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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2002

Commission file number: 0-30900

XO Communications, Inc.

(703) 547-2000

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 ____.

As of August 1, 2002, the number of shares of Class A and Class B common stock of XO Communications, Inc. issued and outstanding was 337,813,235 and 104,423,158, respectively.

XO Communications, Inc. and Subsidiaries
Index to Form 10-Q

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PART I. FINANCIAL STATEMENTS
    Item 1. Financial Statements

XO Communications, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Dollars in thousands, except for share and per share data)

See accompanying notes to the unaudited condensed consolidated financial statements.

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XO Communications, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(Dollars in thousands, except for share and per share data)
(Unaudited)

See accompanying notes to the unaudited condensed consolidated financial statements.

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XO Communications, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)

See accompanying notes to the unaudited condensed consolidated financial statements.

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XO Communications, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.     BASIS OF PRESENTATION

     The condensed consolidated financial statements of XO Communications, Inc. (“XO Parent”) and its subsidiaries (together with its predecessors, collectively referred to as the “Company” or “XO”) are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States for interim financial statements and the Securities and Exchange Commission’s (the “Commission”) instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2001 as filed with the Commission on March 29, 2002 (the “2001 Annual Report”).

     As further discussed in note 2, on June 17, 2002 (the “Petition Date”), XO Parent filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). Accordingly, the accompanying condensed consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code,” (“SOP 90-7”) and on a going concern basis which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. In accordance with SOP 90-7, the financial statements for the periods presented distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the Company. The Company conducts its operations through direct and indirect subsidiaries of XO Parent. While XO Parent is in the reorganization process, the subsidiaries are expected to continue to operate in the ordinary course of business, as they are not directly involved with the Chapter 11 proceedings.

     The financial information included herein reflects all adjustments (consisting only of normal recurring adjustments, except as noted elsewhere in the notes to the condensed consolidated financial statements), which, in the opinion of management, are necessary for a fair presentation of the results for interim periods. Operating results for the three and six month periods ended June 30, 2002 are not indicative of the results that may be expected for the year ending December 31, 2002.

     Consummation of a plan of reorganization confirmed by the Bankruptcy Court will likely materially change the amounts and classifications reported in the accompanying condensed consolidated financial statements, and the XO Parent stand alone financial statements included in note 2. Based on the current terms of XO Parent’s plan of reorganization discussed in note 2, the Company believes it would qualify for and be required to implement the “Fresh Start” accounting provisions of SOP 90-7 upon emergence from bankruptcy, which would establish a “fair value” basis for the carrying value of the assets and liabilities for reorganized XO. The Company expects that the implementation of Fresh Start accounting would result in a substantial reduction in the carrying value of the Company’s long-lived assets, including property and equipment, fixed wireless licenses, other intangible assets and other noncurrent assets.

Reporting Format

     Certain items related to prior periods have been reclassified to conform to the 2002 reporting format.

2.     REORGANIZATION

Background

     Bankruptcy Proceeding

     Concurrent with the Chapter 11 filing, XO Parent filed a proposed plan of reorganization (the “Plan of Reorganization”) with the Bankruptcy Court that includes two alternative reorganization scenarios, either of which would result in a substantial reorganization and restructuring of XO Parent’s balance sheet.

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On July 26, 2002, XO Parent commenced solicitation of its creditors to obtain the approvals needed to confirm and ultimately implement the Plan of Reorganization. The Bankruptcy Court has established August 26, 2002 as the date for the hearing at which XO Parent expects to seek Bankruptcy Court confirmation of the Plan of Reorganization.

     The first of the two reorganization alternatives included in the Plan of Reorganization would implement the transactions contemplated by the Stock Purchase Agreement, dated January 15, 2002 (the “Stock Purchase Agreement”), with XO Parent and two investment partnerships affiliated with Forstmann Little & Co., Forstmann Little & Co. Equity Partnership-VII, L.P. and Forstmann Little & Co. Subordinated Debt and Equity Management Buyout Partnership-VIII, L.P., and Télefonos de México S.A. de C.V. (collectively the “Investors”), that provides for $800.0 million of new capital to be invested in XO Parent in exchange for approximately 80% of the initial outstanding common stock in reorganized XO (the “Forstmann Little/Telmex Investment”). This reorganization alternative under the Plan of Reorganization also contemplates that the loans outstanding under XO Parent’s $1.0 billion senior secured credit facility (the “Facility”) would be reinstated with specific modifications and that holders of XO Parent’s senior unsecured notes and general unsecured creditors would collectively receive 18% of the initial outstanding equity in reorganized XO and $200.0 million in cash. Lenders representing more than a majority of the loans outstanding under the Facility support the reorganization alternative contemplated by the Forstmann Little/Telmex Investment and have executed a Bank Plan Support Agreement, which requires them, subject to certain conditions, to vote in favor of a plan implementing its terms. In addition, the Official Committee of Unsecured Creditors appointed in XO Parent’s bankruptcy case (the “Creditors Committee”) has informed the Bankruptcy Court that it will support the reorganization alternative in the Plan of Reorganization that implements the Forstmann Little/Telmex Investment and will recommend that holders of XO Parent’s senior unsecured notes and general unsecured creditors of XO Parent vote to accept that alternative.

