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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

for the fiscal year ended 12/31/2004

Commission File No. [        ]

Grande Communications Holdings, Inc.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (512) 878-4000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

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.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act).    Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates is not applicable as no public market exists for the voting stock of the registrant.

The number of shares of the registrant’s Common Stock outstanding as of December 31, 2004 was 12,920,366.

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GRANDE COMMUNICATIONS HOLDINGS, INC.

ANNUAL REPORT ON FORM 10-K

YEAR ENDED DECEMBER 31, 2004

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FORWARD-LOOKING INFORMATION

This Annual Report on Form 10-K and the information incorporated by reference herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this Report, the words “expects,” “anticipates” and “estimates” and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those we expect or anticipate. These risks and uncertainties include those discussed below and those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We undertake no obligation to publicly update or correct these forward-looking statements to reflect events or circumstances that occur after the date this Report is filed with the Securities and Exchange Commission.

PART I

For convenience in this annual report, “Grande,” “we,” “us,” and “the Company” refer to Grande Communications Holdings, Inc. and our consolidated subsidiaries, taken as a whole.

Overview

We provide communities in Texas with a bundled package of cable television, telephone and broadband Internet and other services. We operate fully integrated advanced broadband networks in six markets, in eight cities, that pass approximately 308,913 out of approximately 1.4 million marketable homes and small businesses as of December 31, 2004. We had 126,736 residential, small business and enterprise customers as of December 31, 2004. We expect that with existing cash and investments on hand of $61.2 million as of December 31, 2004, and our anticipated cash flow from operations, we will be fully funded to build-out our networks to pass all 1.4 million marketable homes and small businesses. Operating revenues for 2004 were $179.0 million compared to $181.5 million in 2003. We had solid growth in our core business throughout 2004, almost replacing $65.0 million of the lost MCI revenues from 2003.

In July 2000, when our network construction was still in a very early stage, we acquired an established telephone and data network that served as the platform for our provision of residential telephone and broadband Internet services and that still provides network services revenues. This acquisition initially provided a significant portion of our revenues and became the foundation of our business while we moved forward with the construction of our broadband networks. Since 2001, as our network construction proceeded and the number of bundled services customers has grown, we have derived an increasing percentage of our revenues from our retail cable television, telephone and broadband Internet and other services and we expect this trend to continue.

Since inception, we have been funded primarily with private equity investments. Between February 2000 and October 2003, we completed a series of private placements of our preferred stock, raising aggregate gross proceeds of $338.2 million from the sale of our capital stock. The net proceeds from these private placements have been used to fund our network buildout, operations, and our acquisitions, which are described below under the heading “Acquisitions.” As a result of equity investments and mergers where stock was used as consideration, we now have $508 million of total invested equity capital and a base of over 20 institutional private equity investors. We have incurred net losses for the past three years and expect to continue to incur net losses for the next few years. However, we did achieve positive EBITDA in 2002 and 2003 and positive Adjusted EBITDA in 2004. See “EBITDA/Adjusted EBITDA” below for a discussion of this non-GAAP measure of our operating performance as well as our use of Adjusted EBITDA in 2004.

On March 23, 2004, we raised net proceeds of $124.5 million in a private placement of 136,000 units each consisting of 14% senior secured notes due 2011 and a warrant to purchase 100.336 shares of our common stock.

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We used a portion of the net proceeds from the offering to repay all amounts outstanding under our then-existing senior credit facility. That facility was terminated upon repayment and we are not able to borrow any further amounts thereunder.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and special reports, and other information with the SEC, in accordance with the Exchange Act. You may read and copy any document we file with the SEC at the following public reference room:

Public Reference Room

450 Fifth Street, N.W.

Room 1024

Washington, D.C. 20549

1-800-SEC-0330

Please call the SEC at 1-800-SEC-0330 for further information about the public reference room. Our reports and other information filed with the SEC are also available to the public over the Internet at the SEC’s World Wide Web site at http://www.sec.gov.

Grande Competitive Advantages

We believe we have been able to rapidly and cost effectively grow our customer base because of the following competitive advantages:

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The Grande Strategy

We seek to take advantage of our market position by executing the following operating strategy:

Services

Bundled Services

We provide bundled cable television, telephone, broadband Internet and wireless security services to our residential, small business and enterprise customers. Each bundled package offers the convenience and cost-savings of having one bill and one company providing the services. We believe we were the first company in many of our markets to offer one-stop shopping for cable television, telephone and broadband Internet access to residential and small business customers. We price our products competitively in each of our target markets, typically offering our products on an individual basis at a discount to our competitors’ nearest comparable

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offering. When customers purchase our products as part of a bundle of two or more services, they benefit from additional savings. We offer a broad range of services and bundles designed to address the varying needs and interests of a city-wide demographic of existing and potential customers.

Cable Television

We offer basic cable, expanded cable and digital cable packages, as well as premium cable channels and digital music service. Our customers may choose from over 300 channels, including a wide range of television, music and movie channels. We offer additional features such as 30 premium movie channels, high definition television and digital video recording in the majority of our markets. Premium movie channels are offered individually or in packages of several channels as add-on services for an additional monthly fee. As of December 31, 2004, we provided cable television services to 83,098 connections. On average, during 2004, each of our cable television connections generated $45.63 in monthly revenues.

Our cable television offerings include:

Basic Cable. Our basic cable offering consists of over 80 analog channels, which generally consists of local broadcast television, local community and government access programming, and a number of satellite delivered or non-broadcast channels such as ESPN, CNN, Discovery Channel, Lifetime, TNT, A&E and Bravo.

Digital Cable. Our digital cable offering consists of our basic cable offering plus digital cable channels for a total of over 300 channels and includes an interactive electronic programming guide, 45 CD-quality channels of digital music, and an expanded menu of pay-per-view channels. In addition, we have tailored our digital cable programming to include a large number of Spanish language channels to appeal to the large Spanish-speaking population in our markets. We offer this target specific content in tiers.

Premium Movie Channels. These channels, which provide unedited, commercial-free movies, sports and other programming, include HBO, Cinemax, Showtime, The Movie Channel, Starz! and Encore, as well as others.

Pay-Per-View. These channels allow basic analog and digital customers to pay to view a single showing of a recently released movie or a one-time special event, as well as packages of sporting events, such as the NHL^™ hockey package, ESPN FULL COURT^™ college basketball, championship boxing and wrestling.

High-Definition Television, Digital Video Recording and Other New Services. We offer high-definition television and digital video recording as add-on offerings to our digital cable subscribers in the majority of our markets. High-definition television provides our digital cable customers with a higher resolution picture than standard cable television. Digital video recording allows a digital cable customer to record, pause, rewind and replay programs that the customer is currently watching or that was previously recorded by the customer through an interactive menu. Our networks are designed to have sufficient capacity to meet the growing demand for additional high-bandwidth cable products for the foreseeable future.

Telephone

Local Service. We offer full-featured local telephone service, including standard dial tone access, 911 access, operator services and directory assistance, all over a powered network affording greater reliability. In addition, we offer a wide range of custom call services, including call waiting, call forwarding, call return, caller blocker, anonymous call rejection, auto redial, speed dial, three-way calling, priority-call and voice mail, each of which may be activated or deactivated by a customer, usually by dialing a simple activation code. We believe that our local telephone rates are competitive with the rates charged by the incumbent providers. As of December 31, 2004, we provided service to 110,360 telephone connections. On average, during 2004, each of our telephone connections generated $42.38 in monthly revenues, including local and long distance service.

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Long Distance. Because we own our own long-distance telephone networks and related equipment in Texas, we are able to offer a range of retail long distance telephone services on a cost-effective basis. Our long distance services include traditional switched and dedicated long distance, toll-free calling, international, calling card and operator services. We offer our customers an option of a flat rate for long distance calls all day, every day, with no minimum monthly usage fees, and several prepaid long distance plans by which the customer pays a monthly fee for a pre-determined number of long distance minutes and a flat rate for any additional minutes. We also offer flat rate direct-dial international calling with no additional fees, surcharges or minimum call times per call. Our customers also may purchase 800 number calling services and calling card services. We believe our long distance telephone services are competitively priced. We offer our retail customers, as part of their subscription to our services, “free Grande-to-Grande,” which means there are no long distance charges for calls between two of our phone subscribers in different markets.

Broadband Internet Access and Other

Broadband Internet Access. Through Grande.NET^™, our broadband Internet service, we provide our Internet customers with a full suite of high speed broadband Internet products through our networks, with speeds ranging up to 8.0 Mbps download and 1 Mbps upload for residential customers. We offer multiple tiers of high-speed broadband access, including dedicated access and tiered bandwidth, with Ethernet speeds up to 100 Mbps, to enterprise customers. We also offer low-price dial-up Internet access, but most of our residential and small business customers take advantage of the wide bandwidth and high data speeds available on our broadband networks. Our Internet customers have a choice of services with different download and upload speeds for different monthly charges. Grande.NET^™ Internet service provides unlimited dedicated access to the Internet without dialing in or logging on to a network and without a dedicated telephone line. Our higher speed service offers superior speeds to DSL and appeals to the more sophisticated broadband Internet user. We also provide to our customers a specific number of free e-mail accounts and personal Web space. Customers have the option to purchase or rent a cable modem from us or purchase it directly from a retailer. We expect businesses and sophisticated users will require faster Internet access and larger bandwidth in the future, and we intend to offer products that will meet that demand using our high capacity networks.

Security Solutions. Through our wireless security product, we install leading wireless security systems in private residences. We use a third party for 24x7 monitoring, and our trained technical staff is licensed by the Private Security Board under the Texas Department of Public Safety. We offer additional service enhancements such as remote control keyfobs, pet immune motion sensors, and panic pendants. The average wireless security customer enters into a two year service contract with us for the provision of security services. By offering this product, which typically is contractual and has a longer customer life than our existing products do, we believe it will aid in building brand loyalty for Grande and in the longer term, help reduce churn.

As of December 31, 2004, we had 56,184 broadband Internet and other service connections. On average, during 2004, each of our broadband Internet and other connections generated $34.50 in monthly revenues.

Broadband Transport Services

We offer access to our metro area and long-haul fiber networks and provide network related services to other local and long-distance telephone companies and Internet service providers, as well as large and medium sized enterprises that we pass with our networks. These services can include dark fiber leases and indefeasible rights of use, custom network construction or lateral builds and access to the networks at various wavelengths. We also provide private line services to enterprises, carriers and Internet service providers which allow the customer to connect multiple sites through dedicated point-to-point circuits which carry voice and data traffic at high-speeds. We currently provide access to our metro area and long-haul fiber networks in 16 cities in Texas, as well as Tulsa and Oklahoma City, Oklahoma, Little Rock, Arkansas and Shreveport, Louisiana. A metro area network is a high-speed data intra-city network, usually including a fiber optic ring, that links multiple locations within a city. Each of our metro area networks connects to most carrier points of presence, major incumbent local

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exchange carrier, or ILEC, and competitive local exchange carrier, or CLEC, central offices, hotels, central and suburban business centers, data centers and co-location facilities in these areas.

Network Services

We offer network services to medium and large enterprises and other communications service providers. All of these services are provided using primarily the same personnel and network infrastructure which we use to provide telephone and broadband Internet services to our retail customers. This allows us to leverage our existing resources and expertise to generate incremental revenues and cash flow. We believe that our ability to leverage our existing capabilities and network infrastructure has allowed us to support the early development of our core retail services while amortizing the cost of our networks over a larger revenue base. Since our networks pass these larger enterprises and carriers anyway, our goal has been to serve these customers and earn a return from every mile of network.

Our network services encompass a broad range of telephone and data services which primarily include:

Switched Carrier Services. These services consist of our regional transmission services to carriers and other telecommunications companies. This primarily involves our selling access to and transporting minutes for long-distance telephone companies for intrastate, interstate and international long-distance traffic terminations.

Data Services. We provide services to Internet service providers, which we call our managed modem services, that allow the Internet service provider to deliver high-speed Internet service to customers in areas where our networks are located. We provide the modems, offer dial-up and a variety of related services, including server hosting, direct access between our networks and the network of the Internet service provider, a customer-maintained user database, end-user technical support services and billing services. We also offer various other data services, such as inbound local calling and toll-free calling to enterprises and other communications providers.

Managed Services. We provide telephone services, as well as the infrastructure needed to offer local telephone service, to competitive local exchange carriers. This enables the carriers to offer telephone services to their customers using our networks, including a local dial tone, local telephone features, long distance switching and calling cards. We also provide a comprehensive national directory assistance service which includes local and long distance directory assistance for listings in the United States. We also provide equipment co-location services that permit Internet service providers to collocate modems, routers or network servers with our network equipment.

Marketing and Sales

Our sales and marketing efforts focus on building loyality with our customers and acquiring new customers along our existing network footprint. We emphasize the convenience, savings and improved service that can be obtained by subscribing to bundled services.

