CHOICE ONE COMMUNICATIONS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT ON FORM 10-Q

(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

OR

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

FOR THE TRANSITION PERIOD FROM ______ TO ______

COMMISSION FILE NUMBER: 0-29279

----------------------------

CHOICE ONE COMMUNICATIONS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

STATE OF DELAWARE 6-1550742
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

100 CHESTNUT STREET, SUITE 600, ROCHESTER, NEW YORK 14604-2417
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(585) 246-4231
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

----------------------------

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 the filing
requirements for the past 90 days. Yes __X__ No _____

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

As of November 1, 2004, there were outstanding 44,146,570 shares of the
registrant's common stock, par value $0.01 per share.

CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES FORM 10-Q

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 .... 2

Condensed Consolidated Statements of Operations for the three months ended September
30, 2004 and September 30, 2003 ......................................................... 3

Condensed Consolidated Statements of Operations for the nine months ended September
30, 2004 and September 30, 2003 ......................................................... 4

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,
2004 and September 30, 2003 ............................................................. 5

Notes to Condensed Consolidated Financial Statements .................................... 6

Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations.... 20

Item 3 Quantitative and Qualitative Disclosures about Market Risk .............................. 38

Item 4 Controls and Procedures ................................................................. 39

PART II OTHER INFORMATION

Item 1 Legal Proceedings ....................................................................... 40

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds ............................. 40

Item 3 Defaults Upon Senior Securities ......................................................... 40

Item 4 Submission of Matters to a Vote of Security Holders ..................................... 40

Item 5 Other Information ....................................................................... 40

Item 6 Exhibits ................................................................................ 40

Signatures ........................................................................................ 41

(i)

PART I FINANCIAL INFORMATION
CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

The accompanying notes to condensed consolidated financial statements
are an integral part of these financial statements.

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CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

The accompanying notes to condensed consolidated financial statements
are an integral part of these financial statements.

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CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

The accompanying notes to condensed consolidated financial statements
are an integral part of these financial statements.

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CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)

The accompanying notes to condensed consolidated financial statements
are an integral part of these financial statements.

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CHOICE ONE COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004

(unaudited)

NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Choice One Communications Inc. and its wholly-owned subsidiaries (the "Company")
is an integrated communications provider offering facilities-based voice and
data telecommunications services. The Company, incorporated under the laws of
the State of Delaware on June 2, 1998, provides these services primarily to
small and medium-sized businesses in 29 second and third tier markets in the
northeastern and midwestern United States. The Company operates in one segment
and its services include local exchange and long distance services and
high-speed data and Internet services. The Company seeks to become the leading
integrated communications provider in each market it serves by offering a single
source for competitively priced, high quality, customized telecommunications
services.

The accompanying unaudited interim condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP") for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information required by GAAP for
complete financial statement presentation. The unaudited interim condensed
consolidated financial statements include the consolidated accounts of the
Company with all significant intercompany transactions eliminated. In the
opinion of management, all adjustments (consisting only of normal recurring
adjustments) necessary for a fair statement of the financial position, results
of operations and cash flows for the interim periods presented have been made.
These financial statements should be read in conjunction with the Company's
audited financial statements as of and for the year ended December 31, 2003. The
results of operations for the three month periods and the cash flows for the
three month and nine month periods ended September 30, 2004 are not necessarily
indicative of the results to be expected for other interim periods or for the
year ending December 31, 2004.

Certain amounts in the December 31, 2003 consolidated financial statements have
been reclassified to conform to the current period presentation.

NOTE 2. CHAPTER 11 PROCEEDING/GOING CONCERN MATTER

The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. On October 5, 2004, the Company
filed voluntary petitions in the United States Bankruptcy Court for the Southern
District of New York (the "Bankruptcy Court") seeking relief under the
provisions of Chapter 11 of the United States Bankruptcy Code ("Chapter 11").
The Company continues to operate its business as debtors-in-possession under the
jurisdiction of the Bankruptcy Court and in accordance with applicable
provisions of Chapter 11 and the orders of the Bankruptcy Court.

The Company had net losses applicable to common stockholders of $67.7 million
and $35.2 million for the three months ended September 30, 2004 and September
30, 2003, respectively. The Company had net losses applicable to common
stockholders of $152.9 million for the nine months ended September 30, 2004 and
$148.3 million and $524.1 million for the years ended December 31, 2003 and
2002, respectively. At September 30, 2004, the Company had $6.9 million in cash
and cash equivalents and had drawn all available funding under its senior credit
facility. The Company generated negative cash flows from both operating and
investing activities during the years ended December 31, 2003 and 2002. The
Company had a total stockholders' deficit of $781.9 million as of September 30,
2004. These factors raise substantial doubt about the Company's ability to
continue as a going concern.

On July 30, 2004, August 30, 2004 and September 30, 2004, the Company failed to
make certain interest and principal payments in the aggregate amounts of $5.1
million, $2.1 million and $2.0 million, respectively, that were then due under
its senior credit facility. Such failures constituted events of default

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under the senior credit facility and the Company's subordinated notes and would
permit the Company's obligations under its senior credit facility and
subordinated notes to be declared to be immediately payable. The requisite
majority of both the lenders under the senior credit facility and the holders of
the subordinated notes entered into standstill agreements and, in the case of
the subordinated notes, waiver agreements on July 30, 2004 and August 30, 2004,
subject to certain conditions, pursuant to which they agreed not to take any
action before September 30, 2004 with respect to such default or events of
default so as to provide the Company with additional time to facilitate the
negotiation and initiation of the Financial Restructuring (as defined below). As
a result of the events of default, the Company's long-term debt has been
reclassified to short-term in the consolidated balance sheet as of September 30,
2004. As of September 30, 2004, the Company was not in compliance with the
leverage, fixed charges and interest coverage ratios under the senior credit
facility.

On August 9, 2004, the Company entered into an amendment and waiver to the
interest rate swap agreement with the counterparty under the interest rate swap
agreement pursuant to which a payment of approximately $1.8 million due to be
paid to the counterparty on August 9, 2004 was deferred until September 30, 2004
or such earlier date on which the Company obtains debtor-in-possession ("DIP")
financing in connection with the proposed Financial Restructuring (as defined
below). In the amendment and waiver the counterparty also waived certain
defaults under the interest rate swap agreement until September 30, 2004. The
Company had not entered into DIP financing by September 30, 2004 and did not
make the required payment by such date. As a result of this event, the interest
rate swap liability has been classified as current in the consolidated balance
sheet as of September 30, 2004. The interest due of $1.8 million was
subsequently paid on October 7, 2004, bringing the Company current with payments
due under the interest rate swap agreement.

On August 2, 2004, the Company announced that it had reached an agreement in
principle with ad hoc committees of the lenders under its senior credit facility
and the holders of the subordinated notes to restructure and substantially
reduce the Company's outstanding indebtedness (the "Financial Restructuring").
The Financial Restructuring will consist of: (i) the conversion of approximately
$404.0 million of outstanding debt under the Company's senior credit facility
into $175.0 million of new senior secured term notes payable over six years and
90% of its outstanding common stock following the Financial Restructuring; (ii)
the conversion of the Company's approximately $252.0 million of outstanding
subordinated notes into the remaining 10% of such common stock and into two
series of seven-year warrants to purchase additional shares of common stock
following the Financial Restructuring; and (iii) the establishment of a new
revolving credit facility of $30.0 million from a subset of the lenders under
the senior credit facility to provide for ongoing working capital requirements.

Upon completion of the Financial Restructuring, certain restricted stock and/or
stock option grants are expected to be made to the Company's management in
amounts and subject to conditions to be determined. The rights of the Company's
existing preferred and common stockholders and the existing holders of options
and warrants to purchase its common stock will be extinguished in connection
with the Financial Restructuring and the holders of such securities will not
receive any recovery. The rights of the Company's vendors will not be impaired
by the Financial Restructuring.

On August 30, 2004, the Company entered into a Lock Up Agreement with certain of
its existing lenders pursuant to which the lenders agreed to vote in favor of
and support the proposed Financial Restructuring plan including, among other
things, its filing of the plan under Chapter 11, subject to the terms and
conditions contained in the Lock Up Agreement.

On September 15, 2004, the Company commenced a solicitation of consents in
support of its Financial Restructuring, which is in the form of a "prepackaged"
proceeding under Chapter 11. All of the lenders under the Company's senior
credit facility and holders of its subordinated notes voted to approve the
Financial Restructuring.

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On October 5, 2004, the Company filed voluntary petitions in the Bankruptcy
Court seeking relief under the provisions of Chapter 11. The Company continues
to operate its business as debtors-in-possession under the jurisdiction of the
Bankruptcy Court and in accordance with applicable provisions of Chapter 11 and
the orders of the Bankruptcy Court. In addition, the Company entered into a
Senior Secured, Super-Priority DIP Credit Agreement, dated as of October 5, 2004
(the "DIP Credit Agreement"), with General Electric Capital Corporation, as
agent and lender and the lenders from time to time party thereto. Certain of the
Company's existing lenders are also lenders under the DIP Credit Agreement. The
DIP Credit Agreement received final approval by the Bankruptcy Court on October
25, 2004 and provides for a $20.0 million commitment of DIP financing to fund
the Company's working capital requirements during the Chapter 11 proceedings.

The DIP Credit Agreement provides for certain financial and other covenants
including, but not limited to, affirmative and negative covenants with respect
to additional indebtedness, new liens, declaration or payment of dividends,
sales of assets, acquisitions, loans, investments, capital expenditures and
compliance with the Company's operating budget. Payment under the DIP Credit
Agreement may be accelerated following certain events of default including, but
not limited to, dismissal of any of the Chapter 11 proceedings or conversion to
Chapter 7 of the United States Bankruptcy Code, appointment of a trustee or
examiner with enlarged powers, failure to make payments when due, noncompliance
with covenants, breaches of representations and warranties, failure to confirm a
plan of reorganization within 120 days of the commencement of the Chapter 11
case, the expiration or termination of the Debtors' exclusive right to file a
plan of reorganization, or entry of any order permitting holders of security
interests to foreclose on any of the Debtors' assets which have an aggregate
value in excess of $0.5 million. The DIP Credit Agreement matures on April 5,
2005.

The Company's Plan of Reorganization, which implements the Financial
Restructuring, was confirmed by the Bankruptcy Court on November 8, 2004. It is
anticipated that it will be consummated on or about November 18, 2004, subject
to obtaining certain regulatory approvals and the closing of a new revolving
credit facility. During the restructuring process, the Company has continued to
pay all accrued and accruing interest on its existing senior debt and to make
all scheduled swap payments, as well as all interest payments on the DIP
facility. On October 7, 2004, the Company paid $7.9 million of accrued interest
on its senior credit facility and interest rate swap.

If the Financial Restructuring is completed as currently anticipated, the
Company's balance sheet may be materially impacted, its debt will be
significantly reduced and its liquidity will be improved. The Company expects to
implement fresh start accounting upon emergence from the Financial
Restructuring, requiring the Company to record its assets and liabilities at
fair value, which may vary materially from the carrying value as of September
30, 2004.

The Company's net operating loss carryforwards, which were subject to annual use
limitations, may be significantly reduced as a result of the Financial
Restructuring. Furthermore, other tax attributes, including the tax basis of
certain assets, could also be reduced as a result of the cancellation of
indebtedness as part of the Financial Restructuring. In addition, Section 382 of
the Internal Revenue Code of 1986, which generally applies after a more than 50
percentage point ownership change has occurred, may impose other limitations on
the annual utilization of any remaining net operating losses. The Company
believes that it will experience such an ownership change as a result of the
anticipated completion of its Financial Restructuring. However, because the
Company will be under the jurisdiction of the Bankruptcy Court under Chapter 11
at the time of the ownership change, various alternatives pertaining to the
application of Section 382 are available. At this time, the Company has not yet
determined the full impact of all limitations.

