##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 Commission file number: 0-30900 XO Communications, Inc. (Exact name of registrant as specified in its charter) Delaware
   
    54-1983517(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification no.)
 11111 Sunset Hills Road
Reston, Virginia 20190
(Address of principal executive offices, including zip code)
(703) 547-2000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [ X ] NO [  ] Indicate by check mark whether the Registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). YES [X] NO [  ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES [X] NO [  ] As of November 6, 2004, the number of shares of common stock of XO
Communications, Inc. issued and outstanding was 181,933,035 and the number of
shares of 6% Class A Convertible Preferred Stock of XO Communications, Inc.
issued and outstanding was 4,000,000.




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##### 



XO Communications, Inc. and Subsidiaries
Index to Form 10-Q PagePart I. Financial InformationItem 1. XO Communications, Inc. and Subsidiaries Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003
    
    
    1Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2004 and September 30, 2003 (unaudited)
    
    
    2Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 2004 and September 30, 2003 (unaudited)
    
    
    3Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and September 30, 2003 (unaudited)
    
    
    4Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
        15Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
        28Item 4. Controls and Procedures
    
    
        28Part II. Other InformationItem 1. Legal Proceedings
    
    
        29Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
        29Item 3. Defaults Upon Securities
    
    
        29Item 4. Submission of Matters to a Vote of Security Holders
    
    
        29Item 5. Other Information
    
    
        29Item 6. Exhibits
    
    
        29Signatures
    
    
        30Certifications
 i




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PART I. FINANCIAL INFORMATION


     Item 1. Financial Statements XO Communications, Inc. and Subsidiaries Condensed Consolidated Balance Sheets
 (Amounts in thousands, except for share and per share data)
 September 30,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    237,388
    
    
    $
    478,560Marketable and other securities
    
    
    16,845
    
    
    
    42,052Accounts receivable, net of allowance for doubtful accounts of $43,382 at
September 30, 2004 and $32,986, at December 31, 2003, respectively
    
    
    168,041
    
    
    
    93,958Other current assets
    
    
    55,913
    
    
    
    12,421Total current assets
    
    
    478,187
    
    
    
    626,991Property and equipment, net
    
    
    848,897
    
    
    
    485,984Broadband wireless licenses and other intangibles, net
    
    
    152,342
    
    
    
    109,515Goodwill
    
    
    213,891
    
    
    
    Other assets, net
    
    
    59,056
    
    
    
    42,675Total assets
    
    $
    1,752,373
    
    
    $
    1,265,165LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    93,834
    
    
    $
    63,064Accrued liabilities
    
    
        253,616
    
    
    
    208,353Total current liabilities
    
    
        347,450
    
    
    
    271,417Long-term debt and accrued interest payable
    
    
    358,925
    
    
    
    536,791Other long-term liabilities
    
    
    86,472
    
    
    
    76,532Total liabilities
    
    
        792,847
    
    
    
    884,740Class A convertible preferred stock
    
    
    201,266
    
    
    
    Commitments and contingenciesStockholders equity:Preferred stock, par value $0.01 per share, 200,000,000 shares authorized:4,000,000 shares of Class A convertible preferred stock issued and
outstanding on September 30, 2004
    
    
    
    
    
    
    Warrants and common stock, par value $0.01 per share, 1,000,000,000 shares
authorized: 181,933,035 and 96,274,140 shares issued and outstanding on
September 30, 2004 and December 31, 2003, respectively
    
    
    992,583
    
    
    
    482,440Subscription rights exercised, 32,503,234 shares authorized: none issued
and outstanding
    
    
    
    
    
    
    162,516Subscription rights receivable, 32,503,234 shares authorized: none issued
and outstanding
    
    
    
    
    
    
    (162,516
    )Deferred compensation
    
    
    (664
    )
    
    
    (839
    )Accumulated other comprehensive income
    
    
    2,989
    
    
    
    1,378Accumulated deficit
    
    
        (236,648
    )
    
    
    (102,554
    )Total stockholders equity
    
    
        758,260
    
    
    
    380,425Total liabilities, convertible preferred stock and stockholders equity.
    
    $
    1,752,373
    
    
    $
    1,265,165
 See accompanying notes to the unaudited condensed consolidated financial statements. 1




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XO Communications, Inc. and Subsidiaries Condensed Consolidated Statements of Operations
 (Amounts in thousands, except for share and per share data)
 (Unaudited)
 Three months ended
    
    Three months endedSeptember 30,
    
    September 30,2004
    
    2003Revenue
    
    $
    391,885
    
    
    $
    279,433Costs and expenses:Cost of service
    
    
    161,946
    
    
    
    106,935Selling, operating, and general
    
    
    209,427
    
    
    
    179,988Depreciation and amortization
    
    
    56,739
    
    
    
    28,388Total costs and expenses
    
    
    428,112
    
    
    
    315,311Loss from operations
    
    
    (36,227
    )
    
    
    (35,878
    )Investment income, net
    
    
    1,041
    
    
    
    980Interest expense, net
    
    
    (6,593
    )
    
    
    (5,889
    )Net loss
    
    
    (41,779
    )
    
    
    (40,787
    )Preferred stock accretion
    
    
    (1,839
    )
    
    
    Net loss applicable to common shares
    
    $
    (43,618
    )
    
    $
    (40,787
    )Net loss per common share, basic and diluted
    
    $
    (0.24
    )
    
    $
    (0.42
    )Weighted average shares, basic and diluted
    
    
    181,933,035
    
    
    
    96,019,526
 See accompanying notes to the unaudited condensed consolidated financial statements. 2




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XO Communications, Inc. and Subsidiaries Condensed Consolidated Statements of Operations
 (Amounts in thousands, except for share and per share data)
 (Unaudited)
 Nine Months ended
    
    Nine Months endedSeptember 30,
    
    September 30,2004
    
    2003Revenue
    
    $
    931,013
    
    
    $
    849,443Costs and expenses:Cost of service
    
    
    390,729
    
    
    
    319,339Selling, operating, and general
    
    
    542,129
    
    
    
    511,264Depreciation and amortization
    
    
    112,501
    
    
    
    81,993Total costs and expenses
    
    
    1,045,359
    
    
    
    912,596Loss from operations
    
    
    (114,346
    )
    
    
    (63,153
    )Investment income (loss), net
    
    
    (704
    )
    
    
    9,301Interest expense, net
    
    
    (19,044
    )
    
    
    (27,259
    )Net loss
    
    
    (134,094
    )
    
    
    (81,111
    )Preferred stock accretion
    
    
    (1,839
    )
    
    
    Net loss applicable to common shares
    
    $
    (135,933
    )
    
    $
    (81,111
    )Net loss per common share, basic and diluted
    
    $
    (0.89
    )
    
    $
    (0.85
    )Weighted average shares, basic and diluted
    
    
    152,479,324
    
    
    
    95,411,819
 See accompanying notes to the unaudited condensed consolidated financial statements. 3




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XO Communications, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows
 (Amounts in thousands)
 (Unaudited)
 Nine Months ended
    
    Nine Months endedSeptember 30,
    
    September 30,2004
    
    2003OPERATING ACTIVITIES:Net loss
    
    $
    (134,094
    )
    
    $
    (81,111
    )Adjustments to reconcile net loss to net cash (used
in) provided by operating activities:Depreciation and amortization
    
    
    112,501
    
    
    
    81,993Accrual of interest
    
    
    19,746
    
    
    
    26,824Stock-based compensation
    
    
    316
    
    
    
    447Realized loss on sale of investments
    
    
    5,632
    
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    (26,024
    )
    
    
    7,923Other assets
    
    
    (14,921
    )
    
    
    17,089Accounts payable
    
    
        10,932
    
    
    
    (4,948
    )Accrued liabilities
    
    
        (3,260
    )
    
    
    (9,189
    )Net cash (used in) provided by operating activities
    
    
        (29,172
    )
    
    
    39,028INVESTING ACTIVITIES:Capital expenditures, net
    
    
    (72,756
    )
    
    
    (59,606
    )Cash paid for acquired businesses
    
    
    (324,698
    )
    
    
    Sales of marketable securities and investments
    
    
    21,186
    
    
    
    314,460Purchases of marketable securities and investments
    
    
    (36,413
    )
    
    
    (251,030
    )Net cash (used in) provided by investing activities
    
    
    (412,681
    )
    
    
    3,824FINANCING ACTIVITIES:Repayments of long term debt and capital leases
    
    
    (199,072
    )
    
    
    (895
    )Proceeds from issuance of common stock, net
    
    
    197,612
    
    
    
    Proceeds from issuance of preferred stock, net
    
    
        199,427
    
    
    
    Proceeds from exercise of stock options
    
    
    2,714
    
    
    
    5,624Net cash provided by financing activities
    
    
        200,681
    
    
    
    4,729Net (decrease) increase in cash and cash equivalents
    
    
    (241,172
    )
    
    
    47,581Cash and cash equivalents, beginning of period
    
    
    478,560
    
    
    
    314,038Cash and cash equivalents, end of period
    
    $
    237,388
    
    
    $
    361,619SUPPLEMENTAL DATA:Cash paid for interest
    
    $
    1,798
    
    
    $
    1,843Stock issued for acquired businesses
    
    $
    311,307
    
    
    $
    Assets and obligations acquired through capital lease
    
    $
    2,765
    
    
    $
    
 See accompanying notes to the unaudited condensed consolidated financial statements. 4




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XO Communications, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements
 (Unaudited)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The condensed consolidated financial statements of XO Communications, Inc.
and its subsidiaries (together with its predecessors, collectively referred to
as the Company or XO) are unaudited and have been prepared in accordance
with guidelines established for interim financial statements by the Securities
and Exchange Commissions (the Commission) instructions to Form 10-Q and U.S.
generally accepted accounting principles. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles in the United States for complete financial statements. On June 23,
2004, XO completed the acquisition of all the local exchange carrier businesses
of Allegiance Telecom, Inc. The accompanying financial statements include the
results of operations from this acquisition since June 23, 2004. See note 2 for
additional information. Operating results for the three and nine months ended September 30, 2004
are not necessarily indicative of the results that may be expected for any
subsequent quarterly period, or for the year ending December 31, 2004. In the
opinion of management, the unaudited condensed consolidated financial
statements contain all the adjustments (consisting of those of a normal
recurring nature) considered necessary to present fairly the financial position
and the results of operations and cash flows for the periods presented in
conformity with accounting principles generally accepted in the United States
applicable to interim periods. The accompanying financial statements should be
read in conjunction with the audited consolidated financial statements of XO
included in its Annual Report on Form 10-K for the year ended December 31, 2003
(the 2003 Annual Report). XO emerged from bankruptcy on January 17, 2003 and applied Fresh Start
Accounting as of January 1, 2003. As a result of the reorganization, XO
recognized a gain of approximately $3.0 billion. The operations of the
predecessor XO, which includes the reorganized gain, has not been presented as
it is not comparative. (b) Principles of Consolidation The Companys consolidated financial statements include all of the assets,
liabilities and results of operations of subsidiaries in which the Company has
a controlling interest. All inter-company accounts and transactions among
consolidated entities have been eliminated. (c) Use of Estimates and Assumptions The preparation of consolidated 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 date of the condensed consolidated financial statements and the reported
amounts of revenue and expenses during the reporting period. Management
periodically assesses the accuracy of these estimates and assumptions. Actual
results could differ from those estimates. (d) Net Income (Loss) Per Common Share Net income (loss) per common share, basic and diluted, is computed by
dividing net income (loss) applicable to common shares by the weighted average
number of common shares outstanding for the period. In periods of net loss, the
assumed common share equivalents for options, warrants, and the Class A
convertible preferred stock are anti-dilutive, and are therefore not included
in the weighted average shares balance on the consolidated statement of
operations. As of September 30, 2004, the Company has options outstanding to
purchase approximately 9.5 million shares of common stock of which 4.2 million
are exercisable and exercisable warrants to purchase up to an additional 23.7
million shares of common stock that can further dilute investors, if exercised. (e) Stock-Based Compensation As allowed by Statement of Financial Accounting Standards 148, Accounting
for Stock-Based Compensation-Transition and Disclosure, (SFAS No. 148), the
Company has chosen to continue to account for compensation cost associated with
its employee stock option plan in accordance with the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, (APB No. 25) adopting the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, (SFAS No. 123). Under this method, no
compensation expense is recorded if stock options are granted at an exercise
price equal to or greater than the fair market value of the Companys stock on
the grant date. If the Company had adopted the fair value method of accounting
for its stock awards, stock-based compensation would have been determined based
on the fair value for all stock awards at the grant date using a Black-Scholes
pricing model and the following weighted average assumptions noted below. 5




