UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
_____________________
FORM
10-K
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the
fiscal year ended December 31, 2005
Commission
File No. 000-26728
TALK
AMERICA HOLDINGS, INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
|
23-2827736
|
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
|
incorporation
or organization)
|
Identification
Number)
|
|
6805
Route 202
|
18938
|
|
New
Hope, PA
|
(zip
code)
|
|
(Address
of principal executive offices)
|
(215)
862-1500
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
|
Title
of each class
|
Name
of each exchange on which registered
|
|
None
|
Not
applicable
|
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, Par Value $.01 Per Share
Rights
to Purchase Series A Junior Participating Preferred Stock
(Title
of class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
Yes
[ ]
No [ X]
Indicate
by check mark if the registrant is not required to file reports pursuant
to
section 13 or Section 15(d) of the Act.
Yes
[ ]
No [ X]
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
of this
Form 10-K. [X]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer [ ] Accelerated
filer [ X ] Non-accelerated
filer [ ]
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
Yes
[ ]
No [ X]
As
of
June 30, 2005, the aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the average of the high and low
prices of the common stock on June 30, 2005 of $10.04 per share as reported
on
the Nasdaq National Market, was approximately $277,788,698 (calculated by
excluding solely for purposes of this form outstanding shares owned by directors
and executive officers).
As
of
March 1, 2006, the registrant had issued and outstanding 30,396,192
shares
of common stock, par value $.01 per share.
DOCUMENTS
INCORPORATED BY REFERENCE
None.
ITEMS
OMITTED PURSUANT TO RULE 12b-25
Item
6,
Item 7, Item 8, Item 9A, Item 15 - Financial Statement Schedules and Exhibits
23, 31 and 32.
TALK
AMERICA HOLDINGS, INC. AND SUBSIDIARIES
INDEX
TO FORM 10-K
FOR
THE YEAR ENDED DECEMBER 31, 2005
|
ITEM
NO.
|
PAGE
NO.
|
|
PART
I
|
|
|
1.
Business.
|
2 |
|
1A.
Risk Factors
|
33 |
|
1B. Unresolved
Staff Comments
|
41 |
|
2. Properties
|
42 |
|
3.
Legal Proceedings
|
42 |
|
4.
Submission of Matters to a Vote of Security Holders
|
42 |
|
PART
II
|
|
|
5.
Market for Registrant's Common Equity, Related Stockholder Matters
and
Issuer Purchases
of Equity Securities
|
44 |
|
9.
Changes in and Disagreements with Accountants on Accounting and
Financial
Disclosure
|
44 |
|
9B. Other
Information
|
44 |
| PART III | 45 |
|
PART
IV
|
|
|
15. Exhibits
|
45 |
Unless
the context otherwise requires, references to "us," "we," and "our" or to
"Talk
America" refer to Talk America Holdings, Inc. and its subsidiaries.
1
PART
I
Cautionary
Note Concerning Forward-Looking Statements
Certain
of
the statements contained in this Form 10-K Report may be considered
"forward-looking statements" for purposes of the securities laws. From time
to
time, oral or written forward-looking statements may also be included in
other
materials released to the public. These forward-looking statements are intended
to provide our management’s current expectations or plans for our future
operating and financial performance, based on our current expectations and
assumptions currently believed to be valid. For these statements, we claim
protection of the safe harbor for forward-looking statements provided by
the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements can be identified by the use of forward-looking words or phrases,
including, but not limited to, "believes," "estimates," "expects," "expected,"
"anticipates," "anticipated," "plans," "strategy," "target," "prospects"
and
other words of similar meaning in connection with a discussion of future
operating or financial performance. Although we believe that the expectations
reflected in such forward-looking statements are reasonable, there can be
no
assurance that such expectations will prove to have been correct.
All
forward-looking statements involve risks and uncertainties that may cause
our
actual results to differ materially from those expressed or implied in the
forward-looking statements. This Form 10-K Report includes important information
as to risk factors in the "Risk Factors" section and in the "Business" section
under the headings “Business Strategies,” "Business Operations," "Competition"
and "Regulation" and in "Management’s Discussion and Analysis of Financial
Condition and Results of Operations." In addition to those factors discussed
in
this Form 10-K Report, you should see our other reports on Forms 10-K, 10-Q
and
8-K subsequently filed with the Securities and Exchange Commission from time
to
time for information identifying factors that may cause actual results to
differ
materially from those expressed or implied in the forward-looking
statements.
Overview
Talk
America Holdings, Inc., through its subsidiaries, is a leading competitive
communications services provider offering integrated voice and data services,
including local, long distance, enhanced voice features and dedicated Internet
access services, to commercial (primarily small and medium-sized business)
and
residential customers. We are focused on markets where we have our own
networking assets. Today, we are collocated in 313 end offices in Michigan,
Ohio, Kentucky, Tennessee, North Carolina, Louisiana, Mississippi, Alabama,
Florida and Georgia. As of December 31, 2005, including the lines of Network
Telephone Corporation, which we acquired on January 3, 2006, we had
approximately 745,000 local voice and data equivalent lines, of which
approximately 466,000 were on our own network. The balance of our customers
are“off-net”
(that is, our services over another carrier’s networking facilities) and
represent a large, profitable base of bundled phone service customers that
we
service using the wholesale operating platforms of the incumbent local exchange
companies.
We
expanded into the commercial business market with the acquisition in July
2005
of LDMI Telecommunications, Inc. (“LDMI”), a privately held facilities-based
competitive local exchange provider serving business and residential customers
primarily in Michigan and Ohio. On January 3, 2006, we further significantly
expanded our network and commercial business through our acquisition of Network
Telephone Corporation (“NTC”), a privately held facilities based competitive
local exchange provider serving commercial customers in the Southeast. During
2005, we also completed the construction of our network in Michigan, integrated
this network with LDMI’s network assets and migrated over 200,000 lines from the
incumbent local exchange company wholesale platform to our network.
2
Our
business strategy is to continue to expand our network and grow our “on-net”
(that is, our services over our own networking facilities) customer and revenue
base through (i) organic growth in our core markets, serving both commercial
and
residential customers; (ii) additional acquisitions that either supplement
our
existing markets or offer expansion into new markets; and (iii) enhancement
of
our product portfolio. Growth in our business, both commercial and residential,
on our network will permit us to leverage our investment in our network
facilities due to the complementary telecommunication traffic or usage patterns
of these customer bases.
We
have
developed our own proprietary integrated order processing, provisioning,
leads
management, billing, payment, collection, customer service and information
systems that enable us to provide high-quality service to our customers.
We have
automated the business processes required to migrate our customers off the
incumbent local exchange company platform to our local network. To promote
our
services and to generate new sales, we use both our internal and partner
sales
forces and we use our own sales and customer service centers. We focus on
providing consumers value through competitively priced plans designed to
fit
their particular telecommunication needs, broad feature selections, consolidated
billing and customer service.
Talk
America Inc. (formerly, Talk.com Holding Corp. and Tel-Save, Inc.), our
predecessor and now our principal operating subsidiary, was incorporated
in
Pennsylvania in May 1989 as a provider of long distance phone service. We
were
incorporated in June 1995. In 2000, we decided to expand beyond our historical
long distance service offerings and utilize the unbundled network element
platform to enter the large local telecommunications market and diversify
our
product portfolio through the bundling of local service with our core long
distance service offerings. The address of our principal executive offices
is
6805 Route 202, New Hope, Pennsylvania 18938 and our telephone number is
(215)
862-1500. Our
web
address is www.talkamerica.com.
We make
available free of charge on our website, www.talkamerica.com, our annual
report
on Form 10-K, our quarterly reports on Form 10-Q, our current reports on
Form
8-K, and amendments to our reports filed or furnished pursuant to Section
13(a)
or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably
practicable after we file such material with, or furnish it to, the Securities
and Exchange Commission.
3
OUR
SERVICES AND PRODUCTS
We
provide our commercial and residential customers with a variety of bundled
phone
service packages, stand-alone long distance services, data and Internet access
products and a broad range of business communication services.
Commercial
Services and Products
We
provide our business customers a wide range of voice, data and advanced services
designed to meet their needs. Our SmarT product, which utilizes a single
connection to deliver both integrated voice service and high-speed data service,
is our primary commercial product for new sales; our primary competitor,
AT&T, does not offer an equivalent service. In 2006, we will continue to
develop new commercial products to expand our portfolio, while introducing
existing products and services into markets that were previously not serviced.
Voice
Services. Our
commercial voice service offerings allow our business customers to build
the
calling plan that best suits their organization's needs. We offer basic dial
tone service and vertical features, such as call forwarding, line hunting
and
voicemail. We also offer domestic and international long distance services,
both
bundled with local voice services and on a stand-alone basis. These voice
services are available with unlimited local and long distance calls or calls
billed on a per-minute basis, depending upon calling patterns and the needs
of
the business.
Data
Services. Our
commercial data service offerings are designed to provide our customers with
a
full range of data services. We offer high-speed data transmission services
with
data connection speeds as high as 6.0 megabytes per second, or Mbps. We also
offer high-speed data transmission services that are integrated with a voice
product and delivered simultaneously over the same connection. In addition,
we
are
one of only four companies in the United States certified as an ANX (Advanced
Network Exchange) Service Provider, which allows us to supply data services
to
certain types of enterprises, such as Ford, Dow Chemical, General Motors,
Delphi, and Visteon.
Advanced
Services.
We offer
business customers several advanced services to assist them with their data
and
business needs, including: (i) data hosting services (shared, dedicated and
collocated), (ii) managed security services (firewall, virtual private
networking, anti-virus/SPAM, vulnerability assessment and compliance reporting),
and (iii) professional services management (technical project management,
wide
and local area network, or WAN/LAN, design and development, technical assessment
and maintenance).
Residential
Services and Products
We
provide residential customers with a wide-range of voice calling plans and,
beginning with our deployment of networking assets in Michigan in 2005, data
services.
Voice
Services.
We offer
our residential customers the flexibility to create their own phone service
package, including local phone service, long distance phone service or a
combination thereof. We offer several different local and long distance calling
plans tailored to the customer’s calling needs. Our local phone service
customers receive free “member-to-member” calling and may add additional
features and services to their service, including enhanced domestic and
international calling plans, caller identification and voicemail.
Data
Services. Customers
who receive our local phone service may also purchase data services from
us. We
offer both digital subscriber line services (DSL) and dial-up access services.
Our DSL service, which utilizes ADSL2+ technology, is available to customers
on
our local network whose wiring permits it. This service provides access speeds
of up to 4.0 Mbps download speed and enables us to offer download speeds
of up
to 8.0 Mbps. We offer a standard and accelerated dial-up access service to
all
of our phone service customers. The accelerated dial-up services utilize
compression, caching and other technologies that reduce the time for certain
web
pages to download to users' computers when compared to standard dial-up access
services.
4
NETWORK
OPERATIONS
How
We Provide Local Voice and Data Services
Overview
We
offer
telecommunications services to commercial (small and medium size businesses)
and
residential customers in our markets through either the use of our own network
facilities and the unbundled network element loops or T-1 circuits of the
incumbent local exchange carriers, or, through wholesale agreements with
carriers.
In
2003,
we began deploying networking assets in Michigan. At
the
end of 2004, we had approximately 25,000 local voice equivalent lines on
our own
network in 8 end offices in Michigan.
In July
2005, in an effort to both expand our networking footprint and accelerate
our
market entry into the business communication services segment, we acquired
LDMI,
a
facilities-based communications provider in
Michigan
and Ohio. The deployment of our own networking assets, along with the
acquisition of LDMI, enabled us to migrate more than 200,000 local voice
equivalent lines to our own network in 2005 and end the year with 341,000
local
voice and data equivalent lines on our own network in 151 end offices in
Michigan and Ohio. In January 2006, we acquired NTC, a facilities-based
communications provider in the Southeast United States. The acquisition of
NTC added 156 more end offices in 8 states throughout the Southeast and
125,000 local voice and data equivalent lines on our network. Subsequent
to the end of the year we have opened 6 additional end offices in the Southeast
United States. Prior to construction of our network, we delivered our
services exclusively through the use of the unbundled network element platforms
of the incumbent local exchange companies. The following map details our
local
networking assets as of March 1, 2006:
As
a
result of these acquisitions, we have expanded into the commercial market
and
now provide a full suite of voice and data offerings, including specialized
services such as hosted applications and security services in these areas
to
small and medium-sized business customers. In addition to adding significantly
to our commercial services capabilities, these transactions provide residential
growth opportunities in our networking markets while allowing us to realize
capital expenditure savings and operating synergies.
5
Composition
of Our Network
Our
local
network is comprised of equipment and facilities that are either owned or
leased
by us and certain telecommunication services for which we contract with a
variety of other carriers. We maintain certain pieces of equipment that are
collocated in end office sites owned or leased by AT&T (formerly SBC), the
incumbent local exchange company in Michigan and Ohio, and by BellSouth,
the
incumbent local exchange company throughout the Southeast United States.
The
incumbent local exchange companies provide us with access to these end offices
through both our interconnection agreements with the incumbent local exchange
company or through state and/or federal regulations that require the incumbent
local exchange companies to provide us access to certain elements. Such access,
however, may be conditioned upon our paying charges for upgrading the power
supply or physical layout of the end office.
In
order
to provide a customer with voice and data service on our local network delivered
via a copper loop, we must first submit an order with the incumbent local
exchange company to move, or “hot cut,” the customer’s existing copper loop. The
loop is the copper telephone line that connects the customer’s premises to the
incumbent local exchange company’s switch. We hot cut transfer the customer’s
loop from the incumbent local exchange company’s switch to our loop carrier
equipment in the end office at the incumbent local exchange company’s end office
assigned to that customer.
Upon
confirmation that the customer line has been switched to either our digital
loop
carrier and digital subscriber line access multiplexer equipment or our
broadband loop carrier equipment, we update numerous external databases,
including E911 databases, which, as the customer’s local phone provider, we are
required to timely and accurately update.
Once
the
loop is cut over to our network, we switch local voice traffic between the
customer’s premises and the public switched telephone network using either
circuit switch-based or packet switch-based technology, depending upon the
location of the customer and how our network is deployed in that geographic
area.
Like
many
networks today, most of our network carries local voice traffic via a circuit
switch-based network. Circuit switch-based systems establish a dedicated
channel
for each telecommunication signal (such as a telephone call for voice or
fax),
maintain the channel for the duration of the call, and disconnect the channel
at
the conclusion of the call. The balance of our network utilizes packet
switch-based systems, a newer technology that we began introducing in 2005.
Under packet switch-based systems, the information to be transmitted is
formatted into a series of shorter digital messages called “packets”. In
addition to supporting data, packet switch-based systems have been used for
long
haul voice traffic and is now being deployed to support local phone service.
Each packet consists of a portion of the complete message plus the addressing
information to identify the destination and return address. A key feature
that
distinguishes Internet architecture from the public telephone network is
that on
the packet-switched Internet, a single dedicated channel between
telecommunication points is not required. Packet switch-based systems may
offer
several advantages over circuit switch-based systems, particularly the ability
to commingle packets from several telecommunications sources together
simultaneously onto a single channel. For most telecommunications, particularly
those with bursts of information followed by periods of “silence,” the ability
to commingle packets provides for superior network utilization and efficiency,
resulting in more information being transmitted through a given
telecommunication channel. We believe that, in the future, most new networks
will be based on packet switching to take advantage of transport efficiencies,
more open standards for interoperability, lower capital costs and easier
deployment and maintenance.
6
In
Grand
Rapids, Michigan and Atlanta, Georgia, we have deployed a newly developed
soft-switch technology. The soft-switch is a distributed computer system
that
performs the same functions as a circuit switch. It can support both circuit
and
packet-switched communications. We use this technology to complement and
relieve
traffic from our Lucent 5ESS-2000 circuit switches. Soft-switch technology
is
currently being used by very few residential phone providers and, to our
knowledge, has not been used on this scale. We expect however, that, if
successful, the soft-switched technology will enable us to enter into more
markets because of the lower cost of the soft-switch technology compared
to the
cost of traditional circuit switch technology.
We
continue to actively explore other new networking technology opportunities
with
a variety of vendors in order to decrease our cost of delivering service,
reduce
our reliance upon the incumbent local exchange companies and provide local
telephone services through new, innovative methods of delivery.
Internet
Access Services
We
offer
SDSL, ADSL2+, and T1 Internet access to customers who are on our local network.
These services are provided through either broadband loop carrier equipment
or
digital loop carrier equipment and digital subscriber line (or DSL) access
multiplexer equipment. We are dependent upon a small number of vendors to
provide us with this equipment and failure to attain the equipment in a timely
manner will affect our ability to offer these services. Some of our network
customers will not be able to receive ADSL service due to line conditions,
the
presence of a fiber-optic cable connection to their premises and other
limitations of the incumbent local exchange company’s line facilities and
customer premises wiring. We utilize a third party vendor to supply modems
to
our ADSL customers to enable them to establish an ADSL connection at their
premises. Commercial customers receive their modems and routers via our
installation and activation process, which includes a technician visit to
install, test and verify service delivery to each business customer.
We
also
offer dial-up Internet access service, whether or not such customer is on
our
local network. The service is provided through a third party vendor, who
also
hosts the email service for both our dial-up and ADSL services.
Collocation
Equipment
Each
collocation at an incumbent local exchange company’s end office facility
contains a standard configuration of equipment, including DSL and DS-1
aggregation equipment, Internet protocol (or IP) and ATM routing equipment
and
facility interface equipment to connect to each carrier we are collocated
with.
The collocations generally use a DS3 uplink transport to link the collocation
to
the backbone of our network. These DS3 interconnects carry voice, data and
in-band management traffic. Each collocation is also outfitted with remote
access terminal equipment in order to assess and diagnose any collocation
network anomalies and provide remote repair whenever possible.
