<PAGE>
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC  20549

                                   FORM 10-K

     X           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
  -----
                    OF THE SECURITIES EXCHANGE ACT OF 1934

                 FOR THE FISCAL YEAR ENDED:  DECEMBER 31, 1999
                                      OR

  _____        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934

                       COMMISSION FILE NUMBER  333-59393

                          RHYTHMS NETCONNECTIONS INC.
                          ---------------------------
            (Exact Name of Registrant as Specified in its Charter)

                                   DELAWARE
        (State or Other Jurisdiction of Incorporation or Organization)

                                   33-0747515
                   (I.R. S. Employer Identification Number)

     6933 South Revere Parkway
     Englewood, CO                                      80112
     -------------                                      -----
     (Address of Principal Executive Office)          (Zip Code)

      Registrant's Telephone Number, Including Area Code:  (303) 476-4200

       Securities Registered Pursuant to Section 12(b) of the Act:  NONE

  Securities Registered Pursuant to Section 12(g) of the Act:  COMMON STOCK,
                                $.001 PAR VALUE

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 as the Registrant was
required to file such reports) and, (2) has been subject to such filing
requirements for the past 90 days.

                         (1)  Yes    X        No
                                    ----           ----

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

The aggregate market value of voting common equity held by non-affiliates of the
Registrant was approximately $2,642,913,141. This calculation is based upon
the average bid and asked prices of such common equity on February 29, 2000 of
$36.44, and the number of shares held by non-affiliates, which was 72,527,803
shares on December 31, 1999.  The number of shares of the Registrant's $.001 par
value Common Stock that was outstanding as of December 31, 1999 was 78,255,707.

                      DOCUMENTS INCORPORATED BY REFERENCE:

     The information required by Part III (Items 10, 11, 12, and 13) is
incorporated by reference to portions of the issuing definitive proxy statement
for the 2000 Annual Meeting of Stockholders which will be filed with the
Securities and Exchange Commission within 120 days after the fiscal year ended
December 31, 1999.

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                                     PART 1

Item 1 - Business

     All statements contained herein that are not statements of historical fact
constitute "Forward-Looking Statements" within the meaning of Section 21E of the
Securities Exchange Act.  Such forward-looking statements involve known and
unknown risks, uncertainties and other factors that could cause the actual
results of the Company to be materially different from historical results or
from any future results expressed or implied by such forward-looking statements.
Readers are urged to consider statements that include the terms "believe",
"belief", "expects", "plans", "anticipates", "intends" or the like to be
uncertain and forward-looking.  Forward-looking statements also include
projections of financial performance, statements regarding management's plans
and objectives and statements concerning any assumptions relating to the
foregoing.

     We are a leading provider of broadband local access communication
services to businesses and consumers. Our services include high-speed, "always
on" connections to the Internet and to private networks. We also offer a growing
suite of network features and applications including Internet services that
bring added value to our service offerings. We use multiple Digital Subscriber
Line (DSL) technologies to provide data transfer rates ranging from 128 kbps to
7.1 Mbps delivering data to the user and from 128 kbps to 1.5 Mbps receiving
data from the user. Accordingly, we believe that our peak network transfer rates
to and from the user are higher than those of other national DSL service
providers. For customers that subscribe at the 7.1 Mbps rate, our network
provides data speeds to the user up to 125 times the speed of the fastest dial-
up modem and over 55 times the speed of integrated services digital network
(ISDN) lines. We believe that our Internet Protocol (IP)-over-DSL network
capability is unique compared to other national DSL service providers because it
allows us to provide a broader range of IP internetworking capabilities in a
simpler, more cost-effective way than those offered by traditional networking
alternatives.

     Our customers include Internet service providers (ISPs), telecommunications
carriers and broadband communication services resellers, which we refer to as
broadband service providers. We also sell to businesses or enterprises that are
not otherwise served by our broadband service provider customers. Internet
service providers and broadband communication services resellers typically
purchase our services in order to provide high-speed Internet access to their
business and consumer end users. Telecommunications carriers typically purchase
our services for resale to their Internet service provider affiliates and
business customers. Enterprise customers typically purchase our services
indirectly from our telecommunications carriers or directly from us to provide
employees, branch offices and other affiliates with high-speed remote access to
the enterprise's local and wide area networks.

     We believe we have one of the nation's largest DSL networks with over 1,200
built or operational collocation sites in incumbent carrier central offices
providing access to approximately 30 million homes and businesses as of December
31, 1999. As of December 31, 1999, we had approximately 12,500 DSL lines in
service and were providing service to approximately 1,500 broadband service
providers and businesses. Our broadband service provider customers include MCI
WorldCom, AT&T, Qwest, Level 3 Communications, Williams Communications,
Intermedia Communications, UUNET, Microsoft Network, Flashcom, PSINet, SAVVIS
Communications, CAIS Internet, Telocity, Phoenix Networks, Digital
Island/Sandpiper Networks and iPhysicianNet. Our enterprise customers include
Cisco, Ford Motor Company and SGI, among others. We believe our higher data
transfer rates, combined with our network features and applications, allow us to
record the highest average revenue per installed line per month among national
DSL service providers. From our inception in February 1997 through September 30,
1999 our average revenue per installed line was approximately $131 per month.

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     As of December 31, 1999, we offered our services in 38 markets and 67 of
the largest metropolitan statistical areas (MSAs) in the United States, of which
there are 314 total. We expect to complete the initial build-out of our network
by the end of 2000. At that time we anticipate that our services will be offered
in 70 markets and 108 MSAs, and our network will pass a total of 51 million
homes and businesses, representing approximately 45% of U.S. homes and 50% of
U.S. businesses.

     In addition to our high speed access services, we plan to offer an
increasing variety of network features and applications such as voice-over-DSL.
We believe these new services are important to increase our revenue. First,
these services expand the size of our addressable market by enhancing and
enabling new broadband services, such as video streaming, that cannot be
practically achieved with narrowband communications connections. Second, certain
of these services require higher speed connections that may result in higher
average revenue per installed line per month for us. Third, some of these
services may contain additional network features and applications that may
provide us with additional recurring monthly revenue from our communication
services resellers and business customers.

     To further our goal of offering network features and applications, we
expect to continue to enter into business arrangements and trials with broadband
service providers, such as our arrangements with Digital Island/Sandpiper
Networks, as well as telecommunications carriers, such as our arrangements with
MCI WorldCom and Level 3 Communications, and leading networking equipment
providers such as our arrangements with Cisco.

     We intend to continue to explore expansion of our DSL network both in the
United States and internationally. In October 1999 we invested $5.3 million in
OCI Communications Inc., the parent company of Optel Communications Corporation,
a competitive local exchange carrier in Canada. This investment was made in
connection with our establishing a joint venture company, Rhythms Canada, with
Optel in January 2000. Rhythms Canada is expected to develop a Canadian DSL
network and offer dedicated high-speed DSL services to enterprise customers and
telecommunications carriers throughout Canada.

Market Opportunity

Growing demand for broadband local access communications services

     Demand for broadband local access communication services is growing at a
rapid rate as the use of the Internet, intranets and extranets increases.
Industry experts believe that by 2003, 55% of all enterprises in the United
States and 71% of all home-based businesses in the United States will be on-
line.

     To remain competitive, small and medium-sized businesses increasingly need
high-speed Internet connections to maintain complex web sites, access critical
business information, communicate more effectively with employees, customers and
business partners, and participate in the rapidly growing e-commerce market.
According to industry analysts, Internet commerce revenue in the United States
will reach $556 billion by 2002.

     Today, business spending for connecting remote workers, branch or affiliate
offices and corporate headquarters to each other and to customers, suppliers and
partners either through the Internet or private networks is large and growing.
Much of that growth will be driven by enterprises seeking to find a cost
effective way to make their remote workers, offices and affiliates as productive
as those who have access to all of the high performance communications and
networking resources available to workers located at the corporate headquarters.

     Today, a record number of households use the Internet for e-mail,
information, entertainment and shopping. Increasingly, consumers are demanding
high-speed remote access
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connections. According to industry analysts, the number of U.S.
residential subscribers to high-speed Internet access services should grow to
3.3 million by the end of 2000, and 16.6 million by 2004, up from 1.4 million at
the end of 1999.

     Rapid adoption of new applications and services that are enhanced or
enabled by broadband access is expected to further fuel the growth in broadband
local access communication services. Collaboration services, such as video
conferencing, are expected to grow rapidly, as are video and audio streaming
services. Industry experts project that revenues from video services will
increase from $469 million in 1998 to approximately $1.6 billion in 2002.
Broadcast programming and on-line shopping are expected to grow dramatically in
the consumer market.

     The trend toward convergence of voice, data and video services over a
single, broadband, multimedia Internet Protocol network should further fuel the
demand for broadband local access communication services. Historically,
telecommunications service providers offered multiple, single purpose networks
to deliver a range of voice and data services. Increasingly, small businesses
and consumers will be able to purchase a full range of local and long distance
voice services and features, Internet access services and video services over a
single, cost-effective, high-speed DSL connection. Communications industry
researchers project that by 2005, almost 25 million lines of voice-over-DSL will
be deployed worldwide - with about one third of these lines being deployed in
North America.

DSL is a cost-effective technology for broadband local access communication
services

     We believe that traditional network alternatives are inadequate and
costly as compared to DSL. Only a fraction of buildings in the United States are
currently connected to high-speed fiber networks - typically large buildings in
metropolitan areas, or clusters of buildings in regional campus parks.
Consequently, the vast majority of connections to the Internet or private data
networks are through slow, dial-up modems connected to the traditional circuit
switched public telephone system. The data carrying capacity of the fastest
commercially available dial-up modem is only 56 kbps, and the capacity of
another alternative, ISDN, is only 128 kbps.

     DSL technology dramatically increases the data, voice and video carrying
capacity of standard copper telephone lines. Our peak data transfer rates range
as high as 7.1 Mbps which is up to 125 times the speed of the fastest dial-up
modem and over 55 times the speed of ISDN lines. We anticipate that continued
advances in semiconductor technology will continue to increase peak data
transfer rates, and that equipment prices will decline as DSL technology
continues to be broadly deployed.

     DSL services are generally favorably priced relative to other available
alternatives, and can be less complex to order, install and maintain.
Traditional T1 frame relay and private line services are considerably more
costly than a DSL service, as are heavily used ISDN services that are priced
based on usage. Consumer class DSL services generally are priced competitively
with cable modem services.

     Because DSL technology uses existing copper telephone lines, a broad
network deployment can be implemented rapidly and requires a lower initial fixed
investment than some existing alternative technologies, such as fiber, cable
modems, wireless data and satellite data communications systems. A significant
portion of the cost of building a DSL network is directly related to the demand
of paying subscribers, resulting in a success-based deployment of capital.

     Packet-based networks often are more efficient than traditional
point-to-point networks, and allow end users to connect to any location that can
be assigned an Internet Protocol address. Traditional point-to-point networks,
including the traditional telephone networks and private line networks, are less
efficient because they require a dedicated connection between two locations.
Packet-based networks allow multiple users to share connections between
locations.

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Favorable regulatory environment exists for new broadband local access
communication providers

     The 1996 Telecommunications Act allows competitive carriers to leverage the
existing incumbent carrier infrastructure, as opposed to building a competing
infrastructure at significant cost. The 1996 Telecommunications Act was designed
to create an incentive for incumbent local exchange carriers that were formerly
part of the Bell system to cooperate with competitive carriers. These incumbent
local exchange carriers cannot provide long distance service until regulators
determine that the incumbent local exchange carrier has met a "checklist" test
showing that it is meeting the Act's requirements in opening its network and
markets to competition. The 1996 Telecommunications Act requires traditional
telephone companies, among other things:

     .   to allow competitive telecommunications companies to lease copper
         telephone wires on a line-by-line basis;
     .   to provide central office space for the competitive telecommunications
         companies' DSL and other equipment used to connect to the leased
         copper telephone wires;
     .   to lease access on their central office fiber backbone to link the
         competitive telecommunications companies' equipment; and
     .   to allow competitive telecommunications companies to use their
         operational support systems to place orders and access their databases.

The FCC, in interpreting the 1996 Telecommunications Act, has emphasized the
need for competition-driven innovation in the deployment of advanced
telecommunications services, such as DSL services.

Our Competitive Strengths

We offer an attractive value proposition compared to alternative local access
communications services

     For end users that subscribe at the 7.1 Mbps rate, our network provides
transfer speeds over 55 times the speed of ISDN lines at monthly rates similar
to or lower than those for heavily used ISDN lines, and over four times the
speed of T1 private lines and frame relay circuits at a substantially lower
price. Because we use dedicated connections from each end user to the network of
our broadband service providers and business customers, end users can receive
dependable data transfer rates and reduce the risk of unauthorized access.

     Unlike dial-up modems and ISDN lines, the DSL solution is "always on," and
provides 24 hour continuous connection. Users are not required to dial-up to
connect to the Internet or their local area network for each use. In addition,
our DSL network has been designed to allow us, for certain customers and
services, to proactively and continuously monitor our network to the end user's
DSL modem or router, eliminating the need for the end user to initiate a report
of network malfunctions, as is the case with dial-up modems or ISDN lines.

Our network has been designed to be flexible and easily upgradeable to support
new network features and applications

     Our network has been designed from the outset to be flexible and
upgradeable to support new network features and applications. Because our
network utilizes multiple technology platforms, we can provide higher end user
speeds than other national providers, a broad range of IP internetworking
capabilities in addition to traditional virtual point-to-point connectivity and
various types of network traffic, including data, voice and video.

     The quality and characteristics of each end user's copper telephone wire
are different. Because we use a variety of technologies we are able to select a
solution that provides the highest
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speed available for each end user. As a result, as of December 31, 1999, users
on our network were capable of receiving average data transfer rates of nearly
1.9 Mbps.

     Our network supports traditional transmission protocols such as
Asynchronous Transfer Mode and frame relay, as well as the rapidly growing IP
transmission protocol. Our IP over DSL network capability allows us to provide a
broad range of IP internetworking capabilities in a simpler, more cost-effective
manner compared to traditional protocols. For example, our network can give each
user simultaneous access to the Internet and private networks using a single
connection, the ability to take advantage of distributed content caching
services in an internetworked environment, and the ability to add other emerging
IP services such as voice-over-IP using their existing connection.

     Our network has also been designed to support multiple types of network
traffic, starting with data and expanding to voice applications, including a
variety of voice-over-DSL technologies, and video applications, including
conferencing and streaming. Our network can also be easily upgraded, as it has
been designed to incorporate new applications and features, thereby avoiding
costly and time consuming network upgrades.

We have leveraged our early mover advantage to rapidly expand our dense,
national network and grow our number of lines in service

     We were among the first to widely roll out national DSL services, offering
commercial services in our first market in April 1998. This early start enabled
us to rapidly expand our network to our targeted markets and develop early
relationships with customers requiring a dense, national footprint. Because our
initial network footprint in each market or MSA is extensive in coverage, we
typically are able to make our services available to at least 70% of our
customers' end user homes and businesses.

We have been able to establish customer relationships with recognized leaders in
the networking industry

     We currently have strategic and/or customer relationships with many of the
major interexchange carriers and fiber backbone providers including MCI
WorldCom, AT&T, Qwest, Level 3 Communications, and Williams Communications. We
also have customer relationships with many of the leading national business and
consumer ISPs, including UUNET, Microsoft Network, PSINet, SAVVIS, Flashcom,
Telocity and Phoenix Networks. MCI WorldCom has designated us as their preferred
provider in its alternative carrier access provisioning system for DSL services
in certain circumstances. MCI WorldCom and Qwest together have committed to
purchase an aggregate 200,000 lines over a seven year period subject to
penalties for failure to reach target commitments. Under the terms of our
strategic partnership with Cisco, Cisco has agreed to jointly market and sell
our networking solutions to its customer base in conjunction with our
telecommunications carrier customers and engage in joint development projects
with us, including voice-over-DSL and video streaming applications.

Our management team has extensive experience

     Our senior management team has extensive experience in developing next
generation networking businesses, including:

     .    Catherine Hapka, Chairman of the Board and Chief Executive Officer
          (former Executive Vice President, Markets at U S WEST Communications,
          Inc. and founder, President and Chief Operating Officer, !NTERPRISE
          Networking Services U S WEST's data networking business),

     .    Steve Stringer, President and Chief Operating Officer (former Global
          Chief Operating Officer, GE Capital IT Solutions),

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     .    Scott Chandler, Chief Financial Officer (former President and CEO, C-
          COR.net),
     .    Richard H. Johnston, Chief Sales Officer (former Executive Vice
          President of Sales, GE Capital IT Solutions),
     .    Rand Kennedy, Senior Vice President Networks (former Principal Network
          Architect, CompuServe Incorporated),
     .    B.P. Rick Adams Jr., Chief Marketing Officer (former Group Vice
          President, Marketing, MicroAge, Inc.) and
     .    Michael S. Lanier, Chief Information Officer (former President of
          Technology Extension Corporation, L.L.C.)

Our Business Strategy

     Our goal is to become the leading national service provider of high
performance networking solutions for broadband service providers and businesses.
We intend to implement the following strategies to achieve our goal:

Complete our dense, national network build-out in our target markets and MSAs

     As of December 31, 1999, we offered service in 38 markets and 67 of the
largest MSAs in the United States. When our initial network build-out is
completed, which we expect to be by the end of 2000, our services will be
offered in 70 markets and 108 MSAs, and our network will pass a total of 51
million homes and businesses, representing approximately 45% of homes and 50% of
businesses in the United States.

     Network installation on this scale requires significant time and resources.
Therefore, we believe our progress to date provides us a significant time-to-
market advantage over our present and future competitors. We have gained
significant build-out experience, which we believe will streamline our further
expansion both in the United States and select international markets.

     In addition to our planned footprint covering 108 of the largest MSAs, our
initial footprint in each market is dense, and covers a substantial majority of
the central offices in each market that we enter. This is important, since our
Internet service provider customers, telecommunications carrier and broadband
communication services reseller customers desire to market their services
broadly in each market. Enterprise customers also require a dense footprint in
order to provide all employees remote access to the corporate network
irrespective of where they reside. Typically, our initial footprint in each
market serves a minimum of 70% of our target market. When sufficient demand
materializes in those central offices that were not a part of our original plan,
we intend to expand our build-out to include that central office.

Maintain and build our sales and marketing relationships with leading broadband
service provider customers

     We principally target Internet service providers, telecommunications
carriers and other broadband communications services resellers that can offer
their end user customers cost and performance advantages for Internet access or
private networks using our services. Our objectives in using these channels of
distribution is to increase our volume and reduce our costs by serving multiple
resellers and leveraging their selling efforts.

     We currently serve the large business market through our relationships with
MCI WorldCom, AT&T and Qwest. We have fielded a direct applications and
technical support force to support our partners' solutions-based selling effort
in these large enterprises. In addition, as part of our alliance with Cisco,
Cisco has agreed to jointly market and sell our services to large businesses on
our behalf and on behalf of our telecommunications carrier customers. We believe
our investment in a direct applications and technical support force will lead to
a higher success rate for our telecommunications carrier customers, and a
preference for our services.

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     We primarily serve the small and medium business market through a number of
national and regional Internet service providers, including the affiliates of
our major telecommunications carrier customers. Currently, we have distribution
relationships with many of the major national Internet service providers
including UUNET, AT&T Internet Services (AIS), Qwest Internet Services, PSINet,
Intermedia Communications and SAVVIS Communications, and a growing number of
regional Internet service providers. In the future, we intend to continue to
build the number of relationships we have with these Internet service providers.

     We also market our broadband communications services to small and medium
businesses through our telemarketing and telesales division in markets where we
do not have Internet service providers reselling our services. In markets where
we have such Internet service provider relationships, we use our telemarketing
and telesales division to generate leads on behalf of our broadband service
providers.

     We expect to continue to build relationships with the growing number of new
broadband communication service resellers who wish to resell our services as
part of their Internet-based or content services, such as our relationship with
iPhysicianNet.

     In December 1999, we announced the availability of a consumer Internet
access service. Our consumer service is offered through Internet service
providers such as Flashcom, Telocity, DSLnetworks and Phoenix Networks. We plan
to add additional Internet service provider relationships in the future.

Expand the number of network features and applications we offer

     We seek to have our network support multiple features and applications that
are enhanced and enabled by our broadband local access communications network.
Our objective is to offer multiple features and applications to our customers
that increase the value of our offering to their end users, thereby increasing
the number of subscribers on our network and the revenue we receive for each
network user. Network features and applications under development include voice-
over-DSL and frame relay over DSL.

     In pursuing this objective, we intend to continue to collaborate with
leading industry broadband application service providers such as Digital
Island/Sandpiper Networks, as well as telecommunications carrier customers such
as MCI WorldCom, and leading networking equipment and software providers such as
Cisco and Microsoft to build our portfolio of network features and applications.
For example, in June 1999, MCI WorldCom and we, in conjunction with Cisco and
Jetstream Communications, successfully demonstrated multiple toll quality voice
and high-speed data communications over a single copper line utilizing DSL
technology. In addition, we are testing frame relay over DSL services with MCI
WorldCom and Intermedia Communications, and we are currently participating in
Microsoft's Windows Media Division's Broadband Jumpstart program to hold trials
of streaming media video technology.

Lead the industry in customer service and build a reputation for being a
desirable business partner

     As part of our strategy to provide a high level of customer satisfaction to
obtain and retain customers and accelerate the adoption of our services, we
intend to continue to enhance our efforts to provide superior service and
customer care. Accordingly, we have developed a systematic approach to fully
integrate our operations with our broadband service provider customers'
operations to support functions such as order qualification, order entry,
customer service, installation, service assurance and billing. In addition, we
have invested and will continue to invest significant resources in process
improvement and fully automated customer support systems. Our Network Operations
Center is available to support our customers 24 hours a day, seven days a week.
For certain customers and services, we will guarantee high quality service by
providing

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carrier-class networking solutions including end-to-end proactive
network monitoring and management through our Network Operations Center, as well
as a full range of service level agreements. In addition, our network offers
multiple security features, and has been designed so that we can scale and
expand our network to meet demand.

Capitalize on new regulatory developments to advance our business

     The Federal Communications Commission (FCC) mandated "line sharing" in a
November 1999 decision that became effective in mid 2000. Some details of
implementation of this mandate may be reconsidered by the FCC. Line sharing
requires existing incumbent local exchange carriers to permit competitive local
exchange carriers to add data services existing copper telephone lines to
provide services to the end-user. The Minnesota Public Utility Commission
ordered line sharing as a matter of state law in December 1999. The California
Public Utility Commission also ordered implementation of the FCC's order on line
sharing and called for a shorter implementation time frame in February 2000. In
February 2000, we successfully installed our first line sharing customer in
Minnesota.

     Line sharing, where available, will allow us to provide our asymmetric DSL
service on the same existing copper telephone lines as the existing incumbent
local exchange carrier user to provide its voice service. Until the FCC's line
sharing decision, we were required in every case to provision our asymmetric DSL
services over a separate copper telephone wire from that used by the incumbent
to provide its voice services to the same customer, which required the
installation of an additional copper telephone wire to the customer's location.
Most, if not all, of the traditional telephone companies provide their own
asymmetric DSL services on the same line as existing voice services.

     We believe line sharing is an extremely important opportunity for us to
enhance customer service and reduce cost. First, line sharing should
significantly reduce the time it takes incumbent local exchange carriers to make
their copper telephone wires available for our use. Second, line sharing should
significantly reduce the one time installation cost in those cases where we do
not need to send a technician to the customer site to install the service.
Third, the monthly recurring charge we pay to the incumbent local exchange
carrier for the use of the copper telephone wire should decline since the
incumbent local exchange carrier does not incur a separate monthly charge for
the use of the copper telephone line for its own DSL service.

Evaluate and selectively pursue attractive international markets

     In the future, we intend to replicate our network build-out, customer
acquisition and operational knowledge in selected, attractive international
market. In January 2000, we created a 50% owned joint venture with Optel
Communications Corporation, known as Rhythms Canada. Rhythms Canada is expected
to develop a Canadian DSL network and offer dedicated high-speed DSL services to
enterprise customers and telecommunications carriers throughout Canada. We will
continue to evaluate the merits of entering other international markets, as well
as the best way for us to enter into optimal business entry structure for each
market.

Strategic Partnerships

MCI WorldCom

     In March 1999, we started a strategic partnership with MCI WorldCom in
which MCI WorldCom invested $30.0 million in us.

     .    Providing DSL services to MCI WorldCom. We have been designated MCI
          WorldCom's first choice in its alternative carrier access provisioning
          system for DSL services in areas where we deploy our network for all
          new DSL services, except for services to certain subsidiaries and in
          locations where MCI WorldCom deploys its own DSL equipment. In
          addition, MCI WorldCom has committed to sell a minimum of 100,000
          business quality DSL lines, subject to penalties for

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          failure to reach target commitments. MCI WorldCom will have 60 months
          to place orders for these lines, starting on the date when we have
          1,250 collocations in commercial service in at least 29 metropolitan
          statistical areas. As part of our agreement, we must provide specified
          service levels and have available capacity.

     .    Obtaining network services from MCI WorldCom. We have designated MCI
          WorldCom as our preferred provider of network services, including
          metropolitan area network services and long-haul backbone services.
          MCI WorldCom has a right of first refusal to provide all of these
          services to us at market competitive terms.

     .    Collaboration. We are jointly developing voice and data applications
          over a single DSL connection. For instance, in June 1999, MCI WorldCom
          and we, in conjunction with Cisco and Jetstream Communications,
          successfully demonstrated toll quality voice and high-speed data
          communications over a single copper line utilizing DSL technology. We
          have also formed a working group with MCI WorldCom to develop and
          implement the systems and procedures necessary to jointly deploy DSL
          service nationwide. We will collaborate with MCI WorldCom in selecting
          technologies and vendors to support our network deployments.

Microsoft

     In March 1999, we entered into a strategic partnership with Microsoft, in
which Microsoft invested $30.0 million in us. We are working with Microsoft to
trial a multiple feature consumer offering in Boston including high-speed
Internet access, Internet services, Microsoft Network connectivity and streaming
media. In conjunction with this trial, we are currently participating in
Microsoft's Windows Media Division's Broadband Jumpstart program to hold trials
of streaming media video technology.

Qwest

     In April 1999, we entered into a customer relationship with Qwest, in which
Qwest invested $15.0 million in us. Pursuant to this relationship, among other
things, Qwest has committed to purchase from us performance class DSL services
for sale to its customers. In return, we have agreed to use Qwest's network and
application hosting services in certain situations. The combined DSL line
commitment from Qwest and MCI WorldCom totals 200,000 lines over several years.

Cisco

     In October 1998, we entered into a strategic partnership with Cisco, in
which Cisco agreed to work jointly with us to sell our services to its customers
including providing compensation to its sales representatives for selling our
services. In addition, Cisco has committed to a joint marketing program with us
to increase our market recognition among businesses and consumers. We have also
contracted with Cisco to manage and upgrade its remote access program for 8,500
teleworkers nationwide.

