###### ** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                                                                                                                                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                          |   |
| **ý**                                                                                                                                                    | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                          |   |
| **For the quarterly period ended  September 30, 2003**                                                                                                   |
|                                                                                                                                                          |
| **OR**                                                                                                                                                        |
|                                                                                                                                                          |
| **o**                                                                                                                                                         | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                                          |   |
| **For the transition period  from          to          ** |
|                                                                                                                                                          |
| **Commission File Number: 000-28-559**                                                                                                                        |

 

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**Universal Access GlobalHoldings Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    |   | **36-4408076**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **233 S. Wacker Drive, Suite 600  Chicago, Illinois**           |   | **60606**                             |
| (Address of principal executive offices)                        |   | (Zip Code)                            |
|                                                            |   |                                  |
| **(312) 660-5000**                                         |
| (Registrant’s telephone number, including  area code)      |

 

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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined inExchange Rule 12b-2). Yes o  No ý

 

The number ofshares outstanding of the issuer’s common stock, par value $0.01, as ofOctober 31, 2003 was 11,460,663 shares.

 

 

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**Universal Access Global Holdings Inc.Form 10-QTable of Contents**

 
| Part I               |
|---------------------------|
| **Financial Information** |
|                      |
| Item 1.              | Condensed Consolidated Financial Statements |
|                      |   |
|                      | Condensed Consolidated Balance Sheets at  September 30, 2003 and December 31, 2002 (Unaudited) |
|                      |   |
|                      | Condensed Consolidated Statements of  Operations for the Three Months and Nine Months Ended September 30, 2003  and 2002 (Unaudited) |
|                      |   |
|                      | Condensed Consolidated Statements of Cash  Flows for the Nine  Months Ended  September 30, 2003 and 2002 (Unaudited) |
|                      |   |
|                      | Notes to Condensed Consolidated Financial  Statements (Unaudited) |
|                      |   |
| Item 2.              | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                      |   |
| Item 3.              | Quantitative and Qualitative Disclosures  about Market Risk |
|                      |   |
| Item 4.                   | Controls and Procedures |
|                      |   |
| **Part II**          |
| **Other Information**     |
|                      |   |
| Item 1.              | Legal Proceedings |
|                      |   |
| Item 2.              | Changes in Securities and Use of Proceeds |
|                      |   |
| Item 6.              | Exhibits and Reports on Form 8-K |
|                      |   |
| Signatures                |

 

2

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**PART I.FINANCIAL INFORMATION**

 

## **ITEM I. CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**UNIVERSAL ACCESS GLOBAL HOLDINGS INC. ANDSUBSIDIARIESCONDENSED CONSOLIDATED BALANCESHEETS(in thousands, except share data)(Unaudited)**

 
|                                                                                                                                                                                              |   | **September 30,  2003** |   | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                                                                                                                                                                                              |   |                         |   |                        |   |
| **ASSETS**                                                                                                                                                                                        |   |                         |   |                        |   |
| Current assets:                                                                                                                                                                                   |   |                         |   |                        |   |
| Cash and cash equivalents                                                                                                                                                                         |   | $                            | 16,889 |                        | $      | 12,353 |   |
| Accounts receivable, less allowance for  doubtful accounts of $1,027 and $1,728 at September 30, 2003 and December 31,  2002, respectively                                                        |   | 5,379                        |   | 4,566                       |   |
| Prepaid expenses and other current assets                                                                                                                                                         |   | 3,658                        |   | 2,674                       |   |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| Total current assets                                                                                                                                                                              |   | 25,926                       |   | 19,593                      |   |
| Restricted cash                                                                                                                                                                                   |   | 2,062                        |   | 3,900                       |   |
| Property and equipment, net                                                                                                                                                                       |   | 10,681                       |   | 20,617                      |   |
| Other long-term assets                                                                                                                                                                            |   | 2,144                        |   | 2,607                       |   |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| Total assets                                                                                                                                                                                      |   | $                            | 40,813 |                        | $      | 46,717 |   |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                                    |   |                         |   |                        |   |
| Current liabilities:                                                                                                                                                                              |   |                         |   |                        |   |
| Accounts payable                                                                                                                                                                                  |   | $                            | 2,318  |                        | $      | 2,382 |   |
| Accounts payable – related party                                                                                                                                                             |   | 118                          |   | 0                           |   |
| Non-income tax payable                                                                                                                                                                            |   | 1,696                        |   | 1,071                       |   |
| Accrued carrier expenses                                                                                                                                                                          |   | 11,595                       |   | 15,611                      |   |
| Accrued expenses and other current  liabilities                                                                                                                                                   |   | 1,372                        |   | 2,051                       |   |
| Unearned revenue                                                                                                                                                                                  |   | 9,598                        |   | 9,813                       |   |
| Short-term restructuring liability                                                                                                                                                                |   | 765                          |   | 773                         |   |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| Total current liabilities                                                                                                                                                                         |   | 27,462                       |   | 31,701                      |   |
| Security deposits payable                                                                                                                                                                         |   | 2,238                        |   | 1,859                       |   |
| Notes payable – long-term                                                                                                                                                                    |   | 1,724                        |   | 0                           |   |
| Restructuring liability                                                                                                                                                                           |   | 3,698                        |   | 4,274                       |   |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| Total liabilities                                                                                                                                                                                 |   | 35,122                       |   | 37,834                      |   |
| Commitments and contingencies (Note 9)                                                                                                                                                       |   |                         |   |                        |   |
| Stockholders’ equity :                                                                                                                                                                       |   |                         |   |                        |   |
| Common stock, $.01 par value;  1,000,000,000 shares authorized; 11,459,519 and 4,958,968 shares issued  and outstanding at September 30, 2003 and December 31, 2002,  respectively |   | 115                          |   | 50                          |   |
| Common stock warrants                                                                                                                                                                             |   | 540                          |   | 129                         |   |
| Additional paid-in-capital                                                                                                                                                                        |   | 294,864                      |   | 284,107                     |   |
| Deferred stock plan compensation                                                                                                                                                                  |   | (930                         | )      | (3,010                      | )      |
| Accumulated deficit                                                                                                                                                                               |   | (288,934                     | )      | (271,793                    | )      |
| Accumulated other comprehensive income                                                                                                                                                            |   | 36                           |   | 40                          |   |
| Notes receivable—employees                                                                                                                                                                   |   | 0                            |   | (640                        | )      |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| Total stockholders’ equity                                                                                                                                                                   |   | 5,691                        |   | 8,883                       |   |
|                                                                                                                                                                                              |   |                         |   |                        |   |
| Total liabilities and stockholders’ equity                                                                                                                                                   |   | $                            | 40,813 |                        | $      | 46,717 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

3

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**UNIVERSAL ACCESS GLOBAL HOLDINGS INC. ANDSUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS(in thousands, except share and per share data)(unaudited)**

 
|                                                                 |   | **Three Months Ended****September ****30,** |       | **Nine Months Ended   September 30,** |       |
|----------------------------------------------------------------------|--------|--------------------------------------------------|------------|--------------------------------------------|------------|
|                                                                 |   | **2003**                                         |       | **2002**                                   |       | **2003** |   | **2002** |   |
|                                                                 |   |                                             | ** ** |                                       | ** ** |   | ** ** |   | ** ** |
| Revenues                                                             |   | $                                                | 16,853     |                                       | $          | 27,036 |   | $ | 54,594 |   | $ | 80,229 |   |
| Costs and expenses:                                                  |   |                                             |       |                                       |       |   |   |   |   |
| Cost of circuit access (exclusive of  depreciation shown below)      |   | 12,349                                           |       | 17,172                                     |       | 37,682 |   | 58,526 |   |
| Operations & administration (excluding  stock plan compensation) |   | 7,937                                            |       | 10,730                                     |       | 23,310 |   | 45,972 |   |
| Operations & administration (stock plan  compensation)           |   | 200                                              |       | 729                                        |       | 834 |   | 2,163 |   |
| Impairment of property, plant &  equipment                       |   | 2,550                                            |       | 0                                          |       | 3,749 |   | 46,025 |   |
| Impairment of goodwill                                               |   | 0                                                |       | 0                                          |       | 0 |   | 4,472 |   |
| Depreciation & amortization                                      |   | 1,758                                            |       | 3,082                                      |       | 6,224 |   | 12,970 |   |
| Restructuring charges                                                |   | 0                                                |       | (9,625                                     | )          | 0 |   | (9,625 | ) |
|                                                                 |   |                                             |       |                                       |       |   |   |   |   |
| Total costs and expenses                                             |   | 24,794                                           |       | 22,088                                     |       | 71,799 |   | 160,503 |   |
| Operating income (loss)                                              |   | (7,941                                           | )          | 4,948                                      |       | (17,205 | ) | (80,274 | ) |
| Other income (expense), net                                          |   | 30                                               |       | (482                                       | )     | 64 |   | 18 |   |
|                                                                 |   |                                             |       |                                       |       |   |   |   |   |
| Net income (loss)                                                    |   | $                                                | (7,911     | )                                          | $          | 4,466 |   | $ | (17,141 | ) | $ | (80,256 | ) |
|                                                                 |   |                                             |       |                                       |       |   |   |   |   |
| Basic net income (loss) per weighted  average share                  |   | $                                                | (0.81      | )                                          | $          | 0.91 |   | $ | (2.61 | ) | $ | (16.30 | ) |
| Diluted net income (loss) per weighted  average share                |   | $                                                | (0.81      | )                                          | $          | 0.89 |   | $ | (2.61 | ) | $ | (16.30 | ) |
| Weighted average shares, basic                                       |   | 9,802                                            |       | 4,923                                      |       | 6,572 |   | 4,923 |   |
| Weighted average shares, diluted                                     |   | 9,802                                            |       | 5,044                                      |       | 6,572 |   | 4,923 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

4

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**UNIVERSAL ACCESS GLOBAL HOLDINGS INC. ANDSUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(in thousands)(unaudited)**

 
|                                                                                |   | **Nine Months Ended  September 30,** |    |
|-------------------------------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                                                |   | **2003**                                  |    | **2002** |   |
|                                                                                |   |                                      |    |   |   |
| **Cash flows from  operating activities:**                                          |   |                                      |    |   |   |
| Net cash used by operating activities                                               |   | $                                         | (12,725 | ) | $ | (30,850 | ) |
| **Cash flows from  investing activities:**                                          |   |                                      |    |   |   |
| Additions to property, plant, &  equipment                                      |   | (112                                      | )       | (6,443 | ) |
| Proceeds from sales of property, plant,  & equipment                            |   | 338                                       |    | 0 |   |
| Increase in notes receivable                                                        |   | 0                                         |    | (2,080 | ) |
| Sale of short-term investments                                                      |   | 0                                         |    | 26,299 |   |
|                                                                                |   |                                      |    |   |   |
| Net cash provided/(used) by investing  activities                                   |   | 226                                       |    | 17,776 |   |
| **Cash flows from  financing activities:**                                          |   |                                      |    |   |   |
| Payments on capital lease obligations                                               |   | 0                                         |    | (3,467 | ) |
| Payment of long-term and short-term  obligations                                    |   | (5,000                                    | )       | (932 | ) |
| Proceeds of short-term notes payable                                                |   | 5,000                                     |    | 0 |   |
| Proceeds from issuance of common stock  pursuant to stock option and purchase plans |   | 153                                       |    | 310 |   |
| Proceeds from issuance of common stock, net                                         |   | 15,037                                    |    | 0 |   |
| Proceeds from notes receivable—employee                                        |   | 3                                         |    | 69 |   |
| Release of restriction on cash balance                                              |   | 1,846                                     |    | 7,675 |   |
|                                                                                |   |                                      |    |   |   |
| Net cash provided (used) by financing  activities                                   |   | 17,039                                    |    | 3,655 |   |
| Effect of exchange rate changes on cash                                             |   | (4                                        | )       | 43 |   |
| Net increase/(decrease) in cash and cash  equivalents                               |   | 4,536                                     |    | (9,376 | ) |
| Cash and cash equivalents, beginning of  period                                     |   | 12,353                                    |    | 20,758 |   |
|                                                                                |   |                                      |    |   |   |
| Cash and cash equivalents, end of period                                            |   | $                                         | 16,889  |   | $ | 11,382 |   |
|                                                                                |   |                                      |    |   |   |
| **Non-cash financing activities:**                                                  |   |                                      |    |   |   |
|                                                                                |   |                                      |    |   |   |
| Redemption of notes receivable using  restricted stock                              |   | 1,217                                     |    | 316 |   |

 

The accompanying notes are an integral partof these condensed consolidated financial statements.

5

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**UNIVERSAL ACCESS GLOBAL HOLDINGS INC.AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS(unaudited)**

 

**Note 1—Basis of Presentation**

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared by Universal Access Global Holdings Inc. (“Holdings”) and itssubsidiaries (collectively, “the Company” or “we”), and reflect alladjustments, consisting only of normal recurring adjustments, which in theopinion of management are necessary to state fairly the financial position andthe results of operations for the interim periods. The statements have beenprepared in accordance with the rules and regulations of the Securities andExchange Commission (the “SEC”). Certain information and footnote disclosuresin financial statements prepared in accordance with generally acceptedaccounting principles have been omitted pursuant to such rules and regulations.These statements should be read in conjunction with the Financial Statementsand Notes thereto included in our 2002 Annual Report on Form 10-K. Resultsfor fiscal 2003 interim periods are not necessarily indicative of results to beexpected for the fiscal year ending December 31, 2003. On August 8,2003, we effected a one-for-twenty reverse stock split.  All share and per share information hereinreflect this reverse stock split except as indicated in Item 4 - Submission ofMatters to a Vote of Security Holders. All numbers presented are in thousands, except share and per shareamounts and where otherwise indicated.

 

**Note 2—Liquidity**

 

Our consolidated financial statements have been prepared assuming wewill continue as a going concern. Effective July 23, 2003, we completedour $16 million capital raising transaction with CityNet Telecommunications,Inc. (“CityNet”), as more fully described below.  We completed this transaction to provide resources to fundoperations focusing on marketing to our four major sales channels: wholesalecarrier, foreign telephony providers, cable and government.  We also plan to use the proceeds to fund targetedinvestments to enhance our existing IT tools to help increase our revenue.

