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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [X]
    
    ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003
 [  ]
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 000-30401 U.S. REALTEL, INC. 
  DELAWARE
    
    36-4166222(State or other jurisdiction
of incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 15 PIEDMONT CENTER, SUITE 100, ATLANTA, GEORGIA
    
    30305(Address of principal executive offices)
    
    (Zip Code)
 (404) 869-2500 
  Securities registered under Section 12(b)
of the Exchange Act : Title of each class
    
    Name of each exchange on which registeredNone
    
    None
 Securities registered under Section 12(g)
of the Exchange Act : COMMON STOCK, $0.001 PAR VALUE Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X]
 No [   ]




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Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and no disclosure will be contained, to the best
of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [  ] State issuers revenues for its most recent fiscal year: $84,626,000. The aggregate market value of the registrants outstanding shares of common
stock held by non-affiliates as of March 1, 2004 was $3,494,419, computed by
reference to the closing sale price of the common stock of $1.00 per share on
such date. Aggregate market value has been estimated solely for the purposes
of this report. For purposes of this calculation, all executive officers,
directors and 10% stockholders are classified as affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes. State the number of shares outstanding of each of the issuers classes of
common equity, as of the latest practicable date: 5,873,395 shares of common
stock as of March 1, 2004. DOCUMENTS INCORPORATED BY REFERENCE Part III: Portions of registrants Proxy Statement to be filed with the
Securities and Exchange Commission on or about April 16, 2004 relating to the
2004 Annual Meeting of Stockholders expected to be held on June 11, 2004 are
incorporated into Part III of this Form 10-KSB. Transitional Small Business Disclosure Format (check one): Yes [  ] No [X] 2




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U.S. REALTEL, INC. FISCAL YEAR 2003 FORM 10-KSB ANNUAL REPORT TABLE OF CONTENTS PART IItem 1. Description of Business
    
    
    4Item 2. Description of Property
    
    
    12Item 3. Legal Proceedings
    
    
    13Item 4. Submission of Matters to a Vote of Security Holders
    
    
    13PART IIItem 5. Market for Common Equity and Related Stockholder Matters
    
    
    13Item 6. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    14Item 7. Financial Statements
    
    
    28Item 8. Changes In and Disagreements With Accountants on Accounting and Financial
Disclosure
    
    
    59Item 8A. Controls and Procedures
    
    
    59PART IIIItem 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act
    
    
    59Item 10. Executive Compensation
    
    
    59Item 11.
Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    59Item 12. Certain Relationships and Related Transactions
    
    
    59Item 13. Exhibits and Reports on Form 8-K
    
    
    60Item 14 Principal Accountant Fees and Services
    
    
    61Signatures
    
    
    62EX-4.3 REGISTRATION RIGHTS AGREEMENTEX-4.4 INTERCREDITOR AGREEMENTEX-10.2 EMPLOYMENT AGREEMENT DATED 11/1/2003EX-10.10 LOAN AGREEMENT DATED JULY 16, 2002EX-10.11 FIRST AMENDMENT TO LOAN AGREEMENTEX-10.12 PURCHASE AGREEMENT DATED JULY 16, 2002EX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF VP & CFOEX-32.1 SECTION 906 CERTIFICATION OF CEOEX-32.2 SECTION 906 CERTIFICATION OF VP & CFO
  3




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PART I SPECIAL CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained in this report constitute forward-looking
statements within the meaning of the United States Private Securities
Litigation Reform Act of 1995. In some cases, forward-looking statements can
be identified by the use of forward-looking terminology such as may, will,
estimate, intend, continue, believe, expect, or plan or the
negatives thereof, variations thereon or similar terminology. These
forward-looking statements are found at various places throughout this report.
These forward-looking statements generally relate to estimates, plans and
objectives related to future operations as well as the markets for our services
and products and are based upon managements estimates of future results or
trends. Although we believe that the plans and objectives reflected in or
suggested by such forward-looking statements are reasonable, such plans or
objectives may not be achieved. Actual results may differ from projected
results due, but not limited, to assumptions which do not materialize,
unforeseen developments, and/or matters beyond our control, including
developments relating to the following:  
    
    the availability and adequacy of our cash flow to satisfy our
obligations, including our debt service obligations, and our need for
additional funds required to support capital improvements, development and
acquisitions;
    
    economic, competitive, demographic, business and other conditions in our
markets and with respect to our product offerings;
    
    changes or developments in the laws, regulations or taxes in the
telecommunications industry;
    
    actions taken or omitted to be taken by third parties, including
customers, suppliers, competitors, and stockholders, as well as
legislative, regulatory, judicial and other governmental authorities;
    
    changes in business strategy, capital improvements and development plans;
    
    changes in personnel or their compensation;
    
    an inability to renew or early termination of our contracts;
    
    an inability to increase revenues and reduce costs in our existing operations;
    
    an inability to engage in future acquisitions;
    
    the loss of any license or permit;
    
    resolution of any pending or future litigation in a manner adverse to us; and
    
    the other factors discussed under Risk Factors That May Affect Future Results in Item 6 and elsewhere in this report. You should read this report completely and with the understanding that
actual future results may be materially different from what we expect. All
subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
foregoing factors and the factors discussed in Item 6 and elsewhere in this
report. These forward-looking statements speak only as of the date of the
document in which they are made. We disclaim any obligation or undertaking to
provide any updates or revisions to any forward-looking statement to reflect
any change in our expectations or any change in events, conditions or
circumstances on which the forward-looking statement is based, in any future
statement, report, press release or other communication. 
 ITEM 1. DESCRIPTION OF BUSINESS INTRODUCTION U.S. RealTel, Inc. (together with its subsidiaries, U.S. RealTel, we,
us, or our) operates in one business segment, namely, the provision of
telecommunications services. Since U.S. RealTels acquisition of Cypress
Communications, Inc. (Cypress Communications) in February 2002, it has
provided a full range of telecommunications services to businesses in
commercial office buildings located in select major metropolitan markets in the
United States. During 2001 and through the first quarter of 2002, U.S. RealTel
also operated in the telecommunications business rights segment, all of which
operations were conducted in Latin America, namely in Argentina and Brazil. In
March 2002, U.S. RealTel liquidated its Latin American telecommunications
rights operations. See Description of Business  Discontinuance of
Telecommunications Rights Business. 4




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TELECOMMUNICATIONS SERVICES Overview U.S. RealTel, through Cypress Communications, is the preferred
communications provider in approximately 1,300 Class A commercial office
buildings. We provide a full range of reliable, feature rich, integrated
telecommunications services to businesses in those commercial office buildings,
including high speed Internet access and data services, local and long-distance
voice services, digital telephone systems, digital satellite business
television, voicemail, e-mail, web site hosting, security/monitoring services
and other advanced communication services. We deliver these services over
fiber optic, digital and broadband networks that we design, construct, own and
operate inside large and medium-sized office buildings. We target large and medium sized commercial office buildings in central
business districts and suburban office markets within select major metropolitan
markets within the United States where small and medium-sized businesses are
typically located. We believe that our target businesses generally are
under-served by incumbent providers. Properties that house many tenants with
heavy demand for telecommunications services are the most desirable properties
and offer us the opportunity to generate the highest revenue. Our current
operations are in the following 25 markets: Atlanta, Birmingham, Boston,
Chicago, Dallas, Denver, Hartford, Houston, Indianapolis, Miami, Minneapolis,
Nashville, New Orleans, New Jersey, New York, Orlando, Philadelphia, Phoenix,
Pittsburgh, Portland, San Francisco, Seattle, Southern California (Los Angeles
and Orange County), Tampa and Washington, DC. In all of our markets we bundle voice and data services to provide
one-stop shopping communications solutions to building tenants at competitive
prices. In 58 buildings, we also provide video services as part of our
comprehensive communications package. Because we currently own and operate our
in-building networks, we are typically able to deploy services to a new
customer within a few days of receiving an order. In addition, we are often
able to provide same day service for existing customers requesting new services
or features, such as increased bandwidth or additional lines. Our current telecommunications services include: Data Services. We utilize in-building fiber optic networks to deliver
high-speed Internet access directly to our customers in approximately 20
percent of our in-service buildings. We also utilize in-building CATV
(Category 5 Cable) to deliver high-speed Internet access directly to our
customers in approximately another 20 percent of our in-service buildings. The
buildings which utilize fiber optic networks and CATV deliver the high-speed
Internet access using a Cisco Systems router and switch deployed in the
building. The remaining buildings employ high speed Internet access delivered
through a Digital Subscriber Line Access Multiplexer (DSLAM) deployed in the
building over twisted pair copper infrastructure. Our Internet service
provides full Internet protocol routing, symmetric upstream and downstream
bandwidth, and plug-and-play installation. Our customers do not need to
purchase or maintain any specialized hardware to use our Internet service.
Moreover, because our service is capable of delivering up to 10/100 Mbps
Ethernet connectivity, we are poised to meet our customers growing bandwidth
needs. The key features of our Internet services are:  
    
    Dedicated connectivity: Our service is designed to be always
on, providing instantaneous connections and the capability to receive
or transmit information continuously.
    
    Flexibility: We can usually increase a customers bandwidth
speed within minutes of receiving a request.
    
    Diversity: We incorporate logically and physically diverse
Internet circuits in our collocation facilities in each city to
protect customer Internet connections from disruption.
    
    Reliability: Each of our collocation facilities is supported by
backup battery power. Moreover, we monitor all of our equipment,
circuits and connections from our network operations center in
Atlanta, Georgia. Should an outage occur in our network, we are
notified immediately. In addition to our standard Internet access service, we offer other
enhanced data services, including:  
    
    E-mail, featuring IPSwitchs mail server version 7.13 and
Postfix. Our service permits customers to use any e-mail client,
including Microsoft Outlook, Outlook Express and Netscape Mail;
access e-mail remotely using any web browser; set instant reply
messages; and forward messages to supported pagers or voice e-mail
systems. 5




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
    
    Web conferencing, which permits our customers to upload
visuals, including Microsoft PowerPoint presentations, engage in
online collaboration with a remote audience, record and replay
audio-visual presentations, and combine superior audio conferencing
technology with the reach and visual impact of the Internet.
    
    Web site hosting, featuring Compaq Proliant Servers running
Microsoft Windows 2000 Advanced Servers with IIS and Linux with
Apache Servers. Our web site hosting also includes, on the Linux
servers, graphs of web site hit statistics, access to a database
called MySQL, PHP and PERL support.
    
    Domain Name Registration (DNS). DNS can include all or some of
the following: registration of a domain, hosting, and the ability to
make DNS updates quickly with one phone call.
    
    Firewall Security Services. We offer a dedicated,
cost-efficient firewall product to protect customer data and
equipment. Our products of firewalls offer the latest in intrusion
prevention by using state-full packet inspection compared to other
products that use standard packet filtering. We also offer web site
blocking, logging, VPN support and various other features.
    
    Monitoring Services. We provide 24-hour monitoring of web
servers, e-mail servers and customer local area networks. We can
monitor customer systems every 5 minutes, 24 hours a day. If we
encounter problems, we can notify our customers via e-mail, pager or
both.
    
    NNTP Internet News Feed. We carry a network news feed that
contains over 30,000 news groups. Voice Services. Substantially all of our voice services customers rent
their telephones from us. This ensures a compatible interface with our
in-building communications equipment and provides customers with a number of
key benefits, including access to an advanced, multi-function digital telephone
system; significant reductions in up-front capital costs; and reduced risk of
technological obsolescence. Our voice offerings include both traditional
telephone services, such as local and long distance services, as well as
value-added services, such as integrated voicemail, audio conferencing,
webconferencing, calling cards and customizable toll-free number services.
Additional enhanced features include call waiting, call forwarding, dial-back
and caller identification. Bundled Voice and Data Services. Our customers tell us that assessing
needs and selecting and managing vendors for voice/ data and video
communications services is becoming increasingly complex. The historical
approach to selling communications services has been a la carte packaging
from numerous vendors. In the fall of 2003, we introduced our EZ Office Suite
which provides complete solutions for a simplified seat price. This bundling
approach has been popular with both new and existing customers and has the
potential to substantially optimize the customer buying process. We have also
seen a significant trend toward flat rate or unlimited long distance packaging.
We began packaging EZ Office Flat Rate solutions in the fall of 2003 and
expect a majority of future customers to purchase these types of solutions. Voice over Internet Protocol (VoIP) Services. In the summer of 2003, we
began a trial in Southern California for enabling our VoIP solutions over our
high speed Internet service. The specific application for delivering voice
communications features to end users is known as IP Centrex. IP Centrex can
enable significant new functionality for our customers and is expected to be
the next wave of communications solutions for business customers. IP Centrex
can also be provided over managed local loops which allows us to provide
services to customers in off-net buildings. The trial was successful and we
intend to launch IP Centrex services in additional markets starting in 2004.
The benefits of IP Centrex for us includes opportunities to:  
    
    Follow customers if they move out of our current buildings.
    
    Sell new services to existing customers.
    
    Compete for customers that want a common solution for multiple locations.
    
    Obtain customers that want the latest in technology.
    
    Sell to customers in almost any building. Our VoIP solution consists of our EZ Office Web Dashboard, unlimited local
calling, bundled minutes or unlimited long distance, high speed Internet and
Cisco IP telephones. Functionality includes: 6




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
    
    IP Phones. To date, we have provided IP phones from Cisco, but
there are other potential providers in this market. IP phones provide
the traditional telephone features as well as the flexibility to plug
the phone into a standard Ethernet connection  at the office or
home. Cisco has sold over 2.5 million IP phones and is a leader in
the market. IP phones permit software updates to be uploaded to
provide patches and enhancements that are not possible on traditional
phones.
    
    Find Me. Provides the ability to control the routing of your
incoming calls. Establishes one number for all your phones (office,
cell, home office). Manages important calls and blocks calls as your
business needs change.
    
    Visual Voicemail. Accesses and manages your voicemail just
like email from your laptop or desktop PC, which we believe is much
easier to utilize than the traditional method of using the keypad on
a telephone.
    
    Unified Messaging. Delivers voicemails to your email inbox
(such as Outlook) and attaches voicemail messages to emails.
    
    Call Logs. Displays all received, missed and dialed calls for
last 90 days. Allows for simple click to call dialing, even when you
are traveling.
    
    Instant Conferencing. Lets you join 2-10 people instantly from
any Internet connection.
    
    Scheduled Conferencing. Allows you to establish a scheduled
conference call for several participants with advanced functionality
to manage the call.
    
    Company Private Instant Messaging. Allows employees to chat
with each other without the distractions of more commonly available
instant messaging solutions.
    
    Soft Console. Allows users to determine each employees availability status, even if they are remote.
    
    Management Console. Provides simple administration from a web interface for set-up and changes. Video and Other Services. In 58 buildings, we offer our customers a
comprehensive package of business television services consisting of news,
business, sports and network programming. We deliver these services directly to
our customers over our in-building networks using a combination of direct
broadcast satellite programming and off-air local channels. Our customers can
elect to receive more or less programming depending on their needs. We continue to investigate, test and add, where appropriate, complementary
communications products and services to enhance our one-stop shopping
strategy. Employees As of March 1, 2004 we employed 311 full-time employees, all in the United
States. All of these employees are employed by U.S. RealTels
wholly-owned subsidiary, Cypress Communications. We believe our employee
relationships are good. Competition We face significant competition. Both existing competitors and numerous
other companies that may seek to enter one or more aspects of our businesses
may expose us to severe price competition for our services and for building
access rights. Many of our competitors have significantly greater financial
resources and may also be able to respond more quickly to technological
developments and changes in customers needs. We face competition in providing telecommunications services from:  
    
    In-Building Communications Providers. Because our license
agreements are generally non-exclusive, substantially all of the
landlords of the buildings in which we provide services are free to
grant access, sales and marketing rights to one or more of our
competitors. It is not yet clear whether it will be profitable for
two or more companies to operate in-building networks within the same
property. We are the only in-building provider in most of the
buildings in which we operate, however, there is no assurance that
this will continue to be the case in the future.
    
    Local Telephone Companies. Incumbent local telephone companies
(ILECs) have several competitive strengths, 7




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including established brand names and reputations, and sufficient
capital resources to rapidly deploy or expand communications equipment
and networks. The Telecommunications Act of 1996 (the 1996 Act)
established certain conditions before the regional Bell operating
companies (RBOCs) are allowed to offer interLATA long distance
services to customers within their local service regions. By 2003,
however, the RBOCs had received Federal Communications Commission
(FCC) approval to offer in-region long distance service in all
states, enabling them to offer one-stop shopping for communications
services in competition with us. Many competitive local telephone
companies (CLECs), that also possess competitive advantages, market
retail services and selectively construct in-building facilities within
our licensed buildings. ILEC dominance, and the more limited
competition presented by CLECs, diminishes our opportunity to provide
competitive local exchange services and may necessitate reductions in,
or shrink potential margins from, our voice operations generally.
    
    Long Distance Companies. Many of the leading long distance
companies, such as AT&T, MCI and Sprint, have the capacity to build
their own in-building voice and data networks. Other national long
distance carriers, such as Level 3, Qwest and Williams
Communications, are building and managing high speed, fiber-based,
national voice and data networks, and such companies may extend their
networks by installing in-building facilities and equipment.
Additionally, the RBOCs are now permitted to provide long distance
services in territories where they are not the dominant provider of
local services. These companies may also provide long distance
services in the territories where they are the dominant provider of
local services if they satisfy a regulatory checklist established by
the FCC. Because RBOCs are permitted to provide long distance
services in territories where we operate, we face greater price
competition.
    
    Internet Service Providers. Internet service providers, such as
Earthlink, Prodigy, Sprint and the Uunet subsidiary of MCI, provide
traditional and high-speed internet access to residential and
business customers, generally using existing communications
infrastructure.
    
    Digital Subscriber Line Companies. Digital subscriber line
companies and/or their internet service provider customers, such as
Covad, AT&T and various RBOC affiliates, provide high capacity
internet access using digital subscriber line technology, which
enables data traffic to be transmitted over standard copper telephone
lines at much higher speeds than these lines would normally allow.
    
    Cable-based Service Providers. Cable-based service providers
use cable television distribution systems to provide high capacity
Internet access and video services.
    
    VoIP/ IP Centrex Providers. National Retail IP Centrex
providers such as ICG and MCI Advantage have competitive offerings
today and may become more aggressive in the marketplace. Wholesale
providers such as Level 3 and GoBeam are expected to partner with
numerous national retail channels which could include RBOCs and long
distance companies. IP-PBX providers such as Cisco, Avaya, Nortel,
Shoreline, Siemens and others are competing for PBX upgrades and
multi-site networks which would compete for, or replace our
offerings. Network-only providers such as Cbeyond are using low cost
VoIP networks to package bundles of local/ long distance and Internet
services in competition to our offerings. IP Phone providers will
also grow and could offer both phone and service solutions in
competition to our offerings. It is expected that most
telecommunications service providers will build/ partner to deploy
VoIP services of some kind. There are still many issues with
integration, standardization, OSS systems, operational support and
other areas that make building your own network very complex. We
expect numerous acquisitions to reshape the industry players. For
example, GoBeam recently announced a merger with Covad. The VoIP
market is in the early stages and is rapidly evolving. Sales and Marketing We market our telecommunications services directly to the tenants in our
licensed buildings. Our typical license agreement enables us to display and
disseminate our marketing materials in the leasing office and other locations
within a building. Many of our agreements also require building owners, along
with management and leasing representatives to advise tenants of the
availability of our services and notify us as new tenants enter the building.
In addition to these rights, we use landlord, property manager and tenant
testimonials and references as marketing tools. We currently provide data
and/or voice communications services to many of the landlords and property
managers within our licensed buildings, due in part to the requirement under
some of our license agreements that we provide free basic Internet access to
such parties. Our sales approach is highly consultative. In our initial sales meetings,
we work closely with prospective customers to assess their particular
communications needs. We then present potential customers with customized
proposals which we believe are often less expensive, more comprehensive and
easier to administer than their current communications solutions. 8




