** **

**United States**Securities and Exchange Commission

**Washington, D.C.  20549**

 

**Form 10-Q**

 

**ý**** QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period Ended June 30,2004**

 

**o**** TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commission File Number 0-27024**

 

**METRO ONE TELECOMMUNICATIONS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **OREGON**                                                      | ** ** | **93-0995165**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**11200 Murray Scholls Place, Beaverton,Oregon  97007**

(Address of principal executiveoffices) (zip code)

 

**(503) 643-9500**

(Registrant’s telephone number,including area code)

 

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

 

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

 

**Number of shares of common stock outstanding as of August 3, 2004:24,897,712 shares, no par value per share.**

 

 

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**METRO ONE TELECOMMUNICATIONS, INC.**

 

**INDEX TO FORM 10 - Q**

 
| Part I  | Financial Information                                                                              |   |
|---------|----------------------------------------------------------------------------------------------------|--------|
|    |                                                                                               |   |
| Item 1. | Financial Statements (Unaudited)                                                                   |   |
|    |                                                                                               |   |
|    | Condensed Statements of Operations for the  three and six months ended June 30, 2004 and 2003 |   |
|    |                                                                                               |   |
|    | Condensed Balance Sheets as of  June 30, 2004 and December 31, 2003                      |   |
|    |                                                                                               |   |
|    | Condensed Statements of Cash Flows for the  six months ended June 30, 2004 and 2003           |   |
|    |                                                                                               |   |
|    | Notes to Condensed Financial Statements                                                            |   |
|    |                                                                                               |   |
| Item 2. | Management’s Discussion and Analysis of  Financial Condition and Results of Operations        |   |
|    |                                                                                               |   |
| Item 3. | Quantitative and Qualitative Disclosures  About Market Risk                                        |   |
|    |                                                                                               |   |
| Item 4. | Controls and Procedures                                                                            |   |
|    |                                                                                               |   |
| Part II | Other Information                                                                                  |   |
|    |                                                                                               |   |
| Item 4. | Submission of Matters to a Vote of Security  Holders                                               |   |
|    |                                                                                               |   |
| Item 6. | Exhibits and Reports on Form 8-K                                                                   |   |
|    |                                                                                               |   |
|    | Signatures                                                                                         |   |

 

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**Metro One Telecommunications, Inc.**

**CondensedStatements of Operations (Unaudited)**

 
| ** **                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(In  thousands, except per share data)** | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Revenues                                   |       | $                                    | 43,539     |                               | $          | 51,035 |   | $ | 87,068 |   | $ | 110,370 |   |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Costs and expenses:                        |       |                                 |       |                               |       |   |   |   |   |
| Direct operating                           |       | 24,174                               |       | 28,981                             |       | 49,717 |   | 62,494 |   |
| Selling, general and administrative        |       | 25,030                               |       | 36,829                             |       | 50,985 |   | 56,028 |   |
|                                       |       | 49,204                               |       | 65,810                             |       | 100,702 |   | 118,522 |   |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Loss from operations                       |       | (5,665                               | )          | (14,775                            | )          | (13,634 | ) | (8,152 | ) |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Other income, net                          |       | 292                                  |       | 186                                |       | 411 |   | 399 |   |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Loss before income taxes                   |       | (5,373                               | )          | (14,589                            | )          | (13,223 | ) | (7,753 | ) |
| Income tax expense (benefit)               |       | 124                                  |       | (5,409                             | )          | 124 |   | (2,683 | ) |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Net loss                                   |       | $                                    | (5,497     | )                                  | $          | (9,180 | ) | $ | (13,347 | ) | $ | (5,070 | ) |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Net loss per common share:                 |       |                                 |       |                               |       |   |   |   |   |
| Basic                                      |       | $                                    | (.22       | )                                  | $          | (.37 | ) | $ | (.54 | ) | $ | (.21 | ) |
| Diluted                                    |       | $                                    | (.22       | )                                  | $          | (.37 | ) | $ | (.54 | ) | $ | (.21 | ) |
|                                       |       |                                 |       |                               |       |   |   |   |   |
| Weighted average shares outstanding:       |       |                                 |       |                               |       |   |   |   |   |
| Basic                                      |       | 24,845                               |       | 24,693                             |       | 24,810 |   | 24,703 |   |
| Diluted                                    |       | 24,845                               |       | 24,693                             |       | 24,810 |   | 24,703 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

1

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**Metro One Telecommunications, Inc.**