 

Effective April 7, 2003, we entered into a definitive StockPurchase Agreement (the “Purchase Agreement”) with CityNet. Pursuant to theterms of the Purchase Agreement, on July 23, 2003, (a) CityNet paid to us$16 million in cash and transferred to us fiber optic rings located inAlbuquerque, New Mexico and Indianapolis, Indiana having an estimated fairmarket value of $200 thousand, (b) we issued to CityNet newly issued sharesof our common stock representing approximately 55% of our outstandingcommon stock on a fully diluted basis (with any options and warrants having an exercise price in excess of $20.00,adjusted for the August 8, 2003, one-for-twenty reverse stock split, beingexcluded from the calculation of “fully diluted,” subject to CityNet’s right to receivecompensating shares in the event that any of these options or warrants aresubsequently exercised) and (c) we assumed certain liabilities ofCityNet. In particular, we assumed $2 million in principal amount of aPromissory Note executed by CityNet and made to Electro Banque.  The note is secured by the fiber optic ringlocated in Albuquerque, New Mexico, maturesin a single installment on December 31, 2007 and does not bear interestuntil January 1, 2006; thereafter, it bears interest at 8% per annum.

 

Related to this transaction, effective April 7, 2003, we obtained$5 million in secured debt financing from CityNet.  The financing was evidenced by a promissorynote (the “Note”) and secured by substantially all of our assets.  Under the terms of the Note, the unpaidprincipal balance accrued interest at a rate of 12% per annum, compoundedquarterly, and the entire unpaid principal balance and accrued but unpaid interestwas payable on April 6, 2004 unless otherwise accelerated under theNote.  Upon the closing of thePurchase Agreement, principal and accrued interest of $5.2 million under theNote was (in lieu of cash payment to CityNet) applied to reduce the cash portionof the purchase price payable by CityNet under the Purchase Agreement.(Therefore, at the closing of the Purchase Agreement, the Note was cancelledand we received a cash payment of $10.8 million from CityNet).

 

After payingexpenses related to the Purchase Agreement, including interest and appraisalfees, the net proceeds from the Purchase Agreement were approximately$14.7 million.  Pursuant tothe terms of the Purchase Agreement, our board of directors consists of ninemembers, five of whom, including the chairman, have been designated by CityNet.

 

6

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Based on our receipt of net proceeds of approximately $14.7 millionfrom the Purchase Agreement, and assuming (a) our operational cash receiptsremain stable, (b) we generate significantly higher revenues and (c) wecontinue to control uses of cash, we estimate that we will have sufficientliquidity and capital resources to meet our short term liquidity needs. Inaddition, we estimate that meeting all of these conditions will allow us tomeet our long term liquidity goal of funding our business with internallygenerated cash.  We are also currentlyseeking strategic partnership opportunities to help us meet our short and longterm liquidity needs.  However, therecan be no assurance these conditions will be met, and our operational andfinancial flexibility may be limited in the future. Further, unexpected eventsadversely affecting our cash resources, including declines in collections dueto client bankruptcies or deteriorating industry conditions, bankruptcypreference payment settlements, security deposit requirements, acceleratedvendor payment terms, payments required to settle disputes or adverselydetermined litigation, may create a need for us to obtain more funding fromexternal sources.  There can be noassurance that additional financing will be available to us on terms andconditions acceptable to us, if at all.

 

**Note 3—Property and Equipment, Net**

 

Property and equipment consists of the following, stated at the lowerof fair market value or cost:

 
|                                             |   | **September 30, 2003** |   | **December 31, 2002** |   |
|--------------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
|                                             |   |                        |   |                       |   |
| Furniture and fixtures                           |   | $                           | 1,082  |                       | $      | 1,075 |   |
| Leasehold improvements                           |   | 1,442                       |   | 1,442                      |   |
| UTX equipment                                    |   | 10,435                      |   | 15,572                     |   |
| Computer hardware and software                   |   | 21,466                      |   | 21,436                     |   |
| Other equipment                                  |   | 522                         |   | 523                        |   |
|                                             |   |                        |   |                       |   |
| Property and equipment, gross                    |   | 34,947                      |   | 40,048                     |   |
| Less: Accumulated depreciation and  amortization |   | (24,266                     | )      | (19,431                    | )      |
|                                             |   |                        |   |                       |   |
| Property and equipment, net                      |   | $                           | 10,681 |                       | $      | 20,617 |   |

 

Included incost of computer hardware and software are software development and websitecosts of $2.8 million that were capitalized during 2002.  Accumulated amortization related tocapitalized software and website assets was $9.4 million and $4.7 million atSeptember 30, 2003 and December 31, 2002, respectively.

 

**Note 4 - Impairment of Long-Lived Assets**

 

In compliance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets,* we evaluate therecoverability of our long-lived assets. Under SFAS No. 144, an impairmentreview is performed if events occur or circumstances change indicating that thecarrying amount might not be recoverable. Factors considered important thatcould trigger an impairment review include, but are not limited to, a significantdecrease in the market value, a significant adverse change in legal factors orin the business climate, a current period operating or cash flow loss combinedwith a history of operating or cash flow losses or a projection or forecastshowing continuing losses, and a current expectation that more-likely-than-nota long-lived asset will be sold or otherwise disposed of significantly beforethe end of its previously estimated useful life. If any of the impairmentindicators are present or if other circumstances indicate that an impairmentmay exist, we must then determine whether an impairment loss should berecognized. An impairment loss may be recognized only if the undiscounted cashflows used to test for recoverability are less than the carrying value.

 

As of September 30, 2003, we reviewed our assets and determinedthat an impairment existed as a result of circuit disconnections for the UTXassets located at Los Angeles, Washington D.C. and Dallas.  Accordingly, we recognized an impairmentcharge of $2.6 million.  The remainingbook value of these sites reflects the estimated salvage value of $200 thousandper site.  All of our UTXs are nowvalued at the estimated salvage value except for Chicago and New York that havenet book

 

7

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values atSeptember 30, 2003 of $2.2 million and $1.0 million, respectively.  Management believes that all necessaryimpairment adjustments have been made at September 30, 2003; however,management will continue to evaluate its long-lived assets for impairment basedon specific events and circumstances.

 

**Note 5—Other Long-term Assets**

 

During 2001, we paid a supplier $3.3 million in exchange forfavorable pricing terms and were amortizing this cost over the ten-year life ofthe agreement. At December 31, 2002, based on an analysis we performed, weconcluded that we expect to realize the benefits associated with this asset butonly over the next 3.75 years. As a result, starting in 2003 theamortization expense for this asset is being recognized over the remaining3.75 years. The cash flows directly attributable to this asset exceed thenet book value, so no impairment is warranted. Accumulated amortization relatedto this asset was $1 million and $438 thousand at September 30, 2003 and December 31,2002, respectively.

 

We also have security deposits receivable classified as long-termtotaling $628 thousand at September 30, 2003 and $523 thousand atDecember 31, 2002. We pay these security deposits to carriers, landlords,and utility companies in the ordinary course of business.

 

**Note 6—Related Party Transactions**

** **

For the quarter ended September 30,2003, the company has $118 thousand in accounts payable to CityNet mainly forreimbursement of rental payments associated with, and maintenance services for,the optical fiber rings operated in Indianapolis, Indiana, and Albuquerque, NewMexico.  Universal Access entered intoan agreement with CityNet at the time of the Purchase Agreement whereby CityNetwould provide maintenance services for the optical fiber rings operated inIndianapolis, Indiana, and Albuquerque, New Mexico at a rate of $40 thousandper month.  In September 2003, wenotified CityNet of our exercise of a contractual right to cancel theagreement, which will become effective in March 2004.  After cancellation of the agreement, we willutilize internal resources to monitor maintenance for the rings.

 

**Note 7—Term Loans**

** **

As described in Note 2—Liquidity, we assumed as part of thePurchase Agreement with CityNet $2 million in principal amount of a promissorynote executed by CityNet and made to Electro Banque.  The note is secured by the fiber optic ring in Albuquerque, NewMexico transferred to us from CityNet as a part of this same transaction onJuly 23, 2003.  The note matures ina single installment on December 31, 2007 and does not bear interest untilJanuary 1, 2006; thereafter, it bears interest at 8% per annum.  Due to the terms for repayment, the note wasrecorded at a present value of $1.7 million. Amortization of the discount related to this note of $24 thousand wasrecognized in the quarter ended September 30, 2003.   

 

## **Note 8—Restructuring**

 

Therestructuring program is substantially complete, except for facility exit costsand operating lease payments for office equipment. The ability to subletfacilities at the rates contemplated by the restructuring charge will depend onmarket conditions. Amounts relating to facilities will be paid over therespective lease terms through 2013 and will be net of any sublease recoveries,while operating lease payments for office equipment will be paid through 2003.

 

The following summarizes the significant components of therestructuring reserve at September 30, 2003:

 
|                                                       |   | **Balance at  December 31,  2002** |   | **Incurred Cash  Payments** |   | **Balance at  September 30,  2003** |   |
|------------------------------------------------------------|--------|-----------------------------------------|--------|-----------------------------|--------|------------------------------------------|--------|
|                                                       |   |                                    |   |                        |   |                                     |   |
| Facility exit costs, net of estimated  sublease recoveries |   | $                                       | 5,014  |                        | $      | (556                                     | )      | $ | 4,458 |   |
| Other                                                      |   | 33                                      |   | (28                         | )      | 5                                        |   |
| Total                                                      |   | $                                       | 5,047  |                        | $      | (584                                     | )      | $ | 4,463 |   |

 

8

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**Note 9—Commitments and Contingencies**

 

In November 2001, acomplaint was filed in federal district court for the Southern District of NewYork on behalf of a purported class of persons who purchased our stock betweenMarch 16, 2000 and December 6, 2000. The complaint generally allegesthat various underwriters engaged in improper and undisclosed activitiesrelated to the allocation of shares in our initial public offering ofsecurities. The complaint brings claims for violation of several provisions ofthe federal securities laws against the underwriters of our IPO, and alsoagainst us and certain of our former directors and officers under theSecurities Act of 1933 and the Exchange Act of 1934. Similar lawsuitsconcerning more than 300 other companies’ initial public offerings were filedin 2001, all of which were consolidated into a single coordinated proceeding inthe Southern District of New York. We believe that the allegations against usare without merit. On June 30, 2003, the litigation committee ofour board of directors conditionally approved a proposed partial settlementwith the plaintiffs in this matter.  Thesettlement would provide, among other things, a release of us and of theindividual defendants for the conduct alleged in the action to be wrongful inthe complaint.  We would agree toundertake other responsibilities under the partial settlement, includingagreeing to assign away, not assert, or release certain potential claims we mayhave against our underwriters.  Ourinsurers are expected to bear any direct financial impact of the proposedsettlement.   The committee agreed toapprove the settlement subject to a number of conditions, including theparticipation of a substantial number of other issuer defendants in the proposedsettlement, the consent of our insurers to the settlement, and the completionof acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness andapproval by the Court overseeing the litigation.

 

We haveentered into a settlement agreement with respect to an action that Level 3Communications, LLC filed in the United States District Court for theEastern District of Virginia, and which was referred to a bankruptcy judge. Thecomplaint named as defendants the Company, three bankrupt entities (Aleron, Inc.,Aleron U.S., Inc., and TA Acquisition Corp.), and those threeentities’ bankruptcy trustee. In its complaint, Level 3 claimed that itwas owed for certain telecommunication services provided under contractsbetween Level 3 and TA Acquisition and for termination charges underthose contracts. On July 2, 2003, Level 3 Communications, LLCaccepted a settlement agreement entered into in June 2003 relating to theclaims Level 3 brought against us. Under the settlement agreement, we agreed topay Level 3 a total of $1.4 million to settle the litigation and othermatters.  We may use up to $200 thousandof this amount as a prepayment of certain services. On September 3, 2003the bankruptcy court issued an order dismissing us from the suit.  The entire settlement amount of $1.2 millionwas accrued for in the period ending June 30, 2003 in accrued carrierexpenses.  At September 30, 2003,$225 thousand was owed to Level 3 payable in monthly installments of $75thousand.

 

We have reached a settlement agreement withAleron, Inc. and TA Acquisition Corp. regarding potential claimsagainst us.  Under the terms of thesettlement, each party released all claims that it might have had against theother.  Before their conversion underChapter 7 of the Bankruptcy Code, Aleron, Inc. andTA Acquisition Corp. listed potential claims against us in theirChapter 11 schedules listing their assets. Aleron stated that it “hassubstantial breach of contract and other claims against Universal Access”arising out of contractual agreements and provided that the estimated value ofthe claims was between $3 and $5 million. TA Acquisition stated thatit “may have substantial claims against Universal Access” and provided that thevalue of those claims was unknown.  OnOctober 31, 2003, the bankruptcy court issued an order approving the termsof the settlement.

 

We and certain of our formerdirectors and officers are defendants in an action pending in the United StatesDistrict Court for the Eastern District of Texas, Frandsen v. Universal Access,Inc., et al., No. 9:02CV103 (E.D. Tex.). The complaint alleged causes of actionfor securities fraud in connection with public disclosures made by our officersbetween 2000 and 2002. We believe that the allegations against us are withoutmerit. On March 7, 2003, the court granted a motion to dismiss thecomplaint and granted plaintiffs the opportunity to replead the complaint withrespect to a minority of the alleged misstatements.  On May 27, 2003, plaintiffs filed a second amendedconsolidated complaint.  Pursuant to theCourt’s September 17, 2003 order, on October 1, 2003, plaintiffsfiled a revised second amended consolidated

 

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complaint. Defendants’ motion to dismiss is scheduled to be fully briefedand under submission by November 2003. Plaintiffs have not specified theamount of damages they seek.

 

In August 2003, GenuityTelecom Inc. filed a complaint against Universal Access in the United StatesBankruptcy Court for the Southern District of New York.  In its complaint, Genuity alleges that wedid not purchase the minimum amount of telecommunications services specified bythe parties’ contract.  Genuity seeksdamages of approximately $1.6 million, plus costs and interest, representingthe difference between the purported minimum purchase commitment and the amountof telecommunications services we purchased. We believe that Genuity’s claims are without merit. We answeredGenuity’s complaint and asserted several defenses to Genuity’s claims.  We also filed a motion seeking to stay theaction and to compel arbitration of the matter in accordance with the mandatoryarbitration provision in the contract. Genuity assigned the contract to Level 3 Communications, LLC onFebruary 4, 2003 as part of Genuity’s bankruptcy proceeding andreorganization efforts.  The amountsought by Genuity in its complaint relates to our actions prior toFebruary 4, 2003.

 

We are currently subject to negotiations with several carriers tosettle open billing disputes.  We believewe have adequately accrued for any payments required to settle thesedisputes.  We are in negotiations withone carrier where we estimate we will pay between $1.2 million and $2.4 millionto resolve all open disputes totaling $7.5 million.

