**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.   20549**

 

**Form 10-K**

 

**ý****ANNUAL REPORT UNDERSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Forthe fiscal year ended December 31, 2003**

 

**or**

 

**o****TRANSITION REPORT UNDERSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

#### ** **

**Forthe transition period from               to               **

 

**CommissionFile Number 0-27024**

 

**METRO ONETELECOMMUNICATIONS, INC.**

(Exact name of registrant as specified in itscharter)

 
| **Oregon**                                                                                                |   | **93-0995165**                       |
|-----------------------------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                                           |   | (I.R.S. Employer Identification No.) |
|                                                                                                      |   |                                 |
| **11200 Murray Scholls Place**                                                                            |   | **Beaverton, OR  97007**        |
| (Address of principal executive offices)                                                                  |
|                                                                                                      |   |                                 |
| Registrant’s telephone number, including  area code:       **503-643-9500** |
|                                                                                                      |   |                                 |
| Securities registered pursuant to  Section 12(b) of the Act:                                         |
| **NONE**                                                                                                  |
|                                                                                                      |   |                                 |
| Securities registered pursuant to  Section 12(g) of the Act:                                         |
| **Common Stock, No Par Value**                                                                            |
| (Title of Class)                                                                                          |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. YES  ý    NO  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).       YES  ý    NO  o

 

The aggregate market value of the voting and non-voting common equityheld by non-affiliates, (which excludes shares held by Sonera Holding B.V.)based on the closing price of the common stock as reported by the NasdaqNational Market on June 30, 2003 was $95,221,383.

 

The number of shares outstanding of the registrant’s common stock, asof March 8, 2004, was 24,775,341.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the registrant’s Proxy Statement for its 2004 AnnualMeeting, to be filed with the Securities and Exchange Commission within 120days of the registrant’s fiscal year end, are incorporated by reference intoPart III of this Report.

 

 

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**METROONE TELECOMMUNICATIONS, INC.**

**2003FORM 10-K ANNUAL REPORT**

**TABLEOF CONTENTS**

 
| **PART I**   |   |
|--------------|--------|
|         |   |   |   |
| Item 1       |   | Business |   |
|         |   |   |   |
| Item 2       |   | Properties |   |
|         |   |   |   |
| Item 3       |   | Legal  Proceedings |   |
|         |   |   |   |
| Item 4       |   | Submission of Matters to a Vote of Security  Holders |   |
|         |   |   |   |
| **PART II**  |   |
|         |   |   |   |
| Item 5       |   | Market for Registrant’s Common Equity and  Related Stockholder Matters |   |
|         |   |   |   |
| Item 6       |   | Selected Financial Data |   |
|         |   |   |   |
| Item 7       |   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|         |   |   |   |
| Item 7A      |   | Quantitative and Qualitative Disclosures  about Market Risk |   |
|         |   |   |   |
| Item 8       |   | Financial Statements and Supplementary Data |   |
|         |   |   |   |
| Item 9       |   | Changes In and Disagreements With  Accountants on Accounting and Financial Disclosure |   |
|         |   |   |   |
| Item 9A      |   | Controls and Procedures |   |
|         |   |   |   |
| **PART III** |   |
|         |   |   |   |
| Item 10      |   | Directors and Executive Officers of the  Registrant |   |
|         |   |   |   |
| Item 11      |   | Executive Compensation |   |
|         |   |   |   |
| Item 12      |   | Security Ownership of Certain Beneficial  Owners and Management |   |
|         |   |   |   |
| Item 13      |   | Certain Relationships and Related  Transactions |   |
|         |   |   |   |
| Item 14      |   | Principal Accountant Fees and Services |   |
|         |   |   |   |
| **PART IV**  |   |
|         |   |   |   |
| Item 15      |   | Exhibits, Financial Statement Schedules,  and Reports on Form 8-K |   |
|         |   |   |   |
|         |   | Signatures |   |

 

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*In this annual report on Form 10-K, “MetroOne” and the terms “Company,” “we,” “us” and “our” refer to Metro OneTelecommunications, Inc.*

# ** **

# **PART I**

# ** **

**ITEM 1****.****                  BUSINESS.**

 

Metro One isthe leading developer and provider of Enhanced Directory Assistance®and other information services.  Wecontract primarily with wireless carriers to provide our services to theirsubscribers.  In addition to being aplatform for providing directory assistance listings, Enhanced DirectoryAssistance includes a number of content features, such as MetroDex®, a service thathandles personal contacts and calendars, and TeleConcierge®, formaking reservations and performing other concierge services.  Enhanced Directory Assistance also includesa number of connectivity features, such as StarBack® and AutoBack®,return-to-operator features that help to ensure that a caller gets the mostfrom every call, and NumberBack® and QuickSend®, featuresthat allow a requested number or other information to be sent to a caller’stelephone.  Many of our features oraspects thereof are the subject of patents or pending patent applications.

 

We have been in business since 1989, when we began developing andtesting provision of information services over the telephone.  In 1991, we entered into our first contractwith a wireless carrier to provide our services to that carrier’s subscriberson a charge-per-call basis.  Ourcustomers include several of the leading wireless and other telecommunicationscarriers such as Nextel Communications, ALLTEL Communications, XOCommunications and Cablevision.  Inaddition, we have expanded into the landline telecommunications market andprovide our services to regional competitive local exchange carriers.

 

In May 2003, we launched Infone®, a servicethat provides Enhanced Directory Assistance and personal assistant servicesdirectly to consumers.  Callers may use theservice from nearly any domestic telephone, landline or wireless, simply bydialing “888-411-1111.”  Billing ishandled by using a major credit card. Calls can be connected nationwide and to Canada and Puerto Rico for theall-inclusive price of 89 cents for any call of up to 15 minutes, plus 5 centsper minute after that.  Infone offers anumber of additional features, including “My InfoneTM,” a personalassistant service which brings a caller’s personal preferences to bear on acall, and Voice E-mailTM, which allows callers to send e-mail from atelephone without the use of a computer on their part.  As of February 20, 2004, we hadapproximately 58,000 Infone subscribers.

 

### **TelecommunicationsIndustry**

### ** **

The U.S. telecommunications industry has generally been characterizedby strong growth and increased competition due to new technologies, a morefavorable regulatory environment and, for carriers, an increasinglysophisticated and demanding subscriber. Telecommunications carriers face increasing competitive pressures todifferentiate their products and establish brand loyalty.  With rising costs to acquire newsubscribers, carriers are seeking ways to minimize subscriber turnover throughthe use of, among other things, value-added services and features.  In addition, carriers are increasinglyoffering local, long distance, wireless, cable and Internet services bundledinto one package in order to appeal to a wider market.  Competitive pressures are particularly acutefor wireless and newer landline carriers, such as competitive local exchangecarriers.  The industry has alsoexperienced a considerable amount of consolidation and investment in newtechnologies and alternative methods of delivery, including cable and theInternet.

 

*Wireless Telecommunications.*  The U.S. wireless telecommunications markethas experienced dramatic growth over the last decade.  This growth has been due largely to technological advances thatgive callers affordable, high-quality mobile services.  According to industry analysts, the numberof wireless subscribers in the United States will reach nearly 200 million bythe end of 2006.  A relatively smallnumber of carriers dominate the wireless telecommunications market.  In terms of estimated number of subscribers,the largest U.S. wireless carriers include Verizon Wireless, AT&T WirelessServices and Cingular Wireless.  Othernationwide carriers include Sprint PCS, Nextel Communications and T-Mobile.

 

Competition in the industry has been intense with at least fivecarriers competing for wireless subscribers in most major U.S. markets.  With slowing subscriber growth and downwardpressure on average revenue per user (“ARPU”), carriers are seeking todifferentiate themselves from their competitors.  While pricing pressures are fierce, carriers also focus onvalue-added services and features as a means of differentiatingthemselves.  As subscriber and ARPUgrowth slow, most observers expect significant consolidation to occur in theindustry in the next several years, as evidenced by the recent announcement ofthe proposed merger of Cingular Wireless and AT&T Wireless.

 

*LandlineTelecommunications.* The U.S. landline telecommunications market is significantly larger thanthe U.S. wireless market.  For example,in 2001, domestic landline services generated approximately $227 billion inrevenues as compared to approximately $75 billion in revenues generated bywireless services, according to the Federal Communications Commission.  Like the wireless market, the landlinemarket is dominated by a relatively small number of major carriers.  Carriers providing local service include theregional Bell operating

 

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companies, such as SBC Communications, independent telephone companies,such as ALLTEL Communications, and competitive local exchange carriers, such asCox Communications or Integra Telecom. Carriers providing long distance service include AT&T, MCI WorldComand Sprint Corp., as well as many discount long distance companies.  In addition, cable companies are beginningto offer packaged services including local and long distance telephoneservices.

 

Local and long distance carriers competing in each other’s markets, aswell as against newer and smaller independent carriers, have added to competitionin the landline market.  Withderegulation, the entry of new landline competitors and the increasingaffordability of wireless services, subscribers who were historically bound tolocal carriers as a matter of geography are now increasingly able to choosetheir carriers.  This includes theopportunity to select a competitive local exchange carrier.  These companies compete with incumbent localcarriers to provide a variety of services, including local, long distance andInternet and other data services.  As aresult, the landline telecommunications market is rapidly becomingsubscriber-based and carriers must find ways to differentiate their services toattract and retain subscribers.  Inaddition, to maintain operational focus, competitive local exchange carriersoften outsource non-core operations, including directory assistanceservices.  While many incumbent carriersprovide directory assistance services on an outsourced basis, the competitivelocal exchange carriers may prefer to outsource their directory assistanceneeds to independent companies rather than use the services of theircompetitors.

 

### **DirectoryAssistance Market**

### ** **

Call volumes generated by the wireless directory assistance market inthe United States are estimated to grow significantly to over 3.6 billion callsby the end of 2006, according to some industry sources, among which individualestimates vary.  Wireless subscriberstend to be heavy users of directory assistance services.  According to Frost & Sullivan, growth inthe wireless directory assistance market is driven by a number of factors,including growth in the wireless subscriber base, rising wireless penetration,increasing subscriber mobility and the offering of quality directory assistanceservices by wireless carriers.

 

The landline directory assistance market today is larger than thewireless directory assistance market. According to industry sources, landline directory assistance isprojected to reach four billion calls by the end of 2006.  Growth in the landline directory servicesmarket is driven by a number of factors, including the growing informationneeds of subscribers and the offering by landline carriers of call completionservices. However, the Pelorus Group projects that by the end of 2006, wirelessdirectory assistance revenues will have surpassed that of landline directoryassistance, amounting to nearly 57% of total directory assistancerevenues.  In addition, enhancedservices are expected to account for nearly 37% of all directory assistancecalls by the end of 2006.

 

Unlike other aspects of telecommunications services, directoryassistance pricing has seen a period of rising retail prices in the lastseveral years.  For example, inJune 2001 the range of retail prices charged for a directory assistancecall among the major wireless carriers was $0.75 to $1.29, with a majority oflarge carriers at $0.99 per call.  InJanuary 2004 this same range was $1.00 to $1.40, with the majority oflarge carriers at $1.25.  During thissame timeframe, prices for many other telecommunications services have trendeddownward.

 

### **Customers**

### ** **

Our principal business involves providing Enhanced Directory Assistanceand information services to several of the nation’s leading wireless carriersin all or a portion of their service areas. Our carrier customers include Nextel Communications and ALLTELCommunications and, during a transition period, AT&T WirelessServices.  In addition, we provide ourservices to certain competitive local exchange carriers in the landlinetelecommunications market.  Customersthat accounted for more than 10% of our revenues during any of the periodsindicated are as follows:

 
|                       |   | **Years  ended December 31,** |   |
|----------------------------|--------|-------------------------------|--------|
| **Customer**               |   | **2003**                      |   | **2002** |   | **2001** |   |
| AT&T Wireless Services |   | 44                            | %      | 33 | % | 30 | % |
| Nextel Communications      |   | 35                            |   | 24 |   | 23 |   |
| Sprint PCS                 |   | 13                            |   | 33 |   | 32 |   |

 

Our contract with AT&T Wireless expired on December 1, 2003,and we were unable to reach an economic arrangement acceptable to both parties,thus, our negotiations did not result in a new contract to replace the existingone.  We expect that the call volumefrom AT&T Wireless will transition away from us during the second quarterof 2004.  The expiration of our contractwith AT&T Wireless will have a material adverse effect on our financialposition, future operating results and cash flows, as well as ouroperations.  We expect to adjustpersonnel, call centers and network capacities in order to address varyingbusiness circumstances, including the expiration of this contract.

 

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Our contract with Sprint PCS expired on December 31, 2002.  We agreed to a transition arrangement withSprint PCS, pursuant to which we continued to handle its subscribers’ callssubsequent to December 31, 2002. The transition began in March 2003 and was substantially completedby June 30, 2003.

 

We offer our services to a carrier’s subscribers under a brand nameselected by the carrier, such as “Nextel 411” or “ALLTEL Directory Plus.”  The carrier establishes its own feestructure with its subscribers.  Subscriberstypically pay the carrier’s fees ranging from $1.00 to $1.40 plus airtimecharges for our services.  We chargecarriers directly and, at present, bear no subscriber collection risk.  We charge our customers on a per callbasis.  To stimulate increased callvolume and to attract and expand customer commitments, we offer volume-pricingdiscounts to certain of our customers. Our success with this program in thepast resulted in call volume increases, which caused our average revenue percall to decrease.

 

### **We currently provide our servicesto several carrier customers in addition to various affiliates of AT&TWireless Services.  The terms of thesecontracts are generally similar, with variations in the geographic market to beserved, the services and features we are to provide the carriers’ subscribersand the term, which is generally up to five years.  None of these contracts precludes us from providing services toothers.  Generally, carrier customersagree to route some or all of their directory assistance calls to us.**

### ** **

### **We also provide enhancedinformation and directory assistance services directly to retail and enterprisecustomers through our Infone service.**

### ** **

### **Call Centers andNetwork**

### ** **

We operate 31 call centers strategically located in markets throughoutthe United States.  Our call centernetwork enables us to provide Enhanced Directory Assistance and informationservices nationwide.  We are located inor near major metropolitan areas and therefore are situated locally for morethan one-half of the U.S. population. We believe that the local nature of our call centers and operatorspermits us to offer more accurate and valuable service than would be availablethrough a single or a few call centers attempting to serve the entire U.S.market.  We operate our call centers 24hours a day, seven days a week, 365 days a year.

 

We have historically adjusted our call center personnel, and expect toadjust personnel, call centers and network capacities in order to addresschanges in volume demands caused by the expiration of carrier contracts and thedevelopment of our recently launched Infone service.  Capacity needs will vary significantly as a result of changes involume from existing customers, changes in usage within existing marketsserved, changes in our carrier customers and/or the number of calls they routeto us or as a result of our Infone service or alternative strategies to attractadditional calls.  We will continue toopportunistically pursue additional significant new business.

 

We periodically upgrade our network and systems to allow greaterutility, speed and efficiency in processing calls.  We also frequently expand our capacity to store, manipulate andmanage the additional data that we acquire. In addition, our telephone switching systems allow scalability,including the ability to join multiple switches together or configure switchesso that they can handle large volumes of calls.  These systems, covering all of our call centers, are monitoredand supported on a 24-hour per day basis from our network operations centerlocated at our corporate headquarters. We have designed our systems to permit redundancy and avoid downtimefrom natural disasters or other adverse events.

 

We believe quality and reliability are important considerations in acustomer’s decision to use our services. To ensure high quality and consistency, we emphasize training,monitoring and customer support.  Wemaintain a national training force with training personnel in each callcenter.  Our operators undergo extensivetraining and testing on search techniques, etiquette and local information,including landmarks, major thoroughfares and geography.  We continually monitor, test and evaluatecall center performance.  We alsomonitor our call centers for compliance with contract performance standards andreport this information to the carriers on a regular basis.  In addition to accessing our systemsmaintenance and support personnel, customers can obtain extensive customerusage information.

 

We are deploying a voice over Internet protocol (“VoIP”) capability toroute voice traffic over a data network. VoIP not only provides excellent quality of service but substantiallyreduces transport cost from the traditional call routing over the PublicService Telephone Network.  Inconjunction with this underlying technology, we also intend to further refineour system of dynamic call routing, which, together with VoIP, provides us withthe ability to quickly route calls from call center to call center, bothimproving our call efficiency and protecting our service levels.

 

Recently, we completed the conversion of ourdigital telecommunications network from Multi Frequency Voice Circuits toSystem Signaling 7 (“SS7”).  SS7supports a vast range of services accessible from a variety of user terminals,including basic phones and more complex multimedia devices.  Originally developed for IntelligentNetworks simply to connect calls using out-of-band signals, SS7 is now drivingmajor Advanced Intelligent Network network-based application services such asremote voicemail retrieval, calling-card services and 1-800 access.

