**UNITED
STATES SECURITIES AND EXCHANGE COMMISSION**
 **Washington,
D.C. 20549**
 _______________
 **Form
10-K**
 
 **x ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE** **ACT
OF 1934**
 
 **For
the fiscal year ended: December 31, 2004**
 
 **OR**
 
 **o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** **EXCHANGE
ACT OF 1934**
 ****
 
 **Commission
File Number 001-32264**
 
 **DSL.net,
Inc.**
 *(Exact
name of registrant as specified in its charter)*
 
 **DELAWARE**
    
    **06-1510312***(State
      or other jurisdiction of*
    
    *(I.R.S.
      Employer**incorporation
      or organization)*
    
    *Identification
      Number)*
 
 **545
      Long Wharf Drive, New Haven, Connecticut**
    **06511**
    **(203)
      772-1000*******(Address
      of principal executive offices)*
    *(Zip
      Code)*
    *(Telephone
      No.)*
 
 **Securities
registered pursuant to Section 12(b) of the Act:**
 
 **Title
      of Each Class**
    **Name
      of Each Exchange on which Each Class is
  Registered****Common
      Stock, par value $.0005 per share**
    **American
      Stock Exchange**
 
 **Securities
registered pursuant to Section 12(g) of the Act: None**
  Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such report(s)), and (2) has been subject to such filing requirements
for the past 90 days. Yes x  No o
 
 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 definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. x
 
 Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes o No x
 
 The
aggregate market value of the Common Stock held by non-affiliates of the
registrant, as of the last business day of the registrant’s most recently
completed second fiscal quarter, was approximately $43,357,776 (based on the
closing price of the registrant’s Common Stock on that day of $0.31 per share).
The number of shares outstanding of the registrant’s Common Stock, par value
$.0005 per share, as of March 1, 2005, was **** 233,619,817.
 
 
 
   **DSL.net,
Inc.**
 
 **ANNUAL
REPORT ON FORM 10-K**
 
 **YEAR
ENDED DECEMBER 31, 2004**
 
 **TABLE
OF CONTENTS**
 
 
 ****
    Page
      No.Part
      IItem
      1.
    Business
    2Item
      2.
    Properties
    16Item
      3.
    Legal
      Proceedings
    17Item
      4.
    Submission
      of Matters to a Vote of Security Holders
    17Part
      IIItem
      5.
    Market
      for Registrant’s Common Equity, Related Stockholder
Mattersand Issuer Purchases of Equity Securities
    19Item
      6.
    Selected
      Financial Data
    21Item
      7.
    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
    23Item
      7A.
    Quantitative
      and Qualitative Disclosure About Market Risk
    61Item
      8.
    Financial
      Statements and Supplementary Data
    62Item
      9.
    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
    107Item
      9A.
    Controls
      and Procedures
    107Item
      9B.
    Other
      Information
    107Part
      IIIItem
      10.
    Directors
      and Executive Officers of the Registrant
    107Item
      11.
    Executive
      Compensation
    111Item
      12.
    Security
      Ownership of Certain Beneficial Owners and Management
    121Item
      13.
    Certain
      Relationships and Related Transactions
    124Item
      14
    Principal
      Accountant Fees and Services
    128Part
      IVItem
      15.
    Exhibits
      and Financial Statement Schedule
    130SIGNATURES
    136
  1
  **PART
I**
 
 **Item
1. Business**
 
 THIS
BUSINESS SECTION AND OTHER PARTS OF THIS ANNUAL REPORT ON FORM 10-K CONTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT
LIMITED TO, THOSE SET FORTH IN “ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS” AND ELSEWHERE IN THIS ANNUAL
REPORT ON FORM 10-K. EXISTING AND PROSPECTIVE INVESTORS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF
THE DATE HEREOF. WE UNDERTAKE NO OBLIGATION, AND DISCLAIM ANY OBLIGATION, TO
UPDATE OR REVISE THE INFORMATION CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K,
WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR CIRCUMSTANCES OR
OTHERWISE.
 
 **General**
 
 DSL.net,
Inc., itself and through its affiliates (“DSL.net”, “we” or the “Company”),
provides high-speed data communications, Internet access, and related services
to small and medium sized businesses and branch offices of larger businesses and
their remote office users, throughout the United States, primarily utilizing
digital subscriber line (“DSL,” generally, or “SDSL,” in reference to
symmetrical DSL service) and T-1 technology (“T-1” refers to a digital
transmission link, provisioned via DS-1 (i.e., North American Digital Signal
Level One) or substantially equivalent technology). In September of 2003, we
expanded our service offerings to include integrated voice and data services
using voice over Internet protocol (“VoIP”) to business customers in select
Mid-Atlantic and Northeast markets. Our networks enable data transport over
existing copper telephone lines at speeds of up to 1.5 megabits per second. We
were organized in 1998 as a corporation under the laws of the State of
Delaware.
 
 We sell
directly to businesses and to third party resellers whose end-users are
typically business-class customers. We deploy our own local communications
equipment primarily in select first and second tier cities. As of March 1, 2005,
we operated equipment in approximately 340 cities in the United States. In
certain markets where we have not deployed our own equipment, we
utilize the local facilities of other carriers to provide service.
 
 In
addition to a number of high-speed, high-performance DSL-based data
communications and Internet connectivity solutions specifically designed for
businesses, our product offerings include T-1 Internet connectivity and data
communications services, integrated voice and data services (provisioned over
SDSL or T-1 lines), Web hosting, domain name system management, enhanced e-mail,
on-line data backup and recovery services, firewalls, nationwide dial-up
services, private frame relay services and virtual private networks. Our
services offer customers high-speed digital connections and related services at
prices that we believe are attractive compared to the cost and performance of
alternative data communications services.
  2
  
 In
September of 2003 we introduced our VoIP and data bundles in the Washington,
D.C. metropolitan region. In February of 2004 we introduced our VoIP and data
bundles in the New York City metropolitan area.
 
 **The
DSL.net Solution**
 
 We
provide small and medium sized businesses and branch offices of larger
businesses and their remote office users with high-speed Internet access and
data communications services, and integrated voice and data services, primarily
using DSL and T-1 technology. Key elements of our solutions are:
 
 *High-Speed
Connections* . We
offer Internet access and private network services at speeds of up to 1.5
megabits per second, via SDSL and T-1 technology. Our network is designed to
provide data transmission at the same speed to and from the customer, known as
symmetrical data transmission, and is also capable of providing service at
different speeds to and from the customers, known as asymmetrical data
transmission. We believe that symmetrical data transmission is best suited for
business applications, because business users require fast connections both to
send and receive information, and to host advanced services and
applications.
 
 *Voice
over Internet Protocol.* We offer
a suite of VoIP-based telephony services in conjunction with our high speed data
connections. Each bundle includes unlimited local, unlimited regional, and
unlimited domestic long-distance calling (subject to certain limitations set
forth in our service agreement). Multiple voice and data bundles varying by the
number of telephone lines, and varying broadband speeds, are available to meet
the needs of a variety of business types and sizes. Our VoIP services are
offered over a “quality of service” (“QoS”) controlled network to ensure that
telephone calls are delivered with carrier-grade quality.
 
 *Complete
Business Solution* . We
offer our customers a single point of contact for a  complete
solution that includes all of the necessary equipment and services to establish
and maintain digital data communications. Our services include high-speed
Internet access and data communications services, integrated voice and data
services, frame relay, Web hosting, domain name system management, enhanced
e-mail, on-line data backup and recovery services, firewalls, nationwide dial-up
services and virtual private networks. Our network is designed to enable us to
individually configure each customer's service remotely.
 
 *Always-On
Connections* . With
our high-speed service, customers can access the Internet continuously without
having to dial into the network for each use. These “always-on” connections
provide customers with the ability to readily access the Internet and transfer
information. We charge our customers a flat fee per month for high-speed
connectivity service rather than billing them based on usage.
 
 *Value
Proposition* . Our DSL
and T-1 services offer customers high-speed digital connections at prices that
we believe are attractive compared to the cost and performance of certain
alternative data communications services, such as multiple dial-up connections,
ISDN or traditional frame relay lines. We believe that our services also
increase the productivity of network users by decreasing the time they spend
connecting to the Internet and waiting for information downloads and transfers.
The ability to bundle multiple services, such as Internet access, data
communications and voice, over the same access line allows us to offer our
services at price points which are significantly less than those of the same
communications services if purchased separately.
 
 3
 *Customer
Support* . We
provide customer support coverage through a combination of automated systems and
live personnel. With our remote monitoring and troubleshooting capabilities, we
continuously monitor our network.
 
 **Our
Services**
 
 As part
of our service offerings, we often function as our customers' Internet service
provider and deliver a range of Internet-based, value-added solutions. Our
services currently include all necessary equipment, software and lines required
to establish and maintain a digital Internet connection and carrier-class voice
service. Our primary services include high-speed data communications, with or
without Internet access, integrated voice and data services, and private frame
relay and virtual private networks that connect customers’ various offices.
Other services provided by DSL.net include firewalls, e-mail, domain name system
management and Web hosting, on-line data backup and recovery services and
nationwide dial-up services.
 
 Customers
typically pay an installation charge and a monthly fee for our service. Revenue
related to installation charges is deferred and amortized to revenue over 18
months, which is the average customer life of the existing customer base. The
monthly fee for our data communications services includes all telephone line
charges, general Internet access services, e-mail, and domain name system
management, including the issuance of Internet protocol (“IP”) addresses for
customers who wish to assign fixed IP addresses to their network computers. The
monthly fee for our integrated voice and data service includes all telephone
line charges, general Internet access services, local and domestic long distance
phone service (subject to subscription bundles and other restrictions set forth
in the customer’s service agreement), caller ID, call waiting, call forwarding,
e-mail, and domain name system management, including the issuance of IP
addresses. Customers generally contract for our services for a minimum of 12 or
24 months, depending upon the service, and are billed for services on a monthly
basis.
 
 **Customers**
 
 Our
target customers are primarily small and medium sized businesses and branch
locations of larger enterprises and their remote office users. We sell to these
customers on a direct basis and through various referral channels. In
particular, we believe the following market segments are especially attractive
prospective customers:
 
 ·
    businesses
      currently using other high-speed data communications services, such as
      ISDN and frame relay services;
 
 ·
    professional
      or service-based firms that have multiple Internet service provider
      dial-up accounts and phone lines;
 
 ·
    branch
      office locations that require transmission of large files between
      locations;
 
 ·
    business
      users that require remote access to corporate local area
      networks;
 
 ·
    businesses
      that use data-intensive applications, such as financial services,
      technology and publishing; and
  4
 
 ·
    businesses
      that cannot afford to pay the costs for maintaining high-speed connections
      for voice and data services separately, but can justify the cost of a
      high-speed connection if shared for voice and data
    services.
 
 No
customer accounted for more than 5% of our total revenue for fiscal years ended
December 31, 2004, 2003 and 2002.
 
 **Sales
and Marketing**
 
 Our
marketing professionals have developed a methodology to identify the businesses
that we believe would most likely benefit from our services. Once we identify
businesses in a specific market, we employ a targeted marketing strategy
utilizing a variety of media. We also partner with various resellers,
wholesalers and referral channels, including local information technology
professionals, application service providers and marketing partners, to assist
in the sale of our services.
 
 **Customer
Acquisitions**
 
 In
addition to our sales and marketing efforts, and our reseller and referral
channels, we have supplemented our customer base, from time to time, by
acquiring end users of other Internet service providers and companies offering
broadband access. We continuously identify and evaluate customer acquisition
candidates, and in many cases engage in discussions and negotiations regarding
potential transactions. Customer acquisition candidates include both subscriber
lines and whole businesses. Our discussions and negotiations may not result in a
transaction. Further, if we transact a customer acquisition, through purchase,
merger or other form of transaction, the combined business may not operate
profitably. We intend to continue to seek additional customer acquisition
opportunities, which we believe represent commercially viable opportunities to
acquire large and select groups of customers for our business. However, our
ability to pursue a future customer acquisition for cash is dependent upon our
ability to raise additional capital.
 
 **Customer
Support and Operations**
 
 Our
customer support professionals work to streamline for our customers the
ordering, installation and maintenance processes associated with data and voice
communications and Internet access.
 
 *Implementation* . We
manage the implementation of our service for each customer. In areas where we
have installed our own local communications facilities, we lease the copper
telephone lines from the local telephone company. These lines run from our
equipment located in the telephone company's central office to our customer. We
test these lines to determine whether they meet our specifications and work with
the local telephone company to correct any problems identified by our testing.
In other areas, we utilize the local communications facilities of other
carriers, and work with these carriers to provide the service. In both cases,
field service technicians install the modem or router purchased or leased from
us and any necessary wiring at our customers' offices and test the modem or
router and network connection to confirm successful installation.
 
 *Maintenance* . Our
network operations centers provide network surveillance for all equipment in our
network. We are able to detect and correct many of our customers' maintenance
problems remotely, often before our customer is aware of the problem.
Customer-initiated maintenance
 
 5
 
 and
repair requests are managed and resolved primarily through our customer service
department. Our information management system, which generates reports for
tracking maintenance problems, allows us to communicate maintenance problems
from our network operations centers to our customer service center.
 
 *Operations
Support Systems* . Our
operations support systems are intended to improve many of our business
processes, including customer billing, service activation, inventory control,
customer care reports and maintenance reports. They have been designed to
provide us with accurate, up-to-date information in these areas. Additional
enhancements of these systems were made in 2004, including improved automation
and support for (i) the provisioning of services into our billing system, (ii)
the distribution of milestone communications to our customers in respect to the
installation process, and (iii) the consolidation of our provisioning and
trouble ticketing systems. We believe that our operations support systems
provide us with the flexibility to support additional customers and additional
services.
 
 **Our
Network**
 
 Our
network has been designed to deliver reliable, secure and scaleable high-speed,
high-performance Internet access data communication services, local voice
service as well as domestic and international long distance.
 
 *Network
Design.* The key
design principles of our network are:
 
 ·
    *Intelligent
      End-To-End Network Management*.
      Our network is designed to allow us to monitor network components and
      customer traffic from a central location. We can perform network
      diagnostics and equipment surveillance continuously. From our network
      operations centers, we have visibility across our entire network, allowing
      us to identify and address network problems quickly and to provide quality
      service and performance.
 
 ·
    *Next
      Generation VoIP Technology*.
      We have deployed the latest in “session initiation protocol”
      (“SIP”)-based, soft-switching technology to deliver voice services over
      our existing network backbone. In contrast to certain other VoIP services,
      our voice services are provided over a facilities-based, fully controlled,
      QoS-enabled network. This quality-of-service approach is designed to
      assure that adequate bandwidth is always available for the voice service
      and that the voice quality is equivalent to traditional voice
      services.
 
 ·
    *Consistent
      Performance With The Ability To Expand*.
      We have designed our network to leverage the economics of DSL technology,
      to grow with our business and to provide consistent performance. We also
      use asynchronous transfer mode equipment in our network, which enables
      high-speed, high volume transmission of
data.
 
 ·
    *Security.*Our network is designed to reduce the possibility of unauthorized access
      and to allow our customers to safely transmit and receive sensitive
      information and applications. The third-party modems and routers we sell
      or lease to our customers for use in support of subscribed services are
      designed to work in conjunction with installed security systems and
      network servers in an effort to provide safe connections to the Internet
      and a secure operating environment. All of our IP core sites are equipped
      with the Nortel Shasta BSN 5000. This network aggregation device allows us
      to provision and maintain efficiently a standardized network-based
      state-full firewall solution. Since this is a
  network-based
  6
 *product,
      customers receive the benefit of this advanced solution without the need
      to purchase expensive termination and firewall equipment.* *Network
Components* . The
primary components of our network are:
 
 ·
    *Network
      Backbone; Connection To The Internet.*Network
      traffic gathered at each of our central offices is directed to one of our
      regional hubs, if applicable in support of the customer’s service, and
      then to the Internet. In certain areas where we offer service from more
      than one central office, network traffic is directed from each central
      office in that area to a local hub which aggregates its traffic along with
      the traffic from the other central offices located in that area and
      directs the traffic to a regional hub. At our regional hubs, we also
      connect to other carriers’ networks via high-speed connections. Our hubs
      contain extra equipment and backup power to provide backup facilities in
      the event of an equipment failure and are actively monitored from our
      network operations centers. We lease space for our hubs in facilities
      designed to host network equipment. Our hubs are connected to one another
      via high-speed data communications lines. We have agreements with MCI,
      Level 3 Communications and other carriers to provide this service.
      Internet connectivity is provided by various transit arrangements.
 
 ·
    *Central
      Office Collocation.*Through our interconnection agreements, we secure space to locate our
      equipment in certain central offices of traditional local telephone
      companies and offer our services from these locations. These collocation
      spaces are designed to offer the same high reliability and availability
      standards as the telephone companies’ own central office spaces. We
      install the equipment necessary to provide high-speed DSL or T-1 service
      to our customers in these spaces. We have continuous access to these
      spaces to install and maintain our equipment located in these central
      offices. In markets where we have not deployed our own equipment, we
      utilize the local facilities installed in central offices by other
      carriers, to provide high-speed connections to our customers.
 
 ·
    *Soft
      Switch, PSTN Access and Gateway*.
      In support of our integrated voice and data offerings, we have deployed
      our own soft switching equipment, comparable in functionality to
      traditional Class 4 and Class 5 switches, to deliver business-class,
      line-side features to customers. We are directly interconnected to the
      public switched telephone network (“PSTN”), and do not rely on other
      service providers for access to the PSTN. Our integrated voice and data
      network uses soft switches, routers, and gateways from Cisco Systems. In
      addition, we utilize additional software applications to provide voice
      features and enhanced services.
 
 ·
    *Copper
      Telephone Lines*.
      In areas where we have deployed our own local communications facilities,
      we lease a copper telephone line running to each customer from our
      equipment in the local telephone company’s central office under terms
      specified in our interconnection agreements with these companies. In areas
      where we utilize the local communications facilities of other carriers,
      the carrier leases the telephone line from the local telephone company and
      makes that line available to us for our customer’s use.
 
 ·
    *Modems,
      Routers and On-Site Connections*.
      We purchase modems and routers and provide them to our customers, as
      appropriate, depending on our customers’ specific needs and contractual
      service agreements. We configure the modem or router and arrange for the
      installation of the modem or router along with the on-site wiring needed
      to connect the modem or router to the copper telephone line. In areas
      where we have deployed our own
  7
 local facilities, we either perform these services
ourselves or we contract with independent field service organizations to perform
these services on our behalf. In areas where we utilize the local facilities of
other carriers, these other carriers (or their contractors) provide these
installation services. We will either lease or sell customer premise equipment
(modem or router) to our customers. When we lease the customer premise
equipment, we charge the customer for the use of this equipment as part of our
monthly service fee. These modems and routers are capitalized and depreciated
over their estimated useful life of three years. Such leased equipment remains
our exclusive property. When we sell customer premise equipment (modem or
router) to the customer, we recognize the revenue from the sale and expense the
cost of this equipment at the time of sale.
 
 ·
    *Network
      Operations Centers*.
      Our network is managed from our network operations centers located in New
      Haven, Connecticut, and in Herndon, Virginia. We provide network
      management 24 hours per day, seven days per week. From the network
      operations centers, we are able to monitor the performance of individual
      subscriber lines and the equipment and circuits in our
      network.
 
 **Competition**
 
 We face
competition from many companies with significantly greater financial resources,
well-established brand names and large installed customer bases. Our industry
has and continues to experience consolidation and we expect that such activities
will continue and that the level of competition in our markets may intensify in
the future. We expect competition from:
 
 *Other
Broadband Carriers/Competitive Local Exchange Carriers.* A number
of competitive carriers, including Covad Communications and New Edge Networks,
offer DSL and T-1 services to residential and business customers. The
Telecommunications Act of 1996 (the “1996 Telecommunication Act”) specifically
grants competitive telecommunications companies, including other DSL providers,
the right to negotiate interconnection agreements with traditional telephone
companies, including interconnection agreements that may be identical in all
respects to, or more favorable than, our agreements.
 
 *Internet
Service Providers.* Several
national and regional Internet service providers, including Speakeasy, EarthLink
and MegaPath, offer high-speed Internet access, along with other products and
services. These companies generally provide Internet access to residential and
business customers through a host of methods, including DSL and T-1 services.
These companies leverage wholesale arrangements to resell broadband access they
purchase from facility-based broadband providers.
 
 *Next
Generation Voice and Data Providers.* A number
of competitive carriers, including Broadview, Conversant and CTC, offer
converged voice and data products to residential and business customers. These
companies provide services over a single data connection primarily using DSL and
T-1 access methods.
 
 *Traditional
Local Telephone Companies* . Many of
the traditional local telephone companies, including BellSouth, SBC
Communications, Qwest and Verizon, have deployed **** DSL and
T-1-based services, either directly or through affiliated companies. These
companies have established brand names, possess sufficient capital to deploy DSL
equipment rapidly, have their own copper telephone lines and can bundle digital
data services with their existing voice services to achieve a competitive
advantage in serving customers. In addition, these companies also offer
high-speed
 
 8
 
 data
communications services that use other technologies, including fiber loops that
may offer greater capacity to end users than our T-1 services. We depend on
these traditional local telephone companies to enter into agreements for
interconnection and to provide us access to individual elements of their
networks. Although the traditional local telephone companies are required to
negotiate in good faith in connection with these agreements, future
interconnection agreements may contain less favorable terms and result in a
competitive advantage to the traditional local telephone companies.
 
 *National
Long Distance Carriers* .
National long distance carriers, such as AT&T, Sprint, and MCI, have
deployed large-scale data networks, sell connectivity to businesses and
residential customers, and have high brand recognition. They also have
interconnection agreements with many of the traditional local telephone
companies, and many offer competitive DSL and T-1 services.
 
 *Other
Fiber-Based Carriers* .
Companies such as Williams Communications, XO Communications and Choice One have
extensive fiber networks in many metropolitan areas, primarily providing
high-speed data and voice circuits to small and large corporations. They also
have interconnection agreements with the traditional local telephone companies
under which they have acquired collocation space in many large markets, and some
offer competitive DSL and T-1 services.
 
 *Cable
Modem Service Providers* . Cable
modem service providers, such as Time-Warner Cable, Comcast and RCN, offer
high-speed Internet access over cable networks primarily to residential
consumers. Where deployed, these networks provide high-speed local access
services, in some cases at speeds higher than DSL service. They typically offer
these services at lower prices than our services, in part by sharing the
capacity available on their cable networks among multiple end
users.
 
 *Wireless
and Satellite Data Service Providers* . Several
companies, including Hughes Communications and Clearwire, are emerging as
wireless and satellite-based data service providers. These companies use a
variety of new and emerging technologies to provide high-speed data
services.
  *Broadband
over Powerline (“BPL”) Providers* .
Electric companies, including Pacific Gas and Electric and Cinergy Corp, along
with AT&T, have been developing BPL technology to deliver high speed
Internet and voice services over electric lines. Where deployed, such technology
could provide high speed data and voice services at potentially higher speeds
and potentially improved voice sound quality compared to DSL service.
 
 The most
significant competitive factors include: transmission speed, service
reliability, breadth of product offerings, price/performance, network security,
ease of access and use, content and service bundling, customer support,
geographic availability, brand recognition, operating experience, capital
availability and exclusive contracts with customers, including Internet service
providers and businesses with multiple offices. We believe our services compete
favorably within our service markets with respect to transmission speed,
price/performance, geographic availability, ease of access and use and customer
support. Many of our competitors enjoy competitive advantages over us based on
their brand recognition, breadth of product offerings, financial resources,
customer bases, operating experience and exclusive contracts with
customers.
 
 9
 **Interconnection
Agreements with Traditional Local Telephone Companies**
 
 Under the
1996 Telecommunications Act, the traditional local telephone companies (which
are often also referred to as “regional Bell operating companies” and “incumbent
local exchange carriers”) have a statutory duty to negotiate in good faith with
us for agreements for interconnection and unbundled access to certain individual
elements of their networks that the Federal Communications Commission (“FCC”) or
a state utility commission has required them to provide to competitors such as
us. This interconnection process is subject to review and approval by the state
regulatory commissions. We have signed interconnection agreements with
BellSouth, Cincinnati Bell, SBC Communications, Qwest, Sprint, and Verizon, or
their subsidiaries, which govern our relationships with the traditional local
telephone companies in 49 states and the District of Columbia. These agreements
govern, among other things:
 
 ·
    the
      price and other terms under which we locate our equipment in the telephone
      company's central offices;
 
 ·
    the
      prices we pay both to direct the installment of, and to lease, copper
      telephone lines;
 
 ·
    the
      special conditioning of these copper lines that the traditional telephone
      company provides to enable the transmission of DSL
  signals;
 
 ·
    the
      price we pay to access the telephone company's transmission facilities;
      and
 
 ·
    certain
      other terms and conditions of our relationship with the telephone
      company.
 
 We are
negotiating renewal agreements with these carriers as the current agreements
expire and are also negotiating amendments to existing agreements. Future
interconnection agreements may contain terms and conditions less favorable to us
than those in our current agreements and could increase our costs of operations,
particularly when there are changes to the federal or state legal requirements
applicable to such agreements. The FCC adopted new unbundling rules in August
2003 and again in February 2005 that have not yet been implemented in our
interconnection agreements. These new rules are less favorable in many
significant respects than those embodied in our existing agreements, and are
likely to have an impact on our business as early as March 2005, as discussed
below.
 
 During
our interconnection agreement negotiations, either the telephone company or we
may submit disputes to the state regulatory commissions for mediation. Also,
after the expiration of the statutory negotiation period set forth in the 1996
Telecommunications Act, we may submit outstanding disputes to the states for
binding arbitration, in which the state regulatory commissions may arbitrate a
new agreement or particular portions thereof.
 
 Under the
1996 Telecommunications Act, most states have completed regulatory proceedings
to determine the pricing of individual elements of networks and services. The
results of these proceedings determine the price we pay for, and whether it is
economically attractive for us to use, these elements and services. These prices
may be subject to change as the result of ongoing and future regulatory
proceedings.
 
 Our
interconnection agreements generally have terms of one or two years. Therefore,
we have renegotiated, and expect to continue to renegotiate, existing agreements
when they expire. Although we expect to renew our interconnection agreements and
believe the 1996 Telecommunications Act limits the ability of traditional local
telephone companies not to renew these agreements, we may not succeed in
extending or renegotiating our interconnection
 
 10
 
 agreements
on favorable terms. In addition, the traditional local telephone companies may
seek to materially increase the pricing of the network elements that we lease
from them and that are necessary for us to service our new and existing
customers. Further, disputes have arisen and will likely arise in the future as
a result of differences in interpretations of various rules which govern the
interconnection agreements. These disputes have, in the past, delayed the
deployment of our networks. Finally, the interconnection agreements are subject
to state regulatory commission, FCC and judicial oversight. These government
authorities may modify the terms of the interconnection agreements in ways that
are harmful to our business.
 
 **Government
Regulations**
 
 Significant
portions of the services that we offer are subject to regulation at the federal
and/or state levels. The FCC and state public utility commissions regulate
telecommunications common carriers, which are companies that offer
telecommunications services to the public or to all prospective users on
standardized rates and terms. Our DSL and other facilities-based data transport
services are common carrier services.
 
 While we
serve many of our customers using transport facilities that we own or lease, in
some areas where we do not have the necessary facilities, we provide our
Internet access and other services using the local facilities of another
carrier. The FCC has determined that Internet service providers, such as us, who
are using another carrier's transport facilities, are not acting as common
carriers. Therefore, in those markets where we have not deployed our own local
transport facilities, our services are not subject to common carrier regulation.
Our ability to provide such services, however, is affected by regulations
imposed upon the carriers whose local transport facilities we
utilize.
 
 The FCC
exercises jurisdiction over common carriers, and their facilities and services,
to the extent they are providing interstate or international communications. The
various state utility commissions retain jurisdiction over telecommunications
carriers, and their facilities and services, to the extent they are used to
provide communications that originate and terminate within the same state. The
degree of regulation varies from state to state.
 
 In recent
years, the regulation of the telecommunications industry has been in a state of
flux as the United States Congress and various state legislatures have passed
laws seeking to foster greater competition in telecommunications markets. The
FCC and state regulatory commissions have adopted many rules to implement those
laws and to encourage competition. These changes, which are still incomplete,
have created new opportunities and challenges for us and our competitors.
However, certain of these and other existing federal and state regulations
remain the subject of judicial proceedings, legislative hearings and
administrative proposals, any or all of which could change, in varying degrees,
the manner in which the telecommunications industry operates. Neither the
outcome of these various proceedings nor their impact upon the
telecommunications industry or us can be predicted at this time. Indeed, future
federal or state regulations and legislation may be less favorable to us than
current regulations and legislation and therefore have a material and adverse
impact on our business and financial prospects by undermining our ability to
provide services at competitive prices. In addition, we may expend significant
financial and managerial resources to participate in legislative, regulatory, or
judicial proceedings at the federal and/or state level, without achieving
favorable results.
 
 *Federal
Regulation and Legislation*
 
 We must
comply with the requirements of a common carrier under the Communications Act
 
 11
 
 of 1934,
as amended, to the extent we provide regulated interstate telecommunications
services. These requirements include an obligation that our charges, terms and
conditions for telecommunications services must be “just and reasonable” and
that we may not make any “unjust or unreasonable discrimination” in our charges
or terms and conditions. The FCC also has jurisdiction to act upon complaints
against common carriers for failure to comply with their statutory obligations.
We are not currently subject to price cap or rate of return regulation at the
federal level and are not currently required to obtain FCC authorization for the
installation, acquisition or operation of our facilities.
 
 The FCC
has established different levels of regulation for dominant and non-dominant
carriers. Of domestic carriers, only the traditional local telephone companies
are classified as dominant carriers and all other providers of domestic common
carrier service, including us, are classified as non-dominant carriers. As a
non-dominant carrier, we are subject to less FCC regulation than are dominant
carriers.
 
 Comprehensive
changes to the Communications Act of 1934 were made by the 1996
Telecommunications Act, enacted on February 8, 1996. It represents a significant
milestone in telecommunications policy by establishing competition in local
telephone service markets as a national policy. The 1996 Telecommunications Act
removes many state regulatory barriers to competition and forecloses state and
local governments from creating laws preempting or effectively preempting
competition in the local telephone service market.
 
 The 1996
Telecommunications Act places substantial interconnection requirements on the
traditional local telephone companies, including the following obligations that
are, to varying degrees and/or at varying times, relevant to our
business:
 
 ·
    Traditional
      local telephone companies are required to provide physical collocation,
      which allows companies such as us and other interconnectors to install and
      maintain their own equipment in the central offices of traditional local
      telephone companies. This requirement is intended to enable us and other
      competitive carriers to deploy our equipment on a relatively convenient
      and economical basis and is integral to our
business.
 
 ·
    Traditional
      local telephone companies are required to unbundle certain, but not all,
      components of their local service networks so that other providers of
      local service can compete for a wide range of local service customers.
      This requirement is designed to provide us flexibility to purchase only
      the network elements we require to deliver our services and is integral to
      our business.
 
 ·
    Traditional
      local telephone companies are required to establish “wholesale” rates for
      their retail telecommunications services to promote resale by competitive
      local exchange carriers and other
competitors.
 
 ·
    Traditional
      local telephone companies are required to provide non-discriminatory
      access to telephone poles, ducts, conduits and rights-of-way, and this
      requirement is integral to our business.
 
 The 1996
Telecommunications Act generally sets forth the rights and obligations of
competing carriers. The FCC issues regulations interpreting the 1996
Telecommunications Act and imposing more specific requirements upon which we and
our competitors rely. The outcome of various ongoing FCC rulemaking proceedings
or judicial appeals of such proceedings could
 
 12
 
 materially
affect our business and financial prospects by increasing the cost or decreasing
our flexibility in providing services.
 
 The FCC’s
rules to implement the unbundling requirements of the 1996 Telecommunications
Act have been vacated (at least in part) three times by federal courts (the 1996
rules in 1999, the 1999 rules in 2002, and the 2003 rules in 2004). The FCC’s
Triennial Review Remand Order (TRRO) adopted new rules, effective March 11,
2005, to replace those that were most recently vacated, but these rules will
also likely be appealed. We cannot predict the outcome of these proceedings. In
the meantime, however, more so than prior FCC orders, the TRRO will likely have
a significant and possibly immediate impact on portions of our business. The
TRRO limits the traditional local telephone companies’ unbundling obligations
for DS1 loops originating from, and DS1 and DS3 dedicated transport facilities
between, certain telephone company wire centers that are deemed to be
sufficiently competitive based upon the number of fiber collocators or the
number of business access lines within such central offices so as to no longer
necessitate impairment price protection discounts for competitive local exchange
carriers. While we have arguments that these changes should not immediately
become effective, especially with respect to SBC and Verizon, the traditional
local telephone companies have announced that they disagree with these arguments
and intend to implement the changes immediately. Under their planned terms for
implementation, the TRRO would have the following consequences for the
Company:
 
 ·
    As
      of March 11, 2005, the traditional local telephone companies have
      indicated that they will no longer provide unbundled high capacity DS1 and
      DS3 circuits on certain transport routes that meet the TRRO’s no
      impairment criteria at the discounted rates we now receive under the 1996
      Telecommunications Act. We use these circuits to connect our equipment
      located at the traditional local telephone company’s wire centers which
      enables us to efficiently aggregate traffic at our hubs. Specifically, we
      would no longer be able to obtain new discounted unbundled DS1 transport
      circuits between a pair of wire centers both of which contain at least
      four fiber-based collocators or at least 38,000 business access lines, or
      DS3 transport on routes which connect a pair of wire centers both of which
      contain at least three fiber-based collocators or at least 24,000 business
      access lines. While there will likely be disputes related to which routes
      meet these criteria, some of our routes, particularly for larger markets,
      will be affected. Also, to obtain new transport arrangements on these
      routes, we would need to purchase higher-priced “special access” services
      from the traditional local telephone companies or find competitive
      alternatives.
 
 ·
    As
      of March 11, 2005, the traditional local telephone companies have
      indicated that they will no longer provide new unbundled DS1 loops at the
      discounted rates we now receive under the 1996 Telecommunications Act to
      buildings served by wire centers that contain both 60,000 or more business
      lines and 4 or more fiber-based collocators. These thresholds will be met
      most often in urban centers of large metropolitan areas. We use DS1 loops
      to provide our T-1 services to end- users. To obtain new DS1 loops to
      these buildings, we would need to purchase higher-priced “special access”
      services from the traditional local telephone companies or find
      competitive alternatives.
 
 ·
    Certain
      restrictions were also established for higher-capacity DS3 loops, but we
      do not use any significant number of such loops.
 
 ·
    As
      for our existing loop and transport arrangements that fall within these
      criteria, we would be able to keep them until March 10, 2006, generally at
      a 15% price increase. By the end of that period, we would be required to
      transition these existing facilities to alternative
 
 13
 
 arrangements, such as competitive facilities or the
higher-priced “special access services” offered by the traditional telephone
companies.
  ·
    The
      traditional local telephone companies have identified the wire centers
      that they believe fall within the above criteria, and we are still
      evaluating their analysis. We are currently assessing the potential impact
      on our network costs resulting from the TRRO, as well as evaluating our
      network configuration alternatives to minimize increases to our network
      costs. We plan to attempt to negotiate agreements that will cover terms
      and conditions for existing facilities and future installations of such
      facilities in these offices. We cannot predict the outcome or success of
      these negotiations.
 
 In
addition to the impact of the TRRO, at least one portion of the FCC’s August
2003 Triennial Review Order (the “TRO”) that was not vacated by the D.C. Circuit
could materially affect our business in the long-term. The TRO exempted from
unbundling obligations certain loop transmission facilities that use fiber or
new technologies. This exemption arguably applies only for loops that serve
residential customers and “very small” businesses. The FCC has not defined “very
small” business, and if it does not do so in a rulemaking proceeding the
definition will probably be established in interconnection agreement
arbitrations at the state commissions. Subsequent to the TRO, the FCC has on two
occasions added additional loop architectures to this exemption, and it has also
held that the ILECs do not have to make these facilities available to
competitors at any price, discounted or otherwise. The traditional local
telephone companies are continuing to lobby the FCC to expand these exemptions
much deeper into the business market, and alternatively at times appear to
suggest that the exemption already applies to all markets.  Depending
on how these rules are implemented, the traditional local telephone companies
over time may decide to modify, characterize or replace their facilities in ways
that would qualify them for this exemption and thereby preclude us from
accessing these facilities pursuant to the terms of their interconnection
agreements. Without access to these facilities, we may not be able to provide
all or certain of our services in these areas. In addition, if we are unable to
obtain unbundled access to these fiber facilities, we may not be able to offer
services that are competitive with the new offerings of the traditional local
telephone companies.
 
 In
addition to the TRO and TRRO proceedings and related judicial activity, the FCC
in February 2002 initiated a new proceeding that will reevaluate the appropriate
degree of regulation of broadband services offered by the traditional local
telephone companies, including whether they should continue to be required to
offer network access to competitors such as us. This proceeding appeared to
stall after the Ninth Circuit vacated the FCC’s decision to classify cable modem
services as information services, rather than regulated telecommunications
services. The Supreme Court will soon review this decision, after which it is
possible that the FCC’s broadband proceeding could resume. Any changes to the
obligation of the traditional local telephone companies to provide us with
unbundled copper loops and/or interoffice transport could have significant
adverse consequences for our business. It is currently unclear when a rule or
decision regarding this specific matter will be issued.
 
 In a
separate rulemaking proceeding, the FCC is considering changes to the formula
used to determine the rates we must pay the traditional local telephone
companies for unbundled access to their networks. In addition, the TRO included
changes to the FCC’s pricing formula, and state commissions where we do business
may have to revise prices we pay for access to the local telephone company’s
network accordingly. Changes to this formula could have an adverse impact on our
business.
 
 The
traditional local telephone companies have also lobbied numerous state
legislatures to
 
 14
 
 adopt new
legislation that would limit, or prohibit, the ability of their state utility
commissions to expand upon certain federal requirements relating to the
obligations of the traditional local telephone companies to provide access to
competitors such as us. Because the existing FCC framework relies substantially
on state implementation, the effect of such state legislation, if passed, could
be to inhibit favorable implementation of the 1996 Telecommunications Act with
respect to broadband services, and could negatively affect our ability to offer
services in these states.
 
 Pursuant
to the 1996 Telecommunications Act, the FCC requires all telecommunications
carriers providing interstate telecommunications services to contribute to a
universal service fund used to provide subsidies to carriers that provide
service to individuals that live in rural, insular, and high-cost areas, and to
provide telecommunications-related services and facilities for schools,
libraries and certain rural health care providers. The telecommunications
portion of our service is currently subject to this requirement. For the fourth
quarter of 2004, the FCC has established a contribution rate of 8.9% and the
first quarter 2005 contribution rate is 10.7% of our interstate
telecommunications revenues. We pass the cost of our universal service fund
contributions along to our customers.
 
 The FCC's
implementation of universal service requirements remains subject to judicial and
additional FCC review. In several new proceedings, the FCC will consider the
degree to which companies providing services such as ours should be obligated to
contribute to this fund. We are unable to predict the outcome of these
proceedings and their impact on our business at this time.
 
 Certain
of our subsidiaries are authorized to provide interstate telecommunications
services pursuant to its access tariff filed with the FCC in April 1999.
Although not required for our existing DSL data service offering, on August 6,
1999 we obtained authority from the FCC to provide international
telecommunications services originating from the United States.
 
 *State
Regulation*
 
 In
October 1998, the FCC ruled that DSL and other advanced data services provided
as dedicated access services in connection with interstate services such as
Internet access are interstate services subject to the FCC's jurisdiction.
Accordingly, we could offer DSL services without state regulatory authority, so
long as we do not also provide local or intrastate telecommunications services
via our network. This decision allows us to provide our DSL services in a manner
that potentially reduces state regulatory obligations. However, the regulatory
parameters used to define DSL service are, directly and indirectly, subject to
many pending FCC and judicial proceedings and could change in the
future.
 
 Also,
some of our services that are not limited to interstate access potentially may
be classified as intrastate services subject to state regulation. All of the
states where we operate require some degree of state regulatory commission
approval to provide certain intrastate services and maintain ongoing regulatory
supervision. In most states, intrastate tariffs are also required for various
intrastate services, although our services are not subject to price or rate of
return regulation. Actions by state public utility commissions could cause us to
incur substantial legal and administrative expenses and adversely affect our
business.
 
 We have
obtained authorizations to provide local exchange and long-distance
telecommunications services in all 50 states, the District of Columbia and
Puerto Rico.
 
 15
 *Local
Government Regulation*
 
 In
certain instances, we may be required to obtain various permits and
authorizations from municipalities, such as for use of rights-of-way, in which
we operate our own local distribution facilities. Whether various actions of
local governments over the activities of telecommunications carriers such as
ours, including requiring payment of franchise fees or other surcharges, pose
barriers to entry for competitive local exchange carriers which violate the 1996
Telecommunications Act or may be preempted by the FCC is the subject of
litigation. While we are not a party to this litigation, we may be affected by
the outcome. If municipal governments impose conditions on granting permits or
other authorizations or if they fail to act in granting such permits or other
authorizations, the cost of providing our services may increase or it may
negatively impact our ability to expand our network on a timely basis and
adversely affect our business.
 
 **Intellectual
Property**
 
 We regard
our products, services and technology as proprietary and attempt to protect them
with patents, copyrights, trademarks, service marks, trade secret laws,
restrictions on disclosure and other methods, as applicable. For example, we own
a federal supplemental registration and claim rights in the name, “DSL.net.”
There can be no assurance these methods will be sufficient to protect our
technology and intellectual property. We also generally enter into
confidentiality agreements with our employees, consultants and business
partners, and generally control access to and distribution of our documentation
and other proprietary information. Despite these precautions, it may be possible
for a third party to copy or otherwise obtain and use our proprietary
information without authorization, or to develop similar information
independently. Effective patent, copyright, trademark and trade secret
protection may be unavailable or limited in certain foreign countries, and the
global nature of the Internet makes it virtually impossible to control the
ultimate destination of our technology or proprietary information. There can be
no assurance that the steps we have taken will prevent misappropriation or
infringement of our technology or proprietary information. In addition,
litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others. Such litigation could result in substantial
costs and diversion of resources and could have a material adverse effect on our
business, operating results and financial condition. In addition, some of our
information, including our competitive carrier status in individual states and
our interconnection agreements, is a matter of public record and can be readily
obtained by our competitors and potential competitors, possibly to our
detriment.
 
 **Employees**
 
 As of
March 1, 2005, we had 140 employees. We believe that our future success will
depend in part on our continued ability to attract, hire and retain qualified
personnel. Competition for qualified personnel can be intense, and we may be
unable to identify, attract and retain such personnel in the future. In
addition, reductions in our workforce that we undertook in the last several
years may make it difficult to attract, hire and retain qualified personnel.
None of our employees is represented by a labor union or is the subject of a
collective bargaining agreement. We have never experienced a work stoppage and
believe that our employee relations are good.
 
 **Item
2. Properties**
 
 Our
headquarters consists of approximately 31,500 square feet in an office building
in New Haven, Connecticut. We also lease other offices in Minneapolis,
Minnesota; Wilmington, North
 
 16
 
 Carolina
and Herndon, Virginia. On December 31, 2004, our lease of office space in Santa
Cruz, California expired and was not renewed. We vacated the Santa Cruz office
in December 2001, and sublet said facility through July 2003. In addition, we
lease warehouse space to store network equipment and other inventory in a number
of other locations. With respect to our arrangements to use space in traditional
telephone companies’ central offices, please see Item 1 - Business,
“Interconnection Agreements with Traditional Local Telephone Companies.”
 
 **Item
3. Legal Proceedings**
 
 A lawsuit
for wrongful termination of employment was filed against us in the Superior
Court in New Haven, Connecticut on July 29, 1999 by a former officer who was
employed by us for less than two months. Plaintiff's claims are based chiefly on
his allegation that we terminated his employment because he allegedly voiced
concerns to senior management about the feasibility of certain aspects of our
business strategy. The plaintiff is principally seeking compensatory damages for
wages and unvested stock options. We deny the plaintiff’s allegations and
believe that his claims are without merit. We have been defending the case
vigorously and plan to continue to do so.
 
 A lawsuit
was filed against us in Connecticut State Court in the Judicial District of New
Haven on January 15, 2004 by an individual who claims that he was offered a
sales manager position at the Company in December 2003 but was wrongly deprived
of that position at or immediately prior to his initial employment date. The
plaintiff’s complaint includes claims for breach of contract, negligent
misrepresentation and intentional infliction of emotional distress. We deny the
plaintiff’s allegations and believe that his claims are without merit. We have
been defending the case vigorously and plan to continue to do so.
 
 We are
also a party to certain consolidated legal proceedings along with other
competitive local exchange carriers related to regulatory approvals and are
subject to state commission, FCC and court decisions related to the
interpretation and implementation of the 1996 Telecommunications Act and the
interpretation of competitive carrier interconnection agreements in general and
the Company’s interconnection agreements in particular. In some cases, we may be
deemed to be bound by the results of ongoing proceedings of these bodies. We
therefore may participate in proceedings before these regulatory agencies or
judicial bodies that affect, and allow us to advance, our business
plans.
 
 From time
to time, we may be involved in other litigation concerning claims arising in the
ordinary course of our business, including claims brought by current or former
employees and claims related to acquisitions. We do not currently believe that
any of these legal claims or proceedings will result in a material adverse
effect on our business, financial position, results of operations or cash
flows.
 
 **Item
4. Submission of Matters to a Vote of Security Holders**
 
 Our 2004
Annual Meeting of Stockholders was held on February 9, 2005. Holders of an
aggregate of 233,619,817 shares of our common stock and 14,000 shares of our
Series Z preferred stock at the close of business on December 20, 2004 were
entitled to vote at the meeting. The holders of our common stock and Series Z
preferred stock voted together as a single class with respect to the subject
proposals. At such meeting, our stockholders voted in favor of all of the
proposals submitted in our proxy statement, dated December 22, 2004 for approval
at the meeting, as follows:
 
 17
 ·  Proposal
1 . To
elect one member of the board of directors to serve for a three-year term as a
Class I director, this director to serve for his term or until his successor has
been duly elected and qualified, or until his earlier death, resignation or
removal.
 
 Director
      Name
    Total
      Votes for the Nominee
    Total
      Votes Withheld from the NomineeRobert
      B. Hartnett, Jr.
    218,904,767
    2,142,102
 
 No other
persons were nominated, or received votes, for election as directors at the 2004
Annual Meeting of Stockholders. Messrs. Duncan Davidson, Robert G. Gilbertson,
Paul J. Keeler, William J. Marshall, James D Marver and Kirby G. Pickle each
continued their respective terms of office after the 2004 Annual Meeting of
Stockholders.
 
 ·  Proposal
2 . To
consider and act upon a proposal to approve warrants to purchase up to an
aggregate of 19,143,000 shares of our common stock issued to holders of our
senior secured promissory notes, and the shares of our common stock to be issued
upon exercise of such common stock purchase warrants.
 
 Total
      Votes for
      Proposal
      2
    Total
      Votes Against
      Proposal
      2
    Abstentions
      from
      Proposal
      2
    Broker
      Non-Votes108,810,337
    3,625,468
    223,721
    108,387,343
 
 ·  Proposal
3 . To
consider and act upon a proposal to approve an amendment to our Amended and
Restated 2001 Stock Option and Incentive Plan to increase the number of shares
of common stock reserved for issuance thereunder by 20,000,000 shares to an
aggregate of 65,000,000 shares, and to increase the maximum number of options or
stock appreciation rights to purchase shares of common stock that may be issued
to an employee in any calendar year from 5,000,000 shares to 8,000,000 shares
and to ratify such plan as amended.
 
 Total
      Votes for
      Proposal
      3
    Total
      Votes Against
      Proposal
      3
    Abstentions
      from
      Proposal
      3
    Broker
      Non-Votes108,822,189
    7,615,745
    221,591
    108,387,344
 
  18
 ****
 **PART
II**
 
 **Item** **** **5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities**
 
 *Market
Information*
 
 As of
March 1, 2005, there were approximately 604 holders of record of our common
stock. On August 4, 2004, the listing and trading of our common stock moved from
the Nasdaq SmallCap Market to the American Stock Exchange. On such date, our
common stock trading symbol changed from “DSLNC” to “BIZ.”
 
 The range
of high and low bid prices per share of DSL.net's common stock as reported on
the Nasdaq SmallCap Market and the American Stock Exchange for the two most
recent fiscal years are shown below. The closing price of DSL.net common stock
on March 1, 2005 was $0.16 per share.
 