Marketing

In each of our markets we have established a strong community presence that we believe has positioned Grande as the home-town company, despite the fact that we are not an incumbent service provider in any of our markets. We believe our home-town image enables us to appeal to residential customers and small businesses in our markets as well as to local universities, utilities, hospitals and other institutions. A key part of our marketing strategy has been to support local community organizations by sponsoring and participating in local charitable events and other community activities. Our Passion and Commitment Investment Club, which supports community organizations that provide food, shelter, clothing and healthcare to persons in need in our markets, has made significant donations to non-profit organizations across Texas and has been recognized with numerous local and state-wide awards for its’ community service. We believe that this community participation directly

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supports our direct sales force by creating a strong local brand to which we believe potential customers are receptive. We believe that this helps us to penetrate our target markets where the acquisition of new customers is typically dependent upon customers switching to our services from their existing providers.

We focus our marketing efforts on areas served by our networks through such means as direct mail campaigns, outdoor space advertising and local events sponsorship. In newly constructed network areas, we will undertake an extensive marketing campaign prior to activation of our services, beginning with direct mailings and door-hangers. In established areas we focus on marketing additional services to those customers who have previously subscribed to one or two of our products. For example, we run Grande television advertisements on our own cable system which emphasize our telephone and broadband Internet products that are available as part of a bundle. In both new and established areas, we will, to a lesser extent, use traditional advertising outlets, such as television, radio and local newspaper advertising, to reach potential customers.

Sales

We have separate sales teams in each of our markets dedicated to residential, multiple dwelling units (MDUs), and commercial customers. Each of these sales teams reports to separate sales management that is responsible for all of the sales in a particular product area. We also have separate sales teams dedicated to broadband transport and network services.

A standard residential sales team consists of direct sales, outbound sales, counter sales and support personnel. A typical commercial sales team consists of account executives and specialized business installation coordinators. Our MDU sales team has developed relationships with owners and management of the MDU properties in our target markets, which enables us to gain access to new customers as soon as they move into their unit. Our network services sales team focuses on making direct contact with communications providers principally via sales calls, trade shows and our sales team’s existing industry relationships. Our call center sales team handles all incoming and outgoing sales calls.

Our sales team is cross-trained on all our products to support our bundling strategy. Our sales team is compensated based on connections and is therefore motivated to sell more than one product to each customer. However, our sales force is highly incentivized to sell the right services to a particular customer without overselling. Our sales personnel will not get credit for selling products that are later cancelled within a certain number of months after the start of service. We believe that by providing the appropriate level of services to each customer, we are more likely to retain that customer, which reduces our overall customer turnover rate.

In addition, we have different sales strategies for marketing to customers in newly constructed network areas and to customers in established network areas. In new areas, prior to activation of our services, we target customers with door-to-door solicitations and outbound telemarketing as part of an extensive marketing campaign in the area. In established areas, we assign territories to individual direct sales representatives, which provides the ability to adjust sales techniques to fit the profile of different buyers in particular areas.

We work to gain customer referrals for additional sales by focusing on service and customer satisfaction. We have implemented several retention and customer referral tactics, including customer newsletters, personalized e-mail communications and loyalty programs. These programs are designed to increase loyalty, retention and up sell among our current base of customers.

Customer Care, Billing and Installation

Customer Care

We believe that the combination of bundled communications services on our own networks and quality customer care will be key drivers to effectively compete in the residential and business markets. We believe that the quality of service and responsiveness differentiates us from many of our competitors. We provide customer

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service 24 hours a day, seven days a week. Our representatives are cross-trained to handle customer service transactions for all of our products. We operate a virtual customer phone center system, with centers in Waco, Dallas and Austin that handle all customer service transactions other than network trouble calls, which we handle through our technical service center centrally located in San Marcos. In addition, we provide our business customers with a local customer service representative, which we believe improves our responsiveness to customer needs and distinguishes our products in the market. We believe it is a competitive advantage to provide our customers with the convenience of a single point of contact for all customer service issues for our cable television, telephone and broadband Internet services and is consistent with our bundling strategy.

We monitor our networks 24 hours a day, seven days a week through our network operations center. All of our acquisitions have been fully integrated into our network operating systems and are monitored by our central network operations and control center, or NOCC, in San Marcos. Our NOCC allows us to typically detect problems before or as soon as any service interruption occurs. We strive to resolve service delivery problems prior to customer awareness of any service interruptions.

Billing

We have invested significant resources in an integrated provisioning and billing system that is sufficiently scalable to support a full build-out in our existing markets and beyond. This system greatly enhances our ability to address customer billing issues and also enables us to send a single bill to our customers for cable television, telephone and broadband Internet services. We have separate billing platforms for enterprise, broadband transport and network services.

Installation

Within each market, we have a single group of installers who install the equipment for all our of our cable television, telephone, broadband Internet and security offerings. This creates operating efficiencies for us by reducing the number of installation personnel we are required to maintain and allowing us to make one trip to the customer premises at the commencement of service. Our dispatch, order taking and installation management processes are coordinated for increased efficiency. We believe that this integrated and streamlined installation process creates a positive experience with Grande for the customer.

Industry

In recent years, regulatory developments have led to changes and increased competition in the telecommunications industry. The Telecommunications Act of 1996 and its implementation through Federal Communications Commission (FCC) regulations have broken down barriers between providers of different types of communications services. Companies that were effectively limited to providing one telecommunications service can now provide additional services with fewer regulatory restrictions or requirements.

We believe the industry is moving more towards an environment where both the cable television providers and the local telephone providers will be competing head to head for local telephone, long distance, cable television, and high speed data service. Advances in technology have furthered convergence in the industry by enabling delivery of cable television services, telephone services and broadband Internet services over different types of networks and making the delivery of more than one service over one broadband network feasible and economical. The cable companies have introduced telephone services via Voice over Internet Protocol (VoIP) to residential customers, and the local telephone providers are investing large amounts of capital into new networks to offer television over IP in addition to their existing telephone and DSL services. It is our understanding that Verizon has begun constructing fiber-to-the-home networks and SBC has announced its intention to construct fiber-to-the-curb networks.

Additionally, consolidation is continuing in the industry. Verizon and Qwest have announced their individual desires to acquire MCI, and SBC has announced its intent to acquire AT&T. These proposed

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acquisitions must go through regulatory, shareholder and other approvals. With the completion of these proposed transactions, the telecommunications landscape will be altered as the RBOCs begin to compete for enterprise customers and long distance customers within each other’s traditional network operating area. We believe that the RBOCs’ focus on their acquisitions and subsequent integration processes could create an opportunity for regional players, like Grande, to attract new customers.

We believe as the market continues to converge across product and market segments, communications providers will have to distinguish themselves from competitors by offering high quality products and services across all service types, better pricing that reflects some of the operational efficiencies and convenience to the customer in the form of a single bill and unified customer support. We believe that our ability to provide a tailored package of bundled services developed from a wide range of service options at competitive prices over one network system with a regional focus on Texas has been a key factor in enabling us to penetrate our markets.

Markets

The following table sets forth, in each of our markets, total marketable homes and marketable homes we pass.

Competition

The broadband communications industry is highly competitive. We compete primarily on the basis of the price, availability, reliability, variety, quality of our offerings, our people and on the quality of our customer service. Our ability to compete effectively depends on our ability to maintain high-quality services at prices generally equal to or below those charged by our competitors. Price competition in the retail services and broadband transport services markets generally has been intense and is expected to increase.

We are not the first provider of any of our three principal retail services in any of our markets. We compete with numerous other companies that have provided services for a longer period of time in each of our markets, and we often have to convince people to switch from other companies to Grande. Some of our competitors have significant competitive advantages over us, such as more years of experience, greater resources, mass marketing capabilities and broader name recognition. Our primary competitors include:

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Advances in communications technology as well as changes in the marketplace and the regulatory and legislative environment are constantly occurring. In certain areas of our markets, for example Austin, we compete for local and long distance services against the VoIP offerings of Vonage and Time Warner. In addition, the continuing trend toward business combinations and alliances (e.g. pending acquisition of MCI and AT&T) in the telecommunications industry will create significant new competitors. As a result of these business combinations and the introduction of VoIP offerings, we anticipate that the competitive environment will become increasingly intense.

Telephone

Our principal competitor for local services is the incumbent carrier in the particular market, which is SBC Communications in a large majority of our market areas. Incumbent carriers enjoy substantial competitive advantages arising from their historical monopoly position in the local telephone market, including pre-existing customer relationships with all or virtually all end-users. We also face competition from the alternative service providers including competitive providers such as CenturyTel and other CLECs, many of which already have established local operations in our markets. A cable provider has also entered the local telephone market in some of our service areas. Time Warner is offering a VoIP local telephone services product. Other VoIP providers, e.g. Vonage, may enter the local telephone market in some of our areas.

We expect to continue to face significant competition for long distance telephone services from the incumbent long distance providers, such as AT&T, MCI and Sprint, which account for the majority of all U.S. long distance revenues. The major long distance service providers benefit from established market share, both in traditional direct-dial services as well as in prepaid and dial around products, and from established trade names through nationwide advertising. However, we regard our long-distance service as a complementary service rather than a principal source of revenues. Certain incumbents including, AT&T, MCI and Sprint, are able to offer local services in major U.S. markets using their existing infrastructure in combination with resale of ILEC service, lease of unbundled local loops or other providers’ services. Additional new threats may present themselves if SBC Communications, Verizon and other incumbent carriers acquire or merge with other large providers of telecommunications services. SBC Communications, for example, has announced plans to acquire AT&T, and Verizon and Qwest recently announced competing plans to acquire MCI. These mergers and others like them, if consummated, could provide incumbent carriers with additional, considerable competitive resources, particularly in the market for long distance, broadband transport and network services, thereby strengthening their market position and their ability to compete with us.

We increasingly face competition in the local and long distance telephone market from cable companies, wireless carriers and VoIP providers. We believe that wireless telephone service currently is viewed by consumers as a supplement to, and not a replacement for, traditional telephone service. Wireless service generally is more expensive than traditional local telephone service and is priced on a usage-sensitive basis. However, the rate differential between wireless and traditional telephone service has begun to decrease and is expected to further decrease and lead to more competition between providers of local and wireless telephone services. Although customers generally continue to subscribe to their landline telephone service, wireless telephone service may be an even bigger threat to the long distance telephone market especially as usage rates continue to decrease and nationwide wireless telephone services are offered for flat monthly rates.

We also may increasingly face competition from businesses, including incumbent cable providers, offering long distance services over the Internet. These businesses could enjoy a significant cost advantage because, at this time, they generally do not pay carrier access charges or universal service fees. As explained more fully below under the caption “—Legislation and Regulation,” the regulatory status of VoIP service is being considered by the FCC and various states, and the FCC initiated a rule making proceeding on VoIP in 2004. The

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conclusions reached by these agencies will largely determine the viability and profitability of VoIP service, and, possibly, the success of our competitors offering this service. Currently, Time Warner, Cox Communications, Comcast and Vonage each provide a VoIP offering in certain of our market areas.

Cable Television

Our cable television service competes with the incumbent cable television provider in all of our markets except in certain private development subdivisions and MDUs where we are currently the only authorized cable provider. The incumbent cable providers in our markets, such as TimeWarner in Austin, San Antonio, Corpus Christi and Waco, Cable One in Odessa, Cox Communications in Midland and Austin and Comcast in northwest Dallas, have significantly greater resources and operating history than we do. We also compete with satellite television providers such as DirecTV, as well as other cable television providers, broadcast television stations, other satellite television companies and wireless cable services. We face additional competition from private satellite master antenna television systems that serve condominiums, apartment and office complexes and private residential developments, and these systems are generally free of any regulation by state or local government authorities.

Legislative and regulatory developments may lead to additional cable competitors. The Cable Television Consumer Protection and Competition Act of 1992 contains provisions, which the FCC has implemented with regulations, to enhance the ability of cable competitors to purchase and make available to consumers certain satellite-delivered cable programming at competitive costs. The Telecommunications Act of 1996 eliminated many of the restrictions on local telephone companies that offer cable programming, and we may face increased competition from such companies. Several major local telephone companies have announced plans to provide cable television services to homes, which may compete with our services. For example, at least one telephone company, SBC Communications, is planning to offer an Internet Protocol based video service to some of its customers in Texas. Verizon also is pursuing plans to upgrade its network to provide cable services.

We obtain our cable programming by entering into arrangements or contracts with cable programming suppliers. Currently, a programming supplier that delivers its programming terrestrially (as opposed to by satellite) may be able to enter into an exclusive arrangement with one of our cable competitors for the delivery of certain programming, creating a competitive disadvantage for us by restricting our access to that programming. This generally involves local and regional programming, such as news and sporting events.

Some of our competitors may purchase programming at more advantageous rates due to their size and the availability of volume discounts. We purchase programming using the services of a national cooperative that seeks to obtain more favorable pricing on behalf of smaller cable providers nationwide.

The FCC and Congress also have adopted laws and policies providing a more favorable operating environment for new and existing technologies that may compete with our various video distribution systems. These technologies include, among others, direct broadcast satellite service in which signals are transmitted by satellite to receiving facilities located on customer premises.

Broadband Internet Services

The Internet access market is extremely competitive and highly fragmented. Providing broadband Internet services is a rapidly growing business and competition is increasing in each of our markets. Some of our competitors benefit from stronger name recognition and greater resources, experience and marketing capabilities. For broadband Internet services, we primarily compete with SBC Communications, TimeWarner, Verizon, Comcast, Charter Communications, CenturyTel, Direct-PC, Earthlink and STIC.NET. Other competitors include traditional dial-up Internet service providers, providers of satellite-based Internet services, other local and long distance telephone companies and cable television companies.