 

We lease UTX facilities, office facilitiesand certain equipment over periods ranging from two to fifteen years.  In July 2003, we reached a settlementwhereby we paid a landlord the sum of $723 thousand to eliminate a monthlyrental expense of $32 thousand and aggregate minimum lease payments of $3.0million.  This expense was recorded inthe third quarter of 2003.  In addition,the landlord is required to release a letter of credit of $320 thousand within90 days of the settlement payment that we expect to receive in the fourthquarter 2003.  In connection with theclosing under the Purchase Agreement, we also agreed to reimburse CityNet forthree years for the cost of office space leased by CityNet in Maryland withmonthly rental expense of $20 thousand. Rent expense for the nine months ended September 30, 2003 and 2002was approximately $5.75  million and$6.75 million, respectively. Future adjusted rentals for non-cancelableoperating leases, inclusive of amounts in our restructuring liability, are asfollows as of September 30, 2003:

 
| 2003                         |   | $      | 2,014  |   |
|------------------------------|--------|--------|--------|--------|
| 2004                         |   | 8,035  |   |
| 2005                         |   | 6,969  |   |
| 2006                         |   | 6,677  |   |
| 2007                         |   | 6,868  |   |
| Thereafter                   |   | 28,598 |   |
| Total minimum lease payments |   | $      | 59,161 |   |

 

In connection with a lease buyout agreement completed inSeptember 2002, we entered into a new lease for a reduced amount ofoffice space at our principal offices. The new lease requires us to deliver aletter of credit in the amount of $2.5 million to secure our obligationsunder the new lease by October 1, 2003. Delivering this letter of creditwould reduce our cash and cash equivalents and short-term investments, andincrease our restricted cash balance, by $2.5 million.  We are currently under negotiations with thelandlord concerning the $2.5 million deposit and have not paid this amount.  

 

Additionally,we have entered into agreements with various telecommunications vendors topurchase minimum amounts of network services within a defined period, such ason a monthly basis.  In March 2003,we reached a settlement with a supplier that eliminated with that supplier theremaining minimum purchase commitment of approximately $54.8 million as ofDecember 31, 2002.  The adjustedtotal amount of remaining purchase commitments at September 30, 2003 is asfollows:

 
| 2003                               |   | $      | 5,285  |   |
|------------------------------------|--------|--------|--------|--------|
| 2004                               |   | 20,614 |   |
| 2005                               |   | 17,025 |   |
| 2006                               |   | 1,750  |   |
| Total minimum purchase commitments |   | $      | 44,674 |   |

 

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We have standby letters of credit, which have been issued on our behalftotaling $2.1 million, collateralizing performance of certain contractswith carriers, state regulators, and landlords. These letters of creditdirectly relate to the operating leases, carrier agreements, and staterequirements, which they secure, and expire according to the terms andconditions of these agreements.

 

We are involved in various legal matters in the ordinary course ofbusiness. In the opinion of management, the ultimate resolution of thesematters will not have a material adverse impact on our financial position,results of operations or cash flows.

 

**Note 10—Executive Notes**

 

During 2002, we recorded a charge of $1.7 million related to notesreceivable from certain of our current and former executives. The notesevidenced loans made to these individuals, including loans made in part tocover exercise price and payroll tax obligations in connection with theexercise of options to acquire our common stock. Each note allows theindividual to satisfy the outstanding principal balance thereof (and in onecase, the principal and interest owed under the note) by returning a fixednumber of shares of our common stock. The charge reduced the value of the notesreceivable to the total amount we would receive if the notes were to besatisfied by the return of shares of our common stock, based on the closingprice of our common stock on September 30, 2002. We adjust this charge asour stock price changes to reflect the value of the notes receivable as of eachbalance sheet date.

 

In the quarterended September 30, 2003, the remainder of our officer notes and amountsof related accrued and unpaid interest were repaid by certain of our formerofficers through the return of 54,458 shares of our common stock.  For the three months endedSeptember 30, 2003, we recorded an additional charge of $38 thousand dueto a lower valuation of the shares returned to us to repay certain officernotes than the amount previously recorded. For the nine months ended September 30, 2003, we reversed $592thousand in reserves for these notes from the initial $1.7 million charged in 2002.  The Company retired the returned shares.

 

**Note 11—Comprehensive Income**

 

Comprehensiveincome, which includes net income and all other non-owner changes in equityduring a period, is as follows for the three and nine months endedSeptember 30, 2003 and 2002:

 
|                                     |   | **Three Months  Ended September 30,** |   | **Nine Months  Ended September 30,** |   |
|------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                     |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                     |   |                                       |   |                                      |   |   |   |   |   |
| Net income (loss)                        |   | $                                          | (7,911 | )                                         | $      | 4,466 |   | $ | (17,141 | ) | $ | (80,256 | ) |
| Foreign currency translation adjustments |   | (7                                         | )      | 61                                        |   | (4 | ) | 43 |   |
|                                     |   |                                       |   |                                      |   |   |   |   |   |
| Comprehensive net income (loss)          |   | $                                          | (7,918 | )                                         | $      | 4,527 |   | $ | (17,145 | ) | $ | (80,213 | ) |

 

**Note 12—Stock-Based Compensation Plans**

 

Effective for2003, we adopted the disclosure requirements under Statement of FinancialStandards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation –Transition and Disclosure,” as an amendment of SFAS No. 123. Stock-basedemployee compensation, including stock options, is accounted for under theintrinsic value method as prescribed by Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees.”  No compensation expense is recognized forthese options when they are issued at fair market value at date of grant.  If options are granted at an exercise pricebelow fair market value to employees, stock plan compensation expense isdeferred for an amount equal to the intrinsic value on the grant date andrecognized over the respective vesting period.

 

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If we were torecognize compensation expense over the relevant service period under thefair-value method of SFAS No. 123 with respect to stock options granted andemployee stock purchases for the three months and nine months endedSeptember 30, 2003 and all prior periods, net loss would have increased,resulting in pro forma net losses and losses per share as presented below:

 
|                                                                                                                   |   | **Three  MonthsEnded September 30,** |   | **Nine  Months  Ended September 30,** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                                                   |   | **2003**                                  |   | **2002**                                   |   | **2003** |   | **2002** |   |
| Net income (loss):                                                                                                     |   |                                      |   |                                       |   |   |   |   |   |
| As reported                                                                                                            |   | $                                         | (7,911 | )                                          | $      | 4,466 |   | $ | (17,141 | ) | $ | (80,256 | ) |
| Less:   Stock-based compensation expense determined under fair value method  for all awards, net of related taxes |   | (456                                      | )      | (322                                       | )      | (950 | ) | (1,084 | ) |
| Pro forma net loss                                                                                                     |   | $                                         | (8,367 | )                                          | $      | 4,144 |   | $ | (18,091 | ) | $ | (81,340 | ) |
|                                                                                                                   |   |                                      |   |                                       |   |   |   |   |   |
| Earnings (loss) per weighted average share:                                                                            |   |                                      |   |                                       |   |   |   |   |   |
| Basic - as reported                                                                                                    |   | $                                         | (0.81  | )                                          | $      | 0.91 |   | $ | (2.61 | ) | $ | (16.30 | ) |
| Basic - pro  forma                                                                                                     |   | $                                         | (0.85  | )                                          | $      | 0.84 |   | $ | (2.75 | ) | $ | (16.52 | ) |
| Diluted - as  reported                                                                                                 |   | $                                         | (0.81  | )                                          | $      | 0.89 |   | $ | (2.61 | ) | $ | (16.30 | ) |
| Diluted -  pro forma                                                                                                   |   | $                                         | (0.85  | )                                          | $      | 0.82 |   | $ | (2.75 | ) | $ | (16.52 | ) |

 

**Note 13—CommonStock**

 

On July 23, 2003, we issued toCityNet 6,567,168 newly issuedshares of our common stock, adjusted for the August 8, 2003, one-for-twenty reverse stock split, representing approximately55% of our outstanding common stock on a fully diluted basis (with any options and warrants having an exerciseprice in excess of $20.00, adjusted for the August 8, 2003, one-for-twentyreverse stock split, being excluded from the calculation of “fully diluted,” subject to CityNet’s right to receivecompensating shares in the event that any of these options or warrants aresubsequently exercised).  Asdescribed in Note 2-Liquidity, CityNet paid to us $16 million in cash andtransferred to us fiber optic rings located in Albuquerque, New Mexico andIndianapolis, Indiana having an estimated fair value of $200 thousand and weassumed certain liabilities of CityNet. In particular, we assumed$2 million in principal amount of a Promissory Note executed by CityNetand made to Electro Banque.  The note issecured by the fiber optic ring located in Albuquerque, New Mexico, matures in a single installment on December31, 2007 and does not bear interest until January 1, 2006; thereafter, itbears interest at 8% per annum.  Theincrease in common stock and additional paid-in-capital as a result of thistransaction amounted to approximately $13.1 million, which takes into affectthe transfer of fiber optic rings to us and our assumption of the statedpromissory note, as well as the necessary transaction costs associated.  After paying expenses related to thePurchase Agreement, including interest and appraisal fees, the net proceedsfrom the Purchase Agreement were approximately $14.7 million.

On July 30, 2003, weannounced a one-for-twenty reverse split of our common stock. The reverse splitwas effective at the close of business on August 8,2003, and on August 11, 2003, our common stock began trading on apost-split basis. As a result, common shares outstanding decreased byapproximately 217 million shares and resulted in a reclassification in equityof approximately $2.2 million from common stock to additionalpaid-in-capital.  The reverse stock split is intended to help usregain compliance with the $1.00 per share minimum bid price requirement forcontinued listing of our common stock on the Nasdaq SmallCap Market. OnJune 3, 2003, we received a Nasdaq Staff Determination indicating that we hadfailed to comply with the $1.00 per share minimum bid price requirement forcontinued listing set forth in Marketplace Rule 4310(c)(4) and that oursecurities were, therefore, subject to delisting from the Nasdaq SmallCapMarket. On July 24, 2003, we had a hearing before a Nasdaq ListingQualifications Panel to review the Staff Determination and on August 22, 2003,the panel granted our request for continued listing. However, there can be noassurance that the market price per share of our common stock will remain above$1.00 per share. Accordingly, we cannot predict whether we will be able tomaintain compliance with the minimum bid requirement or NASDAQ’s otherrequirements for continued listing of our common stock.

 

**Note 14—CommonStock Warrants**

 

On July 23, 2003, we issued to a third party 50,000common stock warrants, adjusted for the one-for-twenty reverse stock split, forservices rendered in connection with the Purchase Agreement with CityNet.  The warrants were granted at an exerciseprice of $4.40 per common share and are exercisable at the option of the holderfor a period of four years from July 23, 2003. We recorded these warrants at an estimated fair value of approximately$411 thousand.

 

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

The information in this discussion contains forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended. Such statements are based upon current expectations that involve risksand uncertainties. Any statements contained herein that are not statements ofhistorical facts may be deemed to be forward-looking statements. For example,words such as “may”, “will”, “should”, “estimates”, “predicts”, “potential”, “continue”,“strategy”, “believes”, “anticipates”, “plans”, “expects”, “intends”, andsimilar expressions are intended to identify forward-looking statements. Ouractual results and the timing of certain events may differ significantly fromthe results discussed in the forward-looking statements. Factors that mightcause or contribute to such a discrepancy include, but are not limited to,those discussed under the heading “Risk Factors.” The following discussionprovides information and analysis of our results of operations for the threemonths and nine months ended September 30, 2003 and 2002 and of ourliquidity and capital resources. You should read the following discussion inconjunction with our consolidated financial statements and the related notesincluded elsewhere in this quarterly report as well as the other reports wefile with the SEC. Amounts are in thousands, except for items otherwiseindicated and share and per share amounts.

 

**Overview**

 

We began operations on October 2, 1997 for the purpose offacilitating the provisioning, installation and servicing of dedicatedcommunications circuits for service providers who buy network capacity andtransport suppliers who sell network capacity. To date, we have derivedsubstantially all of our revenues from providing ongoing, dedicated circuitaccess. Monthly recurring circuit revenues are generated under client contractswith terms generally ranging from 12 to 60 months. The average length ofcircuit terms has declined as we install new circuits with shorter terms, asmost new contracts are for 12-month terms. Contracts with our clients may beterminated by the client at any time, subject to additional payments whereapplicable.

 

Our resultshave been affected by bankruptcies of our customers and suppliers, creditproblems in the telecommunications industry, circuit disconnections andlengthening new business closing cycles. We have provided and currently provide services to several clients thatare involved in bankruptcy proceedings. Although these services generally areentitled to priority payment as post-bankruptcy services, we could experiencecollectibility issues with respect to services we provide these clients. Whencollectibility of a receivable is not assured in the month service is provided,we recognize revenue when payment is received, not at the time the receivableis recorded.

 

Circuit revenues include bundled charges for provisioning, networkmanagement and maintenance services.

 

Our clients primarily consist of communications service providers andtransport suppliers, such as competitive access providers, incumbenttelecommunication service providers, cable companies and other application andnetwork service providers. Our three largest clients represented approximately30% and 38% of total revenues for the quarter ended September 30, 2003 and2002, respectively. The decrease in client concentration was primarily theresult of large disconnections by clients operating under bankruptcyprotection.

 

To date, cost of circuit access has primarily consisted of amounts paidto transport suppliers for circuits. We have negotiated volume discounts andnetwork route-specific discounts under contracts with many of our suppliers.These contracts generally have terms ranging from three to ten years and sometimesinclude minimum purchase commitments. At September 30, 2003, these minimumpurchase commitments totaled approximately $1.8 million per month. Ouraggregate actual purchases under these contracts, which averaged approximately$1.6 million per month for the quarter ended September 30, 2003, havenot exceeded these minimum purchase commitments for certain vendors. When ouractual purchases fall short of contractual commitments, we may seek tonegotiate alternate arrangements with these suppliers, but in

 

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the event that thesenegotiations are unsuccessful, we may be left with a shortfall that couldaffect our operating margins or result in a dispute or litigation with thesupplier. Management believes we are adequately reserved for any commitmentshortfalls.

 

Operations and administration expense consists of salaries and employeebenefits, costs associated with developing, expanding and maintaining ourUniversal Information Exchange (“UIX”) database, and costs associated withsales, marketing, operations, administration and facilities.

 

In each year since our inception, we have incurred operating losses andnet losses, and have experienced negative cash flows from operations. AtSeptember 30, 2003, we had an accumulated deficit of $289 million.