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Real Estate Selection and Marketing Overall,
as of December 31, 2003, we had license agreements giving us the
right to operate our networks in more than 2,000 buildings, representing more
than 733 million rentable square feet of office space in the United States and
we were actually operating in approximately 1,300 of those buildings,
representing more than 472 million rentable square feet of office space. Under
the terms of our license agreements, we pay property owners a fixed rental fee
and/or a percentage of the revenue we receive from providing communications
services to the tenants in a building. Suppliers We connect our in-building networks to local, long distance and Internet
service providers in order to serve our customers. In most of our markets, we
connect our networks to, and lease facilities from, CLECs and local telephone
companies. We purchase long-distance transmission capacity from several long-distance
carriers, such as MCI, XO Communications and AT&T. Under some of these
agreements, we are required to undertake material minimum revenue and/or volume
commitments. For a description of our aggregate commitments see Note 9(c) to
the Notes to our Consolidated Financial Statements. To provide Internet services to our customers, we purchase intraLATA data
transmission connectivity between our licensed buildings and local points of
presence from CLECs, including MCI, XO Communications, Time Warner Telecom and
local exchange carriers. We obtain our local points of presence from colocation
service providers, such as C3 Communications, IX2, Semaphore and Switch & Data.
We use broadband service providers, such as MCI, XO Communications, Level 3 and
Sprint, to procure connectivity between our colocation facilities and the
Internet backbone. Our in-building networks contain equipment such as data switches and
routers, voice switches and other communications and video equipment that we
purchase from Nortel Networks, Cisco Systems, Viadux and other manufacturers.
As of March 1, 2004, we do not have minimum purchase commitments with any of
our manufacturers. There are alternative vendors available to us for all the
types of equipment that we purchase. Regulation Overview. Our telecommunications services are subject to regulation at
the federal, state and local levels. The regulations that apply to our
operations are susceptible to change or cancellation as a result of ongoing
administrative proceedings, litigation and new legislation. For example, the
FCC is considering the implementation of new rules for multiple tenant
environments (MTEs) that may impact our provision of in-building services,
such as by limiting the preferences that landlords may allow to an in-building
provider. This proceeding has been pending for a number of years. In addition,
our costs are affected by regulations governing the dominant local telephone
companies, on which we rely for transmission facilities and network access in
many cases. The outcome of these various proceedings, as well as any other
regulatory initiatives, cannot be predicted. Future regulatory changes may
have a material adverse affect on our business and operations. Local Voice Telephone Service.Cypress Communications Operating Company,
Inc. (Cypress Operating Company), a wholly owned subsidiary of Cypress
Communications, is authorized to provide local exchange service as a CLEC in
Alabama, Arizona, California, Colorado, Connecticut, Delaware, Florida,
Georgia, Illinois, Indiana, Louisiana, Maryland, Massachusetts, Minnesota, New
Jersey, New York, Oregon, Pennsylvania, Tennessee, Texas, Utah, Washington and
Washington, D.C. Another subsidiary of Cypress Communications, Cypress
Communications Holding Company of Virginia, Inc. (Cypress Virginia), is
authorized to provide local exchange service in Virginia. As a CLEC, Cypress
(including both Cypress Operating Company and Cypress Virginia) is authorized
to resell other carriers local voice services. If Cypress obtains such
services from ILECs, the tariff rates under which it obtains services may be
subject to change as the result of regulatory proceedings over which Cypress
does not have control. Depending on state regulations, Cypress may also
construct its own facilities or purchase network elements from ILECs in order
to provide telecommunications services. To provide local voice services as a
CLEC, Cypress obtains interconnection services from an ILEC under the ILECs
existing tariff or by separate interconnection agreement. Cypress has entered
into interconnection agreements with the dominant ILECs in each of the markets
in which it operates. Regulations promulgated by the FCC under the 1996 Act require ILECs to
provide interconnection, including access to unbundled network elements and
retail services, at wholesale rates to CLEC competitors. During 2003, we began
to exercise our rights under the 1996 Act to obtain access to unbundled
elements of the ILECs networks in several of its markets. By doing this, as
well as by migrating circuits to other CLECs, we have been able to reduce our
network operating costs. These cost savings, however, 9




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depend on the regulatory duties of ILECs to provide us with unbundled
elements at regulated rates. Because the regulatory duties of ILECs are
subject to change, we cannot assure you that we can continue to benefit from
cost savings in the future. The FCC has revised its interconnection regulations several times since
1996 and many of the FCCs decisions have been subject to court appeals.
During 2003, the FCC released significant changes to its rules governing access
to unbundled network elements, and proposed additional changes (which have not
yet been adopted) to its rules governing the prices for these elements. The
FCCs rules preserve CLEC access to unbundled network elements for the
provision of most existing voice and data services, but also permit the ILECs
to petition state regulatory commissions to withdraw access to particular
network elements, including high-capacity circuits, based upon the presence of
actual or potential competitive provisioning of those elements. The FCC rules
are currently the subject of an appeal before the U.S. Court of Appeals for the
District of Columbia Circuit. The uncertainty from this and other pending
judicial and regulatory proceedings makes it difficult to predict whether we
will be able to rely on existing interconnection rights and obligations or have
the ability to negotiate acceptable interconnection agreements in the future. CLECs local and in-state telecommunications services are typically
subject to some degree of state regulation. Most states require that CLECs
receive approval to operate from the states public service commission. CLECs
are generally required to file tariffs setting forth the terms, conditions and
prices for voice services. In addition, under federal law, including the 1996
Act, CLECs are subject to additional obligations, including requirements to
interconnect with other carriers, to provide other carriers access to their
networks, to comply with number portability and dialing parity obligations, and
to make the terms of their agreements available to other carriers on a
non-discriminatory basis. On the other hand, CLECs have the right, among
other things, to obtain interconnection with ILECs, to receive reciprocal
compensation for terminating the calls of other local carriers and access
charges for originating and terminating long distance calls for other long
distance providers, and to purchase unbundled network elements and wholesale
services of the ILECs network at prices not available to other ILEC customers. As a CLEC, we are required to comply with a variety of state laws and
regulations concerning billing format, notices to customers, restrictions on
disconnection for non-payment and other causes, filing of tariffs and reports,
and payment of taxes, fees, and surcharges, including the federally-mandated
universal service fund contribution. Compliance with these legal requirements
increases the cost of our operations. In addition, complaints by customers or
by state regulatory agencies alleging violations of any of these requirements
could cause us to incur substantial legal and administrative expenses and
adversely affect our business, even if the allegations are not ultimately
proven. If we construct facilities that cross public rights-of-way, for example to
connect customers in two or more buildings, or to connect to the facilities of
an ILEC, we may also be subject to local government land use and franchise
regulations. If local governments impose conditions on granting permits or
other authorizations or if they fail to grant such permits or other
authorizations in a timely manner, it may negatively impact our ability to
expand our network on a timely basis and adversely affect our business. Long Distance Voice Services. Under current regulations, we are not
required to file tariffs with, or seek authorization from, the FCC in order to
provide domestic interstate long distance services; but we are required to
adhere to certain basic rules and regulations regarding such services that are
promulgated by the FCC, including the payment of certain regulatory fees.
Cypress Operating Company is authorized by the FCC to provide international
switched resale services. In some states, we must obtain authorization to
provide intrastate long distance voice services. Cypress Operating Company is
currently authorized to provide intrastate long distance services in Alabama,
Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia,
Illinois, Indiana, Kentucky, Louisiana, Maryland, Massachusetts, Michigan,
Minnesota, Mississippi, Nevada, New Jersey, New York, North Carolina, Ohio,
Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Utah,
Washington, Washington, D.C. and Wisconsin. Cypress Virginia is authorized to
provide intrastate long distance services in Virginia. Data Services. Our Internet and data services generally are not subject
to federal, state or local regulation. Congress and some state legislatures
have considered imposing taxes and other burdens on Internet service providers
and regulating content provided over the Internet. In addition, we may be
affected by certain statutes, regulations and court cases that assess liability
against Internet service providers and other on-line service providers for
providing information or content across their services or equipment that
violates copyright, indecency, obscenity and other laws, or is defamatory,
fraudulent or tortious in nature. The FCC is now considering a variety of
proposals that could impose additional burdens on some services offered over
the Internet, including obligations on some or all providers of Internet access
services to contribute to the cost of federal universal service programs, and
additional regulation of services that transmit voice communications over the
Internet. Future regulation may have a negative impact on our ability to offer
Internet services at competitive and profitable rates. 10




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##### Table of Contents



Video and Other Services.Our video services are regulated to a far
lesser extent than the video services of traditional cable operators, which
receive franchises from the municipalities they serve and typically construct
facilities across public rights of way. For example, our video programming
rates are not regulated and we are not subject to must carry obligations,
which require cable license franchisees to provide certain programming to
customers. We are subject to some technical requirements with regard to our
provision of video services, such as requirements that our facilities not cause
harmful interference with certain other communications systems. We do not own or operate any direct broadcast satellites (DBS) or hold
any similar types of licenses. Rather, we resell the programming services of
DBS providers, such as DirecTV, Inc. Thus, our video services are regulated to
a far lesser extent than the video services of traditional DBS operators Recent rulings of the FCC may help facilitate the provision of our video
services. For example, the FCC has ruled that under certain circumstances, a
roof may be considered an area controlled by a tenant upon which the owners of
multiple unit premises cannot forbid the installation of some communication
devices, such as satellite dishes. We do not hold any cellular or similar types of radio licenses. To the
extent that we provide cellular or paging services, we rent or sell pagers and
wireless phones and resell the services of third party wireless providers.
Consequently, while we do pay some regulatory fees, we generally are not
subject to federal regulation with respect to these services. 911 and Enhanced 911.The FCC requires certain communications providers
to establish 911 service, i.e.,three digit dialing access to public safety
call centers for emergency services. Enhanced 911, or E911, service permits
the public safety call center to identify a callers telephone number and
calling location for the dispatch of emergency personnel. 911 and E911
services are regulated at the federal, state and local level. Some states have
enacted, or are likely to enact, legislation that will impose a penalty or
surcharge on service providers whose telecommunications equipment does not meet
or exceed the E911 requirements for the applicable jurisdiction. We currently
offer, or are preparing to offer, 911 or E911 services in locations where the
service is technically feasible; however, our ability to provide emergency
service may be impeded by failed systems, systems that were not properly
configured, systems that were not updated to reflect changes in technology or
public networks, and certain other technical problems. We may incur penalties,
surcharges, damages or other liabilities where, and to the extent that, we
cannot provide 911 or E911 service. Intellectual Property We regard certain aspects of our products, services and technology as
proprietary; however, because we are not currently prosecuting any patent,
trademark or copyright applications before the United States Patent and
Trademark or Copyright Office, it may be possible for third parties to copy or
use some of our intellectual property without authorization. Notwithstanding
the foregoing, we regularly execute confidentiality, non-disclosure and
non-competition agreements with our carriers, vendors, employees and
representatives, in addition to other precautions, to protect our intellectual
property. DISCONTINUANCE OF TELECOMMUNICATIONS RIGHTS BUSINESS Overview In our former telecommunications rights operations, we provided site
access and usage rights, which we call telecommunications rights, to
telecommunications companies in Latin America. We obtained telecommunications
rights from property owners under long-term, master lease agreements. Under
the master leases, we received the rights to install communications
infrastructure in a property and/or to provide communications services to the
propertys tenants. In exchange, we paid the property owner a percentage of the
revenues that we received from subleasing the telecommunications rights to
telecommunications companies. We conducted these operations only in Argentina
and Brazil. In March 2002, we liquidated our Latin American operations. HISTORY U.S. RealTel was organized in January 1997 under the name AGILE, LLC.
U.S. RealTel was incorporated in the State of Illinois under the name U.S.
RealTel, Inc. in August 1997. In November 1997, U.S. RealTel merged with and
into Admiral Two Capital Corporation and the surviving companys name was
changed to U.S. RealTel, Inc. On May 8, 2000, U.S. RealTel reincorporated in
the State of Delaware. U.S. RealTel established operations in Buenos Aires,
Argentina in December 1998 and in Sao Paolo, Brazil in February 2000. U.S.
RealTel conducted its Latin American operations in Argentina through RealTel de
Argentina, 11




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##### Table of Contents



S.A., a majority owned Argentine corporation, and in Brazil through
RealTel do Brasil, S.A., a majority owned Brazilian corporation. Both Latin
American operations have been liquidated. In January 2002, U.S. RealTel entered into a definitive agreement for the
acquisition of Cypress Communications, a U.S. based operation that provides a
full range of telecommunications services to businesses in commercial office
buildings located in select major metropolitan markets within the United
States. Pursuant to the agreement, U.S. RealTel initiated a tender offer for
all the outstanding shares of common stock of Cypress Communications, including
the associated rights to purchase preferred stock, at $3.50 per share net to
the stockholder, in cash. The transaction, which was subject to 90% of the
shares of common stock outstanding being tendered and not withdrawn as well as
other customary and legal closing conditions, was completed on February 25,
2002. Approximately 94% of the shares of Cypress Communication common stock
were tendered for cash payments, in the aggregate, of approximately $15
million. The acquisition of the remaining shares of Cypress Communications was
completed immediately after the closing of the tender offer through the
short-form merger of a wholly owned subsidiary of U.S. RealTel with and into
Cypress Communications, with Cypress Communications surviving as a wholly owned
subsidiary of U.S. RealTel. In July 2002, through Cypress Communications, U.S. RealTel completed the
purchase of certain assets of Intermedia Advanced Building Networks, the shared
tenant telecommunications services business of WorldCom, Inc. (ABN/STS). The
acquired assets included all customer contracts, in-building networks and the
associated building access rights, as well as the necessary employees to
support such assets. The acquisition of ABN/STS allowed Cypress Communications
to extend its telecommunications services operations to over 5,700 small and
medium sized business customers in 25 major metropolitan U.S. markets. Cypress
Communications paid $29 million in cash at closing to the sellers, assumed
various commitments arising out of the operation of the business after the

closing, assumed accrued but unpaid liabilities incurred by the sellers in the
operation of the business prior to the closing in an amount up to a maximum of
$2 million, assumed vehicle lease obligations of approximately $284,000 and
paid expenses incurred in connection with the acquisition of approximately
$899,000. The acquisition was accounted for as a purchase, and accordingly,
the results of operations of ABN/STS have been included since the date of
acquisition in the accompanying statements of operations. In March 2003, U.S. RealTel, through Cypress Communications, acquired the
Southern California building-centric voice and data services business of Eureka
Broadband Corporation (Eureka). These assets included customer contracts, as
well as Eurekas in-building networks and associated building access rights.
The acquisition of the Eureka assets has allowed U.S. RealTel to expand its
telecommunications services operations to include over 750 small and medium
sized business customers in the California market. U.S. RealTel paid $2.5
million in cash at closing to Eureka, assumed a note payable for $500,000
payable six months after the acquisition upon meeting certain operational
covenants of which $330,000 was disbursed, assumed various commitments arising
out of the operation of the business after the closing, assumed equipment lease
obligations of approximately $107,000 and paid expenses incurred in connection
with the acquisition of approximately $70,000. In July 2003, U.S. RealTel, through Cypress Communications, negotiated the
surrender of certain assets from E-Building Solutions, Inc. (E-Building) in
California, a building-centric data services business, to mitigate the loss
resulting from E-Buildings default on a $450,000 note receivable due to
Cypress Communications. These assets included customer contracts, as well as
E-Buildings in-building networks and associated building access rights. In
addition to the $450,000 note receivable, U.S. RealTel, assumed equipment lease
obligations of approximately $43,000 and paid expenses incurred in connection
with the note of approximately $43,000. 
 ITEM 2. DESCRIPTION OF PROPERTY LOCATION
    
    CITY
    
    GENERAL CHARACTER
    
    SQUAREFEET
    
    ANNUAL RENT
    
    LEASE EXPIRATIONPiedmont Center
    
    Atlanta, GA
    
    Principal Executive
Office,Cypress Headquarters
    
    
    
    
    35,245
    
    
    $
    1,141,568
    
    
    2005-200733 N. LaSalle
    
    Chicago, IL
    
    General Office
    
    
    
    
    14,283
    
    
    $
    417,613
    
    
    April 30, 2006160 Federal Street
    
    Boston, MA
    
    General Office
    
    
    
    
    7,292
    
    
    $
    339,504
    
    
    June 30, 20051555 Oakbrook
    
    Norcross, GA
    
    General Office / Warehouse
    
    
    
    
    36,503
    
    
    $
    314,919
    
    
    January 1, 20071525 Wilson Blvd.
    
    Arlington, VA
    
    General Office
    
    
    
    
    10,175
    
    
    $
    330,970
    
    
    July 31, 20071900 Avenue of the Stars
    
    Los Angeles, CA
    
    General Office
    
    
    
    
    7,065
    
    
    $
    258,761
    
    
    July 31, 2007
 12




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##### Table of Contents



LOCATION
    
    CITY
    
    GENERAL CHARACTER
    
    SQUAREFEET
    
    ANNUAL RENT
    
    LEASE EXPIRATION1650 Market Street
    
    Philadelphia, PE
    
    General Office
    
    
    
    
    5,898
    
    
    $
    147,528
    
    
    December 31, 20094851 LBJ Freeway
    
    Dallas, TX
    
    General Office
    
    
    
    
    7,742
    
    
    $
    218,865
    
    
    September 30, 2005222 W Colinas Boulevard
    
    Dallas, TX
    
    General Office
    
    
    
    
    7,928
    
    
    $
    218,916
    
    
    December 31, 20071600 Broadway
    
    Denver, CO
    
    General Office
    
    
    
    
    8,974
    
    
    $
    171,576
    
    
    July 31, 2007One Riverway
    
    Houston, TX
    
    General Office
    
    
    
    
    5,188
    
    
    $
    126,636
    
    
    August 20, 2005
 U.S. RealTel has subleased all or part of the above offices with the
exception of: 160 Federal Street, 1555 Oakbrook, 1650 Market Street, 222 W.
Los Colinas and One Riverway, which U.S. RealTel leases directly from the
landlord. We lease space in 30 additional commercial properties in the United States
for general office purposes, network facilities, storage and warehouses, in
each instance under leases that do not contain material financial obligations. 
 ITEM 3. LEGAL PROCEEDINGS We are a party to various legal proceedings that are ordinary and
incidental to our business. Except as set forth below, management does not
expect that any currently pending legal proceedings will have a material
adverse effect on our results of operations or financial position. With respect to our ABN/STS acquisition, on or about January 23, 2003, we
filed proofs of claim in the bankruptcy cases of WorldCom, Inc. and certain of
its debtor affiliates as a result of such parties defaults under that certain
Asset Purchase Agreement dated May 31, 2002 by and among Intermedia
Communications, Inc., Shared Technologies Fairchild, Inc., Shared Technologies
Fairfield Telecom, Inc., MCI Worldcom Communications, Inc., Worldcom, Inc.,
MCI-WORLDCOM Network Services, Inc. and Cypress Communications, that certain
Omnibus Post-Closing Agreement dated July 16, 2002, by and among Intermedia
Communications, Shared Technologies Fairchild, Shared Technologies Fairfield
Telecom, MCI Worldcom Communications, Worldcom, Inc., MCI-WORLDCOM Network
Services and Cypress Communications and certain other related ancillary
documents. We filed amendments to these proofs of claim on January 29, 2004 to
increase our claim to approximately $13.9 million, which amended proofs of
claim to include damages caused to us as a result of certain fraudulent
accounting practices of the debtors (not, so far as we are aware, specific to
Cypress Communications) and failure to perform required actions and other
breaches of the Transaction Documents by the Debtors. As a result of our communications with the debtors, we expect that they
will object to these proofs of claim and most likely will bring counterclaims
against us alleging breaches by us of the agreements and related ancillary
documents. We expect such counterclaims may seek damages of approximately $2.7
million, of which we have approximately $2.0 million currently recorded in
accrued expenses. We cannot express an opinion as to whether a favorable or
unfavorable outcome is either probable or remote or to estimate the range of
any possible loss or gain that may result from the settlement of these claims.
An unfavorable outcome could, under certain circumstances, result in a material
adverse effect on our business, financial condition and results of operations. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of fiscal 2003 to a
vote of the security holders. 
 PART II 
 ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is quoted on the Nasdaq OTC Bulletin Board (OTCBB)
under the symbol USRT. The following table sets forth, for the periods
indicated, the high and low bid quotations for the common stock, as reflected
on the OTCBB. The following quotations represent inter-dealer prices without
adjustment for retail markups, markdowns or commissions and may not necessarily
represent actual transactions. 13




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##### Table of Contents



PERIOD
    
    HIGH
    
    LOW2003Fourth Quarter
    
    $
    1.01
    
    
    $
    0.53Third Quarter
    
    
    1.40
    
    
    
    0.70Second Quarter
    
    
    2.00
    
    
    
    1.01First Quarter
    
    
    3.00
    
    
    
    1.502002Fourth Quarter
    
    $
    3.00
    
    
    $
    1.50Third Quarter
    
    
    2.15
    
    
    
    1.30Second Quarter
    
    
    1.95
    
    
    
    0.86First Quarter
    
    
    1.50
    
    
    
    0.65
 As of March 1, 2004, there were 123 holders of record of our common stock.
We believe that there are in excess of 300 beneficial owners of our common
stock. To date, we have not declared or paid any dividends on our common stock.
The payment of dividends, if any, is within the discretion of our board of
directors and will depend upon our earnings, capital requirements and financial
condition and other relevant factors. We do not intend to declare any dividends
in the foreseeable future, but instead intend to retain future earnings, if
any, for use in our business operations. The following table describes the equity securities issuable as of
December 31, 2003 pursuant to our equity compensation plans. For a description
of our equity compensation plans see Note 10 to our consolidated financial
statements. Equity Compensation Plan Information (a)
    
    (b)
    
    (c)Number of
    
    
    
    
    
    Number ofsecurities to
    
    
    
    
    
    securitiesbe issued
    
    
    
    
    
    remaining availableupon
    
    
    
    
    
    for future issuanceexercise of
    
    Weighted-average
    
    under equityoutstanding
    
    exercise price of
    
    compensation plansoptions,
    
    outstanding
    
    (excludingwarrants and
    
    options, warrants
    
    securities reflectedPlan Category
    
    rights
    
    and rights
    
    in column (a))Equity compensation plans approved by
security holders
    
    
    3,896,759
    
    
    
    2.24
    
    
    
    1,103,241Equity compensation plans not approved by
security holders
    
    
    12,204,859
    
    
    
    1.77
    
    
    
    Total
    
    
    16,101,618
    
    
    
    1.88
    
    
    
    1,103,241
 
 ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements, which involve
risks and uncertainties. Actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain risk
factors, including those set forth under Risk Factors That May Affect Future
Results below and elsewhere in this report. The following discussion also
should be read in conjunction with the information set forth in our
consolidated financial statements and notes thereto included in Item 7.
Financial Statements of this Annual Report onForm 10-KSB. 14




