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

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

         For the fiscal year ended December 31, 1998.

                                       OR

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

         For the transition period from              to

                          Commission File No. 333-53467

                                  Pathnet, Inc.
             (Exact name of registrant as specified in its charter)

          Delaware                                          52-1941838
(State or other jurisdiction of                           (I.R.S. Employer
 incorporation or organization)                           Identification No.)

     1015 31st Street, N.W.
          Washington, DC                                       20007
 (Address of principal executive offices)                    (Zip Code)

                                 (202) 625-7284
              (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
                                      None

Securities registered pursuant to Section 12(g) of the Act:
                                      None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.

                                 Yes [X]     No [ ]

As of March 12, 1999 there were 2,903,324  shares of the Issuer's  common stock,
par value $.01 per share, outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

                                      None


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                                TABLE OF CONTENTS
<TABLE>

                                                                                    Page


<S>             <C>                                                                  <C>
<CAPTION>
                                     PART I
Item 1          Business                                                             3
Item 2          Properties                                                           8
Item 3          Legal Proceedings                                                    9
Item 4          Submission of Matters to a Vote of Security Holders                  9

                                     PART II

Item 5          Market for Registrant's Common Equity and Related
                Stockholder Matters                                                 11
Item 6          Selected Consolidated Financial Data                                11
Item 7          Management's Discussion and Analysis of Financial
                Condition and Results of Operations                                 12
Item 7A         Quantitative and Qualitative Disclosures about Market Risk          31
Item 8          Financial Statements and Supplementary Data                         31
Item 9          Changes in and Disagreements with Accountants on
                Accounting and Financial Disclosure                                 31

                                    PART III

Item 10         Directors and Executive Officers of the Registrant                  32
Item 11         Executive Compensation                                              35
Item 12         Security Ownership of Certain Beneficial Owners and
                Management                                                          39
Item 13         Certain Relationships and Related Transactions                      41

                                     PART IV

Item 14         Exhibits, Financial Statement Schedules and Reports on Form 8-K     45

Signatures                                                                          48

Index to Financial Statements                                                      F-1
</TABLE>

                                       2

<PAGE>


          Certain  statements in this Report,  in future  filings by the Company
  with the Securities and Exchange  Commission,  in the Company's press releases
  and in oral statements made by or with the approval of an authorized executive
  officer  of  the  Company  constitute  forward-looking  statements,  including
  statements which can be identified by the use of  forward-looking  terminology
  such as "believes,"  "anticipates,"  "expects,"  "may," "will," or "should" or
  the negative of such  terminology or other  variations on such  terminology or
  comparable terminology, or by discussions of strategies that involve risks and
  uncertainties.  All statements  other than  statements of historical  facts in
  this Report, including,  without limitation, such statements under the caption
  "Management's  Discussion  and Analysis of Financial  Condition and Results of
  Operations,"  regarding  the Company or any of the  transactions  described in
  this  Report  or  the  timing,  financing,  strategies  and  effects  of  such
  transaction,  are  forward-looking  statements.  Although the Company believes
  that  the  expectations  reflected  in  such  forward-looking  statements  are
  reasonable,  it can give no assurance that such  expectations will prove to be
  correct.   Important  factors  that  could  cause  actual  results  to  differ
  materially from expectations include,  without limitation,  those described in
  conjunction with the forward-looking statements in this Report, as well as the
  amount of  capital  needed to deploy  the  Company's  network;  the  Company's
  substantial   leverage  and  its  need  to  service  its   indebtedness;   the
  restrictions  imposed by the Company's  current and possible future  financing
  arrangements;   the  ability  of  the  Company  to  successfully   manage  the
  cost-effective and timely completion of its network and its ability to attract
  and retain customers for its products and services; the ability of the Company
  to implement its newly  expanded  business plan; the ability of the Company to
  retain  and  attract   relationships   with  the   incumbent   owners  of  the
  telecommunications assets with which the Company expects to build its network;
  the  ability  of the  Company  to obtain and  maintain  rights-of-way  for the
  deployment  of its network;  the  Company's  ability to retain and attract key
  management and other personnel as well as the Company's  ability to manage the
  rapid  expansion of its  business and  operations;  the  Company's  ability to
  compete  in the highly  competitive  telecommunications  industry  in terms of
  price,  service,  reliability and technology;  the Company's dependence on the
  reliability of its network equipment, its reliance on key suppliers of network
  equipment and the risk that its technology  will become  obsolete or otherwise
  not economically  viable; and the Company's ability to conduct its business in
  a  regulated  environment.   See  "Management's  Discussion  and  Analysis  of
  Financial  Condition  and Results of  Operations - Risk  Factors." The Company
  does not intend to update these forward-looking statements.

PART I

ITEM 1.  BUSINESS

THE COMPANY

         Pathnet, Inc. ("Pathnet" or the "Company") was founded in 1995 and is a
leading  "carrier's   carrier"   providing   high-quality,   low-cost,   digital
telecommunications  capacity to  under-served  and second- and  third-tier  U.S.
markets. The Company's strategy is to partner with owners of  telecommunications
assets, including utility,  pipeline and railroad companies  ("Incumbents"),  to
upgrade  and  aggregate  existing  infrastructure  to a  state-of-the-art  SONET
network.  The Company currently has approximately 2,000 route miles of completed
network,  approximately  5,000 route  miles of network  under  construction  and
approximately  10,000  route  miles  of  network  under  contract.  The  Company
originally    focused    its   network    development    efforts   on   wireless
telecommunications  technology.  

                                       3

<PAGE>

However,  as a result of  customer  demand and market  opportunity,  the Company
expanded  the  scope of its  existing  wireless  network  business  strategy  in
February 1999 to include fiber optic technology as part of the Company's overall
digital  telecommunications  network.  As a  result,  the  Company  is no longer
limiting the development of its strategic  network  relationships  to incumbents
with  wireless  assets.  The Company's  expanded  product line will enable it to
deliver high bandwidth  services as well as dark and dim fiber to inter-exchange
carriers ("IXCs"), local exchange carriers, Internet service providers ("ISPs"),
Regional Bell Operating  Companies  ("RBOCs"),  cellular operators and resellers
(collectively,  "Telecom  Service  Providers").  The  bandwidth and dark and dim
fiber  available  on selected  routes  resulting  from  deployment  of Pathnet's
integrated  network is intended to enable these Telecom Service Providers to (i)
deliver  advanced  services to areas that are currently  under-served by digital
networks,  (ii) aggregate traffic from cities in second- and third-tier  markets
and (iii) obtain dedicated network services in such markets.  In addition,  upon
obtaining the requisite  rights-of-way  and other required permits and licenses,
the Company  will be able to offer  customized  builds to such  Telecom  Service
Providers.

         The  Company  has  held  meetings  with  over 300  potential  strategic
partners who own  telecommunications  assets.  As of December 31, 1998,  nine of
these entities have entered into ten binding agreements  relating to the initial
design and construction of approximately  10,000 route miles of digital network.
Eight of these binding  agreements are long-term Fixed Point Microwave  Services
Agreements ("FPM  Agreements")  with affiliates of Burlington  Northern Santa Fe
Railroad,  Enron, Idaho Power Company,  Northeast Missouri Electric Cooperative,
Northern  Indiana Public Service  Company,  Texaco and with two affiliates of KN
Energy.  The ninth  agreement  is a  binding  term  sheet  with  American  Tower
Corporation,  which controls certain telecommunications assets including certain
assets divested by CSX Railroad, ARCO Pipeline and MCI WorldCom, Inc. ("MCI") to
enable the  Company  to utilize  tower  assets and other  facilities.  The tenth
agreement is a tower lease agreement with Titan Towers. In addition to deploying
its wireless and fiber network to serve  under-served and second- and third-tier
markets by forming long-term  relationships with strategic partners, the Company
may pursue opportunities to acquire or deploy  complementary  telecommunications
assets or technologies and to serve other markets. See "Risk Factors -- Risks of
Completing the Company's Network; Market Acceptance."

PRODUCTS AND SERVICES

         The Company offers  dedicated  private line access for voice,  data and
video  transmission in DS-1, DS-3 and OC-3 increments on the wireless portion of
its network and will offer larger increments of dedicated private line access on
the fiber portion of its network. In addition to bandwidth services, the Company
plans  to offer  dark  and dim  fiber to  customers.  Management  believes  this
flexibility  together  with the scope of the Company's  integrated  wireless and
fiber network will appeal to a broad variety of customers.

         The  Company  also  offers   telecommunications   project   management,
provisioning services and other customer services. The Company expects to employ
a state-of-the-art  operating support system capable of supporting on-line order
entry and  remote  circuit  provisioning.  The  Company  also  expects to employ
information  systems that permit  customers  to monitor  network  quality  using
benchmarks such as network uptime, mean time to repair,  installation intervals,
timeliness of billing and network operating center ("NOC")  responsiveness.  The
Company expects that its state-of-the-art "NOC" will permit pro-

<PAGE>


                                       4

active  service  monitoring  and system  management on a 24 hours per day, seven
days per week basis. The Company expects to combine network management,  billing
and  customer  care on an  integrated  platform to offer its  customers a single
point of contact.

DEVELOPMENT OF THE COMPANY'S NETWORK

         The Company is in various stages of evaluating and negotiating  several
agreements and arrangements relating to the deployment of its network including,
but not limited to, agreements to obtain rights-of-way, co-development and other
partnering  arrangements.  There can be no assurance,  however, that any of such
potential  relationships  will result in binding  agreements  or that any of the
transactions currently being evaluated will be consummated.  See "Risk Factors--
Risks of Completing the Company's Network; Market Acceptance."

EQUIPMENT SUPPLY AGREEMENTS

         Pursuant  to a Master  Agreement  entered  into by the  Company and NEC
America,  Inc.  and it  affiliates  ("NEC") on August 8, 1997,  as amended,  the
Company agreed to purchase from NEC by December 31, 2002 a total of $200 million
worth of certain  equipment,  services and  licensed  software to be used by the
Company in its network under pricing and payment terms that the Company believes
are  favorable  based on the prices of  comparable  products  in other  markets.
However,  in the event the Company fails to purchase all of such equipment,  NEC
has reserved the right to withdraw such favorable  pricing levels.  NEC warrants
the equipment  against defects for three years and has agreed promptly to repair
or  replace  defective  equipment.  NEC will  also  maintain  for the  Company's
benefit,  a stock of  critical  spare  parts for up to 15 years.  The  Company's
agreement with NEC provides for fixed prices during the first three years of its
term. In addition,  pursuant to a Purchase  Agreement between Andrew Corporation
("Andrew") and the Company,  the Company agreed  exclusively to recommend to the
Incumbents  certain  products  manufactured  by Andrew and Andrew agreed to sell
such products to Incumbents and the Company for a three-year  period,  renewable
for two additional one-year periods at the option of the Company.  The Company's
agreement  with  Andrew  generally  provides  for  discounted  pricing  based on
projected order volume.

         Pursuant to a supply  agreement  entered into by the Company and Lucent
Technologies  ("Lucent")  on December 18, 1998,  the Company  agreed that Lucent
would  be the  Company's  exclusive  supplier  of  fiber  optic  cable  for  its
nationwide,  voice and data network.  The agreement is initially  valued at $440
million  and  could  grow up to $2.1  billion  over the  life of the  seven-year
agreement. As part of the supply agreement, Lucent will provide a broad level of
support,  including  fiber  optic  equipment,  network  planning  and design and
technical  and  marketing  support.  Certain  material  terms  of the  Company's
agreements  with Lucent are  currently  under  review by Lucent and the Company.
There can be no  assurance  that the  transactions  contemplated  by this supply
agreement  will be  consummated  or  consummated  on the  terms  and  conditions
described  above.  Lucent has also  agreed to  provide  equipment  financing  in
connection with this supply agreement. See "Management's Discussion and Analysis
of  Financial  Condition  and  Results of  Operations  -  Liquidity  and Capital
Resources" and "Risk Factors - Reliance on Lucent - Lucent Agreements."

                                       5

<PAGE>


INTELLECTUAL PROPERTY

         The Company uses the name  "Pathnet" as its primary  business  name and
service  mark and has  registered  that name with the United  States  Patent and
Trademark  Office.  On February 26, 1998,  the Company filed an  application  to
register  its service  mark "A NETWORK OF  OPPORTUNITIES"  in the United  States
Patent and Trademark Office for communications services, namely establishing and
operating a network  through the use of fiber  optic and high  capacity  digital
radio  equipment.  Registration  of such  service mark is expected by the end of
1999.  The  Company  reasonably  believes  that the  application  will mature to
registration, but there can be no assurance that such registration will actually
be issued.

         The Company  relies upon a  combination  of  licenses,  confidentiality
agreements  and  other  contractual  covenants  to  establish  and  protect  its
technology and other intellectual  property rights. These rights are critical to
certain  aspects  of the  design,  deployment  and  operation  of the  Company's
network.  The Company currently has no patents or patent  applications  pending.
There can be no  assurance  that the steps taken by the Company will be adequate
to prevent misappropriation of its technology or other intellectual property. In
addition,  the Company  depends on the use of  intellectual  property of others,
including the hardware and software used to construct,  operate and maintain its
network.  Although the Company believes that its business as currently conducted
does not  infringe on the valid  proprietary  rights of others,  there can be no
assurance  that third parties will not assert  infringement  claims  against the
Company or that, in the event of an unfavorable  ruling on such claim, a license
or similar  agreement  to utilize  technology  relied upon by the Company in the
conduct of its business  will be available to the Company on  reasonable  terms.
The Company's equipment supply contracts with Lucent, NEC and Andrew provide for
indemnification  by  the  supplier  to the  Company  for  intellectual  property
infringement  claims  regarding  the  suppliers'  equipment.  In the case of the
agreement with Andrew,  however, such indemnification is limited to the purchase
price paid for the particular equipment.

CUSTOMERS AND SALES AND MARKETING STRATEGY

         The Company  primarily  targets  Telecom  Service  Providers as well as
smaller  carriers and large end-users.  The Company's  marketing focus is to (i)
offer  capacity to fill gaps in its  customers'  networks,  including  dedicated
network  through the sale of dark fiber;  (ii) provide  alternative  capacity to
incumbent  local  exchange  carriers  ("ILECs"),  and (iii) capture  demand from
Telecom  Service  Providers  for the  Company's  products,  including  bandwidth
services,  as a lower cost  provider.  The Company  markets its network to major
IXCs such as AT&T Corp.  ("AT&T"),  MCI and  Sprint  Corporation  ("Sprint")  to
satisfy their expanding network  requirements.  The Company expects that it will
be well  positioned  to provide  capacity to meet  demand in diverse  geographic
areas.

         The Company believes there will be significant  opportunities to market
its capacity to RBOCs when they commence long distance  service outside of their
current service areas. The Company also plans to market the Company's network to
RBOCs or other  ILECs  for use  within  their own  service  areas.  The  Company
believes   ILECs  will  be  attracted  to  the  Company's   ability  to  provide
supplemental capacity on a leased basis, permitting them to conserve capital and
providing a low-cost  redundancy  alternative.  The Company believes its network
will  allow  RBOCs and ILECs to focus on larger  cities  while  providing  small
communities within their service areas with broadband connectivity.

                                       6
<PAGE>


         The Company expects that mobile wireless operators will be attracted to
the Company's  ability to provide back haul  capacity from remote  network sites
that connect its mobile switches with backbone transport  capacity.  The Company
also  intends  to market  its  capacity  to  competitive  access  providers  and
competitive  local  exchange  carriers  ("CLECs")  who can utilize the Company's
network to  interconnect  various  service areas on an intra-LATA and inter-LATA
basis.  Additionally  the Company will market capacity to ISPs to facilitate the
creation  of   additional   points  of  presence   ("POPs")  for  local  dial-up
connectivity  to  the  ISPs'  customer  base,  thereby   eliminating  the  ISPs'
dependence on IXCs for capacity.

         As  of  December  31,  1998,  the  Company  was  providing   commercial
telecommunications  service to three customers with several additional customers
awaiting installation. As the Company continues to deploy its nationwide network
and expand its  products  and  services to include dark and dim fiber as well as
high  bandwidth  services,  the  Company  expects  that its  customer  base will
materially grow.  Although the Company  currently  derives some revenue from the
sale of bandwidth services,  the majority of the Company's revenues to date have
been derived from construction management and advisory services. For a statement
of the Company's revenue and operating results for each of the three years ended
December 31, 1998, 1997 and 1996, see "Consolidated Statement of Operations."

COMPETITION

         The telecommunications  industry is highly competitive.  In particular,
price competition in the carrier's carrier market has generally been intense and
is  expected  to  increase.  The Company  competes  and expects to compete  with
numerous  competitors  who have  substantially  greater  financial and technical
resources,  long-standing  relationships  with their  customers and potential to
subsidize  competitive  services from less competitive service revenues and from
federal  universal  service  subsidies.  Such  competitors  may be  operators of
existing or newly deployed wireline or wireless telecommunications networks. The
Company  will  also  face  intense  competition  due to an  increased  supply of
telecommunications  capacity, the effects of deregulation and the development of
new  technologies,  including  technologies  that will  increase the capacity of
existing networks.

         The Company  anticipates that prices for its carrier's carrier services
will continue to decline over the next several years.  The Company is aware that
certain long distance  carriers are expanding  their  capacity and believes that
other long distance carriers, as well as potential new entrants to the industry,
are constructing new long distance  transmission  networks in the United States.
If industry  capacity  expansion results in capacity that exceeds overall demand
along the Company's routes, severe additional pricing pressure could develop. As
a result the Company could face dramatic and substantial price reductions.  Such
pricing pressure could have a material adverse effect on the business, financial
condition  and  results  of  operations  of  the  Company.   See  "Risk  Factors
Competition; Pricing Pressures."

         While the Company  generally  will not  compete  with  Telecom  Service
Providers for end-user customers, the Company may compete, on certain routes, as
a carrier's carrier with long distance carriers such as AT&T, MCI and Sprint and
operators of fiber optic systems such as IXC Communications,  Inc., The Williams
Companies   Inc.,   Qwest   Communications   International   Inc.  and  Level  3
Communications   Inc.,  who  would  otherwise  be  the  Company's  customers  in
under-served  and second- and  third-tier  markets.  The Company  will also face
competition  increasingly in the long haul market from local exchange  carriers,
regional network providers,  resellers, satellite carriers, public utilities and
cable companies.  In particular,  certain ILECs and CLECs are allowed to provide
inter-LATA long distance


                                       7
<PAGE>


services. Furthermore, RBOCs will be allowed to provide inter-LATA long distance
services  within their  regions after meeting  certain  regulatory  requirements
intended to foster opportunities for local telephone competition.  Certain RBOCs
have requested  regulatory  approval to provide  inter-LATA data services within
their regions.  The RBOCs already have extensive  fiber optic cable,  switching,
and other network  facilities in their  respective  regions that can be used for
long  distance  services  after  a  waiting  period.  In  addition,   other  new
competitors may build  additional  fiber capacity in the geographic areas served
and to be  served  by the  Company.  See "Risk  Factors  --Competition;  Pricing
Pressures."

         Furthermore, although the Company believes its strategy will provide it
with a cost advantage, there can be no assurance that technological developments
will not result in  competitors  achieving  even  greater  cost  efficiency  and
therefore  a  competitive  advantage.   See  "Risk  Factors  --  Risk  of  Rapid
Technological Changes."

         A continuing trend toward business combinations and strategic alliances
in the  telecommunications  industry  may  create  stronger  competitors  to the
Company,  as the resulting  firms and  alliances are likely to have  significant
technological, marketing and financing resources greater than those available to
the Company. See "Risk Factors -- Competition; Pricing Pressures."

EMPLOYEES

         As of December 31, 1998,  the Company had 144  employees,  none of whom
was represented by a union or covered by a collective bargaining agreement.  The
Company believes that its relationship with its employees is good. In connection
with the  construction  and  maintenance  of its  network and the conduct of its
other  operations,  the  Company  uses third  party  contractors,  some of whose
employees  may be  represented  by unions or  covered by  collective  bargaining
agreements.

ITEM 2.  PROPERTIES

         As part of its  network,  the  Company  holds  leasehold  interests  or
licenses in the land,  towers,  shelters  and other  facilities  located at each
Incumbent's  sites  at  which  the  Company  has  an  agreement  and  will  have
indefeasible  rights to use,  leasehold and other real estate interests pursuant
to its agreements with independent  tower companies owners of rights-of-way  and
other owners of telecommunications assets. The Company expects to lease, license
and  obtain  additional  real  estate  rights  to  additional   facilities  from
Incumbents,  owners  of  rights-of-way  and other  owners of  telecommunications
assets in connection with the planned expansion of its digital network.

         The Company leases its corporate headquarters space in Washington, D.C.
from 6715 Kenilworth Avenue General Partnership,  a general partnership of which
David Schaeffer,  a director of the Company, is General Partner (the "Kenilworth
Partnership"),  pursuant  to a  Lease  Agreement  between  the  Company  and the
Kenilworth  Partnership,  dated as of August 9, 1997 (the "Headquarters Lease").
The  Headquarters  Lease  expires on August  31,  1999 and can be renewed at the
option of the Company for two additional  one-year periods on the same terms and
conditions. See "Certain Relationships and Related  Transactions--Lease from the
Kenilworth  Partnership."  The Company also leases  office space in  Richardson,
Texas; Lewiston, Texas; and Independence,  Kansas pursuant to leases that expire
in 2003, 2001 and 2000, respectively.

         The Company believes that all of its properties are well maintained.


                                       8
<PAGE>


ITEM 3.  LEGAL PROCEEDINGS

         Other than licensing and other regulatory  proceedings  described under
"Risk  Factors--Regulation,"  the Company is not  currently a party to any legal
proceedings,  which, individually or in the aggregate, the Company believes will
have a material adverse effect on the Company's financial condition,  results of
operations and cash flows.

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

         During the fourth  quarter of the fiscal  year  covered by this  Annual
Report on Form 10-K, the Company held a special  meeting of the  Stockholders on
October 20, 1998.  At such  meeting,  the  following  matters  were  approved by
holders of the  Company's  common  stock,  par value $.01 per share (the "Common
Stock"),  Series A Convertible  Preferred Stock, Series B Convertible  Preferred
Stock and Series C Convertible Preferred Stock (collectively the "Stockholders")
voting together as a single class, by the votes indicated below:

(i)      Approval of several  agreements and  arrangements  made in the ordinary
         course of the Company's  business:  For 17,115,081  Against: 0 Abstain:
         1,651,992.

(ii)     Approval of the hiring certain new employees: For 17,115,081 Against: 0
         Abstain: 1,651,992.

         On  December  2,  1998,  the  Company  held a  special  meeting  of the
Stockholders  where the  following  matters were  approved by the  Stockholders,
voting together as a single class, by the votes indicated below:

(i)      Approval of a loan agreement with KN Energy:  For 14,671,900,  Against:
         0, Abstain: 4,095,173.

(ii)     Approval  of a three-way  transaction  with KN Energy,  American  Tower
         Corporation  and the Company.  For  14,671,900,  Against:  0,  Abstain:
         4,095,173.

(iii)    Approval of a Tower Lease Agreement with Titan Towers.  For 11,771,900,
         Against: 2,900,000, Abstain: 4,095,173.

(iv)     Approval of a fleet leasing  arrangement  for automobile  rentals.  For
         14,671,900, Against: 0, Abstain: 4,095,173.

(v)      Approval of the grant of stock  option  awards to certain  employees of
         the Company. For 14,399,344, Against: 0, Abstain: 4,367,729.

(vi)     Approval  of  certain  amendments  to  the  Company's   Certificate  of
         Incorporation  and Amended and Restated Bylaws of the Corporation.  For
         11,499,344, Against:2,900,000, Abstain: 4,367,729. See Exhibits 3.1 and
         3.2 attached to this Report.

         On December 7, 1998, the Company  solicited  written  consents from the
holders  of its  Series A  Convertible  Preferred  Stock,  Series B  Convertible
Preferred  Stock and Series C Convertible  Preferred 


                                       9
<PAGE>



Stock  (collectively,  the  "Preferred  Stockholders")  to (i)  approve  certain
authorized  signatories  for the transfer and withdrawal of the Company's  funds
and (ii) to approve  the  payment of an invoice  for legal  services.  Effective
December 7, 1998, the Company received written consents approving such proposals
from  Preferred  Stockholders   representing  10,720,610  votes  with  Preferred
Stockholders representing 5,144,105 votes abstaining.

         On December 18, 1998, the Company  solicited  written consents from the
Preferred  Stockholders to approve the supply agreement  between the Company and
Lucent and  related  Commitment  Letter by and  between  the  Company and Lucent
signed on December 14, 1998 (the "Commitment Letter") setting forth the proposed
terms of equipment  financing  by Lucent.  See  "Business  --  Equipment  Supply
Agreements."  Effective December 18, 1998, the Company received written consents
approving such proposals from  Preferred  Stockholders  representing  13,309,853
votes with Preferred Stockholders representing 2,554,862 votes abstaining.