**CondensedBalance Sheets (Unaudited)**

 
| **(In  thousands)**                                                                                                                                                    | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                   |       |                    |       |                        |       |
| **Assets**                                                                                                                                                             |       |                    |       |                        |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Current assets:                                                                                                                                                        |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                              |       | $                       | 54,345     |                        | $          | 44,381 |   |
| Restricted cash                                                                                                                                                        |       | 4,900                   |       | 4,900                       |       |
| Accounts receivable                                                                                                                                                    |       | 24,923                  |       | 32,078                      |       |
| Prepaid costs and other current assets                                                                                                                                 |       | 6,045                   |       | 15,944                      |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Total current assets                                                                                                                                                   |       | 90,213                  |       | 97,303                      |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Furniture, fixtures and equipment, net                                                                                                                                 |       | 53,653                  |       | 62,187                      |       |
| Intangible assets                                                                                                                                                      |       | 5,227                   |       | 4,819                       |       |
| Other assets                                                                                                                                                           |       | 477                     |       | 575                         |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Total assets                                                                                                                                                           |       | $                       | 149,570    |                        | $          | 164,884 |   |
|                                                                                                                                                                   |       |                    |       |                        |       |
| **Liabilities and  Shareholders’ Equity**                                                                                                                         |       |                    |       |                        |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                   |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                       |       | $                       | 1,897      |                        | $          | 3,146 |   |
| Accrued liabilities                                                                                                                                                    |       | 2,102                   |       | 2,634                       |       |
| Accrued payroll and related costs                                                                                                                                      |       | 11,914                  |       | 12,297                      |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Total current liabilities                                                                                                                                              |       | 15,913                  |       | 18,077                      |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Deferred tax liabilities                                                                                                                                               |       | 3,799                   |       | 3,799                       |       |
| Other long-term liabilities                                                                                                                                            |       | 721                     |       | 670                         |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Total liabilities                                                                                                                                                      |       | 20,433                  |       | 22,546                      |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Commitments and contingencies                                                                                                                                          |       |                    |       |                        |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Shareholders’ equity:                                                                                                                                             |       |                    |       |                        |       |
| Preferred stock, no par value; 10,000  shares authorized, no shares issued or outstanding                                                                              |       | —                  |       | —                      |       |
| Common stock, no par value; 50,000 shares  authorized, 24,898 and 24,682 shares issued and outstanding at June 30,  2004 and December 31, 2003, respectively |       | 119,829                 |       | 119,683                     |       |
| Retained earnings                                                                                                                                                      |       | 9,308                   |       | 22,655                      |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Total shareholders’ equity                                                                                                                                        |       | 129,137                 |       | 142,338                     |       |
|                                                                                                                                                                   |       |                    |       |                        |       |
| Total liabilities and shareholders’ equity                                                                                                                        |       | $                       | 149,570    |                        | $          | 164,884 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

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**Metro One Telecommunications, Inc.**

**CondensedStatements of Cash Flows (Unaudited)**

 
| ** **                                                                                 | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(In  thousands)**                                                                        | ** ** | **2004**                           | ** ** | **2003** | ** ** |
|                                                                                       |       |                               |       |   |   |
| Cash flows from operating activities:                                                      |       |                               |       |   |   |
| Net loss                                                                                   |       | $                                  | (13,347    | ) | $ | (5,070 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                               |       |   |   |
| Depreciation and amortization                                                              |       | 11,133                             |       | 10,312 |   |
| Loss on disposal of fixed assets                                                           |       | 143                                |       | 75 |   |
| Deferred income taxes                                                                      |       | —                             |       | (4,060 | ) |
| Changes in certain assets and liabilities:                                                 |       |                               |       |   |   |
| Accounts receivable                                                                        |       | 7,155                              |       | 7,301 |   |
| Prepaid costs and other assets                                                             |       | 9,294                              |       | (11,498 | ) |
| Accounts payable and other liabilities                                                     |       | (2,113                             | )          | 1,651 |   |
|                                                                                       |       |                               |       |   |   |
| Net cash provided by (used in) operating  activities                                       |       | 12,265                             |       | (1,289 | ) |
|                                                                                       |       |                               |       |   |   |
| Cash flows from investing activities:                                                      |       |                               |       |   |   |
| Capital expenditures                                                                       |       | (2,469                             | )          | (8,775 | ) |
| Proceeds from sale of assets                                                               |       | 22                                 |       | 65 |   |
|                                                                                       |       |                               |       |   |   |
| Net cash used in investing activities                                                      |       | (2,447                             | )          | (8,710 | ) |
|                                                                                       |       |                               |       |   |   |
| Cash flows from financing activities:                                                      |       |                               |       |   |   |
| Restricted cash to secure letter of credit                                                 |       | —                             |       | (1,552 | ) |
| Proceeds from exercise of stock options and  employee stock purchases                      |       | 146                                |       | 60 |   |
|                                                                                       |       |                               |       |   |   |
| Net cash provided by (used in) financing  activities                                       |       | 146                                |       | (1,492 | ) |
|                                                                                       |       |                               |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |       | 9,964                              |       | (11,491 | ) |
|                                                                                       |       |                               |       |   |   |
| Cash and cash equivalents, beginning of  period                                            |       | 44,381                             |       | 76,528 |   |
|                                                                                       |       |                               |       |   |   |
| Cash and cash equivalents, end of period                                                   |       | $                                  | 54,345     |   | $ | 65,037 |   |
|                                                                                       |       |                               |       |   |   |
| Supplemental disclosure of cash flow  information:                                         |       |                               |       |   |   |
| Cash (refunded) paid for income taxes, net                                                 |       | $                                  | (10,032    | ) | $ | 638 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

