<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                   FORM 10-K

(Mark One)

     X  Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
     -                                                                          
Act of 1934


        For the fiscal year ended December 31, 1996

                                       or
 
    [_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

 
     For the transition period from                to               
                                    --------------    -------------

     Commission file number                       0-20913
                            ----------------------------------------------------

                                   Teleport Communications Group Inc.
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            (Exact Name of Registrant as Specified in Its Charter)

          Delaware                                       13-3173139
-------------------------------                     -------------------------
(State or Other Jurisdiction of                          (I.R.S. Employer
Incorporation or Organization)                           Identification No.)

437 Ridge Road, Executive Building 3, Dayton, NJ         08810
------------------------------------------------    -------------------------
(Address of Principal Executive Offices)                 (Zip Code)

                                                 908-392-2000
--------------------------------------------------------------------------------
             (Registrant's Telephone Number, Including Area Code)

     Securities registered pursuant to Section 12 (b) of the Act:

                                                  Name of Each Exchange
     Title of Each Class                          on Which Registered
     -------------------                          ---------------------

          None                                           None
----------------------------                  ----------------------------------

     Securities registered pursuant to Section 12(g) of the Act:

 
                             Class A Common Stock
--------------------------------------------------------------------------------
                               (Title of Class)

     Indicate by check mark whether the Registrant:(1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during 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  
                                               -----      -----

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

Based on the closing sales price on March 20, 1997 the aggregate market value of
the voting stock held by non-affiliates of the Registrant was approximately
$800,113,800.

At March 20, 1997, 37,576,689 shares of the Registrant's Class A Common Stock
and 127,274,632 shares of Registrant's Class B Common Stock were outstanding.

Portions of the Registrant's definitive Proxy Statement to be filed with the
Securities and Exchange Commission in connection with its 1997 Annual Meeting
are incorporated by reference into Part III of this Report on Form 10-K.

Certain Exhibits filed with the Registrant's  Registration Statement on Form S-1
(File Nos. 333-3850 and 333-3984, as amended), are incorporated by reference as
Exhibits to this Report on Form 10-K in Part III, Item 14.
<PAGE>
 
TABLE OF CONTENTS

ITEM  PAGE
       
       PART I

1.     Business
2.     Properties
3.     Legal Proceedings
4.     Submission of Matters to a Vote of Security Holders

       PART II

5.     Market for Registrant's Common Stock and Related Stockholder Matters
6.     Selected Financial Data
7.     Managements' Discussion and Analysis of Financial Condition and Results
       of Operations
8.     Financial Statements and Supplementary Data
9.     Changes in and Disagreements with Accountants on Accounting and Financial
       Disclosure

       PART III

10.    Directors and Executive Officers of the Registrant
11.    Executive Compensation
12.    Security Ownership of Certain Beneficial Owners and Management
13.    Certain Relationships and Related Transactions

       PART IV

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

                                       3
<PAGE>
 
PART I

ITEM 1. BUSINESS

                                  INTRODUCTION
                                  ------------

     Teleport Communications Group Inc. (the "Company" or "TCG" or the
"Registrant"), the first and largest competitive local exchange carrier ("CLEC")
in the United States, offers a wide range of telecommunications services in
major metropolitan markets nationwide.  The Company competes with incumbent
local exchange carriers ("ILECs") as "The Other Local Phone Company"(R) by
providing high quality, integrated telecommunications services, primarily over
fiber optic digital networks, to meet the voice, data and video transmission
needs of its customers.  TCG's customers are principally telecommunications-
intensive businesses, hospitals and educational institutions, governmental
agencies,  long distance carriers and resellers, Internet service providers,
disaster recovery service providers and wireless communications companies.  TCG
offers these customers technologically advanced telecommunications services, as
well as superior customer service, flexible pricing and vendor and route
diversity.

     For over 10 years, TCG has developed, operated and expanded its local
telecommunications networks.  As of December 31, 1996, the Company operated high
capacity state-of-the-art digital networks in 51 metropolitan markets, including
17 of the 20 largest metropolitan areas.  These Company networks were located in
metropolitan New York/New Jersey, Los Angeles, Chicago, San Francisco, Boston,
Detroit, Baltimore/Washington, D.C., Dallas, Houston, Miami/Ft. Lauderdale,
Seattle, San Diego, St. Louis, Pittsburgh, Phoenix, Denver, Milwaukee,
Indianapolis, Hartford, Omaha, Providence, Cleveland, Portland (Oregon) and Salt
Lake City. When the Company completed its acquisition of Eastern TeleLogic
Corporation in March 1997, two additional metropolitan markets, Philadelphia and
Wilmington (Delaware), were added to TCG's services areas. See "Business --
Eastern TeleLogic Acquisition".  Additional TCG networks are under development
for the metropolitan areas of Nashville, Chattanooga, Knoxville, Birmingham,
Cincinnati, Columbus (Ohio), Charlotte, Tampa Bay, Sacramento, Minneapolis-St.
Paul, Atlanta and Orlando.  Upon completion of these networks, the Company will
operate networks in 65 metropolitan markets including 28 of the 30 largest
metropolitan areas.  As of December 31, 1996, the fiber optic networks of the
Company's wholly-owned subsidiaries spanned over 6,700 route miles, contained
over 345,000 fiber miles and served approximately 7,765 buildings.

     TCG has grown rapidly over the last several years, expanding its existing
networks, developing new networks and increasing its service offerings.  On a
pro forma basis, after giving effect to the Reorganization (as hereinafter
defined), the Company's revenues were approximately $283 million for 1996,
substantially all of which were derived from the provision of local
telecommunications services.

     Total revenues from the local telecommunications market in the United
States were estimated to have been approximately $100 billion in 1996.  In the
past, competitive access providers, including the Company, were limited to
serving only the dedicated services portion of this market, which was estimated
to have been approximately $5.5 billion in 1996, whereas the local switched
services portion of  this market for business customers was estimated to have
been approximately $60 billion.  The Company has expanded into the switched
services market in a number of states over the last five years by constructing
switched networks and obtaining the necessary regulatory authorizations and
interconnection arrangements to become a CLEC.

                                       4
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      With the passage and initial implementation of the Telecommunications Act
of 1996 (the "1996 Act"), the Company believes that it is well positioned to
address a significantly larger portion of the  telecommunications market and to
improve its operating margins in the switched and dedicated services markets by
expanding its networks, installing additional high capacity digital switches (as
well as increasing the switching capacity of existing switches) and offering new
products and services. In 1996 the Company introduced a new service offering
consisting of basic Internet access for business customers and in February 1997
TCG acquired a leading regional Internet services provider for business
customers.  See "Business -- CERFnet Acquisition".

     TCG has benefited from its relationships with the parents of its Class B
stockholders, TCI Communications, Inc.  (together with its consolidated
subsidiaries, "TCI"), Cox Communications, Inc. (together with its consolidated
subsidiaries, "Cox"), Comcast Corporation (together with its consolidated
subsidiaries, "Comcast") and Continental Cablevision, Inc. (together with its
consolidated subsidiaries, "Continental") (collectively, the Cable
Stockholders"), which are among the largest cable television companies in the
United States.  Through such relationships, the Company has been able to utilize
rights-of-way, obtain fiber optic facilities and share the cost of building new
fiber optic networks, thereby allowing the Company to achieve significant
economies of scale and scope through capital efficiencies in extending its
existing networks in a rapid, efficient and cost-effective manner.

     The Company believes that it has several advantages that enable it to
compete successfully in the new competitive local telecommunications
marketplace, including (i) extensive, technologically advanced networks located
or under development in major metropolitan markets nationwide, (ii) state-of-
the-art information systems, (iii) an experienced management team with
significant operational, technical, financial and regulatory expertise in the
local telecommunications industry, (iv) positive relationships with its broad
array of commercial customers, and (v) TCG's reputation for high quality
service, and (vi) working relationships with cable television operators.

                               BUSINESS STRATEGY

      As a premier competitive local telecommunications carrier, the key
elements of the Company's business strategy are to:

 .  PROVIDE A WIDE RANGE OF LOCAL TELECOMMUNICATIONS SERVICES. The Company
   provides a broad array of local telecommunications services to meet the
   voice, data and video transmission needs of its customers, including basic
   local exchange telephone services, enhanced switched services, dedicated
   services, high speed switched data services, Internet services, disaster
   avoidance services and video channel transmission services. In 1996,
   approximately 40% of the Company's revenues on a pro forma basis were
   generated from switched services. The Company expects a growing portion of
   its revenue to be derived from basic local exchange telephone services,
   enhanced switched services, Internet services and high speed switched data
   services as it deploys digital switches in its markets. As of

                                       5
<PAGE>
 
   December 31, 1996, the Company had 25 digital telephone switches and 101
   asynchronous transfer mode ("ATM") devices in operation and 414 ATM and other
   high speed data circuits in service. On a pro forma basis, after giving
   effect to the Reorganization (as hereinafter defined), the Company's revenues
   from switched services, which include local calling, grew by approximately
   77% to $113.0 million in 1996 from $63.9 million in 1995.

 .  FOCUS ON BUSINESS CUSTOMERS AND TELECOMMUNICATIONS CARRIERS. The Company's
   networks serve large metropolitan markets, which have significant
   concentrations of telecommunications-intensive businesses. The Company's
   customers in these markets include financial services firms, media and
   insurance companies, long distance carriers and resellers, hospitals and
   educational institutions, governmental agencies, Internet service providers,
   disaster recovery service providers, wireless communications companies,
   residential multiple dwelling units and an increasing number of small and
   medium-sized business customers. The national scope of the Company's local
   networks allows it to offer high volume business customers and long distance
   carriers uniformity of services, pricing, quality standards and customer
   service. In addition, the Company has arrangements with other
   telecommunications providers, including shared tenant services providers,
   cable television companies and long distance carriers, to resell TCG's
   services. In 1996, approximately 62% of the Company's revenues were generated
   from business customers (including resellers) and approximately 38% were
   generated from long distance carrier customers.

 .  BROADEN SERVICE OFFERINGS TO MEET CUSTOMER DEMAND AND COMPETE WITH ALL
   DISTANCE SERVICE OFFERINGS OF OTHER CARRIERS. The Company's large business
   customers generally have purchased local, long distance and other
   telecommunications services separately. As TCG increasingly seeks to market
   its services to small and medium-sized businesses, the Company has identified
   a demand from these customers to purchase all or most of their
   telecommunications services as a single package. TCG believes that other
   telecommunications carriers offer, or plan to offer, such packaged services.
   In addition to the Company's already announced plans to offer wholesale
   private line long distance services to its long distance carrier customers,
   TCG expects to make a general service offering of all distance services at
   the appropriate time. The Company will seek to leverage its existing network
   investment by routing and switching as great a portion as possible of such
   services over its existing local and regional facilities, with the balance of
   such services being provided by the resale by TCG of the services of other
   carriers.

 .  EXPAND GEOGRAPHIC REACH AND DENSITY OF EXISTING NETWORKS AND ENTER NEW
   MARKETS. In response to customer demand, the Company plans to increase the
   geographic reach and density of its existing networks by deploying additional
   fiber optic rings and connecting additional customers to its networks. The
   Company anticipates that making significant capital expenditures over the
   next several years to expand its existing networks and to develop new
   networks will lead to significant increases in revenue opportunities. The
   Company may also make selected acquisitions. As a facilities-based carrier,
   the Company

                                       6
<PAGE>
 
   utilizes a variety of means to expand geographically, including rights-of-
   way, easements, poles, ducts and conduits that are available from cable
   television operators, incumbent local exchange carriers, railways, subways,
   electric, gas and water utilities and municipal, state and federal street and
   highway authorities. In the course of expanding its networks, the Company
   also has the ability to reach TCG customers by reselling all or a portion of
   the telecommunications services offered by ILECs. However, the Company
   believes that the extensive geographic reach and density of its networks make
   it less reliant than other competitive local exchange carriers on the
   networks of the ILECs. In addition, where appropriate, the Company has the
   ability to link its customers to its networks through a variety of
   technologies including the use of microwave, including 38 gigahertz ("GHz")
   milliwave, services. The Company plans to expand into additional metropolitan
   markets, which the Company believes will further broaden its customer base
   and enhance its ability to attract national business accounts for its
   services.

 .  OFFER HIGH QUALITY NETWORKS AND SUPERIOR CUSTOMER SERVICE. TCG believes that
   it offers cost and service quality advantages over ILECs as a result of its
   integrated operations, customer support, network monitoring and management
   systems and state-of-the-art technology deployed in the Company's digital
   networks. TCG consults closely with its customers to develop competitively
   priced telecommunications services that are tailored to their particular
   needs. The Company's centrally managed customer care and support operations
   are also designed to facilitate the processing of orders for changes and
   upgrades in services. TCG believes that it provides greater attention and
   responsiveness to its customers than do the ILECs.

 .  BENEFIT FROM WORKING RELATIONSHIPS WITH CABLE TELEVISION OPERATORS. As of
   December 31, 1996, the cable television facilities of TCI, Cox and Comcast
   collectively passed approximately 36% of the country's 94 million homes
   passed by cable television facilities. Through its relationships with cable
   television operators, the Company has been able to utilize existing 
   rights-of-way, obtain fiber optic facilities and share the cost of building
   new fiber optic networks, thereby allowing the Company to achieve significant
   economies of scale and scope through capital efficiencies in extending its
   existing networks in a rapid, efficient and cost-effective manner. The
   Company is currently working with the Cable Stockholders for the provision of
   residential or multiple dwelling unit telephony services over the cable
   television operators' hybrid fiber-coaxial networks with TCG providing
   switching, call processing, calling features and ancillary services.
   Beginning as technical trials, these efforts have expanded into commercial
   offerings in certain locations in Connecticut, Michigan, California and
   Illinois, with additional offerings planned in Maryland and Florida. See
   "Certain Relationships and Related Transactions".

 .  SPEARHEAD REGULATORY REFORM. As the first and largest CLEC, TCG has been at
   the forefront of industry efforts for over a decade to introduce competition
   to the local telecommunications market. The Company has aggressively pursued
   the goal of making competitive local exchange services economically,
   technically and operationally feasible by

                                       7
<PAGE>
 
   working for legislative and regulatory reform and through negotiations with
   ILECs. The Company has continued its regulatory reform activities in an
   effort to ensure that the 1996 Act is implemented and interpreted in a manner
   that promotes fair competition for telecommunications services.

 .  CAPITALIZE ON MANAGEMENT TEAM EXPERIENCE. TCG's management team is comprised
   of executives who are recognized as leaders in the development of the
   competitive local telecommunications industry. This management team has
   extensive operational, technical, financial and regulatory expertise as well
   as a proven track record in a rapidly changing marketplace.

                                 THE OFFERINGS

     On June 27, 1996, TCG sold 27,025,000 shares of Class A Common Stock which
resulted in gross proceeds of approximately $432 million  (the "Stock
Offering"), and $300 million of 9 7/8% Senior Notes due 2006 and $1,073 million
of 11 1/8% Senior Discount Notes due 2007 (the "Notes Offerings") as part of an
initial public offering (the Stock Offering and the Notes Offerings are
collectively referred to as the "Offerings").  The Notes Offerings resulted in
aggregate gross proceeds of approximately $925 million.  The gross proceeds of
the Offerings (approximately $1.3 billion) were received by TCG on July 2, 1996.
In July 1996 TCG utilized a portion of the net proceeds of the Offerings (i) to
repay $250 million of bank indebtedness plus accrued interest, and (ii) to
purchase 7,975,738 shares of Class B Common Stock owned by Continental for
$16.00 per share less related expenses for a net cost of $121 million.

                               THE REORGANIZATION

     Prior to the Offerings, TCG was owned by subsidiaries of Cox (approximately
30%), TCI (approximately 30%), Comcast (approximately 20%) and Continental
(approximately 20%).  The business was operated through TCG, and beginning in
1992, TCG Partners, which is a New York general partnership owned prior to the
Reorganization by the Cable Stockholders in the same percentages as TCG.  TCG
Partners was formed to invest, with TCG, the Cable Stockholders and other cable
operators, in 14 partnerships (the "Local Market Partnerships") to develop and
operate local telecommunications networks. The Local Market Partnerships were
owned by TCG, and/or TCG Partners, and certain of the Cable Stockholders which
have cable operations in the particular markets addressed by the Local Market
Partnerships and, in some cases, other cable operators in such markets.  To
simplify this complex ownership structure, TCG and the Cable Stockholders agreed
to consolidate the ownership of TCG Partners and the Local Market Partnerships
as wholly-owned subsidiaries of TCG.  As part of this process, certain of the
other cable operators agreed to sell their interests in the Local Market
Partnerships to TCG directly or through a Cable Stockholder.

     Reorganization Transactions Consummated Prior to or in Connection with the
Offerings.  In connection with the Offerings, TCG and the Cable Stockholders
entered into a reorganization agreement (the "Reorganization Agreement")
pursuant to which TCG, TCG Partners and the Local

                                       8
<PAGE>
 
Market Partnerships were reorganized (the "Reorganization").  The principal
transactions comprising the Reorganization, all of which occurred during 1996,
were:

 .  The acquisition by TCG of TCG Partners in exchange for Class B Common Stock
   issued to the Cable Stockholders.

 .  The acquisition by TCG of all of the interests in 12 of the 14 Local Market
   Partnerships in exchange for Class B Common Stock issued to the Cable
   Stockholders and Class A Common Stock issued to other cable operators.

 .  The contribution to TCG of $269.0 million in aggregate principal amount of
   indebtedness, plus accrued interest from May 1995, owed by TCG to the Cable
   Stockholders (except that TCI retained a $26 million subordinated note of
   TCG) in exchange for Class B Common Stock issued to the Cable Stockholders.

 .  In connection with Continental's pending merger with U S WEST, the purchase
   by TCG of 7,975,738 shares (out of 25,761,330 shares) of Class B Common Stock
   owned by Continental at a price per share equal to $16.00 per share of the
   Class A Common Stock offered in the Stock Offering, less the applicable
   underwriting discount and pro rata portion of the registration fees,
   representing an aggregate purchase price of $121 million. (On November 5,
   1996, the U.S. Department of Justice announced, and on February 27, 1997,
   moved for final judgment with respect to, a settlement with U S WEST and
   Continental pursuant to which Continental will be required to reduce its
   ownership in TCG to below 10% by June 30, 1997 and to eliminate such
   ownership entirely by December 31, 1998. On February 19, 1997, pursuant to
   the Amended and Restated Stockholders Agreement dated June 26, 1996, between
   TCG and the Cable Stockholders (the "Amended Stockholders Agreement"),
   Continental converted 4,000,000 shares of Class B Common Stock into 4,000,000
   shares of Class A Common Stock and in accordance with the provisions of Rule
   144, promulgated by the Securities and Exchange Commission under the
   Securities Act of 1933, as amended (the "Securities Act"), transferred these
   shares to one or more third party transferees.)

     In consideration of the transfer by each of the Cable Stockholders of its
respective interest in TCG Partners and the Local Market Partnerships and the
contribution to TCG of the indebtedness described above, the Company issued
immediately prior to the Offerings 69,250,230 additional shares of Class B
Common Stock to the Cable Stockholders.

     Reorganization Transactions After the Offerings.  On July 2, 1996, TCG
issued 576,263 shares of Class A Common Stock to the unaffiliated minority
partners in TCG Detroit in consideration for the transfer to TCG of the
remaining partnership interests in TCG Detroit.

     On December 26, 1996, TCI transferred its interest in TCG Seattle and TCG
San Francisco

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<PAGE>
 
to the Company.  In addition, having acquired the 22.9% and 22.2% minority
partnership interests in TCG San Francisco and TCG Seattle, respectively,
formerly held by Viacom Telecom, Inc., TCI transferred those partnership
interests to TCG.  (The issuance of shares of Class B Common Stock to TCI
pursuant to the Reorganization  assumed that, subsequent to the Offerings, TCI
would so contribute its then current partnership interests in TCG Seattle and
TCG San Francisco, and that TCI would so acquire and contribute to TCG the
partnership interests of Viacom Telecom, Inc. in TCG Seattle and TCG San
Francisco.)

     In addition, on December 26, 1996 TCI was issued  (i) 638,862 shares of
Class A Common Stock in consideration for the transfer on such date to TCG of
the partnership interest which TCI had acquired from MicroNet, Inc. in TCG San
Francisco and (ii) 372,666 shares of Class A Common Stock in consideration for
the transfer on such date to TCG of the partnership interest which TCI had
acquired from InterMedia Partners in TCG San Francisco.  As a result, as of
December 26, 1996, all of the Local Market Partnerships had become wholly-owned
subsidiaries of TCG.

     As of December 31, 1996, TCI, Cox, Comcast and Continental owned 37.2%,
29.8%, 19.5% and 13.6%, respectively, of the Company's Class B Common Stock,
representing 36.4%, 29.1%, 19.1% and 13.3%, respectively, of the combined voting
power of the Company's Common Stock. In addition, TCI owned 3.4% of the
Company's Class A Common Stock, representing 0.1% of the combined voting power
of the Company's Common Stock.  The Cable Stockholders collectively owned 82.7%
of the Company's Common Stock, representing 98.0% of the combined voting power
of the Company's Common Stock.

                         EASTERN TELELOGIC ACQUISITION

     Effective March 1, 1997, TCG completed its previously announced acquisition
of Eastern TeleLogic Corporation ("ETC") for 2,757,083 shares of TCG's Class A
Common Stock.  ETC is the leading competitive local exchange carrier in
Philadelphia, Pennsylvania and in the neighboring cities of Camden, New Jersey
and Wilmington, Delaware.  In the first of two steps, on October 25, 1996, ETC
redeemed shares of its stock and employee stock options (approximately 47%) not
held by Comcast CAP of Philadelphia, Inc. ("Comcast CAP"), a corporation owned
51% by Comcast Corporation and 49% by TCG.  Comcast CAP borrowed at a market
interest rate approximately $115 million from TCG as a short-term loan and, in
turn, loaned this amount to ETC to effect the redemption.  In the second step,
TCG acquired Comcast's 51% stock interest in Comcast CAP in exchange for
2,757,083 shares of the Company's Class A Common Stock, resulting in ETC
becoming a wholly-owned subsidiary of TCG. TCG also assumed an aggregate of
approximately $60 million of ETC debt  and other obligations.  The acquisition
of ETC will provide TCG with access to the  Philadelphia market, the nation's
fifth largest  market, and will allow TCG to establish a contiguous network
between Boston and Washington, D.C.  ETC operates a Class 5 digital telephone
switch on its 525-mile fiber optic network which connects to more than 360
buildings.
 

                              CERFNET ACQUISITION

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     On February 4, 1997, the Company acquired from General Atomics all the
outstanding capital stock of CERFnet Services, Inc. ("CERFnet"), a leading
regional provider of Internet-related services to businesses, including dial-up
and dedicated Internet access, World Wide Web hosting and colocation services
and Internet  training.  TCG issued to General Atomics, CERFnet's former
controlling stockholder, 2,100,000 shares of its Class A Common Stock and
granted to General Atomics certain registration rights with respect to such
shares of Class A Common Stock. CERFnet operates an advanced nationwide backbone
network, maintains state-of-the-art Internet server facilities, has established
and maintains direct peering relationships with other Internet service
providers,  and serves currently over 6,000 customers located primarily in
California and Arizona.  TCG expects to upgrade CERFnet's backbone, to
accelerate the expansion of CERFnet's services nationwide and to achieve
marketing synergies by packaging CERFnet's Internet services with TCG's
complementary telecommunications services.


                               BIZTEL INVESTMENT

       On February 29, 1996, the Company acquired a minority investment in
BizTel Communications, Inc. ("BizTel"), which holds FCC licenses to provide
telecommunications services utilizing 38 GHz digital milliwave transmission in
160 geographic areas, which have a population of approximately 178 million
people, and include more than 80 of the 100 largest metropolitan markets and all
markets where TCG operates. BizTel also has applications for 84 additional
licenses pending Federal Communications Commission ("FCC")  approval in
geographic areas which have a population of an additional 55 million people.
BizTel's 38 GHz milliwave services can be used by TCG to economically connect
customers to the Company's fiber optic networks, to provide network redundancy,
diverse routing or quick temporary installations and to provide stand-alone
facilities where the Company does not have fiber optic networks.  On February
28, 1997, TCG obtained an option, effective July 15, 1997, to acquire the
remaining equity interest in BizTel in exchange for the issuance of 1,667,631
shares of the Company's Class A Common Stock to the majority owners of Biztel,
who will  be granted certain registration rights with respect to such Class A
Common Stock.  The Company also granted a reciprocal option to such majority
owners,  also effective July 15, 1997, to put the remaining equity interest in
BizTel to TCG in exchange for the issuance of such shares of Class A Common
Stock.  The closing of this purchase is subject to regulatory approvals,
including approval of the FCC.

                      REGULATORY AND GOVERNMENTAL MATTERS

     Introduction.    TCG is subject to extensive federal and state regulation.
In most states, the Company is subject to certification and tariff filing
requirements with respect to intrastate services. TCG is required to file
tariffs for interstate access services with the FCC, although such tariff
requirements are generally less restrictive than those imposed on ILECs which
offer similar services.  An  October 1996 FCC ruling required federal tariffs
for domestic interstate, interexchange services to be canceled by September 22,
1997.  The  FCC's order has been temporarily stayed and  a number of parties
have filed petitions with the FCC seeking reconsideration of the FCC's decision.

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<PAGE>
 
     Under the 1996 Act, all local exchange carriers, including TCG, must
interconnect with other carriers, make their services available for resale by
other carriers, provide non-discriminatory access to rights of way, offer
reciprocal compensation for termination of traffic  and provide dialing parity
and telephone number portability. See "Business -- Competition".  The Company,
ILECs, other CLECs and long distance carriers, are likely to be required to
contribute some portion of their gross revenues (subject to adjustments)  to the
support of universal service programs  under the 1996 Act when the FCC adopts
final rules implementing the universal service provisions.  TCG may also be
eligible to receive funds from universal service programs if the Company
provides services to schools and libraries.

     Interconnection/Access Arrangements.  Under the 1996 Act, ILECs are
required to negotiate with TCG to provide for interconnection to the ILEC
network.  In the event that an interconnection agreement cannot be negotiated
the 1996 Act provides for mandatory arbitration before State public utility
commissions ("State PUCs").  TCG was able to reach negotiated agreements with
NYNEX for New York, with Pacific Telesis for California and with Bell South for
its entire region.  TCG was required to seek arbitration with ILECs to obtain
interconnection agreements in other states where the Company operates.  During
this process TCG has been able to operate pursuant to pre-existing arrangements
with ILECs.  TCG's initial set of arbitrations are largely at an end and its
interconnection agreements are either final or nearing final regulatory
approval.  However, some ILECs are seeking judicial review of the arbitrated
decisions and certain of TCG's final interconnection agreements are subject to
appeal to federal and state courts as permitted by the 1996 Act.  In particular,
TCG's agreements with U S WEST in Arizona, Colorado and Washington (State) have
been appealed by U S WEST and its agreement with Southwestern Bell in Texas has
been appealed by Southwestern Bell.  TCG has appealed its agreement with
Ameritech in Wisconsin.  In none of these appeals has a preliminary injunction
been sought or granted and accordingly the interconnection agreements as
approved by the State PUCs remain valid and in effect.
 