 **Quarter
      Ended**
    ******High**
    ******Low**March
      31, 2003
    $0.67
    $0.36June
      30, 2003
    0.76
    0.35September
      30, 2003
    1.07
    0.51December
      31, 2003
    0.77
    0.51March
      31, 2004
    0.83
    0.44June
      30, 2004
    0.52
    0.27September
      30, 2004
    0.43
    0.13December
      31, 2004
    0.28
    0.15
 
 *Dividend
Policy*
 
 We have
never declared or paid any cash dividends on our common stock and currently
intend to retain any future earnings for the future operation and expansion of
our business. We do not anticipate that any cash dividends will be declared or
paid on our common stock in the foreseeable future.
 
 Prior to
and in preference to any declaration or payment of any cash dividends on our
common stock, the holders of our Series X and Series Y preferred stock were
entitled to receive cumulative dividends of $120.00 per share per annum when and
as declared by the DSL.net Board of Directors. All such dividends on the Series
X and Series Y preferred stock accrued monthly were payable in cash, except in
the case of the conversion of the Series X or Series Y preferred stock, as the
case may be, into common stock, in which case dividends may be paid, at the sole
option of DSL.net, in shares of DSL.net common stock. During the second half of
2003 and the first and third quarters of 2004, all of the issued and outstanding
shares of our Series Y preferred stock and our Series X preferred stock were
converted into shares of our common stock and all accrued dividends on these
converted shares were paid in shares of our common stock.
 
 Our
Series Z preferred stock provides that we shall not declare, pay or set aside
any cash dividends on shares of our common stock unless we simultaneously
declare, pay or set aside, respectively, a cash dividend on each outstanding
share of our Series Z preferred stock in an amount equal to the dividend so
payable with respect to one share of our common stock.
 
 19
 Under the
terms of our October 2004 financing transaction with Laurus Master Fund, Ltd.
(“Laurus”), we are prohibited from declaring, paying or making any dividend
distribution on any class of stock other than any previously issued and
outstanding preferred stock without the prior consent of Laurus.
 
 *Equity
Compensation Plan Information*
 
 The
following table provides information as of December 31, 2004, with respect to
the shares of the Company’s common stock that may be issued under the Company’s
existing equity compensation plans:
  Plan
      Category
    Number
      of
      Securities
      to be
      Issued
      upon
      Exercise
      of
      Outstanding
      Options
    Weighted
      Average
      Exercise
      Price of
      Outstanding
      Options
    Number
      of Securities
      Remaining
      Available for
      Future
      Issuance Under Equity
      Compensation
      Plans
      (Excluding
      Securities
      Reflected
      in the First Column)Equity
      Compensation Plans Approved by Shareholders
    30,651,934
    $0.77
    19,579,375Equity
      Compensation Plans Not Approved by Shareholders (1)
    10,000,000
    $0.48
    —Total
    40,651,934
    $0.70
    19,579,375
 (1) In
April 2004, as authorized by the Company’s Board of Directors, the Company
entered into an employment agreement and related stock option agreement with
Kirby G. Pickle, the Company’s new chief executive officer. Under the stock
option agreement for Mr. Pickle, an option to purchase a total of 10,000,000
shares of the Company’s common stock, represented in the above table, was
granted to Mr. Pickle as an inducement to his employment with the
Company.
  
 
   20
 **(Dollars
in Thousands, Except Per Shaer Amounts)**
  **Item
6. Selected Financial Data**
 
 The
following historical data for the years ended December 31, 2004, 2003, 2002,
2001 and 2000, except for “Other Data,” has been derived from our financial
statements audited by PricewaterhouseCoopers LLP, independent registered public
accounting firm. Our balance sheets at December 31, 2004 and 2003 and the
related statements of operations, changes in stockholders' equity and cash flows
for the years ended December 31, 2004, 2003 and 2002 and notes thereto appear
elsewhere in this Annual Report on Form 10-K.
 
 Reference
is also made to “Item 7 - Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and the more complete financial information
included elsewhere in this Annual Report on Form 10-K.
 
 **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Statement
      of Operations Data:**Revenue
    
    $
    68,449
    
    $
    71,333
    
    $
    45,530
    
    $
    41,969
    
    $
    17,789Operating
      expenses:Network
      (A)
    
    
    45,727
    
    
    51,452
    
    
    33,470
    
    
    44,451
    
    
    30,599Operations
      (A)
    
    
    9,864
    
    
    11,873
    
    
    7,
      949
    
    
    45,752
    
    
    32,112General
      and administrative (A)
    
    
    12,601
    
    
    12,200
    
    
    11,403
    
    
    25,229
    
    
    17,974Sales
      and marketing (A)
    
    
    5,126
    
    
    8,642
    
    
    6,969
    
    
    13,188
    
    
    25,263Stock
      compensation
    
    
    -
    
    
    438
    
    
    1,228
    
    
    1,202
    
    
    3,192Depreciation
      and amortization
    
    
    13,132
    
    
    16,359
    
    
    20,332
    
    
    28,043
    
    
    21,133Total
      operating expenses
    
    
    86,450
    
    
    100,964
    
    
    81,351
    
    
    157,865
    
    
    130,273Operating
      loss
    
    
    (18,001
    )
    
    (29,631
    )
    
    (35,821
    )
    
    (115,896
    )
    
    (112,484
    )Interest
      income (expense), net
    
    
    (5,363
    )
    
    (2,936
    )
    
    (458
    )
    
    455
    
    
    6,730Other
      (expense) income, net
    
    
    135
    
    
    (2,430
    )
    
    185
    
    
    (13
    )
    
    (9
    )Net
      loss
    
    $
    (23,229
    )
    $
    (34,997
    )
    $
    (36,094
    )
    $
    (115,454
    )
    $
    (105,763
    )Dividends
      on preferred stock
    
    
    (950
    )
    
    (3,698
    )
    
    (3,573
    )
    
    (122
    )
    
    -Accretion
      of preferred stock
    
    
    (8,852
    )
    
    (14,327
    )
    
    (10,078
    )
    
    (348
    )
    
    -Fair
      value of Series Z Preferred Stock
    
    
    (2,630
    )
    
    -
    
    
    -
    
    
    -
    
    
    -Net
      loss applicable to common stockholders
    
    $
    (35,661
    )
    $
    (53,022
    )
    $
    (49,745
    )
    $
    (115,924
    )
    $
    (105,763
    )**Net
      Loss Per Common Share Data:**Net
      Loss per common share, basic and diluted
    
    $
    (0.20
    )
    $
    (0.72
    )
    $
    (0.77
    )
    $
    (1.81
    )
    $
    (1.75
    )Shares
      used in computing net loss per share
    
    
    181,831
    
    
    74,126
    
    
    64,858
    
    
    63,939
    
    
    60,593
 
 **December
      31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Balance
      Sheet Data:**Cash,
      cash equivalents, restricted cashand marketable securities
    
    $
    9,511
    
    $
    13,784
    
    $
    11,319
    
    $
    19,631
    
    $
    76,435Total
      assets
    
    
    40,862
    
    
    59,061
    
    
    53,496
    
    
    81,024
    
    
    194,806Long-term
      obligations (including currentportion)
    
    
    14,830
    
    
    5,529
    
    
    4,565
    
    
    7,463
    
    
    14,114Mandatorily
      Redeemable ConvertiblePreferred Stock
    
    
    -
    
    
    17,019
    
    
    14,122
    
    
    470
    
    
    -Stockholders’
      equity
    
    $
    12,106
    
    $
    18,300
    
    $
    20,751
    
    $
    50,725
    
    $
    149,417
  21
 **(Dollars
in Thousands, Except Per Shaer Amounts)**
 **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Cash
      Flow Data:**Used
      in operating activities
    
    $
    (7,541
    )
    $
    (13,715
    )
    $
    (17,706
    )
    $
    (62,989
    )
    $
    (74,986
    )Used
      in investing activities
    
    
    (3,078
    )
    
    (11,135
    )
    
    (2,368
    )
    
    (2,921
    )
    
    (60,225
    )Provided
      by financing activities
    
    $
    3,919
    
    $
    27,311
    
    $
    12,107
    
    $
    12,871
    
    $
    141,960**Other
      Data:**Reconciliation
      of net loss to Adjusted EBITDA:Net loss
    
    $
    (23,229
    )
    $
    (34,997
    )
    $
    (36,094
    )
    $
    (115,454
    )
    $
    (105,763
    )Add: Interest and other (income) expense,
      net
    
    
    5,228
    
    
    5,366
    
    
    273
    
    
    (442
    )
    
    (6,721
    )Depreciation and amortization
    
    
    13,132
    
    
    16,359
    
    
    20,332
    
    
    28,043
    
    
    21,133Stock compensation
    
    
    -
    
    
    438
    
    
    1,228
    
    
    1,202
    
    
    3,192Adjusted EBITDA (B)
    
    $
    (4,869
    )
    $
    (12,834
    )
    $
    (14,261
    )
    $
    (86,651
    )
    $
    (88,159
    )
 
 Reconciliation
      of Adjusted EBITDA to netcash used in operating activities:Adjusted
      EBITDA
    
    $
    (4,869
    )
    $
    (12,834
    )
    $
    (14,261
    )
    $
    (86,651
    )
    $
    (88,159
    )Interest and other (expense) income, net
    
    
    (160
    )
    
    (450
    )
    
    (444
    )
    
    611
    
    
    6,764Financing
      costs (deferrals) expenses
    
    
    -
    
    
    (183
    )
    
    -
    
    
    49
    
    
    21Bad
      debt expense
    
    
    1,119
    
    
    2,117
    
    
    2,536
    
    
    2,996
    
    
    700Sales
      discounts
    
    
    2
    
    
    394
    
    
    1,181
    
    
    1,498
    
    
    590Restructuring
      / impairment charges
    
    
    -
    
    
    -
    
    
    -
    
    
    34,083
    
    
    1,417Write
      off / sales of equipment
    
    
    120
    
    
    46
    
    
    555
    
    
    229
    
    
    (7
    )Net
      changes in assets and liabilities
    
    
    (3,754
    )
    
    (2,805
    )
    
    (7,273
    )
    
    (15,804
    )
    
    3,687Net
      cash used in operating activities
    
    $
    (7,541
    )
    $
    (13,715
    )
    $
    (17,706
    )
    $
    (62,989
    )
    $
    (74,986
    )Capital
      expenditures
    
    $
    651
    
    $
    2,405
    
    $
    1,647
    
    $
    5,345
    
    $
    55,943
  (A)
Excluding stock compensation, depreciation and amortization.
 
 (B)
Adjusted EBITDA, shown above under “Other Data,” consists of net loss excluding
net interest and other income/expense, taxes, depreciation, amortization of
intangibles and non-cash stock compensation expense. We believe that Adjusted
EBITDA provides useful information because it is an additional measure of
financial performance commonly used for comparing companies in the
telecommunications industry in terms of core operating performance, leverage,
and ability to incur and service debt. Since the network configurations, assets
and related capital expenditures and capital structures vary greatly within the
telecommunications industry, a financial measure that excludes interest,
depreciation and amortization is useful in comparing the core operating
performance that supports and measures the return on a company’s network assets
and capital structure and enhances comparability between periods. In addition,
Adjusted EBITDA is used by us when reporting operating performance to our senior
management and board of directors.
 
 22
 **(Dollars
in Thousands, Except Per Share Amounts)**
 Adjusted
EBITDA is not a measure determined under generally accepted accounting
principles. Adjusted EBITDA should not be considered in isolation from, and you
should not construe it as a substitute for:
 
 ·
    operating
      loss as an indicator of our operating performance;
 
 ·
    cash
      flows from operating activities as a measure of liquidity;
 
 ·
    other
      consolidated statement of operations or cash flows data presented in
      accordance with generally accepted accounting principles; or
 
 **·**
    as
      a measure of profitability or liquidity.
 
 The above
financial data includes the operating results of acquisitions from their
acquisition date, which consequently will affect the comparability of such
financial data from year to year.
 
 **Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations**
 
 THE
FOLLOWING DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH “ITEM 6 - SELECTED CONSOLIDATED
FINANCIAL DATA” AND “ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” THAT
APPEAR ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K. THIS DISCUSSION AND
ANALYSIS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE
INCLUDE, BUT ARE NOT LIMITED TO, THOSE SET FORTH UNDER “RISK FACTORS” AND
ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K. EXISTING AND PROSPECTIVE
INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING
STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. WE UNDERTAKE NO OBLIGATION,
AND DISCLAIM ANY OBLIGATION, TO UPDATE OR REVISE THE INFORMATION CONTAINED IN
THIS ANNUAL REPORT ON FORM 10-K, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR CIRCUMSTANCES OR OTHERWISE.
 
 **Overview**
 
 *Our
Business*
 
 We
provide high-speed data communications, Internet access, and related services to
small and medium sized businesses and branch offices of larger businesses and
their remote office users, throughout the United States, primarily utilizing
digital subscriber line (“DSL”) and T-1 technology. In September 2003, we
expanded our service offerings to business customers in the Washington, D.C.
metropolitan region to include integrated voice and data services using voice
over Internet protocol technology (“VoIP”). In February 2004, we introduced our
VoIP and data bundles in the New York City metropolitan area. Our networks
enable data transport over existing copper telephone lines at speeds of up to
1.5 megabits per second. Our product offerings also include Web hosting, domain
name system management, enhanced e-mail, on-line data
 
 23
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 backup
and recovery services, firewalls, nationwide dial-up services, private frame
relay services and virtual private networks.
 
 We sell
directly to businesses through our own sales force utilizing a variety of sales
channels, including referral channels such as local information technology
professionals, application service providers and marketing partners. We also
sell directly to third party resellers whose end-users are typically
business-class customers. We deploy our own local communications equipment
primarily in select first and second tier cities. In certain markets where we
have not deployed our own equipment, we
utilize the local facilities of other carriers to provide our
service.
 
 *Our
Challenges and Opportunities*
 
 Our
business is in transition from an earlier strategy focused primarily on growth
to a strategy focused primarily on financial performance. In 2003, in an effort
to expand our network footprint, customer base and product offerings, we
completed the acquisitions of substantially all of the assets and operations of
Network Access Solutions Corporation (“NAS”), and TalkingNets, Inc. and its
affiliate (collectively, “TalkingNets”). The NAS acquisition significantly
increased our facilities-based network in central offices from Virginia to
Massachusetts. The TalkingNets acquisition provided us the ability to offer, in
the business-intensive, Mid-Atlantic and Northeast regions, carrier-class
integrated voice and data services utilizing VoIP technology. We completed the
integration of both of these acquisitions into our operations during 2004.
 
 During 2004
we focused on reducing operating losses and increasing gross margins. On March
25 and September 21, 2004, we implemented reductions-in-force of 62 and 32
employees, respectively, as part of our cost reduction measures. In connection
with this latter reduction-in-force, during the third quarter of 2004, we began
implementing a new sales and marketing strategy by reorganizing our inside sales
force, reducing funding for certain sales and marketing activities, and
re-directing our focus to sales of multi-line accounts and sales of higher
margin services, including our integrated voice and data services and T-1 data
services. As a result of these and other cost-savings measures, we achieved
positive operating cash flow results in the fourth quarter of 2004 for the first
time in our history. However, our cost reduction measures, and
particularly, our sales force reductions, have and continue to place downward
pressure on our ability to sustain or grow our revenue base. Additionally, like
many of our competitors, we
experience a degree of customer disconnects or “churn” due to competitive
pricing pressures and other factors, which churn is in excess of the rate
that we are currently acquiring new customers. In response to this, we have
implemented a program pursuant to which our customer retention representatives
proactively endeavor to renew existing customers to service agreements prior to
or at the time of initial term expiration. While we are taking measures to
control customer churn, our
ability to generate and sustain positive operating cash flow in future periods
will be dependent, in large part, on our ability to obtain additional funding to
support our working capital needs and increase our sales and customer
acquisition activities, while continuing to further control our operating costs.
There can be no assurance that we will be able to obtain additional funding,
increase our sales or further control our operating costs in future periods (see
“Liquidity and Capital Resources”).
 
 While the
foregoing operational and market factors pose significant challenges for our
business, we believe our current operating results, facilities-based voice
and data network and established customer base favorably position us to leverage
opportunities in our industry, provided we obtain the additional financing
required to support our operations and growth strategy.
 
 24
 **(Dollars
in Thousands, Except Per Share Amounts)**
 *Operating Cash
Flow.* Our
operating cash flow for the quarter ended December 31, 2004, was $1,337, a 120%
improvement over operating cash flow of negative $6,740 for the same period
2003. Our operating cash flow for the year ended December 31, 2004 was negative
$7,541, a 45% improvement over operating cash flow of negative $13,715 for the
year ended December 31, 2003. **
 
 *Greater
Utilization of our Network to Drive Higher Margins.* We have
an extensive facilities-based network with the major portion of our
footprint in the densest business communications corridor in the country. We
continue to prioritize the sale of services provisioned directly over our
network and the sale of T-1 and integrated voice and data services, all of which
yield higher margins.
 
 *New
Market Opportunities.* We
believe that there continues to be significant revenue growth opportunities for
our data/Internet access services and our VoIP suite of integrated voice and
data services. However, we will need additional funding to grow our sales
channels, further expand our voice network and fund customer acquisitions in
order to permit us to capitalize on these growth opportunities.
 
 In
addition to pursuing additional financing to support our operations and fund
cost-effective growth for our business, we continue to explore various strategic
opportunities that would accelerate our growth and/or improve our operating
performance (including potential customer acquisitions), and merger and
acquisition opportunities. In many cases, we engage in discussions and
negotiations regarding such potential transactions. Our discussions and
negotiations may not result in a transaction. Further, if we effect any such
transaction, it may not result in a positive impact upon our operating results
or financial performance.
 
 
 **Critical
Accounting Policies and Estimates**
 
 Management’s
discussion and analysis of financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles. The preparation of
financial statements in accordance with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, including the recoverability of tangible and
intangible assets, disclosure of contingent assets and liabilities as of the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting periods. The markets for our services are
characterized by intense competition, rapid technological development,
regulatory and legislative changes, and frequent new product introductions, all
of which could impact the future value of our assets and liabilities.
 
 We
evaluate our estimates on an on-going basis. The most significant estimates
relate to revenue recognition, goodwill, intangible assets and other long-lived
assets, the allowance for doubtful accounts, the fair value of financial
instruments and derivatives, contingencies and litigation. We base our estimates
on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ materially
from those estimates.
 
 The
following is a brief discussion of the critical accounting policies and methods
and the judgments and estimates used by us in their application:
 
 25
 **(Dollars
in Thousands, Except Per Share Amounts)**
 *Revenue
Recognition*
 
 We
recognize revenue in accordance with Securities and Exchange Commission (“SEC”)
Staff Accounting Bulletin (“SAB”) No. 104, “ *Revenue
Recognition,”* which
outlines the four basic criteria that must be met before revenue can be
recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has
occurred or services have been rendered; (3) the fee is fixed or determinable;
and (4) collectibility is reasonably assured. Determination of criteria (3) and
(4) are based on management’s judgments regarding the fixed nature of the fee
charged for services rendered and products delivered and the collectibility of
those fees. Subjectivity and uncertainties are inherent in making such judgments
that could result in an overstatement or understatement of
revenues.
 
 Revenue
is recognized pursuant to the terms of each contract on a monthly service fee
basis, which varies based on the speed of the customer’s Internet connection and
the services ordered by the customer. The monthly fee includes phone line
charges, Internet access charges, the cost of any leased equipment installed at
the customer's site and fees for the other services we provide, as applicable.
Revenue that is billed in advance of the services provided is deferred until the
services are rendered. Revenue related to installation charges is also deferred
and amortized to revenue over 18 months which is the expected customer
relationship period. Related direct costs incurred (up to the amount of deferred
revenue) are also deferred and amortized to expense over 18 months. Any excess
of direct costs over installation charges are charged to expense as incurred. In
certain instances, we negotiate credits and allowances for service related
matters. We establish a reserve against revenue for credits of this nature based
on historical experience. Also, from time to time we offer sales incentives to
our customers in the form of rebates toward select installation services and
customer premise equipment. We establish a reserve based on historical
experience for such estimated rebate costs, with a corresponding reduction to
revenue and deferred revenue, as applicable. Establishing such reserves requires
subjective judgments and estimates primarily pertaining to the number and
amounts of such credits, allowances and rebates. Actual results may differ from
our estimates that could result in an overstatement or understatement of
revenues.
 
 We seek
to price our services competitively. The market for high-speed data
communications services and Internet access is rapidly evolving and intensely
competitive. While many of our competitors and potential competitors enjoy
competitive advantages over us, we are pursuing a significant market that, we
believe, is currently under-served. Although pricing is an important part of our
strategy, we believe that direct relationships with our customers and
consistent, high quality service and customer support are key to generating
customer loyalty. During the past several years, market prices for many
telecommunications services and equipment have been declining, a trend that
might continue.
 
 *Goodwill
and Other Long-Lived Assets*
 
 We
account for our long-lived assets (excluding goodwill) in accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 144, “ *Accounting
for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed
of,”* which
requires that long-lived assets and certain intangible assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable such as technological changes or
significant increased competition. If undiscounted expected future cash flows
are less than the carrying value of the assets, an impairment loss is to be
recognized based on the fair value of the assets, calculated using a discounted
cash flow model. There were no impairment
 
 26
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 charges
taken during the years ended 2004, 2003 and 2002. There is inherent subjectivity
and judgments involved in cash flow analyses such as estimating revenue and cost
growth rates, residual or terminal values and discount rates, which can have a
significant impact on the amount of any impairment.
 
 Effective
January 1, 2002, we adopted SFAS No. 142, “ *Goodwill
and Other Intangible Assets.* ” This
statement requires that the amortization of goodwill be discontinued and instead
an impairment approach be applied. If impairment exists, under SFAS No. 142, the
resulting charge is determined by the recalculation of goodwill through a
hypothetical purchase price allocation of the fair value and reducing the
current carrying value to the extent it exceeds the recalculated goodwill. The
impairment tests were performed initially upon adopting SFAS 142 in 2002 and
annually thereafter and were based upon the fair value of reporting units rather
than an evaluation of the undiscounted cash flows. We estimated the fair value
of the goodwill based on discounted forecasts of future cash flows. There is
inherent subjectivity and judgments involved in cash flow analyses such as
estimating revenue and cost growth rates, residual or terminal values and
discount rates, which can have a significant impact on the amount of any
impairment. We did not record any goodwill impairment adjustments resulting from
our impairment reviews during 2004, 2003 and 2002.
 
 Other
long-lived assets, such as identifiable intangible assets and fixed assets, are
amortized or depreciated over their estimated useful lives. These assets are
reviewed for impairment whenever events or circumstances provide evidence that
suggests that the carrying amount of the assets may not be recoverable, with
impairment being based upon an evaluation of the identifiable undiscounted cash
flows. If impaired, the resulting charge reflects the excess of the asset’s
carrying cost over its fair value. As described above, there is inherent
subjectivity involved in estimating future cash flows, which can have a
significant impact on the amount of any impairment. Also, if market conditions
become less favorable, future cash flows (the key variable in assessing the
impairment of these assets) may decrease and as a result we may be required to
recognize impairment charges in the future.
 
 *Allowance
for Doubtful Accounts*
 
 We
maintain an allowance for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. Such allowances
require management’s estimates and judgments and are computed based on
historical experience using varying percentages of aged receivables. Actual
experience may differ from our estimates and require larger or smaller charges
to income. We primarily sell our services directly to end users mainly
consisting of small to medium sized businesses, but we also sell our services to
certain resellers, such as to Internet service providers (“ISPs”). We believe
that we do not have significant exposure or concentrations of credit risk with
respect to any given customer. However, if the country or any region we service,
experiences an economic downturn, the financial condition of our customers could
be adversely affected, which could result in their inability to make payments to
us. This could require additional provisions for allowances. In addition, a
negative impact on revenue related to those customers may occur.
 
 With the
acquisition of the NAS assets on January 10, 2003, we acquired a number of end
users, some of whom we service indirectly through various ISPs. We sell our
services to such ISPs who then resell such services to the end users. We have
some increased exposure and concentration of credit risk pertaining to such
ISPs. However, no individual customer accounted for more than 5% of revenue for
the years ended December 31, 2004, 2003 and 2002 or more than 10% of accounts
receivable at December 31, 2004 and 2003.
 
 27
 **(Dollars
in Thousands, Except Per Share Amounts)**
 *Inventory*
 
 Inventories
consist of modems and routers (generally referred to as customer premise
equipment) that we either sell or lease to customers and are required to
establish a high-speed DSL or T-1 digital connection. Inventories are stated at
the lower of cost or market. Cost of inventory is determined on the “first-in,
first-out” or average cost methods. We establish inventory reserves for excess,
obsolete or slow-moving inventory based on changes in customer demand,
technology developments and other factors. Such reserves require managements’
estimates and judgments primarily relating to forecasts of future usage which
could vary from actual results and require adjustments to our estimated
reserves.
 
 *Fair
Value of Financial Instruments and Derivatives*
 
 We have
issued various debt and equity instruments, some of which have required a
determination of their fair value, where quoted market prices were not published
or readily available. We base our determinations on valuation techniques that
require judgments and estimates including, discount rates used in applying
present value analyses, the length of historical look-back used in determining
the volatility of our stock, expected future interest rate assumptions and
probability assessments. From time to time, we may hire independent valuation
specialists to perform and or assist in the fair value determination of such
instruments. Actual results may differ from our estimates and assumptions which
may require adjustments to the fair value carrying amounts and result in a
charge or credit to our statement of operations.
 
  **Recently
Issued Accounting Pronouncements**
 
 In
September 2004, the Emerging Issues Task Force (“EITF”) issued EITF Issue No.
04-10 “Applying Paragraph 19 of FASB Statement No. 131 *,
‘Disclosures about Segments of an Enterprise and Related Information,’* in
Determining whether to Aggregate Operating Segments that do not Meet the
Quantitative Thresholds”. EITF No. 04-10 presents guidelines for two alternative
approaches in determining whether to aggregate operating segments and is
effective for fiscal years ending after October 13, 2004. EITF No. 04-10 did not
have an impact on our operating segment disclosures.
 
 On
December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB
Statement No. 123 (revised 2004) *“Share-Based
Payment”* (“SFAS
123R”), which is a revision of Statement No. 123, *“Accounting
for Stock-Based Compensation”* (“SFAS
123”) supersedes APB Opinion No. 25, *“Accounting
for Stock Issued to Employees,”* and
amends FASB Statement No. 95, *“Statement
of Cash Flows.”* Generally, the approach in SFAS 123R is similar to the approach described in
SFAS 123. However, SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an
alternative.
 
 Under
SFAS 123R, we must determine the appropriate fair value model to be used for
valuing share-based payments, the amortization method for compensation cost and
the transition method to be used at the date of adoption. The transition
alternatives include retrospective and prospective adoption methods. Under the
retrospective method, prior periods may be restated based on the amounts
previously recognized under SFAS 123 for purposes of pro forma disclosures
either for all periods presented or as of the beginning of the year of adoption.
 
 28
 **(Dollars
in Thousands, Except Per Share Amounts)**
 The
prospective method requires that compensation expense be recognized beginning
with the effective date, based on the requirements of SFAS 123R, for all
share-based payments granted after the effective date, and based on the
requirements of SFAS 123, for all awards granted to employees prior to the
effective date of SFAS 123R that remain unvested on the effective date.
 
 The
provisions of this statement are effective as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005. We expect to
adopt the standard on July 1, 2005. We are evaluating the requirements of SFAS
123R and have not determined its method of adoption or its impact on our
financial condition or results of operations.
 
 In
December 2004, the FASB issued SFAS 153, *“Exchange
of Non-monetary Assets, an amendment of APB Opinion No 29”* (“SFAS
153”). SFAS 153 eliminates the exception for non-monetary exchanges of similar
productive assets, which were previously required to be recorded on a carryover
basis rather than a fair value basis. Instead, this statement provides that
exchanges of non-monetary assets that do not have commercial substance be
reported at carryover basis rather than a fair value basis. A non-monetary
exchange is considered to have commercial substance if the future cash flows of
the entity are expected to change significantly as a result of the exchange. The
provisions of this statement are effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. We expect to adopt
the standard on July 1, 2005. We are evaluating the requirements of SFAS 153 and
have not determined its impact on our financial condition or results of
operations.
 
  29
 **(Dollars
in Thousands, Except Per Share Amounts)**
  **Results
of Operations**
 
 The
following table depicts our results of operations data and the components of net
loss as a percentage of revenue:
 
 **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**Revenue
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %Operating
      expenses:
      Network
      (excluding stock compensation
      and
      depreciation and amortization)
    
    
    66.8
    %
    
    72.1
    %
    
    73.5
    %Operations
      (excluding
      stock compensation and
      depreciation
      and amortization)
    
    
    14.4
    %
    
    16.6
    %
    
    17.4
    %General
      and administrative
      (excluding
      stock compensation and
      depreciation
      and amortization)
    
    
    18.4
    %
    
    17.2
    %
    
    25.0
    %Sales
      and marketing
      (excluding
      stock compensation and
      depreciation
      and amortization)
    
    
    7.5
    %
    
    12.1
    %
    
    15.3
    %Stock
      compensation
    
    
    0
    %
    
    0.6
    %
    
    2.7
    %Depreciation
      and amortization
    
    
    19.2
    %
    
    22.9
    %
    
    44.7
    %Total
      operating expenses
    
    
    126.3
    %
    
    141.5
    %
    
    178.7
    %Operating
      loss
    
    
    (26.3
    )%
    
    (41.5
    )%
    
    (78.7
    )%Interest
      (expense) income, net
    
    
    (7.8
    )%
    
    (4.1
    )%
    
    (1.0
    )%Other
      (expense) income, net
    
    
    0.2
    %
    
    (3.4
    )%
    
    0.4
    %Net
      loss
    
    
    (33.9
    )%
    
    (49.0
    )%
    
    (79.3
    )%Net
      loss applicable to common stockholders:Net
      loss
    
    
    (33.9
    %)
    
    (49.0
    )%
    
    (79.3
    )%Dividends
      on preferred stock
    
    
    (1.4
    )%
    
    (5.2
    )%
    
    (7.8
    )%Accretion
      of preferred stock
    
    
    (12.9
    %)
    
    (20.1
    )%
    
    (22.1
    )%Fair
      Value of Series Z Preferred Stock
    
    
    (3.8
    )%
    
    0
    %
    
    0
    %Net
      loss applicable to common stockholders
    
    
    (52.1
    )%
    
    (74.3
    )%
    
    (109.3
    )%
 
 
 30
 **(Dollars
in Thousands, Except Per Share Amounts)**
 *Revenue* . Revenue
for the year ended December 31, 2004, decreased by approximately $2,884 (4%) to
approximately $68,449, from approximately $71,333 for the year ended December
31, 2003. The decrease in revenue primarily resulted from the decrease in the
number of customers subscribing to our services.
 
 Revenue
for the year ended December 31, 2003, increased by approximately $25,803 (57%)
to approximately $71,333 from approximately $45,530 for the year ended December
31, 2002. The revenue increase was primarily due to the expansion of our
network, the increased number of customers subscribing for our services and
contributions from acquisitions of certain network assets, equipment and
associated subscriber lines of NAS during 2003.
 
 The
revenue attributable to contributions from acquired businesses was approximately
$0, $23,013 and $2,069 and for the years ended December 31, 2004, 2003 and 2002,
respectively.
 
 *Network
Expenses* . Our
network expenses include costs related to network engineering and network field
operations personnel, costs for telecommunications lines between customers,
central offices, network service providers and our network, costs for rent and
power at our central offices, costs to connect to the Internet, costs of
customer line installations and the costs of customer premise equipment when
sold to our customers. We lease high-speed lines and other network capacity to
connect our central office equipment and our network. Costs incurred to connect
to the Internet are expected to vary as the volume of data communications
traffic generated by our customers varies.
 
 Network
expenses for the year ended December 31, 2004, decreased by approximately $5,725
(11%) to approximately $45,727 from approximately $51,452 for the year ended
December 31, 2003. The
decrease resulted primarily from lower telecommunications expenses of
approximately $5,250, decreases in other equipment costs of approximately $266,
lower installation subcontractor and outside services expenses of approximately
$667, lower personnel expenses of approximately $243 and decreases in other
miscellaneous expenses of approximately $122, partially offset by increases in
other installation costs of approximately $823. The decrease in the
aforedescribed network expenses was primarily attributable to savings resulting
from the closure of certain duplicative central office locations that were
acquired with the NAS acquisition and other network cost containment efforts and
decreases in recurring loop costs associated with lower number of subscriber
lines.
 
 Network
expenses for the year ended December 31, 2003, increased by approximately
$17,892 (54%) to approximately $51,452, from approximately $33,470 for the year
ended December 31, 2002. The increase in network expenses was primarily
attributed to increased
telecommunications expenses of approximately $16,299 and increased network
engineering and field operations personnel expenses of approximately $1,279
resulting from our acquisition of the NAS assets. The increase was also
attributable to increased subcontract labor and consulting fees of approximately
$886 related to increased customer installations and the elimination of certain
duplicate central offices, and was partially offset by net decreases in
miscellaneous other expenses of approximately $483.
 
 Network
expenses incurred for certain high capacity loops and transport facilities that
we lease from incumbent local exchange carriers that connect to certain of our
central offices and our network will increase as early as March 2005, as a
result of the FCC’s Triennial Review Remand Order issued February 4, 2005 (the
“TRRO”). We are currently assessing the potential impact on our network expenses
resulting from the TRRO, as well as evaluating our network configuration
alternatives to minimize increases to our network expense.
 
 31
 **(Dollars
in Thousands, Except Per Share Amounts)**
 *Operations
Expenses.* Our
operations expenses include costs related to customer care, customer
provisioning, customer billing, customer technical assistance, purchasing,
headquarters facilities operations, operating systems maintenance and support
and other related overhead expenses.
 
 Operations
expenses for the year ended December 31, 2004 ,
decreased by approximately $2,009 (17%) to approximately $9,864 from
approximately $11,873 for the year ended December 31, 2003. The decrease in
operations expenses was primarily due to decreases in personnel expenses of
approximately $1,168, lower licenses and fees of approximately $357, decreases
in professional services expenses of approximately $302, decreases in
telecommunication expenses of approximately $144, and decreases in office
expenses of approximately $116, partially offset by increases in miscellaneous
expenses of approximately $78.
 
 Operations
expenses for the year ended December 31, 2003, increased by approximately $3,924
(49%) to approximately $11,873 from approximately $7,949 for the year ended
December 31, 2002. The increase in operations expenses was primarily attributed
to increases in operations personnel expenses of approximately $2,346, other
outside services of approximately $1,230, equipment costs of approximately $95
and net increases in other miscellaneous expenses of approximately $253. All
such increases were primarily associated with the acquisition of the NAS
assets.
 
 *General
and Administrative* . Our
general and administrative expenses consist primarily of costs relating to human
resources, finance, executive, administrative services, recruiting, insurance,
public reporting, legal and auditing services, leased office facilities rent and
bad debt expenses.
 
 General
and administrative expenses for the year ended December 31, 2004, increased by
approximately $401 (3%) to approximately $12,601 from approximately $12,200 for
the year ended December 31, 2003. The increase was primarily due to increases in
professional services costs of approximately $1,430 and miscellaneous increases
of approximately $33, partially offset by lower bad debt expenses of
approximately $903 and lower facilities costs of approximately
$159.
 
 General
and administrative expenses for the year ended December 31, 2003, increased by
approximately $797 (7%) to approximately $12,200 from approximately $11,403 for
the year ended December 31, 2002. The increase was primarily due to increases in
professional fees of approximately $750, tax expenses of approximately $735, and
miscellaneous expenses of approximately $321. These increased expenses were
partially offset by reductions in salaries and benefits of approximately $266,
bad debt expenses of approximately $481, and insurance expenses of approximately
$262.
 
 In March
2002, we filed an application with the Connecticut Department of Revenue
Services for research and development expenditure credits for the 1999 and 2000
calendar years. The credits were approved as a reduction against our corporation
business tax. With regard to credits approved for the 2000 calendar year, we
were entitled to elect a cash refund at 65 percent of the approved credit. We
elected to receive the 2000 calendar year credit as a cash refund of
approximately $1,301. The 1999 calendar year credit of approximately $671 is
available as a carryforward offset to future State of Connecticut business
taxes. In July of 2002, we received the first installment of the cash refund
pertaining to the 2000 calendar year of approximately $1,000. Upon receipt of
the research and development credits, we were obligated to pay
 
 32
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 approximately
$402 to a professional service provider as a result of a contingent fee
arrangement for professional services in connection with obtaining such credits.
During 2002, we recorded the $1,000 refund as a reduction in our state corporate
franchise tax expenses which are included in general and administrative
expenses, and the $402 contingent fee as professional services expenses, also
included in general and administrative expenses. We received the second and
third installments of approximately $150 each in 2003 and 2004, respectively,
which were recorded as reductions of general and administrative expenses in
those respective years.
 
 *Sales
and Marketing* . Our
sales and marketing expenses consist primarily of expenses for personnel, the
development of our brand name, promotional materials, direct mail advertising
and sales commissions and incentives.
 
 Sales and
marketing expenses for the year ended December 31, 2004, decreased by
approximately $3,516 (41%) from approximately $8,642 for the year ended December
31, 2003. The decrease was primarily attributable to reductions in salaries and
benefits (including commissions of approximately $2,457) stemming from our
reductions in force, lower advertising expenses of approximately $881 and sundry
other expenses of approximately $178.
 
 Sales and
marketing expenses for the year ended December 31, 2003, increased by
approximately $1,673 (24%) to approximately $8,642 from approximately $6,969 for
the year ended December 31, 2002. The increase was primarily due to increases in
salaries and benefits (including commissions) of approximately $1,685 and
miscellaneous expenses of approximately $128, which were partially offset by
reductions in advertising expenses of approximately $140.
 
 *Stock
Compensation* . We
incurred non-cash stock compensation expenses as a result of the granting of
stock and stock options to employees, directors and members of our former board
of advisors with exercise prices per share below the fair values per share of
our common stock at the dates of grant. The stock compensation, if vested, was
charged immediately to expense, while non-vested compensation was amortized over
the vesting period of the applicable options or stock, which was generally 48
months for initial grants and 36 months for subsequent grants. Unvested options
for terminated employees are cancelled and the value of such options is recorded
as a reduction of deferred compensation with an offset to additional
paid-in-capital.
 
 Non-cash
stock compensation expenses were approximately $0, $438 and $1,228 for the years
ended December 31, 2004, 2003 and 2002, respectively. As of December 31, 2004
and 2003, respectively, there were no remaining unamortized balances of stock
compensation expenses.
 
 As of
December 31, 2004 and 2003, options to purchase 40,651,934 and 18,671,766 shares
of common stock, respectively, were outstanding, which were exercisable at
weighted average exercise prices of $0.70 and $1.07 per share, respectively.
 
 *Depreciation
and Amortization.* Depreciation and amortization is primarily attributable to the following: (i)
depreciation of network and operations equipment and Company-owned modems and
routers installed at customer sites, (ii) depreciation of information systems
and computer hardware and software, (iii) amortization and depreciation of the
costs of obtaining, designing and building our collocation space and corporate
facilities and (iv) amortization of intangible capitalized costs pertaining to
acquired businesses and customer line acquisitions.
 
 Depreciation
and amortization for the year ended December 31, 2004, was approximately $13,132
or $3,227 (20%) lower than depreciation and amortization for the year ended
December
 
 33
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 31, 2003,
of approximately $16,359. The decrease was primarily attributable to certain
intangible and fixed assets having become fully depreciated and amortized during
2004.
 
 Depreciation
and amortization for the year ended December 31, 2003, was approximately $3,973
(20%) lower than depreciation and amortization for the year ended December 31,
2002 of approximately $20,332. The decrease was primarily attributable to
certain intangible and fixed assets having become fully depreciated and
amortized during 2003, resulting in a decline in depreciation and amortization
of approximately $7,371, which was partially offset by increased depreciation
and amortization relating to our acquisition of the NAS assets and the
TalkingNets assets and associated subscriber lines of approximately $3,398.
 
 Our
identified intangible assets (excluding goodwill) consist solely of customer
lists, which are amortized over two years. Amortization of intangible assets for
the years ended December 31, 2004, 2003 and 2002 was approximately $941, $2,756
and $5,349, respectively. Accumulated amortization of customer lists as of
December 31, 2004 and 2003 was approximately $15,437 and $14,496, respectively.
The expected future amortization of customer lists as of December 31, 2004, is
approximately $47 in 2005, when these intangible assets will be fully
amortized.
 
 Depreciation
pertaining to network assets was approximately $11,241, $12,300 and $13,719 for
the years ended December 31, 2004, 2003 and 2002, respectively. Depreciation and
amortization pertaining to general and administrative assets was approximately
$1,891, $4,059 and $6,613 for the years ended December 31, 2004, 2003 and 2002,
respectively.
 
 *Interest
Income (Expense), Net* . For the
year ended December 31, 2004, net interest expense of approximately $5,363
consisted of approximately $5,474 in interest expense, partially offset by
approximately $111 in interest income. The increase in interest expense during
2004 of approximately $2,388 (77%) was primarily due to the non-cash
amortization of debt discount of approximately $3,748 related to warrants issued
as part of our July 2003 note and warrant financing and derivatives issued under
our October 2004 convertible note and warrant financing and $279 of interest
expense pertaining to notes issued in connection with those transactions,
partially offset by lower interest expense of approximately $909 of non-cash
interest expense related to the warrants issued during 2003 in consideration for
loan guarantees under our Reimbursement Agreement (as defined and discussed
below), approximately $318 of lower interest pertaining to the note we issued to
NAS in connection with our purchase of the NAS assets which was pre-paid in
2003, and approximately $412 of lower other interest expense primarily due to
lower capital lease balances. The decrease in interest income of approximately
$39 was primarily due to lower cash balances during 2004.
 
 For the
year ended December 31, 2003, net interest expense of approximately $2,936
included approximately $3,086 in interest expense, partially offset by $150 in
interest income. For the year ended December 31, 2002, net interest expense of
approximately $458 consisted of approximately $790 in interest expense,
partially offset by $332 in interest income. The increase in interest expense
during 2003 of approximately $2,296 (74%) was primarily attributable to the
non-cash amortization of debt discount of approximately $1,266 which related to
warrants issued as part of our July 2003 note and warrant financing, and the
amortization of deferred non-cash financing costs of approximately $909 which
related to the warrants issued in consideration for loan guarantees under our
Reimbursement Agreement (as defined and discussed below) and increased interest
on new borrowings during 2003 pertaining to the note issued in connection with
our acquisition of the NAS assets and the notes issued as part of our July 2003
note and warrant financing of approximately $489, partially offset by decreased
other interest expense of
 
 34
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 approximately
$367 primarily due to lower capital lease balances. The decrease in interest
income during 2003 of approximately $182 was due to lower interest rates on
lower cash balances.
 
 *Other
(Expense) Income, net.* For the
year ended December 31, 2004, net other income of $135, included $190 in
miscellaneous income, partially offset by $55 representing an increase in the
fair value of derivatives. For the year ended December 31, 2003, net other
expense of approximately $2,430 included expenses that were primarily
attributable to the loss on the sale of assets of approximately $115, the
write-off of approximately $184 in unamortized loan origination fees and
approximately $5,747 of unamortized deferred non-cash financing costs which
related to warrants issued in consideration for loan guarantees under our
Reimbursement Agreement (discussed below). These items were written-off as a
result of the loan repayment and cancellation of the Credit Agreement (as
defined and discussed below) and the Reimbursement Agreement subsequent to our
$30,000 note and warrant financing on July 18, 2003. These write-offs were
partially offset by miscellaneous income of approximately $116 and a non-cash
gain of $3,500 resulting from the $1,500 settlement of the $5,000 note payable
to NAS. For the year ended December 31, 2002, net other income of approximately
$185 included gains on sale of assets and miscellaneous income.
 
 *Restructuring
and Impairment Charges* . During
the year ended December 31, 2004, we charged approximately $540 against our
restructuring reserve related to facilities expense associated with the
Company’s vacated office space in Santa Cruz, California. The lease on that
facility expired in December of 2004 and our restructuring reserve balance was
$0 at December 31, 2004. During the year ended December 31, 2003, we increased
our reserve for vacated facilities by approximately $252 as a sublet tenant
vacated our Santa Cruz facility and we did not anticipate any additional
sublets. We also charged approximately $647 against our restructuring reserves;
of which, approximately $315 related to payment of certain termination fees
associated with the closure of certain central offices during 2001, and
approximately $332 related to facilities expense associated with the Company’s
vacated office space in Santa Cruz, California. At December 31, 2003, the
remaining restructuring reserve balance for our leased Santa Cruz facility of
approximately $540 was included in our accrued liabilities. During
2002 we charged approximately $576 against
our restructuring reserves pertaining to facilities expense associated with our
vacated office space in Santa Cruz, California and the remaining reserve balance
at December 31, 2002 of approximately $935 was included in our accrued
liabilities.
 
 The
following table summarizes the additions and charges to the restructuring
reserve and the remaining reserve balances from December 31, 2001 through
December 31, 2004.
 **FacilityLeases**
    
    **Central**
      **Office**
      **Term.**
      **Fees**
    
    **Total**Reserve
      balance at
      Dec.
      31, 2001
    
    $
    1,196
    
    $
    315
    
    $
    1,511Charges
      to the
      reserve
    
    
    (576
    )
    
    -
    
    
    (576
    )Reserve
      balance at
      Dec.
      31, 2002
    
    
    620
    
    
    315
    
    
    935Additions
      to the
      reserve
    
    
    252
    
    
    -
    
    
    252
  35
 **(Dollars
in Thousands, Except Per Share Amounts)**
  Charges
      to the
      reserve
    
    
    (332
    )
    
    (315
    )
    
    (647
    )Reserve
      balance at
      Dec.
      31, 2003
    
    
    540
    
    
    -
    
    
    540Charges
      to the
      reserve
    
    
    (540
    )
    
    -
    
    
    (540
    )Reserve
      balance at
      Dec.
      31, 2004
    
    $
    -
    
    $
    -
    
    $
    -
 
  *Net
Loss* . For
reasons explained above, net loss of approximately $23,229 for the year ended
December 31, 2004 decreased by approximately $11,768 (34%) from $34,997 for the
year ended December 31, 2003. Net loss of approximately 34,997 for the year
ended December 31, 2003 decreased by approximately $1,097 (3%) from
approximately $36,094 for the year ended December 31, 2002.
 
 **Liquidity
and Capital Resources**
 
 We have
financed our capital expenditures, acquisitions and operations primarily with
the proceeds from the sale of stock and from borrowings, including equipment
lease financings. As of December 31, 2004, we had cash and cash equivalents of
approximately $7,079, additional but restricted cash of approximately $2,432 and
working capital of approximately $4,273.
 
 *Cash
Provided By Financing Activities.* Net cash
provided by financing activities in the years ended December 31, 2004, 2003 and
2002, was approximately $3,919, $27,311 and $12,107, respectively. For 2004,
this cash was provided primarily from the sale of a secured convertible note
issued together with warrants to purchase our common stock. For 2003, this cash
was provided primarily from the sale of our senior secured notes and warrants
issued in accordance with the Note and Warrant Purchase Agreement we entered
into in July, 2003. For 2002, this cash was provided primarily from the sale of
our preferred stock. We have used, and intend to continue using, the proceeds
from these financings primarily to implement our business plan and for working
capital and general corporate purposes. We have also used, and may in the future
use, a portion of these proceeds to acquire complementary businesses or
assets.
 
 *Details
of Cash Provided by Financing Activities.* From time
to time we have entered into equipment lease financing arrangements with
vendors. In the aggregate, there was approximately $50 and $155 outstanding
under capital lease obligations at December 31, 2004 and 2003,
respectively.
 
 In March
of 2002, we received proceeds of $10,000 from the sale of 10,000 shares, of
mandatorily redeemable convertible Series X preferred stock. In May 2002, we
received net proceeds of $5,000 from the sale of 8,531 shares of Series Y
preferred stock and, pursuant to the provisions of the Series Y preferred stock
purchase agreement, $3,531 of promissory notes issued to the Series Y preferred
stock investors were cancelled.
 
 We
entered into a Revolving Credit and Term Loan Agreement, dated as of December
13, 2002 (the “Credit Agreement”), with a commercial bank providing for a
revolving line of credit of up to $15,000 (the “Commitment”). Interest on
borrowings under the Credit Agreement was payable at 0.5% percent above the
Federal Funds Effective Rate. Our ability to borrow amounts available under the
Credit Agreement was subject to the bank’s receipt of a like amount of
 
 36
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 guarantees
from certain of our investors and/or other guarantors. On February 3, 2003, we
borrowed $6,100 under the Credit Agreement. As of March 5, 2003, certain of our
investors had guaranteed $9,100 under the Credit Agreement. On July 18, 2003, we
repaid the $6,100 outstanding balance plus accrued interest, and terminated the
Credit Agreement. We wrote off approximately $184 of the related unamortized
balance of loan origination fees.
 