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**Metro One Telecommunications, Inc.**

**Notesto Condensed Financial Statements (Unaudited)**

 

**1.****                                     ****Summary of Significant AccountingPolicies**

 

**Basis of Presentation**

 

The accompanying unaudited interim condensed financial statements havebeen prepared by Metro One Telecommunications, Inc. in conformity with accountingprinciples generally accepted in the United States of America for interimfinancial information.  Accordingly,certain financial information and footnotes have been omitted or condensed.  In the opinion of management, the condensedfinancial statements include all adjustments, consisting only of normalrecurring adjustments, necessary for a fair presentation of the results for theinterim periods.  These condensedfinancial statements and notes thereto should be read in conjunction with ouraudited financial statements included in our Annual Report on Form 10-K for theyear ended December 31, 2003.  Theresults of operations for the interim period shown in this report are notnecessarily indicative of results for any future interim period or the entire fiscalyear.

 

**Advertising**

 

Costs of advertising are expensed as incurred except for commercialadvertising production costs, which are expensed at the time the relatedcommercials are first run.  Advertisingexpense was approximately $6 million and $12 million in the three-month and sixmonth periods ended June 30, 2004, respectively, and approximately $17million and $18 million in the three and six months periods ended June 30,2003, respectively.  These expenses wereprimarily related to marketing and promotion of our Infone service.

 

**Stock-Based Compensation**

 

We have elected to account for stock options according to AccountingPrinciples Bulletin No. 25, “Accounting for Stock Issued to Employees,” and tofurnish the pro forma disclosures required under Statement of FinancialAccounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation— Transition and Disclosure — an amendment of FASB Statement No. 123.”   Accordingly, no compensation cost has beenrecognized in the financial statements related to stock options issued underour 1994 Stock Incentive Plan and our 2004 Stock Incentive Plan (the “Plans”).

 

If compensation cost on stock options granted under the Plans in thethree and six months periods ended June 30 of 2004 and 2003 had beendetermined based on the fair value of the options as of the grant date in amethod consistent with that described in SFAS No. 123, “Accounting forStock-Based Compensation,” our net loss and net loss per share would have beenchanged to the pro forma amounts indicated below for the three and six monthperiods ended June 30:

 
| ** **                              | ** ** | **Three Months Ended  June 30,**        | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|-------------------------------------|------------|
| ** **                              | ** ** | **2004**                                     | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                              | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net loss, as reported                   |       | $                                            | (5,497     | )                                   | $          | (9,180 | ) | $ | (13,347 | ) | $ | (5,070 | ) |
| Stock-based compensation expense        |       | (827                                         | )          | (987                                | )          | (1,706 | ) | (1,917 | ) |
| Net loss, pro forma                     |       | $                                            | (6,324     | )                                   | $          | (10,167 | ) | $ | (15,053 | ) | $ | (6,987 | ) |
|                                    |       |                                         |       |                                |       |   |   |   |   |
| Basic net loss per share, as reported   |       | $                                            | (0.22      | )                                   | $          | (0.37 | ) | $ | (0.54 | ) | $ | (0.21 | ) |
| Basic net loss per share, pro forma     |       | $                                            | (0.25      | )                                   | $          | (0.41 | ) | $ | (0.61 | ) | $ | (0.28 | ) |
|                                    |       |                                         |       |                                |       |   |   |   |   |
| Diluted net loss per share, as reported |       | $                                            | (0.22      | )                                   | $          | (0.37 | ) | $ | (0.54 | ) | $ | (0.21 | ) |
| Diluted net loss per share, pro forma   |       | $                                            | (0.25      | )                                   | $          | (0.41 | ) | $ | (0.61 | ) | $ | (0.28 | ) |

 

4

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**2.****                                      NetLoss Per Share**

 

Basic net loss per share is based on the weighted average number ofcommon shares outstanding.  Diluted netloss per share reflects the potential dilution that could occur if securitiesor other contracts to issue common stock were exercised or converted intocommon stock.  There were no adjustmentsto net loss in the calculation of both basic and diluted net loss per share forall periods presented.

 

The calculation of weighted average outstanding shares is as follows:

 
| ** **                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                        |       | **(in thousands)**                    |       |
| Weighted  average shares outstanding used in computing Basic net loss per share   |       | 24,845                                |       | 24,693                              |       | 24,810 |   | 24,703 |   |
| Potential  common shares resulting from the exercise of stock options             |       | —                                |       | —                              |       | — |   | — |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Weighted  average shares outstanding used in computing Diluted net loss per share |       | 24,845                                |       | 24,693                              |       | 24,810 |   | 24,703 |   |

 

Options to purchase 3,015,000 and 2,812,000 shares of common stock wereoutstanding at June 30, 2004 and 2003, respectively, but were not includedin the computation of diluted net loss per share for the three months endedJune 30, 2004 and 2003, respectively, because their effect would be anti-dilutive.  Options to purchase 3,015,000 and 2,723,000shares of common stock were outstanding at June 30, 2004 and 2003,respectively, but were not included in the computation of diluted net loss pershare for the six months ended June 30, 2004 and 2003, respectively,because their effect would be anti-dilutive.