Our
Atlanta, Georgia and Michigan collocations have recently been augmented with
the
broadband loop carrier technology offering IP-based connectivity for ADSL2+
and
IP controlled voice services over the same copper loop. We also have TDM
transport equipment to provide multiplexing and fiber interfaces in the more
heavily populated collocations.
7
Transport
The
Michigan and Ohio customer lines in each collocated end office are aggregated
and connected to our Lucent 5ESS-2000 switches, using DS3 or higher capacity
transmission equipment that we lease primarily from AT&T, the incumbent
local exchange company, supplemented by leases with competitive access
providers. The Southeast customer lines in each end office are aggregated
and
connected to our Lucent 5ESS-2000 switch located in Atlanta, Georgia, and
Distinctive Remote Modules in 12 other Southeast locations, using DS3 or
higher
capacity transmission equipment that we lease primarily from BellSouth, the
incumbent local exchange company, supplemented by leases with competitive
access
providers. This transmission is referred to as transport. As we expand our
local
switching capacity during 2006, these dedicated transport facilities, dark
fiber
(otherwise unused fiber optic cable that is leased by us for transport),
and
entrance facilities may, under the FCC’s rules, be unavailable to us on an
unbundled basis at cost-based rates along certain routes. This may adversely
impact us where our own switching facilities have been deployed and could
substantially impede our plans to deploy additional network facilities. We
could
be forced to use other means to effect this deployment, including the use
of
facilities purchased from the incumbent local exchange carrier at higher
tariffed special access rates or transport services purchased from other
competitive access providers. In either event, our cost of service
could rise dramatically and our plans for a service roll-out using our own
network facilities could be delayed substantially or derailed entirely.
Our
Lucent 5ESS-2000 switches are generally considered extremely reliable and
feature the Digital Networking Unit-SONET technology. The Digital Networking
Unit is a switching interface that is designed to increase the reliability
of
these switches and to provide much greater capacity in a significantly smaller
footprint. We deliver the line side services to our customers through a packet
gateway that converts the traditional voice services to packet-based services
in
order to integrate voice and data on to a single customer loop. This loop
is
terminated to a customer router that delivers analog voice and packet-based
data
to each customer premises. Our switches are connected to other carriers in
the
public switched telephone network through circuit trunking equipment. We
lease
the circuit trunking equipment primarily from the incumbent local exchange
companies. If the incumbent local exchange companies are no longer required
to
provide this circuit trunking equipment or to provide it at Total
Element Long Run Incremental Cost, or
TELRIC,
based rates, we will be forced to acquire this trunking equipment at higher
rates from either a competitive access provider, if available, or, if they
are
willing to lease the trunking equipment to us, from the incumbent local exchange
company. The equipment that comprises this physical layer of our network
can
support both voice and data communications technologies.
How
We Provide Our Long Distance Phone Services
Our
long
distance network is comprised of equipment and facilities that are either
owned
or leased by us. We contract for certain telecommunication services with
a
variety of other carriers. We own, operate and maintain three Lucent 5ESS-2000
switches in our long distance network, which feature the Digital Networking
Unit-SONET technology. The switches are connected to each other by connection
lines and digital cross-connect equipment that we own or lease. We also have
installed lines to connect our long distance switches to switches owned by
various local telecommunication service carriers. We are responsible for
maintaining these lines and have entered into a contract with a third party
vendor with respect to the monitoring, servicing and maintenance of this
equipment. In addition to the three long distance switches we have in service
currently, in 2005, we decommissioned two of our other switches as part of
our network optimization.
With
respect to connections to local carriers, international and operator assisted
services, in December 2003, we entered into a four-year master carrier agreement
with AT&T. The agreement provides us with a variety of services, including
transmission facilities to connect our long distance network switches as
well as
services for international calls, local traffic, international calling cards,
overflow traffic and operator assisted calls. The agreement also provides
that,
subject to certain terms and conditions, we will purchase these services
exclusively from AT&T during the term of the agreement, provided, however,
that we are not obligated to purchase exclusively in certain cases, including
if
such purchases would result in a breach of any contract with another carrier
that was in place when we entered into the AT&T agreement, or if vendor
diversity is required. Our
AT&T agreement establishes pricing and provides for annual minimum
commitments based upon usage as follows: 2006 - $32 million and 2007 - $32
million and obligates us to pay 65 percent of the revenue shortfall, if any.
In
February 2006, we amended the AT&T agreement to provide that certain
services that we purchase or may purchase from AT&T (and its affiliates)
will now count toward the minimum commitment. With this amendment we anticipate
that we will not be required to make any shortfall payments under this contract.
To
the
extent that we are unable to meet these minimum commitments, however, our
costs
of purchasing the services under the agreement would correspondingly
increase.
8
Additional
Network Technologies and Management Solutions
We
have
extensive testing facilities in Pensacola, Florida and Detroit, Michigan,
where
we conduct rigorous testing of new technologies including service provider
and
customer premises equipment. As network technologies advance, we are continuing
to evaluate network transport and have kept our infrastructure flexible enough
to migrate to any topology when beneficial.
We
also
operate a centralized network management center in Reston, Virginia and
regionalized subscriber management centers in Detroit, Michigan and Pensacola,
Florida. Our network management center monitors our network elements facilities
and elements 24 hours a day, 7 days a week to identify and resolve any network
anomalies and/or customer -related service issues. Our regionalized subscriber
monitoring centers provide proactive customer monitoring for the commercial
customer base and are directly aligned with switch technicians and regional
network technicians in the field to quickly and accurately respond to any
requirement identified.
Telecommunications
and data technologies evolve quickly in this industry. We
believe that our network design positions us to rapidly implement future
voice
and data switching technology and seamlessly migrate to new topologies while
keeping costs low and delivering quality services to our customers.
INTEGRATED INFORMATION SYSTEMS
We
have
integrated leads management, order processing, provisioning, billing, payment,
collection, customer service and information systems that enable us to offer
and
deliver high-quality, competitively priced telecommunication services to
our
customers and process millions of call records each day. These operational
support systems were developed by us and customized for our business and
operational requirements and, due to the system's component-based architecture,
provide an extensible framework for the introduction of new products and
services.
We
use
"state-of-the-art" software and hardware applications and products to support
our systems and development efforts. During
2005, we successfully migrated our Talk America Inc. database systems from
an
Informix to an Oracle architecture. As a result of our acquisition of LDMI
and
NTC, we are currently operating and maintaining three separate information
systems. In 2006, we will begin to enhance and consolidate the database systems
to support our commercial and residential product offerings on a single
integrated operating system, but there can be no assurances that we will
be able
to integrate these systems timely and successfully. Through
dedicated electronic connections with our local and long distance networks
and
the incumbent local exchange companies, we have designed our systems to process
information on a "real time" basis. We have automated the business processes
required to deploy and support our local circuit switch-based network, and
continue to automate the business processes required to provide DSL service.
The
information functions of our systems are designed to provide easy access
to all
information about a customer, including volumes and patterns of use. This
information can be used to identify emerging customer trends and to respond
with
services to meet customers' changing needs. This information also allows
us to
identify unusual usage by an individual customer, which may indicate fraud.
FCC
rules, however, limit our use of customer proprietary network information.
See
"Regulation."
9
Our
core
operational support systems include the following:
| · |
Our
leads database system is utilized in the marketing of our
telecommunication services. The leads database system enables us
to alter
telemarketing campaigns to track areas where mass advertisements
are
airing, manage the product sales price by customer, zone and state,
maintain customer credit information, and comply with various regulatory
requirements.
|
| · |
Our
automated order processing system enables us to shorten the customer
provisioning time cycle and reduce associated costs. Prior to submitting
an order to provision a customer to our service, our system processes
the
customer's credit history, and, once the customer's credit is approved,
the customer's service record detailing the customer's existing
phone
service is immediately verified. In addition, our system has enabled
us to
significantly increase our customer provisioning rate for qualified
and
verified orders while reducing the number of orders that are rejected
by
the incumbent local exchange company, reducing manual work
requirements.
|
| · |
Our
automated service provisioning system enhances our ability to add
customer
lines to our telecommunication service and to change the features
associated with that particular customer's service, reducing manual
work
requirements.
|
| · |
Our
billing system enables us to preview and run a bill cycle for the
many
different, tailored service packages, increasing customer satisfaction
while minimizing revenue leakage in the provision of local
telecommunication service.
|
| · |
Our
automated payment and collections management system is integrated
with our
billing and customer relationship management system. This system
increases
the efficiency of our collection process, accelerates the recovery
of
accounts receivable and assists in the retention of valuable
customers.
|
| · |
Our
customer relationship manager system, enables our customer service
representatives to access data in a real-time, organized manner,
while the
representative is speaking with the customer, thereby reducing
the length
of customer service calls and improving the customer
experience.
|
In
addition, we maintain our own web sites at www.talkamerica.com, www.talk.com,
www.ldmi.com and www.networktelephone.net to provide for customer sign-up
and to
provide customers and potential customers with information about our products
and services as well as billing information and customer service.
10
SALES
AND MARKETING
We
focus
on targeting, acquiring and retaining profitable commercial and residential
customers that we can directly provision to our own network platform by
providing savings, simplicity and service. We currently market to customers
to
whom we can provide service over our own network in Michigan, Ohio and the
Southeast United States. We continue to seek new marketing partners and
arrangements to expand both our opportunities to attract customers to our
services and the products and services that we offer to our
customers.
We
use
diverse sales and marketing channels to reach the commercial and residential
markets with our service offerings. Our sales and marketing efforts focus
on (i)
marketing to business customers voice, data and advanced services applications,
and (ii) marketing to residential customers a bundle of local and long distance
phone services with complementary data services. We market to commercial
customers utilizing the Talk America, LDMI and Network Telephone brands and
residential customers utilizing the Talk America brand.
We
market
our commercial services in the Michigan and Ohio markets predominantly through
our direct sales force and partner sales force, and, in the Southeast markets,
almost exclusively through our direct sales force. We purchase business lead
databases to assist our direct sales force in targeting particular customers.
Our commercial independent agents also usually provide other types of
communication or data services to the businesses to which they market our
products and services. Often, these customers rely heavily upon the independent
agent in making a decision regarding their voice and data services.
We
market
our residential services within our targeted markets through the following
channels:
| · |
Telemarketing
- We operate our own call centers and purchase residential lead
databases
utilized for targeted, professional and courteous outbound telesales
campaigns.
|
| · |
Direct
Mail - We purchase residential lead databases utilized for demographically
targeted direct mail campaigns designed to direct inbound calls
to our
telemarketing centers.
|
| · |
Referrals
- We solicit potential customers by gathering their names from
our
existing customers through the use of referral promotions and our
free
member-to-member calling.
|
| · |
Online
Marketing - We have developed a productive online marketing presence,
through traditional online media and business
relationships.
|
| · |
Direct
Sales - Utilizing independent agents, we solicit new customers
in targeted
geographic areas.
|
| · |
Broadcast
Media - We solicit inbound subscriber calls through advertising
on
television, radio and in print.
|
We
employ
a targeted approach to customer acquisition and use database-marketing tools
to
identify and prioritize target customers. For our business customers, we
offer
customized communications, data, Internet and specialized network solutions
that
permit us to work with our business customers to meet their needs. For our
residential customers, we offer our customers the ability to build their
own
telecommunications package beginning with an extended local calling area,
a
diverse selection of intrastate and interstate calling plans, discounted
feature
packages and “a la carte” feature selection, and several options for Internet
access. While we do not actively market our stand-alone long distance
telecommunications service, we offer the long distance telecommunications
service when contacted by persons located in those regions where local service
is unavailable. We also add long distance customers when the customer requests
its local service provider to provide the customer with our long distance
telecommunications service. Customers can switch to us online, through a
telesales representative, through a direct sales agent, or through an authorized
independent agent, each of which uses consultative sales tools to assist
the
customer’s creation of the right plan for their telecommunications needs.
At
the
point of sale, we provide each customer with an estimate of their first month’s
invoice, including all fees and taxes. Customers are able to keep their same
phone lines and number, can easily add features, and, generally within days
of
the sale, residential customers are switched to our service and receive a
personalized welcome kit explaining their service. For our business customers,
we enter into service relationships through negotiated contracts that specify
the services we offer and that bind the customers to a term commitment, with
penalties for early termination.
We
only
actively market our services in those markets where we can provision customers
directly to our own network facilities. In addition, we offer, but do not
actively market, services to customers that cannot be provisioned to our
own
network facilities and that we service using services purchased from
the incumbent local exchange company under negotiated wholesale arrangements.
11
REGULATION
OF OUR SERVICES
Overview
We
are
subject to federal, state, local and foreign laws, regulations, and orders
affecting the rates, billing, terms, and conditions of certain of our service
offerings, our costs and other aspects of our operations, including our
relations with other service providers. Regulation varies in each jurisdiction
and may change in response to judicial proceedings, legislative and
administrative proposals, government policies, competition and technological
developments. We cannot predict what impact, if any, such changes or proceedings
may have on our business or results of operations, and we cannot guarantee
that
regulatory authorities will not raise material issues regarding our compliance
with applicable regulations.
The
FCC
has jurisdiction over our facilities and services to the extent they are
used in
the provision of interstate or international communications services or as
otherwise required by federal law. State regulatory commissions, commonly
referred to as PUCs, generally have jurisdiction over facilities and services
to
the extent they are used in the provision of intrastate services. Local
governments may assert authority to regulate aspects of our business through
zoning requirements, permit or right-of-way procedures and franchise fees.
Foreign laws and regulations apply to communications that originate or terminate
in a foreign country. Generally, the FCC and state public utility commissions
do
not regulate Internet, video conferencing and certain data services, although
the underlying communications components of such offerings may be regulated.
Our
operations also are subject to various environmental, building, safety, health
and other governmental laws and regulations.
Federal
law generally preempts state statutes and regulations that restrict the
provision of competitive local, long distance and enhanced services;
consequently, we generally are free to provide the full range of local, long
distance and data services in every state. While this federal preemption
greatly
increases our potential for growth, it also increases the amount of competition
to which we may be subject.
Federal
Regulation
The
Communications Act of 1934, as amended, or the “1934 Act,” grants the FCC
authority to regulate interstate and foreign communications by wire or radio.
We
are regulated by the FCC as a non-dominant carrier and are subject to less
comprehensive regulation than dominant carriers. Nevertheless, we remain
subject
to numerous requirements of the Communications Act, applicable to most common
carriers, which require us to offer service upon reasonable request and pursuant
to just and reasonable charges and terms that are not unjustly or unreasonably
discriminatory. The FCC has authority to impose additional requirements on
non-dominant carriers.
The
Telecommunications Act of 1996, or the “1996 Act,” amended the 1934 Act to
eliminate many barriers to competition in the U.S. communications industry,
by
setting standards for relationships between communications providers, including
between new entrants, such as our company, and the Regional Bell Operating
Companies and other incumbent local exchange companies. In general, the 1996
Act
requires incumbent local exchange companies to provide competitors with
nondiscriminatory access to, and interconnection with, the incumbent local
exchange company networks, and to provide unbundled network elements at
cost-based prices. The FCC and state public utility commissions have adopted
extensive rules to implement the 1996 Act, and revisit such regulations on
an
ongoing basis in light of court decisions and as marketplaces
evolve.
Legislation
has recently been introduced in Congress that would rewrite substantial portions
of the 1996 Act. Any effort to reform the 1996 Act could result in changes
that
would materially reduce the obligations of the incumbent
local exchange companies
to
interconnect with, or provide unbundled network elements to, competitors.
Any
such legislative change could have a material adverse impact on our business
and
operations.
Long
Distance Competition
Section 271
of the 1934 Act, enacted as part of the 1996 Act, established a process by
which
a Regional Bell Operating Company could obtain authority to provide long
distance service in a state within its region. The process required
demonstrating to the FCC that the Regional Bell Operating Company has adhered
to
a 14-point competitive checklist and that granting such authority would be
in
the public interest. Each of the Regional Bell Operating Companies already
has
received FCC approval to provide long distance services in each state within
its
respective region, resulting in increased competition in certain markets
and
services. The Regional Bell Operating Companies have a continuing obligation
to
comply with the checklist. Section 272 of the 1934 Act requires that, for a
period of three years after receiving Section 271 approval in any state
(absent an FCC extension), a Regional Bell Operating Company must comply
with
certain other structural and operational safeguards, including the provision
of
in-region long distance service through a separate affiliate.
12
Local
Service Regulation
The
1996
Act required the FCC to establish national rules implementing the local
competition provisions of the 1996 Act, which impose duties on all local
exchange carriers, including competitive local exchange companies such as
our
company, to provide network interconnection, reciprocal compensation, resale,
number portability and access to rights-of-way.
The
1996
Act imposes additional duties on incumbent local exchange companies, including
the duty to provide access on an unbundled basis to individual network elements
on non-discriminatory terms and cost-based rates; to allow competitors to
interconnect with their networks in a nondiscriminatory manner at any
technically feasible point on their networks; to permit collocation of
competitors' equipment at the incumbent local exchange company premises;
and to
offer retail services at wholesale rates to competitive local exchange companies
for resale.
Unbundled
Network Elements
Access
to
incumbent
local exchange companies’
unbundled network elements at cost-based rates is critical to our business.
Historically, our local telecommunications services were predominantly provided
through the use of combinations of unbundled network elements, and it was
the
availability of cost-based rates for these elements that had enabled us to
price
our local telecommunications services competitively. However, the obligation
of
incumbent
local exchange companies
to
provide the unbundled network elements upon which we have relied at such
cost-based rates is the subject of recent regulatory action that resulted
in the
availability of these elements being substantially reduced or otherwise subject
to significantly higher, non-cost-based rates.