                                       10
<PAGE>


PART II

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

         The Company has authorized  60,000,000 shares of Common Stock for which
there is no established  public trading market. As of March 12, 1999, there were
3 record holders of the Company's  Common Stock. As of December 31, 1998,  stock
option awards to purchase 2,885,883 shares of Common Stock were outstanding.

         Pathnet has not paid any cash dividends on its Common Stock in the past
and does not  anticipate  paying any cash  dividends  on its Common Stock in the
foreseeable  future.  Further,  the terms of the  Indenture  by and  between the
Company and The Bank of New York, dated April 8, 1998 (the "Indenture") relating
to the  Company's  12 1/4%  Senior  Notes due 2008  restrict  the ability of the
Company to pay  dividends on the Common  Stock,  as  described  in  Management's
Discussion  and Analysis of Financial  Condition and Results of  Operations,  as
well as in Note 11 to the  Company's  Financial  Statements  included in Item 14
elsewhere in this Annual Report on Form 10-K.

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA

         The following  consolidated  balance sheet data as of December 31, 1997
and 1998 and statement of operations  data for the twelve months ended  December
31, 1996,  1997 and 1998 and the period  August 25, 1995 (date of  inception) to
December 31, 1998, have been derived from the Company's financial statements and
the notes thereto,  included elsewhere in this Annual Report on Form 10-K, which
have been audited by  PricewaterhouseCoopers  LLP, independent  accountants,  as
stated in their report included herein. Such summary statement of operations and
balance  sheet data should be read in  conjunction  with such audited  financial
statements  and the notes thereto and  "Management's  Discussion and Analysis of
Financial  Condition  and Results of  Operations."  The  following  consolidated
balance sheet data as of December 31, 1995 and 1996 and statements of operations
data for the period  August 25, 1995 (date of  inception)  to December  31, 1998
have been derived from the Company's audited financial  statements which are not
included  in this  Annual  Report  on Form  10-K,  which  have been  audited  by
PricewaterhouseCoopers LLP.


                                       11
<PAGE>


<TABLE>
<CAPTION>

                                                Period from                                             Period from
                                             August 25, 1995                                          August 25, 1995
                                                 (date of                                                 (date of
                                               inception) to                                            inception) to
                                               December 31,              Year Ended December 31,        December 31,
                                                  1995             1996          1997         1998           1998  
                                               -----------   ------------  ------------  ------------  ------------
<S>                                            <C>           <C>           <C>           <C>           <C>    
Statement of Operation Data:
Revenue ....................................   $      --     $      1,000  $    162,500  $  1,583,539  $  1,747,039
Operating expenses:
  Cost of revenue ..........................          --             --           --        7,547,620     7,547,620
  Selling, general and administrative ......       429,087      1,333,294     4,247,101     9,615,867    15,625,349
  Depreciation expense .....................           352          9,024        46,642       732,813       788,831
                                               -----------   ------------  ------------  ------------  ------------
Total operating expenses ...................       429,439      1,342,318     4,293,743    17,896,300    23,961,800
Net operating loss .........................      (429,439)    (1,341,318)   (4,131,243)  (16,312,761)  (22,214,761
                                                                    
Interest expense (a) .......................          --         (415,357)        --      (32,572,454)  (32,987,811
                                                                 
Interest income ............................         2,613         13,040       159,343    13,940,240    14,115,236
Write off of initial public offering costs .          --             --           --       (1,354,534)   (1,354,534)
                                                                           
Other income (expense), net ................          --             --          (5,500)        2,913        (2,587)
                                               -----------   ------------  ------------  ------------  ------------ 
Net loss ...................................   $  (426,826)  $  1,743,635) $ (3,977,400) $(36,296,596) $(42,444,457)
                                               ===========   ============  ============  ============  ============
           
Basic and diluted loss per common share ....   $     (0.15)  $      (0.60) $      (1.37) $     (12.51) $     (14.63)
                                               ===========   ============  ============  ============  ============
Weighted average number of common
   shares outstanding ......................     2,900,000      2,900,000     2,900,000     2,902,029     2,900,605
                                               ===========   ============  ============  ============  ============
Balance Sheet Data:
Cash, cash equivalents and marketable
   securities (excluding marketable
   securities pledged as collateral) .......   $    82,973    $ 2,318,037  $  7,831,384  $227,117,417
Property and equipment, net ................         8,551         46,180     7,207,094    47,971,336
Total assets ...............................        91,524      2,365,912    16,097,688   365,414,129
Total liabilities ..........................        17,350        145,016     5,892,918   366,492,370
Convertible preferred stock ................       500,000      4,008,367    15,969,641    35,969,639
Stockholders' equity (deficit) .............   $  (425,826)  $ (1,787,471) $ (5,764,871)  (37,047,880)

--------------------------   
</TABLE>

(a)      The 1996 expense relates to the beneficial conversion feature of a loan
         at December 31, 1996.

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

OVERVIEW

          The Company is a leading  carrier's  carrier  providing  high-quality,
low-cost,  digital  telecommunications  capacity to under-served and second- and
third-tier U.S. markets.

         The Company's business commenced on August 25, 1995 and has been funded
primarily through equity investments by the Company's stockholders and a private
placement  (the "Debt  Offering") in April 1998 of 350,000 units (the  "Units"),
consisting  of 12 1/4% Senior Notes (the  "Restricted  Notes") and warrants (the
"Warrants") to purchase  shares of Common Stock. On October 2, 1998, the Company
completed an exchange (the "Exchange Offer") of all outstanding Restricted Notes
for  $350,000,000  aggregate  principal  amount of 12 1/4% Senior Notes due 2008
which have been  registered  under the


                                       12
<PAGE>


Securities  Act of 1933, as amended (the  "Registered  Notes").  The  Restricted
Notes  and the  Registered  Notes  are  collectively  referred  to herein as the
"Senior Notes."

         Due to Pathnet's focus to date on developing its network,  the majority
of its revenues reflect certain  consulting and project  management  services in
connection with the design,  development and  construction of digital  microwave
infrastructure. The remaining portion of its revenues has resulted from the sale
of bandwidth  services  along its network.  The Company has also been engaged in
the  acquisition of  telecommunications  network  equipment,  the development of
operating  systems,  the design and construction of the NOC, capital raising and
the hiring of management  and other key personnel.  The Company has  experienced
significant  operating and net losses and negative  operating  cash flow to date
and expects to  continue to  experience  operating  and net losses and  negative
operating cash flow until such time as it is able to generate revenue sufficient
to cover its  operating  expenses.  See "Risk  Factors -  Substantial  Leverage;
Ability to Service Debt; Restrictive Covenants."

NETWORK-RELATED COSTS

         The limited  incremental cost of operating and maintaining the wireless
portion of Pathnet's network, as well as the financial support of Incumbents who
will be responsible for a significant  portion of such operating and maintenance
costs,  are  expected to enable the  Company to enjoy  operating  leverage  with
respect to the wireless  portion of Pathnet's  network.  The Company  expects to
maintain  similar  operating  leverage  with respect to the fiber portion of its
network through the use of co-development and partnering arrangements,  however,
there  can be no  assurance  that  the  Company  will be able to  achieve  these
operating  efficiencies  through the use of these  arrangements.  The  Company's
primary  network  operating  costs are expected to be the costs of  maintenance,
provisioning  of new  circuits,  interconnection  and  operation of the NOC. See
"Risk Factors - Risks of Completing the Company's  Network;  Market  Acceptance;
Risks  Related to Expansion in Strategy;  Need to Obtain and Maintain  Rights of
Way; Risks Relating to Interconnection."

COST OF OPERATIONS

         Pathnet  will incur costs common to all  telecommunications  providers,
including customer service and technical support,  information systems,  billing
and collections, general management and overhead expenses. As a facilities-based
carrier's  carrier,  the Company will differ from  non-facilities-based  Telecom
Service Providers in the scope and complexity of systems supporting its business
and network.  The Company  anticipates  that the vast  majority of its customers
will be Telecom Service  Providers  purchasing  wholesale private line transport
capacity across multiple portions of the Company's network. As such, the Company
believes  that it will be able to  maintain a  relatively  low ratio of overhead
expenses to revenues compared to other Telecom Service Providers.

         Sales and  Marketing  Costs.  To attract and retain  customers  for the
Company's  digital  network,  the Company has built a sales team that includes a
direct  national  accounts sales force, a regional sales force and a sales force
dedicated  to  alternate  channels.  In  addition,  the Company is  assembling a
centralized  marketing  organization  to focus on  product  development,  market
analysis  and pricing  strategies,  as well as customer  communications,  public
relations, and branding.

         Administration  Costs. The Company's general and  administrative  costs
will include expenses  typical of other  telecommunications  service  providers,
including infrastructure costs, customer care,   


                                       13
<PAGE>

billing, corporate administration, and human resources. The Company expects that
these costs will grow significantly as it expands operations.  See "Risk Factors
- Significant Capital Requirements; Uncertainty of Additional Financing."

DEPRECIATION AND AMORTIZATION

         Depreciation of the completed communications network commences when the
network  equipment  is ready  for its  intended  use and is  computed  using the
straight-line  method with  estimated  useful  lives of network  assets  ranging
between three to ten years.  Depreciation  of the office and computer  equipment
and furniture and fixtures is computed using the straight-line method, generally
over three to five years, based upon estimated useful lives, commencing when the
assets are available for service.  Leasehold improvements are amortized over the
lesser of the useful  lives of the assets or the lease  term.  Expenditures  for
maintenance and repairs are expensed as incurred.

CAPITAL EXPENDITURES

         The Company's  principal  capital  requirements  for  deployment of its
wireless network include the costs of tower enhancement,  site preparation work,
base digital wireless equipment and incremental digital wireless equipment.  The
Company's goal is to leverage the assets of Incumbents to (i) reduce the capital
costs associated with developing long haul, digital network capacity as compared
to so-called  "green  field"  network  expansion  and (ii) improve the Company's
speed to market due to the elimination of site preparation activities, including
local permitting,  power connection,  securing road access and rights-of-way and
tower construction.  The actual allocation of costs between the Company and each
Incumbent  has varied  with each of the  Company's  agreements  with  Incumbents
executed to date and is expected to vary, perhaps  significantly,  in the future
on a case-by-case basis.

         The primary capital costs of deploying the Company's fiber network will
include the costs of fiber,  rights-of-way,  installation and construction  work
and  optronics  equipment  used in  regeneration  facilities  and to "light" the
fiber.  The portion of these  capital costs that will be borne by the Company or
that will be defrayed  by  consummating  dark fiber  sales of any fiber  network
segment will be determined on a case-by-case  basis as the Company evaluates and
enters  into  co-development  and other  partnering  arrangements  to deploy its
nationwide digital network.

BUSINESS DEVELOPMENT, CAPITAL EXPENDITURES AND ACQUISITIONS

         From inception  through  December 31, 1998,  expenditures for property,
plant and equipment,  including construction in progress, totaled $48.8 million.
In addition,  the Company incurred  significant  other costs and expenses in the
development  of its business and has recorded  cumulative  losses from inception
through December 31, 1998 of $42.4 million. See "Risk  Factors--Limited  History
of Operations; Operating Losses and Negative Cash Flow."

LIQUIDITY AND CAPITAL RESOURCES

         The  Company  expects to  continue  to  generate  cash  primarily  from
external financing and, as its network matures, from operating  activities.  The
Company's  primary  uses of cash will be to fund capital  expenditures,  working
capital  and  operations.  Deployment  of  the  Company's  digital  network  and
expansion of the  Company's  operations  and services  will require  significant
capital expenditures.  Capital 

                                       14
<PAGE>


expenditures  will be used primarily for continued  development and construction
of its network,  implementing  the Company's  sales and  marketing  strategy and
constructing and improving the Company's NOC.

         During the period  from  August  1995  through  June 1997,  the Company
raised an aggregate of $6 million  through the issuance and sale of its Series A
Convertible Preferred Stock and Series B Convertible Preferred Stock in a series
of private  placements.  See "Certain  Relationships and Related  Transactions -
Series A Purchase  Transactions" and -- "Series B Purchase Agreement" and Note 9
to the Company's Consolidated Financial Statements that appear elsewhere in this
Annual Report on Form 10-K.

         On October 31,  1997,  the Company  consummated  a private  offering of
939,850 shares of Series C Convertible  Preferred  Stock for  approximately  $10
million,  less  issuance  costs  of  $38,780.  On  April 8,  1998,  the  Company
consummated  an  additional  private  offering of  1,879,699  shares of Series C
Convertible  Preferred  Stock for an aggregate  purchase price of  approximately
$20.0  million,  bringing the total  investment by the Company's  private equity
investors to $36.0 million.

         On April 8, 1998, the Company completed the Debt Offering  resulting in
net proceeds to the Company of approximately $339.5 million, after reduction for
offering costs of approximately  $10.5 million. In addition to the Senior Notes,
as part of the Debt  Offering,  the  Company  issued  Warrants  to  purchase  an
aggregate of 1,116,500  shares of Common Stock.  The Company used  approximately
$81.1  million of the net proceeds of the Debt  Offering to purchase  securities
(the  "Pledged  Securities")  in an amount  sufficient to provide for payment in
full of the interest due on the Senior Notes through April 15, 2000. The Pledged
Securities have been pledged as security for repayment of the Senior Notes.  The
Company  made its first  interest  payment  of  approximately  $22.3  million on
October 15, 1998. The Indenture relating to the Senior Notes contains provisions
restricting,  among other things, the incurrence of additional indebtedness, the
payment of dividends and the making of restricted  payments,  the sale of assets
and the creation of liens.

         On  September 2, 1998,  the Company  commenced  the  Exchange  Offer to
exchange all outstanding Restricted Notes for Registered Notes. The terms of the
Registered  Notes are  identical  in all  material  respects to the terms of the
Restricted  Notes,  except that the Registered  Notes have been registered under
the  Securities  Act of 1933 and are generally  freely  transferable  by holders
thereof  and  are  issued  without  any  covenant  upon  the  Company  regarding
registration  under the  Securities  Act of 1933.  The Exchange Offer expired on
October  2,  1998  and all  outstanding  Restricted  Notes  were  exchanged  for
Registered Notes.

         The net proceeds from the issuance of the Units (after  purchasing  the
Pledged  Securities)  and the  issuance  and sale of the  Series  C  Convertible
Preferred  Stock are being used for capital  expenditures,  working  capital and
general corporate purposes, including the funding of operating losses.

         On May 8, 1998,  the Company filed a registration  statement  under the
Securities Act of 1933 with the Securities and Exchange Commission,  relating to
a proposed  initial public offering of the Company's  Common Stock (the "Initial
Public  Offering").  On August 13,  1998,  the Company  announced  that it would
postpone  the Initial  Public  Offering  due to general  weakness in the capital
markets.  The timing  and size of any  future  initial  public  offering  of the
Company's  Common Stock are dependent on market  conditions  and there can be no
assurance that the Initial Public Offering will be completed.



                                       15
<PAGE>

         As of  December  31,  1998,  the Company  had  capital  commitments  of
approximately  $28  million  relating  to  telecommunications  and  transmission
equipment.  It is anticipated that these will be met with the current  resources
of the Company.

         As of December 31,  1998,  the Company had  approximately  $227 million
available  for the  funding of future  operations.  The  Company  expects  these
resources are sufficient to fund the  implementation  of the Company's  business
plan into 2000.  After such time,  the  Company is  expected  to be  required to
procure  additional  financing  which may include  commercial  bank  borrowings,
additional  vendor  financing  or  the  sale  or  issuance  of  equity  or  debt
securities.  There can be no assurance the Company will be successful in raising
sufficient  capital or in obtaining  such  financing on terms  acceptable to the
Company.  See "Risk Factors - Significant Capital  Requirements;  Uncertainty of
Additional Financing."

         Pursuant  to the  Commitment  Letter  in  connection  with  the  supply
agreement between Lucent and the Company,  Lucent may provide financing of up to
approximately  $400  million for fiber  purchases  for the  construction  of the
Company's network and may provide or arrange financing for future phases of such
network. Under the terms of the Commitment Letter, the total amount of financing
provided by Lucent will not exceed $1.8  billion of the $2.1  billion  potential
value  of  the  supply  agreement.  Certain  material  terms  of  the  Company's
agreements  with  Lucent,  including  the terms of the  Commitment  Letter,  are
currently under review by Lucent and the Company. There can be no assurance that
the  transactions,  including the financing  contemplated by Commitment  Letter,
will be consummated or consummated on the terms  described  above.  In addition,
the  Company  may  require  additional  capital in the future to fund  operating
deficits and net losses and for potential  strategic  alliances,  joint ventures
and  acquisitions.   See  "Risk  Factors   Significant   Capital   Requirements;
Uncertainty of Additional Financing."

         Because the Company's cost of rolling out its network and operating its
business,  as  well  as its  revenues,  will  depend  on a  variety  of  factors
(including,  among other things, the ability of the Company to meet its roll-out
schedules,  its ability to negotiate  favorable  prices for purchases of network
equipment,  the number of customers and the services they  purchase,  regulatory
changes and changes in  technology),  actual costs and  revenues  will vary from
expected amounts,  possibly to a material degree, and such variations are likely
to affect the Company's future capital requirements.  Accordingly,  there can be
no assurance that the Company's actual capital  requirements will not exceed the
anticipated amounts described above.

RESULTS OF OPERATIONS

COMPARISON OF YEAR ENDED DECEMBER 31, 1998 WITH YEAR ENDED DECEMBER 31, 1997

         During the twelve months ended December 31, 1998, the Company continued
to develop  relationships with Incumbents,  buildout its network and develop its
infrastructure,  including  hiring key  management  personnel.  The Company also
began  marketing and sales efforts,  and hired Mr. Bennis to develop and execute
its sales efforts and marketing plan.

         REVENUE

         Substantially all of the Company's revenues for the year ended December
31, 1998  consisted of fees  received in connection  with  services  provided to
Incumbents,  including analysis of existing  facilities and system  performance,
advisory  services  relating to PCS  relocation  matters,  and  turnkey  network


                                       16
<PAGE>

construction  management services.  The Company expects substantially all future
revenue to be generated from the sale of  telecommunications  services.  For the
year ended  December 31, 1998 the Company  generated  revenues of  approximately
$1.6 million,  approximately  $1.4 million (89.6%) of which were attributable to
fees  received in  connection  with the continued  performance  of  construction
management  services  primarily from one customer,  and  approximately  $165,000
(10.4%) were attributable to the sale of  telecommunications  capacity.  For the
year ended December 31, 1997, the Company  generated  revenues of  approximately
$162,500 derived from construction management and advisory services.

         OPERATING EXPENSES

         For the year ended  December  31, 1998 and 1997,  the Company  incurred
operating   expenses  of   approximately   $17.9   million  and  $4.3   million,
respectively. The increase is primarily as a result of the increased activity in
the buildout of the Company's  network and  additional  staff costs  incurred as
part the  development  of the  Company's  infrastructure.  The  Company  expects
selling,  general  and  administrative  expenses  to  continue  to  increase  as
additional  staff is added in all functional  areas,  particularly  in sales and
marketing.  Cost of revenue reflects direct costs associated with performance of
construction,  management  services and costs  incurred in  connection  with the
provision of telecommunications  services. Cost of revenue reflects direct costs
associated  with  performance  of  construction  management  services  and costs
incurred for  telecommunications  services such as network  operations,  network
interconnections and provisioning of capacity for customers. These costs include
salaries  and other  employee  expenses of the new  employees  hired  during the
second  quarter to staff the NOC, costs for leased  telecommunications  capacity
used to monitor  the  network,  maintenance  fees paid to  Incumbents  and other
overhead expenses.

         INTEREST EXPENSE

         Interest expense for the year ended December 31, 1998 was approximately
$32.6 million.  Interest  expense  primarily  represents  interest on the Senior
Notes  issued in April  1998  together  with  financing  costs  associated  with
obtaining debt financing  arrangements and the  amortization  expense related to
bond issuance costs in respect of the Senior Notes. The Company did not incur an
interest expense during 1997.

         INTEREST INCOME

         Interest  income  for the year  ended  December  31,  1998 and 1997 was
approximately $13.9 million and $159,300,  respectively. This increase primarily
represents  interest  earned on the proceeds of the Senior Notes issued in April
1998.

         INITIAL PUBLIC OFFERING COSTS

         During the third quarter of 1998, the Company recorded a one-time write
off of  costs of  approximately  $1.3  million,  associated  with the  postponed
Initial Public  Offering of the Company's  Common Stock.  These costs  consisted
primarily of legal and  accounting  fees,  printing  costs,  and  Securities and
Exchange Commission and Nasdaq Stock Market fees.


                                       17
<PAGE>

COMPARISON OF YEAR ENDED DECEMBER 31, 1997 WITH YEAR ENDED DECEMBER 31, 1996

         During  the  year  ended  December  31,  1997,  the  Company  initiated
construction on the first segment of its network, and additional engineering and
management  personnel  were  recruited,  including  Mr.  Jalkut.  The  Company's
principal  activity  through the third quarter of 1996 involved the introduction
of its business  plan to  Incumbents.  As the Company began to enter into formal
relationships  with  Incumbents  in 1996,  additional  engineering,  legal,  and
financial  personnel  were  recruited to support the  increased  workflow and to
negotiate Incumbent contracts.

         REVENUE

         In establishing  relationships with Incumbents,  the Company acted as a
provider of services for  transitioning  the  Incumbents  from their old network
systems onto the Company's network. These services included analysis of existing
facilities and system performance,  advisory services relating to PCS relocation
matters,  and turnkey  network  construction  management.  Revenues for the year
ended  December  31,  1997  consisted  of  $100,000  derived  from  construction
management  services  and  $62,500  from PCS  relocation  advisory  services  as
compared with revenues for the year ended December 31, 1996 of $1,000  generated
from PCS relocation advisory services.

         OPERATING EXPENSES

         For the year ended  December 31, 1997, the Company  incurred  operating
expenses of approximately  $4.3 million  compared to operating  expenses of $1.3
million for the year ended December 31, 1996. This increase was directly related
to an increase in selling,  general and  administrative  expenses as the Company
expanded its engineering,  technical,  legal,  finance,  and general  management
personnel in connection with the continued  signing of new Incumbent  agreements
and the ongoing construction of the Company's network.

YEAR 2000

         The Year 2000 issue exists  because many computer  systems and software
applications  use two digits  rather than four digits to designate an applicable
year. As a result,  the systems and applications may not properly  recognize the
Year 2000,  or process data that includes  that date,  potentially  causing data
miscalculations or inaccuracies or operational malfunctions or failures.

         In the  fourth  quarter of 1998,  the  Company  began a  corporate-wide
program to ready its technology systems and non-technology  systems and software
applications  for the Year 2000. The Company's  objective is to target Year 2000
compliance for all of its systems,  including  network and customer  interfacing
systems.  Due to the development stage status of the Company, few legacy systems
or applications  exist.  However,  the Company is identifying all of its systems
and  applications  that  may need to be  modified  or  reprogrammed  in order to
achieve Year 2000 compliance.

         As part of its Year 2000 plan, the Company is seeking confirmation from
its communications equipment vendors and other suppliers, financial institutions
and customers  that their systems will be Year 2000  compliant.  There can be no
assurance  that the systems of companies  with which the Company  does  business
will be Year 2000  compliant.  If the vendors  important  to the Company fail to
provide  needed  products  and  services,  the  Company's  network  buildout and
operations  could be affected and thereby have a material  adverse effect on the
Company's results of operations, liquidity and financial condition. Moreover, to
the extent  that  significant  customers  are not Year 2000  compliant  and that


                                       18
<PAGE>

affects their network needs,  the Company's  sales could be lower than otherwise
anticipated.

         The Company does not believe its  expenditures  to  implement  its Year
2000 strategy will be material. Because its existing systems are relatively new,
it does not  expect  that it will have to  replace  any of its  systems.  To the
extent it would have to replace a significant portion of its technology systems,
its expenditures could have material adverse effect on the Company.  The Company
has hired an outside consultant to assist it with its Year 2000 compliance,  but
the  Company  has relied  primarily  on its  existing  employees  to develop and
implement its Year 2000 compliance  strategy.  As a result,  its expenditures to
ensure Year 2000  compliance have not been material to date. The Company expects
to continue to use existing  employees for the significant part of its Year 2000
compliance efforts in the future.

         The Company does not  currently  have a  contingency  plan in the event
that it or its suppliers or customers are not Year 2000 compliant.  However, the
Company  expects to develop a contingency  plan to deal with potential Year 2000
related business interruptions.