 We
entered into a Reimbursement Agreement, dated as of December 27, 2002 (the
“Reimbursement Agreement”), with VantagePoint Venture Partners III (Q), L.P.
(“VP”) and Columbia Capital
Equity Partners (together with its co-guarantors, “Columbia”)and other
holders of our Series X preferred stock and Series Y preferred stock or their
affiliates (the “Guarantors”), and a related Security Agreement. Pursuant to the
terms of the Reimbursement Agreement, on December 27, 2002, VP and Columbia
issued guarantees in an aggregate amount of $6,100 to support certain of our
obligations under the Credit Agreement. On July 18, 2003, in connection with the
termination of the Credit Agreement, the guarantees, the Reimbursement Agreement
and the related Security Agreement were terminated.
 
 Pursuant
to the terms of the Reimbursement Agreement, on December 27, 2002, we issued
warrants to purchase 12,013,893 shares of our common stock to VP and certain of
its affiliates and Columbia, in consideration for their guarantees aggregating
$6,100. All such warrants have a ten year life and an exercise price of $0.50
per share. **** On March
26, 2003, we issued additional warrants, exercisable for ten years, to purchase
a total of 936,107 shares of our common stock at $0.50 per share, to VP and
certain of its affiliates and Columbia, bringing the total number of warrants
issued in connection with the Reimbursement Agreement to 12,950,000. On February
3, 2003, we borrowed $6,100 on the Credit Agreement and the Guarantors’
guarantees of the subject loan became effective.
 
 On
February 3, 2003, we valued the 12,950,000 warrants at $0.514 each with a total
value of approximately $6,656. The valuation was performed using a Black-Scholes
valuation model with the following assumptions: (i) a risk free interest rate of
4.01% (ten-year Treasury rate), (ii) a zero dividend yield, (iii) a ten year
expected life, (iv) an expected volatility of 153%, (v) an option exercise price
of $0.50 per share and (vi) a current market price of $0.52 per share (the
closing price of our common stock on February 3, 2003). Since the warrants were
issued in consideration for loan guarantees, which enabled us to secure
financing at below market interest rates, we recorded their value as a deferred
debt financing cost to be amortized to interest expense over the term of the
loan (approximately 57 months) using the “Effective Interest Method” of
amortization. On July 18, 2003, we repaid our outstanding loan balance that was
secured by these loan guarantees, and terminated the Credit Agreement.
Accordingly, we wrote-off approximately $5,747 of the related unamortized
balance of deferred financing costs to other expense. For years ended December
31, 2003, expense relating to amortized deferred financing costs approximated
$909.
 
 On March
5, 2003, we and VP entered into Amendment No. 1 to the Reimbursement Agreement,
pursuant to which VP increased its guarantee by $3,000 bringing the aggregate
guarantees by all Guarantors under the Reimbursement Agreement, as amended, to
$9,100. As consideration for VP’s increased guarantee, if we closed an equity
financing on or before December 3, 2003, we were authorized to issue VP and
certain of its affiliates additional warrants to purchase the type of equity
securities issued by us in such equity financing. The number of such additional
warrants would be determined by dividing the per share price of such equity
securities into a thousand dollars. Accordingly, since we closed a financing on
July 18, 2003, we issued to VP and certain of its affiliates in December 2003,
additional warrants with a three-year life to purchase 2,260,909 shares of our
common stock at a per share price of $0.4423.
 
 37
 **(Dollars
in Thousands, Except Per Share Amounts)**
 On July
18, 2003, we entered into a Note and Warrant Purchase Agreement (the “Note and
Warrant Purchase Agreement”) with Deutsche Bank AG London, acting through DB
Advisors LLC as Investment Agent (“Deutsche Bank”), and VantagePoint Venture
Partners III (Q), L.P., VantagePoint Venture Partners III, L.P., VantagePoint
Communications Partners, L.P. and VantagePoint Venture Partners 1996, L.P.
(collectively, “VantagePoint” and, together with Deutsche Bank, the “Senior
Noteholders”) relating to the sale and purchase of an aggregate of (i) $30,000
in senior secured promissory notes (the “Notes”) and (ii) warrants to purchase
157,894,737 shares of our common stock for a period of three years at an
exercise price of $0.38 per share (the “2003 Warrants”). The aggregate purchase
price for the Notes and 2003 Warrants was $30,000.
 
 Subject
to the terms and conditions of the Note and Warrant Purchase Agreement, we
issued an aggregate of $30,000 in principal amount of Notes to the Senior
Noteholders on July 18, 2003. As of December 31, 2004, an aggregate principal
amount of $30,000 of Notes remained outstanding. Principal on the Notes is
payable in a single payment on July 18, 2006. The Notes provide for an annual
interest rate of 1.23%, payable in cash, quarterly in arrears commencing on
October 31, 2003, unless we were to elect to capitalize such interest and pay it
together with the principal amount of the Notes at maturity on July 18, 2006.
Pursuant to the Security Agreement, our obligations under the Notes are secured
by a security interest in a majority of our personal property and assets and
certain of our subsidiaries. The terms
of the Notes also contain provisions that limit our ability to incur additional
indebtedness and place other restrictions on our business. Prior to
the due date of the first interest payment, we elected to defer all interest
payments on the Notes until further notice. Interest expense accrued on the
Notes for the years ended December 31, 2004 and 2003, approximated $379 and
$171, respectively.
 
 Subject
to the terms and conditions of the Note and Warrant Purchase Agreement, we
issued a warrant to purchase 12,950,000 shares of our common stock to Deutsche
Bank on or about August 12, 2003. We issued the remaining 2003 Warrants to
purchase an aggregate of 144,944,737 shares of our common stock to Deutsche Bank
(105,471,053 shares) and VantagePoint (39,473,864 shares) on or about December
9, 2003.
 
 On July
18, 2003, we recorded the note and warrant transactions in accordance with
Accounting Principles Board Opinion No. 14, “ *Accounting
for Convertible Debt and Debt Issued with Stock purchase Warrants,”* whereby a
fair value was ascribed to the 157,894,737 2003 Warrants to be issued to the
Senior Noteholders (related to the Note and Warrant Purchase Agreement) together
with the 2,260,909 warrants to be issued to VantagePoint (related to
VantagePoint’s increased guarantee under Amendment No. 1 to the Reimbursement
Agreement) using a Black-Scholes valuation model with the following assumptions:
(i) a risk free interest rate of 2.24% (three-year Treasury rate), (ii) a zero
dividend yield, (iii) a three-year life, (iv) an expected volatility of 152%,
(v) a warrant option price of $0.38 per share for the 157,894,737 2003 Warrants
and $0.4423 per share for the 2,260,909 warrants, and (vi) a current market
price of $0.83 per share (the closing price of our common stock on July 18,
2003). A fair value was ascribed to the $30,000 Notes using a present value
method with a 19% discount rate. The relative fair value of the warrants
representing 87% of the combined fair value of the warrants and Notes was
applied to the $30,000 proceeds to determine a note discount of approximately
$26,063, which was recorded as a reduction to the Notes payable and an increase
to additional paid in capital. The note discount is being amortized to interest
expense using the “Effective Interest Method” over the 36 month term of the
Notes. For the years ended December 31, 2004 and 2003, approximately $4,954 and
$1,266, respectively, of this note discount has been amortized to interest
expense.
 
 38
 **(Dollars
in Thousands, Except Per Share Amounts)**
 Also, on
July 18, 2003, in connection with the Note and Warrant Purchase Agreement, we , the
Senior Noteholders and certain of our stockholders entered an Amended and
Restated Stockholders Agreement (the “Amended and Restated Stockholders
Agreement”), which provides for rights relating to election of directors, the
registration of our common
stock and certain protective provisions.
 
 As part
of the agreements negotiated in conjunction with our $30,000 financing on July
18, 2003, we and holders of a majority of the Series X preferred stock and
Series Y preferred stock agreed to extend the redemption dates of the Series X
preferred stock and Series Y preferred stock from January 1, 2005 to July 18,
2006. Also, as a result of this financing transaction, in accordance with the
terms of the Series Y preferred stock, the Series Y preferred stock conversion
price was adjusted from $0.50 per share (each Series Y preferred share is
convertible into 2,000 shares of common stock) to $0.4423 per share (each Series
Y preferred share is convertible into approximately 2,260.9 shares of common
stock).
 
 A portion
of the proceeds from the sale of the Notes and 2003 Warrants was used by the
Company to repay certain debt and lease obligations. During 2003, the Company
pre-paid approximately $10,200 for the complete repayment of approximately
$14,600 of its debt and lease obligations.
 
 On
October 7, 2004, we closed a financing transaction with Laurus Master Fund, Ltd
(“Laurus”), pursuant to which we sold to Laurus convertible notes and a warrant
to purchase our common stock. The securities issued to Laurus were a $4,250
Secured Convertible Minimum Borrowing Note (the “MB Note”), a $750 Secured
Revolving Note (the “Revolving Note” and, together with the MB Note, the “Laurus
Notes”), and a Common Stock Purchase Warrant to purchase 1,143,000 shares of our
common stock (the “Laurus Warrant”). As part of the financing transaction with
Laurus, we paid Laurus a closing fee of $163. Our obligations under the Laurus
Notes are secured by a security interest and first priority lien on certain of
our trade accounts receivable.
 
 The
Company and Laurus had placed the transactions and funds into escrow on August
31, 2004, pending our procurement of a waiver of certain rights of the Senior
Noteholders, represented by Deutsche Bank Trust Company Americas (“DBTCA”), and
agreement from such noteholders to subordinate their lien on trade accounts
receivable of the Company to the lien granted to Laurus. On October 7, 2004, we
reached agreement with Laurus and the Senior Noteholders on subordination terms
and the initial financing proceeds of $4,250 were released from escrow, of which
$4,024 were deposited into a Company account with DBTCA. Our withdrawal and use
of such deposited financing proceeds are subject to the prior approval of DB
Advisors, LLC, as advisor to Deutsche Bank, and DBTCA. As of March 1, 2005, we
have received approval to withdraw and have received $3,038 of the $4,250
borrowed to date, of which $2,432 was identified as restricted cash at December
31, 2004. As of March 1, 2005, we also received approval to draw down all of the
$750 subject to the revolving credit facility.
 
 The
Laurus Notes mature on August 1, 2006. Annual interest on the Laurus Notes is
equal to the prime rate published in The Wall Street Journal from time to time,
plus two percent, provided, that, such annual rate of interest on the Laurus
Notes may not be less than six percent or more than seven percent.
Notwithstanding the six percent interest rate floor, the interest rate on the
Laurus Notes will be decreased two percent per annum for each 25% increase in
the price of our common stock above $0.28 per share, if, at that time, we have
on file with the SEC a registration statement for the shares of common stock
issued or issuable upon conversion of the MB Note and upon exercise of the
Laurus Warrant and, if not, the interest rate will be decreased one percent per
 
 39
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 annum for
each 25% increase in the price of our common stock above $0.28 per share. As of
February 4, 2005, the Company has an effective registration statement on file
with the SEC in respect to the resale of such common stock. Any change in the
interest rate on the Laurus Notes will be determined on a monthly basis. In no
event will the interest rate on the Laurus Notes be less than 0.00%.  Interest
on the Laurus Notes is payable monthly in arrears on the first day of each month
during the term of the Laurus Notes.
 
 The
initial fixed conversion price under the Laurus Notes is $0.28 per share. The
initial conversion price and the number of shares of our common stock issuable
upon conversion of each of the Laurus Notes are subject to adjustment in the
event that we reclassify, subdivide or combine our outstanding shares of common
stock or issue additional shares of our common stock as a dividend on our
outstanding shares of common stock. The fixed conversion price is subject to
anti-dilution protection adjustments, on a weighted average basis, upon our
issuance of additional shares of common stock at a price that is less than the
then current fixed conversion price. Subject to certain limitations, Laurus may,
at any time, convert the outstanding indebtedness of each of the Laurus Notes
into shares of our common stock at the then applicable conversion price. Subject
to certain trading volume and other limitations, the MB Note will automatically
convert at the then applicable conversion price into shares of our common stock
if, at any time while an effective registration statement under the Securities
Act of 1933, as amended, for the resale of our common stock underlying the MB
Note and Laurus Warrant is outstanding, the average closing price of our common
stock for ten consecutive trading days is at least $0.31, subject to certain
adjustments. The Revolving Note is potentially convertible into more than $750
worth of the Company’s common stock, depending upon the amount of aggregate
borrowings by us under the Revolving Note and the amount of conversions by
Laurus.
 
 The
Laurus Warrant grants Laurus the right to purchase up to 1,143,000 shares of our
common stock at an exercise price of $0.35 per share. On October 7, 2004, we
also issued a warrant to purchase 178,571 shares of our common stock at an
exercise price of $0.35, and made a cash payment of approximately $38, to TN
Capital Equities, Ltd. (“TN Capital”), as compensation for TN Capital’s having
served as the placement agent in the financing transaction with Laurus. The
Laurus Warrant and the warrant issued to TN Capital each expire on August 31,
2009. Under the terms of the Minimum Borrowing Note Registration Rights
Agreement, Laurus has been afforded certain registration rights with respect to
the shares of the Company’s common stock underlying the MB Note and the Laurus
Warrant. TN Capital was also afforded piggyback registration rights for the
shares of our common stock underlying the warrant it received. On November 5,
2004, we filed with the SEC a preliminary registration statement on Form S-3
covering the potential resale of the shares of common stock underlying the MB
Note, Laurus Warrant and the warrant issued to TN Capital. The registration
statement was declared effective and we filed with the SEC our Rule 424(b) final
prospectus on February 4, 2005.
 
 In
exchange for agreement by the Senior Noteholders to subordinate to Laurus their
prior lien on certain of our accounts receivable, we issued warrants to the
Senior Noteholders (the “2004 Warrants”), allocated ratably in accordance with
the Senior Noteholders’ interests in the Company's July 2003 note and warrant
financing, to purchase up to an aggregate of 19,143,000 shares of common stock.
The 2004 Warrants were approved by our stockholders on February 9, 2005; expire
on July 18, 2006; and are exercisable solely in the event of a change of control
of the Company where the price paid per share of common stock or the value per
share of common stock retained by our common stockholders in any such change of
control (the “Change of Control Price”) is less than the then current per share
exercise price of the 2003 Warrants. The exercise price of the 2004 Warrants
will be calculated at the time of a qualifying change of control of the Company,
if any, and will be equal to the Change of Control Price. The Senior Noteholders
have been afforded certain registration rights with regard to the 2004 Warrants.
As a condition to our issuance of the 2004 Warrants, the Senior
 
 40
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 Noteholders
waived any anti-dilution rights to which they might otherwise be entitled under
all warrants previously issued to the Senior Noteholders resulting from the
issuance or exercise of the 2004 Warrants. We determined that the fair value of
the 2004 Warrants is not material and accordingly no modification to the July
18, 2003, note and warrant transaction was required.
 
 We
determined, in accordance with the guidance of SFAS 133, “ *Accounting
for Derivative Instruments and Hedging Activities,”* that the
following derivatives resulted from the Laurus financing transaction
described above: (i) the conversion option of the MB Note, and (ii) the
1,321,571 warrants issued to Laurus and TN Capital. Accordingly, we recorded the
fair value of these derivatives approximating $231 as a debt discount and a
non-current liability on our consolidated balance sheet. The note discount is
being amortized to interest expense using the “Effective Interest Method” of
amortization over the 22 month term of the MB Note. For the year ended December
31, 2004, approximately $27 of this note discount has been amortized to interest
expense. Also, at December 31, 2004, the recorded value of the derivatives, were
increased by approximately $55, with a corresponding charge to other expense, to
the then current fair value of approximately $286.
 
 *Cash
Used In Operating Activities.* In 2004,
2003 and 2002, net cash used in our operating activities was approximately
$7,541, $13,715 and $17,706, respectively.
 
 Net cash
used in operating activities of $7,541 in 2004 decreased by $6,174 (45%) from
$13,715 in 2003. The improvement in net cash used for operating activities was
primarily due to lower net loss of approximately $11,768 primarily due to
reduced operating expenses resulting from our cost containment efforts,
partially offset by lower non-cash items including: depreciation and
amortization, provisions for bad debt expense and sales credits and allowances,
stock compensation, amortization of debt issuance costs, amortization of debt
discount and gain on note settlement totaling approximately $4,645. Also
contributing to the improved operating cash flow was a net improvement in
accounts receivable of approximately $6,742 (due to a decrease in accounts
receivable of approximately $589 in 2004 primarily resulting from lower revenues
combined with improved collections, compared to an increase in 2003 of
approximately $6,153 due to the acquisition of the NAS assets). These
improvements were partially offset by (i) lower net accrued expenses and
accounts payable of approximately $3,776 (caused by a decrease of approximately
$2,689 in 2004 combined with an increase of approximately $1,087 in 2003),
principally due to payment of previously accrued network costs related to
operation of the NAS assets, (ii) a net decrease in deferred revenue of
approximately $2,662 (caused by approximately $1,268 decrease in 2004 due
to deferred amortization of installation revenue exceeding deferred new
installations versus an increase of approximately $1,394 in 2003 resulting from
the acquisition of the NAS assets), and (iii) a net increase in other assets of
approximately $1,253 (due to approximately $386 increase in 2004 compared to a
decrease in 2003 of approximately $867).
 
 *Cash
Used in Investing Activities.* Net cash
used in investing activities in 2004, 2003 and 2002, was approximately $3,078,
$11,135 and $2,368, respectively. For the year ended December 31, 2004,
approximately $651 was used primarily for the purchase of equipment and $2,427
was attributable to an increase in restricted cash resulting from the balance of
proceeds of the Laurus financing. For the year ended, December 31, 2003,
approximately $2,405 was used primarily for the purchase of equipment and
approximately $8,743 was used for acquisition of subscriber lines and a $4
increase in restricted cash, resulting from an increase of the Company’s share
of matching contributions for terminated employees in the Company’s 401(k) plan.
These expenditures were partially offset by approximately $17 in proceeds from
sale of equipment. For the year ended, December 31, 2002, approximately $1,647
was used primarily for the purchase of equipment and approximately $1,150 was
used for acquisition of subscriber lines. These expenditures were partially
offset by approximately $85 in proceeds from sale of equipment and a $344
decrease in restricted cash, primarily resulting from our settlement of holdback
payments attributable to acquisitions.
 
 41
 **(Dollars
in Thousands, Except Per Share Amounts)**
 The
development and expansion of our business has required significant capital
expenditures (we spent approximately $55,942 and $33,811, including collocation
application fees, in calendar years 2000 and 1999, respectively). During the
last three years, capital expenditures, excluding acquisitions, have been made
primarily for maintenance and/or replacement equipment, and were approximately
$651, $2,405 and $1,647 for the years ended December 31, 2004, 2003 and 2002,
respectively. The actual amounts and timing of our future capital expenditures
will vary depending on the speed at which we expand and implement our network
and implement service for our customers. We currently anticipate spending less
than $1,000 for capital expenditures, during the year ending December 31, 2005,
primarily for the maintenance of our network and for minimal replacement
equipment. The actual amounts and timing of our capital expenditures could
differ materially both in amount and timing from our current plans. In addition
to capital spent on equipment, we have spent the amounts described below for
certain acquisitions:
 
 In
December of 2002, the U.S. Bankruptcy Court for the District of Delaware
approved our bid to purchase the on-network assets and associated subscriber
lines of NAS for $14,000, consisting of $9,000 in cash and $5,000 in a note
payable to NAS. We closed the transaction on January 10, 2003, whereby we
acquired NAS’ operations and network
assets, associated equipment in approximately 300 central offices and
approximately 11,500 associated subscriber lines. In connection with the closing
of the NAS transaction, on January 10, 2003, we hired approximately 78 former
NAS employees. No pre-closing liabilities were assumed in connection with the
NAS transaction. The cash portion of the purchase price was paid from our
existing cash. The NAS note had a term of approximately 5 years and carried
interest at 12% and was secured by the NAS network assets acquired. During
August 2003, we
paid $1,500 to repurchase and cancel the $5,000 note issued by us to NAS. The
difference between the $5,000 note and the $1,500 settlement amount was recorded
as other income during 2003.
 
 In
connection with the integration of the NAS business, on January 17, 2003, we had
a reduction in force of 35 employees at our headquarters facility in New Haven,
Connecticut. We paid approximately $62 **** in
severance to the terminated employees.
 
 On
September 8, 2003, in accordance with the terms of an asset purchase agreement
by and among the TalkingNets entities and the Company, dated April 8, 2003, we
completed the transaction to acquire certain assets and subscribers of
TalkingNets (the “TalkingNets Assets”) for approximately $726 in cash (the
“TalkingNets Asset Purchase Agreement”). As TalkingNets had filed a voluntary
petition for Chapter 11 reorganization in February 2003, the TalkingNets Asset
Purchase Agreement was subject to the approval of the U.S. Bankruptcy Court for
the Eastern District of Virginia. On April 9, 2003, the TalkingNets Asset
Purchase Agreement and the transactions contemplated thereby were approved by
the Bankruptcy Court. On April 11, 2003, we paid the full purchase price of
approximately $726 into escrow.
 
 The
TalkingNets acquisition has been accounted for under the purchase method of
accounting in accordance with SFAS No. 141. The results of TalkingNets’
operations have been included in our consolidated financial statements since
September 8, 2003 (the closing date). The allocated estimated fair values of the
acquired assets at the date of acquisition exceeded the purchase price and,
accordingly, have been written down on a pro-rata basis by asset group to the
purchase price of approximately $851 ($726 plus associated direct acquisition
costs of approximately $125) as follows: (i) certain accounts receivables of
approximately $55, (ii) intangible assets pertaining to approximately 90
acquired subscriber lines of approximately $111, and (iii) property and
equipment of $685.
 
 42
 **(Dollars
in Thousands, Except Per Share Amounts)**
 In the
first quarter of 2002, we entered into an Asset Purchase Agreement, dated as of
January 1, 2002 (the “Broadslate Asset Purchase Agreement”), with Broadslate
Networks, Inc. (“Broadslate”) for the purchase of business broadband customer
accounts and certain other assets, including certain accounts receivable related
to the customer accounts, for $800, subject to certain adjustments. The
Broadslate Asset Purchase Agreement provided for an initial cash payment of
$650, with $150 retained by us (the “Broadslate Holdback Amount”), to be paid to
Broadslate after a transition period, subject to certain adjustments, as
provided for in the Broadslate Asset Purchase Agreement. On March 26, 2002, we
gave notice to Broadslate of our intent to pursue an indemnity claim against the
Broadslate Holdback Amount for the full amount in accordance with the provisions
of the Broadslate Asset Purchase Agreement. The claim and final settlement
amount of $150 was applied to the Broadslate Holdback Amount as follows: (i)
approximately $50 pertained to our request for reimbursement of a ratable
portion of the purchase price paid for certain subscriber lines which were not
available for migration to our network, and (ii) approximately $100 was for
amounts due to us from revenue collected by Broadslate, net of related costs,
during the customer transition period as provided for in the Broadslate Asset
Purchase Agreement. The Broadslate customer line acquisitions were accounted for
under the purchase method of accounting and, accordingly, the adjusted purchase
price of approximately $750 was allocated to the assets acquired based on their
estimated fair values at the date of acquisition as follows: approximately $28
to net accounts receivable acquired and approximately $722 to approximately 520
subscriber lines acquired, which amount was amortized on a straight-line basis
over two years from the date of purchase.
 
 In the
third quarter of 2002, we entered into an Asset Purchase Agreement dated as of
July 30, 2002 (the “Abacus Asset Purchase Agreement”) with Abacus America, Inc.
(“Abacus”) for the purchase of broadband subscriber lines. The Abacus Asset
Purchase Agreement provided for a cash payment for each successfully migrated
broadband customer line, up to a maximum payment of approximately $844 and
required a purchase price deposit of approximately $211. Ultimately, we were
able to migrate and acquire 1,066 lines for a purchase price of approximately
$543. The Abacus customer line acquisitions were accounted for under the
purchase method of accounting and, accordingly, the purchase price has been
allocated to the subscriber lines acquired based on their estimated fair values
at the date of acquisition. This amount was amortized on a straight-line basis
over two years from the date of purchase.
 
 *Contractual
Obligations.* As of
December 31, 2004, we had the following contractual obligations:
 
 Payments
      due by periodContractual
      Obligations
    
    Total
    
    Less
      than 1 year
    
    1-3
      years
    
    3-5
      years
    
    More
      than 5 yearsLong-Term
      Debt Obligations (1)
    
    $
    35,393
    
    $
    -
    
    $
    35,393
    
    $
    -
    
    $
    -Capital
      Lease Obligations
    
    
    51
    
    
    51
    
    
    -
    
    
    -
    
    
    -Operating
      Lease ObligationsFacilities
      Leases (2)
    
    
    1,205
    
    
    789
    
    
    416
    
    
    -
    
    
    -Operating
      Equipment &
      Maintenance
      Contracts
    
    
    152
    
    
    145
    
    
    7
    
    
    -
    
    
    -Purchase
      ObligationsSoftware
      Maintenance and
      Support
    
    
    402
    
    
    402
    
    
    -
    
    
    -
    
    
    -Marketing
      Services
    
    
    114
    
    
    108
    
    
    6
    
    
    -
    
    
    -Network
      Service Providers (3)
    
    
    11,771
    
    
    6,323
    
    
    5,145
    
    
    303
    
    
    -Total
    
    $
    49,088
    
    $
    7,818
    
    $
    40,967
    
    $
    303
    
    $
    -
 
 43
 **(Dollars
in Thousands, Except Per Share Amounts)**
 
 Notes:
 (1)
    Represents
      $30,000 aggregate principal amount of senior secured notes which mature on
      July 18, 2006 plus accrued interest of $1,143 and $4,250 aggregate
      principal amount of secured convertible note which matures on August 1,
      2006. Amounts shown on the Company’s balance sheets relating to this
      indebtedness at December 31, 2004 and 2003 are net of debt discounts.
(2)
    Office
      facility operating leases with minimum lease payments of approximately
      $788 in 2005, $233 in 2006, $169 in 2007 and $14 in
  2008.
(3)
    Includes
      early termination fees that would be assessable in connection with the
      termination of certain purchase commitments with various service
      providers. We
transmit data across our network via transmission facilities that are leased
from certain carriers, including Level 3 Communications, Inc. and MCI. The
failure of any of our data transport carriers to provide acceptable service on
acceptable terms could have a material adverse effect on our operations.
  In
addition to our contractual obligations identified in the above table, on July
22, 2004, we issued to VantagePoint, pursuant to a recapitalization agreement,
14,000 shares of Series Z preferred stock, with a liquidation preference, in
certain circumstances, of up to $1,120 per share, as more fully set forth in our
Certificate of Designation of Series Z Preferred Stock under our certificate of
incorporation.
  
 *Cash
Resources and Liquidity Constraints.* As of
December 31, 2004, we had cash and cash equivalents of approximately $7,079,
additional but restricted cash of approximately $2,432 and working capital of
approximately $4,273.
 
 We intend
to use our cash resources to finance our operating losses, capital expenditures,
lease payments, and working capital requirements, and for other general
corporate purposes, including the contractual obligations summarized above under
the heading, “Contractual Obligations.” The amounts actually expended for these
purposes will vary significantly depending on a number of factors, including our
ability to raise sufficient additional debt, equity or other capital, market
acceptance of our services, revenue growth, planned capital expenditures, cash
generated from operations, improvements in operating productivity, the extent
and timing of entry into new markets, the introduction of new products or
services, the modification or elimination of certain products or services, and,
to the extent that we seek additional acquisitions of complementary businesses,
subscriber lines and other assets to accelerate our growth and the availability
of and prices paid for acquisitions.
 
 We
experience end-user disconnections, or “churn,” that significantly impact our
ability to sustain or grow our revenue base. End-user churn is the result of
several factors, including (i) r ecent
consolidation in our industry and higher competition leading to reduced pricing
for the services we offer; (ii) end-users’
closing facilities, moving to new locations or ceasing operations; and (iii)
end-users’ determinations that less robust but lower-priced service offerings
from competitors are sufficient for their needs . While
we are working to reduce our end-user churn, many of the causes of such churn
are beyond our control. In addition, in the absence of our


44
 **(Dollars
in Thousands, Except Per Share Amounts)**





raising
additional funding to finance increased sales and marketing activities and new
customer acquisitions, our end-user churn will in all likelihood continue
to exceed the rate at which we can replace such disconnecting customers. As a
result, we anticipate that our end-user churn in the near term will continue to
result in declining revenue and will
adversely affect our cash generated from operations.


Our
actions during 2004 to reduce operating losses included a decision to eliminate
certain sales channels, reorganize our sales force and suspend certain marketing
initiatives. While such actions positively impacted our overall financial
performance for 2004, these actions have and continue to place downward pressure
on our ability to sustain or grow our revenue base. Additionally, if our
end-user churn increases or we are not able to offset such churn by increases in
new sales, we will experience increasing operating losses and decreasing cash
generated from operations in future periods.





Our
independent registered public accounting firm has noted in their report on our
financial statements that our sustained operating losses raise substantial doubt
about our ability to continue as a going concern. Based on our current business
plans and projections, we believe that our existing cash resources and cash
expected to be generated from operations will be sufficient to fund our
operating losses, capital expenditures, lease payments, and working capital
requirements at least through the third quarter of 2005. As a result, we will
need to raise additional financing, through some combination of borrowings or
the sale of equity or debt securities, during 2005 to finance our 2006
requirements and to enable us to repay all of our existing long-term debt. We
are pursuing financing alternatives to fund our anticipated cash deficiency and
to refinance our existing long-term debt. We may not be able to raise sufficient
additional debt, equity or other capital on acceptable terms, if at all. Failure
to generate sufficient revenues, contain certain discretionary spending, achieve
certain other business plan objectives, refinance our long-term debt or raise
additional funds could have a material adverse affect on our results of
operations, cash flows and financial position, including our ability to continue
as a going concern, and may require us to significantly reduce, reorganize,
discontinue or shut down our operations. Our financial statements do not include
any adjustments that might result from this uncertainty. **Off-balance
Sheet Arrangements**

We do not
have any off-balance sheet arrangements.

**RISK
FACTORS**

**Special
Note Regarding Forward-Looking Statements and Certain Other
Information**

This
report contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E
of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The
statements contained in this report, which are not historical facts, may be
deemed to contain forward-looking statements. These statements relate to future
events or our future financial or business performance, and are identified by
terminology such as “may,” “might,” “will,” “should,” “expect,” “scheduled,”
“plan,” “intend,” “anticipate,” “believe,” “estimate,” “potential,” or
“continue” or the negative of such terms or other comparable terminology. These
statements are subject to a variety of risks and uncertainties, many of which
are beyond our control, which could cause actual results to differ materially
from those contemplated in these forward-looking statements. In particular, the
risks and uncertainties include, among other things, those described below. Each
of these factors, and others, are discussed from time to time in our filings
with the Securities and Exchange


45
 **(Dollars
in Thousands, Except Per Share Amounts)**








Commission
copies of which may be accessed through the SEC’s website at http://www.sec.gov.
Existing and prospective investors are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date hereof. We
undertake no obligation, and disclaim any obligation, to update or revise the
information contained in this report, whether as a result of new information,
future events or circumstances or otherwise.





**Risks
Relating To Our Business**





**We
Have Incurred Losses And Expect Our Losses To Continue**





We have
incurred significant losses since our inception and have experienced negative
operating cash flow for each fiscal quarter since our formation, other than our
most recently completed fourth quarter 2004. We expect to continue to incur
significant losses throughout 2005 and there can be no assurance that we will
achieve or maintain positive operating cash flow for any future financial
quarters. Failure to generate sufficient revenues, contain certain discretionary
spending, achieve certain other business plan objectives or raise additional
funds, could have a material adverse affect on our results of operations, cash
flows and financial position, including our ability to continue as a going
concern ***.*** Our
independent registered public accounting firm has noted in its report on our
financial statements that our sustained operating losses raise substantial doubt
about our ability to continue as a going concern.


We intend
to use our cash resources to finance our operating losses, capital expenditures,
lease payments, and working capital requirements, and for other general
corporate purposes.





Our cash
requirements and financial performance, including our ability to achieve and
sustain profitability or become and remain cash flow positive, may vary based
upon a number of factors, including:


·
    our
      ability to raise sufficient additional
capital;


·
    our
      business plans or projections change or prove to be inaccurate;


·
    we
      curtail and/or reorganize our operations;




·
    development
      of the high-speed data and integrated voice and data communications
      industries and our ability to compete effectively in such
      industries;





·
    amount,
      timing and pricing of customer revenue;





·
    availability,
      timing and pricing of acquisition opportunities, and our ability to
      capitalize on such opportunities;





·
    identification
      of and generation of synergies with potential business combination
      candidates, and our ability to close any transactions with such parties on
      favorable terms, if at all;





·
    commercial
      acceptance of our services and our ability to attain expected penetration
      within our target markets;


46
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·
    our
      ability to recruit and retain qualified
personnel;





·
    up
      front sales and marketing expenses;





·
    cost
      and utilization of our network components that we lease from other
      telecommunications providers and that hinge, in substantial part, on
      government regulation that has been subject to considerable flux in recent
      years;




47
 **(Dollars
in Thousands, Except Per Share Amounts)**




·
    our
      ability to establish and maintain relationships with marketing partners;





·
    successful
      implementation and management of financial, information management and
      operations support systems to efficiently and cost-effectively manage our
      operations and growth; and





·
    favorable
      outcomes of numerous federal and state regulatory proceedings and related
      judicial proceedings, including proceedings relating to the 1996
      Telecommunications Act.





There can
be no assurance that we will be able to achieve our business plan objectives or
that we will achieve or maintain cash flow positive operating results. If we are
unable to generate adequate funds from our operations or raise additional funds,
we may not be able to continue to operate our network, respond to competitive
pressures or fund our operations. As a result, we may be required to
significantly reduce, reorganize, discontinue or shut down our operations. Our
financial statements do not include any adjustments that might result from this
uncertainty.





**Our
Independent Registered Public Accounting Firm Has Raised Questions About Our
Ability To Continue As A Going Concern In Their Report On Our Audited Financial
Statements, Which May Have An Adverse Impact On Our Ability To Raise Additional
Capital And On Our Stock Price**





Our
independent registered public accounting firm has included in its report on our
audited financial statements for the fiscal year ended December 31, 2004, an
explanatory paragraph relating to our ability to continue as a going concern.
This explanatory paragraph includes the following language: “The accompanying
financial statements have been prepared assuming that DSL.net will continue as a
going concern. As discussed in Note 1 to the financial statements, DSL.net has
suffered recurring losses from operations that raise substantial doubt about its
ability to continue as a going concern. Management’s plans in regard to these
matters are also described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.” The
inclusion of this explanatory paragraph in the report of our independent
registered public accounting firm may have an adverse impact on our ability to
raise additional capital and on our stock price. We cannot assure you that we
will be able to continue as a going concern.





**We
Have Incurred, And May Incur Additional, Significant Amounts Of Debt To
Implement Our Business Plan And This Indebtedness Creates Greater Financial And
Operating Risk And Limits Our Flexibility**





We issued
$30,000 in notes in July 2003. In addition, in connection with our convertible
note and warrant financing, on October 7, 2004, we issued a minimum borrowing
note for $4,250 and a revolving note for $750. Those notes contain provisions
that limit our ability to incur additional indebtedness and place other
restrictions on our business. We may seek additional debt financing in the
future and may or may not be able to obtain such debt. We may not be able to
repay or refinance any existing or future long-term debt. If we incur additional
debt, we may be required to devote increased amounts of our cash flow to service
indebtedness. Our incurrence of additional debt, and/or our inability to repay
or finance any existing or future debt, could require us to modify, delay or
abandon certain aspects of our business plan, or require us to significantly
reduce, reorganize, discontinue or shut down our operations.





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****


**The
Use Of Proceeds From The Investment By Laurus Master Fund, Ltd. As Part Of Our
2004 Convertible Note And Warrant Financing Is Subject To Approval Of Our Senior
Noteholders**





A portion
of the proceeds we received in our October 2004 convertible note and warrant
financing with Laurus Master Fund, Ltd described above under the heading
“Liquidity and Capital Resources” are currently being held in an account of
DSL.net at DBTCA and our withdrawal and use of such proceeds are subject to the
prior approval of DBTCA and of DB Advisors, L.L.C., as advisor to Deutsche Bank.
Such prior approval is in the sole discretion of DBTCA and DB Advisors, L.L.C.,
as advisors to Deutsche Bank, and, therefore, we cannot assure you that all of
those funds will be made available to us to finance our continuing operations or
to further our strategic initiatives. We will require these monies for working
capital purposes and, if these funds are not made available to us, our ability
to sustain operations will be materially adversely affected and we may be
required to significantly reduce, reorganize, discontinue or shut down our
operations.





**Additional
Financing Will Be Required If We Are To Sustain Our Operations, Repay All Of Our
Long-Term Debt Or Achieve Our Strategic and Operating
Objectives**





Based on
our current business plans and projections, we believe that our existing cash
resources and cash expected to be generated from operations will be sufficient
to fund our operating losses, capital expenditures, lease payments, and working
capital requirements at least through the third quarter of 2005. As a result, we
will need to raise additional financing, through some combination of borrowings
or the sale of equity or debt securities, during 2005 to finance our 2006
requirements and to enable us to repay all of our existing long-term debt. We
may not be able to raise sufficient additional debt, equity or other capital on
acceptable terms, if at all. Failure to generate sufficient revenues, contain
certain discretionary spending, achieve certain other business plan objectives,
refinance our long-term debt or raise additional funds could have a material
adverse affect on our results of operations, cash flows and financial position,
including our ability to continue as a going concern, and may require us to
significantly reduce, reorganize, discontinue or shut down our operations.





**Because
The High-Speed Data And Integrated Voice And Data Communications Industries
Continue to Rapidly Evolve, We Cannot Predict Their Future Growth Or Ultimate
Size**





The
high-speed data and integrated voice and data communications industries are
subject to rapid and significant technological change. Because the technologies
available for high-speed data and integrated voice and data communications
services are rapidly evolving, we cannot accurately predict the rate at which
the market for our services will grow, if at all, or whether emerging
technologies will render our services less competitive or obsolete. If the
market for our services fails to develop or grows more slowly than anticipated,
our business, prospects, financial condition and results of operations could be
materially adversely affected. Many providers of high-speed data and integrated
voice and data communication services are testing products from numerous
suppliers for various applications.





**Our
Business Model Is Unproven, And May Not Be Successful**





We do not
know whether our business model and strategy will be successful. If the
assumptions underlying our business model are not valid or we are unable to
implement our business plan, achieve the predicted level of market penetration
or obtain the desired level of pricing of our services for sustained periods,
our business, prospects, financial condition and results of operations could be
materially adversely affected. We have adopted a different strategy





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than
certain other broadband Internet service providers and DSL providers. We focus
on selling directly, and through resellers, to small and medium sized businesses
and branch offices of larger businesses and their remote office users. Our
unproven business model makes it difficult to predict the extent to which our
services will achieve market acceptance. It is possible that our efforts will
not result in significant market penetration, favorable operating results or
profitability.





**If
Our Services Fail To Achieve Or Sustain Market Acceptance At Desired Pricing
Levels, Our Ability To Achieve Or Sustain Profitability Or Positive Cash Flow
Would Be Impaired**





Prices
for digital communication services have fallen historically. Accordingly, we
cannot predict to what extent we may need to reduce our prices to remain
competitive or whether we will be able to sustain future pricing levels as our
competitors introduce competing services or similar services at lower prices. If
our services fail to achieve or sustain market acceptance at desired pricing
levels, our ability to achieve or sustain profitability or positive cash flow
would be impaired, which would have a material adverse effect on our business,
prospects, financial condition and results of operations.





**We
May Be Subject To Risks Associated With Strategic
Opportunities**





We may
not be able to compete successfully for strategic opportunities, including
merger and acquisition, business combination and strategic partnering
opportunities. We may not have the capital resources available to make strategic
acquisitions that would accelerate our growth or expand our services and, if we
complete further acquisitions, we may not have sufficient working capital to
operate the acquired assets or businesses profitably. We have made a number of
strategic asset and business acquisitions. We intend to continue to seek
strategic opportunities that we believe represent distinct market opportunities
to accelerate our growth. We continuously identify and evaluate strategic
opportunities, including strategic partnerships, business combinations, and
merger and acquisition candidates, and in many cases engage in discussions and
negotiations regarding potential transactions. Our discussions and negotiations
may not result in any transaction. There is significant competition for
strategic opportunities in our business. As the consolidation in our industry
continues, this competition may intensify and increase the costs of capitalizing
on such opportunities. We compete for acquisition opportunities with companies
that have significantly greater financial and management resources. Our ability
to pursue a future customer acquisition or similar strategic acquisition for
cash is dependent upon our ability to raise additional capital. Also, to the
extent all or part of the purchase price of any future acquisition is paid in
cash, that would deplete our remaining cash resources. In addition, an
acquisition may not produce the revenue, earnings, cash flows or business
synergies that we anticipate, an acquired asset or business might not perform as
we anticipated, and a strategic transaction such as a merger might not yield
positive operating results for the combined businesses. Any such event may delay
the time at which we expect to achieve profitability or positive cash flows.
Further, if we pursue any future acquisition or other strategic opportunities,
our management could spend a significant amount of time and effort in
identifying and completing the transaction and may be distracted from the
operation of our business. We will also have to devote a significant amount of
management resources to integrating any acquired businesses, with our existing
operations, and that may not be successful.





**Our
Management Team Is Critical And The Loss Of Key Personnel Could Adversely Affect
Our Business**





We depend
on a small number of executive officers and other members of senior management
to work effectively as a team, to execute our business strategy and business
plan,





50
 **(Dollars
in Thousands, Except Per Share Amounts)**





and to
manage employees located in several locations across the United States. The loss
of key managers or their failure to work effectively as a team could have a
material adverse effect on our business and prospects. We cannot guarantee that
our key employees will desire to continue their employment with DSL.net over any
period of time and thus there is the risk that any or all of these individuals
may seek employment opportunities with other employers at any time. Further,
there is no assurance that we will be able to attract highly-qualified
employees, as we have in the past, to replace key personnel in the future.





**Our
Failure To Maintain The Necessary Infrastructure To Support Our Business And To
Manage Our Growth Could Strain Our Resources And Adversely Affect Our Business
And Financial Performance**





We have
had significant growth in the number of markets in which we provide service and
the number of customers subscribing for our services. This growth has placed a
significant strain on our management, financial controls, operations, personnel
and other resources. We have deployed operations support systems to help manage
customer service, bill customers, process customer orders and coordinate with
vendors and contractors. Subsequent integration and enhancement of these systems
could be delayed or cause disruptions in service or billing. To efficiently and
cost-effectively manage our geographically dispersed business, we must continue
to successfully implement these systems on a timely basis, and continually
expand and upgrade these systems as our operations expand.





**If
We Fail To Retain Our Employees Or Recruit Qualified Personnel In A Timely
Manner, We Will Not Be Able To Execute Our Business Plan And Our Business Will
Be Harmed**





To
execute our business plan, we need to hire and retain qualified personnel. If we
are unable to retain our employees or recruit qualified personnel in a timely
manner, we will not be able to execute our business plan. The reductions in
workforce that we have made since 2000, including the restructuring of our sales
team and our work force reduction in September 2004 and the competitive nature
of our industry, may make it difficult for us to hire qualified personnel on a
timely basis and to retain our employees.





**Disappointing
Quarterly Revenue, Operating Results Or Operating Statistics Could Cause The
Price Of Our Common Stock To Fall**





Our
quarterly revenue, operating results and operating statistics are difficult to
predict and may fluctuate significantly from quarter to quarter. If our
quarterly revenue, operating results or operating statistics fall below the
expectations of investors or security analysts, the price of our common stock
could fall substantially. Our quarterly revenue, operating results and operating
statistics may fluctuate as a result of a variety of factors, many of which are
outside of our control, including:





·
    the
      timing and success of acquisitions, if any;





·
    the
      timing of the rollout of our services and any additional infrastructure,
      and the amount and timing of expenditures relating thereto;





·
    regulatory
      and legal developments;





51
 **(Dollars
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·
    the
      rate at which we are able to attract customers and our ability to retain
      these customers at sufficient aggregate revenue levels;





·
    the
      availability of financing;





·
    technical
      difficulties or network service interruptions;
and





·
    the
      introduction of new services or technologies by our competitors and
      resulting pressures on the pricing of our
services.





**The
Failure Of Our Customers To Pay Their Bills On A Timely Basis Could Adversely
Affect Our Cash Flow**





Our
target customers consist mostly of small and medium sized businesses. We bill
and collect numerous relatively small customer accounts. We may experience
difficulty in collecting amounts due on a timely basis. In addition, with the
acquisition of the Network Access Solutions assets on January 10, 2003, we
acquired a number of end users that we service indirectly through various
Internet service providers. We sell our services to such Internet service
providers who then resell such services. Our failure to collect accounts
receivable owed to us by our customers on a timely basis could have a material
adverse effect on our business, financial condition and cash flow.





**We
Depend On Wholesale DSL And T-1 Providers, Some Of Whom Are Competitors, To
Provide Us With Local Facilities In Areas Where We Have Not Deployed Our Own
Equipment**





In
markets where we have not deployed our own local DSL and T-1 equipment, we
utilize local facilities from wholesale providers, including Covad
Communications, in order to provide service to our end-user customers. In these
cases, we are dependent upon these wholesale carriers to provide, or arrange the
provision of, the equipment and on-site wiring required to provide local DSL or
T-1 services to our end-user customers, as well as to provide and maintain the
local DSL or T-1 line. In general, these carriers may terminate the service they
provide to us with little or no notice. These carriers may not continue to
provide us with acceptable local services for our customers on the scale, at the
price levels and within the time frames we require, or at all. If we are unable
to obtain acceptable services from these wholesale carriers or they terminate
the service they provide us, we may be required to install our own equipment in
a central office and provide and install new equipment for our customers, or
arrange for another wholesale carrier to do so. Obtaining space and provisioning
equipment in a new central office is a lengthy and costly process. We cannot
assure you that we, or another carrier with whom we work, would be able to
obtain the space required in a central office on a cost effective basis, if at
all, or that we could provide services to such customers on a timely basis. Our
failure to install and provide services to customers on a timely basis, or the
disruption in the services provided to our customers, would likely result in the
loss of many, if not all, of the customers in the affected locations, and could
result in claims brought by these customers against us. This could have a
material adverse effect on our competitive position, business, results of
operations, financial position and prospects.





Certain
wholesale providers with whom we work offer services that compete with ours, or
have other customers whose services compete with ours. Such competing interests
may affect the ability or willingness of these providers to provide us with
acceptable services on acceptable terms. In addition, certain of these providers
are relatively young companies that are facing





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substantial
operational and financial challenges. The operational success and abilities of
these carriers to operate their businesses could materially affect our business.
The failure of any of these companies could cause us to lose customers and
revenue, expose us to claims and otherwise have a material adverse effect on our
competitive position, business, results of operations, financial position and
prospects.





**Our
Services Are Subject To Federal, State And Local Regulation, And Changes In Laws
Or Regulations Could Adversely Affect The Way We Operate Our
Business**





The
facilities we use and the services we offer are subject to varying degrees of
regulation at the federal, state and local levels. Changes in applicable laws or
regulations could, among other things, increase our costs, restrict our access
to the network elements and central offices of the traditional local telephone
companies, or restrict our ability to provide our services. For example, the
1996 Telecommunications Act, which, among other things, requires traditional
local telephone companies to unbundle network elements and to allow competitors
to locate their equipment in the traditional local telephone companies’ central
offices, is the subject of ongoing proceedings at the federal and state levels,
litigation in federal and state courts, and legislation in federal and state
legislatures. In particular, the TRRO that became effective on March 11, 2005,
limits our ability to obtain DS1 loops and DS1 and DS3 transport facilities from
and between certain ILEC central offices. We will not be able to obtain new such
facilities in the impacted central offices other than at special access or
negotiated prices that are higher than the discounted unbundled prices that we
have historically paid for such facilities. Additionally our existing DS1 loops
and DS1 and DS3 transport facilities in those impacted central offices will
likely be subject to at least a 15% price increase in 2005 and further increases
thereafter. We are currently assessing the potential impact on our network costs
resulting from the TRRO, as well as evaluating our network configuration
alternatives to minimize increases to our network costs. We will pursue
negotiation of favorable terms for these circuits with the traditional telephone
companies and/or with alternate providers, however, we cannot guarantee the
outcome of these negotiations will not materially impact our business.





**Our
Success Depends On Negotiating And Entering Into Interconnection Agreements With
Traditional Local Telephone Companies**





We must
enter into and renew interconnection agreements with traditional local telephone
companies in each market in which we deploy our own equipment. These agreements
govern, among other things, the price and other terms regarding our location of
equipment in the traditional local telephone companies’ offices, known as
central offices, and our lease of copper telephone lines that connect those
central offices to our customers. We have entered into agreements with
BellSouth, Cincinnati Bell, Frontier, SBC Communications, Qwest, Sprint and
Verizon, or their subsidiaries, which govern our relationships in 49 states and
the District of Columbia. Delays in obtaining or renewing interconnection
agreements would delay our entrance into new markets or impact our operations in
existing markets, and could have a material adverse effect on our business and
prospects. In addition, disputes have arisen, and will likely arise in the
future, regarding the interpretation of these interconnection agreements. These
disputes have, in the past, delayed the deployment of our network. Our
interconnection agreements generally have limited terms of one to two years and
we cannot assure you that new agreements will be negotiated on a timely basis,
if at all, or that existing agreements will be extended on terms favorable to
us. Interconnection agreements must be approved by state regulators and are also
subject to oversight by the FCC and the courts. These governmental authorities
may modify the terms or prices of our interconnection agreements in ways that
could adversely affect our ability to deliver service and our business and
results of operations.





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****


**Failure
To Negotiate Interconnection Agreements With The Traditional Local Telephone
Companies Could Lead To Costly And Lengthy Arbitration Which May Not Be Resolved
In Our Favor**





Under
federal law, traditional local telephone companies have an obligation to
negotiate with us in good faith for agreements for interconnection and access to
certain individual elements of their networks that the FCC or a state utility
commission has required them to provide to competitors such as us. In August
2003 and again in February 2005. the FCC adopted new unbundling rules for
network elements that have not yet been implemented in our interconnection
agreements. The FCC’s new rules have reduced the traditional local telephone
companies’ obligations to provide us with certain network elements at unbundled
element discount prices, including DS1 loops and DS1 and DS3 transport
facilities in certain central offices. Consequently, our future interconnection
agreements with traditional local telephone companies are likely to contain
terms and conditions less favorable to us than those in our current agreements
and could result in our incurring increased network operating
costs.





During
our interconnection agreement negotiations, either the telephone company or we
may submit disputes to the state regulatory commissions for mediation. Also,
after the expiration of the statutory negotiation period set forth in the 1996
Telecommunications Act, we may submit outstanding disputes to the states for
binding arbitration, in which the state regulatory commissions may arbitrate a
new agreement or particular portions thereof. Arbitration is a costly and
lengthy process that could delay our entry into markets and could harm our
ability to compete. Interconnection agreements resulting from arbitration must
be approved by state regulators. We cannot assure you that a state regulatory
authority would resolve disputes in our favor.





**Our
Success Depends On Traditional Local Telephone Companies Providing Acceptable
Transmission Facilities And Copper Telephone Lines**





We
interconnect with and use the networks of traditional local telephone companies
to provide services to our customers in the markets where we have deployed our
own equipment. In markets where we utilize the local facilities of other
carriers to provide our service, those carriers must interconnect with and use
the networks of traditional local telephone companies to provide this service.
We cannot assure you that these networks will be able to meet the
telecommunications needs of our customers or maintain our service standards. We
also depend on the traditional local telephone companies to provide and maintain
their transmission facilities and the copper telephone lines between our network
and our customers’ premises. The FCC’s decision in 2003 to exempt the
traditional local telephone companies from their obligation to provide access to
certain loop transmission facilities that use fiber or new technologies to
competitors such as us may motivate the traditional local telephone companies to
modify, characterize or replace their facilities in ways that would qualify them
for this exemption and thereby preclude us from accessing those facilities. Our
dependence on traditional local telephone companies could cause delays in
establishing our network and providing our services. Any such delays could have
a material adverse effect on our business. We, and the other competitive
carriers with which we work, lease copper telephone lines running from the
central office of the traditional local telephone companies to each customer’s
location. In many cases, the copper telephone lines must be specially
conditioned by the telephone company to carry digital signals. We may not be
able to obtain a sufficient number of acceptable telephone lines on acceptable
terms, if at all. Traditional telephone companies often rely on unionized labor
and labor-related issues have in the past, and may in the future, adversely
affect the services provided by the traditional telephone
companies.





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****


**We
Compete With The Traditional Local Telephone Companies On Which We
Depend**





Most of
the traditional local telephone companies, including those created by AT&T’s
divestiture of its local telephone service business, offer DSL-based services.
In addition, these companies also currently offer high-speed data communications
services that use other technologies, including T-1 services. Consequently,
these companies have certain incentives to delay:





·
    our
      entry into, and renewals of, interconnection agreements with
      them;





·
    our
      access to their central offices to install our equipment and provide our
      services;





·
    provisioning
      of acceptable transmission facilities and copper telephone lines on our
      behalf; and





·
    our
      introduction and expansion of various
services.





Any such
delays could negatively impact our ability to implement our business plan and
harm our competitive position, business and prospects.





In
addition, the other carriers whose local facilities we utilize in markets where
we have not deployed our own equipment also compete with the traditional local
telephone companies and rely on these companies for the same facilities and
services that we do. Any delay in the provision of acceptable transmission
facilities and copper telephone lines provided by the traditional local
telephone companies to these carriers which are used in the provision of our
service could negatively impact our ability to implement our business plan and
harm our competitive position, business and prospects.





Competition
from the traditional local telephone companies offering DSL, T-1 or other
competitive high-speed data and integrated voice and data communications
services in a specific market may adversely impact our ability to obtain
customers in that area and harm our competitive position, business and
prospects. These companies have established brand names and reputations for
quality in their service areas, possess a large, existing customer base to whom
they can market their various products and services, possess sufficient capital
to deploy broadband equipment rapidly, have their own copper telephone lines and
can bundle digital data services with their existing voice services to achieve a
competitive advantage in serving customers. In addition, we depend upon these
traditional local telephone companies to provide us access to their central
offices and to individual elements of their networks. As a result, they can
significantly influence the actual and perceived reliability, quality and
timeliness of our services in their service areas. The perceived relative
stability of the traditional local telephone companies, particularly in light of
the failure of certain competitive telephone companies and the financial and
operational issues surrounding other such companies, provides the traditional
local telephone companies a significant competitive advantage.





**We
Depend On Long Distance Carriers To Connect Our Network**





Data is
transmitted across our network via transmission facilities that we lease from
long distance carriers, including Level 3 Communications and MCI. Failure of
these carriers to





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provide
service or to provide quality service may interrupt the use of our services by
our customers. The service provided by these carriers has been interrupted in
the past, which has affected the services we provide to our customers. We cannot
be sure that this service will not be interrupted in the future.





**Intense
Competition In The High-Speed Data And Integrated Voice And Data Communication
Services Market May Negatively Affect The Number Of Our Customers And The
Pricing Of Our Services**





The
high-speed data and integrated voice and data communication services market is
intensely competitive. If we are unable to compete effectively, our business,
prospects, financial condition and results of operations would be adversely
affected. We expect the level of competition to intensify in the future, due, in
part, to increasing consolidation in the data communications industry and
increased competition in the integrated voice and data communications industry
as technological advances are deployed by our competitors, both established and
new market entrants, in this service area. Our competitors use various high
speed communications technologies for local access connections such as
integrated services digital network, (or “ISDN”), frame relay, T-1,  DSL
services and wireless, satellite-based and cable networks. We expect
significant competition from:





·
    Other
      providers of DSL and T-1 services, including Covad Communications and New
      Edge Networks;





·
    Internet
      service providers, such as Speakeasy, EarthLink and MegaPath, which offer
      high-speed access capabilities, as well as other related products and
      services;





·
    Traditional
      local telephone companies, including the traditional local telephone
      companies created by AT&T’s divestiture of its local telephone service
      business, which deploy DSL and T-1 services and which provide other
      high-speed data communications services, including fiber loops that may
      offer greater capacity to end users than our services;





·
    Competitive
      carriers offering their own integrated voice and data services, including
      Cbeyond Communications, LLC and DSLi;





·
    National
      long distance carriers, such as AT&T, Sprint, Williams and MCI, some
      of which are offering competitive DSL and T-1 services and other
      high-speed data communications services;





·
    Cable
      modem service providers, such as Time-Warner Cable, Comcast and RCN, which
      are offering high-speed Internet access over cable networks; and





·
    Providers
      utilizing alternative technologies, such as fiber optic, broadband over
      powerlines, wireless and satellite-based data service
      providers.





Many of
our current and potential competitors have longer operating histories, greater
brand name recognition, larger customer bases and substantially greater
financial, technical, marketing, management, service support and other resources
than we do. Therefore, they may be able to respond more quickly than we can to
new or changing opportunities, technologies, standards or customer requirements.





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****


**Our
Failure To Develop And Maintain Good Relationships With Marketing Partners In A
Local Service Market Could Adversely Affect Our Ability To Obtain And Retain
Customers In That Market**





In
addition to marketing through our direct sales force, we rely on relationships
with local marketing partners, such as integrators of computer systems and
networks and consultants. These partners recommend our services to their
clients, provide us with referrals and help us build a local presence in each
market. We may not be able to identify, and maintain good relationships with,
quality marketing partners and we cannot assure you that they will recommend our
services rather than our competitors’ services to their customers. Our failure
to identify and maintain good relationships with quality marketing partners
could have a material adverse effect on our ability to obtain and retain
customers in a market and, as a result, our business would suffer.





**Uncertain
Tax And Other Surcharges On Our Services May Increase Our Payment Obligations To
Federal And State Governments**





Telecommunications
providers are subject to a variety of federal and state surcharges and fees on
their gross revenues from interstate and intrastate services. These surcharges
and fees may be increased and other surcharges and fees not currently applicable
to our services could be imposed on us. In either case, the cost of our services
would increase and that could have a material adverse effect on our business,
prospects, financial condition and results of operations.





**A
System Failure Could Delay Or Interrupt Service To Our
Customers**





Our
operations depend upon our ability to support a highly complex network
infrastructure and avoid damage from fires, earthquakes, floods, power losses,
excessive sustained or peak user demand, telecommunications failures, network
software flaws, computer worms and viruses, transmission cable cuts and similar
events. The occurrence of a natural disaster or other unanticipated interruption
of service at our owned or leased facilities could cause interruptions in our
services. In addition, failure of a traditional telephone company, competitive
telecommunications company or other service provider to provide communications
capacity or other services that we require, as a result of a natural disaster or
other unanticipated interruptions, operational disruption or any other reason,
could cause interruptions in our services. Any damage or failure that causes
sustained interruptions in our operations could have a material adverse effect
on our business.





**A
Breach Of Our Network Security Could Result In Liability To Us And Deter
Customers From Using Our Services**





Our
network may be vulnerable to unauthorized access, computer viruses and other
disruptive problems. Any of the foregoing problems could result in liability to
us and deter customers from using our service. Unauthorized access could
jeopardize the security of confidential information stored in the computer
systems of our customers. Eliminating computer viruses and alleviating other
security problems may require interruptions, delays or cessation of service to
our customers, cause us to incur significant costs to remedy the problem, and
divert management’s attention. We can provide no assurance that the security
measures we have implemented will not be circumvented or that any failure of
these measures will not have a material adverse effect on our ability to obtain
and retain customers. Any of these factors could have a material adverse effect
on our business and prospects.





57
 **(Dollars
in Thousands, Except Per Share Amounts)**


****


**Our
Failure To Adequately Protect Our Proprietary Rights May Adversely Affect Our
Business**





We rely
on unpatented trade secrets and know-how to maintain our competitive position.
Our inability to protect these secrets and know-how could have a material
adverse effect on our business and prospects. We protect our proprietary
information by entering into confidentiality agreements with employees and
consultants and business partners. These agreements may be breached or
terminated. In addition, third parties, including our competitors, may assert
infringement claims against us. Any of such claims could result in costly
litigation, divert management’s attention and resources, and require us to pay
damages and/or to enter into license or similar agreements under which we could
be required to pay license fees or royalties.





**We
May Be Exposed To Liability For Information Carried Over Our Network Or
Displayed On Web Sites That We Host**





Because
we provide connections to the Internet and host web sites for our customers, we
may be perceived as being associated with the content carried over our network
or displayed on web sites that we host. We do not and cannot screen all of this
content. As a result, we may face potential liability for defamation,
negligence, copyright, patent or trademark infringement and other claims based
on the content carried over our network or displayed on web sites that we host.
These types of claims have been brought against providers of online services in
the past and can be costly to defend regardless of the merit of the lawsuit. The
protection offered by recent federal legislation that protects online services
from some claims when the material is written by third parties is limited.
Further, the law in this area remains in flux and varies from state to state. We
may also suffer a loss of customers or reputational harm based on this content
or resulting from our involvement in these legal proceedings.





**Risks
Relating To Ownership Of Our Common Stock**





**Our
Stock Price Could Fluctuate Widely In Response To Various Factors, Many Of Which
Are Beyond Our Control**





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





·
    actual
      or anticipated variations in our quarterly operating results or operating
      statistics or our financial condition;





·
    announcements
      of new products or services by us or our competitors or new competing
      technologies;





·
    the
      addition or loss of customers;





·
    changes
      in financial estimates or recommendations by securities
      analysts;





·
    conditions
      or trends in the telecommunications industry, including regulatory or
      legislative developments;





·
    growth
      of Internet and on-line commerce usage and the Internet and on-line
      commerce industries;





58
 **(Dollars
in Thousands, Except Per Share Amounts)**


·
    announcements
      by us of significant acquisitions, strategic partnerships, joint ventures
      or capital commitments;





·
    additions
      or departures of our key personnel;





·
    future
      equity or debt financings by us or our announcements of such financings;
      and





·
    general
      market and economic conditions.





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





**Our
Common Stock May Be De-listed From The American Stock Exchange, Which May Have A
Material Adverse Impact On The Trading Prices And Trading Of Our Common
Stock**





On August
4, 2004, we transferred the listing of our common stock to the American Stock
Exchange from the Nasdaq SmallCap Market. While we currently meet the listing
requirements of the American Stock Exchange, there can be no assurance that we
will continue to meet these requirements and that shares of our common stock
will remain listed on the American Stock Exchange.





**Certain
Investors Have Significant Influence Regarding Most Matters Requiring
Stockholder Approval, Which Could Have A Material Adverse Effect On The Market
Price Of Our Common Stock.**





As of
March 1 2005, VantagePoint, together with VantagePoint Associates, L.L.C., owned
of record approximately 55.1 million shares of our outstanding common stock, and
14,000 **** shares of
our outstanding Series Z preferred stock, which represented approximately 24% of
the combined voting power of all issued and outstanding capital stock of the
Company. In addition, as of March 1, 2005, that group owns exercisable warrants
to purchase an aggregate of 53,326,566 shares of our common stock (exclusive of
warrants to purchase 4,785,751 shares of our common stock that are exercisable
solely upon the occurrence of certain conditions involving a change of control
of the Company). As long as VantagePoint entities maintains a certain level of
ownership of our common stock (or warrants to purchase shares of common stock),
VantagePoint is entitled to elect two members of our Board of Directors, subject
to the provisions of a stockholders agreement relating to the election of
directors. As a result, subject to the provisions of the stockholders agreement,
VantagePoint can significantly influence most matters requiring board or
stockholder approval, including approval of significant corporate transactions.
Further, subject to the terms of such stockholders agreement, the investors who
are parties thereto have agreed to vote their shares of voting capital stock of
the Company to cause and maintain the election to our Board of Directors of one
representative of Deutsche Bank, for so long as certain investment thresholds
are maintained. This concentration of ownership and/or board control may have
the effect of delaying, preventing or deterring a change in control, could
deprive our stockholders of an opportunity to receive a premium for their common
stock as part of a sale and might affect the market price of our common
stock.





59
 **(Dollars
in Thousands, Except Per Share Amounts)**


****


**If
Our Outstanding Options And Warrants Are Exercised Or Our Outstanding
Convertible Debt Is Converted Into Common Stock, It Will Result In
Dilution**





As of
March 1, 2005, we had 233,619,817 shares of common stock issued and outstanding.
We also had obligations to issue (i) approximately 227,725,782 shares of common
stock under outstanding stock options and warrants and the convertible minimum
borrowing note issued to Laurus (exclusive of common stock which may be issuable
in lieu of payment for accrued but unpaid interest on the MB Note), and (ii) a
contingent obligation to issue approximately 19,143,000 shares of common stock
under warrants issued on October 7, 2004, to our senior noteholders in exchange
for their subordination of certain rights to our accounts receivable that
facilitated the closing of our financing with Laurus, that are exercisable, now
that stockholder approval has been obtained, only following a qualifying change
of control of DSL.net. The issuance of these additional shares of common stock
may be dilutive to our current stockholders and could negatively impact the
market price of our common stock.





**If
Certain Transactions Occur, The Value That The Holders Of Our Common Stock May
Receive Will Be Adversely Affected by Our Outstanding Debt and Preferred Stock
Obligations.**







If the
Company enters into certain transactions, the value that the holders of our
common stock may receive as a result of any such transaction will be adversely
affected by the Company’s outstanding debt and preferred stock. As of December
31, 2004, the Company’s existing long-term debt consisted of $30,000 aggregate
principal amount of senior secured notes which mature on July 18, 2006 and
$4,250 aggregate principal amount of secured convertible note which matures on
August 1, 2006. Further, the Company’s issued and outstanding Series Z preferred
stock has an aggregate liquidation preference of up to $15,680, which is payable
in the event of any liquidation, dissolution or winding up of the Company
(including a transaction approved in advance by the board of directors of the
Company for: (i) the sale of the Company to another entity in a reorganization,
merger, consolidation or otherwise, if following such transaction or series of
transactions the holders of the outstanding voting power of the Company prior to
such transaction would own less than a majority of the voting power of the
surviving entity or (ii) the sale of substantially all of the assets of the
Company). The Company is pursuing financing and strategic opportunities in order
to fund its operations, growth and business plan objectives and to refinance its
long-term debt obligations. As part of this process, the Company is also
considering various strategic business combination, merger and acquisition
opportunities. These activities may or may not result in a sale of the Company
or some or all of its assets, whether through asset sale, merger or other
business combination. There can be no assurance that a sale transaction, merger
or liquidating distribution by the Company will result in any minimum value or
minimum amount of proceeds accreting to the benefit of our common stockholders
as a result of any such transaction, should one occur.


**Certain
Provisions Of Our Charter, By-Laws And Delaware Law Could Make A Takeover
Difficult**





Our
corporate documents and Delaware law contain provisions that might enable our
management to resist a third-party takeover. These provisions include a
staggered board of directors, limitations on persons authorized to call a
special meeting of stockholders, advance notice procedures required for
stockholders to make nominations of candidates for election as directors or to
bring matters before an annual meeting of stockholders, and the rights of
certain





60
 **(Dollars
in Thousands, Except Per Share Amounts)**





significant
holders of our capital stock to designate members of our Board of Directors.
These provisions might discourage, delay or prevent a change in control by a
third-party or a change in our management. These provisions could also
discourage proxy contests and make it more difficult for our stockholders to
elect directors and take other corporate actions. The existence of these
provisions could limit the price that investors might be willing to pay in the
future for shares of our common stock and could deprive our stockholders of an
opportunity to receive a premium for their common stock as part of a
sale.





**Item
7A. Quantitative and Qualitative Disclosures About Market
Risk**





We have
no derivative financial instruments in our cash and cash equivalents. We invest
our cash and cash equivalents in investment-grade, highly liquid investments,
consisting of commercial paper, bank certificates of deposit and corporate
bonds.
















61





**Item
8. Financial Statements and Supplementary Data**





**REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**








To the
Board of Directors and Stockholders of DSL.net, Inc.:





In our
opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in stockholders' equity, and
of cash flows present fairly, in all material respects, the financial position
of DSL.net, Inc. and its subsidiaries at December 31, 2004 and 2003 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the standards of the
Public Company Accounting Oversight Board (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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

















PricewaterhouseCoopers
LLP


Stamford,
CT


March 22,
2005





62







**DSL.net,
      Inc.****CONSOLIDATED
      BALANCE SHEETS**(dollars
      in thousands, except per share data)December
      31,ASSETS
    
    2004
    
    2003Current
      assets:Cash
      and cash equivalents
    
    $
    7,079
    
    $
    13,779Accounts
      receivable (net of allowances of $874 and $902at
      December 31, 2004 and 2003, respectively)
    
    
    6,344
    
    
    8,054Inventory
    
    
    438
    
    
    477Deferred
      costs
    
    
    424
    
    
    931Prepaid
      expenses and other current assets
    
    
    3,914
    
    
    1,002Total
      current assets
    
    
    18,199
    
    
    24,243Fixed
      assets, net
    
    
    12,719
    
    
    24,357Goodwill
    
    
    8,482
    
    
    8,482Other
      intangible assets, net
    
    
    47
    
    
    1,010Other
      assets
    
    
    1,415
    
    
    969Total
      assets
    
    $
    40,862
    
    $
    59,061LIABILITIES,
      MANDATORILY REDEEMABLE, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
    
    $
    5,887
    
    $
    3,570Accrued
      salaries
    
    
    730
    
    
    1,046Accrued
      liabilities
    
    
    2,459
    
    
    7,529Deferred
      revenue
    
    
    4,800
    
    
    6,068Current
      portion of capital leases payable
    
    
    50
    
    
    105Total
      current liabilities
    
    
    13,926
    
    
    18,318Capital
      leases payable
    
    
    -
    
    
    50Notes
      payable, net of discount
    
    
    14,544
    
    
    5,374Financial
      instrument derivatives
    
    
    286
    
    
    -Total
      liabilities
    
    
    28,756
    
    
    23,742Commitments
      and contingencies (Note 7)Mandatorily
      redeemable, convertible preferred stock :20,000,000
      preferred shares authorized: 20,000 shares designated as Series X,mandatorily
      redeemable, convertible preferred stock, $.001 par value; 0 and 20,000shares
      issued and outstanding as of December 31, 2004 and December 31, 2003,respectively;
      liquidation preference: $0 and $24,660 as of December 31, 2004and
      December 31, 2003, respectively
    
    
    -
    
    
    16,23120,000,000
      preferred shares authorized: 15,000 shares designated as Series Y,mandatorily
      redeemable, convertible preferred stock, $.001 par value; 0 and 1,000shares
      issued and outstanding as of December 31, 2004 and December 31, 2003,respectively;
      liquidation preference: $0 and $1,211 as of December 31, 2004and
      December 31, 2003, respectively
    
    
    -
    
    
    788Stockholders’ equity :Preferred
      Stock: 20,000,000 preferred shares authorized: 14,000 shares designated asSeries
      Z, $.001 par value; 14,000 and 0 shares issued and outstanding as ofDecember
      31, 2004 and December 31, 2003, respectively; liquidation preference:$15,680
      and $0 as of December 31, 2004 and December 31, 2003,
      respectively
    
    
    2,630
    
    
    -Common
      stock, $.0005 par value; 800,000,000 shares authorized, 233,619,817 and105,449,054
      shares issued and outstanding as of December 31, 2004 and 2003,
      respectively
    
    
    117
    
    
    53Additional
      paid-in capital
    
    
    352,076
    
    
    337,735Accumulated
      deficit
    
    
    (342,717
    )
    
    (319,488
    )Total
      stockholders’ equity
    
    
    12,106
    
    
    18,300Total
      liabilities, mandatorily redeemable convertible preferred stock and
      stockholders’ equity
    
    $
    40,862
    
    $
    59,061The
      accompanying notes are an integral part of these consolidated financial
      statements.





63





**DSL.net,
Inc.**





**CONSOLIDATED
STATEMENTS OF OPERATIONS**


**(dollars
      in thousands, except per share data)Year
      ended December 31,2004
    
    2003
    
    2002Revenue
    
    $
    68,449
    
    $
    71,333
    
    $
    45,530Operating
      expenses:Network
      (A)
    
    
    45,727
    
    
    51,452
    
    
    33,470Operations
      (A)
    
    
    9,864
    
    
    11,873
    
    
    7,949General
      and administrative (A)
    
    
    12,601
    
    
    12,200
    
    
    11,403Sales
      and marketing (A)
    
    
    5,126
    
    
    8,642
    
    
    6,969Stock
      compensation
    
    
    -
    
    
    438
    
    
    1,228Depreciation
      and amortization
    
    
    13,132
    
    
    16,359
    
    
    20,332Total
      operating expenses
    
    
    86,450
    
    
    100,964
    
    
    81,351Operating
      loss
    
    
    (18,001
    )
    
    (29,631
    )
    
    (35,821
    )Interest
      (expense) income, net
    
    
    (5,363
    )
    
    (2,936
    )
    
    (458
    )Other
      income (expense), net
    
    
    135
    
    
    (2,430
    )
    
    185Net
      loss
    
    $
    (23,229
    )
    $
    (34,997
    )
    $
    (36,094
    )Net
      loss applicable to common stockholders:Net
      loss
    
    $
    (23,229
    )
    $
    (34,997
    )
    $
    (36,094
    )Dividends
      on preferred stock
    
    
    (950
    )
    
    (3,698
    )
    
    (3,573
    )Accretion
      of preferred stock
    
    
    (8,852
    )
    
    (14,327
    )
    
    (10,078
    )Fair
      value of Series Z Preferred Stock
    
    
    (2,630
    )
    
    -
    
    
    -Net
      loss applicable to common stockholders
    
    $
    (35,661
    )
    $
    (53,022
    )
    $
    (49,745
    )Net
      loss per share, basic and diluted
    
    $
    (0.20
    )
    $
    (0.72
    )
    $
    (0.77
    )Shares
      used in computing net loss per share, basic and diluted
    
    
    181,831,059
    
    
    74,125,513
    
    
    64,857,869

(A) 
Stock compensation and depreciation and amortization were excluded from the
following operating expense line items and presented as separate operating
expense line items:
Stock
      compensationNetwork
    
    $
    -
    
    $
    10
    
    $
    30Operations
    
    
    -
    
    
    11
    
    
    52General
      and administrative
    
    
    -
    
    
    69
    
    
    283Sales
      and marketing
    
    
    -
    
    
    348
    
    
    863Total
    
    
    -
    
    
    438
    
    
    1,228Depreciation
      and amortizationNetwork
    
    
    11,241
    
    
    12,300
    
    
    13,719General
      and administrative
    
    
    1,891
    
    
    4,059
    
    
    6,613Total
    
    $
    13,132
    
    $
    16,359
    
    $
    20,332The
      accompanying notes are an integral part of these consolidated financial
      statements.**


64




**DSL.net,
Inc.**


**CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY**


(dollars
      in thousands)AdditionalPreferred
      Stock
    
    Common
      Stock
    
    Paid
      - In
    
    Deferred
    
    AccumulatedShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Compensation
    
    Deficit
    
    TotalBalance
      as of December 31, 2001
    
    
    -
    
    $
    -
    
    
    64,851,462
    
    $
    32
    
    $
    300,757
    
    $
    (1,668
    )
    $
    (248,397
    )
    $
    50,724Deferred
      compensation - stock options
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (2
    )
    
    2
    
    
    -
    
    
    -Amortization
      of deferred compensation
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    1,228
    
    
    -
    
    
    1,228Issuance
      of common stock - employee stock purchase plan
    
    
    -
    
    
    -
    
    
    14,000
    
    
    -
    
    
    4
    
    
    -
    
    
    -
    
    
    4Issuance
      of common stock - stock options
    
    
    -
    
    
    -
    
    
    64,437
    
    
    -
    
    
    9
    
    
    -
    
    
    -
    
    
    9Beneficial
      conversion feature of preferred stock
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    18,531
    
    
    -
    
    
    -
    
    
    18,531Accrued
      dividends on preferred stock
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (3,573
    )
    
    -
    
    
    -
    
    
    (3,573
    )Accretion
      of beneficial conversion feature of preferredstock,
      net of issuance costs
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (10,078
    )
    
    -
    
    
    -
    
    
    (10,078
    )Net
      loss
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (36,094
    )
    
    (36,094
    )Balance
      as of December 31, 2002
    
    
    -
    
    
    -
    
    
    64,929,899
    
    
    32
    
    
    305,648
    
    
    (438
    )
    
    (284,491
    )
    
    20,751Amortization
      of deferred compensation
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    438
    
    
    -
    
    
    438Valuation
      of common stock warrants issued for loan guarantees
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    6,656
    
    
    -
    
    
    -
    
    
    6,656Issuance
      of common stock - employee stock purchase plan
    
    
    -
    
    
    -
    
    
    15,380
    
    
    -
    
    
    5
    
    
    -
    
    
    -
    
    
    5Issuance
      of common stock - stock options
    
    
    -
    
    
    -
    
    
    5,363,763
    
    
    3
    
    
    2,278
    
    
    -
    
    
    -
    
    
    2,281Issuance
      of common stock - preferred stock conversions
    
    
    -
    
    
    -
    
    
    31,629,760
    
    
    16
    
    
    13,984
    
    
    -
    
    
    -
    
    
    14,000Issuance
      of common stock - dividends on preferred stock conversions
    
    
    -
    
    
    -
    
    
    3,510,252
    
    
    2
    
    
    2,520
    
    
    -
    
    
    -
    
    
    2,522Accrued
      dividends on preferred stock
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (3,698
    )
    
    -
    
    
    -
    
    
    (3,698
    )Accretion
      of beneficial conversion feature of preferred stock
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (14,327
    )
    
    -
    
    
    -
    
    
    (14,327
    )Preferred
      stock reclassification
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (1,394
    )
    
    -
    
    
    -
    
    
    (1,394
    )Debt
      discount ascribed to warrants and notes payable
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    26,063
    
    
    -
    
    
    -
    
    
    26,063Net
      loss
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (34,997
    )
    
    (34,997
    )Balance
      as of December 31, 2003
    
    
    -
    
    
    -
    
    
    105,449,054
    
    
    53
    
    
    337,735
    
    
    -
    
    
    (319,488
    )
    
    18,300Issuance
      of common stock - employee stock purchase plan
    
    
    -
    
    
    -
    
    
    8,836
    
    
    -
    
    
    4
    
    
    -
    
    
    -
    
    
    4Issuance
      of common stock - stock options
    
    
    -
    
    
    -
    
    
    39,911
    
    
    -
    
    
    12
    
    
    -
    
    
    -
    
    
    12Issuance
      of common stock - preferred stock conversions
    
    
    -
    
    
    -
    
    
    113,372,015
    
    
    57
    
    
    20,943
    
    
    -
    
    
    -
    
    
    21,000Issuance
      of common stock - dividends on preferred stock conversions
    
    
    -
    
    
    -
    
    
    14,336,841
    
    
    7
    
    
    5,814
    
    
    -
    
    
    -
    
    
    5,821Issuance
      of common stock - warrant exercise
    
    
    -
    
    
    -
    
    
    413,160
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Accrued
      dividends on preferred stock
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (950
    )
    
    -
    
    
    -
    
    
    (950
    )Accretion
      of beneficial conversion feature of preferred stock
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (8,852
    )
    
    -
    
    
    -
    
    
    (8,852
    )Issuance
      of Series Z preferred stock at fair value
    
    
    14,000
    
    
    2,630
    
    
    -
    
    
    -
    
    
    (2,630
    )
    
    -
    
    
    -
    
    
    -Net
      loss
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (23,229
    )
    
    (23,229
    )Balance
      as of December 31, 2004
    
    
    14,000
    
    $
    2,630
    
    
    233,619,817
    
    $
    117
    
    $
    352,076
    
    $
    -
    
    $
    (342,717
    )
    $
    12,106The
      accompanying notes are an integral part of these consolidated financial
      statements.


65


****


**DSL.net,
      Inc.****CONSOLIDATED
      STATEMENTS OF CASH FLOWS**(dollars
      in thousands)Year
      ended December 31,2004
    
    2003
    
    2002Cash
      flows from operating activities:Net
      loss
    
    $
    (23,229
    )
    $
    (34,997
    )
    $
    (36,094
    )Reconciliation
      of net loss to net cash (used in)operating
      activities:Depreciation
      and amortization
    
    
    13,132
    
    
    16,359
    
    
    20,332Bad
      debt expense
    
    
    1,119
    
    
    2,117
    
    
    2,536Sales
      credits and allowances
    
    
    2
    
    
    394
    
    
    1,181Amortization
      of deferred debt issuance costs and debt discount
    
    
    5,014
    
    
    7,922
    
    
    9Non-cash
      mark to market adjustment
    
    
    55
    
    
    -
    
    
    -Stock
      compensation expense
    
    
    -
    
    
    438
    
    
    1,228Loss
      on sale/write-off of fixed assets
    
    
    120
    
    
    163
    
    
    375Gain
      on note settlement
    
    
    -
    
    
    (3,500
    )
    
    -Non-cash
      interest on lease payoff
    
    
    -
    
    
    194
    
    
    -Net
      changes in assets and liabilities, net of acquired assets:(Increase)
      / decrease in accounts receivable
    
    
    589
    
    
    (6,153
    )
    
    (2,194
    )Decrease
      / (increase) in prepaid and other current assets
    
    
    61
    
    
    (213
    )
    
    1,318Decrease
      / (increase) in other assets
    
    
    (447
    )
    
    1,080
    
    
    (1,480
    )Increase
      / (decrease) in accounts payable
    
    
    2,317
    
    
    (1,051
    )
    
    294(Decrease)
      / increase in accrued salaries
    
    
    (316
    )
    
    (179
    )
    
    318(Decrease)
      / increase in accrued expenses
    
    
    (4,690
    )
    
    2,317
    
    
    (5,111
    )(Decrease)
      / increase in deferred revenue
    
    
    (1,268
    )
    
    1,394
    
    
    (418
    )Net
      cash used in operating activities
    
    
    (7,541
    )
    
    (13,715
    )
    
    (17,706
    )Cash
      flows from investing activities:Purchases
      of property and equipment
    
    
    (651
    )
    
    (2,405
    )
    
    (1,647
    )Proceeds
      from sales of property and equipment
    
    
    -
    
    
    17
    
    
    85Acquisitions
      of businesses and customer lines
    
    
    -
    
    
    (8,743
    )
    
    (1,150
    )(Increase)
      / decrease in restricted cash
    
    
    (2,427
    )
    
    (4
    )
    
    344Net
      cash used in investing activities
    
    
    (3,078
    )
    
    (11,135
    )
    
    (2,368
    )Cash
      flows from financing activities:Proceeds
      from credit facility
    
    
    -
    
    
    6,100
    
    
    -Payments
      on credit facility
    
    
    -
    
    
    (6,100
    )
    
    -Proceeds
      from common stock issuance
    
    
    16
    
    
    2,287
    
    
    14Proceeds
      from preferred stock issuance and bridge note
    
    
    -
    
    
    -
    
    
    15,000Proceeds
      from note issuances
    
    
    4,008
    
    
    30,000
    
    
    -Principal
      payments under notes and capital lease obligations
    
    
    (105
    )
    
    (4,976
    )
    
    (2,907
    )Net
      cash provided by financing activities
    
    
    3,919
    
    
    27,311
    
    
    12,107Net (decrease)
      / increase in cash and cash equivalents
    
    
    (6,700
    )
    
    2,461
    
    
    (7,967
    )Cash
      and cash equivalents at beginning of year
    
    
    13,779
    
    
    11,318
    
    
    19,285Cash
      and cash equivalents at end of year
    
    $
    7,079
    
    $
    13,779
    
    $
    11,318Supplemental
      disclosure:Cash
      paid: interest
    
    $
    56
    
    $
    782
    
    $
    819Fixed
      asset purchases included in accounts payable
    
    $
    32
    
    $
    3
    
    $
    485Supplemental
      disclosure of non-cash investing activities:On
      January 10, 2003, the Company purchased network assets and associated
      subscriber lines ofNetwork
      Access Solutions Corporation (Note 4)The
      fair value of the assets acquired was $14,737On
      September 8, 2003, the Company purchased network assets and associated
      subscriber lines ofTalkingNets
      Holdings, LLC (Note 4)The
      fair value of the assets acquired was $851Supplemental
      disclosure of non-cash financing activities:During
      the first and third quarters of 2004, a total of 20,000 shares of Series X
      Preferred Stock were convertedinto
      111,111,108 shares of common stock and $5,600 of accrued dividends
      pertaining thereto werepaid
      by issuing 14,026,974 shares of common stock (Note 9).Also
      during the first quarter 2004, 1,000 shares of Series Y Preferred Stock
      were convertedinto
      2,260,910 shares of common stock and $221 of accrued dividends pertaining
      thereto werepaid
      by issuing 309,864 shares of common stock. (Note 9).Also
      during the first quarter of 2004, the Company issued 413,160 shares of its
      common stockupon
      the exercise of 1,358,025 of stock warrants granted in connection with
      certain loan guaranteesin
      a cashless exchange (Note 9).During
      the third and fourth quarter 2003, 14,000 shares of Series Y Preferred
      Stock were converted into31,629,759
      shares of common stock and $2,522 of accrued dividends pertaining thereto
      were paid by issuing3,510,255
      shares of common stock (Note 9).The
      accompanying notes are an integral part of these consolidated financial
      statements.


66
 DSL.net,
Inc.Notes to Consolidated Financial Statemments(Dollars in Thousands,
Except Per Share Amounts)


****


**1.    
Formation and Operations of the Company**





DSL.net,
Inc. (the “Company”) was incorporated in Delaware on March 3, 1998 and
operations commenced on March 28, 1998. The Company combines its facilities,
nationwide network infrastructure, and Internet service capabilities to provide
various broadband communications services to businesses throughout the United
States, primarily using digital subscriber line (“DSL”) and T-1 technology. In
certain markets where it has not deployed its own equipment, the Company
utilizes the local facilities of other carriers to provide service. The
Company’s product offerings include T-1 and business-class DSL network
connectivity and Internet access, virtual private networks (VPNs), frame relay,
Web hosting, domain name services management, enhanced e-mail, online data
backup and recovery services, firewalls and nationwide dial-up services, as well
as integrated voice and data offerings in select markets.





The
Company has incurred substantial losses and negative cash flows from operations
in every fiscal year since inception. For the year ended December 31, 2004, the
Company incurred operating losses of $18,001 and negative operating cash flows
of $7,541 that were financed primarily by proceeds from debt and equity
issuances. The Company had accumulated deficits of $342,717 and $319,488 at
December 31, 2004 and 2003, respectively. The Company expects its operating
losses, net operating cash outflows and capital expenditures to continue through
2005.





The
Company successfully completed equity financing transactions of approximately
$10,000 in March 2002 and $8,500 in May 2002 (which, after cancellation of
certain bridge loans, yielded net proceeds of approximately $5,000) (Note 9). On
July 18, 2003, the Company successfully raised approximately $30,000 in debt and
equity financing (Note 6). In addition, on October 7, 2004, the Company raised
$4,250 in a secured convertible note and warrant financing (Note 6). The
Company’s independent registered public accounting firm has noted in their
report that the Company’s sustained operating losses raise substantial doubt
about its ability to continue as a going concern. Based on its current business
plans and projections, the Company believes that its existing cash resources and
cash expected to be generated from operations will be sufficient to fund its
operating losses, capital expenditures, lease payments, and working capital
requirements at least through the third quarter of 2005. As a result, the
Company will need to raise additional financing, through some combination of
borrowings or the sale of equity or debt securities, during 2005 to finance its
2006 requirements and to enable it to repay all of its existing long-term debt.
The Company is pursuing financing alternatives to fund its anticipated cash
deficiency and to refinance its existing long-term debt. The Company may not be
able to raise sufficient additional debt, equity or other capital on acceptable
terms, if at all. Failure to generate sufficient revenues, contain certain
discretionary spending, achieve certain other business plan objectives,
refinance our long-term debt or raise additional funds could have a material
adverse affect on the Company’s results of operations, cash flows and financial
position, including its ability to continue as a going concern, and may require
it to significantly reduce, reorganize, discontinue or shut down its operations.


The
Company intends to use its cash resources to finance its operating losses,
capital expenditures, lease payments, and working capital requirements and for
other general corporate purposes.













67
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**


The
Company’s cash requirements and financial performance, including its ability to
achieve and sustain profitability or become and remain cash flow positive, may
vary based upon a number of factors, including:
 
 ·
    its
      ability to raise sufficient additional
capital;
 
 ·
    its
      business plans or projections change or prove to be inaccurate;
 
 ·
    the
      Company curtails and/or reorganizes its
operations;
 
 ·
    development
      of the high-speed data and integrated voice and data communications
      industries and the Company’s ability to compete effectively in such
      industries;
 
 ·
    amount,
      timing and pricing of customer revenue;
 
 ·
    availability,
      timing and pricing of acquisition opportunities, and the Company’s ability
      to capitalize on such opportunities;
 
 ·
    identification
      of and generation of synergies with potential business combination
      candidates, and the Company’s ability to close any transactions with such
      parties on favorable terms, if at all;
 
 ·
    commercial
      acceptance of the Company’s services and the Company’s ability to attain
      expected penetration within its target markets;
 
 ·
    the
      Company’s ability to recruit and retain qualified
    personnel;
 
 ·
    up
      front sales and marketing expenses;
 
 ·
    cost
      and utilization of the Company’s network components that it leases from
      other telecommunications providers and that hinge, in substantial part, on
      government regulation that has been subject to considerable flux in recent
      years;
 
 ·
    the
      Company’s ability to establish and maintain relationships with marketing
      partners;
 
 ·
    successful
      implementation and management of financial, information management and
      operations support systems to efficiently and cost-effectively manage the
      Company’s operations and growth; and
 
 ·
    favorable
      outcomes of numerous federal and state regulatory proceedings and related
      judicial proceedings, including proceedings relating to the 1996
      Telecommunications Act.
 
 There can
be no assurance that the Company will be able to achieve its business plan
objectives or that it will achieve or maintain cash flow positive operating
results. If the Company is unable to generate adequate funds from its operations
or raise additional funds, it may not be able to repay its existing debt,
continue to operate its network, respond to competitive pressures or fund its
operations. As a result, the Company may be required to significantly reduce,
reorganize, discontinue or shut down its operations. The Company’s financial
statements do not include any adjustments that might result from this
uncertainty.





**2.     
Summary of Significant Accounting Policies**





**Principles
of Consolidation**





The
accompanying consolidated financial statements include the transactions and
balances of DSL.net, Inc. and its wholly owned subsidiaries, including without
limitation DSLnet Communications, LLC, DSLnet Communications VA, Inc., DSLnet
Atlantic, LLC, and Vector Internet Services, Inc. All material intercompany
transactions and balances have been eliminated.





**Use
of Estimates**





The
preparation of financial statements in accordance with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, including the recoverability of tangible and intangible assets,
disclosure of contingent assets and liabilities as of the date of the financial
statements, and the reported amounts of revenues and expenses during the
reported period. The markets for the Company’s services are characterized by
intense competition, rapid technological development, regulatory and legislative
changes, and frequent new product introductions, all of which could impact the
future value of the Company’s assets and liabilities. Actual results may differ
from those estimates. Certain prior period amounts have been reclassified to
conform to the 2004 presentation.





The
Company evaluates its estimates on an on-going basis. The most significant
estimates relate to revenue recognition, goodwill and other long-lived assets,
the allowance for doubtful accounts, the fair value of financial instruments and
derivatives and contingencies. Such estimates are based on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments





68
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ materially from those
estimates.





**Cash
Equivalents**





The
Company considers all highly liquid investments purchased with an original
maturity of three months or less from date of acquisition, to be cash
equivalents.





**Restricted
Cash**





Restricted
cash is included with other current assets in the Company’s Consolidated Balance
Sheets. Restricted cash at December 31, 2004, was approximately $2,432 and
represents the balance of proceeds received from a convertible note and warrant
financing the use of which requires approval from certain of the Company’s
senior secured debt holders (Note 6). Restricted cash at December 31, 2003, was
approximately $5, and represents the balance of unvested amounts of the
Company’s share of matching contributions for terminated employees in the
Company’s 401(k) plan and is restricted for future funding of matching
contributions to the Company’s 401(k) plan.





**Concentration
of Credit Risk and Concentration of Data Transmission Service Providers**





Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash, cash equivalents and accounts receivable. The
Company's cash and investment policies limit investments to short-term,
investment grade instruments. Concentrations of credit risk with respect to
accounts receivable are limited due to the large number of customers comprising
the Company's customer base. No individual customer accounted for more than 5%
of the Company’s revenue for the years ended December 31, 2004, 2003 or
2002.





The
Federal Deposit Insurance Corporation’s (“FDIC”) maximum insurance against bank
failures for deposits is $100 per institution. The Company’s funds, maintained
at its banking institutions from time to time, exceed the insured amounts. The
Company’s short-term investment grade instruments are not insured by the
FDIC.





In
certain markets where the Company has not deployed its own DSL or T-1 equipment,
the Company utilizes local DSL or T-1 facilities from wholesale providers,
including Covad Communications, Inc. (“Covad”), in order to provide service to
its end-user customers. These wholesale providers may terminate their service
with little or no notice. The failure of Covad to provide acceptable
service on acceptable terms could have a material adverse effect on the
Company’s operations and cash flows.





The
Company transmits data across its network via transmission facilities that are
leased from certain carriers, including Level 3 Communications, Inc. and MCI.
The failure of any of the Company’s data transport carriers to provide
acceptable service on acceptable terms could have a material adverse effect on
the Company’s operations and cash flows.





**Inventory**





Inventories
consist of modems and routers (generally referred to as customer premise





69
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





equipment)
that the Company sells or leases to customers and are required to establish a
high speed DSL or T-1 digital connection. Inventories are stated at the lower of
cost or market. Cost of inventory is determined on the “first-in, first-out” or
average cost methods. The Company establishes inventory reserves for excess,
obsolete or slow-moving inventory based on changes in customer demand,
technology developments and other factors.





**Fixed
Assets**





Fixed
assets are stated at cost and are depreciated using the straight-line method
over the estimated useful lives of the assets, which are five years for network
equipment (except for routers and modems, which are three years), three years
for computer equipment, five years for furniture, fixtures and office equipment
and three years for capitalized software and vehicles. Leasehold improvements
are amortized over the shorter of the term of the related lease or the useful
life of the asset. Collocation space improvements represent payments to carriers
for infrastructure improvements within their central offices to allow the
Company to install its equipment, which allows the Company to interconnect with
the carrier's network. These payments are being amortized over their estimated
useful lives of five years. Maintenance and repairs are charged to expense as
incurred. The Company also installs its equipment at customer locations to
enable connections to its network.





The
Company, in accordance with AICPA Statement of Position 98-1, “ *Accounting
for the Costs of Computer Software Developed or Obtained for Internal
Use,”* (“SOP
98-1”), capitalizes certain costs incurred in the development of internal use
software. Internal use software has an estimated useful life of three
years.





Upon
disposal of fixed assets, the cost and related accumulated depreciation are
removed from the accounts and the resulting gain or loss is reflected in
earnings. Fully depreciated assets are not removed from the accounts until
physical disposition.





**Goodwill
and Other Intangible Assets**





Other
intangible assets are amortized on a straight-line basis over the estimated
future periods to be benefited, ranging from two to five years. Goodwill
represents the excess purchase price over the fair value of identifiable net
assets of businesses acquired and is not amortized.





The
Company reviews the recoverability of goodwill annually and when events and
circumstances change by comparing the estimated fair values, based on a
discounted forecast of future cash flows, of reporting units with their
respective net book values. If the fair value of a reporting unit exceeds its
carrying amount, the goodwill of the reporting unit is not considered impaired.
If the carrying amount of the reporting unit exceeds its fair value, the
goodwill impairment loss is measured as the excess of the carrying value of
goodwill over its implied fair value. There was no impairment of goodwill at
December 31, 2004 and 2003.





**Long-Lived
Assets**





The
Company accounts for its long-lived assets in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 144, “ *Accounting
for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed
of,”* which
requires that long-lived assets and certain intangible assets be reviewed for
impairment whenever events or changes in circumstances





70
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





indicate
that the carrying amount may not be recoverable. If undiscounted expected future
cash flows are less than the carrying value of the assets, an impairment loss is
to be recognized based on the fair value of the assets. There was
no impairment of long-lived assets at December 31, 2004 and 2003.








**Other
Assets**





Other
assets include: (i) refundable deposits held as security on certain lease or
other obligations, and (ii) the non-current portion of deferred financing costs
which are amortized to general and administrative expense over the respective
terms of the related debt, and (iii) the non-current portion of prepaid
directors’ and officers’ liability insurance. As of December 31, 2004 and 2003,
refundable deposits were approximately $528 and $659, respectively, deferred
financing costs were approximately $162 and $310, respectively, and non-current
prepaid directors’ and officers’ liability insurance were approximately $725 and
$0, respectively.





**Accounting
for Derivative Instruments**





The
Company accounts for derivative instruments in accordance with SFAS No. 133 *“Accounting
for Derivative Instruments and Hedging Activities,” as amended,* which
establishes accounting and reporting standards for derivative instruments and
hedging activities, including certain derivative instruments imbedded in other
financial instruments or contracts and requires recognition of all derivatives
on the balance sheet at fair value, regardless of the hedging relationship
designation. Accounting for the changes in the fair value of the derivative
instruments depends on whether the derivatives qualify as hedge relationships
and the types of the relationships designated are based on the exposures hedged.
Changes in the fair value of derivatives designated as fair value hedges are
recognized in earnings along with fair value changes of the hedged item. Changes
in the fair value of derivatives designated as cash flow hedges are recorded in
other comprehensive income (loss) and are recognized in earnings when the hedged
item affects earnings. Changes in the fair value of derivative instruments which
are not designated as hedges are recognized in earnings as other income (loss).
At December 31, 2004 and 2003, the Company did not have any derivative
instruments that were designated as hedges.





**Fair
Value of Financial and Derivative Instruments**





The
Company has issued various financial debt and/or equity instruments, some of
which have required a determination of their fair value and/or the fair value of
certain related derivatives, where quoted market prices were not published or
readily available. The Company bases its fair value determinations on valuation
techniques that require judgments and estimates including, discount rates used
in applying present value analyses, the length of historical look-backs used in
determining the volatility of its stock, expected future interest rate
assumptions and probability assessments. From time to time, the Company may hire
independent valuation specialists to perform and or assist in the fair value
determination of such instruments.





**Income
Taxes**





The
Company uses the liability method of accounting for income taxes, as set forth
in SFAS No. 109, “ *Accounting
for Income Taxes.* ” Under
this method, deferred tax assets and liabilities are recognized for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax basis of assets and liabilities





71
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





and net
operating loss carryforwards, all calculated using presently enacted tax rates.





The
Company has not generated any taxable income to date and, therefore, has not
paid any federal income taxes or state taxes based on income since inception.
The Company’s state and federal net operating loss carryforwards begin to expire
in 2004 and 2019, respectively. Use of the Company’s net operating loss
carryforwards may be subject to significant annual limitations resulting from a
change in control due to securities issuances including the Company’s sales of
its mandatorily redeemable convertible Series X preferred stock and its
mandatorily redeemable convertible Series Y preferred stock in 2001 and 2002
(Note 9) and from the sale of $30,000 in notes and warrants in 2003 (Note 6).
The Company is currently assessing the potential impact resulting from these
transactions. The Company has provided a valuation allowance for the full amount
of the net deferred tax asset since it has not determined that these future
benefits will more likely than not be realized **.**





**Revenue
Recognition**





The
Company recognizes revenue in accordance with Securities and Exchange Commission
(“SEC”) Staff Accounting Bulletin (“SAB”) No. 104, “ *Revenue
Recognition”,* which
outlines the four basic criteria that must be met before revenue can be
recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has
occurred or services have been rendered; (3) the fee is fixed or determinable;
and (4) collectibility is reasonably assured. Determination of criteria (3) and
(4) are based on management’s judgments regarding the fixed nature of the fee
charged for services rendered and products delivered and the collectibility of
those fees.





Revenue
is recognized pursuant to the terms of each contract on a monthly service fee
basis, which varies based on the speed of the customer’s broadband connection
and the services ordered by the customer. The monthly fee includes phone line
charges, Internet access charges, the cost of any leased equipment installed at
the customer's site and fees for the other services we provide, as applicable.
Revenue that is billed in advance of the services provided is deferred until the
services are provided by the Company. Revenue related to installation charges is
also deferred and amortized to revenue over 18 months, which is the average
customer life of the existing customer base. Related direct costs incurred (up
to the amount of deferred revenue) are also deferred and amortized to expense
over 18 months. Any excess of direct costs over installation charges are charged
to expense as incurred. In certain instances, the Company negotiates credits and
allowances for service related matters. The Company establishes a reserve
against revenue for such credits based on historical experience. From time to
time the Company offers sales incentives to its customers in the form of rebates
toward select installation services and customer premise equipment. The Company
records a liability based on historical experience for such estimated rebate
costs, with a corresponding reduction to revenue.





The
Company seeks to price its services competitively. The market for high-speed
data communications services and Internet access is rapidly evolving and
intensely competitive. While many competitors and potential competitors may
enjoy competitive advantages over the Company, it is pursuing a significant
market that, it believes, is currently under-served. Although pricing is an
important part of the Company’s strategy, management believes that direct
relationships with customers and consistent, high quality service and customer
support will be key to generating customer loyalty. During the past several
years, market prices for many





72
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





telecommunications
services and equipment have been declining, which is a trend that might
continue.





**Allowance
for Doubtful Accounts**





The
Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. Such
allowances require managements estimates and judgments and are computed based on
historical experience using varying percentages of aged receivables. The Company
principally sells its services directly to end users mainly consisting of small
to medium sized businesses, but the Company also sells its services to certain
resellers, such as Internet service providers (“ISPs”). The Company believes
that it does not have significant exposure or concentrations of credit risk with
respect to any given customer. However, if the country or any region the Company
services experiences an economic downturn, the financial condition of the
Company’s customers could be adversely affected, which could result in their
inability to make payments to the Company. This could require additional
provisions for allowances. In addition, a negative impact on revenue and cash
flows related to those customers may occur.





With its
acquisition of certain of the assets of Network Access Solutions Corporation
(“NAS”) on January 10, 2003, the Company acquired a number of end users, some of
whom it serves indirectly through various ISPs. The Company sells its services
to such ISPs who then resell such services to the end user. The Company has some
increased exposure and concentration of credit risk pertaining to such ISPs.
However, no individual customer accounted for more than 5% of revenue for 2004
and 2003.





**Stock
Compensation**





The
Company applies Accounting Principles Board Opinion No. 25 (“APB No. 25”) and
related interpretations in accounting for its stock option plans and stock
awards with the disclosure provisions of SFAS No. 123, “ *Accounting
for Stock-Based Compensation* ” (“SFAS
No. 123”). Under APB No. 25, compensation expense is computed to the extent that
the fair market value of the underlying stock on the date of grant exceeds the
exercise price of the employee stock option or stock award. Compensation so
computed is then recognized over the vesting period. The Company accounts for
equity instruments issued to non-employees in accordance with SFAS No. 123 and
Emerging Issues Task Force (“EITF”) 96-18.





Stock
compensation expense includes amortization of deferred compensation and charges
related to stock grants. Stock compensation expense for the years ended December
31, 2004, 2003 and 2002, was approximately $0, $438 and $1,228,
respectively.





73
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**




If
compensation expenses had been recognized based on the fair value of the options
at their grant date, in accordance with SFAS No. 123, the results of operations
for the years ended December 31, 2004, 2003 and 2002, would have been as
follows:





Year
      Ended December 31,2004
    
    2003
    
    2002Net
      loss, as reported
    
    $
    (23,229
    )
    $
    (34,997
    )
    $
    (36,094
    )Add:
      Stock-based employee compensation included in net loss
    
    
    -
    
    
    438
    
    
    1,228Deduct:
      Total stock-based employee compensation expense determined under fair
      value based method for all awards
    
    
    (4,889
    )
    
    (3,863
    )
    
    (4,476
    )Pro
      forma under SFAS 123
    
    $
    (28,118
    )
    $
    (38,422
    )
    $
    (39,342
    )Net
      loss applicable to common stockholders:As
      reported
    
    $
    (35,661
    )
    $
    (53,022
    )
    $
    (49,745
    )Pro
      forma under SFAS 123
    
    $
    (40,550
    )
    $
    (56,447
    )
    $
    (52,993
    )Basic
      and diluted net loss per common share:As
      reported
    
    $
    (0.20
    )
    $
    (0.72
    )
    $
    (0.77
    )Pro
      forma under SFAS 123
    
    $
    (0.22
    )
    $
    (0.76
    )
    $
    (0.82
    )





**Earnings
(Loss) Per Share**





The
Company computes net loss per share pursuant to SFAS No. 128, “ *Earnings
Per Share.”* ****** **** Basic
earnings (loss) per share is computed by dividing income or loss applicable to
common stockholders by the weighted average number of shares of the Company's
common stock outstanding during the period, excluding shares subject to
repurchase.





Diluted
earnings per share is determined in the same manner as basic earnings per share
except that the number of shares is increased assuming exercise of dilutive
stock options and warrants using the treasury stock method and dilutive
conversion of the Company’s outstanding preferred stock. The diluted earnings
per share amount is presented herein as the same as the basic earnings per share
amount because the Company had a net loss during each period presented, and the
impact of the assumed exercise of stock options and warrants and the assumed
conversion of preferred stock would have been anti-dilutive.





As of
December 31, 2004, the Company had 233,619,817 shares of common stock issued and
outstanding. As of December 31, 2003, the Company had 105,449,054 shares of
common stock issued and outstanding. The increase of 128,170,763 shares
primarily resulted from common stock issued for preferred stock conversions and
for employee stock option exercises. The weighted average number of outstanding
common shares used in computing earnings per share for the years ended December
31, 2004, 2003 and 2002 were 181,831,059, 74,125,513 and 64,857,869,
respectively.





74
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**








The
following options, warrants and convertible preferred stock and convertible debt
instruments were excluded from the calculation of diluted earnings per share
since their inclusion would be anti-dilutive for all periods presented:





Shares
      of Common StockDecember
      31,2004
    
    2003
    
    2002Options
      to purchase common stock
    
    40,651,934
    
    18,671,766
    
    23,877,004Warrants
      to purchase common stock
    
    
    192,212,192
    
    
    173,105,646
    
    
    13,033,314Preferred
      Series X Stock convertible to common stock
    
    
    -
    
    
    111,111,111
    
    
    111,111,111Preferred
      Series Y Stock convertible to common stock
    
    
    -
    
    
    2,260,909
    
    
    30,000,000Convertible
      note payable
    
    
    15,178,571
    
    
    -
    
    
    -Total
    
    
    248,042,697
    
    
    305,149,432
    
    
    178,021,429





**Comprehensive
Income**





The
Company has adopted the accounting treatment prescribed by SFAS No. 130, *“Comprehensive
Income.”* The
adoption of this statement had no material impact on the Company's financial
statements for the periods presented.





**Business
Operating Segments**





The
Company has one reportable business operating segment under the requirements of
SFAS No. 131.





**Recently
Issued Accounting Pronouncements**





In
September 2004, the EITF issued EITF No. 04-10 *“* Applying
Paragraph 19 of Financial Accounting Standards Board (“FASB”) Statement No.
131 *,
“Disclosures about Segments of an Enterprise and Related Information,”* in
Determining whether to Aggregate Operating Segments that do not Meet the
Quantitative Thresholds. *”* EITF No.
04-10 presents guidelines for two alternative approaches in determining whether
to aggregate operating segments and is effective for fiscal years ending after
October 13, 2004. The Company has determined that EITF No. 04-10 will not have
an impact on its operating segment disclosures.





On
December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004) *“Share-Based
Payment”* (“SFAS
123R”), which is a revision of Statement No. 123, *“Accounting
for Stock-Based Compensation”* (“SFAS
123”), and supersedes APB Opinion No. 25, *“Accounting
for Stock Issued to Employees,”* and
amends FASB Statement No. 95, *“Statement
of Cash Flows.”* Generally, the approach in SFAS 123R is similar to the approach described in
SFAS 123. However, SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an
alternative.





75
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





Under
SFAS 123R, the Company must determine the appropriate fair value model to be
used for valuing share-based payments, the amortization method for compensation
cost and the transition method to be used at the date of adoption. The
transition alternatives include retrospective and prospective adoption methods.
Under the retrospective method, prior periods may be restated based on the
amounts previously recognized under SFAS 123 for purposes of pro forma
disclosures either for all periods presented or as of the beginning of the year
of adoption.





The
prospective method requires that compensation expense be recognized beginning
with the effective date, based on the requirements of SFAS 123R, for all
share-based payments granted after the effective date, and based on the
requirements of SFAS 123, for all awards granted to employees prior to the
effective date of SFAS 123R that remain unvested on the effective date.





The
provisions of this statement are effective as of the beginning of the first
interim or annual reporting period that begins after June 15, 2005. The Company
expects to adopt the standard on July 1, 2005. The Company is evaluating the
requirements of SFAS 123R and has not determined its method of adoption or its
impact on its financial condition or results of operations.





In
December 2004, the FASB issued SFAS 153, *“Exchange
of Non-monetary Assets, an Amendment of APB Opinion No 29”* (“SFAS
153”). SFAS 153 eliminates the exception for non-monetary exchanges of similar
productive assets, which were previously required to be recorded on a carryover
basis rather than a fair value basis. Instead, this statement provides that
exchanges of non-monetary assets that do not have commercial substance be
reported at carryover basis rather than a fair value basis. A non-monetary
exchange is considered to have commercial substance if the future cash flows of
the entity are expected to change significantly as a result of the exchange. The
provisions of this statement are effective for non-monetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The Company expects
to adopt the standard on July 1, 2005. The Company is evaluating the
requirements of SFAS 153 and has not determined the impact on its financial
condition or results of operations.








76
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**




**3.**  **Fixed
Assets**





EstimatedUsefulLives
    
    2004
    
    2003Network
      and computer equipment
    
    
    3-5
      years
    
    $
    45,593
    
    $
    45,303Furniture,
      fixtures, office equipment and software
    
    
    3-5
      years
    
    
    19,129
    
    
    18,994Vehicles
    
    
    3
      years
    
    
    190
    
    
    190Collocation
      costs
    
    
    5
      years
    
    
    17,014
    
    
    16,98581,926
    
    
    81,472Less-accumulated
      depreciation and amortization
    
    
    
    
    
    (69,207
    )
    
    (57,115
    )$
    12,719
    
    $
    24,357





As of
December 31, 2004 and 2003, the recorded cost of equipment under capital lease
was $393 and $566, respectively. As of December 31, 2004 and 2003, the cost of
equipment under capital lease included in network and computer equipment was $0
and $173, respectively. The cost of equipment under capital lease included in
furniture, fixtures, office equipment and software as of December 31, 2004 and
2003, was $393 and $393, respectively. Accumulated depreciation for equipment
under capital lease at December 31, 2004 and 2003, was $347 and $442,
respectively.





As of
December 31, 2004 and 2003, the Company had capitalized computer software costs
of $10,675 and $10,583, respectively, and had recorded accumulated amortization
expense related to these costs of $10,322 and $10,027, respectively.
Depreciation and amortization expense related to fixed assets was $12,191,
$13,604 and $14,983, for the years ended December 31, 2004, 2003 and 2002,
respectively.





**4.**  **Acquisitions**





On April
8, 2003, the Company entered into an asset purchase agreement with TalkingNets,
Inc. and TalkingNets Holdings, LLC (collectively, “TalkingNets”) pursuant to
which the Company agreed to acquire assets and subscribers of TalkingNets (the
“TalkingNets Assets”) for $726 in cash (the “TalkingNets Asset Purchase
Agreement”). As TalkingNets had filed a voluntary petition for Chapter 11
reorganization in February 2003, the TalkingNets Asset Purchase Agreement was
subject to the approval of the U.S. Bankruptcy Court for the Eastern District of
Virginia. On April 9, 2003, the TalkingNets Asset Purchase Agreement and the
transactions contemplated thereby were approved by the Bankruptcy Court. On
April 11, 2003, the Company paid the full purchase price of $726 into escrow.





On
September 8, 2003, in accordance with the TalkingNets Asset Purchase Agreement,
the Company completed its transaction to acquire the TalkingNets Assets. This
acquisition has been accounted for under the purchase method of accounting in
accordance with SFAS No. 141. The results of TalkingNets’ operations have been
included in the Company’s consolidated financial statements since September 8,
2003 (the closing date). The estimated fair values of the acquired assets at the
date of acquisition exceeded the purchase price and, accordingly, the acquired
assets have been written down on a pro-rata basis by asset group to the purchase
price of approximately $851 ($726 plus associated direct acquisition costs of
approximately $125) as follows: (i) certain accounts receivables of $55, (ii)
intangible assets pertaining to approximately 90 acquired





77
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





subscriber
lines of $111, and (iii) property and equipment of $685.





In
December of 2002, the U.S. Bankruptcy Court for the District of Delaware
approved the Company’s bid to purchase certain network assets, equipment and
associated subscriber lines of NAS for $14,000 consisting of $9,000 in cash and
$5,000 in a note payable to NAS. The Company closed the transaction on January
10, 2003, whereby it acquired certain of NAS’ network assets, equipment in
approximately 300 central offices and approximately 11,500 associated subscriber
lines (the “NAS Assets”), pursuant to an Amended and Restated Asset Purchase
Agreement, dated as of December 11, 2002, by and among the parties thereto (the
“NAS Asset Purchase Agreement”).  Additionally,
on January 10, 2003, the Company hired approximately 78 employees formerly
employed by NAS. No pre-closing liabilities were assumed in connection with the
NAS transaction. The cash portion of the consideration was paid from the
Company’s existing cash. In accordance with the NAS Asset Purchase Agreement,
the Company negotiated a $1,083 reduction in the cash paid at the closing,
representing the Company’s portion of January revenue which was billed and
collected by NAS, bringing the net cash paid for the NAS Assets to $7,917.





NAS
provided high-speed Internet and virtual private network services to business
customers using digital subscriber line, frame relay and T-1 technology via its
own network facilities in the Northeast and Mid-Atlantic markets. The NAS
acquisition significantly increased the Company’s subscriber base and its
facilities-based footprint in one of the largest business markets in the United
States.





The
acquisition has been accounted for under the purchase method of accounting in
accordance with SFAS No. 141 “ *Business
Combinations”* (“SFAS
No. 141”). The results of NAS’ operations have been included in the consolidated
financial statements since January 10, 2003 (the acquisition date). The
estimated fair values of the acquired assets at the date of acquisition exceeded
the purchase price and, accordingly, the acquired assets have been written down
on a pro-rata basis by asset group to the purchase price of approximately
$14,737 ($14,000 plus associated direct acquisition costs of approximately $737)
as follows: (i) intangible assets pertaining to approximately 11,500 acquired
subscriber lines of $1,480 and (ii) property and equipment of $13,113 and
inventory of $144. In July, 2003, the Company paid $1,500 into escrow for the
negotiated repurchase and cancellation of the $5,000 note issued by the Company
to NAS as part of the purchase price for the NAS Assets. The payment was subject
to approval by the bankruptcy court presiding over NAS’ bankruptcy petition. On
August 25, 2003, the court approved the transaction, and the $1,500 held in
escrow was paid to NAS in full satisfaction of the note.





With the
acquisition of the NAS Assets on January 10, 2003, the Company acquired a number
of end users, some of whom it serves indirectly through various ISPs. The
Company sells its services to such ISPs who then resell such services to the end
user. Accordingly, the Company had some increased exposure and concentration of
credit risk pertaining to such ISPs during 2003. However, no individual customer
accounted for more than 5% of revenue for 2003.





The
Company entered into an Asset Purchase Agreement dated as of July 30, 2002 (the
“Abacus Asset Purchase Agreement”) with Abacus America, Inc. (“Abacus”) for the
purchase of broadband subscriber lines. The Abacus Asset Purchase Agreement
provided for a cash payment for each successfully migrated broadband customer
line, up to a maximum payment of approximately $844, and required a purchase
price





78
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





deposit
of approximately $211. Ultimately, the Company was able to migrate and acquire
1,066 lines for a purchase price of approximately $543. The Abacus customer line
acquisitions were accounted for under the purchase method of accounting and,
accordingly, the purchase price has been allocated to the subscriber lines
acquired based on their estimated fair values at the date of acquisition. This
amount is being amortized on a straight-line basis over two years from the date
of purchase.





The
Company entered into an Asset Purchase Agreement, dated as of January 1, 2002,
with Broadslate Networks, Inc. (“Broadslate”) for the purchase of business
broadband customer accounts and certain other assets, including certain accounts
receivable related to the customer accounts. The initial purchase price of
approximately $800 was subject to certain adjustments, which resulted in a $50
reduction in the purchase price. The Broadslate customer line acquisitions were
accounted for under the purchase method of accounting and, accordingly, the
adjusted purchase price of approximately $750 was allocated to the assets
acquired based on their estimated fair values at the date of acquisition as
follows: approximately $28 to net accounts receivable acquired and approximately
$722 to approximately 520 subscriber lines acquired, which amount is being
amortized on a straight-line basis over two years from the date of
purchase.





The
following table sets forth the unaudited pro forma consolidated financial
information of the Company, giving effect to the acquisition of Broadslate
customers, Abacus customers, and NAS customers as if the transactions occurred
at the beginning of the periods presented. Inclusion of the TalkingNets
Acquisition would not materially change the pro forma results. There were no
acquisitions during 2004.





Year
      ended December 312003
    
    2002Pro
      forma revenue
    
    $
    72,091
    
    $
    71,615Pro
      forma operating loss
    
    
    (29,604
    )
    
    (43,477
    )Pro
      forma net loss
    
    
    (35,016
    )
    
    (65,269
    )Pro
      forma net loss applicable to common stockholders
    
    $
    (53,041
    )
    $
    (78,921
    )Pro
      forma net loss per share, basic and diluted
    
    $
    (0.72
    )
    $
    (1.22
    )Shares
      used in computing pro forma net loss
      per
      share, basic and diluted
    
    
    74,125,513
    
    
    64,857,869





The pro
forma results are not necessarily indicative of the actual results of operations
that would have been obtained had the acquisitions taken place at the beginning
of the respective periods or the results that may occur in the
future.








79
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**







**5.**  **Goodwill
and Other Intangible Assets**





The
following table shows the gross and unamortized balances of other intangible
assets which are comprised solely of customer lists:










December
      31, 2004
    
    December
      31, 2003Accumulated
    
    
    
    
    
    AccumulatedGross
    
    Amortization
    
    Net
    
    Gross
    
    Amortization
    
    NetCustomer
      lists
    
    $
    15,483
    
    $
    15,436
    
    $
    47
    
    $
    15,506
    
    $
    14,496
    
    $
    1,010







Amortization
expense of other intangible assets for the years ended December 31, 2004 and
2003 was $940 and $2,756, respectively. Accumulated amortization at December 31,
2004 and 2003, was $19,367 and $18,427, respectively. The future amortization of
the unamortized balance of customer lists as of December 31, 2004, is $47 in
2005.





In
accordance with the provisions SFAS No. 142, “ *Goodwill
and Other Intangible Assets* ” (“SFAS
No. 142”), which became effective on January 1, 2002, the Company ceased to
amortize $8,482 of goodwill in accordance with of SFAS No. 142.





In lieu
of amortization, the Company made an initial impairment review of its goodwill
in January of 2002 which did not result in any impairment adjustments. Annual
impairment reviews were also performed in December of 2004, 2003 and 2002. The
Company did not record any goodwill impairment adjustments resulting from its
impairment reviews. The Company did not acquire nor dispose of any goodwill
during 2004, 2003 and 2002; therefore, the carrying value of the goodwill is
$8,482 as of each of those year ends, respectively. The Company will continue to
perform annual impairment reviews, unless a change in circumstances requires a
review in the interim.





**6.
Debt**





On
January 10, 2003,  the
Company issued a $5,000 note to NAS in conjunction with its acquisition of the
NAS Assets (Note 4). The Company negotiated settlement of the note for $1,500,
which was approved by the bankruptcy court on August 25, 2003 and resulted in a
gain of $3,500 in other income.





The
Company entered into a Revolving Credit and Term Loan Agreement, dated as of
December 13, 2002 (the “Credit Agreement”), with a commercial bank providing for
a revolving line of credit of up to $15,000 (the “Commitment”). Interest on
borrowings under the Credit Agreement was payable at 0.5% percent above the
Federal Funds Effective rate. The Company’s ability to borrow amounts available
under the Credit Agreement was subject to the bank’s receipt of a like amount of
guarantees from certain of the Company’s investors and/or other guarantors.





On
February 3, 2003, the Company borrowed $6,100 under the Credit Agreement. As of
March 5, 2003, certain of the Company’s investors had guaranteed $9,100 under
the Credit Agreement. On July 18, 2003, the Company repaid the $6,100
outstanding balance plus accrued interest and terminated the Credit Agreement.
The Company wrote off approximately $184 of the related unamortized balance of
loan origination fees.





80
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





The
Company entered into a Reimbursement Agreement (the “Reimbursement Agreement”)
and related Security Agreement, dated as of December 27, 2002, with VantagePoint
Venture Partners III (Q), L.P. (“VP”) and Columbia Capital
Equity Partners (together with its co-guarantors, “Columbia”)and other
holders of or affiliates of holders of the Company’s Series X and Series Y
preferred stock (the “Guarantors”). Pursuant to the terms of the Reimbursement
Agreement, on December 27, 2002, VP and Columbia issued guarantees in an
aggregate amount of $6,100 to support certain obligations of the Company under
the Credit Agreement. On July 18, 2003, in connection with the termination of
the Credit Agreement, the guarantees, the Reimbursement Agreement and the
related Security Agreement were terminated.





Pursuant
to the terms of the Reimbursement Agreement, on December 27, 2002, the Company
issued warrants to purchase an aggregate of 12,013,893 shares of its common
stock to VP and certain of its affiliates and Columbia, in consideration for
their guarantees aggregating $6,100. All such warrants have a ten year life and
an exercise price of $0.50 per share. **** On March
26, 2003, the Company issued additional warrants, exercisable for ten years, to
purchase a total of 936,107 shares of its common stock at $0.50 per share to VP
and certain of its affiliates and Columbia, bringing the total number of
warrants issued in connection with the Reimbursement Agreement to 12,950,000. On
February 3, 2003, the Company borrowed on the Credit Agreement and the
Guarantors’ guarantees of the subject loan became effective.





On
February 3, 2003, the Company valued the 12,950,000 warrants at $0.514 each with
a total value of approximately $6,656. The valuation was performed using a
Black-Scholes valuation model with the following assumptions: (i) a risk free
interest rate of 4.01% (ten-year Treasury rate), (ii) a zero dividend yield,
(iii) a ten year expected life, (iv) an expected volatility of 153%, (v) an
option exercise price of $0.50 per share and (vi) a current market price of
$0.52 per share (the closing price of the Company’s common stock on February 3,
2003). Since the warrants were issued in consideration for loan guarantees,
which enabled the Company to secure financing at below market interest rates,
the Company recorded their value as a deferred debt financing cost to be
amortized to interest expense over the term of the loan (approximately 57
months) using the “Effective Interest Method” of amortization. On July 18, 2003,
the Company repaid its outstanding loan balance that was secured by these loan
guarantees, and terminated the Credit Agreement. Accordingly, the Company
wrote-off approximately $5,747 of the related unamortized balance of deferred
financing costs to other expense. For the year ended December 31, 2003 expense
relating to amortized deferred financing costs was approximately
$909.





On March
5, 2003, the Company and VP entered into Amendment No. 1 to the Reimbursement
Agreement, pursuant to which VP increased its guarantee by $3,000 bringing the
aggregate guarantees by all Guarantors under the Reimbursement Agreement, as
amended, to $9,100. As consideration for VP’s increased guarantee, if the
Company closed an equity financing on or before December 3, 2003, it was
authorized to issue VP and certain of its affiliates additional warrants to
purchase the type of equity securities issued by the Company in such equity
financing. The number of such additional warrants would be determined by
dividing the per share price of such equity securities into a thousand dollars.
Accordingly, since the Company closed a financing on July 18, 2003, the Company
issued to VP and certain of its affiliates in December 2003, additional warrants
with a three year life, to purchase 2,260,909 shares of its common stock at a
per share price of $0.4423.





On July
18, 2003, the Company entered into a Note and Warrant Purchase Agreement (the
“Note and Warrant Purchase Agreement”) with Deutsche Bank AG London, acting
through DB Advisors LLC as Investment Agent (“Deutsche Bank”), and VantagePoint
Venture Partners III (Q), L.P., VantagePoint Venture Partners III,





81
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





L.P.,
VantagePoint Communications Partners, L.P. and VantagePoint Venture Partners
1996, L.P. (collectively, “VantagePoint,” and, together with Deutsche Bank, the
“Investors”) relating to the sale of an aggregate of (i) $30,000 in senior
secured promissory notes (the “Notes”) and (ii) warrants to purchase an
aggregate of 157,894,737 shares of the Company’s common stock for a period of
three years at an exercise price of $0.38 per share (the “2003 Warrants”). The
aggregate purchase price for the Notes and 2003 Warrants was $30,000.





Subject
to the terms and conditions of the Note and Warrant Purchase Agreement, the
Company issued an aggregate of $30,000 in principal amount of Notes to the
Investors on July 18, 2003. As of December 31, 2004, an aggregate principal
amount of $30,000 of Notes remained outstanding. Principal on the Notes is
payable in a single payment on July 18, 2006. The Notes provide for an annual
interest rate of 1.23%, payable in cash quarterly in arrears commencing on
October 31, 2003, unless the Company elects to defer payment of such interest
and pay it together with the principal amount of the Notes at maturity on July
18, 2006. Pursuant to the terms of the Security Agreement, the Company’s
obligations under the Notes are secured by a security interest in a majority of
the personal property and assets of the Company and certain of its subsidiaries.
Interest expense accrued on the Notes for year ended December 31, 2003
approximated $170. Prior to the due date of the first interest payment, the
Company elected to defer all interest payments until further
notice.





Subject
to the terms and conditions of the Note and Warrant Purchase Agreement, the
Company issued a warrant to purchase 12,950,000 shares of its common stock to
Deutsche Bank on or about August 12, 2003. The Company issued the remaining 2003
Warrants to purchase an aggregate of 144,944,737 shares of its common stock to
Deutsche Bank (105,471,053 shares) and VantagePoint (39,473,864 shares) on or
about December 9, 2003. All of these warrants were issued with an exercise price
of $0.38 per share.





On July
18, 2003, the Company recorded the Note and Warrant transactions in accordance
with Accounting Principles Board Opinion No. 14, “ *Accounting
for Convertible Debt and Debt Issued with Stock Purchase Warrants,”* whereby a
fair value was ascribed to the 157,894,737 2003 Warrants to be issued to the
Investors (related to the Note and Warrant Purchase Agreement) together with the
2,260,909 warrants to be issued to VantagePoint (related to VantagePoint’s
increased guarantee under Amendment No. 1 to the Reimbursement Agreement) using
a Black-Scholes valuation model with the following assumptions: (i) a risk free
interest rate of 2.24% (three-year Treasury rate), (ii) a zero dividend yield,
(iii) a three-year life, (iv) an expected volatility of 152%, (v) a warrant
option price of $0.38 per share for the 157,894,737 2003 Warrants and $0.4423
per share for the 2,260,909 warrants and (vi) a current market price of $0.83
(the closing price of the Company’s common stock on July 18, 2003) per share. A
fair value was ascribed to the Notes using a present value method with a 19%
discount rate. The relative fair value of the warrants representing 87% of the
combined fair value of the warrants and Notes was applied to the $30,000
proceeds to determine a note discount of approximately $26,063 which was
recorded as a reduction to the Notes payable and an increase to additional paid
in capital. The note discount is being amortized to interest expense using the
“Effective Interest Method” of amortization over the 36 month term of the Notes.
For the years ended December 31, 2004, and 2003, approximately $4,954 and
$1,266, respectively of this note discount has been amortized to interest
expense.





82
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





On July
18, 2003, in connection with the Note and Warrant Purchase Agreement, the
Company, the Investors and certain of the stockholders of the Company entered an
Amended and Restated Stockholders Agreement, which provides for rights relating
to the election of directors, the registration of the Company’s common stock and
certain protective provisions.





A portion
of the proceeds from the sale of the Notes and 2003 Warrants was used by the
Company to repay certain debt and lease obligations. During 2003, the Company
pre-paid approximately $10,200 for the complete repayment of approximately
$14,600 of its debt and lease obligations.





On
October 7, 2004, the Company closed a financing transaction with Laurus Master
Fund, Ltd. (“Laurus”), pursuant to which the Company sold to Laurus convertible
notes and a warrant to purchase common stock of the Company. The securities
issued to Laurus were a $4,250 Secured Convertible Minimum Borrowing Note (the
“MB Note”), a $750 Secured Revolving Note (the “Revolving Note” and, together
with the MB Note, the “Laurus Notes”), and a Common Stock Purchase Warrant to
purchase 1,143,000 shares of the Company’s common stock (the “Laurus Warrant”).
As part of the financing transaction with Laurus, the Company paid Laurus a
closing fee of $163. The Laurus Notes are collateralized by a security interest
and first priority lien on certain trade accounts receivable.





The
Company and Laurus had placed the transactions and funds into escrow on August
31, 2004, pending the Company's procurement of a waiver of certain rights of its
Investors, represented by Deutsche Bank Trust Company Americas, the
administrative agent to the Investors (“DBTCA”), and agreement from such
Investors to subordinate their lien on trade accounts receivable of the Company
to the lien granted to Laurus. On October 7, 2004, the Company reached agreement
with Laurus and the Investors on subordination terms and the initial financing
proceeds of $4,250 were released from escrow, of which $4,024 were deposited
into a Company account with DBTCA. The Company's withdrawal and use of such
financing proceeds are subject to the prior approval of DB Advisors L.L.C., as
advisor to Deutsche Bank, and DBTCA.





The
Laurus Notes mature on August 1, 2006. Annual interest on the Laurus Notes is
equal to the prime rate (5.25% as of December 31, 2004) published in The Wall
Street Journal from time to time, plus two percent, provided, that, such annual
rate of interest on the Laurus Notes may not be less than six percent or more
than seven percent. Notwithstanding the six percent interest rate floor, the
interest rate on the Laurus Notes will be decreased two percent per annum for
each 25% increase in the price of the Company’s common stock above $0.28 per
share, if, at that time, the Company has on file with the SEC an effective
registration statement for the resale of shares of common stock issued or
issuable upon conversion of the MB Note and upon exercise of the Laurus Warrant
and, if not, the interest rate will be decreased one percent per annum for each
25% increase in the price of the Company’s common stock above $0.28 per share.
As of February 4, 2005, the Company has on file with the SEC an effective
registration statement for the resale of shares of common stock underlying the
MB Note and Laurus Warrant. Any change in the interest rate on the Laurus Notes
will be determined on a monthly basis. In no event will the interest rate on the
Laurus Notes be less than 0.00%.  Interest
on the Laurus Notes is payable monthly in arrears on the first day of each month
during the term of the Laurus Notes.





The
initial fixed conversion price under the Laurus Notes is $0.28 per share. The
initial conversion price and the number of shares of the Company’s common stock
issuable upon





83
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





conversion
of the each of the Laurus Notes are subject to adjustment in the event that the
Company reclassifies, subdivides or combines its outstanding shares of common
stock or issues additional shares of its common stock as a dividend on its
outstanding shares of common stock. The fixed conversion price is subject to
anti-dilution protection adjustments, on a weighted average basis, upon the
Company's issuance of additional shares of common stock at a price that is less
than the then current fixed conversion price. Subject to certain limitations,
Laurus may, at any time, convert the outstanding indebtedness of each of the
Laurus Notes into shares of the Company’s common stock at the then applicable
conversion price. Subject to certain trading volume and other limitations, the
MB Note will automatically convert at the then applicable conversion price into
shares of the Company’s common stock if, at any time while an effective
registration statement under the Securities Act of 1933, as amended (the
“Securities Act”), for the resale of the Company’s common stock underlying the
MB Note and Laurus Warrant is outstanding, the average closing price of the
Company’s common stock for ten consecutive trading days is at least $0.31,
subject to certain adjustments. The Revolving Note is potentially convertible
into more than $750 worth of the Company’s common stock, depending upon the
amount of aggregate borrowings by the Company under the Revolving Note and the
amount of conversions by Laurus.





The
Laurus Warrant grants Laurus the right to purchase up to 1,143,000 shares of the
Company’s common stock at an exercise price of $0.35 per share. On October 7,
2004, the Company also issued a warrant to purchase 178,571 shares of the
Company’s common stock at an exercise price of $0.35, and made a cash payment of
approximately $38, to TN Capital Equities, Ltd. (“TN”), as compensation for TN
having served as the placement agent in the financing transaction with Laurus.
The Laurus Warrant and the warrant issued to TN each expire on August 31, 2009.
Under the terms of the Minimum Borrowing Note Registration Rights Agreement,
Laurus has been afforded certain registration rights with respect to the shares
of the Company’s common stock underlying the MB Note and the Laurus Warrant. TN
was also afforded piggyback registration rights for the shares of the Company’s
common stock underlying the warrant it received. On November 5, 2004, the
Company filed with the SEC a preliminary registration statement on Form S-3
covering the potential resale of the shares of common stock underlying the MB
Note, Laurus Warrant and the warrant issued to TN. The registration statement
was declared effective and the Company filed with the SEC its Rule 424(b) final
prospectus on February 4, 2005.





In
exchange for agreement by the Investors to subordinate to Laurus their prior
lien on certain of the Company’s accounts receivable, the Company issued
warrants to the Investors (the “2004 Warrants”), allocated ratably in accordance
with the Investors’ interests in the Company's July 2003 note and warrant
financing, to purchase up to an aggregate of 19,143,000 shares of common stock.
The 2004 Warrants were approved by the Company’s stockholders on February 9,
2005; expire on July 18, 2006; and are exercisable solely in the event of a
change of control of the Company where the price paid per share of common stock
or the value per share of common stock retained by the Company's common
stockholders in any such change of control (the “Change of Control Price”) is
less than the then current per share exercise price of the 2003 Warrants. The
exercise price of the 2004 Warrants will be calculated at the time of a
qualifying change of control of the Company, if any, and will be equal to the
Change of Control Price. The Investors have been afforded certain registration
rights with regard to the 2004 Warrants. As a condition to the Company's
issuance of the 2004 Warrants, the Investors waived any anti-dilution rights to
which they might otherwise be entitled under all warrants previously issued to
the Investors resulting from the issuance or exercise of the 2004 Warrants. The
Company determined





84
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





that the
fair value of the 2004 Warrants is not material and accordingly no modifications
to the July 18, 2003, Note and Warrant transaction was required.





The
Company determined, in accordance with the guidance of SFAS 133, “ *Accounting
for Derivative Instruments and Hedging Activities,”* that the
following derivatives resulted from the Laurus financing transaction described
above: (i) the conversion option of the MB Note and (ii) the 1,321,571 warrants
issued to Laurus and TN. Accordingly, the Company recorded the fair value of
these derivatives approximating $231 as a debt discount and a non-current
liability on its consolidated balance sheet. The note discount is being
amortized to interest expense using the “Effective Interest Method” of
amortization over the 22 month term of the Laurus Note. For the year ended
December 31, 2004, approximately $27 of this note discount has been amortized to
interest expense. Also, at December 31, 2004 the value of the derivatives were
increased by approximately $55 to the then current fair value of approximately
$286 with a corresponding charge to other expense. The Company will continue to
mark these derivatives to market on a quarterly basis.


**7.
Commitments and Contingencies**





**Leases**





Rent
expense under operating leases was approximately $1,392, $1,480 and $1,460, for
the years ended December 31, 2004, 2003 and 2002, respectively.





The
Company leases space in several buildings, which are used for office, warehouse
and network operations facilities. The Company is obligated under various
building leases and capital equipment leases, primarily for its network and
computer equipment, which expire at different times through February
2015.





The
future minimum annual lease payments under the terms of such non-cancelable
leases as of December 31, 2004 are as follows:





**Operating**
    **Capital****Leases**
    **Leases**2005
    $
      788
    $
      512006
    233
    -2007
    169
    -2008
    14
    -$
      1,204
    $
      51Less:
      Amount representing interest
    
    1Present
      value of future minimum lease payments
    $
      50





In July
2000, the Company entered into a 48-month lease agreement with an equipment
vendor to finance the purchase of network equipment. The Company had leased
approximately $8,900 under this agreement. In July 2003, the Company paid $2,600
in full settlement of this outstanding capital lease obligation approximating
$3,728. The difference between the lease carrying value and the purchase price
of the assets, of approximately $1,128, was recorded as a reduction of the
carrying value of the assets acquired under the lease obligation. Amounts
financed under this lease agreement carried an interest rate of 12% per annum
and were secured





85
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





by the
financed equipment. There were no amounts outstanding under this capital lease
at December 31, 2004 and 2003.





In
addition, during 1999 and 2000, the Company purchased and assumed through
acquisition certain equipment and computer software under other capital leases,
which are being repaid over periods ranging from 24 months to 60 months at rates
ranging from 7.5% to 15%. In the aggregate, there were capital lease obligations
of approximately $50 and $155 at December 31, 2004 and 2003, respectively.





**Purchase
Commitments**





The
Company has varying purchase commitments with certain service providers that
range from one to five years all of which may be cancelled with prior written
notice of which some are subject to early termination fees.





**Litigation**





A lawsuit
for wrongful termination of employment was filed against the Company in the
Superior Court in New Haven, Connecticut on July 29, 1999 by a former officer
who was employed by the Company for less than two months. Plaintiff's claims are
based chiefly on his allegation that the Company terminated his employment
because he allegedly voiced concerns to senior management about the feasibility
of certain aspects of the Company’s business strategy. The plaintiff is
principally seeking compensatory damages for wages and unvested stock options.
The Company denies the plaintiff’s allegations and believes that his claims are
without merit. The Company has been defending the case vigorously and plans to
continue to do so.





A lawsuit
was filed against the Company in Connecticut State Court in the Judicial
District of New Haven on January 15, 2004 by an individual who claims that he
was offered a sales manager position at the Company in December 2003 but was
deprived of that position at or immediately prior to his initial employment
date. The plaintiff’s complaint includes claims for breach of contract,
negligent misrepresentation and intentional infliction of emotional distress.
The Company denies the plaintiff’s allegations and believes that his claims are
without merit. The Company has been defending the case vigorously and plans to
continue to do so.





The
Company is also a party to certain consolidated legal proceedings along with
other competitive local exchange carriers related to regulatory approvals and is
subject to state commission, FCC and court decisions related to the
interpretation and implementation of the 1996 Telecommunications Act and the
interpretation of competitive carrier interconnection agreements in general and
the Company’s interconnection agreements in particular. In some cases, the
Company may be deemed to be bound by the results of ongoing proceedings of these
bodies. The Company, therefore, may participate in proceedings before these
regulatory agencies or judicial bodies that may materially adversely affect,
and/or allow it to favorably advance, various aspects of its business
plan.





From time
to time, the Company may be involved in other litigation concerning claims
arising in the ordinary course of its business, including claims brought by
former employees and claims related to acquisitions. The Company does not
believe any of these legal claims or proceedings will result in a material
adverse effect on its business, financial position, results of operations or
cash flows.





86
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**


****


**Other
Matters**





The
Company has entered into interconnection agreements with traditional local
telephone companies. The agreements generally have terms of one to two years and
are subject to certain renewal and termination provisions by either party,
generally upon 30 days’ notification. The Company has renewed such agreements
beyond their initial terms in the past and anticipates that it will do so in the
future. Future interconnection agreements may contain terms and conditions less
favorable to the Company than those in its current agreements and could increase
the Company’s costs of operations, particularly when there are changes to the
federal or state legal requirements applicable to such agreements. The FCC
adopted new unbundling rules in August 2003 and again in February 2005 that have
not yet been implemented in the Company’s interconnection agreements. These new
rules are less favorable in many significant respects than those embodied in the
Company’s existing agreements, and are likely to have an impact on the business
as early as March 2005.





In
certain markets where the Company has not deployed its own equipment, the
Company utilizes local facilities from wholesale providers, including Covad, in
order to provide service to its end-user customers. These wholesale providers
may terminate their service with little or no notice. The failure of Covad or
any of the Company’s other wholesale providers to provide acceptable service
could have a material adverse effect on the Company’s operations. There can be
no assurance that Covad or other wholesale providers will be successful in
managing their operations and business plans.





The
Company transmits data across its network via transmission facilities that are
leased from certain carriers, including Level 3 Communications, Inc. and MCI.
The failure of any of the Company’s data transport carriers to provide
acceptable service on acceptable terms could have a material adverse effect on
the Company’s operations.





**8.** **Related
Party Transactions**





On
October 7, 2004, in exchange for the agreement by the Investors
to subordinate to Laurus their prior lien on the Company’s trade accounts
receivable in connection with the closing of the Company’s $5,000 convertible
notes and warrant financing with Laurus, the Company issued to the Investors the
2004 Warrants and granted to the Investors certain registration rights under
these newly issued warrants. As a further condition to the agreement by the
Investors to subordinate to Laurus their prior lien on certain of the Company’s
trade accounts receivable, the Company agreed to deposit the proceeds from the
Laurus convertible notes and warrant financing into a Company account maintained
at DBTCA. The Company’s withdrawal and use of the proceeds of the Laurus
convertible notes and warrant financing are subject to the prior approval of
DBTCA and of DB Advisors L.L.C., as advisor to Deutsche Bank. As of March 1,
2005, the Company has received approval to withdraw and has received $3,038 of
the $4,250 borrowed to date, of which $2,432 was identified as restricted cash
at December 31, 2004. As of March 1, 2005, the Company had also received
approval to draw down all of the $750 subject to the revolving credit facility
with Laurus.





Additionally,
certain of the Company’s directors (through their affiliation with the
Investors) have direct or indirect interests in the Laurus financing
transaction, as follows: (1) director Duncan Davidson is a venture partner with
VantagePoint, (2) director James D. Marver is a





87
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





managing
partner of the general partner of the VantagePoint entities, (3) Roderick Glen
MacMullin, who resigned from the Company’s Board of Directors on November 19,
2004 and who was a member of the Board at the time of the Laurus financing
transaction, was, as of the time period of the Laurus financing, affiliated with
Xavier Sussex, LLC, an investment advisory firm that has performed investment
advisory services to DB Advisors, L.L.C. (“DB Advisors”), the investment advisor
to Deutsche Bank, (4) Roger Ehrenberg, who resigned from the Company’s Board of
Directors on September 8, 2004, prior to the
closing of the Laurus financing, was a
member of the Board during the negotiation and approval of the Laurus financing
and during such time was affiliated with DB Advisors, and (5) director William
J. Marshall is a principal of RockRidge Capital Partners, Inc., an investment
advisory firm that has performed investment advisory services to DB
Advisors.





During
2004, VantagePoint converted 20,000 shares of Series X preferred stock into
125,138,082 shares of the Company’s common stock (inclusive of shares of common
stock issued in lieu of cash to pay accrued dividends on the Series X preferred
stock). As of December 31, 2004, VantagePoint held warrants to purchase
approximately 58,112,319 shares of the Company’s common stock. In addition, as
of December 31, 2004, VantagePoint owned 93,810,789 shares of the Company’s
common stock. Currently, two affiliates (Mr. Marver and Mr. Davidson) and one
former affiliate (Mr. Marshall) of VantagePoint are members of the Company’s
Board of Directors. Further, Michael Yagemann, a member of the Company’s Board
of Directors through July 7, 2004, was also affiliated with
VantagePoint.




As of
December 31, 2004 and 2003, as a result of the July 2003 $30,000 financing
transaction, Deutsche Bank held warrants issued to acquire approximately
118,421,053 shares of the Company’s common stock. Mr. Marshall, one of the
Company’s current directors, is affiliated with entities that provide investment
advisory services to Deutsche Bank. Further, Messrs. Ehrenberg and MacMullin,
who were members of the Company’s Board of Directors until September 8, 2004,
and November 19, 2004, respectively, were formerly affiliated with DB Advisors
and, in the case of Mr. MacMullin, had provided investment advisory services to
DB Advisors through his affiliation with Xavier Sussex, LLC.


During 2003, the Series Y
Investors (including Columbia) converted 14,000 shares of Series Y preferred
stock into 35,140,012 shares of the Company’s common stock (including shares
issued as dividends) (Note 9). As of December 31, 2003, funds affiliated with
one remaining Series Y Investor (Charles River Partnership, L.P.) owned 1,000
shares of Series Y preferred stock which are convertible into approximately
2,260,909 shares of the Company’s common stock (Note 9). These remaining 1,000
shares of Series Y preferred stock were converted into common shares in
February, 2004. In addition, resulting from guarantees issued under the
Reimbursement Agreement (Note 6), Columbia had warrants to acquire approximately
1,358,025 shares of the Company’s common stock. These warrants were exercised in
February 2004. An affiliate of Columbia, Harry Hopper, was a member of the
Company's Board of Directors until August 5, 2003.





In
January 2002, the Company entered into an Asset Purchase Agreement with
Broadslate for the purchase of business broadband customer accounts and certain
other assets, including accounts receivables related to the acquired customer
accounts, for an adjusted purchase price of approximately
$750. Certain of the Company’s stockholders, including investment funds
affiliated with Columbia, in the aggregate owned in excess of 10% of the capital
stock of





88
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





Broadslate.
Mr. Hopper, an affiliate of Columbia, was a director of Broadslate until
February 2002 and a member of the company’s Board of Directors until August 5,
2003.