 

**Resultsof Operations**

 

**Comparisonof Three Months and Nine Months Ended September 30, 2003 to Three Monthsand Nine Months Ended September 30, 2002**

 

**Revenues**

 

Revenues decreased to $16.9 million for the three months endedSeptember 30, 2003 from $27 million for the three months endedSeptember 30, 2002.  Revenues fornine months ended September 30, 2003 decreased to $54.6 million from $80.2million for the nine months ended September 30, 2002.  Substantially all of our revenues consistedof circuit revenues in each of these quarters. The decrease in revenues for the three and nine months endedSeptember 30, 2003 compared to the three and nine months endedSeptember 30, 2002 was attributable to circuit disconnections, mainly fromcustomers in bankruptcy, lengthened new business closing cycles, and therecognition of $2.7 million in termination revenues in the three months endedSeptember 30, 2002.  We expect thatcontinued negative trends in the telecommunications industry will continue toadversely affect our revenues.

 

**Cost of Circuit Access**

 

Cost ofcircuit access decreased to $12.3 million for the three months endedSeptember 30, 2003 from $17.2 million for the three months endedSeptember 30, 2002. Cost of circuit access for the nine months endedSeptember 30, 2003 decreased to $37.7 million compared to $58.5 millionfor the nine months ended September 30, 2002.  As a percentage of total revenues, cost of circuit accessincreased to 73% for the three months ended September 30, 2003 from 64%for the three months ended September 30, 2002. The decrease in cost ofcircuit access in absolute dollars was primarily attributable to circuitdisconnections.  The increase in circuitcost as a percentage of total revenues for the three months endedSeptember 30, 2003 was primarily attributable to the recognition of $2.7million in termination revenues in the three months ended September 30,2002 with minimal corresponding costs of circuit access.  

 

**Operations and Administration (ExcludingStock Plan Compensation)**

 

Operations and administration expenses (excluding stock plancompensation) decreased $2.8 million to $7.9 million for the three months endedSeptember 30, 2003 from $10.7 million for the three months endedSeptember 30, 2002. Operations and administration expenses (excludingstock plan compensation) decreased $22.7 million to $23.3 million for the ninemonths ended September 30, 2003 from $46.0 million for the nine monthsended September 30, 2002. This decrease in the three and nine months ended2003 was primarily attributable to significant decreases in personnel and baddebt expense.

 

The number of employees decreased to 111 at September 30, 2003from 139 at September 30, 2002.  Asa result, salaries, benefits, travel expenses and employee related payrolltaxes decreased $1.7 million for the three months ended September 30, 2003and $10.5 million for the nine months ended September 30, 2003 as comparedto the three and nine months ended September 30, 2002.  We expect headcount to remain relativelyflat for the remainder of 2003.  As aresult of collections of accounts receivable that were previously reserved, werecorded a reversal of bad debt expense of $335 thousand and

 

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$1 million in the three andnine months ended September 30, 2003 compared to a reversal of $300thousand in three months ended September 30, 2002 and a charge of $4.4million for the nine months ended September 30, 2002.

 

**Operations and Administration (Stock PlanCompensation)**

 

During fiscalyear 1999 and the first quarter of 2000, we granted stock options to employeesand non-employees with per share exercise prices deemed to be below the fairmarket value of our common stock at the dates of grant. These stock optionissuances have resulted in stock plan compensation charges, which are initiallydeferred and subsequently amortized over the vesting period of the relatedoptions. In addition, a restricted stock plan was adopted during fiscal year2001, whereby zero-cost restricted stock was granted to employees. The stockplan compensation expense for restricted stock grants is also initiallydeferred and subsequently recognized over the vesting period.

 

Stock plancompensation expense totaled $200 thousand for the three months endedSeptember 30, 2003 and $729 thousand for the three months ended  September 30, 2002. For the nine monthsended September 30,2003 and September 30, 2002 the stockplan compensation expense was $834 thousand and $2.2 million, respectively.  The decrease in stock plan compensationexpense was primarily due to the forfeiture of restricted stock upon employeeterminations in 2002 and 2003 and a reduction in charges taken for optionsgranted at a price less than the market price in prior periods.  Stock plan compensation expense in the ninemonths ended September 30, 2002 would have been approximately $707thousand greater than the expense recognized in the nine months ended September 30,2003 had there not been any restricted stock forfeitures subsequent toSeptember 30, 2002.

 

There were 449,718 and 327,014 stock options outstanding, adjusted forthe August 8, 2003, one-for-twenty reverse stock split, atSeptember 30, 2003 and 2002, respectively.

 

## **Impairment of Property, Plant and Equipment**

 

Based on impairment reviews performed at June 30, 2002, thecompany recognized a $46 million impairment charge to reduce the carrying valueof ATM equipment, a web-based pricing, quoting and provisioning software tool(Project Gemini) and UTX assets and a $4.5 million impairment charge related togoodwill.  In the quarter endedSeptember 30, 2003, we recorded an additional $2.6 million impairmentcharge for three UTX assets affected by significant circuit disconnects bycustomers and $3.7 million for the nine months ended September 30, 2003.

 

## **Depreciation and Amortization**

 

Depreciation expense includes depreciation of furniture, fixtures andequipment at our office facilities and of equipment at our UTX facilities.Depreciation expense was $1.8 million in the three months endedSeptember 30, 2003, compared to $3.0 million in the three monthsended September 30, 2002, representing a decrease of $1.2 million.Depreciation expense for the nine months ended September 30, 2003 decreasedto $6.2 million compared to $12.8 million for the nine months endedSeptember 30, 2002. The decrease in depreciation expense is primarilyattributable to lower asset values due to the impairments of the UTX equipmentin 2002 and 2003 and assets becoming fully depreciated.

 

Amortization expense, which decreased to $0 in the quarter endedSeptember 30, 2003 from $42 thousand in the quarter endedSeptember 30, 2002, relates to intangible assets acquired in connectionwith the purchases of Stuff Software, Inc. in November 1999 that weresubsequently sold for a nominal amount in 2002.  Amortization expense decreased $169 thousand to $0 in the ninemonths ended September 30, 2003 compared to the nine months endedSeptember 30, 2002.

 

## **Restructuring**

 

The restructuring program is substantially complete, except forfacility exit costs and operating lease payments for office equipment. Theability to sublet facilities at the rates contemplated by the restructuringcharge will depend on market conditions. Amounts relating to facilities will bepaid over the

 

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respective lease terms through2013 and will be net of any sublease recoveries, while operating lease paymentsfor office equipment will be paid through 2003.

 

The following summarizes the significant components of therestructuring reserve at September 30, 2003:

 
|                                                       |   | **Balance at********December 31,  2002** |   | **Incurred Cash   Payments** |   | **Balance at   September 30,  2003** |   |
|------------------------------------------------------------|--------|-----------------------------------------------|--------|------------------------------|--------|-------------------------------------------|--------|
|                                                       |   |                                          |   |                         |   |                                      |   |
| Facility exit costs, net of estimated  sublease recoveries |   | 5,014                                         |   | (556                         | )      | 4,458                                     |   |
| Other                                                      |   | 33                                            |   | (28                          | )      | 5                                         |   |
| Total                                                      |   | 5,047                                         |   | (584                         | )      | 4,463                                     |   |

 

**Other Income (Expense)**

 

Other income increased $512 thousand in the three months endedSeptember 30, 2003 to $30 thousand from a net expense of $482 thousand inthe three months ended September 30, 2002. Other income increased $46thousand to $64 thousand for the nine months ended September 30, 2003,compared to $18 thousand for the nine months ended September 30, 2002. Theincrease in other income in the three months ended September 30, 2003 wasattributable to the sale of Stuff Software for a loss in the third quarter 2002of $585 thousand and was partially offset by incurred interest expense of $138thousand incurred on the $5.0 million note payable to CityNet.  This note payable as described in Note 2 ofthe Notes to Condensed Consolidated Financial Statements was borrowed inApril 2003 and repaid in July 2003 when the Purchase Agreement wascompleted.

 

**Income Taxes**

 

From ourinception through September 27, 1998, we elected to be treated as asubchapter S-corporation for income tax purposes. On September 27, 1998,we converted to a C-corporation. At December 31, 2002, we hadapproximately $196 million of federal and state net operating loss carryforwards. These carry forwards may be available to offset future taxableincome. Our federal and state net operating loss carry forwards expire atvarious dates beginning in 2018. Due to the uncertainty that we will generatefuture earnings sufficient to enable us to realize the benefit of these netoperating loss carry forwards, we have recorded a valuation allowance for thefull amount of our deferred tax asset. As a result, no income tax benefit hasbeen recorded in our statement of operations. We assess our deferred tax asseton an ongoing basis and adjust the valuation allowance based on thisassessment. Additionally, Section 382 of the Internal Revenue Code of1986, as amended, imposes annual limitations on the use of net operating losscarry forwards if there is a change in ownership, as defined, within anythree-year period. Our capital stock transactions may limit our ability to usecertain net operating loss carry forwards. In particular, the issuance of stock under the Purchase Agreement willlimit our ability to use certain net operating loss carry forwards.

 

 

**Liquidity and Capital Resources**

 

Based on our receipt of net proceeds of approximately $14.7 millionfrom the Purchase Agreement as described in Note  2 of the Notes to Condensed Consolidated Financial Statements,and assuming (a) our operational cash receipts remain stable, (b) we generatesignificantly higher revenues and (c) we continue to control uses of cash, weestimate that we will have sufficient liquidity and capital resources to meetour short term liquidity needs. In addition, we estimate meeting theseconditions will allow us to accomplish our long term liquidity goal to fund ourbusiness with internally generated cash. We are also currently seeking strategic partnership opportunities tohelp us meet our short and long term liquidity needs.  However, there can be no assurance that we can meet theseconditions, and our operational and financial flexibility may be limited in thefuture.  Further, unexpected events adversely affecting our cashresources, including declines in collections due to client bankruptcies ordeteriorating industry conditions, bankruptcy preference payment settlements,security deposit requirements, accelerated vendor terms, payments

 

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required to settle disputes oradversely determined litigation, may create a need for us to obtain morefunding from external sources. There can be no assurance that additionalfinancing will be available to us on terms and conditions acceptable to us, ifat all.

 

The Company had $19 million in cash (including cash, cash equivalents,short term investments and restricted cash) at September 30, 2003, compared to$12.6 million at June 30, 2003 and $16.3 million atDecember 31, 2002.

 

In March 2003, we reached a settlement with a supplier thateliminated a remaining aggregate minimum purchase commitment of approximately$54.8 million. As part of the settlement, we paid a total of$1.1 million, including a $1.0 million prepayment for private lineservices and $104 thousand to satisfy outstanding billing disputes. AtSeptember 30, 2003, the remaining prepaid asset was $0.

 

In July 2003, we reached a settlement whereby we paid a landlord$723 thousand to eliminate a monthly rental expense of $32 thousand andaggregate minimum lease payments of $3.0 million.  The landlord is required to release a letter of credit of $320thousand within 90 days of the settlement payment and we expect receipt inNovember 2003.

 

Also in July 2003, in connection with the closing under thePurchase Agreement, (a) we hired marketing, operations and sales personnelpreviously employed by CityNet totaling approximately $160 thousand monthly,(b) we agreed to reimburse CityNet for the cost of office space leased byCityNet in Maryland totaling $20 thousand monthly and (c) we entered into anagreement with CityNet under which CityNet will perform maintenance servicesfor the two fiber optic rings we assumed from CityNet. Under the maintenanceagreement, we have agreed to pay CityNet $40 thousand per month for theseservices.  We terminated thismaintenance agreement with Citynet in September 2003, but still arecontractually obligated to pay the $40 thousand fee until March 2004.

 

In the third quarter of 2003, we paid Level 3 a total of $1.2 millionto settle the litigation and other matters described in Note 9 to the condensedfinancial statements.  We will pay Level3 an additional $225 thousand over the next three months.  We may use up to $200 thousand of thisamount as a prepayment of certain services.

 

The followingsummarizes our adjusted contractual obligations at September 30, 2003 andthe effect such obligations are expected to have on our liquidity and cash flowin future periods.

 
|       |   | **Non-Cancelable   Operating Leases (incl.   restructured facilities)** |   | **Non-Cancelable   Purchase Commitments** |   | **Total** |   |
|------------|--------|-------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------|--------|
| 2003       |   | $                                                                       | 2,014  |                                      |   | 5,285     |   |   | 7,299 |   |
| 2004       |   | 8,035                                                                   |   | 20,614                                    |   | 28,649    |   |
| 2005       |   | 6,969                                                                   |   | 17,025                                    |   | 23,994    |   |
| 2006       |   | 6,677                                                                   |   | 1,750                                     |   | 8,427     |   |
| 2007       |   | 6,868                                                                   |   | 0                                         |   | 6,868     |   |
| Thereafter |   | 28,598                                                                  |   | 0                                         |   | 28,598    |   |
| Total      |   | $                                                                       | 59,161 |                                      | $      | 44,674    |   | $ | 103,835 |   |

 

Our principal uses of cash are to fund operations including aninvestment in marketing and our sales channels, working capital requirementsand limited capital expenditures. Our capital expenditures will be limited tothe enhancement of selected elements of our two primary service elements,information and facilities. For information, we will continue to enhance our ITtools to help achieve our sales objectives and we will continue to seek out newdata resources relating to the provisioning of circuits. For facilities, wewill continue to enhance our UTX and metropolitan connectivity facilities so asto create a competitive advantage in terms of service delivery, cost andpricing.

 

Restricted cash was $2.1 million at September 30, 2003,declining $1.8 million from a balance of $3.9 million at December 31,2002. Restricted cash consists of letters of credit issued to real estatelandlords, carriers and other vendors. The decline of $1.8 million was dueprimarily to the release of letters of credits described below.

 

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•                  OnMarch 14, 2003, we completed the renegotiation of  a contract with one of our carriers. As partof the renegotiation and in return for a $1 million prepayment, the carrierreleased a $500 thousand letter of credit, reducing our restricted cashbalance.

•                  Pursuant to a lease buyout agreementcompleted in 2002 with the landlord of an office facility, in January 2003the landlord returned to us a letter of credit in the amount of $900 thousand,reducing our restricted cash balance.

 

In general, our obligations under certain real estate leases, carriercontracts and other business agreements are secured by letters of credit issuedto the landlord or applicable vendor. Each of these letters of credit is secured by restricted cash we havepledged to the bank issuing the letter of credit. In the past, we havecompleted negotiations with certain of our landlords to reduce our future leaseobligations in exchange for consideration including the release to the landlordof funds under letters of credit. We expect to continue these types ofnegotiations in the future. If these negotiations to reduce our leaseobligations are successful, then we expect our restricted cash balance willdecline further.

