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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number
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CHOICE ONE COMMUNICATIONS INC.
(Exact name of Registrant as specified in its charter)
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Delaware 16-1550742
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Chestnut Street, Suite 600, Rochester, NY 14604
(Address of principal executive office) (Zip Code)
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(716) 246-4231
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Aggregate market value of all Common Stock held by non-affiliates as of March 1,
2001, was $94,382,666.
37,921,291 shares of $.01 par value Common Stock were issued and outstanding
as of March 1, 2001.
The Index of Exhibits filed with this Report begins at page 60.
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CHOICE ONE COMMUNICATIONS INC.
TABLE OF CONTENTS
Page
Part I
Item 1. Business...................................................2
Item 2. Properties................................................23
Item 3. Legal Proceedings.........................................23
Item 4. Submission of Matters to a Vote of Security Holders.......23
Item 4A. Executive Officers of the Registrant......................23
Part II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters.......................................26
Item 6. Selected Financial Data...................................27
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................29
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk ........................................35
Item 8. Financial Statements and Supplementary Data...............36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................36
Part III
Item 10. Directors and Executive Officers of the Registrant........36
Item 11. Executive Compensation....................................36
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................36
Item 13. Certain Relationships and Related Transactions............36
Part IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.................................................37
Signatures................................................................59
Exhibits..................................................................60
1
Part I
ITEM 1: BUSINESS
General
We are an integrated communications provider offering voice and broadband data
telecommunications services primarily to small and medium-sized businesses in
second and third tier markets in the northeastern and midwestern United States.
Our services include local exchange service, long distance service, high-speed
data and Internet service, principally utilizing digital subscriber line ("DSL")
technology, and Web page design, development and hosting services. We seek to
become the leading integrated communications provider in each of our markets by
offering a single source of competitively priced, high quality, customized
telecommunications services. A key element of our strategy is to be one of the
first integrated communications providers to provide comprehensive network
coverage in each of the markets we serve. We are achieving this market coverage
by installing both voice and data equipment in multiple established telephone
company central offices. We have connected the majority of our clients directly
to our own switches, which allows us to more efficiently route traffic, ensure
quality of service and control costs. As of December 31, 2000, we were providing
service to 34,220 clients for 177,614 access lines, including 3,795 data lines.
On August 1, 2000, we acquired US Xchange, Inc., a facilities-based competitive
local exchange carrier with operations in the midwestern United States. Through
our acquisition of US Xchange, Inc., we have accelerated our entry into
midwestern markets and created a service area that now extends from Wisconsin to
Massachusetts. We have integrated US Xchange's operations and infrastructure
with ours and enhanced their product offerings to match those provided in our
northeastern markets. While US Xchange primarily offered voice services, we are
installing DSL equipment in those collocations and offering clients in the
former US Xchange markets a single source for voice and data telecommunications
services. US Xchange also resold other carriers' services to gain early entry
into a market and offered services to both residential and business clients, but
we have reduced the emphasis on resale and residential businesses in the former
US Xchange markets and are focusing on providing switch-based services to small
and medium-sized businesses.
On February 24, 2000, we acquired EdgeNet, Inc. a corporation based in Buffalo,
New York, which is engaged in the business of providing Internet home page
design and development.
In November 1999, we purchased all of the outstanding units of Atlantic
Connections, L.L.C., a local and long distance provider with operations in the
Portsmouth, New Hampshire and Worcester, Massachusetts metropolitan areas.
We currently offer telecommunications services in 26 markets in 11 states and
plan to become operational in an additional three markets during 2001. Following
the completion of our planned expansion to these 29 markets, we believe our
networks will be able to reach approximately 5.4 million business lines, which
constitute more than 70% of the estimated business lines in these markets. While
our network expansion would allow us to reach this number of business lines, the
number of business lines that we actually service will depend on our ability to
obtain market share from our competitors.
We have developed a flexible network buildout strategy which allows us to
achieve speed to market and cost efficiencies and to leverage rapidly evolving
telecommunications technology. In most of our markets, we initially deploy
digital switching platforms and lease network capacity to connect our switch
with our transmission equipment collocated in central offices of the established
telephone companies. This allows us to enter our markets more rapidly and with
lower initial costs than if we had to acquire or build fiber capacity. We
currently lease network capacity when entering a new market, and intend to
continue leasing, but may choose to own fiber capacity when and where traffic
volumes and other conditions make this alternative more cost efficient. As part
of our merger with US Xchange, we acquired rights to fiber formerly owned by US
Xchange in eight midwestern markets under an indefeasible right to use fiber
with a term of 20 years. In a separate transaction, we also purchased 20-year
indefeasible right to use fibers from Fiber Technologies, LLC for fiber capacity
in an additional 13 markets and acquired a minority interest and certain
governing rights in Fiber Technologies.
We have designed and are developing integrated operations support systems and
other back office systems. We believe these integrated systems give us
significant competitive advantages by enhancing our efficiency, allowing us to
support rapid and sustained growth and enabling us to provide exceptional client
care. We have automated most of our back office systems and are in the process
of integrating them into a seamless end-to-end system that will synchronize
multiple tasks, including installation, billing and client care. We recently
integrated our order management and billing systems in a manner that enables us
to transmit client information directly from the order management and service
fulfillment systems into the billing system, thereby eliminating redundant
keying
2
and reducing the potential for errors. In addition, in order to minimize the
time between a client order and service installation, we have also established
an on-line and real-time connection, called electronic bonding, of our
operations support systems with Verizon and Ameritech. We anticipate
establishing similar real-time connections with other established telephone
companies.
In each of our markets, we have a locally based sales force that provides high
quality, personalized client care. In addition to our direct sales force, we use
third party agencies to sell our services. These agencies include
telecommunications equipment vendors, consultants, systems integrators and
cellular phone retailers.
Business Strategy
We have an aggressive growth strategy to become the provider of choice offering
one-stop communications solutions to clients in our markets. Our future success
will depend upon our ability to implement this strategy. The key elements of our
business strategy are to:
Capitalize on Early to Market Advantage
Our goal is to continue to be among the first integrated communications
providers in an area to actively market and provide a bundled package of
integrated services to small and medium-sized businesses. We believe this
strategy provides us with a significant advantage over competitors who enter our
markets after us.
Target Underserved Clients
We are targeting small and medium-sized businesses primarily in second and third
tier markets in the northeastern and midwestern United States. We believe these
markets are currently being underserved by the established telephone companies
and other competitive telecommunications providers. We are focusing on markets
where there is a high concentration of potential business clients and a demand
for the types of services we offer. We believe we can attract and satisfy
clients in these areas by offering a simplified, comprehensive package of
services and a high level of client care.
Offer Broad Coverage
Once we enter a market, we provide broad geographic coverage within the market
by collocating in multiple locations within these markets to reach both central
business districts and outlying areas. While other companies often limit their
network buildout to highly concentrated downtown areas, our collocation strategy
is to reach 70% to 80% of the business lines within each market. As a result, we
are often the only competitor to the established telephone company to offer
integrated services to small and medium-sized businesses at many of our
collocation sites.
Offer Bundled Services with a Single Point of Contact
We strive to attract new clients and maximize client retention by offering
bundled services with a single point of contact for sales and service and
convenient, integrated billing. Our clients may bundle local exchange service,
long distance service, high-speed data and Internet service principally
utilizing DSL technology, e-mail, Web page design, development and server
hosting, voicemail and other enhanced services not generally available from the
established telephone companies, or available only at higher prices along with
their traditional local and long distance services. In addition, we have
developed a billing system which will provide our clients with a single, easy to
understand statement covering all of their services.
Lead Competition in Providing DSL Services
We believe we are and will continue to be one of the first integrated
communications providers in each of our markets to provide dedicated, high-speed
digital communications services using DSL technology. DSL technology permits
broadband transmissions over existing copper telephone lines, allowing us to
provide high-speed services economically. High-speed connectivity is becoming
increasingly important to small and medium-sized businesses due to the dramatic
growth in Internet and electronic business applications. We have installed DSL
equipment in most of our collocations and are retrofitting the existing
collocations in the former US Xchange markets with DSL equipment. We expect to
build out all new collocations with this equipment.
Maintain Our Flexible Network Buildout Strategy
We have developed a flexible network buildout strategy which allows us to
achieve speed to market and cost efficiencies and to leverage rapidly evolving
telecommunications technology. In most of our markets we initially deploy
digital switching platforms and lease network capacity to connect our switch
with our transmission equipment collocated in central offices of the established
telephone carriers. This allows us to enter our markets more rapidly and with
lower initial costs than if we had to acquire fiber capacity. We intend to
continue to lease network capacity when entering a new market, but may choose to
own fiber capacity when and where traffic volume makes this alternative more
cost-efficient.
3
Utilize Efficient Automated and Integrated Back Office Systems
Our management team is committed to having efficient operations support systems
and other back office systems that can support rapid and sustained growth. To
realize this objective, we have a team of engineering and information technology
professionals experienced in the telecommunications industry. Our systems team
is developing a seamless end-to-end system that will synchronize multiple tasks,
including installation, billing and client care. We have already integrated
software from ADC Communications, Inc. (formerly Saville Systems Inc.), MetaSolv
Software Inc. and DSET Corporation, and are currently working with other third
party vendors to integrate their software into our end-to-end system. Unlike the
legacy systems currently employed by many established telephone companies and
competitive local exchange carriers, which require multiple entries of client
information to synchronize multiple tasks, our system will require only a single
entry to transfer client information from sales to service to billing. Our
customized system will also integrate our back office systems to minimize the
time between client order and service installation and to reduce our costs. We
have implemented an electronic interface, referred to as electronic bonding,
linking our operations support systems directly to Verizon and Ameritech, so
that we can switch Verizon and Ameritech clients to our network on an automated
basis. We anticipate developing similar bonds with other established telephone
companies.
Increase Our Market Share by Providing Service-Driven Client
Relationships and a Local Presence
We seek to attract and retain clients by establishing local sales offices in
each of our markets and providing a highly experienced, locally based account
management team which will provide face-to-face sales and personalized client
care. We are dedicated to building long-term relationships with our clients,
which we believe have not typically received a satisfying level of local support
from the established telephone companies. Our service guarantee provides that if
a client is not satisfied with the quality of our service and we cannot remedy
the problem within 30 days, we will incur all of the costs to switch the client
back to its previous provider. In addition, we are committed to supporting and
further developing the communities in which our clients live and work. Our
employees live in these communities and many of them participate in local
charities, organizations and chambers of commerce. We believe that this local
presence builds strong, positive Choice One name recognition within these
communities.
Accelerate Growth Through Acquisitions
We intend to continue to accelerate our growth into new market regions and
expand our presence in our existing target market regions by acquiring
telecommunications companies and related businesses and assets. We seek
acquisition targets that offer similar services to ours which can be integrated
into our existing operations and networks. We also seek acquisition targets
which would allow us to offer additional value-added or other related services
as well as new technologies that we may seek to implement. Once we have acquired
a company, we intend to integrate the company by expanding its offered services
to the full range of Choice One services, centralizing administrative, billing
and client care functions and reducing redundant overhead. We currently have no
definitive agreements relating to any material acquisitions.
Leverage Management Experience
Our management team has extensive experience and success in the
telecommunications industry, especially in our target markets. We believe that
our ability to draw upon the collective talent and expertise of our senior
management gives us a competitive advantage in the execution of network
deployment, sales and marketing, service installation, billing and collection,
back office and operations support systems, finance, regulatory affairs and
client care.
Our Telecommunications Services
Our service offerings are tailored to meet the specific needs of small and
medium-sized businesses in our markets. In all of our markets, we offer both
voice and data services, which can be purchased by our clients either as a
bundled package or as individual services.
Bundled Services
Through our InfiniteChoiceSM plans, our clients may bundle local, long distance
and high-speed Internet services in a variety of combinations to meet their
particular needs. Our InfiniteChoiceSM bundled plans can save our clients up to
20% off the regular price lists disclosed by established telephone companies for
the same services. The rates that we use as a baseline for our services are
established telephone companies' tariff rates, which do not include special
price promotions.
4
Individual Services
As an alternative to choosing an InfiniteChoiceSM plan, clients can select one
or more individual services. Our clients can choose from the following services:
Local Calling Services. Our local exchange services are offered through our
ChoiceXchangeSM service plan. This service includes dialing parity, simplified
local rates, local number portability, listing in white and yellow page
directories and access to 911 and directory assistance. Also available through
the service are enhanced features, such as three-way conference calling, line
rollover, call forwarding, call waiting, caller identification and voice mail.
Our voice mail service, known as ChoiceMessageSM, includes free call forwarding,
remote access, paging notification, personalized greetings and password
protection. In certain of our markets we also originate and terminate
interexchange calls placed or received by our clients at no additional charge
and offer free local calling between our clients.
Long Distance Services. Through our ChoiceOnePlusSM service, we offer a full
range of domestic and international long distance services, including "1+"
outbound calling, six second incremental billing, inbound toll free service, and
complementary services such as calling cards with operator assistance and
conference calling. To provide easy to understand billing to our clients, we
also offer one rate on any calls within the U.S. We do not offer long distance
as a stand-alone service to new clients.
Internet Access and DSL High-speed Data Services. With our ChoiceOneOnLineSM
suite of Internet services, we offer a comprehensive solution to our clients'
requirements including Internet access, e-mail, domain name hosting and other
value-added services. We offer Internet access via DSL technology; dedicated
digital transmission links with a capacity equivalent to 24 standard telephone
lines, known as T-1 connections; and dial-up. We provide high-speed data
communications and Internet access to our targeted small and medium-sized
businesses at rates that we believe are very attractive when compared to the
cost and performance of other available data service offerings.
Our Choice NetJetSM service, powered by DSL technology, is highlighted by
the following key elements:
o Customizable Bandwidth. We offer our clients speeds ranging from 128kps
to 1.544 mbps. Our clients choose the speed and bandwidth capacity that
meets their needs.
o Always On. Through Choice NetJetSM, our clients are connected 24 hours
a day, 7 days a week.
o Symmetric Connections. Our service allows for data transmission at the
same speed in both directions.
o Security. Our server is designed to prevent unauthorized access to our
clients' information and enable the safe and secure transmission of
sensitive information and applications.
o No Usage Fees. Our clients may use their Choice NetJetSM connection for
any period of time without per minute usage charges.
Dedicated T-1 Services. We offer ChoicePathSM dedicated T-1 services as an
integrated low cost solution for dedicated access for bundling Internet/data,
local and long distance services over a single connection. ChoicePathSM permits
digital connections to be purchased in blocks of 24 circuits or on an individual
basis.
Virtual Private Network Services. Our Choice One DataLinkSM services combine our
DSL and dedicated T-1 access services with our virtual private network equipment
to provide clients with high-speed and secure connections to their corporate
local area network and the Internet. This flexible and cost-effective solution
supports both telecommuters and site-to-site connections.
Web Hosting. We offer a range of shared web hosting products targeted to meet
the needs of most small to medium-sized businesses. We provide clients with a
reliable web presence they need to meet their Internet-related objectives
without the initial capital expense required to purchase and maintain their own
equipment. We also provide e-mail hosting solutions and domain name registration
and hosting.
Web Design Services. We offer web design solutions that accommodate a range of
client needs, from establishing a simple web presence to creating sophisticated
web sites. We offer three different web design options that combine the economy
of a packaged design product with the flexibility to create a customized look.
Our clients can choose the layouts, colors, and content they desire to create a
web site suitable to their particular needs. When clients are ready to expand
their web presence, we also offer custom web design services for higher-end
applications.
5
Other Planned Services
Network Based Services. By leveraging our network resources, we plan to provide
network based services, such as firewall security, basic routing and network
monitoring, for which clients would pay a combined monthly charge. We believe
these products will be attractive to small to medium-sized businesses that
require high-end network services, but do not want to make the large capital
investments required to perform these functions themselves.
Hosted Application Services. We plan to offer a suite of advanced software
applications that can be accessed via our high-speed data services. Clients
would pay a monthly charge per user, per application, which would eliminate the
need for them to purchase and support these applications themselves.
Sales and Client Care
We attract and retain clients by establishing local sales offices in each of our
markets and providing a highly experienced, locally based, dedicated account
management team which provides face-to-face sales and personalized client care.
In each market we have a sales force that uses a consultative selling approach
to offer clients a full range of sophisticated and cost-effective
telecommunications solutions. We are committed to support and development of the
communities in which our clients and our employees live and work.
In each of our markets, we have a sales teams led by a general manager who is
responsible for the acquisition and retention of all revenue in that market.
Each team includes direct salespersons, service order coordinators, client
development representatives and technical consultants. Our direct salespersons
target various segments of business clients with the goal of calling on every
qualified prospective business client in the territory. Sales teams use a
variety of methods to qualify leads and set up initial appointments, including
telemarketing and building canvassing. Client development representatives are
assigned to each client to manage our relationship with the client on an
on-going basis. These representatives are responsible for client service and
retention as well as responding to and supporting our client's on-going needs by
identifying their evolving requirements and up-selling a broader array of
comprehensive telecommunications services. In addition to our direct sales
force, we use independent third-party sales agencies who sell our products and
services directly to their unique client bases. These agencies include
telecommunications equipment vendors, consultants, system integrators and
cellular phone retailers.
We target our sales recruitment efforts to experienced sales representatives
with significant local market experience and business contacts. Each member of
our sales and sales support team is required to participate in a training
program designed to enhance knowledge of telecommunications, sales processes and
activity management. This program also promotes our quality client care and
personalized local service principles and ensures a consistent market message in
all our territories. We have designed commission plans and incentive programs to
reward and retain our top performers and to encourage strong client
relationships.
We focus on providing responsive client care 24 hours a day, seven days a week.
Our commitment is demonstrated by our service guarantee, which provides that if
a client is not satisfied with the quality of our service and we cannot remedy
the problem within 30 days, we will incur all of the costs to switch the client
back to its previous provider. Our automatic call distribution system enables us
to efficiently manage our client contacts. In addition to basic call
distribution features, this system allows for computer telephony integration,
allowing access to client information at the time of a call; task queuing,
enabling automatic distribution of a phone call, fax or e-mail; and geographic
routing, which allows client services representatives to receive incoming
contacts from an assigned geographic area.
As of December 31, 2000, we had 572 persons in our sales and sales support
staff, not including our independent third-party sales agencies.
6
Our Markets
We offer telecommunications services in 26 markets, comprising 34 basic trading
areas, and have plans to expand into three additional markets during 2001. In
selecting our markets, we estimate market demand for our services using data
gathered from interexchange carriers, the FCC, local sources, site visits and
specific market studies. In addition to market demand, we also consider the
established telephone companies' level of service as well as the level of
penetration within the market by other integrated communication providers.
We are currently operating in the following markets:
Akron, OH(1) Green Bay, WI(2) Providence, RI
Albany, NY Harrisburg, PA(3) Rochester, NY
Allentown, PA Hartford, CT Rockford, IL
Buffalo, NY Kalamazoo, MI(4) Scranton, PA
Columbus, OH Madison, WI South Bend, IN(6)
Dayton, OH Manchester, NH Springfield, MA
Evansville, IN Milwaukee, WI Syracuse, NY
Fort Wayne, IN New Haven, CT(5) Worcester, MA
Grand Rapids, MI Pittsburgh, PA
(1) Also includes the basic trading area for Youngstown, OH.
(2) Also includes the basic trading areas for Appleton, WI and Oshkosh, WI.
(3) Also includes the basic trading area for Lancaster, PA.
(4) Also includes the basic trading area for Battlecreek, MI.
(5) Also includes the basic trading areas for Bridgeport, CT and Stamford, CT.
(6) Also includes the basic trading area for Elkhart, IN.
We are constructing voice and data switching facilities in the following three
markets: Ann Arbor/Lansing, MI; Richmond, VA; and Indianapolis, IN. We expect
these markets to be operational during 2001.
As of December 31, 2000, we had applications accepted to collocate our network
equipment in 467 established telephone company central offices, had completed
410 of these collocations and had 57 additional collocations in progress in our
operational and under construction markets. Most of these collocations also
include equipment to provide DSL services.
The table below provides selected key operational data as of the years ended
December 31:
2000 1999
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Markets Served 26 9
Number of switches-voice 24 8
Number of switches-data 45 10
Total Central Office Collocations 410 141
Estimated Addressable Market (Business Lines) 4.1 million 1.5 million
Lines in service-total 177,614 20,096
Lines in service-voice 173,819 19,890
Lines in service-data 3,795 206
Total Employees 1,420 390
Sales Employees 572 156
7
Network Infrastructure
We have developed a flexible network buildout strategy to allow us to enter
markets quickly, to achieve cost efficiencies and attractive rates of return on
capital by adding incremental network capacity as needed, and to integrate and
benefit from new telecommunications technologies.
We have a Lucent Series 5ESS(R) digital switch in each of our operational
markets, other than Worcester, MA and New Haven, CT. We are serving the
Worcester market by connecting our equipment in the Worcester market to our
Springfield, MA switch. A similar network configuration is utilized between the
Hartford and New Haven, CT markets. We are also installing a packet based switch
network in each market in order to establish a widespread coverage area for the
offering of high bandwidth digital connections utilizing DSL technology. As of
December 31, 2000, we had 24 Lucent 5-ESS(R) switches in service and 45 data
switches in service. Our switches are connected to established telephone
companies' networks and long distance and Internet service provider
points-of-presence.
We are pursuing a collocation strategy under which we are installing voice
concentrators, referred to as integrated digital loop carriers, and related
equipment in numerous established telephone company central offices in each of
our markets. Additionally, we are installing data concentrators, referred to as
digital subscriber line access modules, in the same central offices so that we
can provide high-speed DSL data access using the existing established telephone
company network. Our goal is to install our network equipment, including both
voice and data components, in sufficient established telephone company central
offices to address 70% to 80% of the business lines in each market. Because US
Xchange did not offer DSL service prior to its acquisition by us, we are
currently retrofitting the former US Xchange voice collocations with data
concentrators. Work is progressing on the completion of these data installations
and we anticipate that the remaining sites will be completed by the end of 2001.
We lease unbundled loops from the established telephone company or T-1
facilities from the established telephone company or competitive network
provider to connect our equipment in the telephone company central office to the
client locations.
When entering into a market, we lease local network facilities from the
established telephone company and/or one or more competitive network providers
to connect our switch to established telephone company central offices.
Initially leasing these facilities allows us to begin operations more quickly
and at a lower upfront cost than if we had to acquire or build them, but we may
choose to own local fiber network capacity when and where traffic volume and
other conditions make this alternative more cost effective. We received a
20-year indefeasible right to use fiber for operational intra-city fiber in
eight markets as part of our acquisition of US Xchange and are replacing leased
capacity with our own network in numerous other markets. Additionally as part of
the acquisition, we acquired a 20-year indefeasible right to use fiber for a
1,691 mile inter-city fiber network between nine markets in Wisconsin, Illinois,
Indiana and Michigan. We expect this inter-city fiber network to be operational
during the first half of 2001.
We have also entered into an agreement with Fiber Technologies, LLC. ("Fiber
Technologies"), to become the anchor tenant on its local fiber loops in certain
markets. We acquired 20-year indefeasible right to use fiber capacity in 13
markets, with additional markets to be determined. Fiber Technologies commenced
construction in three of our markets during the third quarter of 2000. Our
contract with Fiber Technologies calls for preferred pricing for the first five
years of the agreement. We expect that benefits of these indefeasible right to
use fibers will include network redundancy, reduced provisioning intervals
(provisioning onto our own network, versus relying on the incumbent local
exchange carriers for provisioning) and reduced per unit costs with additional
product offerings. In addition to this arrangement, we have acquired a minority
interest in Fiber Technologies, have the right to appoint one representative to
the board of directors, and will have a vote in determining the new markets in
which Fiber Technologies will develop and build fiber.
