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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K/A

(Amendment No. 1)



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(Mark One)

|x | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
|- | -------------------------------------------------------------------------------



For the fiscal year ended December 31, 2003



OR



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
|- | -----------------------------------------------------------------------------------



Commission file number 000-24661



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FiberNet Telecom Group, Inc.

(Name of Registrant in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 52-2255974                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|570 Lexington Avenue, New York, NY                             |  | 10022                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          



(212) 405-6200

(Issuers Telephone Number, Including Area Code)



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Securities registered under Section 12(b) of the Exchange Act: None



Securities registered under Section 12(g) of the Exchange Act:



Common Stock, par value $.001 per share

(Title of Class)



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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for past 90 days.    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 registrants knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. ̈



As of July 6, 2004, the aggregate market value of the registrants voting stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in such calculation is an
affiliate) was $25,706,033, as computed by reference to the price at which the common stock was last sold on June 30, 2003.



The number of shares outstanding of the registrants common stock, as of July 6, 2004, was 51,064,872 shares of Common Stock, $.001 par value.



Check whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).    Yes ̈No   x



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EXPLANATORY NOTE



This Amendment No. 1 to our Annual Report on Form 10-K for our fiscal year ended December 31, 2003 is being filed in order
to reflect the restatement of our consolidated financial statements for the years ending December 31, 2001, December 31, 2002 and December 31, 2003. The effects of the reclassifications and additional disclosure discussed below had no impact on our
previously reported revenues, net loss, net loss per share, assets, total liabilities, statements of cash flows, or statements of stockholders equity for the years ended December 31, 2001, 2002 and 2003.



This amendment reflects a reclassification of loss from the early
extinguishment of debt from operating expenses to other expenses. The reclassification was made based on guidance with respect to the treatment of early extinguishment of debt. This reclassification resulted in a reduction of loss from operations
for the years ending 2001, 2002 and 2003.



In addition, this
amendment also reflects a reclassification of a portion of deferred revenue from a current liability to a long-term liability. Subsequent to the issuance of our consolidated financial statements, we determined that certain prepayments from customers
classified as current deferred revenue were related to long-term contracts and should have been classified as a long-term liability. As a result, we have reclassified that portion of current deferred revenue as a long-term liability. This
reclassification resulted in a reduction of current liabilities and a corresponding increase in long-term liabilities of $1.4 million and $0.5 million as of December 31, 2003 and 2002, respectively.



This amendment also contains additional disclosures on income taxes relating
to a permanent difference caused by the impairment of non-deductible goodwill and the change in the valuation allowance included in the statutory rate reconciliation contained in Note 12. In 2003, we recorded an adjustment to our gross deferred tax
assets and the related valuation allowance. This adjustment had no effect on the consolidated financial statements as we provide a full valuation allowance for all deferred taxes. In the 2001 statutory income tax rate reconciliation, we have
provided additional disclosures relating to a difference caused by the impairment of non-deductible goodwill and the change in the valuation allowance. Such amounts had been combined into one line item in the disclosure previously presented. As a
result of this additional disclosure, the aforementioned adjustment previously disclosed in 2003 was no longer required.



Finally, certain disclosures previously presented in Note 1 to the consolidated financial statements were moved to Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations in the section entitled Certain Facts That May Affect Future Results of Operations.



The following document contains only parts that were affected by the aforementioned restatement. For the full document,
please refer to the Form 10-K previously filed in addition to this Form 10-K/A.



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PART II



ITEM 6. SELECTED FINANCIAL DATA



You should read the selected financial data presented below, in conjunction with our consolidated financial statements, the notes to those consolidated
financial statements and the managements discussion and analysis of financial condition and results of operations section appearing elsewhere in this report on Form 10-K/A.



The consolidated statement of operations data for the years ended December 31, 2003, 2002, and 2001 and the balance sheet
data as of December 31, 2003 and 2002 have been derived from our audited consolidated financial statements included elsewhere herein, and should be read in conjunction with those financial statements (including notes thereto). The selected financial
data as of December 31, 2001, 2000 and 1999 and for the years ended December 31, 2000 and 1999 have been derived from audited consolidated financial statements not included herein, but which were previously filed with the Securities and Exchange
Commission, or SEC. Our historical results are not necessarily indicative of the operating results to be realized in the future.



The consolidated financial statements as of and for the years ended December 31, 2003 and 2002 have been audited by Deloitte & Touche LLP, independent
registered public accounting firm. The previous periods referred to above were audited by Arthur Andersen LLP, independent public accountants.



CONSOLIDATED FINANCIAL DATA

(in
thousands, except per share amounts)



|                                                                        |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|----------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ------------------- |  | - | ------------------ | - |  | ------------------ | ------- | - |  | - | ------- | -
|                                                                        |  | Year Ended December 31, |        
|                                                                        |  | 1999                    |         |   | 2000 |   |         | 2001 (restated) (1) |  |   | 2002 (restated)(1) |   |  | 2003 (restated)(1) |        
|Statement of Operations Data:                                           |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Revenues                                                                |  | $                       |        |   |      | $ | 13,117  |                     |  | $ | 31,195             |   |  | $                  | 25,334  |   |  | $ | 26,604  |  
|Operating expenses:                                                     |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Cost of services (exclusive of items shown separately below)            |  |                         |        |   |      |   | 5,388   |                     |  |   | 13,801             |   |  |                    | 7,537   |   |  |   | 8,806   |  
|Selling, general and administrative expenses                            |  |                         | 7,355   |   |      |   | 27,072  |                     |  |   | 32,917             |   |  |                    | 16,053  |   |  |   | 16,409  |  
|Stock related expense for selling, general and administrative matters   |  |                         | 803     |   |      |   | 8,468   |                     |  |   | (1,172             | ) |  |                    | 225     |   |  |   | 222     |  
|Non-recurring expenses                                                  |  |                         | 4,304   |   |      |   |        |                     |  |   |                   |   |  |                    |        |   |  |   |        |  
|Impairment of property, plant and equipment                             |  |                         |        |   |      |   |        |                     |  |   | 51,848             |   |  |                    | 13,175  |   |  |   | 1,346   |  
|Impairment of goodwill                                                  |  |                         |        |   |      |   |        |                     |  |   | 56,467             |   |  |                    |        |   |  |   | 7,509   |  
|Depreciation and amortization                                           |  |                         | 520     |   |      |   | 7,652   |                     |  |   | 15,319             |   |  |                    | 10,346  |   |  |   | 8,840   |  
|                                                                        |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Total operating expenses                                                |  |                         | 12,982  |   |      |   | 48,580  |                     |  |   | 169,180            |   |  |                    | 47,336  |   |  |   | 43,132  |  
|                                                                        |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Loss from operations                                                    |  |                         | (12,982 | ) |      |   | (35,463 | )                   |  |   | (137,985           | ) |  |                    | (22,002 | ) |  |   | (16,528 | )
|Loss on early extinguishments of debt                                   |  |                         |        |   |      |   |        |                     |  |   | (7,398             | ) |  |                    | (7,859  | ) |  |   | (8,951  | )
|Interest income (expense), net                                          |  |                         | (1,356  | ) |      |   | (5,657  | )                   |  |   | (8,594             | ) |  |                    | (7,543  | ) |  |   | (2,296  | )
|Interest expense from beneficial conversion                             |  |                         | (15,870 | ) |      |   |        |                     |  |   |                   |   |  |                    |        |   |  |   |        |  
|                                                                        |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Net loss                                                                |  |                         | (30,208 | ) |      |   | (41,120 | )                   |  |   | (153,977           | ) |  |                    | (37,404 | ) |  |   | (27,775 | )
|Preferred stock dividends                                               |  |                         | (757    | ) |      |   | (8,113  | )                   |  |   | (1,080             | ) |  |                    | (44     | ) |  |   |        |  
|Preferred stockbeneficial conversion                                   |  |                         | (100    | ) |      |   | (27,766 | )                   |  |   | (23,109            | ) |  |                    |        |   |  |   |        |  
|                                                                        |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Net loss applicable to common stockholders                              |  | $                       | (31,065 | ) |      | $ | (76,999 | )                   |  | $ | (178,166           | ) |  | $                  | (37,448 | ) |  | $ | (27,775 | )
|                                                                        |  |                         |         |   |      |   |         |                     |  |   |                    |   |  |                    |         |   |  |   |         |  
|Net loss applicable to common stockholders per share: basic and diluted |  | $                       | (55.47  | ) |      | $ | (77.93  | )                   |  | $ | (130.14            | ) |  | $                  | (6.09   | ) |  | $ | (0.75   | )
|Weighted average common shares outstanding: basic and diluted           |  |                         | 560     |   |      |   | 988     |                     |  |   | 1,369              |   |  |                    | 6,148   |   |  |   | 37,192  |  



On May 12, 2003, we
completed our 1-for-30 reverse stock split previously approved by stockholders. The earnings per share information and all share amounts as presented in these selected financial data have been adjusted to reflect the reverse stock split.



|                                   |  |                    |        |      |   |         |  |                     |         |                     |   |         |  |   |       
|---------------------------------- |  | ------------------ | ------ | ---- | - | ------- |  | ------------------- | ------- | ------------------- | - | ------- |  | - | ------
|                                   |  | As of December 31,
|                                   |  | 1999               |        | 2000 |   | 2001    |  | 2002 (restated) (1) |         | 2003 (restated) (1)
|Balance Sheet Data:                |  |                    |        |      |   |         |  |                     |         |                     |   |         |  |   |       
|Cash and cash equivalents          |  | $                  | 9,512  |      | $ | 1,582   |  | $                   | 3,338   |                     | $ | 3,788   |  | $ | 3,488 
|Other current assets               |  |                    | 160    |      |   | 14,990  |  |                     | 3,359   |                     |   | 3,505   |  |   | 6,876 
|Property, plant and equipment, net |  |                    | 55,177 |      |   | 126,114 |  |                     | 109,837 |                     |   | 95,122  |  |   | 86,958
|Total assets                       |  |                    | 77,588 |      |   | 227,165 |  |                     | 136,587 |                     |   | 113,795 |  |   | 99,618
|Long-term liabilities              |  |                    | 956    |      |   | 46,559  |  |                     | 89,403  |                     |   | 31,080  |  |   | 19,769
|Total stockholders equity         |  |                    | 68,252 |      |   | 144,283 |  |                     | 24,348  |                     |   | 68,598  |  |   | 64,734

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|(1) | See Note 17 to the consolidated financial statements.
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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS



Restatement of Statement of Operations



Subsequent to the issuance of our consolidated financial statements for the
year ended December 31, 2003, we restated our consolidated financial statements for the items discussed in Note 17. The effects of the restatement have been reflected in the accompanying Managements Discussion and Analysis of Financial
Condition and Results of Operations.



Overview



We deploy, own and operate fiber-optic networks designed to provide
comprehensive broadband connectivity for data, voice and video transmission to other telecommunications service providers in major metropolitan areas. We have experienced significant operating losses, net losses and negative cash flows from
operating activities. We expect to continue to experience such losses as we continue to operate our business. We also have a limited operating history. Consequently, prospective investors have limited operating history and financial data upon which
to evaluate our performance.



The telecommunications industry
continues to experience a period of uncertainty and rationalization. Many companies in our industry are in financial distress, and some of our largest customers have filed for bankruptcy. We have been negatively impacted by the general economic
environment and by the difficulties that are impacting our industry. Expectations for growth in demand for broadband services have not materialized, resulting in significant excess capacity in existing communications networks. This excess supply of
bandwidth and the intense competition among industry participants has produced substantial pressure on the pricing of our services with decreases of up to 50% in recurring monthly charges. In addition, customer contracts and services have been
cancelled, resulting in a loss of recurring revenues to us. We are unable to determine the extent to which additional contracts or services that we provide to our customers will be cancelled, and we cannot forecast our ability to replace those
cancelled contracts with new contracts. As a result, our revenues, business operations and liquidity may continue to be negatively affected by the market environment.



Factors Affecting Future Operations



Revenues. We generate revenues from selling network capacity and related services to other communications service providers. Revenues are derived
from three general types of services:



| |  | Transport services. Our transport services include the offering of broadband circuits on our metropolitan transport networks and FiberNet in-building networks (FINs). Over
our metropolitan transport networks, we can provision circuits from one of our carrier point facilities to another carrier point facility or to an on-net building via an interconnection with our FIN in that building. We can also provision circuits
vertically between floors in a carrier point facility or an on-net building. In 2003, we also initiated a new type of transport service offering to provide our customers with circuits on networks that we do not own. We sell this connectivity to our
customers by purchasing the underlying circuits from other wholesale telecommunications carriers. With this new initiative, we believe that we can better serve the broader network capacity needs of our customers than we are currently able to on our
own networks.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Colocation services. Our colocation services include providing customers with the ability to locate their communications and networking equipment at our carrier point
facilities in a secure technical operating environment. We can also provide our customers with colocation services in the central equipment rooms of certain of our on-net and off-net buildings. Typically, if a customer colocates its equipment at our
facilities, our agreement with them also includes a commitment to use our transport services.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Communications access management services.Our access management services include providing our customers with the non-exclusive right to market and provide their retail
services to tenants in our on-net and off-net buildings. Customers typically enter into an agreement with us to gain access to all or a significant number of our properties. For certain of our on-net and off-net buildings, we have the exclusive
right to manage communications access. Once a customer has entered into an agreement with us for access services, we typically require that customer to utilize our in-building networking infrastructure for connectivity to its retail customers, if
such networking infrastructure is available.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our
revenues are generated on a non-recurring and monthly recurring basis under contracts with our customers. The terms of these contracts can range from month-to-month to fifteen years in length. Throughout 2002 and 2003, we continued to experience a
trend of entering into shorter term contracts with our customers. Previously, our customers typically entered into contracts with terms of three to five years. Increasingly, our customers are electing to purchase services on a month-to- month basis
or for a contracted period of only one year. Our revenues are generated in the United States of America.



Our services are typically sold under fixed price agreements. In the case of transport services, we provide an optical circuit or other means of
connectivity for a fixed price. Revenues from transport services are not dependent on customer usage or the distance



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between the origination point and termination point of a circuit. The pricing of colocation services is based upon the
size of the colocation space or the number of colocation units, such as cabinets, provided to the customer. Revenues from access management services are typically determined by the square footage of the commercial office properties to which a
customer purchases access. The pricing of all of our services have declined significantly over the past year, with transport services experiencing the greatest decreases. We expect our operating results to continue to be negatively impacted by
decreases in the prices of our services.



The growth of our
revenues is dependent upon our ability to provide additional services in our existing facilities. We also believe that the majority of the growth in our revenues will come from our existing customers. Consequently, our growth in revenues is
dependent on the underlying growth of our customers businesses and their need for our services within the facilities that we already operate. We continue to add additional customers, particularly domestic subsidiaries of internationally based
carriers. However, we believe the number of companies that are potential customers is decreasing, due to the industry rationalization. In addition, we currently do not anticipate expanding our network infrastructure to other carrier point facilities
or on-net buildings and off-net buildings. Within each of our existing facilities, our revenues will depend upon the demand for our services, the competition that we face and our customer service.



We typically begin our sales cycle by entering into a telecommunications
services agreement. This document outlines the operating specifications and commercial standards that are required of us by the customer. Customers can order a specific circuit or colocation space, or, alternatively, they can purchase general
availability on our networks or in our facilities by establishing minimum revenue commitments on a recurring basis.



During the past year, customers have primarily purchased services from us only on an as-needed basis, when their networks requirements mandate an
immediate need for additional services. They have not elected to purchase general availability on our networks, nor have they purchased services on a speculative basis. We have also experienced significant disconnections of services, as customers
groom their networks to eliminate excess capacity. This loss of revenues has had a significantly negative impact on our financial results and may continue.



Currently our colocation and access services produce less than one-third of our revenues. In the future we anticipate generating significantly more of our
revenues from transport services than from colocation or access management services. The scalability of our network architecture allows us to increase transport capacity to a greater degree than is possible with our colocation and access services.



Our transport services have been negatively impacted by
customers disconnecting higher-bandwidth circuits they are purchasing from us and replacing them with lower-bandwidth circuits to more efficiently manage the access costs of their networks. The new transport services that we are providing typically
are for lower-bandwidth circuits, as our customers expand their network connections on a more limited basis. The growth in transport revenues that we have experienced on a quarterly basis in 2003 is a result of an increase in the number of circuits
we have provisioned, offsetting our disconnections and price declines.



Our colocation services have not experienced the same level of disconnections and price declines as our transport services. The physical constraints of available colocation space in our facilities and our competitors facilities have
limited the supply imbalance that has developed in the connectivity market. In addition, unlike the fluctuations in demand for bandwidth based upon end-user usage, demand for colocation space is more stable because of the consistent need for a
location to locate networking equipment. As a result, prices for colocation have not decreased as much as those of bandwidth, and carriers are less likely to terminate colocation contracts. Contrarily, the growth prospects of our colocation services
are not as great as those of our transport services, as we are limited in the amount of colocation space that we can sell without making a significant investment in an additional colocation facility. Our ability to expand the capacity of our
transport networks is much greater due to technological advancements in more efficient usage of fiber optics, such as dense wave division multiplexing or DWDM.



Our access management services business has been steadily declining, and we expect it to continue to decline. The demand for access to commercial
office properties from carriers has declined precipitously. The revenues that we are generating from this type of service are from long-term contracts entered into in prior years. We do not expect to sign any new contracts for access management in
the near future. The remaining terms of our existing access management service contracts range from a month-to-month basis to expiration in 2008.



Cost of Services. Cost of services is associated with the operation of our networks and facilities. The largest component of our cost of services
is the occupancy expenses at our carrier point facilities, on-net buildings and off-net buildings. These occupancy expenses primarily represent rent expense under direct leases with landlords. They also include charges for colocation space in other
carriers facilities and cross connection fees to interconnect our networks with other carriers networks. Other specific cost of services include maintenance and repair costs, utility costs and license fees. Our license agreements for our
on-net and off-net buildings require us to pay license fees to the owners of these properties. In addition, our leases at 60 Hudson Street in New York City also require us to pay license fees. These license fees typically are calculated as a
percentage of the revenues that we generate in each particular building. Our cost of services also include the charges that we incur by purchasing connectivity from other wholesale



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telecommunications carriers to provide our customers with transport services that are not on our networks. As we provide
additional, off-net transport services, we will purchase more connectivity from other carriers. Other than our license fees and off-net connectivity charges, our cost of services is generally fixed in nature. We do not anticipate that cost of
services will change commensurately with any change in our revenues.



Selling, General and Administrative Expenses. Selling, general and administrative expenses generally include all of our personnel costs, occupancy costs for our corporate offices, insurance costs, professional fees, sales and
marketing expenses and other miscellaneous expenses. Personnel costs, including wages, benefits and sales commissions, are our largest component of selling, general and administrative expenses. All of our personnel costs are included in selling,
general and administrative expenses. We do not allocate any personnel cost relating to networks operations or sales activities to cost of services. We have reduced the number of our employees from 75 at the beginning of 2003 to 66 as of December 31,
2003. Prospectively, we do not anticipate significant changes in headcount, and we believe that our personnel costs will increase moderately. Professional fees, including legal and accounting expenses, represent the second largest component of our
selling, general and administrative expenses. These fees, which primarily are attributed to our required activities as a publicly traded company, such as SEC filings and financial statement audits, could increase prospectively due to the enhanced
regulations regarding corporate governance and compliance matters. Other costs included in selling, general and administrative expenses, such as insurance costs, may increase due to changes in the economic environment and telecommunications
industry.



Stock Related Expense. Stock related expense
relates to the granting of stock options and restricted stock to our employees. We make equity grants to our employees in order to attract, retain and incentivize qualified personnel. These costs are non-cash charges that are amortized over the
vesting term of each employees equity agreement.



In
December 2000, we repriced stock options for certain of our executive officers, resulting in variable plan accounting in accordance with FASB Interpretation (FIN) No. 44, Accounting for Certain Transactions Involving Stock Compensation
(FIN No. 44), from the date of modification. The additional intrinsic value was determined on the date of modification using the then market price of the common stock. The additional compensation cost was recognized over the period from
the date of modification to the date the awards vest. The additional compensation cost has been adjusted in subsequent periods for changes in the market price. After the awards vested, adjustments to compensation cost for changes in the market price
were recognized immediately. In subsequent periods, the market price declined, resulting in negative compensation cost being recognized. In accordance with FIN No. 44, illustration 3(g), income (negative expense) has been recognized up to the amount
of expense previously recognized in prior periods relating specifically to the modified awards.



Depreciation and Amortization. Depreciation and amortization expense includes the depreciation of our network equipment and infrastructure,
computer hardware and software, furniture and fixtures, and leasehold improvements, as well as the amortization of certain deferred charges. We commence the depreciation of network related fixed assets when they are placed into service and
depreciate those assets over periods ranging from three to 20 years. As a result of the impairments of fixed assets that we recorded during 2003, 2002 and 2001, depreciation and amortization expense may decrease going forward.



Critical Accounting Policies



Our significant accounting policies are described in Note 2 to the
consolidated financial statements included in Item 8 of this Form 10-K/A. Our discussion and analysis of financial condition and results from operations are based upon our consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States. The preparation of the financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the estimates that we have made. These estimates have been based upon historical experience and on various other assumptions that we believe to be reasonable under
the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe our most critical accounting policies include revenue recognition, an allowance for doubtful accounts, the impairment of
long-lived assets including goodwill and the recognition of deferred tax assets and liabilities.



Revenue Recognition



We
recognize revenues when earned as services are provided throughout the life of each contract with a customer. The majority of our revenues are invoiced on a monthly recurring basis under long-term contracts, typically one year in length. Certain of
our contracts require us to invoice our customers for the periods ranging from one year to the full term of the contract. We record deferred revenue for the amount of an invoice that has not been recognized as revenue. Deferred revenue is recorded
for the full value of the contract at contract inception, only if we are contractually entitled to invoice the customer for the full value of the contract and the customer had paid such invoice.



We have one reciprocal agreement, whereby we purchase services from one of
our customers under a single agreement. At the beginning of 2002, we had two such reciprocal agreements, but one was terminated during the year. The services provided and



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obtained through these agreements were priced at fair value as of the date of the agreement. We recognized the transport
and colocation revenues from these agreements in accordance with our stated revenue recognition policy, and we concurrently recorded the expenses for colocation services as cost of services in our statements of operations. None of the expenses
associated with our reciprocal agreements are capitalized. All of the costs are expensed as incurred. Reciprocal agreements accounted for $5.2 million, or 17%, of revenues in 2001 and $5.4 million of our cost of services. In 2002, reciprocal
agreements accounted for $0.8 million, or 3%, of revenues and $0.8 million of our cost of services. For the year ended December 31, 2003, our only reciprocal agreement accounted for $0.5 million, or 2%, of revenues and $0.5 million of our cost of
services.



Allowance for Doubtful Accounts



We continuously monitor collections and payments from our customers and
maintain allowances for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations, there can be no assurance
that we will continue to experience the same level of credit losses that we have in the past. A significant number of our customers have filed for bankruptcy or are otherwise in significant financial distress. A significant change in the liquidity
or financial position of any one of these customers or a further deterioration in the economic environment or telecommunications industry, in general, could have a material adverse impact on the collectability of our accounts receivable and our
future operating results, including a reduction in future revenues and additional allowances for doubtful accounts. If we determine that collection of a receivable is not reasonably assured, we defer the revenue and recognize it at the time
collection becomes reasonably assured, which is generally upon receipt of payment.



Impairment of Long-Lived Assets



We assess the
fair value and recoverability of our long-lived assets, whenever events and circumstances indicate the carrying value of an asset may not be recoverable from estimated undiscounted future cash flows expected to result from its use and eventual
disposition. In doing so, we make assumptions and estimates regarding future cash flows and other factors to make our determination. The fair value of our long-lived assets is dependent upon the forecasted performance of our business, changes in the
telecommunications industry and the overall economic environment. When we determine that the carrying value of our long-lived assets may not be recoverable, we measure any impairment based upon a forecasted discounted cash flow method. If these
forecasts are not met, we may have to record additional impairment charges not previously recognized.



In 2001, we also determined that our forecasts for revenues for certain of our facilities would not be achieved due to the significant adverse change in
the business climate. We further determined that the dramatic change in the operating environment for the telecommunications industry resulted in a significantly less demand for our services in these facilities. We believe that the decrease in
demand was a result of the significant number of bankruptcies of telecommunications companies that were existing or potential customers of ours and the overall economic recession. We also determined that a rebound in demand for our services would
not occur in the near term. As a result, we revised our business plan and conducted extensive reviews of our assets and operations. The revisions to the business plan primarily included reductions in forecasts of revenues and capital expenditures.
The projected amounts of certain cost of services and overhead expenses were reduced as well to reflect the decrease in our expected business activity. We also determined that certain financial covenants in our credit facility would need to reflect
the revised business plan, including our reduced revenue forecasts. Consequently, we amended our credit facility in December 2001.



We used an undiscounted forecasted cash flow model to determine if there was an impairment based on the cash flows expected to be generated from the
assets related to these facilities, and used a discounted cash flow model to measure the impairment. As a result of this analysis, we have recorded an asset impairment of approximately $51.8 million in the fourth quarter of 2001, based on the amount
by which the carrying amount of these assets exceeded their fair value. Of this amount, $40.4 million related to assets held for use, and $11.4 million represented assets to be disposed of.



The assets that we identified for disposition were abandoned, as we
determined that these assets had no value. Consequently, there was no cost to us for this abandonment, nor do we expect to receive any proceeds or other consideration from this abandonment. We recorded no reserves, accruals or other liabilities
related to this abandonment. These assets primarily related to engineering and network architecture design costs and general contracting and project management costs for facilities that we are no longer pursuing.



During 2002, we recovered approximately $0.3 million from the sale of assets
previously written off as impaired. The proceeds were recorded as a recovery of the impairment recorded previously.



During 2002, we recorded a write-off of property, plant and equipment of $0.7 million. We recorded this write-off of capital assets due to the termination
of several leases and license agreements for network facilities. There was no cost to us to abandon these assets, nor do we expect to receive any proceeds or other consideration from the abandonment of these assets.



During 2002, we again determined that our forecasts for revenues at certain
facilities would not be achieved due to the ongoing difficulties in the overall business climate and the continued deterioration of the telecommunications industry. The dramatic change in



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the operating environment for our industry has resulted in significantly less demand for our services in these
facilities, and we also determined that a rebound in demand for our services would not occur in the near term. In fact we concluded that the prospects for the industry, and our business in particular, were worse than we had forecasted in 2001,
because the economy had not rebounded as expected and many significant telecommunications business failures occurred in 2002. As a result, we revised our business plan and conducted extensive reviews of our assets and operations. The revisions to
the business plan primarily included further reductions in forecasts of revenues and capital expenditures. The projected amounts of certain cost of services and overhead expenses were reduced as well to reflect the decrease in our expected business
activity.



We again used an undiscounted forecasted cash flow
model to determine if there was an impairment based on the cash flows expected to be generated from the assets related to these facilities, and used a discounted cash flow model to measure the impairment. As a result of this analysis, we recorded an
asset impairment of approximately $12.7 million in the fourth quarter of 2002, based on the amount by which the carrying amount of these assets exceeded their fair value.



During 2003, we recovered approximately $0.2 million from the sale of assets previously written off as impaired. The
proceeds were recorded as a recovery of impairments previously recorded.



During 2003, the economic environment and the telecommunications industry, in particular, did not rebound as expected. The dramatic change in the operating environment for our industry over the past few years has
resulted in significantly less demand and lower prices for our services than we had expected, and we also determined that the recovery in demand and pricing that we anticipated would not occur in the near term. Although we concluded that the
prospects for the industry, and our business in particular, were not worse than we had forecasted in 2002, we once again revised our forecasts for revenues at certain facilities, as we concluded that they would not be achieved. In conjunction with
our reassessment of certain revenue forecasts, we revised our business plan and conducted reviews of our assets and operations. The revisions to the business plan primarily included further reductions in forecasts of revenues and capital
expenditures. The projected amounts of certain cost of services and overhead expenses were reduced as well to reflect the decrease in our expected business activity, although not commensurately with revenues and capital expenditures.



We again used an undiscounted forecasted cash flow model to determine if
there was an impairment based on the cash flows expected to be generated from the assets related to these facilities, and used a discounted cash flow model to measure the impairment. As a result of this analysis, we have recorded an asset impairment
of approximately $1.5 million in the fourth quarter of 2003, based on the amount by which the carrying amount of these assets exceeded their fair value.



Impairment of Goodwill



During 2001, we performed an assessment of the goodwill related to our acquisition of Devnet, LLC, pursuant to SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS No. 121). Devnet had entered into exclusive license agreements to manage communications access to commercial office properties, and we associated the
goodwill resulting from the acquisition primarily to those agreements. We made the determination to perform an assessment based upon significant negative industry and economic trends. In 2001, a change in the business environment resulted in
significantly less demand for telecommunications access to commercial office properties, and the number of potential customers seeking these services diminished greatly. Consequently, we revised our forecasted cash flows from Devnet and determined
that the decline in the market conditions within this market segment was material and other than temporary. After using an undiscounted cash flow model of the future cash flows forecasted to be generated from business activities in the commercial
office properties underlying the license agreements and determining there was an impairment, we used a discounted cash flow model to determine the size of the impairment. As a result, we recorded a charge of $56.5 million during the third quarter of
2001 to reduce goodwill associated with the purchase of Devnet. The charge was based on the amount by which the carrying amount of these assets exceeded their fair value. During 2001, we recorded approximately $3.1 million of amortization of
goodwill relating to Devnet.



In June 2001, the FASB issued
SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142), applicable for fiscal years beginning after December 15, 2001. SFAS No. 142, which we adopted effective January 1, 2002, requires that goodwill and certain
intangible assets resulting from business combinations entered into prior to June 30, 2001 no longer be amortized, but instead be reviewed for recoverability. Any write-down of goodwill would be charged as a cumulative change in accounting principle
upon adoption of the new accounting standard if the recorded value of goodwill and certain intangibles exceeds its fair value. During the fourth quarter of 2002, we considered then current information, including an analysis of our market value as a
result of our recapitalization, and determined that there is no additional impairment of goodwill. During the fourth quarter of 2003, we performed our annual impairment test and determined that we did have an impairment of goodwill. Accordingly, we
recorded a charge of $7.5 million to eliminate our remaining goodwill.



Recognition of Deferred Tax Assets and Liabilities



We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and
establish a valuation allowance based upon historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. As a result of this review, we have established a full valuation allowance
against our deferred tax assets.



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Results of Operations



Fiscal Year Ended December 31, 2003 Compared to Fiscal Year Ended December 31, 2002



Revenues. Revenues for the fiscal year ended December 31, 2003 were $26.6 million as compared to $25.3 million for
the fiscal year ended December 31, 2002. We increased the number of our customers from 104 at the end of 2002 to 152 at the end of 2003, with the addition of many international carriers to our customer base. We believe that there are greater
opportunities to serve domestic subsidiaries of foreign telecommunications companies in our gateway markets, as domestic carriers consolidate and rationalize.



Revenues were generated by providing transport, colocation and communications access management services to our customers. We recognized $18.1 million
in transport service revenues in 2003, up from $15.8 million in 2002. Revenues from colocation and other services increased to $6.0 million in 2003 from $5.9 million in 2002, and revenues from communications access management services declined to
$2.5 million in 2003 from $3.6 million in 2002.



The vast
majority of our transport and colocation services are provided within and between our carrier point facilities in the New York City market. Transport revenues increased as we provided a greater number of lower-bandwidth circuits to our customers,
offsetting the disconnections and price decreases that we have been experiencing. We benefited from growth in transport services from within our existing customer base, as well as through the addition of new customers. Prospectively, we expect that
the current trends in our transport services will continue. Colocation revenues grew as we leased additional caged space, cabinets and racks in our facilities. Since we are approaching capacity at some of our colocation facilities, we may have to
invest in expanding these facilities to offer additional space to our customers. We expect transport services to grow at a faster rate than colocation. Our network infrastructure has significant capacity to provide additional broadband transport
connectivity, and our colocation facilities are approaching more stabilized utilization rates. The decrease in access revenues was due to the severe decline in the market for building-centric services and the resulting bankruptcies of many
building-centric service providers, many of whom were our customers. We do not expect to sell any additional access services, and we believe our existing contracts for access services may not be renewed when they expire.



For fiscal year 2003, there were no individual customers that accounted for
over 10.0% of our revenues. During 2002, two customers accounted for approximately 24.0% of our revenues. Reciprocal agreements accounted for $0.5 million, or 1.8%, of revenues in 2003, down from $0.8 million, or 3.1%, of revenues in 2002. In 2002,
we terminated one of our reciprocal agreements leaving only one agreement in place during 2003.



In July 2002 we negotiated a revised pricing structure with a significant customer for the services that we provided to it, although we previously were
not obligated to do so. In addition, this customer subsequently terminated certain services that we were providing. The impact to revenues attributable to these two events was approximately a $2.3 and a $1.4 million reduction in revenues for the
years ended December 31, 2003 and 2002, respectively. The impact of these events does not put us in a loss position with respect to the remaining services with this customer.



Cost of Services. Cost of services, associated with the operation of our networks and facilities, were $8.8 million
in 2003, compared to $7.5 million in 2002. The majority of our cost of services is occupancy expenses, consisting of rent and utility costs, for our carrier hotel facilities, on-net buildings and off-net buildings. Other cost of services includes
license fees, maintenance and repair costs and off-net connectivity charges.



Occupancy expenses represented 73% of cost of services in 2003 and increased by only 1% over 2002. However, in the coming year we expect occupancy expenses to increase by 25% to 30% over 2003, as we consolidate the
costs of the carrier point facility at 165 Halsey Street in Newark, New Jersey that we acquired in the first quarter of 2004. License fees, which were 17% of cost of services in 2003, increased by over 200% from 2002 because a greater proportion of
our revenues were generated in facilities in which our agreements with the building owners mandate these license fees. License fees are typically calculated as a percentage of the revenues we generate in the respective facility, as per our lease
agreement with the facility, and they are expensed in cost of services as the corresponding services are provided. We expect license fees to represent an equivalent percentage of cost of services, prospectively.



Maintenance and repair costs were 5% of cost of services in 2003, and
although these costs decreased by 41% from 2002, they will continue to represent a relatively small and fixed component of cost of services. Off-net connectivity charges also were 5% of cost of services in 2003. We did not incur these expenses in
2002, as we did not provide this type of transport service. Going forward, these charges will increase commensurately with our growth in off-net transport services.



We negotiated certain non-recurring concessions from vendors in the amount of $0.7 million, which reduced cost of services
for the year ended December 31, 2002. These items were expensed in prior periods and included in our cost of services. Reciprocal agreements accounted for $0.5 million of our cost of services for the year ended December 31, 2003 and $0.8 million for
the same period in 2002.



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Selling, General and Administrative Expenses. Selling, general and administrative expenses for
2003 were $16.4 million compared to $16.1 million for 2002. Personnel costs represented 60% of selling, general and administrative expenses in 2003 and were unchanged from 2002. Professional fees, which were 16% of selling, general and
administrative expenses in 2003, increased by $0.4 million over 2002 due primarily to the legal costs of an arbitration proceeding in which we were the claimant. Also included in selling, general and administrative expenses for 2003 and 2002 were
legal settlement expenses of approximately $0.5 million and $0.6 million, respectively, unrelated to the arbitration proceeding. Also included in 2002 was a charge of $2.1 million incurred for professional fees related to our recapitalization in
October 2002. We anticipate selling, general and administrative expenses to increase modestly in 2004 with the general growth of our business.



Stock Related Expense. Stock related expense for 2003 was $0.2 million, compared to $0.2 million for 2002. This non-cash expense relates to the
amortization of stock options granted below fair market value and restricted stock granted to our employees.



In December 2000, we repriced stock options for certain of our executive officers, resulting in variable plan accounting in accordance with FIN No. 44,
from the date of modification. The additional intrinsic value was determined on the date of modification using the then market price of the common stock. The additional compensation cost was recognized over the period from the date of modification
to the date the awards vest. The additional compensation cost has been adjusted in subsequent periods for changes in the market price. After the awards vested, adjustments to compensation cost for changes in the market price were recognized
immediately. In subsequent periods, the market price declined, resulting in negative compensation cost being recognized. In accordance with FIN No. 44, illustration 3(g), income (negative expense) has been recognized up to the amount of expense
previously recognized in prior periods relating specifically to the modified awards.



Impairment of property, plant and equipment. In 2003, we recorded an asset impairment of $1.3 million as a result of our revised business plan and forecast of revenues reflecting the continued adverse business
environment and industry conditions. Included in this charge in 2003 is a recovery of $0.2 million due to the disposition of equipment that was previously impaired. In 2002, we also recorded an asset impairment of $13.2 million to reflect our
business plan and forecast of revenues at that time. Included in this charge in 2002 is a recovery of $0.3 million due to the disposition of equipment that was previously impaired. We also recorded a write-off of property, plant and equipment of
$0.7 million in April 2002. We recorded this write-off of capital assets due to the termination of several property leases and license agreements for network facilities. There was no cost to us to abandon these assets, nor do we expect to receive
any proceeds or other consideration from the abandonment of these assets. We recorded no other reserves, accruals or other liabilities related to these write-offs.



Impairment of goodwill. In 2003, we recorded a charge for the impairment of goodwill of $7.5 million. This goodwill
was originally recorded in connection with our acquisition in 1999 of a minority interest in Local Fiber, LLC held by a third party. SFAS No. 142, which we adopted effective January 1, 2002, requires that goodwill and certain intangible assets
resulting from business combinations entered into prior to December 31, 2001 no longer be amortized, but instead be reviewed for recoverability at least on an annual basis. We recorded this impairment of goodwill in accordance with SFAS No. 142. No
impairment of goodwill was recorded in 2002.



Depreciation
and Amortization. Depreciation and amortization expense for 2003 was $8.8 million, compared to $10.3 million for 2002. This decrease resulted from the impairments of property, plant and equipment that were previously recorded.



Loss on early extinguishment of debt. We recorded a non-cash charge of
$9.7 million related to the partial extinguishment of our credit facility on January 10, 2003. We recorded a loss for the fair value given in excess of the amount of debt extinguished and related pro-rata write-off of original issue discount and
deferred financing charges. The fair value given in exchange for $13.4 million in indebtedness was 4.6 million shares of common stock, the issuance of 2.2 million warrants with an exercise price of $3.60 per share and the re-pricing of the exercise
price of 3.0 million existing warrants from $3.60 to $0.03 per share. Also included in this loss is $1.0 million in fees associated with the consummation of the recapitalization. As this extinguishment of debt represented approximately 38.1% of our
outstanding balance, we wrote-off the same percentage of deferred financing charges and original issue discount of $0.9 million and $1.8 million, respectively, which is also included in our calculation of loss on early extinguishment of debt. On
March 17, 2003, we entered into an agreement to terminate all of our capital lease obligations for a payment of $85,000. This termination of our capital lease obligations resulted in a gain on early extinguishments of debt of approximately $0.8
million, partially offsetting our earlier loss.



In 2002, we
recorded a non-cash charge of $5.8 million related to the extinguishment of our subordinated note payable on October 30, 2002, as part of our recapitalization.



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Interest Expense, Net. Interest expense, net for 2003 was $2.3 million, compared to $7.5 million
in 2002. Interest expense decreased primarily due to the conversion of debt into equity as part of our recapitalization that occurred in October 2002 and January 2003, as well as due to lower effective interest rates on the remaining indebtedness
under our credit facility. All of our indebtedness bears interest at a floating rate, so we are subject to fluctuations in interest rates.



Preferred Stock Dividends. For the year ended December 31, 2002, we paid approximately $44,000 in non-cash dividends on our series H preferred
stock in the form of additional shares of series H preferred stock, which were convertible into shares of common stock. All outstanding preferred stock was converted into common stock as part of our recapitalization during the fourth quarter of
2002, and as a result there were no preferred stock dividends recorded for the year ended December 31, 2003.



Net Loss Applicable to Common Stockholders. We reported a net loss applicable to common stockholders of $27.8 million in 2003 compared to a loss of
$37.4 million in 2002. The decrease in the net loss applicable to common stockholders is a result of the aforementioned changes in our operations.



Fiscal Year Ended December 31, 2002 Compared to Fiscal Year Ended December 31, 2001



Revenues. Revenues for the fiscal year ended December 31, 2002 were $25.3 million as compared to $31.2 million for
the fiscal year ended December 31, 2001. During 2002, our number of customers increased from 88 at the beginning of the year to 104 at the end of the year.



Revenues were generated by providing transport, colocation and communications access management services to our customers. We recognized $15.8 million in
transport services in 2002, down from $19.6 million in 2001. Revenues from colocation and other services increased to $5.9 million in 2002 from $5.5 million in 2001, and revenues from communications access management services declined to $3.6
million in 2002 from $6.1 million in 2001.



The decrease in
transport services was primarily the result of the termination of three of our reciprocal agreements and customer service disconnections. These negative trends were partially offset by the provisioning of new services for new and existing customers.
Colocation revenues grew as we leased more space in our carrier point facilities to our customers. The decrease in access revenues was due to the severe decline in the market for building-centric services and the resulting bankruptcies of many
building-centric service providers, many of whom were our customers.



For fiscal year 2002, two customers accounted for approximately 24.0% of our revenues. During 2001, three customers accounted for approximately 53.3% of our revenues. Two of those companies have filed for bankruptcy. Once a customer has
filed for bankruptcy, we recognize revenues from that customer only upon the receipt of payment. Reciprocal agreements accounted for $0.8 million, or 3%, of revenues in 2002, down from $5.2 million, or 17%, of revenues in 2001. In 2001, we
terminated two of our reciprocal agreements, and in 2002 we terminated one additional reciprocal agreement.



In July 2002, we negotiated a revised pricing structure with a significant customer for the services that we provided to it, although we previously were
not obligated to do so. In addition, this customer subsequently terminated certain services that we were providing. The impact to revenues attributable to these two events was approximately a $1.4 million reduction in revenues for the year ended
December 31, 2002. The impact of these events does not put us in a loss position with respect to the remaining services with this customer.



Cost of Services. Cost of services, associated with the operation of our networks and facilities, were $7.5 million in 2002, compared to $13.8
million in 2001. Occupancy expenses, consisting of rent and utility costs, for our carrier hotel facilities, on-net buildings and off-net buildings, were 84% of our cost of services in 2002, down from 92% in 2001. Cost of services also includes
license fees and maintenance and repair costs. License fees were 7% and 4% of cost of services in 2002 and 2001, respectively, and maintenance and repair costs were 9% and 4% of cost of services in 2002 and 2001, respectively. The decrease of $6.3
million was due to a reduction in expenses associated with the elimination of certain of our network facilities and the termination of certain reciprocal agreements.



In addition, cost of services for the year ended December 31, 2002 was reduced by $0.7 million due to certain, non-recurring
concessions that we negotiated from vendors, thereby reducing accounts payable. These items were expensed in prior periods and included in our cost of services. Reciprocal agreements accounted for $0.8 million of our cost of services in 2002 and
$5.4 million of our cost of services for 2001.



Selling,
General and Administrative Expenses. Selling, general and administrative expenses for 2002 were $16.1 million compared to $32.9 million for 2001. The decrease was a result of our aggressive cost savings initiatives to reduce corporate overhead
in line with our outlook for business activity. Cost reductions were realized in nearly all components of selling, general and administrative expenses, including advertising and marketing costs, professional fees and travel and entertainment
expenses. The greatest decrease in overhead came in personnel costs, as we reduced headcount from 108 employees at the beginning of 2002 to 75,



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as of December 31, 2002. Personnel costs, as a percentage of selling, general and administrative expenses, were
approximately 62% and 65% in 2002 and 2001, respectively. Included in selling, general and administrative expenses for 2002 was a legal settlement expense of approximately $0.6 million.



Stock Related Expense. Stock related expense for 2002 was $0.2 million, compared to $(1.2) million for 2001. This
non-cash expense relates to the granting of stock options to employees. The amount for the prior period reflects a reversal of a previously recorded expense, due to the decline in the price per share of our common stock.



In December 2000, we repriced stock options for certain of our executive
officers, resulting in variable plan accounting in accordance with FIN No. 44 from the date of modification. The additional intrinsic value was determined on the date of modification using the then market price of the common stock. The additional
compensation cost was recognized over the period from the date of modification to the date the awards vest. The additional compensation cost has been adjusted in subsequent periods for changes in the market price. After the awards vested,
adjustments to compensation cost for changes in the market price were recognized immediately. In subsequent periods, the market price declined, resulting in negative compensation cost being recognized. In accordance with FIN No. 44, illustration
3(g), income (negative expense) has been recognized up to the amount of expense previously recognized in prior periods relating specifically to the modified awards.



Impairment of property, plant and equipment. In 2002, we recorded an asset impairment of $13.2 million to reflect our
revised business plan and forecast of revenues due to the continued adverse business environment and industry conditions. Included in this charge is a recovery of $0.3 million due to the disposition of equipment that was impaired in 2001. We also
recorded a write-off of property, plant and equipment of $0.7 million in April 2002. We recorded this write-off of capital assets due to the termination of several property leases and license agreements for network facilities. There was no cost to
us to abandon these assets, nor do we expect to receive any proceeds or other consideration from the abandonment of these assets. We recorded no other reserves, accruals or other liabilities related to these write-offs. In 2001, we recorded an asset
impairment of $51.8 million to reflect our revised business plan and the state of the market at that time.



Impairment of goodwill. In 2001, we recorded a charge for the impairment of goodwill, relating to our acquisition of Devnet, LLC in the amount of
$56.5 million. We recorded this write down of goodwill in accordance with SFAS No. 121. No additional impairment of goodwill was recorded in 2002.



Depreciation and Amortization. Depreciation and amortization expense for 2002 was $10.3 million, compared to $15.3 million for 2001. This decrease
resulted from the impairment of property, plant and equipment that we recorded in 2001 and the adoption of SFAS No. 142, applicable for fiscal years beginning after December 15, 2001. SFAS No. 142, which we adopted effective January 1, 2002,
requires that goodwill and certain intangible assets resulting from business combinations entered into prior to December 31, 2001 no longer be amortized, but instead be reviewed for recoverability annually.



Loss on early extinguishment of debt. In 2002, we recorded a non-cash
charge of $7.9 million related to the extinguishment of our subordinated note payable on October 30, 2002, as part of our recapitalization. Included in the loss on early extinguishment of debt was a charge of $2.1 million incurred for professional
fees related to our recapitalization in October 2002. In 2001, we recorded a non-cash charge of $7.4 million related to an early extinguishment of debt from the modification of our credit facility on February 9, 2001.



Interest Expense, Net. Interest expense, net for 2002 was $7.5
million, compared to $8.6 million in 2001. Interest expense decreased due to lower effective interest rates on the indebtedness under our credit facility, and the conversion of debt into equity as part of our recapitalization that occurred in
October 2002.



Preferred Stock Dividends. For the year
ended December 31, 2002, we paid approximately $44,000 in non-cash dividends on our series H preferred stock in the form of additional shares of series H preferred stock, which were convertible into shares of common stock. In 2001, we paid non-cash
dividends on our series D, E, F, H and I preferred stock of $1.1 million in the form of additional shares of each respective series of preferred stock, which were convertible into shares of common stock. The amounts of the dividends assume the
market price per share of the underlying common stock, as of the date the dividends are paid. The decrease in preferred dividends was the result of a decline in the public market price of our common stock and the conversion of certain series of
preferred stock. The liquidation value of the dividends paid in 2002 was $0.6 million, compared to $5.3 million for dividends paid in 2001.



Preferred Stock - Beneficial Conversion.In February 2001, the conversion price of our series H and series I preferred stock was reduced to $4.38,
in accordance with the original terms of the issuance transactions. The certificates of designation of the series H and series I included provisions requiring the conversion prices to be lowered to the per share price at which we issued any shares
of common stock, subject to certain exceptions, subsequent to the initial issuance of the series H and series I. In February 2001, we issued shares of common stock in a directed public offering at a price of $4.38 per share, resulting in the
reduction of the conversion price. We recorded a beneficial conversion charge of $21.0 million as a result of the reduction of the conversion price. Additionally, in



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connection with the conversion of the series H and series I, the conversion price of the remaining 100,000 shares of
series H was reduced to $1.31. However, as all of the proceeds from the issuances of the series H and series I had been allocated to beneficial conversion features, no additional proceeds were allocated upon the reset of the conversion price of the
series H to $1.31.



On December 7, 2001, we consummated a
directed public offering of 360 shares of a new series of preferred stock, designated series J preferred stock for an aggregate purchase price of $3.6 million. Subject to certain adjustments, the series J preferred stock was convertible into the
number of shares of common stock equal to 90% of the average of the five lowest volume weighted average prices for our common stock during the 15 trading days immediately prior to the date of conversion, provided that such average price shall not be
less than $0.20 nor greater than $0.50. In connection with this transaction, we recorded a non-recurring, non-cash charge for a beneficial conversion feature in the amount of $2.1 million to reflect the market price of the common stock as of the
date of the issuance. The amounts of the beneficial conversion charges assume the market price per share of the underlying common stock, as of the date the charge is incurred, in accordance with EITF Issue 98-05, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratio. There was no preferred stock - beneficial conversion recorded in 2002.



Net Loss Applicable to Common Stockholders. We reported a net loss applicable to common stockholders of $37.4 million
in 2002 compared to a loss of $178.2 million in 2001. The decrease in the net loss applicable to common stockholders is a result of the aforementioned changes in our operations.



Liquidity and Capital Resources



To date, we have financed our operations through direct equity investments from our stockholders, the issuance of additional debt and equity securities in
private transactions and by arranging a credit facility with a group of lenders. We incurred a loss from operations and a net loss applicable to common stockholders for 2003 of $16.5 million and $27.8 million, respectively, compared to a loss from
operations and a net loss applicable to common stockholders of $24.1 million and $37.4 million, respectively, for 2002. During 2003, cash provided by operating activities was $2.2 million, and cash purchases of property, plant and equipment were
$2.4 million, compared to cash used to fund operating activities of $4.5 million and $2.5 million of cash purchases of property, plant and equipment for 2002.



For the year ended December 31, 2003 we received $2.2 million in net cash proceeds from financing activities. For the year ended December 31, 2002 we
received $7.4 million in net cash proceeds from financing activities. We received these proceeds from financing activities primarily in connection with our recapitalization transactions, which occurred in October 2002 and January 2003.



On October 30, 2002, we completed a series of transactions with the
lenders under our credit facility as well as certain investors to undertake the recapitalization of our company. Pursuant to the terms of a common stock purchase agreement dated as of October 30, 2002 by and among us and our lenders under our credit
facility, we issued 14,666,666 shares of our common stock to the lenders at a price of $4.50 per share, as prepayment of an aggregate of $66.0 million of outstanding indebtedness under our credit facility. We also issued warrants to purchase
3,666,666 shares of common stock at an exercise price of $3.60 per share with a term of five years to the lenders.



Furthermore, the payment of all accrued interest on borrowings during the period beginning on October 30, 2002 and ending on June 30, 2003 was capitalized
and added to the outstanding principal amount of the term loan indebtedness. Prior to October 30, 2002, there was $5.2 million of interest due and payable on the indebtedness outstanding under the credit facility. As part of this transaction,
accrued interest of $3.2 million was capitalized and added to the outstanding principal amount of the term loan indebtedness. Subsequently on November 11, 2002, we issued to our lenders in exchange for the remaining $2.0 million of accrued interest
666,666 shares of common stock and warrants to purchase 666,666 shares of common stock at an exercise price of $3.60 per share with a term of five years.



On October 30, 2002, we also entered into a common stock purchase agreement with certain investors, pursuant to which we issued to the investors in a
private offering an aggregate of 1,266,666 shares of common stock for a price of $3.00 per share for an aggregate cash consideration of $3.8 million. Pursuant to the terms of this purchase agreement, we also issued to such investors warrants to
purchase an additional 1,266,666 shares of common stock at an exercise price of $3.60 per share with a term of five years.



We also consummated certain related transactions on October 30, 2002 and November 11, 2002, whereby we converted $2.5 million of other indebtedness into
2,033,401 shares of common stock and our series H and series J preferred stock, with a combined liquidation preference of $13.7 million, into 5,506,048 shares of common stock.



In total, 21,739,449 shares of common stock and warrants to purchase an aggregate of 4,933,333 shares of common stock were
issued on October 30, 2002, as part of these transactions, and a total of 2,400,000 shares of common stock and warrants to purchase an aggregate of 666,666 shares of common stock were issued on November 11, 2002.



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On January 10, 2003, we completed a series of transactions with the lenders under our credit facility.
Pursuant to the terms of three debt exchange agreements between us and each of Bank One, N.A., Nortel Networks Inc. and TD Securities (USA) Inc., we issued 4,617,151 shares of our common stock to these lenders at a price of $3.00 per share, in
satisfaction of approximately $13.4 million of indebtedness, representing all of the outstanding principal indebtedness and accrued interest owing to these lenders under our credit facility.



We also entered into a common stock purchase agreement, dated as of January
10, 2003, with certain investors, pursuant to which we issued to the investors in a private offering an aggregate of 972,222 shares of common stock at a price of $3.60 per share, for an aggregate cash consideration of $3.5 million. Pursuant to the
terms of the purchase agreement, we also issued warrants to purchase an additional 1,895,652 shares of common stock at an exercise price of $3.60 per share with a term of five years. Concurrently with the other transactions occurring on January 10,
2003, the investors also purchased 9,820,061 shares of common stock from the three lenders departing from the credit facility in a privately negotiated transaction for an aggregate cash consideration of $9.0 million.



In connection with the purchase agreement with the investors, we entered into
a registration rights agreement, dated as of January 10, 2003, with the investors, which required us to file a resale registration statement with the Securities and Exchange Commission with respect to the registration of all of the shares of common
stock issued under the purchase agreement and the shares that the investors purchased from the departing lenders. These shares were included in a registration statement that was declared effective on February 20, 2003.



In connection with the transactions contemplated by the debt exchange
agreements, we executed a ninth amendment to our credit agreement, pursuant to which, among other things, the rights and obligations of the departing lenders under the credit facility terminated, subject to standard reinstatement and survival
provisions. As a condition to the lenders entering into this amendment, we agreed to reduce the exercise price of certain warrants previously issued to and held by the lenders to purchase approximately 2,544,974 shares of common stock from $3.60 per
share to $0.03 per share. All of the repriced warrants were immediately exercised by the lenders. In addition pursuant to a security agreement and a securities account control agreement, we agreed to deposit approximately $2.3 million in a
restricted account as cash collateral to secure the assumption by Deutsche Bank AG New York Branch of the departing lenders funding obligations for our outstanding letters of credit, which totaled approximately $6.1 million.



On March 17, 2003, we entered into an agreement to terminate all of our
capital lease obligations for a payment of $85,000. This termination of our capital lease obligations resulted in a gain on early extinguishments of debt of approximately $0.8 million, recorded in 2003.



On May 12, 2003, we completed our 1-for-30 reverse stock split previously
approved by stockholders. The share information discussed above and below has been adjusted to reflect the reverse stock split.



On June 13, 2003, we executed the loan documentation necessary to establish a subordinated credit facility to provide the funding for the purchase of up
to $3.0 million of our common stock, under a stock repurchase program. Repurchases could have been made from time to time until December 31, 2003 through open market purchases, privately negotiated transactions, block trades or otherwise.
Repurchases are subject to the availability of stock, prevailing market conditions, trading price of the stock and our financial performance. The repurchase program did not obligate us to acquire any specific number of shares and could have been
discontinued or suspended at any time. Any shares repurchased in the program would have been treated as shares of common stock held in treasury. As of December 31, 2003, there were no outstanding amounts under this subordinated credit facility and
no repurchases of common stock had been made. On December 31, 2003, this subordinated credit facility expired and was not renewed.



On June 27, 2003, we commenced our previously approved exchange offer for certain of our outstanding warrants. Holders of certain of our outstanding
warrants were given the opportunity to exchange their currently outstanding warrants for shares of our common stock as if the exercise price of their warrants is $0.001 per share if such warrants were exercised in full on a cashless basis. The offer
was implemented to, among other things, satisfy certain of our obligations undertaken with respect to our recapitalization transactions, which occurred in October 2002 and January 2003. The offer expired on August 29, 2003. The warrants issued in
connection with the recapitalization transactions that we completed in October 2002 and January 2003 did not participate in the offer to exchange. In connection with this offer we exchanged 695,828 warrants for 695,147 shares of common stock.



As of December 31, 2003, we had $22.4 million of indebtedness
outstanding under our credit facility and $6.1 million of outstanding letters of credit, which together reflect the total amount available under the credit facility. The weighted average interest rate on our outstanding borrowings under the facility
was 4.78% at an applicable borrowing rate of LIBOR+375 basis points. Effective January 1, 2004 our applicable borrowing rate increased to LIBOR+450 basis points. We were in full compliance with all of the covenants contained in the credit agreement
underlying the facility as of December 31, 2003. We must comply with financial covenants that include minimum consolidated revenue, minimum consolidated EBITDA (as defined in the credit agreement underlying the credit facility), maximum cumulative
capital expenditures, a maximum consolidated leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated fixed charge coverage ratio. The compliance levels and calculation



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of such levels with respect to those covenants are as defined in the credit agreement underlying our credit facility, as
amended, which is on file with the Securities and Exchange Commission. Non-compliance with any of the covenants, requirements, or other terms and conditions under the credit agreement constitutes an event of default and potentially accelerates the
outstanding balance of the credit facility for immediate payment.



We spent approximately $2.4 million in capital expenditures during 2003, primarily for the implementation of customer orders. Our capital expenditures totaled $2.5 million in 2002. We have substantially completed the deployment of our FINs,
carrier hotel facilities and metropolitan transport networks. In 2004, we expect to invest $3.0 million to $4.0 million in capital expenditures, also primarily for customer order activity. This includes purchasing networking equipment to provision
connectivity and constructing extensions of our network to increase capacity and to interconnect with new customers. We also intend to upgrade certain information technology systems and key operating systems at our carrier point facilities. We may
expend additional capital for the selected expansion of our network infrastructure, depending upon market conditions, customer demand and our liquidity and capital resources.



During the year ended December 31, 2003, holders of warrants exercised warrants for 1.5 million shares of common stock with
an exercise price ranging from $0.001 to $0.03 per share. During the year ended December 31, 2003, we granted options to purchase an aggregate of 408,500 shares of common stock to employees with a weighted average exercise price of $1.13 per share.



On January 30, 2004, we completed the acquisition of the
operating assets of gateway.realty.new jersey.llc, also known as Gateway Colocation. Gateway Colocation operates a 49,000 square foot communications hub and colocation facility located at 165 Halsey Street in Newark, New Jersey. The transaction was
structured as an acquisition of assets, and the purchase price paid at closing consisted of 2.9 million shares of our common stock with a fair value of $4.8 million on the closing date and approximately $170,000 in cash. The purchase agreement also
includes an earn-out payment based upon the achievement of certain financial objectives with respect to the revenues generated by the facility. More specifically, the earn-out payment will be based on the gross revenues, on
an annualized basis, for a particular month designated by Gateway Colocation during the twenty-four month period immediately subsequent to closing. The earn-out payment, if payable, will be paid in shares of our common stock. However,
the issuance of such additional shares, in the aggregate with the shares of common stock issued on January 30, 2004, will not exceed 19.9% of the issued and outstanding shares of our common stock as of the closing date without first receiving
stockholder approval. We have agreed to file with the Securities and Exchange Commission a registration statement covering the resale of the shares issued at closing, and have also agreed to file a registration statement with respect to the resale
of shares issued, if any, pursuant to the terms of the earn-out provision.



Also on January 30, 2004, in an unrelated transaction, we entered into a common stock purchase agreement with certain investors, pursuant to which we issued to the investors, in a private offering, an aggregate of 6.4
million shares of common stock at a price of $1.25 per share, for gross proceeds of $8.0 million. Pursuant to the terms of the purchase agreements, we also issued to such investors warrants to purchase an aggregate of 1.9 million shares of common
stock at an exercise price of $1.75 per share with a term of three and one-half years. In connection with the purchase agreements, we entered into a registration rights agreement with the investors, which requires us to file a registration statement
with the Securities and Exchange Commission with respect to the resale of (i) the shares of common stock issued to the investors and (ii) the shares of common stock underlying the warrants issued to the investors.



We utilized a portion of the gross proceeds to permanently repay $2.1 million
of term loan indebtedness underlying the credit facility and to cancel $1.1 million of letter of credit by providing cash securing deposits in lieu thereof. We also permanently reduced our availability to issue letters of credit by $0.9 million. In
doing so, we satisfied the mandatory automatic reductions of commitments of the credit facility for 2004, as discussed below. By canceling the letters of credit, we also released for general corporate purposes $0.5 million of restricted cash
previously held as cash collateral. Furthermore, we temporarily repaid $3.5 million of outstanding revolving loan indebtedness, which is available to be redrawn in the future subject to compliance with the terms of the credit agreement. As a result
of these transactions, we have $16.8 million of outstanding indebtedness and $4.8 million of outstanding letters of credit as of March 15, 2004. In addition, we have $3.5 million of available borrowing capacity and $0.2 million of availability to
issue letters of credit under the credit facility, again subject to compliance with the terms of the credit agreement.



In connection with the consummation of both the acquisition and equity financing on January 30, 2004, we entered into certain transactions with the
lenders under our credit facility. We executed an eleventh amendment to the credit agreement, pursuant to which, among other things, the lenders consented to the above-referenced transactions. The eleventh amendment also revised the automatic
reductions of the commitments underlying the Credit Facility that are required on a quarterly basis beginning on March 31, 2004. Expressed as a percentage of the aggregate, outstanding commitments, the automatic reductions were revised to a total of
8% in 2004, 40% in 2005, 48% in 2006 and 4% at maturity on March 31, 2007. As of March 15, 2004 we had satisfied the entire 8% of the mandatory reduction of commitments for 2004. In addition, the eleventh amendment also incorporated adjustments to
the financial covenants of the credit facility. As a condition to the lenders entering into the eleventh amendment, we agreed to reduce the exercise price of certain previously issued outstanding warrants held by the lenders to purchase
approximately 379,230 shares of common stock from $3.60 per share to $0.001 per share. All of the repriced warrants were immediately exercised by the lenders.



On February 12, 2004, we provided 200,000 shares of common stock to a stockholder in settlement of certain litigation matters. The price on the date of
the grant was $1.61 per share. This settlement was accrued for as of December 31, 2003.



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On March 10, 2004, we were notified that we prevailed in an arbitration regarding a breach of contract.
We were awarded approximately $2.7 million, which included approximately $0.4 million for the reimbursement of legal fees. As of March 15, 2004, we had not yet received payment of the award.



As of March 15, 2004, we had approximately 51.1 million shares of common
stock outstanding, or approximately 58.1 million shares of common stock outstanding on a fully diluted basis, assuming the exercise of all outstanding options and warrants.



We believe that the completion of the transactions that constituted our recapitalization and our recent equity financing
significantly enhanced our liquidity and improved our financial position. Under our current operating plan, we do not anticipate requiring any external sources of capital to fund our operations in the coming year. However, from time to time, we may
consider private or public sales of additional equity or debt securities and other financings, depending upon market conditions, in order to provide additional working capital or finance the continued operations of our business, although there can
be no assurance that we would be able to successfully consummate any such financing on acceptable terms, if at all. For additional disclosure and risks regarding future financings and funding our ongoing operations, please see the subsection
entitled, We may require additional capital to fund the further development of our networks and operation of our business, and an inability to obtain such capital could harm our business. in the section entitled Factors
Affecting our Business Condition. We do not have any off-balance sheet financing arrangements, nor do we anticipate entering into any.



Our obligations and commitments to make future payments under contracts primarily include scheduled reductions in the availability of our credit facility
and payments under our operating leases.



The chart below
identifies our outstanding contractual obligations and commitments as of December 31, 2003. As discussed above, we have made all mandatory repayments and reductions of indebtedness for 2004 as of March 15, 2004.



|                                                    |  |                                       |        |      |   |        |  |      |        |      |   |        |  |            |       |  |   |       |  |   |       
|--------------------------------------------------- |  | ------------------------------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | ---------- | ----- |  | - | ----- |  | - | ------
|                                                    |  | Payments Due by Period (in thousands)
|Contractual Obligation                              |  | Total                                 |        | 2004 |   | 2005   |  | 2006 |        | 2007 |   | 2008   |  | Thereafter
|Mandatory Repayments and Reductions of Indebtedness |  | $                                     | 22,433 |      | $ | 1,795  |  | $    | 8,973  |      | $ | 10,768 |  | $          | 897   |  | $ |      |  | $ |      
|Operating Leases(1)                                 |  |                                       | 75,948 |      |   | 9,425  |  |      | 7,880  |      |   | 6,692  |  |            | 6,257 |  |   | 6,198 |  |   | 39,496
|                                                    |  |                                       |        |      |   |        |  |      |        |      |   |        |  |            |       |  |   |       |  |   |       
|Total Contractual Obligations                       |  | $                                     | 98,381 |      | $ | 11,220 |  | $    | 16,853 |      | $ | 17,460 |  | $          | 7,154 |  | $ | 6,198 |  | $ | 39,496
|                                                    |  |                                       |        |      |   |        |  |      |        |      |   |        |  |            |       |  |   |       |  |   |       

---

|(1) | Includes estimated future license fees for carrier hotel facilities.
|--- | --------------------------------------------------------------------



Recent Accounting Pronouncements



In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which we adopted on January 1, 2003. The statement
requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the
related long-lived asset. Over time, the liability is accreted to its then present value, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation
for its recorded amount or incurs a gain or loss upon settlement. The adoption of this statement did not have a material impact on our consolidated financial statements.



In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS No. 145). SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items,
eliminates the provisions of SFAS No. 44 regarding transition to the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS No.
145 related to classification of debt extinguishment are effective for fiscal years beginning after May 15, 2002, and were adopted on January 1, 2003. As a result of the adoption of this statement we classified debt extinguishment costs within other
income and reclassified previously reported debt extinguishments as such.



In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146). SFAS No. 146 nullifies Emerging Issues Task Force (EITF)
No. 94-3, Liability Recognition for certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in as Restructuring) (EITF No. 94-3). The principal difference between SFAS No.
146 and EITF No. 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of an entitys commitment to an exit plan. SFAS No. 146 was adopted on January 1, 2003. The adoption of SFAS No. 146 did not have a
material impact on our consolidated financial statements.



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In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
CompensationTransition and Disclosurean Amendment of FASB Statement No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of
the method used on reported results.



In May 2003, the FASB
issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (SFAS No.150). SFAS No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). The requirements of this
statement apply to issuers classification and measurement of freestanding financial instruments, including those that comprise more than one option or forward contract. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The initial adoption did not have a material effect on our consolidated financial statements.



In November 2002, the Emerging Issues Task Force (EITF) of the
FASB reached a consensus on EITF No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (EITF No. 00-21). EITF No. 00-21 addresses how to account for arrangements that may involve multiple
revenue-generating activities. The consensus guidance is applicable to agreements entered into in quarters beginning after June 15, 2003. We adopted EITF No. 00-21 effective July 1, 2003 and are applying it on a prospective basis. The initial
adoption did not have a material effect on our consolidated financial statements.



In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of
FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34 (FIN 45). FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under
certain guarantees that it has issued. The initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this statement did not have a
material impact on our consolidated financial statements.



In
January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, (FIN 46), an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements. FIN 46
establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary beneficiary. In December 2003, the FASB revised FIN 46 and issued FIN 46 (revised December 2003) (FIN
46R). In addition to conforming to previously issued FASB Staff Positions, FIN 46R deferred the implementation date for certain variable interest entities. This revised interpretation is effective for all entities no later than the end of the
first reporting period that ends after March 15, 2004. We do not have any investments in or contractual relationship or other business relationship with a variable interest entity and therefore the adoption of this interpretation will not have any
impact on our financial position or results of operations.



Certain Facts
That May Affect Future Results of Operations



This
report contains certain forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on managements current expectations and are subject to a number of factors and
uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Investors are cautioned that there can be no assurance that actual results or business conditions will not differ materially
from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, those discussed below. As a result, our future operations involve a high degree of risk. Except as required by law,
we undertake no obligation to update any forward- looking statement, whether as a result of new information, future events or otherwise.



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Factors Affecting our Business Condition



In addition to the other information and factors included in this report, the following factors should be considered in
evaluating our business and future prospects:



We are an early-stage
company, and we expect to encounter risks and difficulties frequently experienced by early-stage companies in new and rapidly evolving markets.



We did not begin to engage in our current business until 1999 and did not begin to offer our services until the first quarter of 2000. Our limited
operating history makes the evaluation of our future prospects very difficult. We will encounter risks and difficulties frequently experienced by early stage companies in new and rapidly evolving markets. As an early-stage organization, we are at a
competitive disadvantage to larger, more established competitors. We anticipate that this competitive disadvantage may persist for the foreseeable future. If we do not successfully address these risks, our business may suffer.



We have and may continue to experience operating losses, net losses and a cash flow
deficit.



We may not achieve or sustain operating income,
net income or positive cash flow from operations in the future. Since our inception we have incurred operating losses and net losses both on an annual and quarterly basis. We have not achieved profitability and expect to continue to incur operating
losses and net losses in 2004, and we may not for the foreseeable future. In 2001, we had an operating loss of $138.0 million and a net loss applicable to common stockholders of $178.2 million, and in 2002, we had an operating loss of $24.1 million
and a net loss applicable to common stockholders of $37.4 million. In 2003, we had an operating loss of $16.5 million and a net loss applicable to common stockholders of $27.8 million.



You should also be aware that our financial and operational performance depends upon a number of factors, many of which are
beyond our control. These factors include:



| |  | the economic and competitive conditions in the communications and networking industries;
| | - | ----------------------------------------------------------------------------------------



| |  | any operating difficulties, increased operating costs or pricing pressures we may experience;
| | - | ---------------------------------------------------------------------------------------------



| |  | the passage of legislation or other regulatory developments that may adversely affect us;
| | - | -----------------------------------------------------------------------------------------



| |  | changes in technologies creating alternative services to our services or making our services and networks obsolete;
| | - | -------------------------------------------------------------------------------------------------------------------



| |  | any delays in implementing any strategic projects; and
| | - | ------------------------------------------------------



| |  | our ability to operate our networks in a reliable and cost-effective manner.
| | - | ----------------------------------------------------------------------------



The sector in which we operate is highly competitive, and we may not be able to compete effectively.



We face competition from many entities with significantly greater financial
resources, well-established brand names and larger customer bases. The entities that compete with us include mobile and fixed wireless service providers, local telephone companies, long distance companies, competitive access providers, competitive
local exchange carriers and competitive colocation providers. The numerous companies that compete in our market expose us to severe price competition for our services. We expect competition to intensify in the future. If additional competitors focus
on our market opportunity, there may be intensified price competition which could have a material adverse effect on our business. Additionally, we may experience an increased number of service disconnections.



In the communications industry, continued pricing pressure from our competitors and an
excess of network capacity continue to cause prices for our services to decline.



In 2003, we experienced decreases in the prices of our services of up to 50% in recurring monthly charges. We anticipate that prices for broadband network services, in general, and for our services, in particular,
will continue to decline dramatically over the next several years due primarily to the following:



| |  | price competition as various service providers continue to sell services at greatly reduced process to absorb significant excess capacity in existing networks and continue to
install additional networks that compete with our networks;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | recent technological advances that permit substantial increases in the transmission capacity and more efficient utilization of both new and existing fiber; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | strategic alliances, consolidations or similar transactions that increase customers purchasing power.
| | - | ------------------------------------------------------------------------------------------------------



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Many of our customers and vendors are experiencing financial difficulties and have filed or may file for bankruptcy
protection.



The recent general economic weakness has
severely impacted the telecommunications industry. The expected demand for broadband connectivity has not been realized in many segments of the market. As a result, there has been an industry-wide slowdown in capital spending and a large number of
industry-related bankruptcy filings. Many of our customers and vendors are currently experiencing financial distress, and some of them have filed for bankruptcy protection.



We have contracts with communications providers that have filed for relief from creditors under the Bankruptcy Code, as well
as contracts with other communications providers who may still yet file for bankruptcy protection. As a result, there is a significant doubt that some of our customers or vendors will perform their obligations under our contracts with them. In
bankruptcy proceedings, the debtor, or trustee, as the case may be, has the right to, among other things, reject certain contracts.



In the past, bankruptcy courts have determined that certain of our contracts with our customers constitute executory contracts, and the contracts were
rejected. As a result, we received an unsecured claim for damages against the debtors, and all rights and privileges under the contracts were terminated, including payment for services rendered. There can be no assurance that additional customers or
vendors will not seek bankruptcy protection and that additional contracts will be terminated.



We may require additional capital to fund the further development of our networks and operation of our business, and an inability to obtain such capital could harm our business.



Although we have substantially completed the build-out of our networks, we
may selectively expand our networks in the future as market conditions and customer demand dictate. In addition, we may have to expand or adapt our networks to respond to the following:



| |  | an increasing number of customers;
| | - | ----------------------------------



| |  | demand for greater network capacity or colocation space;
| | - | --------------------------------------------------------



| |  | the replacement of inadequate or malfunctioning network elements;
| | - | -----------------------------------------------------------------



| |  | changes in our customers service requirements; and
| | - | ---------------------------------------------------



| |  | technological advances.
| | - | -----------------------



To do so, we may need to raise additional funds through public or private equity or debt financings. If we raise funds through the issuance of equity
securities, the ownership percentage of our then-current stockholders will be diluted and the holders of new equity securities may have rights, preferences or privileges senior to those of the holders of our common stock. If additional funds are
raised through another bank credit facility or the issuance of debt securities, the holders of such indebtedness would have rights senior to the rights of the holders of our common stock, and the terms of this indebtedness could impose restrictions
on our ability to incur additional indebtedness and on our operations, which could impede the successful completion of our business plan.



If our actual results vary from the anticipated results of our operating plan, we may not be able to fund operating and investing activities with
internally generated cash flows, and we may require external sources of capital. From time to time, we may consider private or public sales of additional equity or debt securities and other financings, depending upon market conditions, in order to
finance the continued operations of our business or for other strategic purposes. There can be no assurance that we will be able to successfully consummate any such financing on acceptable terms, or at all. Our inability to obtain additional
financing, as needed, could have a material adverse effect on our business. We do not have any off-balance sheet financing arrangements, nor do we anticipate entering into any.



We must maintain our existing agreements for space in major carrier hotels or our business will be harmed.



Our business depends upon our ability to lease space in carrier hotels to
establish carrier point facilities where we can locate our networking equipment and interconnect with our customers. At a minimum, to provide our services in a particular metropolitan area, we must obtain space in the major carrier hotels in that
area. In addition, we need adequate space at our carrier point facilities in order to continue offering colocation services. There may be significant competition for space in major carrier hotels. Our inability to obtain additional space, or our
inability to renew existing leases, would negatively impact our operations and have a material adverse effect on our business.



We should increase the number of our significant customers and the volume of traffic on our networks or our business may suffer.



Our revenues continue to be negatively impacted by the general economic
environment and by the difficulties that are affecting our industry. We have experienced significant disconnections of services by our customers and decreases in the prices of our services.



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As a result, we should increase the current volume of traffic on our networks in order to realize anticipated revenues
and cash flows. To do so, we must obtain long-term commitments from new large-volume customers, as well as expand our relationships with current customers. This need is more critical as a wholesale carrier because our potential customers are a
limited number of service providers. Therefore, it is essential for us to succeed at establishing and expanding customer relationships; otherwise our business will suffer.



If we cannot maintain the scalability, reliability and speed of our network, potential customers will not use our services.



Because of the limited deployment of our services, our
ability to manage a substantial amount of traffic on our networks while maintaining superior service is unknown at this time. There is no assurance that our network will be able to maintain current levels of service as the number of our customers
and amount of traffic grows. Our failure to maintain such levels of service would significantly reduce customer demand for our services and have a material adverse effect on our business.



Service interruptions on our networks could expose us to liability or cause us to lose customers.



Our operations depend on our ability to prevent or mitigate any damages from
power losses, network failures, transmission cable cuts or natural disasters. The failure of any equipment or facility on our networks could result in the interruption of service until we make the necessary repairs or install replacement equipment.
If service is not restored in a timely manner, agreements with our customers may obligate us to provide credits or other remedies to them, which would reduce our revenues or increase our expenses and may be exposed to litigation from our customers.
Service disruptions could also damage our reputation with customers, causing us to lose existing customers or to have difficulty attracting new ones. Many of our customers communications needs are extremely time sensitive, and delays in signal
delivery may cause significant losses to a customer using our networks. Our networks may also contain undetected design faults and software bugs that, despite our testing, may be discovered only after our networks have been completed and
are in use.



The occurrence of a natural disaster or act of terrorism in
close proximity to our facilities would substantially harm our business.



The substantial majority of our facilities are located within the New York metropolitan area, with the remainder located in Chicago and Los Angeles. In particular, our facilities located at 60 Hudson Street and 111
Eighth Avenue in New York City are critical to our business. Given the concentration of our facilities, the loss of one of our facilities through the occurrence of a natural disaster, fire or flood, or an act of terrorism would have a material
adverse effect on our business, results of operations and financial condition. We may not carry sufficient insurance to compensate us for losses caused by such an occurrence, and we may not be able to operate our business after the loss of one of
our facilities.



Our failure to manage the growth of our operations could
harm our business.



We have rapidly and significantly
expanded our operations. We anticipate that further expansion will be required to grow our customer base if we are to be successful in implementing our business strategy. Our future performance depends in part upon our ability to manage our growth
effectively. We may not be able to implement 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.
If we are unable to manage our growth effectively, our business will suffer.



Our business will be harmed if our information support systems are not further developed.



Sophisticated information processing systems, including provisioning, accounting and network management, are vital to our growth and our ability to
achieve operating efficiencies. Our plans for the development and implementation of these systems rely largely upon acquiring products and services from third party vendors and integrating those products and services. We may be unable to implement
these systems on a timely basis or at all, and these systems may not perform as expected. A failure of these systems could substantially impair our ability to provide services, send invoices and monitor our operations. We may also be unable to
maintain and upgrade our operational support systems as necessary.



We
license key software from third parties. If we are unable to obtain such software on commercially acceptable terms, our business could be adversely affected.



We rely on software licensed from third parties, including applications that are integrated with internally developed
software and used in our services. Most notably, we license Preside and MetaSolv TBS. These third-party technology licenses may not continue to be available to us on commercially reasonable terms, or at all, and we may not be able to obtain licenses
for other existing or future technologies that we desire to integrate into our services. Although we believe that there are alternative suppliers for the software that we rely upon, it could take a significant period of time to establish
relationships with alternative suppliers and integrate their software into our services. The loss of any of our relationships with these suppliers could have a material adverse affect on our business.



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We depend on our key personnel, and the loss of their services may adversely affect our business.



We are highly dependent upon the efforts of our senior management team, none
of whom currently has an employment agreement with us. The death or departure of any of our key personnel could have a material adverse effect on our business. We have previously announced the intention of Michael S. Liss, our President and Chief
Executive Officer, to resign during 2004. There can be no assurance that Mr. Liss departure will coincide with the hiring of his replacement or that this transition will not adversely impact our business.



We may become the subject of litigation by our stockholders, which could adversely affect
our business.



In addition to claims that may arise in the
normal course of our business and financing activities, certain of our stockholders may sue us in an attempt to recover their losses as a result of the decline in our stock price, which has been significant since 2000. The resolution of such a claim
would likely be costly and time-consuming. If any or all of such claims cannot be resolved through a negotiated settlement, we could become a party to the resulting litigation. Any litigation, even if we are successful, could result in substantial
costs and diversion of resources and management attention. An adverse determination in any litigation could also subject us to significant liability, under the judgment of a court or by default.



We may face competition from various service providers in buildings for which we have
exclusive license agreements.



We generally have exclusive
license agreements for both our on-net and off-net buildings. Even though our competitors cannot install a central distribution system in any of our buildings covered by an exclusive agreement, they may still compete with us by installing
infrastructure designed to directly service one or more specific tenants in the building as requested by such tenants. Consequently, they could indirectly compete against us by not utilizing our in-building networks to gain connectivity to tenants.
In addition, incumbent local exchange carriers, or ILECs, and the regional bell operating companies, or RBOCs, currently own pre-existing, copper-based networks in many of our on-net and off-net buildings. These ILECs and RBOCs may be able to
upgrade their existing networks to provide advanced broadband services which would place them in direct competition with us. Furthermore, service providers may have pre-existing license agreements in our buildings, which allow these providers to
install, and possibly expand, their network infrastructure in our buildings. As a result, we may face competition in some of the buildings for which we have exclusive license agreements.



Alternative technologies pose competitive threats.



In addition to fiber-optic technology, there are other technologies that provide more capacity and speed than traditional
copper wire transmission technology, such as digital subscriber lines, or DSL, and wireless technologies, and can be used instead of our networks. Furthermore, these technologies may be improved and other new technologies may be developed that
provide more capacity, reliability, scalability and speed than the fiber-optic technology we deploy. The development of new technologies or the significant penetration of alternative technologies into our target markets may reduce the demand for our
services and consequently could have a material adverse effect on our business.



We have outstanding debt that may limit our ability to borrow additional money, restrict the use of our cash flows and constrain our business strategy, and we may not be able to meet our debt obligations.



As of February 28, 2004, we had total outstanding debt of $16.8 million,
with the availability to borrow an additional $3.5 million. As a result of this debt and debt that we may incur in the future, we will need to devote a portion of our available cash towards debt service payments. In addition, our ability to borrow
additional money is restricted by our current debt arrangements. Furthermore, we have agreed to terms in the credit agreement (which governs our credit facility) that expose us to certain risks and limitations, including the following:



| |  | as the interest rate on our debt is variable, if interest rates rise, our debt service payments will increase;
| | - | --------------------------------------------------------------------------------------------------------------



| |  | principal amortization payments are required to be made quarterly beginning in 2004 and extending through maturity in 2007;
| | - | ---------------------------------------------------------------------------------------------------------------------------



| |  | we have made affirmative financial covenants that we will breach if our financial results do not meet our expectations; and
| | - | ---------------------------------------------------------------------------------------------------------------------------



| |  | we have agreed to certain negative covenants that may cause us to make choices regarding the operation of our business that we would not otherwise make.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------



You should be aware that our ability to repay or refinance our debt depends on our successful
financial and operating performance and on our ability to implement our business strategy successfully. We cannot assure you that our future cash flows and capital resources will be sufficient to repay our existing indebtedness and any indebtedness
we may incur in the future, or that we will be successful in obtaining alternative financing. Further, our borrowings under our credit facility are secured by substantially all of our assets, and our obligations under our facility are guaranteed by
our subsidiaries. In the event that we are unable to repay our debts, we may be forced



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to reduce or delay the completion or expansion of our networks, sell some of our assets, obtain additional equity capital
or refinance or restructure our debt. If we are unable to meet our debt service obligations or comply with our covenants, we would be in default under our existing debt agreements, which would accelerate the repayment of our indebtedness. Our
failure to achieve certain financial results would also violate certain covenants, potentially accelerating the outstanding balance of our debt for immediate payment. To avoid a default, we may need waivers from third parties, which might not be
granted.



Legislation and government regulation could adversely affect us.



We are subject to federal, state and local regulations
that affect our services, competition, the taxation of our services and other aspects of our operations. The regulation of the communications industry is changing rapidly, and varies from state to state. Changes in the regulatory environment could
affect our operating results by increasing competition, decreasing revenue, increasing costs or impairing our ability to offer services. Certain communications services are subject to significant regulation at the federal and state level. The
Federal Communications Commission, or FCC, regulates communications carriers providing intrastate, interstate and international common carrier services. State public utility commissions exercise jurisdiction over intrastate communications services.
The FCC and state public utility commissions do not regulate most enhanced services, which involve more than the pure transmission of customer provided information. Our subsidiary, Local Fiber, LLC, is regulated as a common carrier by virtue of its
provision of communications services directly to the public for a fee. As a common carrier, Local Fiber, LLC is subject to extensive federal, state and local communications regulation, which includes the payment of all applicable regulatory
assessments.



Many of our competitors and vendors, especially
ILECs, are subject to federal and state regulations. These regulations change from time to time in ways that are difficult for us to predict. Although we believe the services we provide today, other than those provided by Local Fiber, LLC, are not
subject to regulation imposed on other telecommunications services by the FCC or the state public utility commissions, changes in regulation or new legislation may impose regulation on our non-regulated services.



Regulation of access to office buildings could negatively affect our
business. Some states have adopted laws that require that commercial building owners provide non-discriminatory access to communications providers. The FCC has released its decision relating to access to commercial multiple tenant buildings, and
legislation was enacted that increases telecommunications access to buildings owned or used by the federal government. Among other decisions, the FCC prohibited telecommunications carriers from entering into exclusive agreements with commercial
building owners on a prospective basis, and required utilities, including local exchange carriers, to provide access to other telecommunications carriers and cable service providers. Other building access issues remain to be addressed by the FCC.
Depending on how these rules are interpreted, these requirements may facilitate our competitors entry into buildings in which we offer our services, which in turn will diminish the value of our access rights and adversely affect our
competitive position.



As an access provider, we may incur
liability for information disseminated through our networks. The law relating to the liability of access providers and on-line services companies for information carried on or disseminated through their networks is unsettled. Although we have not
been sued for information carried on our networks, it is possible that we could be. Federal and state statutes have been directed at imposing liability on Internet service providers for aspects of content carried on their networks. There may be new
legislation and court decisions that may affect our services and expose us to potential liability.



As the law in this area develops, the potential imposition of liability for information carried on and disseminated through our networks could require us
to implement measures to reduce our exposure to such liability, which may require the expenditure of substantial resources or the discontinuation of certain products or services offerings. Any significant costs that we incur as a result of such
measures or the imposition of liability could have a material adverse effect on our business, including our operating expenses and our liquidity.



Our principal stockholders, directors and executive officers currently control a majority of the voting rights of our stock, and this may limit your ability to affect
the outcome of any stockholder vote or exercise any influence over our business.



The concentration of ownership of our common stock may have the effect of delaying, deferring or preventing a change in control, merger, consolidation, or tender offer that could involve a premium over the price of
our common stock. Currently, our executive officers, directors and greater-than-five-percent stockholders and their affiliates, in the aggregate, beneficially own approximately 51.6% of our outstanding common stock. These stockholders, if they vote
together, are able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions and matters.



Anti-takeover provisions could prevent or delay a change of control that stockholders may
consider favorable.



Provisions in our certificate of
incorporation, our bylaws and Delaware law could delay or prevent a change of control or change in management that would provide stockholders with a premium to the market price of their common stock. The authorization of undesignated preferred
stock, for example, gives our board the ability to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of the company. If a change of control or change in management is
delayed or prevented, this premium may not be realized, or the market price of our common stock could decline.



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Holders of our common stock will not receive a return on their shares until they sell them because we do not plan to
pay cash dividends on our shares.



We have neither
declared nor paid any dividends on our common stock and do not anticipate paying cash dividends in the future. We currently intend to retain any earnings to fund operations and future growth. Furthermore, our credit facility currently prohibits, and
the terms of any future debt agreements or preferred stock will likely restrict, the payment of cash dividends on our common stock.



Our stock price is likely to be highly volatile.



The trading price of our common stock is highly volatile. Failure to meet market expectations because of quarterly fluctuations in our financial results
could cause our stock price to decline. Moreover, factors that are not related to our operating performance could cause our stock price to decline. The stock market has periodically experienced significant price and volume fluctuations that have
affected the market prices for securities of technology and communications companies. Consequently, you may experience a decrease in the market value of your common stock, regardless of our operating performance or prospects.



We could issue a substantial number of additional shares of common stock, which could
adversely affect the trading price of our common stock.



We have approximately 7.0 million shares of common stock subject to stock options and warrants. We cannot predict the effect, if any, that future sales of shares of common stock, or the availability of shares of common stock for future
sale, will have on the market price of our common stock. Sales of substantial amounts of common stock (including shares issued upon the exercise of stock options or warrants), or the perception that such sales could occur, may adversely affect
prevailing market prices for our common stock.



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ITEM 8. FINANCIAL STATEMENTS



CONSOLIDATED FINANCIAL STATEMENTS



TABLE OF CONTENTS



|                                                        |  |     
|------------------------------------------------------- |  | ----
|                                                        |  | Page
|Report of Independent Registered Public Accounting Firm |  | 25  
|Report of Independent Public Accountants                |  | 27  
|Consolidated Balance Sheets (Restated)                  |  | 28  
|Consolidated Statements of Operations (Restated)        |  | 29  
|Consolidated Statements of Stockholders Equity         |  | 30  
|Consolidated Statements of Cash Flows                   |  | 31  
|Notes to Consolidated Financial Statements              |  | 32  



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Shareholders of FiberNet Telecom Group, Inc.:



We have audited the accompanying consolidated balance sheets of FiberNet Telecom Group, Inc. (FiberNet or the Company) as of December 31, 2003 and 2002, and the related consolidated statements of operations,
stockholders equity and cash flows for each of the two years in the period ended December 31, 2003. These financial statements are the responsibility of FiberNets management. Our responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial statements of FiberNet Telecom Group, Inc. for the year ended December 31, 2001, before the reclassifications and inclusion of the disclosures discussed in Note 2 and the restatement
discussed in Note 17, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements in their report dated February 28, 2002 (except with respect to the matters
discussed in Note 17 (as originally filed and not presented herein), as to which the date is May 16, 2002).



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



In our opinion, the 2003 and 2002 consolidated financial
statements present fairly, in all material respects, the financial position of FiberNet Telecom Group, Inc., as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the two years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.



As discussed in Note 2 to the consolidated financial statements, FiberNet adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets on January 1, 2002, and adopted Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections, on January 1, 2003.



As discussed
above, the consolidated financial statements of the Company as of December 31, 2001 and for the year then ended were audited by other auditors who have ceased operations. Those consolidated financial statements have been revised as follows:



| | 1. | As described in Note 2, the 2001 consolidated financial statements have been revised to include the transition disclosures required by Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company on January 1, 2002. Our audit procedures with respect to 2001 included (a) agreeing the previously reported net loss to the previously issued consolidated financial
statements and the adjustments to reported net loss representing amortization expense recognized in those periods relating to goodwill to the Companys underlying records obtained from management, and (b) testing the mathematical accuracy of
the reconciliation of adjusted net loss to reported net loss.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | As described in Note 2, the 2001 consolidated financial statements have been revised to include the reclassification provisions required by Statement of Financial Accounting
Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, (SFAS No. 145) which was adopted by the Company on January 1, 2003. We audited the adjustments
described in Note 2 that were applied to conform the 2001 financial statements to the presentation required by SFAS No. 145. Our audit procedures with respect to 2001 included (a) agreeing the reported amount to underlying accounting records
obtained from management, (b) on a test basis, comparing the amounts comprising the loss on extinguishment of debt obtained from management to independent supporting documentation, and (c) testing the mathematical accuracy of reclassification of
gain on early extinguishment of debt (see Note 17).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | As described in Note 2, the 2001 financial statements have been revised to give effect to the one for 30 reverse stock split on May 12, 2003. Our audit procedures with respect to
2001 included (a) comparing the amounts
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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shown in the earnings per share disclosures for 2001 to the Companys underlying accounting analysis
obtained from management, (b) comparing the previously reported shares outstanding and income statement amounts per the Companys accounting analysis to the previously issued financial statements, and (c) recalculating the additional shares to
give effect to the stock split and testing the mathematical accuracy of the underlying analysis.



| | 4. | As described in Note 6, the 2001 financial statements have been reclassified to include additional disclosures relating to the components comprising interest income and interest
expense. Our audit procedures with respect to the 2001 disclosures in Note 6 included (1) comparing the previously reported interest expense, net to previously issued financial statements, (2) comparing the interest income and interest expense to
the Companys underlying analysis obtained from management, and (3) testing the mathematical accuracy of the underlying analysis.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5. | As described in Note 17, the 2001 financial statements have been restated to correct the Companys initial adoption of SFAS No. 145 in which a loss from early extinguishment of
debt was classified as a component of loss from operations rather than other expense. Our audit procedures with respect to the 2001 restatement included agreeing reported operating expenses and loss from operations to the originally issued
consolidated financial statements audited by other auditors.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 6. | As described in Note 17, the 2001 income tax footnote (Note 12) includes additional disclosures relating to the components of the statutory income tax rate reconciliation. Our audit
procedures with respect to the 2001 disclosures in Note 12 included (1) comparing the previously reported tax effect related to non-deductible goodwill impairment to the previously issued financial statements, (2) comparing the tax effect related to
non-deductible goodwill impairment to the Companys underlying analysis obtained from management, and (3) testing the mathematical accuracy of the underlying analysis.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In our opinion, such disclosures and reclassifications are appropriate and have been properly applied. However, we were not
engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of the Company other than with respect to such disclosures and reclassifications, and accordingly, we do not express an opinion or any other form of
assurance on the 2001 consolidated financial statements taken as a whole.



As discussed in Note 17, the accompanying consolidated financial statements have been restated.



/s/ DELOITTE & TOUCHE LLPNew York, New YorkMarch 29, 2004 (July 6, 2004, as to the effects of the restatement discussed in Note 17)




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THIS REPORT SET FORTH BELOW IS A COPY OF A PREVIOUSLY ISSUED AUDIT REPORT BY ARTHUR ANDERSEN LLP. THIS
REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH ITS INCLUSION IN THIS FORM 10-K/A.



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To
FiberNet Telecom Group, Inc.:



We have audited the
accompanying consolidated balance sheets of FiberNet Telecom Group, Inc. and subsidiaries (a Delaware corporation) as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders equity and cash flows for
the years ended December 31, 2001, 2000 and 1999, as restated-see Note 16. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements
based on our audits.



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



We have also audited the adjustments described in Note 16 that were applied to restate the 1999 financial statements. In our opinion, such adjustments are
appropriate and have been properly applied.



In our opinion,
the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FiberNet Telecom Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their
cash flows for the years ended December 31, 2001, 2000 and 1999, as restated, in conformity with accounting principles generally accepted in the United States.



/s/ ARTHUR ANDERSEN LLPNew York, New YorkFebruary 28, 2002




(except with respect to the
matters discussed in Note 17, as to which the date is May 16, 2002)



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FIBERNET TELECOM GROUP, INC.



CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)



|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | -------- | - | --------------------------- | - | -------- | -
|                                                                                                                                                                       |  | December 31, 2003           |          |   | December 31, 2002           |  
|                                                                                                                                                                       |  | (As restated  see Note 17) |          |   | (As restated  see Note 17) |  
|ASSETS                                                                                                                                                                 |  |                             |          |   |                             |   |          |  
|Current Assets:                                                                                                                                                        |  |                             |          |   |                             |   |          |  
|Cash and cash equivalents                                                                                                                                              |  | $                           | 3,488    |   |                             | $ | 3,788    |  
|Restricted cash                                                                                                                                                        |  |                             | 2,337    |   |                             |   |         |  
|Accounts receivable, net of allowance of $721 and $1,005 at December 31, 2003 and 2002, respectively                                                                   |  |                             | 3,785    |   |                             |   | 2,765    |  
|Prepaid expenses and other                                                                                                                                             |  |                             | 754      |   |                             |   | 740      |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|Total current assets                                                                                                                                                   |  |                             | 10,364   |   |                             |   | 7,293    |  
|Property, plant and equipment, net                                                                                                                                     |  |                             | 86,958   |   |                             |   | 95,122   |  
|Other Assets:                                                                                                                                                          |  |                             |          |   |                             |   |          |  
|Goodwill                                                                                                                                                               |  |                             |         |   |                             |   | 7,509    |  
|Deferred charges, net of accumulated amortization of $1,402 and $1,405 at December 31, 2003 and 2002, respectively                                                     |  |                             | 2,035    |   |                             |   | 3,383    |  
|Other assets                                                                                                                                                           |  |                             | 261      |   |                             |   | 488      |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|Total other assets                                                                                                                                                     |  |                             | 2,296    |   |                             |   | 11,380   |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|TOTAL ASSETS                                                                                                                                                           |  | $                           | 99,618   |   |                             | $ | 113,795  |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                   |  |                             |          |   |                             |   |          |  
|Current Liabilities:                                                                                                                                                   |  |                             |          |   |                             |   |          |  
|Accounts payable                                                                                                                                                       |  | $                           | 3,598    |   |                             | $ | 4,147    |  
|Accrued expenses                                                                                                                                                       |  |                             | 5,138    |   |                             |   | 5,608    |  
|Deferred revenuescurrent portion                                                                                                                                      |  |                             | 4,584    |   |                             |   | 4,091    |  
|Notes payablecurrent portion                                                                                                                                          |  |                             | 1,795    |   |                             |   |         |  
|Capital lease obligationcurrent portion                                                                                                                               |  |                             |         |   |                             |   | 271      |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|Total current liabilities                                                                                                                                              |  |                             | 15,115   |   |                             |   | 14,117   |  
|Long-Term Liabilities:                                                                                                                                                 |  |                             |          |   |                             |   |          |  
|Notes payable, less original issue discount of $2,308 and $4,880 at December 31, 2003 and 2002, respectively                                                           |  |                             | 18,330   |   |                             |   | 30,356   |  
|Deferred revenues                                                                                                                                                      |  |                             | 1,439    |   |                             |   | 522      |  
|Capital lease obligation                                                                                                                                               |  |                             |         |   |                             |   | 202      |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|Total liabilities                                                                                                                                                      |  |                             | 34,884   |   |                             |   | 45,197   |  
|Commitments and contingent liabilities (Note 7)                                                                                                                        |  |                             |          |   |                             |   |          |  
|Stockholders Equity:                                                                                                                                                  |  |                             |          |   |                             |   |          |  
|Common stock, $.001 par value, 2,000,000,000 shares authorized and 40,540,334 and 26,405,482 shares issued and outstanding at December 31,
2003 and 2002, respectively |  |                             | 41       |   |                             |   | 26       |  
|Additional paid-in-capital and other                                                                                                                                   |  |                             | 429,991  |   |                             |   | 401,298  |  
|Deferred compensation                                                                                                                                                  |  |                             | (4,797   | ) |                             |   |         |  
|Accumulated deficit                                                                                                                                                    |  |                             | (360,501 | ) |                             |   | (332,726 | )
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|Total stockholders equity                                                                                                                                             |  |                             | 64,734   |   |                             |   | 68,598   |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                             |  | $                           | 99,618   |   |                             | $ | 113,795  |  
|                                                                                                                                                                       |  |                             |          |   |                             |   |          |  



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



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FIBERNET TELECOM GROUP, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)



|                                                                            |  |                            |         |   |                            |   |         |                            |  |   |          |  
|--------------------------------------------------------------------------- |  | -------------------------- | ------- | - | -------------------------- | - | ------- | -------------------------- |  | - | -------- | -
|                                                                            |  | Year Ended December 31,    |        
|                                                                            |  | 2003                       |         |   | 2002                       |   |         | 2001                       | 
|                                                                            |  | (As restated see Note 17) |         |   | (As restated see Note 17) |   |         | (As restated see Note 17) | 
|Revenues                                                                    |  | $                          | 26,604  |   |                            | $ | 25,334  |                            |  | $ | 31,195   |  
|Operating expenses:                                                         |  |                            |         |   |                            |   |         |                            |  |   |          |  
|Cost of services (exclusive of items shown separately below)                |  |                            | 8,806   |   |                            |   | 7,537   |                            |  |   | 13,801   |  
|Selling, general and administrative expense excluding stock related expense |  |                            | 16,409  |   |                            |   | 16,053  |                            |  |   | 32,917   |  
|Stock related expense for selling, general and administrative matters       |  |                            | 222     |   |                            |   | 225     |                            |  |   | (1,172   | )
|Impairment of property, plant and equipment                                 |  |                            | 1,346   |   |                            |   | 13,175  |                            |  |   | 51,848   |  
|Impairment of goodwill                                                      |  |                            | 7,509   |   |                            |   |        |                            |  |   | 56,467   |  
|Depreciation and amortization                                               |  |                            | 8,840   |   |                            |   | 10,346  |                            |  |   | 15,319   |  
|                                                                            |  |                            |         |   |                            |   |         |                            |  |   |          |  
|Total operating expenses                                                    |  |                            | 43,132  |   |                            |   | 47,336  |                            |  |   | 169,180  |  
|                                                                            |  |                            |         |   |                            |   |         |                            |  |   |          |  
|Loss from operations                                                        |  |                            | (16,528 | ) |                            |   | (22,002 | )                          |  |   | (137,985 | )
|Loss on early extinguishments of debt                                       |  |                            | (8,951  | ) |                            |   | (7,859  | )                          |  |   | (7,398   | )
|Interest income                                                             |  |                            | 46      |   |                            |   | 28      |                            |  |   | 182      |  
|Interest expense                                                            |  |                            | (2,342  | ) |                            |   | (7,571  | )                          |  |   | (8,776   | )
|                                                                            |  |                            |         |   |                            |   |         |                            |  |   |          |  
|Net loss                                                                    |  |                            | (27,775 | ) |                            |   | (37,404 | )                          |  |   | (153,977 | )
|Preferred stock dividends                                                   |  |                            |        |   |                            |   | (44     | )                          |  |   | (1,080   | )
|Preferred stock-beneficial conversion                                       |  |                            |        |   |                            |   |        |                            |  |   | (23,109  | )
|                                                                            |  |                            |         |   |                            |   |         |                            |  |   |          |  
|Net loss applicable to common stockholders                                  |  | $                          | (27,775 | ) |                            | $ | (37,448 | )                          |  | $ | (178,166 | )
|                                                                            |  |                            |         |   |                            |   |         |                            |  |   |          |  
|Net loss applicable to common stockholders per sharebasic and diluted      |  | $                          | (0.75   | ) |                            | $ | (6.09   | )                          |  | $ | (130.14  | )
|Weighted average common shares outstandingbasic and diluted                |  |                            | 37,192  |   |                            |   | 6,148   |                            |  |   | 1,369    |  



