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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K  þ ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
 FOR THE YEAR ENDED DECEMBER 31, 2004
 OR oTRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE 
ACT OF 1934 
FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER: 000-28467 TRINSIC, INC.  DELAWARE
    
    59-3501119(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)
 601 South Harbour Island Boulevard, Suite 220
Tampa, Florida 33602
(813) 273-6261
(Address, including zip code, and
telephone number including area code, of
Registrants principal executive offices) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON
STOCK, PAR VALUE $.01 PER SHARE, PREFERRED STOCK PURCHASE RIGHTS Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes  
þ  No  o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12B-2 of the Exchange Act) Yes  
o  No  þ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K o. The aggregate market value of the Registrants Common Stock held by non-affiliates of the
Registrant on June 30, 2004 (assuming solely for these purposes that only directors, executive
officers and beneficial owners of greater than 10% of the Registrants Common Stock are
affiliates), based on the closing price of the Common Stock on the Nasdaq SmallCap Market as of
such date, was approximately $38,083,872. The number of shares of the Registrants Common Stock outstanding as of April 13, 2005 was
approximately 55,313,302. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants proxy statement relating to its 2005 Annual Meeting of Stockholders,
to be filed subsequently, are incorporated by reference into Part III of this Report.




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TABLE OF CONTENTS PART I.Item 1.
    
    BusinessItem 2.
    
    PropertiesItem 3.
    
    Legal ProceedingsItem 4.
    
    Submission of Matters to a Vote of Security HoldersPART II.Item 5.
    
    Market for the Registrants Common Equity and Related Stockholder MattersItem 6.
    
    Selected Consolidated Financial DataItem 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7A.
    
    Quantitative and Qualitative Disclosures about Market RiskItem 8.
    
    Financial Statements and Supplementary DataItem 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A.
    
    Controls and ProceduresPART III.Item 10.
    
    Directors and Executive Officers of the RegistrantItem 11.
    
    Executive CompensationItem 12.
    
    Security Ownership of Certain Beneficial Owners and ManagementItem 13.
    
    Certain Relationships and Related TransactionsItem 14.
    
    Principal Accountant Fees and ServicesPART IV.Item 15.
    
    Exhibits and Financial Statement SchedulesSignaturesEx-3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATIONEX-4.1 FORM OF COMMON STOCK CERTIFICATEEX-10.2.2 2000 EQUITY PARTICIPATION PLAN, AS AMENDEDEX-21 LIST OF SUBSIDIARIESEX-23 PRICEWATERHOUSE CONSENTEX-31.1 SECTION 302 CEO CERTIFICATIONEX-31.2 SECTION 302 CFO CERTIFICATIONEX-32.1 SECTION 906 CEO CERTIFICATIONEX-32.2 SECTION 906 CFO CERTIFICATION
  
 ITEM 1. BUSINESS GENERAL Trinsic, Inc. (formerly Z-Tel Technologies, Inc.) and subsidiaries (Trinsic, we or us) is a
provider of residential and business telecommunications services. We offer local and long distance
telephone services in combination with enhanced communications features accessible through the
telephone, the Internet and certain personal digital assistants. We recently began offering
services utilizing Internet protocol, often referred to as IP telephony, voice over Internet
protocol or VoIP. We provide services at both the retail and wholesale level. At the retail level, we provide our traditional circuit-switched local services in forty-nine
states, although our customers are primarily concentrated in six states. Our business VOIP
offerings will be limited to the New York City metropolitan area and Tampa. Our facilities based
residential services will be available in New York City. Excluding VoIP lines, we serve
approximately 189,000 retail residential lines, 47,000 retail business lines, and 40,000 retail
stand-alone long distance lines. We gained nearly all of the long distance customers with our
acquisition of Touch 1 Communications, Inc. in April 2000. We serve approximately 1,600 VoIP
lines. We introduced our wholesales services during the first quarter of 2002. This service provides
other companies with the opportunity to offer local, long-distance and enhanced telephone service
to their own residential and business customers on a private label basis by utilizing our telephone
exchange services, enhanced services platform, infrastructure and back-office operations. Sprint
Communications Company (Sprint) has been our principal wholesale customer since February 2003.
Previously, we had an agreement for wholesale services with MCIWORLDCOM (MCI), but that agreement
was terminated in October 2003. At the wholesale level, we serve approximately 300,000 billable
lines. Historically we have utilized the unbundled network elements platform (UNE-P) as the primary
basis of delivering our services to our retail customers and to the end users of our wholesale
customers. Under UNE-P, we utilize various unbundled elements of the traditional local telephone
companies (incumbent local exchange carriers or ILECs) to facilitate the delivery of our
services to end users. Our access to ILEC networks has historically been based upon the
Telecommunications Act of 1996 (the Telecommunications Act) which imposed a variety of duties
upon the ILECs, including the duty to provide competitive local exchange carriers (CLECs), like
us, with access to the individual components of their networks. Recent court decisions and rulings
by the Federal Communications Commission (FCC), however, have sharply limited our rights to
access the ILEC networks. FCC rules effective on March 11, 2005 eliminated mandatory national
access to UNE-P for new customers and require us to transition our customers to alternative
arrangements within one year unless we enter into commercial service agreements with 2




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ILECs that provide otherwise. See sections of this report entitled Government Regulation and
Risks Relating to Our Financial Condition and Our Business. Our launch of VoIP services is
designed to mitigate our reliance on access to certain ILEC network components. In the normal course of business we have entered into interconnection agreements with ILECs that
set forth the terms by which we gain access to their networks. These agreements are now subject to
revision consistent with the FCCs recent UNE-P ruling. We have entered into an arrangement with
Qwest that will allow us to continue utilizing UNE-P in its territories. We have also entered into
an interim commercial services agreement with Verizon through May 31, 2005. We are discussing
revised interconnection agreements and alternative commercial agreements with other ILECs as well.
There can be no assurance that we will be successful in negotiating new interconnection agreements
upon favorable terms. We have invested heavily in our enhanced communications platform and our operational support
systems. Our enhanced communications platform enables us to offer distinctive Web integrated and
voice activated features. Our advanced operational support systems are functionally integrated to
support the entire customer life cycle including price quotation, order entry and processing, ILEC
interaction, customer care, billing and subscriber management. We believe our operational systems
are scalable, both vertically and horizontally, and give us reliable, flexible, low-cost
operational capabilities. We changed our name from Z-Tel Technologies, Inc. to Trinsic, Inc. on January 3, 2005. SEGMENT FINANCIAL INFORMATION For internal reporting purposes, we evaluate our business performance in terms of two segments:
retail services and wholesale services. Financial information relating to both segments (including
information relating to the revenue contributed by our services) is set forth in Item 7,
Managements Discussion and Analysis of Financial Condition and Results of Operations and
footnote 23 Segment Reporting in the Notes to the Consolidated Financial Statements. INDUSTRY BACKGROUND The Telecommunications Act of 1996 (the Telecommunications Act) was enacted principally to foster
competition in the local telecommunications markets. The Telecommunications Act imposed a variety
of duties upon the ILECs, including the duty to provide other communications companies, like us,
with access to the individual components of their networks, called network elements, on an
unbundled basis at any feasible point and at rates and on terms and conditions that were just,
reasonable and nondiscriminatory. A network element is a facility or piece of equipment of the
ILECs network or the features, functions or capabilities such facility or equipment provides. In
1996, the FCC, pursuant to the Telecommunications Act, mandated that incumbent local exchange
carriers provide access to a set of unbundled network elements including, among other elements,
local loops (i.e. the wires that reach from the ILEC central office to the end users premises),
switching, transport and signaling. This combined set of elements is referred to as the unbundled
network element platform or UNE-P. Moreover, the FCC mandated that ILECs must provide the
unbundled network element platform at rates based on a forward-looking, total long-run incremental
cost methodology. Recent court decisions and FCC rulings have substantially reversed these earlier
FCC mandates. (See sections entitled Government Regulation and Risks Relating to Our Financial
Condition and Our Business. ) The Telecommunications Act also established procedures by which the regional Bell operating
companies (Bell operating companies) were allowed to handle in-region long distance calls, that
is, calls that originated from within their telephone service areas and terminated outside their
service areas. The 1984 court order that divided AT&T prohibited Bell operating companies from
providing in-region long distance telephone service. Under the Telecommunications Act, Bell
operating companies could provide such in-region service if they demonstrated to the FCC and state
regulatory agencies that they complied with a 14-point regulatory checklist, including offering
interconnection to other communications companies, like us, and providing those companies access to
their unbundled network elements on terms approved by a state public service commission. Bell
operating companies received authority to provide in-region long distance services in all 47
applicable states. However, the Section 271 checklist is a continuing obligation pursuant to
section 271(d)(6) of the Telecommunications Act. (See section of this report entitled Government
Regulation.) RETAIL SERVICES Within the retail segment, our principal services are traditional, circuit-switched local and
long-distance telephone services for residences and businesses. We also recently launched
VoIP-based services for residences and businesses. Circuit-Switched Residential Services Our local residential circuit-switched telephone service is typically bundled with long distance
and a suite of our proprietary Internet-accessible and voice-activated functions called Trinsic
Center. The enhanced features include voicemail, Find Me Notify Me, caller identification,
call forwarding, three-way calling, call waiting, speed dialing and Personal Voice Assistant
(PVA), which utilizes voice-recognition technology so that users can access secure, online
address books from any phone using 3




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simple voice commands in order to send voice e-mails, find contact information and dial numbers,
among other things. We offer various plans, including unlimited plans that include unlimited,
nationwide, direct-dialed long distance calling toll-free and lower priced plans that include a
limited number of long distance minutes at no additional charge. Bell operating company customers
switching to our local services keep their existing phone numbers. We currently provide residential
services in every state except Alaska, in areas served by a Bell operating company or Sprint and
areas formerly served by GTE. Our residential service includes unique features, all of which can be accessed and manipulated by
telephone or Internet. Our proprietary voicemail enables subscribers to retrieve and listen to
their voice-mail messages via telephone or the Internet. Our voicemail system also enables users to
forward voicemails via e-mail, as attachments. Our Find-Me feature forwards an incoming call to
as many as three additional numbers. Our Notify Me feature notifies the subscriber via e-mail,
pager or ICQ Internet Chat (instant messaging) when a new voice mail message arrives. Both Find
Me and Notify Me are accessible via the Internet so that users may easily enable, disable or
otherwise alter the functions. PVA allows users to store contacts in a virtual address book and
then access and utilize that information through voice commands from any telephone. Users say
call and the contacts name, call John Doe for example, and PVA connects the call. PVA users
can also send voice e-mails. Users record a message via telephone and instruct PVA to deliver the
message to a contact. PVA then attaches the voice message to an e-mail and sends the e-mail to the
contact. We market and sell residential services primarily through direct mail, telemarketers, joint
marketing efforts with entities that have access to large numbers of consumers, independent sales
contractors (including multi-level marketing companies) and referral programs. . Circuit-Switched Business Services Our local business circuit-switched business telephone service is targeted to small and medium
sized businesses (typically having four or fewer lines) and businesses having multiple units. The
service is local telephone service bundled with long distance (1+) telephone service, calling card
services and enhanced features, including our proprietary features. Because we provide service in
nearly every state, our business services are particularly valuable to firms having multiple
locations in various states. With us, they deal with only one telephone company. We began offering
business services in 2002. We provide service in every state but Alaska, in areas served by a Bell
operating company or formerly served by GTE. Current customers include Darden Restaurants,
Compass, Foot Locker, Metromedia Restaurant Group and Rand McNally Stores. We market and sell our circuit-switched business telephone services primarily through our own
in-house sales personnel and independent sale contractors. Long Distance We offer long distance services on a stand-alone basis to residences and business. Our stand-alone
long-distance is a usage-based service that allows customers to use us as their primary long
distance calling provider to complete their direct-dialed long distance (1+) calls. We do not
actively market the long distance services. We gained nearly all of the long distance customers
with our acquisition of Touch 1 Communications, Inc. in April 2000. VoIP Services We offer VoIP telephone services in areas within reach of our own IP telephony network. Our VoIP
network utilizes Cisco technology and services and is integrated with our enhanced communications
services platform so that in addition to increased bandwidth and service flexibility, our customers
enjoy features such as PVA, our voice-activated virtual address book. The services are offered to
both residences and businesses. Our facilities based residential services will be available in New
York City and our business VOIP offerings will be limited to the New York City metropolitan area
and Tampa. We plan to expand out IP telephony network to additional cities as resources permit. We market and sell our residential VoIP services primarily through direct mail and independent
sales contractors. We market and sell our business VoIP services primarily through our own
in-house sales personnel. Billing and Collection We have three primary methods for billing and collecting from our retail customers. For our
residential customers, we can (1) direct bill by mail and receive payment through a check or money
order by mail; (2) charge a credit card account or (3) set up an automatic withdrawal from a
checking account. Currently, we bill the majority of our retail customers by mail and receive
payment through checks delivered by mail. 4




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WHOLESALE SERVICES Within the wholesale segment, we offer a comprehensive package of communications and advanced
support services to other communications companies for their use in providing services to their own retail customers. Among
the wholesale services we offer are local exchange telephone services, long distance telephone
services, our proprietary enhanced features, enhanced features we acquire from incumbent local
exchange carriers, ordering, provisioning (i.e. the process by which a telephone company is
established as the end users primary telephone company), inbound sales, fulfillment, billing,
collections and customer care. Our enhanced communications platform has the capability to integrate
with most communications transport networks, including wireless, cable, and Internet networks. On February 4, 2003, we signed a non-exclusive, wholesale services agreement with the Sprint
Communications Company L.P. (Sprint). The agreement gives Sprint access to our telephone exchange
services and our Web-integrated, enhanced communications platform and operational support systems
in connection with Sprints local residential telephone service. Sprint is our sole wholesale
services customer. OPERATIONS SUPPORT SYSTEMS We have invested heavily in our operations systems and support platform. The platform integrates
ordering, provisioning, customer care and billing functionality throughout the customer lifecycle
and consequently gives us (and our wholesale customers) reliable, flexible, low-cost operational
capabilities. We believe our operational systems are scalable, both vertically and horizontally.
They have the capability to integrate with wireline, wireless, cable, Internet and other
communications transport networks. Our principal method of delivering services to our customers requires access to ILEC networks. To
facilitate interaction with the ILECs, we have established, with outside integration and consulting
assistance, electronic gateways, software and a standard internal provisioning interface. Our
systems can interact with the ordering systems of multiple incumbent local exchange carriers. They
reduce the number of steps required to provision a customer and consequently reduce costs and
increase accuracy. Provisioning is the process by which we (or our wholesale customers) are
established as the customers primary local exchange and long distance telephone service provider.
Our systems also support mediation, network administration and revenue assurance. BUSINESS STRATEGY Our basic business strategy is to -  
    Re-focus our marketing resources on the Northeastern United States where we have a dense
existing consumer customer base and an IP telephony network successfully deployed;
    Continue to build out our IP telephony network in the Northeast to compliment our
existing network and customer density there as resources permit;
    Continue to migrate customers to our own network as resources and the terms of our agreements allow; and
    Continue to add multi-line business customers directly to our IP telephony network. GOVERNMENT REGULATION Overview and Current Regulatory Developments The Telecommunications Act of 1996 (the Telecommunications Act), signed into law on February 8,
1996, comprehensively amended the Communications Act of 1934 (the Communications Act) and
effected changes in regulation at both the federal and state levels that impact nearly every
segment of the telecommunications industry. The stated purpose of the Telecommunications Act is to
promote competition in all areas of telecommunications. Some of our services are regulated and some are not. In providing our non-common carrier
services such as Personal Voice Assistant, voice mail, Find-Me notification and directory
services, we operate as an unregulated provider of information services, as that term is defined
in the Communications Act, and as an enhanced service provider, as that term is defined in the
rules of the Federal Communications Commission (FCC). These operations currently are not
regulated by the FCC or the states in which we operate. In providing residential and business
telecommunications services, we are regulated as a common carrier at the state and federal level
and are subject to additional rules and policies not applicable to providers of information
services alone. Certain aspects of our voice over Internet protocol (VoIP) services (also called
IP telephony services) may or may not be subject to common carrier regulation. The regulatory
classification of these services is currently subject to a number of regulatory proceedings before
state regulatory commissions, the FCC, and the courts. However, unlike many of our VoIP
competitors, we are certified as a facilities-based competitive local exchange carrier in
forty-nine states and the District of Columbia. We believe our 5




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certification as a common carrier gives us the flexibility to operate and offer our advanced IP
telephony services regardless of the final regulatory classification of those services. The local and long distance telecommunications services we provide are regulated by federal, state,
and, to some extent, local government authorities. The FCC has jurisdiction over all
telecommunications common carriers to the extent they provide interstate or international
communications services. Each state regulatory commission has jurisdiction over the same carriers
with respect to intrastate communications services. (As discussed below, the FCC has ruled that
VoIP services in certain instances are inherently interstate and therefore subject to federal
regulation, and not state level regulation.) The extent of federal or state regulation of
information services depends upon the nature of the service offered. Local governments sometimes
seek to impose franchise requirements and fees on telecommunications carriers and regulate
construction activities involving public rights-of-way. Changes to the regulations imposed by any
of these regulatory authorities could have a material adverse effect on our business, operating
results and financial condition. In recent years, the regulation of the telecommunications industry has been in a state of flux as
the United States Congress and various state legislatures have passed laws seeking to foster
greater competition in telecommunications markets. The FCC and state utility commissions have
adopted many new rules to implement this legislation and encourage competition. These changes,
which are still incomplete, have created new opportunities and challenges for us and our
competitors. The following summary of regulatory developments and legislation is intended to
describe the most important, but not all, present and proposed federal, state and local regulations
and legislation affecting the telecommunications industry. Some of these and other existing federal
and state regulations are the subject of judicial proceedings and legislative and administrative
proposals that could change, in varying degrees, the manner in which this industry operates. We
cannot predict the outcome of any of these proceedings or their impact on the telecommunications
industry at this time. Some of these future legislative, regulatory or judicial changes may have a
material adverse impact on our business. FEDERAL REGULATION FCC Policy on Unbundled Access to Network Elements of Incumbent Local Exchange Carriers While Trinsics regulatory environment continues to be dynamic and complex, there is one overriding
issue that drives our business: our ability to interconnect with, access and use the local
networks of incumbent local telephone exchange carriers (like Verizon, SBC, BellSouth and Qwest) to
provide our services. The incumbent local exchange carrier or ILEC is the old established
wireline telephone company. Non-incumbent telephone companies like us are referred to as
competitive local exchange carriers or CLECs. All of our telecommunications services, residential
and business, analog and VoIP, utilize, to some extent, an ILEC network.  §
    Our residential and business local telephone services throughout the United States
predominantly utilize the unbundled network element platform (or UNE-P) which is a
combination of functions and components of an ILEC network, including analog loops,
switching and transport. As discussed below, FCC rules effective on March 11, 2005
restricted our access to UNE-P for new customers and are requiring us to transition our
customers to alternative commercial arrangements, different networks or resale.§
    As an alternative to utilizing UNE-P, in New York City and in Tampa, Florida, we have
begun to provide VoIP residential and business telephone services through a network
architecture called UNE loop, or UNE-L. The UNE-L entry strategy requires us to
establish collocation arrangements with the ILEC and have unbundled access to analog
loops, and transport.§
    We provide VoIP telephony services to businesses in the New York City metropolitan
area and Tampa utilizing a next-generation IP network. This network requires us to
purchase or lease high-capacity digital connections from the customers premises to our
next-generation IP facilities. In many instances, the only cost-effective means of
obtaining that high-capacity digital connection is from the ILEC. Typically, we provide
service by means of a combination of unbundled high-capacity loops and transport, which
is called an Enhanced Extended Link, or EEL. In some situations, we obtain
transport from another, non-incumbent provider but are dependent upon the ILEC for the
final, last-mile connection to the customer premises. In those situations, we
purchase an unbundled high-capacity loop from the ILEC. In the absence of access to
unbundled access to high-capacity loops and transport, our only option would be to
purchase these connections as retail, special access circuits that are available from
ILECs and other providers. The prices of these retail (and largely-deregulated) special
access circuits are, in many instances, substantially higher than the wholesale (and
regulated) prices for unbundled network elements. Recent court decisions and FCC rulings have sharply limited our ability to utilize the networks of
incumbent local telephone companies to provide our services, requiring us to adjust our business
plan accordingly. 6




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On December 15, 2004, the FCC limited the availability of unbundled network elements pursuant to
section 251 of the Telecommunications Act of 1996 that Trinsic utilized to provide services to our
customers in the Triennial Review Remand Order, Review of Section 251 Unbundling Obligations of
Incumbent Local Exchange Carriers,WC Docket No. 04-313, CC Docket No. 01-338, FCC 04-290 (rel.
Feb. 4, 2005). The FCC ruled that ILECs are no longer required to provide Trinsic and other
entrants access to unbundled analog switching  a key component of the unbundled network element
platform combination of elements, which is how we provide services to the vast majority of our
customers. This FCC Triennial Review Remand Orderalso limited our ability to access unbundled
high-capacity loops and dedicated transport in many urban and suburban locations. The FCC Triennial Review Remand Orderbecame effective March 11, 2005. After that date, we are
unable to place orders for new customers and lines that utilized unbundled switching and
high-capacity loops and transport that no longer qualified for unbundling under the new rules. For
Trinsics embedded base of customers, the FCC imposed price increase of $1 per month for each line
that utilized unbundled switching and a price increase of 15% for each high-capacity loop or
transport arrangement that no longer qualified for unbundling under the new rules. The FCC
Triennial Review Remand Orderalso established a one-year transition period for this embedded base
of customers  at the end of that transition period, currently set as March 15, 2006, the prices
for access to unbundled switching and those loop and transport arrangements will no longer be
federally regulated. In the normal course of our business, we enter into contractual arrangements with ILECs for access
to their networks. We are currently in negotiations to establish new contractual arrangements with
ILECs for both our embedded base and future customers. We have already executed one such
commercial arrangement with Qwest, which covers Qwest territories in Washington, Oregon, Arizona,
Colorado, New Mexico, Idaho, Montana, North Dakota, South Dakota, Iowa, and Nebraska. We are
currently in discussions with Verizon, SBC and BellSouth over changes to interconnection agreements
that may be required by the FCC Triennial Review Remand Order. CLECs, states, and ILECs have filed appeals of the Triennial Review Remand Order. ILECs have filed
an appeal before the D.C. Circuit Court, United States Telecom Assn et al. v. FCC,No. 05-1058,
and have asked that the D.C. Circuit stay a portion of the Triennial Review Remand Orderthat
permits competitors to convert essentially deregulated special access circuits to regulated,
unbundled high-cap loop and transport circuits in certain circumstances. CLECs and states filed
appeals before several circuit courts and those appeals were consolidated before the Third Circuit
Court of Appeals in Philadelphia. The third circuit court of appeals has subsequently transferred
these appeals to DC circuit court. Briefs in that appeal have not been filed and we cannot
anticipate whether the outcome of those appeals will improve or decrease our options in providing
service to our customers. The FCCs Triennial Review Remand Orderis the result of years of litigation over the terms and
conditions on which Trinsic and other competitors may provide service utilizing the networks of
incumbent local exchange carriers. In 2003, the FCC ruled that entrants like Trinsic would be able
to purchase analog switching, dedicated transport and high-capacity loops on an unbundled basis,
subject to state-by-state review of whether such unbundling was needed in their states. Carriers
were involved in those state-by-state proceedings when, on March 2, 2004, the D.C. Circuit Court of
Appeals overturned the FCCs decision as an improper delegation of authority to state public
utility commissions. SeeReport and Order and Order on Remand and Further Notice of Proposed
Rulemaking, Review of Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers, 18
FCC Rcd 16978 (2003) (Triennial Review Order), revd in part and remanded, United States Telecom
Assn v. FCC, Nos. 00-1012, 00-1015, 03-1310 et al.(D.C. Cir. March 2, 2004) (USTA II). The
D.C. Circuit ordered that the unbundled switching and transport rules be vacated after sixty days
or upon denial of a petition for rehearing, whichever was later. In June 2004, the FCC and the
U.S. Department of Justice declined to appeal this decision to the United States Supreme Court, and
the Petition for Writ of Certiorari filed by Trinsic (then Z-Tel) and other companies before the
United States Supreme Court was denied. The FCC issued interim rules and immediately began work on
formulating the final unbundled network access rules that appear in the Triennial Review Remand
Order. Court consideration of the unbundled access rules followed a parallel track. The FCC first
established network element unbundling rules in its August 1996 Local Competition Orderin CC
Docket No. 96-98. Those rules were appealed to the Eighth Circuit Court of Appeals and later to
the U.S. Supreme Court. In its January 25, 1999 AT&T v. Iowa Utilities Boardruling, the Supreme
Court remanded the network unbundling rules to the FCC for further consideration of the necessity
of each one under the Telecommunications Acts statutory standard for unbundling. On November 5,
1999, the FCC released an order (referred to as the UNE Remand Order)that retained many of its
original list of unbundled network elements, but providing further explanation of the need for such
unbundling and eliminated the requirement that incumbent local exchange carriers provide unbundled
access to operator services and directory assistance and limiting unbundled access to local
switching in certain geographic areas. With regard to operator services and directory assistance,
the FCC concluded that the market has developed since 1996 such that competitors can and do
self-provision these services, or acquire them from alternative sources. The FCC also noted that
incumbent local exchange carriers remain obligated under the non-discrimination requirements of the
Communications Act of 1934 to comply with the reasonable request of a carrier that purchases these
services from the incumbent local exchange carriers to rebrand or unbrand those services, and to
provide directory assistance listings and updates in daily electronic batch files. With regard to
unbundled local switching, the FCC concluded that, notwithstanding the incumbent local exchange
carriers general duty to provide unbundled local circuit switching, an incumbent local exchange
carrier is not required to unbundle local circuit switching for competitors for end-users with four
or more voice grade (DSO) equivalents or lines, provided that the incumbent local 7




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exchange carrier provides nondiscriminatory access to combinations of unbundled loops and transport
(also known as the Enhanced Extended Link or EEL) throughout Density Zone 1, and the incumbent
local exchange carriers local circuit switches are located in (i) the top 50 Metropolitan
Statistical Areas as set forth in Appendix B of the Third Report and Order and Fourth Further
Notice of Proposed Rulemaking in CC Docket No. 96-98, and (ii) in Density Zone 1, as defined in the
FCCs rules. For operator services and directory assistance, as well as for unbundled local
switching, the FCC noted that the competitive checklist contained in Section 271 of the
Communications Act of 1934 requires Bell operating companies to provide nondiscriminatory access to
these services. Thus, Bell operating companies must continue to provide these services to
competitors; however, Bell operating companies may charge different rates for these offerings. The FCCs 1999 UNE Remand Orderwas appealed by several parties to the United States Court of
Appeals for the D.C. Circuit, including incumbent local exchange carriers, USTA v. FCC. In
addition, competitive carriers sought reconsideration of that decision, including the FCCs
limitation on the availability of unbundled local switching, before the FCC. While that appeal was
pending, the FCC, on December 20, 2001, released a Notice of Proposed Rulemaking in CC Dockets No.
01-338, 96-98 and 98-147 as part of its comprehensive Triennial Review of the 1999 UNE Remand
Order. While the Triennial Reviewproceeding was pending before the FCC, the D.C. Circuit ruled in the
USTAappeal of the 1999 UNE Remand Order.The D.C. Circuit reversed the UNE Remand Orderon the
courts belief that the FCC had not taken into sufficient account the availability of substitutes
for unbundled network elements from outside incumbent local telephone networks. The court called
upon the FCC to engage in a detailed granular review as to whether any particular network element
should be unbundled, based upon a specific analysis as to whether competitors could obtain
comparable elements from other sources or whether a network element possessed natural monopoly
characteristics. In addition, the D.C. Circuit required that the FCC balance the benefits of
unbundling for competitors and consumers against the costs that unbundling might impose upon
incumbent local telephone companies. Competitors filed for review of the USTAdecision before the
United States Supreme Court, but the Supreme Court denied the competitors request for an appeal. In August 2003, the FCC released its final decision in the Triennial Reviewproceeding. In the
Triennial Review Order,the FCC also ruled that entrants would no longer be able to access network
elements utilized by incumbent local telephone companies to provide broadband services, such as
fiber-to-the-premises loops, high-capacity transport, packet switching, line-sharing for DSL
services, and fiber-fed next-generation digital loop carrier loops. In subsequent decisions, the
FCC has even more sharply limited the ability of companies like Trinsic to obtain unbundled access
to ILEC fiber optic lines. On August 9, 2004, in a reconsideration order in CC Docket No. 01-338,
the FCC ruled that ILECs need not be required to unbundled fiber to multiple dwelling units, even
if fiber only reaches the minimum point of entry of the building. On October 18, 2004, in a second
reconsider order in CC Docket No. 01-338, the FCC ruled that fiber-to-the-curb loops will also be
exempt from unbundling requirements just as fiber-to-the-premises loops were exempted in the August
2003 order. The FCC also clarified that ILECs were not required to add time-division
multiplexing capabilities to any new packetized transmission facilities constructed in order to
facilitate interconnection by competitors. These restrictions on access to ILEC fiber networks and next-generation architecture could have a
significant impact on our ability to provide services to our customers. In particular, even in
situations in which Trinsic would otherwise be entitled to unbundled access to a loop, transport
circuit or EEL, these exclusions could permit ILECs to refuse to offer these connections to us, on
the basis that loop, transport or EELs qualifies as fiber-to-the-premises, or
fiber-to-the-curb, or involves access to packet switching. As a result, these exclusions from
unbundling could limit our ability to provide service to customers cost-effectively and could have
a significant and material impact upon our business. The regulatory uncertainty and the absence of effective network access rules have required us to
adjust our business plan in a number of ways, as discussed elsewhere in this report. For example,
we are attempting to migrate portions of our UNE-P customer base in New York City to our own
network, which uses an architecture called UNE-L. In other markets, we have rolled-out of our
next-generation VoIP network, which depends in part on unbundled access to high-capacity loops. As
a result, these regulatory developments have had an immediate, significant, adverse and material
impact upon our business. We are in discussions with ILECs to establish commercial terms and
arrangements for access to their local networks, but we have only been successful in doing so with
Qwest. There is no assurance that we will be able to reach similar commercial arrangements with
Verizon, SBC, BellSouth or other ILECs. Moreover, even if we enter into such commercial
arrangements, the terms of those arrangements might require us to adjust our business plan and
service offerings significantly. We may be required by these regulatory developments to limit
access to our service, withdraw from certain markets, alter our negotiation strategy and
potentially arbitrate these agreements. Arbitration would likely take some time and could result
in uncertainty as to our legal rights in the interim. It is also possible that during the pendancy
of these negotiations, one or more incumbent local telephone company suppliers may refuse to abide
by the terms of the existing agreements or act terminate those agreements outright. Trinsic is
currently evaluating all of its legal options to ensure that we can continue to meet the needs of
our existing and future customers. 8




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Pricing of Unbundled Network Elements Even in situations where we retain the right to unbundled access under the new FCC rules (for
example, analog loops and high-capacity loops and transport in many instances), the regulated
pricing of those network elements is subject to change. The FCC issued its first interconnection order on August 8, 1996 and in that Local Competition
Order,the FCC established the pricing methodology for unbundled network elements. That
methodology was Total Element Long-Run Incremental Cost, or TELRIC. Incumbent local telephone
companies and state commissions appealed the FCCs 1996 Local Competition Orderto the United
States Court of Appeals for the Eighth Circuit. On July 18, 1997, the Eighth Circuit issued a
decision vacating the FCCs pricing rules, as well as certain other portions of the FCCs
interconnection rules, on the grounds that the FCC had improperly intruded into matters reserved
for state jurisdiction. On January 25, 1999, the Supreme Court, in AT&T Corp. v. Iowa Utilities
Board, largely reversed the Eighth Circuits holding that the FCC has general jurisdiction to
implement the local competition provisions of the Telecommunications Act. In so doing, the Supreme
Court stated that the FCC has authority to set pricing guidelines for unbundled network elements,
to prevent incumbent local exchange carriers from physically separating existing combinations of
network elements, and to establish pick and choose rules regarding interconnection agreements. The Supreme Court in 1999 did not evaluate the specific forward-looking pricing methodology
mandated by the FCC and remanded the case to the Eighth Circuit for further consideration. Some
incumbent local exchange carriers argued that this pricing methodology does not allow adequate
compensation for the provision of unbundled network elements. The Eighth Circuit subsequently
upheld the FCCs TELRIC rules, which use forward-looking incremental costs as the basis for
establishing rates for interconnection and unbundled network elements. The Eighth Circuit further
agreed with the FCCs interpretation of the Telecommunications Act as rejecting historical costs
as the basis for setting rates. However, the Eighth Circuit vacated the FCCs regulation, codified
at 47 C.F.R. Sec. 51.505(b), setting forth the FCCs approach to computing forward-looking
incremental costs, and directed the FCC to review its approach so that it is based on the costs
incurred by the incumbent local exchange carrier to provide the actual facilities and equipment
that will be used by the requesting carrier instead of the lowest cost based on the most efficient
technologies currently available. In 2001, the United States Supreme Court granted a writ of
certiorari to the Eighth Circuit decision, and in 2002, in Verizon v. FCC,the Supreme Court upheld
the FCCs TELRIC pricing rules. Although the FCCs TELRIC rules have been supported by the courts, the establishment of rates
occurs on a state-by-state basis and is subject to change. Some states are currently re-evaluating
the pricing of these unbundled network elements. As a result, it is possible that prices in some
states could increase or lower rates over existing levels. Our intent is to be an active
participant in many of these rate cases and any others that might be critical to our operations. We
anticipate joining other competitive service providers in arguing that existing rates and rates
proposed by the incumbents are overstated and do not reflect the true total element long run
incremental costing principles required by the FCC and the Telecommunications Act. Despite the fact that the TELRIC rules have been supported by the courts, the FCC is currently
reevaluating several of these rules, by means of a rulemaking notice issued in September 2003 in WC
Docket No. 03-173. The FCC rulemaking proposes to modify the TELRIC methodology by mandating that
states set prices based upon the forward-looking costs of operating the existing network
architecture of incumbent local telephone company networks. In many instances, modifying the
TELRIC methodology in this way could increase the rates we pay for certain elements; for other
elements, such a modification could result in lower rates. We believe that the FCCs proposals to
modify TELRIC are inconsistent with the Supreme Courts decision in the Verizoncase, meaning that
new FCC TELRIC rules may be subject to considerable litigation if they are adopted. The FCC
rulemaking is still pending, and changes to the FCCs TELRIC rules could significantly alter the
prices we pay for unbundled access to ILEC network elements. While the prevailing productivity
trends within the industry would predict the adoption of lower rates in association with the
provision of unbundled network elements and network element combinations, we cannot predict the
outcome of any pending or potential rate case or judicial proceeding. Increases or decreases in
rate levels charged by incumbent local exchange carriers as a result of regulatory and/or judicial
review through rate case, court case or arbitration proceedings could significantly impact our
business plans. The Rights and Obligations Common Carriers Under Federal Law We are certified as a local exchange common carrier in forty-nine states and the District of
Columbia. The Communications Act, as amended by the Telecommunications Act, imposes a number of
regulatory requirements on common carriers generally and local exchange carriers specifically.
There is currently significant regulatory uncertainty as to whether certain new enhanced services
such as VoIP-based telephone services must be subject to common carrier regulation. We believe
that having our common carrier licenses gives us the flexibility to provide our customers a broad
array of services and does not make our service offerings dependent upon any one particular
regulatory classification. In addition, our status as a common carrier gives us rights under section 251 of the
Telecommunications Act to interconnect with, obtain access to, and collocate on the premises of
incumbent local exchange carriers like Verizon, SBC, BellSouth, and Qwest. Section 251 of the Act
requires ILECs to   
    provide physical collocation to other common carriers, which allows companies such as us and other
competitive local 9




