

 

 

 

 

 

This management’s discussion and analysis of financial condition and results of operations is intended to provide readers with an understanding of our past performance, our financial condition and our prospects. This discussion should be read in conjunction with our audited consolidated financial statements and notes appearing in Item 8 of this Annual Report.

 

Executive Summary

 

We are a leading nationwide facilities-based competitive telecommunications services provider that delivers a comprehensive array of telecommunications solutions to large enterprises, medium and small business, government customers, telecommunications carriers and service providers, and internet content providers. The items we believe differentiate us from the competition include our nationwide high-capacity network, advanced IP and converged communications services, broadband wireless capabilities, and a responsive, customer-focused orientation. We offer customers a broad range of managed voice, data and IP services in more than 80 metropolitan markets across the United States.

 

During 2009, we continued to see the results from a number of initiatives previously implemented including the lighting of our long-haul fiber network, development of the carrier/wholesale channel, and expansion of our portfolio of services to business and enterprise customers. Our prior capital expenditure investments significantly contributed to $82.1 million of revenue growth for our core services. While our total revenue increased 3.0% for the year ended December 31, 2009 compared to the year-ago period, we were able to limit the corresponding increase in cost of service to 1.0% due primarily to planned network optimization projects. Additionally, improvements to our internal cost structure have driven the reduction in our selling, general and administrative expenses as a percentage of revenue to 32.2% for the year ended December 31, 2009 compared to 33.7% and 35.6% for the years ended December 31, 2008 and 2007, respectively.

 

For the year ended December 31, 2009 we recognized net income of $21.8 million. These results were primarily derived from investment gains from the sale of marketable securities of $53.3 million during 2009 and the year over year improvement in operating losses of $37.6 million. While we expect continued improvements in operating losses, we do not anticipate significant investment gains in 2010.

 

On July 9, 2009, we redeemed 304,314 shares of our Class A preferred stock from entities unaffiliated with our Chairman at an aggregate purchase price of approximately $18.4 million. On January 15, 2010, we redeemed all remaining 599,137 shares of Class A preferred stock held by entities unaffiliated with our Chairman at an aggregate purchase price of approximately $41.4 million. As of March 31, 2010, ACF Holding is the record holder of 100% of the remaining 3,096,549 shares of Class A preferred stock. We are required to redeem any outstanding ACF Holding Shares for cash at an aggregate liquidation preference of up to $217.4 million at a date no later than April 15, 2010.

 

On July 9, 2009, we received a letter from ACF Holding, an entity wholly owned by the Chairman that owns the majority of the Company’s common shares, pursuant to which ACF Holding made a non-binding proposal to acquire all of the Company’s outstanding common shares which it does not own, for consideration in the form of cash of $0.55 net per share.

As reported in our 8-K filing, on September 28, 2009 the special committee of the Board of Directors of XO Holdings, Inc. announced that it has “unanimously concluded that the proposal of ACF Industries Holding Corp., an affiliate of Carl C. Icahn and holder of a majority of the shares of XO Holdings’ common stock, to purchase all of the shares of XO Holdings’ common stock not currently held by ACF Holding at a price of $0.55 per share substantially undervalues the company, and, therefore, the special committee does not support the proposal.” The special committee communicated to Mr. Icahn that it would consider a proposal that recognizes the full value of the company and reflects the significant benefits that would accrue to ACF Holding as a result of full ownership.

 

On October 23, 2009, ACF Holding sent a letter to the special committee pursuant to which ACF Holding made a non-binding proposal to increase its previously outstanding offer to acquire all of the outstanding shares which it does not own, to an aggregate of $0.80 net per share in cash. The offer made on October 23, 2009 expired on October 26, 2009 at 6:00 pm (EST). The Chairman and other related parties filed Amendment no. 22 to Schedule 13D on November 9, 2009. Such amendment stated: “In the period following October 26, 2009, the stated termination date of ACF Holding’s $0.80 per share offer, representatives of ACF Holding continued to discuss the matter with members of the Special Committee and its advisors...Representatives of ACF Holding pointed out that the CLEC industry faced difficult times ahead and that ACF Holding believed that its offer of $0.80 per share was fair, especially in light of the fact that it required a majority of the minority stockholders to vote for it in order to become effective. Representatives of ACF Holding also pointed out that ACF Holding had raised its proposed merger price from $0.55 to $0.80 per share without receiving a counteroffer. They also stated that the initial offer was made when the market price for the Shares was under $0.30 per share. In light of all of the above facts, ACF Holding is now terminating its offer.”

 

We believe that to remain competitive with much larger telecom and cable companies, we will require significant additional capital expenditures to enhance and operate our fiber network. We believe that cash on hand and operating cash flow will be sufficient to finance our operational needs for at least the next 12 months. However, in order to maintain our competitive position, we intend to raise additional capital and continue to explore various alternatives to obtain additional capital. We continue to believe that these alternatives should not include an issuance of high yield debt because such an issuance would be deleterious to XOH for the following reasons: 1) the high cost of such debt will negatively affect our ability to compete in the current highly competitive telecommunications environment; and 2) the burdensome restrictive covenants associated with such debt would impair our ability to pursue potential strategic investments and to take advantage of other opportunities which may be necessary for us to compete in such environment. We believe that certain opportunities exist today in the highly competitive telecommunications industry that may not recur such as, but not limited to, the acquisition of other CLECs. For all the above reasons, we intend to seek to raise appropriate levels of capital in the near future.