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



29



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(in thousands, except per share amounts)



|                                                                 |  |                 |   |  |              |         |                                   |        |            |                      |        |   |                    |  |   |         |   |  |   |        |   |  |   |          |   |  |   |          |  
|---------------------------------------------------------------- |  | --------------- | - |  | ------------ | ------- | --------------------------------- | ------ | ---------- | -------------------- | ------ | - | ------------------ |  | - | ------- | - |  | - | ------ | - |  | - | -------- | - |  | - | -------- | -
|                                                                 |  | Preferred Stock |   |  | Common Stock |         | AdditionalPaid inCapitaland Other |        |            | DeferredCompensation |        |   | AccumulatedDeficit |  |   | Total   |  
|                                                                 |  | Shares          |   |  | Amount       |         |                                   | Shares |            |                      | Amount |   |                    |  |  
|Balance at December 31, 2000                                     |  | 1,605,422       |   |  | $            | 101,085 |                                   |        | 1,107,945  |                      |        | $ | 1                  |  | $ | 154,854 |   |  | $ |       |   |  | $ | (111,658 | ) |  | $ | 144,282  |  
|                                                                 |  |                 |   |  |              |         |                                   |       
|Direct issuance of common stock, Feb 2001                        |  |                |   |  |              |        |                                   |        | 214,667    |                      |        |   |                   |  |   | 24,806  |   |  |   |       |   |  |   |         |   |  |   | 24,806   |  
|Issuance of warrants in connection with bank financing           |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 7,148   |   |  |   |       |   |  |   |         |   |  |   | 7,148    |  
|Series D preferred stock dividends                               |  | 12,123          |   |  |              | 96      |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 96       |  
|Series E preferred stock dividends                               |  | 22,802          |   |  |              | 184     |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 184      |  
|Series F preferred stock dividends                               |  | 27,445          |   |  |              | 219     |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 219      |  
|Series H preferred stock dividends                               |  | 33,959          |   |  |              | 264     |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 264      |  
|Series I preferred stock dividends                               |  | 4,885           |   |  |              | 38      |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 38       |  
|Exercise of options and warrants to purchase common stock        |  |                |   |  |              |        |                                   |        | 3,686      |                      |        |   |                   |  |   | 1       |   |  |   |       |   |  |   |         |   |  |   | 1        |  
|Beneficial conversion on repricing of series H                   |  |                |   |  |              | 16,254  |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 16,254   |  
|Beneficial conversion on repricing of series I                   |  |                |   |  |              | 4,766   |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 4,766    |  
|Issuance of warrants in connection with conversions              |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 279     |   |  |   |       |   |  |   |         |   |  |   | 279      |  
|Conversion of series C preferred stock                           |  | (83,688         | ) |  |              | (135    | )                                 |        | 2,790      |                      |        |   |                   |  |   | 135     |   |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of series D preferred stock                           |  | (334,827        | ) |  |              | (6,291  | )                                 |        | 111,609    |                      |        |   |                   |  |   | 6,291   |   |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of series E preferred stock                           |  | (340,655        | ) |  |              | (7,528  | )                                 |        | 113,552    |                      |        |   |                   |  |   | 7,528   |   |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of series F preferred stock                           |  | (403,647        | ) |  |              | (14,093 | )                                 |        | 134,549    |                      |        |   |                   |  |   | 14,093  |   |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of series H preferred stock                           |  | (373,947        | ) |  |              | (63,990 | )                                 |        | 284,912    |                      |        |   | 1                  |  |   | 63,989  |   |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of series I preferred stock                           |  | (69,316         | ) |  |              | (13,773 | )                                 |        | 63,375     |                      |        |   |                   |  |   | 13,773  |   |  |   |       |   |  |   |         |   |  |   |         |  
|Issuance of series J preferred stock, net                        |  | 360             |   |  |              | 7,094   |                                   |        | 10,909     |                      |        |   |                   |  |   | 1,862   |   |  |   |       |   |  |   |         |   |  |   | 8,956    |  
|Subscription receivable on series J preferred stock              |  |                |   |  |              | (5,700  | )                                 |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | (5,700   | )
|Beneficial conversion on series J preferred stock                |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 2,091   |   |  |   |       |   |  |   |         |   |  |   | 2,091    |  
|Conversion of series J preferred stock                           |  | (4              | ) |  |              | (31     | )                                 |        | 4,427      |                      |        |   |                   |  |   | 31      |   |  |   |       |   |  |   |         |   |  |   |         |  
|Stock compensation to employees                                  |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | (1,172  | ) |  |   |       |   |  |   |         |   |  |   | (1,172   | )
|Net loss applicable to common stockholders                       |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   | (178,166 | ) |  |   | (178,166 | )
|                                                                 |  |                 |   |  |              |         |                                   |        |            |                      |        |   |                    |  |   |         |   |  |   |        |   |  |   |          |   |  |   |          |  
|Balance at December 31, 2001                                     |  | 100,912         |   |  |              | 18,459  |                                   |        | 2,052,421  |                      |        |   | 2                  |  |   | 295,709 |   |  |   |       |   |  |   | (289,824 | ) |  |   | 24,346   |  
|                                                                 |  |                 |   |  |              |         |                                   |       
|Issuance of common stock                                         |  |                |   |  |              |        |                                   |        | 1,275,071  |                      |        |   | 1                  |  |   | 3,217   |   |  |   |       |   |  |   |         |   |  |   | 3,218    |  
|Issuance of warrants                                             |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 2,165   |   |  |   |       |   |  |   |         |   |  |   | 2,165    |  
|Series H preferred stock dividends                               |  | 4,022           |   |  |              | 31      |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   | 31       |  
|Conversion of series H preferred stock                           |  | (104,575        | ) |  |              | (17,127 | )                                 |        | 3,486,048  |                      |        |   | 3                  |  |   | 17,124  |   |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of series J preferred stock                           |  | (359            | ) |  |              | (1,363  | )                                 |        | 2,103,566  |                      |        |   | 2                  |  |   | 1,311   |   |  |   |       |   |  |   |         |   |  |   | (50      | )
|Deemed dividend charge on conversion of series J preferred stock |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 5,454   |   |  |   |       |   |  |   | (5,454   | ) |  |   |         |  
|Exercise of options and warrants to purchase common stock        |  |                |   |  |              |        |                                   |        | 102,595    |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   |         |   |  |   |         |  
|Stock compensation to employees                                  |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 225     |   |  |   |       |   |  |   |         |   |  |   | 225      |  
|Conversion of note payableaffiliate to common stock             |  |                |   |  |              |        |                                   |        | 300,068    |                      |        |   |                   |  |   | 1,080   |   |  |   |       |   |  |   |         |   |  |   | 1,080    |  
|Forgiveness of note payableaffiliate                            |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 893     |   |  |   |       |   |  |   |         |   |  |   | 893      |  
|Conversion of notes payable to common stock                      |  |                |   |  |              |        |                                   |        | 14,666,666 |                      |        |   | 15                 |  |   | 52,785  |   |  |   |       |   |  |   |         |   |  |   | 52,800   |  
|Conversion of notes payable to warrants                          |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 10,691  |   |  |   |       |   |  |   |         |   |  |   | 10,691   |  
|Conversion of subordinated note payable                          |  |                |   |  |              |        |                                   |        | 1,733,333  |                      |        |   | 2                  |  |   | 6,238   |   |  |   |       |   |  |   |         |   |  |   | 6,240    |  
|Conversion of accrued interest to common stock                   |  |                |   |  |              |        |                                   |        | 666,667    |                      |        |   | 1                  |  |   | 2,399   |   |  |   |       |   |  |   |         |   |  |   | 2,400    |  
|Conversion of accrued interest to warrants                       |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 1,944   |   |  |   |       |   |  |   |         |   |  |   | 1,944    |  
|Legal settlement                                                 |  |                |   |  |              |        |                                   |        | 19,047     |                      |        |   |                   |  |   | 63      |   |  |   |       |   |  |   |         |   |  |   | 63       |  
|Net loss applicable to common stockholders                       |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   | (37,448  | ) |  |   | (37,448  | )
|                                                                 |  |                 |   |  |              |         |                                   |        |            |                      |        |   |                    |  |   |         |   |  |   |        |   |  |   |          |   |  |   |          |  
|Balance at December 31, 2002                                     |  |                |   |  |              |        |                                   |        | 26,405,482 |                      |        |   | 26                 |  |   | 401,298 |   |  |   |       |   |  |   | (332,726 | ) |  |   | 68,598   |  
|                                                                 |  |                 |   |  |              |         |                                   |       
|Issuance of common stock                                         |  |                |   |  |              |        |                                   |        | 972,222    |                      |        |   | 1                  |  |   | 1,190   |   |  |   |       |   |  |   |         |   |  |   | 1,191    |  
|Issuance of warrants                                             |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 3,465   |   |  |   |       |   |  |   |         |   |  |   | 3,465    |  
|Reprice of warrants                                              |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | 1,963   |   |  |   |       |   |  |   |         |   |  |   | 1,963    |  
|Exercise of warrants to purchase common stock                    |  |                |   |  |              |        |                                   |        | 3,798,652  |                      |        |   | 4                  |  |   | (4      | ) |  |   |       |   |  |   |         |   |  |   |         |  
|Conversion of notes payable to common stock                      |  |                |   |  |              |        |                                   |        | 4,617,010  |                      |        |   | 5                  |  |   | 16,616  |   |  |   |       |   |  |   |         |   |  |   | 16,621   |  
|Common stock issuance cost                                       |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   | (684    | ) |  |   |       |   |  |   |         |   |  |   | (684     | )
|Restricted stock grants                                          |  |                |   |  |              |        |                                   |        | 4,710,500  |                      |        |   | 5                  |  |   | 5,318   |   |  |   | (5,318 | ) |  |   |         |   |  |   | 5        |  
|Legal settlement                                                 |  |                |   |  |              |        |                                   |        | 301,568    |                      |        |   |                   |  |   | 1,128   |   |  |   |       |   |  |   |         |   |  |   | 1,128    |  
|Restricted stock surrendered                                     |  |                |   |  |              |        |                                   |        | (265,100   | )                    |        |   |                   |  |   | (299    | ) |  |   | 299    |   |  |   |         |   |  |   |         |  
|Deferred compensation amortization                               |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   | 222    |   |  |   |         |   |  |   | 222      |  
|Net loss applicable to common stockholders                       |  |                |   |  |              |        |                                   |        |           |                      |        |   |                   |  |   |        |   |  |   |       |   |  |   | (27,775  | ) |  |   | (27,775  | )
|                                                                 |  |                 |   |  |              |         |                                   |        |            |                      |        |   |                    |  |   |         |   |  |   |        |   |  |   |          |   |  |   |          |  
|Balance at December 31, 2003                                     |  |                |   |  | $            |        |                                   |        | 40,540,334 |                      |        | $ | 41                 |  | $ | 429,991 |   |  | $ | (4,797 | ) |  | $ | (360,501 | ) |  | $ | 64,734   |  
|                                                                 |  |                 |   |  |              |         |                                   |        |            |                      |        |   |                    |  |   |         |   |  |   |        |   |  |   |          |   |  |   |          |  



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



30



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|----------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | -------- | -
|                                                                                          |  | Year Ended December 31, |        
|                                                                                          |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Cash flows from operating activities:                                                     |  |                         |         |   |      |   |         |      |  |   |          |  
|Net loss applicable to common stockholders                                                |  | $                       | (27,775 | ) |      | $ | (37,448 | )    |  | $ | (178,166 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                         |         |   |      |   |         |      |  |   |          |  
|Depreciation and amortization                                                             |  |                         | 8,840   |   |      |   | 10,346  |      |  |   | 15,319   |  
|Preferred stock dividends                                                                 |  |                         |        |   |      |   | 44      |      |  |   | 1,080    |  
|Preferred stockbeneficial conversion                                                     |  |                         |        |   |      |   |        |      |  |   | 23,109   |  
|Stock related expense for selling, general and administrative matters                     |  |                         | 222     |   |      |   | 225     |      |  |   | (1,172   | )
|Impairment of property, plant and equipment                                               |  |                         | 1,544   |   |      |   | 13,175  |      |  |   | 51,848   |  
|Impairment of goodwill                                                                    |  |                         | 7,509   |   |      |   |        |      |  |   | 56,467   |  
|Loss on early extinguishments of debt                                                     |  |                         | 8,951   |   |      |   | 7,859   |      |  |   | 7,398    |  
|Non-cash interest expense capitalized on notes payable                                    |  |                         | 663     |   |      |   | 5,421   |      |  |   |         |  
|Other non-cash expenses                                                                   |  |                         | 977     |   |      |   | 1,418   |      |  |   | 4,545    |  
|Change in assets and liabilities:                                                         |  |                         |         |   |      |   |         |      |  |   |          |  
|(Increase) decrease in accounts receivable, prepaid expenses and other assets             |  |                         | (807    | ) |      |   | (789    | )    |  |   | 9,686    |  
|Increase (decrease) in accounts payable, accrued expenses, and deferred revenue           |  |                         | 2,124   |   |      |   | (4,757  | )    |  |   | (12,144  | )
|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash provided by (used in) operating activities                                           |  |                         | 2,248   |   |      |   | (4,506  | )    |  |   | (22,030  | )
|Cash flows from investing activities:                                                     |  |                         |         |   |      |   |         |      |  |   |          |  
|Capital expenditures                                                                      |  |                         | (2,388  | ) |      |   | (2,453  | )    |  |   | (46,737  | )
|Increase in restricted cash                                                               |  |                         | (2,337  | ) |      |   |        |      |  |   |         |  
|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash used in investing activities                                                         |  |                         | (4,725  | ) |      |   | (2,453  | )    |  |   | (46,737  | )
|Cash flows from financing activities:                                                     |  |                         |         |   |      |   |         |      |  |   |          |  
|Payments of financing fees                                                                |  |                         | (1,238  | ) |      |   | (448    | )    |  |   | (2,306   | )
|Proceeds from debt financing                                                              |  |                         |        |   |      |   | 2,307   |      |  |   | 45,000   |  
|Proceeds from subordinated note payable                                                   |  |                         |        |   |      |   | 2,000   |      |  |   |         |  
|Proceeds from issuance of equity securities                                               |  |                         | 3,500   |   |      |   | 3,800   |      |  |   | 28,062   |  
|Repayment of capital lease obligation                                                     |  |                         | (85     | ) |      |   | (250    | )    |  |   | (233     | )
|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash provided from financing activities                                                   |  |                         | 2,177   |   |      |   | 7,409   |      |  |   | 70,523   |  
|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|Net (decrease) increase in cash and cash equivalents                                      |  |                         | (300    | ) |      |   | 450     |      |  |   | 1,756    |  
|Cash and cash equivalents at beginning of year                                            |  |                         | 3,788   |   |      |   | 3,338   |      |  |   | 1,582    |  
|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|Cash and cash equivalents at end of year                                                  |  | $                       | 3,488   |   |      | $ | 3,788   |      |  | $ | 3,338    |  
|                                                                                          |  |                         |         |   |      |   |         |      |  |   |          |  
|Supplemental disclosures of cash flow information:                                        |  |                         |         |   |      |   |         |      |  |   |          |  
|Interest paid                                                                             |  | $                       | 563     |   |      | $ | 35      |      |  | $ | 6,732    |  
|Non-cash financing activities:                                                            |  |                         |         |   |      |   |         |      |  |   |          |  
|Conversion of accrued interest into common stock                                          |  |                         |        |   |      |   | 2,000   |      |  |   |         |  
|Conversion of accrued interest into notes payable                                         |  |                         |        |   |      |   | 3,522   |      |  |   |         |  
|Conversion of notes payable into common stock                                             |  |                         | 13,382  |   |      |   | 66,000  |      |  |   |         |  
|Conversion of subordinated note payable into common stock                                 |  |                         |        |   |      |   | 2,080   |      |  |   |         |  
|Conversion of note payableaffiliate into common stock                                    |  |                         |        |   |      |   | 450     |      |  |   |         |  
|Conversion of series H preferred stock into common stock                                  |  |                         |        |   |      |   | 17,127  |      |  |   |         |  
|Conversion of series J preferred stock into common stock                                  |  |                         |        |   |      |   | 1,363   |      |  |   |         |  



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



31



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1.
ORGANIZATION AND OPERATIONS



FiberNet Telecom Group, Inc.
(hereinafter referred to as the Company or FiberNet) is a communications service provider focused on providing wholesale broadband connectivity for data, voice and video transmission on its fiber optic networks in major
metropolitan areas. The Company offers an advanced high-bandwidth, fiber-optic solution to support the demand for network capacity in the intra-city market, or local loop. The Company has established its primary operations in the New York and Los
Angeles metropolitan areas.



FiberNet is a holding company that
owns all of the outstanding common stock of FiberNet Operations, Inc., a Delaware corporation and an intermediate level holding company, and all the outstanding membership interests of Devnet L.L.C. (Devnet), a Delaware limited liability
company. FiberNet Operations, Inc. owns all of the outstanding common stock of FiberNet Telecom Inc., a Delaware corporation. FiberNet Telecom, Inc. owns all of the outstanding membership interests of Local Fiber, LLC (Local Fiber), a
New York limited liability company, and all of the outstanding membership interests of FiberNet Equal Access, LLC (Equal Access), also a New York limited liability company. The Company conducts its primary business operations through its
operating subsidiaries, Devnet, Local Fiber and Equal Access.



The Company has agreements with other entities, including telecommunications license agreements with building landlords, interconnection agreements with other telecommunications service providers and leases with carrier hotel property
owners. FiberNet also has entered into contracts with suppliers for the components of its telecommunications networks. These contracts and agreements are critical to the Companys ability to execute its business strategy and operating plan.



The Companys operations and ability to grow may be
affected by numerous factors, including the state of the telecommunications industry, the difficulty inherent in operating an early-stage company in a new and rapidly evolving market; its history of operating losses and cash flow deficits; its
limited financial resources and uncertainty as to the availability of additional capital to fund its operations on acceptable terms, if at all; its success in maintaining carrier hotel lease agreements and license agreements with building owners and
in obtaining additional agreements; the financial difficulties and instability that its customers and vendors are experiencing; the lack of growth in demand for its services or the failure to manage the growth of its operations; the frequency of
service interruptions on its networks and the scalability and reliability of its networks; the potential occurrence of a natural disaster of act of terrorism that could impact its networks; the potential loss of key personnel, information support
systems or key software licenses; the potential for litigation from stockholders, customers, vendors or other third parties; continued pricing pressure and price competition for its services; the potential development by competitors of competing
products and technologies; restrictions imposed on it as a result of its debt; and changes in the regulatory environment.



The Company believes that the completion of the transactions that constituted its recapitalization, as discussed in Note 6, significantly enhanced its
liquidity and improved its financial position. Under FiberNets current operating plan, which reflects the events discussed in Note 16, it does not anticipate requiring any additional external sources of capital to fund its operations in the
coming year. The Company does not have any off-balance sheet financing arrangements, nor does it anticipate entering into any.



2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, FiberNet Operations, Inc., Devnet, FiberNet
Telecom, Inc., Equal Access and Local Fiber and have been prepared in accordance with accounting principles generally accepted in the United States of America. All significant intercompany balances and transactions have been eliminated in
consolidation.



Use of Estimates



The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates.



Cash and Cash Equivalents



Cash and cash equivalents include highly liquid investments with an original maturity of three months or less when purchased. The carrying amount
approximates fair value because of the short maturity of the instruments



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Restricted Cash



Restricted cash is invested in highly liquid investments with an original maturity of three months or less when purchased. The carrying amount
approximates fair value because of the short maturity of the instruments. The Company has a restricted cash account used as collateral to secure the funding obligations for its outstanding letters of credit, which are in lieu of a cash security
deposit for its facilities. See Note 6.



Property, Plant and Equipment



Property, plant and equipment are stated at cost less
accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, once placed in service. The estimated lives are as follows:



|                              |  |         
|----------------------------- |  | --------
|Computer software             |  | 3 Years 
|Computer equipment            |  | 3 Years 
|Office equipment and fixtures |  | 5 Years 
|Leasehold improvements        |  | 15 Years
|Network equipment             |  | 10 Years
|Network infrastructure        |  | 20 Years



Maintenance and
repairs are expensed as incurred. Long-term improvements are capitalized as additions to property, plant and equipment.



Impairment of Long-Lived Assets



The Company reviews the carrying value of long-lived assets for impairment whenever events and circumstances indicate the carrying value of an asset may
not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss would be recognized equal
to an amount by which the carrying value exceeds the fair value of the assets.



On January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144).
SFAS No. 144 replaced SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of (SFAS No. 121), and establishes accounting and reporting standards for long-lived assets to be
disposed of by sale. SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell. SFAS No. 144 also broadens the reporting of discontinued operations to include all components of an entity
with operations that can be distinguished from the rest of the entity that will be eliminated from the ongoing operations of the entity in a disposal transaction. In 2003, the Company reviewed its long-lived assets for impairment in accordance with
SFAS No. 144 and determined that changes in circumstances have indicated that asset carrying values were no longer recoverable and that impairment charges were necessary. See Note 4.



Revenue Recognition



FiberNet generates revenues from selling network capacity and related services to other communications service providers. The Company recognizes revenues
when earned as services are provided throughout the life of each contract with a customer. The majority of the Companys revenues are generated on a monthly recurring basis under contracts of various lengths, ranging from one month to fifteen
years. Most of the Companys services are for a contract period of one year. Revenue is recognized over the service contract period for all general services. If the Company determines that collection of a receivable is not reasonably assured,
it defers the revenue and recognizes it at the time collection becomes reasonably assured, which is generally upon receipt of payment. Deferred revenues consist primarily of payments received in advance of revenue being earned under the service
contracts. Most of the Companys customers are obligated to make minimum payments for the utilization of its networks and facilities. Customers may elect to purchase additional services in excess of minimum contractual requirements.



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Revenues are derived from three general types of services:



Transport services. FiberNets transport services include the offering
of broadband circuits on its metropolitan transport networks and FiberNet in-building networks (FINs). Over the Companys metropolitan transport networks, it can provision circuits from one of its carrier point facilities to another
carrier point facility or to an on-net building via an interconnection with its FIN in that building. The Company can also provision circuits vertically between floors in a carrier point facility or an on-net building. In 2003, the Company also
initiated a new type of transport service offering to provide its customers with circuits on networks that it does not own.



Colocation services. FiberNets colocation services include providing customers with the ability to locate their communications and networking
equipment at its carrier point facilities in a secure technical operating environment. The Company also can provide its customers with colocation services in the central equipment rooms of certain of its on-net and off-net buildings. If a customer
colocates its equipment at the Companys facilities, FiberNets agreement with them may include a minimum commitment to use its transport services.



Communications access management services. FiberNets access management services include providing its customers with the non-exclusive right to
market and provide their retail services to tenants in its on-net and off-net buildings. Customers typically enter into an agreement with the Company to gain access to a significant number of its properties. For certain of its on-net and off-net
buildings, the Company has the exclusive right to manage communications access. Once a customer has entered into an agreement with the Company for access services, FiberNet typically requires that customer to utilize its in-building network
infrastructure for connectivity to end-user tenants, if such networking infrastructure is available.



As of December 31, 2003 and 2002 the Company had one reciprocal agreement. As of December 2001 the Company had four reciprocal agreements. The services
provided and obtained through these agreements were priced at fair market value as of the date of the agreements and are included in revenues and cost of services in the accompanying consolidated statements of operations. The Company recorded
revenues from these reciprocal agreements for transport services and colocation services in the amount of approximately $0.5 million, $0.8 million and $5.2 million for the years ended December 31, 2003, December 31, 2002 and December 31, 2001,
respectively. The Company leased colocation facilities under these agreements. The total amounts expensed for services rendered under the reciprocal agreements for the years ended December 31, 2003, December 31, 2002, and December 31, 2001 were
approximately $0.5 million, $0.8 million and $5.4 million, respectively.



Fair Value of Financial Instruments



The
Company estimates that the carrying value of its financial instruments approximates fair value, as all financial instruments are short term in nature or bear interest at variable rates. The Company estimates that the carrying value of its notes
payable approximates fair value because they bear interest at a variable rate.



Goodwill



Cost in excess of net assets of an
acquired business, principally goodwill, is accounted for under SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 142,
which is applicable for fiscal years beginning after December 15, 2001. SFAS No. 142, which was adopted by the Company effective January 1, 2002, requires that goodwill and certain intangible assets resulting from business combinations entered into
prior to June 30, 2001 no longer be amortized, but instead be reviewed for recoverability. The Company performs its annual impairment test in December. The Company determined that there was an impairment as a result of this annual test. See Note 5.



The following table presents the impact of SFAS No. 142 as if
it had been in effect for the years ended December 31, 2003, 2002 and 2001 (in thousands, except per share amounts):



|                                                    |  |                         |         |   |      |   |         |      |  |   |          |  
|--------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | -------- | -
|                                                    |  | Year Ended December 31, |        
|                                                    |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Net loss applicable to common stockholders          |  | $                       | (27,775 | ) |      | $ | (37,448 | )    |  | $ | (178,166 | )
|Plus: goodwill amortization                         |  |                         |        |   |      |   |        |      |  |   | 3,724    |  
|Adjusted net loss applicable to common stockholders |  | $                       | (27,775 | ) |      | $ | (37,448 | )    |  | $ | (174,442 | )
|Basic and diluted earnings per share:               |  |                         |         |   |      |   |         |      |  |   |          |  
|Net loss applicable to common stockholders          |  | $                       | (0.75   | ) |      | $ | (6.09   | )    |  | $ | (130.14  | )
|Plus: goodwill amortization                         |  |                         |        |   |      |   |        |      |  |   | 2.72     |  
|Adjusted net loss applicable to common stockholders |  | $                       | (0.75   | ) |      | $ | (6.09   | )    |  | $ | (127.42  | )



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company performed the annual goodwill asset impairment analysis during the year ended December
31, 2003. Based on the results if this impairment test, and in accordance with SFAS No. 142, the Company recorded an impairment charge of $7.5 million during the year ended December 31, 2003.