Pursuant
to the terms of the Reimbursement Agreement, on December 27, 2002, the Company
issued warrants to purchase 10,379,420 shares of its common stock to
VantagePoint and warrants to purchase 1,634,473 shares of its common stock to
Columbia (Columbia subsequently transferred 445,254 of such warrants to
VantagePoint), in consideration for their guarantees aggregating $6,100. The
Company issued additional warrants to purchase 767,301 shares of its common
stock to VantagePoint and 168,806 shares of its common stock to Columbia during
the first quarter of 2003, bringing the total number of warrants issued to
12,950,000. All such warrants are exercisable for ten years at an exercise price
of $0.50 per share (Note 6). Prior to the execution of the Reimbursement
Agreement, VantagePoint beneficially owned 21,956,063 shares of the Company’s
common stock and 20,000 shares of the Company’s Series X preferred stock, which
were convertible into 111,111,111 shares of the Company’s common stock, and
Columbia owned 15,000 shares of the Company’s Series Y preferred stock, which
were convertible into 30,000,000 shares of the Company’s common stock (Note 9). At the
time of the transactions described immediately above, Mr. Marver was an
affiliate of VantagePoint and a member of the Board of Directors. Mr. Marver
remains affiliated with VantagePoint and currently serves on the Board of
Directors. Mr. Hopper, an affiliate of the Columbia entities, was a member
of the Company’s Board of Directors from December 28, 2001 to August 5,
2003.





On March
5, 2003, the Company and certain of the Guarantors entered into Amendment No. 1
to the Reimbursement Agreement, pursuant to which VP increased its guarantee by
$3,000 bringing the aggregate guarantees by all Guarantors under the
Reimbursement Agreement, as amended, to $9,100. As consideration for VP’s
increased guarantee, if the Company closed an equity financing on or before
December 3, 2003, it was authorized to issue VantagePoint additional warrants to
purchase the type of equity securities issued by the Company in such equity
financing. The number of such additional warrants would be determined by
dividing the per share price of such equity securities into a thousand dollars.
Accordingly, since the Company closed a financing on July 18, 2003, the Company
issued to VantagePoint in December 2003, additional warrants with a three-year
life, to purchase 2,260,909 shares of its common stock at a per share price of
$0.4423 (Note 6). At the time of these transactions, two of the Company’s
Directors, Mr.
Marver and Mr. Yagemann, were affiliated with VantagePoint. Mr. Yagemann
resigned from the Board of Directors on July 7, 2004. Mr. Marver remains on the
Board of Directors.





On July
18, 2003, the Company entered into the Note and Warrant Purchase Agreement (Note
6). VantagePoint participated in the transactions contemplated by the Note and
Warrant Purchase Agreement). Two affiliates of VantagePoint (Messrs. Marver and
Yagemann) were members of the Company’s Board of Directors. Mr.
Yagemann resigned from the Board of Directors on July 7, 2004. Mr. Marver
remains on the Board of Directors.
 
 On July 22, 2004, the Company entered
into a recapitalization agreement with VantagePoint, pursuant to which all of
the then remaining issued and outstanding shares of Series X preferred stock of
the Company were converted into shares of the Company’s common stock and 14,000
shares of newly issued Series Z preferred stock of the Company were issued to
VantagePoint as an inducement to such conversion (Note 9). During the
negotiation and closing of this transaction, two affiliates of VantagePoint
(Messrs. Marver and Yagemann) served on the
  
 89
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**
 
 Company’s
Board of Directors. Mr.
Yagemann resigned from the Board of Directors on July 7, 2004. Mr. Marver
remains on the Board of Directors.


**9.     
Mandatorily Redeemable Convertible Preferred Stock and Stockholders' Equity**





**Mandatorily
Redeemable Convertible Preferred Stock**





On
November 14, 2001, the Company entered into a
purchase agreement with VantagePoint relating to the sale and purchase of up to
an aggregate of 20,000 shares of mandatorily redeemable convertible Series X
preferred stock of the Company at a purchase price of $1,000


per share
(the “Series X Purchase Agreement”). Pursuant to the Series X Purchase
Agreement, on November 14, 2001, December 10, 2001 and March 1, 2002 the Company
sold an aggregate of 6,000 shares, 4,000 shares and 10,000 shares, respectively,
of Series X preferred stock to VantagePoint for total proceeds of $20,000,
before direct issuance costs of $189.





The
holders of the Series X preferred stock are entitled to receive cumulative
dividends of 12% per year ($120.00 per share per annum) when and as declared by
the Board of Directors. All such dividends shall accrue monthly and shall be
payable in cash, except in the case of the conversion of the Series X preferred
stock into common stock, in which case such dividends may be paid, at the sole
option of the Company, in shares of common stock. The accrued but unpaid
dividends are payable upon the earliest to occur of (i) the liquidation,
dissolution, winding up or change in control (as described below) of the
Company, (ii) the conversion of the Series X preferred stock into common stock
and (iii) the redemption of the Series X preferred stock.





In the
event of the liquidation, dissolution or winding up of the Company, the holders
of the Series X preferred stock shall be entitled to $1,000 per share plus all
unpaid accrued dividends (whether or not declared), on parity with holders of
the Series Y preferred stock (discussed below). Remaining assets, if any, shall
be distributed to the holders of Series X preferred stock, Series Y preferred
stock, common stock and any other class or series of the Company’s capital stock
that is not limited to a fixed sum or percentage of assets, on a pro rata basis
assuming full conversion into the Company’s common stock of all preferred stock.
Unless a majority of the holders of the then outstanding Series X preferred
stock elect otherwise, (i) an acquisition, merger or consolidation which results
in a majority ownership change or (ii) the sale of all or substantially all of
the assets of the Company (i.e., a “change in control”) shall be deemed to be a
liquidation of the Company.





At the
option of the holders of the Series X preferred
stock, each share of Series X preferred stock may be converted at any time, into
approximately 5,555.56 shares of common stock, which shall be adjusted for
certain subsequent dilutive issuances and stock splits. Since the conversion
option price was less than the market price of the Company’s common stock on the
date the Series X Purchase Agreement was signed (“the Series X commitment
date”), the Company has recorded a Beneficial Conversion Feature (“BCF”) by a
reduction (discount) to Preferred Stock in accordance with the guidance under
EITF 00-27. The BCF was determined using the intrinsic value method which is
defined as the “accounting conversion price” less the quoted market price of the
common stock on the Series X commitment date multiplied by the number of common
shares into which the preferred stock converts; however, the BCF recognized was
limited to the net proceeds received from the issuance of the Series X preferred
stock. The BCF is accreted from the Preferred Stock issuance dates to the
redemption date of July 18, 2006. The accreted BCF is included in the
calculation of net loss applicable to common stockholders.








90
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





The
Series X preferred stock shall automatically convert into common stock upon the
close of business on the date on which the closing sale price of the Company’s
common stock has exceeded $2.50 per share (as adjusted for any stock splits,
stock dividends, recapitalizations or the like) for a period of 45 consecutive
trading days beginning after May 13, 2002.

The
Series X preferred stock has voting rights similar to common stock based on the
number of shares into which such Series X preferred stock is initially
convertible. So long as at least 50% of the Series X preferred stock issued
pursuant to the Series X Purchase Agreement remains outstanding, the holders of
the Company’s Series X preferred stock shall have the right to elect amajority of the members of the Company’s Board of Directors. In addition,
so long as at least 25% of the Series X preferred stock issued pursuant to the
Series X Purchase Agreement remains outstanding, the holders of the Company’s
Series X preferred stock shall have the right to vote as a separate class with
respect to the approval of (i) the authorization or issuance, or obligation to
issue, any equity-related security having rights, preferences or privileges
senior to or, during the six-month period commencing December 28, 2001, on
parity with, to the Series X preferred stock, (ii) any alteration or change to
the rights, preferences or privileges of the Series X preferred stock or (iii)
any reclassification of the Series X preferred stock. The Series X preferred
stock is redeemable, on parity with the Series Y preferred stock (discussed
below), at the option of the holders of a majority of the then outstanding
shares of Series X preferred stock at any time on or after January 1, 2005
(which date was subsequently extended to July 18, 2006, as discussed below) at a
price equal to $1,000 per share plus all unpaid accrued dividends (whether or
not declared).





On
December 24, 2001, the Company entered into a purchase agreement with Columbia
Capital Equity Partners III (QP), L.P., Columbia Capital Equity Partners II
(QP), L.P., The Lafayette Investment Fund, L.P., Charles River Partnership X, A
Limited Partnership and N.I.G. - Broadslate, Ltd. (the “Series Y Investors”)
relating to the sale and purchase of up to an aggregate of 15,000 shares of
Series Y Preferred Stock of the Company at a purchase price of $1,000 per share
(the “Series Y Purchase Agreement”). Subject to the terms and conditions of the
Series Y Purchase Agreement, on December 28, 2001, the Company sold an aggregate
of 6,469 shares of Series Y preferred stock to the Series Y Investors for an
aggregate purchase price of $6,469, before direct issuance costs of $300. In
addition, on December 28, 2001, the Company issued promissory notes to the
Series Y Investors in the aggregate principal amount of $3,531 in exchange for
proceeds of $3,531 (Note 6). The promissory notes provided for an annual
interest rate of 12%. On May 29, 2002, in accordance with the terms of the
Series Y Purchase Agreement, the Company sold 8,531 additional shares of Series
Y preferred stock for net proceeds of $5,000 in cash and delivered the
promissory notes for cancellation. All accrued interest of approximately $145 on
the promissory notes was forgiven.





The
holders of Series Y preferred stock are entitled to receive cumulative dividends
of 12% per year ($120.00 per share per annum) when and as declared by the
Company’s Board of Directors. All such dividends accrue monthly and are payable
in cash, except in the case of the conversion of the Series Y preferred stock
into common stock, dividends may be paid, at the sole option of the Company, in
shares of common stock. Notwithstanding the foregoing, accrued but unpaid
dividends are payable upon the earliest to occur of (i) the liquidation,
dissolution, winding up or change of control (as described below) of the
Company, (ii) the conversion of the Series Y preferred stock into common stock
and (iii) the redemption of the Series Y preferred stock.








91
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





In the
event of the liquidation, dissolution or winding up of the Company, the holders
of Series Y preferred stock are entitled to receive $1,000 per share plus all
unpaid accrued dividends (whether or not declared) in parity with the holders of
the Company's Series X preferred stock. Remaining assets, if any, shall be
distributed to the holders of Series X preferred stock, Series Y preferred
stock, common stock and any other class or series of the Company’s capital stock
that is not limited to a fixed sum or percentage of assets on a pro rata basis,
assuming full conversion into the Company’s common stock of all Preferred Stock.
Unless a majority of the holders of the then outstanding Series Y preferred
stock elect otherwise, (i) an acquisition, merger or consolidation of the
Company which results in a majority ownership change or (ii) the sale of all or
substantially all of the assets of the Company (i.e., a “change in control”)
shall be deemed to be a liquidation of the Company.




holders
of the Series Y preferred stock, each share of Series Y preferred stock may be
converted into 2,000 shares of common stock, subject to adjustment for certain
subsequent dilutive issuances and stock splits (adjusted to 2,260.9 shares of
common stock on July 18, 2003, as discussed below). Since the conversion option
price was less than the market price of the Company’s common stock on the dates
the Series Y commitments occurred, the Company has recorded a BCF by a reduction
(discount) to Preferred Stock in accordance with the guidance under EITF 00-27.
The BCF was determined using the intrinsic value method which is defined as the
“accounting conversion price” less the quoted market price of the common stock
on the Series Y commitment dates multiplied by the number of common shares into
which the preferred stock converts; however, the BCF recognized was limited to
the net proceeds received from the issuance of the Series Y preferred stock. The
BCF is accreted from the Preferred Stock issuance dates to the redemption date
of July 18, 2006. The accreted BCF is included in the calculation of net loss
applicable to common stockholders.





The
Series Y preferred stock automatically converts into common stock upon the close
of business on the date on which the closing sale price of the common stock has
exceeded $2.50 per share (as adjusted for any stock splits, stock dividends,
recapitalizations or the like) for a period of 45 consecutive days commencing on
or after June 26, 2002.





Each
share of Series Y preferred stock has the right to 978.5 votes and, except as
otherwise provided in the Company's certificate of incorporation or required by
law, votes together with all other classes and series of capital stock of the
Company as a single class on all actions to be taken by all holders of the
Company’s stock. So long as at least 25% of the Series Y preferred stock issued
pursuant to the Series Y Purchase Agreement remains outstanding, the holders of
the Company’s **** Series Y
preferred stock have the right to vote as a separate class with respect to the
approval of (i) the authorization or issuance, or obligation to issue, any
equity-related security having rights, preferences or privileges senior to or,
during the six-month period commencing December 28, 2001, on parity with, the
Series Y preferred stock, (ii) any alteration or change to the rights,
preferences or privileges of the Series Y preferred stock or (iii) any
reclassification of the Series Y preferred stock.





The
Series Y preferred stock is redeemable, on parity with the Series X preferred
stock and any other class or series of the Company’s capital stock entitled to
redemption that is on parity with the Series X preferred stock, at the option of
a majority of the holders of the then outstanding shares of Series Y preferred
stock at any time on or after July 18, 2006, at a price





92
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





equal to
$1,000 per share plus all unpaid accrued dividends (whether or not declared).

In
connection with the Series Y Purchase Agreement, the holders of the Series Y
preferred stock and the Series X preferred stock entered into voting agreements
which obligated them to vote in favor of the required transactions contemplated
by the Series Y Purchase Agreement and related matters. In addition, a
stockholders agreement, as amended, among the Company, the holders of the Series
X preferred stock and the holders of the Series Y preferred stock provides for
rights relating to election of directors, the registration of the Company’s
common stock issuable upon conversion of the Series X and Series Y preferred
stock and certain protective provisions.

Due to the effects of the Company’s $30,000 debt financing issued
with warrants to purchase common stock at $0.38 per share (Note 6) on July18,
2003, the Series Y conversion price was adjusted from $0.50 per share (each
share of Series Y preferred
stock was convertible into 2,000 shares of common stock) to $0.4423 per share
(each share of Series Y preferred stock is convertible into approximately
2,260.9 shares of common stock) in accordance with certain anti-dilution
provisions of the Series Y preferred stock. Accordingly, the Company recorded an
additional BCF. In addition, the Company and holders of a majority of the Series
X preferred stock and Series Y preferred stock agreed to extend the redemption
dates of the Series X preferred stock and Series Y preferred stock from January
1, 2005 to July 18, 2006.





In the
third quarter of 2003, 88 shares of Series Y preferred stock were converted into
176,000 shares of the Company’s common stock at a conversion price of $0.50 per
share and, in accordance with the terms of the Series Y preferred stock, the
Company elected to pay accrued dividends approximating $11 by issuing 22,431
shares of its common stock, based on an average fair market value for the ten
days preceding conversion of approximately $0.51 per share.





Also in
the third quarter of 2003, 9,862 shares of Series Y preferred stock were
converted into 22,297,079 shares of the Company’s common stock at a conversion
price of $0.4423 per share and, in accordance with the terms of the Series Y
preferred stock, the Company elected to pay accrued dividends approximating
$1,781 by issuing 2,423,465 shares of its common stock, based on average fair
market values for the ten days preceding each conversion, ranging between
approximately $0.70 per share and $0.74 per share.





As a
result of the third quarter conversions of 9,950 shares of Series Y preferred
stock, the Company was required to accelerate the unaccreted BCF related to such
shares, which amounted to an additional $4,724 of preferred stock accretion
charged in the third quarter of 2003.





In
December 2003, 4,050 shares of Series Y preferred stock were converted into
9,156,680 shares of the Company’s common stock at a conversion price of $0.4423
per share and, in accordance with the terms of the Series Y preferred stock, the
Company elected to pay accrued dividends approximating $729 by issuing 1,064,359
shares of its common stock, based on average fair market values for the ten days
preceding each conversion, ranging between approximately $0.68 per share and
$0.69 per share.





As a
result of the fourth quarter conversions of 4,050 shares of Series Y preferred
stock, the Company was required to accelerate the unaccreted BCF related to such
shares, which amounted to an additional $1,699 of preferred stock accretion
charged in the fourth quarter of 2003.








93
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





In
January 2004, VantagePoint converted 6,000 shares ofSeries X
preferred stock into 33,333,333 shares of the Company’s common stock at a
conversion price of $0.18 per share and, in accordance with the terms of the
Series X preferred stock, the Company elected to pay accrued dividends
approximating $1,560 by issuing 2,316,832 shares of its common stock, calculated
based on the average fair market value for the ten days preceding the conversion
of $0.67 per share.

In
February 2004, the Series Y Investors converted the remaining 1,000 shares of
Series Y preferred stock into 2,260,910 shares of the Company’s common stock at
a conversion price of $0.4423 per share and, in accordance with the terms of the
Series Y preferred stock, the Companyelected to pay accrued dividends
approximating $221 by issuing 309,864 shares of its common stock, calculated
based on the average fair market value for the ten days preceding the conversion
of $0.71 per share.





As a
result of the above described conversions of 6,000 shares of Series X preferred
stock and 1,000 shares of Series Y preferred stock in 2004, the Company was
required to accelerate the unaccreted beneficial conversion feature related to
such shares, which amounted to an additional $2,850 of preferred stock accretion
charged in the first quarter of 2004.





On July
22, 2004, the Company entered into a Recapitalization Agreement with
VantagePoint, the holder of all of the then remaining issued and outstanding
shares of Series X
preferred stock (the “Recapitalization Agreement”). In accordance with the
Recapitalization Agreement, the remaining 14,000 shares of Series X preferred
stock were converted into 77,777,775 shares of the Company’s common stock at a
conversion price of $0.18 per share and, in accordance with the terms of the
Series X preferred stock, the Company elected to pay accrued dividends
approximating $4,040 by issuing an additional 11,710,142 shares of its common
stock at a per share price of $0.345, calculated based on the average fair
market value for the ten days ending three days preceding the conversion. As a
result of these conversions, the Company was required to accelerate the
unaccreted beneficial conversion feature related to such converted shares, which
resulted in $4,812 of preferred stock accretion charged in the third quarter of
2004.





For the
year ended December 31, 2004, there was $7,662 of additional preferred stock
accretion related to the conversion of 20,000 shares of Series X preferred stock
and the conversion of 1,000 shares of Series Y preferred stock.





94
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**








The
Series X preferred stock and Series Y preferred stock activity for the years
ended December 31, 2004, 2003 and 2002, is summarized as follows:





Mandatorily
      Redeemable Convertible Preferred StockSeries
      X
    
    Series
      YShares
    
    Amount
    
    Shares
    
    AmountBalance
      December 31, 2001
    
    
    10,000
    
    $
    436
    
    
    6,469
    
    $
    35Issuance
      of shares
    
    
    10,000
    
    $
    10,000
    
    
    8,531
    
    $
    8,531Discount
      on Series X and Y Preferred Stock resulting
      from a beneficial conversion feature, net of issuance
      costs
    
    
    
    
    
    (10,000
    )
    
    
    
    
    (8,531
    )Accrued
      dividends on Series X and Y Preferred Stock
    
    
    
    
    
    2,200
    
    
    
    
    
    1,373Accretion
      of beneficial conversion feature of Series X
      and Y Preferred Stock
    
    
    
    
    
    6,105
    
    
    
    
    
    3,973Balance
      December 31, 2002
    
    
    20,000
    
    $
    8,741
    
    
    15,000
    
    $
    5,381Conversion
      of Series Y Preferred Stock to
      Common stock
    
    
    
    
    
    
    
    
    (14,000
    )
    $
    (14,000
    )Payment
      of dividends on converted Series
      Y Preferred Stock
    
    
    
    
    
    
    
    
    
    
    
    (2,522
    )Accrued
      dividends on Series X and Y
      Preferred Stock
    
    
    
    
    
    2,345
    
    
    
    
    
    1,353Accretion
      of beneficial conversion feature
      of Series X and Y Preferred Stock
    
    
    
    
    
    5,145
    
    
    
    
    
    9,182Preferred
      Stock reclassification
    
    
    
    
    
    -
    
    
    
    
    
    1,394Balance
      December 31, 2003
    
    
    20,000
    
    $
    16,231
    
    
    1,000
    
    $
    788Conversion
      Series X and Y Preferred Stock
      to common stock
    
    
    (20,000
    )
    $
    (20,000
    )
    
    (1,000
    )
    $
    (1,000
    )Accrued
      dividends on Series X and Y Preferred Stock
    
    
    
    
    
    940
    
    
    
    
    
    10Payment
      of dividends on converted Series X and Y
      Preferred Stock
    
    
    
    
    
    (5,600
    )
    
    
    
    
    (221
    )Accretion
      of beneficial conversion feature of Series X
      and Y Preferred Stock
    
    
    
    
    
    8,429
    
    
    
    
    
    423Balance
      December 31, 2004
    
    
    -
    
    $
    -
    
    
    -
    
    $
    -





In
accordance with the above described Recapitalization Agreement, the Company
issued to VantagePoint 14,000 shares of Series Z preferred stock, with a
liquidation preference of up to $1,120





95
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





per share
($15,680 in the aggregate) and a total fair value of $2,630 (further discussed
below). The Series Z preferred stock was issued to VantagePoint in the
recapitalization to induce them to convert their remaining 14,000 shares of
Series X preferred stock and to preserve, for a period up to four years,
VantagePoint’s liquidation preference rights, which would otherwise have
terminated upon such conversion. VantagePoint will have the right to a
liquidation preference on the shares of Series Z preferred stock it holds in the
event of any liquidation, dissolution or winding up of the Company (including a
transaction approved in advance by the board of directors of the Company for:
(i) the sale of the Company to another entity in a reorganization, merger,
consolidation or otherwise, if following such transaction or series of
transactions the holders of the outstanding voting power of the Company prior to
such transaction would own less than a majority of the voting power of the
surviving entity or (ii) the sale of substantially all of the assets of the
Company). The Series Z preferred stock does not contain any conversion or
mandatory redemption provisions, nor does it have any special dividend or
special voting rights. The
Series Z preferred stock’s liquidation preference will be eliminated, and the
shares of Series Z preferred stock cancelled, on July 18, 2008.  In
addition, the liquidation preference amount
shall be reduced upon the occurrence of the following events:





·
    if
      the Company is subject to a petition under the U.S. Bankruptcy Code and
      sells all or substantially all of its assets other than in a transaction
      of series of transactions in which the business of the Company is acquired
      by a third party as a business and VantagePoint has sold more than 39
      million shares, but less than 58 million shares, of the Company’s common
      stock issued in connection with the transactions contemplated by the
      recapitalization agreement, then the liquidation preference shall be
      reduced to $8,680 in the aggregate; and





·
    upon
      the first of any of the following, the liquidation preference shall be
      reduced to $0 in the aggregate and the Series Z Preferred Stock shall be
      cancelled:





§
    July
      18, 2008;


§
    the
      Company is subject to a petition under the U.S. Bankruptcy Code and sells
      in or pursuant to such proceeding all or substantially all of its assets
      and VantagePoint has sold more than 58 million shares of the Company’s
      common stock issued in connection with the transactions contemplated by
      the recapitalization agreement;


§
    VantagePoint
      owns more than 50% of the Company’s common stock;
or


§
    the
      Company’s common stock closes above $1.50 per share for 45 consecutive
      trading days.





The
Company has recorded the $2,630 fair value of Series Z preferred stock in the
equity section of its statement of financial position, and included that amount
as a charge in the calculation of net loss applicable to common
stockholders.




The fair
value of the Series Z preferred stock of $2,630 was determined based on a number
of factors including, but not limited to: (i) review of the Recapitalization
Agreement and the Certificate of Designation of the Series Z Preferred Stock,
(ii) consideration of the Company’s historical financial results, (iii) review
of certain criteria for similar companies obtained from published sources, and
(iv) the use of probability analyses.





96
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**


****


**Common
Stock Transactions**





During
2004, the Company issued 127,708,856 shares of its common stock upon conversion
of 20,000 shares and 1,000 shares of Series X and Series Y convertible preferred
stock, respectively, including common stock issued for accrued but unpaid
dividends (discussed above), 39,911 shares of its common stock upon exercise of
vested stock options, and 8,836 shares of its common stock for shares purchased
under its employee stock purchase plan (discussed below). Also in February 2004,
the company issued 413,160 shares of its common stock in a cashless exercise of
1,358,025 warrants owned by Columbia.





During
2003, the Company issued 35,140,012 shares of its common stock upon conversion
of 14,000 shares of Series Y preferred stock (discussed above), 5,363,763 shares
of its common stock upon exercise of vested stock options, and 15,380 shares of
its common stock for shares purchased under its employee stock purchase plan
(discussed below).





**Common
Stock Reserved**





The
Company has reserved shares of common stock as follows:





December
      31,2004
    
    20031999
      Stock Plan
    
    
    5,745,919
    
    
    7,590,3282001
      Stock Plan
    
    
    24,886,823
    
    
    42,455,038VISI
      Stock Option Plans
    
    
    19,192
    
    
    560,364Kirby
      Pickle Stock Option Plan
    
    
    10,000,000
    
    
    -1999
      Employee Stock Purchase Plan
    
    
    206,660
    
    
    215,496Stock
      Warrants
    
    
    192,212,192
    
    
    173,105,646Convertible
      Minimum Borrowing Note
    
    
    15,178,571
    
    
    -Series
      X Redeemable Convertible Preferred Stock
    
    
    -
    
    
    111,111,111Series
      Y Redeemable Convertible Preferred Stock
    
    
    -
    
    
    2,260,909Total
    
    
    248,249,357
    
    
    337,298,892





**Stock
Warrants**





On
October 7, 2004, in exchange for agreement by the Investors to subordinate to
Laurus their prior lien on certain of the Company’s accounts receivable, the
Company issued the 2004 Warrants to the Investors, allocated ratably in
accordance with the Investors’ interests in the Company's July 2003 note and
warrant financing, which warrants provide for the purchase of up to an aggregate
of 19,143,000 shares of common stock (Note 6). The 2004 Warrants expire on July
18, 2006 and are exercisable solely in the event of a qualifying change of
control of the Company at Change of Control Price. The exercise price of the
2004 Warrants will be calculated at the time of a qualifying change of control
of the Company, if any, and will be equal to the Change of Control Price. The
Investors have been afforded certain registration rights with regard to the 2004
Warrants. As a condition to the Company's issuance of the 2004 Warrants, the
Investors waived any anti-dilution rights to which they might otherwise be
entitled under all warrants previously issued to the Investors resulting from
the issuance or exercise of the 2004 Warrants.





Also on
October 7, 2004, as part of the Laurus financing, the Company issued a warrant
to Laurus to purchase up to 1,143,000 shares of the Company’s common stock at an
exercise price





97
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





of $0.35
per share. The Company also issued a warrant to purchase 178,571 shares of the
Company’s common stock, at an exercise price of $0.35 per share, to TN, as
compensation for TN’s having served as the placement agent in the financing
transaction with Laurus. The Laurus Warrant and the warrant issued to TN each
expire on August 31, 2009 (Note 6).





Pursuant
to the terms of the Reimbursement Agreement, in December 2002, the Company
issued warrants to purchase 12,013,893 shares of its common stock and in March
2003, the Company issued warrants to purchase 936,107 shares of its common
stock, to VantagePoint and Columbia, in consideration for their loan guarantees
aggregating $6,100. All such warrants have a ten-year life and an exercise price
of $0.50 per share (Note 6). The Company issued additional warrants in December
2003, to purchase 2,260,909 shares of its common stock to VantagePoint in
consideration for their additional $3,000 loan guarantee. Such warrants have a
ten-year life and an exercise price of $0.4423 per share (Note 6).





In July
2003, pursuant to the Note and Warrant Purchase Agreement, the Company issued to
Deutsche Bank and VantagePoint, warrants to purchase 157,894,737 shares of its
common stock. All such warrants have a three-year life and an exercise price of
$0.38 per share (Note 6).





In
November 2003, warrants owned by VantagePoint to purchase 83,314 shares of the
Company’s common stock expired and accordingly, were cancelled.





At
December 31, 2004 and 2003, the Company had outstanding warrants to purchase
192,212,192 and 173,105,646 shares of common stock, respectively.





**10.    
Income Taxes**





An income
tax provision has not been recorded for the years ended December 31, 2004, 2003
and 2002, because the Company generated net operating losses for those
respective years.





98
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**







The
Company's gross deferred tax assets and liabilities were comprised of the
following:





December
      31,2004
    
    2003
    
    2002Gross
      deferred tax asset:Net
      operating loss carryforwards
    
    $
    122,014
    
    $
    111,175
    
    $
    98,956Depreciation
    
    
    -
    
    
    195
    
    
    -Other
    
    
    5,636
    
    
    6,189
    
    
    6,197Gross
      deferred tax assets
    
    
    127,650
    
    
    117,559
    
    
    105,153Gross
      deferred tax liability:Depreciation
    
    
    1,227
    
    
    -
    
    
    765Other
    
    
    596
    
    
    863
    
    
    513Gross
      deferred tax liabilities
    
    
    1,823
    
    
    863
    
    
    1,278Net
      deferred tax assets
    
    
    125,827
    
    
    116,696
    
    
    103,875Valuation
      allowance
    
    
    (125,827
    )
    
    (116,696
    )
    
    (103,875
    )Net
      deferred taxes
    
    $
    -
    
    $
    -
    
    $
    -





A full
valuation allowance is recorded against the net deferred tax assets because
management believes it is more likely than not that these assets will not be
realized. If future profitability is achieved, a significant portion of the net
deferred tax assets may not be available to offset future income tax
liabilities.





At
December 31, 2004 and 2003, the Company had approximately $313,074 and $282,200
of federal and state net operating loss carryforwards, respectively. Of this
amount, approximately $6,000 relates to stock-based compensation deductions
which, when realized, will be accounted for as a credit to additional
paid-in-capital rather than a reduction to the income tax provision. The federal
net operating loss carryforwards begin to expire in 2019 and the state net
operating loss carryforwards began to expire in 2004. A significant portion of
the net operating loss carryforwards may be subject to limitations under the
U.S. federal income tax laws due to changes in the capital structure of the
Company.





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





**December
      31,****2004**
    
    **2003**
    
    **2002**Statutory
      federal tax rate
    
    (34.00)
    %
    (34.00)
    %
    (34.00)
    %State
      income tax, net of federal benefit
    
    
    (4.96
    )
    
    (4.62
    )
    
    (4.97
    )Permanent
      differences
    
    
    0.06
    
    
    2.39
    
    
    0.04Deferred
      tax state rate change
    
    
    0.00
    
    
    0.00
    
    
    8.27Deferred
      tax asset valuation allowance
    
    
    38.90
    
    
    36.23
    
    
    30.66Effective
      federal tax rate
    
    
    -
    %
    
    -
    %
    
    -
    %








99
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





**11.    
Research and Development Expenditure Credits**





In March
2002, the Company filed an application with the Connecticut Department of
Revenue Services for research and development expenditure credits for the 1999
and 2000 calendar years. The credits were approved as a reduction against the
Connecticut corporation business tax. With regard to credits approved for the
2000 calendar year, the Company was entitled to elect a cash refund at 65
percent of the approved credit. The Company elected to receive the 2000 calendar
year credit as a cash refund of approximately $1,301. The 1999 calendar year
credit of approximately $671 is available as a carry forward to offset future
State of Connecticut corporation business taxes. In July 2002, the Company
received the first installment of the cash refund pertaining to the 2000
calendar year of approximately $1,000. Upon receipt of the research and
development credits, the Company was obligated to pay approximately $402 to a
professional service provider as a result of a contingent fee arrangement for
professional services in connection with obtaining such credits. In 2003 and
2004, the Company received the second and third installments of approximately
$150 and $151, respectively.





For the
years ended December 31, 2004, 2003 and 2002, the Company recorded the
approximate $151, $150 and $1,000 refunds, respectively, as a reduction in its
state corporate franchise tax expenses which are included in general and
administrative expenses. The approximate $402 related professional services fee
was recorded in general and administrative expenses during 2002.





**12.    
Incentive Stock Award Plans**





**Employee
Stock Option Plan**





In
February 2005, the Company further amended the Amended and Restated 2001 Stock
Option and Incentive Plan (the “2001 Plan”) to (i) increase the number of shares
of common stock authorized under the 2001 Stock Plan to a total of 65,000,000,
and to (ii) increase the number of options that may be issued to an employee in
any calendar year from 5,000,000 shares to 8,000,000
shares.


Options
granted to employees under the Company’s Amended and Restated 1999 Stock Plan
(the “1999 Plan”) and the 2001 Stock Plan generally vest, at the discretion of
the Board of Directors, either at (i) 25% after one year, then ratably over the
next thirty-six months, or (ii) 16% after six months and a day, then ratably
over the next thirty months. Once vested, the options under both plans are
exercisable for ten years from the date of grant.





In
conjunction with the acquisition of Vector Internet Services, Inc. (“VISI”), the
Company also assumed all of the then outstanding options issued under the VISI
1997 and 1999 Stock Option Plans (together with the 1999 Plan and the
2001 Plan, the “Plans”), which became fully vested options to purchase an
aggregate of 898,926 shares of common stock. No additional options will be
granted by the Company under the VISI stock option plans. The VISI options were
valued at $6,654 at the time of the acquisition.





In April
2004, as authorized by the Company’s Board of Directors, the Company entered
into an employment agreement and related stock option agreement with Kirby G.
Pickle, the Company’s new chief executive officer. Under the stock option
agreement for Mr. Pickle (the





100
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





“Kirby
Pickle Stock Plan”), an option to purchase a total of 10,000,000 shares of the
Company’s common stock was granted to Mr. Pickle as an inducement to his
employment with the Company. Options granted under the Kirby Pickle Stock Plan
vest approximately
16.6% on the date six months following the grant date, and thereafter vest
ratably on a monthly basis over the next thirty months. Once vested, the options
are exercisable at an exercise price of $0.48 per share for ten years from the
date of the grant.





A summary
of activity under the Plans for the years ended December 31, 2002, 2003 and 2004
is as follows:





Weighted
      AverageNumber
      of
    
    Fair
    
    ExerciseShares
    
    Value
    
    PriceOutstanding
      at December 31, 2001
    
    13,877,394Granted
    
    
    10,891,500
    
    $
    0.25
    
    $
    0.29Exercised
    
    
    (64,433
    )
    
    
    
    $
    0.14Cancelled
    
    
    (827,457
    )
    
    
    
    $
    3.47Outstanding
      at December 31, 2002
    
    
    23,877,004Granted
    
    
    1,463,000
    
    $
    0.47
    
    $
    0.56Exercised
    
    
    (5,363,763
    )
    
    
    
    $
    0.43Cancelled
    
    
    (1,304,475
    )
    
    
    
    $
    1.41Outstanding
      at December 31, 2003
    
    
    18,671,766Granted
    
    
    31,950,000
    
    $
    0.51
    
    $
    0.64Exercised
    
    
    39,911
    
    
    
    
    $
    0.29Cancelled
    
    
    9,929,922
    
    
    
    
    $
    0.85Outstanding
      at December 31, 2004
    
    
    40,651,934


The
following summarizes the outstanding and exercisable options under the Plans as
of December 31, 2004, 2003 and 2002:





Options
      Outstanding
    
    Options
      ExercisableWeighted
      Avg.Remaining
      Life
    
    Weighted
      Avg.
    
    
    
    Weighted
      Avg.Exercise
      Price
    
    Number
    
    (in
      years)
    
    Exercise
      Price
    
    Number
    
    Exercise
      Price12/31/04$0.02-0.49
    
    
    17,807,444
    
    
    7.7
    
    
    $ 
      0.40
    
    
    7,558,901
    
    
    $ 
      0.34$0.49-1.05
    
    
    19,148,341
    
    
    7.7
    
    
    $ 
      0.58
    
    
    8,243,953
    
    
    $ 
      0.60$1.05-2.07
    
    
    1,379,692
    
    
    6.9
    
    
    $ 
      1.10
    
    
    1,374,627
    
    
    $ 
      1.10$2.07-5.19
    
    
    1,963,124
    
    
    5.4
    
    
    $ 
      2.80
    
    
    1,953,852
    
    
    $ 
      2.80$5.19-7.78
    
    
    171,833
    
    
    4.6
    
    
    $ 
      6.89
    
    
    171,833
    
    
    $ 
      6.89$7.78-10.37
    
    
    80,000
    
    
    0.2
    
    
    $ 
      8.38
    
    
    80,000
    
    
    $ 
      8.38$10.37-12.96
    
    
    91,000
    
    
    5.3
    
    
    $11.94
    
    
    91,000
    
    
    $11.94$12.96-15.56
    
    
    8,500
    
    
    2.7
    
    
    $14.52
    
    
    8,500
    
    
    $14.52$15.56-$25.94
    
    
    2,000
    
    
    5.0
    
    
    $22.34
    
    
    2,000
    
    
    $22.3440,651,934
    
    
    7.5
    
    
    $ 
      0.70
    
    
    19,484,666
    
    
    $ 
      0.90

101
**DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**

12/31/03$0.02-0.49
    
    
    8,026,838
    
    
    8.5
    
    
    $ 
      0.29
    
    
    2,752,783
    
    
    $ 
      0.28$0.49-1.05
    
    
    5,953,181
    
    
    8.2
    
    
    $ 
      0.62
    
    
    2,653,537
    
    
    $ 
      0.64$1.05-2.07
    
    
    1,799,475
    
    
    6.9
    
    
    $ 
      1.24
    
    
    1,339,411
    
    
    $ 
      1.29$2.07-5.19
    
    
    2,314,069
    
    
    6.8
    
    
    $ 
      2.87
    
    
    1,868,464
    
    
    $ 
      2.87$5.19-7.78
    
    
    325,745
    
    
    6.3
    
    
    $ 
      6.76
    
    
    294,496
    
    
    $ 
      6.77$7.78-10.37
    
    
    81,000
    
    
    5.8
    
    
    $ 
      8.38
    
    
    81,000
    
    
    $ 
      8.38$10.37-12.96
    
    
    103,000
    
    
    6.3
    
    
    $11.94
    
    
    94,725
    
    
    $11.94$12.96-15.56
    
    
    62,458
    
    
    6.0
    
    
    $14.79
    
    
    61,213
    
    
    $14.80$15.56-$25.94
    
    
    6,000
    
    
    6.1
    
    
    $21.50
    
    
    5,874
    
    
    $21.4418,671,766
    
    
    8.0
    
    
    $ 
      1.07
    
    
    9,151,503
    
    
    $ 
      1.5712/31/02$0.02-0.49
    
    
    11,382,076
    
    
    9.2
    
    
    $ 
      0.28
    
    
    927,605
    
    
    $ 
      0.22$0.49-1.05
    
    
    7,511,060
    
    
    8.5
    
    
    $ 
      0.62
    
    
    3,152,807
    
    
    $ 
      0.61$1.05-2.07
    
    
    1,864,473
    
    
    7.8
    
    
    $ 
      1.25
    
    
    941,417
    
    
    $ 
      1.40$2.07-5.19
    
    
    2,449,597
    
    
    7.7
    
    
    $ 
      2.88
    
    
    1,436,678
    
    
    $ 
      2.89$5.19-7.78
    
    
    387,432
    
    
    7.2
    
    
    $ 
      6.74
    
    
    258,784
    
    
    $ 
      6.76$7.78-10.37
    
    
    83,000
    
    
    6.6
    
    
    $ 
      8.40
    
    
    82,352
    
    
    $ 
      8.40$10.37-12.96
    
    
    104,000
    
    
    7.3
    
    
    $11.94
    
    
    69,641
    
    
    $11.94$12.96-15.56
    
    
    82,200
    
    
    6.0
    
    
    $14.65
    
    
    59,686
    
    
    $14.66$15.56-$25.94
    
    
    13,166
    
    
    3.4
    
    
    $20.25
    
    
    9,994
    
    
    $20.1323,877,004
    
    
    8.7
    
    
    $ 
      0.98
    
    
    6,938,964
    
    
    $ 
      1.72


The
estimated fair value at date of grant for options granted for the year ended
December 31, 2004, ranged from $0.18 to $0.71 per share, for the year ended
December 31, 2003, ranged from $0.49 to $0.69, and for the year ended December
31, 2002, ranged from $0.25 to $0.94 per share. The minimum value of each option
grant is estimated on the date of grant using the Black-Scholes option pricing
model with the following weighted average assumptions:







102
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**




December
      31,2004
    2003
    2002Risk
      free interest rate
    1.96%-3.67%
    2.15%-3.06%
    2.49%-4.42%Expected
      dividend yield
    None
    None
    NoneExpected
      life of option
    3-4
      years
    3-4
      years
    3
      yearsExpected
      volatility
    134
      - 145%
    152%
    152%


As
additional options are expected to be granted in future years, and the options
vest over several years, the above pro forma results are not necessarily
indicative of future pro forma results.





The
Company records deferred compensation when common stock options and shares of
restricted stock are granted with an exercise price below estimated fair value.
Deferred compensation is recognized to compensation expense generally over the
vesting period. Unvested options for terminated employees are cancelled and the
value of such options are recorded as a reduction of deferred compensation with
an offset to additional-paid-in-capital. Stock compensation expense totaled
approximately $0, $438 and $1,228, for the years ended December 31, 2004, 2003
and 2002, respectively .





**Employee
Stock Purchase Plan**





The
Company's 1999 Employee Stock Purchase Plan (the ''Purchase Plan'') authorized
the issuance of up to a total of 300,000 shares of common stock to participating
employees.





All
employees of the Company and all employees of any participating subsidiaries
whose customary employment is more than 20 hours per week and more than three
months in any calendar year are eligible to participate in the Purchase Plan.
Under the terms of the Purchase Plan, the price per share paid by each
participant on the last day of the offering period (as defined therein) is an
amount equal to 85% of the fair market value of the common stock on either the
first day or the last day of the offering period, whichever is lower. Each
employee participating in the Purchase Plan may purchase a maximum of 500 shares
during each six-month offering period. The Purchase Plan terminates on December
31, 2009 or such earlier date as the Board of Directors determines. The Purchase
Plan will terminate in any case when all or substantially all of the unissued
shares of stock reserved for the purposes of the Purchase Plan have been
purchased. Upon
termination of the Purchase Plan all amounts in the accounts of participating
employees will be promptly refunded.





During
the years ended December 31, 2004, 2003 and 2002, the Company issued 8,836,
15,380 and 14,000 shares of its common stock, respectively, under the
plan.





**13.
Employee Savings Plan 401(k)**





On April
1, 2000, the Company started a 401(k) savings plan under which it matches
employee contributions at 50% up to the first 4% of their contribution.
Employees may elect to participate in the plan bi-annually on the enrollment
dates provided they have been employees for at least ninety days. Employees
participating in the plan may chose from a portfolio of investments, with the
Company’s match having the same investment distribution as the employees’
election. The Company’s contribution to the 401(k) plan during the years ended
December 31, 2004, 2003 and 2002 was $110, $166 and $140,
respectively.





103
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**








**14.
Accrued Liabilities**





Accrued
liabilities included the following:





December
      31,2004
    
    2003Taxes
      payable - other than
      income
      taxes
    
    $
    906
    
    $
    1,828Accrued
      telecommunication
      expenses
    
    
    531
    
    
    3,886Accrued
      restructuring expenses
    
    
    -
    
    
    540Other
      accrued liabilities
    
    
    1,022
    
    
    1,275Total
    
    $
    2,459
    
    $
    7,529





The
decrease in accrued telecommunications expenses between December 31, 2004 and
2003 of approximately $3,355 was primarily attributable to payments during 2004
of telecommunications expenses related to the Company’s operation of the NAS
Assets.





**15.
Restructuring and Impairments**





During
the year ended December 31, 2004, the Company charged approximately $540 against
the restructuring reserve related to facilities expense associated with the
Company’s vacated office space in Santa Cruz, California. The lease on that
facility expired in December of 2004 and the restructuring reserve balance was
$0 at December 31, 2004.





During
the year ended December 31, 2003, the Company increased its reserve for vacated
facilities by approximately $252 as a sublet tenant vacated its Santa Cruz
facility and no additional sublets were anticipated. The Company also charged
approximately $647 against its restructuring reserves; of which, approximately
$315 related to payment of certain termination fees associated with the closure
of certain central offices during 2001, and approximately $332 related to
facilities expense associated with the Company’s vacated office space in Santa
Cruz, California. At December 31, 2003, the remaining restructuring reserve
balance for the leased Santa Cruz facility of approximately $540 was included in
accrued liabilities.





During the year
ended December 31, 2002, the
Company charged approximately $576 against
the restructuring reserves pertaining to facilities expense associated with its
vacated office space in Santa Cruz, California and the remaining reserve balance
at December 31, 2002 of approximately $935 was included in accrued liabilities.





104
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**








The
following table summarizes the additions and charges to the restructuring
reserve from December 2001 through December 2004, and the remaining reserve
balances at December 31, 2004:


**Facility
      Leases**
    
    **Central**
      **Office**
      **Term.**
      **Fees**
    
    **Total**Reserve
      balance at
      Dec.
      31, 2001
    
    $
    1,196
    
    $
    315
    
    $
    1,511Charges
      to the
      reserve
    
    
    (576
    )
    
    -
    
    
    (576
    )Reserve
      balance at
      Dec.
      31, 2002
    
    
    620
    
    
    315
    
    
    935Additions
      to the
      reserve
    
    
    252
    
    
    -
    
    
    252
  Charges
      to the
      reserve
    
    
    (332
    )
    
    (315
    )
    
    (647
    )Reserve
      balance at
      Dec.
      31, 2003
    
    
    540
    
    
    -
    
    
    540Charges
      to the
      reserve
    
    
    (540
    )
    
    -
    
    
    (540
    )Reserve
      balance at
      Dec.
      31, 2004
    
    $
    -
    
    $
    -
    
    $
    -
 
 **16.    
Subsequent Events**





In
February 2005, upon recommendation of the Board of Directors, the Company’s
stockholders approved an amendment to the 2001 Stock Plan to (i) increase the
number of shares of common stock authorized under the 2001 Stock Plan to a total
of 65,000,000, and to (ii) increase the number of options that may be issued to
an employee in any calendar year from 5,000,000 shares to 8,000,000
shares.





In
February 2005, the FCC issued its Triennial Review Remand Order (the “TRRO”) and
adopted new rules, effective March 11, 2005, governing the unbundling
obligations of incumbent local exchange carriers (“ILECs”). Among other things,
the TRRO reduces the ILECs’ obligations to provide high-capacity DS1 loops and
DS1 and DS3 dedicated transport facilities between certain ILEC wire centers
that are deemed to be sufficiently competitive, based upon the number of fiber
collocators or the number of business access lines within such wire centers. The
TRRO eliminates, over time, the ILECs’ obligations to provide these
high-capacity circuits to competitive local exchange carriers (“CLEC”) like the
Company at the discounted rates CLECs have historically received under the 1996
Telecommunications Act. Beginning as early as March 2005, the costs for those of
the Company’s existing high-capacity circuits impacted by the FCC’s new rules
will increase by 15%. By March 10, 2006, the Company will be required to
transition those existing facilities to alternative arrangements, such as other
competitive facilities or the





105
 **DSL.net,
Inc.Notes to Consolidated Financial Statements(continued)(Dollars in
Thousands, Except Per Share Amounts)**





higher-priced
“special access services” offered by the ILECs. Additionally, subject to any
contractual protections the Company may have under its existing interconnection
agreements with ILECs, commencing March 11, 2005, the Company will incur the
ILECs’ higher “special access” pricing for any new installations of DS1 loops
and/or DS1 and DS3 transport facilities in the impacted ILEC wire centers. The
Company is currently assessing the potential impact of these price increases on
its network operating expense, as well as evaluating network configuration
alternatives that may help minimize the impact of these increases.





**17.    
Selected Unaudited Quarterly Financial Data**





The
following table depicts selected quarterly unaudited financial data for the
years ended December 31, 2004 and 2003.








Net
      Revenue
    
    Operating
      Loss
    
    Net
      Loss
    
    Preferred
      Stock Dividends, Accretion and Fair Value Charges
    
    Net
      Loss Applicable to Common Stockholders
    
    Net
      Loss Per Share, Basic and DilutedQ1
      2004
      Q2
      2004
      Q3
      2004
      Q4
      2004
    
    $
    17,820
      17,686
      16,827
      16,116
    
    $
    (6,156
      (4,680
      (4,515
      (2,650
    )
      )
      )
      )
    $
    (7,063
      (5,824
      (5,919
      (4,423
    )
      )
      )
      )
    $
    (3,942)
      (1,008)
      (7,482)
      -
    
    $
    (11,005
      (6,832
      (13,401
      (4,423
    )
      )
      )
      )
    $
    (0.08
      (0.05
      (0.06
      (0.02
    )
      )
      )
      )Q1
      2003
      Q2
      2003
      Q3
      2003
      Q4
      2003
    
    $
    16,765
      18,097
      18,227
      18,244
    
    $
    (8,632
      (7,890
      (5,957
      (7,152
    )
      )
      )
      )
    $
    (9,243
      (8,700
      (9,111
      (7,943
    )
      )
      )
      )
    $
    (4,061
      (4,061
      (6,363
      (3,540
    )
      )
      )
      )
    $
    (13,304
      (12,761
      (15,474
      (11,483
    )
      )
      )
      )
    $
    (0.20
      (0.20
      (0.22
      (0.12
    )
      )
      )
      )
















106





**Item
9.     Changes in and Disagreements with Accountants on
Accounting and Financial** **Disclosure**





There
have been no changes in or disagreements with accountants on accounting or
financial disclosure matters during the Company’s two most recent fiscal
years.