 

In 2008, we commenced an enterprise-wide transformation initiative intended to enhance shareholder value through focusing on improving service delivery, accelerating revenue growth, and reducing operating costs. These initiatives are being partially realized in 2009, with further realization expected in 2010 and beyond. In conjunction with this transformation initiative, we intend to continue to invest in new network infrastructure, develop new service offerings and continue expanding our customer base in high-growth markets.

 

We continue to monitor the impact of macro-economic conditions on our business. Potential negative aspects include a general slowdown in the demand for telecommunications services, delayed IT and other projects that have telecommunications needs, elongated sales cycles on the part of our customers, higher involuntary churn, and delayed payments from customers.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. We continually evaluate the estimates we use to prepare the consolidated financial statements and update those estimates as necessary. In general our estimates are based on historical experience, on information from third

party professionals, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates made by management.

 

The following list is not intended to be a comprehensive list of all of our accounting policies. Our significant accounting policies are described in Note 2 or our consolidated financial statements in Item 8 of this Annual Report.

 

Revenue Recognition

 

Revenue from telecommunications services is recognized when the related services are provided. Fees billed in connection with service installations and other non-recurring charges related to ongoing service are deferred and recognized ratably over the average customer life. Up front cash collected from lease of unlit network capacity under indefeasible rights of use is recognized ratably over the contract term.

 

Receivable Reserves

 

Sales Credit Reserves

 

During each reporting period we must make estimates for potential future sales credits to be issued related to billing errors, service interruptions and customer disputes. We utilize both specific identification and general reserve methods for determining the sales credit reserves. A specific reserve requirement review is performed on customer accounts with larger balances. We also estimate a general sales credit reserve related to unknown billing errors and disputes based on a rolling six months of historical sales credit activity. We assess the adequacy of our sales credit reserve on a monthly basis using several factors, including the likelihood of billing being disputed by customers and historical sales credit trends.

 

Historically management’s estimates used in the sales credit reserve calculation have not led to significant write-offs in excess of reserves recorded. Although we believe that our accounting policy is designed to properly assess our sales credit reserves, changes to the estimates in our reserve calculation could result in a material impact on our Consolidated Statement of Operations.

 

Allowance for Doubtful Accounts

 

During each reporting period we must make estimates for potential losses resulting from uncollectible trade accounts receivable. The determination of our allowance for doubtful accounts requires significant estimation and assumptions. The corresponding provision for doubtful accounts is recorded as a Selling, General and Administrative expense. We utilize both specific and general allowance methods for determining the allowance for doubtful accounts.

 

A specific reserve requirement review is performed on customer accounts with larger balances. An additional reserve requirement review is performed on accounts not subject to specific review using several factors, including the length of time individual receivables are past due, historical collection experience, the economic and competitive environment, and changes in the creditworthiness of our customers. We can and have experienced significant month-to-month changes in reserve level requirements. If circumstances relating to financial viability of significant customers change or economic conditions worsen such that our past collection experience and assessment of the economic environment are no longer relevant, our estimate of the recoverability of our trade receivables could be changed. If this occurs, we would adjust our valuation allowance in the period the new information is known. Any material change in the financial status of any one or group of customers could have a material adverse effect on our results of operations, financial position or cash flows.

 

Cost of Service

 

Cost of Service — Telecommunications Services include expenses for customer loop, interconnect access and transport services paid to third-party telecommunications providers. We accrue for the expected cost of services obtained from third-party telecommunications providers during the period the services are rendered.

It is common for invoices received from the third-party telecommunications providers to include items which result in disputes due to billing discrepancies. We perform monthly bill verification procedures to identify errors in vendors’ billing processes. The bill verification procedures include the examination of the bills, comparing billing rates used with contractual billing rates, evaluating the trends of invoiced amounts by vendors and reviewing the types of charges being processed. If we believe we have been billed inaccurately, we accrue costs for disputed invoices based on the last 24 months of historical trends for resolutions of similarly disputed items. If we ultimately settle a disputed amount which is different than the accrual, we recognize the difference in the period in which the settlement is finalized as an adjustment to cost of service. We believe that our accounting policy is designed to properly assess dispute accruals for third-party telecommunications costs, however, changes to the estimates used in our calculation could result in a material impact on our Consolidated Statement of Operations.

 

Assessment of Loss Contingencies

 

We have legal and other contingencies that could result in significant losses upon the ultimate resolution of such contingencies. We have provided for losses in situations where we have concluded that it is probable that a loss has been or will be incurred and the amount of the loss can be reasonably estimated. A significant amount of judgment is involved in determining whether a loss is probable and reasonably estimatable due to the uncertainty involved in predicting the likelihood of future events and estimating the financial impact of such events. Accordingly, it is possible that upon the further development or resolution of a contingent matter, a significant charge could be recorded in a future period related to an existing contingent matter. For additional information regarding all of our legal proceedings and loss contingencies, see Note 19 of our consolidated financial statements in Item 8 of this Annual Report.