The
1996
Act requires incumbent local exchange companies to provide requesting
telecommunications carriers with nondiscriminatory access to network elements
on
an unbundled basis at any technically feasible point on rates, terms and
conditions that are just, reasonable and nondiscriminatory, in accordance
with
the other requirements set forth in Sections 251 and 252 of the 1934 Act.
The
1996 Act gives the FCC authority to determine which network elements must
be
made available to requesting carriers such as us. For network elements that
are
not proprietary, the Commission is required to determine whether the failure
to
provide access to such network elements would impair the ability of the carrier
seeking access to provide the services it seeks to offer. The FCC has determined
that most network elements are nonproprietary in nature and thus are subject
to
the "impair" standard. The FCC's initial list of incumbent local exchange
company network elements that are required to be unbundled on a national
basis
was first released in 1996 and has been subject to almost constant review
and
revision since then.
When
the
FCC first adopted unbundled network element rules, it indicated that it would
reexamine the list of unbundled network elements every three years. In
December 2001, the FCC initiated its first so-called “triennial review” of
those rules. In August 2003, in the Triennial Review Order, or TRO,
the FCC
substantially modified its rules governing access to unbundled network elements.
The FCC redefined the "impair" standard, concluding that a requesting carrier
is
impaired when a lack of access to an unbundled network element poses barriers
to
entry, including operational and economic barriers that are likely to make
entry
into a market uneconomic. The FCC limited requesting carrier access to certain
aspects of the loop, transport, switching and signaling databases unbundled
network elements but continued to require some unbundling of these elements.
In
the TRO,
the FCC
also determined that certain broadband elements, including fiber-to-the-home
loops in greenfield situations, broadband services over fiber-to-the-home
loops
in overbuild situations, packet switching and the packetized portion of hybrid
loops, are not subject to unbundling obligations.
13
All
of
the FCC’s decisions regarding unbundling have been the subject of judicial
review. Most recently, on March 2, 2004, the U.S. Court of Appeals for the
District of Columbia Circuit, or the D.C. Circuit, in United
States Telecom Ass'n v. FCC,
or the
USTA
II
decision, vacated certain portions of the TRO
and
remanded to the FCC for further proceedings. Specifically, the D.C. Circuit
vacated the FCC's delegation of decision-making authority to state commissions
and several of the FCC's nationwide impairment determinations. The D.C. Circuit
found that the FCC used a flawed methodology when making certain impairment
determinations, including those relating to the mass market switching and
local
transport network elements, and remanded those determinations to the FCC
for
further analysis and justification. The D.C. Circuit affirmed the FCC's decision
to relieve the incumbent local exchange companies from unbundling obligations
with respect to broadband elements. The D.C. Circuit did not make a formal
pronouncement regarding the status of the FCC's findings regarding enterprise
market loops, batch hot cuts or preemption of inconsistent state laws. The
FCC
and the United States Solicitor General declined to seek certiorari
from the
Supreme Court. The National Association of Regulatory Utility Commissioners
and
a coalition of competitive local exchange companies separately petitioned
for
certiorari. The Supreme Court denied those petitions.
Thereafter,
the FCC released a series of orders that further reduced the facility unbundling
obligations of incumbent local exchange carriers. First, in orders released
in
August 2004, the FCC extended relief from the unbundling obligations to
fiber-to-the-home loops serving predominantly residential multiple dwelling
units and granted the same relief to fiber-to-the-curb that it has applied
to
fiber-to-the-home.
Second,
on October 27, 2004, the FCC issued an order granting requests by the
Regional Bell Operating Companies that the FCC forbear from enforcing the
independent unbundling requirements of Section 271 of the 1934 Act with
regard to the broadband elements that the FCC had determined in the TRO
are not
subject to unbundling obligations (fiber-to-the-home loops, fiber-to-the-curb
loops, the packetized functionality of hybrid loops and packet switching).
The
FCC declined to address broader forbearance requests by SBC and Qwest, who
had
asked the FCC to forbear from applying applicable Section 271 requirements
to any element that the FCC has determined no longer meets the impairment
standard.
Third,
on
December 15, 2004, the FCC adopted rules modifying the unbundling obligations
for incumbent local exchange companies under Section 251 of the 1934 Act,
substantially reducing the incumbent local exchange companies’ obligation to
provide unbundled local switching as well as certain levels of unbundled
loops
and transport. The FCC issued final rules on February 4, 2005 in its Triennial
Review Remand Order, or TRRO.
Those
rules were effective on March 11, 2005. In response to the USTA
II
decision, the
FCC
clarified that it evaluated impairment with regard to the capabilities of
a
reasonably efficient competitor. The FCC also modified the impairment standard
set forth in the TRO
by: (1)
setting aside the TRO’s
“qualifying service” interpretation of section 251(d)(2), but prohibiting the
use of unbundled
network elements
for the
provision of exclusively long distance or exclusively wireless services;
(2)
drawing inferences regarding the prospects for competition in one geographic
market based on the state of competition in another, similar market; and
(3)
determining that in the context of local exchange markets, a general rule
prohibiting access to unbundled
network elements
whenever
a requesting carrier is able to compete using an incumbent
local exchange company’s
tariffed
special access offering would be inappropriate. It is not clear at this time
whether we will be successful in finding viable substitutes for unbundled
switching and the other elements affected by the TRO,
the
USTA
II decision
or the TRRO
and what
the ultimate effect will be on our business and operations. However, as a
result
of these decisions, the availability of unbundled
network elements
at
cost-based rates has been substantially reduced and will have a material
effect
on the way we conduct our business and operations and may have a material
adverse effect on our profitability.
The
principal parts of the TRRO
regarding unbundled switching and unbundled loops and transport and the expected
impact to our business are summarized below:
14
Local
Switching:
The FCC
eliminated an incumbent
local exchange company’s
obligation to provide local switching (and the unbundled network element
platform, in particular, upon which we have historically relied) to requesting
carriers at Total
Element Long Run Incremental Cost,
or
TELRIC, rates. In doing so, the FCC found that competitive
local exchange companies
are not
impaired nationwide without access to unbundled local switching. The FCC
adopted
a twelve-month transition plan for competitive
local exchange companies
to
transition away from the unbundled network element platform commencing on
March
11, 2005 and ending on March 10, 2006. The transition plan applied only to
our
customer base as it existed on March 11, 2005 and we were able to obtain
local
switching for those customers at a rate per customer equal to the greater
of:
(1) the rate at which we leased that combination of elements on June 15,
2004,
plus one dollar; and (2) the rate, if any, the applicable state public utility
commission establishes between June 16, 2004 and the effective date of the
FCC’s
order, for the unbundled network element platform, plus one dollar.
Because
local circuit switching effectively became unavailable to us for new orders
as
of March 11, 2005, we were unable to offer our telecommunications services
as we
had done in the past for new customers. As a result, to provide service to
customers that were not on our own network facilities, we signed commercial
agreements with AT&T (formerly SBC), Verizon and BellSouth. The terms of
these commercial agreements enable us to continue offering high quality
telecommunications services to our customers who were previously served on
unbundled network element platforms. In addition, we could serve customers
by
other means, including through total service resale agreements with the
incumbent
local exchange companies,
by
migrating customers onto the networks of other facilities-based competitive
local telephone companies or by purchasing critical network elements on an
unbundled basis at "just and reasonable" rates pursuant to Section 271 of
the
1996 Act, which presumably will be higher than the rates currently available
to
us. Since network element purchases pursuant to Section 271would be on an
unbundled basis, we would need to pay additional charges to combine these
elements. For existing customers, as detailed earlier, the FCC announced
a one
year transition during which we migrated customers to our own network facilities
and to commercial arrangements with the incumbent local exchange carriers.
At
this time, no regional bell operating company has offered elements industry
wide
through Section 271, although in January 2006, the Georgia Public Service
Commission voted to commence a proceeding to set rates for unbundled loops,
transport, and switching that must be made available by the incumbent local
exchange carrier, BellSouth, pursuant to Section 271 of the 1996 Act.
This
determination and others by the FCC, courts, or state commission(s) that
make
unbundled local switching and/or combinations of unbundled network elements
effectively unavailable to us in some or all of our geographic service areas,
require us either to provide services in these areas through other means,
including resale of the incumbent local exchange companies' retail services,
commercial agreements with incumbent local exchange companies, purchase of
special access services, or the purchase of network elements from the Regional
Bell Operating Companies at "just and reasonable" rates under Section 271
of the
Act, in all cases likely at significantly increased costs, or to provide
services over our own switching facilities, if we are able to deploy
them.
15
Although
the incumbent
local exchange companies’
unbundling requirements for local circuit switching arising under Section
251 of
the 1996 Act have been eliminated by the TRRO,
competitive carriers’ access to local circuit switching on an unbundled basis is
preserved under Section 271 of the 1996 Act as a condition to the Regional
Bell Operating Company’s
ability to provide in-region long distance services. However, the local circuit
switching element, if accessible to competitive carriers only pursuant to
Section 271 of the 1996 Act, are likely to be offered at significantly higher
rates and subject to less favorable terms and conditions imposed by the
incumbent
local exchange companies,
including the possibility that the incumbent
local exchange companies
will not
be required to combine unbundled local circuit switching provided pursuant
to
Section 271 with other non-unbundled network elements or tariffed
services.
Because
of the (a) significant changes to the FCC rules that previously required
the
incumbent local exchange companies to provide us access to the unbundled
network
element platform at TELRIC rates, and (b) increases in TELRIC rates for network
elements adopted by various state PUCs, the rates that we are charged by
the
incumbent local exchange companies to provide our services increased
significantly in 2004 and 2005 and will likely continue to increase over
time,
despite the fact that the FCC has prohibited both SBC and Verizon from
affirmatively seeking state commission-approved TELRIC rate increases for
a
period of two years from the closing dates of their mergers with AT&T and
MCI, respectively. These cost increases have and will continue to lead us
to
increase our product pricing for customers located in those areas where we
do
not currently have or plan to deploy network facilities, which we believe
inhibits our ability to add new customers and to retain existing customers.
While these price increases may increase our current revenues from such
customers, it will adversely affect our ability to retain such customers
on our
service and negatively affect our revenues over time.
Local
Loops and Transport:
The FCC
also made impairment findings and placed certain limitations with respect
to
local loops and dedicated interoffice transport. The FCC established 10 DS1s
and
12 DS3s as the maximum transport a carrier can purchase per route. Furthermore,
for local loops, the FCC concluded that competitive local exchange companies
are
impaired without access to (1) DS1-capacity
loops except in any building within the service area of a wire center containing
60,000 or more business lines and four
or
more fiber-based collocators; and (2) DS3-capacity loops except in any building
within the service area of a wire center containing 38,000 or more business
lines and four
or
more fiber-based collocations. The FCC determined that competitive
local exchange companies
are not
impaired without access to dark fiber loops in any instance. For dedicated
transport, the FCC found that competitive
local exchange companies
are
impaired without access to (1) DS1 transport except on routes connecting
a pair
of wire centers where both wire
centers contain at least four fiber-based collocators or at least 38,000
business lines; and (2) DS3 or dark fiber transport except on routes connecting
a pair of wire centers where both wire
centers contain at least three fiber-based collocators or at least 24,000
business lines. The FCC concluded that competitive
local exchange companies
are not
impaired without access to entrance facilities connecting an incumbent
local exchange company’s
network with a competitive
local exchange company’s
network in any instance. For both local loops and dedicated transport, the
FCC
adopted a twelve-month transition plan for competitive
local exchange companies
to
transition away from the use of DS1 and DS3 loops and dedicated transport
where
there is no impairment, and an eighteen-month transition plan to transition
away
from dark fiber. The transition plans apply only to the customer base as
it
exists on March 11, 2005, and do not permit competitive
local exchange companies
to add
new dedicated transport unbundled
network elements
in the
absence of impairment. During the transition periods, competitive
local exchange companies
will
retain access to unbundled high-capacity loops and transport at a rate equal
to
the greater of: (1) 115% of the rate the requesting carrier paid for the
unbundled network element on June 15, 2004; and (2) 115% of the rate the
state
commission has established or establishes, if any, between June 16, 2004,
and
the effective date of the FCC’s order.
16
The
determination of whether a particular network element is either impaired
or
unimpaired in a particular market, as defined in the FCC’s final rules, has a
significant effect on markets where we already have networking facilities
and on
our plans for entering a new market. It is difficult to predict which geographic
areas will become unimpaired for network elements because the incumbent local
exchange companies are using non-public information to determine the thresholds
for availability; while we may challenge the incumbent local exchange companies’
threshold assumptions, we may not be successful in such challenges. If a
market
is determined to be unimpaired, we may be unable to cost-effectively offer
service in that market.
The
incumbent local exchange companies have issued accessible letters, which
announced that they would not provision any loops in areas that they deemed
to
be unimpaired and further that they would not provision any transport on
routes
they deemed to be competitive. Although we and other competitive local exchange
carriers are challenging this action, if the incumbent local exchange companies
are successful, our business could be negatively impacted. On September 9,
2005,
SBC issued a revised list of its Michigan end offices that SBC maintains
meets
the FCC’s criteria for non-impairment. After a successful challenge on December
20, 2005, the Michigan PUC required AT&T (formerly SBC) to file all of its
data with the Commission to support its assertion that certain wire centers
are
non-impaired for the provision of high capacity loops and transport and to
re-classify any wire center in which the former AT&T was identified as a
competitive fiber based collocator. In January 2006, AT&T complied with such
requirement and provided a revised list of wire centers it deemed as unimpaired
for either loops or transport. As part the proceeding, competitive carriers
are
given an opportunity to inspect wire centers identified in the January 2006
AT&T list and challenge AT&T’s designation of the wire centers as
unimpaired. We are participating in this proceeding and expect a resolution
by
April 15, 2006. We cannot predict the outcome of these wire center challenges
or
whether they will have any impact on our operations. If AT&T were to prevail
on its current position, we would be limited in our ability to
purchase
local
loops and dedicated interoffice transport.
As we
expand our local network during 2006, the unavailability of these dedicated
transport facilities, dark fiber and entrance facilities under the FCC’s rules
at cost-based rates may adversely impact us where our own switching facilities
have been deployed and could substantially impede our plans to deploy additional
network facilities. We could be forced to use other means to effect this
deployment, including the use of facilities purchased from the incumbent
local
exchange carrier at higher tariffed special access rates or transport services
purchased from other competitive access providers. In either event,
our cost of service could rise dramatically and our plans for a service roll-out
for use of our own network facilities could be delayed substantially or derailed
entirely.
Beginning
in 2003, we deployed networking assets in Michigan and, as of December 31,
2005,
including the lines from the January 3, 2006 acquisition of NTC, we had
approximately 466,000 local voice and data equivalent lines on our network.
We
are continuing the expansion of our network by collocating our networking
equipment in the incumbent local exchange companies’ end offices to provide
service over our own network. We have, and continue to improve, the automation
of the business processes required to provide local network-based
services. We are utilizing next generation networking equipment for the
build-out of our network in Grand Rapids and certain other areas in Michigan,
as
well as in the Atlanta market.
Our
business strategy is to serve small and medium-sized businesses, in addition
to
residential consumers, in those areas where we have our own network facilities.
Expansion into this business market increases our addressable market in such
areas and permits us to leverage our investment in our network facilities
due to
the complementary telecommunication traffic or usage patterns of these business
customers and our residential customers. We continue to explore acquisitions
that will further expand our marketing footprint.
Furthermore,
we utilize enhanced extended links, or EELs, which are a combination of
dedicated interoffice transport and high capacity loops, to provide T-1 level
services to medium-sized businesses. While the FCC did not explicitly restrict
the availability of EELs, the incumbent local exchange companies have taken
the
position that EELs are not available in any geographic area where DS1 transport
is not available as a network element at TELRIC rates. A negative determination
on this issue by the FCC or the public utility commission in any state in
which
we provide services could negatively affect our network rollout and results
of
operations.
17
Where
competitive local exchange carriers are deemed “impaired,” under the FCC’s new
rules, they are permitted to lease unbundled network elements at rates
determined by state PUCs employing the FCC's TELRIC forward looking, cost-based
pricing model. On September 15, 2003, the FCC opened a proceeding
reexamining the TELRIC methodology and wholesale pricing rules for
communications services made available for resale by incumbent local exchange
companies in accordance with the 1996 Act. This proceeding will comprehensively
re-examine whether the TELRIC pricing model produces unpredictable pricing
inconsistent with appropriate economic signals; fails to adequately reflect
the
real-world attributes of the routing and topography of an incumbent local
exchange company's network; and creates disincentives to investment in
facilities by understating forward-looking costs in pricing Regional Bell
Operating Company network facilities and overstating efficiency assumptions.
We
have participated in this proceeding as a member of a consortium of competitive
local exchange companies. To date, the FCC has not issued revised TELRIC
rules;
thus the TELRIC methodology still governs our pricing for loops purchased
from
the incumbent local exchange companies. We cannot predict if the FCC will
order
new TELRIC pricing or if Congress will amend the 1996 Act, affecting such
pricing. The application and effect of a revised TELRIC pricing model on
the
communications industry generally and on certain of our business activities
cannot be determined at this time but it would have a material impact on
our
business.
On
December 12, 2005 the FCC granted, in part, a petition for forbearance filed
by
Qwest Corporation seeking relief from statutory and regulatory obligations
that
apply to it as the incumbent local exchange company in the Omaha-Council
Bluffs,
NE-IA Metropolitan Statistical Area (“Omaha MSA”). The FCC relieved Qwest of
certain legacy monopoly regulations after finding that the Omaha MSA was
subject
to facilities-based competition, including the substantial infrastructure
investment made by Cox Communications, Inc. in its competitive network.