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The Companys pro forma net loss applicable to common shares, and pro
forma net loss per common share, basic and diluted, if the Company had used the
fair value method would have been as follows (dollars in thousands, except per
share data): Three months ended
    
    Three months endedSeptember 30, 2004
    
    September 30, 2003Net loss applicable to common shares, as reported
    
    $
    (43,618
    )
    
    $
    (40,787
    )Add: Stock-based employee compensation expense included
in net loss, as reported
    
    
    90
    
    
    
    193Deduct: Total stock-based employee compensation expense
determined under fair value based methods for all stock
awards
    
    
    (2,378
    )
    
    
    (3,735
    )Pro forma net loss applicable to common shares
    
    $
    (45,906
    )
    
    $
    (44,329
    )Net loss per common share, basic and diluted:Net loss per common share, basic and diluted  as reported
    
    $
    (0.24
    )
    
    $
    (0.42
    )Net loss per common share, basic and diluted  pro forma
    
    $
    (0.25
    )
    
    $
    (0.46
    )Black Scholes Assumptions:Expected volatility
    
    
    63.0
    %
    
    
    75.0
    %Risk free interest rate
    
    
    3.4
    %
    
    
    2.4
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected life (range in years)
    
    
    4.0
    
    
    
    4.0Weighted average fair value per share at grant date
    
    $
    1.71
    
    
    $
    2.73
 Nine Months ended
    
    Nine Months endedSeptember 30, 2004
    
    September 30, 2003Net loss applicable to common shares, as reported
    
    $
    (135,933
    )
    
    $
    (81,111
    )Add: Stock-based employee compensation expense included
in net loss, as reported
    
    
    316
    
    
    
    447Deduct: Total stock-based employee compensation expense
determined under fair value based methods for all stock
awards
    
    
    (6,479
    )
    
    
    (11,730
    )Pro forma net loss applicable to common shares
    
    $
    (142,096
    )
    
    $
    (92,394
    )Net loss per common share, basic and diluted:Net loss per common share, basic and diluted  as reported
    
    $
    (0.89
    )
    
    $
    (0.85
    )Net loss per common share, basic and diluted  pro forma
    
    $
    (0.93
    )
    
    $
    (0.97
    )Black Scholes Assumptions:Expected volatility
    
    
    63.0
    %
    
    
    75.0
    %Risk free interest rate
    
    
    3.1
    %
    
    
    2.6
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected life (range in years)
    
    
    4.0
    
    
    
    4.0Weighted average fair value per share at grant date
    
    $
    2.23
    
    
    $
    2.83
 The XO Communications, Inc. 2002 Stock Incentive Plan (the 2002 Stock
Incentive Plan) was adopted in January 2003 and amended and restated in July
2003. Under the 2002 Stock Incentive Plan, the Company is authorized to issue
awards for up to 17.6 million shares of its common stock in the form of
restricted stock or options to purchase stock. The Company granted a total of
3,415,882 options during the nine months ended September 30, 2004. 6




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(f) Comprehensive Loss Comprehensive loss includes the Companys net loss applicable to common
shares, as well as net unrealized gains and losses on available-for-sale
investments. The following table reflects the Companys calculation of
comprehensive loss for the three and nine months ended September 30, 2004 and
2003 (dollars in thousands): Three Months Ended September 30,2004
    
    2003Net loss applicable to common shares
    
    $
    (43,618
    )
    
    $
    (40,787
    )Other comprehensive loss:Net unrealized gains (losses) on investment
    
    
    (1,410
    )
    
    
    Comprehensive loss
    
    $
    (45,028
    )
    
    $
    (40,787
    )
 Nine Months Ended September 30,2004
    
    2003Net loss applicable to common shares
    
    $
    (135,933
    )
    
    $
    (81,111
    )Other comprehensive loss:Net unrealized gains (losses) on investment
    
    
    1,610
    
    
    
    Comprehensive loss
    
    $
    (134,323
    )
    
    $
    (81,111
    )
 (g) Business Combinations The Company accounts for acquisitions in accordance with Statement of
Financial Accounting Standards 141, Accounting for Business Combinations
(SFAS 141). Accordingly, when a business combination occurs, the Company
allocates the cost of the acquired enterprise to the estimated fair value of
the assets acquired and liabilities assumed. Any excess of cost over the net of
the amounts assigned to assets acquired and liabilities assumed is recognized
as goodwill. Direct costs of the acquisition are included in the cost of the
acquired enterprise, while indirect and general expenses such as salaries and
overhead costs are expensed as incurred. Costs of issuing equity securities in
connection with business combinations are deducted from the amount of
additional paid-in-capital resulting from the issuance. (h) Goodwill
and Other Intangibles Assets The Company accounts for goodwill and other intangible assets in
accordance with Statement of Financial Accounting Standards 142, Goodwill and
Other Intangible Assets. Goodwill is evaluated for impairment at least
annually. Other intangible assets consist of customer relationships, internally
developed technology and trade names. Customer relationships and internally
developed technology are amortized using the straight-line method over the
estimated useful lives of three years. Certain trade names were determined to have
indefinite lives and are not being amortized, but are reviewed at least
annually for impairment. Other trade names are amortized over their estimated useful lives of 4 years. (i) Class A Convertible Preferred Stock The Company accretes changes in the redemption value of its Class A
Convertible Preferred Stock as they occur and adjusts the carrying value of the
security to equal the redemption value at the end of each reporting period. The
accretion is included in net income (loss) applicable to common shares in the
Companys consolidated statement of operations. 2. BUSINESS COMBINATION On June 23, 2004 (the Closing Date), XO completed the acquisition of all
of the local exchange carrier businesses (the Acquired Businesses) of
Allegiance Telecom, Inc. (ATI) under the terms of the Asset Purchase
Agreement ( the Purchase Agreement) entered into on February 18, 2004 by and
among the Company, ATI and Allegiance Telecom Company Worldwide (together with
ATI, Allegiance), and approved by the United States Bankruptcy Court for the
Southern District of New York (the Bankruptcy Court) on February 19, 2004. Allegiance and its direct
and indirect subsidiaries operated as debtors-in-possession under the
Bankruptcy Code from May 14, 2003 to June 23, 2004. Allegiance was a
facilities-based national local exchange carrier that provided integrated
telecommunications services to business, government and other institutional customers in 36
major metropolitan areas across the United States. Allegiances service
offerings included voice, data, and integrated telecommunications services. XO
did not acquire Allegiances customer premises installation and maintenance
business, shared hosting business, or dedicated dial-up Internet access service
business. 7




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##### 



Under the Purchase Agreement, XO paid approximately $636.0 million for the
Acquired Businesses consisting of approximately $324.7 million of cash,
including $13.0 million of adjustments for working capital and $0.6 million of
direct costs, and 45,380,000 shares of XO common stock valued at approximately
$311.3 million using XOs common stock market price for a reasonable period
before and after the Allegiance acquisition was announced. XO filed an administrative claim with the Bankruptcy Court in August 2004
against the Allegiance Telecom Liquidating Trust (the ATLT), for at least
approximately $40.0 million under the Purchase Agreement and other agreements
between the parties. Subsequently, XO informed the ATLT that the amount in
dispute exceeds $50.0 million. The ATLT has claimed in correspondence that it
believes it is owed approximately $13.7 million in respect to operating,
working capital and other disputes that have arisen between the parties since
the Closing Date. XO and the ATLT have met preliminarily to attempt to review
and settle these claims, but there can be no assurance that these claims will
be resolved favorably to XO. XO is vigorously pursuing its claim. The majority of any amounts recovered
by XO in connection with this claim would reduce the purchase price paid by XO
to purchase the Acquired Businesses, as well as the resulting goodwill recorded
in the accompanying financial statements. To the extent that the ATLT is
successful in asserting any counterclaims pursuant to which XO is required to
pay additional amounts to the ATLT, the majority of any payment by XO would
increase the purchase price paid by XO to purchase the Acquired Businesses, as
well as the resulting goodwill recorded in the accompanying financial
statements. Upon the Closing Date, XO acquired title to the Acquired Businesses. XO
retained independent appraisers to determine the fair value of the property,
plant and equipment and intangible assets acquired as required under SFAS 141.
The following are the estimated fair value of assets acquired and liabilities
assumed as of the Closing Date (dollars in thousands): Current assets
    
    $
    51,060Property and equipment
    
    
    368,916Goodwill
    
    
    213,891Other intangible assets
    
    
    68,052Other long-term assets
    
    
    9,028Total assets acquired
    
    
    710,947Current liabilities
    
    
    (60,968
    )Long-term liabilities
    
    
    (13,969
    )Total liabilities acquired
    
    
    (74,937
    )Purchase price
    
    $
    636,010
 Of the $68.1 million of acquired intangible assets, approximately $5.7
million was assigned to various trade names, which have estimated useful lives of 4 years. Approximately $62.4 million was
assigned to the Acquired Businesses customer base, which has an estimated
useful life of 3 years. The values assigned in these financial statements are
preliminary and represent managements best estimate of current values which
are subject to revision due to changes in estimates of fair value as well as
the pending claim discussed above. 8




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##### 



The results of operations for the Acquired Businesses are included in the
accompanying consolidated financial statements from the Closing Date through
September 30, 2004. The following is unaudited pro forma financial information
of the Company assuming the Allegiance acquisition had occurred at the
beginning of the periods presented (dollars in thousands, except share and per
share data): Three Months EndedSeptember 30, 2004
    
    September 30, 2003Revenue
    
    $
    391,885
    
    
    $
    408,033Net loss applicable to common shares
    
    $
    (43,618
    )
    
    $
    (90,892
    )Net loss per common share  basic and diluted
    
    $
    (0.24
    )
    
    $
    (0.64
    )Weighted average shares  basic and diluted
    
    
    181,933,035
    
    
    
    141,399,526
 Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Revenue
    
    $
    1,160,346
    
    
    $
    1,242,474Net loss applicable to common shares
    
    $
    (189,806
    )
    
    $
    (271,562
    )Net loss per common share  basic and diluted
    
    $
    (1.05
    )
    
    $
    (1.93
    )Weighted average shares  basic and diluted
    
    
    181,297,833
    
    
    
    140,791,819
 3. MARKETABLE AND OTHER SECURITIES The amortized cost, gross unrealized gains and losses and fair value of
the equity securities available-for-sale as of September 30, 2004 and December
31, 2003, are in the following table. Other securities as of September 30, 2004
and December 31, 2003 consist of debt securities, carried at cost, that mature
in 2007 (dollars in thousands): GrossGross
    
    UnrealizedUnrealized
    
    HoldingFair Value
    
    Cost Basis
    
    Holding Gains
    
    (Losses)As of September 30, 2004Equity securities
    
    $
    4,834
    
    
    $
    1,845
    
    
    $
    2,989
    
    
    $
    Other securities
    
    
    12,011
    
    
    
    12,011
    
    
    
    
    
    
    
    Total marketable and other securities
    
    $
    16,845
    
    
    $
    13,856
    
    
    $
    2,989
    
    
    $
    As of December 31, 2003Equity securities
    
    $
    30,041
    
    
    $
    28,663
    
    
    $
    3,001
    
    
    $
    (1,623
    )Other securities
    
    
    12,011
    
    
    
    12,011
    
    
    
    
    
    
    