 

5

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### **Our Services andFeatures**

### ** **

We use a customized array of hardware and software, along withproprietary database search engines, to provide our Enhanced DirectoryAssistance and information services.  Wereceive incoming calls by means of assigned telephone numbers, which, in almostall cases are “411,” “555-1212,” “00” or retail 800 numbers such as“888-411-1111.”  Our operators answerincoming calls and, in the case of carrier customers, identify the serviceusing the appropriate customer’s brand name. In some cases we use speaker verification and other means to identifycallers and greet them by name, a patented feature of our Infone service.  Upon receiving information requests fromcallers, operators search applicable databases using one or more of our searchengines.  The operator then connects thecaller to the called party or supplies the caller with the requested information.  We offer a variety of information andservices, including the following:

 

•      Directory listingsinformation, which may be retrieved by methods that include reverse andcategory searches;

 

•      Contacts and calendarmanagement and other personal assistant services;

 

•      Movie, local event and venueinformation;

 

•      TeleConcierge® services,including hotel and restaurant information and reservations;

 

•      Turn-by-turn drivinginstructions; and

 

•      Weather conditions androadside assistance.

 

Our Enhanced Directory Assistance and information services alsoincorporate connectivity features that make the telephone more useful andeasier to use.  These connectivityfeatures include the following:

 

•      Call completion – allows acaller to be directly connected to the number requested without the need toredial;

 

•      StarBack® – allows thecaller to return to a live operator simply by pressing a key, such as the star[*] key or by otherwise issuing a command at any time during a call;

 

•      AutoBack® – automaticallyreturns the caller to a live operator or provides other options upon a busysignal, “ring-no-answer” or other common situations without pressing a singlekey;

 

•      NumberBack® – sends thecaller the called number simply by pressing the number [#] key;

 

•      QuickSend®  – a short messaging service allowing ouroperators to send customized alphanumeric messages on behalf of a caller; and

 

•      Voice E-mailTM –allows a caller to send an audio e-mail message in his or her own voice withouta computer.

 

### **Database Systemsand Content**

### ** **

We believe the quality of our services is related to the scope,quantity and quality of the information content that resides within ourdatabase systems.  The majority of theinformation that we acquire, develop and maintain is telephone listings data.  To ensure high quality and accuracy, weobtain these listings data from multiple sources, including certain of theregional Bell operating companies, independent telephone companies and othercommercial sources.  These data areenhanced by our direct data collection efforts and a principal database oflocal information is developed for each call center or region.

 

Our proprietary operator interface software allows operators toefficiently and simultaneously search and reverse-search multiple databases.   Our search engine has been optimized fordirectory assistance services and large national databases, providingsub-second search times even in complex searches.  We use proprietary database management systems to maintain andupdate our directory listings.  Wecontinually acquire additional content or access to content that will, in manycases, build on these listings data to make them more useful.  Acquisitions are made from a variety ofsources and are supplemented with information relating to local events andamenities.

 

We build application-specific databases for a variety of portals, bethey wired or wireless, voice or data. Our proprietary data extraction and processing technology enables thecreation and ongoing maintenance of high quality databases from distributed andfragmented data on the web and elsewhere. We believe that these capabilities will contribute to the expansion ofour services and data offerings to our wireless and other customers.

 

### **Marketing**

### ** **

We market to telecommunications carriers, businesses, governmentalunits, other enterprises and anyone who may be a potential caller or user ofour information services.  The marketingprocess involves a considerable amount of time and attention by our seniormanagement.  Call center managers alsoplay a key role in maintaining and developing wholesale customerrelationships.  Some of our contractswith carrier

 

6

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customers provide for their promotion of the services we provide to thecarrier’s subscribers.  In addition, weoccasionally assist our carrier customers in the promotion of theseservices.  We intend to continue toparticipate in marketing services in conjunction with carrier programs.

 

We communicate on a regular basis with our existing carrier customersthrough our quality assurance and customer service programs.  We have developed proprietary programs thatallow us and our customers to monitor the quality of our performance and thevolume and duration of directory assistance and information requests on areal-time basis.  These programs alsogive us an opportunity to learn more about our carriers’ evolving needs.

 

We have expended significant efforts and funds advertising Infonethrough a variety of media including television, radio, outdoor advertising anddirect mail to create brand awareness and attract subscribers, and we expect tocontinue marketing and promotional activities in the future.  We continually monitor the results of mediacampaigns and their effectiveness.  Inaddition, we administer a variety of product promotion campaigns and customerreferral programs designed to attract subscribers and users of our Infoneservice.

 

### **Technology**

### ** **

Our ability to provide Enhanced Directory Assistance and informationservices is dependent to a great extent on our proprietary technology.  Our proprietary software applicationsenhance our call handling and delivery capabilities and provide the basis forour connectivity features.  We havedeveloped search engines to quickly access information from our databases.  We continue to upgrade our operatorinterface software, database management systems and search engines to increasethe efficiency and broaden the search capability of our operators.

 

Our call processing systems incorporate programmable switchingequipment, host computers, voice response units and database servers.  Our technology is powered by customizedsoftware.  One of the characteristics ofour call processing systems is the ability to take all calls from a switch andhave these run through our switch for the entire length of the call so that weare able to provide a full range of our services to the caller.

 

We are also monitoring technological advances in the methods ofdelivery of information and data and are working to insure that our systems arecompatible with, and we can take advantage of, such developments.  We believe that by expanding reliance on thetelephone as a source of information, the application of various new data andvoice technologies will also benefit our Enhanced Directory Assistance andinformation services business.

 

### **IntellectualProperty**

### ** **

We rely on a combination of trademark, patent and trade secrets lawsand confidentiality procedures to protect our intellectual propertyrights.  We have 17 U.S. patents issuedand one foreign patent issued, including four relating to our StarBacktechnology and others associated with our turn-by-turn driving directions andother services.  We recently have beenallowed six sets of additional claims, each of which we expect to result in anadditional issued patent.  We haveapproximately 111 applications pending for additional U.S. and foreignpatents.  We also have U.S. and foreignregistered trademarks for, among others, “Metro One,” “StarBack,” “AutoBack”and “Infone,” and numerous other applications pending for U.S. trademarkregistrations.

 

### **Competition**

### ** **

The directory assistance and information services markets arecharacterized by rapidly changing market forces, technological advancements andincreasing competition from large carrier-affiliated companies and smallindependent companies.  Our principalcompetitors include regional Bell operating companies and other independentproviders.  Telephone carriers, bothlandline and wireless, provide directory assistance or information servicesboth in and outside their own operating regions.  Although we believe that none of these competitors offers a formof directory assistance that incorporates all of our features, they may havesubstantially greater financial, technical and marketing resources than we doand may be able to offer features similar to ours in the future.  We also face competition from independentcompanies seeking to offer forms of directory assistance and other informationservices.  Included among these are firmsthat offer full or partial automation (with little or no involvement by a liveoperator) and firms offering low cost, low quality directory assistanceprovided by overseas operators.

 

We believe the principal competitive factors in the directory assistancemarket are quality and range of features, technological innovation, experience,responsiveness to customers and price. Historically, we have sought to distinguish ourselves from ourcompetitors based on the quality of our services, the development of usefulfeatures, the breadth of the content provided and our extensive nationalnetwork of call centers.  In recentyears, wireless carriers appear to have become more focused on reducing costs,even if such reduction results in diminished services and quality.  In addition, other sources of directoryassistance, such as automation and those provided by offshore call centers andthe Internet, provide low cost forms of competitive services.

 

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### **Government Regulation**

### ** **

While in the past, our principal business as a wholesale supplier ofenhanced directory assistance and information services for telecommunicationscommon carriers has not been directly regulated, the offering of those servicesto the public by our customers is regulated by various federal and stateregulatory authorities.  The FederalCommunications Commission (“FCC”) has jurisdiction over all U.S.telecommunications common carriers to the extent they provide interstate orinternational communications services, including, in our case, the use of ourlocal networks to originate or terminate such services.  The operations of our Infone servicecurrently involve interstate and intrastate communications services.

 

To the extent that we provide telecommunications services thatoriginate and terminate within the same state, including in-state long distancetoll calls, we are subject to regulation by that state’s utilitycommission.  We are subject to directregulation in all jurisdictions in which we operate, including all fifty statesand the District of Columbia and Puerto Rico. Many states require certification before a company can provideintrastate communications services.  Weare certified as an interexchange carrier in all jurisdictions where required,and as a local exchange carrier where required.  Most states require us to file tariffs or price lists settingforth the terms, conditions and prices for services that are classified asintrastate.  We have filed such tariffsor price lists where required.

 

Weare subject to numerous local, state and federal taxes and regulatory fees,including the Federal excise tax, FCC Universal Service and regulatory fees andnumerous public utility commission regulatory fees.  We have procedures in place to ensure that we properly collecttaxes and fees from our customers and remit such taxes and fees to theappropriate entity pursuant to applicable laws and/or regulations.

 

Otheraspects of our services may be subject to state or federal regulation, such asregulations relating to the confidentiality of data and communications,copyright issues, and taxation of services. We cannot predict the actions that federal, state, and local regulatorsmay take or what impact such actions would have on our business.

 

### **Employees**

### ** **

As of December 31, 2003, we had approximately 4,400 employees,including approximately 26% who were employed on a part-time basis.  Most of our employees are operators, and thenumber of full-time and part-time operators varies from time to time reflectingfluctuations in the volume of calls.  Weanticipate that the departure of AT&T Wireless volume during 2004 willresult in a significant reduction in staffing needs in many of our call centersthat service this carrier.  However,given the expected timing of the departure of this volume, normal fluctuationsin employee tenure, new product initiatives and our pursuit of additionalgrowth strategies, we believe that most staffing reductions will besubstantially aided by normal attrition. None of our employees is subject to a collective bargainingagreement.  We consider relations withour employees to be good.

 

We invest significant resources in the recruitment, training andretention of qualified operators.  Ourorganizational structure provides opportunities and encourages talentedindividuals to take on roles of increasing responsibility.  We also invest considerable resources inpersonnel motivation, including providing incentive plans for our operators,management and corporate staff.

 

### **Available Information**

### ** **

We invite you to visit our website at www.metro1.com to accessfree-of-charge our annual report on Form 10-K, our quarterly reports on Form10-Q, our current reports on Form 8-K and any amendments to those reports,which we make available as soon as reasonably practicable after weelectronically file such materials with or furnish such materials to theSecurities and Exchange Commission. The information on our website should notbe considered part of this filing.

 

**ITEM 2****.****                  PROPERTIES.**

 

We lease our principal executive and administrative offices, consistingprimarily of two adjacent locations totaling approximately 57,000 square feetof space, in Beaverton, Oregon.  Theterms of the leases extend through mid-2009.

 

We also lease call centers and other operational facilities, whichgenerally range in size from 5,000 to 40,000 square feet, including spacesublet to others.  We have 35 leases forcall centers and other remote facilities, with remaining terms of up to sevenyears.  We expect to adjust call centersand capacities in order to address changes in volume demands caused by theexpiration of carrier contracts and the development of our other businessinitiatives.

 

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**ITEM 3****.****                  LEGALPROCEEDINGS.**

 

We are not aware of any pending legal proceedings other than routinelitigation that is incidental to the business.

 

**ITEM 4****.****                  SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

No matters were submitted to a vote of security holders during thequarter ended December 31, 2003.

 

# **PART II**

# ** **

**ITEM 5****.****                  MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**

 

Our common stock trades on the Nasdaq National Market under the symbol“MTON.”  The high and low closing salesprices as reported on the Nasdaq National Market for each quarterly periodwithin the two most recent fiscal years were as follows:

 
| **2003**                              |   | **High** |   | **Low** |   |
|---------------------------------------|--------|----------|--------|---------|--------|
| Quarter ended December 31, 2003  |   | $        | 3.58   |    | $      | 1.66 |   |
| Quarter ended September 30, 2003 |   | $        | 5.50   |    | $      | 3.49 |   |
| Quarter ended June 30, 2003      |   | $        | 7.17   |    | $      | 4.68 |   |
| Quarter ended March 31, 2003     |   | $        | 7.05   |    | $      | 4.92 |   |

 
| **2002**                              |   | **High** |   | **Low** |   |
|---------------------------------------|--------|----------|--------|---------|--------|
| Quarter ended December 31, 2002  |   | $        | 9.60   |    | $      | 4.49 |   |
| Quarter ended September 30, 2002 |   | $        | 15.35  |    | $      | 8.49 |   |
| Quarter ended June 30, 2002      |   | $        | 26.01  |    | $      | 11.06 |   |
| Quarter ended March 31, 2002     |   | $        | 30.80  |    | $      | 19.52 |   |

 

The approximate number of shareholders of record as of March 8,2004 was 160.  On March 8, 2004,the closing price of our common stock, as reported on the Nasdaq NationalMarket, was $2.91 per share.

 

We have never declared or paid cash dividends on our common stock.  We intend to retain earnings from operationsfor use in the operation and expansion of our business and do not anticipatepaying cash dividends with respect to our common stock in the foreseeablefuture.

 

**Equity CompensationPlan Information**

 

The following table contains information as of December 31, 2003,with respect to compensation plans under which our equity securities areauthorized for issuance.

 
| **Plan Category**                                           |   | **Number of  securities to be  issued upon exercise of  outstanding options, warrants  and rights** |   | **Weighted  average exercise price  of outstanding options, warrants  and rights** |   | **Number of  securities remaining  available for future issuance  under equity compensation plans  (excluding securities reflected in column (a))** |    |
|-------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|---------|
|                                                        |   | **(a)**                                                                                             |   | **(b)**                                                                            |   | **(c)**                                                                                                                                             |    |
| Equity compensation plans approved by  security holders     |   | 2,889,000                                                                                           |   | $                                                                                  | 12.18  |                                                                                                                                                | 902,784 |   |
| Equity compensation plans not approved by  security holders |   | —                                                                                              |   | —                                                                             |   | —                                                                                                                                              |    |
| Total                                                       |   | 2,889,000                                                                                           |   | $                                                                                  | 12.18  |                                                                                                                                                | 902,784 |   |

 

9

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**ITEM 6****.****                  SELECTEDFINANCIAL DATA.**

 

The selected financial data presented below should be read inconjunction with the Financial Statements and related Notes that appearelsewhere in this annual report and Management’s Discussion and Analysis ofFinancial Condition and Results of Operations set forth in Item 7.

 
|                                                       |   | **Years  Ended December 31,**            |       |
|------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                       |   | **2003**                                      |       | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
|                                                       |   | **(In  thousands, except per share amounts)** | ** ** |
| Operations data:                                           |   |                                          |       |   |   |   |   |   |   |   |   |
| Revenues                                                   |   | $                                             | 201,636    |   | $ | 257,951 |   | $ | 233,318 |   | $ | 156,981 |   | $ | 77,831 |   |
| Direct operating expenses                                  |   | 117,126                                       |       | 144,164 |   | 131,851 |   | 97,438 |   | 46,494 |   |
| Selling, general and administrative  expenses              |   | 128,271                                       |       | 72,461 |   | 65,422 |   | 46,112 |   | 28,711 |   |
| Impairment loss on goodwill and related intangible  assets |   | 4,715                                         |       | — |   | — |   | — |   | — |   |
| (Loss) income from operations                              |   | (48,476                                       | )          | 41,326 |   | 36,045 |   | 13,431 |   | 2,626 |   |
| Net (loss) income                                          |   | (33,309                                       | )          | 26,129 |   | 28,422 |   | 9,742 |   | 1,906 |   |
|                                                       |   |                                          |       |   |   |   |   |   |   |   |   |
| Basic (loss) income per share                              |   | (1.35                                         | )          | 1.06 |   | 1.20 |   | .56 |   | .11 |   |
| Diluted (loss) income per share                            |   | (1.35                                         | )          | 1.04 |   | 1.15 |   | .54 |   | .11 |   |
|                                                       |   |                                          |       |   |   |   |   |   |   |   |   |
| Cash flow from operations                                  |   | (19,189                                       | )          | 45,307 |   | 49,862 |   | 5,350 |   | 3,326 |   |
|                                                       |   |                                          |       |   |   |   |   |   |   |   |   |
| Balance sheet data (1):                                    |   |                                          |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                  |   | $                                             | 44,381     |   | $ | 76,528 |   | $ | 53,692 |   | $ | 6,463 |   | $ | 9,564 |   |
| Working capital                                            |   | 79,226                                        |       | 103,705 |   | 73,747 |   | 17,066 |   | 11,750 |   |
| Total assets                                               |   | 164,884                                       |       | 198,689 |   | 169,759 |   | 106,641 |   | 65,475 |   |
| Long-term liabilities                                      |   | 4,469                                         |       | 9,310 |   | 3,844 |   | 29,074 |   | 18,940 |   |
| Shareholders’ equity                                  |   | 142,338                                       |       | 175,389 |   | 147,369 |   | 45,404 |   | 31,979 |   |

 

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(1)   In February 2001, we completed a transactionwith Sonera Media Holding B. V. (“Sonera”), at that time a wholly-ownedsubsidiary of Sonera Corporation of Helsinki, Finland, whereby Sonera purchasedsix million newly-issued shares of our common stock at a price of $11.33 pershare, for an aggregate price of $64.6 million and an approximate 25.5%ownership position at that time.  Aportion of the proceeds from this transaction was used to pay off all outstandingdebt.  See “Significant Events” in Item7 below.