Our Service Offerings

     We offer our customers solutions that address many of their broadband
access networking needs. Our local connection services use a variety of DSL
technologies to deliver high-speed, "always on" local access. We also aggregate
traffic within metropolitan areas and route or switch the traffic to our
broadband service provider customers, or to a corporate network within the same
metropolitan area or another metropolitan area using our inter-network
connections. In addition to local connections and metropolitan and wide area
inter-network connections, we offer a growing

                                       10
<PAGE>

suite of network features and applications that bring additional value-added
services to our customers.

Local connection services

     Our local connection services connect individual users or multiple users
on a local area network through our metropolitan network to our national
network, the Internet or a telecommunications carrier network using DSL
technology over traditional telephone lines. Our network is capable of data
transfer rates ranging from 128 kbps to 7.1 Mbps. Unlike dial-up modems and ISDN
lines, our DSL solution is "always on"; it does not require users to dial-up to
connect to the Internet or their local area network for each use.

     We place DSL equipment both at the customer premises  a residence or
business and in the central office that services that specific customer
premises. There are typically many incumbent carrier central offices in each
metropolitan area. We connect the DSL equipment in each central office to one of
our Metro Service Centers so that we can route or switch network traffic to
either a local destination, a national destination, or the Internet.

     For our local connection services, the speed and effectiveness of the DSL
connection will vary based on a number of factors, including the distance of the
end user from the central office and the condition of the copper telephone line
that connects the end user to the central office. The specific number of
potential users who will qualify for higher speeds will vary by central office
and will be affected by line quality. In the future, we intend to examine adding
additional high-speed local access technologies to our offering as they are
developed, including emerging wireless technologies. The chart below compares
the performance and range of our local connection services as of December 31,
1999.

            Speed to      Speed From      Range*      Technology**
            End User       End User       (feet)      ------------
            --------       --------       ------

             144 kbps     144 kbps***     50,000      IDSL****
             256 kbps     256 kbps        18,000      SDSL****
             384 kbps     384 kbps        15,000      RADSL
             512 kbps     512 kbps        14,000      RADSL
             768 kbps     768 kbps        12,000      RADSL
               1 Mbps     1 Mbps          12,000      RADSL
             1.5 Mbps     1.5 Mbps         8,000      SDSL****
               3 Mbps     1 Mbps          10,700      RADSL
               5 Mbps     1 Mbps           9,000      RADSL
             7.1 Mbps     1.1 Mbps         7,800      RADSL

___________

*    Estimated maximum distance from the central office to the end user.

**   The technologies listed below are more fully described in "DSL
     Technologies" below.

***  May be 128 kbps under some circumstances. ****  Cannot be used with
     line-sharing.

     We offer three classes of broadband local access communication services,
all of which are available up to 50,000 feet from the central office which
serves the end user:

  Select Links.  Our Select Links offer is available in the following range of
speeds: 128 kbps x 128 kbps, 256 kbps x 256 kbps, 384 kbps x 384 kbps, 512 kbps
x 512 kbps, 768 kbps x 768 kbps, 1

                                       11
<PAGE>

Mbps x 1 Mbps and 1.5 Mbps x 1.5 Mbps. We plan to make this service available
soon in a range of additional speeds, including 3 Mbps x 1 Mbps, 5 Mbps x 1 Mbps
and 7.1 Mbps x 1.1 Mbps.

     Our Select Links services are sold through Internet service providers,
telecommunications carrier customers and broadband communication services
resellers, and are primarily used by small and medium businesses for high-speed
Internet access.

     Basic installation for our Select Links offering includes our standard
inside wiring service, installation and basic configuration of the fully
featured DSL router and service activation. Installation charges consist of a
one-time charge and may be discounted for large volume commitments, long term
end user contracts, and promotions.

  Complete Links.  Our Complete Links service offers a fully managed Internet
Protocol (IP) over DSL service, which is available in all of our symmetric and
asymmetric speeds. Our Complete Links services are sold though Internet service
providers, broadband communications services resellers, and our internal sales
and marketing division, called the Channel Development Organization, in those
markets which are not otherwise served by our Internet service provider
customers. Our Complete Links services are primarily used by small and medium
businesses for high-speed Internet access, and enterprises for telework and
branch office connectivity.

     We offer a premium installation for our Complete Links offering that
includes our standard inside wiring service, installation and basic
configuration of the fully featured DSL router or modem, end-to-end service
activation and management, maintenance and support of the DSL router or modem.
Installation charges consist of a one-time charge and may be discounted for
large volume commitments and/or long term end user contracts and promotions.

  Consumer Links.  Our Consumer Links services are available at the following
speeds: 144 kbps x 144 kbps, 208 kbps x 208 kbps, 384 kbps x 272 kbps, 408 kbps
x 384 kbps, 768 kbps x 408 kbps, 1. Mbps x 408 kbps, 3 Mbps x 1 Mbps and 7.1
Mbps x 1.1 Mbps. Our Consumer Links services are sold though Internet service
providers and broadband communications services resellers, and are primarily
used for Internet access.

     Basic installation for our Consumer Links offering includes our standard
inside wiring service, installation and configuration of a basic DSL modem, and
service activation. We also offer our premium installation option.

     Prices for our broadband local access services vary depending upon the
performance level of the service. For example, a 144 kbps service is our lowest
priced service and our 7.1 Mbps is our highest priced service.

Metropolitan area and wide area inter-network connection services

     For our broadband service provider and business customers, we offer two
high-speed connection services both within and among metropolitan areas.

  Metropolitan LAN.  Our metropolitan area inter-network connection service
allows us to aggregate traffic from each of the central offices within a
metropolitan area to an Internet service provider, telecommunications services
carrier, broadband communications services reseller or an enterprise customer
site within that same metropolitan area. We offer our Metropolitan LAN services
in two speeds. Our 1.544 Mbps service (DS-1) is suitable for small broadband
service providers and business customers, and is available in both asynchronous
transfer mode and Internet protocols. Our 45 Mbps service (DS-3) is intended for
large broadband service providers, and business customers, and is available in
two protocols-asynchronous transfer mode and Internet protocol. In addition to
monthly service charges, we impose nonrecurring order setup charges for inter-
network connection services.

                                       12
<PAGE>

  U.S. LAN.  Our wide area inter-network connection service currently operates
between each of the metropolitan areas in which we provide service, and allows
our Internet service provider customers the ability to quickly and cost-
effectively offer services in new markets, and our enterprise customers the
ability to connect affiliate offices and teleworkers nationwide. Our monthly
service charge varies depending on the number of local access connections and
the data transfer rate required by the customer.

Network features and applications

     We intend to continue to add further network features and applications to
add additional value to our offering. We believe our strategy to provide
additional network features and applications will increase our revenue by
expanding the size of our addressable market, increasing the speeds required by
our customers and allowing us to receive additional recurring monthly revenue
from certain of our customers.

     The features and applications that our network currently offers or
enables are listed below:

     .    Internet Services. We bundle high-speed DSL-based local access with
          Internet access services for small and medium business customers in
          markets that are not otherwise served by our broadband service
          provider customers. Our basic Internet services include Internet
          access using our Complete Links services, e-mail accounts and IP
          addresses. Optional features include domain name transfer and
          registration, Web hosting services, collocation services and virtual
          private network over DSL capability. These services are provided in
          cooperation with Epoch Internet.

     .    Service Selection. We have implemented a service selection feature
          within our network that enables end users to access multiple
          destinations, including the corporate local area network, the
          corporate telephone system, the Internet, customers, suppliers and
          partners, using the same DSL access line. This feature alleviates the
          corporate network from servicing Internet traffic to a teleworker.

     .    Dynamic Host Configuration Protocol Functionality. This feature
          relieves network administrators from the burden of notifying each
          teleworker of network configuration changes. The use of this protocol
          ensures that once teleworkers start up their computers, the customer's
          server automatically downloads all of his or her network configuration
          parameters.

     .    Collocation Services. We have announced plans to offer certain
          broadband application service providers the ability to collocate their
          equipment in our network. Collocation allows these providers to take
          advantage of our distributed, fully routed IP network by placing their
          caching and hosting equipment in our markets in order to seamlessly
          and cost-effectively extend their network optimization services to
          their customers' end users using our broadband communications access
          services.

     .    Virtual Private Network (VPN) over DSL. This service uses the public
          Internet backbone or our private data networks in conjunction with our
          high-speed DSL access connections, to create a channel for sharing
          information and applications within a closed user group in different
          locations. Our private VPN service is available for remote or branch
          offices that require high-speed interoffice connectivity across
          multiple locations and for teleworkers and other remote users who want
          secure access to their corporate network and the Internet from home.

     .    Voice over IP. Utilizing the IP over DSL capability of our network, we
          enable or support our customers' implementation of voice over DSL
          services through the addition of customer premises equipment and
          software. This feature allows our business customers to extend the
          functionality of the corporate telephone system directly into a
          teleworker's home. Benefits to our business customers include

                                       13
<PAGE>

          increased worker productivity, reduced second line expenses for voice
          service and the ability to aggregate and control long distance
          charges.

     .    Streaming. Our network supports streaming media services. For certain
          customers and services, we provide guaranteed data transfer rates
          through service level agreements. For example, we are working with
          iBEAM Broadcasting Corporation to provide a business-class video
          streaming service. In addition, we are currently participating in
          Microsoft's Windows Media Division's Broadband Jumpstart program to
          hold trials of streaming media video technology for consumers.

     In the future, we plan to continue to expand our network features and
applications by working closely with leading broadband applications service
providers, networking equipment companies, and our telecommunications carrier
customers. Future development efforts include frame relay-over-DSL.

     Our expected development of voice-over-DSL will allow our broadband service
provider customers to provide a full range of local and long distance voice
services in addition to high-speed Internet and private networking services to
their end user customers over a single DSL connection. We are currently
conducting trials for a voice-over-DSL service with MCI WorldCom and Intermedia.

     If we develop frame relay-over-DSL, it would allow our telecommunications
carrier customers to replace expensive, low-speed, local access frame relay
connections currently purchased from the incumbent local exchange carrier with
affordable, high-speed DSL connections that utilize the frame relay protocol. We
are currently conducting frame relay-over-DSL trials with MCI WorldCom and other
telecommunications carriers.

Customers, sales and marketing

     We offer our services to broadband service providers and businesses not
otherwise served by our broadband service providers. As of December 31, 1999, we
were providing services to approximately 1,500 broadband service providers and
business customers, and had approximately 12,500 DSL lines in service. The
following is a list of selected Internet service provider, telecommunications
carrier and enterprise customers:



Select Internet Service Provider   Select Telecommunications  Select Enterprise
 Customers                         Carriers                   Customers

UUNET                              MCI WorldCom               Cisco
Microsoft Network                  AT&T                       Ford Motor Company
PSINet                             Qwest                      QUALCOMM
Digex                              Level 3 Communications     SGI
SAVVIS                             Williams Communications
CAIS Internet                      Intermedia Communications
Flashcom
Telocity
Phoenix Networks
DSLnetworks

Internet service providers

     Our business-focused Internet service provider customers resell our
services, typically to small and medium businesses, and our consumer-focused
Internet service providers, including Telocity, Flashcom and Microsoft Network,
resell our services to consumers. We offer our
                                       14
<PAGE>

business-focused Internet service providers our Select Links services or our
Complete Links services, and our consumer-focused Internet service providers our
Consumer Links services. We also offer our Internet service provider customers
our metropolitan area and wide area inter-network connection services. Our
Internet service provider customers can then combine our services with their own
services to offer a total solution to their customers.

Telecommunications carrier customers

     A key element of our strategy is to enter into relationships with leading
telecommunications carriers, including interexchange carriers and competitive
telecommunications carriers in order that they may resell our services to their
customers. For example, we have entered into commercial agreements with each of
MCI WorldCom, AT&T, Qwest, Level 3 Communications, Williams Communications and
Intermedia providing for the resale of our services, primarily to their carrier,
Internet service provider, broadband communication services resellers,
enterprise and small business customers.

     In order to advance our telecommunications carrier customers' sales
effort to enterprises, and develop preference for the Rhythms solution, we have
fielded a carrier applications and technical support force to support our
customers' solutions-based selling efforts. We reinforce our applications and
technical support force through our alliance with Cisco. Cisco has agreed to
assist us and certain of our telecommunications carrier customers in marketing
and selling our broadband local access communications services.

     We supplement our carrier applications and technical support efforts by
offering sales support services that may include training, joint proposal
development, lead generation, joint participation in national and regional
customer events and seminars, and press announcements. Additionally, we support
our carrier customers' efforts through dedicated support teams and complete
operations integration including qualifying potential end users for our service,
ordering connections, installing equipment on the customer premises, turning up
the service, monitoring the network and invoicing our carrier customer on a
single bill.

Broadband communications services resellers

     An emerging component of our strategy is to enter into relationships with
broadband communications services resellers that include firms with existing
Web-based customer relationships that wish to resell broadband applications and
access services to their customers. It also includes a number of emerging
integrators of broadband communications infrastructure and applications services
to serve a specialized or vertical market need. For example, in January 2000 we
entered into a relationship with iPhysicianNet to provide its physician
customers with Web-based multimedia and fully IP internetworked broadband local
access services. We believe that this channel will enable us to penetrate our
target markets more rapidly.

Channel development organization

     In markets where we do not have established indirect channels, we market
our services directly to business customers through our Channel Development
Organization. Our Channel Development Organization seeks to sell Internet
access, telework and remote branch connectivity solutions to small and medium
sized businesses, through direct marketing and consultative selling over the
phone. As of December 31, 1999, we had roughly 150 persons dedicated to this
effort. Our contracts are typically one to two years in length, and we receive
an average revenue per line per month that is higher than what we receive
through our broadband service provider channels. Once we have established
indirect channels in a market, our Channel Development Organization will provide
direct marketing, lead generation and telesales support services for our
customers.

Customer support

                                       15
<PAGE>

     We supplement certain of our Internet service providers' and broadband
communication services resellers' sales efforts by offering sales tools and
marketing programs that may include market development funds, promotions and
incentives, launch programs, sales collateral, joint participation in national
and regional customer events and training. Through our Channel Development
Organization, we will also provide direct marketing, lead generation and
telesales support services.

     We support our customers through sales and marketing personnel dedicated to
each type of channel and to each of our largest broadband service provider
customers. Additionally, we support our broadband service provider customers
through complete operational integration including qualifying potential end
users for service, ordering connections, installing equipment on the customer
premises, turning up the service, monitoring the network and invoicing the
customer on a single bill.

     Our agreements with our broadband service providers vary widely. Generally,
our agreements have a one to three year term, and are based on negotiated prices
that decline with increasing levels of volume achievement. Certain of our
broadband service provider customers have committed to sell specified quantities
of DSL lines, subject to penalties for failure to reach these target
commitments. In many cases, our broadband service providers have selected one or
two, and perhaps as many as three, DSL service providers as suppliers in each
market.

     Our goal is to be selected as the preferred supplier or one of the
preferred suppliers by broadband service providers in each metropolitan area
where we operate. When we are selected as a preferred supplier within a given
market, we may enter into nonstandard joint marketing arrangements to promote
our DSL services. We may also offer additional price discounts in return for our
selection as a preferred supplier with first right of refusal on orders. See
"Risk Factors - We depend on third parties for the marketing and sales of our
network services."

Brand campaign

     In December 1999 we launched a two-phase national brand development
campaign, including television, print, radio and online advertisements. The
first phase consists of television and national print advertising, and is
intended to build awareness for our brand and educate the market about our
broadband service offering and differentiate our services. The second phase,
which focuses on product messaging, will run in local newspapers and drive-time
radio in 30 major metropolitan markets, and is designed to generate demand for
our broadband services.

Customer Service, Operations and Support Systems

     We offer our broadband service provider and business customers a one-stop
broadband service solution including network implementation, customer service,
technical support and ongoing network monitoring and billing. For major
broadband service providers and businesses, we establish dedicated teams to work
with the account to develop and implement a complete, fully automated operations
integration plan in order to ensure that our service implementation, maintenance
and billing proceeds smoothly.

Network implementation

     Working with a broadband service provider or business customer we connect
our customer's premises and their end users to our network by ordering telephone
lines from the incumbent local exchange carrier or a competitive
telecommunications company, connecting our customer's premises and end users to
our network, testing the connections, configuring our customers' end users'
endpoints, connecting to our customers' routers or switches and monitoring the
connections from our Network Operations Center.

                                       16
<PAGE>

     We are implementing fully automated, Web-based, service qualification and
order entry tools using standard industry interfaces. For large customers, we
develop and implement a personalized, fully automated, private extranet site for
service qualification and order entry. Orders can be placed individually, in
real time through our Web site, or in bulk through our customers' private
extranet sites.

     We are installing systems to ensure that our customers' orders
automatically flow through to the incumbent local exchange carriers' order entry
systems. In October 1999, we announced our selection of NightFire
SupplierExpress from NightFire Software to automate our process for pre-
ordering, ordering and provisioning unbundled local loops from the incumbent
local exchange carrier.

     We outsource field service personnel and, to a more limited extent, use our
own field service personnel to perform any necessary inside wiring, install and
configure the endpoint and, if required, install a network interface card and
configure the end user's PC or laptop. Currently, we offer two types of
installation service. Our basic installation service includes a standard inside
wiring service, endpoint installation and configuration, and line test. Our
premium installation service also includes installing one network interface card
in the end user's computer, configuring one computer and a complete end-to-end
service test.

Customer service, technical support, and network monitoring

     Our Network Operations Center in Denver provides network surveillance
through standard Simple Network Management Protocol tools for all equipment in
our network. Because we have complete end-to-end visibility of our network, we
are able to proactively detect and correct the majority of our customers'
maintenance problems remotely for certain customers and services. Our goal is to
proactively detect and repair 90% of our customer's maintenance problems before
our customers become aware of a problem.

     Customer-initiated maintenance and repair requests are managed and resolved
primarily through our customer advocacy team in our Network Operations Center.
We provide support to our customers 24 hours a day, seven days a week. Our
broadband service provider and business customers typically serve as the initial
contact for service and technical support while we provide the second level of
support.

     We utilize a trouble ticket management system to communicate customer
maintenance problems from the customer advocacy team to our Network Operations
Center engineers and the field service engineers. Because our Network Operations
Center is fully staffed 24 hours a day, seven days a week, we believe our
ability to provide superior proactive maintenance is significantly enhanced.

Billing

     Customer bills are currently issued on a monthly basis through an internal
billing system. In the future, we expect our billing system to electronically
interface with our customers and support a broad array of billing options. Our
Customer Service Center manages customer billing inquiries. In the future,
billing inquiries will also be supported through our Web-based interfaces. In
November 1999 we announced our intention to utilize Portal Software's Infranet
customer management and billing software.

Operational Support Systems

     We are implementing what we believe to be industry leading operational
support systems for DSL broadband access services. We are installing complete
flow through order management
                                       17
<PAGE>

and provisioning systems with system-to-system interfaces. These systems will
allow us to scale our business rapidly because they will eliminate many manual
processes such as order taking and verification, line ordering, receipt and
testing, network path configuration, equipment configuration and billing.

     Our system architecture is designed to enable rapid order fulfillment and
reduce the cost of customer support. We use a set of standard, off-the-shelf
systems to support our business processes. All business functions, including
sales, ordering, provisioning, maintenance and repair, billing, accounting and
decision support use a single database management system from Oracle. Complete
systems integration is accomplished through the use of Vitria middleware to
ensure rapid scaling of all business functions and uninterrupted growth.

Network Architecture

     The network design features that we believe are important to our customers
are:

Carrier-class network management

     Our network is designed to be carrier-class throughout. For example, it has
been designed with redundant network electronics and transmission paths. We have
the ability to electronically view our entire network including the DSL modem
located at the end user's premise from our Network Operations Center in Denver.
Because we proactively monitor and manage the network at all times for certain
customers and services, we can identify and address network problems quickly. In
addition, for those customers that choose our Internet Protocol-over-DSL
capability, we are able to monitor and manage Internet Protocol applications all
the way to the end user location.

Scaleable network performance

     We anticipate significant volume on our network over time. Accordingly, we
have designed our network for scalability and consistently high performance as
network usage grows. Our local access network is designed so that each line in
service is a dedicated connection, and as such, does not contend for bandwidth
or capacity with other users as they are added to the network. Our metropolitan
and wide area inter-networking services have been designed to support a wide
array of service level agreements that guarantee specific levels of network
performance to our broadband service provider and business customers.

     We believe that our network is unique in that we support Internet Protocol
routing as well as Asynchronous Transfer Mode switching equipment in our
network. IP networks allow our customers' end users to easily access thousands
of Internet or private network destinations without the need to establish
physical permanent virtual connections for each destination, creating a much
less complex, cost-effective, easily scalable network for our customers and
their end users.

     Our network support systems are also scaleable. We use industry standard,
off-the-shelf software to support network provisioning, installation, testing,
monitoring and trouble management. We have implemented and are continually
enhancing these systems using Web-based, distributed client-server systems
architecture. This approach will allow us to grow our customer support and
network management capabilities as customer demand increases.

Network security

     Non-dedicated access, such as dial-up modem or ISDN lines, or dedicated
access to the public Internet, represents security risks for business networks.
These security risks are mitigated through the use of virtual private network
technologies such as authentication, tunneling, encryption and through the use
of permanent virtual circuits that define a logical dedicated connection between
the end user and the corporate network. Our network enables businesses to fully
employ these
                                       18
<PAGE>

virtual private network technologies by using their own equipment at the edges
of our network, or optionally purchasing virtual private networking services
from us. For our IP-over-DSL network implementation, we have added several
layers of security for our customers including Multi-Protocol Label Switching
(MPLS), policy routing, network segmentation by customer and the implementation
of access control at the end user's DSL router.

Multiple network features and applications capability

     Our network has been designed from the outset to be flexible and
upgradeable to support new network features and applications. Because our
network utilizes multiple technology platforms, we can provide higher end user
speeds than other national providers, a broad range of IP internetworking
capabilities in addition to traditional virtual point-to-point connectivity, and
various types of network traffic starting with data, but expanding to voice and
video as well. Our use of multiple technology platforms, also allows us to
leverage the research and development capabilities of several different
equipment manufacturers to provide a growing number of network features and
applications in our offering.

     Because the quality and characteristics of each end user's telephone wire
is different, we are able to select a technology solution that provides the
highest speed available for each end user. As of December 31, 1999, users on our
network were capable of receiving average data transfer rates of 1.9 Mbps.

     Our network supports traditional transmission protocols such as
Asynchronous Transfer Mode and Frame Relay, as well as the rapidly growing IP
transmission protocol. Our IP-over-DSL network capability allows us to provide a
broad range of IP internetworking capabilities in a simpler, more cost-effective
manner than by using more traditional protocols. For example, our network can
give each user simultaneous access to the Internet and private networks using a
single connection, the ability to take advantage of distributed content caching
services in an internetworked environment and the ability to add other emerging
IP services such as voice over IP using their existing connection.

     Our network has also been designed to support multiple types of network
traffic, starting with data but expanding to voice applications, such as voice
over DSL and video applications such as conferencing and streaming. Our network
is also easily upgradeable in that it has been designed to incorporate new
applications and features with customer premises equipment and software alone,
avoiding costly, time consuming network upgrades.

     Our network is an overlay network; we place our network electronics on an
already existing physical network that we lease from existing transport services
providers  local access telephone wires from incumbent local exchange carriers,
metropolitan fiber from incumbent local exchange carriers or competitive
telecommunications carriers and long-distance backbone fiber from long distance
(interexchange) carriers. The primary components of our network are customer
endpoint devices, local transport, our connection points, high-speed
metropolitan area network, our Metro Service Centers, our backbone and our
Network Operations Center.

Customer endpoint devices

     Depending upon the wishes of our broadband service provider customer, we
will either include the end user endpoint device the DSL modem or router as part
of our complete service offering, or buy our DSL endpoints from our suppliers
for resale to our service provider for use by their end users. For our business
customers, we always include the end user endpoint device as part of our
complete service offering. We configure and install these modems on the end
user's premises along with any basic on-site wiring needed to connect the modem
to the copper telephone line leased from the incumbent carrier. Although we
generally deploy central office based DSL multiplexing equipment from multiple
vendors in each of our central offices, currently, almost all of the DSL modems
and central office-based DSL multiplexing equipment we use for a single
connection over a copper telephone line must


                                       19
<PAGE>

come from the same vendor since there are no existing interoperability standards
for the equipment used in our higher speed services.

Local transport

     Our local transport connects customer endpoint devices to our network
using a DSL-capable copper telephone wire leased by us from the incumbent local
exchange carrier under terms specified in our interconnection agreements and/or
the terms and conditions set by the state public utility commissions. In some
cases, DSL-capable lines result from removing certain devices from voice grade
lines to allow the lines to carry digital signals; at times involving an
additional one-time or monthly charge relative to voice grade lines. For private
line access, the transport is leased copper or fiber trunks provided by the
incumbent local exchange carrier or a competitive telecommunications carrier.

Connection points

     Through our interconnection agreements with the incumbent local exchange
carriers, we secure collocation space in central offices serving the area where
we intend to offer our services. In each of these connection points, we connect
our end users' DSL endpoint equipped copper telephone lines to our DSL
multiplexing equipment (DSLAMs) to provide high-speed DSL signals to them. Each
of our connection points is designed to offer the same high reliability and
availability standards as the incumbent carrier's own central office equipment.
We expect to place our equipment in certain of the central offices in any
metropolitan area that we enter. As of December 31, 1999, we had connection
points in over 1,200 central offices. Although we expect that many connection
points will be physically located within the central office, we have placed and
will continue to place our connection points in locations immediately adjacent
to central offices, when collocation space within the central office is not
available.

High-Speed Metropolitan Area Network

     In each of our targeted metropolitan area markets, we operate a private
metropolitan area network. The network consists of high-speed Asynchronous
Transfer Mode communications circuits that we lease from competitive carriers or
incumbent local exchange carriers to connect our connection points to the Metro
Service Center. The metropolitan area network operates at 45 Mbps (DS-3) today,
and can be upgraded to 155 Mbps (OC-3) and 622 Mbps (OC-12) in the future. We
lease a substantial portion of this capacity from MCI WorldCom, as described in
"Strategic Partnerships."

Metro Service Centers

     The Metro Service Center is a physical point of presence within a
metropolitan area where local access traffic is aggregated from the connection
points over our high-speed metropolitan area network. Although we generally
expect to have one Metro Service Center in each of our targeted metropolitan
areas, in larger metropolitan areas, we may have two. The Metro Service Center
houses our Asynchronous Transfer Mode switches and Internet Protocol routers. We
design our Metro Service Centers for high availability including battery backup
power, redundant equipment and active network monitoring.

Backbone

     Our backbone interconnects our Metro Service Centers so that communications
traffic can be transported among different metropolitan areas. We currently
lease frame relay backbone and Asynchronous Transfer Mode backbone capacity from
a number of long distance carriers. We have almost completed upgrading our
nationwide network to two protocols  Asynchronous Transfer Mode and Internet
Protocol.