    Total marketable and other securities
    
    $
    42,052
    
    
    $
    40,674
    
    
    $
    3,001
    
    
    $
    (1,623
    )
 As part of the purchase effort with Allegiance, XO acquired $92.5 million
in face value of unsecured Allegiance debt securities for $36.4 million.
Consequently, XO is a claimant in Allegiances bankruptcy. This asset is being
carried in other long term assets at cost. The ATLT will eventually settle all
outstanding claims against the Allegiance estate with cash or the XO common
stock that was distributed to it on the Closing Date. Based on the current
status of the ATLT bankruptcy, it is difficult to assess how much of the claim
XO will recover, or when the recovery will be paid. Based on the cash position
filed by the ATLT as part of its bankruptcy proceedings and the current value
of XOs common stock, this debt investment appears to be recoverable. This
assessment could change based upon the total amount of claims the ATLT is
directed to pay, the amount of administrative costs that it incurs and XOs
stock price. 4. LONG-LIVED ASSETS XOs long-lived assets include property and equipment, goodwill, broadband
wireless licenses, and identifiable intangible assets to be held and used.
Depreciation and amortization is calculated on a straight-line basis over the
estimated useful lives of the assets. 9




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Property and Equipment The estimated useful lives of telecommunications networks and acquired
bandwidth are 3 to 20 years and 5 to 7 years for furniture fixtures, equipment
and other. These useful lives are determined based on historical usage with
consideration given to technological changes and trends in the industry that
could impact the network architecture and asset utilization. Costs of additions and improvements are capitalized
and repairs and maintenance are charged to expense as incurred. Direct external
and internal costs of constructing property and equipment are capitalized
including interest costs related to construction. During the three months ended
September 30, 2004 and 2003, we capitalized interest on construction costs of
$1.2 million and $0.9 million, respectively. Capitalized interest for the nine
months ended September 30, 2004 and 2003 was $3.1 million and $2.2 million,
respectively. Property and equipment consisted of the following components
(dollars in thousands): September 30,
    
    December 31,2004
    
    2003Telecommunications networks and acquired
bandwidth
    
    $
    697,199
    
    
    $
    407,747Furniture, fixtures, equipment, and other
    
    
    212,836
    
    
    
    77,783910,035
    
    
    
    485,530Less: accumulated depreciation
    
    
    (161,274
    )
    
    
    (79,501
    )748,761
    
    
    
    406,029Construction-in-progress
    
    
    100,136
    
    
    
    79,955$
    848,897
    
    
    $
    485,984
 Depreciation expense related to property and equipment for the three and
nine months ended September 30, 2004 was $45.3 million and $87.3 million,
respectively, and for the three and nine months ended September 30, 2003 was
$21.8 million and $62.4 million, respectively. Assets classified as
construction-in-progress are not being depreciated as they are not currently
ready for their intended use. Broadband Wireless Licenses and Other Intangibles Broadband wireless licenses and other intangible assets consisted of the
following components (dollars in thousands): September 30,
    
    December 31,2004
    
    2003Broadband wireless licenses
    
    $
    59,508
    
    
    $
    59,508Customer relationships
    
    
    112,366
    
    
    
    49,987Internally developed technology
    
    
    9,521
    
    
    
    9,521Acquired trade names
    
        
    5,673
    
    
    
    187,068
    
    
    
    119,016Less: accumulated amortization
    
    
    (51,388
    )
    
    
    (26,163
    )135,680
    
    
    
    92,853Trade names  indefinite life asset
    
    
    16,662
    
    
    
    16,662$
    152,342
    
    
    $
    109,515
 Amortization expense related to broadband wireless licenses and other
intangible assets for each of the three and nine months ended September 30,
2004 was $11.5 million and $25.2 million, respectively and for the three and
nine months ended September 30, 2003 was $6.5 million and $19.6 million,
respectively. As of September 30, 2004, approximately $23.5 million of fixed
wireless licenses are not being amortized as commercial services have not been
deployed in the licenses geographic area. Annual amortization expense for
intangible assets currently in service is estimated to be $48.4 million for
2005, $28.5 million for 2006, $17.4 million for 2007, $4.9 million for 2008 and
$0.1 million for 2009. 5. LONG-TERM DEBT The Company
    has a secured credit facility (the Credit Facility) which matures
    on July 15, 2009. There are no additional borrowings available under
    the Credit Facility. At September 30, 2004, more than 90% of the underlying
    loans of the Credit Facility are held by an entity controlled by Mr. Carl
    C. Icahn, Chairman of the Companys Board of Directors (Mr. Icahn).
    At September 30, 2004, long-term debt consisted of $354.1 million in
    principal and $4.8 million of accrued interest that, if not paid, converts
    to principal. There are no current debt service requirements since cash interest
    payments as well as automatic and permanent quarterly reductions on the principal
    amount outstanding do not commence until 2009. However, in the event that
    consolidated excess cash flow (as defined in the Credit Facility) for any
    fiscal quarter during the term of the agreement is greater than $25.0 million,
    at the request of the lender, the Company will pay an amount equal to 50%
    of such excess cash flow greater than $25.0 million toward the reduction
    of outstanding indebtedness. In addition, if the ratio of XOs consolidated
    earnings before interest, taxes, depreciation and amortization (EBITDA)
    to consolidated interest expense for four consecutive quarters exceeds 4:1,
    XO would be required to pay cash interest, unless waived by the lenders. 10




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##### 



The security for the Credit Facility consists of all assets of XO
including the stock of its direct and indirect subsidiaries, and substantially
all the assets of those subsidiaries. The Credit Facility limits additional
indebtedness, liens, dividend payments and certain investments and
transactions, and contains certain covenants with respect to EBITDA
requirements and maximum capital expenditures. In addition, the Company was
required to achieve a minimum consolidated positive EBITDA of not less than
$34.0 million for the four-quarter period ended September 30, 2004. On August
3, 2004 the lender waived the applicability of the minimum EBITDA covenant for
each quarter from March 31, 2004 through December 31, 2005. Actual consolidated
EBITDA loss for the four-quarter period ended September 30, 2004 was $23.2
million. The Company is also required under the terms of the Credit Facility to
maintain an unrestricted cash balance of $25.0 million at the end of March 31,
2004 and each fiscal quarter thereafter during the term. On June 23, 2004, as
part of the closing of the Allegiance acquisition, the Company obtained the
waiver and consent of the lenders with respect to the following covenants
contained in the Credit Facility and subject to XO providing updated collateral
descriptions and legal opinions not later than November 22, 2004: (i) the $25.0
limitation on the incurrence of permitted indebtedness, permitted equipment
financings, acquired debt, and capital leases; (ii) the limitation on the
incurrence of additional liens with respect to liens on the Allegiance assets
that remained in place following the effective date of the Allegiance plan of
reorganization; (iii) the restriction on making acquisitions in excess of $50.0
million; (iv) the requirement that accounts acquired as part of the Allegiance
acquisition be subject to control agreements until November 22, 2004; and (v)
any noncompliance arising from the entering into of the Operating Agreement. As discussed above, the Company is not required to pay cash interest
accrued on the principal amount under the Credit Facility until it meets
certain financial ratios; however, the Company can elect to begin paying
interest in cash prior to the required date. Loans under the Credit Facility
bear interest, at the Companys option, at an alternate base rate, as defined,
or a Eurodollar rate plus, in each case, applicable margins. Once the Company
begins to pay accrued interest in cash, the applicable margins are reduced. At
September 30, 2004, the annualized weighted average interest rate applicable to
outstanding borrowings under the Credit Facility was 7.54%. 6. CONVERTIBLE PREFERRED STOCK On August 6, 2004, XO completed a private placement of 4.0 million shares
of its 6% Class A Convertible Preferred Stock (the
Preferred Stock Offering) for net proceeds of $199.4
million.
Affiliates of Mr. Icahn purchased 95% of the preferred shares sold in the
Preferred Stock Offering, and an affiliate of Amalgamated
Gadget, L.P., holder of approximately 9.4% of XOs outstanding common stock,
purchased the remaining five percent. The Preferred Stock Offering was reviewed and approved by a special
committee of XOs Board of Directors consisting of XOs three independent
directors, Messrs. Dell, Gradin and Knauss. The special committee selected its
own counsel and financial advisor. The financial advisor advised the special
committee that, subject to specified qualifications, assumptions and
limitations, the material terms of the 6% Class A Convertible Preferred Stock
were fair to XO, from a financial point of view, at the time of issuance.
Proceeds of the Preferred Stock Offering will be used for general working
capital purposes and to fund possible future acquisitions that would add
additional scale and synergies to XOs business. The Class A Preferred Stock ranks senior to the Companys common stock.
Holders of the Class A Preferred Stock are not entitled to receive annual
dividends, however, the liquidation preference of the Class A Preferred Stock
automatically increases at a rate of 1.5% each quarter through the maturity
date, January 15, 2010. The Company is required to redeem the then-outstanding
shares of Class A Preferred Stock on the maturity date at 100% of their
aggregate liquidation preference, including compounded accretion through that
date, unless earlier redeemed or converted into common stock. If all of the
shares of Class A Preferred Stock were to remain outstanding on the maturity
date, and assuming the accretion of all the required increases to the
liquidation preference thereof, holders of the Class A Preferred Stock would be
entitled to 59,868,561 shares of common stock and would have an aggregate
liquidation preference of approximately $276.6 million. The shares of Class A
Preferred Stock are convertible into common stock based on a share price of
$4.62, a premium of approximately 20% above the trading price of the common
stock on the closing date of the Preferred Stock Offering. The Company may
also, at its sole option, redeem the Class A Preferred Stock at any time after
the third anniversary of the issue date of such shares if the average market
price of the Companys common stock for the 20 days prior to such redemption is
equal to or greater than 250% of the conversion price of the Class A Preferred
Stock. Each holder of the Class A Preferred Stock is entitled to one vote for
each share of common stock issuable upon the conversion of the shares of Class
A Preferred Stock as of the record date for such stockholders vote. Both the
conversion ratio and the voting power of each share of Class A Preferred Stock
will be automatically increased each quarter as the liquidation preference
increases at the rate of 1.5% each quarter. The holders of Class A Preferred
Stock also have anti-dilution protection in the event that the Company issues
shares of common stock at a price below the then-prevailing market price of the
Companys common stock. 11




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##### 



7. STOCKHOLDERS EQUITY The Company initiated a rights offering (the Rights Offering) during the
fourth quarter of 2003 offering 40.0 million shares of its common stock at a
price of $5.00 per share. The Rights Offering closed on January 5, 2004. An
aggregate of 39.7 million shares were issued, yielding net proceeds of $197.6
million. Subsequent to closing, these net proceeds were used to pay down the
Companys Credit Facility. As
discussed in Note 2, the Company issued 45,380,000 of its common shares on June 23,
2004 as part of the purchase price for the Acquired Businesses of Allegiance. As
discussed in Note 6, the Company issued 4.0 million shares of
its 6% Class
A Convertible Preferred Stock on August 6, 2004 in a private placement for
aggregate consideration of $200.0 million. 8. OPERATING SEGMENTS Reportable Segments The Company operates its business as one telecommunications segment. The
Companys telecommunications segment includes all of its products and services
including voice, data, and integrated voice and data. These services have
similar network operations and technology requirements and are sold through
similar sales channels to a similar targeted customer base. Therefore, the
Company manages these services as a single segment that are sold in geographic
areas, or markets, within the United States, or that are sold to customers with
a presence across geographical markets. Products and Services The Company classifies its products and services revenues offered by its
telecommunications services segment into voice services, data services, and
integrated voice and data services (dollars in thousands): Three months ended
    
    Nine months endedSeptember 30,

    
    September 30,2004
    
    2003
    
    2004
    
    2003Voice services
    
    $
    214,665
    
    
    $
    140,387
    
    
    $
    487,265
    
    
    $
    441,129Data services
    
    
    110,021
    
    
    
    101,038
    
    
    
    298,582
    
    
    
    300,336Integrated voice and data services
    
    
    67,199
    
    
    
    38,008
    
    
    
    145,166
    
    
    
    107,978Total revenue
    
    $
    391,885
    
    
    $
    279,433
    
    

    $
    931,013
    
    
    $
    849,443
 9. RELATED PARTY TRANSACTIONS Various entities controlled by Mr. Icahn hold the following interests in
XO: Outstanding Common
    
    
    
    
    
    
    
    
    