 

Property and Equipment

 

We annually evaluate the estimated useful lives used to depreciate our assets. When performing this assessment we consider (i) our historical usage and future planned use of the assets, (ii) the views of experts within and outside of XOH, (iii) the impact of technological advances and (iv) trends in the industry on the value and useful lives of our network assets. Such criteria includes the valuation of similar assets within the industry and information gathered from manufacturers and other market participants. While we believe our current estimates of useful lives are reasonable, significant differences in actual experience or significant changes in assumptions may cause additional changes to future depreciation expense. As a result of an evaluation, we changed the estimated useful life of certain network equipment which resulted in an increase of $4.2 million and $13.3 million to depreciation expense during 2009 and 2007, respectively. No significant revisions were made as a result of evaluations made in 2008.

 

Impairment of Long-lived Assets

 

We assess the possible impairment of equipment and other assets held for use whenever events or changes in circumstances indicate that the carrying amount of the assets may be impaired. The assessment includes comparing estimated future undiscounted cash flows with the carrying values of the assets. This analysis requires management to make subjective assessments of factors including future cash flows, holding periods of assets and capitalization rates. In the event that there are changes in the planned use of these assets or our expected future undiscounted cash flows are reduced significantly, the assessment of our ability to recover the carrying value of these assets in the future could change. There were no impairments of our long-lived assets held for use recorded during 2009, 2008 or 2007.

 

Goodwill and Indefinite Lived-Intangible Assets

 

We assess the possible impairment of goodwill and indefinite-lived intangible assets on an annual basis or when impairment indicators exist. Both goodwill and indefinite-lived intangible assets are tested using a discounted cash flow model. Cash flow projections and assumptions are based on a combination of our historical performance and trends, our business plans and management’s estimate of future performance, giving

consideration to existing and anticipated competitive economic conditions. Other assumptions include our estimated weighted average cost of capital and long-term rate of growth for our business.

 

Goodwill is tested by comparing the fair value of a reporting unit with its carrying amount including goodwill. If the carrying value of the reporting unit exceeds fair value, the second step of the goodwill impairment test is performed to measure the impairment loss, if any. Our indefinite-lived intangible assets are tested in a manner similar to our goodwill. We estimate the fair value of our indefinite-lived intangible assets using a discounted cash flow model. If the carrying value exceeds its fair value, the carrying value of the asset is reduced to its fair value, resulting in an impairment charge. Any impairment loss determined by our analysis would be recorded as a reduction in the carrying value of the related goodwill or indefinite-lived intangible asset and charged to results of operations.

 

As a result of integrating our Nextlink segment into our existing service offerings, we performed an impairment evaluation of our LMDS licenses as of May 31, 2009. Based on this evaluation, we determined that the fair value of the LMDS licenses was less than the carrying value. Accordingly, LMDS licenses with a carrying amount of $35.8 million were written down to their fair value of $27.5 million, resulting in an impairment charge of $8.3 million.

 

We performed another impairment evaluation on goodwill and indefinite-lived intangible assets at October 1, 2009 and concluded that no additional impairment charge was required. There were no impairments of goodwill or indefinite-lived assets as of December 31, 2008 or 2007. Although we believe our accounting policies are designed to properly analyze our goodwill and indefinite-lived intangible assets for impairment, if actual results are not consistent with our assumptions and estimates, we may be required to record additional impairment charges in future periods.

Results of Operations

 

The following tables contain certain data from our Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007 (dollars in thousands):

 

 

 

 

 

 

Revenue — 2009 Compared to 2008

 

Total revenue for 2009 increased 3% compared to the prior year. We experienced strong growth in our core service offerings relating to Broadband Services. For 2010, we anticipate continued revenue growth. Based on continued investments which leverage next-generation IP-based technologies, we expect revenue from Legacy/TDM services, as a percentage of our total revenue, will continue to decline during 2010 as our sales continue to be focused on next-generation IP-based solutions. The projections for 2010 will be sensitive to influences in a challenging macro-economic environment and regulatory climate changes.

 

Revenue was earned from services provided in the following categories for the years ended December 31 (dollars in thousands):

 

 

Core Services.  For the year, Core Services increased $82.1 million, or 8.3%, as compared to 2008 reported results. Within Core Service, Broadband Services grew $127.7 million, or 19.0% as compared to 2008 reported results. Broadband Services contains strategically important products which are deployed largely using IP-enabled technologies as well as other strategic data transmission and internet services.

 

Contributing to the growth in Broadband Services were the IP-based products and services which increased $73.6 million, or 49.5%. As one of the relatively mature and more established products of the IP suite, IP Flex increased $21.6 million, or 22.2%, year-over-year, and it continues to show solid sequential growth. IP VPN in its second full year increased $29.4 million, or 158.8%, as compared to 2008. We expect that the IP-based services will continue to be central to revenue growth in 2010 and beyond.