 

In connection with a lease buyout agreement completed inSeptember 2002, we entered into a new lease for a reduced amount ofoffice space at our principal offices. The new lease requires us to deliver aletter of credit in the amount of $2.5 million to secure our obligationsunder the new lease by October 1, 2003. Delivering this letter of creditwould reduce our cash and cash equivalents and short-term investments, andincrease our restricted cash balance, by $2.5 million.  We are currently under negotiations with thelandlord concerning the $2.5 million deposit and have not paid thisamount.  

 

We are currently subject to negotiations with several carriers tosettle open billing disputes.  Webelieve we are adequately accrued for any payments required to settle thesedisputes.  We are in negotiations withone carrier where we believe we will pay between $1.2 million and $2.4 millionto resolve all open disputes totaling $7.5 million.

 

Cash used by operating activities was $12.7 million for the ninemonths ended September 30, 2003, compared to $30.9 million for the ninemonths ended September 30, 2002. The decrease in cash used by operatingactivities was due primarily to reduced payroll costs and a decrease in rentexpense after renegotiating lease contracts.

 

Cash provided by investing activities was $226 thousand for the ninemonths ended September 30, 2003, compared to cash provided of $17.8million for the nine months ended September 30, 2002. The decrease isprimarily due to a reduction in the sale of short-term investments used to fundoperations in 2002 and was offset by a reduction in the purchase of property,plant, and equipment to support the business in the nine months endedSeptember 30, 2003.

 

Cash provided by financing activities was $17.0 million for the ninemonths ended September 30, 2003, compared to  $3.7 million for the nine months ended September 30,2002.  The increase was primarilyattributable to the receipt of $15.0 million in net proceeds from CityNetafter closing of the Purchase Agreement and the reduction of $1.8 million inrestricted cash as a result of the carrier and lease negotiations describedabove.

 

**RISK FACTORS**

 

In addition to the factors discussed elsewhere in this Form 10-Qand our other reports filed with the SEC, the following are important factorswhich could cause actual results or events to differ materially from thosecontained in any forward-looking statements made by or on behalf of us.

 

**We have incurred substantial losses since our inception, and if we failto generate significantly higher revenues and reduce our costs, we will beunable to achieve and maintain profitability and may be unable to continue ouroperations.**

 

We haveincurred significant losses since inception and expect to continue to incurlosses in the future. As of September 30, 2003, we had an accumulateddeficit of $288.9 million. Our revenues have

 

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decreased to $16.9 million inthe three months ended September 30, 2003 from $27.0 million in the threemonths ended September 30, 2002. Revenue was $54.6 million for nine monthsended September 30, 2003, compared to $80.2 million for nine monthsended September 30, 2002. We cannot be certain that we will be successfulin reducing our costs, that we will be able to significantly increase ourrevenues or that we will achieve sufficient revenues to become profitable. Weexpect to continue to incur expenses in order to:

 

•                                          Developand sell new service offerings, such as software or information based products;

 

•                                          Expandsales and marketing channels, including our government markets group;

 

•                                          Enhanceour UIX database and develop other intellectual property; and

 

•                                          Maintainour UTX facilities.

 

As a result, we will need to generate significantly higher revenues toachieve and maintain profitability. If we fail to significantly reduce ourcosts or to generate significantly higher revenues, we will continue to incuroperating losses and net losses and may be unable to continue our operations.

 

**Our efforts to develop new service offeringsand expand marketing channels may not be successful.**

 

In an effort to increase our revenues, we plan to invest significantresources to develop and sell new service offerings, such as software orinformation based products, and to expand marketing channels, including ourgovernment markets group. These initiatives may require significantexpenditures, which would reduce resources available to maintain and developour traditional lines of business. Whether new service offerings or expandedmarketing efforts succeed depends on factors we control, such as coordinatingour internal financial, engineering, marketing, information technology andsales personnel, and on factors we cannot control, including whether clientswill pay for these offerings and whether our vendors will provide the goods andservices we need. If we do not successfully develop and sell new serviceofferings and expand marketing channels, we may not increase our revenues andcould incur substantial losses that would harm our existing business.

 

**Industry conditions and further deteriorationin credit quality may affect our clients’ ability to pay their obligations tous in a timely manner or at all and may affect the ability of our carriersuppliers to provide reliable service.**

 

We operate in a highly concentrated, high-risk market that hasexperienced a general deterioration of credit quality. Credit-quality concerns,which have historically affected smaller network service providers andsubsequently smaller telecommunications providers, have more recently impacted,and continue to impact, larger telecommunications providers and carriers.Several of our significant clients have filed for reorganization or liquidationunder the bankruptcy laws. As a result of the decline in credit quality andthese bankruptcies, some of our clients may have inadequate financial resourcesto meet all of their obligations and may seek to reject or renegotiate theirpurchase agreements with us. If either significant clients or a significantnumber of smaller clients are unable to meet their obligations to us, rejecttheir contracts or renegotiate their contracts, we may not be able to recognizefuture revenues and we may also incur additional bad debt expenses and experiencereduced opportunities for growth. If a client fails to pay us, we may remainobligated to third parties for the cost of circuits previously provided to theclient. Certain current or former clients who are bankrupt have filed andadditional clients might file preference actions to try to recover amounts thatthey previously paid us. These events would harm our cash flow, results ofoperations and financial condition, as would future deterioration in marketconditions in our industry or in the creditworthiness of our significantclients or a significant number of smaller clients.

 

In addition,some of our carrier suppliers, including MCI (formerly WorldCom), may haveinadequate financial resources to provide reliable service or to meet theirother obligations to us. If a carrier supplier is unable to meet itsobligations to us, we could be required to purchase replacement services onless favorable terms or experience disruptions in service, which could impairour ability to retain or attract clients. Disruptions in service could requireus to issue outage credits to our clients or incur other liability, which wouldreduce our revenue and gross margins.

 

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**If we do not significantly increase ourrevenues or decrease our expenses, we may require additional financing in thefuture to meet our operating needs, and if we cannot obtain such financing oncommercially reasonable terms, our ability to operate our business may suffer.**

 

If ouroperational cash receipts decline, we fail to generate significantly higherrevenues or we fail to control uses of cash, we will need additional financingin the future to meet our operating needs. There can be no assurance thatadditional financing will be available to us on terms and conditions acceptableto us, if at all. In addition, if in the future we need to issue additionalshares of common stock to fund our business, our common stockholders would bediluted. If we are unable to obtain additional financing when needed or on acceptableterms, we may have to curtail our operations, delay or abandon our businessplans or take further actions to strengthen our cash position, which couldmaterially adversely affect our ability to continue our operations. Moreover,without adequate financing, potential customers who otherwise would select ourservices to purchase may decide to buy from other vendors whom the customersperceive to have greater financial stability.

 

## **Our recently implemented reversestock split might cause our stock price and our total market capitalization todecline.**

 

We implementeda one-for-twenty reverse split of our common stock and on August 11, 2003,our common stock began trading on a post-split basis. The total marketcapitalization of our common stock (the aggregate value of all our common stockat the then current market price) after the reverse stock split may be lowerthan the total market capitalization before the reverse stock split. Inaddition, the per share market price of our common stock after the reversestock split may be lower than the per share market price of our common stockbefore the reverse stock split.

 

Our stockprice may not attract institutional investors or investment funds and may notsatisfy the investing guidelines of such investors and, consequently, thetrading liquidity of our common stock may not improve. Now that the reversestock split has been completed, a decline in the market price of our commonstock may result in a greater percentage decline than would occur in theabsence of a reverse stock split. In addition, the reduced number of sharesoutstanding after the reverse stock split could adversely affect the liquidityof our common stock.

 

**Our common stock may be de-listed from theNASDAQ Small Cap Market, which would reduce the liquidity in the market for ourcommon stock and make capital raising and other transactions more difficult.**

 

In 2002, we moved from the NASDAQ National Market System to the NASDAQSmall Cap Market. As a result, future capital raising activities and acquisitionsmay be more difficult due to increased state securities laws complianceobligations. The NASDAQ Small Cap Market requires a minimum bid price of $1.00for continued listing. On June 3, 2003, we received a Nasdaq StaffDetermination indicating that we had failed to comply with the $1.00 per shareminimum bid price requirement for continued listing set forth in MarketplaceRule 4310(c)(4) and that our securities were, therefore, subject to delistingfrom the NASDAQ SmallCap Market.  OnJuly 21, 2003, our stockholders approved a reverse stock split in aneffort to increase our stock price.  OnJuly 24, 2003, we had a hearing before a NASDAQ Listing QualificationsPanel to review the Staff Determination. On August 11, 2003, our stock began trading on a post splitbasis.  On August 22, 2003,  the Panel granted our request for continuedlisting.  However, in the future, therecan be no assurance that the market price per share of our common stock willremain above $1.00 per share. Accordingly, we cannot predict whether we will beable to maintain compliance with the minimum bid requirement or NASDAQ’s otherrequirements for continued listing.

 

If we fail to meet the minimum requirements for NASDAQ listing in thefuture and we are de-listed from the NASDAQ Small Cap Market, our common stockwould trade, if it traded at all, in the over-the-counter market, which mostinvestors view as a less desirable, less liquid marketplace. Among otherthings, this would place increased regulatory burden upon brokers, making themless likely to make a market in our stock. Loss of our NASDAQ Small Cap Marketstatus would likely make it more difficult for us to raise capital in thefuture. If we lose our NASDAQ Small Cap Market status stockholders may find it

 

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more difficult to dispose of,or to obtain accurate quotations as to the price of our common stock therebyreducing the liquidity of our stock, making it difficult for a stockholder tobuy or sell our stock at competitive market prices, or at all. In addition, wemay lose support from institutional investors, brokerage firms and marketmakers that currently buy and sell our stock and provide information toinvestors about us. Delisting could also cause the price of our stock todecrease further.

 

**If we fail to manage our cost reductionefforts and future expansion effectively, our ability to operate and toincrease our services and client base could suffer.**

 

Our ability to successfully offer our services and implement ourbusiness plan in a rapidly evolving market requires effective planning andmanagement of our operations, including our workforce. At December 31,1997, we had five employees. By the first quarter 2001, we had over 400full-time employees. Since that time, we have reduced our headcount toapproximately 107 full-time employees as of October 31, 2003. Theseperiods of growth and headcount reductions and potential growth in futureoperations will continue to place a significant strain on our management systemsand resources. We cannot be sure that our reduced workforce will be sufficientfor us to identify and take advantage of market opportunities and managemultiple relationships with various clients, suppliers and other third parties.If our operations and headcount grow in the future, we expect that we will needto improve our financial and managerial controls, reporting systems andprocedures, and expand, train and manage our workforce, and we cannot be surethat will be able to manage this potential expansion effectively.

 

**Due to our financial condition or paymenthistory, our carrier suppliers may demand security deposits or acceleratedpayment terms.**

 

Certain of our carrier suppliers might claim the right to demand asecurity deposit or accelerated payment terms from us due to our financialcondition or payment history. Our carrier suppliers may further seek to bill usfor purported failure to meet purchase commitments or purported under billingsor other billings notwithstanding factual or legal disputes regarding any suchpurported failure.  If we are requiredto pay any of these amounts, our cash resources could be materially diminished.Alternatively, if we not make these payments, carrier suppliers may be unwillingto continue to do business with us. Some of these failures may be claimed by incumbent local exchangecarriers, which historically have been reluctant to engage in negotiations onsuch matters and if they do engage in negotiations, often refuse to significantlyreduce the amounts they claim we owe. Such disputes may also affect thewillingness of suppliers to provide us with capacity or other services, whichwould reduce our operating flexibility and ability to deliver services toexisting or potential clients. If the supplier in any such dispute enters abankruptcy or similar proceeding, our business relationship with the suppliercould be disrupted, which would impair our ability to negotiate. As ofSeptember 30, 2003, we had $15.8 million in open billing disputes withcarriers.

 

**We depend on our key personnel to manage ourbusiness effectively in a rapidly changing market, and our ability to generaterevenues will suffer if we are unable to retain our key personnel and hireadditional personnel.**

 

Our future success depends upon the continued services of our executiveofficers and other key sales, marketing and support personnel. We do not have“key person” life insurance policies covering any of our employees. Inaddition, we depend on the ability of a relatively new management team to effectivelyexecute our strategies. We have recently hired or promoted the majority of ourexecutive officers and many of our key employees. Because our management teamhas worked together for a short period of time, we need to integrate theseindividuals into our operations.

 

We may need to hire additional personnel in the future, and we believeour success depends, in large part, upon our ability to attract and retain ourkey employees. Attracting and retaining key employees is becoming moredifficult due to recent negative publicity regarding our industry, our lowstock market capitalization, our limited financial resources and our recentworkforce reductions. The loss of the services of any of our key employees, theinability to attract or retain qualified personnel in the future, or delays inhiring required personnel could limit our ability to generate revenues and tooperate our business.

 

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**Conditionsin our industry make forecasting difficult.**

 

Our results have been affected by bankruptcies, credit problems in thetelecommunications industry and circuit disconnections. These industryconditions make it difficult for us to accurately predict trends in ourbusiness. Accordingly, we are subject to all of the risks that are associatedwith companies in such an industry, including:

 

•                                          Undercapitalization;

 

•                                          Cashshortages;

 

•                                          Controllingour expenses and cash expenditures;

 

•                                          Thenew and unproven nature of the market for some of our services;

 

•                                          Theneed to make significant expenditures and incur significant expenses as wedevelop our business, infrastructure and operations;

 

•                                          Thelack of sufficient clients and revenues to sustain our operations and growthwithout additional financing;

 

•                                          Difficultiesin managing growth; and

 

•                                          Limitedexperience in providing some of the services that we offer or plan to offer.

 

For example,from time to time we enter into long-term agreements with communicationstransport suppliers for the supply and installation of communications networkcapacity. These agreements may generally provide for minimum revenuecommitments from us, which we must negotiate based on forecasts of our futurenetwork capacity requirements. At September  30, 2003, these minimumpurchase commitments totaled approximately $1.8 million per month. If wefail to forecast our network capacity requirements accurately or fail toaccurately forecast other aspects of our business, it will be difficult for usto meet these minimum purchase commitments or to become profitable. Inaddition, it may be difficult for us to meet these minimum purchase commitmentsif our clients refuse to use capacity provided by a supplier that has filed forbankruptcy protection or is otherwise financially distressed.

 

**Our business has been unprofitable, and wemay be unable to profitably manage and market our services to clients.**

 

Our business has been unprofitable. To be successful, we must convinceprospective clients to entrust their network capacity data and transportrequirements to us. We are not aware of any companies that have a directlycomparable business, and we cannot be sure that clients will widely accept ourservices.