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Many companies provide individuals and businesses with direct access to the Internet and a variety of supporting services. In addition, many companies such as Microsoft Corporation and AOL offer online services consisting of access to closed, proprietary information networks with services similar to those available on the Internet, in addition to direct access to the Internet. These companies generally offer broadband Internet services over telephone lines using computer modems. Some of these Internet service providers also offer high-speed integrated services using digital network connections and DSL connections to the Internet, and the focus on delivering high-speed services is expected to increase. Cable television companies also have entered the Internet access market using broadband facilities.

Bundled Services

We believe that, among our existing competitors, incumbent cable providers, the ILECs, CLECs and satellite television providers represent our primary competitors in the delivery of a bundle of two or more telephone, cable television and broadband Internet services. Presently, TimeWarner and SBC Communications broadly offer a combination of two or more of these services in our markets. They are, however, offering all three services in certain areas in our markets. We expect that the ILECs and incumbent cable providers that do not yet offer more than one service will begin to offer a combination of these services in the near future. The introduction of bundled service offerings by our competitors could have a significant adverse impact on our ability to market our bundled services to customers, especially in markets where we are currently the only source of a combination of these services.

Network Services

We have a wide range of competitors in the provision of network services. We compete with virtually all communications companies that own their own network equipment.

Legislation and Regulation

The cable television industry is currently regulated by the FCC, some state governments, not including Texas, although the Texas legislature is considering legislation that would alter state regulation, and most local governments. Telecommunications services are regulated by the FCC and state public utility commissions, including the Public Utility Commission of Texas, (PUCT). Internet services generally are not subject to significant regulation although this may change in the future. Legislative and regulatory proposals under consideration by Congress and federal agencies may materially affect the provision, cost and profitability of cable television, telecommunications and broadband Internet services. Set forth below is a brief summary of significant federal laws and regulations affecting the growth and operation of the cable television and telecommunications industries and a description of certain state and local laws.

Regulation of Cable Services

Federal Regulation of Cable Services

The FCC, the principal federal regulatory agency with jurisdiction over cable television, has promulgated regulations covering many aspects of cable television operations pursuant to federal laws governing cable television. The FCC may enforce its regulations through the imposition of fines, the issuance of cease and desist orders and/or the imposition of other administrative sanctions, such as the revocation of FCC licenses, permits and authorization. A brief summary of certain federal regulations follows.

Rate Regulation. The Cable Television Consumer Protection and Competition Act of 1992 authorized rate regulation for certain cable communications services and equipment in communities where the cable operator is not subject to effective competition. Pursuant to the Telecommunications Act of 1996, as of April 1, 1999, only the basic tier of cable television service, which does not include the expanded basic tier of cable television service, and equipment used to receive the basic tier of cable television service remain subject to rate regulation.

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Basic rates of operators not subject to effective competition are subject to limited regulation by local franchising authorities that choose to regulate these rates.

The Cable Television Consumer Protection and Competition Act of 1992 requires such local franchising authorities to certify with the FCC before regulating basic cable rates. The FCC’s rate regulations do not apply where a cable operator demonstrates that it is subject to effective competition. Our company meets the FCC definition of effective competition in the areas that we currently serve. To the extent that any municipality attempts to regulate our basic rates or equipment, we believe we could demonstrate to the FCC that our systems all face effective competition and, therefore, are not subject to rate regulation.

Carriage of Broadcast Television Signals. The Cable Television Consumer Protection and Competition Act of 1992 established broadcast signal carriage requirements. These requirements allow commercial television broadcast stations that are local to a cable system to elect every three years whether to require the cable system to carry the station (“must-carry”) or whether to require the cable system to negotiate for consent to carry the station (“retransmission consent”). The most recent must-carry/retransmission consent elections were made in October 2002 for a period ending December 31, 2005. Stations are generally considered local to a cable system where the system is located in the station’s Nielsen designated market area. Cable systems must obtain retransmission consent for the carriage of all distant commercial broadcast stations, except for certain superstations, which are commercial satellite-delivered independent stations such as WGN. We carry some stations pursuant to retransmission consents and in some cases have agreed to either pay fees for such consents or to carry additional services pursuant to retransmission consent agreements.

Local non-commercial television stations are also given mandatory carriage rights, subject to certain exceptions, within a certain limited radius. Non-commercial stations are not given the option to negotiate for retransmission consent.

The FCC has recently adopted rules for the carriage of digital broadcast signals, but declined to adopt rules that would require cable systems to carry both the analog and digital signals of television stations entitled to must-carry rights during those stations’ transition to full digital operations. The FCC also recently declined to adopt rules that would require cable television systems to carry more than a single programming stream from any particular television broadcaster that has converted to a digital format. These recent FCC decisions, however, may be appealed. If these decisions are modified or overturned on appeal and “dual carriage” and “multicasting” requirements are adopted, we, like other cable operators, may have to discontinue or forego the opportunity to transmit other channels of programming.

As the marketplace for the programming and distribution of broadcast television evolves, so too may our rights and obligations as a provider of cable service. For instance, the FCC recently consented to the purchase of DirecTV by News Corp., the owner of the Fox television network, subject to certain conditions. As a result of this transaction, in addition to owning a broadcast television network, News Corp. and a number of broadcast television stations became a nationwide multichannel video programming distributor. News Corp.’s vertical integration prompted the FCC to impose certain conditions on the company. Some of these conditions could affect our business. For instance, with respect to News Corp.’s Fox television network:

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Nonduplication of Network Programming. Cable television systems that have 1,000 or more subscribers must, upon the appropriate request of a local television station, delete or “black out” the simultaneous or nonsimultaneous network programming of a distant same-network station when the local station has contracted for such programming on an exclusive basis.

Deletion of Syndicated Programming. Cable television systems that have 1,000 or more subscribers must, upon the appropriate request of a local television station, delete or “black out” the simultaneous or nonsimultaneous syndicated programming of a distant station when the local station has contracted for such programming on an exclusive basis.

Registration Procedures and Reporting Requirements. Prior to commencing operation in a particular community, all cable television systems must file a registration statement with the FCC listing the broadcast signals they will carry and certain other information. Additionally, cable operators periodically are required to file various informational reports with the FCC.

Technical Requirements. Historically, the FCC has imposed technical standards applicable to the cable channels on which broadcast stations are carried and has prohibited franchising authorities from adopting standards which were in conflict with or more restrictive than those established by the FCC. The FCC has applied its standards to all classes of channels which carry downstream National Television System Committee video programming. The FCC also has adopted standards applicable to cable television systems, including Grande, using frequencies in certain bands in order to prevent harmful interference with aeronautical navigation and safety radio services and has also established limits on cable system signal leakage. Operators are required to conduct tests and to file with the FCC results of those cumulative leakage testing measurements. Operators that fail to make this filing or exceed the FCC’s allowable cumulative leakage index risk being prohibited from operating in those frequency bands in addition to monetary fines or other sanctions.

The Cable Television Consumer Protection and Competition Act of 1992 requires the FCC to update periodically its technical standards. Pursuant to the Telecommunications Act of 1996, the FCC adopted regulations to assure compatibility among televisions, VCRs and cable systems, leaving all features, functions, protocols and other product and service options for selection through open competition in the market. The Telecommunications Act of 1996 also prohibits states or franchising authorities from prohibiting, conditioning or restricting a cable system’s use of any type of subscriber equipment or transmission technology. Most recently, the FCC has adopted technical standards in connection with cable systems’ carriage of digital television signals.

Franchise Authority. The Cable Communications Policy Act of 1984 affirmed the right of franchising authorities, which are the cities, counties or political subdivisions in which a cable operator provides cable television service, to award franchises within their jurisdictions and prohibited non-grandfathered cable systems from operating without a franchise in such jurisdictions. We hold cable franchises in all of the franchise areas in which we provide service. The Cable Television Consumer Protection and Competition Act of 1992 encouraged competition with existing cable systems in several areas, including by:

The Telecommunications Act of 1996 exempted those telecommunications services provided by a cable operator or its affiliate from cable franchise requirements although municipalities retain authority subject to state law to regulate the manner in which a cable operator uses the public rights-of-way to provide telecommunications services.

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Franchise authorities may not require a cable operator to provide telecommunications service or facilities, other than institutional networks, as a condition of franchise grant, renewal, or transfer. Similarly, franchise authorities may not impose any conditions on the provision of such service.

Franchise Fees. Although franchising authorities may impose franchise fees under the Cable Communications Policy Act of 1984, as modified by the Telecommunications Act of 1996, such payments cannot exceed 5% of a cable system’s annual gross revenues derived from the operation of the cable system to provide cable television services. The FCC concluded that Internet access via cable modem is an information service and that revenues derived from cable modem services may not be included in the gross revenues used to calculate cable franchise fees. Franchise fees apply only to revenues from cable television services. However, the Ninth Circuit Court of Appeals recently held that cable modem service is comprised of both an information component and a telecommunications component. This holding contradicts the FCC’s finding that cable modem service is an information service. The FCC has appealed the Court’s holding to the Supreme Court, where the matter is pending. A finding that cable modem service is not strictly an information service could subject the service to payment of franchise or other fees and other regulatory requirements.

Franchise Renewal. The Cable Communications Policy Act of 1984 established renewal procedures and criteria designed to protect incumbent franchisees against arbitrary denials of renewal. These formal procedures are mandatory only if timely invoked by either the cable operator or the franchising authority. Even after the formal renewal procedures are invoked, franchising authorities and cable operators remain free to negotiate a renewal outside the formal process. Although the procedures provide substantial protection to incumbent franchisees, renewal is by no means assured, as the franchisee must meet certain statutory standards. Even if a franchise is renewed, a franchising authority may impose new and more onerous requirements such as upgrading facilities and equipment, although the municipality must take into account the cost of meeting such requirements.

The Cable Television Consumer Protection and Competition Act of 1992 made several changes to the process which may make it easier in some cases for a franchising authority to deny renewal. The cable operator’s timely request to commence renewal proceedings must be in writing and the franchising authority must commence renewal proceedings not later than six months after receipt of such notice. Within a four-month period beginning with the submission of the renewal proposal, the franchising authority must grant or deny the renewal. Franchising authorities may consider the “level” of programming service provided by a cable operator in deciding whether to renew. Franchising authorities currently may deny renewal based on failure to substantially comply with the material terms of the franchise, even if the franchising authority has “effectively acquiesced” to such past violations. The franchising authority is stopped only if, after giving the cable operator notice and opportunity to cure, the authority fails to respond to a written notice from the cable operator of its failure or inability to cure. Courts may not reverse a denial of renewal based on procedural violations found to be harmless error.

Program Access and Exclusivity. The Cable Television Consumer Protection and Competition Act of 1992 and the FCC’s rules generally prohibit cable operators and vertically integrated satellite programmers from entering into agreements that have the purpose or effect of preventing or substantially hindering the ability of multichannel video programming distributors from providing satellite programming to their subscribers. The rules specifically prohibit vertically integrated cable operators from entering into exclusive distribution agreements with satellite programmers in which they have an attributable interest. Unless the FCC finds that the prohibitions continue to be necessary to protect competition, the rules will expire on October 5, 2007.

The program access rules currently do not restrict a vertically integrated cable operator from offering terrestrially delivered programming on an exclusive basis. If vertically integrated competitors obtain exclusive programming agreements, they may gain competitive advantages that adversely affect the ability to grow our business.

The FCC’s Order consenting to the DirecTV-News Corp. merger prohibits News Corp. from offering any existing or future national and regional programming services on an exclusive or discriminatory basis. News

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Corp. also is prohibited from unduly or improperly influencing any of its affiliated programming services in the sale of programming to unaffiliated cable operators.

Additionally, News Corp. is subject to certain conditions regarding its ownership of numerous regional sports programming networks. Specifically, cable operators may submit a dispute with News Corp. over the terms and conditions of a regional sports programming service to commercial arbitration. While the arbitration is pending, News Corp. may not deny continued carriage of the regional sports programming service, as long as it is not a first time request for carriage. An aggrieved cable operator may seek review of an arbitrator’s decision by the FCC. A cable operator with fewer than 400,000 total subscribers may appoint a bargaining agent to bargain collectively on its behalf in negotiating with News Corp. for regional sports programming. Despite these conditions, we cannot predict whether we will experience difficulty obtaining programming from News Corp.

Channel Set-Asides. The Cable Communications Policy Act of 1984 permits local franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The Cable Communications Policy Act of 1984 further requires cable television systems with 36 or more activated channels to designate a portion of their channel capacity for commercial leased access by unaffiliated third parties. The Cable Television Consumer Protection and Competition Act of 1992 requires leased access rates to be set according to a FCC-prescribed formula.

Ownership. The Telecommunications Act of 1996 eliminated the Cable Communications Policy Act of 1984 provisions prohibiting local exchange carriers from providing video programming directly to customers within their local exchange telephone service areas, except in rural areas or by specific waiver. Under the Telecommunications Act of 1996, local exchange carriers may, subject to certain restrictions described below, provide video programming by radio-based systems, common carrier systems, open video systems, or cable systems. Local telephone companies that elect to provide open video systems must allow others to use up to two-thirds of their activated channel capacity. Open video systems are relieved of regulation as common carriers and are not required to obtain local franchises but are still subject to many other regulations applicable to cable systems. Local telephone companies operating as cable systems are subject to all rules governing cable systems, including franchising requirements.