 

Also important to Broadband Services growth are the data and internet products which grew $24.7 million, or 7.5%, and $29.5 million, or 15.2%, respectively. Dedicated Private Line, the largest component of Data Services, increased $19.2 million, or 6.9%. Investments in our long haul network continue to support the growth of Dedicated Private Line. Ethernet increased $12.6 million, or 36.7%, year-over-year supported by continued strong demand for Ethernet-Over-Copper (EoC) which utilizes existing telephony infrastructure to deliver high-speed IP connectivity at a competitive value. Low cost access utilizing EoC also supported growth in Dedicated Internet Access (DIA) of $16.9 million, or 10.6%.

 

Offsetting some of the growth in Broadband, Integrated/Voice Services reduced $45.6 million, or 14.4%, as compared to 2008 reported results. These products include traditional Carrier Long Distance Termination (CLDT) and older integrated offerings which are not IP-enabled. Customers continue to migrate away from these products to IP-enabled offerings which offer more flexibility and better value.

 

Legacy/TDM Services.  In 2009 revenue from Legacy/TDM Services decreased $38.5 million, or 7.9%, as compared to 2008. Though XO continues to offer and service these products and services, they are largely based upon traditional dial modality (TDM) which is not a significant focus of marketing efforts.

Revenue — 2008 Compared to 2007

 

Total revenue for 2008 increased slightly compared to the prior year. Revenue was earned from services provided in the following categories for the years ended December 31 (dollars in thousands):

 

 

Core Services.  We experienced a continued growth in market demand for telecommunications services using next generation IP technologies and transport services. For 2008, revenue from our Core Broadband Services increased 26.5% compared to the prior year primarily due to growth in our Dedicated Private Line and IP Flex services. During 2008, our Dedicated Private Line revenues increased $35.8 million, or 14.7%, over the prior year as a result of our investments in our long-haul network. A significant portion of Dedicated Private Line sales were driven by our wholesale Carrier sales force offering wavelength solutions. The growth in IP solutions was led by a year over year $29.8 million, or 44.3%, revenue increase in IP Flex, our flagship integrated data and voice solution which is largely sold by our commercial Business Services unit. Also contributing significantly to the growth in our Broadband revenue was our DIA, IP VPN, and Telco Collocation solutions. DIA revenue increased $24.5 million, or 18.2%, for 2008 compared to 2007 as DIA continues to be a centerpiece of our overall Core Broadband marketing in response to continued strong demand. IP VPN revenue increased $16.9 million to $18.6 million for 2008 due to strong response to marketing efforts in 2008 following the product launch in late 2007. Telco Collocation revenue increased $14.6 million, or 58.9%, for 2008 compared to 2007 in tandem with growth in Dedicated Private Line, DIA, and ethernet networking. Secured qualified collocation space remains at a premium in a number of key markets, and we have been able to capitalize on the growth of key Broadband products to drive growth in Telco Collocation.

 

The growth in the Broadband category of our Core Services was slightly offset by a net reduction in Integrated/Voice revenue. This category contains more mature bundled data and voice offerings introduced in 2000 such as XOptions and Integrated Access, as well as traditional CLDT. The primary driver of the decrease in Core Integrated/Voice revenue for 2008 compared to the prior year was the customer demand shift to IP-enabled solutions such as IP Flex. This decline was partially offset by a $21.3 million increase in CLDT revenue for 2008 compared to 2007, caused primarily by increased volume.

 

Legacy/TDM Services.  For 2008, revenue from services in our Legacy/TDM category decreased compared to 2007 due to a continuing shift in marketing and customer demand away from TDM products to next generation solutions.

 

COS — 2009 Compared to 2008

 

Our cost of service (“COS”) includes telecommunications services costs, network operations costs and pass-through taxes. Telecommunication services costs include expenses directly associated with providing services to customers, such as the cost of connecting customers to our network via leased facilities, leasing components of network facilities and interconnect access and transport services paid to third-party service providers. Network operations include costs related to network repairs and maintenance, costs to maintain rights-of-way and building access facilities, and certain functional costs related to engineering, network, system delivery, field operations and service delivery. Pass-through taxes are taxes we are assessed related to selling our services which we pass through to our customers. COS excludes depreciation and amortization expense.

The following table summarizes our COS by component for the years ended December 31 (dollars in thousands):

 

 

The primary factors that contributed to the year over year increase in the costs related to providing Telecommunications services were the net growth of our products (including the increased sales of our Broadband services), resulting in a $50.7 million increase in related costs, and the increased volume of wholesale long distance usage resulting in a $17.4 million increase in related costs. These increases were partially offset by a $19.5 million decrease in the cost of terminating the wholesale long distance usage due to traffic terminating to lower cost locations. Additional offsets include $40.9 million of incremental cost savings achieved through planned network optimization projects completed in 2009 and $5.0 million of decreased costs due to improved results from our dispute resolution efforts. Network optimization projects are initiatives and actions we take to reduce our costs associated with providing telecommunications services to our customers. Network optimization projects include rehoming circuits to the nearest network POP, hubbing circuits onto the same transport facility, moving network facilities to lower cost providers, disconnection of capacity from third party providers which is no longer needed and other similar actions which vary in type, size and duration.