We operate a network operations control center, or NOCC, facility in Grand
Rapids, Michigan, which provides monitoring of the switching and fiber
facilities across our entire network 24 hours per day, seven days per week.
We have had ongoing market tests of voice over DSL with clients since late 1999.
This technology allows us to provide both voice and high-speed data
communications over one established telephone company line, thereby reducing our
network costs. Our network architecture, comprised of both DSL or voice and data
switching technologies, enables us to integrate this traffic over DSL from the
client location to our access equipment, and then to our regional switching
center. At the regional center, this traffic is split into its voice and data
components. Data traffic is switched via a data switch to its appropriate
destination. The voice components are switched through the Lucent 5ESS(R)
switch, which is interconnected to the public switched telephone network.
Rapid and significant changes in technology are expected in the
telecommunications industry. Our future success will depend, in part, on our
ability to anticipate and adapt to technological changes. For example, we are
currently evaluating new switching devices, from leading equipment manufacturers
that are significantly smaller and less expensive than the switches that we have
deployed to date. We believe that this network design positions us to rapidly
implement our future voice-switching infrastructure. Using various
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combinations of voice and data switching, our network uses a distributed design
that creates network efficiencies, closely correlates capital costs with traffic
volumes, and distributes access/routing elements closer to our clients. Many
switch and product elements are centralized to serve multiple markets. This
design encourages capital efficiencies while enabling enhanced feature and
service functionality.
Information Systems
We are implementing an integration strategy for our operations support systems
and other back office systems that we believe will provide significant
competitive advantages in terms of efficiency, capacity to process large order
volumes and the ability to deliver exceptional client care. We are developing a
seamless end-to-end system that will synchronize multiple activities. This
system will allow information to be entered once and at the appropriate time
within our sales, client care, trouble management and billing process.
Information will then be shared between the various components of our systems.
We believe that our single entry system will be superior to systems requiring
multiple entries of client information. Duplicate information entered into
multiple systems can result in billing problems, service interruptions, and
delays in installation. Our single entry process is less labor intensive and
will reduce the margin for error. In addition, the sales to billing interval
will be significantly shortened. We expect that our customized, integrated
system will also enable us to support rapid and sustained growth.
The individual components of our system are as follows:
Order Entry, Process Flow, Network Inventory, Billing and Administration
We have entered into an agreement with MetaSolv Software Inc. to license its
Telecom Business Solution, or TBS, software to manage our back office operations
support system. MetaSolv's software manages our order entry, service
installation, network element inventory, gateway interconnects and workflow
business functions and will allow our sales team to monitor the status of the
order from initiation through service implementation.
We have entered into an agreement with ADC Communications to utilize its
Convergent Billing Platform AS/400 software which enables us to combine and bill
current and future service offerings and present the information on a single
bill for our clients. This system supports client care functions, including
billing inquiries and collection processes. Call detail records, such as the
billing records generated by our voice or data switches will be automatically
processed by the billing services provider in order to calculate and produce
bills in a variety of formats.
Our MetaSolv system has been integrated with our ADC Communications billing and
administration system to ensure data integrity and eliminate redundant data
entry. This integrated software solution allows us to efficiently bill for
multiple products on a single statement and provides a central point of contact
for handling orders and activities.
Electronic Bonding
Through software that we have licensed from DSET Corporation and have integrated
with our MetaSolv software, we have established electronic bonding with Verizon
and Ameritech. We have implemented an electronic interface linking our
operations support systems directly to the established telephone company system
so that we can process orders on an automated basis for our clients which are
switching service from an established telephone company. Additionally, we can
confirm receipt and installation of service on-line and in real-time. We
anticipate forming similar connections with other established telephone
companies, although some established telephone companies are just beginning to
develop automated interfaces. We intend to continue to take a lead role with
selected established telephone companies to create standards for automation of
these interfaces.
Trouble Ticketing
We have created a system that logs information related to and monitors the
resolution of network problems. This system acts as a central repository for
logging client trouble calls, assigning responsibility for addressing the
problem to the appropriate party, and tracking the status of the response to the
calls, including automatically escalating the response process, as appropriate.
Sales Force Automation and Contact Management
Our sales force utilizes software referred to as contact automated sales helper.
This software assists us in the management of potential customer contacts, the
distribution of lists of potential clients, the preparation of client forecast
materials, the management of the sales process with particular client prospects
and the preparation of proposals, correspondence and order forms.
9
Service Introduction
Prior to offering services in a market, we must secure certification from state
regulatory commissions. Typically, we must file tariffs, or price lists, for the
services that we will offer. The certification process varies from state to
state; however, the fundamental requirements are largely the same. State
regulators require new entrants to demonstrate that they have secured adequate
financial resources to establish and maintain good client service. New entrants
are also required to show that they have the requisite technical and managerial
ability required to establish and operate a telecommunications network. Our
operating subsidiaries have already received certificates of authority to
provide local exchange and interexchange telecommunications services in each of
the states in which we currently operate and Virginia. In addition, we have
received authority under Section 214 of the Communications Act of 1934 to
provide international switched services.
Before providing local service, we must also negotiate and execute an
interconnection agreement with the established telephone company. While such
agreements can be voluminous and may take months to negotiate, most of the key
interconnection issues have now been thoroughly addressed and regulatory
commissions in most states have ruled on arbitrations between the established
telephone companies and new entrants. New entrants may adopt an interconnection
agreement already entered into by the established telephone company and another
carrier. We will selectively adopt such an approach so that we can enter markets
quickly. At the same time, we will preserve our right to replace the adopted
agreement with a customized interconnection agreement that can be negotiated
once service has already been established. We have adopted interconnection
agreements with the established telephone companies in each of the states in
which we currently operate and Virginia. Some established telephone companies,
such as Verizon, have sought to limit the rights of competitive
telecommunications providers to adopt existing interconnection agreements. We
cannot predict whether we will be able to adopt such interconnection agreements
in the future.
While interconnection agreements include key terms and prices for
interconnection circuits, a significant joint implementation effort must be made
with the established telephone company in order to establish operationally
efficient and reliable traffic interchange arrangements. Interchange
arrangements must include those between the new entrant's network and the
facilities of other service providers as well as public service agencies.
Examples of traffic interchange and interconnection arrangements utilizing the
established telephone companies network include connectivity to its out-of-band
signaling facilities, interconnectivity to the established telephone company's
operator services and directory assistance personnel, and access through the
established telephone company to the networks of wireless companies and
interexchange carriers.
Regulation
The following summary of regulatory developments and legislation describes
the primary present and proposed federal, state, and local regulations and
legislation that is related to the telecommunications and Internet service
industries that would have a material effect on our business. Existing federal
and state regulations are currently subject to judicial proceedings, legislative
hearings and administrative proposals that could change, in varying degrees, the
manner in which our industries operate. We cannot predict the outcome of these
proceedings or their impact upon the telecommunications and Internet service
industries or upon us.
Overview
Our telecommunications services are subject to federal, state and local
regulation. The FCC exercises jurisdiction over all facilities and services of
telecommunications common carriers to the extent those facilities are used to
provide, originate, or terminate interstate or international communications.
State regulatory commissions exercise jurisdiction over facilities and services
to the extent those facilities are used to provide, originate or terminate
intrastate communications. In addition, as a result of the passage of the
Telecommunications Act of 1996, state and federal regulators share
responsibility for implementing and enforcing the domestic pro-competitive
policies of the Telecommunications Act. In particular, state regulatory
commissions have substantial oversight over the provision of interconnection and
non-discriminatory network access to established telephone companies. Local
governments often regulate public rights-of-way necessary to install and operate
networks.
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Federal Regulation
We are regulated at the federal level as a nondominant common carrier subject to
minimal regulation under Title II of the Communications Act of 1934. Recent
legislation amending the Communications Act provides for comprehensive reform of
the nation's telecommunications laws and is designed to enhance competition in
the local telecommunications marketplace by requiring established telephone
companies to provide us with access and interconnection to their facilities and
open their local markets to competition.
One of our current market advantages is our ability to offer both local and long
distance service, while the largest established telephone companies can only
offer local service in their region. Under the Telecommunications Act, regional
Bell operating companies have the opportunity to provide long distance services
in the same region in which they offer local service if they comply with
market-opening conditions. Established telephone companies are no longer
prohibited from providing specified cable TV services. In addition, the
Telecommunications Act eliminates particular restrictions on utility holding
companies, thus clearing the way for them to diversify into telecommunications
services.
Before a regional Bell operating company can provide in-region long distance
services, it must obtain FCC approval upon showing that it has entered into
interconnection agreements with competitive local exchange carriers in the
states where it seeks authority, that the interconnection agreements satisfy a
14-point "checklist" of competitive requirements and that such entry is in the
public interest. To date, Verizon has been granted such authority in New York,
and Southwestern Bell has been granted such authority in Texas, Kansas and
Oklahoma. Several additional requests for such authority either have or soon
will be filed. The provision of in-region long distance services by the regional
Bell operating companies could permit them to offer "one-stop shopping" of
bundled local and long distance services, thereby eliminating our current
marketing advantage.
FCC Rules Implementing the Local Competition Provisions of the
Telecommunications Act
Over the last four years, the FCC has established a framework of national rules
enabling local competition. Some of those rules have important bearing on our
business, particularly:
Interconnection. Established telephone companies are required to provide
interconnection for telephone exchange or exchange access service, or both, to
any requesting telecommunications carrier at any technically feasible point. The
interconnection must be at least equal in quality to that provided by the
company to itself or subsidiaries, affiliates or any other party to which it
provides interconnection, and must be provided on rates, terms and conditions
that are just, reasonable and nondiscriminatory.
We have obtained or will obtain agreements with some established telephone
companies. These agreements must be renegotiated periodically. Renewal terms may
be less favorable and could affect our overall costs.
Access to Unbundled Elements. Established telephone companies are required to
lease portions of their networks to requesting telecommunications carriers by
providing them with nondiscriminatory access to network elements on an unbundled
basis at any technically feasible point, on rates, terms, and conditions that
are just, reasonable, and nondiscriminatory. This is important, because it
minimizes our need to make major investments in building our network. At a
minimum, established telephone companies must provide competitors with access to
various network elements used to originate and terminate telephone calls, call
routing database facilities, and computerized operations support systems.
For example, the FCC recently adopted additional rules that direct established
telephone companies to share their local telephone lines so that competitors
could make use of the high frequency portion of the line. This will enable
competitive carriers like us to use DSL technology to provide high-speed data
services over the same telephone lines simultaneously used by established
telephone companies to provide basic telephone service, a technique referred to
as "line sharing." The short term effect of this order is difficult to predict,
as the FCC left it to the states to determine how this should be done, and what
rates the incumbent local exchange carriers may charge. This process could take
some time, even without considering any appeals of this order that may be filed.
In the long term, however, this rule could have the effect of sharply reducing
our costs of providing DSL service.
Collocation. Established telephone companies are required to provide space in
their switching offices so that requesting telecommunications carriers can
physically "collocate" equipment necessary for interconnection or access to
unbundled network elements at the company's premises, except that the
established telephone company may provide off-site "virtual" collocation, if it
demonstrates to the state regulatory commission that physical collocation is not
practical for technical reasons, or because of space limitations.
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Other Regulations
In general, the FCC has a policy of encouraging new competitors, such as us, in
the telecommunications industry and preventing anti-competitive practices.
Therefore, the FCC has established different levels of regulation of dominant
carriers, the established telephone companies, and nondominant carriers,
integrated communications providers and competitive local exchange carriers.
Tariffs. As a nondominant carrier, we may install and operate facilities for the
transmission of domestic interstate communications without the time and expense
of obtaining prior FCC authorization. Our primary regulation obligations are to
file schedules of rates and terms of service, called tariffs, and making
periodic reports. A filed tariff benefits us because it relieves us from
negotiating contracts with each customer.
In October 1996, the FCC adopted its de-tariffing order, which eliminated the
requirement that nondominant interstate carriers like us maintain tariffs on
file with the FCC for domestic interstate services, and provided that, after a
nine-month transition period, relationships between interstate carriers and
their clients would be set by contract, not tariff. Although the effectiveness
of these rules was stayed for more than three years, they were ultimately
upheld. The de-tariffing order is now scheduled to become effective in early
2001, after which time nondominant interstate services providers will no longer
be able to rely on the simple filing of tariffs with the FCC as a means of
providing notice to clients of prices, terms and conditions under which they
offer their interstate services. If we cancel our FCC tariffs as a result of the
de-tariffing order, we will need to implement replacement contracts with each
customer, which could result in substantial administrative and selling expenses.
International Services. Nondominant carriers such as us also are required to
obtain FCC authorization pursuant to Section 214 of the Communications Act and
file tariffs before providing international communications services. We have
obtained such authority. The FCC has adopted rules for a multi-year transition
to lower international settlement payments by U.S. common carriers. We believe
that these rules are likely to lead to lower rates for some international
services and increased demand for these services, including capacity on the U.S.
facilities, like ours, that provide these services.
Established Telephone Company Pricing Regulation Reform. The FCC has adopted a
number of proposals to significantly reduce its regulation of established
telephone company pricing which would greatly enhance the ability of established
telephone companies to compete against us, particularly by targeting price cuts
to particular clients, which could have a material adverse effect on our ability
to compete based on price. Review of these FCC decisions is currently pending
before the District of Columbia Circuit.
Access Charges. The FCC has also made various reforms to the existing rate
structure for charges assessed on long distance carriers for allowing them to
connect to local networks. These changes will reduce access charges and will
shift charges, which had historically been based on minutes-of-use, to flat
rate, monthly per line charges on end-user clients rather than long distance
carriers. As a result, the aggregate amount of access charges paid by long
distance carriers to access providers like us may decrease.
At the same time, the FCC, noting the proliferation of fixed monthly charges on
the bills of long distance customers, has recently initiated a public inquiry on
the impact of these charges on consumers.
Moreover, major long distance carriers are attempting to undermine our ability
to set access charges as we choose. In October 1998, AT&T initiated a proceeding
in which it sought a declaration from the FCC that AT&T may avoid competitive
local exchange carrier access charges by declining to direct calls to the
clients of those competitive local exchange carriers. In addition, AT&T and
Sprint have sent letters to virtually every competitive local exchange carrier
stating that competitive local exchange carriers access charges for in-bound
long distance calls are unreasonable, and demanding a reduction in rates to a
"competitive" level. If competitive local exchange carriers are unwilling to
comply, AT&T and Sprint threaten to no longer deliver those calls. The FCC has
instituted a proceeding to investigate the issues surrounding competitive local
exchange carriers' access charges, including whether regulation of competitive
local exchange carriers' rates is warranted. If long distance providers may in
fact refuse to purchase competitive telecommunications providers' switched
assess services, or if such services are ultimately regulated, competitive
telecommunications providers like us may be adversely affected.
Universal Service Reform. Universal telephone service is a long-standing policy
initiative designed to assure that as many people as possible have access to
quality telephone service at affordable rates, particularly in rural and
high-cost areas, as well as providing advanced telecommunications services for
schools, health care providers and libraries. All telecommunications carriers
providing interstate telecommunications services, including us, must contribute
to the universal service support fund.
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In October 1999, the FCC issued an order changing the way that universal service
contributions are calculated to eliminate revenues from intrastate services from
the calculation. In November 1999, the FCC issued an order revising its rules
for calculating the size of the universal service fund, which shifts more of the
costs of universal service to the federal program. The changes resulting from
these orders are likely to increase the overall burden of the federal universal
service program on carriers providing interstate services, such as long
distance. Various states also are in the process of implementing their own
universal service programs, which also may increase our overall costs.
Slamming. The FCC has adopted rules to govern the process by which end users
choose their carriers. Under their rules, a user may change service providers at
any time, but specific client authentication procedures must be followed. When
they are not, particularly if the change is unauthorized or fraudulent, the
change in service providers is referred to as "slamming." Slamming is such a
significant problem that it was addressed in detail in the Telecommunications
Act and by the FCC in recent orders. The FCC has levied significant fines for
slamming. The risk of financial damage and harm to business reputation from
slamming is significant. Even one slamming complaint could cause extensive
litigation expenses for us. The FCC recently decided to apply its slamming
rules, which originally covered only long distance, to local service.
State Regulation. We believe that most, if not all, states in which we propose
to operate will require a registration, certification or other authorization to
offer intrastate services. Many of the states in which we operate or intend to
operate are in the process of addressing issues relating to the regulation of
competitive local exchange carriers. We will also be subject to tariff filing
requirements. In most states, we are required to file tariffs setting forth the
terms, conditions and prices for services that are classified as intrastate.
We have received, through our operating subsidiaries, certificates of authority
to provide local exchange and interexchange telecommunications services in
Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, New
York, Ohio, Pennsylvania, Rhode Island, Virginia, and Wisconsin. Applications
for such authority are pending in Maine and Vermont.
In addition to tariff filing requirements, some states also impose reporting,
client service and quality requirements, as well as unbundling and universal
service requirements. In addition, we will be subject to the outcome of generic
proceedings held by state utility commissions to determine new state regulatory
policies. Some states, including some of our target states, have adopted or have
pending proceedings to adopt specific universal service funding obligations.
These state proceedings may result in obligations that are equal to or more
burdensome than the federal universal service obligations.
We believe that, as the degree of intrastate competition increases, the states
will offer the established telephone companies increasing pricing flexibility.
This flexibility may present the established telephone companies with an
opportunity to subsidize services that compete with our services with revenue
generated from non-competitive services, thereby allowing established telephone
companies to offer competitive services at lower prices. This could have a
material adverse effect on our revenue.
We are also subject to requirements in some states to obtain prior approval for,
or notify the state commission of, specified events such as transfers of
control, sales of assets, corporate reorganizations, issuances of stock or debt
instruments and related transactions.
Local Authorizations. When constructing a network, such as fiber optic cables,
we generally must obtain municipal franchises and other permits. These rights
are typically the subject of non-exclusive agreements of finite duration and
provide for the payment of fees or the provision of services to the
municipality. In addition, we must secure rights-of-way, pole attachments and
other access rights, which are typically provided under non-exclusive multi-year
agreements that generally contain renewal options. In some municipalities we
will be required to pay license or franchise fees based on a percentage of gross
revenue or on a per linear foot basis, as well as post-performance bonds or
letters of credit.
Internet. Our Internet operations are not currently subject to direct regulation
by the FCC or any other telecommunications regulatory agency, although they are
subject to regulations applicable to businesses generally. However, the future
Internet service provider regulatory status continues to be uncertain. In an
April 1998 report, the FCC concluded that while some Internet service providers
should not be treated as telecommunications carriers, some services offered over
the Internet, such as phone-to-phone telephony, may be functionally
indistinguishable from traditional telecommunications service offerings, and
that their non-regulated status may have to be re-examined. Moreover, although
the FCC has decided not to allow local telephone companies to impose per-minute
access charges on Internet service providers, and that decision has been upheld
by the reviewing court, further regulatory and legislative consideration of this
issue is likely. The imposition of access charges would affect our costs of
serving dial-up clients and could have a material adverse effect on our
business, financial condition and results of operations. In addition, Congress
and other federal entities have adopted or are considering other legislative and
regulatory proposals that would further regulate the Internet. Various states
have adopted and are considering Internet-related legislation. Increased U.S.
regulation of the Internet may slow its growth or reduce potential revenue,
particularly if other governments follow suit, which may increase the cost of
doing business over the Internet.
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We believe that, under the Telecommunications Act, competitive local exchange
carriers are entitled to receive compensation from established telephone
companies for delivering traffic bound for Internet service provider clients of
the competitive local exchange carriers, despite the objections of established
telephone companies. While most states have required established telephone
companies to pay this compensation to competitive local exchange carriers, the
FCC is expected to issue a decision phasing out reciprocal compensation payments
over the next few years. If such a decision is made, there is a risk that state
public utility commissions that have previously considered this issue and
ordered the payment of reciprocal compensation by the established telephone
companies to the competitive local exchange carriers may be asked by the
established telephone companies to revisit their determinations, or may revisit
their determinations on their own motion.
Competition
We operate in a highly competitive environment and currently do not have a
significant market share in any of our markets. Most of our actual and potential
competitors have substantially greater financial, technical, marketing and other
resources, including brand name recognition, than we do. Also, the continuing
trend toward business alliances in the telecommunications industry, and the
increasingly reduced regulatory and technological barriers to entry in the data
and Internet services markets, could give rise to significant new competition.
We believe that the principal competitive factors affecting our business will be
pricing, client service, accurate billing and, to a lesser extent, variety of
services. Our ability to compete effectively will depend upon our ability to
provide high quality market-driven services at prices generally equal to or
below those charged by our competitors. To maintain our competitive posture, we
believe that we must be in a position to reduce our prices in order to meet
reductions in rates, if any, by others.
Established Telephone Companies
In each of our target markets, we will compete principally with the established
telephone company serving that area, such as Verizon, Frontier Telephone of
Rochester, Southern New England Telephone, SBC/Ameritech and GTE. Established
telephone companies are the established providers of dedicated and local
telephone services to the majority of telephone subscribers within their
respective service areas. In addition, established telephone companies generally
have long-standing relationships with their clients and with federal and state
regulatory authorities and have financial, technical and marketing resources
substantially greater than we do, and the potential to subsidize competitive
services from a variety of businesses.
While recent regulatory initiatives provide increased competitive opportunities
to voice, data, and Internet-service providers such as us, they also provide the
established telephone companies with increased pricing flexibility for their
private line, special access, and switched access services. With respect to
competitive access services, the fees to connect to an established telephone
companies' facilities, the FCC recently decided to increase established
telephone company pricing flexibility and deregulation for such services, either
automatically or after specified criteria are met. If the established telephone
companies are allowed additional flexibility to offer discounts to large
clients, engage in aggressive volume and term discount pricing practices, and/or
charge competitors with excessive fees for interconnection to their local
networks, the potential income of integrated communications providers and
competitive local exchange carriers, could be adversely affected.
Services Which Compete With Our DSL Services
The established telephone companies represent the dominant competition for DSL
services in all our markets. These companies have an established brand name,
possess sufficient capital to deploy DSL equipment rapidly, have their own
telephone wires and can bundle digital data services with their existing analog
voice services to achieve economies of scale in serving clients.
Cable modem service providers are deploying high-speed Internet services over
cable networks. Where deployed, these networks provide similar and in some cases
higher speed Internet access than we provide. We believe the cable modem service
providers face a number of challenges that providers of DSL service do not face.
For example, different regions within a metropolitan area may be served by
different cable modem service providers, making it more difficult to offer the
blanket coverage required by potential business clients. Also, much of the
current cable infrastructure in the U.S. must be upgraded to support cable
modems, a process which we believe is significantly more expensive and
time-consuming than the deployment of DSL-based networks.
Many competitive telecommunications companies have deployed large-scale Internet
access networks, and have high brand recognition. Internet service providers
also provide Internet access to residential and business clients, generally at
lower speeds than we offer.
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Competitive Telecommunications Providers
We also face competition from other current and potential market entrants,
including long distance carriers seeking to enter, reenter or expand entry into
the local exchange market such as AT&T and MCI WorldCom, and from resellers of
local exchange services and competitive access providers. We also face
competition from other competitive local exchange carriers with overlap in our
targeted markets, such as Adelphia Business Solutions, Inc. and Time Warner
Telecom. Even the established telephone companies, particularly the regional
Bell operating companies, have established independent competitive local
exchange carrier subsidiaries to compete with each other. Some of these
competitors have significantly greater financial resources than we do. For
example, AT&T, MCI WorldCom, and Sprint, which historically were only long
distance carriers, have each begun to offer local telecommunications services in
major U.S. markets using their own facilities or by resale of the other
providers' services. In addition, a continuing trend toward consolidation of
telecommunications companies and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies,
could give rise to significant new competitors. For example, the merger of
WorldCom, Inc. with MCI, Global Crossing's purchase of Frontier Corp., SBC's
merger with Ameritech, Qwest's merger with US WEST, and AT&T's acquisition of
Teleport Communications Group, Inc. and Telecommunications Inc. are examples of
these competitive alliances. Such combined entities may provide a "bundled
package" of telecommunications products, such as local, long distance, and
Internet telephony, that directly competes with the products we offer. These
types of consolidations and strategic alliances could put us at a competitive
disadvantage.