The Company's ability to function as a going concern after the implementation of
the Financial Restructuring will depend on it obtaining and retaining a
significant number of customers, generating significant and sustained growth in
its cash flows from operating activities, and managing its costs and capital
expenditures to be able to meet its reduced debt service obligations. The
Company's revenue and

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costs are dependent upon some factors that are not entirely within its control,
including regulatory changes, changes in technology, and increased competition.
Due to the uncertainty of these factors, actual revenue and costs may vary from
expected amounts, possibly to a material degree, and such variations could
affect the Company's future funding requirements. Based on its current financial
condition, the Company may need to raise additional capital or obtain additional
financing in order to continue to operate its business. Additional financing may
also be required in response to changing conditions within the industry or
unanticipated competitive pressures. There can be no assurance that the Company
would be successful in raising additional capital or obtaining additional
financing on favorable terms or at all.

NOTE 3. STOCK OPTION PLANS

In accordance with Statement of Financial Accounting Standards ("SFAS") No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure," the
Company adopted the financial statement measurement and recognition provisions
of SFAS No. 123, "Accounting for Stock-Based Compensation," effective January 1,
2003. Under SFAS No. 123, on a prospective basis, the Company recognizes
compensation expense for the fair value of all stock options granted after
December 31, 2002, over the vesting period of the options. For stock options
granted prior to December 31, 2002, the Company accounts for stock based
compensation issued to its employees in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees."

The Company granted no stock options during the three month period ended
September 30, 2004. During the three month periods ended September 30, 2004 and
2003, the Company recorded $0.1 million of compensation expense for the fair
value of options previously granted. During the nine month periods ended
September 30, 2004 and 2003, the Company recorded $0.3 million and $0.8 million
of compensation expense for the fair value of options previously granted,
respectively.

Had compensation expense been determined based on the fair value of the options
at the grant dates for awards granted prior to December 31, 2002 consistent with
the method prescribed in SFAS No. 123, the Company's net loss and net loss per
share would have increased to the pro forma amounts indicated below (in
thousands, except per share data):

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For purposes of the pro forma disclosures above, the fair value of each option
grant is estimated on the date of the grant using the Black-Scholes
option-pricing model and the following weighted average assumptions:

The weighted average fair value of options granted during the nine-month periods
ended September 30, 2004 and 2003 was $0.29 and $0.25, respectively.

Basic and diluted loss per common share for all periods presented was computed
by dividing the net loss attributable to common stockholders by the weighted
average outstanding common shares for the period. The Company had options and
warrants to purchase 8,793,307 and 6,969,643 shares outstanding at September 30,
2004 and 2003, respectively, that were not included in the calculation of
diluted loss per common share because the effect would be anti-dilutive. It is
expected that the rights of the Company's existing holders of options and
warrants to purchase the Company's common stock will be extinguished in
connection with the Financial Restructuring and that the holders of such
securities would not receive any recovery. See Note 2.

NOTE 4. NEW ACCOUNTING PRONOUNCEMENT

At its March 31, 2004 meeting, the Emerging Issues Task Force ratified its
consensus in EITF No. 03-16, "Accounting for Investments in Limited Liability
Companies" ("EITF 03-16"). EITF 03-16 requires companies to evaluate whether or
not their investments in limited liability companies (LLCs) should be accounted
for using the equity method of accounting. The Task Force confirmed its previous
conclusion that LLCs that have separate ownership accounts for each investor
should be accounted for like investments in partnerships. This conclusion is
based on the fact that the investor's separate account is its claim on the
long-term appreciation in the net assets of the LLC similar to a partner's
capital account. Investors in partnerships have used a lower threshold for
determining whether they should record an investment using the equity method
(under SOP No. 78-9, Accounting for Investments in Real Estate Ventures) than
allowed under APB Opinion No. 18. The consensus must be applied in the first
period beginning after June 15, 2004. The Company has an investment in a limited
liability company, which is required to be accounted for using the equity
method. Effective July 1, 2004, the Company adopted the provisions of EITF 03-16
and reduced its carrying value as recorded in other assets in the consolidated
balance sheet in the LLC investment and recorded a cumulative effect of a change
in accounting principle in the amount of $1.5 million. This amount was
calculated based on the Company's share (8.3%) of the net assets of the LLC as
of July 1, 2004 compared to the cost basis carrying value at that date.

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The following presents the Company's net loss per share as if EITF 03-16 had
been applied retroactively for the periods presented:

NOTE 5. PROPERTY AND EQUIPMENT

Property and equipment, at cost, consisted of the following (in thousands):

Depreciation expense, including amortization of IRUs, amounted to $12.5 million
and $12.7 million for the three months ended September 30, 2004 and September
30, 2003, respectively, and $38.3 million and $42.0 million for the nine months
ended September 30, 2004 and September 30, 2003, respectively.

Refer to Notes 2 and 15 regarding the potential impact of the Financial
Restructuring on the Company's property and equipment.

During September 2004, the Company committed to a plan to exit certain of its
leased locations throughout its market footprint as discussed in Note 11. In
conjunction with the plan, the Company disposed of $3.2 million in unrecoverable
leasehold improvements and office and computer equipment.

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Assets held for future use are directly related to the recovery of switch and
collocation equipment from consolidations within certain markets that are
expected to be redeployed throughout the Company's footprint.

In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company has evaluated all of their long-lived assets for
impairment as of September 30, 2004. When the carrying value of an asset exceeds
the undiscounted cash flows directly related to it, there is an indication of
impairment. The impairment loss, if any, is recognized as the amount by which
the asset's carrying value exceeds its fair value. No such impairment losses
under the SFAS No. 144 standard were recorded as of September 30, 2004. If the
Financial Restructuring (see Note 2) is completed as currently anticipated, the
Company's balance sheet may be materially impacted. The Company expects to
implement fresh start accounting under SOP 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code", upon emergence from the
Financial Restructuring, requiring the Company to record its assets and
liabilities at fair value, which may vary materially from the carrying value as
of September 30, 2004.

NOTE 6. INTANGIBLE ASSETS

The Company accounts for certain intangible assets with finite lives in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." (Refer to
Notes 2 and 15 regarding the potential impact of the Financial Restructuring on
the Company's intangible assets.) The following schedule sets forth the major
classes of intangible assets held by the Company (in thousands):

The Company continues to amortize its intangible assets that have finite lives.
The estimated amortization expense on customer relationships, which have an
estimated life of five years, is as follows for the following fiscal periods (in
thousands):

October to December, 2004...................................... $ 2,570
2005........................................................... 6,027
2006........................................................... 370
2007........................................................... 109

Amortization expense relating to customer relationships was $2.7 million for
each of the three month periods ended September 30, 2004 and 2003, respectively,
and was $8.0 million and $8.1 million for the nine month periods ended September
30, 2004 and 2003, respectively.

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NOTE 7. ACCRUED EXPENSES

Accrued expenses consisted of the following (in thousands):

NOTE 8. DEBT

Long-term debt outstanding consists of the following (in thousands):

Included in the subordinated notes is a discount on the notes of $1.7 million
and $2.2 million as of September 30, 2004 and December 31, 2003, respectively.
Included in the Term C loan is a discount on the notes of $3.2 million and $3.6
million as of September 30, 2004 and December 31, 2003, respectively, and
payable in-kind ("PIK") interest which accreted to principal of $5.2 million and
$4.3 million as of September 30, 2004 and December 31, 2003, respectively.

The discount on the subordinated notes is being amortized over its nine-year
term. For each of the three month periods ended September 30, 2004 and 2003,
$0.2 million of the discount was amortized, respectively. For the nine month
periods ended September 30, 2004 and 2003, $0.5 million and $0.4 million of the
discount was amortized, respectively. The discount on the Term C loan is being
amortized over its seven and one-half year term. For each of the three month
periods ended September 30, 2004 and 2003, $0.1 million of the discount on the
Term C loan was amortized, respectively. For each of the nine month periods
ended September 30, 2004 and 2003, $0.4 million of the discount on the Term C
loan was amortized, respectively.

As of September 30, 2004, the Company had principal borrowings of $245.5 million
in subordinated notes, excluding the discount of $1.7 million and PIK interest
of $12.6 million that had accrued but not accreted to principal. Interest on the
subordinated notes is fixed at 13% per annum and accretes to the

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principal semi-annually until November 2006. Thereafter interest will be payable
quarterly, in cash, based on LIBOR plus an applicable margin. During the nine
months ended September 30, 2004, $15.1 million in PIK interest accreted to
principal. The subordinated notes mature on November 9, 2010.

As of September 30, 2004, the maximum borrowings under the Term A loan, Term B
loan, Term C loan, Term D loan, revolver loan, and the subordinated notes were
all outstanding. At September 30, 2004, $279.1 million was variable rate debt
and $370.5 million was fixed rate debt, including variable rate debt fixed by an
interest rate swap agreement. At September 30, 2004, the weighted average
floating interest rate and the weighted average fixed swapped interest rate were
5.95% and 12.53%, respectively. The weighted average floating interest rate and
the weighted average fixed swapped interest rate at September 30, 2003 were
5.53% and 11.37%, respectively.

The Company's Third Amended and Restated Credit Agreement ("Credit Agreement")
provides the Company with the following borrowing limits, maturities and
interest rates (in thousands):

* The applicable margin is determined by a grid tied to the
Company's leverage ratio. Initially, the applicable margin is
4.0% if the LIBOR rate is used, or 3.0% if the Base Rate is
used.

** Interest on the Term C loan accrued to principal through March
31, 2004, and thereafter is payable monthly.

Borrowings under the Credit Agreement are secured by substantially all of the
assets of the Company. The Credit Agreement contains certain covenants that are
customary for credit facilities of this nature, all of which are defined in the
Credit Agreement. These covenants, as amended, require the Company to maintain
an aggregate minimum amount of cash and committed financing of $10.0 million
through May 10, 2004, $6.0 million from May 11, 2004 through August 31, 2004,
$4.0 million from September 1, 2004 through September 14, 2004 and $3.5 million
from September 15, 2004 through November 15, 2004, impose limits on its capital
expenditures that vary annually, and require it to maintain certain leverage,
fixed charges and interest coverage ratios as described in the Credit Agreement.
A default in the observance of these covenants could cause the lenders to
declare the principal and interest outstanding at that time to be payable
immediately. As of September 30, 2004, the Company was not in compliance with
the leverage, fixed charges and interest coverage ratios under its senior credit
facility.

On May 12, 2004, the Company and the lenders under the Credit Agreement entered
into the Third Amendment. Pursuant to the Third Amendment, the covenant
previously obligating the Company to maintain an aggregate minimum amount of
cash and committed financing of $10.0 million during the period from May 11,
2004 through September 30, 2004 was amended to require the Company to maintain
an aggregate minimum amount of cash and committed financing of $6.0 million
during the period from May 11, 2004 through November 15, 2004. The Third
Amendment does not affect the Company's other financial covenants to maintain
certain leverage, fixed charges and interest coverage

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ratios, which became effective on September 30, 2004. The Third Amendment also
incorporated certain clarifying and ministerial changes to the Credit Agreement.

On June 30, 2004, the Company and the lenders under the Credit Agreement entered
into the Standstill Agreement and Conditional Amendment to the Credit Agreement
(the "First Standstill Agreement") that deferred the Company's obligation to
make certain principal payments in the aggregate amount of $3.1 million from
June 30, 2004 to July 30, 2004.

On July 30, 2004, the Company and its lenders entered into a Second Standstill
Agreement and Conditional Amendment to the Credit Agreement (the "Second
Standstill Agreement") that extended the deferment of the obligation to make
certain principal payments in the aggregate amount of $3.1 million and deferred
interest payments of $1.9 million due from July 30, 2004 to August 30, 2004.

On August 30, 2004, the Company and its lenders executed a Third Standstill
Agreement and Conditional Amendment to the Credit Agreement (the "Third
Standstill Agreement") that extended the deferment of the obligation to make
certain principal payments of $3.1 million and deferred interest payments of
$4.1 million to September 30, 2004. Under the Third Standstill Agreement, the
lenders also agreed not to exercise any remedies resulting from the Company's
failure to make certain interest and principal payments due on July 30, 2004 and
August 30, 2004 under the Credit Agreement. The Third Standstill Agreement also
amended the minimum cash covenants under the Credit Agreement. The covenants, as
amended, require the Company to maintain an aggregate minimum amount of cash and
committed financing of $6.0 million from May 11, 2004 through August 31, 2004,
$4.0 million from September 1, 2004 through September 14, 2004, and $3.5 million
from September 15, 2004 through November 15, 2004.