 

Network operations costs increased from 2008 to 2009 principally due to a $3.2 million increase in building access rights of way and a $2.4 million increase in network related costs including circuit maintenance and leased fiber costs.

 

The decrease in pass-through taxes from 2008 to 2009 principally resulted from a $4.1 million error correction recorded in 2008 pertaining to the period from 2003 through 2006. We determined certain payments for taxes due to various state and local jurisdictions had been incorrectly recorded and concluded the correction was not material to any of the affected years and corrected the liability during the first quarter of 2008.

 

In 2010, we expect growth in revenue and volume will contribute to increases in our COS, compared to 2009. Although we continue to undertake initiatives and actions to reduce the cost of providing service to our customers, we expect the cost savings from network optimization projects to decline in 2010, compared to 2009. Overall, excluding the effects of future dispute settlements, if any, we expect our cost of service as a percentage of revenue for 2010 will remain relatively consistent with 2009.

 

COS — 2008 Compared to 2007

 

The following table summarizes our cost of service by component for the years ended December 31 (dollars in thousands):

 

 

The cost of service increase for 2008 compared to 2007 was substantially due to the increase in Telecommunications services costs in both dollars and as a percentage of total revenue. The primary factors that contributed to the year over year increase in the costs related to providing Telecommunications services were increased growth in sales of our Broadband services, resulting in a $34.6 million increase in related costs, and

the increased volume of wholesale long distance usage resulting in a $47.4 million increase in related costs. Additionally, 2008 did not include the beneficial change related to the FCC’s TRRO that decreased 2007 cost of service by $22.1 million. These increases were partially offset by a $11.3 million decrease in the cost of terminating the wholesale long distance usage due to traffic terminating to lower cost locations. Additional offsets include $40.2 million of incremental cost savings achieved through planned network optimization projects completed in 2008 and $16.4 million of decreased costs due to improved results from our dispute resolution. Telecommunications services costs as a percentage of revenue increased from 2007 to 2008 due to the $22.1 million revision to the 2007 TRRO estimate previously mentioned. Excluding the impact of this one-time benefit in 2007, Telecommunications services costs as a percentage of revenue would have decreased from 42.5% in 2007 to 42.1% in 2008.

 

Selling, General and Administrative — 2009 Compared to 2008

 

Selling, general and administrative expense (“SG&A”) includes expenses related to payroll, commissions, sales and marketing, information systems, general corporate office functions and collection risks. SG&A decreased in 2009 as payroll and related expenses were $7.4 million lower than in 2008 as a result of headcount reductions and changes in employee benefit programs. Sales and marketing cost reductions of $4.5 million further decreased SG&A in 2009. In addition, office related expenses decreased by approximately $5.9 million year over year, mostly due to increased sublease income and changes in our estimated liability related to expected technical site decommissioning costs. Offsetting these 2009 decreases in SG&A expense, legal expenses in 2008 were reduced by $9.8 million due to favorable developments in ongoing litigation.

 

SG&A as a percentage of revenue decreased to 32.2% for 2009 from 33.7% for 2008. This improvement was principally driven by our continued execution on our initiatives to increase revenue growth, while improving our internal cost structure. We plan on continuing to invest in the resources and infrastructure necessary to help grow and support our business units during 2010 while continuing to realize cost savings. Our goal during 2010 is to further decrease SG&A as a percentage of revenue through implementation of our transformation initiative.

 

Selling, General and Administrative — 2008 Compared to 2007

 

The decrease in SG&A for 2008 compared to 2007 was due to (i) an $11.0 million reduction in legal expenses, resulting partially from the settlement of the ATLT litigation, (ii) a $7.7 million decline in use and property taxes, (iii) a $4.8 million increase in the level of capitalized costs on fixed asset projects, (iv) a $4.2 million reduction in the level and costs of contractor and professional services, (v) a $2.7 million reduction in our directors’ and officers’ insurance costs, and (vi) a $2.4 million reduction in bad debt expense due to improvements in our collections efforts, offset partially by a $20.7 million increase in payroll and commissions expenses and a $4.2 million increase in sales and marketing costs.

 

Depreciation and Amortization

 

Depreciation and amortization did not include amortization expense for 2009 and 2008 because our definite lived intangible assets became fully amortized during 2007. For 2007 depreciation and amortization included amortization expense of $10.0 million.

 

Depreciation expense for 2009 and 2007 included adjustments related to changes in depreciable lives of certain fixed assets. These changes resulted in adjustments of $4.2 million and $13.3 million in 2009 and 2007, respectively. No adjustments related to changes in depreciable lives were recorded during 2008. Excluding these changes in estimate, depreciation expense for 2009, 2008 and 2007 was $175.9 million, $189.2 million and $183.7 million, respectively. The year over year changes in depreciation expense were primarily due to the retirement of assets, for which depreciation expense was accelerated, such that the assets were fully depreciated at the time of their retirement. Additional expense relating to the retirement of these assets was approximately $0.8 million, $15.4 million and $6.2 million for 2009, 2008 and 2007, respectively.