                                       20
<PAGE>

Network Operations Center

  Our entire network is managed from the Network Operations Center located in
Denver. From this center, we provide end-to-end network monitoring and
management, 24 hours a day, seven days a week, using advanced network management
tools. This enhances our ability to address performance or connection issues
before they affect our end user's experience. From the Network Operations
Center, we monitor the equipment and circuits in each Metro Service Center, each
metropolitan area network, each connection point, and each of the individual end
user lines and endpoints. A second Network Operations Center is under
construction. Please see "Risk Factors - system failure or breach of network
security could cause delays or interruptions of service to our customers."

     We are pursuing a program of ongoing network development. Our engineering
efforts focus on the design and development of new technologies and services to
increase the speed, efficiency, reliability and security of our network and to
enable network features and applications developed by us or by third parties.
Please see "Risk Factors - We may be unable to effectively expand our network
services and provide high performance to a substantial number of end users."

DSL Technologies

     We utilize various DSL equipment and technologies from different vendors.
The various DSL technologies allow us to offer a range of connection speeds and
value-added network features and applications. Actual speeds that can be
provided over a particular line are a function of the distance from the end user
or local area network to the central office and the quality of the copper
telephone line. The basic features and the market positioning of our primary DSL
technologies include:

Rate adaptive digital subscriber line (RADSL)

     RADSL technology allows each end user or local area network to utilize the
full digital capability of the underlying telephone line. Speeds reach up to 7.1
Mbps downstream and up to 1.1 Mbps upstream if the end user or local area
network is within 7,800 feet from the central office. We use this technology for
end users or local area networks needing very high access speeds. Our target
customers for RADSL connections consist of small and medium businesses and
branch offices of large businesses needing T-1 (1.5 Mbps) or higher speeds. We
believe that these businesses often find the cost of dedicated private line or
frame relay services to be prohibitive. Our RADSL connection competes favorably
on a price and performance basis relative to traditional fractional T-1 and
frame relay services.

     Our RADSL service also provides the highest speed of any of our DSL
services for bandwidth intensive applications, and is necessary to support line
sharing, which we believe will offer us significant customer service and cost
advantages when implemented.

Symmetric digital subscriber line (SDSL)

     Our SDSL technology allows end users and local area network to achieve up
to 1.5 Mbps speeds both downstream and upstream. Depending on the quality of the
copper telephone line, 1.5 Mbps can typically be achieved if the end user or
local area network is within 8,000 feet, or approximately 1.5 miles, from the
central office.

Integrated digital subscriber line (IDSL)

     IDSL technology allows us to reach all end users or local area networks
within a central office serving area within 50,000 feet of the end user or local
area network distance from the central office. Our IDSL service operates at up
to 144 kbps in each direction. This service can use existing integrated services
digital network (ISDN) equipment at the end user site, and is targeted at the

                                       21
<PAGE>

integrated services digital network (ISDN) replacement market. For information
intensive users, we believe that IDSL compares favorably with integrated
services digital network (ISDN) on a price/performance basis when the monthly
flat rate IDSL charge is compared with the per minute integrated services
digital network (ISDN) charge and because IDSL, as an "always on" service is not
subject to the inconvenience of ISDN's dial-up characteristics. We also offer
IDSL to end users that have lines that do not consist of continuous copper, such
as digital line carrier equipped lines that are partially copper and partially
fiber.

Competition

     The markets for broadband service provider and business broadband access
services are extremely intense. We face competition from many competitors with
significantly greater financial resources, well-established brand names and
large, existing installed customer bases. Moreover, we expect the level of
competition to intensify in the future. We expect significant competition from:

Incumbent Local Exchange Carriers.  All of the largest incumbent local exchange
carriers in our target markets have begun offering DSL services or have
announced their intention to provide DSL services in the near term. As a result,
the incumbent local exchange carriers represent strong competition in all of our
markets, and we expect this competition to intensify. The incumbent local
exchange carriers have well-established brand names and reputations, for high
quality service in their regions, possess sufficient capital to deploy a DSL
network rapidly and own the central offices and copper telephone wires.
Importantly, they can offer both digital data services and their existing voice
services over a single line to achieve a lower cost per line per month than we
can until line sharing is widely implemented. Certain of the incumbent local
exchange carriers have priced their consumer DSL services as low as $19-$29 per
line per month, placing very high pricing pressure on our Consumer Links
services.

Traditional Interexchange Carriers. Many of the leading traditional
interexchange carriers, such as AT&T, MCI WorldCom and Sprint, are rapidly
expanding their networks to include high-speed, local access services, and/or
acquiring other companies with high-speed local access capabilities, including
cable modem (such as AT&T's acquisition of TCI and its pending acquisition of
MediaOne, both of which can offer cable modem service). They also have
interconnection agreements with the incumbent local exchange carriers and may
have secured collocation spaces from which they may have begun to offer
competitive DSL services. When combined with their extensive, existing
metropolitan and wide area networks, and full range of Internet and private
networking services, they are able to provide their customers with a complete
broadband communications offer capable of voice, data and video solutions.
Because these competitors have significantly greater financial resources, enjoy
strong brand recognition, and have large, existing business and consumer
franchises, they represent significant competition.

Newer Interexchange Carriers.  The newer interexchange carriers, such as
Williams Communications, Qwest and Level 3 Communications, are building and
managing high bandwidth, packet-based metropolitan and wide area networks
nationwide. Additionally, they are constructing large hosting centers in major
metropolitan areas and partnering with broadband applications services providers
to provide a full range of broadband communications services to their Internet
service providers, telecommunications carriers, broadband communications
services resellers, and in some cases their business and consumer customers.
Some carriers also have interconnection agreements with the incumbent local
exchange carriers and have secured collocation spaces from which they could
begin to offer competitive DSL services. Because they could extend their
existing fiber networks to include high-speed, local access services using DSL,
either alone, or in partnership with others, they represent a significant
competitive threat.

Cable Modem Service Providers.  Cable modem service providers, like Excite@Home,
AT&T (through its acquisition of TCI and pending acquisitions of MediaOne) and
AOL, and their cable partners, are offering high-speed Internet access over
hybrid fiber coaxial cable networks to consumers, and increasingly, businesses.
Similar networks are being deployed in some areas by the electric power company,
by itself or in partnership with other service providers. Where deployed,


                                       22
<PAGE>

these networks provide Internet access services similar to our services, and in
some cases at higher speeds. In certain cases cable modem services are priced
lower than our services, partly because operators share the bandwidth available
on their cable networks among multiple end users.

Wireless and Satellite Data Service Providers.  Wireless and satellite data
service providers are developing wireless and satellite-based Internet and
private network connectivity. We may face competition from terrestrial wireless
services, including two Gigahertz (Ghz) and 28 Ghz wireless cable systems
(Multi-channel Multipoint Distribution System (MMDS) and Local Multipoint
Distribution System (LMDS)), and 18 Ghz and 39 Ghz point-to-point microwave
systems. For example, the FCC has recently revised its rules to permit ITFS and
MMDS licensees to use their systems to offer two-way services, including high-
speed data, rather than solely to provide one-way video services. Many ITFS and
MMDS providers are teaming with wireless data technology companies, or on their
own planning to offer wireless data services. The FCC also recently auctioned
spectrum for LMDS services in all markets, and later this year will auction
spectrum in the 700 MHz range, currently being used for television channels 60-
69. This spectrum is expected to be used for wireless cable and telephony
services, including high-speed digital services, to both businesses and
individual consumers. In addition, companies such as Teligent, Advanced Radio
Telecom and WinStar Communications hold point-to-point microwave licenses to
provide fixed wireless services such as voice, data and video conferencing.

     We also may face increasing competition from satellite-based systems.
Motorola Satellite Systems, Inc., Hughes Space Communications (a subsidiary of
General Motors Corporation), Teledesic LLC, and others have filed applications
with the FCC for global satellite networks which can be used to provide
broadband voice and data services, and in some cases have begun providing such
services. The FCC has authorized several of these applicants to operate their
proposed networks, and some are providing commercial service.

Internet Service Providers.  Internet service providers provide Internet access
to residential and business customers. These companies generally provide such
Internet access, on a dial-up basis, over the incumbent carriers' circuit
switched networks at integrated services digital network (ISDN) speeds (either
64 kbps or 128 kbps) or below. However, some Internet service providers have
begun offering DSL-based access using their own DSL services such as HarvardNet
and InterAccess, or DSL services offered by the incumbent local exchange carrier
or other DSL-based competitive local exchange carriers. Because certain large,
national Internet service providers, such as Verio and Concentric, have made
investments in our competitors, and entered into joint marketing arrangements
nationwide, it is difficult for us to recruit these Internet service partners as
customers, and as a result, they represent important competitors.

Online Service Providers.  Online service providers include companies such as
AOL, and the Microsoft Network (MSN) that provide, over the Internet and on
proprietary online services and networks, content and applications ranging from
news and sports to consumer video conferencing. These services are designed for
broad consumer access over telecommunications-based transmission media, which
enable the provision of digital services to the significant number of consumers
who have personal computers with modems. In addition, they provide Internet
connectivity, ease-of-use and consistency of environment. Many of these online
service providers have developed their own access networks for modem
connections. If these online service providers were to extend their access
networks to include DSL or other high-speed service technologies, they would
become competitors of ours.

Competitive Local Exchange Carriers.  Certain competitive carriers, including
Covad Communications Group and NorthPoint Communications, offer DSL-based
broadband access services using a business strategy similar to ours. In
addition, regional competitive carriers, including HarvardNet, Network Access
Solutions Corp., Blue Star, and DSL.net, offer DSL-based access services that
compete with the services we offer. Other voice competitive local exchange
carriers, such as NEXTLINK Communications, Allegiance Communications and MGC
Communications, have also announced that they have or will deploy DSL-based.
Conditions attached to the merger


                                      23
<PAGE>

between SBC and Ameritech may make entry and operation in affected regions
easier for our competitors. The 1996 Telecommunications Act specifically grants
competitive carriers the right to negotiate interconnection agreements with
incumbent carriers, including interconnection agreements that may be identical
in all respects to our agreements.

     Many of these competitors are offering, or may soon offer, technologies and
services that will directly compete with some or all of our service offerings.
Such technologies include integrated services digital network (ISDN), DSL,
wireless and satellite data and cable modems. Please see "Risk Factors: The
market in which we operate is highly competitive, and we may not be able to
compete effectively, especially against established industry competitors with
significantly greater financial resources, for more details about this risk."
Some of the competitive factors we face include:

     . transmission speed,
     . reliability of service,
     . breadth of service availability,
     . price/performance,
     . network security,
     . ease of access, installation and use,
     . content bundling,
     . customer support,
     . brand recognition,
     . operating experience,
     . ability to scale,
     . capital availability and
     . exclusive contracts.

Interconnection Agreements With Incumbent Carriers

     Interconnection agreements with incumbent carriers are critical to our
business. These agreements cover a number of aspects of our relationships with
incumbent carriers, including:

     . the prices we pay to lease and the access we have to the incumbent
       carrier's copper lines;
     . the removal by the incumbent carrier of equipment or electronics from
       lines to enable these lines to transmit DSL signals;
     . the price and terms for collocation of our equipment in the incumbent
       carrier central offices;
     . the price we pay and the access we have to the incumbent carrier's
       transport facilities;
     . the ability we have to access conduits and other rights-of-way the
       incumbent carrier uses to construct its own network facilities;
     . the operational support systems and interfaces that we can use to place
       orders and report and monitor the incumbent carrier's response to our
       requests;
     . the dispute resolution process we use with the incumbent carrier to
       resolve disagreements on the terms of the interconnection contract; and
     . the term of the interconnection agreement, its transferability to
       successors, its liability limits and other general aspects of our
       relationship with the incumbent carrier.

     We have signed interconnection agreements with seven different major
incumbent carriers covering 24 states and the District of Columbia. In many
cases, incumbent carriers do not agree to the provisions in interconnection
agreements that we request, and we have not consistently prevailed in obtaining
all of the provisions we desire. We may be unable to continue to sign
                                       24
<PAGE>

interconnection agreements with incumbent carriers. If we are unable to enter
into, or experience delay in obtaining, interconnection agreements, this
inability or delay may materially and adversely affect our business and
financial prospects. The Telecommunications Act also requires the incumbent
carriers to permit competitive carriers to adopt previously signed
interconnection agreements, in whole or in part, in some circumstances.

     Our interconnection agreements have a maximum term of three years,
requiring us to renegotiate the existing terms in the future. We may be unable
to extend our existing interconnection agreements or renegotiate new agreements
on favorable or any terms. In addition, our interconnection agreements are
subject to state commission, Federal Communications Commission and judicial
oversight. These bodies may modify the terms or prices of our interconnection
agreements in ways that would adversely affect our business and financial
prospects.

Government Regulation

     A significant portion of the services that we offer, particularly through
our wholly owned subsidiaries, Rhythms Links Inc., formerly ACI Corp., and
Rhythms Links Inc.-Virginia, formerly ACI Corp.-Virginia, may be subject to
regulation at the federal, state and/or local levels. Future federal or state
regulations and legislation may be less favorable to us than current regulation
and legislation and therefore have a material and adverse impact on our business
and financial prospects. In addition, we may expend significant financial and
managerial resources to participate in proceedings setting rules at either the
federal or state level, without achieving a favorable result.

Federal legislation and regulation

     The 1996 Telecommunications Act, enacted on February 8, 1996, substantially
departs from prior legislation in the telecommunications industry by
establishing local exchange competition as a national policy. This act removes
state regulatory barriers to competition and preempts laws restricting
competition in the local exchange market.

     The 1996 Telecommunications Act in some sections is self-executing, but in
addition, the Federal Communications Commission issues regulations that identify
specific requirements upon which we and our competitors rely in implementing the
changes it prescribes. The outcome of these various ongoing Federal
Communications Commission rulemaking proceedings or judicial appeals of such
proceedings could materially affect our business and financial prospects.

     The 1996 Telecommunications Act, and the Federal Communications
Commission's initial rules interpreting such act, encourage increased local
competition. A federal appeals court for the Eighth Circuit reviewed some of the
initial rules, and overruled some of its provisions, including some rules on
pricing and nondiscrimination. In January, 1999, the United States Supreme Court
reversed elements of the Eighth Circuit's ruling, finding that the Federal
Communications Commission has broad authority to interpret the 1996
Telecommunications Act and issue rules for its implementation, specifically
including authority over pricing methodology. The Supreme Court upheld the
Federal Communications Commission's orders to the incumbent carriers to combine
unbundled elements for competitors, and to allow competitors to pick and choose
among provisions in existing interconnection agreements. The Supreme Court also
found that the Federal Communications Commission's interpretation of the rules
for establishing unbundled elements was not consistent with the 1996
Telecommunications Act, and required the Federal Communications Commission to
reconsider its delineation of unbundled elements. The Federal Communications
Commission's replacement decision on unbundled elements reaffirmed the right of
CLECs like Rhythms to obtain access to the necessary unbundled elements in the
incumbent network. This decision remains subject to reconsideration appeal.

     In November, 1998, the Federal Communications Commission ruled that DSL
services provided as dedicated access services in connection with interstate
services such as Internet access are interstate services subject to the Federal
Communications Commission's jurisdiction. In

                                       25
<PAGE>

November, 1999 the Federal Communications Commission, upon further
reconsideration, reiterated this decision. On March 24, 2000, the D.C. Circuit
vacated the Federal Communications Commissions order with respect to dial-up
Internet traffic, without addressing the jurisdictional nature of DSL services.

     In addition, in the Spring of 1998, four of the regional Bell Operating
Companies petitioned the Federal Communications Commission, and they and others
have initiated legislative efforts since then, to be relieved of certain
regulatory requirements in connection with their own DSL services, including
obligations to unbundle DSL loops, but not the obligation to unbundle the loops
we purchase for our DSL services, and to resell DSL services. In October 1998,
the Federal Communications Commission ruled that DSL services are
telecommunications services subject to the requirements of the 1996
Telecommunications Act to unbundle such services and offer them for resale. In
October 1998, the Federal Communications Commission also issued a Notice of
Proposed Rulemaking indicating its intention to clarify expanded rights of
competitive carriers for collocation, access to copper loops, and various other
issues of consequence to competitive carriers deploying DSL services. The
Federal Communications Commission also indicated its intention to allow
incumbent carriers to create separate affiliates for their DSL businesses that
would have to operate as competitive carriers and would be permitted to operate
free of the resale and unbundling obligations of the 1996 Telecommunications
Act. The final outcome of these decisions, originally scheduled to be announced
on January 28, 1999, had been postponed by the Federal Communications Commission
while it considered the impact of the Supreme Court's ruling on the 1996
Telecommunications Act. On March 31, 1999, the Federal Communications Commission
issued a decision on collocation issues that was generally favorable to the
competitive carriers. This decision was appealed to the D.C. Circuit by U S WEST
and GTE. On March 17,2000, the D.C. Circuit vacated and remanded certain aspects
of the Commission's decision. The Commission decision on remand could impact the
terms and conditions governing our ability to collocate. In the same decision
the Federal Communications Commission established further proceedings to
consider issues related to unbundled network elements. In December of 1999, the
Federal Communications Commission determined that by June of 2000, incumbents
must allow data carriers to provide service over the same line that the
incumbent provides its own voice services otherwise known as "line sharing".
These decisions are subject to reconsideration and appeal. In addition, state
commission determination of the prices for these new elements could
significantly impact our business interest.

State regulation

     Some of our services, particularly those of our subsidiaries, Rhythms Links
Inc. and Rhythms Links Inc.-Virginia, may be classified as intrastate services
subject to state regulation. All of the states where we operate, or will
operate, require some degree of state regulatory commission approval to provide
certain intrastate services. In most states, intrastate tariffs are also
required for various intrastate services, although we are not typically subject
to price or rate of return regulation for tariffed intrastate services. Actions
by state public utility commissions could cause us to incur substantial legal
and administrative expenses.

     Under the 1996 Telecommunications Act, if we so request, incumbent carriers
have a statutory duty to negotiate in good faith with us for agreements for
interconnection and access to unbundled network elements. These negotiations are
conducted on a region-wide basis, and individual agreements are then signed for
each of the states in the region for which we have made a request. We have
signed interconnection agreements with SBC Communications, Bell Atlantic,
BellSouth, GTE, Pacific Bell, U S WEST and Cincinnati Bell. We have signed an
interconnection agreement with Cincinnati Bell for Ohio and Kentucky. We have
signed agreements with SBC Communications for Illinois, Michigan, Indiana, Ohio,
Wisconsin (formerly Ameritech) and California (formerly Pacific Bell). We have
signed agreements with Bell Atlantic for the District of Columbia, Maryland,
Massachusetts, New Jersey, New York, Pennsylvania, Virginia, Connecticut,
Delaware, New Hampshire and Rhode Island. We are currently negotiating an
agreement for West Virginia. We have signed agreements with BellSouth for
Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina,
South Carolina and Tennessee. We have signed agreements with GTE for California,
Florida, North Carolina, Washington and Texas and are currently completing
agreements for Ohio, Oregon and Virginia. We have signed agreements with

                                       26
<PAGE>

U S WEST for Arizona, Colorado, Minnesota, Oregon, Washington, Iowa, Nebraska,
New Mexico, North Dakota, Montana, and Utah. In addition, we have signed an
arbitrated agreement with SBC for Texas, and are currently negotiating for
Kansas and Missouri and with Sprint for Florida, Minnesota, Nevada, New Jersey,
North Carolina, Ohio, Pennsylvania, Tennessee and Virginia and with the Southern
New England Telephone Company for Connecticut. These interconnection agreements
may not be on terms that are entirely satisfactory to us.

     During these negotiations, either the incumbent carrier or we may submit
disputes to the state regulatory commissions for mediation and, after the
expiration of the statutory negotiation period set forth in the 1996
Telecommunications Act, we may submit outstanding disputes to the states for
arbitration. We arbitrated with SBC Communications Inc. in Texas the terms of
our interconnection agreement with Southwestern Bell for Texas. On November 30,
1999 the Texas Public Utilities Commission Arbitrators issued an Award deciding
most issues in favor of Rhythms' positions, and ordered the parties to conclude
the negotiations by adopting language consistent with the Award. On February 7,
2000, the full Commission approved the interconnection agreement proposed by the
Parties implementing the Arbitrator's Award, and rejected requests by SBC for
rehearing of the Arbitrator's Award. This Order remains subject to additional
requests for rehearing or appeal.

     Under the 1996 Telecommunications Act, states have begun and, in a number
of cases, completed regulatory proceedings to determine the pricing of unbundled
network elements and services, and the results of these proceedings will
determine the price we pay for, and whether it is economically attractive for us
to use, these elements and services.

     We are subject to requirements in some states to obtain prior approval
for, or notify the state commission of, any transfers of control, sales of
assets, corporate reorganizations, issuances of stock or debt instruments and
related transactions. Although we believe such authorizations could be obtained,
there can be no assurance that the state commissions would grant us authority to
complete any transactions.

Local government regulation

     Should we in the future decide to operate our own transport facilities over
public rights-of-way, we may be required to obtain various permits and
authorizations from municipalities in which we operate such facilities. Some
municipalities may seek to impose similar requirements on users of transmission
facilities, even though they do not own such facilities. If municipal
governments impose conditions on granting permits or other authorizations or if
they fail to act in granting such permits or other authorizations, our business
could be adversely affected.

Employees

     As of December 31, 1999, we had approximately 1,250 employees. We believe
that our future success will depend in part on our continued ability to attract,
hire and retain qualified personnel. Competition for such personnel is intense,
and we may be unable to identify, attract and retain such personnel in the
future. None of our employees are represented by a labor union or are the
subject of a collective bargaining agreement. We have never experienced a work
stoppage and believe that our employee relations are good.

Risk Factors

     In addition to the other information contained herein, you should carefully
consider the following risk factors in evaluating our company.

                                       27
<PAGE>

We cannot predict our success because we have a short operating history

     We formed our company in February 1997, and we have a short operating
history for you to review in evaluating our business. We have limited historical
financial and operating data upon which you can evaluate our business and
prospects. We entered into our first interconnection agreement with an incumbent
carrier in July 1997 and began to offer commercial services in our first market
in April 1998. We have limited commercial operations and have recognized limited
revenue since our inception. In addition, our senior management team and our
other employees have worked together at our company for only a short period of
time.

Because our market is new and evolving, we cannot predict its future growth or
ultimate size, and we may be unable to compete effectively

     The market for broadband local access DSL communication services using
copper telephone lines is in the early stages of development. Since this market
is new and evolving and because our current and future competitors are likely to
introduce competing services, we cannot accurately predict the rate at which
this market will grow, if at all, or whether new or increased competition will
result in market saturation. Various providers of broadband local access DSL
communication services are testing products from various suppliers for various
applications. Certain critical issues concerning commercial use of DSL for
Internet and private network access, including security, reliability, ease and
cost of access and quality of service, remain unresolved and may impact the
growth of these services. If the markets for our services fail to develop, grow
more slowly than anticipated or become saturated with competitors, these events
could materially and adversely affect our business, prospects, operating results
and financial condition.

     Our success will depend on the development of this new and rapidly evolving
market and our ability to compete effectively in this market. To address these
risks, we must, among other things:

 . rapidly expand the geographic coverage of our network services;
 . raise additional capital;
 . enter into interconnection agreements and working arrangements with
  additional incumbent carriers, substantially all of which we expect to be
  our competitors;
 . deploy an effective network infrastructure;
 . attract and retain customers;
 . successfully develop and maintain relationships and activities with our
  broadband service providers, including MCI WorldCom, Microsoft, Qwest,
  Level 3 Communications and Cisco;
 . continue to attract, retain and motivate qualified personnel;
 . accurately assess potential markets and effectively respond to
  competitive developments;
 . continue to develop and integrate our operational support system and
  other back office systems;
 . obtain any required governmental authorizations;
 . comply with evolving governmental regulatory requirements;
 . increase awareness of our services;
 . rapidly scale our operations and the systems that support those
  operations;
 . continue to upgrade our technologies; and
 . effectively manage our expanding operations.

     We may not be successful in addressing these and other risks, and our
failure to address risks would materially and adversely affect our business,
prospects, operating results and financial condition.

Our substantial debt creates financial and operating risk

                                       28
<PAGE>

     We are highly leveraged, and we intend to seek additional debt funding in
the future. As of December 31, 1999, we had approximately $506.1 million of
outstanding debt. We are not generating sufficient revenue to fund our
operations or to repay our debt. Our substantial leverage poses the risks that:

 . we may be unable to pay dividends on our preferred stock or to repay our debt,
  due to one or more events discussed in "Risk Factors;"
 . we may be unable to obtain additional financing;
 . we must dedicate a substantial portion of our cash flow from operations to
  servicing our debt once our debt requires us to make cash interest payments,
  and any remaining cash flow may not be adequate to fund our planned
  operations; and
 . we may be more vulnerable during economic downturns, less able to withstand
  competitive pressures and less flexible in responding to changing business and
  economic conditions.

We will need significant additional funds, which we may not be able to obtain

     The expansion and development of our business will require significant
additional capital. We intend to seek substantial additional financing in the
future to fund the growth of our operations, including funding the significant
capital expenditures and working capital requirements necessary for us to
provide service in our targeted markets. We believe that our current capital
resources, will be sufficient to fund our aggregate capital expenditures and
working capital requirements, including operating losses, through approximately
December 2001. Although we expect that our initial build-out will be complete by
this date, we anticipate that we will continue building our network beyond our
initial build-out plans and will need significant additional capital, whether or
not our estimate on how long current capital resources will last is accurate. In
addition, our actual funding requirements may differ materially if our
assumptions underlying this estimate turn out to be incorrect. Therefore, you
should consider our estimate in light of the following facts:

 . we have no meaningful history of operations or revenues;
 . our estimated funding requirements do not reflect any contingency amounts and
  may increase, perhaps substantially, if we are unable to generate revenues in
  the amount and within the time frame we expect or if we have unexpected cost
  increases; and
 . we face many challenges and risks, including those discussed elsewhere in Risk
  Factors.

     We may be unable to obtain any future equity or debt financing on
acceptable terms or at all. Recently the financial markets have experienced
extreme price fluctuations. A market downturn or general market uncertainty may
adversely affect our ability to secure additional financing. The indentures that
govern the 1998 senior discount notes, the 1999 senior notes and the 2000 senior
notes restrict our ability to obtain additional debt financing. Any future
borrowing instruments, such as credit facilities and lease agreements, are
likely to contain similar or more restrictive covenants and could require us to
pledge assets as security for the borrowings. If we are unable to obtain
additional capital or are required to obtain it on terms less satisfactory than
what we desire, we will need to delay deployment of our network services or take
other actions that could adversely affect our business, prospects, operating
results and financial condition. If we are unable to generate sufficient cash
flow or obtain funds necessary to meet required payments of our debt, then we
will be in default on our debt instruments. To date, our cash flow from
operations has been insufficient to cover our expenses and capital needs. For
more details about our financial condition, please see Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations-
Liquidity and Capital Resources.