In conjunction with the execution of the Second and Third Standstill Agreements,
the Company and certain holders of the Subordinated Notes entered into a First
and Second Subordinated Notes Waiver and Agreements (the "Waiver Agreements").
Under the Waiver Agreements, the Subordinated Note lenders agreed to waive any
default or event of default under the Subordinated Notes that resulted from the
Company's failure to make the required interest and principal payments under the
Credit Agreement. The Waiver Agreements did not amend any other events that
could constitute a default or event of default under the Subordinated Notes. As
a result of these events, the Company's long-term debt has been classified as
current in the consolidated balance sheet as of September 30, 2004. As a result
of the Chapter 11 filing, this debt has been accelerated. (Refer to Note 2 for
further details.)

On October 5, 2004, the Company entered into the DIP Credit Agreement, with
General Electric Capital Corporation, as agent and the lenders from time to time
party to the DIP Credit Agreement. The DIP Credit Agreement, which received
final approval by the Bankruptcy Court on October 25, 2004, provides for a $20.0
million commitment of DIP financing to fund the Company's working capital
requirements during the Chapter 11 proceedings and matures on April 5, 2005. The
interest rate on the DIP financing is 7.75%. The DIP Credit Agreement also
contains certain financial and other covenants as discussed in Note 2 to the
financial statements.

NOTE 9. DERIVATIVE INSTRUMENTS

The Company accounts for its derivative instruments in accordance with SFAS No.
133, as amended, which requires that all derivative financial instruments, such
as interest rate swap agreements, be recognized in the financial statements and
measured at fair value regardless of the purpose or intent for holding them.

The Company has used derivative instruments to manage its interest rate risk.
Interest rate swaps were employed as a requirement under the Company's Second
Amended and Restated Credit Agreement. The Third Amended and Restated Credit
Agreement does not have such a requirement. The Credit Agreement does prohibit
the Company from entering into any new interest rate swap, collar, cap, floor,

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or forward rate agreements without the prior written consent of the lenders. The
interest differential to be paid or received under the interest rate swap
agreement is recognized over the life of the related debt and is included in
interest expense or income.

At September 30, 2004, the Company had an interest rate swap agreement with a
notional principal amount of $125.0 million expiring in February 2006. The
interest rate swap agreement is based on the three-month LIBOR, which is fixed
at 6.94%. Approximately 31% of the underlying senior credit facility debt is
being hedged with this interest rate swap agreement. Credit risk associated with
nonperformance by counterparties is mitigated by using major financial
institutions with high credit ratings.

On August 9, 2004, the Company entered into an amendment and waiver to the
interest rate swap agreement with the counterparty under the interest rate swap
agreement pursuant to which a payment of approximately $1.8 million due to be
paid to the counterparty on August 9, 2004 was deferred until September 30, 2004
or such earlier date on which the Company obtains DIP financing in connection
with the proposed Financial Restructuring (Note 2). In the amendment and waiver,
the counterparty also waived certain defaults under the interest rate swap
agreement until September 30, 2004. The Company had not entered into DIP
financing by September 30, 2004 and did not make the required payment by such
date. As a result of this event, the interest rate swap liability has been
classified as current in the consolidated balance sheet as of September 30,
2004. The interest due of $1.8 million was subsequently paid on October 7, 2004,
bringing the Company current with payments due under the interest rate swap
agreement.

The Company assesses the fair value of its interest rate swap on an ongoing
basis in accordance with SFAS No. 133 to determine if it is maintaining its
ability to be a highly effective cash flow hedge and remain eligible for cash
flow hedge accounting. If this assessment yields results that indicate that the
swap is no longer a highly effective cash flow hedge, the derivative is adjusted
to its fair value at the time of assessment and is no longer eligible for cash
flow hedge accounting. Prior to the three months ended September 30, 2004, the
fair value of the interest rate swap agreement, designated and effective as a
cash flow hedging instrument, was included in accumulated other comprehensive
loss within stockholders' deficit on the balance sheet. The Company determined
as of September 30, 2004 that because the underlying debt that the swap hedged
would be cancelled as a result of the Company's Financial Restructuring, the
swap was no longer a highly effective cash flow hedge as the future interest
payments on the underlying debt will no longer probable of occurring. The fair
value of the interest rate swap of $8.3 million was reclassified from
accumulated comprehensive income and recorded for the three months ended
September 30, 2004 in the income statement as additional interest expense. The
fair value of the hedge was a $13.5 million liability as of December 31, 2003.
The fair value of the interest rate swap agreement is estimated based on quotes
from a broker and represents the estimated amount that the Company would expect
to pay to terminate the agreement at each such date.

NOTE 10. COMPREHENSIVE LOSS

Prior to September 30, 2004, the fair value of the interest rate swap agreement
had been included in accumulated other comprehensive loss in stockholders'
deficit on the consolidated balance sheet and the change in the fair value of
the interest rate swap agreement was the only component of the other
comprehensive loss. For the three months ended September 30, 2004, the Company's
comprehensive loss was comprised of the Company's net loss and $1.0 million
related to the fair value of the interest rate swap. For the three months ended
September 30, 2003, the Company's comprehensive loss was comprised of the
Company's net loss and $2.1 million related to the fair value of the interest
rate swap. Comprehensive loss for the three month periods ended September 30,
2004 and 2003 was $56.8 million and $33.1 million, respectively. Comprehensive
loss for the nine month periods ended September 30, 2004 and 2003 was $137.8
million and $117.2 million, respectively. For the nine months ended September
30, 2004, the Company's comprehensive loss was comprised of the Company's net
loss and $5.2 million related to the fair value of the interest rate swap. For
the nine months ended September 30,

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2003, the Company's comprehensive loss was comprised of the Company's net loss
and $3.6 million related to the fair value of the interest rate swap.

NOTE 11. RESTRUCTURING COSTS

On September 23, 2004, the Company implemented an operational restructuring plan
that includes the reduction of costs and improvements in efficiency in
back-office and sales operations necessitating a reduction in workforce. On that
date, the Company announced its reduction in workforce by 193. All affected
positions were notified of the plan and termination benefits for these positions
are included in the restructuring costs for the three and nine months ended
September 30, 2004. The Company expects cost savings of $1.0 million per month
related to salaries and benefits as a result of these actions.

During September 2004, the Company negotiated lease terminations with several of
its landlords. Included in these terminations was the sale to the landlords of
certain assets located within the leased locations. Both the lease termination
costs and losses on the asset sales are included in the restructuring costs for
the three and nine months ended September 30, 2004. In connection with this
plan, the Company recorded restructuring costs of approximately $1.2 million for
lease terminations, $0.8 million for employee termination benefits, and $0.4
million for losses on assets sold related to lease contract terminations. The
Company anticipates incurring additional charges under its restructuring as it
consolidates its sales and network locations.

The Company also implemented an operational restructuring plan in September 2002
(the "2002 Restructuring") and in conjunction with the plan recorded
restructuring costs of $5.3 million, comprised of employee termination benefits
of $0.6 million, contractual lease obligations of $3.4 million and network
facility costs of $1.3 million. A portion of the 2002 Restructuring plan was
modified in February 2003. At that time, the Company revised the restructuring
costs for $0.1 million in termination benefits and other network facility costs
that became known during the first quarter of 2003 and reversed approximately
$0.7 million in restructuring costs related to certain collocation sites. During
September 2004, the Company again modified a portion of the 2002 Restructuring
plan when it determined that $0.5 million in accrued lease costs and $0.3
million in network facility termination costs would not be incurred as a result
of the actions taken in September 2004, and reversed the charges.

At September 30, 2004, approximately $1.7 million of the total restructuring
costs recognized had been paid, and it is anticipated that the remaining charges
will be liquidated within the next calendar year, except for contractual lease
obligations of $1.9 million that extend beyond one year and are included in
other long-term liabilities.

The following table highlights the cumulative restructuring activities of the
operational restructuring and 2002 Restructuring through
September 30, 2004 (in thousands):

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NOTE 12. SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES AND CASH
FLOW INFORMATION

Supplemental disclosures of non-cash investing activities and cash flow
information for the nine months ended September 30 (in thousands):

NOTE 13. COMMITMENTS AND CONTINGENCIES

On November 20, 2001, the Company and three of its officers were named in a
complaint filed in the United States District Court of the Southern District of
New York on behalf of a class of persons consisting of certain purchasers of the
Company's common stock in its initial public offering which was completed on
February 23, 2000. The complaint seeks damages based on allegations that the
Company's Registration Statement and Prospectus relating to the offering
contained material misstatements and/or omissions regarding the compensation
received by the underwriters of the offering and certain transactions engaged in
by the underwriters. This case, which has been consolidated with more than 300
other cases against other companies involving similar allegations, also names
six underwriters of the Company's offering and the offerings of other issuers,
and alleges that the underwriters engaged in a pattern of conduct to extract
inflated commissions in excess of the amounts disclosed in offering materials
and manipulated the post-offering markets in connection with hundreds of
offerings by engaging in stabilizing transactions and issuing misleading and
fraudulent analyst and research reports. The complaint alleges that the Company
is strictly liable under Section 11 of the Securities Act of 1933 because Item
508 of Regulation S-K allegedly required the disclosure of commissions to be
paid to underwriters and of stabilizing transactions, and that the Company and
its officers acted with scienter, or recklessness, in failing to disclose these
facts, in violation of Section 10(b) of the Securities Exchange Act and Rule
10b-5 promulgated thereunder. The claims against the individual defendants were
dismissed without prejudice, by an agreement with the plaintiffs. After the
court denied motions to dismiss the cases, the parties entered into a mediation
which has resulted in the execution of a Memorandum of Understanding by the
Company and approximately 300 other issuers who are the subject of similar
litigation. The settlement contemplated by the Memorandum of Understanding will
not involve any payments by the Company and would terminate only the claims by
the plaintiffs against issuers. The claims against the underwriters will
continue, and the Company will be required to participate in limited discovery
related to those claims.

From time to time, the Company is involved in legal proceedings arising in the
ordinary course of business. Other than as described above, the Company believes
there is no litigation pending against it that could have, individually or in
the aggregate, a material adverse effect on its financial position, results of
operations or cash flows.

NOTE 14. INCOME TAXES

The Company's net operating loss carryforwards, which were subject to annual use
limitations, may be significantly reduced as a result of the Financial
Restructuring. Furthermore, other tax attributes, including the tax basis of
certain assets, could also be reduced as a result of the cancellation of
indebtedness as part of the Financial Restructuring. In addition, Section 382 of
the Internal Revenue

-18-

Code of 1986, which generally applies after a more than 50 percentage point
ownership change has occurred, may impose other limitations on the annual
utilization of any remaining net operating losses. The Company believes that it
will experience such an ownership change as a result of the implementation of
its Financial Restructuring. However, because the Company will be under the
jurisdiction of a court in a case under Chapter 11 of the United States
Bankruptcy Code at the time of the ownership change, various alternatives
pertaining to the application of Section 382 are available. At this time, the
Company has not yet determined the full impact of all limitations.

NOTE 15. SUBSEQUENT EVENTS

On October 5, 2004, the Company filed voluntary petitions in the Bankruptcy
Court seeking relief under the provisions of Chapter 11. The Company continues
to operate its business as debtors-in-possession under the jurisdiction of the
Bankruptcy Court and in accordance with applicable provisions of Chapter 11 and
the orders of the Bankruptcy Court. In addition, the Company entered into the
DIP Credit Agreement that provides for a $20.0 million commitment of DIP
financing to fund the Company's working capital requirements during the Chapter
11 proceedings. The DIP Credit Agreement received final approval by the
Bankruptcy Court on October 25, 2004. The Company's Plan of Reorganization,
which implements the Financial Restructuring, was confirmed by the Bankruptcy
Court on November 8, 2004. It is anticipated that it will be consummated on or
about November 18, 2004, subject to obtaining certain regulatory approvals and
the closing of a new revolving credit facility to replace the financing under
the DIP Credit Agreement. See Note 2 for further details.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS

Certain statements contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations", and elsewhere in this Form 10-Q
and in other filings with the Securities and Exchange Commission ("SEC")
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995, and we intend that such
forward-looking statements be subject to the "safe harbor" provisions created
thereby. The words "believes", "expects", "estimates", "anticipates", "will",
"will be", "could", "may" and "plans" and the negative or other similar words or
expressions identify forward-looking statements made by or on behalf of the
Company.