Specifically, the FCC relieved Qwest of the obligation to provide unbundled
network elements to competitors in 9 of Qwest’s 24 wire center service areas in
the Omaha MSA. The FCC left in place, however, unbundling requirements such
as
interconnection and interconnection-related collocation obligations, as well
as
Section 271 obligations to provide wholesale access to local loops, local
transport, and local switching at just and reasonable rates. For mass market
telephone services, the FCC granted Qwest relief from dominant carrier
regulations that apply to it in the entire Omaha MSA. Specifically, the
Commission granted Qwest’s request to forbear from applying price cap, rate of
return, 15-day tariffing and 60-day discontinuance regulations to Qwest for
its
provision of interstate mass market exchange access services and broadband
Internet access services. On October 6, 2005, the incumbent local exchange
company in Alaska asked that similar forbearance relief be granted in the
Anchorage, Alaska market. We expect other incumbent local exchange carriers
to
file similar petitions covering other markets.
Broadband
Services
On
March
25, 2005, the FCC issued an order finding that a state commission may not
require an incumbent local exchange carrier to provide digital subscriber
line
(“DSL”) service to an end user customer over the same unbundled network element
loop that a competitive local exchange provider uses to provide voice services
to that end user. Incumbent local exchange carriers, with the exception of
AT&T and Verizon for a limited period of time as a result of the FCC’s
merger orders, may now lawfully refuse to offer stand-alone DSL service to
their
retail customers, making it more difficult for us to attract new voice customers
that want to retain their existing incumbent-provided DSL service.
18
On
August
5, 2005, the
FCC
issued an order finding that wireline broadband Internet access services
are
“information services” functionally integrated with a telecommunications
component and therefore eliminated the long-standing requirement that incumbent
local exchange companies share the underlying transmission component used
to
provide Internet access services. The FCC had previously required
facilities-based providers to offer that wireline broadband transmission
component separately from their Internet service as a stand-alone service
on a
common-carrier basis, and thus had previously classified that component as
a
telecommunications service. As a result, incumbent
local exchange companies
may now
refuse to offer underlying broadband transmission services to unaffiliated
providers of broadband services or charge above-cost rates that make it
economically infeasible for unaffiliated providers to compete with the
incumbent
local exchange company’s
broadband services. We use unbundled high capacity services purchased from
incumbent local exchange carriers as network elements to provide Internet
access
to some of our customers. These carriers may contend that, as a result of
the
FCC’s wireline broadband order, they will no longer provide high capacity
facilities as network elements for use in providing Internet access. If so,
we
may be forced to substitute higher priced special access services for this
purpose.
Subsequently,
Verizon filed a petition asking the FCC to extend the Wireline Broadband
Order
to all packetized and optical special access services. If granted, this would
enable incumbent local exchanges companies to offer most services that are
not
TDM-based on an unregulated basis. The petition is one that asks the FCC
to
forbear from regulation of its packetized and optical services, and the deadline
for decision is March 19, 2006.
SBC-AT&T
and Verizon-MCI Mergers and the Announced AT&T-BellSouth
Merger
On
October 31, 2005, the FCC approved the SBC-AT&T and Verizon-MCI mergers,
subject to certain conditions. The merger conditions, which the FCC set out
in
two separate orders issued on November 17, 2005, include: (1) the Regional
Bell
Operating Companies are prohibited from affirmatively seeking any increase
in
state-approved rates for unbundled network elements for a period of two years
from the respective merger closing dates; (2) the Regional Bell Operating
Companies shall not raise rates for DS1 and DS3 private line service provided
by
AT&T and MCI for a period of 30 months from the respective merger closing
dates; (3) the Regional Bell Operating Companies shall not increase their
interstate access rates for a period of 30 months following the respective
merger closing dates; (4) for a period of 30 months following the merger
closing
dates, the Regional Bell Operating Companies will not provide special access
offerings to their wireline affiliates that are not available to other similarly
situated special access customers on the same terms and conditions; and (5)
within 12 months of the respective merger closing dates, the Regional Bell
Operating Companies will offer “stand-alone” Asynchronous Digital Subscriber
Line (“ADSL”) service throughout their regions for two years. The mergers of
AT&T with SBC and Verizon with MCI effectively eliminated the two largest
competitive local exchange carriers in the United States, each of which was
a
strong voice in federal and state lobbying related to telecommunications
matters. These mergers will place an increased demand on our resources and
employees for lobbying and other regulatory matters and there can be no
assurances that our efforts will prove effective.
On
March
5, 2006, AT&T and BellSouth announced that they had entered into an
agreement to merge the companies. The proposed merger, which is subject to
regulatory approval, will merge our two largest vendors into one entity.
This
merger, if completed, may have an adverse impact on our business.
19
Interconnection
Agreements
Pursuant
to FCC rules implementing the 1996 Act, we negotiate interconnection agreements
with incumbent local exchange companies to obtain access to unbundled network
elements and other services, generally on a state-by-state basis. These
agreements typically have two- to three-year terms. We currently have
interconnection agreements, or their equivalent, in effect with AT&T,
BellSouth, Verizon and Qwest in the states where such companies act as the
incumbent local exchange company. Our agreements generally are subject to
amendment based upon a change of law. Following the adoption or vacating
of
unbundling rules, the incumbent local exchange companies typically invoke
the
change of law provisions in our interconnection agreements. These provisions
generally provide that when a party to the agreement believes that its
obligations under the agreement have changed as a result of a change in
applicable law, it may request that the other party enter into negotiations
to
amend the agreement, and that in the event the parties are unable to agree
upon
an amendment, the dispute
is to be arbitrated either by a neutral arbitrator or by the relevant state
commission.
We
have
participated in and continue to participate in generic “change of law”
proceedings to determine the affect of the change of law on the various
unbundling rules as a result of the TRO and TRRO. We have signed “change of law”
amendments as required by those proceedings. The affect of these amendments
are
to implement the TRO and TRRO into our interconnection agreements, thereby
eliminating our access to local switching and curtailing our access to unbundled
loops and transport as required by the FCC rules.
We
are in
the process of renegotiating certain of our interconnection agreements and/or
replacing them by opting into other carriers’ existing agreements. In addition,
due to regulatory changes, we are frequently negotiating amendments to our
existing interconnection agreements to reflect these changes. We are generally
negotiating these agreements with little leverage or ability to actually
negotiate the terms. If any negotiation process does not produce, in a timely
manner, an interconnection agreement that we find acceptable, we may petition
the applicable PUC to arbitrate any open issues. Arbitration decisions in
turn
may be reviewed by federal courts. We cannot predict how successful we will
be
in negotiating terms critical to our provision of local network services,
and we
may be forced to arbitrate certain provisions of necessary agreements. Pending
the completion of such proceedings and approval of successor agreements,
we
operate in these states with these incumbent local exchange companies under
the
rates, terms and conditions of the predecessor agreements pursuant to their
evergreen provisions. Other interconnection agreement arbitration proceedings
before various state commissions brought by other carriers may result in
decisions that could affect our business, but we cannot predict the extent
of
any such impact. As an alternative to negotiating an interconnection agreement,
we may adopt, or opt into, another carrier's approved agreement, in its
entirety. We cannot predict whether an acceptable alternative will be available
for us to opt into at such time as we are looking for a new or successor
agreement in any given state with a particular incumbent local exchange
company.
Collocation
FCC
rules
generally require incumbent local exchange companies to permit competitors
to
collocate equipment used for interconnection and/or access to unbundled network
elements. Changes to those rules, upheld in 2002 by the D.C. Circuit, allow
competitors to collocate multifunctional equipment and require incumbent
local
exchange companies to provision cross-connects between collocated carriers.
We
cannot determine the effect, if any, of future changes in the FCC’s collocation
rules on our business or operations.
20
Access
Charges
We
pay
access charges to local exchange carriers for the origination and termination
of
our long distance communications traffic. Generally, intrastate access charges
are higher than interstate access charges. Therefore, to the extent access
charges increase or a greater percentage of our long distance traffic is
intrastate, our costs of providing long distance services will increase.
As a
local exchange provider, we bill long distance providers access charges for
the
origination and termination of those providers' long distance calls.
Accordingly, in contrast with our long distance operations, our local exchange
business benefits from the receipt of intrastate and interstate long distance
traffic. As an entity that collects and remits access charges, we must properly
track and record the jurisdiction of our communications traffic and remit
or
collect access charges accordingly. The result of any changes to the existing
regulatory scheme for access charges or a determination that we have been
improperly recording the jurisdiction of our communications traffic could
have a
material adverse effect on our business.
The
FCC
has indicated that its existing carrier compensation rules constitute
transitional regimes that will conclude upon the establishment of a new
interstate intercarrier compensation regime based on bill-and-keep or another
alternative. Because we both make payments to and receive payments from other
carriers for the exchange of local and long distance calls, we will be affected
by changes in the FCC's intercarrier compensation rules. We cannot predict
the
impact that any such changes may have on our business.
Our
costs
of providing long distance services, and our revenues for providing local
services, also are affected by changes in access charge rates imposed on
competitive local exchange companies. Pursuant to the FCC's 2001 CLEC Access
Charge Order, which lowered the rates that competitive local exchange companies
may charge long distance carriers for the origination and termination of
calls
over local facilities, access rates were reduced during 2003 and were reduced
again during 2004. AT&T and Sprint have appealed the CLEC Access Charge
Order to the D.C. Circuit, arguing that the FCC's benchmark rates are too
high.
The
FCC
issued the first Access Charge Reform Report and Order in 1997. Although
the FCC
has since issued five further orders in that docket, several petitions for
reconsideration and clarification of the 1997 Order remain pending. On
December 15, 2003, the FCC issued a public notice requesting that the
parties to such petitions file supplemental notices identifying any issues
that
were raised in the petitions and that have not been otherwise resolved. We
cannot predict whether the FCC will further modify its access charge rules
as a
result of this proceeding, or the effect that any such changes would have
on our
business.
Over
the
last several years, the FCC has granted incumbent local exchange companies
significant flexibility in pricing interstate special and switched access
services. In August 1999, the FCC granted immediate pricing flexibility to
many incumbent local exchange companies and established a framework for granting
greater flexibility in the pricing of all interstate access services once
an
incumbent local exchange company market satisfies certain prescribed competitive
criteria. In February 2001, the D.C. Circuit upheld the FCC's prescribed
competitive criteria. To date, the FCC has granted pricing flexibility in
numerous specific markets to the Regional Bell Operating Companies. This
pricing
flexibility may result in Regional Bell Operating Companies lowering their
prices in high traffic density areas, including areas where we compete or
plan
to compete. We anticipate that the FCC will continue to grant incumbent local
exchange companies greater pricing flexibility for access services if the
number
of actual and potential competitors increases in each of these
markets.
The
FCC
issued a Notice of Public Rulemaking on February 10, 2005 in WCC Docket No.
05-25. This notice includes a broad examination of the regulatory framework
that
is applied to local exchange carriers’ interstate special access services
preventing them from exceeding certain prices after June 30, 2005. In conducting
this examination, the FCC announced that it seeks comment on the special
access
regulatory regime that should follow the expiration of the Coalition for
Affordable Local and Long Distance Service plan, including whether to maintain
or modify the Commission’s pricing flexibility rules for special access
services. We cannot predict whether the FCC will further modify its access
change rules as a result of this proceeding or the effect that any such changes
would have on our business.
21
On
February 10, 2005, the FCC also adopted a Further Notice of Proposed Rulemaking,
and solicited comment on whether to adopt any of seven different comprehensive
proposals for reform of the FCC's existing rules relating to intercarrier
compensation. Further action in that proceeding could lead to substantial
changes to the way that reciprocal compensation, switched access and universal
charges are established and administered, and could lead to material reductions
in our intercarrier compensation revenues.
During
late
2005, petitions for declaratory ruling were filed by SBC, Vartec, Grande
and
Frontier asking the FCC to clarify in various ways the extent to which
IP-enabled services are subject to the assessment of switched access charges,
and how access charge liability should be parsed out when several carriers
participate in the transport and termination of IP-enabled services. During
the
same timeframe, two carriers and a coalition of mid-sized incumbent local
exchange companies asked the FCC to adopt new rules designed to reduce the
amount of so-called “phantom traffic” terminated over their networks. Traffic is
referred to as “phantom” when it lacks certain signaling information required to
determine its originating location or jurisdictional character. Resolution
of
these petitions could result in the imposition of access charges on certain
IP-based services.
Detariffing
Consistent
with other deregulatory measures, the FCC has largely eliminated carriers'
obligations to file tariffs with the FCC containing prices, terms and conditions
of service. In lieu of federal tariffs, the FCC requires carriers to post
information relating to the rates, terms, and conditions of services on their
corporate web sites. Detariffing precludes our ability to rely on filed rates,
terms and conditions as a means of providing notice to customers of prices,
terms and conditions under which we offer services, and requires us instead
to
rely on individually negotiated agreements with end users. We remain subject
to
the 1934 Act's requirements that rates, terms and conditions of communications
service be just, reasonable and not discriminatory, and we are subject to
the
FCC's jurisdiction over customer complaints regarding our communications
services.
Universal
Service
Section 254
of the 1934 Act and the FCC's implementing rules require all communications
carriers providing interstate or international communications services to
periodically contribute to the Universal Service Fund, or USF. The USF supports
four programs administered by the Universal Service Administrative Company
with
oversight from the FCC: (i) communications and information services for
schools and libraries, (ii) communications and information services for
rural health care providers, (iii) basic telephone service in regions
characterized by high communications costs or low income levels, and
(iv) interstate common line support. Periodic USF contribution requirements
currently are measured and assessed based on the total subsidy funding needs
and
each contributor's percentage of the total of certain interstate and
international end user communications revenues reported to the FCC by all
communications carriers. We measure and report our revenues in accordance
with
rules adopted by the FCC. The contribution rate factors are calculated and
revised quarterly and we are billed for our contribution requirements each
month
based on projected interstate and international end-user communications
revenues, subject to periodic true up.
22
USF
contributions may be passed through to consumers on an equitable and
nondiscriminatory basis either as a component of the rate charged for
communications services or as a separately invoiced line item. Since
April 1, 2003, communications carriers have been prohibited from using a
separate line item on invoices to identify, as a recovery of USF contributions,
amounts that exceed the rate of actual USF contributions.
A
proceeding pending before the FCC has the potential to significantly alter
our
USF contribution obligations. The FCC is considering changing the basis upon
which our USF contributions are determined from a revenue percentage measurement
to a connection or telephone number measurement. Adoption of this proposal
could
have a material adverse affect on our costs, our ability to separately list
USF
contributions on end-user bills and our ability to collect these fees from
our
customers.
The
application and effect of changes to the USF contribution requirements and
similar state requirements on the communications industry generally and on
certain of our business activities cannot be predicted. If our collection
procedures result in over-collection, we could be required to make
reimbursements of such over-collection and be subject to penalty, which could
have a material adverse affect on our business, financial condition and results
of operations. If a federal or state regulatory body determines that we have
incorrectly calculated or remitted any USF contribution, we could be subject
to
the assessment and collection of past due remittances as well as interest
and
penalties thereon. No such proceeding has been commenced at this time against
us.
Telephone
Numbering
The
FCC
oversees the administration and the assignment of local telephone numbers,
an
important asset to voice carriers, by NeuStar, Inc., in its capacity as
North American Numbering Plan Administrator. Extensive FCC regulations govern
telephone numbering, area code designation and dialing procedures. Since
1996,
the FCC has permitted businesses and residential customers to retain their
telephone numbers when changing local telephone companies, referred to as
Local
Number Portability. The availability of number portability is important to
competitive carriers like us, because customers, especially businesses, may
be
less likely to switch to a competitive carrier if they cannot retain their
existing telephone numbers.
On
November
3, 2005, BellSouth filed a petition at the FCC asking the commission to revise
the system by which the costs of implementing local number portability are
recovered. Specifically, BellSouth has asked the Commission to move from
a
system where cost recovery is allocated according to a carrier’s proportion of
overall industry revenue to a cost recovery mechanism based on usage. If
adopted, the modifications could significantly increase our LNP
charges.
23
Communications
Assistance for Law Enforcement Act
The
Communications Assistance for Law Enforcement Act, or CALEA, requires
communications providers to provide law enforcement officials with call content
and call identifying information under a valid electronic surveillance warrant,
and to reserve a sufficient number of circuits for use by law enforcement
officials in executing court-authorized electronic surveillance. Because
we
provide facilities-based services, we incur costs in meeting these requirements.
Noncompliance with these requirements could result in substantial fines.
Although we will attempt to comply, we cannot assure that we would not be
subject to a fine in the future.
Network
Information
FCC
rules
protect the privacy of certain information about customers that communications
carriers, including us, acquire in the course of providing communications
services. Such protected information, known as Customer Proprietary Network
Information, or CPNI, includes information related to the quantity,
technological configuration, type, destination and the amount of use of a
communications service. The FCC's initial CPNI rules prevented a carrier
from
using CPNI to market certain services without the express approval of the
affected customer, referred to as an opt-in approach. In July 2002, the FCC
revised its opt-in rules in a manner that limits our ability to use the CPNI
of
our subscribers without first engaging in extensive customer service processes
and record keeping. Certain states have also adopted state-specific CPNI
rules.
On January 30, 2005 the FCC issued an order requiring all wireline and wireless
carriers to file with the Federal Communications Commission ("FCC" or
"Commission") a certificate verifying that they are in full compliance with
the
Commission's customer proprietary network information ("CPNI") rules. We
use our
subscribers' CPNI in accordance with applicable regulatory requirements and
complied with the FCC’s January 30, 2005 order. However, if a federal or state
regulatory body determines that we have implemented those guidelines
incorrectly, we could be subject to fines or penalties. In addition, on February
10, 2006, the Commission released the text of a Notice of Proposed Rulemaking
asking for comment on whether various proposals are feasible and/or advisable:
(a) requiring carriers to adopt a consumer-set password system; (b) requiring
carriers to record audit trails which would show all instances when a customer’s
CPNI records were accessed, what information was disclosed and to whom; (c)
requiring data stored by carriers to be encrypted; (d) requiring carriers
to
remove identifying information from customer records they maintain; and (e)
requiring carriers to notify customers when the security of CPNI may have
been
breached. We cannot predict whether any or all of these proposals will be
ultimately adopted by the Commission or what the impact of implementation
of new
CPNI rules would have on our operations.