We may be unable to satisfy, or may be adversely constrained by, the covenants
in our debt securities

     The indentures governing our 1998 senior discount notes, our 1999 senior
notes and our 2000 senior notes impose significant restrictions on how we can
conduct our business. For example,
                                       29
<PAGE>

the restrictions prohibit or limit our ability to make dividend payments, incur
additional debt and engage in certain business activities. The restrictions may
materially and adversely affect our ability to finance future operations or
capital needs or conduct additional business activities. Any future senior debt
that we may incur will likely impose additional restrictions on us. If we fail
to comply with any existing or future restrictions, we could default under the
terms of the applicable debt and be unable to meet our debt obligations. If we
default, the holders of the applicable debt could demand that we repay the debt,
including interest, immediately. We may be unable to make the required payments
or raise sufficient funds from alternative sources to make the payments. Even if
additional financing is available in the event that we default, it may not be on
acceptable terms.


We cannot predict our success because our business model is unproven

     We have not validated our business model and strategy in the market. We
believe that the combination of our unproven business model and the highly
competitive and fast changing market in which we compete makes it impossible to
predict the extent to which our network services will achieve market acceptance
and our overall success. To be successful, we must develop and market network
services that are widely accepted at profitable prices. We may never be able to
deploy our network as planned, achieve significant market acceptance, favorable
operating results or profitability or generate sufficient cash flow to repay our
debt. Of the approximately 12,500 lines that are in service, we installed
approximately 60% to only five customers, with approximately 40% of these total
lines to Cisco. None of our large business customers, with the exception of
Cisco, has rolled out our services broadly to its employees and none of our
broadband service provider customers have rolled out our services broadly to
their end-users, and we cannot be certain when or if these rollouts will occur.
We will not receive significant revenue from our large customers unless these
rollouts occur. Any continued or ongoing failure for any reason of large
customers to roll out our services, failure to validate our business model in
the market, including failure to build-out our network, achieve widespread
market acceptance or sustain desired pricing would materially and adversely
affect our business, prospects, operating results and financial condition.

We expect our losses to continue

     We have incurred losses and experienced negative operating cash flow for
each month since our formation. As of December 31, 1999, we had an accumulated
deficit of approximately $257.6 million. We intend to rapidly and substantially
increase our expenditures and operating expenses in an effort to expand our
network services. We expect to have annual interest and amortization expense
relating to our 1998 senior discount notes, our 1999 senior notes and our 2000
senior notes of approximately $89.0 million in 2000 and increasing to $123.0
million in 2003. In addition, we may incur more debt in the future. In addition,
dividends of approximately $126.0 million will accrue on the Series E preferred
stock through February 2005. No cash dividends are payable on the Series E
preferred stock until 2005, and at our option such dividends may continue to
accrue as liquidation preference. Dividends on the 6 3/4% Series F preferred
stock are cumulative from the date of issuance in an annual amount of
approximately $16.9 million. As a result of these factors, we expect to incur
substantial operating and net losses and negative operating cash flow for the
foreseeable future. We will need to obtain additional financing to pay our
expenses and to make payments on our debt. We cannot give you any assurance
about whether or when we will have sufficient revenues to satisfy our funding
requirements or pay our debt service and preferred stock obligations.

Our operating results in one or more future periods are likely to fluctuate
significantly and may fail to meet or exceed the expectations of securities
analysts or investors

     Our annual and quarterly operating results are likely to fluctuate
significantly in the future due to numerous factors, many of which are outside
of our control. These factors include:

                                       30
<PAGE>

 . the rate of customer acquisition and turnover;
 . the prices our customers are willing to pay which may decline due to
  competitive factors;
 . the amount and timing of expenditures relating to the expansion of our
  services and infrastructure;
 . the timing and availability of incumbent carrier central office collocation
  facilities and transport facilities;
 . our ability to effectively develop and market network features and
  applications;
 . the mix of our services that our customers purchase at different prices;
 . our ability to scale our business to meet the demands of our customers;
 . our ability to control our corporate overhead while rapidly growing our
  business;
 . the success of our relationships with our partners and distributors, including
  MCI WorldCom, Microsoft, Qwest and Cisco;
 . our ability to deploy our network on a timely basis;
 . introduction of new services or technologies by our competitors;
 . price competition;
 . the ability of our equipment and service suppliers to meet our needs;
 . regulatory developments, including interpretations of the 1996
  Telecommunications Act;
 . technical difficulties or network downtime;
 . the success of our strategic alliances;
 . the condition of the telecommunication and network service industries and
 . general economic conditions.

     Because of these factors, our operating results in one or more future
periods could fail to meet or exceed the expectations of securities analysts or
investors. In that event, any trading price of our common stock would likely
decline.

We depend on third parties for the marketing and sales of our services

     We rely significantly on indirect sales channels for the marketing and
sales of our services. We will seek to continue to establish and maintain
relationships with numerous broadband service providers in order to gain access
to end-users. Our agreements to date with these broadband service providers are
non-exclusive, and we anticipate that future agreements will also be on a non-
exclusive basis, allowing these broadband service providers to sell services
offered by our competitors. These agreements are generally short term, and can
be cancelled by these broadband service providers without significant financial
consequence. We cannot control how these broadband service providers perform and
cannot be certain that their performance will be satisfactory to us or our
customers. Many of these companies have similar arrangements with our
competitors and also compete directly with us. If the number of customers we
obtain through indirect sales channels is significantly lower than our forecast
for any reason, or if these broadband service providers with which we have
contracted are unsuccessful in competing in their own intensely competitive
markets, these events would have a material and adverse effect on our business,
prospects, operating results and financial condition.

If forecasted sales for services sold directly to our business customers for a
particular period are not realized in that period due to the lengthy sales cycle
of our services, our operating results for that period will be harmed

     The sales cycle of our network services can be very lengthy, particularly
for large businesses. Our sales cycle for large businesses typically lasts at
least six months. During this lengthy sales cycle, we will incur significant
expenses in advance of the receipt of revenues. If sales that we forecast for a
particular period do not occur because of our lengthy sales cycle, this event
could materially and adversely affect our business, prospects, operating results
and financial condition, during that period.

                                       31
<PAGE>

We depend on incumbent carriers for collocation and transmission facilities

     We must use copper telephone lines controlled by the incumbent carriers to
provide DSL connections to customers. We also depend on the incumbent carriers
for collocation and for a substantial portion of the transmission facilities we
use to connect our equipment in incumbent carrier central offices to our Metro
Service Centers. In addition, we depend on the incumbent carriers to test and
maintain the quality of the copper telephone lines that we use. In many cases,
we may be unable to obtain access to collocation and transmission facilities
from the incumbent carriers, or to gain access at acceptable rates, terms and
conditions, including timeliness. We have experienced, and expect to experience
in the future, lengthy periods between our request for and the actual provision
of the collocation space and copper telephone lines. An inability to obtain or
maintain adequate and timely access to collocation space or transmission
facilities on acceptable terms and conditions from incumbent carriers could have
a material and adverse effect on our business, prospects, operating results and
financial condition.

     Because we compete with incumbent carriers in our markets, they may be
reluctant to cooperate with us. The incumbent carriers may experience, or claim
to experience, a shortage of collocation space or transmission capacity. If this
occurs, we may not have alternate means of connecting our DSL equipment with the
copper telephone lines or connecting our equipment in central offices to Metro
Service Centers. We have experienced rejections of some of our collocation
applications on the grounds that no space is available. We may receive
additional rejections in the future. The number of other competitive local
exchange carriers that request collocation space will also affect the
availability of collocation space and transmission capacity. If we are unable to
obtain physical collocation space or transmission capacity from our targeted
incumbent carriers, we may face delays, additional costs or an inability to
provide services in certain locations. Where we use virtual collocation in our
network, it reduces our control over our equipment, and therefore may reduce the
level of quality and service we provide to our customers. Delays in obtaining
access to collocation space and copper telephone lines or the rejection of our
applications for collocation could result in delays in, and increased expenses
associated with, the rollout of our services, which in turn could have a
material and adverse effect on our business, prospects, operating results and
financial condition.

We are unable to control the terms and conditions under which we gain access to
incumbent carrier collocation and transmission facilities

     We cannot control the terms under which we collocate our equipment,
connect to copper telephone lines or gain the use of an incumbent carrier's
transmission facilities. State tariffs, state public utility commissions, the
Federal Communications Commission and interconnection agreements with the
incumbent carriers determine the price, terms and conditions under which
collocation space is made available, and they make these administrative
determinations in ongoing hearings. Interconnection agreements and state public
utility commissions also determine the terms and conditions of access to copper
telephone lines and other components of an incumbent carrier's network. We may
be unable to negotiate or enter into interconnection agreements on acceptable
terms or at all. In addition, we cannot be sure that incumbent carriers will
abide by their obligations under those agreements. Delays in obtaining
interconnection agreements would delay our entry into certain markets. In
addition, disputes may arise between us and the incumbent carriers with respect
to interconnection agreements, and we may be unable to resolve disputes in our
favor. If we are unable to enter into, or experience a delay in obtaining,
interconnection agreements, this inability or delay could adversely affect our
business, prospects, operating results and financial condition. Further, the
interconnection agreements are generally short term, and we may be unable to
renew the interconnection agreements on acceptable terms or at all. The state
commissions, the Federal Communications Commission and the courts oversee, in
varying degrees, interconnection arrangements as well as the terms and
conditions under which we gain access to incumbent carrier copper telephone
lines and transmission facilities. These government entities may modify the
terms or prices of our interconnection agreements and our access to incumbent
carrier copper telephone
                                       32
<PAGE>

lines and transmission facilities in ways that would be adverse to our business.
The Federal Communications Commission and state regulatory commissions establish
the rates for DSL-capable copper telephone lines as well as other rates, terms
and conditions of our dealings with the incumbent carriers in ongoing public
hearings. Participation in these hearings will involve significant management
time and expense. Incumbent carriers may from time to time propose new rates,
and the outcomes of hearings and rulings could have a material and adverse
effect on our business, prospects, operating results and financial condition.

The market in which we operate is highly competitive, and we may not be able to
compete effectively, especially against established industry competitors with
significantly greater financial resources

     We will face competition from many competitors with significantly greater
financial resources, well-established brand names and large, existing installed
customer bases. We expect the level of competition to intensify in the future.
We expect significant competition from incumbent local exchange carriers,
traditional and new interexchange carriers, other DSL providers, cable modem
service providers, Internet service providers, wireless and satellite data
service providers and other competitive carriers. Incumbent local exchange
carriers have existing metropolitan area networks and circuit-switched local
access networks. In addition, most incumbent local exchange carriers are
establishing their own Internet service provider businesses and are in some
stage of market trials and retail sales of DSL-based access services. Incumbent
local exchange carriers are aggressively marketing these services to their
residential customers at attractive prices. We believe that incumbent local
exchange carriers have the potential to quickly overcome many of the issues that
have delayed widespread deployment of DSL services in the past. It is possible
that present or future competitors may reduce prices for competitive services,
perhaps drastically. In addition, we may experience substantial customer
turnover in the future. Many providers of telecommunications and networking
services experience high rates of customer turnover.

     Many of the leading traditional long distance carriers, including AT&T
Corporation, MCI WorldCom and Sprint, are expanding their capabilities to
support high-speed, end-to-end networking services. The newer long distance
carriers, including Williams, Level 3 Communications, Inc. and Qwest, are
building and managing high bandwidth, nationwide packet networks and partnering
with Internet service providers to offer services directly to the public. Cable
modem service providers, like Excite@Home Networks, are offering or preparing to
offer high-speed Internet access over hybrid fiber networks to consumers, and
@Work has positioned itself to do the same for businesses. Several new companies
are emerging as wireless, including satellite-based, data service providers.
Internet service providers, including some with significant and even nationwide
presences, provide Internet access to residential and business customers,
generally over the incumbent carriers' circuit switched networks, although some
offer competitive DSL-based access. Certain competitive carriers, including
Covad Communications Group, Inc. and NorthPoint Communications, Inc., offer
competitive DSL-based access services, and, like us, have attracted strategic
equity investors, marketing allies and product development partners. Others are
likely to do the same in the future. In addition, regional Internet service
providers and competitive carriers, including HarvardNet, Inc., Network Access
Solutions Corp. and DSL.net, Inc. offer competitive DSL-based services that
compete with the services we offer. As a result of increasing competition for
our services, we are experiencing substantial price competition, particularly
with respect to sales generated through our indirect sales channels.

     Many of these competitors are offering, or may soon offer, technologies and
services that will directly compete with some or all of our service offerings.
Some of the technologies used by these competitors for local access connections
include ISDN, DSL, wireless data and cable modems. Some of the competitive
factors in our markets include transmission speed, reliability of service,
breadth of service availability, price, network security, ease of access and
use, content bundling, customer support, brand recognition, operating
experience, capital availability and exclusive contracts. We believe that we
compare unfavorably with many of our competitors with

                                       33
<PAGE>

regard to, among other things, brand recognition, existing relationships with
end users, available pricing discounts, central office access, capital
availability and exclusive contracts. Substantially all of our competitors and
potential competitors have substantially greater resources than us. We may not
be able to compete effectively in our target markets. Our failure to compete
effectively would have a material and adverse effect on our business, prospects,
operating results and financial condition. For more details about our
competitors, please see Item 1 -Business - Competition.

Our network services may not achieve significant market acceptance because our
prices are often higher than those charged for competing services

     Our prices are in some cases higher than those that our competitors charge
for some of their services. Prices for digital communications services have
fallen historically, and we expect prices in the industry in general, and for
the services we offer now and plan to offer in the future, to continue to fall.
We may be required to reduce prices periodically to respond to competition and
to generate increased sales volume. Our prices may not permit our network
services to gain a desirable level of commercial acceptance, and we may be
unable to sustain any current or future pricing levels. Due to these factors, we
cannot accurately forecast our revenues or the rate at which we will add new
customers.

Our services are subject to government regulation, and changes in current or
future laws or regulations could restrict the way we operate our business

     A significant portion of the services that we offer through our
subsidiaries is subject to regulation at the federal, state and/or local levels.
Future federal or state regulations and legislation may be less favorable to us
than current regulation and legislation and therefore have an adverse impact on
our business, prospects, operating results and financial condition. In addition,
we may expend significant financial and managerial resources to participate in
rule-setting proceedings at either the federal or state level, without achieving
a favorable result. In particular, we believe that incumbent carriers will work
aggressively to modify or restrict the operation of many provisions of the 1996
Telecommunications Act. We expect incumbent carriers will pursue litigation in
courts, institute administrative proceedings with the Federal Communications
Commission and other regulatory agencies and lobby the United States Congress,
all in an effort to affect laws and regulations in a manner favorable to the
incumbent carriers and against the interest of competitive carriers such as us.
If the incumbent carriers succeed in any of their efforts, if these laws and
regulations change or if the administrative implementation of laws develops in
an adverse manner, these events could have a material and adverse effect on our
business, prospects, operating results and financial condition. For more details
about our regulatory situation, please see Item 1 - Business - Government
Regulation.

Our failure to manage growth could adversely affect us

     We have rapidly and significantly expanded our operations. We anticipate
further significant expansion of our operations and the systems supporting those
operations in an effort to achieve our network rollout and deployment
objectives. Our expansion to date has strained our management, financial
controls, operations systems, personnel and other resources. Any future rapid
expansion would increase these strains. If our marketing strategy is successful,
we may experience difficulties responding to customer demand for services and
technical support in a timely manner and in accordance with their expectations.
As a result, rapid growth of our business would make it difficult to implement
successfully our strategy to provide superior customer service. To manage any
growth of our operations, we must:

 . improve existing and implement new operational, financial and management
  information controls, operational support systems, reporting systems and
  procedures;
 . hire, train and manage additional qualified personnel;
 . expand and upgrade our core technologies; and

                                       34
<PAGE>

 . effectively manage multiple relationships with our customers, suppliers and
  other third parties.

     We may not be able to install operational support systems or management
information and control systems in an efficient and timely manner, and our
current or planned personnel, systems, procedures and controls may not be
adequate to support our future operations. Failure to manage our future growth
effectively could adversely affect the expansion of our customer base and
service offerings. Any failure to successfully address these issues could
materially and adversely affect our business, prospects, operating results and
financial condition.

Failure to effectively develop and market network features and applications
could limit our revenue growth

     Our business model relies on network features and applications to
increase our revenues. We have only recently begun to develop these network
features and applications. In order to be successful, we must develop and
effectively market network features and applications that are widely accepted,
at profitable prices. We cannot assure you that we will be able to do so. Our
failure to develop and market these features and applications could materially
and adversely affect our business, prospects, operating results and financial
condition.

The telecommunications industry is undergoing rapid technological change, and
new technologies may be superior to the technology we use

     The telecommunications industry is subject to rapid and significant
technological changes, such as continuing developments in DSL technology and
alternative technologies for providing high-speed data communications. We cannot
predict the effect of technological changes on our business. We will rely in
part on third parties, including certain of our competitors and potential
competitors, for the development of and access to communications and networking
technology. We expect that new products and technologies applicable to our
market will emerge. New products and technologies may be superior to and/or
render obsolete the products and technologies that we currently use. Our future
success will depend, in part, on our ability to anticipate and adapt to
technological changes and evolving industry standards. We may be unable to
obtain access to new technology on acceptable terms or at all, and we may be
unable to adapt to new technologies and offer services in a competitive manner.
Our joint development projects with Cisco and MCI WorldCom and our strategic
arrangement with Microsoft may not produce useful technologies or services for
us. Further, new technologies and products may not be compatible with our
technologies and business plan. In addition, many of the products and
technologies that we intend to use in our network services are relatively new
and unproven and may be unreliable.

We may be unable to effectively expand our network services and provide high
performance to a substantial number of end users

     Due to the limited deployment of our network services, we cannot guarantee
that our network will be able to connect and manage a substantial number of end
users at high transmission speeds. We may be unable to scale our network to
service a substantial number of end users while achieving high performance.
Further, our network may be unable to achieve and maintain competitive digital
transmission speeds. While digital transmission speeds of up to 7.1 Mbps are
possible on certain portions of our network, that speed is not available over a
majority of our network. Actual transmission speeds on our network will depend
on a variety of factors and many of these factors are beyond our control,
including the type of DSL technology deployed, the distance an end user is
located from a central office, the quality of the telephone lines, the presence
of interfering transmissions on nearby lines and other factors. As a result, we
may not be able to achieve and maintain digital transmission speeds that are
attractive in the market.

Our services may suffer or be unavailable because the copper telephone lines we
require may be unavailable or in poor condition

                                       35
<PAGE>

     Our ability to provide DSL-based services to potential customers depends on
the quality, physical condition, availability and maintenance of copper
telephone lines within the control of the incumbent carriers. We believe that
the current condition of copper telephone lines in many cases will be inadequate
to permit us to fully implement our network services. In addition, the incumbent
carriers may not maintain the copper telephone lines in a condition that will
allow us to implement our network effectively. The copper telephone lines may
not be of sufficient quality or the incumbent carriers may claim they are not of
sufficient quality to allow us to fully implement or operate our network
services. Further, some telephone services employ technologies other than copper
lines, and DSL might not be available over these telephone lines.

Our success depends on our retention of certain key personnel and on the
performance of those personnel

     Our success depends on the performance of our officers and key employees,
especially our Chief Executive Officer and our President and Chief Operating
Officer. Members of our senior management team have worked together for only a
short period of time. We do not have "key person" life insurance policies on any
of our employees nor do we have employment agreements for fixed terms with any
of our employees. Any of our employees, including any member of our senior
management team, may terminate his or her employment with us at any time. Given
our early stage of development, we depend on our ability to retain and motivate
high quality personnel, especially our management. Our future success also
depends on our continuing ability to identify, hire, train and retain highly
qualified technical, sales, marketing and customer service personnel. Moreover,
the industry in which we compete has a high level of employee mobility and
aggressive recruiting of skilled personnel. We may be unable to continue to
employ our key personnel or to attract and retain qualified personnel in the
future. We face intense competition for qualified personnel, particularly in
software development, network engineering and product management. For more
details about our officers and key employees, please see Item 1 - Business -
Employees.

We depend on third parties for equipment, installation and provision of field
service

     We currently plan to purchase all of our equipment from many vendors and
outsource the majority of the installation and field service of our networks to
third parties. Our reliance on third party vendors involves a number of risks,
including the absence of guaranteed capacity and reduced control over delivery
schedules, quality assurance, production yields and costs. If any of our
suppliers reduces or interrupts its supply, or if any significant installer or
field service provider interrupts its service to us, this reduction or
interruption could disrupt our business. Although multiple manufacturers
currently produce or are developing equipment that will meet our current and
anticipated requirements, our suppliers may be unable to manufacture and deliver
the amount of equipment we order, or the available supply may be insufficient to
meet our demand. Currently, almost all of the DSL modem and DSL multiplexing
equipment we use for a single connection over a copper telephone line must come
from the same vendor since there are no existing interoperability standards for
the equipment used in our higher speed services. If our suppliers or licensors
enter into competition with us, or if our competitors enter into exclusive or
restrictive arrangements with the suppliers or licensors, then these events may
materially and adversely affect the availability and pricing of the equipment we
purchase and the technology we license.

A system failure or breach of network security could cause delays or
interruptions of service to our customers

     Our operations depend on our ability to avoid damages from fires,
earthquakes, floods, power losses, excessive sustained or peak user demand,
telecommunications failures, network software flaws, transmission cable cuts and
similar events. A natural disaster or other unanticipated problem at our owned
or leased facilities could interrupt our services. Additionally, if an incumbent
carrier, competitive carrier or other service provider fails to provide the
communications capacity
                                       36
<PAGE>

we require, as a result of a natural disaster, operational disruption or any
other reason, then this failure could interrupt our services.

     Despite the implementation of security measures, our network may be
vulnerable to unauthorized access, computer viruses and other disruptive
problems. Corporate networks and Internet service providers have in the past
experienced, and may in the future experience, interruptions in service as a
result of accidental or intentional actions of Internet users, current and
former employees and others. Unauthorized access could also potentially
jeopardize the security of confidential information stored in the computer
systems of our customers, which might cause us to be liable to our customers,
and also might deter potential customers. Eliminating computer viruses and
alleviating other security problems may require interruptions, delays or
cessation of service to our customers and our customers' end users.

Interference or claims of interference could delay our rollout or harm our
services

     All transport technologies deployed on copper telephone lines have the
potential to interfere with, or to be interfered with by, other transport
technologies on the copper telephone lines. We believe that our DSL
technologies, like other transport technologies, do not interfere with existing
voice services. We believe that a workable plan that takes into account all
technologies could be implemented in a scalable way across all incumbent
carriers using existing plant engineering principles. There are several
initiatives underway to establish national standards and principles for the
deployment of DSL technologies. We believe that our technologies can be deployed
consistently with these evolving standards. Nevertheless, incumbent carriers may
claim that the potential for interference permits them to restrict or delay our
deployment of DSL services. Interference could degrade the performance of our
services or make us unable to provide service on selected lines. The procedures
to resolve interference issues between competitive carriers and incumbent
carriers are still being developed, and these procedures may not be effective.
We may be unable to successfully negotiate interference resolution procedures
with incumbent carriers. Moreover, incumbent carriers may make claims regarding
interference or unilaterally take action to resolve interference issues to the
detriment of our services. State or federal regulators could also institute
responsive actions. Interference, or claims of interference, if widespread,
would adversely affect our speed of deployment, reputation, brand image, service
quality and customer satisfaction and retention.

We depend on third parties for fiber optic transport facilities

     We depend on the availability of fiber optic transmission facilities from
third parties to connect our equipment within and between metropolitan areas.
These third party fiber optic carriers include long distance carriers, incumbent
carriers and other competitive carriers. Many of these entities are, or may
become, our competitors. This approach includes a number of risks. For instance,
we may be unable to negotiate and renew favorable supply agreements. Further, we
depend on the timeliness of these companies to process our orders for customers
who seek to use our services. We have in the past experienced supply problems
with certain of our fiber optic suppliers, and they may not be able to meet our
needs on a timely basis in the future. Moreover, the fiber optic transport
providers whose networks we lease may be unable to obtain or maintain permits
and rights-of-way necessary to develop and operate existing and future networks.

Uncertain federal and state tax and other surcharges on our services may
increase our payment obligations

     Telecommunications providers pay a variety of surcharges and fees on their
gross revenues from interstate and intrastate services. The division of our
services between interstate and intrastate services is a matter of
interpretation, and in the future the Federal Communications Commission or
relevant state commission authorities may contest this division. A change in the
characterization of the jurisdiction of our services could cause our payment
obligations to increase. In addition,

                                       37
<PAGE>

pursuant to periodic revisions by state and federal regulators of the applicable
surcharges, we may be subject to increases in the surcharges and fees currently
paid.

Our intellectual property protection may be inadequate to protect our
proprietary rights, and we may be subject to infringement claims

     We rely on a combination of licenses, confidentiality agreements and other
contracts to establish and protect our technology and other intellectual
property rights. We have applied for trademarks and servicemarks on certain
terms and symbols that we believe are important for our business. We currently
have no patents or patent applications pending. The steps we have taken may be
inadequate to protect our technology or other intellectual property. Moreover,
our competitors may independently develop technologies that are substantially
equivalent or superior to ours. Third parties may assert infringement claims
against us and, in the event of an unfavorable ruling on any claim, we may be
unable to obtain a license or similar agreement to use technology we rely upon
to conduct our business. We also rely on unpatented trade secrets and know-how
to maintain our competitive positions, which we seek to protect, in part, by
confidentiality agreements with employees, consultants and others. However,
these agreements may be breached or terminated, and we may not have adequate
remedies for any breach. In addition, our competitors may otherwise learn or
discover our trade secrets. Our management personnel were previously employees
of other telecommunications companies. In many cases, these individuals are
conducting activities for us in areas similar to those in which they were
involved prior to joining us. As a result, we or our employees could be subject
to allegations of violation of trade secrets and other similar claims.

Risks associated with potential general economic downturn

     In the last few years the general health of the economy, particularly the
economy of California where we have conducted a significant portion of our
operations to date, has been relatively strong and growing, a consequence of
which has been increasing capital spending by individuals and growing companies
to keep pace with rapid technological advances. To the extent the general
economic health of the United States or of California declines from recent
historically high levels, or to the extent individuals or companies fear a
decline is imminent, these individuals and companies may reduce expenditures
such as those for our services. Any decline or concern about an imminent decline
could delay decisions among certain of our customers to roll out our services or
could delay decisions by prospective customers to make initial evaluations of
our services. Any delays would have a material and adverse effect on our
business, prospects, operating results and financial condition.

We expect our stock price to be volatile

     The trading price of our common stock has been and is likely to continue
to be highly volatile. Our stock price could fluctuate widely in response to
many factors, including the following:

 . our historical and anticipated quarterly and annual operating results;
 . announcements of new products or services by us or our competitors or new
  competing technologies;
 . the addition or loss of business or service provider customers;
 . variations between our actual results and analyst and investor expectations;
 . investor perceptions of our company and comparable public companies;
 . conditions or trends in the telecommunications industry, including regulatory
  developments;
 . announcements by us of significant acquisitions, strategic partnerships, joint
  ventures or capital commitments;
 . additions or departures of key personnel;
 . future equity or debt offerings or our announcements of such offerings; and
 . general market and economic conditions.

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<PAGE>

     In addition, in recent years the stock market in general, and the Nasdaq
National Market and the market for Internet and technology companies in
particular, have experienced extreme price and volume fluctuations. These
fluctuations have often been unrelated or disproportionate to the operating
performance of these companies. These market and industry factors may materially
and adversely affect our stock price, regardless of our operating performance.

We have not paid and do not intend to pay dividends

     We have not paid any dividends on our common stock, and we do not intend to
pay cash dividends on our common stock in the foreseeable future. Our current
financing documents contain provisions which restrict our ability to pay
dividends.

Anti-takeover provisions could negatively impact our stockholders

     Our Board of Directors has adopted a stockholder rights plan. Our
stockholder rights plan would cause substantial dilution to any person or group
that attempts to acquire our company on terms not approved in advance by our
Board of Directors. In addition, some of the provisions that may be included in
our certificate of incorporation and bylaws may discourage, delay or prevent a
merger or acquisition at a premium price. These provisions include:

 . authorizing the issuance of "blank check" preferred stock;
 . providing for a classified Board of Directors with staggered, three-year
  terms;
 . eliminating the ability of stockholders to call a special meeting of
  stockholders;
 . limiting the removal of directors by the stockholders to removal for cause;
  and
 . requiring a super-majority stockholder vote to effect certain amendments.

     In addition, certain provisions of the Delaware General Corporation Law and
our stockholder rights plan may deter someone from acquiring or merging with us,
including a transaction that results in stockholders receiving a premium over
the market price for the shares of common stock held by them. Section 203 of the
Delaware General Corporation Law also imposes certain restrictions on mergers
and other business combinations between us and any holder of more than 15% and
less than 85% of our common stock.

     The indentures governing our 1998 senior discount notes, 1999 senior notes
and 2000 senior notes require us to offer to repurchase all such notes for 101%
of their principal amount or accreted value, as the case may be, plus any
accrued interest and liquidated damages, within 30 days after a change of
control. We might not have sufficient funds available at the time of any change
of control to make any required payment, as well as any payment that may be
required pursuant to any other outstanding indebtedness at the time, including
our indebtedness to equipment financing lenders, or outstanding preferred stock.
These covenants may also deter third parties from entering into a change of
control transaction with us.

The price of our common stock may decline due to shares eligible for future sale

     Sales of substantial amounts of common stock in the public market following
this offering, or the appearance that a large number of shares is available for
sale, could adversely affect the market price for the common stock. In addition
to the adverse effect a price decline could have on holders of common stock,
that decline would likely impede our ability to raise capital through the
issuance of additional shares of common stock or other equity securities.

Item 2 - Properties

     Our headquarters are located in facilities consisting of approximately 80,
000 square feet in Englewood, Colorado, which we occupy under a lease that
expires in January 2004. This lease may

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<PAGE>

be extended. We also lease space for network equipment installations and
business offices in a number of other locations.

Item 3 - Legal Proceedings

     In December 1998, we instituted an arbitration proceeding, before the
Public Utility Commission of Texas, with Southwestern Bell Telephone Company
regarding the terms of interconnection with Southwestern Bell in Texas. On
November 30, 1999 the Texas Public Utilities Commission Arbitrators issued an
award deciding most issues in favor of our positions, and ordered the parties to
conclude the negotiations by adopting language consistent with the award. On
February 7, 2000 the full Commission approved the interconnection agreement
proposed by the parties implementing the arbitrator's award, and rejected
requests by SBC for rehearing of the arbitrator's award. This order remains
subject to additional requests for rehearing or appeal.

     In addition, on March 12, 1999, our subsidiary Rhythms Links Inc. filed a
complaint with the Oregon Public Utilities Commission against U S WEST
requesting that the Oregon Public Utilities Commission determine that U S WEST
permit collocation by Rhythms Links in several central offices in which U S WEST
claimed that it had no space available. U S WEST agreed to permit Rhythms Links
collocation in the disputed central offices just before hearings were scheduled
to begin in June 1999.

     On February 18, 1999, we filed a complaint for declaratory relief in San
Diego County Superior Court, North County against Thomas R. Lafleur. Mr. Lafleur
is a former employee of the Company. After he left, he was sent a check for the
repurchase or buy-back of his unvested shares. Mr. Lafleur refused to cash this
check. The declaratory relief action is to determine that his shares were
unvested and thus properly repurchased. We have since amended our complaint to
allege additional causes of action, including fraud, breach of contract, and
interference with prospective economic advantage. On or about March 26, 1999,
Mr. Lafleur filed an answer to the complaint and also filed a cross-complaint
against us. The cross-complaint has been amended a number of times and seeks
compensatory and punitive damages. We intend to defend vigorously against the
claims asserted in the current cross-complaint. We are currently accounting for
these 438,115 shares as treasury stock.

     We are aware of the filing of a legal action by i2 Technologies, Inc. in
the United States District Court in the Northern District of Texas on January 7,
2000 challenging our use of the name "Rhythms" on various grounds and alleging
that our use of that name infringes certain trademarks owned by i2 Technologies.
We deny that it infringes any legitimate trademark rights of i2 Technologies, in
part on the grounds that we have priority in the Rhythms name with respect to
the goods and services provided by us and that our use of those marks is not
likely to cause confusion among the consumers of our services, and the services
provided by i2 Technologies, respectively. We intend to vigorously defend the
continued use of our name in the manner in which we have used it in the past and
our interests in the name "Rhythms".

     In addition, we are subject to state commission, Federal Communications
Commission and court decisions as they relate to the interpretation and
implementation of the 1996 Telecommunications Act, the interpretation of
competitive carrier interconnection agreements in general and our
interconnection agreements in particular. In some cases, we may be deemed to be
bound by the results of ongoing proceedings of these bodies. We therefore may
participate in proceedings before these regulatory agencies or judicial bodies
that affect, and allow us to advance, our business plans.

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

     No matters were submitted to a vote of security holders during the quarter
ended December 31, 1999.

                                       40
<PAGE>

                                    PART II


Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters.

     The Company's common stock is traded on the Nasdaq National Market under
the symbol "RTHM." As of March 15, 2000, there were approximately 329
shareholders of record of the Company's common stock, par value $.001 per share.
The common stock began trading on the Nasdaq National Market on April 7, 1999,
the date of our initial public offering. Prior to April 7, 1999, there was no
public market for our common stock. The following table sets forth, for the
period indicated, the high and low closing daily bid prices for our common stock
as quoted by the Nasdaq National Market.

--------------------------------------------------------------------------------
Year Ended December 31, 1999:                                 High         Low
                                                              ----         ----
--------------------------------------------------------------------------------
 Second Quarter (from April 7, 1999 through June 30, 1999)   $93.13       $45.25
--------------------------------------------------------------------------------
 Third Quarter................................................68.94        30.00
--------------------------------------------------------------------------------
 Fourth Quarter...............................................45.50        26.69
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

Dividend Policy

     We have not paid dividends on our common stock and currently intend to
continue this policy in order to retain earnings for use in our business.  In
addition, the terms of the indentures governing our 1998 senior discount notes,
1999 senior notes and 2000 notes contain restrictions on our ability to pay
dividends or other distributions.

Sales of Unregistered Securities

         Since our  incorporation  in  February  1997,  we have  issued  and
sold unregistered securities as follows (adjusted for subsequent stock splits):

         (1)   An  aggregate  of  2,161,764  shares of common  stock was
               issued in private placements in February through June 1997 to
               Enterprise Partners in connection with our initial funding. The
               consideration received for such shares was $901.

         (2)   An aggregate of 6,140,000 shares of Series A preferred stock
               (which were converted into 14, 736,000 shares of common stock)
               was issued in a private placement in July 1997 to Brentwood
               Venture Capital, Enterprise Partners, Kleiner Perkins Caufield &
               Byers, the Sprout Group and certain other purchasers pursuant to
               a Series A Preferred Stock Purchase Agreement. The consideration
               received for such shares was $6,138,500.

         (3)   An aggregate of 6,350,000 shares of Series A preferred stock
               (which were converted into 15,240,000 shares of common stock) was
               issued in a private placement in December 1997 to Brentwood
               Venture Capital, Enterprise Partners, Kleiner Perkins Caufield &
               Byers, the Sprout Group and certain other purchasers pursuant to
               a Series A Preferred Stock Purchase Agreement and a Subsequent
               Closing Purchase Agreement. The consideration received for such
               shares was $6,350,000.

         (4)   An aggregate of 365,094 shares of Series A preferred stock (which
               were converted into 876,226 shares of common stock) was issued in
               a private placement in February 1998 to Catherine Hapka in
               connection with the Series A Preferred Stock Purchase Agreement,
               the Subsequent Closing Purchase Agreement and an employment
               agreement between us and Ms. Hapka. The consideration received
               for such shares was $292,075.

         (5)   An aggregate of 4,044,943 shares of Series B preferred stock
               (which were converted into 9,707,863 shares of common stock) was
               issued in a private placement in March 1998 to Brentwood Venture
               Capital, Enterprise Partners, Kleiner Perkins Caufield & Byers,
               the Sprout Group and Enron Communications Group, Inc. The
               consideration received for such shares was $18,000,000.

         (6)   In May 1998, we issued 290,000 units consisting of 13 1/2% senior
               discount notes due 2008 and warrants to purchase an aggregate of
               4,732,800 shares of common stock with exercise prices of $0.004
               per share to Merrill Lynch & Co. and Donaldson, Lufkin & Jenrette
               Securities Corporation, as initial purchasers, for resale to
               qualified institutional buyers. Merrill Lynch & Co. and
               Donaldson, Lufkin & Jenrette Securities Corporation received
               commissions of $5,262,920 for acting as initial purchasers in
               connection with this transaction. Effective November 20, 1998, we
               completed an exchange offer of the 13 1/2% senior discount notes
               that allowed for registration of such notes under the Securities
               Act of 19333, as amended. Of the original issue notes, $289.0
               million were tendered for exchange.

         (7)   In May 1998, we issued to Sun Financial Group, Inc., now GATX
               Capital Corporation, a warrant to purchase 574,380 shares of
               common stock with an exercise price of $1.85 per share in
               connection with an equipment lease financing.

         (8)   In March 1999, we issued to MCI WorldCom Venture Fund, Inc. and
               to Microsoft Corporation 3,731,410 and 3,731,409 shares of Series
               C preferred stock, respectively, and issued to each of them a
               warrant to purchase 720,000 shares of common stock for an
               aggregate purchase price of $60.0 million.

         (9)   In April 1999, we issued to Qwest 932,836 shares and 441,176
               shares of Series C and Series D preferred stock, respectively,
               and warrants to purchase 180,000 shares of common stock for an
               aggregate purchase price of $15.0 million.

         (10)  Effective April 12, 1999, we completed an initial public offering
               of our common stock. A total of 10,781,250 common shares were
               issued at $21.00 per share for aggregate proceeds of
               approximately $210.1 million after payment of underwriting fees
               and related issue costs. Upon completion of the offering, all
               classes of preferred stock automatically converted to common
               stock, resulting in an additional 51,076,051 shares of common
               stock being issued leaving no shares of preferred stock issued
               and outstanding.

         (11)  Effective August 17, 1999, we completed a secondary public
               offering of our common stock in a transaction that allowed
               certain holders of warrants issued in connection with the 13 1/2%
               senior discount notes to exercise those warrants and sell the
               resulting common stock at $29.00 per share. In connection with
               the secondary offering, the underwriters of the offering were
               allowed to purchase 594,279 shares of common stock from us for
               $29.00 per share. The sale of these shares was completed on
               September 14, 1999 for aggregate proceeds of $16.4 million, net
               of underwriting discount.

         (12)  In February 2000, we issued $300.0 million aggregate principal
               amount of 14% senior notes due 2010 for net proceeds of
               approximately $291.3 million. The notes are redeemable at our
               option, in whole or in part, at any time after February 15, 2005,
               at predetermined redemption prices, together with any accrued and
               unpaid interest through the date of redemption. Upon a change of
               control, each holder of the senior notes may require us to
               purchase the notes at 101% of the principal amount thereof, plus
               any accrued and unpaid interest to the date of purchase. The 2000
               senior notes contain restrictive covenants, including limitations
               on future indebtedness, restricted payments, transactions with
               affiliates, liens, sale of stock of subsidiaries, entering new
               lines of business, dividends, mergers and transfer of assets.

         (13)  In February and March 2000, we issued 3,000,000 shares of 6 3/4%
               Series F cumulative convertible preferred stock in a private
               placement. Net proceeds were approximately $291.0 million. Each
               share of Series F preferred stock is convertible into 2.35 shares
               of common stock at any time at a conversion price of $42.56 per
               share, subject to adjustment. Holders of Series F preferred stock
               are entitled to dividends on a cumulative basis at an annual rate
               of 6 3/4%, payable quarterly in cash. The preferred stock is
               redeemable at our option, in whole or in part, at any time after
               March 6, 2003, at predetermined redemption prices, together with
               any accrued and unpaid dividends through the date of redemption.
               Upon a change of control, each holder of the preferred shares may
               require us to purchase any or all of the shares at 100% of the
               liquidation preference, plus any accrued and unpaid dividends to
               the date of purchase. The Series F preferred stock is subject to
               mandatory redemption on March 3, 2012.

         (14)  In March 2000, we sold $250.0 million of 8 1/4% Series E
               convertible preferred stock to Hicks, Muse, Tate & Furst Inc.
               (Hicks Muse). Each share of Series E preferred stock is
               convertible into shares of common stock at any time at a
               conversion price of $37.50 per share, subject to adjustment. In
               addition, we issued Hicks Muse warrants to purchase 1,875,000
               shares of common stock at an exercise price of $45.00 per share,
               exercisable for three years; 1,875,000 shares of common stock at
               an exercise price of $50.00 per share, exercisable for five
               years; and 1,875,000 shares of common stock at an exercise price
               of $55.00 per share, exercisable for seven years.

         (15)  From August 1997 through December 31, 1999, we granted stock
               options to purchase an aggregate of 17,407,722 shares of common
               stock to employees and consultants with aggregate exercise prices
               ranging from $0.21 to $56.94 per share pursuant to our stock
               option plan. As of December 31, 1999, 8,592,013 shares of common
               stock have been issued upon exercise of options.

         No underwriters  were used in connection  with these sales and
issuances except for the issuance of the senior discount notes and related
warrants in (6) above, issuances of common stock in our public and secondary
offerings in (11) and (12) above and issuance of senior notes in (12) above and
issuances of preferred stock in (13) above. The sales and issuances of these
securities except for those in (6), (11) and (12) above were exempt from
registration under the Securities Act pursuant to Rule 701 promulgated
thereunder on the basis that these securities were offered and sold either
pursuant to a written compensatory benefit plan or pursuant to written contracts
relating to consideration, as provided by Rule 701, or pursuant to Section 4 (2)
thereof on the basis that the transactions did not involve a public offering.
The sales and issuance in (6), (12), (13) and (14) above were exempt from
registration under the Securities Act pursuant to Section 4 (2) and, in
connection with the resale by the initial purchasers of the securities described
in (6) above, Rule 144A thereunder.


Use of Proceeds

         We have and continue to use aggregate net proceeds from our initial
public offering as follows:

 .   to fund the expenditures incurred in the continuing deployment of network
    services in our existing markets, as well as our planned rollout in
    additional markets;
 .   for expenses associated with the continued development of our sales and
    marketing activities;
 .   to fund the addition of subscribers or end-users;
 .   to fund operating losses;
 .   to pay our debt obligations; and
 .   for general corporate purposes.

         We have also invested them in short-term,  investment grade securities
to the extent permitted by the covenants governing the notes and our existing
senior discount notes and our existing debt and any statistical asset tests
imposed by the Investment Company Act of 1940.

         The actual  amounts we spend have varied and will vary  significantly
depending upon a number of factors, including future revenue growth, if any,
capital expenditures, the amount of cash generated by our operations and other
factors, many of which are beyond our control. Additionally, we may modify the
number, selection and timing of our entry with respect to any or all of our
targeted markets. Accordingly, our management has and will retain broad
discretion in the allocation of the net proceeds.


                                       41
<PAGE>

Item 6 - Selected Financial Data

     The following table sets forth the Selected Consolidated Financial Data for
the Company for the periods from inception on February 27, 1997 to December 31,
1997 and for the years ended December 31, 1998, and 1999, and is based on the
audited Consolidated Financial Statements of the Company and its subsidiaries.
Such data should be read in conjunction with the Company's Consolidated
Financial Statements and the notes thereto incorporated into this report in Item
8 and Management's Discussion and Analysis of Financial Condition and Results of
Operations.

<TABLE>
<CAPTION>

   (In thousands, except per share amounts)
   ________________________________________________________________________________________________
                                                           Period From
                                                         February 27, 1997,
                                                            (Inception)
                                                             Through              Year Ended
                                                           December 31,          December 31,
                                                                          -------------------------
                                                              1997           1998           1999
  -------------------------------------------------------------------------------------------------
  <S>                                                      <C>           <C>            <C>
  Statement of Operations:
  Revenue                                                  $        -    $       528    $    11,089
  Operating expenses:
      Network and service costs                                     -          4,695         68,161
      Selling, marketing, general and administrative            2,342         22,428        110,947
      Depreciation and amortization                                 1          1,081         12,639
      Amortized deferred business acquisition costs                 -              -          4,765
      Deferred compensation                                       192            725          3,742
  -------------------------------------------------------------------------------------------------
        Total operating expenses                                2,535         28,929        200,254
  -------------------------------------------------------------------------------------------------
  Loss from operations                                         (2,535)       (28,401)      (189,165)
  Interest and other income (expense)                             113         (7,933)       (29,715)
  -------------------------------------------------------------------------------------------------
  Net loss                                                 $   (2,422)   $   (36,334)   $  (218,880)
  -------------------------------------------------------------------------------------------------
  Net loss per share (basic and diluted)                   $    (1.12)   $    (12.18)   $     (4.15)
  -------------------------------------------------------------------------------------------------

  Balance Sheet:
  Cash, cash equivalents, and short-term investments       $   10,166     $  136,812     $  340,255
  Restricted cash                                          $        -     $        -     $   96,233
  Total assets                                             $   12,241     $  171,726     $  685,424
  Total debt                                               $      568     $  158,270     $  506,140
  Mandatorily redeemable common stock warrants             $        -     $    6,567     $       42
  Total stockholders' equity (deficit)                     $   10,346     $   (6,747)    $  116,287

  Other Financial Data:
  EBITDA  (1)                                              $   (2,342)    $  (26,562)    $ (167,870)
  Adjusted EBITDA  (2)                                     $   (2,342)    $  (24,970)    $ (146,250)
  Net cash used for operating activities                   $   (1,560)    $  (19,024)    $ (153,774)
  Net cash used for investing activities                   $   (1,345)    $ (139,032)    $ (471,401)
  Net cash provided by financing activities                $   13,071     $  169,205     $  652,107
  -------------------------------------------------------------------------------------------------
</TABLE>
_____________

(1)  EBITDA consists of the net loss excluding net interest, depreciation and
     amortization of capital assets, deferred business acquisition costs and
     deferred compensation expense. EBITDA is presented to enhance an
     understanding of our operating results and is not intended to represent
     cash flow or results of operations in accordance with generally accepted
     accounting principles for the period indicated and may be calculated
     differently than EBITDA for other companies.

(2)  Adjusted EBITDA reflects EBITDA excluding total operating lease expenses to
     GATX Capital Corporation (GATX) and Cisco Systems Capital Corporation
     (Cisco). No amounts were incurred to GATX and Cisco for operating leases in
     1997. Total operating expenses for the year ended December 31, 1998 include
     $1.6 million of operating lease expense to GATX. Total operating expenses
     for the year ended December 31, 1999 include $21.6 million of operating
     lease expense to GATX and Cisco.

                                       42
<PAGE>

Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations

     All statements contained within the Management's Discussion and Analysis
of Financial Condition and Results of Operations that are not statements of
historical fact constitute "Forward-Looking Statements" within the meaning of
Section 21E of the Securities Exchange Act. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors that could
cause the actual results of the Company to be materially different from
historical results or from any future results expressed or implied by such
forward-looking statements. Readers are urged to consider statements that
include the terms "believe", "belief", "expects", "plans", "anticipates",
"intends" or the like to be uncertain and forward-looking. Forward-looking
statements also include projections of financial performance, statements
regarding management's plans and objectives and statements concerning any
assumptions relating to the foregoing. Certain important factors regarding the
Company's business, operations and competitive environment, which may cause
actual results to vary materially from these forward-looking statements, are
discussed above under the caption "Risk Factors"

Overview

     We are a leading service provider of broadband local access communication
services to businesses and consumers. We began offering commercial services in
the United States in April 1998. As of December 31, 1999, we offered our
services in 38 markets and 67 of the largest of the 314 Metropolitan Statistical
Areas (MSAs) in the U.S., and our national DSL network passed 30 million homes
and businesses.  We intend to continue our network rollout into an additional 32
markets and 41 MSAs by the end of 2000.

     Since our inception in February 1997, our primary activities have consisted
of:

     .  obtaining required governmental authorizations;
     .  negotiating and executing interconnection agreements with incumbent
        carriers;
     .  entering into strategic alliances;
     .  identifying collocation space and locations for our connection points,
        Metro Service Centers and business offices;
     .  acquiring and deploying equipment and facilities;
     .  launching service trials;
     .  hiring management and other personnel;
     .  raising capital;
     .  forming a joint venture company, Rhythms Canada, to develop a Canadian
        DSL network;
     .  adding end user subscribers to our network;
     .  conducting various marketing and sales activities;
     .  launching a national brand campaign;
     .  creating and expanding relationships with broadband service providers;
     .  implementing process improvement and quality programs; and
     .  developing and integrating our operations support system and other back
        office systems.

     During 1999, we continued the development of our business operations as
follows:

     .  entered 28 new markets for a total of 38 markets at December 31, 1999;
     .  added 1,025 central office locations for a total of 1,225 central
        offices at December 31, 1999;
     .  added 12,000 DSL lines for a total of 12,500 DSL lines at December 31,
        1999; and

                                       43
<PAGE>

     .  increased headcount by 1,090 employees for a total of approximately
        1,250 employees at December 31, 1999.

     We have incurred operating losses, net losses and negative operating
cash flow for each month since our formation. As of December 31, 1999, we had an
accumulated deficit of $257.6 million. We intend to substantially increase our
capital expenditures and operating expenses in an effort to rapidly expand our
network infrastructure, network features and applications, and add end user
subscribers.  We expect to incur substantial operating losses, net losses and
negative cash flow during our network build and initial penetration of each new
market we enter. These losses are expected to continue for at least the next
several years.

Factors Affecting Operations

     Revenue

     The following factors affect our revenue:

     .  Service Offerings. We derive a majority of our operating revenue from
        broadband local connection services, metropolitan area inter-network
        connection services and installation. For broadband local connection
        services, we bill our customers a flat rate, monthly recurring charge
        based on the data transfer speeds selected by the end user. We also bill
        our broadband local connection services customers for nonrecurring
        service activation and installation charges on each line. For our
        metropolitan area internetwork connection services, we bill fixed,
        monthly recurring charges and nonrecurring charges to each customer for
        the high-speed connection between our Metro Service Center and the
        customer's router or switch. To encourage potential customers to adopt
        our services, we sometimes offer reduced metropolitan area internetwork
        connection service prices for an initial period of time. In some
        situations, we reduce the nonrecurring service activation and
        installation charges on our broadband local connection services for
        customers who sign long-term contracts of greater than 12 months. We
        expect that, as a result of competitive forces and our evolving service
        offerings, our prices will decline over time. We expect that the mix of
        services our customers purchase from us will change from time to time
        and that a mix more heavily weighted toward the lower priced services
        would reduce the average revenue per end-user subscriber.

     .  Number and Penetration of Target Markets. The total number of markets in
        which we choose to provide our service offerings, as well as the
        penetration within each market, will affect our revenues. We base our
        target market assessment on the number of local area networks in each
        market, which we believe is the best indication of data-intensive
        business density and potential customers for our service offerings. For
        each target market, we expect to collocate in the appropriate number of
        incumbent local exchange carrier (ILEC) central offices to cover 70% of
        the total market opportunity within the metropolitan area.

     .  Turnover. To date, our customer turnover has been minimal. We expect
        this to increase in the future as competition intensifies.

     Network and Service Costs

     Our network and service costs are generally composed of the following:

     .  End-User Subscriber Installation Charges. In each market, we require a
        number of field service technicians to perform installation services at
        end-user locations. We currently outsource most of this function.

                                       44
<PAGE>

     .  Customer Premise Equipment. We provide a DSL modem or router for use at
        the end user's location. We purchase this equipment from various DSL
        equipment providers.

     .  Monthly Recurring and Nonrecurring Line and Service Charges. We pay
        ILECs a one-time installation and activation fee and a monthly service
        fee for each copper telephone line.

     .  Metropolitan Area Network Transport Charges. We incur monthly recurring
        and nonrecurring charges for transport between our connection points and
        our Metro Service Centers. These charges are typically for DS-3 services
        from a competitive local exchange carrier (CLEC) or ILEC. These charges
        also include metropolitan area internetwork connections to our network.

     .  Network Facilities Operating Expenses. We incur various monthly
        recurring costs at our connection points and Metro Service Centers.
        These costs include facility rent and utility costs.

     .  Wide Area Network Connection Charges. We pay interexchange carriers a
        one-time installation and activation fee and a monthly service fee for
        leasing wide area network connections over a frame relay or Asynchronous
        Transfer Mode (ATM) network.

     .  Equipment Operating Lease Expenses. We currently take advantage of
        short-term operating leases to finance the acquisition of substantially
        all of our network equipment, including DSL multiplexers, ATM switches
        and routers.

     .  Line Repair and Support Costs. Similar to other telecommunication
        providers, we estimate that a small percentage of our lines may require
        repair or support. These costs will consist of field dispatch labor and
        a portion of our Network Operations Center costs.

     Selling, Marketing, General and Administrative

     Our selling, marketing, general and administrative expenses include
customer service and technical support, information systems, billing and
collections, general management and overhead, and administrative functions.
Headcount in functional areas, such as customer service, engineering and
operations, will increase as we expand our network, and add new customers and
end-user subscribers.

     .  Selling and Marketing Costs. Our sales and marketing efforts focus on
        attracting and retaining broadband service providers and business
        customers, adding end-users to our network, and building and maintaining
        our brand.

     .  General and Administrative Costs. As we expand our network, we expect
        the number of employees located in specific markets to grow. We also use
        outside contractors, in addition to our own employees, for certain
        activities. Certain functions, such as network operations, information
        systems, marketing, quality, national sales management, finance, billing
        and site planning, are likely to remain centralized in order to achieve
        economies of scale.

     Depreciation and Amortization

     Depreciation expense arises from the capitalization of our equipment and
furniture. Collocation fees are capitalized and amortized over an estimated
useful life of ten years.

                                       45
<PAGE>

Results of Operations

1999 Compared to 1998

     Revenue

     We recorded $11.1 million in revenue in 1999 compared to $0.5 million in
revenue in 1998. Revenue consisted of net monthly recurring service fees of $7.5
million in 1999 compared to $0.3 million in 1998.  Nonrecurring net installation
revenue totaled $3.5 million for 1999 compared to $0.2 million in 1998.  We
recorded late fees of $0.1 million in 1999 compared to none in 1998. The
substantial increase in revenue in 1999 is a result of our increased sales and
marketing efforts and continued network deployment as more fully detailed above.
Each new market we enter provides us with an additional revenue opportunity, but
also higher costs until we have an established customer base in the market.