Fixed Wireless Companies
We also face competition from companies using radio and microwave spectrum
instead of physical wiring, known as fixed wireless services. These companies
utilize various wireless communications systems, and unlicensed wireless radio
services. The FCC has issued, or is in the process of issuing, licenses for
these services to provide broadband integrated telecommunications services on a
point-to-point and/or point-to-multi-point basis. Some of these service
providers, such as WinStar, Advanced Radio Telecom and Teligent, are operating
their wide-area networks in many top-50 urban areas. These service providers
offer integrated voice and data services to small and medium-sized businesses.
Several equipment manufacturers have developed still other low data-rate
transmission devices, such as infrared, that may provide non-regulated
competition to us.
The FCC has authorized mobile cellular personal communications services and
other commercial mobile radio services providers to offer wireless services to
fixed locations. Previously, cellular providers could provide service to fixed
locations only on an ancillary or incidental basis. This authority to provide
fixed as well as mobile services will enable these commercial providers to offer
"wireless" local loop service and other services to high density fixed
locations, such as office and apartment buildings, in direct competition with us
and other providers of traditional telephone service.
Other Competitors
Other companies that currently offer, or are capable of offering, local switched
services include: cable television companies, electric utilities, microwave
carriers, and large business clients who build private networks. These entities,
upon entering into appropriate interconnection agreements or resale agreements
with established telephone companies, could offer single source local and long
distance services like those that we offer. We also expect to increasingly face
competition from companies offering long distance data and voice services over
the Internet. Such companies could enjoy a significant cost advantage because
they do not currently pay carrier access charges or universal service fees.
In addition, at least two Bell operating companies have begun offering single
source local and long distance services in limited areas and others may follow.
Currently, Verizon is providing long distance service in New York State and
Southwestern Bell is offering long distance service in the state of Texas and is
authorized to offer long distance service in the states of Kansas and Oklahoma.
In general, regional Bell operating companies cannot provide long-distance
service that originates, or in some cases terminates, in one of its in-region
states until the regional Bell operating company has satisfied statutory
conditions in that state, and has received the approval of the FCC. Once the
regional Bell operating companies are allowed to offer in-region long distance
services, they will undoubtedly offer single-source local and long distance
service, which will give rise to increased competition to us. In the spring of
1998, four of the regional Bell operating companies petitioned the FCC to be
relieved of some particular regulatory requirements in connection with their
provision of high-speed data services, including obligations to unbundle
high-speed data loops and to resell such services. In October 1998, the FCC
ruled that high-speed services are telecommunications services subject to the
unbundling and resale obligations of the Telecommunications Act. However, the
FCC has initiated a proceeding to determine whether regional Bell operating
companies can create separate affiliates for their high-speed data services that
would be free from these obligations.
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Intellectual Property
We regard our products, services and technology as proprietary and attempt to
protect them with copyrights, trademarks, trade secret laws, restrictions on
disclosure and other methods. We also generally enter into confidentiality or
license agreements with our employees and consultants, and generally control
access to and distribution of our documentation and other proprietary
information. Currently we have 15 servicemark applications or registrations.
Despite our precautions, we may not be able to prevent misappropriation or
infringement of our products, services and technology.
Our logo and some titles and logos of our services mentioned in this prospectus
are either our service marks or service marks that have been licensed to us.
Each trademark, trade name or service mark of any other company appearing in
this prospectus belongs to its holder.
Employees
As of December 31, 2000, we had 1,420 employees. We believe that our future
success will depend on our continued ability to attract and retain highly
skilled and qualified employees. None of our employees are currently represented
by collective bargaining agreements nor have we experienced any work stoppage
due to labor disputes. We believe that we enjoy good relationships with our
employees.
RISK FACTORS
Risks Related to Our Business
WE ANTICIPATE HAVING FUTURE NEGATIVE EBITDA AND OPERATING LOSSES AS WE CONTINUE
TO EXPAND OUR BUSINESS AND ENTER INTO NEW MARKETS
The expansion and development of our business and the deployment of our
networks, services and systems will require significant capital expenditures, a
substantial portion of which will need to be incurred before the realization of
sufficient revenue. We expect that our adjusted EBITDA will be negative while we
emphasize development, construction and expansion of our telecommunications
services business and until we establish a sufficient revenue-generating client
base. Adjusted EBITDA represents earnings before interest, income taxes,
depreciation and amortization, non-cash deferred compensation, non-cash
management allocation charges, accretion on preferred stock and accrued PIK
(paid in kind) dividends on preferred stock. Adjusted EBITDA is used by
management and certain investors as an indicator of a company's historical
ability to service debt. For the year ended December 31, 2000, after giving pro
forma effect to the acquisitions of US Xchange and Atlantic Connections and the
incurrence of debt in connection therewith, we would have had operating losses
of $262.1 million, net losses applicable to common stock of $317.2 million and
negative adjusted EBITDA of $91.1 million. We expect that each of our markets
will generally produce negative adjusted EBITDA for at least 18 to 30 months
after operations commence in such market, and we expect to experience increasing
operating losses, net losses and negative adjusted EBITDA as we expand our
operations. We can make no assurances that we will achieve or sustain
profitability or generate sufficient adjusted EBITDA to meet our working capital
and debt service requirements, which could have a material adverse effect on our
business, financial condition and results of operations.
TO EXPAND AND DEVELOP OUR BUSINESS WE WILL NEED A SIGNIFICANT AMOUNT OF CASH,
WHICH WE MAY BE UNABLE TO OBTAIN
The expansion and development of our business and the deployment of our
networks, services and systems will require significant capital expenditures,
working capital and debt service, and the ability to sustain substantial cash
flow deficits.
The actual amount and timing of our future capital requirements may differ
materially from our estimates as a result of, among other things, the demand for
our services and regulatory, technological and competitive developments,
including additional market developments and new opportunities in our industry.
Our revenue and costs may also be dependent upon factors that are not within our
control, including regulatory changes, changes in technology, and increased
competition. Due to the uncertainty of these factors, actual revenue and costs
may vary from expected amounts, possibly to a material degree, and such
variations are likely to affect our future capital requirements.
We also expect that we may require additional financing or require financing
sooner than anticipated if our development plans change or prove to be
inaccurate. We may also require additional financing in order to develop new
services or to otherwise respond to changing business conditions or
unanticipated competitive pressures. Sources of additional financing may include
commercial bank borrowings, vendor financing, or the private or public sale of
equity or debt securities. We can make no assurances that we will be
successful in raising sufficient additional capital on favorable terms or at all
or that the terms of any indebtedness we may incur will not impair our ability
to expand and develop our business. Failure to raise sufficient funds may
require us to modify, delay or abandon some of our planned future expansion or
expenditures, which could have a material adverse effect on our business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
16
OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND
COULD PREVENT US FROM FULFILLING OBLIGATIONS
We are highly leveraged and have significant debt service and related
obligations. As of December 31, 2000, our aggregate outstanding indebtedness and
obligations was $447.0 million, our stockholders' equity was $259.5 million and
our redeemable preferred stock was $162.5 million. We have the ability to incur
up to an aggregate of $350.0 million under our senior credit facility and may
incur additional indebtedness subject to certain limitations in our credit
facility. The amount outstanding under our senior credit facility at December
31, 2000 was $267.0 million. We also had $180.0 million outstanding under our
subordinated debt facility. If new indebtedness is added to our current levels,
the related risks that we face could intensify.
Our substantial leverage could have important consequences to us. For example,
it could:
o make it more difficult for us to obtain additional financing for working
capital, capital expenditures, or acquisitions;
o require us to dedicate a substantial portion of our cash flow from
operations to the payment of principal and interest on our indebtedness,
thereby reducing the funds available to us for our operations and other
purposes, including investments in service development, capital spending
and acquisitions;
o place us at a competitive disadvantage to our competitors that are not as
highly leveraged as we are;
o impair our ability to adjust to changing market conditions; and
o make us more vulnerable in the event of a downturn in general economic
conditions or in our business or of changing market conditions and
regulations.
SERVICING OUR INDEBTEDNESS WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH AND OUR
ABILITY TO GENERATE CASH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL
We can make no assurances that we will be able to meet our debt service
obligations. If we are unable to generate sufficient cash flow or otherwise
obtain funds necessary to make required payments, or if we otherwise fail to
comply with the various covenants in our debt obligations, we would be in
default under the terms thereof, which would permit the holders of such
indebtedness to accelerate the maturity of such indebtedness and could cause
defaults under other debt related agreements. Our ability to repay or to
refinance our obligations with respect to our indebtedness will depend on our
future financial and operating performance, which, in turn, will be subject to
prevailing economic and competitive conditions and to certain financial,
business, regulatory and other factors, many of which are beyond our control.
These factors could include operating difficulties, increased operating costs,
pricing pressures, the response of competitors, regulatory developments and
delays in implementing strategic projects.
Our adjusted EBITDA is currently insufficient to pay our fixed charges. See
"Selected Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations". The successful
implementation of our business strategy, including deployment of our networks
and obtaining and retaining a significant number of clients, and significant and
sustained growth in our cash flow are necessary for us to be able to meet our
debt service obligations and working capital requirements. We can make no
assurances that we will successfully implement our business strategy, that the
anticipated results of our strategy will be realized, or that we will be able to
generate sufficient cash flow from operating activities to meet our debt service
obligations and working capital requirements. See "Business--Business Strategy".
If our cash flow and capital resources are insufficient to fund our debt service
obligations and working capital requirements, we could be forced to reduce or
delay capital expenditures (including switch and network expenditures), sell
assets, seek to obtain additional equity capital, or refinance or restructure
our debt. A disposition of assets in order to make up for any shortfall in the
payments due on our indebtedness could take place under circumstances that might
not be favorable to realizing the highest price for such assets.
17
WE EXPECT TO GROW OUR BUSINESS AND CANNOT GUARANTEE THAT WE WILL BE ABLE TO
EFFECTIVELY MANAGE OUR FUTURE GROWTH
The successful implementation of our business plan will result in rapid
expansion of our operations and the provision of bundled telecommunications
services on a widespread basis, which could place a significant strain on our
management, operations, financial and other resources and increase demands on
our systems and controls. Failure to manage our future growth effectively could
adversely affect the expansion of our client base and service offerings. We can
make no assurances that we will be able to successfully implement and maintain
efficient operations and financial systems, procedures and controls or
successfully obtain, integrate and utilize the employees and management,
operations, financial and other resources necessary to manage a developing and
expanding business in our evolving, highly regulated and increasingly
competitive industry. Any failure to expand in these areas and to implement and
improve such systems, procedures and controls in an efficient manner at a pace
consistent with the growth of our business could have a material adverse effect
on our business, financial condition and results of operations.
If we were unable to hire sufficient qualified personnel or develop, acquire and
integrate successfully our operations and financial systems, procedures and
controls, our clients could experience delays in connection of service and/or
lower levels of client service, our resources may be strained and we may be
subjected to additional expenses. Our failure to meet client demands and to
manage the expansion of our business and operations could have a material
adverse effect on our business, financial condition and results of operations.
IF WE ARE UNABLE TO DEVELOP OR INTEGRATE OUR INFORMATION AND PROCESSING SYSTEMS
OR PROPERLY MAINTAIN AND UPGRADE THEM, WE MAY NOT BE ABLE TO EFFECTIVELY BILL
OUR CLIENTS OR PROVIDE ADEQUATE CLIENT SERVICE
Sophisticated back office information and processing systems are vital to our
growth and our ability to monitor costs, bill clients, provision client orders
and achieve operating efficiencies. Our plans for the development and
implementation of these systems rely, for the most part, on choosing products
and services offered by third party vendors and integrating such products and
services in-house to produce efficient operational solutions. We can make no
assurances that these systems will be successfully implemented on a timely
basis, that they will be implemented at all or that, once implemented, they will
perform as expected. Risks to our business associated with our systems include:
o failure by our vendors to deliver their products and services in a timely
and effective manner and at acceptable costs;
o failure by us to adequately identify all of our information and processing
needs;
o failure of our related processing or information systems; and
o failure by us to effectively integrate new products or services.
Furthermore, as our suppliers revise and upgrade their hardware, software and
equipment technology, we could encounter difficulties in integrating the new
technology into our business or the new systems may not be appropriate for our
business. In addition, our right to use these systems is dependent upon license
agreements with third party vendors. Some of these agreements may be cancelled
by the vendor and the cancellation or nonrenewal of these agreements may have an
adverse effect on us.
WE MAY NEED TO RELY ON THE ESTABLISHED LOCAL TELEPHONE COMPANIES TO IMPLEMENT
SUCCESSFULLY OUR SWITCHED AND ENHANCED SERVICES WHOSE FAILURE TO COOPERATE WITH
US COULD AFFECT THE SERVICES WE OFFER
We are a recent entrant into the newly created competitive local
telecommunications services industry. The local exchange services market in most
states was only recently opened to competition. There are numerous operating
complexities associated with providing these services. We are required to
develop new products, services and systems and need to develop new marketing
initiatives to sell these services. We can make no assurances that we will be
able to continue to develop such products and services.
We are deploying high capacity voice and data switches in the cities in which we
will operate networks. We initially rely on the networks of established
telephone companies or those of new market entrants, known as competitive local
exchange carriers, for some aspects of transmission. Federal law requires most
of the established telephone companies to lease or "unbundle" elements of their
networks and permit us to purchase the call origination and call termination
services we need, thereby decreasing our operating expenses. We can make no
assurances that such unbundling will continue to occur in a timely manner or
that the prices for such elements will be favorable to us. In addition, our
ability to implement successfully our switched and enhanced services will
require the negotiation of interconnection and collocation agreements with
established telephone companies and competitive local exchange carriers, which
can take considerable time, effort and expense and are subject to federal, state
and local regulation.
18
Many new carriers have experienced difficulties in working with the established
telephone companies with respect to ordering, interconnecting, leasing premises,
and implementing the systems used by these new carriers to order and receive
unbundled network elements and wholesale services from the established telephone
companies. We can make no assurances that these established telephone companies
will continue to cooperate with us once they are permitted to offer long
distance service. If we are unable to obtain the cooperation of an established
telephone company in a region, whether or not such company has been authorized
to offer long distance service, our ability to offer local services in such
region on a timely and cost-effective basis would be adversely affected. In
addition, both proposed and recently completed mergers involving regional Bell
operating companies and other competitors could facilitate such a combined
entity's ability to provide many of the services offered by us, thereby making
it more difficult to compete against them.
Our data and voice services may not be profitable due to, among other factors,
lack of client demand, inability to secure access to established telephone
company facilities on acceptable terms, and competition and pricing pressure
from the established telephone companies and competitive local exchange
carriers. We can make no assurances that we will be able to successfully
implement our switched and enhanced services strategy. Implementation of our
data and voice services is also dependent upon equipment manufacturers' ability
to meet our equipment deployment schedule. We can make no assurances that
switches will be deployed on the schedule contemplated by us or that, if
deployed, such switches will be utilized to the degree contemplated by us. Any
of the foregoing factors could have a material adverse effect on our business,
financial condition and results of operations.
WE DEPEND ON PORTIONS OF THE ESTABLISHED TELEPHONE COMPANIES' NETWORKS FOR DSL
TECHNOLOGY, AND THIS TECHNOLOGY MAY NOT OPERATE AS EXPECTED ON ESTABLISHED
TELEPHONE COMPANY NETWORKS AND MAY INTERFERE WITH OR BE AFFECTED BY OTHER
TRANSPORT TECHNOLOGIES
We depend significantly on the quality and maintenance of the copper telephone
lines we lease from the established telephone companies which are providing
services in our markets to provide DSL services. We can make no assurances that
we will be able to lease the copper telephone lines and the services we require
from these established telephone companies on a timely basis or at quality
levels, prices, terms and conditions satisfactory to us or that such established
telephone companies will maintain the lines in a satisfactory manner.
All transport technologies using copper telephone lines have the potential to
interfere with, or to be interfered with by, other traffic on adjacent copper
telephone lines. This interference could degrade the performance of our services
or make us unable to provide service on selected lines. In addition, established
telephone companies may claim that the potential for interference by DSL
technology permits them to restrict or delay our deployment of DSL services. The
telecommunications industry and regulatory agencies are still developing
procedures to resolve interference issues between competitive carriers and
established telephone companies, and these procedures may not be effective. We
may be unable to successfully negotiate interference resolution procedures with
established telephone companies. Interference, or claims of interference, if
widespread, would adversely affect our speed of deployment, reputation, brand
image, service quality and client retention and satisfaction and may have a
material adverse effect on our business, financial condition and results of
operations.
IF WE FAIL TO OBTAIN ACCESS TO TRANSMISSION LINES, IT MAY AFFECT OUR ABILITY TO
DEVELOP OUR NETWORKS
Under our network buildout strategy, we will initially seek to lease from
established telephone companies and competitive local exchange carriers local
transmission lines connecting our switch to particular telephone company central
offices. In the future, we may seek to replace this leased capacity with our own
fiber optic lines if warranted by traffic volume growth. We can make no
assurances that all required transmission line capacity will be available to us
on a timely basis or on favorable terms. If we fail to obtain such leased fiber
optic lines, we could be delayed in our ability to penetrate some of our markets
or required to make additional unexpected up-front capital expenditures to
install our own fiber optic lines. If and when we seek to install our own fiber
optic lines, we must obtain local franchises and other permits, as well as
rights-of-way to utilize underground conduit and aerial pole space and other
rights-of-way from entities such as established telephone companies and other
utilities, railroads, long distance companies, state highway authorities, local
governments and transit authorities. We can make no assurances that we will be
able to obtain and maintain the franchises, permits and rights needed to
implement our network buildout on favorable terms. The failure to enter into and
maintain any such required arrangements for a particular network may affect our
ability to develop that network and may have a material adverse effect on our
business, financial condition and results of operations. See "Business--Service
Introduction."
19
WE DEPEND ON CERTAIN KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR
SERVICES
We are managed by a number of key executive officers. We believe that our
success will depend in large part on our ability to continue to attract and
retain qualified management, technical, marketing and sales personnel and the
continued contributions of such management and personnel. Competition for
qualified employees and personnel in the telecommunications industry is intense
and there is a limited number of persons with knowledge of and expertise in the
industry. We do not maintain key person life insurance for any of our executive
officers, other than Steve M. Dubnik, our Chairman, President and Chief
Executive Officer. Although we have been successful in attracting and retaining
qualified personnel, we can make no assurances that we will be able to hire or
retain necessary personnel in the future. The loss of services of one or more of
our key executives, or the inability to attract and retain additional qualified
personnel, could materially and adversely affect us.
WE MAY NOT HAVE THE ABILITY TO DEVELOP STRATEGIC ALLIANCES, ACQUIRE ASSETS OR
MAKE INVESTMENTS NECESSARY TO COMPLEMENT OUR EXISTING BUSINESS
We may seek, as part of our growth strategy, to continue to develop strategic
alliances or to make investments or acquire assets or other businesses that will
relate to and complement our existing business. We are unable to predict whether
or when any planned or prospective strategic alliances or acquisitions will
occur or the likelihood of a material transaction being completed on favorable
terms and conditions. Our ability to finance strategic alliances and
acquisitions may be constrained by our degree of leverage at the time of such
strategic alliance or acquisition. In addition, our credit facility may
significantly limit our ability to enter into strategic alliances or make
acquisitions and to incur indebtedness in connection with strategic alliances
and acquisitions.
We can make no assurances that any acquisition will be made or that we will be
able to obtain financing needed to fund such acquisition. We currently have no
definitive agreements with respect to any material acquisition, although from
time to time we may have discussions with other companies and assess
opportunities on an ongoing basis.
In addition, if we were to proceed with one or more significant strategic
alliances, acquisitions or investments in which the consideration consists of
cash, we could use a substantial portion of our available cash to consummate the
strategic alliances, acquisitions or investments. The financial impact of
strategic alliances, acquisitions and investments could have a material adverse
effect on our business, financial condition and results of operations and could
cause substantial fluctuations in our quarterly and yearly operating results.
Furthermore, if we use our common stock as consideration for acquisitions our
shareholders could experience dilution of their existing shares.
WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE ACQUIRED BUSINESSES AND OPERATIONS
Recently we acquired US Xchange, a local exchange carrier, and as part of our
business strategy, we may seek to acquire complementary assets or businesses or
develop strategic alliances. Any future acquisitions or strategic alliances
would be accompanied by the risks commonly encountered in such transactions.
Such risks include, among others:
o the difficulty of assimilating the acquired operations and personnel;
o the disruption of our ongoing business and diversion of resources and
management time;
o the inability to maximize our financial and strategic position by the
successful incorporation of licensed or acquired technology and rights into
our service offerings;
o the inability of management to maintain uniform standards, controls,
procedures and policies;
o the risks of entering markets in which we have little or no direct prior
experience; and
o the impairment of relationships with employees or clients as a result of
changes in management or otherwise arising out of such transactions.
We can make no assurances that we will be able to successfully integrate
acquired businesses or operations that we may acquire in the future.
Risks Related to our Industry
20
WE FACE A HIGH LEVEL OF COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY
The telecommunications industry is highly competitive, and one of the primary
purposes of the Telecommunications Act of 1996 is to foster further competition.
In each of our markets, we compete principally with the established telephone
company serving such market. We currently do not have a significant market share
in any of our markets. The established telephone companies have long-standing
relationships with their clients, financial, technical and marketing resources
substantially greater than ours and the potential to fund competitive services
with cash flows from a variety of businesses. Established telephone companies
also benefit from existing regulations that favor them over integrated
communications providers and competitive local exchange carriers in some
respects. Furthermore, one large group of established telephone companies, the
regional Bell operating companies, recently have been granted, pricing
flexibility under particular conditions from federal regulators with regard to
some services with which we compete. This may present established telephone
companies with an opportunity to subsidize services that compete with our
services and offer such competitive services at lower prices.
It is likely that we will also face competition from other integrated
communications providers, facilities-based competitive local exchange carriers
and many other competitors in some of our markets. We believe that second and
third tier markets will support only a limited number of competitors and that
operations in such markets with multiple competitive providers are likely to be
unprofitable for one or more of such providers.
We expect to experience declining prices and increasing price competition. We
can make no assurances that we will be able to achieve or maintain adequate
market share or margins, or compete effectively, in any of our markets.
Moreover, substantially all of our current and potential competitors have
financial, technical, marketing, personnel and other resources, including brand
name recognition, substantially greater than ours as well as other competitive
advantages over us. Any of the foregoing factors could have a material adverse
effect on our business, financial condition or results of operations. See
"Business--Competition."
FCC AND STATE REGULATIONS MAY LIMIT THE SERVICES WE CAN OFFER
Our networks and the provision of telecommunications services are subject to
significant regulation at the federal, state and local levels. The costs of
complying with these regulations and the delays in receiving required regulatory
approvals or the enactment of new adverse regulation or regulatory requirements
may have a material adverse effect upon our business, financial condition and
results of operations.
We can make no assurances that the Federal Communications Commission, called the
FCC, or state commissions will grant required authority or refrain from taking
action against us if we are found to have provided services without obtaining
the necessary authorizations. If we do not fully comply with the rules of the
FCC or state regulatory agencies, third parties or regulators could challenge
our authority to do business. Such challenges could cause us to incur
substantial legal and administrative expenses.