Billing
In
1999,
the FCC first adopted its so-called “Truth-in-Billing” rules, which specify the
information that must be included in, and the format of, carrier invoices
for
telecommunications services. The primary objective of the FCC’s Truth-in-Billing
regulations is to reduce telecommunications fraud, including slamming and
cramming, by making telephone bills easier for subscribers to read and
understand. Pursuant to the Truth-in-Billing rules, carrier bills must be
clearly organized and “clearly and conspicuously” satisfy the following
requirements: (1) identify each service provider associated with each charge
on
the bill; (2) where charges for more than one carrier appear on the same
bill
separate charges by service provider; (3) identify any “new” service provider,
that is, a service provider that did not bill the subscriber for service
during
the previous billing cycle; (4) describe billed charges by use of a brief,
clear, non-misleading, plain language description of the service or services
rendered; (5) distinguish between “deniable” and “non-deniable” charges,
i.e.,
where a
bill contains charges for basic local service, the bill must distinguish
between
charges for which non-payment will result in the disconnection of basic local
service and those charges for which non-payment will not result in such
disconnection; and (6) carriers must include a toll-free number for billing
questions.
24
Regulation
of Internet Service Providers and VoIP
To
date,
the FCC has treated Internet service providers, or ISPs, as enhanced service
providers exempt from federal and state regulations governing common carriers,
including the obligation to pay access charges and contribute to the USF.
Nevertheless, regulations governing the disclosure of confidential
communications, copyright, excise tax and other requirements may apply to
our
Internet access services. In addition, Congress has passed a number of laws
that
concern the Internet and Internet users. Generally, these laws limit the
potential liability of ISPs and hosting companies that do not knowingly engage
in unlawful activity. Congress is actively considering a variety of Internet
regulation bills, some of which, if signed into law, could impose obligations
on
us to monitor the Internet activities of our customers.
Where
communications service providers have offered enhanced services in addition
to
their communications services, the FCC and state PUCs generally have exempted
the enhanced service component and its associated revenue from legacy
communications regulations. Some of the services we provide are enhanced
services. Future and pending FCC and state proceedings may significantly
affect
our future provision of enhanced services.
The
use
of the public Internet and private Internet protocol networks to provide
voice
communications services, including voice-over-Internet protocol, or VoIP,
is a
relatively recent market development. The provision of such services is largely
unregulated within the United States. In a 1998 Report to Congress, the FCC
declined to conclude that IP telephony services constitute telecommunications
services and stated that it would undertake a subsequent examination of whether
certain forms of phone-to-phone Internet telephony are information services
or
telecommunications services. The FCC indicated that, in the future, it would
consider the extent to which phone-to-phone Internet telephony providers
could
be considered telecommunications carriers such that they could be subject
to
regulations governing traditional telephone companies. The FCC also stated
that,
although it did not have a sufficient record upon which to make a definitive
ruling, the record suggested that, to the extent that certain forms of
phone-to-phone IP telephony appear to possess the same characteristics as
traditional communications services and to the extent the providers of those
services utilize circuit-switched access in the same manner as interexchange
carriers, the FCC may find it reasonable to require that IP telephony providers
pay charges similar to access charges. The FCC recognized, however, that
it
should consider forbearing from imposing rules that would apply to
phone-to-phone Internet telephony providers if they were classified as
telecommunications carriers. To date, the FCC has not imposed regulatory
surcharges or traditional common carrier regulation upon providers of Internet
communications services.
Several
pending FCC proceedings will affect the regulatory status of Internet telephony.
On February 12, 2004, the FCC adopted a notice of proposed rulemaking to
address, in a comprehensive manner, the future regulation of services and
applications making use of Internet protocol, including VoIP. In the absence
of
federal legislation, we expect that through this proceeding, the FCC will
resolve certain regulatory issues relating to VoIP services and develop a
regulatory framework that is unique to IP telephony providers or that subjects
VoIP providers to minimal regulatory requirements. We cannot predict when
the
FCC may take such actions. The FCC may determine that certain types of Internet
telephony should be regulated like basic interstate communications services,
rendering VoIP calls subject to the access charge regime that permits local
telephone companies to charge long distance carriers for the use of the local
telephone networks to originate and terminate long-distance calls, generally
on
a per minute basis. The FCC also may conclude that Internet telephony providers
should contribute to the USF. The FCC's pending review of intercarrier
compensation policies (discussed above) also may have an adverse impact on
enhanced service providers.
25
In
a
series of decisions issued in 2004, the FCC clarified that the FCC, not the
state PUCs, has jurisdiction to decide the regulatory status of certain
IP-enabled services, including certain types of VoIP. On November 12, 2004,
in response to a request by Vonage Holdings Corp. (“Vonage”), a VoIP services
provider, the FCC issued an order preempting the Minnesota PUC from imposing
traditional telephone company regulation of VoIP service, finding that the
FCC
alone could make such decisions because the service cannot be separated into
interstate and intrastate communications without negating federal rules and
policies. In September 2003, the Minnesota PUC had issued an order
requiring Vonage to comply with Minnesota laws that regulate telephone
companies. That order was appealed to the U.S. District Court for the District
of Minnesota, which issued a permanent injunction based on its determination
that federal communications law preempts the Minnesota PUC from imposing
state
law common carrier telecommunications regulations on information service
providers such as Vonage. The Minnesota PUC appealed the judgment to the
U.S.
Court of Appeals for the Eighth Circuit. While the appeal was pending, the
FCC
issued its preemption order. In an order filed December 22, 2004, the Eighth
Circuit concluded that the intervening FCC preemption order was binding on
the
court and could not be challenged in the litigation. On that basis, the Court
of
Appeals affirmed the judgment of the district court, that the Minnesota PUC
did
not have jurisdiction to regulate the provision of the Vonage services. Four
state commissions, including Minnesota, and the National Association of State
Utility Consumer Advocates (“NASUCA”) have asked federal appeals courts to
overturn the FCC’s November 2004 order.
On
October 18, 2002, AT&T filed a petition with the FCC seeking a
declaratory ruling that would prevent incumbent local exchange companies
from
imposing traditional circuit-switched access charges on phone-to-phone IP
services. In April 2004, the FCC issued an order concluding that, under
current rules, AT&T's phone-to-phone IP telephony service is a
telecommunications service upon which interstate access charges may be assessed.
AT&T's service consists of an interexchange call initiated by an end user
who dials 1 + the called number from a regular telephone. When the
call reaches AT&T's network, AT&T converts it into an IP format and
transports it over AT&T's Internet backbone. AT&T then converts the call
back from the IP format and delivers it to the called party through local
exchange carrier local business lines. This decision is thus limited to
interexchange service that: (1) uses ordinary customer premises equipment
with no enhanced functionality; (2) originates and terminates on the public
switched telephone network; and (3) undergoes no net protocol conversion
and provides no enhanced functionality to end users due to the provider's
use of
IP technology. The FCC made no determination regarding retroactive application
of its ruling, and stated that the decision does not preclude it from adopting
a
different approach when it resolves the IP-Enabled
Services
or
Intercarrier
Compensation
rulemaking proceedings.
On
February 5, 2003, pulver.com filed a petition with the FCC seeking a
declaratory ruling that its Free World Dialup service, which facilitates
point-to-point broadband Internet protocol voice communications, is neither
telecommunications nor a telecommunications service as these terms are defined
in the 1934 Act. The FCC granted the pulver.com petition on February 12,
2004, establishing that Free World Dialup is an information service, as defined
in the 1934 Act. The FCC limited this finding to VoIP services that, like
Free
World Dialup, exist solely as an Internet application, similar to electronic
mail and instant messaging, and which do not rely on the public switched
telephone network. Information services are subject to federal regulatory
authority, but may not be regulated by state authorities.
26
On
February 23, 2005, the FCC denied a petition filed by AT&T requesting that
the FCC deem its “enhanced” prepaid calling card plan interstate and
informational in nature, and thus exempt from universal service and intrastate
access charge payments. The FCC ruled that the AT&T prepaid calling cards at
issue constituted “telecommunications service” that is subject to the assessment
of switched access charges and universal service fund assessments. The FCC
also
requested further comment on whether other types of prepaid cards, including
those that provide callers the option to listen to information or are
transmitted using internet protocol technology, are also subject to switched
access charge and universal service fund assessment.
Other
aspects of VoIP and Internet telephony services, such as regulations relating
to
the confidentiality of data and communications, copyright issues, taxation
of
services, licensing and 911 emergency access, may be subject to federal or
state
regulation. For instance, in 2002 the FCC undertook an examination of whether
emergency 911 requirements should be extended to packet-based networks and
services, and on June 3, 2005 it released an order requiring providers of
certain Voice over Internet Protocol services to provide enhanced 911 emergency
services to their customers. Similarly,
changes in the legal and regulatory environment relating to the Internet
connectivity market, including regulatory changes that affect communications
costs or that may increase the likelihood of competition from Regional Bell
Operating Companies or other communications companies could increase our
costs
of providing service.
Taxes
and Regulatory Fees
We
are
subject to numerous local, state and federal taxes and regulatory fees,
including but not limited to a 3% Federal excise tax on communications service,
FCC regulatory fees and PUC regulatory fees. We have procedures in place
to
ensure that we properly collect taxes and fees from our customers and remit
such
taxes and fees to the appropriate entity pursuant to applicable law and/or
regulation. If our collection procedures prove to be insufficient or if a
taxing
or regulatory authority determines that our remittances were inadequate,
we
could be required to make additional payments, which could have a material
adverse effect on our business.
On
July 2, 2004, the Internal Revenue Service issued an advance notice of
proposed rulemaking asking for public comment on expanding the current 3%
excise
tax to new communications services, such as VoIP and other IP-based services,
applications, and technologies, to reflect changes in technology. The comment
cycle ended September 30, 2004. We cannot predict the outcome of this
proceeding on our business.
27
Federal
Legislation
For
the
past several years, there has been a concerted effort, particularly by the
regional bell operating companies and their allies, to rewrite the 1934 Act
and
the 1996 Act by repealing or weakening their pro-competition provisions.
Until
recently, that effort did not gain much traction, but, with the introduction
of
legislation in both the House and Senate in 2006, the dynamics have shifted,
and
the Congress has begun to consider seriously moving legislation.
In
the
Senate, in late 2005, Senator Ensign (R-NV) and 14 co-sponsors introduced
S.
1504, the Broadband Investment and Consumer Choice Act, which would grant
extensive regulatory relief to the regional bell operating companies and
other
incumbent local exchange carriers. Soon thereafter Senator Jim DeMint (R-SC)
introduced legislation that would phase out most existing telecommunications
regulations. As drafted, both pieces of legislation would phase out most
existing interconnection and network unbundling requirements over time.
Partially in response to the Ensign bill, the Chairman of this Committee,
Senator Ted Stevens (R- AK), has announced a sweeping set of hearings to
review
a broad range of telecommunications issues - from regulation and competition
to
intercarrier compensation and USF. These hearings began in earnest in January,
and the Chairman is likely to introduce legislation after the
hearings.
In
the
House, the Chairman (Joe Barton (R-TX)) and the Ranking Democrat (John Dingell
(D-MI)) of the Energy and Commerce Committee directed their staff in September
2005 to release a draft bill. While not as deregulatory as the Ensign and
DeMint
bills, this draft also substantially limits the pro-competition provisions
of
the 1996 Act. The staff has received voluminous comments from a large number
of
companies and groups, many of whom criticized one or more provisions of the
draft. Staff later released a new version of the bill, but it was not supported
by the Democrats on the Committee because it took a much more pro-regional
bell
operating company view on critical issues. Hearings were held on this bill,
and,
once again, the staff is redrafting, but any new draft is unlikely to appease
the many opponents of the legislation. These
range from competitive providers, who are upset about the deregulatory
provisions, to cable operators and municipalities, who oppose the video
franchising relief awarded the incumbent local exchange companies. Despite
the
opposition, Chairman Barton has stated that he would like the Telecommunications
Subcommittee to consider the bill in March 2006 and for the full Committee
to
consider the bill in late March or April. The chances of enactment of such
sweeping federal telecommunications legislation in 2006 is uncertain.
However,
passage of any such legislation could substantially reduce or eliminate our
ability to interconnect with incumbent local exchange carriers or lease their
unbundled facilities at cost-based rates.
Additional
legislation during 2006 is possible to address Congressional concerns that
the
FCC does not have jurisdiction to extend USF assessments to intraLATA and
local
calling, to clarify the scope of FCC jurisdiction over VoIP services, and
to
limit the ability of local governments to require telephone companies to
obtain
video franchise rights. Legislation is also possible to address customer
proprietary network information to address Congressional concerns with regard
to
impersonation of consumers in order to illegally obtain calling information
(pre-texting) as well as other issues relating identify fraud and privacy.
We
are unable to predict when any such legislation will be enacted and if such
legislation will have an impact on our operations.
28
State
Regulation
The
1934
Act maintains the authority of individual states to impose their own regulation
of rates, terms and conditions of intrastate services, so long as such
regulation is not inconsistent with the requirements of federal law. Because
we
provide communications services that originate and terminate within individual
states, including both local service and in-state long distance toll calls,
we
are subject to the jurisdiction of the PUC and other regulators in each state
in
which we provide such services. For instance, we must obtain a Certificate
of
Public Convenience and Necessity or similar authorization before we may commence
the provision of communications services in a state. We have obtained
Certificates of Public Convenience and Necessity to provide facilities-based
or
resold competitive local and interexchange service in every state, including
the
District of Columbia. As our local service business expands, we may offer
additional intrastate services and may become subject to additional state
regulations.
In
addition to requiring certification, state regulatory authorities may impose
tariff and filing requirements and obligations to contribute to state universal
service and other funds. State commissions also have jurisdiction to approve
negotiated rates, and to establish rates through arbitration for
interconnection, including rates for unbundled network elements.
We
also
are subject to state laws and regulations regarding slamming, cramming and
other
consumer protection and disclosure regulations. These rules could substantially
increase the cost of doing business in any particular state. State commissions
have issued or proposed several substantial fines against competitive local
exchange companies for slamming or cramming. The risk of financial damage
from
slamming, in the form of fines, penalties and legal fees and costs, and to
business reputation is significant. A slamming complaint before a state
commission could generate substantial litigation expenses. In addition, state
law enforcement authorities may use their consumer protection authority against
us if we fail to meet applicable state law requirements.
States
also retain the right to sanction a service provider or to revoke certification
if a service provider violates relevant laws or regulations. If any regulatory
agency were to conclude that we are or were providing intrastate services
without the appropriate authority, the agency could initiate enforcement
actions, which could include the imposition of fines, a requirement to disgorge
revenues, or refusal to grant regulatory authority necessary for the future
provision of intrastate services.
We
may be
subject to requirements in some states to obtain prior approval for, or notify
the state commission of, any transfers of control, sales of assets, corporate
reorganizations, issuance of stock or debt instruments and related transactions.
Although we believe such authorizations could be obtained in due course,
there
can be no assurance that state commissions would grant us authority to complete
any of these transactions, or that such authority would be granted on a timely
basis.
29
Rates
for
intrastate switched access services, which we provide to long-distance companies
to originate and terminate in-state toll calls, are subject to the jurisdiction
of the state in which the call originated and /or terminated. Such regulation
by
states could have a material adverse affect on our revenues and business
opportunities within that state. State PUCs also regulate the rates incumbent
local exchange companies charge for interconnection of network elements with,
and resale of services by, competitors. In response to the USTA II
decision
and the FCC's TRO
and
TRRO
proceedings, some state commissions have continued proceedings to address
issues
affecting the rates, terms and conditions of intrastate services while other
states suspended or terminated their proceedings. Any such proceedings may
affect the rates, terms, and conditions contained in our interconnection
agreements. The pricing, terms and conditions under which the incumbent local
exchange company in each of the states in which we currently operate offers
such
services may preclude our ability to offer a competitively viable and profitable
product within these and other states prospectively.
Some
states are considering enactment of legislation that would deregulate
incumbent
local exchange company
broadband facilities and services. If such legislation became law, it could
prevent state regulators from requiring that incumbent
local exchange companies
allow
competitive carriers to interconnect with critical facilities used to provide
broadband services on reasonable terms.
In
November 2005, the Michigan Telecommunications Act was renewed for four years
and was amended to eliminate retail price regulation over most telecommunication
services.
Local
Regulation
In
some
municipalities where we have installed facilities, we are required to pay
license or franchise fees based on a percentage of our revenue generated
from
within the municipal boundaries. We cannot guarantee that fees will remain
at
their current levels following the expiration of existing franchises or that
other local jurisdictions will not impose similar fees.
Federal
and State Regulation of Marketing
Our
current and past direct and partner marketing efforts all require compliance
with relevant federal and state regulations that govern the sale of
telecommunication services. The FCC and many states have rules that prohibit
switching a customer from one carrier to another without the customer’s express
consent and specify how that consent must be obtained and verified. Most
states
also have consumer protection laws that further define the framework within
which our marketing activities must be conducted. While directed at curbing
abusive marketing practices, the design and enforcement of these rules can
have
the incidental effect of entrenching incumbent local exchange companies and
hindering the growth of new competitors, such as our business.