    OutstandingStock
    
    Warrants
    
    Credit Facility
    
    Preferred StockAt December 31, 2003
    
    Greater than 80%
    
    Greater than 40%
    
    Greater than 90%
    
    
    N/AAt September 30, 2004
    
    Greater than 50%
    
    Greater than 40%
    
    Greater than 90%
    
    Greater than 90%
 The terms of the common stock, warrants and the Credit Facility, as well
as the lease and tax allocation agreements discussed below, were all approved
by the bankruptcy court as part of the Chapter 11 proceedings from which XO
emerged in January 2003. On August 6, 2004, after the closing of the Preferred Stock Offering
discussed in Note 6, Mr. Icahn filed a schedule 13D amendment disclosing his
beneficial ownership of common stock was 60.7%. 12




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##### 



As a result of his significant majority ownership, Mr. Icahn has the right
to elect all of XOs directors, who in turn have the right to appoint the
members of the committees of XOs Board of Directors, appoint key members of
XOs executive management team, and appoint XOs auditors. Currently, Mr. Icahn
is Chairman of the Board of Directors and three employees of Icahn Associates
also sit on the Board of Directors and various committees of the Board of
Directors. Under applicable law and XOs Certificate of Incorporation and
by-laws, certain actions cannot be taken without the approval of holders of a
majority of the Companys voting stock, including, without limitation, mergers,
acquisitions, the sale of substantially all of the assets, and amendments to
XOs Certificate of Incorporation and by-laws. Mr. Icahn, through various entities that he owns or controls, has the
right to require XO to register, under the Securities Act of 1933, shares of
XOs Common Stock held by such entities and to include shares of XOs Common
Stock held by them in certain registration statements filed by XO. Dixon Properties, LLC (Dixon), which is controlled by Mr. Icahn, owns
the building in which XOs headquarters is located. XO currently leases
approximately 170,000 square feet of space in that building. Pursuant to the
lease agreement, XO has paid $1.0 million and $3.0 million in lease rent to
Dixon for the three and nine months ended September 30, 2004, respectively, and
XO is obligated to pay approximately $13.1 million to Dixon through the
expiration of the initial term of the lease, which is November 30, 2007. XO has entered into a Tax Allocation Agreement, dated January 16, 2003,
between XO and Starfire Holding Corporation (Starfire), the parent entity of
the affiliated group of corporations controlled by Mr. Icahn. XO and Starfire
will file consolidated returns during the period in which Mr. Icahns ownership
of XO was equal to or greater than 80%, as required by the Internal Revenue
Code. Upon the closing of the Rights Offering in January 2004, Mr. Icahns
ownership percentage fell below 80%. Consequently, XO will no longer be
included as part of Starfires consolidated group after January 2004. Upon
deconsolidation, the Tax Allocation Agreement generally provides that Starfire
will reimburse XO each year going forward for the excess of XOs actual income
tax expense over the income tax that XO would have been owed if the net
operating losses or other tax attributes used in prior periods by the Starfire
consolidated group were still available to XO. The Company provides certain telecommunications services to companies
affiliated with Mr. Icahn (Icahn Affiliates). For the three and nine months
ended September 30, 2004, the total revenue recognized on such services to
Icahn Affiliates was approximately $0.6 million and $1.3 million, respectively.
During the three and nine months ended September 30, 2004, the Company has
purchased approximately $0.1 million and $0.5 million, respectively, in
services from Icahn Affiliates. During the nine months ended September 30, 2004, the Company purchased
$0.5 million in hardware and services from Dell, Inc. Mr. Adam Dell, an XO
director, is the brother of Mr. Michael Dell, the Chairman of Dell, Inc. XO provided telecommunications services to Allegiance from February 18,
2004 through the Closing Date. Total revenue recognized for those services was
approximately $1.7 million. On June 8, 2004 XO entered into a Registration Rights Agreement with the
ATLT, holder of approximately 24.9% of XOs outstanding common stock, pursuant
to which the ATLT can require XO to register the 45,380,000 shares of XO common
stock issued as part of the acquisition of the Acquired Businesses. On November 2, 2004, XO entered into an Indemnification Agreement with
each of Mr. Dell, Robert L. Knauss and Fredrik Gradin, each of whom is a member
of XOs Board of Directors, pursuant to which XO has agreed to indemnify each
of such directors for any personal liability and costs that he may incur in
connection with the performance of services as a director of XO, and advance to
each such director any expenses that he may incur in connection with any
litigation or actions related to such services. 13




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##### 



10. COMMITMENTS AND CONTINGENCIES In addition to the claim filed against the ATLT that is discussed in Note
2, XO is involved in lawsuits, claims, investigations and proceedings
consisting of commercial, securities, tort, employment, and telecommunications
regulatory matters, which arise in the ordinary course of business. In
accordance with Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies, XO makes a provision for a liability when it is both
probable that a liability has been incurred and the amount of the loss can be
reasonably estimated. XO believes it has adequate provisions for any such
matters. Disputes with respect to claims against XO in the aggregate amount of
approximately $21.5 million remain pending from XOs 2002 Chapter 11 proceedings. XO reviews these provisions at least
quarterly and adjusts these provisions to reflect the impacts of negotiations,
settlements, rulings, advice of legal counsel, and other information and events
pertaining to a particular case. Litigation is inherently unpredictable.
However, XO believes that it has valid defenses with respect to legal matters
pending against it. Nevertheless, it is possible that cash flows or results of
operations could be materially affected in any particular period by the
unfavorable resolution or disposition of one or more of these contingencies. On August 20, 2004, the Federal Communications Commission (or FCC)
issued an Order and Notice of Proposed Rulemaking which established Interim
Rules regarding the availability of unbundled network elements (or UNEs). The
Interim Rules are designed to preserve the status quo for rates in effect as of
June 16, 2004 while the FCC completes a more comprehensive proceeding to
develop the New UNE Rules. The Interim UNE Rules dictate that the Regional Bell
Operating Companies (or RBOCs) will make available all previously provisioned
UNEs at their current cost-based rates for a six month period ending March
15, 2005. The Interim Rules propose that after March 15, 2005 the RBOCs can (i)
increase the price of existing provisioned UNEs by 15%, and (ii) charge special
access, or retail rate, on new orders for the use of their network assets
formerly available as UNEs. While XO believes that the FCC will adopt New UNE
Rules prior to March 15, 2005, if this adoption is delayed, the proposed
interim rules price increase, could materially and adversely affect XOs
financial condition and results of operations. 14




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##### 



PART I. FINANCIAL INFORMATION Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations Forward-looking and Cautionary Statements Some statements and information contained in this document are not
historical facts, but are forward-looking statements, as such term is defined
in the Private Securities Litigation Reform Act of 1995. These forward-looking
statements can be identified by the use of forward-looking terminology such as
believes, expects, plans, may, will, would, could, should, or
anticipates or the negative of these words or other variations of these words
or other comparable words, or by discussions of strategy that involve risks and
uncertainties. Such forward-looking statements include, but are not limited to,
statements regarding:  
    
    our services, including the development and deployment of data
products and services based on IP, Ethernet and other technologies and
strategies to expand our targeted customer base and broaden our sales
channels;
    
    the operation of our network and back office systems, including
with respect to the development of IP protocols;
    
    liquidity and financial resources, including anticipated capital
expenditures, funding of capital expenditures and anticipated levels of
indebtedness;
    
    trends related to and expectations regarding the results of
operations in future periods, including but not limited to those
statements set forth in Managements Discussion and Analysis of
Financial Condition and Results of Operations below; and
    
    the impact of judicial decisions, legislation, and regulatory
developments on our costs structure, services, and marketing
initiatives. All such forward-looking statements are qualified by the inherent risks
and uncertainties surrounding expectations generally and also may materially
differ from our actual experience involving any one or more of these matters
and subject areas. The operation and results of our business also may be
subject to the effect of other risks and uncertainties in addition to the
relevant qualifying factors identified in the Liquidity Assessment
discussions set forth below the Risk Factors section of our 2003 Annual
Report, including, but not limited to:  
    
    general economic conditions in the geographic areas that we are
targeting for the sale of telecommunications services;
    
    the ability to achieve and maintain market penetration and revenue
levels sufficient to provide financial viability to our business;
    
    the quality and price of similar or comparable telecommunications
services offered, or to be offered, by our current or future
competitors; and
    
    future judicial decisions, telecommunications-related legislation
and/or regulatory decisions and the conduct of incumbent carriers in
reaction to such developments. Overview We provide a comprehensive array of voice and data telecommunications
services to business customers. Our voice services include local and long
distance services, both bundled and standalone, other voice-related services
such as conferencing, domestic and international toll free services and
voicemail, and transactions processing services for prepaid calling cards. Our
data services include Internet access, private data networking, including
dedicated transmission capacity on our networks, virtual private network
services, Ethernet services, and web hosting services. We also combine many of
these services in flat rate service packages. These services are offered to a
variety of customers, including small, medium and large retail businesses,
multi-location businesses and carrier or wholesale customers. 15




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##### 



To serve our customers broad telecommunications needs, we operate a
network comprised of a series of rings of fiber optic cables located in the
central business districts of numerous metropolitan areas, which we refer to as
metro fiber networks, that are connected primarily by a network of numerous
dedicated wavelengths of transmission capacity on fiber optic cables, which we
refer to as an intercity network. By integrating these networks with advanced
telecommunications technologies, we are able to provide a comprehensive array
of telecommunications services primarily or entirely over a network that we own
or control, from the initiation of the voice or data transmission to the point
of termination, which we refer to as end-to-end service. This capability
enables us to provide telecommunications services between customers connected
to our network and among customers with multiple locations primarily or
entirely over our network. With the acquisition of Allegiances network assets and customer base
discussed below, XO is one of the nations largest competitive providers of
national local telecommunications and broadband services. We own one of the
largest networks of nationwide connections to the Regional Bell
Operating Companies, or RBOCs, networks, and doubled
our Points of Presence (PoPs) within the 36 metropolitan areas where both XO and Allegiance operated with the
acquisition. We believe that this extensive network will allow the combined
company to (i) improve delivery of service to customers (ii) improve operating
results and (iii) improve our ability to compete with other companies in the
nationwide local telecommunications services market. Recent Events FCC Rulemaking On
August 20, 2004, the Federal Communications Commission, or FCC, issued an Order and Notice of Proposed
Rulemaking which established Interim Rules regarding the availability of
unbundled network elements or UNEs. The Interim Rules are designed to preserve
the status quo for rates in effect as of June 16, 2004 while the FCC completes
a more comprehensive proceeding to develop the New UNE Rules. The Interim UNE
Rules dictate that the RBOCs will make available all previously provisioned
UNEs at their current cost-based rates for a six month period ending March
15, 2005. The Interim Rules propose that after March 15, 2005 the RBOCs can (i)
increase the price of existing provisioned UNEs by 15%, and (ii) charge special
access, or retail rate, on new orders for the use of their network assets
formerly available as UNEs. While we believe that the FCC will adopt New UNE
Rules prior to March 15, 2005, if this adoption is delayed, the proposed
interim rules price increases could materially and adversely affect XOs
financial condition and results of operations. The proposed FCC rulemaking is
discussed in greater detail below under the heading Regulatory Overview. Convertible Preferred Stock Offering On August 6, 2004, we completed a private placement of 4.0 million shares
of 6% Class A Convertible Preferred Stock for net proceeds of
$199.4 million.
Affiliates of Mr. Icahn, purchased 95% of the preferred shares sold in the
offering, and an affiliate of Amalgamated Gadget, L.P., holder of approximately
9.4% of our outstanding common stock, purchased the remaining five percent. Business Combination On
June 23, 2004, the Closing Date, we completed the acquisition of
the Competitive Local Exchange Carrier, or CLEC, businesses of
Allegiance Telecom, Inc., which we refer to as the Acquired Businesses,
pursuant to the Asset Purchase Agreement entered into on February 18, 2004
between us, Allegiance Telecom, Inc. and Allegiance Telecom Company Worldwide,
collectively referred to as Allegiance, and approved by the United States
Bankruptcy Court for the Southern District of New York on February 19, 2004.
Allegiance and its direct and indirect subsidiaries operated as
debtor-in-possession under the Bankruptcy Code from May 14, 2003 to June 23,
2004. The assets of the Acquired Businesses consist primarily of:  
    
    switching and routing equipment, located both in current XO
facilities and in facilities operated by one or more incumbent local
exchange carriers;
    
    physical points of presence in the form of network operations
centers, data centers, central offices, and sales offices located in 36
major metropolitan areas;
    
    customer and sales agreements and receivables;
    
    leased intercity and metro fiber network capacity that is both
redundant to and expansive of XOs prior network; and
    
    billing, provisioning, and other back-office information technology
platforms. 16