These forward-looking statements are subject to many uncertainties and factors
that may cause our actual results to be materially different from any future
results expressed or implied by such forward-looking statements. Examples of
such uncertainties and factors include, but are not limited to:

o The ability to effect a Financial Restructuring described under the
caption "Chapter 11 Proceeding /Going Concern Matter" below that will
significantly reduce the amount of our indebtedness,

o Compliance with covenants for borrowings under our debtors-in-
possession ("DIP") Credit Agreement, the credit facility to be
entered into as part of the Financial Restructuring and any
subsequently negotiated financing and the willingness of the lenders
thereunder to cooperate with us in connection with any non-compliance,

o The impact that the Financial Restructuring may have on our business,

o Availability of additional capital or financing,

o Availability of significant operating cash flows,

o Continued availability of regulatory approvals,

o The number of potential customers and average revenue for such
customers in a market,

o The existence or continuation of strategic alliances or relationships,

o Technological, regulatory or other developments in our business,

o Changes in the competitive climate in which we operate, and

o The emergence of future opportunities.

All of these could cause our actual results and experiences to vary
significantly from our current business plan and to differ materially from
anticipated results and expectations expressed in the forward-looking statements
contained herein. These and other applicable risks are summarized under the
caption "Risk Factors" and elsewhere in our Annual Report on Form 10-K, filed on
March 30, 2004. You should consider all of our written and oral forward-looking
statements only in light of such cautionary statements. You should not place
undue reliance on these forward-looking statements and you should understand
that they represent management's view only as of the dates we make them.

OVERVIEW

We are an integrated communications provider offering facilities-based voice and
data telecommunications services. We market and provide these services to small
and medium-sized businesses in 29 second and third tier markets in 12 states in
the northeastern and midwestern United States. Our services include:

o local exchange and long distance service; and

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o high-speed data and Internet services.

Our principal competitors are incumbent local exchange carriers, such as the
regional Bell operating companies, other integrated communications providers,
and voice over internet protocol providers.

We seek to become the leading integrated communications provider in each of our
markets by offering a single source for competitively priced, high quality,
customized telecommunications services. A key element of our strategy has been
to be one of the first integrated communications providers to provide
comprehensive network coverage in each of the markets we serve. We achieve
comprehensive coverage in the markets we serve by installing both voice and data
equipment in multiple established telephone company central offices, a process
known as collocation. All of our collocations also include equipment to provide
digital subscriber loop ("DSL") services.

We have connected approximately 95% of our clients directly to our own switches,
which allows us to more efficiently route traffic, ensure quality of service and
control costs. Our networks reach approximately 5.7 million business lines,
which constitute approximately 72% of the estimated business lines in the
markets we serve. While our network allows us to reach this number of business
lines, the number of business lines that we actually service will depend on our
ability to sell telecommunications services to customers and our success in
winning market share from our competitors. We have no current plans to expand
into additional markets.

We evaluate the growth of our business by focusing on various operational data
in addition to financial data. Lines in service represent the lines sold that
are now being used by our clients subscribing to our services. On average, our
business clients have 5 lines. We plan to continue to focus primarily on small-
to medium-sized business clients.

The table below provides selected key operational data as of:

CHAPTER 11 PROCEEDING/GOING CONCERN MATTER

On October 5, 2004, we filed voluntary petitions in the United States Bankruptcy
Court for the Southern District of New York (the "Bankruptcy Court") seeking
relief under the provisions of Chapter 11 of the United States Bankruptcy Code
("Chapter 11"). We continue to operate our business as debtors-in-possession
under the jurisdiction of the Bankruptcy Court and in accordance with applicable
provisions of Chapter 11 and the orders of the Bankruptcy Court. Our financial
statements have been prepared on a going concern basis, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The report of independent accountants dated March 25, 2004
concerning our financial statements for the year ended December 31, 2003,
included in our annual report filed on Form 10-K, noted that we had suffered
recurring losses from operations and had a net capital deficiency that raised
substantial doubt about our ability to continue as a going concern.

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We had net losses applicable to common stockholders of $67.7 million and $35.2
million for the three months ended September 30, 2004 and September 30, 2003,
respectively. We had net losses applicable to common stockholders of $152.9
million for the nine months ended September 30, 2004 and $148.3 million and
$524.1 million for the years ended December 31, 2003 and 2002, respectively. At
September 30, 2004, we had $6.9 million in cash and cash equivalents and had
drawn all available funding under our senior credit facility. We generated
negative cash flows from both operating and investing activities during the
years ended December 31, 2003 and 2002. We had a total stockholders' deficit of
$781.9 million as of September 30, 2004. These factors raise substantial doubt
about our ability to continue as a going concern.

On July 30, 2004, August 30, 2004 and September 30, 2004, we failed to make
certain interest and principal payments in the aggregate amounts of $5.1
million, $2.1 million and $2.0 million, respectively, that were then due under
our senior credit facility. Such failures constituted events of default under
the senior credit facility and the subordinated notes and would permit our
obligations under the senior credit facility and the subordinated notes to be
declared to be immediately payable. The requisite majority of both the lenders
under the senior credit facility and the holders of the subordinated notes
entered into standstill agreements and, in the case of our subordinated notes,
waiver agreements on July 30, 2004 and August 30, 2004, subject to certain
conditions, pursuant to which they agreed not to take any action before
September 30, 2004 with respect to such default or events of default so as to
provide us with additional time to facilitate the negotiation and initiation of
the Financial Restructuring (as defined below). As a result of the events of
default, our long-term debt has been reclassified to short-term in the
consolidated balance sheet as of September 30, 2004.

On August 9, 2004, we entered into an amendment and waiver to the interest rate
swap agreement with the counterparty under the interest rate swap agreement
pursuant to which a payment of approximately $1.8 million due to be paid to the
counterparty on August 9, 2004 was deferred until September 30, 2004 or such
earlier date on which we obtain debtor-in-possession ("DIP") financing in
connection with the proposed Financial Restructuring (as defined below). In the
amendment and waiver the counterparty also waived certain defaults under the
interest rate swap agreement until September 30, 2004. The Company had not
entered into DIP financing by September 30, 2004 and did not make the required
payment by such date. As a result of this event, the interest rate swap
liability has been classified as current in the consolidated balance sheet as of
September 30, 2004. The interest due of $1.8 million was subsequently paid on
October 7, 2004, bringing us current with payments due under the interest rate
swap agreements.

On August 2, 2004, we announced that we reached an agreement in principle with
ad hoc committees of the lenders under our senior credit facility and the
holders of our subordinated notes to restructure and substantially reduce our
outstanding indebtedness (the "Financial Restructuring"). The Financial
Restructuring will consist of: (i) the conversion of approximately $404.0
million of outstanding debt under our senior credit facility into $175.0 million
of new senior secured term notes payable over six years and 90% of our
outstanding common stock following the Financial Restructuring; (ii) the
conversion of our approximately $252.0 million of outstanding subordinated notes
into the remaining 10% of such common stock and into two series of seven-year
warrants to purchase additional shares of common stock following the Financial
Restructuring; and (iii) the establishment of a new revolving credit facility of
$30.0 million from a subset of the lenders under our senior credit facility to
provide for ongoing working capital requirements.

Upon completion of the Financial Restructuring, certain restricted stock and/or
stock option grants are expected to be made to our management in amounts and
subject to conditions to be determined. The rights of our existing preferred and
common stockholders and the existing holders of options and warrants to purchase
our common stock will be extinguished in connection with the Financial
Restructuring and the holders of such securities will not receive any recovery.
The rights of our vendors will not be impaired by the Financial Restructuring.

-22-

On August 30, 2004, we entered into a Lock Up Agreement with certain of the our
existing lenders pursuant to which the lenders agreed to vote in favor of and
support our proposed Financial Restructuring plan including, among other things,
our filing of the plan under Chapter 11 of the United States Bankruptcy Code
("Chapter 11"), subject to the terms and conditions contained in the Lock Up
Agreement.

On September 15, 2004, we commenced a solicitation of consents in support of our
Financial Restructuring, which is in the form of a "prepackaged" proceeding
under Chapter 11. All of the lenders under our senior credit facility and the
holders of our subordinated notes voted to approve our Financial Restructuring.

On October 5, 2004, we filed voluntary petitions in the United States Bankruptcy
Court for the Southern District of New York (the "Bankruptcy Court") seeking
relief under the provisions of Chapter 11. We continue to operate our business
as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in
accordance with applicable provisions of Chapter 11 and the orders of the
Bankruptcy Court. In addition, we entered into a Senior Secured, Super-Priority
DIP Credit Agreement (the "DIP Credit Agreement"), with General Electric Capital
Corporation, as agent and lender and the lenders from time to time party
thereto. Certain of our existing lenders are also lenders under the DIP Credit
Agreement. The DIP Credit Agreement received final approval by the Bankruptcy
Court on October 25, 2004 and provides for a $20.0 million commitment of DIP
financing to fund our working capital requirements during the Chapter 11
proceedings.

The DIP Credit Agreement contains certain financial and other covenants
including, but not limited to, affirmative and negative covenants with respect
to additional indebtedness, new liens, declaration or payment of dividends,
sales of assets, acquisitions, loans, investments, capital expenditures and
compliance with the Company's operating budget. Payment under the DIP Credit
Agreement may be accelerated following certain events of default including, but
not limited to, dismissal of any of the Chapter 11 proceedings or conversion to
Chapter 7 of the United States Bankruptcy Code, appointment of a trustee or
examiner with enlarged powers, failure to make payments when due, noncompliance
with covenants, breaches of representations and warranties, failure to confirm a
plan of reorganization within 120 days of the commencement of the Chapter 11
proceeding, the expiration or termination of the Debtors' exclusive right to
file a plan of reorganization, or entry of any order permitting holders of
security interests to foreclose on any of the Debtors' assets which have an
aggregate value in excess of $0.5 million. The DIP Credit Agreement matures on
April 5, 2005.

The Company's Plan of Reorganization, which implements the Financial
Restructuring, was confirmed by the Bankruptcy Court on November 8, 2004. It is
anticipated that it will be consummated on or about November 18, 2004, subject
to obtaining certain regulatory approvals and the closing of the new revolving
credit facility. During the restructuring process we have continued to pay all
accrued and accruing interest on our existing senior debt and to make all
scheduled swap payments, as well as all interest payments on the DIP facility.
On October 7, 2004 we paid $7.9 million of accrued interest under the senior
credit facility and interest rate swap.

If the Financial Restructuring is completed as currently anticipated, our
balance sheet may be materially impacted, our debt will be significantly reduced
and our liquidity will be improved. We expect to implement fresh start
accounting under Statement of Position ("SOP") 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code", upon emergence from the
Financial Restructuring, requiring us to record our assets and liabilities at
fair value, which may vary materially from the carrying value as of September
30, 2004.

Our net operating loss carryforwards, which were subject to annual use
limitations, may be significantly reduced as a result of the Financial
Restructuring. Furthermore, other tax attributes, including the tax basis of
certain assets, could also be reduced as a result of the cancellation of
indebtedness as part of the Financial Restructuring. In addition, Section 382 of
the Internal Revenue Code of 1986, which generally applies after a more than 50
percentage point ownership change has occurred, may impose other

-23-

limitations on the annual utilization of any remaining net operating losses. We
believe that we will experience such an ownership change as a result of the
completion of our Financial Restructuring. However, because we will be under the
jurisdiction of the Bankruptcy Court under Chapter 11 at the time of the
ownership change, various alternatives pertaining to the application of Section
382 are available. At this time, we have not yet determined the full impact of
all limitations.