30
Our
marketing efforts are carried out through a variety of marketing programs,
including referrals from existing customers, outbound telemarketing, direct
sales through independent agents, broadcast media, online marketing initiatives
and direct mail. Restrictions on the marketing of telecommunication services
are
becoming stricter in the wake of widespread consumer complaints throughout
the
industry about "slamming" (the unauthorized change of a customer’s service from
one carrier to another carrier) and "cramming" (the unauthorized provision
of
additional telecommunication services). The 1996 Act strengthened penalties
against slamming, and the FCC issued and updated rules tightening federal
requirements for the verification of orders for telecommunication services
and
establishing additional financial penalties for slamming. In addition, many
states have been active in restricting marketing through new legislation
and
regulation, as well as through enhanced enforcement activities. On October
1,
2003, the FCC's rules and regulations governing the creation and enforcement
of
national "do not call" databases became effective, which has had the effect
of
reducing the total number of leads available to us for outbound telemarketing
(which is currently one of our important sales channels) in a given market.
On
February 18, 2005, the FCC released new rules that clarified certain aspects
of
the national “do not call” database. Notwithstanding, we can still market to
these leads through our other sales channels, including direct mail. Our
marketing activities have subjected us to investigations or enforcement actions
by government authorities. The constraints of federal and state regulation,
as
well as increased FCC, Federal Trade Commission and state enforcement attention,
could limit the scope and the success of our marketing efforts and subject
them
to enforcement actions, which may have an adverse effect on us.
Statutes
and regulations designed to protect consumer privacy also may have the
incidental effect of hindering the growth of newer telecommunication carriers
such as us. For example, the FCC rules that restrict the use of "customer
proprietary network information" (information that a carrier obtains about
its
customers through their use of the carrier’s services) may make it more
difficult for us to market additional telecommunication services (such as
local
and wireless), as well as other services and products, to our existing
customers.
Other
Domestic Regulation
We
are
subject to a variety of federal, state, and local environmental, safety and
health laws, and regulations governing matters such as the generation, storage,
handling, use, and transportation of hazardous materials, the emission and
discharge of hazardous materials into the atmosphere, the emission of
electromagnetic radiation, the protection of wetlands, historic sites, and
endangered species and the health and safety of employees. We also may be
subject to laws requiring the investigation and cleanup of contamination
at
sites we own or operate or at third-party waste disposal sites. Such laws
often
impose liability even if the owner or operator did not know of, or was not
responsible for, the contamination.
We
operate several sites in connection with our operations. We are not aware
of any
liability or alleged liability at any operated sites or third-party waste
disposal sites that would be expected to have a material adverse effect on
us.
Although we monitor our compliance with environmental, safety and health
laws
and regulations, we cannot give assurances that it has been or will be in
complete compliance with these laws and regulations. We may be subject to
fines
or other sanctions by federal, state and local governmental authorities if
we
fail to obtain required permits or violate applicable laws and
regulations.
31
OUR
COMPETITION
We
face
significant competition in all of our service areas, both residential and
business. The telecommunications industry is highly competitive. Major
participants in the industry regularly introduce new services and marketing
activities. Competition in the telecommunication industry is based upon the
ability to offer services at competitive prices, customer service, billing
service and perceived quality. We face competition in all of our service
areas,
including voice, data, Internet, managed services, etc. Competition has led
to
lower prices for services.
Our
principal competitors are AT&T and BellSouth, incumbent local exchange
companies in our networked markets. On March 5, 2006, AT&T and BellSouth
announced that they had entered into an agreement to merge the companies.
The
proposed merger, which is subject to regulatory approval, if completed, may
have
an adverse impact on our business. The incumbent local exchange companies
are
well-capitalized, well-known companies that have the capacity to "bundle"
other
services, such as local and wireless telephone services and high speed Internet
access, with long distance telephone services. The incumbent local exchange
companies' name recognition in their existing markets, the established
relationships that they have with their existing local service customers,
their
ability to take advantage of those relationships, and the FCC’s final rules
regarding the unbundled network element platform that are favorable to the
incumbent local exchange companies, also make it more difficult for us to
compete with them. These companies as well as other incumbent local exchange
companies and the major carriers, including Verizon, have targeted price
plans
at residential customers with significantly simplified rate structures and
with
bundles of local services with long distance, which may lower overall local
and
long distance prices. Competition is also fierce for the small and medium
sized
businesses that we also serve. In addition, other competitive local exchange
carriers, cable televisions companies, direct broadcast satellite companies,
other DSL resellers as well as technological substitutions such as VoIP,
high-speed cable and broadband internet service, e-mail and wireless services
are additional competitors to our services. Many of our competitors have
greater
financial, technical and marketing resources.
During
2005, the number of competitors in the telecommunication industry shrank
significantly as a result of the FCC’s final rules regarding access to the
incumbent local exchange companies’ networks. We expect other competitive local
exchange carriers to likewise decide to cease marketing in 2006, resulting
in
very limited competition for the incumbent local exchange company.
EMPLOYEES
As
of
December 31, 2005, we employed approximately 1,100 persons. Following the
acquisition of NTC, we employed approximately 1,500 persons as of January
4,
2006. We consider relations with our employees to be good.
32
ITEM
1A. RISK FACTORS
Our
business is subject to extensive regulation that continues to change, and
we are
therefore exposed to a variety of risks.
Our
marketing and provision of telecommunication services is subject to significant
regulation and may be adversely affected by regulatory developments at the
federal, state and local levels. These regulations can, among other things,
affect the way we conduct our business, the types of services we may offer,
how
we can market our services, the rates we are permitted to charge for our
services, the availability to us of services and network access that we may
need
from others and the rates we must pay them for these services and the use
of
their networks, all of which may reduce the revenue we generate from our
operating activities and the profitability of our business. These regulations
can affect the level of regulation of other telecommunication services
providers, including the incumbent local exchange carriers, or ILECs, and
their
ability to compete with us. These regulations also determine the level of
contribution we must make to state and federal telecommunication subsidy
programs. If we fail to comply with applicable regulations, or if the
regulations change in a manner adverse to us, including in any of the ways
described in some of the following risk factors, our business and operating
results may suffer.
Our
own local network is dependent upon our ability to obtain access to key network
elements from some of our primary competitors. If we are unable to obtain
these
elements on acceptable terms, we may not be able to continue to offer our
telecommunications services on a profitable basis, if at
all.
We
will
not be able to provide our local voice and data services on a profitable
basis,
if at all, unless we are able to obtain key network elements from some of
our
primary competitors on acceptable terms. To offer local voice and data services
in a market, we must connect our network with the network of the incumbent
carrier in that market. This relationship is governed by an interconnection
agreement between us and the incumbent carrier. We also must lease from these
or
other providers the telephone and data transmission lines we need to connect
customers to our network. Our ability to provide our local voice and data
services is dependent on existing regulations that require these elements
to be
provided to us on specified terms and on the compliance by our competitors
with
these provisioning regulations. In addition, because we rely on a limited
number
of suppliers for access to these network elements, we are vulnerable to the
risk
that we may not be able to renew or renegotiate our contracts with these
suppliers on favorable terms or be able to obtain services under these contracts
promptly.
As
a
result of recent and pending regulatory changes, the incumbent carriers in
the
future may be able to increase significantly the rates they charge us for
these
network elements and services, or even decline to provide some of these network
elements and services under certain circumstances. The rates that these or
other
providers may charge us under future interconnection, lease or resale agreements
may not allow us to offer usage rates that are low enough to attract a
sufficient number of network services customers or to operate at satisfactory
profit margins. In addition, recent and pending regulatory developments and
related judicial decisions have restricted the list of network components
that
incumbent carriers are required to make available on a nondiscriminatory
basis
to competitive carriers such as we.
These
developments or future similar developments could limit or terminate our
access
to the network components we need to provide local voice and data services
and
maintain and expand our own local network and could adversely affect our
ability
to grow our customer base and cost-effectively offer services in our existing
and planned markets.
33
Our
need to comply with extensive government regulatory requirements could increase
our costs and slow our growth and ongoing changes in regulatory requirements
could adversely affect our competitive position.
We
are
subject to varying degrees of federal, state and local regulation. The FCC
exercises jurisdiction over us with respect to interstate and international
services. For example, we must comply with various federal regulations, such
as
the duty to contribute to universal service subsidies. State regulatory
commissions exercise jurisdiction over us because we provide intrastate
services. We are required to obtain regulatory authorization and/or file
tariffs
at state agencies in most of the states in which we operate. Constructing
a
network and selling telephone service is also subject to numerous local
regulations such as building codes and licensing. Such regulations vary on
a
city by city and county by county basis. Failure to comply with federal and
state reporting and regulatory requirements may result in fines or other
penalties, including loss of certification to provide services.
The
ILECs
with whom we compete generally have significantly greater resources than
we do
to pursue their regulatory and legislative agendas in the jurisdictions where
we
compete. State authorities may continue to relax restrictions on the ILECs
through increased pricing flexibility for their services and other regulatory
relief, which could have a material adverse effect on competitive service
providers, including us. Future regulatory provisions may be less favorable
to
competitive service providers and more favorable to the ILECs. Changes in
current or future regulations adopted by the FCC or state regulators, or
other
legislative, administrative or judicial initiatives relating to the
communications industry, could have a material adverse effect on our business,
operating results and financial condition.
Increased
regulation of marketing may hinder our ability to obtain new customers and
may
expose us to increased costs and certain liabilities.
Our
current and past direct and partner marketing efforts all require compliance
with relevant federal and state regulations that govern the sale of
telecommunication services. The FCC and many states have rules that prohibit
switching a customer from one carrier to another without the customer’s express
consent and specify how that consent must be obtained and verified. Most
states
also have consumer protection laws that further define the framework within
which our marketing activities must be conducted. While directed at curbing
abusive marketing practices, the design and enforcement of these rules can
have
the incidental effect of entrenching incumbent local exchange companies and
hindering the growth of new competitors, such as our business.
Our
marketing efforts are carried out through a variety of marketing programs,
including referrals from existing customers, outbound telemarketing, direct
sales through independent contractors, broadcast media, online marketing
initiatives and direct mail. In recent years, restrictions on the marketing
of
telecommunication services have become stricter, including the creation of
national "do not call" databases, and the enforcement of the restrictions
by
federal and state regulatory authorities has intensified. Our marketing
activities have subjected us to investigations or enforcement actions by
government authorities. The constraints of federal and state regulation,
as well
as increased FCC, Federal Trade Commission and state enforcement attention,
could limit the scope and the success of our marketing efforts and subject
them
to enforcement actions, which may have an adverse effect on us.
Statutes
and regulations designed to protect consumer privacy also may have the
incidental effect of hindering the growth of newer telecommunication carriers
such as we. For example, the FCC rules that restrict the use of "customer
proprietary network information" (information that a carrier obtains about
its
customers through their use of the carrier’s services) may make it more
difficult for us to market additional telecommunication services (such as
local
and wireless), as well as other services and products, to our existing
customers.
34
We
are in a highly competitive industry.
We
face
significant competition in all of our service areas, both business and
residential. The telecommunications industry is highly competitive. Major
participants in the industry regularly introduce new services and marketing
activities. Competition in the telecommunication industry is based upon the
ability to offer services at competitive prices, customer service, billing
service and perceived quality. We face competition in all of our service
areas,
including voice, data, Internet and managed services. Many of our competitors
have greater financial, technical and marketing resources. Competition has
led
to lower prices for services.
Our
principal competitors are AT&T and BellSouth, the incumbent local exchange
carriers in our networked markets. The incumbent local exchange carriers
are
well-capitalized, well-known companies with significantly greater resources
than
we. They have the capacity to "bundle" other services, such as local and
wireless telephone services and high speed Internet access, with long distance
telephone services. On March 5, 2006, AT&T and BellSouth announced that they
had entered into an agreement to merge the companies. The proposed merger,
which
is subject to regulatory approval, will merge our two largest vendors into
one
entity. This merger, if completed, may have an adverse impact on our business.
The
incumbent local exchange carriers' name recognition in their existing markets,
the established relationships that they have with their existing local service
customers, their ability to take advantage of those relationships, and their
ability to apply their significantly greater resources to influence applicable
regulations in ways that are more favorable to them, also make it more difficult
for us to compete with them. These companies as well as other incumbent local
exchange carriers and the major carriers, including Verizon and Sprint Nextel,
have targeted price plans at residential customers with significantly simplified
rate structures and with bundles of local services with long distance, which
may
lower overall local and long distance prices. Competition is also fierce
for the
small- and medium-sized businesses that we also serve. Other competitive
local
exchange carriers, such as we, are competitors to our services.
We
are
also experiencing increasing competition from wireless communication companies.
Telecommunications carriers that offer both wireless and landline
telecommunications services can offer bundled services that may be more
attractive to our customers than landline offerings alone. Mobile wireless
is
also "cannibalizing" long distance minutes and local landline installations.
In
addition, several wireless competitors operate or plan to operate wireless
telecommunications systems that encompass most of the United States, which
could
give them a significant competitive advantage. We currently do not offer
wireless services in our bundle of services. We could also face additional
competition from users of new wireless technologies including, but not limited
to, currently unlicensed spectrum.
Additionally,
cable companies and companies using the cable lines for access to the customer,
direct broadcast satellite companies, other DSL resellers, as well as
technological substitutions such as Voice over Internet Protocol, or VoIP,
high-speed cable and broadband internet service and e-mail are competitors
to
our services. Many of these service providers are able to offer service at
lower
prices and have begun replacing the traditional land line telecommunications
provider, such as we.
If
we are
not able to compete successfully against our existing competitors and the
new
entrants into the telecommunication services market, our financial condition
and
results of operations could be materially and adversely affected.
35
We
have increased and will continue to increase prices for those customers that
we
are unable to service over our own local network, which will result in increased
customer attrition and associated loss of revenues.
As
a
result of the changes in government regulation that effectively prevent us
from
profitably obtaining new customers in markets where we do not have our own
local
network, we have increased rates for our existing customers that are located
in
such markets and plan to continue increasing rates for these customers to
reflect the increasing costs to us of providing telecommunication services
to
them. While these price increases may increase our current revenues from
such
customers, it will adversely affect our ability to retain such customers
on our
service and negatively affect our revenues over time. These price increases
will
also result in these customers seeking other providers for their
telecommunications needs, further bolstering the dominance of the incumbent
local exchange companies, with whom we compete, in these markets.
We
may be unable to replace those customers that leave our
service.
Purchasers
of our residential local bundled product, which represent the large majority
of
our customers, are not obligated to purchase any minimum amount of our services,
and can stop using our services at any time without penalty. Our customers
may
not continue to buy their local and/or long distance telephone service through
us. If a significant portion of our customers were to decide to purchase
telecommunications service from other service providers, we may not be able
to
replace these customers. Furthermore, we do not intend to seek to replace
those
customers that are outside the service area of our local networks. A high
level
of customer attrition is common in the telecommunications industry, and our
financial results are affected by this attrition. Attrition is attributable
to a
variety of factors, including our termination of customers for nonpayment,
changes in the economy, public impression of the quality of our services
and the
initiatives of existing and new competitors who, to attract new customers,
may
| · |
implement
national advertising campaigns,
|
| · |
utilize
telemarketing programs, and
|
| · |
provide
cash payments and other forms of
incentives.
|
While
we
cannot predict future pricing by our competitors, we anticipate aggressive
price
competition to continue. Lower prices offered by our competitors could
contribute to an increase in our customer turnover, or churn.
36
We
rely upon our local network, long-distance network, proprietary back office
technology and information systems, and third parties to provide services
to our
customers. Interruption or failure of, or failure to manage, these systems
increases the likelihood that we could incur losses or face other
difficulties.
Since
we
operate our own local and long distance switches, our network is subject
to the
risk of significant interruption. Fires or natural disasters, for example,
could
cause damage to our switching equipment or to transmission facilities connecting
our switches. Any interruption in our services over our network caused by
such
damage could have a material adverse impact on our financial condition and
results of operations. In operating our network, we may be unable to connect
and
manage a large number of customers or a large quantity of traffic at high
speeds. Any failure or perceived failure to achieve or maintain high-speed
data
transmission could significantly reduce demand for our services and adversely
affect our operating results. In addition, computer viruses, break-ins, human
error, natural disasters and other problems may disrupt our network. The
network
security and stability measures we implement may be circumvented in the future
or otherwise fail to prevent the disruption of our services. The costs and
resources required to eliminate computer viruses and other security problems
may
result in interruptions, delays or cessation of services to our customers,
which
could decrease demand, decrease our revenue and slow our planned
expansion.
We
rely
on our proprietary back office technology to support all aspects of our
operations. Should our systems fail and we are unable to return them to
operation in an acceptable timeframe or lose valuable customer data, our
operational and financial condition will be adversely affected. If we are
unable
to integrate the back-office systems of our newly acquired companies, or
to
maintain or enhance our back office information systems, we may not be able
to
expand our revenue as quickly as we plan or to compete effectively.
Sophisticated back office information systems are vital to our revenue growth
and our ability to monitor costs, bill customers, initiate, implement and
track
customer orders and achieve operating efficiencies. We must select products
and
services offered by third-party vendors and efficiently integrate those products
and services into our existing back office operations. We may not successfully
implement these products, services and systems on a timely basis, and our
systems may fail to perform as we expect. A failure or delay in the expected
integration or performance of our back office systems could slow the pace
of our
expected revenue growth or harm our competitiveness by adversely affecting
our
service quality.
We
obtain
services from various long distance and local carriers of telecommunications
services for our customers. If these carriers fail to provide service or
the
provision of such services is interrupted, our customers would still hold
us
responsible and this could have a material adverse effect on our financial
condition and results of operations.
We
obtain
the majority of our network equipment and software from third party suppliers.
In addition, we rely on these suppliers for technical support and assistance.