 

Our ability to expand our client base and, therefore, to increase ourrevenues may be limited by the following factors:

 

•                                          Thespeed, reliability and cost effectiveness of our services;

 

•                                          Thewillingness of clients to outsource the obtaining of circuits;

 

•                                          Thefinancial viability of clients and prospective clients;

 

•                                          Thefinancial viability of our suppliers;

 

•                                          Ourperceived financial viability;

 

•                                          Ourability to market our services effectively; and

 

•                                          Thegrowth of the Internet and demand for telecommunications services.

 

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We may not be able to execute our business model if the markets for ourservices fail to develop or grow more slowly than anticipated, if competitionin our industry intensifies or if we are unable to expand our client base.

 

**Recent legal proceedings may adversely affectour results and financial position.**

 

We are party to several legal proceedings, including two securitiesclass action lawsuits that are pending against us.  Management believes that these lawsuits are without merit, and weintend to defend these actions vigorously or to settle these lawsuits. Becauseof the complexity of certain of the transactions underlying these lawsuits, aswell as the inherent uncertainty of litigation, however, it is possible thatthe outcome of one or more of these cases may be adverse to us. In addition,the resources required to defend these cases, including the management time andattention required to adequately defend our position, and the costs ofpotential settlements, or any judgment award may adversely affect our resultsof operations and financial position.

 

**If we have difficulties or delays indelivering circuits to our clients, our ability to generate revenue will sufferand we may lose existing and potential new clients.**

 

It typically takes 30 to 90 days to supply a circuit for a client,and we do not begin to recognize revenue until a circuit has been installed andaccepted by the client. Once we agree to facilitate the supply of a circuit fora client, we negotiate with one or more transport suppliers and manage thepersonnel and field technicians of multiple vendors. A client can withdraw itsorder with minimal liability at any time before accepting the circuit. We mayexperience difficulties in facilitating the supply of circuits if our transportsuppliers run out of capacity, which would force us to look for alternativesources of capacity on short notice. In addition, credit concerns, billing orother disputes with our suppliers may adversely affect their willingness toprovide capacity in a timely manner. If we are unable to facilitate the supplyof a circuit in a timely manner or fail to obtain client acceptance of thecircuit, we would be unable to recognize revenues for that circuit, may incurfinancial liability to our supplier for that circuit, and our operating resultswould be adversely affected. Furthermore, because our clients may cancel ordersat any time before accepting the circuit, we may find it difficult to forecastrevenue and plan our expenses accordingly.

 

**Our ability to implement and maintain our UIXdatabase is a critical business requirement, and if we cannot maintain precisedata, we might be unable to cost-effectively facilitate obtaining circuits forour clients.**

 

To be successful, we must increase and update information aboutpricing, capacity, availability and location of circuits contained in our UIXdatabase. Our ability to cost effectively facilitate the supplying of circuits,to provide ongoing support and to develop new software or information-basedproducts or services depends upon the information we collect from our transportsuppliers regarding their networks, which we include in our UIX database. Oursuppliers are not obligated to provide us with this information and coulddecide to stop providing this information to us at any time. Moreover, wecannot be certain that the information that our suppliers share with us isaccurate or current. If we cannot continue to maintain and expand our UIXdatabase as planned, we may be unable to increase our revenues, develop newproducts or services, or cost-effectively facilitate the supplying of thecircuits.

 

**If we cannot successfully operate our networkoperations center, we will be unable to provide monitoring, maintenance andrestoration services to our clients.**

 

One of our primary business objectives is to provide our clients withnetwork monitoring, maintenance and restoration services 24 hours a day,seven days a week through a network operations center. While we currentlyoperate our own network operations facility, our experience in this regard islimited both by the amount of time we have been in business and providing thisservice on our own as well as by the technical limitations of managing circuitsand services on the networks of other providers. As a consequence, we cannot besure that our efforts to provide these services will be successful. Our abilityto operate a network operations center will depend on many factors, includingour ability to train, manage and retain employees. If we fail to successfullyoperate a network operations center, we may not be able to

 

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monitor network operationseffectively or troubleshoot circuits in a cost-effective manner, which wouldcause us to lose clients and make it difficult for us to attract new clients.

 

**Competition in our industry is intense andgrowing, and we may be unable to compete effectively.**

 

The market in which we operate is rapidly changing and highlycompetitive. We believe that at this time no single competitor competesdirectly with us with respect to all of the services we offer; however, wecurrently or potentially compete with a variety of companies, including some ofour transport suppliers, with respect to our products and servicesindividually, including:

 

•                                          Nationaland local carriers, such as AT&T, Level 3, Broadwing, Qwest, Sprint,MCI (formerly WorldCom) and WilTel;

 

•                                          Companiesthat provide collocation facilities, such as Switch & Data, AT&Tand Equinix;

 

•                                          Competitiveaccess providers and local exchange carriers, such as AT&T, ICGCommunications, WorldCom, XO Communications and FiberNet; and

 

•                                          Incumbentlocal exchange carriers, such as Verizon, BellSouth and SBC Communications.

 

Our industry is expected to consolidate, which would increase the sizeand scope of our competitors. Competitors could benefit from assets acquiredfrom distressed carriers or strategic alliances in the telecommunicationsindustry. New entrants could enter the market with a business model similar toours. Our target markets may support only a limited number of competitors.Operations in such markets with multiple competitive providers may beunprofitable for one or more of such providers. Prices in both thelong-distance business and the data transmission business have declinedsignificantly in recent years and are expected to continue to decline. Inparticular, companies that have reduced their debt or other obligations throughbankruptcy or other restructurings may have significantly lower cost structuresthat allow them to offer services at significantly reduced prices.  This downward pressure on prices has causedus to lower our prices and margin percentage to remain competitive.  As a result, our gross margins havedecreased.  Accordingly, we mustsignificantly increase our sales volumes in order to maintain our gross margins.

 

Moreover, while recent regulatory initiatives allow carriers such as usto interconnect with incumbent local exchange carrier facilities and to obtainunbundled network elements from incumbent local exchange carriers, certaininitiatives also provide increased pricing flexibility for, and relaxation ofregulatory oversight of, incumbent local exchange carriers. This may allowincumbent local exchange carriers to use revenues generated fromnon-competitive services to subsidize services that compete with our services,allowing them to offer competitive services at lower prices. Existing laws alsorestrict the Regional Bell Operating Companies from fully competing with us inthe market for interstate and international long-distance telecommunicationsservices, but also permit the FCC to lessen or remove some restrictions.Recently the Bell companies have received FCC permission to offer long-distanceservices to customers in a number of states, and the FCC is expected toconsider several additional requests for this relief in the near future. TheseFCC decisions under existing law, or future amendments to Federaltelecommunications laws permitting the regional Bell operating companies tocompete fully with us in this market, may result in a reduction to our revenuesfrom these services if these companies are able to attract substantial businessfrom our clients.

 

We must distinguish ourselves through the quality of our clientservice, our service offerings and brand name recognition. We may not be successfulin doing this.

 

Many of our potential competitors have certain advantages over us,including:

 

•                                          Substantiallygreater financial, technical, marketing and other resources, including brand orcorporate name recognition;

 

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•                                          Substantiallylower cost structures, including cost structures of facility-based providerswho have significantly reduced debt and other obligations through bankruptcy orother restructuring proceedings;

 

•                                          Largerclient bases;

 

•                                          Longeroperating histories; and

 

•                                          Moreestablished relationships in the industry.

 

Our competitors may be able to use these advantages to:

 

•                                          Expandtheir offerings more quickly;

 

•                                          Adaptto new or emerging technologies and changes in client requirements morequickly;

 

•                                          Takeadvantage of acquisitions and other opportunities more readily;

 

•                                          Enterinto strategic relationships to rapidly grow the reach of their networks andcapacity;

 

•                                          Devotegreater resources to the marketing and sale of their services; and

 

•                                          Adoptmore aggressive pricing and incentive policies, which could drive down margins.

 

If we are unable to compete successfully against our current and futurecompetitors, our gross margins could decline and we could lose market share,either of which could materially and adversely affect our business.

 

**The unpredictability of our operating resultsmay adversely affect the trading price of our common stock.**

 

Our revenues and operating results may vary significantly from periodto period due to a number of factors, many of which we cannot control and anyof which may cause our stock price to fluctuate. These factors include thefollowing:

 

•                                          Uncertaintyregarding timing for supplying circuits or failure to obtain client acceptanceof circuits;

 

•                                          Decisionsby existing clients not to renew services on a timely basis when existingclient contracts terminate;

 

•                                          Decisionsby existing clients operating under bankruptcy protection to reject agreementswith us or to try to recover from us in preference actions amounts that theypreviously paid us;

 

•                                          Theamount of unused circuit capacity that we hold;

 

•                                          Costsrelated to acquisitions of technology or businesses;

 

•                                          Costsrelated to defending and settling litigation;

 

•                                          Generaleconomic conditions as well as those specific to the telecommunications,Internet and related industries;

 

•                                          Paymentobligations to our suppliers under service agreements in situations in whichour client is not able to meet its obligations with us or is not liable to us;and

 

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•                                          Internetgrowth and demand for Internet infrastructure and telecommunications services.

 

In addition, we depend on decisions by our clients to expand theirInternet and telecommunications infrastructure, which in turn depend upon thesuccess and expected demand for the services these clients offer.

 

We expect our operating expenses to remain relatively constant ordecline moderately in future periods. Our operating expenses are largely basedon anticipated revenue trends, and a high percentage of our expenses are, andwill continue to be, fixed in the short term due in large part to maintenanceof our UTX facilities. As a result, fluctuations in our revenue for the reasonsset forth above, or for any other reason, could cause significant variations inour operating results from period to period and could result in substantialoperating losses.

 

Becauseof these factors, we believe that period-to-period comparisons of our operatingresults are not, and will not be, a good indication of our future performance.It is likely that, in some future quarters, our operating results may not meetthe expectations of public market analysts and investors. In that event, theprice of our common stock may fall.

 

**We expect to experience volatility in thetrading of our stock, which could negatively affect its value.**

 

The market price of our common stock has fluctuated significantly sinceour initial public offering. The market price of our common stock may in thefuture fluctuate significantly in response to a number of factors, some ofwhich are beyond our control, including:

 

•                                          Theone-for-twenty reverse split of our common stock completed in August 2003;

 

•                                          Variationsin operating results;

 

•                                          Changesin financial estimates or coverage by securities analysts;

 

•                                          Reducedliquidity resulting from our transfer from the NASDAQ National Market to theNASDAQ SmallCap;

 

•                                          Changesin market valuations of telecommunications and Internet-related companies;

 

•                                          Announcementsby our competitors or us of new products and services or of significantacquisitions, strategic partnerships or joint ventures;

 

•                                          Anyloss or bankruptcy of a major client or supplier;

 

•                                          Additionsor departures of key personnel;

 

•                                          Anydeviations in net revenues or in losses from levels expected by securitiesanalysts;

 

•                                          Futuresales of common stock; and

 

•                                          Volumefluctuations, which are particularly common among highly volatile securities oftelecommunications and Internet-related companies.

 

**Our facilities and the networks on which wedepend may fail, which would interrupt the circuit access and indefeasiblerights of use we provide and make it difficult for us to retain and attractclients.**

 

Our clients depend on our ability to provide ongoing dedicated circuitaccess and indefeasible rights of use (“IRU’s”). The operation of thesecircuits depends on the networks of third party transport suppliers. Thenetworks of transport suppliers and clients who may use our UTX facilities maybe interrupted by failures in or damage to these facilities. Our facilities andthe ongoing circuit and IRU access we provide may be interrupted as a result ofvarious

 

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events, many of which we cannotcontrol, including fire, human error, earthquakes and other natural disasters,disasters along communications rights-of-way, power loss, telecommunicationsfailures, sabotage or vandalism, or the financial distress or other eventadversely affecting our suppliers, such as bankruptcy or liquidation.

 

We may be subject to legal claims and be liable for losses suffered byclients and carriers for disruptions to circuits or IRU’s or damage to clientor carrier equipment or other property resulting from failures at ourfacilities or on the networks of third party providers. Unless caused by anevent excused under our contract, such as a “force majeure” event, we generallyprovide outage credits to our clients if service disruptions occur. If ourservice failure rate is high, we may incur significant expenses related toservice outage credits, which would reduce our revenues and gross margins. Wewould also incur significant expenses in investigating and addressing thecauses of such service failures, which would divert resources from themaintenance or expansion of our services and cause our business to suffer. Inaddition, we may lack the resources to investigate and address any suchfailures in as timely a manner as our clients may expect, which may damage ourbusiness relationship with those clients and reduce our ability to obtainfuture business. Clients may seek to terminate their contracts with us if thereis a service failure. In addition, if our service failure rate is high, ourreputation could be harmed.

 

**Terrorist attacks and threats or actual war maynegatively impact our business, financial condition and results of operations.**

 

Our businessis affected by general economic conditions that can decline as a result ofnumerous factors outside of our control, such as terrorist attacks and acts ofwar. Recent terrorist attacks against the United States, as well as eventsoccurring in response to or in connection with them, including future terroristattacks against U.S. targets, rumors or threats of war, actual conflictsinvolving the United States or its allies, or military or trade disruptionsimpacting our suppliers or our clients, may adversely impact our operations. Asa result, there could be delays or losses in the delivery of our service,decreased sales of our services and extension of time for payment of accountsreceivable from our clients. Strategic targets such as communications networksand the Sears Tower (where our principal business offices are located) may beat greater risk of future terrorist attacks than other targets in the United States.This occurrence could have an adverse impact on our operations. It is possiblethat any or a combination of these occurrences could have a material adverseeffect on our business, financial condition and results of operations.

 

**We depend on several large clients, and theloss of one or more of these clients, or a significant decrease in totalrevenues from any of these clients, would likely significantly reduce ourrevenue and income.**

 

Historically, a substantial portion of our revenues has come from a limitednumber of clients. For example, for the year ended December 31, 2001, ourthree largest clients accounted for approximately 56% of our total revenues,and for the year ended December 31, 2002, our three largest clientsaccounted for approximately 39% of our total revenues. For the quarterended September 30, 2003, our three largest clients accounted forapproximately 30% of our total revenues. We have a number of significantcontracts with these clients under which we derive a significant amount of ourrevenues. These contracts expire on various dates between now andMarch 2005. If, through a bankruptcy proceeding or otherwise, we lose oneor more large clients, or if one or more of our large clients reduces theservices they purchase from us or otherwise renegotiates the terms on whichthey purchase services from us and we fail to add new clients, our revenuescould decline and our results of operations would suffer.