Our Internet operations are not currently subject to direct regulation by the
FCC or any other governmental agency, other than regulations applicable to
businesses generally. However, the FCC has recently indicated that the
regulatory status of some services offered over the Internet may have to be
re-examined. New laws or regulations relating to Internet services, or existing
laws found to apply to them, may have a material adverse effect on our business,
financial condition or results of operations.
The Telecommunications Act remains subject to judicial review and additional FCC
rulemaking, and thus it is difficult to predict what effect the legislation will
have on us and our operations. There are currently many regulatory actions
underway and being contemplated by federal and state authorities regarding
interconnection pricing and other issues that could result in significant
changes to the business conditions in the telecommunications industry. We can
make no assurances that these changes will not have a material adverse effect on
our business, financial condition or results of operations.
IF WE ARE UNABLE TO ADAPT TO TECHNOLOGICAL CHANGES IN THE TELECOMMUNICATIONS
INDUSTRY OUR BUSINESS COULD BE ADVERSELY AFFECTED
The telecommunications industry is subject to rapid and significant changes in
technology, including continuing developments in DSL technology, which does not
presently have widely accepted standards, and alternative technologies for
providing high-speed data transport and networking. The absence of widely
accepted standards may delay or increase the cost of our market entry due to
changes in equipment specifications and customer needs and expectations. If we
fail to adapt successfully to technological changes or obsolescence, fail to
adopt technology that becomes an industry standard or fail to obtain access to
important technologies, our
21
business, financial condition or results of operations could be materially
adversely affected. We may also be dependent on third parties for access to new
technologies. Also, if we acquire new technologies, we may not be able to
implement them as effectively as other companies with more experience with those
technologies and in their markets.
WE MAY FAIL TO ACHIEVE ACCEPTABLE PROFITS ON OUR LONG DISTANCE BUSINESS DUE TO
DECLINING PRICES, LOW CUSTOMER RETENTION RATES AND OUR CONTRACTUAL OBLIGATIONS
Prices in the long distance business have declined substantially in recent years
and are expected to continue to decline. In addition, the long distance industry
has a low customer retention rate, as clients frequently change long distance
providers in response to the offering of lower rates or promotional incentives
by competitors. We will rely on other carriers to provide us with a major
portion of our long distance transmission network. Such agreements typically
provide for the resale of long distance services on a per-minute basis and may
contain minimum volume commitments. The negotiation of these agreements involves
estimates of future supply and demand for transmission capacity as well as
estimates of the calling patterns and traffic levels of our future clients. In
the event that we fail to meet such minimum volume commitments, we may be
obligated to pay underutilization charges, and, in the event we underestimate
our need for transmission capacity, we may be required to obtain capacity
through more expensive means. Our failure to achieve acceptable profits on our
long distance business could have a material adverse effect on our business,
financial condition and results of operation.
AS A NEW ENTRANT IN THE DATA TRANSMISSION MARKET, WE MAY INITIALLY GENERATE LOW
OR NEGATIVE GROSS MARGINS
As a new entrant in the data transmission business, we expect to generate low or
negative gross margins and substantial start-up expenses as we begin to offer
data transmission services. The success of our data transmission business will
be dependent upon, among other things, the effectiveness of our sales personnel
in the promotion and sale of our data transmission services, the acceptance of
such services by potential clients, and our ability to hire and train qualified
personnel and further enhance our services in response to future technological
changes. We can make no assurances that we will be successful with respect to
these matters. If we are not successful with respect to these matters, it could
have a material adverse effect on our business, financial condition and results
of operations.
RISKS REGARDING FORWARD-LOOKING STATEMENTS
We have made some statements in this Form 10-K, including some under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere, which constitute
forward-looking statements. These statements may discuss our future expectations
or contain projections of our results of operations or financial condition or
expected benefits to us resulting from acquisitions or transactions and involve
known and unknown risks, uncertainties and other factors that may cause our
actual results, levels of activity, performance or achievements to be materially
different from any results, levels of activity, performance or achievements
expressed or implied by any forward-looking statements. These factors include,
among other things, those listed under "Risk Factors" and elsewhere in this
prospectus. In some cases, forward-looking statements can be identified by
terminology such as "may," "will," "should," "could," "expects," "intends,"
"plans," "anticipates," "believes," "estimates," "predicts," "potential" or
"continue" or the negative of these terms or other comparable terminology.
Although we believe that the expectations reflected in forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
22
ITEM 2. PROPERTIES
We are headquartered in Rochester, New York. We occupy office space in
Rochester under a market-rate lease that expires in 2009. As of December 31,
2000, this lease covered 73,830 square feet. In addition, we lease space in a
number of locations, primarily for sales offices and network equipment
installations. We believe that our leased facilities are adequate to meet our
current needs and that additional facilities are available to meet our
development and expansion needs in existing and projected target markets.
ITEM 3. LEGAL PROCEEDINGS
We are not party to any pending legal proceedings that we believe would,
individually or in the aggregate, have a material adverse effect on our
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security-holders during the fourth
quarter of the fiscal year ended December 31, 2000.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning our executive
officers and other key personnel, including their ages, as of December 31, 2000.
Name Age Title
Steve M. Dubnik...... 38 Chairman of the Board and Director,
President and Chief Executive Officer
Kevin S. Dickens..... 37 Co-Chief Operating Officer
Ajay Sabherwal....... 34 Executive Vice President, Finance and Chief
Financial Officer
Mae H. Squier-Dow.... 39 Co-Chief Operating Officer
Philip H. Yawman..... 35 Executive Vice President, Corporate
Development
Robert O. Bailey..... 54 Vice President, Planning and Technology
Douglas R. Black..... 30 Vice President, Operations
Joseph A. Calzone.... 37 Senior Vice President, Engineering
Linda S. Chapman..... 37 Vice President, Human Resources
James R. Currie...... 53 Vice President, Operations
Michael A. D'Angelo.. 35 Vice President, Sales, Eastern Region
Scott D. Deverell.... 35 Vice President, Accounting, and Controller
Elizabeth A. Ellis... 42 Senior Vice President, Information Technology
Daniel S. Fabry...... 37 Vice President, Network Development
Robert J. Merrill.... 45 Vice President, Business Development
Stephen R. Oyer...... 39 Vice President, Sales, Western Region
Michelle C. Paroda... 37 Senior Vice President, Client Services
Ricky G. Pigeon...... 36 Vice President, Billing Services
Joseph M. Schaal..... 34 Vice President, Internet and Emerging Technologies
Kim Robert Scovill... 47 Vice President, Legal and Regulatory Affairs,
and General Counsel
Lee Thibaudeau....... 48 Vice President, Business Services
John J. Zimmer....... 42 Vice President, Finance, and Treasurer
- --------------
23
Steve M. Dubnik, our Chairman of the Board, President, Chief Executive
Officer and Co-Founder, has worked in the telecommunications industry for 16
years. Prior to founding Choice One in June 1998, Mr. Dubnik served in various
capacities with ACC Corp., including as the President and Chief Operating
Officer of North American Operations of ACC from November 1996 to April 1998 and
as Chairman of the Board of Directors of ACC TelEnterprises Ltd. from July 1994
to April 1998. From December 1997 to April 1998, he also jointly performed the
functions of Chief Executive Officer of ACC.
Kevin S. Dickens, our Co-Chief Operating Officer and Co-Founder since
August 2000 and prior to that Senior Vice President, Operations and Engineering
since July 1998, has worked in the telecommunications industry for 12 years.
Prior to joining us, Mr. Dickens was President and Chief Executive Officer of
ACC Corp.'s Canadian subsidiary, ACC TelEnterprises Ltd., from May 1997 to June
1998. Prior thereto, Mr. Dickens was Vice President of Network Planning and
Optimization at Frontier Corporation, from September 1996 to May 1997, with
responsibility for Frontier's long distance network.
Ajay Sabherwal, our Executive Vice President, Finance and Chief Financial
Officer since September 1999, has worked both directly in the telecommunications
industry and as an equity analyst covering the telecommunications industry for
over 11 years. Mr. Sabherwal was most recently executive director of
institutional equity research for Toronto-based CIBC World Markets from June
1996 to September 1999. Prior to joining CIBC World Markets as a senior research
analyst in June of 1996, Mr. Sabherwal was the telecommunications analyst for
BZW (Barclays de Zoete Wedd) Canada and its successor company from November 1993
until June 1996
Mae H. Squier-Dow, our Co-Chief Operating Officer and Co-Founder since
August 2000 and prior to that Senior Vice President, Sales, Marketing and
Service since June 1998, has worked in the telecommunications industry for 16
years. Ms. Squier-Dow served as President of ACC Telecom, a U.S. subsidiary of
ACC Corp., from June 1996 to May 1998, and in several positions at ACC Long
Distance U.K. Ltd., including as Commercial Director from April 1995 to June
1996, and as Director of Client Relations and Marketing, Vice President of
International Planning and Operations Director from October 1993 to April 1995.
Philip H. Yawman, our Executive Vice President, Corporate Development and
Co-Founder since July 1998, has worked in the telecommunications industry for 13
years. Prior to joining us, Mr. Yawman was Vice President of Investor Relations
and Corporate Communications at ACC Corp. from April 1997 to January 1998. Mr.
Yawman also served in various positions at Frontier Corporation from July 1989
to April 1997, including as head of investor relations' activities and in
several product management positions.
Robert O. Bailey, our Vice President, Planning and Technology since
September 1999, is responsible for evaluating and selecting the technology to be
deployed by Choice One in the next generation of switching systems architecture,
including the evolution from circuit switching systems to packet and ATM-based
infrastructure. Most recently, he was Vice President and Chief Technology
Officer for the Upstate Cellular Network (Frontier Cellular), a joint venture of
Verizon Mobile and Frontier Corporation, from January 1985 until April 1999,
where he was responsible for engineering and operations of a cellular network
that covered 5.5 million population units in upstate New York.
Douglas R. Black, our Vice President, Operations had joined US Xchange as
Director of Switching Technology in April 1997. In August 1999 he was promoted
to Vice President, Operations. Prior to joining US Xchange, Mr. Black was
Operations Manager for Nextlink Solutions from April 1996 to April 1997. Prior
thereto, he had been an Operations Manager at US Signal from April 1993 to April
1996.
Joseph A. Calzone, our Senior Vice President, Engineering since August
2000 and prior to that Vice President, Engineering and Network Operations since
July 1998, has worked in the telecommunications industry for 15 years. Prior to
joining us, Mr. Calzone held various key management positions at Citizens
Communications from October 1995 to May 1998, most recently as head of the
National Sales and Services organization and as Vice President of Long Distance
Engineering and Operations.
Linda S. Chapman, our Vice President, Human Resources since August 1998,
was the Director of Human Resources of ACC Corp.'s U.S. subsidiary, ACC Telecom,
from June 1997 to July 1998. Prior thereto, Ms. Chapman held various management
positions with MCI from March 1994 to May.
24
James R. Currie, our Vice President, Operations since June 1999, has over
25 years of operations and engineering experience. Mr. Currie was at Citizens
Communications from 1994 until joining us and held a number of executive
positions including Director of Long Distance Operations, Director of Network
Provisioning, Senior Director--Business Call Centers and Sales Engineering, Vice
President of Eastern Region Operations and Vice President of Carrier Access
Sales.
Michael A. D'Angelo, our Vice President, Sales, Eastern Regions since
August 2000 and prior to that Vice President of Sales, since September 1998, has
worked in the telecommunications industry for over 13 years. Prior to joining
us, Mr. D'Angelo was the Director of Sales, Southeast Regional Manager at ICG
Communications from November 1997 to September 1998. Prior thereto, Mr. D'Angelo
was Regional Sales Manager for Citizens Communications from January 1995 to
November 1997.
Scott D. Deverell, our Vice President, Accounting, and Controller since
March 2000 and Director of Accounting since December 1998, is a certified public
accountant. Prior to joining us, Mr. Deverell was employed by PSC Inc. as
Assistant Treasurer from September 1997 to December 1998 and as Controller from
1990 until September 1997.
Elizabeth A. Ellis, our Senior Vice President, Information Technology
since August 2000 and prior to that Vice President, Information Technology since
July 1998, has worked in the information technology field for over 20 years,
including the past seven years in the telecommunications industry. Prior to
joining us in July 1998, Ms. Ellis was Commercial Director for ACC Telecom's
subsidiaries in the United Kingdom and Germany from August 1994 to June 1998
where she was responsible for all aspects of network, operations, client
service, telemarketing and information technology.
Daniel S. Fabry, our Vice President, Network Development since August 2000
has more than 14 years of experience in the telecommunications industry. In
March 1997, he became a founding leader of US Xchange, Inc. responsible for
overall product development and management and in November 1999 his role was
expanded to include network development and cost management. Mr. Fabry was
Director of Marketing for Schneider Logistics, Inc. from February 1996 to March
1997. Previous to Schneider Logistics Inc., Mr. Fabry had been at Schneider
Communications, Inc. since 1985 in various roles including Manager of Capacity
Systems, Manager of Network Development, Director of Product Development and
Vice President of Product Development.
Robert J. Merrill, our Vice President, Business Development since
September 1998, has worked in the telecommunications industry for over 22 years.
Prior to joining us, Mr. Merrill was the Vice President of Marketing and Product
Development for Frontier Communication's Carrier Services Group, from January to
September 1998 and the Director of Product Development (Wholesale) from June
1997 to January 1998. Prior thereto, Mr. Merrill was at Rochester Telephone as
the Director of Marketing and Product Development from April 1995 to June 1997
and as the General Manager of Visions Long Distance from June 1993 to April
1995.
Stephen R. Oyer, our Vice President, Sales, Western Region since August
2000 has 13 years of experience in the telecommunications industry having held
various positions in sales, sales management and senior level management. Mr.
Oyer began with US Xchange in December 1997 as Senior Director of Field Sales
and in September 1999 was promoted to Vice President of Sales and Marketing.
Prior thereto, Mr. Oyer served as an independent consultant to a start up
billing and customer care provider to the wireless industry from September 1996
to November 1997 and was with Centennial Wireless from August 1991 to August
1996 as Regional General Manager, National Sales Manger, and Senior Director of
Sales.
Michelle C. Paroda, our Senior Vice President, Client Services since
August 2000 and prior to that Vice President, Client Care since July 1998, has
worked in the telecommunications industry for 16 years. Prior to joining us, Ms.
Paroda had been employed in a variety of positions by Frontier Corporation since
1984, most recently as Vice President of Client Care.
Ricky Pigeon, our Vice President, Billing Services since August 2000 has
more than 15 years of experience in the telecommunications industry. In March
1997 Mr. Pigeon became a founding leader with US Xchange of Wisconsin as Vice
President of Technology Development and Billing Assurance. Prior to joining US
Xchange, Mr. Pigeon was Director of Product Development with Airadigm
Communication, a wireless PCS carrier from April 1996 to March 1997. From
February 1986 to April 1996, Mr. Pigeon held various positions with Schneider
Communications, including Manager of Network Systems, Product Manager, and
Senior Manager of Local Operations Network Operations after Schneider had been
acquired by Frontier Communications.
25
Joseph M. Schaal, our Vice President, Internet and Emerging Technologies,
since June 1998, has worked in the telecommunications industry for 11 years.
Prior to joining us, Mr. Schaal held various positions at Frontier Corporation
in project management, business planning, financial management, operations and
software development from January 1995 to February 1997, most recently as its
Director of Application and Product Development from March 1997 to May 1998.
Kim Robert Scovill, our Vice President, Legal and Regulatory Affairs and
General Counsel since December 1998, has worked in the telecommunications
industry for over 27 years. From January 1991 to February 1998, Mr. Scovill was
Vice President of Worthington Voice Services, a telecommunications and
e-commerce company. From February 1998 to December 1998, Mr. Scovill was Vice
President and General Counsel of Omnicall, a South Carolina-based CLEC.
Lee Thibaudeau, our Vice President, Business Services since August 2000
has more than 22 years of experience in the telecommunications industry. Mr.
Thibaudeau joined US Xchange in March 1997 and had been responsible for leading
the development of the company in Wisconsin and Illinois, as well as regulatory
matters on a corporate level. From 1996 through 1997, Mr. Thibaudeau held
positions as Director of Program Management and Director of Development for
Schneider Logistics. Prior to that, Mr. Thibaudeau held positions accountable
for operations, engineering, network cost management, information systems, and
sales within the telecommunications industry.
John J. Zimmer, our Vice President, Finance and Treasurer since August
1998, is a certified public accountant and has worked in the telecommunications
industry for 10 years. Prior to joining us, Mr. Zimmer was employed by ACC
Corp., as Vice President and Treasurer from January 1997 to July 1998, as Vice
President of Finance from September 1994 to January 1997.
Each of our officers serves at the pleasure of the board of directors.
Part II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Our common stock has traded on the Nasdaq Stock Market's National Market under
the symbol "CWON" since our initial public offering on February 16, 2000. Prior
to that time, there was no public market for our common stock. The following
table sets forth the high and low prices for our common stock for the periods
indicated as reported by the Nasdaq National Market.
Common Stock Price
---------------------------------
2000
---------------------------------
High Low
-------------- -------------
First Quarter (from $71.38 $24.81
February 16, 2000)
Second Quarter $40.88 $19.63
Third Quarter $41.13 $10.50
Fourth Quarter $13.63 $ 3.94
Dividend Policy
We have never paid or declared any cash dividends on our common stock and
do not anticipate paying cash dividends in the foreseeable future. We currently
intend to retain all future earnings, if any, for use in the operation of our
business and to fund future growth. Our future dividend policy will depend on
our earnings, capital requirements, requirements of financing agreements to
which we are a party, our financial condition and other factors considered
relevant by our board of directors. The agreements and terms of our credit
facility and Series A senior cumulative preferred stock prohibit us from paying
dividends on our common stock.
26
Recent Sales of Unregistered Securities; Use of Proceeds of Registered
Securities
On August 1, 2000, we issued 200,000 shares of Series A senior
cumulative redeemable preferred stock and related warrants in a private
placement for $200.0 million. This transaction was exempt from registration
under the Securities Act pursuant to Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
The Series A preferred stock was issued to certain funds of Morgan
Stanley Dean Witter Capital Partners. These funds and other related funds have a
large portion of our common stock and rights to seats on our board of directors.
Each share of Series A preferred stock has a stated value of $1,000 and ranks
senior to each other class or series of our capital stock. Dividends will be
payable quarterly at the rate of 14.0% per annum, cumulative and compounded
quarterly. The Series A preferred stock matures on August 1, 2012, at which time
we must redeem the shares for their stated value plus any unpaid dividends.
Prior to August 1, 2005 which is the fifth anniversary of the issue date, we may
pay dividends quarterly in additional shares of Series A preferred stock or in
cash, at our option. Thereafter until maturity, we must pay dividends in cash.
In connection with the issuance of the Series A preferred stock, we
sold warrants to purchase 1,747,454 shares of our common stock to the holders of
the Series A preferred stock. The warrants are exercisable in whole or in part
at any time at an exercise price is $0.01 per share of common stock. The
warrants will expire on August 1, 2012.
On August 1, 2000, we acquired all the outstanding common stock of US
Xchange, Inc. from its sole shareholder, and a portion of the consideration for
the US Xchange, Inc. stock was 6,207,663 shares of our common stock. Of that
amount, 240,640 shares were issued to certain employees of US Xchange, Inc. The
shares issued in this transaction are subject to transfer restrictions which are
noted on the stock certificates. This transaction was exempt from registration
under the Securities Act pursuant to Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
On February 16, 2000, we completed our initial public offering through the sale
of 7,145,000 shares of our common stock, at a price of $20.00 per share. We sold
an additional 1,071,750 shares on February 23, 2000 pursuant to an
over-allotment option that we had granted to the underwriters. We raised net
proceeds from these sales of $150 million after expenses. The shares were
registered with the Securities and Exchange Commission pursuant to a
registration statement filed on Form S-1 (No. 333-91321), and underwritten by a
syndicate of underwriters led by Morgan Stanley & Co. Incorporated, Lehman
Brothers Inc., Warburg Dillon Read LLC, First Union Securities, Inc. and CIBC
World Markets, as their representatives. Proceeds from the offering were used
for repayment of our debt ($64.4 million). The remaining net proceeds were
invested in investment grade, interesting bearing securities. The remainder of
the proceeds were used between February and July 2000 for capital and other
general corporate purposes. Our use of proceeds from the offering did not
represent a material change in the use of proceeds described in the registration
statement.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected consolidated financial data
for the periods indicated. The consolidated statement of operations data for the
period from inception through December 31, 1998 and as of and for the years
ended December 31, 1999 and 2000 have been derived from our consolidated
financial statements included elsewhere in this Form 10-K which have been
audited by Arthur Andersen LLP, independent public accountants, as indicated in
their report included elsewhere in this Form 10-K. The results of our operations
for the periods indicated are not necessarily indicative of the results of
operations in the future.
You should read the selected consolidated financial data set forth below
in conjunction with the Consolidated Financial Statements and notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Form 10-K.
27
Year ended Year ended Period ended
December 31, 2000 December 31, 1999 December 31, 1998
(in thousands, except per share data)
Statement of Operations Data:
Revenue.................................................................... $ 68,082 $ 4,518 $ -
Operating expenses:
Network costs........................................................... 56,182 6,979 -
Selling, general and administrative, including noncash deferred
compensation and non-cash management ownership allocation charge of
$90,527, $2,048 and $376 in 2000, 1999 and 1998, respectively......... 173,197 22,978 5,060
Depreciation and amortization........................................... 41,003 5,153 36
------ ------ -----
Total operating expenses................................................ 270,382 35,110 5,096
------- ------- -----
Loss from operations....................................................... (202,300) (30,592) (5,096)
Interest income (expense).................................................. (14,552) (1,883) 22
-------- ------- -----
Net loss................................................................... (216,852) (32,475) (5,074)
Accretion of preferred stock........................................... 2,393 - -
Accrued preferred stock dividends...................................... 11,830 - -
------ ------- -----
Net loss applicable to common stock........................................ $(231,075) $(32,475) $ (5,074)
=========== ======== ========
Weighted average number of shares outstanding, basic and diluted........... 32,481,307 22,022,256 18,017,791
========== ========== ==========
Net loss per share, basic and diluted...................................... $ (7.11) $ (1.47) $ (0.28)
========= ========= =========
As of As of As of
December 31, 2000 December 31, 1999 December 31, 1998
Balance Sheet Data:
Cash and cash equivalents.................................................. $173,573 $3,615 $1,491
Restricted cash............................................................ 30,000 - -
Investments................................................................ 9,801 - -
Working capital............................................................ 185,800 (9,035) 9,707
Property and equipment, net................................................ 302,833 72,427 21,110
Total assets............................................................... 923,830 94,512 24,472
Long-term debt............................................................. 447,000 51,500 -
Redeemable preferred stock................................................. 162,523 - -
Stockholder's equity....................................................... 259,530 26,724 13,130
Year ended Year ended Period ended
December 31, 2000 December 31, 1999 December 31, 1998
(in thousands, except per share data)
Other Financial Data:
Net cash (used in) provided by operating activities........................ $(69,604) $(24,319) $ 6,587
Net cash used in investing activities...................................... (489,280) (56,077) (21,146)
Net cash provided by financing activities.................................. 728,842 82,520 16,050
Capital expenditures....................................................... 119,400 56,077 21,146
Adjusted EBITDA............................................................ (70,770) (23,391) (4,684)
Operating Data: As of As of As of
December 31, 2000 December 31, 1999 December 31, 1998
Lines in service:
Voice lines in service................................................ 173,819 19,890 -
Data lines in service................................................. 3,795 206 -
Total lines in service................................................ 177,614 20,096 -
Central office collocations................................................ 410 141 -
Markets in operation....................................................... 26 9 -
Number of voice switches................................................... 24 8 -
Number of data switches.................................................... 45 10 -
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are an integrated communications provider offering voice and broadband data
telecommunications services primarily to small and medium-sized businesses in
second and third tier markets in the northeastern and midwestern United States.