The Telecommunications Act of 1996 prohibits a local telephone company or its affiliate from acquiring more than a 10% financial or management interest in any cable operator providing cable television service in its telephone service area. It also prohibits a cable operator or its affiliate from acquiring more than a 10% financial or management interest in any local telephone company providing telephone service in its franchise area. A local telephone company and cable operator whose telephone service area and cable franchise area are in the same market may not enter into a joint venture to provide telecommunications services or video programming. There are exceptions to these limitations for rural facilities, very small cable systems and small local telephone companies in non-urban areas, and such restrictions do not apply to local exchange carriers that were not providing local telephone service prior to January 1, 1993.

Internet Access via Cable Modem. The FCC determined that cable modem service is an information service and is therefore generally not subject to local regulation as a cable service, including the payment of franchise fees. The Ninth Circuit Court of Appeals, however, recently decided that cable modem service is comprised of both an information services component and a telecommunications component. The decision of the Ninth Circuit Court of Appeals, if upheld, by the Supreme Court, may result in cable modem service being subject to certain telecommunications regulations, including non-discrimination, interconnection obligations and the payment of fees. Such a decision may adversely impact our business. The FCC has appealed the Ninth Circuit’s decision, and the matter is pending.

Pole Attachments. The Telecommunications Act of 1996 requires utilities, defined to include all local exchange telephone companies and public utilities except those owned by municipalities and co-ops, to provide cable operators and telecommunications carriers with nondiscriminatory access to poles, ducts, conduit and

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rights-of-way. The right to mandatory access is beneficial to facilities-based providers such as our company. The Telecommunications Act of 1996 also establishes principles to govern the pricing of such access. Telecommunications providers are charged a higher rate than cable operators for pole attachments. Companies that provide both cable television and telecommunications services over the same facilities, such as us, may be required to pay the higher telecommunications rate. At this time, we believe it is unclear what regulation will allow utility pole owners to charge cable operators offering a VoIP services for pole rentals.

Inside Wiring of Multiple Dwelling Units. The FCC has adopted rules to promote competition among multichannel video program distributors in multiple dwelling units, or MDUs. The rules provide generally that, in cases where the program distributor owns the wiring inside an MDU but has no right of access to the premises, the MDU owner may give the program distributor notice that it intends to permit another program distributor to provide service there. The program distributor then must elect whether to remove the inside wiring, sell the inside wiring to the MDU owner at a price not to exceed the replacement cost of the wire on a per-foot basis or abandon the inside wiring. The FCC has also adopted rules that, among other things, require utilities (including incumbent local exchange carriers) to permit telecommunications carriers and cable operators to obtain reasonable and non-discriminatory access to utility-owned or controlled conduits and rights-of-way in all “multiple tenant environments” (including, for example, apartment buildings, office buildings, campuses, etc.).

Privacy. The Cable Communications Policy Act of 1984 imposes a number of restrictions on the manner in which cable system operators can collect and disclose data about individual system customers. The statute also requires that the system operator periodically provide all customers with written information about its policies regarding the collection and handling of data about customers, their privacy rights under federal law and their enforcement rights. In the event that a cable operator is found to have violated the customer privacy provisions of the Cable Communications Policy Act of 1984, it could be required to pay damages, attorneys’ fees and other costs. Under the Cable Television Consumer Protection and Competition Act of 1992, the privacy requirements were strengthened to require that cable operators take such actions as are necessary to prevent unauthorized access to personally identifiable information.

Franchise Transfer. The Telecommunications Act of 1996 repealed most of the anti-trafficking restrictions imposed by the Cable Television Consumer Protection and Competition Act of 1992, which prevented a cable operator from selling or transferring ownership of a cable system within 36 months of acquisition. However, a local franchise may still require prior approval of a transfer or sale. The Cable Television Consumer Protection and Competition Act of 1992 requires franchising authorities to act on a franchise transfer request within 120 days after receipt of all information required by FCC regulations and the franchising authority. Approval is deemed granted if the franchising authority fails to act within such period.

Copyright. Cable television systems are subject to federal compulsory copyright licensing covering carriage of broadcast signals. In exchange for making semi-annual payments to a federal copyright royalty pool and meeting certain other obligations, cable operators obtain a statutory license to retransmit broadcast signals. The amount of the royalty payment varies, depending on the amount of system revenues from certain sources, the number of distant signals carried and the location of the cable system with respect to over-the-air television stations. Adjustments in copyright royalty rates are made through an arbitration process supervised by the U.S. Copyright Office.

Various bills have been introduced in Congress in the past several years that would eliminate or modify the cable television compulsory license. Without the compulsory license, cable operators might need to negotiate rights from the copyright owners for each program carried on each broadcast station retransmitted by the cable system.

Internet Service Providers. A number of Internet service providers have requested that the FCC and state and local officials adopt rules requiring cable operators to provide unaffiliated Internet service providers with direct access to the operators’ broadband facilities on the same terms as the operator makes those facilities

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available to affiliated Internet service providers. To date, the FCC has rejected these unbundling proposals, but a number of local franchising authorities outside our service territory imposed this type of requirement on cable operators, and pending litigation over the regulatory classification of cable modem service has prevented this issue from being resolved. Some cable operators, including Grande, have agreed to open their systems to competing Internet service providers or have been required to do so as a condition of a merger. At this time it is uncertain whether these requirements will be imposed on cable operators on a broad scale or how pervasive they ultimately may be if upheld in court.

Regulatory Fees and Other Matters. The FCC requires payment of annual regulatory fees by the various industries it regulates, including the cable television industry. In 2002, 2003 and 2004 the fee was $0.53 per subscriber, $0.66 per subscriber and $0.70 per subscriber, respectively. Fees are also assessed for other FCC licenses often used by cable television operators, including licenses for business radio, cable television relay systems and earth stations.

FCC regulations also address:

Regulation of Telecommunications Services

Our telecommunications services are subject to varying degrees of federal, state and local regulation. Pursuant to the Communications Act of 1934, as amended by the Telecommunications Act of 1996, the FCC generally exercises jurisdiction over the facilities of, and the services offered by, telecommunications carriers that provide interstate or international communications services. State regulatory authorities retain jurisdiction over the same facilities and other services to the extent that they are used to provide intrastate communications services.

Federal Regulation of Telecommunications Services

Tariffs and Licensing. Our company is classified as a non-dominant long distance carrier and as a competitive local exchange carrier by the FCC. The FCC requires non-dominant long distance companies to detariff interstate long distance domestic and international services. The FCC also permits competitive local carriers to either (1) detariff the interstate access services that they sell to long distance companies or (2) maintain tariffs but comply with certain rate caps. Prior to detariffing, we filed tariffs with the FCC to govern our relationship with most long distance customers and companies. The detariffing process requires us to, among other things, post the rates, terms, and conditions formerly in our tariffs on our website instead of filing them at the FCC. Because detariffing precludes us from filing our tariffs at the FCC, we may no longer be subject to the “filed rate doctrine,” which stands for the proposition that the tariff controls all contractual disputes between a carrier and its customers. This may expose us to certain legal liabilities and costs as we can no longer rely on this doctrine to settle disputes with customers. The FCC still requires companies such as us to obtain licenses under Section 214 of the Communications Act of 1934, as amended, to provide international long distance calling service. We hold such international authority from the FCC.

Interconnection. The Telecommunications Act of 1996 establishes local telephone competition as a national policy. This Act preempts laws that prohibit competition for local telephone services and establishes uniform

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requirements and standards for local network interconnection, unbundling and resale. Interconnection, unbundling and resale standards were developed initially by the FCC and have been, and will continue to be, implemented by both the FCC and the states in numerous proceedings.

In August 1996, the FCC adopted a wide-ranging decision regarding the interconnection obligations of local telephone carriers. This Interconnection Order specified, among other things, which network elements (and combinations of elements) incumbent carriers must unbundle and provide to competitive carriers on a nondiscriminatory basis. The FCC’s initial list of network elements and combinations was affirmed by the Supreme Court, but has since been subject to further review by the FCC, after several rounds of review by the courts, has been significantly pared. The FCC’s most recent decision paring this list was released in February 2005, and this decision has been appealed. We cannot predict the results of this appeal or its impact on the list of unbundled network elements that must be made available to competitive carriers. We also cannot predict the ultimate implications of any court ruling or future proceedings in this area on our business. Changes to this list of network elements and combinations have had-and may continue to have-a significant impact on the industry and, to a lesser extent, on our company.

The FCC’s Interconnection Order also established pricing principles, for use by the states, to determine rates for unbundled network elements and discounts. These pricing principles also are undergoing further review by the FCC and may change, which could have a significant impact on the industry and on our company.

The Telecommunications Act of 1996 requires incumbent local telephone carriers to enter into mutual compensation arrangements with other local telephone companies for transport and termination of local calls on each other’s networks. In the past, most state public utility commissions ruled that traffic to Internet service providers is covered by this requirement. Thus, carriers that counted traffic-generating Internet service providers as customers benefited from such reciprocal compensation arrangements. In April 2001, the FCC changed the compensation mechanism for traffic exchanged between telecommunications carriers that is destined for Internet service providers. In doing so, the FCC prescribed a new rate structure for such traffic and prescribed gradually reduced caps for its compensation. The FCC’s ruling in connection with such traffic affected a large number of carriers and further developments in this area could have a significant impact on the industry and on our company.

The FCC recently launched a new proceeding intended to examine comprehensively the “intercarrier compensation” rates paid among carriers for exchanging various categories of traffic, including but not limited to local calls. Several proposals for how the FCC’s intercarrier compensation rules should be structured also have been submitted to the FCC by industry groups and coalitions. We cannot predict how the FCC will act in response to these proposals, or, more generally, in connection with its intercarrier compensation proceeding. FCC rulings in this area will affect a large number of carriers and could have a significant impact on the industry and our company.

Additional Requirements. The FCC imposes additional obligations on all telecommunications carriers, including obligations to:

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Forbearance. The Telecommunications Act of 1996 permits the FCC to forbear from requiring telecommunications carriers to comply with certain regulations. Specifically, the Act permits the FCC to forbear from applying statutory provisions or regulations if the FCC determines that:

The FCC has exempted certain carriers from reporting requirements pursuant to this provision of the Telecommunications Act of 1996. The FCC may take similar action in the future to reduce or eliminate other requirements. Such actions could free us from regulatory burdens but also might increase the pricing and general flexibility of our competitors.

Collocation. The FCC has adopted rules designed to improve competitor access to incumbent local telephone carriers’ collocation space and to reduce the delays and costs associated with collocation, but we cannot be sure that these rules will not change or otherwise accrue to the advantage of incumbent carriers in the future.

Advanced Services. Section 706 of the Telecommunications Act of 1996 requires the FCC to encourage the deployment of advanced telecommunications capabilities to all Americans through the promotion of local telecommunications competition. The FCC has taken steps to facilitate competitors’ access to lines connecting customer premises to the operator for purposes of digital subscriber line deployment. Specifically, the FCC requires incumbent local exchange carriers, like SBC Communications, to permit unaffiliated providers of digital subscriber line services to use a portion of the lines connecting customer premises to the operator used for basic telephone service rather than purchasing new lines. The FCC ruled in August 2003 that incumbent local exchange carriers were required, on a transitional basis over three years, to continue to permit unaffiliated carriers access to the high-frequency portion of local loop facilities for purposes of providing digital subscriber line services; however, the FCC declined to make a similar finding in connection with more advanced, newly-constructed transmission facilities such as fiber-to-the-home. On appeal, the United States Court of Appeals for the District of Columbia Circuit upheld the FCC’s August 2003 determination that fiber-to-the-home transmission facilities are not required unbundled network elements. Separately, Congress has periodically considered initiatives proposing to deregulate the advanced services offerings of incumbent carriers. If one of these initiatives becomes law, the use of incumbent carrier facilities for the deployment of digital subscriber lines by competitive carriers such as Grande may be adversely affected. This, however, is not a material part of our business since we typically provide these services over our own network.

Voice-over-Internet Protocol. VoIP is an application that manages the delivery of voice information across data networks, including the Internet, using Internet Protocol. VoIP sends voice information in digital form using discrete packets that are routed in the same manner as data packets. VoIP is widely viewed as a potentially more cost-effective, feature-rich alternative to traditional circuit-switched telephone service. Because VoIP can be deployed by carriers in various capacities, and because it is widely considered a next-generation communication service, its regulatory classification—and, thus, its revenue potential—is unclear. A number of state regulatory commissions have issued conflicting rulings on this issue, and at least seven petitions have been filed at the FCC seeking guidance on the regulatory classification of VoIP service. The FCC thus far has issued three declaratory rulings in response to those petitions, but its decisions in those cases have been narrowly tailored.