RISK FACTORS

         LIMITED HISTORY OF OPERATIONS; OPERATING LOSSES AND NEGATIVE CASH FLOW

         The  Company  was  formed in August  1995 to begin  development  of its
digital   network.   As  of  December  31,  1998,   the  Company  had  completed
approximately  2,000 route miles of network,  an additional  approximately 5,000
route miles of network are under  construction  and  approximately  10,000 route
miles of network are under contract. In addition, the Company was only providing
commercial telecommunications service to three customers with several additional
customers awaiting installation. There can be no assurance that the Company will
enter  into  any  additional  contracts  with  Incumbents  or  other  owners  of
telecommunications assets to obtain rights-of-way or rights to sites, towers and
other assets for the  construction  of additional  network or with customers for
the purchase and sale of bandwidth services or dark or dim fiber. As a result of
development  and  operating  expenses,  the  Company  has  incurred  significant
operating  and net losses to date.  The  Company's  operations  have resulted in
cumulative net losses of $42.4 million and cumulative net losses before interest
income  (expense) and income tax benefit of $23.6 million from inception in 1995
through December 31, 1998.

         The Company expects to incur significant  operating losses, to generate
negative cash flows from operating activities and to invest substantial funds to
construct its digital  network  during the next several  years.  There can be no
assurance  that the Company  will achieve or sustain  profitability  or generate
sufficient  positive  cash flow to meet its debt  service  obligations,  capital
expenditure requirements or working capital requirements.

         SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE DEBT; RESTRICTIVE COVENANTS

         The Company is highly  leveraged.  As of December 31, 1998, the Company
had $346.2 million of  indebtedness  outstanding.  The Company will likely incur
substantial  additional  indebtedness  (including secured  indebtedness) for the
development  of its network and other  capital and operating  requirements.  The
level of the  Company's  indebtedness  could  adversely  affect the Company in a
number of ways. For example,  (i) the ability of the Company to obtain necessary
financing in the future for working capital, capital expenditures,  debt service
requirements  or other  purposes  may be limited;  (ii) the  Company's  level of
indebtedness  could  limit its  flexibility  in planning  for,  or reacting  to,
changes



                                       19
<PAGE>

in its business;  (iii) the Company will be more highly  leveraged  than some of
its  competitors,  which may place it at a  competitive  disadvantage;  (iv) the
Company's  degree of  indebtedness  may make it more vulnerable to a downturn in
its business or the economy generally;  (v) the terms of the existing and future
indebtedness restrict, or may restrict, the payment of dividends by the Company;
and (vi) a substantial  portion of the Company's cash flow from  operations must
be dedicated to the payment of principal  and interest on its  indebtedness  and
will not be available for other purposes.

         The Indenture relating to the Senior Notes and certain of the Company's
agreements with Incumbents contain, or will contain, restrictions on the Company
and its subsidiaries that will affect, and in certain cases  significantly limit
or prohibit, among other things, the ability of the Company and its subsidiaries
to  create  liens,  make  investments,  pay  dividends  and make  certain  other
restricted  payments,  issue stock of  subsidiaries,  consolidate,  merge,  sell
assets and incur  additional  indebtedness.  There can be no assurance that such
covenants and restrictions  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.

         In  addition,  any future  indebtedness  incurred by the Company or its
subsidiaries is likely to impose similar restrictions. Failure by the Company or
its subsidiaries to comply with these restrictions could lead to a default under
the  terms  of  the   Senior   Notes  or  the   Company's   other   indebtedness
notwithstanding the ability of the Company to meet its debt service obligations.
In the event of such a default,  the holders of such indebtedness could elect to
declare all such indebtedness due and payable,  together with accrued and unpaid
interest. In such event, a significant portion of the Company's indebtedness may
become  immediately  due and  payable,  and there can be no  assurance  that the
Company  would be able to make such  payments  or borrow  sufficient  funds from
alternative  sources to make any such  payments.  Even if  additional  financing
could be  obtained,  there can be no  assurance  that it would be on terms  that
would be acceptable to the Company.

         The  successful  implementation  of the Company's  strategy,  including
expanding its digital network and obtaining and retaining a sufficient number of
customers,  and significant and sustained growth in the Company's cash flow will
be necessary for the Company to meet its debt service requirements.  The Company
does not currently,  and there can be no assurance that the Company will be able
to, generate sufficient cash flows to meet its debt service obligations.  If the
Company is unable to generate  sufficient  cash flows or otherwise  obtain funds
necessary to make required payments, or if the Company otherwise fails to comply
with  the  various   covenants  under  the  terms  of  its  existing  or  future
indebtedness,  it could trigger a default under the terms  thereof,  which would
permit the  holders of such  indebtedness  to  accelerate  the  maturity of such
indebtedness  and could cause defaults under other  indebtedness of the Company.
The ability of the Company to meet its  obligations  will be dependent  upon the
future performance of the Company,  which will be subject to prevailing economic
conditions and to financial, business, regulatory and other factors.

         SIGNIFICANT CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FINANCING

         Deployment  of the  Company's  network and  expansion of the  Company's
operations and services will require significant capital expenditures, primarily
for continued  development and construction of its network and implementation of
the  Company's  sales and  marketing  strategy.  The  Company  will need to seek
additional  financing to fund capital expenditures and working capital to expand
its  network  further.  The  Company  may also  require  additional  capital for
activities complementary to its currently 


                                       20
<PAGE>

planned businesses.

         The actual amount of the Company's  future  capital  requirements  will
depend upon many factors,  including the costs of network  deployment in each of
its markets,  the speed of the development of the Company's network,  the extent
of competition and pricing of telecommunications  services in its markets, other
strategic  opportunities  pursued  by the  Company  and  the  acceptance  of the
Company's  services.  Accordingly,  there can be no  assurance  that the  actual
amount of the Company's financing needs will not exceed,  perhaps significantly,
the current estimates.

         There  can be no  assurance  that the  Company  will be  successful  in
raising  additional capital or on terms that it will consider  acceptable,  that
the terms of such  indebtedness  or other  capital will not impair the Company's
ability to develop its business or that all available capital will be sufficient
to service its indebtedness. Sources of additional capital may include equipment
financing  facilities and public and private equity and debt financing.  Failure
to raise  sufficient  funds may require the Company to modify,  delay or abandon
some of its  planned  future  expansion  or  expenditures,  which  could  have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

         RISKS OF COMPLETING THE COMPANY'S NETWORK; MARKET ACCEPTANCE

         The Company's  ability to achieve its strategic  objectives will depend
in large part upon the successful,  timely and cost-effective  completion of its
network,  as well as on selling a substantial amount of its products,  including
bandwidth  services.  The successful  completion of the Company's network may be
affected by a variety of factors, uncertainties and contingencies, many of which
are beyond the Company's control. The Company has gained experience in budgeting
and  scheduling  as it has completed  segments of its network,  and although the
Company believes that its cost estimates and buildout  schedules relating to the
currently  planned  portions of its network are reasonable,  only  approximately
2,000 route miles under  contract  have been  completed as of December 31, 1998.
There can be no  assurance  that the  Company's  network  will be  completed  as
planned at the cost and within the time frame currently estimated, if at all. In
addition,   although   the   Company   recently   began   providing   commercial
telecommunications  service to three customers with several additional customers
awaiting installation,  there can be no assurances that the Company will attract
additional purchasers of its products, including bandwidth services.

         The successful and timely  construction  of the Company's  network will
depend upon, among other things, the Company's ability to (i) obtain substantial
amounts  of  additional   capital  and  financing  at  reasonable  cost  and  on
satisfactory  terms and conditions,  (ii) manage effectively and efficiently the
construction  of its network,  (iii) enter into  agreements  with Incumbents and
other  owners of  telecommunications  assets  that will  enable  the  Company to
leverage  the assets of  Incumbents  and of other  owners of  telecommunications
assets,  (iv) access markets and enter into customer contracts to sell bandwidth
services and other  products on its network,  (v)  integrate  successfully  such
networks and associated  rights  acquired in connection  with the development of
the Company's network,  including cost-effective  interconnections,  (vi) obtain
necessary Federal Communication  Commission ("FCC") licenses and other approvals
and (vii) obtain adequate  rights-of-way  and other property rights necessary to
install and operate the fiber  portions  of the  Company's  network.  Successful
construction  of  the  Company's  network  also  will  depend  upon  the  timely
performance  by third party  contractors of their  obligations.  There can be no
assurance  that the Company  will  achieve any or all of these  objectives.  Any
failure  by the  Company  to  accomplish  these  objectives  may have a material
adverse  affect on the 


                                       21
<PAGE>

Company's business, financial condition and results of operations.

         The  development  of the  Company's  network and the  expansion  of the
Company's  business  may  involve   acquisitions  of  other   telecommunications
businesses and assets or implementation of other technologies  either in lieu of
or as a supplement to the  technologies  contemplated  by the Company's  current
business  plan.  In  addition,  the  Company may enter into  relationships  with
Telecom  Service  Providers or other  entities to manage  existing  assets or to
deploy alternative telecommunications technologies. Furthermore, the Company may
seek to serve markets which are not  under-served  or second- or third-tier  and
which  may  present   differing  market  risks  (including  as  to  pricing  and
competition).   If  pursued,   these   opportunities  could  require  additional
financing,  impose additional risks (such as increased or different competition,
additional  regulatory  burdens  and  network  economics  different  from  those
described  elsewhere  herein) and could divert the resources and management time
of the Company. There can be no assurance that any such opportunity, if pursued,
could be successfully  integrated into the Company's operations or that any such
opportunity  would perform as expected.  Furthermore,  as the Company builds out
its  network,  there  can be no  assurance  that the  Company  will  enter  into
agreements   with  the   best-suited   Incumbents   or  such  other   owners  of
telecommunications  assets,  as the  case  may  be.  Moreover,  there  can be no
assurance  that the resulting  network will match or be responsive to the demand
for  telecommunications  capacity or will  maximize the  possible  revenue to be
earned by the  Company.  There can be no  assurance  the Company will be able to
develop  and expand its  business  and enter new markets as  currently  planned.
Failure  of  the  Company  to  implement  its  expansion  and  growth   strategy
successfully  could have a material  adverse  effect on the Company's  business,
financial condition and results of operations.

         RISKS RELATED TO EXPANSION IN STRATEGY.

         On February 3, 1999, the Company announced it had expanded its business
strategy to include  construction  and deployment of digital networks using both
wireless and fiber optic  technologies.  The Company has limited  experience  in
designing and budgeting,  deploying,  operating and maintaining a fiber network.
In addition, the Company could encounter customers with preferences in employing
one  technology  over  another.  There  can be no  assurance  the  Company  will
effectively  design and budget,  deploy,  operate or maintain such facilities or
that it will be able to address such potential  customer  preferences.  Further,
there can be no assurance  that the fiber  network  deployed by the Company will
provide the expected functionality.

         To the extent that the  Company  enters  into  co-development  or other
partnering  arrangements where the Company's partner has primary  responsibility
for key network development matters such as perfecting  rights-of-way or project
management, there can be no assurance that such partners will perform such tasks
adequately or that any failures in such  performance  will not adversely  effect
the Company's financial condition, business or results of operations.

         DEPENDENCE ON  RELATIONSHIP WITH  INCUMBENTS;  RIGHTS OF INCUMBENTS TO
CERTAIN ASSETS

         There can be no assurance that existing  long-term  relationships  with
the  Company's  Incumbents  will  be  maintained  or that  additional  long-term
relationships will result on terms acceptable to the Company,  or at all. If the
Company is not successful in negotiating such agreements,  its ability to deploy
its network would be adversely affected.

                                       22
<PAGE>

         The Company does not typically  expect to own the underlying  sites and
facilities upon which the wireless portion of its network is deployed.  Instead,
the Company has entered into and expects to enter into  long-term  relationships
with  Incumbents  whereby each such  Incumbent  agrees to grant to the Company a
leasehold interest in or a similar right to use such Incumbent's  facilities and
infrastructure  as is required  for the Company to deploy its  network.  In some
cases,  system assets may be held by  subsidiaries in which both the Company and
the  Incumbent  own an  interest.  As a result,  the Company  will depend on the
facilities  and  infrastructure  of its  Incumbents  for  the  operation  of its
business. Long-term relationships with Incumbents may expire or terminate if the
Company does not satisfy  certain  performance  targets with respect to sales of
telecommunications  capacity or fails to  commission  an initial  communications
system within specified time periods. In such cases,  certain equipment relating
to the initial  communications system will be transferred to the Incumbent.  Any
such expiration of a relationship  with an Incumbent,  and the resulting loss of
use of the  corresponding  system and opportunity to utilize such segment of its
network,  could  result in the  Company  not being  able to recoup  its  initial
capital  expenditure  with  respect  to such  segment  and could have a material
adverse  effect on the business  and  financial  condition  of the  Company.  In
addition,  such a loss under certain  circumstances  could result in an event of
default under the Company's debt financings.  There can be no assurance that the
Company will continue to have access to such  Incumbent's  sites and  facilities
after the expiration of such agreements or in the event that an Incumbent elects
to  terminate  its  agreement  with  the  Company.  If  such an  agreement  were
terminated  or expire  and the  Company  were  forced  to  remove  or  abandon a
significant portion of its network, such termination or expiration,  as the case
may  be,  could  have a  material  adverse  effect  on the  business,  financial
condition and results of operations of the Company.

         The Company  expects to rely  significantly  on its  Incumbents for the
maintenance and provisioning of circuits on the wireless portion of its network.
The Company has entered into  maintenance  agreements  with six  Incumbents  and
expects to enter into agreements with additional  Incumbents  pursuant to which,
among other things, the Company will pay the Incumbent a monthly maintenance fee
and a  provisioning  services  fee in  exchange  for  such  Incumbent  providing
maintenance and provisioning  services for that portion of the Company's network
that primarily resides along such Incumbent's system.  Failure by the Company to
enter  successfully  into  similar  agreements  with  other  Incumbents  or  the
cancellation  or  non-renewal  of any of such existing  agreements  could have a
material adverse effect on the Company's business.  To the extent the Company is
unable  to  establish  similar  arrangements  in  new  markets  with  additional
Incumbents or establish replacement  arrangements on systems where a maintenance
agreement  with a particular  Incumbent is canceled or not renewed,  the Company
may be required to maintain  its network and  provision  circuits on its network
through  establishment of its own maintenance and  provisioning  workforce or by
outsourcing  maintenance  and  provisioning  to a  third  party.  The  Company's
operating costs under these conditions may increase.

         NEED TO OBTAIN AND MAINTAIN RIGHTS-OF-WAY.

         The Company expects to obtain easements, rights-of-way,  franchises and
licenses  from  various  private  parties,  ILECs,  utilities,  railroads,  long
distance  companies,  state highway  authorities,  local governments and transit
authorities in order to construct and maintain its fiber optic  network.  If the
Company were to acquire right-of-way directly from a governmental  authority, it
would be  directly  affected  by state and local  law.  To the  extent  that the
Company obtains  rights-of-way  from others, it would be indirectly  affected by
state and local law.  There is a  possibility  that  disputes may arise with


                                       23
<PAGE>

the  licensing  authority  or a  competitor,  the  result  of which  may favor a
competitor of the Company.  Such disputes could impose legal and  administrative
costs  on  the  Company,   including  out-of-pocket  expenses  and  lost  market
opportunity because of delays.  Further, the Company may be subject to franchise
fees  imposed by state and local  governments.  In  addition,  the  Company  may
require pole attachment  agreements with utilities and ILECs to operate existing
and future networks,  and there can be no assurance that such agreements will be
obtained on reasonable terms.

         There can be no  assurance  that the Company will be able to obtain and
maintain  the  additional  rights and  permits  needed to build its fiber  optic
network and  otherwise  implement its business  plan on  acceptable  terms.  The
failure to enter  into and  maintain  required  arrangements  for the  Company's
network  could  have  a  material  adverse  effect  on the  Company's  business,
financial  condition and results of operations.  There can be no assurance that,
once   obtained,   the  Company  will   continue  to  have  access  to  existing
rights-of-way  and  franchises  after the  expiration of such  agreements.  If a
franchise,  license or lease  agreement  were  terminated  and the Company  were
forced  to  remove  or  abandon  a  significant  portion  of its  network,  such
termination could have a material adverse effect on the Company.

         MANAGEMENT OF GROWTH AND RISKS  ASSOCIATED WITH POSSIBLE  ACQUISITIONS,
STRATEGIC ALLIANCES AND JOINT VENTURES.

         The Company's expanded business plan may, if successfully  implemented,
result in rapid  expansion of its  operations.  Rapid expansion of the Company's
operations may place a significant strain on the Company's management, financial
and other resources.  The Company's  ability to manage future growth,  should it
occur,  will  depend  upon its  ability to monitor  operations,  control  costs,
maintain regulatory  compliance,  maintain effective quality controls and expand
significantly  the Company's  internal  management,  technical,  information and
accounting  systems and to attract and retain  additional  qualified  personnel.
Furthermore,  as the Company's  business develops and expands,  the Company will
need additional facilities for its growing workforce.  There can be no assurance
that the Company will  successfully  implement and maintain such operational and
financial  systems or successfully  obtain,  integrate and utilize the employees
and  management,  operational  and  financial  resources  necessary  to manage a
developing and expanding  business in an evolving and  increasingly  competitive
industry  which is subject to  regulatory  change.  Any failure to expand  these
areas and to implement and improve such systems,  procedures  and controls in an
efficient manner at a pace consistent with the growth of the Company's  business
could have a material  adverse effect on the business,  financial  condition and
results of operations of the Company.

         The Company believes that a part of its future growth may come from the
formation  of  strategic  alliances  with  other  telecommunications   companies
designed to assist and accelerate the building of the Company's  digital network
to provide services to customers of the Company which are complementary to those
provided by the Company.  The Company  intends to pursue joint ventures with, or
acquisitions  of,  companies  that have an existing  network  infrastructure  or
customer base in order to increase the Company's  penetration  of its markets or
accelerate  entry  into  new  markets.   Limitations  under  the  Indenture  may
significantly  limit the  Company's  ability to make  acquisitions  and to incur
indebtedness in connection with acquisitions. Such transactions commonly involve
certain  risks,  including,  among others:  the difficulty of  assimilating  the
acquired  operations  and personnel;  the potential  disruption of the Company's
ongoing  business and diversion of resources and  management  time; the possible
inability of management to maintain uniform standards,  controls, procedures and
policies;  the risks of  entering

                                       24
<PAGE>

markets in which the Company has little or no direct prior  experience;  and the
potential impairment of relationships with employees or customers as a result of
changes in management.  There can be no assurance that any  acquisition or joint
venture  will be  made,  that  the  Company  will be able to  obtain  additional
financing  needed to finance such  acquisitions  and joint  ventures and, if any
acquisitions  are so  made,  that the  acquired  business  will be  successfully
integrated  into the  Company's  operations  or that the acquired  business will
perform as expected. The Company has no definitive agreement with respect to any
acquisition,  although  it has had  discussions  with other  companies  and will
continue to assess opportunities on an ongoing basis.

         DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL

         The success of the Company will depend to a significant extent upon the
abilities and continued efforts of its senior management,  particularly  members
of its senior management team, including Richard A. Jalkut,  President and Chief
Executive  Officer,  Kevin  J.  Bennis,  Executive  Vice  President  serving  as
President of the Company's Communications Services Division, William R. Smedberg
V, Executive Vice President,  Corporate Development, and Michael L. Brooks, Vice
President  of Network  Development.  Other than its  Employment  Agreement  with
Richard A. Jalkut, the Company does not have any employment agreements with, nor
does the Company maintain "key man" insurance on, these  employees.  The loss of
the services of any such individuals could have a material adverse effect on the
Company's business,  financial condition and results of operations.  The success
of the  Company  will  also  depend,  in part,  upon the  Company's  ability  to
identify,  hire and retain  additional key management  personnel,  including the
senior  management,  who are also being sought by other businesses.  Competition
for  qualified  personnel  in the  telecommunications  industry is intense.  The
inability  to  identify,  hire and retain such  personnel  could have a material
adverse effect on the Company's results of operations.

         COMPETITION; PRICING PRESSURES

         The telecommunications  industry is highly competitive.  In particular,
price competition in the carrier's carrier market has generally been intense and
is  expected  to  increase.  The Company  competes  and expects to compete  with
numerous  competitors  who have  substantially  greater  financial and technical
resources,  long-standing  relationships  with their  customers and potential to
subsidize  competitive  services from less competitive service revenues and from
federal  universal  service  subsidies.  Such  competitors  may be  operators of
existing or newly deployed wireline or wireless telecommunications networks. The
Company  will  also  face  intense  competition  due to an  increased  supply of
telecommunications  capacity, the effects of deregulation and the development of
new  technologies,  including  technologies  that will  increase the capacity of
existing networks. See "Business - Competition."

         RELIANCE  ON  EQUIPMENT  SUPPLIERS  FOR  THE  WIRELESS  PORTION  OF THE
COMPANY'S NETWORK

         The  Company  currently   purchases  most  of  its   telecommunications
equipment  pursuant to an agreement with NEC from whom the Company has agreed to
purchase  $200 million of equipment by December 31, 2002 and has entered into an
equipment  purchase  agreement  with Andrew.  Any reduction or  interruption  in
supply from either  supplier or any increase in prices for such equipment  could
have a disruptive effect on the Company. Currently NEC and Northern Telecom Ltd.
are the  only 

                                       25
<PAGE>

manufacturers  of SONET radios that are compatible  with the Company's  proposed
system design and reliability  standards relating to the wireless portion of its
network,  although Harris  Corporation and Alcatel  Alsthom  Compagnie  Generale
d'Electricite  SA are in the  process of  developing  and  testing  similar  and
compatible products. Further, the Company does not manufacture, nor does it have
the capability to manufacture,  any of the telecommunications  equipment used on
its  network.  As a result,  the  failure of the  Company to procure  sufficient
equipment at reasonable prices and in a timely manner could adversely affect the
Company's successful deployment of its network and results of operations.

         RELIANCE ON LUCENT; LUCENT AGREEMENTS.

         The Company and Lucent have entered into a supply agreement under which
Lucent will provide and will deploy  personnel to assist in, among other things,
the design and marketing of the Company's  network.  Any failure or inability by
Lucent to perform  these  functions  could cause delays or  additional  costs in
providing  services to  customers  and  building  out the  Company's  network in
specific  markets.  Any such failure could  materially and adversely  affect the
Company's financial condition, business and results of operations.

         The Company and Lucent have entered into the Commitment Letter which is
contingent  upon various  conditions,  including  the  execution of a definitive
financing  agreement,  compliance  with financial  covenants,  completion of due
diligence and the absence of any material  adverse change in the Company.  There
can be no assurance that a definitive agreement will be executed with respect to
the  financing  contemplated  by the  Commitment  Letter  or that the  financing
contemplated  by the  Commitment  Letter  will be  consummated.  Any  failure to
consummate the financing  contemplated by the Commitment Letter could materially
and adversely effect the Company's financial condition,  business and results of
operations.

         TECHNICAL LIMITATIONS OF THE WIRELESS NETWORK

         The Company will not be able to offer route  diversity  until such time
as it has completed a substantial  portion of its mature  network.  In addition,
the wireless  portion of the Company's  network  requires a direct line of sight
between two antennae  (each such interval  comprising a "path") which is subject
to distance limitations, freespace fade, multipath fade and rain attenuation. In
order to meet industry standards for reliability, the maximum length of a single
path similar to those being  designed by the Company is generally  limited to 40
miles and, as a result, intermediate sites in the form of back-to-back terminals
or repeaters are required to permit digital  wireless  transmission  beyond this
limit based on the  climate  and  topographic  conditions  of each path.  In the
absence  of a  direct  line  of  sight,  additional  sites  may be  required  to
circumvent  obstacles,  such as tall  buildings  in urban areas or  mountains in
rural areas.  Topographic conditions of a path and climate can cause reflections
of signals from the ground, which can affect the transmission quality of digital
wireless  services.  In addition,  in areas of heavy rainfall,  the intensity of
rainfall and the size of the  raindrops can affect the  transmission  quality of
digital  wireless  services.  Paths in these  areas are  engineered  for shorter
distances to maintain  transmission  quality and use space diversity,  frequency
diversity,  adaptive  power  control and forward  error  correction  to minimize
transmission  errors.  The use of additional sites and shorter paths to overcome
obstructions,  multipath  fade or rain  attenuation  will increase the Company's
capital costs.  While these increased costs may not be significant in all cases,
such  costs  may  render  digital  wireless  services  uneconomical  in  certain
circumstances.

                                       26
<PAGE>

         Due to line of sight  limitations,  the Company currently  installs its
antennae on towers, the rooftops of buildings or other tall structures.  Line of
sight  and  distance  limitations  generally  do not  present  problems  because
Incumbents  have  already  selected,   developed  and  constructed  unobstructed
transmission sites. In certain instances,  however,  the additional  frequencies
required  for the excess  capacity  to be  installed  by the  Company may not be
available from  Incumbents'  existing  sites.  In these  instances,  the Company
generally  expects to use other  developed sites already owned or leased by such
Incumbent. In some instances,  however, the Company has encountered,  and may in
the future encounter, line of sight, frequency blockage and distance limitations
that cannot be solved economically.  While the effect on the financial condition
and  results of  operations  of the Company  resulting  from such cases has been
minimal to date,  there can be no assurance  that such  limitations  will not be
encountered more frequently as the Company expands its network. Such limitations
may have a material adverse effect on the Company's future development costs and
results of operations. In addition, the current lack of compression applications
for wireless technology limits the Company's ability to increase capacity on the
wireless  portion of its network without  significant  capital  expenditures for
additional equipment.