Our services include local exchange service, long distance service, high-speed
data and Internet service principally utilizing DSL technology, and Web page
design, development and hosting services. We seek to become the leading
integrated communications provider in each of our markets by offering a single
source of competitively priced, high quality, customized telecommunications
services. A key element of our strategy is to be one of the first integrated
communications providers to provide comprehensive network coverage in each of
the markets we serve. We are achieving this market coverage by installing both
voice and data equipment in multiple established telephone company central
offices. We have connected the majority of our clients directly to our own
switches, which allows us to more efficiently route traffic, ensure quality
service and control costs.
On August 1, 2000, we acquired US Xchange, Inc., a facilities-based competitive
local exchange carrier with operations in the midwestern United States. Through
our acquisition of US Xchange, we have accelerated our entry into midwestern
markets and created a service area that now extends from Wisconsin to
Massachusetts. We have integrated US Xchange's operations and infrastructure
with ours and enhanced their product offerings to match those provided in our
northeastern markets.
Included in our management's discussion and analysis of financial condition and
results of operations are adjusted EBITDA amounts. Adjusted EBITDA represents
earnings before interest, income taxes, depreciation and amortization, non-cash
deferred compensation and non-cash management allocation charges. Adjusted
EBITDA is used by management and certain investors as an indicator of a
company's historical ability to service debt. Management believes that an
increase in adjusted EBITDA is an indicator of improved ability to service
existing debt, to sustain potential future increases in debt and to satisfy
capital requirements. However, adjusted EBITDA is not intended to represent cash
flows, nor has it been presented as an alternative to either operating income,
as determined by generally accepted accounting principles, nor as an indicator
of operating performance or cash flows from operating, investing and financing
activities, as determined by generally accepted accounting principles, and is
thus susceptible to varying calculations. Adjusted EBITDA as presented may not
be comparable to other similarly titled measures used by other companies. We had
negative adjusted EBITDA of $70.8 million, $23.4 million, and $4.7 million for
the years ended December 31, 2000 and 1999 and the period from inception (June
2, 1998) to December 31, 1998, respectively. We expect that our adjusted EBITDA
will continue to be negative while we emphasize development, construction and
expansion of our telecommunications services business and until we establish a
sufficient revenue-generating client base.
FACTORS AFFECTING RESULTS OF OPERATIONS
Revenue
We generate revenue from the following categories of service:
o local calling services, which consist of monthly recurring charges for
basic service, usage charges for local calls and service charges for
features such as call waiting and call forwarding;
o long distance services, which include a full range of retail long distance
services, including traditional switched and dedicated long distance,
800/888 calling, international, calling card and operator services;
o DSL and other data services, which consist primarily of monthly recurring
charges for connections from the end-user to our facilities;
o access charges, which we earn by connecting our clients to their selected
long distance carrier for outbound calls or by delivering inbound long
distance traffic to our local service clients;
o reciprocal compensation, which entitles us to bill the established
telephone companies and competitive local exchange carriers for calls in
the same local calling area placed by their clients to our clients; and
o web design and web hosting.
29
The market for local and long distance services is well established and we
expect to achieve revenue growth principally from taking market share away from
other service providers. Although we anticipate that access charges will decline
on a unit basis, we expect our aggregate revenue from access charges that are
based on long distance calls made by and to our clients to grow as we are able
to increase our client base.
The market for high-speed data communications services and Internet access is
rapidly growing and intensely competitive. While many of our competitors enjoy
advantages over us, we are pursuing a significant market that, we believe, is
currently underserved. See "Business--Market Opportunity."
We price our services competitively in relation to those of the established
telephone companies and offer combined service discounts designed to give
clients incentives to buy a portfolio of our services. During the past several
years, market prices for many telecommunications services on a unit basis have
been declining, which is a trend that we believe will likely continue. This
decline will have a negative effect on our revenue that may not be offset
completely by savings from decreases in our cost of services. As prices decline
for any service, we believe that the total number of users and their usage will
increase. Although pricing will be an important part of our strategy, we believe
that direct relationships with our clients and consistent, high quality service
and client support will be essential to generating client loyalty. See
"Business--Competition."
Our experience demonstrates that there is significant churn of clients within
the telecommunications industry, and we believe that churn is especially high
when clients are only buying long distance services from a carrier or when
clients are buying resold services. The former US Xchange initially resold
established telephone company services to establish a market presence and
enhance its market penetration efforts. We have reduced our emphasis on resale
services and intend to transition most US Xchange resale clients to our
switch-based network. We seek to minimize churn by providing superior client
care, by offering a competitively priced portfolio of local, long distance and
Internet services, and by focusing on offering our own facilities-based
services.
There is uncertainty surrounding the payment of reciprocal compensation by the
established telephone companies for calls delivered to Internet service
providers due to pending regulatory proceedings. However, the amount of
reciprocal compensation revenue that we receive related to Internet service
providers is not material. See "Regulation--Federal Regulation."
Network Costs
Our network costs include the following:
o The cost of leasing high-capacity digital lines that interconnect our
network with established telephone company networks. These facilities are
also used to connect our switching equipment to our transmission equipment
located in established telephone company central offices, as well as to
connect our transmission equipment between these offices. These network
expenses include non-recurring installation costs and monthly recurring
fixed costs. As new markets are entered, these fixed costs are a major
component of our total network costs. As markets mature, these costs remain
a significant part of our ongoing cost of services, but at a declining
percentage of total costs. We are planning to deploy fiber in many of our
markets, which will replace the leased network facilities and decrease our
leasing costs. In our markets in Wisconsin, Michigan, Indiana and Illinois
we already have operational intra-city fiber in place and, as a result, our
leasing costs in these markets are significantly less than in the markets
where fiber has not been deployed. We plan to deploy fiber in many of our
other markets beginning in 2001.
o The cost of leasing local loop lines which connect our clients to our
network. The costs to lease local loop lines from established telephone
companies vary by company and are regulated by state authorities under the
Telecommunications Act. These client loop costs are for voice and data
lines as well as client T-1 links. These expenses include non-recurring
installation costs and monthly recurring fixed costs. As our clients and
related lines continue to increase, total local loop line costs will
continue to increase and will remain an increasingly significant component
of our ongoing network costs.
o The cost of leasing space in established telephone company central offices
for collocating our transmission equipment. In constructing switching and
transmission equipment for a new market, we capitalize, as a component of
property and equipment, non-recurring charges for items such as
construction. We also capitalize the monthly recurring costs of the
collocations during the construction period, typically one to two months.
These capitalized non-recurring costs are depreciated over the life of the
lease and are not included in our network costs. Recurring costs, after
traffic is being carried, are expensed as incurred and are included in our
network costs. As a market matures, these costs should remain relatively
constant, decreasing as a total component of total network costs.
30
o The cost of completing local calls originated by our clients. These local
call costs are referred to as "reciprocal compensation" costs and are
incurred in connection with both voice and data services. We must enter
into an interconnection agreement with the established telephone company to
make widespread calling available to our clients when we enter a market.
These agreements typically set the cost per minute to be charged by each
party for the calls that are exchanged between the two carriers' networks
and provide that a carrier must compensate another carrier when a local
call by the first carrier's client terminates on the other carrier's
network. These reciprocal compensation costs will grow as our clients'
outbound calling volume grows and will continue to be a significant
component of total network costs. As clients and related lines installed
increase, our costs will continue to increase proportionately.
o The cost of completing, originating (1+ calling) and terminating (inbound
800 calling) long distance calls by our clients. The cost of securing long
distance service capacity is a variable cost that increases in direct
relationship to increases in our client base and our clients' long distance
calling volumes. These minute of usage charges will continue to be a
significant component of total network costs. As clients and related lines
installed increase, these costs will continue to increase proportionately.
o The cost of leasing our inter-city network. Our inter-city network
facilities are used to carry data traffic between our markets and for
delivery to Internet access points. The costs of these lines will increase
as we increase capacity to address client demand, open new markets and
connect additional markets to our Internet network. As we deploy fiber,
however, the costs associated with the leased facilities will decrease.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses include costs associated with
sales and marketing, client care, billing, corporate administration, personnel
and network maintenance. We expect to incur significant selling and marketing
costs as we continue to expand our operations. We also plan to offer sales
promotions to win clients, especially during the next several years as we
continue to establish our market presence.
Because our business strategy stresses the importance of personalized client
care, we expect our client care department to become a larger part of our
ongoing administrative expenses. We also expect billing costs to increase as our
number of clients and call volume increase. Bill processing costs are expected
to be a significant part of our ongoing administrative expenses.
We will incur other costs and expenses, including network maintenance costs,
administrative overhead, office lease expense and bad debt expense. We expect
that these costs and expenses will grow significantly as we expand our
operations and that administrative overhead will be a large portion of these
costs and expenses during the first few years of our operations. However, we
expect these costs and expenses to become a smaller percentage of our revenue as
we build our client base.
Deferred Compensation
As the estimated fair market value of our common stock exceeded the exercise
price of certain options granted, we recognized deferred compensation which is
amortized over the vesting period of the options.
As our estimated fair market value has exceeded the price at which shares of our
stock have been sold to management employees since our formation, we have
recognized a deferred compensation charge of $4.4 million which is being
amortized over a four year period from the date the shares were issued. In
addition, we have similarly recognized a deferred compensation charge of $7.5
million in connection with the issuance of options to various employees, which
is being amortized over a four-year period from the date the options were
issued.
Management Ownership Allocation Charge
Upon consummation of our initial public offering, we were required by generally
accepted accounting principles to record the $119.9 million increase in the
assets of Choice One Communications L.L.C. allocated to management as an
increase in additional paid-in capital, with a corresponding increase in
deferred compensation. We were required to record $62.4 million of the deferred
compensation as a non-cash, non-recurring charge to operating expense during the
period in which the initial public offering was consummated, and the remaining
$57.5 million was recorded as deferred management ownership allocation charge.
We amortized $21.1 million of the deferred charge during 2000 and will amortize
$24.8 million and $11.6 million during 2001 and 2002, respectively, base on the
period over which we have the right to repurchase the securities.
31
Depreciation and Amortization
Our depreciation and amortization expense includes depreciation of switch
related equipment, non-recurring charges and equipment collocated in established
telephone company central offices, network infrastructure equipment, information
systems, furniture, fixtures and indefeasible rights to use fiber. It also
includes amortization of goodwill, client base and deferred financing costs
related to our senior credit facility. Our acquisitions of US Xchange, Atlantic
Connections and EdgeNet have been accounted for using the purchase method of
accounting. The amount of the purchase price in excess of the fair value of the
net assets acquired (goodwill) for US Xchange, Atlantic Connections and EdgeNet
was $318.4 million, $7.3 million and $3.5 million, respectively, and is being
amortized over 10 year periods. The value of the client bases acquired from US
Xchange, Atlantic Connections and EdgeNet is $48.5 million, $3.3 million and
$0.5 million, respectively, and is being amortized over five year periods. The
value of the indefeasible right to use fiber acquired from US Xchange is $34.3
million and is being amortized over 20 years. We expect that our depreciation
and amortization expense will increase as we continue to make capital
expenditures and acquire long-term rights in telecommunications facilities.
Interest Income (Expense)
Our interest income includes income generated from our cash and other short-term
investments. We expect interest income to gradually decline as we use our
surplus cash to fund our operations and capital expenditures.
Our interest expense includes interest payments on borrowings under our senior
credit and subordinated debt facilities, amortization of deferred financing
costs related to these facilities and unused commitment fees on the senior
credit facility. We expect interest expense to increase over the next several
quarters, once our surplus cash is depleted and as our borrowings increase to
fund our operations and capital expenditures.
Income Taxes
We have not generated any taxable income to date and do not expect to generate
taxable income in the next few years. The use of our net operating loss
carryforwards, which begin to expire in 2018, may be subject to limitations
under Section 382 of the Internal Revenue Code of 1986, as amended. We have
recorded a full valuation allowance on the deferred tax asset, consisting
primarily of net operating loss carryforwards, due to the uncertainty of its
realizability.
RESULTS OF OPERATIONS
For the years ended December 31, 2000 and December 31, 1999
Revenue
We generated $68.1 million in revenue for the year ended December 31, 2000,
compared to $4.5 million for the year ended December 31, 1999. We increased, or
obtained through the incremental gain from the acquisition of US Xchange, the
lines in service by 157,518 lines during the year ended December 31, 2000,
compared to 20,096 lines in service during the year ended December 31, 1999. At
December 31, 2000, we had a total in service base of 177,614 lines, which
compares to 20,096 lines in service as of December 31, 1999. Sales are expected
to increase from the level realized during the year ended December 31, 2000 as
new markets are opened and as existing markets are further developed.
Network Costs
Network costs for the year ended December 31, 2000 were $56.2 million, compared
to network costs of $7.0 million for the year ended December 31, 1999. This
increase is due to the deployment of our networks and growth of our services in
26 markets with 410 collocation sites as compared to nine markets with 141
collocation sites as of December 31, 1999.
We achieved positive gross margin (revenue less direct network costs) of $11.9
million or 17.5% of revenue for the year ended December 31, 2000, compared to a
negative gross margin of $2.5 million for the year ended December 31, 1999.
32
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the year ended December 31,
2000 were $173.2 million, compared to $23.0 million for the year ended December
31, 1999. These increased expenses resulted primarily from the recording of a
$83.6 million non-cash management allocation charge as a result of our initial
public offering and from the acquisition of US Xchange and the related growth in
employees. Revenue growth has exceeded the increase in selling, general and
administrative expenses. Revenue increased 1407% for the year ended December 31,
2000 as compared to the year ended December 31, 1999, while selling, general and
administrative expenses, excluding the non-cash management allocation charge and
amortization of non-cash deferred compensation, grew 295% during the same
period. Excluding the non-cash management ownership allocation charge and
amortization of deferred compensation, selling, general and administrative
expenses were $82.7 million for the year ended December 31, 2000, compared to
$20.9 million for the year ended December 31, 1999.
Our number of employees increased to 1,420 as of December 31, 2000, from 390 as
of December 31, 1999. As of December 31, 2000, there were 572 sales employees,
including direct sales, sales support and sales management. This compares to 156
as of December 31, 1999. We expect the number of sales employees and total
employees to increase as we expand in our existing markets and as we enter new
markets.
Management Ownership Allocation Charge and Deferred Compensation
For the year ended December 31, 2000, we recognized non-cash management
ownership allocation charges of $83.6 million. We also recognized $7.0 million
and $2.0 million of non-cash deferred compensation amortization for the year
ended December 31, 2000 and 1999, respectively. Deferred compensation was
recorded in connection with membership units of Choice One Communications L.L.C.
sold to certain management employees and grants to employees under our 1998
Stock Option Plan. In August 2000, deferred compensation of $14.8 million was
recorded to stockholders' equity in connection with the issuance of restricted
shares to the employees of US Xchange.
Depreciation and Amortization
Depreciation and amortization for the year ended December 31, 2000 was $41.0
million, compared to $5.2 million for the year ended December 31, 1999. The
increase results from higher capital expenditures from the deployment of our
networks and initiation of services in new markets and the acquisition of US
Xchange. Approximately half of the depreciation and amortization was generated
from the intangibles as a result of our acquisitions, the most significant being
the August 2000 acquisition of US Xchange.
Goodwill from the acquisitions of US Xchange, Atlantic Connections and EdgeNet
was $318.4 million, $7.3 million and $3.5 million, respectively. Client base
acquired through the acquisitions of US Xchange, Atlantic Connections and
EdgeNet was $48.5 million, $3.3 million and $0.5 million, respectively. The
value assigned to the indefeasible right to use fiber received in connection
with the acquisition of US Xchange was $34.3 million. We expect that our
depreciation and amortization expense will increase as we continue to make
capital expenditures and acquire long-term rights in telecommunications
facilities.
Net Loss
The net loss applicable to common stock for the year ended December 31, 2000 was
$231.1 million. The net loss for the year ended December 31, 1999 was $32.5
million. Adjusted EBITDA was negative $70.8 million for the year ended December
31, 2000, compared to negative $23.4 million for the year ended December 31,
1999.
Interest Income (Expense)
Interest expense for the year ended December 31, 2000 was $16.7 million.
Interest expense includes interest payments on borrowings under our senior
credit and subordinated debt facilities, amortization of deferred financing
costs related to such facilities and unused commitment fees on the senior credit
facility. Interest expense for the year ended December 31, 1999 was $2.0
million. Interest expense is expected to increase as our borrowings increase and
as a result of the full-year effect of indebtedness incurred during the year
ended December 31, 2000.
33
Interest income for the year ended December 31, 2000 was $2.1 million. Interest
income results from the investment of cash and cash equivalents, mainly from the
cash proceeds generated from the borrowings under our senior credit and
subordinated debt facilities. Interest income for the year ended December 31,
1999 was $76,000.
Income Taxes
We have not generated any taxable income to date and do not expect to generate
taxable income in the next few years. We have recorded a full valuation
allowance on the deferred tax asset, consisting primarily of net operating loss
carryforwards, due to the uncertainty of its realizability.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 AND THE PERIOD FROM
JUNE 2, 1998 (DATE OF INCEPTION) TO DECEMBER 31, 1998
During the period from our inception on June 2, 1998 through December 31,
1998, we were in the development stage of operations and did not generate any
revenue. Our principal activities during 1998 consisted of the following:
o the hiring of management and other key personnel;
o the raising of capital;
o the procurement of governmental authorizations;
o the acquisition of equipment and facilities;
o the development, acquisition and integration of operations support systems
and other back office systems; and
o the negotiation of interconnection agreements.
During the period from our inception on June 2, 1998 through December 31,
1998, we incurred a net loss of $5.1 million, which was attributable to selling,
general and administrative expenses of $5.1 million, including noncash deferred
compensation of $.4 million, and minimal depreciation and amortization expense.
We became operational in nine markets by the end of 1999 and generated
$4.5 million in revenue for the year ended December 31, 1999. For the year ended
December 31, 1999, after giving pro forma effect to the acquisition of Atlantic
Connections and the incurrence of debt in connection therewith, we would have
had a net loss of $34.2 million. Our historical network operating costs,
selling, general and administrative expenses and depreciation and amortization
expense during this period were $7.0 million, $23.0 million, and $5.2 million,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
At December 31, 2000 we had $173.6 million in cash and cash equivalents,
$30.0 million in restricted cash and $9.8 million in short term investments. In
addition, we had $83.0 million available under the revolving credit facility.
Credit Facility. Our credit facility permits us to borrow up to $350.0
million, subject to various conditions, covenants and restrictions, including
those described below, with maximum borrowing limits to be reduced starting in
2003 by 5.0% with increasing reductions thereafter for each year until maturity
in February 2009. As of December 31, 2000, there was $125.0 million outstanding
under the term B loan, $125.0 million outstanding under the term A loan and
$17.0 million outstanding under the $100.0 million revolving credit facility,
leaving $83.0 million available under the revolving credit facility. The senior
credit facility, which is secured by liens on substantially all of our and our
subsidiaries' assets and a pledge of our subsidiaries' common stock, contains
covenants and events of default that are customary for credit facilities of this
nature. We also have $180.0 million outstanding under our subordinated debt
facility.
34
Cash Flows. We have incurred significant operating and net losses since
our inception. We expect to continue to experience increasing operating losses
and negative EBITDA as we expand our operations and build our client base. As of
December 31, 2000, we had an accumulated deficit of $254.4 million. Net cash
used in operating activities was approximately $69.6 million and $24.3 million
for the years ended December 31, 2000 and 1999, respectively. Net cash used for
operating activities for the year ended December 31, 2000 was primarily due to
net losses and an increase in current liabilities due to market expansion and
central office collocations added during the year. Net cash used for operating
activities for the year ended December 31, 1999 was due to net losses and a
decrease in current liabilities.
Net cash provided by financing activities was $728.8 million and $82.5
million for the years December 31, 2000 and 1999, respectively. Net cash
provided by financing activities for the year ended December 31, 2000 was
related to $396.0 million of net borrowings under the senior credit facility and
subordinated debt facility, $347.9 million of equity contributions, including
the issuance of Series A preferred stock, and $14.6 million of payments of
financing costs related to the senior credit and subordinated debt facility. Net
cash provided by financing activities for the year ended December 31, 1999 was
related to $43.3 million of borrowings under the credit facility, $44.0 million
of equity contributions and $4.8 million of payments of financing costs.
Capital Requirements. Capital expenditures were $119.4 million and $56.1
million from the years ended December 31, 2000 and 1999, respectively. We expect
that our capital expenditures will be less in future periods as we become
operational in all of our 29 planned markets. Net cash used in our investing
activities was $489.3 million for the year ended December 31, 2000 and $56.1
million for the year ended December 31, 1999. Net cash used for investing
activities for the year ended December 31, 2000 was due to capital expenditures
for new and existing markets during 2000. It was also due to the acquisitions of
US Xchange in August 2000 and EdgeNet in February 2000 for net cash
consideration of $324.6 million and $1.9 million, respectively. Net cash used
for investing activities for the year ended December 31, 1999 was due to capital
expenditures.
To expand and develop our business, we will need a significant amount of
cash. The actual amount and timing of our future capital requirements may differ
materially from our estimates as a result of the demand for our services and
regulatory, technological and competitive developments, including additional
market developments and new opportunities in the industry and other factors. We
may require additional financing, or require financing sooner than anticipated,
if our development plans or projections change or prove to be inaccurate. We may
also require additional financing in order to take advantage of unanticipated
opportunities, to effect acquisitions of businesses, to develop new services or
to otherwise respond to changing business conditions or unanticipated
competitive pressures. Sources of additional financing may include commercial
bank borrowings, vendor financing or the private or public sale of equity or
debt securities. Our ability to obtain additional financing is uncertain. We
believe that our cash resources and available credit facilities are sufficient
to meet our future capital and operating requirements for our 29 market plan.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 31, 2000, the carrying value of our debt obligations excluding
capital lease obligations was $447.0 million and the fair value of those
obligations was $445.0 million. The weighted average interest rate of our debt
obligations at December 31, 2000 was 12.43%. A hypothetical decrease of
approximately 1% from prevailing interest rates at December 31, 2000, would
result in an increase in the fair value of our long-term debt by approximately
$9.8 million.
Also, a hypothetical increase of approximately 1% from prevailing interest
rates at December 31, 2000, would result in an approximate increase in cash
required for interest on our variable rate debt during the next five fiscal
years of $1.5 million per year.
We do not use derivative financial instruments for speculative purposes.
Interest rate swap agreements are used to reduce our exposure to risks
associated with interest rate fluctuations and, subject to limitations and
conditions, are required by our credit facility. Under the credit facility
agreement, we are required to enter into hedging agreements with respect to
interest rate exposure with an aggregate notional amount equal to 50% of the
outstanding borrowings once at least 50% of the aggregate commitment has been
utilized. By their nature, these interest rate swap agreements involve risk,
including the risk of nonperformance by counterparties, and our maximum
potential loss may exceed the amount recognized in our balance sheet. We attempt
to control our exposure to counterparty credit risk through monitoring
procedures and by entering into multiple contracts.
At December 31, 2000, we had an interest rate swap agreement for a
notional amount of $125.0 million. Based on the fair value of the interest rate
swap at December 31, 2000, it would have cost us $5.5 million to terminate the
agreement. A hypothetical 1% decrease in the rate would decrease the fair value
by approximately $0.4 million.
35
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, SFAS, No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which was amended by SFAS No.
137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of
the Effective Date of FASB Statement No. 133, an amendment of FASB Statement No.