The following summarizes the changes in goodwill for the years ended December
31, 2003 and 2002:



|                                    |  |   |        |  
|----------------------------------- |  | - | ------ | -
|Net balance as of December 31, 2001 |  | $ | 7,509  |  
|Amortization                        |  |   |       |  
|                                    |  |   |        |  
|Net balance as of December 31, 2002 |  | $ | 7,509  |  
|                                    |  |   |        |  
|Amortization                        |  |   |       |  
|Impairment charges                  |  |   | (7,509 | )
|                                    |  |   |        |  
|Net balance as of December 31, 2003 |  | $ |       |  
|                                    |  |   |        |  



Deferred Charges



Deferred charges include the cost to access buildings and deferred financing
costs. Costs to access buildings are amortized over 15 years, which is the term of the related contracts. Deferred financing costs are amortized over the term of the related debt instrument.



Earnings Per Share



Basic earnings per share has been computed using the weighted average number of shares outstanding during the period.
Diluted earnings per share is computed by including the dilutive effect on common stock that would be issued assuming conversion of stock options, warrants and other dilutive securities. Options, warrants and other securities did not have an effect
on the computation of diluted earnings per share for the years ended December 31, 2003, 2002 and 2001, as they were anti-dilutive due to the fact that the Company was in a loss position for the respective periods.



On May 12, 2003, the Company completed its 1-for-30 reverse stock split
previously approved by stockholders. The earnings per share information and all share amounts as presented in the financial statements has been adjusted to reflect the reverse stock split.



Concentration of Credit Risk



The Company has concentration of credit risk among its customer base. The
Company performs ongoing credit evaluations of its customers financial condition. As of December 31, 2003, one customer accounted for 12.2% of the Companys total accounts receivable, and as of December 31, 2002 one customer accounted for
15.2% of the Companys total accounts receivable.



For the
year ended December 31, 2003, there were no individual customers that accounted for more than 10.0% of revenue. For the year ended December 31, 2002, two customers in the aggregate accounted for 24.0% of the Companys total revenue. For the
year ended December 31, 2001, three customers in the aggregate accounted for 53.3% of the Companys total revenue.



The Company continuously monitors collections and payments from its customers and maintains allowances for doubtful accounts based upon its historical
experience and any specific customer collection issues that is has identified. While such credit losses have historically been within the Companys expectations, there can be no assurance that the Company will continue to experience the same
level of credit losses that it has in the past. A significant number of the Companys customers have filed for bankruptcy or are otherwise in significant financial distress. A significant change in the liquidity or financial position of any one
of these customers or a further deterioration in the economic environment or telecommunications industry, in general, could have a material adverse impact on the collectability of the Companys accounts receivable and its future operating
results, including a reduction in future revenues and additional allowances for doubtful accounts. If the Company determines that collection of a receivable is not reasonably assured, the Company defers the revenue and recognizes it at the time
collection becomes reasonably assured, which is generally upon receipt of payment.



As of December 31, 2003, the Company had an allowance for doubtful accounts of $0.7 million. During the year ended December 31, 2003, the Company did not record bad debt expense, as its evaluation of its outstanding
receivables and the credit quality of its customers indicated that recording such expense was not warranted. During the years ended December 31, 2002, and 2001, FiberNet recorded $0.5 million and $0.9 million of bad debt expense, respectively.
During the years ended December 31, 2003, 2002, and 2001, FiberNet wrote-off $0.3 million, $1.7 million, and $2.6 million of this allowance, respectively.



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Equity Incentive Plan



The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) and complies with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation
(SFAS No. 123) as amended by SFAS No. 148. Under APB No. 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Companys stock and the exercise price. The Company accounts
for stock options issued to non-employees in accordance with the provisions of SFAS No. 123. The resulting expense is charged against operations ratably over the vesting period of the options.



In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based CompensationTransition and Disclosurean Amendment of FASB Statement No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results.



The
following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:



|                                                                                                                             |  |                         |         |   |      |   |         |      |  |   |          |  
|---------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | -------- | -
|                                                                                                                             |  | Year Ended December 31, |        
|(Amounts in thousands)                                                                                                       |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|Net loss applicable to common stockholders, as reported                                                                      |  | $                       | (27,775 | ) |      | $ | (37,448 | )    |  | $ | (178,166 | )
|Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects                     |  |                         |        |   |      |   | 225     |      |  |   | (1,172   | )
|Deduct: Total stock-based employee compensation expense determined under fair value based method, net of related tax effects |  |                         | (2,306  | ) |      |   | (5,826  | )    |  |   | (2,853   | )
|Pro forma net loss                                                                                                           |  | $                       | (30,081 | ) |      | $ | (43,049 | )    |  | $ | (182,191 | )
|Net loss per share applicable to common stockholders:                                                                        |  |                         |         |   |      |   |         |      |  |   |          |  
|As reported: Basic and diluted                                                                                               |  | $                       | (0.75   | ) |      | $ | (6.09   | )    |  | $ | (130.14  | )
|Pro forma: Basic and diluted                                                                                                 |  | $                       | (0.81   | ) |      | $ | (7.00   | )    |  | $ | (133.08  | )



The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants in December 31, 2003, 2002 and 2002: risk-free interest rates of 4.18%, 3.375% and 4.875%, respectively,
expected dividend yields of 0%, expected life of six years to expiration and expected volatility of 357%, 113% and 159%, respectively.



On July 30, 2003, the Company issued 4.7 million shares of restricted stock and 0.4 million stock options at an exercise price of $1.13 per share to
employees and directors under its Equity Incentive Plan. During 2003, 0.3 million shares were returned to the Company as the result of employee terminations prior to vesting. All shares of restricted stock vest on the tenth anniversary of the grant
date, and the stock options vest in three equal annual installments, commencing on July 30, 2004, subject to the terms and conditions of the Equity Incentive Plan. The Company recorded $5.3 million of deferred compensation for this issuance. In
accordance with FASB Interpretation (FIN) No. 44, Accounting for Certain Transactions Involving Stock Compensation (FIN No. 44), the deferred compensation is being amortized ratably over the ten-year cliff vesting period.



Accounting for Income Taxes



The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes, which requires the use of the liability method of accounting for deferred income taxes. Under this method, deferred income taxes represent the net tax effect of temporary differences between carrying amount
of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Additionally, if it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is
required to be recognized.



Accounting for Derivative Instruments



The Company accounts for derivative instruments in
accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No.133), as amended. SFAS No. 133 establishes standards of accounting and reporting for derivative instruments and hedging
activities, and requires that all derivatives be recognized on the balance sheet at fair value. Changes in the fair value of derivatives that do not meet the hedge accounting criteria reported in earnings.



On January 2, 2002, the Company entered into an interest rate swap
transaction with Deutsche Bank AG for a notional amount of $25.0 million and a term of two years. Pursuant to this transaction, the Company was obligated to make quarterly interest payments



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



at a fixed, annual interest rate of 3.7%, excluding the applicable margin that it paid on its credit facility. As
part of this agreement, Deutsche Bank AG was obligated to pay to the Company on a quarterly basis a floating rate of interest based upon LIBOR with a designated maturity of three months. On March 20, 2002, the Company terminated this interest rate
swap transaction with Deutsche Bank AG with no payments or other amounts owed by either party. As a result, all of its outstanding borrowings under the Companys credit facility bear interest at a floating rate.



Reclassifications



Certain balances have been reclassified in the consolidated financial statements to conform to current year presentation.



Segment Reporting



The Company is a single segment operating company providing
telecommunications services.



Revenues were generated by
providing transport, colocation and communications access management services to our customers. We recognized $18.1 million, $15.8 million and $19.6 million in transport service revenues in 2003, 2002 and 2001, respectively. Revenues from colocation
and other services was $6.0 million, $5.9 million and $5.5 million in 2003, 2002 and 2001, respectively, and revenues from communications access management services was $2.5 million, $3.6 million and $6.1 million in 2003, 2002 and 2001,
respectively.



Recent Accounting Pronouncements



In July 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which was adopted by the Company on January 1, 2003. The statement requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability
is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its then present value, and the capitalized cost is depreciated over the useful life of
the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The adoption of this statement did not have a material impact on the Companys
consolidated financial statements, and the Company currently does not have any asset retirement obligations.



In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). The
statement replaces SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121), although it retains the impairment testing methodology used in SFAS No. 121. The
accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB No. 30) are superceded by SFAS No. 144, except that the statement preserves the requirement of APB Opinion No. 30 to report discontinued operations separately from continuing operations. The statement covers a
variety of implementation issues inherent in SFAS No. 121, unifies the framework used in accounting for assets to be disposed of and discontinued operations, and broadens the reporting of discontinued operations to include all components of an
entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. The statement is effective for fiscal years beginning after December 15,
2001. FiberNet adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Companys consolidated financial statements.



In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS No. 145). SFAS No. 145 rescinds the provisions of SFAS No. 4 that requires companies to classify certain gains and losses from debt extinguishments as extraordinary items,
eliminates the provisions of SFAS No. 44 regarding transition to the Motor Carrier Act of 1980 and amends the provisions of SFAS No. 13 to require that certain lease modifications be treated as sale leaseback transactions. The provisions of SFAS No.
145 related to classification of debt extinguishment are effective for fiscal years beginning after May 15, 2002, and were adopted by the Company on January 1, 2003. As a result of the adoption of this statement, the Company classified debt
extinguishment costs within income from operations and reclassified previously reported debt extinguishments as such. Refer to Note 17, which discusses the change in this classification to other expense.



In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS No. 146). SFAS No. 146 nullifies Emerging Issues Task Force (EITF) No. 94-3, Liability Recognition for certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in as Restructuring) (EITF No. 94-3). The principal difference between SFAS No. 146 and EITF No. 94-3 relates to its requirements for recognition of a liability for a cost
associated with an exit or disposal activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the
date of an entitys commitment to an exit plan. SFAS No. 146 was adopted by the Company on January 1, 2003. The adoption of SFAS No. 146 did not have a material impact on the Companys consolidated financial statements.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity (SFAS No.150). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). The requirements of this statement apply to issuers classification and
measurement of freestanding financial instruments, including those that comprise more than one option or forward contract. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at
the beginning of the first interim period beginning after June 15, 2003. The Companys adoption did not have a material effect on the Companys consolidated financial statements.



In November 2002, the Emerging Issues Task Force (EITF) of the
FASB reached a consensus on EITF No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (EITF No. 00-21). EITF No. 00-21 addresses how to account for arrangements that may involve multiple
revenue-generating activities. The consensus guidance is applicable to agreements entered into in quarters beginning after June 15, 2003. The Company adopted EITF No. 00-21 effective July 1, 2003 and is applying it on a prospective basis. The
Companys adoption did not have a material effect on the Companys consolidated financial statements.



In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34 (FIN 45). FIN 45 elaborates on the disclosures to be made by the guarantor in its
interim and annual financial statements about its obligations under certain guarantees that it has issued. The initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of this statement did not have a material impact on the Companys consolidated financial statements.



In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, (FIN 46), an
interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements. FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary
beneficiary. In December 2003, the FASB revised FIN 46 and issued FIN 46 (revised December 2003) (FIN 46R). In addition to conforming to previously issued FASB Staff Positions, FIN 46R deferred the implementation date for certain
variable interest entities. This revised interpretation is effective for all entities no later than the end of the first reporting period that ends after March 15, 2004. The Company does not have any investments in or contractual relationship or
other business relationship with a variable interest entity and therefore the adoption of this interpretation will not have any impact on our financial position or results of operations.



3. PROPERTY, PLANT AND EQUIPMENT



Property, plant and equipment consist of the following (dollars in thousands):



|                                     |  |                  |         |   |                  |   |         |  
|------------------------------------ |  | ---------------- | ------- | - | ---------------- | - | ------- | -
|                                     |  | December 31,2003 |         |   | December 31,2002 |  
|Computer software                    |  | $                | 200     |   |                  | $ | 200     |  
|Computer equipment                   |  |                  | 256     |   |                  |   | 250     |  
|Leasehold improvements               |  |                  | 30      |   |                  |   | 30      |  
|Office equipment and furniture       |  |                  | 146     |   |                  |   | 146     |  
|Network equipment and infrastructure |  |                  | 113,858 |   |                  |   | 113,725 |  
|                                     |  |                  |         |   |                  |   |         |  
|Total                                |  |                  | 114,490 |   |                  |   | 114,351 |  
|Accumulated depreciation             |  |                  | (27,532 | ) |                  |   | (19,229 | )
|                                     |  |                  |         |   |                  |   |         |  
|Property, plant and equipment, net   |  | $                | 86,958  |   |                  | $ | 95,122  |  
|                                     |  |                  |         |   |                  |   |         |  



Depreciation expense
on property, plant and equipment was $8.8 million, $9.6 million and $10.9 million for the years ended December 31, 2003, 2002 and 2001, respectively.



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



4. IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT



The Company reviews the carrying value of its assets for impairment whenever events and circumstances indicate the carrying
value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition.



Beginning in 2001 and continuing through 2003, the Company determined that its forecasts for revenues for certain of its facilities would not be achieved
due to the significant adverse change in the business climate. The Company further determined that the dramatic change in the operating environment for the telecommunications industry resulted in a significantly less demand and in reduced pricing
for its services due to the highly competitive marketplace. The Company believes that the decrease in demand was a result of the significant number of business failures of telecommunications companies that were existing or potential customers, the
failure of certain bandwidth-intensive networking applications to develop, and the overall economic recession. The Company also determined that a rebound in demand for its services would not occur in the near term. As a result, the Company revised
its business plan and conducted extensive reviews of its assets and operations. The revisions to the business plan primarily included reductions in forecasts of revenues and capital expenditures. The projected amounts of certain cost of services and
overhead expenses were reduced as well to reflect the decrease in its expected business activity.



The Company used an undiscounted forecasted cash flow model to determine if there was an impairment based on the cash flows expected to be generated from
the assets related to the facilities discussed above, and used a discounted cash flow model to measure the impairment. As a result of this analysis during 2001, the Company recorded an asset impairment of approximately $51.8 million based on the
amount by which the carrying amount of these assets exceeded their fair value. Of this amount, $40.4 million related to assets held for use, and $11.4 million represented assets to be disposed of.



The assets that the Company identified for disposition were abandoned, as the
Company determined that these assets had no value. Consequently, there was no cost to the Company for this abandonment, nor did the Company expect to receive any proceeds or other consideration from this abandonment. The Company recorded no
reserves, accruals or other liabilities related to this abandonment. These assets primarily related to engineering and network architecture design costs and general contracting and project management costs for facilities that the Company is no
longer pursuing.



The Company has recovered approximately $0.3
million from the sale of assets previously written off as impaired during the year ended December 31, 2002. The proceeds were recorded as a recovery of the impairment previously recorded.



As a result of an update to the forecast and analysis performed in 2002, the Company has recorded an additional asset
impairment of approximately $12.7 million in 2002, based on the amount by which the carrying amount of these assets exceeded their fair value. Also during 2002, the Company recorded a write-off of property, plant and equipment of $0.7 million. The
Company recorded this write-off of capital assets due to the termination of several property leases and license agreements for network facilities. There was no cost to abandon these assets, nor did the Company expect to receive any proceeds or other
consideration from the abandonment of these assets.



During
2003 the Company determined that the negative trends of lower demand and reduced pricing still impacted the industry and the Companys business in particular. As a result, the Company updated its forecasts, reducing revenues and capital
expenditures without commensurate decreases in operating expenses. Utilizing this analysis, the Company again evaluated the carrying value of its assets as of December 31, 2003. The Company recorded an asset impairment of approximately $1.5 million,
based on the amount by which the carrying amount of these assets exceeded their fair value. Also during 2003, the Company has recovered approximately $0.2 million from the sale of assets previously written off as impaired. The proceeds were recorded
as a recovery of the impairment previously recorded.



5. IMPAIRMENT OF
GOODWILL



During 2001, the Company evaluated the carrying
value of certain long-lived assets, consisting primarily of goodwill resulting from the Companys acquisition of Devnet. Pursuant to APB Opinion No. 16, Business Combinations, the purchase price was determined and goodwill was
recorded based on the stock price at the time the merger agreement was executed and announced. During 2001, the Company reviewed the carrying value of long-lived assets including goodwill and property, plant and equipment for impairment whenever
events and circumstances indicated the carrying value of an asset would not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition.



An assessment of the goodwill related to the Devnet acquisition was performed pursuant to SFAS No. 121, due to the negative
industry and economic trends affecting certain of the Companys current operations and expected future revenues, as well as the general decline in the valuations of telecommunications companies. The conclusion of that assessment was that the
decline in market conditions within the telecommunications industry was significant and other than temporary.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Devnet had entered into exclusive license agreements to manage communications access to commercial
office properties, and the company associated the related goodwill primarily to those agreements. The Company used an undiscounted forecasted cash flow model to determine if there was an impairment based on the cash flows expected to be generated
from business activities in the commercial office properties underlying the license agreements and used a discounted cash flow model to measure the impairment. As a result, the Company recorded a charge of $56.5 million during 2001 to reduce
goodwill associated with the purchase of Devnet. The charge was based on the amount by which the carrying amount of the asset exceeded its fair value.



In June 2001, the FASB issued SFAS No. 142 applicable for fiscal years beginning after December 15, 2001, which was adopted by the Company effective
January 1, 2002 and requires that goodwill and certain intangible assets resulting from business combinations entered into prior to June 30, 2001 no longer be amortized, but instead be reviewed for recoverability annually. Any write-down of goodwill
would be charged as a cumulative change in accounting principle upon adoption of the new accounting standard if the recorded value of goodwill and certain intangibles exceeds its fair value. During the fourth quarter of 2003, the Company performed
its annual impairment test and determined that there was an impairment of goodwill. The Company determined it has one reporting unit where its net assets as of December 31, 2003 were in excess of the fair value of equity based on the Companys
market capitalization, which indicated there was an impairment. As such, the Company recorded a charge of $7.5 million as a result of this impairment.



6. NOTES PAYABLE AND NOTE PAYABLE-AFFILIATE



Note Payable-Affiliate



On December 7, 2001 the Company issued a promissory note in the amount of $2.3 million to Nortel Networks Inc. (Nortel), a related party, as
consideration for accounts payable previously due and owing for equipment and services. The note bore interest at an annual rate of 14% and was payable in eight monthly installments of approximately $300,000 beginning in January 2002. The Company
believes the terms of this transaction were no less favorable than could be received from an independent, third party. During 2002 the Company repaid approximately $1.1 million of the note, and approximately $0.9 million was forgiven and recorded as
an additional capital contribution to the Company. On October 30, 2002, the remaining amount of the note was converted into common stock as part of the recapitalization of the Company, discussed below.



Credit Facility



On April 11, 2000, the Company entered into a $75.0 million senior secured credit facility (the Credit Facility)
with Deutsche Bank AG New York Branch, Deutsche Bank Securities Inc., Toronto Dominion (Texas), Inc. and Nortel. In addition to the initial lenders, First Union National Bank, Bank One Capital Corporation and IBM Credit Corporation were lenders
under the Credit Facility. FiberNet used the funds available under the Credit Facility for the acquisition and construction of its network infrastructure and for general corporate purposes. The Credit Facility had a term of four and one-half years,
consisting of revolving credit availability for the first 18 months and a term loan for the remaining three years. The Credit Facility is secured by the Companys assets, except for the assets pledged in connection with its capital lease
obligations, which were terminated in 2003, and contains certain restrictive covenants customary for a financing of this type. In connection with the placement of the Credit Facility, the Company issued to the lenders approximately 50,000 warrants
to purchase common stock with and exercise price of $541.86 and a term of five years.



On December 18, 2000, the Company issued 16,820 additional warrants to its lending group with an exercise price of $511.86 and an expiration date of April 11, 2005, and repriced the warrants issued on April 11, 2000
from $541.86 to an exercise price of $511.86. The discount is being amortized over the term of the Credit Facility. The fair value of the warrants was estimated on the date of issuance using the Black-Scholes option pricing model. The transaction
was evaluated in accordance with the guidance in EITF Issue 96-19, Debtors Accounts for a Modification or Exchange of Debt Instruments (EITF 96-19). The value on December 18, 2000 of the cash flows under the terms of
the revised debt instrument as compared to the cash flows under the original debt instrument resulted in a difference that was not substantially different. An adjustment was made to the original issue discount, initially recorded in
connection with the issuance of the warrants, and to additional paid-in-capital to reflect the new exercise price of those warrants.



On February 9, 2001, the Company amended the Credit Facility to increase the availability thereunder to $105.0 million and to the extend the maturity
thereof to six years. In connection with this amended Credit Facility, the Company issued warrants to purchase an additional 15,147 shares of its common stock, with an expiration date of April 11, 2005, at an exercise price of $240.00 per share. In
addition, all warrants issued under the original credit agreement were replaced with warrants to purchase an equivalent amount of the Companys common stock, with an expiration date of April 11, 2005, at an exercise price of $240.00 per share.
The transaction was evaluated in accordance with EITF 96-19, and it was determined that a substantial modification of terms had been made. As such, the transaction was accounted for, and reported in the same manner as an extinguishment, and the
Company recorded a $7.4 million charge for the loss from extinguishment of debt, representing deferred financing fees and the original issue discount relating to the original Credit Facility.



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Also, on April 27, 2001, in connection with a waiver and agreement under our Credit Facility,
warrants to purchase 10,000 shares of our common stock at a purchase price of $240.00 per share held by Deutsche Banc Alex Brown were replaced with new warrants to purchase an equivalent amount of our common stock at a purchase price of $0.30 per
share.



The Company valued the warrants at each issuance and
pricing date using the Black-Scholes valuation model and recorded a debit to original issue discount with a credit to additional paid-in-capital for the warrants value.



In connection with the Companys sale of its series J preferred stock, on December 7, 2001, it entered into an
amendment of its Credit Facility with its lenders pursuant to which the lenders consented to the sale of the series J preferred stock and adjusted certain covenants contained in the credit agreement underlying the Credit Facility. Additionally, all
warrants outstanding issued to the lenders under the Credit Facility were replaced with warrants with identical terms other than with respect to a reduction of the exercise price to $15.00.



On October 30, 2002, the Company completed a series of transactions with the
lenders under its Credit Facility as well as certain investors to undertake the recapitalization of the Company. These transactions are described below.



Pursuant to the terms of a common stock purchase agreement dated as of October 30, 2002 by and among FiberNet and the lenders under the Companys
Credit Facility, FiberNet issued 14,666,666 shares of its common stock to the lenders with a fair market value of $3.60 per share on the date of issuance, as prepayment of an aggregate of $66.0 million of outstanding indebtedness under the Credit
Facility. The Company also issued warrants to purchase 3,666,666 shares of common stock at an exercise price of $3.60 per share with a term of five years to the lenders valued at $10.7 million using the Black-Scholes option pricing model on the date
of issuance. These warrants are immediately exercisable and contain standard anti-dilution protection. As of October 30, 2002, the 14,666,666 shares issued to the lenders constituted approximately 61% of the total number of outstanding shares of
common stock. Such shares, together with shares issuable upon exercise of the warrants, also constituted approximately 61% of the shares of common stock outstanding on a fully diluted basis, assuming the exercise of all outstanding options and
warrants. Prior to October 30, 2002, there was $5.2 million of interest due and payable on the indebtedness outstanding under the Credit Facility. As part of this transaction, accrued interest of $3.2 million was capitalized and added to the
outstanding principal amount of the term loan indebtedness, included above. Subsequently, on November 11, 2002, the Company issued to its lenders in exchange for the remaining $2.0 million of accrued interest 666,666 shares of common stock with a
fair market value of $3.60 per share on the date of issuance, and warrants to purchase 666,666 shares of common stock at an exercise price of $3.60 per share with a term of five years valued at $1.9 million using the Black-Scholes option pricing
model on the date of issuance. These warrants are immediately exercisable and contain standard anti-dilution protection. The Company evaluated the accounting for this transaction under the guidance of EITF No. 02-4 Determining Whether a
Debtors Modification or Exchange of Debt Instruments is within the Scope of Financial Accounting Standards Board Statement No. 15, FASB No. 15 Accounting by Debtors and Creditors for Troubled Debt Restructurings and EITF No.
96-19 Debtors Accounts for a Modification or Exchange of Debt Instruments. As a result of the above transaction, the Company deducted the fair value of the consideration given on the date of the transaction from the carrying value
of the debt. The Company then determined that the remaining modified debt was not substantially different from the original debt, and accordingly, no extinguishment gain or loss was recognized. The difference resulting from the modification and
settlement of debt is being treated as an adjustment to yield and is being amortized as a charge to interest expense over the remaining life of the debt.



In connection with this transaction, FiberNet and certain of its lenders also entered into a stockholders agreement dated as of October 30, 2002. Under
the terms of this stockholders agreement, such lenders have the right to designate two independent persons to be members of the Companys board of directors, along with other certain rights and privileges. Together with the lenders, the Company
also executed a seventh amendment to its credit agreement which, among other things, amends certain terms of the credit agreement in conjunction with the transactions that were consummated on October 30, 2002.



