<PAGE>   1
 
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                                  FORM 10-KSB
 
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
   SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
                COMMISSION FILE NOS. 333-04603 AND 333-04603-01
 
                         NEXTLINK COMMUNICATIONS, INC.
         A WASHINGTON CORPORATION       I.R.S. EMPLOYER NO. 91-1738221
 
                             NEXTLINK CAPITAL, INC.
         A WASHINGTON CORPORATION       I.R.S. EMPLOYER NO. 91-1716062
 
         155 108TH AVENUE, N.E., 8TH FLOOR, BELLEVUE, WASHINGTON 98004
                        TELEPHONE NUMBER (425) 519-8900
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                    CLASS A COMMON STOCK, PAR VALUE $0.0227
 
     Indicate by check mark whether the Issuers (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days.  Yes [X]  No [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Registration S-B is not contained herein, and will not be contained, to
the best of Registrants' knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
 
     The Issuers' revenues for its most recent fiscal year were $57,579,000.
 
     The aggregate market value of the Class A and Class B Common Stock held by
non-affiliates of the Issuers, based upon the closing sale price of the Common
Stock on March 6, 1998 as reported on the NASDAQ National Market System, was
approximately $706,098,643. Shares of Class A and Class B Common Stock held by
each executive officer and director and by each person who owns 5% or more of
the outstanding Class A and Class B Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
 
     As of March 6, 1998, the number of outstanding shares of NEXTLINK
Communications, Inc.'s Class A Common Stock was 19,249,940 and Class B Common
Stock was 34,247,644. NEXTLINK Capital, Inc. had outstanding 1,000 shares of
Common Stock, par value $0.01 per share.
 
     NEXTLINK Capital, Inc. ("NEXTLINK Capital" and together with the Company,
the "Issuers") meets the conditions set forth in General Instruction G(1)(a) and
(b) of Form 10-KSB and is therefore filing this form with the reduced disclosure
format.
 
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                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
ITEM                                                                 PAGE
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<C>    <S>                                                           <C>
                                 PART I
 1.    Description of Business.....................................    1
 2.    Description of Properties...................................   21
 3.    Legal Proceedings...........................................   21
 4.    Submission of Matters to a Vote of Security Holders.........   21
 
                                 PART II
 5.    Market for Registrants' Common Stock and Related Stockholder
       Matters.....................................................   21
 6.    Management's Discussion and Analysis of Financial Condition
       and Results of Operations...................................   22
 7.    Financial Statements and Supplementary Data.................   34
 8.    Changes in and Disagreements with Accountants on Accounting
       and Financial Disclosure....................................   34
 
                                PART III
 9.    Directors and Executive Officers of the Company.............   35
10.    Executive Compensation......................................   40
11.    Security Ownership of Certain Beneficial Owners and
       Management..................................................   40
12.    Certain Relationships and Related Transactions..............   40
13.    Exhibits, Financial Statement Schedules, and Reports on Form
       8-K.........................................................   41
</TABLE>
 
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                         NEXTLINK COMMUNICATIONS, INC.
                             NEXTLINK CAPITAL, INC.
 
                                     PART I
 
ITEM 1. DESCRIPTION OF BUSINESS
 
     Capitalized terms used herein which are not otherwise defined have the
respective meanings ascribed to them in the Glossary, beginning on page 19.
 
OVERVIEW
 
     NEXTLINK Communications, Inc. ("NEXTLINK" or the "Company") was founded in
1994 by Craig O. McCaw, its largest and controlling shareholder, to provide
local facilities-based telecommunications services to its targeted customer base
of small and medium-sized businesses. In July 1996, NEXTLINK became one of the
first competitive local exchange carriers ("CLECs") in the United States to
provide facilities-based switched local services under the Telecommunications
Act of 1996 (the "Telecom Act"), which opened the entire local exchange market
to competition. In each of the markets it serves, NEXTLINK seeks to become a
principal competitor to the incumbent local exchange carrier ("ILEC") for its
targeted customers by providing an integrated package of high quality local,
long distance and enhanced telecommunications services at competitive prices. In
October 1997, the Company completed an initial public offering of shares of its
Class A Common Stock.
 
     The market potential for competitive telecommunications services is large
and growing. Industry sources estimate that in 1996 the total revenues from
local and long distance telecommunications services were approximately $183
billion, of which approximately $101 billion were derived from local exchange
services and approximately $82 billion from long distance services. Based upon
FCC information, aggregate revenues for local and long distance services grew at
a compounded annual rate of approximately 5.5% between 1991 and 1996. The
Telecom Act, the FCC's issuance of rules for competition and pro-competitive
policies developed by state regulatory commissions, has created opportunities
for new entrants, including the Company, to capture a portion of the ILEC's
dominant, and historically monopoly controlled, market share of local services.
The development of switched local services competition, however, is in its early
stages, and the Company believes that CLECs currently serve fewer than 5% of the
total business lines in the United States.
 
     The Company's targeted customer base within the national telecommunications
market is small to medium-sized businesses, generally those businesses with
fewer than 50 access lines. Based on consultants' reports, the Company estimates
that as of year end 1996, there were approximately 170 million access lines
nationwide, including approximately 55 million business lines.
 
     The Company develops and operates high capacity, fiber optic networks with
broad market coverage in a growing number of markets across the United States.
In its switched local service markets, the Company offers its customers a
bundled package of local and long distance services and also offers dedicated
transmission and competitive access services to long distance carriers and end
users. In addition, NEXTLINK offers several non-network-based enhanced
communications services to customers nationwide, including a variety of
interactive voice response ("IVR") products.
 
     The Company currently operates 16 facilities-based networks providing
switched local and long distance services in 26 markets in eight states. The
Company anticipates developing additional new markets during 1998 which,
together with its existing markets, are expected to have a total of
approximately 15 million addressable business lines by the end of 1998. The
Company's goal is to add or expand markets to increase its addressable business
lines for markets in service or under development to approximately 21 million by
the end of 1999.
<PAGE>   4
 
     The Company's goal of targeting 15 million addressable business lines by
year end 1998 represents a 36% increase over the Company's previous objective.
The Company has increased its line targets based principally on three factors:
initial success in establishing networks and launching services in major
metropolitan markets in Los Angeles, Chicago and Philadelphia; the Company's
significant growth in the sale and installation of access lines throughout all
markets; and the Company's review of several potential target markets, which
underlined the significant market opportunities available to NEXTLINK in those
markets.
 
     NEXTLINK is pursuing its targeted customer base in markets of all sizes. In
larger markets, the Company has operational networks in Los Angeles, Chicago and
Philadelphia, and networks under development in New York City, the San Francisco
Bay Area and Atlanta. The Company also has operational networks in medium-sized
markets such as Las Vegas and Nashville as well as smaller markets that have
been clustered in Orange County, California and central Pennsylvania. The
Company will enter large markets on a stand-alone basis where it is economically
attractive to do so and where competitive and other market factors warrant such
entry. The Company also considers pursuing smaller markets where it can extend
or cluster an existing network with relatively little incremental capital. The
Company anticipates that the addressable business lines in the larger markets
that it is currently operating and developing will represent the majority of the
Company's addressable business lines by year end 1998 and 1999.
 
     NEXTLINK has experienced significant growth in its customer base.
NEXTLINK's customer access lines in service have increased from 8,511 access
lines at December 31, 1996 to 50,131 access lines at December 31, 1997. This
growth is attributable to both new network launches as well as significant
increases in growth rates in those markets where the Company launched service in
1996. For markets launched in 1996, the Company has increased its access lines
in service by 248%, from 8,511 to 29,591 at December 31, 1996 and 1997,
respectively, representing 51% of the Company's overall increase in access lines
in service over the respective periods. The Company has also improved the
quarterly rate of access line installations from 1,604 in the fourth quarter of
1996 to 19,187 in the fourth quarter of 1997. Approximately 32% of the increase
in total quarterly installations was driven by an increase in quarterly
installations in those markets launched in 1996, where installations increased
from 1,604 in the fourth quarter 1996 to 7,293 in the fourth quarter of 1997.
 
     NEXTLINK believes that a critical factor in the successful implementation
of its strategy is the quality of its management team and their extensive
experience in the telecommunications industry. The Company has built a
management team that it believes is well suited to challenge the dominance of
the ILECs in the local exchange market. Craig O. McCaw, the Company's founder
and largest and controlling shareholder, Steven W. Hooper, the Company's
Chairman of the Board, Wayne M. Perry, the Company's Vice Chairman and Chief
Executive Officer, James F. Voelker, the Company's President, and George M.
Tronsrue III, the Company's Chief Operating Officer, each has 15 or more years
of experience in leading companies in competitive segments of the
telecommunications industry. In addition, the presidents of the Company's
operating subsidiaries and the Company's senior officers have an average of 14
years of experience in the telecommunications industry. Mr. Hooper and Mr. Perry
were members of the senior management team at McCaw Cellular Communications,
Inc. ("McCaw Cellular") during the years in which it became the nation's largest
cellular telephone company. Following McCaw Cellular's sale to AT&T Corp. in
1994, Messrs. Perry and Hooper were Vice Chairman and Chief Executive Officer,
respectively, of AT&T Wireless Services, Inc.
 
MARKET OPPORTUNITY
 
     Prior to 1984, AT&T Corp. ("AT&T") dominated both the local exchange and
long distance marketplace by owning the operating entities that provided both
local exchange and long distance services to most of the U.S. population. While
long distance competition began to emerge in the late 1970s, the critical event
triggering the growth of long distance competition was the breakup of AT&T and
the separation of its local and long distance businesses as mandated by the
Modified Final Judgment relating to the breakup of AT&T (the "MFJ"). To foster
competition in the long distance market, the MFJ prohibited AT&T's divested
local exchange businesses, the Regional Bell Operating Companies ("RBOCs"), from
acting as a single source provider of telecommunications services.
 
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     The Company believes that a similarly critical event occurred in 1996 with
the passage of the Telecom Act. In most locations throughout the United States,
the ILEC has operated with a virtual monopoly over the provision of most local
exchange services. However, just as competition slowly emerged in the long
distance business prior to the MFJ, competitive opportunities also have slowly
emerged over the last 10 years at the local level.
 
     Industry sources estimate that in 1996 the total revenues from local and
long distance telecommunications services were approximately $183 billion, of
which approximately $101 billion were derived from local exchange services and
approximately $82 billion from interLATA long distance services. Based upon FCC
information, aggregate revenues for local and long distance services grew at a
compounded annual rate of approximately 5.5% between 1991 and 1996. Although the
MFJ relating to the breakup of AT&T established the preconditions for
competition in the market for long distance services in 1984, the market for
local exchange services has been, until recently, virtually closed to
competition and has largely been dominated by regulated monopolies. Efforts to
open the local exchange market began in the late 1980s on a state-by-state basis
when competitive access providers ("CAPs") began offering dedicated private line
transmission and special access services. These types of services together
currently account for approximately 12% of the total local exchange revenues.
CAPs were restricted, often by state laws, from providing the other, more
frequently used services such as basic and switched services, which today
account for approximately 88% of local exchange revenues.
 
     The Telecom Act and the FCC's issuance of rules for competition,
particularly those requiring the interconnection of all networks and the
interchange of traffic among the ILECs and the CLECs, as well as pro-competitive
policies already developed by state regulatory commissions, have caused
fundamental changes in the structure of the local exchange markets. Although a
recent decision by the United States Court of Appeals for the Eighth Circuit
substantially limits the FCC's jurisdiction and expands the state regulators'
jurisdiction to set and enforce rules governing the development of local
competition, most states have already begun to establish rules for local
competition that are consistent with the FCC rules overturned by the Eighth
Circuit. See "-- Regulatory Overview."
 
     These developments create opportunities for new entrants offering local
exchange services to capture a portion of the ILEC's dominant, and historically
monopoly controlled, market share of local services. The development of switched
local services competition, however, is in its early stages and the Company
believes that CLECs currently serve fewer than 5% of the total business lines in
the United States.
 
     NEXTLINK believes that the provisions of the Telecom Act requiring the
ILECs to cooperate on a technical level with competitors are as significant as
the Telecom Act's provisions eliminating state laws barring competitors from
entering the local exchange services market. Under the Telecom Act, the FCC and
state regulators are required to ensure that ILECs implement:
 
     -  Interconnection -- provides competitors the right to connect to the
        ILECs' networks at any technically feasible point and to obtain access
        to its rights-of-way;
 
     -  Unbundling of the Local Network -- allows competitors to purchase and
        utilize components of the ILECs' network selectively;
 
     -  Reciprocal Compensation -- establishes the framework for pricing between
        the CLEC and the ILEC for use of each other's networks; and
 
     -  Number Portability -- allows ILEC customers to retain their current
        telephone numbers when they switch to a CLEC.
 
     In addition, the Telecom Act provides that ILECs that are subsidiaries of
RBOCs cannot combine in-region, long distance services across local access and
transport areas ("LATAs") with the local services they offer until they have
demonstrated that they have complied with certain regulatory requirements
relating to local competition. See "-- Regulatory Overview." One federal
district court has ruled that the Telecom Act's restrictions on RBOC long
distance entry are unconstitutional. This decision has been stayed pending
appeal. See " -- Federal legislation." The Company believes it will have an
opportunity to gain market share in
 
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certain markets by combining local and long distance services in a single
offering to its customers before that market's ILEC, if it is a subsidiary of a
RBOC, is permitted to do so.
 
BUSINESS STRATEGY
 
     The Company has built an end user-focused, locally oriented organization
dedicated to providing switched local and long distance telephone service at
competitive prices to small and medium-sized businesses. The key components of
the Company's strategy to become a leading provider of competitive
telecommunications services and to maximize penetration of its targeted customer
base are:
 
          Provide Integrated Telecommunications Services to Small and
     Medium-Sized Businesses. The Company primarily focuses its sales efforts
     for switched local and long distance services on small and medium-sized
     businesses and professional groups, those businesses having fewer than 50
     business lines. The Company's market research indicates that these
     customers prefer a single source for all of their telecommunications
     requirements, including products, billing, installation, maintenance and
     customer service. The Company has chosen to focus on this segment based on
     its expectations that higher gross margins will generally be available on
     services provided to these customers as compared with larger business, and
     that ILECs may be less likely to apply significant resources towards
     retaining these customers. The Company expects to attract and retain these
     customers through a direct sales effort by offering: (i) bundled local and
     long distance services, as well as the Company's enhance communications
     services; (ii) up to a 10% to 15% discount to comparable pricing by the
     ILEC as well as promotional discounts, depending on the individual market;
     and (iii) responsive customer service and account management provided on a
     local level.
 
          Foster Decentralized Local Management and Control. The Company
     believes that its success is enhanced by building locally based management
     teams that are responsible for the Company's success in each of their
     operational markets. The Company has recruited experienced entrepreneurs
     and industry executives as presidents of each of the Company's operating
     subsidiaries, many of whom have previously built and led their own start-up
     telecommunications businesses. The local presidents and their teams are
     charged with achieving growth objectives in their respective markets and
     have decision making authority in key operating areas, including customer
     care, network growth and building connectivity, and managing the
     relationship and provisioning efforts with the ILEC. The Company has
     established an incentive based compensation policy for these management
     teams that is based upon the achievement of targeted growth and operational
     objectives. The Company believes that this local management focus will
     provide a critical competitive edge in customer acquisition and retention
     in each market.
 
          Further Develop Effective Direct Sales and Customer Care
     Organizations. NEXTLINK is building a highly motivated and experienced
     direct sales force and customer care organization that is designed to
     establish a direct and personal relationship with its customers. The
     Company has expanded its sales force from 98 salespeople at year end 1996
     to 223 salespeople at December 31, 1997. The Company expects to further
     increase its sales force to approximately 350 salespeople by year end 1998.
     Salespeople are given incentives through a commission structure that
     targets 40% of a salesperson's compensation to be based on performance. To
     ensure customer satisfaction, each customer will have a single point of
     contact for customer care who is responsible for solving problems and
     responding to customer inquiries. The Company has expanded its customer
     care organization from 36 customer care employees at year end 1996 to 162
     customer care employees at December 31, 1997. The Company expects to
     further increase its customer care organization to approximately 275
     customer care employees by year end 1998.
 
          Continuously Improve Provisioning Processes to Accelerate Revenue
     Growth. The Company believes that a significant ongoing challenge for CLECs
     will be to continuously improve provisioning systems, which include the
     complex process of transitioning ILEC customers to the Company's network.
     Accordingly, the Company will continue to identify and focus, as a key
     competitive strategy, on implementing best provisioning practices in each
     of its markets that will provide for rapid and seamless transitions of
     customers from the ILEC to the Company. To support the provisioning of its
     services, the Company has begun the long-term development and
     implementation of a comprehensive information
 
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<PAGE>   7
 
     technology platform geared toward delivering information and automated
     ordering and provisioning capability directly to the end user as well as to
     the Company's internal staff. The Company believes that these practices and
     its comprehensive information technology platform, as developed, will
     provide the Company with a long-term competitive advantage and allow it to
     more rapidly implement switched local services in its markets and to
     shorten the time between the receipt of a customer order and the generation
     of revenues. The Company's improving capacity to provision access lines to
     its networks is reflected in the number of access lines installed per
     business day. For those markets in which the Company has offered switched
     local services since 1996, the rate increased from 44 installations per
     business day in the first quarter of 1997 to 309 per business day in the
     fourth quarter of 1997.
 
          Develop High Capacity Fiber Optic Networks with Broad Market
     Coverage. NEXTLINK designs its networks with a long-term view focusing on
     three key elements. First, the Company designs and builds its networks to
     provide extensive coverage of those areas where the density of business
     lines is highest and to enable the Company to provide direct connections to
     a high percentage of nearby commercial buildings and ILEC central offices
     situated near the network. Over time, this broad coverage is expected to
     result in a higher proportion of traffic that is both originated and
     terminated on the Company's networks, which should provide higher long-term
     operating margins. In addition, the Company is participating in the FCC's
     Local Multipoint Distribution Service ("LMDS") auction which, depending on
     the bidding and deployment costs, may offer an economically efficient means
     to supplement the Company's fiber network build-out in some localities.
     Furthermore, a wireless local loop alternative may create competitive
     pressure on high unbundled loop costs in certain areas. Second, the Company
     constructs high capacity networks that utilize large fiber bundles capable
     of carrying high volumes of voice, data, video and Internet traffic as well
     as other high bandwidth services. This strategy should reduce potential
     "overbuild" costs and provide added network capacity as the Company adds
     high bandwidth services in the future. In Atlanta, Chicago, New York and
     Newark, New Jersey, the Company will utilize leased dark fiber and fiber
     capacity to launch facilities-based services and begin building a customer
     base in advance of completing construction of its own fiber optic network
     in these markets. Third, the Company employs a uniform technology platform
     based on Nortel DMS 500 switches, associated distribution technology and
     other common transmission technologies enabling the Company to (i) deploy
     features and functions quickly in all of its networks, (ii) expand
     switching capacity in a cost effective manner and (iii) lower maintenance
     costs through reduced training and spare parts requirements. The Company
     currently has 12 operational Nortel DMS 500 switches, including one
     installed switch at the Company's testing and network operations control
     center ("NEXTLAB"). For economic or strategic reasons, the Company may in
     the future elect to utilize other switch vendors and may also acquire and
     utilize non-Nortel switches in connection with acquisitions of other
     companies. The Company plans to install three additional Nortel DMS 500
     switches by June 1998. The Company also utilizes unbundled loops from the
     ILEC to connect the Company's switch and network to end user buildings and
     is evaluating other alternatives for building connectivity, including
     wireless connections, for the "last mile" of transport.
 
          Continue Market Expansion. The Company's goal is to add markets and
     market clusters to increase its addressable business lines to approximately
     15 million by the end of 1998 and 21 million by the end of 1999. The
     Company anticipates continued expansion into new geographic areas,
     including additional large markets, as opportunities arise either through
     building new networks, acquiring existing networks or other
     telecommunications companies, or acquiring or leasing dark fiber and fiber
     capacity. NEXTLINK also believes that its strategy of operating its
     networks in clusters (i) offers substantial advantages including economies
     of scale in management, marketing, sales and network operations, (ii)
     enables the Company to capture a greater percentage of regional traffic and
     to develop regional pricing plans, because the Company believes that a
     significant level of traffic terminates within 300 miles of its origination
     and (iii) provides opportunities in smaller markets that are too small to
     develop on a stand-alone basis.
 
          Offer Enhanced Communications Services. NEXTLINK offers customers
     value-added services such as the Company's IVR products that are not
     dependent on the Company's local facilities. The Company offers its
     enhanced communications services in all of its markets, as well as in areas
     of planned
 
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     network expansion. The Company believes these services increase its
     visibility in attracting local exchange customers when it operates networks
     in these markets.
 
THE COMPANY'S TELECOMMUNICATIONS SERVICES
 
  LOCAL AND LONG DISTANCE SERVICES
 
     The Company commenced the offering of switched local and long distance
services in seven markets on July 4, 1996, and in 18 additional markets in 1997.
In February 1998, the Company launched switched local and long distance services
in Chicago, Illinois and expects to commence the offering of switched local and
long distance services in additional markets, including the south San Francisco
Bay Area, New York City, Atlanta and Newark (NJ) areas, during the remainder of
1998. The Company focuses its product offering on basic telecommunications
services, which it believes are the core of local exchange services. Pricing,
which is determined and implemented by the Company's operating subsidiary in
each local market, has been generally 10% to 15% lower than the pricing for
comparable local services from the ILEC and the Company also makes promotional
offering prices available from time to time. The Company's current product
offering includes:
 
     -  Standard dial tone, including touch tone dialing, 911, and operator
        assisted calling;
 
     -  Multi-trunk services, including direct inward dialing (DID) and direct
        outward dialing (DOD);
 
     -  Long distance service, including 1+, 800/888 and operator services;
 
     -  Voice messaging with personalized greetings, send, transfer, reply and
        remote retrieval capabilities; and
 
     -  Directory listings and assistance.
 
     Currently, the Company offers CAP services in 26 markets, focusing on long
distance carriers and the private line needs of high volume customers. In
addition, data services that are currently offered by the Company include
Ethernet, TOKEN rings, and Fiber Distributed Data Interface (FDDI).
 
     The Company's CAP services, which are used as both primary and back-up
circuits, fall into three principal categories: (1) special access circuits that
connect end users to long distance carriers, (2) special access circuits that
connect long distance carriers' facilities to one another and (3) private line
circuits that connect several facilities owned by the same end user.
 
  ENHANCED COMMUNICATIONS SERVICES
 
     NEXTLINK's IVR platform allows a consumer to dial into a computer-based
system using a toll-free number and a touch tone phone and, by following a
customized menu, to access a variety of information and to leave,
simultaneously, a profile of the caller behind for use by either NEXTLINK or its
clients. Currently, NEXTLINK provides four types of IVR services:
 
     -  LeaveWord -- prompts the consumer to leave messages of any length or
        complexity, ranging from catalog requests and contest entries to
        specific product questions and surveys;
 
     -  Dealer Locator -- helps a consumer to locate the nearest dealer of the
        client's products by instantly identifying the consumer's area and
        responding with the names, addresses and phone numbers of the client's
        locations within any desired mileage radius;
 
     -  Automated Order Entry -- allows consumers to purchase products using the
        interactive phone service 24-hours a day, with real-time order and
        credit card confirmation as well as arranging for delivery of the new
        item to the consumer's desired address; and
 
     -  Interactive Call Center -- provides the consumer with a menu of
        selections that include Dealer Locator, Automated Order Entry and other
        functions, including receiving a catalog, registering the warranty of a
        product, contest entry and an option for callers to be forwarded to a
        live operator.
 
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<PAGE>   9
 
     The Company anticipates that it will continue to explore other enhanced
communications services opportunities and may acquire, invest in or establish
marketing relationships with additional service providers in the future that
support its overall business and marketing strategies.
 
SALES AND CUSTOMER CARE
 
  OVERVIEW
 
     The Company utilizes a two-pronged sales strategy in each of its markets,
one directed to the sale of local and long distance services and the other to
enhanced communications services. The primary sales efforts in the Company's
markets are for switched local and long distance services focusing on small and
medium-sized businesses and professional groups with fewer than 50 business
lines. The Company's market research indicates that these customers prefer a
single source for all of their telecommunications requirements, including
products, billing, installation, maintenance and customer service. The Company
utilizes a direct sales effort offering combined local and long distance
services with prices that are generally at a 10% to 15% discount from the ILEC.
Providing a combination of local and long distance services provides the
Company's customers a level of convenience that has been generally unavailable
since the break-up of AT&T. The Company is also marketing its enhanced
communications services through a separate direct sales force in each market,
which is expected to increase the number of customers for all of NEXTLINK's
telecommunications services in that market at a faster rate. In addition, the
Company is continuing its sales efforts for traditional CAP services to long
distance carriers and large commercial users.
 