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##### Table of Contents



Overview Beginning in February 2002 with U.S. RealTels acquisition of Cypress
Communications, we have provided a full range of reliable, feature rich,
integrated telecommunications services to businesses located in select major
metropolitan markets within the United States. We are the preferred
communications provider in 1,300 Class A commercial office buildings in such
select markets. Our telecommunications services include high speed Internet
access and data services, local and long-distance voice services, digital
telephone systems, digital satellite business television, voicemail, e-mail,
web site hosting, security/monitoring services, and other advanced
communications services. We deliver these services over fiber optic, digital
and broadband networks that we design, construct, own and operate inside large
and medium-sized office buildings. Additionally, during the three month period
ended March 31, 2002, we provided, or sought to provide, site access and usage
rights to telecommunications companies in Latin America through our 71%-owned
Argentinean subsidiary and our 89%-owned Brazilian subsidiary. In March 2002,
we liquidated our Latin American telecommunications rights operations. Except for a net gain of approximately $15.5 million on the sale of our
old North American telecommunications rights operations in December 2000 and an
extraordinary gain of approximately $7.9 million on the acquisition of Cypress
Communications, under purchase accounting, we have incurred significant
operating losses and experienced negative cash flows from operations since
inception. Moreover, we expect to continue to incur costs as part of our
efforts to achieve profitability. Net loss for the fiscal year ended December
31, 2003 was approximately $4.2 million compared with net loss of approximately
$1.7 million for the fiscal year ended December 31, 2002. As of December 31,
2003, we had cash and cash equivalents of approximately $1.9 million. The Consolidated Statements of Operations for the for the fiscal year
ended December 31, 2002 include operations of Cypress Communications from
February 1, 2002, the date of its acquisition for accounting purposes. Executive Summary In evaluating our financial condition, management focuses on several key
themes and indicators of both revenues and expense as described below: Revenue The key areas of management focus relative to our revenues revolve around
the status of our customer base. We provide our services generally to tenants
resident within the approximately 1,300 office buildings in which we maintain
access agreements. These tenants are generally operating under the terms of
multi-year lease agreements with the building landlord. To the extent tenants
who are our customers leave these buildings either during the term of or at the
termination of their lease agreements, they may cease to be our customer. We

endeavor to replace these lost customers with new tenants entering the
buildings. We expend significant effort in determining the status and
intentions of our existing customers relative to their current lease agreements
within buildings we serve, as well as the status of prospective tenants who may
be moving into these buildings. In addition to move in  move out activity, the other key revenue focus
area within our customer base is the average number of users per customer. This
factor is significant in determining and forecasting the average revenue per
customer, and is directly tied to overall employment factors within the general
economy. To the extent an existing customer hires additional employees, our
revenue from that customer should generally increase. Conversely, reductions in
employment totals of a customer would result in a reduction in revenue from the
customer. During 2002 and 2003, we determined that, within our retained customer
base, there was an overall reduction in the number of contracted users of our
services, resulting in a reduction in the average revenue per customer for our
services. We expect an improvement in the occupancy rates for the types of buildings
that we serve in 2004. Improvement in occupancy rates in these buildings
increases the number of potential sales opportunities for our services.
Additionally, management believes that recent stabilization in the general
employment picture in the United States will result in a stabilization or
improvement in the average revenue per customer over what we are now
experiencing. 15




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##### Table of Contents



Costs One of the most significant cost elements for us is the amounts paid to
telecommunications carriers for the provision of our voice and data network
elements. These costs have both fixed and variable components. A key focus of
managements attention is the proper management of these cost elements. Managements objectives in managing the voice and data network elements is
to provide a cost effective and highly reliable solution for our business.
Achieving this objective involves determining both the correct number of
circuit elements necessary to provide an appropriate level of customer service,
along with determining the best cost provider for those circuit elements. Starting in late 2002 and throughout 2003, management expended
considerable effort in analyzing our network on a building by building basis to
optimize the combination of service and cost. We were successful in reducing
our overall network costs as a percentage of revenues throughout the year,
while continuing to provide an appropriate level of service to our customers. During 2003, we substantially completed a process of obtaining
certification to be a CLEC in most of the markets where we operate. CLEC
certification allows us to enter into agreements with the incumbent local
exchange carriers (ILECs) to obtain network services at rates generally lower
than those we previously paid. Starting in late 2003, we began the process of
converting our network to the lower rate platforms with the various ILEC
providers. This process will continue into 2004. Management believes that we
will realize substantial network cost savings through this process. The process of network analysis and re-grooming is ongoing. Management
believes that there are additional opportunities for reduction in network costs
through either reduction in network elements or transfer of elements to lower
cost providers. Liquidity and Capital Resources Our primary sources of liquidity have been proceeds from the issuance of
our common stock, convertible debentures, lines of credit and bridge loans, as
well as proceeds from the sale of our former North American telecommunications
rights operations in December 2000 and cash acquired through our acquisition of
Cypress Communications. The terms of certain of our indebtedness limit our
ability to incur additional indebtedness, pay dividends or undertake certain
other transactions. We have also pledged certain assets as security under our
senior credit facility. We must devote a substantial portion of our cash flow
to service our indebtedness and cannot utilize that cash flow for operations Beginning in the first quarter of 2002 and continuing throughout 2003, we
initiated certain actions intended to improve liquidity and operating results.
We expect the results of our actions to begin to materialize. As a result, our
management believes that our cash position should stabilize during the
following quarters, however, there is no assurance this will be the case. Our
liquidity and capital resources remain a focal point of our managements
attention. Asset Acquisitions As part of our business strategy, we have acquired certain assets of other
companies which have had and are expected to continue to have an impact on our
results of operations. In July 2002, through Cypress Communications, we acquired certain assets
of Intermedia Advanced Building Networks, the shared tenant telecommunications
services business of WorldCom, Inc (ABN/STS). The acquisition of ABN/STS has
allowed us to extend our telecommunication services operations to over 5,700
small and medium sized business customers in 25 major metropolitan U.S.
markets. In March 2003, U.S. RealTel, through Cypress Communications, acquired the
Southern California building-centric voice and data services business of Eureka
Broadband Corporation (Eureka). These assets included customer contracts, as
well as Eurekas in-building networks and associated building access rights.
The acquisition of the Eureka assets has allowed U.S. RealTel to expand its
telecommunications services operations to include over 750 small and medium
sized business customers in the California market. In July 2003, U.S. RealTel, through Cypress Communications, negotiated the
surrender of certain assets from E-Building Solutions, Inc. (E-Building) in
California, a building-centric data services business, to mitigate the loss
resulting from E-Buildings 16




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##### Table of Contents



default on a $450,000 note receivable due to Cypress Communications. These
assets included customer contracts, as well as E-Buildings in-building
networks and associated building access rights. Results of Operations U.S. REALTEL YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31,
2002 The following table sets forth consolidated financial and operating data
as well as the percentage of total revenues represented by certain items in
our Consolidated Statements of Operations for the periods indicated: For the year ended December 31,2002
    
    % of Revenue
    
    2003
    
    % of RevenueREVENUES
    
    $
    51,717,000
    
    
    
    100
    %
    
    $
    84,626,000
    
    
    
    100
    %DIRECT COSTS
    
    
    28,704,000
    
    
    
    56
    %
    
    
    44,447,000
    
    
    
    53
    %REVENUES  NET OF DIRECT COSTS
    
    
    23,013,000
    
    
    
    44
    %
    
    
    40,179,000
    
    
    
    47
    %OPERATING EXPENSESSales and marketing
    
    
    3,977,000
    
    
    
    8
    %
    
    
    5,342,000
    
    
    
    6
    %General and administrative
    
    
    25,789,000
    
    
    
    50
    %
    
    
    37,694,000
    
    
    
    45
    %Stock based compensation
    
    
    
    
    
    
    
    
    
    
    438,000
    
    
    
    1
    %Extinguishment of liabilities and other credits
    
    
    
    
    
    
    
    
    
    
    (1,995,000
    )
    
    
    (2
    )%TOTAL OPERATING EXPENSES
    
    
    29,766,000
    
    
    
    58
    %
    
    
    41,479,000
    
    
    
    49
    %TOTAL OTHER INCOME / (EXPENSE)
    
    
    (4,791,000
    )
    
    
    (9
    )%
    
    
    (2,863,000
    )
    
    
    (3
    )%LOSS FROM CONTINUING OPERATIONS
    
    
    (11,544,000
    )
    
    
    (22
    )%
    
    
    (4,163,000
    )
    
    
    (5
    )%DISCONTINUED OPERATIONS
    
    
    2,032,000
    
    
    
    4
    %
    
    
    
    
    
    
    0
    %LOSS BEFORE EXTRAORDINARY ITEM
    
    
    (9,512,000
    )
    
    
    (19
    )%
    
    
    (4,163,000
    )
    
    
    (5
    )%EXTRAORDINARY ITEM
    
    
    7,783,000
    
    
    
    15
    %
    
    
    
    
    
    
    0
    %NET LOSS
    
    $
    (1,729,000
    )
    
    
    (3
    )%
    
    $
    (4,163,000
    )
    
    
    (5
    )%
 REVENUES. For the year ended December 31, 2003, revenues from our
telecommunications services business represented substantially all of our
consolidated revenues. Revenues from this business increased to approximately
$84.6 million for the year ended December 31, 2003 from approximately $51.7
million for the year ended December 31, 2002. The increase in revenues resulted
from the full year of operations related to the customer base we acquired in
July 2002 from ABN/STS, as well as the acquisitions during 2003 of the Eureka
and E-Building customer base. While overall revenues increased for the year ended December 31, 2003, as
indicated above, our quarterly revenues provided a downward trend. This trend
was the result of several factors:  1.
    
    Over the period following the acquisition of the customer base
from ABN/STS, there was attrition in this customer base. This was
attributable, in part, to the fact that a number of the acquired
ABN/STS customers did not fit our overall business model, and
terminated their service at the end of the term of their agreements.2.
    
    There was a negative trend in occupancy rates in the commercial
real estate business. Occupancy in the types of buildings in which we
offer our services declined significantly in the period after 2001.
By some industry estimates, 17




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vacancy rates in these type buildings was
as high as 30% in some markets. Vacancy rates in buildings we service
has a direct impact on our opportunity to add new customers and to
retain existing customers.3.
    
    The average revenue per customer declined during the period
primarily as a result in reductions in the overall employment within
our customer base. As employment falls within our customer base, the
average number of users for which we can bill our services declines. Management believes that the major impact of these factors has been
reflected in our operating results and believes that the negative trend in
quarterly revenues should flatten in the early part of 2004. REVENUES-NET. Revenues-net (after direct costs) increased to
approximately $40.2 million for the year ended December 31, 2003 from
approximately $23.0 million for the year ended December 31, 2002. Margins
increased to approximately 47.5% of revenues in 2003 from approximately 44.5%
in 2002, due to the increased revenue volumes acquired since July 2002, and
reduced network costs as a percentage of revenue. Additionally, revenue from
the customer bases acquired from Eureka and E-Buildings were substantially for
internet services, which results in a lower average margin than our overall
business. Management believes that further improvements in margins can be achieved
in the future as a result of the efforts expended to date relative to overall
reduction in the cost of telecommunications network elements. OPERATING EXPENSES. Operating expenses increased to approximately $41.5
million for the year ended December 31, 2003 from approximately $29.8 million
for the year ended December 31, 2002. The increase in operating expenses is
primarily due to the full year of operations in 2003 of the ABN/STS business
acquired in July 2002, along with additional operating expenses related to the
2003 acquisitions of assets from Eureka and E-Building. Operating expenses
decreased as a percentage of revenues to approximately 49% for the year ended
December 31, 2003 from approximately 58% for the year ended December 31, 2002
as a result of operating efficiencies achieved through focused cost reduction
efforts in all areas of our business. Sales and marketing expenses increased
to approximately $5.3 million for the year ended December 31, 2003 from
approximately $4.0 million for the year ended December 31, 2002 primarily due
to the full year employment in 2003 of sales and marketing personnel we hired
during 2002. Sales and marketing expense declined as a percentage of revenue to
6% for the year ended December 31, 2003 from approximately 8% for the year
ended December 31, 2002 as a result of restructuring of the sales and marketing
functions during 2003 and the efficiencies achieved. General and
administrative expenses increased to approximately $37.7 million for the year
ended December 31, 2003 from approximately $25.8 million for the year ended
December 31, 2002 primarily due to the full year operation of the ABN/STS
business acquired in 2002. General and administrative expenses decreased as a
percentage of revenues to approximately 45% for the year ended December 31,
2003 from approximately 50% for the year ended December 31, 2002 as a result of
efficiencies achieved through the acquisition consolidation. General and
administrative expenses for the year ended December 31, 2003 included
depreciation and amortization expense of approximately $712,000. Depreciation
and amortization expense included in general and administrative expenses for
the year ended December 31, 2002 was approximately $1.5 million. EXTINGUISHMENT OF LIABILITIES AND OTHER CREDITS. The extinguishment of
liabilities and other charges for the year ended December 31, 2003 reflects
credits for approximately $1 million resulting from negotiated settlements of
certain liabilities assumed through our acquisition of Cypress Communications,
and the redemption of various certificates of deposit for approximately
$378,000, also acquired through our acquisition of Cypress Communications. The
extinguishment of liabilities and other charges also includes the benefit from
a one time charge for approximately $598,000 resulting from the reactivation of
an office facility that had been previously shut-down by our predecessor. We
are currently in the process or renegotiating prior telecommunications
contracts and expect similar credits over the next year. OTHER INCOME AND (EXPENSE). Other income and (expense) was ($2.9) million
for the year ended December 31, 2003 as compared with approximately ($4.8)
million during year ended December 31, 2002. Interest expense for the year
ended December 31, 2003 was approximately ($2.7) million and consisted
primarily of interest expense on debt incurred in 2002 and used in connection
with acquisition of certain assets of ABN/STS. Interest expense for the year
ended December 31, 2002 was approximately ($4.9) million and consisted
primarily of approximately ($1.6) million in interest and finance charges
incurred by U.S. RealTel in connection with the acquisition of Cypress
Communications, and ($3.3) in interest and finance charges incurred by us in
connection with the acquisition of certain assets of ABN/STS. DISCONTINUED OPERATIONS. There was no income or loss from discontinued
operations for the year ended December 31, 2003. Net results from our Latin
American operations are included under loss from discontinued operations for
the year ended December 31, 2002. Income from discontinued operations was
approximately $2.0 million for the year ended December 31, 2002. 18




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The income
resulted from the recognition of currency exchange gains due to the devaluation
of the Argentinean peso after the Argentinean currency crashed in January 2002
and the liquidation of our Latin-American operations in March 2002. EXTRAORDINARY GAIN. The year ended December 31, 2002 includes an
extraordinary gain of approximately $7.8 million of which resulted after the
elimination of all of our long-term assets in an aggregate amount of
approximately $26.8 million (Note 4 to Consolidated Financial Statements). INCOME TAXES. For the years ended December 31, 2003 and 2002, no income
tax benefit from our consolidated net operating losses was recognized because
of uncertainty as to whether the benefit from such net operating losses will be
realized. NET LOSS. Our net loss for the year ended December 31, 2003 was
approximately $4.2 million. For the year ended December 31, 2002, the net loss
was approximately $1.7 million. The increase in net loss is a direct result of
the extraordinary gain of approximately $7.9 million and income from
discontinued operations of approximately $2.0 million, both realized in 2002.
Without the benefit of the aforementioned gains, the net loss for the year
ended December 31, 2002 would have been approximately $11.6 million. The
network cost reductions and other cost control initiatives implemented during
2002 and 2003 combined with the full year operation of ABN/STS business
acquired in 2002, resulted in a significant reduction in the operating loss
from continuing operations in 2003 as compared to 2002. Liquidity and Capital Resources Beginning in the first quarter of 2002, we initiated certain actions
intended to improve liquidity and operating results. Such actions included,
among other things, (i) completing the acquisition of Cypress Communications
and making certain adjustments to Cypress Communications staffing levels and
cost structure, (ii) liquidation of the operations in Argentina and Brazil,
(iii) completing the purchase of certain assets of ABN/STS, and (iv) raising
$28 million in connection with such asset acquisition. Net cash used by our operations was approximately $1.4 million for the
year ended December 31, 2003 versus cash provided by our operations of
approximately $5.1 million for the year ended December 31, 2002. The net cash
used for operating activities in 2003 includes the one-time payments to reduce
accrued expenses as a result of settlements with some of our vendors. Cash used by investing activities was approximately $5.3 million for the
year ended December 31, 2003, as compared with cash used of approximately $16.5
million for the year ended December 31, 2002. Cash used in 2003 includes an
investment related to the acquisition of Eurekas Southern California
building-centric voice and data services business and for capital expenditures.
We also made cash advances to E-Building pursuant to a note receivable
agreement with E-Building. We completed the purchase of the Eureka assets on
April 1, 2003. The E-Building loan was declared in default in June 2003, and
in July 2003, Cypress Communications negotiated the surrender of E-Buildings
assets in settlement of the our initial investment of $450,000. After valuing
the assets surrendered, which included property and a customer list, we
recorded a loss on investment in the amount of $149,000. Cash used in 2002
was for our acquisition of Cypress Communications, net of the approximately $33
million in cash that we acquired in the acquisition, net of capital
expenditures. Our primary sources of liquidity have been proceeds from the issuance of
our common stock, convertible debentures, lines of credit and bridge loans, as
well as proceeds from the sale of our former North American telecommunications
rights operations in December 2000 and cash acquired through our acquisition of
Cypress Communications. Cash provided by financing activities was
approximately $300,000 for the year ended December 31, 2003, as compared to
cash provided of approximately $17.6 million for year ended December 31, 2002.
Cash provided during the year ended December 31, 2003 included payments for
capital lease obligations of Cypress Communications, net of advances from a
line of credit for approximately $2.0 million. Cash provided during the year
ended December 31, 2002 included payments (i) to pay a bridge loan for
approximately $16.4 million in connection with the Cypress Communications
acquisition, (ii) to pay a credit line for approximately $8 million in
connection with the acquisition of the ABN/STS assets, (iii) to pay for capital
lease obligations of Cypress Communications and (iv) for the acquisition of
treasury stock, net of the effect of financing raised of approximately $26
million in connection with the acquisition of the ABN/STS assets. Management believes that our cash position should stabilize during the
following quarters as actions initiated in 2002 and throughout 2003 to reduce
our costs are expected to materialize. We cannot, however, give any assurance
that we will be able to generate sufficient cash flows from operations or
financing activities to cover our future costs of operations or to operate on a
profitable basis. Likewise, no assurance can be given that we can generate
sufficient cash flow from operations or financing activities to support our
debt service obligations, including debt raised in connection with our
acquisition of certain assets from ABN/STS. Moreover, the terms of the
indebtedness we incurred in connection with the acquisition of certain assets
from ABN/STS contain 19




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restrictive covenants that limit our ability to incur
additional indebtedness, pay dividends or undertake certain other transactions.
We have also pledged certain assets as security under our senior credit
facility. Therefore, we must devote a substantial portion of our cash flow to
service our indebtedness and cannot utilize that cash flow for operations.
Accordingly, there can be no assurance that we will have sufficient liquidity
to implement our business plan. Likewise, there can also be no assurance that
we will be able to obtain cash through future financing activities on
acceptable terms, or at all, or that we will ever become profitable. As of December 31, 2003, we had cash and cash equivalents of approximately
$1.9 million. Our business has some seasonality primarily attributable to
usage charges for voice services, which generally decline during holiday
periods such as Thanksgiving, Christmas and New Years and during the summer
months; however, the effects of such seasonality have not had, and are not
expected to have, a material impact on our liquidity. Cash generated from
operations, along with the availability under our line of credit, is expected
to be sufficient to fund our operations for at least the next twelve months. Despite our efforts and those of our advisors, to date, we have not been
able to obtain sufficient historical data to provide the necessary audited
financial statements of ABN/STS pursuant to the applicable SEC regulations. A
number of factors have led to our inability to obtain the necessary financial
information related to the ABN/STS assets acquired, including, but not limited
to, (i) the bankruptcy filing by WorldCom, Inc. following the acquisition of
the assets, (ii) the resignation of Arthur Andersen as the auditors for
WorldCom, Inc., and (iii) the fact that the assets acquired were spread among
various divisions and entities all under the control of WorldCom, Inc. Our
inability to provide the necessary financial statements pursuant to the applicable SEC regulations may have an adverse impact on our future ability to raise
capital, especially to the extent such capital raising activity would require
the filing of a registration statement with the SEC, until at least two years of
financial information with respect to the acquired assets have been included in
our audited financial statements. Contractual Obligations and Commitments The following table contains information relating to our contractual
obligations and commitments for the five years subsequent to December 31, 2003
and thereafter. The amounts represent the maximum future contractual
obligations and are reported without giving effect to any related discounts,
premiums and other adjustments necessary to comply with accounting principles
generally accepted in the U.S. In addition, we have unused line of credit
outstanding totaling approximately $8 million at December 31, 2003. Payments Due by PeriodLess than 1
    
    
    
    
    
    
    
    
    
    After 5Total
    
    Year
    
    1-3 Years
    
    4-5 Years
    
    YearsDebt
    
    
    18,000,000
    
    
    
    
    
    
    
    8,000,000
    (1)
    
    
    
    
    
    
    10,000,000
    (2)Interest Expense on Debt
    
    
    7,210,000
    
    
    
    1,120,000
    
    
    
    840,000
    
    
    
    
    
    
    
    5,250,000Capital Leases
    
    
    529,000
    
    
    
    494,000
    
    
    
    35,000
    
    
    
    
    
    
    
    Operating Leases
    
    
    19,371,000
    
    
    
    6,400,000
    
    
    
    11,030,000
    
    
    
    806,000
    
    
    
    1,135,000Obligations under license agreements
    
    
    5,274,000
    
    
    
    1,640,000
    
    
    
    2,490,000
    
    
    
    495,000
    
    
    
    649,000Obligations under communications service agreements
    
    
    28,019,000
    
    
    
    18,438,000
    
    
    
    9,460,000
    
    
    
    121,000
    
    
    
    Total contractual cash obligations
    
    
    78,403,000
    
    
    
    28,092,000
    
    
    
    31,855,000
    
    
    
    1,422,000
    
    
    
    17,034,000
 (1) The Bridge Loan accrues interest at 14% per annum, and matures on the
earlier to occur of (i) one business day following the maturity of the Senior
Credit Facility and (ii) July 16, 2005. On March 25, 2004, we amended the
terms of the Bridge Loan such that, in the event that the Senior Credit
Facility is not renewed at its maturity in July 2004, the Bridge Loan will not
mature until the earlier to occur of (i) its original maturity date of July 15,
2005 and (ii) an event whereby we substantially refinance our debt obligations. (2) The Convertible Notes accrue interest at the rate of 7.5% per annum,
compounded quarterly, and payable at maturity of the notes, whether upon their
stated maturity of July 1, 2009, or earlier as a result of acceleration in the
event of a default or upon redemption of the Convertible Notes. The principal
of and accrued interest on the Convertible Notes is convertible into
our common stock at $1.13 per share. The Convertible Notes are redeemable
by us at any time by 20




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payment of the
outstanding principal balance and accrued interest. In the event that the
Convertible Notes are redeemed, the Purchasers have been issued warrants which
will then be eligible for exercise to purchase the number of shares of our
common
stock that the Convertible Notes were convertible into on the
redemption date at a conversion price of $1.13 per share. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures, or capital resources that are
material to investors. Critical Accounting Policies Managements Discussion and Analysis of Financial Condition and Results
of Operations are based upon our Consolidated Financial Statements and the
notes thereto, which have been prepared in accordance with generally accepted
accounting principles. We are required to make, in the preparation of the
Consolidated Financial Statements, estimates and judgments that affect the
reported amounts of assets, liabilities, revenue, and expenses, and related
disclosure of contingent assets and liabilities. We have reviewed the
accounting policies used in reporting our financial results on a regular basis.
Management has reviewed the accounting policies and related disclosures with
our Audit Committee. The following is not intended to be a comprehensive list of all of our
accounting policies. Our significant accounting policies are more fully
described in Note 1 to the Consolidated Financial Statements. In many cases,
the accounting treatment of a particular transaction is specifically dictated
by accounting principles generally accepted in the United States of America,
with no need for managements judgment in their application. There are also
areas in which managements judgment in selecting an available alternative
would not produce a materially different result. We have identified the following as accounting policies critical to us: REVENUE RECOGNITION Monthly recurring charges for local access, long-distance, equipment
rental, Internet access, digital satellite business television, voicemail,
inbound 800, and other enhanced voice and data services, are recognized as
services are provided. Deferred income represents monthly recurring charges
received in advance. At December 31, 2003, approximately $1.3 million of
deferred income is recorded in deferred revenues in the accompanying balance
sheet. Nonrecurring charges include installations and moves, adds, and changes.
Installation fees represent the initial cost charged by Cypress Communications
for installing voice phone lines, data lines, and business television in the
tenants premises. Move, add, and change (MAC) charges are for Cypress
Communications labor and materials related to moving, adding, or changing a
customers services. Installation and MAC charges are recognized when the
services are provided as they represent separate earnings process. All related
up front costs have been expensed as incurred. STOCK-BASED COMPENSATION The Financial Accounting Standards Board (FASB) Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123), became effective in 1997. SFAS No. 123
encourages companies to recognize expense for stock options and other
stock-based employee compensation plans based on the fair value of such awards
at the
date of grant. As permitted by SFAS No. 123, we have and will retain our
prior accounting policy under Accounting Principles Board Opinion Number 25,
"Accounting for Stock Issued to Employees, and, accordingly, compensation
expense for stock options is measured as the excess, if any, of the fair value
of our stock at the date of grant over the exercise price. MANAGEMENT ESTIMATES The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. 21




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We have a history of losses, which have generated sizeable net operating
loss carryforwards for both state and Federal tax purposes. We are required
under accounting principles generally accepted in the United States of America
to record a valuation allowance offsetting our deferred tax asset associated
with these net operating loss carry forwards if we are not able to demonstrate
that it is more likely than not that we will generate sufficient taxable income
in future years to allow us to utilize some or all of the net operating loss
carryforwards. Our history of losses precludes us, at this time, from
recognizing any of our tax loss carryforwards. When we are able to demonstrate
through subsequent profitable operations that it is more likely than not that
we will have taxable income, we would then reverse the valuation allowance and
reflect the full value of our deferred tax asset at that time. Recent Accounting Pronouncements In January 2003, FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities(FIN No. 46).FIN No. 46 addresses consolidation
by business enterprises of variable interest entities, which are entities that
either (a) do not have equity investors with vesting rights or (b) have equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN No. 46 is effective immediately for variable
interest entities created after February 1, 2003. In December 2003, FASB
published Interpretation No. 46 (revised December 2003), Consolidation of
Variable Interest Entities(Revised FIN No. 46). Revised FIN No. 46, among
other things, defers the effective date of implementation for certain entities.
Revised FIN No. 46 is effective for the first interim or annual reporting
period ending after March 15, 2004, with the exception of structures that are
commonly referred to as special-purpose entities, for which the statement is
effective for periods ending after December 15, 2003. The adoption of Revised
FIN No. 46 is not expected to have a material impact on our results of
operations or financial position. On April 30, 2003, FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities(SFAS No. 149), which
amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities(SFAS No. 133). The amendments set forth are intended to improve
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. In particular, SFAS No. 149 clarifies the
circumstances under which a contract with an initial net investment meets the
characteristics of a derivative as discussed in SFAS No. 133. In addition,
SFAS No. 149 clarifies when a derivative contains a financing component that
warrants special reporting in the statement of cash flows. SFAS No. 149 amends
certain other existing pronouncements, resulting in more consistent reporting
of contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, except for hedging
relationships designated after June 30, 2003. The guidance should be applied
prospectively. The provisions of SFAS No. 149 that relate to SFAS No. 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003 should continue to be applied in accordance with their
respective effective dates. In addition, certain provisions relating to forward
purchases or sales of when issued securities or other securities that do not
yet exist should be applied to existing contracts as well as new contracts
entered into after June 30, 2003. U.S. RealTel does not expect the adoption of
SFAS No. 149 to have a material impact on its consolidated financial
statements. In April 2002,
FASB issued SFAS No. 145, Rescission of FASB Statements
SFAS 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections (SFAS No. 145). SFAS No. 45 rescinded
SFAS No. 4, Reporting Gains and
Losses from Extinguishments of Debt (SFAS No. 4), and
an amendment of SFAS No. 4, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements. SFAS No. 45 also rescinded SFAS No. 44,
Accounting
for Intangible Assets of Motor Carriers. SFAS No. 45 amended
SFAS No. 13, Accounting for Leases (SFAS
No. 13), to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. SFAS No. 45 also amended other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The
provision of SFAS No. 45 related to the rescission of SFAS No. 4 must
be applied in fiscal year beginning after May 15, 2002. The
provisions of SFAS No. 45 related to SFAS No. 13 will be applicable for transactions
occurring after May 15, 2002. Early application of the
provisions of SFAS No. 45 is encouraged. We do not expect the adoption of
SFAS No. 145
will have a significant impact on its consolidated results of operations,
financial position or cash flows. On May 15, 2003, FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity (
SFAS No. 150), which aims to eliminate diversity in practice by requiring that
the following three types of freestanding financial instruments be reported
as liabilities by their issuers: (i) mandatorily redeemable instruments (i.e.,
instruments issued in the form of shares that unconditionally obligate the
issuer to redeem the shares for cash or by transferring other assets); (ii)
forward purchase contracts, written put options, and other financial
instruments not in the form of shares that either obligate or may obligate the
issuer to repurchase its equity shares and settle its obligation for cash or by
transferring other assets; (iii) certain financial instruments that include an
obligation that (1) the issuer may or must settle by issuing a variable number
of its equity 22




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shares and (2) has a monetary value at inception that (a) is
fixed, (b) is tied to a market index or other benchmark (something other than
the fair value of the issuers equity shares), or (c) varies inversely with the
fair value of the equity shares. The provisions of SFAS No. 150, which also
include a number of new disclosure requirements, are effective for (1)
instruments entered into or modified after May 31, 2003 and (2) pre-existing
instruments as of the beginning of the first interim period that commences
after June 15, 2003. There is, however, a delayed effective date for private
companies mandatorily redeemable instruments. The adoption of SFAS No. 150 did
not have a material impact on the consolidated financial statements. Risk Factors That May Affect Future Results An investment in our common stock involves a high degree of risk. You
should carefully consider the factors described below, in addition to those
discussed elsewhere in this report, in analyzing an investment in our common
stock. If any of the events described below occurs, or if any risk not
identified below negatively impacts us, our business, financial condition and
results of operations would likely suffer, the trading price of our common
stock could fall and you could lose all or part of the money you paid for our
common stock. In addition, the following factors could cause our actual results to
differ materially from those projected in our forward-looking statements,
whether made in this Form 10-KSB, our annual or quarterly reports to
shareholders, future press releases, SEC filings or orally, whether in
presentations, responses to questions or otherwise. See Special Cautionary
Statement Regarding Forward-Looking Statements. Our short operating history makes it difficult to predict future operating
results. Our business was founded in January 1997. We have only operated in the
telecommunications services business since February 2002. As such, we have a
short operating history and limited historical financial and operating data
with respect to our business. We have incurred significant operating losses and
negative cash flows from operations since inception. We expect to continue to incur operating losses for the foreseeable future. Since we entered into the telecommunications services business, we have
not achieved profitability and expect to continue to incur losses for the
foreseeable future. As a result, we will need to generate significant revenue
to achieve profitability, which may not occur. Our business model may not succeed. We are attempting to implement our business model in a highly competitive
and fast-changing telecommunications market which makes it impossible to
predict the extent to which our business model will succeed. We may continue to
make substantial capital expenditures in deploying our networks without knowing
whether our business plan can be successfully executed. As a result, there is
a risk that our business will fail. Additionally, our limited operating history
makes it difficult to evaluate the execution of our business model thus far. To be successful, we must develop, market and implement the various
components of our business strategy at widely accepted prices that exceed our
operating expenses. Even if we execute our business model as we plan, we cannot
be certain that we will ever achieve favorable operating results, profitability
or generate revenues sufficient to cover our capital and operating costs. We have substantial debt. We have incurred substantial debt to date for purposes of funding our
acquisitions and operations. We may use a substantial portion of our cash flow
to pay principal and interest on our debt, thereby reducing the funds available
for working capital, capital expenditures and other general corporate purposes,
including executing our business strategy. In addition, a substantial portion
of this debt will become due in the next 18 months. We may not be able to
generate adequate cash flows from operations to repay this debt, or we may not
be able to refinance this debt with a long term debt facility. Our inability to
repay or refinance this debt could have a material negative impact on our
operations. 23




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We must attract and retain key personnel in order to implement our business
plan. The loss of the services of key personnel or the failure to attract
additional qualified personnel as required could have a material adverse effect
on our ability to sustain our business or grow. We believe that our future
success will depend in large part on our ability to attract and retain
qualified managerial, technical and sales personnel. In
March 2004, we
announced that Mr. Gregory P.
McGraw has been appointed as acting chief executive officer and is acting in
this role in addition to the other functions he is performing. Our former chief
executive officer, Charles B. McNamee, left the Company. We are actively
seeking a new chief executive officer but no assurance can be made that we will
identify or attract a qualified candidate. We may not be able to grow sufficiently and manage that growth in order to be
successful. If we are successful in implementing our business plan, our operations may
expand rapidly. We believe we must grow our business in order to achieve
sufficient economies of scale to operate profitably. Because the
communications industry is capital intensive, rapidly evolving and subject to
significant economies of scale, as a relatively small organization we are at a
competitive disadvantage. The growth we must achieve to reduce that
disadvantage will put a significant strain on all of our resources. We will
require substantial additional capital beyond that which is currently available
to us in order to finance our growth according to our current business plan. If
we fail to grow rapidly or obtain additional capital, we may not be able to
compete with larger, more established companies Furthermore, rapid expansion could place a significant strain on our
management, financial and other resources. Our ability to manage future growth,
if it occurs, will depend on, among other things, our ability to: (1) control
expenses related to our business plan; (2) maintain responsive customer
service; (3) improve existing, and implement new, billing and collections,
operational support and administrative systems; and (4) expand, train and
manage our employee base, in particular qualified sales, technical and
managerial personnel. The failure to manage our growth effectively would impair
our business and operational performance. We may not be able to maintain the
quality of our operations, to control our costs, and to expand our internal
management, technical, information and accounting systems in order to support
our desired growth. We rely upon information processing systems provided by others. Sophisticated information processing systems are vital to our growth and
our ability to achieve operating efficiencies. A failure of any of these
systems would have a material adverse effect on our operations and business. In
addition, there may be other systems we have not identified that are required
or in need of improvement. We may also be unable to maintain and upgrade these
systems as necessary. We must purchase voice and data transmission capacity from third parties who
may be unable or unwilling to meet our requirements. We rely upon other communications carriers, such as local telephone
companies, long distance companies and Internet service providers, to provide
transmission capacity from the buildings we serve. Our failure to obtain
adequate connections from other carriers on a timely and efficient basis could
delay or impede our ability to provide services and generate revenue.
Sufficient capacity or redundant capacity may not be readily available from
third parties at commercially reasonable rates, if at all. Our failure to
obtain sufficient redundant connectivity could result in an inability to
provide service in certain buildings and service interruptions, which could in
time lead to loss of customers and damage to our reputation. Additionally,
many of the communications carriers we rely on for transmission capacity are
also our direct competitors. The sector in which we operate is highly competitive, and we may not be able to
compete effectively. The numerous companies that may seek to enter our niche may expose us to
greater price competition for our services. Competition could also result in a
diminution of our net revenue margins. We face competition from many
communications providers with significantly greater financial resources,
well-established brand names, larger customer bases and diverse strategic plans
and technologies. For example, we face competition from traditional and new
communications companies, including local, long distance, cable modem,
Internet, digital subscriber line, fixed and mobile wireless and satellite data
service providers. Intense competition has led to declining prices and margins
for many communications services. We expect this trend to continue as
competition intensifies in the future. 24




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If our competitors successfully focus on our market, the intense
competition could materially harm our business. To the extent these
competitors are successful, we may face difficulties in building our networks
and marketing our services within some of our target buildings. Because our
agreements to use utility shaft space within buildings are generally not
exclusive, owners of such buildings may give similar rights to our competitors.
If a competitor installs a network in a building in which we operate, there
will likely be substantial price competition preventing us from operating in
that building profitably. In addition, we may also face severe price
competition for building access rights, which could result in higher sales and
marketing expenses and lower profit margins. We must continue to obtain license agreements with building owners and managers
in order to be successful. Our business depends upon our ability to install in-building networks. The
failure of building owners or managers to grant or renew access rights on
acceptable terms, or any deterioration in our existing relationships with
building owners or managers, could harm our marketing efforts and could
substantially reduce our potential customer base. Current federal and state
regulations do not require building owners to make space available to us, or to
do so on terms that are reasonable or nondiscriminatory. Building owners or
managers may decide not to permit us to install our networks in their buildings
or may elect not to renew our license agreements. Non-renewal of these
agreements would reduce our revenues and we might not recover our
infrastructure costs. Alternative technologies pose competitive threats. The communications industry is subject to rapid and significant
technological change, such as continuing developments in digital subscriber
line technology and alternative technologies for providing high-speed data
communications. In addition to fiber-optic technology, there are other
technologies, such as VoIP, DSL and wireless technology that provide more
capacity and speed than traditional copper wire transmission technology. Our
success in improving and expanding our operations and services will depend on
our ability to anticipate or adapt to new technology on a timely basis. The
development of new technologies or the significant penetration of alternative
technologies into our target market may either reduce the demand for our
services, require us to devote important capital, and human and technical
resources to upgrade, reconfigure or replace our current or future technology
or some combination of each of these, and consequently could have a material
adverse effect on our business. Retained control by our principal stockholders may create conflicts of
interest. The concentration of ownership of our stock may have the effect of
delaying, deferring or preventing a change in control, merger, consolidation,
or a tender offer which could involve a premium over the price of our common
stock. Currently, our executive officers, directors and
greater-than-five-percent stockholders and their affiliates, in the aggregate,
beneficially own a substantial percentage of the outstanding common stock (not
including shares issuable upon the conversion or exercise of warrants or
options). If all of these stockholders were to vote together as a group, they
would have the ability to exert significant influence over our board of
directors and its policies as well as other significant corporate matters such
as charter and bylaw amendments and possible mergers or corporate control
contests. Legislation and government regulation could adversely affect us. Many of our services are subject to federal, state and/or local
regulation. If we fail to comply with all applicable regulations or experience
delays in obtaining required approvals, our business could be harmed. For
example, we must make regular filings in some of the states in which we operate
and could be fined if we do not timely make these filings. Additionally,
compliance with these regulatory requirements may be costly. We may experience
delays in closing future corporate transactions, including debt and equity
financings and sales of any portion of our regulated business, due to
requirements to obtain regulatory approval of these transactions. Regulations
governing communications services also change from time to time in ways that
are difficult to predict. Such changes may
harm our business by increasing competition, decreasing revenue, increasing
costs, impairing our ability to offer services or otherwise. For example, the
FCC could mandate that building owners give access to competitive providers of
communications services. If our interpretation of regulations applicable to our operations is
incorrect, we may incur additional expenses or become subject to more stringent
regulation. If our interpretations of these regulations and guidelines are
incorrect, we may incur additional expenses to comply with additional
regulations applicable to our operations. We also may incur significant
expenses to defend ourselves against complaints by customers or other persons
who claim we have violated applicable regulations, even if our interpretation
of the rules is ultimately upheld by the regulatory agency. 25




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We have significant fixed costs. As of December 31, 2003, we have committed to pay approximately $28
million for services from other communications carriers through 2006. We will
have to pay those carriers even if we do not use their services. We operate in
a market that requires high fixed costs to build out our in-building networks
and we therefore must have high utilization of our products and services with
each building in which we operate in order to be successful. We expect that
the communications needs will be in excess of the purchase requirements for the
years ending December 31, 2004, 2005 and 2006. Our business could suffer from a reduction or interruption from our equipment
suppliers. We purchase our equipment from various vendors. Any reduction in or
interruption of deliveries from our major equipment suppliers, such as Cisco
Systems and Nortel Networks, could delay our plans to install in-building
networks, impair our ability to acquire or retain customers and harm our
business generally. In addition, the price of the equipment we purchase may
substantially increase over time, increasing the costs we pay in the future.
It could take a significant period of time to establish relationships with
alternative suppliers for each of our technologies and substitute their
technologies into our networks. We must make capital expenditures before generating revenues, which may prove
insufficient to justify those expenditures. We typically install an in-building network before we have any customers
in that building. Since we generally do not solicit customers within a
building until our network is in place we may not be able to recoup all of our
expenditures within any building. Prior to generating revenues in a building,
we must incur initial capital expenditures. Our expenditures will vary
depending on the size of the building and whether we encounter any
construction-related difficulties. After initial installation of our network,
our capital expenditures continue to grow based on the extent to which we add
customers within a building. Any acquisitions or investments we make could disrupt our business and be
dilutive to our existing stockholders. We intend to consider acquisitions of, or investments in, complementary
businesses, technologies, services or products. Acquisitions and investments
involve numerous risks, including:  
    
    the diversion of management attention;
    
    difficulties in assimilating the acquired business;
    
    potential loss of key employees, particularly those of the acquired business;
    
    difficulties in transitioning key customer relationships;
    
    risks associated with entering markets in which we have no or limited prior experience; and
    
    unanticipated costs. In addition, these acquisitions or investments may result in:  
    
    dilutive issuances of equity securities;
    
    the incurrence of debt or assumption of liabilities;
    
    large one-time expenses; and
    
    the creation of other intangible assets that result in significant amortization expense. Any of these factors could materially harm our business or our operating
results. Our networks may be vulnerable to unauthorized access which could interfere
with the provision of our services. Our networks may be vulnerable to unauthorized access, computer viruses
and other disruptive problems. Remediating the effects of computer viruses and
alleviating other security problems may require interruptions, incurrence of
costs and delays or cessation of service to our customers. Unauthorized access
could jeopardize the security of confidential information stored in our 26




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computer systems or those of our customers, for which we could possibly be held
liable. Any unauthorized access could further damage our reputation and
ultimately our ability to successfully compete in our market. Impairment of our intellectual property rights could harm our business. We regard certain aspects of our products, services and technology as
proprietary and attempt to protect them with legal rights, contractual rights
and other methods. Despite these precautions, it may be possible for a third
party to copy or otherwise obtain and use our proprietary products, services or
technology without authorization, or to develop similar proprietary matter
independently. If a third party were to obtain our proprietary information and
we were unable to prevent them from disseminating that information or using it
to our disadvantage, our business could be harmed. This exercise of outstanding securities my have a dilutive effect. We have outstanding warrants and options with exercise prices ranging from
$0.01 per share to $10.00 per share. The exercise of these securities could
have a dilutive effect with respect to holders of our common stock. As of March
1, 2004, the total number of shares issuable by us under outstanding warrants
and options was approximately 16,101,618. 27




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ITEM 7. FINANCIAL STATEMENT INDEX TO CONSOLIDATED FINANCIAL STATEMENTS U.S. REALTEL, INC.Independent Auditors Report
    
    
    29Consolidated Balance Sheet at December 31, 2003
    
    
    30Consolidated Statements of Operations for the year ended December 31, 2002 and 2003
    
    
    31Consolidated Statements of Stockholders Equity (Deficit) for the years ended December 31, 2002 and 2003
    
    
    32Consolidated Statements of Cash Flows for the years ended December 31, 2002 and 2003
    
    
    33Notes to Consolidated Financial Statements
    
    
    34CYPRESS COMMUNICATIONS, INC. (PREDECESSOR)Independent Auditors Report
    
    
    51Consolidated Statement of Operations for the one-month period from January 1, 2002 to January 31, 2002
    
    
    52Consolidated Statement of Stockholders Equity for the one-month period from January 1, 2002 to January 31, 2002
    
    
    53Consolidated Statement of Cash Flows for the one-month period from January 1, 2002 to January 31, 2002
    
    
    54Notes to Consolidated Financial Statements
    
    
    55
 28




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Independent Auditors Report U.S. RealTel, Inc. We have audited the accompanying consolidated balance sheet of U.S. RealTel,
Inc. as of December 31, 2003, and the related consolidated statements of
operations, changes in stockholders equity (deficit) and cash flows for each
of the two years in the period ended December 31, 2003. These financial
statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company at
December 31, 2003, and the results of its operations and its cash flows for
each of the two years in the period ended December 31, 2003 in conformity with
accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche, LLP Atlanta, Georgia
March 29, 2004 29




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U.S. REALTEL, INC. 
 CONSOLIDATED BALANCE SHEET December 31,
    
    2003ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    1,900,000Accounts receivable, net of allowance for doubtful accounts of $412,000
    
    
    7,652,000Prepaid expenses and other current assets
    
    
    1,271,000TOTAL CURRENT ASSETS
    
    
    10,823,000PROPERTY AND EQUIPMENT, NET (Note 5)
    
    
    24,249,000INTANGIBLE ASSETS, NET
    
    
    523,000$
    35,595,000LIABILITIES AND STOCKHOLDERS DEFICITCURRENT LIABILITIESAccounts payable and accrued expenses (Note 7)
    
    $
    16,344,000Line of Credit (Note 8)
    
    
    2,016,000Deferred Income
    
    
    1,316,000Current portion of long term debt (Note 8)
    
    
    494,000TOTAL CURRENT LIABILITIES
    
    
    20,170,000Long term debt (Note 8)
    
    
    17,543,000Accrued liabilities, long-term
    
    
    315,000TOTAL LONG-TERM LIABILITIES
    
    
    17,858,000COMMITMENTS AND CONTINGENCIES (Notes 8 and 9)STOCKHOLDERS DEFICIT (Note 10)Preferred stock, $.001 par value; 5,000,000 shares authorized;
(100 Series A issued)
    
    
    Common stock, $.001 par value; 50,000,000 shares authorized;
6,467,808 issued and 5,873,395 outstanding shares
    
    
    6,000Additional paid-in capital
    
    
    23,607,000Accumulated deficit
    
    
    (25,186,000
    )Less: Treasury Stock, at cost; 594,413 shares (Note 11)
    
    
    (860,000
    )TOTAL STOCKHOLDERS DEFICIT
    
    
    (2,433,000
    )$
    35,595,000
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 30




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U.S. REALTEL, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS Year ended
    
    Year endedDecember 31,
    
    December 31,2002
    
    2003REVENUES
    
    $
    51,717,000
    
    
    $
    84,626,000DIRECT COSTS
    
    
    28,704,000
    
    
    
    44,447,000REVENUES  NET OF DIRECT COSTS
    
    
    23,013,000
    
    
    
    40,179,000OPERATING EXPENSESSales and marketing
    
    
    3,977,000
    
    
    
    5,342,000General and administrative
    
    
    25,789,000
    
    
    
    37,694,000Extinguishment of liabilities and other credits
    
    
    
    
    
    
    (1,995,000
    )Stock based compensation
    
    
    
    
    
    
    438,000TOTAL OPERATING EXPENSES
    
    
    29,766,000
    
    
    
    41,479,000OTHER INCOME (EXPENSE)Interest income
    
    
    60,000
    
    
    
    17,000Interest expense and financing costs
(Notes 8)
    
    
    (4,914,000
    )
    
    
    (2,684,000
    )Net gain (loss) on disposal of assets
    
    
    (22,000
    )
    
    
    61,000Gain on extinguishment of debt
    
    
    85,000
    
    
    
    Net loss on investment
    
    
    
    
    
    
    (149,000
    )Other
    
    
    
    
    
    
    (108,000
    )TOTAL OTHER INCOME (EXPENSE)  NET
    
    
    (4,791,000
    )
    
    
    (2,863,000
    )Loss From Continuing Operations
    
    
    (11,544,000
    )
    
    
    (4,163,000
    )GAIN (LOSS) FROM DISCONTINUED OPERATIONS
    
    
    2,032,000
    
    
    
    Loss Before Extraordinary Item
    
    
    (9,512,000
    )
    
    
    (4,163,000
    )Extraordinary Item  gain on acquisition (Note 4)
    
    
    7,783,000
    
    
    
    Net Loss
    
    $
    (1,729,000
    )
    
    $
    (4,163,000
    )Net Income (Loss) Per Common ShareLoss from continuing operations
    
    $
    (1.95
    )
    
    $
    (0.71
    )Gain (loss) from discontinued operations
    
    
    0.34
    
    
    
    Extraordinary item
    
    
    1.32
    
    
    
    Net Income (Loss) Per Common Share  Basic and
Diluted
    
    $
    (0.29
    )
    
    $
    (0.71
    )Weighted Average Common Shares Outstanding
    
    
    5,894,000
    
    
    
    5,874,000
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 31




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U.S. REALTEL, INC. 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AccumulatedPreferred Stock
    
    Common Stock
    
    AdditionalPaid-in

    
    Accumulated
    
    Comprehensive
    
    OtherComprehensive
    
    Treasury StockShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Deficit
    
    Loss
    
    Income
    
    Shares
    
    Amount
    
    TotalBalance, at
December 31, 2001
    
    
    
    
    
    
    
    
    
    
    6,468,000
    
    
    $
    6,000
    
    
    $
    19,599,000
    
    
    $
    (19,294,000
    )
    
    
    
    
    
    $
    2,170,000
    
    
    
    533,000
    
    
    $
    (800,000
    )
    
    $
    1,681,000Stock Warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,181,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,181,000Issuance of
Preferred Stock
    
    
    100Beneficial
Conversion Feature
(Note 10)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,389,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,389,000Payment for
Treasury Stock
(Note 11)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    61,000
    
    
    
    (60,000
    )
    
    
    (60,000
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,729,000
    )
    
    
    (1,729,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,729,000
    )Other
Compre-hensive Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,170,000
    )
    
    
    (2,170,000
    )
    
    
    
    
    
    
    
    
    
    
    (2,170,000
    )Comprehensive Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (3,899,000
    )Balance, at
December 31, 2002
    
    
    100
    
    
    
    
    
    
    
    6,468,000
    
    
    $
    6,000
    
    
    $
    23,169,000
    
    
    $
    (21,023,000
    )
    
    $
    
    
    
    $
    
    
    
    
    594,000
    
    
    $
    (860,000
    )
    
    $
    1,292,000Stock Based
Compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    438,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    438,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,163,000
    )
    
    
    (4,163,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,163,000
    )Comprehensive Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,163,000
    )Balance, at
December 31, 2003
    
    
    100
    
    
    
    
    
    
    
    6,468,000
    
    
    $
    6,000
    
    
    $
    23,607,000
    
    
    $
    (25,186,000
    )
    
    
    
    
    
    $
    
    
    
    
    594,000
    
    
    $
    (860,000
    )
    
    $
    (2,433,000
    )
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 32




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U.S. REALTEL, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended
    
    Year endedDecember 31,
    
    December 31,2002
    
    2003Cash Flows From Operating ActivitiesNet loss
    
    $
    (1,729,000
    )
    
    $
    (4,163,000
    )Adjustments to reconcile net loss to net cash used
in operating activitiesDepreciation and amortization
    
    
    1,459,000
    
    
    
    4,246,000Bad debt expense
    
    
    679,000
    
    
    
    1,697,000Deferred Compensation
    
    
    
    
    
    
    438,000Stock warrants in connection with acquisition
    
    
    1,181,000Loss on disposal of assets
    
    
    
    
    
    
    196,000Extraordinary gain
    
    
    (7,783,000
    )Discontinued operations
    
    
    (2,207,000
    )Amortization of warrant cost as interest expense
    
    
    305,000
    
    
    
    608,000Gain on extinguishment of debt
    
    
    85,000
    
    
    
    Changes in assets and liabilities, net of dispositions(Increase) decrease in accounts receivable
    
    
    4,408,000
    
    
    
    (517,000
    )(Increase) decrease in prepaid expenses and other current assets
    
    
    (956,000
    )
    
    
    80,000(Increase) decrease in other assets
    
    
    (619,000
    )
    
    
    (45,000
    )Increase (decrease) in accounts payable and accrued expenses
    
    
    11,117,000
    
    
    
    (4,777,000
    )Increase (decrease) in deferred income
    
    
    (794,000
    )
    
    
    840,000Net cash provided by (used in) operating activities
    
    
    5,146,000
    
    
    
    (1,397,000
    )Cash Flows From Investing ActivitiesInvestment in subsidiary
    
    
    (48,495,000
    )
    
    
    Capital expenditures
    
    
    (1,050,000
    )
    
    
    (1,941,000
    )Purchase of assets related to Eureka and E-Building acquisitions
    
    
    
    
    
    
    (3,543,000
    )Sale of property and equipment
    
    
    
    
    
    
    227,000Cash acquired in acquisitions
    
    
    33,023,000
    
    
    
    Net cash provided by (used in) investing activities
    
    
    (16,522,000
    )
    
    
    (5,257,000
    )Cash Flows From Financing ActivitiesProceeds from note payable in connection
to acquisition
    
    
    16,436,000
    
    
    
    Repayment of note payable in connection
with acquisition
    
    
    (16,436,000
    )
    
    
    Borrowings from credit facilities, net of repayments
    
    
    26,551,000
    
    
    
    2,016,000Principal payments of long-term debt
    
    
    (8,918,000
    )
    
    
    (1,720,000
    )Payment for acquisition of treasury stock
    
    
    (60,000
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    17,573,000
    
    
    
    296,000Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    6,197,000
    
    
    
    (6,358,000
    )Cash and Cash Equivalents, at beginning of year
    
    
    2,061,000
    
    
    
    8,258,000Cash and Cash Equivalents, at end of year
    
    $
    8,258,000
    
    
    $
    1,900,000Supplemental Disclosure of Cash Flow InformationInterest paid
    
    $
    4,914,000
    
    
    $
    1,246,000Supplemental Disclosures of Noncash Investing
and Financing ActivitiesWarrants issued for financing costs
    
    
    1,181,000
    
    
    
    
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 33




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U.S. REALTEL, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION, BASIS OF PRESENTATION AND ACCOUNTING POLICIES ORGANIZATION U.S. RealTel, Inc. (together with its subsidiaries, U.S. RealTel, or the
Company), through its wholly owned operating subsidiary, Cypress
Communications Inc. (Cypress Communications or Cypress) provides
comprehensive data, voice and video communications services to small and medium
sized businesses located in approximately 1,300 commercial office buildings in
select major metropolitan markets within the United States. The Company is
incorporated under the laws of the State of Delaware. In July 2002, through Cypress Communications, we acquired certain assets
of Intermedia Advanced Building Networks, the shared tenant telecommunications
services business of WorldCom, Inc (ABN/STS). The acquisition of ABN/STS has
allowed us to extend our telecommunications services operations to over 5,700
small and medium sized business customers in 25 major metropolitan U.S.
markets. BASIS OF PRESENTATION The accompanying financial statements are presented on the accrual basis
of accounting using accounting principles generally accepted in the United
States. Certain prior year amounts have been reclassified to conform to the
current year presentation. PRINCIPLES OF CONSOLIDATION U.S. RealTels subsidiaries at December 31, 2003 are listed below: PercentLocation
    
    Owned
    
    DescriptionCypress Communications, Inc.
    
    Atlanta, GA
    
    
    100
    %
    
    Active subsidiaryCypress Communications
Operating Company, Inc.
    
    Atlanta, GA
    
    
    100
    %
    
    Active subsidiaryCypress Communications
Holding Company of
Virginia, Inc.
    
    Atlanta, GA
    
    
    100
    %
    
    Active subsidiaryCypress Communications
International, Inc.
    
    Atlanta, GA
    
    
    100
    %
    
    Inactive subsidiaryCypress Canada, Inc.
    
    Canada
    
    
    100
    %
    
    Inactive subsidiaryRealTel de Argentina, S.A.
    
    Argentina
    
    
    71
    %
    
    Inactive subsidiaryRealTel do Brasil, S.A.
    
    Brazil
    
    
    89
    %
    
    Inactive subsidiary
 The consolidated financial statements include the accounts of U.S. RealTel
and its subsidiaries that are more than 50% owned. All significant intercompany transactions and balances between the
companies included in the consolidation are eliminated. CASH AND CASH EQUIVALENTS Cash equivalents consist of short-term, highly liquid investments that
mature in three months or less, which are readily convertible into cash. 34




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PROPERTY, EQUIPMENT AND DEPRECIATION Property and equipment are stated at cost. Depreciation is computed over
the estimated useful lives of the assets (three to seven years) by
straight-line methods for financial reporting purposes. Depreciation of
leasehold improvements is computed over the lesser of the estimated useful
lives of the assets or the term of the lease by the straight-line method for
financial reporting purposes. REVENUE RECOGNITION The Companys revenues include recurring charges for local access,
long-distance, equipment rental, Internet access, digital satellite business
television, voicemail, inbound 800, and other enhanced voice and data services,
which are recognized as services provided. Revenues also include nonrecurring
charges for installations and moves, adds, and changes. Installation fees
represent the initial cost charged by Cypress Communications for installing
voice phone lines, data lines, and Business TV in the tenants premises. Move,
add, and change (MAC) charges are for the Companys labor and materials
related to moving, adding, or changing a customers services. Installation and
MAC charges are recognized when the services are provided as they represent
separate earnings process. STOCK-BASED COMPENSATION The Financial Accounting Standards Board Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123),
became effective in 1997. SFAS No. 123 encourages companies to recognize
expense for stock options and other stock-based employee compensation plans
based on their fair value at the date of grant. As permitted by SFAS No. 123,
the Company has and will retain its prior accounting policy under APB Opinion
Number 25, Accounting for Stock Issued to Employees, and, accordingly,
compensation expense for stock options is measured as the excess, if any, of
the fair value of the Companys stock at the date of grant over the exercise
price. FASB Statement 123, Accounting for Stock Based Compensation, requires the
Company to provide pro forma information regarding net income and earnings per
share as if compensation cost for the Companys stock option plan has been
determined in accordance with the fair value based method prescribed in FASB
Statement 123. The Company estimates the fair value of each stock option at the
grant date by using the Black-Scholes option-pricing model with the following
assumptions used for grants in 2002 and 2003: no dividends yield for all years;
expected volatility of 74 percent and 100 percent, respectively; risk-free
interest rate of 4.42 percent and 3.0 percent, respectively; and, expected life
of 7 and 7 years, respectively. The following table illustrates the effect on the loss and loss per share
if U.S. Realtel had applied the fair value recognition provisions of SFAS. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation: Years Ended December 31,2002
    
    2003Net loss, as reported
    
    $
    (1,729,000
    )
    
    $
    (4,163,000
    )Add: Stock-based compensation, as reported
    
    
    
    
    
    
    438,000Deduct: Total stock based compensation determined
under fair value based method for all awards, net
of tax
    
    
    (496,000
    )
    
    
    (1,141,000
    )Proforma net loss
    
    $
    (2,225,000
    )
    
    
    (4,866,000
    )Loss per share:Basic and
diluted loss per share - as reported.
    
    $
    (0.29
    )
    
    $
    (.71
    )Basic and
diluted loss per share - as pro forma
    
    
    (0.38
    )
    
    
    (.83
    )
 ADVERTISING COSTS Advertising costs, aggregating $60,000 in 2002 and $90,000 in 2003, are
expensed as incurred. FAIR VALUES OF FINANCIAL INSTRUMENTS The Companys financial instruments consist principally of cash and cash
equivalents, accounts receivable, accounts payable, accrued liabilities and
notes. The carrying amounts of such financial instruments as reflected in the
balance sheet approximate their 35




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estimated fair value as of December 31, 2003 due to their short-term
nature. The estimated fair value is not necessarily indicative of the amounts
the Company could realize in a current market exchange or of future earnings or
cash flows. VALUATION OF LONG-LIVED ASSETS On January 1, 2002, the Company adopted Financial Accounting Standards
Board (FASB) Statement No. 144 Accounting for Impairment or Disposal of
Long-Lived Assets (FAS No. 144). Under FAS 144, the Company reviews
long-lived assets for impairment when circumstances indicate the carrying
amount of an asset may not be recoverable based on the undiscounted future cash
flows of the asset. If the carrying amount of the asset is determined not to be
recoverable, a write-down to fair value is recorded. INCOME TAXES Income taxes are accounted for under FASB Statement No. 109, Accounting
for Income Taxes (FAS 109). FAS 109 is an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in our
financial statements or tax returns. In estimating future tax consequences, FAS
109 generally considers all expected future events other than proposed changes
in the tax laws or rates. Valuation allowances are provided if it is more
likely than not that a deferred tax asset will not be realized. NET INCOME (LOSS) PER
COMMON SHARE - BASIC AND DILUTED Basic earnings per share (EPS) is calculated by dividing the income
(loss) available to common shareholders by the weighted average number of
common shares outstanding for the period, without consideration for common
stock equivalents. Diluted EPS gives effect to all dilutive potential common
shares outstanding for the period. Shares of common stock issuable upon the
exercise of options (3,769,888 and 3,896,759 shares in 2002 and 2003,
respectively) and warrants (3,143,380 and 2,346,268 shares in 2002 and 2003,
respectively) and shares issued upon conversion of convertible notes (9,152,597
and 9,858,591 in 2002 and 2003, respectively) are antidilutive and are not
included in the computation of shares outstanding. COMPREHENSIVE INCOME (LOSS) The Company follows SFAS No. 130, Reporting Comprehensive Income (SFAS
130). SFAS 130 establishes standards for reporting comprehensive income or
loss and its components in the consolidated financial statements. Comprehensive
income (loss), as defined, includes all changes in equity (net assets) during a
period from non-owner sources. To date, the Company has reported other
comprehensive income from the cumulative effect on exchange rates for the
amount of $(2,170,000) in 2002 and $0 in 2003. The Company had no other
material transactions that are required to be reported in comprehensive income
or loss. ACCOUNTING ESTIMATES The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect that reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates. SEGMENT REPORTING The Company operates in one business segment  the provision of
telecommunication services to small and medium sized businesses on an
integrated basis. RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities.Interpretation No. 46 addresses consolidation by
business enterprises of variable interest entities, which are entities that
either (a) do not have equity investors with vesting rights or (b) have equity
investors that do not provide sufficient financial resources for the entity to
support its activities. The interpretation is effective immediately for
variable interest entities created after February 1, 2003. In December 2003,
the FASB published FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities(FIN 46(R)). FIN
46(R), among
other things, defers the effective date of implementation for certain entities.
The revised interpretation is effective 36




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for the first interim or annual reporting period ending after March 15,
2004, with the exception of structures that are commonly referred to as
special-purpose entities, for which the statement is effective for periods
ending after December 15, 2003. The adoption of Interpretation No. 46 is not
expected to have a material impact on our results of operations or financial
position. In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements
SFAS 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
corrections. This Statement rescinded Statement No. 4, Reporting Gains and
Losses from Extinguishments of Debt, and an amendment of that Statement, FASB
Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements. This Statement also rescinded FASB Statement No. 44, Accounting
for Intangible Assets of Motor Carriers. This Statement amended FASB Statement
No. 13, Accounting for Leases, to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. This Statement also amended other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The
provision of this Statement related to the rescission of Statement No. 4 must
be applied in fiscal year beginning after May 15, 2002. The provisions of this
Statement related to Statement 13 will be applicable for transactions occurring
after May 15, 2002. Early application of the provisions of this Statement is
encouraged. The Company does not expect the adoption of SFAS 145 will have a
significant impact on its consolidated results of operations, financial
position or cash flows. On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities(SFAS No. 149), which
amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities(SFAS No. 133). The amendments set forth are intended to improve
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. In particular, SFAS No. 149 clarifies the
circumstances under which a contract with an initial net investment meets the
characteristics of a derivative as discussed in SFAS No. 133. In addition,
SFAS No. 149 clarifies when a derivative contains a financing component that
warrants special reporting in the statement of cash flows. SFAS No. 149 amends
certain other existing pronouncements, resulting in more consistent reporting
of contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003, except for hedging
relationships designated after June 30, 2003. The guidance should be applied
prospectively. The provisions of SFAS No. 149 that relate to SFAS No. 133
implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003 should continue to be applied in accordance with their
respective effective dates. In addition, certain provisions relating to forward
purchases or sales of when issued securities or other securities that do not
yet exist should be applied to existing contracts as well as new contracts
entered into after June 30, 2003. U.S. RealTel does not expect the adoption of
SFAS No. 149 to have a material impact on its consolidated financial
statements. On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity (
SFAS No. 150), which aims to eliminate diversity in practice by requiring that
the following three types of freestanding financial instruments be reported
as liabilities by their issuers: (i) mandatorily redeemable instruments (i.e.,
instruments issued in the form of shares that unconditionally obligate the
issuer to redeem the shares for cash or by transferring other assets); (ii)
forward purchase contracts, written put options, and other financial
instruments not in the form of shares that either obligate or may obligate the
issuer to repurchase its equity shares and settle its obligation for cash or by
transferring other assets; (iii) certain financial instruments that include an
obligation that (1) the issuer may or must settle by issuing a variable number
of its equity shares and (2) has a monetary value at inception that (a) is
fixed, (b) is tied to a market index or other benchmark (something other than
the fair value of the issuers equity shares), or (c) varies inversely with the
fair value of the equity shares. The provisions of SFAS No. 150, which also
include a number of new disclosure requirements, are effective for (1)
instruments entered into or modified after May 31, 2003 and (2) pre-existing
instruments as of the beginning of the first interim period that commences
after June 15, 2003. There is, however, a delayed effective date for private
companies mandatorily redeemable instruments. The adoption of SFAS No. 150 did
not have a material impact on the consolidated financial statements. 2. LIQUIDITY As reflected in the accompanying consolidated financial statements, the
Company has cumulative losses and, except for the year ended December 31, 2002,
also had negative cash flows from operations. Beginning in the first quarter of 2002, the Company initiated certain
actions intended to improve liquidity and operating results. Such actions
included, among other things, (i) completing the acquisition of Cypress
Communications and making certain adjustments to Cypress Communications
staffing levels and cost structure (Note 4), (ii) liquidation of the operations
in Argentina and 37