 

**3.****                                      Commitmentsand Contingencies**

 

We are party to various legal actions and administrative proceedingsarising in the ordinary course of business. We believe the disposition of these matters will not have a materialadverse effect on our financial position, results of operations or cash flows.

 

From time to time, in the normal course of our business, we issuestandby letters of credit and bank guarantees. At June 30, 2004, we had one letter of credit outstanding in theamount of $4,900,000 related to our workers’ compensation program.  The letter of credit is secured by acertificate of deposit for the same amount that is recorded as restricted cash.  This letter of credit expires inApril 2005.

 

**4.****                                      SignificantEvents**

 

Our contract with AT&T Wireless expired on December 1, 2003,and we were unable to reach an economic arrangement acceptable to both parties;thus, our negotiations did not result in a new contract to replace the existingone.  AT&T Wireless accounted forapproximately 40% and 45% of our revenues in the three month periods endedJune 30, 2004 and 2003, respectively, and approximately 43% and 39% of ourrevenues in the six month periods ended June 30, 2004 and 2003, respectively.  Most of the AT&T Wireless call volumetransitioned away from us during the second quarter of 2004.  Substantially all of the remainder of thecall volume from AT&T Wireless has transitioned away from us as of the dateof this filing.  The expiration of our contractwith AT&T Wireless has had, and will continue to have, a material adverseeffect on our financial position, future operating results and cash flows, aswell as our operations.

 

5

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Our contract with Sprint PCS expired on December 31, 2002.  We agreed to an arrangement with Sprint PCS,pursuant to which we continued to handle a portion of its subscribers’ callsduring a transition period that was substantially completed by June 30,2003.  Revenue from Sprint PCS accountedfor approximately 13% of our total revenue in the second quarter of 2003, andapproximately 23% for the six month period ended June 30, 2003.

 

We have adjusted personnel, and expect to further adjust personnel,call centers and network capacities in order to address varying businesscircumstances, including the expiration of these contracts.

 

In a recent decision, the California Public Utilities Commissionimplemented competitive wholesale pricing for directory assistance data forthird party vendors purchasing the data from SBC Communications.  The decision determined that SBC continues toenjoy a dominant position as the former monopoly provider of local exchangeservice in its territory in California and could not use its market power toextract excessive directory assistance data prices that would discriminateagainst competitors.  The decisionrequired that SBC refund the improper charges with interest.  As a result,in July 2004, we received and recorded a refund from SBC in the amount ofapproximately $2.9 million.

 

6

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**ITEM 2.****                  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

All statements and trend analyses contained in this item and elsewherein this report on Form 10-Q relative to the future constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  These forward-lookingstatements may, but do not necessarily, also include words such as “believes,”“expects,” “anticipates,” “plans,” “estimates,” “may,” “will,” “should,”“could,” “continue” or similar expressions. Forward-looking statements are not guarantees.  They involve known and unknown business andeconomic risks, uncertainties and other factors that may cause our actualresults, performance or achievements to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements.  These risks,uncertainties and other factors include those discussed in our 2003 AnnualReport on Form 10-K filed with the Securities and Exchange Commission (“theSEC”).  Readers are cautioned not toplace undue reliance on these forward-looking statements, which speak only asof the date hereof.  We undertake noobligation to publicly release any revisions to these forward-lookingstatements to reflect events or circumstances after the date hereof or toreflect the occurrence of unanticipated events.

 

Results of operations for the periods discussed below should not beconsidered indicative of the results to be expected in any future period, andfluctuations in operating results may also result in fluctuations in the marketprice of our common stock.  Our quarterlyand annual operating results have in the past and may in the future varysignificantly depending on factors such as changes in the telecommunicationsmarket, the addition or expiration of customer contracts, increasedcompetition, changes in pricing policies by us or our competitors, lengthysales cycles, advertising costs or lack of market acceptance associated withthe introduction of new versions of our products or features, the cost andsuccess of new growth strategies, the timing of the initiation of wireless orother telecommunications services through new delivery systems or theiracceptance by customers, the timing and expense of the expansion or contractionof our national call center network, the general employment environment,general economic conditions and the other factors discussed in our 2003 AnnualReport on Form 10-K filed with the Securities and Exchange Commission.

 

**Overview**

 

We are the leading developer and provider of EnhancedDirectory Assistance® and information services for the telecommunicationsindustry.  In recent years, our effortshave focused on contracting with wireless carriers to provide our services totheir subscribers.

 

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

 

Each carrier customer establishes its own directoryassistance fee structure for its subscribers. Wireless subscribers typically pay fees to their carrier ranging from$1.00 to $1.40 plus airtime charges for our services.  We bear no subscriber collection risk withrespect to wholesale carrier subscribers; however, there may be collection riskto the extent growth and profitability in the telecommunications industrydecreases and to the extent we provide services to other types of customers,including businesses, governmental units or callers attracted through othermeans or affiliations.