 

We expect depreciation expense to increase slightly in 2010 as we continue to increase our fixed assets in order to continue to grow our revenue and enhance our networks.

Impairment of LMDS Licenses

 

As a result of our integration of the Nextlink segment into our existing product offerings, we performed an impairment evaluation of our LMDS licenses as of May 31, 2009. We determined that the fair value of the LMDS licenses were less than their carrying value. Accordingly, LMDS licenses with a carrying amount of $35.8 million were written down to their fair value of $27.5 million, resulting in an impairment charge of $8.3 million during 2009. We performed another impairment evaluation during October 2009. Based on the results of this evaluation, no additional impairment changes were recorded in 2009. There were no impairments of long-lived assets recognized during 2008 or 2007.

 

Investment Gain, Net

 

The net investment gain for 2009 was comprised of a $41.2 million gain from the sale of debt securities, a $12.1 million gain from the sale of equity securities, a $5.8 million gain related to the settlement agreement associated with the Company’s holding of Global Crossing debt securities and a $0.9 million gain from the settlement of claims with ATLT related to the Company’s holdings of Allegiance debt securities.

 

The net investment gain for 2008 was due to a $35.9 million gain from the settlement with the ATLT and a $4.4 million gain from the conversion of a non-current asset to an available-for-sale security, partially offset by a $20.9 million impairment charge for other-than-temporary declines in market value for marketable securities. Investment gain, net for 2007 primarily resulted from $21.5 million received from the settlement related to our holdings of Global Crossing debt securities.

 

The marketable securities balance at December 31, 2009 was $1.3 million. Therefore, investment gains comparable to those recognized in 2009 and 2008 are not anticipated for 2010.

 

Interest Expense, Net

 

Net interest expense was $1.6 million, $21.3 million and $37.7 million, for 2009, 2008 and 2007 respectively. The decrease in net interest expense over these periods is primarily due to the retirement of all outstanding debt in July 2008. We retired our long term debt with the issuance of preferred stock and therefore incurred no related interest expense subsequent to the retirement in 2008. Net interest expense for 2009 primarily relates to imputed interest under our capital lease agreements and interest on various accruals, partially offset by capitalized interest.

 

Interest costs related to internally constructed assets, including our telecommunications networks, are capitalized. Total interest expense was offset by capitalized interest of $1.7 million, $2.4 million and $4.5 million, respectively for 2009, 2008 and 2007.

 

Capital Expenditures

 

 

During 2009, we continued to invest in our operations through enhancement and expansion of our network and service capabilities. The reduction in capital expenditures from 2008 to 2009 primarily relates to improved capital efficiency on new customer installations, the integration and rationalization of Nextlink, as well as, our consolidation of switch facilities in 2008 which resulted in capital expenditures not repeated in 2009. Capital expenditures remained flat between 2008 and 2007 as we continued to invest in network enhancements at a similar pace as in 2007. We plan to spend between $210.0 million and $240.0 million on capital expenditures during 2010 for continued investment in our networks, ethernet and IP-based services, expansion into new markets and continuation of our transformation initiative.

Segment Financial Results

 

As previously reported in our 2008 Annual Report, we operated our business in two reportable segments through two primary operating subsidiaries. XO Communications, LLC operated our wireline business under the trade name “XO Communications” (“XOC”) and Nextlink Wireless, Inc. (“Nextlink”) operated our fixed-wireless business. XOC and Nextlink were managed separately; each segment required different resources, expertise and marketing strategies. In April 2009, we decided to integrate Nextlink’s operations into XOC’s existing product offerings, discontinuing Nextlink as a separate operating segment. As a result of this change, our chief operating decision maker no longer reviews the results of Nextlink’s operations to evaluate performance and allocate resources. Thus, Nextlink ceased to be considered a reportable segment resulting in XOC being our only operating segment as of June 30, 2009. XOC continues to use the Nextlink LMDS spectrum assets to support existing fixed wireless customers, customer growth and network cost reduction opportunities.

 

Liquidity and Capital Resources

 

Our primary capital needs are to finance the cost of operations, to acquire capital assets in support of our operations, to fund the redemption of our Class A preferred stock and to take advantage of opportunities to enhance our competitive position. We believe that to remain competitive with much larger telecom and cable companies, we will require significant additional capital expenditures to enhance and operate our fiber network. We believe that cash on hand and operating cash flow will be sufficient to finance our operational cash needs for at least the next twelve months. However, in order to maintain our competitive position, we intend to raise additional capital and continue to explore various alternatives to obtain additional capital. We continue to believe that these alternatives should not include an issuance of high yield debt because such an issuance would be deleterious to XOH for the following reasons: 1) the high cost of such debt will negatively affect our ability to compete in the current highly competitive telecommunications environment; and 2) the burdensome restrictive covenants associated with such debt would impair our ability to pursue potential strategic investments and to take advantage of other opportunities which may be necessary for us to compete in such environment. We believe that certain opportunities exist today in the highly competitive telecommunications industry that may not recur such as, but not limited to, the acquisition of other CLECs. For all the above reasons, we intend to seek to raise appropriate levels of capital in the near future.