         RISKS RELATING TO INTERCONNECTION

         In order to obtain the necessary access to install its radios, antennae
and other equipment required for interconnection of the Company's network to the
public switched  telephone  network or to POPs of the Company's  customers,  the
Company must acquire the  necessary  rights and enter into the  arrangements  to
secure  such  interconnections  and  deploy  and  operate  such  interconnection
equipment.  There can be no assurance that the Company will succeed in obtaining
the  rights  necessary  to  secure  such  interconnections  and  to  deploy  its
interconnection equipment in its market areas on acceptable terms, if at all, or
that  delays in or terms for  obtaining  such  rights  will not have a  material
adverse effect on the Company's development or results of operations.

         DEPENDENCE ON INFORMATION AND PROCESSING SYSTEMS

         Sophisticated  information  and  processing  systems  are  vital to the
Company's  growth  and its  ability to monitor  network  performance,  provision
customer  orders for  telecommunications  capacity,  bill customers  accurately,
provide high-quality customer service and achieve operating efficiencies. As the
Company  grows,  any  inability  to operate  its  billing  and  information  and
processing  systems, or to upgrade internal systems and procedures as necessary,
could  have a  material  adverse  impact on the  Company's  ability to reach its
objectives, or on its business, financial condition and results of operations.

         RISK OF RAPID TECHNOLOGICAL CHANGES

         The  telecommunications  industry  is subject to rapid and  significant
changes in  technology.  Although the Company has expanded its business  plan to
include fiber optic technologies,  which may diversify the Company's exposure to
the risk of such  technological  changes,  their  effect on the  business of the
Company  cannot be predicted.  There can be no assurance  that (i) the Company's
network  will not be  economically  or  technically  outmoded by  technology  or
services now  existing or  developed  and  implemented  in the future,  (ii) the
Company will have sufficient resources to develop or acquire new technologies or
to introduce  new  services  capable of competing  with future  technologies  or
service  offerings or (iii) the cost of the  equipment  used on its network will
decline as rapidly as that of competitive alternatives. The occurrence of any of
the foregoing events may have a material adverse


                                       27
<PAGE>

effect on the operations of the Company.

         REGULATION

         RISKS  RELATING  TO  REGULATION  OF  WIRELESS  NETWORK.  The  Company's
arrangements  with  Incumbents  contemplate  that the  wireless  portion  of the
Company's   digital   network  will  provide   largely   "common  carrier  fixed
point-to-point  microwave"  telecommunications  services  under  Part 101 ("Part
101") of the rules of the FCC,  which  services  are  subject to  regulation  by
federal,  state and local  governmental  agencies.  Changes in existing federal,
state or local laws and  regulations,  including those relating to the provision
of Part 101  telecommunications  services,  any failure or significant  delay in
obtaining  (or  complying  with the terms of)  necessary  licenses,  permits  or
renewals,  or any expansion of the Company's  business that subjects the Company
to additional  regulatory  requirements  could have a material adverse effect on
the Company's business, financial condition, and results of operations.

         FCC   LICENSE   REQUIREMENTS.   Prior  to   applying  to  the  FCC  for
authorization to use portions of the 6 GHz band, the Company must coordinate its
use of the frequency with any existing licensees,  permittees, and applicants in
the same area whose  facilities  could be subject to interference as a result of
the  Company's  proposed use of the  spectrum.  There can be no assurance in any
particular  case that the Company will not encounter other entities and proposed
uses of the desired  spectrum that would  interfere  with the Company's  planned
use, and that the Company  will be able to  coordinate  successfully  such usage
with such entities. In addition, as part of the requirements of obtaining a Part
101  license,  the FCC  requires  the Company to  demonstrate  the site  owner's
compliance with the reporting,  notification  and technical  requirements of the
Federal  Aviation  Administration  ("FAA")  with  respect  to the  construction,
installation,   location,  lighting  and  painting  of  transmitter  towers  and
antennae,  such as  those  to be used by the  Company  in the  operation  of its
network. Furthermore, in order to obtain the Part 101 licenses necessary for the
operation of its network, the Company,  and in some cases Incumbents,  must file
applications  with the FCC for such  licenses and  demonstrate  compliance  with
routine  technical and legal  qualification  to be an FCC licensee.  The Company
must also obtain FCC  authorization  before  transferring  control of any of its
licenses or making certain modifications to a licensed facility. There can be no
assurance  that the Company or any Incumbent who desires to be the licensee with
respect to its portion of the Company's  network will obtain all of the licenses
or approvals necessary for the operation of the Company's business, the transfer
of any license,  or the  modification of any facility,  or that the FCC will not
impose burdensome conditions or limitations on any such license or approval.

         RISKS  RELATING  TO  REGULATION  OF  FIBER  NETWORK.  Pursuant  to  the
interconnection  provisions  of the  Telecommunications  Act of 1996 (the  "1996
Telecom Act"),  the FCC identified a minimum list of unbundled  network elements
that ILECs must make  available to other  telecommunications  carriers.  The FCC
declined to include  incumbent  ILECs' dark fiber in this list,  finding that it
did not have adequate information to determine whether dark fiber qualifies as a
network  element.  The FCC indicated  that is would continue to review or revise
its rules regarding unbundled network elements as necessary.  State commissions,
however, have the authority to impose additional unbundling requirements so long
as the  requirements  are  consistent  with the 1996  Telecom  Act and the FCC's
requirements,  which could include  requiring  incumbent ILECs to unbundle their
dark fiber.

         In  the   recent   Supreme   Court   decision   regarding   the   FCC's
interconnection  and unbundling  rules,


                                       28
<PAGE>

the Supreme  Court  vacated the FCC's rule  establishing  the list of  unbundled
network  elements.  The Supreme Court found that the FCC had not interpreted the
terms of the 1996  Telecom Act  regarding  an  incumbent  ILEC's duty to provide
network elements in a reasonable  fashion.  The Supreme Court found that the FCC
had  given  telecommunications  carriers  blanket  access to  unbundled  network
elements. The statute,  however, limits  telecommunications  carriers' access to
network elements to those that are "necessary" or to those where failure to have
access would "impair the ability of the  telecommunications  carrier" to provide
services it seeks to offer. The FCC plans to commence a rulemaking proceeding to
adopt new  requirements  regarding  unbundled  network  elements  that  properly
consider the "necessary and impair" standard in the 1996 Telecom Act.

         A decision  by the FCC or states to  require  unbundling  of  incumbent
ILECs' dark fiber could  increase the supply of dark fiber and  decrease  demand
for the Company's dark fiber, and thereby have an adverse effect on the Company'
business, financial condition and results of operations.

         GENERAL

         PROVISION  OF COMMON  AND  PRIVATE  CARRIER  SERVICES.  The  Company is
currently  offering,  and  expects to offer in the  future,  its  services  on a
private carrier basis.  The Company's  private carrier  services are essentially
unregulated,  while any common carrier  offerings would be subject to additional
regulations and reporting  requirements including payment of additional fees and
compliance  with  additional  rules  and  regulations  including  that  any such
services must be offered pursuant to filed tariffs and non-discriminatory terms,
rates and  practices.  There can be no assurance that the FCC will not find that
some or all of the private carrier  services  offered by the Company are in fact
common carrier  services,  and thus subject to such  additional  regulations and
reporting  requirements  including  the  non-discrimination  and  tariff  filing
requirements  imposed  on common  carriers,  in which  case the  Company  may be
required to pay additional fees or adjust,  modify or cease provision of certain
of its services in order to comply with any such regulations, including offering
such  services on the same terms and  conditions  to all of those  seeking  such
services, and pursuant to rates made public in tariff filings at the FCC.

         FOREIGN OWNERSHIP.  As the licensee of facilities designated for common
carriage,  the Company is subject to Section 310(b)(4) of the Communications Act
of 1934, as amended (the "Communications Act"), which by its terms restricts the
holding company of an FCC common carrier licensee (the Company is such a holding
company,  because  it  expects  to hold  all FCC  licenses  indirectly,  through
subsidiaries) to a maximum of 25% foreign  ownership and/or voting control.  The
FCC has determined  that it will  authorize a higher level of foreign  ownership
(up to 100%) on a streamlined basis where the indirect foreign investment in the
common carrier licensee is by citizens of, or companies organized under the laws
of  World  Trade  Organization  ("WTO")  member  countries.  Where  the  foreign
ownership is by citizens or corporations of non-WTO nations,  FCC  authorization
to exceed the 25% limitation must be obtained on a non-streamlined basis and the
licensee must meet a more  demanding  public  interest  showing.  The Company is
presently within the 25% foreign  ownership  limitation.  In connection with any
future financings, the Company will have to monitor foreign investment to ensure
that its foreign  ownership does not exceed the 25%  limitation.  If it appeared
that  foreign  ownership  of the  Company  was coming  close to  exceeding  this
benchmark, the Company would have to obtain FCC authorization prior to exceeding
the 25% limitation.  In addition,  if any Incumbent elects to be the licensee on
the portion of the  Company's  network  relating to its system,  such  Incumbent
would also be subject to such


                                       29
<PAGE>

foreign ownership restrictions.  If such analysis showed that such Incumbent had
more than 25% foreign ownership, the Incumbents would have to seek authorization
from the FCC to exceed the 25% limitation or it would have to reduce its foreign
ownership.

         In the event that an Incumbent were to choose to hold the relevant Part
101 license itself,  and not through a holding company,  that Incumbent would be
subject to Section  310(b)(3) of the  Communications  Act,  which limits  direct
foreign  ownership of FCC licenses to 20%. The FCC does not have  discretion  to
waive this limitation.  If an Incumbent  exceeded the 20% limitation it would be
required to reduce its foreign  ownership  in order to obtain or retain its Part
101 license.

         STATE AND LOCAL  REGULATION.  Although  the Company  expects to provide
most of its  services  on an  interstate  basis,  in those  instances  where the
Company provides service on an intrastate  basis, the Company may be required to
obtain a certification  to operate from state utility  commissions in certain of
the states where such intrastate  services are provided,  and may be required to
file tariffs covering such intrastate services. In addition,  the Company may be
required to obtain  authorizations  from or notify  such states with  respect to
certain transfers or issuances of capital stock of the Company. The Company does
not expect any such state or local requirements to be burdensome; however, there
can be no assurance that the Company will obtain all of the necessary  state and
local  approvals  and consents or that the failure to obtain such  approvals and
consents  will not have a material  adverse  affect on the  Company's  business,
financial  condition  and results of  operations.  In addition,  there can be no
assurance  that state or local  authorities  will not impose  burdensome  taxes,
requirements or conditions on the Incumbent or the Company.

         INVESTMENT COMPANY ACT CONSIDERATIONS

         The Company has  substantial  cash,  cash  equivalents  and  short-term
investments.  The Company has invested and intends to invest the proceeds of its
financing  activities  so as to  preserve  capital  by  investing  primarily  in
short-term instruments consistent with prudent cash management and not primarily
for the  purpose of  achieving  investment  returns.  Investment  in  securities
primarily  for the purpose of achieving  investment  returns could result in the
Company being treated as an "investment  company"  under the Investment  Company
Act of 1940 (the "1940 Act").  The 1940 Act requires  the  registration  of, and
imposes various substantive  restrictions on, investment  companies that are, or
hold themselves out as being, engaged primarily,  or propose to engage primarily
in, the business of investing,  reinvesting  or trading in  securities,  or that
fail certain  statistical  tests regarding the composition of assets and sources
of income and are not  primarily  engaged in  businesses  other than  investing,
reinvesting, owning, holding or trading securities.

         The Company  believes that it is primarily  engaged in a business other
than  investing,   reinvesting,  owning,  holding  or  trading  securities  and,
therefore,  is not an investment  company within the meaning of the 1940 Act. If
the Company were  required to register as an  investment  company under the 1940
Act, it would  become  subject to  substantial  regulation  with  respect to its
capital structure, management, operations,  transactions with affiliated persons
(as defined in the 1940 Act) and other matters. Application of the provisions of
the  1940  Act to the  Company  would  have a  material  adverse  effect  on the
Company's business, financial condition and results of operations.

                                       30
<PAGE>

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not applicable

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The Company's  financial  statements and supplementary  data,  together
with the report of the independent accountants,  are included or incorporated by
reference  elsewhere  herein.  Reference  is made  to the  "Index  to  Financial
Statements" following the signature pages hereto.

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

         None.


                                       31
<PAGE>

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Executive Officers

         The table below sets forth certain information concerning the directors
and executive  officers of the Company.  Directors of the Company are elected at
the annual meeting of stockholders.  Executive officers of the Company generally
are appointed at the Board of Directors' first meeting after each annual meeting
of stockholders.

<TABLE>
<CAPTION>

NAME                                         AGE           POSITION(S) WITH COMPANY
<S>                                            <C>         <C>    
Richard A. Jalkut (1) ......................   54          President, Chief Executive Officer and Director
Kevin J. Bennis ............................   45          Executive Vice President, and President,
                                                             Communications Services Division
William R. Smedberg, V......................   37          Executive Vice  President,  Corporate  Development, 
                                                             Treasurer and Assistant Secretary
Michael A. Lubin ...........................   49          Vice President, General Counsel and Secretary
Michael L. Brooks ..........................   55          Vice President, Network Development
David Schaeffer (1).........................   42          Director
Peter J. Barris (2) ........................   47          Director
Kevin J. Maroni (2)(3) .....................   36          Director
Patrick J. Kerins (3) ......................   43          Director
Richard K. Prins (2)(3) ....................   41          Director
Stephen A. Reinstadtler ....................   32          Director
------------------------------------
</TABLE>

(1) Member of Contract Committee.

(2) Member of Compensation Committee.

(3) Member of Audit Committee.

         Set forth below is the  background of each of the  Company's  executive
officers and directors.

         RICHARD A. JALKUT has served as President,  Chief Executive Officer and
director of the  Company  since  August  1997.  Mr.  Jalkut has over 30 years of
telecommunications  experience. From 1995 to August 1997, he served as President
and Group Executive of NYNEX Telecommunications  Group, where he was responsible
for all activities of the NYNEX  Telecommunications  Group, an organization with
over 60,000  employees.  Prior to that, Mr. Jalkut served as President and Chief
Executive  Officer of New York  Telephone Co. Inc., the  predecessor  company to
NYNEX  Telecommunications  Group,  from 1991 until 1995.  Mr.  Jalkut  currently
serves  as a  member  of the  Board of  Directors  of  Marine  Midland  Bank,  a
commercial bank, Ikon Office Solutions, Inc., a company engaged in wholesale and
retail  office  equipment,  and  Home  Wireless  Networks,  a  start-up  company
developing a wireless product for home and business premises.

         KEVIN J.  BENNIS has served as  Executive  Vice  President,  serving as
President of the Company's Communications Services Division since February 1998.
From 1996  until he joined  the  


                                       32
<PAGE>

Company,  Mr.  Bennis  served as  President of Frontier  Communications,  a long
distance  communications  company,  where  he was  responsible  for  the  sales,
marketing and customer service activities of 3,500 employees. Prior to that, Mr.
Bennis served in various  positions for 21 years at MCI,  including as President
of MCI's Integrated Client Services Division from 1995 to 1996, as President and
Chief Operating Officer of Avantel Telecommunications,  MCI's joint venture with
Banamex in Mexico,  from 1994 to 1995, and as Senior Vice President of Marketing
from 1992 to 1994.

         WILLIAM R. SMEDBERG,  V joined the Company initially as a consultant in
1996, served as Vice President,  Finance and Corporate  Development from January
1997 to February  1999 and assumed the  position of  Executive  Vice  President,
Corporate  Development in March 1999. Prior to joining the Company, Mr. Smedberg
served  in  various  financial  and  planning   positions  at  the  James  River
Corporation of Virginia, Inc. ("James River") for nine years. In particular,  he
served as Director,  Strategic Planning and Corporate  Development for Jamont, a
European  consumer  products joint venture among Nokia Oy, Montedison S.p.A. and
James River, from 1991 to 1996, where he was responsible for Jamont's  corporate
finance,  strategic  planning  and  corporate  development.  Prior to that,  Mr.
Smedberg  worked in the defense  industry as a consultant  and engineer for TRW,
Inc.

         MICHAEL A.  LUBIN has served as Vice  President,  General  Counsel  and
Secretary of the Company  since its  inception in August 1995.  Prior to joining
the Company,  Mr. Lubin was an  attorney-at-law at Michael A. Lubin, P.C., a law
firm,  which he founded in 1985. Mr. Lubin has experience in  telecommunications
matters,  copyright and intellectual property matters,  corporate and commercial
law,  construction  claims  adjudication and trial work.  Earlier he served as a
Federal  prosecutor  with the Fraud Section,  Criminal  Division,  United States
Department of Justice.

         MICHAEL L. BROOKS has served as Vice President,  Network Development of
the Company since June 1996.  Mr.  Brooks has extensive  experience in voice and
data  communications.  From 1992  through May 1996,  Mr.  Brooks  served as Vice
President,  Engineering  for Ikelyn,  Inc.  Ikelyn  provided  system  design and
technical support for  telecommunication  systems and support  facilities.  From
1982  to  1992,  Mr.  Brooks  worked  for  Qwest  Microwave  Communications,   a
predecessor of Qwest, where he directed the initial construction of a 3,500-mile
digital network.

         DAVID  SCHAEFFER  founded  the  Company  in August  1995 and has been a
director of the Company since its inception. Mr. Schaeffer served as Chairman of
the Board and  Treasurer of the Company from August 1997 to February  1999,  and
served as President,  Chief Executive  Officer and Treasurer of the Company from
August 1995 until August 1997. From 1986 to the present,  Mr. Schaeffer has also
served as  President  and Chief  Executive  Officer of Empire  Leasing,  Inc., a
specialized  mobile radio  licensee and  operator.  In addition,  Mr.  Schaeffer
founded and, since 1992, has served as President and Chief Executive  Officer of
Mercury  Message  Paging,  Inc., a paging  company  which  operates  networks in
Washington, D.C., Baltimore and Philadelphia.

         PETER J. BARRIS has been a director of the Company  since  August 1995.
Since 1992, Mr. Barris has been a partner, and, in 1994, was appointed a General
Partner  of New  Enterprise  Associates,  a firm that  manages  venture  capital
investments.  Mr.  Barris is also a member of the Board of  Directors  of Mobius
Management Systems,  Inc. and pcOrder.com,  Inc. each of which are quoted on the
Nasdaq National Market.

         KEVIN J. MARONI has been a director of the Company  since  August 1995.
Since 1994,  Mr. Maroni has been a principal,  and, in 1995,  was appointed as a
General Partner of Spectrum Equity


                                       33
<PAGE>

Investors,  L.P.,  which manages  private equity funds focused on growth capital
for  telecommunications  companies.  From 1992 to 1994,  he  served as  Manager,
Finance and Development at Time Warner Telecommunications, where he was involved
in corporate development projects.  Mr. Maroni served as a consultant at Harvard
Management  Company  from 1990 to 1992,  where he worked in the  private  equity
group. Mr. Maroni is also currently on the board of directors of several private
companies and CTC Communications  Corp., an integrated  communications  provider
that is quoted on the Nasdaq National Market.

         PATRICK J. KERINS has been a director  of the Company  since July 1997.
Mr. Kerins has served as Managing  Director of Grotech  Capital Group,  which is
engaged in venture  capital and other private  equity  investments,  since March
1997. From 1987 to March 1997, he worked in the investment  banking  division of
Alex.  Brown  & Sons,  Incorporated,  including  serving  as  Managing  Director
beginning in January 1994. Mr. Kerins is also a member of the Board of Directors
of CDnow,  Inc.,  an online  retailer of compact  discs and other  music-related
products, which is quoted on the Nasdaq National Market.

         RICHARD K. PRINS has been a director of the Company  since 1995.  Since
1996,  Mr.  Prins has served as Senior  Vice  President  of Ferris  Baker  Watts
Incorporated,  where he heads the technology and  communication  practice in the
investment banking division. From 1988 to 1996, he was Senior Vice President and
Managing  Director  in the  investment  banking  division  of Crestar  Financial
Corporation.  Mr. Prins is currently a director of Startec Global Communications
Corporation,  a  communications  company  that is quoted on the Nasdaq  National
Market.

         STEPHEN  A.  REINSTADTLER  has been a  director  of the  Company  since
October  1997.  Mr.  Reinstadtler  has served as Vice  President and Director at
Toronto  Dominion  Capital  (U.S.A.) Inc., where he has been involved in private
equity and mezzanine  debt  investments,  since August 1995.  From April 1994 to
July  1995,  he served as  Manager at The  Toronto-Dominion  Bank,  where he was
involved in commercial  lending activities to the  telecommunications  industry.
From August 1992 to April 1994,  Mr.  Reinstadtler  also served as  Associate at
Kansallis-Osake-Pankki,  where he was involved in commercial  lending activities
to the telecommunications industry.

DIRECTOR COMPENSATION

         Mr. Prins, a director of the Company,  was granted  options to purchase
70,131  shares of Common  Stock in 1995.  See  "Security  Ownership  of  Certain
Beneficial  Owners and  Management."  Directors  of the  Company  are  currently
neither compensated nor reimbursed for their out-of-pocket  expenses incurred in
connection  with  attendance  at meetings of, and other  activities  relating to
serving on, the Board of Directors and any committees  thereof.  The Company may
consider  additional  compensation  arrangements  for its directors from time to
time.

LIMITATION OF LIABILITY AND INDEMNIFICATION

         The Restated Certificate of Incorporation of the Company limits, to the
fullest  extent  permitted by law, the liability of directors to the Company and
its stockholders  for monetary damages for breach of directors'  fiduciary duty.
This  provision  is intended to afford the  Company's  directors  benefit of the
Delaware General Corporation Law (the "DGCL"),  which provides that directors of
Delaware  corporations may be relieved of monetary liability for breach of their
fiduciary duty of care, except under

                                       34
<PAGE>

certain  circumstances.  This  limitation  on  liabilities  does not  extend  to
including any breach of a director's  duty of loyalty,  acts or omissions not in
good faith or which involve  intentional  misconduct  or a knowing  violation of
law,  violations of the DGCL regarding the improper  payment of dividends or any
transaction from which the director derived any improper  personal  benefit.  In
addition,  the  Certificate of  Incorporation  of the Company  provides that the
Company  will  indemnify  its  directors  and  officers  to the  fullest  extent
authorized or permitted by law.

ITEM 11. EXECUTIVE COMPENSATION

         The following table sets forth certain information  concerning the cash
and non-cash  compensation  earned by or awarded to the Chief Executive  Officer
and the four other most  highly  compensated  executive  officers of the Company
(the "Named Executive Officers") for services rendered in all capacities in each
of the years ended December 31, 1998 and 1997.

<TABLE>
<CAPTION>
                                                                                                   Long - Term
                                                                                                  Compensation
                                                                                                   Securities
                                                       Annual Compensation *      Other            Underlying
Name And Principal Position                 Year     Salary        Bonus       Compensation      Options Granted
---------------------------                 ----     ------        -----       ------------      ---------------
<S>                                         <C>     <C>          <C>            <C>                   <C>    
Richard A. Jalkut                           1998    $400,000     $   --         $  40,289(1)            --
President and Chief Executive Officer       1997     166,154(2)      --             9,857(3)          858,754

David Schaeffer                             1998     300,000         --              --                 --
Chairman of the Board and Treasurer         1997     216,923(4)      --              --               430,413

Kevin J. Bennis                             1998     246,353(5)      --           185,602(6)          382,500
Executive Vice President and President      1997                     --              --                 --
Communications Services

Michael A. Lubin                            1998     136,840       5,000             --                15,000
Vice President, General Counsel and         1997     136,115         --              --                 --
Secretary

Michael L. Brooks                           1998     102,000      38,780             --                85,732
Vice President, Network Operations          1997     103,077                         --                 --
-----------------------------------
</TABLE>

*        Except as stated  herein,  none of the above Named  Executive  Officers
         received perquisites or other personal benefits in excess of the lesser
         of $50,000 or 10% of such individual's salary plus annual bonus.
(1)      Consists  of $16,277  for club dues;  $7,756 for  lodging;  $11,685 for
         airfare; and $4,571 for other transportation.
(2)      Mr. Jalkut  commenced  employment  with the Company in August 1997, and
         was compensated at a rate of $400,000 per annum in 1997.
(3)      Reimbursement for travel expenses.
(4)      Mr.  Schaeffer's  salary  increased to $300,000 per annum from $150,000
         per annum in August 1997.
(5)      Mr. Bennis joined the Company in February 1998.
(6)      Consists of $48,093 in residence settlement charges in Georgia; $99,319
         in residence  settlement  charges in Virginia;  $22,780 in other moving
         expenses; and $15,410 in rent.