 

**ITEM 7****.****                  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

*All statements andtrend analyses contained in this item and elsewhere in this annual report onForm 10-K relative to the future constitute “forward-looking statements” withinthe meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements may, but donot necessarily, also include words such as “believes,” “expects,” “anticipates,”intends,” “plans,” “estimates,” “ may,” “will,” “should,” “could,” “continue”or similar expressions.  Forward-lookingstatements are not guarantees.  Theyinvolve known and unknown business and economic risks, uncertainties and otherfactors that may cause our actual results, performance or achievements to bematerially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements.  These risks, uncertainties and other factorsinclude those discussed in this Item 7 under “Issues and Uncertainties.”  Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datehereof.  We undertake no obligation topublicly release any revisions to these forward-looking statements to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events.*

 

*Results ofoperations for the periods discussed below should not be considered indicativeof the results to be expected in any future period and fluctuations inoperating results may also result in fluctuations in the market price of ourcommon stock.  Our quarterly and annualoperating results have in the past and may in the future vary significantlydepending on factors such as changes in the telecommunications market, theaddition or expiration of customer contracts, increased competition, changes inpricing policies by us or our competitors, lengthy sales cycles, advertisingcosts or lack of market acceptance associated with the introduction of newversions of our products or features, the*

 

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*cost and success ofnew growth strategies, the timing of the initiation of wireless or othertelecommunications services through new delivery systems or their acceptance bycustomers, the timing and expense of the expansion or contraction of ournational call center network, the general employment environment, generaleconomic conditions and the other factors discussed under the heading “Issuesand Uncertainties” in this Item 7.*

 

### **Overview**

### ** **

We are the leading developer and provider of Enhanced DirectoryAssistance and information services.  Weprimarily contract with wireless carriers to provide these services to theirsubscribers.

 

Under our contracts, carriers agree to route some or all of theirdirectory assistance calls to us.  Weoffer our services to multiple carriers within the same market.  When a carrier’s subscribers dial a typicaldirectory assistance number, such as “411,” “555-1212” or “00,” the calls arerouted to and answered by our operators identifying the service by thatcarrier’s brand name, such as “Nextel 411” or “ALLTEL Directory Plus.”

 

Each carrier customer establishes its own directory assistance fee structurefor its subscribers.  Wirelesssubscribers typically pay fees ranging from $1.00 to $1.40 plus airtime chargesfor our services.  We bear no subscribercollection risk with respect to carrier subscribers; however, there may becollection risk to the extent growth and profitability in thetelecommunications industry decreases and to the extent we provide services toother types of customers, including businesses, governmental units or callersattracted through other means or affiliations.

 

We charge our carrier customers directly on a per call basis, withprices varying in some cases based on call volume.  In order to encourage our carrier customers to route more oftheir calls to us, our long-term strategy has been based in part on reducingthe price we charge them.  We expectthat average revenue per call may continue to decrease over time, as we believethis pricing strategy better positions us to retain and expand service withexisting carrier customers, where profitable, and to attract new carrier customers.  Prices for services provided to other typesof customers, including businesses, governmental units or other callers, mayvary based on the nature of the service, volume and other circumstances.

 

Competition in the telecommunications industry, and in the directoryassistance market in which we participate, has recently been intense.  With slowing subscriber growth and decliningrevenue per user, carriers are looking to lower their costs of providingdirectory assistance and other services through, among other ways, outsourcingto low cost domestic or overseas operators and utilizing automation to reducecosts.  In response to these and otherissues, in May 2003, we launched Infone, a service that provides enhanceddirectory and personal assistant services directly to consumers.  Callers may use the service from nearly anydomestic telephone, landline or wireless, simply by dialing“888-411-1111.”  Billing is handled by usinga major credit card.  Calls can beconnected nationwide and to Canada and Puerto Rico for the all-inclusive priceof 89 cents for any call of up to 15 minutes, plus 5 cents per minute afterthat.

 

The initial launch of Infone was accompanied by a significantnationwide marketing and promotion campaign designed to build brand awarenessand encourage customers to sign up for Infone. During fiscal 2003, we spent approximately $49.9 million on suchmarketing and promotion campaigns, and we will likely spend significantadditional funds on marketing and promotional activities in the future.

 

### **Significant Events**

### ** **

Our contract with AT&T Wireless expired on December 1, 2003,and we were unable to reach an economic arrangement acceptable to both parties,thus, our negotiations did not result in a new contract to replace the existingone.  AT&T Wireless accounted forapproximately 44%, 33% and 30% of our revenues in 2003, 2002 and 2001,respectively.  We expect that the callvolume from AT&T Wireless will transition away from us during the secondquarter of 2004.  The expiration of ourcontract with AT&T Wireless will have a material adverse effect on ourfinancial position, future operating results and cash flows, as well as ouroperations.  We expect to adjustpersonnel, call centers and network capacities in order to address varyingbusiness circumstances, including the expiration of this contract.

 

Our contract with Sprint PCS expired on December 31, 2002.  We agreed to a transition arrangement withSprint PCS, pursuant to which we continued to handle its subscribers’ callssubsequent to December 31, 2002. The transition began in March 2003 and was substantially completedby June 30, 2003.  Revenue fromSprint PCS accounted for approximately 13%, 33% and 32% of our total revenue in2003, 2002 and 2001, respectively.

 

In February 2001, we completed a transaction with Sonera MediaHolding B. V. (“Sonera”), at that time a wholly-owned subsidiary of SoneraCorporation of Helsinki, Finland, whereby Sonera purchased six millionnewly-issued shares of our common stock at a price of $11.33 per share, for anaggregate price of $64.6 million and an approximate 25.5% ownership position atthat time.  A portion of the proceedsfrom this transaction was used to pay off all outstanding debt.  In August 2002, the shares weretransferred to Sonera Holding B.V., another wholly-

 

11

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owned subsidiary of Sonera Corporation.  In December 2002, Sonera merged with Telia AB to formTeliaSonera AB.  According to aSchedule 13-D/A filed with the Securities and Exchange Commission inJanuary 2004, TeliaSonera AB reported that it no longer holds any sharesof our common stock.

 

### **Results ofOperations**

### ** **

The following table shows selected items of our statements ofoperations data expressed as a percentage of revenues:

 
|                                                       |   | **Years  Ended December 31,** |   |
|------------------------------------------------------------|--------|------------------------------------|--------|
|                                                       |   | **2003**                           |   | **2002** | ** ** | **2001** | ** ** |
| Revenues                                                   |   | 100.0                              | %      | 100.0 | % | 100.0 | % |
| Direct operating expenses                                  |   | 58.1                               |   | 55.9 |   | 56.5 |   |
| Selling, general and administrative  expenses              |   | 63.6                               |   | 28.1 |   | 28.0 |   |
| Impairment loss on goodwill and related  intangible assets |   | 2.3                                |   | — |   | — |   |
| (Loss) income from operations                              |   | (24.0                              | )      | 16.0 |   | 15.5 |   |
| Other income, net                                          |   | 0.3                                |   | 0.4 |   | 0.5 |   |
| Interest and loan fees                                     |   | (0.0                               | )      | (0.0 | ) | (0.3 | ) |
| (Loss) income before income taxes                          |   | (23.7                              | )      | 16.4 |   | 15.7 |   |
| Income tax (benefit) expense                               |   | (7.2                               | )      | 6.3 |   | 3.5 |   |
| Net (loss) income                                          |   | (16.5                              | )%     | 10.1 | % | 12.2 | % |

 

### **2003 Compared to2002**

### ** **

*Revenues.*  Revenues decreased 21.8% to $201.6 millionfrom $258.0 million.  Call volumedecreased to approximately 434 million calls from approximately 544 millioncalls.  These decreases resultedprimarily from lower call volume from Sprint PCS due to expiration of theircontract, partially offset by growth in call volume under other existingcontracts and markets.  Our averagerevenue per call was effectively $0.47 in both 2003 and 2002.

 

*Direct operatingexpenses.* Direct operating expenses consist of costs of salaries, wages, benefitsand taxes of call center personnel and costs of listings data and contentacquisition.  These expenses decreased18.8% to $117.1 million from $144.2 million. This decrease was primarily due to lower personnel and data costsassociated with servicing lower call volumes. As a percentage of revenues, direct operating expenses increased to58.1% from 55.9%, due primarily to higher costs associated with medicalinsurance and workers’ compensation programs.

 

*Selling, general andadministrative expenses.*  Selling, general and administrative expenses increased 77.0% to$128.3 million from $72.5 million.  Thisincrease resulted primarily from marketing and promotion costs of approximately$49.9 million and increased network costs associated with our Infoneservice.  As a percentage of revenues,selling, general and administrative expenses increased to 63.6% from 28.1% resultingfrom lower revenue and increased marketing, promotion and network costs.

 

*Impairment loss ongoodwill and related intangible assets.*  Based on our evaluation in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 142 during 2003, wedetermined that goodwill and certain related intangible assets were impaired;thus, goodwill in the amount of $4.4 million and non-amortizing intangibleassets of approximately  $300,000 werewritten off during the fourth quarter of 2003.

 

*Depreciation andamortization.* Depreciation and amortization increased 14.8% to $21.6 million from$18.8 million, due primarily to equipment purchased for upgrades of ourcorporate-wide infrastructure and existing call centers and product developmentactivities.

 

*Other income, net*.  Other income for the years endedDecember 31, 2003 and 2002 consisted primarily of interest income earnedon cash and cash equivalents of approximately $668,000 and $961,000,respectively.  The decrease in 2003resulted primarily from a decrease in cash available for investment and adecrease in market interest rates.  Interest expense was not significant in either 2003 or 2002.

 

*Income tax (benefit)expense.* Income tax benefit for 2003 was approximately $14.5 million resultingprimarily from our ability to carry current year losses back to offset incomein prior years and to receive refunds of income taxes paid in those years.  Income tax expense for 2002 was $16.2million for an effective tax rate of approximately 38.2% which resulted fromthe combined federal and state statutory rate of approximately 39% partiallyoffset by various federal and state tax credits.

 

12

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### **2002 Compared to2001**

### ** **

*Revenues.*  Revenues increased 10.6% to $258.0 millionfrom $233.3 million.  Call volume grewto approximately 544 million calls from approximately 472 million calls.  These increases resulted from growth in callvolume under existing contracts and markets, as well as new call volume fromnew contracts and new markets.  Ouraverage revenue per call was approximately $0.47 in 2002 compared to $0.49 in2001 as we continued to offer volume pricing discounts to encourage carriercustomers to send us additional call volume.

 

*Direct operatingexpenses.* Direct operating expenses, consisting of the costs of salaries, wages,benefits and taxes of call center personnel, listings data and contentacquisition costs, increased 9.3% to $144.2 million from $131.9 million.  This increase was primarily due to the costsof servicing increased call volumes.  Asa percentage of revenues, direct operating expenses decreased to 55.9% from56.5%, due primarily to operating efficiencies realized from greater callvolumes and lower costs of accessing information content.

 

*Selling, general andadministrative expenses.*  Selling, general and administrative expenses increased 10.8% to$72.5 million from $65.4 million resulting primarily from additional costsnecessary to support our increased call center capacity and call volumes.* *Asa percentage of revenues, selling, general and administrative expenses remainedapproximately flat at 28.1% in 2002 compared to 28.0% in 2001 with additionalefficiencies related to the growth of our business offset by new productdevelopment costs.

 

*Depreciation andamortization.* Depreciation and amortization increased by 19.0% to $18.8 million from$15.8 million, due primarily to equipment purchased for new call centers, forupgrades and expansions of existing call centers and product developmentactivities offset by the decrease in amortization of $518,000 due to theadoption of SFAS No. 142, “Goodwill and Other Intangible Assets.”

 

*Other income, net*.  Other income for the years endedDecember 31, 2002 and 2001 consisted primarily of interest income earnedon cash and cash equivalents of approximately $961,000 and $1.3 million,respectively.  The 2002 decreaseresulted primarily from a decrease in market interest rates.

 

*Interest expense andloan fees.* Interest expense and loan fees decreased 99%, to $10,000 in 2002 from$895,000 in 2001.  This decreaseresulted from a reduction in average debt outstanding during the year.  All debt was paid in full as ofMarch 31, 2001.

 

*Income tax expense.*  Income tax expense for 2002 was $16.2million for an effective tax rate of approximately 38.2% which resulted fromthe combined federal and state statutory rate of approximately 39% partiallyoffset by various federal and state tax credits.  For 2001, income tax expense was $8.1 million for an effectivetax rate of approximately 22.2%.  Thisrate differs from the combined federal and state statutory rate ofapproximately 39% due primarily to the use of net operating loss carryforwardsand various federal and state tax credits.

 

### **Liquidity andCapital Resources**

### ** **

Cash and cash equivalents and restricted cash are recorded at costwhich approximates their fair market value. As of December 31, 2003, we had approximately $49.3 million in cashand cash equivalents and restricted cash (including $4.9 million of restrictedcash) compared to approximately $79.9 million (including $3.3 million ofrestricted cash) at December 31, 2002. The net decrease of $30.6 million resulted primarily from our use ofcash to advertise, market and promote our Infone service and capital expendituresof approximately $11.6 million, partially offset by cash generated fromoperations excluding advertising, marketing and promotional expenditures.  We have no outstanding debt.

 

Working capital was $79.2 million at December 31, 2003, comparedto $103.7 million at December 31, 2002. This decrease was primarily due toworking capital used to advertise, market and promote Infone and by the use ofworking capital for capital expenditures, partially offset by working capitalgenerated from operations excluding advertising, marketing and promotional expenditures.

 

*Cash flow fromoperations.* Net cash used in operations was $19.2 million in 2003 compared to netcash provided by operations of $45.3 million in 2002. This difference resultedprimarily from a decrease in revenues and our use of cash to market and promoteInfone, partially offset by a decrease in cash paid to or on behalf ofemployees and a decrease in federal and state income tax payments.  Cash received from customers decreased byapproximately $58.7 million, and cash paid to employees decreased byapproximately $25.3 million, in 2003 compared to 2002, primarily resulting fromthe expiration of our contract with Sprint PCS.  As a result of the net loan generated in 2003, we paidapproximately $900,000 in federal and state income taxes in 2003 compared toapproximately $12.4 million in 2002.

 

13

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*Cash flow frominvesting activities.* Cash used in investing activities was $11.6 million, $21.4 million and$31.4 million for the years ended December 31, 2003, 2002 and 2001,respectively.  In 2003, capitalexpenditures were primarily for equipment to upgrade existing call centers andcorporate networks and infrastructure.  In2002, cash used in investing activities was related primarily to capital expendituresfor the purchase of equipment for new call centers, the upgrade and expansionof existing call centers, upgrades and expansions of corporate networks andinfrastructure and, in 2001, cash paid in the acquisition of a data extractionand processing company.

 

*Cash flow fromfinancing activities*. Cash used in financing activities was $1.3 million and $1.1 million forthe years ended December 31, 2003 and 2002 and was primarily related tocash used to secure a letter of credit offset by proceeds from the exercise ofstock options and employee stock purchases. Cash provided by financing activities was $28.7 million for the yearended December 31, 2001 resulting primarily from the proceeds of theinvestment by Sonera and the receipt of cash proceeds from the exercise ofstock options and from employee stock purchases, offset by the repayment of alloutstanding debt.

 

*Future capital needsand resources.* The primary uses of our capital in the near future are expected to befor the continued advertising, marketing and promotion of Infone, thedevelopment or acquisition of technologies, features and content complementaryto our business and for general corporate purposes.  These general corporate purposes could include acquisitions,efforts to pursue and market new growth strategies, other corporate developmentactivities and working capital.  We havebegun to adjust personnel, and expect to adjust personnel, call centers andnetwork capacities in order to address varying business circumstances,including the expiration of our contract with AT&T Wireless.

 

We believe our existing cash and cash equivalents and cash fromoperations will be sufficient to fund our operations for the next twelvemonths.  Although cash on hand(including restricted cash) at December 31, 2003  was approximately $49.3 million, future activities, includingadvertising, marketing and promoting Infone, execution of new productinitiatives and growth strategies, new product development and rollout mayreduce available cash.  In such event,we will attempt to establish borrowing arrangements in order to maintainadequate liquidity.   Depending on thedevelopment of our business, we believe we will have access to future financingsources, although we cannot provide assurance that financing will be availablein amounts or on terms acceptable to us.

 

*Contractual obligations and commitments.*  Our contractual obligations are presented inthe table below.  Other than operatingleases, we have no significant off-balance sheet arrangements or obligations.

 
|                         |   | **Payments due by period** |       |
|------------------------------|--------|----------------------------|------------|
| **Contractual  Obligations** |   | **Total**                  | ** ** | **Less  than 1  year** | ** ** | **1 - 3  years** | ** ** | **3 - 5  years** | ** ** | **More  than 5  years** | ** ** |
|                         |   |                       |       |   |   |   |   |   |   |   |   |
| Operating lease obligations  |   | $                          | 30,910     |   | $ | 8,865 |   | $ | 13,583 |   | $ | 7,199 |   | $ | 1,263 |   |
| Total                        |   | $                          | 30,910     |   | $ | 8,865 |   | $ | 13,583 |   | $ | 7,199 |   | $ | 1,263 |   |

 

We generally lease our facilities through non-cancelable operatingleases extending for up to ten years.

 

From time to time, in the normal course of our business, we issuestandby letters of credit and bank guarantees. At December 31, 2003, we had one letter of credit outstanding inthe amount of $4.9 million related to our workers’ compensation insuranceprogram.  The letter of credit issecured by a certificate of deposit for the same amount that is recorded as restrictedcash.  This commitment expires onApril 1, 2004 and is typically renewed on an annual basis.

 

In accordance with accounting principles generally accepted in theUnited States of America, these contractual obligations and commitments are notreflected in our balance sheets.

 

### **Effect ofInflation**

### ** **

Inflation did not materially affect our business during the lastseveral years.

 

### **CriticalAccounting Policies**

 

We prepare our financial statements in conformity with accountingprinciples generally accepted in the United States of America.  As such, we are required to make certainestimates, judgments and assumptions that we believe are reasonable based uponthe information available.  Theseestimates and assumptions affect the reported amounts of assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the periods presented. Management believes that of our significant accounting policies (seeNote 1 to the financial statements), those governing accounts receivable, thelives and recoverability of the carrying amount of

 

14

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equipment and other long-lived assets, such as existing intangibles andgoodwill, estimates involving the levels of our contingent liabilities forworkers’ compensation and medical self-insurance and estimates of current anddeferred taxes owed may involve a higher degree of judgment, estimation anduncertainty.

 

*Accounts receivable.*  Our customer base has primarily consisted oflarge wireless telephone carriers in the United States.  As such, we have had minimal risk ofuncollectability, at any point in time, related to outstanding accountsreceivable with these customers.  Wehave not experienced significant collection issues or write-offs related tothese customers.  Since our accountsreceivable are concentrated in relatively few of these wholesale customers, asignificant change in the liquidity or financial position of any one of them couldadversely impact collection of our accounts receivable and therefore have amaterial adverse effect on our financial position and future operatingresults.  In addition, with the launchof our Infone service, we generate receivables from retail customers andbusinesses that may expose us to greater risk of uncollectible receivables thanwe have experienced in the past.

 

*Long-lived assetsand goodwill.* We evaluate the remaining life and recoverability of equipment and otherassets, including patents and trademarks and internally developed software,whenever events or changes in circumstances indicate that the carrying amountof the asset may not be recoverable.  Atsuch time, we estimate the future cash flows expected upon eventual dispositionand, if lower than the carrying amount, adjust the carrying amount of the assetto its estimated fair value.  Because ofour changing business conditions and dependence on a relatively small number ofcustomers for a significant portion of our revenues, our estimates of futurecash flows to be generated from our operations could change materially,resulting in the need for us to record an impairment charge.  In addition, as a result of our changingbusiness conditions, we expect to adjust personnel, call centers and networkcapacities. If any of these activities result in certain of our assets nolonger being used in operations, we may need to record an impairment charge.

 

Goodwill, which represents the excess of cost over the fair value ofnet assets acquired in a business combination, was amortized on a straight-linebasis, over its estimated economic life, through December 31, 2001.  On January 1, 2002, we adopted SFAS No.142.  Under SFAS No. 142, wediscontinued amortization of goodwill and are required to evaluate goodwill forimpairment annually and whenever events or changes in circumstances mayindicate that the carrying amount of goodwill is impaired.  When we performed our evaluation of goodwillin 2003, particularly given the expiration of our contract with AT&TWireless in December 2003, our analysis indicated that our estimate of thefair value of our business, as determined by the market price of our stock, wasless than its carrying value; therefore, the book value of goodwill and relatedintangibles of approximately $4.7 million was written off during the fourthquarter of 2003.

 

*Self-insurancereserves.*  Weself-insure a portion of our workers’ compensation and employee medicalinsurance programs.  We purchase stop loss coverage at varying levels inorder to mitigate our potential future losses.  The nature of theseliabilities, which may not fully manifest themselves for several years,requires significant judgment.  We evaluate pending workers’ compensationand medical claims periodically to determine the reasonableness of the reserveswe have recorded for such claims.  Ourevaluation includes estimates of potential incurred-but-unreported claims aswell as factors that may cause original estimates of such claims to increaseover time, such as available claims data and historical trends and experience,as well as future projections of ultimate losses, expenses, premiums andadministrative costs.  We adjust these reserves if events or changes incircumstances indicate that ultimate payments related to the claims will bemore than the recorded reserves.  Whilewe believe that the amounts reserved for these obligations are sufficient, anysignificant increase in the number of claims and costs associated with claimsmade under these plans could have a material effect on our financial position,results of operations or cash flows.

 

*Income taxe*s. Accounting for income taxes requires us to estimate our income taxes in eachjurisdiction in which we operate.  Due to differences in the recognitionof items included in income for accounting and tax purposes, temporarydifferences arise which are recorded as deferred tax assets orliabilities.  We estimate the likelihood of recovery of these assets,which is dependent on future levels of profitability and enacted taxrates.  Should any amounts be determined not to be recoverable, orassumptions change, we would be required to take a charge, which could have amaterial effect on our financial position, results of operations or cash flows.

 

### **Recent AccountingPronouncements**

### ** **

In July 2002, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities,” the provisions of which are effective for exit or disposalactivities that are initiated after December 31, 2002.  The statement requires that a liability fora cost associated with an exit or disposal activity be recognized when theliability is incurred.  Under previousguidance, a liability for an exit cost was recognized at the date of anentity’s commitment to an exit plan.  Weadopted this statement effective January 1, 2003.  The adoption of this statement did not havea material impact on our financial position, results of operations or cashflows.

 

In December 2002, the FASB issued Financial Interpretation (“FIN”)No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  The disclosure requirements in thisinterpretation were applied as of December 31, 2002.  We adopted the recognition provisions of FIN45 effective January 1, 2003.  Theadoption of this statement did not have a material impact on our financialposition, results of operations or cash flows.

 

15

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### **Issues andUncertainties**

### ** **

While management is optimistic about our long-term prospects, thefollowing issues and uncertainties, among others, should be considered inevaluating our outlook.

 

*We have contractswith a limited number of carrier customers. If we fail to extend or renew these contracts, or if these contracts areterminated prior to their expiration, our business could be adversely affected.*

 

A limited number of customers account for substantially all ourrevenues.  For example, our top fourcustomers accounted for approximately 98.8% of our revenues in 2003.  Our two largest customers, AT&T WirelessServices, and Nextel Communications accounted for approximately 78.6% of ourrevenues in 2003.  Our contract with AT&TWireless expired in December 2003 as described above in “SignificantEvents.”  In addition, our contract withALLTEL Communications expired in December 2003.  While we did enter into an extension agreement, it is notcurrently a long-term arrangement.  Ourcontract with Nextel Communications extends through early in 2005.  Some contracts contain performance and otherstandards and may be terminated prior to their scheduled expiration dates underspecified circumstances.  If we fail toextend or replace our contracts, or other contracts are terminated prior totheir expiration, our business could be adversely affected.  Although we seek to increase the number ofour customers, opportunities are limited because a small number of companiesdominate the telecommunications market. This limits the potential carrier customer base and our expansionopportunities through carrier relationships.

 

*Our inability toachieve desired pricing levels could adversely affect our profitability andoperations.*

 

We are subject to competitive pressures with respect to pricing thatcould adversely affect our profitability and operations.  The prices that we charge our carriercustomers are subject to the terms of our contracts.  The changing telecommunications market, the relative leverage ofthe negotiating parties and the overall competitive landscape can significantlyimpact contract pricing negotiations. We charge our carrier customers on a per call basis, with prices varyingin some cases based on call volume.  Ourlong-term strategy is based in part on reducing the price we charge our carriercustomers.  Generally, our pricinglevels have declined and, in the future, will likely continue to decline ascall volumes increase with specific carrier customers and in response tocompetition in the industry.  If we wereto substantially reduce our prices without correspondingly increasing volume,there could be an adverse impact on our ability to operate profitably.

 

*We face substantialcompetition from a number of other companies.*

 

Many of our competitors in the directory assistance market, includingthe regional Bell operating companies, have far greater resources and bettername recognition.  The regional Belloperating companies also may have the advantage of being the local telephonecarrier in their area of operation. Some of these companies are or may be developing their own versions ofquality directory assistance services. We also face competition from a number of other independent directoryassistance providers.  Individual competitorsmay also seek to provide low cost domestic or offshore service or to provideautomation of directory assistance services. If we are unable to compete successfully, it could have an adverseeffect on our business, financial condition, results of operations or cashflows.  Our ability to competesuccessfully depends, in part, on our ability to anticipate and appropriatelyrespond to many factors, including retail pricing decisions by carriers,decisions by carriers to force consumers to accept lower-quality informationservices products, the introduction of new services and products by ourcompetitors, changes in subscriber preferences, changes in economic conditionsand discount pricing strategies by our competitors.

 

*We may not gaincustomer acceptance of our Infone service or the costs of advertising,marketing and promotion of Infone to obtain such acceptance may result infuture losses and pressure on our liquidity and capital resources.*

 

In order to build awareness among consumers and encourage them to signup for our Infone service, we have undertaken a national advertising andmarketing campaign that has required significant expenditures to date andlikely will require that further expenditures be made to gain consumeracceptance.  These expenditures have necessarily preceded the receipt ofsubstantial revenues from customers for the Infone services.  If ourcustomer base and related number of calls for this service do not grow togenerate sufficient levels of revenue on a timely basis, or our financial andpricing assumptions are not accurate, these advertising and marketing expensesmay result in further losses and pressure on our liquidity and capitalresources.  In such event, we may need additional financing, but there canbe no assurance that such financing would be available or that the termsoffered would be acceptable to us.  Because the Infone service is still inits initial stages and until we gain more experience with consumer acceptance,it will be difficult to predict our future results of operations.

 

*We are dependent onthe wireless telecommunications industry, and a decrease in wireless usage bysubscribers could have an adverse impact on our results of operations,additionally, consolidation of, or reduction in, the number of carriercompetitors in this industry could affect us adversely.*

 

Most of our revenues have historically comefrom providing Enhanced Directory Assistance and information services towireless carrier customers’ subscribers.  A decrease in wireless usage in general, orof our products in particular, could have an adverse effect on our results ofoperations.  Wireless usage bysubscribers appears to be affected by a number of factors, many of which arebeyond our control, including pricing, safety concerns, reliability andavailability of the wireless network, government regulation and reliability andavailability of alternative technologies.

 

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*Our quarterly andannual operating results may vary significantly in part due to factors outsideour control.*

 

In the future, as in the past, our quarterly and annual operatingresults may vary significantly as a result of a number of factors.  We cannot control many of these factors,which include, among others:

 

•      Changes in thetelecommunications market, including the addition or withdrawal of carriersfrom the market, changes in technology and increased competition from existingand new competitors;

 

•      The timing and expense ofour call center network expansion or contraction, including changing staffingand infrastructure expenses related to anticipated call volume changes;

 

•      The continued costs ofadvertising, marketing and promotion of Infone without commensurate consumeracceptance or revenues;

 

•      The addition or expirationof contracts with carrier customers;

 

•      Changes in our or ourcompetitors’, customers’ or suppliers’ pricing policies;

 

•      Lengthy sales cycles for newand extended contracts;

 

•      The timing of thecommencement of our services under new or existing contracts with our carriercustomers, which depends in part on the customers’ ability to adapt theirnetworks and billing systems to allow them to transfer calls to us;

 

•      Lack of market acceptance ordelays or increased development costs related to the introduction of ourservices or features; and

 

•      General economic conditions.

 

For these reasons, you should not rely on period-to-period comparisonsof our financial results as an indication of any future results.  Our future operating results could fallbelow the expectations of securities industry analysts or investors.  Any such shortfall could result in a declinein the market price of our common stock. Fluctuations in our operating results would likely increase thevolatility of our common stock price.

 

*The rapidly changingtelecommunications market could unfavorably affect us.*

 

The telecommunications market is subject to rapid change anduncertainty that may result in competitive situations which could unfavorablyaffect us.  These changes anduncertainties are due to, among other factors, the following:

 

•      Mergers, acquisitions and alliancesamong carriers and among our competitors, which can result in fewer carriers inthe marketplace, lost carrier customers, increased negotiating leverage fornewly affiliated carriers and more effective competitors;

 

•      Changes in the regulatoryenvironment, which may affect us directly, by affecting our ability to accessand update listings data at a reasonable cost, or indirectly, by restrictingour carrier customers’ ability to operate or provide a competitive service;

 

•      Increasing availability ofalternative methods for delivery of directory assistance and other informationservices, including the Internet;

 

•      Evolving industry standards,including frequent technological changes and new product introductions; and

 

•      Changes in retail pricesoffered to consumers for our services or for services perceived to besubstitutes for ours, in whole or in part.

 

*We have a long salescycle which may cause delays that adversely affect our revenue growth andoperating results.*

 

A customer’s decision to contract for our directory assistance andinformation services involves a significant commitment of technical and otherresources.  As a result, we have a longsales cycle for both new and extended contracts, particularly with largecustomers.  The selling process involvesdemonstrating the value-added benefits of outsourcing directory assistance andusing our services rather than those of our competitors.  Additionally, the effectiveness of ourmarketing to other types of customers, including businesses, governmental unitsor callers attracted through other means or affiliations, is difficult topredict at any given point in time, given a wide variety of potential businesscircumstances.  Any delays due tolengthy sales cycles could significantly affect our revenue growth andoperating results.

 

*Our operatingresults are significantly affected by our ability to accurately estimate theamount and timing of call volume, which is often subject to factors outside ofour control.*

 

Our operating results are significantly affected by costs incurred forexpanding or contracting staffing and infrastructure.  We incur significant staffing and general and administrativecosts in contracting operations, if necessary, and in anticipation ofadditional call volume under our customer contracts.  If such call volume does not depart or arrive as scheduled, inthe amount anticipated, or at all, our operating results can be adverselyaffected.  This could increase ouroperating expenses without a corresponding increase in revenues.

 

17

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*We need to maintainor expand call volume and increase efficiencies in order to be successful.*

 

In order to successfully execute our business strategies, we need tomaintain or increase the volume of calls made to our call center network, whilerealizing the benefits of operating leverage. We intend to increase call volume by seeking additional customers,including landline carrier customers, as well as seeking additional businessfrom our existing carrier customers and through our Infone service and byoffering our services to other types of customers.  We have limited experience in the landline market, which isdominated by the regional Bell operating companies.  If we are unable to expand our wireless business or attractsignificant landline business, or grow our Infone revenues on a cost effectivebasis or at all, we may be unable to attain meaningful profitability or sustainpast growth rates.

 

*Regulationsaffecting our customers and suppliers and future regulations to which we may besubject may adversely affect our business.*

 

While in the past, our principal business as a wholesale supplier ofenhanced directory assistance and information services for telecommunicationscommon carriers has not been directly regulated, the offering of those servicesto the public by our customers is regulated by various federal and stateregulatory authorities.  The FederalCommunications Commission (“FCC”) has jurisdiction over all U.S.telecommunications common carriers to the extent they provide interstate orinternational communications services, including, in our case, the use of ourlocal networks to originate or terminate such services.  The operations of our Infone service currentlyinvolve interstate and intrastate communications services.  The application of the FCC’s current and/orfuture policies could have a material adverse effect on our business, operatingresults and financial conditions.

 

To the extent that we provide telecommunications services that originateand terminate within the same state, including in-state long distance tollcalls, we are subject to regulation by that state’s utility commission.  We are subject to direct regulation in alljurisdictions in which we operate.  Manyjurisdictions require certification before a company can provide intrastatecommunications services.  We arecertified as an interexchange carrier in all jurisdictions where required, andas a local exchange carrier where required.

 

Weare also subject to numerous local, state and federal taxes and regulatoryfees, including the Federal excise tax, FCC Universal Service and regulatoryfees and numerous public utility commission regulatory fees.  We have procedures in place to ensure thatwe properly collect taxes and fees from our customers and remit such taxes andfees to the appropriate entity pursuant to applicable law and/orregulation.  If our collectionprocedures prove to be insufficient or if a taxing or regulatory authority determinesthat our remittances were inadequate, we could be required to make additionalpayments, which could have a material adverse effect on our business.

 

Other aspects of our services may be subject to state or federalregulation, such as regulations relating to the confidentiality of data andcommunications, copyright issues, and taxation of services.  We cannot predict the actions that federal,state, and local regulators may take or what impact such actions would have onour business.

 

*Future acquisitionsor efforts to pursue additional growth strategies may strain our operations.*

 

We intend to evaluate, and in the future may pursue, acquisition orbusiness opportunities that are consistent with our business strategy.  If we fail to adequately address financialand operational risks associated with such acquisitions or businessopportunities, such activities may adversely affect our business.

 

These risks can include, among other things:

 

•      Difficulties in assimilatingthe operations, technology, information systems and personnel of an acquiredcompany, including the inability to maintain uniform standards, controls andpolicies, and the loss of key employees of the acquired company;

 

•      Diversion of management’sattention from other business concerns;

 

•      Impairment of relationshipswith licensors, customers and suppliers;

 

•      Difficulties in enteringinto markets in which we have no direct prior experience and potentialmarketing expenses related thereto;

 

•      Use of cash resources,potentially dilutive issuances of equity securities and incurrence ofadditional debt and contingent liabilities; and

 

•      Significant write-offsrelated to goodwill and amortization expenses related to other intangibleassets.

 

*If we are unable toanticipate changes in technology and industry standards and to develop new servicesand features, we may not succeed.*

 

Our success depends, in part, on our ability to anticipate changes intechnology and industry standards and to develop and introduce new services andfeatures that are accepted by the marketplace and cost effective for us toprovide as a part of our overall service offerings.  The development of new services and features can be veryexpensive.  Further, given rapidtechnological changes, frequent introduction of new products, services andfeatures, and changing consumer demands that characterize our industry, it canbe difficult to correctly anticipate future changes in technology and industrystandards.  If we fail to develop newservices and features, encounter difficulties that delay the

 

18

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introduction of such services and features, or incorrectly anticipatefuture changes and develop services and features that are not accepted by themarketplace or are not cost effective for us to provide as a part of our overallservice offerings, we may not succeed at our business.

 

*Alternative methodsfor delivery of directory assistance and information services could reduce thedemand for our services.*

 

Our business comes primarily from providing Enhanced DirectoryAssistance and information services to telephone users.  However, information can be transmitted inother ways, including more intelligent communications devices and othertechnologies and protocols, and over the Internet.  For example, as the Internet continues to develop and becomeseasier to use and access, technologies may be developed that decrease oreliminate the demand for telephone-based or voice-based directory orinformation services.  Widespreadacceptance of existing and developing technologies and protocols, such as voicerecognition and wireless application protocol, could adversely affect ourbusiness.  Our call volume could declineif telephone users change their usage habits and rely on the Internet or other alternativesas their primary source for information.

 

*Systems failures,delays and other problems could harm our reputation and business, cause us tolose customers and expose us to customer liability.*

 

Our success also depends on our ability to provide reliableservices.  Our operations could beinterrupted by significant damage to or failure of our network, our connectionsto third parties, our computer hardware or software or our customers’ orsuppliers’ computer hardware or software. Any such significant damage or failure could disrupt the operations ofour network and the provision of our services and result in the loss of currentand potential customers.  In addition,if call volume increases, we may need to expand and/or upgrade our technologyand network hardware and software in order to provide services.  Capacity limits on our technology andnetwork hardware and software may make it difficult for us to expand andupgrade our systems in a timely and economical manner.

 

*If we are unable toobtain or adequately update directory or information content at an economicalcost, we may be unable to provide current levels of service or improve ourservice.*

 

Our operations depend on our access to the names, telephone numbers andother information that we supply directly to callers or we use in providing ourservices.  The availability, cost,quality and usefulness of such data varies widely across geographicregions.  If we are unable to obtain orupdate directory or information content at an economical cost, we may be unableto provide current levels of service, improve our Enhanced Directory Assistanceservice or provide new services and features. Ultimately, the satisfaction of callers and our carrier customers, andour ability to renew and extend our current customer contracts, enter into newcustomer contracts and expansion of our Infone service, depends on the qualityof services we provide.  The quality ofour services is directly related to the quality of our listings data and otherinformation content.

 

*As we rely on alimited number of suppliers, an abrupt loss of any key supplier could adverselyaffect our business operations or delay our development efforts.*

 

We rely on some key suppliers to provide us with programming andengineering services and to license us their technology.  An abrupt loss of any current key suppliercould cause a disruption in our operations or a delay in our developmentefforts and could adversely affect our business operations.

 

*If we are unable tocontinue to attract and retain qualified senior management, technical personneland call center operators, or our call center staff is unionized, ouroperations could be adversely affected.*

 

Our success depends to a significant extent on the efforts andabilities of our senior management, technical personnel and call centeroperators.  The loss of the services ofour senior management and technical personnel could have a material adverseeffect on our business and our ability to meet our strategic objectives.  We also depend on the continued service ofour call center operators, who we hire from the available labor pool.  The ability to attract and retain qualifiedsenior management, technical personnel, operators and other skilled employeesis extremely important to the operation of our business.  If we are unable to attract and retainqualified individuals, or we are required to pay significantly higher wages andother benefits to such individuals, or if our call center staff is unionized,it could adversely affect our business operations.  We find it more difficult to recruit and retain qualifiedindividuals during periods of low unemployment and, therefore, may be subjectto increasing pressure to offer higher wages and other benefits during suchperiods.  In our call center hiring, wemay also feel the effects of the telecommunications industry in general, whichhas widespread union membership among its operators and other workers.

 

*If we are unable touse and protect our intellectual property, we may be unable to provide some ofour Enhanced Directory Assistance and information services or profitablyoperate our business.*

 

We regard aspects of our Enhanced Directory Assistance and informationservices and their features and processes to be proprietary.  If we are unable to use and protect ourintellectual property, we may be unable to provide some of our EnhancedDirectory Assistance and information services or profitably operate ourbusiness.  To a limited extent, we relyon a combination of trade secret, patent and other intellectual property law,nondisclosure agreements and other protective measures to protect ourintellectual property.  However, these

 

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measures may be difficult and costly to meaningfully enforce.  In addition, attempts to enforce ourintellectual property rights may bring into question the validity of theserights.  Litigation with respect topatents or other intellectual property rights can result in substantial costsand diversion of management attention and other resources.

 

*We may needadditional capital in the future, and it may not be available on acceptableterms, or at all.*

 

We may require more capital in the future to fund our operations,finance investments in equipment and infrastructure needed to maintain orexpand our call center and network capabilities, enhance and expand the rangeof services and features we offer, respond to competitive pressures andpotential opportunities, such as investments, acquisitions and new productinitiatives and growth strategies and advertise, market and promoteInfone.  We cannot be certain thatadditional financing will be available on terms favorable to us or at all.  The terms of available financing may placelimits on our financial and operating flexibility.  If adequate financing is not available on acceptable terms, wemay be forced to reduce our operations or abandon expansion opportunities.

 

*If we expand ourbusiness into international markets, we will encounter risks which couldadversely affect us.*

 

We have operated only in the United States; however, an element of ourbusiness strategy is to continue to explore international businessopportunities.  If we expand into one ormore international markets, we will encounter significant risks anduncertainties.  These risks anduncertainties include increased operational difficulties arising from, amongother things:

 

•      Our ability to attractsufficient business or locate a suitable partner or joint venture candidate toenable us to overcome logistical and economic barriers to entry;

 

•      Our ability and cost togather sufficient information content and listings data, properly modify ourfeatures and services to meet applicable standards, and hire and trainpersonnel;

 

•      Fluctuations in foreigncurrency exchange rates; and

 

•      Political, regulatory andeconomic developments and cultural differences.

 

*Our common stockprice is volatile.*

 

The market price of our common stock has experienced volatility and islikely to continue to experience significant fluctuations in response to anumber of factors.  These factorsinclude, among others, those that affect our quarterly and annual operatingresults and the following:

 

•      Announcements of extensions,expirations or changes in our contracts and the effects on our call centers andinfrastructure of such activities;

 

•      Announcements relating tomaterial events concerning our customers;

 

•      Actual or anticipatedvariations in our results of operations;

 

•      The success of our Infoneservice;

 

•      Changes in financialestimates by securities analysts;

 

•      Obsolescence of technologiesthat we or our customers use;

 

•      Introductions of newtechnologies, products or features;

 

•      New product initiatives andgrowth strategies; and

 

•      General market conditions.

 

From January 1, 2003 through December 31, 2003, our commonstock price fluctuated from a low of $1.65 per share to a high of $7.24 pershare and has on several days fluctuated more than 10%.  These trading prices may changesignificantly and arbitrarily.  Inaddition, broad market factors affecting telecommunications or technology stocksmay adversely affect the market price of our common stock.  General economic, political and marketconditions, including interest rate changes and recession, may also adverselyaffect our stock price.

 

*Our results ofoperations could be impacted by a significant increase in the rate ofinflation.*

 

Inflation has not historically had a material affect on ourbusiness.  Operating expenses such assalaries, employee benefits and occupancy costs are, however, subject to normalinflationary pressures which could adversely affect our operating results.

 

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*Oregon law andprovisions of our charter could make the acquisition of our company moredifficult.*

 

We are authorized to issue up to 10,000,000shares of preferred stock, and our Board of Directors has the authority to fixthe preferences, limitations and relative rights of those shares without anyvote or action by the shareholders.  Thepotential issuance of preferred stock may delay or prevent a change in controlof our company, may discourage bids for the common stock at a premium over themarket price and may adversely affect the market price of, and the voting andother rights of the holders of, our common stock.  In addition, provisions under Oregon law limit the ability ofparties who acquire a significant amount of voting stock to exercise controlover our company.  These provisions mayhave the effect of lengthening the time required for a person to acquire controlof our Company through a proxy contest or the election of a majority of theBoard of Directors and may deter efforts to obtain control of our Company.

 

**ITEM 7A****.****               QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

Substantially all of our liquid investments are invested in money marketinstruments, and therefore, the fair market value of these investments isaffected by changes in market interest rates. However, these investments were invested in overnight money marketinstruments at December 31, 2003 and were redeemable on a daily basis.  All of the underlying investments in themoney market fund had maturities of three months or less.  As a result, we believe the market riskarising from our holdings of financial instruments is minimal.  A hypothetical 1% fluctuation in interest rateswould not have a material adverse effect on our financial position, results ofoperations or cash flows.

 

**ITEM 8****.****                  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.**

 

See pages 27 through 40.

 

**ITEM 9****.****                                                     CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.**

 

None.

 

**ITEM 9A****.****               CONTROLSAND PROCEDURES.**

 

Under the supervision and with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, we have evaluated our disclosure controlsand procedures at the end of the period covered by this annual report.  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that suchdisclosure controls and procedures are adequate and effective.  There have not been any significant changesin our internal controls or in other factors that could significantly affectthese controls subsequent to the date of management’s evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

We intend to review and evaluate the design and effectiveness of ourdisclosure controls and procedures on an ongoing basis and to improve ourcontrols and procedures over time and to correct any deficiencies that we maydiscover in the future.  Our goal is toensure that our senior management has timely access to all material financialand non-financial information concerning our business.  While we believe the present design of ourdisclosure controls and procedures is effective to achieve our goal, futureevents affecting our business may cause us to significantly modify ourdisclosure controls and procedures.

 

# **PART III**

# ** **

**ITEM10****.****               DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT.**

 

The information required by Item 10 is incorporated by reference to theProxy Statement for our 2004 Annual Meeting under the captions “Management,”“Nominees and Directors” and “Corporate Governance” to be filed with theSecurities and Exchange Commission within 120 days of our fiscal year end.

 

*Compliance withSection 16(a) of the Exchange Act.*  The information required by Item 10 relatingto compliance with Section 16(a) of the Securities Exchange Act of 1934 isincorporated by reference to the Proxy Statement for our 2004 Annual Meetingunder the caption “Section 16(a) Beneficial Ownership ReportingCompliance” to be filed with the Securities and Exchange Commission within 120days of our fiscal year end.

 

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*Code of Ethics.*  We have adopted a “Code of Business Conductand Ethics” applicable to our directors, officers and employees and a “Code ofEthics” applicable to our Chief Executive Officer and our senior financialofficers.  Both our Code of BusinessConduct and Ethics and our Code of Ethics are available by requesting a freecopy by writing us at Metro One Telecommunications, Inc., 11200 Murray SchollsPlace, Beaverton, OR 97007, attention Investor Relations.  We intend to satisfy the disclosurerequirements regarding any amendment to, or waiver from, a provision of ourCode of Business Conduct and Ethics or Code of Ethics by disclosing suchmatters in the Investor Relations section of our website.

 

**ITEM11****.****               EXECUTIVECOMPENSATION.**

 

The information required by Item 11 is incorporated by reference to theProxy Statement for our 2004 Annual Meeting under the caption “ExecutiveCompensation,” to be filed with the Securities and Exchange Commission within120 days of our fiscal year end.

 

**ITEM12****.****               SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.**

 

The information required by Item 12 is incorporated by reference to theProxy Statement for our 2004 Annual Meeting under the caption “PrincipalShareholders,” to be filed with the Securities and Exchange Commission within120 days of our fiscal year end.

 

**ITEM 13****.****               CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.**

 

None.

 

**ITEM 14****.****               PRINCIPALACCOUNTANT FEES AND SERVICES.**

 

The information required by Item 12 is incorporated by reference to theProxy Statement for our 2004 Annual Meeting under the caption “PrincipalAuditor Fees and Services,” to be filed with the Securities and ExchangeCommission within 120 days of our fiscal year end.

 

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# **PART IV**

# ** **

**ITEM 15****.****               EXHIBITS,FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.**

 
| **(a)(1)** | **Financial Statements**                                                                                                          |
|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                              |
|       | Independent Auditors’ Report                                                                                                 |
|       |                                                                                                                              |
|       | Statements of Operations for each of the  years ended December 31, 2003, 2002 and 2001                                       |
|       |                                                                                                                              |
|       | Balance Sheets at December 31, 2003  and 2002                                                                                |
|       |                                                                                                                              |
|       | Statements of Shareholders’ Equity for each  of the years ended December 31, 2003, 2002 and 2001                        |
|       |                                                                                                                              |
|       | Statements of Cash Flows for each of the  years ended December 31, 2003, 2002 and 2001                                       |
|       |                                                                                                                              |
|       | Notes to Financial Statements                                                                                                     |
|       |                                                                                                                              |
| **(a)(2)** | **Exhibits**                                                                                                                      |
|       |                                                                                                                              |
| 3.1        | Third Restated Articles of Incorporation of Metro One  Telecommunications, Inc.                                                   |
|       |                                                                                                                              |
| 3.2        | Amendment to Third Restated Articles of Incorporation of Metro One  Telecommunications, Inc.                                      |
|       |                                                                                                                              |
| 3.3        | Amended and Restated Bylaws of Metro One Telecommunications, Inc.                                                                 |
|       |                                                                                                                              |
| 10.1       | Form of Enhanced Directory Assistance Agreement (1)                                                                               |
|       |                                                                                                                              |
| 10.11      | Lease Agreement between and among Murray Scholls, LLC, Gramor  Development Northwest, Inc. and the Company (2)                    |
|       |                                                                                                                              |
| 10.21      | Commercial Lease Agreement between Murray Scholls, LLC and the  Company (3)                                                       |
|       |                                                                                                                              |
| 10.23      | Deferred Compensation Plan Document (3)*                                                                                          |
|       |                                                                                                                              |
| 10.24      | 1999 Employee Stock Purchase Plan, as amended (3)*                                                                                |
|       |                                                                                                                              |
| 10.27      | 1994 Stock Incentive Plan, as amended (4)*                                                                                        |
|       |                                                                                                                              |
| 10.28      | 2003 Employment Agreement with Timothy A. Timmins (5)*                                                                            |
|       |                                                                                                                              |
| 23.1       | Consent of Deloitte & Touche LLP, independent auditors                                                                        |
|       |                                                                                                                              |
| 31.1       | Certification of Timothy A. Timmins pursuant to Rule 15d-14(a)                                                                    |
|       |                                                                                                                              |
| 31.2       | Certification of Dale N. Wahl pursuant to Rule 15d-14(a)                                                                          |
|       |                                                                                                                              |
| 32.1       | Certification Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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*     Management contract orcompensatory plan

 

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| (1)    | Incorporated herein by reference to the Company’s Quarterly Report on  Form 10-Q dated October 22, 1999, Commission No. 0-27024.                                                                                       |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                             |
| (2)    | Incorporated herein by reference to the Company’s annual report on  Form 10-K dated March 31, 1999, Commission No.   0-27024.                                                                                          |
|   |                                                                                                                                                                                                                             |
| (3)    | Incorporated herein by reference to the Company’s annual report on  Form 10-K dated April 2, 2001, Commission No.   0-27024 and to the Company’s Form S-8 dated September 26, 2003,  Commission No. 0-27024. |
|   |                                                                                                                                                                                                                             |
| (4)    | Incorporated herein by reference to the Company’s Form S-8 dated  February 12, 2002, Commission No. 0-27024 and to the Company’s Form S-8  dated September 10, 2002, Commission No. 0-27024.                 |
|   |                                                                                                                                                                                                                             |
| (5)    | Incorporated herein by reference to the Company’s annual report on  Form 10-K dated March 31, 2003, Commission No.   0-27024                                                                                           |

 

**(b) Reports Filedon Form 8-K**

On October 24, 2003, we filed a current report on Form 8-K, datedOctober 24, 2003, under Item 12, Results of Operations and FinancialCondition which furnished our third quarter 2003 financial statements.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of theExchange Act, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
|                                                           | Metro One Telecommunications, Inc. |
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|                                                           |                               |   |
|                                                           |                               |   |
|                                                           | By:                                | /s/ Timothy A. Timmins |   |
|                                                           |                               | Timothy A. Timmins |
|                                                           |                               | President and Chief Executive Officer |
|                                                           |                               |   |
| Date:       March 15,  2004 |                               |   |

 

Pursuant to the requirements of the Exchange Act, this report has beensigned below by the following persons on behalf of the registrant in thecapacities and on the date indicated:

 
| **Signature**             |   | **Title**                      |                               | **Date** |
|---------------------------|--------|--------------------------------|------------------------------------|----------|
|                      |   |                           |                               |     |
| /s/ Timothy A. Timmins    |   |                           | President, Chief Executive         |     | March 15, 2004 |
| Timothy A. Timmins        |   | Officer and Director           |                               |     |
|                      |   | (Principal Executive Officer)  |                               |     |
|                      |   |                           |                               |     |
| /s/ Gary E. Henry         |   |                           | Executive Vice President,          |     | March 15, 2004 |
| Gary E. Henry             |   | Chief Operating Officer        |                               |     |
|                      |   | and Director                   |                               |     |
|                      |   |                           |                               |     |
| /s/ Dale N. Wahl          |   |                           | Senior Vice President,             |     | March 15, 2004 |
| Dale N. Wahl              |   | Chief Financial Officer        |                               |     |
|                      |   | (Principal Financial Officer)  |                               |     |
|                      |   |                           |                               |     |
| /s/ Duane C. Fromhart     |   |                           | Vice President, Finance            |     | March 15, 2004 |
| Duane C. Fromhart         |   | (Principal Accounting Officer) |                               |     |
|                      |   |                           |                               |     |
| /s/ William D. Rutherford |   |                           | Chairman of the Board of Directors |     | March 15, 2004 |
| William D. Rutherford     |   |                           |                               |     |
|                      |   |                           |                               |     |
| /s/ Roger L. Pringle      |   |                           | Director                           |     | March 15, 2004 |
| Roger L. Pringle          |   |                           |                               |     |
|                      |   |                           |                               |     |
| /s/ James M. Usdan        |   |                           | Director                           |     | March 15, 2004 |
| James M. Usdan            |   |                           |                               |     |
|                      |   |                           |                               |     |
| /s/ David A. Williams     |   |                           | Director                           |     | March 15, 2004 |
| David A. Williams         |   |                           |                               |     |
|                           |        |                                |                                    |          |  |  |  |  |  |  |  |  |

 

25

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INDEPENDENTAUDITORS’ REPORT

 

To The Board of Directors and Shareholders of

Metro One Telecommunications, Inc.

Beaverton, Oregon

 

We have audited the accompanying balance sheets of Metro OneTelecommunications, Inc. as of December 31, 2003 and 2002, and the relatedstatements of operations, shareholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2003.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion, such financial statements present fairly, in allmaterial respects, the financial position of Metro One Telecommunications, Inc.as of December 31, 2003 and 2002, and the results of its operations andits cash flows for each of the three years in the period endedDecember 31, 2003, in conformity with accounting principles generallyaccepted in the United States of America.

 

 

DELOITTE & TOUCHE LLP

Portland, Oregon

March 12, 2004

 

26

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**Metro OneTelecommunications, Inc.**

**Statements of Oper****ations **(In thousands, except per shareamounts)

 
|                                                       |   | **Years  ended December 31,** |    |
|------------------------------------------------------------|--------|------------------------------------|---------|
|                                                       |   | **2003**                           |    | **2002** | ** ** | **2001** | ** ** |
|                                                       |   |                               |    |   |   |   |   |
| Revenues                                                   |   | $                                  | 201,636 |   | $ | 257,951 |   | $ | 233,318 |   |
|                                                       |   |                               |    |   |   |   |   |
| Costs and expenses:                                        |   |                               |    |   |   |   |   |
| Direct operating                                           |   | 117,126                            |    | 144,164 |   | 131,851 |   |
| Selling, general and administrative                        |   | 128,271                            |    | 72,461 |   | 65,422 |   |
| Impairment loss on goodwill and related  intangible assets |   | 4,715                              |    | — |   | — |   |
|                                                       |   | 250,112                            |    | 216,625 |   | 197,273 |   |
|                                                       |   |                               |    |   |   |   |   |
| (Loss) income from operations                              |   | (48,476                            | )       | 41,326 |   | 36,045 |   |
|                                                       |   |                               |    |   |   |   |   |
| Other income, net                                          |   | 678                                |    | 978 |   | 1,388 |   |
| Interest and loan fees                                     |   | —                             |    | (10 | ) | (895 | ) |
|                                                       |   |                               |    |   |   |   |   |
| (Loss) income before income taxes                          |   | (47,798                            | )       | 42,294 |   | 36,538 |   |
| Income tax (benefit) expense                               |   | (14,489                            | )       | 16,165 |   | 8,116 |   |
| Net (loss) income                                          |   | $                                  | (33,309 | ) | $ | 26,129 |   | $ | 28,422 |   |
|                                                       |   |                               |    |   |   |   |   |
| Net (loss) income per common share:                        |   |                               |    |   |   |   |   |
|                                                       |   |                               |    |   |   |   |   |
| Basic                                                      |   | $                                  | (1.35   | ) | $ | 1.06 |   | $ | 1.20 |   |
| Diluted                                                    |   | $                                  | (1.35   | ) | $ | 1.04 |   | $ | 1.15 |   |
|                                                       |   |                               |    |   |   |   |   |
| Weighted average shares outstanding:                       |   |                               |    |   |   |   |   |
| Basic                                                      |   | 24,706                             |    | 24,576 |   | 23,589 |   |
| Diluted                                                    |   | 24,706                             |    | 25,078 |   | 24,812 |   |

 

The accompanying notes are an integral partof these financial statements.

 

27

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**MetroOne Telecommunications, Inc.**

**Balance Sheet****s **(In thousands)

 
|                                                                                                                                                     |   | **December 31,** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                                                                                                     |   | **2003**              |       | **2002** |   |
|                                                                                                                                                     |   |                  |       |   |   |
| **Assets**                                                                                                                                               |   |                  | ** ** |   | ** ** |
|                                                                                                                                                     |   |                  |       |   |   |
| Current assets:                                                                                                                                          |   |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                |   | $                     | 44,381     |   | $ | 76,528 |   |
| Restricted cash                                                                                                                                          |   | 4,900                 |       | 3,348 |   |
| Accounts receivable                                                                                                                                      |   | 32,078                |       | 31,321 |   |
| Prepaid costs and other current assets                                                                                                                   |   | 15,944                |       | 6,498 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Total current assets                                                                                                                                     |   | 97,303                |       | 117,695 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Furniture, fixtures and equipment, net                                                                                                                   |   | 62,187                |       | 71,668 |   |
| Goodwill                                                                                                                                                 |   | —                |       | 4,432 |   |
| Intangible assets                                                                                                                                        |   | 4,819                 |       | 4,023 |   |
| Other assets                                                                                                                                             |   | 575                   |       | 871 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Total assets                                                                                                                                             |   | $                     | 164,884    |   | $ | 198,689 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| **Liabilities and Shareholders’ Equity**                                                                                                            |   |                  | ** ** |   | ** ** |
|                                                                                                                                                     |   |                  |       |   |   |
| Current liabilities:                                                                                                                                     |   |                  |       |   |   |
| Accounts payable                                                                                                                                         |   | $                     | 3,146      |   | $ | 1,366 |   |
| Accrued liabilities                                                                                                                                      |   | 2,634                 |       | 1,054 |   |
| Accrued payroll and related costs                                                                                                                        |   | 12,297                |       | 11,570 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Total current liabilities                                                                                                                                |   | 18,077                |       | 13,990 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Deferred tax liabilities                                                                                                                                 |   | 3,799                 |       | 8,789 |   |
| Other long-term liabilities                                                                                                                              |   | 670                   |       | 521 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Total liabilities                                                                                                                                        |   | 22,546                |       | 23,300 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Commitments and contingencies                                                                                                                            |   |                  |       |   |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Shareholders’ equity:                                                                                                                               |   |                  |       |   |   |
| Preferred stock, no par value; 10,000  shares authorized, no shares issued or outstanding                                                                |   | —                |       | — |   |
| Common stock, no par value; 50,000 shares  authorized, 24,775 and 24,682 shares issued and outstanding at  December 31, 2003 and 2002, respectively |   | 119,683               |       | 119,425 |   |
| Retained earnings                                                                                                                                        |   | 22,655                |       | 55,964 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Shareholders’ equity                                                                                                                                |   | 142,338               |       | 175,389 |   |
|                                                                                                                                                     |   |                  |       |   |   |
| Total liabilities and shareholders’ equity                                                                                                          |   | $                     | 164,884    |   | $ | 198,689 |   |

 

The accompanying notes are an integral partof these financial statements.

 

28

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**Metro OneTelecommunications, Inc.**

**Statements of Share****holders’Equity **(In thousands)

 
|                                  |   | **Shareholders’  Equity** |       |
|---------------------------------------|--------|--------------------------------|------------|
|                                  |   | **Common  Stock**              |       | **Retained  Earnings** |   | **Shareholders’  Equity** |   |
|                                  |   | **Shares**                     |       | **Amount** | ** ** |   |   |
|                                  |   |                           | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Balances at December 31, 2000    |   | 17,747                         |       | $ | 43,991 |   | $ | 1,413 |   | $ | 45,404 |   |
|                                  |   |                           |       |   |   |   |   |   |   |
| Issuance of common stock, net         |   | 6,000                          |       | 64,607 |   | — |   | 64,607 |   |
| Shares issued in business combination |   | 155                            |       | 3,200 |   | — |   | 3,200 |   |
| Employee stock options exercised      |   | 510                            |       | 3,300 |   | — |   | 3,300 |   |
| Tax benefit from stock plans          |   | —                         |       | 1,730 |   | — |   | 1,730 |   |
| Employee stock purchase plan          |   | 51                             |       | 706 |   | — |   | 706 |   |
| Net income                            |   | —                         |       | — |   | 28,422 |   | 28,422 |   |
|                                  |   |                           |       |   |   |   |   |   |   |
| Balances at December 31, 2001    |   | 24,463                         |       | 117,534 |   | 29,835 |   | 147,369 |   |
|                                  |   |                           |       |   |   |   |   |   |   |
| Employee stock options exercised      |   | 91                             |       | 594 |   | — |   | 594 |   |
| Tax benefit from stock plans          |   | —                         |       | 498 |   | — |   | 498 |   |
| Employee stock purchase plan          |   | 128                            |       | 799 |   | — |   | 799 |   |
| Net income                            |   | —                         |       | — |   | 26,129 |   | 26,129 |   |
|                                  |   |                           |       |   |   |   |   |   |   |
| Balances at December 31, 2002    |   | 24,682                         |       | 119,425 |   | 55,964 |   | 175,389 |   |
|                                  |   |                           |       |   |   |   |   |   |   |
| Tax benefit from stock plans          |   | —                         |       | 24 |   | — |   | 24 |   |
| Employee stock purchase plan          |   | 93                             |       | 234 |   | — |   | 234 |   |
| Net loss                              |   | —                         |       | — |   | (33,309 | ) | (33,309 | ) |
|                                  |   |                           |       |   |   |   |   |   |   |
| Balances at December 31, 2003    |   | 24,775                         |       | $ | 119,683 |   | $ | 22,655 |   | $ | 142,338 |   |

 

The accompanying notes are an integral partof these financial statements.

 

29

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**Metro OneTelecommunications, Inc.**

**Statements of Cash****Flows **(In thousands)

 
|                                                                                                |   | **Years  ended December 31,** |    |
|-----------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|
|                                                                                                |   | **2003**                           |    | **2002** | ** ** | **2001** | ** ** |
|                                                                                                |   |                               |    |   |   |   |   |
| Cash flows from operating activities:                                                               |   |                               |    |   |   |   |   |
| Net (loss) income                                                                                   |   | $                                  | (33,309 | ) | $ | 26,129 |   | $ | 28,422 |   |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities: |   |                               |    |   |   |   |   |
| Depreciation and amortization                                                                       |   | 21,585                             |    | 18,794 |   | 15,824 |   |
| Loss on disposal of fixed assets                                                                    |   | 94                                 |    | 398 |   | 176 |   |
| Impairment loss on goodwill and related  intangible assets                                          |   | 4,715                              |    | — |   | — |   |
| Deferred rent                                                                                       |   | 149                                |    | 243 |   | 248 |   |
| Deferred income taxes                                                                               |   | (5,963                             | )       | 5,325 |   | 1,775 |   |
| Tax benefit from employee stock plans                                                               |   | 24                                 |    | 498 |   | 1,730 |   |
| Changes in certain assets and liabilities:                                                          |   |                               |    |   |   |   |   |
| Accounts receivable                                                                                 |   | (757                               | )       | 1,473 |   | 3,765 |   |
| Prepaid costs and other assets                                                                      |   | (9,815                             | )       | (3,022 | ) | (2,727 | ) |
| Accounts payable and other liabilities                                                              |   | 4,088                              |    | (4,531 | ) | 649 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Net cash (used in) provided by operating  activities                                                |   | (19,189                            | )       | 45,307 |   | 49,862 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Cash flows from investing activities:                                                               |   |                               |    |   |   |   |   |
| Capital expenditures                                                                                |   | (11,640                            | )       | (21,416 | ) | (27,966 | ) |
| Acquisition of business                                                                             |   | —                             |    | — |   | (3,388 | ) |
|                                                                                                |   |                               |    |   |   |   |   |
| Net cash used in investing activities                                                               |   | (11,640                            | )       | (21,416 | ) | (31,354 | ) |
|                                                                                                |   |                               |    |   |   |   |   |
| Cash flows from financing activities:                                                               |   |                               |    |   |   |   |   |
| Cash restricted to secure letter of credit                                                          |   | (1,552                             | )       | (2,448 | ) | (900 | ) |
| Net repayment of line of credit                                                                     |   | —                             |    | — |   | (4,750 | ) |
| Repayment of debt                                                                                   |   | —                             |    | — |   | (34,242 | ) |
| Proceeds from issuance of common stock, net                                                         |   | —                             |    | — |   | 64,607 |   |
| Proceeds from exercise of stock options and  employee stock purchases                               |   | 234                                |    | 1,393 |   | 4,006 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Net cash (used in) provided by financing  activities                                                |   | (1,318                             | )       | (1,055 | ) | 28,721 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Net (decrease) increase in cash and cash  equivalents                                               |   | (32,147                            | )       | 22,836 |   | 47,229 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Cash and cash equivalents, beginning of  year                                                       |   | 76,528                             |    | 53,692 |   | 6,463 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Cash and cash equivalents, end of year                                                              |   | $                                  | 44,381  |   | $ | 76,528 |   | $ | 53,692 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Supplemental disclosure of cash flow  information:                                                  |   |                               |    |   |   |   |   |
| Cash paid for income taxes                                                                          |   | $                                  | 875     |   | $ | 12,358 |   | $ | 4,395 |   |
| Cash paid for interest                                                                              |   | 2                                  |    | 11 |   | 993 |   |
|                                                                                                |   |                               |    |   |   |   |   |
| Summary of non-cash investing and financing  activities:                                            |   |                               |    |   |   |   |   |
| Issuance of 155 shares of common stock in  business combination                                     |   | $                                  | —  |   | $ | — |   | $ | 3,200 |   |

 

The accompanying notes are an integral partof these financial statements.

 

30

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**Metro OneTelecommunications, Inc.**

**Notes to Financial Statements**

 

**1.****             Summaryof Operations and Significant Accounting Policies**

 

***Nature ofOperations.*** We provide Enhanced Directory Assistance and information services totelecommunications carriers, their customers and directly to businesses andother customers.  Revenues are derivedprincipally through fees charged to telecommunications carriers and othercustomers.  We operate call centerslocated in many metropolitan areas throughout the United States.

 

***Major Customers.***  In each of the years ended December 31,2003, 2002 and 2001, a small number of customers accounted for substantiallyall revenue and accounts receivable reported. In 2003, our three largest customers accounted for approximately 44%,35% and 13% of our revenues.  Our threelargest customers accounted for approximately 33%, 33% and 24% of revenue in2002 and approximately 32%, 30% and 23% of revenue in 2001.  In 2003 and historically, we have notincurred significant losses related to our accounts receivable.

 

***Significant Events.***  Our contract with AT&T Wireless expiredon December 1, 2003, and we were unable to reach an economic arrangementacceptable to both parties, thus, our negotiations did not result in a newcontract to replace the existing one. AT&T Wireless accounted for approximately 44%, 33% and 30% of ourrevenues in 2003, 2002 and 2001, respectively. We expect that the call volume from AT&T Wireless will transitionaway from us during the second quarter of 2004.  The expiration of our contract with AT&T Wireless will have amaterial adverse effect on our financial position, future operating results andcash flows, as well as our operations. We expect to adjust personnel, call centers and network capacities inorder to address varying business circumstances, including the expiration ofthis contract.

 

Our contract with Sprint PCS expired on December 31, 2002.  We agreed to a transition arrangement withSprint PCS, pursuant to which we continued to handle its subscribers’ callssubsequent to December 31, 2002. The transition began in March 2003 and was substantially completedby June 30, 2003.  Revenue fromSprint PCS accounted for approximately 13%, 33% and 32% of our total revenue in2003, 2002 and 2001, respectively.

 

***Use of Estimates.***  The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires us to make estimates and assumptions that affect reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expenses during the fiscal year. Actual results could differ from those estimates.

 

***Reclassification.***  Certain balances in the 2002 and 2001financial statements have been reclassified to conform to 2003presentations.  Such reclassificationshad no effect on reported net income.

 

***Cash and CashEquivalents.*** Cash and cash equivalents include cash deposits in banks and highlyliquid investments with maturity dates of three months or less at the date ofacquisition.  Restricted cash consistsof cash restricted to secure a letter of credit related to our workers’compensation program and is invested in a bank certificate of deposit.

 

***Furniture, Fixturesand Equipment.*** Furniture, fixtures and equipment are stated at cost and are depreciatedover their estimated useful lives of three to seven years using thestraight-line method.  Leaseholdimprovements are amortized over the lesser of the remaining lease term or theuseful life.  Expenses for repairs andmaintenance are expensed as incurred.

 

***Goodwill.***  Purchased goodwill, which represents theexcess of cost over the fair value of net assets acquired in a businesscombination, was amortized on a straight-line basis, over its estimatedeconomic life, through December 31, 2001. On January 1, 2002, we adopted Statement of Financial AccountingStandards (“SFAS”) No. 142.  Under SFASNo. 142, we discontinued amortization of goodwill and are required to evaluategoodwill for impairment annually and whenever events or changes incircumstances may indicate that the carrying amount of goodwill is impaired.  When we performed our evaluation of goodwillin 2003, particularly given the expiration of our contract with AT&TWireless in December 2003, our analysis indicated that our estimate of thefair value of our business was less than its carrying value, therefore, thebook value of goodwill and related intangibles of approximately $4.7 millionwas written off during the fourth quarter of 2003.

 

***Intangible Assets.***  Intangible assets include patents, patentspending and trademarks.  These assetsare carried at cost less accumulated amortization and are amortized over theirestimated useful lives of three to ten years beginning at the time the relatedpatent or trademark is

 

31

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granted.  Accumulatedamortization related to intangible assets was $1,192,000 and $634,000 atDecember 31, 2003 and 2002, respectively. The related amortization expense was $558,000, $377,000 and $210,000 forthe years ended December 31, 2003, 2002 and 2001, respectively.

 

The estimated aggregate amortization expense related to intangibleassets for the five years subsequent to 2003 is shown below.   We have not included any amounts related toamortization of costs of patents or trademarks currently pending but not yetgranted, totaling $2.6 million at December 31, 2003.

 

| **Year Ending  December 31,** |   | **Estimated  amortization expense** | ** ** |
|------------------------------------|--------|-------------------------------------|------------|
|                               |   | **(In  thousands)**                 |       |
| 2004                               |   | $                                   | 560        |   |
| 2005                               |   | 538                                 |       |
| 2006                               |   | 435                                 |       |
| 2007                               |   | 415                                 |       |
| 2008                               |   | 239                                 |       |
|                                    |        |                                     |            |  |

 

***Impairment ofLong-lived and Intangible Assets.***  We evaluate the carrying value of furniture,fixtures, equipment and intangible assets with finite lives for possibleimpairment whenever events or changes in circumstances indicate that suchassets may be impaired.  If an asset isdetermined to be impaired, the loss is measured as the amount by which thecarrying value of the asset exceeds its fair value.  We prepare an estimate of future undiscounted cash flows expectedto result from the use of the asset and its eventual disposition to determineits fair value.

 

***Deferred IncomeTaxes.*** Deferred income taxes are provided for temporary differences between theamounts of assets and liabilities for financial and tax reportingpurposes.  Deferred tax assets arereduced by a valuation allowance when it is estimated to be more likely thannot that some or all of the deferred tax assets will not be realized.

 

***Fair Value ofFinancial Instruments.***  The carrying value of cash and cash equivalents, restricted cash,accounts receivable, accounts payable, accrued liabilities and accrued payrolland related costs approximate fair value due to their short-term maturities.

 

***Revenue Recognition.***  Under existing contracts withtelecommunications carriers, we record revenue for the number of callsprocessed at the agreed upon price per call, calculated on a monthlybasis.  Revenue per call may vary basedon monthly volumes achieved.  Revenuefrom our Infone® service is recognized on a per-call basis.  Revenue is recognized as services areprovided.

 

***Advertising. ***Costs ofadvertising are expensed as incurred except for commercial advertisingproduction costs, which are expensed at the time the related commercials arefirst run.  Advertising expense wasapproximately $50 million in 2003, primarily related to marketing and promotionof our Infone service launched in May 2003.

 

***Net (Loss) IncomePer Share.*** We report basic and diluted net (loss) income per share in accordancewith SFAS No. 128, “Earnings per Share.” Basic net (loss) income per share is calculated based on the weightedaverage number of common shares outstanding during each period.  Diluted net (loss) income per share iscalculated based on these same shares plus dilutive potential shares issuableupon assumed exercise of outstanding stock options, based on the treasury stockmethod, unless inclusion of such potential shares would be anti-dilutive.

 

***Stock-Based Compensation.***  We have elected to account for stock optionsaccording to Accounting Principles Bulletin No. 25, “Accounting for StockIssued to Employees,” and to furnish the pro forma disclosures required underSFAS No. 148, “Accounting for Stock-Based Compensation — Transition andDisclosure — an amendment of FASB Statement No. 123.”   Accordingly, no compensation cost has been recognized in thefinancial statements related to stock options issued under our Stock IncentivePlan (the “Plan”).

 

32

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If compensation cost on stock options granted in 2003, 2002 and 2001under the Plan had been determined based on the fair value of the options as ofthe grant date in a method consistent with that described in SFAS No. 123,“Accounting for Stock-Based Compensation,” our net (loss) income and net (loss)income per share would have been changed to the pro forma amounts indicatedbelow for the years ended December 31:

 
|                                              |   | **2003**                                      |       | **2002** |   | **2001** |   |
|---------------------------------------------------|--------|-----------------------------------------------|------------|----------|--------|----------|--------|
|                                              |   | **(In  thousands, except per share amounts)** | ** ** |
| Net (loss) income, as reported                    |   | $                                             | (33,309    | )        | $      | 26,129   |   | $ | 28,422 |   |
| Stock-based compensation expense                  |   | (4,135                                        | )          | (4,250   | )      | (2,804   | )      |
| Net (loss) income, pro forma                      |   | $                                             | (37,444    | )        | $      | 21,879   |   | $ | 25,618 |   |
|                                              |   |                                          |       |     |   |     |   |
| Basic net (loss) income per share, as  reported   |   | $                                             | (1.35      | )        | $      | 1.06     |   | $ | 1.20 |   |
| Basic net (loss) income per share, pro  forma     |   | $                                             | (1.52      | )        | $      | 0.89     |   | $ | 1.09 |   |
|                                              |   |                                          |       |     |   |     |   |
| Diluted net (loss) income per share, as  reported |   | $                                             | (1.35      | )        | $      | 1.04     |   | $ | 1.15 |   |
| Diluted net (loss) income per share, pro  forma   |   | $                                             | (1.52      | )        | $      | 0.87     |   | $ | 1.03 |   |

 

The pro forma amounts may not be indicative of the effects on reportedresults for future periods due to the effect of options vesting over a periodof years and the awarding of stock compensation in future years.

 

The fair value of each option grant was estimated on the date of grantusing the Black-Scholes option-pricing model with the following assumptions forthe years ending December 31:

 
|                                            |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                            |   |     |   |     |   |     |   |
| Dividend yield                                  |   | 0.0      | %      | 0.0      | %      | 0.0      | %      |
| Risk free interest rate                         |   | 2.9      | %      | 4.1      | %      | 4.4      | %      |
| Expected volatility                             |   | 98.7     | %      | 82.8     | %      | 87.0     | %      |
| Expected life in years                          |   | 4.0      |   | 4.0      |   | 4.0      |   |
|                                            |   |     |   |     |   |     |   |
| Weighted-average fair value of options  granted |   | $        | 3.40   |     | $      | 13.92    |   | $ | 15.59 |   |
|                                                 |        |          |        |          |        |          |        |  |  |  |

 

***Commitments and Contingencies.***  We are party to various legal actions andadministrative proceedings arising in the ordinary course of business.  We believe the disposition of these matterswill not have a material adverse effect on our financial position, results ofoperations, or cash flows.

 

From time to time, in the normal course of our business, we issuestandby letters of credit and bank guarantees. At December 31, 2003, we had one letter of credit outstanding inthe amount of $4,900,000 related to our workers’ compensation program.  The letter of credit is secured by acertificate of deposit for the same amount that is recorded as restrictedcash.  This commitment expires onApril 1, 2004 and is typically renewed on an annual basis.

 

***Recent AccountingPronouncements.***  In July 2002, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities,” the provisions of which are effective for exit or disposalactivities that are initiated after December 31, 2002.  The statement requires that a liability fora cost associated with an exit or disposal activity be recognized when theliability is incurred.  Under previous guidance,a liability for an exit cost was recognized at the date of an entity’s commitmentto an exit plan.  We adopted thisstatement effective January 1, 2003. The adoption of this statement did not have a material impact on ourfinancial position, results of operations or cash flows.

 

In December 2002, the FASB issued Financial Interpretation (“FIN”)No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  The disclosure requirements in thisinterpretation were applied as of

 

33

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December 31, 2002.  Weadopted the recognition provisions of FIN 45 effective January 1,2003.  The adoption of this statementdid not have a material impact on our financial position, results of operationsor cash flows.

 

**2.****             Furniture,Fixtures and Equipment**

 

Furniture, fixtures and equipment by major classification aresummarized as follows:

 
|                                          |   | **December 31,** |       |
|-----------------------------------------------|--------|-----------------------|------------|
|                                          |   | **2003**              |       | **2002** | ** ** |
|                                          |   | **(In  thousands)**   | ** ** |
| Equipment                                     |   | $                     | 109,052    |   | $ | 101,198 |   |
| Furniture and fixtures                        |   | 14,598                |       | 14,788 |   |
| Leasehold improvements                        |   | 7,380                 |       | 7,211 |   |
|                                          |   |                  |       |   |   |
|                                          |   | 131,030               |       | 123,197 |   |
| Accumulated depreciation                      |   | (68,843               | )          | (51,529 | ) |
|                                          |   |                  |       |   |   |
| Total furniture, fixtures and equipment,  net |   | $                     | 62,187     |   | $ | 71,668 |   |

 

**3.****             Goodwilland other intangible assets**

 

The following presents the activity in goodwill for the years endedDecember 31, 2003 and 2002:

 
| Balance at January 1, 2002   |   | $      | 4,432  |   |
|-----------------------------------|--------|--------|--------|--------|
| No activity                       |   | — |   |
| Balance at January 1, 2003   |   | 4,432  |   |
| Impairment loss                   |   | (4,432 | )      |
|                              |   |   |   |
| Balance at December 31, 2003 |   | $      | — |   |

 

The following presents our net (loss) income adjusted for the adoptionof SFAS No. 142:

 
|                                              |   | **2003**                                      |       | **2002** |   | **2001** |   |
|---------------------------------------------------|--------|-----------------------------------------------|------------|----------|--------|----------|--------|
|                                              |   | **(In  thousands, except per share amounts)** | ** ** |
| Net (loss) income, as reported                    |   | $                                             | (33,309    | )        | $      | 26,129   |   | $ | 28,422 |   |
| Goodwill amortization                             |   | —                                        |       | —   |   | 401      |   |
| Other intangible amortization                     |   | —                                        |       | —   |   | 117      |   |
|                                              |   |                                          |       |     |   |     |   |
| Net (loss) income, adjusted                       |   | $                                             | (33,309    | )        | $      | 26,129   |   | $ | 28,940 |   |
|                                              |   |                                          |       |     |   |     |   |
| Basic net (loss) income per share, as  reported   |   | $                                             | (1.35      | )        | $      | 1.06     |   | $ | 1.20 |   |
| Basic net (loss) income per share, adjusted       |   | $                                             | (1.35      | )        | $      | 1.06     |   | $ | 1.23 |   |
|                                              |   |                                          |       |     |   |     |   |
| Diluted net (loss) income per share, as  reported |   | $                                             | (1.35      | )        | $      | 1.04     |   | $ | 1.15 |   |
| Diluted net (loss) income per share,  adjusted    |   | $                                             | (1.35      | )        | $      | 1.04     |   | $ | 1.17 |   |

 

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Below is a summary of other intangible assets:

 
|                   |   | **Gross  carrying  amount** | ** ** | **Accumulated  amortization** | ** ** |
|------------------------|--------|-----------------------------|------------|-------------------------------|------------|
|                   |   | **(In  thousands)**         | ** ** |
| Amortized intangibles: |   |                        |       |                          |       |
| Patents                |   | $                           | 4,934      |                          | $          | 977 |   |
| Trademarks             |   | 994                         |       | 189                           |       |
| Other                  |   | 83                          |       | 26                            |       |
|                   |   |                        |       |                          |       |
| Totals                 |   | $                           | 6,011      |                          | $          | 1,192 |   |

 

**4.**             **Lease Obligations**

 

We lease operating facilities and equipment under operating leases withremaining terms of one to seven years. Rental expenses related to operating leases were approximately$9,513,000, $9,355,000 and $7,496,000 in 2003, 2002 and 2001, respectively.

 

Minimum annual rent payments for the five years subsequent to 2003 andin the aggregate thereafter are as follows:

 

| **Year Ending  December 31,** |   | **Annual  lease payments** | ** ** |
|------------------------------------|--------|----------------------------|------------|
|                               |   | **(In  thousands)**        |       |
| 2004                               |   | $                          | 8,865      |   |
| 2005                               |   | 7,708                      |       |
| 2006                               |   | 5,875                      |       |
| 2007                               |   | 4,590                      |       |
| 2008                               |   | 2,609                      |       |
| Thereafter                         |   | 1,263                      |       |
| Total minimum lease payments       |   | $                          | 30,910     |   |

 

**5.****             Shareholders’Equity**

 

***SignificantTransactions.***  On January 31, 2001, our shareholdersapproved the issuance and sale to Sonera Media Holding B.V. of 6,000,000 sharesof common stock for a net amount of approximately $64,600,000, whichrepresented approximately 25.5% of our outstanding common stock after theissuance.  At that time, Sonera MediaHolding B.V. was a wholly-owned subsidiary of Sonera Corporation, a publiclytraded telecommunications company organized in Finland.  This transaction was completed inFebruary 2001.  DuringFebruary and March 2001, we paid all outstanding debt with a portionof the proceeds from this transaction. In August 2002, the shares were transferred to Sonera Holding B.V.,another wholly-owned subsidiary of Sonera Corporation.  In December 2002, Sonera Corporationmerged with Telia AB to form TeliaSonera AB.  According to a Form 13-D/A filed with the Securities and ExchangeCommission in January 2004, TeliaSonera AB reported that it no longerholds any shares of our common stock.

 

***Preferred Stock.***  We have authorized 10,000,000 shares ofpreferred stock for issuance.  Our boardof directors has the authority to issue one or more series of preferred sharesand the authority to fix and determine the rights and preferences of suchshares.  No preferred shares were issuedor outstanding as of December 31, 2003.

 

***Common StockOptions.*** We have a Stock Incentive Plan (the “Plan”), approved by ourshareholders, which provides for the award of incentive stock options to keyemployees and the award of non-qualified stock options, stock sales and grantsto employees, outside directors, independent contractors and consultants.  As of December 31, 2003, approximately903,000 shares of common stock were reserved for issuance under the Plan.  It is intended that the Plan will be usedprincipally to attract and retain key employees.

 

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The option price per share of an incentive stock option may not be lessthan the fair market value of a share of common stock as of the date suchoption is granted.  The option price pershare of a non-qualified stock option may be at a price established by theboard of directors or a committee thereof established for purposes ofadministering the plan, which price generally equals the fair market value of ashare of common stock as of the date such option is granted.  Options become exercisable at the times andsubject to the conditions prescribed by the board of directors.  Generally, options vest over a period offour years and the term of each option may not exceed ten years.  Payment for shares purchased pursuant tooptions may be made at the option of the board of directors, in cash or by deliveryof shares of common stock having a market value equal to the exercise price ofthe options.

 

A summary of the status of our stock option plan as ofDecember 31, and changes during the years ending on those dates is asfollows:

 
|                                                                |   | **2003**                                      |       | **2002**                            |       | **2001**   |       |
|---------------------------------------------------------------------|--------|-----------------------------------------------|------------|-------------------------------------|------------|------------|------------|
|                                                                |   | **Shares**                                    |       | **Weighted-  Average  Exer. Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exer. Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exer. Price** | ** ** |
|                                                                |   | **(In  thousands, except per share amounts)** | ** ** |
|                                                                |   |                                          |       |                                |       |       |       |   |   |   |   |   |   |
| Outstanding at beginning of year                                    |   | 2,422                                         |       | $                                   | 13.81      |       | 2,203      |   | $ | 12.16 |   | 2,056 |   | $ | 6.75 |   |
| Granted                                                             |   | 506                                           |       | 4.89                                |       | 379        |       | 22.15 |   | 668 |   | 24.43 |   |
| Exercised                                                           |   | —                                        |       | —                              |       | (91        | )          | 6.52 |   | (510 | ) | 6.47 |   |
| Forfeited                                                           |   | (39                                           | )          | 18.60                               |       | (69        | )          | 16.54 |   | (11 | ) | 9.81 |   |
|                                                                |   |                                          |       |                                |       |       |       |   |   |   |   |   |   |
| Outstanding at end of year                                          |   | 2,889                                         |       | $                                   | 12.18      |       | 2,422      |   | $ | 13.81 |   | 2,203 |   | $ | 12.16 |   |
|                                                                |   |                                          |       |                                |       |       |       |   |   |   |   |   |   |
| Options exercisable at year-end                                     |   | 2,236                                         |       |                                |       | 1,781      |       |   |   | 1,448 |   |   |   |
| Weighted-average exercise price of options  exercisable at year end |   | $                                             | 11.49      |                                |       |       | $          | 10.81 |   |   |   | $ | 9.15 |   |   |   |
|                                                                     |        |                                               |            |                                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table summarizes information about stock optionsoutstanding and exercisable under the Plan at December 31, 2003:

 
|                          |                    | **Outstanding**                               |       | **Exercisable**                                         |   |
|-------------------------------|-------------------------|-----------------------------------------------|------------|---------------------------------------------------------|--------|
| **Range of  Exercise Prices** |                    | **Number  of  Options**                       | ** ** | **Weighted-Average  Remaining  Contractual Life (yrs)** |   | **Weighted-Average  Exercise Price** | ** ** | **Number  of  Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|                          |                    | **(In  thousands, except per share amounts)** | ** ** |
| $                             | 3.57 – 8.00        |                                          | 1,575      |                                                    | 5.08   |   | $ | 5.70 |   | 1,243 |   | $ | 5.62 |   |
| 8.16 – 22.55             |                    | 487                                           |       | 6.56                                                    |   | 11.22 |   | 465 |   | 11.30 |   |
| 23.00                         |                    | 461                                           |       | 7.08                                                    |   | 23.00 |   | 346 |   | 23.00 |   |
| 25.50 – 38.00            |                    | 366                                           |       | 7.98                                                    |   | 27.62 |   | 182 |   | 28.56 |   |
| $                             |  3.57 – 38.00 |                                          | 2,889      |                                                    | 6.01   |   | $ | 12.18 |   | 2,236 |   | $ | 11.50 |   |
|                               |                         |                                               |            |                                                         |        |  |  |  |  |  |  |  |  |  |  |

 

We have an employee stock purchase plan (the “ESPP”), the purpose ofwhich is to attract and retain qualified employees essential to our success,and to provide such persons with an incentive to perform in our best interests.The ESPP allows qualified employees to purchase shares of our common stock on asemi-annual basis, limited to 10% of pre-tax compensation.  The purchase price is set at 85% of the lowerof the stock price at the beginning or ending of each purchase period.  In 2003, shareholders approved an amendmentto the ESPP which increased the number of shares of common stock initiallyauthorized for purchase under the ESPP by 250,000 shares, from 225,000 to475,000 shares of common stock.  Inaddition, the amendment provides that the number of authorized sharesautomatically increases on January 1 of each year until and includingJanuary 1, 2013 by 1% of the number of shares of common stock outstandingon that date; provided, however, that the total number of shares of commonstock available for issuance under the ESPP shall not exceed 3% of the numberof shares of common stock outstanding on that date.  As of December 31, 2003, 173,000 shares of common stock werereserved

 

36

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for issuance under the ESPP. Under the ESPP, during 2003, employees purchased approximately 93,000shares at an average price of $2.52 per share. During 2002, employees purchased approximately 128,000 shares at anaverage price of $6.24 per share.

 

**6.****             OtherIncome and Expense**

 

Included in other income and expense are certain items that do notrelate directly to current ongoing business activity.  Included in this classification for the years endedDecember 31, 2003, 2002 and 2001, is interest income of $668,000, $960,000and $1,337,000, respectively.  Inaddition, this classification included other miscellaneous non-operating incomeand expenses, none of which were individually significant, netting to $10,000,$18,000 and $51,000 of income in 2003, 2002 and 2001, respectively.

 

**7.****             IncomeTaxes**

 

The components of income tax (benefit) expense for the years endedDecember 31 are as follows:

 
|                        |   | **2003**            |       | **2002** |   | **2001** |   |
|-----------------------------|--------|---------------------|------------|----------|--------|----------|--------|
|                        |   | **(In  thousands)** | ** ** |
| Current:                    |   |                |       |     |   |     |   |
| Federal                     |   | $                   | (8,562     | )        | $      | 8,201    |   | $ | 5,671 |   |
| State                       |   | 36                  |       | 2,639    |   | 670      |   |
|                        |   | (8,526              | )          | 10,840   |   | 6,341    |   |
| Deferred:                   |   |                |       |     |   |     |   |
| Federal                     |   | (5,298              | )          | 5,460    |   | 1,775    |   |
| State                       |   | (665                | )          | (135     | )      | —   |   |
|                        |   | (5,963              | )          | 5,325    |   | 1,775    |   |
|                        |   |                |       |     |   |     |   |
| Total tax (benefit) expense |   | $                   | (14,489    | )        | $      | 16,165   |   | $ | 8,116 |   |

 

Income tax (benefit) expense differs from the amount that would resultfrom applying the U.S. statutory rate to income before taxes.  A reconciliation of this difference is asfollows:

 
|                                                       |   | **December 31,** |       |
|------------------------------------------------------------|--------|-----------------------|------------|
|                                                       |   | **2003**              |       | **2002** | ** ** | **2001** | ** ** |
|                                                       |   |                  | ** ** |   | ** ** |   | ** ** |
| Federal statutory rate                                     |   | (35.0                 | )%         | 35.0 | % | 34.0 | % |
| State income taxes, net of federal benefit                 |   | (0.9                  | )          | 3.9 |   | 3.0 |   |
| Federal and state tax credits                              |   | (1.0                  | )          | (1.5 | ) | (6.0 | ) |
| Impairment loss on goodwill and related  intangible assets |   | 3.4                   |       | 0.0 |   | 0.0 |   |
| Change in valuation allowance                              |   | 5.3                   |       | 0.0 |   | (7.0 | ) |
| Other                                                      |   | (2.1                  | )          | 0.8 |   | (1.8 | ) |
|                                                       |   |                  |       |   |   |   |   |
| Effective tax rate                                         |   | (30.3                 | )%         | 38.2 | % | 22.2 | % |

 

37

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Net deferred tax assets and liabilities are included in the followingbalance sheet line items:

 
|                                   |   | **December 31,** | ** ** |
|----------------------------------------|--------|-----------------------|------------|
|                                   |   | **2003**              |       | **2002** | ** ** |
|                                   |   | **(In  thousands)**   | ** ** |
| Prepaid costs and other current assets |   | $                     | 2,853      |   | $ | 1,881 |   |
| Deferred tax liabilities               |   | (3,799                | )          | (8,789 | ) |
|                                   |   |                  |       |   |   |
| Net deferred tax liabilities           |   | $                     | (946       | ) | $ | (6,908 | ) |

 

The temporary differences and carryforwards that give rise to deferredtax assets and liabilities are as follows:

 
|                                      |   | **December 31,** |       |
|-------------------------------------------|--------|-----------------------|------------|
|                                      |   | **2003**              |       | **2002** | ** ** |
|                                      |   | **(In  thousands)**   | ** ** |
| Deferred tax assets:                      |   |                  |       |   |   |
| Net operating loss carryforwards          |   | $                     | 2,651      |   | $ | 569 |   |
| Reserves not currently deductible         |   | 2,860                 |       | 1,880 |   |
| State taxes                               |   | —                |       | 150 |   |
| Start-up costs                            |   | 3,361                 |       | — |   |
| Deferred rent                             |   | 265                   |       | 204 |   |
| Tax credit carryforwards                  |   | 4,265                 |       | 979 |   |
| Total deferred tax asset                  |   | 13,402                |       | 3,782 |   |
| Less: Valuation allowance                 |   | (2,556                | )          | — |   |
|                                      |   |                  |       |   |   |
| Net deferred tax asset                    |   | 10,846                |       | 3,782 |   |
|                                      |   |                  |       |   |   |
| Deferred tax liabilities:                 |   |                  |       |   |   |
| Accumulated depreciation and amortization |   | (11,709               | )          | (10,690 | ) |
| Other                                     |   | (83                   | )          | — |   |
| Total deferred tax liability              |   | (11,792               | )          | (10,690 | ) |
|                                      |   |                  |       |   |   |
| Net deferred tax liability                |   | $                     | (946       | ) | $ | (6,908 | ) |

 

At December 31, 2003, we had approximately $1,626,000 and$32,536,000 of federal and state net operating loss carryforwards,respectively.  These net operating losscarryforwards expire during the years 2007 to 2023.  Ownership changes as defined by section 382 of the InternalRevenue Code could limit the amount of net operating loss carryforwards used inany one year or in the aggregate.

 

**8.****             Net(Loss) Income Per Share**

 

Basic net (loss) income per share is based on the weighted averagenumber of common shares outstanding. Diluted net (loss) income per share reflects the potential dilution thatcould occur if outstanding options to purchase common stock were exercised orconverted into common stock.  There wereno adjustments to net income for the calculation of both basic and diluted net(loss) income per share for all periods.

 

38

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The calculation of weighted-average outstanding shares is as follows:

 
|                                                                                                |   | **Average  Shares** |       |
|-----------------------------------------------------------------------------------------------------|--------|---------------------|------------|
|                                                                                                |   | **2003**            |       | **2002** | ** ** | **2001** | ** ** |
|                                                                                                |   | **(In  thousands)** | ** ** |
| Weighted average common shares outstanding  (used in computing Basic net (loss) income per share)   |   | 24,706              |       | 24,576 |   | 23,589 |   |
| Potential common shares                                                                             |   | —              |       | 502 |   | 1,223 |   |
|                                                                                                |   |                |       |   |   |   |   |
| Weighted average common shares outstanding  (used in computing Diluted net (loss) income per share) |   | 24,706              |       | 25,078 |   | 24,812 |   |

 

Options to purchase approximately 2,889,000, 909,000 and 32,000 sharesof common stock were outstanding at December 31, 2003, 2002 and 2001,respectively, but were not included in the computation of diluted net (loss)income per share because their effect would be anti-dilutive.

 

All common shares have been restated for a 50% stock dividend whichresulted in a three-for-two stock split effective June 29, 2001.

 

**9.**             **Benefit Plans**

 

We have a deferred compensation savings plan for the benefit of oureligible employees.  The plan permitscertain voluntary employee contributions to be excluded from the employees’current taxable income under the provisions of Internal Revenue CodeSection 401(k).  Each employeebecomes eligible to participate in the savings plan six months following theinitial date of employment.  Theemployee must also complete at least 500 hours of service in any twelve-monthperiod.  Under the plan, we can makediscretionary contributions to the plan as approved by the board ofdirectors.  Participants’ interest inour contributions to the plan vest over a four-year period.  We made contributions of approximately$196,000, $201,000 and $159,000 during 2003, 2002 and 2001, respectively.

 

39

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**SupplementalInformation**

**Quarterly FinancialData (Unaudited)**

 
|                                        |   | **Quarter  ended**                           |       |
|---------------------------------------------|--------|----------------------------------------------|------------|
|                                        |   | **March 31**                            |       | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|                                        |   | **(In  thousands except per share amounts)** | ** ** |
| **2003**                                    |   |                                         | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Revenues                                    |   | $                                            | 59,336     |   | $ | 51,035 |   | $ | 45,516 |   | $ | 45,750 |   |
| Direct operating expense                    |   | 33,513                                       |       | 28,981 |   | 27,268 |   | 27,364 |   |
| Selling, general and administrative expense |   | 19,199                                       |       | 36,829 |   | 34,631 |   | 42,329 | (1) |
| Income (loss) from operations               |   | 6,624                                        |       | (14,775 | ) | (16,383 | ) | (23,943 | ) |
| Net income (loss)                           |   | 4,110                                        |       | (9,180 | ) | (10,653 | ) | (17,587 | ) |
| Basic net income (loss) per share           |   | 0.17                                         |       | (0.37 | ) | (0.43 | ) | (0.71 | ) |
| Diluted net income (loss) per share         |   | 0.17                                         |       | (0.37 | ) | (0.43 | ) | (0.71 | ) |
|                                        |   |                                         |       |   |   |   |   |   |   |
| **2002**                                    |   |                                         | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Revenues                                    |   | $                                            | 61,765     |   | $ | 67,853 |   | $ | 66,172 |   | $ | 62,161 |   |
| Direct operating expense                    |   | 35,250                                       |       | 37,518 |   | 37,133 |   | 34,262 |   |
| Selling, general and administrative expense |   | 18,013                                       |       | 18,504 |   | 17,167 |   | 18,777 |   |
| Income from operations                      |   | 8,502                                        |       | 11,831 |   | 11,872 |   | 9,122 |   |
| Net income                                  |   | 5,432                                        |       | 7,471 |   | 7,389 |   | 5,837 |   |
| Basic net income per share                  |   | 0.22                                         |       | 0.30 |   | 0.30 |   | 0.24 |   |
| Diluted net income per share                |   | 0.22                                         |       | 0.30 |   | 0.30 |   | 0.24 |   |

 

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(1) In the fourth quarter of 2003, we recorded an impairment charge of$4.7 million to write off goodwill and certain related intangibles.

 

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