Our ability to function as a going concern after the completion of our Financial
Restructuring will depend on our obtaining and retaining a significant number of
customers, generating significant and sustained growth in our cash flows from
operating activities, and managing our costs and capital expenditures to be able
to meet our reduced debt service obligations. Our ability to do so will depend
on a number of uncertainties and factors outside our control, including those
previously described.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 AS COMPARED
TO THE THREE MONTHS ENDED SEPTEMBER 30, 2003

EBITDA

In this filing, we include references to and analyses of earnings before
interest, income taxes, depreciation and amortization ("EBITDA") amounts that
are not calculated and presented in accordance with accounting principles
generally accepted in the United States of America ("GAAP"). EBITDA is used by
management and certain investors as an indicator of a company's liquidity and
should not be substituted for cash flow provided by/(used in) operations
determined in accordance with GAAP, the most directly comparable financial
measure under GAAP. Regulation G, "Conditions for Use of Non-GAAP Financial
Measures," and other provisions of the Securities Exchange Act of 1934 define
and prescribe the conditions for use of certain non-GAAP financial information
in SEC filings.

EBITDA highlights trends that may not otherwise be apparent when relying solely
on GAAP financial measures, because this non-GAAP financial measure eliminates
from net cash used in operating activities financial items that have less
bearing on our liquidity. Management believes that the presentation of EBITDA is
meaningful because it is an indicator of our ability to service existing debt,
to sustain potential increases in debt, and to satisfy capital requirements.
EBITDA is also used as a factor in the calculation of management's variable
compensation.

Investors or potential investors are urged to read our consolidated financial
statements and notes thereto in conjunction with their consideration of our
EBITDA. They should not rely solely on a single financial measure to evaluate
our business. EBITDA information is presented for the limited purpose of
supplementing our GAAP results to provide a more complete understanding of the
factors and trends affecting our business. EBITDA as presented may not be
comparable to other similarly titled measures used by other companies.

-24-

The following table shows the differences between our net cash provided by
operating activities, as determined in accordance with GAAP, and our EBITDA for
the three months ended (in thousands):

During the three months ended September 30, 2004, our EBITDA was impacted by a
number of factors. We recorded an increase of $6.0 million in network cost
dispute reserve relating to outstanding disputes with certain of our network
providers.

Selling, general and administrative expenses increased due to increases in
professional services and salary and benefits expense. Professional services
increased $4.5 million for the three months ended September 30, 2004 as compared
to the three months ended September 30, 2003 primarily due to the engagement of
consultants and other advisors to guide and facilitate our efforts with respect
to our lenders. For the three months ended September 30, 2004, salary and
benefits expense increased approximately $2.8 million as compared to the three
months ended September 30, 2003. Included within salary and benefits expense for
the three months ended September 30, 2004 were withholding tax payments on
non-recourse executive loans, which had been impaired during the three months
ended June 30, 2004.

We had a loss on disposition of assets for $3.2 million primarily related to the
disposal of unrecoverable leasehold improvements and office and computer
equipment in connection with the negotiated lease terminations under our
operational restructuring described in Restructuring Costs below.

On September 23, 2004, we implemented an operational restructuring plan that
includes the reduction of costs and improvements in efficiency in back-office
and sales operations necessitating a reduction in workforce. On that date, we
announced a reduction in our workforce by 193. All affected positions were
notified of the plan and termination benefits for these positions are included
in the restructuring costs.

During September 2004, we negotiated lease terminations with several of our
landlords. Included in these terminations was the sale to the landlords of
certain assets located within the leased locations. Both the lease termination
costs and losses on the asset sales are included in the restructuring costs for
the three months ended September 30, 2004. In connection with this plan, we
recorded restructuring costs of approximately $1.2 million for lease
terminations, $0.8 million for

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employee termination benefits, and $0.4 million for losses on assets sold
related to lease contract terminations. We anticipate incurring additional
charges under the restructuring as we consolidate our sales and network
locations.

REVENUE

We generated $81.8 million in revenue for the three months ended September 30,
2004, a 1.2% increase as compared to revenue for the three months ended
September 30, 2003.

Revenue for the three months ended September 30, 2004 increased as compared to
the three months ended September 30, 2003 primarily as a result of the increase
in lines in service offset by reductions in access revenue and the loss of a
large wholesale customer. Our total lines in service increased from September
30, 2003 by approximately 7.1% to 550,831 lines at September 30, 2004. The
increase in revenue from having more lines in service was offset by a decrease
in access revenue attributable to reduced interstate per minute rates that we
charge other carriers as FCC mandated per minute rate reductions took effect in
June 2004. The loss of the wholesale customer negatively impacted revenue by
approximately $1.8 million for the three months ended September 30, 2004.
Average revenue per line for the three months ended September 30, 2004 decreased
by approximately 4.7% as compared to the three months ended September 30, 2003.
We expect total revenue to be relatively stable over the last quarter of 2004.
We expect per minute rate reductions for access and reciprocal compensation to
continue to occur annually.

Our churn rate for the three months ended September 30, 2004, of our
facilities-based business clients, was 1.4% per month. This compares to 1.3% per
month for the three months ended September 30, 2003. We seek to minimize churn
by providing superior client care, by offering a competitively priced portfolio
of local, long distance and Internet services, by signing a significant number
of clients to multi-year service agreements, and by focusing on offering our own
facilities-based services.

Network Costs

Network costs for the three months ended September 30, 2004 were $45.4 million,
representing a 16.8% increase from network costs of $38.8 million for the three
months ended September 30, 2003. Network costs as a percentage of total revenues
were 55.4% at September 30, 2004, an increase compared to 48.1% for the three
months ended September 30, 2003. This increase is directly attributable to an
increase of $6.0 million in network cost dispute reserve relating to outstanding
disputes with certain of our network providers. Since the announcement of our
Chapter 11 filing, we have received many more inquiries from our network
providers regarding our outstanding disputes. Based on that, and the current
status of those disputes, we expect to pay amounts in excess of what we had
accrued as of June 30, 2004, and have increased our accrual accordingly.

The improvements in network costs as a percentage of revenue reflects the
continuing benefits of our fiber network implementation and other network
optimization initiatives. These initiatives included least cost routing,
replacing leased capacity with alternative technologies and grooming and
capacity sizing of our network facilities. As a result, for the three months
ended September 30, 2004, our average cost per line, excluding increases in
network cost dispute reserve, declined approximately 4.7% as compared to the
three months ended September 30, 2003. These changes highlight the effectiveness
of our network optimization initiatives and the benefits of leasing fiber.
Amortization of the cost of assets under the capital leases for fiber is
included in depreciation and amortization expense which is not a component of
network costs.

Our network costs include:

o Leases of high-capacity digital lines that interconnect our network
with established telephone company networks;

o Leases of our inter-city network;

o Leases of local loop lines which connect our clients to our network;

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o Leased space in established telephone company central offices for
collocating our transmission equipment;

o Completion of local calls originated by our clients,

o Completion of originating (1+ calling) and terminating (inbound 800
calling) long distance calls by our clients, and

o Non-recurring costs for installing and disconnecting lines.

Fiber deployment provides the bandwidth necessary to support substantial
incremental growth and allows us to reduce network costs and enhance the quality
and reliability of our network, which strengthens our competitive position in
the markets we serve. We currently have operational intra-city fiber in 19 of
the markets that we serve. We plan to activate fiber in one additional market in
our footprint during early 2005. Our fiber network consists of 1,428 route miles
of operational intra-city fiber and 1,170 miles of operational inter-city fiber.

Our revenues exceeded our network costs by $36.5 million, or 44.6% of revenue,
for the three months ended September 30, 2004, as compared to $42.0 million, or
51.9% of revenue, for the three months ended September 30, 2003. We expect that
our revenue in excess of network costs, as a percentage of revenue and excluding
the increase in network cost dispute reserve, will remain relatively unchanged
as our projected revenue increases will be offset by additional per minute rate
reductions in access and reciprocal compensation.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses for the three months ended
September 30, 2004 were $40.6 million compared to $31.7 million for the three
months ended September 30, 2003. Excluding non-cash stock-based compensation
expense described below, the selling, general and administrative expenses
increased 28.2% from $31.6 million for the three months ended September 30, 2003
to $40.5 million for the three months ended September 30, 2004. Selling, general
and administrative expenses are expected to increase during the remaining fiscal
quarter of 2004 due to professional services expenses for consultants and other
advisors engaged to guide and facilitate our efforts with respect to our lenders
but partially offset by decreases mainly in salaries, benefits and commissions
resulting from the operational restructuring plan implemented in September 2004.

Our selling, general and administrative expenses include:

o Costs associated with sales and marketing, client care, billing,
corporate administration, personnel and network maintenance;

o Administrative overhead and office lease expense; and

o Bad debt expense.

Selling, general and administrative expenses, excluding non-cash stock-based
compensation charges, as a percentage of revenue, were 49.4% for the three
months ended September 30, 2004, as compared to 39.1% for the three months ended
September 30, 2003. The increase in selling, general and administrative expenses
from the three months ended September 30, 2003 resulted from increased salaries,
benefits, professional services and outside consulting. Professional services
increased $4.5 million for the three months ended September 30, 2004 as compared
to the three months ended September 30, 2003 primarily due to the engagement of
consultants and other advisors to guide and facilitate our efforts with respect
to our lenders. For the three months ended September 30, 2004, salary and
benefits expense increased approximately $2.8 million as compared to the three
months ended September 30, 2003. Included within salary and benefits expense for
the three months ended September 30, 2004 were withholding tax payments on
non-recourse executive loans, which had been impaired

-27-

during the three months ended June 30, 2004. We employed 1,201 individuals and
1,373 individuals at September 30, 2004 and September 30, 2003, respectively.
Our headcount was reduced approximately 14.0% late in September 2004 when we
implemented our operational restructuring plan which is more fully explained in
Restructuring (Credits)/Costs later in our discussion and analysis.

Also included in selling, general and administrative expenses for the three
months ended September 30, 2004, is non-cash stock-based compensation expense of
$0.1 million as compared to $0.1 million for the three months ended September
30, 2003. Compensation expense for the three months ended September 30, 2004 and
2003 includes the expense associated with our adoption of Statement of Financial
Accounting Standards ("SFAS") No. 148, under which we adopted the financial
statement measurement and recognition provisions of SFAS No. 123. Under SFAS No.
123, on a prospective basis, we recognize compensation expense for the fair
value of all stock options granted after December 31, 2002 over the vesting
period of the options.

RESTRUCTURING COSTS

On September 23, 2004, we implemented an operational restructuring plan that
includes the reduction of costs and improvements in efficiency in back-office
and sales operations necessitating a reduction in workforce. On that date, we
announced a reduction in our workforce by 193. All affected positions were
notified of the plan and termination benefits for these positions are included
in the restructuring costs for the three months ended September 30, 2004. We
expect cost savings of $1.0 million per month related to salaries and benefits
as a result of these actions.

During September 2004, we negotiated lease terminations with several of our
landlords. Included in these terminations was the sale to the landlords of
certain assets located within the leased locations. Both the lease termination
costs and losses on the asset sales are included in the restructuring costs for
the three months ended September 30, 2004. In connection with this plan, we
recorded restructuring costs of approximately $1.2 million for lease
terminations, $0.8 million for employee termination benefits, and $0.4 million
for losses on assets sold related to lease contract terminations. We anticipate
incurring additional charges under the restructuring as we consolidate our sales
and network locations.

We implemented an operational restructuring plan in September 2002 (the "2002
Restructuring") and modified such plan in February 2003 and again in September
2004, as described further below. The plan included restructuring costs for
employee termination benefits, contractual lease obligations and network
facility costs.

The following table highlights cumulative restructuring activities of the
operational restructuring and 2002 Restructuring through September 30,
2004 (in thousands):

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For the three months ended September 30, 2004, approximately $0.2 million of the
restructuring costs were paid and it is anticipated that the remaining charges
will be liquidated within the next calendar year, except for contractual lease
obligations of $1.9 million that extend beyond one year and are included in
other long-term liabilities.