     On August 8, 1996, the FCC released both a First Report and Order and a
Second Report and Order and Memorandum Opinion and Order in its CC Docket No.
96-98 (collectively, the "Interconnection Orders").   The Interconnection Orders
establish a framework of minimum national rules designed to enable State PUCs
and the FCC to begin implementing many of the local competition provisions of
the 1996 Act. On September 27, 1996, the FCC issued an Order on Reconsideration
of the First Report and Order in CC Docket No. 96-98, in which it added a non-
usage sensitive charge to the rate for unbundled switching and clarified that,
as a practical matter, an IXC may not lease unbundled switching for the
provision of exchange access service only. Although the new rules were scheduled
to become effective on September 30, 1996, numerous parties to the rulemaking
filed petitions for review of the Interconnection Orders, and the U.S. Court of
Appeals for the Eighth Circuit on October 15, 1996 issued a stay of certain
provisions of the Orders pending resolution of the pending appeals.  The stay
will defer effectiveness of the FCC's pricing rules and the "pick and choose"
rule, which allows CLECs to receive the benefit of the most favorable provisions
contained in an ILEC's agreements with other carriers, until the Court of
Appeals issues a decision in the appeal.  On November 12, 1996, the U.S. Supreme
Court rejected applications to vacate the stay filed by the United States and
intervenors in support of the United

                                       12
<PAGE>
 
States.  The appeals of the FCC's First Report and Order have been fully
briefed, and oral argument occurred on January 17, 1997.  Petitions for review
have also been filed with the FCC challenging certain other aspects of the
Interconnection Orders.   Oral argument on petitions for review of the Second
Interconnection Order  is scheduled to occur in mid-April 1997.  In addition, a
number of parties have filed petitions with the FCC, asking the FCC to
reconsider and revise portions of the Interconnection Orders.  TCG is unable to
predict whether the new rules and policies described above will be further
revised by the FCC on reconsideration or set aside by the Court of Appeals, or
whether another federal court would find that some or all portions of the 1996
Act are unconstitutional.

     ILEC Provision of InterLATA Services.  The 1996 Act establishes procedures
under which certain ILECs (Ameritech, Bell Atlantic, Bell South, NYNEX, Pacific
Telesis Group, SBC Communications and U S WEST) can provide long distance
services within their  telephone service areas, upon satisfying certain
conditions, subject to  the FCC's approval.   Although no such ILECs have
applications for long distance authority pending at the FCC  (Ameritech, the
only ILEC to file such an application, withdrew its request), ILECs are expected
to make such filings in the future.  The ability of such ILECs to provide long
distance services will enable them to provide customers with a full range of
local and long distance telecommunications services.  The provision of long
distance services by such ILECs may reduce the market share of the major long
distance carriers, which are among TCG's largest customers, but TCG believes it
may encourage these carriers to use TCG's and other CLECs' services instead of
such ILECs' services.

     Access Charge Reform.  On December 24, 1996, the FCC adopted certain
changes and proposed other changes in the interstate access charge system.  The
FCC removed restrictions on ILECs' ability to lower access prices and relaxed
the regulation of new switched access services in those markets where there are
other providers of access services.  If this increased pricing flexibility is
not effectively monitored by federal regulators, it could have a material
adverse effect on TCG's ability to compete in providing interstate access
services.  The FCC also proposed rules to reform the interstate access charge
rate structure, including proposals that would either grant ILECs increased
pricing flexibility based on increased levels of competition, or mandate lower
rates regardless of the level of competition.  Although it is impossible to
predict the outcome of the upcoming access charge reform, TCG believes that it
is likely that the planned reform of the FCC's access charge rules ultimately
will result in a significant restructuring of the rates for ILEC interstate
switched access services, and a significant increase in pricing flexibility for
ILECs.

     Other 1996 Act Provisions.  The 1996 Act contains other provisions that
potentially could affect TCG's business, which may be subject to FCC rulemaking
and judicial interpretation, including a provision that limits the ability of a
cable television operator and its affiliates to acquire more than a 10%
financial interest or any management interest in a LEC which provides local
exchange service in such cable operator's franchise area.

     Telephone Numbering Issues. On July 2, 1996, the FCC released its First
Report and Order and Further Notice of Proposed Rulemaking promulgating rules
and regulations to implement

                                       13
<PAGE>
 
Congress' statutory directive concerning number portability (the "Number
Portability Order").  The Number Portability Order was modified on March 6,
1997.  As modified, the Number Portability Order requires all ILECs and CLECs to
begin phased development of a long-term service provider portability method in
the 100 largest Metropolitan Statistical Areas ("MSAs") no later than October 1,
1997, and to complete deployment in those MSAs by December 31, 1998 for all MSAs
in which another carrier has made a specific request for the provision of
portability.  After December 31, 1998, each ILEC and CLEC must make number
portability available within specific time frames after receiving a specific
request by another telecommunications carrier.  Until long-term service
portability is available, ILECs and CLECs must provide currently available
number portability measures as soon as reasonably possible after a specific
request from another carrier.  As new carriers are at a competitive disadvantage
without telephone number portability, the Number Portability Order should
enhance the ability of the Company to offer service in competition with the
ILECs, but it is uncertain how effective these regulations will be in promoting
number portability. The Number Portability Order does not address how the costs
of implementing long-term service portability, which could be substantial, will
be recovered.
 
     State Regulation.  Most State PUCs require carriers that wish to provide
local and other jurisdictionally intrastate common carrier services to be
authorized to provide such services.  TCG's operating subsidiaries are
authorized to provide local exchange services in Arizona, California, Colorado,
Connecticut, the District of Columbia, Florida, Illinois, Indiana, Maryland,
Massachusetts, Michigan, Missouri, Nebraska, New Jersey, New York, Ohio, Oregon,
Pennsylvania, Rhode Island, Texas, Utah, Virginia, Washington and Wisconsin.
TCG expects to file for CLEC authority in a number of additional states in 1997,
and to seek geographically broadened authority in states in which it already
holds LEC authority for portions of the state.

     TCG typically is not subject to price regulation or to rate of return
regulation for its intrastate services.  In most states, TCG is required to file
tariffs setting forth the terms, conditions and prices for its intrastate
services.  In some jurisdictions, the tariff can list a rate range for
intrastate services. TCG may be subject to additional regulatory burdens in some
states, such as quality of service requirements, the requirement to offer
residential service and universal service contributions.  TCG's ability to incur
long-term indebtedness is subject to the approval of the New York Public Service
Commission and the New Jersey Board of Public Utilities, which have granted TCG
authority to issue up to $2 billion of long term debt, a level well in excess of
the Company's current level of long-term indebtedness.
 
     Local Government Authorizations.  TCG may be required to obtain from
municipal authorities in certain cities street opening and construction permits
and other rights-of-way to install and expand its digital networks.  In some
cities, TCG's affiliates or subcontractors may already possess the requisite
authorizations to construct or expand TCG networks.

     In some of the metropolitan areas where TCG provides network services, TCG
may pay license or franchise fees.  There can be no assurance that
municipalities that do not currently impose fees will not seek to impose fees in
the future, nor is there any assurance that following the

                                       14
<PAGE>
 
expiration of existing authorizations, fees will remain at their current levels.
Under the 1996 Act, such fees must be fair and reasonable, applied on a
competitively neutral and non-discriminatory basis and be publicly disclosed by
the relevant governmental entity.  There can be no assurance, however, that
municipalities that currently favor the ILECs will conform their practices in a
timely manner or without legal challenges by the TCG or another CLEC.  In
September 1996, TCG filed suit in federal district court alleging that the City
of Dearborn, Michigan acted in unlawful and discriminatory manner in imposing a
fee equal to a percentage  of  gross revenues for its use of public 
rights-of-way, which fee is not imposed on the local ILEC (Ameritech Michigan)
in violation of applicable state law and Section 253(c) of the 1996 Act. TCG's
suit is currently awaiting trial in the U.S. District Court for the Eastern
District of Michigan (Southern Division). In addition, in July 1996, a
subsidiary of TCG, Teleport Communications (New York) ("TCNY") filed suit in
United States District Court in Newark, New Jersey alleging that an ordinance
adopted by the Township of Bloomfield, New Jersey imposing a fee per linear foot
per year for the right to use a public right-of-way is unlawfully
discriminatory, in violation of the United States Constitution and Section
253(c) of the Communications Act. TCNY has filed a motion for summary judgment,
which is currently awaiting action by the U.S. District Court for the District
of New Jersey. In addition, in February 1997 the City of Chattanooga joined TCG
in a pending action in the U.S. District Court for Eastern Tennessee seeking to
interpret the nondiscriminatory and competitively neutral requirements of
Section 253(c) of the 1996 Act.

     TCNY and The City of New York entered into a Franchise Agreement, dated as
of May 2, 1994 (the "New York Franchise") pursuant to which The City of New York
granted TCNY the non-exclusive right for a term of fifteen years to provide
Telecommunications Services (as defined in the New York Franchise) in The City
of New York.  In addition to other payments specifically required by the New
York Franchise, the New York Franchise requires that TCNY pay to The City of New
York as an annual franchise fee an amount based on a percentage of TCNY's gross
revenues.  TCG is restricted under the terms of the New York Franchise from
providing cable service or mobile telecommunications services in The City of New
York.  TCNY has recently entered into discussions with The City of New York
regarding the possible amendment of the New York Franchise.


                             THE COMPANY'S SERVICES

     The Company provides its customers with a wide array of  local
telecommunications services, including basic local exchange telephone services,
enhanced switched services, Internet services, dedicated services, high-speed
switched data services, disaster avoidance services and video channel
transmission services.  Switched voice services offered by the Company
primarily use high-capacity digital switches to route voice transmission
anywhere on the public switched telephone network.  TCG's dedicated services,
which include private line and special access services, use high-capacity
digital circuits to carry voice, data and video transmission from point-to-point
in multiple configurations.  The Company provides its media industry customers
with point-to-point, broadcast-quality video channels for video transmission
between two or more locations, including video link services to all the major
television networks as well as to other programmers.  The Company also

                                       15
<PAGE>
 
provides private network management and systems integration services for
businesses that require combinations of various dedicated and switched
telecommunications services.

SWITCHED SERVICES

      The Company's switched services provide customers with local dial tone and
local and regional calling capabilities and connection to their interexchange
carriers.  The Company's switched services are branded under the "Prime" name
and include the following:

      PrimeNBX /SM/ gives voice and data customers a choice for analog, digital
      voice-only and ISDN Centrex telephone lines to customers' desktops. With
      PrimeNBX, TCG owns, houses, manages and maintains the switch. PrimeNBX
      allows customers to retain control over network configurations. Lines can
      be added, deleted and moved as needed. Business customers can utilize TCG
      as their primary Centrex provider, as a supplement to the ILEC's Centrex
      service, or as an addition to a fully-utilized customer owned private
      branch exchange ("PBX").

      PrimeXpress /SM/ service is utilized by PBX users to provide access to the
      local, regional and long distance telephone networks. PBX customers may
      use either the Company's telephone numbers or their ILEC-assigned
      telephone numbers. Customer access to the Company's network is
      accomplished by a DS-1 digital connection or analog trunks between the
      customer's PBX port and the Company's switching centers.

      PrimePath /SM/ service enables customers to connect to the TCG network
      using Prime Business Lines or Prime Business PBX Trunks. PrimePath is
      available in a variety of feature packages which have been developed to
      serve TCG customers, with features such as Call- Waiting, Call-Forwarding,
      Conference Calling and PrimeMail voice mail.

      PrimePlus /SM/ service provides customers with a competitive alternative
      to ILEC service for intraLATA toll calls. It is a customized, high quality
      calling plan available to PrimeNBX, PrimePath and PrimeXpress customers.
      TCG works with customers to devise cost-saving intraLATA calling programs
      based on actual usage and calling patterns.

      PrimeOne /SM / service is basic local exchange service which can be
      tailored to a customer's particular calling requirements. Local telephone
      service includes operator and directory assistance services, as well as an
      intraLATA toll plan.

      TCG Pay Phone Services provide full public pay telephone service to public
      customers and dial tone services and access lines to other public pay
      telephone providers. TCG is the primary provider of public pay phone
      service for all properties of The Port Authority of New York and New
      Jersey, including Kennedy, La Guardia and Newark airports. In 1996 TCG was
      awarded a multi-year exclusive contract to provide all pay phone services
      at the Sky Harbor International Airport and other municipal airports in
      Phoenix, Arizona.

      Switched Access Services provides interexchange carriers with a switched
      connection to their customers for the origination and termination of long
      distance telephone calls.

      Integrated Services Digital Network ("ISDN") PrimePlex/SM/ Services
      provides TCG's customers with multiple voice and data communications
      services over a single telecommunications line, The Company's ISDN
      services allow customers to perform

                                       16
<PAGE>
 
      multiple functions such as simultaneous voice and computer links, and
      enable the Company to offer customers value-added features. High speed
      ISDN applications include desk top video conferencing, interconnection of
      local area networks ("LANs") and Internet access.
 
      Advanced Intelligent Network ("AIN") Services, utilizing the Bellcore
      ISCP/tm / format, offer customers advanced, customized switching features
      which may include local number portability.
 
DEDICATED SERVICES

     The Company's dedicated services, which include special access and digital
private line services, use high-capacity digital circuits to carry voice, data
and video transmission from point-to-point in flexible configurations involving
different standardized transmission speeds and circuit capacities, including:

     DS-0 A dedicated service that accommodates business communications with
     digital data transmission through a voice grade equivalent circuit with a
     capacity of up to 64 kilobits per second ("kbps"). This service offers a
     private line digital channel for connecting telephones, fax machines,
     personal computers and other telecommunications equipment. Multiple DS-0
     services are offered in a variety of combinations, depending on the
     particular application and can also provide voice grade analog connections.

     DS-1 A high speed digital channel that typically links customer locations
     to long distance carriers or other customer locations. Used for multiple
     voice or data transmission, access to the Internet and interconnection of
     LANs, DS-1 services accommodate digital data transmission capacity of up to
     1.544 megabits per second ("mbps"), the equivalent of 24 voice grade
     circuits.

     European-Standard DS-1(E-1) The Company was the first U.S.-based local
     carrier to offer this dedicated high capacity service, which allows
     customers to accommodate their international traffic with a digital data
     transmission capacity of up to 2.048 mpbs, which is equivalent to 30 voice
     grade equivalent circuits. This dedicated service offers international
     business customers the flexibility to connect their United States locations
     to international circuits that operate at the high capacity European
     standard transmission speed.

     DS-3 With digital data transmission capacity of up to 44.736 mbps, this
     dedicated service provides a very high capacity digital channel, which is
     equivalent to 28 DS-1 circuits or 672 voice grade equivalent circuits. This
     digital service is used by long distance carriers for central office
     connection and by some large corporate users to link multiple sites. It is
     also used for data services applications.

     TCG OmniRing(SM) service provides a standard Optical Carrier ("OC") service
     for those customers requiring enhanced network survivability, advanced
     network architectures and

                                       17
<PAGE>
 
     centralized network monitoring and management capabilities. With TCG
     OmniRing customers enjoy the benefits of dedicated private local OC3 or
     OC12 synchronous optical network ("SONET") rings between various customer-
     designated sites and the Company's nodes.

DATA SERVICES

     The Company offers its customers a broad array of data services that enable
customers to create their own internal computer networks and access external
computer networks and the Internet. In 1992, TCG introduced its  native speed
LAN inter-networking data service which is used to connect workstations and
personal computer users on one or more LANs.  Called OmniLAN /SM/, this service
provides users with transmission capacity for 10 mbps Ethernet, 4 and 16 mbps
Token Ring and 100 mpbs FDDI  LAN interconnections.  Native speed services avoid
the bottleneck problems that are frequently encountered with customary DS-1
connections by providing the customer with a circuit that matches the
transmission speeds of its LAN.  OmniLAN provides dedicated circuits, guaranteed
transmission capacity and guaranteed bandwidth for virtually all LAN
applications. Users can share files and databases as if they were all working on
the same computer, or within the same LAN.  In 1996 TCG introduced Fast Ethernet
LAN Interconnect Service for business customers which have or plan to build Fast
Ethernet networks and require native speed connections between geographically
disparate LANs.

     As companies and communications become more sophisticated, there is an
increased need for customer access to superior traffic management of sensitive
data, video and voice transmission within a single metropolitan area or between
various company operations.  The Company's switched data services, called
OmniStream /SM/, offer sophisticated switched data services  over the Company's
SONET/ATM backbone and provide high standards in reliability and flexibility
while enabling users to reduce the costs associated with interconnecting various
geographically dispersed and architecturally diverse information systems.  The
Company's ATM platform supports evolving high-speed applications, such as
multimedia, desktop video conferencing and medical imaging. Additionally, the
Company's services allow users to interconnect both high speed and low speed LAN
environments.  Customers also benefit from flexible billing, as well as detailed
usage reports.

INTERNET SERVICES

     OmniOnLine/SM / Internet Services provide business customers with basic
     Internet access over   TCG's SONET based ATM backbone network.
 
     CERFnet Services include a full range of Internet-related services for
     businesses and professionals. These services include basic Internet dial up
     access for professionals and small businesses, marketed as DIALn'CERF(SM)
     services and dedicated Internet access for larger customers at speeds
     ranging from 56 kbps to DS-3, as well as LAN connections. CERFnet also
     provides World Wide Web hosting services; the customer may choose to locate
     its Internet server on its own premises with CERFn'WEB(SM) services or may
     colocate

                                       18
<PAGE>
 
     its server at a CERFnet facility connected directly to CERFnet's Internet
     backbone with WEB SuperSite(SM) services. CERFnet also offers Internet
     training and consulting including the design of World Wide Web sites.
 
VIDEO SERVICES

     TCG provides analog video link services to its media industry customers,
including all of the major television networks as well as to many cable services
and independent programmers.  The Company's video services include offering a
broadcast quality, analog channel which can be provided on a point-to-point or
point-to-multipoint basis.

WIRELESS SERVICES

     OmniWave /SM/ services, TCG's 38 GHZ digital milliwave private line
     service, supports capacities of 4 DS-1s, 8 DS-1s and 1 DS-3. These services
     can be multiplexed at either end of the circuit to provide lower levels of
     bandwidth. OmniWave services utilize a broadband milliwave transmission
     spectrum for quality and reliability that is comparable to that achieved by
     conventional fiber optic networks. BizTel is TCG's primary and preferred
     provider of these services.

RESIDENTIAL SERVICES

     TCG currently offers residential telephony services on a retail basis in
several multiple dwelling units and  in a number of single family residences and
continues to develop services for this market. The Company has also commenced
offering  residential services directly to consumers in New York City.  TCG
provides wholesale local exchange services, including local and long distance
toll usage, features and auxiliary functions such as network provisioning,
installation, customer service, billing, operator services, and directory
assistance.  TCG's customers, which resell these services to individual users,
include landlords, real estate development and management companies and the
Cable Stockholders.

CUSTOMERS AND MARKETING

     The Company's customers are principally telecommunications-intensive
businesses, hospitals, and educational institutions, governmental agencies, long
distance carriers and resellers, Internet service providers, disaster recovery
service providers  and wireless communications companies.  In 1985, the
Company's customers were primarily long distance carriers.  While the Company's
carrier business has continued to grow, in 1996 all other customers (including
resellers) accounted for approximately 62% of the Company's pro forma revenues.
During 1996, the company's top 10 customers accounted for approximately 52% of
TCG's total pro forma revenues. Sprint accounted for more than 10% of such
revenues, and no customer accounted for 15% or more of such revenues.

                                       19
<PAGE>
 
     The Company has sought to establish "TCG"(R) , "Prime-" and "Omni-" as
recognized brand names for its services and products.  TCG plans to rebrand the
Internet services of its CERFnet subsidiary as "TCG CERFnet" services.   The
Company's marketing emphasizes its state-of-the art digital networks, flexibly
priced products and services, responsive customer service orientation and
integrated operations, customer support and network monitoring and management
systems.  For large telecommunications-intensive businesses that depend on
accurate and reliable telecommunications, the Company promotes the operational
and strategic security achieved through vendor and physical diversity. The
Company's centrally managed customer care and support operations are designed to
facilitate the installation of new services and the processing of orders for
changes and upgrades in TCG customer services.  The Company seeks to be among
the first to introduce new telecommunications products and service, thereby
increasing usage among existing TCG customers and attracting new customers to
the Company's networks.

     The Company generally offers its services in accordance with applicable
tariffs filed with the FCC (for interstate services) and State PUCs (for
intrastate services).  As a non-dominant carrier, TCG does not have to cost-
justify its rates and frequently enters into customer and service specific
arrangements.  The services offered by TCG are typically priced at a modest
discount to the prices of the ILECs.

     With a direct sales force in each of its markets, TCG initially targets the
large telecommunications-intensive businesses concentrated in the major
metropolitan markets served by its networks.  The Company's customers in these
markets include financial services firms, media and health care companies and
educational and governmental institutions.  In addition, TCG markets its
services through sales agents, landlords, advertisements, trade journals, media
relations, direct mail and participation in trade conferences.

     The Company is increasing its marketing to small and medium-sized business
customers. The Company's strategies for addressing this market include (i)
hiring and training specialized account executives dedicated to developing this
market; (ii) increased marketing to this class of customers in office buildings
or multiple dwelling units already served by TCG's network; (iii) developing
special services and packages of services attractive to this market segment; and
(iv) employing 38 GHz wireless technology to reach these customers cost-
effectively.  The Company believes that this market segment offers significant
opportunities.

     TCG also targets long distance carriers and resellers, Internet service
providers, disaster recovery service providers  and wireless telephone companies
through its national sales organization. The Company has master services
agreements (which generally set forth technical standards, ordering processes,
pricing methodologies and service grade requirements, but do not guarantee any
specified level of business for TCG) with a significant number of long distance
carriers.  AT&T considers TCG a preferred national supplier of dedicated and
switched access services.  By providing long distance companies a local
connection to their customers, the Company enables these carriers to avoid
complete dependence on the ILECs for access and to obtain a high quality,
reliable local connection at savings over the ILECs' charges.  The national
scope of the Company's local networks

                                       20
<PAGE>
 
allows it to offer high volume business customers and long distance carriers
uniformity of services, pricing, quality standards and customer service.  In
addition, the Company has arrangements with other telecommunications providers,
including shared tenant service providers, cable television companies and long
distance carriers, to resell TCG's services.  TCG has engaged in technical
trials pursuant to which certain long distance carriers have resold TCG local
exchange service and intraLATA toll service bundled with their long distance
service.  These trials began in the second half of 1995, and as of December 31,
1996, one such trial was continuing.  Because of the limited scope and
preliminary nature of these trials, the Company is unable to determine at this
time whether these services will be expanded or become commercial offerings.
The Company believes that it has been and will continue to be one of the largest
providers of competitive local access services for long distance carriers.

                                  COMPETITION

     The Company faces substantial and increasing competition in each of the
metropolitan areas it serves or plans to serve from entities that offer services
similar to those offered by TCG, including ILECs such as Ameritech, Bell
Atlantic, Bell South, NYNEX, Pacific Telesis Group, SBC Communications, U S
WEST, Southern New England Telecommunications and GTE.  The Company believes
that ILECs generally benefit from their long-standing relations with customers,
substantial technical and financial resources, established ubiquitous networks
and federal and state regulations that could provide them with increased pricing
flexibility as competition increases.  In addition, in most of the metropolitan
areas in which the Company currently operates, at least one, and sometimes
several, other CLECs offer substantially similar services at substantially
similar prices to those of the Company.  Other CLECs, ILECs entering new
geographic  markets, cable television companies, electric utilities, long
distance carriers, microwave carriers, wireless telephone system operators and
private networks built by large end users may offer services similar to those
offered by the Company.  In addition, the current trend of actual and proposed
business combinations and alliances in the telecommunications industry, which
include mergers between ILECs, between interexchange carriers ("IXCs") and
international carriers and between IXCs and CLECs, may create significant new
competitors for the Company.

     The 1996 Act is intended to increase competition in the local
telecommunications business. The 1996 Act requires all local exchange providers,
including the Company and new entrants, to offer their services for resale and
requires ILECs to offer their substantial network facilities on a discounted
wholesale basis and on an unbundled basis.  These requirements may facilitate
entry by new competitors without substantial capital risk or investment.
However, there can be no assurance that any rates or facilities offered by ILECs
to TCG or other CLECs will be economically attractive or technically viable.

     The Company believes that the 1996 Act will provide it with increased
business opportunities and potentially better margins  by opening all local
markets to competition and by requiring ILECs to provide improved direct
interconnection at lower cost.  However, under the 1996 Act, the FCC and some
state regulatory authorities may provide ILECs with increased flexibility to
reprice their

                                       21
<PAGE>
 
service as competition develops and as ILECs allow competitors to interconnect
to their networks. In addition, some new entrants in the local market may price
certain services to a particular customer or for a particular route below the
prices charged by the Company for services to that customer or for that route,
just as the Company may itself underprice those new entrants.  If ILECs and
other competitors lower their rates and can sustain significantly lower prices
over time, this may adversely affect revenues and margins of TCG.  If regulatory
decisions permit the ILECs to charge CLECs substantial fees for interconnection
to the ILECs' networks or afford ILECs other regulatory relief, such decisions
could also have a material adverse effect on the Company.  However, the Company
believes that the negative effects of the 1996 Act may be more than offset by
(i) increased revenues available as a result of being able to address the entire
local exchange market, (ii) mutual reciprocal compensation with the ILEC that
results in TCG terminating its local exchange traffic on the ILEC's network at
little or no net cost to TCG, (iii) obtaining access to off-network customers
through more reasonably priced expanded interconnection with ILEC networks and
(iv) a shift by IXCs to purchase access services from CLECs instead of ILECs.
There can be no assurance, however, that these anticipated results will offset
completely the effects of increased competition as a result of the 1996 Act.

     In addition, historically, the Company has been able to build new networks
and expand existing networks in a more timely and economical manner than most
CLEC competitors through strategic arrangements such as leasing fiber optic
cable from cable operators that already possess rights-of-way and have
facilities in place.  The Company intends to use its experience and presence in
the telecommunications industry to further develop and expand its existing
telecommunications infrastructure.

     Currently, TCG's services are predominantly local and regional, although
TCG does offer wholesale and other long distance services on a limited basis.
However, TCG has examined from time to time, and will continue to examine,
opportunities to expand its provisioning of  other related telecommunications
services such as providing long distance and local services on a packaged basis.
If the Company were to expand its provisioning of  telecommunications or
Internet services, it could incur certain additional risks in connection with
such expansion, including technological compatibility risks, legal and
regulatory risks and possible adverse reaction by some of its current customers.