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##### 



Under the Purchase Agreement, we paid approximately $636.0 million for the
Acquired Businesses, consisting of approximately $324.7 million of cash,
including $13.0 million of adjustments for working capital and $0.6 million in
direct costs, and 45,380,000 shares of our common stock valued at approximately
$311.3 million using our common stock market price for a reasonable period
before and after the Allegiance acquisition was announced. XO filed an administrative claim with the Bankruptcy Court in August 2004
against the Allegiance Telecom Liquidating Trust, or the ATLT, for at least
approximately $40.0 million under the Purchase Agreement and other agreements
between the parties. Subsequently, XO informed the ATLT that the amount in
dispute exceeds $50.0 million. The ATLT has claimed in correspondence that it
believes it is owed approximately $13.7 million in respect to operating,
working capital and other disputes that have arisen between the parties since
the Closing Date. XO and the ATLT have met preliminarily to attempt to review
and settle these claims, but there can be no assurance that these claims will
be resolved favorably to XO. XO
is vigorously pursuing its claim. The majority of any amounts
recovered by XO in connection with this claim would reduce the purchase price
paid by XO to purchase the Acquired Businesses, as well as the resulting
goodwill recorded in the accompanying financial statements. To the extent that
the ATLT is successful in asserting any counterclaims pursuant to which XO is
required to pay additional amounts to the ATLT, the majority of any payment by XO would increase
the purchase price paid by XO to purchase the Acquired Businesses, as well as
the resulting goodwill recorded in the accompanying financial statements. Comparison of Financial Results The operational results of XO for the three and nine months ended
September 30, 2004 are discussed below. As the acquisition of the Acquired
Businesses closed June 23, 2004, our consolidated results of operations include
the Acquired Businesses from the Closing Date through September 30, 2004.
Forward looking information with respect to consolidated XO is discussed at the
end of each financial results analysis. Our actual experience may differ
materially from our projections of the combined company, based on many factors
including, among others:  
    
    there are inherent uncertainties in projecting future results for
any business;
    
    we may not successfully integrate the Acquired Businesses and/or
may experience delays in the integration process;
    
    while Allegiances consolidated financial position and results of
operations have been audited through December 31, 2003, stand alone
financial information with respect to the Acquired Businesses has not
been audited; and
    
    we cannot predict the outcome of future judicial decisions,
telecommunications related legislation and/or regulatory decisions or
the reaction by incumbent carriers to such developments. Three and Nine Months Ended September 30, 2004 versus Three and Nine
Months Ended September 30, 2003 Revenue. Total revenue for the three months ending September 30, 2004
increased to $391.9 million from $279.4 million in the same period of 2003
while total revenue for the nine months ended September 30, 2004 increased to
$931.0 million from $849.4 million for the same period of 2003. The three and
nine month financial results for 2004 include approximately $107.8 million and
$116.9 million, respectively, of revenue from the Acquired Businesses. Without
the revenue from the Acquired Businesses, our 2004 revenue for the three months
ended September 30, 2004 increased to $284.1 million from 2003 results of
$279.4 million. Our revenue for the nine months ended September 30, 2004
without the revenue from the Acquired Businesses decreased to $814.1 million
from $849.4 million. 17




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##### 



If current business and industry trends continue, we would expect that the
revenue for the combined company will be relatively stable with third quarter
2004 results for the year following the acquisition, although it may fluctuate
quarter to quarter. This projection could be negatively impacted if we do not
successfully integrate and retain the Acquired Businesses customers, sales
forces and services. Revenue was earned from providing the following services set forth in the
table below (dollars in thousands). Three months ended September 30,% of2004
    
    % of Revenue
    
    2003
    
    Revenue
    
    % ChangeVoice services
    
    $
    214,665
    
    
    
    54.8
    %
    
    $
    140,387
    
    
    
    50.2
    %
    
    
    52.9
    %Data services
    
    
    110,021
    
    
    
    28.1
    %
    
    
    101,038
    
    
    
    36.2
    %
    
    
    8.9
    %Integrated voice and data services
    
    
    67,199
    
    
    
    17.1
    %
    
    
    38,008
    
    
    
    13.6
    %
    
    
    76.8
    %Total revenue
    
    $
    391,885
    
    
    
    100.0
    %
    
    $
    279,433
    
    
    
    100.0
    %
    
    
    40.2
    %
 Nine Months ended September 30,% of2004
    
    % of Revenue
    
    2003
    
    Revenue
    
    % ChangeVoice services
    
    $
    487,265
    
    
    
    52.3
    %
    
    $
    441,129
    
    
    
    51.9
    %
    
    
    10.5
    %Data services
    
    
    298,582
    
    
    
    32.1
    %
    
    
    300,336
    
    
    
    35.4
    %
    
    
    (0.6
    %)Integrated voice and data services
    
    
    145,166
    
    
    
    15.6
    %
    
    
    107,978
    
    
    
    12.7
    %
    
    
    34.4
    %Total revenue
    
    $
    931,013
    
    
    
    100.0
    %
    
    $
    849,443
    
    
    
    100.0
    %
    
    
    9.6
    %
 Voice services revenue includes revenue from local and long distance voice
services, prepaid calling card processing, and other voice telecommunications
based services, interactive voice response services and stand-alone long
distance services. Our three and nine month financial results for 2004 include
approximately $63.9 million and $68.9 million of voice services from the
Acquired Businesses, respectively. Voice services revenue exclusive of voice
service revenue from the Acquired Businesses for the three months ended
September 30, 2004 increased to $150.7 million from $140.4 million for the same
period of 2003 and for the nine months ended September 30, 2004 decreased to
$418.3 million from $441.1 million for the same period in 2003. The third
quarter versus third quarter increase is due in large measure to favorable
dispute settlements with incumbent local exchange carriers. The nine months
versus nine months decrease is primarily attributable to carrier customer
declines during 2003 driven by churn and competitive pricing pressures offset
by the settlements referenced above. In addition, the FCC mandated certain rate
reductions in carrier access rates. Data services revenue includes revenue from Internet access, network
access and web applications hosting services. Our three and nine month
financial results for 2004 include approximately $16.6 million and $18.2
million of data services revenue from the Acquired Businesses, respectively.
Data services revenue exclusive of data service revenue from the Acquired
Businesses for the three months ended September 30, 2004 decreased to $93.4
million from $101.0 million for the same period of 2003 and for the nine months
ended September 30, 2004 decreased to $280.3 million from $300.3 million for
the same period in 2003. The decrease is primarily due to carrier customer
churn due to network downsizing. Integrated voice and data services revenue is generated largely from our
XOptions and Total Communications service offerings, which are flat-rate
bundled packages offering a combination of voice and data services. Our three
and nine month financial results for 2004 include approximately $27.3 million
and $29.8 million of integrated voice and data revenue from the Acquired
Businesses, respectively. Integrated voice and data services revenue exclusive
of services revenue from the Acquired Businesses for the three months and nine
months ended September 30, 2004 increased to $39.9 million and $115.4 million,
respectively, from $38.0 million and $108.0 million for the three months and
nine months ended September 30, 2003, respectively, due to growth in our
XOptions bundled package service. 18




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##### 



Costs and expenses. The table below provides costs and expenses by
classification and as a percentage of revenue (dollars in thousands). Our
consolidated costs and expenses in 2004 include the costs to run the Acquired
Businesses from June 23, 2004 through September 30, 2004. Three months ended September 30,2004
    
    % of Revenue
    
    2003
    
    % of Revenue
    
    % ChangeCosts and expenses:Cost of service
    
    $
    161,946
    
    
    
    41.3
    %
    
    $
    106,935
    
    
    
    38.3
    %
    
    
    51.4
    %Selling, operating and general
    
    
    209,427
    
    
    
    53.4
    %
    
    
    179,988
    
    
    
    64.4
    %
    
    
    16.4
    %Depreciation and amortization
    
    
    56,739
    
    
    
    14.5
    %
    
    
    28,388
    
    
    
    10.2
    %
    
    
    99.9
    %Total
    
    $
    428,112
    
    
    
    
    
    
    $
    315,311
 Nine Months ended September 30,2004
    
    % of Revenue
    
    2003
    
    % of Revenue
    
    % ChangeCosts and expenses:Cost of service
    
    $
    390,729
    
    
    
    42.0
    %
    
    $
    319,339
    
    
    
    37.6
    %
    
    
    22.4
    %Selling, operating and general
    
    
    542,129
    
    
    
    58.2
    %
    
    
    511,264
    
    
    
    60.2
    %
    
    
    6.0
    %Depreciation and amortization
    
    
    112,501
    
    
    
    12.1
    %
    
    
    81,993
    
    
    
    9.7
    %
    
    
    37.2
    %Total
    
    $
    1,045,359
    
    
    
    
    
    
    $
    912,596
 Cost of service. Cost of service includes expenses directly associated
with providing telecommunications services to our customers. Cost of service
includes, among other items, the cost of connecting customers to our networks
via leased facilities, the costs of leasing components of our network
facilities and costs paid to third party service providers for interconnect
access and transport services. Cost of service for the three and nine months
ended September 30, 2004 increased as a percentage of revenue compared to the
same period in 2003 due to pricing pressures from both mandated FCC carrier
access rate reductions and general pricing reductions, as well as a shift in
traffic mix for terminations. Based
on our review and analyses, we believe that cost of service as a percentage of revenue for the combined companies will
remain relatively stable with third quarter 2004 results. However, cost of
service may be adversely impacted due to recently proposed regulatory rules on
UNE loop and transport rates as discussed later in Regulatory Overview. We
originally estimated a potential benefit of approximately $60.0 million in pro
forma annualized cost of service expense synergies for the combined companies
if our integration efforts with the Acquired Businesses were successful. We have made progress integrating
the two companies and are on plan to reach our synergy targets. Cost of service
as a percentage of revenue may be adversely impacted if we do not successfully
integrate the Acquired Businesses and/or experience delays in our integration
efforts. Selling, operating and general.Selling, operating and general expense
includes expenses related to sales and marketing, internal network operations
and engineering, information systems, general corporate office functions,
business taxes and collection risks. Selling, operating and general expense as
a percentage of revenue for the three months ended September 30, 2004 and for
the nine months ended September 30, 2004 decreased when compared to the same
periods in 2004. The decrease in selling, operating and general expense as a
percentage of revenue is primarily due to the achievement of synergies related
to the acquisition of the Acquired Businesses. Based on our review and analyses, we believe that, selling, operating and
general expense will remain relatively stable with third quarter 2004 results,
both in absolute dollars and as a percentage of revenue. We originally
estimated a potential benefit of approximately $100.0 million in pro forma
annualized selling, operating and general expense synergies for the combined
companies if our integration efforts with the Acquired Businesses were successful. We have made progress
integrating the two companies and are on plan to reach our synergy targets.
This projection would be adversely affected if we do not successfully integrate
the Acquired Businesses in a timely manner and/or experience delays in our
integration efforts. 19




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##### 



Depreciation and amortization. Depreciation expense was $45.3 million for
the three months ended September 30, 2004, and $21.8 million for the same
period in 2003. Depreciation expense was $87.3 million for the nine months
ended September 30, 2004, and $62.4 million for the same period in 2003.
Amortization expense includes the amortization of broadband wireless licenses
and other intangible assets with definite useful lives. Total amortization
expense was $11.5 million for the three months ended September 30, 2004 and
$6.5 million for the same period of 2003 and was $25.2 million in the nine months ended
September 30, 2004 and $19.6 million in the same period of 2003. The increase
in absolute dollars is due to the inclusion of the fixed
assets and intangibles of the Acquired Businesses. As of September 30, 2004, we
had approximately $100.1 million of construction-in-progress plus $23.5 million
of fixed wireless licenses that are not currently ready for their intended use
or placed into service and, accordingly, are not currently being depreciated or
amortized. Based on our review and analyses, we believe that depreciation and
amortization will remain relatively stable with third quarter 2004 results. Investment income (loss), net. Investment income (loss), net includes
interest income on investments and realized gains or losses on the sale of
investments. For each of the three months ended September 30, 2004 and 2003 we
reported a net investment income of $1.0 million. Investment loss, net for the
nine months ended September 30, 2004 was $0.7 million while we had net
investment income of $9.3 million for the same period in 2003. The decrease in
investment income is due primarily to the recognized losses on the sale of
marketable securities during 2004, as well as reduced investment balances. Interest expense, net.Interest expense, net includes interest expense on
our Credit Facility and capital leases, less any amounts capitalized. The
majority of interest expense in 2004 is non-cash as the Credit Facility allows
for accrued interest to be converted into principal if unpaid. Interest
expense, net for the three months ended September 30, 2004 and 2003 was $6.6
million and $5.9 million, respectively. Interest expense, net for the nine
months ended September 30, 2004 and 2003 was $19.0 million and $27.3 million,
respectively. The significant reduction for 2004 was due to the repayment of
outstanding principal under the Credit Facility with the proceeds of the Rights
Offering in January 2004. During the three months ended September 30, 2004 and
2003, we capitalized interest on construction costs of $1.2 million and $0.9
million, respectively. Capitalized interest for the nine months ended September
30, 2004 and 2003 was $3.1 million and $2.2 million, respectively. Critical Accounting Policies Our significant accounting policies are more fully described in the notes
to the consolidated financial statements in our 2003 Annual Report. The
preparation of the condensed consolidated financial statements in accordance
with accounting principles generally accepted in the United States requires
management to make judgments, estimates and assumptions regarding uncertainties
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities and the reported amounts of revenues and
expenses. Management uses historical experience and all available information
to make these judgments and estimates and actual results could differ from
those estimates and assumptions that are used to prepare our financial
statements at any given time. Despite these inherent limitations, management
believes that Managements Discussion and Analysis and the accompanying
condensed consolidated financial statements and footnotes provide a meaningful
and fair perspective of our financial condition and our operating results for
the quarterly period ended September 30, 2004. Management believes the
following critical accounting policies represent the more significant judgments
and estimates used in the preparation of our condensed consolidated financial
statements included in this Quarterly Report on Form 10-Q. Business Combinations The Company accounts for business acquisitions in accordance with Statement of
Financial Accounting Standards 141, Accounting for Business Combinations or
SFAS 141. Accordingly, when a business combination occurs, the Company
allocates the cost of the acquired enterprise to the estimated fair value of
the assets acquired and liabilities assumed. Any excess of cost over the net of
the amounts assigned to assets acquired and liabilities assumed is recognized
as goodwill. Direct costs of the acquisition are included in the cost of the
acquired enterprise, while indirect and general expenses such as salaries and
overhead costs are expensed as incurred. Costs of issuing equity securities in
connection with business combinations are deducted from the amount of
additional paid-in-capital resulting from the issuance. 20




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##### 



Upon the Closing Date, XO acquired title to the Acquired Businesses. XO
retained independent appraisers to determine the fair value of the property,
plant and equipment and intangible assets acquired as required under SFAS 141.
The following are the estimated fair value of assets acquired and liabilities
assumed as of the Closing Date (dollars in thousands): Current assets
    
    $
    51,060Property and equipment
    
    
    368,916Goodwill
    
    
    213,891Other intangible assets
    
    
    68,052Other long-term assets
    
    
    9,028Total assets acquired
    
    
    710,947Current liabilities
    
    
    (60,968
    )Long-term liabilities
    
    
    (13,969
    )Total liabilities acquired
    
    
    (74,937
    )Purchase price
    
    $
    636,010
 The values assigned in these financial statements are preliminary and
represent managements best estimate of current values which are subject to
revision due to changes in estimates of fair value as well as the pending
claim discussed in Recent Events. Long-Lived Assets Our long-lived assets include property and equipment, goodwill, broadband
wireless licenses, and identifiable intangible assets to be held and used.
Depreciation is calculated on a straight-line basis over the estimated useful
lives of the assets. The estimated useful lives of telecommunications networks
and acquired bandwidth are 3 to 20 years and 5 to 7 years for furniture
fixtures, equipment and other. These useful lives are determined based on
historical usage with consideration given to technological changes and trends
in the industry that could impact the network architecture and asset
utilization. This latter assessment is significant because we operate within an
industry in which new technological changes could render some or all of our
network related equipment obsolete requiring application of a shorter useful
life or, in certain circumstances, a write-off of the entire value of the
asset. Accordingly, in making this assessment, we consider our planned use of
the assets, the views of experts both from internal and outside sources
regarding the impact of technological advances and trends in the industry on
the value and useful lives of our network assets. Costs of additions and
improvements are capitalized and repairs and maintenance are charged to expense
as incurred. Direct external and internal costs of constructing property and
equipment are capitalized including interest costs related to construction.
Depreciation or amortization of the long-lived assets, with finite lives,
begins when the asset is substantially complete or placed into service. Investments in broadband wireless licenses are amortized over the portion
of the original license term remaining after the license is placed in service,
or 10 years, whichever is shorter. The original license period is determined by
the FCC. In order to receive an
extension of the original license term from the FCC, we are required to show
substantial service in the license area within ten years of being licensed.
Failure to meet this requirement could result in forfeiture of the license.
Approximately $23.5 million in book value of these licenses have not yet been
placed into service. Had these licenses been in service during the first three
quarters of 2004, amortization expense would have increased by approximately
$3.3 million. If we fail to show substantial service in the licensed geographic
area at the end of the original ten year period and are not granted an
extension or renewal from the FCC, we would forfeit the right to offer such
services in that market, and write-off the impaired asset. XO is evaluating
recent improvements in the price and performance of broadband wireless
equipment, and is developing a plan to meet the FCCs substantial service test
in all its licensed areas before the licenses are due for renewal proceedings. Other intangibles consist of customer relationships, internally developed
technology and trade names. The customer relationships and internally developed
technology are being amortized using the straight-line method over the
estimated useful lives of three years. Certain trade names were determined to have
indefinite lives and are not being amortized. Goodwill and definite life tradenames are
reviewed at least annually for impairment, as required under
Statement of Financial Accounting Standards 142, Goodwill and Other Intangible Assets, or
SFAS 142. Other trade names are amortized over their estimated useful lives of 4 years. 21




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##### 



Long-lived assets that are not required to be reviewed annually under SFAS
142 are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount should be addressed pursuant to SFAS 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS
144. The criteria for determining impairment for long-lived assets to be held
and used is determined by comparing the carrying value of these long-lived
assets to managements best estimate of future undiscounted cash flows expected
to result from the use of the assets and their eventual disposition. We believe
that no impairment existed under SFAS 144 as of September 30, 2004. In the
event that there are changes in the planned use of our long-lived assets or our expected future undiscounted cash flows are reduced
significantly, our assessment of our ability to recover the carrying value of
these assets under SFAS 144 could change. Revenue Recognition Revenues from telecommunications services are recognized when the services
are performed, evidence of an arrangement exists, the charges are fixed and
determinable and collectability is probable. In circumstances when these
criteria are not met, revenue recognition is deferred until resolution occurs.
For example, if a customer files for protection under bankruptcy, we believe
the probability of collection is weakened. Consequently, under such
circumstances, although we continue to bill the customer for all services
provided, we do not recognize revenue until cash is received. In addition,
telecommunications customers often dispute the amounts that we invoice them due
to regulatory issues, late payment fees, and early termination charges based on
differences of opinion regarding contract terms or service levels. Accordingly,
as these billings are not considered fixed and determinable and collection of
such amounts is not considered probable while these amounts are disputed,
revenue recognition is deferred until the dispute is resolved and the
collection is probable. Service discounts and incentives related to telecommunications services
are recorded as a reduction of revenue when granted or ratably over a contract
period. Fees billed in connection with customer installations and other
non-recurring fees are deferred and recognized ratably over the estimated
customer life. The estimated customer life is calculated by analyzing customer
disconnects as a percentage of revenue. This calculation is reviewed every
quarter. We establish an allowance for collection of doubtful accounts and other
sales credit adjustments. Allowances for sales credits are established through
a charge to revenue, while allowances for doubtful accounts are established
through a charge to selling, operating and general expenses. We assess the
adequacy of these reserves monthly by considering general factors, such as the
length of time individual receivables are past due, historical collection
experience, the economic and competitive environment, and changes in the
creditworthiness of our customers. As considered necessary, we also assess the
ability of specific customers to meet their financial obligations to us and
establish specific valuation allowances based on the amount we expect to
collect from these customers. We can and have experienced material changes to
our reserve requirements on a month to month basis as significant customers
have in the past unexpectedly filed for bankruptcy or otherwise became
insolvent. We believe that our established credit and valuation allowances were
adequate as of September 30, 2004. If circumstances relating to specific
customers change or economic conditions worsen such that our past collection
experience and assessment of the economic environment are no longer valid, our
estimate of the recoverability of our trade receivables could be changed. If
this occurs, we would adjust our valuation allowance in the period the new
information is known. Cost of Service Cost of service includes expenses directly associated with providing
telecommunications services to customers. We accrue for the estimated costs of
services received from third party telecommunications providers during the
period the services are received. Invoices received from the third party
telecommunications providers are often disputed due to billing discrepancies.
We accrue for all invoiced amounts, even amounts in dispute, as these amounts
represent contingent liabilities that are considered probable and measurable.
Disputes resolved in our favor may reduce cost of service in the period the
dispute is settled. As the period of time required to resolve these types of
disputes often lapses over several quarters, the benefits associated with the
favorable resolution of such disputes normally are realized in periods
subsequent to the accrual of the disputed invoice. Liquidity and Capital Resources Capital Resources and Liquidity Assessment During the nine months ended September 30, 2004, our operating activities
used net cash of $29.2 million, our investing activities used net cash of
$412.7 million, and our financing activities provided net cash of $200.7
million. Consequently, our balance of cash and cash equivalents decreased to
$237.4 million at September 30, 2004 from $478.6 million at December 31, 2003. Our operations used net cash of $29.2 million for the nine months ended
September 30, 2004. This use of cash is due to our results of operations and
the timing of receipts and disbursements in our accounts receivable and
accounts payable. We have paid approximately $8.0 million of costs that
benefited the businesses retained by ATLT that is part of the claim discussed
in Recent Events. 22