133," and is effective on a prospective basis for interim periods and fiscal
years beginning January 1, 2001. This Statement establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging securities. For our existing
derivative instruments and to the extent we begin to enter into such
transactions in the future, we will adopt the Statement's accounting and
disclosure requirements in the financial statements for the year ending December
31, 2001.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements with supplementary data are included under Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Part III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 regarding our Directors and
nominees is incorporated in this report by reference from certain sections of
our definitive proxy statement for our 2001 annual meeting of stockholders,
which will be filed with the Securities and Exchange Commission no later then
April 30, 2001. You will find our responses to this Item 10 in the sections
titled " Elections of Directors ". The information required by this Item 10
regarding our executive officers and other key personnel is included under Item
4A of this Form 10-K under the heading "Executive Officers of the Registrant".
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated in this report by
reference from the sections titled "Compensation of Executive Officers" and
"Executive Agreements" of our proxy statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is incorporated in this report by
reference from the section titled "Security Ownership of Certain Beneficial
Owners and Management" of our proxy statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated in this report by
reference from the section titled "Certain Relationships and Related
Transactions" of our proxy statement.
36
Part IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
a. Documents filed as a part of this report.
1. Financial Statements
See Index to Financial Statements on page 38.
2. Financial Statement Schedules
See Index to Financial Statements on page 38.
3. Exhibits
See Index to Exhibits on page 60.
b. Reports on Form 8-K.
None filed.
37
INDEX TO FINANCIAL STATEMENTS
Page
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
Report of Independent Public Accountants................................. 39
Consolidated Balance Sheets as of December 31, 2000 and 1999............. 40
Consolidated Statements of Operations for the years ended December 31,
2000 and 1999 and the period from inception (June 2, 1998)
through December 31, 1998...............................................41
Consolidated Statements of Redeemable Preferred Stock and Stockholders'
Equity for the years ended December 31, 2000 and 1999 and the
period from inception (June 2, 1998) through December 31, 1998.........42
Consolidated Statements of Cash Flows for the years ended December 31,
2000 and 1999 and the period from inception (June 2, 1998) through
December 31, 1998.................................................... 43
Notes to Consolidated Financial Statements...................................44
Schedule II-Valuation and Qualifying Accounts................................58
38
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Choice One Communications Inc.:
We have audited the accompanying consolidated balance sheets of Choice One
Communications Inc. (a Delaware corporation) and subsidiaries as of December 31,
2000 and 1999 and the related consolidated statements of operations, redeemable
preferred stock and stockholders' equity, and cash flows for the years ended
December 31, 2000 and 1999, and the period from inception (June 2, 1998) through
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the 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 financial statements referred to above present fairly, in
all material respects, the financial position of Choice One Communications Inc.
and subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for the years ended December 31, 2000 and 1999,
and the period from inception (June 2, 1998) through December 31, 1998, in
conformity with accounting principles generally accepted in the United States.
/S/ ARTHUR ANDERSEN LLP
Rochester, New York
February 9, 2001
39
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 2000 and 1999
(Amounts in thousands, except share and per share data)
December 31, 2000 December 31, 1999
ASSETS
Current Assets:
Cash and cash equivalents....................................... $173,573 $ 3,615
Restricted cash................................................. 30,000 -
Investments..................................................... 9,801 -
Accounts receivable (net of allowance for doubtful accounts of
$2,372 and $86 at December 31, 2000 and 1999).............. 20,655 2,929
Prepaid expenses and other current assets....................... 4,913 709
----- ----------
Total current assets................................................. 238,942 7,253
------- ---------
Property and Equipment:
Property and equipment.......................................... 329,704 77,318
Less-accumulated depreciation................................... (26,871) (4,891)
-------- ----------
Total property and equipment......................................... 302,833 72,427
------- --------
Other assets, net.................................................... 382,055 14,832
------- --------
Total assets......................................................... $923,830 $94,512
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of capital lease................................ $ 32 $ --
Accounts payable................................................ 14,782 5,060
Accrued expenses................................................ 38,328 11,228
------ --------
Total current liabilities............................................ 53,142 16,288
------ --------
Long-term debt....................................................... 447,000 51,500
Long-term capital lease.............................................. 1,635 --
----- ----------
Total long-term debt and other liabilities........................... 448,635 51,500
Commitments and Contingencies
Redeemable Preferred Stock:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized;
200,000 shares issued and outstanding, ($214,000 162,523 --
liquidation value at December 31, 2000) ........................
Stockholders' Equity:
Common stock, $0.01 par value, 150,000,000 and 47,730,196
authorized, 37,911,851 and 22,022,256 shares issued as of
December 31, 2000 and 1999, respectively...................... 379 220
Treasury stock, 68,197 shares, at cost, at December 31, 2000.... (216) --
Additional paid-in capital...................................... 566,975 72,454
Deferred compensation........................................... (53,207) (8,401)
Accumulated deficit............................................. (254,401) (37,549)
--------- ---------
Total stockholders' equity........................................... 259,530 26,724
------- --------
Total liabilities and stockholders' equity........................... $923,830 $94,512
======== =======
The accompanying notes to consolidated financial statements
are an integral part of these balance sheets.
40
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For years ended December 31, 2000 and 1999 and
the period from inception (June 2, 1998) through December 31, 1998
(Amounts in thousands, except share and per share data)
Period from
inception
(June 2, 1998)
Year Ended Year Ended through
December 31, December 31, December 31,
2000 1999 1998
---------------------------------------------
Revenue .............................................................. $ 68,082 $ 4,518 $ --
Operating expenses:
Network costs ................................................... 56,182 6,979 --
Selling, general and administrative, including non-cash deferred
compensation of $6,973, $2,048 and $376 in 2000, 1999 and 1998,
respectively, and non-cash management ownership allocation
charge of $83,554 in 2000 and $0 in 1999 and 1998 ............. 173,197 22,978 5,060
Depreciation and amortization ................................... 41,003 5,153 36
------------ ------------ ------------
Total operating expenses ........................................ 270,382 35,110 5,096
------------ ------------ ------------
Loss from operations ................................................. (202,300) (30,592) (5,096)
------------ ------------ ------------
Interest income/(expense):
Interest income ................................................. 2,111 76 138
Interest expense ................................................ (16,663) (1,959) (116)
------------ ------------ ------------
Interest income/(expense), net .................................. (14,552) (1,883) 22
------------ ------------ ------------
Net loss ............................................................. (216,852) (32,475) (5,074)
Accretion on preferred stock .................................... 2,393 -- --
Accrued dividends on preferred stock ............................ 11,830 -- --
------------ ------------ ------------
Net loss applicable to common stock .................................. $ (231,075) $ (32,475) $ (5,074)
============ ============ ============
Net loss per share, basic and diluted ................................ $ (7.11) $ (1.47) $ (0.28)
============ ============ ============
Weighted average number of shares outstanding, basic and diluted ..... 32,481,307 22,022,256 18,017,791
============ ============ ============
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
41
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
For the years ended December 31, 2000 and 1999 and
the period from inception (June 2, 1998) through December 31, 1998
(Amounts in thousands, except share data)
Redeemable Treasury Additional
Preferred Stock Common Stock Stock Paid-In Deferred Accumulated Total
Shares Amount Shares Amount Amount Capital Compensation Deficit
------ ------ ------ ------ ------ ------- ------------ -------- -----
Balance, June 2, 1998
(date of inception)............. - $. -- $ - $ - $ - $ -- $ -- $ -
Issuance of common stock........ - . 21,275,829 213 - 17,615 -- -- 17,828
Deferred compensation........... - . -- - - 3,699 (3,699) -- -
Amortization of deferred
compensation................... - . -- - - 376 -- 376
Net loss and comprehensive loss - . -- - - - - (5,074) (5,074)
---- ---- ---------- ---- ------- -------- ------- ----------- ----------
Balance, December 31, 1998 ...... - . 21,275,829 213 - 21,314 (3,323) (5,074) 13,130
Capital contributions and
issuance of common stock........ - . 746,427 7 - 44,014 -- -- 44,021
Deferred compensation.......... - . -- - - 7,126 (7,126) -- -
Amortization of deferred
compensation................... - . -- - - - 2,048 -- 2,048
Net loss and comprehensive loss - . -- - - - - (32,475) (32,475)
---- ---- ----------- ---- ------- --------- -------- ---------- ----------
Balance, December 31, 1999...... - . 22,022,256 220 - 72,454 (8,401) (37,549) 26,724
Issuance of common stock....... - . 9,014,488 91 - 150,451 -- -- 150,542
Conversion of promissory note
to common stock................ - . 132,148 1 - 2,399 -- -- 2,400
Deferred compensation.......... - . 535,296 5 - 15,789 (15,794) -- --
Management ownership
allocation charge............. - . -- - - 119,866 (119,866) -- --
Amortization of deferred
compensation.................. - . -- - - - 90,527 -- 90,527
Issuance of common stock for
the US Xchange acquisition.... - . 6,207,663 62 - 171,021 -- -- 171,083
Issuance of preferred stock
and warrants.................. 200,000 148,300 -- - - 49,353 -- -- 49,353
Accretion on preferred stock.. - 2,393 -- - (2,393) -- -- (2,393)
Accrued dividends on preferred
stock......................... - 11,830 -- - - (11,830) -- -- (11,830)
Acquisition of treasury shares. - . (68,197) - (216) (135) 327 -- (24)
Net loss and comprehensive loss - . -- - - - -- (216,852) (216,852)
---- ----- ----------- ---- ------- ---------- -------- ---------- -----------
Balance, December 31, 2000..... 200,000 $162,523 37,843,654 $379 $(216) $566,975 $(53,207)$(254,401) $259,530
======== ========= =========== ==== ======= ========== ======== ========== ===========
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
42
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For years ended December 31, 2000 and 1999 and
the period from inception (June 2, 1998) through December 31, 1998
(Amounts in thousands)
Period from inception
Year Ended Year Ended (June 2, 1998)
December 31, December 31, through December 31,
2000 1999 1998
---- ---- ----
Cash flows from operating activities:
Net loss ........................................................................ $(216,852) $ (32,475) $ (5,074)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization ............................................... 41,003 5,153 36
Amortization of deferred financing costs .................................... 1,860 294 51
Deferred compensation and management ownership allocation
charge ................................................................... 90,527 2,048 376
Changes in assets and liabilities:
Accounts receivable, net ................................................. (9,554) (1,771) --
Prepaid expenses and other current assets ................................ (3,147) (476) (144)
Other long term assets ................................................... 703 -- --
Accounts payable ......................................................... 2,323 2,107 1,630
Accrued expenses ......................................................... 23,533 801 9,712
--------- --------- ---------
Net cash (used in) provided by operating activities ................... (69,604) (24,319) 6,587
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures ........................................................ (119,400) (56,077) (21,146)
Purchase of investments ..................................................... (11,545) -- --
Increase in restricted cash ................................................. (30,000) -- --
Cash payments for acquisition of business, net of cash acquired ............. (328,335) -- --
--------- --------- ---------
Net cash used in investing activities .................................... (489,280) (56,077) (21,146)
Cash flows from financing activities:
Additions to long-term debt .............................................. 620,125 71,251 --
Principal payments of long-term debt ..................................... (224,625) (28,000) --
Proceeds from capital contributions and issuance of
common stock .......................................................... 150,276 44,021 17,828
Repurchase of treasury stock ............................................. (24) -- --
Proceeds from issuance of preferred stock ................................ 197,655 -- --
Payments of financing costs .............................................. (14,565) (4,752) (1,778)
--------- --------- ---------
Net cash provided by financing activities ....................................... 728,842 82,520 16,050
--------- --------- ---------
Net increase in cash and cash equivalents ....................................... 169,958 2,124 1,491
Cash and cash equivalents, beginning of period .................................. 3,615 1,491 --
--------- --------- ---------
Cash and cash equivalents, end of period ........................................ $ 173,573 $ 3,615 $ 1,491
========= ========= =========
Supplemental disclosures of cash flow information:
Interest paid.................................................... $ 8,930 $ 1,381 $ 65
=========== ============ ==========
Income taxes paid................................................ $ 27 $ 10 $ -
=========== ============ ==========
The accompanying notes to consolidated financial statements
are an integral part of these financial statements.
43
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000
(All amounts in thousands, except share and per share data)
NOTE 1. DESCRIPTION OF BUSINESS
Choice One Communications Inc. and subsidiaries (the "Company"), an integrated
communications provider, was incorporated under the laws of the State of
Delaware on June 2, 1998.
The Company is an integrated communications provider offering voice and
broadband data telecommunications services primarily to small and medium- sized
businesses in second and third tier markets in the northeastern and midwestern
United States. The Company's services include local exchange and long distance
services, and high-speed data and Internet service, principally utilizing
digital subscriber line technology. The Company seeks to become the leading
integrated communications provider in each market by offering a single source
for competitively priced, high quality, customized telecommunications services.
NOTE 2. RECLASSIFICATION
Certain amounts in the 1999 consolidated financial statements have been
reclassified to conform to the current period presentation.
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include all accounts of Choice One
Communications Inc. and all of its subsidiaries. All significant intercompany
balances and transactions have been eliminated.
Development Stage Company
Until February 1999, the Company was in the development stage, as defined by
Statement of Financial Accounting Standards ("SFAS") No. 7, "Accounting and
Reporting by Development Stage Enterprises." Accordingly, the Company has
incurred operating losses and operating cash flow deficits. Expenses are
expected to exceed revenue until a sufficient customer base is established.
Management anticipates that obtaining a sufficient customer base will take a
number of years, and positive cash flows from operations are not expected in the
near future.
Cash and Cash Equivalents
Cash and cash equivalents are highly liquid investments with original maturities
of three months or less. The cost of the cash equivalents approximates fair
market value.
Restricted Cash
Restricted cash represents funds held in escrow for future interest payments on
the subordinated debt facility payable quarterly in February, May, August and
November 2001.
Investments
Short-term investments consist of commercial papers and mature in less than four
months. The investments are considered available for sale and are stated at fair
value which approximates the carrying value of the investment.
44
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
Property and Equipment
Property and equipment includes office furniture and equipment, computer
equipment and software, switch equipment, construction-in-progress of switches
and leasehold improvements. These assets are stated at cost, which includes
direct costs, capitalized labor and capitalized interest. For financial
reporting purposes, depreciation and amortization are computed using the
straight-line method over the following estimated useful lives:
Switch equipment...................................... 10 years
Computer equipment and software....................... 3-5 years
Office furniture and equipment........................ 3-7 years
Indefeasible right to use fiber....................... 20 years
Depreciation of the switch equipment begins once the switches are placed in
service. Construction in progress costs relate to projects to acquire, install
and make operational switch equipment. Direct labor costs, monthly recurring
costs of the collocations, and interests costs incurred in connection with the
installation and construction of certain equipment are capitalized until such
equipment becomes operational. These costs are then amortized over the life of
the related asset.
Leasehold improvements are amortized using the straight-line method over the
shorter of the estimated life of the asset or the related lease term.
Betterments, renewals and extraordinary repairs that extend the life of the
asset are capitalized; other repairs and maintenance are expensed as incurred.
Included in property and plant is leased equipment which has been capitalized
and the present value of minimum lease payments is recorded as a liability.
Amortization on the capitalized leased equipment is computed on the
straight-line method over the term of the lease.
Other Assets
Other assets primarily consist of goodwill, customer base, deferred financing
costs and other assets.
Goodwill represents the excess purchase price over the fair value of net assets
acquired and is being amortized using the straight-line method over ten years.
Customer base represents the fair value of the customer base obtained through
acquisitions and is being amortized using the straight-line method over five
years.
Deferred financing costs consists of capitalized amounts for bank financing
fees, professional fees and other expenses related to the Company's senior
credit facility and subordinated debt facility. These costs are being amortized
on the effective interest rate method, over the life of the related debt.
Amortization expense for these costs is included as a component of interest
expense in the Consolidated Statements of Operations.
The Company reviews its long-lived assets in accordance with SFAS No. 121,
"Accounting for the Impairment of Long-lived Assets and Long-lived Assets to be
Disposed of," for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If such
events or changes in circumstances are present, a loss is recognized if the
carrying value of the asset is in excess of the sum of the undiscounted cash
flows expected to result from the use of the asset and its eventual disposition.
An impairment loss is measured as the amount by which the carrying amount of the
asset exceeds the fair value of the asset.
Income Taxes
Income taxes are accounted for in accordance with SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 requires an asset and liability method of accounting
for income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for temporary differences between financial statement
and income tax bases of assets and liabilities. Deferred tax assets and
liabilities are measured using the tax rates and laws that are currently in
effect. In addition, the amount of any future tax benefits is reduced by a
valuation allowance until it is more likely than not that such benefits will be
realized.
45
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
Deferred Compensation
The Company recognizes deferred compensation for the difference between the fair
market value of the Company's stock and the price at which such stock has been
sold to management employees since the formation of the Company, for the
difference between fair market value of the Company's stock and the exercise
price of certain options granted, and for restricted shares issued to employees.
The deferred compensation charge and management allocation charges included in
deferred compensation on the consolidated balance sheet are amortized over the
period in which the employee earns the right to sell the stock at market value
or, in the case of options and restricted stock, over the vesting period.
Fair Value of Financial Instruments
The fair value of financial instruments are accounted for in accordance with
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." SFAS No.
107 requires that the Company disclose the fair value of its financial
instruments for which it is practicable to estimate fair value. The carrying
amounts of cash and cash equivalents, restricted cash, short-term investments,
prepaid expenses and other current assets, accounts payable and amounts included
in accruals meeting the definition of a financial instrument approximate fair
value because of the short-term maturity of these instruments. The carrying
values, notional amounts and related estimated fair values for the Company's
remaining financial instruments are as follows:
2000 1999
Carrying Value/ Carrying Value/
Notional Amount Fair Value Notional Amount Fair Value
Long-term debt $447,000 $444,895 $51,500 $51,500
Interest rate swap agreements $125,000 $(5,526) $ - $ -
Net Loss per Common Share
The Company calculates net loss per share under the provisions of the SFAS No.
128, "Earnings per Share." SFAS No. 128 requires dual presentation of basic and
diluted earnings per share on the face of the income statement. Basic earnings
per share is based on the weighted average number of common shares outstanding.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. No reconciliation of basic and diluted is needed, as the
effect of dilutive securities would be antidilutive. The Company had options and
warrants to purchase 4,391,260, 605,202 and 198,397 shares outstanding at
December 31, 2000, 1999 and 1998, respectively, that were not included in the
calculation of diluted loss per share because the effect would be antidilutive.
Comprehensive Income
During 1998 the Company adopted SFAS No. 130, "Reporting Comprehensive Income,"
which requires comprehensive income and its components to be presented in the
financial statements. During 2000, 1999 and 1998, the Company had no
comprehensive income components; therefore, comprehensive loss was the same as
net loss for the periods presented.
Revenue Recognition
Revenue is recognized in the month in which service is provided. Deferred
revenue represents advance billings for services not yet provided. Such revenue
is deferred and recognized in the month in which service is provided.
46
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
Network Costs
Network costs include lease costs and costs of originating and terminating calls
incurred through third party providers.
Concentrations of Risk
The Company has no concentration of credit risk within its receivables. As of
and for the year ended December 31, 2000, no customers represented more than 10%
of the Company's receivables or revenue.
The Company leases its transport capacity from a limited number of suppliers and
are dependent upon the availability of transmission facilities owned by the
suppliers. The Company is vulnerable to the risk of being unable to renew
favorable supplier contracts, and the supplier not timely processing orders for
the Company's customers. The Company is at risk with respect to regulatory
agreements that govern rates charged by the suppliers.
Derivatives
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS No. 133), " Accounting for
Derivative Instruments and Hedging Activities". The effective date of the
statement was deferred until fiscal years beginning after June 15, 2000.
Therefore, the Company is expected to adopt the statement in its first fiscal
quarter of 2001. SFAS No. 133 requires that all derivative instruments, such as
interest rate swap agreements, be recognized in the financial statements and
measured at fair value regardless of the purpose or intent for holding them. Due
to the Company's limited use of derivatives, the adoption of SFAS No. 133 is not
expected to have a material effect on the Company's financial statements.
Derivative instruments are used by the Company to manage its interest rate
exposures. The Company does not use the instruments for speculative purposes.
Interest rate swap agreements are employed as a requirement of the Company's
senior credit facility. The facility requires an interest rate hedge for 50% of
the outstanding principal balance once the Company has utilized 50% of the
aggregate funding under the facility. The interest differential to be paid or
received under the related interest rate swap agreements is currently recognized
over the life of the related debt and is included in interest expense or income.
Credit risk associated with nonperformance by counterparties is mitigated by
using major financial institutions with high credit ratings.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of these assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
NOTE 4. ACQUISITIONS
On August 1, 2000, the Company acquired US Xchange, Inc. ("US Xchange"), a
corporation headquartered in Grand Rapids, Michigan, which is engaged in the
business of providing integrated communications services within the midwest,
primarily third tier cities. The purchase price was approximately $324.6 million
in net cash and 6.2 million shares of common stock issued to the sole
shareholder. The net cash consideration paid consists of $303.0 million
disbursed upon closing and $21.6 million disbursed prior to and subsequent to
the closing date in connection with the acquisition. The acquisition was
accounted for using the purchase method of accounting and, accordingly, the net
assets and results of operations of US Xchange have been included in the
Company's consolidated financial statements since the acquisition date.
The purchase price was allocated based upon the fair value of the assets
acquired and liabilities assumed with any excess reflected as goodwill. Goodwill
of $318.4 million, customer base of $48.5 million and property and equipment
consisting of an indefeasible right to use fiber of $34.3 million are being
amortized on a straight-line basis
47
over 10 years, five years and 20 years, respectively. The assets and liabilities
of US Xchange have been recorded at their fair values. In connection with the
acquisition, liabilities assumed and cash paid were as follows:
Fair value of assets acquired, including cash acquired.... $ 535,648
Less-liabilities assumed.................................. 10,833
------
Total consideration paid.................................. 524,815
Less-cash acquired........................................ 29,086
Less-common stock issued.................................. 171,083
-------
Net cash paid for acquisition............................. $ 324,646
=========
On February 24, 2000, the Company acquired EdgeNet, Inc. ("EdgeNet"), a
corporation based in Buffalo, New York, which is engaged in the business of
providing Internet home page design and development. The purchase price was
approximately $4.3 million, consisting of approximately $1.9 million in cash and
approximately $2.4 million in a promissory note that was converted into 132,148
shares of the Company's common stock in September 2000. The acquisition was
accounted for using the purchase method of accounting and, accordingly, the net
assets and results of operations of EdgeNet, Inc. have been included in the
Company's consolidated statement since the acquisition date. The purchase price
was allocated based upon the fair value of the assets acquired and liabilities
assumed with any excess reflected as goodwill of $3.5 million, which is being
amortized on a straight-line basis over ten years.
In connection with the acquisition, liabilities assumed and cash paid were as
follows:
Fair value of assets acquired, including cash acquired...... $ 4,397
Less-liabilities assumed.................................... 134
--------
Total consideration paid.................................... 4,263
Less-cash acquired.......................................... 1
Less-amounts borrowed....................................... 2,400
-----
Net cash paid for acquisition............................... $ 1,862
=========
In November 1999, the Company purchased all of the outstanding units of Atlantic
Connections, L.L.C. ("Atlantic Connections"), a local and long distance provider
with operations in the Portsmouth, New Hampshire and Worcester, Massachusetts
metropolitan areas. The purchase price, including contingent consideration of
$1.5 million in cash that was paid in September 2000, was approximately $10.0
million. The transaction was accounted for as a purchase and is included in the
Company's Consolidated Statements of Operations since the date of acquisition.
The purchase price was allocated based upon the fair value of the assets
acquired and liabilities assumed with any excess reflected as goodwill of $7.3
million, which is being amortized on a straight-line basis over ten years.