     All of the Cable Stockholders are in the telecommunications business and
may, now or in the future, provide services which are the same or similar to
those provided by TCG. In addition, affiliates of TCI, Cox and Comcast, which
collectively have designated a majority of the directors of the Company,
together with an affiliate of Sprint, have formed Sprint Spectrum, a partnership
created to provide certain wireless telecommunications services. In addition
affiliates of TCI, Cox and Comcast are principal owners of At Home Corporation,
a provider of Internet related services over the @Home Network.(TM) No assurance
can be given that the Cable Stockholders will not compete with TCG in certain
markets or in the provision of certain telecommunications services. Although
directors of TCG who are also directors, officers or employees of the Cable
Stockholders or any of their respective affiliates have certain fiduciary
obligations to TCG under Delaware law,

                                       22
<PAGE>
 
such directors and the Cable Stockholders, as the controlling stockholders of
TCG, are in positions that may create conflicts of interest with respect to
certain business opportunities available to and certain transactions involving
the Company. The Cable Stockholders have not adopted any special voting
procedures to deal with such conflicts of interest, and there can be no
assurance that any such conflict will be resolved in favor of TCG. In this
regard, TCG's Amended and Restated Certificate of Incorporation provides that
TCG may not provide certain (i) wireless communications services (other than
products and services delivered via point-to-point microwave and milliwave
transmissions) or (ii) telecommunications services to residences until, in each
case, the earlier of the date that is five years after the filing of the Amended
and Restated Certificate of Incorporation or the date on which the holders of
Class B Common Stock no longer represent at least 50% of the voting power of the
outstanding Common Stock of the Company, without the affirmative vote of the
holders of a majority of the Class B Common Stock, subject to certain
exceptions.

                          FORWARD- LOOKING STATEMENTS

     The matters discussed or incorporated by reference in this Form 10-K
contain forward-looking statements, within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended. Actual results and events may
differ significantly from those discussed in such forward-looking statements.
In addition to other information discussed herein, factors that might cause or
contribute to such differences include the risks and uncertainties set forth
under the caption "Risk Factors" in the Prospectuses, dated as of June 27, 1996,
relating to the Stock Offering and to the Notes Offerings, respectively,
included in the Company's Registration Statements on Form S-1 (File Nos. 333-
3850 and 333-3984).

ITEM 2. PROPERTIES

                                  THE NETWORKS

     The Company uses the latest technologies and network architectures to
develop a highly reliable infrastructure for delivering high speed, quality
digital transmission of voice, data and video telecommunications.  The basic
transmission platform consists primarily of optical fiber equipped with high
capacity SONET equipment deployed in self-healing rings.  These SONET rings give
TCG the capability of routing customer traffic simultaneously in both directions
around the ring thereby eliminating loss of service in the event of a cable cut.
The Company extends SONET rings or point-to-point links from rings to each
customer's premises over its own fiber optic cable, unbundled facilities
obtained from ILECs, microwave (including 38 GHz milliwave) transmission
facilities (primarily provided by BizTel) and other technologies.  TCG also
installs diverse building entry points where a customer's security needs require
such redundancy.  TCG then places necessary customer-dedicated or shared
electronic equipment at a location near or in the customer's premises to
terminate the link.

     TCG serves its customers from one or more nodes or hubs strategically
positioned throughout its networks.  The node houses the transmission and
switching equipment needed to interconnect

                                       23
<PAGE>
 
customers with each other, the interexchange carriers and other local exchange
networks.  Redundant electronics, with automatic switching to the backup
equipment in the event of failure, protect against signal deterioration or
outages.  Continuous monitoring of system components focuses on proactively
avoiding problems rather than just reacting upon failure.

     TCG adds switched, dedicated, Internet  and data services to its basic
fiber optic transmission platform by installing sophisticated digital
electronics at its network nodes and at customer locations. TCG's advanced ISDN-
capable digital telephone switches are connected to multiple ILEC and long
distance carrier switches to provide TCG's customers access to every telephone
in the local market as well as across the country and around the world.
Similarly, TCG provides ATM switched and LAN multiplexers at the customer's
premises and in its nodes to provide high speed LAN interconnection and native
ATM services.

     The Company's strategy for adding customers is designed to maximize the
speed and impact of its marketing efforts while maintaining attractive rates of
return on capital invested to connect customers directly to its networks.  To
initially serve a new customer, for example, TCG may use various transitional
links, such as reselling a portion of the ILEC's network and, where appropriate,
using alternative transmission services such as microwave, including 38 GHz
milliwave, transmission.  Once the new customer's communications volume and
product needs are identified, the Company may build its own fiber optic
connection between the customer's premises and its networks to accommodate (i)
the customer's current and future telecommunications  needs and (ii) the
Company's efforts to maximize return on network investment.

     In determining which new markets to enter, the Company carefully analyzes
the potential customer base and competitive condition within the market.  The
Company is planning on building new facilities, entering into fiber leases, and
other arrangements with cable television companies and other carriers, acquiring
existing telecommunications providers and exploring new technologies that have
potential to enhance network expansion (such as the use of microwave radio
facilities).  The Company also seeks to utilize relationships with the Cable
Stockholders or other cable television operators who have an existing presence
in the market and with which the Company may be able to develop a fiber optic
network rapidly and efficiently.  As a facilities-based carrier, the Company
utilizes a variety of means to expand geographically, including rights-of-way,
easements, poles, ducts and conduits that are available from cable television
operators, incumbent local exchange carriers, railways, subways, electric, gas
and water utilities and municipal, state and federal street and highway
authorities.  TCG plans to continue making selected acquisitions of existing
local telecommunications networks in markets in which it has existing local
telecommunications operations or which are geographically proximate to such
markets, as well as in markets that are otherwise attractive to TCG.  The
Company's use of BizTel as its primary and preferred provider of 38 GHz services
offers the Company the opportunity to market telecommunications facilities to
customers in geographical areas where the Company has not yet constructed, and
may not find it economical to construct, fiber optic facilities.

     The following chart sets forth information regarding each of the Company's
active or

                                       24
<PAGE>
 
 currently planned local telecommunications networks as of December 31, 1996:

<TABLE>
<CAPTION>                                                                                                          
                                                                             Date of                               
    Metropolitan                                                              First     ---------  Services   ---- 
        Area                       Metropolitan Market(a)                    Revenue    Dedicated  Switched   Data 
        ----                       ----------------------                    -------    ---------  --------   ---- 
<S>                     <C>                                                  <C>        <C>        <C>        <C>   
New York/New Jersey...  Bergen- Passaic                Nassau-Suffolk           7/85        x          x        x  
                        Jersey City                    New York                                                    
                        Middlesex-Somerset-            Newark                                                      
                        Hunterdon                      Trenton                                                     

Boston................  Boston                         Lawrence                 5/89        x          x        x  
                        Brockton                       Worcester                                                   
                                                                                                                   
                                                                                                                   
San Francisco.........  Oakland                                                 4/90        x          x        x  
                        San Francisco                                                                              
                        San Jose                                                                                   
                                                                                                                   
Chicago...............  Chicago                                                 5/90        x          x        x  
                        Gary                                                                                       
                                                                                                                   
Los Angeles...........  Los Angeles - Long Beach                               10/90        x          x        x  
                        Orange County                                                                              
                                                                                                                   
Houston...............  Houston                                                 5/91        x          x        x  
                                                                                                                   
Dallas................  Dallas                                                  6/91        x          x        x  
                        Fort Worth - Arlington                                                                     
                                                                                                                   
Omaha.................  Omaha                                                   1/93        x                   x  
                                                                                                                   
Seattle...............  Bellingham                                              1/93        x          x        x  
                        Seattle-Bellevue-Everett                                                                   
                        Tacoma                                                                                     
                                                                                                                   
San Diego.............  San Diego                                               2/93        x          x        x  
                                                                                                                   
Milwaukee.............  Kenosha                                                 8/93        x          x        x  
                        Milwaukee - Waukesha                                                                       
                        Racine                                                                                     
                                                                                                                   
Detroit...............  Detroit                                                11/93        x          x        x  
                                                                                                                   
Miami/Ft. Lauderdale..  Fort Lauderdale                                        12/93        x          x           
                        Miami                                                                                      
                        W. Palm Beach - Boca Raton                                                                 
                                                                                                                   
Phoenix...............  Phoenix - Mesa                                          3/94        x          x        x  
                                                                                                                   
Hartford..............  Bridgeport            New London -Norwich               3/94        x          x        x  
                        Danbury               New Haven - Meriden                                                  
                        Hartford              Waterbury                                                           
                                                                                                                   
St. Louis.............  St. Louis                                               3/94        x                   x   
                                                                                                                   
</TABLE>

                                       25
<PAGE>
 
<TABLE>
<CAPTION>                                                                                                          
                                                                             Date of                               
    Metropolitan                                                              First     ---------  Services   ---- 
        Area                       Metropolitan Market(a)                    Revenue    Dedicated  Switched   Data 
        ----                       ----------------------                    -------    ---------  --------   ---- 
<S>                     <C>                                                  <C>        <C>        <C>        <C>   

Indianapolis..........  Indianapolis                                           10/94        x          x        x      
                                                                                                                       
Baltimore/Washington..  Baltimore                                              10/94        x          x        x      
                        Washington, D.C.                                                                               
                                                                                                                       
Pittsburgh............  Pittsburgh                                              1/95        x          x        x      
                                                                                                                       
Denver................  Boulder - Longmont                                      8/95        x          x        x      
                        Denver                                                                                         
                                                                                                                       
Providence............  Providence - Fall River - Warwick                       9/95        x          x               
                                                                                                                       
Cleveland.............  Cleveland-Lorain-Elyria                                 2/97        x                          
                                                                                                                       
Portland (Oregon).....  Portland -Vancouver                                     8/96        x                          
                                                                                                                       
Salt Lake City........  Salt Lake City - Ogden                                 11/96        x                           

Birmingham............  Birmingham                                           in progress
                                                                                        
Chattanooga...........  Chattanooga                                          in progress
                                                                                        
Knoxville.............  Knoxville                                            in progress
                                                                                        
Nashville.............  Nashville                                            in progress
                                                                                        
Tampa Bay.............  Tampa Bay                                            in progress
                                                                                        
Orlando...............  Orlando                                              in progress
                                                                                        
Columbus (Ohio).......  Columbus                                             in progress
                                                                                        
Charlotte.............  Charlotte                                            in progress
                                                                                        
Cincinnati............  Cincinnati                                           in progress
                                                                                        
Atlanta...............  Atlanta                                              in progress
                                                                                        
Minneapolis-St. Paul..  Minneapolis-St. Paul                                 in progress
                                                                                        
Sacramento............  Sacramento                                           in progress 
</TABLE>

(a) Consists of primary metropolitan statistical areas, metropolitan statistical
    areas and New England consolidated metropolitan areas, as defined by the
    U.S. Census Bureau.


     The Company leases network hub sites and other facility locations and sales
and administrative offices in each of  the cities in which its operates
networks. During the years ended December 31, 1995 and 1996, rental expense for
operating leases totaled $11.8 million and $18.0 million, respectively. On a pro
forma basis, rental expense for operating leases totaled $16.4 million and $20.4
million for the years ended December 31, 1995 and 1996, respectively. The
Company has no significant real estate holdings. Management believes that its
properties, taken as a whole, are in good operating condition and are suitable
and adequate for the Company's business operations. The Company currently leases
approximately 200,000 square feet of space at

                                       26
<PAGE>
 
The Teleport complex in Staten Island, New York, where it maintains its
headquarters, approximately 120,000 square feet in Dayton, New Jersey, where its
principal executive offices are located, and approximately 70,000 square feet in
Englewood, Colorado where its National Customer Service Center is located.

ITEM 3. LEGAL PROCEEDINGS

     The Company is a party to various claims and legal proceedings arising in
the ordinary course of business.  The Company does not believe that such claims
or proceedings, individually or in the aggregate, will have a material adverse
effect on the Company's financial condition or results of operations.

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

     None.

PART II

ITEM 5.  MARKET PRICE FOR REGISTRANT'S CLASS A COMMON STOCK AND RELATED
STOCKHOLDER MATTERS

Price Range of Class A Common Stock

     The Registrant's Class A Common Stock commenced trading on the Nasdaq
National Market on June 27, 1997 under the symbol "TCGI".  As of March 20, 1997,
the last reported sale price of the Class A Common Stock was $23 3/4.  As of
March 24, 1997, there were approximately 13,315 holders of record of the Class A
Common Stock.  The following table sets forth the high and low sale prices of
the Class A Common Stock as reported by the Nasdaq National Market for each of
the quarters in the period commencing June 27, 1996 through the quarter ended
December 31, 1996.
 
 
      1996                       HIGH                    LOW    
      ----                       ----                    ---   
Second Quarter                  19 1/8                      16 
Third Quarter                   27 3/8                  14 1/8 
Fourth Quarter                  35 3/8                      22  

Dividend Policy

     The Registrant has never paid or declared dividends on its capital stock
and intends to retain future earnings to finance the development and expansion
of its networks and operations.  The Registrant does not anticipate paying any
cash dividends in the foreseeable future on its capital stock.   Any decision
whether to pay cash dividends will be made by the Company's Board of Directors
in light of the conditions then existing, including the Company's results of
operations,

                                       27
<PAGE>
 
financial condition and requirements, business conditions and other factors.  In
addition, the Indentures governing the Registrant's 9 7/8% Senior Notes due 2006
and 11 1/8% Senior Discount Notes due 2007 contain covenants which may limit the
ability of the Registrant to pay dividends on the Class A Common Stock.

Recent Sales of Unregistered Securities

     In connection with the Reorganization, the Registrant issued 69,250,230
shares of Class B Common Stock to the Cable Stockholders.  Following the
Offerings, the Registrant issued 1,011,528 shares of Class A Common Stock to TCI
for certain partnership interests.  See "Business -- The Reorganization".
Concurrent with the Offerings, the Registrant issued an aggregate of 576,263
shares of Class A Common Stock for the acquisition of the interest in TCG
Detroit not owned by the Registrant.  In each of the foregoing instances, the
issuance of Common Stock was deemed exempt from the registration requirements of
the Securities Act as a transaction not involving any public offering, pursuant
to Section 4(2) of the Securities Act.  These transactions are the only instance
where the Registrant issued unregistered securities during the fiscal year ended
December 31, 1996.

     Since December 31, 1996, the Registrant has issued (i) an aggregate of
2,100,000 shares of Class A Common Stock in connection with the acquisition of
CERFnet,  and (ii) 2,757,083 shares of Class A Common Stock in connection with
the acquisition of ETC. See "Business -- CERFnet Acquisition" and "Eastern
TeleLogic Acquisition ."  The issuance of Class A Common Stock in each
acquisition was deemed exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) of the Securities Act.  The recipients
of Class A Common Stock in each transaction represented their intentions to
acquire the Class A Common Stock for investment purposes only and not with a
view to or for sale in connection with any distribution of Class A Common Stock.

ITEM 6.  SELECTED FINANCIAL DATA

     The following tables present selected financial data derived from the
audited historical financial statements of TCG and TCG Partners for 1992.
Historical summary combined financial data for the years 1993, 1994 and 1995
have been derived from the combined audited historical financial statements of
TCG and TCG Partners, and the selected financial data set forth below for 1996
has been derived from the consolidated financial statements of TCG.  The
financial statements for the years 1994-1996 have been audited by Deloitte &
Touche LLP, independent auditors, whose report thereon appears elsewhere in this
Form 10-K. The following tables also present selected unaudited pro forma
financial data for the years 1995 and 1996, as if the Reorganization had
occurred at the beginning of each of the respective years. Pro forma adjustments
include the reversal of TCG's equity in losses of 13 Local Market Partnerships
for 1996 and 1995, as well as amortization of the goodwill which was recorded
upon closing of the transactions and the reduction of interest expense from the
conversion of subordinated debt to parents to equity. The summary unaudited pro
forma financial information does not purport to represent what TCG's and TCG
Partners' results of operations or financial condition would

                                       28
<PAGE>
 
actually have been if the transactions that give rise to the pro forma
adjustments had occurred on the dates assumed.

<TABLE>
<CAPTION>
 
                                                                                                            PRO FORMA FOR THE
                                                                                                            REORGANIZATION (1)
                                                   YEARS ENDED DECEMBER 31,                              YEARS ENDED DECEMBER 31, 
                             ---------------------------------------------------------                -----------------------------
                                                         (dollars in thousands, except per share amounts)

                                  1996           1995         1994             1993         1992             1996        1995       
                                  ----           ----         ----             ----         ----             ----        ----       
<S>                          <C>            <C>            <C>         <C>             <C>               <C>         <C>            
STATEMENTS OF OPERATIONS                                                                                                            
 DATA:                                                                                                                              
                                                                                                                                    
Revenues:                                                                                                                           
                                                                                                                                    
Telecommunications services     $  244,864       $134,652    $ 99,983        $ 82,374      $  57,256       $ 283,383     $184,852   
                                                                                                                                    
Management and royalty                                                                                                              
 fees from Local  Market                                                                                                            
 Partnerships                       22,805         31,517      20,691           1,555              -               -            -   
                                ----------       --------    --------        --------      ---------       ---------     --------   
                                                                                                                                    
Total Revenues                     267,669        166,169     120,674          83,929         57,256         283,383      184,852   
                                                                                                                                    
Operating expenses                 157,591         93,118      76,573          54,218         28,820         172,374      112,575   
                                                                                                                                    
Selling, general and                
 administrative                     85,025         50,475      39,989          34,281         19,625          98,436       71,688   
                                                                                                                                    
Depreciation and                    
 amortization                       78,416         37,837      19,933          16,197         12,035          96,260       62,797   
                                ----------       --------    --------        --------      ---------       ---------     -------- 
Operating loss                     (53,363)       (15,261)    (15,820)        (20,767)        (3,224)        (83,687)     (62,208)  
                                ----------       --------    --------        --------      ---------       ---------     --------   
Interest:                                                                                                                           
                                                                                                                                    
 Interest income                    30,219          4,067       1,711           1,072            446          29,163        4,824   
                                                                                                                                    
 Interest expense                  (73,633)       (23,331)     (5,079)         (1,407)        (1,508)        (66,946)     (11,661)  
                                ----------       --------    --------        --------      ---------       ---------     --------   
                                                                                                                                    
Net Interest expense               (43,414)       (19,264)     (3,368)           (335)        (1,062)        (37,783)      (6,837)  
                               ===========       ========    ========        ========      =========       =========     ========
                                                                                                                                    
Minority interest                    3,520            663       1,395             796           (142)          4,713        3,198   
                                                                                                                                    
Equity in losses of                                                                                                                 
 unconsolidated                                                                                                                     
 affiliates                        (19,400)       (19,541)    (11,763)         (2,114)             -          (7,650)      (1,368)  
                                ----------       --------    --------        --------      ---------       ---------     --------   
                                                                                                                                    
Loss before income taxes          (112,657)       (53,403)    (29,556)        (22,420)        (4,428)       (124,407)     (67,215)  
                                                                                                                                    
Income tax benefit                                                                                                                  
 (provision)                        (2,193)          (401)       (433)          4,149              -          (2,193)        (404)  
                                ----------       --------    --------        --------      ---------       ---------     --------   
                                                                                                                                    
Net loss                        $ (114,850)      $(53,804)   $(29,989)       $(18,271)     $  (4,428)      $(126,600)    $(67,619)  
                                ==========       ========    ========        ========      =========       ==========    ========   
                                                                                                                                    
Net loss per share                   (1.00)         (0.77)      (0.43)          (0.26)         (0.06)          (0.86)       (0.51)  
                                                                                                                                    
Weighted average                                                                                                                    
  number of shares             114,443,695     70,000,140  70,000,140      70,000,140     70,000,140     146,423,705  132,911,232   
                                                                                                                                    
OTHER DATA:                                                                                                                         
                                                                                                                                    
EBITDA                          $   25,053       $ 22,576    $  4,113        $ (4,570)     $   8,811       $  12,573     $    589   
                                                                                                                                    
Capital expenditures (2)           308,112        154,807     143,276         155,184         47,505         358,204       281,601
</TABLE>

                                       29
<PAGE>
 
<TABLE>
<S>                          <C>             <C>              <C>          <C>             <C>             <C>            <C>
   Ratio of earnings
   available to cover
   fixed charges (3)                     -              -            -               -               -              -             -

Dividends per share                      -              -            -               -               -              -             -

<CAPTION>  
                                                             As of December 31,
                                 ------------------------------------------------------------------
                                                          (dollars in thousands)
BALANCE SHEET DATA:                  1996          1995          1994          1993          1992                      
                                     ----          ----          ----          ----          ----                      
<S>                              <C>             <C>           <C>           <C>          <C> 
Cash and cash equivalents        $  277,540      $ 11,862      $ 26,000      $ 31,716     $   3,563                      
                                                                                                                         
Working capital                     545,325       (47,083)      (32,719)      (15,278)      (12,507)                     
                                                                                                                         
Fixed assets - at cost            1,304,229       545,653       422,964       329,686       193,650                      
                                                                                                                         
Total assets                      2,050,097       614,793       486,983       365,202       171,583                      
                                                                                                                         
Long-term debt (including         1,021,063       368,464       200,462        29,689        49,679                      
 capital lease                                                                                                           
 obligations)                                                                                                            
                                                                                                                         
Minority interest                         -         4,409         2,903        12,661         6,201                      
                                                                                                                         
Stockholder's equity and            796,870       125,348       179,152       209,141        77,371                      
 partners' capital
 (deficit)
</TABLE>

(1) Pro forma financial information for the years ended December 31, 1996 and
1995 is as if the Reorganization had occurred at the beginning of each of the
respective years.  Pro forma adjustments include the reversal of TCG's equity in
the losses of 13 Local Market Partnerships for 1996 and 1995, as well as
amortization of the goodwill which was recorded upon closing of the
transactions and the reduction of interest expense from the conversion of 
subordinated debt to parents to equity.

(2) Capital expenditures for 1996 are net of the effect of the inclusion of the
Local Market Partnerships as of June 30, 1996.

(3) The ratio of earnings to fixed charges is computed by dividing pre-tax
income from operations before fixed charges (other than capitalized interest) by
fixed charges.  Fixed charges consist of interest charges and amortization of
debt expenses and discount or premium related to indebtedness, whether expensed
or capitalized and that portion of rental expense the Company believes to be
representative of interest.  For the years 1992, 1993, 1994, 1995 and 1996,
earnings were insufficient to cover fixed charges by $4.4 million, $23.3
million, $31.0 million, $54.1 million and $116.2 million. On a basis which is
pro forma for the Reorganization, the Company's earnings would have been
insufficient to cover fixed charges for the years ended December 31, 1996 and
1995 by $129.1 million and $70.4 million, respectively.
 

                                       30
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS


OVERVIEW

  TCG, the first and largest CLEC in the United States, offers a wide range of
local telecommunications services in major metropolitan markets nationwide. The
Company competes with ILECs as "The Other Local Phone Company"(R) by providing
high quality, integrated telecommunications services, primarily over fiber optic
digital networks, to meet the voice, data and video transmission needs of its
customers.  TCG's customers are principally telecommunications-intensive
businesses, hospitals and educational institutions, governmental agencies, long
distance carriers and resellers, Internet service providers, disaster recovery
service providers and wireless communications companies.  TCG offers these
customers technologically advanced local telecommunications services, as well as
superior customer service, flexible pricing and vendor and route diversity.

  For over 10 years, TCG has developed, operated and expanded its local
telecommunications networks.  As of December 31, 1996, the Company operated high
capacity state-of-the-art digital networks in 51 metropolitan markets, including
17 of the 20 largest metropolitan areas.  Company networks were located in
metropolitan New York/New Jersey, Los Angeles, Chicago, San Francisco, Boston,
Detroit, Baltimore/Washington, D.C., Dallas, Houston, Miami/Ft. Lauderdale,
Seattle, San Diego, St. Louis, Pittsburgh, Phoenix,  Providence,  Denver,
Milwaukee, Indianapolis, Hartford, Omaha, Cleveland, Portland (Oregon) and Salt
Lake City.  When the Company completed its acquisition of ETC, in March 1997,
two additional metropolitan markets, Philadelphia and Wilmington (Delaware),
were added to TCG's service area.  See "Business -- Eastern TeleLogic
Acquisition".  Additional TCG networks are under development for the
metropolitan areas of Nashville, Chattanooga, Knoxville, Birmingham, Cincinnati,
Columbus (Ohio), Charlotte, Tampa Bay, Sacramento, Minneapolis-St. Paul, Atlanta
and Orlando.  Upon the completion of these networks, TCG will operate networks
in 65 metropolitan markets including 28 of the 30 largest metropolitan areas.
As of December 31, 1996, the fiber optic networks of the Company's wholly-owned
subsidiaries spanned over 6,700 route miles, contained over 345,000 fiber miles
and served approximately 7,765 buildings.
 
  TCG has benefited from its relationships with the parents of its Class B
stockholders, TCI, Cox, Comcast and Continental, which are among the largest
cable television companies in the United States.  Through such relationships,
the Company has been able to utilize rights-of-ways, obtain fiber optic
facilities and share the cost of building new fiber optic networks, thereby
allowing the Company to achieve significant economies of scale and scope through
capital efficiencies in extending its existing networks in a rapid, efficient
and cost-effective manner.

  The Company believes that it has several advantages that enable it to compete
successfully in the new competitive local telecommunications marketplace,
including (i) extensive,

                                       31
<PAGE>
 
technologically-advanced networks located or under development in major
metropolitan markets nationwide, (ii) state-of-the-art information systems,
(iii) an experienced management team with significant operational, technical,
financial and regulatory expertise in the local telecommunications industry,
(iv) positive relationships with its broad array of commercial customers, (v) a
reputation for high quality service, and (vi) working relationships with cable
television operators.

  On June 27, 1996, TCG sold 27,025,000 shares of Class A Common Stock which
resulted in gross proceeds of approximately $432.4 million, and $300 million of
Senior Notes due 2006 and $1,073 million of Senior Discount Notes due 2007 as
part of an initial public offering.  Prior to the Offerings, the Company was
owned by subsidiaries of the Cable Stockholders.  The business was operated
through TCG and, beginning in 1992, TCG Partners, which is a New York general
partnership owned prior to the Reorganization by the Cable Stockholders in the
same percentages as TCG.  TCG Partners was formed to invest, with TCG, the Cable
Stockholders and other cable operators, in 14 Local Market Partnerships to
develop and operate local telecommunications networks.  The Local Market
Partnerships were owned by TCG, and/or TCG Partners and certain of the Cable
Stockholders which had cable operations in the particular markets addressed by
the Local Market Partnerships and, in some cases, other cable operators in such
markets.  To simplify this complex ownership structure, the Company and the
Cable Stockholders agreed to consolidate the ownership of TCG Partners and of
the Local Market Partnerships as wholly-owned subsidiaries of TCG. As part of
this process, certain of the other cable operators agreed to sell their
interests in the Local Market Partnerships to TCG directly or through a Cable
Stockholder.  See "Business -- The Reorganization".

  In response to customer demand, the Company plans to increase the geographic
reach and density of its existing networks by deploying additional fiber optic
rings and connecting additional customers to its networks.  The costs associated
with the initial installation and expansion of each network, including
development, installation, certain organizational costs and early operating
expenses, are significant and result in negative cash flow for that market until
an adequate customer base and revenue stream have been established.  In addition
to capital expenditures, TCG begins to incur direct operating costs upon
commencement of the installation phase of a network for such items as salaries
and office rent.  The exact amounts and timing of these expenditures and costs
are subject to a variety of factors which may vary greatly by geographic market.
As network installation progresses, TCG incurs rights-of-way costs, increased
sales and marketing expenses (including sales commissions) and, in certain
markets, franchise fees and taxes paid to local governments based on revenue.
Although the Company's revenues have increased substantially, the Company's
expenses associated with the expansion and development of its local
telecommunications networks has exceeded such revenues.  The Company expects its
net losses to grow as it continues to expand its networks.  However, generally,
after the network infrastructure is established, the Company can add customers
and revenues with less additional expense.  After a customer is added and the
volume of such customer's communications traffic handled by TCG grows,
incremental revenues can be added with minimal additional expense, providing
significant contributions to EBITDA, (earnings (loss) before interest, income
taxes, depreciation, amortization, minority interest and equity in losses of
unconsolidated affiliates).

                                       32
<PAGE>
 
  As of December 31, 1996, the Company's consolidated financial statements
reflect the results of the Company's wholly-owned subsidiaries located in
Baltimore, Boston, Cleveland, Denver, Houston, Indianapolis, Milwaukee,
metropolitan New York/New Jersey, Portland (Oregon), Providence, Salt Lake City,
Washington D.C., St. Louis and the former 13 Local Market Partnerships.
Additionally, the consolidated financial statements as of December 31, 1996
reflect the Company's equity in losses of ETC and BizTel in which the Company
retained an approximate 49% indirect interest and an approximate 49% direct
interest, respectively. See "Business -- Eastern TeleLogic Aquisition" and "--
BizTel Investment". Commencing July 1, 1996, the statements of operations and
cash flows consolidate the operations of 13 of the former Local Market
Partnerships as a result of the Reorganization. Management fees and royalty fees
charged to the Local Market Partnerships by TCG were recorded as revenue in the
consolidated financial statements through June 30, 1996.

  As of December 31, 1995, the combined financial statements of TCG and TCG
Partners reflect the financial results of the Company's wholly-owned
subsidiaries located in Baltimore, Boston, Cleveland, Denver, Houston,
Indianapolis, Milwaukee, metropolitan New York/New Jersey, Portland (Oregon),
Providence, Salt Lake City, Washington D.C. , and the Local Market Partnership
in St. Louis in which TCG and TCG Partners owned 60.8% of the partnership
interests. Additionally, the combined financial statements of TCG and TCG
Partners for 1995 reflect the Company's equity in losses of 13 unconsolidated
Local Market Partnerships, as well as the Company's equity in losses of  ETC, in
which the Company retained an approximate 25% indirect interest.  Management
fees and royalty fees charged to the Local Market Partnerships by TCG prior to
the Reorganization were recorded as revenue in the combined financial
statements.

  For the year ended December 31, 1996, TCG's capital expenditures, the
acquisition of an additional interest in ETC and working capital have been
funded by the Offerings, which raised approximately $1.3 billion of aggregate
gross proceeds, as well as borrowings under a Credit Agreement (the "Revolving
Credit Agreement"), pursuant to which certain financial institutions have agreed
to loan the Company's wholly-owned subsidiary TCG New York, Inc. up to $250
million.

  The development of TCG's business, the construction and expansion of its
telecommunications networks and its operating expenses require significant
expenditures, often resulting in negative cash flow. Although TCG generated
positive EDITDA for 1996, several of its subsidiaries did not and will not
generate positive EDITDA until such time as adequate customer bases are
established. As city operations mature and customer bases grow, incremental
revenue is added, while TCG strives to minimize additional expenses so that
significant contributions can be provided to EDITDA.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

                                       33
<PAGE>
 
Revenues

  Total revenues increased to $267.7 million for 1996 from $166.2 million for
1995, representing an increase of $101.5 million, or 61%.  Telecommunications
services revenue increased to $244.9 million for 1996 from $134.7 million for
1995, an increase of $110.2  million, or 82%. Revenue increased in every
category, most significantly in switched services.  These increases reflect
increased sales of services in existing and new markets and the growth of TCG's
customer base.

  During 1996, TCG expanded its dedicated services markets to Salt Lake City,
Portland (Oregon), Cleveland and Washington D.C.  It also expanded its switched
services markets to Indianapolis, Denver, and New Jersey and installed a second
switch in its Boston metropolitan serving area.  TCG significantly increased
revenue from the Company's data services line of business in 1996 by $3.0
million, an increase of 290% from 1995.

  On a pro forma basis, had telecommunications services revenue generated by
unconsolidated Local Market Partnerships been included in the consolidated
financial statements of the Company in 1996 and the combined financial
statements of TCG and TCG Partners in 1995, total revenues would have increased
to $283.4 million for 1996 from $184.9 million for 1995, an increase of $98.5
million, or 53%.  This growth in revenues is a direct result of increased market
penetration of all telecommunications services offered in existing markets and
the addition of new markets.  On a pro forma basis, annualized monthly recurring
revenue increased to approximately $329.0 million for December 1996 from $211.1
million for December 1995, an increase of $117.9 million, or 56%. Monthly
recurring revenue represents monthly service charges billable to
telecommunications services customers for the month indicated, but excludes non-
recurring revenues for certain one-time services, such as installation fees or
equipment charges.

  On a pro forma basis, switched services revenue increased to $113.0 million
for 1996 from $63.9 million for 1995, an increase of $49.1 million, or 77%.  The
increase is due primarily to: increases in switched, local and toll services 
revenue; long distance carrier access usage volumes; and to sales of additional
enhanced switched services products to customers in existing and new markets. On
a pro forma basis, dedicated services revenue increased to $161.7 million for
1996 from $116.5 million, which included $1.7 million in data services products
for 1995, an increase of $45.2 million, or 39%.

  Management and royalty fees from Local Market Partnerships decreased to $22.8
million for 1996, a decrease of $8.7 million, or 28%, from $31.5 million for
1995.  Management fees are directly related to operating and administrative
support services provided by TCG to the former Local Market Partnerships.  The
royalty fees were charged to the Local Market Partnerships based on revenue.  As
a result of the Reorganization, management and royalty fees from the Local
Market Partnerships are no longer reflected as revenue beginning July 1, 1996,
due to the consolidation of the Local Market Partnerships.
 
Operating Expenses

                                       34
<PAGE>
 
  TCG, in order to be consistent with industry standards, has reclassified
certain compensation and overhead expenses, related to engineering, customer
service and new technology, from selling, general and administrative to
operating expenses.  Operating expenses increased to $157.6 million for 1996
from $93.1 million for 1995, an increase of $64.5 million, or 69%.  This
increase is primarily attributable to costs associated with the expansion of
networks throughout the country, including technical personnel costs and access,
rights-of-way, node, rent and maintenance expenses. The increase in operating
expenses is also attributable to the access and maintenance expenses associated
with the growth of switched services in existing markets and the expansion into
new markets.  On a pro forma basis, operating expenses, which included expenses
generated by the Local Market Partnerships, increased to $172.4 million for 1996
from $112.6 million for 1995, an increase of $59.8 million, or 53%.

Selling, General and Administrative Expenses

  TCG, in order to be consistent with industry standards, has reclassified
certain compensation and overhead expenses, related to engineering, customer
service and new technology, from selling, general and administrative to
operating expenses.  Selling, general and administrative expenses increased to
$85.0 million for 1996 from $50.5 million for 1995, an increase of $34.5
million, or 68%.  This increase is a result of the continued expansion of
network infrastructure to support continued expansion of the Company's networks,
including costs associated with servicing the increased number of both dedicated
and switched services customers.  These costs include expenses related to
compensation, occupancy, insurance and professional fees.  On a pro forma basis,
selling, general and administrative expenses which included expenses generated
by the Local Market Partnerships, increased to $98.4 million for 1996 from $71.7
million for 1995, an increase of $26.7 million, or 37%.

EBITDA

EBITDA increased to $25.1 million for 1996 from $22.6 million for 1995, an
increase of $2.5 million. This increase is primarily attributable to increases
in dedicated and switched revenues. Additionally, on a pro forma basis, TCG has
reduced its operating and administrative expenses, as a percentage of revenues,
primarily by obtaining lower unit access costs through negotiation of, and
participation in, regulatory proceedings relating to various interconnection and
reciprocal agreements with ILECs across the country, and by obtaining greater
efficiencies through automation. On a pro forma basis, EBITDA increased to $12.6
million for 1996 from $0.6 million for 1995, an increase of $12.0 million. The
Local Market Partnerships are included in the pro forma financial data as a
result of the Reorganization.

Depreciation and Amortization Expense

  Depreciation and amortization expense increased to $78.4 million for 1996 from
$37.8 million for 1995, an increase of $40.6 million, or 107%. This increase is
primarily attributable to increased depreciation associated with the expansion
of the local telecommunications networks

                                       35
<PAGE>
 
throughout the country and increased amortization of goodwill related to various
1996 acquisitions. On a pro forma basis, depreciation and amortization expense,
which included depreciation and amortization of the Local Market Partnerships,
increased to $96.3 million for 1996 from $62.8 million for 1995, an increase of
$33.5 million, or 53%.

Interest Income

  Interest income increased to $30.2 million for 1996 from $4.1 million for
1995, an increase of $26.1 million. This increase is attributable to interest
earned on the cash and cash equivalents and marketable securities that resulted
from the proceeds of the Offerings.

Interest Expense

  Interest expense increased to $73.6 million for 1996 from $23.3 million for
1995, an increase of $50.3 million. This increase resulted from interest on the
Company's Senior Notes, Senior Discount Notes, and a subordinated note to a
related party, issued on June 27, 1996, offset by the absence of approximately
six months of interest associated with the Revolving Credit Agreement and
borrowings under a loan agreement from Cable Stockholders (the "Stockholders
Loan Agreement") for the year ended December 31, 1996.

Equity in Losses of Unconsolidated Affiliates

  Equity in losses of unconsolidated affiliates decreased to $19.4 million for
1996 from $19.5 million for 1995, a decrease of $.1 million. This decrease
resulted from the consolidation of the Local Market Partnerships in June 1996,
offset by greater losses in 1996 versus 1995.

Income Taxes

  In 1996 and 1995, TCG generated net operating losses and, accordingly,
incurred a net tax benefit.  In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," such tax
benefit was fully offset, each year, by a valuation allowance.  Both the 1996
and 1995 provisions for income taxes resulted from state income taxes where TCG
is required to file separate state income tax returns.

  At December 31, 1996, TCG had operating loss carry-forwards for tax purposes
of approximately $170.5 million, expiring principally in 2009 through 2012.

Net Loss

  The Company's results for 1996 reflected a net loss of $114.9 million,
compared to a net loss of $53.8 million for 1995, an increase of $61.1 million.
This increase in net loss is attributable to the factors discussed above. On a
pro forma basis, net loss increased to $126.6 million for 1996 from $67.6
million for 1995, an increase of $59.0 million.

                                       36
<PAGE>
 
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

Revenues

  Total revenues increased to $166.2 million for 1995 from $120.7 million for
1994, an increase of $45.5 million, or 38%.  Telecommunications services
revenues increased to $134.7 million for 1995 from $100.0 million for 1994, an
increase of $34.7 million, or 35%.  The increase in revenue occurred in every
revenue category, most significantly in switched services.  This increase in
revenue also is a result of increased market penetration primarily in TCG's
existing markets as well as expansion into new markets.

  Management and royalty fees from Local Market Partnerships increased to $31.5
million for 1995, an increase of $10.8 million, or 52%, from $20.7 million for
1994.  These fees are directly related to operating and administrative support
services provided by TCG to unconsolidated Local Market Partnerships.  The
increase in management fees revenue in 1995 over 1994 is due to the increased
support that was provided to these unconsolidated Local Market Partnerships,
specifically in developing existing dedicated services business as well as in
building new switched businesses.

Operating Expenses

  TCG, in order to be consistent with industry standards, has reclassified
certain compensation and overhead expenses, related to engineering, customer
service and new technology, from selling, general and administrative to
operating expenses.  Operating expenses increased to $93.1 million for 1995 from
$76.6 million for 1994, an increase of $16.5 million, or 22%.  This increase is
primarily attributable to costs associated with network operations including
compensation costs for technical personnel, access, rights-of-way, node, rent 
and maintenance expenses.

Selling, General and Administrative Expenses

  TCG, in order to be consistent with industry standards, has reclassified
certain compensation and overhead expenses, related to engineering, customer
service and new technology, from selling, general and administrative to
operating expenses.  Selling, general and administrative expense increased to
$50.5 million for 1995 from $40.0 million for 1994, an increase of $10.5
million, or 26%.  This increase is attributable to the costs required to
maintain an infrastructure which supports the continued expansion of the
Company's networks, the introduction of new services and the delivery of high
levels of customer service.  These costs include compensation, occupancy,
insurance, professional fees, and sales and marketing expenses.

EBITDA

  EBITDA increased to $22.6 million for 1995 from $4.1 million for 1994, an
increase of $18.5 million. This increase is primarily attributable to increases
in dedicated and switched services revenue. Furthermore, TCG has obtained
increases through greater automation

                                       37
<PAGE>
 
and through lower access costs.

Depreciation and Amortization Expense

  Depreciation and amortization expense increased to $37.8 million for 1995 from
$19.9 million for 1994, an increase of $17.9 million, or 90%.  This increase is
primarily attributable to an increase in deprecation related to the expansion of
the Company's local telecommunications network nationally and to changes in the
estimated useful lives of certain electronics equipment, which were made during
1995 in order to conform with industry standards.

Interest Income

  Interest income increased to $4.1 million in 1995 from $1.7 million in 1994,
an increase of $2.4 million due to a greater average balance in cash and cash
equivalents.

Interest Expense

  Interest expense increased to $23.3 million for 1995 from $5.1 million in
1994, an increase of $18.2 million. This increase is primarily attributable to
the interest due Cable Stockholders under the Stockholders Loan Agreement as
well as interest under the Revolving Credit Agreement which was entered into in
May 1995. Also, contributing to the increased interest expense is an increase of
$15.2 million in capital lease obligations under agreements entered into with
various Cable Stockholders.

Equity in Losses of Unconsolidated Affiliates

  Equity in losses of unconsolidated affiliates increased to $19.5 million for
1995 from $11.8 for 1994, an increase of $7.7 million.  This increase is
directly attributable to the development and operation of twelve unconsolidated
Local Market Partnerships for 1993 and 1994 as well as the recording of TCG's
equity in losses of TCG San Diego during a portion of 1994 and TCG's equity
share in the losses of  ETC.

Income Taxes

  In 1995 and 1994, TCG generated net operating losses and, accordingly,
incurred a net tax benefit.  In accordance with SFAS No. 109, "Accounting for
Income Taxes," such tax benefit was fully offset, each year, by a valuation
allowance.  Both the 1995 and 1994 provisions for income taxes, which do not
fluctuate substantially year to year, resulted from state income taxes where TCG
is required to file separate state income tax returns.

  As of December 31, 1995, TCG had operating loss carry-forwards for tax
purposes of approximately $105.3 million, expiring principally in 2009 through
2011.

                                       38
<PAGE>
 
  TCG Partners is not subject to federal, state or local income taxes.  The
distributive share of each partner in a Local Market Partnership of partnership
revenues, expenses and other items is computed on the basis of the respective
partner's capital interest in the partnership and is reported by the partners in
their respective federal or state income tax returns.

Net Loss

  The combined results for TCG and TCG Partners reflected a net loss of $53.8
million for 1995, from a net loss of $30.0 million for 1994, an increase of
$23.8 million. This increase in net loss is attributable to the factors
discussed above.

LIQUIDITY AND CAPITAL RESOURCES

  As of December 31, 1996, TCG had total assets of approximately $2.1 billion,
an increase of approximately $1.5 billion from $615 million as of December 31,
1995.  This growth is attributable to the Offerings which occurred on June 27,
1996, whereby TCG issued 27,025,000 shares of Class A Common Stock, $300 million
principal amount of Senior Notes and $1,073 million principal amount of Senior
Discount Notes for aggregate gross proceeds of approximately $1.3 billion. The
increase in assets from December 31, 1995 as compared to December 31, 1996 is
also attributable to the assets of the Local Market Partnerships which TCG
acquired from the Cable Stockholders pursuant to the Reorganization.  The
Company's current assets of $787.6 million as of December 31, 1996, exceeded
current liabilities of  $242.2 million, providing working capital of
approximately $545.4 million.  Network and equipment, net of depreciation as of
December 31, 1996, aggregated approximately $1.1 billion.

  For a period of time, the Company will have excess liquidity as a result of
the Offerings. TCG has invested the proceeds from the Offerings in marketable
securities such as Treasury bills and commercial paper.  TCG will utilize the
remaining proceeds to expand its networks, for acquisitions and to provide funds
for working capital.

  Prior to the Offerings, growth had been funded primarily by the Cable
Stockholders through equity contributions, and through $269 million in
borrowings by TCG under the Stockholders Loan Agreement, as well as through $250
million in borrowings under the Revolving Credit Agreement. Pursuant to the
Reorganization, the $269 million of indebtedness (plus $20.6 million of accrued
interest as of June 27, 1996) under the Stockholders Loan Agreement was
contributed by the Cable Stockholders to capital in exchange for Class B Common
Stock (except that TCI retained a $26 million subordinated note of TCG).
Additionally, the $250 million of indebtedness under the Revolving Credit
Agreement was repaid in July 1996 from the proceeds of the Offerings.  TCG plans
to utilize the credit facility under the Revolving Credit Agreement, of which
$250 million is currently available, to supplement TCG's funding requirements
related to its network expansion.

  Effective as of March 1, 1997, TCG completed its previously announced
acquisition of ETC for 2,757,083 shares of its Class A Common Stock.  ETC is the
leading competitive local exchange

                                       39
<PAGE>
 
carrier in Philadelphia, Pennsylvania and in the neighboring cities of Camden,
New Jersey and Wilmington, Delaware.  In the first of two steps, on October 25,
1996, employees of ETC exercised their stock options and then ETC redeemed the
shares (approximately 47%) not held by Comcast CAP of Philadelphia, Inc.
("Comcast CAP"), a corporation owned 51% by Comcast Corporation and 49% by TCG.
Comcast CAP borrowed at a market interest rate approximately $115 million from
TCG as a short-term loan and, in turn, loaned this amount to ETC to effect the
redemption.  See "Business -- Eastern TeleLogic Acquisition".

  The Company has incurred significant net operating losses resulting from the
development and operation of new networks which TCG expects will continue as it
expands its networks. Persistent demands from TCG's customers for capital
intensive local services drives the development, construction and expansion of
its networks.  While cash provided by operations may be sufficient to fund
modest incremental growth it may not be sufficient to fund the extensive
expansion and development of networks as currently planned.

  Net cash provided by financing activities for the years ended December 31,
1996 and 1995 was $1.1 billion and $157.7 million, respectively, comprised
primarily of proceeds from the Offerings for the year ended December 31, 1996
and borrowings under the Revolving  Credit Agreement and the Stockholder Loan
Agreement for the year ended December 31, 1995.  Net cash provided by operating
activities was $93.6 million and $36.1 million for the years ended December 31,
1996 and 1995, respectively.  Net cash provided by operating activities
increased for the year ended December 31, 1996 as compared to the similar period
in 1995, due to inclusion of the Local Market Partnerships for six months in
1996.  Net cash used for investing activities was $913.5 million and $208.0
million for the years ended December 31, 1996 and 1995, respectively.  As of
December 31, 1996, cash and cash equivalents were $277.5 million and marketable
securities were $440.8 million.

  On a pro forma basis, TCG made capital expenditures of $358.2 million and
$281.6 million for the years ended December 31, 1996 and 1995, respectively. The
Company anticipates that capital expenditures will be approximately $500 million
in the aggregate in 1997, and will primarily be used for the expansion,
development and construction of its networks, the acquisition and deployment of
switches and the expansion of operating support systems.

  For the year ended December 31, 1996, on a pro forma basis over 1995, TCG has
expanded its route and fiber miles by 24% and 37%, respectively.  The Company
has also increased the metropolitan areas and the buildings its serves by 19%
and  69%, respectively, for the year ended December 31, 1996.

  The Company believes that the net proceeds from the Offerings and the amount
of credit available under the Revolving Credit Agreement will be adequate for
its 1997 funding requirements. The Company intends to preserve financial
flexibility in order to respond to the rapidly evolving telecommunications
marketplace.  TCG will continue to take advantage of favorable financing
arrangements, including the sale of debt or equity securities in the public
markets, private

                                       40
<PAGE>
 
placements, increasing the amount of the existing credit facility or adding
additional lines of credits.

  The Company from time to time evaluates acquisitions and investments in light
of the Company's long range plans.  The Company may have future opportunities
with certain of its Cable Stockholders to invest in additional markets as a
minority partner or shareholder as well as opportunities as a managing partner
or controlling shareholder in new or existing telecommunications ventures which
are consistent with the Company's business plans.  The Company expects to
continue to build on its existing relationships with cable television providers
and other strategic customers, suppliers and telecommunications carriers.  Such
acquisitions, investments and strategic arrangements, if available, could use a
material portion of the Company's financial resources following the Offerings
and may accelerate the need for raising additional capital in the future.

  Earnings before fixed charges were insufficient to cover fixed charges for the
year  ended December 31, 1996 and 1995, by $116.2 million and $54.1 million,
respectively.  On a pro forma basis for the Reorganization, the Company's
earnings would have been insufficient to cover fixed charges for the year ended
December 31, 1996 and 1995 by $129.1 million and $70.4 million, respectively.

EFFECTS OF INFLATION

  Inflation has not had a significant effect on the Company's operations.
However, there can be no assurance that inflation will not have a material
effect on the Company's operations in the future.

 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Registrant's financial statements are included in this report beginning on
page F-1.


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

None.

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

                                   DIRECTORS

  The following persons are the current directors of the Company:

                                       41
<PAGE>
 
  Robert Annunziata, age 48,  has been Chairman of the Board since 1990 and a
director since 1984. See "-- Executive Officers" for a description of  Mr.
Annunziata's business experience.

  Brendan R. Clouston, age 43, has been a director since April 1996. Prior to
that time, he was a director of TCG from November 1992 to October 1995. Mr.
Clouston has been Chief Financial Officer of TCI since February 1997. Before
that, Mr. Clouston had been Executive Vice President of TCI and President and
Chief Executive Officer of TCI Communications, Inc. ("TCIC") since January 1994.
Prior to that, he had been Executive Vice President and Chief Operating Officer
of TCI since March 1992 and Senior Vice President of TCI since December 1991.
From 1987 through 1991, Mr. Clouston served in various executive positions with
United Artists Entertainment Company and its predecessor United Artists
Communications, Inc., most recently as Executive Vice President and Chief
Financial Officer. He is a director of the Kaitz Foundation.

  John R. Dillon, age 55, has been a director since December 1991.  Mr. Dillon
was Senior Vice President and Chief Financial Officer of Cox Enterprises, Inc.
("CEI") since 1990 and retired on December 31, 1996. He continues to serve as a
consultant to Cox and joined Cravey, Green & Whalen, a private equity firm, as
Managing Director in February, 1997. He is also a director of CEI, Cox and the
 Georgia Center for Advanced Telecommunications Technology.

  Gerald W. Gaines, age 40, has been a director since November 1994.  Mr. Gaines
has been Senior Vice President of Telephony Services for TCI since 1994.  Prior
to that, he had been President of GCG Inc., a management services firm servicing
the telecommunications industry, since 1991.

  Jimmy W. Hayes, age 44, has been a director since August 1996.  He joined CEI
in 1980 as Accounting Manager. He was promoted in May 1981 to Assistant
Controller in December of that year. He was named a corporate officer in
December 1982, and promoted to Vice President of Finance of Cox in August 1989.
He was promoted to Senior Vice President of Finance in January 1992. Prior to
joining Cox, Mr. Hayes was an Audit Manager with Price Waterhouse & Company in
Atlanta.

  James Bruce Llewellyn, age 68, has been a director since June 1996.  He has
been the Chairman of the Board of the Philadelphia Coca-Cola Bottling Company
since 1988.  Prior to 1988, he was the principal stockholder and chairman of ABC
television network affiliate in Buffalo, New York and partner in the Washington,
D.C.  law firm of Dickstein, Shapiro & Morin.  He serves on the Board of
Directors of Chase Manhattan Corporation, Coors Brewing Company and Essence
Communications, Inc.  From 1989 to 1994, he also served as the Chairman of
Garden State Cablevision, Inc.

  James O. Robbins, age 54, has been a director since April 1996.  Mr. Robbins
has served as President and Chief Executive Officer of Cox since May 1994.
Prior to that, Mr. Robbins had been President of Cox since 1985.  Mr. Robbins
has been a director of Cox since May 1994.  Mr. Robbins

                                       42
<PAGE>
 
is a member of the Executive Committee of the National Cable Television
Association. Mr. Robbins also serves as a director to TeleWest Communications
plc and NCR Corporation and is a representative on the Partnership Board of
Sprint Spectrum Holding Company, L.P., the general partner of Sprint Spectrum
L.P.

  Brian L. Roberts, age 37, has been a director since April 1996.  Mr. Roberts
has been President of Comcast since 1990 and a director of Comcast since 1987.
He is also a director of Comcast UK Cable Partners Limited, and Storer
Communications, Inc.

  C.B. Rogers, Jr., age 67, has been a director since June 1996.  He has been
Chairman of Equifax Inc. since 1992.  He was Chief Executive Officer of Equifax
Inc. from 1989 to December 1995.  He is Chairman of the Board of Directors and
the Executive Committee of Equifax Inc.  Mr. Rogers is a former Senior Vice
President of International Business Machines Corporation where he was employed
for 33 years before joining Equifax Inc. in 1987.  He also serves on the Board
of Directors of Sears, Roebuck & Co., Briggs & Stratton Corporation, Oxford
Industries, Inc. and Dean Witter, Discover & Co.

  Larry E. Romrell, age 57, has been a director since April 1996.  Prior to that
time, he was a director of TCG from November 1992 to October 1995.  Mr. Romrell
has been Executive Vice President of TCI since January 1994 and President of TCI
Technology Ventures since September 1994.  Prior to that, he had been Senior
Vice President of TCIC from 1991 to October 1994.  Mr. Romrell previously held
various executive positions with WestMarc Communications, Inc., a subsidiary of
TCI.

  Lawrence S. Smith, age 48, has been a director since May 1993.  Mr. Smith has
been Executive Vice President of Comcast since January 1996.  Prior to that, he
had been Senior Vice President of Accounting and Administration for Comcast for
more than five years.  Mr. Smith is a director of Comcast UK Cable Partners
Limited and a Partnership Board Representative of Sprint Spectrum Holding
Company, L.P.

  Bernard W. Schotters, age 52, has been a director since August 1996. He was
appointed Senior Vice President - Finance and Treasurer of TCIC in October 1991.
Previously he served as TCI's Vice President - Finance. Mr. Schotters is
currently a member of the National Association of Securities Dealers 1994 Issuer
Affairs Committee and functions in a consultative capacity to the National Cable
Television Association. Prior to joining TCI in 1983, Mr. Schotters was
Vice President of Wells Fargo Bank where he was involved in commercial lending
activities.

  David M. Woodrow, age 51, has been a director since November 1992.  Mr.
Woodrow has been Senior Vice President of Broadband Services for Cox since 1994.
Prior to that, he had been Senior Vice President of Operations for Cox since
1989. Mr. Woodrow is a director of the Cellular Telephone Industry Association.

                               EXECUTIVE OFFICERS

                                       43
<PAGE>
 
  Following is a list of  individuals who served as Company officers during
1996.  All of these individuals were designated by the Company's Board of
Directors as Executive Officers during 1996, with the exception of Marsha
Gewirtzman, who is expected to be designated by the Board of Directors as an
Executive Officer as of April 1, 1997.

  Robert Annunziata, age 48,  has been Chairman of the Board since 1990 and
President and Chief Executive Officer since 1985.  Prior to that, Mr. Annunziata
had been Senior Vice President and Chief Operating Officer since 1983.  He has
been a director of the Company since 1984.  He has 30 years of experience in the
telecommunications industry, including 17 years in a variety of operations and
marketing positions with AT&T.  He has served as President of the World Teleport
Association ("WTA") from 1987 to 1991 and remains a WTA director.  He currently
serves on the New York State Governor's Advisory Board on Telecommunications,
the New York City Mayor's Alliance for International Business and the Board of
Directors  of the YMCA of New York City.

  Robert C. Atkinson, age 45, has been Senior Vice President - Legal, Regulatory
and External Affairs since February 1990.  Prior to that, he had been Vice
President - Regulatory and External Affairs since 1985.  Prior to joining the
Company, Mr. Atkinson held various business development, regulatory and
government relations positions at ITT World Communications Inc., Satellite
Business Systems, GTE Sprint and RCA Global Communications, Inc.  He was a
founder and first President of the Association for Local Telecommunications
Services, the CLEC trade association.

  Joel D. Gross, age 42, has been Senior Vice President - Corporate Development
since February 1993.  Prior to that, he had been Vice President and Senior
Securities Analyst - Telecommunications for Donaldson, Lufkin & Jenrette
Securities Corporation since 1987 and Vice President and Senior Securities
Analyst - Telecommunications for Dean Witter since 1985.  Prior to that, Mr.
Gross held variety of management positions at AT&T spanning 8 years. Mr. Gross
serves on the Board of Directors of BizTel Communications, Inc.

  Alf T. Hansen, age 54, has been Senior Vice President - National Operations
since February 1993.  Prior to that, he had been Vice President- National
Operations since March 1990 and Vice President - Engineering and Operations
since March 1989.  Prior to joining the Company, Mr. Hansen worked at AT&T for
22 years in various managerial positions.

  J. Curt Hockemeier, age 48, is Senior Vice President - Network Services.  Mr.
Hockemeier joined TCG in  January 1993.  Prior to that, he had been Vice
President and General Manager of Cox Cable Oklahoma City since 1983.

  Marvin L. Lindsey, age 56, has been Senior Vice President - Engineering and
MIS since December 1993.  Prior to that, he had been an independent
telecommunications consultant for various large international telecommunications
companies since July 1991.  Mr. Lindsey was Service Vice President of AT&T's
Business Communications organization from April 1987 to July 1991 and worked
more than 28 years in various technical and operations positions with AT&T.

                                       44
<PAGE>
 
  Stuart A. Mencher, age 57, has been Senior Vice President - National Sales and
Marketing since February 1994.  Prior to that, he had been Senior Vice President
- New York Operations since February 1993 and Vice President and General Manager
of TCNY since June 1992.  From June 1991 until May 1992, Mr. Mencher worked as
an independent consultant in the international telecommunications industry.
From March 1987 to January 1990, Mr. Mencher served as a Senior Vice President
of MCI Telecommunications Corp., primarily responsible for sales and marketing,
and, from February 1990 to May 1991, he served as Senior Vice President of the
U.S. Distribution Division of Motorola/Codex Corp.  Prior to joining MCI, Mr.
Mencher served in a variety of senior sales and marketing management positions
with AT&T Information Systems following almost sixteen years of sales and
marketing management experience with IBM's Data Processing Division.

  John A. Scarpati, age 45, has been Senior Vice President and Chief Financial
Officer since March 1990.  Mr. Scarpati has held various executive positions
since joining TCG in August 1984, including Vice President, Chief Financial
Officer, Treasurer and Controller.  Mr. Scarpati is a director of BizTel
Communications, Inc.  He was a director of the Company in 1991.  He is also a
Certified Public Accountant.

  Kenneth A. Shulman, age 43, has been Senior Vice President - Technology since
August 1995. Prior to that, he had been Vice President of Applied Research and
Development since February 1994, Vice President of Technology and Network
Planning since October 1991, Director, Engineering and Technology since June
1990 and Director, Research and Technology since November 1989.  Prior to
joining the Company in 1987, Mr. Shulman held positions as Director -Systems
Engineering at MCI International, as District Manager - Integrated Network
Evolution Planning at Bell Communications Research and as Supervisor - Switching
Systems Engineering at Bell Laboratories.  Mr. Shulman is a director of BizTel
Communications, Inc. and is a Director of Warpspeed Communications, Inc.

  Maria Terranova-Evans, age 41, has been Vice President and Controller since
February 1992. Mrs. Evans has held various managerial and executive financial
positions since joining TCG in September 1984 including accounting Manager,
Controller, and accounting Director/Controller.  She is also a Certified Public
Accountant.

  Wayne G. Fox, age 41, has been Vice President and Treasurer since June 1995.
Prior to that, he had been Vice President - Corporate Ventures since January
1993 and Managing Director of Corporate Ventures since November 1992.  Mr. Fox
was a director of the Company from April 1991 to November 1992.  Prior to
joining the Company, he had been a Vice President and Director in the Mergers &
Acquisitions Group for Merrill Lynch Capital Markets.

  Marsha Gewirtzman, age 46, has been Vice President - People Services since
July 1996.  She joined TCG as Vice President - Sales Operations in January 1996.
Prior to joining TCG she held various senior management and executive positions
over a period of 8 years with Tiffany & Co.  She also spent 15 years with AT&T
in a variety of marketing, sales, management and planning positions. Ms.
Gewirtzman serves on the Board of Directors of the Business School of the
College of William

                                       45
<PAGE>
 
& Mary.

  John W. Thomson, age 48, has been Vice President and Secretary since June
1984.  Mr. Thomson also served as General Counsel of TCG from June 1984 until
February 1996, and as Senior Counsel for Merrill Lynch & Co., Inc. from 1981 to
1988.

  W. Terrell Wingfield, Jr., age 44, has been Vice President and General Counsel
since March 1996.  From March 1994 to February 1996, Mr. Wingfield served as
Regional Vice President -Central Region Operations, and from January 1993 to
March 1994 as Counsel - Affiliate Services. Prior to that, Mr. Wingfield had
been Senior Counsel of Cox Enterprises, Inc. since 1989.


ITEM 11.  EXECUTIVE COMPENSATION.

  The information required by this Item 11 is incorporated by reference to the
Proxy Statement to be filed in connection with the Registrant's Annual Meeting
of Shareholders (the "Proxy Statement").

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The information required by this Item 12 is incorporated by reference to the
Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Amended Stockholders' Agreement. In connection with the Reorganization,
TCG and the Cable Stockholders  entered into the Amended Stockholders'
Agreement. The following summary description of the Amended Stockholders'
Agreement does not purport to be complete and is qualified in its entirety by
reference to the text of the Amended Stockholders' Agreement, which is filed as
an exhibit to the Registration Statement on Form S-1 (Registration Nos. 333-3850
and 333-3984, as amended).   Furthermore, there can be no assurance that the
Cable Stockholders will not cause the Amended Stockholders' Agreement to be
amended, modified or terminated or cause TCG to waive any provision of the
Amended Stockholders' Agreement.

        The Amended Stockholders' Agreement provides that at each annual meeting
of the Company's stockholders at which directors are elected, the holders of the
Class B Common Stock will vote their shares in favor of nominees for director to
be designated as follows: (i) the holders of Class B Common Stock (other than
Continental) will designate ten nominees (with the right of a holder of Class B
Common Stock to designate one or more nominees depending on the percentage of
the Class B Common Stock held by it), (ii) the Board of Directors of the Company
will designate by unanimous consent the Chief Executive Officer of the Company
as a nominee and (iii) the Board of Directors with the unanimous approval of the
holders of Class B Common Stock that have the right to designate nominees for
director shall designate two individuals as nominees for director who

                                       46
<PAGE>
 
are neither employed by nor affiliated with TCG or any holder of Class B Common
Stock.  Under the Amended Stockholders' Agreement, a holder of Class B Common
Stock generally is entitled to designate one director nominee for each 9% of the
outstanding shares (other than shares held by Continental) of Class B Common
Stock held by it and its affiliates.  Under the Company's Amended and Restated
Certificate of Incorporation or the Amended Stockholders' Agreement,  the
holders of the Class A Common Stock will not have the right, as a class, to
nominate any individuals for election to the Board of Directors. The Amended
Stockholders' Agreement prohibits any transfer of Class B Common Stock held by
the parties thereto, unless expressly permitted under the terms thereof. Parties
to the Amended Stockholders' Agreement have certain rights of first offer and
rights of first refusal thereunder with respect to proposed sales of the Class B
Common Stock.

       Each holder of Class B Common Stock has the right to sell all or a part
of its Class B Common Stock upon receiving a bona fide offer from an
unaffiliated third party, subject to giving notice to the other holders of Class
B Common Stock who have designated at least one director, which notice shall
contain an offer to sell such stock to such other holders of Class B Common
Stock on the terms and conditions set forth in the offer from the third party.
Subject to certain limitations, the non-selling holders of Class B Common Stock
have the right to purchase pro rata all, but not less than all, of the Class B
Common Stock offered. If the non-selling holders of Class B Common Stock do not
purchase all of the Class B Common Stock offered, the offering holder of Class B
Common Stock may sell the Class B Common Stock to the third party on the terms
contained in the offer made to the other holders of Class B Common Stock.
However, unless the amount of Class B Common Stock is sufficient to entitle the
transferee to designate a nominee for director under the Amended Stockholders'
Agreement (i.e., the total percentage of Class B Common Stock that would be held
by the transferee and certain of its affiliates is at least nine percent) and
the transferee agrees to become a party to the Amended Stockholders' Agreement,
any Class B Common Stock included in the stock being sold must be converted to
Class A Common Stock.

       If any party desires to convert Class B Common Stock to Class A Common
Stock, it must first offer that stock at a market price to the other holders of
Class B Common Stock who have the right to designate at least one director. If
such other holders do not elect to buy such stock, then such stock can be
converted to Class A Common Stock and sold by the selling stockholder free of
restrictions under the Amended Stockholders' Agreement.

       The parties to the Amended Stockholders' Agreement  have demand
registration rights on the following terms:  (i) such parties collectively will
have the right to make one demand per year (with any such party having the right
to make such demand), (ii) the amount which can be sold pursuant to any demand
may be limited if the managing underwriter selected by the Company with the
approval of the party to the Amended Stockholders' Agreement that has included
the largest

                                       47
<PAGE>
 
number of shares in the registration advises the Company that marketing factors
require a limitation of the number of shares to be underwritten and (iii) if the
amount determined pursuant to clause (ii) is less than the aggregate amount
which such parties want to sell in such offering, each such party will have the
right to sell its pro rata portion of the maximum amount; provided, however,
that during the period ending 42 months after the date of the Offerings, if
Continental is subject to a regulatory requirement as a result of its merger
with U S WEST to reduce or eliminate its investment in the Company, Continental
will have a priority claim in specified percentages on the amount specified in
clause (ii) above and the balance will be split proportionately among the other
stockholders which are a party to the Amended Stockholders' Agreement. See
"Business -- The Reorganization".  The parties to the Amended Stockholders'
Agreement participating in the registration must reimburse the Company for its
out-of-pocket expenses incurred in connection with any such demand registration.

       The Amended Stockholders' Agreement will terminate when the aggregate
voting power of the Class B Common Stock represents less than 30% of the
aggregate voting power of all outstanding Common Stock.

       Eastern TeleLogic Corporation and Comcast. See "Business -- Eastern
TeleLogic Acquisition".

       Operator Managed Ventures Services Agreements with Cox. Pursuant to the
terms of three Operator Managed Ventures Services Agreements between TCG and
certain affiliates of Cox, TCG has options to acquire up to a 35% interest in
the competitive access businesses conducted by such affiliates of Cox in New
Orleans, Oklahoma City and the Hampton Roads, Virginia area, respectively. To
the extent the Cox competitive access provider has derived revenue from any
contract entered into by TCG as a result of sales efforts engaged in by TCG on
behalf of such Cox operations, the purchase price shall be the ratio of the
annual TCG generated revenue to total annual revenue of the Cox operation
multiplied by the book value of the assets of the Cox operation. If such ratio
is less than 35%, TCG may purchase the balance, up to 35%, of that Cox operation
for the fair market value (as determined in accordance with the Operator Managed
Ventures Services Agreements) of the operation. There is no cap or maximum
purchase price under the terms of the Operator Managed Ventures Services
Agreements. In November 1996 TCG notified Cox of its intention to exercise its
option to purchase a 35% interest in Cox's Hampton Roads, Virginia operations
(the Company's options to acquire 35% interests in Cox's New Orleans and
Oklahoma City operations do not mature until 1999). Cox and TCG are currently
engaged in discussions concerning the calculation of the purchase price formula
for Hampton Roads, Virginia, and a possible renegotiation and restructuring of
the respective rights and obligations of the parties under each of the Operator
Managed Ventures Services Agreements.

       TCG also provides management services to certain affiliates of Cox under
these agreements, including billing services, network monitoring and accounts
receivable functions. Under the terms of the agreements, TCG retains 8% of the
collected revenues from Cox customers as a royalty fee. Royalty fees recorded
from Cox were approximately $318,000, $98,000, and $27,000

                                       48
<PAGE>
 
for the years ended 1996, 1995 and 1994, respectively, and are included in
management and royalty fees from affiliates in the statements of operations. The
amount due to Cox under these agreements was $1,079,000 and $295,000 as of
December 31, 1996 and 1995, respectively.  Included in accounts receivable-trade
are approximately $436,000 and $262,000 at December 31, 1995 and 1994,
respectively, for amounts owed by Cox customers.  In the event of a purchase of
an interest in any of the Cox operations by TCG, the royalty fee for such
operation is  reduced to 3%.

       Fidelity. In 1987, a subsidiary of TCG and a subsidiary of FMR Corp.
created a joint venture, Teleport Communications Boston. Pursuant to a series of
transactions consummated in October 1994, TCG acquired from a subsidiary of FMR
Corp. the 50% partnership interest in Teleport Communications Boston that it did
not own. As part of the transaction, TCG reimbursed the FMR Corp. subsidiary for
approximately $7 million of capital contributions paid by that subsidiary to
Teleport Communications Boston. The purchase price for the partnership interest
was $30.5 million which was paid by TCG's purchase of stock of Continental
valued at $30.5 million, and the delivery of that stock to the FMR Corp.
subsidiary. The purchase price for the purchase of the Continental stock was
paid by TCG's delivery to Continental of a promissory note in the amount of
$30.5 million, bearing interest at the rate of 7 5/16% per annum. The entire
principal amount of the promissory note, plus accrued interest in the amount of
$105,320, was paid in November 1994. The promissory note was canceled upon such
payment, and no amounts of principal or interest remain outstanding thereunder.
As a result of those transactions, Teleport Communications Boston became a
wholly owned subsidiary of TCG.

       Residential Telephony Agreements.  In 1996 TCG entered into a
preliminary, short-term agreement with TCI which provides for the provision of
certain services by TCG to TCI in connection with the development by TCI of
residential telephony service offerings in Hartford, Connecticut, San Francisco,
California and Arlington Heights, Illinois and possibly other locations. TCI has
agreed to reimburse TCG for certain costs and cost of capital in connection with
these services.  TCI and TCG are in the process of negotiating a definitive
agreement regarding the provision of these services.  TCG has also entered into
or is negotiating agreements with each of the other three Cable Stockholders
regarding the provision of services with respect to the offering of residential
telephony services by such Cable Stockholders to individual multiple dwelling
units. The total number of residential customers with respect to which TCG
provided services to the Cable Stockholders as of December 31, 1996 was
approximately 1,000.   TCG is also negotiating an agreement with Comcast to
support  a residential trial to be conducted in Baltimore, Maryland and Miami,
Ft. Lauderdale and West Palm Beach, Florida.  TCG expects that this agreement
will provide for TCG to be reimbursed for certain costs and cost of capital.  At
December 31, 1996, the amount due to TCG for reimbursement by Cable Stockholders
in respect of residential services was $1,057,000, and is included in related
parties within the accounts receivable.

       Sales of Fiber Optic Cable. In 1994, TCG entered into agreements with
providers of fiber optic cable that contained discounts for certain volumes of
purchases. The agreements permitted TCG to purchase cable on behalf of
affiliates, including minority partners in the Local Market Partnerships, and to
apply those purchases toward the volume discounts. In 1995 and 1996, TCG

                                       49
<PAGE>
 
purchased cable on behalf of certain of the Cable Stockholders which it then
sold to them at cost. At December  31, 1996, the amount receivable from the
Cable Stockholders was approximately $1,496,000. TCG has purchased cable on
behalf of unaffiliated parties as well.

       CAP Assets. In connection with the formation of the Local Market
Partnerships in Chicago, Dallas, Pittsburgh and Seattle, TCI contributed to the
capital of such Local Market Partnerships certain businesses it owned which
provided local telecommunications services in the service area of such Local
Market Partnerships, in exchange for partnership interests in such Local Market
Partnerships. None of such businesses had a value in excess of $20.0 million,
and each was valued based on the cost thereof. The agreed value of the assets
TCI contributed to TCG Chicago was approximately $4 million, for which it
received a 7.4% partnership interest (in addition to the 26.6% interest it
received for cash). The agreed value of the assets TCI contributed to TCG Dallas
was approximately $3.3 million, for which it received a 14.3% partnership
interest (in addition to the 40.8% interest it received for cash). The agreed
value of the assets TCI contributed to TCG Pittsburgh was approximately $19
million, for which it received a 60% partnership interest. The agreed value of
the assets TCI contributed to TCG Seattle was approximately $3.3 million, for
which it received a 10.8% partnership interest (in addition to the 32.0%
interest it received for cash).

       Facilities Arrangements. Affiliates of the Cable Stockholders have
entered into two types of arrangements with and TCG pursuant to which fiber
optic and cable transmission facilities are made available to it. Pursuant to
the terms of one type of such arrangements, providing an indefeasible right of
use, the compensation payable by and TCG is based on the affiliate's cost of
construction of such facilities, generally payable over five years. For the year
ended December 31, 1996, payments, representing principal plus interest, made to
TCI, Cox, Continental and Comcast pursuant to facilities lease arrangements with
TCG were approximately $12.0 million, $4.8 million, $2.8 million and $2.4
million, respectively. Under the terms of the other type of such arrangements,
TCG agrees to provide, install and maintain all customer premise and nodal
electronics equipment and provide 24-hour electronics maintenance and monitoring
with respect to the cable transmission service. The compensation payable by TCG
is based on a percentage of the total monthly recurring amount which TCG bills
to its customers which are served through such affiliate's cable transmission
service. In connection with a preliminary agreement between TCG and TCI relating
to the provision of residential telephony services, certain Cable Stockholders
have agreed to enter into additional facility agreements with TCG for certain
additional metropolitan areas. The terms of these additional facilities
arrangements have not yet been completely finalized.  The Company believes that
it will continue to be able to enter into additional facilities arrangements
with the Cable Stockholders which will be negotiated on an arm's-length basis
but which may not be as favorable to the Company as facilities arrangements
negotiated prior to the Offerings.

       Sprint Spectrum Service Arrangements. Sprint Spectrum, a partnership
owned 60% by TCI, Comcast and Cox, has entered into preliminary agreements or
letters of intent with a number of wholly-owned subsidiaries of TCG providing
for the construction of special facilities and the provision of services to
Sprint Spectrum by TCG. TCG and Sprint Spectrum are in the process of
negotiating a national master services agreement.  The amount receivable from
Sprint Spectrum at

                                       50
<PAGE>
 
December 31, 1996 was $345,000.

       Comcast Service Arrangements.  TCG has agreed to provide Comcast, after
TCG's acquisition of ETC, certain services on customary terms in the
Philadelphia area, and Comcast has agreed to utilize exclusively TCG's wireline
telecommunications services in the Philadelphia area, subject to certain
qualifications.  See "Business -- Eastern TeleLogic Acquisition."

       TCI Subordinated Note.  See "Business -- The Reorganization".

       The Company believes that the terms, taken as a whole, of the
transactions under the headings "Eastern TeleLogic Corporation and Comcast,"
"Operator Managed Ventures Services Agreements with Cox," "Fidelity,"
"Residential Telephony Agreements," "Sales of Fiber Optic Cable," "CAP Assets",
"Facilities Arrangements", "Sprint Spectrum Service Arrangements", "Comcast
Service Arrangements" and "TCI Subordinated Note" were no less favorable to the
Company than could have been obtained from unaffiliated parties.



PART IV

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

<TABLE>
<CAPTION>
EXHIBIT NO.
-----------
<C>            <S>                                                                          
                                                                                            
*2.1           Reorganization Agreement dated as of April 18, 1996                          
*3.6           Amended and Restated Certificates of Incorporation of TCG, as revised        
*3.7           Amended and Restated By-laws of TCG, as revised                              
*4.2           Amended and Restated Stockholders' Agreement (incorporated by reference to Exhibit
               E of Exhibit 2.1 hereof)                                                
*4.3           Indenture between TCG and United States Trust Company of New York, as   
               Trustee, relating to the 11 1/8% Senior Discount Notes due 2007 of TCG     
*4.4           Indenture of TCG and United States Trust Company of New York, as        
               Trustee, relating to 9 7/8% senior Notes due 2006 of TCG                   
*10.1          New York Franchise Agreement dated May 2, 1994, as amended              
*10.2          Participation Agreement, dated May 15, 1984                             
*10.3          Agreement of Lease, dated May 15, 1984, as amended                      
*10.4          Keepwell Agreement, dated June 7, 1984, as amended                      
*10.5          Agreement of Lease with Teleport Associates, dated November 10, 1987    
*10.6          Agreement of Sublease between Merrill Lynch/WFC/L, Inc. and TC          
               Systems, Inc. dated January 30, 1990                                    
*10.7          Loan Agreement, dated May 5, 1993                                       
*10.8          Amendment No. 1 to Loan Agreement, dated March 1, 1994                  
*10.9          Amendment No. 2 to Loan Agreement, dated October 23, 1994               
*10.10         Amendment No. 3 to Loan Agreement, dated February 15, 1995               
</TABLE> 

                                       51
<PAGE>
 
<TABLE> 
<CAPTION> 
<S>            <C> 
*10.11         Loan Agreement, dated May 22, 1995 and related documents                
*10.12         Amendment No. 1 to Loan Agreement, dated May 31, 1996                   
*10.13         Teleport Communications Group Inc. 1992 Unit Appreciation Plan          
*10.14         Teleport Communications Group Inc. 1993 Unit Appreciation Plan          
*10.15         Teleport Communications Group Inc. 1003 Stock Option Plan, as amended   
*10.16         Teleport Communications Group Inc. Employee Stock Purchase Plan         
*10.17         Deferred Compensation Plan of Teleport Communications Group Inc.        
*10.18         Make-Up Plan of Teleport Communications Group Inc. for the Retirement   
               Savings Plan                                                            
*10.19         Teleport Communications Group Inc. 1996 Equity Incentive Plan           
*10.20         Robert Annunizata Employment Agreement, dated December 18, 1992, as     
               amended                                                                 
*10.21         John A. Scarpati Employment Agreement, dated July 12, 1994, as amended  
*10.22         Robert C. Atkinson Employment Agreement, dated July 12, 1994, as        
               amended                                                                 
*10.23         Stuart A. Mencher Employment Agreement, dated July 12, 1994, as amended 
*10.24         Alf T. Hansen Employment Agreement, dated July 12, 1994, as amended     
*10.25         Partnership Agreement of TCG Detroit, dated as of November 1, 1993      
*10.26         Amended and Restated Partnership Agreement of TCG Los Angeles, dated    
               as of March 1, 1994                                                     
*10.27         Partnership Agreement of TCG Pittsburgh, dated as of March 1, 1994      
*10.28         Partnership Agreement of TCG San Diego, dated as of June 1, 1994        
*10.29         Partnership Agreement of TCG San Francisco, dated as of January 1,      
               1994, as amended                                                        
*10.30         Partnership Agreement of TCG Seattle dated as of January 1, 1994, as    
               amended                                                                 
*10.31         Agreement among Teleport Communications Group Inc. and Comcast          
               Corporation, dated 18, 1996                                             
*10.32         First Amendment to the Teleport Communications Group Inc. 1993 Stock    
               Option Plan                                                             
*10.33         Second Amendment to the Teleport Communications Group Inc. 1993 Stock   
               Option Plan                                                             
*10.34         Letter of Intent between ViacomTelecom, Inc. and Teleport               
               Communications Group Inc., dated as of May 30, 1996.                    
*10.35         Letter of Intent between Viacom Telecom, Inc. and Teleport              
               Communications Group Inc., dated as of May 30, 1996.                    
*10.36         First Amendment to the Teleport Communications Group Inc. 1996 Equity   
               Incentive Plan                                                          
*10.37         Stockholders' Agreement of Comcast CAP of Philadelphia, Inc. dated as   
               of June 30, 1993                                                        
 11.00         Computation of Loss Per Common Share                                    
 12.00         Computation of Ratio of Earnings to Fixed Charges                       
 21.00         Subsidiaries of the Registrant                                          
 23.1          Consent of Deloitte & Touche LLP
 27.00         Financial Data Schedule                                                 
</TABLE> 

*Incorporated by reference to the corresponding exhibit of TCGI's Registration
Statements on Form S-1 (File Nos. 333-3850 and 333-3984)

REPORTS ON FORM 8-K
-------------------

                                       52
<PAGE>
 
  The following reports on Form 8-K were filed during the Company's quarter
ended December 31, 1996:

       A report on Form 8-K, dated October 23, 1996, was filed reporting
Registrant's agreement to acquire Eastern TeleLogic Corporation in a two-step
transaction.

       A report or Form 8-K, dated October 31, 1996 was filed reporting
Registrants's financial results for the fiscal quarter ended September 30, 1996.

                                       53
<PAGE>
 
TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES

INDEX TO AUDITED FINANCIAL STATEMENTS
-------------------------------------

<TABLE>
<CAPTION>
                                                                                                     PAGE
                                                                                                     ----
<S>                                                                                                  <C>
 
 Independent Auditors' Report                                                                          F-1
 
 Balance Sheets at December 31, 1996 and 1995                                                          F-2
 
 Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994                         F-4
 
 Statements of Changes in Stockholders' Equity and Partners' Capital (Deficit)
  for the Years Ended December 31, 1996, 1995 and 1994                                                 F-5
 
 Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994                         F-6
 
 Notes to Financial Statements                                                                         F-7
</TABLE>
<PAGE>
 
INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of
 Teleport Communications Group Inc.:

We have audited the accompanying consolidated balance sheet of Teleport
Communications Group Inc. and its subsidiaries ("TCG") as of December 31, 1996
and the related consolidated statements of operations, changes in stockholders'
equity and partners' capital (deficit), and cash flows for the year then ended
and the combined balance sheet of Teleport Communications Group Inc. and its
subsidiaries and TCG Partners (collectively, "TCGP"), which were under common
ownership and management, as of December 31, 1995 and the related combined
statements of operations, changes in stockholders' equity and partners' capital
(deficit), and cash flows for the years ended December 31, 1995 and 1994.  These
financial statements are the responsibility of management.  Our responsibility
is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the consolidated (combined) financial position of TCG and TCGP at
December 31, 1996 and 1995, respectively, and the results of their operations
and their cash flows for the three years ended December 31, 1996, 1995 and 1994
in conformity with generally accepted accounting principles.