In one case, the FCC held that a computer-to-computer VoIP application provided by Pulver.com is an unregulated information service, in part because it does not include a transmission component, offers computing capabilities, and is free to its users. In another case, the FCC reached a different conclusion, holding that AT&T’s use of VoIP to transmit the long-haul portion of certain calls constitutes a telecommunications service, thus

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subjecting it to regulation, because the calls use ordinary customer premises equipment with no enhanced functionality, originate and terminate on the public switched telephone network, and undergo no net protocol conversion and provide no enhanced functionality to end users. In yet a third case, which involved the VoIP application of Vonage, the FCC preempted the authority of the State of Minnesota (and presumably all other states) and ruled that Vonage’s VoIP application, and others like it, was an interstate service subject only to Federal regulation, thus preempting the authority of the Minnesota commission to require Vonage to obtain state certification. The FCC, however, refused to rule in the Vonage case whether Vonage’s VoIP application is a telecommunications service or an information service, thus leaving open the question of the extent to which the service will be regulated.

The FCC has initiated a more generic proceeding to address the many regulatory issues raised by the development and growth of VoIP service, including the extent to which VoIP will be negotiated at the Federal level and has expressly reserved the right to reconsider its declaratory rulings in the generic proceeding. The FCC also is examining what requirements, if any, should be applied to VoIP service to enable law enforcement agencies to, when necessary and appropriate, access information transmitted through VoIP applications. Federal and state rulings in connection with VoIP will likely have a significant impact on us, our competitors and the communications industry.

State Regulation of Telecommunications Services

Traditionally, states have exercised jurisdiction over intrastate telecommunications services, and the Telecommunications Act of 1996 largely upholds that traditional state authority. The Telecommunications Act of 1996 does place limits on state authority to the extent necessary to advance competition in the telecommunications industry; for example, the statute contains provisions that prohibit states and localities from adopting or imposing any legal requirement that may prohibit, or have the effect of prohibiting, market entry by new providers of interstate or intrastate telecommunications services. The FCC is required to preempt any such state or local requirement to the extent necessary to enforce the Telecommunications Act of 1996’s open market entry requirements. State and localities may, however, continue to regulate the provision of intrastate telecommunications services and require carriers to obtain certificates or licenses before providing service.

We are certified as a CLEC in Arkansas, Florida, Georgia, Indiana, Oklahoma and Texas and as an interexchange service provider (IXC) in Arkansas, Florida, Georgia, Indiana, North Carolina, Oklahoma, Washington and Texas. If we expand to provide similar telecommunications services in new states, we will likely be required to obtain certificates of authority to operate and be subject to ongoing regulatory requirements in those states as well.

Although we are authorized to provide telecommunications services in several states, the majority of our telecommunications end user customers are located in Texas. Since 1995, Texas law has provided a regulatory framework for competitive carriers such as us to provide telecommunications services in the state. Like the Federal Telecommunications Act of 1996, Texas law is intended to promote competition in the local exchange market, as well as in the intrastate interexchange market. The PUCT is responsible for regulating these markets, and the PUCT plays a key role in promulgating rules and policies and by arbitrating interconnection agreements between carriers in the local market. The rules, policies and decisions of the PUCT are influenced by a variety of factors, and future regulatory developments in the state could have a significant impact on us.

Among the PUCT’s regulatory responsibilities is review of SBC Communications’ performance in its provision of wholesale telecommunications services to competitive carriers such as us through a comprehensive set of performance measurements and a performance remedy plan. This performance remedy plan requires SBC Communications to pay certain fines when it fails to meet its prescribed performance benchmarks. Although the performance remedy plan is intended to provide SBC Communications with incentive to provide timely wholesale service to competitive carriers on a nondiscriminatory basis, SBC Communications holds considerable market power in Texas and may be able to use that market power to the detriment of the competitive

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telecommunications market, and, in turn, carriers such as us. In addition, the continuation of the performance measurements remedy plan is being contested by SBC Communications in interconnection agreement arbitration proceedings currently before the PUCT.

Telecommunications carriers in Texas are subject to numerous state policies, the application of which could affect our business. These policies include, but are not limited to, the Texas Universal Service Fund, broadband initiatives, such as the state’s DSL and advanced services in rural areas initiatives, and the Texas Infrastructure Fund, which is intended to promote the deployment of equipment and infrastructure for distance learning library information sharing programs and telemedicine services. Telecommunications carriers also are subject to various consumer protection regulations, such as prohibitions relating to slamming (changing an end user’s service provider without appropriate authorization), cramming (adding charges to an end user’s account without appropriate authorization) and telemarketing. Grande must comply with these and other regulations or risk significant fines and penalties.

Texas has long been involved in both federal and state initiatives relating to homeland security, defense and disaster recovery. These initiatives sometimes require telecommunications carriers to, among other things, maintain certain network security procedures and monitoring systems. The growing emphasis on homeland security at the federal and state level may cause us to incur unforeseen expenses relating to the security and protection of telecommunications networks.

Local Regulation

Occasionally we are required to obtain street use and construction permits and franchises to install and expand our interactive broadband network using state, city, county or municipal rights-of-way. Some municipalities where we have installed or anticipate constructing networks require the payment of license or franchise fees which are based upon a percentage of gross revenues or on a per linear foot basis. The Telecommunications Act of 1996 requires municipalities to manage public rights-of-way in a competitively neutral and non-discriminatory manner.

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RISK FACTORS

RISKS RELATING TO OUR BUSINESS

We expect to lose money during the next few years.

We expect to incur net losses during the next few years as we continue to build our networks. Our ability to generate profits and maintain positive cash flow will depend in large part on our ability to obtain enough subscribers for our services to offset the costs of constructing and operating our networks. We cannot predict when we will achieve positive net income and cannot assure you that we will be able to do so at all.

Changes in demand for our services could harm our business.

We could be affected by changes in demand for the services we provide in our markets. Our plan to provide bundled broadband communications services is fairly new and relatively untested in our existing and anticipated markets. Our plan could be unsuccessful due to:

Any downturn in demand for our services will harm our business and our prospects for growth and profitability.

Competition from other cable television, telephone and broadband Internet service providers could have an adverse effect on our growth and revenues.

We are not the first provider of any of our three principal services in any of our markets. We compete with numerous other companies that have long-standing customer relationships with the residents in these markets, and we often have to convince people to switch from other companies to Grande. Some of our competitors have significant competitive advantages over us, including greater experience, resources, marketing capabilities and name recognition.

As the incumbent local telephone company, and a major provider of long distance telephone services, SBC Communications is a particularly strong competitor in telephone and data services and has indicated that it intends to enter the market for video services, as well. With respect to cable television services, TimeWarner is

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the incumbent provider in the majority of our markets. Several of these competitors offer more than one service, such as telephone companies and cable providers offering broadband Internet services. A few have begun to offer all three services, in particular, TimeWarner, and other cable operators have begun providing digital phone services through VoIP technology. SBC Communications and Verizon, who have stated that they are upgrading their networks and plan to provide video services, may eventually be able to provide all three services as well. We also compete with wireless telephone carriers for both local and long distance services. In addition, a continuing trend toward business combinations and alliances in the telecommunications industry, such as the recently announced venture between SBC Communications and EchoStar Communications (DISH Network), and the announced mergers of SBC Communications and AT&T, and Verizon or Quest and MCI, may create significant new competitors for us. We expect these business combinations and the level of competition to continue to increase in the future. If we fail to compete successfully in our markets and grow our customer base, our business and financial condition will be harmed.

The Texas legislature is currently undertaking a complete review of telecommunications regulation. The outcome is uncertain, but could include complete deregulation of some or all of the incumbent telephone companies, which could result in significant new competitive situations.

The outcome of the investigation of MCI in which we are involved could have a material adverse impact on our business and financial condition.

Both the FCC and the Department of Justice have been and may still be conducting investigations understood to involve billing practices by MCI and related issues involving companies that terminated or otherwise may have handled traffic on behalf of MCI, including those companies participating in MCI’s Least Cost Routing Program. We believe we were a substantial participant in the Least Cost Routing Program. The Department of Justice convened a grand jury in the Southern District of New York as part of its investigation. The grand jury issued document subpoenas to a number of companies in the telecommunications industry, including us. We cooperated with the Department of Justice and produced responsive documents. The FCC issued a letter of inquiry to us and other companies seeking documents and requesting information relating to the above described billing practices and the compliance by such companies, including us, with applicable law and regulations. We responded to the letter of inquiry and produced additional documentation to supplement our answers to certain questions. The FCC may issue additional letters of inquiry in the future, to which we would intend to respond in the same manner. We cannot predict the outcome of these investigations or their duration. If these investigations result in current or prior billing practices being identified as violative of applicable laws or regulations, result in penalties being imposed upon us, result in further proceedings against specific companies, including us, result in changes in the law or regulations that would have an industry-wide effect, or lead to litigation among parties involved in terminating or otherwise routing traffic, the impact could have a material adverse effect on our business and financial condition. There have been no substantial communications, of any kind, on this investigation between the Department of Justice or the FCC and Grande since January 2004.

Restrictive covenants under our indebtedness may limit our ability to grow and operate our business.

The indenture governing our 14% senior secured notes due 2011 contains, among other things, covenants imposing significant financial and operating restrictions on our business. These restrictions may affect our ability to manage and operate our business, may limit our ability to take advantage of potential business opportunities as they arise and may adversely affect the conduct or management of our current business. These restrictions limit our ability to, among other things:

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These limitations may affect our ability to finance our future operations or to engage in other business activities that may be in our best interest. Also, since we are a holding company with no assets other than our ownership of our subsidiaries, we will be dependent on the receipt of funds from our subsidiaries to pay the interest and principal on the 14% senior secured notes due 2011, and these limitations could adversely affect our ability to make such payment on the notes.

The amount of debt we have could harm our business.

As of December 31, 2004, we had approximately $142.2 million of indebtedness outstanding, including our 14% senior secured notes due 2011, all of which was secured. In addition, the indenture governing the notes allows us to incur additional indebtedness under certain circumstances. Our significant indebtedness could adversely affect our business in a number of ways, including the risks that:

If we cannot generate sufficient cash flow from operations to meet our obligations, we may be forced to reduce or delay capital expenditures, sell assets, restructure or refinance our debt, or seek additional equity capital. We cannot assure you that these remedies would be available or satisfactory. Our cash flow from operations will be affected by prevailing economic conditions, financial, business and other factors, which may be beyond our control.

We may be required to purchase a significant amount of equipment from some of our suppliers, which could adversely affect our financial condition.

We may be required to purchase a minimum of $42.7 million of equipment from some of our suppliers between January 2005 and December 2010. We entered into these agreements based upon estimates of equipment we expect to need over this six-year period. The majority of these purchase commitments are contingent upon delivery of technical and functional next generation requirements. If we do not actually need the estimated amount and type of equipment, our financial condition could be adversely affected because we would be obligated to spend money on equipment we do not need, rather than applying it to help grow and develop our business.

Failure to maintain existing and obtain new favorable cable television franchises could adversely affect our ability to grow our business.

We provide cable television service over our networks generally pursuant to cable franchises, permits or licenses typically granted by a municipality or other state or local government controlling the public rights-of-

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way. Our ability to grow our business depends on the terms of these cable franchises, including payment obligations and construction requirements. Many cable franchises include specific build-out requirements for the related city or town; if we do not meet these build-out requirements, we may have to seek an extension for the build-out and/or pay additional fees to the franchise authority. Local franchise authorities also can seek to impose regulatory constraints on us and our competitors by local ordinance or as part of a grant or renewal of a franchise. Further, they may seek to impose additional fees or customer service or other requirements, which would increase our expenses in operating our business. We cannot predict whether local franchise authorities will seek to impose additional obligations or constraints on us or be amenable to changes we may wish to make in the franchise terms to accommodate changes in our build-out requirements plans.

Cable franchises often are terminable if the franchisee fails to comply with material terms of the franchise order or the local franchise authority’s regulations. Further, cable franchises generally are for a fixed period of years and must be renewed periodically. Local franchising authorities may resist granting a renewal if they consider either our prospective operating proposal or our past performance to be inadequate. If one of our cable franchises is not renewed or is terminated, our business will be harmed.

Under federal law, our cable franchises are non-exclusive. Our market areas are currently served by at least one incumbent provider. The local franchising authorities can grant cable franchises to competitors who may build networks in our market areas. In addition, under federal law, municipal entities can operate cable television systems without franchises. New competitors in our existing markets or changes to franchise terms could adversely affect our business and financial condition.

Failure to maintain favorable interconnection arrangements could adversely impact our telephone service.

Like most telephone providers, even though we operate our own networks, we rely on other companies to connect our customers with users of telephone service who are not our customers. The interconnection agreements we have with other providers will expire in the near future, and we cannot predict whether replacement agreements will be favorable to us. We access Verizon’s and BellSouth’s telephone networks under interconnection agreements that expired in June 2004 and will expire in June 2006, respectively. We access SBC Communications’ telephone network under an interconnection agreement that expires when SBC Communications’ successor interconnection agreement is completed and becomes effective. We access Valor Telecommunications’ telephone network under an interconnection agreement that is in effect on a month-to-month basis. The SBC Communications interconnection agreement is the subject of an arbitration proceeding before Texas regulatory authorities involving most telephone providers in Texas. If one or more of these interconnection agreements cannot be renewed on favorable terms, there would be an adverse impact on our business unless we can obtain a more favorable interconnection agreement with another company that reaches the relevant users. It is difficult to negotiate favorable agreements, even though the law requires telephone network owners to negotiate interconnection agreements, because the other parties to these agreements are our competitors.

