LEXENT INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
MARK ONE
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

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

COMMISSION FILE NUMBER 000-31105

LEXENT INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 13-3990223
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

THREE NEW YORK PLAZA
NEW YORK, NEW YORK 10004
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

(212) 981-0700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

TITLE OF EACH CLASS

COMMON STOCK, $.001 PAR VALUE

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [X] No [ ]

Indicate by check mark 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. [ ]

As of March 1, 2001, the aggregate market value of the Common Stock of the
Registrant held by non-affiliates of the Registrant, based on the last sale
price of the Common Stock of the Registrant was approximately $35,103,627 on
that date.

The number of shares of the Common Stock of the Registrant outstanding as
of March 1, 2001 was 41,205,712.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Definitive Proxy Statement for the 2001 Annual
Meeting of Stockholders to be held on May 3, 2001, are incorporated by reference
into Part III of this Form 10-K.
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LEXENT INC.

ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2000

INDEX

PAGE
NUMBER
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 6
Item 3. Legal Proceedings........................................... 6
Item 4. Submission of Matters to a Vote of Security Holders......... 7

PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters..................................................... 7
Item 6. Selected Consolidated Financial Data........................ 9
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 16
Item 8. Financial Statements and Supplementary Data................. 16
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................... 16

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 17
Item 11. Executive Compensation...................................... 17
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 17
Item 13. Certain Relationships and Related Transactions.............. 17

PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 17

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PART I

ITEM 1. BUSINESS

GENERAL

We are a leading provider of outsourced local telecommunications network
services for established and emerging communications companies, including
competitive local exchange carriers, Internet service providers and carriers'
carriers. Our principal focus is to provide the expertise and resources our
customers need to build and connect their networks to other local and long
distance carriers and individual end users. Our complete local solution allows
our customers to outsource all or a portion of the design, build-out, upgrade
and maintenance of their networks. We generally provide services 24 hours a day,
seven days a week, to ensure the reliability of these networks.

Currently, we operate in 15 major national markets. Over the past three
years, we have expanded our operations from the New York City metropolitan area
into several key markets across the country, including Atlanta, San Jose,
Chicago, Miami and Los Angeles in 2000. All of our expansions have been through
internal growth. At December 31, 2000, our consolidated revenues were $296.0
million as compared to $150.9 million in 1999, which represents a revenue growth
of 96% as compared to 1999. Moreover, virtually all of our revenue growth to
date has been internally generated.

Our largest customers include Level 3 Communications, Winstar
Communications, MCI Worldcom, Metromedia Fiber Network, and AT&T. We generated
25.4%, 8.3%, 8.2%, 6.9% and 5.5%, respectively, of our revenues from each of
these customers during 2000.

We also continued to increase and broaden our customer base in 2000. During
2000, we provided service to more than 200 customers, as compared to 74 and 36
customers during 1999 and 1998, respectively.

Lexent was incorporated in Delaware in January 1998. Our wholly owned
subsidiaries, Hugh O'Kane Electric Co., LLC, National Network Technologies LLC,
Lexent Services, Inc. and HOK Datacom, Inc. were formed in June 1998, August
1998, May 2000 and November 2000, respectively. In July 1998, Hugh O'Kane
Electric Co., Inc., our predecessor company, merged into Lexent, and Lexent
issued 22,716,600 shares of common stock to the stockholders of our predecessor.
Following the merger, substantially all of our assets were contributed to our
subsidiary Hugh O'Kane Electric Co., LLC, and that entity also assumed all of
the obligations of Lexent, including those of our predecessor company.

INDUSTRY OVERVIEW

Growth of the Telecommunications Industry

The Telecommunications Act of 1996 opened the local telephone market to
competition by requiring the incumbent local exchange carriers to provide
competitive local exchange carriers with conditional access to their local
networks. Competitive local exchange carriers can now offer local, long distance
and data services to their customers and are focused on providing the high
bandwidth that businesses and consumers are demanding. The telecommunications
industry has grown rapidly, and our customers have made large capital
investments to build and expand their networks to satisfy the demand for
broadband Internet access, wireless communications and enhanced data and voice
services.

We believe the competitive local exchange carriers' share of the growing
local telecommunications market may increase significantly, resulting in a
future competitive local exchange carrier market substantially larger than
today. Certain competitive local exchange carriers have announced plans to build
out their networks as quickly as possible to capture a greater share of this
expanding opportunity. By supplying the last mile connection directly to their
customers, competitive local exchange carriers are able to provide customers
with the broadband access that they increasingly need. The challenges of quickly
building a complex local network, particularly over the last mile, require
competitive local exchange carriers to allocate their resources efficiently. We
believe that, increasingly, this has led them to outsource network design,
deployment, upgrades and maintenance.

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The demand for broadband Internet access and other enhanced data services
is accelerating the adoption of new technologies. High-speed fiber networks are
being coupled with broadband wireless technologies to deliver enhanced
telecommunications capabilities and applications to new customers and markets.
According to International Data Corporation, the market for broadband fixed
wireless access services in the United States alone is expected to generate $7.4
billion in revenue by 2003.

Competitive local exchange carriers are expected to upgrade their networks
with new technologies and expand into new geographic regions in order to remain
competitive and satisfy the demand for broadband services. Additionally, new
carriers are entering the market as a result of deregulation, new technologies
and the demand for new services, fueling the development of new networks. These
carriers are deploying new networks and expanding and/or upgrading their
existing networks and equipment.

Due to this increasingly competitive environment, telecommunications
companies are focused on satisfying customer demand for enhanced services,
better quality, faster data transmission and lower prices. The proliferation of
telecommunications companies and new technologies has created an environment
where speed to market is a critical component of a telecommunication company's
success. Telecommunication companies are also faced with the challenge of
managing increasingly complex networks and technologies. For example, the ever
increasing demand for broadband services and capacity requiring the transmission
of large amounts of data creates additional new technological hurdles for
companies establishing or upgrading their networks. In this dynamic environment,
customer acquisition and retention are key determinants of success. We believe
this has led carriers to increasingly prioritize their resources, focusing on
revenue generating activities and outsourcing when they can do so effectively.

We believe the changing environment is also placing significant operational
challenges on telecommunications companies. Telecommunication companies must
make decisions about which geographic markets to serve and which services and
technologies to offer. Personnel challenges and process implementations can
present cost uncertainties and operational challenges for carriers to deploy and
manage their networks. Additionally, networks are being deployed with equipment
from unrelated vendors, posing system integration challenges. This situation is
exacerbated by consolidation in the industry, which often entails the
integration of distinct networks.

COMPETITION

Our market is highly competitive and fragmented and is served by numerous
vendors. Our primary competitors in the areas where we operate are often the
internal departments of our customers and prospective customers and the
companies which may be able to provide certain components of the package of
services we offer. We may also compete with independent vendors and
telecommunications equipment manufacturers. In addition, as there may be
relatively few barriers to entry into the markets in which we operate, any
organization with adequate financial resources and access to technical expertise
and personnel may become our competitor.

We believe the principal competitive factors in our market include quality
and responsiveness of service, industry experience, reputation, the ability to
deliver results on time and competitive pricing. In addition, expertise in new
and evolving technologies, such as broadband fixed wireless, has become
increasingly important. We believe that we can compete effectively on the basis
of our experience and reputation in the industry, our knowledge of emerging
technologies and familiarity with equipment from multiple vendors, and our
highly trained workforce.

GROWTH STRATEGY

Our objective is to be a nationwide provider of outsourced local
telecommunications network services in major metropolitan markets for
competitive local exchange carriers, Internet service providers and carriers'
carriers. The key elements of our strategy are to:

Exploit the Rapidly Growing Demand for Broadband Internet Access and
Wireless Communications. The demand for high bandwidth connections to the
Internet is tremendous and is expected to increase

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dramatically in the next 10 years. According to International Data Corporation,
the number of Internet users worldwide is expected to increase from 196.1
million in 1999 to 502.4 million in 2003 and the market for fixed wireless
technologies for voice and data/Internet access services for U.S. businesses is
expected to grow from $309.3 million in 1999 to $5.2 billion in 2003. We believe
that our customers will increasingly turn to us for the design, deployment,
upgrading and maintenance of their networks as these markets grow. Also,
according to Vertical Systems Group, approximately 76% of businesses are within
one mile of an existing fiber optic network. Our ability to design, deploy,
upgrade and maintain the last mile connection has positioned us to capitalize on
our customers' goal to complete and enhance these connections to end users.

Grow Our Base of Leading Customers by Focusing on Customer Satisfaction and
Increasing Their Speed to Market. Our customers depend on us to quickly and
efficiently design, deploy, upgrade and maintain network assets critical to the
success of their businesses. To justify this reliance, we must consistently
provide our customers with responsive, reliable and high quality service. We are
committed to meeting the needs of our customers and strive to exceed their
expectations in quality and speed to market. We believe we have been successful
in developing customer loyalty and trust because of our high standards and
responsiveness and the fact that a majority of our customers give us repeat
business.

Pursue Client-Driven Geographic Expansion in Major Metropolitan Areas. We
have expanded our geographic presence with some of our key customers as they
have grown their networks. This has allowed us to enter new markets with a
customer base already in place. We believe that the major metropolitan areas in
the U.S. represent a significant opportunity for future growth for us as
competitive local exchange carriers, Internet service providers and carriers'
carriers continue to expand and upgrade their networks. We intend to expand our
service area on a city by city basis to satisfy the demands of our growing
customers. As we penetrate these new markets, we expect to continue to
capitalize on opportunities created by new market entrants, as well as the
expansion and maintenance of networks for existing customers. We may also expand
by pursuing acquisitions that will supplement our technical expertise, allowing
us to acquire additional human resources or strategic customer relationships or
expand our presence in key geographic markets where we could more effectively
complete a project or gain access to new contracts.

Pursue Selective Acquisitions and Strategic Alliances. Through selective
acquisitions as well as strategic alliances, we have added expertise and
manpower to our capabilities. We anticipate continuing this strategy as we
expand our geographic coverage and solidify our ability to service existing and
new customers in major metropolitan areas. We believe that certain acquisitions
and alliances can increase revenues through synergistic, cost effective
combinations. We have recently executed an agreement with the owners of US
Electric to purchase its stock and believe that consummation of this acquisition
will constitute a significant expansion in the Midwest.

Attract, Motivate and Retain a Highly Specialized Workforce Capable of
Remaining at the Forefront of Emerging Technologies. We believe that our future
success will depend on our continued ability to attract, retain, integrate and
motivate qualified personnel, and upon the continued service of our senior
management and key technical personnel. Our workforce has extensive experience
working with various leading edge technologies and equipment from numerous
manufacturers. We intend to continue to attract and retain highly skilled and
experienced professionals by offering technical training opportunities, bonus
opportunities and competitive salaries and benefits.

Create New Revenue Streams by Expanding Our Services and Pursuing
Cross-Selling Opportunities. We are constantly searching for new ways to serve
our customers. For example, we have developed and are testing a web-based
workflow and asset management software system which will enable us to process
orders and maintain online records of all work performed at our customers'
facilities. Expanding our services provides new channels for revenues and the
ability to cross-sell our services to existing customers and offer a broader
array of services to new customers. We often utilize our design and engineering
services to establish relationships with customers as soon as a project is
conceived. Based on these relationships, we pursue opportunities for program
management and network deployment. Once a network is deployed, we offer ongoing
network upgrade and maintenance services. Our experience with emerging
technologies also offers opportunities for network upgrades and deployment of a
carrier's next generation network. As technologies

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continue to evolve and networks become more complex, we will continue to broaden
our services to meet the changing needs of our customers.

ACQUISITIONS AND INVESTMENTS

In September 2000, we completed the acquisition of certain assets of
Communication Planning and Services Inc., which provides certain design and
implementation services for communications systems. In October 2000, we
completed the acquisition of certain assets of Magnetic Electric Construction
Corp., which provides certain telecommunications and electrical services.
Through these selective acquisitions we have effectively strengthened our
capabilities and broadened our technical expertise in the New York metropolitan
market. They have added depth to our workforce and allow us to better serve the
demands of our existing customers. The employees of these companies have been
deployed in the New York region, where growth has historically been constrained
by a tight labor market.

In February, 2001, we purchased one million convertible preferred shares of
Telseon, Inc., an Internet infrastructure company which provides optical
networking services for an approximate cost of $1.6 million. Telseon is one of
our customers.

In February, 2001, we executed a stock purchase agreement to purchase US
Electric and affiliated companies. These companies supply certain
telecommunications services in the Greater Chicago market. Assuming that all
conditions precedent to closing are met, the transaction is expected to close in
the second quarter of 2001.

SERVICES

We provide complete local telecommunications network solutions to
competitive local exchange carriers, integrated communication providers and
carriers' carriers. These services span from the design and engineering phases,
through the deployment and ongoing upgrade and maintenance of our customers'
networks on a 24-hour a day, 7-day a week basis.

Design, Engineering and Program Management

Design and Engineering. Our engineers design route maps for fiber optic
and fixed wireless backbone rings to suit our customers' needs and minimize
delays due to limited right of way or conduit access. Because of our knowledge
of the areas where we operate and our familiarity with the conduits in the
streets and entrances into buildings where cable may be placed, we are often
able to avoid disruptions or delays in installations by designing networks
avoiding known or potential problem areas. In addition, we design layouts for
facilities within central offices and other network locations, which include
equipment configurations, power distribution systems and cable routes throughout
building riser systems. We also develop record keeping and maintenance
procedures.

Program Management. Our Program Management team is responsible for
managing all aspects of the relationship with our customers. Program managers
oversee the total scope of services we provide, including supervising and
coordinating the engineering and design process, securing building and zoning
permits, managing multiple vendors and documenting the entire process for the
customer. The program manager provides the customer with a single point of
contact to ensure their needs are continually being met.

Network Deployment Services

We believe our success is largely based on our ability to be a single
source provider of vertically integrated services that have traditionally been
offered separately by multiple vendors and coordinated by a carrier's internal
deployment staff. We provide a wide range of services for the deployment of
telecommunications networks that allow for broadband connectivity. We install
fiber backbone, local SONET rings, dense wave division multiplexing (DWDM)
systems, fixed wireless systems, digital subscriber line (DSL) and digital loop
carrier equipment, digital cross connect systems, routers, power distribution
systems and telemetry monitoring systems. We also provide daily circuit testing
of DS0, DS1 and DS3 services provided by the ILECs for our customers. Our
technicians can install any of these and other options for our customers. We
have the expertise

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to install equipment from most major telecommunications equipment vendors.
Additionally, we set up the interconnections between CLECs, long distance
carriers and ILECs, which allow calls and data to be transmitted between their
respective networks.

Network Upgrade and Maintenance Services

We provide daily upgrade and maintenance services to our customers. As
network usage increases, we install new access lines and other
telecommunications and electrical equipment to handle the additional capacity.
We also upgrade equipment and reconfigure the network as the technology changes
or improves. We have technicians based at customers' premises to monitor any
service issues that may arise and perform routine maintenance. Our technicians
are available 24 hours a day, seven days a week to handle emergency repairs,
such as fiber cuts or equipment problems, while preventing or minimizing service
disruptions. These services allow our customers to maintain the reliability of
their networks without building a large workforce in all of their locations to
handle day-to-day problems.

EMPLOYEES

As of December 31, 2000, we had 1,357 employees, 1,128 of whom are billable
employees working directly on projects. Approximately 861 of our employees are
represented by a labor union, the International Brotherhood of Electrical
Workers or IBEW. We have not experienced any work stoppages in the past 25 years
and we believe that our relationships with our employees and union
representatives are excellent.

Training and Career Development. We believe that our continuous focus on
training and career development helps us to retain our employees. Employees
participate in ongoing educational programs, many of which are internally
developed, to enhance their technical and management skills through classroom
and field training. Manufacturers of telecommunications equipment also sponsor
training programs covering the installation and maintenance of their equipment,
which our employees regularly attend. We also provide opportunities for
promotion and mobility within Lexent that we believe are key components of
employee retention.

We believe our employee training, development and advancement structure
better aligns the interests of our employees with our interests and creates a
cooperative, entrepreneurial atmosphere and shared vision. We are dedicated to
maintaining an innovative, creative and empowering environment where we work as
a team to exceed the expectations of our customers and provide our employees
with personal and professional growth opportunities.

ITEM 2. PROPERTIES

FACILITIES

We lease space at 29 separate locations throughout California, Connecticut,
Florida, Georgia, Illinois, Maryland, Massachusetts, New Jersey, New York,
Pennsylvania, Texas and Virginia. Of these locations, three are owned by Hugh J.
O'Kane, Jr., our Chairman, and Kevin M. O'Kane, our Vice Chairman and Chief
Operating Officer, and two of these three locations are also owned by Denis J.
O'Kane, a stockholder in Lexent Inc. and the brother of each of Kevin and Hugh
O'Kane, Jr. Our principal executive offices are located in approximately 20,000
square feet of office space at Three New York Plaza in New York, New York. The
lease for this office space expires in May 2004.

ITEM 3. LEGAL PROCEEDINGS

On or about March 30, 2000, a former employee filed a lawsuit against us in
the U.S. District Court for the Southern District of New York, naming as
defendants Lexent Inc., Hugh O'Kane Electric Co., Inc., Hugh O'Kane Electric
Co., LLC, National Network Technologies, LLC, and certain of our employees,
officers and directors. The complaint alleged claims of sexual harassment,
employment discrimination and retaliation. In December 2000, this action was
settled and the complaint was dismissed with prejudice. We are aware of no

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other legal proceedings, other than legal proceedings arising in the normal
course of business, none of which is expected to be material to the Company's
financial position.

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

There were no matters submitted to a vote of the stockholders during the
fourth quarter of the year ended December 31, 2000.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

We completed an initial public offering of our common stock on July 28,
2000, at a price of $15.00 per share. Our common stock is listed on the NASDAQ
National Market System under the symbol "LXNT". The following table sets forth,
for the quarters indicated, the high and low sale prices of the Company's common
stock as reported by NASDAQ.

HIGH LOW
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YEAR ENDED DECEMBER 31, 2000
3rd Quarter.............................................. $37.81 $ 18.75
4th Quarter.............................................. $30.94 $ 11.19
YEAR ENDED DECEMBER 31, 2001
1st Quarter (through March 1, 2001)...................... $24.13 $ 7.00

On March 1, 2001, there were approximately 41,205,712 shares of Common
Stock outstanding which were held by approximately 2,139 shareholders of record
of the Company's common stock. The last sale price for the common stock as
reported by NASDAQ was $7.0938 per share on that date.

DIVIDEND POLICY

Covenants in our credit facility prohibit us from paying cash dividends in
excess of 25% of net income for the preceding calendar year. We currently intend
to retain any future earnings to finance the growth and development of our
business and therefore do not anticipate paying any cash dividends in the
foreseeable future. Any future determination to pay cash dividends will be at
the discretion of the board of directors and will be dependent upon our
financial condition, results of operations, capital requirements, general
business conditions and other factors that the board of directors may deem
relevant.

RECENT SALES OF UNREGISTERED SECURITIES

In 2000, the Company sold and issued the following securities that were not
registered under the Securities Act:

1. On February 17, 2000, pursuant to a common stock purchase agreement
dated January 21, 2000, the Company issued 30,000 shares of common stock to
a director of the Company for $200,000. This issuance was effected in
reliance on the exemptions from registration provided by Section 4(2) of
the Securities Act.

2. On March 20, 2000, pursuant to a right under his employment
agreement, the Company issued 322,500 shares of common stock to Alf T.
Hansen for $2,150,000. This issuance was effected in reliance on the
exception from registration provided in Section 4(2) of the Securities Act.

3. On October 2, 2000, in partial consideration for the acquisition of
the assets of Magnetic Electrical Construction Corp. ("Magnetic"), we
issued 23,077 shares of our common stock to the owner of Magnetic. This
issuance was effected in reliance on the exemptions from registration
provided by Section 4(2) of the Securities Act.

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4. During the period from October 1, 2000 through December 31, 2000,
the Company granted either incentive stock options or non-qualified stock
options to employees, officers, directors and other individuals eligible to
participate in the Lexent Inc. and its Subsidiaries Amended and Restated
Stock Option and Restricted Stock Purchase Plan, covering an aggregate of
407,000 shares of the Company's common stock.

5. Pursuant to certain grants, the Company has issued 96,625 shares of
common stock upon the exercise thereof during the period October 1, 2000
through December 31, 2000. These issuances were effected in reliance on the
exemption from registration provided by Rule 701 promulgated under Section
3(b) of the Securities Act.

The recipients of securities in each such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates and instruments issued in such
transactions. All recipients had adequate access, through their relationships
with the Company, to information about the Company.

USE OF PROCEEDS

On August 2, 2000 we completed an initial public offering of 6,900,000
shares of our common stock at a price per share of $15.00. After deducting all
underwriting discounts and commissions and other issuance costs, the total net
proceeds we received was $93,995,000. The following table sets forth our
cumulative use of these net proceeds as of December 31, 2000:

Acquisition of other businesses............................. 1,400,000
Repayment of indebtedness................................... 10,700,000
Working capital............................................. 24,000,000
Cash, cash equivalents and other short-term investments..... 56,795,000
All other purposes.......................................... 1,100,000

Other than (i) approximately $1,100,000 for the payment of dividends
accrued after December 31, 1998 on our redeemable convertible preferred stock,
(ii) approximately $600,000 for the repayment of certain cash advances and
subordinated notes payable to our principal stockholders and (iii) an estimated
$500,000 for the payment of rents pursuant to leases relating to premises owned
by entities controlled by some of our principal stockholders, none of the net
proceeds from our initial public offering were used to pay, directly or
indirectly, any directors or officers of our company, any persons owning ten
percent or more of our equity securities or any of our affiliates.

The effective date of our registration statement on Form S-1 was July 27,
2000, and the Commission file number assigned to the registration statement was
333-30660. The foregoing use of proceeds does not represent a material change in
the use of proceeds described in such registration statement.

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth certain selected consolidated financial data
of the Company for the years ended December 31, 2000, 1999, 1998, 1997 and 1996.
The selected consolidated data is derived from our consolidated financial
statements. You should read the following selected consolidated financial data
together with our consolidated financial statements and their notes as well as
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

YEAR ENDED DECEMBER 31,
-------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues................................... $295,993 $150,862 $70,959 $53,718 $48,989
Cost of revenues........................... 222,754 119,577 55,752 42,801 38,664
General, administrative and marketing
expenses................................. 22,891 11,385 7,911 6,907 4,917
Depreciation and amortization.............. 3,628 1,495 779 510 366
Non-cash stock-based compensation.......... 26,159 2,191 -- -- --
-------- -------- ------- ------- -------
Operating income........................... 20,561 16,214 6,517 3,500 5,042
Interest expense........................... 1,252 1,104 1,143 1,151 620
Other (income) expense, net................ (1,971) 27 166 9 --
-------- -------- ------- ------- -------
Income before income taxes................. 21,280 15,083 5,208 2,340 4,422
Provision for income taxes................. 12,704 7,131 1,380 151 470
-------- -------- ------- ------- -------
Net income................................. $ 8,576 $ 7,952 $ 3,828 $ 2,189 $ 3,952
======== ======== ======= ======= =======
Net income per share:
Basic.................................... $ 0.27 $ 0.32 $ 0.16 $ 0.10 $ 0.17
======== ======== ======= ======= =======
Diluted.................................. $ 0.22 $ 0.24 $ 0.15 $ 0.10 $ 0.17
======== ======== ======= ======= =======
Weighted average common shares outstanding:
Basic.................................... 30,839 22,721 22,717 22,717 22,717
======== ======== ======= ======= =======
Diluted.................................. 38,266 33,531 26,390 22,717 22,717
======== ======== ======= ======= =======
PRO FORMA INFORMATION (UNAUDITED):
Income before income taxes................. $ 5,208 $ 2,340 $ 4,422
Pro forma provision for income taxes(1).... 2,344 1,053 1,990
------- ------- -------
Pro forma net income(2).................... $ 2,864 $ 1,287 $ 2,432
======= ======= =======
Pro forma net income per share(3):
Basic.................................... $ 0.21 $ 0.24 $ 0.11 $ 0.06 $ 0.11
======== ======== ======= ======= =======
Diluted.................................. $ 0.20 $ 0.23 $ 0.11 $ 0.06 $ 0.11
======== ======== ======= ======= =======
Pro forma weighted average shares:
Basic.................................... 40,654 32,536 27,025 22,717 22,717
======== ======== ======= ======= =======
Diluted.................................. 42,356 34,606 27,025 22,717 22,717
======== ======== ======= ======= =======

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AS OF DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------- -------
(IN THOUSANDS)

CONSOLIDATED BALANCE SHEET DATA:
Cash.................................... $ 63,690 $ 1,158 $ 1,495 $ 2,312 $ 1,526
Working capital......................... 140,811 25,697 10,691 2,516 2,847
Total assets............................ 199,001 60,379 32,309 18,212 18,417
Total debt.............................. 10,807 18,812 13,985 15,460 4,970
Total stockholders' equity (deficit).... 150,481 3,715 (6,388) (4,676) 3,795

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(1) Through July 23, 1998, we elected to be taxed as an S corporation under the
Internal Revenue Code of 1986. Accordingly, we did not recognize any
provision for federal income tax expense during periods prior to that time.
The pro forma adjustment for income taxes reflects the pro forma provision
for federal income taxes which we would have recorded if we had been a C
corporation during these periods.

(2) Pro forma net income for 1998 through 1996 gives effect to the pro forma
provision for federal income taxes that we would have recorded if we had
been a C corporation during these periods.

(3) Pro forma net income per share for 2000, 1999 and 1998 assumes conversion of
the redeemable convertible preferred stock at the rate of 1.77209 shares of
common stock for each share of redeemable convertible preferred stock, at
the later of the beginning of the period presented or the date of issuance
of the redeemable convertible preferred stock. For a description of the
computation of pro forma net income per share and the number of shares used
in the pro forma calculations for the years 2000, 1999 and 1998, see Note 1
of "Notes to Consolidated Financial Statements".

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

We provide outsourced local telecommunications network services to
telecommunications companies by supplying the expertise and resources needed to
enable our customers to build and connect their networks to other
telecommunications companies and individual end users. We provide services 24
hours a day, seven days a week.

For most of our services, revenues and expenses are recognized under the
completed contract method, in which we recognize revenues and expenses when our
services have been performed and the projects have been completed. For projects
whose duration is expected to exceed 90 days, we recognize revenues and expenses
using the percentage-of-completion method. Under the percentage-of-completion
method, in each period we recognize expenses as they are incurred and we
recognize revenue based on a comparison of the costs incurred for each project
to our currently estimated total costs to be incurred for the project.
Accordingly, the revenue we recognize in a given quarter depends on the costs we
have incurred for individual projects and our current estimate of the total
remaining costs to complete individual projects. If in any period we
significantly increase our estimate of the total remaining costs to complete a
project, we may recognize very little or no additional revenue with respect to
that project. As a result, our gross margin in such period and in future periods
may be significantly reduced and in some cases we may recognize a loss on
individual projects prior to their completion. The projects for which we use the
percentage-of-completion method of accounting are typically structured with
milestone events that dictate the timing of payments to us from our customers.
Accordingly, there may be a significant delay between the date we record the
revenue and the date we receive payment from our customers. Our customers for
these projects may withhold 10% from each billing until after the project has
been completed.

We operate in various regions in the United States, including but not
limited to, New York, New Jersey, Long Island, White Plains, Philadelphia,
Washington D.C./Northern Virginia, Greater Boston, Miami, Chicago, Atlanta,
Northern California, Southern California, Dallas, Tampa and Detroit. For the
years 2000 and 1999, approximately 75% and 80%, respectively, of our revenues
was earned from services provided in the New York metropolitan region, including
New York City, New Jersey, Long Island and White Plains.

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12

Our cost of revenues includes direct compensation and benefits, overhead
including supervision and support, vehicles, facilities expenses, tools and
equipment, and other direct project-related expenses. Labor and related benefits
comprise the largest portion of our cost of revenues because our customers
generally furnish most of the materials required for each project. However,
where we provide program management services, we may be responsible for
providing the required materials as well as any subcontracting services.

General, administrative and marketing expenses include compensation and
benefits, facilities expenses, a portion of the provision for unrealizable
accounts receivable, and other expenses not related to supervision and support
of employees working directly on projects. Prior to December 31, 1999, we did
not have any employees devoted full time to sales and marketing, and our sales
and marketing expenses were not significant. We anticipate increasing our sales
and marketing expenses in the future. Depreciation and amortization expenses
include depreciation of our property and equipment and amortization related to
capitalized leases of equipment, leasehold improvements and computer software
purchased for internal use.

As of December 31, 2000, we had 1,128 employees working directly on
projects and 229 employees providing supervision and support, and general,
administrative and marketing functions.

On January 1, 1997, we repurchased common shares owned by a stockholder and
issued a subordinated promissory note in the amount of $10.2 million bearing
interest at 6% per year. We make quarterly payments on that note, and as of
December 31, 2000 and 1999, a balance of $5.1 million and $6.7 million,
respectively, was outstanding.

On July 23, 1998, we converted from an S corporation to a C corporation.
Prior to becoming a C corporation, our stockholders were taxed individually for
their share of our profits. Until July 23, 1998, our financial statements did
not reflect a provision for federal income taxes. Subsequent to that date, we
have recorded federal income taxes at the standard statutory C corporation rates
based on pre-tax income. For the year 1998, our financial statements reflect an
income tax provision based on pre-tax income earned from July 23, 1998 to
December 31, 1998.

Non-cash stock-based compensation expense consists primarily of the
amortization of deferred non-cash stock-based compensation resulting from the
grant of stock options or sale of restricted stock at exercise or sale prices
subsequently deemed, for financial reporting purposes, to be less than the fair
value of the common stock on the grant or sale date. These deferred charges are
being amortized to expense over the vesting periods of the options or restricted
stock, ranging from immediately to up to four years. We recorded deferred non-
cash stock-based compensation of $41.7 million and $9.3 million in the years
2000 and 1999, respectively, in connection with stock options granted and
restricted stock issued during those periods. Amortization of deferred non-cash
stock-based compensation was $26.2 million and $2.2 million for the years 2000
and 1999, respectively, and we expect future amortization to be $9.0 million,
$9.0 million and $4.7 million for the years 2001, 2002 and 2003, respectively.
These amounts assume that all vesting periods are completed by all employees. To
the extent that options are forfeited by an employee, previously recorded
amortization will be credited to expense. Deferred tax benefits are recorded in
connection with amortization of non-cash stock-based compensation expense
related to non-qualified options, to the extent that we expect to realize such
deferred tax benefits. These deferred tax benefits amounted to $8.1 million and
$0.8 million in the years 2000 and 1999, respectively. To the extent that
non-qualified options for which we have recorded deferred tax benefits are
forfeited or are exercised at a time when the fair value of the stock is lower
than the deemed fair value of the stock for financial reporting purposes on the
date the options were granted, a portion of such deferred tax benefits would not
be realized and such portion may be charged to expense.

Our customers for the design and deployment of telecommunications networks
include large, well-established telecommunications carriers as well as smaller,
early stage telecommunications carriers. We have derived, and believe that we
will continue to derive, a significant portion of our revenues from a limited
number of customers. For the years 2000 and 1999, we derived approximately 25%
and 26%, respectively, of our revenues from our largest customer, and 8% and
13%, respectively, of our revenues from our second largest customer. The volume
of work performed for specific customers is likely to vary from period to
period, and a major customer in one period may require a lesser amount of our
services in a subsequent period.

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RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, selected
statement of income data as a percentage of total revenues. Our results of
operations are reported as a single business segment. The percentages may not
add due to rounding.

YEAR ENDED DECEMBER 31,
-----------------------
2000 1999 1998
----- ----- -----

CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues.................................................... 100.0% 100.0% 100.0%
Cost of revenues............................................ 75.3 79.3 78.6
General, administrative and marketing expenses.............. 7.7 7.5 11.1
Depreciation and amortization............................... 1.2 1.0 1.1
Non-cash stock-based compensation........................... 8.8 1.5 --
----- ----- -----
Operating income............................................ 6.9 10.7 9.2
Interest expense............................................ 0.4 0.7 1.6
Other (income) expense, net................................. (0.7) -- 0.2
----- ----- -----
Income before income taxes.................................. 7.2 10.0 7.3
Provision for income taxes.................................. 4.3 4.7 1.9
----- ----- -----
Net income.................................................. 2.9% 5.3% 5.4%
===== ===== =====

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

Revenues. Our revenues increased by 96% to $296.0 million in 2000 from
$150.9 million in 1999. The increase in revenues was a result of expanded
business from existing key customers, revenue generation from a growing customer
base and expansion into new markets. During 1999, we entered into an
engineering, procurement and construction contract with a customer, or the EPC
contract, under which we recorded approximately $69.2 million and $34.6 million
of revenues for 2000 and 1999, respectively.

Cost of revenues. Our cost of revenues increased by 86% to $222.8 million
in 2000 from $119.6 million in 1999. The increase was due in part to increased
technical personnel in support of additional demand from customers for our
services, an increase in rent expense for additional premises and equipment, and
an increase in our fleet of vehicles. In addition, we expanded our operations
into new geographic markets in 2000, where we incurred costs for new supervisory
and support personnel, tools and equipment, vehicles and leasehold improvements.
Cost of revenues declined to 75.3% of total revenues in 2000 from 79.3% in the
same period of 1999, because the rate of increase in our revenues was higher
than the rate of increase in our expenses. Costs of approximately $60.7 million
and $31.0 million were incurred in 2000 and 1999, respectively, in connection
with the EPC contract.

General, administrative and marketing expenses. Our general,
administrative and marketing expenses increased 101% to $22.9 million in 2000
from $11.4 million in 1999. The increase was primarily due to additional
compensation and related benefits for new executive and administrative personnel
required to support our increased revenues, as well as a higher provision for
unrealizable accounts receivable, which increased by $1.9 million in 2000
compared with 1999 as a result of our increased revenues.

Depreciation and amortization. Our depreciation and amortization expense
increased 143% to $3.6 million in 2000 from $1.5 million in 1999. The increase
reflects the depreciation of additional specialty equipment and computer
equipment acquired during 2000.

Non-cash stock-based compensation. We recorded amortization of non-cash
stock-based compensation of $26.2 million in 2000, compared with $2.2 million in
1999, related to options and restricted stock granted at exercise prices
determined by our Board of Directors at dates of grant to be equal to the fair
value of the underlying stock, but with respect to which, for financial
reporting purposes, the exercise or sales prices were

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subsequently determined to be lower than the deemed fair values of the
underlying common stock at dates of grant.

Operating income. Operating income in 2000 (before amortization of
deferred non-cash stock-based compensation) was $46.7 million, compared with
$18.4 million in 1999. After giving effect to amortization of deferred non-cash
stock-based compensation, operating income in 2000 was $20.6 million, compared
with $16.2 million in 1999.

Interest expense. Interest expense increased to $1.3 million in 2000 from
$1.1 million in 1999. The increase was due to higher interest rates on our
revolving line of credit and increases in equipment and capital lease
obligations, offset by lower interest expense on subordinated notes payable
because of a lower average level of such subordinated notes outstanding as a
result of repayments of $2.0 million during 2000.

Provision for income taxes. Excluding the effect of amortization of
deferred stock-based compensation, our effective tax rate is approximately 44%
because a significant portion of our operations is currently concentrated in New
York City, which subjects us to a local tax on income derived in that
jurisdiction. Amortization of deferred stock-based compensation relates to both
incentive stock options and nonqualified stock options, however, tax benefits
are not available for compensation expense recorded in connection with incentive
stock options. Deferred tax benefits of $8.1 million and $0.8 million were
recorded for the years 2000 and 1999, respectively, in connection with
amortization of $17.9 million and $1.9 million of stock-based compensation
related to nonqualified stock options for 2000 and 1999, respectively. The
balance of $8.3 million and $0.3 million of amortization of stock-based
compensation for the years 2000 and 1999, respectively, is not subject to tax
benefits because it relates to incentive stock options. As a result, our total
effective tax rate for financial reporting purposes was 60% and 47% for the
years 2000 and 1999, respectively.

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

Revenues. Our revenues increased 113% to $150.9 million in 1999 from $71.0
million in 1998. The increase was attributable to higher demand from our
customers for our services, as they expanded their telecommunications networks
primarily in the New York metropolitan area. We also expanded our operations to
the New England area during 1999. During 1999, we recorded approximately $34.6
million of revenues from the EPC contract.

Cost of revenues. Our cost of revenues increased 114% to $119.6 million in
1999 from $55.8 million in 1998, primarily due to an increase in technical
personnel in support of additional demand from customers for our services. The
costs of increased technical personnel are comprised of wages, related benefits,
and payroll-based insurance premiums. In addition, we expanded our operations
into new geographic regions in 1999, incurring costs for new facilities,
supervisory and support personnel. We also increased our fleet of specialty
vehicles during 1999. Costs of approximately $31.0 million were incurred in
connection with the EPC contract.

General, administrative and marketing expenses. Our general,
administrative and marketing expenses increased 44% to $11.4 million in 1999
from $7.9 million in 1998. The increase was primarily due to $2.7 million for
additional salaries and related benefits for new administrative personnel
required to support our increased level of revenues, as well as a higher
provision for unrealizable accounts receivable, which increased by $1.7 million
in 1999 compared with 1998 as a result of our increased level of revenues.

Depreciation and amortization. Our depreciation and amortization expense
increased 92% to $1.5 million in 1999 from $0.8 million in 1998. The increase
reflects the depreciation of additional specialty equipment and computer
equipment acquired during 1999.

Non-cash stock-based compensation. We recorded amortization of non-cash
stock-based compensation of $2.2 million in the year 1999 related to options
granted during the year at exercise prices determined by our Board of Directors
on the dates of grant to be equal to the fair value of the underlying stock, but
with respect to which, for financial reporting purposes, the exercise prices
were subsequently determined to be lower than the deemed fair values of the
underlying common stock on the dates of grant.

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Interest Expense. Interest expense was approximately $1.1 million for both
years 1999 and 1998. Interest on notes payable to banks increased in the year
1999 because of a higher average level of bank debt outstanding during the year
1999 resulting from additional borrowings under our revolving credit line,
offset by lower interest expense on subordinated notes payable because of a
lower average level of such subordinated notes as a result of repayments of $1.6
million during 1999.

Provision for income taxes. We changed from an S corporation to a C
corporation on July 23, 1998. That change resulted in an increase in our
effective tax rate to 46% in 1999 excluding the effect of amortization of
deferred stock-based compensation, up from 27% in 1998. Our financial statements
for 1998 reflected an income tax provision based on pre-tax income earned from
July 23, 1998 to December 31, 1998. If we had been a C corporation for the
entire year 1998, our provision for income taxes would have been $2.3 million,
and our net income would have been $2.9 million. Excluding the effect of
amortization of deferred stock-based compensation, our effective tax rate is
approximately 46% because a significant portion of our operations is currently
concentrated in New York City, which subjects us to a local tax on income
derived in that jurisdiction. However, amortization of deferred stock-based
compensation ($2.2 million in the year 1999) relates to both incentive stock
options and nonqualified stock options, but tax benefits are not available for
compensation expense recorded in connection with incentive stock options.
Deferred tax benefits of $0.8 million were recorded in the year 1999 in
connection with amortization of $1.9 million of stock-based compensation related
to nonqualified stock options. The balance of $0.3 million of amortization of
stock-based compensation in the year 1999 is not subject to tax benefits because
it relates to incentive stock options. As a result, our total effective tax rate
for financial reporting purposes was 47% for the year 1999.

LIQUIDITY AND CAPITAL RESOURCES

Our primary liquidity needs are for working capital and capital
expenditures. In July 1998, we raised $11.5 million through a private sale of
redeemable convertible preferred stock. Of these proceeds, $4.9 million was used
to pay dividends to common stockholders, $2.6 million was used to pay portions
of promissory notes to stockholders, and the balance of $4.0 million was used to
fund our working capital requirements.

On August 2, 2000, we completed an initial public offering (IPO) of
6,900,000 shares of common stock at a price of $15.00 per share. We received net
proceeds of $96.3 million after underwriting discounts and before expenses of
the offering. We used approximately $10.1 million of the net proceeds to pay a
portion of the outstanding balance under our revolving credit facility before
its due date. We also used $1.1 million of the net proceeds to pay dividends
accrued after December 31, 1998 on the redeemable convertible preferred stock
converted to common stock upon consummation of our IPO and $0.4 million to repay
subordinated notes payable to our two principal common stockholders. The
remaining net proceeds, after expenses of the offering, were invested in cash
and cash equivalents.

Prior to June 1999, we had a $4.5 million line of credit from a bank. In
June 1999, we obtained a $10 million revolving credit facility from two banks,
which was subsequently increased to $12.5 million in December 1999, and then to
$20 million in March 2000. In November 2000, we completed a new $50 million bank
credit facility with five banks, which expires in November 2003, and bears
interest at the prime rate or at a rate based on LIBOR, at our option. This
credit facility is to be used for general corporate purposes including working
capital. As of December 31, 2000, the prime rate was 9.5%. The credit facility
is secured by substantially all of our business assets, including our membership
interests and stock in our subsidiaries, and is senior to $5.1 million of
subordinated indebtedness to a principal common stockholder. As of December 31,
2000, $2 million was outstanding under the credit facility.

Under the terms of the credit facility, we are required to provide the
banks with periodic financial statements and other reports and must meet
specified thresholds with respect to profitability, net worth, and fixed charge
coverage ratios. Additionally, covenants in the credit facility limit the
Company's ability to sell any assets outside the ordinary course of business and
incur additional indebtedness, except that we may incur up to $20 million of
additional indebtedness in connection with acquisitions. The credit facility
also permits the Company to make loans and investments representing less than
50% of the ownership interest in other companies, up to a maximum of $30 million
outstanding at any time. The covenants also prohibit the

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Company from declaring or paying dividends in excess of 25% of net income for
the immediately preceding year, and creating liens or incurring additional
indebtedness other than for equipment obtained in the ordinary course of
business.

Our primary sources of liquidity are cash flows from operations, borrowings
under our bank credit facility and the remaining net proceeds from our initial
public offering. As of December 31, 2000, we had cash and cash equivalents of
$63.7 million and we had $48.0 million of availability under our bank credit
facility.

Cash used in operations is primarily used for projects in process and
changes in working capital. Net cash used in operations was $15.1 million for
the year 2000, $0.0 million in 1999 and $3.4 million in 1998. For the year 2000,
our primary use of cash was to finance higher receivables, which increased by
$60.2 million primarily as a result of our increased revenues. This use of cash
was offset in part by increases in accounts payable, accrued liabilities, and
billings in excess of costs and estimated earnings on uncompleted contracts.

We invoice our customers for large projects on a monthly basis as work is
performed and/or when milestones are achieved. Unattained milestones would
result in a delay in billing the customers, which would in turn result in a
delay in cash receipts. For certain projects, customers hold back 10% until the
project is completed. As of December 31, 2000, these hold-backs aggregated $2.4
million. If revenues increase in future years, we expect that we would be
required to finance an increased level of working capital, primarily comprised
of higher levels of accounts receivable.

Cash used in investing activities was $11.3 million for the year 2000, $2.9
million for 1999 and $0.9 million for 1998. Investing activities consist of
capital expenditures and acquisitions to support our growth. Our cost of
acquisitions was approximately $2.0 million in 2000.

Net cash provided by financing activities for the year 2000 was $88.9
million, comprised of $96.3 million in proceeds from our IPO and $6.6 million in
proceeds from exercises of stock options and sales of restricted stock, offset
by costs of the initial public offering of $2.3 million, net repayments under
our revolving credit facility of $6.8 million, repayments of $2.0 million of
subordinated notes payable to stockholders, payments of preferred dividends of
$1.1 million and repayments of $1.3 million for equipment and capital leases.
Net cash provided from financing activities in the year 1999 was $2.6 million,
comprised of $8.8 million borrowed under our revolving credit agreement and $0.4
million borrowed from related parties, offset by repayments of our previous bank
loan of $4.5 million, payments of $1.6 million on a subordinated note payable to
a stockholder, and $0.7 million repayments of equipment loans and capital
leases. Net cash provided from financing activities in the year 1998 was $3.5
million, which was primarily derived from the proceeds from issuance of
redeemable convertible preferred stock totaling $11.5 million and proceeds from
subordinated notes payable to stockholders, offset by $5.1 million of dividends
to common stockholders, repayment of $1.9 million on a subordinated note payable
to a stockholder, repayments of $0.6 million to related parties, and $0.4
million repayments of equipment loans and capital leases.

We have no material commitments other than obligations under our bank
credit facility, installment obligations related to equipment purchases, leases
for facilities, computer equipment and vehicles, and subordinated note payable
to a stockholder. We anticipate that available cash, cash flows from operations
and borrowing availability under our credit facility will be sufficient to
satisfy our working capital requirements for the foreseeable future. Our future
capital requirements will depend upon many factors, including our potential
expansion to additional geographic regions, which will require that we expend
funds for personnel, equipment and facilities in each region in advance of
earning revenue and receiving payments from customers.

In February 2001, we invested $1.6 million to acquire 1,000,000 convertible
preferred shares of Telseon Inc., which provides optical networking services to
its customers in metropolitan areas. Telseon is one of our customers.

In February 2001, we entered into an agreement to acquire U.S. Electric, a
supplier of end-to-end telecommunications infrastructure solutions in the
Greater Chicago Market. The acquisition price will include a combination of
stock and cash, and the acquisition will be accounted for as a purchase.
Assuming that all conditions precedent to closing are met, the transaction is
expected to be completed in the second quarter of 2001.
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EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments and hedging activities. The Company does not currently
use derivative financial instruments.

FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K, including the Notes to the Consolidated
Financial Statements and this Management's Discussion and Analysis of Financial
Condition and Results of Operations, contains both historical and
forward-looking statements. All statements other than statements of historical
fact are, or may be deemed to be, forward-looking statements within the meaning
of section 27A of the Securities Act of 1933 and section 21E of the Securities
Exchange Act of 1934. These forward-looking statements are only predictions and
generally can be identified by use of statements that include phrases such as
"believe," "expect," "anticipate," "intend," "plan," "foresee" or other words or
phrases of similar import. Similarly, statements that describe the Company's
objectives, plans or goals also are forward-looking statements. The Company's
operations are subject to certain risks and uncertainties that could cause
actual results to differ materially from those contemplated by the relevant
forward-looking statement. The forward-looking statements included herein are
made only as of the date of this Annual Report on Form 10-K and the Company
undertakes no obligation to publicly update such forward-looking statements to
reflect subsequent events or circumstances. No assurances can be given that
projected results or events will be achieved.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discusses our exposure to market risk related to changes in
interest rates, equity prices and foreign currency exchange rates. We do not
believe that our exposure to market risk is material.

As of December 31, 2000, we had cash and cash equivalents of $63.7 million.
Cash equivalents are interest-bearing investment grade securities, primarily
short-term, highly liquid investments with maturities at the date of purchase of
less than 90 days. These investments are subject to interest rate risk and will
decrease in value if market interest rates increase. A hypothetical increase or
decrease in the market interest rates by 10 percent from the rates in effect on
the date of this Form 10-K would cause the fair value of these short-term
investments to decline by an insignificant amount. We have the ability to hold
these investments until maturity, and therefore we do not expect the value of
these investments to be affected to any significant degree by the effect of a
sudden change in market interest rates. Declines in interest rates over time
will, however, reduce our interest income.

We currently do not own any investments in publicly traded equity
securities. Therefore, we do not currently have any direct equity market price
risk.

We currently do not have any international operations, and we currently do
not enter into forward exchange contracts or other financial instruments with
respect to foreign currency. Accordingly, we currently do not have any foreign
currency exchange rate risk.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Item 14 and the Index therein for a listing of the Financial Statements
included as a part of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information concerning the Company's directors and officers required by
Item 10 is incorporated by reference to the information set forth in Lexent's
Proxy Statement for the 2001 Annual Meeting of Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

The information concerning the Company's directors and officers required by
Item 11 is incorporated by reference to the information set forth in Lexent's
Proxy Statement for the 2001 Annual Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information concerning the Company's directors and officers required by
Item 12 is incorporated by reference to the information set forth in Lexent's
Proxy Statement for the 2001 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information concerning the Company's directors and officers required by
Item 13 is incorporated by reference to the information set forth in Lexent's
Proxy Statement for the 2001 Annual Meeting of Stockholders.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

The information concerning the Company's directors and officers required by
Item 14 is incorporated by reference to the information set forth in Lexent's
Definitive Proxy Statement for the 2000 Annual Meeting of Stockholders.

(a) The following financial statements, schedules and exhibits are filed as
part of this Report:

(1) Financial Statements. Reference is made to the Financial
Statements commencing on page of this Report.

(2) All schedules are omitted because they are not applicable or the
required information is shown in the financial statements or the notes to
the financial statements.

(3) Exhibits:

EXHIBIT
NO. DESCRIPTION
- ------- -----------

3.1** Amended and Restated Certificate of Incorporation of Lexent
Inc. as amended
3.2** Second Amended and Restated Certificate of Incorporation
3.3** By-Laws of Lexent Inc.
3.4** Amended and Restated By-Laws
3.5** Certificate of Amendment to Amended and Restated Certificate
of Incorporation of Lexent Inc.
3.6** Certificate of Amendment to Amended and Restated Certificate
of Incorporation of Lexent Inc.
4.1** Specimen certificate for shares of Common Stock
4.2** Registration Rights Agreement, dated as of July 23, 1998,
among Lexent Inc. and the investors named therein

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EXHIBIT
NO. DESCRIPTION
- ------- -----------

4.3** Stockholders Agreement, dated as of July 23, 1998, as
amended January 13, 2000, among Lexent Inc. and the
stockholders identified on Annex I thereto
4.4** Agreement, dated July 20, 1998, by and among Lexent Inc.,
Hugh O'Kane Electric Co., Inc. and Denis J. O'Kane
4.5** Voting Agreement, dated February 11, 2000, by and among
Lexent Inc., Hugh J. O'Kane, Jr. and Kevin M. O'Kane
10.1** Lexent Inc. and Its Subsidiaries Amended and Restated Stock
Option and Restricted Stock Purchase Plan
10.2** Form of Stock Option Agreement pursuant to the Stock Option
and Restricted Stock Purchase Plan
10.3** Credit Agreement, dated as of June 29, 1999, as amended
November 1999, by and among Lexent Inc. and European
American Bank, as Administrative Agent, and the lenders
party thereto
10.4** Amended and Restated Promissory Note, dated July 23, 1998,
between Lexent Inc. and Denis J. O'Kane
10.5** Agreement between Lexent Inc. and the executive officers and
directors thereof
10.6** Employment Agreement, dated July 23, 1998, as amended
February 14, 2000, between Hugh O'Kane Jr. and Lexent Inc.
10.7** Employment Agreement, dated July 23, 1998, as amended
February 14, 2000, between Kevin O'Kane and Lexent Inc.
10.8** Employment Agreement, dated August 20, 1998, as amended
February 14, 2000, between Jonathan H. Stern and Lexent Inc.
10.9** Employment Agreement, dated December 13, 1999, between
Joseph Haines and Lexent Inc.
10.11** Employment Agreement, dated December 23, 1999, between
Victor P. DeJoy, Sr. and Lexent Inc.
10.12** Employment Agreement, dated January 9, 2000, between Alf T.
Hansen and Lexent Inc.
10.13** Second Amendment to Credit Agreement, dated as of March 8,
2000, by and among Lexent Inc. and European American Bank,
as Administrative Agent, and the Lenders party thereto
10.14**+ Engineer, Procure and Construct Contract, dated December 28,
1998, between Level 3 Communications, LLC and Lexent Inc.
10.15** Employment Agreement, dated March 30, 2000, between Sidney
A. Sayovitz and Lexent Inc.
10.16** Employment Agreement, dated June 1, 2000 between Charles T.
Christ and Lexent Inc.
10.17** Employment Agreement, dated July 2, 2000 between Nancy T.
Huson and Lexent Inc.
10.18 Credit Agreement, dated November 22, 2000 by and among
Company, European American Bank, The Bank of New York,
Israel Discount Bank of New York, Bank Leumi USA, and State
Bank of Long Island.
10.19 Employment Agreement, dated December 18, 2000 between Joel
H. Rothwax and Lexent Inc.
11.1*** Statement Regarding Computation of Per Share Earnings
21.1 Subsidiaries of Lexent Inc.
23.1** Consent of independent accountants, PricewaterhouseCoopers
LLP

- ---------------
** Previously filed on Company's Registration Statement on Form S-1 (File No.
333-30660)

*** Information is provided in Note A of Notes to Consolidated Financial
Statements

+ Portions of this exhibit have been filed confidentially with the Commission
pursuant to a confidential treatment request filed by the Company

(b) Reports on Form 8-K: None.

18
20

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Lexent Inc. has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of New
York, New York, on March 27, 2001.

LEXENT INC.

By: /s/ HUGH J. O'KANE, JR.
------------------------------------
Hugh J. O'Kane, Jr.
Chairman of the Board of Directors

Pursuant to the requirements of the Securities Act of 1934, this
Registration Statement has been signed by the following persons in the
capacities held on the dates indicated.

SIGNATURES TITLE DATE
---------- ----- ----

/s/ ALF T. HANSEN President and Chief Executive March 27, 2001
- --------------------------------------------------- Officer (Principal Executive
Alf T. Hansen Officer); Director

/s/ HUGH J. O'KANE, JR. Chairman of the Board of March 27, 2001
- --------------------------------------------------- Directors
Hugh J. O'Kane, Jr.

/s/ KEVIN M. O'KANE Vice Chairman and Chief March 27, 2001
- --------------------------------------------------- Operating Officer; Director
Kevin M. O'Kane

/s/ JONATHAN H. STERN Executive Vice President and March 27, 2001
- --------------------------------------------------- Chief Financial Officer
Jonathan H. Stern (Principal Financial and
Accounting Officer)

/s/ PETER O. CRISP Director March 27, 2001
- ---------------------------------------------------
Peter O. Crisp

/s/ THOMAS W. HALLAGAN Director March 27, 2001
- ---------------------------------------------------
Thomas W. Hallagan

/s/ L. WHITE MATTHEWS III Director March 27, 2001
- ---------------------------------------------------
L. White Matthews III

/s/ RICHARD L. SCHWOB Director March 27, 2001
- ---------------------------------------------------
Richard L. Schwob

19
21

SIGNATURES TITLE DATE
---------- ----- ----

/s/ RICHARD W. SMITH Director March 27, 2001
- ---------------------------------------------------
Richard W. Smith

/s/ WALTER C. TEAGLE III Director March 27, 2001
- ---------------------------------------------------
Walter C. Teagle III

20
22

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

TABLE OF CONTENTS

PAGE
NO.
----

Report of Independent Accountants........................... 22
Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... 23
Consolidated Statements of Income for the Years Ended
December 31, 2000, 1999 and 1998.......................... 24
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended December 31, 2000, 1999 and 1998...... 25
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000, 1999 and 1998.......................... 26
Notes to Consolidated Financial Statements.................. 27

21
23

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Lexent Inc.:

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, changes in stockholders' equity
(deficit) and of cash flows present fairly, in all material respects, the
financial position of Lexent Inc. and Subsidiaries at December 31, 2000 and
1999, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2000 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
auditing standards generally accepted in the United States of America, which
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.

/s/ PRICEWATERHOUSECOOPERS LLP
- --------------------------------------

New York, New York
February 7, 2001

22
24

LEXENT INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

DECEMBER 31,
-------------------
2000 1999
-------- -------

ASSETS:
Current Assets:
Cash and cash equivalents................................. $ 63,690 $ 1,158
Receivables, net.......................................... 105,253 48,748
Prepaid expenses and other current assets................. 400 156
Deferred tax asset, net................................... 12,359 3,592
-------- -------
Total current assets.............................. 181,702 53,654
Property and equipment, net................................. 14,614 6,180
Other assets................................................ 2,685 545
-------- -------
Total assets...................................... $199,001 $60,379
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable.......................................... $ 11,124 $ 8,434
Accrued liabilities....................................... 17,857 9,613
Income taxes payable...................................... 3,628 5,798
Billings in excess of costs and estimated earnings on
uncompleted projects................................... 5,080 1,084
Subordinated note payable to stockholder.................. 1,582 1,582
Equipment and capital lease obligations................... 1,596 1,014
Due to related parties.................................... 24 432
-------- -------
Total current liabilities......................... 40,891 27,957
Subordinated notes payable to stockholders.................. 3,561 5,533
Notes payable to banks...................................... 2,000 8,841
Equipment and capital lease obligations..................... 2,068 1,842
-------- -------
Total liabilities................................. 48,520 44,173
-------- -------
Redeemable convertible preferred stock at stated liquidation
preference of $0.00 per share at 2000 and $2.2553 per
share at 1999; $0.001 par value, 5,000,000 shares
authorized, 0 shares issued and outstanding at 2000;
$0.001 par value, 5,538,458 shares authorized, issued and
outstanding at 1999....................................... -- 12,491
-------- -------
Stockholders' equity:
Common stock, $.001 par value, 120,000,000 shares
authorized, 41,084,300 and 22,919,100 shares
outstanding at 2000 and 1999, respectively............. 41 23
Additional paid-in capital................................ 165,919 11,787
Deferred stock-based compensation......................... (22,705) (7,142)
Retained earnings (accumulated deficit)................... 7,226 (953)
-------- -------
Total stockholders' equity........................ 150,481 3,715
-------- -------
Total liabilities and stockholders' equity........ $199,001 $60,379
======== =======

See accompanying notes to consolidated financial statements.
23
25

LEXENT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEAR ENDED DECEMBER 31,
-------------------------------
2000 1999 1998
-------- -------- -------

Revenues.................................................... $295,993 $150,862 $70,959
Cost of revenues............................................ 222,754 119,577 55,752
General, administrative and marketing expenses.............. 22,891 11,385 7,911
Depreciation and amortization............................... 3,628 1,495 779
Non-cash stock-based compensation*.......................... 26,159 2,191 --
-------- -------- -------
Operating income............................................ 20,561 16,214 6,517
Interest expense............................................ 1,252 1,104 1,143
Other (income)expense, net.................................. (1,971) 27 166
-------- -------- -------
Income before income taxes.................................. 21,280 15,083 5,208
Provision for income taxes.................................. 12,704 7,131 1,380
-------- -------- -------
Net income.................................................. $ 8,576 $ 7,952 $ 3,828
======== ======== =======
Net income per share:
Basic..................................................... $ 0.27 $ 0.32 $ 0.16
======== ======== =======
Diluted................................................... $ 0.22 $ 0.24 $ 0.15
======== ======== =======
Weighted average common shares outstanding:
Basic..................................................... 30,839 22,721 22,717
======== ======== =======
Diluted................................................... 38,266 33,531 26,390
======== ======== =======
Pro Forma Information (unaudited):
Income before income taxes.................................. $ 5,208
Pro forma provision for income taxes........................ 2,344
-------
Pro forma net income........................................ $ 2,864
=======
Pro forma net income per share:
Basic..................................................... $ 0.21 $ 0.24 $ 0.11
======== ======== =======
Diluted................................................... $ 0.20 $ 0.23 $ 0.11
======== ======== =======
Pro forma weighted average shares:
Basic..................................................... 40,654 32,536 27,025
======== ======== =======
Diluted................................................... 42,356 34,606 27,025
======== ======== =======

- ---------------
* Substantially all of these amounts would have been classified as general,
administrative and marketing expenses

See accompanying notes to consolidated financial statements.
24
26

LEXENT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)

STOCKHOLDERS' EQUITY (DEFICIT)
# SHARES ---------------------------------------------
REDEEMABLE REDEEMABLE
CONVERTIBLE CONVERTIBLE # SHARES ADDITIONAL DEFERRED
PREFERRED PREFERRED COMMON COMMON PAID-IN STOCK-BASED
STOCK STOCK STOCK STOCK CAPITAL COMPENSATION
----------- ----------- -------- ------ ---------- ------------

Balance at January 1, 1998...... -- $ -- -- $100 $ -- $ --
Conversion of Hugh O'Kane
Electric Co. Inc. common
shares into Lexent Inc. common
shares........................ -- -- 22,717 (77) -- --
Cancellation of treasury stock
due to merger of Hugh O'Kane
Electric Co. Inc. into Lexent
Inc. ......................... -- -- -- -- -- --
Dividends declared to common
stockholders.................. -- -- -- -- -- --
Net income January 1, 1998
through July 23, 1998......... -- -- -- -- -- --
Transfer of undistributed
retained earnings to
additional paid-in capital
upon termination of S
corporation election.......... -- -- -- -- 1,804 --
Issuance of 5,538,458 redeemable
convertible preferred shares
at $2.07639 per share......... 5,538 11,500 -- -- -- --
Cost of issuing preferred
stock......................... -- -- -- -- -- --
Dividends accrued on preferred
shares........................ -- 301 -- -- -- --
Net income July 24, 1998 through
December 31, 1998............. -- -- -- -- -- --
------ -------- ------ ---- -------- --------
Balance at December 31, 1998.... 5,538 $ 11,801 22,717 $ 23 $ 1,804 $ --
Issuance of 202,500 common
shares........................ -- -- 202 -- 68 --
Tax benefit from exercise of
nonqualified stock options.... -- -- -- -- 582 --
Deferred stock-based
compensation.................. -- -- -- -- 9,333 (9,333)
Amortization of deferred
stock-based compensation...... -- -- -- -- -- 2,191
Dividends accrued on preferred
shares........................ -- 690 -- -- -- --
Net income...................... -- -- -- -- -- --
------ -------- ------ ---- -------- --------
Balance at December 31, 1999.... 5,538 $ 12,491 22,919 $ 23 $ 11,787 $ (7,142)
Issuance of 1,450,576 common
shares........................ -- -- 1,450 1 6,576 --
Issuance of 6,900,000 common
shares in initial public
offering...................... -- -- 6,900 7 96,248 --
Conversion of preferred shares
to common upon initial public
offering...................... (5,538) (11,801) 9,815 10 11,791 --
Costs of initial public
offering...................... -- -- -- -- (2,309) --
Tax benefit from exercise of
nonqualified stock options.... -- -- -- -- 104 --
Deferred stock-based
compensation.................. -- -- -- -- 41,722 (41,722)
Amortization of deferred
stock-based compensation...... -- -- -- -- -- 26,159
Dividends accrued on preferred
shares........................ -- 397 -- -- -- --
Dividends paid on preferred
shares........................ -- (1,087) -- -- -- --
Net income...................... -- -- -- -- -- --
------ -------- ------ ---- -------- --------
Balance at December 31, 2000.... -- $ -- 41,084 $ 41 $165,919 $(22,705)
====== ======== ====== ==== ======== ========

STOCKHOLDERS' EQUITY (DEFICIT)
---------------------------------------
RETAINED TOTAL
EARNINGS TREASURY STOCKHOLDERS'
(ACCUMULATED STOCK AT EQUITY
DEFICIT) COST (DEFICIT)
------------ -------- -------------

Balance at January 1, 1998...... $ 4,042 $(8,818) $ (4,676)
Conversion of Hugh O'Kane
Electric Co. Inc. common
shares into Lexent Inc. common
shares........................ 77 -- --
Cancellation of treasury stock
due to merger of Hugh O'Kane
Electric Co. Inc. into Lexent
Inc. ......................... (8,818) 8,818 --
Dividends declared to common
stockholders.................. (4,900) -- (4,900)
Net income January 1, 1998
through July 23, 1998......... 1,804 -- 1,804
Transfer of undistributed
retained earnings to
additional paid-in capital
upon termination of S
corporation election.......... (1,804) -- --
Issuance of 5,538,458 redeemable
convertible preferred shares
at $2.07639 per share......... -- -- --
Cost of issuing preferred
stock......................... (339) -- (339)
Dividends accrued on preferred
shares........................ (301) -- (301)
Net income July 24, 1998 through
December 31, 1998............. 2,024 -- 2,024
------- ------- --------
Balance at December 31, 1998.... $(8,215) $ -- $ (6,388)
Issuance of 202,500 common
shares........................ -- -- 68
Tax benefit from exercise of
nonqualified stock options.... -- -- 582
Deferred stock-based
compensation.................. -- -- --
Amortization of deferred
stock-based compensation...... -- -- 2,191
Dividends accrued on preferred
shares........................ (690) -- (690)
Net income...................... 7,952 -- 7,952
------- ------- --------
Balance at December 31, 1999.... $ (953) $ -- $ 3,715
Issuance of 1,450,576 common
shares........................ -- -- 6,577
Issuance of 6,900,000 common
shares in initial public
offering...................... -- -- 96,255
Conversion of preferred shares
to common upon initial public
offering...................... -- -- 11,801
Costs of initial public
offering...................... -- -- (2,309)
Tax benefit from exercise of
nonqualified stock options.... -- -- 104
Deferred stock-based
compensation.................. -- -- --
Amortization of deferred
stock-based compensation...... -- -- 26,159
Dividends accrued on preferred
shares........................ (397) -- (397)
Dividends paid on preferred
shares........................ -- -- --
Net income...................... 8,576 -- 8,576
------- ------- --------
Balance at December 31, 2000.... $ 7,226 $ -- $150,481
======= ======= ========

See accompanying notes to consolidated financial statements.
25
27

LEXENT INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------

Cash flows from operating activities:
Net income................................................ $ 8,576 $ 7,952 $ 3,828
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Provision for uncollectible amounts, net................ 3,675 1,812 1,096
Depreciation and amortization........................... 3,628 1,495 779
Loss on disposition of assets........................... 21 71 42
Non-cash stock-based compensation....................... 26,159 2,191 --
Provision for deferred tax benefits..................... (8,767) (1,896) (1,696)
Changes in working capital items:
Receivables.......................................... (60,180) (24,218) (13,854)
Prepaid expenses and other current assets............ (244) 379 6
Other assets......................................... (784) (391) (7)
Accounts payable..................................... 2,690 3,065 658
Accrued liabilities.................................. 8,244 5,464 2,613
Income taxes payable................................. (2,066) 3,304 3,012
Billings in excess of costs and estimated earnings on
uncompleted projects................................. 3,996 778 110
-------- -------- --------
Net cash (used in) provided by operating
activities........................................ (15,052) 6 (3,413)
-------- -------- --------
Cash flows from investing activities:
Capital expenditures and acquisitions, net of equipment
loans and capital leases................................ (11,350) (2,908) (910)
Proceeds from sales of fixed assets....................... 56 -- --
-------- -------- --------
Net cash used in investing activities.............. (11,294) (2,908) (910)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of convertible preferred stock..... -- -- 11,500
Proceeds from exercise of stock options and sales of
restricted stock........................................ 6,576 68 --
Issuance cost of convertible preferred stock.............. -- -- (339)
Preferred dividends paid.................................. (1,087) -- --
Dividends and distributions to common shareholders........ -- -- (5,138)
Proceeds from initial public offering of common stock..... 96,255 -- --
Costs of initial public offering.......................... (2,309) -- --
Proceeds from subordinated notes payable to
stockholders............................................ -- -- 388
Repayment of subordinated notes payable to stockholders... (1,972) (1,581) (1,902)
Net (repayments) borrowings under revolving credit line... (6,841) 8,841 --
Repayment of notes payable to bank........................ -- (4,500) --
Net (payments) borrowings (to) from related parties....... (408) 421 (599)
Repayment of equipment loans and capital leases........... (1,336) (684) (404)
-------- -------- --------
Net cash provided by financing activities.......... 88,878 2,565 3,506
-------- -------- --------
Net increase (decrease) in cash and cash equivalents........ 62,532 (337) (817)
Cash and cash equivalents at beginning of period............ 1,158 1,495 2,312
-------- -------- --------
Cash and cash equivalents at end of period.................. $ 63,690 $ 1,158 $ 1,495
======== ======== ========
Supplemental cash flow information:
Cash paid for:
Interest........................................... $ 1,307 $ 1,009 $ 1,626
Income taxes....................................... 23,541 3,532 252
Supplemental disclosures of noncash investing and financing
activities:
Property and equipment additions financed by equipment
loans and capital leases................................ $ 2,143 $ 2,751 $ 443
Cancellation of treasury shares due to merger............. -- -- 8,818
Adjustment to common shares due to merger................. -- -- 55
Accrued dividends on preferred shares..................... -- 690 301
Tax benefit from exercise of nonqualified stock options... 104 582 --

See accompanying notes to consolidated financial statements.
26
28

LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Formation of Company

Lexent Inc. ("Lexent"), formerly named National Network Technologies, Inc.,
was incorporated in Delaware in January 1998. Its wholly-owned subsidiary, Hugh
O'Kane Electric Co. LLC ("HOK") was formed in June 1998. On July 16, 1998, Hugh
O'Kane Electric Co., Inc. ("HOK Inc.") issued dividends aggregating $4.9 million
in the form of promissory notes to its two principal common stockholders. On
July 22, 1998, HOK Inc. was merged with and into Lexent, and Lexent issued
22,716,600 shares of common stock to the stockholders of the former HOK Inc. In
addition, on such date substantially all of the assets of Lexent were
contributed to HOK, and HOK assumed all of the obligations of the former HOK
Inc. The merger was accounted for in a manner similar to a pooling of interests
since all entities were under common control. Accordingly, HOK recorded the
assets and liabilities of HOK Inc. at their historical book values, and HOK's
results of operations have been presented as if the merger had occurred at the
beginning of the earliest period presented.

Lexent's wholly-owned subsidiary, National Network Technologies LLC ("NNT")
was formed in August 1998. Lexent's wholly-owned subsidiary, Lexent Services,
Inc. ("LSI") was formed in May 2000. Lexent's wholly-owned subsidiary HOK
Datacom, Inc. ("HOK Datacom") was formed in November 2000. Lexent, HOK, NNT, LSI
and HOK Datacom are together referred to herein as "the Company."

Description of Business

The Company provides outsourced local telecommunications network services
to telecommunications companies by supplying expertise and resources to enable
its customers to build and connect their networks to other telecommunications
companies and individual end users. Certain projects whose duration is expected
to exceed 90 days may be structured with milestone events that dictate the
timing of payments, and customers for these projects may withhold 10% from each
billing until after the project has been completed and satisfactorily accepted.

We operate in various regions in the United States, including but not
limited to, New York, New Jersey, Long Island, White Plains, Philadelphia,
Washington D.C./Northern Virginia, Greater Boston, Miami, Chicago, Atlanta,
Northern California, Southern California, Dallas, Tampa and Detroit. For the
years 2000, 1999 and 1998, a majority of revenues was earned from services
provided in the New York metropolitan region, including New York City, New
Jersey, Long Island and Westchester County.

Principles of Consolidation

The consolidated financial statements include the accounts of Lexent and
its wholly-owned subsidiaries, HOK, NNT, LSI and HOK Datacom. All significant
intercompany accounts and transactions have been eliminated in consolidation.

Revenue and Cost Recognition

Design and engineering services are generally performed on a unit price
basis or on a time and materials basis. Program management services are
generally performed on a cost-plus-fee basis. Network deployment services are
generally performed on a unit price or fixed price basis. Network upgrade and
maintenance services are generally performed on a unit price basis or on a time
and materials basis. For projects whose duration is expected to be 90 days or
less, revenues and related expenses are recognized using the completed contract
method. Under this method, revenues and expenses are recognized when the project
has been completed.

27
29
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

For projects whose duration is expected to exceed 90 days, revenues and
expenses are recognized using the percentage-of-completion method. Under the
percentage-of-completion method, expenses are recognized in each period as
incurred and revenues are recognized in each period based on a comparison of the
costs incurred for each project to the currently estimated total costs to be
incurred for the project. Accordingly, the revenue recognized in a given period
depends on the costs incurred for individual projects through that period and
currently estimated total remaining costs to complete the individual projects.
If in any period the estimates of the total remaining costs to complete a
project are significantly increased, very little or no additional revenue may be
recognized with respect to that project. Project costs include all direct
material, equipment, and labor costs and allocated indirect costs, such as
fringe benefits, payroll taxes, supervision and support, depreciation,
maintenance, supplies, and small tools. Provisions for estimated losses on
projects are made in the period in which such losses are determined.

Revenues from cost-plus-fee projects are recognized on the basis of costs
incurred during the period plus the fee earned.

General, administrative and marketing costs are charged to expense as
incurred.

Cash and Cash Equivalents

Cash equivalents consist of interest-bearing investment grade securities
that are readily convertible into cash and have original maturities of 3 months
or less.

Property and Equipment

Property and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization of property and equipment is
calculated on the straight-line basis over the estimated useful lives of the
assets. Useful lives of property and equipment are as follows: motor
vehicles -- 5 years, tools and equipment -- 4-7 years, furniture, office and
computer equipment -- 3-5 years, leasehold improvements -- 3 years or duration
of lease. Expenditures for repairs and maintenance are expensed as incurred;
expenditures for major renewals and betterments are capitalized. When assets are
sold or otherwise disposed of, the cost and related accumulated depreciation are
removed from the accounts and any gain or loss on disposition is reflected in
current operations. Property and equipment is reviewed for impairment whenever
events or changes in circumstances indicate that the related carrying amount may
not be recoverable. 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 fair value of the assets. Fair value is determined using
current market prices or anticipated cash flows discounted at a rate
commensurate with the risks involved. The Company capitalizes the costs of
purchased software and related implementation, and amortizes such costs over its
estimated useful life of three years. Management does not believe that there are
any material impairments in property and equipment at December 31, 2000.

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 consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates relate
to realizability of accounts receivable including unbilled receivables and costs
of uncompleted projects, percentages of completion of projects in progress,
contracts, property and equipment and accrued expenses. Actual results could
differ from those estimates.

28
30
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Income Taxes

The Company recognizes deferred income taxes for the tax consequences in
future years of differences between the tax basis of assets and liabilities and
their financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense consists of the tax payable for the period and the change
during the period in deferred tax assets and liabilities.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 permits
entities to recognize the fair value of all stock-based awards on the date of
grant as expense over the vesting period or allows entities to apply the
provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees." Under APB No. 25 compensation expense is recorded on
the date of grant only if the current market price of the underlying stock
exceeds the exercise price, with pro forma net income disclosures as if the
fair-value-based method defined in SFAS No. 123 had been applied. The Company
has elected to apply the provisions of APB Opinion No. 25 and provide the pro
forma disclosure provisions of SFAS No. 123.

Deferred non-cash stock-based compensation is recorded when the exercise
price of an option or the sale price of restricted stock is lower than the fair
market value of the underlying stock on the grant or sale date. For certain
options and restricted stock granted in the years 2000 and 1999, the exercise or
sale prices were determined by the Board of Directors at dates of grant to be
equal to the fair value of the underlying stock; however, such exercise or sale
prices were subsequently determined to be lower than the deemed fair values for
financial reporting purposes of the underlying common stock on the date of
grant. Accordingly, for those options and restricted stock grants, the Company
has recorded deferred non-cash stock-based compensation, which is amortized over
the vesting periods of the options or restricted stock, ranging from immediately
to up to four years. Deferred tax benefits are recorded in connection with
amortization of deferred non-cash stock-based compensation related to
non-qualified options, to the extent that the Company expects to realize such
tax benefits.

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, receivables, accounts
payable, and accrued expenses approximate fair value due to the short-term
nature of these instruments. The carrying amounts reported for the equipment
obligations approximate fair value because the underlying instruments earn
interest at rates comparable to current terms offered to the Company for
instruments of similar risk. The carrying amounts reported for the notes payable
to banks approximate fair value because the interest rate on such notes
fluctuates with the prime rate or LIBOR. The fair values of subordinated notes
payable to stockholders are not estimable due to their related party nature.

Segment Reporting

All of the Company's business activities are aggregated into one reportable
segment given the similarities of economic characteristics between the
activities and the common nature of the Company's services and customers.

Recent Accounting Pronouncements

In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software

29
31
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Developed or Obtained for Internal Use," which requires entities to capitalize
certain costs related to internal-use software once certain criteria have been
met. In April 1998, the same committee issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities." These standards were effective
for the first quarter of the year 1999. The adoption of these standards did not
have a material effect on the Company's consolidated financial statements.

Net Income Per Share

Basic net income per share is computed by dividing net income (after
deducting dividends declared on preferred stock) by the weighted average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution of other securities by assuming the redeemable
convertible preferred stock had been converted into common stock as of the later
of the date of issuance of the preferred stock or the beginning of the fiscal
period presented, at the conversion rates that would have been in effect at such
dates (and without deducting from net income dividends declared on preferred
stock), and by including the dilutive effect of outstanding stock options in the
weighted average number of common shares outstanding for each period. Options
granted in 1998 were anti-dilutive and are therefore excluded from the
calculation. Details of the calculations are as follows:

YEAR ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)

NET INCOME PER SHARE -- BASIC:
Net income.......................................... $ 8,576 $ 7,952 $ 3,828
Less: preferred dividends........................... (397) (690) (301)
------- ------- -------
Net income available to common stockholders......... $ 8,179 $ 7,262 $ 3,527
======= ======= =======
Weighted average shares-basic....................... 30,839 22,721 22,717
======= ======= =======
Net income per share-basic.......................... $ 0.27 $ 0.32 $ 0.16
======= ======= =======
NET INCOME PER SHARE -- DILUTED:
Net income.......................................... $ 8,576 $ 7,952 $ 3,828
======= ======= =======
Assumed conversion of preferred stock............... 5,725 8,740 3,673
Dilutive effect of stock options.................... 1,702 2,070 --
------- ------- -------
Weighted average shares-diluted..................... 38,266 33,531 26,390
======= ======= =======
Net income per share-diluted........................ $ 0.22 $ 0.24 $ 0.15
======= ======= =======

Reclassifications

Certain prior period amounts have been reclassified to conform to the
current year presentation.

Pro Forma Information -- (unaudited)

Pro forma information included in the consolidated statements of income for
the year 1998 reflects the pro forma effect of providing income taxes on
previously untaxed subchapter "S" income before income taxes. This pro forma
effect is calculated assuming a 45% effective tax rate.

Pro forma information reflects the pro forma effect of the conversion of
redeemable convertible preferred stock into common stock upon the consummation
of the Company's initial public offering on August 2, 2000,

30
32
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

at the conversion rate of 1.77209 shares of common stock for each share of
redeemable convertible preferred stock. Pro forma basic and diluted weighted
average share calculations reflect the assumed conversion of redeemable
convertible preferred stock at the later of the beginning of the period
presented or the date of issuance of the redeemable convertible preferred stock,
at such conversion rate. The calculation of pro forma basic and diluted income
per share after giving effect to the foregoing assumption is as follows:

YEAR ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)

PRO FORMA NET INCOME PER SHARE -- BASIC:
Pro forma net income................................ $ -- $ -- $ 2,864
------- ------- -------
Actual net income................................... $ 8,576 $ 7,952 $ --
======= ======= =======
Weighted average shares -- actual................... 30,839 22,721 22,717
Assumed conversion of preferred stock............... 9,815 9,815 4,308
------- ------- -------
Pro forma weighted average shares -- basic.......... 40,654 32,536 27,025
======= ======= =======
Pro forma net income per share -- basic............. $ 0.21 $ 0.24 $ 0.11
======= ======= =======
PRO FORMA NET INCOME PER SHARE -- DILUTED:
Dilutive effect of stock options.................... 1,702 2,070 --
------- ------- -------
Pro forma weighted average shares -- diluted........ 42,356 34,606 27,025
======= ======= =======
Pro forma net income per share -- diluted........... $ 0.20 $ 0.23 $ 0.11
======= ======= =======

2. ACQUISITIONS

In September 2000, the Company purchased certain assets of Communications
Planning and Services, Inc., which provides certain design and implementation
services for communications systems. The acquisition was accounted for under the
purchase method of accounting. The purchase price was $0.7 million, of which
$0.4 million was allocated to goodwill and is being amortized over ten years.

In October 2000, the Company purchased certain assets of Magnetic Electric
Construction Corp., which provides certain electrical services. The purchase
price was $1.3 million, comprised of $0.7 million in cash and 23,077 common
shares of the Company valued at approximately $0.6 million on date of closing.
The acquisition was accounted for under the purchase method of accounting, and
approximately $1.2 million of the purchase price was allocated to goodwill and
is being amortized over ten years.

31
33
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. RECEIVABLES, NET

DECEMBER 31, DECEMBER 31,
2000 1999
------------ ------------
(IN THOUSANDS)

Accounts receivable -- billed to customers................. $ 73,009 $30,226
Unbilled receivables on completed projects accounted for
under the completed contract method...................... 16,839 4,908
Costs and estimated earnings in excess of billings on
projects accounted for under the percentage-of-completion
method................................................... 4,238 3,858
Unbilled receivables on cost-plus contracts................ 5,426 6,066
Costs of uncompleted projects accounted for under the
completed contract method................................ 10,572 6,138
Retainage.................................................. 2,446 1,154
-------- -------
112,530 52,350
Less: allowance for uncollectible amounts.................. (7,277) (3,602)
-------- -------
$105,253 $48,748
======== =======

For the years 2000, 1999, and 1998, the Company's provision for
uncollectible amounts was $5.8 million, $2.4 million, and $1.6 million,
respectively. The amounts written off against the allowance for the years 2000,
1999 and 1998 were $2.1 million, $0.6 million and $0.5 million, respectively.

Amounts retained by customers related to projects that are progress-billed
may be outstanding for periods that exceed one year.

4. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

DECEMBER 31, DECEMBER 31,
2000 1999
------------ ------------
(IN THOUSANDS)

Motor vehicles..................................... $ 4,765 $ 5,069
Tools and equipment................................ 7,749 2,171
Office equipment and furniture..................... 1,015 640
Computer equipment................................. 4,465 1,033
Leasehold improvements............................. 1,017 363
Purchased software................................. 1,109 383
------- -------
Property, plant and equipment.................... 20,120 9,659
Less: accumulated depreciation and amortization.... (5,506) (3,479)
------- -------
Property, plant and equipment, net............... $14,614 $ 6,180
======= =======

Depreciation and amortization expense for the years 2000, 1999 and 1998 was
$3.6 million, $1.5 million, and $0.8 million, respectively. Accumulated
amortization at December 31, 2000 included $0.6 million related to capitalized
leases -- see Note 10 of Notes to Consolidated Financial Statements for further
information.

5. NOTES PAYABLE AND OTHER FINANCING ARRANGEMENTS

At December 31, 2000, the Company had notes payable to banks aggregating
$2.0 million under a $50 million collateralized revolving credit facility, which
expires in November 2003. Borrowings bear interest at the prime rate or at a
rate based on LIBOR, at the option of the Company. This credit facility is to be
used for

32
34
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

general corporate purposes including working capital. As of December 31, 2000,
the prime rate was 9.5%. The line of credit is secured by substantially all of
the Company's assets, including its membership interests and stock in its
subsidiaries, and is senior to $5.1 million of subordinated indebtedness to a
principal common stockholder.

Under the terms of the credit facility, the Company is required to provide
the banks with periodic financial statements and other reports, and must meet
specified thresholds with respect to profitability, net worth, and fixed charge
coverage ratios. Additionally, covenants in the credit facility limit the
Company's ability to sell any assets outside the ordinary course of business and
incur additional indebtedness, except that up to $20 million of additional
indebtedness outstanding at any time may be incurred in connection with
acquisitions. The credit facility also permits the Company to make loans and
investments representing less than 50% of the ownership interest in other
companies, up to a maximum of $30 million outstanding at any time. The covenants
also prohibit the Company from declaring or paying dividends in excess of 25% of
net income for the immediately preceding year, and creating liens or incurring
additional indebtedness other than for equipment obtained in the ordinary course
of business.

At December 31, 2000 and 1999, the Company had $2.4 million and $2.2
million, respectively, of installment loans payable, primarily related to its
fleet of vehicles. Of those amounts, $1.0 million and $0.7 million,
respectively, were classified as current, with the balance classified as
non-current. The loans bear interest at rates ranging between 0.9% and 9.5%,
have terms averaging three years, and are collateralized by the vehicles.

At December 31, 2000 and 1999, the Company had $1.3 million and $0.7
million of capital lease obligations, respectively. See Note 10 of Notes to
Consolidated Financial Statements for further information.

The following are the maturities of long-term debt (excluding capitalized
lease obligations) for the next five years:

MATURITY AMOUNT
- -------- --------------
(IN THOUSANDS)

2001........................................................ $1,000
2002........................................................ 884
2003........................................................ 2,410
2004........................................................ 96
------
Total....................................................... $4,390
======

6. SUBORDINATED NOTES PAYABLE TO STOCKHOLDERS AND RELATED PARTY
TRANSACTIONS

On January 1, 1997, the Company repurchased common shares owned by a
stockholder and issued a subordinated promissory note in the amount of $10.2
million. The note bears interest at the rate of 6%. The first payment on the
note was made on July 23, 1998, at which time $1.5 million plus accrued interest
was paid. The remaining balance is payable in twenty-two quarterly installments
of $0.4 million plus accrued interest starting October 1, 1998, with the final
payment due on January 1, 2004. As of December 31, 2000 and 1999, the
outstanding principal balance of the note was $5.1 million and $6.7 million,
respectively, of which $1.6 million is classified as current at both dates, and
the balance is classified as non-current. The note is subordinated to all senior
debt.

As of December 31, 1999, the Company also had outstanding subordinated
promissory notes payable to its two principal common stockholders in the
aggregate amount of $0.4 million, which were classified as non-current. The
notes bore interest at 6% and were subordinated to all senior debt. Payment of
principal and interest on these notes was permitted under the Company's bank
credit agreement after consummation of the

33
35
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

initial public offering of common stock. On August 31, 2000, the Company repaid
those notes to its two principal common stockholders.

From time to time prior to 2000, the Company's two principal common
stockholders advanced money to the Company for its operating needs, and the
Company made repayments of such advances. At December 31, 1999, the amount owed
by the Company to its two principal common stockholders for such advances
aggregated $0.2 million, which was repaid in November 2000. The advances bore
interest at the rate of 6%, were not subordinated, and were classified as
current because there were no formal repayment terms.

The Company leases two premises from entities which are owned by three of
its principal common stockholders. Annual rentals for office and warehouse
premises at 88-90 White Street, New York, NY are $0.3 million for calendar years
1998 through 2001, and $0.4 million for calendar year 2002. Annual rentals for
office and warehouse premises in South Plainfield, NJ are $0.1 million for the
twelve-month periods April through March, commencing April 1998 through March
2008.

On May 1, 2000, the Company entered into a ten-year lease for a garage and
warehouse facility in Long Island City, New York. The lease payments are $0.5
million per year commencing May 1, 2000. The facility is leased from an entity
that is owned by the Company's two principal common stockholders.

During 1999 and 1998, the Company purchased services for total costs of
$1.4 million and $0.5 million, respectively, from Metro Design Systems, Inc.
("MDS"), an entity, which was owned by three of the Company's principal common
stockholders and a director of the Company. In September 1999, the Company
acquired the plant and equipment, trade name, and goodwill of MDS for a purchase
price of $0.2 million, which was paid in cash. As of December 31 1999, amounts
payable by the Company to MDS amounted to $0.2 million, which was paid in 2000.

On July 20, 1998, the Company agreed to provide a former officer, who is
currently a common stockholder, with a new automobile every three years and
lifetime medical, dental and life insurance benefits consistent with his
then-existing coverage, while he remains a common stockholder. Costs incurred
for such benefits are charged to expense as incurred, and were insignificant for
the years 2000, 1999 and 1998, respectively. The Company has also agreed to pay
its founder a pension of $0.1 million per year for life.

Interest expense incurred by the Company to related parties during the
years 2000, 1999 and 1998 amounted to $0.4 million, $0.5 million and $0.6
million, respectively. Accrued interest payable to related parties as of
December 31, 2000 and 1999 was $0.1 million for both years, respectively.

7. RETIREMENT PLANS AND 401K SAVINGS PLAN

Until December 31, 1998, the Company had two noncontributory, defined
contribution pension plans and a defined benefit pension plan covering all
employees who are not subject to collective bargaining agreements. Contributions
from the Company were accrued and funded annually. Those plans were terminated
as of December 31, 1998, and the assets were distributed to the participants in
January 1999. No pension expense was recorded for the year 1998, because the
plans were fully funded at termination.

Effective January 1, 1999, the Company adopted a 401(k) savings plan,
covering all employees who are not subject to collective bargaining agreements.
Each covered employee is eligible to become a participant, and may contribute up
to 15% of salary on a tax-deferred basis. The Company contributes 3% of each
covered employee's salary up to the maximum annual amount permitted by IRS
regulations. The Company's contributions vest ratably over the employees' first
five years of service. For the years 2000 and 1999, $0.6 million and $0.2
million, respectively, was charged to expense for the 401(k) plan.

34
36
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. INCOME TAXES

The Company files a consolidated federal income tax return with its
subsidiaries. The provision for income taxes consists of:

DECEMBER 31,
-----------------------------
2000 1999 1998
------- ------- -------
(IN THOUSANDS)

Current:
Federal............................................. $17,345 $ 7,950 $ 2,099
State and local..................................... 4,327 2,360 977
Deferred.............................................. (8,968) (3,179) (1,696)
------- ------- -------
Provision for income taxes............................ $12,704 $ 7,131 $ 1,380
======= ======= =======

In July 1998, the Company's tax status changed from an S corporation to a C
corporation in connection with the transactions described in Note 1 of Notes to
Consolidated Financial Statements. The difference between the expected federal
income tax provision calculated using statutory rates and the actual provision
recorded for the year 1998 is due principally to the effect of the Company's
change in tax status, the allowance for uncollectible amounts, depreciation and
amortization, deferred costs on uncompleted projects and certain accrued
liabilities.

The components of deferred tax assets and liabilities are as follows:

DECEMBER 31,
---------------------------
2000 1999 1998
------- ------ ------
(IN THOUSANDS)

Deferred tax assets:
Allowance for uncollectible amounts................... $ 2,742 $1,669 $ 498
Amortization of deferred stock-based compensation
related to nonqualified options.................... 8,914 844 --
Deferred costs on uncompleted projects................ 1,076 858 643
Accrued liabilities................................... 48 340 558
------- ------ ------
Total deferred tax assets..................... 12,780 3,711 1,699
------- ------ ------
Deferred tax liability:
Depreciation and amortization......................... 421 119 3
------- ------ ------
Net deferred tax asset.................................. $12,359 $3,592 $1,696
======= ====== ======

In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that a portion or all of the deferred tax
assets will not be realized. Based upon the level of historical taxable income
and projections for future taxable income, management believes it is more likely
than not that the deferred tax assets will be realized and, accordingly, no
valuation allowance was established during the years 2000, 1999 and 1998. With
respect to deferred tax benefits recorded in connection with amortization of
stock-based compensation expense related to non-qualified options, to the extent
that non-qualified options are forfeited or are exercised at a time when the
fair value of the stock is lower than the deemed fair value of the stock for
financial reporting purposes on the date the options were granted, a portion of
such deferred tax benefits would not be realized and such portion may be charged
to expense.

35
37
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation for statutory federal income tax expense is as follows:

2000 1999 1998
---- ---- -----

Federal statutory rate applied to pre-tax income............ 35.0% 35.0% 34.0%
State and local taxes, net of federal benefit............... 9.5 10.4 11.5
Tax effect of non-deductible items.......................... 15.2 1.9 3.7
Effect on income from S corporation years................... -- -- (22.7)
---- ---- -----
Total tax provision......................................... 59.7% 47.3% 26.5%
==== ==== =====

9. CONTINGENCIES

From time to time, the Company is involved in various lawsuits and legal
proceedings, which arise in the ordinary course of business. On or about March
31, 2000, a former employee filed a lawsuit against the Company and certain of
the Company's employees, officers and directors in the U.S. District Court for
the Southern District of New York, seeking, among other things, reinstatement
with back and front pay, compensatory damages in excess of $5.0 million,
punitive damages, costs and attorneys' fees, based upon allegations of sexual
harassment, employment discrimination and retaliation. This matter was settled
in December 2000 for an insignificant amount.

10. LEASE COMMITMENTS

The Company leases equipment, motor vehicles and real estate (including
real estate leased from related parties referred to in Note 6 of Notes to
Consolidated Financial Statements) under leases accounted for as operating
leases for lease terms ranging from one to nine years. Total rent expense
amounted to $2.9 million, $1.8 million and $0.8 million for the years 2000, 1999
and 1998, respectively.