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exchange carriers to install and maintain our own network termination equipment in
incumbent local exchange carrier central offices or, if requested or if physical collocation is
demonstrated to be technically infeasible, virtual collocation;
    offer components of their local service networks on an unbundled basis to other common carriers so that
other providers of local service can use these elements in their networks to provide a wide range of
local services to customers (SeeFCC Policy on Unbundled Access, above); and
    establish wholesale rates for their services to promote resale by competitive local exchange carriers. Companies that are not common carriers do not have the section 251 rights described above. In
addition, all local exchange carriers must   
    interconnect with the facilities of other common carriers;
    establish number portability, which will allow customers to retain their existing phone
numbers if they switch from the local exchange carrier to a competitive local service
provider;
    provide nondiscriminatory access to telephone poles, ducts, conduits and rights-of-way; and
    compensate other local exchange carriers on a reciprocal basis for traffic originated by
one local exchange carrier and terminated by another local exchange carrier. The FCC is charged with establishing national guidelines to implement certain portions of the
Telecommunications Act. FCC implementation of those provisions of the Telecommunications Act has
been the subject of ongoing litigation that continues to this day. The most contentious litigation
has centered around FCC and state rules regarding the rates, terms and conditions of unbundled
network access, and the current status of those rules is discussed above (FCC Policy on Unbundled
Access and Pricing of Unbundled Network Elements) The rights and obligations of common carriers under federal law impact our business, as do other
pending FCC proceedings. The subsections that follow outline a number of these areas. These and
many other issues remain subject to further consideration by the courts and the FCC. We cannot
predict the ultimate disposition of any of these and other matters. These and other FCC determinations are likely to be the subject of further appeals or
reconsideration. Thus, while the Supreme Court has resolved many issues, including aspects of the
FCCs jurisdictional authority, other issues remain subject to further consideration by the courts
and the FCC. We cannot predict the ultimate disposition of any of these and other matters. Regulation of Rates, Terms and Conditions of Interstate Service With regard to the FCC, Trinsic is classified by the FCC as a non-dominant provider of interstate
telecommunications services. In general, the FCC does not regulate the rates, services, and market
entry of non-dominant telecommunications carriers, but does require them to contribute to universal
service and comply with other regulatory requirements. We are currently regulated as a non-dominant
carrier with respect to both our local and long distance telephone services. As a result, we currently are not subject to rate of return regulation at the federal level and are
not currently required to obtain FCC authorization for the installation, acquisition or operation
of our domestic exchange or interexchange network facilities. However, we must comply with the
requirements of common carriage under the Communications Act. We are subject to the general
requirement that our charges and terms for our telecommunications services be just and reasonable
and that we not make any unjust or unreasonable discrimination in our charges or terms. The FCC
has jurisdiction to act upon complaints against any common carrier for failure to comply with its
statutory obligations. We are also subject to FCC rules that limit our ability to discontinue to
provide certain interstate services; however, the FCC has implemented a process that generally
permits a non-dominant, competitive company to discontinue such interstate services on an expedited
basis. We are entitled to file tariffs for the termination of interstate traffic by other carriers to our
customers, and those tariffs are subject to certain FCC regulation (SeeInterstate Tariffs and
Rates, below). Interconnection Agreements The rights and obligations Trinsic has pursuant to section 251 and 271 of the Telecommunications
Act are generally implemented through interconnection agreements with ILECs through which we
obtain access to the ILEC networks. Section 252 of the Telecommunications Act requires local exchange carriers to negotiate with us in good faith to enter
into interconnection agreements and contains a specific process for negotiating and arbitrating
interconnection agreements with incumbent local 10




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telephone companies. If we cannot reach a
voluntary interconnection agreement with an incumbent local exchange carrier on acceptable terms,
either side may petition the applicable state commission to arbitrate remaining disagreements.
These arbitration proceedings can last for a substantial period of time and can require substantial
resources to litigate. Moreover, state commission approval of any interconnection agreement
resulting from negotiation or arbitration is required, and any party may appeal an adverse decision
by the state commission to federal district court. The incentive of the incumbent local exchange
carrier to negotiate fair or proper interconnection agreement terms is a function of the
willingness and authority of state commissions and the FCC to enforce rules and policies
promulgated under the Telecommunications Act. The potential cost in resources and delay from this
interconnection agreement negotiation and arbitration process could harm our ability to compete in
certain markets, and there is no guarantee that a state commission would resolve disputes,
including pricing disputes, in our favor. In the normal course of business, we have entered into interconnection agreements with the ILECs in
all states where we currently offer local exchange services. To implement the Triennial Review
Remand Orderand to ensure that we obtain interconnection and unbundled access, we are reviewing
available contracts or negotiating new contracts in a number of states. However, at any point in
time an interconnection agreement may not contain the best-available terms offered to our
competitors, a situation that could adversely affect our ability to compete in the market. In
addition, several of our interconnection agreements with Verizon, SBC and BellSouth have expired.
The terms of those contracts provide for the agreements to continue in place until a replacement is
executed or upon termination by either party. A 2004 FCC decision has a direct impact on the interconnection agreement negotiation and
arbitration process. On July 13, 2004, the FCC released a Report and Order in WC Docket No. 01-338
and CC Docket No. 96-98 that substantially and significantly curtailed the Pick-and-Choose rule
that applied to Section 251 interconnection agreements. Section 252(i) of the Act requires that
ILECs permit CLECs like Trinsic the ability to opt in to any interconnection and network access
arrangements that an ILEC offers to another CLEC in an approved Section 251 agreement. This
process is important to ensuring that ILECs do not discriminate between CLECs in the terms of
interconnection and network access. Trinsic has utilized this pick-and-choose process to obtain
interconnection agreements with ILECs in many of the states in which we do business. The Supreme
Court in the Verizondecision supported the FCCs original pick-and-choose rule as being consistent
with the nondiscriminatory access purpose of the 1996 Act. The FCCs July 2004 Order significantly
changes this process and drops the pick-and-choose requirement with an all-or-nothing approach.
This rule requires that Trinsic, in order to avail itself of a particular rate, term, or condition
of interconnection or access that an ILEC is offering another CLEC, must adopt the ILEC-CLEC
contract in its entirety, rather than simply the specific term of interconnection or access.
Trinsic opposed this proposal before the FCC and we believe that it is inconsistent with the plain
language of section 252(i) of the Act. The rule has the potential to make it more difficult for
Z-Tel to obtain interconnection agreements suitable to our business and opens up the possibility
that another CLEC may obtain better terms of interconnection or access from an ILEC on an important
service or element than Trinsic because other provisions of the ILEC-CLEC agreement (such as
arrangements on other network elements) may be unsuitable or unworkable for Trinsic.
Implementation of the FCC rule in a manner that increases our cost of obtaining interconnection
agreements or results in discrimination could significantly and adversely impact Trinsics
business. The ability of a CLEC like Trinsic to enforce interconnection agreements with incumbent local
exchange carriers or appeal state commission arbitrations regarding such agreements is currently
subject to considerable legal uncertainty. A January 2002 decision by the United States Circuit
Court for the Eleventh Circuit ruled that the Georgia state commission did not have authority to
enforce interconnection agreements between incumbent local exchange carriers and new entrants. This
decision is in apparent conflict with decisions by other United States Circuit Courts. As a result
of this decision, litigating enforcement of interconnection agreements in state or federal courts
in the Eleventh Circuit and elsewhere could substantially increase the cost of such litigation. A
November 2003 decision by the United States Circuit Court for the Fifth Circuit ruled that state
commission jurisdiction to arbitrate terms and conditions of access pursuant to section 252 may
relate only to items specifically-related to section 251 of the 1996 Act and other items
voluntarily negotiated by the parties. That decision could limit our ability to arbitrate
acceptable interconnection terms with incumbent local telephone companies before state commissions;
at the same time, that decision could enhance our ability to resist inclusion of clauses in our
contracts by those ILECs that we deem unacceptable. Collocation The FCC has adopted rules designed to make it easier and less expensive for competitive local
exchange carriers to collocate equipment at incumbent local exchange carriers central offices by,
among, other things, restricting the incumbent local exchange carriers ability to prevent certain
types of equipment from being collocated and requiring incumbent local exchange carriers to offer
alternative collocation arrangements, such as cageless collocation. Restrictions and impediments
to collocation could harm our business, as we collocate in ILEC central offices to provide both our
UNE-L network services and our next-generation network VoIP services. The FCCs collocation rules have been subject to a number of legal challenges by incumbent local
telephone companies. On June 18, 2002, the D.C. Circuit affirmed the legality of the FCCs
collocation rules in Verizon Telephone Companies v. FCC. In the
process of these court challenges, the FCC was required to modify its rules in a way that could
increase the cost and time for competitors to collocate equipment and could have a substantial and
material impact on Trinsics future network deployment. 11




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Line Sharing, Line Splitting, and Dialtone-DSL Tying In the Triennial Review Order,the FCC eliminated its rules that required ILECs to facilitate
line-sharing arrangements. Line-sharing permits a competitive carrier to obtain unbundled access
to the high-frequency portion of a loop in order to provide DSL on that loop while the ILEC
continues to provide analog dialtone service over the low frequencies. Line-splitting is an
alternative arrangement that permits one competitive carrier to provide DSL service over the
high-frequency portion of an ILECs loop while another competitive carrier provides analog dialtone
service over the ILECs loop. FCC rules adopted in 1999 (for line-sharing) and 2001 (for
line-splitting) required ILECs to offer to facilitate these arrangements on an unbundled basis.
The FCC eliminated these requirements in the 2003 Triennial Review Order. The elimination of the
line-sharing rules could harm Trinsics business. If a customer chooses to purchase DSL from the
ILEC, Trinsics ability to provide voice services over that facility will be limited. Many ILECs, including BellSouth, Verizon and SBC, require their DSL customers to purchase analog
dialtone service from them as well. Those policies limit the market for VoIP services that utilize
broadband, DSL connections to provide dialtone service, as DSL customers will have already
purchased dialtone from the ILEC. The FCC is also considering a petition filed by BellSouth that
would preempt state orders in Kentucky, Georgia and Louisiana that order BellSouth to stop
requiring its DSL customers to purchase analog dialtone service from BellSouth. Trinsic and other
entrants have opposed BellSouths efforts to tie the sale of DSL to analog dialtone service on
the basis that such a policy has an unreasonable and unlawful effect of suppressing competition for
next-generation, VoIP services. Other ILECs, like Qwest and Verizon, do not have such a policy.
The FCC has not yet ruled on the BellSouth petition. Bell Operating Company Entry into the Long Distance Market. The Telecommunications Act permitted the Bell operating companies (Verizon, SBC, Qwest, and
BellSouth) to provide long distance services outside their local service regions immediately, and
permits them to provide in-region long distance service upon demonstrating to the FCC that they
have adhered to the Telecommunication Acts Section 271 14-point competitive checklist. The FCC
must also find that granting the application would be in the public interest. Bell operating
companies have received long-distance authority in all 50 states. With Bell operating companies authorized to provide long-distance service nationwide, it is
generally expected that competition for Trinsics local and long-distance services will increase.
Section 271 entry permits the Bell operating company to offer a bundle of local, long-distance and
enhanced services comparable to Trinsics services and therefore could increase competition and
harm our business, especially if we cannot obtain adequate access to unbundled network elements
from that same Bell operating company. At the same time, the Section 271 process also provides an important ongoing incentive for
Bell operating companies to comply with the unbundling and interconnection requirements of the
Telecommunications Act. The section 271 competitive checklist specifically requires Bell
companies to provide competitors access to loop transmission, switching, transport and
signaling. In the Triennial Review Order, the FCC ruled that these section 271 checklist
requirements were independent legal obligations that Bell companies must comply with, regardless of
the status of the unbundling rules under section 251. In the USTA IIdecision, the D.C. Circuit
characterized this independent legal obligation as a reasonable approach. The Triennial Review
Remand Orderissued earlier this year did not directly address the question of a Bell companys
statutory obligation under section 271 of the Act to provide access to the network elements
specifically-enumerated in section 271, particularly with regard to checklist item six,
switching, even if those network elements are not required to be unbundled pursuant to section
251. However, last fall, the FCC ruled that with regard to the broadband network elements that
it did not require to be unbundled under section 251 in the 2003 Triennial Review Order,the FCC
ruled that Bell companies are not required to offer access to broadband elements pursuant to
section 271 absent a 251 unbundling requirement. Trinsic disagrees with that FCC ruling. All of
the Bell companies have currently pending before the FCC petitions requesting that the FCC
forbear from these independent section 271 regulatory requirements. Trinsic has vigorously
opposed those petitions. Trinsic will vigorously enforce its rights to access to Bell company
networks pursuant to the independent legal authority that the section 271 checklist requires. If
the FCC, state commissions or the courts do not enforce section 271 checklist items as separate
obligations on Bell companies, our ability to provide service to our customers and our business
would be harmed. Universal Service Contributions. In May 1997, the FCC released an order establishing a significantly expanded universal service
regime to subsidize the cost of telecommunications service to high cost areas, as well as to
low-income customers and qualifying schools, libraries and rural health care providers. Providers
of interstate telecommunications services, like us, as well as certain other entities, must pay for
these programs. We are also eligible to receive funding from these programs if we meet certain
requirements. Our share of the payments into these subsidy funds is based on our share of certain defined interstate
telecommunications end-user revenues. Currently, the FCC assesses funds owed based on a providers
interstate revenue and the FCC adjusts payment requirements and 12




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levels quarterly. Various states are also in the process of implementing their own universal service programs. We are currently
unable to quantify the amount of subsidy payments that we will be required to make to the FCC and
individual states in the future. On July 30, 1999, in Texas Office of Public Utility Counsel v. FCC, the Fifth Circuit overturned
many of the FCCs universal service collection rules. In October 1999, on remand from that
decision, the FCC issued new collection rules which stated that if a carrier derives less than 8
percent of its revenue from interstate services, its international revenues will not be used in
calculating the contribution. For carriers receiving 8 percent or more of their revenues from
interstate services (as Trinsic does), the FCC stated that it will include international revenues
in the base for determining collections. This and other changes to the universal service program
could affect our costs by increasing charges for interstate access or requiring higher assessments
on interstate revenues. On May 20, 2001, the Fifth Circuit once again reversed the FCCs rules and
decided, in Comsat Corp. v. FCC,that the FCC cannot permit local exchange carriers to recover
universal service charges through access charges, as such an arrangement would create an implicit
subsidy. In 2002, the FCC modified the method in which carriers are required to make payments into the fund.
Among other changes, the FCC announced that carriers are to make payments based upon projected,
collected end-user interstate revenues (as opposed to historical, gross-billed revenues, as the FCC
had previously used). Competitive carriers are also prohibited form marking-up USF contributions
for administrative fees if carriers recover universal service contributions through phone bill line
items. These measures impact the manner in which we make contributions into the federal universal
service fund and could impact our business. The FCC is currently studying proposals to increase
services for which the universal service fund would support, which could increase the size of the
fund significantly and subsequently increase our financial obligation to the fund. The FCC is also
examining its rules relating to the designation of Eligible Telecommunications Carriers that are
eligible to receive payments from the fund. The outcome of these proceedings and subsequent
litigation could adversely impact or delay our ability to obtain universal service funding for our
services if we seek it, and may also increase the sums we pay into federal or state universal
service funds, increase the price for access, and harm our ability to compete with carriers that do
obtain such funding. Changes to federal or state universal service support programs could
adversely affect our costs, our ability to separately list these charges on end-user bills, and our
ability to collect these fees from our customers. Interstate Tariffs and Rates Beginning July 31, 2001, interstate domestic long distance companies were no longer allowed to file
interstate long-distance end-user tariffs with the FCC. This regulatory change requires that
Trinsic make its long-distance service information directly available to customers pursuant to
private contracts. In March 1999, the FCC adopted rules that require interexchange carriers like
Trinsic to make specific disclosures on their web sites of their rates, terms and conditions for
domestic interstate services. These detariffing and disclosure requirements could increase our
costs in providing interstate long-distance services to our customers. The FCC effectively regulates the rates Trinsic and other competitive carriers may charge to
terminate long-distance calls from other providers  known as interstate terminating switched
access. The April 27, 2001 Report and Order in CC Docket No. 96-262 provided for a four-year
transition for Trinsics and other competitive carriers terminating access rates, which completed
on June 20, 2004. As of that date, Trinsics interstate terminating switched access rate tariffed
before the FCC can be no higher than the competing ILEC in any particular area. Trinsic
maintains a switched access tariff with the FCC that it believes meets these requirements.
However, as ILEC switched access rates change, Trinsic may be obligated to change its tariff
similarly. The result could be lost revenues from interstate terminating access and administrative
costs of compliance. In the past, Z-Tel/Trinsic has had disputes with interexchange carriers over nonpayment of
terminating access charges owed to us. We have settled many of these disputes. However, there is
a risk of nonpayment and bad debt with regard to nonpayment. In the past, Trinsic has adamantly
litigated and defended its position, but nonpayment or default could have a substantial and
material adverse impact on our business. Numbering and Number Portability. The FCC has issued rules that permit a customer to keep its telephone number and transfer it among
carriers. In 1996, the FCC released rules requiring all local exchange carriers to have the
capability to permit both residential and business customers to retain their telephone numbers when
switching from one local service provider to another, known as number portability. In 2004,
those rules were extended to wireless customers and require that Trinsic and other carriers permit
customers to port their landline telephone number to wireless customers. Number portability has
been implemented in most of the areas in which we provide service, but has not been implemented
everywhere in the United States. Some carriers have obtained waivers of the requirement to provide
number portability, and others have delayed implementation by obtaining extensions. Lack of number
portability in a given market could adversely affect our ability to attract customers for our
competitive local exchange service offerings, particularly business customers, should we seek to
provide services to such customers. 13




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The FCC and state commissions also regulate the availability and assignment of telephone numbers
and area codes. Before the 1996 Telecommunications Act, the Bell operating companies and other
ILECs controlled a number of these tasks. In August 1997, the FCC issued rules transferring
responsibility for administering and assigning local telephone numbers from the Bells and ILECs to
an independent, neutral entity. In 1996, the FCC issued new numbering regulations that prohibit
states from creating new area codes in a manner that would unfairly hinder competitive local
exchange carriers by requiring that their customers use 10-digit dialing while ILEC customers need
only use 7-digit dialing. Each carrier is required to contribute to the cost of numbering
administration through a formula based on end-user telecommunications revenues. In May 1999, the FCC initiated a proceeding to address the problem of the declining availability of
area codes and phone numbers. In December 2000, the FCC issued a Further Notice of Proposed
Rulemaking in CC Dockets Nos. 96-98 and 99-200 that proposed adoption of a market based approach
of optimizing number resources, which would involve the introduction of charges for allocation of
number resources. If a market-based approach to number allocation is introduced, as the FCC
proposed, it could result in added administrative expenses for us and possibly make it more
difficult or costly for us to obtain telephone numbers for our customers. Restrictions on Bundling.On March 30, 2001, in CC Dockets Nos. 96-61 and 98-183, the FCC
eliminated a rule that prohibited all carriers form bundling customer premises equipment and
telecommunications services. Current FCC rules prohibit dominant carriers from bundling their
non-competitive regulated telecommunications services with their unregulated enhanced or
information services. To our knowledge, the FCC has not enforced this rule with respect to
competitive local exchange carriers and has proposed eliminating the rule for all carriers. Slamming.A customers choice of local or long distance telecommunications company is encoded in a
customer record, which is used to route the customers calls so that the customer is served and
billed by the desired company. A user may change service providers at any time, but the FCC and
some states regulate this process and require that specific procedures be followed. When these
procedures are not followed, particularly if the change is unauthorized or fraudulent, the process
is known as slamming. Slamming is such a significant problem that it has been addressed in detail
by Congress in the Telecommunications Act, by some state legislatures, and by the FCC in recent
orders. The FCC has levied substantial fines for slamming. The risk of financial damage, in the
form of fines, penalties and legal fees and costs, and to business reputation from slamming is
significant. Even one slamming complaint could cause extensive litigation expenses for us. The FCC
also applies its slamming rules (which originally covered only long distance) to local service as
well. Trinsic is also subject to state rules and regulations regarding slamming, cramming, and
other consumer protection regulation. Network Information.Section 222 of the Communications Act of 1934 and FCC rules protect the
privacy of certain information about telecommunications customers that a telecommunications carrier
such as us acquires by providing telecommunications services to such customers. Such protected
information, known as Customer Proprietary Network Information (CPNI), includes information related
to the quantity, technological configuration, type, destination and the amount of use of a
telecommunications service. The FCCs original rules prevented a carrier from using CPNI acquired
through one of its offerings of a telecommunications service to market certain other services
without approval of the affected customer. The United States Court of Appeals for the Tenth Circuit
overturned a portion of the FCCs rules established in CC Docket No. 96-115 regarding the use and
protection of CPNI. In response to the Tenth Circuit decision, in October 2001, in CC Docket No. 96-115, the FCC
clarified that the Tenth Circuit reversal was limited and that most of the FCCs CPNI rules
remained in effect. The FCC sought further comment on what method of customer consent offered by a
carrier (either an opt-in or opt-out approach) would serve the governmental interest in Section
222 and be consistent with the First Amendment. The final determination of this issue and other FCC
rules regarding handling of CPNI could result in significant administrative expense to Trinsic in
modifying internal customer systems to meet these requirements. FCC Policy on Enhanced, Information Services and Internet Protocol-Enabled Services (such as Voice
over Internet Protocol) On March 10, 2004, the FCC released a Notice of Proposed Rulemaking that seeks to establish a
comprehensive regulatory framework for Internet Protocol-Enabled Service, or IP-Enabled
Services. IP-Enabled services include Voice over Internet Protocol services and other services
that Z-Tel intends to deploy or may in the future deploy over its Next-Generation Network. The FCC
proposed that IP-Enabled Services be subject to limited regulation and that inconsistent state and
local regulation would be preempted. Under the FCCs proposal, the regulation that survives would
be tied to the particular functionality offered by the service provider. For example, the
application of E911 services may be different for dialtone-like services as opposed to voice
capabilities of interactive computer games. The FCC IP-Enabled Services proceeding builds upon several decades of precedent in which the FCC
has largely sought to wall-off from regulation certain enhanced or information services. In
1980, the FCC created a distinction between basic 14




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telecommunications services, which it regulates as common carrier services, and enhanced
services, which remain unregulated. The FCC exempted enhanced service providers from federal
regulations governing common carriers, including the obligation to pay access charges for the
origination or termination of calls on carrier networks and the obligation to contribute to the
universal service fund. The Telecommunications Act of 1996 established a similar distinction
between telecommunications services and information services. The distinction between information services and common carrier services is important in many
respects. A panoply of federal (tariffs), state (certification requirements) and even local
regulation (franchise or rights of way fees), apply to common carrier services but not
necessarily all information services. Under FCC rules, interstate common carriers must
contribute a percentage of revenue to federal universal service support systems; information
service providers do not make such a contribution. At the same time, common carriers are granted
certain rights that information service providers do not have  for example, only common carriers
have the ability to collocate equipment and purchase unbundled network elements from incumbent
local telephone companies pursuant to section 251 of the 1996 Act. Interexchange common carriers
(e.g., long-distance providers) generally have to pay access charges to local exchange companies
for long-distance calls that originate or terminate on a local exchange carriers local network.
Information service providers (such as an Internet service provider) do not pay these access
charges when their customers utilize local exchange carrier networks to utilize the information
service providers service. As discussed above, since Z-Tel offers both common carrier and
information services to its customers, these distinctions have an important impact upon our
business. Changing technology and changing market conditions, however, sometimes make it difficult to discern
the boundary between unregulated and regulated services. In particular, the ability to place and
route voice communications over information service provider networks has called into question the
FCCs common carrier/information service provider distinction. In 1998, the FCC outlined in a
Report to Congressits belief that voice over Internet services should be classified and
regulated, if at all, on a case-by-case basis. Since that report, several companies have filed
petitions seeking declarations from the FCC as to the regulatory status of VoIP services. In
February 2004, the FCC ruled that Pulver.coms Free World Dialup service was an information
service and not a regulated common carrier service because Free World Dialup did not offer its
users the ability to transmit calls for a fee. On April 21, 2004, the FCC determined that certain
of AT&Ts long-distance services that utilize IP technology were to be regulated as a
telecommunications service because AT&Ts use of IP technology did not change the form or content
of the long-distance communication and therefore meet the statutory definition of information
service. The FCC was careful to state in both the Pulver.com and AT&T IP Telephony decisions that
in so ruling, it was reserving its right to come to a different outcome in the IP-Enabled Services
rulemaking proceeding. On November 12, 2004, in WC Docket No. 03-211, the FCC ruled that Vonages
DigitalVoice service, a Voice over IP application, was inherently interstate; as a result, the
FCC preempted an attempt by the Minnesota regulator to impose traditional telephone company
regulations, including certification requirements, on that service. These FCC decisions and proposals indicate the state of regulatory flux that industry participants
face, and it is impossible to forecast the final outcome of these regulatory classification
decisions. We believe that many of the services we provide, including Personal Voice Assistant and
features and functions are information services under the FCCs definition. Because the regulatory
boundaries in this area are somewhat unclear and subject to dispute, however, the FCC could seek to
characterize some of our information services as telecommunications services or subject them to
certain types of regulation applicable to common carrier telecommunications services. If that
happens, those services would become subject to FCC regulation, and the impact of that
reclassification is difficult to predict. Unlike many VoIP and information service providers,
Trinsic maintains common carrier certificates in the states in which we do business; as a result,
we are positioned to comply with state or federal rulings that would declare any or part of these
services to be regulated common carrier services. Certain of Trinsics IP telephony services could be classified as information services in a way
that could potentially limit our ability to access the local networks of incumbent local telephone
companies. On December 20, 2001, the FCC issued a Notice of Proposed Rulemaking in CC Docket No.
01-337 in which the FCC sought comment on regulatory requirements for incumbent local exchange
carrier provision of broadband telecommunications services. In this proceeding, the FCC is
considering whether it should remove regulatory safeguards and common carrier obligations,
including unbundling regulations, on incumbent local exchange carrier broadband networks. An FCC
decision limiting unbundling or deregulating incumbent local exchange carrier broadband networks
could have a significant and material adverse impact on our business. For example, incumbent local
exchange carriers may be able to offer consumers deregulated broadband network packages of local
exchange, information services and broadband service (such as DSL) that Trinsic would not be able
to offer because Trinsic would not have unbundled access to that broadband network. In addition,
because the incumbent local exchange carrier broadband network in most instances utilizes the
same network facilities as the current incumbent local exchange dial tone network, limitations on
unbundling or deregulation of that broadband network could inexorably make it difficult, more
costly, or even impossible, for Trinsic to provide its current telecommunications and information
services to consumers. In addition, several ILECs, including BellSouth and SBC, have filed petitions before the FCC
requesting that the FCC forbear from long-standing network access requirements for their networks
to the extent those networks are capable of supporting IP services. These petitions would remove
ILEC broadband networks from the Computer II/IIIrules that give competitors the 15




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ability to interconnect with these networks. Similarly, on February 13, 2003, the FCC proposed in
CC Docket No. 02-42 that incumbent local exchange carrier provision of wireline broadband Internet
access services as an information service and regulate the provision of such services pursuant to
Title I of the Communications Act of 1934. In addition, the FCC sought comment on whether its
Computer II/Computer IIIrules, which govern access to ILEC networks by third parties to provide
information services. The proposed rules could, if adopted without adequate assurances for
competitive access, limit the ability of new entrants to access and utilize the networks of
incumbent local exchange carriers to provide advanced, broadband Internet access and could
therefore harm Trinsics ability to provide services to its customers. Intercarrier Compensation (Interstate Access Charges and Reciprocal Compensation) Because Trinsic, as a competitive local exchange carrier, passes and receives local and long
distance calls to and from other local exchange carriers and long-distance companies, the rates for
intercarrier compensation for these calls has a significant and substantial impact on the
profitability of our business. In addition, the rates that our competitors, especially the
incumbent local exchange carriers, are permitted to charge end-users, other local exchange
carriers, and long-distance companies for originating, transmitting, and terminating
telecommunications traffic can have a substantial impact on our ability to offer services in
competition with those carriers. On March 3, 2005, the FCC, in WC Docket No. 01-92, issued a Further Notice of Proposed Rulemaking
that called for reform of the current intercarrier compensation regime. Under current rules, the
rate for the exchange of traffic depends on (1) the type of traffic, (2) the types of carriers
involved and (3) the end points of the communication. The FCC found that those disparities
presented opportunities for regulatory arbitrage, and the FCC presented several proposals made by
industry participants and the states. The 2005 FCC proposal reaches no tentative conclusion as to the proper intercarrier rate, an
approach that differs from the FCCs prior position on this topic. In April 2001, the FCC released
a Notice of Proposed Rulemaking in the same docket as the March 2005 notice (CC Docket No. 01-92),
and in that document the FCC proposed that carriers transport and terminate traffic between one
another on a bill-and-keep basis, rather than per-minute reciprocal compensation charges. Because
Trinsic both makes payments to and receives payments from other carriers for exchange of local and
long-distance calls, at this time we cannot predict the effect that the FCCs final determination
in CC Docket No. 01-92 may have upon our business. The current intercarrier compensation regime is subject to dispute and litigation on a number of
fronts. In particular, FCC rules relating to compensation for dial-up calls to Internet service
providers have been reversed by the D.C. Circuit Court of Appeals twice, with no final resolution.
The FCC is under an obligation to report on its progress for these rules before the D.C. Circuit
periodically. We cannot predict the effect that the FCCs resolution of these issues will have on
our business. FCC decisions relating to intercarrier compensation have a significant impact upon industry
structure and economics. Since passage of the Telecommunications Act of 1996, the FCC has twice
fundamentally restructured the access charges that incumbent local exchange carriers charge to
interexchange carriers and end-user customers to connect to the incumbent local exchange carriers
network. The FCC revised access charges for the largest incumbent local exchange carriers in May
1997, reducing per-minute access charges and increasing flat-rated monthly charges paid by both
long-distance carriers and end-users. Further changes in access charges were effected for the
largest incumbent local exchange carriers when the FCC adopted the Coalition for Affordable Local
and Long-Distance Service (CALLS) proposal in May 2000. CALLS, which reflected a negotiated
settlement between AT&T and most of the Bell operating companies, reduced per-minute charges by 60
percent. It further increased flat-rated monthly charges to end-users, in particular, multi-line
business users. The CALLS plan also attempted to remove implicit universal service subsidies paid
for by long-distance companies in interstate access rates and place those funds into the federal
universal service support system, where they would be recovered from all interstate carriers. Most
of the reductions in the CALLS plan resulted from shifting access costs away from interexchange
carriers onto end-user customers. In addition, as discussed above, the rates that Z-Tel and other competitive local exchange carriers
may charge for interstate switched access services are regulated pursuant to the FCCs April 2001
CLEC Access Charge Order (See Interstate Tariffs and Rates above). Changes to the intercarrier
compensation regime could affect our costs and revenues and could also impact the competitive
environment for telecommunications and information services. Potential Federal Legislation Changes to the market-opening and enforcement provisions of the Communications Act of 1934 or the
Telecommunications Act of 1996 could adversely affect our ability to provide competitive services
and could harm our business. In 2004, Representative Chip Pickering and Senator John Sununu both
introduced legislation that would determine that services that utilized the Internet Protocol would
not be subject to state and local regulation. Both of those bills have had hearings before
respective committees in the House and Senate. Senator Sununus bill passed the Senate Commerce
Committee. Neither bill has been submitted to the full chamber for consideration and a vote.
While similar, these bills differ in how issues such as access charges and universal service 16




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obligations would apply to services that utilize the Internet Protocol. It is difficult to
determine the long-run impact either of these bills if they were to become law would have upon our
business. Other Issues There are a number of other federal regulatory issues and proceedings that could have an effect on
our business in the future, including the fact that   
    The FCC has adopted rules to require telecommunications service
providers to make their services accessible to individuals with
disabilities, if readily achievable.
    In March, 2004, the Department of Justice filed a rulemaking petition
before the FCC that asks for new rules to implement the Communications
Assistance with Law Enforcement Act (CALEA). CALEA requires
telecommunications providers to design and engineer their networks to
permit law enforcement agencies to wiretap and obtain customer service
information (e.g., call trace, call records). The Department of
Justice CALEA petition proposes to extend many of those requirements
to information services as well. Implementation of the proposed CALEA
rules could have a significant impact upon our ability to provide both
regulated common carrier and information services to our customers.
Such rules could increase the cost of equipment we purchase to deploy
our services and such rules could also delay the availability of
equipment we need. We cannot predict any such delays or the potential
cost at this time. Current FCC rules require telecommunications
service providers to provide law enforcement personnel with a
sufficient number of ports and technical assistance in connection with
wiretaps. We cannot predict the cost to us of complying with these
rules at this time.
    The FCC has adopted Do-Not-Call-Rules that limit the ability of
telemarketers to make telephone calls to consumers that choose to be
listed on the national Do-Not-Call-Registry. These rules could make
future telemarketing efforts more expensive and less effective.In 1999, the FCC has adopted rules designed to make it easier for
customers to understand the bills of telecommunications carriers.
These Truth-in-Billing Rules, CC Docket No. 98-170, establish certain
requirements regarding the formatting of bills and the information
that must be included on bills. In 2000, the FCC modified its
Truth-in-Billing rules to clarify that where an entity bundles a
number of services, some of which might be provided by different
carriers, as a single package, that offering can be listed on a bill
as a single offering. On March 30, 2004, NASUCA, an organization of
state consumer advocates, filed a petition before the FCC asking for
more-stringent regulation of bill format, which the FCC is considering
in WC Docket No. 04-208. Changes in these FCC rules could increase
our costs of doing business significantly and could make it more
difficult to assess and collect regulatory and other fees that, as a
common carrier, we are obligated to pay to local, state and federal
entities.
    We are subject to annual regulatory fees assessed by the FCC, and must
file an annual employment report to comply with the FCCs Equal
Employment Opportunity policies.
    The FCC has adopted an order granting limited pricing flexibility to
large incumbent local exchange carriers, and is considering granting
additional pricing flexibility and price deregulation options. These
actions could increase competition for some of our services. The foregoing is not an exhaustive list of proceedings or issues that could materially affect
our business. We cannot predict the outcome of these or any other proceedings before the courts,
the FCC, legislative bodies, or state or local governments. STATE REGULATION To the extent that we provide telecommunications services that originate and terminate within the
same state, we are subject to the jurisdiction of that states public service commission. The
Telecommunications Act maintains the authority of individual state utility commissions to preside
over rate and other proceedings, and to impose their own regulation on local exchange and
intrastate interexchange services, so long as such regulation is not inconsistent with the
requirements of federal law. For instance, states may require us to obtain a Certificate of Public
Convenience and Necessity before commencing service in the state. We have obtained such authority
in all states in which we operate, and, as a prelude to market entry in additional states, we have
obtained such authority to provide local service in 49 states and the District of Columbia. In addition to requiring certification, state regulatory authorities may impose tariff and filing
requirements, consumer protection measures, and obligations to contribute to universal service and
other funds. State commissions also have jurisdiction to approve negotiated rates, or establish
rates through arbitration, for interconnection, including rates for unbundled network elements.
Changes in those rates for unbundled network elements could have a substantial and material impact
on our business. 17