                                       35
<PAGE>

STOCK OPTION GRANTS AND EXERCISES

         The following  table sets forth the  aggregate  number of stock options
granted to each of the Named  Executive  Officers  during the fiscal  year ended
December 31, 1998. Stock options are exercisable to purchase Common Stock of the
Company.


                        OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
                               Number of       Percent of                               Potential Realizable Value at
                               Securities    Total Options                               Assumed Annual Rate of Stock
                               Underlying      Granted to     Exercise                Price Appreciation for the Option
                                Options       Employees in      Price    Expiration                  Term
                                Granted       Fiscal Year      $/Share      Date        0%             5%          10%
                                -------       -----------      -------      ----        --             --          ---
<S>                             <C>              <C>          <C>         <C>         <C>         <C>         <C>

Richard A. Jalkut ........         --              --         $  --          --       $   --      $    --     $     --

David Schaeffer...........         --              --            --          --           --           --           --

Kevin J. Bennis...........      362,500(3)       32.74%         1.13      3/24/2008    1,475,375   2,660,841   4,479,580
                                 20,000(3)        1.81%         5.20      12/2/2008       --          65,405     165,749

Michael A. Lubin .........       15,000(3)        1.35%         5.20      12/2/2008       --          49,054     124,312

Michael L. Brooks ........       70,732(2)        6.39%         1.13      3/24/2008      287,879     519,191     878,567
                                 15,000(3)        1.35%         5.20      12/2/2008       --          49,054     124,312
------------------------
</TABLE>
(1)      The information disclosed assumes, solely for purposes of demonstrating
         potential  realizable value of the stock options,  that the fair market
         value per share of Common  Stock was $5.20 per share  (the fair  market
         value per share of Common  Stock  approved by the Board of Directors in
         connection  with stock  option  awards  granted on December 2, 1998 and
         January 26, 1999,  which awards had an exercise price equal to the fair
         market  value per share on the date of grant) as of  December  31, 1998
         and increases at the rate indicated during the option term. See Note 10
         to the financial statements included elsewhere in this Report.

(2)      The options vest  ratably  over a three year period.  The option may be
         transferred  only by will or by the laws of descent  and  distribution.
         Upon a change of control of the Company and  termination  of optionee's
         employment  without  cause,  the options  that would  otherwise  become
         vested  within one year will be deemed vested  immediately  before such
         optionee's termination.

(3)      The options vest  ratably  over a four year  period.  The option may be
         transferred  only by will or by the laws of descent  and  distribution.
         Upon a change of control of the Company and  termination  of optionee's
         employment  without  cause,  the options  that would  otherwise  become
         vested  within one year will be deemed vested  immediately  before such
         optionee's termination.

Option Exercises and Fiscal Year-End Option Values

         None of the Named Executive  Officers  exercised any options during the
fiscal  year ended  December  31,  1998.  The  following  table sets forth as of
December 31,  1998,  the  aggregate  number of options held by each of the Named
Executive Officers.



                                       36
<PAGE>

                          FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>

                                                        Number of Securities 
                                                       Underlying Unexercised          Value of Unexercised In-the-
                                                    Options at December 31, 1998             Money Options (1)
                                                    ----------------------------            -----------------
Name                                               Exercisable     Unexercisable     Exercisable        Unexercisable
----                                               -----------     -------------     -----------        -------------
<S>                                                    <C>             <C>           <C>                  <C>

Richard A. Jalkut .........................            286,251         572,503       $ 1,165,042          $ 2,330,087
David Schaeffer   .........................                 --         430,413 (2)            --              658,532
Michael A. Lubin...........................            141,465          15,000           731,374                   --
Kevin J. Bennis............................             90,625         291,875           368,844            1,106,531
Michael L. Brooks..........................             35,366          50,366           143,940              143,940
------------------------------
</TABLE>
(1)     Based on an assumed market price of the Common Stock of $5.20 per share.

(2)     One-half of Mr. Schaeffer's  options, or 215,206,  would vest on January
        1, 1999,  at an  exercise  price of $3.67 per  share,  in the event that
        certain performance criteria related to 1998 earnings have been met. The
        Board of Directors' is currently  reviewing  whether these criteria were
        met. See Note 10 to the Company's Consolidated Financial Statements that
        appear elsewhere in this Annual Report on Form 10-K.

JALKUT EMPLOYMENT AGREEMENT

         The  Employment  Agreement  among the Company  and Richard  Jalkut (the
"Jalkut  Employment  Agreement")  took  effect on August 4, 1997 and  expires on
August 4, 2000. The Jalkut  Employment  Agreement will renew  automatically  for
successive  one-year terms unless  terminated by either party.  Under the Jalkut
Employment  Agreement,  Mr.  Jalkut  is  entitled  to an annual  base  salary of
$400,000, subject to increase at the discretion of the Company. In addition, Mr.
Jalkut is entitled to  participate  in the  Company's  benefit plans on the same
basis as other salaried  employees of the Company and on the same basis as other
senior  executives of the Company and is entitled to reimbursement up to a total
of  $50,000  per  year  for  certain  expenses  including  an  apartment  in the
Washington D.C. area, club  memberships and the expenses  incurred by Mr. Jalkut
commuting between his Washington D.C. and New York residences.

         In addition,  pursuant to the Jalkut Employment Agreement, on August 4,
1997 Mr. Jalkut received  nonqualified stock options on 858,754 shares of Common
Stock at an exercise  price of $1.13 per share.  Such  options will vest ratably
over three years.  Under the Jalkut Employment  Agreement,  upon the election of
Mr. Jalkut within 10 business days after the date of termination of Mr. Jalkut's
employment with the Company, the Company will be required to pay, subject to the
terms of the  Indenture,  to Mr. Jalkut the aggregate  Fair Value (as defined in
the  Non-qualified  Option  Agreement by and between the Company and Mr.  Jalkut
dated  August 4, 1997) of the options  then vested or held by Mr.  Jalkut on the
date of such termination of employment with the Company.

         The  Jalkut  Employment   Agreement  (other  than  certain  restrictive
covenants  of Mr.  Jalkut  that are  described  below and an  obligation  of the
company to pay severance for one year following the  termination of Mr. Jalkut's
employment  with the Company) may be  terminated  (i) by the Company (a) without
cause by giving 60 days' prior written notice or (b) for cause upon the Board of
Directors'  confirmation  that Mr.  Jalkut  has failed to cure the  grounds  for
termination  within 30 days of notice thereof and (ii) by Mr. Jalkut (a) without
cause by giving  180 days'  prior  written  notice  and (b)  immediately  upon a
"Constructive  Termination" (as defined below). The Jalkut Employment  Agreement
prohibits  disclosure  by  Mr.  Jalkut  of any  of  the  Company's  confidential
information  at any time.  In


                                       37
<PAGE>

addition,  while he is employed by the Company and for two year thereafter,  Mr.
Jalkut is  prohibited  from  engaging or  significantly  investing  in competing
business  activities  and from  soliciting  any Company  employee to be employed
elsewhere.  The Company has granted Mr. Jalkut  registration rights with respect
to the  shares he will  receive  upon  exercise  of his  options.  "Constructive
Termination"  is  defined  in  the  Jalkut  Employment  Agreement  to  mean  the
occurrence,  without Mr. Jalkut's prior written  consent,  of one or more of the
following  events:  (1) a reduction in Mr.  Jalkut's  then  current  annual base
salary or the  termination  or material  reduction  of any  employee  benefit or
perquisite enjoyed by him (other than as part of an  across-the-board  reduction
applicable to all executive  officers of the Company);  (2) the failure to elect
or reelect Mr. Jalkut to the position of chief  executive  officer or removal of
him from such position;  (3) a material diminution in Mr. Jalkut's duties or the
assignment to Mr. Jalkut of duties which are  materially  inconsistent  with his
duties of which materially  impair Mr. Jalkut's ability to function as the chief
executive  officer of the  Company;  (4) the  failure to continue  Mr.  Jalkut's
participation  in any  incentive  compensation  plan  unless a plan  providing a
substantially similar opportunity is substituted, or under certain other limited
circumstances; or (5) the relocation of the Company's principal office.

OTHER AGREEMENTS

         Messrs. Schaeffer, Lubin, Brooks, Bennis and Smedberg each have entered
into Employee Agreements Regarding Non-Disclosure,  Assignment of Inventions and
Non-Competition  with  the  Company  in which  such  persons  agreed  (i) not to
disclose any of the Company's confidential and proprietary  information to third
parties,  (ii) to assign all work  products  to the Company as "works for hire,"
and (iii) not to compete against the Company for a two-year period following the
termination of the respective person's employment with the Company.

         In  exchange  for  the  non-compete   covenant  and  a  restriction  on
soliciting any employee of the Company to be employed elsewhere, the Company has
agreed to pay Mr. Bennis a severance payment in the aggregate amount of $275,000
paid over one year if his  employment  with the  Company is  terminated  for any
reason.


                                       38
<PAGE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The  following   table  sets  forth  certain   information   concerning
beneficial ownership of the capital stock of the Company as of December 31, 1998
by (i) each person known by the Company to be the beneficial  owner of more than
five percent of the outstanding capital stock of the Company, (ii) each director
of the  Company,  (iii)  each of the  Named  Executive  Officers  and  (iv)  all
directors  and  Named  Executive  Officers  of the  Company  as a group.  Unless
otherwise  indicated,  each of the stockholders listed below has sole voting and
investment power with respect to the shares shown as beneficially owned by them.

<TABLE>
<CAPTION>
                                                                              
Name and Address                                    Series A Preferred   Series B Preferred  Series C Preferred   
                                          Common    ------------------   ------------------  ------------------
                                           Stock   Shares(2) Percentage Shares(2) Percentage Shares(2) Percentage 
                                           -----   --------- ---------- --------- ---------- --------- ---------- 
<S>                                      <C>       <C>           <C>    <C>          <C>     <C>          <C>

Spectrum Equity Investors, L.P. (6).....    --     1,276,000     44.0%  1,134,175    23.7%   1,363,406    16.7%     
Spectrum Equity Investors II, L.P. (6)..    --          --        --         --       --     1,363,406    16.7%    
New Enterprise Associates VI, Limited
Partnership (7).........................    --       522,000     18.0%    685,014    14.3%   1,374,051    16.8%   
Onset Enterprise Associates II, L.P. (8)    --       522,000     18.0%    463,976     9.7%     817,672    10.0%          
Onset Enterprise Associates III, L.P.         
(8).....................................    --          --        --         --       --       272,553     3.3%    
Corman Foundation Incorporated (9)..        --        96,668      3.3%     85,924     1.7%       --         --         
IAI Investment Funds VIII, Inc. (IAI
Value Fund) (10)........................    --       290,000     10.0%    125,143     2.6%       --         --      
Thomas Domencich (11)...................    --       145,000      5.0%     62,573     1.3%       --         --        
FBR Technology Venture Partners L.P.                
(12)....................................    --          --        --         --       --       272,556     3.3% 
Toronto Dominion Capital (USA) Inc. (13)    --          --        --      884,146    18.5%   1,006,500    12.3%         
Grotech Partners IV, L.P. (14)..........    --          --        --      884,146    18.5%   1,006,500    12.3%       
Utech Climate Challenge Fund, L.P. (15)     --          --        --      442,076     9.2%     136,276     1.7%         
Utility Competitive Advantage Fund, LLC
(15)....................................    --          --        --         --       --       366,980     4.5%       
David Schaeffer(16)..................... 2,900,000      --        --         --       --         --         --        
Richard A. Jalkut.......................    --          --        --         --       --         --         --     
Kevin J. Maroni (17)....................    --          --        --         --       --         --         --       
Peter J. Barris (18)....................    --          --        --         --       --         --         --      
Patrick J. Kerins (19)..................    --          --        --         --       --         --         --       
Stephen A. Reinstadtler (20)............    --          --        --         --       --         --         --        
Michael A. Lubin........................    --          --        --         --       --         --         --     
Kevin Bennis............................    --          --        --         --       --         --         --      
Michael L. Brooks.......................    --          --        --         --       --         --         --     
Richard K. Prins........................    --          --        --         --       --         --         --      
All Directors and Named Executive
 Officers as a Group ................... 2,900,000      --        --         --       --         --         --    
-------------------
</TABLE>

<TABLE>
<CAPTION>
                                                                                            
                                                                                              
                                                               Beneficial Ownership    
Name and Address                                                of Common Stock (1)        
----------------                                                -------------------    Percentage
                                                                 Total  Percentage       on a
                                                  Stock          -----  ----------      Diluted
                                                 Options(3)      Shares      (4)        Basis (5)
                                                 ----------      ------      ---        ---------
<S>                                               <C>           <C>          <C>         <C> 
Spectrum Equity Investors, L.P. (6).....             --         3,773,581    56.5%       19.2%
Spectrum Equity Investors II, L.P. (6)..             --         1,363,406    31.7%        6.9%
New Enterprise Associates VI, Limited
Partnership (7).........................             --         2,581,065    47.1%       13.9%
Onset Enterprise Associates II, L.P. (8)             --         1,803,648    38.3%        9.2%
Onset Enterprise Associates III, L.P.                
(8).....................................             --           272,553     8.6%        1.4%
Corman Foundation Incorporated (9)......             --           182,592     5.9%        0.9%
IAI Investment Funds VIII, Inc. (IAI
Value Fund) (10)........................             --           415,143    12.5%        2.1%
Thomas Domencich (11)...................             --           207,573     6.7%        1.0%
FBR Technology Venture Partners L.P.                 --           272,556     8.6%        1.4%
(12)....................................
Toronto Dominion Capital (USA) Inc. (13)             --         1,890,646    39.4%        9.6%
Grotech Partners IV, L.P. (14)..........             --         1,890,646    39.4%        9.6%
Utech Climate Challenge Fund, L.P. (15)              --           578,352    16.6%        2.9%
Utility Competitive Advantage Fund, LLC
(15)....................................             --           366,980    11.2%        1.8%
David Schaeffer(16).....................             --         2,900,000    99.9%       14.7%
Richard A. Jalkut.......................          286,251         286,251     9.0%        1.4%
Kevin J. Maroni (17)....................             --              --       --          --
Peter J. Barris (18)....................             --              --       --          --
Patrick J. Kerins (19)..................             --              --       --          --
Stephen A. Reinstadtler (20)............             --              --       --          --
Michael A. Lubin........................          141,485         141,485     4.6%        0.7%
Kevin Bennis............................             --              --       --          --
Michael L. Brooks.......................           35,366          35,366     1.2%        0.2%
Richard K. Prins........................           70,731          70,731     2.4%        0.4%
All Directors and Named Executive
Officers as a Group ....................          528,853       3,433,933    99.9%       17.4%
-------------------
</TABLE>


                                       39
<PAGE>


(1)      Consists  of the sum of the shares of Common  Stock owned and shares of
         Common Stock  issuable  upon the exercise of stock options and upon the
         conversion  of the  Series A  Convertible  Preferred  Stock  Series,  B
         Convertible  Preferred  Stock and Series C Convertible  Preferred Stock
         that are  exercisable or convertible  within 60 days after December 31,
         1998.
(2)      The shares represent the product of a stock split and the numbers shown
         here are rounded to the whole number in accordance  with the provisions
         of the Company's Certificate of Incorporation and stock option plans.
(3)      Options exercisable within 60 days after December 31, 1998.
(4)      The  percentage  of beneficial  ownership as to each person,  entity or
         group assume the exercise or  conversions of all  outstanding  options,
         warrants and  convertible  securities  held by such  person,  entity or
         group  which  are  exercisable  or  convertible  within  60  days as of
         December  31,  1998,  but not the  exercise or  conversion  of options,
         warrants and convertible  securities held by other holders  (whether or
         not exercisable or convertible within 60 days after December 31, 1998.)
(5)      As a percentage of the sum of the post split and rounded  Common Stock,
         Series A Convertible  Preferred Stock,  Series B Convertible  Preferred
         Stock,  Series C Convertible  Preferred  Stock and options  granted and
         exercisable  within 60 days after December 31, 1998. As of December 31,
         1998, 915,765 options granted by the Company were exercisable.
(6)      The address for Spectrum  Equity  Investors,  L.P. and Spectrum  Equity
         Investors II, L.P. is One International Place, Boston, MA 02110.
(7)      The address of New Enterprise  Associates  VI,  Limited  Partnership is
         1119 Saint Paul Street, Baltimore, MD 21202.
(8)      The  address  for  Onset  Enterprise  Associates  II,  L.P.  and  Onset
         Enterprise  Associates  III,  L.P.  is 8911  Capital of Texas  Highway,
         Austin, TX 78759. 
(9)      The address for Corman Foundation  Incorporation is 100 Brookwood Road,
         Atmore, AL 36502.
(10)     The address for IAI  Investment  Funds VIII,  Inc.  (IAI Value Fund) is
         3700 First Bank Place, Minneapolis, MN 55440.
(11)     The address for Thomas Domencich is 104 Benevolent Street,  Providence,
         RI 02906.
(12)     The  address  for FBR  Technology  Venture  Partners  L.P. is 1001 19th
         Street North, Arlington, VA 22209.
(13)     The  address for Toronto  Dominion  Capital  (USA) Inc. is 31 West 52nd
         Street, New York, NY 10019.
(14)     The address  for  Grotech  Partners  IV,  L.P.  is 9690  Deereco  Road,
         Timonium, MD 21093.
(15)     The  address  for  Utech  Climate  Challenge  Fund,  L.P.  and  Utility
         Competitive Advantage Fund, L.L.C. is c/o Arete Ventures, Two Wisconsin
         Circle, Chevy Chase, MD 20815.
(16)     One-half of Mr. Schaeffer's options, or 215,206,  would vest on January
         1, 1999,  at an  exercise  price of $3.67 per share,  in the event that
         certain  performance  criteria  related to 1998 earnings have been met.
         The Board of Directors' is currently  reviewing  whether these criteria
         were  met.  See  Note  10  to  the  Company's   Consolidated  Financial
         Statements that appear elsewhere in this Annual Report on Form 10-K. In
         the event  that the Board of  Directors  determines  that  these  stock
         options have vested, Mr. Schaeffer's percentage held on a diluted basis
         would be 15.7%.
(17)     Mr. Maroni, who is a limited partner of the general partner of Spectrum
         and a  general  partner  of the  general  partner  of  Spectrum  Equity
         Investors II, L.P.,  disclaims beneficial ownership of the shares owned
         by Spectrum Equity Investors, L.P.
         and Spectrum Equity Investors II, L.P.
(18)     Mr.  Barris,  who is  general  partner  of the  general  partner of New
         Enterprise  Associates VI, Limited  Partnership,  disclaims  beneficial
         ownership of the shares owned by New Enterprise  Associates VI, Limited
         Partnership.
(19)     Mr.  Kerins,  Managing  Director  of the  general  partner  of  Grotech
         Partners IV, LP, disclaims  beneficial ownership of the shares owned by
         Grotech Partners IV, LP.
(20)     Mr.  Reinstadtler,  Vice  President  and  Director of Toronto  Dominion
         Capital (USA) Inc.,  disclaims beneficial ownership of the shares owned
         by Toronto Dominion Capital (USA) Inc.

                                       40

<PAGE>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

SERIES A PURCHASE AGREEMENT

         Pursuant to an  Investment  and  Stockholders'  Agreement,  dated as of
August 28, 1995 (the  "Series A Purchase  Agreement"),  by and among the Company
and Spectrum  Equity  Investors,  L.P.,  New  Enterprise  Associates VI, Limited
Partnership,  Onset  Enterprise  Associates II, L.P., IAI Investment Funds VIII,
Inc.,   Thomas   Domencich,   Dennis  R.  Patrick  and  the  Corman   Foundation
Incorporated,  (together,  the "Series A Purchasers") and David  Schaeffer,  the
Series A Purchasers made their initial investments in the Company.  The Series A
Purchasers (i) agreed,  subject to the  satisfaction of certain  conditions,  to
purchase in the aggregate  1,000,000  shares of Series A  Convertible  Preferred
Stock for an aggregate  purchase price of $1.0 million,  (ii) purchased  500,000
shares of such 1,000,000  shares of Series A Convertible  Preferred Stock for an
aggregate  purchase  price of $500,000 and (iii) agreed to make available to the
Company,  under certain  circumstances,  bridge loans in an aggregate  principal
amount of $500,000 (the "Bridge Loan  Commitment").  Pursuant to Amendment No. 1
to the Investment and Stockholders' Agreement, dated as of February 8, 1996, the
Series  A  Purchasers  purchased  the  remaining  500,000  shares  of  Series  A
Convertible  Preferred  Stock  for an  aggregate  purchase  price  of  $500,000.
Pursuant to Amendment No. 2 to the Investment and Stockholders'  Agreement dated
as of August 2, 1996, the Series A Purchasers, among other things, increased the
amount  of the  Bridge  Loan  Commitment  to an  aggregate  principal  amount of
$700,000 and advanced such amount to the Company,  such loans being evidenced by
bridge loan notes (collectively, the "Bridge Loan Notes"). The Bridge Loan Notes
carried an  interest  rate of 12% per annum and were due and  payable in full on
the earlier to occur of the first anniversary of the issuance of the Bridge Loan
Notes or the closing date of the  Company's  next equity  financing.  The Bridge
Loan Notes were to be convertible  into any future equity security issued by the
Company at 73% of the price to be paid for such security by other investors.  In
addition,  the Series A Purchasers agreed to make available to the Company, upon
the  occurrence  of certain  events,  additional  bridge  loans in an  aggregate
principal amount of $300,000 (the "Additional Bridge Loan Commitment").

SERIES B PURCHASE AGREEMENT

         The  Company,  each of the Series A Purchasers  and several  additional
purchasers (together,  the "Series B Purchasers") and Mr. Schaeffer entered into
an Investment and  Stockholders'  Agreement,  dated as of December 23, 1996 (the
"Series B Purchase  Agreement"),  pursuant  to which,  among other  things,  the
Series B  Purchasers  agreed to acquire  in the  aggregate  1,651,046  shares of
Series B Convertible  Preferred  Stock for an aggregate  purchase  price of $5.0
million.  Of these  amounts,  609,756  shares of Series B Convertible  Preferred
Stock were  purchased on December 23, 1996,  for an aggregate  purchase price of
$2.0 million.  In addition,  the $700,000 principal amount of Bridge Loan Notes,
plus $33,367 of accrued interest, were converted into 306,242 shares of Series B
Convertible  Preferred  Stock.  At the same time,  the Series A Purchasers  paid
$300,000 representing the committed but undrawn portion of the Additional Bridge
Loan  Commitment  to the  Company  for the sale of  125,292  shares  of Series B
Convertible  Preferred  Stock.  The Series B Purchasers  purchased the remaining
609,756 shares of Series B Convertible  Preferred  Stock subject to the Series B
Purchase  Agreement  for  $2.0  million  on June  18,  1997.  See  Note 9 to the
financial statements included elsewhere in this Report.


                                       41
<PAGE>


SERIES C PURCHASE AGREEMENT

         The Company,  the Series A Purchasers,  the Series B Purchasers and one
additional  purchaser  (together the "Series C  Purchasers")  and Mr.  Schaeffer
entered into the Investment and Stockholders' Agreement, dated October 31, 1997,
as amended (the "Investment and  Stockholders'  Agreement"),  pursuant to which,
among other things,  the Series C Purchasers  agreed to acquire 2,819,549 shares
of Series C Convertible Preferred Stock for an aggregate purchase price of $30.0
million.   The  Series  C  Purchasers  purchased  939,850  shares  of  Series  C
Convertible  Preferred Stock for an aggregate purchase price of $10.0 million on
October 31, 1997,  and  purchased  an  additional  1,879,699  shares of Series C
Convertible  Preferred  Stock for an aggregate  purchase  price of $20.0 million
simultaneously  with the closing of the Debt  Offering.  In connection  with the
Investment and Stockholders'  Agreement,  the Company,  the holders of Preferred
Stock  (collectively,  the  "Investors")  and Mr.  Schaeffer agreed to amend and
restate,  in part,  the  Series A Purchase  Agreement  and the Series B Purchase
Agreement.  These amendments restated the provisions of such agreements relating
to affirmative and negative covenants, transfer restrictions, rights to purchase
and  registration  rights.  These  sections  of each of the  Series  A  Purchase
Agreement,  the  amendments  thereto,  and the Series B Purchase  Agreement were
similar in all material respects.  In order to remove any doubt as to this fact,
to simplify  matters and for  convenience (to have in one agreement the material
provisions  that  survive  the  purchase  and sale of the  Series A  Convertible
Preferred Stock,  Series B Convertible  Preferred Stock and Series C Convertible
Preferred Stock  (collectively  the "Series Preferred Stock") and the closing of
an initial  public  offering),  the  aforementioned  sections  were  amended and
restated in the Investment and  Stockholders'  Agreement.  See "--Investment and
Stockholders' Agreement."