 

We charge our wholesale carrier customers directly ona per call basis, with prices varying in some cases based on call volume.  In order to encourage our carrier customersto route more of their calls to us, our long-term strategy has been based inpart on reducing the price we charge them. We expect that average wholesale revenue per call will continue todecrease as we believe this pricing strategy better positionsus to retain and expand service with existing carrier customers, whereprofitable, and to attract new carrier customers.  Prices for services provided to other typesof customers, including individuals, businesses, governmental units or othercallers, may vary based on the nature of the service, volume and othercircumstances.

 

Competition in the telecommunications industry, and inthe directory assistance market in which we participate, is intense.  With slowing subscriber growth and decliningrevenue per user, carriers are looking to lower their costs of providingdirectory assistance and other services through, among other ways, outsourcingto low cost

 

7

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domestic or overseas operatorsand utilizing automation.  In response tothese and other issues, in May 2003, we launched Infone, a service thatprovides enhanced directory and personal assistant services directly toconsumers.  Callers may use the servicefrom nearly any domestic telephone, landline or wireless, simply by dialing“888-411-1111.”  Billing is handled byusing a major credit card.  Calls can beconnected nationwide and to Canada and Puerto Rico for the all-inclusive priceof 89 cents for any call of up to 15 minutes, plus 5 cents per minute afterthat.

 

The launch of Infone has been accompanied by asignificant nationwide marketing and promotion campaign designed to build brandawareness and encourage customers to sign up for Infone.  During the second quarter of 2004, we spentapproximately $6 million, and for the six month period ended June 30,2004, we spent approximately $12 million on such marketing and promotioncampaigns.  We will likely spendsignificant additional funds on marketing and promotional activities in thefuture.  As of July 30, 2004, thedate of our second quarter 2004 financial results press release, we hadobtained approximately 83,000 Infone subscribers.

 

**Significant Events**

 

Our contract with AT&T Wireless expired on December 1, 2003,and we were unable to reach an economic arrangement acceptable to both parties;thus, our negotiations did not result in a new contract to replace the existingone.  AT&T Wireless accounted forapproximately 40% and 45% of our revenues in the three month periods endedJune 30, 2004 and 2003, respectively, and approximately 43% and 39% of ourrevenues in the six month periods ended June 30, 2004 and 2003,respectively.  Most of the AT&TWireless call volume transitioned away from us during the second quarter of2004.  Substantially all of the remainderof the call volume from AT&T Wireless has transitioned away from us as ofthe date of this filing.  The expirationof our contract with AT&T Wireless has had, and will continue to have, amaterial adverse effect on our financial position, future operating results andcash flows, as well as our operations.

 

Our contract with Sprint PCS expired on December 31, 2002.  We agreed to an arrangement with Sprint PCS,pursuant to which we continued to handle a portion of its subscribers’ callsduring a transition period that was substantially completed by June 30,2003.  Revenue from Sprint PCS accountedfor approximately 13% of our total revenue in the second quarter of 2003, andapproximately 23% for the six month period ended June 30, 2003.

 

We have adjusted personnel, and expect to further adjust personnel,call centers and network capacities in order to address varying businesscircumstances, including the expiration of these contracts.

 

In a recent decision, the California Public Utilities Commissionimplemented competitive wholesale pricing for directory assistance data forthird party vendors purchasing the data from SBC Communications.  The decision determined that SBC continues toenjoy a dominant position as the former monopoly provider of local exchangeservice in its territory in California and could not use its market power toextract excessive directory assistance data prices that would discriminateagainst competitors.  The decisionrequired that SBC refund the improper charges with interest.  As a result,in July 2004, we received and recorded a refund from SBC in the amount ofapproximately $2.9 million.

 

**Results of Operations**

 

This table shows selected items from our statements of operationsexpressed as a percentage of revenues:

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                      |       |                                  |       |                                |       |   |   |   |   |
| Revenues                                  |       | 100.0                                 | %          | 100.0                               | %          | 100.0 | % | 100.0 | % |
| Direct operating costs                    |       | 55.5                                  |       | 56.8                                |       | 57.1 |   | 56.6 |   |
| Selling, general and administrative costs |       | 57.5                                  |       | 72.2                                |       | 58.6 |   | 50.8 |   |
| Loss from operations                      |       | (13.0                                 | )          | (29.0                               | )          | (15.7 | ) | (7.4 | ) |
| Other income, net                         |       | 0.7                                   |       | 0.4                                 |       | 0.5 |   | 0.4 |   |
| Loss before income taxes                  |       | (12.3                                 | )          | (28.6                               | )          | (15.2 | ) | (7.0 | ) |
| Income tax expense (benefit)              |       | 0.3                                   |       | (10.6                               | )          | 0.1 |   | (2.4 | ) |
| Net loss                                  |       | (12.6                                 | )%         | (18.0                               | )%         | (15.3 | )% | (4.6 | )% |

 

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*Comparison of second quarter 2004 to second quarter 2003*

 

Revenues decreased 14.7% to $43.5 million from $51.0million.  Call volume decreased toapproximately 94 million calls from approximately 110 million calls.  These decreases resulted primarily from lowercall volume from Sprint PCS due to expiration of its contract and a reductionof call volume from AT&T Wireless as it began its transition away from usduring the second quarter due to the expiration of its contract.  These reductions were partially offset bygrowth in call volume under other existing contracts and markets.  Our average revenue per call was between$0.46 and $0.47 in the second quarter of both 2004 and 2003.