As part of the seventh amendment, the term loan commitments and revolving
loan commitments available under the credit facility were reduced to a total of $40.5 million from a total of $105.0 million. The term loan commitments were reduced to $26.2 million, all of which was drawn and outstanding, and the revolving loan
commitments were reduced to $14.4 million. All of the Companys revolving loan commitments were utilized with drawn, outstanding borrowings of $7.3 million and outstanding letter of credit issued in the amount of $7.1 million. In addition, the
effective applicable interest rate on FiberNets borrowings was reduced from LIBOR+450 basis points to LIBOR+375 basis points until December 31, 2003. Furthermore, the payment of all accrued interest on borrowings during the period beginning on
October 30, 2002 and ending on June 30, 2003 were capitalized and added to the outstanding principal amount of the term loan indebtedness. Other amendments to the Companys Credit Facility include modifications to the automatic reduction of
commitments and to financial covenants. Previously the first automatic reduction in the



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



availability under the credit facility was to have occurred on June 30, 2003. However as amended, the automatic
reduction of commitments were rescheduled to begin on a quarterly basis on March 31, 2004. The Company was also subject to amended financial covenants. The Company was now required to comply with financial covenants that include minimum consolidated
revenue, minimum consolidated EBITDA (as defined in the credit agreement underlying the Credit Facility) and maximum cumulative capital expenditures. Beginning on December 31, 2003 in addition to those requirements, the Companys financial
covenants also included a maximum consolidated leverage ratio, a minimum consolidated interest coverage ratio and a minimum consolidated fixed charge coverage ratio. The compliance levels and calculation of such levels with respect to those
covenants are as defined in the credit agreement underlying the Companys Credit Facility, as amended.



Pursuant to the terms of an investors rights agreement entered into on October 30, 2002 by and among FiberNet and its lenders, the Company also
agreed to file a resale registration statement with respect to all of the shares issued to its lenders, including shares issuable upon exercise of the warrants. This registration statement also included shares issued in the other recapitalization
transactions described below.



On October 30, 2002, the Company
also entered into a common stock purchase agreement with certain investors, pursuant to which the Company issued to the investors in a private offering an aggregate of 1,024,593 shares of common stock for a price of $3.00 per share, or an aggregate
cash consideration of $3.0 million. Pursuant to the terms of this purchase agreement, the Company also issued to such investors warrants to purchase an additional 1,024,593 shares of common stock at an exercise price of $3.60 per share with a term
of five years valued at $1.4 million using the Black-Scholes option pricing model on the date of issuance. These warrants are also immediately exercisable and contain standard anti-dilution protection.



Immediately prior to the private offering of common stock and warrants,
FiberNet consummated certain related transactions with the investors. In one such transaction, the Company issued to one of the investors, SDS Merchant Partners, L.P. (SDS), 300,068 shares of common stock with a fair market value of
$3.60 on the date of issuance, in exchange for the surrender by SDS of a promissory note originally issued on December 7, 2001 by the Company to a related party, which promissory note had been assigned by such related party to SDS immediately prior
to such exchange for $150,000 in cash. This exchange was consummated pursuant to the terms of a note exchange agreement dated as of October 30, 2002 by and among the Company and SDS. Such promissory note, at the time of surrender, had an outstanding
principal amount of $450,102. In addition, the Company sold 242,074 shares of common stock to SDS in connection with the common stock purchase agreement discussed above, for a price of $3.00 per share, or an aggregate cash consideration of $0.7
million. Pursuant to the terms of this purchase agreement, the Company also issued to SDS, warrants to purchase an additional 242,074 shares of common stock at an exercise price of $3.60 per share with a term of five years valued at $0.7 million
using the Black-Scholes option pricing model on the date of issuance. These warrants are also immediately exercisable and contain standard anti-dilution protection.



On November 11, 2002, FiberNet also issued to SDS 1,733,333 shares of common stock with a fair market value of $3.60 on the
date of issuance in exchange for the surrender, by SDS, of the promissory note issued by the Company on March 14, 2002 in the initial principal amount of $2.0 million, pursuant to the terms of a note exchange agreement. Such promissory note, at the
time of surrender, had outstanding principal and accrued interest of $2.1 million owing thereon. Furthermore, the Company also agreed to include such shares issued to its lenders and SDS on November 11, 2002, within the terms of agreements
previously entered into on October 30, 2002, including the registration rights agreement. Other than the inclusion of such additional shares, the terms of such amended and restated agreements are unchanged from those of their respective
predecessors. The Company evaluated the accounting for the above transaction in accordance with FASB Technical Bulletin (FTB) No. 80-1 Early Extinguishment of Debt through Exchange for Common or Preferred Stock (FTB No.
80-1). The Company recorded a charge of $5.8 million related to the early extinguishment of debt for the difference between the net carrying amount of both notes that were extinguished and the reacquisition price represented by the total fair
market value of the common stock and warrants exchanged in the transaction.



Related to the above transactions, the Company issued an aggregate of 3,486,048 shares of common stock with a fair market value of $3.60 on the date of issuance, to the investors pursuant to the terms of a share
exchange agreement dated as of October 30, 2002 by and among the Company and the investors. Such shares were issued upon the conversion of all 104,578 outstanding shares of the Companys series H convertible preferred stock. Such investors had,
immediately prior to such exchange and conversion, acquired these series H preferred shares, along with shares of common stock, from a related party for cash consideration of $735,000. The series H preferred stock had a carrying value of $17.1
million prior to conversion and an aggregate liquidation preference, including accrued dividends thereon, of $10.7 million. The series H preferred stock was converted pursuant to its original terms. During 2001, the Company recorded charges related
to the beneficial conversion feature of the preferred instrument which aggregated the total proceeds from the initial issuance This discount on the preferred stock resulting from the beneficial conversion feature was immediately recognized as a
dividend to the preferred shareholders on the date of issuance as the series H preferred stock was immediately convertible.



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In a third related transaction, the holders of all 303 outstanding shares of the Companys
series J-1 convertible preferred stock surrendered such shares to the Company as a result of an inducement offer by the Company, in exchange for 2,020,000 shares of common stock with a fair market value of $3.60 on the date of issuance. This
transaction was effected pursuant to a series J-1 exchange agreement dated as of October 30, 2002 by and among the Company and the series J-1 holders. The series J-1 preferred stock so surrendered had an aggregate liquidation preference of $3.0
million. The Company evaluated this transaction in accordance with EITF D-42 The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock. The Company recorded a charge to net earnings
of $5.5 million, which represents the excess of the fair value of the common stock issued in the transaction to the holders of the preferred stock over the fair value of the securities issuable pursuant to the original conversion terms. These shares
were also included in the registration rights agreement dated as of October 30, 2002 with these investors.



In total, 21,739,449 shares of common stock and warrants to purchase an aggregate of 4,933,333 shares of common stock were issued on October 30, 2002, as
part of these transactions and a total of 2,400,000 shares of common stock and warrants to purchase an aggregate of 666,667 shares of common stock were issued on November 11, 2002.



In connection with the transactions consummated on October 30, 2002 and November 11, 2002, the Company paid a fee of $0.3
million to a financial advisory firm and issued to that firm warrants to purchase an additional 206,667 shares of common stock at an exercise price of $0.03 per share with a term of one year valued at $1 million using the Black-Scholes option
pricing model on the date of issuance. In addition, the Company paid professional fees of approximately $2.1 million related to the above transactions. All such charges have been included as a charge to loss on early extinguishment of debt in the
accompanying statement of operations for the year ended December 31, 2002.



On January 10, 2003, the Company completed certain transactions with the lenders under its Credit Facility. Pursuant to the terms of three debt exchange agreements between the Company and each of Bank One, N.A.,
Nortel Networks Inc. and TD Securities (USA) Inc., the Company has issued 4,617,010 shares of its common stock to these three lenders at a price of $3.60 per share, in satisfaction of approximately $13.4 million of indebtedness, representing all of
the outstanding principal indebtedness and accrued interest owing to these departing lenders under the Companys credit agreement.



The Company also entered into a common stock purchase agreement, dated as of January 10, 2003, with certain investors, pursuant to which the Company
issued to the investors in a private offering an aggregate of 972,222 shares of common stock for a price of $3.60 per share, for an aggregate cash consideration of $3.5 million. Pursuant to the terms of the investor purchase agreement, the Company
also issued to such investors warrants to purchase an additional 1,895,659 shares of common stock at an exercise price of $3.60 per share with a term of five years. The Company recorded a $0.7 million charge to additional paid-in-capital which
represented the costs incurred to complete this offering. Concurrently with the transactions described above, the investors also purchased 9,820,061 shares of common stock from the departing lenders in a privately negotiated transaction for an
aggregate cash consideration of $9.0 million.



In connection
with the investor purchase agreement, the Company entered into a registration rights agreement, dated as of January 10, 2003, with the investors which required the Company to file a resale registration statement with the Securities and Exchange
Commission with respect to the registration of all of the shares of common stock issued under the investor purchase agreement and the shares that the investors purchased from the departing lenders. This registration statement was declared effective
on February 20, 2003.



In connection with the transactions
contemplated by the debt exchange agreements, the Company and the lenders executed a ninth amendment to the credit agreement, pursuant to which, among other things, the rights and obligations of the departing lenders under the Credit Facility
terminated, subject to standard reinstatement and survival provisions. As a condition to the lenders entering into this amendment, the Company agreed to reduce the exercise price of certain warrants previously issued to and held by the lenders to
purchase approximately 2,544,974 shares of common stock from $3.60 per share to $0.03 per share. All of the repriced warrants were immediately exercised by the lenders. In addition pursuant to a security agreement and a securities account control
agreement, the Company agreed to deposit approximately $2.3 million in a restricted account as cash collateral to secure the assumption by Deutsche Bank AG New York Branch of the departing lenders funding obligations for the Companys
outstanding letters of credit, which total approximately $6.1 million.



The Company evaluated the above transactions under the guidance of FTB No. 80-1, Early Extinguishment of Debt through Exchange for Common or Preferred Stock. During January 2003, the Company recorded a charge of $9.7 million
related to the early extinguishment of debt for the difference between the net carrying amount of debt that was extinguished and the reacquisition price represented by the total fair market value of the common stock issued and the fair market value
of the warrants that were repriced and exercised. The fair value given in exchange for $13.4 million in long term debt was 4.6 million shares of common stock with a fair market value of $3.60 per share on the date of issuance, the issuance of 1.9
million warrants with an exercise price of $3.60 per share



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



with terms between one and five years, which $2.3 million of proceeds were allocated to them. In addition, the
Company repriced 3.0 million existing warrants from $3.60 to $0.03 valued at $2.0 million using the Black-Scholes option pricing model on the date of issuance. Also included in this loss is $1.0 million in fees associated with the consummation of
the recapitalization. As this portion of principal extinguished represented approximately 38.1% of the outstanding balance, the Company wrote-off the same percentage of deferred financing charges and original issue discount of $0.9 million and $1.8
million, respectively, which is also included in its calculation of loss on early extinguishment of debt. The Company also recorded certain non-recurring expenses incurred in connection with the recapitalization transactions. These expenses included
compensation to financial advisors in the form of a cash fee of approximately $0.8 million and the issuance of 0.3 million warrants with an exercise price of $0.03 and with a term of five years valued at $1.2 million using the Black-Scholes option
pricing model on the date of issuance.



As of December 31, 2003
and 2002, the outstanding balances under the Credit Facility were $22.4 and $35.2 million, respectively. These amounts are included in notes payable in the accompanying consolidated balance sheets net of an original issue discount of $2.3 million
and $4.9 million at December 31, 2003 and 2002, respectively. These discounts represent the fair value of the warrants issued to the lenders in connection with the Credit Facility. In addition, as of December 31, 2003, the Company had $3.5 million
of available borrowing capacity and $0.2 million of availability to issue letters of credit under its credit facility, again subject to compliance with the terms of the credit agreement.



As of December 31, 2003, the weighted average interest rate on its outstanding borrowings under the facility was 4.93%.
There were no events of default under its credit agreement. As of December 31, 2003, the Company has no additional availability under its credit facility. As of such date, the three remaining lenders under the Companys credit facility owned
approximately 26% of the outstanding shares of the Companys common stock.



Subordinated Credit Facility



On June 13,
2003, the Company executed the loan documentation necessary to establish a subordinated credit facility to provide the funding for the purchase of up to $3.0 million of the Companys common stock, under a stock repurchase program. Repurchases
could have been made from time to time until December 31, 2003 through open market purchases, privately negotiated transactions, block trades or otherwise. Repurchases were subject to the availability of stock, prevailing market conditions, trading
price of the stock and the Companys financial performance. The repurchase program did not obligate the Company to acquire any specific number of shares and could have been discontinued or suspended at any time. Any shares repurchased in the
program would have been treated as shares of common stock held in treasury. As of December 31, 2003, there were no outstanding amounts under this subordinated credit facility; no repurchases of common stock had been made; and the facility was
terminated.



Reclassification of Interest



During 2003, the Company presented interest income and interest expense
separately, rather than netting such amounts as had been done in prior years. The Company reclassified prior year amounts to conform to current year presentation.



7. COMMITMENTS AND CONTINGENCIES



The Company has entered into various operating lease agreements for office space and other space relating to the Companys operations. Occupancy
expense for the years ended December 31, 2003, 2002 and 2001 was approximately $7.2 million, $7.9 million, and $14.2 million, respectively.



Estimated future minimum notes payable and operating lease payments are as follows (in thousands):



|                                                    |  |                                       |        |      |   |        |  |      |        |      |   |        |  |            |       |  |   |       |  |   |       
|--------------------------------------------------- |  | ------------------------------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | ---------- | ----- |  | - | ----- |  | - | ------
|                                                    |  | Payments Due by Period (in thousands)
|Contractual Obligation                              |  | Total                                 |        | 2004 |   | 2005   |  | 2006 |        | 2007 |   | 2008   |  | Thereafter
|Mandatory Repayments and Reductions of Indebtedness |  | $                                     | 22,433 |      | $ | 1,795  |  | $    | 8,973  |      | $ | 10,768 |  | $          | 897   |  | $ |      |  | $ |      
|Operating Leases(1)                                 |  |                                       | 75,948 |      |   | 9,425  |  |      | 7,880  |      |   | 6,692  |  |            | 6,257 |  |   | 6,198 |  |   | 39,496
|                                                    |  |                                       |        |      |   |        |  |      |        |      |   |        |  |            |       |  |   |       |  |   |       
|Total Contractual Obligations                       |  | $                                     | 98,381 |      | $ | 11,220 |  | $    | 16,853 |      | $ | 17,460 |  | $          | 7,154 |  | $ | 6,198 |  | $ | 39,496
|                                                    |  |                                       |        |      |   |        |  |      |        |      |   |        |  |            |       |  |   |       |  |   |       

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|(1) | Includes estimated future license fees for carrier hotel facilities. License fees are typically calculated as a percentage of the revenues the Company generates in the respective
facility, as per its lease agreement with the facility.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company has $6.1 million in outstanding letters of credit as of December 31, 2003 and December 31, 2002.



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company and its subsidiaries in the normal course of business may become party to any number of
judicial, regulatory and administrative proceedings. The Companys management does not believe that any material liability will be imposed as a result of any of these matters.



On March 17, 2003, the Company entered into an agreement to terminate all of its capital lease obligations for a payment of
$85,000. This termination of its capital lease obligations resulted in a gain on early extinguishment of debt of approximately $0.8 million, recorded in the three months ended March 31, 2003. This amount partially offset the loss on early
extinguishments of debt, discussed in Note 6.



As of April 1,
2003, FiberNet amended a real estate lease to reduce the rent payments thereunder indefinitely. Upon reaching a revenue threshold, the rent expense will increase by approximately $1.5 million on an annual basis. Due to the uncertainty in forecasting
future revenues, the Company does not have a reasonable basis to estimate when the revenue threshold will be reached and has not accrued for a contingent increase in rent as of December 31, 2003.



8. STOCK OPTIONS



In December 1999, the Company adopted an employee equity participation program (the 1999 Stock Option Plan)
covering 150,000 shares of common stock of the Company to advance the growth and success of FiberNet by enabling employees, directors and consultants to acquire a proprietary interest in the Company. The Board of Directors administered the 1999
Stock Option Plan. All employees were eligible to receive awards under the 1999 Stock Option Plan, at the Boards discretion. Options granted pursuant to the 1999 Stock Option Plan (i) are either nonqualified options and/or incentive stock
options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, (ii) have a term of ten years and (iii) typically vest on an annual basis over three years. The Companys previous Employee Equity Participation Program
was terminated during 1999.



On May 23, 2000, FiberNets
board of directors approved, and on July 27, 2000 the Companys stockholders ratified, the adoption of an equity incentive plan (the Equity Incentive Plan), which amends and restates the Companys 1999 Stock Option Plan,
covering 333,333 shares of common stock of the Company. On June 5, 2001, the Companys stockholders ratified an increase in the number of shares available under the Equity Incentive Plan to 421,467. The Equity Incentive Plan provides for the
grant of incentive stock options, non-qualified stock options and other performance and non-performance based equity awards, including restricted stock, performance awards, stock appreciation rights, or SARs, and other types of awards based on the
Companys common stock. During the fiscal year ended December 31, 2002, the Company granted approximately 3,699 options under the Equity Incentive Plan, at an average exercise price of approximately $4.61 per share, with a vesting period of up
to three years. During the fiscal year ended December 31, 2003, the Company granted approximately 408,500 options under the Equity Incentive Plan, at an average exercise price of approximately $1.13 per share, and the stock options vest in three
equal annual installments, commencing on July 30, 2004.



The
Company accounts for stock options under APB Opinion No. 25. During the year ended December 31, 1999, the Company granted some stock options to employees with exercise prices below the market price on the date of the grant. Additionally, on December
21, 2000, the Company repriced certain options previously granted to three of its executive officers, resulting in variable plan accounting in accordance with FIN No. 44, from the date of modification. These options were originally granted in 1999
and 2000 at exercise prices of $120.00, $112.5, $180.00 and $279.30 per share, and were repriced at an exercise prices of $30.00 per share and $180.00 per share. The additional intrinsic value was determined on the date of modification using the
then market price of the common stock. The additional compensation cost was recognized over the period from the date of modification to the date the awards vest. The additional compensation cost has been adjusted in subsequent periods for changes in
the market price. After the awards vested, adjustments to compensation cost for changes in the market price were recognized immediately. In subsequent periods, the market price declined resulting in negative compensation cost being recognized. In
accordance with FIN No. 44, expense reduction has been recognized up to the amount of the expense previously recognized in prior periods relating specifically to the modified awards. As such the Company recorded compensation expense to employees of
approximately $0.2 million and $(1.2) million for 2002, and 2001, respectively. For the year ended December 31, 2003, there was no expense recorded related to the granting of stock options.



Transactions during the years ended December 31, 2003, 2002 and 2001
involving stock options are summarized as follows:



|                                                   |  |                  |   |      |                                |       |                  |         |   |                                |   |                  |  |         |                                |  |   |       
|-------------------------------------------------- |  | ---------------- | - | ---- | ------------------------------ | ----- | ---------------- | ------- | - | ------------------------------ | - | ---------------- |  | ------- | ------------------------------ |  | - | ------
|                                                   |  | 2003             |   | 2002 |                                | 2001 
|                                                   |  | Number of Shares |   |      | Average Option Price Per Share |       | Number of Shares |         |   | Average Option Price Per Share |   | Number of Shares |  |         | Average Option Price Per Share
|Options outstanding at the beginning of the period |  | 449,108          |   |      | $                              | 81.30 |                  | 505,095 |   |                                | $ | 90.00            |  | 322,571 |                                |  | $ | 192.60
|Granted                                            |  | 408,500          |   |      |                                | 1.13  |                  | 3,699   |   |                                |   | 4.61             |  | 255,737 |                                |  |   | 11.95 
|Exercised                                          |  |                 |   |      |                                |      |                  |        |   |                                |   |                 |  | (3,448  | )                              |  |   | 118.50
|Terminated                                         |  | (135,894         | ) |      |                                | 92.22 |                  | (59,686 | ) |                                |   | 151.20           |  | (69,765 | )                              |  |   | 282.30
|                                                   |  |                  |   |      |                                |       |                  |         |   |                                |   |                  |  |         |                                |  |   |       
|Options outstanding at the end of the period       |  | 721,714          |   |      |                                | 33.48 |                  | 449,108 |   |                                |   | 81.30            |  | 505,095 |                                |  |   | 90.00 
|                                                   |  |                  |   |      |                                |       |                  |         |   |                                |   |                  |  |         |                                |  |   |       
|Options exercisable at the end of the period       |  | 299,943          |   |      |                                | 77.68 |                  | 325,468 |   |                                |   | 96.60            |  | 261,106 |                                |  |   | 109.20
|Weighted average fair value of options granted     |  |                  |   |      | $                              | 1.13  |                  |         |   |                                | $ | 10.80            |  |         |                                |  | $ | 11.40 



45



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##### Table of Contents

The following table summarizes information about stock options outstanding as of December 31, 2003:



|                        |  |                             |  |                                           |  |                                |        |                              |         |                                |   |       
|----------------------- |  | --------------------------- |  | ----------------------------------------- |  | ------------------------------ | ------ | ---------------------------- | ------- | ------------------------------ | - | ------
|                        |  | Options Outstanding         |  | Options Exercisable                      
|Range of Exercise Price |  | Outstandingas of 12/31/2003 |  | Weighted-AverageRemainingContractual Life |  | Weighted-AverageExercise Price |        | Exercisable as of 12/31/2003 |         | Weighted-AverageExercise Price
|$0.00-$1.13             |  | 380,800                     |  | 9.6                                       |  | $                              | 1.13   |                              |        |                                | $ | 0.00  
|$1.14-$11.10            |  | 160,188                     |  | 7.9                                       |  | $                              | 9.60   |                              | 119,931 |                                | $ | 9.60  
|$11.11-$90.00           |  | 85,737                      |  | 5.4                                       |  | $                              | 49.39  |                              | 85,023  |                                | $ | 49.27 
|$90.01-$605.09          |  | 94,989                      |  | 6.0                                       |  | $                              | 189.06 |                              | 94,989  |                                | $ | 189.06
|                        |  |                             |  |                                           |  |                                |        |                              |         |                                |   |       
|Total                   |  | 721,714                     |  | 8.2                                       |  | $                              | 33.48  |                              | 299,943 |                                | $ | 77.68 
|                        |  |                             |  |                                           |  |                                |        |                              |         |                                |   |       



In a definitive
Information Statement filed on April 17, 2003, a majority of the Companys stockholders approved the amendment and restatement of the Companys Equity Incentive Plan (the Plan) to, among other things (i) increase the number of
shares available for awards under the Plan to 5,500,000, (ii) eliminate a provision that limited awards of restricted stock to 10% of the shares available for issuance under the Plan, and (iii) increase to 3,333,333 the maximum number of shares of
common stock subject to awards that may be granted to an individual in any given fiscal year. The Information Statement became effective on May 7, 2003.



On July 30, 2003, the Company issued 4.7 million shares of restricted stock to employees and directors under its Equity Incentive Plan. All shares of
restricted stock vest on the tenth anniversary of the grant date, commencing on July 30, 2004, subject to the terms and conditions of the Equity Incentive Plan. The Company recorded $5.3 million of deferred compensation for this issuance. During
2003, 0.3 million shares were returned to the Company as the result of employee terminations prior to vesting. As such the Company recorded compensation expense to employees of approximately $0.2 million for 2003. For the years ended December 31,
2002 and 2001, there was no expense recorded related to the granting of restricted stock.



9. STOCK RESERVED FOR FUTURE ISSUANCE



In addition to shares of common stock underlying outstanding stock options, the Company has reserved for future issuance of additional shares of common stock relating to outstanding warrants. As of December 31, 2003,
the Company had outstanding warrants exercisable into approximately 5.0 million shares of common stock at exercise prices ranging from $0.03 to $196.80 per share.



On June 27, 2003, the Company commenced its previously approved exchange offer for its outstanding warrants. Holders of
certain outstanding warrants were given the opportunity to exchange their currently outstanding warrants for shares of the Companys common stock as if the exercise price of their warrants is $0.001 per share if such warrants were exercised in
full on a cashless basis. The offer was implemented to, among other things, satisfy certain of our obligations undertaken with respect to our recapitalization transactions, which occurred in October 2002 and January 2003. The offer expired on August
29, 2003. The warrants issued in connection with the recapitalization transactions completed in October 2002 and January 2003 did not participate in the offer to exchange. In connection with this offer the Company exchanged 695,828 warrants for
695,147 shares of common stock.



10. PREFERRED STOCK



Series C Voting Preferred Stock



On May 7, 1999 the Company issued approximately 133,000 shares of series C
voting preferred stock. Each share was entitled to 117.03 votes to be voted at any meeting of shareholders. In the event of any voluntary or involuntary liquidation, dissolution, or winding up of the corporation, the holders of shares of the series
C voting preferred stock then outstanding, were entitled to be paid, out of the assets of the Company available for distribution to its stockholders, whether from capital, surplus or earnings, before any payment shall be made in respect of the
Companys common stock in an amount equal to $1.50 per share. Each holder of each share of series C voting preferred stock had the right to convert such share for one share of common stock at a conversion price of $45.00 per share, subject to
adjustment. The holders of the series C voting preferred stock were entitled to share in any dividends declared and paid by the Company to the common stock on a ratable basis. In connection with the issuance of the series C voting preferred stock,
the Company recorded a non-recurring, non-cash charge for a beneficial conversion feature in the amount of $0.1 million, to reflect the market price of the common stock on the date of issuance.