     Although the terms of the Forstmann Little/Telmex Investment remain in full force and effect at this time, its consummation remains subject to the satisfaction of a number of conditions and could be terminated if certain conditions are not satisfied by September 15, 2002, other than the conditions related to the receipt of regulatory approvals, including, without limitation:

	•		that all pending or threatened litigation (other than ordinary course litigation) against XO Parent, the Investors or their respective officers and directors shall have been resolved in a manner satisfactory to each Investor in their sole discretion;
	•		that, as of the closing date of the Forstmann Little/Telmex Investment, there shall not have been a material adverse change in the Company’s business, operations, assets, financial condition, prospects or results of operations;
	•		that the Plan of Reorganization and the related confirmation order shall be reasonably acceptable to the Investors;
	•		that all required regulatory approvals shall have been obtained within the times specified by the Stock Purchase Agreement;
	•		that the amended Facility contemplated by the Plan of Reorganization shall be reasonably acceptable to the Investors;
	•		that XO shall not have entered into a written agreement with respect to an alternative proposal, including the second reorganization alternative described below that would implement a stand-alone reorganization; and
	•		that XO shall have adopted a business plan that is reasonably acceptable to the Investors.

     The Investors have informed XO Parent that they believe that it is “virtually impossible” that the conditions to the Forstmann Little/Telmex Investment will ever be satisfied, have advised XO Parent that they will not waive any of the conditions to their obligations under the Stock Purchase Agreement, and have asked XO Parent to consider terminating the agreement. Some of the reasons given by the Investors for their position are listed in the “Risks and Uncertainties” section in Management’s Discussion and Analysis.

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     The Investors have also asserted that they may currently be entitled to terminate the Stock Purchase Agreement and claim a break-up fee as a result of actions taken by XO Parent with respect to the stand-alone contingency alternative included in the Plan of Reorganization discussed below. Nonetheless, the Investors have not terminated or purported to terminate the Stock Purchase Agreement.

     XO Parent does not believe that the Investors have a right to terminate the Stock Purchase Agreement at this time and, although not free from doubt, XO Parent believes that the conditions to the Investors’ obligations under the agreement can be timely satisfied. Nevertheless, XO cannot be certain that all such conditions will be deemed satisfied or that the Investors will not otherwise attempt to terminate the Stock Purchase Agreement because of the Investors’ prior statements regarding the likelihood that the transaction contemplated by the agreement will close. Consequently, the Plan of Reorganization also includes a stand-alone contingency alternative (the “Stand-Alone Reorganization”) that XO Parent would seek to implement if the Forstmann Little/Telmex Investment is not consummated, unless a superior alternative is presented.

     XO has not entered into any written agreements with respect to the Stand-Alone Reorganization alternative, in part because the Stock Purchase Agreement provides that, if the Company enters into a written agreement with respect to an alternative proposal, the Investors would have the right to terminate the Stock Purchase Agreement. The Company believes, however, that the Stand-Alone Reorganization will have the support of both the informal steering committee of lenders under the Facility (the “Senior Lenders Committee”) and the Creditors Committee.

     Under the Stand-Alone Reorganization alternative, the $1.0 billion of principal outstanding under the Facility plus accrued interest would be converted into:

	•		either 95% or 100% of the outstanding equity of reorganized XO, depending on the support garnered by the holders of senior unsecured notes and general unsecured creditors of XO Parent, as discussed below; and
	•		$500.0 million in principal amount of junior secured loans with no interest payments required by reorganized XO until it achieves specified financial targets.

In addition:

	•		nontransferable rights to purchase $200.0 million (subject to increase in certain events) of reorganized XO’s common stock, at a per share price equal to the implied equity value in the Stand-Alone Reorganization alternative, would be granted to holders of XO Parent’s senior unsecured notes, and, if not fully subscribed by the holders of senior unsecured notes, to holders of XO Parent’s subordinated convertible notes and preferred and common stock and XO Parent’s general unsecured creditors, or
	•		to the extent such rights are not exercised, reorganized XO would be permitted to obtain a senior secured exit facility of up to $200.0 million.

     In addition, if the Stand-Alone Reorganization alternative garners sufficient support from holders of XO Parent’s senior unsecured notes and XO Parent’s general unsecured creditors in the Plan of Reorganization confirmation process, such note holders and general unsecured creditors would collectively receive, among other consideration:

	•		5% of the initial outstanding common equity in reorganized XO; and
	•		three series of warrants exercisable over a seven year period, which would include:

	•		warrants to purchase up to 10% of the common equity of reorganized XO at an exercise price equal to 125% of reorganized XO’s implied equity value in the Stand-Alone Reorganization;
	•		warrants to purchase up to 7 1/2% of the common equity of reorganized XO at an exercise price equal to 150% of the implied equity value in the Stand-Alone Reorganization; and
	•		warrants to purchase up to 7 1/2% of the common equity of reorganized XO at an exercise price equal to 200% of the implied equity value in the Stand-Alone Reorganization.