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Brazil (Note 3), (iii) completing the purchase of certain assets of
Intermedia Advanced Building Networks and the shared tenant telecommunications
services business of WorldCom, Inc. (Note 4), and (iv) raising $28 million in
connection with such asset acquisition. U.S. Realtels cash position decreased during the year ended December 31,
2003 due to one-time payments resulting from renegotiated settlements on
certain liabilities of U.S. RealTel, and the acceleration of payments related
to current accrued expense, also in relation to the settlement agreements.
Management believes that U.S. RealTels cash position should stabilize during
the following quarters as actions initiated in 2002 and throughout 2003 to
reduce U.S. RealTels costs are expected to materialize. U.S. RealTel cannot,
however, give any assurance that it will be able to generate sufficient cash
flows from operations or financing activities to cover its future costs of
operations or to operate on a profitable basis. Likewise, no assurance can be
given that U.S. RealTel can generate sufficient cash flow from operations or
financing activities to support the debt service obligations, including debt
raised in connection with its acquisition of certain assets from ABN/STS.
Moreover, the terms of the indebtedness U.S. RealTel incurred in connection
with the acquisition of certain assets from ABN/STS contain restrictive
covenants that limit its ability to incur additional indebtedness, pay
dividends or undertake certain other transactions. U.S. RealTel has also
pledged certain assets as security under its senior credit facility.
Therefore, U.S. RealTel must devote a substantial portion of its cash flow to
service its indebtedness and cannot utilize that cash flow for operations.
Accordingly, there can be no assurance that U.S. RealTel will have sufficient
liquidity to implement its business plan. Likewise, there can also be no
assurance that U.S. RealTel will be able to obtain cash through future
financing activities on acceptable terms, or at all, or that U.S. RealTel will
ever become profitable. 3. DISCONTINUED OPERATIONS U.S. RealTel discontinued and liquidated its telecommunications rights
operations in Latin America during 2002. Discontinuing U.S. RealTels
operations in Latin America helped U.S. RealTel preserve existing capital and
dedicate its resources to its new telecommunications services business in the
U.S. In 2002, U.S. Realtel recognized a gain from the discontinued operations
of approximately $2 million in connection to the discontinuation and
liquidations of its Latin-American operations. 4. ACQUISITIONS CYPRESS COMMUNICATIONS In February 2002, the Company completed the acquisition of Cypress
Communications, a U.S. based operation that provides a full range of
telecommunications services to businesses in multi-tenant office buildings
located in selected major metropolitan markets within the United States. The
acquisition of Cypress Communications allowed the Company to concentrate its
resources and expertise on providing premium communications services to over
2,500 small and medium sized business customers in seven major metropolitan
U.S. markets: Atlanta, Boston, Chicago, Dallas, Houston, Los Angeles and
Seattle. Cypress Communications prior investment in telecommunications and
broadband infrastructure is expected to enable the Company to provide bundled
communications services to businesses located in multi-tenant office buildings
in a manner that is both reliable and cost effective for its customers. The acquisition of Cypress Communications was completed through a tender
offer for outstanding Cypress Communications common stock and a short form
merger of a new wholly-owned acquisition subsidiary of U.S. RealTel into
Cypress Communications. The purchase price was $3.50 per share, in cash, for a
total purchase price of approximately $18.7 million, which included cash paid
for options to purchase shares of Cypress Communications under option plans in
the amount of $58,000 and expenses incurred in connection with the acquisition
of approximately $1,447,000. As a result of such acquisition, the Company, at
the subsidiary level, acquired 100% of Cypress Communications assets,
including cash and its telecommunications services infrastructure, and
succeeded to all of the liabilities of Cypress Communications, including
operating lease commitments, primarily related to former office space, and
license agreements with property owners and/or operators of several office
buildings. The Company obtained financing to purchase the Cypress
Communications common stock and complete the merger through a loan from the
LaSalle Bank, which was facilitated by the Oliver Estate, a private entity
affiliated with Ross J. Mangano, a director of the Company. The loan was repaid
in February 2002, with interest of approximately $3,000. In connection to the
loan, the Company paid a commission fee to the Oliver Estate of $875,000 and
issued warrants to purchase up to 850,000 shares of the Companys common stock
at an exercise price of $1 per share. The warrants are exercisable through
February 2005 and, based on the Black-Scholes pricing model, were valued by the
Company at $646,000. Assumptions used for the Black-Scholes option-pricing
model included: no dividend yield for all years, expected volatility of 120
percent, risk-free interest rate of 4.75 percent and expected life of 5 years.
The commission and the value of the warrants were treated as interest expense
in the accompanying Consolidated Statements of Operations. In addition, the
Company paid bank fees and interest of approximately $55,000, which also have
been treated as interest expense. 38




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The acquisition of Cypress Communications was accounted for by the
purchase method of accounting and resulted in negative goodwill. The purchase
price allocation, after the elimination of all long-term assets of Cypress
Communications in an aggregate amount of $26.8 million, resulted in an
extraordinary gain associated with the acquisition in the amount of $7,783,000.
The Consolidated Statements of Operations include the operations of Cypress
Communications from February 1, 2002 through December 31, 2003. ACQUISITION COSTS
    
    
    
    
    
    $
    18,688,000FAIR VALUE OF CYPRESS COMMUNICATIONS
    
    
    
    
    
    
    53,311,000NEGATIVE GOODWILL  BEFORE ASSET REDUCTION
    
    
    
    
    
    
    (34,623,000
    )REDUCTION OF LONG TERM ASSETSProperty and equipment
    
    
    26,771,000Other assets
    
    
    69,000
    
    
    
    26,840,000EXTRAORDINARY GAIN
    
    
    
    
    
    $
    7,783,000
 INTERMEDIA ADVANCED BUILDING NETWORKS In July 2002, the Company, through its wholly owned subsidiary, Cypress
Communications, completed the purchase of certain assets of Intermedia Advanced
Building Networks, the shared tenant telecommunications services business of
WorldCom, Inc (ABN/STS). The acquired assets included all customer contracts,
in-building networks and the associated building access rights, as well as the
necessary employees to support these assets. The acquisition of ABN/STS has
allowed the Company to extend its telecommunication services operations to over
5,700 small and medium sized business customers in 25 major metropolitan U.S.
markets. Cypress Communications paid $29 million in cash at closing to the
sellers, assumed various commitments arising out of the operation of the
business after the closing, assumed accrued but unpaid liabilities incurred by
the sellers in the operation of the business prior to the closing in an amount
up to a maximum of $2 million, assumed vehicle lease obligations of
approximately $284,000 and paid expenses incurred in connection with the
acquisition of approximately $899,000. The acquisition was accounted for as a purchase, and accordingly, the
results of operations of ABN/STS have been included since the date of
acquisition in the accompanying statements of operations. The allocation of the
purchase price as of July 17, 2002 was as follows: ACQUISITION COSTS
    
    $
    32,183,000COST ALLOCATIONCURRENT ASSETS
    
    
    10,662,000PROPERTY AND EQUIPMENT
    
    
    22,703,000DEFERRED REVENUES
    
    
    (1,182,000
    )TOTAL
    
    $
    32,183,000
 The useful lives of the assets acquired from ABN/STS are as follows: Network Equipment
    
    Seven yearsVehicles
    
    One year
 Concurrently with the closing, Cypress Communications entered into an
Omnibus Post-Closing Services Agreement with the sellers and certain of their
affiliates. Under the Omnibus Agreement, the sellers and their affiliates
agreed to provide Cypress Communications:  (i)
    
    specified transition services;(ii)
    
    specified wholesale international, interstate, intrastate and
local telecommunications services and Internet services (see refer to
commitments under the Omnibus Post-Closing Agreement described in Note
9);(iii)
    
    access to the sellers U.S. Internet collocation facilities and
support services;(iv)
    
    access to the sellers network collocation facilities; and(v)
    
    access to certain buildings of the sellers in which the purchased
assets are located pending the receipt of certain
consents from building owners and federal and state regulators. 39




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In connection with such acquisition, the Company and Cypress
Communications raised $28 million to finance the acquisition. The $28 million
financing included:  (i)
    
    a $10 million senior secured revolving credit facility from
Silicon Valley Bank (the Senior Credit Facility);(ii)
    
    an $8 million bridge loan (the Bridge Loan) from the J. Oliver
Cunningham Trust (the JOC Trust), the Anne C. McClure Trust (the
ACM Trust), the Jane C. Warriner Trust (the JCW Trust),
Noro-Moseley Partners V, L.P.(Noro-Moseley), and the Wakefield Group
III, LLC (Wakefield); and(iii)
    
    the sale of $10 million of Fixed Rate Convertible Notes due July
1, 2009 (the Convertible Notes) to the Dolphin Communications Fund
II, L.P. (Dolphin Communications), Dolphin Communications Parallel
Fund II (Netherlands), L.P. (Dolphin Netherlands), Noro-Moseley and
Wakefield. The JOC Trust, the ACM Trust and the JCW Trust are affiliates of certain
stockholders of the Company and of Ross J. Mangano, a director and Chairman of
the Board of the Company and of Cypress Communications. EUREKA BROADBAND CORPORATION In March 2003, U.S. RealTel, through Cypress Communications, acquired
Eureka s Southern California building-centric voice and data services
business. These assets included customer contracts, as well as Eurekas
in-building networks and associated building access rights. The acquisition of
the Eureka assets has allowed U.S. RealTel to expand its telecommunications
services operations to include over 750 small and medium sized business
customers in the California market. U.S. RealTel paid $2.5 million in cash at closing to Eureka, assumed a
note payable for $500,000 payable six months after the acquisition upon meeting
certain operational covenants, assumed various commitments arising out of the
operation of the business after the closing, assumed equipment lease
obligations of approximately $107,000 and paid expenses incurred in connection
with the acquisition of approximately $70,000. Eureka did not meet some of the
operational covenants and the Company was only required to pay $330,000. ACQUISITION COSTS
    
    $
    3,007,000COST ALLOCATIONOTHER NON-CURRENT ASSETS
    
    
    393,000PROPERTY AND EQUIPMENT
    
    
    2,614,000TOTAL
    
    $
    3,007,000
 E-BUILDING SOLUTIONS, INC. In July 2003, U.S. RealTel, through Cypress Communications, negotiated the
surrender of certain assets from E-Building Solutions, Inc. in California, a
building-centric data services business, to mitigate the loss resulting from
E-Buildings default on a $450,000 note receivable due to Cypress
Communications. These assets included customer contracts, as well as
E-Buildings in-building networks and associated building access rights. In
addition to the $450,000 note receivable, U.S. RealTel, assumed equipment lease
obligations of approximately $43,000 and paid expenses incurred in connection
with the note of approximately $43,000. After valuing the assets surrendered,
we recorded a loss on investment in the amount of $149,000. ACQUISITION COSTS
    
    $
    536,000COST ALLOCATIONOTHER NON-CURRENT ASSETS
    
    
    274,000PROPERTY AND EQUIPMENT
    
    
    113,000LOSS ON INVESTMENT
    
    
    149,000TOTAL
    
    $
    536,000
 40




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5.
    
    PROPERTY AND EQUIPMENTProperty and equipment consist of the following at December 31, 2003: 2003System infrastructure
    
    $
    24,927,000Undeployed equipment
    
    
    2,618,000Computer and office equipment
    
    
    1,277,000Leasehold improvements
    
    
    487,000Vehicles
    
    
    29,309,000Less accumulated depreciation and amortization
    
    
    5,060,000$
    24,249,000
  6.
    
    INTANGIBLE ASSETS The assets of Eureka and E-Building, acquired in March 2003 and July 2003
respectively, had a portion of their acquisition costs allocated to intangible
assets. The combined Gross Carrying Value for the Customer Contracts was
$567,000. Net Carrying Value at December 31, 2003 was $239,000. The combined
Gross Carrying Value for the Non-Compete Agreement is $100,000 and the Net
Carrying Value is $75,000. Effective January 1, 2002, U.S. RealTel adopted SFAS No. 142, Accounting
for Goodwill and Other Intangible Assets (SFAS No. 142), SFAS No. 142
requires that goodwill and certain intangible assets will no longer be subject
to amortization, but instead will be subject to periodic impairment assessment
by applying a fair value based test. U.S. RealTel did not have any goodwill as
of December 31, 2002 or 2003. Summarized below are the carrying value and accumulated amortization of
intangible assets that are to be amortized under SFAS No. 142. The Company did
not have any other intangible assets as of December 31, 2002. December 31, 2003Gross Carrying Value
    
    Accumulated Amortization
    
    Net Carrying ValueCustomer Contracts
    
    $
    567,000
    
    
    $
    328,000
    
    
    $
    239,000Non-compete
agreement
    
    $
    100,000
    
    
    $
    25,000
    
    
    $
    75,000$
    667,000
    
    
    $
    353,000
    
    
    $
    314,000
 The estimated aggregate amortization expense for the years ended December
31, 2004, 2005 and 2006 is $272,000, $33,000, and $9,000, respectively. 41




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7.
    
    ACCOUNTS PAYABLE AND ACCRUED EXPENSESAccounts payable and accrued expenses at December 31, 2003 consist of: 2003Accounts payable
    
    $
    4,886,000Accrued circuits and connectivity costs
    
    
    7,029,000Accrued termination charges
    
    
    908,000Accrued professional fees
    
    
    190,000Accrued compensation
    
    
    495,000Other accrued expenses
    
    
    2,836,000$
    16,344,000
 ACCRUED
TERMINATION CHARGES - includes costs for office space lease
commitments in markets from which we exited or in which Cypress reduced our
retail operations, net of an estimate for sublease rentals, in the amount of
approximately $311,000, and costs to terminate contracts with communications
service providers to purchase circuits and connectivity for approximately
$597,000. Included in the above totals for the year ended December 31, 2003 are
approximately $2.7 million of accrued expenses which are currently in dispute
with various vendors. We cannot estimate at this time the amount, if any, of
these expenses that may be reduced through resolution of the various disputes.
See Note 9 for further discussion of claims we made related to certain of these
disputed accrued expenses.  8.
    
    CONVERTIBLE NOTES AND DEBENTURESLong-term debt at December 31, 2003 consists of the following: Bridge loan, in the amount of $8,000,000, at a rate of
14% interest payable quarterly beginning September 30,
2002, with principal and any unpaid interest due July 16,
2005
    
    
    8,280,000Convertible notes including accrued interest and net of
discount, with a face value of $10,000,000, at a rate of
7.5%, with interest and principal due July 1, 2009,
    
    
    9,263,000$
    17,543,000
  (a)
    
    SENIOR CREDIT FACILITY The Senior Credit Facility, in the amount of $10 million revolving credit
facility, was obtained by Cypress Communications pursuant to a Loan and
Security Agreement, dated July 12, 2002 between Cypress Communications and
Silicon Valley Bank. The Senior Credit Facility accrues interest at the prime
rate (with a floor of 4.75%) plus 2% per annum and matures on July 12, 2004,
unless terminated earlier. Borrowings under the Senior Credit Facility are
collaterized by all of the assets of Cypress Communications and are
unconditionally guaranteed by the Company. As of December 31, 2003, there was
approximately $2 million outstanding under the Senior Credit Facility and has
been classified as a current liability in the accompanying consolidated balance
sheet.  (b)
    
    BRIDGE LOAN The Bridge Loan, in the amount of $8 million term loan, was obtained by
the Company and Cypress Communications pursuant to a Loan Agreement dated July
16, 2002 among the Company, Cypress Communications, the JOC Trust, the ACM
Trust, the JCW Trust, Noro-Moseley and Wakefield (each, acting in such
capacity, a Bridge Lender and collectively, the Bridge Lenders). The Bridge
Loan accrues interest at 14% per annum, and matures on the earlier to occur of
(i) one business day following the maturity of the Senior Credit Facility and
(ii) July 16, 2005. Each Bridge Lender was entitled to receive an initial loan
fee equal to 42




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##### Table of Contents



2.5% of that portion of the Bridge Loan that was funded by such Bridge
Lender. Because the Bridge Loan was outstanding 60 days after the closing, the
Company and Cypress Communications became obligated to pay each Bridge Lender
an additional loan fee equal to 1.25% of the then outstanding principal balance
of such Bridge Lenders share of the Bridge Loan. Because the Bridge Loan has
been outstanding 90 days after the closing, the Company and Cypress
Communications became obligated subsequent to the end of the quarterly period
ended September 30, 2002 to pay each Bridge Lender an additional loan fee equal
to 1.25% of the then outstanding principal balance of such Bridge Lenders
share of the Bridge Loan. Because the Bridge Loan has been outstanding 120 days
after the closing, the Company and Cypress Communications became obligated to
pay to each Bridge Lender an additional loan fee equal to 1.00% of the then
outstanding principal balance of such Bridge Lenders share of the Bridge Loan.
The loan fees described above are cumulative and are payable on the earlier to
occur of the maturity date of the Bridge Loans or the date on which the Bridge
Loans are paid in full. The Company has accrued $280,000 for these fees, which
were treated as interest expense in the accompanying Consolidated Statements of
Operations. The Bridge Loan, in the amount of $8 million, has been classified
as a long term liability in the accompanying balance sheet as a result of the
terms of the Bridge Loan. At the closing of the Bridge Loan, the Company issued the Bridge Lenders
warrants to purchase an aggregate of 400,000 shares of the Companys common
stock at an exercise price of $1.13 per share. These warrants are exercisable
for a term of 10 years and, based on the Black-Scholes pricing model, were
valued by the Company at $535,000. Assumptions used for the Black-Scholes
option-pricing model included: no dividend yield for all years, expected
volatility of 159 percent, risk-free interest rate of 5.08 percent and expected
life of 10 years. The value of the warrants is being amortized to interest
expense over two years in the accompanying Consolidated Statements of
Operations. On
March 25, 2004, we amended the terms of the Bridge Loan such that, in
the event that the Senior Credit Facility is not renewed at its maturity in
July 2004, the Bridge Loan will not mature until the earlier to occur of (i)
its original maturity date of July 15, 2005 and (ii) an event whereby we
substantially refinance our debt obligations.  (c)
    
    CONVERTIBLE NOTES The Convertible Notes, in the amount of $10 million, were issued by the
Company and Cypress Communications pursuant to a Purchase Agreement dated July
16, 2002 among the Company, Cypress Communications, the JOC Trust, the ACM
Trust, the JCW Trust, Noro-Moseley and Wakefield (each, acting in such
capacity, a Purchaser and collectively, the Purchasers). The Convertible
Notes accrue interest at the rate of 7.5% per annum, compounded quarterly, and
payable at maturity of the notes, whether upon their stated maturity of July 1,
2009, or earlier as a result of acceleration in the event of a default or upon
redemption of the Convertible Notes. The principal of and accrued interest on
the Convertible Notes is convertible into the Companys common stock at $1.13
per share. The Convertible Notes are redeemable by the Company or Cypress
Communications at any time by payment of the outstanding principal balance and
accrued interest. In the event that the Convertible Notes are redeemed, the
Purchasers have been issued warrants which will then be eligible for exercise
to purchase the number of shares of common stock of the Issuer that the
Convertible Notes were convertible into on the redemption date at a conversion
price of $1.13 per share. In connection with the issuance of the Convertible
Notes, the Company, the Purchasers and the Bridge Lenders entered into a
registration rights agreement, which provides for the registration of the
common stock issuable upon (i) the conversion of the Convertible Notes; (ii)
the exercise of the Warrants issued in connection with the Bridge Loan; and
(iii) the exercise of the Warrants exercisable upon the redemption of the
Convertible Notes. In connection with the issuance of the Convertible Notes, the Purchasers
were issued a total of 100 shares of the Companys Series A Preferred Stock
(the Series A Preferred) without additional consideration. The rights of the
Series A Preferred are set forth in a Certificate of Designations adopted by
the Companys board of directors. The holders of a majority of the Series A
Preferred are entitled to elect two members of the Companys board of directors
and the holders of the Series A Preferred are entitled to receive dividends and
distributions equal to those payable to the holders of an equivalent number of
shares of the Companys common stock. In addition, the Company may not, without
the prior written consent of holders of a majority of the Series A Preferred,
(i) increase or decrease (other than by redemption or conversion) the
authorized number of shares of Series A Preferred; (ii) cancel or modify the
voting rights of the holders of Series A Preferred; (iii) cancel or modify the
rights of the holders of Series A Preferred; or (iv) amend, waive, alter,
modify or repeal any provision of the Certificate of Incorporation or Bylaws of
the Corporation, if such amendment, alternation, modification or repeal would
adversely affect the Series A Preferred, including the issuance of preferred
stock with voting rights senior to or pari passu with the Series A Preferred.
The Series A Preferred is redeemable by the Company in the event that:  (i)
    
    at least 75% of the principal amount of the Convertible Notes is
converted into shares of common stock of the Company;  (ii)
    
    at least 75% of the principal amount of the Convertible Notes is
redeemed; 43




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(iii)
    
    the Company has submitted an application in good faith to apply
for listing on AMEX, NASDAQ or another national exchange to register
its securities on such exchange, the average daily trading price per
share of the common stock as reported in such application is at least
$4.00 per share, and the Company subsequently receives a comment from
such exchange that its application for listing will not be accepted so
long as the Series A Preferred remains outstanding with the voting
rights described herein; or  (iv)
    
    the outstanding principal and interest on the Convertible Notes
are paid in full on the maturity date of the Convertible Notes. The redemption price for the Series A Preferred is $0.001 per share. At the closing of the Convertible Notes, the Company issued the
Convertible Note Lenders warrants to purchase the number of shares of the
Companys common stock in to which the Convertible Note Lenders would be
convertible immediately prior to the redemption of such note at a price of
$1.13 per share. These warrants are exercisable if the Convertible Notes are
redeemed and have a life of 7 years. The Company will not record any charge
until the notes are redeemed. The Company has estimated that based on the terms
of the Convertible Notes that if the Company redeemed the Convertible Notes it
would redeem the entire amount. Therefore, based on the Black-Scholes pricing
model, the warrants were valued by the Company at $12,035,000. Assumptions used
for the Black-Scholes option-pricing model included: no dividend yield for all
years, expected volatility of 159 percent, risk-free interest rate of 4.81
percent and expected life of 7 years. The Bridge Lenders and the Purchasers entered into an Intercreditor
(Subordination) Agreement, which, among other things, provides that under
certain limited circumstances, all amounts payable by the Company and Cypress
Communications under the Bridge Loan and the Convertible Notes will be payable,
pro rata among the Bridge Lenders and the Purchasers, on a pari passu basis. To
induce the JOC Trust, the ACM Trust and the JCW Trust to enter into the
Intercreditor (Subordination) Agreement, the Company and Cypress Communications
entered into a Letter Agreement. Pursuant to the Letter Agreement, the Company
and Cypress Communications agreed to pay the Bridge Lenders and the Purchasers,
in proportion to the amounts lent by them under the Bridge Loan, a fee of
$1,000,000 (the Risk Allocation Fee). The Risk Allocation Fee was to be
payable to certain Bridge Lenders and the Purchasers upon the earlier to occur
of the achievement of certain earnings milestones set forth in the Letter
Agreement or June 30, 2003. In December 2002, the Company agreed to accelerate
the payment terms for this Risk Allocation Fee, issuing a payment of $915,000
in settlement of the full outstanding amount. The Company recognized the
$85,000 difference in 2002 as an extraordinary gain on extinguishment of debt. As the exercise price of the Convertible Notes of $1.13 was less than the
relative fair market value of the stock as of the consummation date, a
beneficial conversion feature was created. The Company has calculated the
beneficial conversion feature embedded in the Convertible Notes in accordance
with EITF No. 98-5 and EITF No. 00-27 and recorded approximately $2,389,000 as
a debt discount. This discount is being amortized over the seven-year life of
the Convertible Notes. During the year ended December 31, 2002 and 2003, the
Company recorded approximately $171,000 and $341,000 respectively, in
additional interest expense. FUTURE ANNUAL COMMITMENTS Future annual payments under capital leases and long-term debt as of
December 31, 2003 are as follows: 2004
    
    
    494,0002005
    
    
    8,031,0002006
    
    
    4,00020072008Thereafter
    
    
    11,140,000Total
    
    
    19,669,000Less current portion
    
    
    (494,000
    )Long-term portion
    
    $
    19,175,000
 44




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##### Table of Contents



9.
    