     Network and Service Costs

     Our network and service costs for 1999 were $68.2 million compared to $4.7
million in 1998. The significant increase in network and service costs in 1999
is a result of our continued network deployment as more fully detailed above.

     Selling, Marketing, General and Administrative

     Our selling, marketing, general and administrative expenses were $110.9
million in 1999, compared to $22.4 million for the same period one year ago.
This increase reflects our continued growth in staffing levels, sales and
marketing efforts, and legal expenses associated with the development and launch
of new markets as more fully detailed above.

     Depreciation and Amortization

     Depreciation and amortization in 1999 was $12.6 million, a significant
increase over the $1.1 million recorded in 1998.  This increase reflects the
rapid expansion of our network, as discussed above, and includes amortization of
collocation fees and depreciation on operating equipment as we begin service in
each new location.  We expect depreciation and amortization to continue to
increase in the future as we continue to expand  our network.

     During the first and second quarters of 1999, we entered into strategic
arrangements with Microsoft Corp. and Qwest Communications International Inc. In
addition to their investments in our company totaling $45.0 million, the
strategic arrangements provide for certain other business relationships.
Combined, these business relationships along with certain warrant issuances are
valued at $23.2 million and we have capitalized these costs as deferred assets.
These assets are being amortized over three- and five-year periods. Accordingly,
during 1999 we recorded $4.8 million in amortization for deferred business
acquisition costs that have no corresponding amortization in the prior year.

     Deferred compensation expense increased to $3.7 million in 1999 as
compared to $0.7 million for the same period one year ago and reflects the
granting of stock options to our employees and officers with per share exercise
prices below the per share fair values of our common stock at the dates of
grant. We are amortizing the deferred compensation over the vesting period of
the applicable options.

     Net Interest Income and Expense

                                       46
<PAGE>

     During 1999, we recorded interest income of $22.7 million, compared to $5.8
million in 1998. The increase between years resulted primarily from a
substantial increase in invested cash balances. As of December 31, 1999, we had
unrestricted cash and investments totaling $340.3 million, compared to
unrestricted cash and investments of $136.8 million at December 31, 1998. The
increase during 1999 resulted from a variety of financing activities, including:

     .  issuing Series C and Series D preferred stock and warrants for cash
        proceeds totaling $75.0 million in March and April 1999;
     .  issuing common stock upon our initial public offering in April 1999 for
        net cash proceeds of $210.1 million;
     .  issuing 12 3/4% senior debt in April 1999 for net cash proceeds of
        $314.5 million;
     .  executing additional equipment lease lines of $100.0 million;
     .  issuing common stock upon our secondary public offering in September
        1999 for net cash proceeds of $16.4 million.

     Interest expense and amortized debt discount and issue costs increased
significantly to $52.5 million in 1999 as compared to $13.8 million in 1998.
This increase primarily resulted from the senior notes we issued in April 1999.

     Income Taxes

     We generated net operating loss carryforwards of $2.1 million, $21.2
million, and $186.9 million in 1997, 1998, and 1999, respectively. We expect
significant consolidated losses for the foreseeable future that will generate
additional net operating loss carryforwards. However, our ability to use net
operating losses may be subject to annual limitations. In addition, income taxes
may be payable during this time due to operating income in certain tax
jurisdictions. In the future, if we achieve operating profits and the net
operating losses have been exhausted or have expired, we may incur significant
tax expense. We continue to be in a net operating loss tax position through
December 31, 1999; consequently, we have not recorded a provision for income
taxes for periods through December 31, 1999.


1998 Compared to Period From February 27, 1997, (Inception) to December 31, 1997

     Revenue

     We did not offer commercial services in 1997 and, as a result, did not
record any revenue in 1997. During 1998, we continued the development of our
business operations, commencing service in the San Diego market in April; the
San Francisco, Oakland/East Bay and San Jose markets in July; the Los Angeles
and Orange County markets in September and the Chicago market in October. We
recorded revenue of $0.5 million during this period, which was primarily from
DSL service and installation charges, net of discounts given to customers.

     Network and Service Costs

     Since we did not offer commercial services in 1997, we did not record any
network or service costs in 1997. In 1998, we recorded network and service costs
of $4.7 million. We expect network and service costs to increase significantly
in future periods as we expand our network into additional markets.

     Selling, Marketing, General and Administrative

     From inception through December 31, 1997, selling, marketing, general and
administrative expenses were $2.3 million and consisted primarily of salaries
and legal and consulting fees incurred to establish a management team and
develop our business. In 1998, we recorded selling,

                                       47
<PAGE>

marketing, general and administrative expenses of $22.4 million. This increase
is attributable to growth in staffing levels, increased marketing efforts
coinciding with the launch of commercial services and increased legal fees
associated with the development of additional markets.

     Depreciation and Amortization

     Depreciation from network equipment was minimal since substantially all of
this equipment was leased. Depreciation and amortization was $1,000 for the
period from inception through December 31, 1997, and was $1.1 million in 1998.
The increase was due to the commencement of our operations in 1998.

     Other Income and Expense

     Other income and expense consists primarily of interest income from our
cash and short-term investments and interest expense associated with our debt.
From inception through December 31, 1997, net interest income was $0.1 million,
which was primarily attributable to the interest income earned from the proceeds
raised in our Series A preferred stock financing. In 1998, we recorded net
interest expense of $8.0 million, consisting of interest income of $5.8 million
generated from invested cash balances, offset by $13.8 million in interest
expense. The increase in the interest expense is substantially due to the
accretion of interest on the senior discount notes issued in May 1998.

     Income Taxes

     We generated net operating loss carryforwards of $2.1 million from
inception to December 31, 1997, and $21.2 million during 1998. We expect
significant consolidated losses for the foreseeable future which will generate
additional net operating loss carryforwards. However, our ability to use net
operating losses may be subject to annual limitations. In addition, income taxes
may be payable during this time due to operating income in certain tax
jurisdictions ons. In the future, if we achieve operating profits and the net
operating losses have been exhausted or have expired, we may incur significant
tax expense. We recognized no provision for taxes because we operated at a loss
throughout 1997 and 1998.

Liquidity and Capital Resources

     We have substantial indebtedness and debt service obligations. As of
December 31, 1999, we had $506.1 million of total indebtedness. In addition, the
development and expansion of our business requires significant capital
expenditures. These capital expenditures primarily include network build costs
such as the procurement, design and construction of our connection points and
one or two Metro Service Center locations in each market, as well as other costs
that support our network design.

     The number of targeted central offices in each market varies, as does the
average capital cost to build our connection points in such market. Capital
expenditures, including payments for collocation fees, were $193.3 million in
1999. We expect our capital expenditures to be higher in future periods, arising
primarily from payments of collocation fees and the purchase of infrastructure
equipment necessary for the development and expansion of our network.

     Through December 31, 1999, we have financed our operations and network
primarily through:

     .  private placements of equity totaling $105.8 million, net;
        executing equipment lease lines totaling $126.5 million;
     .  issuing 13 1/2% senior discount notes in May 1998 for $144.0 million
        in netproceeds;
     .  issuing common stock in April 1999 in our initial public offering for
        $210.1 million in net proceeds;
     .  issuing 12 3/4% senior notes in April 1999 for $314.5 million in

                                       48
<PAGE>

     .  net proceeds;
     .  issuing common stock in September 1999 in a secondary public offering
        for $16.4 million in net proceeds

     Subsequent to December 31, 1999, we have:

     .  increased equipment lease lines by an aggregate of $75 million;
     .  issued 14% senior notes in February 2000 for $291.3 million in net
        proceeds; and
     .  issued 6 3/4% Series F cumulative convertible preferred stock in
        February and March 2000 for $291.0 million in net proceeds.
     .  issued $250 million of Series E convertible preferred stock to Hicks
        Muse in a privately negotiated transaction in March 2000;

Refer to Note 10 of the accompanying consolidated financial statements for terms
and descriptions of these transactions.

     The indentures for the 1998 senior discount notes and the 1999 and 2000
senior notes contain covenants that limit our ability to:

     .  pay dividends on, redeem or repurchase our capital stock;
     .  incur additional debt;
     .  make investments;
     .  consolidate, merge or transfer all or substantially all of our assets;
        and
     .  make dividend or other payments to us by our restricted subsidiaries.

     As of December 31, 1999, we had $436.5 million in cash and investments and
we had an accumulated deficit of $257.6 million. Of this cash, $96.2 million is
restricted in accordance with the terms of the 1999 senior notes.

     In 1999, the net cash used in our operating activities was $153.8 million.
This cash was used for a variety of operating purposes, including salaries,
consulting and legal expenses, network operations and overhead expenses. Our net
cash used for investing activities in 1999 was $471.4 million and was used
primarily for purchases of short-term investments and equipment and payments of
collocation fees. Net cash provided by financing activities in 1999 was $652.1
million and primarily came from the issuance of equity and senior notes as
described above.

     In 1998, the net cash used in our operating activities was $19.0 million.
This cash was used for a variety of operating purposes, including salaries,
consulting and legal expenses, network operations and overhead expenses.  Our
net cash used for investing activities in 1998 was $139.0 million and was used
primarily for purchases of short-term investments and equipment and payments of
collocation fees.  Net cash provided by financing activities in 1998 was $169.2
million and primarily came from the issuance of the senior discount notes and
from the issuance of preferred stock.

     Since inception through December 31, 1997, the net cash used in our
operating activities was $1.6 million. The net cash used for operations was
primarily due to working capital requirements and net losses, partially offset
by increases in accounts payable and accrued expenses. Our net cash used for
investing activities for the period ended December 31, 1997 was $1.3 million.
This cash was used for purchases of equipment and collocation fees. Net cash
provided by financing activities for the period ended December 31, 1997 was
$13.1 million and primarily came from the issuance of preferred stock and
proceeds from bank borrowings.

     Our capital requirements may vary based upon the timing and success of our
rollout and as a result of regulatory, technological and competitive
developments, or if:

                                       49
<PAGE>

     .  demand for our services or our anticipated cash flow from operations is
        less or more than expected;
     .  our development plans or projections change or prove to be inaccurate;
     .  we engage in any acquisitions; or
     .  we accelerate deployment of our network services or otherwise alter the
        schedule or targets of our rollout plan.

     We believe that our cash and investment balances as of December 31, 1999,
together with the proceeds of the events subsequent to December 31, 1999, and
anticipated future revenue generated from operations, will be sufficient to fund
our operating losses, capital expenditures, lease payments and interest payments
through approximately December 2001. We expect our operating losses and capital
expenditures to increase substantially in the near-term, primarily due to our
network expansion. We expect that significant additional financing will be
required in the future. We may attempt to raise financing through some
combination of commercial bank borrowings, leasing, vendor financings, or the
private or public sale of equity or debt securities. Future equity or debt
financings may not be available to us at all or, if available, may not be on
favorable terms. If we are unable to obtain financing in the future, we will
continue the expansion of our operations on a reduced scale based on our
existing capital resources.

Impact of the Year 2000 Issue

     Many computer programs have been written using two digits rather than four
to define the applicable year. This posed a problem at the end of the century
because these computer programs might recognize a date using "00" as the year
1900 rather than the year 2000. This, in turn, could have resulted in major
system failures or miscalculations, and was generally referred to as the "Year
2000 issue." We formulated and, to a large extent, effected a plan to address
our Year 2000 issues.

     We are not currently aware of any Year 2000 compliance problems relating to
our systems that would have a material adverse effect on our business, financial
condition and operating results. In response to the Year 2000 issue we
implemented changes to our existing information technology systems through a
combination of modifications and upgrades to Year 2000 compliant software. We
evaluated our non-information technology systems and believe these systems are
Year 2000 compliant.

     We incurred minimal costs associated with identifying and addressing Year
2000 compliance.

     The Year 2000 issue did not have a material adverse effect on our business,
financial condition or operating results. However, despite all our efforts to
date toward ensuring Year 2000 compliance, latent issues may still surface in
the future.

Item 8 - Financial Statements and Supplementary Data

     The financial statements required pursuant to this item are included
in Item 14 of this Form-10K and are presented beginning on page F-1.

Item 9 - Change in and Disagreements with Accountants

     Not applicable.

Item 10 - Directors and Executive Officers of the Company

     The information required by this item concerning the Company's directors,
is incorporated by reference to the information set forth in the Company's proxy
statement (2000 Proxy Statement)
                                       50
<PAGE>

for the 2000 annual meeting of stockholders to be filed with the SEC within 120
days after the end of the Company's fiscal year ended December 31, 1999

Item 11 - Executive Compensation

     The information required by this item regarding executive compensation is
incorporated by reference to the information set forth in the Company's 2000
Proxy Statement.

Item 12 - Security Ownership of Certain Beneficial Owners and Management

     The information required by this item regarding security ownership of
certain beneficial owners and management is incorporated by reference to the
information set forth in the Company's 2000 Proxy Statement.

Item 13 - Certain Relationships and Related Transactions

     The information required by this item regarding certain relationships and
related transactions is incorporated by reference to the information set forth
in the Company's 2000 Proxy Statement.

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

Financial Statements:

     Report of Independent Accountants
     Consolidated Balance Sheets as of December 31, 1999 and 1998
     Consolidated Statements of Operations and Comprehensive Income for the
            period from February 27, 1997, (Inception) through December 31, 1997
            and the years ended December 31, 1998 and 1999
     Consolidated Statements of Stockholders' Equity for the period from
            February 27, 1997, (Inception) through December 31, 1997 and the
            years ended December 31, 1998 and 1999
     Consolidated Statements of Cash Flows for the period from February 27,
            1997, (Inception), through December 31, 1997 and the years ended
            December 31, 1998 and 1999


Financial Statement Schedules:

     Report of Independent Accountants On Financial Statement Schedule
     Schedule II - Valuation and Qualifying Accounts
     All other schedules have been omitted because the information is not
            required or is included in the consolidated financial statements

Exhibits:

3.1** Restated Certificate of Incorporation of the Company.

3.2** Certificate of Designation of Series 1 Junior Participating Preferred
Stock of Company.

3.3** Restated Bylaws of the Company.

3.4  Certificate of Designation of 6 3/4% Series F Convertible Preferred Stock.

3.5  Certificate of Designation of 8.25% Series E Convertible Preferred Stock.

4.1** Form of Certificate of common stock.

4.2* Indenture, dated as of May 5, 1998, by and between the Company and State
Street Bank and Trust Company of California, N.A., as trustee, including form of
the Company's 13 1/2% Senior Discount Notes due 2008, Series A and form of
Company's 13 1/2% Senior Discount Notes due 2008, Series B.

4.3* Warrant Agreement, dated as of May 5, 1998, by and between the Company and
State Street Bank and Trust Company of California, N.A.

4.4* Warrant Registration Rights Agreement, dated as of May 5, 1998, by and
among the Company and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, and Donaldson, Lufkin & Jenrette Securities Corporation.

4.5** Warrant to Purchase Shares of Common Stock, dated May 19, 1998, by and
between the Company and Sun Financial Group, Inc.

4.6** Common Stock Purchase Warrant, dated March 3, 1999, by and between the
Company and MCI WorldCom Venture Fund, Inc.

4.7** Common Stock Purchase Warrant, dated March 16, 1999, by and between the
Company and Microsoft Corporation.

4.8** Warrant to Purchase Shares of Common Stock, dated March 31, 1999, by and
between Company and GATX Capital Corporation.

4.9** Warrant Purchase Agreement, dated as of April 6, 1999, by and between
Company and MCI WorldCom Venture Fund, Inc.

4.10** Common Stock Purchase Warrant, dated April 6, 1999, by and among Company
and MCI WorldCom Venture Fund, Inc.

4.11** Common Stock Purchase Warrant, dated April 6, 1999, by and among the
Company and U.S. Telesource, Inc.

4.12** Common Stock Purchase Warrant, dated April 5, 1999, by and among Company
and Cisco Systems Capital Corporation.

4.13** Rights Agreement, dated April 2, 1999, by and among Company and American
Securities Transfer & Trust, Inc.

4.14*** Indenture, dated as of April 23, 1999, by and between the Company and
State Street Bank and Trust Company of California, N.A., as trustee, including
form of the Company's 12 3/4% Senior Notes due 2009, Series A and form of the
Company's 12 3/4% Senior Notes due 2009, Series B

4.15*** Notes Registration Rights Agreement, dated as of April 23, 1999, by and
among the Company and Merrill Lynch & Co., Merrill Lynch, Pierce Fenner & Smith
Incorporated, Salomon Smith Barney Inc. and Chase Securities Inc.

4.16*** Pledge and Escrow Agreement, dated as of April 23, 1999, from the
Company as Pledgor to State Street Bank and Trust Company of California, N.A.,
as trustee.

4.17**** Amendment No. 1 to Warrant Agreement, dated as of August , 1999 between
the Company and State Street Bank and Trust Company of California, N.A.

4.18  Indenture, dated February 23, 2000. by and between the Company and State
Street Bank and Trust Company of California, N.A., as trustee, including form of
the Company's 14% Senior Notes due 2010, Series A and form of the Company's 14$
Senior Notes due 2010, Series B.

4.19  Notes Registration Rights Agreement, dated as of February 23, 2000, among
the Company, Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner and Smith
Incorporated, and Salomon Smith Barney Inc., Chase Securities Inc., and Credit
Suisse First Boston.

4.20  Registration Rights Agreement, dated March 3, 2000, by and among the
Company and Merrill Lynch, Pierce, Fenner and Smith Incorporated and Salomon
Smith Barney Inc.

4.21  Registration Rights Agreement, dated March 16, 2000, by and among the
Company and the entities listed on Schedule I thereto.

9.1* Voting Trust Agreement, dated as of May 5, 1998, by and among Sprout
Capital VII, L.P., Donaldson Lufkin & Jenrette Securities Corporation, and First
Union Trust Company, National Association, as trustee.

9.2* Voting Trust Agreement, dated as of March 12, 1998, by and between Enron
Communications Group, Inc. and the Company, as trustee.

10.1* Series A Preferred Stock Purchase Agreement, dated July 3, 1997, by and
among the Company and the Investors listed on Schedule A thereto.

10.2* Subsequent Closing Purchase Agreement, dated December 23, 1997, by and
among the Company and the Investors listed on Schedule A thereto.

10.3* Series B Preferred Stock Purchase Agreement, dated March 12, 1998, by and
among the Company and the Investors listed on Schedule A thereto.

10.4** Enterprise Services Solution Agreement between Cisco Systems, Inc. and
the Company, dated December 3, 1998

10.5** Series C Preferred Stock Purchase Agreement, dated March 3, 1999, by and
among the Company and MCI WorldCom Venture Fund, Inc.

10.6** Amended and Restated Investors' Rights Agreement, dated March 3, 1999, by
and among the Company and the Investors listed on Schedule A thereto.

10.7** Agreement, dated March 3, 1999, by and between the Company and MCI
WorldCom, Inc.

10.8** Series C Preferred Stock and Warrant Purchase Agreement, dated March 16,
1999, by and among the Company and Microsoft Corporation.

10.9** Amended and Restated Investors' Rights Agreement, dated March 16, 1999,
by and among the Company and the Investors listed on Schedule A thereto.

10.10** Distribution Agreement, dated March 16, 1999, by and among the Company
and Microsoft Corporation.

10.11* Master Lease Agreement No. 1642 and Addendum thereto, each dated November
19, 1997, and Second Addendum thereto, dated as of May 19, 1998, between the
Company and Sun Financial Group, Inc.

10.12** Business Lease (Single Tenant) between the Company and BR Venture, LLC
dated September 1998.

10.13* Employment Agreement between the Company and Catherine M. Hapka, dated
June 10, 1997.

10.14* 1997 Stock Option/Stock Issuance Plan.

10.15** 1999 Stock Incentive Plan.

10.16** 1999 Employee Stock Purchase Plan.

10.17* Form of Indemnification Agreement between the Company and each of its
directors.

10.18* Form of Indemnification Agreement between the Company and each of its
officers.

10.19* QuickStart Loan and Security Agreement, dated October 29, 1997, between
the Company and Silicon Valley Bank.

10.20** Third Addendum, dated March 31, 1999, to Master Lease Agreement, dated
November 19, 1997, by and among Company and GATX Capital Corporation

10.21** Master Lease Agreement, dated March 31, 1999, by and among Company and
GATX Capital Corporation.

10.22** First Addendum, dated March 31, 1999, to Master Lease Agreement, dated
March 31, 1999, by and among Company and GATX Capital Corporation.

10.23** Amendment No. 1, dated April 6, 1999, to Framework Agreement, dated
March 3, 1999, by and among the Company and MCI WorldCom, Inc.

10.24** Series C Preferred Stock and Warrant Purchase Agreement, dated April 6,
1999, by and among the Company and U.S Telesource, Inc.

10.25** Series D Preferred Stock Purchase Agreement, dated April 6, 1999, by and
among the Company and the Investors listed on Schedule A thereto.

10.26** Amended and Restated Investors' Rights Agreement, dated April 6, 1999,
by and among the Company and the Investors listed on Schedule A thereto.

10.27** Lease Agreement, dated April 5, 1999, by and among the Company and Cisco
Systems Capital Corporation.

10.28*** Amendment No. 2, dated May 10, 1999, to Framework Agreement, dated
March 3, 1999, by and among the Company and MCI WorldCom, Inc.

10.29**** Employment Agreement with Steve Stringer.

10.30**** Employment Agreement with Michael Lanier.

10.31 *****Master Lease Agreement, dated July 30, 1999, by and between the
Company and GATX Capital Corporation

10.32 ****** ACI Plus Service Agreement, dated April 6, 1999, by and between the
Company and Qwest Communications Corporation.

10.33  Joint Venture Agreement, dated January 1, 2000, by and between the
Company, Rhtyms Links, Inc. and Optel Communications Corporation.

10.34  Preferred Stock and Warrant Purchase Agreement, dated February 6, 2000 by
and between the Company and the Purchasers listed on Schedule I thereto.

10.35  Purchase Agreement, dated February 16, 2000, by and between the Company
and the Initial Purchasers listed on Schedule I thereto.

10.36  Purchase Agreement, dated February 28, 2000 by and between the Company
and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and
Salomon Smith Barney Inc.

10.37  Employment Agreement with David J. Shimp.

10.38  Employment Agreement with Scott C. Chandler.

21.1** Subsidiaries of the Company.

23.1   Consent of PricewaterhouseCoopers

24.1 Powers of Attorney (included on signature page).

99.3**** Plus Service Agreement, dated April 6, 1999, by and between the Company
and Qwest Communications Corporation.

* Previously filed with the Commission as an exhibit to the registration
statement on Form S-4 (File No. 333-59393) and incorporated herein by reference.
II-6
**Previously filed with the Commission as an exhibit to the registration
statement on Form S-1 (File No. 333-72409) and incorporated herein by reference.
*** Previously filed with the Commission as an exhibit to the registration
statement on Form S-4 (File No. 333-82637) and incorporated herein by reference.
****Previously filed with the Commission as an exhibit to the registration
statement on Form S-1 (File No. 333-82867) and incorporated herein by reference.
*****Previously filed with the Commission as an exhibit to Form 10-Q filed
November 11, 1999 and incorporated herein by reference.
******Previously filed with the Commission as an exhibit to Form 10-Q filed
August 11, 1999 and incorporated herein by reference.

<PAGE>


Reports on Form 8-K

1.      The Company filed no current reports on Form 8-K in the fourth quarter
        ended December 31, 1999.

                                       52
<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.

                          RHYTHMS NETCONNECTIONS INC.

Date:  March 29, 2000                      By:  /s/    Scott C. Chandler
                                           -------------------------------------
                                           Scott C. Chandler,
                                           Chief Financial Officer
                                           (Principal Financial and Accounting
                                           Officer)

Know all men by these presents, that each person whose signature appears below
constitutes and appoints Catherine M. Hapka or Scott C. Chandler, his or her
attorney-in-fact, with power of substitution in any and all capacities, to sign
any amendments to this Annual Report on Form 10-K, and to file the same with
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that the
attorney-in-fact or his substitute or substitutes may do or cause to be done by
virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

Date:  March 29, 2000                      By:  /s/    Catherine M. Hapka
                                           -------------------------------------
                                           Catherine M. Hapka,
                                           Chairman and Chief Executive Officer

Date:  March 29, 2000                      By:  /s/    Steve Stringer
                                           -------------------------------------
                                           Steve Stringer,
                                           President and Chief Operating Officer

Date:  March 29, 2000                      By:  /s/    Scott C. Chandler
                                           -------------------------------------
                                           Scott C. Chandler,
                                           Chief Financial Officer

Date:  March 29, 2000                      By:  /s/    Kevin R. Compton
                                           -------------------------------------
                                           Kevin R. Compton
                                           Director

Date:  March 29, 2000                      By:  /s/    Susan Mayer
                                           -------------------------------------
                                           Susan Mayer,
                                           Director

Date:  March 29, 2000                      By:  /s/    William R. Stensrud
                                           -------------------------------------
                                           William R. Stensrud,
                                           Director

Date:  March 29, 2000                      By:  /s/    John L. Walecka
                                           ---------------------------
                                           John L. Walecka,
                                           Director

Date:  March 29, 2000                      By:  /s/    Edward J. Zander
                                           ----------------------------
                                           Edward J. Zander,
                                           Director

                                       53
<PAGE>

                         Index to Financial Statements
                         -----------------------------

RHYTHMS NETCONNECTIONS INC.



Contents



Report of Independent Accountants............................................F-1
Financial Statements:
        Consolidated Balance Sheets..........................................F-2
        Consolidated Statements of Operations................................F-3
        Consolidated Statements of Cash Flows................................F-4
        Consolidated Statements of Stockholders' Equity......................F-5
        Notes to Consolidated Financial Statements...........................F-7

                                       54
<PAGE>

                       Report of Independent Accountants


To the Board of Directors and Stockholders
of Rhythms NetConnections Inc.

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and comprehensive income, of cash flows,
and of stockholders' equity present fairly, in all material respects, the
financial position of Rhythms NetConnections Inc. and its subsidiaries at
December 31, 1999 and 1998, and the results of their operations and their cash
flows for the period from February 27, 1997, (Inception) through December 31,
1997, and for each of the two years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.



PricewaterhouseCoopers LLP
February 29, 2000, except for Note 10,
as to which the date is March 16, 2000

                                      F-1
<PAGE>

                          RHYTHMS NETCONNECTIONS INC.
                          CONSOLIDATED BALANCE SHEETS
                     (In thousands, except share amounts)
<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                      --------------------------
                                      ASSETS                                              1998            1999
----------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>             <C>
Current assets:
  Cash and cash equivalents                                                             $ 21,315        $ 48,247
  Short-term investments                                                                 115,497         292,008
  Restricted cash                                                                              -          36,707
  Accounts, loans, interest, and other receivables, net                                    2,376          10,844
  Inventory                                                                                  340           4,071
  Prepaid expenses and other current assets                                                  230           8,460
----------------------------------------------------------------------------------------------------------------
    Total current assets                                                                 139,758         400,337
----------------------------------------------------------------------------------------------------------------
Equipment and furniture, net                                                              11,510         124,831
Collocation fees, net                                                                     13,804          57,421
Restricted cash                                                                                -          59,526
Deferred business acquisition costs, net of accumulated amortization of $0 and $4,765          -          18,425
Deferred debt issue costs, net of accumulated amortization of $216 and $924                6,304          16,194
Other assets                                                                                 350           8,690
----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS                                                                           $ 171,726        $685,424
================================================================================================================

                       LIABILITIES AND STOCKHOLDERS' EQUITY
----------------------------------------------------------------------------------------------------------------
Current liabilities:
  Current portion of long-term debt                                                        $ 333           $ 333
  Accounts payable                                                                        10,601          30,895
  Interest payable                                                                            39           8,787
  Accrued expenses and other current liabilities                                           2,816          23,163
----------------------------------------------------------------------------------------------------------------
    Total current liabilities                                                             13,789          63,178

Long-term debt                                                                               472             111
Senior notes payable                                                                     157,465         505,696
Other liabilities                                                                            180             110
----------------------------------------------------------------------------------------------------------------
    Total liabilities                                                                    171,906         569,095
----------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 9)
Mandatorily redeemable common stock warrants                                               6,567              42
----------------------------------------------------------------------------------------------------------------
Stockholders' equity (deficit):
  Preferred stock                                                                             17               -
  Common stock, $0.001 par value; 250,000,000 shares authorized;
      8,042,530 shares issued as of 1998, 78,255,707 shares issued as of 1999                  8              78
  Treasury stock, at cost; 438,115 shares as of 1998 and 988,894 shares as of 1999           (18)           (469)
  Additional paid-in capital                                                              37,212         373,604
  Warrants                                                                                     -          10,397
  Deferred compensation                                                                   (5,210)        (12,320)
  Accumulated deficit                                                                    (38,756)       (257,636)
  Accumulated other comprehensive income                                                       -           2,633
----------------------------------------------------------------------------------------------------------------
    Total stockholders' equity (deficit)                                                  (6,747)        116,287
----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                                   $ 171,726        $685,424
================================================================================================================
</TABLE>

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

                                      F-2
<PAGE>

                          RHYTHMS NETCONNECTIONS INC.
        CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
              (In thousands, except share and per share amounts)

<TABLE>
<CAPTION>

                                                                     Period From
                                                                  February 27, 1997,                  Year Ended
                                                                 (Inception) Through                 December 31,
                                                                     December 31,           ----------------------------
                                                                        1997                    1998              1999
------------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>                 <C>              <C>
Revenue:
   Service and installation, net                                         $      -           $     528        $    11,089

Operating Expenses:
   Network and service costs                                                    -               4,695             68,161
   Selling, marketing, general and administrative                           2,342              22,428            110,947
   Depreciation and amortization                                                1               1,081             12,639
   Amortization of deferred business acquisition costs                          -                   -              4,765
   Deferred compensation                                                      192                 725              3,742
       Total operating expenses                                             2,535              28,929            200,254

Loss from operations                                                       (2,535)            (28,401)          (189,165)

Other Income (Expense):
   Interest income                                                            114               5,813             22,673
   Interest expense (including amortized debt
     discount and issue costs)                                                 (1)            (13,779)           (52,537)
   Other income                                                                 -                  33                149
       Total other income (expense)                                           113              (7,933)           (29,715)

Net Loss                                                                 $ (2,422)          $ (36,334)        $ (218,880)

Other comprehensive income                                                      -                   -              2,633

Total Comprehensive Income (Loss)                                        $ (2,422)          $ (36,334)        $ (216,247)


Net Loss Per Share:
   Basic                                                                 $  (1.12)        $    (12.18)        $    (4.15)
   Diluted                                                               $  (1.12)           $ (12.18)        $    (4.15)

Shares Used in Computing Net Loss Per Share:
   Basic                                                                2,161,764           2,984,216         52,770,402
   Diluted                                                              2,161,764           2,984,216         52,770,402

</TABLE>



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

                                      F-3
<PAGE>
                          RHYTHMS NETCONNECTIONS INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (In Thousands)

<TABLE>
<CAPTION>
                                                                                  Period From                 Year Ended
                                                                               February 27, 1997,             December 31,
                                                                              (Inception) Through   -----------------------------
                                                                               December 31, 1997         1998              1999
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>                <C>              <C>
Cash Flows from Operating Activities:
  Net loss                                                                         $  (2,422)       $   (36,334)     $   (218,880)
  Adjustments to reconcile net loss to net cash used for operating activities:
    Depreciation and amortization of equipment, furniture, and collocation fees            1                539            12,639
    Amortization of deferred business acquisition costs                                    -                  -             4,765
    Amortization of debt discount and deferred debt issue costs                            -             13,882            23,939
    Amortization of deferred compensation                                                265                725             3,742
    Amortization of gain on sale of equipment to leasing company                           -                  -              (142)
    Loss on sale of equipment to leasing company                                           -                387                 -
    Changes in assets and liabilities:
      Increase in accounts, loans, interest, and other receivables, net                    -             (2,376)           (8,468)
      Increase in inventory                                                                -               (340)           (3,731)
      Increase in prepaid expenses and other current assets                              (95)              (135)           (8,230)
      Increase in other assets                                                           (32)              (318)             (382)
      Increase in accounts payable                                                       388              2,287            11,807
      Increase in interest payable                                                         -                 39             8,748
      Increase in accrued expenses and other current liabilities                         335              2,440            20,347
      Increase in other liabilities                                                        -                180                72
---------------------------------------------------------------------------------------------------------------------------------
                Net cash used for operating activities                                (1,560)           (19,024)         (153,774)
---------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
    Purchases of short-term investments                                                    -           (451,870)         (451,660)
    Maturities of short-term investments                                                   -            336,373           275,149
    Purchases of government securities as restricted cash                                  -                  -           (96,233)
    Investment in common stock                                                             -                  -            (5,325)
    Purchases of equipment and furniture                                              (1,018)            (9,973)         (147,358)
    Payments of collocation fees                                                        (327)           (13,562)          (45,974)
---------------------------------------------------------------------------------------------------------------------------------
                Net cash used for investing activities                                (1,345)          (139,032)         (471,401)
---------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
    Proceeds from leasing company for equipment                                            -              6,606            23,755
    Proceeds from issuance of senior notes and warrants                                    -            150,365           325,000
    Payments of debt issue costs                                                           -             (6,519)          (10,598)
    Proceeds from borrowings on long-term debt                                           568                432                 -
    Repayments of long-term debt                                                           -               (195)             (361)
    Proceeds from issuance of common stock                                                13                242           248,748
    Proceeds from issuance of preferred stock and warrants                            12,490             18,292            75,000
    Payments of equity issue costs                                                         -                  -           (17,473)
    Bank overdraft                                                                         -                  -             8,487
    Purchase of treasury stock                                                             -                (18)             (451)
---------------------------------------------------------------------------------------------------------------------------------
                Net cash provided by financing activities                             13,071            169,205           652,107
---------------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents                                             10,166             11,149            26,932
Cash and cash equivalents at beginning of period                                           -             10,166            21,315
---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period                                         $  10,166        $    21,315      $     48,247
=================================================================================================================================
Supplemental schedule of cash flow information:
    Cash paid for interest                                                         $       3        $        66      $     19,850
=================================================================================================================================
Supplemental schedule of non-cash financing activities:
    Equipment and furniture purchases payable                                      $     604        $     7,363      $        547
    Business acquisition costs from issuance of preferred stock and warrants       $       -        $         -      $     22,010
    Warrants issued to leasing companies                                           $       -        $         -      $      1,180
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
 The accompanying notes are an integral part of these consolidated financial
                                  statements.

                                      F-4
<PAGE>

                          RHYTHMS NETCONNECTIONS INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                     (In thousands, except share amounts)
<TABLE>
<CAPTION>

                                                          Preferred Stock              Common Stock            Treasury Stock
                                                          $0.001 par value            $0.001 par value             at Cost
                                                      -----------------------        -------------------     -------------------
                                                      Shares           Amount        Shares       Amount     Shares       Amount
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>               <C>          <C>            <C>       <C>          <C>
Issuance of common stock to Founders                         -         $    -       2,161,764     $    2             -    $    -
      at inception
Issuance of Series A preferred stock for cash       12,490,000             12               -          -             -         -
Issuance of common stock upon exercise
      of options                                             -              -         320,458          -             -         -
Grant of options to purchase Series A
      preferred stock                                        -              -               -          -             -         -
Deferred compensation from grants of
     options to purchase common stock                        -              -               -          -             -         -
Amortization of deferred compensation                        -              -               -          -             -         -
Net loss                                                     -              -               -          -             -         -
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997                        12,490,000             12       2,482,222          2             -         -

Issuance of Series A preferred stock for cash          365,094              1               -          -             -         -
Issuance of Series B preferred stock for cash        4,044,943              4               -          -             -         -
Issuance of common stock upon exercise
      of options                                             -              -       5,560,308          6             -         -
Purchase of treasury stock for cash                          -              -               -          -       438,115       (18)
Deferred compensation from grants of
     options to purchase common stock                        -              -               -          -             -         -
Amortization of deferred compensation                        -              -               -          -             -         -
Reversal of deferred compensation from
     cancellation of grants to purchase
     common stock                                            -              -               -          -             -         -
Net loss                                                     -              -               -          -             -         -
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998                        16,900,037         $   17       8,042,530     $    8       438,115    $  (18)
</TABLE>
<TABLE>
<CAPTION>
                                                          Additional                                             Total
                                                            Paid-In        Deferred          Accumulated      Stockholders'
                                                            Capital      Compensation          Deficit      Equity (Deficit)
---------------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>            <C>             <C>                <C>
Issuance of common stock to Founders                      $       -        $        -         $       -           $       2
      at inception
Issuance of Series A preferred stock for cash                12,477                 -                 -              12,489
Issuance of common stock upon exercise
      of options                                                 12                 -                 -                  12
Grant of options to purchase Series A
      preferred stock                                            73                 -                 -                  73
Deferred compensation from grants of
     options to purchase common stock                         1,450            (1,450)                -                   -
Amortization of deferred compensation                             -               192                 -                 192
Net loss                                                          -                 -            (2,422)             (2,422)
---------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997                                 14,012            (1,258)           (2,422)             10,346

Issuance of Series A preferred stock for cash                   291                 -                 -                 292
Issuance of Series B preferred stock for cash                17,996                 -                 -              18,000
Issuance of common stock upon exercise
      of options                                                236                 -                 -                 242
Purchase of treasury stock for cash                               -                 -                 -                 (18)
Deferred compensation from grants of
     options to purchase common stock                         4,908            (4,908)                -                   -
Amortization of deferred compensation                             -               725                 -                 725
Reversal of deferred compensation from
     cancellation of grants to purchase
     common stock                                              (231)              231                 -                   -
Net loss                                                          -                 -           (36,334)            (36,334)
---------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998                              $  37,212        $   (5,210)        $ (38,756)          $  (6,747)
</TABLE>

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

                                      F-5
<PAGE>

                          RHYTHMS NETCONNECTIONS INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                     (In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                  Preferred Stock          Common Stock           Treasury Stock
                                                  $0.001 par value       $0.001 par value             at cost            Additional
                                               -------------------      -------------------     -------------------        Paid-in
                                               Shares       Amount      Shares       Amount      Shares      Amount        Captial
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>            <C>        <C>           <C>        <C>          <C>         <C>
Balance at December 31, 1998                  16,900,037    $   17     8,042,530     $    8      438,115     $  (18)     $   37,212
Issuance of common stock in initial public
     offering                                          -         -    10,781,250         11            -          -         226,395
Issuance of common stock upon exercise of
     options for cash                                  -         -     2,711,247          3            -          -           3,333
Issuance of common stock in secondary
     offering                                          -         -       594,279          -            -          -          17,233
Issuance of common stock upon cashless
     exercise of warrants                              -         -     4,954,085          5            -          -           6,520
Issuance of Series C preferred stock and
     warrants for cash                         8,395,655         8             -          -            -          -          60,368
Issuance of Series D preferred stock and
     warrants for cash                           441,176         -             -          -            -          -           6,317
Business relationship value arising from
     issuance of Series C and D preferred stock        -         -             -          -            -          -          21,100
Costs arising from issuances of Series C
     and D preferred stock                             -         -             -          -            -          -            (245)
Conversion of preferred stock to common
     upon initial public offering            (25,736,868)      (25)   51,076,051         51            -          -             (26)
Costs arising from public offerings                    -         -             -          -            -          -         (17,224)
Purchase of treasury stock for cash                    -         -             -          -      550,779       (451)              -
Issuance of warrants to leasing companies              -         -             -          -            -          -               -
Issuance of warrants to business partner               -         -             -          -            -          -               -
Stock issuance under employee stock
     purchase plan                                     -         -        96,265          -            -          -           1,769
Deferred compensation from grants of
     options to purchase common stock                  -         -             -          -            -          -          11,428
Amortization of deferred compensation                  -         -             -          -            -          -               -
Reversal of deferred compensation from
     cancellation of grants to purchase
     common stock                                      -         -             -          -            -          -            (576)
Net loss                                               -         -             -          -            -          -               -
Unrealized gain on available-for-sale
     securities                                        -         -             -          -            -          -               -
-----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999                           -    $    -    78,255,707     $   78      988,894     $ (469)     $  373,604

</TABLE>
<TABLE>
<CAPTION>
                                                                                               Accumulated
                                                                                                  Other             Total
                                                                Deferred       Accumulated     Comprehensive      Stockholders'
                                                Warrants      Compensation       Deficit          Income         Equity (Deficit)
--------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>           <C>               <C>                <C>              <C>
Balance at December 31, 1998                    $      -      $   (5,210)      $  (38,756)        $     -           $    (6,747)
Issuance of common stock in initial public
     offering                                          -               -                -               -               226,406
Issuance of common stock upon exercise of
     options for cash                                  -               -                -               -                 3,336
Issuance of common stock in secondary
     offering                                          -               -                -               -                17,233
Issuance of common stock upon cashless
     exercise of warrants                              -               -                -               -                 6,525
Issuance of Series C preferred stock and
     warrants for cash                             7,124               -                -               -                67,500
Issuance of Series C preferred stock and
     warrants for cash                             1,183               -                -               -                 7,500
Business relationship value arising from
     issuance of Series C and D preferred stock        -               -                -               -                21,100
Costs arising from issuances of Series C
     and D preferred stock                             -               -                -               -                  (245)
Conversion of preferred stock to common
     upon initial public offering                      -               -                -               -                     -
Costs arising from public offerings                    -               -                -               -               (17,224)
Purchase of treasury stock for cash                    -               -                -               -                  (451)
Issuance of warrants to leasing companies          1,180               -                -               -                 1,180
Issuance of warrants to business partner             910               -                -               -                   910
Stock issuance under employee stock
     purchase plan                                     -               -                -               -                 1,769
Deferred compensation from grants of
     options to purchase common stock                  -         (11,428)               -               -                     -
Amortization of deferred compensation                  -           3,742                -               -                 3,742
Reversal of deferred compensation from
     cancellation of grants to purchase
     common stock                                      -             576                -               -                     -
Net loss                                               -               -         (218,880)              -              (218,880)
Unrealized gain on available-for-sale
     securities                                        -               -                -           2,633                 2,633
--------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999                    $ 10,397      $  (12,320)      $ (257,636)        $ 2,633           $   116,287
</TABLE>

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

                                      F-6
<PAGE>

RHYTHMS NETCONNECTIONS INC.
Notes to Consolidated Financial Statements



1.  THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Operations

Rhythms NetConnections Inc. (the Company), a Delaware corporation, was organized
under the name Accelerated Connections Inc. effective February 27, 1997. The
Company's name was changed to Rhythms NetConnections Inc. as of August 15, 1997.
The Company is in the business of providing broadband local access communication
services to businesses and consumers. The Company's services include high-speed
"always on" connections to the Internet and to private networks. The Company
began offering commercial services in the U.S. in April 1998.

The Company's ultimate success depends upon, among other factors, rapidly
expanding the geographic coverage of its network services; entering into
interconnection agreements with ILECs, some of which are competitors or
potential competitors of the Company; deploying network infrastructure;
attracting and retaining customers; accurately assessing potential markets;
continuing to develop and integrate its operational support system and other
back office systems; obtaining any required governmental authorizations;
responding to competitive developments; continuing to attract, retain and
motivate qualified personnel; and continuing to upgrade its technologies and
commercialize its network services incorporating such technologies. There can be
no assurance that the Company will be successful in addressing these matters and
failure to do so could have a material adverse effect on the Company's business,
prospects, operating results and financial condition. As the Company continues
the development of its business, it will seek additional sources of financing to
fund its development. If unsuccessful in obtaining such financing, the Company
will continue expansion of its operations on a reduced scale based on its
existing capital resources.

Principles of Consolidation and Basis of Presentation

The accompanying consolidated financial statements include the transactions and
balances of Rhythms NetConnections Inc. and its wholly owned subsidiaries
Rhythms Links Inc. and Rhythms Links Inc. - Virginia (since February 1998). All
significant intercompany balances and transactions have been eliminated in
consolidation.

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, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting periods. Actual results
could differ from those estimates and assumptions.

Revenue Recognition

Revenue consists of recurring fees for monthly DSL service, and nonrecurring
fees for equipment and installation. Customer contracts are renewable and range
from one to three years in duration with payments due on a monthly basis.
Monthly recurring service revenue is recorded in the month the services are
rendered. Revenue for installations is recognized to the extent of installation
costs in the month incurred. Costs in excess of revenue related to installation
services are deferred and amortized to network and service costs on a straight-
line basis over the term of the customer contracts.

                                      F-7
<PAGE>

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, money market funds, certificates
of deposit, obligations of the U.S. government and its agencies and commercial
paper with a maturity of three months or less at the time of purchase. Included
in accounts payable are outstanding checks in excess of cash balances of $8.5
million at December 31, 1999.

Short-Term Investments

Short-term investments consist of obligations of the U.S. government and its
agencies and commercial paper that have a maturity between 91 days and one year
from the date of purchase. Management determines the appropriate classification
of marketable debt and equity securities at the time of purchase.

Restricted Cash

Restricted cash is made up of a portfolio of U.S. government securities
purchased to secure payment of the first six scheduled interest payments on the
1999 senior notes.

Fair Value of Financial Instruments

The carrying amounts reported in the balance sheets for cash and cash
equivalents, short-term investments, accounts receivable, and accounts payable
approximate fair value because of the immediate or short-term maturity of these
financial instruments. The carrying amounts reported for long-term debt other
than the 12 3/4% senior notes and 13 1/2% senior discount notes approximate fair
value based upon management's best estimates of what interest rates would be
available for the same or similar instruments. The senior notes are publicly
traded securities. The combined quoted fair market value and the combined
carrying amount of the senior notes at December 31, 1999 are $471.9 million and
$505.7 million, respectively.

Investment in OCI Communications Inc.

On October 29, 1999, the Company completed a strategic investment in OCI
Communications Inc. (OCI), a provider of telecommunications services in Canada.
In exchange for a $5.3 million cash investment, the Company received warrants
convertible into 763,680 shares of Class B non-voting stock in OCI. These
warrants were converted in December 1999. As part of this investment, the
Company received various rights, including the ability to appoint a
representative to OCI's Board of Directors, among others. This investment is
classified as an available-for-sale security and is carried at fair value, with
the unrealized gains and losses, net of tax, reported as a separate component of
stockholders' equity. As part of this strategic relationship, in January 2000,
the Company formed a joint venture with OCI to offer DSL-based services in
selected Canadian markets. See Note 10.

Inventory

Inventory consists of communications equipment that will be installed at
customer locations. Inventory is accounted for using the first-in, first-out
method at the lower of cost or market.

Equipment and Furniture

Equipment and furniture consists of purchased equipment, furniture, computer
software, and leasehold improvements. Equipment and furniture is recorded at
cost. Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally three to seven years or the lease term, if
shorter. When equipment and furniture are retired, sold or otherwise disposed
of, the cost and related accumulated depreciation are removed from the accounts,
and gains and losses resulting from such transactions are reflected in
operations.

                                      F-8
<PAGE>

Collocation Fees

Collocation fees represent nonrecurring fees paid to secure central office space
for location of certain Company equipment. The fees are amortized over their
estimated useful lives of ten years.

Impairment of Long-Lived Assets

The Company investigates potential impairments of its long-lived assets on an
exception basis when evidence exists that events or changes in circumstances may
have made recovery of an asset's carrying value unlikely. An impairment loss is
recognized when the sum of the expected undiscounted future net cash flows is
less than the carrying amount of the asset. No such losses have been identified.

Concentrations of Credit Risk

Financial instruments, which potentially subject the Company to concentrations
of credit risk, consist primarily of cash equivalents and short-term
investments. Cash in excess of operating requirements is conservatively invested
in money market funds, certificates of deposit with high quality financial
institutions, obligations of the U.S. government and its agencies, and
commercial paper rated A-1, P-1 to minimize risk.

At December 31, 1998 and 1999, accounts receivable balances from two significant
customers were 22.4% and 33.2%, respectively, of the total net accounts
receivable balance and 50.4% and 40.8%, respectively, of revenues. Ongoing
credit evaluations of customers' financial condition are performed and,
generally, no collateral is required. The Company maintains an allowance for
potential credit losses and such losses, in the aggregate, have not exceeded
management's expectations. At December 31, 1998 and 1999, the allowance for
doubtful accounts was $50,000 and $0.4 million, respectively. The Company's
customer base is widespread geographically.

Advertising Costs

Advertising costs are expensed as incurred. Approximately $0.7 million and $6.9
million of advertising costs were incurred in 1998 and 1999,respectively. No
such material amounts were incurred in 1997.

Income Taxes

The Company provides for income taxes utilizing the liability method. Under the
liability method, current income tax expense or benefit represents income taxes
expected to be payable or refundable for the current period. Deferred income tax
assets and liabilities are established for both the impact of differences
between the financial reporting bases and tax bases of assets and liabilities
and for the expected future tax benefit to be derived from tax credits and tax
loss carryforwards. Deferred income tax expense or benefit represents the change
during the reporting period in the net deferred income tax assets and
liabilities. Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some portion or all
of the deferred tax assets will not be realized.

Net Loss Per Share

Basic earnings per share (EPS) is calculated by dividing the income or loss
available to common stockholders by the weighted average number of common shares
outstanding for the period without consideration for common stock equivalents.
Diluted EPS is computed by dividing the income or loss available to common
stockholders by the weighted average number of common shares outstanding for the
period in addition to the weighted average number of common stock equivalents
outstanding for the period. Shares subject to repurchase by the Company are
considered common stock equivalents for purposes of this calculation. Shares
issuable upon conversion of the Series A and Series B preferred stock, upon the
exercise of outstanding stock options and warrants and shares issued subject to
repurchase by the Company totaling 36,653,940 and 52,958,513, at December 31,
1997 and


                                      F-9
<PAGE>

1998, respectively, have been excluded from the computation since their effect
would be antidilutive. Shares issuable upon conversion of the exercise of
outstanding stock options and warrants and shares issued subject to repurchase
by the Company totaling 6,897,060 at December 31, 1999 have been excluded from
the computation since their effect would be antidilutive.


Stock Options and Stock Purchase Warrants

Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees," is applied in accounting for all employee stock option and stock
purchase warrant arrangements. Compensation cost is recognized for all stock
options and stock purchase warrants granted to employees when the exercise price
is less than the market price of the underlying common stock on the date of
grant. Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation" requires pro forma disclosures
regarding earnings (loss) as if compensation cost for stock options and stock
purchase warrants had been determined in accordance with the fair value based
method prescribed in SFAS No.123. Estimates of the fair market value are made
for each stock option and stock purchase warrant at the date of grant by the use
of the Black-Scholes option pricing model.

New Accounting Pronouncements

In December 1999, the SEC issued Staff Accounting Bulletin No. 101 (SAB No.
101), "Revenue Recognition in Financial Statements." SAB 101 provides specific
guidance, among other things, as to the recognition of revenue related to up-
front non-refundable fees and services charges received in connection with a
contractual arrangement. The Company will adopt SAB No. 101 as required in 2000.
The Company is in the process of evaluating the impact on its consolidated
financial statements.

In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued. This statement establishes accounting and reporting
standards for derivative instruments and for hedging activities. The Company
will adopt SFAS No. 133 as required in 2001. The Company expects that adoption
will have no impact on the consolidated financial statements.

Reclassifications

Certain balances in the 1997 and 1998 financial statements have been
reclassified to conform to the 1999 presentation. The reclassifications had no
effect on financial condition, results of operations or cash flows.


2.  SHORT-TERM INVESTMENTS

The Company's marketable debt securities are classified as held-to-maturity and
carried at amortized cost, which approximates fair value. Short-term investments
consist of the following:

    --------------------------------------------------------------------
                                                        December 31,
                                                ------------------------
    (In thousands)                                  1998            1999
    --------------------------------------------------------------------
    Short-term investments:
    Commercial paper                           $  33,170       $  75,902
    U.S. government securities                    82,327         216,106
    --------------------------------------------------------------------
                                               $ 115,497       $ 292,008
    --------------------------------------------------------------------


                                      F-10
<PAGE>

3.  COMPOSITION OF CERTAIN BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
                                                                       December 31,
                                                                -------------------------
(In thousands)                                                     1998            1999
-----------------------------------------------------------------------------------------
<S>                                                            <C>            <C>
Accounts, loans, interest and other receivables, net:
   Interest                                                      $  2,135       $   5,011
   Trade, net of allowance for doubtful accounts of
      $50 and $367 in 1998 and 1999, respectively                     197           4,016
   Other receivables from third parties                                 -           1,701
   Employee expense advances and loans                                 44             116
                                                                 $  2,376       $  10,844

Equipment and furniture, net:
   Operating equipment                                           $  9,633       $ 101,611
   Office furniture                                                   917           4,815
   Leasehold improvements                                             668           3,199
   Computer software                                                  456           7,993
   Computer equipment                                                 274          17,239
   Lab equipment                                                       17             605
   Accumulated depreciation                                          (455)        (10,631)
                                                                 $ 11,510       $ 124,831

Collocation fees, net:
   Collocation fees                                                13,889          59,860
   Accumulated amortization                                           (85)         (2,439)
                                                                 $ 13,804       $  57,421

Accrued expenses and other current liabilities:
   Accrued payroll                                               $  1,524       $   8,851
   Carrier services and other operating costs                         991           8,492
   Other                                                              301           5,820
                                                                 $  2,816       $  23,163
</TABLE>

4.  DEBT

Outstanding debt consists of the following:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
                                                                       December 31,
                                                                -------------------------
(In thousands)                                                     1998            1999
-----------------------------------------------------------------------------------------
<S>                                                            <C>            <C>
Note payable to bank; due in monthly installments of $28;
interest at prime plus 0.25% (8.0% and 8.75%,respectively);
collateralized by certain assets; matures April 2001            $     805       $     444
12 3/4% senior notes; due April 2009; unsecured                         -         325,000  (a)
13 1/2% senior discount notes; due May 2008; net of unamortized
discount of $109,304; unsecured                                   157,465         180,696  (b)
-----------------------------------------------------------------------------------------
Total debt                                                        158,270         506,140
Less current portion                                                 (333)           (333)
-----------------------------------------------------------------------------------------
                                                                $ 157,937       $ 505,807
-----------------------------------------------------------------------------------------
</TABLE>

                                      F-11
<PAGE>

(a)  Cash proceeds from the issuance of the 1999 senior notes were approximately
$314.5 million of which approximately $113.2 million was used to purchase a
portfolio of U.S. government securities to secure payment of the first six
scheduled interest payments on the 1999 senior notes. These senior notes are
unsecured obligations of the Company and mature on April 15, 2009. The notes are
redeemable at the Company's option, in whole or in part, at any time after April
15, 2004, at predetermined redemption prices, together with any accrued and
unpaid interest through the date of redemption. Upon a change of control, each
holder of the senior notes may require the Company to purchase the notes at 101%
of the principal amount thereof, plus any accrued and unpaid interest to the
date of purchase. The 1999 senior notes contain restrictive covenants, including
limitations on future indebtedness, restricted payments, transactions with
affiliates, liens, sale of stock of subsidiaries, entering new lines of
business, dividends, mergers and transfers of assets.

