MPOWER HOLDING CORP - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

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 33339884-01
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MPOWER HOLDING CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 52-2232143
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

175 SULLY'S TRAIL, SUITE 300, PITTSFORD, NY 14534
(Address of principal executive offices) (Zip Code)

(716) 218-6550
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE

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

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

COMMON STOCK, $0.001 PAR VALUE PER SHARE
7.25% SERIES D CONVERTIBLE REDEEMABLE PREFERRED STOCK
(TITLE OF CLASS)

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 preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

As of March 22, 2002, the aggregate market value of Common Stock held by
non-affiliates of the Registrant, based on the closing sale price of such stock
in the NASDAQ Stock Market on March 22, 2002, was approximately $2.4 million. As
of March 22, 2002, the Registrant had 59,466,023 shares of Common Stock
outstanding.

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

DOCUMENTS INCORPORATED BY REFERENCE
Not Applicable

Exhibit Index is located on page 52.
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PART I

ITEM 1. BUSINESS

THE COMPANY

We are a competitive local exchange carrier ("CLEC") offering local
dial-tone, long distance, high-speed Internet access via dedicated Symmetrical
Digital Subscriber Line ("SDSL") technology, voice over SDSL ("VoSDSL"), Trunk
Level 1 ("T1"), Integrated T1 and Data-only T1 as well as other voice and data
features. Our services are offered primarily to small and medium size business
customers through our wholly owned subsidiary, Mpower Communications Corp.
("Mpower Communications").

RECAPITALIZATION PLAN

We announced on February 25, 2002 that we had reached agreement with an
informal committee representing approximately 66% of the outstanding principal
amount of our 13% Senior Notes due 2010 on a comprehensive recapitalization plan
that would eliminate a significant portion of our long-term debt and all of our
preferred stock. Under the proposed recapitalization plan, we would use $19.0
million of cash on hand and issue common stock to eliminate $583.4 million in
debt and preferred stock, as well as the associated $49.5 million of annual
interest expense related to our 2010 Senior Notes and $15.8 million of annual
dividend payments on our preferred stock.

On March 22, 2002, we announced that we successfully completed our
bondholder solicitation which resulted in more than 99% of the holders of our
2010 Senior Notes entering into voting agreements with us in support of the
proposed recapitalization plan announced on February 25, 2002. On March 27,
2002, each bondholder who participated in the solicitation received a consent
fee equal to their pro-rata share of the $19.0 million.

In addition, more than two-thirds of the holders of our issued and
outstanding shares of preferred stock have also entered into voting agreements
with us in support of the proposed recapitalization plan.

With the necessary backing of these key constituencies, we plan to move
forward with our recapitalization plan, which would retire $583.4 million in
debt and preferred stock in exchange for a consent fee of $19.0 million in cash
and new equity in the reorganized company. We and our subsidiaries, Mpower
Communications and Mpower Lease Corporation, intend to implement the proposed
recapitalization plan by commencing a voluntary, pre-negotiated Chapter 11
proceeding no later than April 30, 2002. This Chapter 11 proceeding may also
include other subsidiaries. We will continue ongoing efforts to secure the
additional funding needed to complete the recapitalization plan. We cannot
assure you that we will be able to secure the necessary additional financing.

Subject to the court's approval, our proposed recapitalization plan would
provide that our 2010 Senior Noteholders receive 85% of the common stock of our
recapitalized company's issued and outstanding stock on the effective date of
the plan, and be entitled to nominate four new members to our reorganized
company's seven member Board of Directors. Our preferred and common stockholders
would receive 13.5% and 1.5% respectively of the common stock of our
recapitalized company on the effective date of the plan, and the preferred
stockholders would be entitled to nominate one new director to our reorganized
company's Board of Directors.

As part of the Chapter 11 proceeding, we will be required to file a plan of
reorganization with the Bankruptcy Court. In order for the plan to be confirmed
by the Court, among other things, the requisite votes under the Bankruptcy Code
must be received and the plan must satisfy the requirements set forth in Section
1129 of the Bankruptcy Code. Some of these requirements are beyond our control
and we cannot assure you that we will be able to successfully implement our
proposed recapitalization plan.

During the Chapter 11 proceeding, we plan to continue to provide customers
with their complete range of services. We do not currently expect any
significant impact on our employees, customers or suppliers. Due to our
remaining available cash resources, we do not believe that we will require
debtor-in-possession financing.

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The proposed recapitalization plan also provides for an employee stock
option plan for up to 10% of the common stock of our recapitalized company's
issued and outstanding common stock on the effective date of the plan (including
existing options), which would dilute the ownership percentages referenced
above.

On March 22, 2002, we also announced that we will voluntarily move from
NASDAQ National Market (the "NASDAQ") to the NASD Over the Counter Bulletin
Board ("OTC Bulletin Board"), a regulated quotation service that displays
real-time quotes, last-sale prices and volume information in over-the-counter
equity securities. We expect that our common and preferred stock will continue
to trade under the symbols MPWR and MPWRP, respectively. After we file Chapter
11, we expect our stock will continue to trade on the OTC Bulletin Board, but
the ticker symbols may change during the time we are in bankruptcy. As a
consequence of our move from the NASDAQ to the OTC Bulletin Board, it is
expected that our stockholders will find it more difficult to buy or sell shares
of, or obtain accurate quotations as to the market value of our common stock. In
addition, our common stock may be substantially less attractive as collateral
for margin borrowings and loan purposes, for investment by financial
institutions under their internal policies or state legal investment laws, or as
consideration in future capital raising transactions.

MPOWER OVERVIEW

We offer voice and high-speed data services using both SDSL and T1
technology in all of our markets. At March 22, 2002, we provide services in 27
metropolitan areas in 8 states. Our network consists of 583 incumbent carrier
central office collocation sites providing us access to approximately 11.7
million addressable business lines. All of our 583 central office collocation
sites are SDSL capable and 374 are T1 capable. We have established working
relationships with BellSouth, Verizon, Sprint, and Southwestern Bell Corporation
(including its operating subsidiaries PacBell and Ameritech collectively
referred to as "SBC"). We have over 400,000 lines in service.

We were one of the first competitive communications carriers to implement a
facilities-based network strategy. As a result, we own the network equipment
that controls how voice and data transmissions originate and terminate, which we
refer to as switches, and we lease the telephone lines over which the voice and
data traffic are transmitted, which we refer to as transport. We install our
network equipment at the site of the incumbent carrier from whom we rent
standard telephone lines. These sites are referred to as collocation sites
within the telecommunications industry. As we have already invested and built
our network, we believe our strategy has allowed us to serve a broad geographic
area at a comparatively low cost while maintaining control of the access to our
customers.

Our business is to deliver packaged voice and broadband data solutions to
small and mid-sized businesses. Specifically, our business plan is based on
serving the small and medium enterprise customers that find business value in
high-speed broadband Internet access integrated with local dial-tone service. We
have more than 75,000 business customers, providing them broadband Internet via
SDSL and T1, integrated services over VoDSL, T1 and local voice telephone
service.

In the fourth quarter of 2001, we began to upgrade our network with T1
technology to increase our revenue potential, gross margin and addressable
customer base. By leveraging our existing equipment, interconnection agreements
with incumbent carriers and network capabilities, we are able to offer fully
integrated and channelized voice and data products over a T1 connection,
overcoming the DSL loop length limitations. This platform utilizes central
office equipment provisioned with T1 line cards that leverage low-cost T1
unbundled network elements leased from incumbent carriers. Our collocation DSL
equipment then aggregates Internet traffic to the central office Internet
gateway. This delivery mechanism provides guaranteed bandwidth and a data
service that is positioned to be a superior offering when compared to the
incumbent carriers' DSL service offering.

By using a T1 service delivery platform, we expect to increase the amount
of revenue per customer. In order to serve the largest portion of our target
audience, our combined voice and data network allows us to deliver services in
several combinations over the most favorable technology: basic phone service on
the traditional phone network, SDSL service, integrated T1 voice and data
service, or data-only T1 connectivity.

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MARKET OPPORTUNITY

We believe we have a significant market opportunity as a result of the
following factors:

IMPACT OF THE TELECOMMUNICATIONS ACT OF 1996

The Telecommunications Act of 1996 allows competitive carriers to use the
existing infrastructure established by incumbent carriers, as opposed to
building a competing infrastructure at significant cost. The Telecommunications
Act requires all incumbent carriers to allow competitive carriers to collocate
their equipment in the incumbent carrier's central offices. This enables
competitive carriers to access customers through existing telephone line
connections. The Telecommunications Act created an incentive for incumbent
carriers' that were formerly part of the Bell system to cooperate with
competitive carriers' by precluding each of these incumbent carriers' from
providing long distance service in its region until regulators determine there
is a significant level of competition in the incumbent carriers' local market.
See "Government Regulations."

NEEDS OF SMALL AND MEDIUM SIZE BUSINESSES FOR INTEGRATED COMMUNICATIONS
SOLUTIONS

Small and medium sized businesses have few cost-effective alternatives for
traditional telecommunication services as well as for Internet access. These
businesses must often contend with productivity limitations associated with slow
transmission speeds from dial-up services. In addition, to meet their
communications needs, small and medium size businesses are subject to the cost
and complexity of using multiple service providers: local dial-tone providers,
long distance carriers, Internet service providers and equipment integrators. We
believe these businesses can benefit significantly from an integrated
cost-effective communications solution delivered by a single provider.

GROWING MARKET DEMAND FOR HIGH-SPEED DATA SERVICES

The rise of the Internet as a commercial medium as well as a necessary
business tool, has driven the demand for high-speed data services. Businesses
are increasingly establishing Web sites and corporate intranets and extranets to
expand their customer reach and improve their communications efficiency. To
remain competitive, small and medium size businesses increasingly need
high-speed data and Internet connections to access critical business information
and communicate more effectively with employees, customers, vendors and business
partners.

SHRINKING COMPETITIVE LANDSCAPE

The shake out of the telecommunications industry over the past year has
significantly reduced the number of competitive local exchange carriers and
other DSL providers in the marketplace. Many companies in the competitive
communications industry have succumbed to heavy debt loads and burdensome
interest payments without the revenue streams to compensate, and therefore have
not been able to sustain their business model. As a result, fewer competitors
are vying for the same customers.

THE MPOWER SOLUTION

We believe that we offer an attractive communications solution to small and
medium size business customers. In developing our solution, we have attempted to
include elements intended to create customer loyalty. Key aspects of our
solution include:

Integrated Communications Solutions. We offer cost-effective,
comprehensive and flexible communications solutions, which include local voice
service, local calling features, long distance, high-speed Internet access
services, and Web hosting all on a single bill. Our customers have the
convenience of a single point of contact for a complete package of services,
eliminating the need to manage multiple vendors.