 

**We have assumed indebtedness that couldrestrict our future operating activities.**

 

In connection with the closing under the Purchase Agreement, we assumed$2 million in principal amount of a Promissory Note executed by CityNetand made to Electro Banque. The note is secured by the fiber optic ring locatedin Albuquerque, New Mexico and related assets, matures in a singleinstallment on December 31, 2007 and does not bear interest untilJanuary 1, 2006; thereafter, it bears interest at 8% per annum.  The loan documents provide that we will notsell the fiber optic ring unless we make certain payments to Electro Banque. Thisrestriction might prevent us from pursuing potentially advantageous

 

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business opportunities. Inaddition, our ability to repay the indebtedness when due will depend upon ourability to generate sufficient revenue, or to renegotiate or replace theindebtedness with Electro Banque on terms and conditions favorable to us, if atall. There can be no assurance that we will generate sufficient revenue or beable to renegotiate or replace the indebtedness with Electro Banque on termsand conditions favorable to us. If we are unable to repay or replace theindebtedness when due, Electro Banque will be permitted to exercise its rightsunder the security agreement securing the indebtedness and take possession ofthe fiber optic ring located in Albuquerque, New Mexico and the related assetsand dispose of such assets to satisfy the indebtedness.

 

**Operating our UTX facilities causes us toincur significant costs and expenses. To date, the market for our UTX services has been unprofitable.**

** **

We have incurred significantcosts and expenses in developing our UTX facilities, and we continue to incurcosts and expenses related to these facilities in connection with leasing realestate; hiring, training and managing employees; maintaining power andredundancy systems; maintaining multiple communications connections; anddepreciation expense.  To date, themarket for our UTX services has been unprofitable and has been developing moreslowly than we had expected.  We havederived substantially all of our revenues from providing on-going circuitaccess and have only limited experience providing our UTX services.  While management believes our UTX facilitieshave significant value to our business, we have tested and impaired our UTXsites in 2002 and in 2003 in compliance with SFAS No. 144. If the market forour UTX services does not increase significantly, we will not generate revenuesto offset the costs we incur in connection with such facilities, and therefore,we will suffer losses. 

 

**The regulatory framework under which weoperate and new regulatory requirements or new interpretations of existingregulatory requirements could require substantial time and resources forcompliance, which could make it difficult for us to operate our business.**

 

Our U.S. communications services are subject to both federal and stateregulation. In providing our interstate and international communicationsservices, we must comply with applicable telecommunications laws andregulations prescribed by the FCC and applicable foreign regulatoryauthorities. At the state level, we are subject to state laws and to regulationby state public utility commissions. Our international services are subject toregulation by foreign authorities and, in some markets, multi-nationalauthorities, such as the European Union.

 

These laws and regulations are subject to frequent changes anddifferent interpretations, and therefore, it is difficult for us to assess theimpact of these factors on our operations. The current domestic andinternational trend is toward deregulation of telecommunications and Internetservices. However, we cannot be certain that this trend will continue, and itis possible that changes in regulatory policies could limit our ability tocompete in some markets. The implementation, modification, interpretation andenforcement of laws and regulations vary and can limit our ability to providemany of our services.

 

We have been required to obtain authorization from the FCC, many statepublic utilities commissions and foreign regulatory authorities to offerparticular types of telecommunications services. Pursuant to theseauthorizations, we have to comply with a variety of regulatory obligations onan ongoing basis. We cannot provide assurance that the FCC, state commissionsor foreign authorities will grant us required authority (or do so in a timelymanner), or refrain from taking action against us if we are found to haveviolated any applicable requirements. If authority is not obtained or if ourschedules of prices, terms and conditions are not filed, or are not updated, orotherwise do not fully comply with the rules of the FCC or state or foreignregulatory agencies, third parties or regulators could challenge our ability tooffer our services or attempt to impose fines. Such challenges or fines couldcause us to incur substantial legal and administrative expenses.

 

Because we purchase telecommunications services from other carriers(including both long-distance and local telephone companies) for resale to ourcustomers, our costs of doing business can be affected by changes in regulatorypolicies affecting these other carriers. For example, the FCC has recentlyannounced decisions that may increase the costs of some dedicated transmissionservices offered by the

 

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local telephone companies. Wecannot control and often cannot predict these types of decisions or theirimpact on our business operations.

 

Changes to existing regulations in particular markets may decrease theopportunities that are available for us to enter into those markets, or mayincrease our legal, administrative or operational costs, or may constrain ouractivities in other ways that we cannot necessarily anticipate.

 

**Required regulatory approvals may interferewith or delay corporate transactions.**

 

As a regulated company, we may be required to obtain the approval ofthe FCC and certain state and foreign regulators before engaging in certainother types of transactions, including some mergers, acquisitions of otherregulated companies, sales of all or substantial portions of our business,issuances of stock, and incurrence of debt obligations. The particular types oftransactions that require approval differ in each jurisdiction. If we cannotobtain the required approvals, or if we encounter substantial delays inobtaining them, we may not be able to enter into transactions on favorableterms, if at all, and our flexibility in operating our business will belimited. If our flexibility is limited, we may not be able to optimize ouroperating results.

 

**We may incur operational and managementinefficiencies if we acquire new businesses or technologies, including thefiber optic rings we assumed from CityNet.**

 

To further our strategy, we may seek to acquire businesses andtechnologies that we believe will complement our existing business or otherwiserelate to a strategic transaction. For example, in July 2003 we assumedfrom CityNet fiber optic rings located in Albuquerque, New Mexico andIndianapolis, Indiana.  Any suchacquisitions would likely involve some or all of the following risks:

 

•                                          Difficultyof assimilating acquired operations and personnel and information systems;

 

•                                          Potentialdisruption of our ongoing business;

 

•                                          Possibilitythat we may not realize an acceptable return on our investment in theseacquired companies or assets;

 

•                                          Diversionof resources;

 

•                                          Possibleinability of management to maintain uniform standards, controls, procedures andpolicies;

 

•                                          Risksof entering markets in which we have little or no experience; and

 

•                                          Potentialimpairment of relationships with employees, suppliers or clients.

 

We may need to complete these transactions in order to generaterevenues, obtain needed capital, and to continue our business strategies.  We cannot be sure that we will be able toobtain any required financing for these transactions or that these transactionswill occur.

 

**We must continue our marketing and salesinitiatives to increase market awareness and sales of our services.**

 

Our services require a sophisticated sales and marketing effort thattargets key people within our prospective clients’ organizations. This saleseffort requires the efforts of select personnel as well as specialized system andconsulting engineers within our organization. Our ability to execute our salesand marketing initiatives depends on many factors, including our ability totrain, manage and retain employees. If we are unable to effectively staff ourmarketing and sales operations, or our marketing efforts are not successful, wemay not be able to increase market awareness or sales of our products andservices, which may prevent us from achieving and maintaining profitability.

 

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**If we do not continue to train, manage andretain our employees, clients may significantly reduce purchases of ourservices.**

 

Our employees are responsible for providing our clients with technicaland operational support, and for identifying and developing opportunities toprovide additional services to our existing clients. If we fail to train,manage and retain our employees, we may be limited in our ability to gain morebusiness from existing clients, and we may be unable to obtain or maintain currentinformation regarding our clients’ and suppliers’ communications networks,which could limit our ability to provision future circuits for our clients ordevelop new service offerings.

 

**Failure to successfully maintain and upgradeour management information systems could harm our ability to operate or manageour business effectively.**

 

We are in the process of augmenting our management information systemsto facilitate management of client order, client service, billing and financialapplications. Our ability to manage our business could be harmed if we fail tosuccessfully and promptly maintain and upgrade our management informationsystems as necessary. In addition, our ability to efficiently operate ourbusiness could suffer if the software that runs our information systemsmalfunctions.

 

**Because we have no patented technology andhave limited ability to protect our proprietary information, competitors maymore easily replicate our business and harm our ability to generate revenues.**

 

We have no patented technology that would preclude or inhibitcompetitors from replicating our business. We rely on a combination ofcopyright, trademark, service mark and trade secret laws and contractualrestrictions to establish and protect our intellectual property. We haveapplied for registration of certain of our service marks in the United Statesand in other countries, and have obtained registrations for certain of ourservice marks in the United States, the European Union, Australia, Korea,Indonesia, Mexico, Thailand, Switzerland, New Zealand and Singapore. Even ifadditional registrations are granted, we may be limited in the scope ofservices for which we may exclusively use our service marks. We enter intoconfidentiality agreements with our employees, consultants and partners, and wecontrol access to, and distribution of, our proprietary information. Ourintellectual property may be misappropriated or a third party may independentlydevelop similar intellectual property. Moreover, the laws of certain foreign countriesmay not protect our intellectual property rights to the same extent as do thelaws of the United States. Unauthorized use of any of our proprietaryinformation could expose us to competition, which would harm our ability toattract new and existing clients and generate revenues.

 

**CityNet owns a majority of our outstandingcommon stock, which may discourage third party offers to acquire us.**

 

CityNet has significant control over us. CityNet owns approximately 55%of our outstanding common stock on a fully-diluted basis (excluding thoseoptions and warrants outstanding at the closing of the Purchase Agreementhaving an exercise price above $1.00 per share). In addition, CityNet hasdesignated five out of nine of the members of our board of directors, includingthe chairman. The extent of CityNet’s control over us may have the effect ofdiscouraging third party offers to acquire us.

 

**Provisions of our charter documents may haveanti-takeover effects that could prevent a change in corporate control.**

 

Provisions of our certificate of incorporation, bylaws, and Delawarelaw could make it more difficult for a third party to acquire us, even if doingso would be a benefit to our stockholders.

 

**There may be sales of a substantial amount ofour common stock that could cause our stock price to fall.**

 

A small number of our current stockholders hold a substantial number ofshares of our common stock. Pursuant to the terms of the Purchase Agreement, onJuly 23, 2003 we entered into a stockholders

 

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agreement with CityNet, ICGHoldings, Inc., ComVentures and two of our former executives. Under thisagreement, these stockholders, including CityNet among other things, haveagreed to limitations on their ability to dispose of shares of Common Stockuntil July 23, 2004 (12 months after the closing under the PurchaseAgreement), except as otherwise agreed to by the vote of a majority of ourboard. These stockholders beneficially own approximately 75% of our outstandingcommon stock. Sales of a substantial number of shares of our common stock ormarket expectations that these sales may occur could cause our stock price tofall. In addition, the sale of these shares could make it difficult for us toraise necessary capital by issuing additional common stock.

 

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**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

The primary objective of our investment activities is to preserveprincipal while at the same time maximizing the income we receive from ourinvestments without significantly increasing risk. Some of the securities thatwe may invest in may be subject to market risk. This means that a change inprevailing interest rates may cause the principal amount of the investment tofluctuate. For example, if we hold a security that was issued with a fixedinterest rate at the then-prevailing rate and the prevailing interest ratelater rises, the principal amount of our investment will probably decline. Tominimize this risk, we maintain our portfolio of cash equivalents andshort-term investments in a variety of securities, including commercial paper,money market funds, government and non-government debt securities. In general,money market funds are not subject to market risk because the interest paid onsuch funds fluctuates with the prevailing interest rate. As of June 30,2003, all of our investments were in cash and cash equivalents.

 

**Interest Rate Sensitivity**

 

We maintainour cash equivalents and short-term investments primarily in a portfoliocomprised of commercial paper, money market funds, and investment grade debtsecurities. As of June 30, 2003, all of our investments had maturities ofless than six months. Accordingly, we do not believe that our investments havesignificant exposure to interest rate risk.

 

**Exchange Rate Sensitivity**

 

We currently operate primarily in the United States, and substantiallyall of our revenues and expenses to date have been in U.S. dollars.Accordingly, we have had no material exposure to foreign currency ratefluctuations.

 

**ITEM4. CONTROLS AND PROCEDURES**

 

Our management, including our Chief Executive Officer and ChiefFinancial Officer, carried out an evaluation of our disclosure controls andprocedures (as required under paragraph (b) of Rule 15d-15 under the SecuritiesExchange Act of 1934, as amended) as of the end of the period covered by thisreport. Based on that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that we had sufficient procedures for recording,processing, summarizing, and reporting information that is required to bedisclosed in our reports under the Securities Exchange Act of 1934, as amended.Our controls were designed by our management.

 

There have not been any significant changes to our internal controlsover financial reporting or in other factors that could significantly affectthese controls subsequent to the date of this evaluation.

 

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**PART II. OTHER INFORMATION**

 

# ***ITEM 1. LEGAL PROCEEDINGS***

# *** ***

In November 2001, acomplaint was filed in federal district court for the Southern District of NewYork on behalf of a purported class of persons who purchased our stock betweenMarch 16, 2000 and December 6, 2000. The complaint generally allegesthat various underwriters engaged in improper and undisclosed activitiesrelated to the allocation of shares in our initial public offering ofsecurities. The complaint brings claims for violation of several provisions ofthe federal securities laws against the underwriters of our IPO, and alsoagainst us and certain of our former directors and officers under theSecurities Act of 1933 and the Exchange Act of 1934. Similar lawsuitsconcerning more than 300 other companies’ initial public offerings were filedin 2001, all of which were consolidated into a single coordinated proceeding inthe Southern District of New York. We believe that the allegations against usare without merit. On June 30, 2003, the litigation committee ofour board of directors conditionally approved a proposed partial settlementwith the plaintiffs in this matter.  Thesettlement would provide, among other things, a release of us and of theindividual defendants for the conduct alleged in the action to be wrongful inthe complaint.  We would agree toundertake other responsibilities under the partial settlement, includingagreeing to assign away, not assert, or release certain potential claims we mayhave against our underwriters.  Ourinsurers are expected to bear any direct financial impact of the proposedsettlement.   The committee agreed toapprove the settlement subject to a number of conditions, including theparticipation of a substantial number of other issuer defendants in the proposedsettlement, the consent of our insurers to the settlement, and the completionof acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness andapproval by the Court overseeing the litigation.

 

We haveentered into a settlement agreement with respect to an action that Level 3Communications, LLC filed in the United States District Court for theEastern District of Virginia, and which was referred to a bankruptcy judge. Thecomplaint named as defendants the Company, three bankrupt entities (Aleron, Inc.,Aleron U.S., Inc., and TA Acquisition Corp.), and those threeentities’ bankruptcy trustee. In its complaint, Level 3 claimed that itwas owed for certain telecommunication services provided under contractsbetween Level 3 and TA Acquisition and for termination charges underthose contracts. On July 2, 2003, Level 3 Communications, LLCaccepted a settlement agreement entered into in June 2003 relating to theclaims Level 3 brought against us. Under the settlement agreement, we agreed topay Level 3 a total of $1.4 million to settle the litigation and othermatters.  We may use up to $200 thousandof this amount as a prepayment of certain services. On September 3, 2003the bankruptcy court issued an order dismissing us from the suit.  The entire settlement amount of $1.2 millionwas accrued for the period ending June 30, 2003 in accrued carrierexpenses.  At September 30, 2003, $225thousand was still owed to Level 3 payable in monthly installments of $75thousand.