If
any of our suppliers were to terminate our relationship or were to cease
making
the equipment we use, our ability to maintain, upgrade or expand our network
could be impaired. Although we believe that we would be able to address our
future equipment needs with equipment obtained from other suppliers, such
equipment could prove to be incompatible with our network or only compatible
with significant modifications and cost. If we are unable to obtain the
equipment necessary to maintain our network, our ability to attract and retain
customers and provide our services would be impaired and our results of
operations could be materially adversely affected.
37
Difficulties
presented by natural disaster, economic, political, legal, health, accounting
and business factors could negatively affect our
business.
We
provide services in various states across the United States. As a result,
our
business is subject to political and economic fluctuations in various states
and
geographic regions. In addition, we currently have physical assets and employees
in sixteen states.
The
day-to-day operation of our business is highly dependent on the integrity
of our
communications and information technology systems, and on our ability to
protect
those systems from damage or interruptions by events beyond our control.
Sabotage, computer viruses or other infiltration by third parties could damage
our systems. Such events could disrupt our service, damage our facilities,
damage our reputation, and cause us to lose customers, among other things,
and
could harm our results of operations. In addition, a catastrophic event could
materially harm our operating results and financial condition. Catastrophic
events could include a terrorist attack on the United States, or a major
earthquake, hurricane, fire, or similar event that affects our central offices,
corporate offices, network operations center or network equipment. We believe
that communications infrastructures, such as the ones on which we rely, may
be
vulnerable in the case of such an event and our markets, which are generally
urban markets, may be more likely to be the targets of terrorist activity.
If we
fail to manage these operations successfully, our ability to service our
clients
and grow our business will be seriously impeded.
We
currently use soft-switching IP technology in lieu of traditional switching
to
offer local service in certain markets, which may result in operational failures
and higher-than-anticipated costs.
We
currently use soft-switching IP technology in certain markets to reduce our
costs of servicing our existing and new customers. We are initially implementing
the technology in Grand Rapids, Michigan and Atlanta, Georgia and continue
to
evaluate the use of this technology in other markets. IP technology enables
voice and data services to be carried using common transport elements, reducing
the cost of providing services compared to traditional circuit switched
technology. However, in contrast to the legacy circuit-switch technology
used by
the ILECs and other providers of communications services, our network is
based
on IP technology. This technology is much newer than that used by the legacy
carriers and has not been used on active networks for as long. Although we
believe that IP technology is well-designed for the provision of a broad
array
of communications services to large numbers of users, we have and could continue
to encounter difficulties in adapting our IP-based network to meet the
requirements of future technological advancements or to handle increasingly
higher volumes of voice and data traffic as we grow our business or as our
customers’ usage increases. Further, the newer IP technology may prove to be
unreliable over a long period of time. Any failure of our network could cause
us
to lose market share and could materially harm our results of
operations.
We
must continue to keep pace with technological changes in our industry in
order
to succeed.
We
face
rapid and significant changes in technology. The telecommunications industry
has
changed significantly over the past several years and is continuing to evolve
rapidly. Emerging technologies and services, such as VoIP applications,
broadband services and advanced wireless offerings, could alter the economic
conditions under which the telecommunications industry operates. New
technologies also could lead to the development of new, more convenient and
cost-effective services. In addition, the preferences and requirements of
customers are rapidly changing. Our ability to retain current customers and
attract new customers may be highly dependent on whether we choose the
technologies that have the greatest customer acceptance, are able to adopt
these
new technologies and offer new services when appropriate, or can compete
successfully against other service providers that use these new technologies.
We
cannot predict the effect of technological changes on our business. The
development and offering of new services in response to new technologies
or
consumer demands may require us to increase our capital expenditures
significantly.
38
We
depend upon qualified personnel to implement our strategy and achieve our
goals.
The loss of qualified personnel or our inability to attract and retain key
personnel could materially harm our business.
Our
success in implementing our strategy and achieving our goals will depend,
in
large part, upon the contributions of our qualified technical, marketing,
programming, engineering, sales and management personnel. We also rely on
independent contractors to market and sell our services. If we are unable
to
attract and retain experienced and motivated personnel, including a large
and
effective direct sales force, we may not be able to obtain new customers
or sell
sufficient amounts of service to execute our business plan.
Competition
for qualified personnel is intense. The loss of the services of qualified
personnel, or the inability to attract, retain and motivate qualified personnel,
may prevent us from achieving our goals and could have a material adverse
effect
on our business, financial condition and results of operations. We do not
have
"key man" life insurance on any of our officers or directors.
The
rapid
development of our own network and the efforts to expand its capacity and
our
customer base places a significant strain on our management, operational,
financial and information management systems and controls, personnel and
other
resources. Failure to implement and improve the operational and financial
information management systems and controls necessary to support this growth
and
to maintain our other resources at a pace consistent with industry changes
and
the growth of our business could cause customers to switch to other
telecommunication service providers, which would have a material adverse
effect
on us.
Failure
to provide adequate service to our customers could have a negative effect
on our
financial condition.
We
are
focused upon providing our customers with quality service. We believe that
satisfactorily servicing our customers will encourage customers to remain
on our
service and positively separate us from our competitors. If we are unable
to
provide adequate service to our customers, including customer service, we
could
experience greater attrition of our existing customers and a decrease in
new
customers, which could have a negative effect on our financial
condition.
If
we are unable to successfully continue our acquisition strategy, our growth
may
suffer.
In
the
past twelve months, we have relied on our acquisitions of other companies
to
supplement our internal expansion of our network and customer base and a
significant portion of our current network assets and lines on net have been
added through these acquisitions. In that period, we have acquired customers
and
assets through our acquisitions of LDMI and NTC. In connection with these
acquisitions, we expended an aggregate of approximately $39 million of our
cash-on-hand and issued 1.8 million shares of our common stock. While we
intend,
as part of our growth strategy, to actively seek to identify and pursue further
acquisitions on acceptable terms, which could include the payment of cash
or the
issuance of shares of our stock, we do not know whether we will be able to
make
such acquisitions or the size, timing or terms thereof. If we are unable
to
continue to identify, fund and complete acquisitions on acceptable terms,
our
ability to implement our growth strategy and continue the expansion of our
network and customer base could be significantly hampered, with potentially
adverse consequences to our competitive flexibility, revenues and operating
results.
39
We
may not be successful with the integration of our
acquisitions.
As
part
of our growth strategy, we seek to supplement internal expansion with targeted
acquisitions. We may not be successful in integrating any newly acquired
businesses into our operations. The integration of acquired businesses poses
a
number of significant risks, including the following:
| · |
we
may be unable to retain skilled management, technical, sales and
back
office personnel of acquired
companies;
|
| · |
customers
of acquired companies may resist our marketing programs, pricing
levels or
services;
|
| · |
we
may not successfully incorporate the services of acquired businesses
into
our package of service offerings;
|
| · |
the
attention we can devote to any one acquired company may be restricted
by
our allocation of limited management resources among various integration
efforts;
|
| · |
our
acquisition and integration activities may disrupt our ongoing
business
activities;
|
| · |
we
may be unable to maintain uniform standards, controls, procedures
and
policies throughout all of our acquired companies;
and
|
| · |
our
relationships with vendors may be adversely
affected.
|
We
have
never attempted to integrate operating platforms of this scale, or with the
necessity to serve business customers, and there can be no assurance that
we
will be successful in integrating these customers or be able to enhance these
systems on a timely basis. Even if acquired companies eventually contribute
to
an increase in our profitability, the acquisitions may adversely affect our
operating results in the short term. Our operating results may decrease as
a
result of transaction-related expenses we record for the period in which
we
complete an acquisition. Our operating results may be further reduced by
the
higher operating and administrative expenses we may incur in the periods
immediately preceding and following an acquisition as we seek to integrate
the
acquired business into our operations.
Furthermore,
companies that we may acquire may not have adequate controls and procedures,
including internal control over financial reporting, or may have control
systems
that are not compatible with ours. We will be required to integrate these
companies with our disclosure and financial reporting controls and procedures.
Our failure to do so in a timely manner could have the adverse results discussed
below under the heading, “There are risks with our financial
reporting.”
40
We
may be required to seek financing to support our ongoing efforts to implement
our growth strategy through acquisitions.
We
have
to date been meeting our ongoing cash requirements (including for the conduct
of
our operations, acquisitions and capital expenditures) from our cash-on-hand
and
from cash generated from operations. However, our continued growth through
further acquisitions, may require that we seek alternative sources of funding.
While we believe that we would have access to financing in the public or
private
markets, there can be no assurance as to the timing, amounts, terms or
conditions of any such financing or whether it could be obtained on terms
acceptable to us. The terms of any debt financing will likely include
restrictive covenants that could limit our operating flexibility and our
flexibility in planning for, or reacting to changes in, our business, any
of
which could place us at a competitive disadvantage.
There
are risks with our financial reporting.
We
have
reported material weaknesses in our internal control over financial reporting
in
the past and additional material weaknesses could be identified in the future.
These control deficiencies resulted in the restatement of our financial
statements for each of the quarters in 2003 and year ended December 31, 2003,
and the first, second and third quarters of 2004 and certain audit adjustments
to the fourth quarter 2004 financial statements.
Any
failure by us to maintain or implement required new or improved controls
or to
integrate any newly acquired companies with such controls, or any difficulties
we encounter in their implementation or such integration, could result in
additional significant deficiencies or material weaknesses, cause us to fail
to
meet our periodic reporting obligations or result in material misstatements
in
our financial statements. Any such failure could also adversely affect the
results of periodic management evaluations and annual auditor attestation
reports regarding the effectiveness of our internal control over financial
reporting. The existence of a material weakness could result in errors in
our
financial statements, including errors that would not be prevented or detected,
which in turn could result in a restatement of our financial statements,
cause
us to fail to meet our reporting obligations and cause investors to lose
confidence in our reported financial information, leading to a decline in
our
stock price.
ITEM
1B. UNRESOLVED STAFF COMMENTS
None.
41
ITEM
2. PROPERTIES.
We
own a
24,000 square foot facility in New Hope, Pennsylvania that serves as our
headquarters and is the location of executive, finance, marketing, legal
and
certain information technology development departments. We also own a 32,000
square foot facility located in Palm Harbor, Florida for our sales, provisioning
and customer service operations. We lease 10,000 square feet of office space
in
Reston, Virginia, that is the location of our networking personnel and our
network management center. We lease 43,000 square feet of office space in
Southfield, Michigan, (LDMI’s former headquarters) that is the location of
certain networking, sales, finance and information technology personnel.
We also
lease 54,000 square feet of office space in Pensacola, Florida, (NTC’s former
headquarters), where certain networking, sales, finance and information
technology personnel are located.
We
also
lease properties in the cities in which switches for our network have been
installed and where we have local sales offices. These other leased facilities
included, as of March 1, 2006, 22 office facilities and nine switch facilities
in 25 U.S. cities.
ITEM
3. LEGAL PROCEEDINGS.
We
are
party to a number of legal actions and proceedings arising from our provision
and marketing of telecommunications services (including matters involving
do not
call, customer proprietary network information and billing regulations),
as well
as certain legal actions and regulatory matters arising in the ordinary course
of business. We believe that the ultimate outcome of the foregoing actions
will
not result in a liability that would have a material adverse effect on our
financial condition or results of operations.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
EXECUTIVE
OFFICERS OF THE REGISTRANT
Our
executive officers, as of March 1, 2006, were as follows:
|
Name
|
Age
|
Position
|
||
|
Edward
B. Meyercord, III (1)
|
40
|
Chief
Executive Officer, President and Director
|
||
|
Warren
Brasselle
|
48
|
Executive
Vice President - Network Operations
|
||
|
Jeffrey
Earhart
|
44
|
Executive
Vice President - Customer Operations
|
||
|
Aloysius
T. Lawn, IV
|
47
|
Executive
Vice President - General Counsel and Secretary
|
||
|
Timothy
W. Leonard
|
45
|
Chief
Information Officer
|
||
|
Patrick
O'Leary
|
50
|
Executive
Vice President - Business Services
|
||
|
Thomas
Walsh
|
46
|
Senior
Vice President - Finance and Treasurer
|
||
|
Paul
Walker
|
41
|
Senior
Vice President - Marketing
|
||
|
Mark
Wayne
|
48
|
Senior
Vice President - Business Sales
|
||
|
David
G. Zahka
|
46
|
Chief
Financial Officer
|
||
| (1) |
Director
whose term expires in 2006.
|
42
All
officers are elected annually by the Board of Directors and hold office until
their successors are elected and qualified.
EDWARD
B.
MEYERCORD, III. Mr. Meyercord currently serves as our Chief Executive Officer
and President. From May 2001 through December 2003, Mr. Meyercord served
as our
President. He served as our Chief Financial Officer between August 1999 and
December 2001 and Chief Operating Officer between January 2000 and May 2001.
He
joined us in September of 1996 as the Executive Vice President, Marketing
and
Corporate Development. Prior to joining us, Mr. Meyercord was a Vice President
in the Global Telecommunications Corporate Finance Group at Salomon Brothers,
Inc., based in New York. Prior to Salomon Brothers he worked in the corporate
finance department at PaineWebber Incorporated. Mr. Meyercord is also a member
of our Board of Directors.
WARREN
BRASSELLE. Mr. Brasselle currently serves us as Executive Vice President
-
Network Operations. Between April 2000 and February 2004, Mr. Brasselle served
us as Senior Vice President - Operations. Prior to joining us, Mr. Brasselle
was
Vice President of Operations for Cable and Wireless North America since 1996,
where he was broadly responsible for the design, provisioning, and maintenance
of Cable & Wireless' voice, data, and IP network. Mr. Brasselle also held a
variety of operational positions at MCI and Williams
Telecommunications.
JEFFREY
EARHART. Mr. Earhart currently serves us as Executive Vice President - Customer
Operations. Between 2000 and 2004, he served us as Senior Vice President
-
Customer Operations and between 1997 and 2000, as Vice President, Operations.
Mr. Earhart originally joined us as our Director of Retail Sales and
Provisioning in 1990, a position he held until 1992. Prior to rejoining us
in
1997, Mr. Earhart served as President of Collective Communications Services,
an
independent long distance reseller of our long distance services.
ALOYSIUS
T. LAWN, IV. Mr. Lawn joined us in January 1996 and currently serves as our
Executive Vice President - General Counsel and Secretary. Prior to joining
us,
from 1985 through 1995, Mr. Lawn was an attorney in private
practice.
TIMOTHY
W. LEONARD. Mr. Leonard joined us in September 2000 and currently serves
as our
Chief Information Officer. Prior to joining us, from 1991 through 2000, Mr.
Leonard was an independent contractor who performed engagements in the
information technology area for numerous Fortune 1000 companies. From 1988
to
1991, Mr. Leonard served as a senior consultant with the PA Consulting Group,
an
information technology consulting company.
PATRICK
O'LEARY. Mr. O'Leary currently serves as our Executive Vice President - Business
Services. Mr.
O'Leary joined us in July 2005 in connection with our acquisition of LDMI,
where
he served as Chairman of the Board, Chief Executive Officer and President.
Prior
to joining LDMI in 1995, Mr. O'Leary served as the Director of Marketing
for
Allnet Communications, a telecommunications provider.
THOMAS
M.
WALSH. Mr. Walsh joined us in September 2000 and currently serves as our
Senior
Vice President - Finance and Treasurer. Before joining us, he served as director
of finance at Comcast Cellular Communications, a telecommunications company,
from 1996 to 1999, and Regional Controller of SBC Mobil Systems, a successor
corporation, from 1999 to 2000. Prior to Comcast Cellular Communications,
he
worked for Call Technology Corporation, a telecommunications company, where
he
was responsible for all finance and accounting functions as Chief Financial
Officer. Prior to his tenure with Call Technology Corporation, Mr. Walsh
served
as an Audit Manager for Ernst & Young. Mr. Walsh is a Certified Public
Accountant.
PAUL
WALKER. Mr. Walker joined us in January 2005 and currently serves as our
Senior
Vice President - Marketing. Prior to joining us, he served as the Director
of
Marketing for Worldnet, a telecommunications division of AT&T, for fourteen
years.
MARK
WAYNE. Mr. Wayne currently serves as our Senior Vice President - Business
Sales.
Mr. Wayne joined us in July 2005 in connection with our acquisition of LDMI,
where he served as the Executive Vice President of Sales and Marketing. Prior
to
joining LDMI in 2001, he served as President, Chief Operating Officer and
a
member of the Board of Directors of BullsEye Telecom. Prior to that, he served
as director of marketing, local services at Midcom Communications and vice
president, marketing and vendor relations at USN Communications in Chicago.
Mr.
Wayne also spent 13 years at Ameritech, where he was a senior director at
Ameritech Information Industry Services.
DAVID
G.
ZAHKA. Mr. Zahka joined us in December 2001 as Chief Financial Officer. Before
joining us, he spent more than 15 years with PaineWebber Incorporated, and
its
successor UBS Warburg, where he served most recently as Executive Director
of
the Financial Sponsors Group. At PaineWebber, Mr. Zahka also served as Senior
Vice President of Debt Capital Markets and First Vice President of its Utility
Finance Group.
43
PART
II
ITEM
5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER
PURCHASES OF EQUITY SECURITIES.
Market
Information; Holders; Dividends
Our
common stock, $.01 par value per share, is traded on the Nasdaq National
Market
under the symbol "TALK." As of March 1, 2006, there were approximately 870
record holders of our common stock. We have never declared or paid any cash
dividends on our capital stock and do not anticipate paying cash dividends
in
the foreseeable future. High and low quotations listed below are actual closing
sales prices as reported by the Nasdaq National Market:
|
Common
Stock
|
Price
Range Of Common Stock
|
||||||
|
|
High
|
Low
|
|||||
|
2004
|
|||||||
|
First
Quarter
|
$
|
12.05
|
$
|
8.14
|
|||
|
Second
Quarter
|
10.05
|
7.07
|
|||||
|
Third
Quarter
|
7.70
|
5.05
|
|||||
|
Fourth
Quarter
|
7.47
|
5.01
|
|||||
|
2005
|
|||||||
|
First
Quarter
|
6.71
|
5.85
|
|||||
|
Second
Quarter
|
10.21
|
6.26
|
|||||
|
Third
Quarter
|
11.61
|
8.58
|
|||||
|
Fourth
Quarter
|
10.01
|
8.63
|
|||||
Stock
Purchases
We
made
no purchases of our common stock in the quarter ended December 31, 2005.