In connection with the acquisition, liabilities assumed and cash paid were as
follows:
Fair value of assets acquired, including cash $ 12,131
acquired...................................
Less-liabilities 2,038
---------
assumed...............................................
Total consideration 10,093
paid..................................................
Less-cash 17
acquired..............................................
Less-amounts 8,249
---------
borrowed..............................................
Net cash paid for $ 1,827
=========
acquisition...........................................
48
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
NOTE 5. PRO FORMA RESULTS OF OPERATIONS
The following unaudited pro forma condensed results of operations combine the
operations of the Company with those of US Xchange acquired on August 1, 2000 as
well as Atlantic Connections acquired on November 3, 1999, as if the
acquisitions had occurred on January 1, 1999. The unaudited pro forma condensed
results of operations are presented after giving effect to certain adjustments
for depreciation, amortization of intangible assets, interest expense on the
acquisition financing and non-cash deferred compensation charge on restricted
shares of common stock issued in connection with the US Xchange acquisition on
August 1, 2000. The acquisitions were accounted for using the purchase method of
accounting.
The unaudited pro forma results of operations are based upon currently available
information and upon certain assumptions that the Company believes are
reasonable. The unaudited pro forma results of operations do not purport to
represent what the Company's financial position or results of operations would
actually have been if the transaction in fact occurred on such date or at the
beginning of the period indicated or to project the Company's financial position
or the results of operations at any future date or for any future period.
Pro Forma Year Ended
December 31, 2000 December 31, 1999
Revenue............................... $ 94,927 $ 38,786
Loss from operations.................. $(262,152) $(147,429)
Net loss.............................. $(284,455) $(167,421)
Net loss applicable to common stock... $(317,249) $(203,231)
Net loss per share, basic and diluted. $ (9.35) $ (7.07)
Weighted average number of shares
outstanding, basic and diluted... 33,924,783 28,765,215
NOTE 6. PROPERTY AND EQUIPMENT
Property and equipment, at cost, consisted of the following:
December 31, 2000 December 31, 1999
Switch equipment........................ $ 213,122 $ 56,263
Computer equipment and software......... 32,754 11,416
Office furniture and equipment.......... 9,520 2,687
Leasehold improvement................... 20,920 1,675
Indefeasible right to use fiber......... 35,995 --
Construction in progress................ 17,393 5,277
------ -----
$ 329,704 $ 77,318
========= =========
Capitalized labor included in property and equipment was $2,464, $3,894 and $647
during the years ended December 31, 2000 and 1999, and the period from inception
(June 2, 1998) through December 31, 1998, respectively. Capitalized monthly
recurring costs of collocations in property and equipment were not material
during the periods presented. Approximately $57 and $250 of interest costs,
associated with borrowings used to finance the construction of long-term assets,
was capitalized during the years ended December 31, 2000 and 1999, respectively.
There were no interest costs capitalized during the period from inception (June
2, 1998) to December 31, 1998.
Depreciation expense for the years ended December 31, 2000 and 1999 and for the
period from inception (June 2, 1998) through December 31, 1998 amounted to
$21,980, $4,855 and $36, respectively.
49
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
NOTE 7. OTHER ASSETS
Other assets consisted of the following:
December 31, 2000 December 31, 1999
Goodwill.......................... $ 329,192 $ 5,464
Customer base..................... 52,285 3,300
Deferred financing costs.......... 19,870 5,305
Other assets...................... 2,231 1,406
----- -----
403,578 15,475
Less-accumulated amortization..... (21,523) (643)
-------- -----
$ 382,055 $14,832
======= ======
NOTE 8. ACCRUED EXPENSES
Accrued expenses consisted of the following:
December 31, 2000 December 31, 1999
Accrued network costs................ $ 18,348 $ 3,969
Accrued payroll and payroll
related benefits................. 4,460 1,440
Accrued collocation costs............ 5,569 2,470
Accrued interest..................... 7,463 547
Other................................ 2,488 2,802
----- -----
$ 38,328 $ 11,228
======== ========
NOTE 9. LONG-TERM DEBT
Long-term debt outstanding consists of the following:
December 31, 2000 December 31, 1999
Term A loan............................$ 125,000 $ --
Term B loan............................ 125,000 --
Subordinated debt...................... 180,000 --
Revolver............................... 17,000 51,500
-------- ---------
Long-term debt........................ $ 447,000 $ 51,500
========== =========
Maturities of long-term debt are as follows for the year ending December 31:
2003...................................... $1,876
2004...................................... 9,063
2005...................................... 18,438
Thereafter................................ 417,623
-------
Total..................................... $ 447,000
=========
In February 2000, in connection with the acquisition of EdgeNet, the Company
entered into $2.4 million of promissory notes with the shareholders of EdgeNet.
The promissory notes were converted into 132,148 shares of the Company's common
stock in September 2000.
50
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
In August 2000, the Company amended and restated its Credit Agreement (the
"Second Amended Agreement"). The Second Amended Agreement, which terminates on
eight and one-half years from August 1, 2000, provides the Company with an
eight-year revolving credit facility of $100.0 million, an eight-year multiple
draw term A loan of $125.0 million and an eight and one-half year term B loan of
$125.0 million. The Second Amended Agreement was used, in part, to finance the
acquisition of US Xchange and will be used to finance capital expenditures and
to provide working capital. Borrowings under the Second Amended Agreement are
secured by substantially all of the assets of the Company and bear interest, at
the Company's option, at either the LIBOR rate or the base rate (the higher of
the prime interest rate or the federal funds rate plus 0.5 percent), with
additional percentage points added based on the Company's leverage ratio, as
defined in the Second Amended Agreement. In addition, the Company is also
required to pay a commitment fee of 0.75 percent to 1.5 percent per annum based
on the unutilized portion of the credit facility. At December 31, 2000, the
weighted average interest rate under the Second Amended Agreement was 11.16%.
The aggregate commitment under the Second Amended Agreement is reduced by 1.25
percent per quarter commencing on December 31, 2003 until September 30, 2004, by
2.50 percent per quarter commencing on December 31, 2004 until September 30,
2005, by 6.25 percent per quarter commencing on December 31, 2005 until
September 30, 2006, and by 7.50 percent per quarter commencing on December 31,
2006 until termination of the loan on January 31, 2009. As of December 31, 2000,
$83.0 million was available under the revolving credit facility.
The Second Amended Agreement revised certain covenants including total debt to
contributed capital, minimum revenue, maximum earnings before interest, taxes,
depreciation and amortization (EBITDA) losses, maximum capital expenditure
levels, minimum asset coverage, leverage ratio, fixed charge ratio and interest
coverage ratio, all as defined in the Amended Agreement. At December 31, 2000,
the Company was in compliance with these covenants.
On August 1, 2000, the Company entered into a $180.0 million unsecured
subordinated debt facility which is a one-year overfunded facility. Upon draw
down of the facility in November 2000, $30.0 million of the proceeds was
credited into escrow to fund cash interest payments on the loan. This amount is
reflected as restricted cash in the consolidated balance sheet. Morgan Stanley
Senior Funding, a related party to the Company, was sole lead arranger for the
subordinated debt facility. The one-year overfunded facility maturity date is
November 10, 2001. On the maturity date, subject to certain conditions, any
outstanding balance will be redeemed with the issuance of rollover notes. The
rollover notes mature on the ninth anniversary of the rollover issuance date. On
the date of the issuance of the rollover notes, the Company will issue warrants
representing up to 5% of the fully diluted common stock of the Company on such
date. All warrants will be exercisable at 10% above the then current trading
price for the common stock of the Company for a period of five years from the
warrants' issuance date.
As of December 31, 2000, the $180.0 million of subordinated debt was
outstanding. Interest will be payable quarterly based on LIBOR plus an
applicable margin. The interest rate was 14.31% on December 31, 2000.
At December 31, 2000, the carrying value of the Company's debt obligations,
excluding capital lease obligations, was $447.0 million and the fair value of
those obligations was $445.0 million.
NOTE 10. DERIVATIVE INSTRUMENTS
Under the Second Amended Agreement, the Company is required to enter into
hedging agreements with respect to interest rate exposure with an aggregate
notional amount equal to 50% of the outstanding borrowings once at least 50% of
the aggregate commitment has been utilized. The Company uses interest rate swap
agreements to reduce its exposure to interest rate changes. On August 31, 2000
the Company entered into a swap contract related to $125.0 million borrowed on
the term B loan. The swap expires in 2006 and is based on three-month LIBOR,
which is fixed at 6.94%, plus an applicable margin. The differential to be
received or paid under the interest rate swap agreement is recognized as a
component of interest expense.
51
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
At December 31, 2000, the notional principal amount of the interest rate swap
agreement was $125.0 million expiring in 2006. The fair value of the swap
agreement was $(5.5) million as of December 31, 2000. The fair value of the
interest rate swap agreement is estimated based on quotes from brokers and
represents the estimated amount that the Company would expect to pay to
terminate the agreement at the reporting date.
NOTE 11. REDEEMABLE PREFERRED STOCK
On August 1, 2000, the Company issued 200,000 shares of Series A senior
cumulative redeemable preferred stock and related warrants in a private
placement for $200.0 million. The Series A Preferred Stock was issued to Morgan
Stanley Dean Witter Capital Partners, a related party to the Company. Each share
of Series A preferred stock has a stated value of $1,000 and ranks senior to
each other class or series of the Company's capital stock.
Dividends will accrue quarterly at the rate of 14.0% per annum, cumulative and
compounded quarterly. Prior to August 1, 2005 (the fifth anniversary of the
issue date) the Company may pay dividends quarterly in additional shares of
Series A preferred stock or in cash, at the Company's option. Thereafter until
maturity, dividends are to be paid in cash. The Series A preferred stock matures
on August 1, 2012, at which time the Company must redeem the shares for their
stated value plus any unpaid dividends. The preferred stock is not redeemable by
the Company prior to August 1, 2005. For redemptions of the preferred stock
between August 1, 2005 and the maturity date of August 1, 2012, the Company must
pay a premium on amounts redeemed based on the following schedule:
August 1, 2005 to July 31, 2006 107%
August 1, 2006 to July 31, 2007 104.67%
August 1, 2007 to July 31, 2008 102.33%
August 1, 2008 and thereafter 100%
For liquidation or change in control during the first five years or any time
through the maturity date, the premium on redeemed amounts would be 100% and
101%, respectively.
During 2000, $11.8 million in dividends were accrued and will be paid in
additional shares of Series A cumulative redeemable preferred stock.
NOTE 12. STOCKHOLDERS' EQUITY
On January 17, 2000, the Company's Board of Directors voted to amend the
Certificate of Incorporation of the Company to increase the number of authorized
common shares and preferred shares to 150 million and 5 million respectively, as
calculated after the stock split.
On January 25, 2000, the Company's Board of Directors approved a 354.60-for-one
stock split, the effect of which is retroactively reflected within these
financial statements for all periods presented.
On February 16, 2000, the Company raised $164.3 million, less $14.0 million in
expenses, in an initial public offering of Common Stock (the "equity offering").
Prior to the equity offering, the Company's institutional investors and
management owned 95.0 percent and 5.0 percent, respectively, of the ownership
interests of Choice One LLC, an entity that owned substantially all of the
Company's outstanding capital stock. As a result of the equity offering, Choice
One LLC was dissolved and its assets, which consisted almost entirely of such
capital stock, were distributed to the Company's institutional investors and
management in accordance with the LLC Agreement. The LLC Agreement provided that
the Equity Allocation between the Company's institutional investors and
management be 68.5 percent to the Investor Members and 31.5 percent to
management based upon the valuation implied by the equity offering.
52
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
As the estimated fair value of the Company had exceeded the price at which
ownership units of Choice One LLC had been sold to management employees since
the formation of the Company and prior to the initial public offering, the
Company had recognized deferred compensation of $4.4 million and $1.7 million at
December 31, 1999 and 1998, respectively, of which $2.1 million, $0.9 million
and $0.2 million had been amortized to expense during the years ended December
31, 2000 and 1999, and the period from inception (June 2, 1998) to December 31,
1998, respectively.
Upon the consummation of the initial public offering, the Company was required
by generally accepted accounting principles to record the increase (based upon
the valuation of the Common Stock implied by the equity offering) in the assets
of Choice One LLC allocated to management as a $119.9 million increase in
additional paid-in capital, with a corresponding increase in non-cash deferred
compensation. We were required to record $62.4 million as an initial non-cash,
nonrecurring charge to operating expense and the remaining $57.5 million was
recorded as a deferred management ownership allocation charge. We amortized
$21.1 million of the deferred charge during 2000 and will amortize $24.8 million
and $11.6 million during 2001 and 2002, respectively, which is the period over
which the Company has the right to repurchase the securities (at fair market
value or the price paid by the employee, if that price is less than fair market
value) in the event the management employee's employment with the Company is
terminated.
In connection with the issuance of the Series A preferred stock, the Company
issued warrants to the holders of the Series A preferred stock. The warrants to
purchase 1,747,454 shares of our common stock are exercisable in whole or in
part at any time. The warrant exercise price is $0.01 per share of common stock.
The warrants will expire on August 1, 2012.
In connection with the acquisition of US Xchange on August 1, 2000, the Company
issued 6,207,663 shares to the sole shareholder and 535,296 of restricted shares
to the employees of US Xchange. The restricted shares issued to the employees
will vest over two years at 50% per annum. Since August 1, 2000, the Company has
reacquired certain of these restricted shares from employees who have terminated
their employment with the Company. These shares are classified as treasury stock
in the accompanying financial statements. Deferred compensation related to the
issuance of the restricted shares for $14.8 million was recorded to
stockholders' equity of which $3.0 million was amortized during 2000.
NOTE 13. STOCK OPTION PLAN
In 1998, the Company's stockholders approved the 1998 Employee Stock Option Plan
(the "1998 Plan"). The persons to whom options are granted, the number of shares
granted to each and the period over which the options become exercisable are
determined by the Employee Option Plan Administrative Committee. The options
granted have a term of ten years and vest at equal rates over a four-year
period. The total number of shares authorized under the 1998 Plan is 6,000,000.
In 1999, the Company's stockholders approved the 1999 Director Stock Incentive
Plan (the "1999 Plan"). Options under the plan are issued to attract and retain
outside directors of the Company. The number of shares granted and the period
over which the options become exercisable are determined by the Board of
Directors. The options granted have a term of ten years and vest at equal rates
over a four-year period. The total number of shares authorized under the 1999
Plan is 531,896.
The Company accounts for stock based compensation issued to its employees in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and has elected to adopt the "disclosure-only" provisions of SFAS No. 123,
"Accounting for Stock Based Compensation." Had compensation cost for the plans
been determined based on the fair value of the options at the grant dates for
awards under the plans consistent with the method prescribed in SFAS No. 123,
the Company's net loss would have increased to the pro forma amount indicated
below for the years ended December 31, 2000 and 1999 and the period from
inception (June 2, 1998) through December 31, 1998.
2000 1999 1998
---- ---- ----
Net loss as reported...............$ (216,852) $ (32,475) $ (5,074)
Net loss pro forma.................$ (220,680) $ (32,658) $ (5,087)
53
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
Net loss per share, basic and diluted:
2000 1999 1998
---- ---- ----
As reported.................... $(7.11) $(1.47) $ (0.28)
Pro forma...................... $(7.23) $(1.48) $ (0.28)
For purposes of the pro forma disclosure above, the fair value of each option
grant is estimated on the date of the grant using the Black-Scholes
option-pricing model:
2000 1999 1998
---- ---- ----
Dividend yield............. 0.00 percent 0.00 percent 0.00 percent
Expected volatility.........136.39 percent 0.00 percent 0.00 percent
Risk-free interest rate..... 5.99 percent 5.74 percent 4.99 percent
Expected life.............. 7 years 7 years 7 years
The weighted average grant date fair value of options granted during the years
ended December 31, 2000 and 1999 and the period from inception (June 2, 1998)
through December 31, 1998 was $17.28, $12.09 and $13.99, respectively. SFAS No.
123 has only been applied to options granted beginning August 12, 1998. As a
result, the pro forma compensation expense may not be representative of that to
be expected in future years.
The following is a summary of the activity in the Company's plans during the
years ended December 31, 2000 and 1999 and the period from inception (June 2,
1998) through December 31, 1998:
2000 1999 1998
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ------ ------ ----- ------ ------
Options outstanding,
beginning of period...... 605,202 $5.32 198,397 $ 2.82 - $ -
Options granted............... 2,314,378 18.23 492,333 5.92 198,397 2.82
Options exercised.... .................(26,947) 3.36 - - - -
Options (248,827) 13.57 85,528) 2.94 - -
----------- --------- -----------
forfeited..........................
Options outstanding,
end of period 2,643,806 15.52 605,202 5.32 198,397 2.82
========= =======- =======
Options exercisable... ................207,344 4.94 - - - -
The weighted-average remaining contractual life of options outstanding was 9.4
years, with exercise prices ranging from $2.82 to $40.81, as of December 31,
2000. None of the options expired during 2000, 1999 and 1998.
54
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
Options outstanding as of December 31, 2000 consisted of the following:
Options Outstanding Options Exercisable
------------------------------------------------------- -------------------------------------
Weighted-Average
Range of Number of Remaining Weighted-Average Number of Weighted-Average
Exercise Prices Shares Contractual Life Exercise Price Per Share Shares Exercise Price Per Share
--------------- ------ ---------------- ------------------------ ------ ------------------------
$2.82 to 4.00 307,704 8.0 years $ 3.19 145,803 $3.07
6.50 to 9.40 1,045,328 9.6 6.92 54,657 8.72
12.19 to 20.00 521,919 9.6 14.31 6,884 14.48
28.25 to 40.81 768,855 9.5 32.98 -
---------- -----------
$2.82 to 40.81 2,643,806 9.4 15.52 207,344 4.94
========= =======
As the estimated fair market value of the Company's stock exceeded the exercise
price of certain options granted, the Company has recognized total gross
deferred compensation expense of $7,507, $6,466 and $1,957 at December 31, 2000,
1999 and 1998, respectively, of which $1,860, $1,115 and $201 has been amortized
to expense during the years ended December 31, 2000 and 1999 and the period from
inception (June 2, 1998) through December 31, 1998, respectively. The deferred
compensation is amortized to expense over the vesting period of the options.
The Company's certificate of incorporation provides that it may issue preferred
stock without shareholder approval. Under certain circumstances, as defined in
the certificate of incorporation and by-laws, preferred stock could be issued by
the Company in connection with a shareholder rights plan. The issuance of
preferred stock in connection with a shareholder rights plan could cause
substantial dilution to any person or group that attempts to acquire the Company
on terms not approved in advance by the Company's board of directors.
NOTE 14. INCOME TAXES
The Company had approximately $125,346 and $32,188 of net operating loss
carryforwards for federal income tax purposes at December 31, 2000 and 1999,
respectively. The net operating loss carryforwards will expire in the years 2020
and 2019, respectively, if not previously utilized. Application of Internal
Revenue Code section 382 may limit the utilization of the net operating loss
carryforward. The Company has recorded a valuation allowance equal to the net
deferred tax assets at December 31, 2000 and 1999, due to the uncertainty of
future operating results. The valuation allowance will be reduced at such time
as management believes it is more likely than not that the net deferred tax
assets will be realized. Any reductions in the valuation allowance will reduce
future income tax provisions.
The deferred tax asset is comprised of the following at December 31:
2000 1999
---- ----
Intangible assets.......................$ (11,527) $ (455)
Accelerated depreciation............... (1,017) -
Start-up and other capitalized 1,768 1,572
costs.................................
Net operating loss 53,613 10,259
carryforwards.........................
Compensation related 1,012 526
adjustments...........................
Less: valuation allowance......... (43,849) (11,902)
-------- ---------
Net deferred tax asset.......... $ - $ -
============= ============
Under existing tax law, all operating expenses incurred prior to a company
commencing its principal operations are capitalized and amortized over a
60-month period for tax purposes.
55
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
NOTE 15. RELATED PARTIES
The Company entered into a master facilities agreement with Fiber Technologies,
LLC. ("Fiber Technologies"), a company that designs, constructs and leases high
performance fiber networks in second and third tier markets in the Northeast and
Mid-Atlantic regions of the United States. The agreement provides the Company
with a 20-year indefeasible right to use (IRU) fiber without electronics in 13
of Choice One's market cities.
In addition to the master facilities agreement, the Company made a minority
equity investment in Fiber Technologies, in return for which the Company has the
right to appoint one representative to the board of directors, and has a vote in
determining the new markets in which Fiber Technologies will develop and build
local loops.
In addition, Fleet Equity Partners , a related party to the Company, has a
significant equity investment in Fiber Technologies.
Morgan Stanley Dean Witter Capital Partners, a related party to the Company,
purchased 200,000 shares of the Company's series A senior cumulative preferred
stock on August 1, 2000.
Morgan Stanley Senior Funding, a related party to the Company, was sole lead
arranger and one of the lenders for the Company's subordinated debt facility and
was one of the lenders for the Company's senior credit facility.
In August 2000, the Company entered into a fiber optic and grant of indefeasible
right to use agreement with RVP Fiber L.L.C. The 20-year indefeasible right to
use was acquired as part of the acquisition of US Xchange. A shareholder of RVP
Fiber L.L.C. is also a shareholder of the Company, and has the right to appoint
one representative to the board of directors of the Company, pursuant to the
merger agreement with US Xchange.
NOTE 16. COMMITMENTS AND CONTINGENCIES
Operating Lease Agreements
The Company leases office space and certain other equipment under various
operating leases that expire through 2009. The minimum aggregate payments under
noncancelable leases are as follows for the years ending December 31:
2001...........................$ 7,072
2002........................... 6,805
2003........................... 5,939
2004........................... 5,097
2005........................... 4,751
Thereafter..................... 18,795
------
$ 48,459
=========
Rent expense for the years ended December 31, 2000 and 1999 and for the period
from inception (June 2, 1998) through December 31, 1998 was approximately
$4,275, $1,111 and $186, respectively.
401(k) Plan
The Company provides a defined contribution 401(k) plan to substantially all of
its employees meeting certain service and eligibility requirements. The Company
pays a monthly matching contribution equal to 50 percent of the employees'
contributions up to a maximum of 6 percent of their eligible compensation. The
matching contribution vests 20% per year beginning after the first year of
employment. Plan expenses were approximately $766, $224 and $32 during the years
ended December 31, 2000 and 1999, and for the period from inception, June 2,
1998, through December 31, 1998, respectively.
56
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (Continued)
Annual Incentive Plan
All full-time noncommissioned Choice One employees are eligible to participate
in the Company's bonus. The total amount included in operations for these
incentive bonuses was approximately $3,355, $748 and $538 during the years ended
December 31, 2000 and 1999, and for the period from inception (June 2, 1998)
through December 31, 1998, respectively.
Other Agreements
In 1999, the Company entered into a sponsorship agreement with Buffalo Bills,
Inc. Under the sponsorship agreement, the Company obtained certain marketing and
signage rights related to Ralph Wilson Stadium and the Buffalo Bills, a National
Football League team, and became the exclusive telecommunications provider of
Ralph Wilson Stadium during the 1999 through 2003 seasons. The agreement
requires the Company to pay a total of $2.4 million during the period from
September 30, 1999 through June 30, 2004.
In 2000, the Company amended its three-year general agreement with Lucent
Technologies, Inc. ("Lucent") establishing terms and conditions for the purchase
of Lucent products, services and licensed materials. The agreement requires the
Company to purchase a minimum of $100.0 million of Lucent products, services and
licensed materials. If the Company fails to purchase the minimum requirements,
an additional price premium is charged.