TERMS OF THE SERIES PREFERRED STOCK

         Each share of Series  Preferred Stock will  automatically  be converted
into Common Stock immediately upon the closing of a qualified public offering of
capital stock of the Company. A qualified public offering is defined as: (i) the
Company is valued on a pre-money  basis at greater  than  $50,000,000,  (ii) the
gross proceeds received by the Company exceed $20,000,000, and (iii) the Company
uses a  nationally  recognized  underwriter  approved  by  holders of a majority
interest of the Series  Preferred  Stock.  As of December 31,  1998,  the Series
Preferred Stock was convertible into an aggregate of 15,864,715 shares of Common
Stock.

         Each share of Series Preferred Stock entitles its holder to a number of
votes  equal to the  number of shares of Common  Stock  into which such share of
Series Preferred Stock is convertible. With respect to the Board of Directors of
the Company,  prior to the  completion  of a qualified  public  offering (i) the
holders of Series A Convertible  Preferred Stock are entitled to vote separately
as a class to elect  two  directors  of the  Company  (the  "Series  A  Investor
Directors"),  (ii) the  holders  of  Series B  Convertible  Preferred  Stock are
entitled to vote  separately  as a class to elect one  director  (the  "Series B
Investor  Director"),  (iii) the holders of the Series C  Convertible  Preferred
Stock are  entitled  to vote  separately  as a class to elect one  director  (to
"Series C Investor Director"), (iv) the holders of the Common Stock are entitled
to vote  separately  as a class  to  elect  two  directors  (the  "Common  Stock
Directors"),  (v) the chief  executive  officer  (the  "CEO") of the  Company is
appointed by the affirmative vote of the Common Stock Directors and the Series A
Investor  Directors,  Series B Investor Director and Series C Investor Director,
voting  together,  and (vi) the CEO will be elected to the Board of Directors of
the Company by the holders of Common Stock and Series  Preferred  Stock,  voting
together.

                                       42
<PAGE>


         The  holders  of the Series  Preferred  Stock are  entitled  to receive
dividends  in  preference  to and at the same  rate as  dividends  are paid with
respect  to the  Common  Stock.  In the event of any  liquidation,  dissolution,
winding  up  or  deemed  liquidation  of  the  Company,   whether  voluntary  or
involuntary,  each holder of a share of Series  Preferred  Stock  outstanding is
entitled  to be paid  before any payment may be made to the holders of any class
of Common  Stock or any  stock  ranking  on  liquidation  junior  to the  Series
Preferred Stock, an amount,  in cash, equal to the original  purchase price paid
by such holder, appropriately adjusted for stock splits, stock dividends and the
like, plus any declared but unpaid dividends.

         The  Series  A  Convertible   Preferred  Stock,  Series  B  Convertible
Preferred Stock and Series C Convertible  Preferred Stock A, Series B and Series
C Preferred Stock were $1,000,000, $5,033,367, and $30,000,052, respectively, as
of December 31, 1998. In the event the assets of the Company are insufficient to
pay liquidation preference amounts, all of the assets available for distribution
shall be  distributed  to each  holder  of  Series  Preferred  Stock pro rata in
proportion  to the  number  of shares of  Series  Preferred  Stock  held by such
holder.

         Shares of the Series  Preferred  Stock may be converted at any time, at
the option of the holder,  into shares of Common Stock.  The number of shares of
voting Common Stock to be received  upon  conversion is subject to adjustment in
the event of stock dividends and  subdividends,  certain  combinations of Common
Stock,  and issuances of Common Stock and of securities  convertible into Common
Stock that have a dilutive effect. As of December 31, 1998, each share of Series
Preferred Stock was convertible into 2.9 shares of Common Stock.

INVESTMENT AND STOCKHOLDERS' AGREEMENT

         Pursuant to the terms of the  Investment and  Stockholders'  Agreement,
the Investors and Mr.  Jalkut are entitled to certain  registration  rights with
respect to  securities of the Company.  On any three  occasions at the option of
the holders,  the holders of a majority of the securities  registrable under the
terms of the Investment and Stockholders' Agreement  ("Registrable  Securities")
may require the Company to effect a  registration  under the  Securities  Act of
1933 of their  Registrable  Securities,  subject to the Company's right to defer
such  registration  for a period of up to 60 days.  In addition,  if the Company
proposes to register  securities  under the Securities Act of 1933 (other than a
registration  relating either to the sale of securities to employees pursuant to
a stock option,  stock purchase or similar plan or a transaction  under Rule 145
of the Securities  Act), then any of the holders of Registrable  Securities have
the right (subject to certain cut-back  limitations) to request that the Company
register such holder's Registrable Securities.  All registration expenses of the
Investors (exclusive of underwriting discount and commissions) up to $60,000 per
offering  will be borne by the Company.  The Company has agreed to indemnify the
Investors  against  certain  liabilities  in  connection  with any  registration
effected pursuant to the foregoing terms,  including  liabilities  arising under
the Securities Act.

LEASE FROM THE KENILWORTH PARTNERSHIP

         The Company has entered into the Headquarters  Lease for  approximately
10,195 square feet of office space from the  Kenilworth  Partnership,  a general
partnership  of which David  Schaeffer,  a director of the  Company,  is general
partner.  The rental rate is  approximately  $20 per square  foot,  plus fees to
cover the  Company's  proportional  share of real  estate  taxes  and  insurance
premiums relating to the 

                                       43
<PAGE>


building.  The Headquarters  Lease expires on August 31, 1999 and may be renewed
at the option of the Company  for two  additional  one-year  periods on the same
terms and conditions.  Rent paid to the Kenilworth  Partnership  during the year
ended December 31, 1998, was approximately  $282,000.  Management  believes that
the terms and conditions of the Headquarters  Lease are at least as favorable to
the Company as those which the Company could have received from an  unaffiliated
third party.

                                       44

<PAGE>


PART IV

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

(a) The following documents are filed as part of this report:

     (1) Financial Statements

         Consolidated Balance Sheets as of December 31, 1998 and 1997

         Consolidated  Statements of Operations for the years ended December 31,
         1998,  1997 and 1996,  and for the  period  August  25,  1995  (date of
         inception) to December 31, 1998

         Consolidated  Statements  of  Comprehensive  Loss for the  years  ended
         December 31, 1998,  1997 and 1996,  and for the period  August 25, 1995
         (date of inception) to December 31, 1998

         Consolidated  Statements of Cash Flows for the years ended December 31,
         1998,  1997 and 1996,  and for the  period  August  25,  1995  (date of
         inception) to December 31, 1998

         Consolidated  Statement of Stockholders' Equity (Deficit) for the years
         ended  December 31, 1998,  1997 and 1996, and for the period August 25,
         1995 (date of inception) to December 31, 1998

         Notes to Consolidated Financial Statements

     (2) Financial Statement Schedules

         All  schedules  are  omitted  because  they are not  applicable  or not
         required or because the required  information is incorporated herein by
         reference  or included in the  financial  statements  or notes  thereto
         included elsewhere in this report.

(b)   Reports on Form 8-K.

      On October  6,  1998,  the  Company  filed a report on Form 8-K  providing
      information  under  Items 5 and 7.  The  Report,  dated  October  6,  1998
      announced the expansion of the Company's  management team to include three
      new additions to its national sales force.

(c)      Exhibits.

      The  following  exhibits are filed as a part of this Annual Report on Form
10-K:

EXHIBIT NUMBER   DESCRIPTION OF DOCUMENT

    3.1(1)        Amended  and  Restated  Certificate  of  Incorporation  of the
                  Company and  Certificate  of Amendment to such  Certificate of
                  Incorporation.  

    3.2(1)        Amended and Restated  Bylaws of the Company.

    4.1+          Indenture  between the  Company  and The Bank of New York,  as
                  trustee, dated April 8, 1998.

    4.2++         Pledge  Agreement  by and among the  Company,  The Bank of New
                  York,  as  

                                       45

<PAGE>

                  trustee, and The Bank of New York, as securities intermediary,
                  dated April 8, 1998.

    4.3**         Form of New Note.

    4.4+          Form of Existing Note (included in Exhibit 4.1).

   10.1*          Master  Agreement  by and between the Company and NEC America,
                  Inc.,  dated August 8, 1997,  as amended by  Amendment  No. 1,
                  dated  November  9, 1997 and  Amendment  No. 2, dated April 2,
                  1998.

   10.1.1*        Amendment No. 3, dated May 4, 1998 to Master  Agreement by and
                  between the Company and NEC America, Inc.

   10.1.2*        Amendment  No. 4, dated July 10, 1998 to Master  Agreement  by
                  and between the Company and NEC America, Inc.

   10.1.3(1)      Amendment No. 5, dated  November 20, 1998 to Master  Agreement
                  by and between the Company and NEC America, Inc.

   10.2(2)*       EmploymentAgreement  by and  between the Company and Richard 
                  A.Jalkut,  dated  August 4, 1997, as amended  by Amendment to
                  Employment Agreement, dated April 6, 1998.

   10.3(2)*       Non-Disclosure, Assignment of Inventions  and  Non-Competition
                  Agreement by and between the Company and Kevin  Bennis,  dated
                  February 2, 1998.

   10.4(2)*       Pathnet, Inc. 1995 Stock Option Plan.

   10.5(2)*       Pathnet,   Inc.  1997  Stock  Incentive Plan,  as amended  by
                  Amendment No. 1 to 1997 Stock Incentive Plan.

   10.6*          Notes  Registration  Rights Agreement by and among the Company
                  and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith
                  Incorporated,  Bear,  Stearns & Co. Inc., TD Securities  (USA)
                  Inc.  and Salomon  Brothers  Inc  (collectively,  the "Initial
                  Purchasers"), dated April 8, 1998.

   10.7*          Warrant  Agreement  by and between the Company and The Bank of
                  New York, as warrant agent, dated April 8, 1998.

   10.8*          Warrant   Registration  Rights  Agreement  by  and  among  the
                  Company,  Spectrum  Equity  Investors,  L.P.,  New  Enterprise
                  Associates   VI,   Limited   Partnership,   Onset   Enterprise
                  Associates II, L.P., FBR Technology  Venture  Partners,  L.P.,
                  Toronto Dominion  Capital (U.S.A.) Inc.,  Grotech Partners IV,
                  L.P.,  Richard A.  Jalkut,  David  Schaeffer  and the  Initial
                  Purchasers, dated April 8, 1998.

   10.9**         Investment and Stockholders Agreement, dated as of October 31,
                  1997 (the "Investment and  Stockholders'  Agreement"),  by and
                  among the Company and certain stockholders of the Company.

   10.9.1**       Consent,  Waiver and  Amendment,  dated as of March 19,  1998,
                  relating to the Investment and Stockholders' Agreement.

                                       46
<PAGE>

   10.9.2**       Amendment No. 1 to the Investment and Stockholders' Agreement,
                  dated as of April 1, 1998.

   10.10*         Lease Agreement, by and between 6715 Kenilworth Avenue General
                  Partnership and the Company,  dated August 9, 1997, as amended
                  by Amendment to Lease, dated March 5, 1998.

   10.10.1*       Second Amendment to Lease, dated June 1, 1998.

   10.10.2(1)     Third Amendment to Lease, dated September 1, 1998.

   10.11(2)*      Non-Qualified  Stock  Option  Agreement  by  and  between  the
                  Company and Richard A. Jalkut, dated August 4, 1997.

   10.12(2)*      Non-Qualified  Stock  Option  Agreement  by  and  between  the
                  Company and David Schaeffer, dated October 31, 1997.

   21.1(1)        Subsidiaries of the Company.

   27.1(1)        Financial Data Schedule for the year ended December 31, 1998.

         +        Incorporated  by reference to Exhibit  10.19 to the  Company's
                  Registration   Statement   on  Form  S-1   (Registration   No.
                  333-52247)  filed  by the  Company  with  the  Securities  and
                  Exchange Commission on May 8, 1998.

         ++       Incorporated  by reference to Exhibit  10.20 to the  Company's
                  Registration   Statement   on  Form  S-1   (Registration   No.
                  333-52247)  filed  by the  Company  with  the  Securities  and
                  Exchange Commission on May 8, 1998.

         *        Incorporated by reference to the corresponding  exhibit to the
                  Company's Registration Statement on Form S-1 (Registration No.
                  333-52247)  filed  by the  Company  with  the  Securities  and
                  Exchange  Commission  on May 8, 1998,  as amended by Amendment
                  No. 1 to such Registration Statement filed with the Securities
                  and Exchange  Commission on July 16, 1998, as further  amended
                  by Amendment No. 2 to such  Registration  Statement filed with
                  the Securities  and Exchange  Commission on July 27, 1998, and
                  as further  amended by  Amendment  No. 3 to such  Registration
                  Statement filed with the Securities and Exchange Commission on
                  August 10, 1998.

         **       Incorporated by reference to the corresponding  exhibit to the
                  Company's Registration Statement on Form S-4 (Registration No.
                  333-53467)  filed  by the  Company  with  the  Securities  and
                  Exchange  Commission  on May 22, 1998, as amended by Amendment
                  No. 1 to such Registration Statement.

         (1)      Filed herewith.

         (2)      Constitutes management contract or compensatory arrangement.

                                       47
<PAGE>


                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its
behalf  by the  undersigned,  thereunto  duly  authorized,  in the  District  of
Columbia on this 16th day of March 1999.

                                   PATHNET, INC.

                                    By: /s/ Michael A. Lubin
                                    ------------------------
                                    Name: Michael A. Lubin
                                    Title: Vice President, General Counsel And
                                               Secretary

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities and on the dates indicated.

SIGNATURE                     TITLE                           DATE

/s/  Richard A. Jalkut
----------------------        Chief Executive Officer and
Richard A. Jalkut                Director                     March 16, 1999


/s/ William R. Smedberg V     Executive Vice-President
-------------------------       Corporate Development
William R. Smedberg, V          (Principal Accounting and
                                 Financial Officer)           March 16, 1999

---------------               Director                        March   , 1999
David Schaeffer


/s/ Peter J. Barris           Director                        March 17, 1999
-------------------                         
Peter J. Barris

/s/ Kevin J. Maroni           Director                        March 11, 1999
-------------------           
Kevin J. Maroni

/s/ Patrick J. Kerins         Director                        March 11, 1999
---------------------                 
Patrick J. Kerins

/s/ Richard K. Prins          Director                        March 17, 1999
--------------------                
Richard K. Prins

/s/ Stephen A. Reinstadtler   Director                        March 15, 1999
---------------------------             
Stephen A. Reinstadtler

                                       48
<PAGE>


                                       F-1
                                  PATHNET, INC.
                          INDEX TO FINANCIAL STATEMENTS
<TABLE>

                                                                                      Page
         <CAPTION>
         <S>                                                                           <C>   
         Report of Independent Accountants                                             F-2

         Consolidated Balance Sheets as of December 31, 1998 and 1997                  F-3

         Consolidated  Statements of Operations for the years ended December 31,
            1998,  1997 and 1996,  and for the period  August 25,  1995 (date of
            inception) to December 31, 1998                                            F-4

         Consolidated  Statements  of  Comprehensive  Loss for the  years  ended
            December 31, 1998, 1997 and 1996, and for the period August 25, 1995
            (date of inception) to December 31, 1998                                   F-5

         Consolidated  Statements of Cash Flows for the years ended December 31,
            1998,  1997 and 1996,  and for the period  August 25,  1995 (date of
            inception) to December 31, 1998                                            F-6

         Consolidated  Statement of Stockholders' Equity (Deficit) for the years
           ended December 31, 1998, 1997 and 1996, and for the period August 25,
           1995 (date of inception) to December 31, 1998                               F-7

         Notes to Consolidated Financial Statements                                    F-8
</TABLE>


                                      F-1

<PAGE>


                        Report of Independent Accountants

To the Board of Directors and Stockholders
Pathnet, Inc.

              In our opinion,  the consolidated  financial  statements listed in
the accompanying index present fairly, in all material  respects,  the financial
position of Pathnet,  Inc. and its  subsidiaries  (the  Company) at December 31,
1998 and 1997, and the results of their operations and their cash flows for each
of the three  years in the period  ended  December  31,  1998 and for the period
August 25, 1995 (date of inception)  to December 31, 1998,  in  conformity  with
generally accepted  accounting  principles.  These financial  statements are the
responsibility of the Company's management;  our responsibility is to express an
opinion on these  financial  statements  based on our audits.  We conducted  our
audits of these  statements  in  accordance  with  generally  accepted  auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the  amounts  and  disclosures  in  the  financial  statements,   assessing  the
accounting  principles  used and significant  estimates made by management,  and
evaluating the overall  financial  statement  presentation.  We believe that our
audits provide a reasonable basis for the opinion expressed above.



                                                      PricewaterhouseCoopers LLP



McLean, VA
February 14, 1999

                                      F-2
<PAGE>

                                           PATHNET, INC.
                               (A Development Stage Enterprise)
                                  CONSOLIDATED BALANCE SHEETS
<TABLE>
                                                                                                              December 31,
                                                                                                     -----------------------------
                                                                                                         1998              1997
                                                                                                     -----------       -----------
<S>                                                                                                <C>                <C>
                                     ASSETS
Cash and cash equivalents                                                                          $  57,321,887      $  7,831,384
Note receivable                                                                                        3,206,841                 -
Interest receivable                                                                                    3,848,753                 -
Marketable securities available for sale, at market                                                   97,895,773                 -
Prepaid expenses and other current assets                                                                205,505            48,571
                                                                                                     -----------       -----------
     Total current assets                                                                            162,478,759         7,879,955
Property and equipment, net                                                                           47,971,336         7,207,094
Deferred financing costs, net                                                                         10,508,251           250,428
Restricted cash                                                                                       10,731,353           760,211
Marketable securities available for sale, at market                                                   71,899,757                 -
Pledged marketable securities held to maturity                                                        61,824,673                 -
                                                                                                     -----------       -----------
      Total assets                                                                                 $ 365,414,129      $ 16,097,688
                                                                                                     ===========       ===========
               LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK
                       AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable                                                                                   $  10,708,263      $  5,592,918
Accrued interest                                                                                       8,932,294                 -
Accrued expenses and other liabilities                                                                   639,688           300,000
                                                                                                     -----------       -----------
    Total current liabilities                                                                         20,280,245         5,892,918
12 1/4% Senior Notes, net of unamortized bond discount of $3,787,875                                 346,212,125                 -
                                                                                                     -----------       -----------
    Total liabilities                                                                                366,492,370         5,892,918
                                                                                                     -----------       -----------
Series A convertible preferred stock, $0.01 par value, 1,000,000 shares authorized, issued and
  outstanding at December 31, 1998 and 1997, respectively (liquidation preference $1,000,000)          1,000,000         1,000,000
Series B convertible preferred stock, $0.01 par value, 1,651,046 shares authorized, issued and
  outstanding at December 31, 1998 and 1997, respectively (liquidation preference $5,033,367)          5,008,367         5,008,367
Series C convertible preferred stock, $0.01 par value, 2,819,549 shares authorized; 2,819,549
  and 939,850 shares issued and outstanding at December 31, 1998 and 1997, respectively
  (liquidation preference $30,000,052)                                                                29,961,272         9,961,274
                                                                                                     -----------       -----------
    Total mandatorily redeemable preferred stock                                                      35,969,639        15,969,641
                                                                                                     -----------       -----------
Common stock,  $0.01 par value,  60,000,000 and 7,500,000  shares  authorized at
  December  31, 1998 and 1997,  respectively;  2,902,358  and  2,900,000  shares
  issued and
  outstanding at December 31, 1998 and 1997, respectively                                                 29,024            29,000
Common stock subscription receivable                                                                           -            (9,000)
Deferred compensation                                                                                   (978,064)                -
Additional paid-in capital                                                                             6,156,406           381,990
Accumulated other comprehensive income                                                                   208,211                 -
Deficit accumulated during the development stage                                                     (42,463,457)       (6,166,861)
                                                                                                     -----------       -----------
    Total stockholders' equity (deficit)                                                             (37,047,880)       (5,764,871)
                                                                                                     -----------       -----------
      Total liabilities, mandatorily redeemable preferred stock and stockholders' equity (deficit) $ 365,414,129      $ 16,097,688
                                                                                                     ===========       ===========
</TABLE>

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


                                      F - 3
<PAGE>


                                  PATHNET, INC.
                        (A Development Stage Enterprise)
                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
  
                                                                                            For the period
                                                         For the year ended                 August 25, 1995
                                                             December 31,                (date of inception)
                                             --------------------------------------------   to December 31,
                                                  1998            1997            1996            1998
                                             ------------    ------------    ------------    ------------
<S>                                          <C>             <C>             <C>             <C>         
Revenue                                      $  1,583,539    $    162,500    $      1,000    $  1,747,039
                                             ------------    ------------    ------------    ------------
Operating expenses:
     Cost of revenue                            7,547,620            --              --         7,547,620
     Selling, general and administrative        9,615,867       4,247,101       1,333,294      15,625,349
     Research and development                        --              --              --
     Depreciation expense                         732,813          46,642           9,024         788,831
                                             ------------    ------------    ------------    ------------
        Total operating expenses               17,896,300       4,293,743       1,342,318      23,961,800
                                             ------------    ------------    ------------    ------------
Net operating loss                            (16,312,761)     (4,131,243)     (1,341,318)    (22,214,761)
Interest expense                              (32,572,454)           --          (415,357)    (32,987,811)
Interest income                                13,940,240         159,343          13,040      14,115,236
Write-off of initial public offering costs     (1,354,534)           --              --        (1,354,534)
Other income (expense), net                         2,913          (5,500)           --            (2,587)
                                             ------------    ------------    ------------    ------------
        Net loss                             $(36,296,596)   $ (3,977,400)   $ (1,743,635)   $(42,444,457)
                                             ============    ============    ============    ============
Basic and diluted loss per
     common share                            $     (12.51)   $      (1.37)   $      (0.60)   $     (14.63)
                                             ============    ============    ============    ============
Weighted average number of
     common shares outstanding                  2,902,029       2,900,000       2,900,000       2,900,605
                                             ============    ============    ============    ============
</TABLE>




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


                                      F - 4
<PAGE>





                                  PATHNET, INC.
                        (A Development Stage Enterprise)
                  CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

<TABLE>
 
                                                                                       For the period
                                                      For the year ended               August 25, 1995
                                                          December 31,               (date of inception)
                                        --------------------------------------------   to December 31,
                                             1998            1997            1996            1998
                                        ------------    ------------    ------------    ------------
<S>                                     <C>             <C>             <C>             <C>          
Net loss                                $(36,296,596)   $ (3,977,400)   $ (1,743,635)   $(42,444,457)

Other comprehensive income
    Net unrealized gain on marketable
    securities available for sale            208,211            --              --           208,211
                                        ------------    ------------    ------------    ------------
Comprehensive loss                      $(36,088,385)   $ (3,977,400)   $ (1,743,635)   $(42,236,246)
                                        ============    ============    ============    ============
</TABLE>




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

                                     F - 5
<PAGE>


                                  PATHNET, INC.
                        (A Development Stage Enterprise)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
        