 

Redemption of Our 6% Class A Convertible Preferred Stock

 

The terms of our Class A preferred stock provided that on January 15, 2010, we redeem in cash and in a manner provided for therein all of the shares of Class A preferred stock then outstanding at a redemption price equal to 100% of its liquidation preference. On February 5, 2009, ACF Holding, an affiliate of our Chairman, agreed to extend the date on which we would be required to redeem the shares of Class A preferred stock held by ACF Holding (the “ACF Holding Shares”) from January 15, 2010 to a date no later than April 15, 2010. The extension did not affect the redemption date of any of the shares of Class A preferred stock other than the ACF Holding Shares.

 

On July 9, 2009, we redeemed 304,314 shares of our Class A preferred stock from entities unaffiliated with our Chairman at an aggregate purchase price of approximately $18.4 million. On January 15, 2010, we redeemed all 599,137 shares of Class A preferred stock held by entities unaffiliated with our Chairman at an aggregate purchase price of approximately $41.4 million. As of March 31, 2010, ACF Holding is the record holder of 100% of the remaining 3,096,549 shares of Class A preferred stock. We are required to redeem any outstanding ACF Holding Shares for cash at an aggregate liquidation preference of up to $217.4 million at a date no later than April 15, 2010.

 

Debt Retirement through Issuance of Preferred Stock

 

During 2008, all of our long-term debt and accrued interest was retired in connection with the issuance and sale of shares from a new series of 7% Class B convertible preferred stock and a new series of 9.5% Class C perpetual preferred stock. On July 25, 2008, we entered into a Stock Purchase Agreement with Arnos Corp.,

Barberry Corp., High River Limited Partnership and ACF Industries Holding Corp., entities affiliated with our Chairman (together, the “Purchasers”), pursuant to which the Purchasers bought 555,000 shares of our Class B convertible preferred stock for $555.0 million and 225,000 shares of our Class C perpetual preferred stock for $225.0 million. The terms of the Stock Purchase Agreement were negotiated on behalf of XOH by a special committee of the Board of Directors that was established on September 28, 2007 to assist us in evaluating financing and other strategic alternatives. See Note 11 to our consolidated financial statements in Item 8 of this Annual Report for additional details regarding the issuance of the Class B convertible preferred stock and Class C perpetual preferred stock.

 

A portion of the purchase price for our Class B convertible preferred stock was paid through the $450.8 million retirement of all of the Purchasers’ right, title and interest in our senior indebtedness. This amount represents all indebtedness held by the Purchasers and their affiliates of $372.5 million in principal and accrued interest under the Credit Facility and $78.3 million in principal and accrued interest for the Promissory Note. The remainder of the purchase price for the Class B convertible preferred stock and all of the Class C perpetual preferred stock was paid in cash. We used $22.3 million of the proceeds from the sale of the Class B convertible and Class C perpetual preferred stock to retire in full the remainder of our indebtedness (including accrued interest) under our Credit Facility, none of which was owed to the Chairman or any affiliates thereof.

 

Cash Flow

 

As of December 31, 2009, our balance of cash and cash equivalents was $363.2 million, an increase of $106.4 million from December 31, 2008. The primary reason for this increase was proceeds received from the sale of available-for-sale investments. We continued to focus on enhancing our next generation IP-based network and customer driven success-based capital to grow revenue. Cash outflow for strategic, growth-related investments during 2009 exceeded cash inflow from operations during the same period. We expect our growth-related investment in network and services will continue to outpace our cash inflows from operations during 2010.

 

The following table summarizes the components of our cash flows for the years ended December 31 (in thousands):

 

 

Operating Activities.  Cash provided by operating activities increased $76.9 million from 2008 to 2009. This increase principally resulted from a $37.6 million year over year decrease in loss from operations and a $34.4 million improvement in working capital cash flow from 2008 to 2009.

 

Cash provided by operating activities decreased $67.9 million from 2007 to 2008 primarily due to changes in accounts receivable, other assets and accrued liabilities. The increase in cash used for accounts receivable mainly resulted from increased revenue as well as the impact of significant collections in 2007 of customer receivables previously reserved. This cash flow benefit was not realized in 2008 as a similar collections effort was not deemed necessary in 2008. The increase in cash used for other assets mainly resulted from the timing of our payroll funding as of December 31, 2008. Specifically, we shifted cash into other assets as of December 31, 2008 as we funded our payroll account; however, our liability was not settled until January 2009. The increase in cash used for operating activities from accrued liabilities principally resulted from timing of payments.

 

Investing Activities.  The $276.8 million decrease in cash used in investing activities primarily resulted from proceeds of $180.9 million received from the sale of available-for-sale investments which were purchased in 2008 for $137.2 million. The marketable securities balance at December 31, 2009 was $1.3 million. Therefore, investment gains comparable to those recognized in 2009 and 2008 are not anticipated for 2010. Also improving cash used in investing activities was an $18.0 million year over year reduction in capital expenditures. These decreases in cash used in investing activities were partially offset by the $56.6 million

decrease in investment recoveries. We continued to focus on investment in our technology infrastructure, operations, and other areas of our business to lay the foundation for our long term strategic plan, which seeks to improve operational efficiency, accelerate revenue growth and significantly shift our revenue mix.