It is generally expected that the law requiring incumbent telephone carriers to negotiate interconnection agreements, the Telecommunications Act of 1996, will continue to undergo changes over the next several years. In particular, provisions of the law relating to access to unbundled network elements, which have changed considerably since 1996, will continue to change. For instance, the FCC in February 2005 issued a decision phasing out access to the unbundled network element platform or UNE-P. Although our present use of UNE-P is quite limited, any one or more of these changes could adversely affect our ability to obtain favorable interconnection agreements, including both with respect to access and cost. We expect the FCC’s recent decision to phase out UNE-P, as well as some of it’s other changes regarding unbundled network elements, to be developed further by, and contested before, the FCC, state public service commissions and courts. We cannot predict the outcome of these changes, the extent to which they may affect our costs or the terms or conditions of our interconnection services. These changes likely will not have the same effects on our competitors who own and operate larger networks than we do, and therefore our ability to compete successfully will be affected as well.

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The costs associated with the provision of our services may increase and we may not be able to pass any cost increases on to our customers.

In recent years, the cable industry has experienced increases in the cost of programming, which is one of the most significant costs of operating a cable system, and we expect these increases to continue. Because we have a relatively small base of subscribers, we cannot obtain programming costs comparable to those of the larger cable providers with which we compete despite using the services of a national cooperative that seeks to obtain better pricing on behalf of smaller cable providers nationwide. We may also see increases over time in other costs, such as the fees we pay utility companies for space on their utility poles. If we are unable to pass any programming or other cost increases on to our customers, our results of operations could be adversely affected.

Future technologies may hurt our business or increase our cost of operations.

The development of future technologies may result in new competition in one or more of the services we offer. Other developments may give our competitors a cost advantage or other features we cannot readily match, or require us to make expensive and time-consuming upgrades to our networks to remain competitive. In addition, we may select one technology or one technology provider over another, while our competitors may select different technologies or providers. If we do not choose the technology that turns out to be the most efficient, economic or appealing to customers, our business could be adversely affected.

If we are not able to manage our growth, our business will be harmed.

Our ability to grow will depend, in part, upon our ability to:

In addition, as we increase our service offerings and expand within our targeted markets, we will have additional demands on our customer support, sales and marketing, administrative resources and network infrastructure. If we cannot effectively manage our growth, our business and results of operations will be harmed.

Our business could be hurt by natural disasters.

Our success depends on the efficient and uninterrupted operation of our communications services. Our networks are attached to poles and other structures in our service areas. A tornado, hurricane, flood or other natural catastrophe in one of these areas could damage our networks, interrupt our service and harm our business in the affected area.

We could be hurt by future regulation of our industry.

Legislation and implementing regulations in the telecommunications and cable areas continue to be quite complex, and regulation of carrier and Internet services may increase. Future actions by the United States Congress, the FCC, the Federal Trade Commission, state legislatures, state utility commissions, local municipalities and other regulators may adversely impact our business. For example, in the event that any regulation or interpretative rulings increase the costs associated with a particular service, e.g. an increase in the cost of termination telecommunications traffic, due to certain providers failing to meet minimum regulatory guidelines, our business may be adversely impacted.

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Difficulties in integrating businesses we have recently acquired or may acquire in the future may demand time and attention from our senior management.

Integrating businesses we have recently acquired or may acquire in the future may involve unanticipated delays, costs and/or other operational and financial problems. Successful integration depends on a number of factors, including our ability to transition acquired businesses to our operational and billing systems and technical specifications. In integrating acquired businesses, we may not achieve expected economies of scale or profitability or realize sufficient revenues to justify our investment. If we encounter unexpected problems at one of the acquired businesses as we try to integrate it into our business, our senior management may be required to expend time and attention to address the problems, which would divert their time and attention from other aspects of our business.

We may require additional funding to cover unforeseen costs, which funding may not be available.

When we expand our networks within our existing markets, introduce new products or services or enter new markets, we project the capital expenditures that will be required based in part on the amount of time necessary to complete the construction of the networks or the introduction of the services and the difficulty of such projects. Although we believe we can complete the build-out of our existing markets without raising additional capital, we may need more money to cover unforeseen costs associated with delays or unforeseen difficulties in connection with the build-out or maintenance of our networks or for other unanticipated reasons. Such financing, if necessary, may not be available on favorable terms or at all. If we cannot obtain additional funds when needed or if cash flow from operations is less than expected, our business and financial condition may be adversely affected.

Expanding into additional markets, either through internal growth or acquisitions, will require additional funding and numerous approvals.

Although currently we do not intend to enter any new markets, we may expand into other attractive markets if the right opportunities arise. However, expansion into additional markets will require significant additional capital, as well as numerous authorizations and approvals such as franchises, construction permits, pole attachment agreements, interconnection agreements and others. Expansion markets may not have the same economics or operating metrics as we have experienced in our existing markets, and may involve more difficult competitive situations or other hurdles.

We could be damaged by the loss of our key personnel.

Our business is currently managed by a small number of key management and operating personnel. While we have an employment agreement with William Morrow, our Chief Executive Officer, we do not have employment agreements with any other employees. Further, we do not maintain “key man” life insurance on any of our employees. If Mr. Morrow or many of the members of our management team were to leave the company, our business could suffer.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This annual report contains statements about future events, including without limitation, information relating to business development activities, as well as capital spending, financing sources and the effects of regulation and increased competition. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements can sometimes be identified by our use of forward-looking words such as “may,” “will,” “anticipate,” “estimate,” “except,” or “intend” and other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are or may be forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be different from any future results, performance

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or achievements expressed or implied by these statements. You should review carefully all of the information, in this annual report, including the financial statements.

In addition to the risk factors described under the heading “Risk Factors,” the following important factors could affect future results, causing actual results to differ materially from those expressed in the forward-looking statements:

These factors and the other risk factors discussed in this annual report are not necessarily all of the important factors that could cause our actual results to differ materially from those expressed in any of the forward-looking statements. Other unknown or unpredictable factors also could have material adverse effects on our future results. The forward-looking statements included in this annual report are made only as of the date of this annual report. We cannot assure you that any projected results or events will be achieved. We do not have and do not undertake any obligation to publicly update any forward-looking statements to reflect subsequent events or circumstances.

Employees

As of December 31, 2004, we had approximately 873 full-time employees, other than temporary employees. None of our employees are subject to collective bargaining agreements. We believe that our relations with our employees are good.

We lease our corporate headquarters and network operations center in San Marcos, Texas, which consists of approximately 67,278 square feet of office space, as well as 8 other office sites in Texas, of approximately 182,477 square feet of office space collectively. We primarily lease the real property sites in each of our markets upon which our network equipment is located, including sites for our head-ends where programming is received via satellite, hubs, network equipment and points of presence. We have rights of way, licenses or other access rights to the real property over which our network fiber crosses, generally under our franchise agreements. With respect to our long-haul network, we lease the real property sites where our switches, network equipment including collocation facilities and points of presence are situated.

Both the FCC and the Department of Justice have been and may still be conducting investigations understood to involve billing practices by MCI and related issues involving companies that terminated or otherwise may have handled traffic on behalf of MCI, including those companies participating in MCI’s Least Cost Routing Program. We believe we were a substantial participant in the Least Cost Routing Program. The Department of Justice convened a grand jury in the Southern District of New York as part of its investigation. The grand jury issued document subpoenas to a number of companies in the telecommunications industry, including us. We cooperated with the Department of Justice and produced responsive documents. The FCC issued a letter of inquiry to us and other companies seeking documents and requesting information relating to the above described billing practices and the compliance by such companies, including us, with applicable law and regulations. We responded to the letter of inquiry and produced additional documentation to supplement our answers to certain questions. The FCC may issue additional letters of inquiry in the future, to which we would intend to respond in the same manner. We cannot predict the outcome of these investigations or their duration. If

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these investigations result in current or prior billing practices being identified as violative of applicable laws or regulations, result in penalties being imposed upon us, result in further proceedings against specific companies, including us, result in changes in the law or regulations that would have an industry-wide effect, or lead to litigation among parties involved in terminating or otherwise routing traffic, the impact could have a material adverse effect on our business and financial condition. There have been no substantial communications, of any kind, on this investigation between the Department of Justice or the FCC and Grande since January 2004.

As a telecommunications company, we are a party to regulatory proceedings in the ordinary course of our business at both the state and federal levels. For example, we along with many other telecommunications companies in Texas are currently a party to a proceeding before the PUCT relating to the terms of SBC Communications’ standard interconnection agreement and an anticipated successor to this interconnection agreement. The proceeding has progressed in two phases, with phase one completed with no changes to the interconnection agreement that materially impacted the company. Phase two issues will be decided in July 2005 are not issues that could, individually, or in the aggregate with any other regulatory proceedings, have a material adverse effect on our business, financial condition or results of operations.

No matters were submitted to a vote of our security holders.

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PART II

Price Range for Common Stock

Our stock is not traded on any exchange or quoted on the Nasdaq National Market or any other established trading market. No market makers currently make a market in our stock and we do not plan to engage a market maker. Therefore, there is no established public trading market and no high and low bid information or quotations available. As of December 31, 2004, we had 12,920,366 shares of common stock outstanding.

Dividend Policy

We have never declared or paid any cash dividends on our capital stock and do not anticipate paying cash dividends on our capital stock in the foreseeable future. It is the current policy of our board of directors to retain earnings to finance the expansion of our operations. Future declaration and payment of dividends, if any, will be determined based on the then-current conditions, including our earnings, operations, capital requirements, financial condition, and other factors the board of directors deems relevant. In addition, our ability to pay dividends is limited by the terms of the indenture governing our outstanding senior secured notes.

You should read the data set forth below in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information appearing elsewhere in this annual report.

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The following is a discussion of our consolidated financial condition and results of operations for the years ended December 31, 2004, 2003 and 2002 and other factors that are expected to affect our prospective financial condition. The following discussion and analysis should be read together with our consolidated financial statements and related notes beginning on page F-1 of this annual report.

Overview

We provide communities in Texas with a bundled package of cable television, telephone and broadband Internet and other services. We operate fully integrated advanced broadband networks in six markets, in eight cities, that pass approximately 308,913 out of approximately 1.4 million marketable homes and small businesses as of December 31, 2004. We had 126,736 residential, small business and enterprise customers as of December 31, 2004. We expect that with existing cash and investments on hand of $61.2 million as of December 31, 2004, and our anticipated cash flow from operations, we will be fully funded to build-out our networks to pass all 1.4 million marketable homes and small businesses. Operating revenues for 2004 were $179.0 million compared to $181.5 million in 2003. We had solid growth in our core business throughout 2004, almost replacing $65.0 million of the lost MCI revenues from 2003.

In July 2000, when our network construction was still in a very early stage, we acquired an established telephone and data network that served as the platform for our provision of residential telephone and broadband Internet services and that still provides network services revenues. This acquisition initially provided a significant portion of our revenues and became the foundation of our business while we moved forward with the construction of our broadband networks. Since 2001, as our network construction proceeded and the number of bundled services customers has grown, we have derived an increasing percentage of our revenues from our retail cable television, telephone and broadband Internet and other services and we expect this trend to continue.

Since inception, we have been funded primarily with private equity investments. Between February 2000 and October 2003, we completed a series of private placements of our preferred stock, raising aggregate gross proceeds of $338.2 million from the sale of our capital stock. The net proceeds from these private placements have been used to fund our network buildout, operations, and our acquisitions, which are described below under the heading “Acquisitions.” As a result of equity investments and mergers where stock was used as

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consideration, we now have $508 million of total invested equity capital and a base of over 20 institutional private equity investors. We have incurred net losses for the past three years and expect to continue to incur net losses for the next few years. However, we did achieve positive EBITDA in 2002 and 2003 and positive Adjusted EBITDA in 2004. See “EBITDA/Adjusted EBITDA” below for a discussion of this non-GAAP measure of our operating performance as well as our use of Adjusted EBITDA in 2004.

On March 23, 2004, we raised net proceeds of $124.5 million in a private placement of 136,000 units each consisting of 14% senior secured notes due 2011 and a warrant to purchase 100.336 shares of our common stock. We used a portion of the net proceeds from the offering to repay all amounts outstanding under our then-existing senior credit facility. That facility was terminated upon repayment and we are not able to borrow any further amounts thereunder.

Acquisitions

The following is a summary of the six major acquisitions that we have completed since inception. Each of our acquisitions has been strategic in nature, either enhancing our capabilities, expanding our network coverage or reducing our anticipated future capital expenditures. We include the operating results of each of our acquisitions in our financial statements beginning on the date of consummation of the acquisition.

Thrifty Call

In July 2000, we acquired the assets of Thrifty Call, a communications service provider, for approximately $69.2 million in cash and $50.0 million in assumed liabilities. The acquisition provided us with corporate overhead structure and an established telephone and data network that served as the platform for our provision of residential telephone and broadband Internet services. In addition, Thrifty Call was the primary provider of telephone services to ClearSource, which we subsequently acquired in June 2002, as discussed below.

US OnLine

Between December 2001 and October 2002, we completed a series of transactions in which we purchased certain assets from US OnLine consisting of certain right of entry agreements, property and equipment located in Texas for approximately $13.2 million in cash. These transactions provided us with an established customer base of approximately 15,000 connections and exclusive long-term service rights to MDUs in Austin and San Antonio. US OnLine was a provider of bundled cable television, telephone and broadband Internet services.