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##### 



The net use of cash for $412.7 million for investing activities is largely
due to the $324.7 million of cash paid as part of the consideration for the
Acquired Businesses. As discussed in Recent Events we believe that this
acquisition will provide us with a competitive position in operational assets,
service offerings and customer base. In addition, we have invested $72.8
million in capital expenditures. Approximately half of this amount was success
based, which results in increased revenue from existing or new customers. The
other half is primarily for information technology system licenses and
upgrades. Our financing activities provided net cash of $200.7 million largely due
to our August 6, 2004, completion of a private placement offering of 4.0
million shares of our 6% Class A Convertible Preferred Stock for $199.4 million
of net proceeds discussed in Recent Events. In addition we completed a Rights
Offering in January 2004 using the net proceeds of $197.6 million to pay down
amounts outstanding under our Credit Facility. Our growth has required substantial capital to fund business acquisitions,
the related integration, expanding working capital needs, new product
initiatives and capital expenditures. We recently raised capital through the
Preferred Stock Offering and we currently believe that this will meet the needs
of the current scope of our business plan. We may however raise additional
capital if we decide to expand the scope of our business plan, invest in new
technologies, including the buildout of our broadband wireless business, or
acquire other businesses. The timing of when to raise this capital could be
sooner if we are unsuccessful in properly integrating the Acquired Businesses
in a timely manner, if we experience unexpected customer losses during the
integration period, if integration costs are higher than expected, if
unfavorable judicial, regulatory, or legislative developments adversely impact
our pricing and/or cost of service, or if there are further downturns in the
industry or the economy. We cannot predict at this time what impact the
regulatory changes discussed under the heading Recent Events may have on our
financial position and projections. The outstanding balance on the Credit Facility as of September 30, 2004
was $358.9 million. We have no current debt service requirements since cash
interest payments as well as automatic and permanent quarterly reductions of
the principal amount outstanding under the Credit Facility do not commence
until 2009. There are no additional borrowings available under our Credit
Facility. However, in the event that consolidated excess cash flow (as defined
in the Credit Facility) for any fiscal quarter during the term of the agreement
is greater than $25.0 million, at the request of the lender, XO will pay an
amount equal to 50% of such excess cash flow greater than $25.0 million toward
the reduction of outstanding indebtedness. In addition, if the ratio of our
consolidated earnings before interest, taxes depreciation and amortization, or
EBITDA, to consolidated interest expense for four consecutive quarters exceeds
4:1, we would be required to pay cash interest, unless waived by the lenders. Our Credit Facility limits additional indebtedness, liens, dividend
payments and certain investments and transactions, and contains certain
covenants with respect to EBITDA requirements and maximum capital expenditures.
In addition, the Company was required to achieve a minimum consolidated
positive EBITDA of not less than $34.0 million for the four-quarter period
ended September 30, 2004. On August 3, 2004 the lender waived the applicability
of the minimum EBITDA covenant for each quarter from March 31, 2004 through
December 31, 2005. Actual consolidated EBITDA loss for the four-quarter period
ended September 30, 2004 was $23.2 million. The Company is also required under
the terms of the Credit Facility to maintain an unrestricted cash balance of
$25.0 million at the end of March 31, 2004 and each fiscal quarter thereafter
during the term. On June 23, 2004, as part of the closing of the Allegiance
acquisition, we obtained the waiver and consent of the lenders with respect to
the following covenants contained in the Credit Facility and subject to XO
providing updated collateral descriptions and legal opinions not later than
November 22, 2004: (i) the $25.0 limitation on the incurrence of permitted
indebtedness, permitted equipment financings, acquired debt, and capital
leases; (ii) the limitation on the incurrence of additional liens with respect
to liens on the Allegiance assets that remained in place following the
effective date of the Allegiance plan of reorganization; (iii) the restriction
on making acquisitions in excess of $50.0 million; (iv) the requirement that
accounts acquired as part of the Allegiance acquisition be subject to control
agreements until November 22, 2004; and (v) any noncompliance arising from the
entering into of the Operating Agreement. Credit Risk Financial instruments that potentially subject us to concentrations of
credit risk consist primarily of trade receivables. Although our trade
receivables are geographically dispersed and include customers in many
different industries, a portion of our revenue is generated from services
provided to other telecommunications service providers. We believe that our
established allowances are adequate as of September 30, 2004 to cover these
risks. 23




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Regulatory Overview Overview The Telecommunications Act of 1996, or the Telecom Act, which
substantially revised the Communications Act of 1934, established the
regulatory framework for the introduction of competition for local
telecommunications services throughout the United States by new competitive
independent entrants such as XO. Prior to the passage of the Telecom Act,
states typically granted an exclusive franchise in each local service area to a
single dominant incumbent carrier  often a former subsidiary of AT&T known as
a Regional Bell Operating Company or RBOC  which owned the entire local
exchange network and operated a virtual monopoly in the provision of most local
exchange services in most locations in the United States. The RBOCs, following
some recent consolidation, now consist of the following companies: BellSouth,
Verizon, Qwest Communications and SBC Communications. Among other things, the Telecom Act preempts state and local governments
from prohibiting any entity from providing telecommunications service, which
has the effect of eliminating prohibitions on entry that existed in almost half
of the states at the time the Telecom Act was enacted. At the same time, the
Telecom Act preserved state and local jurisdiction over many aspects of local
telephone service and, as a result, we are subject to varying degrees of
federal, state and local regulation. Consequently, federal, state, and local
regulation, and other legislative and judicial actions relating to the
telecommunications industry could significantly affect our business. We believe that the Telecom Act provided the opportunity to accelerate the
development of competition at the local level by, among other things, requiring
the incumbent carriers to cooperate with competitors entry into the local
exchange market. We have developed our business and designed and constructed
our networks to take advantage of the provisions of the Telecom Act that
require cooperation from the incumbent carriers, and believe that the continued
viability of the pro-competitive statutory provisions is critical to the
success of the competitive framework contemplated by the Telecom Act. Although the Telecom Act and the related rules governing competition
issued by the FCC, as well as pro-competitive policies already developed by
state regulatory commissions, have enabled new entrants like us to capture a
portion of the incumbent carriers market share of local services, there have
been numerous attempts to limit the pro-competitive policies in the local
exchange services market through a combination of federal legislation, adoption
of new rules by the FCC, and RBOC challenges to existing and proposed
regulations. We expect these efforts to scale back the benefits of the Telecom
Act and local service competition to continue. However, successful
implementation of our business plan is predicated on the assumption that the
basic competitive framework and pro-competitive safeguards will remain in
place. Federal Regulation The FCC exercises jurisdiction over our telecommunications facilities and
services. We have authority from the FCC for the installation, acquisition and
operation of our wireline network facilities to provide facilities-based
domestic interstate and international services. In addition, we have obtained
FCC authorizations for the operation of our LMDS and 39 GHz broadband wireless
facilities. Because XO is not dominant in any of its markets, unlike incumbent
carriers, we are not currently subject to price cap or rate of return
regulation. Thus our pricing policies for end user services are only subject to
the federal guidelines that charges for interstate and international services
be just, reasonable, and non-discriminatory. The FCC allows us to file
interstate tariffs for interstate access services (rates charged by carriers
for access to their networks). As for domestic and international long distance
services, the FCC, requires us to make the terms, conditions and rates of the
detariffed services available to the public on our Company web page, and such
terms, conditions, and rates are located at http://www.xo.com/legal/. The following is a summary of the interconnection and other rights granted
by the Telecom Act that are important for effective local service competition
and our belief as to the effect of those requirements, if properly implemented:  
    
    interconnection with the networks of incumbents and other carriers,
which permits our customers to exchange traffic with customers
connected to other networks;
    
    UNE which is defined as access to incumbent carriers facilities
for our local loops and transport wires that connect the incumbent
carriers central offices and/or customer premises, thereby enabling us
to serve customers not directly connected to our networks; 24




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
    
    reciprocal compensation, which mandates arrangements for local
traffic exchange between us and both incumbent and competitive carriers
and compensation for terminating local traffic originating on other
carriers networks, thereby improving our margins for local service;
    
    number portability, which allows customers to change local carriers
without changing telephone numbers, thereby removing a significant
barrier for a potential customer to switch to our local voice services;
    
    access to phone numbers, which mandates assignment of new telephone
numbers to our customers, thereby enabling us to provide telephone
numbers to new customers on the same basis as incumbent carriers;and
    
    collocation of telecommunications equipment in incumbent carrier
central offices, which enables us to have direct access to unbundled
loops and other network elements and facilitates for efficient
integration with our switching and other network facilities. Although the rights established in the Telecom Act are a necessary
prerequisite to the introduction of full local competition, they must be
properly implemented and enforced to permit competitive telephone companies
like XO to compete effectively with the incumbent carriers. Discussed below are
several FCC and court proceedings relating to the application of certain FCC
rules and policies that are significant to and directly impact our operations
and costs as well as the nature and scope of industry competition. Unbundling of Incumbent Network Elements On August 21, 2003, the FCC released its Triennial Review Order (TRO).
Several carriers and other entities appealed the FCCs TRO decision. On March
2, 2004, the U.S. Court of Appeals for the D.C. Circuit issued its opinion in
United States Telecom Association v. FCC, No. 00-1012 (USTA II Decision). In
the USTA II Decision, the court reversed and overturned many of the conclusions
of the TRO. Specifically, the court found that the FCC improperly delegated to
the states the overall responsibility for deciding whether certain unbundled
elements should remain available to competitive carriers in each of the
respective states. The FCCs determination in the TRO that competitive carriers
should have access to switching platform services as a UNE (UNE-P) was
overturned by the court. The court also overturned the portions of the TRO
which held that competitive carriers should have access to high capacity non-OC
level unbundled dedicated transport circuits at cost-based UNE rates. In
addition, a number of RBOCs have taken the position that they believe the USTA
II Decision overturns portions of the TRO requirement that competitors should
have access to certain non-OC level high capacity loops at cost-based UNE
rates, although we disagree with this interpretation of the USTA II Decision.
We make extensive use of RBOC-provided high capacity local loops to connect our
customers to our network. Therefore, if the RBOCs prevail on their position,
our costs for purchasing high capacity local loops can be expected to increase
depending on final determinations by regulatory agencies and/or the courts and
any such increase could have a material and adverse effect on our cost of
services. The USTA II Decision became effective on June 16, 2004, and the U.S.
Supreme Court has refused to take an appeal of the decision. The FCC will
address the issues reversed and overturned by the USTA II Decision and develop
new rules governing local competitors use of UNEs (New UNE Rules). The FCC
has promulgated interim rules (Interim UNE Rules) which are designed to
preserve the status quo as of June 16, 2004 while the FCC completes a more
comprehensive proceeding to develop the New UNE Rules. The Interim UNE Rules
dictate that the RBOCs will make available all previously available UNEs at
their current cost-based rates for a six month period ending in March 2005.
After the expiration of the Interim UNE Rules, the UNEs overturned by the USTA
II Decision will become unavailable unless the FCC extends the interim rules,
promulgates new replacement UNE rules, or creates a transition period. The
Interim UNE Rules propose that, effective March 15, 2005, the RBOCs (i) can increase the price of existing provisioned UNEs by 15%, and
(ii) change special access, or retail rates, on new orders for the use of the RBOC network assets formerly available as
UNEs. If the FCC does not adopt New UNE Rules prior to March 2005 that alter
the proposed Interim UNE Rules price increases, XOs financial condition and
results of operations could be materially and adversely affected. The FCC has indicated that it expects to adopt the New UNE Rules prior to
March 2005, although there is no assurance that it will do so, or that such New
UNE Rules would continue to provide us access to all UNEs, at cost-based rates,
that we use today. If the FCC does not complete its New UNE Rules in a timely
fashion, our ability to obtain access to certain unbundled network elements and
incumbent network upgrades at cost-based rates may be curtailed or become more
costly in the future. The FCC has urged competitive carriers and incumbent
carriers to engage in good faith, commercial negotiations to agree upon rates,
terms and conditions for the continued availability of UNEs impacted by the USTA II Decision. We are engaged in
such commercial negotiations with several incumbent carriers but, at this time,
we cannot predict the outcome of these negotiations or whether they will result
in preserving existing UNE rates. In addition, if the FCC is unable to adopt
New UNE Rules prior to March, 2005, we have petitioned the FCC to, at a minimum,
act on an emergency basis to require that DS1 level UNE loops continue to be
made available at cost-based rates. XO is unable to predict at this time
whether our petition will be granted. 25