In 2000, the Company entered into a master facilities agreement with Fiber
Technologies. The agreement provides the Company with a 20-year indefeasible
right to use fiber without electronics in 13 of Choice One's market cities. The
Company has committed to four fibers in each cable in the 13 cities. The
Company's commitment could be up to $100.0 million over the 20-year term of the
agreement, subject to certain performance criteria and price reductions in
accordance with the agreement.
NOTE 17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
2000
Revenue ............................................................ $ 6,790 $ 10,411 $ 21,354 $ 29,527
Loss from operations ............................................... (80,618) (24,948) (44,372) (52,362)
Net loss applicable to common stock ................................ (81,656) (25,018) (53,710) (70,688)
Basic and diluted net loss per share ............................... $ (3.10) $ (0.81) $ (1.50) $ (1.87)
1999
Revenue ............................................................ $ 2 $ 152 $ 793 $ 3,571
Loss from operations ............................................... (4,187) (6,196) (8,856) (11,227)
Net loss applicable to common stock ................................ (4,447) (6,523) (9,101) (12,277)
Basic and diluted net loss per share ............................... $ (0.21) $ (0.31) $ (0.41) $ (0.56)
57
CHOICE ONE COMMUNICATIONS INC.
SCHEDULE II- VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
------------------------------
December 31, 1999 Charged to Charged to other Deductions December 31,
expense accounts 2000
------------------ ---------- ---------------- ----------- ------------
Allowance for doubtful accounts $86 $981 $2,663 $ 1,358 $2,372
Deferred tax valuation allowance $11,902 $31,947 $ - $ - $43,849
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: March 5, 2001
CHOICE ONE COMMUNICATIONS INC.
By: /s/ Steve M. Dubnik
----------------------------------------
Steve M. Dubnik, Chairman of the Board,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name Title Date
/s/ Steve M. Dubnik Chairman, President and Chief
- ---------------------------
Steve M. Dubnik Executive Officer (Principal March 5, 2001
Executive Officer)
/s/ Ajay Sabherwal Executive Vice President and Chief
Ajay Sabherwal Financial Officer (Principal March 5, 2001
Financial and Accounting Officer)
_______________________ Director March 5, 2001
John B. Ehrenkranz
_______________________ Director March 5, 2001
Bruce M. Hernandez
/s/ Michael M. Janson Director March 5, 2001
- ---------------------------
Michael M. Janson
/s/ Robert M. Van Degna Director March 5, 2001
- ---------------------------
Robert M. Van Degna
/s/ Royce M. Holland Director March 5, 2001
- ---------------------------
Royce M. Holland
/s/ Richard Postma Director March 5, 2001
- ---------------------------
Richard Postma
/s/ James S. Hoch Director March 5, 2001
- ---------------------------
James S. Hoch
59
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION LOCATION
- ------ ----------- --------
3.1 Amended and Restated Certificate of Incorporation Incorporated by reference from Exhibit 3.1 to
Choice One Communication Inc.'s Registration
Statement on Form S-1 declared effective on
February 16, 2000 located under Securities and
Exchange Commission File No. 333-91321
("February 2000 Registration Statement")
3.2 Amended and Restated Bylaws Incorporated by reference from Exhibit 3.2 to
the February 2000 Registration Statement
3.3 Certificate of Designations for Series A Senior Incorporated by reference from Exhibit 3.1 to
Cumulative Preferred Stock the August 10, 2000 8-K filing located under
the Securities and Exchange Commission File
No. 29279
10.1 1998 Management Stock Incentive Plan of Choice One Incorporated by reference from Exhibit 4.1 to
Communications Inc. (May 2000 Restatement) the September 29, 2000 S-8 located under
Securities and Exchange Commission File No.
333-47002
10.2 1999 Directors' Stock Incentive Plan of Choice One Incorporated by reference from Exhibit 4.1 to
Communications Inc. the September 29, 2000 S-8 located under
Securities and Exchange Commission File No.
333-47008
10.3 Transaction Agreement, dated as of July 8, 1998, Incorporated by reference from Exhibit 10.3 to
among Choice One Communications Inc., Choice One the February 2000 Registration Statement
Communications L.L.C. and holders of Investor
Equity and Management Equity
10.4 Amendment No. 1 dated as of December 18, 1998 to Incorporated by reference from Exhibit 10.4 to
Transaction Agreement, dated as of July 8, 1998, the February 2000 Registration Statement
among Choice One Communications Inc., Choice One
Communications L.L.C. and holders of Investor
Equity and Management Equity
10.5 Amendment No. 2 dated as of February 18, 1999 to Incorporated by reference from Exhibit 10.5 to
Transaction Agreement, dated as of July 8, 1998, the February 2000 Registration Statement
among Choice One Communications Inc., Choice One
Communications L.L.C. and holders of Investor
Equity and Management Equity
10.6 Amendment No. 3 dated as of May, 14 1999 to Incorporated by reference from Exhibit 10.6 to
Transaction Agreement, dated as of July 8, 1998, the February 2000 Registration Statement
among Choice One Communications Inc., Choice One
Communications L.L.C. and holders of Investor
Equity and Management Equity
60
10.7 Amendment No. 4 dated as of June 30, 1999 to Incorporated by reference from Exhibit 10.7 to
Transaction Agreement, dated as of July 8, 1998, the February 2000 Registration Statement
among Choice One Communications Inc., Choice One
Communications L.L.C. and holders of Investor
Equity and Management Equity
10.8 Amendment No. 5 dated as of June 30, 1999 to Incorporated by reference from Exhibit 10.8 to
Transaction Agreement, dated as of July 8, 1998, the February 2000 Registration Statement
among Choice One Communications Inc., Choice One
Communications L.L.C. and holders of Investor
Equity and Management Equity
10.9 Amendment No. 6 dated as of November 18, 1999 to Incorporated by reference from Exhibit 10.9 to
Transaction Agreement, dated as of July 8, 1998, the February 2000 Registration Statement
among Choice One Communications Inc., Choice One
Communications L.L.C. and holders of Investor
Equity and Management Equity
10.10 Amendment No. 7 dated as of August 1, 2000 to Incorporated by reference from Exhibit 10.2 to
Transaction Agreement, dated as of July 8, 1998, the Company's 8-K filed on August 10, 2000
among Choice One Communications Inc., Choice One
Communications L.L.C and holders of Investor Equity
and Management Equity
10.11 Amendment No. 8 dated as of December 20, 2000 to Filed herewith
Transaction Agreement, dated as of July 8, 1998,
among Choice One Communications Inc., Choice One
Communications L.L.C and holders of Investor Equity
and Management Equity
10.12 Registration Rights Agreement dated as of July 8, Incorporated by reference from Exhibit 10.10
1998, among Choice One Communications Inc., the to the February 2000 Registration Statement
Investor Holders and the Management Holders
10.13 Amendment No. 1 dated as of February 18, 1999 to Incorporated by reference from Exhibit 10.11
Registration Rights Agreement dated as of July 8, to the February 2000 Registration Statement
1998, among Choice One Communications Inc., the
Investor Holders and the Management Holders
10.14 Amendment No. 2 dated as of June 30, 1999 to Incorporated by reference from Exhibit 10.12
Registration Rights Agreement dated as of July 8, to the February 2000 Registration Statement
1998, among Choice One Communications Inc., the
Investor Holders and the Management Holders
10.15 Amendment No. 3 dated as of June 30, 1999 to Incorporated by reference from Exhibit 10.13
Registration Rights Agreement dated as of July 8, to the February 2000 Registration Statement
1998, among Choice One Communications Inc., the
Investor Holders and the Management Holders
10.16 Amendment No. 4 dated as of August 1, 2000 to Incorporated by reference from Exhibit 10.1 to
Registration Rights Agreement dated as of July 8, the Company's 8-K filed on August 10, 2000
1998, among Choice One Communications Inc., the
Investor Holders and the Management Holders
61
10.17 Form of Executive Purchase Agreement dated July 8, Incorporated by reference from Exhibit 10.14
1998 among the Choice One Communication Inc., to the February 2000 Registration Statement
Choice One Communications L.L.C. and Certain
Executives of the Registrant
10.18 Executive Purchase Agreement dated as of July 8, Incorporated by reference from Exhibit 10.15
1998 among the Choice One Communication Inc., to the February 2000 Registration Statement
Choice One Communications L.L.C. and Steve M. Dubnik
10.19 Executive Purchase Agreement dated as of July 8, Incorporated by reference from Exhibit 10.16
1998 among the Choice One Communication Inc., to the December 1995 Registration Statement
Choice One Communications L.L.C. and Mae Squire-Dow
10.20 Executive Purchase Agreement dated as of July 8, Incorporated by reference from Exhibit 10.17
1998 among the Choice One Communication Inc., to the February 2000 Registration Statement
Choice One Communications L.L.C. and Philip Yawman
10.21 Executive Purchase Agreement dated as of July 8, Incorporated by reference from Exhibit 10.18
1998 among the Choice One Communication Inc., to the February 2000 Registration Statement
Choice One Communications L.L.C. and Kevin Dickens
10.22 Executive Purchase Agreement dated as of July 8, Incorporated by reference from Exhibit 10.19
1998 among the Choice One Communication Inc., to the February 2000 Registration Statement
Choice One Communications L.L.C. and Ajay Sabherwal
10.23 Second Amended and Restated Credit Agreement dated Incorporated by reference from Exhibit 10.8 to
as of August 1, 2000 among the Registrant as the Company's 8-K filed on August 10, 2000
Guarantor, subsidiaries of the Registrant, as
Borrowers, First Union Investors, Inc., as
Administrative Agent, General Electric Capital
Corporation, as Syndication Agent, and Morgan
Stanley Senior Funding, Inc. as Documentation Agent
and the lenders thereto
10.24 Lease between the Registrant and Incorporated by reference from Exhibit 10.21
Bendersen-Rochester Associates, LLC dated October to the February 2000 Registration Statement
14, 1998, as amended
10.25 Unit Purchase Agreement dated as of October 21, Incorporated by reference from Exhibit 10.22
1999 among the Registrant, Atlantic Connections to the February 2000 Registration Statement
L.L.C., ACL Telecommunications, LTD., Paul Cissel,
Antonio Lopez, Jr. and North Atlantic Venture Fund
II, L.P
10.26 General Agreement between the Registrant and Incorporated by reference from Exhibit 3.1
Lucent Technologies effective as of July 17, 1999, to the Company's 10-Q for the quarter ended
as amended June amended 30, 2000
10.27 Service Bureau Agreement between the Registrant and Incorporated by reference from Exhibit 10.24
Saville Systems Inc. effective September 30, 1998 to the February 2000 Registration Statement
62
10.28 Agreement and Plan of Merger by and among Choice Incorporated by reference from Exhibit 99.2 to
One Communications Inc., Barter Acquisition the Company's 8-K/A filed on May 16, 2000
Corporation, US Xchange, Inc. and the Stockholder
of US Xchange, Inc. dated as of May 14, 2000
10.29 Securities Purchase Agreement dated as of August 1, Incorporated by reference from Exhibit 10.7 to
2000 among Morgan Stanley Dean Witter Capital the Company's 8-K filed on August 10, 2000
Partners IV, L.P., Morgan Stanley Dean Witter
Capital Partners IV 892 Investors, L.P., Morgan
Stanley Dean Witter Capital Investors IV, L.P., and
Choice One Communications Inc. relating to the
purchase and sale of securities of Choice One
Communications Inc.
10.30 Warrants to purchase shares of Common Stock of Incorporated by reference from Exhibit 10.4,
Choice One Communications Inc. 10.5 and 10.6 to the Company's 8-K filed on
August 10, 2000
10.31 Bridge Financing Agreement dated as of August 1, Incorporated by reference from Exhibit 10.3 to
2000 among Choice One Communications Inc., the the Company's 8-K filed on August 10, 2000
Lenders party hereto, and Morgan Stanley Senior
Funding, Inc., as Administrative Agent
10.32 Fiber Optic Agreement and Grant of IRU dated Incorporated by reference from Exhibit 10.9 to
August 1, 2000 by and between Choice One the Company's 8-K filed on August 10, 2000
Communications Inc. and RVP Fiber Company, L.L.C.
10.33 Form of Executive Employment Agreement between Incorporated by reference from Exhibit 10.10
former executives of US Xchange, Inc. and Choice to the Company's 8-K filed on August 10, 2000
One Communications Inc.
10.34 Master Facilities Agreement between Fiber Incorporated by reference from Exhibit 10.1 to
Technologies Operating Company, LLC and Choice One the Company's 10-Q for the quarter ended June
Communications Inc. dated as of May 31, 2000 * 30, 2000
10.35 Addendum Number One 5ESS(R)Switch and Transmission Incorporated by reference from Exhibit 10.1 to
Systems Purchase Agreement between Choice One the Company's 10-Q for the quarter ended March
Communications Inc. and Lucent Technologies Inc. 31, 2000
dated as of January 1, 2000 **
10.36 Choice One Communications Inc. 401(K) Plan Incorporated by reference from Exhibit 4.3 to
the October 23, 2000 S-8 located under
Securities and Exchange Commission File No.
333-48430
21.1 Subsidiaries of Choice One Communication Inc. Filed herewith
23.2 Consent of Arthur Andersen LLP, independent auditors Filed herewith
27.1 Financial Data Schedule Filed herewith
63
*Portions of this agreement have been omitted and filed separately with the
Commission pursuant to an application for confidential treatment under Rule
24b-2, which was granted by the Commission until May 31, 2003.
** Portions of this agreement have been omitted and filed separately with the
Commission pursuant to an application for confidential treatment under Rule
24b-2, which was granted by the Commission until December 31, 2002.
64
EXHIBIT 10.11
Amendment No. 8 to
Transaction Agreement
This Amendment No. 8 ("Amendment") to the Transaction Agreement dated as of
July 8, 1998, as amended by Amendment No. 1 dated as of December 18, 1998, by
Amendment No. 2 dated as of February 18, 1999, by Amendment No. 3 dated as of
May 14, 1999, by Amendment No. 4 dated as of June 30, 1999, by Amendment No. 5
dated as of June 30, 1999, by Amendment No. 6 dated as of November 18, 1999, and
by Amendment No. 7 dated as of August 1, 2000 (the "Original Agreement"), is
made as of December 20, 2000, among Choice One Communications Inc. (the
"Corporation") and the persons listed on the signature pages hereto.
WHEREAS, Section 4.08 of the Original Agreement contemplates that so
long as MSCP holds more than 30% of the aggregate outstanding Investor Equity
and Management Equity of the Corporation that it will have the right to select
the Corporation's financial adviser and lead manager for all securities
offerings; and
WHEREAS, the parties now desire to amend the Original Agreement to
permit the Corporation to select its own financial advisers and lead managers;
NOW, THEREFORE, the parties hereto hereby agree as follows:
SECTION 1. Deletion of Section 4.08. Section 4.08 is hereby deleted in
its entirety from the Original Agreement.
SECTION 3. Other Defined Terms. Capitalized terms used in this Amendment
and not otherwise defined have the meanings ascribed to them in the Original
Agreement.
SECTION 4. Effectiveness; Effect of Amendment; Governing Law. Except as
amended hereby, the Original Agreement shall remain unchanged. The Original
Agreement, as amended hereby, shall remain in full force and effect. This
Amendment shall be governed by, and construed under, the laws of the State of
Delaware, all rights and remedies being governed by said laws, without regard to
conflict of laws principles.
SECTION 5. Counterparts. This Amendment may be executed simultaneously
in two or more counterparts, any one of which need not contain the signatures of
more than one party, but all such counterparts taken together shall constitute
one and the same agreement.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as
of the date first written above.
CHOICE ONE COMMUNICATIONS INC.
By: /s/ Steve M. Dubnik
Steve M. Dubnik
Its: Chairman and Chief Executive Officer
65
MANAGEMENT MEMBERS
/s/ Steve M. Dubnik
-----------------------------------------------
Steve M. Dubnik, as a Management
Member and as Chief Executive Officer of
Choice One Communications Inc.
/s/ Mae Squier-Dow
-----------------------------------------------
Mae Squier-Dow
/s/ Kevin Dickens
-----------------------------------------------
Kevin Dickens
/s/ Philip Yawman
-----------------------------------------------
Philip Yawman
/s/ Ajay Sabherwal
-----------------------------------------------
Ajay Sabherwal
/s/ Elizabeth Ellis
-----------------------------------------------
Elizabeth Ellis
/s/ Joseph Calzone
-----------------------------------------------
Joseph Calzone
/s/ Michelle Paroda
-----------------------------------------------
Michelle Paroda
/s/ Linda Chapman
-----------------------------------------------
Linda Chapman
/s/ John Zimmer
-----------------------------------------------
John Zimmer
/s/ David Fitts
-----------------------------------------------
David Fitts
/s/ Kenneth Okolowicz
-----------------------------------------------
Kenneth Okolowicz
/s/ Daniel K. Iles
-----------------------------------------------
Daniel K. Iles
66
/s/ Michael D'Angelo
-----------------------------------------------
Michael D'Angelo
/s/ Robert Merrill
-----------------------------------------------
Robert Merrill
/s/ Kim Robert Scovill
-----------------------------------------------
Kim Robert Scovill
/s/ Joseph Schaal
-----------------------------------------------
Joseph Schaal
/s/ James Currie
-----------------------------------------------
James Currie
/s/ Robert Bailey
-----------------------------------------------
Robert Bailey
/s/ Scott Deverell
-----------------------------------------------
Scott Deverell
/s/ Nancy Farrell
-----------------------------------------------
Nancy Farrell
/s/ Pamela Huber-Hauck
-----------------------------------------------
Pamela Huber-Hauck
/s/ Carla Vaccaro
-----------------------------------------------
Carla Vaccaro
INVESTOR MEMBERS
MORGAN STANLEY CAPITAL PARTNERS III, L.P.
By MSCP III, LLC, its general partner
By Morgan Stanley Capital Partners III, Inc., its Member
67
By /s/ John Ehrenkranz
-----------------------------------------------
Its
-----------------------------------------------
By /s/ Michael Janson
-----------------------------------------------
Its
-----------------------------------------------
MSCP III 892 INVESTORS, L.P.
By MSCP III, LLC, its general partner
By Morgan Stanley Capital Partners III, Inc., its Member
By /s/ John Ehrenkranz
-----------------------------------------------
Its
-----------------------------------------------
By /s/ Michael Janson
-----------------------------------------------
Its
-----------------------------------------------
MORGAN STANLEY CAPITAL INVESTORS, L.P.
By MSCP III, LLC, its general partner
By Morgan Stanley Capital Partners III, Inc., its Member
By /s/ John Ehrenkranz
-----------------------------------------------
Its
-----------------------------------------------
By /s/ Michael Janson
-----------------------------------------------
Its
-----------------------------------------------
68
MORGAN STANLEY DEAN WITTER CAPITAL PARTNERS IV, L.P.
By MSDW Capital Partners IV, LLC, its
general partner
By MSDW Capital Partners IV, Inc., its Member
By /s/ John Ehrenkranz
-----------------------------------------------
Its
-----------------------------------------------
By /s/ Michael Janson
-----------------------------------------------
Its
-----------------------------------------------
MSDW IV 892 INVESTORS, L.P.
By MSDW Capital Partners IV, LLC, its general partner
By MSDW Capital Partners IV, Inc., its Member
By /s/ John Ehrenkranz
-----------------------------------------------
Its
-----------------------------------------------
By /s/ Michael Janson
-----------------------------------------------
Its
-----------------------------------------------
MORGAN STANLEY DEAN WITTER CAPITAL INVESTORS IV, L.P.
By MSDW Capital Partners IV LLC, its
general partner
By MSDW Capital Partners IV, Inc., its Member
By /s/ John Ehrenkranz
-----------------------------------------------
Its
-----------------------------------------------
By /s/ Michael Janson
-----------------------------------------------
Its
-----------------------------------------------
69
CHISHOLM PARTNERS III, L.P.
By Silverado III, L.P., its General Partner
By Silverado III Corp., its General Partner
By /s/ Robert M. Van Degna
Robert M. Van Degna
Chairman & CEO
KENNEDY PLAZA PARTNERS
By /s/ Robert M. Van Degna
Robert M. Van Degna
Managing General Partner
FLEET VENTURE RESOURCES, INC.
By /s/ Robert M. Van Degna
Robert M. Van Degna
Chairman & CEO
FLEET EQUITY PARTNERS VI, L.P.
By Fleet Growth Resources II, Inc., its
General Partner
By /s/ Robert M. Van Degna
Robert M. Van Degna
Chairman & CEO
WALLER-SUTTON MEDIA PARTNERS, L.P.
By Waller Sutton Media, L.L.C. its general
partner
By /s/ Bruce Hernandez
Bruce Hernandez
Chief Executive Officer
FIRST UNION CAPITAL PARTNERS, INC.
By:
Its:
GENERAL ELECTRIC CAPITAL CORPORATION
By:
Its:
CARAVELLE INVESTMENT FUND, L.L.C.
By Caravelle Advisors, L.L.C.,
as Investment Manager and
Attorney In Fact
By:
Its:
ROYCE J. HOLLAND
/s/ Royce J. Holland
Royce J. Holland
R. PHILIP SILVER
R. Philip Silver
70
Exhibit 21.1
List of Subsidiaries
1. Choice One Communications International Inc.
2. Choice One Communications of New York Inc.
3. Choice One Communications of Pennsylvania Inc.
4. Choice One Communications of Ohio Inc.
5. Choice One Communications of Vermont Inc.
6. Choice One Communications of Connecticut Inc.
7. Choice One Communications of Massachusetts Inc.
8. Choice One Communications of Rhode Island Inc.
9. Choice One Communications of Maine Inc.
10. Choice One of New Hampshire Inc.
11. Atlantic Connections L.L.C.
12. ACL Telecommunications, LTD.
13. Choice One OnLine Inc.
14. Choice One Communications of North Carolina Inc.
15. Choice One Communications of Tennessee Inc.
16. Choice One Communications of Virginia Inc.
17. Choice One Communications of Kentucky Inc.
18. US Xchange, Inc.
19. US Xchange, L.L.C.
20. US Xchange Finance Corporation, L.L.C.
21. US Xchange of Michigan, L.L.C.
22. US Xchange of Indiana, L.L.C.
23. US Xchange of Illinois, L.L.C.
24. US Xchange of Wisconsin, L.L.C.
25. Choice One Communcations Services Inc.
71
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed
Registration Statements on Form S-8 File Nos. 333-30862, 333-47002, 333-47008,
and 333-48430.
/s/ Arthur Andersen LLP
Rochester, New York
March 5, 2001
72
EXHIBIT 27.1
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 2000 AND FROM THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED FINANCIAL STATEMENTS.
0001091953
Choice One Communications Inc.
1,000
PERIOD-TYPE 12-MOS
FISCAL-YEAR-END DEC-31-2000
PERIOD-START JAN-01-2000
PERIOD-END DEC-31-2000
CASH 173,573
SECURITIES 9,801
RECEIVABLES 20,655
ALLOWANCES 0
INVENTORY 0
CURRENT-ASSETS 4,913
PP&E 302,833
DEPRECIATION 26,871
TOTAL-ASSETS 923,830
CURRENT-LIABILITIES 53,142
LONG-TERM DEBT 447,000
PREFERRED-MANDATORY 162,523
PREFERRED 0
COMMON 379
OTHER-SE 259,151
TOTAL-LIABILITY-AND-EQUITY 923,830
SALES 68,082
TOTAL-REVENUE 68,082
CGS 56,182
TOTAL-COSTS 56,182
OTHER-EXPENSES 214,200
LOSS-PROVISION 0
INTEREST-EXPENSE 16,663
INCOME-PRETAX (216,852)
INCOME-TAX 0
INCOME-CONTINUING (216,852)
DISCONTINUED 0
EXTRAORDINARY 0
CHANGES 0
NET-INCOME (231,072)
EPS-BASIC (7.11)
EPS-DILUTED (7.11)
73