Dedicated Support. Our account managers personally call on the small and
mid-size businesses. This is different from many communications companies'
approach to this market segment, which telemarket to these businesses.

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Service Reliability. Our network is designed to mirror the reliability of
the incumbent carriers. In addition, we believe we are able to offer our
customers a high degree of service reliability through efficient, timely
provisioning of lines due to our mature relationships with the incumbent
carriers in the markets we currently serve. We believe our rollout of T1
services will enable us to further improve our service reliability by
simplifying the provisioning process.

BUSINESS STRATEGY

Optimize Current Network Infrastructure. The footprint of our
facilities-based network is completely built out and operational. All of our
traffic and revenue is on-switch and on-collocation, allowing us better control
over our costs. During 2001, we retrenched our expansion plans and focused on
our most profitable markets. Our strategy going forward is to maximize the
investment in this infrastructure and increase market share in the areas we
serve. Our network is designed with technology flexibility that allows us to
deliver our product set in the most efficient manner regardless of the physical
plant quality of the incumbent carriers' networks.

Increase Market Share and Profitable Revenue. We plan to continue to
aggressively sell into our existing network footprint and target those customers
with the products which we believe will generate the highest margin revenue
streams and maximize network efficiencies. Focusing on providing integrated
solutions, feature rich lines, and a minimum size for voice only orders, should
further increase the quality of our revenue streams. We expect that the majority
of network expansion will be centered around augmentation and grooming of our
existing network to further enhance our product portfolio and service delivery
capabilities.

Focused Sales and Marketing Effort. We target small and medium size
business customers through our direct sales force, agent/vendor programs,
telemarketing for lead generation and a limited amount of targeted advertising.
Our account managers consult with businesses and seek to tailor a communications
solution to their needs, focusing on enhancing the productivity with a package
that provides both value and convenience. Our technical consultants and tiered
customer support provide superior technical assistance. As a result of these
factors, a growing percentage of our new customers come to us through referrals
from existing customers. Additionally, we intend to continue our relationships
with independent agents or vendors as a complement to our direct sales channels.

Product Development. Our product development efforts are focused on adding
services that will appeal to a larger size and billing base of business
customers. Services such as digital and analog trunking would allow us to
provide a solution for customers with 12 or more lines or 50 or more employees
and currently utilizing a PBX system. Building on this service, we expect to
also introduce Direct Inward Dialing capable trunks which provide flexibility
for the customer's internal extensions. These services will allow us to attract
new customers and grow along with our existing customers. In addition, an
increasing amount of our services will be provided under contract. We believe
that by providing term contracts on a majority of our products and services we
can provide price protection and service guarantees for our customers and
revenue protection for us.

Targeting Small and Medium Size Businesses. Based on telephone lines in
service, we believe the small and medium size business customer base is a large
and rapidly growing segment of the communications market in the United States.
We target suburban areas of large metropolitan markets because these areas have
high concentrations of small and medium size businesses. In addition to being
densely clustered in the urban areas we serve, business customers generate
approximately 60% of all local telephone service revenues. By providing a
package of voice and data services and focusing on small and medium size
business sales, we believe we will gain a competitive advantage over the
incumbent carrier, our primary competitor for these customers.

Products and Services. We focus on offering bundled communications
packages to our small and medium size business customers. These services include
local voice lines, high speed Internet access, calling cards, web hosting, long
distance, and customer calling features such as voice mail, call waiting, caller
ID and call forwarding. To capitalize on the higher end customer base, we
introduced a variety of T1 based solutions in the fall of 2001, including an
integrated voice and data package over our T1 platform, and a data only solution
over our T1 platform.

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Control Customer Relationship. By connecting the standard telephone line
originating at our customer's site to our central office collocation, we
effectively place the customer on our network. This connection serves as the
platform for delivering our current and future communications services to our
customers. Any future changes our customers want to make to their services,
including purchasing more services from us, are under our direct control. The
one exception is for repairs, which are infrequent but may require the
participation of the incumbent carrier's network maintenance staff.

Capital Efficient Network. We were one of the first competitive local
exchange carriers to implement a facilities-based network strategy of purchasing
and installing switches, collocating in the central offices of the incumbent
carrier and leasing local telephone lines, referred to as a "smart build"
strategy. Now that this network footprint is complete and operational, we
believe this deployment strategy has the potential to provide an attractive
return on our invested capital. We have installed SDSL technology across our
existing network, and have T1 technology in the majority of our network
collocations.

Operations Support System. We have a comprehensive operations support
system to manage our business. Our system provides integrated features
addressing customer care, billing and collections, general ledger, payroll,
fixed asset tracking, and personnel management. During 2001, we augmented our
current back-office systems with some functional components such as network
monitoring and upgraded other components such as general ledger, purchasing and
accounts payable. We have found our systems have the ability to adapt to
multiple incumbent carrier provisioning systems, which can improve our operating
efficiencies and effectiveness.

Timely and Accurate Provisioning for Customers. We believe one of the keys
to our success is effectively managing the provisioning process for new
customers. We have implemented a standardized service delivery process and
consolidated our service delivery centers, which has significantly reduced our
provisioning intervals and improved our provisioning quality metrics. In
addition, through electronic order interfaces with all of the incumbent
carriers, we have been able to substantially reduce the time, number of steps
and duplication of work typically involved in the provisioning process.

Quality Customer Service. We believe providing quality customer service is
essential to offering a superior product to our customers and creating customer
loyalty. We operate one main call center that handles general billing, customer
care and related issues for all of our customers. Our call center is focused on
first call resolution, which involves an enhanced automated call distribution
system that directs callers into the customer service center based on the type
of question they have, and specially trained agents with the tools to more
quickly resolve customer issues. In addition, service delivery representatives
are in contact with our customers during the process of service conversion. Our
service representatives use our operations support system to gain immediate
access to our customers' data, enabling quick responses to customer requests and
needs at any time. This system allows us to present our customers with one fully
integrated monthly billing statement for all communication services.

MARKETS

As of March 22, 2002, we operate in 27 markets in 8 states and have 583
incumbent carrier central office collocation sites providing access to an
estimated 11.7 million addressable business lines. Our collocation facilities
provide us with a service area that covers attractive business markets in 18 of
the top 50 metropolitan statistical areas. In addition, we have built our
network with expansive collocation footprints that average 20,000 addressable
lines per collocation.

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The table below shows the distribution of our central office collocation
sites within these states.

During 2001 and the beginning of 2002, we scaled back from 40 markets to
what we believe to be our most promising 27 markets and from 761 to 583
collocations in incumbent carrier central offices. Our focus at the present time
will be concentrated on building market share within our existing service
territory, as opposed to building into new or additional markets. We believe
there is significant scaling potential within our existing market footprint,
given our past success in market penetration in our base of original markets. In
addition, our robust network backbone is scalable and can provide reliability
and service quality across our collocation footprint, while affording us the
benefit of spreading the fixed costs across our markets.

SALES AND MARKETING

Our highly focused marketing efforts seek to generate well-managed,
profitable growth through increased market share with minimal customer turnover.
Our current sales programs include direct sales efforts, telemarketing and
programs with agents and vendors directed at the small and medium size business
customer. We have established sales training modules that allow a simplified
approach to new product deployment and promotional offerings. As of March 22,
2002, we employed 343 quota-carrying sales personnel and an additional 249 sales
support personnel.

Our sales representatives are supported by customer account managers and
service delivery personnel. These support personnel function as the liaison
between the small business customer and our operational personnel to effect a
coordinated transfer of service from the incumbent carrier's network to our
network. Field technicians are responsible for the installation of customer
premise equipment, if required. Our national sales organization is divided by
geographic territories into four regions. Sales personnel report to city
managers and ultimately the vice presidents of their respective regions.

To complement our sales force, we use established independent
telecommunication equipment and service providers to market our services in
conjunction with their own products to business customers.

NETWORK ARCHITECTURE AND TECHNOLOGY

We have implemented a strategy enabling us to own the hardware that routes
voice calls and data traffic, which we refer to as "switches", while leasing the
telephone lines and cable over which the voice calls and data traffic are
actually transmitted, which we refer to as "transport". We use three basic types
of transport to transmit voice calls and data traffic. First, we lease the
standard telephone line from the incumbent carrier. This allows us to move voice
calls and data traffic from a customer's location to the nearest central office
owned by the incumbent carrier. Inside these central offices, we have equipment
that allows us to deliver the services we sell to our customers. Second, we
lease cable from other communications companies, which connects the equipment we
installed in the central office of the incumbent carrier to our switches. Third,
we lease additional cable from other communications companies, which connect our
switches to each other and allow us to complete our customers' long distance
calls to national and international destinations. We believe

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this network strategy provides us an efficient capital deployment plan, which
allows us to achieve an attractive return on our invested capital.

We believe that leasing the standard telephone line from the incumbent
carriers' central office to the end-user provides a cost-efficient solution for
gaining control of access to our customers. Leasing costs are not incurred until
we have acquired a customer and revenue can be generated. It is our experience
that the cable required to connect our collocation equipment located at an
incumbent carriers' central office to our switching hardware and the cable
required to connect our customers' voice calls and data traffic to the Internet
and other telephones is available at reasonable prices in all of our current
markets. Because the cable required to transport voice calls and data traffic
has become a readily available service from numerous other communications
companies, we focused our efforts on owning and installing the hardware that
determines where to route voice calls and data traffic and on selling and
delivering our services to our customers.

We have 15 operational voice switches and 15 operational data pops (point
of presence). All of our current voice switches are DMS-500 switches
manufactured by Nortel Networks. These switches offer a flexible and cost
efficient way for us to provide local and long distance services to our
customers. Our data pops allow us to efficiently deliver data traffic across our
network.

Once we install equipment in the collocation sites we rent from the
incumbent carrier, we initiate service to a customer by arranging for the
incumbent carrier to physically disconnect a standard telephone line from their
equipment and reconnect the same standard telephone line to our equipment. When
the standard telephone line has been connected to our equipment, we have direct
access to the customer and can deliver our current voice and data services. Any
future changes the customer wishes to make, such as purchasing more services
from us, are under our direct control. The few exceptions are infrequent
repairs, which may require the participation of the incumbent carrier's
maintenance staff.

We have installed our equipment in 583 collocation sites as of March 22,
2002. We believe this network allows us to sell our services to an estimated
universe of 11.7 million small and medium size business customers. Our 15 host
switching sites are connected to each other by cable, which allows us to
transmit data traffic using asynchronous transfer mode technology. Asynchronous
transfer mode technology allows both voice calls and data traffic to be
transported in digital form over a single cable connection at high speeds and
reasonable costs. By deploying SDSL and T1 technology into our network, we are
now able to transport both voice calls and data traffic in digital form on a
single telephone line from a customer's location to one of our switches.