  SALES FORCE
 
     The Company is building a highly motivated and experienced direct sales
force and customer care organization that is designed to establish a direct and
personal relationship with its customers. The Company seeks to recruit
salespeople with strong sales backgrounds, including salespeople from long
distance companies, telecommunications equipment manufacturers, network systems
integrators and the ILECs. The Company has expanded its sales force from 98
salespeople at year end 1996 to 223 salespeople at December 31, 1997. The
Company expects to further increase its sales force to approximately 350
salespeople by year end 1998. Salespeople are given incentives through a
commission structure that targets 40% of a salesperson's compensation to be
based on performance. With respect to traditional CAP services, the Company
currently utilizes a national sales force to establish and expand long distance
company access service sales. Sales efforts for long distance carriers are
centralized in order to provide a single point of contact for these customers.
 
     The Company anticipates that its enhanced communications service offerings
will continue to be sold across the country by its existing national sales force
for these services. The Company has also augmented these efforts with a
separate, targeted, locally based sales force in each of its markets. The
Company believes that this approach to each market will provide revenues that
are incremental to its local exchange operations.
 
  CUSTOMER CARE
 
     The Company is augmenting its direct sales approach with superior customer
care and support through locally based customer care representatives. The
Company is structuring its customer care organization in such a manner that each
customer will have a single point of contact for customer care who is
responsible for solving problems and responding to customer inquiries. The
Company has expanded its customer care organization from 36 customer care
employees at year end 1996 to 162 customer care employees at December 31, 1997.
The Company seeks to provide a customer care group that has the ability and
resources to respond to and resolve customer problems as they arise. The Company
believes that customer care representatives will be the most effective if they
are based in the community in which the Company is offering services, which
placement will allow, among other things, the opportunity for the
representatives to visit the customer's location.
 
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NETWORK DEVELOPMENT
 
  GENERAL
 
     In developing its networks, the Company has generally executed a strategy
of (i) acquiring fully or partially constructed fiber optic networks and (ii)
designing and constructing high capacity fiber optic networks with broad
coverage. The Company has recently entered into leased dark fiber and fiber
capacity arrangements which allow the Company, by installing one or more
switches and related electronics, to enter a market prior to completing
construction of a fiber optic network. The Company regularly evaluates markets
as locations for expansion of the Company's current networks and the development
of additional networks. The decision to build, acquire or utilize capacity of an
existing network is not based on any single factor, but on a combination of a
number of factors including:
 
     -  demographic, economic, telecommunications demand and business line
        characteristics of the market and the surrounding markets;
 
     -  level of capital expenditures relative to the number of business lines;
 
     -  availability of rights-of-way;
 
     -  actual and potential competitors; and
 
     -  potential for the Company to cluster additional networks in the region.
 
     If a particular market targeted for development is deemed to present an
attractive market opportunity, the Company determines whether acquisition
opportunities are available. In some cases a large network can be acquired, and
in other cases a small existing network can serve as a starting point for market
entry. If the Company decides to build a new network, or substantially expand a
small acquired system, the Company designs a proposed new or expanded network
that can connect a large number of businesses, long distance carriers points of
presence and the ILEC's principal central offices in the area to be served,
utilizing existing rights-of-way and/or rights-of-way that the Company will
develop. Concurrently, the Company's market development personnel visit the
location of the proposed network to begin discussions with city officials,
providers of rights-of-way, potential end users and long distance companies.
 
     Based on the data developed during these preliminary studies and visits,
the Company develops detailed financial estimates of the costs of constructing a
network, including the cost of fiber optic cable, transmission and other
electronic equipment, as well as costs related to switching, engineering,
building entrance requirements and right-of-way acquisitions. If the financial
estimates are satisfactory to the Company, the Company's market development
personnel prepare a detailed business and financial plan for the proposed
network, including competitive, regulatory and right-of-way analyses. Based upon
its review of these analyses, the Company determines whether to proceed. The
Company anticipates continuing the expansion of its networks into new markets
utilizing the market development analysis described above. The Company will seek
to continue to expand its operations in states where it has established one or
more networks, by continuing to construct or acquire networks in adjacent areas
to leverage its existing networks, switches and telecommunications equipment,
thereby establishing a cost effective and operationally efficient cluster of
networks in various geographic regions.
 
                                        8
<PAGE>   11
 
  THE COMPANY'S NETWORKS
 
     The following table provides information on the markets in which the
Company has launched switched local and long distance services.
 
<TABLE>
<CAPTION>
                                                         LAUNCH DATE FOR
        STATE                 MARKET                 SWITCHED LOCAL SERVICES
---------------------  ---------------------    ----------------------------------
<S>                    <C>                      <C>               <C>
Tennessee............  Memphis                       July 1996
                       Nashville                     July 1996
Pennsylvania.........  Allentown                     July 1996
                       Harrisburg                    July 1996
                       Lancaster                     July 1996
                       Reading                       July 1996
                       Philadelphia                  July 1997
                       Scranton/Wilkes Barre     December 1997
Washington...........  Spokane                       July 1996
Utah.................  Salt Lake City             January 1997
                       Orem/Provo               September 1997
Nevada...............  Las Vegas                    April 1997
Ohio.................  Cleveland                    April 1997
                       Columbus                     April 1997
California...........  Anaheim                       July 1997
                       Costa Mesa                    July 1997
                       Fullerton                     July 1997
                       Garden Grove                  July 1997
                       Huntington Beach              July 1997
                       Inglewood                     July 1997
                       Irvine                        July 1997
                       Long Beach                    July 1997
                       Los Angeles                   July 1997
                       Orange                        July 1997
                       Santa Ana                     July 1997
Illinois.............  Chicago                   February 1998
</TABLE>
 
NETWORK ARCHITECTURE
 
  DESIGN
 
     The Company builds or acquires its own fiber optic networks because it
believes that facilities-based full service telecommunications companies whose
networks are directly connected to their customers will have the ability to
respond more quickly to customer needs for capacity and services. Moreover, the
Company believes that facilities-based carriers develop a more knowledgeable,
cooperative relationship with their customers, improving their ability to
provide new services and other telecommunications solutions, which should result
in higher long-term operating margins.
 
     The Company believes that the future telecommunications market will be an
interconnected network of networks. The Company believes that calls will flow
between local networks, with customers selecting their service provider based on
high quality and differentiated products, responsive customer service and price.
In some circumstances, depending in part upon regulatory conditions, the Company
will utilize its own network for one portion of a call and resell the services
of another carrier for the remaining portion of a call. In other instances, both
the origination and termination of calls will take place on the Company's
networks. The Company's networks are designed to maximize connectivity directly
with significant numbers of business end users, and to easily interconnect and
provide a least-cost routing flow of traffic between the Company's network and
other networks in the marketplace.
 
                                        9
<PAGE>   12
 
     In general, the Company seeks to build wide, expansive networks, rather
than a simple core ring in a downtown metropolitan area. The Company believes
that this type of broad coverage of the markets in which it operates will result
in the following advantages:
 
     -  an increased number of buildings that can be directly connected to the
        Company's network, which should maximize the number of businesses to
        which the Company can offer its services;
 
     -  a higher volume of telecommunications traffic both originating and
        terminating on the Company's network, which should result in improved
        operating margins;
 
     -  the ability to leverage its investment in high capacity switching
        equipment and electronics; and
 
     -  the opportunity for the Company's network to provide backhaul carriage
        for other telecommunications service providers such as long distance and
        wireless carriers.
 
     The Company seeks to further utilize this network design to increase the
number of buildings and customers directly connected to its networks. The
Company believes that as compared to the extensive use of unbundled loops and
pursuing a pure resale business strategy, having a direct connection to its
customers will provide the Company with the highest long-term operating margins,
allow the Company to provide greater feature and quality control as well as
offer customer service that is both prompt and effective, because the network to
be serviced is controlled by the Company and not another service provider.
 
     The Company seeks to build high capacity networks using a backbone density
ranging between 72 and 240 strands. A single pair of glass fibers on the
Company's networks can currently transmit 32,256 simultaneous voice
conversations, whereas a typical pair of copper wires can currently carry a
maximum of 24 digitized simultaneous voice conversations. The Company believes
that installing high count fiber strands will allow the Company to offer a
higher volume of voice and broadband services without incurring significant
additional construction costs.
 
  CONSTRUCTION
 
     The construction period of a new network varies depending upon the scope of
the activities, such as the number of backbone route miles to be installed,
whether the construction is underground or aerial, whether the conduit is in
place or requires construction, the initial number of buildings targeted for
connection to the network backbone and the general configuration for its
deployment. After installing the network backbone, the Company evaluates
extensions to additional buildings and expansions to other areas of a market,
based on detailed assessments of market potential.
 
     The Company's network backbones are installed in conduits that are either
owned by the Company or leased from third parties. The Company leases conduit or
pole space from entities such as utilities, railroads, long distance carriers,
state highway authorities, local governments and transit authorities. These
arrangements are generally for multi-year terms with renewal options, and are
nonexclusive. The availability of these arrangements is an important part of the
Company's evaluation of a market. Cancellation of any of the Company's material
right-of-way agreements could have an adverse effect on the Company's business
in that area and could have a material adverse effect on the Company.
 
     Office buildings are connected primarily by network backbone extensions to
one of a number of physical rings of fiber optic cable, which originate and
terminate at the Company's central node. Alternatively, the Company may access
an end user's location through interconnection with the ILEC's central office.
The Company is also evaluating other alternatives for building connectivity,
including wireless connections, for the "last mile" of transport. Signals are
generally sent through a network backbone to the central node simultaneously on
both primary and alternate protection paths. Most buildings served have a
discrete Company presence (referred to as a "remote hub") located in the
building. Within each building, Company-owned internal wiring connects the
remote hub to the customer premise. Customer equipment is connected to
Company-provided electronic equipment generally located in the remote hub, where
customer transmissions are digitized, combined and converted to an optical
signal. The traffic is then transmitted through the network backbone to the
Company's central node where originating traffic is reconfigured for routing to
its ultimate
 
                                       10
<PAGE>   13
 
destination. After completion of network construction, the Company employs
maintenance and line crews that are responsible for responding to outages and
routine maintenance of the network.
 
     In January 1998, the Company and Nextel Communications, Inc. ("Nextel")
formed NEXTBAND Communications, L.L.C. ("NEXTBAND"), a joint venture which is
owned 50% by the Company and 50% by Nextel. On January 20, 1998, NEXTBAND filed
an application with the FCC for which it paid a $50.0 million refundable deposit
to participate in the LMDS auction which began on February 18, 1998. Of the
deposit amount, $25.0 million was contributed by the Company. LMDS is a fixed
broadband point-to-multipoint service which the FCC and industry analysts
anticipate will be used for the deployment of wireless local loop, high-speed
data transfer and video broadcasting services. Two licenses will be offered in
each of 493 BTAs when the auction commences. Although the number of licenses
that may be awarded to NEXTBAND is limited by the amount of the deposit,
NEXTBAND has applied for and is eligible to bid on any of the markets being
auctioned for the block A license (1,150 MHz of spectrum) and the block B
license (150 MHz of spectrum).
 
     The Company is exploring LMDS for two reasons. Depending upon the bidding
and deployment costs, LMDS may offer an economically efficient means to
supplement the Company's fiber network build-out in some localities. In
addition, a wireless local loop alternative may create competitive pressure on
high unbundled loop costs in certain areas. There can be no assurance that
NEXTBAND's participation in the auction will result in the purchase of any LMDS
licenses or that LMDS spectrum for wireless connectivity will provide a
cost-effective and efficiently engineered means to connect to end user
locations.
 
     In June 1997, the Company entered into an eight year exclusive agreement,
which contains a five year renewal option, with a company that has excess fiber
capacity in each of Atlanta, Chicago, New York and Newark (NJ). In addition to
this capacity arrangement, the Company also entered into a 20-year lease of
capacity over an existing 47-mile fiber network which extends from the Wall
Street area north to midtown Manhattan. In February 1998, the Company entered
into an agreement for exclusive rights to multiple fibers and innerducts for 20
years, with two 10 year renewals. The route covered by the agreement extends
over 650 route miles from Manhattan to White Plains (NY), to Stamford (CT), to
Newark (NJ) and south from Manhattan through Philadelphia, Wilmington (DE),
Baltimore, and to Washington (DC). The route will offer frequent splice points
within metropolitan areas and splice points at least every 10,000 feet on routes
between metropolitan areas, as well as provide access to ILEC central and tandem
switching offices.
 
  UNIFORM TECHNOLOGY PLATFORM
 
     The Company is implementing a consistent technology platform based on the
Nortel DMS 500 switch throughout its networks. Unlike a traditional long
distance or local switch, the Nortel DMS 500 switch will enable the Company to
provide local and long distance services from a single platform. The Company
believes that having a standardized switch platform will enable it to (i) deploy
features and functions quickly in all of its networks, (ii) expand switch
capacity in a cost effective manner and (iii) lower maintenance costs through
reduced training and spare parts requirements. In addition, the scalability and
capacity of these switches will allow the Company to switch calls from more than
one market, which enhances the Company's ability to use a clustered approach to
the building of its networks. For economic or strategic reasons, the Company may
in the future elect to utilize other switch vendors and may also acquire and
utilize non-Nortel switches in connection with acquisitions of other companies.
 
     The Company also is establishing a uniform transmission technology
utilizing SONET design and standardized digital access and cross connect systems
("DACCS") and other ancillary transmission equipment. DACCS provide the ability
to aggregate and disaggregate capacity along the fiber optic network. Using
DACCS, the capacity of 24 DS-0s can be aggregated to form a DS-1 and, again
through the DACCS, 28 DS-1s can be aggregated to form a DS-3.
 
     The Company's NEXTLAB facility contains a fully functional Nortel DMS 500
switch in a configuration that simulates the working environment of the
Company's operational switches as well as distribution and ancillary equipment.
Located in Plano, Texas, NEXTLAB operates separate and apart from the Company's
operational switches as a testing facility and will serve as the Company's
network operations control center
 
                                       11
<PAGE>   14
 
(NOCC). NEXTLAB provides the Company with a means to test switch software and
service configurations prior to their release on the Company's networks. The
Company believes that this process should: (i) minimize network outages, (ii)
save network operating and training costs and (iii) improve levels of customer
service.
 
IMPLEMENTATION OF LOCAL TELECOMMUNICATIONS
 
     A company preparing to offer local exchange services not only requires an
installed switch, but also must have numerous network and routing arrangements
in place. NEXTLINK has established all of these arrangements for Pennsylvania,
Tennessee, Washington, Utah, Ohio, Nevada, California and Illinois. These key
elements include:
 
     Interconnection. The Company has executed interconnection agreements for
all of its current operating networks: in Nashville and Memphis, Tennessee, with
BellSouth Telecommunications, Inc.; in Harrisburg, Reading, Lancaster and
Allentown, Pennsylvania, with Bell Atlantic-Pennsylvania, Inc.; in New York, New
York with Bell Atlantic-New York, Inc.; in Chicago, Illinois, and in Cleveland
and Columbus, Ohio, with a division of Ameritech; in Spokane, Washington, and
Salt Lake City and Provo/Orem, Utah with U S WEST Communications, Inc.; in Los
Angeles, California and the surrounding markets, with Pacific Bell and GTE
Corporation; and in Las Vegas, Nevada, with a division of Sprint. The Company is
currently negotiating with BellSouth for an interconnection agreement to cover
Atlanta by the end of the third quarter of 1998. In addition, the Company
believes that interconnection arrangements between the ILECs and other CLECs or
the Company will be in place in other markets that the Company may enter. The
Company likely will initially "piggy-back" on these other arrangements while
pursuing more favorable long-term arrangements.
 
     The Company's approach to interconnection has been a two-step process. To
accelerate its launch of switched local services, the Company has entered into
initial interconnection arrangements that allow for the immediate exchange of
local traffic with the ILEC. These arrangements allow the Company to commence
service immediately and then work to optimize its arrangements with the ILEC.
The Company's ILEC agreements are now being re-negotiated under Sections 251 and
252 of the Telecom Act. The actual operating experience gained through the
Company's initial interconnection agreements gives the Company critical
knowledge for negotiating longer term arrangements. In some cases, where
agreement on a long-term arrangement cannot be reached, the Company may pursue
binding arbitration before the state utility commissions as provided under the
Telecom Act. The Company currently has arbitration proceedings pending in
Pennsylvania and Tennessee with Bell Atlantic and BellSouth, respectively.
Negotiations are continuing with both parties during the pendency of the
arbitration proceedings. There can be no assurance, however, that the Company
will be able to negotiate longer term relationships on terms and conditions
satisfactory to the Company.
 
     Telephone Numbers. The Company has been offered interim number portability
arrangements by the ILEC in each of its markets, and the Company also is engaged
in industry negotiations to establish permanent number portability. Number
portability arrangements will allow ILEC customers to retain their telephone
numbers when changing local exchange service carriers. In addition, the Company
has been allocated multiple blocks of 10,000 telephone numbers for each of its
Tennessee, Washington, Pennsylvania, Ohio, Utah, Nevada, California and Illinois
networks, and has applied for such numbers in New York, for use in assigning new
numbers to its customers. These numbers, known as NXX numbers, are the first
three digits of a customer's seven digit local phone number. In each of these
cases, the NXX is fully loaded into the Local Exchange Routing Guide or LERG,
which instructs ILECs and other carriers to send a call using a NEXTLINK NXX to
the appropriate NEXTLINK switch, for delivery to the NEXTLINK customer.
 
     SS7 Point Codes. For each of the Company's switches, the Company has been
assigned Point Codes for use with the advanced signaling system known as SS7
which is a separate or "out of band" communications channel used between
telecommunications carriers to set up and control traffic on and between
networks. The Company has designed its network to fully utilize SS7 signaling,
which improves call processing times and frees capacity for voice, data, and
video transmissions. The Company has entered into an agreement with a
 
                                       12
<PAGE>   15
 
national SS7 service provider that will allow the Company to utilize SS7
signaling in its current and new markets nationwide.
 
REGULATORY OVERVIEW
 
  OVERVIEW
 
     The Company's services are subject to varying degrees of federal, state and
local regulation. The FCC generally exercises jurisdiction over the facilities
of, and services offered by, telecommunications common carriers that provide
interstate or international communications. The state regulatory commissions
retain jurisdiction over the same facilities and services to the extent they are
used to provide intrastate communications. Local governments sometimes impose
franchise or licensing requirements on local exchange and other carriers and
regulate street opening and construction activities.
 
     The Telecom Act imposes on ILECs certain interconnection obligations that,
taken together, grant competitive entrants such as the Company what is commonly
referred to as "co-carrier status." In addition, the Telecom Act generally
preempts state or local legal requirements that prohibit or have the effect of
prohibiting any entity from providing telecommunications services. The Telecom
Act allows state regulatory authorities to continue to impose competitively
neutral requirements designed to promote universal service, protect public
safety and welfare, maintain quality of service and safeguard the rights of
consumers. The Telecom Act also preserves the ability of state and local
authorities to manage and require compensation for the use of public
rights-of-way by telecommunications providers including competitors of the ILECs
in the local market.
 
     It is anticipated that co-carrier status and the preemption of state and
local prohibitions on entry could permit the Company to become a full service
provider of switched telecommunications services anywhere in the United States.
The following table summarizes the interconnection rights granted by the Telecom
Act that are most important to the achievement of this goal and the Company's
belief as to the anticipated effect of the new requirements, if properly
implemented.
 
<TABLE>
<CAPTION>
            ISSUE                         DEFINITION                  ANTICIPATED EFFECT
------------------------------  ------------------------------  ------------------------------
<S>                             <C>                             <C>
Interconnection                 Efficient network               Allows a CLEC to service and
                                interconnection to transfer     terminate calls to and from
                                calls back and forth between    customers connected to other
                                ILECs and competitive networks  networks
                                (including 911, 0+, directory
                                assistance, etc.)
Local Loop Unbundling           Allows competitors to           Reduces the capital costs of a
                                selectively gain access to      CLEC to serve customers not
                                ILEC wires which connect ILEC   directly connected to its
                                central offices with customer   networks
                                premises
Reciprocal Compensation         Mandates reciprocal             Improves the CLEC's margins
                                compensation for local traffic  for local service
                                exchange between ILECs and
                                competitors
Number Portability              Allows customers to change      Allows customers to switch to
                                local carriers without          a CLEC's local service without
                                changing numbers; true          changing phone numbers
                                portability allows incoming
                                calls to be routed directly to
                                a competitor. Interim
                                portability allows incoming
                                calls to be routed through the
                                ILEC to a competitor at the
                                economic equivalent of true
                                portability
Access to Phone Numbers         Mandates assignment of new      Allows CLECs to provide
                                telephone numbers to            telephone numbers to new
                                competitive telecommunications  customers on the same basis as
                                provider's customers            the ILEC
</TABLE>
 
                                       13
<PAGE>   16
 
     While the interconnection rights established in the Telecom Act are a
necessary prerequisite to the introduction of full local competition, they must
be properly implemented to be effective. Significant implementation issues
remain to be resolved, including modifications to, and expansions of, the ILEC
network interface facilities, before the barriers to entry into the local
telephone business are sufficiently lowered to permit widespread competitive
entry. See "Federal Legislation" below for a more complete explanation of the
potential effect of the Telecom Act on the Company's business.
 
  FEDERAL LEGISLATION
 
     The Telecom Act, enacted on February 8, 1996, substantially revised the
Communications Act of 1934. The Telecom Act establishes a regulatory framework
for the introduction of local competition throughout the United States. Among
other things, the Telecom Act preempts any state or local government from
prohibiting any entity from providing telecommunications service. This provision
eliminated prohibitions on entry found in almost half of the states in the
country at the time the Telecom Act was passed. In addition, the Telecom Act now
requires that ILECs provide CLECs with physical collocation on rates, terms and
conditions that are just and reasonable, unless the ILEC can demonstrate to
state regulators that physical collocation is not practical. The Company
believes that either physical or virtual collocation of its facilities in a
timely fashion for appropriate rates and terms will accommodate its purposes.
 
     The Telecom Act also establishes a dual federal-state regulatory scheme for
eliminating other barriers to competition faced by competitors to the ILECs and
other new entrants into the local telephone market. Specifically, the Telecom
Act imposes on ILECs certain interconnection obligations, some of which are to
be implemented by FCC regulations. The Telecom Act contemplates that states will
apply the federal regulations and oversee the implementation of all of the
aspects of interconnection not subject to FCC jurisdiction as they oversee
interconnection negotiations between ILECs and their new competitors.
 
     In addition, the Telecom Act provides that ILECs that are subsidiaries of
RBOCs cannot combine in-region, long distance services across LATAs with the
local services they offer until they have demonstrated that (i) they have
entered into an approved interconnection agreement with a facilities-based CLEC
or that no such CLEC has requested interconnection as of a statutorily
determined deadline, (ii) they have satisfied a 14-element checklist designed to
ensure that the ILEC is offering access and interconnection to all local
exchange carriers on competitive terms and (iii) the FCC has determined that
in-region, interLATA approval is consistent with the public interest,
convenience and necessity.
 
     On July 2, 1997, SBC and its local exchange carrier subsidiaries filed a
lawsuit in the United States District Court for the Northern District of Texas
challenging on Constitutional grounds the Telecom Act restrictions applicable to
the RBOCs only. On December 31, 1997, the District Court ruled in favor of SBC
and held that Sections 271 through 275 of the Telecom Act, including the long
distance entry provisions, are unconstitutional. On February 11, 1998, however,
the District Court issued a stay of its December 31, 1997 decision pending
appeal to the United States Circuit Court of Appeals for the Fifth Circuit. The
appeal is currently pending.
 
  FEDERAL REGULATION
 
     The FCC has significant responsibility in the manner in which the Telecom
Act will be implemented especially in the areas of universal service, access
charges, numbering, number portability and price caps. The details of the rules
adopted by the FCC will have a significant effect in determining the extent to
which barriers to competition in local services are removed, as well as the time
frame within which such barriers are eliminated. The FCC may also grant ILECs
increased pricing flexibility to enable them to respond to competition for
special access and private line services. To the extent such pricing flexibility
is granted, the Company's ability to compete for certain services may be
adversely affected.
 
     On August 8, 1996, the FCC issued an order containing rules providing
guidance to the ILECs, CLECs, long distance companies and state PUCs regarding
several provisions of the Telecom Act. The rules include, among other things,
FCC guidance on (i) discounts for end-to-end resale of ILEC local exchange
services (which the FCC has suggested should be in the range of 17%-25%), (ii)
availability of unbundled local loops
 
                                       14
<PAGE>   17
 
and other unbundled ILEC network elements, (iii) the use of Total Element Long
Run Incremental Costs ("TELRIC") in the pricing of these unbundled network
elements, (iv) average default proxy prices for unbundled local loops in each
state, (v) mutual compensation proxy rates for termination of ILEC/CLEC local
calls and (vi) the ability of CLECs and other interconnectors to opt into
portions of interconnection agreements negotiated by the ILECs with other
parties on a most favored nation (or a "pick and choose") basis. See below for a
discussion of the Eighth Circuit Court of Appeals decision invalidating certain
aspects of this order.
 
     On May 8, 1997, the FCC released an order establishing a significantly
expanded federal telecommu-nications subsidy regime. For example, the FCC
established new subsidies for services provided to qualifying schools and
libraries with an annual cap of $2.25 billion and for services provided to rural
health care providers with an annual cap of $400 million. The FCC also expanded
the federal subsidies to low income consumers. Providers of interstate
telecommunications services, such as the Company, as well as certain other
entities, must pay for these programs. The Company's share of the schools,
libraries and rural health care funds will be based on its share of the total
industry telecommunications service and certain defined telecommunications end
user revenues. The Company's share of all other federal subsidy funds will be
based on its share of the total interstate telecommunications service and
certain defined telecommunications end user revenues. The Company intends to
make all subsidy payments required by law. In the May 8 order, the FCC also
announced that it will soon revise its rules for subsidizing service provided to
consumers in high cost areas. Several parties have appealed the May 8 order.
Such appeals have been consolidated and transferred to the United States Court
of Appeals for the Fifth Circuit where they are currently pending. In addition,
on July 3, 1997, several ILECs filed a petition for stay of the May 8 order with
the FCC. That petition is also pending.
 
     In a combined Report and Order and Notice of Proposed Rulemaking released
on December 24, 1996, the FCC made changes and proposed further changes in the
interstate access charge structure. In the Report and Order, the FCC removed
restrictions on ILECs' ability to lower access prices and relaxed the regulation
of new switched access services in those markets where there are other providers
of access services. If this increased pricing flexibility is not effectively
monitored by federal regulators, it could have a material adverse effect on the
Company's ability to compete in providing interstate access services. On May 16,
1997, the FCC released an order revising its access charge rate structure. The
new rules substantially increase the costs that ILECs subject to the FCC's price
cap rules ("price cap LECs") recover through monthly, no-traffic sensitive
access charges and substantially decrease the costs that price cap LECs recover
through traffic sensitive access charges. In the May 16 order, the FCC also
announced its plan to bring interstate access rate levels more in line with
cost. The plan will include rules to be established sometime this year that
grant price cap LECs increased pricing flexibility upon demonstrations of
increased competition (or potential competition) in relevant markets. The manner
in which the FCC implements this approach to lowering access charge levels will
have a material effect on the Company's ability to compete in providing
interstate access services. Several parties have appealed the May 16 order.
Those appeals have been consolidated and transferred to the United States Court
of Appeals for the Eighth Circuit where they are currently pending.
 
     As part of its overall plan to lower interstate access rates, the FCC also
released an order on May 21, 1997, in which the FCC revised its price cap rules.
In the order, the FCC increased the so-called X-Factor (the percentage by which
price cap LECs must lower their interstate access charges every year, net of
inflation and exogenous cost increases) and made it uniform for all price cap
LECs. The results of these rule changes will be both a one-time overall
reduction in price cap ILEC interstate access charges and an increase in the
rate at which those charges will be reduced in the future. Several parties have
appealed the May 21 order. Those appeals were consolidated and transferred to
the United States Court of Appeals for the Tenth Circuit. They have been
subsequently transferred to the United States Court of Appeals for the District
of Columbia where they are currently pending.
 
     On January 2, 1997, Ameritech of Michigan became the first RBOC to apply
for authority to provide in-region interLATA service pursuant to Section 271 of
the Telecom Act. The application was withdrawn and refiled on May 21, 1997. That
application was denied on August 19, 1997. In denying the application, the FCC
established specific and substantial criteria that must be met before future
Section 271 applications will be granted.
 
                                       15
<PAGE>   18
 
     On April 11, 1997, SBC Communications, Inc. ("SBC") applied to the FCC for
authority to provide in-region interLATA service in the state of Oklahoma. On
June 26, 1997, the FCC released an order rejecting SBC's application on the
grounds that SBC had not demonstrated either that SBC had entered into an
approved interconnection agreement with a facilities-based CLEC or that no CLEC
had requested interconnection as of the statutory deadline. On July 3, 1997, SBC
filed an appeal of the June 26 order with the United States Court of Appeals for
the District of Columbia. On March 20, 1998, the Court of Appeals upheld the
FCC's order.
 
     In September and November 1997, BellSouth Corporation ("BellSouth") filed
applications for authorization to provide in-region interLATA service in the
states of South Carolina and Louisiana. On December 24, 1997 and February 4,
1998, respectively, the FCC released orders rejecting BellSouth's applications
which conclude that BellSouth had not yet demonstrated that it generally offered
each of the items of the competitive checklist set forth in the Telecom Act. On
January 13, 1998, BellSouth filed an appeal for the December 24, 1997 ruling
with the United States District Court of Appeals for the District of Columbia.
That appeal is currently pending.
 
     The Company anticipates that RBOCs will continue to apply for authority to
provide in-region interLATA services in markets where the Company operates or
plans to operate. The Company also expects that the FCC will initiate a number
of additional proceedings, on its own initiative and as a result of requests
from CLECs and others, as a result of the Telecom Act. While the Eighth
Circuit's recent decision in the appeal of the August 8, 1996 order limits the
FCC's jurisdiction over the local competition provisions of the Telecom Act,
such proceedings may nonetheless further define and construe the Telecom Act's
terms.
 
  COURT OF APPEALS DECISION
 
     Various parties, including ILECs and state PUCs, filed appeals of the FCC's
August 8, 1996 order in various U. S. Courts of Appeal, and several parties
petitioned the FCC and the courts to stay the effectiveness of the FCC's rules
included in the FCC's order, pending a ruling on the appeals. Many of the
appeals were consolidated and transferred to the United States Court of Appeals
for the Eighth Circuit. On July 18, 1997, the Eighth Circuit overturned the
pricing rules established in the August 8, 1996 order, except those applicable
to commercial mobile radio service providers. The Eighth Circuit held that, in
general, the FCC does not have jurisdiction over prices for interconnection,
resale, leased unbundled network elements and traffic termination. The Eighth
Circuit also overturned the FCC's "pick and choose" rules as well as certain
other FCC rules implementing the Telecom Act's local competition provisions. In
addition, the Eighth Circuit decision substantially limits the FCC's authority
to enforce the local competition provisions of the Telecom Act.
 
     On October 14, 1997, the Eighth Circuit vacated the FCC's rule prohibiting
ILECs from separating unbundled network elements that are already combined,
except at the request of CLECs. In addition, under the decision, ILECs are not
required to recombine unbundled network elements, but must make such elements
available for CLECs to recombine on their own.
 
     On January 22, 1998, the Eighth Circuit issued a writ of mandamus ordering
the FCC to follow the court's July 1997 decision in addressing certain pricing
issues in the context of RBOC Section 271 in-region interLATA entry
applications.
 
     On January 26, 1998, the United States Supreme Court agreed to hear
challenges to the Eighth Circuit's July 18, 1997 and October 14, 1997 decisions.
The Court has agreed to review all issues raised by the government, the RBOCs,
and competitors. These include whether the FCC has authority (i) to set prices
that ILECs charge CLECs for access to local networks, (ii) to require ILECs to
allow CLECs to use provisions of existing interconnection agreements in their
own agreements and (iii) to force ILECs to offer existing combinations of
unbundled network elements needed to provide local service. Because the Court
will hear the consolidated cases in its next term which begins in October, a
decision is not expected until next year.
 
                                       16
<PAGE>   19
 
     In the short term the Company believes that the Eighth Circuit decisions
will not have a material adverse effect on it, because the Company already has
interconnection agreements in place, or expects to have such agreements in
place, under the provisions of the FCC's order and the Telecom Act which were
not invalidated by the Court. The decision does not delay the implementation of
the Telecom Act by the parties and by the state PUCs, but rather eliminates the
guidance on pricing and most favored nation procedures as well as other issues
that the FCC sought to provide to parties and the state PUCs.
 
     In the long term, the Eighth Circuit's decisions make it more likely that
the rules governing local competition will vary from state to state. Most states
have already begun to establish rules for local competition that are consistent
with the FCC rules overturned by the Eighth Circuit. If a patchwork of state
regulations were to develop, it could increase the Company's costs of regulatory
compliance and could make competitive entry in some markets more difficult and
expensive than in others.
 
  STATE REGULATION
 
     The Company expects that as it offers local exchange and other intrastate
services in an increasing number of states, it will be subject to direct state
public utility commission ("PUC") regulation in most, if not all, such states.
In states where the Company desires to offier its services, the Company may be
required to obtain authorization from the appropriate state commission,
including certification as a CLEC. In all states where the Company is
operational and certification as a CLEC is currently required, the Company's
operating subsidiaries are certificated. In those markets where the Company
anticipates launching services in 1998, it has received or applied for such
certification.
 
     In most states, the Company is required to file tariffs or price lists
setting forth the terms, conditions and prices for services which are classified
as intrastate. In some states, the Company's tariff can list a range of prices
for particular services, and in others, such prices can be set on an individual
customer basis. The Company is not subject to price cap or to rate of return
regulation in any state in which it currently provides services.
 
     As noted above, as a result of the July 18, 1997 Eighth Circuit decision,
PUCs have an even more significant responsibility in implementing the Telecom
Act. Specifically, the states have authority to establish interconnection
pricing, including unbundled loop charges, reciprocal compensation and wholesale
pricing. The states are also charged under the Telecom Act with overseeing the
arbitration process for resolving interconnection negotiation disputes between
CLECs and the ILECs. The Telecom Act allows state regulatory authorities to
continue to impose competitively neutral requirements designed to promote
universal service, protect public safety and welfare, maintain quality of
service and safeguard the rights of consumers.
 
  LOCAL GOVERNMENT AUTHORIZATION
 
     In certain locations, the Company is required to obtain local franchises,
licenses or other operating rights and street opening and construction permits
to install, expand and operate its fiber-optic networks. In some of the areas
where the Company provides network services, the Company's subsidiaries pay
license or franchise fees based on a percentage of gross revenues or on a per
linear foot basis. There is no assurance that certain cities that do not
currently impose fees will not seek to impose such fees in the future, nor is
there any assurance that, following the expiration of existing franchises, fees
will remain at their current levels. Under the Telecom Act, state and local
governments retain the right to manage the public rights-of-way and to require
fair and reasonable compensation from telecommunications providers, on a
competitively neutral and nondiscriminatory basis, for use of public
rights-of-way.
 
     If any of the Company's existing franchise or license agreements were
terminated prior to its expiration date and the Company were forced to remove
its fiber from the streets or abandon its network in place, such termination
would have a material adverse effect on the Company's subsidiary in that area
and could have a material adverse effect on the Company. The Company believes
that the provisions of the Telecom Act barring state and local requirements that
prohibit or have the effect of prohibiting any entity from providing
telecommunications service should be construed to limit any such action.
However, there can be no assurance
 
                                       17
<PAGE>   20
 
that one or more local authorities will not attempt to take such action. Nor is
it clear that the Company would prevail in any judicial or regulatory proceeding
to resolve such a dispute.
 
COMPETITION
 
     As noted above, the regulatory environment in which the Company operates is
changing rapidly. The passage of the Telecom Act combined with other actions by
the FCC and state regulatory authorities continues to promote competition in the
provision of telecommunications services.
 
  ILECS
 
     In each market served by its networks, the Company faces, and expects to
continue to face, significant competition from the ILECs, which currently
dominate their local telecommunications markets.
 
     The Company competes with the ILECs in its markets for local exchange
services on the basis of product offerings, reliability, state-of-the-art
technology, price, route diversity, ease of ordering and customer service.
However, the ILECs have long-standing relationships with their customers and
provide those customers with various transmission and switching services that
the Company, in many cases, does not currently offer. The Company has sought,
and will continue to seek, to achieve parity with the ILECs in order to become
able to provide a full range of local telecommunications services. See
"Regulatory Overview" for additional information concerning the regulatory
environment in which the Company operates. Existing competition for private line
and special access services is based primarily on quality, capacity and
reliability of network facilities, customer service, response to customer needs,
service features and price, and is not based on any proprietary technology. As a
result of the comparatively recent installation of the Company's fiber optic
networks, its dual path architectures and the state-of-the-art technology used
in its networks, the Company may have cost and service quality advantages over
some currently available ILEC networks.
 
  OTHER COMPETITORS
 
     The Company also faces, and expects to continue to face, competition from
other potential competitors in certain of the markets in which the Company
offers its services. In addition to the ILECs and CAPs, potential competitors
capable of offering switched local and long distance services include long
distance carriers such as AT&T, MCI Communications Corporation ("MCI"), Sprint
Corporation ("Sprint") and WorldCom, Inc. ("WorldCom"), cable television
companies such as TeleCommunications, Inc. and Time Warner, Inc., electric
utilities, microwave carriers, wireless telephone system operators and private
networks built by large end users.
 
     The Company believes that the Telecom Act, as well as a recent series of
completed and proposed transactions between ILECs and long distance companies
and cable companies, increases the likelihood that barriers to local exchange
competition will be removed. The Telecom Act states that entry barriers must be
lowered in the areas served by ILECs that are subsidiaries of RBOCs before such
ILECs are permitted to provide in-region, interLATA services. When ILECs that
are RBOC subsidiaries are permitted to provide such services, they will be in a
position to offer single source service. ILECs that are not RBOC subsidiaries
may offer single source service presently.
 
     In some cases, cable television companies are upgrading their networks with
fiber optics and installing facilities to provide fully interactive transmission
of broadband voice, video and data communications. In addition, under the
Telecom Act, electric utilities may install fiber optic telecommunications cable
and may facilitate provision of telecommunications services by electric
utilities over those networks if granted regulatory authority to do so. Cellular
and PCS providers may also be a source of competitive local telephone service.
 
     The Company also competes with equipment vendors and installers, and
telecommunications management companies, with respect to certain portions of its
business.
 
     A continuing trend towards business combinations and alliances in the
telecommunications industry may create significant new competitors to the
Company. In addition, many of the Company's existing and potential
 
                                       18
<PAGE>   21
 
competitors have financial, personnel and other resources, including name
recognition, significantly greater than those of the Company.
 
     The Company also competes with long distance carriers in the provision of
long distance services. Although the long distance market is dominated by four
major competitors, AT&T, MCI, Sprint and WorldCom, hundreds of other companies
also compete in the long distance marketplace.
 
     With respect to the Company's enhanced communications service offerings,
each is subject to competition. For example, there are several competitors that
offer IVR services, such as Call Interactive, which the Company believes focuses
its sales efforts on large volume IVR service users. Another competitor,
Telemedia, which is owned by Sprint, also offers significant call volume
capacity. With respect to Magic Number, the Company's virtual communications
center, there are numerous competitors with product offerings that include some
or all of the services offered by Magic Number.
 
PURCHASING AND DISTRIBUTION
 
     With respect to the Company's fiber optic networks, which constitute the
Company's most significant capital investments, the Company has entered into
general purchase agreements with key equipment suppliers for fiber and fiber
optic transmission equipment, with Nortel for telecommunications switches, and
with other suppliers for various other components of each system. These
agreements provide the basic framework under which purchase orders for these
system components will be made. The specific purchases made for each network
depend upon the configuration and other factors related to the network, such as
the prospective customer base and location and the services to be offered over
the network. Once these decisions are made, purchase orders for the appropriate
fiber and selected equipment types are placed under the general purchase
agreements. In connection with the Company's provision of long distance
services, it purchases capacity at wholesale rates from long distance carriers.
 
EMPLOYEES
 
     As of December 31, 1997, the Company employed 1,327 people, including
full-time and part-time employees. The Company considers its employee relations
to be good. None of the employees of the Company is covered by a collective
bargaining agreement.
 
TRADEMARKS AND TRADE NAMES
 
     The Company uses the name "NEXTLINK" as its primary business name. In July
1995, the Company filed for federal trademark protection of this name and
received its notice of allowance from the U.S. Patent and Trademark Office (the
"PTO") on July 1, 1997. In addition, the Company has received a notice of
allowance from the PTO of its distinctive floating "X" and related marks as
protected trademarks under federal law. The Company from time to time receives
requests to consider licensing certain patents held by third parties that may
have bearing on its IVR and virtual communications center services. The Company
considers such requests on their merits, but has not to date entered into any
such license agreements.
 
GLOSSARY
 
     Addressable business lines -- In accordance with industry practice, the
Company includes in its calculation of actual and targeted addressable business
lines all business lines currently in active use through any service provider in
each market area in which the Company has or plans to build a network.
 
     CAP (competitive access provider) -- A company that provides its customers
with an alternative to the ILEC for local private line and special access
telecommunications services.
 
     Central offices -- The switching centers or central switching facilities of
the LECs.
 
     CLEC (competitive local exchange carrier) -- A company providing local
telephone services in competi-tion with the ILEC.
 
                                       19
<PAGE>   22
 
     Co-carrier status -- A regulatory scheme under which the ILEC is required
to integrate new, competing providers of local exchange service, such as the
Company, into the systems of traffic exchange, inter-carrier compensation, and
other inter-carrier relationships that already exist among ILECs in most
jurisdictions.
 
     Collocation -- The ability of a CLEC such as the Company to connect its
network to the ILECs' central offices. Physical collocation occurs when a CLEC
places its network connection equipment inside the ILEC's central offices.
Virtual collocation is an alternative to physical collocation pursuant to which
the ILEC permits a CLEC to connect its network to the ILEC's central offices on
comparable terms, even though the CLEC's network connection equipment is not
physically located inside the central offices.
 
     Dark fiber -- Unused fiber through which no light is transmitted. Dark
fiber is provided with the customer expected to supply the required electronics
and signals.
 
     Dedicated -- Telecommunications lines dedicated or reserved for use by
particular customers and charged on a flat, usually monthly, basis.
 
     DS-0, DS-1, DS-3 -- The standard circuit capacity classifications. Each of
these transmission services can be provided using the same type of fiber optic
cable, but offer different bandwidth (that is, capacity), depending upon the
individual needs of the end user. A DS-0 is a dedicated circuit that is
considered to meet the requirements of usual business communications, with
transmission capacity of up to 64 kilobits of bandwidth per second (that is, a
voice grade equivalent circuit). This service offers a basic low capacity
dedicated digital line for connecting telephones, fax machines, personal
computers and other telecommunications equipment. A DS-1 is a high speed digital
circuit typically linking high volume customer locations to long distance
carriers or other customer locations. Typically utilized for voice transmissions
as well as the interconnection of LANs, DS-1 service accommodates transmission
speeds of up to 1.544 megabits per second, which is the equivalent of 24 voice
grade equivalent circuits. DS-3 service provides a very high capacity digital
circuit with transmission capacity of 45 megabits per second, which is
equivalent to 28 DS-1 circuits or 672 voice grade equivalent circuits. This is a
digital service used by long distance carriers for central office connections
and by some large commercial users to link multiple sites.
 
     FCC -- The United States Federal Communications Commission.
 
     FDDI (fiber distributed data interface) -- Based on fiber optics, FDDI is a
100 megabit per second local area network technology used to connect computers,
printers, and workstations at very high speeds. FDDI is also used as backbone
technology to interconnect other LANs.
 
     Fiber mile -- The number of route miles installed (excluding pending
installations) along a telecommunications path multiplied by the number of
fibers along that path. See the definition of "route mile" below.
 
     ILEC (incumbent local exchange carrier) -- A company that was providing
local exchange service prior to the entry of the CLECs.
 
     Local Exchange -- A geographic area determined by the appropriate state
regulatory authority in which calls generally are transmitted without toll
charges to the calling or called party.
 
     Line -- An electrical path between an ILEC central office and a subscriber.
 
     Long distance carriers (interexchange carriers) -- Long distance carriers
provide services between local exchanges on an interstate or intrastate basis. A
long distance carrier may offer services over its own or another carrier's
facilities.
 
     Number Portability -- The ability of an end user to change local exchange
carriers while retaining the same telephone number.
 
     POPs (points of presence) -- Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.
 
     PUC (public utility commission) -- A state regulatory body, established in
most states, which regulates utilities, including telephone companies, providing
intrastate services.
 
                                       20
<PAGE>   23
 
     Private line -- A dedicated telecommunications connection between end user
locations.
 
     Reciprocal compensation -- The compensation paid to and from a new
competitive local exchange carrier and the ILEC for termination of a local call
on each other's networks.
 
     Route mile -- The number of miles of the telecommunications path in which
the Company-owned or leased fiber optic cables are installed.
 
     Special access services -- The lease of private, dedicated
telecommunications lines or "circuits" along the network of an ILEC or a CAP,
which lines or circuits run to or from the long distance carrier POPs. Examples
of special access services are telecommunications lines running between POPs of
a single long distance carrier, from one long distance carrier POP to the POP of
another long distance carrier or from an end user to a long distance carrier
POP.
 
     Switch -- A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of information. Switching is a process of
interconnecting circuits to form a transmission path between users.
 
     Switched services -- Transmission of switched calls through the local
switched network.
 
ITEM 2. DESCRIPTION OF PROPERTIES
 
     The Company owns or leases, in its operating territories, telephone
property which includes: fiber optic backbone and distribution network
facilities; point-to-point distribution capacity; central office switching
equipment; connecting lines between customers' premises and the central offices;
and customer premise equipment.
 
     The fiber optic backbone and distribution network and connecting lines
include aerial and underground cable, conduit, and poles and wires. These
facilities are located on public streets and highways or on privately owned
land. The Company has permission to use these lands pursuant to consent or
lease, permit, easement, or other agreements. The central office switching
equipment includes electronic switches and peripheral equipment.
 
     The Company and its subsidiaries lease facilities for their administrative
and sales offices, network nodes and warehouse space. The various leases expire
in years ranging from 1998 to 2028. Most have renewal options. Additional office
space and equipment rooms will be leased as the Company's operations and
networks are expanded and as new networks are constructed.
 
ITEM 3. LEGAL PROCEEDINGS
 
     The Company is not currently a party to any legal proceedings, other than
regulatory and other proceedings that are in the normal course of its business.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     No matters were submitted to a vote of security holders during the quarter
ended December 31, 1997.
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANTS' COMMON STOCK AND RELATED STOCKHOLDER MATTERS
 
MARKET INFORMATION
 
     The Company's Class A Common Stock began trading on the Nasdaq National
Market on September 26, 1997, under the symbol "NXLK". Prior to that date, the
Company's Class A Common Stock was not publicly traded. The following table
shows, for the periods indicated, the high and low bid prices for the
 
                                       21
<PAGE>   24
 
Company's Class A Common Stock as reported by the Nasdaq National Market tier of
The Nasdaq Stock Market.
 
<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                             ------    ------
<S>                                                          <C>       <C>
1997:
  Third Quarter (since September 26, 1997).................  $25.50    $23.13
  Fourth Quarter...........................................  $27.75    $19.50
</TABLE>
 
     There is no public trading market for the Company's Class B Common Stock or
NEXTLINK Capital's common equity.
 
     As of March 6, 1998, the approximate number of shareholders of record of
the Company's Class A and Class B Common Stock was 218 and 15, respectively. The
Company is the sole holder of record of NEXTLINK Capital's Common Stock.
 
USE OF PROCEEDS
 
     The Company filed a registration statement on Form S-1 (File No. 333-32001)
which became effective on September 26, 1997, whereby 15,200,000 shares of Class
A Common Stock , $0.02 par value per share, were sold in an initial public
offering at a price of $17 per share. Of the 15,200,000 shares of Class A Common
Stock sold, 12,000,000 shares were sold by the Company and 3,200,000 shares were
sold by a selling shareholder. The Company did not receive any of the proceeds
from the sale of shares by the selling shareholder. In addition, the
underwriters of the IPO, led by Salomon Smith Barney, exercised an option to
purchase 2,280,000 additional shares of Class A Common Stock at the same price
per share. Net proceeds to the Company from the IPO totaled approximately $226.8
million, after deducting underwriting discounts, advisory fees and expenses
aggregating approximately $16.0 million. The Company intends to use
substantially all of the net proceeds from the IPO for expenditures relating to
the expansion of existing networks and services, the development and acquisition
of new networks and services and the funding of operating losses and working
capital. None of the net proceeds from the IPO had been used by the Company as
of December 31, 1997.
 
     The Company filed a registration statement on Form S-1 (File No. 333-32003)
which became effective on September 26, 1997, whereby the Company sold $400
million aggregate principal amount of 9 5/8% Senior Notes due 2007 ("9 5/8%
Senior Notes"). The offering was led by Salomon Smith Barney. Net proceeds from
the sale of the 9 5/8% Senior Notes totaled approximately $388.5 million, after
deducting issuance costs aggregating approximately $11.5 million, relating to
underwriting discounts, advisory fees and expenses. The use of proceeds from the
debt offering are substantially the same as the Company's IPO. None of the net
proceeds from the sale of 9 5/8% Senior Notes had been used by the Company as of
December 31, 1997.
 
DIVIDENDS
 
     Neither the Company nor NEXTLINK Capital have declared a cash dividend on
any of their respective equity securities. Covenants in the indentures pursuant
to which the Company's and NEXTLINK Capital's Senior Notes have been issued
restrict the ability of the Company to pay cash dividends on its capital stock.
 
SALES OF UNREGISTERED SECURITIES
 
     None.
 
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
OVERVIEW
 
     Since its inception in 1994, the Company has executed a strategy of
developing fiber optic networks and acquiring related telecommunications
businesses. Over this period, the Company has pursued this strategy by
constructing, acquiring, leasing fibers or capacity on, and entering into
agreements to acquire telecommunications networks.
 
                                       22
<PAGE>   25
 
     The Company's primary focus is providing switched local and long distance
and enhanced communications services to small and medium-sized commercial end
user customers. The Company plans to acquire, build or develop networks in new
areas, expand its current networks, and also explore the acquisition or
licensing of additional enhanced communications services and other
telecommunications service providers. These efforts should allow the Company to
increase its presence in the marketplace, and facilitate providing a single
source solution for the telecommunications needs of its customers.
 
     The table provides selected key operational data:
 
<TABLE>
<CAPTION>
                                                            AS OF DECEMBER 31,
                                                              1997       1996
                                                            --------    -------
<S>                                                         <C>         <C>
OPERATING DATA (1):
Route miles(2)............................................    1,897      1,080
Fiber miles(3)............................................  133,224     66,046
On-net buildings connected(4).............................      513        403
Off-net buildings connected(5)............................    3,504         --
Switches installed........................................       13          9
Access lines in service(6)................................   50,131      8,511
Employees.................................................    1,327        568
</TABLE>
 
---------------
(1) The operating data include the statistics of the Las Vegas network, which
    the Company manages and in which the Company has a 40% membership interest.
 
(2) Route miles refers to the number of miles of the telecommunications path in
    which the Company-owned or leased fiber optic cables are installed.
 
(3) Fiber miles refers to the number of route miles installed along a
    telecommunications path, multiplied by the Company's estimate of the number
    of fibers along that path.
 
(4) Represents buildings physically connected to the Company's networks,
    excluding those connected by unbundled incumbent local exchange (ILEC)
    facilities.
 
(5) Represents buildings connected to the Company's networks through leased or
    unbundled ILEC facilities.
 
(6) Represents the number of access lines in service, including those lines
    which are provided through resale of Centrex services, for which the Company
    is billing services.
 
     The Company builds its networks to encompass the significant business
concentrations in each area it serves, focusing on direct connections to end
user locations and ILEC central offices. The Company employs a uniform
technology platform for each of its local exchange networks that is based on the
Nortel DMS 500 digital local and long distance combination switching platform
and associated distribution technology. As of January 31, 1998, the Company had
12 operational Nortel DMS 500 switches, including one switch in its NEXTLAB
facility, and currently plans to install three additional switches by the end of
the second quarter of 1998. NEXTLAB is a fully functional model of one of the
Company's networks, which serves as a testing facility for switch software and
the Company's products and services and will serve as the Company's network
operations control center.
 
     The Company also provides enhanced communications services including
interactive voice response ("IVR") services, which provide an interface between
the Company's clients and their customers for a variety of applications.
Historically, the Company has derived a substantial proportion of its revenues
from these IVR services. As local and long distance revenues are expected to
grow more rapidly than revenues for the Company's enhanced communications
services, the Company anticipates that, over the next five years, local and long
distance revenues will account for a significantly higher percentage of total
revenues.
 
     The development of the Company's businesses and the construction,
acquisition and expansion of its networks require significant expenditures, a
substantial portion of which are incurred before the realization of revenues.
These expenditures, together with the associated early operating expenses,
result in negative cash flow until an adequate customer base is established.
However, as the customer base grows, the Company
 
                                       23
<PAGE>   26
 
expects that incremental revenues can be generated with decreasing incremental
operating expenses, which may provide positive contributions to cash flow. The
Company has made the strategic decision to build high capacity networks with
broad market coverage, which initially increases its level of capital
expenditures and operating losses. The Company believes that over the long term
this will enhance the Company's financial performance by increasing the traffic
flow over the Company's networks. The Company has recently entered into leased
dark fiber and fiber capacity arrangements, which allow the Company, by
installing one or more switches and related electronics, to enter a market prior
to completing construction of its own fiber optic network.
 
     Prior to January 31, 1997, the Company was a limited liability company that
was classified and taxed as a partnership for federal and state income tax
purposes. As of January 31, 1997, the Company was subject to federal and state
income tax.
 
RESULTS OF OPERATIONS
 
  YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
 
     Revenue increased 124% to $57.6 million in 1997 from $25.7 million in the
same period in 1996. The increase was primarily due to 45% growth in the
Company's local and long distance services (both switched and resale), dedicated
services and enhanced communications services, as well as due to recording a
full year's revenue from ITC, a switch-based long distance reseller acquired in
December 1996. To a lesser extent, the acquisitions of Start Technologies
Corporation ("Start") and Chadwick Telecommunications Corporation ("Chadwick")
in the fourth quarter of 1997 also contributed to the increase in revenue.
Revenues reported in 1997 included $38.9 million derived from local and long
distance, competitive access, dedicated line services and shared tenant services
and $18.7 million derived from enhanced communications services, primarily IVR.
The Company's IVR subsidiary contributed 27% and 52% of the Company's revenues
during 1997 and 1996, respectively. The revenues generated by this subsidiary
have tended to fluctuate on a quarter to quarter basis as the revenues are
generally event driven and seasonal in nature.
 
     The Company began offering switched local and long distance services in
seven of its markets in July 1996, and in 18 additional markets during 1997. In
addition, the Company has offered dedicated line services since January 1995 and
has resold Centrex access lines since April 1995. The Company increased its
quarterly customer access line installation rate from 1,604 in the fourth
quarter of 1996 to 19,187 during the fourth quarter of 1997. As of December 31,
1997, the Company had 50,131 access lines in service, compared to 8,511 as of
December 31, 1996. Revenues from the provision of such services are expected to
continue to increase as a component of total revenues over future periods.
Access lines in service includes those lines which are provided through resale
of Centrex services, the number of which is decreasing over time as the Company
converts those customers to its own network.
 
     Operating expenses consist of costs directly related to providing
facilities-based network and enhanced communications services and also include
salaries and benefits and related costs of operations and engineering personnel.
Operating expenses increased 115% in 1997 to $54.0 million, an increase of $28.9
million over the same period in 1996. These increases were attributed to factors
that include an increase in network costs related to the provision of increased
volumes of local, long distance and enhanced communications services and the
Company's increase in employees as well as other related costs primarily to
expand the Company's switched local and long distance service businesses in its
existing and planned markets. Additionally, the effects of the ITC acquisition
in December 1996 and the two acquisitions in the fourth quarter of 1997 further
resulted in an increase in 1997 operating expenses over those of the prior year.
 
     Selling, general and administrative expenses ("SG&A") include salaries and
related personnel costs, facilities expenses, sales and marketing, consulting
and legal fees and equity in loss of affiliates. SG&A increased 142% for the
year ended December 31, 1997 as compared to the corresponding period in 1996.
The increase was primarily due to the Company's increase in employees and other
costs associated with the expansion of the Company's switched local and long
distance service businesses in its existing and planned markets, as well as the
ITC acquisition.
 
                                       24
<PAGE>   27
 
     Deferred compensation expense was recorded in connection with the Company's
Equity Option Plan until April 1997, and in connection with the Company's Stock
Option Plan (the "Plan"), which replaced the Equity Option Plan, subsequent to
April 1997. The stock options granted under the Equity Option Plan were
considered compensatory and were accounted for on a basis similar to that for
stock appreciation rights. All options outstanding under the Equity Option Plan
were regranted under the new Plan with terms and conditions substantially the
same as under the Equity Option Plan. As such, the Company continues to record
deferred compensation expense for those compensatory stock options issued, as
well as for compensatory stock options issued subsequent to the Plan conversion
date. Compensation expense is recognized over the vesting periods based on the
excess of the fair value of the stock options at the date of grant over the
exercise price.
 
     Depreciation expense increased primarily due to placement in service of
additional telecommunications network assets, including switches, fiber optic
cable, network electronics and related equipment. Amortization of intangible
assets increased primarily as a result of the ITC acquisition in December 1996,
as well as the acquisitions of Linkatel, Start and Chadwick in 1997.
 
     Interest expense increased 76% in 1997 over the prior year due to an
increase in the Company's average outstanding indebtedness over the respective
periods, primarily relating to the 12 1/2% and 9 5/8% Senior Notes issued in
April 1996 and October 1997, respectively. See "-- Liquidity and Capital
Resources." Pursuant to Statement of Financial Accounting Standards No. 34, the
Company capitalizes a portion of its interest costs as part of the construction
cost of its communications networks. Capitalized interest during 1997 totaled
$1.8 million. Interest income results from investment of excess cash and certain
securities that have been pledged as collateral for interest payments on the
12 1/2% Senior Notes. The increase in interest income in 1997 over 1996
corresponded to the increase in the Company's average outstanding cash balances.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The competitive local telecommunications service business is a capital
intensive business. The Company's existing operations have required and will
continue to require substantial capital investment for the acquisition and
installation of fiber, electronics and related equipment in order to provide
switched services in the Company's networks and the funding of operating losses
during the start-up phase of each market. In addition, the Company's strategic
plan calls for expansion into additional market areas. Such expansion will
require significant additional capital for: potential acquisitions of businesses
or assets; design, development and construction of new networks; and the funding
of operating losses during the start-up phase of each market. During 1997, the
Company used $94.5 million in cash for operating activities, compared to $40.6
million in 1996. The increase was primarily due to a substantial increase in the
Company's activities associated with the development and initiation of switched
local and long distance services. In addition, during 1997, the Company invested
an additional $210.5 million in cash in property and equipment, acquisitions of
telecommunications businesses and equity investments in telecommunications
businesses. During 1996, the Company invested $78.0 million in cash in property
and equipment, acquisitions of telecommunications assets and businesses and
equity investments in telecommunications businesses.
 
     In February 1998, the Company signed a definitive agreement with Metromedia
Fiber Network for exclusive rights to multiple fibers and innerducts for 20
years, with two 10 year renewals. The route covered by the agreement extends
over 650 route miles from Manhattan to White Plains (NY), to Stamford (CT), to
Newark (NJ) and south from Manhattan through Philadelphia, Wilmington (DE),
Baltimore, and to Washington (DC). The route will offer frequent splice points
within metropolitan areas and splice points at least every 10,000 feet on routes
between metropolitan areas, as well as provide access to ILEC central and tandem
switching offices. The Company will pay $92.0 million in cash for the
transaction, of which $80.3 million will be placed into escrow, to be released
as segments of the route are constructed and delivered to the Company.
 
     In January 1998, the Company and Nextel formed NEXTBAND, a joint venture
which is owned 50% by the Company and 50% by Nextel. On January 20, 1998,
NEXTBAND filed an application with the FCC for which it paid a $50.0 million
refundable deposit to participate in the FCC's LMDS auction which began on
February 18, 1998. Of the deposit amount, $25.0 million was contributed by the
Company. LMDS is a fixed
 
                                       25
<PAGE>   28
 
broadband point-to-multipoint service which the FCC and industry analysts
anticipate will be used for the deployment of wireless local loop, high-speed
data transfer and video broadcasting services. Two licenses will be awarded in
each of 493 BTAs when the auction is concluded. Although the number of licenses
that may be awarded to NEXTBAND is limited by the amount of the deposit,
NEXTBAND has applied for and is eligible to bid on any of the markets being
auctioned for the block A license (1,150 MHz of spectrum) and the block B
license (150 MHz of spectrum).
 
     The Company is exploring LMDS for two reasons. Depending upon the bidding
and deployment costs, LMDS may offer an economically efficient means to
supplement the Company's fiber network build-out in some localities. In
addition, a wireless local loop alternative may create competitive pressure on
high unbundled loop costs in certain areas. There can be no assurance that
NEXTBAND's participation in the auction will result in the purchase of any LMDS
licenses or that LMDS spectrum for wireless connectivity will provide a
cost-effective and efficiently engineered means to connect to end user
locations. If NEXTLINK's bids are successful, the purchase price of the licenses
and the costs of building out any such wireless systems could be substantial.
 
     In November 1997, the Company acquired all outstanding shares of Start, a
shared tenant services provider serving commercial buildings in Dallas, Austin
and Corpus Christi, Texas and Phoenix, Arizona. Services offered by Start
include local and long distance services, Internet access and customer premise
equipment management. Start currently provides services under long term
contracts to 600 corporate customers, or approximately 13,000 end users. The
Company paid consideration for the transaction consisting of $20.0 million in
cash, 441,336 shares of Class A common stock and the assumption of approximately
$5.3 million of liabilities, the majority of which were repaid.
 
     In October 1997, the Company acquired all of the outstanding shares of
Chadwick, a switch-based long distance reseller in central Pennsylvania, through
a merger transaction between Chadwick and a wholly owned subsidiary of NEXTLINK.
Chadwick serves approximately 11,500 customers throughout the central and
eastern Pennsylvania regions. The Company issued consideration for the
transaction consisting of a promissory note payable in the aggregate principal
amount of $5.0 million (which was repaid in full in January 1998), 257,151
shares of Class A Common Stock and the repayment of long term debt and other
liabilities totaling $6.6 million. The merger agreement also provides for
additional payments of up to a maximum of 192,863 shares of Class A Common Stock
over a two year period, with these payments being contingent upon the acquired
operation achieving specified performance goals.
 
     In September 1997, the Company entered into a definitive agreement to
acquire certain telecommunications assets of Unicom Thermal Technologies, Inc.
("UTT"), including two existing route miles of network plus 13 miles of conduit
in downtown Chicago. The Company also has the right to participate in the
ongoing expansion of UTT's network in Chicago. The existing network currently
provides connectivity to 28 buildings. The Company agreed to pay $2.5 million in
cash, plus up to an additional $560,000 for the acquisition of certain
additional telecommunications facilities. The Company will also be required to
pay certain additional consideration to UTT for a portion of the network
expansion costs, up to $3.4 million in cash plus the issuance of up to 60,022
shares of Class A Common Stock.
 
     In June 1997, the Company entered into an eight year exclusive agreement,
with an option to renew for five additional years, with a company that has
excess fiber capacity in each of Atlanta, Chicago, New York City, Newark (NJ)
and Philadelphia which it agreed to make available to the Company in each of
those markets at a substantial discount to the wholesale rates charged by other
vendors of capacity. In addition to the capacity arrangement described above,
the Company also has entered into a 20-year lease of capacity over an existing
47-mile fiber network in New York City, which extends from the Wall Street area
north to midtown Manhattan. In June 1997, the Company paid $11 million in full
satisfaction of its obligations under this lease, $6 million of which was placed
in escrow pending completion of certain building connections by the lessor. As
of December 31, 1997, $4.1 million remained in escrow. These arrangements will
allow the Company to accelerate its entry into each of these markets by enabling
the Company to avoid a significant portion of the infrastructure development and
construction time that would otherwise be required to launch switched local and
long distance services in these markets. Although these agreements have reduced
the initial
 
                                       26
<PAGE>   29
 
capital expenditures necessary to enter these markets, the Company has not, as a
result, reduced its overall planned capital expenditures through 1999.
 
     In June 1997, the Company also executed a definitive agreement to acquire
an existing fiber optic network in downtown Philadelphia in order to extend its
existing network in Pennsylvania. The acquisition is subject to regulatory and
other consents and is anticipated to be consummated by the end of the second
quarter in 1998. During the interim period prior to closing, the Company is
operating under a 36 fiber capacity agreement with the seller.
 
     On February 4, 1997, the Company completed the acquisition of substantially
all of the assets of Linkatel, a Los Angeles-based competitive access
telecommunications provider. At the time of acquisition, Linkatel operated an 80
mile fiber optic telecommunications network covering several markets in the
Orange and Los Angeles county areas. The total purchase price of $42.5 million
consisted of a cash payment of $36.1 million (including the release of $6.0
million which was deposited into escrow during 1996) plus the repayment of debt
of $5.6 million and the assumption of net liabilities totaling $0.8 million.
 
     In January 1997, the Company obtained rights-of-way to expand its existing
Salt Lake City network into Provo and Orem, Utah. The Company has completed the
expansion of this network to Provo and Orem and began providing switched local
and long distance services in Provo and Orem in September 1997.
 
     Prior to April 1996, the Company funded its expenditures with approximately
$55.0 million of cash equity investments from two entities that are controlled
by Craig O. McCaw. On April 25, 1996, the Company raised gross proceeds of
$350.0 million through the issuance of 12 1/2% Senior Notes due April 15, 2006
("12 1/2% Senior Notes"). The Company used $117.7 million of the gross proceeds
to purchase and hold in escrow U.S. government securities, representing funds
sufficient to provide for payment in full of interest on the 12 1/2% Senior
Notes through April 15, 1999, and used an additional $32.2 million to repay
certain advances and accrued interest from Eagle River, a company majority-owned
and controlled by Mr. McCaw. In addition, the Company incurred costs of $9.8
million in connection with the financing. Interest payments on the 12 1/2%
Senior Notes are due semi-annually.
 
     On January 31, 1997, the Company completed the sale of $285 million
aggregate liquidation preference of 14% senior exchangeable redeemable preferred
shares ("Preferred Shares") which, after deducting issuance costs, resulted in
net proceeds to the Company of approximately $274 million. The Preferred Shares
accrue dividends at the rate of 14% per annum. On or before February 1, 2002,
dividends may, at the option of the Company, be paid in cash or by issuing
additional Preferred Shares with an aggregate liquidation preference equal to
the amount of such dividends. After February 1, 2002, dividends must be paid in
cash. As of December 31, 1997, the Company had issued an additional 622,031
shares of Preferred Shares in satisfaction of the first three quarterly
dividends.
 
     Since inception and through December 1996, the Company has also issued
Class A Units valued at $15.5 million primarily for the acquisition of certain
telecommunications assets and businesses, which Units were converted to shares
of Class B Common Stock of the Company on January 31, 1997.
 
     On October 1, 1997, the Company completed an initial public offering
("IPO") of 12,000,000 shares of Class A Common Stock at a price of $17 per
share. In addition, the underwriters of the IPO exercised an option to purchase
2,280,000 additional shares of Class A Common Stock at the same price per share.
Gross proceeds from the IPO totaled $242.8 million, and proceeds net of
underwriting discounts, advisory fees and estimated expenses aggregated
approximately $226.8 million. Concurrently with the IPO, the Company sold $400
million in aggregate principal amount of 9 5/8% Senior Notes due 2007, which,
after deducting estimated issue costs, resulted in net proceeds to the Company
of approximately $388.5 million. Interest payments on the 9 5/8% Senior Notes
are due semi-annually.
 
     On March 3, 1998, the Company completed the sale of $335 million in
aggregate principal amount of 9% Senior Notes due 2008 ("9% Senior Notes").
Proceeds from the sale, net of discounts, underwriting commissions, advisory
fees and expenses, totaled approximately $326.5 million. Interest payments on
the 9% Senior Notes are due semi-annually, beginning September 1998.
 
                                       27
<PAGE>   30
 
     The Company will use the remaining proceeds from the sale of Class A Common
Stock, 9 5/8% Senior Notes and 9% Senior Notes and existing unrestricted cash
balances for expenditures relating to the construction, acquisition and
operation of telecommunications networks and service providers and the offering
of telecommunications services in those areas where the Company currently
operates or intends to operate. Expenditures for the construction and operation
of networks include (i) the purchase and installation of switches and related
electronics in existing networks and in networks to be constructed or acquired
in new or adjacent markets; (ii) the purchase and installation of fiber optic
cable and electronics to expand existing networks and develop new networks,
including the connection of new buildings; (iii) spectrum that may be purchased
during the LMDS auction that is currently ongoing; (iv) the development of its
comprehensive information technology platform and (v) the funding of operating
losses and working capital. The Company may also acquire or invest in businesses
that consist of existing networks or companies engaged in businesses similar to
those engaged in by the Company and its subsidiaries or other complementary
businesses.
 
     As of December 31, 1997, the Company had unrestricted cash and investments
of $742.4 million and $1,068.9 million on a pro forma basis after giving effect
to the sale of the 9% Senior Notes. The Company's current plan contemplates an
aggressive expansion into a number of new markets throughout the United States.
The Company may pursue various alternatives for achieving its growth strategy,
including: additional network construction; additional leases of network
capacity from third party providers; acquisitions of existing networks; and
spectrum that may be purchased during the LMDS auction that is currently ongoing
and associated facilities construction and deployment if any spectrum is
purchased. The Company also anticipates that a substantial amount of additional
capital expenditures will be made in 1999 and beyond. The funding of these
capital expenditures is expected to be provided by existing cash balances,
future vendor and/or credit facilities, future public or private sales of debt
securities, future sales of public or private capital stock and joint ventures.
There can be no assurance, however, that the Company will be successful in
raising sufficient additional capital on terms that it will consider acceptable
or that the Company's operations will produce positive consolidated cash flow in
sufficient amounts to meet its interest and dividend obligations on outstanding
securities. Failure to raise and generate sufficient funds may require the
Company to delay or abandon some of its planned future expansion or
expenditures, which could have a material adverse effect on the Company's growth
and its ability to compete in the telecommunications services industry.
 
     In addition, the Company's operating flexibility with respect to certain
business matters is, and will continue to be, limited by covenants associated
with the 12 1/2% Senior Notes, the 9 5/8% Senior Notes and the 9% Senior Notes.
Among other things, these covenants limit the ability of the Company and its
subsidiaries to incur additional indebtedness, create liens upon assets, apply
the proceeds from the disposal of assets, make dividend payments and other
distributions on capital stock and redeem capital stock. In addition, the terms
of the Preferred Shares contain certain covenants that may limit the Company's
operating flexibility with respect to the incurrence of indebtedness and
issuance of additional preferred shares. There can be no assurance that such
covenants will not adversely affect the Company's ability to finance its future
operations or capital needs or to engage in other business activities that may
be in the interest of the Company. The Company was in compliance with all
covenants associated with the 12 1/2% Senior Notes, the 9 5/8% Senior Notes and
the Preferred Shares as of December 31, 1997.
 
IMPACT OF YEAR 2000
 
     Certain of the Company's older computer systems and applications were
written to define a given year with abbreviated dates using the last two digits
in a year rather than the entire four digits. As a result, those systems and
applications have time-sensitive software that recognize an abbreviated year
"00" as the year 1900 rather than the year 2000. This could cause a system
failure or miscalculations resulting in disruptions of operations including,
among other things, a temporary inability to process transactions, send invoices
or engage in other normal business activities.
 
     The Company has received positive confirmation from its vendor that the
Company's Nortel DMS 500 switches and related telecommunications equipment are
Year 2000 compliant. The Company is currently assessing the extent of
replacements or modifications necessary to certain of its older computer systems
and applications so that such systems and applications will properly utilize
dates beyond December 31, 1999. The
 
                                       28
<PAGE>   31
 
Company believes that the impact of upgrading or modifying existing software and
converting to new software (the "Year 2000 Project") will not be material to the
Company operations or financial position. Costs incurred in connection with the
Year 2000 project will be expensed as incurred unless new software is purchased,
in which case such costs will be capitalized. The Company has not incurred
significant Year 2000 project costs to date. The Company plans to complete the
Year 2000 project no later than December 31, 1998.
 
OUTLOOK: ISSUES AND UNCERTAINTIES
 
     The Company does not provide forecasts of future financial performance.
This Report, however, does contain statements that are not historical facts and
are forward-looking. Actual events or results may differ materially from events
or results indicated, whether expressed or implied. Although the Company's
management is optimistic about the Company's long-term prospects, the following
issues and uncertainties, among others, should be considered in evaluating its
outlook.
 
  NEGATIVE CASH FLOW AND OPERATING LOSSES; LIMITED HISTORY OF OPERATIONS
 
     The development of the Company's businesses and the installation and
expansion of its networks require significant expenditures, a substantial
portion of which must be made before any revenues may be realized. Certain of
the expenditures are expensed as incurred, while certain other expenditures are
capitalized. These expenditures, together with the associated early operating
expenses, result in negative cash flow and operating losses until an adequate
revenue base is established. There can be no assurance that an adequate revenue
base will be established for any of the Company's networks. The Company's
operations have resulted in net losses of $12.7 million, $71.1 million and
$129.0 million for the years ended December 31, 1995, 1996 and 1997,
respectively. The Company will continue to incur significant expenditures in the
future in connection with the acquisition, development and expansion of its
networks, services and customer base. There can be no assurance that the Company
will achieve or sustain profitability or generate positive cash flow in the
future.
 
     The Company was formed in September 1994. A significant, but declining,
portion of the Company's revenue for the years ended December 31, 1995, 1996 and
1997, was derived from the operations of the Company's IVR enhanced service
offering, which operations were acquired by the Company in September 1995.
Prospective investors, therefore, have limited historical financial information
upon which to base an evaluation of the Company's performance in the business
which will be its principal focus in the future. The Company has only recently
commenced operations as a single source service provider of telecommunications
services. Given the Company's limited operating history, there can be no
assurance that it will be able to complete successfully in the
telecommunications business and to generate positive cash flow in the future.
 
  SIGNIFICANT FUTURE CAPITAL REQUIREMENTS; SUBSTANTIAL INDEBTEDNESS
 
     Expansion of the Company's existing networks and services and the
development and acquisition of new networks and services will require
significant capital expenditures. The Company will also continue to evaluate
additional revenue opportunities in each of its markets and, as and when
attractive additional opportunities develop, the Company plans to make capital
investments in its networks that might be required to pursue such opportunities.
The Company expects to meet its additional capital needs with the proceeds from
credit facilities and other borrowings, the proceeds from public or private
sales of debt securities, the sale or issuance of equity securities and through
joint ventures. There can be no assurance, however, that the Company will be
successful in raising sufficient additional capital on terms that it will
consider acceptable or that the Company's operations will produce positive cash
flow in sufficient amounts to service its debt and to pay cash dividends on the
14% Preferred Shares. Failure to raise and generate sufficient funds may require
the Company to delay or abandon some of its planned future expansion or
expenditures, which could have a material adverse effect on the Company's growth
and its ability to compete in the telecommunications services industry. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
 
     The Company expects to incur substantial additional indebtedness (including
secured indebtedness) during the next few years to finance the acquisition,
construction and expansion of networks, the potential
 
                                       29
<PAGE>   32
 
acquisition of telecommunications companies, the possible acquisition of LMDS
spectrum and the construction and deployment of associated facilities, if such
spectrum is purchased, the purchase of additional switches, the offering of
switched local and long distance services, the introduction of other new service
offerings and the development and implementation of a comprehensive information
technology platform. The Indenture does not limit the amount the Company may
invest in Restricted Subsidiaries or certain joint ventures engaged in one or
more Telecommunications Businesses (including the joint venture through which
the Company is participating in the LMDS auction) or the amount of Debt the
Company may incur to fund investments in Restricted Subsidiaries or such joint
ventures. As of December 31, 1997, after giving pro forma effect to the
Offering, the amount of total consolidated liabilities of the Company would have
been approximately $1,164.7 million.
 
     The future funding requirements discussed above are based on the Company's
current estimates. There can be no assurance that actual expenditures and
funding requirements will not be significantly higher or lower.
 
  RISK ASSOCIATED WITH IMPLEMENTATION OF GROWTH STRATEGY
 
     The expansion and development of the Company's operations (including the
construction and acquisition of additional networks) will depend on, among other
things, the Company's ability to assess markets, identify, finance and complete
suitable acquisitions, design fiber optic network backbone routes, install fiber
optic cable and facilities, including switches, and obtain rights-of-way,
building access rights and any required government authorizations, franchises
and permits, all in a timely manner, at reasonable costs and on satisfactory
terms and conditions. In addition, the Company has experienced rapid growth
since its inception, and the Company believes that sustained growth places a
strain on operational, human and financial resources. In order to manage its
growth, NEXTLINK must continue to improve its operating and administrative
systems including the continued development of effective systems relating to
ordering, provisioning and billing for telecommunications services. NEXTLINK
must also continue to attract and retain qualified managerial, professional and
technical personnel. As a result, there can be no assurance that the Company
will be able to implement and manage successfully its growth strategy. The
Company's growth strategy also involves the following risks:
 
     Qualified Personnel. NEXTLINK believes that a critical component for its
success will be the attraction and retention of qualified managerial,
professional and technical personnel. During 1997 the Company has experienced
significant competition in the attraction and retention of personnel that
possess the skill sets that the Company is seeking. Although the Company has
been successful in attracting and retaining qualified personnel, there can be no
assurance that NEXTLINK will not experience a shortage of qualified personnel in
the future.
 
     Switch and Equipment Installation. An essential element of the Company's
current strategy is the provision of switched local service. There can be no
assurance that the installation of the required switches, fiber optic cable and
associated electronics necessary to implement the Company's business plan will
continue to be completed on time or that, during the testing of these switches
and related equipment, the Company will not experience technological problems
that cannot be resolved. The failure of the Company to install and operate
successfully additional switches and other network equipment could have a
material adverse effect upon the Company's ability to enter additional markets
as a single source provider of telecommunications services.
 
     Interconnection Agreements. The Company has agreements or is currently
negotiating agreements for the interconnection of its networks with the networks
of the ILEC covering each market in which NEXTLINK either has or is constructing
a network. NEXTLINK may be required to negotiate new, or renegotiate existing
interconnection agreements as it enters new markets in the future. There can be
no assurance that the Company will successfully negotiate such other agreements
for interconnection with the ILEC or renewals of existing interconnection
agreements. The failure to negotiate required interconnection agreements could
have a material adverse effect upon the Company's ability to enter rapidly the
telecommunications market as a single source provider of telecommunications
services.
 
                                       30
<PAGE>   33
 
     Ordering, Provisioning and Billing. The Company has developed processes and
procedures and is working with external vendors, including the ILECs, in the
implementation of customer orders for services, the provisioning, installation
and delivery of such services and monthly billing for those services. In
connection with its development of a comprehensive information technology
platform, the Company is developing and implementing automated internal systems
for processing customer orders and provisioning. Billing is provided by
unaffiliated third-party vendors. The failure to develop effective internal
processes and systems for these service elements or the failure of the Company's
current vendors or the ILECs to deliver effectively ordering, provisioning
(including establishing sufficient capacity and facilities on the ILEC's
networks to service the Company) and billing services could have a material
adverse effect upon the Company's ability to achieve its growth strategy.
 
     Products and Services. The Company expects to continue to enhance its
systems in order to offer its customers switched local services and other
enhanced products and services in all of its networks as quickly as practicable
and as permitted by applicable regulations. The Company believes its ability to
offer, market and sell these additional products and services will be important
to the Company's ability to meet its long-term strategic growth objectives, but
is dependent on the Company's ability to obtain the needed capital, additional
favorable regulatory developments and the acceptance of such products and
services by the Company's customers. No assurance can be given that the Company
will be able to obtain such capital or that such developments or acceptance will
occur.
 
     Acquisitions. The Company intends to use the net proceeds of the Offering
to expand its networks and service offerings through internal developments and
acquisitions, which could be material. Such acquisitions, if made, could divert
the resources and management time of the Company and would require integration
with the Company's existing networks and services. There can be no assurance
that any such acquisitions will occur or that any such acquisitions, if made,
would be on terms favorable to the Company or would be successfully integrated
into the Company's operations.
 
  NEED TO OBTAIN AND MAINTAIN FRANCHISES, PERMITS AND RIGHTS-OF-WAY
 
     In order to acquire and develop its networks the Company must obtain local
franchises and other permits, as well as rights to utilize underground conduit
and aerial pole space and other rights-of-way and fiber capacity from entities
such as ILECs and other utilities, railroads, long distance companies, state
highway authorities, local governments and transit authorities. There can be no
assurance that the Company will be able to maintain its existing franchises,
permits and rights or to obtain and maintain the other franchises, permits and
rights needed to implement its business plan on acceptable terms. Although the
Company does not believe that any of the existing arrangements will be canceled
or will not be renewed as needed in the near future, cancellation or non-renewal
of certain of such arrangements could materially adversely affect the Company's
business in the affected metropolitan area. In addition, the failure to enter
into and maintain any such required arrangements for a particular network,
including a network which is already under development, may affect the Company's
ability to acquire or develop that network. See "Business -- Company Network
Architecture."
 
  COMPETITION
 
     In each of the markets served by the Company's networks, the Company
competes principally with the ILEC serving that area. ILECs are established
providers of local telephone services to all or virtually all telephone
subscribers within their respective service areas. ILECs also have long-standing
relationships with regulatory authorities at the federal and state levels. While
recent FCC administrative decisions and initiatives provide increased business
opportunities to telecommunications providers such as the Company, they also
provide the ILECs with increased pricing flexibility for their private line and
special access and switched access services. In addition, with respect to
competitive access services (as opposed to switched local exchange services),
the FCC recently proposed a rule that would provide for increased ILEC pricing
flexibility and deregulation for such access services either automatically or
after certain competitive levels are reached. If the ILECs 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, the income of competitors to the ILECs, including the
 
                                       31
<PAGE>   34
 
Company, could be materially adversely affected. If future regulatory decisions
afford the ILECs increased access services, pricing flexibility or other
regulatory relief, such decisions could also have a material adverse effect on
competitors to the ILEC, including the Company.
 
     The Company also faces, and expects to continue to face, competition from
other current and potential market entrants, including long distance carriers
seeking to enter, reenter or expand entry into the local exchange market place
such as AT&T Corp. ("AT&T"), MCI Communications Corporation ("MCI"), Sprint
Corporation ("Sprint") and WorldCom, Inc. ("WorldCom"), and from other CLECs,
competitive access providers ("CAPs"), cable television companies, electric
utilities, microwave carriers, wireless telephone system operators and private
networks built by large end-users. In addition, a continuing trend toward
combinations and strategic alliances in the telecommunications industry could
give rise to significant new competitors. The Telecom Act includes provisions
which impose certain regulatory requirements on all local exchange carriers,
including competitors such as the Company, while granting the FCC expanded
authority to reduce the level of regulation applicable to any or all
telecommunications carriers, including ILECs. The manner in which these
provisions of the Telecom Act are implemented and enforced could have a material
adverse effect on the Company's ability to successfully compete against ILECs
and other telecommunications service providers. The Company also competes with
equipment vendors and installers, and telecommunications management companies
with respect to certain portions of its business. Many of the Company's current
and potential competitors have financial, personnel and other resources,
including brand name recognition, substantially greater than those of the
Company, as well as other competitive advantages over the Company.
 
     The Company also competes with long distance carriers in the provision of
long distance services. Although the long distance market is dominated by four
major competitors, AT&T, MCI, Sprint and WorldCom, hundreds of other companies
also compete in the long distance marketplace.
 
  REGULATION
 
     The Company is subject to varying degrees of federal, state and local
regulation. In each state in which the Company desires to offer its services,
the Company is required to obtain authorization from the appropriate state
commission. Although the Company has received such authorization for each of its
operational markets, there can be no assurance that the Company will receive
such authorization for markets to be launched in the future. The Company is not
currently subject to price cap or rate of return regulation, nor is it currently
required to obtain FCC authorization for the installation, acquisition or
operation of its network facilities. Further, the FCC has determined that
non-dominant carriers, such as the Company and its subsidiaries, are not
required to file interstate tariffs for interstate access and domestic long
distance service on an ongoing basis. On February 13, 1997, the United States
Court of Appeals for the District of Columbia granted motions for a stay on the
FCC detariffing order pending judicial review of that order. The result of this
stay is that carriers must continue to file tariffs for interstate long distance
services. The FCC requires the Company and its subsidiaries to file interstate
tariffs on an ongoing basis for interstate and international inter-exchange
traffic. The Company's subsidiaries that provide or will provide intrastate
services are also generally subject to certification and tariff or price list
filing requirements by state regulators. Although passage of the Telecom Act
should result in increased opportunities for companies that are competing with
the ILECs, no assurance can be given that changes in current or future
regulations adopted by the FCC or state regulators or other legislative or
judicial initiatives relating to the telecommunications industry would not have
a material adverse effect on the Company. In addition, although the Telecom Act
provides incentives to the ILECs that are subsidiaries of Regional Bell
Operating Companies ("RBOCs") to enter the long distance service market, there
can be no assurance that these ILECs will negotiate quickly with competitors
such as the Company for the required interconnection of the competitor's
networks with those of the ILEC. On July 2, 1997, SBC Communications Inc.
("SBC") and its local exchange carrier subsidiaries filed a lawsuit in the
United States District Court for the Northern District of Texas challenging on
Constitutional grounds the Telecom Act restrictions applicable to the RBOCs
only. The plaintiffs in the case seek both a declaratory judgment and an
injunction against the enforcement of the challenged provisions. See
"Business -- Regulatory Overview."
 
                                       32
<PAGE>   35
 
     On December 31, 1997, the United States District Court for the Northern
District of Texas issued a decision holding that Sections 271 through 275,
including the long distance entry provisions, of the Telecom Act are
unconstitutional because they violate the separation of powers principles and
bill of attainder provision of the U.S. Constitution. On February 11, 1998, the
United States District Court for the Northern District of Texas granted the
CLECs' request for a stay of the December 31, 1997 decision pending appeal to
the United States Court of Appeals for the Fifth Circuit. That appeal is
currently pending. If the stay is lifted, or if the Fifth Circuit upholds the
district court's ruling, then the RBOCs would be free to enter the long distance
market, providing additional competition to the Company's bundled service
offering. In addition, the district court's ruling would eliminate the long
distance entry incentives under the Telecom Act that were designed to promote
interconnection between the ILEC and new competitors. The district court's
decision has been appealed by the U.S. government and a number of other
intervenors.
 
     On May 8, 1997, the FCC released an order establishing a significantly
expanded federal telecommunications subsidy regime which both increase the size
of existing subsidies and created new subsidy funds. In the May 8 order, the FCC
also announced that it will soon revise its rules for subsidizing service
provided to consumers in high cost areas. The Company intends to make all
subsidy payments required by law. See "Business -- Regulatory Overview."
 
     On July 18, 1997, the United States Court of Appeals for the Eighth Circuit
overturned many of the rules the FCC had established pursuant to the Telecom Act
governing the terms under which CLECs may, among other things, interconnect with
ILECs, resell ILEC services, lease unbundled ILEC network elements and terminate
traffic on ILEC networks. On October 14, 1997, the United States Court of
Appeals for the Eighth Circuit vacated the FCC's rule prohibiting ILECs from
separating unbundled network elements that are already combined, except at the
request of the CLECs. These eighth Circuit decisions substantially limit the
FCC's jurisdiction and expands the state regulators' jurisdiction to set and
enforce rules governing the development of local competition. As a result, it is
more likely that the rules governing local competition will vary substantially
from state to state. Most states, however, have already begun to establish rules
for local competition that are consistent with the FCC rules overturned by the
Eighth Circuit. If a patchwork of state regulations were to develop, it could
increase the Company's costs of regulatory compliance and could make competitive
entry in some markets more difficult and expensive than in others. See
"Business -- Regulatory Overview."
 
  DEPENDENCE ON LARGE CUSTOMERS
 
     To date the Company has derived a substantial proportion of its revenues
from certain large customers of its competitive access services and its IVR
enhanced communication service offerings, the loss of one or more of which could
have a material adverse effect on the Company's operating results. The Company's
10 largest customers accounted for approximately 25%, 51% and 66% of the
Company's revenues in 1997, 1996 and 1995, respectively. The Company does not
have long-term service contracts with most of these customers. The Company will
continue to be dependent upon a small number of customers for a substantial
portion of its revenues until such time, if at all, as the Company generates
substantial revenues from the provision of switched local and long distance
communications services.
 
  RAPID TECHNOLOGICAL CHANGES; LICENSES
 
     The telecommunications industry is subject to rapid and significant changes
in technology. The effect on the Company of technological changes, including
changes relating to emerging wireline and wireless transmission and switching
technologies, cannot be predicted. In addition, the Company from time to time
receives requests to consider licensing certain patents held by third parties
that may have bearing on its IVR and virtual communications center services. The
Company considers such requests on their merits, but has not to date entered
into any such license agreements. Should the Company be required to pay license
fees in the future, such payments, if substantial, could have a material adverse
effect on the Company's results of operations.
 
                                       33
<PAGE>   36
 
  DEPENDENCE ON KEY PERSONNEL
 
     The Company's businesses are managed by a small number of key executive
officers, the loss of certain of whom could have a material adverse effect on
the Company. The Company believes that its future success will depend in large
part on its ability to develop a large and sophisticated sales force and its
ability to attract and retain highly skilled and qualified personnel. Most of
the executive officers of the Company, including the presidents of its operating
subsidiaries, do not have employment agreements. Although the Company has been
successful in attracting and retaining qualified personnel, there can be no
assurance that NEXTLINK will not experience a shortage of qualified personnel in
the future.
 
  VARIABILITY OF QUARTERLY OPERATING RESULTS
 
     As a result of the significant expenses associated with the expansion and
development of its networks and services and the variability of the level of
revenues generated through sales of NEXTLINK's IVR enhanced communications
services, the Company anticipates that its operating results could vary
significantly from period to period.
 
  CONTROL BY MR. CRAIG O. MCCAW; POTENTIAL CONFLICTS OF INTERESTS
 
     Craig O. McCaw, primarily through his majority ownership and control of
Eagle River Investments, L.L.C., a Washington limited liability company ("Eagle
River"), controls approximately 52% of the Company's total voting power. As a
result, Mr. McCaw has the ability to control the direction and future operations
of the Company. Mr. McCaw is not an executive officer of the Company and, in
addition to his investment in the Company through Eagle River, Mr. McCaw has
significant investments in other communications companies, including Nextel
Communications, Inc., Teledesic Corporation and Cable Plus Inc., some of which
could compete with the Company as a single source provider of telecommunications
services or act as a supplier to the Company of certain telecommunications
services. The Company does not have a noncompetition agreement with either Mr.
McCaw or Eagle River. Mr. McCaw is not bound by any contractual restrictions
against sales of the Company's common stock.
 
  POTENTIAL VOLATILITY OF STOCK PRICE
 
     The market price of the Company's common stock has been, and is likely to
continue to be, volatile. The market price of the common stock could be subject
to significant fluctuations in response to a number of factors, such as actual
or anticipated variations in the Company's quarterly operating results, the
introduction of new products by the Company or its competitors, changes in other
conditions or trends in the Company's industry, changes in governmental
regulations, changes in securities analysts' estimates of the Company's, or its
competitors' or industry's, future performance or general market conditions. In
addition, stock markets have experienced extreme price and volume volatility in
recent years, which has had a substantial effect on the market prices of
securities of many smaller public companies for reasons frequently unrelated to
the operating performance of such companies.
 
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
     The consolidated financial statements of the Company are filed under this
Item, beginning on page 44 of this Report, and of NEXTLINK Capital are filed
under this Item, beginning on Page 61 of this Report.
 
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
     None.
 
                                       34
<PAGE>   37
 
                                    PART III
 
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
 
                                   MANAGEMENT
 
     The following table sets forth the names, ages and positions of the
executive officers and members of the Company's board of directors. Their
respective backgrounds are described following the table.
 
<TABLE>
<CAPTION>
          NAME               AGE                    POSITION
          ----               ---                    --------
<S>                          <C>    <C>
Steven W. Hooper(3)......    45     Chairman of the Board of Directors
Wayne M. Perry(1)........    48     Vice Chairman and Chief Executive Officer
James F. Voelker(1)......    47     President and Director
George M. Tronsrue III...    41     Chief Operating Officer
Jan Loichle..............    50     Vice President, Chief of Local Exchange
                                    Operations
Kathleen H. Iskra........    41     Vice President, Chief Financial Officer
                                    and Treasurer
R. Bruce Easter, Jr......    40     Vice President, General Counsel and
                                    Secretary
Charles P. Daniels.......    41     Vice President, Chief Technology Officer
Michael J. McHale, Jr....    41     Vice President, Chief Marketing Officer
R. Gerard Salemme........    44     Vice President, External Affairs and
                                    Industry Relations
Craig O. McCaw...........    48     Director
Dennis                       46     Director
  Weibling(1)(2)(3)......
Scot Jarvis(2)...........    37     Director
William A.                   44     Director
  Hoglund(1)(2)..........
Sharon L. Nelson(3)......    51     Director
Jeffrey S. Raikes........    39     Director
</TABLE>
 
---------------
(1) Member of the Executive Committee
 
(2) Member of the Compensation Committee
 
(3) Member of the Audit Committee
 
     The following persons are the presidents of the Company's operating
subsidiaries:
 
<TABLE>
<CAPTION>
          NAME               AGE                    POSITION
          ----               ---                    --------
<S>                          <C>    <C>
Hugh C. Cathey...........    47     President of NEXTLINK Ohio, L.L.C.
Don Hillenmeyer..........    52     President of NEXTLINK Tennessee, L.L.C.
Jeff C. Stone............    40     President of NEXTLINK Interactive, L.L.C.
Dwayne Nielson...........    43     President of NEXTLINK Utah, L.L.C.
Gary Rawding.............    46     President of NEXTLINK Pennsylvania, L.P.
Donald W. Sessamen.......    64     President of NEXTLINK California, L.L.C.
Richard Kingston.........    38     President of NEXTLINK Illinois, Inc.
</TABLE>
 
     Directors of the Company are elected annually at the annual meeting of
shareholders. The next annual meeting of shareholders is scheduled for May 1998.
All of the officers identified above serve at the discretion of the Board of
Directors of the Company. There are no family relationships between any person
identified above.
 
     The Audit Committee is responsible for reviewing the services provided by
the Company's independent auditors, consulting with the independent auditors on
audits and proposed audits of the Company and reviewing the need for internal
auditing procedures and the adequacy of internal controls. The Compensation
 
                                       35
<PAGE>   38
 
Committee determines executive compensation and stock option awards. The
Executive Committee exercises, to the maximum extent permitted by law, all
powers of the Board of Directors between board meetings, except those functions
assigned to specific committees. The Board of Directors may establish additional
committees from time to time.
 
     The following are brief biographies of persons identified above.
 
     Steven W. Hooper. Mr. Hooper has been Chairman of the Board since July 21,
1997. Prior to that, Mr. Hooper was Vice Chairman of the Company since June 16,
1997. Mr. Hooper was formerly President and Chief Executive Officer of AT&T
Wireless Services, Inc., following the merger with McCaw Cellular. Prior to
being appointed President and Chief Executive Officer, he served as Chief
Financial Officer for two years. This was preceded by five years as Regional
President for Cellular One's Pacific Northwest/Rocky Mountain region, where his
responsibilities included managing the cellular operations in six western states
and Alaska. Mr. Hooper is a member of the Audit Committee of the Board of
Directors.
 
     Wayne M. Perry. Mr. Perry has been Chief Executive Officer of the Company
since July 21, 1997 and Vice Chairman of the Company since June 16, 1997. Mr.
Perry was formerly Vice Chairman of AT&T Wireless Services, Inc. since September
1994, following the merger with McCaw Cellular. Prior to the merger, he served
as Vice Chairman of the Board of McCaw Cellular since June 1989, and before that
served as President since December 1985. Prior to becoming President of McCaw
Cellular, Mr. Perry served as Executive Vice President and General Counsel and
was primary legal officer from 1976 to 1985. Mr. Perry was appointed Vice
Chairman of the Board of LIN Broadcasting Corporation on March 5, 1990. He also
served as Chairman of the Board of Directors of the Cellular Telecommunications
Industry Association, the nationwide wireless industry association, for the
1993/94 term. Mr. Perry is a member of the Executive Committee of the Board of
Directors.
 
     James F. Voelker. Mr. Voelker has been the President of NEXTLINK since
April 1995 and is responsible for developing the company vision and guiding
overall operations. He is recognized as one of the early entrepreneurs in the
business of building and delivering competitive local exchange service. Mr.
Voelker's career in telecommunications spans almost two decades and includes
experience in very different segments of the industry in a variety of executive
positions. From 1981 to 1984 he served as Vice President of Sales, Marketing and
Customer Service for Lexitel Corporation, the forerunner of Allnet
Communications. Mr. Voelker co-founded Digital Signal Inc. and served as Chief
Operating Officer and Chief Executive Officer from 1985 through the company's
sale to SP Telecom in 1990. Digital Signal operated a nationwide fiber optic
network supplying capacity, engineering, provisioning and operational support to
over one hundred interexchange carriers. In the CAP arena, Mr. Voelker became
Vice Chairman of City Signal Inc. in 1992, which constructed and operated
networks in six markets. Subsequently, he served as its Chief Executive Officer
after the company merged with its sister company Teledial America to form U.S.
Signal. Based in Grand Rapids, Michigan, U.S. Signal was one of the first fully
certified CLECs in the country. Mr. Voelker has served as Vice Chairman of ALTS,
the industry Association of Local Telephone Service providers and as a director
of Phoenix Network Inc., a publicly held long distance company. Mr. Voelker is
also a member of the Executive Committee of the Board of Directors.
 
     George M. Tronsrue III. Mr. Tronsrue has been Chief Operating Officer of
NEXTLINK since October 1997. Prior to that, Mr. Tronsrue was part of the initial
management team of ACSI from February 1994 to September 1997, and was
responsible for planning and overseeing the operations of ACSI for its first
three years serving as Chief Operating Officer, President, Strategy and
Technology Development Division and Executive Vice President, Planning and
Development. Prior to that, Mr. Tronsrue served as the Regional Vice President
of the Central Region of Teleport Communications Group ("TCG"), and as Vice
President, Emerging Markets overseeing the start-up of TCG's initial eight cable
television partnerships. Before TCG, Mr. Tronsrue was at MFS Communications from
its inception in 1987 until 1992. At MFS, Mr. Tronsrue served as Vice President,
Corporate Planning and Information Management; Vice President, Field Sales; Vice
President and General Manager for MFS New York during its first year of
operations and Executive Vice President, MFS Internet. Prior to MFS, Mr.
Tronsrue served at MCI from 1983 to 1986 in a variety of engineering and
operations roles, culminating as Director of Operations, Michigan and Ohio.
 
                                       36
<PAGE>   39
 
     Jan Loichle. Ms. Loichle has been Vice President, Chief of Local Exchange
Operations of NEXTLINK since October 1996. Prior to that, Ms. Loichle was the
President of NEXTLINK Solutions (the virtual communications center) from July
1995. Prior to joining NEXTLINK, Ms. Loichle was Executive Vice President at
U.S. Signal in Detroit and Grand Rapids, Michigan from April 1993 to July 1995.
At U.S. Signal Ms. Loichle led the development of an enhanced service platform
(Magic Number) from concept through production system and implementation. From
1990 to 1993, Ms. Loichle was Assistant Vice President of Finance for SP Telecom
in San Francisco. Prior to that, Ms. Loichle was Vice President of Financial
Operations for Lexitel/Allnet/ALC in Birmingham, Michigan from December 1980 to
October 1989.
 
     Kathleen H. Iskra. Ms. Iskra has been Vice President, Chief Financial
Officer and Treasurer of NEXTLINK since January 1996. Prior to that, she was
President and Chief Executive Officer of Horizon Air, a wholly owned subsidiary
of Alaska Air Group. Prior to her appointment at Horizon Air, Ms. Iskra served
as staff Vice President of Finance and Controller of Alaska Airlines and Alaska
Air Group. Ms. Iskra's service with Alaska began in 1987, when she was appointed
Controller. Prior to joining Alaska, she was an audit manager with Arthur
Andersen.
 
     R. Bruce Easter, Jr. Mr. Easter has been Vice President, General Counsel
and Secretary of NEXTLINK since January 1995. From 1986 to December 1994, Mr.
Easter was an associate and then partner in the law firm of Davis Wright
Tremaine in Seattle, Washington, where he focused on communications law and
media matters.
 
     Charles P. Daniels. Mr. Daniels has been Vice President, Chief Technology
Officer since July 1997. Prior to that, Mr. Daniels was Vice President, Chief
Marketing Officer of NEXTLINK from November 1995. From 1992 to 1995, Mr. Daniels
worked for MCI where he was the founder and Program Manager of the network MCI
Developers Lab. Mr. Daniels was also a founding member of MCI's Advanced
Technology Group. Prior to joining MCI, Mr. Daniels worked for Manufacturers
Hanover Trust from 1989 to 1992 as Vice President/Strategic Technology and
Research, where he was responsible for evaluating and implementing new
technologies that either reduced costs or generated new revenue.
 
     Michael J. McHale, Jr. Mr. McHale has been Vice President, Chief Marketing
Officer since November 1997. Prior to joining NEXTLINK, Mr. McHale served as
Vice President and General Manager of the Phoenix market and Regional Vice
President at Teleport Communications Group, Inc. from 1993, developing the
Phoenix market from its inception. Prior to that, from 1991 to 1993, he was Vice
President, Product Marketing and Development at MFS Intelenet, Inc. and was
responsible for planning and implementing MFS's initial introduction of switched
services in New York City.
 
     R. Gerard Salemme. Mr. Salemme has been Vice President, External Affairs
and Industry Relations since July 1997. Prior to joining NEXTLINK, Mr. Salemme
was Vice President, Government Affairs at AT&T Corp. from December 1994. Prior
to joining AT&T Corp., Mr. Salemme was Senior Vice President, External Affairs
at McCaw Cellular from 1991 to December 1994.
 
     Craig O. McCaw. Mr. McCaw has been a director of the Company since
September 1994 and was Chief Executive Officer of NEXTLINK from September 1994
to July 21, 1997. Mr. McCaw is also Chairman and Chief Executive Officer of
Eagle River, a company formed and owned by Mr. McCaw to make strategic
investments in telecommunications ventures. Mr. McCaw was the founder, Chairman
and Chief Executive Officer of McCaw Cellular, the nation's leading provider of
wireless communications services, until the company was sold to AT&T in August
1994. Prior to entering the cellular telephone business in 1983, Mr. McCaw was
requested by his family to assume responsibility for the daily operations of a
small cable television operation in Centralia, Washington, that he and his three
brothers owned. The one-system operation serving 4,000 subscribers eventually
grew to be the nation's 20th largest cable operator serving 450,000 subscribers.
In 1974, the cable company's services expanded by entering the paging and
conventional mobile telephone industries. The company eventually became the
fifth largest paging operator in the country, serving approximately 320,000
subscribers in 13 states. In 1981, the company began to develop broad-based
cellular telephone services. Later, McCaw Cellular became the nation's largest
cellular telephone operator, with cellular system positions in more than 100
U.S. cities, representing more than 100 million potential customers. The company
also had interests in wireless data transmissions, personal communications
services, air-to-
 
                                       37
<PAGE>   40
 
ground phone systems and satellite communications at the time of its sale to
AT&T. Mr. McCaw is one of the two principal owners of Teledesic Corporation,
which in March 1994 announced plans for a worldwide satellite-based
telecommunications system. Mr. McCaw is indirectly a significant stockholder, a
director and Chairman of the Operating Committee of Nextel Communications, Inc.,
a provider of wireless telecommunications services. Mr. McCaw is also a director
of Cable Plus, Inc.
 
     Dennis Weibling. Mr. Weibling has been a director of the Company since
January 1997 and had been Executive Vice President of NEXTLINK since September
1994. Mr. Weibling is also President of Eagle River, Inc., since October 1993.
Mr. Weibling is a director and member of Nextel Communications, Inc.'s Board of
Directors and operations, audit and compensation committees. Nextel is a leading
provider of integrated wireless communications services for teams of mobile
workers. Mr. Weibling serves on the board and executive committee of Teledesic
Corporation, a satellite telecommunications company backed by Mr. McCaw and
Microsoft founder Mr. William Gates. Mr. Weibling is a director of Cable Plus,
one of the leading providers of private cable television and telephony service
to residential apartment complexes. A licensed certified public accountant in
Washington, Mr. Weibling is a member of the American Society of Certified Public
Accountants and the Washington Society of Certified Public Accountants. In
addition, Mr. Weibling is a licensed attorney in Ohio and a member of the
American Bar Association and Ohio State Bar Association. Mr. Weibling is also a
member of the Executive, Compensation and Audit Committees of the Board of
Directors.
 
     Scot Jarvis. Mr. Jarvis has been a director of the Company since January
1997 and, prior to that, had been Executive Vice President of NEXTLINK since
September 1994, and was a Vice President of Eagle River, Inc. from October 1994
through April 1996. Mr. Jarvis is the co-founder and since March 1997 has been a
member of Cedar Grove Partners, L.L.C. Prior to that, Mr. Jarvis was the acting
President of the Company from September 1994 to April 1995. Prior to joining
Eagle River, Inc., Mr. Jarvis served as Vice President of McCaw Development
Corporation from 1993 to 1994 and of McCaw Cellular from 1985 through 1994.
During his tenure at McCaw Cellular, Mr. Jarvis served in the positions of
General Manager from 1990 to 1993, Vice President of Acquisitions and
Development from 1988 to 1990 and Assistant Vice President from 1985 to 1988.
Mr. Jarvis also recently served on the Board of Directors or executive
committees of: NEXTEL Communications, Inc., PriCellular Corporation, Horizon
Cellular Group, Los Angeles Cellular Telephone Company, Cellular 2000
Partnership, Cybertel Cellular Telephone Company (St. Louis), Northwest Cellular
Partnership, and Movitel del Noroeste (Mexico Region). Mr. Jarvis has also
served as the President of the Iberia Cellular Telephone Company from 1991 to
1994. Mr. Jarvis is also a member of the Compensation Committee of the Board of
Directors.
 
     William A. Hoglund. Mr. Hoglund has been a director of the Company since
January 1997 and, prior to that, had been Executive Vice President of NEXTLINK
since February 1996. Mr. Hoglund is also Vice President and Chief Financial
Officer of Eagle River, Inc. since January 1996. Prior to joining Eagle River,
Inc., Mr. Hoglund was Managing Director of J.P. Morgan & Co. in its investment
banking group. Mr. Hoglund was employed by J.P. Morgan & Co. from 1977 through
1995, focusing for the past nine years on clients in the telecommunications,
cable and media industries. Mr. Hoglund is also a member of the Executive and
Compensation Committees of the Board of Directors.
 
     Sharon L. Nelson. Ms. Nelson has been director of the Company since
September 1997 and, prior to that, was Chairman of the Washington Utilities and
Transportation Commission ("WUTC") from February 11, 1985 until her resignation
on August 15, 1997. Prior to serving on the WUTC, Ms. Nelson served as staff
coordinator for the Washington State Legislature's Joint Select Committee on
Telecommunications (1983 to 1985), an attorney in private practice (1982 to
1983), legislative counsel to the Consumers Union of the United States (1978 to
1981), staff counsel to the Commerce Committee of the U.S. Senate (1976 to 1978)
and secondary school teacher of history and anthropology (1969 to 1973). Ms.
Nelson is also the past president of the National Association of Regulatory
Utility Commissioners. Ms. Nelson also served on the Federal-State Joint Board
on Universal Service created under the Telecom Act and as one of the 20-member
negotiating team appointed by the Governors of Washington, Idaho, Oregon and
Montana to review the Northwest electric power system. Ms. Nelson is also a
member of the Audit Committee of the Board of Directors.
 
                                       38
<PAGE>   41
 
     Jeffrey S. Raikes. Mr. Raikes has been a director of the Company since
September 1997. He is also a member of the Executive Committee and the Group
Vice President, Sales and Marketing of Microsoft Corporation. As Group Vice
President, Mr. Raikes has responsibility for Microsoft's worldwide customer
units as well as sales, marketing, support and service in the United States and
Canada. Prior to joining the Executive Committee in July 1996, Mr. Raikes was
Senior Vice President of Microsoft North America since 1993. Prior to serving as
Senior Vice President of Microsoft North America, from 1990, Mr. Raikes was Vice
President of Office Systems, where he was responsible for the development and
marketing of word processing, workgroup applications and pen computing. From
1984 to 1990, Mr. Raikes was the Director of Applications Marketing, where he
was the chief strategist behind Microsoft's graphical applications for the Apple
Macintosh and Microsoft Windows as well as leading the product strategy and
design of Microsoft Office. Mr. Raikes is also a member of the University of
Nebraska Foundation and a Trustee of the Washington State University Foundation
 
     The following individuals are the senior management of the Company's
subsidiaries.
 
     Hugh C. Cathey. Mr. Cathey has been the President of NEXTLINK Ohio since
August 1996. Prior to joining NEXTLINK, Mr. Cathey had nearly 20 years of
experience in the telecommunications industry. Mr. Cathey was President and
Chief Executive Officer of Digital Network, Inc., a publicly traded, facilities-
based long distance company based in Dallas, Texas. From 1989 to 1993, Mr.
Cathey served as President and Chief Executive Officer of United Telemanagement,
Inc. Prior to that, Mr. Cathey held sales and product management positions of
increasing responsibility with AT&T, culminating as the senior executive of a
business unit of AT&T with annual revenues of approximately $100 million. During
Mr. Cathey's tenure at United Telemanagement, Inc., that company filed a
petition under the Federal bankruptcy laws.
 
     Don Hillenmeyer. Mr. Hillenmeyer has been the President of NEXTLINK
Tennessee since March 1995. Prior to joining NEXTLINK in March of 1995, Mr.
Hillenmeyer was president of MCMG, Inc., a Nashville-based wireless
communications management consulting and operations firm specializing in running
Rural Service Areas for independent cellular telephone owners. Before founding
MCMG, Inc., Mr. Hillenmeyer held various senior management positions at McCaw
Cellular and was responsible for 13 southern states from August 1986 to February
1990.
 
     Jeff C. Stone. Mr. Stone has been the President of NEXTLINK Interactive
(the IVR subsidiary) since August 1, 1997. Prior to joining the Company, Mr.
Stone was Vice President and General Manager for the Western Region of WorldCom,
Inc. (previously MFS Telecom, Inc.) from 1994 to July 1997. Prior to that, from
1989 to 1994, Mr. Stone was the Director of Sales and Marketing of Associated
Communications of Los Angeles.
 
     Dwayne Nielson. Mr. Nielson has been President of NEXTLINK Utah since
February 1996. Prior to joining NEXTLINK, Mr. Nielson was Assistant Vice
President, Consumer and Small Business Market, at Sprint Corporation from
October 1994 to February 1996. Prior to that, from August 1985 through October
1994, Mr. Nielson held a variety of sales and marketing positions at Sprint and
United Telephone.
 
     Gary Rawding. Mr. Rawding has been President of NEXTLINK Pennsylvania since
September 1994. Prior to founding Penns Light Communications, Inc., certain
assets of which were acquired by the Company in September 1994, he served as
Vice President of Sales and Marketing at Eastern TeleLogic Corporation from 1989
until 1993. Prior to joining Eastern TeleLogic, Mr. Rawding held various
positions with Bell Atlantic Corporation.
 
     Donald W. Sessamen. Mr. Sessamen has been President of NEXTLINK California
since November 1996. Prior to that, Mr. Sessamen acted as a consultant to
NEXTLINK. Prior to acting as a consultant to the Company, Mr. Sessamen joined
Brooks Fiber California in 1994 as President, after the company acquired Phoenix
Fiberlink. At Brooks Fiber California, Mr. Sessamen completed the installation
of the San Jose system and managed the entry into switched services in the
Sacramento market. From 1991 to 1994, Mr. Sessamen was Executive Vice President
of Operations, Engineering and MIS at SP Telecom, a fiber optic systems
construction and wholesale transmission company using Southern Pacific Railroad
rights-of-way east
 
                                       39
<PAGE>   42
 
of the Mississippi River. At SP Telecom, Mr. Sessamen led SP Telecom's entry
into switch-based products utilizing the Northern Telecom DMS 250 Super Node,
introducing innovative switch-based products.
 
     Richard Kingston. Mr. Kingston has been the President of NEXTLINK Illinois
since July 1997. Prior to joining NEXTLINK, Mr. Kingston was the Western
Regional Vice President/General Manager of American Communications Services,
Inc. from April 1994 to July 1997. Prior to that, Mr. Kingston operated his own
telecommunications company, King Communications, Inc. from January 1992 to
January 1994. From December 1990 to January 1992, Mr. Kingston was West Region
Agent Manager for Telesphere Communications, Inc. and from 1988 to December
1990, Mr. Kingston was Director of Carrier Sales at MFS Communications Company,
Inc.
 
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Information regarding compliance with Section 16(a) of the Securities
Exchange Act of 1934 is set forth under the caption "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement relating to the
Company's annual meeting of shareholders to be held on May 20, 1998, and is
incorporated herein by reference. Such Proxy Statement will be filed within 120
days of the Company's year end.
 
ITEM 10. EXECUTIVE COMPENSATION
 
     Information called for by Part III, Item 10, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 20, 1998, and is incorporated herein by reference. The information
appears in the Proxy Statement under the caption "Compensation of Executive
Officers." Such Proxy Statement will be filed within 120 days of the Company's
year end.
 
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Information called for by Part III, Item 11, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 20, 1998, and is incorporated herein by reference. The information
appears in the Proxy Statement under the caption "Ownership of Certain
Beneficial Owners." Such Proxy Statement will be filed within 120 days of the
Company's year end.
 
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Information called for by Part III, Item 12, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 20, 1998, and is incorporated herein by reference. The information
appears in the Proxy Statement under the caption "Certain Relationships and
Related Transactions." Such Proxy Statement will be filed within 120 days of the
Company's year end.
 
                                       40
<PAGE>   43
 
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
     (a) FINANCIAL STATEMENTS
 
<TABLE>
        <S>                                                           <C>
        NEXTLINK Communications, Inc.
        Report of Independent Public Accountants....................  43
        Consolidated Balance Sheets as of December 31, 1997 and
          1996......................................................  44
        Consolidated Statements of Operations for the Years Ended
          December 31, 1997
          and 1996..................................................  45
        Consolidate Statements of Changes in Shareholders' Equity
          (Deficit) for the Years Ended December 31, 1997 and
          1996......................................................  46
        Consolidated Statements of Cash Flows for the Years Ended
          December 31, 1997 and 1996................................  47
        Notes to Consolidated Financial Statements..................  48
 
        NEXTLINK Capital, Inc.
        Report of Independent Public Accountants....................  60
        Balance Sheets as of December 31, 1997 and 1996.............  61
        Note to Balance Sheets......................................  62
</TABLE>
 
     (b) LIST OF EXHIBITS:
 
<TABLE>
<CAPTION>
        EXHIBIT NO.                            DESCRIPTION
        -----------                            -----------
        <C>            <S>
            3.1        Articles of Incorporation of NEXTLINK Communications Inc.(2)
            3.2        By-laws of NEXTLINK Communications, Inc.(2)
            3.3        Articles of Incorporation of NEXTLINK Capital, Inc.(1)
            3.4        By-laws of NEXTLINK Capital, Inc.(1)
            4.1        Form of Exchange Note Indenture, by and among NEXTLINK
                       Communications, Inc. and United States Trust Company of New
                       York, as trustee, relating to the Exchange Notes, including
                       form of Exchange Notes.(2)
            4.2        Certificate of Designations of the Powers, Preferences and
                       Relative, Participating, Optional and Other Special Rights
                       of 14% Senior Exchangeable Redeemable Preferred Shares and
                       Qualifications, Limitations and Restrictions Thereof.(2)
            4.3        Form of stock certificate of 14% Senior Exchangeable
                       Redeemable Preferred Shares.(2)
            4.4        Indenture, dated as of April 25, 1996, by and among NEXTLINK
                       Communications, Inc., NEXTLINK Capital, Inc. and United
                       States Trust Company of New York, as Trustee, relating to
                       12 1/2% Senior Notes due April 15, 2006, including form of
                       global note.(1)
            4.5        First Supplemental Indenture, dated as of January 31, 1997,
                       by and among the Company, NEXTLINK Communications, L.L.C.,
                       NEXTLINK Capital and United States Trust Company of New
                       York, as Trustee.(2)
            4.6        Form of Indenture between United States Trust Company, as
                       Trustee and NEXTLINK Communications, Inc., relating to the
                       9 5/8% Senior Notes due 2007.(3)
            4.7        Form of Indenture between United States Trust Company, as
                       Trustee and NEXTLINK Communications, Inc., relating to the
                       9% Senior Notes Due 2008.
           10.1        Stock Option Plan of the Company.(2)
           10.2        First Amendment to Stock Option Plan of the Company.
           10.3        Registration Rights Agreement dated as of January 15, 1997,
                       between the Company and the signatories listed therein.(2)
</TABLE>
 
                                       41
<PAGE>   44
 
<TABLE>
<CAPTION>
        EXHIBIT NO.                            DESCRIPTION
        -----------                            -----------
        <C>            <S>
           10.4        Preferred Exchange and Registration Rights Agreement, dated
                       as of January 31, 1997, by and among the Company and the
                       Initial Purchasers.(2)
           10.5        Fiber Lease and Innerduct Use Agreement, dated as of
                       February 23, 1998, by and between NEXTLINK Communications,
                       Inc. and Metromedia Fiber Network, Inc.(4)
           10.6        Amendment No. 1 to Fiber Lease and Innerduct Use Agreement,
                       dated as of March 4, 1998, by and between NEXTLINK
                       Communications, Inc. and Metromedia Fiber Network, Inc.(4)
           21          Subsidiaries of the Registrants.
           27.1        Financial Data Schedule for the year ended December 31,
                       1997.
           27.2        Financial Data Schedule, restated for the periods ended
                       December 31, 1996, June 30, 1997 and September 30, 1997.
</TABLE>
 
---------------
(1) Incorporated herein by reference to the exhibit filed with the Registration
    Statement on Form S-4 of NEXTLINK Communications, L.L.C. (the predecessor of
    NEXTLINK Communications, Inc.) and NEXTLINK Capital, Inc. (Commission File
    No. 333-4603).
 
(2) Incorporated herein by reference to the exhibit filed with the Annual Report
    on Form 10-KSB for the year ended December 31, 1996 of NEXTLINK
    Communications, Inc. and NEXTLINK Capital, Inc. (Commission File Nos.
    333-04603 and 333-04603-01).
 
(3) Incorporated herein by reference to the exhibit filed with the Registration
    Statement on Form S-1 of NEXTLINK Communications, Inc. (Commission File No.
    333-32003).
 
(4) Portions of this exhibit were omitted and filed separately with the
    Secretary of the Commission pursuant to the Issuer's Application Requesting
    Confidential Treatment under Rule 24(b)-2 of the Securities Exchange Act of
    1934.
 
     (c) REPORTS ON FORM 8-K
 
        None.
 
                                       42
<PAGE>   45
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors of NEXTLINK Communications, Inc.:
 
     We have audited the accompanying consolidated balance sheets of NEXTLINK
Communications, Inc. (a Washington Corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of operations,
changes in shareholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of NEXTLINK Communications,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
 
                                          ARTHUR ANDERSEN LLP
 
Seattle, Washington,
March 12, 1998
 
                                       43
<PAGE>   46
 
                         NEXTLINK COMMUNICATIONS, INC.
 
                          CONSOLIDATED BALANCE SHEETS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              ----------------------
                                                                 1997         1996
                                                              ----------    --------
<S>                                                           <C>           <C>
Current assets:
  Cash and cash equivalents.................................  $  389,074    $ 76,807
  Marketable securities.....................................     353,283      47,713
  Accounts receivable, net..................................      22,955       7,008
  Other.....................................................       4,530         607
  Pledged securities........................................      41,425      39,770
                                                              ----------    --------
          Total current assets..............................     811,267     171,905
Pledged securities..........................................      21,185      61,668
Property and equipment, net.................................     253,653      97,784
Goodwill, net...............................................      52,278      24,110
Other assets, net...........................................      78,770      35,216
                                                              ----------    --------
          Total assets......................................  $1,217,153    $390,683
                                                              ==========    ========
                   LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
  Accounts payable..........................................  $   26,776    $ 18,622
  Accrued expenses..........................................      13,082       4,112
  Notes payable.............................................       8,234          --
  Accrued interest payable..................................      18,880       9,250
  Current portion of capital lease obligations..............       2,610       1,194
  Payable to affiliate......................................          --       1,500
                                                              ----------    --------
          Total current liabilities.........................      69,582      34,678
Long-term debt..............................................     750,000     350,000
Capital lease obligations...................................       7,640       6,262
Deferred compensation.......................................          --      10,289
Other long-term liabilities.................................       3,179       2,850
                                                              ----------    --------
          Total liabilities.................................     830,401     404,079
Commitments and contingencies
Minority interests..........................................          23         308
Redeemable preferred stock (par value $0.01 per share,
  aggregate liquidation preference $323,478; 6,322,031 and 0
  shares issued and outstanding in 1997 and 1996,
  respectively).............................................     313,319          --
Class B common stock, subject to redemption (par value $0.02
  per share, 519,950 and 0 shares issued and outstanding in
  1997 and 1996, respectively)..............................       4,950          --
Equity units subject to redemption (0 and 397,202 units
  outstanding in 1997 and 1996, respectively)...............          --       4,950
Shareholders' equity (deficit):
  Common stock, par value $0.02 per share, stated at amounts
     paid in; Class A, 110,334,000 shares authorized,
     19,167,899 and 0 shares issued and outstanding in 1997
     and 1996, respectively; Class B, 44,133,600 shares
     authorized, 33,746,573 and 0 shares issued and
     outstanding in 1997 and 1996, respectively.............     330,561          --
  Deferred compensation.....................................      (9,596)         --
  Accumulated deficit.......................................    (252,505)    (84,181)
  Members' capital (28,154,509 units, all of which are
     outstanding in 1996)...................................          --      65,527
                                                              ----------    --------
          Total shareholders' equity (deficit)..............      68,460     (18,654)
                                                              ----------    --------
          Total liabilities and shareholders' equity
            (deficit).......................................  $1,217,153    $390,683
                                                              ==========    ========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       44
<PAGE>   47
 
                         NEXTLINK COMMUNICATIONS, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                              --------------------------
                                                                 1997           1996
                                                              -----------    -----------
<S>                                                           <C>            <C>
Revenue.....................................................  $    57,579    $    25,686
Costs and expenses:
     Operating..............................................       54,031         25,094
     Selling, general and administrative....................       75,732         31,353
     Deferred compensation..................................        3,247          9,914
     Depreciation...........................................       18,851          6,640
     Amortization...........................................        8,339          3,700
                                                              -----------    -----------
          Total costs and expenses..........................      160,200         76,701
                                                              -----------    -----------
Loss from operations........................................     (102,621)       (51,015)
Interest income.............................................       27,827         10,446
Interest expense............................................      (54,495)       (30,876)
                                                              -----------    -----------
Loss before minority interests..............................     (129,289)       (71,445)
Minority interests in loss of consolidated subsidiaries.....          285            344
                                                              -----------    -----------
Net loss....................................................  $  (129,004)   $   (71,101)
                                                              ===========    ===========
Preferred stock dividends and accretion of preferred stock
  redemption obligation, including issue costs..............      (39,320)            --
                                                              -----------    -----------
Net loss applicable to common shares........................  $  (168,324)   $   (71,101)
                                                              ===========    ===========
Pro forma:
     Net loss per share.....................................  $     (3.91)   $     (1.81)
                                                              ===========    ===========
     Shares used in computation of pro forma net loss per
      share (1996 amounts have been adjusted for conversion
      of membership units into shares of the Company's Class
      A and Class B common stock upon incorporation; see
      Note 9)...............................................   43,055,885     39,312,482
                                                              ===========    ===========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       45
<PAGE>   48
 
                         NEXTLINK COMMUNICATIONS, INC.
 
                       CONSOLIDATED STATEMENTS OF CHANGES
                       IN SHAREHOLDERS' EQUITY (DEFICIT)
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                     COMMON STOCK
                                         ------------------------------------
                                                  SHARES
                                         -------------------------                DEFERRED     ACCUMULATED   MEMBERS'
                                           CLASS A       CLASS B      AMOUNT    COMPENSATION     DEFICIT     CAPITAL      TOTAL
                                         -----------   -----------   --------   ------------   -----------   --------   ---------
<S>                                      <C>           <C>           <C>        <C>            <C>           <C>        <C>
Balance at December 31, 1995...........           --            --   $     --     $    --       $ (13,080)   $49,799    $  36,719
  Contributed capital..................           --            --         --          --              --      9,502        9,502
  Issuance of units for NEXTLINK Ohio
    acquisition........................           --            --         --          --              --        652          652
  Impact of recapitalization and merger
    of affiliates......................           --            --         --          --              --      5,574        5,574
  Net loss.............................           --            --         --          --         (71,101)        --      (71,101)
                                         -----------   -----------   --------     -------       ---------    -------    ---------
Balance at December 31, 1996...........           --            --         --          --         (84,181)    65,527      (18,654)
  Merger of NEXTLINK Communications,
    L.L.C with and into NEXTLINK
    Communications, Inc................           --    36,165,259     65,527          --              --    (65,527)          --
  Conversion of Equity Option Plan into
    Employee Stock Option Plan.........           --            --     15,363      (4,234)             --         --       11,129
  Issuance of compensatory stock
    options............................           --            --      4,872      (4,872)             --         --           --
  Compensation attributable to stock
    options vesting....................           --            --         --       2,335              --         --        2,335
  Issuance of common stock under
    leasing arrangement................      176,534            --      1,400          --              --         --        1,400
  Issuance of common stock upon
    exercise of stock options..........      672,878       921,314        115          --              --         --          115
  Issuance of common stock in initial
    public offering....................   14,280,000            --    226,760          --              --         --      226,760
  Sale of common stock by selling
    shareholder in initial public
    offering...........................    3,200,000    (3,200,000)        --          --              --         --           --
  Issuance of common stock in
    acquisitions.......................      698,487            --     16,524          --              --         --       16,524
  Conversion of Class B common stock
    into Class A common stock..........      140,000      (140,000)        --          --              --         --           --
  Loans to officers for income taxes
    paid upon exercise of stock
    options............................           --            --         --      (2,825)             --         --       (2,825)
  Cumulative redeemable preferred stock
    dividends and accretion of
    preferred stock redemption
    obligation, including issue
    costs..............................           --            --         --          --         (39,320)        --      (39,320)
  Net loss.............................           --            --         --          --        (129,004)        --     (129,004)
                                         -----------   -----------   --------     -------       ---------    -------    ---------
Balance at December 31, 1997...........   19,167,899    33,746,573   $330,561     $(9,596)      $(252,505)   $    --    $  68,460
                                         ===========   ===========   ========     =======       =========    =======    =========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       46
<PAGE>   49
 
                         NEXTLINK COMMUNICATIONS, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                              ------------------------
                                                                 1997          1996
                                                              ----------    ----------
<S>                                                           <C>           <C>
OPERATING ACTIVITIES:
Net loss....................................................  $(129,004)    $ (71,101)
Adjustments to reconcile net loss to net cash used in
  operating activities:
     Deferred compensation expense..........................      3,247         9,914
     Equity in loss of affiliates...........................      2,544         1,100
     Depreciation and amortization..........................     27,190        10,340
     Minority interests in loss of consolidated
      subsidiaries..........................................       (285)         (344)
Changes in assets and liabilities, net of effects from
  acquisitions:
     Accounts receivable....................................    (11,206)       (1,659)
     Other current assets...................................     (1,953)          (42)
     Other long-term assets.................................     (1,208)       (1,430)
     Accounts payable.......................................      4,116           993
     Accrued expenses and other liabilities.................      2,434         2,416
     Accrued interest payable...............................      9,630         9,250
                                                              ---------     ---------
Net cash used in operating activities.......................    (94,495)      (40,563)
 
INVESTING ACTIVITIES:
Purchase of property and equipment..........................   (142,170)      (51,920)
Investment in assets of acquired businesses (net of cash
  acquired).................................................    (61,609)      (15,169)
Cash withdrawn from (placed into) escrow to be used in
  business acquisition......................................      6,000        (6,000)
Investments in unconsolidated affiliates....................     (6,766)       (4,953)
Purchase of pledged securities..............................         --      (117,688)
Maturity of pledged securities..............................     39,920        16,431
Purchase of marketable securities, net......................   (305,570)      (47,713)
                                                              ---------     ---------
Net cash used in investing activities.......................   (470,195)     (227,012)
 
FINANCING ACTIVITIES:
Net proceeds from issuance of redeemable preferred stock....    274,000            --
Capital contributions.......................................         --         9,935
Proceeds from payable to affiliates.........................         --        28,766
Repayment of payable to affiliates..........................     (1,500)      (33,703)
Repayment of capital lease obligations......................     (1,939)         (771)
Repayment of notes payable..................................     (5,926)           --
Bank overdraft..............................................         --        (1,373)
Net proceeds from sale of common stock......................    226,760            --
Proceeds from sale of senior notes..........................    400,000       350,000
Proceeds from issuance of common stock upon exercise of
  stock options.............................................        115            --
Costs incurred in connection with financing.................    (11,728)       (9,822)
Loans to officers for income taxes paid upon exercise of
  stock options.............................................     (2,825)           --
                                                              ---------     ---------
Net cash provided by financing activities...................    876,957       343,032
                                                              ---------     ---------
Net increase in cash and cash equivalents...................    312,267        75,457
Cash and cash equivalents, beginning of year................     76,807         1,350
                                                              ---------     ---------
Cash and cash equivalents, end of year......................  $ 389,074     $  76,807
                                                              =========     =========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       47
<PAGE>   50
 
                         NEXTLINK COMMUNICATIONS, INC.
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 1997 AND 1996
 
 1. ORGANIZATION AND DESCRIPTION OF BUSINESS
 
     The consolidated financial statements include the accounts of NEXTLINK
Communications, Inc., a Washington corporation, and its majority-owned
subsidiaries (collectively referred to as the Company). The Company, through
predecessor entities, was formed on September 16, 1994 and, through its
subsidiaries, provides competitive local, long distance and enhanced
telecommunications services in selected markets in the United States. The
Company is a majority-owned subsidiary of Eagle River Investments, L.L.C. (Eagle
River).
 
     The competitive local telecommunications service business is a capital
intensive business. The development of the Company's businesses and the
installation and expansion of its networks require significant expenditures, a
substantial portion of which must be made before any revenues may be realized.
These expenditures, together with the associated early operating expenses, have
resulted in negative cash flow and operating losses, which have been
substantially financed with the proceeds from public sales of debt and equity
securities.
 
 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Principles of Consolidation
 
     The Company's financial statements include 100% of the assets, liabilities
and results of operations of subsidiaries in which the Company has a controlling
interest of greater than 50%. The ownership interests of the other members or
partners in such subsidiaries are reflected as minority interests. The Company's
investment in Telecommunications of Nevada, L.L.C., (Nevada L.L.C.) a limited
liability company in which the Company has a 40% interest and which operates a
network that is managed by the Company in Las Vegas, Nevada, is accounted for on
the equity method. Investments in entities in which the Company has voting
interests of not more than 20% are accounted for on the cost method. All
significant intercompany accounts and transactions have been eliminated.
 
  Cash and Cash Equivalents
 
     The Company considers all highly liquid investments with maturities of
three months or less at the time of purchase to be cash equivalents.
 
  Marketable Securities
 
     Marketable securities consist of U.S. government and other securities with
original maturities beyond three months. Marketable securities are stated at
cost, adjusted for discount accretion and premium amortization. The securities
in the Company's portfolio are classified as "held to maturity," as management
has the intent and ability to hold those securities to maturity. The fair value
of the Company's marketable securities approximates the carrying value.
 
  Pledged Securities
 
     In connection with the sale of 12 1/2% Senior Notes (see Note 6), a portion
of the net proceeds was utilized to purchase a portfolio consisting of U.S.
government securities, which mature at dates sufficient to provide for payment
in full of interest on the 12 1/2% Senior Notes through April 15, 1999. The
pledged securities are stated at cost, adjusted for premium amortization and
accrued interest. The fair value of the pledged securities approximates the
carrying value.
 
                                       48
<PAGE>   51
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
  Property and Equipment
 
     Property and equipment are stated at cost. Direct costs of construction are
capitalized, including $1,793,000 and $853,000 of interest costs related to
construction during 1997 and 1996, respectively. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets.
 
     Estimated useful lives of property and equipment are as follows:
 
<TABLE>
<S>                                               <C>
Telecommunications networks.....................  5-20 years
Office equipment, furniture and other...........  3-5 years
Leasehold improvements..........................  the lesser of the
                                                  estimated useful lives
                                                  or the terms of the
                                                  leases
</TABLE>
 
  Intangible Assets
 
     Intangible assets primarily represent costs allocated in acquisitions to
customer bases and contracts, software and related intellectual property and
goodwill. Intangible assets are amortized using the straight-line method over
the estimated useful lives of the assets as follows:
 
<TABLE>
<S>                                               <C>
Customer contracts..............................  term of the contracts
Customer bases..................................  5 years
Software and related intellectual property......  5 years
Goodwill........................................  15-20 years
</TABLE>
 
     Costs incurred in connection with securing the Company's debt facilities,
including underwriting and advisory fees and other such costs, are deferred and
amortized over the term of the financing using the straight-line method.
 
  Income Taxes
 
     Prior to January 31, 1997, the Company was organized and operated as a
limited liability company that was classified and taxed as a partnership for
federal and state income tax purposes. Effective February 1, 1997, the Company
became subject to federal and state income taxes directly as a C corporation.
 
     The Company accounts for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" (SFAS 109), which requires that deferred income taxes be determined based
on the estimated future tax effects of differences between the financial
statement and tax bases of assets and liabilities given the provisions of the
enacted tax laws.
 
  Revenue Recognition
 
     The Company recognizes revenue on telecommunications and enhanced
communications services in the period that services are provided.
 
  Pro Forma Net Loss Per Share
 
     Pro forma net loss per share has been computed using the number of shares
of common stock and common stock equivalents outstanding. Pursuant to Securities
and Exchange Commission Staff Accounting Bulletin No. 98 (SAB 98), issued in
February 1998, nominal issuances of shares during the twelve-month period
preceding the date of the initial filing of the Registration Statement have been
included in the calculation of common stock equivalent shares as if such shares
and options were outstanding for all periods
 
                                       49
<PAGE>   52
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
presented. The provisions of SAB 98 require retroactive application; as such,
pro forma net loss per share amounts and shares used in computation of pro forma
net loss per share for all prior periods have been restated.
 
     In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings Per Share" (SFAS 128), which revises the calculation and
presentation provisions of Accounting Principles Board (APB) Opinion No. 15 and
related interpretations. SFAS 128 is effective for the Company's fiscal year
ending December 31, 1997, and retroactive application is required.
Implementation of SFAS 128 did not have a material effect on the Company's
earnings per share amounts reported prior to that date.
 
  Stock-Based Compensation
 
     As allowed by Statement No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123), the Company has chosen to account for compensation cost associated
with its stock option plans in accordance with APB Opinion No. 25.
 
  Concentration of Credit Risk
 
     Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables. The
Company's trade receivables are geographically dispersed and include customers
in many different industries. Management believes that any risk of loss is
significantly reduced due to the diversity of its customers and geographic sales
areas. The Company continually evaluates the creditworthiness of its customers;
however, it generally does not require collateral. The Company's allowance for
doubtful accounts is based on historical trends, current market conditions and
other relevant factors.
 
  Use of Estimates
 
     The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
  Reclassifications
 
     Certain reclassifications have been made to prior period amounts in order
to conform to the current year presentation.
 
 3. ACQUISITIONS
 
     On November 1, 1997, the Company acquired all of the outstanding shares of
Start Technologies Corporation (Start), a shared tenant services provider
offering local and long distance services, Internet access and customer premise
equipment management in Texas and Arizona. The Company paid consideration for
the transaction consisting of $20.0 million in cash, 441,336 shares of Class A
common stock, and the assumption of approximately $5.3 million of liabilities,
the majority of which were repaid.
 
     On October 1, 1997, the Company acquired all of the outstanding shares of
Chadwick Telecommunications Corporation (Chadwick), a switch-based long distance
reseller in central Pennsylvania, through a merger transaction between Chadwick
and a wholly owned subsidiary of the Company. The purchase price of the
transaction consisted of a $5.0 million promissory note payable, due January 1,
1998, issuance of 257,151 shares of Class A common stock, and the repayment of
long-term debt and other liabilities totaling $6.6 million. The merger agreement
also provides for additional payments of up to a maximum of 192,863 shares of
Class A common stock over a two-year period, with these payments being
contingent upon the acquired operation achieving specified performance goals.
 
                                       50
<PAGE>   53
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
     On February 4, 1997, the Company acquired substantially all of the assets
of Linkatel Pacific, L.P. (Linkatel), a Los Angeles-based competitive access
telecommunications provider. At the time of the acquisition, Linkatel operated
an 80 mile fiber optic telecommunications network covering several markets from
the downtown Los Angeles area to the city of Irvine in Orange County. As part of
the assets acquired, the Company obtained access to approximately 250 route
miles of right-of-way, of which 183 miles have been completed, creating one
network in Los Angeles and one network in the Orange County area. The Company
has been providing competitive access services over these networks since the
acquisition date and launched switched local and long distance services in July
1997. The total purchase price of $42.5 million consisted of a cash payment of
$36.1 million, the repayment of debt of $5.6 million and the assumption of net
liabilities of $0.8 million.
 
     In December 1996, the Company acquired ITC, a switched-based long distance
reseller based in Salt Lake City, Utah. Consideration for the acquisition of ITC
consisted of a cash payment of $4.0 million, of which $2.6 million was placed
into escrow to be paid during 1998, plus the issuance of 397,202 Class A Units
of the Company valued at approximately $5.0 million, which were subsequently
converted into 519,950 shares of the Company's Class B common stock. The Company
has granted the seller an option requiring the Company to repurchase such shares
at $19.92 per share beginning in the fourth quarter of 1999. This repurchase
obligation will terminate if during the three-year period commencing March 25,
1998, the average daily closing price of the Class A common stock during any
consecutive 60 trading day period is greater than $19.92.
 
     In January 1996, the Company acquired certain assets of FoneNet, Inc. and
U.S. Network, Inc. through NEXTLINK Ohio, L.L.C. Consideration for the purchase
consisted of a cash payment of $9.6 million, the issuance of 287,721 Class A
Units of the Company, valued at $651,933, plus the assumption of capital lease
obligations of $6.1 million.
 
     The above acquisitions were accounted for using the purchase method of
accounting and, accordingly, the results of operations of the acquired companies
have been included in the Company's consolidated financial statements since the
effective dates of acquisition. The aggregate purchase price for the
acquisitions occurring in 1997 and 1996 were allocated based on fair values as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                    1997       1996
                                                   -------    -------
<S>                                                <C>        <C>
Fair value of tangible assets acquired and
  liabilities assumed............................  $12,525    $12,579
Fair value of intangible assets acquired.........   70,705     16,425
                                                   -------    -------
                                                   $83,230    $29,004
                                                   =======    =======
Purchase price...................................  $83,230    $29,004
                                                   =======    =======
</TABLE>
 
     The following unaudited condensed pro forma information presents the
results of operations of the Company for the years ended December 31, 1997 and
1996 as if the above transactions had occurred on January 1, 1996 (in thousands,
except per share amounts):
 
<TABLE>
<CAPTION>
                                                  1997         1996
                                                ---------    --------
<S>                                             <C>          <C>
Revenue.......................................  $  79,070    $ 58,050
Net loss......................................  $(134,404)   $(74,423)
Net loss per share............................  $   (3.12)   $  (1.89)
</TABLE>
 
     The unaudited pro forma information is provided for informational purposes
only and is not necessarily indicative of the results of operations that would
have occurred had the purchases been made on January 1, 1996, or of the future
anticipated results of operations of the combined companies.
 
                                       51
<PAGE>   54
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
 4. PROPERTY AND EQUIPMENT
 
     Property and equipment consisted of the following components (in
thousands):
 
<TABLE>
<CAPTION>
                                                     DECEMBER 31,
                                                  -------------------
                                                    1997       1996
                                                  --------    -------
<S>                                               <C>         <C>
Telecommunications networks.....................  $189,629    $66,762
Office equipment, leasehold improvements,
  furniture and other...........................    38,979     18,097
                                                  --------    -------
                                                   228,608     84,859
Less accumulated depreciation...................    36,417      8,369
                                                  --------    -------
                                                   192,191     76,490
Network construction in progress................    61,462     21,294
                                                  --------    -------
                                                  $253,653    $97,784
                                                  ========    =======
</TABLE>
 
     In June 1997, the Company entered into an eight-year operating lease
agreement, with an option to renew for five additional years, with a company
that has excess fiber capacity in Atlanta, Chicago, New York City, Newark, New
Jersey, and Philadelphia which it agreed to make available to the Company in
each of those markets. Payment in exchange for use of the leased network will be
based on monthly charges for actual services provided. In connection with this
lease agreement, the Company also issued to the lessor 176,534 shares of Class A
common stock in June 1997 for certain exclusivity rights to the excess capacity.
 
     In addition to the capacity arrangement described above, in June 1997, the
Company entered into a 20-year capital lease over an existing 47-mile fiber
network in New York City. In connection with this arrangement, the Company paid
$11 million in full satisfaction of its obligation under the lease, $6 million
of which was placed in escrow pending completion of certain building connections
by the lessor. As of December 31, 1997, $4.1 million remained in escrow.
 
5. OTHER ASSETS
 
     Other assets consisted of the following components (in thousands):
 
<TABLE>
<CAPTION>
                                                      DECEMBER 31,
                                                   ------------------
                                                    1997       1996
                                                   -------    -------
<S>                                                <C>        <C>
Customer bases...................................  $53,033    $12,003
Equity investments...............................    8,021      3,853
Financing costs..................................   21,552      9,822
Cash held in escrow for acquisitions.............       --      8,682
Advances to business to be acquired..............       --      1,490
Other noncurrent assets..........................    8,415      4,627
                                                   -------    -------
                                                    91,021     40,477
Less accumulated amortization....................   12,251      5,261
                                                   -------    -------
                                                   $78,770    $35,216
                                                   =======    =======
</TABLE>
 
     The Company's equity investments include (i) a 40% investment in Nevada
L.L.C., which operates a fiber optic telecommunications network serving the Las
Vegas market and (ii) a $3.7 million investment in convertible preferred stock
of Intermind Corporation (Intermind). Intermind has developed and patented an
interactive communications tool for the World Wide Web and intranet
applications.
 
                                       52
<PAGE>   55
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
 6. LONG-TERM DEBT
 
     On October 1, 1997, the Company sold $400 million in aggregate principal
amount of 9 5/8% Senior Notes due October 1, 2007, which, after deducting issue
costs, resulted in net proceeds to the Company of $388.5 million. Interest
payments on the 9 5/8% Senior Notes are due semi-annually. The 9 5/8% Senior
Notes are redeemable at the option of the Company, in whole or in part, at any
time on or after October 1, 2002 at established redemption prices which decline
to 100% of the stated principal amount thereof by October 1, 2005.
 
     On April 25, 1996, the Company completed the sale and issuance of $350
million in principal amount of 12 1/2% Senior Notes due April 15, 2006. The
Company used $117.7 million of the gross proceeds to purchase U.S. government
securities, representing funds sufficient to provide for payment in full of
interest on the 12 1/2% Senior Notes through April 15, 1999 and used an
additional $32.2 million to repay advances and accrued interest from Eagle
River. In addition, the Company incurred costs of $9.8 million in connection
with the financing (including underwriter discounts and commissions). Interest
payments on the 12 1/2% Senior Notes are due semi-annually. The 12 1/2% Senior
Notes are redeemable at the option of the Company, in whole or in part, at any
time on or after April 15, 2001 at established redemption prices which decline
to 100% of the stated principal amount thereof by April 15, 2004. As of December
31, 1997, the approximate fair value of the 12 1/2% Senior Notes was $402.5
million, based on quoted market prices.
 
     The indentures pursuant to which the 9 5/8% and 12 1/2% Senior Notes (the
Notes) are issued contain certain covenants that, among other things, limit the
ability of the Company and its subsidiaries to incur additional indebtedness,
issue stock in subsidiaries, pay dividends or make other distributions,
repurchase equity interests or subordinated indebtedness, engage in sale and
leaseback transactions, create certain liens, enter into certain transactions
with affiliates, sell assets of the Company and its subsidiaries, and enter into
certain mergers and consolidations.
 
     In the event of a change in control of the Company as defined in the
indentures, holders of the Notes will have the right to require the Company to
purchase their Notes, in whole or in part, at a price equal to 101% of the
stated principal amount thereof, plus accrued and unpaid interest, if any,
thereon to the date of purchase. The Notes are senior unsecured obligations of
the Company, and are subordinated to all current and future indebtedness of the
Company's subsidiaries, including trade payables.
 
 7. REDEEMABLE PREFERRED STOCK
 
     On January 31, 1997, the Company completed the sale of 5.7 million units
consisting of (i) 14% senior exchangeable redeemable preferred shares (Preferred
Shares), liquidation preference $50 per share, and (ii) contingent warrants to
acquire in the aggregate 5% of each class of outstanding junior shares (as
defined) of the Company on a fully diluted basis as of February 1, 1998, which
resulted in gross proceeds to the Company of $285 million, and proceeds net of
underwriting discounts, advisory fees and expenses of $274 million. The
contingent warrants expired unused on October 31, 1997 (30 days after the
Company's initial public offering of its Class A common stock). Dividends on the
Preferred Shares accrue from January 31, 1997 and are payable quarterly,
commencing on May 1, 1997, at an annual rate of 14% of the liquidation
preference thereof. Dividends may be paid, at the Company's option, on any
dividend payment date occurring on or prior to February 1, 2002, either in cash
or by issuing additional Preferred Shares with an aggregate liquidation
preference equal to the amount of such dividends. The Company is required to
redeem all of the Preferred Shares outstanding on February 1, 2009 at a
redemption price equal to 100% of the liquidation preference thereof, plus
accumulated and unpaid dividends to the date of redemption. As of December 31,
1997, the approximate fair value of the Preferred Shares was $345.1 million,
based on quoted market prices.
 
                                       53
<PAGE>   56
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
     Subject to certain conditions and the modifications of covenants, the
Preferred Shares are exchangeable in whole, but not in part, at the option of
the Company, on any dividend payment date, for 14% senior subordinated notes
(Senior Subordinated Notes) due February 1, 2009 of the Company. All terms and
conditions (other than interest, ranking and maturity) of the Senior
Subordinated Notes would be substantially the same as those of the Company's
outstanding 12 1/2% Senior Notes due April 15, 2006.
 
 8. INCOME TAXES
 
     Prior to January 31, 1997, the Company was organized and operated as a
limited liability company that was classified and taxed as a partnership for
federal and state income tax purposes. Effective February 1, 1997, the Company
became subject to federal and state income taxes directly as a C corporation,
which resulted in the Company recording a deferred tax liability and deferred
tax provision at that time.
 
     Components of deferred tax assets and liabilities as of February 1, 1997
(date of conversion to a C corporation) and December 31, 1997 are as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                               FEBRUARY 1,    DECEMBER 31,
                                                  1997            1997
                                               -----------    ------------
<S>                                            <C>            <C>
Deferred tax assets:
  Amortization...............................    $   994        $  1,116
  Capitalized costs..........................      4,076           6,508
  Provisions not currently deductible........        252           1,191
  Net operating loss carryforwards...........         --          47,734
                                                 -------        --------
Total deferred tax assets....................      5,322          56,549
Valuation allowance..........................         --         (34,064)
                                                 -------        --------
                                                   5,322          22,485
Deferred tax liabilities:
  Depreciation...............................       (705)         (1,499)
  Purchase acquisitions......................     (6,458)        (20,374)
  Other......................................       (686)           (612)
                                                 -------        --------
Total deferred tax liabilities...............     (7,849)        (22,485)
                                                 -------        --------
Net deferred taxes...........................    $(2,527)       $     --
                                                 =======        ========
</TABLE>
 
     During 1997, the valuation allowance increased $34.1 million, thereby fully
reserving the Company's net deferred tax assets as of December 31, 1997.
 