 

Direct operating costs consist of salaries, wages, benefits and taxesrelating to call center personnel and costs of listings data and contentacquisition.  These costs decreased 16.6%to $24.2 million from $29.0 million. This decrease was primarily due to lower personnel and data costsassociated with servicing lower call volumes. As a percentage of revenues, direct operating costs decreased to 55.5%from 56.8%, due primarily to increased efficiency in the call centers relatedto technology improvements.

 

Selling, general and administrative costs decreased 32.0% to $25.0million from $36.8 million.  Thisdecrease resulted primarily from reductions in marketing and promotion costs ofapproximately $11.5 million.  As apercentage of revenues, selling, general and administrative costs decreased to57.5% from 72.2% resulting from lower marketing and promotion costs.

 

Depreciation and amortization expense, a component of selling, generaland administrative costs, increased 6.4% to $5.5 million from $5.2 million andincreased to 12.7% from 10.2% of revenue. The increase in depreciation and amortization was due primarily to thepurchase of equipment for upgrades of our corporate-wide infrastructure,including expenditures intended to increase efficiency in routing calls, andfor equipment used in new products and product development activities.

 

Other income was $292,000 and $186,000 in the second quarter of 2004and 2003, respectively, and consisted primarily of interest income earned oncash and cash equivalents and various miscellaneous items.

 

Income tax expense in the second quarter of 2004 was approximately$124,000, primarily related to the adjustment of prior estimates to actualstate income tax returns filed.  Becauseof our operating loss in the second quarter of 2004, we recorded no federalincome tax expense.  In the secondquarter of 2003, the income tax benefit was approximately $5.4 million, torecognize tax loss carrybacks.

 

*Comparison of the first six months 2004 to the first six months of 2003*

 

Revenues decreased 21.1% to $87.1 million from $110.4million.  Call volume decreased toapproximately 189 million calls from approximately 236 million calls.  These decreases resulted primarily from lowercall volume from Sprint PCS due to expiration of its contract and a reductionof call volume from AT&T Wireless as it began its transition away from usduring the second quarter due to the expiration of its contract.  These reductions were partially offset bygrowth in call volume under other existing contracts and markets.  Our average revenue per call was between$0.46 and $0.47 in the first six months of both 2004 and 2003.

 

Direct operating costs consist of salaries, wages, benefits and taxesrelating to call center personnel and costs of listings data and contentacquisition.  These costs decreased 20.4%to $49.7 million from $62.5 million. This decrease was primarily due to lower personnel and data costsassociated with servicing lower call volumes. As a percentage of revenues, direct operating costs increased to 57.1%from 56.6%, due primarily to higher costs associated with payroll taxes and ourworkers’ compensation and medical insurance programs, partially offset byincreased efficiency in the call centers related to technology improvements.

 

Selling, general and administrative costs decreased 9.0% to $51.0million from $56.0 million.  Thisdecrease resulted primarily from reductions in marketing and promotion costs ofapproximately $6.2 million.  As a percentageof revenues, selling, general and administrative costs increased to 58.6% from50.8% resulting from lower revenues in 2004, partially offset by lowermarketing and promotion costs.

 

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Depreciation and amortization expense, a component of selling, generaland administrative costs, increased 8.0% to $11.1 million from $10.3 millionand increased to 12.7% from 9.3% of revenue. The increase in depreciation and amortization was due primarily to thepurchase of equipment for upgrades of our corporate-wide infrastructure,including expenditures intended to increase efficiency in routing calls, andfor equipment used in new products and product development activities.

 

Other income was $411,000 and $399,000 in the first six months of 2004and 2003, respectively, and consisted primarily of interest income earned oncash and cash equivalents and various miscellaneous items.

 

Income tax expense in the first six months of 2004 was approximately$124,000, primarily related to the adjustment of prior estimates to actualstate income tax returns filed.  Becauseof our operating loss in the first six months of 2004, we recorded no federalincome tax expense.  In the first sixmonths of 2003, the income tax benefit was $2.7 million, to recognize tax losscarrybacks.

 

**Liquidity and Capital Resources**

 

As of June 30, 2004, we had approximately $59.2 million in cashand cash equivalents and restricted cash (including $4.9 million of restrictedcash) compared to approximately $49.3 million (including $4.9 million ofrestricted cash) at December 31, 2003. The net increase of $9.9 million resulted primarily from our receipt ofa refund of federal income taxes of approximately $10.1 million and the timingof collections of accounts receivable, partially offset by our use of cash toadvertise, market and promote our Infone service and to purchase capitalequipment.  We have no outstanding debt.

 

Working capital was $74.3 million at June 30, 2004, compared to$79.2 million at December 31, 2003. This decrease was primarily due toworking capital used to advertise, market and promoteInfone and the use of working capital to purchase capital equipment.