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Although these rules adopted by the FCC in the TRO became effective on
October 2, 2003, many of the requirements imposed by the FCC in the TRO were
not self-executing. Accordingly, the FCC made clear that carriers must follow
the change of law procedures in their applicable interconnection agreements
with RBOCs to implement any TRO requirements that are not self-executing and
that carriers must follow the procedures set forth in section 252(b) of the
Telecom Act to modify interconnection agreements that are silent as to
implementation of changes in law. We have been in negotiations with incumbent
carriers to amend our interconnection agreements to implement relevant TRO
requirements and, to date, have executed amendments in several states. The United States Telephone Association, Qwest Communications
International, Inc. and the Verizon telephone companies have filed a petition
with the U.S. Court of Appeals for the D.C. Circuit,
requesting the court to, among other things, overturn the Interim UNE Rules. On
October 6, 2004, the court declined to rule on that petition
pending further order of the court and directed the parties to
file motions governing further proceedings by January 4, 2005. Additionally, it
is our understanding that the RBOCs will continue to seek to institute
follow-on administrative proceedings with the FCC and state regulatory
agencies, and lobby the United States Congress, all in an effort to affect laws
and regulations in a manner even more favorable to them and against the
interests of competitive carriers. The RBOCs have many petitions pending with
the FCC that have not been acted on at this time. At the same time, we
anticipate that competitive carriers will endeavor to improve their positions
and access to the RBOCs networks through similar means. The final outcome of
the appellate review and FCC rulemaking proceedings remains unknown at this
time, but it is possible that further changes to the rules could adversely
affect our cost of doing business by substantially increasing our cost of
purchasing or leasing network facilities, which include UNEs, from the RBOCs
and other incumbent carriers. Intercarrier Compensation Reform.Currently, telecommunications carriers are required to pay other carriers
for interstate access charges and local reciprocal compensation charges. These
two forms of intercarrier compensation have been under review by the FCC since
2001. The FCC continues to consider a broad order reforming the intercarrier
compensation system and the following specific proceedings also impact
intercarrier compensation issues for us. Level (3) Forbearance Petition. On December 23, 2003, Level(3) filed a
petition for forbearance requesting the FCC to forbear from application of
interstate or intrastate access charges on Internet protocol (IP) traffic that
originates or terminates on the public switched telephone network (PSTN). If
the FCC grants Level (3)s petition, we would expect that there would be
reductions in our network costs associated with the termination of certain
IP-to-PSTN and PSTN-to-IP traffic. If, on the other hand, the FCC rules against
Level(3) and adopts rules that require interstate access charges to be paid for
the termination of IP-to-PSTN traffic, our network costs will increase. AT&T Declaratory Ruling Re: VoIP.AT&T petitioned the FCC to find that
voice over Internet protocol (VoIP) services, including phone to phone
services, are exempt from switched access charges. On April 21, 2004, the FCC
released an Order denying AT&Ts petition (the AT&T Order). The FCC held that
an interexchange service that uses ordinary customer premises equipment that
originates and terminates on the public switched telephone network, that
provides no enhanced functionality, and that undergoes no net protocol
conversion, is a telecommunications service and subject to switched access
charges. The FCC did not make a determination regarding the retroactive
applicability of access charges to the foregoing type of interexchange service.
While the AT&T Order addressed a limited fact pattern, the order places
interexchange services similar to those VoIP services offered by AT&T in the
same regulatory category as traditional telecommunications services and,
therefore, subjects such VoIP services to access charges and other regulatory
obligations including Universal Service fees. AT&T has filed another petition
asking the FCC to declare that certain of its enhanced prepaid calling card
services are exempt from access charges, but the FCC has not yet ruled on that
request. Like a growing number of carriers, we utilize Internet protocol
technology for the transmission of a portion of our network traffic. The FCC
has now made clear that, to the extent such services share the same
characteristics as those addressed in the AT&T Order, they will be treated as
regulated services subject to access charges going forward. Although the FCC
did not rule on the applicability of access charges for services prior to April
21, 2004, the RBOCs may attempt to assert claims against other telecommunications companies including us for the retroactive
payment of access charges. On April 22, 2004, SBC Communications filed a
collections lawsuit against AT&T seeking retroactive payment of unpaid access
charges. 26




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Pricing of Unbundled Network Elements FCC TELRIC Proceeding.On September 10, 2003, the FCC initiated a new
proceeding to consider significantly revamping the current Total Element Long
Run Incremental Cost (TELRIC) methodology used for the pricing of unbundled
network elements. If the FCC reverses the methodology used for determining UNE
rates to allow for rate increases, such a determination will allow the
incumbent carriers to increase unbundled network element rates and this could
substantially raise XOs costs for leasing unbundled network elements in the
future. A decision is expected sometime in 2005. Several state commissions have
also initiated proceedings to review the rate levels that the incumbent
carriers charge for unbundled network elements. An adverse ruling in these
proceedings would allow the incumbent carriers to increase unbundled network
element rates in the applicable state and this could substantially raise our
costs for leasing unbundled network elements in the future. California PUC Proceeding.On September 23, 2004, the California Public
Utilities Commission issued a decision that requires SBC to
adjust monthly recurring rates for certain types of services offered by SBC. As
a result of this decision, we believe that we are owed a retroactive credit.
The decision is still subject to appeal so we are currently unable to determine
the amount or the timing of the expected credit. Provision of Broadband Telecommunications Services and Information Services Prior to the issuance of the TRO, the network elements that could be used
for broadband services had to be made available as unbundled elements to
competitors. However, at the urging of the RBOCs and other incumbent carriers,
the FCC, in the TRO, greatly curtailed the extent to which the incumbents must
unbundle the broadband portion of their networks that serve mass market
customers. The RBOCs continue to push for further deregulation through federal
and state legislative efforts. In addition, it is anticipated that deregulatory
legislation will be pursued by the RBOCs in Congress. In addition to possible
legislation, the FCC has initiated another pending proceeding that could relax
incumbent carriers obligation to make unbundled network elements that are used
for certain broadband or information services available to us. The FCC has
issued a Notice of Proposed Rulemaking entitled Appropriate Framework for
Broadband Access to the Internet Over Wireline Facilities that requests
comments on the proper classification of broadband access services as either
regulated telecommunications services or unregulated information services. The
TRO decision, in conjunction with a decision in this proceeding, a legislative
change or a court ruling further broadening the definition of what constitutes
unregulated information services, could have the effect of allowing RBOCs to
provide terms, conditions and pricing to their own affiliates that provide data
or information services that are better than those made available to
competitive carriers such as us. To date these deregulatory trends have been
directed towards facilities used primarily by mass market customers, as opposed
to our enterprise customers. An extension of these trends to the enterprise
market could adversely affect our cost of doing business by increasing the cost
of purchasing or leasing such facilities from the RBOCs. Broadband Relief.On October 22, 2004 the FCC announced that it has
approved a request filed by Verizon to grant forbearance from the requirement
to make available to competitive carriers the following specific network
elements: fiber-to-the-home or FTTH loops, fiber-to-the-curb or FTTC loops, the
packetized functionality of hybrid copper-fiber loops, and packet switching.
The FCC concluded that, for those broadband loop facilities for which
unbundling obligations have been eliminated, the corresponding access
obligations should also be eliminated. Previously, the FCC had released similar
unbundling relief orders affecting multiple dwelling unit and fiber-to-the-curb
deregulation. Because of its express limitation to FTTH, FTTC, hybrid loops,
and packet switching, these orders should only limit availability for those
specific network elements, which are not material to us. It is possible,
however, that the RBOCs will seek additional broadband regulatory relief in
future proceedings. 27




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Universal Service.In 1997, the FCC established a significantly expanded federal
telecommunications subsidy regime known as universal service. Specifically,
the FCC established new subsidies for services provided to qualifying schools
and libraries and rural health care providers, and expanded existing subsidies
to low income consumers. Most telecommunications companies, including XO, must
pay for these programs based on their share of interstate and international
telecommunications end user revenues. On September 16, 2004, the FCC released a
public notice announcing that the universal service contribution factor for the
third and fourth quarters of 2004 will remain at 8.7 percent. The FCC has taken
further steps to modify the system for assessment and recovery of universal
service funds. In a Notice of Proposed Rulemaking issued in December, 2002, the
FCC asked many broad-ranging questions regarding universal service, including whether to change
its method of assessing contributions due from carriers by basing it on the
number and capacity of connections they provide, rather than on interstate and
international end user revenues they earn. If the FCC amends its rules so that
universal service contributions are based on the number and capacity of
interstate and international telecommunications circuits, we expect our
Universal Service payment obligations to increase and would expect to pass any
such rate increase through to our customers. At this time, XO is unable to
predict whether the FCCs rulemaking or legislative initiatives will increase
the size of our subsidy payments, the scope of the subsidy program, or our
costs of calculating, collecting and remitting the universal service related
payments. Item 3. Quantitative and Qualitative Disclosures about Market Risk We had $358.9 million in secured loans as of September 30, 2004.
Currently, we do not pay cash interest on the loans under the Credit Facility
and accrued interest converts to principal ratably throughout the loan period.
As interest accrues at variable rates, our Credit Facility subjects us to
interest rate risks. Marketable and other securities, available for sale, at September 30, 2004
consist primarily of investments in equity and debt securities of
publicly-traded companies. The fair value of our investment in equity and debt
securities exposes us to market risk; however, if the fair value were to
increase or decrease immediately, it would not likely have a material impact on
our financial position or our results of operations. We are not currently
engaged in the use of off-balance sheet derivative financial instruments, to
hedge or partially hedge interest rate exposure nor do we maintain any other
off-balance sheet arrangements for the purposes of credit enhancement, hedging
transactions, or other financial or investment purposes. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures The term disclosure controls and procedures is defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. These rules
refer to the controls and other procedures of a company that are designed to
ensure that information required to be disclosed by a company in the reports
that it files under the Exchange Act is recorded, processed, summarized and
reported within required time periods. Our Principal Executive Officer and our
Principal Financial Officer have evaluated the effectiveness of our disclosure
controls and procedures as of the end of the quarterly period covered by this
report. Based on the evaluation, they have concluded that, as of the end of
such period, the controls and procedures were effective at ensuring that
required information was accurate and disclosed on a timely basis in our
reports filed under the Exchange Act. Changes in Internal Controls We maintain a system of internal accounting controls that are designed to
provide reasonable assurance that our books and records accurately reflect our
transactions and that our established policies and procedures are followed. As of June 23, 2004, the newly combined company has been aggressively
working to consolidate overlapping processes, controls, and systems. With the
exception of Carrier Access Billings and the legacy-Allegiance revenue cycle,
the vast majority of overlapping processes, systems, and controls have migrated
to the legacy-XO control environment. The Carrier Access Billings process for
the combined entity has migrated to the legacy-Allegiance control environment.
The legacy-Allegiance revenue cycle remains unchanged but is subject to the
same internal controls over financial reporting that we apply to our legacy
businesses. 28




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PART II. OTHER INFORMATION Item 1. Legal Proceedings In addition to the claim filed against the ATLT that is discussed in Note
2, we are involved in lawsuits, claims, investigations and proceedings
consisting of commercial, securities, tort, employment and telecommunications
regulatory matters, which arise in the ordinary course of business. In
accordance with Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies (SFAS 5), we make a provision for a liability when it is
both probable that a liability has been incurred and the amount of the loss can
be reasonably estimated. We believe we have adequate provisions for any such
matters. Disputes with respect to general unsecured claims and two
administrative expense claims against us in the aggregate amount of
approximately $21.5 million remain pending from our 2002 Chapter 11
proceedings. We review these provisions at least quarterly and adjust these
provisions to reflect the impacts of negotiations, settlements, rulings, advice
of legal counsel, and other information and events pertaining to a particular
case. Litigation is inherently unpredictable. However, we believe that XO has
valid defenses with respect to legal matters pending against it. Nevertheless,
it is possible that cash flows or results of operations could be materially
affected in any particular period by the unfavorable resolution or disposition
of one or more of these contingencies. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. Item 3. Defaults Upon Securities None. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the quarter
ended September 30, 2004. Item 5. Other Information None. Item 6. Exhibits Exhibits10.1
    
    Indemnification Agreement, dated as of November 2, 2004, by
and among Mr. Adam Dell, Starfire Holding Corporation, and XO
Communications, Inc.10.2
    
    Indemnification Agreement, dated as of November 2, 2004, by
and among Mr. Robert L. Knauss, Starfire Holding Corporation, and XO
Communications, Inc.10.3
    
    Indemnification Agreement, dated as of November 2, 2004, by
and among Mr. Fredrik C. Gradin, Starfire Holding Corporation, and
XO Communications, Inc.31.1
    
    Rule 13a  14(a)/15(d)  14(a) Certification31.2
    
    Rule 13a  14(a)/15(d)  14(a) Certification32.1
    
    Certificate pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certificate pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 29




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized. XO Communications, Inc.Date: November 9, 2004
    
    By: /s/ William GarrahanWilliam GarrahanSenior Vice President and ActingChief Financial Officer(Principal Financial Officer)
 30