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We are subject to requirements in some states to obtain prior approval for, or notify the state
commission of, any transfers of control, sales of assets, corporate reorganizations, issuance of
stock or debt instruments and related transactions. Although we believe such authorizations could
be obtained in due course, there can be no assurance that state commissions would grant us
authority to complete any of these transactions. We are also subject to state laws and regulations regarding slamming, cramming, and other consumer
protection and disclosure regulations. These rules could substantially increase the cost of doing
business in any one particular state. State commissions have issued or proposed several substantial
fines against competitive local exchange companies for slamming or cramming. The risk of financial
damage, in the form of fines, penalties and legal fees and costs, and to business reputation from
slamming is significant. Even one slamming complaint before a state commission could cause
extensive litigation expenses for us. In addition, state law enforcement authorities may utilize
their powers under state consumer protection laws against us in the event legal requirements in
that state are not met. Trinsics rates for intrastate switched access services, which Trinsic provides to long-distance
companies to originate and terminate in-state toll calls, are subject to the jurisdiction of the
state commissions in which the call originated and terminated. State commissions may, like Texas,
directly regulate or prescribe this intrastate switched access rate. Such regulation by other
states could materially and adversely affect Trinsics revenues and business opportunities within
that state. The Telecommunications Act generally preempts state statutes and regulations that restrict the
provision of competitive services. As a result of this preemption, we will be generally free to
provide the full range of local, long distance, and data services in any state. While this action
greatly increases our potential for growth, it also increases the amount of competition to which we
may be subject. States, however, may still restrict Trinsics ability to provide competitive
services in some rural areas. In addition, the cost of enforcing federal preemption against certain
state policies and programs may be large and may cause considerable delay. As we roll out new
services on a state-by-state basis, pricing and terms and conditions adopted by the incumbent local
exchange carrier in each of these states may preclude our ability to offer a competitively viable
and profitable product on a going-forward basis. In order to enter new markets, we may be required
to negotiate interconnection agreements or commercial agreements with incumbent local exchange
carriers on an individual state basis. To continue to provide service, we also need to renegotiate
interconnection agreements or commercial agreements with incumbent local exchange carriers. No
assurance can be made that the individual local exchange providers will provide needed components
in a manner and at a price that will support competitive operations. If the ILEC providers do not
readily provide network functionality in the manner required, we have regulatory and legal
alternatives, including arbitration before state public service commissions, to force provision of
services in a manner required to support our service offerings. However, if we are forced to
litigate in order to obtain the combinations of network elements required to support our service,
we are likely to incur significant incremental costs and delays in entering such markets. In
addition, as discussed above, there is considerable legal uncertainty as to how interconnection
agreements are to be enforced before state commissions and where appeals of state commission
interconnection agreement determinations may be heard. State legislatures also may impact our business. For example, in 2003, the Illinois General
Assembly passed a law that ordered the Illinois Commerce Commission to increase unbundled network
elements rates. Z-Tel and several other competitive carriers filed a lawsuit and injunction against
that law, on the basis that the Telecommunications Act of 1996 ordered state commissions  not
state legislatures  to establish rates for network elements. The U.S. District Court for the
Northern District of Illinois and, subsequently, the United States Circuit Court of Appeals for the
Seventh Circuit, agreed and ordered a permanent injunction against the Illinois statute.
Nevertheless, incumbent local telephone exchange carriers actively lobby and support legislation
that would curtail the roles of state public utility commissions, limit competitive access laws
that may exist at the state level that may go beyond the Telecommunications Act, or otherwise limit
the ability of competitive companies like Trinsic to compete against ILECs or obtain access to
local networks at just, reasonable and nondiscriminatory rates. At any point in time, several such
bills are pending before the state legislatures of states in which we do business, and passage of
such legislation could have a significant and material effect on our ability to do business in that
particular state. LOCAL GOVERNMENT REGULATION In some of the areas where we provide service, we may be subject to municipal franchise
requirements requiring us to pay license or franchise fees either on a percentage of gross revenue,
flat fee or other basis. We may be required to obtain street opening and construction permits from
municipal authorities to install our facilities in some cities. The Telecommunications Act
prohibits municipalities from discriminating among telecommunications service providers in imposing
fees or franchise requirements. In some localities, the FCC has preempted fees and other
requirements determined to be discriminatory or to effectively preclude entry by competitors, but
such proceedings have been lengthy and the outcome of any request for FCC preemption would be
uncertain. 18




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COMPETITION Overview The telecommunications industry is highly competitive. However, at present, we believe few
telecommunications carriers provide the type of bundled service packages that include the range of
services and features that we offer, but various competitors offer one or more of the services that
make up our service offerings. Competition in the local telephone services market arises primarily
from the ILECs and alternative transport systems such as wireless, cable and the Internet.
Competition in the long distance and information services markets, which have fewer entry barriers,
is already intense and is expected to remain so. We believe the principal competitive factors affecting our business will be the quality and
reliability of our services, customer confidence, innovation, customer service and price. Our
ability to compete effectively will depend upon our continued ability to offer innovative,
high-quality, market-driven services at prices generally equal to or below those charged by our
competitors and to instill confidence in prospective customers as to our long-term viability and
the viability of our access to ILEC and other networks at reasonable commercial terms and rates.
Many of our current and potential competitors have far greater financial, marketing, personnel and
other resources than we do, as well as other competitive advantages. Local Telephone Service Incumbent Local Exchange Carriers.In each of our target markets, we will compete with the
incumbent local exchange carrier serving that area, which may be one of the Bell operating
companies. The incumbent local exchange carriers have long-standing relationships with their
customers, have financial, technical and marketing resources substantially greater than ours, have
the potential to subsidize services that compete with our services with revenue from a variety of
other unregulated businesses, and currently benefit from certain existing regulations that favor
the incumbent local exchange carriers over us in certain respects. Also, as stated above under
Government Regulation, a recent court ruling will enable ILECs to raise fees they charge to us,
thereby possibly causing us to raise our rates to our end users to non-competitive levels. Regulations that allow competitive local exchange carriers, such as us, to interconnect with
incumbent local exchange carrier facilities and acquire and combine the unbundled network elements
of an incumbent local exchange carrier provide increased business opportunities for us. However,
such interconnection opportunities have been, and will likely continue to be, accompanied by
increased pricing flexibility and relaxation of regulatory oversight for the incumbent local
exchange carriers. Competitive Local Exchange Carriers.We face competition in local telephone services from numerous
competitive local exchange carriers, including our own wholesale customer Sprint. Several of these
companies have name recognition, standing relationships with their customers and financial,
technical and marketing resources substantially greater than we have. The Telecommunications Act
radically altered the market opportunity for competitive local exchange carriers. With the required
unbundling of the incumbent local exchange carriers networks, competitive local exchange carriers
are now able to enter the market more rapidly by leasing switches, trunks and loop capacity until
traffic volume justifies building substantial facilities. Newer competitive local exchange
carriers, like us, will not have to replicate certain existing facilities and can be more
opportunistic in designing and implementing networks, which could have the effect of increasing
competition for local exchange services. How the pending mergers of MCI and AT&T with
Verizon/Qwest and SBC, respectively, will affect their national service offerings is unclear at
this time. Cable Television Operators.Cable television operators are also entering the telecommunications
market by upgrading their networks with fiber optics and installing facilities to provide fully
interactive transmission of broadband voice, video and data communications. These companies have
standing relationships with their customers and generally have financial, technical and marketing
resources substantially greater than we have. Wireless Telephone Companies.Wireless telephone systems are seen by many consumers as a
substitute for traditional wireline local telephone service. Wireless companies have name
recognition, standing relationships with their customers and financial, technical and marketing
resources substantially greater than we have. VoIP Providers.The Internet is being used by a limited number of consumers as a substitute for
traditional wireline local and long distance telephone service. The number of VoIP users could
expand rapidly in the near future. We recently began to offer our own VoIP services. Other
entrants into this market may include ILECs, cable television operators and Internet service
providers as well as new entrants. New Entrants.We could face competition from new entrants into the local exchange market. Because
the Telecommunications Act requires the unbundling of the incumbent local exchange carriers
networks, new entrants are able to enter the market by leasing trunks and loop capacity in lieu of
expending funds building substantial facilities. This lower barrier to entry could have the effect
of increasing competition for local exchange services. Moreover, a continuing trend toward
consolidation of telecommunications companies and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies, could give rise to
significant new competitors. 19




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Long Distance Telephone Service The long distance telecommunications industry has numerous entities competing for the same
customers and a high average churn rate because customers frequently change long distance providers
in response to the offering of lower rates or promotional incentives by competitors. Our primary
competitors in the long distance market include major interexchange carriers such as AT&T, MCI and
Sprint, certain incumbent local exchange carriers and resellers of long distance services. We
believe that pricing levels are a principal competitive factor in providing long distance telephone
service. We hope to avoid direct price competition by bundling long distance telephone service with
a wide array of value-added, enhanced communications services. We believe that incumbent local exchange carriers that offer a package of local, long distance
telephone and information services will be particularly strong competitors. Incumbent local
exchange carriers, including Verizon, BellSouth, Qwest and SBC Communications, are currently
providing both long distance and local services as well as certain enhanced telephone services that
we offer. We believe that the Bell operating companies will attempt to offset market share losses
in their local markets by attempting to capture a significant percentage of the long distance
market. Wireless carriers offering bundled service packages with prepaid anywhere minutes will
also offer an alternative to traditional wireline long distance services. Enhanced Communications Services We compete with a variety of enhanced service companies. Enhanced communications services markets
are highly competitive, and we expect that competition will continue to intensify. Our competitors
in these markets include Internet service providers, Web-based communications service providers and
other telecommunications companies, including the major interexchange carriers, incumbent local
exchange carriers, competitive local exchange carriers and wireless carriers. Wholesale Services We believe we are one of the very few competitive local exchange carriers providing local exchange
services on a wholesale basis. Our chief competitor on the wholesale level in each territory is the
incumbent local exchange carrier, usually a Bell operating company. Our competitive advantage is
our knowledge and experience in dealing with incumbent local exchange carriers, our knowledge and
experience in offering local services, our proprietary enhanced features and our operational
support systems. Bell operating companies, in general, do not promote and market their ability to
offer wholesale services, preferring to minimize competition in the local telephone services
market. We provide our wholesale customers a full suite of services for their use in providing
telephone services to their customers. We face competition from a variety of companies that offer
particular services such as provisioning services, billing services and enhanced communications
services (such as voicemail) or that offer technologies related to such services. Recent
regulatory changes have resulted in a degree of uncertainty with regard to the future of this
business segment. RESEARCH AND DEVELOPMENT ACTIVITIES For the fiscal years ended December 31, 2004, 2003 and 2002, we invested approximately $4.7
million, $6.0 million and $7.4 million, respectively, in company-sponsored research and development
activities. EMPLOYEES As of April 13, 2005, we had approximately 765 employees. None of our employees are covered under
collective bargaining agreements. ACCESS TO INFORMATION The public may read and copy any materials we file with the Securities and Exchange Commission at
the SECs Public Reference Room at 450 Fifth Street N.W., Washington, D.C. 20549. The public may
obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically with the SEC. The
address of that site is http://www.sec.gov. Reports we file electronically with the SEC including annual reports on Forms 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those filings are available
free of charge soon after each filing at the following Web site: http://www.trinsic.com. Select
Investor Relations at the top and then select SEC Filings. 
 ITEM 2. PROPERTIES We currently lease our principal executive offices in Tampa, Florida and our principal engineering
offices in Atlanta, Georgia. We own our offices in Atmore, Alabama. 20




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Our enhanced communications services and operational support systems reside in our Tampa offices.
We estimate the current hardware can support over 1.5 million end user lines. With additional
equipment we estimate the maximum capacity of the facility (because of space constraints) to be
approximately 2.0 million lines. Both of our business segments utilize the foregoing offices and facilities. 
 ITEM 3. LEGAL PROCEEDINGS  1.
    Master File Number 21 MC 92; In re Initial Public Offering Securities
Litigation., in the United States District Court for the Southern
District of New York (filed June 7, 2001) During June and July 2001, three separate class action lawsuits were filed against us, certain of
our current and former directors and officers (the D&Os) and firms engaged in the underwriting
(the Underwriters) of our initial public offering of stock (the IPO). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising out of initial public
offering allocations, have been assigned to a Judge in the United States District Court for the
Southern District of New York for pretrial coordination. The lawsuits against us have been
consolidated into a single action. A consolidated amended complaint was filed on April 20, 2002. A
Second Corrected Amended Complaint (the Amended Complaint), which is the operative complaint, was
filed on July 12, 2002. The Amended Complaint is based on the allegations that our registration statement on Form S-1,
filed with the Securities and Exchange Commission (SEC) in connection with the IPO, contained
untrue statements of material fact and omitted to state facts necessary to make the statements made
not misleading by failing to disclose that the underwriters allegedly had received additional,
excessive and undisclosed commissions from, and allegedly had entered into unlawful tie-in and
other arrangements with, certain customers to whom they allocated shares in the IPO. The plaintiffs
in the Amended Complaint assert claims against us and the D&Os pursuant to Section 11 of the
Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC there under. The plaintiffs in the Amended Complaint assert claims against
the D&Os pursuant to Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated by the SEC there under. The
plaintiffs seek an undisclosed amount of damages, as well as pre-judgment and post-judgment
interest, costs and expenses, including attorneys fees, experts fees and other costs and
disbursements. Initial discovery has begun. We believe we are entitled to indemnification from our
Underwriters. A settlement has been reached by the respective lawyers for plaintiffs, the issuers and insurers of
the issuers. The principal terms of the proposed settlement are (i) a release of all claims against
the issuers and their officers and directors, (ii) the assignment by the issuers to the plaintiffs
of certain claims the issuers may have against the Underwriters and (iii) an undertaking by the
insurers to ensure the plaintiffs receive not less than $1 billion in connection with claims
against the Underwriters. Hence, under the terms of the proposed settlement our financial
obligations will likely be covered by insurance. The court has given preliminary approval of the
settlement subject to certain modifications. A revised settlement agreement has been submitted to
the court. To be binding, the settlement must be executed by the parties and thereafter submitted
to and approved by the court. The settlement will not be binding upon any plaintiffs electing to
opt-out of the settlement.  2.
    C.A. No5:03CV229, Z-Tel Communications Inc. v. SBC Communications,
Inc., in the United States District Court for the Eastern District of
Texas, filed October 9, 2003. On October 9, 2003, Trinsic Communications, Inc., our wholly-owned subsidiary corporation, formerly
known as Z-Tel Communications, Inc., filed a lawsuit against SBC Communications, Inc. and several
of its subsidiaries (collectively, SBC) in federal court in Texas, where both SBC and Trinsic do
business. The lawsuit alleges SBCs violation of the federal antitrust laws, the Racketeering
Influenced Corrupt Organizations Act (RICO), the Lanham Act, and other federal and state laws. The
complaint seeks damages and an injunction against SBC. On November 20, 2003, SBC filed a motion to
dismiss the complaint. On August 6, 2004, the court denied in part, and granted in part, SBCs
motion to dismiss the complaint, allowing certain antitrust, RICO, and Lanham Act claims to
proceed. On March 30, 2005, the lawsuit against SBC was settled and dismissed with prejudice. In
conjunction with the settlement, our subsidiary Trinsic Communications, Inc. (formerly Z-Tel
Communications, Inc.) will receive proceeds of $14 million and the parties have mutually resolved
certain outstanding billing disputes. From our proceeds, we will be responsible for expenses and
attorneys fees approximating $8 million. The net $6 million will be reflected as income in the
2005 statement of operations.  3.
    C.A. No. 04CH07882, Susan Schad, on behalf of herself and all others
similarly situated, v. Z-Tel Communications, Inc., In the Circuit
Court of Cook County, Illinois, Illinois County Department, Chancery
Division, filed May 13, 2004;C.A. No. 4 C 4187, Susan Schad, on behalf of herself and all others
similarly situated, v. Z-Tel Communications, Inc., In the United
States District Court for the Northern District of Illinois, Eastern
Division. Susan Schad, on behalf of herself and all others similarly situated, filed a class action lawsuit
against Trinsic Communications, Inc. (formerly known as Z-Tel Communications, Inc.), our
wholly-owned subsidiary corporation, on May 13, 2004. The lawsuit alleges 21




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that our subsidiary has engaged in a pattern and practice of deceiving consumers into paying amounts in excess of their
monthly rates by deceptively labeling certain line-item charges as government-mandated taxes or
fees when in fact they were not. The complaint seeks to certify a class of plaintiffs consisting of
all persons or entities who contracted with Trinsic for telecommunications services and were billed
for particular taxes or regulatory fees. The complaint asserts a claim under the Illinois Consumer
Fraud and Deceptive Businesses Practices Act and seeks unspecified damages, attorneys fees and
court costs. On June 22, 2004, we filed a notice of removal in the state circuit court action,
removing the case to the federal district court for the Northern District of Illinois, Eastern
Division, C.A. No. 4 C 4187. On July 26, 2004, Plaintiff filed a motion to remand the case to the
state circuit court. On January 12, 2005, the federal court granted the motion and remanded the
case to the state court. Although we believe the plaintiffs allegations are without merit and
intend to defend the lawsuit vigorously, we cannot predict the outcome of this litigation with any
certainty.  4.
    Case. No. 0410453, Wilder Corporation of Delaware, Inc. v. Trinsic
Communications, Inc., In the Circuit Court of the Thirteenth Judicial
Circuit in and for Hillsborough County, Florida, Civil Division,
Division G, filed November 19, 2004 On November 19, 2004, the landlord of our principal Tampa, Florida facility sued us seeking a
declaration of its rights and obligations under the lease and damages for breach of contract. We
assert that the landlord has failed to provide certain services in accordance with the lease,
including maintenance of air conditioning and emergency electrical generating systems crucial to
our operations. We have taken steps necessary to provide this maintenance and have offset the
costs of these measures against the rent, which we believe we are entitled to do under the lease.
Thus far we have withheld approximately $180,000. We also believe we are entitled to reimbursement
from the landlord for approximately $23,000 in costs associated with improvements to the leased
space.  5.
    Case. No. 0410441, Beneficial Management Corporation of America. v.
Trinsic Communications, Inc., In the Circuit Court of the Thirteenth
Judicial Circuit in and for Hillsborough County, Florida, Civil

Division, Division F, filed November 19, 2004 On November 19, 2004, a provider of parking spaces for our Tampa facilities sued us for parking
fees in excess of $334,300. Pursuant to our lease we are entitled to a number of free spaces and
we are obligated to pay for additional usage of parking spaces. We believe the provider has
substantially overstated our use of the spaces. We expect to resolve this dispute.  6.
    Triennial Review Remand Order, Review of Section 251 Unbundling
Obligations of Incumbent Local Exchange Carriers,WC Docket No.
04-313, CC Docket No. 01-338, FCC 04-290 (rel. Feb. 4, 2005). On December 15, 2004, the FCC ruled that incumbent local exchange carriers are no longer required
to provide Trinsic and other competitive telephone companies access to unbundled analog switching 
a key component of the Unbundled Network Element Platform combination of elements, or UNEP, which
is how we provide services to the vast majority of our customers. This FCC Triennial Review Remand
Orderalso limited our ability to access unbundled high-capacity loops and dedicated transport in
many urban and suburban locations. Several parties have petitioned the FCC to reconsider certain
aspects of the order and other parties have filed appeals in federal court. We cannot predict the
outcome of these proceedings. This order will have a material adverse effect on our business.
(See sections of this report entitled Government Regulation and Risks Relating to Our Financial
Condition and Our Business.) 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS On November 19, 2004, we held a special meeting of the stockholders at which a number of proposals
were approved. Among the matters approved were (a) an amendment and restatement of our certificate
of incorporation (i) to effect a reverse stock split of our common stock with the ratio to be
determined by our board of directors; (ii) subject to all of our Series G or D preferred stock
being exchanged in a proposed exchange offer, to eliminate each such fully tendered series
following its exchange; (iii) in the case that all of either the Series G or Series D preferred
stock is not exchanged, to eliminate certain restrictive provisions with respect to each such
series, (iv) to eliminate the Series E preferred stock following the exchange offer and (v) to
change the name of the company from Z-Tel Technologies, Inc. to Trinsic, Inc. and (b) the adoption
of a new management equity incentive plan and reservation of shares for issuance thereunder
representing 8% of our fully diluted common stock, after giving effect to the reverse stock split. The proposals are more fully described in our definitive proxy statement filed with the Securities
and Exchange Commission on November 2, 2004. The proposals and the votes cast for and against each
proposal are set forth below. 1. To approve an offer to exchange, at the election of the holders thereof (subject in each case to
the impact of any reverse stock split) shares of our common stock for all the outstanding shares of
our Series D, Series E and Series G preferred stock. 22




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##### Table of Contents



Common Stock Votes For
    
    Against
    
    
    Abstention34,388,834
    
    
    23,5815
    
    
    
    2,300
 2. To approve, subject to approval and consummation of the exchange offer, an amendment to the
terms of the Series D preferred stock to eliminate certain preferences as set forth below: A. Eliminating the restrictions on payments of dividends on and redemptions of parity and
junior stock. Common Stock Votes For
    
    Against
    
    
    Abstention34,390,135
    
    
    20,514
    
    
    
    4,300
 Series D Preferred Stock Votes For
    
    Against
    
    
    Abstention3,970,803
 B. Eliminating the liquidation rights associated with events deemed a liquidation. Common Stock Votes For
    
    Against
    
    
    Abstention34,391,435
    
    
    19,214
    
    
    
    4,300
 Series D Preferred Stock Votes For
    
    Against
    
    
    Abstention3,970,803
 C. Amending the provisions relating to adjustments to the conversion price to limit the
circumstances pursuant to which the conversion price is adjusted and certain other amendments
related thereto Common Stock Votes For
    
    Against
    
    
    Abstention34,389,935
    
    
    20,714
    
    
    
    4,300
 Series D Preferred Stock Votes For
    
    Against
    
    
    Abstention3,970,803
 D. Eliminating the special voting rights related to certain transactions. Common Stock Votes For
    
    Against
    
    
    Abstention33,386,435
    
    
    1,024,214
    
    
    
    4,300
 Series D Preferred Stock Votes For
    
    Against
    
    
    Abstention3,970,803
 23




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3. To approve, subject to approval and consummation of the exchange offer, and subject to all of
the Series D preferred stock being exchanged in the exchange offer, an amendment of the certificate
of incorporation to eliminate the Series D preferred stock. Common Stock Votes For
    
    Against
    
    
    Abstention33,394,435
    
    
    16,214
    
    
    
    4,300
 4. To approve, subject to approval and consummation of the exchange offer, an amendment to the
certificate of incorporation to eliminate the Series E preferred stock. Common Stock Votes For
    
    Against
    
    
    Abstention33,394,935
    
    
    15,714
    
    
    
    4,300
 Series E Preferred Stock Votes For
    
    Against
    
    
    Abstention4,166,667
 5. To approve, subject to approval and consummation of the exchange offer, an amendment to the
terms of the Series G preferred stock to eliminate certain preferences as set forth below: A. Eliminating the restrictions on payments of dividends on and redemptions of parity and
junior stock. Common Stock Votes For
    
    Against
    
    
    Abstention34,403,336
    
    
    7,313
    
    
    
    4,300
 Series G Preferred Stock Votes For
    
    Against
    
    
    Abstention168.5
 B. Eliminating certain restrictions applicable if dividends on Series G Preferred Stock are
not paid. Common Stock Votes For
    
    Against
    
    
    Abstention34,403,836
    
    
    6,813
    
    
    
    4,300
 Series G Preferred Stock Votes For
    
    Against
    
    
    Abstention168.5
 C. Eliminating provisions related to changes of control. Common Stock Votes For
    
    Against
    
    
    Abstention34,405,836
    
    
    4,813
    
    
    
    4,300
 24




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##### Table of Contents



Series G Preferred Stock Votes For
    
    Against
    
    
    Abstention168.5
 D. Eliminating certain provisions related to liquidation rights Common Stock Votes For
    
    Against
    
    
    Abstention34,423,835
    
    
    16,814
    
    
    
    4,300
 Series G Preferred Stock Votes For
    
    Against
    
    
    Abstention168.5
 E. Amending the provisions relating to adjustments to the conversion price to limit the
circumstances pursuant to which the conversion price is adjusted and certain other amendments
related thereto. Common Stock Votes For
    
    Against
    
    
    Abstention34,403,336
    
    
    7,313
    
    
    
    4,300
 Series G Preferred Stock Votes For
    
    Against
    
    
    Abstention168.5
 6. To approve, subject to approval and consummation of the exchange offer, and subject to all of
the Series G preferred stock being exchanged in the exchange offer, an amendment of the certificate
of incorporation to eliminate the Series G preferred stock. Common Stock Votes For
    
    Against
    
    
    Abstention34,405,835
    
    
    4,814
    
    
    
    4,300
 Series G Preferred Stock Votes For
    
    Against
    
    
    Abstention168.5
 7. To approve, subject to approval and consummation of the exchange offer, an amendment of our
certificate of incorporation to effect a reverse stock split of the common stock in the ratio of an
integral number between and including three and eight to one, as determined at the discretion of
the board of directors, which reverse stock split at any ratio may be abandoned at any time prior
to effectiveness at the discretion of the board of directors, notwithstanding stockholders
authorization thereof. Common Stock Votes For
    
    Against
    
    
    Abstention34,160,234
    
    
    250,415
    
    
    
    4,300
 25




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8. To approve, subject to approval and consummation of the exchange offer, adoption of the 2004
Stock Incentive Plan and reservation of shares for issuance thereunder representing 8% of the fully
diluted common stock (excluding out of the money options and warrants to acquire common stock, but
including shares reserved for issuance under the plan), after giving effect to any reverse stock
split described above. Common Stock Votes For
    
    Against
    
    
    Abstention32,332,956
    
    
    536,213
    
    
    
    5,760
 9. To approve an amendment of our certificate of incorporation to change our name Trinsic, Inc. Common Stock Votes For
    
    Against
    
    
    Abstention32,853,955
    
    
    15,514
    
    
    
    5,460
 
 PART II 
 ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS SALES OF UNREGISTERED SECURITIES On November 30, 2004, we consummated a tender offer whereby we exchanged common shares for all of
our outstanding preferred stock. We reported this transaction on Form 8-K filed December 6, 2004. MARKET INFORMATION Our common shares are traded on the Nasdaq SmallCap Market under the symbol TRIN. The following
table sets forth, for the periods indicated, the range of high and low closing sale prices for the
common shares, as reported on the Nasdaq SmallCap Market. Prices have been adjusted to give
retroactive effect to a one for five reverse stock split consummated on November 30, 2004. High
    
    
    LowFiscal Year 2003:First Quarter
    
    $
    8.00
    
    
    $
    3.00Second Quarter
    
    $
    14.95
    
    
    $
    7.90Third Quarter
    
    $
    14.25
    
    
    $
    8.50Fourth Quarter
    
    $
    15.40
    
    
    $
    7.00Fiscal Year 2004:First Quarter
    
    $
    23.00
    
    
    $
    10.35Second Quarter
    
    $
    14.15
    
    
    $
    6.35Third Quarter
    
    $
    6.75
    
    
    $
    1.50Fourth Quarter
    
    $
    3.90
    
    
    $
    1.20
 HOLDERS As of March 28, 2005, there were approximately 227 registered holders of our common stock. DIVIDENDS We have not paid dividends on our common stock since our inception and do not intend to pay any
cash dividends for the foreseeable future but instead intend to retain earnings, if any, for the
future operation and expansion of our business. Any determination to pay dividends in the future
will be at the discretion of our Board of Directors and will be dependent upon our
results of operations, our financial condition, restrictions imposed by applicable law and other
factors deemed relevant by the Board of Directors. 26




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##### Table of Contents



SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS Number of securitiesremaining availableNumber of securities
    
    
    
    
    
    
    for future issuanceto be issued upon
    
    
    Weighted-average
    
    
    under equityexercise of
    
    
    exercise price of
    
    
    compensation plansoutstanding options,
    
    
    outstanding options,
    
    
    (excluding securitieswarrants and rights
    
    
    warrants and rights
    
    
    reflected in column a)Plan category
    
    (a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved by
security holders (1)
    
    
    2,024,724
    (2)
    
    $
    20.74
    
    
    
    5,337,999
    (3)(4)Equity compensation
plans not approved by
security holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    2,024,724
    
    
    
    
    
    
    
    5,337,999
   (1)   We have three equity participation plans approved by security holders: the 1998 Equity
Participation Plan, the 2000 Equity Participation Plan and the 2004 Stock Incentive Plan. The 1998
Plan was terminated in 2000, but stock options under that plan remain outstanding.(2)   
This number does not include 64,000 restricted common shares issued and outstanding.(3)   Restricted stock, dividend equivalents, deferred stock and stock appreciation rights may be
awarded under our equity participation plans in addition to option grants.(4)   Unless the board of directors sets a lesser number, the aggregate number of shares of common
stock subject to our 2000 Equity Participation Plan increases automatically on the first day of
each fiscal year by a number of shares equal to the lesser of (i) 600,000 or (ii) 6% of the
outstanding common shares on that date. 27




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##### Table of Contents



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA HISTORY OF OPERATIONS We were founded in January of 1998. In our first year of operations, we focused primarily on
research and development activities, recruiting personnel, purchasing operating assets, and
developing our service offerings and marketing plans. In the fourth quarter of 1998 we launched our
first service offering composed of an access card to make long-distance calls from any phone
coupled with enhanced services, such as voice mail, Find-me call forwarding, and community
messaging. In 1998 our revenues totaled $0.1 million. During June of 1999 we launched our residential service offering in New York. This is our bundled
telecommunications service providing integrated local, long-distance and enhanced services targeted
at residential customers. Our revenues for 1999 increased to $6.6 million. On December 15, 1999, we filed our initial public offering of 1.4 million shares. This offering
resulted in net proceeds to us of approximately $109.1 million. This offering provided us with the
opportunity, at the potential expense of profitability, to accelerate our investments in the
building of our network, the continuation of our research and development, the acceleration of
sales and marketing activities, and the development of our administrative infrastructure. We
purchased Touch 1 Communications, Inc. (Touch 1) in April 2000 in an effort to facilitate our
planned growth. These investments lead to our revenues growing to $177.7 million in 2000.
Nevertheless, these investments also significantly increased our operating and cash expenditures. This growth was slowed during 2001 as we moved our focus from growth to operating profitability. We
focused on lowering customer acquisition costs, improving operating efficiencies, and attracting
and maintaining a higher quality customer, which initiatives resulted in a charge of $29.9 million
relating to the write-off of certain accounts receivables and a $59.2 million impairment of assets
relating to the sale of certain assets, primarily telemarketing centers. We also experienced a
reduction in overall headcount in 2001 through a workforce reduction, attrition and the sale of the
majority of the operations and assets of the telemarketing centers that we acquired in 2000. In
2001, we had revenues of $280.4 million and incurred a net loss of $146.1 million compared to a net
loss of $88.0 million in 2000. We continued our focus on operating improvement and cash management during 2002. We also decided to
diversify our services and revenues streams by offering wholesale services to other telephone
companies. We signed a contract with MCI WorldCom Communications, Inc. (MCI) at the end of the
first quarter of 2002. We recorded $238.4 million of revenues and net loss of $19.6 million during
2002. Our wholesale services represented 12.9% of total reported revenues for the year ended
December 31, 2002. Although the results of 2003 appear to be very similar to those reported for 2002, there were
several significant changes that occurred during 2003. We signed an agreement with Sprint
Communications, LP (Sprint) in February of 2003. This agreement provided us with a wholesale
customer that grew to nearly 300,000 lines in the first 10 months of our relationship. This
agreement provided significant positive cash and operating results and helped mitigate the negative
impact of the loss of the MCI wholesale agreement that was terminated in October of 2003. The MCI
wholesale contract had a large amount of uncertainty due to MCIs bankruptcy proceedings. We also
invested in a large amount of sales and marketing during the first half of 2003 to help increase
our retail lines. After assessing the results of these efforts and the increased competition and
pricing pressure that has continued to occur in the residential telephone market we decided to
shift our growth initiatives to our business and wholesale services during the second half of 2003. During 2004, in anticipation of changes in the telecommunications marketplace and also in
anticipation of possible negative regulatory rulings regarding UNE-P, we began deploying our own
facilities-based network in selected areas for Voice over Internet Protocol (VoIP) services.
Subsequent to the change of management that occurred in the third quarter of 2004, several actions
were initiated to improve the overall operating cash flow of the company. The most significant was
a change in company direction that reduced the focus on enhanced services technology development
and increased the focus on building our customer base, revenue streams and continuing VoIP
deployment plans. Related to these improvements, we also began hiring experienced sales teams that
would be able to effectively sell existing and new product offerings to the small to mid-size
business market in areas to be serviced by this network. By the end of 2004, we had deployed Cisco
based network facilities in Tampa, Orlando and Atlanta and were aggressively working toward
deployment in New York. In addition, we enacted a reduction in personnel costs in September and
October 2004 (see Note 15 of notes to financial statements) to better align the companys cost
structure with the companys new direction. During 2005 we expect to generate moderate consumer line growth, largely focused in the Northeast.
We still anticipate that our consumer base will account for the largest portion of our overall revenue stream and our operating
cash flow over the full year. We will also continue to focus on building our IP Telephony business
customer base largely focused on the New York Metro and 28




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Tampa Metro market areas. Our VoIP offerings may provide additional revenues, but will not likely contribute meaningfully to positive
operations or be of a significant nature until 2006. Additionally we will continue to deploy
facilities aimed at serving the consumer market segment as resources permit and look to migrate
customers to our own network at a moderate pace. The following selected historical consolidated financial data have been derived from our
consolidated financial statements and should be read in conjunction with the financial statements,
related notes and other financial information contained in this document. You should also read
Managements Discussion and Analysis of Financial Condition and Results of Operations, presented
later in this document. Historical results are not necessarily indicative of future results. Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000 (6)(In thousands, except share and per share data)Revenues
    
    $
    251,477
    
    
    $
    289,180
    
    
    $
    238,397
    
    
    $
    280,350
    
    
    $
    177,668Operating expenses:Network operations (7)
    
    
    123,723
    
    
    
    135,531
    
    
    
    94,422
    
    
    
    159,617
    
    
    
    107,077Sales and marketing
    
    
    21,094
    
    
    
    19,421
    
    
    
    11,319
    
    
    
    31,243
    
    
    
    45,018General and administrative (2)
    
    
    112,350
    
    
    
    125,765
    
    
    
    123,578
    
    
    
    156,107
    
    
    
    99,606Asset impairment charge (1)
    