**Item
9A.     Controls and Procedures**





a) *Evaluation
of Disclosure Controls and Procedures* .





Under the
supervision and with the participation of the Company’s management, including
the Company’s principal executive officer and principal financial officer, the
Company has evaluated the Company’s disclosure controls and procedures (as
defined in the Securities and Exchange Act of 1934, as amended (the “Exchange
Act”), Rules 13a-15(e) and 15d-15(e)) as of December 31, 2004. Based on this
evaluation, the principal executive officer and principal financial officer
concluded that the Company’s disclosure controls and procedures were effective
to provide reasonable assurance that material information required to be
disclosed in our filings and submissions under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms.





b) *Changes
in Internal Controls*





There
have been no changes in the Company’s internal controls over financial
reporting, or, to the Company’s knowledge, in other factors during the fourth
quarter of 2004 that could materially affect these controls, subsequent to the
date of evaluation of the Company’s disclosure controls and procedures referred
to above.





**Item
9B.     Other Information**





None.





**PART
III**





**Item
10. Directors and Executive Officers of the Registrant**





**Occupations
of Directors and Officers**





Pursuant
to the Company’s certificate of incorporation, the Company has three classes of
directors, each serving for a three year term. Class III directors were elected
at our October 14, 2003 annual meeting of stockholders. One Class I director was
elected at the 2004 annual meeting of stockholders held on February 9, 2005, and
Class II directors shall be up for election at the 2005 annual meeting of
stockholders. Set forth below is information relating to the directors and
executive officers as of March 1, 2005:





**Name*
    *Age*
    *Position*Kirby
      G. Pickle
    48
    Class
      III Director and Chief Executive OfficerJ.
      Keith Markley
    46
    President
      and Chief Operating OfficerRobert
      J. DeSantis
    49
    Chief
      Financial Officer and TreasurerMarc
      R. Esterman
    40
    Vice
      President - Corporate Affairs, General Counsel and
    SecretaryWalter
      R. Keisch
    59
    Vice
      President - FinanceRobert
      B. Hartnett, Jr. (1)(2)(3)
    53
    Class
      I DirectorRobert
      G. Gilbertson (1)(2)(3)
    63
    Class
      II DirectorPaul
      J. Keeler (1)(2)(3)
    60
    Class
      II DirectorWilliam
      J. Marshall
    49
    Class
      II DirectorJames
      D. Marver
    54
    Class
      III DirectorDuncan
      Davison
    52
    Class
      III Director*


107


__________________


(1)
    Member
      of the Audit Committee


(2)
    Member
      of the Compensation Committee


(3)
    Member
      of the Nominating and Corporate Governance
Committee





**Understandings
or Agreements with regard to the Election of Directors.**




Under the
terms of the second amended and restated stockholders agreement dated July 22,
2004, by and among the Company, VantagePoint and Deutsche Bank, the Board of
Directors of the Company shall consist of no more than nine directors unless an
increase is required for the Company to comply with its certificate of
incorporation or with the rules and regulations relating to director
independence of the SEC or any stock market or exchange on which the Company’s
common stock is listed. In connection with the election of the directors,
VantagePoint and Deutsche Bank have agreed to vote all their shares of the
Company’s capital stock for the election to the Company’s Board of Directors
of:







·
    two
      (2) designated representatives of VantagePoint, who are currently James D.
      Marver and Duncan Davidson, for so long as VantagePoint beneficially owns
      at least 39,000,000 shares of the Company’s common
  stock;





·
    the
      chief executive officer of the Company, who is currently Kirby G. Pickle;





·
    one
      (1) designated representative of Deutsche Bank, who is currently William
      J. Marshall, for so long as Deutsche Bank beneficially owns senior secured
      promissory notes issued in July 2003 with an aggregate principal amount of
      at least $5,000,000 or at least 26,315,790 shares of common stock issued
      or issuable upon exercise of the warrants issued in connection with the
      July 2003 note and warrant financing; and





·
    such
      number of independent directors as shall be necessary to comply with any
      applicable SEC rules or the regulations of any exchange or market on which
      shares of the Company’s common stock are then traded, as and to the extent
      nominated from time to time by the Nominating and Corporate Governance
      Committee of the Board of Directors of the Company, three (3) of whom are
      currently Robert G. Gilbertson, Robert B. Hartnett, Jr. and Paul J.
      Keeler.





**Biographical
Information of Directors and Executive Officers**





*Kirby
G. Pickle* has
served as Chief Executive Officer of DSL.net since April 2004 and has been a
member of the Board of Directors of DSL.net since June 2004. Mr. Pickle’s
telecommunications experience spans more than 25 years and includes senior
leadership positions at Fortune 100 companies, startups and restructuring
situations. Prior to joining DSL.net, from September 2000 to April 2004, Mr.
Pickle served as President and Chief Executive Officer of Velocita Corporation.
He is the former President and Chief Operating Officer at business-to-business
telecommunications providers Teligent (where he served from February 1996 to
April 2000) and, prior to that, UUNet Technologies (where he served from January
1995 to February 1996). In addition, Mr. Pickle was one of the original senior
leaders at MFS Communications (where he served in various capacities from
1991-1996), prior to its sale to WorldCom. He also has held senior positions at
Sprint (1986-1991), MCI (1986) and AT&T/Bell System (1978-1986).





*J.
Keith Markley* has
served as President and Chief Operating Officer of DSL.net since November 2000.
From July 1998 to November 2000, Mr. Markley served as President, Eastern Region
of Covad Communications, Inc. From June 1997 to June 1998, Mr. Markley served as
the General Manager of New England Fiber Communications, Inc., a facilities CLEC
that was a joint venture between Brooks Fiber Properties and CMP Communications.
From June 1996 to June 1997, Mr. Markley served as the District Manager of
Advanced Radio Telecommunications, Inc., a wireless broadband communications
company.




108




From June 1994 to June 1996, Mr. Markley was a Principal
and Consultant for Connecticut Research, a strategic and management consulting
company.




*Robert
J. DeSantis* has
served as Chief Financial Officer of DSL.net since December 2001 and as
Treasurer since May 2002. From November 2000 to June 2001, Mr. DeSantis served
as Executive Vice President of Tellium, Inc. From January 1986 to October 2000,
Mr. DeSantis served in various positions at Citizens Communications, most
recently as Chief Financial Officer, Vice President and Treasurer.





*Marc
R. Esterman* has
served as Vice President - Corporate Affairs, General Counsel and Secretary for
DSL.net since December 2003. Prior to being named to his current position in
December 2003, Mr. Esterman served as Vice President - Corporate Affairs and
Associate General Counsel of DSL.net from May 2003 to December 2003, and as
Associate General Counsel of DSL.net from June 2000 to May 2003. From 1990 until
2000, Mr. Esterman worked in private practice as a corporate attorney with the
law firms of Cummings and Lockwood, from March 1996 - June 2000, and Winthrop,
Stimson, Putnam & Roberts, from September 1990 - March 1996.





*Walter
Keisch* has
served as  Vice
President - Finance of DSL.net since March 2001. From January to March 2001, he
served as DSL.net’s Corporate Controller. From July 2000 through December 2000,
Mr. Keisch served as Chief Financial Officer for a start-up e-business unit of
GE Capital Real Estate. From December 1997 to October 1999 he served as Vice
President of Finance, Chief Financial Officer and Secretary for E-Sync Networks,
Inc., an e-business service provider. From February 1990 to July 1997, he served
as Controller at Textron Lycoming/Allied Signal Aerospace, Engines
Division.





*Robert
B. Hartnett, Jr.* has
served as a director of DSL.net since May 2002. Currently, Mr. Hartnett is a
private investor. From April 2002 until August 2004, he served as the Chairman
of the Board of Directors and Chief Executive Officer of Blue Ridge Networks, a
privately held Internet security company. Mr. Hartnett was President of Business
Markets at Worldcom and Chief Executive Officer of UUNET from July 2000 until
April 2001. Previously, Mr. Hartnett was President of global accounts at MCI
Worldcom from August 1998 to June 2000. Prior to its merger with Worldcom in
1998, Mr. Hartnett was President of business sales and service at MCI
Communications.





*Robert
G. Gilbertson* has
served as a director of DSL.net since January 1999. He served as the Chairman of
the Board of Directors of Motia, Inc., a smart antenna company, from November
2002 until November 2004. He has been a venture investor since 1996, and
currently manages a large portfolio of public and private securities. From
October 1999 through June 2001, he served as a Venture Partner and consultant at
Sprout Group, a venture affiliate of Credit Suisse First Boston. In addition,
Mr. Gilbertson served as Chairman of the Board of Directors of Network Computing
Devices, Inc. from August 1999 until December 2001 and as President and Chief
Executive Officer from May 1996 to August 1999. From April 1996 to April 1997,
Mr. Gilbertson also served as Chairman of Avidia Systems Inc.




*Paul
J. Keeler* has
served as a director of DSL.net since June 2001. Mr. Keeler is currently a
managing partner at Convergence Consulting Group, LLC. From February 1991 to
February 2001, Mr. Keeler was a Principal at Morgan Stanley & Co., and Head
of Global Sales and Service for Morgan Stanley Capital International, a joint
venture between Morgan Stanley & Company, Inc. and Capital Group Companies.
Prior to that, Mr. Keeler served as Vice President of Morgan Stanley Technology
Services; President, Chief Executive Officer and Vice Chairman of Tianchi
Telecommunications Corp.; President and Chief Operating Officer of Westinghouse
Communications Software, Inc.; Vice President of Strategic Accounts and Business
Development for Reuters Holdings, PLC; and Director, Northeast Metro Region, of
MCI Communications. He also served as President and CEO of Halcyon Securities
Corporation and is a former member of the New York and American Stock Exchanges.
Mr. Keeler is presently a member of the Board of Directors and Chairman of
SmartServ Online, Inc.




109





*William
J. Marshall* has
served as a director of DSL.net since January 1999. He is currently Managing
Partner at RockRidge Capital Partners, a private equity firm based in Stamford,
Connecticut that Mr. Marshall founded in 2002. Previously, Mr. Marshall was a
Partner with VantagePoint Venture Partners, a leading venture capital firm with
$2.5 billion under management. Prior to joining VantagePoint, Mr. Marshall spent
11 years at Bear Stearns & Company, Inc., serving as Senior Managing
Director, Chief Technology Officer and head of the Communications Technologies
Group. Prior to Bear Stearns, Mr. Marshall was an early employee at MCI
Communications during its high revenue growth years from $70 million to over
$4.0 billion annually. Mr. Marshall is a co-founder of the ATM Forum and also
was a board member of the Securities Industry Association Technology Committee.





*James
D. Marver* has
served as director of DSL.net since April 1999. Mr. Marver has been a Managing
Partner at VantagePoint Venture Partners since co-founding the firm in 1996.
From 1988 to 1996, Mr. Marver was Senior Managing Director and Head of the
Global Technology Group at Bear Stearns & Co. Inc., as well as Head of the
San Francisco Investment Banking office. Prior to Bear Stearns, he served as a
Managing Director, Co-Head of Technology and Head of the San Francisco corporate
finance office at L.F. Rothschild, Unterberg, Towbin. Earlier in his career, he
was an investment banker with Goldman Sachs and a senior consultant with SRI
International (formerly Stanford Research Institute).





*Duncan
Davidson* has been
a director of DSL.net since July 2004. Mr. Davidson has been a Venture Partner
at VantagePoint Venture Partners since November 2003. Prior to joining
VantagePoint he was a founder and senior executive at several start-ups,
including SkyPilot Networks, where he was founder and Chief Executive Officer
from January 2001 to January 2003 and currently serves as its Chairman of the
Board; Covad Communications, where he was a Founder and served as Chairman of
the Board and advisor from July 1996 through February 2000; and InterTrust
Technologies, where he was Senior Vice President of Business Development from
July 1997 through December 2000. Mr. Davidson also served as a director of
Genuity, Inc. from June 2000 through January 2003. Before joining InterTrust,
Mr. Davidson was Managing Partner of The McKenna Group and Vice President at
Gemini Consulting where he led that firm’s technology practice. Mr. Davidson was
also a Partner at Cambridge Venture Partners, an early-stage venture fund.





**Section
16(a) Beneficial Ownership Reporting Compliance**





Section
16(a) of the Securities Exchange Act of 1934, as amended, requires DSL.net’s
directors, executive officers and persons who own more than ten percent of a
registered class of our equity securities to file reports of ownership and
changes in ownership with the SEC. Such persons are required by regulations of
the SEC to furnish DSL.net with copies of all such filings. Based solely on our
review of copies of such filings received with respect to the fiscal year ended
December 31, 2004, DSL.net believes that all such persons’ filings made by them
in the fiscal year ended December 31, 2004 timely complied with all Section
16(a) filing requirements.





**Audit
Committee**





The
Company’s Audit Committee is comprised of Messrs. Robert G. Gilbertson, Robert
B. Hartnett, Jr. and Paul J. Keeler, all of whom are outside directors. Mr.
Gilbertson serves as the Chairman of the Audit Committee. The Board of Directors
of the Company has determined that Mr. Gilbertson is an “audit committee
financial expert,” as such term is defined by regulations promulgated by the
SEC, and that such attributes were acquired through relevant education and/or
experience. Upon its evaluation, the Board of Directors has determined and
believes that all of such persons are capable of exercising independent judgment
as members of the Company’s Audit Committee and are also “independent” under the
listing standards of the American Stock Exchange and applicable securities
laws.





110


****


**Code
of Ethics**





On May 4,
2004, the Company’s Board of Directors adopted a formal, written code of ethics
entitled “Code of Business Conduct and Ethics” within the specific guidelines of
Item 406 of Regulation S-K, promulgated under the Securities Act. The Company
has communicated said code of ethics to all of its employees, including its
officers, and in support of the principals of Item 406 has also established
formal “whistle blower” procedures for the anonymous reporting by employees of
alleged violations of our code of ethics. Such code of ethics can be viewed by
clicking on the Investor Relations link from our website, http://www.dsl.net.





**Item
11.     Executive Compensation**





**Compensation
And Other Information Concerning Directors And Officers**





**Summary
Compensation Table**




The
following summary compensation table sets forth the total compensation paid or
accrued for the 2004 fiscal year for our named executive officers, including our
chief executive officer, the four other most highly compensated executive
officers who were serving as of December 31, 2004, and one individual who would
have been one of our four most highly compensated officers had he served as an
officer on December 31, 2004.





**Summary
Compensation Table**


Long
      Term
      CompensationName
      and Principal Position
    
    Year
    
    Salary
      ($)
    
    Bonus
      ($)
    
    Other
      Annual
      Compensation
    
    Restricted
      Stock Award(s)
    
    Securities
      Underlying Options
    
    All
      Other Compensation ($)Kirby
      G. Pickle (1)
    
    
    2004
    
    
    245,000
    
    
    131,250
      (2)
    
    
    8,500
      (3)
    
    
    —
    
    
    10,000,000
    
    
    —Director and
    
    
    2003
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Chief
      Executive Officer
    
    
    2002
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —David
      F. Struwas (4)
      Former
      Chairman of the Board and
    
    
    2004
      2003
    
    
    183,508
      200,000
    
    
    —
      —
    
    
    —
      —
    
    
    —
      —
    
    
    —
      —
    
    
    —
      —Chief
      Executive Officer
    
    
    2002
    
    
    200,000
    
    
    45,000
    
    
    —
    
    
    —
    
    
    1,700,000
    
    
    —Keith
      Markley
      President
      and Chief
      Operating
      Officer
    
    
    2004
      2003
      2002
    
    
    207,692
      200,000
      200,000
    
    
    —
      —
      45,000
    
    
    —
      —
      —
    
    
    —
      —
      —
    
    
    1,250,000
      —
      1,250,000
    
    
    —
      —
      —Robert
      J. DeSantis
      Chief
      Financial Officer
      and
      Treasurer
    
    
    2004
      2003
      2002
    
    
    207,692
      200,000
      184,615
    
    
    —
      —
      —
    
    
    —
      —
      —
    
    
    —
      —
      —
    
    
    1,250,000
      —
      1,000,000
    
    
    —
      —
      1,018(5
    )Marc
      R. Esterman
      Vice
      President - Corporate Affairs,
    
    
    2004
      2003
    
    
    171,346
      159,856
    
    
    —
      —
    
    
    —
      —
    
    
    —
      —
    
    
    950,000
      —
    
    
    —
      —General
      Counsel and Secretary
    
    
    2002
    
    
    158,684
    
    
    —
    
    
    —
    
    
    —
    
    
    100,000
    
    
    —Walter
      R. Keisch
      Vice
      President Finance
    
    
    2004
      2003
      2002
    
    
    155,769
      150,000
      150,000
    
    
    —
      —
      40,000
    
    
    —
      —
      —
    
    
    —
      —
      —
    
    
    950,000
      —
      400,000
    
    
    —
      —
      —




1.
    Mr.
      Pickle joined the Company on April 15, 2004.





2.
    Represents
      Mr. Pickle’s sign-on bonus.





111


3.
    Represents
      Mr. Pickle’s car allowance.





4.
    As
      of April 15, 2004, Mr. Struwas ceased to be an officer of DSL.net, Inc.,
      and he left the employ of the Company on October 15,
  2004.





5.
    Consists
      of amounts paid to Mr. DeSantis for professional services rendered and
      expenses incurred prior to his date of employment with the
      Company.





**Option
Grants in Last Fiscal Year**





The
following table provides information concerning grants of options to purchase
common stock made during the period from January 1, 2004 through December 31,
2004 to the named executive officers:





OPTION/SAR
GRANTS IN LAST FISCAL YEAR





**Number
      of Securities Underlying Options**
    
    **%
      of Total Options Granted to Employees in**
    
    **Exercise
      Price or Base**
    
    **Expiration**
    
    **Potential**
      **Net**
      **Realizable**
      **Value(4)****Name**
    
    **Granted**
    
    **Fiscal
      Year**
    
    **Price
      ($)**
    
    **Date**
    
    **5%**
    
    **10%**Kirby
      G. Pickle (1)
    
    
    10,000,000
    
    
    31.30
    %
    
    $0.48
    
    
    4/15/2014
    
    
    $3,018,694
    
    
    $3,391,012David
      F. Struwas (2)
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Keith
      Markley (3)
    
    
    1,250,000
    
    
    3.91
    %
    
    $0.56
    
    
    3/18/2014
    
    
    $440,226
    
    
    $494,522Robert
      J. DeSantis (3)
    
    
    1,250,000
    
    
    3.91
    %
    
    $0.56
    
    
    3/18/2014
    
    
    $440,226
    
    
    $494,522Marc
      R. Esterman (3)
    
    
    950,000
    
    
    2.97
    %
    
    $0.56
    
    
    3/18/2014
    
    
    $334,571
    
    
    $375,837Walter
      R. Keisch(3)
    
    
    950,000
    
    
    2.97
    %
    
    $0.56
    
    
    3/18/2014
    
    
    $334,571
    
    
    $375,837




(1)
    These
      options, which were granted as an inducement to employment, became
      exercisable with respect to approximately 16.67% of the total number of
      such shares on October 15, 2004. Thereafter, approximately 2.78% of the
      total number of such shares become exercisable monthly over the next 30
      months.





(2)
    As
      of April 15, 2004, Mr. Struwas ceased to be an officer of the Company, and
      he left the employ of the Company on October 15, 2004.





(3)
    These
      options became exercisable with respect to approximately 16.67% of the
      total number of such shares on September 19, 2004. Thereafter,
      approximately 2.78% of the total number of such shares become exercisable
      monthly over the next 30 months.





(4)
    We
      recommend caution in interpreting the financial significance of the
      figures representing the potential realizable value of the stock options.
      Amounts reported in these columns represent amounts that may be realized
      upon exercise of the options immediately prior to the expiration of their
      term assuming the specified compounded rates of appreciation (5% and 10%)
      on our common stock over the term of the options. These numbers are
      calculated based on rules promulgated by the Securities and Exchange
      Commission and do not reflect our estimate of future stock price growth.
      Actual gains, if any, on stock option exercises and common stock holdings
      are dependent on the timing of such exercise and the future performance of
      our common stock. There can be no guarantee that the market value of the
      common stock will reflect the rates of appreciation assumed in this table
      at the time that the options are
exercisable.




112


****


**Option
Exercises and Fiscal Year End Values**




The
following table sets forth information with respect to the exercise of stock
options during the year ended December 31, 2004 and the number and value of
shares of our common stock underlying the unexercised options held by the named
executive officers as of December 31, 2004.





**Aggregated
Option/SAR Exercises In Last Fiscal Year**


**And
Fiscal Year-End Option/SAR Values**





**Number
      of Securities**
      **Underlying
      Unexercised**
      **Options
      at December 31, 2004**
    
    **Value
      of Unexercised In-the-**
      **Money
      Options at**
      **December 31, 2004(1)****Name**
    
    **Shares**
      **Acquired
      on**
      **Exercise
      (#)**
    
    **Value
      Realized ($)**
    
    **Exercisable**
    
    **Unexercisable**
    
    **Exercisable**
    
    **Unexercisable**Kirby
      G. Pickle
    
    0
    
    $ 0
    
    2,222,222
    
    7,777,778
    
    $ 0
    
    $ 0Keith
      Markley
    
    0
    
    $ 0
    
    2,772,223
    
    1,180,557
    
    $ 0
    
    $ 0Robert
      J. DeSantis
    
    0
    
    $ 0
    
    2,029,166
    
    1,131,946
    
    $ 0
    
    $ 0Marc
      R. Esterman
    
    0
    
    $ 0
    
    411,917
    
    731,946
    
    $ 0
    
    $ 0David
      F. Struwas (2)
    
    0
    
    $ 0
    
    3,150,000
    
    0
    
    $ 0
    
    $ 0Walter
      R. Keisch
    
    0
    
    $ 0
    
    646,560
    
    802,052
    
    $ 0
    
    $ 0













113








(1)
    Value
      is based on the difference between the option exercise price and $0.60,
      the fair market value of DSL.net common stock on December 31, 2003,
      multiplied by the number of shares of common stock underlying the
      options.





(2)
    As
      of April 15, 2004 Mr. Struwas ceased to be an officer of DSL.net, Inc.,
      and he left the employ of the Company on October 15,
  2004.





**Compensation
Committee Interlocks and Insider Participation**




The
Compensation Committee of our Board of Directors, which in fiscal year 2004 was
comprised of Messrs. Gilbertson, Hartnett and Keeler, reviewed salaries and
incentive compensation for our executive officers during fiscal year
2004 **.** No member
of our Compensation Committee (i) was, during the last fiscal year, an officer
or employee of our Company or any of its subsidiaries; (ii) was formerly an
officer of our Company or any of its subsidiaries; or (iii) had any relationship
requiring disclosure under any paragraph of Item 404 of Regulation S-K. None of
our executive officers has served as a director or member of the compensation
committee, or other committee serving an equivalent function, of any other
entity whose executive officers served as a director or member of our
Compensation Committee.





**Compensation
of Directors**





Prior to
2003, the only compensation to directors for services provided as a director or
committee member were periodic grants of stock options subject to vesting,
except for reimbursement of reasonable out-of-pocket expenses incurred in
connection with attending board or committee meetings.





In May
2003, the Board adopted new policies regarding director compensation which
became effective as of October 14, 2003. This compensation plan provided for a
continuation of the compensation benefits listed above. In addition, the new
plan provided for the following payments, payable quarterly in equal
installments only to the Company’s outside directors:





·
    an
      annual retainer of $10,000;


·
    an
      annual retainer of $7,500 for each member of the Audit Committee;
      and


·
    an
      annual retainer of $2,500 for the Chairman of the Audit
      Committee.





In March
2004, the Board adopted new policies regarding director compensation which
provides for the following payments, payable quarterly in equal installments
only to the Company’s outside directors:





·
    an
      annual retainer of $20,000;


·
    an
      aggregate annual meeting fee of $10,000, paid as a flat fee, based on an
      assumed number of meetings;


·
    an
      annual retainer of $7,500 for each Audit Committee
  member;


·
    an
      annual retainer of $5,000 for the Chairman of the Audit
      Committee;


·
    an
      annual retainer of $5,000 for each Compensation Committee
      member;


·
    an
      annual retainer of $2,500 for the Chairman of the Compensation
      Committee;


·
    an
      annual retainer of $2,000 for each Nominating Committee member;
      and


·
    an
      annual retainer of $1,000 for the Chairman of the Nominating
      Committee.


****


****


114


****


**Employment
Contracts and Termination of Employment and Change-in-Control Arrangements**





The
Company entered into compensation agreements with each of David F. Struwas,
Robert J. DeSantis and J. Keith Markley in January 2004.





These
agreements provided these three officers, in pertinent part, with the following
benefits, respectively: (i) base salary and benefits through at least March 31,
2004 (unless the employee was terminated for “cause” or quit for “good reason,”
as those terms are defined in the agreements); (ii) acceleration of vesting of
all unexercised stock options granted to such employee prior to the effective
date of the agreements if the employee was terminated without “cause” or quit
for “good reason” on or prior to December 31, 2004; and (iii) base salary and
benefits in accordance with Company practices, less all withholdings required
under then current Company policy and applicable law or regulation, for six (6)
months from and after April 1, 2004, in the event the employee was terminated
without “cause” or quit for “good reason” on or prior to March 31, 2004, or the
date of termination, in the event the employee was terminated without “cause” or
quit for “good reason” on or after April 1, 2004, subject to the execution and
delivery by such employee of a release in favor of the Company. In addition, Mr.
Struwas had the potential to earn a one-time cash bonus in the amount of
$100,000 under his agreement with the Company if the Company achieved certain
target goals, as described therein. Mr. Struwas was terminated as an officer of
the Company on April 15, 2004 and was afforded the benefits under the
above-described agreement associated with such termination. Mr. Struwas did not
earn the target bonus amount for which he was eligible under said agreement. Mr.
Markley’s and Mr. DeSantis’ rights under the above-described agreements
effectively expired at the end of 2004.





In April
2004, the Company entered into an employment agreement with Kirby G. Pickle, in
connection with his hiring as Chief Executive Officer of the Company. Under Mr.
Pickle’s employment agreement, he is entitled to a one-time sign-on bonus of
$131,250, an annual base salary of $350,000, and certain potential bonuses for
performance, as determined by the Board of Directors. In the event that a
termination without “cause” (as defined in the agreement) or a resignation by Mr
Pickle for “good reason” (as defined in the agreement) occurs at any time before
Mr. Pickle’s twelve month anniversary of employment, he shall be entitled to
receive, as severance, (1) $218,750, which amount shall be paid over twelve
months in accordance with the Company’s payroll practice, and (2) payment of
health and dental insurance coverage under COBRA (to the extent Mr. Pickle
elects to continue such coverage in accordance with the provisions of COBRA
following the date of termination) during the twelve-month period in which
severance is paid. In the event that a termination without “cause” or a
resignation by Mr Pickle for “good reason” occurs at any time on or after Mr.
Pickle’s twelve month anniversary of employment, he shall be entitled to
receive, as severance, (1) his monthly base compensation for the period of
eighteen months following the date of termination, which shall be paid over time
in accordance with the Company’s payroll practice, and (2) payment of health and
dental insurance coverage under COBRA (to the extent Mr. Pickle elects to
continue such coverage in accordance with the provisions of COBRA following the
date of termination) during such eighteen month severance period. Mr. Pickle’s
receipt of any such severance is conditioned upon and subject to Mr. Pickle’s
prior execution of a release in favor of the Company.





In
February 2005, the Company entered into compensation agreements with four of its
e xecutive
officers (representing all of its then current executive officers other than the
Company’s chief executive officer). Under the terms of the agreements, each of
the subject individuals is eligible to receive, in addition to his current
compensation and any other benefits to which he is or may become entitled, a
fixed dollar cash compensation amount, in three equal installments, on





115





June 30,
2005, August 31, 2005 and December 31, 2005, provided such individual is
employed by the Company on each of such dates. If, prior to a payment date, the
individual is terminated by the Company for “cause” (as defined in the
agreement), or resigns other than for “good reason” (as defined in the
agreement), he will forfeit the right to receive any remaining unvested
payments. Upon the occurrence of a “change in control” of the Company (as
defined in the agreement), or if the individual is terminated without “cause” or
terminates his employment with the Company for “good reason,” the individual
shall immediately fully vest in all remaining payments that would have become
due and payable under such agreement but for the passage of time and the
individual’s continued employment with the Company, and he shall have the right
to immediately receive the total amount of all remaining payments under the
agreement. The total amount of potential payments which might be made under
these agreements, for all four individuals in the aggregate, is
$350,000.





**Board
Of Directors Report On Executive Compensation**


****


**Introduction**





During
fiscal year 2004, the Compensation Committee of the Board of Directors was
responsible for developing executive compensation policies and advising the
Company’s Board of Directors with respect to those policies and for maintaining
and administering the Company’s Amended
and Restated 1999 Stock Plan, 1999 Employee Stock Purchase Plan, and Amended and
Restated 2001 Stock Option and Incentive Plan. During fiscal year 2004, the
members of the Company’s Compensation Committee were Messrs. Gilbertson, Keeler
and Hartnett, all non-employee, “independent” directors. The Committee’s goal is
to create and implement a compensation program that will attract and retain
talented executives and provide incentives to management to enhance the
Company’s performance by basing a significant portion of annual and long-term
compensation on performance. On September 1, 2004, the Compensation Committee
adopted a new Compensation Committee charter, subject to Board approval. Our
Board of Directors ratified the new charter on September 9, 2004, and such
charter can be viewed by clicking on the Investor Relations link from DSL.net’s
website, http://www.dsl.net . Under
this new charter, the Compensation Committee reviews and makes recommendations
to management on company-wide compensation programs and practices; takes final
action with respect to individual salary, bonus and equity arrangements of our
executive officers; and recommends, subject to approval by our Board of
Directors, any equity-based plans and any material amendments thereto (including
increases to the number of shares of common stock available for grant as options
or otherwise thereunder) for which stockholder approval is required.





**Executive
Compensation Program**





The
Company’s executive compensation program consists of two elements: salary and
equity interests in the form of restricted stock or stock options. This program
applies to the Company’s key management positions, including the position of
chief executive officer. All of the Company’s executives also are eligible for
employee benefits offered to all employees, including life, health, disability
and dental insurance, and the Company’s 401(k) profit sharing plan and the
Company’s employee stock purchase plan.





*Salary.* The
Compensation Committee reviews and approves cash compensation for the chief
executive officer and all other executive officers’ salaries. Base salaries for
executive officers are established after considering various competitive and
comparative factors, including amounts paid to senior executives with comparable
qualifications, experience and responsibilities at other companies of similar
size and engaged in a similar business to that of the Company, the





116





Company’s
performance relative to comparable companies, and the Company’s overall salary
structure and general financial performance. During 2003, the Company did not
have any specific corporate performance targets in place, the achievement of
which would guarantee any increase in any executive officer’s base salary, but
the Company did consider generally the relationship between corporate
performance and executive compensation.





The
salary compensation of the executive officers is based upon their
qualifications, experience and responsibilities, as well as on the attainment of
planned objectives and other factors deemed relevant by the Compensation
Committee and the Board of Directors, including, in the case of existing
executives, past performance of the given executive. The chief executive officer
makes recommendations to the Compensation Committee regarding compensation
levels for executive officers other than himself.
 
 *Equity
Interests* .
Executives are eligible to receive stock option grants or other stock awards
under the Company’s Amended and Restated 1999 Stock Plan and the Company’s
Amended and Restated 2001 Stock Option and Incentive Plan. As of March 2, 2005,
2,182,421 shares remained available for grant under the Company’s Amended and
Restated 1999 Stock Plan and 38,364,209 shares remained available for grant
under the Company’s Amended and Restated 2001 Stock Option and Incentive Plan.
The Amended and Restated 1999 Stock Plan and the Amended and Restated 2001 Stock
Option and Incentive Plan are designed to provide long-term performance and
retention incentives for top management and other employees. An executive’s
participation in this program is determined by the Compensation Committee and
approved by the Board of Directors.
 
 Executives
participating in the Company’s Amended and Restated 1999 Stock Plan and the
Company’s Amended and Restated 2001 Stock Option and Incentive Plan receive
stock option grants in amounts determined by the Compensation Committee. The
stock options granted to executives under the Amended and Restated 1999 Stock
Plan and the Amended and Restated 2001 Stock Option and Incentive Plan have an
exercise price equal to the fair market value of the Company’s common stock at
the time of grant. Currently, options granted to existing executives are
generally exercisable as to approximately 16.67% of the total number of option
shares on the day after the six-month anniversary of the date of grant of the
options, and monthly thereafter become exercisable as to approximately 2.78% of
the total number of option shares. Options granted to new executives are
generally exercisable as to 25% of the total number of option shares on the
one-year anniversary of such executive’s start date, and monthly thereafter
become exercisable as to approximately 2.08% of the total number of option
shares.


In April
2004, as authorized by the Company’s Board of Directors, the Company entered
into an employment agreement and related stock option agreement with Kirby G.
Pickle, the Company’s new chief executive officer. Under the stock option
agreement for Mr. Pickle, an option to purchase a total of 10,000,000 shares of
the Company’s common stock was granted to Mr. Pickle as an inducement to his
employment with the Company. Options granted under this agreement vest
approximately 16.6% on the date six months following the grant date, and
thereafter vest ratably on a monthly basis over the next thirty months. Once
vested, the options are exercisable at an exercise price of $0.48 per share for
ten years from the date of the grant.





*Bonuses.* The
Company did not have an established bonus plan for executives in fiscal year
2004. From time to time, at the discretion of the Compensation Committee,
subject to the approval by the Company’s Board of Directors, bonuses are paid to
certain executives in recognition of the executive’s performance. During 2004,
no executive officer of the Company received any bonus**,**
except for Mr. Pickle, who received a sign-on bonus, as discussed below.





117





In
February 2005, the Company entered into compensation agreements with four of its
executive officers (representing all of its then current executive officers
other than the Company’s chief executive officer). Under the terms of the
agreements, each of the subject individuals is eligible to receive, in addition
to his current compensation and any other benefits to which he is or may become
entitled, a fixed dollar cash compensation amount, in three equal installments,
on June 30, 2005, August 31, 2005 and December 31, 2005, provided such
individual is employed by the Company on each of such dates. If, prior to a
payment date, the individual is terminated by the Company for cause, or resigns
other than for good reason, he will forfeit the right to receive any remaining
unvested payments. Upon the occurrence of a change in control of the Company, or
if the individual is terminated without cause or terminates his employment with
the Company for good reason, the individual shall immediately fully vest in all
remaining payments that would have become due and payable under such agreement
but for the passage of time and the individual’s continued employment with the
Company, and he shall have the right to immediately receive the total amount of
all remaining payments under the agreement. The total amount of potential
payments which might be made under these agreements, for all four individuals in
the aggregate, is $350,000.





**Chief
Executive Officer's Compensation**





Mr.
Pickle’s’ compensation for 2004 was determined in accordance with his employment
contract which was approved by the Board of Directors.





*Salary.* Mr.
Pickle’s received $245,000 in salary during 2004, representing the ratable
portion of his contracted annual salary of $350,000.





*Equity
Interests* . Mr.
Pickle held 0 shares of the Company’s common stock as of the date of this
report. In April 2004, Mr. Pickle was granted an option to purchase a total of
10,000,000 shares of the Company’s common stock as an inducement to his
employment with the Company. Options granted under this agreement vest
approximately 16.6% on the date six months following the grant date, and
thereafter vest ratably on a monthly basis over the next thirty months. Once
vested, the options are exercisable at an exercise price of $0.48 per share for
ten years from the date of the grant.





*Bonus* . Mr.
Pickle received a sign-on bonus of $131,250 in 2004.





Mr.
Pickle’s total compensation for 2004 is set out in detail in the Summary
Compensation Table, above.





**Compliance
with Internal Revenue Code Section 162(m)**





In
general, under Section 162(m) of the Internal Revenue Code of 1986, as amended,
the Company cannot deduct, for federal income tax purposes, compensation in
excess of $1,000,000 paid to certain executive officers. This deduction
limitation does not apply, however, to compensation that constitutes “qualified
performance-based compensation” within the meaning of Section 162(m) of the
Internal Revenue Code and the regulations promulgated thereunder. The Company
has considered the limitations on deductions imposed by Section 162(m) of the
Internal Revenue Code, and it is the Company’s present intention that, for so
long as it is consistent with its overall compensation objective, substantially
all tax deductions attributable to executive compensation will not be subject to
the deduction limitations of Section 162(m) .





118


****


**Board
of Directors of DSL.net, Inc.**





Duncan
Davidson


Robert G.
Gilbertson*


Robert B.
Hartnett, Jr.*


Paul J.
Keeler*


William
J. Marshall


James D.
Marver


Kirby G.
Pickle





**Member
of Compensation Committee.*





119





**Stock
Performance Graph**





The
following graph compares the yearly change in the cumulative total stockholder
return on the Company’s common stock during the period from December 31, 1999
through December 31, 2004, with the cumulative total return on (i) the Nasdaq
Stock Market and (ii) the Nasdaq Telecommunications Index. The comparison
assumes that $100 was invested on December 31, 1999 in our common stock and in
each of the foregoing indices and assumes reinvestment of dividends, if
any:





COMPARISON
OF 5 YEAR CUMULATIVE TOTAL RETURN*
 AMONG
DSL.NET, INC., THE NASDAQ STOCK MARKET (U.S.) INDEX AND THE NASDAQ
TELECOMMUNICATIONS INDEX (1)(2)(3)




* $100
invested on 12/31/99 in stock or index-including reinvestment of
dividends.


(1) This
graph is not “soliciting material,” is not deemed filed with the SEC and is not
to be incorporated by reference in any filing of the Company under the
Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as
amended, whether made before or after the date hereof and irrespective of any
general incorporation language in any such filing.
 
 (2) The
stock price performance shown on the graph is not necessarily indicative of
future price performance. Information used in the graph was obtained from
Research Data Group, Inc., a source believed to be reliable, but the Company is
not responsible for any errors or omissions in such information.
 
 (3) On
August 4, 2004, the common stock of DSL.net began listing on the American Stock
Exchange and was no longer listed on the Nasdaq SmallCap Market.




120


****


**Item
12.     Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters**





**Equity
Compensation Plan Information**





The
following table provides information, as of December 31, 2004, with respect to
the shares of the Company’s common stock that may be issued under the Company’s
existing equity compensation plans:




Plan
      Category
    Number
      of
      Securities
      to be
      Issued
      upon
      Exercise
      of
      Outstanding
      Options
    Weighted
      Average
      Exercise
      Price of
      Outstanding
      Options
    Number
      of Securities
      Remaining
      Available for
      Future
      Issuance Under Equity
      Compensation
      Plans
      (Excluding
      Securities
      Reflected
      in the First Column)Equity
      Compensation Plans Approved by Shareholders
    30,651,934
    $0.77
    19,579,375Equity
      Compensation Plans Not Approved by Shareholders (1)
    10,000,000
    $0.48
    —Total
    40,651,934
    $0.70
    19,579,375
 (1) In April
2004, as authorized by the Company’s Board of Directors, the Company entered
into an employment agreement and related stock option agreement with Kirby G.
Pickle, the Company’s new chief executive officer. Under the stock option
agreement for Mr. Pickle, an option to purchase a total of 10,000,000 shares of
the Company’s common stock, represented in the above table, was granted to Mr.
Pickle as an inducement to his employment with the Company.





**Securities
Ownership Of Certain Beneficial Owners And Management**





The
following table sets forth certain information regarding beneficial ownership of
the Company’s capital stock as of March 1, 2005, by:





·
    each
      person known by the Company to be the beneficial owner of more than 5% of
      the Company’s common stock or Series Z preferred
stock;





·
    each
      named executive officer;





·
    each
      of the Company’s directors; and





·
    all
      executive officers and directors as a
group.





121





Unless
otherwise noted below, the address of each person listed on the table is c/o
DSL.net, Inc., 545 Long Wharf Drive, New Haven, Connecticut 06511, and each
person has sole voting and investment power over the shares shown as
beneficially owned except to the extent authority is shared by spouses under
applicable law.





Beneficial
ownership is determined in accordance with the rules of the SEC. In determining
the number of shares of common stock beneficially owned, shares of capital stock
issuable by the Company to a person pursuant to options or warrants, in each
case which may be exercised within sixty days after March 1, 2005, are deemed to
be beneficially owned and outstanding for purposes of calculating the number of
shares of common stock and the percentage beneficially owned by that person.
Shares deemed to be beneficially owned by a person in accordance with the above
rules are not deemed to be beneficially owned and outstanding for purposes of
computing the percentage beneficially owned by any other person.









Name
    
    Common
      Stock
    
    Series
      Z
      Preferred
      Stock
    
    Combined
      Voting
      PowerShares
    
    %
      ofClass
    
    Shares
    
    %
      ofClass
    
    Votes
    
    %
      of VotesKirby
      G. Pickle (1)
    
    
    3,333,333
    
    
    1.4%
    
    
    -
    
    
    -
    
    
    3,333,333
    
    
    1.4%J.
      Keith Markley (2)
    
    
    3,050,001
    
    
    1.3%
    
    
    -
    
    
    -
    
    
    3,050,001
    
    
    1.3%Robert
      J. DeSantis (3)
    
    
    2,279,166
    
    
    *
    
    
    
    
    
    
    
    
    2,279,166
    
    
    *Walter
      R.Keisch (4)
    
    
    806,249
    
    
    *
    
    
    -
    
    
    -
    
    
    806,249
    
    
    *Marc
      R. Esterman (5)
    
    
    534,884
    
    
    *
    
    
    -
    
    
    -
    
    
    534,884
    
    
    *Robert
      B. Hartnett, Jr. (6)
    
    
    697,220
    
    
    *
    
    
    -
    
    
    -
    
    
    697,220
    
    
    *Robert
      G. Gilbertson (7)
    
    
    783,248
    
    
    *
    
    
    -
    
    
    -
    
    
    783,248
    
    
    *Paul
      J. Keeler (8)
    
    
    747,913
    
    
    *
    
    
    -
    
    
    -
    
    
    747,913
    
    
    *William
      J. Marshall (9)
    
    
    932,639
    
    
    *
    
    
    -
    
    
    -
    
    
    932,639
    
    
    *Duncan
      Davidson
    
    
    -
    
    
    *
    
    
    -
    
    
    -
    
    
    -
    
    
    *James
      D. Marver (10)
    
    
    109,754,713
    
    
    38.2%
    
    
    14,000
    
    
    100%
    
    
    109,768,713
    
    
    38.2%The
      VantagePoint entities (11)
      1001
      Bayhill Drive, Suite 300
      San
      Bruno, CA 94066
    
    
    108,440,263
    
    
    37.8%
    
    
    14,000
    
    
    100%
    
    
    108,454,263
    
    
    37.8%Deutsche
      Bank AG London (12)
      31
      West 52ndStreet, 16thFloor New York, NY 10019
    
    
    118,421,053
    
    
    33.6%
    
    
    -
    
    
    -
    
    
    118,421,053
    
    
    33.6%All
      executive officers and directors as a group (11 persons)
    (13)
    
    
    122,919,366
    
    
    40.9%
    
    
    14,000
    
    
    100%
    
    
    122,933,366
    
    
    40.9%


__________________





*
Indicates less than 1%.




(1)
    Includes
      3,333,333****shares
      issuable upon exercise of options held by Mr. Pickle that are exercisable
      within 60 days after March 1, 2005.




122




(2)
    Includes
      3,050,001 shares issuable upon exercise of options held by Mr. Markley
      that are exercisable within 60 days after March 1,
2005.




(3)
    Includes
      2,279,166 shares issuable upon exercise of options held by Mr. DeSantis
      that are exercisable within 60 days after March 1,
2005.




(4)
    Includes
      806,249 shares issuable upon exercise of options held by Mr. Keisch that
      are exercisable within 60 days after March 1,
2005.




(5)
    Includes
      528,584 shares issuable upon exercise of options held by Mr. Esterman that
      are exercisable within 60 days after March 1,
2005.




(6)
    Includes
      697,220 shares issuable upon exercise of options held by Mr. Hartnett that
      are exercisable within 60 days after March 1,
2005.




(7)
    Includes
      783,248 shares issuable upon exercise of options held by Mr. Gilbertson
      that are exercisable within 60 days after March 1,
2005.




(8)
    Includes
      747,913 shares issuable upon exercise of options held by Mr. Keeler that
      are exercisable within 60 days after March 1,
2005.




(9)
    Includes
      537,498 shares issuable upon exercise of options held by Mr. Marshall that
      are exercisable within 60 days after March 1,
2005.




(10)
    Includes
      (i) 537,498 shares of common stock issuable upon exercise of options held
      by Mr. Marver that are exercisable within 60 days after March 1, 2005,
      (ii) 27,413 shares of common stock held by the Marver Living Trust, in
      which Mr. Marver is a trustee and beneficiary in his capacity as a limited
      partner of VantagePoint Venture Partners 1996, L.P., and (iii) the shares
      beneficially owned by the VantagePoint entities as set forth in footnote
      11. Mr. Marver is a managing member of VantagePoint Associates, L.L.C. and
      of the general partner of each of the other VantagePoint entities referred
      to in footnote 11. Mr. Marver may be deemed to share voting and investment
      power with respect to the shares beneficially owned by the VantagePoint
      entities and disclaims beneficial ownership of those shares, except to the
      extent of his proportionate pecuniary interest therein.




(11)
    The
      entities listed below owned or have the right to purchase the shares of
      capital stock of the Company indicated in the table below as of March 1,
      2005.







**Stockholder**
    **Shares
      of Common StockHeld**
    **Shares
      of Common Stock Issuable Upon Exercise of
      Warrants**
    ****Shares
      of Series Z Preferred
      Stock****VantagePoint Venture
      Partners 1996, L.P.
    10,561,178
    7,501,826
    2,800VantagePoint
      Communications Partners, L.P.
    10,923,262
    7,501,826
    2,800VantagePoint Venture Partners
      III, L.P.
    3,880,430
    4,162,163
    914.2VantagePoint Venture Partners
      III (Q), L.P.
    29,562,531
    34,160,753
    7,485.8VantagePoint
      Associates, L.L.C.
    186,294
    N/A
    N/A




VantagePoint
Associates, L.L.C. is the general partner of VantagePoint Venture Partners 1996,
L.P.; VantagePoint Communications Associates, L.L.C. is the general partner of
VantagePoint Communications Partners, L.P.; and VantagePoint Venture Associates
III,





123





L.L.C. is
the general partner of VantagePoint Venture Partners III, L.P. and VantagePoint
Venture Partners III (Q), L.P. Messrs. Marver and Alan Salzman are managing
members of each of these limited liability companies. Messrs. Marver and Salzman
may be deemed to share voting and investment power with respect to the shares
beneficially owned by the VantagePoint entities and disclaim beneficial
ownership of those shares, except to the extent of their respective
proportionate pecuniary interest therein. Thus, the VantagePoint entities,
together with VantagePoint Associates, L.L.C., are considered the beneficial
owners of a total of 108,440,263 shares of common stock and 14,000 shares of the
Series Z preferred stock of the Company as of March 1, 2005.




(12)
    Includes
      118,421,053 shares issuable upon exercise of warrants held by Deutsche
      Bank AG London that are exercisable within 60 days after March 1,
      2005.




(13)
    See
      Notes 1 through 11 above. Includes 13,300,710****shares
      issuable upon exercise of options held by the named officers and directors
      that are exercisable within 60 days after March 1,
2005.




**Item
13.     Certain Relationships and Related
Transactions**





On
November 14, 2001, the Company entered into the Series X Purchase Agreement.
Subject to the terms and conditions of the Series X Purchase Agreement, on
November 14, 2001, the Company sold an aggregate of 6,000 shares of Series X
preferred stock to VantagePoint for an aggregate purchase price of $6,000,000,
on December 12, 2001, the Company sold an aggregate of 4,000 shares of Series X
preferred stock to VantagePoint for an aggregate purchase price of $4,000,000,
and on March 1, 2002, the Company sold an aggregate of 10,000 shares of Series X
preferred stock to VantagePoint for an aggregate purchase price of $10,000,000.
No additional shares of Series X preferred stock may be issued under the Series
X Purchase Agreement. At the time of the transactions described immediately
above, each of William J. Marshall and James D. Marver was an affiliate of
VantagePoint and a member of the Board of Directors. Mr. Marshall is no longer
affiliated with VantagePoint but continues to serve on the Board of Directors.
Mr. Marver remains affiliated with VantagePoint and currently serves on the
Board of Directors.