DELOITTE & TOUCHE LLP
NEW YORK, NEW YORK

FEBRUARY 21, 1997 (FEBRUARY 28, 1997 AND MARCH 1, 1997 AS TO NOTE 3)

                                      F-1
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                                BALANCE SHEETS
                          DECEMBER 31, 1996 AND 1995
                                (IN THOUSANDS)
 
 
ASSETS                                    CONSOLIDATED    COMBINED
------                                       
                                              1996          1995
                                              ----          ----   
Current assets:
 Cash and cash equivalents                  $  277,540   $  11,862
                                            ----------   ---------
 Marketable securities                         440,806           -
                                            ----------   ---------
 Accounts receivable:
   Trade - net of allowance for
    doubtful accounts
       ($5,989 in 1996 and $1,161 in  1995)     46,325      26,196
              
   Related parties                               4,191       4,640
   Miscellaneous - net of allowance for
    doubtful accounts
       ($1,406 in 1996 and $543 in 1995)         6,795       2,037
                                            ----------   ---------
        Accounts receivable - net               57,311      32,873
                                            ----------   ---------
   Prepaid expenses                              9,531       4,939
                                            ----------   ---------
   Other current assets                          2,373         532
                                            ----------   ---------
        Total current assets                   787,561      50,206
                                            ----------   ---------
 
Fixed assets - at cost:
   Communications network                    1,211,922     492,858
   Other                                        92,307      52,795
                                            ----------   ---------
                                             1,304,229     545,653
   Less accumulated depreciation and                                
    amortization                              (236,967)   (113,202) 
                                            ----------   ---------  
       Fixed assets - net                    1,067,262     432,451
                                            ----------   ---------
 
Investments in and advances to                                     
 unconsolidated affiliates                     126,561      99,299 
                                            ----------   --------- 
 
Goodwill - net of accumulated
 amortization
   ($3,789 in 1996 and $1,716 in 1995)          57,764      27,008
                                            ----------   ---------
Other assets                                    10,949       5,829
                                            ----------   ---------
   Total assets                             $2,050,097   $ 614,793
                                            ==========   =========

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

                                      F-2
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                           BALANCE SHEETS - CONTINUED
                           DECEMBER 31, 1996 AND 1995
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

LIABILITIES AND STOCKHOLDERS' EQUITY AND PARTNERS' DEFICIT
----------------------------------------------------------

 
                                                                        
                                          CONSOLIDATED         COMBINED        
                                              1996               1995  
                                              ----               ----
Current liabilities:
 Accounts payable and accrued                                           
  liabilities ($1,079 in 1996
   and $295 in 1995 with 
   related parties)                         $  215,808         $ 92,104 

 Current portion of capital lease
  obligations ($21,139 in 1996 
  and $3,338 in 1995 with 
  related parties)                              24,063            4,354 
 Other current liabilities                       2,365              831
                                            ----------         --------
   Total current liabilities                   242,236           97,289
 
Capital lease obligations
  ($28,716 in 1996 and $10,017 in 1995                                  
   with related parties)                        34,489           11,964 
Subordinated debt to parents                         -          269,000
Long-term bank debt                                  -           87,500
Senior Notes                                   300,000                -
Senior Discount Notes                          659,567                -
Unamortized notes costs                        (25,761)               -
TCI note-subordinated (including                
 accrued interest of $1,007)                    27,007                - 
Minority interest                                    -            4,409
Other liabilities                               15,689           19,283
                                            ----------         --------
      Total liabilities                      1,253,227          489,445
                                            ----------         --------
 
  Commitments and contingencies
 
Stockholders' equity and partners'
 deficit:
 Common Stock, Class A $.01 par value:
 450,000,000 shares authorized, 28,668,400 
 shares issued and outstanding at December      
 31, 1996; and Common Stock, $1.00 par
 value: 3,000 shares authorized, 1,667 
 shares issued and outstanding at 
 December 31, 1995                                 287                2 
 
 Common Stock, Class B $.01 par value:
  300,000,000 shares authorized, 139,250,370 
  shares issued and outstanding at December 
  31, 1996; and no shares issued and 
  outstanding at December 31, 1995               1,393                - 
 
 Additional paid-in capital                  1,197,252          195,388
 Unrealized loss on marketable                     
  securities                                       (25)               -
 Accumulated deficit                          (281,012)         (65,648)
 Partners' deficit                                   -           (4,394)
                                            ----------         --------
 
 Less cost of Class B Common Stock held   
  in treasury, 7,975,738 shares at             
  December 31, 1996                           917,895           125,348
                                            ----------         --------
                                             (121,025)                - 
                                            ----------         --------  
   Total stockholders' equity and                                       
    partners' deficit                          796,870          125,348 

Total liabilities and stockholders'         ----------         -------- 
 equity and partners' deficit               $2,050,097         $614,793 
                                            ==========         ======== 

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

                                      F-3
<PAGE>
 
               TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                            STATEMENTS OF OPERATIONS
                  YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                          CONSOLIDATED     COMBINED      COMBINED
                                              1996           1995          1994
                                              ----           ----          ----
Revenues:
<S>                                       <C>            <C>           <C>
  Telecommunications services             $    244,864   $   134,652   $    99,983                                           
  Management and royalty fees from        
   affiliates                                   22,805        31,517        20,691 
                                          ------------   -----------   ----------- 
 
        Total revenues                         267,669       166,169       120,674
                                          ------------   -----------   -----------
 
Expenses:
  Operating                                    157,591        93,118        76,572
  Selling, general and administrative           85,025        50,475        39,989
  Depreciation and amortization                 78,416        37,837        19,933
                                          ------------   -----------   -----------
 
        Total expenses                         321,032       181,430       136,494
                                          ------------   -----------   -----------
 
Operating loss                                 (53,363)      (15,261)      (15,820)
                                          ------------   -----------   -----------
 
Interest:
 
    Interest income                             30,219         4,067         1,711
    Interest expense  ($14,997 in 1996,
     $18,763 in 1995 and $4,998 in 1994                                             
      with related parties)                    (73,633)      (23,331)       (5,079) 
                                          ------------   -----------   -----------  

    Total interest                             (43,414)      (19,264)       (3,368) 
                                          ------------   -----------   -----------  

Loss before minority interest, equity
 in losses of unconsolidated affiliates                                             
 and income tax provision                      (96,777)      (34,525)      (19,188) 
 
Minority interest                                3,520           663         1,395
 
Equity in losses of unconsolidated                                                 
 affiliates                                    (19,400)      (19,541)      (11,763)
                                          ------------   -----------   ----------- 
 
Loss before income tax provision              (112,657)      (53,403)      (29,556)
 
Income tax provision                            (2,193)         (401)         (433)
                                          ------------   -----------   -----------
 
Net loss                                  $   (114,850)  $   (53,804)  $   (29,989)
                                          ============   ===========   ===========
 
Loss per share                                  $(1.00)       $(0.77)       $(0.43)
                                          ============   ===========   ===========
 
Weighted average number of shares          
 outstanding                               114,443,695    70,000,140    70,000,140
                                          ============   ===========   ===========
</TABLE>
   The accompanying notes are an integral part of these financial statements.

                                      F-4
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                     STATEMENTS OF CHANGES IN STOCKHOLDERS'
                     EQUITY AND PARTNERS' CAPITAL (DEFICIT)
                  YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                     (IN THOUSANDS, EXCEPT  SHARE AMOUNTS)
<TABLE>
<CAPTION>
 
                                                                                                                   TOTAL
                                                                                                                STOCKHORLDERS'
                                                                UNREALIZED                                       EQUITY AND  
                                          CLASS B   ADDITIONAL   LOSS ON                 PARTNERS'                PARTNERS'  
                              COMMON       COMMON    PAID-IN    MARKETABLE   ACCUMULATED  CAPITAL     TREASURY     CAPITAL   
                              STOCK        STOCK     CAPITAL    SECURITIES     DEFICIT   (DEFICIT)     STOCK      (DEFICIT)  
                              ------       -----     -------    ----------     -------    -------      -----       -------   
<S>                           <C>       <C>         <C>         <C>         <C>          <C>         <C>        <C>             
Combined balance at                                                                                                                 
 January 1, 1994              $    2    $     -     $  195,388   $    -     $ (10,880)    $ 24,631   $       -    $ 209,141         

                                                                                                                                   
Net loss                           -          -              -        -       (22,381)      (7,608)          -      (29,989)       
                              ------    -------     ----------   ------     ---------     --------   ---------    ---------         

Combined balance at                                                                                                                 
 December 31, 1994                 2          -        195,388        -       (33,261)      17,023           -      179,152         

                                                                                                                                   
Net loss                           -          -              -        -       (32,387)     (21,417)          -      (53,804)       
                              ------    -------     ----------   ------     ---------     --------   ---------    ---------         

Combined balance at                                                                                                                 
 December 31, 1995                 2          -        195,388        -       (65,648)      (4,394)          -      125,348         

                                                                                                                                   
Issuance of 27,025,000                                                                                                             
 shares of Class A Common 
 Stock, net of issuance
 costs of $24.8 million          270          -        407,374        -             -            -           -      407,644         

                                                                                                                                   
Conversion of and 42,000                                                                                                           
 to 1 stock split of $1.00 
 par value Common Stock to  
 139,250,370 shares of                                                                                                            
 Class B Common Stock as                                                                                                           
 part of the Reorganization       (2)     1,393        307,828        -      (100,514)       4,394           -      213,099         

                                                                                                                                   
Purchase of 7,975,738                                                                                                              
 shares of Class B Common 
 Stock from Continental 
 Cablevision, Inc.                 -          -              -        -             -            -    (121,025)    (121,025)        

                                                                                                                                   
Conversion of subordinated 
 debt to parents plus 
 accrued interest of 
 $20.6 million to equity           -          -        263,602        -             -            -           -      263,602         

                                                                                                                                   
Issuance of 1,587,791                                                                                                              
 shares of Class A 
 Common Stock to purchase 
 the minority interests 
 in two Local Market 
 Partnerships                     16          -         22,673        -             -            -           -       22,689         

                                                                                                                                   
Issuance of 55,609 shares                                                                                                          
 of Class A Common Stock 
 upon exercise of options          1          -            387        -             -            -           -          388         

                                                                                                                                   
Unrealized loss on                                                                                                                 
 marketable securities             -          -              -      (25)            -            -           -          (25)        

                                                                                                                                   
Net loss                           -          -              -        -      (114,850)           -           -     (114,850)       
                              ------    -------     ----------   ------     ---------     --------   ---------    ---------         

Consolidated balance at      
 December 31, 1996            $  287    $ 1,393     $1,197,252   $  (25)    $(281,012)    $      -   $(121,025)   $ 796,870        
                              ======    =======     ==========   ======     =========     ========   =========    =========         
</TABLE>

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

                                      F-5
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                            STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                                (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                      CONSOLIDATED   COMBINED   COMBINED
                                                                          1996         1995       1994
                                                                       ----------   ---------   ---------
<S>                                                                    <C>          <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net loss                                                              $ (114,850)  $ (53,804)  $ (29,989)
 Adjustments to reconcile net loss to
  net cash provided by operating activities, net of effects of
  the Reorganization and acquisitions:
   Depreciation and amortization                                           78,416      37,837      19,933
   Amortization of notes costs                                              1,350           -           -
   Equity in losses of unconsolidated affiliates                           19,400      19,541      11,763
   Amortization of deferred credits                                        (2,965)     (2,228)     (1,886)
   Provision for losses on accounts receivable                              3,442         877         768
   Accretion of discount on Senior Discount Notes                          34,567           -           -
   Minority interest                                                       (3,520)      ( 663)     (1,395)
 (Increase) decrease in operating assets and increase
  in operating liabilities: 
   Accounts receivable                                                    (18,386)    (12,771)     (8,958)
   Other assets                                                            (3,596)     (3,108)        592
   Accounts payable and accrued liabilities                                97,230      45,832      94,472
   Deferred credits                                                         2,530       4,628       2,453
                                                                       ----------   ---------   ---------
    Net cash provided by operating activities                              93,618      36,141      87,753
                                                                       ----------   ---------   ---------
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 Capital expenditures                                                    (294,078)   (139,656)   (138,892)
 Due from related parties                                                 (23,042)     (6,707)    (69,007)
 Purchase of minority interest in Teleport Communications Boston                -           -     (36,975)
 Purchases of marketable securities, net of sales and maturities         (440,831)          -           -
 Purchase of a Local Market Partnership interest                          (11,618)          -           -
 Capital contributions to Local Market Partnerships prior to
  Reorganization                                                          (16,435)          -           -
 Investments in and advances to unconsolidated affiliates                (127,509)    (65,004)    (42,342)
 Repayment of advances to unconsolidated affiliate                              -       3,400           -
 Reimbursement of funds advanced to unconsolidated affiliates                   -           -      22,190
                                                                       ----------   ---------   ---------
    Net cash used for investing activities                               (913,513)   (207,967)   (265,026)
                                                                       ----------   ---------   ---------
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from issuance of long-term debt                                 162,500     159,000     172,500
 Payments on bank revolving credit facility                              (250,000)          -           -
 Proceeds from Senior Notes                                               300,000           -           -
 Proceeds from Senior Discount Notes                                      625,000           -           -
 Costs associated with the Offerings                                      (51,867)          -           -
 Proceeds from the issuance of Class A Common Stock                       432,400           -           -
 Proceeds from the exercise of employee stock options                         388           -           -
 Purchase of treasury stock                                              (121,025)          -           -
 Capital contributions from minority partners                                   -       2,168       6,058
 Principal payments on capital leases                                     (11,823)     (3,480)       (459)
 Repayments of short-term debt                                                  -           -      (6,542)
                                                                       ----------   ---------   ---------
   Net cash provided by financing activities                            1,085,573     157,688     171,557
                                                                       ----------   ---------   ---------
 
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS                                                          265,678     (14,138)     (5,716)

CASH AND CASH EQUIVALENTS, JANUARY 1                                       11,862      26,000      31,716
                                                                       ----------   ---------   ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31                                 $  277,540   $  11,862   $  26,000
                                                                       ==========   =========   =========
</TABLE>

   The accompanying notes are an integral part of these financial statements

                                      F-6
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

1.  ORGANIZATION AND OPERATIONS

      Teleport Communications Group Inc. ("TCG" or the "Company"), the first and
    largest competitive local exchange carrier ("CLEC") in the United States,
    offers a wide range of telecommunications services in major metropolitan
    markets nationwide.  TCG competes with incumbent local exchange carriers
    ("ILECs") as "The Other Local Phone Company"(R) by providing high quality,
    integrated telecommunications services, primarily over fiber optic digital
    networks, to meet the voice, data and video transmission needs of its
    customers.  TCG's customers are principally telecommunications-intensive
    businesses, hospitals and educational institutions, governmental agencies,
    long distance carriers and resellers, Internet service providers, disaster
    recovery service providers and wireless communications companies.  TCG
    offers these customers technologically advanced telecommunications services,
    as well as superior customer service, flexible pricing and vendor and route
    diversity.
 
      TCG, incorporated in March 1983, and TCG Partners, formed in December
    1992, were each owned 30.05994% by wholly-owned subsidiaries of Cox
    Communications, Inc. ("Cox"), 29.93994% by wholly-owned subsidiaries of
    Tele-Communications, Inc. ("TCI"), 20.00006% by wholly-owned subsidiaries of
    Comcast Corporation ("Comcast"), and 20.00006% by wholly-owned subsidiaries
    of Continental Cablevision, Inc. ("Continental") (collectively the "Cable
    Stockholders") until June 27, 1996.

      In connection with the public offerings of Class A Common Stock, Senior
    Notes and Senior Discount Notes on June 27, 1996, TCG and its owners entered
    into a Reorganization Agreement dated as of April 18, 1996 (the
    "Reorganization Agreement"), pursuant to which TCG Partners and certain of
    the Company's unconsolidated affiliates became wholly-owned subsidiaries of
    TCG, and TCG acquired the minority interests of  the owners of the remaining
    unconsolidated affiliates.

    REORGANIZATION AND OFFERINGS

    OFFERINGS

      On June 27, 1996, the Company issued 27,025,000 shares of Class A Common
    Stock which resulted in gross proceeds of approximately $432.4 million (the
    "Stock Offering"), and $300 million of Senior Notes and $1,073 million of
    Senior Discount Notes ("the Notes Offerings" and, collectively, with the
    Stock Offering, the "Offerings") as part of an initial public offering. The
    Offerings of the Senior Notes and the Senior Discount Notes resulted in
    aggregate gross proceeds of approximately $925 million. The gross proceeds
    of the Offerings (approximately $1.3 billion) were received by TCG on July
    2, 1996. TCG also recognized a liability of approximately $46.8 million
    which was paid to the Underwriters on July 2, 1996. In July 1996, the
    Company utilized a portion of the net proceeds of the Offerings to (i) repay
    $250 million of bank indebtedness plus accrued interest and (ii) purchase
    7,975,738 shares of Class B Common Stock owned by Continental for $16.00 per
    share, less related expenses, for a net cost of $121 million. In addition, a
    portion of the proceeds was used to loan approximately $115 million to its
    affiliate Comcast CAP of Philadelphia, Inc., ("Comcast CAP"), as part of the
    first step in TCG's acquisition of Eastern TeleLogic Corporation. The
    remaining funds will be used to expand and develop existing and new
    networks, to make acquisitions and for general corporate and working capital
    purposes.

    REORGANIZATION

              Prior to the Offerings, the Company was owned by subsidiaries of
    the Cable Stockholders.  The business was operated through TCG, and
    beginning in 1992, TCG Partners, which is a New York general partnership
    owned prior to the Reorganization by the Cable Stockholders in the same
    percentages as TCG.  TCG Partners was 

                                      F-7
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED

    formed to invest, with TCG, the Cable Stockholders and other cable
    operators, in 14 partnerships (the "Local Market Partnerships") to develop
    and operate local telecommunications networks. The Local Market Partnerships
    were owned by TCG, and/or TCG Partners, certain of the Cable Stockholders
    which had cable operations in the particular markets addressed by the Local
    Market Partnerships, and, in some cases, other cable operators in such
    markets. To simplify this complex ownership structure, the Company and the
    Cable Stockholders agreed to consolidate the ownership of TCG Partners and
    of the Local Market Partnerships as wholly-owned subsidiaries of TCG. As
    part of this process, certain of the other cable operators agreed to sell
    their interests in the Local Market Partnerships to TCG directly or through
    a Cable Stockholder.

      Reorganization Transactions Consummated Prior to or in Connection with the
    Offerings

      On May 13, 1996, in connection with the Reorganization, TCG purchased the
    partnership interest of Hyperion Telecommunications, Inc. of Florida in TCG
    South Florida for $11,618,000.

      In consideration of the transfer by each of the Cable Stockholders of its
    respective interests in TCG Partners and the Local Market Partnerships and
    the contribution to TCG of $269 million of indebtedness plus accrued
    interest from the Cable Stockholders (except that TCI retained $26 million
    subordinated note of TCG), the Company issued, immediately prior to the
    Offerings, 69,250,230 additional shares of Class B Common Stock to the Cable
    Stockholders.

      Pursuant to the Reorganization, TCG Partners and the Local Market
    Partnerships became wholly-owned subsidiaries of TCG.
 
      Reorganization Transactions After the Offering
 
      On July 2, 1996, TCG issued 576,263 shares of Class A Common Stock
    to the unaffiliated minority partners of TCG Detroit in consideration for
    the transfer to TCG of the remaining partnership interests in TCG Detroit.
 
      In addition, on December 26, 1996, TCI was issued (i) 638,862 shares of
    Class A Common Stock in consideration for the transfer on such date to TCG
    of the partnership interest which TCI had acquired from MicroNet, Inc. in
    TCG San Francisco and (ii) 372,666 shares of Class A Common Stock in
    consideration for the transfer on such date to TCG of the partnership
    interest which TCI had acquired from Intermedia Partners in TCG San
    Francisco.  As a result, as of December 26, 1996, all of the Local Market
    Partnerships had become wholly-owned subsidiaries of TCG.

      As of December 31, 1996, TCI, Cox, Comcast and Continental  owned 37.2%,
    29.8%, 19.5% and 13.6%, respectively, of the Company's Class B Common Stock,
    representing 36.4%, 29.1%, 19.1% and 13.3%, respectively, of the combined
    voting power of the Company's Common Stock. TCG is owned 31.1%, 24.4%,
    16.1%, 11.1%  and 17.3% by TCI, Cox, Comcast, Continental and public
    shareholders, respectively.

                                      F-8
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED


      Unaudited pro forma financial information for the years ended December 31,
    1996 and 1995, as if the Reorganization had occurred at the beginning of
    each of the respective years, is as follows:
<TABLE>
<CAPTION>
                                                   (In thousands, except share amounts)
                                                        1996               1995  
                                                        ----               ----                                                     

<S>                                                 <C>                <C> 
Revenues                                            $    283,383       $    184,852                                                 
                                                    ------------       ------------                                                 

                                                                                                                                    

Expenses:                                                                                                                           

     Operating                                           172,374            112,575                                                 

     Selling, general and  administrative                 98,436             71,688                                                 

     Depreciation and amortization                        96,260             62,797                                                 
                                                    ------------       ------------                                                 

             Total expenses                              367,070            247,060                                                 
                                                    ------------       ------------                                                 

                                                                                                                                    

Operating loss                                           (83,687)           (62,208)                                                

                                                                                                                                    

Interest:                                                                                                                           

     Interest income                                      29,163              4,824                                                 

     Interest expense                                    (66,946)           (11,661)                                                
                                                    ------------       ------------                                                 

             Total interest                              (37,783)            (6,837)                                                
                                                    ------------       ------------                                                 

                                                                                                                                    

Loss before minority interest, equity in
     losses of unconsolidated affiliates 
     and income tax provision                           (121,470)           (69,045)

Minority interest                                          4,713              3,198                                                 

Equity in losses of unconsolidated affiliates             (7,650)            (1,368)                                                
                                                    ------------       ------------                                                 

Loss before provision for income taxes                  (124,407)           (67,215)                                                

Income tax provision                                      (2,193)              (404)                                                
                                                    ------------       ------------                                                 

                                                                                                                                    

Net loss                                            $   (126,600)      $    (67,619)                                                
                                                    ============       ============                                                 

Loss per share                                      $      (0.86)      $      (0.51)                                                
                                                    ============       ============                                                 

Weighted average number of shares                                                                                                   
     outstanding                                     146,423,705        132,911,232                                                 
                                                    ============       ============                                                 
</TABLE> 

     Pro forma adjustments include the reversal of TCG's equity in the losses of
13 Local Market Partnerships for 1996 and 1995, as well as amortization of the
goodwill which was recorded upon closing of the transactions and the reduction 
of interest expense from the conversion of subordinated debt to parents to
equity. The pro forma financial information presented above is not necessarily
indicative of the operating results which would have been achieved had the
transactions occurred at the beginning of the periods presented or of the
results to be achieved in the future.

                                      F-9
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED


2.  SIGNIFICANT ACCOUNTING POLICIES

      Basis of Presentation - The 1996 consolidated balance sheet includes the
   accounts of TCG and all wholly-owned  subsidiaries.  The 1996 consolidated
   statements of operations and of cash flows include equity in losses of
   unconsolidated affiliates for all the Local Market Partnerships through June
   30, 1996 except for TCG St. Louis which was consolidated for the year.  As of
   July 1, 1996, the statements of operations and of cash flows consolidate the
   operations of the former Local Market Partnerships.  As of December 31, 1995
   and for the years ended December 31, 1995 and 1994, the balance sheet and
   statements of operations and of cash flows include the combined accounts of
   TCG and TCG Partners.  Minority interest represents another partner's equity
   in TCG St. Louis at December 31, 1995.  Investments in which TCG holds less
   than a 50 percent interest are accounted for under the equity method. All
   material intercompany transactions and balances have been eliminated in the
   financial statements presented.

      Basis of Accounting - The accompanying financial statements have been
    prepared on the accrual basis of accounting.

      Use of Estimates - The preparation of 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 and disclosure of contingent assets and liabilities at the date
    of the financial statements and the reported amounts of revenues and
    expenses during the reporting period.  Actual results could differ from
    those estimates.

      Cash Equivalents - Cash equivalents consist principally of fixed income
    securities, U.S. Treasury bills, commercial paper, floating rate notes and
    certificates of deposit with a maturity date of three months or less when
    purchased.

      Marketable Securities - Marketable securities consist principally of fixed
   income securities, U.S. Treasury bills, commercial paper, floating rate notes
   and  certificates of deposit with a maturity date greater than three months
   when purchased and are stated at market value.  Market value is determined by
   the most recently traded price of the security at the balance sheet date.
   TCG invests primarily in high-grade marketable securities.  All marketable
   securities are classified as available for sale securities under the
   provisions of  Statement of Financial Accounting Standards ("SFAS") No. 115,
   "Accounting for Certain Investments in Debt and Equity Securities" and
   unrealized holding gains and losses are reflected as part of stockholders'
   equity.  Net realized gains and losses are determined on the specific
   identification cost method.

      Financial Instruments - Financial instruments which potentially subject
    the Company to concentrations of credit risk consist principally of cash and
    cash equivalents, marketable securities and accounts receivable.  The
    Company places its temporary cash and cash equivalents and marketable
    securities with high-quality institutions and, by policy, limits the amount
    of credit exposure to any one institution.  Concentrations of credit risk
    with respect to accounts receivable are limited due to the dispersion of
    TCG's customer base among different industries and geographic areas in the
    United States, by credit granting policies adopted by TCG and by remedies
    provided by terms of contracts, tariffs and statutes.

                                      F-10
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED


      Fair Value of Financial Instruments - The estimated fair value amounts
    have been determined by the Company, using available market information and
    appropriate valuation methodologies. However, considerable judgment is
    required in interpreting market data to develop the estimates of fair value.
    Accordingly, the estimates presented herein are not necessarily indicative
    of the amounts that the Company could realize in a current market exchange.
    The use of different market assumptions and/or estimation methodologies may
    have a material effect on the estimated fair value amounts.
 
      Goodwill - Goodwill represents the excess purchase price paid over the net
    assets associated with the purchase of the remaining partnership interests
    in Teleport Communications (New York), Teleport Communications Boston
    ("TCB"), TCG Florida, TCG Detroit and TCG San Francisco, as well as goodwill
    recorded in the financial statements of TCG Pittsburgh, which is included in
    the consolidated financial statements of TCG after the Reorganization.
    Goodwill is amortized on a straight line basis over 40, 20 or 15 years for
    all entities.  The goodwill amortization recorded in 1996, 1995 and 1994 was
    $2,150,000, $1,437,000 and $207,000,  respectively.
 
      The carrying value of intangible assets is periodically reviewed and
    impairments will be recognized when the undiscounted expected future cash
    flows, computed after interest expense derived from the related operations,
    is less than their carrying value.  Effective January 1, 1995, TCG changed
    its estimate of the useful life of the goodwill associated with TCB to 20
    years.  The effect of this change in estimate was to increase depreciation
    and amortization expense by approximately $650,000.

      Deferred Credits - Deferred credits principally represent advance payments
    received  from customers for long-term fiber optic service, and are
    amortized into income over the life of the related contracts.  The current
    portions, $2,365,000 and  $831,000 at December 31, 1996 and 1995,
    respectively, are included in other current liabilities and the non-current
    portions, $9,902,000 and $5,392,000 at December 31, 1996 and 1995,
    respectively, are included in other liabilities.

      Revenue Recognition - Revenue on dedicated line, switch and data services
    is recognized in accordance with the terms of the underlying customer
    contracts or tariffs and over the period in which the services are provided.

      Depreciation and Amortization - Depreciation and amortization are computed
    on the straight-line basis over the estimated useful lives of the assets or
    the length of the lease, whichever is shorter.  Estimated useful lives are
    five to 25 years for the communications network and three to five years for
    other fixed assets, except for buildings which are 40 years.

      When depreciable assets are replaced or retired, the amounts at which such
    assets were carried are removed from the respective accounts and charged to
    accumulated depreciation and any gains or losses on disposition are
    amortized over the remaining original asset lives in accordance with
    industry practice.

      During 1995, TCG completed a review of the useful lives of its fixed
    assets.  TCG determined that the lives of certain electronics equipment were
    longer than industry standard, while the lives of  other electronics
    equipment were shorter than industry standard.  Therefore, TCG adjusted the
    estimated useful lives of certain electronics equipment to conform with
    industry standard, effective December 1, 1995.  The effect of these changes
    in estimate increased depreciation expense for the year ended December 31,
    1995 by approximately $700,000.

      Impairment of Long-Lived Assets -  In March 1995, the Financial Accounting
    Standards Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment
    of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."  This
    statement is effective for fiscal years beginning after December 15, 1995.
    Management has

                                      F-11
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED

    evaluated the effect on its financial condition and results of operations
    from the adoption of this statement and does not believe an impairment of
    the long-lived assets has occurred.

      Income Taxes - TCG accounts for income taxes in accordance with SFAS No.
    109, "Accounting for Income Taxes," pursuant to which deferred income tax
    assets and liabilities are determined based on the difference between the
    financial statement and tax bases of assets and liabilities, using enacted
    tax rates currently in effect.  State and local taxes are based on factors
    other than income.

      Net Loss Per Share - Net loss per share is determined by dividing net loss
    by the weighted average number of common shares outstanding for the period.
    The computation of fully diluted net loss per share was antidilutive in each
    of the periods presented; therefore, the amounts reported as primary and
    fully diluted are the same.

      As part of the Reorganization, TCG declared a 42,000 to one stock split.
    All per share amounts and numbers of shares have been restated to reflect
    the stock split retroactive for the periods presented.

      Presentation - Certain 1995 and 1994 amounts have been reclassified to
    conform with the 1996 presentation.

3.  ACQUISITIONS AND INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES
 
    CERFnet Services Inc.

      On February 4, 1997, the Company acquired from General Atomics all the
    outstanding capital stock of CERFnet Services, Inc. ("CERFnet"), a leading
    regional provider of Internet-related services to businesses, including
    dial-up and dedicated Internet access, World Wide Web hosting and
    colocation services and Internet training.  TCG issued to General Atomics,
    CERFnet's former controlling stockholder, 2,100,000 shares of its Class A
    Common Stock and granted to General Atomics certain registration rights with
    respect to such shares of Class A Common Stock.  CERFnet operates a
    nationwide backbone network, maintains state-of-the-art Internet server
    facilities, has established and maintains direct peering relationships with
    other Internet service providers and serves currently over 6,000 customers
    located primarily in California and Arizona.  TCG expects to upgrade
    CERFnet's backbone, to accelerate the expansion of CERFnet's services
    nationwide and to achieve marketing synergies by packaging CERFnet's
    Internet services with TCG's complementary telecommunications services.

    Eastern TeleLogic Corporation

      In connection with the issuance of capital stock to Comcast and
    Continental in 1993, TCG purchased from Comcast, for approximately $6.5
    million, 49% of the issued and outstanding stock of Comcast CAP, which owned
    51% of the outstanding capital stock of Eastern TeleLogic Corporation
    ("ETC"), on a fully-diluted basis.  Such purchase price was evidenced by a
    note payable in one year from the date thereof with interest at the LIBOR
    rate plus .75% per annum and was secured by a pledge to Comcast of the
    capital stock of  Comcast CAP.  On June 30, 1994, this note was repaid in
    full.

      On August 24, 1994 and September 19, 1994, TCG increased its investment in
    Comcast CAP by approximately $3.2 million in the aggregate.  These
    investments primarily represented TCG's 49% participation in Comcast CAP's
    purchase of various issues of ETC's convertible subordinated debt.  On
    October 3, 1995, ETC converted principal and interest on these notes to
    common stock.  Such investment is included in investments in and advances to
    unconsolidated affiliates in the accompanying balance sheets.

      In March and July 1995, TCG and Comcast CAP provided interim financing to
    ETC for ETC to expand its network geographically.  TCG's portion of the
    financing was approximately $3,400,000 in the form of convertible
    subordinated demand promissory notes.  On October 3, 1995, ETC repaid these
    notes plus interest.

                                      F-12
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED

      Effective as of  March 1, 1997, TCG completed its previously announced
    acquisition of ETC for 2,757,083 shares of TCG's Class A Common Stock.  In
    the first of two steps, on October 25, 1996, employees of ETC exercised
    their stock options and then ETC redeemed the shares of its stock
    (approximately 47%) not held by Comcast CAP.  Comcast CAP borrowed at a
    market interest rate approximately $115 million from TCG as a short-term
    loan and, in turn, loaned this amount to ETC to effect the redemption.  In
    the second step, TCG acquired Comcast's 51% stock interest in Comcast CAP in
    exchange for 2,757,083 shares of the Company's Class A Common Stock,
    resulting in ETC becoming a wholly-owned subsidiary of TCG.  TCG will assume
    approximately $60 million of ETC debt and other obligations.  The
    acquisition of ETC provides TCG with access to the Philadelphia market, the
    nation's fifth largest market, and will allow TCG to establish a contiguous
    network between Boston and Washington, D.C..  ETC operates a Class 5 digital
    telephone switch on its 525-mile fiber optic network which connects to more
    than 360 buildings.

      The goodwill recorded with this investment, which represented the excess
    of the Company's investment over the underlying net assets of ETC, was
    approximately $115,666,000.  Such amount is being amortized over 20 years
    beginning November 1996 and is reported in the statement of operations in
    equity in losses of unconsolidated affiliates.  Amortization expense related
    to such goodwill for the year ended December 31, 1996 was $964,000.

      Unaudited pro forma financial information for the years ended December 31,
    1996 and 1995 as if the Reorganization and the acquisitions of ETC and
    CERFnet had occurred at the beginning of each of the respective years, is as
    follows (in thousands, except share amounts):
 
 
                               1996           1995
                               ----           ----       
    Revenue                $    316,239   $    209,904
 
    Net loss               $   (152,085)  $    (78,561)
 
    Loss per share         $      (1.01)  $      (0.57)
 
    Weighted average
       number of shares                 
       outstanding          151,280,788    137,768,315

      Pro forma adjustments include the reversal of TCG's equity in the losses
    of the 13 Local Market Partnerships and ETC for 1996 and 1995, as well as
    amortization of the goodwill to be recorded upon close of the transaction
    and the reduction of interest expense from the conversion of subordinated
    debt to parents to equity. It is TCG's intention subsequent to the
    acquisition, to more fully evaluate the acquired assets and, as a result,
    the allocation of the acquisition costs among the tangible and intangible
    assets acquired may change. The pro forma financial information presented
    above is not necessarily indicative of the operating results which would
    have been achieved had the transactions occurred at the beginning of the
    periods presented or of the results to be achieved in the future.

    BizTel Communications, Inc.

      On February 29, 1996, the Company acquired a minority investment in BizTel
    Communications, Inc. ("BizTel") which holds Federal Communications
    Commission ("FCC") licenses to provide telecommunications services utilizing
    38 GHz digital milliwave transmission in 160 geographic areas, which have a
    population of approximately 178 million people, and include more than 80 of
    the 100 largest metropolitan markets and all markets where TCG operates.
    BizTel also has applications for 84 additional licenses pending FCC approval
    in geographic areas which have a population of an additional 55 million
    people.  BizTel's 38 GHz milliwave services can be used by TCG to
    economically connect customers to the Company's fiber optic networks, to
    provide network redundancy, diverse routing or quick temporary installations
    and to provide stand-alone facilities where the Company does not have fiber
    optic networks.  On February 28, 1997, TCG obtained an 

                                      F-13
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES
                         NOTES TO FINANCIAL STATEMENTS
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED

    option, effective July 15, 1997, to acquire the remaining equity interest in
    BizTel in exchange for the issuance of 1,667,631 shares of the Company's
    Class A Common Stock, to the majority owners of BizTel, who will be granted
    certain registration rights with respect to such Class A Common Stock. The
    Company also granted a reciprocal option to such majority owners, also
    effective July 15, 1997, to put the remaining equity interest in BizTel to
    TCG in exchange for the issuance of such shares of Class A Common Stock. The
    closing of this purchase is subject to regulatory approvals, including
    approval of the FCC.

      The goodwill recorded with this investment, which represented the excess
    of the Company's investment over the underlying net assets of BizTel, was
    approximately $7,378,000.  Such amount is being amortized over 20 years
    beginning March 1996 and is reported in the statement of operations in
    equity in losses of unconsolidated affiliates.  Amortization expense related
    to such goodwill for the year ended December 31, 1996 was $307,000.
 
    Cox Fibernet Affiliates

      Pursuant to the terms of three Operator Managed Ventures Services
    Agreements between TCG and certain affiliates of Cox, TCG has options to
    acquire up to a 35% interest in the competitive access business conducted by
    such affiliates of Cox in New Orleans, Oklahoma City and the Hampton Roads,
    Virginia area, respectively.  To the extent the Cox competitive access
    provider has derived revenue from any contract entered into by TCG as a
    result of sales efforts engaged in by TCG on behalf of such Cox operations,
    the purchase price shall be the ratio of the annual TCG generated revenue to
    total annual revenue of the Cox operation multiplied by the book value of
    the assets of the Cox operation.  If such ratio is less than 35%, TCG may
    purchase the balance, up to 35%, of that Cox operation for the fair market
    value (as determined in accordance with the Operator Managed Ventures
    Services Agreements) of the operation.  There is no cap or maximum purchase
    price under the terms of the Operator Managed Ventures Services Agreements.
    In November 1996 TCG notified Cox of its intention to exercise its option to
    purchase a 35% interest in Cox's Hampton Roads, Virginia operations (the
    Company's options to acquire 35% interests in Cox's New Orleans and Oklahoma
    City operations do not mature until 1999).  Cox and TCG are currently
    engaged in discussions concerning the calculation of the purchase price
    formula for Hampton Roads, Virginia, and a possible renegotiation and
    restructuring of their respective rights and obligations of the parties
    under each of the Operator Managed Ventures Services Agreements.

    Local Area Telecommunications, Inc.

      Effective October 1, 1995, TC Systems, Inc. , a wholly-owned subsidiary of
    TCG New York, Inc., entered into an assumption agreement with Local Area
    Telecommunications, Inc. ("LOCATE") to acquire certain assets subject to
    associated liabilities.  Aggregate assets and associated liabilities at that
    time were each approximately $2.7 million. TC Systems managed the assets and
    funded the associated operating losses until the closing of the transaction,
    which occurred on May 31, 1996.

    TCG Pittsburgh

      During 1995, TCG contributed cash for a 40% partnership interest in
    TCG Pittsburgh. TCI held the remaining 60% interest in the Pittsburgh
    partnership. In 1996, TCG acquired the remaining interest in TCG Pittsburgh
    as part of the Reorganization.

    Teleport Communications Boston

      On October 24, 1994, TCG paid $6,978,000 to FMR Corp., representing a
    return of Fidelity Communications Inc.'s share of TCB's capital calls
    received from March 1993 to February 1994, including interest in the amount
    of $503,000.  On the same date, TCG Partners entered into a purchase
    agreement with FMR Corp. to purchase 100% of the capital stock of Fidelity
    Communications Inc.  In accordance with the purchase agreement, TCG Partners
    gave a promissory note in the amount of $30,500,000 to Continental in
    consideration of Continental issuing to Fidelity Non-Profit Management
    Foundation 62,886 shares of Continental common stock and in exchange for
    Fidelity Non-Profit Management Foundation transferring all of the common
    stock of Fidelity to TCG Partners.

                                      F-14
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 


      On November 9, 1994, TCG, on behalf of TCG Partners, paid Continental
    $30,605,000 in payment of TCG Partners' promissory note, including interest
    of $105,000.  TCG Partners' promissory note was canceled on November 15,
    1994, and subsequently all security interests of Continental in the stock of
    Fidelity Communications Inc. were released.

    Summarized Financial Information

      Summarized financial information for the Company's investments, which
    include BizTel and ETC and six months of the revenues and net losses of the
    Local Market Partnerships except for TCG St. Louis as of and for the year
    ended December 31, 1996, as well as ETC and the Local Market Partnerships
    except for TCG St. Louis as of and for the year ended December 31, 1995, is
    as follows (in thousands):

                             1996       1995
                             ----       ----   
 
      Total assets         $ 68,053   $501,094
 
      Total liabilities     185,820    151,562
 
      Total revenues         63,940     68,389
 
      Net loss              (52,311)   (47,408)
 
4.  MARKETABLE SECURITIES

    The following is a summary of TCG's marketable securities and cash
equivalents at December 31, 1996 (in thousands):
 
<TABLE> 
<CAPTION> 
                                    AMORTIZED  UNREALIZED UNREALIZED    MARKET      
                                      COST        GAIN      LOSS        VALUE
                                    ---------  ---------- ----------    -----
<S>                                 <C>        <C>        <C>          <C>       
 
    Commercial paper                 $338,390       $   -   $    (83)  $338,307
    U.S. Treasury bills                47,894          33          -     47,927
    Federal agency notes              139,481          11        (29)   139,463
    Corporate medium term notes       118,825          60        (33)   118,852
    Floating rate notes                19,984          16          -     20,000
                                     --------       -----   --------   --------
                                      664,574         120       (145)   664,549
 
    Less: Cash equivalents            223,743           -          -    223,743
                                     --------       -----   --------   --------
    Marketable securities            $440,831       $ 120   $   (145)  $440,806
                                     ========       =====   ========   ========
</TABLE>

                                      F-15
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES  
                         NOTES TO FINANCIAL STATEMENTS             
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 


    The amortized cost and estimated fair value by maturity date as of December
    31, 1996 is as follows (in thousands):
                                                                  
                          AMORTIZED COST              MARKET VALUE
                          --------------              ------------
 
    Due in one year        $ 563,119                    $ 563,043
 
    Due after one year
     through five years      101,455                      101,506
                           ---------                    ---------
 
    Total                  $ 664,574                    $ 664,549
                           =========                    =========

    Proceeds from the sale of investments during 1996 were $664,814,000. Gross
    gains of $57,000 and gross losses of $2,000 were realized on these sales in
    1996.

5.  FIXED ASSETS
 
    The following is a summary of the Company's fixed assets as of December 31,
    1996 and 1995 (in thousands):


                              CONSOLIDATED      COMBINED
                                  1996             1995
                                  ----             ----

   Communications network     $  875,152      $  381,976
   Construction in progress      336,770         110,882
   Other                          92,307          52,795
                              ----------      ---------- 
                               1,304,229         545,653
     Less:  Accumulated                      
      depreciation and                             
      amortization              (236,967)       (113,202)
                              ----------      ---------- 
                                             
     Fixed assets - net       $1,067,262      $  432,451
                              ==========      ==========

6. LONG-TERM DEBT AND FINANCIAL INSTRUMENTS
 
   Long-term debt outstanding as of December 31, 1996 and 1995 consisted of the
   following (in thousands):

<TABLE> 
<CAPTION> 
                                                                          CONSOLIDATED     COMBINED
                                                                             1996            1995
                                                                             ----            ----
<S>                                                                       <C>              <C>      
        Subordinated debt to parents, weighted average interest rate
          of 6.16% and 6.82%, in 1996 and 1995, respectively
          converted to equity in 1996                                     $     -           $269,000                          
                                                                                                                              
        Long-term bank debt, weighted average rate of 6.47% and                                                               
          6.80% in 1996 and 1995, respectively, repaid July 1, 1996              -            87,500                         
                                                                                                                             
        Senior Notes, 9.875%, due 2006                                     300,000                 -                         
                                                                                                                             
        Senior Discount Notes, net of discount of $414,039,                
          11.125% due 2007                                                 659,567                 -                 
                                                                                                                             
        TCI Note, 7.5% due 2001                                             27,007                 -                         
                                                                          --------          --------                          
                                                                                                                             
        Total                                                             $986,574          $356,500                         
                                                                          ========          ========                          
</TABLE> 

                                      F-16
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES  
                         NOTES TO FINANCIAL STATEMENTS             
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 

      Aggregate maturities of long-term debt over the next five years and
    thereafter are as follows (in thousands):
    2001 - $27,007 and thereafter $959,567.

      On June 27, 1996, TCG issued $300 million principal amount of  Senior
    Notes due 2006 and $1,073 million aggregate principal amount of  Senior
    Discount Notes due 2007 (collectively the "Notes").  The Senior Notes were
    issued pursuant to an indenture (the "Senior Notes Indenture") between TCG
    and the United States Trust Company of New York, as trustee, and the Senior
    Discount Notes were issued pursuant to an Indenture (the "Senior Discount
    Notes Indenture" and, together with the Senior Notes Indenture (the
    "Indentures") between the Company and the United States Trust Company of New
    York, as trustee.  The Indentures contain certain restrictive covenants
    which impose limitations on TCG and certain of its subsidiaries' ability to,
    among other  things: (i) incur additional indebtedness, (ii) pay dividends
    or  make certain other distributions and investments, (iii) create liens,
    (iv) create dividend and other payment restrictions on subsidiaries, (v)
    incur certain guarantees, (vi) enter into certain asset sale transactions,
    (vii) enter into certain transactions with affiliates (including the Cable
    Stockholders) and (viii) merge, consolidate or transfer substantially all of
    the Company's assets. Under the terms of the Indentures, TCG currently is 
    not able to pay dividends.

      The Senior Discount Notes were issued at a discount to their aggregate
    principal amount to generate gross proceeds of approximately $625 million.
    The Senior Discount Notes accrete at a rate of 11.125% compounded semi-
    annually, to an aggregate principal amount of $1,073,606,000 by July 1,
    2001.  Thereafter, interest on the Senior Discount Notes will accrue at the
    rate of 11.125% per annum and will be payable semi-annually on January 1 and
    July 1, commencing on January 1, 2002;  provided that at any time prior to
    July 1, 2001, TCG may elect to commence the accrual of cash interest on the
    Senior Discount Notes, in which case the outstanding principal amount on
    such Notes will be reduced to their accreted value as of the date of such
    election and cash interest shall become payable thereafter.  The total
    interest expense for the Notes was $49,297,000 for the year ended December
    31, 1996.

      The Notes will be subject to redemption at the option of TCG, in whole or
    in part, at any time on or after July 1, 2001, initially at 104.938% of
    their principal amount in the case of the Senior Notes, and 105.563% in the
    case of the Senior Discount Notes and declining to 100% of their principal
    amount on or after July 1, 2004 in the case of the Senior Notes, and July 1,
    2004 in the case of the Senior Discount Notes, in all cases plus accrued and
    unpaid interest thereon to the applicable redemption date. The incurrence of
    long-term indebtedness by TCG is subject to approval by the New York Public
    Service Commission (the "NYPSC") and the New Jersey Board of Public
    Utilities (the "NJPBU"). In orders issued in 1993, both the NYPSC and NJBPU
    authorized TCG to issue long-term debt in amounts not to exceed $1 billion.
    Additionally, in 1995, both the NYPSC and NJBPU authorized the Company's
    subsidiary, TCG New York, Inc., to incur long-term debt in an amount not to
    exceed an additional $1 billion; provided, however, that the NYPSC has
    interpreted its authorization as permitting TCG and TCNY, a wholly-owned
    subsidiary of TCG, to incur long-term debt not to exceed $1.75 billion in
    the aggregate. The Company filed petitions for orders from such state
    regulatory authorities to permit TCG to expand TCG's borrowing authority to
    $2 billion. Both the New York and New Jersey state regulatory authorities
    approved these petitions in the third quarter of 1996.

      TCG had a loan agreement with the Cable Stockholders aggregating $349.6
    million ($269.0 million outstanding at December 31, 1995. Borrowings bore
    interest at 75 basis points above the one- month London Interbank Offered
    Rate ("LIBOR"). Total interest expense for this loan was $8,423,000,
    $17,643,000 and $5,477,000 for the years ended December 31, 1996, 1995 and
    1994, respectively.

      In connection with the Offerings, the Cable Stockholders contributed to
    TCG $269.0 million aggregate principal amount of  indebtedness, plus accrued
    interest from May 1995, except that TCI retained a $26 million subordinated
    note of TCG, in exchange for Class B Common Stock issued to the Cable
    Stockholders.   The loan agreement was terminated in connection with the
    Reorganization.  Interest and principal on the TCI Note are payable in 2001.

                                      F-17
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES  
                         NOTES TO FINANCIAL STATEMENTS             
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 


       On May 22, 1995, TCG entered into a Loan Agreement (the "Revolving Credit
    Agreement") with Toronto Dominion (Texas), Inc., as administrative agent,
    Chemical Bank, as documentation agent, and the Banks (as defined in the
    Revolving Credit Agreement) to finance capital expenditures and working
    capital needs of TCG's subsidiaries and of the Local Market Partnerships and
    to repay debt of TCG and its subsidiaries to the Cable Stockholders.
    Borrowings of $250 million were utilized for the growth of TCG.  The $250
    million of indebtedness under the Revolving Credit Agreement was repaid in
    July 1996 from the proceeds of the Offerings.   The total interest expense
    for the amounts borrowed under the Revolving Credit Agreement were
    $6,264,000, $2,950,000 and $0 for the years ended December 31, 1996, 1995
    and 1994, respectively.  At December 31, 1996, the amount available under
    the Revolving Credit Agreement was $250 million.

      The shares of capital stock owned by TCG in certain of the wholly-owned
    subsidiaries of TCG (TC New York Holdings I, Inc., TC New York Holdings II,
    Inc., TCG Payphones, Inc., and TC Systems, Inc., collectively the
    "Restricted Subsidiaries") were and remain pledged as collateral to secure
    loans pursuant to, and may not be pledged to any other party under the
    terms of, the Revolving Credit Agreement.

      In December 1995, the capital stock of the wholly-owned Restricted
    Subsidiaries of TCG was transferred, subject to the pledge, to TCG New York,
    Inc., a wholly-owned subsidiary of TCG, the stock of which was also pledged
    as collateral. TCG New York, Inc. assumed all obligations under the
    Revolving Credit Agreement as of the date of transfer. TCG New York, Inc. is
    permitted under the terms of the Revolving Credit Agreement to advance funds
    to TCG. When made, such advances are to be evidenced by notes from TCG to
    TCG New York, Inc. which will be pledged as collateral under the Revolving
    Credit Agreement.

      The Revolving Credit Agreement contains various covenants and conditions,
    including restrictions on additional indebtedness, maintenance of certain
    financial ratios and limitations on capital expenditures. None of these
    covenants negatively impact TCG's liquidity or capital resources at this
    time.
 
      In 1995, TCG entered into interest rate swap agreements to mitigate the
    impact of changes in interest rates on its long-term bank debt.   At
    December 31, 1996 and 1995, TCG had interest rate swaps with commercial
    banks with a notional value of $0 and $55,000,000, respectively.  The
    average fixed interest rate was 5.93 percent in 1995.  These agreements
    effectively fixed TCG's interest rate exposure on various LIBOR based
    floating rate notes (which ranged from 5.87 percent to 5.94 percent).  
    During July 1996, TCG repaid $250 million of bank indebtedness with the
    proceeds of the Offerings. Due to this repayment, TCG is not currently
    required under its Revolving Credit Agreement to enter into interest rate
    swap arrangements. Accordingly, TCG terminated four interest rate swap
    arrangements which were due to mature in 1997, for a gain of approximately
    $1.5 million.

      The fair value of TCG's long-term debt is estimated based on the quoted
    market price for the same or similar issues or on borrowing rates currently
    available to TCG for debt with similar terms and maturities.  The fair value
    of the TCG's long-term debt was $1,082,000,000 and $356,500,000 at December
    31, 1996 and 1995, respectively.

7.  EMPLOYEE BENEFIT PLANS

      Teleport Communications Group Retirement Savings Plan - TCG has a
    Retirement Savings Plan (the "Plan") with a 401(k) savings component and a
    retirement component covering substantially all eligible employees of TCG
    with one or more years of service. Under the 401(k) component of the plan,
    participants may make pre-tax contributions and TCG matches 50 percent of
    the first 6 percent of annual eligible compensation to a maximum company
    contribution of $1,500 per employee. Under the retirement component of the
    plan, TCG contributes an amount based on years of service and annual
    eligible compensation.

                                      F-18
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 


      Effective November 1, 1996, the Plan offers TCG's Class A Common Stock as
    an investment option.  The Plan purchases shares on the open market.  As of
    December 31, 1996, 36,186 shares, with a total market value of $1,104,000,
    had been purchased under the Plan.

      In 1996, 1995 and 1994, TCG made matching contributions of $1,092,000,
    $736,000  and $456,000, respectively, as required by the 401(k) component
    and $1,413,000, $978,000, and $606,000, respectively, under the retirement
    component of the plan.



      TCG has established a non-qualified, unfunded, deferred compensation Make-
    Up Plan of Teleport Communications Group Inc. (the "Make-Up Plan") for the
    Teleport Communications Group Inc. Retirement Savings Plan.  The purpose of
    the Make-Up Plan is to provide certain eligible participants benefits which
    would have been payable under the Retirement Savings Plan, but were limited
    by the maximum company match of $1,500, as well as compensation limits set
    forth by the IRS.  Expenses incurred in connection with the Make-Up Plan
    were insignificant.

      Teleport Communications Group Unit Appreciation Plan -  TCG has
    established Teleport Communications Group Unit Appreciation Plans (the
    "UAP") for 1992 and 1993.  During the years ended December 31, 1993 and
    1992, TCG made awards of deferred compensation in the form of units (the
    "Units"), pursuant to the UAP, to certain eligible employees of TCG.
    Benefits under the UAP are equal to the value of the Units on the date the
    employee terminates employment or is fully vested in the Units, less the
    initial base price of the Units.  The initial base price of each Unit as of
    January 1, 1993 and 1992 was $34.85 and $30.00, respectively.  Each Unit is
    equal to 8.4 shares of Class A Common Stock.  Except for awards to a certain
    employee, the appreciation of any Unit is limited to 200% of the initial
    base price.  Pursuant to an employee's employment agreement, there is no
    limit on the appreciation he may receive under the 1992 UAPs.  Awards under
    the UAP are subject to a five-year vesting schedule, pursuant to which the
    Units granted will be 60% vested as of December 31, 1995 and December 31,
    1994, respectively, and fully vested no later than December 31, 1997 and
    December 31, 1996, respectively, subject to certain exceptions provided
    therein. 1992 UAPs were fully vested December 31, 1996 and were paid early
    in 1997. In connection with the UAP, TCG recognized compensation expense of
    $1,445,748, $2,474,845, and $6,070,955 for the years ended December 31,
    1996, 1995 and 1994, respectively. In January 1996, TCG adopted a plan which
    permits the awards under the UAP to be deferred in whole or in part at the
    election of the participants for periods of up to five years or, with an
    Administrative Committee's consent, until termination of employment.

      The following table provides additional information concerning the Unit
    Appreciation Plan awards:

<TABLE>
<CAPTION>
                                                    
                             Number         Number                                            Number                   Number  of
                            of Units       of Units        Value of        Number of         of Units       Value         Units
                Initial   Outstanding       Vested           Units           Units            Vested       of Units    Outstanding
  Year           Number       at              at           Vested at       Outstanding          at        Vested at        at
   of              of      December 31,   December 31,   December 31,    at December 31,    December 31, December 31,  December 31, 
 Award           Units        1996           1996            1996             1995              1995         1995          1994
 -----           -----        ----           ----            ----            --------         --------       ----          ----
         
<S>            <C>        <C>              <C>             <C>             <C>               <C>          <C>             <C>
1993              36,000         5,300         4,240       $  295,528          23,700          14,220      $  991,134        25,100
         
1992             170,850        63,250        63,250        7,695,373         139,200         111,360       7,486,200       156,850
                 -------        ------        ------       ----------         -------         -------      ----------       -------
         
Total            206,850        68,550        67,470       $7,990,901         162,900         125,580      $8,477,334       181,950
                 =======        ======        ======       ==========         =======         =======      ==========       =======

</TABLE>

                                      F-19
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES  
                         NOTES TO FINANCIAL STATEMENTS             
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 


      Teleport Communications Group Inc. 1996 Equity Incentive Plan -TCG
    established the Teleport Communications Group Inc. 1996 Equity Incentive
    Plan (the "Equity Incentive Plan") effective June 27, 1996, to provide
    opportunities for certain employees of TCG to participate in the
    appreciation in the value of TCG after the initial public offering.  The
    Board of Directors authorized the issuance of up to 637,792 shares of Class
    A Common Stock under the Equity Incentive Plan.  The Equity Incentive Plan
    is administered by the Compensation Committee which has full and
    discretionary power to award shares under the Equity Incentive Plan.

      Under the Equity Incentive Plan, each employee who had an award under the
    1992 UAP or the 1993 UAP, whether or not the employee had elected to defer
    receipt of the payment of benefits thereunder and who is employed by TCG as
    of June 27, 1996, had the right to waive his interest in all or any portion
    of the employee's benefit in the 1992 UAP or 1993 UAP.  In exchange
    therefore, the employee was granted a number of shares under the Equity
    Incentive Plan equal to the value of the portion of the employee's benefit
    waived (determined as of  June 27, 1996) multiplied by 120% and divided by
    the initial public offering price per share of Class A Common Stock.  No
    employee could receive more than 54,000 shares under the Equity Incentive
    Plan, and a certain employee was not eligible to participate.  A share under
    the Equity Incentive Plan is equivalent in value to one share of Class A
    Common Stock.  Thus, the value of the benefit payable under the Equity
    Incentive Plan will fluctuate in accordance with the fair market value of
    the Class A Common Stock.

      Shares under the Equity Incentive Plan granted in exchange for 1992 UAP
    benefits are subject to a two-year vesting schedule, with 70% of the shares
    becoming vested as of June 27, 1997 and the remaining 30% becoming vested as
    of the June 28, 1998.  Shares granted in exchange for the 1993 UAP benefits
    are subject to a three-year vesting schedule, with 70% of the shares
    becoming vested as of June 27, 1998 and the remaining 30% becoming vested as
    of June 27, 1999.  A participant shall become 100% vested in his shares in
    the event of death, total disability or a change in control.  In the event a
    participant's employment is terminated for cause, his interest in each and
    every share awarded under the Equity Incentive Plan shall be forfeited.

      Shares under the Equity Incentive Plan will be paid to a participant
    either in one lump sum cash payment or in shares of Class A Common Stock, as
    determined at the discretion of the Compensation Committee, on the payment
    date elected by the participant at the time he elects to participate in the
    Equity Incentive Plan. In general, the payment date elected may be the last
    business day of any calendar quarter during the period commencing June 30,
    1998 and ending June 30, 2001.
 
      At December 31, 1996, 421,233 shares were outstanding under the Equity
    Incentive Plan.

      Teleport Communications Group Inc. Stock Option Plan -  TCG established
    the Teleport Communications Group Stock Option Plan (the "SOP") effective
    September 26, 1993.  The SOP is administered at the discretion of the
    Compensation Committee, which has made long-term incentive compensation
    awards in the form of non-qualified and incentive stock options to eligible
    employees.  Stock options were granted with exercise prices at or above the
    fair market value of the shares on the date of grant, and no compensation
    expense has been recognized in connection with the options.  The
    Compensation Committee may permit the exercise price to be paid in cash,
    through delivery of other shares of Class A Common Stock, by delivering
    irrevocable instructions to a financial institution to deliver promptly to
    TCG the portion of sale or loan proceeds sufficient to pay the exercise
    price, or through an election to have shares withheld from the shares
    otherwise to be received by the option holder.

                                      F-20
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES  
                         NOTES TO FINANCIAL STATEMENTS             
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED 

<TABLE>
<CAPTION>                                                                        
                                       Shares of Common Stock                    
                                       ----------------------                    
                                     Available for                 Weighted Avg. 
                                         Grant      Outstanding   Exercise Price 
                                         -----      -----------   -------------- 
<S>                                  <C>            <C>           <C>
Balance, January 1, 1994                2,990,757     2,392,593   $  6.90 - 7.84
     Authorized                                 -             -                -
     Granted                             (324,026)      324,026            10.39
     Exercised                                  -             -                -
     Forfeited                            221,315      (221,315)    6.90 - 10.39
                                        ---------     --------- 
Balance, December 31, 1994              2,888,046     2,495,304   $ 6.90 - 10.39
     Authorized                                 -             -                -
     Granted                             (285,096)      285,096            14.22
     Exercised                                  -       (27,115)            6.90
     Forfeited                            215,225      (215,225)    6.90 - 14.22
                                        ---------     --------- 
Balance, December 31, 1995              2,818,175     2,538,060   $ 6.90 - 14.22
     Authorized                         5,547,683             -                -
     Granted                           (2,003,462)    2,003,462    17.46 - 21.60
     Exercised                                  -       (55,355)            6.90
     Forfeited                            173,443      (173,443)    6.90 - 21.60
                                        ---------     --------- 
Balance, December 31, 1996              6,535,839     4,312,724   $ 6.90 - 21.60
                                        =========     ========= 
</TABLE>

      Teleport Communications Group Inc. Employee Stock Purchase Plan - TCG
    adopted the Teleport Communications Group Inc. Employee Stock Purchase Plan
    ("the Stock Purchase Plan"), effective June 27, 1996.  The Stock Purchase
    Plan is administered by the Compensation Committee.  Each eligible employee
    was given an option to purchase a number of shares of Class A Common Stock
    up to 10% of such employee's compensation plus bonus paid for the calendar
    year preceding the year the option is awarded, divided by the purchase price
    per share under the option.  No employee can receive options for more than
    $25,000 worth of shares in any calendar year.  The purchase price for one
    share of Class A Common Stock is 15% below the initial offering price of
    $16, or $13.60.  The Board of Directors has authorized the issuance of
    745,000 shares under the Stock Purchase Plan.  The options expire on June
    27, 1997.  Options related to 623,894 shares of Class A Common Stock were
    issued.   The expense recorded for the six months ended December 31, 1996
    related to the options issued was approximately $699,000.

<TABLE>                                                                         
<CAPTION>                                                                       
                                       Shares of Common Stock                   
                                       ----------------------                   
                                     Available for                 Weighted Avg.
                                         Grant      Outstanding   Exercise Price
                                         -----      -----------   -------------- 
<S>                                  <C>            <C>           <C> 
Balance, January 1, 1996                        -             -   $            -
     Authorized                           745,000             -            13.60
     Granted                             (623,894)      623,894            13.60
     Exercised                                  -             -                -
     Forfeited                             41,001       (41,001)           13.60
                                         --------       -------
Balance, December 31, 1996                162,107       582,893   $        13.60
                                         ========       =======
</TABLE>

      Stock Based Compensation -  In October 1995, the FASB issued SFAS No. 123,
   "Accounting for Stock-Based Compensation" which encourages but does not
   require companies to record compensation cost for stock based compensation
   plans at fair value.

                                     F-21
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  


      TCG has chosen to continue to account for stock-based compensation using
   the intrinsic value method prescribed in Accounting Principles Board Opinion
   ("APB") No. 25 "Accounting for Stock Issued to Employees," and its related
   interpretations.  Accordingly, no compensation expense  has been recorded for
   its stock awards and employee stock  purchase plan, but rather, the Company
   has determined the pro forma net loss and net loss per share amounts for 1996
   and 1995, as if compensation expense had been recorded for options granted
   during those years under the fair value method described in the statement.
   Compensation cost for stock options is measured as the excess, if any, of the
   quoted market price of the Company's stock at the date of the grant over the
   amount an employee must pay to acquire the stock.  Compensation cost for
   stock appreciation rights and performance equity units is recorded quarterly
   based on the quoted market price of TCG's stock at the end of the period.

      The Company utilized the Black-Scholes option pricing model to estimate
   the fair value at the date of grant of options granted during 1996 and 1995.
   Under the Black-Scholes model, a volatility factor of approximately 0.25 was
   used for options granted on or after the date of the Offerings and the
   minimum value method was used for options granted prior to the date of the
   Offerings, as if there was no market for the Company's common stock in which
   to monitor stock price volatility. Had TCG adopted SFAS No. 123, net loss and
   loss per share would have increased the reported results as indicated below
   (in thousands, except share amounts):
 
 
                                         1996          1995         
                                         ----          ----     

     Net loss - as reported          $    114,850  $    53,804  
                                     ============  ===========  
     Net loss - pro forma            $    116,398  $    53,929  
                                     ============  ===========  
     Loss per share - as reported    $     (1.00)  $      (.77) 
                                     ============  ===========  
     Loss per share - pro forma      $     (1.02)  $      (.77) 
                                     ============  ===========  
     Weighted average number of                                 
       shares outstanding             114,443,695   70,000,140  
                                     ============  ===========   



      Valuation Assumptions -   The fair value of options at the date of grant
   was established using the Black-Scholes model with the following  weighted
   average input assumptions:

<TABLE> 
<CAPTION>                                                                                RISK FREE               ANNUAL
                                   EXPECTED   EXERCISE   STOCK PRICE AT                     INT.        DIV.   FORFEITURE
                                     LIFE       PRICE       GRANT        VOLATILITY         RATE       YIELD      RATE
                                     ----       -----       -----        ----------         ----       -----      ----  
<S>                                <C>        <C>        <C>             <C>             <C>           <C>     <C>
1996 Employee Stock
  Purchase Plan Grants               1.00       $13.60      $16.00           25.0%         5.81%        0%        4.89%        
                                                                                                                              
1995 and 1996 Stock               5.04 to    $14.22 to   $14.22 to          .1 to          6.66% to               3.53% to        
  Option Grants                      5.59       $33.63      $33.63           25.0%         6.73%        0%        4.90%       
</TABLE>

                                     F-22
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  


The following table summarizes information concerning the remaining options
outstanding as of 1996 for the 1995 and 1996 option grants:

<TABLE>
<CAPTION>
 
                                                                                                         OPTIONS
                                         OPTIONS OUTSTANDING                                           EXERCISABLE
                                 -----------------------------------                 -----------------------------------------------

                                                                 WEIGHTED AVG.       WEIGHTED                           WEIGHTED   
                                RANGE OF                           REMAINING         AVERAGE         NUMBER OF          AVERAGE     
                                EXERCISE     NUMBER OF SHARES     CONTRACTUAL        EXERCISE          SHARES           EXERCISE
                                 PRICES        OUTSTANDING           LIFE             PRICES        EXERCISABLE          PRICES     

                                 ------        -----------           ----             ------        -----------          ----- 
 
<S>                          <C>             <C>               <C>                <C>             <C>               <C>
1996 Employee
  Stock Purchase
  Plan Grants                     $13.60           582,893          1                  $13.60                 -                 -   

                                                                                                                                    

1995 and 1996                                                                                                                       
  Stock Option                 $14.22 to                         5.04 to               $14.22 to
  Grants                         $ 33.63       2,204,874          5.59                 $21.60           1,156            $14.22
</TABLE>

      Employment Agreements - TCG has employment agreements  with certain of its
    executive officers and senior management personnel.  These agreements are
    effective through dates ending from June 30, 1998 to December 31, 1999,
    unless terminated earlier by the executive or TCG, and provide for annual
    salaries, cost-of-living adjustments, additional compensation in the form of
    bonuses based on the performance of TCG and the executive, and participation
    in the various benefit plans of TCG.  The agreements contain certain
    benefits to the executive if TCG terminates the executive's employment
    without cause or if the executive terminated his employment as a result of
    change in ownership of TCG.  The salary and bonus expense related to these
    executives for the years ended December 31, 1996 and 1995 approximated
    $2,873,000, and $2,133,000, respectively.  TCG's remaining aggregate
    commitments for salaries under such agreements is approximately $4,903,000.
    The commitments for bonuses under these agreements is approximately
    $1,793,048.
 
      In the event TCG terminates the executive without cause or the executive
    terminates his/her employment as a result of a change in control, the
    agreements provide for continued vesting in deferred compensation and long
    term incentive awards as well as the payment of a base salary for each
    executive plus an annual bonus for the duration of the agreement.  The
    annual bonus is an amount not less than 30% of such base salary, except for
    a certain employee whose minimum annual bonus is 50% of base salary. Each
    executive is entitled to these severance benefits for at least six months
    following such termination, except for a certain employee whose minimum
    entitlement period is 30 months.

                                     F-23
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  


8.  INCOME TAXES

      There are no current income taxes payable based on TCG's operating loss.
    The current state and local tax expense are based on factors other than
    income.  The following temporary differences compose the net deferred income
    tax payable (in thousands):

                                        1996          1995
    Deferred income tax
     liabilities -
     depreciation,
     amortization and
      excess credits                  $ 43,072      $ 23,294
                                      --------      --------
 
    Deferred income tax assets: 
     Deferred revenue                  (2,361)       (2,089)  
     Assets recorded for tax purposes  (3,368)       (1,301)  
     Incentive compensation            (4,579)       (3,303)  
     Operating loss                   (81,578)      (35,233)
     Equity on investments               (138)         (710)  
                                     --------      -------- 
                                      (92,024)      (42,636)

    Less valuation allowance           49,874        20,264
                                     --------      --------
        Total deferred tax assets     (42,150)      (22,372)
                                     --------      --------
    Deferred income taxes
      payable - net                  $    922      $    922
                                     ========      ========
 

       In 1996, 1995 and 1994, the net income tax benefits of approximately
    $29,610,000, $10,909,000 and $7,782,000, respectively, have been offset by
    increases in the valuation allowance of $29,610,000, $10,909,000 and
    $7,782,000 respectively, due to the uncertainty of realizing the benefit of
    the loss carry- forwards.

       At December 31, 1996, TCG had operating loss carry-forwards for tax
    purposes of approximately $170,500,000, expiring principally in 2009 through
    2012.

                                     F-24
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  
 

      A reconciliation of the statutory federal income tax rate and TCG's
    effective income tax rate is as follows:
 
                                          1996     1995     1994

 
    Statutory federal income tax rate     35.00%   35.00%   35.00%
 
    State and local taxes,
    less federal benefit                   2.36     1.30     2.00
 
    Unutilized tax benefit due
    to net operating loss                (31.80)  (33.30)  (35.50)
 
    Permanent differences and other       (3.20)   (1.70)    0.50
                                         ------   ------   ------
 
    Effective rate                         2.36%    1.30%    2.00%
                                         ======   ======   ======

 
9.  RELATED PARTY TRANSACTIONS

      In connection with the management of its previously unconsolidated
    partnerships, TCG entered into management services agreements. Under the
    terms of such agreements, TCG provided certain operating and administrative
    services to such entities, for which it earned management fees. Management
    fees earned were approximately $21,828,000, $29,638,000, and $19,403,000 in
    1996, 1995 and 1994, respectively. After June 27, 1996, such management fee
    revenue is no longer recorded because the previously unconsolidated
    partnerships are now consolidated.

      In 1996 TCG entered into a preliminary, short-term agreement with TCI
    which provides for the provision of certain services by TCG to TCI in
    connection with the development by TCI of residential telephony service
    offerings in Hartford, Connecticut, San Francisco, California and Arlington
    Heights, Illinois and possibly other locations. TCI has agreed to reimburse
    TCG for certain costs and cost of capital in connection with these services.
    TCI and TCG are in the process of negotiating a definitive agreement
    regarding the provision of these services. TCG has also entered into or is
    negotiating agreements with each of the other three Cable Stockholders
    regarding the provision of services with respect to the offering of
    residential telephony services by such Cable Stockholders to individual
    multiple dwelling units. At December 31, 1996 and 1995, the amounts due to
    TCG for this reimbursement were $1,057,000 and $461,000, respectively, and
    is included in accounts receivable - related parties.

      TCG also provides management services to certain affiliates of Cox under
    three Operator Managed Ventures Services Agreements, including billing
    services, network monitoring and accounts receivable functions. Under the
    terms of the agreements, TCG retains eight percent of the collected revenues
    from Cox customers as a royalty fee. Royalty fees recorded from Cox were
    approximately $318,000, $98,000, and $27,000 for the years ended December
    31, 1996, 1995 and 1994, respectively and are included in management and
    royalty fees from affiliates in the statements of operations. Included in
    accounts receivable - trade are approximately $436,000 and $262,000 at
    December 31, 1996 and 1995, respectively, for amounts owed by Cox customers.
    At December 31, 1996 and 1995, the amounts due to Cox affiliates under the 
    agreements were $1,079,000 and $295,000, respectively.

      In 1996 and 1995, TCG purchased cable on behalf of certain of its owners,
    which it then sold to them at cost. The amount receivable from the owners
    was $1,496,000 and $3,683,000 as of December 31, 1996 and 1995,
    respectively.

                                     F-25
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  


      Sprint Spectrum, a partnership owned 60% by TCI, Comcast and Cox, has
    entered into preliminary agreements or letters of intent with a number of
    wholly-owned subsidiaries of TCG providing for the construction of special
    facilities and the provision of services to Sprint Spectrum by TCG. TCG and
    Sprint Spectrum are in the process of negotiating a national master service
    agreement. The amount receivable from Sprint Spectrum at December 31, 1996
    was $345,000.
 
      Revenues earned from all services to the other partner of  TCB and its
    affiliates were approximately $3,709,000 for the year ended December 31,
    1994.

10. COMMITMENTS AND CONTINGENCIES

      Under the terms of contracts with various parties, TCG is obligated to pay
    franchise fees, office rents, node rents and rights-of-way fees in
    connection with its fiber optic network through 2022.  These contracts
    provide for certain scheduled increases and for possible escalation of basic
    rentals based on a change in the cost of living or on other factors. TCG
    expects to enter into other contracts for additional franchise fees, office
    rents, node rents, rights-of-way, facilities, equipment, and maintenance
    services in the future.

      A summary of such fixed commitments at December 31, 1996 is as follows (in
    thousands):
 
                    YEARS               AMOUNT
                    
                     1997            $  25,331
                     1998               23,564
                     1999               22,892
                     2000               21,914
                     2001               20,252
                   Thereafter           63,638
                                     ---------
 
                   Total             $ 177,591
                                     =========

      Rent expense under operating leases was approximately $18,044,000,
    $11,770,000 and $11,185,000 for the years ended December 31, 1996, 1995 and
    1994, respectively.

                                     F-26
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  


      Communications network includes assets acquired under capital leases of
    approximately $114,126,000 and $22,430,000 (including approximately
    $95,980,000, and $16,615,000 with related parties) at December 31, 1996, and
    1995, respectively. The related accumulated depreciation and amortization
    was approximately $12,080,000 and $1,085,000, respectively.

      The following is a schedule, by year, of future minimum payments under the
    leases, together with the present value of the net minimum payments as of
    December 31, 1996 (in thousands):
<TABLE>
<CAPTION>
 
                       YEARS                                     AMOUNT
<S>                    <C>                                      <C>
 
                        1997                                    $29,508
                        1998                                     19,683
                        1999                                     12,270
                        2000                                      4,719
                        2001                                        548
                    Thereafter                                    3,834
                                                                -------
 
               Total minimum lease payments                      70,562
 
               Less amount representing interest                 12,010
                                                                -------
 
               Total obligations under capital leases           $58,552
                                                                =======
 
</TABLE>

      Teleport Communications is subject to a revenue sharing agreement with The
    Port Authority of New York and New Jersey (the "Port Authority").  Based on
    the agreement, Teleport Communications is obligated to pay to the Port
    Authority five percent of its gross revenues, and may be required to pay a
    "net return rental fee," as defined, to the extent its cumulative net return
    exceeds the entitlement amount.  Teleport Communications is also required to
    remit to the Port Authority a minimum payment currently equal to $300,000
    annually.

      Teleport Communications entered into a 15-year franchise agreement with
    the City of New York during 1994, which among other things, requires a
    payment based on certain gross revenues, as defined in the agreement.  The
    franchise provides for the payment of 10% of certain gross revenues in 1995
    and 1996, 6% in 1997 and 5% thereafter, all subject to certain setoffs,
    reductions and adjustments. The franchise also provides that commencing with
    calendar year 1995, payment to the City will be no less than $200,000 per
    year.

      In the ordinary course of business, TCG is involved in various litigation
    and regulatory matters, proceedings and claims.  In the opinion of TCG's
    management, after consultation with counsel, the outcome of such proceedings
    will not have a materially adverse effect on TCG's financial position,
    results of operations or cash flows.

                                     F-27
<PAGE>
 
              TELEPORT COMMUNICATIONS GROUP INC. AND SUBSIDIARIES   
                         NOTES TO FINANCIAL STATEMENTS              
           YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - CONTINUED  


11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

      Cash paid for interest and non-cash investing and financing activities for
    the years ended December 31, 1996, 1995 and 1994 were as follows (in
    thousands):

<TABLE>
<CAPTION>
                                                                  1996     1995     1994
<S>                                                             <C>       <C>      <C>
 
    Cash paid during the year for interest                      $  7,818  $ 8,675  $ 5,693
                                                                ========  =======  =======
 
    Fixed assets acquired under capital leases                  $ 14,034  $15,151  $ 4,384
                                                                ========  =======  =======
 
    Right of way obtained in exchange for cable installation    $      -  $ 1,330  $     -
                                                                ========  =======  =======
 
    Conversion of subordinated debt to parents plus accrued
     interest                                                   $263,602  $     -  $     -
                                                                ========  =======  =======
    Conversion and stock split of $1 par value common
     stock to 139,250,370 shares of Class B Common Stock
     as part of the Reorganization                              $213,099  $     -  $     -
                                                                ========  =======  =======
</TABLE> 

12. SELECTED QUARTERLY INFORMATION (UNAUDITED)

      Summarized below is quarterly financial information for the years ended
    December 31, 1996 and 1995 (in thousands, except per share amounts):
<TABLE>
<CAPTION>
 
                         1ST QUARTER   2ND QUARTER    3RD QUARTER    4TH QUARTER     TOTAL
1996                       COMBINED      COMBINED    CONSOLIDATED   CONSOLIDATED
<S>                      <C>           <C>           <C>            <C>            <C>
Revenues                    $ 50,435      $ 57,087       $ 72,749       $ 87,398   $ 267,669
Net loss                     (18,693)      (19,743)       (33,705)       (42,709)   (114,850)
Loss per common share       $  (0.25)     $  (0.27)      $  (0.21)      $  (0.27)  $   (1.00)
                            
 
1995                        COMBINED      COMBINED       COMBINED       COMBINED     TOTAL
Revenues                    $ 36,792      $ 38,847       $ 42,349       $ 48,181   $ 166,169
Net loss                     (11,540)      (11,705)       (12,672)       (17,887)    (53,804)
Loss per common share       $  (0.16)     $  (0.17)      $  (0.18)      $  (0.26)  $   (0.77)
</TABLE>

                                  * * * * * *

                                     F-28
<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.


                       TELEPORT COMMUNICATIONS GROUP INC.
--------------------------------------------------------------------------------

                                 (REGISTRANT)
                                 ------------
 
BY                      /S/ ROBERT ANNUNZIATA
--------------------------------------------------------------------------------
     ROBERT ANNUNZIATA, PRESIDENT AND CHIEF EXECUTIVE OFFICER
 
DATE                    MARCH 25, 1997
--------------------------------------------------------------------------------

<TABLE> 
<CAPTION>  
                        SIGNATURE                    TITLE                            DATE
                        ---------                    -----                            ----
<S>                                         <C>                                   <C> 
          /S/ ROBERT ANNUNZIATA             Chairman of the Board of Directors,   March 25, 1997
-------------------------------------       President and Chief
          Robert Annunizata                 Executive Officer  

          /S/ JOHN A. SCARPATI              Senior Vice President and Chief       March 25, 1997    
--------------------------------------      Financial Officer (Principal                         
          John A. Scarpati                  Financial Officer) 
                                 

          /S/ MARIA TERRANOVA - EVANS       Vice President and Controller         March 25, 1997 
--------------------------------------      (Principal Accounting Officer)                                   
          Maria Terranova - Evans        
</TABLE> 
<PAGE>
 
<TABLE>
<CAPTION>
          SIGNATURE                   TITLE         DATE
          ---------                   -----         ----
<S>                                  <C>       <C>
 
                                     Director 
-----------------------------------
          Brendan R. Clouston
 
          /S/ JOHN R. DILLON         Director  March 25, 1997
-----------------------------------
          John R. Dillon
 
                                     Director  
-----------------------------------
          Gerald W. Gaines
 
          /S/ JIMMY W. HAYES         Director  March 25, 1997
-----------------------------------
          Jimmy W. Hayes
 
          /S/ J. BRUCE LLEWELLYN     Director  March 25, 1997
-----------------------------------
          J. Bruce Llewellyn
 
          /S/ JAMES O. ROBBINS       Director  March 25, 1997
-----------------------------------
          James O. Robbins
 
                                     Director  
-----------------------------------
          Brian L. Roberts
 
          /S/ C. B. ROGERS           Director  March 25, 1997
-----------------------------------
          C. B. Rogers
 
          /S/ LARRY E.  ROMRELL      Director  March 25, 1997
-----------------------------------
          Larry E. Romrell
 
                                     Director  
-----------------------------------
          Bernard Schotters
 
          /S/ LAWRENCE S. SMITH      Director  March 25, 1997
-----------------------------------
          Lawrence S. Smith
 
          /S/ DAVID M. WOODROW       Director  March 25, 1997
-----------------------------------
          David M. Woodrow
</TABLE>