    
    
    
    
    
    
    
    
    
    1,129
    
    
    
    59,247
    
    
    
    Wholesale development costs (4)
    
    
    
    
    
    
    
    
    
    
    1,018
    
    
    
    
    
    
    
    Restructuring charge (5)
    
    
    4,801
    
    
    
    
    
    
    
    1,861
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    19,764
    
    
    
    23,449
    
    
    
    23,936
    
    
    
    23,277
    
    
    
    17,166Total operating expenses
    
    
    281,732
    
    
    
    304,166
    
    
    
    257,263
    
    
    
    429,491
    
    
    
    268,867Operating loss
    
    
    (30,255
    )
    
    
    (14,986
    )
    
    
    (18,866
    )
    
    
    (149,141
    )
    
    
    (91,199
    )Nonoperating income (loss):Interest and other income
    
    
    2,753
    
    
    
    1,930
    
    
    
    3,448
    
    
    
    6,862
    
    
    
    5,475Interest and other expense
    
    
    (6,111
    )
    
    
    (3,071
    )
    
    
    (4,137
    )
    
    
    (3,789
    )
    
    
    (2,313
    )Total nonoperating income (loss)
    
    
    (3,358
    )
    
    
    (1,141
    )
    
    
    (689
    )
    
    
    3,073
    
    
    
    3,162Net loss
    
    
    (33,613
    )
    
    
    (16,127
    )
    
    
    (19,555
    )
    
    
    (146,068
    )
    
    
    (88,037
    )Less mandatorily redeemable convertible
preferred stock dividends and accretion
    
    
    (15,326
    )
    
    
    (17,480
    )
    
    
    (15,589
    )
    
    
    (15,059
    )
    
    
    (3,644
    )Less deemed dividend related to beneficial

conversion feature
    
    
    (57,584
    )
    
    
    (186
    )
    
    
    (186
    )
    
    
    (9,356
    )
    
    
    (20,027
    )Net loss attributable to common stockholders
    
    $
    (106,523
    )
    
    $
    (33,793
    )
    
    $
    (35,330
    )
    
    $
    (170,483
    )
    
    $
    (111,708
    )Weighted average common shares outstanding (8)
    
    
    11,676,783
    
    
    
    7,079,384
    
    
    
    6,990,344
    
    
    
    33,908,374
    
    
    
    33,066,538Basic and diluted net loss per share
    
    $
    (9.12
    )
    
    $
    (4.77
    )
    
    $
    (5.05
    )
    
    $
    (5.03
    )
    
    $
    (3.38
    )Consolidated Balance Sheet DataCash and cash equivalents (3)
    
    $
    1,363
    
    
    $
    12,013
    
    
    $
    16,037
    
    
    $
    18,892
    
    
    $
    46,650Working capital (deficit)
    
    
    (52,898
    )
    
    
    (31,095
    )
    
    
    (19,380
    )
    
    
    (11,983
    )
    
    
    59,245Total assets
    
    
    61,336
    
    
    
    81,670
    
    
    
    106,711
    
    
    
    116,737
    
    
    
    246,461Total debt
    
    
    20,503
    
    
    
    5,531
    
    
    
    10,144
    
    
    
    15,766
    
    
    
    20,417Mandatorily convertible redeemable preferred
stock (3) (8)
    
    
    
    
    
    
    144,282
    
    
    
    127,631
    
    
    
    112,570
    
    
    
    84,585Total stockholders equity (deficit)
    
    
    (21,082
    )
    
    
    (131,019
    )
    
    
    (99,284
    )
    
    
    (67,172
    )
    
    
    89,100Other Financial DataNet cash provided by (used in) operating
activities
    
    
    (16,845
    )
    
    
    11,956
    
    
    
    18,399
    
    
    
    (21,846
    )
    
    
    (96,862
    )Net cash used in investing activities
    
    
    (9,484
    )
    
    
    (10,996
    )
    
    
    (15,600
    )
    
    
    (15,615
    )
    
    
    (40,602
    )Net cash provided by (used in) financing
activities
    
    
    15,679
    
    
    
    (4,984
    )
    
    
    (5,654
    )
    
    
    9,701
    
    
    
    82,455
 Significant items impacting results In August 2003, we received notice that MCI WorldCom Communications, Inc. was terminating the
wholesale services agreement they signed with us effective October 15, 2003. This agreement was
entered into in March 2002. In February 2003, we signed a wholesale services agreement with Sprint
Communications Company, LP.  (1)
    We recorded a $1.1 and $59.2 million expense related to impaired assets in 2002 and
2001, respectively. This expense was the result of managements decision to reduce various customer growth initiatives, most
notably telemarketing activity levels. In 2001, a majority of the operations and assets of
telemarketing centers acquired from Touch 1 were 29




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##### Table of Contents



either voluntarily closed or sold. In addition to the goodwill impairment of $54.9 million, we recorded a $4.3 million charge
associated with the impairment of assets, composed of $3.0 million relating to unrealizable
software and development projects, $0.9 million of a worthless telemarketing property and
equipment, and $0.4 million of securities deemed to be worthless. As a result of managements
decision in the second quarter of 2002 to enhance future cash flow and operating earnings, we
closed the remaining call centers in North Dakota and recorded a $1.1 million asset
impairment. We also incurred restructuring charges as a result of this decision during 2002
as discussed in item (5).(2)
    Included in the 2001 general and administrative expense was a write-off of accounts
receivable that resulted in $29.9 million of additional bad debt expense.(3)
    During 2000, we issued Series D and E preferred stock for approximately $56.3 million
and $50.0 million, respectively. During 2001 we issued Series G preferred stock for
approximately $17.5 million.(4)
    During 2002, we began to provide our services on a wholesale basis. We recorded
start-up costs for developing this new service offering of approximately $1.0 million. All
wholesale related costs after our initial wholesale services contract signed on March 20,
2002 are included in the operating expenses line items, rather than being segregated.(5)
    During 2002, we closed two call centers in North Dakota and our New York sales office
as discussed in Item 1 above. The restructuring charges consisted primarily of termination
benefits, lease abandonment and lease settlement costs. During 2004, in support of
efforts to improve our future cash flows and operating earnings and to consolidate
operations, we recorded restructuring charges which included termination benefits in
connection with reductions in force as well as the write-off of certain assets.(6)
    We completed the acquisition of Touch 1 Communications, Inc. (Touch 1), on April 14,
2000. We used the purchase accounting method to record our acquisition of Touch 1.(7)
    During 2002, we received a $9.0 million retroactive rate reduction for the unbundled
network elements from Verizon as a result of a settlement with the New York Public Service
Commission.(8)
    On November 19, 2004, at a special shareholders meeting, our shareholders approved an
offer to exchange our three outstanding series of convertible preferred stock for common
stock. 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. You should read the following discussion together with the Selected Consolidated Financial Data,
financial statements and related notes included in this document. This discussion contains
forward-looking statements that involve risks and uncertainties. Our actual results may differ
materially from those projected in the forward-looking statements as a result of certain factors,
including, but not limited to, those discussed in Item 1. Business, as well as Cautionary
Statements Regarding Forward-Looking Statements, and Risks Related to our Financial Condition and
our Business below, and other factors relating to our business and us that are not historical
facts. Factors that may affect our results of operations include, but are not limited to, our
limited operating history and cumulative losses, uncertainty of customer demand, rapid expansion,
potential software failures and errors, potential network and interconnection failure, dependence
on local exchange carriers, dependence on third party vendors, success and profitability of our
wholesale services, dependence on key personnel, uncertainty of government regulation, legal and
regulatory uncertainties, and competition. We disclaim any obligation to update information
contained in any forward-looking statement. OVERVIEW We offer local and long distance telephone services in combination with enhanced communication
features accessible through the telephone or the Internet. These features include Personal Voice
Assistant (PVA), Find-Me, Notify-Me, caller identification, call waiting and speed dialing.
PVA allows users to store contacts in a virtual address book and then access and utilize that
information by voice from any telephone. PVA users can also send voice e-mails. We are an emerging
provider of advanced, integrated telecommunications services targeted to residential and business
customers. We have successfully deployed Cisco soft switches in the Tampa and New York City
markets and intend on targeting multi-line business customers with our converged IP telephony
services. We also intend on using these soft switches to serve consumers as we continue to deploy
broadband loop concentrators into central offices. In addition to providing our services on a
retail basis, we are also providing these services on a wholesale basis. Our wholesale services
provide other companies the ability to utilize our telephone exchange services, enhanced services
platform, infrastructure and back-office operations to provide services to retail and business
customers on a private label basis. For management purposes, we are organized into two reportable operating segments: retail
services and wholesale services. The nature of our business is rapidly evolving, and we have a
limited operating history. 30




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Economic and Industry-Wide Factors The overall telecommunication industry is experiencing an enormous amount of competition. Although
telecommunications has always been relatively competitive, it seems that competitive pressures are
even further intensifying, as incumbent and new providers continue to undercut each other in price
while offering more and new services. In order to promote new services, providers usually provide
immediate discounts and enticements to join and this generally makes prospective customers more
willing perhaps to switch telecommunication providers and experiment with new service offerings.
The industry is also receiving entrants from other industries, which is creating various bundling
and pricing opportunities. Not only are end user prices generally decreasing, but customers are
also receiving more minutes, features, options, and partnering advantages than has been typically
available in the past. The industry is also experiencing increased churn as service providers in
the wireline, wireless, VoIP, cable, internet, satellite, and other markets compete for and in some
cases cannibalize each-others customer bases with various marketing and partnering opportunities.
The overlapping of markets is also driving the desire of companies to be the sole provider of
services across many communication markets, which provides additional margins and an incentive to
customers to stay with the provider as a result of discounts for receiving multiple services. On December 15, 2004, the FCC ruled that incumbent local exchange carriers are no longer required
to provide Trinsic and other competitive telephone companies access to unbundled analog switching 
a key component of the Unbundled Network Element Platform combination of elements, or UNE-P, which
is how we have historically and currently provide services to the vast majority of our customers.
This FCC Triennial Review Remand Orderalso limited our ability to access unbundled high-capacity
loops and dedicated transport in many urban and suburban locations. This order will have a
material adverse effect on our business. Several parties have petitioned the FCC to reconsider
certain aspects of the order and other parties have filed court appeals of the FCC decision in
federal court. To offset this uncertainty and the restrictions imposed by the FCC, we have signed
a commercial agreement with Qwest that will continue to allow us to provide retail services
utilizing a UNE-P type product to new customers. We have also signed an interim commercial
services agreement with Verizon and we are in discussions with other ILECs regarding similar
commercial agreements which would expand the footprint where we can provide services to new end
users. We are also participating in regulatory proceedings on the state level where state law may
require continued provision of UNE-P services. We cannot predict the outcome of these regulatory
proceedings nor the commercial negotiations with any certainty. As the local analog switching
component is the single ILEC component most subject to withdrawal and significant rate increases,
our VoIP service deployment is envisioned to offer some relief to arbitrary ILEC actions. However,
the amount of capital required to deploy VoIP services and the cutting edge nature of VoIP
applications raises risks that we may not deploy and implement VoIP services in a timely manner.
See sections of this report entitled Government Regulation and Risks Relating to Our Financial
Condition and Our Business. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based upon our
consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The preparation of these
financial statements requires us to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates,
including those related to revenue recognition, disputed payables related to network operations
expense, valuation of accounts receivable, property, plant and equipment, long-lived and intangible
assets, restructuring reserves, tax related accruals and contingencies. We base our estimates on
experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
materially differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and
estimates used in the preparation of our consolidated financial statements. Revenue Recognition.Revenues are recognized when earned. Revenues related to long distance and
carrier access service charges are billed monthly in arrears, and the associated revenues are
recognized in the month when services are provided. Charges for our bundled services are billed
monthly in advance and we recognize revenues for these services ratably over the service period.
Revenues from installations and activation activities are deferred and recognized over twelve
months. We began offering wholesale services during 2002. This service offering includes fees for services
provided according to certain per line, per minute and other certain activities as defined in our
agreements and also the payments of providing telephone exchange, vendor and personnel expenses. We
perform a review of each contract and determine the appropriate timing of revenue recognition depending on the facts and circumstances of each individual item within the contract.
We are currently deferring certain revenues over the life of our arrangement, rather than recognizing revenues up-front. We use the gross method to record 31




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our revenues for wholesale services. This method involves the recording of revenues for items that we are directly reimbursed
by our wholesale customer with an offsetting expense reported in the appropriate operating expense
line. Disputed Payables Related to Network Operations and General and Administrative Expense.Network
operations expenses are primarily charges from the ILECs for the leasing of their lines, utilizing
the UNE-P, made available to us as a result of the Telecommunication Act of 1996, and long distance
and other charges from inter-exchange carriers (IXCs). We record certain charges such as up-front
set-up fees, incorrect dispatch, and change and modification charges in the general and
administrative expense line item. We typically have disputed billings with IXCs and ILECs as a
matter of normal business operations. Certain of these disputed amounts are recorded as an expense
at the time of dispute, but we do not pay any of our disputes until they are resolved and it is
determined that we indeed owe part or all of the dispute. Our disputes are for various reasons
including but not limited to incorrect billing rates, alternatively billed services, duplicate
billing errors, and costs associated with line loss. This pricing is subject to both state and
federal oversight and therefore, our pricing is subject to change. Any such change could have a
material impact on our business. Management recognizes as disputes any previously disputed billing that is continued to be presented
as a past-due amount on invoices that we receive. This approach results in the disclosure of
certain disputes that management does not believe are of a significant risk to the company,
primarily due to the age and/or the dispute, but believe are appropriate to disclose the amounts as
they have not been resolved and continue to be billed to us as past-due amounts. Valuation of Accounts Receivable.Considerable judgment is required to assess the ultimate
realization of receivables, including assessing the probability of collection and the current
credit-worthiness of our customers. We regularly analyze our approach as we gain additional
experience or new events and information are identified to determine if any change to our
methodology is warranted. Our current allowance methodology is based upon an ongoing analysis of
customer payment trends. Additionally, we have performed liquidation and other collection analyses
to make necessary changes in reporting our accounts receivable in a reasonable and prudent fashion. Property, Plant and Equipment.Changes in technology or changes in the intended use of property,
plant and equipment may cause the estimated period of use or the value of these assets to change.
We utilize straight-line depreciation for property and equipment. We perform an annual analysis to
confirm the appropriateness of estimated economic useful lives for each category of current
property, plant and equipment. Estimates and assumptions are used in both setting depreciable lives
for various asset classes and in testing for recoverability. These estimates and assumptions
require considerable judgment. Tax Related Accruals. Our estimates of deferred and current income taxes and the significant items
giving rise to the deferred assets and liabilities are shown in footnote 16 Income Taxes to our
consolidated financial statements. These reflect our assessment of actual current and future
estimated income taxes to be paid on items reflected in the financial statements, giving
consideration to both timing and probability of actual realization. Currently we have placed a 100%
valuation allowance on all deferred tax assets. A valuation allowance is provided against the
future benefits of deferred tax assets due to our history of operating losses. We also are subject
to various tax audits from various federal, state, and local jurisdictions and make estimates based
on available information and after consultation with experts, where necessary. We believe that our
estimates are reasonable; however, they may change materially in the future due to new
developments. Contingencies. We are subject to proceedings, lawsuits, audits and other claims related to lawsuits
and other legal and regulatory proceedings that arise in the ordinary course of business. We are
required to assess the likelihood of any adverse judgments or outcomes to these matters as well as
potential ranges of probable losses. A determination of the amount of loss accrual required, if
any, for these contingencies are made after careful analysis of each individual issue. We consult
with legal counsel and other experts where necessary in connection with our assessment of any
contingencies. The required accrual for any such contingency may change materially in the future
due to new developments in each matter. RESULTS OF OPERATIONS The following discussion of results of operations is by business segment. Management evaluates the
performance of each business unit based on segment results, exclusive of adjustments for unusual
items that may arise. Unusual items are transactions or events that are included in our reported
consolidated results, but are excluded from segment results due to their non-recurring or
non-operational nature. See our segment footnote to our consolidated financial statements for a
reconciliation of segmented results to the consolidated financial information. 32




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##### Table of Contents



Revenues For the year ended December 31,
    
    
    Percentage of RevenuesTotal revenues by segment (in millions)


    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Retail Segment
    
    $
    170.8
    
    
    $
    205.1
    
    
    $
    207.6
    
    
    
    68.0
    %
    
    
    70.9
    %
    
    
    87.1
    %Wholesale segment
    
    
    80.4
    
    
    
    84.1
    
    
    
    30.8
    
    
    
    32.0
    %
    
    
    29.1
    %
    
    
    12.9
    %Total Revenues
    
    $
    251.2
    
    
    $
    289.2
    
    
    $
    238.4
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 To be consistent with emerging industry practices, the revenues for all periods presented have been
reclassified to reflect the billing to our customers of the Universal Service Fund (USF) and other
regulatory fees and the related payments into the associated regulatory funds as network operations
expense. Operating income and net income for all periods presented were unaffected. The
additional revenues and expenses recorded were $5.8 million, $4.2 million and $3.1 million for the
years ended December 31, 2004, 2003 and 2002, respectively. Two significant drivers impact our revenues: number of lines in service and average (monthly)
revenue per unit (ARPU). The more significant driver impacting our changes in revenue is the
number of lines in service. The table below provides a detail break-down of our lines: Average lines in service
    
    
    Ending lines in servicefor the year ended
    
    
    as ofDecember 31,
    
    
    December 31,Type of Service
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Bundled residential services
    
    
    181,632
    
    
    
    232,827
    
    
    
    224,049
    
    
    
    188,643
    
    
    
    204,758
    
    
    
    203,453Bundled business services
    
    
    46,958
    
    
    
    8,017
    
    
    
    
    
    
    
    47,299
    
    
    
    21,593
    
    
    
    1+ long distance services
    
    
    41,079
    
    
    
    90,584
    
    
    
    134,000
    
    
    
    40,393
    
    
    
    74,419
    
    
    
    106,652Wholesale services
    
    
    295,493
    
    
    
    158,199
    
    
    
    35,796
    
    
    
    299,644
    
    
    
    296,824
    
    
    
    55,523VoIP
    
    
    1,436
    
    
    
    
    
    
    
    
    
    
    
    1,556
    
    
    
    
    
    
    
    Total lines under management
    
    
    566,598
    
    
    
    489,627
    
    
    
    393,845
    
    
    
    577,535
    
    
    
    597,594
    
    
    
    365,628
 ARPU provides us with a business measure as to the average monthly revenue generation attributable
to each line in service, by business segment. ARPU is calculated by taking total revenues over a
period divided by the number of months in the period to calculate the average revenue per month and
this total is divided by the average lines in service. We use this measure when analyzing our
retail services businesses, but not when assessing our wholesale services business for reasons
discussed earlier in this section under the Critical Accounting Policies and Estimates within the
Revenue Recognition section. The following table provides a detail of our ARPU: For the year ended December 31,Average revenue per unit in service
    
    2004
    
    
    2003
    
    
    2002Bundled residential services
    
    $
    66.30
    
    
    $
    68.26
    
    
    $
    70.86Bundled business services
    
    $
    33.54
    
    
    $
    38.46
    
    
    
    N/A1+ long distance services
    
    $
    15.01
    
    
    $
    9.84
    
    
    $
    10.45
 During 2005 we expect to generate moderate consumer line growth, largely focused in the Northeast.
We still anticipate that our consumer base will account for the largest portion of our overall
revenue stream and our operating cash flow over the full year. We will also continue to focus on
building our IP Telephony business customer base largely focused on the New York Metro and Tampa
Metro market areas. Our VoIP offerings may provide additional revenues, but will not likely
contribute meaningfully to positive operations or be of a significant nature until 2006.
Additionally we will continue to deploy facilities aimed at serving the consumer market segment as
resources permit and look to migrate customers to our own network at a moderate pace. 33




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##### Table of Contents



Retail Segment For the year ended December 31,
    
    
    Percentage of RevenuesRetail segment revenues by type (in millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Bundled residential services
    
    $
    144.5
    
    
    $
    190.7
    
    
    $
    191.2
    
    
    
    84.6
    %
    
    
    93.0
    %
    
    
    91.8
    %Bundled business services
    
    
    18.9
    
    
    
    3.7
    
    
    
    0.3
    
    
    
    11.1
    %
    
    
    1.8
    %
    
    
    0.1
    %1+ long-distance services
    
    
    7.4
    
    
    
    10.7
    
    
    
    16.8
    
    
    
    4.3
    %
    
    
    5.2
    %
    
    
    8.1
    %Total Revenues
    
    $
    170.8
    
    
    $
    205.1
    
    
    $
    208.3
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  
    During 2004, the decrease in retail revenue of $34.3 million as compared to 2003, was
primarily the result of the decline in residential UNE-P lines and access fee revenue
(charges that we bill to other carriers for carrying their traffic to our customers)
declines.
    Although our average number of residential lines increased in 2003, ARPU decreased by
$2.60 primarily due to a decrease in the access rates that went into effect in June of
2003.
    Also during 2003, to address pricing trends and to react to the highly competitive
telecommunications market, we actively marketed our unlimited bundled service offering to
residential customers. The unlimited service has a lower ARPU than some of our historical
pricing plans, because it includes for a fixed price, unlimited domestic and local calling,
in addition to all of our enhanced services. During the first half of 2003, we were almost exclusively focused on growing our residential
services to the exclusion of any of our other lines of business. However, at mid year management
made the decision to slow the growth of residential lines over the second half of the year through
the fourth quarter of 2004, and instead to redirect sales and marketing investment to the newly
formed business services line of business, as well as to the new wholesale services partnership
with Sprint, neither of which existed in a meaningful fashion during most of the first half of
2003. Management judged that the retail business services and wholesale services lines of business
offered a superior return on investment when compared to the traditional retail residential
consumer business. In 2002, we decided to slow our residential line growth and we were solely
dependent on our wholesale services business (primarily MCI at the time) for overall line growth.
In 2003, we had diversified into business services to provide us with more opportunities to achieve
retail line growth. Wholesale Segment For the year ended December 31,
    
    
    Percentage of RevenuesWholesale segment revenues by type (in millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Sprint
    
    $
    78.2
    
    
    $
    59.7
    
    
    $
    
    
    
    
    97.3
    %
    
    
    71.0
    %
    
    
    0.0
    %MCI
    
    
    0.3
    
    
    
    23.9
    
    
    
    30.2
    
    
    
    0.4
    %
    
    
    28.4
    %
    
    
    98.1
    %Other
    
    
    1.9
    
    
    
    0.5
    
    
    
    0.6
    
    
    
    2.4
    %
    
    
    0.6
    %
    
    
    1.9
    %Total Revenues
    
    $
    80.4
    
    
    $
    84.1
    
    
    $
    30.8
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  
    In February 2004, we signed a new wholesale services agreement with Working Assets
Funding Services, Inc. Although the growth from this relationship was significantly less
than that with our Sprint agreement, it provided some additional revenue in 2004. In
January 2005, Working Assets ceased to offer retail services to these customers, any
remaining customers at that time became customers of Trinsic Communications, Inc. and a
commission will be paid to Working Assets on a go forward basis based on monthly recurring
revenues.

    We signed our wholesale services agreement with Sprint in February of 2003. Sprint
contributed $78.2 million and $59.7 million of revenue for the years ended December 31,
2004 and 2003, respectively, and was our primary wholesale customer during those two years,
replacing MCI. Wholesale revenues in 2002 were primarily from our wholesale contract with
MCI. On August 15, 2003, MCI provided us with notice that they were terminating the
contract effective October 15, 2003. As a result of this notice we accelerated the
recognition of $4.7 million of deferred revenue due to the new termination date of October
15, 2003. Prior to MCIs decision to terminate the agreement early, this revenue was being
recognized ratably over the life of the agreement, in accordance with GAAP, with an
original termination date of 34




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##### Table of Contents



December 31, 2005. As a result of this treatment, our revenues related to MCI increased;
however, there was no increase to our cash flow, as the cash had already been paid in the
prior year. We expect that our wholesale lines in service will continue to decline steadily during 2005. While
revenues are expected to decline as well over this period, the amount of decline may not directly
correspond to the reduction in line count. The degree of revenue attrition will be directly tied
to the number of departing Sprint end users whose ILEC local service arrangements were billed
through Trinsic versus the number of departing Sprint end users whose ILEC local service
arrangements were billed directly to Sprint by the ILEC. We employ the gross accounting method for
recognizing revenue within the wholesale service business segment; therefore, where ILEC billings
are passed through Trinsic, we record revenue for certain services that we provide to Sprint at our
cost and record the off-setting expense in one of the respective operating cost lines within our
income statement when we are the primary obligor. These revenues (and cost pass-through items)
result in no contribution to operating profit. The largest revenue component that is treated in
this manner is the charge from the ILECs, which are recorded in network operations and general and
administrative expense. Also our stated accounts payable will decrease as we will no longer be
incurring this liability. Therefore, to the extent that departing Sprint end users are concentrated
among the base billed for ILEC services through Trinsic, the amount of revenue loss per departing
end users will be greater than for departing Sprint end users who are direct billed by the ILEC to
Sprint. The direct impact of the loss of Sprint end users upon profitability to Trinsic has no
relationship to whether the ILEC bills are passed through Trinsic or direct billed to Sprint. Network Operations Our network operations expense primarily consists of fixed and variable transmission expenses for
the leasing of the UNE-P components from the ILECs, domestic and international charges from service
level agreements with IXCs, and the USF and certain other regulatory charges to be consistent with
industry practice. The following table shows the break-down by segment of network operations
expense: Network operations expense, exclusive of depreciation and amortization expense, by segment
    
    For the year ended December 31,
    
    
    Percentage of Segment Revenues(in millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Retail Segment
    
    $
    86.7
    
    
    $
    98.1
    
    
    $
    83.7
    
    
    
    50.8
    %
    
    
    47.8
    %
    
    
    40.3
    %Wholesale Segment
    
    
    37.0
    
    
    
    37.0
    
    
    
    10.8
    
    
    
    46.0
    %
    
    
    44.0
    %
    
    
    0.0
    %Total Network Operations Expense
    
    $
    123.7
    
    
    $
    135.1
    
    
    $
    94.5
    
    
    
    49.2
    %
    
    
    46.7
    %
    
    
    39.6
    %
 The following table shows the break-down by type of network operations expense: For the year ended December 31,
    
    
    Percentage of Network OperationsNetwork operations expense, exclusive of depreciation and amortization, by type (in millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Bundled residential services
    
    $
    75.2
    
    
    $
    93.4
    
    
    $
    74.9
    
    
    
    60.8
    %
    
    
    69.1
    %
    
    
    79.3
    %Bundled business services
    
    
    10.1
    
    
    
    2.1
    
    
    
    5.3
    
    
    
    8.2
    %
    
    
    1.6
    %
    
    
    5.6
    %1+ long distance services
    
    
    1.4
    
    
    
    2.6
    
    
    
    3.5
    
    
    
    1.1
    %
    
    
    1.9
    %
    
    
    3.7
    %Wholesale services
    
    
    37.0
    
    
    
    37.0
    
    
    
    10.8
    
    
    
    29.9
    %
    
    
    27.4
    %
    
    
    11.4
    %Total
    
    $
    123.7
    
    
    $
    135.1
    
    
    $
    94.5
    
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 During 2004, network operations expense decreased by $19.4 million as compared to 2003 for
residential and 1+ long distance services; this is the result of the decrease in average lines year
over year from approximately 323,000 to 223,000. Network operations expense increased for bundled
business services from $2.1 million to $10.1 million in 2004 as compared to 2003 because the
average lines in service increased from approximately 8,000 in 2003 to approximately 47,000 in
2004. The overall increase in network operations expense during 2003 was primarily driven by our increase
in wholesale lines in service from our contract with Sprint. The increase of approximately 8,000
lines in the average bundled residential and business service 35




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lines also contributed to the increased expense. The reduction in our 1+ long distance service
expense provided a small off-set to these increases. We recorded a reduction to network operations expense for certain retroactive rate reductions and
billing errors in the amount of $2.5 million during 2003 compared to a $9.0 million retroactive
rate reduction for access rates recorded in 2002. Excluding the impact of these retroactive rate
reductions, the consolidated network costs, as a percentage of revenues were 47.6% for 2003
compared to 43.4% in the prior year. We also analyze the average expense per unit (AEPU) for network operations, similar to the ARPU
calculation for revenues. AEPU is calculated by taking total network operations expense over a
period divided by the number of months in the period to calculate the average expense per month and
this total is divided by the average lines in service. The following details AEPU for network
operations expense. For the year ended December 31,Average network operations expense per unit
    
    2004
    
    
    2003
    
    
    2002Bundled residential services
    
    $
    34.50
    
    
    $
    33.43
    
    
    $
    27.86Bundled business services
    
    $
    17.92
    
    
    $
    21.83
    
    
    
    N/A1+ long distance services
    
    $
    2.84
    
    
    $
    2.39
    
    
    $
    2.18
 During 2004, AEPU increased on the residential side and decreased on the business side. These
fluctuations are the net result of four offsetting factors: (1) increased usage as a result of our
residential customers choosing our unlimited product which generally results in increased domestic
long-distance charges; (2) changes in per line costs as our customer base continues to become more
geographically diverse resulting in some changes to the average cost experienced as a result of
having more lines in higher or lower priced UNE-P states and zones; (3) our auditing and analysis
of network operations and improving the synchronization of our billing systems to help reduce
network costs on a per unit basis; and (4) changes in ILEC rates. In 2003, we experienced a small increase in the AEPU which contributed to our increase in network
operations expense. In early 2002, the New York Public Service Commission approved a settlement, which reduced the
prices that we and other competitive local exchange carriers paid for unbundled network elements
and expanded the availability of those elements. Specifically, rates for the elements comprising
the unbundled network element platform were reduced by approximately $8 to $9 per month per
subscriber, on average. These rate decreases were effective March 1, 2002. Also, the Commission
directed Verizon to provide bill credits to us in the amount of $9.0 million to implement
retroactive rate decreases for unbundled local switching. We received and recorded the entire
credit during 2002. We expect network operations expense to increase in 2005 as we plan for rate increases associated
with the FCCs recent UNE-P ruling and our interconnection agreement with Qwest as well as any
other rate increases that we may incur by entering into any additional interconnection agreements
with other ILECs. We also expect our network operations expense to increase as a result of the
associated fixed cost structure that we will incur related to our VoIP offering. Retail Segment The following table provides a detail of network operations expense as a percentage of revenues by
the respective revenue types. This table excludes an analysis of wholesale services because
management does not look at this measure, given that network expenses related to wholesale services
are intended to be zero-margin direct cost pass-through in nature. For the year ended December 31,Network operations expense as a percentage of revenues
    
    2004
    
    
    2003
    
    
    2002Bundled residential services
    
    
    52.0
    %
    
    
    49.0
    %
    
    
    39.2
    %Bundled business services
    
    
    53.4
    %
    
    
    56.8
    %
    
    
    N/A1+ long distance services
    
    
    18.9
    %
    
    
    24.3
    %
    
    
    20.8
    %
 36




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##### Table of Contents




    In 2004, network operations expense related to bundled business services and 1+ long
distance services as a percentage of revenues decreased primarily as a result of continued geographical dispersion of customers to
less expensive pricing zones and states and our auditing and analysis of network operations.
Network operations expense related to bundled residential services as a percentage of
revenues increased due to increased usage related to unlimited product offerings, increased
ILEC rates and changes in geographic distribution of our customer base.
    During 2003, the increase in network operations expense after excluding retroactive rate
reductions was a result of increased long distance usage from the growth in our unlimited
service offering and the mix of our customer base being spread across more states that had
less favorable pricing when compared to the states in which we had customers in the prior
year. These increases were partially offset by reductions to network operations as a result
of improved internal operations and processes intended to minimize our network operations
costs. Wholesale Segment  
    During 2004, network operations expense from the wholesale segment was $37.0 million,
the same as it was for 2003. As stated in the revenue paragraph, Sprint decided to become
the customer of record for billing purposes from the ILECs. This caused a decrease to the
network operations expense which was offset by the increase of network operations expenses
associated with approximately 137,000 additional lines in service for the year ended
December 31, 2004.
    In 2003, network operations expense increased by $26.2 million to $37.0 million for the
year ended December 31, 2003, compared to $10.8 million in the prior year. This was
primarily due to the large increase in average wholesale lines in service as a result of
the Sprint contract. Sales and Marketing The sales and marketing expense primarily consists of telemarketing, direct mail, brand awareness
advertising and independent sales representative commissions and salaries and benefits paid to
employees engaged in sales and marketing activities. The following table shows the break-down by
segment of sales and marketing expense: For the year ended December 31,
    
    
    Percentage of Segment RevenuesSales & marketing expense by segment (in millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Retail Segment
    
    $
    20.9
    
    
    $
    19.3
    
    
    $
    11.3
    
    
    
    12.2
    %
    
    
    9.4
    %
    
    
    5.4
    %Wholesale segment
    
    
    0.2
    
    
    
    0.1
    
    
    
    
    
    
    
    0.2
    %
    
    
    0.1
    %
    
    
    0.0
    %Total Sales & Marketing Expense
    
    $
    21.1
    
    
    $
    19.4
    
    
    $
    11.3
    
    
    
    8.4
    %
    
    
    6.7
    %
    
    
    4.7
    %
 The increase in sales and marketing expense during 2004 as compared to 2003 was primarily due to
the additional sales teams we added to begin selling our new VoIP products. We also increased
direct mail campaigns during 2004 as compared to the prior year. These increases were largely
offset by a significant decrease in advertising expense. During the first half of 2003, we increased our sales and marketing efforts to attract residential
lines. As a result of intense competition and the economics of a residential customer relative to
a business customer, we elected to shift our primary focus of time and monetary resources to the
marketing of our newly introduced business services. This was achieved primarily through the
addition of an in-house sales team. We have also recruited master independent sales contractors to
assist with growing this line of business. This focus has provided us with the ability to leverage
our national footprint by offering prospective end users a consolidating billing solution and by
providing local and long distance services to multi-location businesses. This is also intended to
further diversify our service offerings, revenue streams and cash flow streams beyond only retail
residential services and wholesale services. Our business service has provided lower acquisition
cost on a per line basis in some cases, depending on the type of account acquired. Retail Segment  
    During 2004, we hired additional sales and marketing personnel which increased sales and
marketing expense by $3.9 million. We also increased direct mail campaigns by
approximately $1.0 million as compared to 2003. These increases were offset by a decrease
in advertising expense of $3.7 million. The additional increase was due to increased
commissions and marketing expense, offset by decreased strategic partnership and
telemarketing expense. 37




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
    We elected to aggressively grow residential lines during the first half of 2003, and we
also incurred various startup expenses related to the introduction of our business services
line of business during mid 2003. Although we slowed residential line growth during the
second half of 2003, the significant investment during the first half of the year, coupled
with the launch of the business services caused overall sales and marketing expense to
increase during 2003 when compared to 2002.
    Specifically, the increase in our sales and marketing for the year ended December 31,
2003 compared to the prior year was a result of increased commission payments of $8.2
million in 2003. This increase is primarily a result of the increased use of independent
sales contractors during 2003 compared to the prior year. A large portion of our business
services lines are a result of an independent sales contractor agreement that requires that
we pre-pay the full 12 months of the commission per line sold, however, if a customer they
provided discontinues service before being a customer for 12 months we reduce their payment
by the pro-rata portion of the 12 month payment. In accordance with accounting rules and
industry practice the entire payment is expensed when paid.
    This increase was offset by a decrease of $2.2 million in savings in 2003 compared to
2002, as a result of closing our call centers in North Dakota.
    The remaining increase in sales and marketing expense was a result of increased
advertising, primarily during the first half of 2003.
    We continued to more actively conserve cash during 2002, which resulted in less than
historically reported sales and marketing expenses in 2002. Wholesale Segment We are not actively seeking any new wholesale relationships at this time, therefore our sales and
marketing expense is nominal. General and Administrative General and administrative expense primarily consists of employee salaries and benefits, outsourced
services, bad debt expense, billing and collection costs, occupancy costs, legal and provisioning
costs. The following table shows the break-down by segment of general and administrative expense: For the year ended December 31,
    
    
    Percentage of Segment RevenuesGeneral & administrative expense by segment (in millions)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Retail Segment
    
    $
    89.1
    
    
    $
    103.9
    
    
    $
    114.9
    
    
    
    52.2
    %
    
    
    50.7
    %
    
    
    55.3
    %Wholesale segment
    
    
    23.2
    
    
    
    22.3
    
    
    
    8.7
    
    
    
    28.9
    %
    
    
    26.5
    %
    
    
    0.0
    %Total General & Administrative Expense
    
    $
    112.3
    
    
    $
    126.2
    
    
    $
    123.6
    
    
    
    44.7
    %
    
    
    43.6
    %
    
    
    51.8
    %
 The decrease of $13.4 million in general and administrative expenses in 2004 as compared to 2003 is
best explained by decreases in the following line items:  
    Payroll and related expenses   $8.5 million
    Bad debt expense  $7.1 million
    Set-up fees from the ILECs to establish service for new customers   $4.0 million
    Contract development costs   $3.3 million These decreases were partially offset by increases in the following:  
    ILEC performance credits for failure to meet certain service levels   $3.2 million
    Sales and use tax expense  $3.1 million
    Provisioning usage charges   $1.3 million
    Other items including professional and consulting fees, legal fees, collections fees and
incorrect dispatch expense  $1.9 million During 2003, the slight increase in general and administrative expenses as compared to 2002 was
primarily attributable to a large increase in payroll and related expenses which was mostly offset
by a large decrease in bad debt expense. We have improved our operating costs and overall operations, which has contributed to improved per
line administrative cost 38




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factors. We anticipate general and administrative expenditures will decrease in total into the
future as management continues to rationalize its operating cost structure. However, this will be
offset to some extent by our expected increase in VoIP during 2005. We will continue to evaluate
our operations for efficiencies and our employee staffing requirements as they relate to increased
efficiencies or needs to expand or outsource services. We expect to see continued improvements to
the reductions of general and administrative expense as a percentage of total reported revenue in
2005 relative to 2004. Retail Segment  
    General and administrative expense decreased $14.4 million for the year ended December
31, 2004 as compared to the prior year. The largest decreases occurred in payroll and
related expenses and bad debt expense. Additional decreases occurred in contract
development and billing expense. These decreases were slightly offset by increases in ILEC
credits and tax expenses.
    The overall decrease in general and administrative expense for the year ended December
31, 2003 was primarily the result of decreases in bad debt expense, ILEC credits, tax
expenses, billing expenses and provisioning expenses. These decreases were slightly offset
by increases in payroll expenses, contract development, health insurance and incorrect
dispatch charges. Included in the retail services general and administrative expense is all employee benefits,
occupancy, insurance, and other indirect or overhead-related expenses as only direct costs are
recorded in our wholesale services segment. We are in the process of reviewing and possibly
adopting a methodology for internal reporting purposes that would allocate these indirect and
overhead related expenses to the respective segments or possibly separating these expenses from
each segment. On August 25, 2004, then president and chief executive officer and Board member D. Gregory Smith
and then chief technology officer and Board member Charles W. McDonough resigned from their
positions to found a new company. The Board has appointed Trey Davis as Acting Chief Executive
Officer and Executive Vice President. Mr. Davis will retain his present duties as Chief Financial
Officer. The Board also appointed Frank Grillo as Acting Chief Operating Officer and Executive Vice
President. After the management change, our new management began to discontinue certain of our
software development activities, and as such, began to rationalize our operating cost structure.
As part of this process, in September 2004, we approved and implemented a restructuring based on
the change in management and the subsequent change in business focus. The restructuring included a
reduction in force of 152 employees and a write-off of certain assets. In October 2004, we
approved and implemented an additional restructuring related to 44 employees in conjunction with
the consolidation of certain operations in our Atlanta and Tampa offices into our Atmore, Alabama
offices. Wholesale Segment The significant components of this expense are very similar to the administrative expenses incurred
on the retail side of our business; however, we only isolate as wholesale expense those expenses
that are directly associated with our wholesale services activity. Therefore, we have not allocated
any indirect or corporate (i.e. traditional overhead) expenses, such as employee benefits,
occupancy expenses, insurance expenses or other similar expenses to the wholesale services business
segment. These expenses are all currently included in the retail services segment.  
    The increase in general and administrative expense is a direct result of increased
wholesale lines in service from growth attributable to our agreement with Sprint.
    Specifically, these expenses include increased payroll expense, the outsourcing of
certain functions to limit our cost exposure and increased non-recurring provisioning
expenses to establish service for our wholesale customers. We expect to steadily decrease headcount to support our existing wholesale customers. We may
transfer existing employees from our wholesale services to our retail services. We have not
recorded any bad debt expense for wholesale services and have not had any material write-offs of
receivables. We will continue to monitor our wholesale services and determine the appropriate bad
debt methodology based on each individual wholesale contract, but we do not expect any material
changes to our current approach. Depreciation and Amortization  
    Depreciation and amortization expense decreased $3.6 million to $19.8 million for the
year ended December 31, 2004, compared to $23.4 million the prior year. The decrease was
the result of decreased capital spending, increased asset disposals (see footnote 5 of
notes to financial statements Property and Equipment) and an increase in the number of 39




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assets which became fully depreciated during 2004. Depreciation and amortization expense
decreased $0.5 million to $23.4 million for the year ended December 31, 2003, compared to
$23.9 million the prior year. Interest and Other Income  
    Interest and other income consists of interest charged to our bundled residential and
business customers for not paying their bills on time and income from interest earned on
our cash balances.
    Interest and other income increased $0.8 million in 2004 as compared to the prior year.
The increase was primarily the result of interest charged to our customers related to
delinquencies.
    Interest and other income decreased $1.5 million in 2003 as compared to the prior year.
The decrease was primarily attributable to our increased subscriber management activities
which resulted in fewer delinquencies and more timely payments by customers. Interest and Other Expense Interest and other expense includes late fees for vendor payments, interest related to our asset
based loan with Textron and our standby credit facility, charges related to the RFC Capital
Corporation (RFC) accounts receivable agreement, capital leases and our other debt obligations.  
    The increase in interest and other expense during 2004 as compared to 2003 was primarily
attributable to the interest we incurred on our asset based loan with Textron and our
standby credit facility, as well as an increase in late fees for vendor payments.
    The overall decrease in interest and other expense for the year ended December 31, 2003
compared to 2002 was the result of our overall increased liquidity for part of 2003
compared to the prior year period that allowed us to make more timely payments of our
operating expenses while simultaneously reducing our reliance on our RFC accounts
receivable facility during the middle of 2003. We also had less outstanding term debt
obligations, which contributed to lower interest payments. Income Tax Benefit  
    No provision for federal or state income taxes has been recorded due to the full
valuation allowance recorded against the net deferred tax asset for the years ended
December 31, 2004, 2003 and 2002. Net Loss Attributable to Common Stockholders  
    Net loss attributable to common stockholders declined by $72.7 million during 2004 as
compared to 2003. In addition to the increase in our operating loss discussed above, $57.6
million was attributable to the preferred stock conversion. This amount represents 80% of
the fair value of the incremental consideration given to the preferred share holders in
order to affect the conversion.
    Our net loss attributable to common stockholders improved $1.5 million to $33.8 million
for the year ended December 31, 2003, compared to $35.3 million the prior year. This
decrease was primarily discussed above; however, there was also an increase of $1.9 million
for the preferred stock dividends and accretion during 2003 as a result of the additional
accrual of dividends on the unpaid dividends. Asset Impairment  
    As a result of managements decision in the second quarter of 2002 to stabilize its
future operating cash flows and operating earnings, we closed the remaining call centers in
North Dakota and recorded a $1.1 million asset impairment charge.
    No impairment charges were recorded in 2003 or 2004. 40




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##### Table of Contents



Restructuring Charge  
    On May 17, 2004, a termination agreement was signed for our New York office lease on
which we had previously recorded a lease abandonment charge in connection with the
restructure. The settlement included a $90,000 payment in lieu of the remaining balance
of $299,545 previously recorded as a lease abandonment charge. The settlement payment
consisted of a one-time payment of $30,000, paid at the time of agreement, and three
promissory notes of $20,000 payable on November 1, 2004, May 1, 2005 and August 30, 2005,
respectively. All other expenses associated with this restructuring have been paid in
full.
    In June 2004, we approved and implemented a restructuring to improve our future cash
flows and operating earnings. The restructuring included a reduction in work force. In
accordance with SFAS No. 146 Accounting for Costs Associated with Exit or Disposal
Activities the restructuring costs were considered a One-Time Termination Benefit and as
such we recognized the restructuring costs as a liability at the communication date of June
8, 2004. The restructuring charge included termination benefits in connection with the
reduction in force of 102 employees. The total charge taken in the second quarter of 2004
was $0.8 million of which approximately $40,000 was paid in the second quarter. The
majority of the remainder of termination benefits was paid in full at the end of August
2004.
    In September 2004, we approved and implemented a restructuring based on the change in
management that occurred on August 25, 2004 and the subsequent change in business focus.
The restructuring included a reduction in force of 152 employees and a write-off of certain
assets. This restructuring is expected to reduce payroll expense by 25 percent. In
accordance with SFAS No. 146 Accounting for Costs Associated with Exit or Disposal
Activities the restructuring costs were considered a One-Time Termination Benefit and as
such we recognized the restructuring costs as a liability at the communication date of
September 1, 2004. The total charge taken in the third quarter of 2004 was approximately
$3.2 million.
    In October 2004, we approved and implemented an additional restructuring related to 44
employees in conjunction with the consolidation of certain operations in our Atlanta and
Tampa offices into our Atmore, Alabama offices. In accordance with SFAS No. 146
Accounting for Costs Associated with Exit or Disposal Activities the restructuring costs
were considered a One-Time Termination Benefit and as such we recognized the
restructuring costs as a liability at the communication date of October 21, 2004. The
total charge taken in the fourth quarter of 2004 was approximately $0.8 million.
    In April of 2002, we approved and implemented a restructuring to enhance our future cash
flows and operating earnings. The restructuring included a reduction of force coupled with
the closure of our North Dakota call centers and our New York sales office. In accordance
with EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity, the restructuring costs were recognized as liabilities at the
time management committed us to the plan. Management determined that these costs provided
no future economic benefit to us. For the year ended December 31, 2002, we recorded $1.9
million for termination benefits, lease abandonment and lease settlement costs.
    In addition, we agreed to a settlement to exit the two leases for our call centers in
North Dakota as of July 1, 2002. All termination benefits and settlements to exit the
leases in North Dakota were paid as of December 31, 2002. We have recorded a lease
abandonment charge representing the future lease payments for the New York office as a
liability and payments exist through August 2005. Wholesale Development Costs  
    During 2002, we began to provide wholesale telephone service. In connection with
development activities, we recorded start-up costs associated with this new line of
business of approximately $1.0 million. LIQUIDITY AND CAPITAL RESOURCES The accompanying consolidated financial statements were prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in the normal course of
business. The realization of assets and the satisfaction of liabilities in the normal course of
business is dependent on, among other things, the companys ability to operate profitably, to
generate cash flow from operations and to obtain funding adequate to fund its business. We have a limited operating history and our operations are subject to certain risks and
uncertainties, particularly related to the evolution of the regulatory environment, which impacts
our access to and cost of the network elements that we utilize to provide services to our
customers. 41




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We have incurred significant losses since our inception as a result of developing our business,
performing ongoing research and development, building and maintaining our network infrastructure
and technology, the sale and promotion of our services, and ongoing administrative expenditures.
As of December 31, 2004, we had an accumulated deficit of approximately $409.9 million and $1.4
million in cash and cash equivalents. We have funded our expenditures primarily through operating
revenues, private securities offerings, our asset based loan, our standby credit facility, a
sale-leaseback credit facility, an accounts receivable factoring facility and an initial public
offering. For the year ended December 31, 2004, net cash used in operating activities was $16.8 million as
compared to net cash provided by operating activities of $12.0 million in the prior year. The
decrease was a result of our net loss after excluding non-cash items, which increased by $28.7
million. In April 2004, the company secured an asset based loan facility with Textron Financial Corporation
(Textron), which provided up to $25 million to fund operations. We utilized $12.9 million as of
December 31, 2004, which was approximately the maximum loan availability. We did not meet the fixed
charge coverage ratio for the quarters ended June 30, 2004, September 30, 2004 and December 31,
2004. All other financial covenants were met. Per the agreement, Textron could cancel the loan
arrangement at any time. Textron began charging additional interest at a rate of 300 basis points
per annum beginning October 4, 2004. Effective January 27, 2005, we entered into a Modification
and Termination Agreement with Textron. Among other things the Modification and Termination
Agreement provides that Textron will forbear from exercising default rights and remedies until May
31, 2005, will waive the early termination fee and modify the annual facility fee. We agreed to pay
a modification fee of $150,000. On April 4, 2005, we entered into an accounts receivable financing agreement with Thermo Credit,
LLC (Thermo). The agreement provides for the sale of up to $22 million of our accounts
receivable on a continuous basis to Thermo, subject to selection criteria as defined in the
contract. We plan to use the facility to replace our credit facility with Textron. Expected
proceeds from this facility will approximate the year end Textron loan balance. On August 24, 2004, we entered into a $15 million Standby Credit Facility Agreement with The 1818
Fund III, L.P., a related party, which is one of a family of funds managed by Brown Brothers
Harriman. During 2004, we were advanced $6.5 million pursuant to the credit facility. Loans under
the credit facility are represented by a Senior Unsecured Promissory Note bearing interest at 9.95%
annually. The note matures March 31, 2006. As of December 31, 2004, we did not meet a
cross-default covenant due to the non-compliance with the Textron asset based loan facility. Per
the standby credit facility agreement, this could trigger an immediate demand of payment upon
notice by The 1818 Fund. Discussions with The 1818 Fund have indicated that they will not require
immediate payment due to our new factoring arrangement with Thermo Credit, LLC. This loan is
included in the current portion of long term debt on the balance sheet. Subsequent to year end, we
were advanced an additional $7.2 million pursuant to the facility. By letter dated July 28, 2004, the Nasdaq Stock Market, Inc. notified us that for 10 consecutive
days the market value of our listed securities was below $35 million as required for continued
inclusion by Nasdaq Marketplace Rule 4310(c)(2)(B)(ii). Nasdaq initially gave us 30 calendar days
or until August 27, 2004 to regain compliance. Nasdaq asserted that if compliance could not be
demonstrated by that day, the Nasdaq staff would provide written notification that our common stock
would be delisted. We appealed to a Nasdaq Listing Qualifications Hearing Panel and were granted a
temporary exception which expired on December 1, 2004. In December 2004, we received notification
from Nasdaq that we had regained compliance with the rules for continued inclusion on the Nasdaq
SmallCap Market.By letters dated March 22, 2005 and April 4, 2005, Nasdaq notified us
of further non compliance with their rules. We are in the process of preparing a plan to comply
with their rules which we will present to Nasdaq. On November 19, 2004, our shareholders approved a one-for-five reverse stock split of our common
stock. The reverse stock split was affected on November 30, 2004. Fractional shares were not
issued in connection with the reverse stock split. All share and per share amounts have been
restated herein to reflect the one-for-five reverse stock split. In November 2004, we also completed the successful conversion of our mandatorily redeemable
preferred stock to common stock. The effect of the conversion was to reduce stockholders deficit
by $159.6 million. The stockholders deficit at December 31, 2004 is $21.1 million. On August 25, 2004, then president and chief executive officer and Board member D. Gregory Smith
and then chief technology officer and Board member Charles W. McDonough resigned from their
positions to found a new company. Messrs. Smith and McDonough intend to pursue certain product and
business initiatives that were under development in our Atlanta technology center at the time of
their resignation. Our Board of Directors authorized the negotiation of an agreement with Messrs.
Smith and McDonough defining the specific activities, assets and personnel to be transferred to the
new company and other terms of the transaction. The Board has appointed Trey Davis as Acting Chief
Executive Officer and Executive Vice President. Mr. Davis will 42




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retain his present duties as Chief Financial Officer. The Board also appointed Frank Grillo as
Acting Chief Operating Officer and Executive Vice President. Subsequent to the change of management, several actions were initiated to improve the overall
operating cash flow of the company. The most significant was a change in company direction that
reduced the focus on enhanced services development and increased the focus on building our customer
base, revenue streams and continuing VoIP deployment plans. This involved a reduction in force
that occurred in September 2004 to help align the companys cost structure with the companys new
direction. In addition, the company initiated a variety of other measures during the last four
months of 2004 in an effort to improve its cash flows. The company reported a substantial
improvement in its reported operating cash flows during the fourth quarter of 2004, mostly as a
result of these initiatives. Management has continued to pursue a variety of measures subsequent
to January 1 in an effort to improve the operating cash flows of the business on a going forward
basis. Our net cash used in investing activities improved by $1.5 million to $9.5 million for the year
ended December 31, 2004, compared to $11.0 million the prior year. The improvement was
attributable to the purchasing of less property and equipment during 2004 as compared to 2003. For the year ended December 31, 2004, net cash provided by financing activities was $15.7 million
as compared to net cash used in financing activities of $5.0 million for the prior year. This
improvement is primarily the result of funds drawn on our asset based loan facility and our standby
credit facility. Management closely monitors liquidity and updates its forecast regularly. While the current
regulatory climate makes the cash forecast very difficult to predict, the most recent forecast for
2005 reflects positive cash flow from operations before interest charges. There can be no
assurance that the forecasted cash flow will occur. The companys inability to operate profitably and to consistently generate cash flows from
operations, its reliance therefore on external funding either from loans or equity raise
substantial doubt about the companys ability to continue as a going concern. CASH MANAGEMENT In September of 2003 and April of 2004, we decided to postpone a company-wide salary increase.
Merit increases are now scheduled for the 2nd quarter of 2005, however, we are still
assessing if this increase will be further postponed. We are also considering the possibility of
granting certain employees restricted stock in lieu of payroll increases. DEBT INSTRUMENTS AR Financing On April 4, 2005, we entered into an accounts receivable financing agreement with Thermo Credit,
LLC (Thermo). The agreement provides for the sale of up to $22.0 million of our accounts
receivable on a continuous basis to Thermo, subject to selection criteria as defined in the
contract. The discount rate is 2.5%. Purchase of the receivables is at the option of Thermo. We
plan to use this facility to replace our credit facility with Textron. ILEC, IXC AND RELATED DISPUTED CHARGES Since our existence we have disputed and continue to dispute significant charges from the various
ILECs, IXCs, and certain other carriers providing us services. We have a policy of treating all
charges that we believe are without merit, but are still being presented on a bill to us as
disputes, regardless of the age of the dispute. We believe that the majority of these disputes
have significant merit; however, we accrue the amount of the charges we believe represent valid
charges against us. Our outstanding disputes at December 31, 2004 totaled $19.6 million and are
best summarized in the following table: Outstanding Disputesat December 31, 2004(in millions)Alternatively billed services
    
    $
    8.2Late fees for non-payment of disputed charges
    
    
    4.9Billing errors
    
    
    4.3All others
    
    
    2.2$
    19.6
 43




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Alternatively billed services are primarily charges for certain 1-800, collect and information
service calls. These disputes are largely historic in nature. We settled certain of these
disputes in Texas with Southwestern Bell Telephone Company. We remit all monies collected
associated with these services but do not pay the charges unless we collect from our customers. We
believe that our liability related to these charges should be capped at the amount remitted by our
end users; however, some of our settlements have included payments in excess of payments from our
customers. We received a billing for $2.3 million from Verizon relating to the back-billing of dispatch
charges believed to relate to the period from August 2000 to February 2002 and from March 2003 to
September 2003. We do not know if this is the entire amount they will bill related to these
back-billed charges. Our policy is to dispute items that are billed without the necessary
underlying detail records and therefore, we have disputed these charges. We expect that if any of
these charges are valid, a portion of these charges may be subject to being billed to our wholesale
services customers for services that we provided under our contracts with them. We have not
received sufficient detail related to these charges from Verizon and therefore, are unable to
determine their validity. The late fees are accumulating from all of our disputes as we do not pay for disputed items and
therefore incur and accumulate late fees for these disputed billings. We believe that we have adequately accrued for our disputes and we believe our maximum exposure for
these charges is $19.6 million. However, we do not believe that these charges are valid and intend
to continue our dispute and non-payment of these charges. CONTRACTUAL OBLIGATIONS The following table discloses aggregate information about our contractual obligations and the
periods in which payments are due (in thousands): LESS THAN
    
    
    
    
    
    
    
    
    
    
    AFTERCONTRACTUAL OBLIGATIONS
    
    TOTAL
    
    
    1 YEAR-
    
    
    1-3 YEARS
    
    
    4-5 YEARS
    
    
    5 YEARSLong-term debt
    
    $
    587
    
    
    $
    587
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating leases
    
    
    10,934
    
    
    
    2,168
    
    
    
    6,267
    
    
    
    2,499
    
    
    
    Capital leases
    
    
    495
    
    
    
    489
    
    
    
    6
    
    
    
    
    
    
    
    Unconditional purchase
obligations
    
    
    2,750
    
    
    
    2,750
    
    
    
    
    
    
    
    
    
    
    
    Total contractual cash
obligations
    
    $
    14,766
    
    
    $
    5,994
    
    
    $
    6,273
    
    
    $
    2,499
    
    
    $
    
 We have no other significant off-balance sheet items. RELATED PARTY TRANSACTIONS In January 2002, we accelerated the vesting of 96,471 stock options granted to an executive as part
of his severance agreement. This acceleration resulted in the employee being fully vested in stock
options with a strike price of $1.30 when the stock was trading at $1.80. The employee forfeited
76,471 of his vested options in return for the exercise of 20,000 shares of stock. We recorded
approximately $0.1 million in general and administrative expense as a result of this transaction. In February 2003 we received a payment of $0.5 million from an executive officer who was also on
our Board of Directors in fulfillment of an outstanding note receivable to us. In August 2003, we accelerated the vesting of 122,223 stock options granted to an executive as part
of his severance agreement. This acceleration resulted in the employee being fully vested in stock
options with a strike price of $1.30 per share and was in-the-money trading at $2.02 per share as
the time of acceleration. As a result of this transaction we recorded approximately $0.1 million
in general and administrative expense. 44




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In addition to the SipStorm promissory note mentioned in footnote 5 of the notes to financial
statements Property and Equipment, as of December 31, 2004 we have approximately $0.9 million of notes receivable from
employees and former employees for various reasons. We have recorded these loans as a contra to
our equity as the loans were for the purchase of stock. One is a note in the amount of
approximately $0.8 million, due in June 2005, and the other is for approximately $0.1 million and
is a demand note that currently has no specific due date. NEW ACCOUNTING PRONOUNCEMENTS In March 2004, the EITF reached a consensus on EITF Issue No. 03-6, Participating Securities and
the Two-Class Method under FASB Statement No. 128, Earnings per Share (EITF 03-6). EITF 03-6
clarifies what constitutes a participating security and provides further guidance in applying the
two-class method of calculating earnings per share (EPS). The consensus reached by the EITF in
this Issue is effective for reporting periods beginning after March 31, 2004. We adopted EITF
Issue No. 03-06 during the quarter ended June 30, 2004. There was no impact of the adoption on the
computation of EPS, as the effect is anti-dilutive. In periods of net income, we will utilize the
two-class method of computing EPS. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4 (SFAS 151). SFAS 151 clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material (spoilage) by requiring that these costs be
recognized as current period charges. This Statement is effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The adoption of this Statement will not have
any impact on our consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of
APB Opinion No. 29 (SFAS 153). APB Opinion No. 29 stated that there were certain exceptions to
the principle that exchanges of nonmonetary assets should be measured using fair value; SFAS 153
eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have commercial substance.
SFAS 153 states that a nonmonetary exchange has commercial substance if the future cash flows of
the entity are expected to change significantly as a result of the exchange. The SFAS will be
effective for nonmonetary asset exchanges in fiscal years beginning after June 15, 2005. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Accounting for Stock-Based
Compensation (SFAS 123(R)). SFAS 123(R) focuses on accounting for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS 123(R) requires the
cost of such services to be measured based on the grant-date fair value of the award. SFAS 123(R)
will be effective as of the beginning of the first reporting period that begins after June 15,
2005. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements relating to events anticipated to happen in the
future. These forward-looking statements are based on the beliefs of our management, as well as
assumptions made by and information currently available to our management. Forward-looking
statements also may be included in other written and oral statements made or released by us. You
can identify forward-looking statements by the fact that they do not relate strictly to historical
or current facts. The words believe, anticipate, intend, expect, estimate, project and
similar expressions are intended to identify forward-looking statements. Forward-looking statements
describe our expectations today of what we believe is most likely to occur or may be reasonably
achievable in the future, but they do not predict or assure any future occurrence and may turn out
to be wrong. Forward-looking statements are subject to both known and unknown risks and
uncertainties and can be affected by inaccurate assumptions we might make. Consequently, no
forward-looking statement can be guaranteed. Actual future results may vary materially. We do not
undertake any obligation to publicly update any forward-looking statements to reflect new
information or future events or occurrences. These statements reflect our current views with
respect to future events and are subject to risks and uncertainties, including, among other things:  
    our ability to finance network developments and operations;
    the possibility of unforeseen capital expenditures and other upfront investments required to deploy our VoIP network;
    our ability to market our services successfully to new subscribers;
    our ability to retain a high percentage of our customers;
    our reliance on ILEC local networks; 45




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
    the outcome of legal and regulatory proceedings;
    our planned expansion, including consumer acceptance of new price plans and bundled offerings;
    competition, including the introduction of new products or services by our competitors;
    additions or departures of key personnel;
    existing and future laws or regulations affecting our business and our ability to comply with these laws or regulations;
    our reliance on the Regional Bell operating companys systems and provisioning processes;
    technological innovations;
    general economic and business conditions, both nationally and in the regions in which we operate; and
    other factors described in this document, including those described in more detail below. We caution you not to place undue reliance on these forward-looking statements, which speak only as
of the date of this document. RISKS RELATED TO OUR FINANCIAL CONDITION AND OUR BUSINESS Certain material risks to our financial condition and our business are set forth below. The list
is not intended be exhaustive as a listing of all such risks would be impossible. Moreover, the
order in which the risks appear does not necessarily correlate with the magnitude of the risk. Availability of Funds for our Transition to Become Facilities-Based Carrier Our business strategy requires us to transition from a non-facilities-based carrier to a
facilities-based carrier. Approximately 95% of our revenues are derived from the use of ILEC
networks (that is, from being a non-facilities-based carrier). We have no assurance that we will
have sufficient internal and external financial resources to deploy our VoIP network facilities and
maintain our operations during this transition. Our internal operations may not generate
sufficient cash to meet our operating needs, particularly if we lose exiting customers (from normal
attrition and otherwise) at a faster rate than we expect, and external financing may not be
available or available on reasonable terms. Moreover, we will almost certainly encounter
unexpected difficulties and delays. Loss of Asset-Based Financing We depend upon continued access to asset-based financing to fund our operations. We recently
executed a Receivables Financing Agreement with Thermo Credit LLC. Under that agreement, Thermo
Credit will from time to time purchase portions of our customer accounts receivable at its
discretion. There is the possibility that we could lose access to this financing anytime. While
we believe other sources of financing are available, the loss of asset-based financing would
materially and adversely affect our ability to operate. Availability and Favorable Pricing of Unbundled Network Components Part of our business strategy is to focus on territories where we have access to ILEC local
networks at favorable rates to provide our services. We currently have an interconnection
agreement with Qwest that will give us access to the local networks in its territories at least
until July 31, 2008. We also have an interim commercial services agreement with Verizon that will
give us access to the local networks in its territories until May 31, 2005. We are seeking similar
agreements with other ILECs. There can be no assurance that other ILECs will be willing to enter
such contracts with us upon terms favorable to us. Acquisition of New Customers For our business plans to be successful we must gain new customers from which to generate operating
cash flow to fund our operations. We have limited resources to fund marketing and sales
activities. Moreover, although we believe we offer good services at competitive prices, there can
be no assurance that our service plans will be gain acceptance in the marketplace. Intense
competition could further impede our attempts to gain new customers. 46




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Difficulties in Expanding Network Infrastructure We are in the process of deploying a VoIP network as an alternative to utilizing the ILEC networks
to provide services to our customers. We will almost certainly encounter unforeseen delays and
other challenges. We cannot be sure that we will be able to develop, expand or adapt the network
infrastructure to meet additional demand or our customers changing requirements on a timely basis,
at a commercially reasonable cost, or at all. If we fail to deploy our network infrastructure on a
timely basis or adapt it to either changing customer requirements or evolving industry standards,
these failures could adversely affect our business. Competition The telecommunications and information services markets are intensely competitive and rapidly
evolving. We expect competition to increase. Many of our potential competitors have longer
operating histories, greater name recognition, larger customer bases and substantially greater
financial, personnel, marketing, engineering, technical and other resources than we have. We
believe the principal competitive factors affecting our business operations will be price, the
desirability of our service offering, quality and reliability of our services, innovation and
customer service. Our ability to compete effectively will depend upon our ability to maintain high
quality, market-driven services at prices generally equal to or below those charged by our
competitors. Competitor actions and responses to our actions could, therefore, materially and
adversely affect our business, financial condition and results of operations. We face competition from a variety of participants in the telecommunications market. The largest
competitor for local service in each market in which we compete is the incumbent local exchange
carrier serving that market. Incumbent local exchange carriers have established networks,
long-standing relationships with their customers, strong political and regulatory influence, and
the benefit of state and federal regulations that favor incumbent local exchange carriers. In the
local exchange market, the incumbent local exchange carriers continue to hold near-monopoly
positions. The long distance telecommunications market in which we compete has numerous entities
competing for the same customers and a high average churn rate as customers frequently change long
distance providers in response to the offering of lower rates or promotional incentives. Prices in the long distance market have declined significantly in recent years and are expected to
continue to decline. We will face competition from large interexchange carriers. Other competitors
are likely to include incumbent local exchange carriers providing out-of-region (and, with the
removal of regulatory barriers, in-region) long distance services, other incumbent local exchange
carriers, other competitive local exchange carriers, cable television companies, electric
utilities, wireless telephone system operators, microwave and satellite carriers and private
networks owned by large end users. A continuing trend toward combinations and strategic alliances in the telecommunications industry,
including potential consolidation among incumbent local exchange carriers or competitive local
exchange carriers, or transactions between telephone companies and cable companies outside of the
telephone companys service area, or between interexchange carriers and competitive local exchange
carriers, could give rise to significant new competitors. The enhanced and information services markets are also highly competitive and we expect that
competition will continue to intensify. Our competitors in these markets will include information
service providers, telecommunications companies, on-line service providers and Internet service
providers. Network Failure The successful operation of our network will depend on a continuous supply of electricity at
multiple points. Although the system that carries signals has been designed to operate under
extreme weather conditions (including heavy rain, wind and snow), like all other telecommunications
systems, our network could be adversely affected by such conditions. Our network is equipped with a
back-up power supply and our existing network operations center is equipped with both a battery
backup and an on-site emergency generator. We are currently in litigation with the landlord at our
Tampa, Florida facility because, among other reasons, we believe the landlord has failed to
maintain air conditioning and emergency electrical generating systems crucial to the operation of
our network facilities. If a power failure causes an interruption in our service, the interruption
could negatively impact our operations. Our network also may be subject to physical damage, sabotage, tampering or other breaches of
security (by computer virus, break-ins or otherwise) that could impair its functionality. In
addition, our network is subject to unknown capacity limitations that may cause interruptions in
service or reduced capacity for our customers. Any interruptions in service resulting from physical
damage or capacity limitations could cause our systems to fail. 47




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Ability to Resell Long Distance Services We offer long distance telephone services as part of our service packages. We currently have
agreements with two long distance carriers to provide transmission and termination services for all
of our long distance traffic. Recently, several long distance carriers have encountered financial
difficulties, including both carriers utilized by us. Financial difficulties encountered by any of
our carriers could cause disruption of service to our customers and could diminish the value of any
receivables or credits that may be due to us from such carriers. Our agreements with long distance
carriers generally provide for the resale of long distance services on a per-minute basis and
contain minimum volume commitments. In cases in which we have agreed to minimum volume commitments
and fail to meet them, we will be obligated to pay underutilization charges. Risk of Software Failures and Errors The software that we use and the software that we have developed internally and are continuing to
develop may contain undetected errors. Although we have extensively tested our software, errors may
be discovered in the software during the course of its use. Any errors may result in partial or
total failure of our network, loss or diminution in service delivery performance, additional and
unexpected expenses to fund further product development or to add programming personnel to complete
or correct development, and loss of revenue because of the inability of customers to use our
products or services, which could adversely affect our business condition. Protection of Proprietary Technology We currently rely on a combination of copyright, trademark and trade secret laws and contractual
confidentiality provisions to protect the proprietary information that we have developed. Our
ability to protect our proprietary technology is limited, and we cannot assure you that our means
of protecting our proprietary rights will be adequate or that our competitors will not
independently develop similar technology. Also, we cannot be certain that the intellectual property
that incumbent local exchange carriers or others claim to hold and that may be necessary for us to
provide our services will be available on commercially reasonable terms. If we were found to be
infringing upon the intellectual property rights of others, we might be required to enter into
royalty or licensing agreements, which may be costly or not available on commercially reasonable
terms. If successful, a claim of infringement against us and our inability to license the infringed
or similar technology on terms acceptable to us could adversely affect our business. Dependence on Information Systems Our billing, customer service and management information systems are newly developed and we may
face unexpected system difficulties, which would adversely affect our service levels and,
consequently, our business. Sophisticated information and processing systems are vital to our
ability to monitor costs, render monthly invoices for services, process customer orders and achieve
operating efficiencies. We rely on internal systems and third party vendors, some of which have a
limited operating history, to provide our information and processing systems. If our systems fail
to perform in a timely and effective manner and at acceptable costs, or if we fail to adequately
identify all of our information and processing needs or if our related processing or information
systems fail, these failures could have a material adverse effect on our business. In addition, our right to use third party systems is dependent upon license agreements. Some of
these agreements are cancelable by the vendor, and the cancellation or nonrenewal of these
agreements could seriously impair our ability to process orders or bill our customers. As we
continue to provide local telephone service, the need for sophisticated billing and information
systems will also increase significantly and we will have significant additional requirements for
data interface with incumbent local exchange carriers and others. We cannot be certain that we will
be able to meet these additional requirements. Dependence on Local Exchange Carriers We rely on incumbent local exchange carriers to supply key unbundled components of their network
infrastructure to us on a timely and accurate basis, and in the quantities and quality demanded by
us. We may from time to time experience delays or other problems in receiving unbundled services or
facilities which we request, and there can be no assurance that we will able to obtain such
unbundled elements on the scale and within the time frames required by us. Any failure to obtain
these components, services or additional capacity on a timely and accurate basis could adversely
affect us. Dependence on Third Party Vendors We currently purchase the majority of our telecommunications equipment as needed from third party
vendors, including Cisco Systems, Inc., Lucent Technologies, Inc., Sonus Networks, Inc., Dialogic
Communications Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Sun Microsystems,
Inc. and EMC Corporation. In addition, we currently license our software from third party vendors,
including Oracle Corporation, INPRISE Corporation, Mercator Software, Inc., Microsoft Corporation,
Nuance Communications, Inc., SpeechWorks International, Inc., Telution, Inc., AMS, Inc., Netscape 48




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Communications, Inc. and Accenture. We typically do not enter into any long-term agreements with
our telecommunications equipment or software suppliers. Any reduction or interruption in supply
from our equipment suppliers or failure to obtain suitable software licensing terms could have a
disruptive effect on our business and could adversely affect our results of operations. Dependence on Management and Key Personnel We depend on a limited number of key personnel who would be difficult to replace. If we lose the
services of some of our key personnel, our business could suffer. We also depend on a limited
number of key management, sales, marketing and product development personnel to manage and operate
our business. In particular, we believe that our success depends to a significant degree upon our
ability to attract and retain highly skilled personnel, including our engineering and technical
staff. If we are unable to attract and retain our key employees, the value of our common stock
could suffer. Government Regulation and Legal Uncertainties We are subject to varying degrees of federal, state, and local regulation. We must also comply with
various state and federal obligations that are subject to change, such as the duty to contribute to
universal service subsidies, the impact of which we cannot assess on a going-forward basis as the
rates change periodically. Our failure to comply with regulatory requirements may result in fines
or other penalties being imposed on us, including loss of certification to provide services. Decisions of the FCC and state regulatory commissions providing incumbent local exchange carriers
with increased flexibility in how they price their services and with other regulatory relief, could
have a material adverse effect on our business and that of other competitive local exchange
carriers. Future regulatory provisions may be less favorable to competitive local exchange carriers
and more favorable to incumbent local exchange carriers and other competitors. If incumbent local
exchange carriers are allowed by regulators to engage in substantial volume and term discount
pricing practices for their end-user customers, or charge competitive local exchange carriers
higher fees for interconnection to the incumbent local exchange carriers networks, our business,
operating results and financial condition could be materially, adversely affected. Incumbent local
exchange carriers may also seek to delay competitors through legal or regulatory challenges, or by
recalcitrant responses to requirements that they open their markets through interconnection and
unbundling of network elements. Our legal and administrative expenses may be increased because of
our having to actively participate in rate cases filed by incumbent local exchange carriers, in
which they seek to increase the rates they can charge for the unbundled network element platform
components. Our profitability may be adversely affected if those carriers prevail in those cases.
Pending court cases, in which certain provisions of the Telecommunications Act of 1996 will be
conclusively interpreted, may result in an increase in our cost of obtaining unbundled network
elements. We are also subject to federal and state laws and regulations prohibiting slamming, which occurs
when specific procedures are not followed when a customer changes telecommunications services.
Although we attempt to diligently comply with all such laws and regulations and have procedures in
place to prevent slamming, if violations of such laws and regulations occur, we could become
subject to significant fines and penalties, legal fees and costs, and our business reputation could
be harmed. Unauthorized Transactions or Theft of Services We may be the victim of fraud or theft of service. From time to time, callers have obtained our
services without rendering payment by unlawfully using our access numbers and personal
identification numbers. We attempt to manage these theft and fraud risks through our internal
controls and our monitoring and blocking systems. If these efforts are not successful, the theft of
our services may cause our revenue to decline significantly. To date, we have not encountered
material fraud or theft of our service. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not enter into financial instruments for trading or speculative purposes and do not currently
utilize derivative financial instruments. Our operations are conducted primarily in the United
States and as such are not subject to material foreign currency exchange rate risk. The fair value of our investment portfolio or related income would not be significantly impacted by
either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature
of the major portion of our investment portfolio. We have no material future earnings or cash flow exposures from changes in interest rates on our
long-term debt obligations, as substantially all of our long-term debt obligations are fixed rate
obligations. 49




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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PAGEReport of Independent Certified Public Accountants
    
    F-2Consolidated Financial Statements:Consolidated Balance Sheets
    
    F-3Consolidated Statements of Operations
    
    F-4Consolidated Statements of Changes in Stockholders Equity (Deficit) and
Comprehensive Income
    
    F-5Consolidated Statements of Cash Flows
    
    F-6Notes to Consolidated Financial Statements
    
    F-8
 50




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Report of Independent Registered Certified Public Accounting Firm To the Board of Directors and Shareholders of Trinsic, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated
statements of operations, of changes in stockholders equity (deficit) and comprehensive income and
of cash flows present fairly, in all material respects, the financial position of Trinsic, Inc. and
its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2004 in conformity with
accounting principles generally accepted in the United States of America. These financial
statements are the responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion. The accompanying financial statements have been prepared assuming that the Company will continue as
a going concern. As discussed in Note 1 to the financial statements, the Company has suffered
recurring losses from operations and has a net capital deficiency that raise substantial doubt
about its ability to continue as a going concern. Managements plans in regard to these matters are
also described in Note 1. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty. PricewaterhouseCoopers LLP
Tampa, Florida April 14, 2005 51




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TRINSIC, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 December 31,
    
    
    December 31,2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    1,363
    
    
    $
    12,013Accounts receivable, net of allowance for doubtful
accounts of $10,967 and $13,804
    
    
    27,242
    
    
    
    20,605Prepaid expenses and other current assets
    
    
    836
    
    
    
    3,876Total current assets
    
    
    29,441
    
    
    
    36,494Property and equipment, net
    
    
    27,829
    
    
    
    39,069Intangible assets, net
    
    
    457
    
    
    
    2,287Other assets
    
    
    3,609
    
    
    
    3,820Total assets
    
    $
    61,336
    
    
    $
    81,670Liabilities, Mandatorily Redeemable Convertible Preferred
Stock and Stockholders DeficitCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    55,605
    
    
    $
    55,442Deferred revenue
    
    
    6,264
    
    
    
    7,073Current portion of long-term debt and capital lease obligations
    
    
    7,536
    
    
    
    5,074Asset based loan
    
    
    12,934
    
    
    
    Total current liabilities
    
    
    82,339
    
    
    
    67,589Long-term deferred revenue
    
    
    46
    
    
    
    361Long-term debt and capital lease obligations
    
    
    33
    
    
    
    457Total liabilities
    
    
    82,418
    
    
    
    68,407Mandatorily redeemable convertible preferred stock, $0.01 par value;
50,000,000 shares authorized; 1,771,018 issued; 1,747,684
outstanding (aggregate liquidation value of $158,779)
    
    
    
    
    
    
    144,282Commitments and contingencies (Notes 12, 17 and 22)Stockholders deficit:Common stock, $0.01 par value; 150,000,000
shares authorized; 55,253,612 and 7,237,298 shares issued;
55,185,302 and 7,168,988 outstanding
    
    
    553
    
    
    
    73Notes receivable from stockholders
    
    
    (3,685
    )
    
    
    (1,121
    )Unearned stock compensation
    
    
    (466
    )
    
    
    Additional paid-in capital
    
    
    392,488
    
    
    
    188,987Accumulated deficit
    
    
    (409,894
    )
    
    
    (318,880
    )Treasury stock, 68,310 shares at cost
    
    
    (78
    )
    
    
    (78
    )Total stockholders deficit
    
    
    (21,082
    )
    
    
    (131,019
    )Total liabilities, mandatorily redeemable
convertible preferred
stock and stockholders deficit
    
    $
    61,336
    
    
    $
    81,670
 The accompanying notes are an integral part of these consolidated financial statements. 52




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TRINSIC, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Years EndedDecember 31,2004
    
    
    2003
    
    
    2002Revenues
    
    $
    251,477
    
    
    $
    289,180
    
    
    $
    238,397Operating expenses:Network operations, exclusive of depreciation
and amortization shown below
    
    
    123,723
    
    
    
    135,531
    
    
    
    94,422Sales and marketing
    
    
    21,094
    
    
    
    19,421
    
    
    
    11,319General and administrative
    
    
    112,350
    
    
    
    125,765
    
    
    
    123,578Asset impairment charge
    
    
    
    
    
    
    
    
    
    
    1,129Wholesale development costs
    
    
    
    
    
    
    
    
    
    
    1,018Restructuring charge
    
    
    4,801
    
    
    
    
    
    
    
    1,861Depreciation and amortization
    
    
    19,764
    
    
    
    23,449
    
    
    
    23,936Total operating expenses
    
    
    281,732
    
    
    
    304,166
    
    
    
    257,263Operating loss
    
    
    (30,255
    )
    
    
    (14,986
    )
    
    
    (18,866
    )Nonoperating income (expense):Interest and other income
    
    
    2,753
    
    
    
    1,930
    
    
    
    3,448Interest and other expense
    
    
    (6,111
    )
    
    
    (3,071
    )
    
    
    (4,137
    )Total nonoperating expense
    
    
    (3,358
    )
    
    
    (1,141
    )
    
    
    (689
    )Net loss
    
    
    (33,613
    )
    
    
    (16,127
    )
    
    
    (19,555
    )Less mandatorily redeemable convertible
preferred stock dividends and accretion
    
    
    (15,326
    )
    
    
    (17,480
    )
    
    
    (15,589
    )Less deemed dividend related to beneficial
conversion feature
    
    
    (57,584
    )
    
    
    (186
    )
    
    
    (186
    )Net loss attributable to common
stockholders
    
    $
    (106,523
    )
    
    $
    (33,793
    )
    
    $
    (35,330
    )Weighted average common shares outstanding
    
    
    11,676,783
    
    
    
    7,079,384
    
    
    
    6,990,344Basic and diluted net loss per share
    
    $
    (9.12
    )
    
    $
    (4.77
    )
    
    $
    (5.05
    )
 The accompanying notes are an integral part of these consolidated financial statements. 53




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##### Table of Contents



TRINSIC, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (DEFICIT)
AND COMPREHENSIVE INCOME
 Notes Receivable
    
    
    Unearned
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    TotalCommon Stock
    
    
    from
    
    
    Stock
    
    
    Paid-In
    
    
    Accumulated
    
    
    Treasury
    
    
    StockholdersShares
    
    
    Par Value
    
    
    Stockholders
    
    
    Compensation
    
    
    Capital
    
    
    Deficit
    
    
    Stock
    
    
    DeficitBalance, December 31, 2001
    
    
    6,800,022
    
    
    $
    69
    
    
    $
    (1,589
    )
    
    $
    (122
    )
    
    $
    217,761
    
    
    $
    (283,198
    )
    
    $
    (78
    )
    
    $
    (67,157
    )Issuance of common stock
    
    
    200,000
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2,320
    
    
    
    
    
    
    
    
    
    
    
    2,322Exercise of stock options
    
    
    72
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0Exercise of warrants
    
    
    34,286
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Accelerated vesting of stock options
    
    
    4,000
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    84
    
    
    
    
    
    
    
    
    
    
    
    84Conversion of mandatorily redeemable convertible
preferred stock to common
    
    
    15,232
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    679
    
    
    
    
    
    
    
    
    
    
    
    679Vesting of stock options granted
below intrinsic value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    122
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    122Mandatorily redeemable convertible preferred
stock dividends and accretion
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,775
    )
    
    
    
    
    
    
    
    
    
    
    (15,775
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,555
    )
    
    
    
    
    
    
    (19,555
    )Balance, December 31, 2002
    
    
    7,053,612
    
    
    
    72
    
    
    
    (1,589
    )
    
    
    
    
    
    
    205,069
    
    
    
    (302,753
    )
    
    
    (78
    )
    
    
    (99,279
    )Exercise of stock options
    
    
    78,828
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    518
    
    
    
    
    
    
    
    
    
    
    
    519Exercise of warrants
    
    
    14,743
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0Accelerated vesting of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    123
    
    
    
    
    
    
    
    
    
    
    
    123Conversion of mandatorily redeemable convertible
preferred stock to common
    
    
    21,805
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    943
    
    
    
    
    
    
    
    
    
    
    
    943Repayment of notes receivable
    
    
    
    
    
    
    
    
    
    
    468
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    468Mandatorily redeemable convertible preferred
stock dividends and accretion
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,666
    )
    
    
    
    
    
    
    
    
    
    
    (17,666
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,127
    )
    
    
    
    
    
    
    (16,127
    )Balance, December 31, 2003
    
    
    7,168,988
    
    
    
    73
    
    
    
    (1,121
    )
    
    
    
    
    
    
    188,987
    
    
    
    (318,880
    )
    
    
    (78
    )
    
    
    (131,019
    )Exercise of stock options
    
    
    73,474
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    488
    
    
    
    
    
    
    
    
    
    
    
    489Exercise of warrants
    
    
    7,543
    
    
    
    0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0Issuance of common stock
for settlement
    
    
    117,145
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    743
    
    
    
    
    
    
    
    
    
    
    
    744Issue common restricted stock
    
    
    6,700
    
    
    
    0
    
    
    
    
    
    
    
    (466
    )
    
    
    1,030
    
    

    
    
    
    
    
    
    
    
    
    564Conversion of mandatorily redeemable convertible
preferred stock to common
    
    
    47,811,452
    
    
    
    478
    
    
    
    
    
    
    
    
    
    
    
    216,566
    
    
    
    (57,401
    )
    
    
    
    
    
    
    159,643Repayment of notes receivable
    
    
    
    
    
    
    
    
    
    
    251
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251Issuance of notes receivable (SipStorm)
    
    
    
    
    
    
    
    
    
    
    (2,815
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,815
    )Mandatorily redeemable convertible preferred
stock dividends and accretion
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,326
    )
    
    
    
    
    
    
    
    
    
    
    (15,326
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33,613
    )
    
    
    
    
    
    
    (33,613
    )Balance, December 31, 2004
    
    
    55,185,302
    
    
    $
    553
    
    
    $
    (3,685
    )
    
    $
    (466
    )
    
    $
    392,488
    
    
    $
    (409,894
    )
    
    $
    (78
    )
    
    $
    (21,082
    )
 The accompanying notes are an integral part of these consolidated financial statements. 54




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##### Table of Contents



TRINSIC, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Year EndedDecember 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net loss
    
    $
    (33,613
    )
    
    $
    (16,127
    )
    
    $
    (19,555
    )Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:Depreciation and amortization
    
    
    19,764
    
    
    
    23,449
    
    
    
    23,936Provision for bad debts
    
    
    6,199
    
    
    
    14,022
    
    
    
    23,964Asset impairment charge
    
    
    
    
    
    
    
    
    
    
    1,129(Gain) loss on disposal of equipment
    
    
    
    
    
    
    (43
    )
    
    
    (132
    )Expense charged for granting of stock options
    
    
    567
    
    
    
    123
    
    
    
    206Change in operating assets and liabilities:Increase in accounts receivable
    
    
    (12,776
    )
    
    
    (11,873
    )
    
    
    (23,671
    )(Increase) decrease in prepaid expenses
    
    
    3,040
    
    
    
    (1,923
    )
    
    
    (1,780
    )Decrease in other assets
    
    
    185
    
    
    
    1,888
    
    
    
    1,655Increase in accounts payable and accrued liabilities
    
    
    942
    
    
    
    7,460
    
    
    
    2,149Increase (decrease) in deferred revenue
    
    
    (1,124
    )
    
    
    (5,020
    )
    
    
    10,498Total adjustments
    
    
    16,797
    
    
    
    28,083
    
    
    
    37,954Net cash provided by (used in) operating activities
    
    
    (16,816
    )
    
    
    11,956
    
    
    
    18,399Cash flows from investing activities:Purchases of property and equipment
    
    
    (9,509
    )
    
    
    (11,036
    )
    
    
    (15,193
    )Principal repayments received on notes receivable
    
    
    26
    
    
    
    40
    
    
    
    590Issuance of note receivable
    
    
    
    
    
    
    
    
    
    
    (997
    )Net cash used in investing activities
    
    
    (9,483
    )
    
    
    (10,996
    )
    
    
    (15,600
    )Cash flows from financing activities:Payments on long-term debt and capital lease obligations
    
    
    (4,462
    )
    
    
    (5,903
    )
    
    
    (5,622
    )Payment of preferred stock dividends
    
    
    (3
    )
    
    
    (72
    )
    
    
    (34
    )Principal repayments received on notes receivable issued for stock
    
    
    191
    
    
    
    468
    
    
    
    Proceeds from asset based loan
    
    
    12,934
    
    
    
    
    
    
    
    Proceeds from stand by credit facility
    
    
    6,500
    
    
    
    
    
    
    
    Proceeds from exercise of stock options and warrants
    
    
    489
    
    
    
    523
    
    
    
    2Net cash provided by (used in) financing activities
    
    
    15,649
    
    
    
    (4,984
    )
    
    
    (5,654
    )Net decrease in cash and cash equivalents
    
    
    (10,650
    )
    
    
    (4,024
    )
    
    
    (2,855
    )Cash and cash equivalents, beginning of period
    
    
    12,013
    
    
    
    16,037
    
    
    
    18,892Cash and cash equivalents, end of period
    
    $
    1,363
    
    
    $
    12,013
    
    
    $
    16,037
 The accompanying notes are an integral part of these consolidated financial statements. 55




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TRINSIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS  CONTINUED
(In thousands) Year EndedDecember 31,2004
    
    
    2003
    
    
    2002Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    6,108
    
    
    $
    3,070
    
    
    $
    2,788Non-cash investing and financing activities:Property and equipment acquired under capital
lease obligations
    
    $
    
    
    
    $
    1,290
    
    
    $
    222Increase in additional paid-in capital for stock
options granted
    
    $
    1,030
    
    
    $
    518
    
    
    $
    84Common stock granted for wholesale services contract
    
    $
    
    
    
    $
    
    
    
    $
    2,330Net increase in unearned stock
compensation for stock options granted
    
    $
    466
    
    
    $
    
    
    
    $
    122Accrued dividends and accretion on preferred stock
    
    $
    15,326
    
    
    $
    17,480
    
    
    $
    15,589Common stock issued for settlement of obligations
    
    $
    744
    
    
    $
    
    
    
    $
    Note receivable received in exchange for sale of
assets and reduction of accounts payable
    
    $
    2,815
    
    
    $
    
    
    
    $
    Conversion of preferred stock to common stock
    
    $
    159,643
    
    
    $
    943
    
    
    $
    679Beneficial conversion associated with preferred stock
    
    $
    57,584
    
    
    $
    186
    
    
    $
    186
 The accompanying notes are an integral part of these consolidated financial statements. 56




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##### Table of Contents



TRINSIC, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. NATURE OF BUSINESS DESCRIPTION OF BUSINESS Trinsic, Inc. (formerly Z-Tel Technologies, Inc.) and subsidiaries (we or us) is an emerging
provider of advanced, integrated telecommunications services targeted to residential and business
subscribers. We provide local and long distance telephone services in combination with enhanced
communication features accessible through the telephone, the Internet and certain personal digital
assistants. We provide these services in forty-nine states , but our customers are primarily concentrated in six states . We
also provide long-distance telecommunications services to customers nationally. We introduced our wholesale services during the first quarter of 2002. This service provides other
companies with the opportunity to provide local, long-distance and enhanced telephone service to
their own residential and business end user customers on a private label basis by utilizing our
telephone exchange services, enhanced services platform, infrastructure and back-office operations. At a special meeting of our shareholders held in November 2004, the shareholders approved an
amendment to our charter to change our name to Trinsic, Inc., effective January 3, 2005. Our new
Nasdaq trading symbol is TRIN. LIQUIDITY AND GOING CONCERN The accompanying consolidated financial statements were prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in the normal course of
business. The realization of assets and the satisfaction of liabilities in the normal course of
business is dependent on, among other things, the companys ability to operate profitably, to
generate cash flow from operations and to obtain funding adequate to fund its business. We have a limited operating history and our operations are subject to certain risks and
uncertainties, particularly related to the evolution of the regulatory environment, which impacts
our access to and cost of the network elements that we utilize to provide services to our
customers. We have incurred significant losses since our inception as a result of developing our business,
performing ongoing research and development, building and maintaining our network infrastructure
and technology, the sale and promotion of our services, and ongoing administrative expenditures. As
of December 31, 2004, we had an accumulated deficit of approximately $409.9 million and $1.4
million in cash and cash equivalents. We have funded our expenditures primarily through operating
revenues, private securities offerings, our asset based loan, our standby credit facility, a
sale-leaseback credit facility, an accounts receivable factoring facility and an initial public
offering. For the year ended December 31, 2004, net cash used in operating activities was $16.8 million as
compared to net cash provided by operating activities of $12.0 million in the prior year. The
decrease was a result of our net loss after excluding non-cash items, which increased by $28.7
million. In April 2004, the company secured an asset based loan facility with Textron Financial Corporation
(Textron), which provided up to $25 million to fund operations. We utilized $12.9 million as of
December 31, 2004, which was approximately the maximum loan availability. We did not meet the fixed
charge coverage ratio for the quarters ended June 30, 2004, September 30, 2004 and December 31,
2004. All other financial covenants were met. Per the agreement, Textron could cancel the loan
arrangement at any time. Textron began charging additional interest at a rate of 300 basis points
per annum beginning October 4, 2004. Effective January 27, 2005, we entered into a Modification and
Termination Agreement with Textron. Among other things the Modification and Termination Agreement
provides that Text ron will forbear from exercising default rights and remedies until May 31, 2005,
will waive the early termination fee and modify the annual facility fee. We agreed to pay a
modification fee of $150,000. On April 4, 2005, we entered into an accounts receivable financing agreement with Thermo Credit,
LLC (Thermo). The agreement provides for the sale of up to $22 million of our accounts receivable
on a continuous basis to Thermo, subject to 57




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selection criteria as defined in the contract. We plan to use the facility to replace our credit
facility with Textron. Expected proceeds from this facility will approximate the year end Textron
loan balance. On August 24, 2004, we entered into a $15 million Standby Credit Facility Agreement with The 1818
Fund III, L.P., a related party, which is one of a family of funds managed by Brown Brothers
Harriman. During 2004, we were advanced $6.5 million pursuant to the credit facility. Loans under
the credit facility are represented by a Senior Unsecured Promissory Note bearing interest at 9.95%
annually. The note matures March 31, 2006. As of December 31, 2004, we did not meet a
cross-default covenant due to the non-compliance with the Textron asset based loan facility. Per
the standby credit facility agreement, this could trigger an immediate demand of payment upon
notice by The 1818 Fund. Discussions with The 1818 Fund have indicated that they will not require
immediate payment due to our new factoring arrangement with Thermo Credit, LLC. This loan is
included in the current portion of long term debt on the balance sheet. Subsequent to year end, we
were advanced an additional $7.2 million pursuant to the facility. By letter dated July 28, 2004, the Nasdaq Stock Market, Inc. notified us that for 10 consecutive
days the market value of our listed securities was below $35 million as required for continued
inclusion by Nasdaq Marketplace Rule 4310(c)(2)(B)(ii). Nasdaq initially gave us 30 calendar days
or until August 27, 2004 to regain compliance. Nasdaq asserted that if compliance could not be
demonstrated by that day, the Nasdaq staff would provide written notification that our common stock
would be delisted. We appealed to a Nasdaq Listing Qualifications Hearing Panel and were granted a
temporary exception which expired on December 1, 2004. In December 2004, we received notification
from Nasdaq that we had regained compliance with the rules for continued inclusion on the Nasdaq
SmallCap Market. By letters dated March 22, 2005 and April 4, 2005, Nasdaq notified us of
further non compliance with their rules. We are in the process of preparing a plan to comply with
their rules which we will present to Nasdaq. On November 19, 2004, our shareholders approved a one-for-five reverse stock split of our common
stock. The reverse stock split was affected on November 30, 2004. Fractional shares were not issued
in connection with the reverse stock split. All share and per share amounts have been restated
herein to reflect the one-for-five reverse stock split. In November 2004, we also completed the successful conversion of our mandatorily redeemable
preferred stock to common stock. The effect of the conversion was to reduce stockholders deficit
by $159.6 million. The stockholders deficit at December 31, 2004 is $21.1 million. On August 25, 2004, then president and chief executive officer and Board member D. Gregory Smith
and then chief technology officer and Board member Charles W. McDonough resigned from their
positions to found a new company. Messrs. Smith and McDonough intend to pursue certain product and
business initiatives that were under development in our Atlanta technology center at the time of
their resignation. Our Board of Directors authorized the negotiation of an agreement with Messrs.
Smith and McDonough defining the specific activities, assets and personnel to be transferred to the
new company and other terms of the transaction. The Board has appointed Trey Davis as Acting Chief
Executive Officer and Executive Vice President. Mr. Davis will retain his present duties as Chief
Financial Officer. The Board also appointed Frank Grillo as Acting Chief Operating Officer and
Executive Vice President. Subsequent to the change of management, several actions were initiated to improve the overall
operating cash flow of the company. The most significant was a change in company direction that
reduced the focus on enhanced services development and increased the focus on building our customer
base, revenue streams and continuing VoIP deployment plans. This involved a reduction in force that
occurred in September 2004 to help align the companys cost structure with the companys new
direction. In addition, the company initiated a variety of other measures during the last four
months of 2004 in an effort to improve its cash flows. The company reported a substantial
improvement in its reported operating cash flows during the fourth quarter of 2004, mostly as a
result of these initiatives. Management has continued to pursue a variety of measures subsequent to
January 1 in an effort to improve the operating cash flows of the business on a going forward
basis. Our net cash used in investing activities improved by $1.5 million to $9.5 million for the
year ended December 31, 2004, compared to $11.0 million the prior year. The improvement was
attributable to the purchasing of less property and equipment during 2004 as compared to 2003. For the year ended December 31, 2004, net cash provided by financing activities was $15.7 million
as compared to net cash used in financing activities of $5.0 million for the prior year. This
improvement is primarily the result of funds drawn on our asset based loan facility and our standby
credit facility. Management closely monitors liquidity and updates its forecast regularly. While the current
regulatory climate makes the cash forecast very difficult to predict, the most recent forecast for
2005 reflects positive cash flow from operations before interest charges. There can be no assurance
that the forecasted cash flow will occur. 58




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The companys inability to operate profitably and to consistently generate cash flows from
operations, its reliance therefore on external funding either from loans or equity raise
substantial doubt about the companys ability to continue as a going concern. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include all our accounts and our wholly- owned subsidiaries.
All intercompany accounts and transactions have been eliminated. CASH AND CASH EQUIVALENTS We consider all highly liquid investments with original maturity dates of three months or less to
be cash equivalents. PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses and other current assets consist primarily of prepaid maintenance and support,
insurance contracts, advances to suppliers and certain disputes with vendors that require payment
and filing of a dispute claim. PROPERTY AND EQUIPMENT, NET Property and equipment are recorded at historical cost. Depreciation and amortization are
calculated on a straight-line basis over the assets useful life. Maintenance and repairs are
expensed as incurred, while renewals and betterments are capitalized. Upon the sale or other
disposition of property, the cost and related accumulated depreciation are removed from the
accounts and any gain or loss is recognized in operations. Under the Statement of Position (SOP)
98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use, we
expense computer software costs related to internal software that are incurred in the preliminary
project stage. When the capitalization criteria of SOP 98-1 have been met, costs of developing or
obtaining internal-use computer software are capitalized. We capitalized approximately $3.3
million, $3.1 million and $3.7 million of employee salary costs for internally developed software
for the years ended December 31, 2004, 2003 and 2002, respectively. Internal use software is
included as a component of property and equipment on the consolidated balance sheet. We also incur
research and development costs, such as employee salaries and outside consultants; these costs are
expensed in our general and administrative expense. We expensed approximately $4.7 million, $6.0
million and $7.4 million of research and development costs for the years ended December 31, 2004,
2003 and 2002, respectively. LONG-LIVED ASSETS We review long-lived assets for impairment whenever events or changes in circumstances indicate
that the carrying amo unt of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to future net expected
undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying amount of the
assets exceeds the discounted cash flows. We adopted Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets on a prospective basis on January 1, 2002. This
statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. However, SFAS 144 retains the fundamental provisions of SFAS
No. 121 for the recognition and measurement of the impairment of long-lived assets to be held and
used and the measurement of long-lived assets to be disposed of by sale. Impairment of goodwill is
not included in the scope of SFAS No. 144 and will be treated in accordance with the accounting
standards established in SFAS No. 142, Goodwill and Other Intangible Assets. According to SFAS No.
144, long-lived assets are to be measured at the lower of carrying amount or fair value less cost
to sell, whether reported in continuing or discontinued operations. The statement applies to all
long-lived assets, including discontinued operations, and replaces the provisions of APB Opinion
No. 30, Reporting the Results of Operations  Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the
disposal of segments of a business. INTANGIBLE ASSETS, NET We adopted SFAS No. 141 Business Combinations and SFAS No. 142, Goodwill and Other Intangible
Assets, as of January 1, 2002. SFAS 141 addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the
initial recognition and measurement of intangible assets acquired outside of a business 59




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combination, whether acquired individually or with a group of other assets, and the accounting and
reporting for goodwill and other intangible assets subsequent to their acquisition. These standards
require all future business combinations to be accounted for using the purchase method of
accounting. Certain intangible assets will no longer be amortized ratably but instead will be
subject to impairment tests at least annually. Intangible assets on the consolidated balance sheet consist of customer lists resulting from our
acquisition of Touch 1 in 2000. The customer lists are amortized over five years using the
straight-line method and reviewed for impairment as outlined in our long-lived assets policy above.
All goodwill was written-down to a zero value in 2001. (See footnote 7.) REVENUE RECOGNITION Revenues are recognized when earned. Revenues related to long distance and carrier access service
charges are billed monthly in arrears, and the associated revenues are recognized in the month when
services are provided. Charges for our bundled services are billed monthly in advance and we
recognize revenues for these services ratably over the service period. Revenues from installations
and activation activities are deferred and recognized over twelve months, which we believe is the
estimates life of our customer relationships. We began offering wholesale services during 2002. This service offering includes fees for services
provided according to certain per line, per minute and other certain activities as defined in our
agreements and also the payments of providing telephone exchange, vendor and personnel expenses. We
perform a review of each contract and determine the appropriate timing of revenue recognition
depending on the facts and circumstances of each individual item within the contract. We are
currently deferring certain revenues over the life of our arrangements, rather than recognizing
revenues up-front. We use the gross method to record our revenues for wholesale services where we
are the primary obligor. This method involves the recording of revenues for items that we are
directly reimbursed by our wholesale customer with an offsetting expense reported in the
appropriate operating expense line. STOCK-BASED COMPENSATION For employee stock options, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation
requiring entities to recognize as an expense, over the vesting period, the fair value of the
options or utilize the accounting for employee stock options used under APB 25. We apply the
provisions of Accounting Principles Board (APB) Opinion No. 25 and consequently recognize
compensation expense over the vesting period for grants made to employees and directors only if, on
the measurement date, the market price of the underlying stock exceeds the exercise price. We
provide the pro forma net income and earnings per share disclosures as required under SFAS No. 123
for grants made as if the fair value method defined in SFAS No. 123 had been applied. We recognize
expense over the vesting period of the grants made to non-employees based on utilizing the
Black-Scholes stock valuation model to calculate the value of the option on the measurement date. The following table illustrates, in accordance with the provisions of SFAS No. 148, Accounting for
Stock-Based Compensation Transition and Disclosure, an Amendment of SFAS 123, Accounting for
Stock-Based Compensation, the effect on net loss and earnings per share if we had applied the fair
value recognition provisions of SFAS No. 123, to stock-based employee compensation. For the years endedDecember 31,2004
    
    
    2003
    
    
    2002Net loss attributable to common stockholders, as reported
    
    $
    (106,523
    )
    
    $
    (33,793
    )
    
    $
    (35,330
    )Add: Stock based compensation included in net loss
    
    
    567
    
    
    
    123
    
    
    
    206Deduct: Total stock based employee compensation determined
under the fair value based method for all awards
    
    
    (3,260
    )
    
    
    (5,821
    )
    
    
    (13,182
    )Net loss attributable to common stockholders, pro forma
    
    $
    (109,216
    )
    
    $
    (39,491
    )
    
    $
    (48,306
    )Basic and Diluted Net Loss
Per Common ShareAs reported
    
    $
    (9.12
    )
    
    $
    (4.77
    )
    
    $
    (5.05
    )Pro forma
    
    
    (9.35
    )
    
    
    (5.58
    )
    
    
    (6.91
    )
 We calculated the fair value of each grant on the date of grant using the Black-Scholes option
pricing model. In addition to there being no payments of dividends on our common stock and 550,000
options with a strike price of 3.64 expiring in December 2003 the following assumptions were used
for each respective period: 60




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For the years endedDecember 31,2004
    
    
    2003
    
    
    2002Discount Rate
    
    
    3.1
    %
    
    
    3.1
    %
    
    
    3.1
    %Volatility
    
    
    98.4
    %
    
    
    96.6
    %
    
    
    93.0
    %Average Option Expected Life
    
    5 years
    
    5 years
    
    5 years
 Incremental shares of common stock equivalents are not included in the calculation of net loss per
share as the inclusion of such equivalents would be anti-dilutive. ADVERTISING Advertising costs are expensed as incurred. Included in sales and marketing expenses are
advertising costs of approximately $2.6 million, $5.3 million and $5.2 million for the years ended
December 31, 2004, 2003 and 2002, respectively. INCOME TAXES We utilize the asset and liability method of accounting for income taxes. Under this method,
deferred income taxes are recorded to reflect the tax consequences on future years of differences
between the tax basis of assets and liabilities and their financially reported amounts at each
year-end based on enacted laws and statutory rates applicable to the periods in which differences
are expected to affect taxable income. A valuation allowance is provided against the future
benefits of deferred tax assets due to our history of operating losses. CONCENTRATIONS Financial instruments that potentially subject us to concentrations of credit risk consist
principally of cash and cash equivalents and accounts receivable. We place our cash and cash
equivalents in financial institutions considered by management to be high quality. We maintain cash
balances at financial institutions in excess of the $100,000 insured by the Federal Deposit
Insurance Corporation (FDIC). We had approximately $2.4 million and $2.7 million invested in
interest bearing money market and short-term fixed income investments that are not insured by the
FDIC at December 31, 2003 and 2002, respectively. We have not experienced any losses in these
accounts and believe we are not exposed to any significant credit risk on cash balances. During the normal course of business, we extend credit to residential and business customers
residing in the United States. Our customer base is broken-down as follows: Percentage of Total BundledService Revenues2004
    