    COMMITMENTS AND CONTINGENCIES  (a)
    
    LEASES U.S. RealTel is obligated under several operating lease agreements for
office space, including switch room space in the buildings where we have
licenses to provide our services. Future annual minimum rental payments under
these leases as of December 31, 2003 are as follows: 2004
    
    
    
    
    
    
    6,400,0002005
    
    
    
    
    
    
    5,491,0002006
    
    
    
    
    
    
    3,453,0002007
    
    
    
    
    
    
    2,086,0002008
    
    
    
    
    
    
    806,000Thereafter
    
    
    
    
    
    
    1,135,000Total
    
    $
    19,371,000
 Minimum commitments under operating leases above are net of cash due to
U.S. RealTel under subleases of $1,102,000, $966,000, $537,000, $260,000,
$37,000 and $35,000 for 2004, 2005, 2006, 2007, 2008 and thereafter,
respectively. Rent expense for 2002 and 2003 was approximately $4,041,000 and $6,776,000
respectively.  (b)
    
    OBLIGATIONS UNDER LICENSE AGREEMENTS U.S. RealTel has entered into license agreements with property owners
and/or operators of several office buildings whereby U.S. RealTel has the right
to provide communications services in these buildings. Under the terms of the
agreements, U.S. RealTel is generally obligated to pay a commission based on
the greater of a base fee or a percentage of revenue earned in the related
building or development. At December 31, 2003, U.S. RealTels aggregate
minimum obligation under these agreements were as follows: 2004
    
    
    
    
    
    
    1,640,0002005
    
    
    
    
    
    
    1,024,0002006
    
    
    
    
    
    
    853,0002007
    
    
    
    
    
    
    613,0002008
    
    
    
    
    
    
    495,000Thereafter
    
    
    
    
    
    
    649,000Total
    
    $
    5,274,000
 The commitments above exclude an estimated total of $1.2 million of
potential obligations under license agreements in buildings in which U.S.
RealTels communications network has not been constructed. In the opinion of
management, such amounts will not be owed, as U.S. RealTel is not providing
services in those buildings.  (c)
    
    OBLIGATIONS UNDER COMMUNICATIONS SERVICE AGREEMENTS At December 31, 2003, U.S. RealTel had contracts with some communications
providers with minimum purchase obligations for leased voice and data transport
and other services. As of December 31, 2003, approximate future minimum
purchase commitments under these agreements were as follows: 45




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##### Table of Contents



2004
    
    
    
    
    
    $
    18,438,0002005
    
    
    
    
    
    
    9,460,0002006
    
    
    
    
    
    
    121,0002007
    
    
    
    
    
    
    2008
    
    
    
    
    
    
    Thereafter
    
    
    
    
    
    
    Total
    
    $
    28,019,000
  (d)
    
    LEGAL PROCEEDINGS U.S. RealTel is subject to legal proceedings and claims, including
employment and other matters that arise in the ordinary course of business.
Except as set forth below, there are no pending legal proceedings to which U.S.
RealTel is a party that management believes will have a material adverse effect
on the financial position, results of operations, or cash flows of U.S.
RealTel. With respect to the Companys ABN/STS acquisition referenced in Note 4, on
or about January 23, 2003, the Company filed proofs of claim in the bankruptcy
cases of WorldCom, Inc. and certain of its debtor affiliates as a result of the
Debtors defaults under that certain Asset Purchase Agreement dated May 31,
2002 by and among Intermedia Communications, Inc., Shared Technologies
Fairchild, Inc., Shared Technologies Fairfield Telecom, Inc., MCI Worldcom
Communications, Inc., Worldcom, Inc., MCI-WORLDCOM Network Services, Inc. (the
Debtors) and Cypress Communications, that certain Omnibus Post-Closing
Agreement dated July 16, 2002, by and among the Debtors and Cypress
Communications and certain other related ancillary documents (collectively the
Transaction Documents). The Company filed amendments to these proofs of
claim on January 29, 2004 to increase our claim to $13,851,689.92, which
amended proofs of claim include damages caused to us as a result of certain
fraudulent accounting practices of the Debtors (not, so far as the Company is
aware, specific to Cypress Communications) and failure to perform required
actions and other breaches of the Transaction Documents by the Debtors. As a result of the Companys communications with the Debtors, the Company
expects that they will object to these proofs of claim and most likely will
bring counterclaims against the Company alleging breaches by the Company of the
Transaction Documents. The Company expects such counterclaims may seek damages
of approximately $2.7 million, of which the Company has approximately $2.0
million currently recorded in accrued expenses. The Company cannot express an
opinion as to whether a favorable or unfavorable outcome is either probable or
remote or to estimate the range of any possible loss or gain that may result
from the settlement of these claims. An unfavorable outcome could, under
certain circumstances, result in a material adverse effect on our business,
financial condition and results of operations.  10.
    
    STOCKHOLDERS EQUITY  (a)
    
    EMPLOYEE EQUITY INCENTIVE PLAN In April 1999, the Companys Board of Directors approved a 10-year
Employee Equity Incentive Plan, subject to approval of its stockholders. The
stockholders ratified the Plan in September 1999. In March 2002, the Companys board of directors approved an amendment to
the 1999 Employee Equity Incentive Plan (the Option Plan). By this amendment,
the number of shares of common stock reserved for issuance under the Option
Plan was increased to 3,200,000 shares, subject to automatic annual adjustment
to an amount equal to 30% of our outstanding common stock on a fully diluted
basis, up to a maximum of 5,000,000. The amendment was approved by the
Companys shareholders at the Annual Meeting of Shareholders on June 26, 2002. In August 2002, the Companys board of directors approved a second
amendment to the Option Plan. By this amendment, the number of shares of common
stock reserved for issuance under the Option Plan was increased to 4,200,000
shares, subject to the existing automatic annual adjustment contained in the
Option Plan, and increasing to 1,500,000 the aggregate limit on the number of
options that may be granted to any one optionee during the term of the Option
Plan. As of December 31, 2003, after giving effect to the issuance of
additional options following adoption of the amendment, options to purchase
3,896,759 shares were outstanding under such plan. 46




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##### Table of Contents



The following table summarizes the Companys employee stock option
activity: ExercisableWeighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    ExerciseShares
    
    Price
    
    Shares
    
    PriceOutstanding at December 31, 2001
    
    
    537,388
    
    
    $
    6.87
    
    
    
    537,388
    
    
    $
    6.87-2002:Granted
    
    
    3,495,000
    
    
    $
    1.74Forfeited
    
    
    (207,500
    )
    
    $
    1.52Outstanding at December 31, 2002
    
    
    3,824,888
    
    
    $
    2.48
    
    
    
    537,388
    
    
    $
    6.872003:Granted
    
    
    487,500
    
    
    $
    1.38Forfeited
    
    
    (415,629
    )
    
    $
    3.39Outstanding at December 31, 2003
    
    
    3,896,759
    
    
    $
    2.24
    
    
    
    1,731,759
    
    
    $
    2.95
 The following table summarizes information about the stock options
outstanding at December 31, 2003: Number of
    
    WeightedOptions
    
    Average
    
    WeightedOutstanding at
    
    Remaining
    
    AverageDecember 31,
    
    Contractual
    
    Exercise
    
    Exercisable as ofExercise Price
    
    2003
    
    Life (in Years)
    
    Price
    
    December 31, 2003$1.25
    
    
    400,000
    
    
    
    9.87
    
    
    $
    1.25
    
    
    
    $1.50  $1.60
    
    
    1,650,000
    
    
    
    8.10
    
    
    $
    1.50
    
    
    
    850,000$2.00
    
    
    1,470,000
    
    
    
    8.49
    
    
    $
    2.00
    
    
    
    505,000$5.25  $6.50
    
    
    96,759
    
    
    
    0.72
    
    
    $
    5.73
    
    
    
    96,759$8.00  $10.00
    
    
    280,000
    
    
    
    1.94
    
    
    $
    8.07
    
    
    
    280,0003,896,759
    
    
    
    
    
    
    
    
    
    
    
    1,731,759
  (b)
    
    NON-CASH EQUITY TRANSACTIONS In connection with the non-cash aspects of certain issuances of common
stock, options and warrants, the Company valued warrants issued during the year
ended December 31, 2002 in connection with financing agreements at $1,181,000,
using the Black-Scholes pricing model. Warrants issued to purchase up to
850,000 shares of the Companys common stock at an exercise price of $1 per
share, were valued at $646,000, assuming: no dividend yield for all years,
expected volatility of 120 percent, risk-free interest rate of 4.75 percent and
expected life of 5 years. Warrants to purchase 400,000 shares of the Companys
common stock at an exercise price of $1.13 per share were valuated at $535,000,
assuming: no dividend yield for all years, expected volatility of 159 percent,
risk-free interest rate of 5.08 percent and expected life of 10 years. No such transactions were recorded during the year ended December 31,
2003. The $1,181,000 amount in 2002 was charged to interest expense.  (c)
    
    STOCK OPTIONS AND WARRANTS OUTSTANDING All stock options and warrants issued before 2001 are currently
exercisable. Stock options issued in 2001 vest ratably over three years, and
stock options issued in 2002 vest ratably over four years, with the exception
of 1.6 million issued to Company Executives in 2002, which vest 50% upon the
achievement by the Company of positive cash flow for 4 consecutive quarters on
a cumulative basis, 25% on the first anniversary of the vesting of the initial
50%, and 25% on the second anniversary of the vesting of the initial 50%. 47




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Certain members of the executive management of the Company were awarded
performance-based options on March 20, 2002 (the March Options) and August 6,
2002 (the August Options). The purpose of these performance-based options
was to better align executive managements compensation with growth of the
Company. Both the March Options and August Options vest (1) 50% upon the
achievement of four consecutive quarters of positive cash flow, on a cumulative
basis, as defined in the option agreements (the First Performance Date), (2)
25% upon the first anniversary of the First Performance Date, and (3) 25% on
the second anniversary of the First Performance Date. The options have a
ten-year life and were issued with an exercise price above the fair value of
the underlying stock on the date of the grant. The Company follows APB
Opinion Number 25, Accounting for Stock Issued to Employees, and,
accordingly, compensation expense for stock options is measured as the excess,
if any, of the fair value of the Companys stock at the measurement date over
the exercise price. During the second quarter of 2003, the Company achieved the cash flow
performance for the March Options and established the First Performance Date
for the March Options. Accordingly, the first 50% of the March Options vested
in accordance with the terms of the option agreement. The Company has recorded
compensation expense in the amount of $438,000 in connection with the March
Options, which includes the cost related to the 50% vested during the period
and a prorated amount for the 50% to be vested over the next two years
according to the agreement. The Company will expense the remaining
compensation cost over the vesting period. In connection with the August Options, the Company has not recorded any
stock compensation expense, as the exercise price of the performance-based
options is $2.00, which is currently in excess of the fair market value of the
stock. The stock options and warrants expire as follows: WeightedAverageYear Ending December 31, 2003
    
    Shares
    
    Exercise Price2004
    
    
    671,477
    
    
    $
    7.782005
    
    
    1,651,550
    
    
    $
    3.022006
    
    
    
    
    
    
    2007
    
    
    16,667
    
    
    $
    1.602008
    
    
    16,667
    
    
    $
    1.60Thereafter
    
    
    13,745,257
    
    
    $
    1.2716,101,618
    
    
    $
    1.72
  11.
    
    TREASURY STOCK In July 2001, the Company purchased for approximately $800,000 an
aggregate of 533,000 shares of the Companys common stock from a former Company
director and members of his family. On April 1, 2002, U.S. RealTel announced
that its Board of Directors had approved the use of up to $500,000 for
repurchase of its common stock. Under this stock repurchase program, as of
December 31, 2002, the Company had purchased 61,413 shares of the Companys
common stock at fair value for approximately $60,000. The shares were accounted
for as treasury stock and are shown separately as a deduction from the total
common stock.  12.
    
    RELATED PARTY TRANSACTIONS In February 2002, the Company entered into severance arrangements with
certain officers and employees of the Company. Under these arrangements, the
Company paid out severance of approximately $400,000 during the first quarter
of 2002. See
also Notes 8(b) and (c) for interim bridge financing and a
convertible note payable with related parties, equity securities issued to
related parties and subsequent event, respectively.  13.
    
    INCOME TAXES The benefit/(provision) for income taxes from continuing operations
consisted of the following for the years ended December 31, 2002 and 2003: 48




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2002
    
    2003Current
    
    $
    
    
    
    $Deferred
    
    
    5,573,000
    
    
    
    1,602,000Increase in valuation allowance
    
    
    (5,573,000
    )
    
    
    (1,602,000
    )Income tax benefit / (provision)
    
    $
    
    
    
    $
    
 Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of deferred tax assets and liabilities as of as of December 31, 2002
and 2003 are as follows: 2002
    
    2003Deferred tax assets:Net operating loss carryforwards
    
    $
    96,999,000
    
    
    $
    137,344,000Allowance for doubtful accounts
    
    
    411,000
    
    
    
    161,000Restructuring accrual
    
    
    8,371,000
    
    
    
    402,000Real estate access rights
    
    
    46,734,000
    
    
    
    39,520,000Property, plant & equipment
    
    
    15,395,000
    
    
    
    19,785,000Stock Based compensation
    
    
    
    
    
    
    423,000Other  Intangible assets
    
    
    339,000
    
    
    
    21,000Total deferred tax assets
    
    
    168,249,000
    
    
    $
    197,656,000Net deferred income taxes:Valuation allowance
    
    
    (168,249,000
    )
    
    
    (197,656,000
    )Net deferred income taxes
    
    $
    
    
    
    $
    
 At December 31, 2003, U.S. RealTel had available federal net operating
loss carryforwards of approximately $352 million that expire from 2012 to 2023.
The utilization of $220 million of these loss carryforwards is subject to an
annual limitation as a result of a change in ownership of U.S. RealTel, as
defined in the Internal Revenue Code. The limitation does not reduce the total
amount of net operating losses that may be taken, but rather substantially
limits the amount that may be used during a particular year. U.S. RealTel also
had various state net operating loss carryforwards that expire from 2012 to
2023. Management has recorded a total valuation allowance of approximately
$198 million against its deferred tax assets including the operating loss
carryforwards. A reconciliation of the income tax provision computed at statutory tax
rates to the income tax provision for the years ended December 31, 2002 and
2003 is as follows: 2002
    
    2003Income tax benefit at statutory rate
    
    $
    (3,998,000
    )
    
    
    (35
    )%
    
    $
    (1,438,000
    )
    
    
    (35
    )%State income taxes, net of federal
benefit
    
    
    (456,000
    )
    
    
    (4
    )%
    
    
    (164,000
    )
    
    
    (4
    )%Other
    
    
    (1,119,000
    )
    
    
    1.85
    %
    
    
    
    
    
    
    
    %Increase in valuation allowance
    
    
    5,573,000
    
    
    
    40.85
    %
    
    
    1,602,000
    
    
    
    39
    %Income tax benefit (provision)
    
    
    
    
    
    
    
    %
    
    
    
    
    
    
    
    %
 49




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14.
    
    QUARTER-BY-QUARTER COMPARISON (UNAUDITED) First
    
    Second
    
    Third
    
    Fourth2002Operating revenues
    
    $
    3,234,000
    
    
    $
    4,938,000
    
    
    $
    20,515,000
    
    
    $
    23,030,000Gain (loss) from Continuing Operations
    
    
    (6,381,000
    )
    
    
    (3,175,000
    )
    
    
    (2,056,000
    ))
    
    
    68,000Discontinued Operations
    
    
    2,104,000
    
    
    
    (68,000
    )
    
    
    (2,000
    )
    
    
    (2,000
    )Extraordinary item
    
    
    8,186,000
    
    
    
    (746,000
    )
    
    
    
    
    
    
    343,000Net Income (Loss)
    
    
    3,909,000
    
    
    
    (3,989,000
    )
    
    
    (2,058,000
    )
    
    
    409,000Per common
share Basic and Diluted
Operating revenues
    
    
    0.50
    
    
    
    0.84
    
    
    
    3.49
    
    
    
    3.92Income (loss) from Continuing Operations
    
    
    (0.99
    )
    
    
    (0.54
    )
    
    
    (0.35
    )
    
    
    0.01Discontinued Operations
    
    
    0.33
    
    
    
    (0.01
    )
    
    
    (0.00
    )
    
    
    (0.00
    )Extraordinary item
    
    
    1.27
    
    
    
    (0.13
    )
    
    
    
    
    
    
    0.06Net Income (Loss)
    
    
    0.60
    
    
    
    (0.68
    )
    
    
    (0.35
    )
    
    
    0.07Weighted Average Common Shares
Outstanding
    
    
    6,462,000
    
    
    
    5,891,000
    
    
    
    5,874,000
    
    
    
    5,874,000
 First
    
    Second
    
    Third
    
    Fourth2003Operating revenues
    
    $
    21,964,000
    
    
    $
    21,808,000
    
    
    $
    21,046,000
    
    
    $
    19,808,000Loss from Continuing Operations
    
    
    (1,148,000
    )
    
    
    (56,000
    )
    
    
    (1,830,000
    ))
    
    
    (1,129,000
    )Discontinued Operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Extraordinary item
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Income (Loss)
    
    
    (1,148,000
    )
    
    
    (56,000
    )
    
    
    (1,830,000
    )
    
    
    (1,129,000
    )Per common
share Basic and Diluted
Operating revenues
    
    
    3.69
    
    
    
    3.71
    
    
    
    3.58
    
    
    
    3.37Loss from Continuing Operations
    
    
    (0.20
    )
    
    
    (0.01
    )
    
    
    (0.31
    )
    
    
    (0.19
    )Discontinued Operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Extraordinary item
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Income (Loss)
    
    
    (0.20
    )
    
    
    (0.01
    )
    
    
    (0.31
    )
    
    
    (0.19
    )Weighted Average Common Shares
Outstanding
    
    
    5,874,000
    
    
    
    5,874,000
    
    
    
    5,874,000
    
    
    
    5,874,000
 50




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Independent Auditors Report Cypress Communications, Inc. We have audited the accompanying consolidated statements of operations, changes
in stockholders equity and cash flows of Cypress Communications, Inc. and
subsidiaries for the one-month period from January 1, 2002 to January 31, 2002.
These consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of its operations and cash flows
for the one-month period from January 1, 2002 to January 31, 2002, in
conformity with accounting principles generally accepted in the United States
of America. /s/ Deloitte & Touche, LLP
 Atlanta, Georgia
April 1, 2003 51




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CYPRESS COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS FOR THE ONE-MONTH PERIOD FROM JANUARY 1, 2002 TO JANUARY 31, 2002 REVENUES
    
    $
    1,565,000DIRECT COSTS
    
    
    1,318,000REVENUES  NET OF DIRECT COSTS
    
    
    247,000OPERATING EXPENSESSales and Marketing
    
    
    270,000General and administrative
    
    
    7,770,000TOTAL OPERATING EXPENSES
    
    
    8,020,000Loss from continuing operations
    
    
    (7,773,000
    )OTHER INCOME (EXPENSE)Interest income
    
    
    85,000Interest expense
    
    
    (17,000
    )TOTAL OTHER INCOME (EXPENSE)  NET
    
    
    68,000Loss before income taxes
    
    
    (7,705,000
    )Income tax
    
    
    Net Loss
    
    $
    (7,705,000
    )
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 52




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CYPRESS COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY FOR THE ONE-MONTH PERIOD FROM JANUARY 1, 2002 TO JANUARY 31, 2002 Additional
    
    
    
    
    
    OtherPaid-In
    
    Deferred
    
    Comprehensive
    
    Accumulated
    
    Stockholders
    
    ComprehensiveShares
    
    
    
    
    
    Capital
    
    Compensation
    
    Income (Loss)
    
    Deficit
    
    Equity
    
    LossBALANCE, January 1, 2002
    
    
    4,926,000
    
    
    $
    6,000
    
    
    $
    569,827,000
    
    
    $
    (6,312,000
    )
    
    $
    (47,000
    )
    
    $
    (508,739,000
    )
    
    $
    54,735,000
    
    
    $
    Write-off of deferred
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,312,000
    
    
    
    
    
    
    
    
    
    
    
    6,312,000
    
    
    
    Unrealized loss on
short-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (31,000
    )
    
    
    
    
    
    
    (31,000
    )
    
    
    (31,000
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,705,000
    )
    
    
    (7,705,000
    )
    
    
    (7,705,000
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (7,736,000
    )BALANCE, January 31, 2002
    
    
    4,926,000
    
    
    $
    6,000
    
    
    $
    569,827,000
    
    
    $
    
    
    
    $
    (78,000
    )
    
    $
    (516,444,000
    )
    
    $
    54,735,000
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 53




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CYPRESS COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE ONE-MONTH PERIOD FROM JANUARY 1, 2002 TO JANUARY 31, 2002 CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (7,705,000
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    321,000Write-off of deferred compensation
    
    
    6,312,000Bad debt expense
    
    
    8,000Other non cash item
    
    
    (31,000
    )Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (89,000
    )Prepaid expenses and other current assets
    
    
    (831,000
    )Other assets
    
    
    780,000Accounts payable and accrued expenses
    
    
    (908,000
    )Deferred revenues
    
    
    282,000Net cash used in operating activities
    
    
    (1,855,000
    )CASH FLOWS FROM INVESTING ACTIVITIES:Sale of property and equipment
    
    
    8,000Net cash provided by investing activities
    
    
    8,000CASH FLOWS FROM FINANCING ACTIVITIES:Principal payments on capital lease obligations
    
    
    Net cash used in financing activities
    
    
    DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (1,847,000
    )CASH AND CASH EQUIVALENTS, BEGINNING OF MONTH
    
    
    33,757,000CASH AND CASH EQUIVALENTS, END OF MONTH
    
    $
    33,910,000SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest
    
    $
    17,000
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 54




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CYPRESS COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE ONE-MONTH PERIOD FROM JANUARY 1, 2002 TO JANUARY 31, 2002  1.
    
    ORGANIZATION AND NATURE OF BUSINESS Cypress Communications, Inc. and its subsidiaries (Cypress
Communications or the Company) provide a full range of communications
services to businesses in multi-tenant office buildings located in select major
metropolitan markets within the United States. In February 2002, the Company
was acquired by U.S. Realtel, Inc. (U.S. Realtel). The Companys
communications services include high speed Internet access and data services,
local and long-distance voice services, feature-rich digital telephone systems,
digital satellite business television, voicemail, e-mail, web site hosting,
security/monitoring services, and other advanced communications services. The
Company delivers these services over state-of-the-art fiber optic, digital, and
broadband networks that Cypress Communications designs, constructs, owns, and
operates inside large- and medium-sized office buildings.  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying financial statements are presented on the accrual basis
of accounting using accounting principles generally accepted in the United
States. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company
and its subsidiaries, all of which are wholly owned. All significant
intercompany transactions and balances have been eliminated in consolidation. ACCOUNTING ESTIMATES The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the dates of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual amounts could differ from these estimates,
and such differences could be material. REVENUE RECOGNITION The Companys revenues include recurring charges for local access,
long-distance, equipment rental, Internet access, digital satellite business
television, voicemail, inbound 800, and other enhanced voice and data services,
which are recognized as services are provided. Revenues also include
nonrecurring charges for installations and moves, adds, and changes.
Installation fees represent the initial cost charged by Cypress Communications
for installing voice phone lines, data lines, and Business TV in the tenants
premises. Move, add, and change (MAC) charges are for the Companys labor and
materials related to moving, adding, or changing a customers services.
Installation and certain MAC charges are recognized when the services are
provided as they represent separate earnings process. Other MAC charges, which
are not separate earnings process, are generally deferred and amortized over 24
months. CASH AND CASH EQUIVALENTS The Company considers all highly liquid instruments with an original
maturity of three months or less to be cash equivalents. 55




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PROPERTY AND EQUIPMENT Depreciation is computed using the straight-line method over the estimated
useful lives of the assets (generally three to seven years). Leasehold
improvements are depreciated over the lesser of the average lease term (or the
term of the related license agreement) or the assets useful lives.
Depreciation expense was $321,000 for the one-month period ended January 31,
2002. Maintenance and repairs are charged to expense as incurred. Gains or
losses on disposal of property and equipment are recognized in operations in
the year of disposition. DEFERRED COMPENSATION Deferred compensation has been expensed in the one-month period ended
January 31, 2002 due to the acceleration of vesting provision of the underlying
equity instrument in connection with the acquisition by U.S. RealTel, Inc.
(note 5). SEGMENT REPORTING The Company provides an integrated package of communication products to
small- and medium-sized businesses and manages its business on an integrated
basis. RECENT ACCOUNTING PRONOUNCEMENTS In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements
SFAS 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
corrections. This Statement rescinded Statement No. 4, Reporting Gains and
Losses from Extinguishments of Debt, and an amendment of that Statement, FASB
Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements. This Statement also rescinded FASB Statement No. 44, Accounting
for Intangible Assets of Motor Carriers. This Statement amended FASB Statement
No. 13, Accounting for Leases, to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. This Statement also amended other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The
provision of this Statement related to the rescission of Statement No. 4 must
be applied in fiscal year beginning after May 15, 2002. The provisions of this
Statement related to Statement 13 will be applicable for transactions occurring
after May 15, 2002. Early application of the provisions of this Statement is
encouraged. The Company does not expect the adoption of SFAS 145 will have a
significant impact on its consolidated results of operations, financial
position or cash flows. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires the
recording of costs associated with exit or disposal activities at their fair
values when a liability has been incurred. Under previous guidance, certain
exit costs were accrued upon managements commitment to an exit plan, which is
generally before an actual liability has been incurred. SFAS No. 146 is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. The Company does not expect the adoption of SFAS 146 will have a
significant impact on its consolidated results of operations, financial
position or cash flows. In November 2002, the FASB issued Interpretation (FIN) No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantors, Including Indirect
Guarantees of Indebtedness of Others. FIN No. 45 requires that upon issuance of
a guarantee, the guarantor must recognize a liability for the fair value of the
obligation it assumes under the guarantee. Guarantors will also be required to
meet expanded disclosure obligations. The initial recognition and measurement
provisions of FIN No. 45 are effective for guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for annual and
interim financial statements that end after December 15, 2002. The Company does
not believe the adoption of FIN 45 will have a material impact on its
consolidated financial statements. 56




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3.
    
    COMMITMENTS AND CONTINGENCIES LEASES The Company is obligated under several operating and capital lease
agreements, primarily for office space and equipment. Future annual minimum
rental payments assumed on December 31 year-end under these leases as of
January 31, 2002 are as follows: Operating
    
    Capital2002
    
    
    2,756,000
    
    
    $
    473,0002003
    
    
    3,124,000
    
    
    
    327,0002004
    
    
    3,224,000
    
    
    
    25,0002005
    
    
    2,836,000
    
    
    
    16,0002006
    
    
    1,662,000
    
    
    
    0Thereafter
    
    
    903,000
    
    
    
    0Total
    
    
    14,505,000
    
    
    
    841,000Less amount representing interest and taxes
    
    
    
    
    
    
    97,000Present value of future minimum capital lease payments
    
    
    
    
    
    
    744,000Less current portion
    
    
    
    
    
    
    (409,000
    )Long-term portion
    
    
    
    
    
    $
    335,000
 Minimum commitments under operating leases above are net of cash due to
the Company under subleases of $1,023,000, $ 772,000, $521,000, $438,000,
$38,000, and $5,000 for 2002, 2003, 2004, 2005, 2006, and thereafter,
respectively. Rental expense was $ ,000 for the one month period ended
January 31, 2002. Obligations Under License Agreements The Company has entered into license agreements with property owners
and/or operators of several office buildings whereby the Company has the right
to provide communications services in these buildings. Under the terms of the
agreements, the Company is generally obligated to pay a commission based on the
greater of a base fee or a percentage of revenue earned in the related building
or development. At January 31, 2001, the Companys aggregate minimum obligation
under these agreements, assuming a December 31 year-end, were as follows: 2002
    
    $
    1,072,0002003
    
    
    1,164,0002004
    
    
    1,147,0002005
    
    
    539,0002006
    
    
    316,000Thereafter
    
    
    862,000$
    5,100,000
 The commitments above exclude an estimated total of $2.4 million of
potential obligations under license agreements in buildings in which the
Companys communications network has not been constructed. In the opinion of
management, such amounts will not be owed as the Company is not providing
services in those buildings. 57




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OBLIGATIONS UNDER COMMUNICATIONS SERVICE AGREEMENTS At January 31, 2002, the Company had contracts with several communications
providers with minimum purchase obligations for leased voice and data
transport, equipment collocation, and other services. As of January 31, 2001,
approximate future minimum purchase commitments, assuming a December 31
year-end, under these agreements were as follows: 2002
    
    $
    1,933,0002003
    
    
    309,0002004
    
    
    189,0002005
    
    
    66,0002006
    
    
    4,000Thereafter
    
    
    9,000$
    2,510,000
 LEGAL PROCEEDINGS The Company is subject to legal proceedings and claims, including
employment and other matters that arise in the ordinary course of business.
There are no pending legal proceedings to which the Company is a party that
management believes will have a material adverse effect on the financial
position, results of operations, or cash flows of the Company.  4.
    
    INCOME TAXES The Company has estimated net operating loss carryforwards of
approximately $222 million. The net operating loss carryforwards begin to
expire in the year 2017 if not previously utilized. Additionally, use of the
Companys net operating losses is limited due to certain ownership changes as
defined in Section 382 of the Internal Revenue Code. Utilization of existing
net operating loss carryforward may be further limited in future years as a
result of the purchase by U.S. Realtel (Note 5).  5.
    
    SUBSEQUENT EVENTS ACQUISITION OF THE COMPANY In January 2002, the Company entered into a definitive agreement providing
for the sale of the Company to U.S. RealTel. Pursuant to the agreement, U.S.
RealTel initiated a tender offer for all the outstanding shares of common stock
of the Company, including the associated rights to purchase preferred stock, at
$3.50 per share net to the seller, in cash. The transaction, which was subject
to 90% of the shares outstanding being tendered and not withdrawn, as well as
other customary and legal closing conditions, was completed on February 25,
2002 with approximately 94% of the shares tendered for cash payments of
approximately $15 million. The acquisition of the remaining shares was
completed immediately after the closing of the tender through the short-form
merger of a wholly owned subsidiary of U.S. RealTel with and into the Company,
with Cypress Communications surviving as a wholly owned subsidiary of U.S.
RealTel. The merger agreement provided that at the date of closing, each
then-outstanding option to purchase shares of Cypress Communications common
stock under any option plan, program or arrangement of Cypress Communications
(Option), whether or not such Option is then exercisable or vested, was
converted into an obligation of Cypress Communications to pay to the option
holder a cash amount equal to the product of (i) the excess, if any, of the
offer price over the applicable per share exercise price of such Option and
(ii) the number of shares subject to such Option. In connection with the merger and resulting change of control, the Company
paid out severance of $400,000 to the Companys former CEO under a severance
and separation arrangements that existed at December 31, 2001. Additionally, in
February 2002, the Company entered into severance arrangements with certain
other officers and employees of the Company. Under these arrangements, the
Company paid out severance of approximately $400,000 upon the change of control
resulting from the acquisition of the Company by U.S. Realtel. 58




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ITEM 8. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE None. 
 ITEM 8A. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures Pursuant to Rule
13a-15(b) under the Securities Exchange Act of 1934, as amended (the Exchange
Act), U.S. RealTel carried out an evaluation, with the participation of U.S.
RealTels management, including U.S. RealTels Chief Executive Officer and
Chief Financial Officer, of the effectiveness of U.S. RealTels disclosure
controls and procedures (as defined under Rule 13a-15(e) under the Exchange
Act) as of the end of the period covered by this report. Based upon that
evaluation, U.S. RealTels Chief Executive Officer and Chief Financial Officer
concluded that U.S. RealTels disclosure controls and procedures are effective
in timely alerting them to material information relating to U.S. RealTel
(including its consolidated subsidiaries) required to be included in U.S.
RealTels periodic filings with the SEC. (b) Changes in internal controls There has been no change in U.S.
RealTels internal control over financial reporting during the quarter ended
December 31, 2003 that has materially affected, or is reasonably likely to
materially affect, U.S. RealTels internal control over financial reporting. 
 PART III 
 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Directors and Executive Officers  We incorporate herein by reference the
information concerning our directors and executive officers contained in our
Proxy Statement for our 2004 Stockholders Meeting to be filed within 120 days
after the end of our fiscal year (the 2004 Proxy Statement) or in a
subsequent amendment to this report. Section 16(a) Beneficial Ownership Reporting Compliance  We incorporate
herein by reference the information concerning Section 16(a) beneficial
ownership reporting compliance contained in our 2004 Proxy Statement or in a
subsequent amendment to this report. Code of Ethics  We incorporate herein by reference the information
concerning our code of ethics contained in our 2004 Proxy Statement or in a
subsequent amendment to this report. 
 ITEM 10. EXECUTIVE COMPENSATION We incorporate herein by reference the information concerning executive
compensation contained in our 2004 Proxy Statement or in a subsequent amendment
to this report. 
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS We incorporate herein by reference the information concerning security
ownership of certain of our beneficial owners and our management and related
stockholder matters contained in our 2004 Proxy Statement or in a subsequent
amendment to this report. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We incorporate herein by reference the information concerning certain
relationships and related transactions contained in our 2004 Proxy Statement or
in a subsequent amendment to this report. 59




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ITEM 13. EXHIBIT LIST AND REPORTS ON FORM 8-K (a) Exhibits EXHIBITS
    
    DESCRIPTION2.1
    
    Form of Certificate of Merger (1)2.2
    
    Plan and Agreement of Merger (1)2.3
    
    Agreement and Plan of Merger, dated January 10, 2002 by and among Cypress Communications, Inc., U.S.
RealTel, Inc. and Cypress Merger Sub, Inc. (2)2.3.1
    
    Amendment No. 1 to the Merger Agreement, dated January 17, 2002 (2)3.1
    
    Certificate of Incorporation (1)3.2
    
    Bylaws (3)4.1
    
    Form of Common Stock Certificate (1)4.2
    
    Registration Rights Agreement dated October 2, 1998 (1)4.2.1
    
    Amendment dated September 24, 1999 to Registration Rights Agreement dated October 2, 1998 (1)4.3
    
    Registration Rights Agreement, dated July 16, 2002, by and among U.S. RealTel, Inc. and the purchasers
listed therein*4.4
    
    Intercreditor (Subordination) Agreement, dated July 16, 2002, J. Oliver Cunningham Trust dated February
26, 1971, the Anne C. McClure Trust dated February 26, 1971, the Jane C. Warriner Trust dated February
26, 1971, Noro-Moseley Partners V, L.P., Wakefield Group III and the Noteholders signatories thereto*10.1
    
    Employment Agreement dated as of February 21, 2002 between Cypress Communications, Inc. and Gregory P.
McGraw (4)10.2
    
    Employment Agreement dated as of November 1, 2003 between Cypress Communications and Neal L. Miller*10.3
    
    1999 Employee Equity Incentive Plan (1)10.3.1
    
    First Amendment to U.S. RealTels 1999 Employee Equity Incentive Plan (5)10.3.2
    
    Second Amendment to U.S. RealTels 1999 Employee Equity Incentive Plan (6)10.4
    
    Asset Purchase Agreement dated as of October 18, 2000 between U.S. RealTel and Apex Site
Management, Inc. (7)10.5
    
    Stock Purchase Agreement dated
July 26, 2001 between U.S. RealTel and Craig M. Siegler (8)10.6
    
    Loan and Security Agreement dated July 12, 2002 between Cypress Communications, Inc. and Silicon Valley
Bank (9)10.7
    
    Asset Purchase Agreement, dated May 31, 2002 by and among Intermedia Communications, Inc., Shared
Technologies Fairchild, Inc., Share Technologies Fairchild Telcom, Inc., MCI Worldcom Communications,
Inc., Worldcom, Inc. and Cypress Communications, Inc. (10)10.8.1
    
    Amendment No. 1 to Asset Purchase Agreement and Waiver, dated July 17, 2002, by and among Intermedia
Communications, Inc., Shared Technologies Fairchild, Inc., Share Technologies Fairchild Telcom, Inc.,
MCI Worldcom Communications, Inc., Worldcom, Inc. and Cypress Communications, Inc. (10)10.9
    
    Omnibus Post-Closing Agreement, dated July 17, 2002, by and among Intermedia Communications, Inc.,
Shared Technologies Fairchild, Inc., Share Technologies Fairchild Telcom, Inc., MCI Worldcom
Communications, Inc., Worldcom, Inc. and Cypress Communications, Inc. (10)10.10
    
    Loan Agreement, dated as of July 16, 2002, by and among J. Oliver Cunningham Trust dated February 26,
1971, the Anne C. McClure Trust dated February 26, 1971, the Jane C. Warriner Trust dated February 26,
1971, Noro-Moseley Partners V, L.P., Wakefield Group III, LLC, U.S. RealTel, Inc. and Cypress
Communications, Inc.*10.11
    
    First Amendment to the Loan
Agreement, dated March 25, 2004, by and among J. Oliver Cunningham Trust
dated February 26, 1971, the Anne C. McClure Trust dated February 26, 1971, the Jane C. Warriner Trust
dated February 26, 1971, Noro-Moseley Partners V, L.P., Wakefield Group III, LLC, U.S. RealTel, Inc. and
Cypress Communications, Inc. *10.12
    
    Purchase Agreement, dated July 16, 2002, by and among U.S. RealTel, Inc. and the parties listed therein *21.1
    
    List of U.S. RealTels
Subsidiaries (6)31.1
    
    Certificate of Gregory P. McGraw,
Acting Chief Executive Officer pursuant to Rule 13a-14(a)*31.2
    
    Certificate of Neal L. Miller, Executive Vice President and Chief Financial Officer pursuant to Rule
13a-14(a)*32.1
    
    Certificate of Gregory P. McGraw, Acting Chief Executive Officer pursuant to 18 U.S.C., Section 1350, as
adopted pursuant to Section 906 of the Sarbanes Oxley Act of
2002*32.2
    
    Certificate of Neal L. Miller, Executive Vice President and Chief Financial Officer pursuant to 18
U.S.C., Section 1350, as adopted pursuant to Section 906 of
the Sarbanes Oxley Act of 2002*
  *
    
    Filed herewith  (1)
    
    Incorporated by reference to U.S. RealTels Registration Statement on
Form 10-SB (Registration No. 000-30401).  (2)
    
    Incorporated by reference to U.S. RealTels Schedule TO filed on January
22, 2002.  (3)
    
    Incorporated by reference to U.S. RealTels Form 10-QSB filed on August
14, 2002. 60




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(4)
    
    Incorporated by reference to U.S. RealTels Form 10-KSB filed April 16,
2003.(5)
    
    Incorporated by reference to U.S. RealTels Definitive Information
Statement on Schedule 14C filed May 21, 2002.(6)
    
    Incorporated by reference to U.S. RealTels Form 10-KSB filed on April 7,
2003.(7)
    
    Incorporated by reference to U.S. RealTels Definitive Information
Statement on Schedule 14C filed November 7, 2000.(8)
    
    Incorporated by reference to U.S. RealTels Form 10-QSB filed on November
14, 2001.(9)
    
    Incorporated by reference to U.S. RealTels Form 8-K filed on July 31,
2002.(10)
    
    Incorporated by reference to U.S. RealTels Form 8-K filed on July 31,
2002.  (b)
    
    Reports on Form 8-K:None 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES We incorporate herein by reference the information concerning principal
accounting fees and services and the audit committees pre-approval policies
and procedures contained in our 2004 Proxy Statement or in a subsequent
amendment to this report. 61




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##### Table of Contents



SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the
Company caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on March 30, 2004. U.S. REALTEL, INC.Dated: March 30, 2004
    
    By:
    
    /s/ Gregory P. McGraw

Gregory P. McGraw
Acting Chief Executive Officer, President and
Chief Operating OfficerDated: March 30, 2004
    
    By:
    
    /s/ Neal L. Miller

Neal L. Miller
Executive Vice President and Chief Executive
Officer
 POWER OF ATTORNEY Each person whose signature appears below on this Annual Report on Form
10-KSB hereby constitutes and appoints Gregory P. McGraw and Neal L. Miller,
and each of them, his true and lawful attorney-in-fact, acting alone, with full
powers of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities (until revoked in writing), to sign any or all
amendments to this Annual Report on Form 10-KSB of U.S. RealTel, Inc., and to
file the same, with exhibits thereto, and other documents to be filed in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that said attorney-in-fact or his substitute,
acting alone, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated. SIGNATURE
    
    TITLE
    
    DATE/s/ Gregory P. McGraw

Gregory P. McGraw
    
    Acting Chief Executive Officer, President
and Chief Operating Officer
    
    March 30, 2004/s/ Neal L. Miller

Neal L. Miller
    
    Executive Vice President and Chief Financial Officer
    
    March 30, 2004/s/ Ross J. Mangano

Ross J. Mangano
    
    Director
(Non-Executive Chairman of the Board)
    
    March 30, 2004/s/ Steve G. Nussrallah

Steve G. Nussrallah
    
    Director
    
    March 30, 2004/s/ Michael F. Elliott

Michael F. Elliott
    
    Director
    
    March 30, 2004/s/ Gerard H. Sweeney

Gerard H. Sweeney
    
    Director
    
    March 30, 2004
 62