During February 2003, we modified a portion of our 2002 Restructuring plan
related to reduced reliance on certain collocation sites. As we engaged in
restructuring activities in the first quarter of 2003, we were informed that
additional costs would be charged to us by the established telephone companies
in connection with the restructuring. Based on this new information, we reduced
the number of collocation sites that would be affected. As a result, we reversed
approximately $0.7 million in restructuring costs related to the collocation
sites. At the same time, we increased the restructuring accrual for $0.1 million
in termination benefits and other network facility costs that became known
during the three months ended March 31, 2003.

During September 2004, we again modified a portion of our 2002 Restructuring
plan when we determined that $0.5 million in accrued lease costs and $0.3
million in network facility termination costs would not be incurred as a result
of our actions taken in September 2004 and we reversed the charges.

LOSS ON DISPOSITION OF ASSETS

For the three months ended September 30, 2004, the loss on disposition of assets
was approximately $3.2 million as compared to a $154,000 loss for the three
month period ended September 30, 2003. The change in the loss on disposition of
assets was primarily the result of our operational restructuring detailed above.
We disposed of unrecoverable leasehold improvements and office and computer
equipment in connection with the negotiated lease terminations. We continue to
evaluate our assets held for use and may, from time to time, minimize our
investments in such assets.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization for the three months ended September 30, 2004 was
$15.2 million. This represents a 1.5% decrease from the three months ended
September 30, 2003. The decrease in depreciation expense as compared to the
three months ended September 30, 2003 was primarily related to certain assets
that became fully depreciated during three months ended September 30, 2003. Our
depreciation and amortization expense includes depreciation of switch related
equipment, non-recurring charges and equipment collocated in established
telephone company central offices, network infrastructure equipment, information
systems, furniture and fixtures, indefeasible rights to use fiber ("IRUs") and
amortization of the value of acquired customer relationships. We expect our
depreciation and amortization expense to remain consistent with the three months
ended September 30, 2004 for the remaining fiscal quarter of 2004.

INTEREST EXPENSE AND INCOME

Interest expense includes interest payments on borrowings under our senior
credit facility, non-cash interest expense on our subordinated notes,
amortization of deferred financing costs related to these facilities,
amortization of the discount on the subordinated notes and the Term C loan under
the senior credit facility, interest expense related to IRUs, and, since July 1,
2003, dividends on preferred stock. Interest expense on the subordinated notes
is payable-in-kind ("PIK") through November 2006.

Interest expense, net, for the three months ended September 30, 2004 and
September 30, 2003 was approximately $41.9 million and $30.0 million,
respectively. The increase in interest expense, net, from the three months ended
September 30, 2003 was attributable to an increase in interest expense of $1.4
million due to the impact of new borrowings in December 2003, increases in LIBOR
rates that impacted our borrowing rates, the compounding effect of PIK interest
on our subordinated debt, an increase in preferred stock accretion and dividends
on preferred stock and the reclassification of the fair value of our interest
rate swap of $8.3 million to interest expense as a result of it no longer being
eligible for effective

-29-

cash flow hedge accounting. We expect interest expense to increase over the next
three months due to anticipated increases in LIBOR rates that will impact our
borrowing rates. If the Financial Restructuring is completed as anticipated, we
expect our interest expense to decrease substantially because of the resulting
substantial reduction in our outstanding indebtedness and the extinguishment of
our outstanding preferred stock.

Cash interest expense is the interest expense that must be settled periodically
in cash as compared to the interest expense that accretes to principal. Cash
interest expense was $8.5 million for the three months ended September 30, 2004,
and $7.2 million for the three months ended September 30, 2003. The increase in
cash interest expense was the result of interest on the Term C loan of the
senior credit facility being settled in cash monthly beginning on April 30, 2004
and higher interest rates on our senior credit facility borrowings during the
three months ended September 30, 2004. Subject to the impact from the Financial
Restructuring, if implemented as planned, cash interest expense is expected to
increase for the remaining three month period in 2004 due to anticipated
increases in LIBOR rates that will impact our borrowing rates.

The non-cash accretion of and dividends on our preferred stock was $15.6 million
for the three months ended September 30, 2004. Non-cash accretion and dividends
on our preferred stock for the three months ended September 30, 2003 was $13.4
million. The changes were primarily driven by the increase in dividends on
preferred stock that result from the compounding effect of dividends that have
accreted.

INCOME TAXES

We did not generate any taxable income during the three months ended September
30, 2004 and 2003, and did not incur any income tax liability as a result. We do
not expect to generate taxable income during the remainder of 2004. As of
December 31, 2003, we had approximately $598.1 million in net operating loss
carryforwards for federal income tax purposes. Our net operating loss
carryforwards, which were subject to annual use limitations, may be
significantly reduced as a result of the Financial Restructuring. Furthermore,
other tax attributes, including the tax basis of certain assets, could also be
reduced as a result of the cancellation of indebtedness as part of our Financial
Restructuring. In addition, Section 382 of the Internal Revenue Code of 1986,
which generally applies after a more than 50 percentage point ownership change
has occurred, may impose other limitations on the annual utilization of any
remaining net operating losses. We believe that we will experience such an
ownership change as a result of the completion of our Financial Restructuring.
However, because we will be under the jurisdiction of a Bankruptcy Court in a
case under Chapter 11 at the time of the ownership change, various alternatives
pertaining to the application of Section 382 are available. At this time, we
have not yet determined the full impact of all limitations.

CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

During the three months ended September 30, 2004 we implemented the provisions
of Emerging Issues Task Force opinion EITF No. 03-16, "Accounting for
Investments in Limited Liability Companies" ("EITF 03-16"). EITF 03-16 requires
companies to evaluate whether or not their investments in limited liability
companies (LLCs) should be accounted for using the equity method of accounting.
We evaluated our investment in a limited liability company and determined that
it should be accounted for using the equity method. Therefore, we recorded a
cumulative effect of a change in accounting principle of $1.5 million to reflect
this change in accounting principle.

-30-

NET LOSS APPLICABLE TO COMMON STOCKHOLDERS

Our net loss applicable to common stockholders was $67.7 million and $35.2
million for the three months ended September 30, 2004 and September 30, 2003,
respectively. The change in net loss applicable to common stockholders was
attributable to the factors previously discussed.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AS COMPARED
TO THE NINE MONTHS ENDED SEPTEMBER 30, 2003

EBITDA

In this filing, we include references to and analyses of EBITDA amounts that are
not calculated and presented in accordance with GAAP. EBITDA as used by
management and certain investors is described in detail in the results of
operations for the three months ended September 30, 2004 as compared to the
three months ended September 30, 2003 section of this management's discussion
and analysis.

The following table shows the differences between our net cash provided by/(used
in) operating activities, as determined in accordance with GAAP, and our EBITDA
for the nine month periods ended (in thousands):

During the nine months ended September 30, 2004, our EBITDA was impacted by a
number of factors. Selling, general and administrative expenses increased due to
increases in salaries, benefits, commissions, temporary services, professional
services, advertising expenses and a $2.2 million impairment of loans made to
executives in August 2001. The non-recourse executive loans made in August 2001
were deemed to be impaired, as the amounts due on the loans are significantly
greater than the value of the common stock pledged to secure the loans. Benefits
increased due to the withholding tax payments on non-recourse executive loans.
Professional services increased $6.2 million during the nine months ended
September 30, 2004 as compared to September 30, 2003 due to the engagement of
consultants and other advisors to guide and facilitate our efforts with respect
to our lenders. Advertising expense increased $1.4 million primarily as a result
of our new offering of residential voice service which began in selected markets
within our footprint in January 2004. During the nine months ended September 30,
2004, salary and benefits expense increased approximately $7.1 million as
compared to the nine months ended September 30, 2003, primarily as a result of
headcount increases prior to our operational restructuring in September 2004.
Commission expense for the same comparative period increased $3.5 million due to
an increase in lines sold and installed.

We had a loss on disposition of assets for $3.8 million primarily related to the
disposal of unrecoverable leasehold improvements and office and computer
equipment in connection with the negotiated lease terminations under our
operational restructuring described in Restructuring Costs below.

On September 23, 2004, we implemented an operational restructuring plan that
includes the reduction of costs and improvements in efficiency in back-office
and sales operations necessitating a reduction in workforce. On that date, we
announced a reduction in our workforce by 193. All affected positions were
notified of the plan and termination benefits for these positions are included
in the restructuring costs for the nine months ended September 30, 2004.

During September 2004, we negotiated lease terminations with several of our
landlords. Included in these terminations was the sale to the landlords of
certain assets located within the leased locations. Both the lease termination
costs and losses on the asset sales are included in the restructuring costs for
the nine months ended September 30, 2004. In connection with this plan, we
recorded restructuring costs of approximately $1.2 million for lease
terminations, $0.8 million for employee termination benefits, and $0.4 million
for losses for assets sold related to lease contract terminations. We anticipate
incurring additional charges under the restructuring as we consolidate our sales
and network locations.

REVENUE

We generated $245.2 million in revenue for the nine months ended September 30,
2004 which was a 0.8% increase compared to revenue of $243.1 million for the
nine months ended September 30, 2003 and was attributable to an increase in the
number of lines in service offset by a decline in access revenue and the loss of
a large wholesale customer. Our total lines in service increased from September
30, 2003 by approximately 7.1% to 550,831 lines at September 30, 2004. Access
revenue was negatively impacted by reduced interstate per minute rates that we
charge other carriers as FCC mandated per minute rate reductions took effect in
June 2003 and June 2004. The loss of the wholesale customer negatively impacted
revenue by $7.6 million for the nine months ended September 30, 2004. Average
revenue per

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line for the nine months ended September 30, 2004 decreased approximately 2.7%
as compared to the nine months ended September 30, 2003.

Our churn rate for each of the nine month periods ended September 30, 2004 and
2003 of our facilities-based business clients, was 1.4% per month, respectively.

NETWORK COSTS

Network costs for the nine months ended September 30, 2004 were $121.3 million,
representing a 0.5% increase from network costs of $120.7 million for the nine
months ended September 30, 2003. Network costs as a percentage of total revenues
were 49.5% at September 30, 2004, a decrease compared to 49.6% for the nine
months ended September 30, 2003.

The improvements in network costs as a percentage of revenue reflects the
continuing benefits of our fiber network implementation and other network
optimization initiatives. These initiatives include least cost routing,
replacing leased capacity with alternative technologies and grooming and
capacity sizing of our network facilities. As a result, during the nine months
ended September 30, 2004, our average cost per line, excluding the $6.0 million
increase in network cost dispute reserve as discussed in our three months
results declined approximately 7.9% as compared to the nine months ended
September 30, 2003. These changes highlight the effectiveness of our network
optimization initiatives and the benefits of leasing fiber. Amortization of
assets under the cost of the capital leases for fiber is included in
depreciation and amortization expense, which is not a component of network
costs.

Our revenues exceeded our network costs by $123.9 million, or 50.5% of revenue,
for the nine months ended September 30, 2004, compared to $122.4 million, or
50.4% of revenue, for the nine months ended September 30, 2003.

Refer to the results of operations for the three months ended September 30, 2004
as compared to the three months ended September 30, 2003 section of this
management's discussion and analysis for a discussion of the components included
in our network costs.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses for the nine months ended September
30, 2004 were $117.5 million compared to $94.8 million for the nine months ended
September 30, 2003. Excluding non-cash stock-based compensation expense
described below, the selling, general and administrative expenses increased
24.7% from $94.0 million for the nine months ended September 30, 2003 to $117.2
million for the nine months ended September 30, 2004.

Selling, general and administrative expenses, excluding non-cash stock-based
compensation charges, as a percentage of revenue, were 47.8% for the nine months
ended September 30, 2004, as compared to 38.7% for the nine months ended
September 30, 2003. The increase in selling, general and administrative expenses
from the nine months ended September 30, 2003 resulted from increased salaries,
benefits, commissions, temporary services, professional services, advertising
expenses and a $2.2 million impairment of loans made to executives in August
2001. The non-recourse executive loans made in August 2001 were deemed to be
impaired, as the amounts due on the loans are significantly greater than the
value of the common stock pledged to secure the loans. Benefits increased due to
the withholding tax payments on non-recourse executive loans. Professional
services increased $6.2 million during the nine months ended September 30, 2004
as compared to September 30, 2003 due to the engagement of consultants and other
advisors to guide and facilitate our efforts with respect to our lenders.
Advertising expense increased $1.4 million primarily as a result of our new
offering of residential voice service which began in selected markets within our
footprint in January 2004. During the three months ended September 30, 2004, we
suspended the marketing of services to new residential customers.