Future minimum lease payments under operating leases as of December 31,
2000 are as follows:

AMOUNT
--------------
(IN THOUSANDS)

2001................................................... $6,606
2002................................................... 6,363
2003................................................... 5,934
2004................................................... 4,691
2005................................................... 2,699
After 2005............................................. 5,108

During 2000 and 1999, the Company leased computer equipment under capital
leases. As of December 31, 2000 and 1999, the capitalized assets recorded under
capital leases was $2.7 million and $0.8 million, respectively, and accumulated
amortization was $0.6 million and $0.1 million, respectively, and the total
liability recorded under such capital leases was $1.3 million and $0.7 million,
respectively. The weighted average interest rate for capitalized leases is 6.7%
and 6.5% respectively. The following is a schedule by years

36
38
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

of future minimum lease payments under capital leases together with the present
value of the net minimum lease payments as of December 31, 2000:

AMOUNT
--------------
(IN THOUSANDS)

2001................................................... $ 673
2002................................................... 522
2003................................................... 174
------
Total minimum lease payments........................... 1,369
Less: amount representing interest..................... 95
------
Present value of net minimum lease payments............ $1,274
======

11. REDEEMABLE CONVERTIBLE PREFERRED STOCK

On July 23, 1998, the Company sold 5,538,458 shares of redeemable
convertible preferred stock for proceeds of $11.5 million. Costs of $0.3 million
incurred in connection with issuing such preferred stock were charged to
stockholders' equity. The preferred stock was entitled to cumulative dividends
at the rate of 6% per annum. At the option of the holders, dividends may be paid
in the form of additional preferred stock or in cash. For the years 2000, 1999,
and 1998, dividends were accrued as additional preferred stock in the amounts of
$0.4 million, $0.7 million, and $0.3 million, respectively, offset by a charge
to retained earnings (accumulated deficit).

Upon completion of the Company's public offering of common stock on August
2, 2000, preferred dividends accrued through December 31, 1998 of $0.3 million
were paid in the form of additional preferred stock, and preferred dividends
accrued from January 1, 1999 through August 2, 2000 of $1.1 million were paid in
cash.

On August 2, 2000, all outstanding shares of preferred stock were converted
into 9,814,624 shares of common stock.

12. STOCKHOLDERS' EQUITY

On March 28, 2000, the Company effected a 3-for-1 stock split of its common
stock with no change in par value. Accordingly, the stock split was recognized
by reclassifying the $.001 per share par value of the additional shares
resulting from the split, from retained earnings to common stock. Retained
earnings, common stock, per share and shares outstanding data in the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
have been retroactively restated to reflect this stock split.

On March 28, 2000, the Company filed an amendment to its Restated
Certificate of Incorporation. Among other things, the restated certificate
increased the shares of authorized common stock from 44,461,542 to 94,461,542
shares.

On July 6, 2000, the Company effected a 1-for-2 reverse stock split of its
common stock with no change in par value. Accordingly, the stock split has been
recognized by reclassifying the $.001 per share par value of the reduction in
shares resulting from the split, from common stock to retained earnings.
Retained earnings, common stock, per share and shares outstanding data in the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
have been retroactively restated to reflect this reverse stock split.

On July 6, 2000, the Company filed an amendment to its Restated Certificate
of Incorporation, which decreased the shares of authorized common stock from
94,461,542 to 50,000,000 shares.

37
39
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On July 31, 2000, the Company filed a Second Amended and Restated
Certificate of Incorporation. Among other things, the restated certificate
increased the shares of authorized common stock from 50,000,000 to 120,000,000
shares and authorized the issuance of up to 5,000,000 shares of preferred stock,
the terms of which are set at the discretion of the Board of Directors.

On August 2, 2000, the Company completed an initial public offering of
6,900,000 shares of its common stock at a price of $15.00 per share. The Company
received net proceeds of $96.3 million after underwriting discounts and before
expenses of the offering.

13. STOCK OPTIONS AND AWARDS

The Company has adopted a Stock Option and Restricted Stock Purchase Plan,
pursuant to which up to 8,700,000 common shares are available for option grants.
Stock options granted under the plan may be incentive stock options or
nonqualified stock options and are exercisable for up to ten years following the
date of grant. Vesting provisions are determined by the Board of Directors on a
case by case basis. Options granted become exercisable over periods ranging from
immediately to up to four years after the date of grant.

In July 1998, the Company issued 165,000 nonqualified options to an outside
director as a finder's fee in connection with the Company's sale of preferred
stock in July 1998. The fair value of the options at the date of grant was $0.2
million. The options vested immediately. Accordingly, the Company recorded a
charge to retained earnings of $0.2 million in 1998 as a cost of issuing the
preferred stock.

In September 1998, the Company issued 75,000 options to an outside
director. The vesting period of such options was 50% after the first year, with
the balance vesting over the next three years. For options issued to outside
directors, the Company's policy is to charge compensation expense over the
vesting period in an amount equal to the fair value of the options at grant date
as determined by the Board of Directors. For the years 2000, 1999 and 1998, such
charge to compensation expense was immaterial.

Stock option transactions are summarized in the following table:

WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- --------

Outstanding at December 31, 1997...................... -- --
Granted............................................. 570,000 $ 0.33
Exercised or canceled............................... -- --
----------
Outstanding at December 31, 1998...................... 570,000 $ 0.33
Granted............................................. 3,204,750 $ 2.60
Exercised........................................... (202,500) $ 0.33
Canceled............................................ -- --
----------
Outstanding at December 31, 1999...................... 3,572,250 $ 2.36
Granted............................................. 4,758,850 $12.53
Exercised........................................... (1,075,000) $ 3.38
Canceled............................................ (194,125) $ 9.52
----------
Outstanding at December 31, 2000...................... 7,061,975 $ 8.87
==========

38
40
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes options outstanding and exercisable at
December 31, 1999:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------- ----------- --------- -------- ----------- --------

$0.33 - $1.01 2,522,250 9.1 $0.56 565,625 $0.50
$6.67 1,050,000 10.0 $6.67 300,000 $6.67
--------- -------
3,572,250 $2.36 865,625 $2.64
========= =======

The following table summarizes options outstanding and exercisable at
December 31, 2000:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE AVERAGE
EXERCISE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- --------- -------- ----------- --------

$ 0.33 - $ 1.01 1,853,875 8.1 $ 0.53 664,902 $ 0.50
$ 6.67 - $10.00 2,274,000 9.0 $ 6.76 488,649 $ 6.85
$12.00 - $17.13 2,654,100 9.5 $14.62 279,177 $13.99
$19.38 - $28.38 159,100 9.8 $24.85 -- --
$29.13 - $30.00 120,900 9.7 $29.20 2,334 $30.00
--------- ---------
7,061,975 $ 8.87 1,435,062 $ 5.34
========= =========

During the year 2000, the Company issued rights to purchase 352,500 shares
of restricted stock at $6.67 per share, all of which were exercised.

For certain options and restricted stock granted in the year 1999 and the
first quarter of 2000, the exercise or sale prices were determined by the Board
of Directors at dates of grant to be equal to the fair value of the underlying
stock, however, such exercise or sale prices were subsequently determined to be
lower than the deemed fair values for financial reporting purposes of the
underlying common stock on the date of grant. Accordingly, for those options and
restricted stock grants, the Company recorded deferred stock-based compensation
of $41.7 million in the first quarter of 2000 and $9.3 million in the year 1999,
respectively. Amortization of such deferred stock-based compensation for 2000
and 1999 was $26.2 million and $2.2 million, respectively. Deferred tax benefits
of $8.1 million and $0.8 million were recorded in the years 2000 and 1999,
respectively, in connection with amortization of deferred stock-based
compensation related to non-qualified options.

The Company accounts for stock options for which exercise prices are equal
to fair value of the underlying stock at grant date under the method prescribed
by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Had the
Company recorded compensation cost based on the fair value of such stock options
at grant dates as determined under the Black-Scholes option pricing methodology,
the Company's pro

39
41
LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

forma net income for the years 2000 and 1999 would have decreased by
approximately $2.4 million and $0.2 million, respectively. In making that
calculation, the following assumptions were used:

2000 1999
------- -------

Expected volatility factor:
Pre IPO................................................. 0% 0%
Post IPO................................................ 66%
Risk free interest rate................................... 6.27% 6.04%
Expected life............................................. 4 years 4 years
Expected dividend rate.................................... 0% 0%
Weighted average fair value:
Pre IPO................................................. $ 2.10
Post IPO................................................ $ 9.19
Consolidated............................................ $ 5.20 $0.55
Weighted average grant price:
Pre IPO................................................. $ 9.32
Post IPO................................................ $16.66
Consolidated............................................ $12.53 $2.60

For purposes of pro forma disclosures, the estimated fair value of such
stock options at grant date is amortized to pro forma expense over the options'
vesting period. Pro forma information for the years 2000 and 1999 is as follows:

2000 1999
--------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)

Net income:
As reported.............................................. $8,576 $7,952
Pro forma................................................ $6,138 $7,759
Basic and diluted net income per share as reported:
Basic.................................................... $ 0.27 $ 0.32
Diluted.................................................. $ 0.22 $ 0.24
Basic and diluted pro forma net income per share:
Basic.................................................... $ 0.19 $ 0.24
Diluted.................................................. $ 0.16 $ 0.23

14. ACCRUED LIABILITIES

Accrued liabilities are comprised of:

DECEMBER 31,
-----------------
2000 1999
------- ------
(IN THOUSANDS)

Accrued payroll and related benefits...................... $13,016 $5,265
Accrued project costs..................................... 1,270 1,844
Other..................................................... 3,571 2,504
------- ------
Total........................................... $17,857 $9,613
======= ======

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LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. CONCENTRATION OF CREDIT RISK

Financial instruments, which potentially subject the Company to credit
risk, consist primarily of cash, cash equivalents and trade receivables.

Cash balances may, at times, exceed amounts covered by FDIC insurance. The
Company believes it mitigates its risk by depositing cash balances with high
quality financial institutions that it believes are financially sound.
Recoverability is dependent upon the performance of the institution.

The Company's cash equivalents are diversified and consist primarily of
investment grade securities with maturities of 90 days or less. Investments are
made in obligations of high-quality financial institutions, government and
government agencies, and corporations, thereby reducing credit risk
concentrations. Interest rate fluctuations impact the carrying value of the
portfolio.

Trade receivables are primarily short-term receivables from
telecommunications companies and generally well known contracting companies. To
reduce credit risk, the Company performs credit evaluations of its customers but
does not generally require collateral and, therefore, the majority of its trade
receivables are unsecured. Credit risk is affected by conditions within the
economy. The Company establishes an allowance for doubtful accounts based upon
factors surrounding the credit risk of specific customers, historical trends,
and other information.

The Company believes concentration of credit risk with respect to accounts
receivable is limited due to the large number of customers comprising the
Company's customer base and their dispersion across geographic areas. For the
year 2000, the Company had revenues from one customer which comprised 25% of the
Company's total revenues. At December 31, 2000, accounts receivable from this
customer totaled $2.1 million. For the year 1999, the Company had revenues from
two separate customers, which comprised 26% and 13% of the Company's total
revenues. At December 31, 1999, accounts receivable from these customers totaled
$6.8 million and $3.6 million, respectively. For the year 1998, the Company had
revenues from two separate customers, which comprised 16% and 13% of the
Company's total revenues.

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LEXENT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. UNAUDITED QUARTERLY FINANCIAL DATA

MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1999 1999 1999 1999 2000 2000 2000 2000
-------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)

STATEMENT OF OPERATIONS DATA:
Revenues............................. $20,165 $29,357 $46,020 $55,320 $ 56,210 $65,027 $82,412 $92,344
Cost of revenues..................... 16,040 24,501 36,362 42,674 42,149 47,898 61,030 71,677
General, administrative and marketing
expenses........................... 1,911 2,462 3,220 3,792 4,111 5,934 6,344 6,502
Depreciation and amortization........ 198 276 423 598 658 789 892 1,289
Non-cash stock-based
compensation....................... -- 19 11 2,161 19,427 2,244 2,244 2,244
------- ------- ------- ------- -------- ------- ------- -------
Operating income..................... 2,016 2,099 6,004 6,095 (10,135) 8,162 11,902 10,632
Interest expense..................... 224 238 290 352 391 343 283 235
Other expense (income), net.......... -- -- 39 (12) (10) 4 (883) (1,082)
------- ------- ------- ------- -------- ------- ------- -------
Income (loss) before
income taxes....................... 1,792 1,861 5,675 5,755 (10,516) 7,815 12,502 11,479
Provision for income
taxes (benefit).................... 828 860 2,622 2,821 (1,611) 3,605 5,762 4,948
------- ------- ------- ------- -------- ------- ------- -------
Net income (loss).................... $ 964 $ 1,001 $ 3,053 $ 2,934 $ (8,905) $ 4,210 $ 6,740 $ 6,531
======= ======= ======= ======= ======== ======= ======= =======
NET INCOME (LOSS) PER SHARE:
Basic................................ $ 0.03 $ 0.04 $ 0.13 $ 0.12 $ (0.39) $ 0.17 $ 0.19 $ 0.16
======= ======= ======= ======= ======== ======= ======= =======
Diluted.............................. $ 0.03 $ 0.03 $ 0.09 $ 0.09 $ (0.39) $ 0.12 $ 0.16 $ 0.15
======= ======= ======= ======= ======== ======= ======= =======

17. SUBSEQUENT EVENT

In February 2001, we invested $1.6 million to acquire 1,000,000 convertible
preferred shares of Telseon Inc., which provides optical networking services to
its customers in metropolitan areas. Telseon is one of our customers.

In February 2001, we entered into an agreement to acquire U.S. Electric, a
supplier of end-to-end telecommunications infrastructure solutions in the
Greater Chicago Market. The acquisition price will include a combination of
stock and cash, and the acquisition will be accounted for as a purchase.
Assuming that all conditions precedent to closing are met, the transaction is
expected to be completed in the second quarter of 2001.

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