(b)  The sale of the 1998 senior discount notes included warrants to purchase
4,732,800 shares of common stock at an exercise price of $0.004 per share. The
notes were issued at a discount and cash proceeds from the issuance of the notes
and warrants were $150.4 million. The value ascribed to the warrants of $6.6
million resulted in additional debt discount. The debt issue costs are being
amortized to interest expense using the effective interest method over the
period that the notes are outstanding. The notes will accrete in value through
May 15, 2003, at a rate of 13 1/2% per annum, compounded semi-annually; no cash
interest will be payable prior to that date. Upon a change in control or upon
certain asset sales, the Company must offer to repurchase all or a portion of
the outstanding notes. In addition, the Company has the option to repurchase the
notes upon payment of a premium of accreted value at that point in time. The
notes contain restrictive covenants including limitations on future
indebtedness, restricted payments, transactions with affiliates, liens, sale of
stock of subsidiaries, dividends, mergers and transfers of assets.

Effective November 20, 1998, the Company completed an exchange offer of the 13
1/2% senior discount notes that allowed for registration of such notes under the
Securities Act of 1933, as amended. Of the original issue notes, $289.0 million
were tendered for exchange. The registered notes have substantially the same
terms and conditions as the unregistered notes, except that the registered notes
are not subject to the restrictions on resale or transfer that applied to the
unregistered notes.

Effective September 17, 1999, the Company completed an exchange offer of the 12
3/4% senior discount notes that allowed for registration of such notes under the
Securities Act of 1933, as amended. The original issue notes of $325.0 million
were tendered for exchange. The registered notes have substantially the same
terms and conditions as the unregistered notes, except that the registered notes
are not subject to the restrictions on resale or transfer that applied to the
unregistered notes.

Future maturities of outstanding debt are $0.3 million in 2000, $0.1 million in
2001, none in 2002, none in 2003, none in 2004, and $615.0 million thereafter.

5.  STOCKHOLDERS' EQUITY

The Company was initially capitalized in February 1997 with common stock.

On July 3, 1997, the Company issued 12,280,000 shares of its Series A preferred
stock to new and existing investors for an aggregate purchase price of $12.3
million, which converted into 29,472,000 shares of common stock upon the closing
of the initial public offering of the Company's common stock as discussed below.
In addition, 210,000 shares of Series A preferred stock was sold to certain
investors for an aggregate purchase price of $0.2 million, which converted into
504,000 shares of common stock upon the closing of the initial public offering
of the Company's common stock as discussed below. The Company also issued
365,094 shares of Series A preferred stock at a purchase price of $0.80 per
share which converted into 876,226 shares of common stock upon the closing of
the initial public offering of the Company's common stock in April 1999 as
discussed below.

On March 12, 1998, the Company issued 4,044,943 shares of its Series B preferred
stock to new and existing investors at a price of $4.45 per share. The Company
received proceeds totaling $18.0 million, which converted into 9,707,863 shares
of common stock upon the closing of the initial public offering of the Company's
common stock in April 1999 as discussed below.

                                      F-12
<PAGE>

In March 1999, the Company issued 3,731,410 shares of Series C preferred stock
to MCI WorldCom's investment fund for an aggregate purchase price of $30.0
million, which converted into 4,477,692 shares of common stock upon the closing
of the initial public offering of the Company's common stock in April 1999 as
discussed below. The terms of the transaction also provide for the Company and
MCI WorldCom to enter into various business relationships, including MCI
WorldCom's commitment to sell 100,000 of the Company's DSL lines over a period
of five years, subject to penalties for failure to reach target commitments.
This transaction included certain warrants as discussed in Note 6.

In March 1999, the Company issued 3,731,409 shares of Series C preferred stock
to Microsoft for an aggregate purchase price of $30.0 million, which converted
into 4,477,691 shares of common stock upon the closing of the initial public
offering of the Company's common stock in April 1999 as discussed below. The
terms of the transaction also provide for the Company and Microsoft to enter
into various business relationships. In connection with these business
relationships, the Company capitalized $10.0 million in business acquisition
costs that is being amortized to operating expense over a three-year period.
This transaction included certain warrants as discussed in Note 6.

In April 1999, the Company issued 932,836 shares of Series C preferred stock to
Qwest, which converted into 1,119,403 shares of common stock upon the closing of
the initial public offering of the Company's common stock in April 1999, as
discussed below. Also included was 441,176 shares of Series D preferred stock,
which converted into 441,176 shares of common stock upon the closing of the
initial public offering of the Company's common stock. The aggregate purchase
price for these transactions was $15.0 million. In accordance with provisions of
the agreement underlying this investment, the Company and Qwest have entered
into certain business relationships. In connection with this business
relationship, the Company capitalized $11.1 million in business acquisition
costs that is being amortized to operating expense over a five-year period. This
transaction included certain warrants as discussed in Note 6.

Effective April 12, 1999, the Company completed an initial public offering of
its common stock. A total of 10,781,250 common shares were issued at $21.00 per
share; net proceeds to the Company were approximately $210.1 million after
payment of underwriting fees and related issue costs. Upon completion of the
offering, all classes of preferred stock automatically converted to common
stock, resulting in an additional 51,076,051 shares of common stock being issued
leaving no shares of preferred stock issued and outstanding.

Effective August 17, 1999, the Company completed a secondary public offering of
its common stock in a transaction that allowed certain holders of warrants
issued in connection with the 13 1/2% senior discount notes to exercise those
warrants and sell the resulting common stock at $29.00 per share. A total of
3,961,862 shares were issued in the transaction; the company received no
proceeds from the sale of these shares. In connection with the secondary
offering, the underwriters of the offering were allowed to purchase 594,279
shares of common stock from the Company for $29.00 per share. The sale of these
shares was completed on September 14, 1999 and the Company received proceeds of
$16.4 million, net of underwriting discount.

Effective November 4, 1998, the Company completed a two-for-one split of its
common stock. Effective March 19, 1999, the Company completed a six-for-five
split of its common stock. The accompanying consolidated financial statements
have been restated for all periods presented to reflect the stock splits.

6.  STOCK OPTIONS AND WARRANTS

The Company has established the 1999 Stock Incentive Plan (the 1999 Plan) as the
successor equity incentive program to the 1997 Option/Stock Issuance Plan (the
1997 Plan). The 1999 Plan provides for the grant of options to employees,
directors and outside consultants for purchase of up to an aggregate of
17,173,530 shares of


                                      F-13
<PAGE>

common stock. All outstanding options under the 1997 Plan were incorporated into
the 1999 Plan, and no further options grants may be made under the 1997 Plan.
Options granted under the 1997 Plan are immediately exercisable and expire
within ten years after the date of grant. Shares acquired upon exercise are
subject to repurchase by the Company ratably over a four-year period from the
date of grant, at the option of the Company and at the exercise price. Options
granted under the 1999 Plan are exercisable ratably over a four-year period from
date of grant and expire within ten years of the date of the grant. The 1999
Plan provides for both incentive option and non-statutory option grants and for
accelerated vesting in the event of a 50% or more change in control of the
Company.

         The 1999 Plan activity is as follows:
<TABLE>
<CAPTION>
    ------------------------------------------------------------------------------------------------
                                                                       Weighted         Weighted
                                                      Number of         Average          Average
                                                       Shares          Fair Value     Exercise Price
    ------------------------------------------------------------------------------------------------
    <S>                                            <C>                 <C>               <C>
    Granted, below market                             5,801,714          $   0.29          $   0.04
    Exercised                                          (320,458)             0.29              0.04
    ------------------------------------------------------------------------------------------------
       Outstanding at December 31, 1997               5,481,256          $   0.29          $   0.04

    Granted, below market                             3,364,680          $   2.62          $   0.84
    Exercised                                        (5,560,308)             0.30              0.04
    Canceled                                           (136,348)             1.10              0.22
    ------------------------------------------------------------------------------------------------
       Outstanding at December 31, 1998               3,149,280          $   2.73          $   0.89

    Granted, at market                                6,160,030          $  31.58          $  31.58
    Granted, below market                             2,081,298              6.36             12.54
    Exercised                                        (2,711,247)             3.11              1.23
    Canceled                                           (962,100)            19.23             13.65
    ------------------------------------------------------------------------------------------------
       Outstanding at December 31, 1999               7,717,261          $  26.87          $  25.12
    ------------------------------------------------------------------------------------------------
</TABLE>
The following summarizes the outstanding and exercisable options under the 1999
Plan at December 31, 1999:
<TABLE>
<CAPTION>
    --------------------------------------------------------------------------------------------------
                                              Options Outstanding               Options Exercisable
                                            -------------------------       --------------------------
                                            Weighted         Weighted                         Weighted
                                             Average          Average                          Average
         Exercise             Number        Remaining        Exercise         Number          Exercise
          Price            Outstanding         Life            Price        Exercisable         Price
    --------------------------------------------------------------------------------------------------
   <S>                     <C>           <C>              <C>             <C>                <C>
    $0.21 to $0.25             174,384      8.53 years         $0.23          174,384           $0.23
    $1.67 to $1.88             481,223      8.86 years         $1.72          481,223           $1.72
    $3.33 to $6.37             897,176      9.08 years         $4.37          897,176           $4.37
    $14.23 to $16.00         1,780,598      9.26 years        $15.93        1,702,262          $15.98
    $43.50 to $56.94           940,680      9.47 years        $52.65                -               -
    $26.69 to $35.25         3,443,200      9.77 years        $32.27                -               -
    --------------------------------------------------------------------------------------------------
</TABLE>

During 1997, 1998, and 1999, options were granted to employees at less than fair
value on the date of grant, resulting in $1.5 million, $4.9 million, and $11.4
million, respectively, of deferred compensation recorded as a reduction of
stockholders' equity. These amounts are being amortized as a charge to deferred
compensation
                                      F-14
<PAGE>

expense over the vesting periods of the applicable options; such amortization
totaled $0.2 million, $0.7 million, and $3.7 million for the periods ended
December 31, 1997, 1998, and 1999, respectively.

An option to purchase 365,094 shares of Series A preferred stock at $0.80 per
share was granted to an employee during 1997. The Company recorded $73,000 in
compensation expense during 1997 related to this grant.

Had compensation expense for the Company's 1999 Plan and the preferred stock
option been determined based on the fair value method of accounting for stock-
based compensation, the Company's net loss and net loss per share for the
periods ended December 31, 1997, 1998, and 1999 would have been increased by
$11,000, $60,000, and $10.8 million and $0.01, $0.02, and $0.20 per share,
respectively. For purposes of determining this compensation expense, the fair
value of each option grant is estimated on the grant date using the Black-
Scholes option pricing model with the following weighted average assumptions
used for grants during the periods ended December 31, 1997, 1998, and 1999,
respectively: no dividend yield; risk-free interest rates of 5.3%, 4.9%, and
5.5%, respectively; expected volatility of nil for pre-initial public offering
grants; and 50% for post initial public offering grants and expected term of
four years for common options and six months for the preferred option.

The following summarizes the issued, outstanding, and exercised warrants at
December 31, 1999:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------
                                                    Number of
                                                    Original     Number of    Number of
                                                    Warrants     Warrants      Warrants    Exercise Price    Expiration
                                                     Issued      Exercised   Outstanding      Per Share         Date
------------------------------------------------------------------------------------------------------------------------
<S>                                               <C>          <C>           <C>              <C>          <C>
Warrants issued with 13 1/2% senior
   discount notes                                   4,732,800    4,701,973        30,827          $ 0.004       May 2008
Warrants issued with Series C preferred stock       1,440,000            -     1,440,000             6.70     March 2004
Warrants issued with Series C preferred stock         136,996                    136,996            21.00     April 2004
Warrants issued with Series D preferred stock         180,000            -       180,000             6.70     April 2004
May 1998 warrants issued with lease agreement         574,380      258,472       315,908             1.85     March 2009
March 1999 warrants issued with lease agreement        45,498            -        45,498            10.55     March 2009
April 1999 warrants issued with lease agreement        75,000            -        75,000            10.55     April 2002
July 1999 warrants issued with lease agreement         10,000            -        10,000            50.00      July 2004
------------------------------------------------------------------------------------------------------------------------
</TABLE>

In August 1999, after a "net exercise" of the warrants associated with the 13
1/2% senior discount notes, 3,961,862 of these shares were sold and an
additional 740,111 shares were sold by the selling stockholders in November
1999. The Company received no proceeds from these sales. The remaining warrants
have an expiration date of May 15, 2008. The warrants may be required to be
repurchased by the Company for cash upon the occurrence of a repurchase event,
such as a consolidation, merger, or sale of assets to another entity, as defined
in the provisions of the Warrant Agreement, at a price to be determined by an
independent financial expert selected by the Company. In the event a repurchase
event occurs, the difference between the repurchase price and the carrying value
of the warrants would be charged to equity.

During May 1998, the Company entered into a 36-month lease line that provides
for $24.5 million in equipment on an operating lease basis. In connection with
this lease agreement, the Company issued 574,380 warrants to purchase common
stock at a price of $1.85 per share, exercisable immediately. In March 1999, the
Company entered into additional 36-month lease lines for an aggregate of up to
$24.0 million in lease financing. In connection with these March 1999 leases,
the Company issued warrants to purchase an aggregate of 45,498 shares of common
stock at a price of $10.55 per share. These warrants are immediately
exercisable. In April 1999, the Company entered into an agreement for up to
$20.0 million in equipment lease financing and issued a warrant to purchase up
to 75,000 shares of common stock at an exercise price per share of $10.55. This
warrant is immediately exercisable. In July 1999, the Company entered into an
additional 36-month lease line for an aggregate of up to $26.0 million in lease
financing to be used for equipment. In connection with this July 1999

                                      F-15
<PAGE>

lease, the Company issued a warrant to purchase 10,000 shares of common stock at
a price of $50.00 per share. This warrant is immediately exercisable.

7.  INCOME TAXES

As of December 31, 1999, the Company had net operating loss carryforwards of
approximately $210.2 million, which are available to offset future taxable
income through 2019 for federal tax, a portion of which will be subject to the
limitations of Internal Revenue Code Section 382 relating to changes in
ownership of the Company. The deferred tax asset arising from the loss
carryforwards has been fully offset by a valuation allowance since the
utilization is uncertain. The valuation allowance increased by approximately
$1.0 million, $13.9 million, and $84.0 million during 1997, 1998, and 1999,
respectively, primarily as a result of the losses in each of these periods.

Components of deferred income taxes are as follows:

    ---------------------------------------------------------------------
    (In thousands)                                 1998              1999
    ---------------------------------------------------------------------
    Deferred tax assets:
       Net operating loss carryforwards        $ 14,724          $ 85,028
       Original issue discount and other            178            13,885
    ---------------------------------------------------------------------
    Gross deferred tax asset                     14,902            98,913
    Valuation allowance                         (14,902)          (98,913)
    ---------------------------------------------------------------------
    Net deferred income taxes                  $      -          $      -
    ---------------------------------------------------------------------

The provision for (benefit from) income taxes reconciles to the statutory
federal tax rate as follows:

  --------------------------------------------------------------------------
                                              1997         1998        1999
  --------------------------------------------------------------------------
  Statutory federal tax rate                 (34.0%)      (34.0%)     (35.0%)
  State income tax, net of federal benefit    (5.4%)       (5.4%)      (5.3%)
  Other (including non-deductible items)      (1.8%)        0.9%        1.7%
  Deferred tax asset valuation allowance      41.2%        38.5        38.6%
  --------------------------------------------------------------------------
                                                 -%           -%          -%
  --------------------------------------------------------------------------


8.  RELATED PARTY TRANSACTIONS

The Company's in-house legal counsel is also a partner in a law firm used
externally by the Company. During 1998 and 1999, the Company incurred legal fees
and expenses of approximately $1.3 million and $2.4 million, respectively, to
the external firm in addition to the salary paid to the in-house counsel. At
December 31, 1999, the Company had a balance payable of approximately $0.7
million to this entity.

Two members of the Company's Board of Directors serve as directors to a company
that supplies equipment to the Company. The total purchases during 1998 and 1999
from the equipment supplier were approximately $13.0 million and $54.0 million,
respectively. At December 31, 1999, the Company had a balance payable of
approximately $0.4 million to this entity.

One member of the Company's Board of Directors serves as President of MCI
WorldCom Venture Fund and a Senior Vice President of MCI WorldCom. In March
1999, the Company entered into a strategic arrangement with MCI WorldCom. No
revenue was received from MCI WorldCom in 1999 under this arrangement.

                                      F-16
<PAGE>

9.   COMMITMENTS AND CONTINGENCIES

The Company leases office space and certain office equipment, telecommunications
equipment, network equipment and furniture under non-cancelable operating lease
agreements. The leases range in term from 24 months to 60 months and, in certain
instances, provide for options to extend. Rent expense under the operating
leases for 1997, 1998, and 1999 totaled $46,000, $2.0 million, and $21.0
million, respectively. Future minimum rental payments under the leases are $41.1
million in 2000, $40.6 million in 2001, $25.2 million in 2002, $3.5 million in
2003, $1.8 million in 2004, and $58,000 thereafter.

On February 18, 1999, the Company filed a complaint for declaratory relief in
San Diego County Superior Court, North County against Thomas R. Lafleur. Mr.
Lafleur is a former employee of the Company. After he left, he was sent a check
for the repurchase or buy-back of his unvested shares. Mr. Lafleur refused to
cash this check. The declaratory relief action is to determine that his shares
were unvested and thus properly repurchased. The Company has since amended its
complaint to allege additional causes of action, including fraud, breach of
contract, and interference with prospective economic advantage. On or about
March 26, 1999, Mr. Lafleur filed an answer to the complaint and also filed a
cross-complaint against the Company. The cross-complaint has been amended a
number of times and seeks compensatory and punitive damages. The Company intends
to defend vigorously against the claims asserted in the current cross-complaint.
The Company is currently accounting for these 438,115 shares as treasury stock.

The Company is aware of the filing of a legal action by i2 Technologies, Inc. in
the United States District Court in the Northern District of Texas on January 7,
2000, challenging its use of the name "Rhythms" on various grounds and alleging
that its use of that name infringes certain trademarks owned by i2 Technologies.
The Company denies that it infringes any legitimate trademark rights of i2
Technologies, in part on the grounds that the Company has priority in the
Rhythms name with respect to the goods and services provided by it and that its
use of those marks is not likely to cause confusion among the consumers of our
services and the services provided by i2 Technologies, respectively. The Company
intends to vigorously defend the continued use of its name in the manner in
which we have used it in the past and the Company's interests in the name
"Rhythms."

In addition, the Company is subject to state commission, Federal Communications
Commission and court decisions as they relate to the interpretation and
implementation of the 1996 Telecommunications Act, the interpretation of
competitive carrier interconnection agreements in general and our
interconnection agreements in particular. In some cases, the Company may be
deemed to be bound by the results of ongoing proceedings of these bodies. The
Company therefore, may participate in proceedings before these regulatory
agencies or judicial bodies that affect, and allow it to advance, its business
plans.


10.  SUBSEQUENT EVENTS

In January 2000, the Company formed a joint venture with OCI to offer DSL-based
services in selected Canadian markets. The Company and OCI each received 100,000
shares of Class A voting stock. OCI also purchased 10,000,000 shares of Series A
preferred shares with a redemption amount of US $1.00 per share for $10.0
million. The Series A preferred shares have no voting or conversion rights, but
will earn dividends at a rate of six percent per annum payable only upon
redemption. To the extent the joint venture is unable to receive sufficient
financing through third parties, the Company and OCI shall be obligated to
provide additional capital contributions through installments.

In January and February 2000, the Company entered into an additional 36-month
lease line for an aggregate of up to $50.0 million in lease financing with GATX
Capital Corporation to be used for network equipment. In February 2000, the
Company entered into an additional 36-month lease line for $25.0 million in
lease financing with Cisco Systems Capital Corporation to be used for network
equipment.


                                      F-17
<PAGE>

In February 2000, the Company issued $300.0 million aggregate principal amount
of 14% senior notes due 2010. Net proceeds of approximately $291.3 million were
raised. These senior notes are general unsecured obligations of the Company and
mature on February 15, 2010. The notes are redeemable at the Company's option,
in whole or in part, at any time after February 15, 2005, at predetermined
redemption prices, together with any accrued and unpaid interest through the
date of redemption. Upon a change of control, each holder of the senior notes
may require the Company to purchase the notes at 101% of the principal amount
thereof, plus any accrued and unpaid interest to the date of purchase. The 2000
senior notes contain restrictive covenants, including limitations on future
indebtedness, restricted payments, transactions with affiliates, liens, sale of
stock of subsidiaries, entering new lines of business, dividends, mergers and
transfer of assets.

In February and March 2000, the Company issued 3,000,000 shares of 6 3/4% Series
F cumulative convertible preferred stock in a private placement. Net proceeds
were approximately $291.0 million. Each share of Series F preferred stock is
convertible into 2.35 shares of common stock at any time at a conversion price
of $42.56 per share, subject to adjustment. Holders of Series F preferred stock
are entitled to dividends on a cumulative basis at an annual rate of 6 3/4%,
payable quarterly in cash. The preferred stock is redeemable at the Company's
option, in whole or in part, at any time after March 6, 2003, at predetermined
redemption prices, together with any accrued and unpaid dividends through the
date of redemption. Upon a change of control, each holder of the preferred
shares may require the Company to purchase any or all of the shares at 100% of
the liquidation preference, plus any accrued and unpaid dividends to the date of
purchase. The Series F preferred stock is subject to mandatory redemption on
March 3, 2012.

In March 2000, the Company sold $250.0 million of 8 1/4% Series E convertible
preferred stock to Hicks, Muse, Tate & Furst Inc. (Hicks Muse). Each share of
Series E preferred stock is convertible into shares of common stock at any time
at a conversion price of $37.50 per share, subject to adjustment. In addition,
the Company issued Hicks Muse warrants to purchase 1,875,000 shares of common
stock at an exercise price of $45.00 per share, exercisable for three years;
1,875,000 shares of common stock at an exercise price of $50.00 per share,
exercisable for five years; and 1,875,000 shares of common stock at an exercise
price of $55.00 per share, exercisable for seven years.

As part of the Hicks Muse agreement, holders of Series E preferred stock
affiliated with Hicks Muse have the right to appoint one representative to the
Company's Board of Directors provided that they continue to hold 40% of the
Series E preferred stock purchased by them or the underlying common stock or any
combination thereof. In addition, holders of the Company's Series E preferred
stock are be entitled to vote on all matters upon which the Company's common
stockholders can vote.


11.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table sets forth certain unaudited consolidated statement of
income data for each of the Company's last eight quarters. This data has been
derived from unaudited consolidated financial statements that have been prepared
on the same basis as the annual audited consolidated financial statements and,
in the opinion of the Company, include all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of such
information. These unaudited quarterly results should be read in conjunction
with the consolidated financial statements and notes. The consolidated results
of operations for any quarter are not necessarily indicative of the results for
any future period.

                                      F-18
<PAGE>
<TABLE>
<CAPTION>

------------------------------------------------------------------------------------------------
(In thousands, except per share data)       March 31       June 30      Sept. 30       Dec. 31
-------------------------------------------------------  ------------  ------------  -----------
<S>                                        <C>            <C>          <C>            <C>
1998:
Revenue                                           $ 10          $ 71         $ 166         $ 281

Total costs and expenses                       $ 2,536       $ 5,147       $ 8,935       $12,311

Loss from operations                          $ (2,526)     $ (5,076)     $ (8,769)    $ (12,030)

Net loss                                      $ (2,380)     $ (6,769)     $(11,881)    $ (15,304)
------------------------------------------------------------------------------------------------
Net loss per share (basic and diluted)         $ (1.10)      $ (2.84)      $ (3.47)      $ (0.68)
------------------------------------------------------------------------------------------------

------------------------------------------------------------------------------------------------
(In thousands, except per share data)       March 31       June 30      Sept. 30       Dec. 31
-------------------------------------------------------  ------------  ------------  -----------
1999:
Revenue                                          $ 660       $ 1,641       $ 3,317       $ 5,471

Total costs and expenses                       $20,716       $37,370       $55,980       $86,188

Loss from operations                         $ (20,056)    $ (35,729)     $(52,663)    $ (80,717)

Net loss                                     $ (23,899)    $ (42,857)     $(61,778)    $ (90,346)
------------------------------------------------------------------------------------------------
Net loss per share (basic and diluted)         $ (5.38)      $ (0.68)      $ (0.89)      $ (1.23)
------------------------------------------------------------------------------------------------
</TABLE>
                                      F-19
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS
                        ON FINANCIAL STATEMENT SCHEDULE

To the Board of Directors of
Rhythms NetConnections Inc.

    Our audits of the consolidated financial statements referred to in our
report dated February 29, 2000, except for Note 10, as to which the date is
March 16, 2000 included in this Annual Report on Form 10-K also included an
audit of the financial statement schedule listed in the index in Item 14 of this
Form 10-K. In our opinion, this financial statement schedule presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.



PricewaterhouseCoopers LLP


Denver, Colorado
February 29, 2000


<PAGE>

                                  SCHEDULE II


                       Valuation and Qualifying Accounts
                                (in thousands)
<TABLE>
<CAPTION>

<S>                                  <C>              <C>            <C>          <C>
                                   |
                                   |   Balance at     Charged to      Deduction/     Balance at end
                                   |  Beginning of    Costs and       Write-offs       of Period
                                   |     Period        Expenses
-----------------------------------|------------------------------------------------------------------
Allowance for uncollectible trade  |
receivables:                       |
  Year ended December 31, 1997     |    $   -          $   -             $   -            $   -
  Year ended December 31, 1998     |    $   -          $  50             $   -            $  50
  Year ended December 31, 1999     |    $  50          $ 325             $  (8)           $ 367
                                   |

</TABLE>