     As of December 31, 1997, the Company had net operating loss carryforwards
of approximately $119.3 million, which are available to offset future federal
and state taxable income, if any, through 2012.
 
     A reconciliation of the Company's effective income tax rate and the U.S.
federal tax rate is as follows:
 
<TABLE>
<CAPTION>
                                                          YEAR ENDED
                                                       DECEMBER 31, 1997
                                                       -----------------
<S>                                                    <C>
Statutory rate.......................................         34.0%
State income taxes, net of federal benefit...........          6.0%
Conversion to C corporation..........................         (1.9%)
Valuation allowance for deferred tax assets..........        (26.1%)
Purchase acquisitions................................        (12.0%)
                                                             -----
                                                                --%
                                                             =====
</TABLE>
 
                                       54
<PAGE>   57
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
 9. SHAREHOLDERS' EQUITY (DEFICIT)
 
     On October 1, 1997, the Company completed an initial public offering (IPO)
of 12,000,000 shares of Class A common stock at a price of $17 per share. In
addition, the underwriters of the IPO exercised an option to purchase 2,280,000
additional shares of Class A common stock at the same price per share. Gross
proceeds from the IPO totaled approximately $242.8 million, and proceeds net of
underwriting discounts, advisory fees and expenses aggregated approximately
$226.8 million.
 
     On August 27, 1997, the Company effected a 0.441336-for-1 reverse stock
split of the issued and outstanding shares of Class A and Class B common stock.
All common stock, membership units, and per share amounts in the consolidated
financial statements have been adjusted retroactively to give effect to the
reverse stock split.
 
     From January 31, 1997, the Company had two classes of common stock
outstanding, Class A common stock and Class B common stock. The Company's Class
A common stock and Class B common stock are identical in dividend and
liquidation rights, and vote together as a single class on all matters, except
as otherwise required by applicable law, with the Class A shareholders entitled
to cast one vote per share, and the Class B shareholders entitled to cast 10
votes per share.
 
     On January 31, 1997, NEXTLINK Communications, L.L.C. was merged with and
into the Company in a tax-free transaction. In that merger, the Class A
membership interests of NEXTLINK Communications, L.L.C. were converted into
Class B common stock, options to acquire Class A membership interests were
converted into options to purchase Class B common stock, and options to purchase
Class B membership interests were converted into options to purchase Class A
common stock. In calculating the number of shares of the Company's Class B
common stock that each of the Class A members received in the merger, the
Company applied a formula that reflected each member's revalued capital account
balance as of January 31, 1997. Options to purchase Class B membership interests
were converted into the right to receive options to purchase shares of Class A
common stock on a one to one basis.
 
     Prior to January 31, 1997, the Company's limited liability company
agreement provided for both Class A and Class B membership interests in the
Company. Class A Unit holders were entitled to a preferred return on their
investment in the Company plus a return of their capital upon the dissolution of
the Company. Class B Units were granted in connection with the Company's Amended
and Restated Equity Option Plan (EOP). Although Class B Units, when exercised,
constituted an ownership interest in the Company, the interest was limited to
the appreciation in the value of the Company, or the distributable profits
interest, if any, of the Company. The valuation of the membership units was
determined by the EOP Administrative Committee. As of December 31, 1996, the
value of the Class A Units was determined to be approximately $9.88, and the
appreciation interest per unit for Class B Units was approximately $7.93.
 
     Effective January 1, 1996, the Company merged four of its five operating
subsidiaries with newly formed entities owned by the Company. As a result of
these mergers, the entities and individuals holding minority interests in the
subsidiaries exchanged these interests for 1,695,263 Class A Units of the
Company (representing an approximate 5.9% ownership interest in the Company)
which were valued at approximately $5.6 million. NEXTLINK Washington, L.L.C. did
not participate in the merger. The transaction was accounted for as a purchase
of minority interests. Accordingly, the $2.9 million excess of the purchase
price over the book value of the interests acquired was recorded as goodwill.
 
     In addition to the exchange of equity interests, the Company exchanged
options to acquire equity interests in the subsidiaries for options to acquire
Class B Units in the Company. In connection with this transaction, the Company
issued 862,219 options with exercise prices of $0.02 and four-year vesting
schedules. These options had substantially the same economic values and vesting
schedules as the subsidiary options which were exchanged.
 
                                       55
<PAGE>   58
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
10. PRO FORMA NET LOSS PER SHARE
 
     Shares used in the computation of net loss per share amounts were
calculated as follows:
 
<TABLE>
<CAPTION>
                                                                 1997          1996
                                                              ----------    ----------
<S>                                                           <C>           <C>
Weighted average common shares outstanding..................  41,144,275    36,208,588
Nominal issuances during the 12 month period prior to the
  Company's filing of its IPO, treated as if outstanding for
  all periods presented.....................................   1,911,610     3,103,894
                                                              ----------    ----------
Shares used in computation of pro forma net loss per
  share.....................................................  43,055,885    39,312,482
                                                              ==========    ==========
</TABLE>
 
     Subsequent to the Company's IPO and through December 31, 1997, options to
purchase 307,164 shares of common stock were issued but were not included in the
computation of net loss per share, as these options did not fall under the
provisions of SAB 98 and inclusion of such options would have been antidilutive.
 
11. STOCK OPTIONS
 
     Prior to February 1997, the Company maintained an Equity Option Plan which
provided for the granting of equity option interests in the Company. These
option grants were considered compensatory and were accounted for similarly to
stock appreciation rights. The Company recognized compensation expense over the
vesting periods based on the excess of the fair value of the equity option
interests, as determined by the Administrative Committee, over the exercise
price of the option interests. Such expense was periodically adjusted for
changes in the fair value of the equity interest units. These option interests
vested ratably over a four-year period, although some retained vesting schedules
of previous option plans which, in most cases, vested 20% at employment and 20%
at the end of each subsequent year.
 
     In connection with the incorporation of the Company (see Note 9), the
Company established the NEXTLINK Communications, Inc. Stock Option Plan (the
Plan) to replace the Equity Option Plan and to provide a performance incentive
for certain officers, employees and individuals or companies who provide
services to the Company. The Plan provides for the granting of qualified and
non-qualified stock options. All options outstanding under the Equity Option
Plan were regranted under the new Plan with terms and conditions substantially
the same as under the Equity Option Plan, except that option holders will no
longer have the option to require the Company to repurchase units for cash upon
exercise of such units, nor will the Company have the option to repurchase
exercised units for cash. The Company has reserved 4,413,360 shares of Class A
common stock for issuance under the Plan. The options generally vest ratably
over four years and expire no later than 10 years after the date of grant, with
the exception of options originally granted under the Equity Option Plan, which
expire 15 years after the date of grant.
 
     The exercise price of qualified stock options granted under the Plan may
not be less than the fair market value of the common shares on the date of
grant. The exercise price of non-qualified stock options granted under the Plan
may be greater or less than the fair market value of the common stock on the
date of grant, as determined at the discretion of the Board of Directors. Stock
options granted at prices below fair market value at the date of grant are
considered compensatory, and compensation expense is deferred and recognized
ratably over the option vesting period based on the excess of the fair market
value of the stock at the date of grant over the exercise price of the option.
In connection with the regranting of options under the new Plan, the Company
reclassified the deferred compensation liability relating to compensatory
options issued under the Equity Option Plan to common stock, stated at amounts
paid in. The remaining, unrecognized compensation expense attributable to these
compensatory options was also recorded as deferred compensation, a contra-equity
balance, and will be recognized over the remaining vesting periods of the
options.
 
                                       56
<PAGE>   59
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
     During 1997, the Company recorded approximately $2,355,000 and $892,000 of
deferred compensation expense related to the Stock Option Plan and Equity Option
Plan, respectively. For the year ended December 31, 1996, the Company recorded
approximately $9,914,000 of deferred compensation expense related to the Equity
Option Plan.
 
     The Company has adopted the disclosure-only provisions of SFAS 123. Had
compensation costs been recognized based on the fair value at the date of grant
for options awarded under the Plans, the pro forma amounts of the Company's net
loss and net loss per share for the years ended December 31, 1997 and 1996 would
have been as follows (in thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                                          1997         1996
                                                        ---------    --------
<S>                                                     <C>          <C>
Net loss applicable to common shares -- as reported...  $(168,324)   $(71,101)
Net loss applicable to common shares -- pro forma.....  $(182,571)   $(64,512)
 
Net loss per share -- as reported.....................  $   (3.91)   $  (1.81)
Net loss per share -- pro forma.......................  $   (4.24)   $  (1.64)
</TABLE>
 
     The fair value of each option grant was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions: risk-free
interest rates of 5.31% to 7.05%; expected option lives of 3 to 5 years;
expected volatility of 45%; and no expected dividends. The weighted average fair
value of options granted during 1997 and 1996 was $5.94 and $6.87, respectively.
 
     Information with respect to the Equity Option Plan and Stock Option Plan is
as follows:
 
<TABLE>
<CAPTION>
                                                SHARES                           WEIGHTED
                                               SUBJECT       OPTION PRICE        AVERAGE
                                              TO OPTION         RANGE         EXERCISE PRICE
                                              ----------    --------------    --------------
<S>                                           <C>           <C>               <C>
Options outstanding at December 31, 1995....  1,594,471     $0.02                 $0.02
  Granted...................................    455,018     $0.02 -  7.93         $1.93
  Canceled..................................    (44,843)    $0.02                 $0.02
                                              ---------
Options outstanding at December 31, 1996....  2,004,646     $0.02 -  7.93         $0.45
  Granted...................................  2,569,156     $7.93 - 26.50         $9.24
  Canceled..................................   (205,398)    $0.02 - 21.31         $1.19
  Exercised.................................   (672,878)    $0.02 -  7.93         $0.18
                                              ---------
Options outstanding at December 31, 1997....  3,695,526     $0.02 - 26.50         $6.45
                                              =========
</TABLE>
 
<TABLE>
<CAPTION>
                               OPTIONS OUTSTANDING
                 -----------------------------------------------       OPTIONS EXERCISABLE
                                   WEIGHTED                        ----------------------------
                                   AVERAGE           WEIGHTED                       WEIGHTED
   RANGE OF        OPTIONS        REMAINING          AVERAGE         OPTIONS        AVERAGE
EXERCISE PRICES  OUTSTANDING   CONTRACTUAL LIFE   EXERCISE PRICE   EXERCISABLE   EXERCISE PRICE
---------------  -----------   ----------------   --------------   -----------   --------------
<S>              <C>           <C>                <C>              <C>           <C>
$ 0.02 - $ 1.00   1,146,886         12.54             $ 0.23         411,470         $ 0.10
$ 1.01 - $14.00   2,289,755         10.82             $ 7.95         103,256         $ 7.93
$14.01 - $26.50     258,885          9.92             $20.53         110,308         $21.94
</TABLE>
 
     At December 31, 1997, 44,956 shares of Class A common stock were available
for future grants. The Board of Directors has authorized an increase of
5,441,336 in the number of shares that may be issued pursuant to options under
the Plan, subject to shareholder approval. The Company has received an
irrevocable proxy from its majority shareholder approving the increase.
 
                                       57
<PAGE>   60
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
 
     Supplemental disclosure of the Company's cash flow information is as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                         ------------------------
                                                           1997           1996
                                                         ---------      ---------
<S>                                                      <C>            <C>
Noncash financing and investing activities were as
  follows:
  Class A common stock issued under lease
     arrangement.......................................   $ 1,400        $    --
                                                          =======        =======
  Redeemable preferred stock dividends, paid in
     redeemable preferred shares.......................   $31,102        $    --
                                                          =======        =======
  Accrued redeemable preferred stock dividends, payable
     in redeemable preferred shares, and accretion of
     preferred stock redemption obligation.............   $ 8,218        $    --
                                                          =======        =======
  Issuance of notes payable and assumption of
     liabilities in acquisitions.......................   $21,280        $ 8,228
                                                          =======        =======
  Issuance of Class A common stock in acquisitions.....   $16,524        $    --
                                                          =======        =======
  Capital lease obligations assumed....................   $ 4,725        $ 1,377
                                                          =======        =======
  Members' equity recorded in Recapitalization.........   $    --        $ 5,574
                                                          =======        =======
  Goodwill recorded in Recapitalization................   $    --        $ 2,907
                                                          =======        =======
  Exchange of minority interests for Class A units.....   $    --        $ 2,667
                                                          =======        =======
Cash paid for interest.................................   $44,865        $20,912
                                                          =======        =======
</TABLE>
 
13. COMMITMENTS AND CONTINGENCIES
 
     Capitalized leases consist of leases of telecommunications equipment and
fiber optic networks. The Company is also leasing premises under various
operating leases which, in addition to rental payments, require payments for
insurance, maintenance, property taxes and other executory costs related to the
leases. The lease agreements have various expiration dates and renewal options
through 2028.
 
     Future minimum payments required under capital and operating leases that
have an initial or remaining noncancelable lease term in excess of one year at
December 31, 1997 were as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                  CAPITAL    OPERATING
                                                  LEASES      LEASES
                                                  -------    ---------
<S>                                               <C>        <C>
Year ending December 31,
1998............................................  $ 3,285     $ 7,005
1999............................................    3,199       7,269
2000............................................    2,825       6,950
2001............................................    1,209       6,461
2002............................................    1,205       6,305
Thereafter......................................    5,174      22,695
                                                  -------
Total minimum lease payments....................   16,897
Less amounts representing interest..............    6,647
                                                  -------
Present value of future minimum lease
  payments......................................   10,250
Less amounts due in one year....................    2,610
                                                  -------
                                                  $ 7,640
                                                  =======
</TABLE>
 
     Rent expense totaled approximately $6,376,000 and $2,248,000 in 1997 and
1996, respectively.
 
                                       58
<PAGE>   61
                         NEXTLINK COMMUNICATIONS, INC.
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           DECEMBER 31, 1997 AND 1996
 
14. SUBSEQUENT EVENTS
 
  Joint Venture
 
     In January 1998, the Company and Nextel Communications, Inc. (Nextel)
formed a joint venture called NEXTBAND Communications, L.L.C. (NEXTBAND), which
is owned 50% each by the Company and Nextel. On January 28, 1998, NEXTBAND filed
an application with the FCC for which it paid a $50 million refundable deposit
to participate in the FCC's Local Multipoint Distribution Service (LMDS) auction
which began on February 18, 1998. Of the deposit amount, $25 million was
deposited by the Company. LMDS is a fixed broadband point-to-multipoint service
which the FCC and industry analysts anticipate will be used for the deployment
of wireless local loop, high-speed data transfer and video broadcasting service.
NEXTBAND has applied for and is eligible to bid on any of the markets being
auctioned for the licenses, which could result in additional funds being
contributed by the Company to NEXTBAND.
 
  Network Lease
 
     In February 1998, the Company entered into a 20-year capital lease for
exclusive rights to multiple fibers and innerducts extending over 650 route
miles throughout New York, New Jersey, Connecticut, Pennsylvania, Delaware,
Maryland and Washington, D.C. The Company paid $92.0 million for the
transaction, of which $80.3 million was placed into escrow pending completion
and delivery of segments of the network route to the Company. The Company has
the option to renew the lease for two additional 10-year terms.
 
  Financing
 
     On March 3, 1998, the Company completed the sale of $335 million in
aggregate principal amount of 9% Senior Notes due March 15, 2008. Proceeds from
the sale net of discounts, underwriting commissions, advisory fees and expenses,
totaled approximately $326.5 million. The 9% Senior Notes are redeemable at the
option of the Company, in whole or in part, beginning March 15, 2003 at
established redemption prices which decline to 100% of the stated principal
amount thereof by March 15, 2006.
 
     The indenture pursuant to which the 9% Senior Notes are issued contains
certain covenants that, among other things, limits the ability of the Company
and its subsidiaries to incur additional indebtedness, issue stock in
subsidiaries, pay dividends or make other distributions, repurchase equity
interests or subordinated indebtedness, engage in sale and leaseback
transactions, create certain liens, enter into certain transactions with
affiliates, sell assets of the Company and its subsidiaries, and enter into
certain mergers and consolidations.
 
     In the event of a change in control of the Company as defined in the
indenture, holders of the 9% Senior Notes will have the right to require the
Company to purchase their 9% Senior Notes, in whole or in part, at a price equal
to 101% of the stated principal amount thereof, plus accrued and unpaid
interest, if any, thereon to the date of purchase. The 9% Senior Notes are
senior unsecured obligations of the Company, and are subordinated to all current
and future indebtedness of the Company's subsidiaries, including trade payables.
 
                                       59
<PAGE>   62
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To NEXTLINK Capital, Inc.:
 
     We have audited the accompanying balance sheets of NEXTLINK Capital, Inc.
(a Washington corporation) as of December 31, 1997 and 1996. These balance
sheets are the responsibility of the Company's management. Our responsibility is
to express an opinion on these balance sheets based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheets are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the balance sheets. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the balance sheets referred to above present fairly, in all
material respects, the financial position of NEXTLINK Capital, Inc. as of
December 31, 1997 and 1996 in conformity with generally accepted accounting
principles.
 
                                                             ARTHUR ANDERSEN LLP
 
Seattle, Washington,
March 12, 1998
 
                                       60
<PAGE>   63
 
                             NEXTLINK CAPITAL, INC.
 
                                 BALANCE SHEETS
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                              ------------
                                                              1997    1996
                                                              ----    ----
<S>                                                           <C>     <C>
Cash in bank................................................  $100    $100
                                                              ====    ====
                           SHAREHOLDER'S EQUITY
Common stock, no par value,
  1,000 shares authorized, issued and outstanding...........  $100    $100
                                                              ====    ====
</TABLE>
 
                    See accompanying note to balance sheets.
 
                                       61
<PAGE>   64
 
                             NEXTLINK CAPITAL, INC.
 
                             NOTE TO BALANCE SHEETS
                           DECEMBER 31, 1997 AND 1996
 
 1. DESCRIPTION
 
     NEXTLINK Capital, Inc. (NEXTLINK Capital) is a Washington corporation and a
wholly owned subsidiary of NEXTLINK Communications, Inc. (NEXTLINK). NEXTLINK
Capital was formed for the sole purpose of obtaining financing from external
sources and is a joint obligor on the 12 1/2% Senior Notes due April 15, 2006 of
NEXTLINK. NEXTLINK Capital was initially funded with a $100 contribution from
NEXTLINK and has had no operations to date. NEXTLINK Capital's sole source and
repayment for the 12 1/2% Senior Notes will be from the operations of NEXTLINK.
Therefore, these balance sheets should be read in conjunction with the
consolidated financial statements of NEXTLINK.
 
                                       62
<PAGE>   65
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrants have duly caused this report to be signed
on their behalf by the undersigned thereunto duly authorized.
 
                                          NEXTLINK Communications, Inc.
 
Date: March 25, 1998                      By: /s/ WAYNE M. PERRY
                                            ------------------------------------
                                            Wayne M. Perry
                                            Chief Executive Officer, Director
 
                                          NEXTLINK Capital, Inc.
 
Date: March 25, 1998                      By: /s/ WAYNE M. PERRY
                                            ------------------------------------
                                            Wayne M. Perry
                                            Chief Executive Officer, Director
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 25, 1998 by the following persons on
behalf of the Registrants and in the capacities indicated:
 
<TABLE>
<CAPTION>
                          NAME                                                TITLE
                          ----                                                -----
<C>                                                         <S>
 
                   /s/ WAYNE M. PERRY                       Chief Executive Officer, Director
--------------------------------------------------------
                     Wayne M. Perry
 
                 /s/ KATHLEEN H. ISKRA                      Vice President, Chief Financial Officer
--------------------------------------------------------    (Principal Financial Officer and Principal
                   Kathleen H. Iskra                        Accounting Officer)
 
                  /s/ JAMES F. VOELKER                      President, Director
--------------------------------------------------------    (Principal Executive Officer)
                    James F. Voelker
 
                  /s/ STEVEN W. HOOPER                      Director
--------------------------------------------------------
                    Steven W. Hooper
 
                   /s/ CRAIG O. MCCAW                       Director
--------------------------------------------------------
                     Craig O. McCaw
 
                  /s/ DENNIS WEIBLING                       Director
--------------------------------------------------------
                    Dennis Weibling
 
                    /s/ SCOT JARVIS                         Director
--------------------------------------------------------
                      Scot Jarvis
 
                 /s/ WILLIAM A. HOGLUND                     Director
--------------------------------------------------------
                   William A. Hoglund
 
                  /s/ SHARON L. NELSON                      Director
--------------------------------------------------------
                    Sharon L. Nelson
 
                 /s/ JEFFREY S. RAIKES                      Director
--------------------------------------------------------
                   Jeffrey S. Raikes
</TABLE>
 
                                       63
<PAGE>   66

                                              EXHIBIT INDEX
<TABLE>
<CAPTION>
        EXHIBIT NO.                            DESCRIPTION
        -----------                            -----------
        <C>            <S>
          3.1      Articles of Incorporation of NEXTLINK Communications Inc.(2)
          3.2      By-laws of NEXTLINK Communications, Inc.(2)
          3.3      Articles of Incorporation of NEXTLINK Capital, Inc.(1)
          3.4      By-laws of NEXTLINK Capital, Inc.(1)
          4.1      Form of Exchange Note Indenture, by and among NEXTLINK
                   Communications, Inc. and United States Trust Company of New
                   York, as trustee, relating to the Exchange Notes, including
                   form of Exchange Notes.(2)
          4.2      Certificate of Designations of the Powers, Preferences and
                   Relative, Participating, Optional and Other Special Rights
                   of 14% Senior Exchangeable Redeemable Preferred Shares and
                   Qualifications, Limitations and Restrictions Thereof.(2)
          4.3      Form of stock certificate of 14% Senior Exchangeable
                   Redeemable Preferred Shares.(2)
          4.4      Indenture, dated as of April 25, 1996, by and among NEXTLINK
                   Communications, Inc., NEXTLINK Capital, Inc. and United
                   States Trust Company of New York, as Trustee, relating to
                   12 1/2% Senior Notes due April 15, 2006, including form of
                   global note.(1)
          4.5      First Supplemental Indenture, dated as of January 31, 1997,
                   by and among the Company, NEXTLINK Communications, L.L.C.,
                   NEXTLINK Capital and United States Trust Company of New
                   York, as Trustee.(2)
          4.6      Form of Indenture between United States Trust Company, as
                   Trustee and NEXTLINK Communications, Inc., relating to the
                   9 5/8% Senior Notes due 2007.(3)
          4.7      Form of Indenture between United States Trust Company, as
                   Trustee and NEXTLINK Communications, Inc., relating to the
                   9% Senior Notes Due 2008.
         10.1      Stock Option Plan of the Company.(2)
         10.2      First Amendment to Stock Option Plan of the Company.
         10.3      Registration Rights Agreement dated as of January 15, 1997,
                   between the Company and the signatories listed therein.(2)
         10.4      Preferred Exchange and Registration Rights Agreement, dated
                   as of January 31, 1997, by and among the Company and the
                   Initial Purchasers.(2)
         10.5      Fiber Lease and Innerduct Use Agreement, dated as of
                   February 23, 1998, by and between NEXTLINK Communications,
                   Inc. and Metromedia Fiber Network, Inc.(4)
         10.6      Amendment No. 1 to Fiber Lease and Innerduct Use Agreement,
                   dated as of March 4, 1998, by and between NEXTLINK
                   Communications, Inc. and Metromedia Fiber Network, Inc.(4)
         21        Subsidiaries of the Registrants.
         27.1      Financial Data Schedule for the year ended December 31,
                   1997.
         27.2      Financial Data Schedule, restated for the periods ended
                   December 31, 1996, June 30, 1997 and September 30, 1997.
</TABLE>
 
---------------
(1) Incorporated herein by reference to the exhibit filed with the Registration
    Statement on Form S-4 of NEXTLINK Communications, L.L.C. (the predecessor of
    NEXTLINK Communications, Inc.) and NEXTLINK Capital, Inc. (Commission File
    No. 333-4603).
 
(2) Incorporated herein by reference to the exhibit filed with the Annual Report
    on Form 10-KSB for the year ended December 31, 1996 of NEXTLINK
    Communications, Inc. and NEXTLINK Capital, Inc. (Commission File Nos.
    333-04603 and 333-04603-01).
 
(3) Incorporated herein by reference to the exhibit filed with the Registration
    Statement on Form S-1 of NEXTLINK Communications, Inc. (Commission File No.
    333-32003).
 
(4) Portions of this exhibit were omitted and filed separately with the
    Secretary of the Commission pursuant to the Issuer's Application Requesting
    Confidential Treatment under Rule 24(b)-2 of the Securities Exchange Act of
    1934.
 
     (c) REPORTS ON FORM 8-K
 
        None.