<TABLE>
                                                                                                                For the period
                                                                               For the year ended               August 25, 1995
                                                                                   December 31,               (date of inception)
                                                                    ------------------------------------------   to December 31,
                                                                        1998            1997          1996          1998
                                                                    -------------  ------------   ------------   ------------
<S>                                                                <C>            <C>            <C>            <C>
Cash flows from operating activities:
   Net loss                                                        $ (36,296,596) $  (3,977,400) $  (1,743,635) $ (42,444,457)
   Adjustment to reconcile net loss to net cash used in operating
    activities
     Depreciation expense                                                732,813         46,642          9,024        788,831
     Amortization of deferred financing costs                            842,790           --             --          842,790
     Loss on disposal of asset                                              --            5,500           --            5,500
     Write-off of deferred financing costs                               581,334           --             --          581,334
     Interest expense resulting from amortization of discount on
      the bonds payable                                                  307,125           --             --          307,125
     Stock based compensation                                            701,295           --             --          701,295
     Interest expense for beneficial conversion feature of
       bridge loan                                                          --             --          381,990        381,990
     Accrued interest satisfied by conversion of bridge loan to
       Series B convertible preferred stock                                 --             --           33,367         33,367
   Changes in assets and liabilities:
     Interest receivable                                              (4,846,952)          --             --       (4,846,952)
     Prepaid expenses and other current assets                          (156,935)       (46,876)        (1,695)      (205,505)
     Accounts payable                                                      6,709        386,106        110,094        507,614
     Accrued interest                                                  8,932,294           --             --        8,932,294
     Deferred revenue                                                       --             --             --             --
     Accrued expenses and other liabilities                              339,688        269,783         17,572        639,687
                                                                   -------------  -------------  -------------  -------------
       Net cash used in operating activities                         (28,856,435)    (3,316,245)    (1,193,283)   (33,775,087)
                                                                   -------------  -------------  -------------  -------------
Cash flows from investing activities:
   Expenditures for network in progress                              (33,619,342)    (1,739,782)          --      (35,359,124)
   Expenditures for property and equipment                            (2,769,076)      (381,261)       (46,653)    (3,205,893)
   Purchase of marketable securities available for sale             (169,587,319)          --             --     (169,587,319)
   Purchase of marketable securities - pledged as collateral         (83,097,655)          --             --      (83,097,655)
   Sale of marketable securities - pledged as collateral              22,271,181           --             --       22,271,181
   Restricted cash                                                    (9,971,142)      (760,211)          --      (10,731,353)
   Issuance of note receivable to incumbent                           (3,206,841)          --             --       (3,206,841)
   Repayment of note receivable                                            9,000           --             --            9,000
                                                                   -------------  -------------  -------------  -------------
       Net cash used in investing activities                        (279,971,194)    (2,881,254)       (46,653)  (282,908,004)
                                                                   -------------  -------------  -------------  -------------
Cash flows from financing activities:
   Issuance of voting and non-voting common stock                           --             --             --            1,000
   Proceeds from sale of preferred stock                              19,999,998     12,000,054      2,500,000     35,000,052
   Proceeds from sale of Series B convertible  preferred stock
     representing the conversion of committed but undrawn portion
     of bridge loan to Series B convertible preferred stock                 --             --          300,000        300,000
   Proceeds from bond offering                                       350,000,000           --             --      350,000,000
   Proceeds from bridge loan                                                --             --          700,000        700,000
   Exercise of employee common stock options                                  81           --             --               81
   Payment of issuance costs for preferred stock offerings                  --          (38,780)       (25,000)       (63,780)
   Payment of deferred financing costs                               (11,681,947)      (250,428)          --      (11,932,375)
                                                                   -------------  -------------  -------------  -------------
       Net cash provided by financing activities                     358,318,132     11,710,846      3,475,000    374,004,978
                                                                   -------------  -------------  -------------  -------------
Net increase in cash and cash equivalents                             49,490,503      5,513,347      2,235,064     57,321,887
Cash and cash equivalents at the beginning of period                   7,831,384      2,318,037         82,973           --
                                                                   -------------  -------------  -------------  -------------
Cash and cash equivalents at the end of period                     $  57,321,887  $   7,831,384  $   2,318,037  $  57,321,887
                                                                   =============  =============  =============  =============
Supplemental disclosure:
   Cash paid for interest                                          $  22,271,234  $        --    $        --    $  22,271,234
                                                                   =============  =============  =============  =============
   Noncash investing and financing transactions:
     Conversion of bridge loan plus accrued interest to
     Series B convertible preferred stock                          $        --    $        --    $     733,367  $     733,367
                                                                   =============  =============  =============  =============
     Conversion of non-voting common stock to voting common stock  $        --    $        --    $      14,500  $         500
                                                                   =============  =============  =============  =============
     Issuance of voting and non-voting common stock                $        --    $        --    $        --    $       9,000
                                                                   =============  =============  =============  =============
     Acquisition of network equipment financed by accounts payable $  10,200,650  $   5,092,013  $        --    $  10,200,650
                                                                   =============  =============  =============  =============
</TABLE>

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

                                      F - 6
<PAGE>


                                  PATHNET INC.
                        (A Development Stage Enterprise)
                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
     Period from August 25, 1995 (date of inception) to December 31 1995 and
              for the years ended December 31, 1996, 1997 and 1998
<TABLE>

                                                                                                              Deficit
                                                                 Note                           Accumulated  Accumulated
                                                              Receivable              Additional   Other       During
                                               Common Stock      From      Deferred    Paid-in Comprehensive Development
                                           Shares      Amount Stockholder Compensation Capital     Income      Stage       Total
                                          ---------  --------- ----------  ---------  ---------  ---------  ----------  -----------
<S>                                       <C>        <C>        <C>        <C>        <C>        <C>        <C>         <C>       
Balance at August 25, 1995                     --    $    --    $    --    $    --    $    --    $    --    $    --     $      --
Issuance of Voting common stock           1,450,000     14,500     (4,500)      --         --         --       (9,500)          500
Issuance of Non-voting common stock       1,450,000     14,500     (4,500)      --         --         --       (9,500)          500
Net loss                                       --         --         --         --         --         --     (426,826)     (426,826)
                                          ---------  ---------  ---------  ---------  ---------  ---------  ----------  -----------
   Balance at December 31, 1995           2,900,000     29,000     (9,000)      --         --         --     (445,826)     (425,826)
Cancellation of Non-voting common stock   (1,450,000)  (14,500)      --         --         --         --         --         (14,500)
Issuance of Voting common stock           1,450,000     14,500       --         --         --         --         --          14,500
Interest expense for beneficial conversion     --
   feature of bridge loan                      --         --         --         --      381,990       --         --         381,990
Net loss                                       --         --         --         --         --         --    (1,743,635)  (1,743,635)
                                          ---------  ---------  ---------  ---------  ---------  ---------  ----------  -----------
   Balance at December 31, 1996           2,900,000     29,000     (9,000)      --      381,990       --    (2,189,461)  (1,787,471)
Net loss                                       --         --         --         --         --         --    (3,977,400)  (3,977,400)
                                          ---------  ---------  ---------  ---------  ---------  ---------  ----------  -----------
   Balance at December 31, 1997           2,900,000     29,000     (9,000)      --      381,990       --    (6,166,861)  (5,764,871)
Exercise of stock options                     2,358         24       --         --           57       --         --              81
Repayment of note receivable                   --         --        9,000       --         --         --         --           9,000
Deferred compensation expense related to 
   issuance of employee common stock options   --         --         --   (1,679,359) 1,679,359       --         --            --
Compensation expense related to issuance of
   employee common stock options               --         --         --      701,295       --         --         --         701,295
Fair value of warrants to purchase common      --
   stock                                       --         --         --         --    4,095,000       --         --       4,095,000
Net unrealized gain on marketable securities
   available for sale                          --         --         --         --         --      208,211       --         208,211
Net loss                                       --         --         --         --         --         --   (36,296,596) (36,296,596)
                                          ---------  ---------  ---------  ---------  ---------  ---------  ----------  -----------
                                          2,902,358  $  29,024  $    --    $(978,064)$6,156,406  $ 208,211$(42,463,457 $(37,047,880)
                                          =========  =========  =========  =========  =========  =========  ==========  ===========
</TABLE>

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

                                     F - 7

<PAGE>


                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       THE COMPANY

         Pathnet,  Inc.  (Company) is a leading "carrier's  carrier",  providing
high-quality,  low-cost  digital fiber and wireless  communications  capacity to
under-served and second- and third-tier U.S. markets.  The Company's strategy is
to partner with owners of telecommunication  assets, including utility, pipeline
and  railroad  companies   (Incumbents),   to  upgrade  and  aggregate  existing
infrastructure to a state-of-the-art SONET network. As of December 31, 1998, the
Company had approximately 2,000 route miles of completed network,  approximately
5,000 route miles of network under  construction and approximately  10,000 route
miles of network under contract. Due to demand and opportunity, Pathnet expanded
the scope of its existing  business  strategy to include  fiber.  Pathnet offers
telecommunications  service to inter-exchange carriers, local exchange carriers,
internet  service  providers,   Regional  Bell  Operating  Companies,   cellular
operators and resellers.

         The  Company's  business  has  been  funded  primarily  through  equity
investments by the Company's  stockholders and a private placement in April 1998
of units  consisting  of 12 1/4% Senior  Notes due 2008  (Restricted  Notes) and
warrants  (Warrants) to purchase Common Stock (Debt  Offering).  On September 2,
1998,  the  Company  commenced  an  offer  to  exchange   (Exchange  Offer)  all
outstanding Restricted Notes for up to $350.0 million aggregate principal amount
of 12 1/4% Senior Notes due 2008  (Registered  Notes) which have been registered
under the Securities Act of 1933, as amended  (Securities Act). The terms of the
Registered  Notes are  identical  in all  material  respects to the terms of the
Restricted  Notes,  except that the Registered  Notes have been registered under
the Securities Act and are generally freely  transferable by holders thereof and
are issued without any covenant upon the Company  regarding  registration  under
the  Securities  Act.  The  Exchange  Offer  expired  on October 2, 1998 and all
outstanding   Restricted  Notes  were  exchanged  for  Registered   Notes.  (The
Restricted Notes and the Registered Notes are collectively referred to herein as
the "Senior Notes".)

         A substantial portion of the Company's  activities to date has involved
developing  strategic  relationships  with  Incumbents and building its network.
Accordingly,  a majority of its revenues to date reflect only certain consulting
and  advisory   services  in  connection   with  the  design,   development  and
construction of digital microwave infrastructure.  The remainder of its revenues
to date  (approximately  10 per cent of its total revenues) was derived from the
sale of bandwidth along the Company's digital network. The Company has also been
engaged in constructing  network,  developing operating systems,  constructing a
network operations  center,  raising capital and hiring management and other key
personnel.  The Company has experienced significant operating and net losses and
negative  operating  cash flow to date and  expects to  continue  to  experience
operating and net losses and negative  operating cash flow until such time as it
is able to generate revenue sufficient to cover its operating expenses.

2.       SIGNIFICANT ACCOUNTING POLICIES

BASIS OF ACCOUNTING

         While  the  Company  recently  commenced  providing   telecommunication
services  to  customers  and  recognizing  the  revenue  from  the  sale of such
telecommunication  services, its principal activities to date have been securing
contractual  alliances  with  Incumbents,  designing  and  constructing  network

                                      F-8
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

segments, obtaining capital and planning its proposed service.  Accordingly, the
Company's consolidated financial statements are presented as a development stage
enterprise,  as prescribed by Statement of Financial Accounting Standards No. 7,
"Accounting and Reporting by Development  Stage  Enterprises."  As a development
stage  enterprise,  the Company has been  relying on the  issuance of equity and
debt securities, rather than recurring revenues, for its primary sources of cash
since inception.

CONSOLIDATION

         The consolidated  financial statements include the accounts of Pathnet,
Inc. and its wholly-owned  subsidiaries,  Pathnet Finance I, LLC,  Pathnet/Idaho
Power License, LLC, Pathnet Fiber Optics, LLC and Pathnet/BNSF  Equipment,  LLC.
All material  intercompany  accounts and  transactions  have been  eliminated in
consolidation.

USE OF ESTIMATES

         The  preparation  of  the  financial   statements  in  conformity  with
generally accepted  accounting  principles requires management to make estimates
and  assumptions  that affect the reported  amounts of assets and liabilities at
the date of the financial  statements  and the reported  amounts of revenues and
expenses  during the reported  period.  The  estimates  involve  judgments  with
respect to, among other things,  various  future  factors which are difficult to
predict and are beyond the control of the Company.  Actual  amounts could differ
from these estimates.

LOSS PER SHARE

         Basic  earnings  (loss) per share is computed  by  dividing  net income
(loss) by the  weighted  average  number of shares of Common  Stock  outstanding
during the applicable  period.  Diluted earnings (loss) per share is computed by
dividing  net income  (loss) by the  weighted  average  common  and  potentially
dilutive common equivalent shares  outstanding during the applicable period. For
each of the periods  presented,  basic and diluted  loss per share are the same.
The  exercise of  2,885,833  employee  Common  Stock  options,  the  exercise of
warrants to purchase  1,116,500  shares of Common Stock,  and the  conversion of
5,470,595  shares  of  Series  A,  B  and C  convertible  preferred  stock  into
15,864,715  shares  of  Common  Stock  as of  December  31,  1998,  which  could
potentially  dilute basic  earnings per share in the future were not included in
the computation of diluted loss per share for the periods  presented  because to
do so would have been antidilutive in each case.

FAIR VALUE OF FINANCIAL INSTRUMENTS

         The  Company  believes  that the  carrying  amount  of  certain  of its
financial  instruments,  which include cash  equivalents  and accounts  payable,
approximate   fair  value  due  to  the  relatively   short  maturity  of  these
instruments.  As of December 31, 1998, the value of the Company's 12 1/4% Senior
Notes was approximately $245 million.

CASH EQUIVALENTS

         The Company  considers all highly liquid  instruments  with an original
maturity of three months or less to be cash equivalents.

                                      F-9

<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CONCENTRATION OF CREDIT RISK

         Financial   instruments  which  potentially   subject  the  Company  to
concentrations of credit risk consist of cash and cash  equivalents,  marketable
securities and associated interest receivable,  note receivable,  and restricted
cash.  Marketable  securities and associated  interest  receivable  include U.S.
Treasury   securities  and  debt   securities  of  U.S.   Government   agencies,
certificates of deposit and money market funds,  and corporate debt  securities.
The note  receivable is guaranteed by the parent  company of the note holder,  a
leading  utility  company.  The Company has  invested its excess cash in a money
market fund with a commercial bank. The money market fund is  collateralized  by
the underlying  assets of the fund. The Company's  restricted cash is maintained
in an  escrow  account  (see  Note  5) at a  major  bank.  The  Company  has not
experienced any losses on its cash and cash equivalents and restricted cash.

MARKETABLE SECURITIES

         Management determines the appropriate classification of its investments
in  marketable   securities  at  the  time  of  purchase  and  reevaluates  such
determinations  at each balance sheet date.  Debt  securities  are classified as
held to maturity  when the Company has the  positive  intent and ability to hold
the  securities to maturity.  The Company has classified  certain  securities as
held to maturity pursuant to a pledge agreement. Held to maturity securities are
stated at amortized  cost.  Debt  securities for which the Company does not have
the intent or ability to hold to maturity are  classified as available for sale,
along with any  investments in equity  securities.  Securities are classified as
current or non-current based on the maturity date. Securities available for sale
are carried at fair value  based on quoted  market  prices at the balance  sheet
date,  with unrealized  gains and losses  reported as part of accumulated  other
comprehensive income.

         The amortized cost of debt  securities is adjusted for  amortization of
premiums and accretion of discounts to maturity.  Such amortization and interest
are  included  in  interest  income or  expense.  Realized  gains and losses are
included  in other  income  (expense),  net in the  consolidated  statements  of
operations.  The cost of securities sold is based on the specific identification
method. The Company's  investments in debt and equity securities are diversified
among high credit quality securities in accordance with the Company's investment
policy.

PROPERTY AND EQUIPMENT

         Property   and   equipment,   consisting   of  network   in   progress,
communications  network,  office and computer equipment,  furniture and fixtures
and  leasehold  improvements,  is  stated at cost.  Network  in  progress  costs
incurred  during  development  are  capitalized.  Depreciation  of the completed
communications  network  commences  when the network  equipment is ready for its
intended  use and is computed  using the  straight-line  method  with  estimated
useful lives of network assets ranging between three to ten years.  Depreciation
of the office and  computer  equipment  and  furniture  and fixtures is computed
using the straight-line  method,  generally over three to five years, based upon
estimated  useful lives,  commencing  when the assets are available for service.
Leasehold  improvements are amortized over the lesser of the useful lives of the
assets or the lease term.  Expenditures for maintenance and repairs are expensed
as  incurred.  When  assets are  retired or  disposed,  the cost and the related

                                      F-10
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

accumulated  depreciation are removed from the accounts,  and any resulting gain
or loss is recognized in operations for the period.

IMPAIRMENT OF LONG-LIVED ASSETS

         The Company periodically evaluates the recoverability of its long-lived
assets.  This  evaluation  consists of a comparison of the carrying value of the
assets with the assets'  expected  future cash flows,  undiscounted  and without
interest costs.  Estimates of expected future cash flows represent  management's
best estimate based on reasonable and supportable  assumptions and  projections.
If the expected future cash flow,  undiscounted  and without  interest  charges,
exceeds the carrying value of the asset, no impairment is recognized. Impairment
losses are measured as the  difference  between the carrying value of long-lived
assets and their fair value.

DEFERRED INCOME TAXES

         The Company uses the liability  method of accounting  for income taxes.
Deferred income taxes result from temporary differences between the tax bases of
assets and liabilities and their financial  reporting  amounts at each year-end,
based on enacted laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income.  Valuation allowances are
established  when  necessary,  to reduce net  deferred  tax assets to the amount
expected  to be  realized.  The  provision  for  income  taxes  consists  of the
Company's current provision for federal and state income taxes and the change in
the Company's net deferred tax assets and liabilities during the period.

REVENUE RECOGNITION

         The Company earns revenue from the sale of  telecommunication  capacity
and for project  management  and consulting  services.  Revenue from the sale of
telecommunications  capacity is earned when the service is provided. Revenue for
project  management  and  consulting  services  is  recognized  over the related
project  period as milestones  are  achieved.  The Company  defers  revenue when
contractual  payments  are received in advance of the  performance  of services.
During  1998,  one customer  accounted  for 98 per cent of the  Company's  total
revenue.

DEFERRED FINANCING COSTS

         The Company has incurred  costs related to the Debt  Offering  together
with costs  associated with obtaining future debt financing  arrangements.  Such
costs are  amortized  over the term of the debt or financing  arrangement  other
than when financing has not been obtained, in which case, the costs are expensed
immediately.

COMPREHENSIVE LOSS

         Effective March 31, 1998, the Company adopted Statement of Statement of
Financial  Accounting  Standards No 130 which requires additional reporting with
respect  to  certain  changes in assets and  liabilities  that  previously  were
reported  in  stockholders'  equity  (deficit).  Accordingly,  the  Company  has
included  Consolidated  Statements  of  Comprehensive  Loss for the years  ended
December 31, 1998,  1997 and 1996,  and for the period  August 25, 1995 (date of
inception) to December 31, 1998 in the accompanying financial statements.

                                      F-11
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.       MARKETABLE SECURITIES

         The Company's  marketable  securities  are  considered  "available  for
sale," and, as such, are stated at market value.  The net  unrealized  gains and
losses on  marketable  securities  are  reported  as part of  accumulated  other
comprehensive  income.  Realized  gains or  losses  from the sale of  marketable
securities are based on the specific identification method.

        The following is a summary of the  investments in marketable  securities
at December 31, 1998:
<TABLE>
<CAPTION>    
                                                                        Gross Unrealized 
                                                                        ---------------- 
                                                             Cost       Gains        Losses     Market Value
                                                             ----       -----        ------     -------------
     <S>                                            <C>             <C>          <C>            <C>
     Available for sale securities:
       U.S. Treasury securities and debt securities
         of U.S. Government agencies                 $   20,684,791 $    11,436  $         --   $  20,696,227
       Certificates of deposit and money market
       funds                                              7,098,225         116           878       7,097,463
       Corporate debt securities                        141,804,303     225,972        28,435     142,001,840
                                                     -------------- -----------  ------------   -------------
                                                     $  169,587,319 $   237,524  $     29,313   $ 169,795,530
                                                     ============== ===========  ============   =============
</TABLE>

         Proceeds  from the sales of  available  for sale  securities  and gross
  realized  gains  and gross  realized  losses  on sales of  available  for sale
  securities were immaterial during the year ended December 31, 1998.

         The  amortized  cost and  estimated  fair value of  available  for sale
securities by contractual maturity at December 31, 1998 is as follows:
<TABLE>
<CAPTION>

                                                      Cost          Market Value
         <S>                                     <C>              <C>    

         Due in one year or less                 $   97,863,395   $   97,895,773
         Due after one year through two years        71,723,924       71,899,757
                                                 --------------   --------------
                                                 $  169,587,319   $  169,795,530
                                                 ==============   ==============
</TABLE>
         Expected maturities may differ from contractual  maturities because the
issuers  of the  securities  may have the  right to prepay  obligations  without
prepayment penalties.

         In addition to marketable  securities,  the Company has  investments in
pledged  marketable  securities  that are pledged as collateral for repayment of
interest on the  Company's  Senior Notes through April 2000 (see note 8) and are
classified  as  non-current  assets on the  consolidated  balance  sheet.  As of
December  31, 1998 pledged  marketable  securities  consisted  of U.S.  Treasury
securities   classified  as  held  to  maturity   with  an  amortized   cost  of
approximately  $60.8  million,  interest  receivable  on the pledged  marketable
securities  of   approximately   $998,000  and  cash  and  cash  equivalents  of
approximately   $41,000.   Approximately   $40.1  million  of  the   investments
contractually  mature prior to December 31, 1999 and approximately $20.7 million
contractually mature after December 31, 1999 and prior to April 30, 2000.

                                      F-12
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.    NOTE RECEIVABLES

         Under the terms of a  promissory  note with an  incumbent,  the Company
agreed to advance up to $10  million  principal  for the  purpose of funding the
incumbent's  equipment  expenditures  under a  Fixed  Point  Microwave  Services
agreement.  Expenses are initially  incurred by the Company and are recharged at
cost to the  incumbent as principal  under the  promissory  note.  The principal
amount of the promissory note is due and payable on March 31, 1999.  Interest on
the  promissory  note accrues at the rate of 5 per cent per annum  computed from
the date of commissioning of the network,  which had not occurred as of December
31,  1998.  Commissioning  of the  network  occurs  when  the  network  has been
completed  and is  performing  in  accordance  with agreed upon  specifications.
Approximately  $3.2  million was  outstanding  under the  promissory  note as of
December 31, 1998.

5.       PROPERTY AND EQUIPMENT

         Property and  equipment,  stated at cost, is comprised of the following
at December 31, 1998 and 1997:
<TABLE>
<CAPTION>

                                               1998                 1997     
                                       -----------------      ---------------
<S>                                     <C>                   <C>  

         Network in progress            $    38,669,088       $     6,831,795
         Communications network               6,890,686                    --
         Office and computer equipment        2,267,647               248,880
         Furniture and fixtures                 766,013               120,093
         Leasehold improvements                 166,733                62,344
                                       ----------------       ---------------
                                             48,760,167             7,263,112
         Less: accumulated depreciation        (788,831)              (56,018)
                                       -----------------      ---------------
         Property and equipment, net   $      47,971,336      $     7,207,094 
                                       ==================     ===============
</TABLE>

         Network  construction costs include all direct material and labor costs
together  with  related  allocable   interest  costs,   necessary  to  construct
components of a high capacity  digital  network which is owned and maintained by
the Company.  During 1998, a portion of network was completed and made available
for  use by the  Company,  and  was  transferred  from  network  in  process  to
communications  network.  Network  construction in progress at December 31, 1998
and 1997  respectively  included  approximately  $10.2 million and $5.1 million,
respectively,  of telecommunications  equipment not yet paid for by the Company.
Corresponding  amounts are included in accounts payable at December 31, 1998 and
1997, respectively.

6.       DEFERRED FINANCING COSTS

         During 1998, the Company incurred total issuance costs of approximately
$11.3 million in connection with the Debt Offering.  For the year ended December
31, 1998,  amortization  of the costs of  approximately  $843,000 was charged to
interest expense.

                                      F-13
<PAGE>
                                   PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         As of December 31, 1997,  debt-financing costs comprised  approximately
$250,000  related to costs incurred in anticipation of obtaining  debt-financing
arrangements  with a vendor.  During the year ended  December  31,  1998,  these
costs, together with additional debt financing costs incurred during the year of
approximately  $364,000,  were  charged  to  interest  expense  as  the  related
financing arrangements were not consummated.

7.       RESTRICTED CASH

         Restricted cash comprises  amounts held in escrow to collateralize  the
Company's  obligations under certain of its Fixed Point Microwave Services (FPM)
agreements.  The funds in each  escrow  account are  available  only to fund the
projects  to which the escrow is related.  Generally,  funds are  released  from
escrow to pay project  costs as  incurred.  During the year ended  December  31,
1998, the Company deposited  approximately  $10.3 million in escrow and no funds
were released from escrow.

8.       LONG-TERM DEBT

         During 1998,  the Company  completed  the Debt Offering for total gross
proceeds of $350.0  million less total  issuance  costs of  approximately  $11.3
million. Upon issuance,  approximately $345.9 million of the gross proceeds were
allocated to the Senior Notes and  approximately  $4.1 million were allocated to
the Warrants based upon estimated fair values.  The Warrants expire on April 15,
2008.  The  estimated  value  attributed  to the Warrants has been recorded as a
discount  on the face  value  of the  Senior  Notes  and as  additional  paid-in
capital.  This discount is amortized as an increase to interest  expense and the
carrying value of the debt over the related term using the interest method.  The
Company  has  recorded  approximately  $307,000  of  expense  for the year ended
December 31, 1998, related to the amortization of this discount. Interest on the
Senior Notes  accrues at an annual rate of 12 1/4 % , payable  semiannually,  in
arrears,  beginning  October 15, 1998,  with  principal due in full on April 15,
2008. Interest expense,  exclusive of the amortization of the discount,  for the
year ended December 31, 1998 was $31.3 million.  The Company used  approximately
$81.1  million of the  proceeds  related to the Debt  Offering to purchase  U.S.
Government debt  securities,  which are restricted and pledged as collateral for
repayment of all interest due on the Senior Notes  through  April 15, 2000.  The
Company  made its first  interest  payment  of  approximately  $22.3  million on
October 15, 1998. The Senior Notes are redeemable, in whole or part, at any time
on or after  April 15,  2003 at the  option  of the  Company,  at the  following
redemption  prices plus  accrued and unpaid  interest  (i) on or after April 15,
2003; 106% of the principal amount, (ii) on or after April 15, 2004; 104% of the
principal amount, (iii) on or after April 15, 2005; 102% of the principal amount
and (iv) on or after April 15, 2006; 100% of the principal  amount. In addition,
at any time prior to April 15, 2001,  the Company may redeem  within sixty days,
with the net cash proceeds of one or more public equity offerings,  up to 35% of
the aggregate  principal  amount of the Senior Notes at a redemption price equal
to 112.25% of the  principal  amount plus accrued and unpaid  interest  provided
that at least 65% of the  original  principal  amount of the Senior Notes remain
outstanding.  Upon a change in control,  as  defined,  each holder of the Senior
Notes may require the Company to  repurchase  all or a portion of such  holder's
Senior Notes at a purchase  price of cash equal 

                                      F-14
<PAGE>

                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to 101% of the principal  amount plus accrued and unpaid interest and liquidated
damages if any.