 

For 2008, cash used in investing activities increased primarily due to the purchase of $137.2 million of marketable securities, offset partially by the $35.9 million increase in investment recoveries. In 2008, we received $57.4 million from the settlement related to Allegiance debt securities, while in 2007 we received $21.5 million from a settlement related to Global Crossing debt securities. Investment in capital expenditures remained relatively consistent from the prior year at $217.0 million for 2008.

 

We expect that our capital expenditures for 2010 will be between $210 million and $240 million. Without these expenditures, we believe it would be difficult to continue to effectively compete against the ever increasing pressures from the ILECs as well as wireless and cable providers.

 

Financing Activities.  The primary use of cash for financing activities in 2009 was for the redemption of a portion of our Class A preferred stock for $18.4 million. In addition payments on our capital leases were $6.9 million during 2009.

 

For 2008, cash provided by financing activities increased substantially due to proceeds from the sale of preferred stock in July 2008, totaling $329.2 million and the $75.0 million proceeds from the Promissory Note in March 2008. During 2008 our Credit Facility and Promissory Note were repaid in full by the issuance of the Class B convertible preferred stock in a non-cash transaction and a cash payment of $22.3 million.

 

Capital Requirements.  Our capital requirements in 2010 include investments necessary to support revenue growth and infrastructure to continue to provide our customers with the highest levels of service, quality and performance. Our 2010 operating plan includes capital expenditure amounts for continued investment in, and enhancement of, our (i) metro and long-haul fiber optic network, (ii) new markets, (iii) ethernet and IP-based services and (iv) to support our transformation initiative.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of December 31, 2009 (in millions):

 

 

 

 

Off-Balance Sheet Arrangements

 

We are not currently engaged in the use of off-balance sheet derivative financial instruments to hedge or partially hedge interest rate exposure nor do we maintain any other off-balance sheet arrangements for the purpose of credit enhancement, hedging transactions, or other financial or investment purposes.

 

Recently Issued Accounting Pronouncements

 

In September 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13 Revenue Recognition (Topic 605) — Multiple Deliverable Revenue Arrangements. The amendment addresses how revenue should be allocated to separate elements of a multiple deliverable revenue arrangement which could impact the timing of revenue recognition. The amendment will be effective prospectively for revenue arrangements entered into or

materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. Companies may elect, but are not required, to apply retrospectively to all prior periods. We are currently evaluating the impact this amendment will have on our financial position, results of operations and cash flows.

 

In January 2010, the FASB issued ASU 2010-06 Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires new disclosures and clarifies certain existing disclosure requirements about fair value measurements. ASU 2010-06 requires a reporting entity to disclose significant transfers in and out of Level 1 and Level 2 fair value measurements, to describe the reasons for the transfers and to present separately information about purchases, sales, issuances and settlements for fair value measurements using significant unobservable inputs. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which is effective for interim and annual reporting periods beginning after December 15, 2010; early adoption is permitted. We do not expect that the adoption of ASU 2010-06 will have a material impact on our financial position, results of operations or cash flows.

 

 

During 2008, all of our long-term debt and accrued interest was retired. Therefore we are no longer subject to interest rate risk on long-term debt.

 

 

Index to Consolidated Financial Statements

 

 

Board of Directors and Shareholders

XO Holdings, Inc.

 

We have audited the accompanying consolidated balance sheet of XO Holdings, Inc. as of December 31, 2009 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2009. Our audit of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). We also have audited XO Holdings Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). XO Holdings, Inc.’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule and an opinion on XO Holdings Inc.’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of XO Holdings Inc. as of December 31, 2009 and the results of its operations and its cash flows for the year ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

 

In our opinion, XO Holdings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by COSO.

 

/s/ GRANT THORNTON LLP

 

McLean, Virginia

March 31, 2010

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

XO Holdings, Inc.:

 

We have audited the accompanying consolidated balance sheet of XO Holdings, Inc., and subsidiaries as of December 31, 2008, and the related consolidated statements of operations, stockholders’ (deficit) equity, and cash flows for each of the years in the two-year period ended December 31, 2008. In connection with our audits of the consolidated financial statements, we have also audited the consolidated financial statement schedule of valuation and qualifying accounts for the two-year period ended December 31, 2008. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of XO Holdings, Inc. and subsidiaries as of December 31, 2008, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule for the two-year period ended December 31, 2008, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

 

/s/ KPMG LLP

 

McLean, Virginia

March 16, 2009

XO Holdings, Inc.

 

Consolidated Balance Sheets

(in thousands, except per share data)

 

 

See accompanying notes to the consolidated financial statements.

XO Holdings, Inc.

 

Consolidated Statements of Operations

(in thousands, except per share data)

 

 

See accompanying notes to the consolidated financial statements.

XO Holdings, Inc.

 

Consolidated Statements of Stockholders’ (Deficit) Equity