On
December 24, 2001, the Company entered into the Series Y Purchase Agreement. O n
December 28, 2001, the Company sold an aggregate of 6,469 shares of Series Y
preferred stock pursuant to the Series Y Purchase Agreement for an aggregate
purchase price of $6,469,000 and received proceeds of $3,531,000 from the
issuance of promissory notes to the Series Y Investors. On May 29, 2002, the
Company sold an aggregate of 8,531 shares of Series Y preferred stock pursuant
to the Series Y Purchase Agreement for an aggregate of $5,000,000 in net
proceeds and the cancellation of the $3,531,000 in promissory notes issued to
the Series Y Investors. Harry Hopper, an affiliate of Columbia, was a
member of the Company’s Board of Directors from December 28, 2001 to August 5,
2003.





In
January 2002, the Company entered into an Asset Purchase Agreement with
Broadslate for the purchase of business broadband customer accounts and certain
other assets, including accounts receivables related to the acquired customer
accounts, for an adjusted purchase price of approximately $750,000. Certain of
the Company’s stockholders, comprised of certain of the Columbia entities, in
the aggregate, owned in excess of 10% of the capital stock of Broadslate.
Mr. Hopper, an affiliate of Columbia, was a member of the Company’s Board
of Directors from December 28, 2001 to August 5, 2003. Mr. Hopper was also
a director of Broadslate until February 2002.


124





On
December 27, 2002, the Company entered into the Reimbursement Agreement with
certain of the VantagePoint entities, certain of the Columbia entities, The
Lafayette Investment Fund, L.P. and certain entities affiliated with Charles
River Ventures. Pursuant to the terms of the Reimbursement Agreement, the
VantagePoint entities and the Columbia entities issued guarantees in an
aggregate amount of $6,100,000 to support the Company’s obligations under a
credit agreement between the Company and a commercial bank providing for a
revolving line of credit of up to $15,000,000. On March 5, 2003, the Company
entered into amendment no. 1 to the Reimbursement Agreement with the
VantagePoint entities and the Columbia entities pursuant to which the
VantagePoint entities increased their guarantees by $3,000,000, to an aggregate
of $9,100,000 for all guarantors. The Reimbursement Agreement was terminated in
connection with the July 2003 note and warrant financing.





Pursuant
to the terms of the Reimbursement Agreement, on December 27, 2002, the Company
issued warrants to purchase 10,379,420 shares of its common stock to the
VantagePoint entities and 1,634,473 shares of its common stock to the
Columbia entities in consideration for their guarantees aggregating
$6,100,000. The Company issued additional warrants to purchase 767,301 shares of
its common stock to the VantagePoint entities and 168,806 shares of its common
stock to the Columbia entities on March 26, 2003. All such warrants are
exercisable for ten years at an exercise price of $0.50 per share. At the time
of the transactions described immediately above, Mr. Marver was an affiliate of
VantagePoint and a member of the Board of Directors. Mr. Marver remains
affiliated with VantagePoint and currently serves on the Board of Directors. Mr.
Hopper, an affiliate of the Columbia entities, was a member of the
Company’s Board of Directors from December 28, 2001 to August 5,
2003.





On March
5, 2003, the Company and certain of the Guarantors entered into Amendment No. 1
to the Reimbursement Agreement, pursuant to which VantagePoint increased its
guarantee by $3,000,000 bringing the aggregate guarantees by all Guarantors
under the Reimbursement Agreement, as amended, to $9,100,000. As consideration
for VantagePoint’s increased guarantee, if the Company closed an equity
financing on or before December 3, 2003, the Company was authorized to issue
VantagePoint additional warrants to purchase the type of equity securities
issued by the Company in such equity financing. The number of such additional
warrants would be determined by dividing the per share price of such equity
securities into a thousand dollars. Accordingly, since the Company closed a
financing on July 18, 2003, the Company issued to VantagePoint in December 2003,
additional warrants with a three year life, to purchase 2,260,909 shares of its
common stock at a per share price of $0.4423. At the time of these transactions,
two of the Company’s Directors, Mr.
Marver and Michael Yagemann, were affiliated with VantagePoint. Mr. Yagemann
resigned from the Board of Directors on July 7, 2004. Mr. Marver remains on the
Board of Directors.





On July
18, 2003, the Company entered into the Note and Warrant Purchase Agreement
relating to the sale and purchase of an aggregate of (i) $30,000,000 in
principal amount of senior secured promissory notes and (ii) common stock
purchase warrants to purchase an aggregate of 157,894,737 shares of the
Company’s common stock for a period of three years at an exercise price of $0.38
per share. The aggregate purchase price for the senior secured promissory notes
and common stock purchase warrants was $30,000,000. Subject to the terms and
conditions of





125





the Note
and Warrant Purchase Agreement, the Company issued $30,000,000 in aggregate
principal amount of senior secured promissory notes to Deutsche Bank and
VantagePoint on July 18, 2003. Subject to the terms and conditions of the Note
and Warrant Purchase Agreement, on August 12, 2003 Deutsche Bank was issued a
common stock purchase warrant exercisable for 12,950,000 shares of common stock.
Pursuant to the terms and conditions of the Note and Warrant purchase agreement,
the Company issued the remaining warrants to purchase an aggregate of
144,944,737 shares of the Company’s common stock to Deutsche Bank (105,471,053
shares) and VantagePoint (39,473,864 shares) in December, 2003. At the time of
these transactions, two of the Company’s Directors, Mr.
Marver and Mr. Yagemann, were affiliated with VantagePoint. Mr. Yagemann
resigned from the Board of Directors on July 7, 2004. Mr. Marver remains on the
Board of Directors. Roger
Ehrenberg, who became a Director of the Company on July 18, 2003 in connection
with the note and warrant financing, was at the time of these transactions
affiliated with DB Advisors LLC , and
Roderick Glen
MacMullin, who became a Director of the Company on July 18, 2003 in connection
with the note and warrant financing, was at the time of these transactions
affiliated with DB Advisors LLC . Mr.
Ehrenberg resigned from the Board of Directors on September 8, 2004, and Mr.
MacMullin resigned from the Board of Directors on November 19, 2004.




As a
result of the issuance of the common stock purchase warrant exercisable for
12,950,000 shares of the Company’s common stock to Deutsche Bank on August 12,
2003, the conversion price of the Series Y preferred stock was adjusted pursuant
to Section 3(a)(i) of the Series Y designation which constitutes a part of the
Company’s certificate of incorporation. Prior to such issuance, each share of
Series Y preferred stock was convertible into 2,000 shares of common stock.
Subsequent to such issuance, each share of Series Y preferred stock is
convertible into 2,260.91 shares of common stock. Mr.
Hopper, an affiliate of the Columbia entities, was a member of the
Company’s Board of Directors from December 28, 2001 to August 5,
2003.




During
2003, the Series Y Investors (including Columbia) converted 14,000 shares of
Series Y preferred stock into 35,140,012 shares of the Company’s common stock
(including shares issued as payment for accrued dividends). As of December 31,
2003, funds affiliated with one remaining Series Y Investor (Charles River
Partnership, L.P.) owned 1,000 shares of Series Y preferred stock which are
convertible into approximately 2,260,909 shares of the Company’s common stock.
These remaining 1,000 shares of Series Y preferred stock were converted into
common shares in February 2004. In addition, resulting from guarantees issued
under the Reimbursement Agreement, Columbia had warrants to acquire
approximately 1,358,025 shares of the Company’s common stock. These warrants
were exercised in February 2004. Mr.
Hopper, an affiliate of the Columbia entities, was a member of the
Company’s Board of Directors from December 28, 2001 to August 5,
2003.





In
January 2004, 6,000 shares of Series X preferred stock were converted into
33,333,333 shares of the Company’s common stock at a conversion price of $0.18
per share and, in accordance with the terms of the Series X preferred stock, the
Company elected to pay accrued dividends approximating $1,560,000 by issuing
2,316,832 shares of its common stock, based on the average fair market value for
the ten days preceding the conversion of $0.67 per share.





In
February 2004, the remaining 1,000 shares of Series Y preferred stock were
converted into 2,260,910 shares of the Company’s common stock at a conversion
price of $0.4423 per share and, in accordance with the terms of the Series Y
preferred stock, the Company elected to pay accrued dividends approximating
$221,000 by issuing 309,864 shares of its common stock, based on the average
fair market value for the ten days preceding the conversion of $0.71 per
share.





In
February 2004, the Columbia entities exercised their remaining warrants to
purchase 1,358,025





126





shares of
the Company’s common stock at an exercise price of $0.50 per share in a cashless
exchange which resulted in the issuance of 413,160 shares of the Company’s
common stock. The cashless exchange was accomplished by deducting the per share
exercise price from the per share fair market value of the company’s common
stock and multiplying the differential times the total warrants to determine the
aggregate excess of the fair market value over the exercise price; which was
then divided by the per share fair market value of the Company’s common stock to
arrive at the number of shares issued. The fair market value of the Company’s
common stock of $0.72 was determined in accordance with the warrant agreement by
calculating the average of the close prices for the five days immediately
preceding the exercise date.





On July
22, 2004, the Company entered into the Recapitalization Agreement with
VantagePoint, the holder of all of the then remaining issued and outstanding
shares of Series X preferred stock. In accordance with the Recapitalization
Agreement, the remaining 14,000 shares of Series X preferred stock were
converted into 77,777,775 shares of the Company’s common stock at a conversion
price of $0.18 per share and, in accordance with the terms of the Series X
preferred stock, the Company elected to pay accrued dividends approximating
$4,040,000 by issuing an additional 11,710,142 shares of its common stock at a
per share price of $0.345, calculated based on the average fair market value for
the ten days ending three days preceding the conversion. **** In
accordance with the Recapitalization Agreement, the Company issued to
VantagePoint 14,000 shares of Series Z preferred stock, with a liquidation
preference of up to $1,120 per share ($15,680,000 in the aggregate). The Series
Z preferred stock was issued to VantagePoint in the recapitalization to induce
them to convert their remaining 14,000 shares of Series X preferred stock and to
preserve, for a period up to four years, VantagePoint’s liquidation preference
rights, which would otherwise have terminated upon such conversion. VantagePoint
will have the right to a liquidation preference on the shares of Series Z
preferred stock it holds in accordance with the terms of the Series Z preferred
stock. At the time of these transactions, two of the Company’s Directors, Mr.
Marver and Duncan Davidson, were affiliated with VantagePoint. Further, at the
time of these transactions, Mr. Yagemann, a member of the Company’s Board of
Directors through July 7, 2004, was also affiliated with
VantagePoint.





On
October 7, 2004, in exchange for the agreement by the Investors
to subordinate to Laurus their prior lien on the Company’s trade accounts
receivable in connection with the closing of the Company’s $5,000,000
convertible notes and warrant financing with Laurus, the Company issued to the
Investors warrants to purchase, in the aggregate, up to 19,143,000 shares of
common stock. These warrants: were approved by the Company’s stockholders at its
2004 Annual Meeting of Stockholders held on February 9, 2005; expire on July 18,
2006; and are exercisable solely in the event of a change of control of the
Company in which the price paid per share of common stock or the value per share
of common stock retained by the Company’s common stockholders in the change of
control transaction is less than the then current per share exercise price of
the common stock purchase warrants that were issued to the Investors in July
2003. The exercise price of these warrants will be calculated at the time of a
qualifying change of control of the Company, if any, and will be equal to the
consideration paid per share of common stock or the value per share of common
stock retained by the Company’s common stockholders in such change of control
transaction. The Investors have also been granted certain registration rights
under these newly issued warrants. As a further condition to the agreement by
the Investors to subordinate to Laurus their prior lien on certain of the
Company’s trade accounts receivable, the Company agreed to deposit the proceeds
from the convertible notes and warrant financing with Laurus into a Company
account maintained at DBTCA. The Company’s withdrawal and use of the proceeds of
the Laurus convertible note and warrant financing are subject to the prior
approval of DBTCA and of DB Advisors, as advisor to Deutsche Bank. As of March
1, 2005, the Company has received approval to withdraw and has received $3,038,000
of the $4,250,000 borrowed to date, of which





127





$2,432,000
was identified as restricted cash at December 31, 2004. As of March 1, 2005, the
Company had also received approval to draw down all of the $750,000 subject to the
revolving credit facility with Laurus. Certain of the Company’s directors
(through their affiliation with the Investors) have direct or indirect interests
in the Laurus financing transaction, as follows: (1) Mr. Davidson and Mr.
Marver, who were Directors at the time of these transactions and remain so, were
and are affiliated with VantagePoint, (2) Mr. MacMullin, who resigned from the
Company’s Board of Directors on November 19, 2004 and who was a member of the
Board at the time of the Laurus financing transaction, was, as of the time
period of the Laurus financing, affiliated with Xavier Sussex, LLC, an
investment advisory firm that has performed investment advisory services to DB
Advisors, the investment advisor to Deutsche Bank, (3) Mr. Ehrenberg, who
resigned from the Company’s Board of Directors on September 8, 2004, prior to the
closing of the Laurus financing, was a
member of the Board during the negotiation and approval of the Laurus financing
and during such time was affiliated with DB Advisors, and (4) Mr. Marshall, who
was a Director at the time of these transactions and remains so, was and is a
principal of RockRidge Capital Partners, Inc., an investment advisory firm that
has performed investment advisory services to DB Advisors.





**Item
14. Principal Accountant Fees and Services**





The total
fees and related expenses for professional services provided by the Company’s
independent registered public accounting firm, PricewaterhouseCoopers, LLP, for
the years ended 2004 and 2003 are presented in the table below. The Audit
Committee has determined that the provision of these services by
PricewaterhouseCoopers, LLP is compatible with the accountants’ independence.





2004
    
    2003Audit
      fees (1)
    
    $
    555,894
    
    $
    444,950Audit-related
      fees
    
    
    195,000
    
    
    263,000Tax
      fees
    
    
    -
    
    
    -All
      other fees
    
    
    -
    
    
    -Total
    
    $
    750,894
    
    $
    707,950





(1)
    Includes
      $287,185 for 2004 which will be paid in 2005 and $60,000 for 2003 which
      was paid in 2004.





Audit
fees include fees and expenses associated with the annual audit of the Company’s
financial statements included in the Company’s Annual Report on Form 10-K,
reviews of its quarterly reports on Form 10-Q and fees related to the audit of
the Company’s 401(k) plan. Audit related fees include fees and expenses for
accounting consultations and advice and audit services associated with certain
of the Company’s acquisitions.





**Audit
Committee’s Pre-approval Policies and Procedures**





The
Company’s Audit Committee has implemented certain policies and procedures
dealing with the pre-approval of services rendered by the Company’s independent
registered public accounting firm. The Company ’s Audit
Committee, as mandated in its current charter, must consider in advance whether
or not to approve any audit or non-audit services to be performed by the
Company’s independent registered public accounting firm, as required by
applicable rules and regulations. Further, the Chairman of the Audit Committee
has been authorized by the full Audit Committee to approve, on behalf of the
Audit Committee, the engagement of PricewaterhouseCoopers LLP, the Company’s
independent registered public accounting firm to perform





128





such
non-audit related services for the Company not covered by such firm’s audit
services engagement letter with the Company or otherwise approved by the Audit
Committee that are deemed necessary or advisable and in the best interests of
the Company in such individual’s determination, provided that the
fees paid for such non-audit services do not exceed an aggregate amount of
$75,000 in any given calendar year. Otherwise, as more fully set forth in its
charter, the Audit
Committee shall:





1.
    instruct
      the independent registered public accounting firm as to its accountability
      to, and reporting responsibility to, the Audit
  Committee;





2.
    review
      and approve the independent registered public accounting firm’s
      compensation, the proposed term of its engagement, and its independence;
      and





3.
    meet
      with the independent registered public accounting firm prior to the audit
      of the Company’s financial statements to review the planning and staffing
      of the audit and consider whether or not to approve the auditing services
      proposed to be provided.








129





**PART
IV**








**Item
15.     Exhibits and Financial Statement
Schedule**





(a)  The
following documents are filed as part of this form 10-K.





(1)
    Financial
      Statements (see “Financial Statements and Supplementary Data” at Item 8
      and incorporated herein by reference).





(2)
    Financial
      Statement Schedules -- Schedules to the Financial Statements have been
      omitted because the information required to be set forth therein is not
      applicable or is shown in the accompanying Financial Statements or notes
      thereto, except for Schedule II, Valuation and Qualifying Accounts, which
      is attached hereto.





(3)
    Exhibits.





The
following exhibits are filed as part of and incorporated by reference into this
Form 10-K:





**EXHIBIT**








**EXHIBIT**


**NO.**





2.01
    Amended
      and Restated Asset Purchase Agreement, dated as of December 11, 2002, By
      and among DSL.net, Inc., Network Access Solutions Corporation, Network
      Access Solutions LLC, NASOP, Inc. and Adelman Lavine Gold and Levin, A
      Professional Corporation, as deposit escrow agent (incorporated by
      reference to Exhibit 2.1 filed with our Form 8-K dated as of January 10,
      2003).3.01
    Amended
      and Restated Certificate of Incorporation of DSL.net, Inc., as amended
      (incorporated by reference to Exhibit 4.01 filed with our registration
      statement on Form S-8 (No. 333-89886)).3.02
    Amended
      and Restated By-laws of DSL.net, Inc. (incorporated by reference to
      Exhibit 4.02 filed with our registration statement on Form S-8 (No.
      333-89886)).3.03
    Amended
      and Restated Certificate of Incorporation of DSL.net, Inc., as amended
      (incorporated by reference to Exhibit 4.01 filed with our registration
      statement on Form S-8 (No. 333- 110131)).4.01
    Specimen
      Certificate for shares of DSL.net, Inc.’s Common Stock (incorporated by
      reference to the exhibit of corresponding number filed with our
      registration statement on Form S-1 (No. 333-80141)).4.02
    Specimen
      Certificate for shares of DSL.net, Inc.’s Series X Preferred Stock
      (incorporated by reference to Exhibit 4.01 filed with our Quarterly Report
      on Form 10-Q for the quarterly period ended September 30,
      2001).





130








4.03
    Specimen
      Certificate for shares of DSL.net, Inc.’s Series Y Preferred Stock
      (incorporated by reference to Exhibit 4.02 filed with our Form 8-K
      dated as of December 24, 2001).4.04
    Form
      of Stock Purchase Warrant dated as of October 12, 1999 between DSL.net,
      Inc. and certain investors (incorporated by reference to Exhibit 4.03
      filed with our registration statement on Form S-1 (No.
      333-96349)).4.05
    Form
      of Stock Purchase Warrant dated as of December 27, 2002 between DSL.net,
      Inc. and certain guarantors (incorporated by reference to Exhibit 4.06
      filed with our Annual Report on Form 10-K for the year ended December 31,
      2002).4.06
    Form
      of Stock Purchase Warrant dated as of March 26, 2003 between DSL.net, Inc.
      and certain guarantors (incorporated by reference to Exhibit 4.07 filed
      with our Annual Report on Form 10-K for the year ended December 31,
      2002).4.07
    Form
      of Warrant to Purchase Shares of Common Stock of DSL.net, Inc., issued in
      connection with the Note and Warrant Purchase Agreement, dated as of July
      18, 2003, by and among DSL.net, Inc. and the investors named therein
      (incorporated by reference to Exhibit 4.02 filed with our Current Report
      on Form 8-K, dated as of August 4, 2003)*.*4.08
    Form
      of Stock Purchase Warrant dated as of December 22, 2003 between DSL.net,
      Inc. and each of the VantagePoint entities.4.09
    Description
      of Capital Stock (filed as Exhibit 6 to the Registrant's Registration
      Statement on Form 8-A filed on August 3, 2004 pursuant to Section 12(b) of
      the Exchange Act and incorporated herein by reference).4.10
    Common
      Stock Purchase Warrant, dated as of August 31, 2004 between DSL.net and
      Laurus Master Fund, Ltd. (incorporated by reference to Exhibit 10.3 filed
      with our registration statement on Form S-3 (No.
    333-120264)).4.11
    Common
      Stock Purchase Warrant, dated as of October 7, 2004 between DSL.net and TN
      Capital Equities, Ltd. (incorporated by reference to Exhibit 10.4 filed
      with our registration statement on Form S-3 (No.
    333-120264)).4.12
    Form
      of Common Stock Purchase Warrant issued to certain holders of DSL.net's
      senior debt, issued by DSL.net on October 7, 2004 (incorporated by
      reference to Exhibit 10.7 filed with our registration statement on Form
      S-3 (No. 333-120264)).10.01†
    Amended
      and Restated 1999 Stock Plan (incorporated by reference to the
      exhibit of corresponding number filed with our registration statement on
      Form S-1 (No. 333-80141)).10.02†
    1999
      Employee Stock Purchase Plan (incorporated by reference to the exhibit of
      corresponding number filed with our registration statement on Form S-1
      (No. 333-80141)).10.03†
    Amended
      and Restated 2001 Stock Option and Incentive Plan (incorporated by
      reference to Exhibit 4.03 filed with our registration statement on Form
      S-8 (No. 333-89886)).10.04
    Amended
      and Restated Investors' Rights Agreement dated as of July 16, 1999 between
      DSL.net, Inc. and the purchasers named therein (incorporated by reference
      to Exhibit 10.03 filed with our registration statement on Form S-1 (No.
      333-80141)).
  131
  10.05
    Amendment
      No. 1 to Amended and Restated Investors' Rights Agreement (incorporated by
      reference to Exhibit 10.21 filed with our registration statement on Form
      S-1 (No. 333-80141)).10.06
    Lease
      Agreement dated February 5, 1999 by and between DSL.net, Inc. and Long
      Wharf Drive, LLC, as amended (incorporated by reference to Exhibit 10.07
      filed with our registration statement on Form S-1 (No.
      333-96349)).





10.07
    Amendment
      No. 1 dated June 9, 1999 to Lease Agreement by and between DSL.net, Inc.
      and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.08
      filed with our registration statement on Form S-1 (No.
      333-96349)).10.08
    Amendment
      No. 2 dated November 9, 1999 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.09
      filed with our registration statement on Form S-1 (No.
      333-96349)).10.09
    Amendment
      No. 3 dated January 20, 2000 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.10
      filed with our registration statement on Form S-1 (No.
      333-96349)).10.10
    Amendment
      No. 4 dated February 8, 2000 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.12
      filed with our Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000).10.11
    Amendment
      No. 5 dated November 12, 2001 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC. (incorporated by reference to Exhibit
      10.11 filed with our Annual Report on Form 10-K for the year ended
      December 31, 2001).10.12
    Amendment
      No. 6 to Lease, dated as of April 22, 2002, by and between DSL.net, Inc.
      and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.2 filed
      with our Quarterly Report on Form 10-Q for the quarterly period ended June
      30, 2002).10.13
    Amendment
      No. 7 to Lease, dated as of December 4, 2002, by and between DSL.net, Inc.
      and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.13
      filed with our Annual Report on Form 10-K for the year ended December 31,
      2002).10.14
    Amended
      and Restated Shareholders' Agreement, as amended, by and among DSL.net,
      Inc. and certain investors (incorporated by reference to Exhibit 10.08
      filed with our registration statement on Form S-1 (No.
      333-80141)).10.15†
    Additional
      Compensation Agreement dated as of December 29, 1998 between DSL.net, Inc.
      and David Struwas (incorporated by reference to Exhibit 10.18 filed with
      our registration statement on Form S-1 (No. 333-80141)).10.16†
    Vector
      Internet Services, Inc. 1999 Stock Option Plan (incorporated by reference
      to Exhibit 4.4 filed with our registration statement on Form S-8 (No.
      333-39016)).
  132
  10.17†
    Vector
      Internet Services, Inc. 1997 Stock Option Plan (incorporated by reference
      to Exhibit 4.5 filed with our registration statement on Form S-8 (No.
      333-39016)).10.18
    Stockholders
      Agreement dated as of December 24, 2001, by and among DSL.net and the
      Investors named therein (incorporated by reference to Exhibit 99.02 filed
      with our Form 8-K dated as of December 24, 2001).10.19
    Amendment
      No. 1 to Stockholders Agreement dated as of December 24, 2002 by and among
      DSL.net, Inc. and the investors named therein (incorporated by reference
      to Exhibit 10.27 filed with our Annual Report on Form 10-K for the year
      ended 2002).10.20
    Form
      of Senior Secured Promissory Note of DSL.net, Inc., issued in connection
      with the Note and Warrant Purchase Agreement, dated as of July 18, 2003,
      by and among DSL.net, Inc. and the investors named therein (incorporated
      by reference to Exhibit 4.01 filed with our Current Report on Form 8-K,
      dated as of August 4, 2003).10.21
    Form
      of Warrant to Purchase Shares of Common Stock of DSL.net, Inc., issued in
      connection with the Note and Warrant Purchase Agreement, dated as of July
      18, 2003, by and among DSL.net, Inc. and the investors named therein
      (incorporated by reference to Exhibit 4.02 filed with our Current Report
      on Form 8-K, dated as of August 4, 2003).10.22
    Note
      and Warrant Purchase Agreement, dated as of July 18, 2003, by and among
      DSL.net, Inc. and the investors named therein (incorporated by reference
      to Exhibit 10.01 filed with our Current Report on Form 8-K, dated as of
      August 4, 2003).10.23
    Agency,
      Guaranty and Security Agreement, dated as of July 18, 2003, by and among
      DSL.net, Inc., certain of DSL.net, Inc.’s subsidiaries, Deutsche Bank
      Trust Company Americas, as administrative agent, and the investors named
      therein (incorporated by reference to Exhibit 10.02 filed with our Current
      Report on Form 8-K, dated as of August 4, 2003).10.24
    Voting
      Agreement dated as of July 18, 2003, by and between DSL.net, Inc., the
      stockholders named therein and the investors named therein (incorporated
      by reference to Exhibit 10.03 filed with our Current Report on Form 8-K,
      dated as of August 4, 2003).10.25
    Amended
      and Restated Stockholders Agreement dated as of July 18, 2003, by and
      among DSL.net, Inc., the stockholders named therein and the investors
      named therein (incorporated by reference to Exhibit 10.04 filed with our
      Current Report on Form 8-K, dated as of August 4, 2003.10.26†
    Stock
      Option Agreement, dated April 15, 2004, between DSL.net, Inc. and Kirby G.
      Pickle (incorporated by reference to Exhibit 4.01 filed with our Quarterly
      Report on Form 10-Q, for the quarterly period ended June 30,
      2004).10.27†
    Employment
      Agreement, dated as of April 15, 2004, between DSL.net, Inc. and Kirby G.
      Pickle (incorporated by reference to Exhibit 10.01 filed with our
      Quarterly Report on Form 10-Q, for the quarterly period ended June 30,
      2004).10.28†
    Amended
      and Restated 2001 Stock Option and Incentive Plan (incorporated by
      reference to Exhibit 4.03 filed with our registration statement on Form
      S-8 (No. 333-110131)).10.29†
    Agreement,
      dated as of January 1, 2004, between DSL.net, Inc. and David F. Struwas
      (incorporated by reference to Exhibit 10.38 to our Annual Report on Form
      10-K for the year ended December 31, 2003).
  133
  10.30†
    Agreement,
      dated as of January 1, 2004, between DSL.net, Inc. and J. Keith Markley
      (incorporated by reference to Exhibit 10.39 to our Annual Report on Form
      10-K for the year ended December 31, 2003).10.31†
    Agreement,
      dated as of January 1, 2004, between DSL.net, Inc. and Robert J. DeSantis
      (incorporated by reference to Exhibit 10.40 to our Annual Report on Form
      10-K for the year ended December 31, 2003).10.32
    Second
      Amended and Restated Stockholders Agreement dated as of July 22, 2004, by
      and among DSL.net, Inc., the stockholders named therein and the investors
      named therein (incorporated by reference to Exhibit 5 filed on Form 8-A,
      dated as of August 3, 2004).10.33
    Security
      Agreement by and between DSL.net, Inc. and Laurus Master Fund, Ltd., dated
      as of August 31, 2004 (incorporated by reference to Exhibit 10.1 filed
      with our registration statement on Form S-3 (No.
    333-120264)).10.34
    Minimum
      Borrowing Note Registration Rights Agreement by and between DSL.net, Inc.
      and Laurus Master Fund, Ltd., dated as of August 31, 2004 (incorporated by
      reference to Exhibit 10.2 filed with our registration statement on Form
      S-3 (No. 333-120264)).10.35
    Minimum
      Borrowing Note issued by DSL.net, Inc. to Laurus Master Fund, Ltd. on
      August 31, 2004 (incorporated by reference to Exhibit 10.5 filed with our
      registration statement on Form S-3 (No. 333-120264)).10.36
    Secured
      Revolving Note issued by DSL.net, Inc. to Laurus Master Fund, Ltd. on
      August 31, 2004 (incorporated by reference to Exhibit 10.6 filed with our
      registration statement on Form S-3 (No. 333-120264)).10.37
    Subordination
      Agreement between DSL.net, Inc. and certain holders of DSL.net, Inc.'s
      senior debt, dated as of October 7, 2004 (incorporated by reference to
      Exhibit 10.8 filed with our registration statement on Form S-3 (No.
      333-120264)).10.38*
    Waiver
      to the Agency Agreement, dated as of October 7, 2004, by and among
      DSL.net, Inc., DSLnet Communications Puerto Rico, Inc., DSLnet
      Communications VA, Inc., Tycho Networks, Inc., Vector Internet Services,
      Inc., DSLnet Atlantic LLC, Deutsche Bank Trust Company Americas, as Agent,
      Deutsche Bank AG London, VantagePoint Venture Partners III (Q), L.P.,
      VantagePoint Venture Partners III, L.P., VantagePoint Communications
      Partners, L.P. and VantagePoint Venture Partners 1996, L.P.10.39*†
    Form
      of Compensation Agreement, dated as of February 3, 2005, between DSL.net,
      Inc. and certain named officers of DSL.net, Inc., as identified on
      Schedule A thereto.10.40*†
    Amended
      and Restated 2001 Stock Option and Incentive Plan, as amended as of
      February 9, 2005.21.01
    Subsidiaries
      of DSL.net, Inc. (incorporated by reference to Exhibit 21.01 filed with
      our Annual Report on Form 10-K for the year ended 2002).
  134
  23.01*
    Consent
      of PricewaterhouseCoopers LLP.24.01*
    Power
      of Attorney (see signature page hereto).


31.1*
    Certification
      Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    Certification
      Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.32.2*
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.







*  Filed
herewith


†  Indicates
a management contract or any compensatory plan, contract or arrangement.








135











**SIGNATURES**





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








**DSL.NET,
      INC.**Date: March 23,
2005
    By:
    */s/
      Kirby G. Pickle*Kirby G. PickleChief Executive
  Officer





POWER OF
ATTORNEY AND SIGNATURES





We, the
undersigned officers and directors of DSL.net, Inc., hereby severally constitute
and appoint Kirby G. Pickle, Robert J. DeSantis and Marc Esterman, and each of
them singly, our true and lawful attorneys, with full power to them and each of
them singly, to sign for us in our names in the capacities indicated below, any
amendments to this Annual Report on Form 10-K, and generally to do all things in
our names and on our behalf in such capacities to enable DSL.net, Inc. to comply
with the provisions of the Securities Exchange Act of 1934 and all requirements
of the Securities and Exchange Commission.





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





Signature
    Title(s)
    Date*/s
      Kirby G. Pickle*
      Kirby
      G. Pickle
    Director;
      Chief Executive Officer (Principal Executive Officer)
    March
      23, 2005*/s/
      Robert J. DeSantis*
      Robert
      J. DeSantis
    Chief
      Financial Officer
      (Principal
      Financial and Accounting Officer)
    March
      23, 2005*/s/
      Duncan Davidson*
      Duncan
      Davidson
    Director
    March
      23, 2005*/s/
      Robert Gilbertson*
      Robert
      Gilbertson
    Director
    March
      23, 2005
  136
  */s/
      Robert B. Hartnett, Jr.*
      Robert
      B. Hartnett, Jr.
    Director
    March
      23, 2005*/s/
      Paul J. Keeler*
      Paul
      J. Keeler
    Director
    March
      23, 2005*/s/
      William J. Marshall*
      William
      J. Marshall
    Director
    March
      23, 2005*/s/
      James D. Marver*
      James
      D. Marver
    Director
    March
      23, 2005










137




****
 
  **REPORT
OF INDEPENDENT** **REGISTERED
PUBLIC ACCOUNTING FIRM**
 **ON**
 **FINANCIAL
STATEMENT SCHEDULE**
 
 
 
 To the
Board of Directors and Stockholders of
 DSL.net,
Inc.:
 
 Our
audits of the consolidated financial
statements referred to in our report dated March 22, 2005 appearing in this
Annual Report Form 10-K of DSL.net, Inc. also included an audit of the financial
statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion,
this financial statement schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the
related consolidated **** financial
statements.
 
 
 
 
 PricewaterhouseCoopers
LLP
 Stamford,
CT
 March 22,
2005
 
 138


**SCHEDULE
II.     Valuation and Qualifying
Accounts**
  The
following table depicts the activity in the Company’s valuation accounts for the
years ended December 31, 2004, 2003 and 2002:
 
 (Dollars
in Thousands)
 
 Allowance
      for Doubtful AccountsYear
    Balance
      at Beginning of Period
    Additions
      Charged to Costs and Expenses
    Additions
      Charged to Purchase Accounting
    Additions
      Charged to Sales Credits and Allowances
    Additions
      Charged
      Against Valuation Allowance
    Deductions
      Charged Against Valuation Allowance
    Balance
      at End of Period2004
    $
      902
    $
      1,081
    $
      -
    $
      -
    $
      -
    $
      (1,109)
    $
      8742003
    $
      606
    $
      2,047
    $
      -
    $
      -
    $
      -
    $
      (1,751)
    $
      9022002
    $
      3,844
    $
      2,583
    $
      -
    $
      -
    $
      -
    $
      (5,821)
    $
      606Deferred
      Tax Asset Valuation AllowanceYear
    Balance
      at Beginning of Period
    Additions
      Charged to Costs and Expenses
    Additions
      Charged to Purchase Accounting
    Additions
      Charged to Sales Credits and Allowances
    Additions
      Charged
      Against Valuation Allowance
    Deductions
      Charged Against Valuation Allowance
    Balance
      at End of Period2004
    $
      116,696
    $
      -
    $
      -
    $
      -
    $,
      9,131
    $
      -
    $
      125,8272003
    $
      103,875
    $
      -
    $
      -
    $
      -
    $
      12,821
    $
      -
    $
      116,6962002
    $
      92,798
    $
      -
    $
      -
    $
      -
    $
      11,077
    $
      -
    $
      103,875
 
 139


Exhibit
Index to Annual Report on Form 10-K


for
Fiscal Year Ended December 31, 2004





**EXHIBIT**





**EXHIBIT**


**NO.**





2.01
    Amended
      and Restated Asset Purchase Agreement, dated as of December 11, 2002, By
      and among DSL.net, Inc., Network Access Solutions Corporation, Network
      Access Solutions LLC, NASOP, Inc. and Adelman Lavine Gold and Levin, A
      Professional Corporation, as deposit escrow agent (incorporated by
      reference to Exhibit 2.1 filed with our Form 8-K dated as of January 10,
      2003).3.01
    Amended
      and Restated Certificate of Incorporation of DSL.net, Inc., as amended
      (incorporated by reference to Exhibit 4.01 filed with our registration
      statement on Form S-8 (No. 333-89886)).3.02
    Amended
      and Restated By-laws of DSL.net, Inc. (incorporated by reference to
      Exhibit 4.02 filed with our registration statement on Form S-8 (No.
      333-89886)).3.03
    Amended
      and Restated Certificate of Incorporation of DSL.net, Inc., as amended
      (incorporated by reference to Exhibit 4.01 filed with our registration
      statement on Form S-8 (No. 333- 110131)).4.01
    Specimen
      Certificate for shares of DSL.net, Inc.’s Common Stock (incorporated by
      reference to the exhibit of corresponding number filed with our
      registration statement on Form S-1 (No. 333-80141)).4.02
    Specimen
      Certificate for shares of DSL.net, Inc.’s Series X Preferred Stock
      (incorporated by reference to Exhibit 4.01 filed with our Quarterly Report
      on Form 10-Q for the quarterly period ended September 30,
      2001).





140








4.03
    Specimen
      Certificate for shares of DSL.net, Inc.’s Series Y Preferred Stock
      (incorporated by reference to Exhibit 4.02 filed with our Form 8-K
      dated as of December 24, 2001).4.04
    Form
      of Stock Purchase Warrant dated as of October 12, 1999 between DSL.net,
      Inc. and certain investors (incorporated by reference to Exhibit 4.03
      filed with our registration statement on Form S-1 (No.
      333-96349)).4.05
    Form
      of Stock Purchase Warrant dated as of December 27, 2002 between DSL.net,
      Inc. and certain guarantors (incorporated by reference to Exhibit 4.06
      filed with our Annual Report on Form 10-K for the year ended December 31,
      2002).4.06
    Form
      of Stock Purchase Warrant dated as of March 26, 2003 between DSL.net, Inc.
      and certain guarantors (incorporated by reference to Exhibit 4.07 filed
      with our Annual Report on Form 10-K for the year ended December 31,
      2002).4.07
    Form
      of Warrant to Purchase Shares of Common Stock of DSL.net, Inc., issued in
      connection with the Note and Warrant Purchase Agreement, dated as of July
      18, 2003, by and among DSL.net, Inc. and the investors named therein
      (incorporated by reference to Exhibit 4.02 filed with our Current Report
      on Form 8-K, dated as of August 4, 2003)*.*4.08
    Form
      of Stock Purchase Warrant dated as of December 22, 2003 between DSL.net,
      Inc. and each of the VantagePoint entities.4.09
    Description
      of Capital Stock (filed as Exhibit 6 to the Registrant's Registration
      Statement on Form 8-A filed on August 3, 2004 pursuant to Section 12(b) of
      the Exchange Act and incorporated herein by reference).4.10
    Common
      Stock Purchase Warrant, dated as of August 31, 2004 between DSL.net and
      Laurus Master Fund, Ltd. (incorporated by reference to Exhibit 10.3 filed
      with our registration statement on Form S-3 (No.
    333-120264)).4.11
    Common
      Stock Purchase Warrant, dated as of October 7, 2004 between DSL.net and TN
      Capital Equities, Ltd. (incorporated by reference to Exhibit 10.4 filed
      with our registration statement on Form S-3 (No.
    333-120264)).4.12
    Form
      of Common Stock Purchase Warrant issued to certain holders of DSL.net's
      senior debt, issued by DSL.net on October 7, 2004 (incorporated by
      reference to Exhibit 10.7 filed with our registration statement on Form
      S-3 (No. 333-120264)).10.01†
    Amended
      and Restated 1999 Stock Plan (incorporated by reference to the
      exhibit of corresponding number filed with our registration statement on
      Form S-1 (No. 333-80141)).10.02†
    1999
      Employee Stock Purchase Plan (incorporated by reference to the exhibit of
      corresponding number filed with our registration statement on Form S-1
      (No. 333-80141)).10.03†
    Amended
      and Restated 2001 Stock Option and Incentive Plan (incorporated by
      reference to Exhibit 4.03 filed with our registration statement on Form
      S-8 (No. 333-89886)).10.04
    Amended
      and Restated Investors' Rights Agreement dated as of July 16, 1999 between
      DSL.net, Inc. and the purchasers named therein (incorporated by reference
      to Exhibit 10.03 filed with our registration statement on Form S-1 (No.
      333-80141)).
  141
  10.05
    Amendment
      No. 1 to Amended and Restated Investors' Rights Agreement (incorporated by
      reference to Exhibit 10.21 filed with our registration statement on Form
      S-1 (No. 333-80141)).10.06
    Lease
      Agreement dated February 5, 1999 by and between DSL.net, Inc. and Long
      Wharf Drive, LLC, as amended (incorporated by reference to Exhibit 10.07
      filed with our registration statement on Form S-1 (No.
      333-96349)).





10.07
    Amendment
      No. 1 dated June 9, 1999 to Lease Agreement by and between DSL.net, Inc.
      and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.08
      filed with our registration statement on Form S-1 (No.
      333-96349)).10.08
    Amendment
      No. 2 dated November 9, 1999 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.09
      filed with our registration statement on Form S-1 (No.
      333-96349)).10.09
    Amendment
      No. 3 dated January 20, 2000 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.10
      filed with our registration statement on Form S-1 (No.
      333-96349)).10.10
    Amendment
      No. 4 dated February 8, 2000 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.12
      filed with our Annual Report on Form 10-K for the fiscal year ended
      December 31, 2000).10.11
    Amendment
      No. 5 dated November 12, 2001 to Lease Agreement by and between DSL.net,
      Inc. and Long Wharf Drive, LLC. (incorporated by reference to Exhibit
      10.11 filed with our Annual Report on Form 10-K for the year ended
      December 31, 2001).10.12
    Amendment
      No. 6 to Lease, dated as of April 22, 2002, by and between DSL.net, Inc.
      and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.2 filed
      with our Quarterly Report on Form 10-Q for the quarterly period ended June
      30, 2002).10.13
    Amendment
      No. 7 to Lease, dated as of December 4, 2002, by and between DSL.net, Inc.
      and Long Wharf Drive, LLC (incorporated by reference to Exhibit 10.13
      filed with our Annual Report on Form 10-K for the year ended December 31,
      2002).10.14
    Amended
      and Restated Shareholders' Agreement, as amended, by and among DSL.net,
      Inc. and certain investors (incorporated by reference to Exhibit 10.08
      filed with our registration statement on Form S-1 (No.
      333-80141)).10.15†
    Additional
      Compensation Agreement dated as of December 29, 1998 between DSL.net, Inc.
      and David Struwas (incorporated by reference to Exhibit 10.18 filed with
      our registration statement on Form S-1 (No. 333-80141)).10.16†
    Vector
      Internet Services, Inc. 1999 Stock Option Plan (incorporated by reference
      to Exhibit 4.4 filed with our registration statement on Form S-8 (No.
      333-39016)).10.17†
    Vector
      Internet Services, Inc. 1997 Stock Option Plan (incorporated by reference
      to Exhibit 4.5 filed with our registration statement on Form S-8 (No.
      333-39016)).
  142
  10.18
    Stockholders
      Agreement dated as of December 24, 2001, by and among DSL.net and the
      Investors named therein (incorporated by reference to Exhibit 99.02 filed
      with our Form 8-K dated as of December 24, 2001).10.19
    Amendment
      No. 1 to Stockholders Agreement dated as of December 24, 2002 by and among
      DSL.net, Inc. and the investors named therein (incorporated by reference
      to Exhibit 10.27 filed with our Annual Report on Form 10-K for the year
      ended 2002).


10.20
    Form
      of Senior Secured Promissory Note of DSL.net, Inc., issued in connection
      with the Note and Warrant Purchase Agreement, dated as of July 18, 2003,
      by and among DSL.net, Inc. and the investors named therein (incorporated
      by reference to Exhibit 4.01 filed with our Current Report on Form 8-K,
      dated as of August 4, 2003).10.21
    Form
      of Warrant to Purchase Shares of Common Stock of DSL.net, Inc., issued in
      connection with the Note and Warrant Purchase Agreement, dated as of July
      18, 2003, by and among DSL.net, Inc. and the investors named therein
      (incorporated by reference to Exhibit 4.02 filed with our Current Report
      on Form 8-K, dated as of August 4, 2003)*.*10.22
    Note
      and Warrant Purchase Agreement, dated as of July 18, 2003, by and among
      DSL.net, Inc. and the investors named therein (incorporated by reference
      to Exhibit 10.01 filed with our Current Report on Form 8-K, dated as of
      August 4, 2003).10.23
    Agency,
      Guaranty and Security Agreement, dated as of July 18, 2003, by and among
      DSL.net, Inc., certain of DSL.net, Inc.’s subsidiaries, Deutsche Bank
      Trust Company Americas, as administrative agent, and the investors named
      therein (incorporated by reference to Exhibit 10.02 filed with our Current
      Report on Form 8-K, dated as of August 4, 2003).10.24
    Voting
      Agreement dated as of July 18, 2003, by and between DSL.net, Inc., the
      stockholders named therein and the investors named therein (incorporated
      by reference to Exhibit 10.03 filed with our Current Report on Form 8-K,
      dated as of August 4, 2003).10.25
    Amended
      and Restated Stockholders Agreement dated as of July 18, 2003, by and
      among DSL.net, Inc., the stockholders named therein and the investors
      named therein (incorporated by reference to Exhibit 10.04 filed with our
      Current Report on Form 8-K, dated as of August 4, 2003.10.26†
    Stock
      Option Agreement, dated April 15, 2004, between DSL.net, Inc. and Kirby G.
      Pickle (incorporated by reference to Exhibit 4.01 filed with our Quarterly
      Report on Form 10-Q, for the quarterly period ended June 30,
      2004)*.*10.27†
    Employment
      Agreement, dated as of April 15, 2004, between DSL.net, Inc. and Kirby G.
      Pickle (incorporated by reference to Exhibit 10.01 filed with our
      Quarterly Report on Form 10-Q, for the quarterly period ended June 30,
      2004).10.28†
    Amended
      and Restated 2001 Stock Option and Incentive Plan (incorporated by
      reference to Exhibit 4.03 filed with our registration statement on Form
      S-8 (No. 333-110131)).
  143
  10.29†
    Agreement,
      dated as of January 1, 2004, between DSL.net, Inc. and David F. Struwas
      (incorporated by reference to Exhibit 10.38 to our Annual Report on Form
      10-K for the year ended December 31, 2003).10.30†
    Agreement,
      dated as of January 1, 2004, between DSL.net, Inc. and J. Keith Markley
      (incorporated by reference to Exhibit 10.39 to our Annual Report on Form
      10-K for the year ended December 31, 2003).10.31†
    Agreement,
      dated as of January 1, 2004, between DSL.net, Inc. and Robert J. DeSantis
      (incorporated by reference to Exhibit 10.40 to our Annual Report on Form
      10-K for the year ended December 31, 2003).10.32
    Second
      Amended and Restated Stockholders Agreement dated as of July 22, 2004, by
      and among DSL.net, Inc., the stockholders named therein and the investors
      named therein (incorporated by reference to Exhibit 5 filed on Form 8-A,
      dated as of August 3, 2004).10.33
    Security
      Agreement by and between DSL.net, Inc. and Laurus Master Fund, Ltd., dated
      as of August 31, 2004 (incorporated by reference to Exhibit 10.1 filed
      with our registration statement on Form S-3 (No.
    333-120264)).10.34
    Minimum
      Borrowing Note Registration Rights Agreement by and between DSL.net, Inc.
      and Laurus Master Fund, Ltd., dated as of August 31, 2004 (incorporated by
      reference to Exhibit 10.2 filed with our registration statement on Form
      S-3 (No. 333-120264)).10.35
    Minimum
      Borrowing Note issued by DSL.net, Inc. to Laurus Master Fund, Ltd. on
      August 31, 2004 (incorporated by reference to Exhibit 10.5 filed with our
      registration statement on Form S-3 (No. 333-120264)).10.36
    Secured
      Revolving Note issued by DSL.net, Inc. to Laurus Master Fund, Ltd. on
      August 31, 2004 (incorporated by reference to Exhibit 10.6 filed with our
      registration statement on Form S-3 (No. 333-120264)).10.37
    Subordination
      Agreement between DSL.net, Inc. and certain holders of DSL.net, Inc.'s
      senior debt, dated as of October 7, 2004 (incorporated by reference to
      Exhibit 10.8 filed with our registration statement on Form S-3 (No.
      333-120264)).10.38*
    Waiver
      to the Agency Agreement, dated as of October 7, 2004, by and among
      DSL.net, Inc., DSLnet Communications Puerto Rico, Inc., DSLnet
      Communications VA, Inc., Tycho Networks, Inc., Vector Internet Services,
      Inc., DSLnet Atlantic LLC, Deutsche Bank Trust Company Americas, as Agent,
      Deutsche Bank AG London, VantagePoint Venture Partners III (Q), L.P.,
      VantagePoint Venture Partners III, L.P., VantagePoint Communications
      Partners, L.P. and VantagePoint Venture Partners 1996, L.P.10.39*†
    Form
      of Compensation Agreement, dated as of February 3, 2005, between DSL.net,
      Inc. and certain named officers of DSL.net, Inc., as identified on
      Schedule A thereto.10.40*†
    Amended
      and Restated 2001 Stock Option and Incentive Plan, as amended as of
      February 9, 2005.21.01
    Subsidiaries
      of DSL.net, Inc. (incorporated by reference to Exhibit 21.01 filed with
      our Annual Report on Form 10-K for the year ended 2002).
  144
  23.01*
    Consent
      of PricewaterhouseCoopers LLP.24.01*
    Power
      of Attorney (see signature page
hereto).




31.1*
    Certification
      Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    Certification
      Pursuant to Rule 13a-14(a) of the Exchange Act, as Adopted Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.32.2*
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.




*
    Filed
      herewith




†
    Indicates
      a management contract or any compensatory plan, contract or arrangement.





145