 

*Cash flow from operations. *Net cash provided byoperations was $12.3 million for the six months ended June 30, 2004compared to net cash used in operations of $1.3 million for the six monthsended June 30, 2003.  Thisdifference resulted primarily from a decrease in the amount of cash paid foradvertising and promotion and the receipt in the first quarter of 2004 of arefund of federal income taxes of approximately $10.1 million, partially offsetby an increase in our net loss for the six month period ended June 30,2004 compared to the six months ended June 30, 2003.

 

*Cash flow from investing activities. *Cash used ininvesting activities was $2.4 million in the first six months of 2004 resultingprimarily from capital expenditures for equipment purchased for upgrades of ourcorporate-wide infrastructure, including expenditures intended to increaseefficiency in routing calls, and for equipment used in product developmentactivities.

 

*Cash flow from financing activities. *There was nosignificant cash expended or generated related to financing activities in thefirst six months of 2004.

 

*Future capital needs and resources. *The primary uses ofour capital in the near future are expected to be for the continuedadvertising, marketing and promotion of Infone, the development or acquisitionof technologies, features and content complementary to our business and forgeneral corporate purposes.  Thesegeneral corporate purposes could include acquisitions, efforts to pursue andmarket new growth strategies, other corporate development activities andworking capital.

 

We believe our existing cash and cash equivalents and cash fromoperations will be sufficient to fund our operations for the next twelvemonths.  Although cash on hand (includingrestricted cash) at June 30, 2004 was approximately $59.2 million, futureactivities, including advertising, marketing and promoting Infone, execution ofnew product initiatives and growth strategies and new product development androllout likely will reduce available cash. As necessary, we will attempt to establish borrowing arrangements inorder to maintain adequate liquidity.  Depending on the development of our business, we believe we will haveaccess to future financing sources, although we cannot provide assurance thatfinancing will be available in amounts or on terms acceptable to us.

 

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**Critical Accounting Policies**

 

We prepare our financial statements in conformity with accountingprinciples generally accepted in the United States of America.  As such, we are required to make certainestimates, judgments and assumptions that we believe are reasonable based uponthe information available.  Theseestimates and assumptions affect the reported amounts of assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the periods presented. Management believes that of our significant accounting policies (seeNote 1 to the financial statements in our Annual Report on Form 10-K for theperiod ended December 31, 2003), those governing accounts receivable, thelives and recoverability of the carrying amount of equipment and otherlong-lived assets, such as existing intangibles, estimates involving the levelsof our contingent liabilities for workers’ compensation and medicalself-insurance and estimates of current and deferred taxes owed may involve ahigher degree of judgment, estimation and uncertainty.

 

*Accounts receivable. *Our customer base has primarily consisted oflarge wireless telephone carriers in the United States.  As such, we have had minimal risk ofuncollectibility, at any point in time, related to outstanding accountsreceivable with these customers.  We havenot experienced significant collection issues or write-offs related to thesecustomers.  Since our accounts receivableare concentrated in relatively few of these wholesale customers, a significantchange in the liquidity or financial position of any one of them couldadversely impact collection of our accounts receivable and therefore have amaterial adverse effect on our financial position and future operatingresults.  In addition, with the launch ofour Infone service, we generate receivables from retail customers andbusinesses that may expose us to greater risk of uncollectible receivables thanwe have experienced in the past.

 

*Long-lived assets.** *We evaluate the remaining life andrecoverability of equipment and other assets, including patents and trademarksand internally developed software, whenever events or changes in circumstancesindicate that the carrying amount of the asset may not be recoverable.  At such time, we estimate the future cashflows expected upon eventual disposition and, if lower than the carryingamount, adjust the carrying amount of the asset to its estimated fairvalue.  Because of our changing businessconditions and dependence on a relatively small number of customers for asignificant portion of our revenues, our estimates of future cash flows to begenerated from our operations could change materially, resulting in the needfor us to record an impairment charge. In addition, as a result of our changing business conditions, we expectto adjust personnel, call centers and network capacities.  If any of these activities result in certainof our assets no longer being used in operations, we may need to record animpairment charge.

 

*Self-insurancereserves.* We self-insure a portion of our workers’ compensation and employeemedical insurance programs.  We purchase stop loss coverage at varyinglevels in order to mitigate our potential future losses.  The nature ofthese liabilities, which may not fully manifest themselves for several years,requires significant judgment.  We evaluate pending workers’ compensationand medical claims periodically to determine the reasonableness of the reserveswe have recorded for such claims.  Ourevaluation includes estimates of potential incurred-but-unreported claims aswell as factors that may cause original estimates of such claims to increaseover time, such as available claims data and historical trends and experience,as well as future projections of ultimate losses, expenses, premiums and administrativecosts.  We adjust these reserves if events or changes in circumstancesindicate that ultimate payments related to the claims will be different thanthe recorded reserves.  While we believethat the amounts reserved for these obligations are appropriate, anysignificant change in the number of claims and costs associated with claimsmade under these plans could have a material effect on our financial position,results of operations or cash flows.