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During the nine months ended September 30, 2004, salary and benefits expense
increased approximately $7.1 million as compared to the nine months ended
September 30, 2003, primarily as a result of headcount increases prior to our
operational restructuring in September 2004. Commission expense for the same
comparative period increased $3.5 million due to an increase in lines sold and
installed. Also during the nine months ended September 30, 2004, temporary
services increased $1.7 million as compared to the nine months ended September
30, 2003 as we utilized temporary personnel prior to converting to permanent
employees. We employed 1,201 individuals and 1,373 individuals at September 30,
2004 and September 30, 2003, respectively. A significant part of this decrease
occurred in late September 2004 when we reduced headcount by approximately 14.0%
in connection with our operations restructuring plan which is more fully
explained under Restructuring (Credits)/Costs in our discussion and analysis of
results for the three month period ended September 30, 2004.

Also included in selling, general and administrative expenses for the nine
months ended September 30, 2004 is non-cash stock-based compensation expense of
$0.3 million. This compares to $0.8 million for the nine months ended September
30, 2003. Compensation expense for the nine months ended September 30, 2004 and
2003 includes the expense associated with our adoption of SFAS No. 148, under
which we adopted the financial statement measurement and recognition provisions
of SFAS No. 123. Under SFAS No. 123, on a prospective basis, we recognize
compensation expense for the fair value of all stock options granted after
December 31, 2002, over the vesting period of the options.

RESTRUCTURING COSTS/(CREDITS)

On September 23, 2004, we implemented an operational restructuring plan that
includes the reduction of costs and improvements in efficiency in back-office
and sales operations necessitating a reduction in workforce. On that date, we
announced a reduction in our workforce by 193. All affected positions were
notified of the plan and termination benefits for these positions are included
in the restructuring costs for the nine months ended September 30, 2004.

During September 2004, we negotiated lease terminations with several of our
landlords. Included in these terminations was the sale to the landlords of
certain assets located within the leased locations. Both the lease termination
costs and losses on the asset sales are included in the restructuring costs for
the nine months ended September 30, 2004. In connection with this plan, we
recorded restructuring costs of approximately $1.2 million for lease
terminations, $0.8 million for employee termination benefits, and $0.4 million
for losses on assets sold related to lease contract terminations. We anticipate
incurring additional charges under the restructuring as we consolidate our sales
and network locations.

We implemented an operational restructuring plan in September 2002 (the "2002
Restructuring") and modified such plan in February 2003 and again in September
2004 and described further below. The plan included restructuring costs for
employee termination benefits, contractual lease obligations and network
facility costs.

During February 2003, we modified a portion of our 2002 Restructuring plan
related to reduced reliance on certain collocation sites. As we engaged in
restructuring activities in the first quarter of 2003, we were informed that
additional costs would be charged to us by the established telephone companies
in connection with the restructuring. Based on this new information, we reduced
the number of collocation sites that would be affected. As a result, we reversed
approximately $0.7 million in restructuring costs related to the collocation
sites. At the same time, we increased the restructuring accrual for $0.1 million
in termination benefits and other network facility costs that became known
during the three months ended March 31, 2003.

During September 2004, we again modified a portion of our 2002 Restructuring
plan when we determined that $0.5 million in accrued lease costs and $0.3
million in network facility termination costs would not be incurred as a result
of the actions taken in September 2004 and we reversed the charges.

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For the nine months ended September 30, 2004, approximately $0.4 million of the
restructuring costs were paid and it is anticipated that the remaining charges
will be liquidated within the next calendar year, except for contractual lease
obligations of $1.9 million that extend beyond one year and are included in
other long-term liabilities.

LOSS ON DISPOSITION OF ASSETS

For the nine months ended September 30, 2004, loss on disposition of assets was
approximately $3.8 million as compared to approximately $0.2 million for the
nine month period ended September 30, 2003. The change in the loss on
disposition of assets was primarily the result of our operational restructuring
detailed above. We disposed of unrecoverable leasehold improvements and office
and computer equipment in connection with the negotiated lease terminations.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization for the nine months ended September 30, 2004 was
$46.4 million. This represents a 7.5% decrease from the nine months ended
September 30, 2003. The decrease in depreciation expense as compared to the nine
months ended September 30, 2003 was primarily related to certain switch software
assets acquired in the acquisition of US Xchange which became fully depreciated
during three months ended September 30, 2003.

INTEREST EXPENSE AND INCOME

Interest expense, net, for the nine months ended September 30, 2004 and
September 30, 2003 was approximately $105.9 million and $63.1 million,
respectively. The increase in interest expense, net, from the nine months ended
September 30, 2003 was attributable to an aggregate of $29.5 million of
accretion and dividends on our preferred stock being characterized as interest
expense in accordance with the adoption of SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity", where corresponding amounts in prior periods were not included in
interest expense, net. Interest expense also increased $2.6 million from the
comparable period a year ago due to the impact of new borrowings in December
2003 and the compounding effect of PIK interest on our subordinated debt and the
reclassification of the fair value of our interest rate swap of $8.3 million to
interest expense a result of it no longer being eligible for effective cash flow
hedge accounting.

Cash interest expense is the interest expense that must be settled periodically
in cash as compared to the interest expense which accretes to principal. Cash
interest expense was $24.1 million for the nine months ended September 30, 2004,
and $22.1 million for the nine months ended September 30, 2003. The increase in
cash interest expense was the result of interest on the Term C loan of the
senior credit facility being settled in cash monthly beginning on April 30, 2004
and slightly higher interest rates on our senior credit facility borrowings
during 2004.

The non-cash accretion of and dividends on our preferred stock was $45.1 million
for the nine months ended September 30, 2004. Beginning on July 1, 2003,
accretion and dividends on our redeemable preferred stock is classified as a
component of interest expense in accordance with SFAS No. 150. Non-cash
accretion and dividends on our preferred stock for the nine months ended
September 30, 2003 were $38.6 million. This change from the nine months ended
September 30, 2003 was primarily driven by the increase in dividends on
preferred stock which result from the compounding effect of dividends that have
accreted.

INCOME TAXES

We did not generate any taxable income during the nine months ended September
30, 2004 and 2003, and did not incur any income tax liability as a result. Refer
to the discussion in the section captioned "Income Taxes" in the results of
operations for the three months ended September 30, 2004 as compared to the
three months ended September 30, 2003 section of this management's discussion
and analysis for

-34-

information concerning our net operating loss carryforwards for federal income
tax purposes and the potential impact of the Financial Restructuring on such net
operating loss carryforwards.

CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE

We recorded a cumulative effect of a change in accounting principle of $1.5
million during the three months ended September 30, 2004 to reflect the change
in accounting principle associated with the implementation of EITF 03-16. Refer
to our discussion of this EITF and our investment in a limited liability company
in the results of operations for the three months ended September 30, 2004
section of our filing.

NET LOSS AND NET LOSS APPLICABLE TO COMMON STOCKHOLDERS

Our net loss was $152.9 million and $85.3 million for the nine months ended
September 30, 2004 and September 30, 2003, respectively. The change in net loss
was attributable to an aggregate of $29.5 million of accretion and dividends on
our preferred stock being characterized as interest expense in accordance with
the adoption of SFAS No. 150 as of July 1, 2003, and the other factors
previously discussed. The net loss applicable to common stockholders was $152.9
million and $110.5 million for the nine months ended September 30, 2004 and
September 30, 2003, respectively. The change in net loss applicable to common
stockholders was attributable to the factors previously discussed.

LIQUIDITY AND CAPITAL RESOURCES

Refer to the discussion of the Going Concern/Chapter 11 Proceeding matter
earlier in this section of management's discussion and analysis of financial
condition and results of operations.

CREDIT FACILITIES

As of September 30, 2004, we have $398.9 million that has been committed under
our senior credit facility, subject to various conditions, covenants and
restrictions, including those described in Note 8 to the financial statements.
At September 30, 2004, the maximum available funding under our senior credit
facility was outstanding. The senior credit facility, which is secured by liens
on substantially all of our and our subsidiaries' assets and a pledge of our
subsidiaries' common stock, contains covenants and events of default that are
customary for credit facilities of this nature.

We also have $245.5 million of subordinated notes outstanding, excluding the
discount of $1.7 million and PIK interest of $12.6 million that has accrued as
of September 30, 2004 but not accreted to principal. These notes are subordinate
to the senior credit facility. The interest expense on the subordinated notes is
PIK at a fixed rate of 13.0%, accreting to principal semi-annually until
November 2006. Thereafter, until maturity on November 9, 2010, interest will be
payable in cash quarterly. The subordinated notes contain covenants related to
capital expenditures and events of default that are similar to those in our
senior credit facility.

In addition to the payment of our interest expense, we are required to make
periodic payments on our senior credit facility to reduce outstanding balances
in 2004 of $12.2 million. On July 30, 2004, August 30, 2004 and September 30,
2004, we failed to make certain principal and interest payments in the aggregate
amount of $5.1 million, $2.1 million and $2.0 million, respectively, that were
then due under our senior credit facility. Such failures constituted events of
default under our senior credit facility and our subordinated notes and would
have permitted our obligations under our senior credit facility and subordinated
notes to be declared to be immediately payable. The requisite majority of both
the lenders under the senior credit facility and the holders of the subordinated
notes entered into standstill agreements and, in the case of the subordinated
notes, waiver agreements on July 30, 2004 and August 30, 2004, subject to
certain conditions, pursuant to which they agreed not to take any action before
September 30, 2004 with respect to such default or events of default so as to
provide us with additional

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time to facilitate the negotiation and initiation of the Financial
Restructuring. As a result of the events of default, our long-term debt has been
reclassified to short-term in the consolidated balance sheet as of September 30,
2004. As a result of our Chapter 11 filing on October 5, 2004, this debt has
been accelerated. On October 7, 2004 we made a payment on our currently accrued
interest under the senior credit facility of $6.1 million.

On August 9, 2004, we and the counterparty under our interest rate swap
agreement entered into an amendment and waiver to the interest rate swap
agreement pursuant to which a payment of approximately $1.8 million due to be
paid by us to the counterparty on August 9, 2004 was deferred until September
30, 2004 or such earlier date on which we obtain DIP financing in connection
with the proposed Financial Restructuring. In the amendment and waiver the
counterparty also waived certain defaults under the interest rate swap agreement
until September 30, 2004. The Company had not entered into DIP financing by
September 30, 2004 and did not make the required payment by such date. As a
result of this event, the interest rate swap liability has been classified as
current in the consolidated balance sheet as of September 30, 2004. The interest
due of $1.8 million was subsequently paid on October 7, 2004, bringing us
current with payments due under our interest rate swap agreement.

In connection with our Financial Restructuring, we entered into the DIP Credit
Agreement dated as of October 5, 2004, with General Electric Capital
Corporation, as agent and lender and the lenders from time to time party
thereto. Certain of our existing lenders are also lenders under the DIP Credit
Agreement. The DIP Credit Agreement received final approval by the Bankruptcy
Court on October 25, 2004 and provides for a $20 million commitment of DIP
financing to fund our working capital requirements during the Chapter 11
proceedings. The DIP Credit Agreement provides for certain financial and other
covenants that are detailed in the Chapter 11 Proceeding/Going Concern Matter
discussion of this management's discussion and analysis. The DIP Credit
Agreement matures on April 5, 2005.

Upon completion of the Financial Restructuring, we expect the financing under
the DIP Credit Agreement to be replaced with a new revolving credit facility of
up to $30.0 million from a subset of the lenders under our senior credit
facility to provide for our ongoing working capital requirements. We have
commitments for such financing and have agreed to the terms thereof. It is
expected that definitive agreements for such financing will be entered into upon
the consummation of the Financial Restructuring which is expected to occur by
the end of November, 2004. Our Plan of Reorganization, which implements the
Financial Restructuring, was confirmed by the Bankruptcy Court on November 8,
2004. It is anticipated that it will be consummated on or about November 18,
2004, subject to obtaining certain regulatory approvals and the closing of the
new revolving credit facility.