ClearSource

In June 2002, we acquired ClearSource in a stock-for-stock transaction in which we issued to former ClearSource stockholders 114,698,442 shares of Series D preferred stock and 7,999,099 shares of Series E preferred stock valued at $1.30 per share and $2.50 per share, respectively. Our CEO, William Morrow, was one of the founders of ClearSource, and at the time of the acquisition we shared most of the same major investors with ClearSource and a number of ClearSource’s directors were members of our board of directors. ClearSource provided bundled services similar to ours to residential and small business customers over a broadband network in the Waco, Corpus Christi and Midland/Odessa markets and was the largest customer of our local telephone services. This acquisition provided us with approximately 51,000 connections.

TXU Communications

In March 2003, we acquired certain telecommunications equipment assets and customers of TXU Communications Ventures for approximately $1.0 million in cash and assumed leasehold obligations. In this transaction we acquired a DMS-500 switch in Round Rock, Texas, a small number of unbundled network element platform lines in Texas, MDU customers in Austin and customers in single dwelling units and MDUs in the Houston area. The acquisition provided us with growth capacity for telephone and Internet traffic in Austin/San Marcos.

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C3 Communications

In March 2003, we acquired the long-haul network assets and customers of C3 Communications and certain of its affiliates for approximately $7.3 million in cash, which provided us with access to 3,000 route miles of fiber optic cable in Texas, Oklahoma, Arkansas and Louisiana. These assets serve as a backbone connecting each of our markets except Midland/Odessa and, along with our metro area networks, constitute the core infrastructure for our provision of broadband transport and network services.

Advantex Communications

In late October 2003, we acquired Advantex Communications for a purchase price (net of cash received) of $26.8 million in cash. Advantex provided bundled services similar to ours to residential and small business customers primarily in suburban northwest Dallas. This acquisition provided us with approximately 30,000 customers and approximately 400 route miles of fiber optic cable in suburban northwest Dallas.

Marketable Homes Passed, Customers, Connections and Market Level Cash Flow

We report marketable homes passed as the number of residential and business units, such as single residence homes, apartments and condominium units, passed by our networks other than those we believe are covered by exclusive arrangements with other providers of competing services. As of December 31, 2004, our networks passed 308,913 marketable homes and we had 126,736 residential, small business and enterprise customers.

Because we deliver multiple services to our customers, we report our total number of connections for telephone, cable television and broadband Internet and other services in addition to our total number of customers. We count each telephone, cable television and broadband Internet and other service purchase as a separate connection. For example, a single customer who purchases cable television, telephone and broadband Internet service would count as three connections. Similarly, a single customer who purchases our broadband Internet service and our wireless security service would count as two connections. We do not record the purchase of long distance telephone service by a local telephone customer or digital cable services by an analog cable customer as additional connections. However, we do record each purchase of an additional telephone line by a local telephone customer as an additional connection. As of December 31, 2004, we had 249,642 connections.

Operating cash flow at the market level reflects revenue, cost of revenue and some expenses that we are able to specifically identify as directly related to the operation of that market. We follow the same approach in allocating cost of revenue at the market level as we do for cost of revenue allocation in general, as described below under the caption “—Costs and Expenses—Cost of Revenues.” In addition, we do not include centralized customer service expenses or corporate general and administrative expenses in determining market level operating cash flow. Because we provide services in all markets and to network service customers using a common network infrastructure, we do not track assets or liabilities at the market level. Our method of determining operating cash flow at the market level may not be comparable to approaches of other companies. Use of a different method of determining operating cash flow at the market level could change the operating cash flow at the market level, but not our overall operating cash flow. Based upon this method of allocating cost of revenue and excluding certain corporate expenses, we believe that each of our markets has achieved positive operating cash flow.

Operating Revenues

We derive our operating revenues primarily from monthly charges for the provision of cable television, telephone and broadband Internet and other services to residential and small business customers and provision of network services and broadband transport services to medium and large enterprises and communications carriers. These services are a single business provided over a unified network. However, since our different products and services generally involve different types of charges and in some cases different methods of recording revenues, we have presented some information on our revenues from each major product line.

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Bundled services revenues—cable television, telephone, broadband Internet and other. We typically provide cable television, telephone and broadband Internet and other services on a bundled basis for fixed monthly fees billed in advance, with the amount of the monthly fee varying significantly depending upon the particular bundle of services provided. We also charge usage-based fees for additional services, such as pay-per-view movies that involve a charge for each viewing and long-distance services that involve charges by the number of minutes of use. We generally bill for these usage-based services monthly in arrears. We generate revenues from one-time charges for the installation of premises equipment. Most of our bundled offerings include fees for equipment rental, although in some instance we sell modems to customers. We also charge monthly or one-time fees for additional services, including advertising. We collect from our cable customers and include in our gross revenues the fees payable to cable franchise authorities, which are usually 5% of our revenues from cable subscriptions. We began offering security services as part of our bundle in June 2004. We sell all wireless security premise equipment to new customers at installation. The security revenue is now included in broadband Internet and other.

Broadband transport services revenues. Our revenues from broadband transport services, which consist of access to our metro area networks and point-to-point circuits on our long-haul network, involve fixed monthly fees billed in advance, where the amount charged varies with the amount of capacity, type of service and whether any customized capacity or services are provided. Our revenues also include non-recurring charges for construction, installation and configuration services, which can range significantly depending upon the customer’s needs.

Network services revenues. Our revenues from network services consist primarily of revenues from switched carrier services and managed modem services. We bill for most of our network services monthly in arrears based on actual usage. However, some network services, particularly our managed modem services, involve fixed monthly charges billed in advance. Some network services include non-recurring fees for installation or other work needed to connect the customer to our networks. There are monthly charges or negotiated fees for other services such as directory assistance, web hosting, database, collocation, technical support and billing services.

Changes in Revenues

MCI Contract. From July 2000 to October 2003, a significant portion of our revenues was generated under a network services contract pursuant to which we provided carrier services to MCI. This contract generated approximately $66.7 million, $73.3 million and $65.0 million, or 70%, 50% and 36%, of our consolidated revenues for the years ended December 31, 2001, 2002 and 2003, respectively. The agreement with MCI was terminated in the fourth quarter of 2003 as part of MCI’s bankruptcy proceedings. MCI emerged from bankruptcy proceedings in April of 2004. We received a settlement from MCI during these proceedings as a result of minimum purchase requirements under this agreement. We recorded approximately $2.5 million of revenue in the second quarter of 2004, which was 1% of 2004 revenues. We do not expect to receive any further revenue from MCI under this agreement.

Costs and Expenses

Cost of Revenues

Cost of revenues includes those expenses that are directly related to the generation of operating revenues and has fixed and variable components. Our network supports all of the products and services that we provide to customers, and due to a common network infrastructure and many of the same resources and personnel being used to generate revenues from the various product and service categories it is difficult to determine cost of revenues by product. Commencing with costs incurred in 2003 we allocate network and related costs among our products based upon the following approach:

We are able to specifically identify the costs related to cable television and security, so no allocation is needed for these products. We allocate each cost that relates to only one of our retail telephone, broadband Internet, broadband transport and network services products entirely to that product. For example, private line

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costs relate entirely to our broadband transport product and are allocated to it. Other costs, such as interconnect costs, generally are allocated among the various benefited products based upon the use of minutes or bandwidth or other appropriate metrics. These allocation formulas are reviewed for appropriateness every six months. Our method of allocating network and related costs among products may not be comparable to approaches of other companies. Use of a different method of allocation could change the cost of revenues and margin associated with each product. Our overall cost of revenues and gross margin is not affected by this allocation method.

Our cost of revenues include the following:

Selling, general and administrative expenses

Our selling, general and administrative expenses include all of the expenses associated with operating and maintaining our networks that are not cost of revenues, primarily payroll and departmental costs incurred for network design, monitoring and maintenance. They also include payroll and departmental costs incurred for

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customer installation and service personnel, for customer service representatives and management and for sales and marketing personnel. Other included items are advertising expenses and promotional expenses, corporate and subsidiary management, administrative costs, professional fees, taxes, insurance and facilities costs.

Depreciation and amortization

Depreciation and amortization expenses include depreciation of our broadband networks and equipment and amortization of costs in excess of net assets and other intangible assets related to acquisitions.

Operating Data

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Results of Operations

The following table sets forth financial data as a percentage of operating revenues for the years ended December 31, 2002, 2003 and 2004.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Operating Revenues. Our operating revenues for 2003 and 2004 were $181.5 million and $179.0 million, respectively, a decrease of $2.5 million, or 1%. This decrease is a result of the loss of the MCI agreement, which $65 million of revenue in 2003. The MCI revenue loss was partially offset by growth in bundled services, broadband transport, and non-MCI network services as well as the acquisition of Advantex. Operating revenues for our cable television services for 2003 and 2004 were $28.3 million and $43.1 million, respectively, an increase of $14.8 million, or 52%. Operating revenues for our telephone services for 2003 and 2004 were $27.9 million and $54.6 million, respectively, an increase of $26.7 million, or 96%. Operating revenues for our broadband Internet and other services for 2003 and 2004 were $10.5 million and $19.8 million, respectively, an increase of $9.3 million, or 89%. The increased revenues for cable television, telephone and broadband Internet are primarily due to growth in the number of connections, from 207,593 as of December 31, 2003 to 249,642 as of December 31, 2004, the effect of a full year of revenue from Advantex customers and, to a much lesser extent, from rate increases. The additional connections and revenues resulted primarily from the continued construction of our broadband networks, continued penetration growth of marketable homes in our markets and from our acquisition of Advantex. Our acquisition of Advantex was completed in October 2003 and added approximately 58,000 connections.

Operating revenues for our broadband transport services increased from $8.2 million in 2003 to $10.1 million in 2004 primarily due to the acquisition of C3 in March 2003 and new customer growth. Operating revenues for 2003 and 2004 from network services were $106.6 million and $51.4 million, respectively, a

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decrease of $55.2 million, or 52%. This decrease is due to a loss of revenue generated from our agreement with MCI, which terminated in the fourth quarter of 2003. Included in revenue for 2004 is $2.5 million related to the second quarter settlement of the MCI agreement. We do not expect to receive any further revenue from MCI under that agreement. See “— Changes in Revenues” and “—Critical Accounting Policies and Estimates—Revenue Recognition.”

Cost of Revenues. Our cost of revenues for 2003 and 2004 were $81.9 million and $66.8 million, respectively, a decrease of $15.1 million, or 18%. The decrease in our cost of revenues is primarily due to the decline in revenues from network services, partially offset by the growth of costs related to increased connections in our bundled services offerings. Cost of revenues decreased as a percentage of revenues from 45% in 2003 to 37% in 2004, reflecting the increasing percentage of our total revenues derived from our bundled service offerings. Cost of revenues associated with our cable television, telephone, broadband Internet and other services generally are significantly lower as a percentage of revenues than those associated with network services.

Our gross margin for 2004 for our bundled cable television, telephone and broadband Internet and other services was 73%, compared with 68% for 2003. The increase is due primarily to a change in the mix of connections, as we added more telephone and broadband Internet and other service connections versus cable television connections. Both telephone and broadband Internet and other service products carry a somewhat higher gross margin than the cable television product because of the programming costs associated with cable television. For broadband transport services, our gross margin for 2004 was 83%, compared with 75% for 2003. This increase is due to increased usage of excess capacity on the fixed cost portions of our network. For network services, our gross margin for 2004 was 36%, compared with 45% for 2003. In the fourth quarter of 2003 our contract with MCI was terminated. The resulting loss of traffic left us with excess capacity on the network as well as changing the mix of services provided, both of which decreased network services gross margin. Without the effect of the MCI settlement, network services gross margin for 2004 was 33%.

We expect that our overall gross margin will continue to rise as the percentage of revenues derived from our cable television, telephone, broadband Internet and other services and our broadband transport services, which are higher-margin services, increases in accordance with our business plan. Our gross margins are determined based on an allocation of cost of revenues among our products. Our method of allocating costs and therefore, of computing margin, may not be comparable to approaches of other companies. Use of a different method of allocation could change the margin associated with each product, although the overall gross margin would not be affected.

Selling, General and Administrative Expense. Our selling, general and administrative expense for 2003 and 2004 was $82.1 million and $93.5 million, respectively, an increase of $11.4 million, or 14%. The increase is primarily due to the expenses associated with the operations acquired from Advantex in October 2003. Selling, general and administrative expense increased as a percentage of revenues to 52% primarily as a result of the Advantex acquisition. We expect our selling, general and administrative expense to increase as a result of the growth of our business and customer base, and decrease over time as a percentage of revenue.

Depreciation and Amortization Expense. Our depreciation and amortization expense for 2003 and 2004 was $52.0 million and $57.3 million, respectively, an increase of $5.3 million, or 10%. The increase is principally due to increased depreciation due to the expansion of our constructed and acquired network. Additionally, $2.3 million of the depreciation expense increase is due to a recalculation of inception to date accumulated depreciation in the fourth quarter of 2004. We expect depreciation and amortization expense to continue to increase as we make additional capital expenditures to construct and expand our networks in our existing markets.