 

*Income taxes.** *Accounting for income taxes requires us to estimate our income taxes ineach jurisdiction in which we operate.  Due to differences in therecognition of items included in income for accounting and tax purposes,temporary differences arise which are recorded as deferred tax assets or liabilities. We estimate the likelihood of recovery of these assets, which is dependent onfuture levels of profitability and enacted tax rates.  Should any amountsbe determined not to be recoverable, or assumptions change, we would berequired to take a charge, which could have a material effect on our financialposition, results of operations or cash flows.

 

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**ITEM 3.****                  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

Substantially all of our liquid investments areinvested in money market instruments, and therefore, the fair market value ofthese investments is affected by changes in market interest rates.  However, these investments were invested inovernight money market instruments at June 30, 2004 and were redeemable ona daily basis.  All of the underlyinginvestments in the money market fund had maturities of three months orless.  As a result, we believe the marketrisk arising from our holdings of financial instruments is minimal.  A hypothetical 1% fluctuation in interestrates would not have a material adverse effect on our financial position,results of operations or cash flows.

 

**ITEM 4.****                                                     CONTROLSAND PROCEDURES**

 

We maintain disclosure controls and procedures thatare designed to ensure that the information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure based closely on the definition of“disclosure controls and procedures” in Rule 13a-15(e).  In designing and evaluating the disclosurecontrols and procedures, our management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures in reaching thatlevel of reasonable assurance.

 

As of the end of the fiscal quarter covered by thisreport, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective.

 

There has not been any change in our internal controlover financial reporting, that occurred during the fiscal quarter covered bythis report, that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II.****                                                OTHERINFORMATION**

 

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

 

The following is a description of matters submitted to a vote of ourshareholders at an annual meeting of shareholders held on June 2, 2004:

 

A.                                   GaryE. Henry, William D. Rutherford and James M. Usdan were elected as directors tohold office until the annual meeting in the expiration year detailed below anduntil their successors are elected and qualified.  Votes cast for and votes withheld withrespect to each nominee were as follows:

 
| ** **            | ** ** | **New Term  Expiration** | ** ** | **Votes  For** | ** ** | **Votes  Withheld** | ** ** |
|-----------------------|------------|--------------------------|------------|----------------|------------|---------------------|------------|
| Gary E. Henry         |       | 2006                     |       | 21,138,665     |       | 315,676             |       |
|                  |       |                     |       |           |       |                |       |
| William D. Rutherford |       | 2007                     |       | 21,137,292     |       | 317,049             |       |
|                  |       |                     |       |           |       |                |       |
| James M. Usdan        |       | 2007                     |       | 20,287,739     |       | 1,166,602           |       |

 

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B.                                     A briefdescription of each other matter voted upon at the annual meeting and the votescast for, votes cast against, abstentions and broker non-votes as to each suchmatter is as follows:
| ** **                                                                                                                                         | ** ** | **Votes  For** | ** ** | **Votes  Against** | ** ** | **Abstained** | ** ** | **Broker  Non-votes** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------|------------|--------------------|------------|---------------|------------|-----------------------|------------|
| Proposal to approve the 2004 Stock Incentive Plan, effectively  continuing the 1994 Stock Incentive Plan for an additional two-year period         |       | 5,457,644      |       | 2,476,989          |       | 99,971        |       | 13,419,737            |       |
|                                                                                                                                               |       |           |       |               |       |          |       |                  |       |
| Proposal to ratify the selection of Deloitte & Touche LLP as  Metro One’s independent auditors for the year ending December 31, 2004 |       | 21,140,461     |       | 217,537            |       | 96,343        |       | —                |       |

 

**ITEM 6.****                                                     EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)          Exhibits

 

**10.1**                           2004 Stock Incentive Plan (incorporated by referencefrom Appendix A to the Registrant’s Definitive Proxy Statement onSchedule 14-A filed with the Commission on April 26, 2004)

 

**31.1**                           Certification of Principal Executive Officerpursuant to Securities and Exchange Commission Rule 13a-14(a)

 

**31.2**                           Certification of Principal Financial Officerpursuant to Securities and Exchange Commission Rule 13a-14(a)

 

**32.1**                     Certification of Principal Executive Officer andPrincipal Financial Officer Pursuant to 18 U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act Of 2002

 

(b)         Reports on Form 8-K

 

On April 23, 2004, we filed a current report on Form 8-K, datedApril 23, 2004, under Item 12, Results of Operations and FinancialCondition which furnished our first quarter financial statements for thequarter ended March 31, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
| Date:     August 9,  2004 |                                         |
|---------------------------------------------------------|----------------------------------------------|
|                                                    |                                         |
|                                                    | METRO ONE TELECOMMUNICATIONS, INC.           |
|                                                    |                                         |
|                                                    | By:                                          | /s/  Duane C. Fromhart |   |
|                                                    | Duane C. Fromhart                            |
|                                                    | Senior Vice President,                       |
|                                                    | Chief Financial Officer                      |
|                                                    | (Principal Financial and Accounting Officer) |

 

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