Using SDSL technology, we can increase the amount of information we carry
on a standard telephone line, which we refer to as bandwidth, to as much as 1.5
million bits per second or "Mbps". This bandwidth is the equivalent of 24
regular voice telephone lines. Our SDSL equipment is programmed to allocate the
available bandwidth. For example, voice calls are carried at 64 thousand bits
per second or "Kbps"; if a customer has eight phone lines and all are in use at
the same time, then 512 Kbps (eight phone lines multiplied by 64 Kbps each) of
the total 1.5 Mbps are allocated for the voice calls. The remaining bandwidth,
988 Kbps, is available to carry the data traffic.

We believe the SDSL technology significantly reduces our customers'
potential for service outages when the incumbent carrier moves the standard
telephone line from their equipment to ours. Additionally, we believe this
technology reduces our costs since we lease a reduced number of standard
telephone lines per customer from the incumbent carrier. For example, if a
customer today has eight voice lines, we must order from and provision through
the incumbent carrier eight individual standard telephone lines. If the same
customer were to buy our service offering and we deliver the service using SDSL
technology, we only order and provision one standard telephone line from the
incumbent carrier.

T1 TECHNOLOGY

With 4-wire T1 technology we reduce the impact of distance limitations and
service quality common to SDSL. Also, a T1 will consistently offer 1.5 million
Mbps data speed. With this introduction, we now have an alternative to SDSL when
network restrictions will not facilitate SDSL usage. We have two product
offerings

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at this time using T1 technology, integrated service and a data-only service.
Both use the same underlying transport and equipment technology.

"Integrated" service refers to the combination of both traditional voice
services such as local and long distance service, and Internet connectivity. It
refers to a product that offers both elements, voice and data, across a single
cable. Hardware specifically designed to manage these various types of traffic
is needed at both the customer premise and within our network. This product will
allocate unused bandwidth from on-hook telephone lines to the usable data
bandwidth. For example: A customer purchases a package of 16 voice lines and 1
Mbps of data bandwidth. When the customer is not using any of his voice lines,
he will get the full 1.5 Mbps for data. However, if he is using all his voice
lines only 1 Mbps will be available for data.

The "data-only" product provides a more robust and higher bandwidth data
offering that routes traffic directly to the Internet backbone. Here a customer
will not receive any voice lines, but likewise there will be no voice lines to
limit bandwidth. Even though no voice lines come with the package, the same
customer premise device is used in order to maintain a consistency of equipment
in our network.

CUSTOMER PREMISE EQUIPMENT (CPE)

We use two basic types of equipment at the customer premise. One is called
a "modem" and the other an Integrated Access Device ("IAD"). A modem is used for
an SDSL data only connection. Here, no voice ports are needed and therefore the
modem is adequate to support the SDSL connection. The modem communicates with
our collocation via a DSL link and the customer's network via an Ethernet link.
The IAD is used for SDSL integrated access, T1 integrated access and T1 Data
Only. Within our network on the Wide Area Network (WAN), the IAD has a built-in
modem which communicates with the SDSL and/or T1 link. From the customers'
perspective, the IAD appears as regular phone service for the voice channels,
and an Ethernet port for data traffic. An IAD is also used for the Data-Only T1
product to reduce the number of devices used at the customer premise.

INTERCONNECTION AGREEMENTS AND COMPETITIVE CARRIER CERTIFICATIONS

We have interconnection agreements for all of the markets in which we
currently operate. These agreements are with Sprint in Nevada, BellSouth for
Georgia and Florida, Verizon for parts of California and Florida, and SBC
(through one of its operating subsidiaries) in California, Texas, Illinois,
Michigan and Ohio. We are currently in the process of negotiating more
beneficial agreements with Sprint, SBC and BellSouth and we expect to have these
new agreements in place during 2002. We are certified as a competitive carrier
in all of our existing markets.

SERVICE DEPLOYMENT AND OPERATIONS

Customer Service. We strive to provide high quality customer service
through:

- Personnel. Our customer service representatives and sales personnel are
well trained and attentive to our customers' needs.

- Call Center. Our centralized customer service center provides
comprehensive customer support. Calls from our customers are answered and
responded to with minimal wait time.

- Coordination of Service Provisioning. We coordinate service installation
with our customer and the incumbent carrier to ensure a smooth transition
of services from the incumbent carrier to us.

- Close Customer Contact. We proactively monitor our network and keep our
customers informed of installation or repair problems and allocate the
necessary resources to resolve any problems.

- Billing. We provide our customers with accurate, timely and easily
understood bills.

- Process Automation. We have a comprehensive operations support system to
manage our business. Our system provides integrated features addressing
customer care, billing and collections, general ledger, payroll, fixed
asset tracking and personnel management. Our customer service
representatives

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are able to handle all customer service inquiries, including billing
questions and repair calls, with the information available from our
integrated system.

GOVERNMENT REGULATIONS

OVERVIEW

Our services are regulated at the federal, state and local levels. The FCC
exercises jurisdiction over all facilities of, and services offered by,
communications common carriers like us, when those facilities are used in
connection with interstate or international communications. State regulatory
commissions have some jurisdiction over most of the same facilities and services
when they are used in connection with communications within the state. In recent
years, there has been a dramatic change in the regulation of telephone services
at both federal and state levels as both legislative and regulatory bodies seek
to enhance competition in both the local exchange and interexchange service
markets. These efforts are ongoing and many of the legislative measures and
regulations adopted are subject to judicial review. We cannot predict the impact
on us of the results of these ongoing legislative and regulatory efforts or the
outcome of any judicial review.

FEDERAL REGULATION

The FCC regulates interstate and international communications services,
including access to local telephone facilities to place and receive interstate
and international calls. We provide these services as a common carrier. The FCC
imposes more regulation on common carriers that have some degree of market
power, such as incumbent local exchange carriers. The FCC imposes less
regulation on common carriers without market power, including competitive
carriers like us. The FCC grants automatic authority to carriers to provide
interstate long distance service, but requires common carriers to receive an
authorization to construct and operate communications facilities, and to provide
or resell communications services, between the United States and international
points.

The FCC has required competitive carriers like us to cancel their tariffs
for domestic interstate and international long distance services, which were
schedules listing the rates, terms and conditions of all these services offered.
Even without tariff filing, however, carriers offering interstate and
international services must charge just and reasonable rates and must not
discriminate among customers for like services. The FCC may adjudicate
complaints against carriers alleging violations of these requirements.

Our charges for interstate access services, which includes the use of our
local facilities by other carriers to originate and terminate interstate calls,
remain governed by tariffs. In April 2001, the FCC adopted new rules that limit
our rates for these services. Under these rules, which took effect on June 20,
2001, competitive carriers are required to reduce their switched access charges
to rates no higher than 2.5 cents per minute. After one year, the rate ceiling
will be reduced to 1.8 cents and after two years to 1.2 cents per minute. After
three years, all competitive carriers will be required to charge rates no higher
than the incumbent telephone company. These new FCC rules are currently subject
to petitions for re-considerations and/or judicial review. We cannot predict the
ultimate outcome of these proceedings.

The FCC imposes numerous other regulations on carriers subject to its
jurisdiction, some of the most important of which are discussed below. The FCC
also hears complaints against carriers filed by customers or other carriers and
levies various charges and fees.

Except for certain restrictions placed on the Bell operating companies, the
Telecommunications Act permits virtually any entity, including cable television
companies and electric and gas utilities, to enter any communications market.
The Telecommunications Act takes precedence over inconsistent state regulation.
However, entities that enter communications markets must follow state
regulations relating to safety, quality, consumer protection and other matters.
Implementation of the Telecommunications Act continues to be affected by
numerous federal and state policy rulemaking proceedings and review by courts.
We are uncertain as to how our business may be affected by these proceedings.

10

The Telecommunications Act is intended to promote competition. The
Telecommunications Act opens the local services market to competition by
requiring incumbent carriers to permit interconnection to their networks and by
establishing incumbent carrier and competitive carrier obligations with respect
to:

Reciprocal Compensation. All incumbent carriers and competitive
carriers are currently required to complete local calls originated by each
other under reciprocal arrangements at prices based on tariffs or
negotiated prices.

Resale. All incumbent carriers and competitive carriers are required
to permit resale of their communications services without unreasonable
restrictions or conditions. In addition, incumbent carriers are required to
offer wholesale versions of all retail services to other common carriers
for resale at discounted rates, based on the costs avoided by the incumbent
carrier by offering these services on a wholesale basis.

Interconnection. All incumbent carriers and competitive carriers are
required to permit their competitors to interconnect with their facilities.
All incumbent carriers are required to permit interconnection at any
feasible point within their networks, on nondiscriminatory terms, at prices
based on cost, which may include a reasonable profit. At the option of the
carrier requesting interconnection, collocation of the requesting carrier's
equipment in the incumbent carriers' premises must be offered.

Unbundled Access. All incumbent carriers are required to provide
access to specified individual components of their networks, which are
sometimes referred to as unbundled network elements or UNE's, on
nondiscriminatory terms and at prices based on cost, which may include a
reasonable profit.

Number Portability. All incumbent carriers and competitive carriers
are required to permit users of communications services to retain their
existing telephone numbers without impairing quality, reliability or
convenience when switching from one common carrier to another.

Dialing Parity. All incumbent carriers and competitive carriers are
required to provide "1+" equal access dialing to competing providers of
long distance service, and to provide nondiscriminatory access to telephone
numbers, operator services, directory assistance and directory listing,
with no unreasonable dialing delays.

Access to Rights-of-Way. All incumbent carriers and competitive
carriers are required to permit competing carriers access to their poles,
ducts, conduits and rights-of-way at regulated prices.

Incumbent carriers are required to negotiate in good faith with carriers
requesting any or all of the above arrangements. If the negotiating carriers
cannot reach agreement within a predetermined amount of time, either carrier may
request arbitration of the disputed issues by the state regulatory commission.

Our business relies to a considerable degree on the use of incumbent
carrier network elements, which we access through collocation arrangements in
incumbent carrier offices. The terms and conditions, including prices, of these
network elements and collocation elements are largely dictated by regulatory
decisions, and changes in the availability or pricing of these facilities can
have significant effects on our business plan and operating results.

The requirement that incumbent carriers unbundle their network elements has
been implemented through rules adopted by the FCC. In January 1999, the United
States Supreme Court confirmed the FCC's broad authority to issue these rules,
but vacated a particular rule that defined the network elements the incumbent
carriers must offer. In a November 1999 order, the FCC reaffirmed that incumbent
carriers must provide unbundled access to a minimum of six network elements
including local loop and transport facilities (the elements in primary use by
us). In December 2001, the FCC initiated a review of the network elements
unbundling rules, and requested comments on whether to expand, reduce or change
the list of required elements. We anticipate that the proceeding will be
concluded during 2002, but we cannot predict what, if any, change the FCC will
make in the unbundling requirements. Also, in February 2002, the FCC requested
comments on a number of issues relating to regulation of broadband Internet
access services offered over telephone company facilities, including whether the
incumbent carriers should continue to be required to offer the elements of these
services on an unbundled basis. Any change in the existing rules that would
reduce the

11

obligation of incumbent carriers to offer network elements to us on an unbundled
basis could adversely affect our business plan.

The prices that incumbent carriers may charge for access to these network
elements will shortly be resolved, as the Supreme Court is considering whether
incumbent carriers should be required to price these network elements based on
the efficient replacement cost of existing technology, as the FCC methodology
now requires, or whether the price of these elements should be based on their
historical costs. The Court also will consider whether the FCC may require
incumbent carriers to combine certain previously uncombined elements at the
request of a competitive carrier. We cannot predict the outcome of this case. If
the Court requires changes in the existing pricing methodology, these changes
likely would be implemented over a period of a year or longer.

On November 8, 2001, the FCC initiated two rulemaking proceedings to
establish a core set of national performance measurements and standards for
evaluating an incumbent carrier's performance in provisioning wholesale
facilities and services to competitors. It seeks comment on a set of specific
performance measurements and on related issues of implementation, reporting
requirements, and enforcement mechanisms. We cannot predict the ultimate outcome
of these proceedings.

On August 8, 2001, in response to previous court decisions requiring
further consideration of some portions of its existing rules, the FCC adopted
new rules strengthening and clarifying the requirements for collocation of
competitive carriers' equipment in incumbent local carriers' central offices.
The new rules allow competitive carriers to collocate multifunction equipment,
including equipment with switching and routing capabilities, and require
incumbent carriers to provision cross-connects between carriers collocating in
their central offices. The FCC also established several principles to govern
incumbent carriers' space allocation practices, and required that space
allocation practices be reasonable and nondiscriminatory.

The Telecommunications Act also contains special provisions that replace
prior antitrust restrictions that prohibited the regional Bell operating
companies from providing long distance services and engaging in communications
equipment manufacturing. Before the passage of the Telecommunications Act, the
regional Bell operating companies were restricted to providing services within a
distinct geographical area known as a local access and transport area (LATA).
The Telecommunications Act permits the regional Bell operating companies to
provide interLATA long distance service immediately in areas outside of their
market regions and within their market regions once they have satisfied several
procedural and substantive requirements, including:

- a showing that the regional Bell operating company is subject to
meaningful local competition in the area in which it seeks to offer long
distance service; and

- a determination by the FCC that the regional Bell operating company's
entry into long distance markets is in the public interest.

Only two regional Bell operating companies have received approval from the
FCC to provide interLATA long distance services to date. The FCC has authorized
SBC to provide long distance services in Texas (granted June 6, 2000); Kansas
(granted January 22, 2001); Oklahoma (granted January 22, 2001); Arkansas
(granted November 16, 2001); and Missouri (granted November 16, 2001). It has
also approved Verizon's application in New York (granted December 22, 1999);
Massachusetts (granted April 16, 2001); Connecticut (granted July 20, 2001);
Pennsylvania (granted September 19, 2001); and Rhode Island (granted February
24, 2002). Several additional applications are pending before the FCC, and more
are expected to be filed in the near future.

In addition, legislation has been proposed in Congress that would eliminate
FCC review of Bell company applications for entry into the in-region interLATA
long distance market and compliance with the Telecommunications Act's
competitive checklist. If such legislation is enacted, it would significantly
erode the incentives of incumbent carriers to cooperate with competitors, and it
would have a very adverse impact on our ability to compete in the local market.
That bill, known as the Broadband Regulatory Relief Plan, would permit the Bell
operating companies to build data networks across LATA boundaries without having
to satisfy

12

the local market-opening requirements of the Telecommunications Act. The bill
was passed by the House in late February 2002, but no action has yet been
scheduled in the Senate.

On December 12, 2001, the FCC initiated a review of the current regulatory
requirements for incumbent carriers' broadband telecommunications services.
Incumbent carriers are generally treated as dominant carriers, and hence are
subject to certain regulatory requirements, such as tariff filings and pricing
requirements. In this proceeding, the FCC seeks to determine what regulatory
safeguards and carrier obligations, if any, should apply when a carrier that is
dominant in the provision of traditional local exchange and exchange access
services provides broadband service. A decision by the FCC to exempt the
incumbent carriers' broadband services from traditional regulation could have a
significant adverse competitive impact. We cannot reasonably predict the
ultimate outcome of this proceeding.

In several orders adopted in recent years, the FCC has made major changes
in the structure of the access charges incumbent carriers impose for the use of
their facilities to originate or complete interstate and international calls.
Under the FCC's plan, per-minute access charges have been significantly reduced,
and replaced in part with higher monthly fees to end-users and in part with a
new interstate universal service support system. Under this plan, the largest
incumbent carriers are required to reduce their average access charge to $0.0055
per minute over a period of time, and some of these carriers have already
reduced the target level.

In August 1999, the FCC adopted an order providing additional pricing
flexibility to incumbent carriers subject to price cap regulation in their
provision of interstate access services, particularly special access and
dedicated transport. The FCC eliminated rate scrutiny for "new services" and
permitted incumbent carriers to establish additional geographic zones within a
market that would have separate rates. Additional and more substantial pricing
flexibility will be given to incumbent carriers as specified levels of
competition in a market are reached through the collocation of competitive
carriers and their use of competitive transport. This flexibility includes,
among other items, customer specific pricing, volume and term discounts for some
services and streamlined tariffing. As part of the same August 1999 order, the
FCC initiated another proceeding to consider additional pricing flexibility
proposals for incumbent carriers. We cannot predict the outcome of this
proceeding, which may have an unfavorable effect on our business.

Under the Telecommunications Act, competitive local exchange carriers are
entitled to receive reciprocal compensation from other telephone companies for
delivering traffic to their customers. A dispute has existed for several years
on whether this compensation applies to calls bound for Internet service
provider clients of the competitive local exchange carriers. Most states have
required telephone companies to pay this compensation to competitive local
exchange carriers. In April 2001, however, the FCC adopted new rules limiting
the right of competitive local exchange carriers to collect compensation on
calls that terminate to Internet service providers, and preempting inconsistent
state rules. Under the new rules, which took effect on June 14, 2001, the amount
of compensation payable on calls to Internet service providers was limited to
$0.0015 per minute for the first six months after the rules took effect, $0.0010
per minute for the next eighteen months, and $0.0007 per minute thereafter. In
addition, the overall amount of compensation payable in each state is limited by
a provider based upon the number of minutes of Internet traffic terminated in
the first quarter of 2001. The FCC rules permit carriers to continue collecting
the existing higher rates on calls that terminate to customers who are not
Internet service providers. Any traffic exchanged between carriers that exceeds
a three to one ratio of terminating to originating minutes is presumed to be
Internet calls, although either carrier may attempt to rebut this presumption
and claim a different level of Internet traffic.

Internet service providers may be among our potential customers and these
new reciprocal compensation rules could limit our ability to service this group
of customers profitably. While some competitive carriers target Internet service
providers in order to generate additional revenues from reciprocal compensation
charges, at the present time we do not focus our marketing efforts on Internet
service providers. Therefore, these rules will have a minimal impact on us.

On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy program. This order established new
subsidies for telecommunications and information services provided to qualifying
schools, libraries and rural health providers. The FCC also expanded federal
subsidies

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for local dial-tone services provided to low-income consumers. Providers of
interstate telecommunications service, including us, must contribute to these
subsidies. In later years, the FCC created additional subsidies that primarily
benefit incumbent telephone companies. On a quarterly basis, the FCC announces
the contribution factor proposed for the next quarter. For the first quarter of
the year 2002, the contribution factor is $0.068086 of a provider's interstate
and international revenue for the third quarter of 2001. We intend to recover
our share of these costs through charges assessed directly to our customers and
participation in federally subsidized programs. The FCC is considering proposals
to change the way contributions are assessed, but we cannot predict when or
whether the FCC will act on these proposals.

In 1994, Congress passed the Communications Assistance for Law Enforcement
Act ("CALEA") to ensure that law enforcement agencies would be able to conduct
properly authorized electronic surveillance of digital and wireless
telecommunications services CALEA requires telecommunications carriers to modify
their equipment, facilities and services to ensure that they are able to comply
with authorized electronic surveillance requests. For circuit-switched
facilities, carriers such as us were required to comply with CALEA by November
19, 2001. As a result of litigation, the FCC extended the deadline for carriers
to implement the Department of Justice/Federal Bureau of Investigation "punch
list" capabilities until June 30, 2002. The FCC is expected to begin a
proceeding in the next few months to determine which of the six "punch-list"
capabilities carriers must implement.

STATE REGULATION

The implementation of the Telecommunications Act is subject to numerous
state rulemaking proceedings. As a result, it is currently difficult to predict
how quickly full competition for local services, including local dial-tone, will
be introduced.

To provide services within a state, we generally must obtain a certificate
of public convenience and necessity from the state regulatory agency and comply
with state requirements for telecommunications utilities, including state
tariffing requirements. To date, we have satisfied state requirements to provide
local and intrastate long distance services in the 8 states in which we
currently operate.

State regulatory agencies have jurisdiction over our intrastate services,
including our rates. State agencies require us to file periodic reports, pay
various fees and assessments and comply with rules governing quality of service,
consumer protection and similar issues. These agencies may also have to approve
the transfer of assets or customers located in the state, a change of control of
our company or our issuance of securities or assumption of debt. The specific
requirements vary from state to state. State regulatory agencies also must
approve our interconnection agreements with incumbent carriers. Price cap or
rate of return regulation for competitive carriers does not apply in any of our
current markets. However, we cannot assure you that the imposition of new
regulatory burdens in a particular state will not affect the profitability of
our services in that state.

LOCAL REGULATION

Our networks must comply with numerous local regulations such as building
codes, municipal franchise requirements and licensing. These regulations vary on
a city by city and county by county basis. In some of the areas where we provide
service, we may have to comply with municipal franchise requirements and may be
required to pay license or franchise fees based on a percentage of gross revenue
or other factors. Municipalities that do not currently impose fees may seek to
impose fees in the future. We cannot assure you that fees will remain at their
current levels following the expiration of existing franchises.

COMPETITION

The communications industry is highly competitive. We believe the principal
competitive factors affecting our business will be:

- pricing levels and policies,

- transmission speed,

14

- customer service,

- breadth of service availability,

- network security,

- ease of access and use,

- bundled service offerings,

- brand recognition,

- operating experience,

- capital availability,

- exclusive contracts,

- accurate billing, and

- variety of services.

To maintain our competitive posture, we believe we must be in a position to
reduce our prices to meet any reductions in rates by our competitors. Any
reductions could adversely affect us. Many of our current and potential
competitors have financial, personnel and other resources, including brand name
recognition, substantially greater than ours, as well as other competitive
advantages over us. In addition, competitive alternatives may result in
substantial customer turnover in the future. Many providers of communications
and networking services experience high rates of customer turnover.

A continuing trend toward consolidation of communications companies and the
formation of strategic alliances within the communications industry, as well as
the development of new technologies, could give rise to significant new
competitors. For example, WorldCom merged with MCI Communications and AT&T has
acquired Teleport Communications Group Inc., a competitive carrier, and
Tele-Communications, Inc., a cable, communications and high-speed Internet
services provider, and has merged with another cable television company,
MediaOne. Ameritech Corporation has merged with SBC, Bell Atlantic has merged
with GTE Corporation (to form Verizon Communications) and Qwest has merged with
US West. Following this wave of consolidation, there are now only four remaining
regional Bell operating companies. Time Warner and AOL also have merged. These
types of consolidations and other strategic alliances could put us at a
competitive disadvantage.

LOCAL DIAL-TONE SERVICES

Incumbent Carriers

In each of the markets we target, we will compete principally with the
incumbent carrier serving that area. We have not achieved and do not expect to
achieve a significant market share for any of our services. The incumbent
carriers have long-standing relationships with their customers, have financial,
technical and marketing resources substantially greater than ours and have the
potential to subsidize competitive services with revenues from a variety of
businesses. While recent regulatory initiatives which allow competitive carriers
to interconnect with incumbent carrier facilities provide increased business
opportunities for us, interconnection opportunities have been and likely will
continue to be accompanied by increased pricing flexibility for, and relaxation
of regulatory oversight of, the incumbent carriers.

Incumbent carriers have long-standing relationships with regulatory
authorities at the federal and state levels. The FCC recently proposed a rule
that would provide for increased pricing flexibility for incumbent carriers and
deregulation for competitive access services, either automatically or after
competitive levels are reached. If the incumbent carriers are allowed by
regulators to offer discounts to large customers through contract tariffs,
engage in aggressive volume and term discount pricing practices for their
customers, and/or seek to charge competitors excessive fees for interconnection
to their networks, our operating margins could be

15

materially adversely affected. Future regulatory decisions which give the
incumbent carriers increased pricing flexibility or other regulatory relief
could also have a material adverse effect on us.

Competitive Carriers/Long Distance Carriers/Other Market Entrants

We face, and expect to continue to face, competition from long distance
carriers, including AT&T, MCI WorldCom, and Sprint, seeking to enter, reenter or
expand entry into the local exchange market. We also compete with other
competitive carriers, resellers of local dial-tone services, cable television
companies, electric utilities, microwave carriers and wireless telephone system
operators.

The Telecommunications Act includes provisions which impose regulatory
requirements on all incumbent carriers and competitive carriers but grants the
FCC expanded authority to reduce the level of regulation applicable to these
common carriers. The manner in which these provisions of the Telecommunications
Act are implemented and enforced could have a material adverse effect on our
ability to successfully compete against incumbent carriers and other
communications service providers.

The Telecommunications Act radically altered the market opportunity for
competitive carriers. Many existing competitive carriers which entered the
market before 1996 had to build a fiber infrastructure before offering services.
With the Telecommunications Act requiring unbundling of the incumbent carrier
networks, competitive carriers are now able to more rapidly enter the market by
installing switches and leasing standard telephone lines and cable.

A number of competitive carriers have entered or announced their intention
to enter one or more of our markets. We believe that not all competitive
carriers, however, are pursuing the same target customers we pursue. We intend
to keep our prices at levels below those of the incumbent carriers while
providing, in our opinion, a higher level of service and responsiveness to our
customers. Innovative packaging and pricing of basic telephone services are
expected to provide competitive differentiation for us in each of our markets.

LONG DISTANCE SERVICES

The long distance services industry is very competitive and many long
distance providers experience a high average turnover rate as customers
frequently change long distance providers in response to offerings of lower
rates or promotional incentives by competitors. Prices in the long distance
market have declined significantly in recent years and are expected to continue
to decline. We expect to face increasing competition from companies offering
long distance data and voice services over the Internet. Companies offering
these services over the Internet could enjoy a significant cost advantage
because they do not currently pay common carrier access charges or universal
service fees.

DATA AND INTERNET SERVICES

We expect the level of competition with respect to data and Internet
services to intensify in the future. We expect significant competition from:

- Incumbent Carriers. Most incumbent carriers have announced deployment of
commercial DSL services. Some incumbent carriers have announced they
intend to aggressively market these services to their residential
customers at attractive prices. In addition, most incumbent carriers are
combining their DSL service with their own Internet service provider
businesses. We believe incumbent carriers have the potential to quickly
overcome many of the issues that have delayed widespread deployment of
DSL services in the past. The incumbent carriers have an established
brand name in their service areas, possess sufficient capital to deploy
DSL services rapidly and are in a position to offer service from central
offices where we may be unable to secure collocation space. When the
regional Bell operating companies begin providing long distance service,
they may be able to offer "one stop shopping" that would be competitive
with our offerings.

- Traditional Long Distance Carriers. Many of the leading traditional long
distance carriers, including AT&T, MCI WorldCom and Sprint, are expanding
their capabilities to support high-speed, end-to-end networking services.
We expect them to offer combined data, voice and video services over
their

16

networks. These carriers have extensive fiber networks in many
metropolitan areas that primarily provide high-speed data and voice
services to large companies. They could deploy DSL services in
combination with their current fiber networks. They also have
interconnection agreements with many incumbent carriers and have secured
collocation space from which they could begin to offer competitive DSL
services.

- Newer Long Distance Carriers. The newer long distance carriers,
including Williams Communications, Qwest Communications International and
Level 3 Communications, are building and managing high-speed networks
nationwide. They are also building direct sales forces and partnering
with Internet service providers to offer services directly to business
customers. They could extend their existing networks and offer high-speed
services using DSL, either alone or in partnership with others.

- Cable Modem Service Providers. Cable modem service providers are
offering, or are preparing to offer, high-speed Internet access over
cable networks to consumers and businesses. These networks provide
high-speed data services similar to our services, and in some cases at
higher speeds. These companies use a variety of new and emerging
technologies, including point-to-point and point-to-multipoint wireless
services, satellite-based networking and high-speed wireless digital
communications.

- Internet Service Providers. Internet service providers, including Yahoo,
Earthlink, Concentric and Verio, offer Internet portal services which
compete with our service. We offer basic web hosting and e-mail services
and anticipate offering an enhanced set of Internet products in the
future. The competitive Internet service providers generally provide more
features and functions than our current Internet portal.

- Wholesale DSL Carriers. DSL carriers, including Covad Communications
Group, Inc., offer DSL services and have significant strategic equity
investors, marketing alliances and product development partners.

Many of these competitors are offering, or may soon offer, DSL technologies
and services that will directly compete with us.

PERSONNEL

As of March 22, 2002, we had approximately 1,800 employees, a 10% decrease
over the approximate 2,000 employees at December 31, 2000.

We have non-disclosure and non-compete agreements with our executive
employees. None of our employees are represented by a collective bargaining
agreement.

RISK FACTORS

Investors should carefully consider the following risk factors before
making investment decisions regarding our stock.

WE MAY NEED SIGNIFICANT ADDITIONAL FUNDS THAT WE MAY NOT BE ABLE TO OBTAIN

We will require significant amounts of capital to fund the development of
our business and services as well as our operating costs and debt service. If we
cannot generate or otherwise obtain sufficient funds, this may have a negative
impact on our growth and our ability to compete in the communications industry.
We expect to fund our capital requirements through existing resources,
internally generated funds and debt or equity financing. We cannot assure you we
will be successful in raising sufficient debt or equity financing on acceptable
terms or at all.

On February 7, 2002, we announced that we could no longer confirm our prior
guidance of having sufficient cash to fund our operations into the first quarter
of 2003. On February 25, 2002, we announced that we had reached an agreement
with an informal committee representing approximately 66% of the outstanding

17

principal amount of our 13% Senior Notes due 2010 on a comprehensive
recapitalization plan that would eliminate a significant portion of our
long-term debt and all of our preferred stock. On March 22, 2002, we announced
that we had successfully completed our consent solicitation and that 99% of the
holders of our 13% Senior Notes due 2010 had signed voting agreements supporting
the comprehensive recapitalization plan that would eliminate a significant
portion of our long-term debt and all of our preferred stock. On March 22, 2002,
we also announced that more than two-thirds of the preferred shareholders had
signed voting agreements supporting the plan. We also announced that we were
voluntarily de-listing from NASDAQ and moving to the OTC Bulletin Board Service.
Finally, all our outside directors have resigned. The current board members,
Rolla P. Huff, Joseph M. Wetzel and S. Gregory Clevenger, are all officers of
the company.

We plan to implement our proposed recapitalization plan by commencing a
voluntary pre-negotiated Chapter 11 proceeding with respect to us and our
subsidiaries, Mpower Communications Corp. and Mpower Lease Corporation. This
Chapter 11 proceeding may also include other Mpower subsidiaries. Our
reorganized company is expected to have substantial capital needs, and based on
the current business plan, would only have sufficient cash to operate through
the end of 2002. Although we continue to have discussions with current and
potential new equity investors, as well as potential lenders, we cannot assure
you that any additional capital will be available to operate our business beyond
the end of 2002.

THERE IS A POSSIBILITY THAT THE PREVIOUSLY ANNOUNCED CHAPTER 11 BANKRUPTCY
FILING MAY NOT PROCEED AS ANTICIPATED

There are significant risks associated with our proposed Chapter 11
reorganization plan proceeding as planned.

- The proposed reorganization plan could evolve into a lengthy and
contested Chapter 11 bankruptcy case that could ultimately become a
Chapter 7 liquidation proceeding. The Bankruptcy Court could delay
confirming or fail to confirm our plan if it were to find that it was
reasonably unlikely that the reorganized company could obtain additional
financing necessary to fund our ongoing operations.

- We may require additional debt or equity to emerge from bankruptcy. We
cannot assure you that we will be successful in obtaining sufficient debt
or equity financing on acceptable terms or at all.

- The plan may not be confirmed by the Bankruptcy Court for a number of
reasons. For example, a non-accepting creditor of ours might challenge
the terms of the plan as not being in compliance with the Bankruptcy Code
and the Bankruptcy Court might rule in favor of the non-accepting
creditor's objections.

- The Bankruptcy Court may find that our solicitation of acceptances for
the plan does not comply with the requirements of the Bankruptcy Code. In
such an event, we may seek to re-solicit acceptances. Nonetheless,
confirmation of the plan would be delayed and possibly jeopardized.

- We cannot assure you that the plan will not require significant
modifications for confirmation, or that such modifications would not
require a re-solicitation of acceptances.

- Our filing of a bankruptcy petition and the publicity attendant thereto
may adversely affect our business. We believe that any such adverse
effects may worsen during the pendency of a protracted bankruptcy case if
the plan is not confirmed as planned.

- The commencement of our Chapter 11 bankruptcy filing may cause trade
suppliers and vendors to cease providing goods and services to us and our
subsidiaries.

- Because of the traditional stigma associated with any bankruptcy, our
commencement of a Chapter 11 bankruptcy case may adversely affect our
ability to retain and attract customers and/or highly-skilled personnel,
which could harm our business.

- In light of the difficult financial environment, and in particular the
lack of ready sources of either debt or equity financing for telecom
companies, we may not obtain adequate capital to exit the Chapter 11.

18

THE VALUE OF THE EQUITY SECURITIES TO BE ISSUED UNDER THE PROPOSED PLAN OF
REORGANIZATION MAY BE NEGATIVELY AFFECTED BY ADDITIONAL ISSUANCES OF EQUITY
SECURITIES BY THE REORGANIZED COMPANY AND GENERAL MARKET FACTORS

Issues or sales of equity securities by our reorganized company will likely
be heavily dilutive. Assuming the plan is approved and adopted, there will be no
restriction on our ability to issue additional equity securities, which may
include, but not be limited to, common stock, preferred stock and securities
exercisable or convertible into our common stock (including employee stock
options). There can be no certainty as to the effect, if any, that future
issuances or sales of such securities by our reorganized company, or the
availability of such equity securities for future issue or sale, would have on
the price of our common stock prevailing from time to time. Sales of substantial
amounts of equity securities of ours in the public or private market, a
perception in the market that such sales could occur, or the issuance of
securities exercisable or convertible into our stock could adversely affect the
prevailing price of our stock.

LACK OF TRADING MARKET FOR OUR SECURITIES

On March 22, 2002 we announced that we will voluntarily remove our common
stock and our Series D convertible preferred stock from their respective
listings on the NASDAQ. This voluntary removal may adversely affect the ability
of holders of our Series D preferred stock and common stock to sell their shares
because there will be no securities exchange or national automated quotation
system on which to trade our securities.

As a consequence of our move from the NASDAQ to the NASD OTC Bulletin
Board, it is expected that our stockholders will find it more difficult to buy
or sell shares of, or obtain accurate quotations as to the market value of our
common stock. In addition, our common stock may be substantially less attractive
as collateral for margin borrowings and loan purposes, for investment by
financial institutions under their internal policies or state legal investment
laws, or as consideration in future capital raising transactions.

THE MARKET FOR SECURITIES OF TELECOMMUNICATIONS COMPANIES HAS HISTORICALLY BEEN
VOLATILE

The prices for securities of emerging companies in the telecommunications
industry have been highly volatile. In addition, the stock market has
experienced volatility that has affected the market prices of equity securities
of many companies and that often has been unrelated to the operating performance
of such companies. These broad market fluctuations may adversely affect the
prevailing price of our securities.

WE EXPECT OUR LOSSES TO CONTINUE AND WE MAY NOT BE ABLE TO GENERATE SUFFICIENT
CASH FLOW TO MEET OUR DEBT SERVICE REQUIREMENTS

We recorded net losses before extraordinary items of $500.1 million in
2001, $224.6 million in 2000 and $69.8 million in 1999. In addition, we had
negative cash flow from operations of $219.2 million in 2001, $141.5 million in
2000 and $45.9 million in 1999. We do not generate enough cash flow to cover our
operating and investing expenses. Our historical earnings were insufficient to
cover combined fixed charges and dividends on preferred stock by $526.7 million
for the year ended December 31, 2001. Combined fixed charges and dividends
include interest and dividends, whether paid or accrued. We expect to record
significant net losses and generate negative cash flow from operations for the
foreseeable future. We cannot assure you that we will achieve or sustain
profitability or generate sufficient positive cash flow from operations to meet
our planned capital expenditures, working capital and debt service requirements.

OUR SUBSTANTIAL DEBT CREATES FINANCIAL AND OPERATING RISK

We have a substantial amount of debt. As of December 31, 2001, we had
approximately $430.7 million of total debt outstanding. The terms of our
outstanding debt limit, but do not prohibit, us from incurring additional debt.
For example, the indentures for our outstanding debt allow us to incur an
unlimited amount of debt to finance the cost of acquiring equipment used in our
business. While we have initiated a recapitalization plan to reduce our debt,
this plan may not be successful. Our existing level of debt could have important
consequences to you, including the following:

19

- It could limit our ability to obtain additional financing for working
capital, capital expenditures, and general corporate purposes;

- It could require us to dedicate a substantial portion of our cash flow
from operations to payments of principal and interest on our debt,
thereby reducing the funds available to us for other purposes, including
working capital, capital expenditures, and general corporate purposes;

- It could make us more vulnerable to changes in general economic
conditions or increases in prevailing interest rates; limiting our
ability to withstand competitive pressures and reducing our flexibility
in responding to changing business and economic conditions;

- It could limit our flexibility in planning for, or reacting to, changes
in our business and the industry in which we operate;

- It could place us at a competitive disadvantage compared to our
competitors that have less debt; and

- Our failure to comply with the restrictions contained in any of our
financing agreements could lead to a default which could result in our
being required to repay all of our outstanding debt.

OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF OUR INDEBTEDNESS WHEN
DUE

Our ability to make payments on and to refinance our indebtedness will
depend on our ability to generate cash flow in the future. We cannot assure you
that our business will generate sufficient cash flow from operations to meet our
debt service requirements. Our cash flow from operations may be insufficient to
repay our indebtedness at scheduled maturity and some or all of such
indebtedness may have to be refinanced. If we are unable to refinance our debt
or if additional financing is not available on acceptable terms, or at all, we
could be forced to dispose of assets under certain circumstances that might not
be favorable to realizing the highest price for the assets or to default on our
obligations with respect to our indebtedness.

OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE AND WILL BE DIFFICULT TO PREDICT

Our annual and quarterly operating results are likely to fluctuate
significantly as a result of numerous factors, many of which are outside of our
control. These factors include:

- our limited operating history, which makes predicting future results
difficult;

- the timing and willingness of traditional telephone companies to provide
us with central office space and the prices, terms and conditions on
which they make the space available to us;

- the amount and timing of capital expenditures and other costs relating to
the development of our networks and the marketing of our services;

- delays in the generation of revenue because certain network elements have
lead times that are controlled by incumbent carriers and other third
parties;

- the ability to develop and commercialize new services by us or our
competitors;

- the ability to deploy on a timely basis our services to adequately
satisfy customer demand;

- our ability to successfully operate our networks;

- the rate at which customers subscribe to our services;

- decreases in the prices for our services due to competition, volume-based
pricing and other factors;

- the development and operation of our billing and collection systems and
other operational systems and processes;

- the rendering of accurate and verifiable bills from the incumbent
carriers from whom we lease transport and resolution of billing disputes;

20

- the incorporation of enhancements, upgrades and new software and hardware
products into our network and operational processes that may cause
unanticipated disruptions; and

- the interpretation and enforcement of regulatory developments and court
rulings concerning the 1996 Telecommunications Act, interconnection
agreements and the antitrust laws.

THE TERMS OF OUR DEBT COVENANTS AND PREFERRED STOCK COULD LIMIT HOW WE CONDUCT
OUR BUSINESS AND OUR ABILITY TO RAISE ADDITIONAL FUNDS

The agreements which govern the terms of our debt contain covenants that
may restrict our ability to:

- incur additional debt;

- pay dividends and make other distributions;

- prepay subordinated debt;

- make investments and other restricted payments;

- create liens;

- sell assets; and

- engage in transactions with affiliates.

In addition, the terms of our outstanding preferred stock require us to
obtain the approval of the holders before we take specified actions.

Our future financing arrangements will likely contain similar or more
restrictive covenants. As a result of these restrictions, we may be:

- limited in how we conduct our business;

- unable to raise additional debt or equity financing to operate during
general economic or business downturns; and

- unable to compete effectively or to take advantage of new business
opportunities.

These restrictions may affect our ability to grow in accordance with our
plans.

OUR SUCCESS DEPENDS ON THE EFFECTIVENESS AND RETENTION OF OUR MANAGEMENT TEAM

Our business is managed by a small number of key management personnel, the
loss of some of whom could impair our ability to carry out our business plan. We
believe our future success will depend in large part on our ability to attract
and retain highly skilled and qualified personnel. We cannot assure you that our
senior management team will remain with us through the bankruptcy and
recapitalization processes. Under our circumstances, it may be difficult to find
suitable replacements for any departing management personnel. We do not maintain
key man insurance on our officers.

IF OUR EQUIPMENT DOES NOT PERFORM AS WE EXPECT, IT COULD DELAY OUR INTRODUCTION
OF NEW SERVICES

In implementing our strategy, we may use new or existing technologies to
offer additional services. We also plan to use equipment manufactured by
multiple vendors to offer our current services and future services in each of
our markets. If we cannot successfully install and integrate the technology and
equipment necessary to deliver our current services and any future services
within the time frame and with the cost effectiveness we currently contemplate,
we could be forced to delay or abandon the introduction of new services. This
could also affect our ability to attract and retain customers.

21

THE FAILURE OF OUR OPERATIONS SUPPORT SYSTEM TO PERFORM AS WE EXPECT COULD
IMPAIR OUR ABILITY TO RETAIN CUSTOMERS AND OBTAIN NEW CUSTOMERS OR RESULT IN
INCREASED CAPITAL EXPENDITURES

Our operations support system is expected to be an important factor in our
success. If the operations support system fails or is unable to perform as
expected, we could suffer customer dissatisfaction, loss of business or the
inability to add customers on a timely basis, any of which would adversely
affect our revenues. Furthermore, problems may arise with higher processing
volumes or with additional automation features, which could potentially result
in system breakdowns and delays and additional, unanticipated expense to remedy
the defect or to replace the defective system with an alternative system. Our
current system may not be adequate to scale our business.

OUR FAILURE TO MANAGE GROWTH COULD RESULT IN INCREASED COSTS

We may be unable to manage our growth effectively. This could result in
increased costs and delay our introduction of additional services. The
development of our business will depend on, among other things, our ability to
achieve the following goals in a timely manner, at reasonable costs and on
satisfactory terms and conditions:

- purchase, install and operate equipment, including DSL and T1 equipment;

- negotiate suitable interconnection agreements with, and arrangements for
installing our equipment at the central offices of, incumbent carriers on
satisfactory terms and conditions;

- hire and retain qualified personnel;

- lease suitable access to transport networks; and

- obtain required government authorizations.

We have experienced rapid growth since our inception, and we believe
sustained growth will place a strain on our operational, human and financial
resources. Our growth will also increase our operating complexity as well as the
level of responsibility for both existing and new management personnel. Our
ability to manage our growth effectively will depend on the continued
development of plans, systems and controls for our operational, financial and
management needs and on our ability to expand, train and manage our employee
base.

OUR SERVICES MAY NOT ACHIEVE SUFFICIENT MARKET ACCEPTANCE TO BECOME PROFITABLE

To be successful, we must develop and market services that are widely
accepted by businesses at profitable prices. Our success will depend upon the
willingness of our target customers to accept us as an alternative provider of
local, long distance, high-speed data and Internet services. Although we are in
the process of rolling out additional products and services, we might not be
able to provide the range of communication services our target business
customers need or desire.

OUR FAILURE TO ACHIEVE OR SUSTAIN MARKET ACCEPTANCE AT DESIRED PRICING LEVELS
COULD IMPAIR OUR ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW

Prices for data communication services have fallen historically, a trend we
expect will continue. Accordingly, we cannot predict to what extent we may need
to reduce our prices to remain competitive or whether we will be able to sustain
future pricing levels as our competitors introduce competing services or similar
services at lower prices. Our ability to meet price competition may depend on
our ability to operate at costs equal to or lower than our competitors or
potential competitors. There is a risk that competitors, perceiving us to lack
capital resources, may undercut our rates or increase their services or take
other actions in an effort to force us out of business. Our failure to achieve
or sustain market acceptance at desired pricing levels could impair our ability
to achieve profitability or positive cash flow.

22

OUR FAILURE TO SUCCESSFULLY TERMINATE OR SUBLEASE OUR SURPLUS SWITCH SITES,
OTHER FACILITIES AND COLLOCATIONS IN LINE WITH OUR ESTIMATES COULD ADVERSELY
AFFECT OUR FINANCIAL CONDITION

We have estimated the charges to be incurred in connection with our plans
to cancel: (1) our surplus collocation sites; (2) our entry into twelve markets
in the Northeast and Northwest and (3) our ongoing operations in several
markets. Our failure to successfully re-deploy or sell equipment no longer
required for these switch sites and collocations and our inability to terminate
or sublease the switch sites and collocations in line with our estimates could
adversely affect our financial condition.

IF WE ARE UNABLE TO NEGOTIATE AND ENFORCE FAVORABLE INTERCONNECTION AGREEMENTS
AND ARRANGEMENTS FOR INSTALLING OUR EQUIPMENT, WE COULD HAVE DIFFICULTY
OPERATING PROFITABLY IN OUR EXISTING MARKETS

We must negotiate and renew favorable interconnection agreements and
arrangements for installing our equipment with other companies, including
incumbent carriers, in markets we have entered. The rates charged to us under
the interconnection agreements might not continue to be low enough for us to
attract a sufficient number of customers and to operate the business on a
profitable basis. In addition, our interconnection agreements provide for our
connection and maintenance orders to receive attention on the same basis as the
incumbent carrier's customers and for the incumbent carriers to provide adequate
capacity to keep blockage within industry standards. However, from time to time,
we have experienced excessive blockage in the delivery of calls to and from the
incumbent carriers due to an insufficient number of phone lines installed by the
incumbent carriers between their switches and our switches. Blocked calls result
in customer dissatisfaction, which may result in the loss of business.

DELAYS BY THE INCUMBENT CARRIERS IN CONNECTING OUR CUSTOMERS TO OUR NETWORK
COULD RESULT IN CUSTOMER DISSATISFACTION AND LOSS OF BUSINESS

We rely on the timeliness of incumbent carriers and competitive carriers in
processing our orders for customers switching to our service and in maintaining
the customer's standard telephone lines to assure uninterrupted service. The
incumbent carriers are our competitors and have had little experience leasing
standard telephone lines to other companies. Therefore, the incumbent carriers
might not be able to continue to provide and maintain leased standard telephone
lines in a prompt and efficient manner as the number of standard telephone lines
requested by competitive carriers increases.

WE MAY NOT BE ABLE TO SERVICE OUR CUSTOMERS IF WE CANNOT SECURE SUFFICIENT
TELEPHONE LINES AND CABLE TO MEET OUR FUTURE NEEDS

We may not be able to renew our lease arrangements or obtain comparable
arrangements from other carriers in our existing markets. Because we lease
rather than construct telephone lines and cable in each of our markets, we would
be unable to service our customers if we are not able to obtain sufficient
telephone lines and cable. Our inability to lease sufficient telephone lines and
cable could result in the loss of customers and the inability to add new
customers.

OUR RELIANCE ON A LIMITED NUMBER OF EQUIPMENT SUPPLIERS COULD RESULT IN
ADDITIONAL EXPENSES

We currently rely and expect to continue to rely on a limited number of
third party suppliers to manufacture the equipment we require to implement our
DSL and T1 technologies. If our suppliers enter into competition with us, or if
our competitors enter into exclusive or restrictive arrangements with our
supplies it may materially and adversely affect the availability and pricing of
the equipment we purchase. Our reliance on third-party vendors involves a number
of additional risks, including the absence of guaranteed supply and reduced
control over delivery schedules, quality assurance, production yields and costs.

We cannot assure you that our vendors will be able to meet our needs in a
satisfactory and timely manner in the future or that we will be able to obtain
alternative vendors when and if needed. It could take a significant period of
time to establish relationships with alternative suppliers for critical
technologies and to introduce substitute technologies into our network. In
addition, if we change vendors, we may need to replace all or a

23

portion of the equipment deployed within our network at significant expense in
terms of equipment costs and loss of revenues in the interim.

THE TELECOMMUNICATIONS INDUSTRY IS HIGHLY COMPETITIVE WITH PARTICIPANTS THAT
HAVE GREATER RESOURCES THAN WE DO, AND WE MAY NOT BE ABLE TO COMPETE
SUCCESSFULLY

Our success depends upon our ability to compete with other
telecommunications providers in each of our markets, many of which have
substantially greater financial, marketing and other resources than we have. In
addition, competitive alternatives may result in substantial customer turnover
in the future. A growing trend towards consolidation of communications companies
and the formation of strategic alliances within the communications industry, as
well as the development of new technologies, could give rise to significant new
competitors. We cannot assure you that we will be able to compete successfully.
For more information regarding the competitive environment in which we operate,
please see "Competition."

IF WE ARE NOT ABLE TO OBTAIN OR IMPLEMENT NEW TECHNOLOGIES, WE MAY LOSE BUSINESS
AND LIMIT OUR ABILITY TO ATTRACT NEW CUSTOMERS

We may be unable to obtain access to new technology on acceptable terms or
at all. We may be unable to adapt to new technologies and offer services in a
competitive manner. If these events occur, we may lose customers to competitors
offering more advanced services and our ability to attract new customers would
be hindered. Rapid and significant changes in technology are expected in the
communications industry. We cannot predict the effect of technological changes
on our business. Our future success will depend, in part, on our ability to
anticipate and adapt to technological changes, evolving industry standards and
changing needs of our current and prospective customers.

A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS AND RESULT IN CUSTOMER DISSATISFACTION

Interruptions in service, capacity limitations or security breaches could
have a negative effect on customer acceptance and, therefore, on our revenues
and ability to attract new customers. Our networks may be affected by physical
damage, power loss, capacity limitations, software defects, breaches of security
by computer viruses, break-ins or otherwise and other factors which may cause
interruptions in service or reduced capacity for our customers.

IF WE ARE UNABLE TO EFFECTIVELY DELIVER DSL AND T1 SERVICES TO A SUBSTANTIAL
NUMBER OF CUSTOMERS, WE MAY NOT ACHIEVE OUR REVENUE GOALS

We cannot guarantee our network will be able to connect and manage a
substantial number of customers at high transmission speeds. If we cannot
achieve and maintain digital transmission speeds that are otherwise available in
the market, we may lose customers to competitors with higher transmission speeds
and we may not be able to attract new customers. While digital transmission
speeds of up to 1.5 Mbps are possible on portions of our network, that speed may
not be available over a majority of our network. Actual transmission speeds on
our network will depend on a variety of factors many of which are beyond our
control, including the distance an end user is located from a central office,
the quality of the telephone lines, the presence of interfering transmissions on
nearby lines and other factors.

WE MAY LOSE CUSTOMERS OR POTENTIAL CUSTOMERS BECAUSE THE TELEPHONE LINES WE
REQUIRE MAY BE UNAVAILABLE OR IN POOR CONDITION

Our ability to provide DSL services to potential customers depends on the
quality, physical condition, availability and maintenance of telephone lines
within the control of the incumbent carriers. If the telephone lines are not
adequate, we may not be able to provide DSL services to many of our target
customers and our expected revenues will be diminished. We believe the current
condition of telephone lines in many cases may be inadequate to permit us to
fully implement our DSL services. In addition, the incumbent carriers may not
maintain the telephone lines in a condition that will allow us to implement our
DSL services effectively or may

24

claim they are not of sufficient quality to allow us to fully implement or
operate our DSL services. Further, some customers use technologies other than
copper lines to provide telephone services, and as a result, DSL services might
not be available to these customers.

INTERFERENCE OR CLAIMS OF INTERFERENCE COULD RESULT IN CUSTOMER DISSATISFACTION

Interference, or claims of interference by the incumbent carriers, if
widespread, could adversely affect our speed of deployment, reputation, brand
image, service quality and customer satisfaction and retention. Technologies
deployed on copper telephone lines, such as DSL, have the potential to interfere
with other technologies on the copper telephone lines. Interference could
degrade the performance of our services or make us unable to provide service on
selected lines and the customers served by those lines. Although we believe our
DSL technologies, like other technologies, do not interfere with existing voice
services, incumbent carriers may claim the potential for interference permits
them to restrict or delay our deployment of DSL services. The procedures to
resolve interference issues between competitive carriers and incumbent carriers
are still being developed. We may be unable to successfully resolve interference
issues with incumbent carriers.

OUR SUCCESS WILL DEPEND ON GROWTH IN THE DEMAND FOR INTERNET ACCESS AND
HIGH-SPEED DATA SERVICES

If the markets for the services we offer, including Internet access and
high-speed data services, fail to develop, grow more slowly than anticipated or
become saturated with competitors, we may not be able to achieve our projected
revenues. The markets for business Internet and high-speed data services are in
the early stages of development. Demand for Internet services is highly
uncertain and depends on a number of factors, including the growth in consumer
and business use of new interactive technologies, the development of
technologies that facilitate interactive communication between organizations and
targeted audiences, security concerns and increases in data transport capacity.

In addition, the market for high-speed data transmission via DSL technology
is relatively new and evolving. Various providers of high-speed digital services
are testing products from various suppliers for various applications, and no
industry standard has been broadly adopted. Critical issues concerning
commercial use of DSL for Internet and high-speed data access, including
security, reliability, ease of use and cost and quality of service, remain
unresolved and may impact the growth of these services.

THE DESIRABILITY AND MARKETABILITY OF OUR INTERNET SERVICE MAY BE ADVERSELY
AFFECTED IF WE ARE NOT ABLE TO MAINTAIN RECIPROCAL RELATIONSHIPS WITH OTHER
INTERNET SERVICE PROVIDERS

The Internet is comprised of many Internet service providers and underlying
transport providers who operate their own networks and interconnect with other
Internet service providers at various points. As we continue the operation of
Internet services, connections to the Internet will be provided through
wholesale carriers. We anticipate as our volume increases, we will enter into
reciprocal agreements with other Internet service providers. We cannot assure
you other national Internet service providers will maintain reciprocal
relationships with us. If we are unable to maintain these relationships, our
Internet services may not be attractive to our target customers, which would
impair our ability to retain and attract customers. In addition, the
requirements associated with maintaining relationships with the major national
Internet service providers may change. We cannot assure you that we will be able
to expand or adapt our network infrastructure to meet any new requirements on a
timely basis, at a reasonable cost, or at all.

WE MAY INCUR LIABILITIES AS A RESULT OF OUR INTERNET SERVICE OFFERINGS

United States law relating to the liability of on-line service providers
and Internet service providers for information carried on, disseminated through,
or hosted on their systems is currently unsettled. If liability is imposed on
Internet service providers, we would likely implement measures to minimize our
liability exposure. These measures could require us to expend substantial
resources or discontinue some of our product or service offerings. In addition,
increased attention to liability issues, as a result of litigation, legislation
or legislative proposals could adversely affect the growth and use of Internet
services.

25

CHANGES IN LAWS OR REGULATIONS COULD RESTRICT THE WAY WE OPERATE OUR BUSINESS
AND NEGATIVELY AFFECT OUR COSTS AND COMPETITIVE POSITION

A significant number of the services we offer are regulated at the federal,
state and/or local levels. If these laws and regulations change or if the
administrative implementation of laws develops in an adverse manner, there could
be an adverse impact on our costs and competitive position. In addition, we may
expend significant financial and managerial resources to participate in
administrative proceedings at either the federal or state level, without
achieving a favorable result. We believe incumbent carriers and others may work
aggressively to modify or restrict the operation of many provisions of the
Telecommunications Act. We expect incumbent carriers and others to continue to
pursue litigation in courts, institute administrative proceedings with the FCC
and other regulatory agencies and lobby the United States Congress, all in an
effort to affect laws and regulations in a manner favorable to them and against
the interest of competitive carriers. We believe that the recent changes in the
make-up of the FCC and leadership changes in the Congress may create an
atmosphere that is more favorable to the incumbent carriers. For more details
about our regulatory situation, please see "Government Regulations".

WE MAY FACE CHALLENGES TO THE USE OF THE MPOWER TRADEMARK

Other companies utilizing trademarks that are similar to our trademark may
at some time challenge our use of the Mpower mark. A challenge to the mark could
result in litigation to defend our mark and could ultimately require us to adopt
a new trademark for our services and products.

AN ADVERSE DECISION IN AN APPEAL TO OUR CLASS ACTION LAWSUIT COMMENCED AGAINST
US COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION

On September 20, 2000, a class action lawsuit was commenced against us,
alleging violations of the Securities Exchange Act of 1934 and rule 10(b)-5
thereunder (the "Exchange Act") and Section 11 of the Securities Act of 1933.
While we have denied any wrongdoing and will vigorously contest the class action
lawsuit, any judgment that is significantly greater than our available insurance
coverage could have a material adverse effect on our results of operations
and/or financial condition. On February 11, 2002, the United States District
Court for the Western District of New York entered its Decision and Order
dismissing the class action lawsuit. That Decision and Order has been appealed
to the United States Court of Appeals for the Second Circuit. We cannot predict
the outcome of that appeal.

THE PRICES WE CHARGE FOR OUR SERVICES AND PAY FOR THE USE OF SERVICES OF
INCUMBENT CARRIERS AND OTHER COMPETITIVE CARRIERS MAY BE NEGATIVELY AFFECTED IN
REGULATORY PROCEEDINGS, WHICH COULD RESULT IN DECREASED REVENUES, INCREASED
COSTS AND LOSS OF BUSINESS

If we were required to decrease the prices we charge for our services or to
pay higher prices for services we purchase from incumbent carriers and other
competitive carriers, it would have an adverse effect on our ability to achieve
profitability and offer competitively priced services. We must file tariffs with
state and federal regulators which indicate the prices we charge for our
services. In addition, we purchase some tariffed services from incumbent
carriers and/or competitive carriers. The rates we pay for other services we
purchase from incumbent carriers and other competitive carriers are set by
negotiations between the parties. All of the tariffed prices may be challenged
in regulatory proceedings by customers, including incumbent carriers,
competitive carriers and long distance carriers who purchase these services.
These negotiated rates are also subject to regulatory review. On April 27, 2001,
the FCC released an order establishing benchmark rates for competitive local
carrier switched access charges. Under the order, competitive local carrier
access rates that are at or below the benchmark rates will be presumed to be
just and reasonable, and carriers like us may impose them by tariff. Above the
benchmark, these carriers' access service will be mandatorily detariffed, so the
competitive local carriers must negotiate higher rates with long distance
carriers. During the pendency of the negotiations, or if the parties cannot
agree, the local carrier must charge the long distance carrier the appropriate
benchmark rate. The FCC's order has been appealed by several parties, including
us, and is currently pending before the U.S. Court of Appeals for the D.C.
Circuit. While the outcome of the appeal cannot be predicted, with reasonable
certainty, if the court were to affirm the FCC's rules requiring us to

26

decrease our access charges, or if our costs were increased because we had to
negotiate access charges with all long distance providers, it could have an
adverse impact on our expected revenues and operating results. The prices
charged by incumbent carriers for unbundled network elements, collocations and
other services upon which we rely are determined by FCC rules that are currently
being received by the Supreme Court. Change in these prices resulting from a
court decision may adversely affect our business. For more details about our
regulatory situation, please see "Government Regulations".

OUR FORWARD-LOOKING STATEMENTS MAY MATERIALLY DIFFER FROM ACTUAL EVENTS OR
RESULTS

This Report contains "forward-looking statements," which you can generally
identify by our use of forward-looking words including "believe," "expect,"
"intend," "may," "will," "should," "could," "anticipate" or "plan" or the
negative or other variations of these terms or comparable terminology, or by
discussion of strategies that involve risks and uncertainties. We often use
these types of statements when discussing:

- our plans and strategies;

- our anticipation of profitability or cash flow from operations;

- the development of our business;

- the expected market for our services and products;

- our anticipated capital expenditures;

- changes in regulatory requirements; and

- other statements contained in this Report regarding matters that are not
historical facts.

We caution you these forward-looking statements are only predictions and
estimates regarding future events and circumstances. We cannot assure you we
will achieve the future results reflected in these statements.

ITEM 2. PROPERTY

We have leased office space in the Rochester, New York area, where we
maintain our corporate headquarters. The leased office space is 26,000 square
feet and expires during March 2005.

We also lease space in Las Vegas for our national customer service
operations, national network operating center and local sales personnel. This
lease expires in 2004. This facility is owned by a limited liability company,
which is principally owned by two of our former directors, Maurice J. Gallagher,
Jr. and Timothy P. Flynn.

We own property housing our switches in California, Illinois and Florida.
We also lease switch sites in Texas, Ohio, Michigan, Georgia, Florida, Nevada
and California expiring between 2005 and 2010. We have leased facilities to
house our local sales and administration staff in each market in which we
operate.

During 2001, we cancelled our plans to expand into twelve Northeast and
Northwest markets and closed down operations in twelve of the markets we had
recently opened, resulting in the elimination of more than 500 collocations. We
plan to reduce the future commitments associated with switch site and sales
office leases in turned down markets through negotiated settlements.

ITEM 3. LEGAL PROCEEDINGS

We are party to numerous state and federal administrative proceedings. In
these proceedings, we are seeking to define and/or enforce incumbent carrier
performance requirements related to:

- the cost and provisioning of those network elements we lease;

- the establishment of customer care and provisioning;

- the allocation of subsidies; and

27

- collocation costs and procedures.

The outcome of these proceedings will establish the rates and procedures by
which we obtain and provide leased network elements and could have a material
effect on our operating costs.

We have intervened on behalf of the FCC in an appeal filed by AT&T seeking
to overturn the FCC's declaratory ruling in CCB/CPD No. 01-02, in which the FCC
concluded that a long distance carrier may not refuse a call from/to an access
line served by a competitive local carrier with presumptively reasonable access
rates. We have appealed the FCC's order in CC Docket No. 96-262, in which the
FCC, among other things, established benchmark rates for competitive local
carrier switched access charges. We cannot predict the outcome of these appeals.

On September 20, 2000, a class action lawsuit was commenced against us and
our chief executive officer, Rolla P. Huff, in federal court for the Western
District of New York. On March 6, 2001, an amended consolidated class action
complaint was served in that action, seeking to recover damages for alleged
violations by us of the Securities Exchange Act of 1934 and rule 10(b)-5
thereunder (the "Exchange Act") and section 11 of the Securities Act of 1933.
The amended consolidated complaint also seeks to recover damages against several
of our officers and members of our board of directors in addition to Mr. Huff.
The amended consolidated complaint also names various underwriters as defendants
in the action. On February 11, 2002, the Court issued its Decision and Order
dismissing the class action lawsuit. The decision of the Court has been appealed
to the Court of Appeals for the Second Circuit and the final outcome of this
lawsuit is uncertain.

On August 1, 2001, we were named in a judicial complaint seeking
declaratory relief for certain obligations to Fir Tree Partners, a bondholder of
ours. On November 8, 2001, the New York State Supreme Court granted our motion
to dismiss the complaint. No appeal was taken by Fir Tree Partners from the
dismissal.

From time to time, we engage in other litigation and governmental
proceedings in the ordinary course of our business. We do not believe any other
pending litigation or governmental proceeding will have a material adverse
effect on our results of operations or financial condition.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None.

28

PART II

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

MARKET INFORMATION

Our common stock, $0.001 par value, traded on the NASDAQ National Market
(the "NASDAQ") under the symbol "MGCX" from May 11, 1998 (the date of our
initial public offering) until February 18, 2000. On February 18, 2000, our
common stock began trading under the symbol "MPWR." As of March 22, 2002, there
were approximately 265 holders of record of our common stock. The following sets
forth the reported high and low sale prices for the common stock for each
quarterly period in fiscal 2000 and 2001, as adjusted for the three-for-two
stock split paid in the form of a 50% stock dividend on August 28, 2000.

As of March 22, 2002, the closing price of our common stock was $0.04. On
March 22, 2002 we announced that we will voluntarily move from the NASDAQ to the
NASD Over the Counter Bulleting Board, a regulated quotation service that
displays real-time quotes, last-sale prices and volume information in
over-the-counter ("OTC") equity securities. We expect tha