Interest Expense. For 2003 and 2004, our interest expense, which includes interest incurred net of capitalized interest, was $2.9 million and $15.2 million, respectively. Our interest expense increased as a result of interest accrued related to the senior secured notes issued in March of 2004. For 2003 and 2004, we had capitalized interest of $2.2 million and $2.9 million, respectively.

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Write-Off Due to Repayment of Credit Facility. During 2004, we completed a private placement of our senior notes. Concurrent with this offering we repaid $64.8 million to extinguish our senior credit facility. We wrote off debt issuance costs of approximately $2.1 million associated with this repayment.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Operating Revenues. Our operating revenues were $181.5 million in 2003, compared with $147.4 million in 2002, an increase of $34.1 million, or 23%. Operating revenues for our cable television services were $28.3 million in 2003, as compared with $13.2 million in 2002, an increase of $15.1 million, or 115%. Operating revenues for our telephone services were $27.9 million in 2003, as compared with $10.0 million in 2002, an increase of $17.9 million, or 179%. Operating revenues for our broadband Internet services were $10.5 million in 2003, as compared with $3.8 million in 2002, an increase of $6.7 million, or 173%. The increased revenues for cable television, telephone and broadband Internet are primarily due to growth in the number of connections, from 102,228 as of December 31, 2002 to 207,593 as of December 31, 2003 and to a much lesser extent from rate increases. The additional connections resulted primarily from the continued construction of our broadband networks and penetration of marketable homes in our markets and from our acquisitions of ClearSource, TXU and Advantex. Our acquisition of ClearSource was completed in June 2002 and added approximately 51,000 connections. Our acquisition of TXU was completed in March 2003 and added approximately 5,000 connections. Our acquisition of Advantex was completed in October 2003 and added approximately 58,000 connections.

Operating revenues for our broadband transport services were $8.2 million in 2003, as compared with $8.1 million in 2002. This is principally due to our acquisition of C3 Communications in March 2003, but was offset by a reduction in relevant construction services in 2003. The increase in operating revenues from cable television, telephone, broadband Internet and broadband transport services was partially offset by a decline in the revenues from network services, which were $106.6 million in 2003, as compared with $112.0 million in 2002, a decrease of $5.4 million, or 5%. The decrease is primarily from a decline in the revenues generated from our agreement with MCI, which generated approximately $73.3 million in 2002 and approximately $65.0 million in 2003. We do not expect to receive any further revenue from MCI under that agreement, other than the amounts payable in the settlement with MCI when MCI emerges from bankruptcy. See “—Critical Accounting Policies and Estimates—Revenue Recognition.”

Cost of Revenues. Our cost of revenues were $81.9 million in 2003, compared with $79.4 million in 2002, an increase of $2.5 million, or 3%. The increase in our cost of revenues also results from the increase in connections due to internal growth and acquisitions, and we expect our cost of revenues to continue to increase as we add more connections. Cost of revenues decreased as a percentage of revenues from 54% to 45%, reflecting the increasing percentage of our total revenues derived from our bundled service offerings. Cost of revenues associated with our cable television, telephone and broadband Internet services generally are significantly lower as a percentage of revenues than those associated with our carrier, data and other network services, which we believe is due to the greater number of competitor networks over which network services can be provided.

Our gross margin for 2003 for our bundled cable television, telephone and broadband Internet services was 68%. For broadband transport services, our gross margin for 2003 was 75%, and for network services, our gross margin for 2003 was 45%. We expect that our overall gross margin will rise as the percentage of revenues derived from our cable television, telephone and broadband Internet services and our broadband transport services, which are higher-margin services, increases in accordance with our business plan. Our margins are determined based on allocation of cost of revenues among our products, as discussed above. Our method of allocating costs and therefore, of computing margin, may not be comparable to approaches of other companies. Use of a different method of allocation could change the margin associated with each product, although the overall gross margin would not be affected. We began using a different allocation method in 2003 and our gross margins for each of our products in 2002 and before are not comparable to those of 2003 and accordingly are not being reported.

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Selling, General and Administrative Expense. Our selling, general and administrative expense was $82.1 million in 2003, compared with $63.7 million in 2002, an increase of $18.4 million, or 29%. The increase is primarily due to a full year in 2003 of expenses associated with the increase in the number of employees as a result of the ClearSource acquisition in June 2002, and to a lesser extent the acquisition of Advantex in October 2003. Selling, general and administrative expense increased slightly as a percentage of revenues to 45%. We expect our selling, general and administrative expense to increase as a result of the growth of our business and customer base and our acquisition of Advantex.

Depreciation and Amortization Expense. Our depreciation and amortization expense was $52.0 million in 2003, compared with $33.3 million in 2002, an increase of $18.7 million, or 56%. The increase is principally due to depreciation expense with respect to continued expansion of our broadband networks. We expect depreciation and amortization expense to continue to increase as we make additional capital expenditures to construct and expand our networks in our existing markets.

Interest Expense. In 2003, our interest expense, which includes interest payments net of capitalized interest, was $2.9 million, compared with interest expense of $0 in 2002. Our interest expense increased as a result of borrowings in 2003 under our then-existing senior credit facility. We had capitalized interest of $2.2 million in 2003 and $2.6 million in 2002.

EBITDA/Adjusted EBITDA

We measure our operating performance on net income (loss) before interest income, interest expense, taxes, depreciation and amortization, referred to as “EBITDA.” EBITDA is not a measure of financial performance under generally accepted accounting principles. We believe EBITDA is often a useful measure of a company’s operating performance, and is a significant basis used by our management to measure the operating performance of our business.

Because we have funded the build-out of our networks by raising and expending large amounts of capital, our results of operations reflect significant charges for depreciation, amortization, and interest expense, EBITDA, which excludes this information, provides helpful information about the operating performance of our business, apart from the expenses associated with our physical plant or capital structure. We try to make each area of our business generate positive EBITDA, and when we have choices about the market or area in which to best deploy our resources we generally direct our resources towards the network construction that is expected to generate the most EBITDA. EBITDA is frequently used as a basis comparing businesses in our industry, although our measure of EBITDA may not be comparable to similarly titled measures of other companies. EBITDA does not purport to represent operating loss or cash flow from operating activities, as those terms are defined under generally accepted accounting principles, and should not be considered as an alternative to those measurements as an indicator of our performance. In the first quarter of 2004, we wrote off debt issuance costs of approximately $2.1 million associated with the repayment of our senior credit facility following the completion of our senior notes offering. We believe this expense is analogous to amortization and interest expense, and therefore we believe it is more useful to show EBITDA net of this one-time amount because we believe it is a better measure of our operating performance and is more comparable to prior periods. However, because of the nature of the charge, we are referring to our EBITDA in 2004 net of the charge as “Adjusted EBITDA.”

Adjusted EBITDA was $4.8 million, $17.6 million and $19.0 million for 2002, 2003 and 2004, respectively. The increase is primarily due to addition of new customers, added both through acquisitions and the build-out of our networks over such periods.

Since a significant portion of our cost of revenues and overhead expenses are generally fixed in nature, increasing revenue should result in further increases in EBITDA/Adjusted EBITDA and in EBITDA/Adjusted EBITDA as a percentage of revenues. To the extent the increased revenues are from adding residential and small business customers for our bundled services, which have higher margins than network services, EBITDA/Adjusted EBITDA should increase more quickly on a percentage basis.

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The reconciliation of EBITDA/Adjusted EBITDA to net loss is as follows:

Liquidity and Capital Resources

Sources and Uses of Funds

Since inception, we have raised an aggregate of $338 million in equity funding from institutional private equity investors and others to pursue our business plan. As a result of such stock issuances and the ClearSource merger, we have a total of $508 million of total invested equity capital. Funds raised have been used to construct our networks, to make acquisitions, to launch services in our new markets and for working capital and operating expenses.

On March 23, 2004, we issued $136.0 million principal amount at maturity of senior secured notes with fixed interest payable at a rate of 14% per annum. We refer to these notes as the outstanding notes. Interest on the senior notes is payable semi-annually each April 1 and October 1 beginning October 1, 2004. We used a portion of the net proceeds from the issuance of the senior notes to repay all amounts outstanding under our then-existing senior credit facility. The senior credit facility was terminated upon repayment and we are not able to borrow any further amounts thereunder. In connection with the payment and termination of the senior credit facility, we recorded $2.1 million of debt extinguishment expenses, including accelerated amortization of debt issuance costs and other expenses of $1.5 million.

We conducted the offering of the senior notes in order to accelerate the build-out of our networks and to improve our liquidity position. Accelerating the build-out is expected to result in increased revenues and EBITDA/Adjusted EBITDA over the near term. We have the ability to accelerate or postpone construction of extensions to our networks depending upon future cash availability, subject only to the need to eventually complete the build-out of our networks in accordance with the requirements of our franchise agreements.

At December 31, 2004, we had total cash and cash equivalents of $41.2 million, short-term investments of $20 million and $142.2 million of long-term debt outstanding.

Provided that we meet the revenue, expense and cash flow projections in our current business plan, we expect that with existing cash on hand and cash flow from operations, we will be fully funded to build-out our networks to pass all 1.4 million franchised marketable homes and small businesses in our existing markets over the next several years. Our business plan is based on estimates regarding expected future costs and expected revenues. Our costs may exceed or our revenues may fall short of our estimates, our estimates may change, and future developments may affect our estimates. Any of these factors may increase our need for funds to complete construction in our markets, which would require us to seek additional financing.

We may seek additional financing to undertake initiatives not contemplated by our business plan or obtain additional cushion against possible shortfalls. We also may pursue additional financing as opportunities arise. Future financings may include a range of different sizes or types of financing, including the sale of additional debt or equity securities. However, we may not be able to raise additional funds on favorable terms or at all. Our

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ability to obtain additional financing depends on several factors, including future market conditions; our success or lack of success in penetrating our markets; our future creditworthiness; and restrictions contained in agreements with our investors or lenders, including the restrictions contained in the indenture governing the senior notes. These financings could increase our level of indebtedness or result in dilution to our equity holders.

Cash Flows from Operating Activities

Our net cash provided by (used in) operating activities for 2002, 2003 and 2004 was $(2.9) million, $18.9 million and $9.2 million, respectively. Overall, the decrease in cash flow is primarily due to the loss of the MCI contract, as well as the cash used to satisfy the related working capital liabilities associated with providing service under that contract. On December 31, 2004, we had a $4.8 million balance in accrued liabilities related to the accrued interest of our senior secured notes, which will be paid on April 1, 2005.

Cash Flows from Investing Activities

Our net cash used in investing activities for 2002, 2003 and 2004 was $40.6 million, $78.5 million and $71.2 million, respectively. These net cash outflows are primarily due to the build-out of our network, as well as the acquisitions of assets from TXU and C3 Communications in March 2003 and Advantex in October 2003. Additionally, we invested $20 million in short-term securities in 2004, which our indenture includes in the definition of cash and cash equivalents.

Cash Flows from Financing Activities

Our net cash provided by financing activities for 2002, 2003 and 2004 was $49.4 million, $82.1 million and $61.0 million, respectively. Cash flows from financing activities in 2003 consisted primarily of borrowings on our senior credit facility. We paid the outstanding amount of $64.8 million on our senior credit facility with a portion of the net proceeds of $123.8 million received from our 14% Senior Secured Notes offering in March of 2004.

Capital Expenditures

We spent approximately $45.0 million, $46.3 million and $50.8 million in capital expenditures, including capitalized interest, but excluding assets acquired under capital leases, during 2002, 2003 and 2004, respectively. The indenture governing our outstanding senior notes prohibits us from exceeding $50.0 million of capital expenditures, defined to exclude capitalized interest and include assets under capital lease, except for the capital lease on our headquarters, in 2004. Our capital expenditures, as defined in our indenture, were $48.5 million for 2004, which is $1.5 less than the covenant of $50 million. This $50.0 million cap on our capital expenditures only applied to us during the fiscal year ended December 31, 2004, and therefore we no longer are subject to this covenant. Now that the $50.0 million cap no longer applies, the indenture governing the notes only prohibits us from making capital expenditures when the aggregate amount of the cash and cash equivalents held by us (after giving effect to such planned capital expenditure) would be less than $20 million. The capital expenditures amounts described above relate to network construction, installation costs, the purchase of customer premise equipment, such as cable set-top boxes and cable modems, and corporate and network equipment, such as switching and transport equipment, and billing and information systems.

Contractual Obligations and Commercial Commitments

We are obligated to make payments under a variety of contracts and other commercial arrangements, including the following:

Capital Leases. We lease office and facilities space under leasing arrangements. We also have certain immaterial capital leases for office equipment.

Operating Leases. We lease office space, vehicles and other assets for varying periods. Leases that expire are generally expected to be renewed or replaced by other leases.

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Maintenance Agreements. We have numerous agreements for the maintenance of leased fiber optic capacity.

Purchase Agreements. We may be required to purchase a minimum of $42.7 million of equipment from some of our suppliers between January 2005 and December 2010. We entered into these agreements based upon estimates of equipment we expect to need over this six-year period. The majority of these purchase commitments are contingent upon delivery of technical and functional next generation requirements. If we do not actually need the estimated amount and type of equipment, our financial condition could be adversely affected because we would be obligated to spend money on equipment we do not need, rather than applying it to help grow and develop our business.

The following table represents our contractual obligations as of December 31, 2004, and therefore does not include payments subsequent to December 31, 2004: