** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C.   20549**

 

**Form 10-K**

 

**ý****ANNUAL REPORT UNDER SECTION 13OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

**For the fiscal year endedDecember 31, 2004**

**or**

**o****TRANSITION REPORT UNDER SECTION13 OR 15(d) OF THE**

#### **SECURITIES EXCHANGE ACT OF1934**

**For the transition period from               to               **

 

**Commission File Number 0-27024**

 

**METRO ONE TELECOMMUNICATIONS,INC.**

(Exact name of registrantas specified in its charter)

 

| **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 principalexecutive offices)

 

Registrant’s telephonenumber, including area code:    **503-643-9500**

 

Securities registeredpursuant to Section 12(b) of the Act:

**NONE**

 

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, No Par Value**

(Title of Class)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  YES  ý   NO  o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act).

YES  ý   NO o

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates, based on the closing price ofthe common stock as reported by the Nasdaq National Market on June 30, 2004 was$36,182,194.

 

The number of shares outstanding of the registrant’scommon stock, as of March 1, 2005 was 24,984,026.

 

**DOCUMENTS INCORPORATED BYREFERENCE**

 

Portions of the registrant’s Proxy Statement for its2005 Annual Meeting, to be filed with the Securities and Exchange Commissionwithin 120 days of the registrant’s fiscal year end, are incorporated byreference into Part III of this Report.

 

 

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**METRO ONE TELECOMMUNICATIONS,INC.**

**FORM 10-K ANNUAL REPORT**

**TABLE OF 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, Related Stockholder |       |
|          | Matters  and Issuer Purchases of Equity Securities               |       |
|          |                                                             |       |
| 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                                         |       |
|          |                                                             |       |
| Item 9B       | Other Information                                                |       |
|          |                                                             |       |
| **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  and Financial Statement Schedules                      |       |
|          |                                                             |       |
|          | Signatures                                                       |       |

 

2

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

 

# **PARTI**

 

 

**ITEM 1.            BUSINESS.**

 

Metro One is theleading developer and provider of Enhanced Directory Assistance® andother information services.  We contractprimarily with wireless carriers to provide our services to theirsubscribers.  In addition to using our EnhancedDirectory Assistance platform to provide directory assistance listings, we havealso provided other non-directory assistance services and content for telephonecarriers, such as MetroDex®, a service that handles personalcontacts and calendars, and TeleConcierge®, for making reservations andperforming other concierge services.  EnhancedDirectory Assistance also includes a number of connectivity features, such asStarBack® and AutoBack®, return-to-operator features thathelp to ensure that a caller gets the most from every call, and NumberBack®and QuickSend®, features that allow a requested number or otherinformation to be sent to a caller’s telephone. Many of our features or aspects thereof are the subject of patents orpending 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.  We alsoprovide enhanced directory assistance, as well as personal assistant services,directly to retail and enterprise customers through our Infone®service.  Infone services leverage our investment and experience ininfrastructure, content and operators.  We have expanded our customer baseto include enterprise data services, specialized operator services, such aswith Motorola’s VIAMOTO application and information services to corporationswith offices in the United States and Canada, in addition to our flagshippersonal assistant services provided directly to consumers through Infone.  We have also expanded into the landline telecommunicationsmarket and provide our services to regional competitive local exchangecarriers.

 

In May 2003, we launched Infone, a service that provides EnhancedDirectory Assistance and personal assistant services directly toconsumers.  Callers may use the servicefrom nearly any domestic telephone, landline or wireless, simply by dialing “888-411-1111.”  Billing is handled by using a major creditcard.  Calls can be connected nationwideand to Canada and Puerto Rico for the all-inclusive price of 89 cents for anycall of up to 15 minutes, plus 5 cents per minute after that.  Beyond Enhanced Directory Assistance, Infoneoffers a number of non-directory assistance personal service features,including Teleconcierge, Personal Contacts and Calendar and Voice E-mailTM,that allows voice-generated e-mail processing from any phone without access toa computer.  “My InfoneTM,” isa personal assistant feature that allows users to specify which services theydesire and the ways in which they want these services delivered.  As of February 25, 2005, we had approximately126,000 Infone subscribers.

 

### **TelecommunicationsIndustry**

The U.S.telecommunications industry has generally been characterized by strong growthand increased competition due to new technologies, a more favorable regulatoryenvironment and, for carriers, an increasingly sophisticated and demandingsubscriber.  Telecommunications carriersface increasing competitive pressures to differentiate their products andestablish brand loyalty.  With risingcosts to acquire new subscribers, carriers are seeking ways to minimizesubscriber turnover through the use of, among other things, value-addedservices and features.  In addition,carriers are increasingly offering local, long distance, wireless, cable andInternet services bundled into one package in order to appeal to a widermarket.  Competitive pressures areparticularly acute for wireless and newer landline carriers, such ascompetitive local exchange carriers.  Theindustry has also experienced a considerable amount of consolidation andinvestment in new technologies and alternative methods of delivery, includingcable television and the Internet.

 

*Wireless Telecommunications.* The U.S. wireless telecommunications market has experienced dramaticgrowth over the last decade.  This growthhas been due largely to technological advances that give callers affordable,high-quality mobile services.  Accordingto industry analysts, the number of wireless subscribers in the United Stateswill reach nearly 200 million by the end of 2006.  A relatively small number of carriersdominate the wireless telecommunications market.  In terms of estimated number of subscribers,the largest U.S. wireless carriers include Cingular Wireless, Verizon Wireless,Nextel Communications (including a pending merger with Sprint PCS) andT-Mobile.

 

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Competition in theindustry has been intense with several carriers typically competing forwireless 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, carriersalso focus on value-added services and features as a means of differentiatingthemselves.  As subscriber and ARPUgrowth slow, there has been significant recent consolidation in the industry asevidenced by the 2004 combination of Cingular Wireless and AT&T Wirelessand the pending merger of Nextel Communications and Sprint PCS.

 

*Landline Telecommunications.* The U.S. landline telecommunications market is significantly larger thanthe U.S. wireless market.  Like thewireless market, the landline market is dominated by a relatively small numberof major carriers.  Carriers providinglocal service include the regional Bell operating companies, such as SBCCommunications, independent telephone companies, such as ALLTEL Communications,and competitive local exchange carriers, such as Cox Communications or IntegraTelecom.  Many of these carriers andothers, as well as many discount companies, also provide long distance services.  In addition, cable companies are beginning tooffer packaged services including local and long distance telephone services.

 

Local and long distancecarriers competing in each other’s markets, as well as against newer andsmaller independent carriers, have added to competition in the landlinemarket.  With deregulation, the entry ofnew landline competitors and the increasing affordability of wireless services,subscribers who were historically bound to local carriers as a matter ofgeography are now increasingly able to choose their carriers.  This includes the opportunity to select acompetitive local exchange carrier. These companies compete with incumbent local carriers to provide avariety of services, including local, long distance and Internet and other dataservices.  As a result, the landlinetelecommunications market is rapidly becoming subscriber-based and carriersmust find ways to differentiate their services to attract and retainsubscribers.  In addition, to maintainoperational focus, competitive local exchange carriers often outsource non-coreoperations, including directory assistance services.  While many incumbent carriers providedirectory assistance services on an outsourced basis, the competitive localexchange carriers may prefer to outsource their directory assistance needs toindependent companies rather than use the services of their competitors.

 

### **Directory AssistanceMarket**

Call volumes generated bythe wireless directory assistance market in the United States are estimated togrow significantly to over 3.6 billion calls by the end of 2006, according tosome industry sources, among which individual estimates vary.  Wireless subscribers tend to be heavy users ofdirectory assistance services.  Accordingto Frost & Sullivan, growth in the wireless directory assistance market isdriven by factors such as growth in the wireless subscriber base, risingwireless penetration, increasing subscriber mobility and the offering ofquality directory assistance services 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 assistance revenues.  In addition, enhanced services are expectedto account for nearly 37% of all directory assistance calls by the end of 2006.

 

Unlike other aspects of telecommunications services, directoryassistance has seen a period of rising retail prices in the last severalyears.  For example, in June 2001 therange of retail prices charged for a directory assistance call among the majorwireless carriers was $0.75 to $1.29, with a majority of large carriers at$0.99 per call.  In January 2005 thissame range was $1.25 to $1.50.  Duringthis same timeframe, prices for many other telecommunications services havetrended downward.

 

### **Customers**

Our principal businesscurrently involves providing Enhanced Directory Assistance and informationservices to several of the nation’s leading wireless carriers in all or aportion of their service areas.  Ourcarrier customers include Nextel Communications and ALLTEL Communications.  In addition, we provide our services tocertain competitive local exchange carriers in the landline telecommunicationsmarket.  Customers that accounted formore than 10% of our revenues during any of the periods indicated are asfollows:

 

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| ** **                  | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------|------------|------------------------------|------------|
| **Customer**                | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| AT&T Wireless  Services |       | 28                           | %          | 44 | % | 33 | % |
| Nextel  Communications      |       | 56                           |       | 35 |   | 24 |   |
| Sprint PCS                  |       | —                       |       | 13 |   | 33 |   |

 

Our contract with AT&T Wireless expired on December 1, 2003, and wewere 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 agreed to continue to provide serviceto AT&T Wireless customers through a transition period beginning in March2004.  The transition was substantiallycompleted by July 31, 2004.

 

We offer our services toa carrier’s subscribers under a brand name selected by the carrier, such as “Nextel411” or “ALLTEL Directory Plus.”  Thecarrier establishes its own fee structure with its subscribers.  Subscribers typically pay the carrier’s feesranging from $1.25 to $1.50 plus airtime charges for our services.  We charge carriers directly and, at present,bear no subscriber collection risk.  Wecharge our customers on a per call basis. We have offered volume pricing discounts in the past to stimulateincreased call volume and to attract and expand customer commitments, as wellas meet competitive pressures, which caused our average revenue per call todecrease.

 

### **Wecurrently provide our services to several carrier customers.  The terms of these contracts are generallysimilar, with variations in the geographic market to be served, the servicesand features we are to provide the carriers’ subscribers and the term.  None of these contracts precludes us fromproviding services to others.**

 

### **Wealso provide enhanced directory assistance, as well as personal assistant services,directly to retail and enterprise customers through our Infone service. Infone services leverage the investment and experience in infrastructure,content and operators.  We have expanded our customer base to includeenterprise data services, specialized operator services, such as with Motorola’sVIAMOTO application, information services to corporations with offices in theUnited States and Canada in addition to our flagship personal assistantservices provided directly to consumers through Infone.**

 

### **Call Centers andNetwork**

We operate call centersstrategically located in markets throughout the United States.  Our call center network enables us to provideEnhanced Directory Assistance, as well as personal assistant servicesnationwide.  We are located in or nearmajor metropolitan areas and therefore are situated locally for more thanone-half of the U.S. population.  Webelieve that the local nature of our call centers and operators permits us tooffer more accurate and valuable services than would be available through callcenters located outside the U.S., or even a single or a few call centers in theU.S. attempting to serve the entire United States.  We typically operate our call centers 24hours a day, seven days a week, 365 days a year.

 

We have historicallyadjusted our call center personnel, and expect to adjust call centers andnetwork capacities in order to address changes in volume demands caused by theexpiration of carrier contracts and the development of our recently launchedInfone service.  Capacity needs will varysignificantly as a result of changes in volume from existing customers, changesin usage within existing markets served, changes in our carrier customers and/orthe number of calls they route to us or as a result of our Infone service oralternative strategies to attract additional calls.  We continue to pursue additional significantbusiness and our call center system and network are readily scalable to accommodatesuch opportunities.

 

We periodically upgradeour network and systems to allow greater utility, speed and efficiency inprocessing calls.  We also frequentlyexpand our capacity to store, manipulate and manage the additional data that weacquire.  In addition, our telephoneswitching systems allow scalability, including the ability to join multipleswitches together or configure switches so that they can handle large volumesof calls.  These systems, covering all ofour call centers, are monitored and supported on a 24-hour per day basis fromour network operations center located at our corporate headquarters.  Our systems are redundant in order to avoiddowntime from natural disasters or other adverse events.  These arrangements allow us to meet or exceedstrict service level standards.

 

We believe quality andreliability are important considerations in a customer’s decision to use ourservices.  To ensure high quality andconsistency, we emphasize training, monitoring and customer support.  We maintain a national training force withtraining personnel in each call center. Our operators undergo extensive training and testing on searchtechniques, etiquette and local information, including landmarks, majorthoroughfares and geography.  Wecontinually monitor, test and evaluate call center performance.  Call center personnel throughout the Company areincentivized based on measured

 

5

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quality performance.  We also monitor our call centers forcompliance with contract performance standards and report this information tothe carriers on a regular basis.

 

We have deployedvoice over Internet protocol (“VoIP”) capability to route voice traffic over adata network.  VoIP not only providesexcellent quality of service but substantially reduces transport cost from thetraditional call routing over the Public Service Telephone Network.  Dynamic call routing and VoIP technologies provideus with the ability to quickly route calls from call center to call center,both improving our call efficiency and protecting our service levels.

 

Our digitaltelecommunications network allows us the flexibility to serve customers whocontinue to use Multi Frequency Voice Circuits and those who have chosen toemploy System Signaling 7 (“SS7”) in their operations.  SS7 supports a vast range of servicesaccessible from a variety of user terminals, including basic phones and morecomplex multimedia devices.  Originallydeveloped for Intelligent Networks simply to connect calls using out-of-bandsignals, SS7 is now driving major Advanced Intelligent Network network-basedapplication services such as remote voicemail retrieval, calling-card servicesand 1-800 access.

 

### **Our Services andFeatures**

We use a customized arrayof hardware and software, along with proprietary database search engines, toprovide our Enhanced Directory Assistance, as well as personal assistantservices.  We receive incoming calls bymeans of assigned telephone numbers, which, in almost all cases are “411,” “555-1212,”“00” or retail 800 numbers such as “888-411-1111.”  Our operators answer incoming calls and, inthe case of carrier customers, identify the service using the customer’s brandname.  In some cases we use speakerverification and other means to identify callers and greet them by name, apatented feature of our Infone service. Upon receiving information requests from callers, operators searchapplicable databases using one or more of our search engines.  The operator then connects the caller to thecalled party or supplies the caller with the requested information.  We offer a variety of information services,as well as personal assistant services, such as:

•                  Directory listings information, which may be retrievedby methods that include reverse and category searches;

•                  Contacts and calendar management and other personalassistant services;

•                  Voice E-mailTM, which allows voice-powered processingof e-mail over the telephone without a computer and allows the caller to hear,compose and/or reply to messages over the telephone, among several otherfunctions;

•                  Movie, local event and venue information;

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

•                  Turn-by-turn driving instructions; and

•                  Weather conditions and roadside assistance.

 

Our Enhanced DirectoryAssistance, as well as our personal assistant services, also incorporateconnectivity features that make the telephone more useful and easier touse.  These connectivity features includethe following:

•                  Call completion — allows a caller to be directlyconnected to the number requested without the need to redial;

•                  StarBack® — allows the caller to return to a liveoperator simply by pressing a key, such as the star [*] key or by otherwiseissuing a command at any time during a call;

•                  AutoBack® — automatically returns the caller to a liveoperator or provides other options upon a busy signal, “ring-no-answer” orother common situations without pressing a single key;

•                  NumberBack® — sends the caller the called numbersimply by pressing the number [#] key; and

•                  QuickSend®  — ashort messaging service allowing our operators to send customized alphanumericmessages on behalf of a caller.

 

### **Database Systemsand Content**

We believe the quality of our services is directly related to the scope,quantity and quality of the information content in our database systems.  The majority of the information that weacquire, develop and maintain is telephone listings data.  To ensure high quality and accuracy, weobtain this data from multiple sources, including certain of the regional Belloperating companies, independent telephone companies and other commercialsources.  These data are enhanced by ourdirect data collection efforts and a principal database of local information isdeveloped for each call center or region.

 

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Our proprietary operator interface software allows operators toefficiently and simultaneously search and reverse-search multipledatabases.  Our search engine has beenoptimized for directory assistance services and large national databases,providing sub-second search times even in complex searches.  We use proprietary database managementsystems to maintain and update our directory listings.  We continually acquire additional content oraccess to content that will, in many cases, build on these listings data tomake them more useful.  Acquisitions aremade from a variety of sources and are supplemented with information relatingto local events and amenities.

 

We build application-specificdatabases for a variety of portals, be they wired or wireless, voice ordata.  Our proprietary data extractionand processing technology enables the creation and ongoing maintenance of highquality databases from distributed and fragmented data on the web andelsewhere.  We believe these capabilitieswill contribute to the expansion of services and data offerings to our wirelessand other customers, increasing value and the tendency to rely on our services.

 

### **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 customers provide for their promotion of the services we provideto the carrier’s subscribers.  Inaddition, we occasionally assist our carrier customers in the promotion ofthese services.  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, as well aspersonal assistant services, is dependent to a great extent on our proprietarytechnology.  Our proprietary softwareapplications enhance our call handling and delivery capabilities and providethe basis for our connectivity features. We have developed search engines to quickly access information from ourdatabases.  We continue to upgrade ouroperator interface software, database management systems and search engines toincrease the efficiency and broaden the search capability of our operators.

 

Our call processing systems incorporate programmable switchingequipment, host computers, voice response and voice recognition units anddatabase servers.  Our technology ispowered by customized software.  We arealso monitoring technological advances in the methods of delivery ofinformation and data and are working to insure that our systems are compatiblewith, 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 and personalassistant services businesses.

 

### **IntellectualProperty**

We rely on a combination of trademark, patent and trade secrets lawsand confidentiality procedures to protect our intellectual propertyrights.  We have 26 U.S. patents issuedand one foreign patent issued, including several relating to our StarBacktechnology and others associated with our turn-by-turn driving directions andother services.  Currently we have sixsets of additional claims allowed, each of which we expect to result in anadditional issued patent.  We haveapproximately 130 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.

 

7

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### **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 both in and outside theirown operating regions.  Although webelieve that none of these competitors offers a form of directory assistancethat incorporates all features of our service products, they may have substantiallygreater financial, technical and marketing resources than we do and may be ableto offer features similar to ours in the future.  We also face competition from independentcompanies seeking to offer forms of directory assistance, other informationservices and other forms of personal assistant services.  Included among these are firms that offerfull or partial automation (with little or no involvement by a live operator),firms offering low cost, low quality directory assistance provided by overseasoperators and firms offering information, directories and/or search engines viathe Internet.

 

We believe the principal competitive factors in the directoryassistance market are price, quality and range of features, technologicalinnovation, experience and responsiveness to customers.  Historically, we have sought to distinguishourselves from our competitors based on the quality of our services, thedevelopment of useful features, the breadth of the content provided and ourextensive national network of call centers. In recent years, wireless carriers appear to have become more focused onreducing costs, even if such reduction results in diminished services andquality.  In addition, other sources ofdirectory assistance, such as automation and those provided by offshore callcenters and the Internet, provide low cost forms of competitive services.

 

### **GovernmentRegulation**

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.

 

We are subject to regulation by the various state utilitycommissions.  We are also 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 setting forth theterms, conditions and prices for services that are classified asintrastate.  We have filed such tariffsor price lists where required.

 

Our Infone services are subject to numerous local, state and federaltaxes and regulatory fees, including the Federal excise tax, FCC UniversalService and regulatory fees and numerous public utility commission regulatoryfees.  We have procedures in place toensure that we properly collect taxes and fees from our customers and remitsuch taxes and fees to the appropriate entity pursuant to applicable lawsand/or regulations.

 

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.

 

### **Employees**

As of December 31, 2004, we had approximately 2,700 employees,approximately 24% of whom 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. 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.

 

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### **AvailableInformation**

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.  Theinformation on our website should not be 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.  Thelease term for one site, consisting of approximately 21,000 square feet,extends through 2007 while the lease term for the other site extends throughmid-2009.

 

We also lease callcenters and other operational facilities, which generally range in size from5,000 to 40,000 square feet.  We have 33leases for call centers and other remote facilities, with remaining terms of upto six years.  We expect to adjust callcenters and capacities in order to address changes in volume demands caused bythe expiration of carrier contracts and the development of our other businessinitiatives.

 

 

**ITEM 3.            LEGALPROCEEDINGS.**

 

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

 

 

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

 

No matters were submitted to a vote of security holders during thequarter ended December 31, 2004.

 

 

# **PARTII**

 

**ITEM 5.****                                  ****MARKET FOR REGISTRANT’S COMMONEQUITY,RELATED**

**                          STOCKHOLDER MATTERSAND ISSUER PURCHASES OF EQUITY SECURITIES.**

 

Our common stock trades on the Nasdaq National Market under the symbol “INFO.”  The high and low closing sales prices asreported on the Nasdaq National Market for each quarterly period within the twomost recent fiscal years were as follows:

 
| **2004**                          | ** ** | **High** | ** ** | **Low** |   |
|-----------------------------------|------------|----------|------------|---------|--------|
| Quarter ended  December 31, 2004  |       | $        | 1.80       |    | $      | 1.41 |   |
| Quarter ended  September 30, 2004 |       | $        | 1.60       |    | $      | 1.21 |   |
| Quarter ended  June 30, 2004      |       | $        | 2.38       |    | $      | 1.44 |   |
| Quarter ended  March 31, 2004     |       | $        | 3.28       |    | $      | 2.26 |   |

 

 
| **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 |   |

 

The approximate number of shareholders of record as of March 1, 2005was 153.  On March 1, 2005, the closingprice of our common stock, as reported on the Nasdaq National Market, was $1.44per 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.

 

9

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**Equity Compensation Plan Information**

 

The following table contains information as of December 31, 2004, withrespect to compensation plans under which our equity securities are authorizedfor issuance.

 
| ** **                                                   | ** ** | **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))** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan  Category**                                           | ** ** | **(a)**                                                                                           | ** ** | **(b)**                                                                          | ** ** | **(c)**                                                                                                                                           |       |
| Equity  compensation plans  approved by security holders     |       | 3,028,103                                                                                         |       | $                                                                                | 10.72      |                                                                                                                                              | 738,681    |   |
| Equity  compensation plans not  approved by security holders |       | —                                                                                            |       | —                                                                           |       | —                                                                                                                                            |       |
|                                                         |       |                                                                                              |       |                                                                             |       |                                                                                                                                              |       |
| Total                                                        |       | 3,028,103                                                                                         |       | $                                                                                | 10.72      |                                                                                                                                              | 738,681    |   |

 

 

**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,**                 | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                     | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                    | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Operations data:                              |       |                                         |       |   |   |   |   |   |   |   |   |
| Revenues                                      |       | $                                            | 140,369    |   | $ | 201,636 |   | $ | 257,951 |   | $ | 233,318 |   | $ | 156,981 |   |
| Direct operating  expenses                    |       | 84,331                                       |       | 117,126 |   | 144,164 |   | 131,851 |   | 97,438 |   |
| Selling, general  and administrative expenses |       | 94,208                                       |       | 128,271 |   | 72,461 |   | 65,422 |   | 46,112 |   |
| Impairment loss                               |       | 32,193                                       |       | 4,715 |   | — |   | — |   | — |   |
| (Loss) income  from operations                |       | (70,363                                      | )          | (48,476 | ) | 41,326 |   | 36,045 |   | 13,431 |   |
| Net (loss)  income                            |       | (63,166                                      | )          | (33,309 | ) | 26,129 |   | 28,422 |   | 9,742 |   |
|                                          |       |                                         |       |   |   |   |   |   |   |   |   |
| Basic (loss)  income per share                |       | (2.54                                        | )          | (1.35 | ) | 1.06 |   | 1.20 |   | .56 |   |
| Diluted (loss)  income per share              |       | (2.54                                        | )          | (1.35 | ) | 1.04 |   | 1.15 |   | .54 |   |
|                                          |       |                                         |       |   |   |   |   |   |   |   |   |
| Cash flow from  operations                    |       | 8,913                                        |       | (19,189 | ) | 45,307 |   | 49,862 |   | 5,350 |   |
|                                          |       |                                         |       |   |   |   |   |   |   |   |   |
| Balance sheet  data (1):                      |       |                                         |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                    |       | $                                            | 24,093     |   | $ | 44,381 |   | $ | 76,528 |   | $ | 53,692 |   | $ | 6,463 |   |
| Short-term  investments                       |       | 25,375                                       |       | — |   | — |   | — |   | — |   |
| Working capital                               |       | 61,507                                       |       | 78,280 |   | 103,705 |   | 73,747 |   | 17,066 |   |
| Total assets                                  |       | 95,830                                       |       | 164,884 |   | 198,689 |   | 169,759 |   | 106,641 |   |
| Long-term  liabilities                        |       | 1,158                                        |       | 3,523 |   | 9,310 |   | 3,844 |   | 29,074 |   |
| Shareholders’  equity                    |       | 79,437                                       |       | 142,338 |   | 175,389 |   | 147,369 |   | 45,404 |   |

 

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(1) In February2001, we completed a transaction with Sonera Media Holding B. V. (“Sonera”), atthat time a wholly-owned subsidiary of Sonera Corporation of Helsinki, Finland,whereby Sonera purchased six million newly-issued shares of our common stock ata price of $11.33 per share, for an aggregate price of $64.6 million and anapproximate 25.5% ownership position at that time.  A portion of the proceeds from thistransaction was used to pay off all outstanding debt.

 

10

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**ITEM 7.            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL**

**                          CONDITION AND RESULTSOF OPERATIONS.**

 

*All statements and trend analyses contained in thisitem and elsewhere in this annual report on Form 10-K relative to the futureconstitute “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statements may, but do not necessarily, includewords such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,”“may,” “will,” “should,” “could,” “continue” or similar expressions.  Forward-looking statements are notguarantees.  They involve known andunknown business and economic risks, uncertainties and other factors that maycause our actual results, performance or achievements to be materiallydifferent from any future results, performance or achievements expressed orimplied by such forward-looking statements. These risks, uncertainties and other factors include those discussed inthis Item 7 under “Issues and Uncertainties.” Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof.  We undertake no obligation to publiclyrelease any revisions to these forward-looking statements to reflect events orcircumstances after the date hereof or to reflect the occurrence ofunanticipated events.*

 

*Results of operations for the periods discussedbelow should not be considered indicative of the results to be expected in anyfuture period and fluctuations in operating results may also result influctuations in the market price of our common stock.  Our quarterly and annual operating resultshave in the past and may in the future vary significantly depending on factorssuch as changes in the telecommunications market, the addition or expiration ofcustomer contracts, increased competition, changes in pricing policies by us orour competitors, lengthy sales cycles, advertising costs or lack of marketacceptance associated with the introduction of new versions of our products orfeatures, the cost and success of new growth strategies, the timing of theinitiation of wireless or other telecommunications services through newdelivery systems or their acceptance by customers, the timing and expense ofthe expansion or contraction of our national call center network, the generalemployment environment, general economic conditions and the other factorsdiscussed under the heading “Issues and Uncertainties” in this Item 7.*

 

### **Overview**

We are the leadingdeveloper and provider of Enhanced Directory Assistance® and otherinformation services.  We contractprimarily with wireless carriers to provide our services to theirsubscribers.  In addition to using ourEnhanced Directory Assistance platform to provide directory assistance listings,we have also provided other non-directory assistance services and content fortelephone carriers, such as MetroDex®, a service that handlespersonal contacts and calendars, and TeleConcierge®, for makingreservations, and performing other concierge services.  Enhanced Directory Assistance also includes anumber 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.

 

Under our wholesale contracts, carriers agree to route some or all oftheir directory assistance calls to us. We offer 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 callsare routed to and answered by our operators identifying the service by thatcarrier’s brand name, such as “Nextel 411” or “ALLTEL Directory Plus.”

 

Each carrier customerestablishes its own directory assistance fee structure for itssubscribers.  Wireless subscriberstypically pay fees ranging from $1.00 to $1.50 plus airtime charges for ourservices.  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 customers on a per call basis.  We have offered volume pricing discounts inthe past to stimulate increased call volume and to attract and expand customercommitments, as well as meet competitive pressures, which caused our averagerevenue per call to decrease.  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 carriercustomers.  Prices for services providedto other types of customers, including individual consumers, businesses,governmental units or other callers, may vary based on the nature of theservice, volume and other circumstances.

 

11

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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 providing directoryassistance and other services through, among other ways, outsourcing to lowcost 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 using a major creditcard.  Calls can be connected nationwideand to Canada and Puerto Rico for the all-inclusive price of 89 cents for anycall of up to 15 minutes, plus 5 cents per minute after that.

 

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. We spent approximately $17.5 million during 2004 and approximately $49.9million during fiscal 2003 on such marketing and promotion campaigns, and wewill likely spend significant additional funds on marketing and promotionalactivities in the future.  Revenue fromour Infone service was not significant in relation to total revenues in 2004 or2003.

 

### **Significant Events**

In February 2005, we entered into a Master Services Agreement forDirectory Assistance Services (the “Services Agreement”) with NextelOperations, Inc., acting on behalf of certain affiliates (collectively “Nextel”)of Nextel Communications, Inc.  TheServices Agreement supercedes the previous services agreement between theparties dated in June 1999.  Under theServices Agreement, we agreed to provide directory assistance services toNextel’s customers on a non-exclusive basis. Price levels in the Services Agreement are lower than those of theprevious agreement and, additionally, Nextel may transition call volume awayfrom us on short notice and/or terminate services entirely.  The term of the Services Agreement is forthree years, and may be renewed by Nextel for two additional one-year periods.

 

Our contract with AT&T Wireless expired in December 2003, and ournegotiations did not result in a new contract. AT&T Wireless accounted for approximately 28%, 44% and 33% of ourrevenues in 2004, 2003 and 2002, respectively.  The call volume from AT&T Wirelesstransitioned away during the second and third quarters of 2004.  The expiration of this contract has had amaterial adverse effect on our financial position, operating results and cashflows.

 

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.  Thetransition began in March 2003 and was substantially completed by June 30,2003.  Revenue from Sprint PCS accountedfor approximately 13% and 33% of our total revenue in 2003 and 2002,respectively.

 

In a 2004 decision, the California Public Utilities Commission (“PUC”)implemented competitive wholesale pricing for directory assistance data forthird party vendors purchasing the data from SBC Communications (“SBC”).  The decision determined that SBC continues toenjoy a dominant position as the former monopoly provider of local exchangeservice in its territory in California and could not use its market power toextract excessive directory assistance data prices that would discriminateagainst competitors.  The decisionrequired that SBC refund the improper charges with interest.  As a result,in the third quarter of 2004, we received, and recorded in revenues, a refundfrom SBC in the amount of approximately $2.9 million.  To more appropriately reflect the nature ofthis transaction we have reclassified the refund to “Other income, net” in ourDecember 31, 2004 financial statements.

 

### **Results ofOperations**

The following table shows selected items of our consolidated statementsof operations data expressed as a percentage of revenues:

 
| ** **                                    | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues                                      |       | 100.0                        | %          | 100.0 | % | 100.0 | % |
| Direct operating  expenses                    |       | 60.1                         |       | 58.1 |   | 55.9 |   |
| Selling, general  and administrative expenses |       | 67.1                         |       | 63.6 |   | 28.1 |   |
| Impairment loss                               |       | 22.9                         |       | 2.3 |   | — |   |
| (Loss) income  from operations                |       | (50.1                        | )          | (24.0 | ) | 16.0 |   |
| Other income,  net                            |       | 2.7                          |       | 0.3 |   | 0.4 |   |
| (Loss) income  before income taxes            |       | (47.4                        | )          | (23.7 | ) | 16.4 |   |
| Income tax  (benefit) expense                 |       | (2.4                         | )          | (7.2 | ) | 6.3 |   |
| Net (loss)  income                            |       | (45.0                        | )%         | (16.5 | )% | 10.1 | % |

 

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**2004 Compared to 2003**

 

*Revenues.*  Revenuesdecreased 30.4% to $140.4 million from $201.6 million.  Call volume decreased to approximately 306million calls from approximately 434 million calls.  These decreases resulted primarily from lowercall volumes due to the expiration of contracts with Sprint PCS and AT&TWireless.  Our average revenue per callwas approximately $0.46 in 2004 and approximately $0.47 in 2003.  Average revenue per call will decreasesignificantly in the near term due to lower pricing under new or renewedwholesale agreements.

 

*Direct operating expenses.* Direct operating expenses, consisting of the costs of salaries, wages,benefits and taxes of call center personnel, listings data and contentacquisition costs, decreased 28.0% to $84.3 million from $117.1 million.  This decrease was primarily due to lowerpersonnel and data cost associated with servicing lower call volumes.  As a percentage of revenues, direct operatingexpenses increased to 60.1% from 58.1%, due primarily to a lower averagerevenue per call.

 

*Selling, general and administrative expenses.* Selling, general and administrative expenses decreased 26.6% to $94.2million from $128.3 million resulting primarily from decreased advertisingexpense related to Infone of approximately $32.3 million and generalcost-cutting efforts.* *As a percentage of revenues,selling, general and administrative expenses increased to 67.1% in 2004compared to 63.6% in 2003, primarily due to decreased revenues.

 

*Impairment loss. *As aresult of changes in our business climate, primarily significantly reducedpricing of renewed wholesale contracts, we evaluated our fixed assets forimpairment in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” asof December 31, 2004.  We determined thatthe value of our fixed assets was impaired; thus, in the fourth quarter of2004, we recorded a $32.2 million write-down of those assets to estimated fairmarket value.

 

*Depreciation and amortization.* Depreciation and amortization expense was $21.7 million in 2004 comparedto $21.6 million in 2003.

 

*Other income, net*.  Other incomein 2004 was approximately $3.8 million, consisting primarily of the $2.9million refund from SBC discussed above and approximately $694,000 of interestincome earned on cash, cash equivalents and short-term investments.  In 2003 other income consisted primarily ofinterest income earned on cash and cash equivalents of approximately $668,000.

 

*Income tax benefit.*  Income taxbenefit in 2004 and 2003 was $3.4 million and $14.5 million, respectively.  These benefits result primarily from ourability to carry losses back to offset income in prior years and to receiverefunds of income taxes paid in those years. Our effective tax rates for 2004and 2003 were tax benefits of approximately 5.1% and 30.3%, respectively.  These rates differ from the statutory rates primarilydue to the increase in valuation allowance in both years, as it is more likelythan not that some portion or all of the deferred tax assets may not berealized.

 

### **2003 Compared to2002**

*Revenues.*  Revenuesdecreased 21.8% to $201.6 million from $258.0 million.  Call volume decreased to approximately 434million calls from approximately 544 million calls.  These decreases resulted primarily from lowercall volume from Sprint PCS due to expiration of their contract, partiallyoffset by growth in call volume under other existing contracts andmarkets.  Average revenue per call waseffectively $0.47 in both 2003 and 2002.

 

*Direct operating expenses.* Direct operating expenses decreased 18.8% to $117.1 million from $144.2million.  This decrease was primarily dueto lower personnel and data costs associated with servicing lower callvolumes.  As a percentage of revenues,direct operating expenses increased to 58.1% from 55.9%, due primarily tohigher costs associated with medical insurance and workers’ compensationprograms.

 

*Selling, general and administrative expenses.* Selling, general and administrative expenses increased 77.0% to $128.3million 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%resulting from lower revenue and increased marketing, promotion and networkcosts.

 

*Impairment loss.*  Based on ourevaluation in accordance with Statement SFAS No. 142, “Goodwill and OtherIntangible Assets,” during 2003, we determined that goodwill and certainrelated intangible assets were impaired; thus, goodwill in the amount of $4.4million and non-amortizing intangible assets of approximately $300,000 werewritten off during the fourth quarter of 2003.

 

13

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*Depreciation and amortization.* 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 forthe years ended December 31, 2003 and 2002 consisted primarily of interestincome earned on cash and cash equivalents of approximately $668,000 and$961,000, respectively.  The decrease in2003 resulted 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 $16.2 millionfor an effective tax rate of approximately 38.2% which resulted from thecombined federal and state statutory rate of approximately 39% partially offsetby various federal and state tax credits.

 

### **Liquidity andCapital Resources**

Cash and cashequivalents, short-term investments and restricted cash are recorded at costwhich approximates their fair market value. As of December 31, 2004, we had approximately $54.4 million in cashand cash equivalents, short-term investments and restricted cash (including$4.9 million of restricted cash) compared to approximately $49.3 million(including $4.9 million of restricted cash) at December 31, 2003.  The net increase of $5.1 million resultedprimarily from the receipt of a $10.1 million federal income tax refund and adecrease in the average time to collect accounts receivable.  We have no outstanding debt.

 

Working capital was $61.5million at December 31, 2004, compared to $78.9 million at December 31, 2003.This change was primarily due to decreased revenue in 2004.

 

*Cash flow from operations.* Net cash provided by operations was $8.9 million in 2004 compared to netcash used in operations of $19.2 million in 2003.  This difference resulted primarily from netincreases in cash resulting from a decrease in cash paid to or on behalf ofemployees, a decrease in our use of cash to market and promote Infone and thereceipt in 2004 of a significant federal income tax refund.  These net increases in cash were partiallyoffset by a decrease in cash resulting from lower revenues in 2004.  Cash paid to or on behalf of employeesdecreased by approximately $31.2 million in 2004 compared to 2003, while cashreceived from customers decreased by approximately $46.0 million, primarilyresulting from the expiration of our contract with AT&T Wireless.  In 2004 we paid approximately $17.5 million tomarket and promote Infone while we paid approximately $49.9 million for suchactivities during Infone’s initial rollout in 2003.  As a result of carrying back 2003 net operatinglosses against income earned in prior years, we received a federal income taxrefund of approximately $10.1 million in 2004.

 

*Cash flow from investingactivities.*  Cash used in investing activities was $29.5million, $11.6 million and $21.4 million for the years ended December 31, 2004,2003 and 2002, respectively.  In 2004,cash used in investing activities included approximately $25.4 million ofinvestment grade auction rate securities. Such securities are intended to be available to fund currentoperations.  In 2004 and 2003, capitalexpenditures were primarily for equipment to upgrade existing call centers andcorporate networks and infrastructure. In 2002, cash used in investing activities was related primarily tocapital expenditures for the purchase of equipment for new call centers, theupgrade and expansion of existing call centers, upgrades and expansions ofcorporate networks and infrastructure.

 

*Cash flow from financingactivities*.  Cash provided by financing activities was $258,000for the year ended December 31, 2004 resulting from proceeds from employeestock purchases.  Cash used in financingactivities was $1.3 million and $1.1 million for the years ended December 31,2003 and 2002 and was primarily related to cash used to secure a letter ofcredit offset by proceeds from the exercise of stock options and employee stockpurchases.

 

*Future capital needs andresources.*  The primary uses of our capital in the nearfuture are expected to be for the continued advertising, marketing andpromotion of Infone, the development or acquisition of technologies, featuresand content complementary to our business and for general corporatepurposes.  These general corporatepurposes could include acquisitions, efforts to pursue and market new growthstrategies, other corporate development activities and working capital.  We expect to adjust personnel, call centersand network capacities in order to address varying business circumstances,including changes in pricing and other provisions of customer contracts.

 

14

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We believe our existingcash and cash equivalents and short-term investments and cash from operationswill be sufficient to fund our operations for the next twelve months.  Although cash on hand (including restrictedcash) and short-term investments at December 31, 2004 was approximately $54.4million, our operations and future activities, including advertising, marketingand promoting Infone, execution of new product initiatives and growthstrategies, new product development and rollout may reduce available cash.  In such event, we may attempt to establishborrowing arrangements in order to maintain adequate liquidity.  Depending on the development of our business,we may have access to future financing sources, although we cannot provideassurance that financing will be available in amounts or on terms acceptable tous.

 

*Contractual obligations and commitments.* Our contractual obligations are presented in the table below.  Other than operating leases, we have nosignificant off-balance sheet arrangements or obligations.

 
| *** ***                  | *** *** | ***Payments due by period*** | *** *** |
|-------------------------------|--------------|------------------------------|--------------|
| *** ***                  | *** *** | *** ***                 | *** *** | ***Less*** | *** *** | *** *** | *** *** | *** *** | *** *** | ***More*** | *** *** |
| *** ***                  | *** *** | *** ***                 | *** *** | ***than 1*** | *** *** | ***1 - 3*** | *** *** | ***3 - 5*** | *** *** | ***than 5*** | *** *** |
| ***Contractual Obligations*** | *** *** | ***Total***                  | *** *** | ***year*** | *** *** | ***years*** | *** *** | ***years*** | *** *** | ***years*** | *** *** |
|                          |         |                         |         |   |   |   |   |   |   |   |   |
| Operating lease  obligations  |         | $                            | 22,116       |   | $ | 7,779 |   | $ | 10,465 |   | $ | 3,605 |   | $ | 267 |   |
| Total                         |         | $                            | 22,116       |   | $ | 7,779 |   | $ | 10,465 |   | $ | 3,605 |   | $ | 267 |   |

 

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

 

From time to time, in thenormal course of our business, we issue standby letters of credit and bankguarantees.  At December 31, 2004, we hadone letter of credit outstanding in the amount of $4.9 million related to ourworkers’ compensation insurance program. The letter of credit is secured by a certificate of deposit for the sameamount that is recorded as restricted cash. This commitment expires on April 1, 2005 and is typically renewed on anannual basis.

 

In accordance withaccounting principles generally accepted in the United States of America, thesecontractual obligations and commitments are not reflected in our balancesheets.

 

### **Effect of Inflation**

Inflation did notmaterially affect our business during the last several years.

 

### **CriticalAccounting Policies**

We prepare our financialstatements in conformity with accounting principles generally accepted in theUnited States of America.  As such, weare required to make certain estimates, judgments and assumptions that webelieve are reasonable based upon the information available.  These estimates and assumptions affect thereported amounts of assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the periodspresented.  Management believes that ofour significant accounting policies (see Note 1 to the financial statements),those governing accounts receivable, the lives and recoverability of thecarrying amount of equipment and other long-lived assets, such as existingintangibles and goodwill, estimates involving the levels of our contingentliabilities for workers’ compensation and medical self-insurance and estimatesof current and deferred taxes owed may involve a higher degree of judgment,estimation and uncertainty.

 

*Accounts receivable.*  Our wholesale customerbase has primarily consisted of large wireless telephone carriers in the UnitedStates.  As such, we have had minimal riskof uncollectibility, at any point in time, related to outstanding accountsreceivable with these customers.  We havenot experienced significant collection issues or write-offs related to thesecustomers.  Since our accounts receivableare concentrated in relatively few of these wholesale customers, a significantchange 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 launch ofour 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 assets and 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 amount ofthe assets may not be recoverable.  Atsuch time, we estimate the future cash flows expected from use of

 

15

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such assets and their eventual disposition and, if lower than thecarrying amounts, adjust the carrying amount of the assets to their estimatedfair value.  Because of our changingbusiness conditions, including lower wholesale prices and dependence on arelatively small number of customers for a significant portion of our revenues,our estimates of future cash flows to be generated from our operations couldchange materially, resulting in the need for us to record additional impairmentcharges.  In addition, as a result of ourchanging business conditions, we expect to adjust personnel, call centers andnetwork capacities.  If any of theseactivities result in certain of our assets no longer being used in operations,we may need to record an additional impairment charge.  As a result of certain of the circumstancesnoted above, we evaluated our fixed assets for impairment in accordance withSFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” as of December 31,2004.  We determined that the value ofour fixed assets was impaired, thus, in the fourth quarter of 2004, we recordeda $32.2 million write-down of those assets to their estimated fair marketvalue.

 

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, “Goodwill and Other Intangible Assets.”  Under SFAS No. 142, we discontinuedamortization of goodwill and were required to evaluate goodwill for impairmentannually and whenever events or changes in circumstances may have indicatedthat the carrying amount of goodwill was impaired.  When we performed our evaluation of goodwillin 2003, our analysis indicated that our estimate of the fair value of ourbusiness, as determined by the market price of our stock, was less than itscarrying value; therefore, the book value of goodwill and related intangiblesof approximately $4.7 million was written off during the fourth quarter of2003.

 

*Self-insurance reserves.* We self-insure a portion of our workers’ compensation and employeemedical insurance programs.  We purchase stop loss coverage at varyinglevels in order to mitigate our potential future losses.  The nature ofthese liabilities, 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.  AtDecember 31, 2004, we have reserved approximately $6.4 and $1.1 million relatedto our workers’ compensation and medical programs, respectively.  While we believe that the amounts reservedfor these obligations are sufficient, any significant increase in the number ofclaims and costs associated with claims made under these plans could have amaterial effect on our financial position, results of operations or cash flows.

 

*Income taxe*s.  Accounting for income taxes requires us toestimate our income taxes in each jurisdiction in which we operate.  Dueto differences in the recognition of items included in income for accountingand tax purposes, temporary differences arise which are recorded as deferredtax assets or liabilities.  We estimate the likelihood of recovery ofthese assets, which is dependent on future levels of profitability and enactedtax rates.  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 December 2004,the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFASNo. 123R”) an amendment of FASB Statement No. 123, “Accounting for Stock-Based Compensation”and Statement No. 95, “Statement of Cash Flows,” which requires companies to recognizein their statements of operations the grant-date fair value of stock optionsand other equity-based compensation issued to employees.  SFAS No. 123R is effective for interimor annual periods beginning after June 15, 2005.  Accordingly, we will adopt SFAS No. 123Rin our third quarter of 2005.  SFASNo. 123R will not have any effect on our cash flows.

 

### **Issues andUncertainties**

The risks described below should be carefully considered.  These risks are not the only ones that we mayface.  Additional issues anduncertainties that we are unaware of, or that we currently deem immaterial,also may become important factors that affect us.  If any of the following risks occur, ourbusiness, financial condition, results of operations or cash flows could bematerially and adversely affected.

 

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*We have contracts with a limitednumber of carrier customers.  If we failto extend these contracts or sign new ones, 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 threecustomers accounted for approximately 94% of our revenues in 2004.  Two customers, AT&T Wireless Services,and Nextel Communications accounted for approximately 84% of our revenues in2004.  With the expiration of ourcontract with AT&T Wireless, Nextel Communications and ALLTELCommunications account for nearly 89% of our ongoing revenue as of the date ofthis filing.  In addition, under terms ofour new contract effective January 1, 2005, Nextel can terminate without cause onshort notice, and our contract with ALLTEL expires in October 2005.  Some of these and our other contracts arenon-exclusive, contain performance and other standards and call volume may betransferred to alternative providers within the term of the agreements.  If we fail to extend or replace ourcontracts, or other contracts are terminated prior to their expiration, ourbusiness could be adversely affected. Although we seek to increase the number of our customers, opportunitiesare limited because a small number of companies dominate the telecommunicationsmarket.  This limits the potentialcarrier customer base and our expansion opportunities through carrierrelationships.

 

*Our inability to achieve desiredpricing levels could adversely affect our profitability and operations.*

We are subject to competitive pressures with respect to pricing thatcould adversely affect our profitability and operations.  Generally, our pricing levels have declinedand, in the future, may continue to decline in response to competition in theindustry.  The prices that we charge ourcarrier customers are subject to the terms of our contracts.  The changing telecommunications market, therelative leverage of the negotiating parties and the overall competitivelandscape can significantly impact contract pricing negotiations.  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.  We charge our carrier customers on a per callbasis, with prices varying in some cases based on call volume.  Our long-term strategy is based in part onreducing the price we charge our carrier customers.  If we continue to reduce our prices without acorresponding increase in call volume, there could be an adverse impact on ourability to achieve and maintain profitability.

 

*We face substantial competitionfrom 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.  Someof these companies are or may be developing their own versions of directoryassistance services.  We also facecompetition from a number of other independent directory assistanceproviders.  Individual competitors mayalso 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 pricing decisions by carriers, decisions bycarriers to force consumers to accept lower-quality information servicesproducts, the introduction of new services and products by our competitors,changes in subscriber preferences, changes in economic conditions and discountpricing strategies by our competitors.

 

*We may not gain customeracceptance of our Infone service or the costs of advertising, marketing andpromotion of Infone to obtain such acceptance may result in future losses andpressure 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.  As ofFebruary 25, 2005, we had approximately 126,000 Infone subscribers.  If our customer base and related number ofcalls for this service do not grow to generate sufficient levels of revenue ona timely basis, or our financial and pricing assumptions are not accurate,these advertising and marketing expenses may result in further losses andpressure on our liquidity and capital resources.  In such event, we mayneed additional financing, but there can be no assurance that such financingwould be available or that the terms offered would be acceptable to us. Because the Infone service is still in its initial stages and until we gainmore experience with consumer acceptance, it will be difficult to predict ourfuture results of operations.

 

*We may need additional capital inthe future, and it may not be available on acceptable terms, or at all.*

We have experienced net losses in each of the quarterly and annualperiods since the first quarter of 2003. We expect to meet our cash requirements in 2005 through a combination ofexisting cash and cash equivalents and short-term investments.  Our capital requirements depend on severalfactors, including the rate of market acceptance of our services, the abilityto expand and retain our customer base, and other factors.  We may require more capital in the future tofund our

 

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operations, finance investments in equipment and infrastructure neededto maintain or expand our call center and network capabilities, enhance andexpand the range of services and features we offer, respond to competitive pressuresand potential opportunities, such as investments, acquisitions and new productinitiatives and growth strategies and advertise, market and promoteInfone.  If our cash requirements varymaterially from those currently planned, if our cost reduction initiatives donot yield the results we anticipate, or if we fail to generate sufficient cashflows from the sales of our services, we may require additional financingsooner than anticipated.  We cannot becertain that additional financing will be available on terms favorable to us orat all.  The terms of available financingmay place limits on our financial and operating flexibility.  If adequate financing is not available on acceptableterms, we may be forced to reduce our operations or abandon expansionopportunities.

 

*Our quarterly and annualoperating results may vary significantly in part due to factors outside ourcontrol.*

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 the telecommunications market, includingthe addition or withdrawal of carriers from the market, changes in technologyand increased competition from existing and new competitors;

•                  The timing and expense of our call center networkexpansion or contraction, including changing staffing and infrastructureexpenses related to anticipated call volume changes;

•                  The continued costs of advertising, marketing andpromotion of Infone without commensurate consumer acceptance or revenues;

•                  The addition or expiration of contracts with carriercustomers;

•                  Changes in our or our competitors’, customers’ orsuppliers’ pricing policies;

•                  Lengthy sales cycles for new and extended contracts;

•                  The timing of the commencement of our services undernew or existing contracts with our carrier customers, which depends in part onthe customers’ ability to adapt their networks and billing systems to allowthem to transfer calls to us;

•                  Lack of market acceptance or delays or increaseddevelopment costs related to the introduction of our services 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 fall belowthe 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 alliances among carriers andamong our competitors, which can result in fewer carriers in the marketplace,lost carrier customers, increased negotiating leverage for newly affiliatedcarriers and more effective competitors;

•                  Changes in the regulatory environment, which mayaffect us directly, by affecting our ability to access and update listings dataat a reasonable cost, or indirectly, by restricting our carrier customers’ability to operate or provide a competitive service;

•                  Increasing availability of alternative methods fordelivery of directory assistance and other information services, including theInternet;

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

•                  Changes in retail prices offered to consumers for ourservices or for services perceived to be substitutes for ours, in whole or in part.

 

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*We have a long sales cycle whichmay cause delays that adversely affect our revenue growth and operatingresults.*

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 contracts and contract extensions, particularly withlarge customers.  The selling processinvolves demonstrating the value-added benefits of outsourcing directoryassistance and using 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 to lengthysales cycles could significantly affect our revenue growth and operatingresults.

 

*Our operating results aresignificantly affected by our ability to accurately estimate the amount andtiming of call volume, which is often subject to factors outside of ourcontrol.*

Our operating results are significantly affected by costs incurred forexpanding or contracting staffing and infrastructure.  We incur significant staffing and general andadministrative costs in contracting operations, if necessary, and inanticipation of additional call volume under our customer contracts.  If such call volume does not depart or arriveas scheduled, in the amount anticipated, or at all, our operating results canbe adversely affected.  This couldincrease our operating expenses without a corresponding increase in revenues.

 

*We need to maintain or expandcall 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 landlinemarket, which is dominated by the regional Bell operating companies.  If we are unable to expand our wirelessbusiness or attract significant landline business, or grow our Infone revenueson a cost effective basis or at all, we may be unable to achieve and maintainprofitability.

 

*Regulations affecting ourcustomers and suppliers and future regulations to which we may be subject mayadversely 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 state regulatoryauthorities.  The Federal CommunicationsCommission (“FCC”) has jurisdiction over all U.S. telecommunications commoncarriers to the extent they provide interstate or international communicationsservices, including, in our case, the use of our local networks to originate orterminate such services.  The operationsof our Infone service currently involve interstate and intrastatecommunications services.  The applicationof the FCC’s current and/or future policies could have a material adverse effecton our business, operating results and financial condition.

 

We are subject to regulation by the various state utilitycommissions.  We are also subject todirect regulation in all jurisdictions in which we operate, including all fiftystates and the District of Columbia and Puerto Rico.  Many states require certification before acompany can provide intrastate communications services.  We are certified as an interexchange carrierin all jurisdictions where required, and as a local exchange carrier whererequired.  Most states require us to filetariffs or price lists setting forth the terms, conditions and prices forservices that are classified as intrastate. We have filed such tariffs or price lists where required.

 

Our Infone services are subject to numerous local, state and federaltaxes and regulatory fees, including the Federal excise tax, FCC UniversalService and regulatory fees and numerous public utility commission regulatoryfees.  We have procedures in place toensure that we properly collect taxes and fees from our customers and remitsuch taxes and fees to the appropriate entity pursuant to applicable lawsand/or regulations.

 

Other aspects of our services may be subject to state or federal regulation, such as regulations relating to the confidentiality of data and communications, 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 on our business.

 

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*Future acquisitions or efforts topursue 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 assimilating the operations,technology, information systems and personnel of an acquired company, includingthe inability to maintain uniform standards, controls and policies, and theloss of key employees of the acquired company;

•                  Diversion of management’s attention from otherbusiness concerns;

•                  Impairment of relationships with licensors, customersand suppliers;

•                  Difficulties in entering into markets in which we haveno direct prior experience and potential marketing expenses related thereto;

•                  Use of cash resources, potentially dilutive issuancesof equity securities and incurrence of additional debt and contingentliabilities; and

•                  Significant write-offs related to goodwill andamortization expenses related to other intangible assets.

 

*If we are unable to anticipatechanges in technology and industry standards and to develop new services andfeatures, 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 featurescan be very expensive.  Further, givenrapid technological changes, frequent introduction of new products, servicesand features, and changing consumer demands that characterize our industry, itcan be difficult to correctly anticipate future changes in technology andindustry standards.  If we fail todevelop new services and features, encounter difficulties that delay theintroduction of such services and features, or incorrectly anticipate futurechanges and develop services and features that are not accepted by themarketplace or are not cost effective for us to provide as a part of ouroverall service offerings, we may not succeed at our business.

 

*Alternative methods for deliveryof directory assistance and information services could reduce the demand forour services.*

Our revenues continue to come primarily from providing EnhancedDirectory Assistance 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 todevelop and becomes easier to use and access, technologies may be developedthat decrease or eliminate the demand for telephone-based or voice-baseddirectory or information 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 otheralternatives as their primary source for information.

 

*Systems failures, delays andother problems could harm our reputation and business, cause us to losecustomers and expose us to customer liability.*

Our success also depends on our ability to provide reliable services.  Our operations could be interrupted bysignificant damage to or failure of our network, our connections to thirdparties, our computer hardware or software or our customers’ or suppliers’computer hardware or software.  Any suchsignificant damage or failure could disrupt the operations of our network andthe provision of our services and result in the loss of current and potentialcustomers.  In addition, if call volumeincreases, we may need to expand and/or upgrade our technology and networkhardware and software in order to provide services.  Capacity limits on our technology and networkhardware and software may make it difficult for us to expand and upgrade oursystems in a timely and economical manner.

 

*If we are unable to obtain oradequately update directory or information content at an economical cost, wemay be unable to provide current levels of service or improve our service.*

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

 

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unable to provide current levels of service, improve our EnhancedDirectory Assistance service or provide new services and features.  Ultimately, the satisfaction of callers andour carrier customers, and our ability to renew and extend our current customercontracts, enter into new customer contracts and expansion of our Infoneservice, depends on the quality of services we provide.  The quality of our services is directlyrelated to the quality of our listings data and other information content.

 

*As we rely on a limited number ofsuppliers, an abrupt loss of any key supplier could adversely affect ourbusiness 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 to continue toattract and retain qualified senior management, technical personnel and callcenter operators, or our call center staff is unionized, our operations couldbe 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 andretain qualified individuals during periods of low unemployment and, therefore,may be subject to increasing pressure to offer higher wages and other benefitsduring such periods.  In our call centerhiring, we may also feel the effects of the telecommunications industry ingeneral, which has widespread union membership among its operators and otherworkers.

 

*If we are unable to use andprotect our intellectual property, we may be unable to provide some of ourEnhanced Directory Assistance and information services, or personal assistantservices, or profitably operate our business.*

We regard aspects of our Enhanced Directory Assistance, as well as ourpersonal assistant services and their features and processes to beproprietary.  If we are unable to use andprotect our intellectual property, we may be unable to provide some of ourEnhanced Directory Assistance and/or our personal assistant services orprofitably operate our business.  To alimited extent, we rely on a combination of trade secret, patent and otherintellectual property law, nondisclosure agreements and other protectivemeasures to protect our intellectual property. However, these measures may be difficult and costly to meaningfullyenforce.  In addition, attempts toenforce our intellectual property rights may bring into question the validityof these rights.  Litigation with respectto patents or other intellectual property rights can result in substantialcosts and diversion of management attention and other resources.

 

*Our common stock price isvolatile.*

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 inour contracts and the effects on our call centers and infrastructure of suchactivities;

•                  Announcements relating to material events concerningour customers;

•                  Actual or anticipated variations in our results ofoperations;

•                  The success of our Infone service;

•                  Changes in financial estimates by securities analysts;

•                  Obsolescence of technologies that we or our customersuse;

•                  Introductions of new technologies, products orfeatures;

•                  New product initiatives and growth strategies; and

•                  General market conditions.

 

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From January 1, 2004 through December 31, 2004, our common stock pricefluctuated from a low of $1.21 per share to a high of $3.28 per share and hason several days fluctuated more than 10%. These trading prices may change significantly and arbitrarily.  In addition, broad market factors affectingtelecommunications or technology stocks may adversely affect the market priceof our common stock.  General economic,political and market conditions, including interest rate changes and recession,may also adversely affect our stock price.

 

*Oregon law and provisions of ourcharter could make the acquisition of our company more difficult.*

We are authorized to issue up to 10,000,000 shares of preferred stock,and our Board of Directors has the authority to fix the preferences, limitationsand relative rights of those shares without any vote or action by theshareholders.  The potential issuance ofpreferred stock may delay or prevent a change in control of our company, maydiscourage bids for the common stock at a premium over the market price and mayadversely affect the market price of, and the voting and other rights of theholders of, our common stock.  Inaddition, provisions under Oregon law limit the ability of parties who acquirea significant amount of voting stock to exercise control over our company.  These provisions may have the effect oflengthening the time required for a person to acquire control of our Companythrough a proxy contest or the election of a majority of the Board of Directorsand may deter efforts to obtain control of our Company.

 

 

**ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK.**

 

Substantially all of ourliquid resources are invested in money market instruments and short-term debtsecurities, and therefore, the fair market value of these investments isaffected by changes in market interest rates. However, these funds were invested in overnight money market instrumentsor debt securities with short-term effective maturities at December 31, 2004and were redeemable on a daily or monthly basis.  All of the underlying investments in themoney market fund had maturities of three months or less.  The short-term investments consisted ofauction rate securities, of which the underlying securities, while havinglong-term actual maturities, effectively reset as to interest rate based onauction results on terms typically between 7 and 49 days.  As a result, we believe the market riskarising from our holdings of financial instruments is minimal.  A hypothetical 1% fluctuation in interestrates would not have a material adverse effect on our financial position,results of operations or cash flows.

 

 

**ITEM 8.            FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.**

 

See pages 30 through 44.

 

**ITEM 9.            CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING**

**                          AND FINANCIALDISCLOSURE.**

 

None.

 

**ITEM 9A.         CONTROLS AND PROCEDURES.**

 

Controls and Procedures

 

Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of our disclosure controls and procedures (as such term isdefined under Rule 13a-15(e) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”)) at the end of the period covered by thisannual report.  Based upon that evaluation,our Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of the end of the periodcovered by this annual report.

 

Management’s Report on Internal Controls over Financial Reporting

 

Management’s Report on Internal Controls over Financial Reporting canbe found at page 27 of this annual report. Our independent registered public accounting firm, Deloitte &ToucheLLP, has issued an audit report on our assessment of our internal control overfinancial reporting, which can be found at page 28 of this annual report.  There were no changes in our internalcontrols over financial reporting during the quarter ended December 31, 2004that have materially affected, or are reasonably likely to materially affectour internal controls over financial reporting.

 

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**ITEM 9B.         OTHERINFORMATION.**

 

None

# ** **

# **PARTIII**

 

**ITEM10.         DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT.**

 

The information required by Item 10 is incorporated by reference to theProxy Statement for our 2005 Annual Meeting under the captions “Management,” “Nomineesand Directors” and “Corporate Governance” to be filed with the Securities andExchange Commission within 120 days of our fiscal year end.

 

*Compliance with Section 16(a) of the Exchange Act.* The information required by Item 10 relating to compliance with Section16(a) of the Securities Exchange Act of 1934 is incorporated by reference tothe Proxy Statement for our 2005 Annual Meeting under the caption “Section16(a) Beneficial Ownership Reporting Compliance” to be filed with theSecurities and Exchange Commission within 120 days of our fiscal year end.

 

*Code of Ethics.*  We haveadopted a “Code of Business Conduct and Ethics” applicable to our directors,officers and employees and a “Code of Ethics” applicable to our Chief ExecutiveOfficer and our senior financial officers. Both our Code of Business Conduct and Ethics and our Code of Ethics areavailable in the Investor Relations section of our website(www.metro1.com/corporate-governance.html) or by requesting a free copy bywriting us at Metro One Telecommunications, Inc., 11200 Murray Scholls Place,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.         EXECUTIVE COMPENSATION.**

 

The information required by Item 11 is incorporated by reference to theProxy Statement for our 2005 Annual Meeting under the caption “ExecutiveCompensation,” to be filed with the Securities and Exchange Commission within120 days of our fiscal year end.

 

**ITEM12.         SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT.**

 

The information required by Item 12 is incorporated by reference to theProxy Statement for our 2005 Annual Meeting under the caption “PrincipalShareholders,” to be filed with the Securities and Exchange Commission within120 days of our fiscal year end.

 

**ITEM 13.         CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

 

None.

 

**ITEM 14.         PRINCIPAL ACCOUNTANT FEES AND SERVICES.**

 

The information required by Item 12 is incorporated by reference to theProxy Statement for our 2005 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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# **PARTIV**

 

**ITEM 15.         EXHIBITS, FINANCIAL STATEMENT SCHEDULES.**

 

**(a)(1)     **Consolidated Financial Statements

 

Pg. 26**               **Report of Independent Registered Public AccountingFirm

 

Pg. 27                Consolidated Statements of Operations for each of theyears ended December 31, 2004, 2003 and 2002

 

Pg. 28                Consolidated Balance Sheets at December 31, 2004 and2003

 

Pg. 29                Consolidated Statements of Shareholders’ Equity foreach of the years ended December 31, 2004, 2003 and 2002

 

Pg. 30     Consolidated Statementsof Cash Flows for each of the years ended December 31, 2004, 2003 and 2002

 

Pg. 31     Notes to Consolidated FinancialStatements

 

**(a)(3)      Exhibits**

 

3.1                                 Third Restated Articles of Incorporationof Metro One Telecommunications, Inc. (1)

 

3.2                                 Amendment to Third Restated Articles ofIncorporation of Metro One Telecommunications, Inc. (1)

 

3.3                                 Amended and Restated Bylaws of Metro OneTelecommunications, Inc. (1)

 

10.1                           Lease Agreement between Murray Scholls,LLC, Gramor Development Northwest, Inc. and the Company (2)

 

10.2                           Commercial Lease Agreement between MurrayScholls, LLC and the Company (3)

 

10.3                           Metro One Telecommunications DeferredCompensation Plan Document (3)*

 

10.4         Amendment to MetroOne Telecommunications Deferred Compensation Plan (4)*

 

10.5         2004 Stock IncentivePlan (5)*

 

10.6         Form of Stock OptionAgreements and Exercise Notice under 2004 Stock Incentive Plan (6)*

 

10.7         Form of RestrictedStock Purchase Agreement under 2004 Stock Incentive Plan (6)*

 

10.8         1999 Employee StockPurchase Plan, as amended (3)*

 

10.9                           1994 Stock Incentive Plan, as amended (7)*

 

10.10                     2003 Employment Agreement with Timothy A. Timmins (8)*

 

23.1                           Consent of Independent Registered PublicAccounting Firm

 

31.1                           Certification of Principal ExecutiveOfficer pursuant to Securities and Exchange Commission Rule 13a-14(a)

 

31.2                           Certification of Principal FinancialOfficer pursuant to Securities and Exchange Commission Rule 13a-14(a)

 

32.1                           Certification of Principal ExecutiveOfficer and Principal Financial Officer Pursuant to 18 U.S.C.Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act Of 2002

 

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*****              Managementcontract or compensatory plan

 

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(1)                                  Incorporated herein by reference to theCompany’s Annual Report on Form 10-K dated March 15, 2004.

 

(2)                                  Incorporated herein by reference to theCompany’s Annual Report on Form 10-K dated March 31, 1999.

 

(3)                                  Incorporated herein by reference to theCompany’s Annual Report on Form 10-K dated April 2, 2001 and to the Company’sForm S-8 dated September 26, 2003.

 

(4)                                  Incorporated herein by reference to theCompany’s Current Report on Form 8-K dated February 8, 2005.

 

(5)                                  Incorporated herein by reference fromAppendix A to the Registrant’s Definitive Proxy Statement on Schedule 14-Adated April 26, 2004.

 

(6)                                  Incorporated herein by reference to theCompany’s Quarterly Report on Form 10-Q dated November 11, 2004.

 

(7)                                  Incorporated herein by reference to theCompany’s Form S-8 dated February 12, 2002 and to the Company’s Form S-8 datedSeptember 10, 2002.

 

(8)                                  Incorporated herein by reference to theCompany’s Annual Report on Form 10-K dated March 31, 2003.

 

25

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Exchange Act, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized.

 

 
|   |   | Metro One Telecommunications, Inc. |
|--------|--------|------------------------------------|
|   |   |  

 

              |
|   |   | By:                                | /s/ Timothy A. Timmins |   |
|   |   |                               | Timothy A. Timmins |
|   |   |                               | President and Chief Executive Officer |

 

Date:       March 16, 2005

 

 

**POWER OF ATTORNEY**

 

                KNOW ALL PERSONSBY THESE PRESENTS, that each person whose signature appears below constitutesand appoints Timothy A. Timmins and Duane C. Fromhart, jointly and severally,his or her attorneys-in-fact, each with the power of substitution, for him orher in any and all capacities, to sign any amendments to this Report on Form 10-K,and to file the same, with exhibits thereto and other documents in connectiontherewith with the Securities and Exchange Commission, hereby ratifying andconfirming all that each of said attorneys-in-fact, or his or her substitute orsubstitutes may do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Exchange Act, thisreport has been signed below by the following persons on behalf of theregistrant in the capacities and on the date indicated:

 

 
| **Signature**             | ** ** | **Title**                          | ** ** | **Date**       |
|---------------------------|------------|------------------------------------|------------|----------------|
|                      |       |                               |       |           |
| /s/ Timothy A. Timmins    |       | President, Chief Executive         |       | March 16, 2005 |
| Timothy A. Timmins        |       | Officer and Director               |       |           |
|                      |       | (Principal Executive Officer)      |       |           |
|                      |       |                               |       |           |
| s/ Gary E. Henry          |       | Executive Vice President,          |       | March 16, 2005 |
| Gary E. Henry             |       | Chief Operating Officer            |       |           |
|                      |       | and Director                       |       |           |
|                      |       |                               |       |           |
| /s/ Duane C. Fromhart     |       | Senior Vice President,             |       | March 16, 2005 |
| Duane C. Fromhart         |       | Chief Financial Officer            |       |           |
|                      |       | (Principal Financial and           |       |           |
|                      |       | Accounting Officer)                |       |           |
|                      |       |                               |       |           |
| /s/ William D. Rutherford |       | Chairman of the Board of Directors |       | March 16, 2005 |
| William D. Rutherford     |       |                               |       |           |
|                      |       |                               |       |           |
| /s/ Roger L. Pringle      |       | Director                           |       | March 16, 2005 |
| Roger L. Pringle          |       |                               |       |           |
|                      |       |                               |       |           |
| /s/ James M. Usdan        |       | Director                           |       | March 16, 2005 |
| James M. Usdan            |       |                               |       |           |
|                      |       |                               |       |           |
| /s/ David A. Williams     |       | Director                           |       | March 16, 2005 |
| David A. Williams         |       |                               |       |           |

 

26

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**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

 

 

Our management is responsible for establishing and maintaining adequateinternal control over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act).  Our managementassessed the effectiveness of our internal control over financial reporting asof December 31, 2004.  In making thisassessment, our management used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (“COSO”) in InternalControl-Integrated Framework.

 

Our management has concluded that, as of December 31, 2004, ourinternal control over financial reporting is effective based on these criteria. Our independent registered publicaccounting firm, Deloitte & Touche LLP, has issued an audit report on ourassessment of our internal control over financial reporting, which follows thisreport.

 

 
| /s/ Timothy A. Timmins             |   |
|------------------------------------|--------|
| Timothy A. Timmins                 |
| President, Chief Executive Officer |
|                               |
| /s/ Duane C. Fromhart              |   |
| Duane C. Fromhart                  |
| Senior Vice President,             |
| Chief Financial Officer            |

 

27

----

 

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

 

To the Board of Directors and Shareholders of Metro One Telecommunications, Inc.: Portland, Oregon

 

We have audited management’s assessment, included in the accompanyingReport of Management, that Metro One Telecommunications, Inc. and subsidiaries(the “Company”) maintained effective internal control over financial reportingas of December 31, 2004 based on criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinions.

 

A company’s internal control over financial reporting is a processdesigned by, or under the supervision of, the company’s principal executive andprincipal financial officers, or persons performing similar functions, andeffected by the company’s board of directors, management, and other personnelto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. A company’s internalcontrol over financial reporting includes those policies and procedures that(1) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (2) provide reasonable assurance that transactions are recordedas necessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Because of the inherent limitations of internal control over financialreporting, including the possibility of collusion or improper managementoverride of controls, material misstatements due to error or fraud may not beprevented or detected on a timely basis. Also, projections of any evaluation ofthe effectiveness of the internal control over financial reporting to futureperiods are subject to the risk that the controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

In our opinion, management’s assessment that the Company maintainedeffective internal control over financial reporting as of December 31, 2004, isfairly stated, in all material respects, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. Also in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of December 31, 2004, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the consolidated balancesheet as of December 31, 2004, and the related statements of operations,shareholders’ equity, and cash flows for the year ended December 31, 2004 ofthe Company and our report dated March 16, 2005 expressed an unqualifiedopinion on those financial statements.

 

 

DELOITTE & TOUCHE LLP

Portland, OregonMarch 16, 2005

 

28

----

 

 

 

 

 

 

 

 

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

 

 

To the Board of Directors and Shareholders ofMetro One Telecommunications, Inc.:Portland, Oregon

 

 

 

We have audited the accompanying consolidated balance sheets of MetroOne Telecommunications, Inc. and subsidiaries (the “Company”) as ofDecember 31, 2004 and 2003, and the related consolidated statements ofoperations, shareholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2004. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audits to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of the Company as ofDecember 31, 2004 and 2003, and the results of their operations and theircash flows for each of the three years in the period ended December 31,2004, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

We have also audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the effectiveness of theCompany’s internal control over financial reporting as of December 31,2004, based on the criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission and our report dated March 16, 2005 expressed an unqualifiedopinion on management’s assessment of the effectiveness of the Company’sinternal control over financial reporting and an unqualified opinion on theeffectiveness of the Company’s internal control over financial reporting.

 

 

 

DELOITTE & TOUCHE LLP

Portland, Oregon

March 16, 2005

 

29

----

 
| **Metro One Telecommunications,  Inc.**

**Consolidated Statements of  Operations**  (In thousands, except per share amounts) |
|------------------------------------------------------------------------------------------------------------------------------------|

 

 
| ** **                            | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------|------------|------------------------------|------------|
| ** **                            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                  |       |                         |       |   |   |   |   |
| Revenues                              |       | $                            | 140,369    |   | $ | 201,636 |   | $ | 257,951 |   |
|                                  |       |                         |       |   |   |   |   |
| Costs and  expenses:                  |       |                         |       |   |   |   |   |
| Direct operating                      |       | 84,331                       |       | 117,126 |   | 144,164 |   |
| Selling, general  and administrative  |       | 94,208                       |       | 128,271 |   | 72,461 |   |
| Impairment loss                       |       | 32,193                       |       | 4,715 |   | — |   |
|                                  |       | 210,732                      |       | 250,112 |   | 216,625 |   |
|                                  |       |                         |       |   |   |   |   |
| (Loss) income  from operations        |       | (70,363                      | )          | (48,476 | ) | 41,326 |   |
|                                  |       |                         |       |   |   |   |   |
| Other income,  net                    |       | 3,808                        |       | 678 |   | 978 |   |
| Interest and  loan fees               |       | —                       |       | — |   | (10 | ) |
|                                  |       |                         |       |   |   |   |   |
| (Loss) income  before income taxes    |       | (66,555                      | )          | (47,798 | ) | 42,294 |   |
| Income tax  (benefit) expense         |       | (3,389                       | )          | (14,489 | ) | 16,165 |   |
| Net (loss)  income                    |       | $                            | (63,166    | ) | $ | (33,309 | ) | $ | 26,129 |   |
|                                  |       |                         |       |   |   |   |   |
|                                  |       |                         |       |   |   |   |   |
| Net (loss)  income per common share:  |       |                         |       |   |   |   |   |
|                                  |       |                         |       |   |   |   |   |
| Basic                                 |       | $                            | (2.54      | ) | $ | (1.35 | ) | $ | 1.06 |   |
| Diluted                               |       | $                            | (2.54      | ) | $ | (1.35 | ) | $ | 1.04 |   |
|                                  |       |                         |       |   |   |   |   |
| Weighted average  shares outstanding: |       |                         |       |   |   |   |   |
| Basic                                 |       | 24,869                       |       | 24,706 |   | 24,576 |   |
| Diluted                               |       | 24,869                       |       | 24,706 |   | 25,078 |   |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

30

----

 
| **Metro One Telecommunications,  Inc.**

**Consolidated Balance Sheets**  (In thousands) |
|-----------------------------------------------------------------------------------------------|

 

 
| ** **                                                                                                                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                           | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                                                                                                                                 |       |             |       |   |   |
| **Assets**                                                                                                                                           |       |             |       |   |   |
|                                                                                                                                                 |       |             |       |   |   |
| Current assets:                                                                                                                                      |       |             |       |   |   |
| Cash and cash  equivalents                                                                                                                           |       | $                | 24,093     |   | $ | 44,381 |   |
| Short-term  investments, available for sale                                                                                                          |       | 25,375           |       | — |   |
| Restricted cash                                                                                                                                      |       | 4,900            |       | 4,900 |   |
| Accounts  receivable                                                                                                                                 |       | 17,524           |       | 32,078 |   |
| Prepaid costs  and other current assets                                                                                                              |       | 4,850            |       | 15,944 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Total current  assets                                                                                                                                |       | 76,742           |       | 97,303 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Furniture,  fixtures and equipment, net                                                                                                              |       | 12,701           |       | 62,187 |   |
| Intangible  assets                                                                                                                                   |       | 5,916            |       | 4,819 |   |
| Other assets                                                                                                                                         |       | 471              |       | 575 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Total assets                                                                                                                                         |       | $                | 95,830     |   | $ | 164,884 |   |
|                                                                                                                                                 |       |             |       |   |   |
| **Liabilities  and Shareholders’ Equity**                                                                                                       |       |             |       |   |   |
|                                                                                                                                                 |       |             |       |   |   |
| Current  liabilities:                                                                                                                                |       |             |       |   |   |
| Accounts payable                                                                                                                                     |       | $                | 1,107      |   | $ | 3,146 |   |
| Accrued  liabilities                                                                                                                                 |       | 2,003            |       | 3,580 |   |
| Accrued payroll  and related costs                                                                                                                   |       | 12,125           |       | 12,297 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Total current  liabilities                                                                                                                           |       | 15,235           |       | 19,023 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Deferred tax  liabilities                                                                                                                            |       | —           |       | 2,853 |   |
| Other long-term  liabilities                                                                                                                         |       | 1,158            |       | 670 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Total  liabilities                                                                                                                                   |       | 16,393           |       | 22,546 |   |
|                                                                                                                                                 |       |             |       |   |   |
| 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, 24,984 and 24,775 shares issued and  outstanding  at December 31, 2004 and 2003, respectively |       | 119,948          |       | 119,683 |   |
| Retained  (deficit) earnings                                                                                                                         |       | (40,511          | )          | 22,655 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Shareholders’  equity                                                                                                                           |       | 79,437           |       | 142,338 |   |
|                                                                                                                                                 |       |             |       |   |   |
| Total  liabilities and shareholders’ equity                                                                                                     |       | $                | 95,830     |   | $ | 164,884 |   |

 

31

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| **Metro One Telecommunications, Inc.**

**Consolidated Statements of Shareholders’ Equity**   (In thousands) |
|------------------------------------------------------------------------------------------------------------------------|

 

 
| ** **                        | ** ** | **Shareholders’ Equity** | ** ** |
|-----------------------------------|------------|-------------------------------|------------|
| ** **                        | ** ** | **Common Stock**              | ** ** | **Retained** | ** ** | **Shareholders’** | ** ** |
| ** **                        | ** ** | **Shares**                    | ** ** | **Amount** | ** ** | **(Deficit) Earnings** | ** ** | **Equity** | ** ** |
|                              |       |                          |       |   |   |   |   |   |   |
| Balances at  January 1, 2002      |       | 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 |   |
|                              |       |                          |       |   |   |   |   |   |   |
| Employee stock  purchase plan     |       | 184                           |       | 258 |   | — |   | 258 |   |
| Employee  restricted stock grant  |       | 25                            |       | 7 |   | — |   | 7 |   |
| Net loss                          |       | —                        |       | — |   | (63,166 | ) | (63,166 | ) |
|                              |       |                          |       |   |   |   |   |   |   |
| Balances at  December 31, 2004    |       | 24,984                        |       | $ | 119,948 |   | $ | (40,510 | ) | $ | 79,437 |   |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

32

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| **Metro One Telecommunications, Inc.**

**Consolidated Statements of Cash Flows **(In thousands) |
|-------------------------------------------------------------------------------------------------------|

 

 
| ** **                                                                                           | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                           | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                 |       |                         |       |   |   |   |   |
| Cash flows from  operating activities:                                                               |       |                         |       |   |   |   |   |
| Net (loss)  income                                                                                   |       | $                            | (63,166    | ) | $ | (33,309 | ) | $ | 26,129 |   |
| Adjustments to  reconcile net (loss) income to net cash provided by (used in) operating  activities: |       |                         |       |   |   |   |   |
| Depreciation and  amortization                                                                       |       | 21,738                       |       | 21,585 |   | 18,794 |   |
| Loss on disposal  of fixed assets                                                                    |       | 230                          |       | 94 |   | 398 |   |
| Impairment loss                                                                                      |       | 32,193                       |       | 4,715 |   | — |   |
| Deferred rent                                                                                        |       | 489                          |       | 149 |   | 243 |   |
| Deferred income  taxes                                                                               |       | —                       |       | (5,963 | ) | 5,325 |   |
| Tax benefit from  employee stock plans                                                               |       | —                       |       | 24 |   | 498 |   |
| Employee stock  compensation                                                                         |       | 7                            |       | — |   | — |   |
| Changes in  certain assets and liabilities:                                                          |       |                         |       |   |   |   |   |
| Accounts  receivable                                                                                 |       | 14,554                       |       | (757 | ) | 1,473 |   |
| Prepaid costs  and other assets                                                                      |       | 6,656                        |       | (9,815 | ) | (3,022 | ) |
| Accounts payable  and other liabilities                                                              |       | (3,788                       | )          | 4,088 |   | (4,531 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| Net cash  provided by (used in) operating activities                                                 |       | 8,913                        |       | (19,189 | ) | 45,307 |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| Cash flows from  investing activities:                                                               |       |                         |       |   |   |   |   |
| Purchase of  short-term securities                                                                   |       | (32,050                      | )          | — |   | — |   |
| Sales of  short-term securities                                                                      |       | 6,675                        |       | — |   | — |   |
| Capital  expenditures                                                                                |       | (4,084                       | )          | (11,640 | ) | (21,416 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| Net cash used in  investing activities                                                               |       | (29,459                      | )          | (11,640 | ) | (21,416 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| Cash flows from  financing activities:                                                               |       |                         |       |   |   |   |   |
| Cash restricted  to secure letter of credit                                                          |       | —                       |       | (1,552 | ) | (2,448 | ) |
| Proceeds from  exercise of stock options and employee stock purchases                                |       | 258                          |       | 234 |   | 1,393 |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| Net cash  provided by (used in) financing activities                                                 |       | 258                          |       | (1,318 | ) | (1,055 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| Net (decrease)  increase in cash and cash equivalents                                                |       | (20,288                      | )          | (32,147 | ) | 22,836 |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| Cash and cash  equivalents, beginning of year                                                        |       | 44,381                       |       | 76,528 |   | 53,692 |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| Cash and cash  equivalents, end of year                                                              |       | $                            | 24,093     |   | $ | 44,381 |   | $ | 76,528 |   |
|                                                                                                 |       |                         |       |   |   |   |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| Supplemental  disclosure of cash flow information:                                                   |       |                         |       |   |   |   |   |
| Cash (refunded)  paid for income taxes                                                               |       | $                            | (10,002    | ) | $ | 875 |   | $ | 12,358 |   |

 

 

 

 

 

 

 

The accompanying notes are an integral part of these consolidated financialstatements.

 

33

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| **Metro  One Telecommunications, Inc.**

**Notes to Consolidated Financial Statements** |
|-----------------------------------------------------------------------------------------|

 

 

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

 

***Nature of Operations.***  We are the leading developer and providerof Enhanced Directory Assistance® and other informationservices.  We contract primarily withwireless carriers to provide our services to their subscribers.  In addition to using our Enhanced DirectoryAssistance platform to provide directory assistance listings, we have alsoprovided other non-directory assistance services and content for telephonecarriers, such as MetroDex®, a service that handles personalcontacts and calendars, and TeleConcierge®, for making reservations,and performing other concierge services. Enhanced Directory Assistance also includes a number of connectivityfeatures, 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.  Revenues are derived principally through feescharged to telecommunications carriers and other customers.  We operate call centers located in manymetropolitan areas throughout the United States.

 

***Major Customers.***  In each of theyears ended December 31, 2004, 2003 and 2002, a small number of customersaccounted for substantially all revenue and accounts receivable reported.  In 2004, our two largest customers accountedfor approximately 56%, and 28% of our revenues. One customer accounted for approximately 81% of total receivables atDecember 31, 2004.  Our three largestcustomers accounted for approximately 44%, 35% and 13% of revenue in 2003 andapproximately 33%, 33% and 24% of revenue in 2002.  In 2004 and historically, we have notincurred significant losses related to our accounts receivable.

 

***Significant Events.***  In February2005, we entered into a Master Services Agreement for Directory AssistanceServices (the “Services Agreement”) with Nextel Operations, Inc., acting onbehalf of certain affiliates (collectively “Nextel”) of Nextel Communications,Inc.  The Services Agreement, supercedesour previous services agreement dated in June 1999.  Under the Services Agreement, we agreed toprovide directory assistance services to Nextel’s customers on a non-exclusivebasis.  Price levels in the ServicesAgreement are lower than those of the previous agreement and, additionally,Nextel may transition call volume away from us on short notice and/or terminateservices entirely.  The term of theServices Agreement is for three years, and may be renewed by Nextel for twoadditional one-year periods.

 

Our contract with AT&T Wireless expired in December 2003, and ournegotiations did not result in a new contract. AT&T Wireless accounted for approximately 28%, 44% and 33% of ourrevenues in 2004, 2003 and 2002, respectively.  The call volume from AT&T Wirelesstransitioned away during the second and third quarters of 2004.

 

Our contract with Sprint PCS expired in December 2002.  We agreed to an arrangement with Sprint PCS,pursuant to which we continued to handle its subscribers’ calls through atransition period that began in March 2003 and was substantially completed byJune 30, 2003.  Revenue from Sprint PCSaccounted for approximately 13% and 33% of our total revenue in 2003 and 2002,respectively.

 

We have experienced net losses in each of the quarterly and annualperiods since the first quarter of 2003. We expect to meet our cash requirements in 2005 through a combination ofexisting cash and cash equivalents and short-term investments.  We may require more capital in the future tofund our operations and/or finance various corporate initiatives.  We cannot be certain that additional fundswill be available on terms favorable to us or at all.  If adequate funds are not available onacceptable terms, we may be forced to reduce our operations or abandonexpansion opportunities.

 

In a 2004 decision, the California Public Utilities Commission (“PUC”)implemented competitive wholesale pricing for directory assistance data forthird party vendors purchasing the data from SBC Communications (“SBC”).  The decision determined that SBC continues toenjoy a dominant position as the former monopoly provider of local exchangeservice in its territory in California and could not use its market power toextract excessive directory assistance data prices that would discriminateagainst competitors.  The decisionrequired that SBC refund the improper charges with interest.  As a result,in the third quarter of 2004, we received, and recorded in revenues, a refundfrom SBC in the amount of approximately $2.9 million.  To more appropriately reflect the nature ofthis transaction, we have reclassified the refund to “Other income, net” in ourDecember 31, 2004 financial statements.

 

***Use of Estimates.***  Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires us to makeestimates and assumptions that affect reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the fiscal year.  Actual resultscould differ from those estimates.

 

34

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***Reclassification.***  Certainbalances in the 2003 consolidated financial statements have been reclassifiedto conform to 2004 presentation.  Suchreclassifications had no effect on reported net (loss) income.

 

***Cash, Cash Equivalents and Short-term Investments.*** 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 consists ofcash restricted to secure a letter of credit related to our workers’compensation program and is invested in a bank certificate of deposit.

 

Short-term investments are carried at fair value and at December 31,2004 consisted of $25.4 million of available-for-sale auction rate securities (“ARS”)that we classify as current assets based upon our intent and ability to usethese funds as necessary to satisfy short-term liquidity requirements.  Our portfolio at year-end consisted of twotypes of ARS.  We held $15.4 million ofinvestment-grade taxable auction rate notes of municipal issuers, which aredebt-securities with variable interest rates that reset through a Dutch auctionwith principal traded at par.  The ratetypically resets on a periodic basis, usually between 7 and 49 days.  Actual maturities of the underlyingsecurities are greater than ten years.  Inaddition, at December 31 2004, we held $10.0 million of auction rate preferredsecurities which consist of shares of closed-end investment funds invested inlong-term fixed income securities.  Thesefunds generally issue auction rate preferred shares that provide liquidity atpar value every 28 days through the auction rate market.  The reset rate for both types of ARS is setby a modified Dutch auction process in which bids are filled from lowest yieldbid to highest; the highest bid cleared sets the rate for all winningbidders.  Although the underlyingsecurities have long-term contractual maturities, we can sell or buy thesecurities at par on auction dates.  Thus,they are classified as short-term investments since they are intended to beavailable to fund current operations. Fair values are based on quoted market prices and at December 31, 2004,the fair value of these securities approximated their carrying value.  As a result of the interest rate resets, wehad no cumulative unrealized  or realizedholding gains or losses from these investments in the year ended December 31,2004.

 

***Furniture, Fixtures and Equipment.***  Furniture,fixtures and equipment are stated at cost and are depreciated over theirestimated useful lives of three to seven years using the straight-linemethod.  Leasehold improvements areamortized over the lesser of the remaining lease term or the useful life.  Expenditures for repairs and maintenance areexpensed as incurred.

 

***Goodwill.***  Purchased goodwill, whichrepresents the excess of cost over the fair value of net assets acquired in abusiness combination, was amortized on a straight-line basis, over itsestimated economic life, through December 31, 2001.  In January 2002, we adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” and discontinuedamortization of goodwill.  As a result ofour evaluation of goodwill for impairment under SFAS No. 142 in December 2003,we estimated that the fair value of our business was less than its carryingvalue; therefore, goodwill and related intangibles of approximately $4.7million was written off during the fourth quarter of 2003.

 

***Intangible Assets.***  Intangibleassets include patents, patents pending and trademarks.  These assets are carried at cost lessaccumulated amortization and are amortized over their estimated useful lives ofthree to ten years beginning at the time the related patent or trademark isgranted.  Accumulated amortization relatedto intangible assets was $1,784,000 and $1,192,000 at December 31, 2004 and2003, respectively.  The relatedamortization expense was $592,000, $558,000, and $377,000 for the years endedDecember 31, 2004, 2003 and 2002, respectively.

 

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The estimated aggregate amortization expense related to intangibleassets for the five years subsequent to 2004 is shown below.  We have not included any amounts related toamortization of costs of patents or trademarks currently pending but not yetgranted, totaling $3.7 million at December 31, 2004.

 
| **Year Ending**  | ** ** | **Estimated**                                                                   | ** ** |
|------------------|------------|---------------------------------------------------------------------------------|------------|
| **December 31,** | ** ** | **amortization expense**                                                        | ** ** |
|             |       | **(In  thousands)**                                                             |       |
| 2005             |       | $              | 635        |   |
| 2006             |       |                                                                            | 534        |   |
| 2007             |       |                                                                            | 507        |   |
| 2008             |       |                                                                            | 298        |   |
| 2009             |       |                                                                            | 121        |   |

 

***Impairment of Long-lived and Intangible Assets.*** In accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” we evaluate thecarrying value of furniture, fixtures, equipment and intangible assets withfinite lives for possible impairment whenever events or changes in circumstancesindicate that the carrying amounts of such assets may not be recoverable.  If an asset or group of assets is determinedto be impaired, the impairment loss is measured as the amount by which thecarrying value of the asset or group of assets exceeds its fair value.  We prepare an estimate of future undiscountedcash flows expected to result from the use of the asset and its eventualdisposition to determine its fair value. Because of our changing business conditions, including lower wholesaleprices and dependence on a relatively small number of customers for asignificant portion of our revenues, in the fourth quarter of 2004, we testedthe recoverability of the carrying value of our fixed assets and determinedthat the value was impaired.  As a result,we recorded a $32.2 million write-down of those assets to their estimated fairvalue based on estimated prices for similar assets.

 

***Deferred Income Taxes.***  Deferredincome taxes are provided for temporary differences between the amounts ofassets and liabilities for financial and tax reporting purposes.  Deferred tax assets are reduced by avaluation allowance when it is estimated to be more likely than not that someor all of the deferred tax assets will not be realized.

 

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

 

***Revenue Recognition.***  Under existingcontracts with telecommunications carriers, we record revenue for the number ofcalls processed 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 of advertising are expensed asincurred except for commercial advertising production costs, which are expensedat the time the related commercials are first run.  Advertising expense was approximately $17.5million and $49.9 million in 2004 and 2003, respectively, primarily related tomarketing and promotion of our Infone service launched in May 2003.

 

***Net (Loss) Income Per Share.***  We reportbasic and diluted net (loss) income per share in accordance with SFAS No. 128, “Earningsper Share.”  Basic net (loss) income pershare is calculated based on the weighted average number of common sharesoutstanding during each period.  Dilutednet (loss) income per share is calculated based on these same shares plusdilutive potential shares issuable upon assumed exercise of outstanding stockoptions, based on the treasury stock method, unless inclusion of such potentialshares would be anti-dilutive.

 

***Stock-Based Compensation.***  We haveelected to account for stock options and shares issued under our Employee StockPurchase Plan (“ESPP”) according to Accounting Principles Bulletin No. 25, “Accountingfor Stock Issued to Employees,”

 

36

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and to furnish the pro forma disclosures required under SFAS No. 148, “Accountingfor Stock-Based Compensation — Transition and Disclosure — an amendment of FASBStatement No. 123.”  Accordingly, no compensationcost has been recognized in the financial statements related to stock optionsissued under our Stock Incentive Plan (the “Plan”) or shares issued under ourESPP.

 

If compensationcost on stock options granted and ESPP shares issued in 2004, 2003 and 2002under the Plan had been determined based on the fair value of the options andESPP shares as of the grant or issue date in a method consistent with thatdescribed in SFAS No. 123, “Accounting for Stock-Based Compensation,” our net(loss) income and net (loss) income per share would have been changed to thepro forma amounts indicated below for the years ended December 31:

 
| ** **                                        | ** ** | **2004**                                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                        | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net (loss)  income, as reported                   |       | $                                            | (63,166    | )        | $          | (33,309  | )          | $ | 26,129 |   |
| Stock-based  compensation expense                 |       | (3,451                                       | )          | (4,248   | )          | (4,543   | )          |
| Net (loss)  income, pro forma                     |       | $                                            | (66,617    | )        | $          | (37,457  | )          | $ | 21,586 |   |
|                                              |       |                                         |       |     |       |     |       |
| Basic net (loss)  income per share, as reported   |       | $                                            | (2.54      | )        | $          | (1.35    | )          | $ | 1.06 |   |
| Basic net (loss)  income per share, pro forma     |       | $                                            | (2.68      | )        | $          | (1.52    | )          | $ | 0.88 |   |
|                                              |       |                                         |       |     |       |     |       |
| Diluted net  (loss) income per share, as reported |       | $                                            | (2.54      | )        | $          | (1.35    | )          | $ | 1.04 |   |
| Diluted net  (loss) income per share, pro forma   |       | $                                            | (2.68      | )        | $          | (1.52    | )          | $ | 0.86 |   |

 

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 ofeach option grant was estimated on the date of grant using the Black-Scholesoption-pricing model with the following assumptions for the years endingDecember 31:
| ** **                                            | ** ** | **2004**    | ** ** | **2003**    | ** ** | **2002**     | ** ** |
|-------------------------------------------------------|------------|-------------|------------|-------------|------------|--------------|------------|
| ** **                                            | ** ** | ** **  | ** ** | ** **  | ** ** | ** **   | ** ** |
| Dividend yield                                        |       | 0.0         | %          | 0.0         | %          | 0.0          | %          |
| Risk free  interest rate                              |       | 3.0         | %          | 2.9         | %          | 4.1          | %          |
| Expected  volatility                                  |       | 75.2        | %          | 98.7        | %          | 82.8         | %          |
| Expected life in  years                               |       | 4.0         |       | 4.0         |       | 4.0          |       |
|                                                  |       |        |       |        |       |         |       |
| Weighted-average  fair value of  options granted |       | $ 1.21 |       | $ 3.40 |       | $ 13.92 |       |

 

***Commitments and Contingencies.***  We are partyto various legal actions and administrative proceedings arising in the ordinarycourse of business.  We believe thedisposition of these matters will not have a material adverse effect on ourfinancial position, results of operations or cash flows.

 

From time to time, in thenormal course of our business, we issue standby letters of credit and bankguarantees.  At December 31, 2004, we hadone letter of credit outstanding in the amount of $4,900,000 related to ourworkers’ compensation program.  Theletter of credit is secured by a certificate of deposit for the same amountthat is recorded as restricted cash. This commitment expires on April 1, 2005 and is typically renewed on anannual basis.

 

***RecentAccounting Pronouncements.***  InDecember 2004, the Financial Accounting Standards Board issued SFASNo. 123 (Revised 2004), “Share-Based Payment,” an amendment of SFASNo. 123, “Accounting forStock-Based Compensation” and SFAS No. 95, “Statement of Cash Flows,” whichrequires companies to recognize in their statements of operations thegrant-date fair value of stock options and other equity-based compensationissued to employees.  SFAS No. 123Ris effective for interim or annual periods beginning after June 15,2005.  See “Stock-Based Compensation”above

 

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for the approximate proforma effects of how SFAS No. 123R would have affected our results ofoperations in 2004, 2003 and 2002.  SFASNo. 123R will not have any effect on our cash flows.

 

 

**2.     Furniture,Fixtures and Equipment**

 

Furniture,fixtures and equipment by major classification are summarized as follows:

 
| ** **                                    | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------|------------|--------------------|------------|
| ** **                                    | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(In thousands)** | ** ** |
| Equipment                                     |       | $                  | 10,505     |   | $ | 109,052 |   |
| Furniture and  fixtures                       |       | 2,177              |       | 14,598 |   |
| Leasehold  improvements                       |       | 19                 |       | 7,380 |   |
|                                          |       |               |       |   |   |
|                                          |       | 12,701             |       | 131,030 |   |
| Accumulated  depreciation                     |       | —             |       | (68,843 | ) |
|                                          |       |               |       |   |   |
| Total furniture,  fixtures and equipment, net |       | $                  | 12,701     |   | $ | 62,187 |   |

 

As discussed inNote 1., “Impairment of Long-lived and Intangible Assets,” we recorded awrite-down of our fixed assets in the fourth quarter of 2004.  As a result, the cost bases of the assetsshown above have been adjusted to reflect this write-down.

 

 

**3.     Goodwilland other intangible assets**

 

The following presents the activity in goodwill for the years endedDecember 31, 2004, 2003 and 2002 (in thousands):

 
| Balance at January  1, 2002   |   | $      | 4,432  |   |
|-------------------------------|--------|--------|--------|--------|
| No activity                   |   | — |   |
| Balance at  December 31, 2002 |   | 4,432  |   |
| Impairment loss               |   | (4,432 | )      |
| Balance at  December 31, 2003 |   | — |   |
| No activity                   |   | — |   |
|                          |   |   |   |
| Balance at  December 31, 2004 |   | $      | — |   |

 

Below is a summary of other intangible assets at December 31:

 
| ** **                 | ** ** | **2004**           | ** ** | **2003**         | ** ** |
|----------------------------|------------|--------------------|------------|------------------|------------|
| ** **                 | ** ** | **Gross carrying** | ** ** | **Accumulated**  | ** ** | **Gross carrying** | ** ** | **Accumulated** | ** ** |
| **Amortized intangibles:** | ** ** | **amount**         | ** ** | **amortization** | ** ** | **amount** | ** ** | **amortization** | ** ** |
| ** **                 | ** ** | **(in thousands)** | ** ** |
| Patents                    |       | $                  | 6,052      |             | $          | 1,377 |   | $ | 4,934 |   | $ | 977 |   |
| Trademarks                 |       | 1,425              |       | 354              |       | 994 |   | 189 |   |
| Other                      |       | 223                |       | 53               |       | 83 |   | 26 |   |
|                       |       |               |       |             |       |   |   |   |   |
| Totals                     |       | $                  | 7,700      |             | $          | 1,784 |   | $ | 6,011 |   | $ | 1,192 |   |

 

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

 

We lease operating facilities and equipment under operating leases withremaining terms of one to six years. Rental expenses related to operating leases were approximately$9,888,000, $9,513,000, and $9,355,000 in 2004, 2003 and 2002, respectively.

 

Minimum annual rent payments for the five years subsequent to 2004 andin the aggregate thereafter are as follows:

 
| **Year Ending**               | ** ** | ** **                | ** ** |
|-------------------------------|------------|---------------------------|------------|
| **December 31,**              | ** ** | **Annual lease payments** | ** ** |
| ** **                    | ** ** | **(In thousands)**        | ** ** |
| 2005                          |       | $                         | 7,779      |   |
| 2006                          |       | 5,875                     |       |
| 2007                          |       | 4,590                     |       |
| 2008                          |       | 2,609                     |       |
| 2009                          |       | 996                       |       |
| Thereafter                    |       | 267                       |       |
| Total minimum  lease payments |       | $                         | 22,116     |   |

 

 

**5.     Shareholders’Equity**

 

***Preferred Stock.***  We haveauthorized 10,000,000 shares of preferred stock for issuance.  Our board of directors has the authority toissue one or more series of preferred shares and the authority to fix anddetermine the rights and preferences of such shares.  No preferred shares were issued oroutstanding as of December 31, 2004.

 

***Common Stock Options.***  In 2004, ourshareholders approved the 2004 Stock Incentive Plan (the “Plan”), whichprovides for the award of incentive stock options to key employees and theaward of non-qualified stock options, stock sales and grants to employees,outside directors, independent contractors and consultants.  As of December 31, 2004, approximately739,000 shares of common stock remained reserved for issuance under thePlan.  It is intended that the Plan willbe used principally to attract and retain key employees.

 

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 such optionis granted.  The option price per shareof a non-qualified stock option may be at a price established by the board ofdirectors or a committee thereof established for purposes of administering theplan, which price generally equals the fair market value of a share of commonstock as of the date such option is granted. Options become exercisable at the times and subject to the conditionsprescribed by the board of directors. Generally, options vest over a period of four years and the term of eachoption may not exceed ten years.  Paymentfor shares purchased pursuant to options may be made, at the option of theboard of directors, in cash or by delivery of shares of common stock having amarket value equal to the exercise price of the options.

 

During 2004, we granted 25,000 shares of restricted stock in accordancewith the Plan, pursuant to an employment agreement with a key employee.  The shares had a fair market value ofapproximately $40,000 on the date of grant and vest quarterly over four yearssubject to the grantee’s continued employment. Compensation expense for the shares issued is recorded over the vestingperiod.

 

39

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A summary of thestatus of our stock option plan as of December 31, and changes during the yearsending on those dates is as follows:

 
| ** **                          | ** ** | **2004**                                     | ** ** | **2003**        | ** ** | **2002**   | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-----------------|------------|------------|------------|
| ** **                          | ** ** | ** **                                   | ** ** | **Weighted-**   | ** ** | ** ** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                          | ** ** | ** **                                   | ** ** | **Average**     | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                          | ** ** | **Shares**                                   | ** ** | **Exer. Price** | ** ** | **Shares** | ** ** | **Exer. Price** | ** ** | **Shares** | ** ** | **Exer. Price** | ** ** |
| ** **                          | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                |       |                                         |       |            |       |       |       |   |   |   |   |   |   |
| Outstanding at  beginning of year   |       | 2,889                                        |       | $               | 12.18      |       | 2,422      |   | $ | 13.81 |   | 2,203 |   | $ | 12.16 |   |
| Granted                             |       | 417                                          |       | 2.47            |       | 506        |       | 4.89 |   | 379 |   | 22.15 |   |
| Exercised                           |       | —                                       |       | —          |       | —     |       | — |   | (91 | ) | 6.52 |   |
| Forfeited                           |       | (278                                         | )          | 13.50           |       | (39        | )          | 18.60 |   | (69 | ) | 16.54 |   |
|                                |       |                                         |       |            |       |       |       |   |   |   |   |   |   |
| Outstanding at  end of year         |       | 3,028                                        |       | $               | 10.72      |       | 2,889      |   | $ | 12.18 |   | 2,422 |   | $ | 13.81 |   |
|                                |       |                                         |       |            |       |       |       |   |   |   |   |   |   |
|                                |       |                                         |       |            |       |       |       |   |   |   |   |   |   |
| Options  exercisable at year-end    |       | 2,535                                        |       |            |       | 2,236      |       |   |   | 1,781 |   |   |   |
| Weighted-average  exercise price    |       |                                         |       |            |       |       |       |   |   |   |   |   |   |
| of options  exercisable at year end |       | $                                            | 11.40      |            |       |       | $          | 11.49 |   |   |   | $ | 10.81 |   |   |   |
|                                     |            |                                              |            |                 |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The followingtable summarizes information about stock options outstanding and exercisableunder the Plan at December 31, 2004:

 
| ** **                    | ** **                   | **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)** | ** **                                              |
| $ 1                      | .48  —   4.06 |                    | 466                                          |                                                    | 9.27       |   | $ | 2.65 |   | 214 |   | $ | 2.69 |   |
| 5                             | .10 —    8.59 |                    | 1,569                                        |                                                    | 3.80       |   | 6.17 |   | 1,405 |   | 6.30 |   |
| 8                             | .83 — 23.00             |                    | 698                                          |                                                    | 5.68       |   | 19.14 |   | 698 |   | 19.14 |   |
| 25                            | .50 — 38.00             |                    | 295                                          |                                                    | 6.99       |   | 27.68 |   | 218 |   | 28.13 |   |
| $ 1                      | .48 — 38.00             |                    | 3,028                                        |                                                    | 5.38       |   | $ | 10.72 |   | 2,535 |   | $ | 11.40 |   |

 

We have a compensatory Employee Stock Purchase Plan (the “ESPP”), thepurpose of which is to attract and retain qualified employees essential to oursuccess, and to provide such persons with an incentive to perform in our bestinterests. The ESPP allows qualified employees to purchase shares of our commonstock on a semi-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, our shareholders approved anamendment to the ESPP which increased the number of shares of common stockinitially authorized for purchase under the ESPP by 250,000 shares, from225,000 to 475,000 shares of common stock. In addition, the amendment provided that the number of authorized sharesautomatically increases on January 1 of each year until and including January1, 2013 by 1% of the number of shares of common stock outstanding on that date;provided, however, that the total number of shares of common stock availablefor issuance under the ESPP shall not exceed 3% of the number of shares ofcommon stock outstanding on that date. As of December 31, 2004, 237,000 shares of common stock were reservedfor issuance under the ESPP.  Under theESPP, during 2004, employees purchased approximately 184,000 shares at anaverage price of $1.40 per share.  During2003, employees purchased approximately 93,000 shares at an average price of$2.52 per share.

 

40

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**6.     OtherIncome and Expense**

 

Included in other income and expense are certain items that do notrelate directly to current ongoing business activity.  Other income in 2004 includes the $2.9million refund of data costs from SBC Communications as discussed in “SignificantEvents” in Note 1. above.  Also includedin this classification for the years ended December 31, 2004, 2003 and 2002, isinterest income of $694,000, $668,000, and $960,000, respectively.  In addition, this classification includedother miscellaneous non-operating income and expenses, none of which wereindividually significant.

 

 

**7.         Income Taxes**

 

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

 
| ** **                   | ** ** | **2004**            | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------|------------|---------------------|------------|----------|------------|----------|------------|
|                         |       | **(In  thousands)** |       |
| Current:                     |       |                |       |     |       |     |       |
| Federal                      |       | $                   | (3,508     | )        | $          | (8,562   | )          | $ | 8,201 |   |
| State                        |       | 119                 |       | 36       |       | 2,639    |       |
|                         |       | (3,389              | )          | (8,526   | )          | 10,840   |       |
| Deferred:                    |       |                |       |     |       |     |       |
| Federal                      |       | —              |       | (5,298   | )          | 5,460    |       |
| State                        |       | —              |       | (665     | )          | (135     | )          |
|                         |       | —              |       | (5,963   | )          | 5,325    |       |
|                         |       |                |       |     |       |     |       |
| Total tax  (benefit) expense |       | $                   | (3,389     | )        | $          | (14,489  | )          | $ | 16,165 |   |

 

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,** | ** ** |
|------------------------------------------------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                       |       |             |       |   |   |   |   |
| Federal  statutory rate                                    |       | 35.0             | %          | 35.0 | % | 35.0 | % |
| State income  taxes, net of federal benefit                |       | 4.5              |       | 0.9 |   | 3.9 |   |
| Federal and  state tax credits                             |       | 0.5              |       | 1.0 |   | (1.5 | ) |
| Impairment loss  on goodwill and related intangible assets |       | —           |       | (3.4 | ) | 0.0 |   |
| Change in  valuation allowance                             |       | (40.1            | )          | (5.3 | ) | 0.0 |   |
| Refund of prior  year taxes                                |       | 4.3              |       | — |   | — |   |
| Other                                                      |       | 0.9              |       | 2.1 |   | 0.8 |   |
|                                                       |       |             |       |   |   |   |   |
| Effective tax  rate                                        |       | 5.1              | %          | 30.3 | % | 38.2 | % |

 

Net deferred tax assetsand liabilities are included in the following balance sheet line items:

 
| ** **                              | ** ** | **December 31,**   | ** ** |
|-----------------------------------------|------------|--------------------|------------|
| ** **                              | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Prepaid costs  and other current assets |       | $                  | —     |   | $ | 2,853 |   |
| Deferred tax  liabilities               |       | —             |       | (2,853 | ) |
|                                    |       |               |       |   |   |
| Net deferred tax  assets (liabilities)  |       | $                  | —     |   | $ | — |   |

 

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The temporary differencesand carryforwards that give rise to deferred tax assets and liabilities are asfollows:

 
| ** **                                 | ** ** | **December 31,**   | ** ** |
|--------------------------------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2004**           | ** ** | **2003** | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| Deferred tax  assets:                      |       |               |       |   |   |
| Net operating  loss carryforwards          |       | $                  | 12,584     |   | $ | 2,651 |   |
| Reserves not  currently deductible         |       | 4,342              |       | 2,860 |   |
| Start-up costs                             |       | 2,600              |       | 3,361 |   |
| Deferred rent                              |       | 467                |       | 265 |   |
| Impairment loss  on long-lived assets      |       | 13,328             |       | — |   |
| Tax credit  carryforwards                  |       | 4,532              |       | 4,265 |   |
| Total deferred  tax asset                  |       | 37,853             |       | 13,402 |   |
| Less: Valuation  allowance                 |       | (29,318            | )          | (2,556 | ) |
|                                       |       |               |       |   |   |
| Net deferred tax  asset                    |       | 8,535              |       | 10,846 |   |
|                                       |       |               |       |   |   |
| Deferred tax  liabilities:                 |       |               |       |   |   |
| Accumulated  depreciation and amortization |       | (8,243             | )          | (10,763 | ) |
| Other                                      |       | (292               | )          | (83 | ) |
| Total deferred  tax liability              |       | (8,535             | )          | (10,846 | ) |
|                                       |       |               |       |   |   |
| Net deferred tax  asset (liability)        |       | $                  | —     |   | $ | — |   |

 

At December 31, 2004, we had approximately $25,882,000 and $55,079,000of federal and state net operating loss carryforwards, respectively.  These net operating loss carryforwards expireduring the years 2007 to 2024.  Ownershipchanges as defined by section 382 of the Internal Revenue Code could limit theamount of net operating loss carryforwards used in any one year or in theaggregate.

 

 

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

 

Basic net (loss) incomeper share is based on the weighted average number of common sharesoutstanding.  Diluted net (loss) incomeper share reflects the potential dilution that could occur if outstandingoptions to purchase common stock were exercised or converted into common stock. There were no adjustments to net incomefor the calculation of both basic and diluted net (loss) income per share forall periods.

 

The calculation of weighted-average outstanding shares is as follows:
| ** **                                                                                           | ** ** | **Average Shares** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                           | ** ** | **2004**           | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                           | ** ** | **(In thousands)** | ** ** |
| Weighted average  common shares outstanding  (used in computing basic net (loss) income per share)   |       | 24,869             |       | 24,706 |   | 24,576 |   |
| Potential common  shares                                                                             |       | —             |       | — |   | 502 |   |
|                                                                                                 |       |               |       |   |   |   |   |
| Weighted average  common shares outstanding  (used in computing diluted net (loss) income per share) |       | 24,869             |       | 24,706 |   | 25,078 |   |

 

Options topurchase approximately 3,028,000, 2,889,000, and 909,000 of common stock wereoutstanding at December 31, 2004, 2003 and 2002, respectively, but were notincluded in the computation of diluted net (loss) income per share becausetheir effect would be anti-dilutive.

 

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**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 employees’ currenttaxable income under the provisions of Internal Revenue Code Section401(k).  Employees become eligible toparticipate in the savings plan six months following the initial date of employment.  Employees must also complete at least 500hours of service in any twelve-month period to be eligible forparticipation.  Under the plan, we canmake discretionary contributions to the plan as approved by the board ofdirectors.  Participants’ interest in ourcontributions to the plan vest over a four-year period.  We made contributions of approximately$180,000, $196,000, and $201,000 during 2004, 2003 and 2002, respectively.

 

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**Supplemental Information**

**Quarterly Financial Data(Unaudited)**

 

 
| ** **                                   | ** ** | **Quarter ended**                           | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **March 31**                                | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                                   | ** ** | **(In thousands except per share amounts)** | ** ** |
| **2004**                                     |       |                                        |       |   |   |   |   |   |   |
| Revenues                                     |       | $                                           | 43,529     |   | $ | 43,539 |   | $ | 27,694 | (1) | $ | 25,607 |   |
| Direct operating  expense                    |       | 25,543                                      |       | 24,174 |   | 17,585 |   | 17,029 |   |
| Selling, general  and administrative expense |       | 25,954                                      |       | 25,030 |   | 21,119 |   | 54,297 | (2) |
| Loss from  operations                        |       | (7,969                                      | )          | (5,665 | ) | (11,010 | ) | (45,719 | ) |
| Net loss                                     |       | (7,849                                      | )          | (5,497 | ) | (7,887 | ) | (41,932 | ) |
| Basic net loss  per share                    |       | (0.32                                       | )          | (0.22 | ) | (0.32 | ) | (1.68 | ) |
| Diluted net loss  per share                  |       | (0.32                                       | )          | (0.22 | ) | (0.32 | ) | (1.68 | ) |
|                                         |       |                                        |       |   |   |   |   |   |   |
| **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 | (3) |
| 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 | ) |

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(1) A refund of $2.9 million originallyrecorded in revenue in our September 30, 2004 statement of operations has beenreclassified to other income (see “Significant Events” in Note 1.)

(2) In the fourth quarter of 2004, we recordedan impairment charge of $32.2 million to write down certain long-lived assets.

(3) In the fourth quarter of 2003, werecorded an impairment charge of $4.7 million to write off goodwill and certainrelated intangibles.

 

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