46



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Series D, E and F Preferred Stock



On November 30, 1999 the Company issued approximately (i) 309,000 shares of series D preferred stock, (ii) 292,000 shares of
series E preferred stock and (iii) 346,000 shares of series F preferred stock. The shares of series D, E and F preferred stock were entitled to voting rights at any meeting of shareholders. In the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the corporation, the holders of shares of the series D, E and F preferred stock then outstanding, were entitled to be paid, out of the assets of the Company available for distribution to its stockholders, whether from
capital, surplus or earnings, before any payment shall be made in respect of the Companys common stock an amount equal to $15.00, $15.00 and $30.00 per share, respectively. Each holder of each share of series D, E and F preferred stock had the
right to convert such share for ten shares of common stock at conversion prices of $45.00, $45.00 and $90.00 per share, respectively, subject to adjustment. However upon the date of issuance, the effective conversion price of these series of
preferred stock ($217.50 per share) was equal to the value of the common stock that was exchanged for each share of preferred stock, and into which the preferred stock is convertible. The holders of the series D, E and F preferred stock were
entitled to receive dividends at a rate of 4%, 8% and 8% per annum, respectively. Such dividends were payable semi-annually, and at the option of the Company, in cash or in additional shares of the respective series of series D, E or F preferred
stock.



Series G, H and I Preferred Stock



On June 30, 2000, the Company issued and sold 2,000,000 shares of series G
preferred stock to Nortel in a private placement for an aggregate purchase price of $20.0 million. Each share of series G preferred stock was convertible into one share of common stock of FiberNet at $300.00 per share, subject to anti-dilution
adjustments. In connection with this transaction, the Company recorded a non-recurring non-cash charge for a beneficial conversion feature in the amount of $14.0 million to reflect the market price of the common stock as of the date of the issuance.



On July 31, 2000 the Company issued and sold 426,333 shares of
series H preferred stock to Nortel in a private placement for an aggregate purchase price consisting of $22.5 million in cash plus the cancellation by Nortel of the 2,000,000 shares of the series G preferred stock, including all accrued and unpaid
dividends thereon. Each share of series H preferred stock is convertible into ten shares of common stock at $300.00 per share, subject to anti-dilution adjustments. This amount was reflected on the Companys balance sheet net of the value of
warrants to purchase 14,166 shares of common stock of the Company issued in connection with this transaction. The value of these warrants was estimated on the date of issuance using the Black-Scholes option pricing model. In connection with this
transaction, the Company recorded a non-recurring non-cash charge for the beneficial conversion feature in the amount of $12.3 million to reflect the market price of the common stock as of the date of the issuance.



On August 11, 2000 FiberNet issued and sold 62,500 shares of series I
preferred stock to Nortel in a private placement for an aggregate purchase price of $7.5 million. Each share of series I preferred stock is convertible into ten shares of common stock at $360.00 per share, subject to anti-dilution adjustments. The
Company recorded a beneficial conversion charge of $1.5 million in connection with this issuance. Nortel invested a total of $50.0 million in preferred stock of the Company.



In February 2001, the conversion price of the series H and series I was reduced to $131.25, in accordance with the original
terms of the issuance transactions. The certificates of designation of the series H and series I included provisions requiring the conversion prices to be lowered to the per share price at which the Company issues any shares of common stock, subject
to certain exceptions, subsequent to the initial issuance of the series H and series I. In February 2001, the Company issued shares of common stock in a directed public offering at a price of $131.25 per share, resulting in the reduction of the
conversion price. The Company recorded a beneficial conversion charge of $21.0 million as a result of the reduction of the conversion price.



Conversion of Series C, D, E, F, H and I Preferred Stock



On December 6, 2001, all of the Companys outstanding shares of series C, D, E and F preferred stock were converted into shares of the Companys
common stock. In addition, the holder of the Companys series H and I preferred stock converted all of its series I preferred stock and 373,947 shares, or 79%, of its series H preferred stock into shares of the Companys common stock.
Additionally, in connection with the conversion of the series H and I preferred stock, the conversion price of the remaining 100,000 shares of series H preferred stock was reduced to $39.30. However, as all of the proceeds from the issuances of the
series H and series I had been allocated to beneficial conversion features, no additional proceeds were allocated upon the reset of the conversion price of the series H preferred stock to $39.30.



Accordingly, as a result of the conversion of the series C, D, E, F, H and I
preferred stock into common stock, the Company issued an aggregate of 688,252 shares of common stock to stockholders who held shares of series C, D, E, F, H and I preferred stock



47



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



and cancelled an aggregate of 1,534,221 shares of series C, D, E, F, H and I preferred stock. In connection with the
conversion of the series C, D, E and F preferred stock, the holders of such preferred stock received, in the aggregate, warrants to purchase 32,833 shares of the Companys common stock. The Company recorded a non-cash preferred stock dividend
of $0.3 million, representing the fair value of the warrants issued, as determined using the Black-Scholes option model. These warrants have an exercise price of $16.50 and an expiration date of 5 years from the date of issuance.



On October 30, 2002, as a result of the recapitalization of the Company all
outstanding shares of series H preferred stock were converted into common stock. See Note 6.



Series J Preferred Stock



On December 7, 2001, the Company consummated a directed public offering of 360 shares of a new series of preferred stock, designated series J preferred stock for an aggregate purchase price of $3.6 million, under the Companys existing
shelf registration statement. Pursuant to the stock purchase agreement, the Company also issued to the purchasers two series of warrants, series A and B, to purchase up to 340,390 shares of the Companys common stock having an expiration date
five years from the date of issuance and at an exercise price of $9.00 per share, all of which are subject to adjustment in certain circumstances and 150,330 of which, representing the series B warrants, were subject to certain vesting conditions.
In addition, subject to certain conditions, the stock purchase agreement included two additional closings for the sale of an additional $5.7 million of the Companys series J preferred stock to the purchasers. The Company also paid $0.3 million
and issued 10,909 shares of its common stock to the placement agent for the sale of the series J preferred stock.



The original terms of the preferred stock provided that the Company may redeem any or all of the currently outstanding shares of series J preferred stock
for 150% of the purchase price of such stock. In addition, under certain circumstances, the Company must redeem any outstanding series J preferred stock in exchange for either 100% or 150% of the purchase price, depending upon the event that
transpires. Furthermore, subject to certain adjustments, the series J preferred stock was convertible into the number of shares of common stock equal to 90% of the average of the five lowest volume weighted average prices for the Companys
common stock during the 15 trading days immediately prior to the date of conversion, provided that such average price shall not be less than $6.00 nor greater than $15.00 for the series J preferred stock issued at the first closing. Other than with
respect to matters directly affecting the rights, preferences and privileges of the series J preferred stock, the terms of the series J preferred stock do not provide voting rights to the holders thereof.



As the purchasers made a firm commitment to participate in the two additional
closings totaling $5.7 million, the transaction was accounted for as a subscription receivable from series J preferred stock. The series J preferred stock was reflected in the December 31, 2001 balance sheet net of the relative fair value of
warrants to purchase 340,390 shares of common stock of the Company issued in connection with this transaction. The value of these warrants was estimated on the date of issuance using the Black-Scholes option pricing model and determined to be $3
million. However, as the value assigned to the warrants is based on the relative fair value of the warrants and the preferred stock, a valuation of $1.8 million was assigned to the warrants, based upon their relative fair value. In connection with
this transaction, the Company recorded a non-recurring non-cash charge for a beneficial conversion feature in the amount of $2.1 million to reflect the market price of the common stock as of the date of the issuance.



On October 30, 2002, as a result of the recapitalization of the Company all
outstanding shares of series J Preferred Stock were converted into common stock. The two additional closings of the series J preferred stock were never consummated. See Note 6.



11. RELATED PARTY TRANSACTIONS



As a result of its restructuring the Companys lenders, Deutsche Bank AG New York Branch, Wachovia Investors, Inc., and IBM Credit LLC, became
related parties. Deutsche Bank Trust Company North America, as subsidiary of Deutsche Bank AG, is the Companys primary bank, where it maintains its cash accounts. An affiliate of Wachovia Investors, Inc. provides stock transfer agent services
and stock option plan administration services to the Company. The Company pays customary fees for these services.



Pursuant to the terms of a consulting agreement dated June 12, 2003, the Company paid a total of $37,500 in consulting fees to Richard Sayers, who is a
member of the Companys board or directors, during 2003.



The Company capitalized in property, plant and equipment amounts paid for services related to building the Companys network from Nortel, a shareholder, of approximately $0.8 million, $0.1 million and $7.4 million during 2003, 2002 and
2001, respectively. As of December 31, 2003, the Company had approximately $31,000 in accounts payables to Nortel. During 2002, the Company had a note payable to Nortel for approximately $2.3 million. During 2002 the Company repaid approximately
$1.1 million of the note, and approximately $0.9 million was forgiven and recorded as an additional capital contribution to the Company. On October 30, 2002, as a result of the recapitalization discussed in Note 6, the remaining portion of this note
was converted into common stock.



48



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



12. INCOME TAXES



The Company accounts for income taxes in accordance with the provisions of SFAS 109, Accounting For Income Taxes. During 2003, 2002 and 2001
the Company did not record a current or deferred federal income tax provision because the Company had losses for federal income tax purposes and it does not expect to realize the benefits of the net operating tax losses generated in those years.



A reconciliation of the actual income tax (provision)/benefit
and the tax computed by applying the U.S. federal rate (34%) to the loss from continuing operations, before income taxes, for the three years ended December 31, 2003, 2002 and 2001 follows (dollars in thousands):



|                                                       |  |                         |        |   |      |   |         |      |  |   |         |  
|------------------------------------------------------ |  | ----------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                       |  | Year Ended December 31, |       
|                                                       |  | 2003                    |        |   | 2002 |   |         | 2001 | 
|Computed tax at federal statutory rate                 |  | $                       | (9,444 | ) |      | $ | (11,075 | )    |  | $ | (51,303 | )
|State and local tax, net of federal income tax benefit |  |                         | (917   | ) |      |   | (1,028  | )    |  |   | (7,329  | )
|Interest expense from beneficial conversion            |  |                         |       |   |      |   |        |      |  |   | 29      |  
|Non-deductible goodwill impairment                     |  |                         |       |   |      |   |        |      |  |   | 29,319  |  
|Other                                                  |  |                         | 1,205  |   |      |   | 9       |      |  |   |        |  
|Change in valuation allowance                          |  |                         | 9,156  |   |      |   | 12,094  |      |  |   | 29,284  |  
|                                                       |  |                         |        |   |      |   |         |      |  |   |         |  
|                                                       |  | $                       |       |   |      | $ |        |      |  | $ |        |  
|                                                       |  |                         |        |   |      |   |         |      |  |   |         |  



The tax effects of
temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities, for the three years ended December 31, 2003, 2002, and 2001, consist of the following (dollars in thousands):



|                                                             |  |                         |         |   |      |   |         |  
|------------------------------------------------------------ |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                                             |  | Year Ended December 31, |        
|                                                             |  | 2003                    |         |   | 2002 |  
|Deferred tax assets/(liabilities):                           |  |                         |         |   |      |   |         |  
|Deferred expenses                                            |  | $                       | 678     |   |      | $ | (344    | )
|Stock options                                                |  |                         | 4,232   |   |      |   | 4,149   |  
|Depreciation and impairment of property, plant and equipment |  |                         | (6,165  | ) |      |   | (2,256  | )
|Goodwill                                                     |  |                         | 7,416   |   |      |   | 5,209   |  
|Net operating loss                                           |  |                         | 65,720  |   |      |   | 55,861  |  
|Bad debts                                                    |  |                         | 269     |   |      |   | 375     |  
|Valuation allowance                                          |  |                         | (72,150 | ) |      |   | (62,994 | )
|                                                             |  |                         |         |   |      |   |         |  
|Net deferred tax asset/(liability)                           |  | $                       |        |   |      | $ |        |  
|                                                             |  |                         |         |   |      |   |         |  



The temporary
differences described above represent differences between the tax basis of assets or liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years when the reported
amounts of the assets or liabilities are recovered or settled.



During the tax year ended December 31, 2003 a valuation allowance for the full amount of the net deferred tax asset was recorded. The valuation allowance represents the portion of tax net operating loss carryforwards and other items for
which it is more likely than not that the benefit of such items will not be realized. Based upon the level of historical taxable income and projections for the future taxable periods, it is more likely than not that the Company will not realize the
benefit of the deferred tax asset.



As of December 31, 2003,
the Company had net operating loss carryforwards for federal income tax purposes of approximately $176 million. These tax loss carryforwards begin expiring in 2012. In addition, the tax net operating losses are subject to limitation on future
utilization under Section 382 of the Internal Revenue Code of 1986. Section 382 imposes limitations on the availability of a Companys net operating losses after a more than 50 percentage point ownership change occurs, generally, with respect
to a companys stock. It was determined that such an ownership change(s) occurred during the year ended December 31, 2002. The amount of the Companys net operating losses incurred prior to the ownership change is limited (the Loss
Limitation) based on the value of the Company on the date of the ownership change. The annual Loss Limitation is uncertain since it is dependent upon the ultimate determination of the value of the Company on the date of ownership change and
the implementation of certain tax strategies. It is estimated that the effect of Section 382 will reduce the amount of net operating loss which is available to offset future taxable income to approximately $500,000 per year.



49



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##### Table of Contents

FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



13. METROMEDIA FIBER NETWORK SERVICES, INC. PRIVATE NETWORK AGREEMENT



Pursuant to a Private Network Agreement dated as of December 17, 1999 and
other related agreements by and between Metromedia Fiber Network Services, Inc. (MFN) and the Company (the Network Agreement), the Company issued 166,666 common shares at an assumed price of $260.70 per share. As part of the
Network Agreement, the Company issued 133,333 shares (of the total 166,666) to acquire an exclusive right of use for 20 years of dark fiber in multiple markets for a total price of approximately $34.8 million. This amount has been reflected in the
accompanying consolidated financial statements as property, plant and equipment being amortized over its 20-year useful life. As part of the remaining part of the Network Agreement, the Company issued 33,333 shares (of the total 166,666) to
repurchase a 10% membership interest in Local Fiber held by MFN. The transaction was recorded as a purchase business combination. The Company recorded approximately $8.7 million of goodwill in the accompanying consolidated financial statements,
which was being amortized over a period of 15 years until the adoption of SFAS No.142, upon which the amortization of goodwill ceased. As of December 31, 2003, the net balance of goodwill of $7.5 million was written off as impaired according to SFAS
No.142. See Note 5.



14. QUARTERLY INFORMATION (dollars in thousands, except
per share data) (unaudited)



|                                                                       |  |                             |         |   |               |   |        |                    |  |   |                      |   |  |   |         |  
|---------------------------------------------------------------------- |  | --------------------------- | ------- | - | ------------- | - | ------ | ------------------ |  | - | -------------------- | - |  | - | ------- | -
|                                                                       |  | March 31, 2003(a)           |         |   | June 30, 2003 |   |        | September 30, 2003 |  |   | December 31, 2003(b) |  
|                                                                       |  | (As restated  see Note 17) |         |   |               |   |        |                    |  |   |                      |  
|Revenues                                                               |  | $                           | 6,377   |   |               | $ | 6,451  |                    |  | $ | 6,680                |   |  | $ | 7,097   |  
|Loss from operations (d)                                               |  |                             | (1,600  | ) |               |   | (1,447 | )                  |  |   | (1,570               | ) |  |   | (11,911 | )
|Net loss                                                               |  |                             | (11,176 | ) |               |   | (1,990 | )                  |  |   | (2,112               | ) |  |   | (12,497 | )
|Net loss applicable to common stockholders                             |  |                             | (11,176 | ) |               |   | (1,990 | )                  |  |   | (2,112               | ) |  |   | (12,497 | )
|Net loss applicable to common stockholders per share-basic and diluted |  | $                           | (0.33   | ) |               | $ | (0.06  | )                  |  | $ | (0.05                | ) |  | $ | (0.31   | )



|                                                                       |  |                |        |   |               |   |        |                    |  |   |                            |   |  |   |         |  
|---------------------------------------------------------------------- |  | -------------- | ------ | - | ------------- | - | ------ | ------------------ |  | - | -------------------------- | - |  | - | ------- | -
|                                                                       |  | March 31, 2002 |        |   | June 30, 2002 |   |        | September 30, 2002 |  |   | December 31, 2002(c)       |  
|                                                                       |  |                |        |   |               |   |        |                    |  |   | (As restated  seeNote 17) |  
|Revenues                                                               |  | $              | 7,014  |   |               | $ | 6,427  |                    |  | $ | 5,875                      |   |  | $ | 6,019   |  
|Loss from operations (d)                                               |  |                | (2,331 | ) |               |   | (2,035 | )                  |  |   | (2,401                     | ) |  |   | (15,235 | )
|Net loss                                                               |  |                | (4,488 | ) |               |   | (4,154 | )                  |  |   | (4,736                     | ) |  |   | (24,025 | )
|Net loss applicable to common stockholders                             |  |                | (4,516 | ) |               |   | (4,157 | )                  |  |   | (4,749                     | ) |  |   | (24,025 | )
|Net loss applicable to common stockholders per share-basic and diluted |  | $              | (2.18  | ) |               | $ | (1.97  | )                  |  | $ | (2.21                      | ) |  | $ | (1.33   | )

---

|(a) | The Company recorded a charge of $9.0 million related to an early extinguishment of debt related to the restructuring of its Credit Facility. See Note 6.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | The Company recorded a $7.5 million charge for the impairment of goodwill. The Company recorded a $1.5 million charge for the impairment of certain long-lived assets. See Note 4.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) | The Company recorded a charge of $5.8 million related to an early extinguishment of its note payable. The Company recorded a $12.7 million charge for the impairment of certain
long-lived assets. See Note 4.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) | The loss from operations as previously reported for the quarters ended March 31, 2003 and December 31, 2002 was $10,551 and $23,093, respectively. Amounts as restated are indicated
above.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



15. LEGAL SETTLEMENT EXPENSE



In December 2002, the Company settled certain outstanding litigation matters
in part by issuing approximately 13,333 warrants to purchase common stock at $0.03 per share and by repricing the exercise price of approximately 6,667 of existing warrants to purchase common stock from exercise prices ranging from $15.00 to $45.00
per share to $0.03 per share. All of these warrants have a term of five years.



In February 2003, the Company settled other certain litigation matters by issuing approximately 43,267 shares of common stock, 243,400 warrants to purchase common stock with an exercise price of $0.03 per share and a
term of five years, which were exercised immediately, and 166,666 warrants to purchase common stock with an exercise price of $3.60 per share and a term of five years. The Company also repriced 16,667 of existing warrants, which were exercised
immediately, to purchase common stock from exercise prices of $15.00 and $20.10 per share to $0.03 per share. These warrants also have a term of five years. FiberNet recorded a $0.6 million expense in selling, general and administration for the
period ending December 31, 2002, as a result of the litigation matters settled in December 2002 and February 2003.



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In February 2004, the Company settled a threatened litigation matter by issuing 200,000 shares of
common stock, and a one-time cash payment of $0.3 million. As a result of the settlement of this outstanding litigation matter, FiberNet recorded a $0.5 million expense in selling, general and administration for the period ending December 31, 2003.
A portion of this settlement was covered by insurance, and the Company recorded an outstanding receivable of approximately $0.2 million related to the insurance coverage for this claim.



16. SUBSEQUENT EVENTS



On January 30, 2004, the Company completed the acquisition of the operating assets of gateway.realty.new jersey.llc, also known as Gateway Colocation.
Gateway Colocation operates a 49,000 square foot communications hub and colocation facility located at 165 Halsey Street in Newark, New Jersey. The transaction was structured as an acquisition of assets, and the purchase price paid at closing
consisted of 2.9 million shares of the Companys common stock with a fair value of $4.8 million on the closing date and approximately $170,000 in cash. The purchase agreement includes an earn-out payment based upon the achievement
of certain financial objectives with respect to the revenues generated by the facility. More specifically, the earn-out payment will be based on the gross revenues, on an annualized basis, for a particular month designated by Gateway
Colocation during the twenty-four month period immediately subsequent to closing. The earn-out payment, if payable, will be paid in shares of the Companys common stock. However, the issuance of such additional shares, in the
aggregate with the shares of common stock issued at closing, will not exceed 19.9% of the issued and outstanding shares of common stock of the Company as of the closing date without first receiving stockholder approval. FiberNet has agreed to file
with the Securities and Exchange Commission a registration statement covering the resale of the shares issued at closing, and has also agreed to file a registration statement with respect to the resale of shares issued, if any, pursuant to the terms
of the earn-out provision. In connection with the closing of the acquisition, Oskar Brecher, a founder of Gateway Colocation, has been appointed to the board of directors of the Company.



In connection with the acquisition, the Company paid $432,000 in cash
(including acquisition costs of approximately $262,000), and issued to Gateway Colocation 2.9 million shares of common stock with fair value of approximately $4.6 million on the date issued. The acquisition was accounted for under the purchase
method of accounting.



Also on January 30, 2004 in an unrelated
transaction, the Company entered into a Common Stock Purchase Agreement (the Investor Purchase Agreement), with certain investors, pursuant to which the Company issued to the investors, in a private offering, an aggregate of 6.4 million
shares of common stock at a price of $1.25 per share, for gross proceeds to the Company of $8.0 million. Pursuant to the terms of the Investor Purchase Agreement, the Company also issued to such investors warrants (with an expiration date three and
one-half years after closing) to purchase an aggregate of 1.9 million shares of common stock at an exercise price of $1.75 per share. Additionally, the Company issued 256,000 shares of its common stock to the placement agent.



In connection with the Investor Purchase Agreement, the Company entered into
a Registration Rights Agreement with the investors, dated as of January 30, 2004, which requires the Company to file a registration statement with the Securities and Exchange Commission with respect to the resale of (i) the shares of common stock
issued to the investors and (ii) the shares of common stock underlying the warrants issued to the investors.



In connection with the consummation of both the acquisition and equity financing described above, the Company entered into certain transactions with the
lenders under its Credit Facility. The Company and the lenders executed an eleventh amendment to the credit agreement, pursuant to which, among other things, the lenders consented to the above-referenced transactions. The eleventh amendment, which
was effective as of December 31, 2003, also revised the automatic reductions of the commitments underlying the Credit Facility that are required on a quarterly basis beginning on March 31, 2004. Expressed as a percentage of the aggregate,
outstanding commitments, the automatic reductions were revised to a total of 8% in 2004, 40% in 2005, 48% in 2006 and 4% at maturity on March 31, 2007. As of March 16, 2004 the Company had satisfied the entire 8% of the mandatory reduction of
commitments for 2004. In addition, the eleventh amendment also incorporated adjustments to the financial covenants of the Credit Facility. As a condition to the lenders entering into the eleventh amendment, the Company agreed to reduce the exercise
price of certain previously issued outstanding warrants held by the lenders to purchase approximately 379,230 shares of common stock from $3.60 per share to $0.001 per share. All of the repriced warrants were immediately exercised by the lenders.



On March 10, 2004, the Company was notified that it has
prevailed in an arbitration proceeding regarding a breach of contract. The Company was awarded approximately $2.7 million, which included approximately $0.4 million for the reimbursement of legal fees.



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FIBERNET TELECOM GROUP, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



17. RESTATEMENT



Subsequent to the issuance of its consolidated financial statements for the year ended December 31, 2003, the Company determined that based on guidance
the loss on early extinguishment of debt should be classified in other expenses rather than operating expenses in its consolidated statement of operations. This reclassification resulted in a reduction of loss from operations of $7.4 million, $7.9
million and $9.0 million for the years ending 2001, 2002 and 2003, respectively.



Subsequent to the issuance of its consolidated financial statements, the Company determined that certain prepayments from customers classified as current deferred revenue were related to long-term contracts and should
have been classified as a long-term liability. As a result, the Company has reclassified that portion of current deferred revenue as a long-term liability. This reclassification resulted in a reduction of current liabilities and a corresponding
increase in long-term liabilities of $1.4 million and $0.5 million as of December 31, 2003 and 2002, respectively.



In 2003, the Company recorded an adjustment to its gross deferred tax assets and related valuation allowance. This adjustment had no effect on the
consolidated financial statements as the Company provides a full valuation allowance for all deferred taxes. In the 2001 statutory income tax rate reconciliation, the Company has provided additional disclosures relating to a difference caused by the
impairment of non-deductible goodwill and the change in the valuation allowance. Such amounts had been combined into one line item in the disclosure previously presented. As a result of this additional disclosure, the aforementioned adjustment
previously disclosed in 2003 was no longer required.



Finally,
the Company has modified certain disclosures previously contained in Note 1. The effects of the reclassifications and additional disclosure discussed above had no impact on the Companys previously reported revenues, net loss, net loss per
share, assets, total liabilities, statements of cash flows or statements of stockholders equity for the years ended December 31, 2001, 2002 and 2003.



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SIGNATURES



In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



FIBERNET TELECOM GROUP, INC .By:

/s/ MICHAEL S. LISSName:

Michael S. LissTitle:

Chairman, President and Chief Executive OfficerDate: July 9, 2004




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



|                                                       |  |                                                                                       |  |             
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------- |  | ------------
|Name                                                   |  | Title                                                                                 |  | Date        
|                                                       |  |                                                                                      
|/s/ MICHAEL S. LISSMichael S. Liss                     |  | Chairman, President and Chief Executive Officer (Principal Executive Officer)         |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ JON A. DELUCAJon A. DeLuca                         |  | Senior Vice President-Finance, Chief Financial Officer (Principal Accounting Officer) |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ TIMOTHY P. BRADLEYTimothy P. Bradley               |  | Director                                                                              |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ OSKAR BRECHEROskar Brecher                         |  | Director                                                                              |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ ROBERT E. LABLANCRobert E. LaBlanc                 |  | Director                                                                              |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ ROY (TREY ) D. FARMER IIIRoy (Trey ) D. Farmer III |  | Director                                                                              |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ CHARLES J. MAHONEYCharles J. Mahoney               |  | Director                                                                              |  | July 9, 2004
|                                                       |  |                                                                                      
|/s/ RICHARD E. SAYERSRichard E. Sayers                 |  | Director                                                                              |  | July 9, 2004