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     Regardless of which alternative under the Plan of Reorganization is completed, all equity interests in XO Parent, including its class A common stock, will be cancelled and discharged and the holders of such equity securities will not receive any distribution. XO Parent believes that this outcome is also likely to occur even if a new alternative plan of reorganization is proposed and subsequently confirmed by the Bankruptcy Court and implemented by XO Parent. Under the Stand-Alone Restructuring alternative, the current holders of common stock may be allowed to participate in the $200.0 million rights offering discussed above.

     As a consequence of the bankruptcy petition, all pending claims and litigation against XO Parent are stayed automatically by Section 362 of the Bankruptcy Code, and absent further order of the Bankruptcy Court, no party may take any action to recover any pre-petition claims, enforce any lien against or obtain possession of any property from XO Parent. In addition, pursuant to Section 365 of the Bankruptcy Code, XO Parent may reject or assume pre-petition executory contracts and unexpired leases, and parties affected by rejections of these contracts or leases may file claims with the Bankruptcy Court in accordance with the Chapter 11 reorganization process. The Creditors Committee has been formed to represent all unsecured creditors, including all holders of XO Parent’s senior unsecured notes and, in accordance with the provisions of the Bankruptcy Code, will have the right to be heard on all matters that come before the Bankruptcy Court.

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XO Parent Stand-Alone Financial Statements

     In accordance with SOP 90-7, stand-alone financial statements of XO Parent are presented below. Such financial statements have been prepared using standards consistent with the Company’s condensed consolidated financial statements without eliminating intercompany transactions (dollars in thousands).

XO Communications, Inc.
(XO Parent)
Debtor in Possession
Stand-Alone Balance Sheet
As of June 30, 2002
(Unaudited)

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XO Communications, Inc.
(XO Parent)
Debtor in Possession
Stand-Alone Statement of Operations
For the Period From the Petition Date of June 17, 2002 through June 30, 2002
(Unaudited)

XO Communications, Inc.
(XO Parent)
Debtor in Possession
Stand-Alone Statement of Cash Flows
For the Period From the Petition Date of June 17, 2002 through June 30, 2002
(Unaudited)

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Accounting Impact of Bankruptcy Filing

     Liabilities subject to compromise refer to the liabilities of XO Parent incurred prior to the Petition Date that are with unrelated parties (other than those that are payable to a subsidiary in the XO Parent Stand-Alone Balance Sheet above). In accordance with SOP 90-7, liabilities subject to compromise are recorded at the estimated amount that is expected to be allowed on prepetition claims in the Chapter 11 proceedings and are subject to future adjustments. Adjustments may result from negotiations, actions of the Bankruptcy Court, further developments with respect to disputed claims, rejection of executory contracts and unexpired leases, proofs of claim, implementation of the Plan of Reorganization, or other events. XO Parent submitted a motion with the Bankruptcy Court rejecting operating lease agreements with a total commitment of approximately $54.8 million. Other obligations of the Company’s subsidiaries that are not subject to compromise have retained their historical balance sheet classifications and amounts. Liabilities subject to compromise consisted of the following as of June 30, 2002 (dollars in thousands):

     In order to record its debt instruments at the amount expected to be allowed by the Bankruptcy Court in accordance with SOP 90-7, as of the Petition Date, XO Parent wrote off all debt issuance costs, discounts and purchase accounting adjustments (collectively the “Deferred Financing Fees”) related to debt as a component of reorganization expense. Reorganization expense also includes deferred professional fees associated with the Plan of Reorganization that were written off as of the Petition Date and fees for bankruptcy services. Reorganization expenses for the three and six month periods ended June 30, 2002 consisted of the following (dollars in thousands):

     XO Parent is required to accrue interest expense during the Chapter 11 proceedings only to the extent that it is probable that such interest will be paid pursuant to the proceedings. As only the Facility will have any principal recovery pursuant to the Plan of Reorganization, XO Parent recognized interest expense subsequent to the Petition Date only with respect to the loans under the Facility.

     In accordance with SOP 90-7, XO Parent is required to record its preferred stock at the amount expected to be allowed by the Bankruptcy Court. Accordingly, as of the Petition Date, XO Parent recognized a deferred modification fee of $81.5 million. XO Parent also wrote off all issuance costs and recognized purchase accounting adjustments related to its preferred stock totaling $11.7 million and $8.9 million, respectively, which amounts are included in other preferred stock reorganization items, net. In addition, the Company stopped accruing preferred stock dividends subsequent to the Petition Date.

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3. CUMULATIVE EFFECT OF ACCOUNTING CHANGE

     In July 2001, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (“SFAS No. 142”) which revises the accounting for purchased goodwill and intangible assets and supersedes Accounting Principles Board Opinion No. 17, “Intangible Assets.” Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but must be tested for impairment annually or more frequently if an event indicates that the asset might be impaired. This impairment test under SFAS No. 142 is based on fair values determined by using market prices, current prices for similar assets and liabilities, or a discounted cash flow methodology. Intangible assets with definite useful lives continue to be amortized over their useful lives.