 

We have reached a settlement agreement withAleron, Inc. and TA Acquisition Corp. regarding potential claimsagainst us.  Under the terms of thesettlement, each party released all claims that it might have had against theother. Before their conversion under Chapter 7 of the Bankruptcy Code,Aleron, Inc. and TA Acquisition Corp. listed potential claims againstus in their Chapter 11 schedules listing their assets. Aleron stated thatit “has substantial breach of contract and other claims against UniversalAccess” arising out of contractual agreements and provided that the estimatedvalue of the claims was between $3 and $5 million. TA Acquisitionstated that it “may have substantial claims against Universal Access” andprovided that the value of those claims was unknown.  On October 31, 2003, the bankruptcy court issued an orderapproving the terms of the settlement.

 

We and certain of our formerdirectors and officers are defendants in an action pending in the United StatesDistrict Court for the Eastern District of Texas, Frandsen v. Universal Access,Inc., et al., No. 9:02CV103 (E.D. Tex.). The complaint alleged causes of actionfor securities fraud in connection with public disclosures made by our officersbetween 2000 and 2002. We believe that the allegations against us are without merit.On March 7, 2003, the court granted a motion to dismiss the complaint andgranted plaintiffs the opportunity to replead the complaint with respect to aminority of the alleged misstatements. On May 27, 2003, plaintiffs filed a second amended consolidatedcomplaint.  Pursuant to the Court’sSeptember 17, 2003 order, on October 1, 2003, plaintiffs filed arevised second amended consolidated

 

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complaint. Defendants’ motion to dismiss is scheduled to be fullybriefed and under submission by November 2003. Plaintiffs have notspecified the amount of damages they seek.

 

In August 2003, GenuityTelecom Inc. filed a complaint against Universal Access in the United StatesBankruptcy Court for the Southern District of New York.  In its complaint, Genuity alleges that wedid not purchase the minimum amount of telecommunications services specified bythe parties’ contract.  Genuity seeksdamages against us of nearly $1.6 million, plus costs and interest, representingthe difference between the purported minimum purchase commitment and the amountof telecommunications services we purchased. We believe that Genuity’s claims are without merit. We answeredGenuity’s complaint and asserted several defenses to Genuity’s claims.  We also filed a motion seeking to stay theaction and to compel arbitration of the matter in accordance with the mandatoryarbitration provision in the contract. Genuity assigned the contract to Level 3 Communications, LLC onFebruary 4, 2003 as part of Genuity’s bankruptcy proceeding andreorganization efforts.  The amountsought by Genuity in its complaint relates to our actions prior toFebruary 4, 2003.

 

**ITEM 2.CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

Pursuant to stockholderand board approval we implemented a one-for-twenty reverse splitof our common stock effective at the close ofbusiness on August 8, 2003, and on August 11, 2003, our common stock began trading on a post-splitbasis. The reverse stock split was intended to help us regain compliance withthe $1.00 per share minimum bid price requirement for continued listing on theNASDAQ SmallCap Market.

 

Effective April 7,2003, we entered into a Purchase Agreement with CityNet. Pursuant to the termsof the Purchase Agreement, on July 23, 2003 (a) CityNet paid to us$16 million in cash and transferred to us fiber optic rings located inAlbuquerque, New Mexico and Indianapolis, Indiana, (b) we issued to CityNet6,567,168 newly issued shares of our common stock, adjusted for the one-for-twentyreverse stock split, representing approximately 55% of our outstanding commonstock on a fully diluted basis (with any options and warrants having anexercise price in excess of $20.00, adjusted for the August 8, 2003,one-for-twenty reverse stock split being excluded from the calculation of“fully diluted,” subject to CityNet’s right to receive compensating shares inthe event that any of these options or warrants are subsequently exercised) and(c) we assumed certain liabilities of CityNet. In particular, we assumed$2 million in principal amount of a Promissory Note executed by CityNetand made to Electro Banque.  The note issecured by the fiber optic ring located in Albuquerque, New Mexico, matures ina single installment on December 31, 2007 and does not bear interest untilJanuary 1, 2006; thereafter, it bears interest at 8% per annum.

 

After payingexpenses related to the Purchase Agreement, the net proceeds from the PurchaseAgreement were approximately $14.7 million.  Proceeds will be used for working capital, general corporatepurposes and as possible consideration for acquisitions.

 

In December2002 we engaged Broadmark Capital, LLC (“Broadmark”) to provide financialadvisory and investment banking services. Under the engagement, Broadmark was obligated to use its best efforts toraise capital from a mutually agreed upon list of third parties.  The compensation for such services wassuccess based.  Pursuant to the closingunder the Purchase Agreement with CityNet, on July 23, 2003 we issued toBroadmark a warrant to acquire 1,000,000 of our common shares at a price of$.22 per share (50,000 of our common shares at a price of $4.40 per share aftergiving effect to of our one-for twenty reverse stock split completed on August8, 2003).  These warrants areexercisable for four years from the date of grant.

 

Nounderwriters were involved in the foregoing sales of securities. Such saleswere made in reliance upon an exemption from the registration provisions of theSecurities Act of 1933, as amended, set forth in Section 4(2) thereof relativeto sales by an issuer not involving any public offering or the rules andregulations thereunder.

 

CityNet hascontractually agreed not to sell shares of our common stock they own until July23, 2004.  In addition, the shares ofour common stock CityNet owns are subject to the restrictions on resalepursuant to certain provisions of SEC Rule 144.

 

The shares ofour common stock to be issued upon the exercise of the warrant owned byBroadmark are subject to the restrictions on resale pursuant to certainprovisions of SEC Rule 144.

 

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**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Our annual meeting ofstockholders was held on July 21, 2003. At this meeting, four proposals were submitted to a vote of ourstockholders: (1) the election of two Class I directors (with Anthony P.Dolanski and Carolyn F. Katz being the nominees); (2) the ratification of ourappointment of PricewaterhouseCoopers LLP as our independent accountants forfiscal year 2003; (3) the approval of the issuance of our common stock toCityNet Telecommunications, Inc. under the stock purchase agreement; and (4)the approval of an amendment to our restated certificate of incorporation to effecta reverse stock split of our issued and outstanding common stock.  At the close of business on the record datefor the meeting (which was May 23, 2003), there were 99,134,117 shares ofcommon stock outstanding and entitled to be voted at the meeting.    Holders of 91,855,544 shares of common stock outstanding orapproximately 92.66% of the total shares outstanding and entitled to vote atthe meeting were either present in person or represented by proxy.  The following table sets forth the resultsof the voting.  These numbers do notreflect the one-for-twenty reverse stock split completed on August 8, 2003.

 

 
| **Proposal**                 |   | **For**    |   | **Withheld** |   |
|------------------------------|--------|------------|--------|--------------|--------|
| 1. Election of two directors |   |       |   |         |   |
| Anthony P. Dolanski          |   | 82,720,523 |   | 9,135,021    |   |
| Carolyn F. Katz              |   | 91,278,028 |   | 577,516      |   |

 
|                                                                                                                                                  |   |       |   |        |   |        |   | **Broker**    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|--------|-------------|--------|-------------|--------|---------------|--------|
|                                                                                                                                                  |   | **For**    |   | **Against** |   | **Abstain** |   | **Non-Votes** |   |
| 2. Ratification of PricewaterhouseCoopers  as our independent accountants                                                                             |   | 91,796,435 |   | 26,174      |   | 32,935      |   | 0             |   |
| 3. Approval of the issuance of our common  stock to CityNet Telecommunications, Inc. under the stock purchase agreement                               |   | 57,467,898 |   | 131,810     |   | 79,166      |   | 34,176,670    |   |
| 4. Approval of an amendment to our Restated  Certificate of Incorporation to effect a reverse stock split of our issued  and outstanding common stock |   | 90,762,496 |   | 373,277     |   | 719,771     |   | 0             |   |

 

Each of the proposals set forthabove received more than the required number of votes for approval and weretherefore duly and validly approved by the stockholders.

 

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**ITEM 6.EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)                                  Listof Exhibits

 
| **Exhibit   Number** |   | **Description of Document**                                                                                                                                                                                                                                                         |
|----------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                                                                                                                                                |
| 2.1                  |   | Agreement and Plan of Merger among the  Company, Migration Corporation and Universal Access, Inc. dated July 18,  2001.(1)                                                                                                                                                     |
| 2.2                  |   | Stock Purchase Agreement with CityNet Telecommunications,  Inc. dated April 7, 2003.(2)                                                                                                                                                                                        |
| 2.3                  |   | Letter agreement with CityNet  Telecommunications, Inc. dated April 7, 2003.(2)                                                                                                                                                                                                |
| 2.4                  |   | Letter agreement with CityNet  Telecommunications, Inc. dated July 23, 2003.                                                                                                                                                                                                   |
| 3.1                  |   | Restated Certificate of Incorporation of  the Company.(3)                                                                                                                                                                                                                           |
| 3.1.1                |   | Amendment to the Restated Certificate of  Incorporation of the Company.                                                                                                                                                                                                             |
| 3.2                  |   | Amended and Restated Bylaws of the  Company.(1)                                                                                                                                                                                                                                     |
| 4.1                  |   | Form of the Company’s Common Stock  certificate.                                                                                                                                                                                                                               |
| 4.2                  |   | Amended and Restated Registration and Informational  Rights Agreement dated June 28, 1999.(5)                                                                                                                                                                                  |
| 4.3                  |   | Amended and Restated Registration and  Informational Rights Agreement dated June 30, 1999.(5)                                                                                                                                                                                  |
| 4.4                  |   | Registration Rights Agreement dated  November 10, 1999.(5)                                                                                                                                                                                                                     |
| 4.5                  |   | Registration Rights Agreement dated July 1,  2000.(6)                                                                                                                                                                                                                          |
| 4.6                  |   | Registration rights Agreement with CityNet  Telecommunications, Inc. dated July 23, 2003.                                                                                                                                                                                      |
| 4.7                  |   | Form of warrant to purchase shares of  Common Stock of the Company issued to Advanced Equities.(5)                                                                                                                                                                                  |
| 4.8                  |   | Preferred Stock Rights Agreement, dated as  of July 31, 2000, between Universal Access, Inc. and Wells Fargo,  including the Certificate of Designation, the form of Rights Certificate and  the Summary of Rights attached thereto as Exhibits A, B, and C,  respectively.(7) |
| 4.8.1                |   | Assumption of and Amendment to the  Universal Access, Inc. Preferred Stock Rights Agreement dated July 13,  2001.(1)                                                                                                                                                           |
| 4.8.2                |   | Second Amendment to the Universal Access  Global Holdings Inc. Preferred Stock Rights Agreement dated April 7,  2003. (2)                                                                                                                                                      |
| 4.9                  |   | Stockholders Agreement dated July 23,  2003.                                                                                                                                                                                                                                   |
| 4.10                 |   | Warrant to purchase shares of Common Stock  of the Company issued to Broadmark Capital, Inc. dated July 23, 2003.                                                                                                                                                              |
| 10.34                |   | Form of Employment Agreement for certain  executive officers.                                                                                                                                                                                                                       |
| 31.1                 |   | Certification of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                           |
| 31.2                 |   | Certification of Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                           |
| 32.1                 |   | Certification of Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                           |
| 32.2                 |   | Certification of Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                           |

 

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(1)                                  Filedwith the Company’s Quarterly Report on Form 10-Q for the quarterly period endedJune 30, 2001.

 

(2)                                  Filed with the Company’sCurrent Report on Form 8-K dated April 11, 2003.

 

(3)                                  Filedwith the Company’s Quarterly Report on Form 10-Q for the period endedJune 30, 2002.

 

(4)                                  Filedwith the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2001.

 

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(5)                                  Filedwith the Company’s Registration Statement on Form S-1 (No. 333-93039) filedwith the Securities and Exchange Commission by the Company in connection withits initial public offering that became effective March 16, 2000.

 

(6)                                  Filedwith the Company’s Quarterly Report on Form 10-Q for the quarterly period endedJune 30, 2000.

 

(7)                                  Filedwith the Company’s Registration Statement on Form 8-A, filed with theSecurities and Exchange Commission on August 9, 2000.                     

 

 

(b)         Reportson Form 8-K:

 

On July 3, 2003, we filed with the SEC areport on Form 8-K, which was filed pursuant to Item 5 of Form8-K and which announced that Mark F. Spagnolo had resigned as a member of ourBoard of Directors effective July 1, 2003.

 

OnJuly 24, 2003, we filed with the SEC a report on Form 8-K, which was filedpursuant to Items 5 of Form 8-K and which announced: (i) that our annualmeeting of stockholders was held July 21, 2003 and that the stockholdersof the Company approved each proposal described in the proxy statement for themeeting; (ii) that on July 22, 2003 Randall R. Lay was appointed as ourChief Executive Officer and as a Class II Director, and that Brian Coderre wasappointed as our Chief Financial Officer; (iii) that on July 21, 2003Roland Van der Meer resigned from our board of directors and that onJuly 22, 2003 Kevin Power resigned from of our board of directors; (iv)that on July 23, 2003 we closed a transaction with CityNetTelecommunications, Inc. under a stock purchase agreement (the “PurchaseAgreement”); (v) that onJuly 23, 2003 William J. Elsner and Anthony L. Coelho were elected asClass I Directors, and that Fred Vierra and Anthony S. Daffer were appointed asClass III Directors; and (vi) that pursuant to the terms of the PurchaseAgreement we entered into a stockholders agreement with CityNet and certain ofour significant stockholders.

 

On September 22, 2003, we filed with theSEC a report on Form 8-K, which was filed pursuant to Item 5 ofForm 8-K and announced that Scott D. Fehlan had resigned as our General Counseland Secretary, effective September 30, 2003 and that Annette V. Erdmannhas resigned as our interim Chief Information Officer, effectiveSeptember 30, 2003.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                                    | UNIVERSAL ACCESS GLOBAL HOLDINGS INC.   (Registrant) |
|-----------------------------------------|------------------------------------------------------|
|                                    |                                                 |   |
| Date:  November 14, 2003 | By:                                                  | /s/ BRIAN CODERRE |   |
|                                    |                                                 | Brian Coderre |
|                                    |                                                 | *Chief Financial Officer  (Principal Financial and Accounting Officer)* |

 

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