    
    2003New York
    
    
    29
    %
    
    
    33
    %Illinois
    
    
    8
    %
    
    
    10
    %Michigan
    
    
    7
    %
    
    
    9
    %Georgia
    
    
    6
    %
    
    
    6
    %Texas
    
    
    6
    %
    
    
    6
    %Kentucky
    
    
    6
    %
    
    
    6
    %Pennsylvania
    
    
    4
    %
    
    
    4
    %Florida
    
    
    4
    %
    
    
    3
    %Virginia
    
    
    4
    %
    
    
    2
    %Maryland
    
    
    3
    %
    
    
    3
    %California
    
    
    3
    %
    
    
    2
    %Indiana
    
    
    2
    %
    
    
    2
    %New Jersey
    
    
    2
    %
    
    
    1
    %Tennessee
    
    
    2
    %
    
    
    2
    %Alabama
    
    
    2
    %
    
    
    2
    %All Others
    
    
    12
    %
    
    
    9
    %100
    %
    
    
    100
    %
 61




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This results in a concentration of credit to residential and business customers in these states. We
believe our credit policies, collection procedures and allowance for doubtful accounts minimize the
exposure to significant credit risk of accounts receivable balances. Additionally, our wholesale
services receivables are concentrated with Sprint Communications Company L.P. (Sprint) as they
are the primary wholesale customer. We rely upon the Regional Bell Operating Companies (RBOCs) for provisioning of customers and the
RBOCs are the primary suppliers of local central office switching and local telephone lines. Global
Crossing Ltd and WilTel Communications Group, Inc. are the primary suppliers for our long-distance
calling. We have not incurred any material impact to our operations or financial statements as a
result of the Chapter 11 bankruptcy filings made by these companies. We rely upon two separate service providers for provisioning and billing services essential to
support our operations. SEGMENT REPORTING SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, requires that
we report financial and descriptive information about reportable segments, and how these segments
were determined. We determine the allocation and performance of resources based on total
operations. Based on these factors, management has determined that we operate as two segments as
defined by SFAS No. 131. Our segments are retail services and wholesale services. FINANCIAL INSTRUMENTS The recorded amounts of cash and cash equivalents approximate fair value due to the short-term
nature of these instruments. We have determined that due to the interest rates and short-term
nature of the capital lease obligation, the fair value approximates the value recorded. We have
determined that the long-term debt assumed through acquisition is recorded at fair value. The
interest rates were adjusted to the current market rate for purchase accounting treatment and we
believe the debt is properly recorded at fair value. MANAGEMENTS USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements. Estimates also affect the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates. NEW ACCOUNTING PRONOUNCEMENTS In March 2004, the EITF reached a consensus on EITF Issue No. 03-6, Participating Securities and
the Two-Class Method under FASB Statement No. 128, Earnings per Share (EITF 03-6). EITF 03-6
clarifies what constitutes a participating security and provides further guidance in applying the
two-class method of calculating earnings per share (EPS). The consensus reached by the EITF in
this Issue is effective for reporting periods beginning after March 31, 2004. We adopted EITF Issue
No. 03-06 during the quarter ended June 30, 2004. There was no impact of the adoption on the
computation of EPS, as the effect is anti-dilutive. In periods of net income, we will utilize the
two-class method of computing EPS. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4 (SFAS 151). SFAS 151 clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material (spoilage) by requiring that these costs be
recognized as current period charges. This Statement is effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The adoption of this Statement will not have any
impact on our consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of
APB Opinion No. 29 (SFAS 153). APB Opinion No. 29 stated that there were certain exceptions to
the principle that exchanges of nonmonetary assets should be measured using fair value; SFAS 153
eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have commercial substance.
SFAS 153 states that a nonmonetary exchange has commercial substance if the future cash flows of
the entity are expected to change significantly as a result of the exchange. SFAS will be effective
for nonmonetary asset exchanges in fiscal years beginning after June 15, 2005. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Accounting for Stock-Based
Compensation (SFAS 123(R)). SFAS 123(R) focuses on accounting for transactions in which an
entity obtains employee services in share-based 62




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payment transactions. SFAS 123(R) requires the cost of such services to be measured based on the
grant-date fair value of the award. SFAS 123(R) will be effective as of the beginning of the first
reporting period that begins after June 15, 2005. RECLASSIFICATION To be consistent with emerging industry practices, the revenues for all periods presented have been
changed to reflect the billing to our customers of the Universal Service Fund (USF) and other
regulatory fees and the related payments into the associated regulatory funds as network operations
expense. Operating income and net income for all periods presented were unaffected. USF billings
included in revenues and expenses were $5.8 million, $4.2 million and $3.1 million for the years
ended December 31, 2004, 2003 and 2002, respectively. We also have certain other amounts in the
December 31, 2003 and 2002 financial statements that have been reclassified to conform to the
December 31, 2004 presentation. 3. WHOLESALE SERVICES In February 2003, we executed an agreement providing for the resale of our local wireline
telecommunications services and provision of ancillary services with Sprint. Under this agreement,
we provide Sprint access to our Web-integrated, enhanced communications platform and operational
support systems. This contract includes various per-minute, per-line, and other charges that are
being recorded as revenue when earned. We are the primary obligor for underlying expenses that are
incorporated into our pricing in connection with the agreement and therefore, are recording
revenues using a gross presentation. This method results in all per-line, per-minute and certain
direct costs being recorded as revenues and the corresponding expenses being recorded in the
appropriate operating expense line. As a result of this accounting treatment, increases or
decreases in pricing or volume that impact direct costs that are incurred in connection with this
agreement would have no impact on net income, as the amount is recorded in both revenue and
expense. Our wholesale services agreement with Sprint is non-exclusive in nature. We are deferring $1.0 million of revenues for pre-contract payments by recognizing this amo unt
ratably over the life of the agreement. Additionally, we received a $1.0 million payment prior to
inception of the agreement, which we have returned to Sprint as a bill credit during the second
half of 2003, for the achievement of reaching certain line-count thresholds. At December 31, 2004, under our contract with Sprint, we had approximately $0.4 million of deferred
revenue, of which $0.03 million is recorded as long-term deferred revenue. At December 31, 2003 we
had approximately $0.4 million of long-term and $0.3 million and short-term deferred revenue. On March 20, 2002, we entered into a 48-month agreement with MCI for wholesale telephone exchange
services, ancillary services and a limited-term technology license. The agreement was cancelable by
either party after eighteen months. Under the original terms of the agreement, MCI was to pay us a maximum of $50 million related to
the use of our network in the form of a technology license fee, should the agreement not be
terminated early. Cash flows related to the license were to be paid based on the number of MCI
customers on our network, as defined in the contract, and were subject to monthly minimum amounts.
In addition, MCI was to pay for services provided through usage-based fees according to certain per
line and per minute calculations defined in the agreement and MCI was to also pay fees to us for
providing telephone exchange services, payroll costs and certain vendor fees. We were the primary
obligor for all costs incurred under this agreement. We recognized the $50 million license fee, and amounts received in advance of the contract, on a
straight-line basis over the four-year contract period beginning in April 2002. In connection with
the agreement, we issued MCI one million shares of our common stock at a price of $2.33, the market
price of our stock at the date of the agreement. As a result of this transaction an asset totaling
$2.3 million was being amortized on a straight-line basis as a reduction to revenues over the
48-month term of the agreement with the remaining balance recorded in other non-current assets.
Monthly usage-based charges and cost reimbursements were recognized when earned. On November 1, 2002 we significantly amended the terms or our agreement with MCI. This amendment
was made as a result of MCIs bankruptcy filing on July 21, 2002. The significant financial changes
in this amendment are the elimination of the $50 million limited-term technology license fee,
increases to various fees calculated on a per minute and per line basis, certain additional fees
for services provided, elimination of exclusivity clauses, a reduction to the monthly minimum
payments and forgiveness of certain amounts to be repaid to MCI. On August 7, 2003, we amended our contract with MCI to terminate the contract on December 31, 2003.
On August 15, 2003, MCI provided us with notice that they were terminating the contract effective
October 15, 2003. As a result of these events we accelerated the recognition of deferred revenue to
the termination date of October 15, 2003. Prior to the early termination, we were recognizing the
deferred revenue ratably over the life of the agreement with a termination date of December 31,
2005. As a result of these actions, we recognized $4.8 million of previously deferred revenue
during 2003. 63




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4. ACCOUNTS RECEIVABLE AGREEMENT In July 2000, we entered into an accounts receivable agreement with RFC Capital Corporation, a
division of Textron, Inc. (RFC), providing for the sale of certain of our accounts receivable to
RFC. The RFC agreement provided for the purchase of up to $25.0 million of certain of our
accounts receivable, subject to selection criteria as defined in the contract. In July 2002, we
extended our agreement with RFC under substantially similar terms for an additional two years. The
purchase of the receivables was at the option of RFC and they utilized selection criteria to
determine which receivables would be purchased. We had been selling our receivables to RFC at a 23%
discount. Prior to March 2002 we sold our receivables at a 32% discount. Our collection percentage
for receivables sold to RFC was 98.5% and 92.9% for the years ended December 31, 2003 and 2002,
respectively. We received an additional payment from RFC for servicing the assets in an amount
equal to every dollar collected over the advance rate, less certain fees. The accounts receivable
agreement did not have a minimum receivable sales requirement. We sold approximately $138.2 million and $135.2 million of receivables to RFC, for net proceeds of
approximately $111.9 million and $107.3 million, during the years ended December 31, 2003 and 2002,
respectively. A net receivable servicing asset of approximately $13.2 million and $8.5 million was
included in the accounts receivable balance at December 31, 2003 and 2002, respectively. We
recorded costs related to the agreement of approximately $1.0 million and $1.3 million for the
years ended December 31, 2003 and 2002, respectively. Included in accounts payable and accrued
liabilities were advances for unbilled receivables in the amount of $4.2 million and $3.4 million
at December 31, 2003 and 2002, respectively. We were responsible for the continued servicing of the
receivables sold. In April 2004 we signed a three-year asset based loan agreement with Textron, which eliminated our
RFC accounts receivable factoring agreement. See note 10 for more information on the Textron
agreement. 5. PROPERTY AND EQUIPMENT At the respective dates, property and equipment consist of the following: DepreciableLives in
    
    December 31,Years
    
    2004
    
    
    2003Switching equipment
    
    5-10
    
    $
    14,686
    
    
    $
    14,488Computer equipment
    
    5-10
    
    
    38,674
    
    
    
    36,064Software
    
    3
    
    
    57,038
    
    
    
    53,822Furniture and office equipment
    
    5-10
    
    
    9,018
    
    
    
    8,990Leasehold improvements
    
    3-15
    
    
    6,393
    
    
    
    6,247Land and building
    
    20-30
    
    
    4,354
    
    
    
    4,332Construction-in-progress
    
    
    
    
    300
    
    
    
    1,047Vehicles
    

5
    
    
    20
    
    
    
    130,483
    
    
    
    124,990Less accumulated depreciation and amortization
    
    
    
    
    (102,654
    )
    
    
    (85,921
    )Property and equipment, net
    
    
    
    $
    27,829
    
    
    $
    39,069
 Depreciation expense related to property and equipment amounted to approximately $9.2 million,
$9.4 million and $10.5 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Amortization expense related to software amounted to approximately $8.7 million, $11.2 million and
$11.3 million for the years ended December 31, 2004, 2003 and 2002, respectively. On September 29, 2004 we signed an agreement with SipStorm, Inc., a company formed by our former
Chief Executive officer, D. Gregory Smith, and former Chief Technology Officer, Charles McDonough.
Under this agreement we have transferred selected computer hardware, software and intellectual
property rights to SipStorm. These non-core assets are mainly related to our second generation
enhanced service products. SipStorm agreed to continue development of these applications and
provide us with access to the developed product over the course of the next 15 months. Relative to
the purchase, SipStorm has assumed responsibility for certain accounts payable, future maintenance
payments and provided a promissory note in the amount of $2.8 million. The promissory note is
collateralized by shares of our common stock owned by Messrs. Smith and McDonough. 64




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Assets acquired under capital leases, included in property and equipment, consist of the following: December 31,2004
    
    
    2003Computer equipment
    
    $
    2,443
    
    
    $
    2,443Software
    
    
    912
    
    
    
    9123,355
    
    
    
    3,355Less accumulated depreciation and amortization
    
    
    (1,967
    )
    
    
    (1,357
    )Capital leases, net
    
    $
    1,388
    
    
    $
    1,998
 6. ASSET IMPAIRMENT In April of 2002, we announced a restructuring plan that included a reduction in force and the
closure of the North Dakota call centers, acquired from Touch 1, resulting in the settlement of the
leases in these locations and an asset impairment charge totaling approximately $1.1 million being
recorded in the second quarter of 2002. No impairments were recorded in 2004 or 2003. 7. INTANGIBLE ASSETS In accordance with SFAS No. 142, we reassessed the expected useful lives of our existing intangible
assets. This reassessment resulted in no changes to the expected useful lives of our customer
lists. DECEMBER 31, 2004
    
    
    DECEMBER 31, 2003CARRYING
    
    
    ACCUMULATED
    
    
    NET INTANGIBLE
    
    
    CARRYING
    
    
    ACCUMULATED
    
    
    NETINTANGIBLE
    
    AMOUNT
    
    
    AMORTIZATION
    
    
    ASSETS
    
    
    AMOUNT
    
    
    AMORTIZATION
    
    
    ASSETSINTANGIBLE ASSETS SUBJECT TO AMORTIZATION:Customer related intangible assets
    
    $
    9,145
    
    
    $
    8,688
    
    
    $
    457
    
    
    $
    9,145
    
    
    $
    6,858
    
    
    $
    2,287
 The following table presents current and expected amortization expense of the existing
intangible assets as of December 31, 2004 for each of the following periods: Aggregate Amortization Expense: For the year ended December 31, 2004
    
    $
    1,830Expected amortization expense for the year ending December 31, 2005
    
    
    457
 8. OTHER ASSETS At the respective dates, other assets consist of the following: 2004
    
    
    2003Deposits
    
    $
    3,425
    
    
    $
    3,062Inventory
    
    
    184
    
    
    
    Certificates of deposit, restricted
    
    
    
    
    
    
    673Interest receivable
    
    
    
    
    
    
    54Other
    
    
    
    
    
    
    31$
    3,609
    
    
    $
    3,820
 The certificates of deposit were pledged as collateral on outstanding letters of credit in the
amount of approximately $0.7 million at December 31, 2003, related to lease obligations on office
space and $0.1 million for certain surety bonds required for regulatory purposes. 65




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9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES At the respective dates, accounts payable and accrued liabilities consist of the following: 2004
    
    
    2003Trade accounts payable
    
    $
    40,586
    
    
    $
    39,485Accrued sales and use tax payable
    
    
    10,223
    
    
    
    6,908Advances on accounts receivable
    
    
    
    
    
    
    4,181Accrued payroll
    
    
    1,033
    
    
    
    2,560Accrued rent
    
    
    1,028
    
    
    
    1,263Accrued restructuring charges
    
    
    954
    
    
    
    351Accrued sales commissions
    
    
    816
    
    
    
    644Accrued interest payable
    
    
    965
    
    
    
    50$
    55,605
    
    
    $
    55,442
 10. ASSET BASED LOAN In April 2004, we signed a three-year asset based loan facility with Textron. This agreement
provides us with an availability to borrow up to $25 million at a 6% interest rate. Our overall
availability is based on the eligibility of our accounts receivable, subject to certain limitations
and advance rates. The asset based loan facility includes residential, business and wholesale
accounts receivable while our prior arrangement with RFC Capital Corporation (RFC) only included
certain portions of our accounts receivable. This agreement has three primary quarterly financial covenants: a fixed charge coverage ratio,
accounts receivable turnover requirement and an unfunded capital expenditures cap. We did not
meet the fixed charge coverage ratio for the quarters ended June 30, 2004, September 30, 2004 and
December 31, 2004. All other financial covenants have been met per our agreement with Textron.
Textron notified us on October 1, 2004 that they would be charging an additional interest rate of
300 basis points starting on October 4, 2004 due to the fixed charge coverage ratio not being met. Under the amended asset based loan structure with Textron, we had an outstanding loan balance to
Textron of approximately $12.9 million included in current liabilities at December 31, 2004. Effective January 27, 2005, we entered into a Modification and Termination Agreement with Textron
Financial Corporation, our asset-based lender. Among other things the Modification and Termination
Agreement provides that Textron will forbear from exercising default rights and remedies until May
31, 2005, will waive the early termination fee and modify the annual facility fee. We agreed to pay
a modification fee of $150,000. On April 4, 2005, we entered into an accounts receivable financing agreement with Thermo Credit,
LLC (Thermo). The agreement provides for the sale of up to $22.0 million of our accounts
receivable on a continuous basis to Thermo, subject to selection criteria as defined in the
contract. The discount rate is 2.5%. Purchase of the receivables is at the option of Thermo. We
plan to use this facility to replace our credit facility with Textron. 11. STANDBY CREDIT FACILITY On August 24, 2004, we entered into a $15 million Standby Credit Facility Agreement with The 1818
Fund, a related party, which is one of a family of funds managed by Brown Brothers Harriman. During
2004, we were advanced $6.5 million pursuant to the credit facility. Loans under the credit
facility are represented by a Senior Unsecured Promissory Note bearing interest at 9.95% annually.
The note matures March 31, 2006. As of December 31, 2004, we did not meet a cross-default covenant due to the non-compliance with
the Textron asset based loan facility (see note 10). Per the standby credit facility agreement,
this could trigger an immediate demand of payment upon notice by The 1818 Fund. Upon discussions
with The 1818 Fund, they have indicated that they will not require immediate payment due to our new
factoring arrangement with Thermo Credit, LLC. This loan has been reclassified to short term on
the balance sheet. 66




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12. LONG-TERM DEBT Long-term debt consists of the following: 2004
    
    2003RELATED PARTIES:Note payable to Corman Elegre, customer base pledged
as collateral, payable in monthly installments, due
September 2004, interest rate at 6%
    
    $
    532
    
    
    $
    2,364Note payable to First Revocable Trust of W. F.
Corman, unsecured, payable in monthly installments,
due September 2004, interest rate at 6%
    
    
    
    
    
    
    132Note payable to James F. Corman, unsecured, payable
in monthly installments, due September 2004, interest
rate at 6%
    
    
    
    
    
    
    45UNRELATED PARTIES:Note payable to Franklin Investment Funds, unsecured,
payable in monthly installments, due September 2004,
interest rate of 6%
    
    
    
    
    
    
    919Note payable to First National Bank of Atmore,
unsecured, personally guaranteed by James F. Corman,
payable in monthly installments, due September 2004,
interest rate at 6%
    
    
    
    
    
    
    123Notes payable to Touch 1 pre-petition creditors (trade
vendors), unsecured, payable in monthly installments,
due September 2004, interest rate at 6%
    
    
    
    
    
    
    409Notes payable to Touch 1 pre-petition creditors (trade
vendors), priority unsecured, payable in monthly
Installments, due September 2005, interest rate at 6%
    
    
    55
    
    
    
    58587
    
    
    
    4,050Less: Current portion
    
    
    (587
    )
    
    
    (3,992
    )Total long-term debt
    
    $
    
    
    
    $
    58
 OPERATING LEASES We have entered into various non-cancelable operating leases for equipment and office space with
monthly payments through the year 2009. Included in general and administrative expense is rental
expense relating to operating leases of approximately $2.8 million, $2.9 million and $2.9 million
for the years ended December 31, 2004, 2003, and 2002, respectively. Sales and marketing expense
includes $0.3 million of rental expense relating to operating leases for the year ended December
31, 2002. CAPITAL LEASES We have entered into various capital lease obligations that have effective interest rates ranging
from 3.18% to 19.92%, with five capital leases remaining with payments through 2006. 67




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Future minimum lease payments under non-cancelable operating and capital leases and long-term debt
as of December 31, 2004 are as follows: CAPITALOPERATING
    
    
    LEASE
    
    
    LONG-TERMYEAR ENDING DECEMBER 31,
    
    LEASES
    
    
    OBLIGATIONS
    
    
    DEBT2005
    
    $
    2,168
    
    
    $
    449
    
    
    $
    5872006
    
    
    2,014
    
    
    
    33
    
    
    
    2007
    
    
    2,087
    
    
    
    
    
    
    
    2008
    
    
    2,166
    
    
    
    
    
    
    
    2009
    
    
    1,459
    
    
    
    
    
    
    
    Thereafter
    
    
    1,040
    
    
    
    
    
    
    
    Less amount representing
estimated executory costs
(taxes, etc.), including
profit thereon, included
in minimum lease payments
    
    
    
    
    
    
    (35
    )
    
    
    Net minimum payment
    
    $
    10,934
    
    
    
    447
    
    
    $
    587Less amount representing
Interest on obligations under
capital lease
    
    
    
    
    
    
    (39
    )Present value of minimum
lease payments
    
    
    
    
    
    $
    408
 13. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK In November 2004 we consummated a tender offer to exchange our three outstanding series of
convertible preferred stock as follows:  
    For our Series D Convertible Preferred Stock, which as of September 27, 2004 3,976,723
shares with a liquidation preference of $16.55 per share and a conversion price of $8.47
per share were outstanding, to exchange 25.69030 shares of our common stock, for each share
of our Series D Preferred Stock (representing an exchange price of approximately $0.644 per
share);
    For our 8% Convertible Preferred Stock, Series E, which as of September 27, 2004
4,166,667 shares with a liquidation preference of $16.26 per share and a conversion price
of $8.08 per share were outstanding, to exchange 25.24216 shares of our common stock, for
each share of our Series E Preferred Stock (representing an exchange price of approximately
$0.644 per share); and
    For our 12% Junior Redeemable Convertible Preferred Stock, Series G, which as of
September 27, 2004 171.214286 shares outstanding with had a liquidation preference of
$144,974.90 per share and conversion price of $1.28 per share were outstanding, to exchange
161,469.4 shares of our common stock, for each share of our Series G Preferred Stock
(representing an exchange price of approximately $0.898 per share). The conversion of these three series of preferred stock resulted in a deemed dividend for the
beneficial conversion of $57.4 million. Simultaneously with the exchange we consummated a one for five reverse stock split of our common
stock. As a result of the tender offer, we exchanged approximately 46,657,636 of our common shares
(on a post reverse split basis) for all of our outstanding preferred stock. On a fully diluted basis, the previous holders of the Series D Preferred Stock own approximately
34.0% of our outstanding common stock, the previous holders of the Series E Preferred Stock
approximately 35.0%, the previous holders of the Series G Preferred Stock approximately 9.2%, the
existing holders of the common stock approximately 13.8% and approximately 8.0% is available for
issuance under a new management equity incentive plan. In 2003, four holders of our Series D Convertible Preferred Stock (Series D) converted their
shares to common stock. There was a total of 13,333 shares of Series D converted into 21,805
shares of common stock. We also paid $0.1 million in cash for certain dividends. In 2002, we had
one conversion of 10,000 shares of Series D converted into 15,232 common shares. In accordance with EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios, APB Opinion No. 14, Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants, EITF 00-27, Application of Issue
No. 98-5 to Certain Convertible Instruments and SFAS No. 128 Earnings Per
Share we recorded non-cash charges relating to a beneficial conversion, cumulative dividends and
preferred stock accretion. We recorded preferred stock dividends and accretion of $15.3 million,
$17.5 million and $15.6 million for the years ended December 31, 2004, 2003 and 2002, respectively.
We also recorded a deemed dividend related to a beneficial conversion feature in the 68




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amounts of
approximately $57.6 million, $0.2 million and $0.2 million for the years ended December 31, 2004,
2003 and 2002, respectively. The recording of the beneficial conversion feature and the resulting preferred stock accretion is
the result of calculating the accounting conversion price through a fair value allocation of the
net proceeds received in the preferred stock offerings between the preferred stock and the warrants
issued. This required the use of the Black-Scholes valuation model to calculate the fair value on a
per share or warrant basis for the Series D, E and G Preferred. The beneficial conversion and
resulting preferred stock accretion and the cumulative dividend are included in the calculations of
the net loss attributable to common stockholders and the net loss per share calculation. 14. COMMON STOCK The board of directors has never declared dividends on our common stock since inception on January
15, 1998. On November 19, 2004, our shareholders approved a one-for-five reverse stock split of our common
stock. The reverse stock split was affected on November 30, 2004. Fractional shares were not
issued in connection with the reverse stock split. All share and per share amounts have been
restated herein to reflect the one-for-five reverse stock split. 15. RESTRUCTURING CHARGES In April of 2002, we approved and implemented a restructuring to enhance our future cash flows and
operating earnings. The restructuring included a reduction of force coupled with the closure of our
North Dakota call centers and our New York sales office. In accordance with EITF 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity, the
restructuring costs were recognized as liabilities at the time management committed to the plan.
Management determined that these costs provided no future economic benefit to us. The restructuring charge included termination benefits in connection with the termination of 167
employees and lease abandonment costs. In addition, we agreed to a settlement to exit the two
leases for our call centers in North Dakota as of July 1, 2002. All termination benefits and
settlements to exit our leases in North Dakota were paid as of December 31, 2002. We recorded a
lease abandonment charge representing the future lease payments for our New York office as a
liability and payments exist through August 2005. On May 17, 2004, a termination agreement was signed for our New York office lease on which we had
previously recorded a lease abandonment charge in connection with the restructure. The settlement
included a $90,000 payment in lieu of the remaining balance of $299,545 previously recorded as a
lease abandonment charge. The settlement payment consisted of a one-time payment of $30,000, paid
at the time of agreement, and three promissory notes of $20,000 payable on November 1, 2004, May 1,
2005 and August 30, 2005, respectively. All other expenses associated with this restructuring have
been paid in full. In June 2004, we approved and implemented a restructuring to improve our future cash flows and
operating earnings. The restructuring included a reduction in work force. In accordance with SFAS
No. 146 Accounting for Costs Associated with Exit or Disposal Activities the restructuring costs
were considered a One-Time Termination Benefit and as such we recognized the restructuring costs
as a liability at the communication date of June 8, 2004. The restructuring charge included
termination benefits in connection with the reduction in force of 102 employees. The total charge
taken in the second quarter of 2004 was $0.8 million of which approximately $40,000 was paid in the
second quarter. The majority of the remainder of termination benefits was paid in full at the end
of August 2004. In September 2004, we approved and implemented a restructuring based on the change in management
that occurred on August 25, 2004 and the subsequent change in business focus. The restructuring
included a reduction in force of 152 employees and a write-off of certain assets. In accordance
with SFAS No. 146 the restructuring costs were considered a One-Time Termination Benefit and as
such we recognized the restructuring costs as a liability at the communication date of September 1,
2004. The total charge taken in the third quarter of 2004 was approximately $3.2 million. In October 2004, we approved and implemented an additional restructuring related to 44 employees in
conjunction with the consolidation of certain operations in our Atlanta and Tampa offices into our
Atmore, Alabama offices. In accordance with SFAS No. 146 the restructuring costs were considered a
One-Time Termination Benefit and as such we recognized the restructuring
costs as a liability at the communication date of October 21, 2004. The total charge taken in the
fourth quarter of 2004 was approximately $0.8 million. 69




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The following table shows the restructuring charges and related accruals recognized under the plan
and the effect on our consolidated financial position: Employee
    
    
    Lease
    
    
    LeaseTermination
    
    
    Settlement
    
    
    Abandonment
    
    
    AssetBenefits
    
    
    Costs
    
    
    Costs
    
    
    Retirement
    
    
    TotalBalance at January 1, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Plan Charges
    
    
    913
    
    
    
    325
    
    
    
    623
    
    
    
    
    
    
    
    1,861Cash paid
    
    
    (913
    )
    
    
    (325
    )
    
    
    (72
    )
    
    
    
    
    
    
    (1,310
    )Balance at December 31, 2002
    
    
    
    
    
    
    
    
    
    
    551
    
    
    
    
    
    
    
    551Cash paid
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    
    
    
    
    (200
    )Balance at December 31, 2003
    
    
    
    
    
    
    
    
    
    
    351
    
    
    
    
    
    
    
    351Plan Charges
    
    
    4,527
    
    
    
    
    
    
    
    234
    
    
    
    40
    
    
    
    4,801Cash paid
    
    
    (3,646
    )
    
    
    
    
    
    
    (262
    )
    
    
    
    
    
    
    (3,908
    )Asset disposal
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (40
    )
    
    
    (40
    )Converted to note payable
    
    
    
    
    
    
    
    
    
    
    (40
    )
    
    
    
    
    
    
    (40
    )Lease termination settlement reversal
    
    
    
    
    
    
    
    
    
    
    (210
    )
    
    
    
    
    
    
    (210
    )Balance at December 31, 2004
    
    $
    881
    
    
    $
    
    
    
    $
    73
    
    
    $
    
    
    
    $
    954
 16. INCOME TAXES We account for income taxes under SFAS No. 109, Accounting for Income Taxes. Deferred income tax
assets and liabilities are determined based upon differences between financial reporting and tax
basis of assets and liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The components of the income tax provision are as follows: Year ended December 312004
    
    
    2003
    
    
    2002Current:State Income Tax Expense
    
    $
    23
    
    
    $
    82
    
    
    $
    Subtotal
    
    
    23
    
    
    
    82
    
    
    
    Total
    
    $
    23
    
    
    $
    82
    
    
    $
    
 State income tax expense is included in interest and other expense on the consolidated statement of
operations. A reconciliation of the difference between the effective income tax rate and the statutory federal
tax rate follows: Year ended December 312004
    
    
    2003
    
    
    2002Tax at U.S. statutory rate
    
    $
    (11,772
    )
    
    $
    (5,644
    )
    
    $
    (6,844
    )State taxes, net of federal benefit
    
    
    (997
    )
    
    
    (413
    )
    
    
    (573
    )Change in valuation allowance
    
    
    12,776
    
    
    
    5,807
    
    
    
    7,255Other
    
    
    16
    
    
    
    332
    
    
    
    162$
    23
    
    
    $
    82
    
    
    $
    
 70




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Significant components of our deferred tax assets and liabilities are as follows: Year ended December 312004
    
    
    2003
    
    
    2002Current deferred tax assets:Accounts receivable
    
    $
    4,167
    
    
    $
    5,246
    
    
    $
    6,612Other Reserves
    
    
    2,241
    
    
    
    1,968
    
    
    
    95Noncurrent deferred tax assets:Net operating loss carryforward
    
    
    117,678
    
    
    
    106,691
    
    
    
    99,869Deferred revenue
    
    
    
    
    
    
    271
    
    
    
    2,385Deferred compensation
    
    
    
    
    
    
    181
    
    
    
    616Excess Capital Losses
    
    
    133
    
    
    
    133
    
    
    
    133Accrued Expenses
    
    
    821
    
    
    
    145
    
    
    
    696Other
    
    
    389
    
    
    
    480
    
    
    
    541Gross deferred tax assets
    
    
    125,429
    
    
    
    115,115
    
    
    
    110,947Less: Valuation Allowance
    
    
    (124,676
    )
    
    
    (111,900
    )
    
    
    (106,093
    )753
    
    
    
    3,215
    
    
    
    4,854Noncurrent deferred tax liabilities:Property and equipment
    
    
    (579
    )
    
    
    (2,346
    )
    
    
    (3,290
    )Intangible assets
    
    
    (174
    )
    
    
    (869
    )
    
    
    (1,564
    )Net deferred tax asset (liability)
    
    $
    
    
    
    $
    
    
    
    $
    
 Generally accepted accounting principles require a valuation allowance to reduce the deferred tax
assets reported if, based on the weight of the evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. After consideration of all of the
evidence, both positive and negative, management has determined that a valuation allowance of
approximately $124.7 million is necessary at December 31, 2004 to offset the net deferred tax
asset. At December 31, 2004, our net operating loss carryforward for federal income tax purposes is
approximately $309.7 million, expiring in various amounts from 2018 through 2024. Utilization of
our net operating loss carryforwards may be subject to substantial annual limitations due to the
ownership change rules as provided by the Internal Revenue Code and similar state provisions.
Such annual limitation could result in the expiration of the net operating loss being utilized. 17. COMMITMENTS AND CONTINGENCIES We have disputed billings and access charges from certain inter-exchange carriers (IXCs) and
incumbent local exchange carriers (ILECs). We contend that the invoicing and billings of these
access charges are not in accordance with the interconnection, service level, or tariff agreements
between us and certain IXCs and ILECs. We have not paid these disputed amounts and management
believes that we will prevail in these disputes. At December 31, 2004, the total disputed amounts
were approximately $19.6 million. We have accrued access charges we believe are probable of
payment. In August 2000, we entered into an agreement with a service firm to outsource customer provisioning
and other ordering through electronic bonding with the incumbent local exchange carriers. In
September 2002, we renegotiated this agreement, resulting in a lowering of our monthly minimum
payments and an increase to the fees we pay on a per transaction basis. In October 2004, we
renegotiated this agreement once again, resulting in an annual commitment, subject to certain
adjustments, of approximately $2.75 million for the year ending December 31, 2005. We made
payments under the agreement totaling $11.2 million, $11.8 million and $9.7 million for the years
ended December 31, 2004, 2003 and 2002, respectively. The minimum payments are required by us,
regardless of our use of the services provided for in the contract. This contract provides, under
certain circumstances, for early termination and severance fees for such action. We currently have agreements with two long-distance carriers to provide transmission and
termination services for all of our long distance traffic. These agreements generally provide for
the resale of long distance services on a per-minute basis and contain minimum volume commitments.
As a result of not fulfilling all of our volume commitments as outlined in one of these contracts
we agreed to pay an increased per minute charge for minutes until the achievement of certain
minimum minute requirements. Once we meet the new agreed upon minimum minutes we will revert to
the terms of our original agreement. All other terms of the original agreement continue in full
force. In connection with certain of our wholesale services agreements, a portion of customers are
provisioned using our company code. Therefore, we are the customer of record for the Regional Bell
Operating Companies wholesale billing. It is very likely that the state commissions would require
us to continue providing services to our wholesale customers for at least a 90-day period, 71




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regardless of whether our wholesale relationships continue. We have agreed to certain service level agreements (SLAs) for providing service under our
wholesale agreements. If we were to not fulfill the SLAs after the phase-in period there are
certain remedies including but not limited to financial compensation. We have not had to pay or
accrue any financial compensation as a result of any SLAs since our inception. 18. RELATED PARTY TRANSACTIONS In January 2002, we accelerated the vesting of 96,471 stock options granted to an executive as part
of his severance agreement. This acceleration resulted in the employee being fully vested in stock
options with a strike price of $1.30 when the stock was trading at $1.80. The employee forfeited
76,471 of his vested options in return for the exercise of 20,000 shares of stock. We recorded
approximately $0.1 million in general and administrative expense as a result of this transaction. In February 2003 we received a payment of $0.5 million from an executive officer who is also on our
Board of Directors in fulfillment of an outstanding note receivable to us. In August 2003, we accelerated the vesting of 122,223 stock options granted to an executive as part
of his severance agreement. This acceleration resulted in the employee being fully vested in stock
options with a strike price of $1.30 per share and was in-the-money trading at $2.02 per share as
the time of acceleration. As a result of this transaction we recorded approximately $0.1 million
in general and administrative expense. In addition to the SipStorm promissory note mentioned in footnote 5 above, as of December 31, 2004
we have approximately $0.9 million of notes receivable from employees and former employees for
various reasons. We have recorded these loans as a contra to our equity as the loans were for the
purchase of stock. One is a note in the amount of approximately $0.8 million, due in June 2005,
and the other is for approximately $0.1 million and is a demand note. We paid interest on our related party term debt in the amounts of $0.3 million, $0.3 million and
$0.4 million for the years ended December 31, 2004, 2003 and 2002, respectively. 19. EMPLOYEE BENEFIT PLAN In 1999, we established a 401(k) plan covering defined employees who meet established eligibility
requirements. Under the original plan provisions, we did not make matching contributions. Effective
September 15, 2000, we merged the plans of Touch 1 and Trinsic and established a matching
contribution for the 401(k) plan to 50% of participating contributions to a maximum matching amount
of 5% of a participants compensation. As of July 2004, we discontinued our matching contribution.
Our contributions were approximately $0.3 million, $0.5 million and $0.5 million for the years
ended December 31, 2004, 2003 and 2002, respectively. 20. STOCK-BASED COMPENSATION Effective October 30, 1998, we adopted the 1998 Equity Participation Plan (1998 Plan), for the
grant to eligible employees and eligible participants of options to purchase up to 252,200 shares
of our common stock. During September and November 1999, the Board of Directors (the Board)
increased the shares available for grant under the 1998 Plan to 1.2 million and 1.5 million shares,
respectively. The 1998 Plan was terminated in 2000. Effective April 20, 2000, we adopted the 2000 Equity Participation Plan (2000 Plan). This plan
allows for the grant to eligible employees and eligible participants of options to purchase up to
400,000 shares of our common stock. Restricted stock, dividend equivalents, deferred stock and
stock appreciation rights may be awarded in lieu of stock options. The 2000 Plan automatically
increases the number of shares available for grant on the first day of each fiscal year beginning
in 2001 equal to the lesser of (i) 600,000 shares, (ii) 6% of the outstanding shares on such date,
or (iii) a lesser amount determined by the Board. Effective November 19, 2004, we adopted the 2004 Stock Incentive Plan (2004 Plan). This plan
allows for the grant to eligible
employees and eligible participants of options to purchase up to 4,808,153 shares of our common
stock. Restricted stock, dividend equivalents, deferred stock and stock appreciation rights may be
awarded in lieu of stock options. Our plans are administered by a committee appointed by the Board, or by the Board. The Board or the
appointed committee shall administer the 1998, 2000 and 2004 Plans, select the eligible employees
and eligible participants to whom options will be granted, the price to be paid, the exercise
period and the number of shares subject to any such options and interpret, construe and implement
the provisions of the Plans. 72




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##### Table of Contents



Stock option grants approximate the fair market value at the date of grant. The vesting periods on
these options range from immediately to four years and have a maximum contractual life of ten
years. Prior to the adoption of the 1998 Plan, the Board awarded options (the Initial Plan) for the
right to purchase 773,760 shares of common stock at a weighted average option price per share of
$14.15. The vesting periods on these options range from immediately to four years, and have a
maximum contractual life of ten years. A summary of the stock option activity for the years ended December 31, 2004, 2003 and 2002 is
presented below. 1998 Equity ParticipationInitial Plan
    
    
    Plan
    
    
    2000 Equity Participation Plan
    
    
    TotalWeighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageNumber of
    
    
    Exercise
    
    
    Number of
    
    
    Exercise
    
    
    Number of
    
    
    Exercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Number of Shares
    
    
    PriceOutstanding, December 31, 2001
    
    
    548,724
    
    
    $
    15.05
    
    
    
    571,742
    
    
    $
    67.90
    
    
    
    1,056,343
    
    
    $
    19.00
    
    
    
    2,176,809
    
    
    $
    30.85Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    674,095
    
    
    
    6.45
    
    
    
    674,095
    
    
    
    6.45Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,072
    )
    
    
    6.50
    
    
    
    (4,072
    )
    
    
    6.50Forfeited
    
    
    (3,519
    )
    
    
    16.55
    
    
    
    (96,169
    )
    
    
    99.85
    
    
    
    (248,426
    )
    
    
    17.90
    
    
    
    (348,114
    )
    
    
    40.50Outstanding, December 31, 2002
    
    
    545,206
    
    
    
    15.05
    
    
    
    475,573
    
    
    
    61.45
    
    
    
    1,477,939
    
    
    
    13.50
    
    
    
    2,498,718
    
    
    
    22.95Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    342,520
    
    
    
    9.70
    
    
    
    342,520
    
    
    
    9.70Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (78,829
    )
    
    
    6.60
    
    
    
    (78,829
    )
    
    
    6.60Forfeited
    
    
    
    
    
    
    
    
    
    
    (58,447
    )
    
    
    16.05
    
    
    
    (80,837
    )
    
    
    61.55
    
    
    
    (139,284
    )
    
    
    43.35Expired
    
    
    (110,000
    )
    
    
    18.20
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (110,000
    )
    
    
    18.20Outstanding, December 31, 2003
    
    
    435,206
    
    
    
    14.25
    
    
    
    417,125
    
    
    
    67.80
    
    
    
    1,660,794
    
    
    
    10.50
    
    
    
    2,513,125
    
    
    
    20.70Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    453,665
    
    
    
    13.60
    
    
    
    453,665
    
    
    
    13.60Exercised
    
    
    
    
    
    
    
    
    
    
    (440
    )
    
    
    18.20
    
    
    
    (73,256
    )
    
    
    6.60
    
    
    
    (73,696
    )
    
    
    6.67Forfeited
    
    
    
    
    
    
    
    
    
    
    (308,444
    )
    
    
    23.99
    
    
    
    (342,470
    )
    
    
    11.82
    
    
    
    (650,914
    )
    
    
    17.59Expired
    
    
    
    
    
    
    
    
    
    
    (220
    )
    
    
    18.20
    
    
    
    
    
    
    
    
    
    
    
    (220
    )
    
    
    18.20Outstanding, December 31, 2004
    
    
    435,206
    
    
    
    
    
    
    
    108,021
    
    
    
    
    
    
    
    1,698,733
    
    
    
    
    
    
    
    2,241,960
 We did not grant any options to non-employees during 2004, 2003 or 2002. The following table summarizes information about stock options outstanding at December 31, 2004: WeightedAverageNumber
    
    
    Number
    
    
    ExercisableExercise Price Range
    
    Outstanding
    
    
    Exercisable
    
    
    Price$  0.00 -
$    5.00
    
    
    27,816
    
    
    
    23,266
    
    
    $
    3.47$  5.01
- $  10.00
    
    
    1,139,778
    
    
    
    945,258
    
    
    $
    6.69$10.01
- $  15.00
    
    
    504,550
    
    
    
    90,614
    
    
    $
    11.83$15.01
- $  20.00
    
    
    171,744
    
    
    
    205,086
    
    
    $
    18.25$25.01
- $  30.00
    
    
    56,274
    
    
    
    58,005
    
    
    $
    27.25$30.01
- $  35.00
    
    
    52,980
    
    
    
    52,980
    
    
    $
    35.00$35.01
- $  40.00
    
    
    31,591
    
    
    
    31,591
    
    
    $
    36.81$40.01
- $  45.00
    
    
    1,690
    
    
    
    1,690
    
    
    $
    44.76$45.01
- $  50.00
    
    
    13,250
    
    
    
    13,250
    
    
    $
    50.00$55.01
- $  60.00
    
    
    8,880
    
    
    
    8,880
    
    
    $
    60.00$60.01
- $  65.00
    
    
    145,688
    
    
    
    145,688
    
    
    $
    65.00$65.01
- $  70.00
    
    
    5,000
    
    
    
    5,000
    
    
    $
    70.00$70.01
- $  75.00
    
    
    21,300
    
    
    
    21,300
    
    
    $
    75.00$90.01
- $  95.00
    
    
    6,000
    
    
    
    6,000
    
    
    $
    95.00Greater
than  $100.00
    
    
    55,420
    
    
    
    55,420
    
    
    $
    193.302,241,960
    
    
    
    1,664,027
 21. COMPUTATION OF NET LOSS PER SHARE Basic net loss per share is computed by dividing net loss attributable to common stockholders by
the weighted average number of common shares outstanding during the period. Incremental shares of
common stock equivalents are not included in the calculation 73




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of net loss per share as the inclusion
of such equivalents would be anti-dilutive. Net loss per share is calculated as follows: Year Ended December 31,2004
    
    
    2003
    
    
    2002Basic and diluted net loss per share:Net loss
    
    $
    (33,613
    )
    
    $
    (16,127
    )
    
    $
    (19,555
    )Less mandatorily redeemable convertible preferred
stock dividends and accretion
    
    
    (15,326
    )
    
    
    (17,480
    )
    
    
    (15,589
    )Less preferred stock conversion loss
    
    
    (57,584
    )
    
    
    
    
    
    
    Less deemed dividend related to beneficial conversion feature
    
    
    
    
    
    
    (186
    )
    
    
    (186
    )Net loss attributable to common stockholders
    
    $
    (106,523
    )
    
    $
    (33,793
    )
    
    $
    (35,330
    )Weighted average common shares outstanding
    
    
    11,676,783
    
    
    
    7,079,384
    
    
    
    6,990,344Basic and diluted net loss per share
    
    $
    (9.12
    )
    
    $
    (4.77
    )
    
    $
    (5.05
    )
 For each of the periods presented, basic and diluted net loss per share is the same. The
following table includes potentially dilutive items that were not included in the computation of
diluted net loss per share for all periods presented because to do so would be anti-dilutive in
each case: Year Ended December 31,2004
    
    
    2003
    
    
    2002Unexercised stock options
    
    
    2,241,960
    
    
    
    2,513,125
    
    
    
    2,498,718Unexercised warrants
    
    
    1,078,781
    
    
    
    2,130,554
    
    
    
    2,088,666Mandatorily redeemable preferred stock
convertible into common shares
    
    
    
    
    
    
    6,335,759
    
    
    
    5,580,331Total potentially dilutive shares of common
stock equivalents
    
    
    3,320,741
    
    
    
    10,979,438
    
    
    
    10,167,715
 22. LEGAL AND REGULATORY PROCEEDINGS During June and July 2001, three separate class action lawsuits were filed against us, certain of
our current and former directors and officers (the D&Os) and firms engaged in the underwriting
(the Underwriters) of our initial public offering of stock (the IPO). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising out of initial public
offering allocations, have been assigned to a Judge in the United States District Court for the
Southern District of New York for pretrial coordination. The lawsuits against us have been
consolidated into a single action. A consolidated amended complaint was filed on April 20, 2002. A
Second Corrected Amended Complaint (the Amended Complaint), which is the operative complaint, was
filed on July 12, 2002. The Amended Complaint is based on the allegations that our registration statement on Form S-1,
filed with the Securities and Exchange Commission (SEC) in connection with the IPO, contained
untrue statements of material fact and omitted to state facts necessary to make the statements made
not misleading by failing to disclose that the underwriters allegedly had received additional,
excessive and undisclosed commissions from, and allegedly had entered into unlawful tie-in and
other arrangements with, certain customers to whom they allocated shares in the IPO. The plaintiffs
in the Amended Complaint assert claims against us and the D&Os pursuant to Section 11 of the
Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC there under. The plaintiffs in the Amended Complaint assert claims against
the D&Os pursuant to Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated by the SEC there under. The
plaintiffs seek an undisclosed amount of damages, as well as pre-
judgment and post-judgment interest, costs and expenses, including attorneys fees, experts fees
and other costs and disbursements. Initial discovery has begun. We believe we are entitled to
indemnification from our Underwriters. A settlement has been reached by the respective lawyers for plaintiffs, the issuers and insurers of
the issuers. The principal terms of the proposed settlement are (i) a release of all claims against
the issuers and their officers and directors, (ii) the assignment by the issuers to the plaintiffs
of certain claims the issuers may have against the Underwriters and (iii) an undertaking by the
insurers 74




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to ensure the plaintiffs receive not less than $1 billion in connection with claims
against the Underwriters. Hence, under the terms of the proposed settlement our financial
obligations will likely be covered by insurance. The court has given preliminary approval of the
settlement subject to certain modifications. A revised settlement agreement has been submitted to
the court. To be binding, the settlement must be executed by the parties and thereafter submitted
to and approved by the court. The settlement will not be binding upon any plaintiffs electing to
opt-out of the settlement. On October 9, 2003, Trinsic Communications, Inc., our wholly-owned subsidiary corporation, formerly
known as Z-Tel Communications, Inc., filed a lawsuit against SBC Communications, Inc. and several
of its subsidiaries (collectively, SBC) in federal court in Texas, where both SBC and Trinsic do
business. The lawsuit alleges SBCs violation of the federal antitrust laws, the Racketeering
Influenced Corrupt Organizations Act (RICO), the Lanham Act, and other federal and state laws. The
complaint seeks damages and an injunction against SBC. On November 20, 2003, SBC filed a motion to
dismiss the complaint. On August 6, 2004, the court denied in part, and granted in part, SBCs
motion to dismiss the complaint, allowing certain antitrust, RICO, and Lanham Act claims to
proceed. On March 30, 2005, the lawsuit against SBC was settled and dismissed with prejudice. In
conjunction with the settlement, our subsidiary Trinsic Communications, Inc. (formerly Z-Tel
Communications, Inc.) will receive proceeds of $14 million and the parties have mutually resolved
certain outstanding billing disputes. From our proceeds, we will be responsible for expenses and
attorneys fees approximating $8 million. The resulting $6 million will be reflected as a gain in
the 2005 statement of operations. Susan Schad, on behalf of herself and all others similarly situated, filed a class action lawsuit
against Trinsic Communications, Inc. (formerly known as Z-Tel Communications, Inc.), our
wholly-owned subsidiary corporation, on May 13, 2004. The lawsuit alleges that our subsidiary has
engaged in a pattern and practice of deceiving consumers into paying amounts in excess of their
monthly rates by deceptively labeling certain line-item charges as government-mandated taxes or
fees when in fact they were not. The complaint seeks to certify a class of plaintiffs consisting of
all persons or entities who contracted with Trinsic for telecommunications services and were billed
for particular taxes or regulatory fees. The complaint asserts a claim under the Illinois Consumer
Fraud and Deceptive Businesses Practices Act and seeks unspecified damages, attorneys fees and
court costs. On June 22, 2004, we filed a notice of removal in the state circuit court action,
removing the case to the federal district court for the Northern District of Illinois, Eastern
Division, C.A. No. 4 C 4187. On July 26, 2004, Plaintiff filed a motion to remand the case to the
state circuit court. On January 12, 2005, the federal court granted the motion and remanded the
case to the state court. Although we believe the plaintiffs allegations are without merit and
intend to defend the lawsuit vigorously, we cannot predict the outcome of this litigation or
potential range of loss, if any. On November 19, 2004, the landlord of our principal Tampa, Florida facility sued us seeking a
declaration of its rights and obligations under the lease and damages for breach of contract. We
assert that the landlord has failed to provide certain services in accordance with the lease,
including maintenance of air conditioning and emergency electrical generating systems crucial to
our operations. We have taken steps necessary to provide this maintenance and have offset the
costs of these measures against the rent, which we believe we are entitled to do under the lease.
Thus far we have withheld approximately $180,000. We also believe we are entitled to reimbursement
from the landlord for approximately $23,000 in costs associated with improvements to the leased
space. On November 19, 2004, a provider of parking spaces for our Tampa facilities sued us for
parking fees in excess of $334,300. Pursuant to our lease we are entitled to a number of free
spaces and we are obligated to pay for additional usage of parking spaces. We believe the provider
has substantially overstated our use of the spaces. We expect to resolve this dispute without
additional expense beyond the amount accrued. On December 15, 2004, the FCC ruled that incumbent local exchange carriers are no longer required
to provide Trinsic and other competitive telephone companies access to unbundled analog switching 
a key component of the Unbundled Network Element Platform combination of elements, or UNEP, which
is how we provide services to the vast majority of our customers. This FCC Triennial Review Remand
Orderalso limited our ability to access unbundled high-capacity loops and dedicated transport in
many urban and suburban locations. This order will have a material adverse effect on our business. 23. SEGMENT REPORTING We have two reportable operating segments: Retail Services and Wholesale Services. The retail services segment includes our residential and business services that offer bundled local
and long-distance telephone services in combination with enhanced communication features
accessible, through the telephone, the Internet and certain personal digital assistants. We provide
these in forty-nine states, but our customers are concentrated primarily in metropolitan areas in
six states. This segment also includes our Touch 1 residential long-distance offering that is
available nation-wide. 75




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The wholesale services segment allows companies to offer telephone exchange and enhanced services
to residential and small business customers. This service is currently available in 46 states and
Sprint is our primary customer for this offering. Management evaluates the performance of each business unit based on segment results, exclusive of
adjustments for unusual items. Special items are transactions or events that are included in our
reported consolidated results but are excluded from segment results due to their nonrecurring or
non-operational nature. It is also important to understand when viewing our segment results that we
only record direct expenses in our wholesale services and therefore, all employee benefits,
occupancy, insurance, and other indirect or overhead related expenses are reflected in the retail
services segment. The following summarizes the financial information concerning our reportable segments for the years
ended December 31, 2004, 2003 and 2002: December 31,Retail Services
    
    2004
    
    
    2003
    
    
    2002Revenues
    
    $
    171,024
    
    
    $
    205,059
    
    
    $
    208,280Depreciation and amortization
    
    $
    19,019
    
    
    $
    20,956
    
    
    $
    22,428Segment results
    
    $
    (25,816
    )
    
    $
    (18,754
    )
    
    $
    (9,914
    )Capital expenditures
    
    $
    9,510
    
    
    $
    10,239
    
    
    $
    6,657Identifiable assets
    
    $
    55,260
    
    
    $
    69,325
    
    
    $
    95,887
 December 31,Wholesale Services
    
    2004
    
    
    2003
    
    
    2002Revenues
    
    $
    80,453
    
    
    $
    84,121
    
    
    $
    30,774Depreciation and amortization
    
    $
    745
    
    
    $
    2,493
    
    
    $
    1,508Segment results
    
    $
    20,126
    
    
    $
    24,717
    
    
    $
    11,315Capital expenditures
    
    $
    
    
    
    $
    797
    
    
    $
    8,536Identifiable Assets
    
    $
    6,076
    
    
    $
    12,345
    
    
    $
    8,797
 The following table reconciles our segment information to the consolidated financial information
for 2004, 2003 and 2002: December 31,2004
    
    
    2003
    
    
    2002RevenuesTotal segment revenues
    
    $
    251,477
    
    
    $
    289,180
    
    
    $
    239,054MCI bankruptcy revenue reversal
    
    
    
    
    
    
    
    
    
    
    (657
    )Total consolidated
    
    $
    251,477
    
    
    $
    289,180
    
    
    $
    238,397
 December 31,2004
    
    
    2003
    
    
    2002Segment results:Total segment results
    
    $
    (5,690
    )
    
    $
    5,963
    
    
    $
    1,401Retroactive reduction to network access rate
    
    
    
    
    
    
    2,500
    
    
    
    8,981MCI bankruptcy
    
    
    
    
    
    
    
    
    
    
    (1,304
    )Asset impairment charge
    
    
    
    
    
    
    
    
    
    
    (1,129
    )Wholesale development costs
    
    
    
    
    
    
    
    
    
    
    (1,018
    )Restructuring charge
    
    
    (4,801
    )
    
    
    
    
    
    
    (1,861
    )Depreciation and amortization
    
    
    (19,764
    )
    
    
    (23,449
    )
    
    
    (23,936
    )Total consolidated operating loss
    
    $
    (30,255
    )
    
    $
    (14,986
    )
    
    $
    (18,866
    )
 76




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24. SUBSEQUENT EVENTS On February 14, 2005, we received an advance in the amount of $3.5 million from our standby credit
facility. We also received additional advances of $2.5 million and $1.2 million on March 4, 2005
and March 24, 2005, respectively. On March 30, 2005, the lawsuit against SBC was settled and dismissed with prejudice. In
conjunction with the settlement, our subsidiary Trinsic Communications, Inc. (formerly Z-Tel
Communications, Inc.) will receive proceeds of $14 million and the parties have mutually resolved
certain outstanding billing disputes. From our proceeds, we will be responsible for expenses and
attorneys fees approximating $8 million. The net $6 million will be reflected as income in the
2005 statement of operations. By letter dated March 22, 2005, the Nasdaq Stock Market notified us that for the previous 30
business days the bid price of our stock closed below the minimum $1.00 per share requirement for
continued inclusion under Marketplace Rule 4310(c)(4) and therefore we will be provided 180
calendar days, or until September 19, 2005, to regain compliance. If at anytime before September
19, 2005, the bid price of our stock closes at or above $1.00 per share for a minimum of 10
consecutive business days we will receive written notification of compliance with Marketplace Rule
4310(c)(4). Furthermore, if we cannot demonstrate compliance by September 19, 2005, but meet The
Nasdaq SmallCap Market initial listing criteria, except the minimum bid price requirement, then
Nasdaq will grant to us an additional 180 day compliance period. We have not at this time
determined to take any action in response to this notice. By letter dated April 4, 2005, the Nasdaq Stock Market notified us that we do not comply with
MarketPlace Rule 4310(c)(2)(B) which requires us to have a minimum $2,500,000 in stockholders
equity or $35 million market value of listed securities or $500,000 of net income from continuing
operations for the most recently completed fiscal year or two of the three most recently completed
fiscal years. Consequently, the Nasdaq staff is reviewing our eligibility for continued listing on
the Nasdaq SmallCap Market. We expect to present to the Nasdaq staff a plan to achieve and maintain
compliance with all the Nasdaq SmallCap Market listing requirements. However, we have no
expectation that such plan will in the staffs view adequately address this situation. On April 6, 2005 we initiated a reduction in force which terminated the employment of approximately
107 of our employees. We expect to incur a one-time charge of approximately $450,000 consisting
primarily of post termination wages and salaries we intend to pay to those employees and the
associated payroll taxes. Substantially all of those post termination wages will be paid within 30
days following the reduction in force. SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (UNAUDITED) In the following summary of quarterly financial information, all adjustments necessary for a fair
presentation of each period were included. Quarter EndedMarch 31,
    
    
    June 30,
    
    
    September 30,
    
    
    December 31,2004
    
    
    2004
    
    
    2004
    
    
    2004Revenues
    
    $
    68,467
    
    
    $
    63,797
    
    
    $
    60,912
    
    
    $
    58,301Operating loss
    
    $
    (9,971
    )
    
    $
    (9,464
    )
    
    $
    (9,733
    )
    
    $
    (1,087
    )Net loss
    
    $
    (10,384
    )
    
    $
    (11,111
    )
    
    $
    (10,342
    )
    
    $
    (1,776
    )Loss per share (1-2)
    
    $
    (1.44
    )
    
    $
    (1.52
    )
    
    $
    (1.37
    )
    
    $
    (0.07
    )Weighted average shares outstanding (2)
    
    
    7,213,381
    
    
    
    7,321,741
    
    
    
    7,530,046
    
    
    
    24,416,355
 Quarter EndedMarch 31,
    
    
    June 30,
    
    
    September 30,
    
    
    December 31,2003
    
    
    2003
    
    
    2003
    
    
    2003Revenues
    
    $
    60,929
    
    
    $
    71,046
    
    
    $
    82,716
    
    
    $
    74,489Operating loss
    
    $
    (3,280
    )
    
    $
    (5,587
    )
    
    $
    (2,069
    )
    
    $
    (4,050
    )Net loss
    
    $
    (3,105
    )
    
    $
    (6,008
    )
    
    $
    (2,553
    )
    
    $
    (4,461
    )Loss per share (1-3)
    
    $
    (0.44
    )
    
    $
    (0.85
    )
    
    $
    (0.36
    )
    
    $
    (0.63
    )Weighted average shares outstanding (2)
    
    
    7,053,651
    
    
    
    7,061,090
    
    
    
    7,073,752
    
    
    
    7,128,287
   (1)
    
    Earnings per share were calculated for each three-month period on a stand-alone basis.(2)
    
    Information for all periods presented has been restated for the one for five reverse stock
split.(3)
    
    We recorded approximately $2.5 million as a result of retroactive rate reduction for the
unbundled network elements in 2003. 77




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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 
 ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures designed to ensure that material information related
to us, including our consolidated subsidiaries, is recorded, processed, summarized and reported in
accordance with SEC rules and forms. Our management, with the participation of Chief Executive
Officer and Chief Financial Officer, Horace J. Davis, III, has evaluated the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this report. Based upon
that evaluation, Mr. Davis has concluded that our disclosure controls and procedures are effective
in causing material information to be recorded, processed, summarized, and reported so as to ensure
the quality and timeliness of our public disclosures in compliance with SEC rules and forms. Changes in Internal Control over Financial Reporting We also maintain a system of internal control over financial reporting. Our internal control over
financial reporting is a process designed under the supervision of our chief executive officer and
our chief financial officer and effected by our board of directors, management and other personnel
to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external reporting purposes in accordance with generally
accepted accounting principles and 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 our assets and (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made only in accordance
with authorizations of our management and directors. There was no change in our internal control over financial reporting that occurred during our most
recent fiscal quarter that has materially affected, or is reasonably likely to materially affect
our internal control over financial reporting. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding directors, nominees for director and executive officers is in our 2005 Annual
Meeting proxy statement and is incorporated herein by reference. 
 ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation is included in our 2005 Annual Meeting proxy statement
and is incorporated herein by reference. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by this item is included in our 2005 Annual Meeting proxy statement and is
incorporated herein by reference. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by this item is included in our 2005 Annual Meeting proxy statement and is
incorporated herein by reference. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information required by this item is included in our 2005 Annual Meeting proxy statement and is
incorporated herein by reference. 78




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PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) 1. The following financial statements of Trinsic, Inc. and the report thereon of
PricewaterhouseCoopers LLP dated April 14, 2005 are filed as part of this report: Report of Independent Certified Public Accountants Consolidated Balance Sheets at December 31, 2004 and 2003 Consolidated Statements of Operations for the years ended December 31, 2004, 2003, 2002 Consolidated Statements of Changes in Stockholders Equity (Deficit) for the years ended December
31, 2004, 2003 and 2002 Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 Notes to Financial Statements (a) 3. The following exhibits are filed as part of this report. EXHIBITNUMBER
    
    DESCRIPTION3.1
    
    Amended and Restated Certificate of Incorporation of Trinsic, Inc. as amended.3.2
    
    Amended and Restated Bylaws of Trinsic, as amended. Incorporated by reference to the
correspondingly numbered exhibit to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 filed November 15, 2004.4.1
    
    Form of Common Stock Certificate.4.2
    
    See Exhibits 3.1 and 3.2 of this Form for provisions of the Amended and Restated
Certificate of Incorporation, as amended, and our Bylaws, as amended, defining rights of
security holders.4.6
    
    Form of Warrant for the purchase of shares of our common stock by each of the purchasers
of our Series D Convertible Preferred Stock. Incorporated by reference to the
correspondingly numbered exhibit to our Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, filed on August 14, 2000.4.7
    
    Stock and Warrant Purchase Agreement, dated October 19, 2000, by and among us and The
1818 Fund III, L.P. Incorporated by reference to the correspondingly numbered exhibit to
our Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, filed on
November 14, 2000.4.9
    
    Registration Rights Agreement between and among us and The 1818 Fund III, L.P.
Incorporated by reference to the correspondingly numbered exhibit to our Quarterly Report
on Form 10-Q for the quarter ended September 30, 2000, filed on November 14, 2000.4.10
    
    Warrant issued to The 1818 Fund III, L.P. for the purchase of shares of our common stock.
Incorporated by reference to the correspondingly numbered exhibit to our Quarterly Report
on Form 10-Q for the quarter ended September 30, 2000, filed on November 14, 2000.
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4.11
    
    Certificate of Designation of Series F Junior Participating Preferred Stock. Incorporated
by reference to the correspondingly numbered exhibit to our Annual Report on Form 10-K
for the year ended December 31, 2000, filed on March 30, 2001.4.12
    
    Rights Agreement dated as of February 19, 2001 between Z-Tel Technologies, Inc. and
American Stock Transfer & Trust Company, as Rights Agent, as amended July 2, 2001
incorporated be reference to the correspondingly numbered exhibit to our quarterly report
on Form 10-Q for the quarter ended June 30, 20014.13
    
    Amendment No. 1 to Rights Agreement dated as of November 19, 2004 between Z-Tel
Technologies, Inc. and American Stock Transfer & Trust Company, as Rights Agent,
incorporated by reference to Exhibit 4.1 to our registration statement on form 8-A/A
filed on December 6, 2004.4.14
    
    Stock and Warrant Purchase Agreement, dated as of July 2, 2001, by and between us, D.
Gregory Smith, and others. Incorporated by reference to Exhibit 1 to Amendment No. 1 of
the Schedule 13D filed July 12, 2001 with respect to our common stock by, among other
persons, The 1818 Fund III, L.P.4.15
    
    Warrant for the Purchase of Shares of Common Stock of Trinsic, dated as of July 2, 2001.
Incorporated by reference to Exhibit 2 to Amendment No. 1 of the Schedule 13D filed July
12, 2001 with respect to our common stock by, among other persons, The 1818 Fund III,
L.P.4.16
    
    Backup Purchase Agreement, dated as of July 2, 2001, by and among Z-Tel Communications,
Inc., a Delaware corporation and our wholly owned subsidiary, Touch 1 Communications,
Inc., an Alabama corporation and our wholly owned subsidiary, D. Gregory Smith and
others. Incorporated by reference to Exhibit 4 to Amendment No. 1 of the Schedule 13D
filed July 12, 2001 with respect to our common stock by, among other persons, The 1818
Fund III, L.P.4.17
    
    Additional Investor Registration Rights Agreement, dated as of July 2, 2001, between
Z-Tel, D. Gregory Smith and others. Incorporated by reference to Exhibit 5 to the
Schedule 13D filed July 24, 2001 with respect to our common stock by, among other
persons, D. Gregory Smith.4.18
    
    Voting Agreement, dated as of June 29, 2001, between us and certain of our stockholders.
Incorporated by reference to Exhibit 5 to Amendment No. 1 of the Schedule 13D filed July
12, 2001 with respect to our common stock by, among other persons, The 1818 Fund III,
L.P.10.1
    
    Standby Credit Facility Agreement, dated August 24, 2004, by and among Trinsic, Inc. and
The 1818 Fund III, L.P. Incorporated by reference to Form 8-K filed on August 26, 200410.2.1
    
    1998 Equity Participation Plan. Incorporated by reference to the correspondingly numbered
exhibit to our Registration Statement on Form S-1 (File No. 333-89063), originally filed
October 14, 1999, as amended and as effective December 14, 1999.10.2.2
    
    2000 Equity Participation Plan, as amended10.2.3
    
    2004 Stock Incentive Plan incorporated by reference to Annex G to our Definitive Proxy
Statement filed November 1, 2004.10.3
    
    Loan and Security Agreement, dated April 22, 2004, by and between Textron
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Financial
Corporation and Z-Tel. Incorporated by reference to Exhibit 10.2 of our Registration
Statement on Form S-3 (File No. 333-116747), originally filed June 22, 2004, as amended
and as effective July 15, 2004.10.4
    
    Receivables Sales Agreement dated as of July 27, 2000 by and between Z-Tel
Communications, Inc., as seller and subservicer, Touch 1 Communications, Inc., as seller
and subservicer, and RFC Capital Corporation, as purchaser. Incorporated by reference to
the correspondingly numbered exhibit to our Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, filed on August 14, 2000, with an amendment extending the agreement
until July 27, 2004.10.5
    
    Form of Indemnification Agreement for our executive officers and directors. Incorporated
by reference to the correspondingly numbered exhibit to our Annual Report on Form 10-K
for the year ended December 31, 2000, filed on March 30, 2001.10.6
    
    Employment Agreement of Horace J. Trey Davis III, dated August 14, 2002. Incorporated by
reference to the correspondingly numbered exhibit to our Quarterly Report on Form 10-Q
for the quarter ended March 31, 2004, filed on May 17, 2004. By amendment dated October
5, 2004, the annual salary was increased to $300,000. The amendment is incorporated by
reference to Exhibit 99.1 to Form 8-K filed October 12, 2004.10.7
    
    Modification and Termination Agreement dated January 27, 2005 with Textron Financial
Corporation modifying our Loan and Security Agreement dated April 22, 2004. Incorporated
by reference to Exhibit 10.4 to Form 8-K filed February 2, 2005.10.8
    
    Asset Sale and Purchase Agreement dated September 29, 2004, between and among
SipStorm, Inc. and us. Incorporated by reference to Exhibit 99.1 to October 6, 2004.10.11
    
    Promissory Note, dated September 10, 1999, from Touch 1 Communications, Inc. to William
F. Corman (First Revocable Trust). Incorporated by reference to the correspondingly
numbered exhibits to our Annual Report on Form 10-K for the year ended December 31, 2000,
filed on March 30, 2001.10.12
    
    Promissory Note, dated September 10, 1999, from Touch 1 Communications, Inc. to James F.
Corman. Incorporated by reference to the correspondingly numbered exhibits to our Annual
Report on Form 10-K for the year ended December 31, 2000, filed on March 30, 2001.10.13
    
    Agreement for Resale of Local Wireline Telecommunications Services and Provision of
Ancillary Services, dated February 4, 2003, between Z-Tel Communications, Inc. and Sprint
Communications L.P. Incorporated by reference to Exhibit 10.14 of our Annual Report on
Form 10-K for the year ended December 31, 2003, filed March 30, 2004. Portions of this
exhibit have been omitted pursuant to a request for confidential treatment10.14
    
    Receivables Sales Agreement, dated as of March 28, 2005, by and between Trinsic
Communications, Inc. and Touch 1 Communications, Inc., collectively as Seller and
Subservicer, and Thermo Credit, LLC, as Purchaser and Master Servicer. Incorporated by
reference to Exhibit 10.1 to our Form 8-K filed April 5, 2005.21.
    
    List of Subsidiaries23.
    
    Consent of PricewaterhouseCoopers LLP31.1
    
    Certification of the Chief Executive Officer31.2
    
    Certification of the Chief Financial Officer32.1
    
    Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C.ss.135032.2
    
    Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C.ss.1350
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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto
duly authorized, as of the 15th day of April 2005. TRINSIC, INC. By:
    
    /s/ Horace J. Davis, IIIHorace J. Davis, IIIActing Chief Executive Officer and ChiefFinancial Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed
below by the following persons on behalf of the Registrant in the capacities and on the dates
indicated. SIGNATURE
    
    TITLE
    
    DATE/s/ Horace J. Davis, III
    
    
    
    April 15, 2005Horace J. Davis, III
    
    Acting Chief Executive
Officer and Chief
Financial Officer
(Principal Executive
Officer and Principal
Financial and Accounting
Officer)/s/ Andrew C. Cowen
    
    
    
    April 15, 2005Andrew C. Cowen
    
    Director/s/ Richard F. LaRoche, Jr.
    
    
    
    April 15, 2005Richard F. LaRoche, Jr.
    
    Director/s/ Lawrence C. Tucker
    
    
    
    April 15, 2005Lawrence C. Tucker
    
    Director/s/ W. Andrew Krusen, Jr.
    
    
    
    April 15, 2004W. Andrew Krusen, Jr.
    
    Director/s/ Roy Neel
    
    
    
    April 15, 2005Roy Neel
    
    Director/s/ Raymond L. Golden
    
    
    
    April 15, 2005Raymond L. Golden
    
    Director
 A signed original of this report has been provided to Trinsic, Inc. and will be retained by the
Trinsic, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. 82