     As described in greater detail in the 2001 Annual Report, SFAS No. 142 requires that the initial impairment analysis of goodwill be completed by June 30, 2002. The Company performed the required impairment tests of goodwill as of January 1, 2002, and during the first quarter of 2002 recorded a $1,876.6 million adjustment as a cumulative effect of accounting change to write-off all of its goodwill. The pro forma impact on net loss before cumulative effect of accounting change for the three and six months ended June 30, 2002 and 2001 compared to the actual results for those same periods is as follows (dollars in thousands, except for per share data):

4. LONG-LIVED ASSETS

     Long-lived assets, including property and equipment, fixed wireless licenses, and intangible assets with definite useful lives to be held and used, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”). SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” (“SFAS No. 121”). In accordance with implementation requirements, the Company implemented the provisions of SFAS No. 144 in 2002. The criteria for determining impairment for long-lived assets to be held and used are generally consistent with SFAS No. 121. Pursuant to SFAS No. 144, impairment is determined by comparing the carrying value of these long-lived assets to management’s best estimate of future undiscounted cash flows expected to result from the use of the assets and their eventual disposition.

     The Company believes that no impairment existed under SFAS No. 144 as of June 30, 2002. In the event that there are changes in the planned use of the Company’s long-lived assets or its expected future undiscounted cash flows are reduced significantly, the Company’s assessment of its ability to recover the carrying value of these assets under SFAS No. 144 could change. In addition, as discussed in note 2, if the

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Plan of Reorganization, or any similar plan of reorganization is implemented, the Company believes it would be required to apply Fresh Start accounting upon emergence from bankruptcy under which its assets and liabilities would be recorded at their then fair values resulting in a significant write-down of the Company’s long-lived assets.

     Intangible assets with definite useful lives consisted of the following components (dollars in thousands):

     The Company amortizes its intangible assets with definite useful lives on a straight-line basis over their useful lives that range from three to five years. Fixed wireless licenses are amortized over their estimated useful life of 20 years on a straight-line basis. Amortization expense related to these intangible assets and fixed wireless licenses for the three and six months ended June 30, 2002 was $26.4 million and $52.7 million, respectively, and $28.0 million and $55.8 million for the three and six months ended June 30, 2001, respectively. Amortization expense related to these intangible assets and fixed wireless licenses for the year ended December 31, 2001 was $120.6 million.

     As of June 30, 2002, the Company had approximately $1,232.3 million of long-lived assets, including construction-in-progress and certain fixed wireless licenses that are not currently ready for their intended use and accordingly, are not currently being depreciated or amortized.

5. RESTRUCTURING CHARGES

     During the second half of 2001, the Company implemented a plan to restructure certain of its business operations. The restructuring plan included reducing the Company’s discretionary spending, capital expenditures and workforce based on its assessment of current and future market conditions. In the second quarter of 2002, the Company continued to restructure its operations and reduced its workforce by approximately 350 additional employees, the majority of which were employed in the network operations group, and recorded a $2.9 million restructuring charge related to involuntary termination severance liabilities. These employees were notified of their termination of employment in the second quarter of 2002 and the employment of the majority of the notified employees was terminated by June 30, 2002.

     As of June 30, 2002, the remaining restructuring accrual was $90.2 million, which relates primarily to payments due to landlords on exited leased facilities. The restructuring accrual has decreased from $125.8 million as of December 31, 2001 due to payments associated with exited lease facilities.

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6. OPERATING SEGMENTS

     The Company operates its business as one communications segment. The Company classifies its products and services revenues offered by its communications services segment into voice services, data services, integrated voice and data services, and other services (dollars in thousands):

7. COMPREHENSIVE LOSS

     Comprehensive loss includes the Company’s net loss applicable to common shares, as well as net unrealized gains and losses on available-for-sale investments and foreign currency translation adjustments from the Company’s European operations, which was sold in February 2002. The following table reflects the Company’s calculation of comprehensive loss for the three and six months ended June 30, 2002 and 2001 (dollars in thousands):

8. NEW ACCOUNTING PRONOUNCEMENT

     In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 requires that costs associated with exit or disposal activities be recorded at their fair value when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. The provisions of SFAS 146 are to be applied prospectively to exit or disposal activities initiated after December 31, 2002, although earlier adoption is allowed.

9. RELATED PARTY TRANSACTIONS

     The Company provides telecommunications services to Nextel Communications, Inc. (“Nextel”) and purchases various administrative services from Nextel. For the year ended December 31, 2001 and the six-month period ending June 30, 2002, the Company recognized revenue of $27.6 million and $37.2 million, respectivelly, of which $12.4 million remained outstanding at June 30, 2002. Payments to Nextel during the year ended December 31, 2001 and six-month period ending June 30, 2002 totaled $6.2 million and $1.5 million, respectively. In addition, the Company provides certain telecommunications services to McLeodUSA (“McLeod”), and also purchases similar services from McLeod. For the year ended December 31, 2001 and the six-month period ending June 30, 2002, the Company recognized revenue of $7.1 million and $0.2 million, respectively. Payments to McLeod for the year ended December 31, 2001 and the six-month period ending June 30, 2002 totaled $8.4 million and $1.0 million, respectively.

10. COMMITMENTS AND CONTINGENCIES

     Legal Proceedings

     The Company, members of its board of directors, and the Investors had been named as party defendants in a number of lawsuits filed that purported to be class actions brought on behalf of XO’s stockholders. Some of these suits were filed in the United States Federal Court for the Eastern District of Virginia. The federal actions contained various allegations of federal securities law violations by the Company and certain directors relating to certain financial disclosures during the year 2001, and breaches of certain fiduciary duties by certain directors of the Company in connection with the proposed investments by the Investors, and that the Investors aided and abetted the directors with respect to such alleged breaches. In May 2002, the federal court dismissed all of the claims based on alleged securities law violations with prejudice and dismissed the breach of fiduciary duty claims without prejudice.

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     In addition, state court lawsuits filed in New York and Delaware allege that the members of the Company’s board of directors breached certain fiduciary duties in connection with the proposed investments by the Investors, and that the Investors aided and abetted the directors with respect to such alleged breaches. In July 2002, the Company entered into a settlement agreement pursuant to which the plaintiff class would dismiss and release all claims and causes of action in exchange for one of the following: (1) if the Forstmann/Telmex Investment closes, the Senior Secured Lenders will fund the settlement out of interest payments due to them under the Facility or (2) if the Forstmann/Telmex Investment does not close, the plaintiff class would share in any recovery received by the Company from the Investors through a lawsuit or settlement of any litigation for breach of the Stock Purchase Agreement. The settlement is subject to bankruptcy and state court approvals.

     The Company is not currently a party to any other legal proceedings, other than regulatory and other proceedings that are in the normal course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

     Credit Risk

     Financial instruments that potentially subject the Company to concentrations of credit risk exist primarily in its trade receivables. Although the Company’s trade receivables are geographically dispersed and include customers in many different industries, a portion of the Company’s revenue is generated from services provided to other telecommunications service providers. Several of these companies have recently filed for protection under Chapter 11 of the Bankruptcy Code. The Company believes that its established valuation and credit allowances are adequate as of June 30, 2002 to cover these risks.

     Going Concern

     The condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company’s independent accountants as of December 31, 2001, Arthur Andersen LLP, issued a going concern opinion modification in its report on the Company’s financial statements for the year ended December 31, 2001. The Company had incurred recurring operating losses and negative cash flows from operating activities and XO Parent had defaulted on its debt obligations. These financial issues raised substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon a number of factors including, but not limited to, the Bankruptcy’s Court approval of, and the Company’s implementation of the Plan of Reorganization, customer and employee retention, and the Company’s continued ability to provide high quality services. If the Plan of Reorganization is not approved and implemented, the Company may be forced to liquidate under applicable provisions of the Bankruptcy Code. There can be no assurance of the level of recovery its secured and unsecured creditors would receive in such a liquidation. The condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities if the Company was forced to liquidate.

11. SUBSEQUENT EVENTS

     Intercity Network Agreement

     On August 8, 2002, the Company entered into a Master Agreement with Level 3 Communications, Inc., (“Level 3”) which will amend various agreements related to XO’s acquisition of fiber networks in the United States from Level 3 and the recurring maintenance thereon. Effective as of the closing, which is subject to, among other things, Bankruptcy Court and regulatory approvals, Level 3 will reduce the operating and maintenance fees as well as expected fiber relocation charges from approximately $17 million annually to a fixed rate of $5.0 million per year beginning January 1, 2003, over the remaining term of the initial agreement. In exchange for this reduction and certain other concessions, the Company will surrender its indefeasible right to use the empty conduit and 6 of the 24 fibers previously acquired from Level 3. Other provisions of the agreement stipulate the conditions and price under which XO can lease segments of the conduit that is returned to Level 3, terms and conditions of credits that can be applied to future services by both companies, and Level 3 conveying certain metro conduit to XO. With respect to the transaction, we expect to record a non-cash loss, currently estimated at approximately $300.0 million, in the second half of 2002. Either party may terminate the Master Agreement in the event that the contemplated transactions do not close by February 28, 2003.

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     Prepaid Calling Card Tax Matter

     On July 26, 2002, the Company was advised by the staff of the Securities and Exchange Commission that it was conducting an informal inquiry relating to the Company’s obligations with respect to, and its accrual of liabilities for, specified federal excise and state sales tax and similar tax obligations arising in connection with prepaid calling card services. Sales generated by the Company from prepaid calling card services that are potentially subject to these taxes accounted for approximately $56 million of the Company’s total revenues from 1999, when the Company began providing these services, through June 30, 2002. On August 8, 2002, the Company responded to the SEC’s request for information. The Company believes that its accounting for these potential tax obligations is appropriate and that its accruals of liabilities relating to these obligations is adequate.

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PART I. FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

     We provide a comprehensive array of data and voice communications services. Our data services include Internet access, private data networking, including dedicated transmission capacity on our networks, virtual private network services and Ethernet services, and hosting services. Our voice services include bundled local and long distance, interactive voice response and shared tenant services. We also combine many of these services in flat rate service packages.

     To serve our customers’ broad and expanding telecommunications needs, we operate a network comprised of a series of rings of fiber optic cables located in the central business districts of numerous metropolitan areas, which we refer to as metro fiber networks, that are connected primarily by a network of numerous dedicated wavelengths on fiber optic cables, which we refer to as an inter-city network. By integrating these networks with advanced communications technologies, we are able to provide a comprehensive array of communications services entirely over a network that we own or control, from the initiation of the voice or data transmission to the point of termination, which we refer to as end-to-end service. This capability enables us to provide communication services between customers connected to our network and among customers with multiple locations entirely over our network.

     To develop these networks, we have assembled a collection of metro and inter-city network assets in the United States, substantially all of which we own or control, making us a facilities-based carrier. These network assets incorporate state-of-the-art fiber optic cable, dedicated wavelengths and transmission equipment and fixed wireless spectrum and equipment capable of carrying high volumes of data, voice, video and Internet traffic. We operate 37 metro broadband fiber optic networks in 22 states and the District of Columbia, including 25 of the 30 largest metropolitan areas in the U.S. We have constructed or acquired many of these metro networks, which consist of up to 432 strands of fiber optic cable and, in some cases, additional empty fiber conduits. For our inter-city network, we have acquired dedicated, high-capacity wavelengths on fiber optic cables, onto which we have deployed our own switching, routing and optical equipment, thereby giving us greater control over the transmission of voice and data information. We also hold indefeasible exclusive rights to use additional facilities, including unlit fiber optic strands, on the routes served by our inter-city networks.

     The Chapter 11 proceedings discussed below have not disrupted our ability to operate our networks or provide our services to new and existing customers, but they have had an impact on our ability to maintain historical revenue growth levels.

Proposed Reorganization

     Bankruptcy Proceeding

     On June 17, 2002, or the Petition Date, XO Communications, Inc., the holding company that owns and operates our more than 60 operating subsidiaries, and which we refer to as XO Parent, filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York, which we refer to as the Bankruptcy Court, as part of the balance sheet recapitalization process that we commenced in November 2001. Concurrent with the Chapter 11 filing, XO Parent filed a proposed plan of reorganization, which we refer to as the Plan of Reorganization, with the Bankruptcy Court that includes two alternative restructuring scenarios, either of which is intended to result in a substantial reorganization and recapitalization of XO Parent’s balance sheet. On July 26, 2002, XO Parent commenced solicitation of its creditors to obtain the approvals needed to confirm and ultimately implement the Plan of Reorganization. The Bankruptcy Court has established August 26, 2002 as the date for the hearing at which XO Parent expects to seek Bankruptcy Court confirmation of the Plan of Reorganization.

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     The first of the two reorganization alternatives in the Plan of Reorganization would implement the transactions contemplated by the Stock Purchase Agreement, dated January 15, 2002, with XO Parent, and two investment partnerships affiliated with Forstmann Little & Co., Forstmann Little & Co. Equity Partnership-VII, L.P. and Forstmann Little & Co. Subordinated Debt and Equity Management Buyout Partnership-VIII, L.P., and Télefonos de México S.A. de C.V. We refer to the Forstmann Little & Co. investment partnerships and Télefonos de México S.A. de C.V. collectively as the Investors. This reorganization alternative provides for $800.0 million in new capital to be invested in XO Parent in exchange for approximately 80% of the initial outstanding common stock in reorganized XO. We refer to this investment and the related transactions as the Forstmann Little/Telmex Investment. The Forstmann Little/Telmex Investment also contemplates that the loans outstanding under XO Parent’s $1.0 billion senior secured credit facility, which we refer to as the Facility, would be reinstated with specified modifications and that the holders of XO Parent’s senior unsecured notes and general unsecured creditors would collectively receive 18% of the initial outstanding equity in reorganized XO and $200 million in cash. Lenders representing more than a majority of the loans outstanding under the Facility support the reorganization alternative contemplated by the Forstmann Little/Telmex Investment and have executed a Bank Plan Support Agreement, which requires them, subject to certain conditions, to vote in favor of a plan implementing its terms. In addition, the Official Committee of Unsecured Creditors appointed in XO Parent’s bankruptcy case, which we refer to as the Creditors Committee, has informed the Bankruptcy Court that it will support the reorganization alternative in the Plan of Reorganization that implements the Forstmann Little/Telmex Investment and will recommend that holders of XO Parent’s senior unsecured notes and general unsecured creditors of XO Parent vote to accept that alternative.

     Although the terms of the Forstmann Little/Telmex Investment remain in full force and effect at this time, its consummation remains subject to the satisfaction of a number of conditions, and could be terminated if certain conditions are not satisfied by September 15, 2002, other than the conditions related to the receipt of regulatory approvals, including without limitation:

	•		that all pending or threatened litigation (other than ordinary course litigation) against XO Parent, the Investors or their respective officers and directors shall be resolved in a manner satisfactory to each Investor in their sole discretion;
	•		that, as of the closing date of the Forstmann Little/Telmex Investment, there shall not have been a material adverse change in the Company’s business, operations, assets, financial condition, prospects or results of operations;
	•		that the Plan of Reorganization and the related confirmation order shall be reasonably acceptable to the Investors;
	•		that all required regulatory approvals shall have been obtained within the times specified by the Stock Purchase Agreement;
	•		that the amended Facility contemplated by the Plan of Reorganization shall be reasonably acceptable to the Investors;
	•		that XO shall not have entered into a written agreement with respect to an alternative proposal, including the second reorganization alternative described below that would implement a stand-alone reorganization; and
	•		that XO shall have adopted a business plan that is reasonably acceptable to the Investors.

     The Investors have informed XO Parent that they believe that it is “virtually impossible” that the conditions to the Forstmann Little/Telmex Investment will ever be satisfied, have advised XO Parent that they will not waive any of the conditions to their obligations under the Stock Purchase Agreement applicable at the time of closing and have asked XO Parent to consider terminating the agreement. Some of the reasons given by the Investors for their position are listed under the heading “Risks and Uncertainties” below.

     The Investors have also asserted that they may currently be entitled to terminate the Stock Purchase Agreement and claim a break-up fee as a result of actions taken by XO Parent with respect to the stand-alone contingency alternative included in the Plan of Reorganization discussed below. Nonetheless, the Investors have not terminated or purported to terminate the Stock Purchase Agreement.

     We do not believe that the Investors have a right to terminate the Stock Purchase Agreement at this time, and, although not free from doubt, we believe that the conditions to the Investors’ obligations under the agreement can be satisfied. Nevertheless, we cannot be certain that all such conditions will be deemed satisfied or that the Investors will not otherwise attempt to terminate the Stock Purchase Agreement because of the Investor’s prior statements regarding the likelihood that the transaction contemplated by the agreement will close. Consequently, the Plan of Reorganization also includes a stand-alone contingency alternative, which we refer to as the Stand-Alone Reorganization, that we would seek to implement only if the Forstmann Little/Telmex Investment is not consummated, unless a superior alternative is presented.

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     We have not entered into any written agreements with respect to the Stand-Alone Reorganization, in part because the Stock Purchase Agreement provides that, if we enter into a written agreement with respect to an alternative proposal, the Investors would have the right to terminate the Stock Purchase Agreement. We believe, however, that the Stand-Alone Reorganization will have the support of both the informal steering committee of lenders under the Facility, which we refer to as the Senior Lenders Committee and the Creditors Committee.

     Under the Stand-Alone Reorganization alternative, the $1 billion in principal outstanding under the Facility plus accrued interest would be converted into:

	•		either 95% or 100% of the outstanding equity of reorganized XO, depending on the support garnered by the holders of senior unsecured notes and general unsecured creditors of XO Parent, as discussed below; and
	•		$500.0 million in principal amount of junior secured loans with no interest payments required by reorganized XO until it achieves specified financial targets.

     In addition:

	•		nontransferable rights to purchase $200.0 million (subject to increase in certain events) of reorganized XO’s common stock, at a per share price equal to the implied equity value in the Stand-Alone Reorganization alternative, would be granted to holders of XO Parent’s senior unsecured notes, and if not fully subscribed by the holders of senior unsecured notes, to holders of XO Parent’s subordinated convertible notes and preferred and common stock and to XO Parent’s general unsecured creditors; or
	•		to the extent such rights are not exercised, reorganized XO would be permitted to obtain a senior secured exit facility of up to $200.0 million.

     In addition, if the Stand-Alone Reorganization alternative garners sufficient support of holders of XO Parent’s senior unsecured notes and XO Parent’s general unsecured creditors in the Plan of Reorganization confirmation process, such note holders and creditors would collectively receive, among other consideration:

	•		5% of the initial outstanding common equity in reorganized XO; and
	•		three series of warrants exercisable over a seven year period, which would include:

	•		warrants to purchase up to 10% of the common equity of reorganized XO at an exercise price equal to 125% of reorganized XO’s implied equity value in the Stand-Alone Reorganization;
	•		warrants to purchase up to 7 1/2% of the common equity of reorganized XO at an exercise price equal to 150% of the implied equity value in the Stand-Alone Reorganization; and
	•		warrants to purchase up to 7 1/2% of the common equity of reorganized XO at an exercise price equal to 200% of the implied equity value in the Stand-Alone Reorganization.

     Regardless of which alternative under the Plan of Reorganization is completed, all equity interests in XO Parent, including its class A common stock, will be cancelled and discharged and the holders of such equity securities will not receive any distribution. XO Parent believes that this outcome is also likely to occur even if a new alternative plan of reorganization is proposed and subsequently confirmed by the Bankruptcy Court and implemented by XO Parent. Under the Stand-Alone Plan, the current holders of common stock may be allowed to participate in the $200.0 million rights offering discussed above.

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     As a consequence of the bankruptcy petition, all pending claims and litigation against XO Parent are stayed automatically by Section 362 of the Bankruptcy Code, and absent further order of the Bankruptcy Court, no party may take any action to recover any pre-petition claims, enforce any lien against or obtain possession of any property from XO Parent. In addition, pursuant to Section 365 of the Bankruptcy Code, XO Parent may reject or assume pre-petition executory contracts and unexpired leases, and parties affected by rejections of these contracts or leases, may file claims with the Bankruptcy Court in accordance with the Chapter 11 reorganization process. The Creditors Committee has been formed to represent all unsecured creditors including all holders of XO Parent’s unsecured notes and, in accordance with the provisions of the Bankruptcy Code, will have the right to be heard on all matters that come before it by the Bankruptcy Court.

     Due to XO Parent’s Chapter 11 filing, our financial statements have been prepared in accordance with AICPA Statement of Position 90-7 “Financial Reporting by Entities in Reorganization under the Bankruptcy Code,” hereinafter referred to as SOP 90-7. As such, the financial statements for the periods presented distinguish transactions and events that are directly associated with our reorganization from our ongoing operations. We conduct our operations through direct and indirect subsidiaries of XO Parent. While XO Parent is in the reorganization process under Chapter 11 of the Bankruptcy Code, our subsidiaries are expected to continue to operate in the ordinary course of business. Bankruptcy Court approval of our Plan of Reorganization could materially change the amounts and classifications reported in the condensed consolidated financial statements. Additionally, we may, subject to Bankruptcy Court approval, if required, or as permitted in the normal course of business, sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the financial statements. Based on the current terms of the Plan of Reorganization, we believe we would qualify for and be required to implement the “Fresh Start” accounting provisions of SOP 90-7 upon emergence from bankruptcy, which would establish a “fair value” basis for the carrying value of the assets and liabilities of reorganized XO. We expect that the implementation of Fresh Start accounting would result in a substantial reduction in the carrying value of the our long-lived assets, including property and equipment, fixed wireless licenses, other intangible assets and other noncurrent assets.

New Accounting Pronouncement

     In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No, 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that costs associated with exit or disposal activities be recorded at their fair value when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. The provisions of SFAS 146 are to be applied prospectively to exit or disposal activities initiated after December 31, 2002, although earlier adoption is allowed.

Subsequent Events

     Intercity Network Agreement

     On August 8, 2002, we entered into a Master Agreement with Level 3 Communications, Inc., which will amend various agreements related to our acquisition of fiber networks in the United States from Level 3 and the recurring maintenance thereon. Effective as of the closing, which is subject to, among other things, Bankruptcy Court and regulatory approvals, Level 3 will reduce the operating and maintenance fees as well as expected fiber relocation charges from approximately $17 million annually to a fixed rate of $5.0 million per year beginning January 1, 2003, over the remaining term of the initial agreement. In exchange for this reduction and certain other concessions, we will surrender our indefeasible right to use the empty conduit and six of the 24 fibers previously acquired from Level 3. Other provisions of the agreement stipulate the conditions and price under which XO can lease segments of the conduit that is returned to Level 3, terms and conditions of credits that can be applied to future services by both companies, and Level 3 conveying certain metro conduit to XO. With respect to the transaction, we expect to record a non-cash loss, currently estimated at approximately $300.0 million, in the second half of 2002. Either party may terminate the Master Agreement in the event that the contemplated transactions do not close by February 28, 2003.

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     Prepaid Calling Card Tax Matter

     On July 26, 2002, we were advised by the staff of the Securities and Exchange Commission that it was conducting an informal inquiry relating to our obligations with respect to, and our accrual of liabilities for, specified federal excise and state sales tax and similar tax obligations arising in connection with prepaid calling card services. Sales generated by us from prepaid calling card services that are potentially subject to these taxes accounted for approximately $56 million of our total revenues from 1999, when we began providing these services, through June 30, 2002. On August 8, 2002, we responded to the SEC’s request for information. We believe that our accounting for these potential obligations is appropriate and that our accruals of liabilities relating to these tax obligations is adequate.

Comparison of Financial Results

     Three and Six Months Ended June 30, 2002 versus Three and Six Months Ended June 30, 2001

     All of the discussions of our expectations with respect to future periods below, particularly with respect to revenue and operating expenses, are predicated on the assumption that the Plan of Reorganization will be confirmed by the Bankruptcy Court and subsequently consummated in the near term, and, therefore, should be read as qualified by all of the substantial uncertainties surrounding any such transaction, as well as uncertainties with respect to general economic conditions and the telecommunications industry. See “Risks and Uncertainties.”

     Revenue. Total revenue in the second quarter of 2002 increased 6.1% to $325.5 million from $306.8 million in the second quarter of 2001, and revenue for the six months ended June 30, 2002 increased 12.8% to $658.9 million from $584.1 million in the same period of 2001. The revenue growth is primarily due to the penetration of enhanced products to new and existing customers. Revenue for the second quarter of 2002 declined slightly, when compared with revenue for the first quarter of 2002 of $333.4 million, primarily as a result of our February 2002 sale of our European operations, customer bankruptcies and churn. We believe that total revenue in the near term will decline somewhat due to the impact of recent customer bankruptcies, the weakened economy and customer churn, and the perceived uncertainties in the market regarding XO Parent’s bankruptcy proceedings.

     Revenue was earned from providing the following services (dollars in thousands):