On June
1, 2004, we announced that our Board of Directors had authorized a share
buy
back program for us to purchase up to $50 million of our outstanding shares.
The
shares may be purchased from time to time on the open market and in private
transactions. There is currently no stated expiration date for this program
and
through December 31, 2005, we had not purchased any shares under this
program.
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
ITEM
9B. OTHER INFORMATION.
None.
44
PART
III
The
information called for by Part III of Form 10-K (Item 10 —
Directors and Executive Officers of the Registrant, Item 11 —
Executive Compensation, Item 12 — Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters,
Item 13 — Certain Relationships and Related Transactions, and
Item 14 — Principal Accounting Fees and Services), to the extent not
set forth in
Part I
of this Form 10-K Report under the caption“EXECUTIVE
OFFICERS OF THE REGISTRANT,”
is
incorporated by reference from our definitive proxy statement, which will
be
filed with the Securities and Exchange Commission within 120 days after the
end of the fiscal year to which this Annual Report relates. The
information regarding our executive officers included in Part I of this Annual
Report under the caption “EXECUTIVE OFFICERS OF THE REGISTRANT” is incorporated
herein by reference.
PART
IV
ITEM
15. EXHIBITS
(a)
(3)
EXHIBITS:
EXHIBIT
NUMBER
DESCRIPTION
|
3.1
|
Our
composite form of Amended and Restated Certificate of Incorporation,
as
amended through October 15, 2002 (incorporated by reference to
Exhibit 3.2
to our Current Report on Form 8-K, dated October 16, 2002).
|
|
3.2
|
Our
Bylaws (incorporated by reference to Exhibit 3.2 to our registration
statement on Form S-1 (File No. 33-94940)).
|
|
3.3
|
Certificate
of Designation of Series A Junior Participating Preferred Stock
dated
August 27, 1999 (incorporated by reference to Exhibit A to Exhibit
1 to
our registration statement on Form 8-A (File No. 000-26728)).
|
|
4.1
|
Specimen
of Talk America Holdings, Inc. common stock certificate (incorporated
by
reference to Exhibit 4.1 to our Annual Report on Form 10-K for
the year
ended December 31, 2002).
|
|
4.2
|
Form
of Warrant Agreement for MCG Credit Corporation dated August 9,
2000
(incorporated by reference to Exhibit 4.3 to our Annual Report
on Form
10-K for the year ended December 31, 2000).
|
|
4.3
|
Form
of Warrant Agreement for MCG Credit Corporation dated October 20,
2000
(incorporated by reference to Exhibit 4.4 to our Annual Report
on Form
10-K for the year ended December 31, 2000).
|
|
4.4
|
Form
of Warrant Agreement for MCG Finance Corporation dated October
20, 2000
(incorporated by reference to Exhibit 4.5 to our Annual Report
on Form
10-K for the year ended December 31, 2000).
|
|
10.1
|
Employment
Agreement with Aloysius T. Lawn, IV dated July 30, 2004 (incorporated
by
reference to Exhibit 10.4 to our Quarterly Report on Form 10-Q
for the
quarter ended September 30, 2004).*
|
|
10.2
|
Employment
Agreement with Edward B. Meyercord, III dated January 1, 2004
(incorporated by reference to Exhibit 10.2 to our Annual Report
on Form
10-K for the year ended December 31, 2003).*
|
|
10.3
|
Tel-Save
Holdings, Inc. 1995 Employee Stock Option Plan (incorporated by
reference
to Exhibit 10.15 to our registration statement on Form S-1 (File
No.
33-94940)).*
|
|
10.4
|
Stock
Option Agreement, dated as of November 13, 1998, with Gabriel Battista
(incorporated by reference to Exhibit 10.4 to our Current Report
on Form
8-K dated January 20, 1999).*
|
|
10.5
|
1998
Long-Term Incentive Plan (incorporated by reference to Exhibit
10.14 to
our Current Report on Form 8-K dated January 20, 1999).*
|
|
10.6
|
2000
Long-Term Incentive Plan (incorporated by reference to Exhibit
10.31 to
our Registration Statement on Form S-4 (No. 333-40980)). *
|
|
10.7
|
Form
of Non-Qualified Stock Option Agreement, dated December 12, 2000,
for each
of Gabriel Battista, Aloysius T. Lawn IV and Edward B. Meyercord,
III
(incorporated by reference to Exhibit 10.40 to our Annual Report
on Form
10-K for the year ended December 31, 2000).*
|
|
10.8
|
Rights
Agreement dated as of August 19, 1999 by and between the Talk.com
Inc. and
First City Transfer Company, as Rights Agent (incorporated by reference
to
Exhibit 1 to our registration statement on Form 8-A (File No. 000-26728)).
|
|
10.9
|
Employment
Agreement with Thomas M. Walsh dated as of May 9, 2005 (incorporated
by
reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q
dated March
31, 2005).*
|
|
10.10
|
Indemnification
Agreement with Thomas M. Walsh dated as of August 7, 2000 (incorporated
by
reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q
dated
November 14, 2000).*
|
|
10.11
|
Non-Qualified
Stock Option Agreement with Thomas M. Walsh dated as of August
7, 2000
(incorporated by reference to Exhibit 10.3 to our Quarterly Report
on Form
10-Q dated November 14, 2000).*
|
|
10.12
|
Lease
by and between Talk.com Holding Corp. and University Science Center,
Inc.
dated April 10, 2000 (incorporated by reference to Exhibit 10.54
to our
Annual Report on Form 10-K for the year ended December 31, 2000).
|
|
10.13
|
Lease
by and between The Other Phone Company, dba Access One Communications
and
University Science Center, Inc. dated December 8, 1999 (incorporated
by
reference to Exhibit 10.55 to our Annual Report on Form 10-K for
the year
ended December 31, 2000).
|
|
10.14
|
Restated
Access One Communications Corp. 1997 Stock Option Plan (incorporated
by
reference to Exhibit 4.2 to our registration statement on Form
S-8 (File
No. 333-52166).*
|
|
10.15
|
Restated
Access One Communications Corp. 1999 Stock Option Plan (incorporated
by
reference to Exhibit 4.3 to our registration statement on Form
S-8 (File
No. 333-52166).*
|
|
10.16
|
Employment
Agreement with Jeffrey Earhart dated July 30, 2004 (incorporated
by
reference to Exhibit 10.3 to our Quarterly Report on Form 10-Q
for the
quarter ended September 30, 2004). *
|
|
10.17
|
Employment
Agreement with Warren Brasselle dated July 30, 2004 (incorporated
by
reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q
for the
quarter ended September 30, 2004).
*
|
|
10.18
|
Employment
Agreement with Timothy Leonard dated March 15, 2005 (incorporated
by
reference to Exhibit 10.18 to our Annual Report on Form 10-K for
the year
ended December 31, 2004).*
|
|
10.19
|
Lease
by and between Talk America Inc. and BTS Owners LLC, dated as of
July 1,
2003 (incorporated by reference to Exhibit 10.24 to our annual
Report on
Form 10-K for the year ended December 31,
2003).
|
|
10.20
|
Amendment
to Office Lease by and between Michigan Plaza LLC (predecessor-in-interest
to BTS Owners LLC) and Talk America Inc. dated November 30, 2005
(filed
herewith).
|
|
10.21
|
First
Amendment, dated as of September 19, 2001, to the Rights Agreement
dated
as of August 19, 1999, by and between Talk America Holdings, Inc.
and
First City Transfer Company, as Rights Agent (incorporated by reference
to
Exhibit 10.9 to our Current Report on Form 8-K filed on September
24,
2001).
|
10.22
Employment Agreement with David G. Zahka dated July 30, 2004 (incorporated
by
reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter
ended September 30, 2004).*
|
10.23
|
Our
2001 Non-Officer Long Term Incentive Plan (incorporated by reference
to
Exhibit 4.1 to our registration statement on Form S-8 (File No.
333-74820).*
|
|
10.24
|
Office
Lease by and between TMT Reston I & II, Inc. and Talk America Inc.
dated as of September 16, 2005 (filed herewith).
|
|
10.25
|
Our
2003 Long Term Incentive Plan (incorporated by reference to Exhibit
B of
our Definitive Proxy Statement filed on May 6,
2003).*
|
|
10.26
|
Second
Amendment to Rights Agreement, dated as of December 13, 2002, to
the
Rights Agreement dated as of August 19, 1999, by and between Talk
America
Holdings, Inc., First City Transfer Company and Stocktrans, Inc.
(incorporated by reference to Exhibit 10.1 to our Current Report
on Form
8-K filed on December 13, 2002).
|
|
10.27
|
2005
Executive Officer and Management Bonus Program Summary (incorporated
by
reference to Exhibit 10.1 to our Current Report on Form 8-K filed
on April
26, 2005) *
|
|
10.28
|
2005
Supplemental Incentive Compensation Plan Summary (incorporated
by
reference to Exhibit 10.2to our Current Report on Form 8-K filed
on April
26, 2005). *
|
|
10.29
|
Consulting
Agreement between Talk America Holdings, Inc. and Gabriel Battista,
dated
as of January 1, 2005 (incorporated by reference to Exhibit 10.1
to our
Current Report on Form 8-K dated January 1, 2005).
|
|
10.30
|
Indemnification
Agreement with Edward B. Meyercord, III dated January 1, 2004
(incorporated by reference to Exhibit 10.4 to our Annual Report
on Form
10-K for the year ended December 31,
2003).
|
|
10.31
|
Employment
Agreement with Gabriel Battista dated January 1, 2004 (incorporated
by
reference to Exhibit 10.6 to our Annual Report on Form 10-K for
the year
ended December 31, 2003).*
|
|
10.32
|
Agreement
and Plan of Merger dated May 23, 2005 among LDMI Telecommunications,
Inc.,
Talk America Holdings, Inc. and Lion Acquisition Corp. (incorporated
by
reference to Exhibit 10.1 to our Current Report on Form 8-K filed
on May
23, 2005).
|
|
10.33
|
Escrow
Agreement, dated as of July 13, 2005 among LDMI Telecommunications,
Inc.,
Talk America Holdings, Inc., the representatives named therein
and U.S.
Bank National Association, as Escrow Agent (incorporated by reference
to
Exhibit 10.2 to our Current Report on Form 8-K filed on July 13,
2005).
|
|
10.34
|
Agreement
and Plan of Merger dated as of October 18, 2005 among NT Corporation,
Talk
America Holdings, Inc. and THNetco, Inc. (incorporated by reference
to
Exhibit 10.1 to our Current Report on Form 8-K filed on October
18, 2005).
|
|
10.35
|
Employment
Agreement with Patrick O'Leary dated July 13, 2005 (incorporated
by
reference to Exhibit 10.3 to our Current Report on Form 8-K filed
on July
13, 2005).*
|
10.36
Employment
Agreement with Mark Wayne dated July 13, 2005 (filed herewith).*
|
10.37
|
Summary
of Talk America Holdings, Inc. Non-Employee Director Compensation
(incorporated by reference to Exhibit 10.1 to our Current Report
on Form
8-K filed on December 28, 2005).*
|
|
10.38
|
Talk
America Executive Nonqualified Savings Plan (incorporated by reference
to
Exhibit 4.1 to Registrant's Registration Statement on Form S-8
(Registration No. 333-131230)).*
|
|
10.39
|
Executive
Officer and Management Bonus Program Summary, as amended as of
February
14, 2006 (incorporated by reference to Exhibit 10.1 to our Current
Report
on Form 8-K filed on February 14,
2005).*
|
|
10.40
|
2006
Executive Officer and Management Bonus Program Summary (incorporated
by
reference to Exhibit 10.2 to our Current Report on Form 8-K filed
on
February 14, 2005).*
|
|
10.41
|
2006
Supplemental Incentive Compensation Plan Summary (incorporated
by
reference to Exhibit 10.3 to our Current Report on Form 8-K filed
on
February 14, 2005).*
|
|
10.42
|
Office
Lease by and between Cordova Associates, LLC and NT Corporation
dated as
of September 7, 2000 (filed herewith).
|
|
10.43
|
Amendment
to Office Lease by and between Cordova Associates, LLC and NT Corporation
dated as of November 28, 2001 (filed
herewith).
|
|
10.44
|
Second
Amendment to Office Lease by and between Cordova Associates, LLC
and NT
Corporation dated as of October 21, 2002 (filed
herewith).
|
|
10.45
|
Office
Lease by and between BSRT Phoenix Business Park, LLC and LightNetworks,
Inc. dated as of January 13, 2000 (filed herewith).
|
|
10.46
|
Amendment
to Office Lease by and between BSRT Phoenix Business Park, LLC
and
LightNetworks, Inc. dated February 17, 2000 (filed herewith).
|
|
10.47
|
Second
Amendment to Office Lease by and between BSRT Phoenix Business
Park, LLC
and LightNetworks, Inc. dated April 17, 2000 (filed
herewith).
|
|
10.48
|
Assignment
of Office Lease by and between LightNetworks, Inc., Network Telephone
Corporation and BSRT Phoenix Business Park, LLC dated September
21, 2000
(filed herewith).
|
|
10.49
|
Amendment
to Office Lease by and between Phoenix Business Park, LLC, successor
to DA
Phoenix, LLC, successor to BSRT Phoenix Business Park LLC and Network
Telephone Inc., successor to LightNetworks, Inc. dated August 4,
2005
(filed herewith).
|
|
10.50
|
Amendment
to Office Lease by and between Phoenix Business Park, LLC and Network
Telephone Inc., dated October ___, 2005 (filed
herewith).
|
|
10.51
|
Amendment
to Office Lease by and between Phoenix Business Park, LLC and Network
Telephone Inc., dated December 21, 2005 (filed
herewith).
|
|
10.52
|
Amendment
to Office Lease by and between Phoenix Business Park, LLC (successor
in
interest to BSRT Phoenix Business Park, LLC and Network Telephone,
Inc.
(successor in interest to LightNetworks, Inc.) dated as of January
9, 2005
(filed herewith).
|
|
10.53
|
Office
Lease by and between American Center LLC and LDMI Telecommunications,
Inc.
dated as of January 28, 2003 (filed herewith).
|
10.54
First Lease Modification to Office Lease by and between American Center LLC
and
LDMI Telecommunications, Inc. dated as of February 13, 2003 (filed herewith).
10.55
Second Lease Modification to Office Lease by and between American Center
LLC and
LDMI Telecommunications, Inc. dated as of May 9, 2003 (filed
herewith).
10.56
Third Lease Modification to Office Lease by and between American Center LLC
and
LDMI Telecommunications, Inc. dated as of October 22, 2003 (filed
herewith).
10.57
Fourth Lease Modification to Office Lease by and between American Center
LLC and
LDMI Telecommunications, Inc. dated as of May 19, 2004 (filed
herewith).
10.58
Fifth Lease Modification to Office Lease by and between American Center LLC
and
LDMI Telecommunications, Inc. dated as of February 1, 2005 (filed
herewith).
10.59
Six Lease Modification to Office Lease by and between American Center LLC
and
LDMI Telecommunications, Inc. dated as of May 1, 2005 (filed
herewith).
10.60
Seventh Lease Modification to Office Lease by and between American Center
LLC
and LDMI Telecommunications, Inc. dated as of October 1, 2005 (filed
herewith).
|
10.61
|
Office
Lease by and between Galleria Equities, LLC and LDMI Telecommunications,
Inc. dated May 31, 2000 (filed
herewith).
|
|
10.62
|
Office
Lease by and between Southfield Technecenter Re 1 LLC and Talk
America
Inc. dated February 24, 2003 (filed
herewith).
|
10.63
Talk America Holdings, Inc. 2003 Long Term Incentive Plan Non-Qualified Stock
Option Agreement for Non-Employee Directors (incorporated by reference to
Exhibit 10.2 to our Current Report on Form 8-K filed on December 29, 2005).
|
14.1
|
Code
of Ethics (incorporated by reference to Exhibit 14.1 to our Annual
Report
on Form 10-K for the year ended December 31,
2003).
|
|
21.1
|
Our
Subsidiaries (filed herewith).
|
*
Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of
1934, the registrant has duly caused this report to be signed on its behalf
by
the undersigned thereunto duly authorized.
Date:
March 16, 2006
TALK
AMERICA HOLDINGS, INC.
By:
/s/
Edward B. Meyercord, III
Edward
B. Meyercord, III
Chief Executive Officer, President
and Director
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed by the following persons on behalf of the registrant in the capacities
and on the dates indicated.
SIGNATURE TITLE
DATE
/s/
Edward B. Meyercord III Chief
Executive
Officer,
March
16,
2006
Edward
B.
Meyercord,
III President
and Director
(Principal
Executive Officer)
/s/
David G. Zahka Chief
Financial Officer
March
16,
2006
David
G.
Zahka (Principal
Financial Officer)
/s/
Thomas M. Walsh Senior
Vice President -
Finance
March
16,
2006
Thomas
M.
Walsh and
Treasurer
(Principal
Accounting Officer)
/s/
Gabriel Battista Chairman
of the Board
March
16,
2006
Gabriel
Battista of
Directors
/s/
Mark S. Fowler
Director
March
16,
2006
Mark
S.
Fowler
/s/
Robert J. Korzeniewski
Director
March
16,
2006
Robert
J.
Korzeniewski
/s/
Ronald R.
Thoma
Director
March
16,
2006
Ronald
R.
Thoma