         The  Senior  Notes  contain   certain   covenants  which  restrict  the
activities of the Company  including  limitations  of  indebtedness,  restricted
payments,  issuances and sales of capital stock, affiliate transactions,  liens,
guarantees, sale of assets and dividends.

9.       CAPITAL STOCK TRANSACTIONS

COMMON STOCK

         The initial capitalization of the Company, on August 28, 1995, occurred
through the issuance by the Company of 1,450,000  shares of voting  common stock
and 1,450,000 shares of non-voting common stock.

         On May 8, 1998,  the Company filed a  Registration  Statement  with the
Securities  and Exchange  Commission  for an initial  public  offering of common
stock  (Initial  Public  Offering).  See "Item 7.  Management's  Discussion  and
Analysis of Financial  Condition  and Results of  Operations  --  Liquidity  and
Capital  Resources"  for a discussion of the Company's  decision to postpone the
Initial Public  Offering.  In relation to the postponement of the Initial Public
Offering,  the  Company  wrote  off  approximately  $1.4  million  in  expenses,
consisting   primarily  of  legal  and  accounting  fees,  printing  costs,  and
Securities  and Exchange  Commission  and Nasdaq Stock Market fees.  On July 24,
1998,  the  Company's  stockholders  approved a 2.9-for-1  stock split which was
effected on August 3, 1998,  the record  date.  All share  information  has been
adjusted for this stock split for all periods presented.

PREFERRED STOCK

         As part of its initial  capitalization  on August 25, 1995, the Company
initiated  a private  offering  of  1,000,000  shares  of  Series A  convertible
preferred  stock for  $1,000,000.  Pursuant to the terms of the  Investment  and
Stockholders' Agreement by and among the Company and certain stockholders of the
Company  (Investment and  Stockholders'  Agreement),  the offering closed in two
phases of $500,000 each. As of the signing of the  Investment and  Stockholders'
Agreement, the Company received $500,000, representing the first closing on this
offering in 1995. In addition,  the offering  provided for a convertible  bridge
loan in the amount of  $1,000,000.  The bridge loan carried an interest  rate of
12% per annum and was due and  payable  in full on the  earlier  to occur of the
anniversary  date  of the  bridge  loan  issuance  or the  closing  date  of the
Company's  next equity  financing.  The bridge loan was converted  into Series B
preferred stock at 73% of the price of the Series B convertible  preferred stock
issued in the next equity financing.

         In  February  1996,  the  Company  issued  500,000  shares  of Series A
convertible  preferred stock to the original investors in exchange for $500,000,
representing   the  second  closing  under  the  Investment  and   Stockholders'
Agreement.  In August 1996,  the Company drew $700,000 on a bridge loan with the
original investors.

         On December 23, 1996,  the Company  consummated  a private  offering of
609,756  shares of Series B  convertible  preferred  stock for  $2,000,000  less
issuance  costs  of  $25,000  pursuant  to  the  Investment  and   Stockholders'
Agreement. In addition, simultaneously, the $700,000 bridge loan plus

                                      F-15
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

$33,367  of accrued  interest  was  converted  into  306,242  shares of Series B
convertible preferred stock. The Company recognized $271,107 of interest expense
to  account  for the  beneficial  conversion  feature  of the  bridge  loan.  In
addition,  $300,000 representing the committed but undrawn portion of the bridge
loan,  was  paid to the  Company  for the sale of  125,292  shares  of  Series B
convertible  preferred  stock  at a  discounted  rate.  The  Company  recognized
$110,883 of interest expense to account for the beneficial conversion feature of
the  committed  but  undrawn  bridge  loan.  On June 18,  1997,  pursuant to the
Investment  and  Stockholders'  Agreement,  the Company  received an  additional
$2,000,000  in a second  closing  in  exchange  for  609,756  shares of Series B
convertible  preferred  stock.  There were no issuance costs associated with the
second closing.

         On October 31,  1997,  pursuant  to the  Investment  and  Stockholders'
Agreement,  the Company  consummated  a private  offering  of 939,850  shares of
Series C  convertible  preferred  stock  for  approximately  $10  million,  less
issuance  costs of $38,780.  On April 8, 1998,  pursuant to the  Investment  and
Stockholders'  Agreement,  the Company consummated a second closing of 1,879,699
shares of Series C convertible  preferred stock for an aggregate  purchase price
of approximately $20.0 million. There were no issuance costs associated with the
second closing.

         Each  share of Series A,  Series B and Series C  convertible  preferred
stock entitles each holder to a number of votes per share equal to the number of
shares of Common  Stock into which each share of Series A, Series B and Series C
convertible preferred stock is currently convertible.

         The  holders  of the  Series  A,  Series  B and  Series  C  convertible
preferred  stock are entitled to receive  dividends in  preference to and at the
same rate as dividends are paid with respect to the common  stock.  In the event
of any liquidation,  dissolution or winding up of the Company, whether voluntary
or  involuntary,  holders  of each  share of  Series  A,  Series B and  Series C
convertible  preferred  stock  outstanding  are  entitled  to be paid before any
payment  shall be made to the holders of any class of common  stock or any stock
ranking on liquidation junior to the convertible  preferred stock, an amount, in
cash, equal to the original purchase price paid by such holder plus any declared
but unpaid dividends.

         In  the  event  the  assets  of the  Company  are  insufficient  to pay
liquidation   preference   amounts,   then  all  of  the  assets  available  for
distribution  shall be  distributed  pro rata so that each holder  receives that
portion  of the assets  available  for  distribution  as the number of shares of
convertible  preferred  stock held by such holder  bears to the total  number of
shares of convertible preferred stock then outstanding.

         Shares of the Series A,  Series B, and Series C  convertible  preferred
stock may be  converted  at any time,  at the option of the holder,  into voting
common  stock.  The  number  of  shares of voting  common  stock  entitled  upon
conversion is the quotient  obtained by dividing the face value of the Series A,
Series B and Series C convertible  preferred stock by the Applicable  Conversion
Rate,  defined as the Applicable  Conversion Value of $0.34,  $1.13 or $3.67 per
share, respectively.

         Each  share of  convertible  preferred  stock  shall  automatically  be
converted into the number of shares of voting common stock which such shares are
convertible upon application of the Applicable  Conversion Rate immediately upon
the closing of a qualified  underwritten  public offering covering the offer and
sale of  capital  stock  which is  defined  as:  (i) the  Company is valued on a
pre-money basis at greater than $50,000,000, (ii) the gross proceeds received by
the  Company  exceed  $20,000,000,  and  (iii)  

                                      F-16
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the Company uses a nationally  recognized  underwriter  approved by holders of a
majority  interest of the Series A, Series B and Series C convertible  preferred
stock voting together.

         If the  Company  issues any  additional  shares of common  stock of any
class at a price less than the Applicable  Conversion  Value,  in effect for the
Series A, Series B or Series C convertible  preferred stock immediately prior to
such issuance or sale,  then the Applicable  Conversion  Value shall be adjusted
accordingly.

         In the event a qualified  public  offering  has not  occurred  prior to
December 23, 2000, the holder of shares of Series A or Series B preferred  stock
can  require  the  Company  to  redeem  the  shares  of  Series  A and  Series B
convertible preferred stock. After receipt from any one holder of an election to
have any shares redeemed, the Company is required to send a notice to the Series
A and Series B preferred  stockholders  on December  24, 2000 of the  redemption
price. If after sending the redemption notice to Series A and Series B preferred
stockholders,  the  Company  receives  requests  for  redemption  on or prior to
January 11, 2001,  from the holders of at least 67% of the Series A and Series B
convertible  preferred stock taken together,  the Company must redeem all shares
of Series A and Series B convertible  preferred stock. Payment of the redemption
price is due on  January  23,  2001,  for a cash  price  equal  to the  original
purchase  price  paid by such  holders  for each  share of Series A and Series B
convertible  preferred stock as adjusted for any stock split, stock distribution
or stock dividends with respect to such shares.  The successful  completion of a
qualified  public offering is not within the control of the Company.  Therefore,
the Company  does not  present  the Series A and Series B  preferred  stock as a
component of stockholders' equity.

         In the event that a qualified public offering has not occurred prior to
November 3, 2001,  the holder of shares of Series C preferred  stock can require
the Company to redeem the shares of Series C convertible  preferred stock. After
receipt  from any one holder of an  election  to have any shares  redeemed,  the
Company is required to send a notice to the Series C preferred  stockholders  on
November 4, 2001 of the redemption price. If after sending the redemption notice
to Series C preferred stockholders, the Company receives requests for redemption
on or prior to November 21, 2001, from the holders of at least 67% of the Series
C convertible  preferred  stock,  the Company must redeem all shares of Series C
convertible  preferred stock. Payment of the redemption price is due on December
3, 2001 for a cash  price  equal to the  original  purchase  price  paid by such
holders for each share of Series C convertible  preferred  stock as adjusted for
any stock split,  stock  distribution  or stock  dividends  with respect to such
shares.  The successful  completion of a qualified public offering is not within
the control of the Company. Therefore, the Company does not present the Series C
preferred stock as a component of stockholders' equity.

         Notwithstanding the provisions for optional redemption described above,
pursuant to a Consent  Waiver and Amendment  effective  March 24, 1998 among the
Company and certain  stockholders  of the Company,  the holders of the Series A,
Series B and  Series C  convertible  preferred  stock  agreed  that no  optional
redemption of the Series A, Series B or Series C convertible preferred stock may
be made by the Company  prior to 90 days after (i) the final  maturity  dated of
the Senior Notes (ii) or such earlier date (after the redemption  date specified
for such preferred stock) as the Senior Notes shall be paid in full.

                                      F-17
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.      STOCK OPTIONS

         On August 28,  1995,  the Company  adopted  the 1995 Stock  Option Plan
(1995 Plan), under which incentive stock options and non-qualified stock options
could be granted to the  Company's  employees  and  certain  other  persons  and
entities in accordance with law. The Compensation  Committee,  which administers
the 1995 Plan,  determined the number of options granted, the vesting period and
the  exercise  price of each award made under the 1995 Plan.  The 1995 Plan will
terminate August 28, 2005 unless  terminated  earlier by the Board of Directors.
During 1998, the Compensation  Committee determined that no further awards would
be granted under the 1995 Plan.

         Options granted to date under the 1995 Plan generally vest over a three
period and expire  either 30 days after  termination  of  employment or 10 years
after date of grant.  As of December 31,  1998, a total of 70,731  non-qualified
stock  options and 424,393  incentive  stock  options were issued at an exercise
price of $0.03 per share,  an amount  estimated to equal or exceed the per share
fair value of the common  stock at the time of grant.  As of December  31, 1998,
the  options  issued  at an  exercise  price of  $0.03  had a  weighted  average
contractual life of 6.68 years. As of December 31, 1998,  490,410 of the options
issued at an exercise price of $0.03 were exercisable.

         On August 1, 1997,  the Company  adopted the 1997 Stock  Incentive Plan
(1997 Plan), under which incentive stock options,  non-qualified  stock options,
stock  appreciation  rights,  restricted stock,  performance  awards and certain
other  types of awards may be granted to the  Company's  employees  and  certain
other  persons  and  entities  in  accordance   with  the  law.  To  date,  only
non-qualified  stock  options  have  been  granted  under  the  1997  Plan.  The
Compensation  Committee,  which administers the 1997 Plan, determines the number
of options  granted,  the vesting  period and the  exercise  price of each award
granted under the 1997 Plan.  The 1997 Plan will  terminate July 31, 2007 unless
earlier terminated by the Board of Directors.

         Options  granted  under  the 1997 Plan  generally  vest over a three to
seven year  period and expire:  (1) ten years  after the date of grant,  (2) two
years after the date of the participant's  termination without cause, disability
or death, (3) three months after the date of the participant's resignation,  (4)
on the date of the  participant's  termination  with cause or (5) on the date of
any  material  breach of any  confidentiality  or  non-competition  covenant  or
agreement entered into between the participant and the Company.

         The options  issued on October 31, 1997, at $3.67,  vest on October 31,
2004  provided,  however  (i) if the  Company  has  met 80% of its  revenue  and
Earnings Before Interest,  Taxes,  Depreciation and Amortization (EBITDA) budget
for the calendar year ending December 31, 1998,  which budget is approved by the
Board of  Directors  of the  Company,  50% of the shares  covered by the options
shall vest and become  exercisable  on January 1, 1999,  (ii) if the Company has
met 80% of its revenue and EBITDA budget for the calendar  year ending  December
31, 1999, which budget is approved by the Board of Directors of the Company, the
remaining  50% of the  shares  covered  by the  options  shall  vest and  become
exercisable on January 1, 2000, and (iii) in the event that the first 50% of the
shares  covered by the  options  did not vest on January 1, 1999 as set forth in
(i) above and the Company  not only meets 80% of its  revenue and EBITDA  budget
for the year ending  December 31, 1999 but exceeds 80% of its

                                      F-18
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

revenue and EBITDA budget for the year ending December 31, 1999, which budget is
approved by the Board of Directors  of the Company,  in an amount at least equal
to the deficiency  that occurred in the year ending  December 31, 1998,  100% of
the shares  covered by the options shall vest and become  exercisable on January
1, 2000.  Unvested and uncancelled  options issued at $3.67  immediately  become
fully  vested and  exercisable  upon a change of control or a  qualified  public
offering, as defined in the option agreement.

         The options issued at $1.13 vest ratably over three or four consecutive
years  subject to certain  acceleration  provisions  set forth in an  employment
agreement such as the immediate  vesting upon a change in control or a qualified
initial public offering. Under certain circumstances and subject to the terms of
the  Senior  Notes,  upon the  election  of the  employee  upon  termination  of
employment,  the Company  will be required to pay the employee the fair value of
the vested options held on the date of such termination.

         As of December 31, 1998,  a total of  2,390,707  non-qualified  options
were issued and outstanding,  1,523,323 at an exercise price of $1.13 per share,
520,134 at an exercise price of $3.67 per share and 347,250 at an exercise price
of $5.20  per  share.  Of the  options  issued  at $1.13,  425,790  shares  were
exercisable  at December 31, 1998.  None of the options issued at $3.67 or $5.20
were  exercisable  at December 31, 1998.  As of December 31, 1998,  the weighted
average contractual life of the options issued at $1.13, $3.67 and $5.20 was 8.9
and 8.9 and 9.9 years, respectively.

          During the year ended  December 31, 1998,  667,373 and 89,721  options
were issued at an exercise price of $1.13 and $3.67 per share, respectively. The
estimated fair value of the Company's  underlying  common stock in each case was
determined  to be $1.99 per share and  $16.00,  respectively.  Accordingly,  the
Company calculated deferred  compensation  expense of approximately $1.7 million
related  to the  options  granted  during the year and  recognized  compensation
expense of approximately $701,000. The Company will recognize the balance of the
compensation expense over the remainder of the vesting period of the options.

                                      F-19

<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          Stock option activity was as follows:
<TABLE>
<CAPTION>

                                                          1995 Plan                       1997 Plan    
                                             -----------------------------------   --------------------
                                                              Non-                   Non-                    Weighted
                                                Incentive   Qualified              Qualified                  Average
                                                  Stock       Stock                  Stock                    Exercise
                                                 Options     Options      Price     Options       Price        Price
                                                 -------     -------      -----     -------       -----        -----
    <S>                                          <C>          <C>       <C>       <C>         <C>             <C>

    Options outstanding, December 31, 1995       410,248      70,731    $ 0.034          --         --        $  0.034
    Granted                                       14,147       7,074    $ 0.034          --         --        $  0.034
    Exercised                                         --          --         --          --         --              --
    Canceled                                          --          --         --          --         --              --
                                                 -------
    Options outstanding, December 31, 1996       424,395      77,805    $ 0.034          --         --        $  0.034
    Granted                                           --          --         --   1,289,167   $1.13-$3.67     $  1.980
    Exercised                                         --          --         --          --         --              --
    Canceled                                          --          --         --          --         --              --
                                               ---------     -------              ---------        
    Options outstanding, December 31, 1997       424,395      77,805     $0.034   1,289,167   $1.13-$3.67     $  1.430

    Options granted                                   --          --         --   1,107,094   $1.13-$5.20     $  2.622
    Options exercised                                 --      (2,358)    $0.034          --         --          --
    Options cancelled                                 --      (4,716)    $0.034      (5,554)  $1.13-$5.20     $  3.145
                                               ---------     -------              ---------               
    Options outstanding at December 31, 1998     424,395      70,731     $0.034   2,390,707   $1.13-$5.20     $  1.888
                                               =========     =======              =========                       
</TABLE>

The  Company  measures   compensation   expense  for  its  employee  stock-based
compensation using the intrinsic value method and provides pro forma disclosures
of  net  loss  as if the  fair  value  method  had  been  applied  in  measuring
compensation  expense.  Under  the  intrinsic  value  method of  accounting  for
stock-based  compensation,  when  the  exercise  price  of  options  granted  to
employees  is less than the fair  value of the  underlying  stock on the date of
grant,  compensation  expense is to be recognized  over the  applicable  vesting
period.

<TABLE>
<CAPTION>

                                                    Year Ended December 31,
                                           --------------------------------------
                                            1998            1997             1996
                                            ----            ----             ----
      <S>                                <C>            <C>               <C>       
      Net loss as reported               $36,296,596    $3,977,400        $1,743,635
      Pro forma net loss                 $36,859,594    $3,978,164        $1,747,570
      Basic and diluted net loss per
          share as reported.                 $(12.51)       $(1.37)           $(0.60)
      Pro forma basic and diluted net
          loss per share                     $(12.70)       $(1.37)           $(0.60)
</TABLE>

The fair value of each option is  estimated on the date of grant using a type of
Black-Scholes   option   pricing  model  with  the  following   weighted-average
assumptions  used for grants during the years ended  December 31, 1997 and 1996,
respectively:  dividend  yield  of 0%,  expected  volatility  of  0%,  risk-free
interest  rate of 6.55% and 6.35% and expected  terms of 5.0 and 5.8 years.  The
following  weighted-average  assumptions  were used for  grants  during the year
ended  December 31,  1998:  dividend  yield of 0%,  expected  volatility  of 0%,
risk-free interest rate of 5.18% and expected terms of 5.5 years.

                                      F-20
<PAGE>
                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

         As of  December  31,  1998 and 1997,  the  weighted  average  remaining
contractual life of the options is 8.63 years and 9.21 years,  respectively.  As
of  December  31,  1998 and 1997 the pro  forma tax  effects  would  include  an
increase to the deferred tax asset and the valuation  allowance of approximately
$225,000, and $300 respectively; therefore, there is no pro forma tax effect.

11.      VENDOR AGREEMENTS

         Pursuant to a Master  Agreement  entered into by the Company and NEC on
August 8, 1997, as amended,  the Company has the option to acquire, by March 31,
2003, a total of $200 million worth of certain equipment,  services and licensed
software  to be used by the  Company in its  network  under  pricing and payment
terms that the Company  believes are  favorable.  In  addition,  NEC has agreed,
subject to certain  conditions,  to warranty equipment  purchased by the Company
from NEC for three years, if defective,  to repair or replace certain  equipment
promptly and to maintain a stock of critical spare parts for up to 15 years. The
Company's  agreement  with NEC provides for fixed prices  during the first three
years of its term.  As of December 31,  1998,  the Company had  purchased  $31.1
million of equipment under this agreement.

         Pursuant to a supply  agreement  entered into by the Company and Lucent
Technologies  (Lucent)  on December  18,  1998,  the Company  agreed that Lucent
should be its exclusive supplier of fiber optic cable for its nationwide,  voice
and data  network.  Lucent may provide  financing  of up to  approximately  $400
million of fiber purchases for the construction of the Company's network and may
provide  or arrange  financing  for  future  phases of the fiber  portion of the
Company's  network.  The  total  amount  of  financing  over  the  life  of this
seven-year  agreement is not to exceed $1.8 billion.  Certain  material terms of
the Company's  transactions with Lucent are currently under review by Lucent and
the Company.  There can be no assurance that the financing  contemplated  by the
supply  agreement will be  consummated  or, if  consummated,  consummated on the
terms and conditions  described above. The supply agreement provides that Lucent
will  provide the Company with a broad level of support,  including  fiber optic
equipment,  network planning and design,  technical and marketing  support,  and
financing.  As of December 31, 1998, no purchases were made by the Company under
this agreement.

12.      COMMITMENTS AND CONTINGENCIES

         The Company  maintains  office space in  Washington,  D.C.,  Kansas and
Texas. The most significant lease relates to the Company's headquarters facility
in Washington,  D.C. The  partnership  leasing the space in Washington,  D.C. is
controlled  by a director of the Company.  The lease expires on August 31, 1999,
and is renewable by the Company for two additional  one-year periods.  Rent paid
to this related  party during the year ended  December 31, 1998,  1997 and 1996,
was $281,890,  $60,980 and $0,  respectively.  The Company has no amounts due to
the related party as of December 31, 1998.

         On December 30, 1998,  the Company  entered into a lease  agreement for
the lease of tower site space,  sufficient  to perform its  obligations  under a
fixed point microwave agreement (FPMA) with an incumbent. Under the terms of the
lease,  the  Company is  obligated  to rent of  $130,000  per month for a period
expiring on the later of (i) the expiration of the FPMA as to that site, or (ii)
ten years from the

                                      F-21
<PAGE>

                                  PATHNET, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

effective date of the agreement.  The agreement  provides for an increase in the
rent  payable  commencing  on  December  1,  1999  and on each  succeeding  year
thereafter  to  December 1, 2008,  by an amount  equal to 4 per cent of the rent
then in effect.

         The Company's  future  minimum  rental  payments  under  noncancellable
operating leases are as follows:
<TABLE>
<CAPTION>
         <S>                            <C>    

         1999                            $     2,177,440
         2000                                  1,913,822
         2001                                  1,967,214
         2002                                  2,033,577
         2003 and thereafter                  12,089,432
                                         ---------------
         Total                           $    20,181,485
                                         ===============
</TABLE>


         Rent expense for the years ended  December 31 1998,  1997, and 1996 was
$389,969, $114,673 and $4,399, respectively.

         The Company earns microwave telecommunication capacity revenue under an
  indefeasible  right of use (IRU) agreement dated December 1, 1998, of $137,000
  per  month  commencing  December  1998 and  expiring  on the  later of (i) the
  expiration  of the FPMA as to that site,  or (ii) ten years from the effective
  date of the agreement.  The IRU agreement provides for an increase in the rent
  receivable  commencing  on  December  1,  1999  and on  each  succeeding  year
  thereafter  to December 1, 2008,  by an amount equal to 4 per cent of the rent
  then in effect.

         In exchange for a non-compete agreement,  the Company has agreed to pay
a senior management employee a severance payment of $275,000, if such employee's
employment with the Company is terminated.

         As at  December  31,  1998,  the Company  had  capital  commitments  of
approximately  $28.0 million  relating to  telecommunications  and  transmission
equipment.

13.      INCOME TAXES

         The tax effect of temporary  differences  that give rise to significant
portions of the deferred tax asset at December 31, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>

                                                               December 31,
                                                           1998            1997
                                                           ----            ----
     <S>                                            <C>                 <C>        
     Deferred revenue                               $          949      $   117,000
     Capitalized start-up costs                          1,370,937        1,271,227
     Capitalized research and development costs             66,111           79,333
     Net operating loss carryforward.                   15,325,484          754,458
                                                    --------------      -----------
                                                        16,763,481        2,222,018
     Less valuation allowance                          (16,763,481)      (2,222,018)
                                                    --------------     ------------
     Net deferred tax asset                         $           --      $        --
                                                    ==============      ===========
</TABLE>

                                      F-22
<PAGE>

         Capitalized  costs represent  expenses incurred in the organization and
start-up of the Company. For federal income tax purposes,  these costs are being
amortized over sixty months.

         The ultimate  realization  of deferred tax assets is dependent upon the
generation  of future  taxable  income in the periods in which  those  temporary
differences  are  deductible.  The  Company has  provided a valuation  allowance
against  its  deferred  tax  assets as they are  long-term  in nature  and their
ultimate realization cannot be determined.



                                      F-23