We expect that the financing available under the DIP Credit Agreement and our
cash reserves and our cash flow from operations will be sufficient to satisfy
our operating cash needs until the Financial Restructuring is completed and the
financing under the new revolving credit facility is available. During the
financial restructuring process we have continued to pay all accrued and
accruing interest on our existing senior debt and to make all scheduled swap
payments, as well as all interest payments on the DIP facility.

In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", we have evaluated all of our long-lived assets for
impairment as of September 30, 2004. When the carrying value of an asset exceeds
the undiscounted cash flows directly related to it, there is an indication of
impairment. The impairment loss, if any, is recognized as the amount by which
the asset's carrying value exceeds its fair value. No such impairment losses
under the SFAS No. 144 standard were recorded as of September 30, 2004. If the
Financial Restructuring is completed as currently anticipated, our balance sheet
may be materially impacted. Among other things, the outstanding debt under our
senior credit facility would be reduced to $175.0 million, our obligations under
our subordinated notes will be extinguished, and our preferred stock will be
extinguished. We expect to implement fresh start accounting upon our emergence
from Financial Restructuring, requiring us to record our assets and liabilities
at

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fair value, which may vary materially from the carrying value as of
September 30, 2004.

CASH FLOWS

We have incurred significant operating and net losses since our inception.
Although not necessarily indicative of future cash flow results, we have
generated positive cash flow from operations for the nine months ended September
30, 2004, as well as for the six months ended December 31, 2003. While we expect
our cash flows from operations to remain positive for the last fiscal quarter of
2004, changes in interest rates and working capital make it difficult to predict
whether cash flows from operations will increase or decrease during the period.
We also generated positive EBITDA during each of the first three fiscal quarters
of 2004 and each of the fiscal quarters in 2003. While we expect to continue to
generate positive EBITDA and expect our EBITDA to grow, we also expect to
continue to have operating losses. As of September 30, 2004, we had an
accumulated deficit of $1.2 billion. If our Financial Restructuring is completed
as anticipated, we would expect our cash flow from operations to increase
primarily due to a reduction in interest expense. As part of the Financial
Restructuring, we will close on a new revolving credit facility. The proceeds
from this facility will fund general operations including payments to settle
network cost disputes.

Net cash provided by operating activities was approximately $4.3 million for the
nine months ended September 30, 2004 while net cash used in operating activities
for the nine months ended September 30, 2003 was approximately $7.1 million. Net
cash provided by operating activities for the nine months ended September 30,
2004 was primarily due to positive net working capital changes of $29.0 million,
of which $0.7 million was related to payments of our operational restructuring
obligations. Included in the net working capital changes is a $14.2 million
increase in accounts payable. This increase was the result of payments to
vendors being stretched because of our cash constraints. Net cash used in
operating activities for the nine months ended September 30, 2003 was primarily
due to net losses from operations, negative net working capital changes of $14.0
million, of which $0.7 million was related to payments of our operational
restructuring obligations, and interest expense payable in cash of $22.1
million. The change in net working capital for the nine months ended September
30, 2004 compared to the nine months ended September 30, 2003 was primarily due
to the timing of vendor invoice payments and collections and settlements of
amounts owed to us since September 30, 2003.

Net cash used in investing activities was $12.9 million and $6.9 million for the
nine months ended September 30, 2004 and 2003, respectively. Net cash used in
investing activities for the nine months ended September 30, 2004 primarily
related to capital expenditures for technology to support the growth in newer
service offerings, including Select Savings.free and other bundled voice and
data offerings. Net cash used in investing activities for the nine months ended
September 30, 2003 related to capital expenditures in support of growth in our
existing markets.

Net cash used in financing activities was $0.7 million for the nine months ended
September 30, 2004 compared to net cash provided by financing activities of $2.0
million for the nine months ended September 30, 2003. Net cash used in financing
activities for the nine months ended September 30, 2004 was primarily related to
payments under capital lease obligations. Net cash provided by financing
activities for the nine months ended September 30, 2003 was related to
borrowings under the senior credit facility offset by payments under capital
lease obligations. Funds received from senior credit facility borrowings were
used for capital expenditures and general corporate purposes. We do not expect
to receive additional cash from financing activities as a result of borrowings
under our existing senior credit facility as all of the existing financing
commitments have been used. As noted above, we have entered into a $20.0 million
DIP Credit Agreement to fund our working capital requirements during the Chapter
11 proceedings.

CAPITAL REQUIREMENTS

Capital expenditures were $13.0 million and $7.0 million for the nine months
ended September 30, 2004 and 2003, respectively. We expect that our capital
expenditures will be between $15.0 million and $20.0

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million for 2004 as we continue to penetrate our existing markets. The actual
amount and timing of our future capital requirements may differ materially from
our estimates as a result of the availability of financial resources, the demand
for our services and regulatory, technological and competitive developments,
including new opportunities in the industry and other factors.

CRITICAL ACCOUNTING POLICIES

Our critical accounting policies are described in Item 7 of our Form 10-K for
the year ended December 31, 2003. There have been no changes in the critical
accounting policies as discussed.

RECENT ACCOUNTING PRONOUNCEMENT

At its March 31, 2004 meeting, the Emerging Issues Task Force ratified its
consensus in EITF No. 03-16, "Accounting for Investments in Limited Liability
Companies" ("EITF 03-16"). EITF 03-16 requires companies to evaluate whether or
not their investments in limited liability companies (LLCs) should be accounted
for using the equity method of accounting. The Task Force confirmed its previous
conclusion that LLCs that have separate ownership accounts for each investor
should be accounted for like investments in partnerships. This conclusion is
based on the fact that the investor's separate account is its claim on the
long-term appreciation in the net assets of the LLC similar to a partner's
capital account. Investors in partnerships have used a lower threshold for
determining whether they should record an investment using the equity method
(under SOP No. 78-9, Accounting for Investments in Real Estate Ventures) than
allowed under APB Opinion No. 18. The consensus must be applied in the first
period beginning after June 15, 2004. We have an investment in a limited
liability company, which is required to be accounted for using the equity
method. Therefore, we recorded a cumulative effect of a change in accounting
principle of $1.5 million during the three months and nine months ended
September 30, 2004 in accordance with EITF 03-16.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At September 30, 2004 and December 31, 2003, the carrying value of our debt
obligations, excluding capital lease obligations, was $657.3 million and $632.0
million, respectively. The fair value of these debt obligations at September 30,
2004 is not readily determinable though it is recognized to be less than the
carrying value due to the contemplated Financial Restructuring. The fair value
of these obligations at December 31, 2003 was $643.3 million. The changes in
carrying value are due to non-cash amortization of debt discount of $0.9
million, interest payable in-kind that accreted to principal of $15.1 million,
and changes in related interest rates. The weighted average interest rate of our
debt obligations at September 30, 2004 and December 31, 2003 was 7.71% and
7.41%, respectively.

Also, a hypothetical increase of 100 basis points from prevailing interest rates
at September 30, 2004 would have resulted in an approximate increase in cash
required for interest on variable rate debt during the remaining fiscal year of
$1.6 million, increasing to $2.5 million in the next fiscal year, and then
declining to $2.1 million, $1.5 million, 0.8 million, and $0.1 million in the
second, third, fourth and fifth years, respectively. At September 30, 2004,
$279.1 million of our debt was variable rate debt.

As a result of our operating and financing activities, we are exposed to changes
in interest rates that may adversely affect our results of operations and
financial position. In seeking to minimize the risks and/or costs associated
with such activities, we may enter into derivative contracts. However, we do not
use derivative financial instruments for speculative purposes. Interest rate
swaps were employed as a requirement under our Second Amended and Restated
Credit Agreement. The Third Amended and Restated Credit Agreement does not have
such a requirement. This agreement does prohibit us from entering into any new
interest rate swap, collar, cap, floor or forward rate agreements without the
prior written consent of the lenders. Interest rate swap agreements are used to
reduce our exposure to risks associated with interest rate fluctuations. By
their nature, these instruments would involve risk,

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including the risk of nonperformance by counterparties, and our maximum
potential loss may exceed the amount recognized in our balance sheet. We attempt
to mitigate our exposure to counterparty credit risk by using major financial
institutions with high credit ratings. In a declining interest rate market, the
benefits of the hedge position are minimized, however, we continue to monitor
market conditions.

At September 30, 2004, we had an interest rate swap agreement for a notional
amount of $125.0 million. At September 30, 2004, the weighted average pay rate
for the interest rate swap agreement was 6.94% and the average receive rate was
1.71%.

We assess the fair value of our interest rate swap on an ongoing basis in
accordance with SFAS No. 133 to determine if it is maintaining its ability to be
a highly effective cash flow hedge and still eligible for cash flow hedge
accounting. If this assessment yields results that indicate that the swap is no
longer a highly effective cash flow hedge, the derivative is adjusted to its
fair value at the time of assessment and is no longer eligible for cash flow
hedge accounting. We determined as of September 30, 2004 that because the
underlying debt that the swap hedged would likely be cancelled as a result of
our Financial Restructuring, the swap was no longer a highly effective cash flow
hedge as the future interest payments on the underlying debt will no longer
probable of occurring. The fair value of the interest rate swap of $8.3 million
was reclassified from accumulated other comprehensive loss and recorded for the
three months ended September 30, 2004 in the income statement as additional
interest expense. The fair value of the interest rate swap agreement is
estimated based on quotes from a broker and represents the estimated amount that
we would expect to pay to terminate the agreement at each such date. Based on
the fair value of the interest rate swap at September 30, 2004, it would have
cost us $8.3 million to terminate the agreement. A hypothetical decrease of 100
basis points in the receive rate would have increased the cost to terminate this
agreement by approximately $1.6 million.

ITEM 4. CONTROLS AND PROCEDURES

Based on their evaluation as of the end of the period covered by this Quarterly
Report on Form 10-Q, our principal executive officer and principal financial
officer with the participation and assistance of our management, concluded that
our disclosure controls and procedures, as defined in Rules 13a-15(e)
promulgated under the Securities Exchange Act of 1934, were effective in design
and operation. There have been no changes in our internal controls over
financial reporting that occurred during the quarter ended September 30, 2004
that have materially affected, or are reasonably likely to materially affect,
our internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

On July 30, 2004, August 30, 2004 and September 30, 2004, we
failed to make certain payments in the aggregate amount of $5.1
million, $2.1 million and $2.0 million that were then due under
our senior credit facility ($3.1 million is the total arrearage
due as of the date of the filing of this report, after payment of
$6.1 million on October 7, 2004). Such failures constituted events
of default under our senior credit facility and our subordinated
notes and would have permitted our obligations under our senior
credit facility and subordinated notes to be declared to be
immediately payable. The requisite majority of both the lenders
under our senior credit facility and the holders of our
subordinated notes have entered into standstill agreements and, in
the case of the subordinated notes, waiver agreements on July 30,
2004 and August 30, 2004 subject to certain conditions, pursuant
to which they have agreed to not take any action before September
30, 2004 with respect to such default to provide us with
additional time to facilitate the negotiation and initiation of
the Financial Restructuring discussed in the "Chapter 11
Proceeding/Going Concern Matter" section of the Management's
Discussion and Analysis of Financial Condition and Results of
Operations section of this report. As a result of our Chapter 11
filing, our obligations under our senior credit facility and our
subordinated notes have been accelerated.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

See Exhibit Index

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SIGNATURES

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

CHOICE ONE COMMUNICATIONS INC.
Registrant

DATE: November 18, 2004 By: /s/ Steve M. Dubnik
--------------------------------------------------
Steve M. Dubnik, Chairman and Chief Executive Officer
(Principal Executive Officer)

By: /s/ Ajay Sabherwal
--------------------------------------------------
Ajay Sabherwal, Executive Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)

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EXHIBIT INDEX

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EXHIBIT INDEX

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EXHIBIT INDEX

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